Political risk stems from the threat of unexpected host government actions that adversely affect firms’ overseas performance (Brewer, 1985; Kobrin, 1979). The predominant approach that has been used to understand political risk is based on the relative bargaining power between a firm and a government, with foreign firms facing political risk when they lose bargaining power relative to the host government (Kobrin, 1987; Vachani, 1995; Vernon, 1971). The set of core assumptions underlying this approach includes the following: (a) the host government is fundamentally antagonistic towards foreign firms, due to distrust relating to their “foreignness,” (b) the host government is an opportunistic actor that intervenes whenever it has the ability to do so, and (c) bargaining is a zero-sum game where the host government ‘wins’ by taking over the foreign firm’s profits or property (Eden, Lenway, & Schuler, 2005). These assumptions, however, are no longer valid in the context of globalization, reducing the explanatory power of the bargaining power approach to political risk. The competitive forces brought about by globalization have intensified the co-dependence of host governments and foreign firms, reducing the benefits of opportunistic intervention and a zero-sum mindset (Dunning, 1997; Luo, 2001). In this enhanced competitive environment, I expect host governments to have more long-term and complex concerns with regard to foreign firms (Kobrin, 2005), that change the underpinnings of political risk. In light of this, in this dissertation I outline an alternative approach to political risk based on the perception of legitimacy by the government towards foreign firms.
First, I review the literature, argue for the need for a new theory of political risk, and create the conceptual model that provides the foundation for this legitimacy-based approach to political risk. Next, I present empirical tests of this new theoretical approach to political risk. To test my hypotheses, I examine the local activities of U.S. multinational firms’ foreign subsidiaries in 13 industries within 53 host countries over a time period of 2000 to 2006, representing the most recent years for which data are available. My measure of political risk captures the unexplained performance volatility of these subsidiaries due to the political environment (Click, 2005), at the industry level.
My results indicate broad support for the legitimacy-based approach for explaining systematic variance in political risk. They also indicate broad support for my proposition that political risk in a given industry is based on how the activities of firms in that industry compare to salient within- or across-country comparison groups. Furthermore, I find support for the argument that activities relating to broader, national-level goals such as employment, export intensity, and fixed capital formation are best predicted using within-country comparison groups while across-country comparison groups are more salient for predicting intervention associated with more focused industry-specific goals relating to R & D intensity, wages, and profitability.