Addressing Country Risk in the Boardroom
At a board meeting of a top 10 multinational corporation, the question of whether to invest $80 million in a project in an African country was discussed. The president of the company subsidiary seeking the board’s approval insisted that the country was a safe place to invest because of its recent history of economic and political stability. Satisfied with the president’s assurances and facts, the board approved the investment -- a decision they came to regret. As it turns out, the country in question was not as stable as it was portrayed and the company’s investment became tied up in costly legal limbo, which has had far-reaching and potentially damaging implications for the company’s brand and reputation.
To make matters worse, the interests of some of the actors involved were not directly aligned with those of the company. The corporate underwriters were incentivized to promote the deal internally so they could meet their production targets. And while the underwriters sought the views of the country risk manager charged with vetting the transaction, a large portion of that analysis was deleted from the final version that was sent to the corporate risk manager for final approval before being given to the president. Neither the corporate risk manager, the president nor the board of directors knew this had happened, and believed all necessary approvals had been obtained in the manner previously mandated by the board.
As is illustrated by this real example, companies often rely exclusively on their own risk management processes, which they believe are bullet proof, but which may in fact be riddled with holes, inconsistencies and contradictions. Clearly, the company’s risk management function and, more specifically, the final version of the country risk analysis, were faulty. Without data or insight of its own, the board was too reliant on the company’s assessment to make an effective decision and fulfill its duty to protect the interests of the company and shareholders.
If the board had been better educated about the economic, social, media and political situation in that country, it may have been able to identify the errors in the assessment it received. The board may then have forced the company to conduct more thorough due diligence before taking a vote, rejected the request outright or made the approval conditional on receipt of the company’s plans to mitigate and address the potential risks. This is where the training department can add value, assisting not just in terms of knowledge management, but through knowledge sharing.
This example is just one where the due diligence process in place failed to alert decision makers to the risks associated with their international business operations. In the last several years a number of high-profile international investments have faced serious unanticipated obstacles to success. For example, a prominent private equity firm’s ability to monetize its investment in a Korean bank was jeopardized by political and popular resistance; a Middle Eastern port operator’s management of a U.S. asset was derailed by political opposition; an Australian’s mining company’s executives were jailed in China; a major beverage manufacturer’s products faced concerted rumors of contamination in South Asia; and, there have been numerous nationalizations among multiple industries in Bolivia, Ecuador and Venezuela.
As company operations and holdings continue to expand into all corners of the globe, decision makers too often pay too little attention to specific country risks and other matters of crucial importance. Boards of directors are particularly vulnerable to this glaring oversight due mainly to a lack of direct insight into a particular country -- which leads to an inability to discern fact from fiction -- and not knowing the right questions to ask of corporate management. Training for board members helps here, too.
How can boards make better decisions with respect to country risks? One place to start is in the composition of the board itself. Too often, board members are selected from a small group of high-profile, well-connected and prestigious individuals who may not have relevant experience in foreign investments or operations, and who may not want to appear ignorant about a subject matter being discussed, so they may fail to contribute meaningfully to board discussions. Company management should emphasize experience and knowledge when selecting board members. That said, it is difficult, if not impossible to find individuals who have direct and timely experience in every country that may be an investment target for a large corporation. For this reason, it is particularly important that new board members become engaged in the learning process at the earliest opportunity.
Another solution is for boards of directors to press companies to regularly update their own risk management procedures and insist on instituting appropriate checks and balances. Given the competing interests that may influence an internal risk management team, a better solution is to look outside of the company’s country risk management function and insist that either the company hire an independent third-party assessor or, ideally, do so themselves. A qualified third-party can conduct regular risk management audits that test and stress the system, provide insights into the target country that incorporate political, economic and social risk, and thus can provide board members with unbiased information, empowering them to ask the right questions.
Ultimately, a company’s and board’s ability to successfully address risk rests with the establishment of a sound risk management process that creates an environment conducive to effectively managing risk. An essential place to start is to establish an effective in-house process to analyze country risk. This should include: a) country exposure limits and an accurate system for reporting country exposures, b) a country risk rating system, and c) regular monitoring of country conditions.
Adequate internal controls and an audit function can give management the ability to stress test foreign exposures and engage in scenario planning. It is important to establish clear tolerance limits, delineate clear lines of responsibility and accountability for decisions made, and identify in advance desirable and undesirable types of business to be engaged in. Policies, standards, and practices should be clearly communicated, and enforced, with affected staff and offices. At least quarterly reporting should be imposed — more frequently if foreign exchange exposure impacts a given investment.
Regardless of the course that a board may choose to make better decisions, there are a number of factors they must consider in addition to the straight financial, legal and regulatory assessments:
- The political landscape, including election schedules, the current government’s composition and the strength and platform of the opposition;
- The media landscape, including the editorial position of the leading dailies as well as of the most popular and populist outlets;
- The relative strength and fervency of advocacy groups, including labor unions and non-governmental organizations;
- The target country’s relationship with and attitude towards foreign investment and the company’s country of origin; and
- The regional political and economic climate.
When looking at these different data points, a board will be better attuned to the potential for unexpected obstacles and problems and can look for warning signs -- some more obvious than others. Among these are a highly contested and partisan upcoming election, a strong nationalistic orientation in popular media and a history of crippling labor actions.
When gathering and managing information, it is best to utilize information from a variety of sources, identify the central themes that keep reappearing and make a judgment about the nature of the risk. This should not be done in a vacuum, however; training has an integral role to play. The underwriting and pricing process should be viewed as collaborative, seeking the affirmation of others in the decision-making chain.
Unfortunately, even when a problem is identified, boards are sometimes reluctant to confront management. Candor often gets lost in the politeness of board proceedings, and too often boards are focused on building consensus, which inhibits due diligence and proper risk management. By remaining polite and silent, boards can do more than contribute to monetary losses and they may unwittingly cause reputational risk, often with long lasting and severe consequences. Therefore, board members must exercise their responsibilities with renewed vigor and with a solid base of knowledge and insight. If that had been the case with the company described above, the outcome would have been much different.
The Role of the Educator
That’s where the role of the educator is crucial. Since the vast majority of international companies have either little, or no, indigenous capability to monitor and makes sense of country risk, training middle management, senior management and the board to become informed and ask the right questions can make all the difference between engaging in ill fated cross-border adventures versus sensible, measured and smart investment decisions. The business world is in dire need of such education – even if it doesn’t realize it.
Daniel Wagner is CEO of Country Risk Solutions, a cross-border risk management consultancy based in Connecticut (USA), Director of Global Strategy with the PRS Group and author of the forthcoming book Managing Country Risk (March 2012).
Written for TrainingIndustry.com