Let’s talk about political risk

As investor relations people, we don’t generally talk about “politics.” But all the fears about nationalization of big banks, a federal takeover of automakers and so on have captured the market’s attention.

In fact, political events – writ large to include wars and all sorts of government or anti-government disruptions – are huge influences in the market. They affect economic life and individual companies.

A new book, The Fat Tail, digs deeply into the many “political” events that pose risks to a company’s business or even entire economies:

Looking ahead, political risks are likely to become more, not less, relevant to both governments and corporations. … War, terrorism, expropriation, violent changes of government, politically motivated lawmaking, and civil strife are not going away.

Geopolitical experts Ian Bremmer and Preston Keat argue in the book that seemingly fat-tail-scan1very unlikely (but catastrophic) events – say, 9/11 or the current severe credit crisis – are in fact somewhat predictable. And they offer plenty of historical examples.

Businesses should plan for these “fat tail” events, so called because they’re out in the low-probability tails of a normal distribution curve – but actually occur far more often than probability suggests. By extrapolation, I might add that investor relations teams should consider how political trends or disruptions should be disclosed.

In the US and developed world, businesses across many industries today face possible regulatory controls they might not have imagined a couple of years ago. The outpouring of anti-business feeling suggests plenty of potential activism by politicians that may wind up damaging individual companies or even the whole economy.

The writers offer one warning a bit late, noting that if businesses do a poor job of communicating, they almost invite political ill will:

External, reputation risk is one area where transparency and clear reporting are important. Shareholders and regulators are two other constituencies with whom communication must be well managed. A lack of reporting and transparency can transform itself into political and regulatory risks.

Politics can seem even less predictable in some parts of the world. The authors note that “emerging markets” – an occasional darling of investors – are optimistically named. Some of these markets will not emerge at all, and some will go along nicely – until a coup or civil unrest suddenly devastates their economic prospects.

Imagine how uncertainty, especially a government upheaval or popular uprising that could cause total loss of a business in a country or region, changes the discount part of an investor’s valuation formula.

So, let’s talk politics – wisely – with investors.

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