Written Assignment

Kevin Kim

z5060289

Tutor: Marius

QUESTIONS
1. How

would

you

compare

Iceland

and

Venezuelas

corruption

percentage index? What might be driving these differences? What

2.

issues could this create?

In general how would you rate the overall political risk of both
countries? Are there any recent examples of political risk? What are
some possible methods, as well as potential drawbacks, to hedge
against such risk?

1.There exists a drastic difference in corruption levels between Iceland and Venezuela.
Legal restrictions in Iceland are far more restrictive on businesses, whereas these laws
arent regularly enforced in Venezuela, leading to an environment conducive to
corruption. However, the insurance of organisations internal shareholder rights and the
disclosure of price altering information ensure the economys health in Iceland.

The

corruption percentage index enables provides a better understanding of Venezuelas

governance framework and its effects on domestic market and shareholders of
companies.
Compounded economic disturbances have arisen from a lack of corporate governance
policy implementation, exacerbating higher corruption levels. Venezuelas Moody credit
rating has degraded from Caa1 to Caa3, reflecting the worlds highest inflation rate
(Moodys 2015). With declining oil prices and inflation rates of 186%, there is an
immense loss of import revenue (Egan 2013). There were many attempts to provide an
effective guideline on corporate governance. However, they failed to abide by the
suggested guidelines. Ultimately, poor implementation to policy incurred economic
downfalls with deficits in foreign reserves and increased arbitrage opportunities.
There are many socio-political issues that inflict higher corruption levels in Venezuela as
companies attempt to prevent measures to insure their security. Venezuela faces high
level foreign debt of $6.85 billion in 2016 with a risk of sending 30 million people into
default (Wilkinson 2016). As an aftereffect of historical expropriation of private
enterprises, companies prevent disclosure of information. This led to higher
concentration of major shareholder interest over minority shareholder rights. Major
shareholders actions to exploit weakness deteriorates liquidity in the domestic market,
potentially resulting in a large economic cost as investors lose interest and confidence in
the market.
In contrast, Iceland is strictly adopting the corporate governance laws and is
experiencing economic and social political growth. Transparency International (2015)
ranks Iceland at 13th least corrupted, reflecting the positive influence of their legally
mandated governance system. After the banking crisis in 2008, key legislations such as

the Act on Annual Report helped a successful establishment of governance mechanisms.

The strong implementation of corporate governance laws ensures domestic economy
efficiency,

guaranteeing

minimum

rights

of

shareholders

(International

Business

Publications 2008). For instance, any deviation to the document such as the Articles of
Association requires an approval of shareholders. It creates liquidity in the market as
firms disclose information, improving Icelands position in the corruption index above that
of Venezuela.

2.A governments political decisions may have adverse effects on the profitability of an
investment action. Venezuela experiences high political risk as a result of an inconsistent
implementation of government policies. However, Icelands strict enforcement of
government policies assisted in minimising such risk. In order to reduce political risk, it is
essential to monitor and measure the political risk factors. The comparison of political
risk factors of both countries concludes that Venezuela experiences higher political risk
than Iceland.
Iceland experiences less political risk due to the enforcement of capital controls, resulting
from the Icelandic banking crisis in 2008(International Comparative Legal Guides 2015).
The legal structure of Iceland is stabilised by the imposition of governance regulations.
Despite low political risk, the risk still resides in Iceland. One example of political risk in
Iceland is the convenience of international business from the withdrawal from EU
membership without a public referendum (A.M. Best Company 2015).
In contrast, Venezuela is exposed to higher political risk due to the reigning socialist
government expropriation of privately owned enterprises and exchange controls. The
expropriations by the predecessor Hugo Chavez resulted in overflowing settlement
claims from foreign companies. One of the recent examples is the expropriation of Exxon
Valdez projects where only the book value was compensated. As a result, World Bank
Arbitration Tribunal Venezuela was forced to compensate US$1.6 billion in 2014
(Hanrahan 2014).
Furthermore, Venezuelan exchange controls prohibit acquisition of foreign currency. It is
due to the governments attempt to maintain an unsustainable currency rate, enhancing

the level of corruption. This resulted in deficits in foreign reserves and arbitrage
opportunities. Furthermore, leading importers to inflate goods values to fake shipments
and the low exchange rate (Neuman & Torres 2015).
Evidently, high political risk will harm the engagement of firms in FDI in Venezuela and
would require hedging. One method of mitigating the risk is to purchase negative beta
assets in the index of Venezuela. In doing so, the profitability increases in reverse to the
poor market performance, which can potentially occur. A possible drawback is that
investors must attentively select assets such as gold that guarantee a profit (Streissguth,
n.d).
Furthermore, investors will hedge the erosion of Venezuelan currency due to
hyperinflation. Hence, they forward hedge by borrowing Bolivars and invest in
instruments with stable returns. Similar to the negative beta asset method, a major
drawback is the possibility of making a loss. Therefore, investors must ensure that the
investments return exceeds the inflation rate to reserve their buying power
(Investopedia n.d.).
References
International Comparative Legal Guides 2015, Iceland Corporate Governance 2015, 2016
Global Legal Group, accessed 15 May 2016, http://www.iclg.co.uk/practiceareas/corporate-governance/corporate-governance-2015/iceland.
Moodys 2015, Moodys downgrades Venezuelas rating to Caa3 from Caa1; outlook
stable, Moodys Investors Service, accessed 15 May 2016,
https://www.moodys.com/research/Moodys-downgrades-Venezuelas-rating-to-Caa3-fromCaa1-outlook-stable--PR_315563.
Hanrahan, M 2014, Venezuela Ordered To Pay Exxon Mobil $1.6B Over Asset
Expropriation, International Business Times, accessed 16 May 2016,
http://www.ibtimes.com/venezuela-ordered-pay-exxon-mobil-16b-over-assetexpropriation-1702737.
International Business Publications 2008, Iceland Company Laws and Regulations
Handbook, 1st volume, International Business Publications, Washington D.C.
Egan, M 2013, Strong-Arm Policies Leave Venezuela Teetering on the Brink of Collapse,
Fox Business, accessed 16 May 2016,
http://www.foxbusiness.com/politics/2013/12/17/strong-arm-policies-leave-venezuelateetering-on-brink-collapse.html.
Streissguth, T n.d., Is a Negative Beta Coefficient More Risky Than a Positive in the Stock
Market?, accessed 17 May 2016, http://finance.zacks.com/negative-beta-coefficient-riskypositive-stock-market-7596.html.

Investopedia n.d., Inflation Hedge, accessed 25 May 2016,

http://www.investopedia.com/terms/i/inflation-hedge.asp.
Neuman, W & Torres, P 2015, Venezuelas Economy Suffers as Import Schemes Siphon
Billions, The New York Times, accessed 26 May 2016,
http://www.nytimes.com/2015/05/06/world/americas/venezuelas-economy-suffers-asimport-schemes-siphon-billions.html?_r=0.
Transparency International 2015, Corruption Perceptions Index 2015, Transparency
International, accessed 26 May 2016. http://www.transparency.org/cpi2015.
Wilkinson, T 2016, U.S. intelligence warns of Venezuela collapse, Los Angeles Times,
accessed 26 May 2016, http://www.latimes.com/world/mexico-americas/la-fg-u.s.venezuela-20160513-snap-story.html.
A.M. Best Company 2015, AMB Country Risk Report, A.M. Best Company, USA