Policy Risk, Political Capabilities and International Investment Strategy: Evidence from the Global Electric Power Industry

While conventional wisdom holds that policy risk—the risk that a government will opportunistically alter policies to expropriate a firm’s profits or assets—deters foreign direct investment (FDI), we argue that multinational firms vary in their response to host-country policy risk as the result of differences in organizational capabilities for assessing and managing such risk, which are shaped by the home-country policymaking environment. Specifically, we hypothesize that firms from home countries with weaker institutional constraints on policymakers, or more intense policy competition among interest groups divided along economic or ethnic lines, will be less sensitive to host-country policy risk in their international expansion strategies. Moreover, firms from sufficiently risky or contentious home-country environments will seek out riskier host countries for their international investments, in order to leverage their political capabilities and attain competitive advantage. We find support for our hypotheses in a statistical analysis of the FDI location choices of multinational firms in the electric power industry during the period 1990 – 1999, the industry’s first decade of internationalization.  Author order is alphabetical and does not reflect relative contribution. We are grateful to Witold Henisz, Amy Hillman, David Mowery, Joanne Oxley, Beth Rose, Pablo Spiller, Oliver Williamson and to seminar participants at the University of California, Berkeley, the Academy of Management, the Academy of International Business and the Strategy Research Forum for many helpful comments and suggestions on this and earlier drafts of the paper. Guy L.F. Holburn and Bennet A. Zelner 1 Policy Risk, Political Capabilities and International Investment Strategy