The International Centre for Settlement of Investment Disputes (ICSID) of the World Bank is the leading venue for settling investment disputes between foreign firms and host governments. According to the ICSID database, the number of cases presented before ICSID has constantly increased in the last twenty years, reflecting the substantial growth both in cross-border investments and in the number of international investment agreements.

Because of the number and relevance of these disputes, managers, political authorities and other stakeholders are trying to understand how to prevent and manage them. When a host government becomes hostile to foreign investors, why do some multinational companies (MNCs) respond more effectively than others? According to research in strategy and international business firms use nonmarket strategies to improve their performance by managing the institutional and societal context through connections with political actors, both local and national. These connections mitigate various political and contractual hazards by legitimating the foreign firm with local stakeholders and facilitating access to valuable resources and information.

However, the relationships between MNCs and political authorities may deteriorate over time, along with the bargaining power that MNCs initially enjoy when they negotiate access to a country. For example, investments in fixed assets could expose MNCs to later attempts by host governments to renegotiate terms in ways that would reduce the profitability of local operations. Some of these attempts may escalate into deleterious legal disputes or even the partial or total expropriation of those operations.

Past studies, however, have paid little attention to how events evolve from the inception of a dispute between an MNC and a host government to its eventual resolution, whether favorable or not to the focal MNC. Therefore, we know little of what makes some MNCs better able than others to deal with government hostility, once it arises.

The research

To begin to shed light on this question, in a study recently published in the Journal of Management Studies (forthcoming in the Special Issue on The Management of Socio-Political Essues and Environments: Organizational and Strategic Perspectives) we conducted a comparative case study of eight MNCs involved in disputes with foreign governments in Latin America between 2001 and 2012 – Cemex in Venezuela; Telefonica, Repsol, Vivendi and Endesa in Argentina; Telecom Italia in Bolivia; Shell in Nicaragua; and Iberdrola in Guatemala. All these firms filed expropriation claims before the ICSID. In some of these cases, the firms eventually left the country; in others, they continued operations, albeit in diminished form.

To ensure theoretical comparability across cases, we focused on sectors – Construction, Electric Power and other Energy; Oil, Gas and Mining; Water, Sanitation and Flood Protection – where sunk assets and reduced bargaining power would make the option to exit equally arduous and costly for all firms.

We conducted 63 semi-structured interviews with 43 informants, including executives who had personally experienced the dispute or were involved in strategic decision making, managers of peer firms, government officers, representatives of political associations, experts in diplomacy and political economics and labor union experts. We then used secondary data, such as analyst reports, newspaper articles, GRI initiative dossiers, corporate documents shared by informants, governmental documents (e.g., transcripts of parliamentary debates, laws, and decrees), legal documents (from vLex International and the ICSID website) and speeches by political authorities, to reconstruct events and interactions, and to integrate and triangulate evidence from interviews.

All the firms analyzed sought to protect their position in the country hoping to continue operations there, but only some succeeded, whereas others eventually left the country. This variation in an otherwise relatively homogenous sample (in terms of firm size, type of industry, source of dispute and configuration of the political system) offered us an opportunity to examine contextual conditions and managerial choices that could illuminate the different responses.

Why did these MNCs respond differently to the host government’s hostility? Our findings

Our study reveals that differences in these MNCs’ local ties and social investments shaped the timeliness and effectiveness of their interpretations of government hostility, and ultimately their capacity to mobilize local and international support:

• The importance of local ties and social investments that derive from the networking strategies firms had adopted before the dispute. Some firms operated locally through an international joint venture, an entity partly owned by the MNC and partly owned by one or more domestic firms. These MNCs largely relied on local partners to relate to nonmarket stakeholders.

Other MNCs, instead, operated through directly controlled subsidiaries. They had been more hands-on in local operations and had engaged more collaboratively with local nonmarket stakeholders. These direct social ties eventually help them respond more timely and effectively to the rising hostility of local political authorities.

• The importance of picking up early warning signals. Firms operating through an international joint venture failed to pick up early warning signals, as local partners – to protect their own interests – filtered information and retained exclusive interaction with local political authorities. Because of this, managers at the headquarters could not diagnose the situation in an accurate and timely way and delayed their response until it was too late to effectively counter the host governments’ narratives stirring local stakeholders against them MNCs.

In contrast, operating directly and having built multiple local ties helped other firms stay alert to warning signals. They could then draw on these cues to craft alternative accounts that countered those disseminated by the government and used these accounts to mobilize local and/or international stakeholders to their defense.

The core theoretical novelty: “Liability of insidership”

Comparison across our cases suggests that what really made a difference, especially early on, was the use of local ties as a source of direct or indirect cues on how to interpret events and respond appropriately. Indeed, some of the firms adopting proximal embedding strengthened their position not by relying on pre-existing ties with local stakeholders but by using timely and comprehensive information to mobilize peers and international political actors.

Our study suggests that reliance on local partners could inadvertently create a “liability of insidership” to the extent that local partners insulate foreign investors from local stakeholders, thus precluding them from developing direct contacts, nurturing local ties and building local reputation – all of which, our study shows, can make a significant difference on the MNCs’ capacity to respond adaptively to the sudden hostility of local governments.

Image: Venezuela: expropriation of Cemex (source: BBC Mundo, 19/08/2008)