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Gambling on Conflict: Profiling Investments in Conflict Countries
Unformatted Document Text:  Andreea Mihalache Updated: March 20, 2008 of income for developing countries, are destabilizing and affect, among other things, the dynamics of conflict. Governments able to predict and preempt such changes can manage political violence more effectively. Existing research on political risk cannot yet explain this puzzle, because it focuses on peace-time constraints on policy-making processes, ranging from elections or regime change in the host country to global political and economic dynamics 11 . The few authors who do investigate the effects of conflict on FDI (e.g., Li 2006, Jensen and Young 2007) still leave the puzzle I outlined earlier unsolved. The question remains: Why do some foreign investors avoid host countries marred by political violence while others continue to select these locations? To answer it, I open the black box of outcomes of political violence for foreign investors. Firms are heterogeneous, which suggests that the firm-level consequences of political violence are heterogeneous as well. The heterogeneity of the outcomes of political violence implies heterogeneity in firm perceptions of and reactions to political violence. I show that the relationship between investment characteristics and firm behavior when faced with conflict in their hosts is nonrandom: investment attributes that increase a firm’s expected costs from political violence increase the likelihood that the firm perceives political violence as threatening. As such, the uncertainty over the probability of political violence is not the exclusive determinant of firm behavior; uncertainty over the set of firm-specific consequences of political violence and over the probabilities associated with these consequences affects behavioral outcomes as well. 11 E.g., Henisz, Witold (2000), “The Institutional Environment for Multinational Investment” (in Journal of Law Economics and Organization); Jensen, Nathan (2003), “Democratic governance and multinational corporations: political regimes and inflows of foreign direct investment” (in International Organization); Kobrin, Stephen (1982), Managing Political Risk Assesment; Li, Quan and Adam Resnick (2003), “Reversal of fortunes: democratic institutions and foreign direct investment inflows to developing countries” (in International Organization). 4

Authors: Mihalache, Andreea.
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background image
Andreea Mihalache
Updated: March 20, 2008
of income for developing countries, are destabilizing and affect, among other things, the
dynamics of conflict. Governments able to predict and preempt such changes can
manage political violence more effectively.
Existing research on political risk cannot yet explain this puzzle, because it
focuses on peace-time constraints on policy-making processes, ranging from elections or
regime change in the host country to global political and economic dynamics
. The few
authors who do investigate the effects of conflict on FDI (e.g., Li 2006, Jensen and
Young 2007) still leave the puzzle I outlined earlier unsolved. The question remains:
Why do some foreign investors avoid host countries marred by political violence while
others continue to select these locations? To answer it, I open the black box of outcomes
of political violence for foreign investors.
Firms are heterogeneous, which suggests that the firm-level consequences of
political violence are heterogeneous as well. The heterogeneity of the outcomes of
political violence implies heterogeneity in firm perceptions of and reactions to political
violence. I show that the relationship between investment characteristics and firm
behavior when faced with conflict in their hosts is nonrandom: investment attributes that
increase a firm’s expected costs from political violence increase the likelihood that the
firm perceives political violence as threatening. As such, the uncertainty over the
probability of political violence is not the exclusive determinant of firm behavior;
uncertainty over the set of firm-specific consequences of political violence and over the
probabilities associated with these consequences affects behavioral outcomes as well.
11
E.g., Henisz, Witold (2000), “The Institutional Environment for Multinational Investment” (in Journal of
Law Economics and Organization); Jensen, Nathan (2003), “Democratic governance and multinational
corporations: political regimes and inflows of foreign direct investment” (in International Organization);
Kobrin, Stephen (1982), Managing Political Risk Assesment; Li, Quan and Adam Resnick (2003),
“Reversal of fortunes: democratic institutions and foreign direct investment inflows to developing
countries” (in International Organization).
4


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