Policy Risk and Divestitures: Firm-Specific and Macro Considerations

Abstract

We explore whether and how firm-specific facets of policy risk lead firms to dispose of and divest their units in foreign countries. Specifically, we argue that when firms experience a serious dispute with a host government, their assessment of their exposure to policy risk changes, making them more likely to divest in the host country’s region and to significantly reduce the amount of shares that they want to retain in their units in the host country. We find support for this argument using a hand-collected database that matches all the disputes presented before the World Bank with the claimants’ divesting activity in the last 18 years. Furthermore, when we analyze the aggregate effect of firm-specific risks and macro environmental risks, we find that firms do reduce and contract their investments when encountering high levels of policy risk. These results extend the boundaries of current knowledge with respect to the determinants of divestitures and show that policy risk is an important driver of divestiture decisions. By highlighting the potential disjuncture between macro environmental characteristics and how they apply to, or are experienced by, individual firms, we offer a nuanced understanding of environmental features and firms’ strategies.