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Top1. Introduction
Based on the traditional Knightian definition (Knight, 1921) political risk might seem like a contradiction in terms. Knight (1921) advocated a distinction between risk, with known or estimable probabilities and state payoffs, and uncertainty, where probabilities (and often potential states and/or state payoffs) are difficult to estimate. Political decisions are, by their nature, difficult to estimate probabilities for, and “political uncertainty” would, based on this, be a more appropriate term. However, the Knightian definition has become less important, and “political risk” seems to be the most common term these days. We will hence use the term “political risk” for the rest of the paper. Some further clarification of the concept could also be necessary. Although political decisions could impact different stakeholders in different ways, this paper will be limited to the economic impact of such risk. Hence, environmental, social, emotional or other effects of political decisions will not be discussed, although these of course often might be important. Also, whereas individuals too face political risk, for instance related to changes in the tax system or the pension system, this paper will primarily consider the risk faced by for-profit firms. Political risk is important for many, if not most firms (see e.g. Giambona et al., 2017). Many examples are intuitively easy to grasp. All firms are affected by changes to the tax system, and most firms in a country are exposed to potential shocks like the Brexit referendum (Hill et al., 2019) Many firms sell goods or services to the government, and particular industries has been substantially hindered (or supported) by government regulations or subsidies, for instance the tobacco industry or the renewable energy industry. An example of how such risk is perceived is provided by Bergfjord (2009), where fish-farmers were asked to rate various risk sources based on their perceived importance for them. Although fish-farming is not considered to be an industry particularly exposed to political decisions, the political risk factors were still considered the most important, ahead of various operational and financial risk factors. Although intuitively important, surprisingly little research has been conducted on this particular type of risk. A bibliometric study (Jiménez & Bjorvatn, 2018) finds 709 published articles related to the topic between 1965 and 2015, which is a very small proportion of the appx 90M articles published in total during the same period. The most common perspective has been risk related to investment in foreign (developing) countries, see e.g. Kher & Chun (2020). As part of the finance literature, such studies often construct indices of risk levels for different countries, which in turn are used to calculate required rates of return for investments in different countries. Risk factors included in these analyses typically include risk of expropriation, corruption and various legal challenges (Clark, 1997). Some work on political risk has also been done related to social security and pension benefits (see e.g. Shoven & Slavov, 2006), and within the political economy literature (see e.g. Persson & Tabellini, 2002 for an overview). However, most of this literature has different perspectives, for instance how political decisions can reduce or distribute risk. A good recent contribution is provided by Fägersten (2015), which provides a good discussion of the concept “political risk” and its importance for the commercial sector. Whereas most of the analysis in Fägersten (2015) is based on a political science viewpoint, this paper is more concerned with how companies could analyse this risk, and what decisions they could and should make. The main purpose of this paper is to introduce a simple theoretical model for how firms across different industries could think about the political risk they are facing; and possible strategies for managing this risk. The further structure of this paper is as follows: First, we will discuss different types of political risk. Second, we will outline a framework for how such risk could be analyzed. Finally, we will discuss how economical agents could manage this risk, and whether/how governments should try to reduce the risk.