Country Risk Management: Removing Board Blinders
September 2009
At a board meeting of a top 20
multinational corporation, the question of whether to invest $50
million in a project in a Middle Eastern country was discussed.
The president of the company's subsidiary who was 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.
by
Daniel Wagner
Country Risk Solutions and PFC Global Risk
and Jack Gutt
Kreab Gavin Anderson
As it turns out, the country in question was not as stable as
it was portrayed and the company's investment is now 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 went 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.
Inherent Failure of Internal Risk Analysis
This is just one example where the due diligence process in place
failed to alert decision makers to the risks associated with their
international business operations. As is illustrated by this real
example, companies often rely exclusively on their own risk management
processes, which they believe are bulletproof, 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 requesting 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.
Problem Areas
The above example is far from extraordinary. In the last couple
of years, a number of high-profile international investments have
faced serious unanticipated obstacles to success. For example, to
name just a few:
- A prominent private equity firm's ability to
monetize its investment in a Korean bank was jeopardized
by political and popular resistance there.
- A Middle Eastern port operator's management
of a U.S. asset was derailed by political opposition.
- An Australian mining company's executives were
jailed in China.
- A major beverage manufacturer's products faced
concerted rumors of contamination in South Asia.
- In Venezuela, there have been numerous nationalizations
among multiple industries.
Expanding the Board's View
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.
Look at the Board Composition
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.
Look at the Risk Management Procedures
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:
- Country exposure limits and an accurate system
for reporting country exposures
- A country risk rating system
- Regular monitoring of country conditions
Look at Internal Controls
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
in which to be engaged. Policies, standards, and practices should
be clearly communicated, and enforced, with affected staff and offices.
Reporting should be imposed at least quarterly—more frequently if
foreign exchange exposure affects a given investment.
Look at the Board/Management Relationship
Especially when considering international business operations,
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.
Look Very Closely at the Prospective Country
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 nongovernmental
organizations
- The target country's relationship with and attitude
toward foreign investment and the company's country
of origin
- 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.
Conclusion
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. 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.
Jack
Gutt is Director of Kreab Gavin Anderson in New York.
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