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Summary

My research examines the interdependence between the foreign investment decisions of multinational corporations and the political environments in which they operate. Identifying and adapting to cross-national differences in the political environment are among the foremost challenges faced by managers of multinational firms. While the average manager prefers a stable policy environment (i.e., low policy volatility), the strength of such preferences will vary depending on the manager’s beliefs about the direction of future changes in policy. Specifically, managers who believe that any future changes in policy will likely favor their own interests or that they can induce policy changes that suit their interests may be less sensitive to policy volatility and, at the extreme, may even prefer environments that, at the aggregate level, are politically hazardous (i.e., have greater policy volatility). Attempts by managers and the political actors that represent them in their home countries to influence the future policy environment of host countries in their own interest may, in turn, have an influence on the evolution of the host country’s political environment.

In developing theoretical arguments regarding these relationships, I draw from the disciplines of economics, political science, and sociology but consider myself a scholar of the interdisciplinary field of international business. My primary interest is not in development economics, international political economy, social movement theory or institutional theory, though I draw from each of these research traditions. Rather, I seek to understand how managers of firms that differ in their costs and competencies and that span national political environments (1) react to the variation in the political environments in which they could currently operate; (2) seek to influence those political environments; and, as a result, (3) shape the political environments in which they and their peers will operate in the future. I focus on explaining strategic decisions by managers who act with a profit motive, but with a severely limited understanding of the causal mechanisms that link their actions at the helm of complex organizations with heterogeneous resources and capabilities, to economic outcomes in multiple political environments.

Introduction

The performance of multinational firms is strongly influenced by their ability to identify the risks and opportunities in the political environments in which they operate and craft strategies that influence policy outcomes in those environments. The crises that began in the property market of Thailand and circled the globe from South East Asia, Russia, Central Europe to Latin America in 1997-98 resurrected the interest of both academics and practitioners in political risk management. The optimism that characterized the early 1990s regarding the inevitability of convergence between industrialized countries and those emerging markets that had adopted the basic principles of free-market economics foundered on the realization that the institutional supports for capitalism were more complex and context-specific than previously recognized. Over decades, each modern advanced economy has developed systems that protect private property rights, but each of these systems is relatively unique, continually evolving, and thus practically infeasible to simply transplant into another country context particularly one that is evolving rapidly. Attempts to transplant policies or innovations without a proper understanding of their necessary institutional and cognitive supports led to investor disappointment and, more recently, in countries including Argentina, Bolivia, the Dominican Republic, Ecuador, India, Peru, and Thailand, a backlash against market-oriented reforms. Multinational firms considering investing in these and other emerging markets are rapidly learning the scope of the unconventional risks that they face due to gaps in the governance of agency problems within the firm and, more centrally to my own research, in the governance of the policy environment.

A recent report by Merchant International Group based on a survey of 7,500 multinational firms reported that these unconventional risks in emerging markets had cost corporations as much as $24 billion in 1998 alone or 8 to 10 percent of total expected returns. The report found that “a huge amount of financial resources and management time is lost each year as a result of inadequate research and analysis prior to embarking into a non-domestic market.” The report stressed that the mechanisms employed to “identify and evaluate hidden risks will need to become more sophisticated.”

These unconventional risks are not easily hedged using financial instruments or mitigated by farsighted contracting. Given the strong dependence of realized outcomes on managers’ efforts and capabilities in identifying and managing political risk, the available insurance and financial instruments for protecting long-term foreign direct investment against future changes in the policy environment are sparse and extremely expensive. Each of these instruments also rationally leaves substantial residual risk with the investor. As investors’ concerns about political risk mounted after the 1997-98 crises, investors increased their efforts to incorporate an ex-ante analysis of the expected future policy environment into their corporate strategy. Such an analysis does not treat the future policy environment as an exogenous outcome against which one can purchase financial hedges or for which one can specify contingent contracts but, rather, as susceptible to well-crafted influence strategies that are implemented on an ongoing basis for the life of the investment. Substantial uncertainty remains as to the types of influence strategies that will generate the most desirable short- and long-term policy environments for a given firm. In addition to the difficulty of choosing their own best strategy to influence policy outcomes, managers also need to be aware of and to counteract the influence strategies of their competitors. Managing political risks and opportunities is thus not a task that can be done solely using the tools of international finance or of international law.

The tools available to both managers and academics to design appropriate influence strategies, however, remain nascent. My efforts to enhance the sophistication of these strategies draw upon and seek to integrate relevant insights from multiple relevant disciplines.

(1) While scholars in new institutional economics have long argued that the structure of political institutions can have strong effects on economic outcomes and scholars in mainstream economics increasingly accept this argument, empirical progress in demonstrating this linkage was for limited for some time by an atheoretical approach to measuring those political institutions. While theoretical arguments increasingly focused on the checks and balances present in a country’s political institutions as a primary determinant of investment and growth, researchers relied on measures that were orthogonal to this construct or subject to severe coding biases. In my dissertation research, I used spatial modeling tools developed in positive political theory to construct a new cross-national time-varying measure of the constraints faced by political actors in altering the policy environment. I used cross-national panel data to show that such political constraints are associated with reduced variability in policies, higher investment, and higher economic growth.

(2) A stable policy environment may be preferred on average, but change is periodically needed and, more frequently, requested. A second segment of my research incorporates insights from interest-group theories of politics that allow the relative strength of economic and political actors seeking to influence the policymaking process to influence cross-national variation in policy outcomes.

(3) A third segment of research draws on the strategic management literature to explain variance in the observed effect of the political environment on multinational firms’ choices about entry, entry mode, and entry type. I further demonstrate that multinational firms, particularly those with extensive experience in the host country or politically risky countries in general, do not treat the political environment as an exogenous constraint but, rather, actively seek to influence policy outcomes so as to minimize inimical policy change and promote favorable policy change.

(4) Finally, my current research begins to address the influence that multinational firms and the political actors that represent them have on policy innovations and institutional change in the countries in which they invest. In the coming years, I plan to extend this analysis to identify short-term influence strategies that generate sustainable policy innovations and institutional change, rather than a political backlash against the long-term interests of multinational firms.

I review these four segments of research (depicted in Figure 1) in turn.

(1) Political Constraints and Country-level Economic Outcomes

My interest in the strategic management of political risks and opportunities grew out of a long-standing interest in the political economy of policy reform. I studied international trade policy as an undergraduate; worked for the International Monetary Fund after completing an M.A. in International Relations at the Paul H. Nitze School of Advanced International Studies of Johns Hopkins University; and spent the summer after the first year of my doctoral studies in the Business and Public Policy Program of the Haas School of Business conducting dozens of interviews with managers, bureaucrats, and politicians in New Zealand. My interest in each of these endeavors was in understanding the drivers of successful market-oriented reform.

What convinced my private sector interviewees in New Zealand that the next government would not renege on the radical reforms implemented in response to a financial crisis in 1984 was the redesign of New Zealand’s electoral system. They explained that opposition to the radical nature of the reforms led to a public outcry and an attempt to limit the concentration of power of subsequent governments. The electoral system was changed in a manner that promoted greater representation of diverse interests in Parliament and, as a result, coalition governments. Political actors subsequently faced greater difficulties in formulating new policy initiatives. Efforts to secure a change in policy had to gain the assent of actors from different political parties, frequently including those who represented different constituencies or who were driven by different ideologies. This change reduced the concentration of power held by subsequent government and “locked-in” current policies. To be sure, reforms encountered some difficulties, were altered at the margin, and “softened” over time, but the fundamental thrust of the 1984 transformation of the New Zealand economy remains to this day (see Henisz, W. J. 1999. 'The Institutions and Governance of Economic Reform': Theoretical Extensions and Applications. Public Management, 1(3): 369-92).

In post-electoral reform New Zealand or in other countries characterized by checks and balances in national political institutions, the variability in future policies is lower than when political power is more concentrated. Reduced policy variability, like reduced inflation, reduces uncertainty thereby promoting investment, particularly of capital that is long-lived and difficult to redeploy. It also minimizes the extent to which such investments are motivated by a political rent-seeking calculus as opposed to an economic decision calculus, thus enhancing growth by increasing both the capital stock and the productivity of that capital.

To test these arguments on a panel of countries with widely varying formal institutional structures, I developed a simple spatial model that incorporated information on the number of independent institutional actors with veto power over policy change and the heterogeneity of preferences within any institutional actor. By making some simplifying assumptions about the distribution of preferences, I was able to transform readily available data from political science databases into a cross-national time-varying measure of the feasibility of policy change in a country. The main results of the derivation, consistent with extant theory, are that (1) each additional veto point (a branch of government that is both constitutionally effective and controlled by a party different from other branches) provides a positive but diminishing effect on the total level of political constraints, and (2) homogeneity (or heterogeneity) of party preferences within an opposed (or aligned) branch of government is positively correlated with the level of political constraints. This political constraint index (POLCON) is featured in all of my empirical work, and the underlying theoretical arguments behind it are featured in my comparative and conceptual analyses as well.

Before using this measure to examine questions in the fields of international business, I assessed its validity by using it in a cross-national empirical study of the link between political institutions and economic growth in a panel of as many as 88 countries over the period 1960-89. Building on extant empirical models, I find that the Political Constraint Index is a statistically and economically significant determinant of economic growth (see Henisz, W. J. 2000. The Institutional Environment for Economic Growth. Economics and Politics, 12(1): 1-31). This result is robust across various specifications, estimation methodologies, and sub-sample analyses. I find that political institutions that constrained political discretion promoted growth among all countries, but particularly among relatively poor countries that had the most potential to catch up or converge to the income levels of their wealthier counterparts.

A related article, coauthored with Bennet A. Zelner, (Fuqua School of Business Duke University), demonstrates that POLCON is also a robust determinant of cross-national variation in telecommunications investment across 55 countries over the period 1974-94 (see Henisz, W. J. & B. A. Zelner. 2001. The Institutional Environment for Telecommunications Investment. Journal of Economics & Management Strategy, 10(1): 123-47). To address the critique that left-censoring of observations led to an erroneous conclusion about the importance of political constraints when, in fact, initial conditions determined subsequent infrastructure investments and political constraints, a follow-on article extends the analysis backwards in time for telecommunications and electricity generation investment to the inception of these technologies (a period of 119 years) in 129 countries (see Henisz, W. J. 2002. The Institutional Environment for Infrastructure Investment. Industrial and Corporate Change, 11(2): 355-89). In both cases, the positive effect of POLCON on investment is again greater for countries with relatively lagging levels of investment in which the potential returns from new investment are the highest.

In a recently published article, I identify one causal mechanism by which political constraints have a positive impact on investment and growth. Specifically, I demonstrate that cross-national variation in POLCON in a panel of 172 countries over a period of 18 years explains observed volatility in eight of nine different categories of fiscal spending and revenue, with the greatest effect observed on non-tax revenue and capital expenditures, highlighting the discretionary nature of these line items relative to the greater constraints political actors face in altering social security taxes, taxes on capital, or expenditures on subsidies and transfers (see Henisz, W. J. 2004. Political Institutions and Policy Volatility. Economics and Politics, 16(1): 1-27). I also find that the negative effect of POLCON on observed policy volatility is higher in the aftermath of a macroeconomic shock than in periods of economic stability. While researchers had previously argued for such a linkage between the structure of a nation’s political institutions and the volatility of expenditure or revenue and have shown the deleterious effect of such policy volatility, no previous work had shown the existence of the intermediate linkage between political institutions and policy volatility.

(2) Interest Groups, Political Constraints and Country-level Economic Outcomes

While checks and balances in national political institutions impede policy change, they do not preclude it. When a proposed change in policy enjoys broad-based support from multiple interest groups and political parties, even the most constraining structure of political institutions and most heterogeneous profile of preferences can still yield a radical policy innovation. Policy volatility is a function not only of the strength of the constraints in the current policymaking process but also of the relative strength of the key political and economic actors that seek to influence that process (see Henisz, W. J. 2004. The Institutional Environment for International Business.In Buckley, Peter J., editor, What is International Business? New York NY: Palgrave).

Zelner and I explore the relationship between country-level political constraints and the strength of the industrial consumers of electricity on investment by 78 state-owned electricity generation companies over the period 1970-94 (see Henisz, W. J. & B. A. Zelner. 2004. Interest Groups, Veto Points and Electricity Infrastructure Deployment). We demonstrate that industrial users are able to successfully lobby the government to reduce overinvestment or the inefficient use of existing investments by state-owned enterprises, for which they pay disproportionately. We also show that the relative success of industrial users in securing their desired policy outcome is a function of the political constraints in the policymaking process. When political constraints are high, industrial users are less successful in reducing overinvestment.

In two conceptually related papers, I examine the impact of political institutions and interest-group pressures on trade policy. In the first article, I survey macroeconomic trends on the impetus for trade liberalization and retrenchment in Latin America, emphasizing the importance of sustained macroeconomic and social progress for sustained liberalization of trade policies (see Henisz, W. J. 2004. The Political Economy of Trans-Pacific Business Linkages. Business and Politics, 6(1): Article 2). In a co-authored paper, Edward Mansfield (University of Pennsylvania) and I find that unemployment serves as a powerful force to limit the expansion of free trade or even impose protectionist policies in a panel of 58 countries over the period 1980-2000 (see Henisz, W. J. & E. Mansfield. 2004. Votes and Vetoes: The Political Determinants of Commercial Openness). The effect of unemployment is felt most strongly, however, in democratic countries (where political actors tend to place greater weight on the concerns of the middle class) and, among democracies, in countries with weaker political constraints (where political actors have the discretion to respond to interest groups’ pressure for protection). By contrast, in democracies with strong political constraints, the negative effect of unemployment on openness to trade is muted. I hope to further extend this work in the coming years by examining episodes of liberalization and protectionism as well as the relative strength of the protectionist vs. free-trade lobbies.

(3) Political Hazards and the Foreign Investment Strategies of Multinational Firms

In the next and largest segment of my research, I show that the pressure for policy change emanating from the political environment does not have an equal impact on all firms. Multinational firms can insulate themselves from adverse changes in policy by adapting their investment strategies. Specifically, I demonstrate that the choice of which country to enter, what entry mode to choose for that entry, and the sequence of entry type (e.g., a sales office versus a manufacturing plant) will all be a function of both the political environment and firm-level characteristics that enhance the investing firm’s influence over policy outcomes.

A firm’s asset profile, experience profile, and level of technological sophistication will each influence the observed reaction to and performance implications of political hazards. Variation in each of these dimensions generates differences in the costs and benefits to a multinational firm’s partners, buyers, and suppliers (their counterparties) of opportunistic behavior. As the value of an asset in its next best use declines (e.g., a billion dollar investment in an immobile electrical generating plant, cellular license, or semiconductor fabrication facility) or can otherwise be rapidly depreciated (e.g., a patent or brand), multinational managers must assess the costs and benefits to counterparties of opportunistic behavior not only in the market but also in the policymaking process, where these counterparties could also seek to secure advantage. Suppliers can seek to renegotiate the price of fuel, the cost of installing cell towers, or wage rates directly and independently simply by threatening non-supply or indirectly, with the aid of the government, which can help them gain leverage in their bilateral negotiations.

The first two articles in this research stream demonstrate the firm-level variation in the impact of political hazards on the choice of entry mode. Prior literature in transaction cost economics and internalization theory in international business had argued that multinational firms are increasingly likely to choose a wholly owned subsidiary as contractual hazards (i.e., the incentives for opportunistic behavior by counterparties) increase. Prior literature in political risk management had argued that multinational firms are increasingly likely to choose a joint venture as political hazards increase. In a co-authored article, Oliver Williamson (University of California, Berkeley), the chair of my dissertation committee, and I explore the implications of combining these two theoretical arguments (see Henisz, W. J. & O. E. Williamson. 1999. Comparative Economic Organization -- Within and Between Countries. Business and Politics, 1(3): 261-77). Our analysis uncovers important interdependencies among contractual and political hazards. As joint venture partners chosen to mitigate political hazards can use their influence with political actors in a manner that serves to magnify contractual hazards, it is insufficient to consider merely the level of contractual hazards and political hazards independently. Instead, we develop theoretical arguments and, in a subsequent sole-authored article, I present empirical evidence that managers of 461 firms choosing between a joint venture and a wholly owned subsidiary for their operations in 112 countries consider not only contractual hazards or political hazards but also the extent to which political hazards magnify contractual hazards (see Henisz, W. J. 2000. The Institutional Environment for Multinational Investment. Journal of Law, Economics and Organization, 16(2): 334-64).

In a series of six articles co-authored with Andrew Delios (National University of Singapore), we highlight that not all multinational managers will be equally susceptible to political hazards or equally successful in influencing the policymaking process. We argue that, over time, managers operating in politically hazardous environments develop better routines for influencing that process. Specifically, managers’ ability to maintain incentive alignment not only with their counterparties but also with a broader class of political and economic actors that can support them in the policymaking process improves via experiential learning.

Beginning with the choice of which country to enter, Delios and I find that while a lack of familiarity with a market and political hazards both serve as a deterrent to entry, managers of 2,705 publicly traded Japanese companies who observe their peers to enter one of 155 countries in the 1990-96 period or who have extensive prior international experience are less sensitive to their own lack of experience when considering whether to enter a country (see Henisz, W. J. & A. Delios. 2001. Uncertainty, Imitation, And Plant Location: Japanese Multinational Corporations, 1990-1996. Administrative Science Quarterly, 46(3): 443-75). By contrast, these alternative sources of information about the attractiveness of a potential host country do not alter managers’ sensitivity to the deterring effect of political hazards. In a follow-on article, we demonstrate an important qualification to this result using a narrower sample of 665 Japanese publicly traded multinationals over the period 1980-98 (see Delios, A. & W. J. Henisz. 2003. Political Hazards, Experience and Sequential Entry Strategies: The International Expansion of Japanese Firms, 1980-1998. Strategic Management Journal, 24(12): 1153-64). We find that multinational firms who have extensive international experience in other politically hazardous countries are less sensitive to the deterring effect of political hazards when evaluating a potential host country market. Together, the results of these two articles suggest that (1) political hazards remain a strong deterrent for investment even in the face of other sources of information suggesting that a potential host-country market is attractive; and (2) multinational firms can, through accumulated experience in politically hazardous markets, develop the ability to identify and mitigate the negative effects of political hazards.

Our next two articles consider the impact of political hazards on the choice of entry strategy for a given country. In the first article, we use a sample of 2,827 subsidiaries of 660 Japanese multinational firms in 18 emerging markets in 1997 to demonstrate that the sensitivity of a multinational firm to either political or contractual hazards declines in its relevant international or host-country experience (see Delios, A. & W. J. Henisz. 2000. Japanese Firms' Investment Strategies in Emerging Economies. Academy of Management Journal, 43(3): 305-23). More experienced firms are less likely to choose joint ventures when facing high political hazards and less likely to choose wholly owned subsidiaries when facing high contractual hazards. In the second article, we use a sample of 665 Japanese multinational firms that undertake 6,465 international expansions in 49 countries in the period 1980-98 to demonstrate that the conventional wisdom about the appropriate order of entry by multinational enterprises into a host country holds only for entries into countries with low political hazards. A large body of qualitative and quantitative research holds that multinational firms’ overseas expansions should begin with a sales office and only later expand to a joint venture and, eventually, a wholly owned manufacturing facility. We find that in politically hazardous environments, by contrast, entry sequences begin with a manufacturing plant (see Delios, A. & W. J. Henisz. 2003. Political Hazards and the Sequence of Entry by Japanese Firms. Journal of International Business Studies, 34(3): 227-41). We argue that opening up a local sales office is an act of competition with local suppliers or incumbent producers and is thus more likely to incur the enmity of political or regulatory actors. By contrast, opening a manufacturing plant for export generates jobs and hard currency earnings, thus crafting an alignment of interests with the host-country government.

Our most recent article considers the determinants of survival of 2,283 Japanese overseas subsidiaries of 642 Japanese multinationals in 53 countries over the period 1991-2000. We exploit cross-national variation not just in political hazards but also in political regime change to ascertain whether experienced firms have higher survival rates in politically hazardous markets because they have better information on or stronger influence over host-country governments. We observe that the performance benefits of experience transform into liabilities in politically hazardous countries that experience a regime change. We argue that this result is consistent with the hypothesis that experience generates real or perceived influence as opposed to merely enhancing information. Real or perceived influence depreciates rapidly and can engender retribution by the political actors in a subsequent regime. By contrast, information gained through experience should still be of positive value in the aftermath of a regime change (see Henisz, W. J. & A. Delios. 2004. Information of Influence: The Benefits of Experience for Managing Political Uncertainty. Strategic Organization, 2(4): Forthcoming). Delios and I have also published a conceptual overview of our joint work to date (see Henisz, W. J. & A. Delios. 2002. Learning about the Institutional Environment.In Ingram, Paul & Brian Silverman, editors, The New Institutionalism in Strategic Management. New York: JAI Press).

In another recent article (co-authored with Jeffrey T. Macher, Georgetown University), we examine the choice by 388 semiconductor manufacturers of where to build an overseas fabrication facility over the period 1994-2002. We find that technologically advanced and lagging firms respond quite differently to tradeoffs between the deterring effect of a nation’s political hazards and the attraction of a nation’s level of technological advancement. Technologically advanced manufacturers, while attracted to technologically advanced nations, are unwilling to accept higher political hazards in return. By contrast, their technologically lagging counterparts do make such a tradeoff and, if they go to technologically sophisticated nations, also tend to choose those nations that are politically hazardous (see Henisz, W. J. & J. T. Macher. 2004. Firm- and Country-Level Tradeoffs and Contingencies in the Evaluation of Foreign Investment: The Semiconductor Industry, 1994-2002. Organization Science, Forthcoming). We surmise that these lagging firms are forced to take on the risk that they can reap the benefits of technological spillovers before adverse political events devalue their investment.

Unlike studies that identify experienced firms as more capable and thus better performers, these analyses are less vulnerable to the common critique that experience is confounded with unobserved firm heterogeneity because the relationships we posit are conditional ones. We argue that firms with certain types of experience will perform better or worse as a function of other independent variables. While unobserved firm heterogeneity remains an empirical problem with which we grapple, the strength and robustness of these conditional effects strongly suggest that our empirical constructs are, in fact, capturing relevant differences in capabilities to identify and manage political risk.

Two additional articles, two book chapters, and a working paper in this stream highlight the heterogeneity among multinational firms in their ability to protect and generate value through the strategic management of political risks and opportunities (see Henisz, W. J. 2003. The Power of the Buckley and Casson Thesis: The Ability to Manage Institutional Idiosyncrasies. Journal of International Business Studies, 34(2): 173-84; Henisz, W. J. & J. Story. 2003. Corporate Risk Assessment and Business Strategy: A Prime Task for Senior Management. In Cornelius, Peter K. & Bruce Kogut, editors, Corporate Governance and Capital Flows in a Global Economy. New York: Oxford University Press; Henisz, W. J. & B. A. Zelner. 2003. Political Risk Management: A Strategic Perspective.In Moran, Theodore, editor, International Political Risk Management: The Brave New World. Washington D.C.: The World Bank Group ;Henisz, W. J. & B. A. Zelner. 2003. The Strategic Organization of Political Risks and Opportunities. Strategic Organization, 1(4): 451-60; and Henisz, W. J. & B. A. Zelner. 2004. Nine Principles for Political Risk Management).

(4) Ongoing and Future Research: Multinational and Multilateral Influence Strategies in Emerging Markets and the Backlash against Globalization

Just as clearly as the checks and balances in national political institutions and the interest-group lobbying that occurs within that institutional structure alter foreign investment strategies, so too do foreign investors have preferences about and seek to alter institutional structures and interest groups’ preferences. My most recent research begins to consider multinational firms’ preferences about political governance (i.e., when would an investor in infrastructure services or another politically salient industry prefer to be overseen by an independent regulatory agency as opposed to a simple law?) I am also exploring the time-consistency problem faced by multinational firms themselves with respect to their preferences for political governance (see Henisz, W. J. & B. A. Zelner. 2004. Explicating Political Hazards: A Transaction Cost Politics Approach. Industrial and Corporate Change, 13(6): Forthcoming). My underlying concern is that by individually seeking the best possible policy outcomes for their own short-term interests, multinational actors and their governments could be setting in place negative policy dynamics that ultimately make the institutional structures and interest groups’ preferences of emerging markets more hostile to multinational firms’ interests.

This research grew out of over 300 interviews with managers, analysts, consultants, lawyers, regulators and politicians in the electricity and telecommunication sectors of 14 emerging markets. In country after country, Zelner and I listened to managers complain not about the lack of checks and balances in the national political institutions, but rather the power of the mob opposed to market-oriented reforms in infrastructure services, particularly those reforms induced by multilateral lenders. In a forthcoming conceptual article, Zelner and I offer an interdisciplinary analysis of the determinants of the sustainability of recently enacted policies (see Henisz, W. J. & B. A. Zelner. 2005. Legitimacy, Interest Group Pressures and Change in Emergent Institutions: The Case of Foreign Investors and Host Country Governments. Academy of Management Review, 30(2): Forthcoming). Returning to the question that prompted my trip to New Zealand, we ask when can investors believe a government announcing a radical set of market-oriented reforms? Extending the analysis beyond the earlier insights into the importance of political constraints, we provide a framework in which new policies, in contrast to their more established counterparts, are not taken for granted but rather are evaluated based on the outcomes that they generate or the process by which they reach those outcomes. Given the cognitive limitations of the economic and political actors in the policymaking process, however, there is a large range of potential policy outcomes. The actual observed outcome is the result of the political battle among interest groups with a stake in the issue (investors, key classes of consumers, and those affected by any externalities) to gain the support of uninformed, unorganized, or unaffected interest groups who are needed to generate a coalition powerful enough to overturn the existing policy. This battle occurs within the structure of established political institutions that may limit the discretion of political actors to change the existing policy. Further, any efforts to change that policy may not equally impact all investors.

In the first attempt to test elements of this conceptual framework empirically (co-authored with Zelner and Mauro Guillen, University of Pennsylvania), we take a step backward in time to identify a class of policy innovations that may be disproportionately subject to renegotiations (see Henisz, W. J., B. A. Zelner, & M. F. Guillén. 2004. The Worldwide Diffusion of Market-Oriented Infrastructure Reform. American Sociological Review 70(6):Forthcoming). Specifically, we demonstrate that the conditional lending of multilateral institutions (e.g., the World Bank, International Monetary Fund, and Regional Development Banks) had an important impact on the adoption of market-oriented reform in infrastructure services in a sample of 205 countries during the period 1977-99. Furthermore, this effect is increasing over time. This paper demonstrates that not all politics is local and that studies of the domestic political, economic, and social forces that drive policy adoption can be usefully supplemented by an examination of the international context.

In a work in progress with Zelner, we seek to predict the incidence of unilateral and adverse changes in government policy and public disputes between the government and multinational firms in 1,401 private investments in electricity generation and telecommunication services in 85 countries from 1990 to 2001 (see Henisz, W. J. & B. A. Zelner. 2004. Resistance to Illegitimate Multilateral Influence on Reform: The Political Backlash Against Private Infrastructure Investments. Mimeo). We find that such resistance is much more likely in countries where multilateral lending served as a greater impetus for the reforms particularly in the event of a financial or macroeconomic crisis. As political constraints or the experience of the investing coalition in the host country increases, however, the positive effect of multilateral induced reforms on resistance is moderated. Our interpretation of these findings is that multilateral influence is perceived as illegitimate. Crises help mobilize interest group opposition to reforms but such pressures must filter through the checks and balances in the national political institutions. Finally, experienced investors are likely to be able to influence the policy outcome or at least insulate themselves from inimical policy change.

This initial analysis cannot answer the question of whether multilateral intervention enhances welfare. It only shows that multinational firms should be wary in countries where multilateral lending has induced market-oriented reforms. In subsequent analyses, however, we will explicitly compare performance outcomes (quantity, quality, and market concentration) in countries that adopted reforms under multilateral inducements with those countries that failed to adopt reforms. It may well be that despite the higher incidence of government policy changes and disputes in countries where multilateral lenders induced reforms, consumers in reforming countries are still substantially better off. Alternatively, it is also possible that the success of reforms induced by conditional lending obligations is a function of the country’s institutional capacity to support private investment in a politically salient, technologically complex, and highly capital-intensive sector such as infrastructure services. Where these institutional supports exist, a push from multilateral lenders that destabilizes an existing policy of state ownership and operation promotes well-designed reforms, and multinational firms encounter relatively few difficulties. Where local institutional capacity is lacking, however, a very different dynamic could be triggered. Here, given the risk of government retrenchment, informed buyers are few or they demand substantial front-loading of returns (i.e., supranormal payments in the early years of a contract to compensate for the risk that the contract may be prematurely terminated or renegotiated). Markets remain concentrated or prices remain high, and improvements in service are limited. As a result, the support of multiple interest groups in the effort to overturn multilateral induced reforms is a signal that these reforms are actually harming consumer welfare.

The broader questions that I seek to address in this nascent stream of research relate to the type of influence strategies that multinational firms and the governmental interests that support them should seek in emerging markets. What policy initiatives help to foster a sustainable and profitable environment for private-sector enterprise in infrastructure services and other politically salient sectors? By contrast, what policy initiatives, though conceived with the best intentions, are imperfectly transplantable to some emerging markets due to the lack of supporting institutional structures or due to the polity’s beliefs about the role of the government in the economy or the perceived bounds of fair policy outcomes (i.e., those that do not require government intervention)? I believe that multinational firms and the government interests that support them in their foreign investments too often fail to fully appreciate our lack of understanding of which policy innovations or institutional changes fall into one category or the other. Greater efforts at exploiting cross-national variation in policy adoption, policy sustainability and economic outcomes to identify desirable and sustainable policy innovations could improve prospects for multinational firms and for emerging market consumers. More importantly, given the stickiness and path dependence of the policymaking process that makes it difficult to correct mistakes, multinational firms and multilateral lenders need to avoid inducing policy innovations or institutional changes that undermine long-term support for capitalism. A polity that once equates privatization with theft may not be easy to convince again that market-oriented reforms are worthwhile. A mob descending on the presidential palace demanding a change in regime and a public sector response to a power crisis triggered by a dispute with a private investor will not be turned back by rational arguments that continued state ownership could have been worse.

What policy initiatives in a country burdened by massive public debt, poorly performing courts, and rent-seeking politicians with substantial discretion over policy outcomes can improve the quality and quantity of infrastructure services? The answer surely lies in harnessing the profit motive but, just as clearly, also involves careful attention to politics. I want to share my perspective on identifying and managing political risk with scholars in development economics, international political economy, social movement theory, and institutional theory to identify policy initiatives or institutional changes that could make emerging markets more profitable and wealthier in the short term and the long term. I anticipate that the early stages of this research will continue to focus on infrastructure services but will increasingly broaden its focus to include other politically salient sectors, including natural resource extraction, the manufacture of capital goods, and technologically advanced manufacturing sectors. I also anticipate developing a parallel research stream that examines the incidence and sustainability of trade liberalization both at the country level and, eventually, at the industry or product level.

Conclusion

The same question that I asked in my interviews in New Zealand ten years ago remains at the heart of my research agenda: “When should private investors believe in a policy innovation or institutional change implemented by political actors?” My early research focused on one dimension of the political environment (i.e., checks and balances in national political institutions). I developed a quantitative index to measure that construct and demonstrated its importance in predicting country- and firm-level economic outcomes. I have already extended that initial research question in several directions by considering other facets of the political environment (i.e., interest group pressures on political actors to change existing policies) and heterogeneity in the population of firms in their response to the political environment. Combining these extensions (i.e., recognizing that interest group pressures can influence policy outcomes and that some firms are more adept than others at organizing and influencing policy outcomes) suggests a feedback from the strategic actions of multinational firms to the structure of the political environment. In the next few years, as I detailed in the previous section, I anticipate focusing on the question “What influence strategies can private investors and the political actors that represent them follow to enhance the likelihood of sustainable and desirable policy innovations and institutional change?”

In the longer term, I anticipate continuing to deepen the scope of my inquiry into the interdependence of the political environment in which multinational firms could currently operate, their strategic behavior in those political environments, and the shape of the political environments in which they will operate in the future. In addressing these questions, I will continue to draw insights from economics, political science, and sociology as appropriate but will remain an interdisciplinary scholar of the field of international business. While I hope that my research increasingly contributes to development economics, international political economy, social movement theory and institutional theory, my primary audience is and will remain scholars and practitioners who seek to explain and enhance the performance of the foreign investment decisions of multinational firms.