Firm Level Political Risks Influence Various Firm Level Outcomes

Introduction

The relationship between business and politics is intricately entwined, to the point where it is frequently impossible to differentiate the two fields. Whether it is based on intuition or cognitive processes, the ability to comprehend and handle risk in the economy or company is a vital component of either the survival or the prosperity of an economic system. When viewed from a different angle, having the ability to effectively evaluate and capitalise on risk can lead to extraordinary achievement. However, if there are any mistakes in the computations, the results could be disastrous. In particular, the fields of finance and economics have a comprehensive understanding of the aforementioned claims, which have also been extensively researched and meticulously documented. Despite this, the concept of risk is multifaceted and usually convoluted, even within the sphere of business. The application of economic resources and the returns they generate are subject to a variety of hazards, some of which include the performance of the market, the distribution of credit, the architecture of financial institutions, competition, inflation, and exchange rates. These risks are well-documented in both theoretical and empirical literature, which helps academics and market practitioners understand and manage the uncertainties associated with these risks. The topic of political risk is one that is not well understood and is managed in an ineffective manner.

Research Questions

The research questions are as follows:-

1. i) Whether Firm-Level Political Risk Influence Credit Rating?
2. ii) Whether Firm-Level Political Risk Influences Trade Credit?
3. iii) Whether Firm-Level Political Risk Influence Investor while making decisions about ETF?

Theoretical Framework

The natural world necessarily poses some dangers. The evaluation, management, and mitigation of potential harm, as well as the adjustment to unanticipated conditions in our surroundings, is crucial to the evolutionary requirement and acts as the major incentive for survival. This is because our surroundings are always changing, and it is impossible to forecast how they will affect us. In addition, it is important to have a profound understanding of the nature of uncertainty opens up the door to the possibility of achieving superior outcomes. Business and politics are inextricably linked, to the point where their interactions are frequently difficult to differentiate from one another. For an organization to maintain its financial standing and achieve success, it is essential to have a complete understanding of, and an effective handle on, the risks that are present in the economy or in business. This understanding and management can be based on intuitive or analytical thinking. When viewed from a different angle, the rigorous analysis and deliberate application of risk can ultimately lead to a significant amount of financial and other rewards. However, if there are any mistakes in the computations, the results could be disastrous. In particular, the fields of finance and economics have a comprehensive understanding of the aforementioned claims, which have also been extensively researched and meticulously documented. Despite this, the concept of risk is multifaceted and usually convoluted, especially in the sphere of business. The application of economic resources and the rewards on those investments are both susceptible to a variety of risks. These risks include the performance of the market, the allocation of credit, the mechanisms of the financial system, competition, inflation, and exchange rates. The availability of a significant amount of theoretical and empirical material that can assist academics and market practitioners in comprehending and effectively managing the aforementioned uncertainties is currently in existence. The topic of political risk is not well understood and is managed in an unsatisfactory manner.

Both the financial markets and individual businesses are exposed to the systematic and non-systematic dangers that are posed by political risk factors. The global financial crisis of 2008, the Arab Spring, the rise in the number of terrorist acts, and the emergence of nativism, populism, protectionism, and isolationism have all contributed to the pervasive political uncertainty that exists today. Businesses, investors, and regulators cannot overlook the huge economic repercussions that this uncertainty has since it poses a significant risk. As a strategy for mitigating risk and lowering levels of uncertainty, the cultivation of political connections between corporations and political figures has grown increasingly common.

The normative framework, in particular the limits imposed by the administrative and legislative departments, creates an environment in which political risk is more difficult to materialize. Taking on this point of view could lead to the utilization of unreliable data sources and the development of an inaccurate comprehension of the political risk. To begin, it is unable of distinguishing between occurrences or activities that are significant and those that are not. This is a serious flaw. In addition, none of the authors that fall under this group have effectively proven the connection between political risk and the impact that it has on the decision-making process within corporations. In addition, the sole focus that political inquiry places on specific shifts in the status quo limits the scope of the field. In the end, placing an emphasis on the unfavourable results that result from governmental actions can serve to strengthen the underlying idea that political intervention is useless. However, it is essential to acknowledge that this perception might not be valid in all situations.

These classifications widen the initial categories to include a wide variety of actors in such inquiries, both locally and internationally. Actors in the legislative or executive branches of government are not the only ones responsible for creating political risk. In addition, there are non-state players in the form of political parties, societal groups, and unions, among other organizations. Nevertheless, this viewpoint argues that political risk is exceedingly nuanced and multifaceted, which makes the challenge of operationalizing it much greater. In addition to this, the appraisal of political risk based on these categories places an emphasis on the prioritization of the identification of disruptions. It does not conduct an in-depth analysis of the nature of the political risk factors it considers because it covers such a wide variety of political risk factors.

Firm-level Political Risks Influence Various Firm Level Outcomes

Primary Research Question

The primary research question is as follows:-

Whether firm-level political risks influence various firm level outcomes?

Literature Review

Overall Impact on the Political Risk

Hassan et al. (2019) discovered that a sizeable percentage of the variation in political risk may be observed at the individual firm level, as evaluated by their firm-level political risk measurement. To be more specific, the change in total political risk over a period of time only explains 0.81 percent of the variation in their measurement, whereas the change at the level of individual enterprises contributes to more than 90 percent of the variation. Conventional models, which make the assumption that individual businesses have the same exposure to total political risk, do not appropriately capture many of the economic repercussions of policy uncertainty (Baker, Bloom, and Davis, 2016). These models presume that individual businesses have the same exposure. In addition, Hassan et al. (2019) investigate the financial repercussions that firms face as a result of exposure to political risk. Hassan et al. (2019) found that businesses that are exposed to higher levels of political risk experience substantial increases in the volatility of their stock returns, in addition to reductions in their hiring, investment, and projected capital expenditures. On the other hand, as per the findings of Baker, Bloom, and Davis (2016), businesses choose to delay investments so that they can protect the value of prospects that are more tangible.

Impact on Trade-credit

Nguyen and Phan (2017) use the Baker, Bloom, and Davis (2016) index to study the association between economic policy uncertainty and mergers and acquisitions (M&As) in the United States. Their findings suggest that there is a positive correlation between the two. They come to the conclusion that the level of policy uncertainty has an inverse relationship with the probability of engaging in mergers and acquisitions (M&As), but it has a positive relationship with the amount of time required to close transactions. The presence of unknown policies has a beneficial effect on the long-term performance of the acquiring company, as measured by abnormal returns held over time and the return on assets after the merger. This is because the presence of unknown policies has a positive effect on the abnormal return of the acquiring company during the announcement period as well as during the announcement period itself. Additional data is provided by Bonaime, Gulen, and Ion (2018) to establish the inverse association between policy uncertainty and business acquisitiveness. The researchers make this discovery by applying four different measures to determine the irreversibility of an investment. They find that the inverse correlation is more prominent in transactions that involve higher levels of irreversibility.

As a consequence of this, there is a lack of a thorough knowledge of the ways in which firms adjust the investment strategies they use for their intellectual capital in response to political unpredictability. In addition, the overall impact that political uncertainty has on company investment as a whole has been extensively recorded. This is a concern for investors. In previous research, uncertainty was measured on a national scale using uncertainty indices. This allowed researchers to get a more comprehensive picture of political unpredictability.

Corporate strategy involves an in-depth understanding of the link between political hazards at the firm level and intellectual capital, as well as the elements that influence this relationship. Additionally, this correlation must be understood in terms of the factors that influence it. In addition to this, it has substantial implications for the decision-makers in charge of policy and the stakeholders in the financial markets. Therefore, the objective of this study is to fill the information gap in the previously published research by investigating the impact that enterprise-specific political risks have on the investment of intellectual capital. In addition, in light of previous research that was done concerning political unpredictability and managerial competence, we investigate further the influence that managerial competence has on the association between intellectual investment and firm-level political risk. Previous research has demonstrated that managerial competency is an essential intangible asset for businesses, as it has a significant bearing on the efficiency with which operations are carried out. Numerous companies are reassessing their global presence as a direct result of the COVID-19 epidemic as well as the rules that have been implemented by the government, such as trade restrictions and industrial legislation. In the midst of the COVID-19 epidemic, the implementation of political risk management strategies is absolutely necessary. This is because governments are becoming more involved in the administration of economies. Establishing appropriate governance frameworks is necessary for firms if they are to successfully incorporate political risk analysis into their strategic planning and overall risk management processes. It is of the highest essential to do so in order to limit the possible negative repercussions of political risk and seize any potential advantages that may emerge from the evolving political environment. It is also of the utmost need to do so in order to maximize the potential benefits that may emerge from the changing political environment. In 2019, over fifty percent of the global CEOs questioned reported that the influence of political risk on their company had increased since the previous two years. This represents an increase from the forty-eight percent who said the same thing in 2017. Numerous commercial endeavours are subject to significant disruption as a direct result of exposure to political risk. The incorporation of political risk assessments into the fundamental decision-making process that takes place in the C-suite, which is now quite important, will only grow in significance over the next few years.

The present body of research on the influence of political risk on corporate investment focuses mostly on evaluating the general levels of political risk during significant political events. This is because this is where the majority of the impact is felt. This strategy has a number of inherent flaws, one of which is the assumption that business conglomerates are all in the same way impacted by macro-level political issues. A particular political event cannot, without a shadow of a doubt, have an all-pervasive effect on the economy as a whole, and the risks that result from this inability are not always distributed in the same way among different types of companies.

Instability in the political sphere has the potential to have a substantial impact on the investment decisions made by companies with regard to their intellectual capital. This is a consideration that is also included in the investment policies of corporations. Putting money into intellectual capital typically involves making bets on wealth-generating human capital, innovation capital, and interpersonal capital as well. Elections frequently create a climate of unpredictability, which has the potential to dramatically damage a variety of commercial undertakings. The presidential election in the United States, which is slated to take place in November, will therefore be among the most serious political risks that can occur in 2020. According to the findings of one study, the unpredictability that is caused by the election cycle in the United States has a negative impact on the stock returns of other countries. The influence that was discussed before is especially noticeable in countries whose stock markets are more open to participation from overseas investors.

In addition, political hazards present an even more direct risk to foreign business. The difficulties that are experienced by enterprises that operate on a worldwide scale have been made worse as a result of supply bottlenecks and export restrictions. This is especially true for products that have just recently been categorized as strategic, such as personal protective equipment and ventilators. As a consequence of this, their supply networks are under an increased amount of strain. Countries may choose to create physical barriers between themselves and other nations in order to restrict commerce if certain requirements are met. One study found that the presence of these barriers is frequently associated with a 31% drop in commerce in both directions. The value that corresponds to this is 3. The large potential ramifications of legislative decisions on trade volume could have an effect on the long-term viability of the cross-border supply chains of many different types of firms.

In recent research, researchers have tried to shed light on the manner in which political risk impacts the dividend payments of corporations. Utilizing empirical evidence that is grounded in numerous theories, these studies substantiate the agency theory. Organizations are more prone to encountering agency problems in periods of political uncertainty, as postulated by this theory. As a result, corporations may opt to augment their dividend payments, especially in the case of governance frameworks that are less robust. The aforementioned effect is emphasized in the study performed by Attig et al. (2021). Further investigation indicates that corporations confronted with substantial political unpredictability ought to exercise greater prudence in their dividend disbursements, given the anticipation of increased financing expenses (Huang et al., 2015). As a direct outcome, dividend payments will be diminished. Political policies regarding expenditure, taxation, regulation, and rule enforcement exert a substantial impact on the business climate. Notwithstanding the efficient operation of democracies, the repercussions of such decisions often prove unpredictable, thereby giving rise to a state of unpredictability.

Concerned economists are those who believe that political risk may influence the decisions of businesses and households negatively. The potential social costs of these repercussions might outweigh the potential benefits of reforms that are implemented with good intentions. The social consequences of inconsistent political decision-making are thus called into question. However, the precise evaluation of the consequences of political risk has often presented difficulties, primarily because there is a scarcity of measurable indicators.

The interests of a variety of different groups are reflected in the structure of political institutions during the process by which policy decisions are made. The actions taken by these organizations serve as a catalyst for unpredictability, which in turn leads to a wide variety of political upheavals. These shocks are typically caused by substantial levels of uncertainty, as various interest groups fight to protect their own interests through political procedures, law amendments, protests, and even armed battles and wars. This can result in a variety of unexpected outcomes. It is not uncommon for significant modifications in government economic policy to occur as a direct consequence of frequent acrimonious conflicts in politics, particularly during election periods. As a result, political unrest increases the possibility that economic measures and adjustments will be implemented, which has the potential to have an impact on the operations of corporations. 

Hassan et al. (2019) contend that when firms take on higher levels of political risk, there is a notable rise in the volatility of their stock returns and a large decline in their investments, projected capital expenditures, and hiring. In their study, Gad et al. (2019) discovered that political risk at the level of lenders has a noteworthy impact on the availability of credit and on the cost of loans. This article employs a one-of-a-kind metric to evaluate political risk at the corporate level in order to study the association between political risk and the successful completion and duration of takeover negotiations.

Impact of Risk

It has been found that mergers and acquisitions, also known as M&As, have a positive link with a rise in the value of real options when placed in an uncertain environment. Consistent with this hypothesis, Borthwick et al. (2020) and Nguyen and Phan (2017) discovered that policy uncertainty has an adverse impact on M&A investments, affecting both the quantity and total worth of M&A transactions. The study conducted by Dang et al. (2022) revealed that policy uncertainty has an impact on the conclusion of deals due to its potential to disrupt the anticipated short- and mid-term synergistic benefits. In accordance with this hypothesis, political uncertainty may diminish firms' inclination to engage in M&A transactions by nullifying the declared deal. Another branch of the literature, grounded in agency theory, contends that managers are more inclined to engage in mergers and acquisitions (M&A) when they encounter elevated levels of political uncertainty. 

This study presents empirical evidence of additional factors contributing to the failure of business deals, specifically related to the political conditions around the party making the offer. By utilizing a measure of political risk at the level of the firm, we have discovered that the level of political risk assumed by the acquiring party has a notable impact on both the successful completion of a takeover and the duration of the agreement. Mergers and acquisitions (M&As) are highly significant business investments. Our analysis leads us to the conclusion that the acquirer's exposure to political risk is a crucial aspect that corporations should take into account when making decisions about such investments. Companies should also participate in initiatives that might mitigate the adverse effects of political risk on business investments and enhance investors' impression of a company's value and reliability. As an illustration, potential buyers can mitigate their exposure to political risks by actively participating in political lobbying. This is because political risk has a significant impact on companies' choices to either go with or postpone business transactions.

The significant political risk has the potential to make the knowledge gap between managers and stakeholders even wider, which will increase the chance of managers engaging in activities designed to maximize profits at the expense of the value of financial information. On the other hand, epochs that are characterized by significant political instability can motivate stakeholders to seek greater transparency, which would then lead to higher scrutiny and a drop in the number of activities related to profit management. It is usual practice to categorize the factors that influence the quality of earnings as either intrinsic or discretionary variables. Inherent qualities are thought to include not only business models but also external aspects such as the operating environment and the dynamics of the economy as a whole. The only authority that managers and stakeholders often have over them is the ability to recognize and acknowledge their presence and impact. In general, this level of authority is quite limited. The inherent unpredictability of R&D operations makes it difficult to ascertain whether or not they are profitable; as a consequence, industries and organizations who rely on such endeavours often receive conflicting reports regarding the results of their efforts.

In the current examination, an empirical investigation of the influence of political risk and uncertainty on managerial decision-making with respect to accounting earnings and the consequent ramifications for earnings quality are carried out. In this particular setting, we are having a discussion about the process that is followed by managers when making decisions. A very targeted approach was taken in the gathering of the data required for this inquiry. By utilizing a wider range of data, one is able to achieve a comparison that is more objective between the assessment of political risk at the business level and the aggregated political risk. In addition, the likelihood of deducing generalizations is increased when the data set under consideration is of a more comprehensive kind. Investigating further into the effects that political risk has on the factors that are fundamental to determining the level of profitability in a business is an additional factor that is worthy of consideration. Previous study has demonstrated that the conditions of the macroeconomy are influenced by the political risk environment. As a consequence of this, additional research into the possibilities of outcomes with regard to the impact on the quality of profits is required. In recent years, there has been an increased focus on the ways in which political system risks influence both the conditions of the macroeconomy as a whole and the decision-making processes of particular companies. In the current examination, an empirical investigation of the influence of political risk and uncertainty on managerial decision-making with respect to accounting earnings and the consequent ramifications for earnings quality are carried out. The former is an approach that has been around for a while, while the latter is more recent. This investigation is ground-breaking because it makes use of an analysis of political risk at the level of the corporation in order to investigate the effects of earnings management, which is a particular aspect of managerial decision-making. As a result, this is the first study in this particular scenario to compare an assessment of political risk taken at the firm level with an aggregate measurement of political risk. As a result, the timing of our investigation is optimal, and it enables us to make an important contribution by pursuing additional queries in a largely unexplored field.

This intricacy has prompted academicians to cultivate consciousness regarding the imperative of incorporating political risk assessment in corporate decision-making. In the current geopolitical landscape, characterized by rapid changes, technological upheavals, and global problems, businesses face heightened risks that they must negotiate due to shifts in economic integration and expansion and changes in the "rules of the game." The process of political risk assessment should be conducted as a comprehensive method that incorporates many aspects and human judgment in order to effectively address the uncertainties of the current era. Companies make tangible economic choices depending on their anticipations of the forthcoming economic policy landscape. Therefore, officials who are supportive of the market can inadvertently raise the level of risk by creating an atmosphere of unpredictability regarding their forthcoming economic policy choices.

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