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Political risk is the risk an investment's returns could suffer as a result of political changes or instability in a country. Instability affecting investment returns could stem from a change in government, legislative bodies, other foreign policy makers or military control.
A Multinational Firm could reduce political Risk by first of all doing a risk assessment to determine the level of risk involved in doing business in a particular country, then they will have the informed option to not set up operations in countries that are considered to be political risk hot spots. Other ways are political risk insurance where the firm pays some premium. Multinational companies can go to one of the many organizations that specialize in selling political risk insurance and purchase a policy that would compensate them if an adverse event occurred. In this case premium rates depend on the country, the industry, the number of risks insured and other factors, the cost of doing business in one country may vary considerably compared to another.
Other ways are dealing with risks on an ongoing basis where leaders or executives of Multinational companies need to come to terms with the fact that they won't be able to identify every political risk. Consequently they need to have exit plan or strategies and evaluate alternative investment options on an ongoing basis, especially as they invest more and more money into infrastructure in those areas.
A Multinational Firms can also diversify political risks. Firms that have strategic business units in various geographies need to acknowledge their cost base, and that some regions that look very attractive might also carry high political risk. For example, if you plan to move into Nigeria there may be ‘some’ political risk, but at the same time cheap materials and resources are available to those firms too. This implies that there is a trade off, and leaders should look at their costs and benefits of diversifying their strategic business units throughout different regions. Multinational Firms should not put all their eggs in one basket.
