Dealing away risk: The political economy of private foreign investment in emerging telecommunications markets

Why do private foreign investors make positive investment decisions in the context of significant political hazards? What contract or deal mechanisms are available to shift governments' decision calculus, and under what conditions are those mechanisms implemented? What effect do they have on deal performance? I create a formal, game-theoretic model of “dealing away risk” that explicates the investment process between foreign investors and governments in four periods: market decision, contract design, participation, and expropriation. By creating an original panel dataset of investments in 103 emerging countries over ten years (1990–1999), I systematically test the relationships of market opportunity, country risk, specific deal mechanisms, and private foreign investment performance. Random-effects logit and ordered probit regression analyses, difference in means hypothesis testing, and two-staged Heckman models are employed to explicate the micro-analytics of investment.; As market opportunity and country credibility increase, investment increases. But ex ante market and credibility measures cannot alone fully explain the decision calculus of investors, nor the performance of the deals themselves. I present evidence that, in fact, foreign investors and governments design hazard-mitigating strategies in the contract design period to “deal away” risk. Using extensive data on the 598 telecom service investments in the 103 emerging economies, I contend that ‘profit safeguards’ and ‘commitment institutions’ are the gapfilling measures employed by private foreign investors and governments to overcome investment risks and thereby generate investment in less than ideal environments. Empirical evidence links with contract design findings to demonstrate the patterns of profit safeguards and commitment institutions. Ultimately, the likelihood of better deal performance (i.e., less creeping and outright expropriation) increases as ex ante market opportunity and country credibility decreases, profit safeguards decrease, and commitment institutions increase.; These counterintuitive findings affirm the formal model: what it takes to generate a positive investment decision from private foreign investors is not what it takes to secure the performance of that deal over time. Optimal contract design takes into account investors' participation constraint and governments' expropriation constraint. In other words, institutions matter. But it's the analytics of institutional action, the details of transaction and governance, that matter most.