By Stephen J. Morgan, A Philadelphia area freelance writer and frequent contributor to the magazine
Investing in Emerging Markets Can be
Profitable, but Risky. Wharton's
Witold Henisz Sheds Light on how
Government Actions Can Wreak Havoc
on Businesses That Invest Overseas
When Witold J. Henisz was a boy, his parents told him stories–stories of what it was like to live under communist
rule in Poland. His mother and father, both
physicians, eventually left their native land, but only after years
of waiting for the right opportunity.
The government, not wanting a brain drain to the West,
made it difficult for citizens, especially professionals, to leave
the country. Henisz’ parents were restricted to traveling separately
to medical conferences.
“Then, after a couple of years of going abroad, they were
allowed to travel together,” says Henisz, assistant professor of
management. “They drove down from Poland to meet a friend
in Italy and left from Italy to JFK (airport) in New York.”
They had $100 in their pockets.
That was in 1969, when Henisz (pronounced HEN-ish)
was a little more than a year old. In the years that followed, his
parents told him tales of how Poland’s command-and-control
economic system was stifling. “It was a very strong recurring
theme about how incentives weren’t provided by the system,”
Henisz tells a visitor at his office in Steinberg Hall-Dietrich
Hall. “The government could backtrack on anything it said,
and it could be arbitrary in its behavior. There was this filter
that everything sort of had to travel through within the communist
party’s view before it could get to individuals, and that
imposed distortions.”
It is not surprising then that Henisz - who joined Wharton
in 1998 and is known by the nickname Vit (pronounced
VEET) – today devotes his research to the topic of political risk.
Henisz, who earned a doctoral degree at the University of California
at Berkeley in 1998 after working for a time at the International
Monetary Fund in Washington, analyzes how arbitrary
government actions can wreak havoc on businesses that invest
large sums of money in countries other than their own.
Much At Stake
Henisz says much is at stake for firms that fail to conduct thorough
political-risk analysis. In a paper titled “Political Risk and
Infrastructure Investment,” Henisz and co-author Bennet A.
Zelner, of the McDonough School of Business at Georgetown
University, cite World Bank figures showing that infrastructure
spending in developing countries exceeds $200 billion a year.
But foreign businesses are having trouble making profits in
these markets. The authors point to a report by Merchant
International Group, a risk consultancy based in the United
Kingdom, which surveyed 7,500 multinational corporations
and found that 84 percent of their operations spawned in
emerging markets from 1995 to 1998 failed to meet financial
targets. Risks in emerging markets cost multinationals an estimated
$24 billion in 1998 alone, or between eight and 10 percent
of total expected returns.
“A huge amount of financial resource and management
time is lost each year as a result of inadequate research and
analysis prior to embarking into a non-domestic market,” the
Merchant study notes. It goes on to say that techniques for
“identifying and evaluating hidden risks will need to become
more sophisticated.”
Henisz’ work is intended to aid companies in honing their
risk-analysis techniques. His research is based on in-depth
analyses of electricity generation and telecommunications, but
is applied to a broad range of manufacturing and service industries.
Risk analysis is especially critical in those two industries
because forays into foreign markets involve large sunk costs,
substantial economies of scale and pricing structures that can
become highly controversial and politicized.
The concept of assessing political risk is nothing new to corporations.
If a firm is considering investing in a foreign country,
its leaders want to know everything they can about the
national and local governments with which they will have to
deal. A company wants to be able to assess with the highest
degree of certainty the stability of current policies and how likely
they are to change.
Traditionally, firms have analyzed political stability by
examining macroeconomic factors, such as the rate of economic
growth or unemployment; by using political science
measures, such as democracy or stability; or by relying on
the subjective judgments of how managers perceive risk in a
given nation.
A New Approach
What makes Henisz’ research different is that it aims to quantify
— in an objective, consistent and internationally comparable
way — how risks vary from country to country.
Specifically, Henisz explores how easy or difficult it is for governments
to change policies. In addition, if a government does
change a law or regulation, Henisz says investors need to know
whether the shift will be beneficial or harmful to them. His
work, with Zelner’s, addresses this issue too.
“Researchers have increasingly focused on the question
of credible commitments by governments in the past five to
10 years, but the tools to measure this commitment haven’t
existed,” Henisz explains. “Researchers have latched onto
certain measures, such as whether a country is democratic
or autocratic. But some democracies can be really unstable
and some autocracies can be relatively stable and really friendly
to investors.”
He says Russia, which has a strong democratic constitution
but is characterized by extreme political uncertainty, is an
example of how even a democracy can pose challenges to
potential investors seeking a certain amount of political consistency.
On the other hand, Singapore is a non-democratic
nation but is considered investor-friendly.
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