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1 October 2015 CFA Institute Journal Review

Political Risk and the Commercial Sector—Aligning Theory and Practice (Digest Summary)

  1. Derek Bilney, CFA

Traditionally, risk managers have not adopted the theories and methods used by political scientists when analyzing political risk in a commercial setting. Likewise, the political science field has been reticent to embrace the tools of traditional risk management when explaining international relations. But both areas could benefit from acknowledging and using this mutual and considerable overlap.

What’s Inside?

Political risk has long been identified as a key risk in the activities of commercial organizations. But the tools used to measure and monitor this risk have generally been quite crude and have not used the models embraced by the field of political science. The author provides a high-level overview that looks at the considerable overlap between commercial risk management and the field of international relations and illustrates how both fields could benefit from adopting ideas from each other.

How Is This Research Useful to Practitioners?

This article would be of particular interest to the risk management and strategic development divisions of most commercial organizations (both financial and nonfinancial) because it provides insight into how the theories of political science, in particular international relations and foreign policy analysis, can be integrated into a traditional risk management framework. The author conducted a survey of relevant political science literature with application to the management of political risk in a commercial environment. Unlike areas of financial risk management, the methods are more theoretical and do not easily lend themselves to quantification.

How Did the Author Conduct This Research?

The author provides a high-level framework that highlights the potential overlap between the traditionally crude approach to understanding and managing political risk used by commercial organizations and the more theoretical approach adopted by political scientists. He begins by outlining current risk management practice as it pertains to political risk. Political risk is defined as the potential harm to commercial activities caused by political action or arising from dysfunctional political systems. Examples of risk mitigation actions are then described, noting that, as with all risks, political risk can be assessed by considering the probability and consequences of an adverse event. The author then proceeds to describe some of the theoretical models adopted by political scientists and suggests ways that these models can be applied to the more practical problems faced by risk managers in a commercial environment.

Abstractor’s Viewpoint

Large corporate organizations appreciate the concept of political risk and attempt to manage this risk as best they can. At the domestic level, one approach often used is government lobbying. Lobbyists operate in most countries, ensuring that legislators are fully aware of the issues facing business and the need to protect incumbency and discourage business disrupters. But this approach is arguably less successful with foreign governments that may have a natural suspicion of “outsiders.” Most companies struggle to define and articulate strategies to manage political risk. To be fair, in some cases political risk involves an all-or-nothing scenario; if a government removes a company’s license to operate in a particular jurisdiction, then it is difficult to hedge this risk. The author does not suggest that there are any easy answers but does highlight that commercial organizations could benefit from a stronger understanding of the key themes of political science.

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