Political Risk and Foreign Direct Investment in Global Capital Budgeting

Project vs. Parent Perspectives in Global Capital Budgeting

There are two different viewpoints in capital budgeting known as the project perspective and the parent perspective. The project is a locally addressed perspective that is subordinate to the parent. The parent is the main organization to which the project's financial and operating cash flows are directed. The project perspective is useful for local purposes; however, it is subordinated to evaluation from the parent's viewpoint (Moffett, Stonehill & Eiteman, 2012). A project evaluation will guarantee cash returns based on the host government's bonds. If a project fails to receive cash equal to the bond yield, a parent firm should purchase host government bonds instead of investing in a risky project or investing elsewhere. Multinational firms should invest only if they can earn a risk-adjusted return greater than locally based competitors can earn on the same project (Hough & Neuland, 2008). If this is not possible, stockholders will invest their shares in local firms and allow those companies to carry out the local projects.

Although project firms are systematically part of the parent firm, parent firms hold greater responsibilities as they are the owners of project organizations. Parent firms will produce results that are typically closer to the traditional meaning of net present value in capital budgeting (Moffett, Stonehill & Eiteman, 2012). Necessarily, a parent firm will handle any standardized actions that a project firm was unable to complete. Meanwhile, project firms will provide estimates closer to the effects on consolidated earnings per share, which may become a significant concern for managers.

Macro-Level vs. Micro-Level Political Risk

Political risks are typically faced by corporations, governments, and investors. These risks can be managed with reasonable foresight and investment. There are two levels of political risk: macro-level political risk and micro-level political risk. Macro-level political risk focuses on non-project-specific risks at the local, national, and regional level (Moffett, Stonehill & Eiteman, 2012). It is a common misconception, however, that macro-level political risks address only the host country's specific political risk level. Many macro-level political risks involve national security concerns and pose questions about how a foreign government conducts its current affairs. This level of political risk also poses threats to corporations operating in foreign regions. Such risks can resemble the confiscation of business assets or the seizure of business property.

Micro-level political risks, by contrast, focus on non-project-specific risks to the local economy, paying close attention to a particular industry and its relative contributions. Typically, the region in which the political risk occurs will consider the local political climate in relation to a business endeavor. The use of political risk in governance is very prominent, and it can be a decisive factor in how a bill, law, or regulatory structure is enacted (Hough & Neuland, 2008).

The most critical aspect of political risk analysis lies at the micro level, which pursues a qualitative approach to explore the interactions between groups and powerful individuals within a country. Political risks can take on a distinctly human character. From the micro perspective, political risk is context-dependent and is tailored to the needs of different industries, sectors, and projects (Moffett, Stonehill & Eiteman, 2012). This means that political exposure is not identical for every enterprise. Political risk can also unfold at levels below the central government, underscoring the importance of identifying influential local and regional actors. Accordingly, political risk analysis should not be limited to providing basic information about the political framework of foreign countries. A broad overview has proven to be insufficient compared to a nuanced understanding of the decision-making processes that affect a specific project — including informal relationships between political officials and executives engaged in behind-the-scenes dealings.