Political Risk as a Hold-Up Problem: Implications for Integrated Strategy

I develop a simple hold-up model of political risk, which can be used to explore firms’ strategic options when their investments are subject to the threat of government expropriation. In the model, a firm decides whether to invest and then the government decides whether to expropriate the firm’s investment or to simply collect normal taxes on its profits. The government is motivated by revenue and a wide range of non-pecuniary factors: its reputation, electoral pressures, patronage opportunities, and pressure from external actors. In the model, the likelihood of expropriation depends on the firm’s profits and the amount of taxes it pays, as well as the government’s political incentives. Effective management of political risk requires an integrated strategy, consisting not only of public and government relations efforts, but also financial, value chain, and human resources strategies designed to reduce the government’s incentives for expropriation.