Political Risk, Political Capabilities and International Investment Strategy: Evidence from the Power Generation Industry

In this paper, I examine the effect of political risk on the international expansion strategies of firms in a single industry, electric power generation. I argue that due to differences in non-market capabilities, the impact of political risk will be unequal across firms, and that firms with stronger political risk-management skills will be more likely to enter higher political risk countries. I test my hypotheses using a data set covering all privately-financed power generation projects outside North America, spanning 10 years, 191 firms and 64 countries. Using the firm’s decision to enter a country in a given year as the dependent variable, I find first that the effect of political risk is indeed uneven across firms. While higher levels of political risk typically discourage entry, the impact is significantly lower for firms with greater levels of international experience. In addition to the level, I find that the type of prior experience is an important factor in explaining the variation in firm market entry strategy. Specifically, the experience that firms accumulate in monopsony generation markets – where firms negotiate and contract directly with governments – has a significantly greater impact on their propensity to expand into more politically risky environments than does experience in competitive generation markets (where firms interact less frequently with governments). Thus, as multinationals gain more experience over time in monopsony markets, they gradually expand into more politically risky environments. More generally, the paper provides empirical support for the sequential theory of foreign expansion. In contrast to much literature in this field, however, I demonstrate that firms build on their expertise not only by re-investing in their existing country markets, but also by systematically expanding into new countries where their mix of market and non-market skills gives them a competitive advantage. 1 Assistant Professor, Richard Ivey School of Business, University of Western Ontario. 1151 Richmond Street North, London, Ontario. Canada. N6A 3K7. Tel: 519 661 4247. Fax: 519 661 3485. Email: [email protected]