International Financial Management

On May 1, 2007, which is a traditional day for celebrating socialist causes, Venezuelan President Hugo Chavez announced that operating control of Venezuelan oil fields would transfer from international oil companies, such as Exxon Mobil and ConocoPhillips of the United States, France's Total, Norway's Statoil, and Britain's BP, to Venezuela's government-owned oil company, Petroleos de Venezuela SA (PDVSA). This action was a realization of political risk, which is the risk that a government action will negatively affect a company's cash flows. In its most extreme form, governments seize property without compensating the owners in a total expropriation (or nationalization). Venezuela offered some compensation, but Exxon Mobil and ConocoPhillips rejected the terms and filed compensation claims with the World Bank's arbitration panel. In 2014, the World Bank's international court awarded Exxon Mobil $1.6 billion in damages while the ConocoPhillips case is still pending although some of ConocoPhillips's claims were declared legitimate in a 2013 decision on the merits of the case.

Country risk is a broader concept that encompasses both the potentially adverse effects of a country's political environment and its economic and financial environment. Understanding country risk and political risk is an important aspect of international capital budgeting and managing operations in other countries, especially developing countries.

This chapter discusses these risks and examines how they can be measured. It also explains which risks are diversifiable and which are not. Finally, it explores how multinationals, such as the international oil companies, manage the risks.

Country Risk Versus Political Risk

This section explores the general differences between country risk and political risk. We begin with the broader concept of country risk.

Country Risk

Country risk includes the adverse political and economic risks of operating in a country. For example, a recession in a country that reduces the revenues of exporters to that nation is a realization of country risk. Labor strikes by a country's dockworkers, truckers, and transit workers that disrupt production and distribution of products, thus lowering profits, also qualify as country risks. Clashes between rival ethnic or religious groups that prevent people in a country from shopping can also be considered country risks.