Importance of managing political risk in IPOs

Recent research related to political risk management in IPOs consider political risks as one of the major concerns (Voelker et al. 2008; Zhang & Wei 2012; Han et al. 2018) which play a crucial role for the international projects’ success and investment decisions particularly in the context of emerging markets (Meschi 2005; Sachs 2006; Kardes et al. 2013; Voelker et al.

2008; Han et al. 2018). Sachs (2006) and Voelker et al. (2008) argued political risks in the Asian emerging markets as an uncertain, vague and uncontrollable risk element which represent a negative correlation among perceived level of political risks, PPP opportunities and investment desire into these markets. However, Kardes et al. (2013) submit that even though global megaprojects are swamped with various risks including those of the political risks, the success rate of global megaprojects can be assured by adopting proper risk management approach and by following the best practices.

On the other hand, Zhang & Wei (2012) highlight the importance of managing political risks in IPOs by categorizing the possible negative impact of political risks on MNCs’ local investments. Zhang & Wei (2012) and Han et al. (2018) outline that because of the negative impact of political risks, MNCs can realize the following negative outcomes in their international investments;

1) Direct financial loss and injury or death of local and expat employees (e.g., Strikes or political turmoil, terrorism attacks, violence, etc.) (Zhang & Wei 2012).

2) MNCs’ ability to continue IPOs in local and global markets (e.g., Reputational crisis, country of origin effects and hand of home country government) (Han et al. 2018).

3) Profit loss because of extra expenses to adjust the unexpected costs into the operational plan (e.g., the ambiguity in the rent creation and rent extraction by government regulation, etc.) (Zhang & Wei 2012).

Furthermore, Harms (2002), Economist Intelligence Unit (2007) and Zhang & Wei (2012) conclusively argue that political risks have negative effects on MNCs’ profit maximization ability in their IPOs. On a similar research stance, Diamonte et al., (1996), Perotti & Van Oijen (2001) and Lehkonen & Heimonen (2015) collectively argue that democracy and underlying political risks in the emerging markets have statistically significant correlation with

international firms’ investments and stock market returns. In this instance, research results indicate that higher stock market investment returns are resulted from decreasing political risks in the emerging markets (Lehkonen & Heimonen 2015).

To evident the underlying importance of overall project risk management (may include political risk management) Royers (2000) and Lyons & Skitmore (2004) argued that risk management ought to be considered as an integral part of the overall project management as often unmanaged risks lead to higher chances of project failure. This conclusion is also elaborated in one of 10 project management knowledge areas (i.e., Project risk management) as defined by PMI’s PMBOK® Guide (2017).

Concurrently, Hwang et al. (2014) argue that a formalized and standardized risk management process throughout the entire course of the PLC of a small project enable project managers’

to develop a strong risk awareness and ensure proper flow of risk management information among various teams which facilitate the execution of adopted risk management strategies.

Nevertheless, in general terms, proper risk management in small projects have demonstrated positive correlation between risk implementation and project performance (i.e., project quality, cost and schedule/budget), and risk management was considered to be significantly important for the overall success of small construction projects in Singapore (Hwang et al.

2014).

Evidently, this study acknowledges various previous research that demonstrated the benefits of overall risk management in the infrastructure construction projects, such as Mok et al.

(1997) and Mills (2001) argued that proper risk management enhances cost estimation and decision making qualities in construction projects. Klemetti (2006) submitted proper risk management reduces transaction costs and improves risk allocation ability of a construction firm. Conversely, risk management ensures project completion on agreed time and within allocated schedule/budgets (Ali 2000).

However, a few studies such as Zhang & Wei’s (2012) provides an extensive review of the importance of managing political risk in international infrastructure development project operations in an emerging market such as the Libyan construction industry. In their study, Zhang & Wei (2012) as demonstrated in table 8, outlines a number of intangible and tangible

losses that some 75 Chinese MNCs had to go through for not having a proper political risk management approach in Libya.

Table 8. Different intangible and tangible losses faced by the Chinese MNCs in the Libyan construction industry. (Adapted from Zhang & Wei 2012).

Type of loss Element

Intangible Contract value loss

Expenses to evacuate and rearrange jobs for the expatriate employees Negative business reputations and image crisis

Future high costs in insurance

Future stressful political risk management Tangible Suspension of contracted projects

Robbery and severe damage to property and equipment Death and serious injuries of employees

Evacuation of the expatriate employees

Thus this study concurs with the empirical research evidence of Zhang & Wei (2012) and Hwang et al. (2014) to reinstate that it is critically important to manage political risks in IPOs in order to avoid the mentioned intangible and tangible losses and to improve project performance (i.e., project quality, cost and schedule/budget).

Although it is beyond the scope of this study to discuss the positive side effects of political risks for international project companies in a host-country situation, however, this study acknowledges the empirical evidence of Booth (1993) and Hadjikhani (1998) who argue that political risks do also have positive side effects for international firms provided that these firms choose to adopt a so-called ‘sleeping strategy’ particularly in an empty turbulent market to increasemarket imperfection when all of the competitors have gone away because of the extreme political risks’ exposure.