Managing Country Risk in the Boardroom

Daniel Wagner

|

March 1, 2014

ff_countryrisk

Among the many issues boards of directors in international corporations must routinely address is whether to assume the risk that comes with operating abroad. Although this has become a more common concern in recent years, surprisingly few board members have the expertise required to answer the questions that inevitably arise. Even fewer know the right questions to ask of senior management. As a result, risks associated with operating internationally may arise from the moment a decision to trade or invest is made.

Boards often end up regretting decisions made as a result of overreliance on managerial assurances that the international operational risks are understood and have been properly vetted. Often, a country that was portrayed as stable turns out not to be, but the organization has already committed to trade or invest in the region. Companies may then get caught up in unforeseen, lengthy public legal battles with far-reaching and potentially damaging implications for brand and reputation.

To make matters worse, the interests of some corporate actors may not be directly aligned with the organization’s best long-term interests. For example, corporate sales teams are often incentivized to promote transactions internally in order to meet production targets. Sales teams may seek input from corporate risk managers tasked with vetting international transactions. Unless the risk management process is well developed and a specific country risk function exists, sales may cherry pick only positive information to deliver to decision-makers. This presents a biased and unbalanced view of the risks associated with the transaction. In such cases, decision-makers up the chain of command may not realize that the information is faulty.
As illustrated by this example, companies often rely exclusively on their own risk management processes, believing they are bulletproof. Without data or insight of its own, a board may become too reliant on the organization’s ability (or inability) to make effective decisions. Consequently, the board runs the risk of falling short in its duty to protect the interests of the company and shareholders.

As corporate operations and holdings continue to expand globally, decision-makers often pay too little attention to specific country risks and other crucial matters. Boards of directors are particularly vulnerable to this type of oversight, mainly due to lack of direct insight into a particular region, which can lead to an inability to discern fact from fiction.

If boards were more educated about economic, social and political risks, they might be better equipped to identify errors in the assessments they receive. Being knowledgeable about country risk can force organizations to conduct more thorough due diligence before requesting a board vote. This will enable senior decision-makers to reject requests outright or make approvals conditional on the receipt of the company’s plans to mitigate and effectively address the potential risks.

How can boards make better decisions regarding country risk? One place to start is with the composition of the board itself. Too often, board members are selected from a small group of high-profile, well-connected individuals who may not have relevant experience in foreign trade or investment, and who may not want to appear ignorant about the matters being discussed.
Company management should emphasize experience and knowledge directly relevant to their operations when selecting board members. That said, it is difficult to find individuals who have direct experience in every country a large corporation may want to target. Regardless, too few companies focus on this knowledge as a critical requirement for long-term success.
Another solution is for boards to press companies for regular updates on their risk management procedures and insist on instituting appropriate checks and balances. Given the competing interests that may influence an internal risk management team, a better solution is to look outside a company’s risk management function and hire an independent third-party assessor. A qualified third party can conduct regular risk management audits that test the system, provide insights into the target country, and give board members unbiased information that empowers them to ask the right questions.

Unfortunately, even when a problem is identified, boards are sometimes reluctant to confront management. Candor can get lost in the politeness of board proceedings and, too often, boards are focused on building consensus, which inhibits due diligence and proper risk management. By remaining polite and silent, boards can not only contribute to monetary losses, they may unwittingly contribute to reputational risk with long-lasting and severe consequences. Board members must therefore exercise their responsibilities with renewed vigor and a solid base of knowledge. Doing so is one of the best investments an international company can make.
Daniel Wagner is is senior investment officer for guarantees and syndications at the Asian Infrastructure Investment Bank in Beijing. He has more than three decades of experience assessing cross-border risk, is an authority on political risk insurance and analysis, and has worked for some of the world’s most respected and best-known companies, including AIG, GE, the African Development Bank, the Asian Development Bank and the World Bank Group. He has published eight books—The Chinese Vortex, The America-China Divide, China Vision, AI Supremacy, Virtual Terror, Global Risk Agility and Decision-Making, Managing Country Risk, and Political Risk Insurance Guide—as well as more than 700 articles on current affairs and risk management.