We had a question submitted a little while ago to the Corporate Strategy Board's "Mergers, Acquisitions, and Alliances" Discussion group [link for members of select CEB programs only] from a member seeking views on how companies establish country risk premiums as they evaluate M&A opportunities. This question actually takes on new relevance these days, as we've seen risks emerge seemingly out of the blue in Latvia and Bulgaria, continued political instability in Thailand, and of course the terror attacks in Mumbai this past November.
A few things we've learned from our member conversations about how companies successfully account for country-level risk in their global footprint strategies:
1. Start with the Usual Suspects. There are a wide variety of reputable sources providing an overview of country-level risks. Some of the resources we've found helpful have been the OECD's Country Risk Classification, which focuses on likelihood of repaying externally held debt, and the Belgian government's export agency ratings, which provide a very useful breakdown of both political and commercial risks. Although it's somewhat outdated, countryrisk.com provides a helpful overview of and direct links to a variety of additional sources.
2. Apply A Weighting Methodology Tailored to Your Company and the Current Activity. Ratings by external agencies are only a starting point, as companies have different levels of risk tolerance. Members have highlighted a variety of methods for factoring their risk tolerance into external ratings. Typically this involves a calculation of the difference between different credit spreads (e.g. a country's long-term government bonds vs. those of the US government, or in-country corporate credit spreads vs. country-level spreads) to establish a country-level risk premium. Members often also layer on top of these a project-specific volatility assumption to establish the overall risk premium of an in-country investment.
3. Price in Insurance. Members also recommend pricing political risk insurance and including that cost in any financial forecasting to get a more complete total cost assessment.
4. Establish An Internal Rating "Agency". Finally, members have established company-level classifications of countries around the world (in formats such as A through E), with varying hurdle rates and risk premiums attached to each classification, and "off-limits" countries clearly established. Centralizing this reduces decision-making uncertainty or conflict across different functions or business units, eliminates the need for repeated assessments, and provides a company-level view on country risk to inform decisions.
Ultimately, country-level risks to businesses are typically a function of both the market itself and the degree of tolerance companies have for the risks that are present in any environment. Some members we've spoken with are comfortable operating in literally
any country in the world; others stick primarily to developed economies,
as that’s where their most promising customer bases exist. Regardless of methods being used to factor country risk into your evaluations, companies need to be sure they're not only aware of and comfortable with the risk environment they're entering or operating under, but also continuously monitoring that environment, and have sound processes in place for employees to stay safe and to avoid potential ethical dilemmas in less stable environments.
