The rise in the number of disputes between local communities and foreign investors in recent years is a troubling trend

resulting from a failure on the part of firms, specifically foreign multinationals engaged in the extractive industries, to take into account local political and social-cultural stakeholders. This oversight often leads to local noncommercial risk and a loss of a firms social license to operate. Many firms have attempted to avoid the financial penalties of local noncommercial risk with Corporate Social Reasonability (CSR) strategies, attempting to demonstrate their cultural sensitivity while winnings the hearts and minds of local communities. Thus far, most efforts have failed to achieve the sought after peaceful relations and stable work environment. This paper proposes that CSR efforts, understood as an attempt by firms to ensure a social license to operate, have failed because the existing conceptualizations of local noncommercial risk do not recognize that it originates from the interaction of a firm's strategy and the local community, placing local stakeholders at the center of the risk. Corporate Social Responsibility: Its Purpose and its Failings. Although a firms CSR efforts can have different goals: moral obligation, sustainability, social license to operate and reputation, this paper will take the license to operate as the principal goal of CSR efforts. This means that a firm implements a CSR effort in order to help achieve and or preserve a social license to operate, generating a stable work environment in which they may carry out their business free from negative interference by local communities. CSR efforts frequently fall short of this goal as they lack the context-specific knowledge necessary for addressing stakeholder demands. The cause of these failures is poor understanding on the part of firms of the noncommercial risks that create inhospitable and unstable operating environments. Shortcomings in Corporate and Academic Understanding of Noncommercial Risk and the Resulting limitations of Analysis based on that Understanding The literature on noncommercial risk possesses many diverse definitions and interpretations of the phenomena, few of which are readily applicable to local noncommercial risk. At the root of the confusion is the assumption that noncommercial risk is fixed within a given country. Economic or macro political risk may be fixed within a country but local noncommercial risk is the result of corporate strategies interacting with stakeholders within the system. A firm acts, the stakeholders react, and a noncommercial risk that affects operations arises. Local noncommercial risk is the result of adverse action by local secondary political and social-cultural stakeholders stemming from their perception of a firm's strategy and its effect on the community. The failure of firms to recognize this fact severely limits the analytical value of any traditional noncommercial risk measurement in the crafting of a strategy to mitigate such risks. Country stability and/or political risk indexes, which aggregate countrywide political, economic, and social variables as a measure of the noncommercial risk in a country, are an example of such fruitless analysis. In such indexes stakeholder demands are replaced with aggregate statistics, and firm strategy is completely absent as a variable. Nevertheless, they are the most commonplace measure of noncommercial risk utilized firms in their analysis. Moving Noncommercial Risk Assessment from a Focus on Environment to a Focus on Stakeholders The weakness common to the aforementioned attempts at understanding noncommercial risk is confusion regarding its cause; as a result, firms frequently fail at finding an appropriate method for mitigating risks. Disjointed CSR programs that seek to positively influence a host communitys perception of a firm, come up short because a stable operating environment cannot be achieved

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without addressing specific stakeholder needs. In order to address such needs, a firm must recognize that they arise from an expectations "gap" between the performance of a firm/the execution of its strategy and the expectations of what that performance will mean for stakeholders. By identifying key stakeholders, who may pose a risk to a firms strategy, firms can engage more effectively and make strategic adjustments, the result being CSR efforts that can close the stakeholder expectations gaps. A Sequenced Approach to Crafting CSR Strategies to Counter Noncommercial Risk Addressing all of the aforementioned issues in a static model is difficult, especially given the clear need for context-specific knowledge. As such, it is necessary to recognize that best practice can only ever be a general road map, given this constraint, we propose that the following four-step process be followed: 1) Firms must look inward and articulate clearly their own goals and strategy for a project. 2) Firms must collect atmospherics/information on the local communities that their project is going to affect. Firms must then reassess goals and strategy and align as best as possible with the apparent social-cultural and political norms of the principal secondary stakeholders as much as possible. 3) A firm should initiate engagement with secondary stakeholders in two ways: first with educational meetings exploring the nature of a projects industry/nature and secondly with projectspecific meetings. The educational meetings allow firms to teach the limitations of a projects benefits and project-specific meetings all firms to collect community impressions and concerns. 4) Finally, firms should review and prioritize the inputs, suggestions, demands, and potential threats from secondary stakeholders, all should be prioritized based on impact on value creation of a project for the firm. Firms will then need to choose which issues to address based on impact on the ability of a firm to create value for shareholders. At all times, the affect and success of every effort should be measured, and its progress towards a predetermined goal should be measured. The repetitive nature of this process cannot be overstated, it should be repeated as frequently as possible, with an emphasis on education and radical transparency, both of which will earn respect and increase the ease of conversion to a firms position. Measures of Effectiveness: The critical step in a successful noncommercial risk mitigation strategy The single most important factor in successful engagement and management of noncommercial risk is attempting to measure the effectiveness of such efforts. The failure to do so is often the cause of the uncoordinated initiatives most companies claim as their CSR efforts. Absent good measures of success and failure, firms cannot properly assess the effectiveness of noncommercial risk mitigation efforts. As a result, noncommercial risk lacks meaning within the broader context of a firms project strategy. Despite the importance of measurement, it remains one of the most difficult tasks in the management of noncommercial risks principally because measures of effectiveness must be tailored to the situation and operating environment. Although, broadly speaking, they can be divided into three categories, social measures, informational measures, and economic measures, the specific dependent and independent variables being assed will always depend on the mix of secondary stakeholders that pose a risk to a firm and the nature of its project. The the number of disputes between foreign investors and host states ison the rise and not since the 1980s have we seen as many government interventions in energy and mining investments as we have in the last two yearsmany as a result of or accompanied by vigorous community
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opposition.1 This troubling trend is the result of a failure on the part of firms, specifically foreign multinationals engaged in the extractive industries (principally mining, and oil and natural gas) to take into account local political and social-cultural stakeholders (who are collectively referred to as local secondary stakeholders in this paper) who can create contentious operating environments that frequently lead to failed projects or otherwise suboptimal outcomes. In order to address this situation what is needed, as Stephen Korbins highlighted in 1977, is better definitions of the [noncommercial risk] phenomena, a conceptual structure relating [to] the firm and a great deal of information about the impact of the political environment.2 In recent years many firms have attempted to avoid the financial penalties of local noncommercial risk with Corporate Social Reasonability (CSR) strategies, attempting to demonstrate their cultural sensitivity while winnings the hearts and minds of local communities. Thus far most efforts have failed to buy the stable space and peaceful relations with local communities that firms hoped they would. This paper proposes CSR efforts, understood as an attempt by firms to ensure a social license to operate, have generally failed because existing understandings and conceptualizations of local noncommercial risk originates from within a companys strategy, which is to say that the risk is a result of corporate action rather than a fixed issue that is simply present in the social and political environment in which a company operates in. See comments throughout the paper. Some are very minor; others, substantive. Overall, the writing is much improved at the sentence level, but the difficult task remains of creating a long document (hopefully, shorter than this draft) that has a coherent argument inside paragraphs and running from beginning to end of the paper. I am going to ask you to tell me in three or four sentences the argument and points of each chapter. And then suggest you use subtitles to keep you focused on those arguments and points. I think you will end up discarding a lot of material that isnt relevant to what youre trying to argue. Thats difficult for all of us. Once we learn something when we are focusing on a topic, its hard to throw it out of the final product. But, it needs to be done. I also believe youll end up re-ordering a good deal of the paper. The same points appear a number of times in different parts of the paper. Consolidate! I think that will happen if you make subtitles (better, full sentence subtitles that say what the section is arguing). Youll discover that sentences and paragraphs are often out of place. See you tomorrow. Lou

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Chapter One: Introduction

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The best of business opportunities can go awry when local political and socio-cultural stakeholders are not taken into account, as Meridian Gold learned when it attempted to build a gold mine in the mountainous and picturesque town of Esqual in the Chubut province of Argentinean Patagonia. One of the towns main attractions is the Old Patagonian Express that runs through the foothills of the Andes, winding its way over pristine mountain rivers and through alpine valleys. Esquel is also the gateway to the Los Alerces National Park, famous for the rare Alerce tree, a species unique to the region and capable of living up to 3,000 years. The town is also happens to be home to a rocky

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1 Lisa J. Laplante and Suzanne A. Spears, Out of the Conflict Zone: The Case For Community Consent Processes In The Extractive Sector, Yale Human Rights & Development Law Journal 69 (2008): 70. 2 Stephen J. Korbin, Political Risk: A Review and Reconsideration. Journal of International Business Studies 10, no. 1 (1979): 77.

outcrop seven kilometers to the east that possesses a rich vein of approximately 3-million ounces of gold.3 It was at this site that Meridian Gold, a Nevada-based gold miner, intended to develop an open-pit gold mine, complete with facilities for extraction, processing (via the cyanide vat leach methodology), and waste disposal. In 2002, Meridian acquired the site as part of a $310 million acquisition from Brancote Gold, a London-based mining and exploration firm, and quickly commenced a staged build- out of the mine, starting with the setting up of a laboratory to test the cyanide process and the quality of the ore. Meridian did all this shortly after publicly dismissing the town of Esquels recently-completed, and widely accepted, development plan for the community. Meridian moved ahead with mine development despite mounting opposition from the community of Esquel. In the end, Meridian did try to win the town and community over with a widespread public relations campaign, but it was too little, too late, and the company was not able to change the communitys perception of Meridian as an unresponsive foreign firm that is unwilling to engage in meaningful dialogue about community interests and concerns. By February of 2003, the community had turned on Meridian, and the mayor authorized a public referendum on the proposed mine. The referendum produced disappointing results for Meridian, with 81% of voters coming out against the project.4 Subsequently, the Chubut province government banned open-pit mining and the use of cyanide in the mining process, bringing Meridian's high hopes for the mine to an end.5 The failure to develop the mine resulted in Meridian needing to write down the value of the Esquel property to its fair commercial value without mineral resources, resulting in a net loss for the fiscal year ended 2005 of $346.4 million.6 In 2007, Canadian mining firm Yamana purchased Meridian. At the time, Yamana had no plans to develop the Argentine site, and the firm's CEO, Peter Marrone, stated the local community has taken the position that they prefer not to have a mine, and so our position is that were respecting that, and, so we are withdrawing our efforts as they relate to Esquel.7 A review of recent Yamana corporate filings suggests that nothing has changed and so, as a result of one firm's oversight and/or ignorance of local noncommercial risks, 3-million ounces of gold (worth roughly $4 billion at today's prices) remains locked in the mountains surrounding the town of Esquel.8 This is a common story, and highlights the trouble that can result when foreign firms move forward with large-scale foreign direct investment without local stakeholder buy-in.9 The failure of firms, specifically foreign multinationals engaged in the extractive industries (principally mining, and oil and natural gas) in the case of this paper, to take into account local political and socialcultural stakeholders (who will be collectively referred to as secondary stakeholders in this paper) runs the risk of creating a contentious operating environment that can lead to a failed project or an otherwise suboptimal outcome.

Comment [LW1]: Not quite sure what this means.

Comment [LW2]: Was this net of profits elsewhere, or was this the amount of the writeoff? Not terribly important which, but as written, its not clear. Comment [LW3]: What kind of rights did it have to the mine? I assume in Argentina, as in almost every country outside the US, minerals belong to the state. Had the Argentine government given the company some kind of mining license? If so, did the government make some kind of commitment with respect to acquiring access to the minerals for the investor? These are common. Would the company have had a claim based on the rights it had acquired and which were in some way taken? Comment [WT4]: Check Formatted: No Spacing Formatted: No Spacing, Indent: First line: 0"

3 No Dirty Gold, Esquel Argentina, last modified April 14th, 2006, http://www.nodirtygold.org/esqual_argentian.cfm 4 Jonathan Sohn, Development Without Conflict (Washington D.C., World Resources Institute), 28. 5 Sohn, Development Without Conflict, 28. 6 Sohn, Development Without Conflict, 28. 7 Romina Maurino, Yamana Set to Expand to 7 Mines, Develop 5 Projects, The Star, October 18, 2007. http://www.thestar.com/business/2007/10/18/yamana_set_to_expand_7_mines_develop_5_projects.html 8 The term noncommercial risk refers to risks to business operations that stem from social-cultural tensions, environmental factors, security issues, and government/political factors. This thesis uses the term noncommercial risk in place of terms like political risk or country risk as it is a more inclusive term for a category of risks that are fuzzy and difficult to quantify. Furthermore, as Stephen Kobrin pointed out in his work Managing Political Risk Assessment: the common functional divisions of the external environment (e.g., political, social, legal, cultural, economic) are analytical abstractions that breaks down at the level of experiential reality. (pg. 29) 9 Yongqiang Gao, Managing Political Risk in Cross-National Investment: A Stakeholder View, Singapore Management Review 31, no. 1 (2009): 104.

In recent years, many firms have attempted to mitigate risks arising from secondary stakeholder action with Corporate Social Reasonability (CSR) strategies, which seek to win the hearts and minds of local communities. In essence, firms have sought to buy peace. CSR efforts have had mixed results and have been received by secondary stakeholders as little more than superficial window-dressing efforts which demonstrate, with no particular depth, the foreign firms commitment to sustainable and socially responsible practice, as Lite Nartey demonstrates in her paper External Stakeholder Engagement: Transforming Corporate Social Responsibility from Principle Rhetoric to Theoretically Grounded Practice.10 The concerns of secondary stakeholders are not without merit; ill-conceived execution of largescale projects in the extractive industries has a track record of damaging local community environments and economies and at times even infringing on basic human rights. Presently, the poor record of extractive industries of taking into account the concerns of local stakeholders has made the easy implementation of projects beneficial to both host communities and corporations all the more difficult, and has indeed prompted introspection on the part of many firms operating within the extractive industry. Such introspection has resulted in many within the industry tepidly taking up the mantra of Free, Prior, and Informed Consent (FPIC). Sadly, the operationalization of FPIC has proven difficult, and it appears to be as much a "window dressing" as related CSR efforts. Although not initially conceived of as risk mitigation strategies, FPIC and CSR are increasingly looked to as methods to mitigate noncommercial risk. Thus far FPIC and CSR efforts have proven less than adequate, as the number of disputes between foreign investors and host states ison the rise and not since the 1980s have we seen as many government interventions in energy and mining investments as we have in the last two yearsmany as a result of or accompanied by vigorous community opposition.11 This is largely the result of a failure on the part of both academics and practitioners to answer Stephen Korbins 1977 call for better definitions of the [noncommercial risk] phenomena, a conceptual structure relating [to] the firm and a great deal of information about the impact of the political environment.12 The goal of this thesis is to answer Korbin's call and, in doing so, create a framework for operationalizing noncommercial risk that will allow critical extractive industry projects to move forward while still respecting the rights of secondary stakeholders to respond to legitimate environmental, human rights, and other threats. This paper proposes that many efforts to engage stakeholders by extractive industry firms fail because definitions of noncommercial risk are inadequate to the task, leading to poor understanding of the problem, along with misguided information collection and assessment on the part of corporate leadership. The result is that CSR/FPIC efforts often come up short, and thus fail to negate risks, because they lack context- specific knowledge of local issues, fail to involve secondary stakeholders, and are often not integrated into the strategic plan for a firms investment and project in a given area. These shortcomings result in a perception gap on the part of the host community between the promise of project and the actual results. This perception gap is in part the caused by the focus of noncommercial literature on the idea of the political environment as given and exogenous.13 Such thinking has resulted in attempts to simply to avoid noncommercial risk altogether either by transferring risk via risk management products such as political risk insurance or by discarding otherwise potentially profitable projects. Although political risk insurance is a useful product for risk management, it is both expensive and limited in its scope, and avoiding projects is clearly not a profitable, or wise, long-term strategy.
10 Lite Nartey, External Stakeholder Engagement: Transforming Corporate Social Responsibility from Principle Rhetoric to Theoretically Grounded Practice. (Paper presented at the Annual Strategy and the Business Environment Conference at the Kellogg School of Management, January 15, 2010): 3. 11 Lisa J. Laplante and Suzanne A. Spears, Out of the Conflict Zone: The Case For Community Consent Processes In The Extractive Sector, Yale Human Rights & Development Law Journal 69 (2008): 70. 12 Stephen J. Korbin, Political Risk: A Review and Reconsideration. Journal of International Business Studies 10, no. 1 (1979): 77. 13

Comment [LW5]: Not essential, but Id avoid split infinitives.

Comment [LW6]: Does it ever cover community relations?? Even if it does, it doesnt cover future profits, I suspect. At least OPIC covers investment, not the NPV of future earnings. Plus there is the equivalent of some co-pay not 100% of investment is covered.

Gao, Managing Political Risk in Cross-National Investment: A Stakeholder View,102.

Some authors recognize the endogenous nature of political risk, and as such realize that active engagement with the political and social-cultural environment in which firms operate is a possible approach to addressing noncommercial risks. 14 This paper continues that line of thought and posits that it is only through a shared vision of the future, produced through a vigorous education/influence strategy on the part of firms, that local communities and extractive industry firms can live in harmony and thus allow firms to work unhindered . Historically, the extractive industries have attempted to manage community-related risks in order to protect their license to operate, while communities have disrupted projects in order to protect their way of life. This is a contentious arrangement, but it need not always be so; if properly executed, influence strategies geared towards achieving an outcome in keeping with the principles of FPIC (albeit not outwardly endorsing FPIC) should allow for the forward development of projects in less conflicted environments. This paper will set out a framework for information collection and assessment that will allow for the effective design of education/influence strategies to counteract local noncommercial risk by first exploring in detail the shortcomings of both current methods for analyzing noncommercial risk assessment by corporations, which primarily focus on geopolitical and country risk issues rather than local concerns, along with CSR and FPIC, which set the stage for a contentious relationship between host communities and the extractive industries by leading corporate strategists to develop plans informed by misleading or non-relevant information.15This analysis will culminate in a definition of noncommercial risk that can be used to guide information/corporate intelligence collection efforts and analysis. Second, we will turn to several cases of extractive industry conflict and cooperation in search of best practices for operationalizing education/influence strategies based on good information resulting from our newly proposed definition. Finally, we will synthesize these best practices to create an information collection and management framework for effectively operationalizing political risk information within the context of an influence strategy that we believe can lead to the development of a more collegial local operating environment for extractive industry firms. Chapter Two: Failure of CSR/FPICCorporate Social Responsibility: Its Purpose and its Failings. This paper will argue that noncommercial risk generally originates from within a companys strategy, which is to say that the risk is a result of corporate action rather than a fixed issue that is simply present in the social and political environment that a company operates in. As such it needs to be addressed in a more proactive manner by a firm than is typically practiced. At the current time CSR and FPIC are ideas in vogue that, although not directly geared towards risk mitigation, have been adopted by firms as a route toward establishing a stable work environment for projects and investments, in essence an environment of decreased noncommercial risk For example, Shells Nigerian operations have often made use of the Shell CSR team, the Shell Petroleum Development Company (SPDC), in order to try and avoid the frequent halts in oil operations resulting from community protests.16 There are several issues with such efforts that have stunted their value. First is that such practices are necessarily short-term; in the case of SPDC projects the budget for local development projects is typically closed after construction in a difficult area is completed. As Jedrzeji George Frynas comments in his paper The False Developmental Promise of Corporate Social Responsibility, if social projects are initiated in order to buy a short spell of peace, the companies
See Boddewyn, 1998, Hadjikhani, 2000 Jo Jackobsen, Old Problems Remain, New Ones Crop Up: Political Risk In The 21st Century Business Horizons 53, no. 5 (2010): 482. 16 Jedrzej Goeroge Frynas and Kamel Mellahi, Political Risk as Firm-Specific (Dis)Advantages: Evidence on Transnational Oil Firms in Nigeria, Thunderbird International Business Review 45 (2003): 584
15 14

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are unlikely to engage in proper consultation with the entire affected community. In line with stakeholder theory, firms will listen primarily to those stakeholders who pose the greatest threat to their operations, not those best placed to contribute towards developmental aims.17 It is thus not surprising that many CSR efforts do little more than provide communities with shallow philanthropic gestures (school textbooks, mosquito nets, etc) while failing to consult local communities on what exactly their needs are. An Economist article that examined Shells efforts in Nigeria highlights these ongoing challenges: Having looked at 82 of the 408 projects on Shell's booksranging from the electrification of villages to building schools and hospitalsthe team concludes that less than a third have been successful. Farm projects and those that aim to make villages more self-sufficient by giving them the means to earn more do least well. The micro-credit schemes run by women do best. The report finds that the company has still been decreeing too many projects from on high. Although it has tried, it is still essentially buying off the locals with giftssome of them forced out of it by ransom-demanding kidnappers and protection-merchantsrather than helping people to develop their future.18 Besides the obvious "short-termism", CSR efforts fail at risk mitigation because they often lack context-specific knowledge of the problems a community is faced with and the concerns a community has regarding a specific project. Shells SPDC is again a perfect example. Shell operates throughout the world, from Nigeria to Yemean to the Gulf of Mexico, and the demands of secondary stakeholders in such a diverse geographic theater of operation isare immense. In Nigeria the SPDC needs to be on the lookout for corruption in a way they do not when seeking to address community needs in the Gulf of Mexico, but they perhaps do not need to be as careful with offending local religious customs as they might when operating in Yemen. There is no substitute for context-specific knowledge, the inclusion of which would immediately go a long way towards addressing short-termism. Another element of CSR failure stems from not involving impacted affected stakeholders themselves in the development of CSR efforts. CSR efforts frequently are, as with Shells SPDC, designed at home offices or far from projects. According to Jedrzej Frynas, in villages he visited in the Niger delta, even in some where the local community had signed a formal memorandum of understanding with an oil company for delivery of a wide range of development projectsthe local people sometimes saw a representative of the company less than once a year. When oil company representatives do visit local communities, they do not stay overnight and their consultation exercise may involve only one or several meetings with key community representatives.19 In short, CSR efforts are built off of limited knowledge and limited consultation. The SPDC again serves as an example of what can go wrong when such an approach is employed. It has been reported that Shell built three town halls as part of SPDC work in the Niger River Delta, not because the communities needed them, or that building them addressed a concern regarding Shells investment and projects in the region, but because village chiefs asked for construction contracts for their construction firms.20 It should be unsurprising that CSR efforts fail when communities are not consulted. Historically philanthropic efforts work best when they target those who are willing to help themselves and thus avoid developing a dependency mentality. As E.F Schumacher has suggested,
17 Jedrzej Goeroge Frynas, The False Developmental Promise of Corporate Social Responsibility, International Affairs 81, no. 3 (2005): 585 18 Nigeria and Shell: Helping But Not Developing, The Economist, May 10, 2001, http://www.economist.com/node/617266. 19 Frynas and Mellahi, Political Risk as Firm-Specific (Dis)Advantages: Evidence on Transnational Oil Firms in Nigeria, 590. 20 Nigeria and Shell: Helping But Not Developing, The Economist, May 10, 2001, http://www.economist.com/node/617266.

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Comment [LW9]: Is it realistic to expect a firm to circumvent a chief in a local culture to determine what the community wants? Or is the chief the one who is going to stir up trouble (or suppress trouble) and therefore the one to please? I suppose it depends on the political structure, but I can imagine in some places pleasing the chief is the point.

"if rural people of the developing countries are helped to help themselves, I have no doubt that a genuine development will ensure[but it] cannot be produced by skillful grafting operations carried out by foreign technicians or an indigenous elite that has lost contact with the ordinary people."21 This is not to say that CSR is pointless; this paper will in fact make the case that attempting to be a social responsible stakeholder will mitigate noncommercial risk, as it should allow firms to create stable work environments. That being said, the efforts need to be properly executed. With all things, as the saying goes, "the devil is in the details". Superficial window-dressing efforts which demonstrate, with no particular depth, a foreign firms commitment to sustainable and socially responsible practice will not succeed at mitigating the risks created by secondary stakeholders who feel misused by foreign firms investing in local communities. Meanwhile, any sincere attempts to move beyond window-dressing efforts often fail because definitions of noncommercial risk are inadequate to the task of diagnosing the problem, leading to poor understanding and misguided information collection and assessment on the part of corporate leadership. Although a firms CSR efforts can have different goals: moral obligation, sustainability, social license to operate and reputation, this paper will take the license to operate as the principal goal of CSR efforts. This means that a firm implements a CSR effort in order to help achieve and or preserve a social license to operate generating a stable work environment in which t carry other their business free from the negative interference by local communities. CSR efforts frequently fall short of this goal as they often lack the necessary context-specific knowledge and fail to involve affected stakeholders in development of CSR initiatives. The root cause of these failures is poor understanding on the part of firms of the noncommercial risks that create inhospitable and unstable operating environments. Shortcomings in Corporate and Academic Understanding of Noncommercial Risk and the Resulting limitations of Analysis based on that Understanding The literature on political and country risk posses many diverse definitions and interpretations of noncommercial risk, few, if any, are not flawed and or inapplicable to local noncommercial risk. The diversity of literature and possible understandings of noncommercial risk, and the often-in appropriate application macro focused definitions to local issues, makes the analysis and integration of local noncommercial risks into a firms strategic planning difficult. This difficulty in turn makes the pursuit of a stable local operating environment challenging, and the result of CSR efforts pointless as they often target a misdiagnosed problem. The principal shortcoming of existing understandings of noncommercial risk, that makes them inapplicable to local noncommercial risk, is the assumption that noncommercial risk is fixed within a given country. Although there are risks are already present with in different countries, local noncommercial risks are not. Local noncommercial risk is the result of corporate strategies engaging with the system. The firm acts, the community reacts, and a noncommercial risk that affects operations arises. In order for firms to better mitigate local noncommercial risk, and invigorate CSR efforts, they must recognize local noncommercial risk as the impact of adverse action by local secondary political and social-cultural stakeholders stemming from a firm's strategy. The failure of firms to recognize this fact severely limits their subsequent analysis of noncommercial risk to the measurement of country stability and macroeconomic variables. Such analysis typically takes the form of a country risk ranking which attempt, utilizing political, economic, and social variables measure the noncommercial risk in a country in comparison to other countries. The necessarily macroscopic perspective of such rankings, and the inability to
21

Comment [LW10]: If this is a quotation, you need a citation. (You dont for the devil.

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E.F. Schumacher, Small is Beautiful: Economics As If People Mattered (New York: Harper & Row, 1973):

216.

integrate a firms strategy as a variable in such rankings, makes them particularly poor tools for the analysis of local noncommercial risk. Nevertheless, they are the only commonplace measure of noncommercial risk available to firms in their analysis. Chapter Three: Defining Noncommercial Risk The literature on political and country risk is confusing, partly because different authors have different definitions and use different terms, and the work is and includes an ever-changing set of terms that is often used in a less- than-no rigorous. As a result, fashion, making the academic information analysis obtained from such of noncommercial risk analysis especiallyis difficult for corporate leadership to process and understand. This is a significant flaw that leads to useless The information and analysis, that in turn is difficult to operationalize and fails to achieve the buy-in of secondary stakeholders. In addition, the wide and varied understandings of noncommercial risk have prevented the emergence of consensus and on [?] best practice, making it difficult for firms to improve performance. All fFirms and businesses are of course different, including being and subject to different varying risks, but that does not mean that the assessment of social-cultural and political environments should proceed without some common threads. Once again, what we are searching for in this paper is to answer Stephen Korbins 1977 call for better definitions of the [noncommercial risk] phenomena, a conceptual structure relating [to] the firm and a great deal of information about the impact of the political environment.22 There are better definitions, that can yield best practices and improve a firms performance by mitigating noncommercial risks, and it is just a matter of discovering what they are. Given the similar issues faced by firms in the extractive industries, a class of business particularly susceptible to noncommercial risk, this paper will focus on the issues confronted by business in mining, and oil and natural gas and in doing so develop a more rigorous framework for assessment and risk mitigation. That process starts with a workable definition of the problem. What is referred to in this paper as noncommercial risk has a wide and varying terminology associated with it; a varied terminology that is accompanied by an equal variety of evaluative approaches that do not relate or build on each other in any noticeable way. Table 1, adapted from Bouchet, Clark, and Groslambert, depicts this diversity, presenting the different terms used to describe noncommercial risks, the multiple definitions of some of those terms, as well as numerous possible sources, impacts, historical perspectives and methodologies. Each bullet point represents different ideas related to thinking on noncommercial risks:23
Table 1: Various approaches of the literature on country risk Terminologies Political Risk Country Risk Sovereign Risk Cross-border Risk Definitions of Risk Performance variance Negative outcome Sources of Risk Sovereign interference Environmental Instability Nature of Investment Foreign Direct Investment Banking Commercial Loans Porfolio Investment Historical Perspective 1960s-1970s 1980s 1990s-? Methodology Qualitative Quantitative

Formatted: No Spacing, Indent: First line: 0" Comment [LW11]: I wonder why this section doesnt come before the previous one, on CSR. Might one not first define the problem before pointing to the failures of one approach to solving it? Formatted: No Spacing Formatted: No Spacing, Left Formatted: Indent: First line: 0" Comment [LW12]: Are? Comment [LW13]: Is this what you mean? Comment [LW14]: Sorry. I dont know whats being said here. Do the secondary stakeholders read the academic literature? I doubt it! Comment [LW15]: This whole paragraph needs to be sharpened.

Comment [LW16]: Seems out of place. Put early in the paper? Comment [LW17]: Are wide and varying different? Id have possibly understood varying to mean changing over time. Is that the intent?

Comment [WT18]: Fix Comment [LW19]: Clean up capitalization in table. Why is country risk not relevant for FDI? Table isnt at all clear. What does historical perspective mean? Literature of that period? Risks that materialized during that period? Is there a difference between political risk and country risk and sovereign risk? Not sure what cross-border risk means. I suppose this confusion is what youre trying to point out, but it still isnt clear what the table comes from or the data in the cells mean. Formatted: Font: Comment [LW20]: Do most mining firms have such? I really dont know not a rhetorical question. Comment [LW21]: Not in the table.

As one can see, this information makes it difficult for a corporate strategist unfamiliar with the subject (in the case of most firms the Chief Risk Officer (CRO) who is likely best versed in financial risks), to chart an information collection strategy and subsequent risk mitigation strategy.
22

Stephen J. KorbinKobrin, Political Risk: A Review and Reconsideration, 77.

23 Michel Henri Bouchet, Ephraim Clark, and Bertrand Grosslambert. Country Risk Assessment. (New York: John Wiley & Sons, 2003):10

Do they examine country risk with an eye towards its negative effects on the firm, in light of potential sovereign interface? Do they look at the wave of nationalizations in the 1960s and 1970s in search of methods for avoiding a similar event? Do they take a purely quantitative approach and assess the risks as a bank might, in a purely quantitative way? Although the right approach certainly differs by industry and firm, there are no clear guidelines as to which approach a particular company n industry should use, or even a simple starting point. A firms CRO is thus left to wonder to and fro in search of answers. The remainder of this chapter will sort through some of this variety of terms, ideas, and approaches to the assessment of noncommercial risk in order to highlight the lack of consistency the thinking on noncommercial risk produces, which in turn makes operationalization of such noncommercial risk information for the development of risk mitigation strategies particularly difficult and complex. Perhaps the most important trend to notice in the definitions and thinking explored in this chapter is that all assume noncommercial risk is fixed within a given country; as this chapter will begin to demonstrate, we believe this is a central flaw of the field, and that in order to create noncommercial risk mitigation strategies noncommercial risk must be seen in a fundamentally different light. History of Noncommercial Risk Since the 1960s, the a rapidly growing proportion of firms profits has generated its generated by profits overseas activities has been growing rapidly. through international operations. According to the latest available aggregate data (2006), the number of multinational corporations (MNCs) in the global economy has increased to 78,000, with total sales of $25 trillion and employment of 73 million people.24 The extent of overseas activity measured in terms of Foreign Direct Investment (FDI) reflects a similar trend, with the total cumulative value of FDI standing at $112 billion in 1967, growing to $4.1 trillion in 1998 and expanding to $7.1 trillion in 2003.25 Emblematic of the growing importance of overseas commerce to Global Gross Domestic product (GDP) is the rise in economic power enjoyed by MNCs. As the primary agents of globalization, MNCs have witnessed year-on-year increases in the volume of economic activity they generate, from less than 5% of global GDP in 1970 to 10% in 2003. However, such figures underestimate the growth of MNCs, since much of their growth is financed internally or from capital markets . . . they now account for up to a third of world output and two-thirds of world trade, with around a quarter of world trade being between branches of the same company.26 Not surprisingly, the revenues generated by some MNCs are significantly greater than the GDP of many nation states. Specifically, the combined revenues of the ten largest MNCs in 2003 exceeded the combined GDP of the worlds poorest 100 states. The annual revenue of Wal-Mart ($258.681 billion), one of the largest MNCs, is greater than the economy of Belgium ($245.3 billion), Saudi Arabia ($188.4 billion), Ireland ($121.4 billion), and Singapore ($86.9 billion), as well as the gross national product (GNP) of 168 other states.27 Globalization provides greater opportunities, along with greater risk as complications increase and the spread of operations expands to less-established locations. This is nothing new, though; risks from social-cultural and political issues in disparate geographical locales have long been a feature of international trade and investing. Evidence of extortion and expropriation of assets of foreign investors can be found as far back as ancient
24 Todor Petkovic and Marko Rakic. Transnational Companies: A Global Empire. Megatrend Review 7.2 (2010): 292. 25 United Nations Conference on Trade and Development (UNCTAD), World Investment Report 2003 (New York and Geneva: United Nations, 2003). 26 Jonathan Perraton, David Goldblatt, David Held and Anthony McGrew, Economic Activity in a Globalizing World, in David Held and Anthony McGrew (eds.), The Global Transformations Reader (Cambridge: Polity, 2000), p. 296. 27 Petkovic and Rakic. Transnational Companies: A Global Empire. 292.

Comment [LW22]: Do banks act that way???

Comment [LW23]: wander? Formatted: Indent: First line: 0"

Comment [LW24]: This may be the core of your thesis. If so, Id probably put it right up at the beginning. It would go along with the fact youre dealing only with extractive industries and with one kind of noncommercial risk: that arising from problems with the local community. If you do that, it will be clear what the thesis is about, and the analysis can follow more clearly. Formatted: Indent: First line: 0" Comment [LW25]: Does the rewrite of the previous sentence convey what youre trying to say? Comment [LW26]: These data dont support the point made in the previous sentence. Comment [LW27]: The previous sentence does not have data that show a trend. Comment [LW28]: Now, this shows a trend. But it doesnt support the paragraphs lead sentence, which is about profits. Comment [LW29]: Commerce includes trade. Youre talking about FDI, I thought. Comment [LW30]: Common statement, but does it really reflect power?

Comment [LW31]: Is this the point youre trying to make in these paragraphs? If so, put it up-front, and support it.

Greece. In the 17th and 18th centuries, high seas pirates posed an ongoing risk for British, Spanish, and French mariners importing exotic wares from the New World, while in the 20th century invasion and armed aggression have beenwere frequent occurrences threatening commercial and colonial holdings in Europe, Africa, Asia, and Latin America. Political and country risks are thus concepts with a long history in International Relations (IR). Yet, for all of the prevalence of noncommercial risk in the international system, it has received scant attention in the academic discipline of IR. In part, this is explained by the predominance of high politics in the 20th century. Recurrent inter-state warfare combined with the prospects of nuclear confrontation monopolized intellectual inquiry and theoretical efforts during the Cold War. The impact of politics on business, in contrast, has received little attention. Furthermore, since the Peace of Westphalia in 1648, the sovereign state has been the primary unit of international study. MNCs, given their non-state actor status, have only been topics of study as significant actors on the international stage, especially in academic study, when they appeared especially susceptible to the whims of state actors, as in the late 1960s and early 1970s. MNCs are often overshadowed even when it comes to non-state actor studies, such as those of terrorist organizations, which are perceived as posing an existential threat and thus given primacy in terms of study. Additionally, MNCs have most often been written off as instruments of powerful states. Many CEOs of MNCs would disagree with this simplistic view; MNCs, at this point, are more likely to think of themselves as stateless actors, as the following excerpt from Private Empires: Exxon Mobile and American Power demonstrates: ExxonMobils interests were global, not national. Once, at an industry meeting in Washington, an executive present asked Raymond (Lee Raymond, former CEO) whether Exxon might build more refineries inside the United States, to help protect the country against potential gasoline shortages. Why would I want to do that? Raymond asked, as the executive recalled. Because the United States needs itfor security, the executive replied. Im not a U.S. company and I dont make decisions based on whats good for the U.S., Raymond said.28 In short, despite evidence to the contrary, much of the literature in IR has thus been ill-disposed to view MNCs as anything other than either marginal or exploitive, predatory agents subordinate to state actors, or at the very least as institutions that become subordinate. The reality, in which MNCs are in fact independent actors, makes noncommercial risk analysis that much more difficult, as the study of most firms would straddle numerous disciplines, a reality that is the likely source of the terminology difficulties and abstract analytical categories. While not the primary focus of either economic or political scientists, all MNCs have grappled with the problem of political and country risk. The ubiquity of political and country risk explains the empirical presence of it, despite its conceptual absence in academic study. [Kobrin?] Country risk and political risk are thus normally understood as a function of IR and as a product that blooms out of cross-border activities. Indeed, political risk is intimately connected to the state system and its organizing principle of sovereignty. Sovereignty has been the guiding principle of the Westphalian system, limiting the judicial scope of regulatory orders, property, and individual rights, and exposing individuals, commercial actors, and state agents to the uncertainties that arise from foreign social, political, and economic orders. Ironically, while globalization has witnessed the emergence of transnational regimes (NATO, the UN, the WTO) and the increasing standardization of international norms and rule-governed behavior, the depth of these regimes has not been so great as to reverse the nature of sovereignty and the monopoly of force, and coercion possessed by the state within its purview. Even where
28

Comment [LW32]: Or is this the point? If there are two points (likely), they get confused. Make them individually and organize the data presentation to support them. And make it clear why they are relevant to your subject.

Formatted: Indent: Left: 0", Right: 0"

Formatted: Indent: First line: 0"

Steve Coll. Private Empire: Exxon Mobil and American Power. (New York: Penguin Press, 2012), 71.

Comment [WT33]: Run on Actually, its not a run-on sentence. It may try to cram too much into a single sentence, however.

such state excesses have been moderated with the global movement towards liberalization of financial markets (removal of capital controls, increasing recognition of international property rights, and the rollback of protectionist measures), state discretion to transgress international norms persists. The result is that the assessment of noncommercial risk is compromised, with little consensus, and remains in the pre-theory stage of its evolution, as noted by Jarvis and Griffiths.29 The pre-theory nature of the subject has led to it being skeptically received by corporate leadership, and has slowed the transformation of political and social risk management from art to quasi-formal science despite the fact that extractive industries have been grappling with conflicting pressures from multiple social and political actors for some time.30 Furthermore, the failure to clearly define the boundaries of the subject has resulted in a diverse literature, in which theoretical and methodological problems abound.

Definitional Problems A common definition of noncommercial risk, here represented by Charlotte Brinks, broadly understands the issue as is the probability that business will either earn less money, or suffer losses in profit as a result of stakeholders within a political systems (in) actions or reaction to events, decisions and politics.31 This definition is consistent with coverage of in keeping with political risk insurance, which protects against discreet government actions such as nationalizations. But , [what? definition or political risk insurance? Seems that local community acts are covered in the definition but not in political risk insurance. No? ] but fails to take into account the possible influence of political acts by non-state political actors, or social and culturally-driven events. Yet, actions of these kinds that represent a significant risk component of the investing environment for investors. and are only separate analytical categories only in the abstract. This definition is an incomplete one, and fails to recognize that It is easy to assume that the risk so defined is a given, that corporations are not purely takers of noncommercial risk. Their actions do not create it and ; they are creators, and their strategies and business plans do not result in stakeholders losing or gaining power, influence, money, etc. One might think that The definition implies that the risks are already present in the system, but when in fact they are at least to some extent the result of corporate strategies engaging with the system. Consider an example, where the investor influenced the noncommercial risks. Take for example The-US US-based mining firm Freeport McMoRan, which operates the largest gold and copper mine in Papua, Indonesia. It employees and also is an employer of 18,000 people,, is one of Indonesias largest taxpayers, and has brought in more than $33 billion in revenue.32 Nevertheless, the company is reported to have lost approximately $48 million and as much as 20% of its share price at times due to clashes with the population surrounding the Freeport mine.33
Darryl S.L. Jarvis & Martin Griffiths. Learning to Fly: The Evolution of Political Risk Analysis Global Society 21:1 (2007), 2. 30 Witold J. Henisz, Network-Based Strategies and Competencies for Political and Social Risk Management in Global Projects, in Global Projects: Institutional and Political, ed. W. Richard Scott and Raymond E. Levitt (Cambridge: Cambridge University Press, 2011): 353. 31 Charlotte Brink, Measuring Political Risk: Risks to Foreign Investment. (Burlington VT: Ashgate, 2004): 18. See: Coplin and OLeary,1994; Howell,1986; Kobrin,1978. 32 John McBeth, Freeport Indonesia: Filling in the Holes, Asia Times, February 22, 2006, http://www.atimes.com/atimes/Southeast_Asia/HB22Ae01.html 33 Tamara Bekefi and Marc J. Epstein, Integrating Social and Political Risk Into Management DecisionMaking (CMA-Canada, 2006), http://www.cimaglobal.com/Documents/ImportedDocuments/Tech_MAG_Integrating_Social_Political_Risks_Sept06. pdf: 13.
29

Formatted: No Spacing, Indent: First line: 0" Comment [LW34]: I find it awkward to say definitions.understand.

Comment [LW35]: Not sure what the rest of this sentence means. Comment [LW36]: I dont see how this makes her definition incomplete. Once you define the term, then it is a separate question as to whether risk is fixed or influenced by the firm, no?

Comment [LW37]: When to when? Comment [LW38]: When? Comment [LW39]: ? Cant be so precise on loss figure and so vague on time.

These clashes have arisen for multiple reasons, but of particular interest here is the decision by the firm to prohibit prospecting by local residents in the firm's tailings due to health concerns. The tailings from copper and gold mining can often be quite toxic, but also have some precious metal content. The local communities viewed this restriction not as an effort on the part of the company to safeguard the health of local residents, but instead as an effort to Decision to keep the local community from FreeportRestrict profiting. As a result, the local Community McMoRan population protested, shutting the Prospecting mine down for four days at a cost to the company of $12 million a day.34 Perception of Noncommercial This example demonstrates the feedback loop shown in Figure 1: Decision by

Comment [LW40]: Were these truly Papuans, or immigrants from other parts of Indonesia? (I dont know the answer.) The implications for management must, however, differ if theyre immigrants, instead of local Papuans.

stakeholders

Risk to Firm

Figure 1: Noncommercial Risk Feedback Loop35 Effected The firm acts, the community reacts, Decision to and a noncommercial risk that Stakeholder Protests Act affectsimpacts operations arises. s Additionally, the Brink definition falls short in that it results in a tendency to conflate sovereign debt risk, often referred to as country risk, with political risk. As Llewellyn D. Howell, author of The Handbook of Country and Political Risk Analysis, suggests, this conflation is all too common and ignores social, cultural, and purely political dynamics at play in most markets.36 On the other end of the definitional spectrum, noncommercial risk is defined not in terms of discrete events but rather in terms of country stability or volatility. This has become common in the political risk consulting world, as stability is an idea political scientists have spent a great deal of time trying to measure and model. However, this definition misinterprets volatility; although volatility is often considered a negative risk, especially in the financial world, this is not always the case. Some, such as Brink, believe that: the underlying risk that political instability holds for the foreign organization is the possibility that political disequilibrium might result in government limitations on producing profits.37 Although this is certainly a major possibility, it is also possible that political volatility would create opportunity for further investment, or great profits. For example, a post-Peronist regime in Argentina came to power via a military coup, yet had a more positive view of foreign investment than the presidency of Juan Domingo Peron. It turned out that impending political instability presaged a better investment environment. Another example is the benefits enjoyed by the armored car industry in 2001 that resulted from the "war on terror" and growing instability throughout the Middle East following the events of September 11th, 2001, both of which led to a dramatic increase in sales.38 The narrow viewpoint of stability and volatility as an undesirable risk is a particularly important issue for corporate leadership,
Chart 1: PRS Group IRGC Index Rankings for Libya 100 Tamara Bekefi and Marc J. Epstein, Integrating Social and Political Risk Into Management DecisionMaking, 12. 35 80 Based on Appendix 1 Exhibit: Tamara Bekefi and Marc J. Epstein, Integrating Social and Political Risk Into Management Decision-Making, 12. 60 36 Llewellyn D. Howell. The Handbook of Country and Political Risk Analysis. (New York: Political Risk Services, 1994): ___ 40 37 Charlotte Brink, Measuring Political Risk: Risks to Foreign Investment. (Burlington VT: Ashgate, 2004). 20 19. 38 Michel Henri Bouchet, Ephraim Clark, and Bertrand Grosslambert. Country Risk Assessment, 10
1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013
34

Formatted: Font: 9 pt, Font color: Accent 1 Formatted: No Spacing, Don't keep with next Formatted: No Spacing Formatted: No Spacing, Indent: First line: 0" Comment [WT41]: Define sovereign debt risk Comment [LW42]: Not sure I get this, nor am I sure its important. True, holders of sovereign debt dont have to worry much about a local community. But is that something that is implied in the definition?

Comment [LW43]: From the prospective of risk associated with the local community, isnt the point that the local risk can arise even if the country is stable? Why get off on volatility? It isnt what youre interested in.

Comment [WT44]: Expand Comment [LW45]: This is kind of fun, but relevant to your paper??

Libya

Linear (Libya)

especially in the extractive industries, which would be wise avoid conflating the two; stability is readily observable and thus can result in a cognitive bias in which political stability (or the absence of volatility) is associated with the longevity of a particular political regime, and thus seen as a seemingly safe investment environment. Such a misinterpretation could, and certainly has, easily led to investments that a proper noncommercial risk assessment may have deemed safe but was in fact not. As Nassim Taleb highlights, apparent stability is often false, as it involves unobserved risks being pushed into the statistical tails of the probability distribution.39 This tendency creates macro risk "time bombs." For example, as depicted in Chart 1 (time is laid out on the X axis and political risk is on the Y axis, with 100 corresponding with a hypothetical country lacking political risk and 0 indicating a country on the throes of upheaval), according to the PRS IRGC index the situation in Libya improved with each passing year that Gadhafi was in power. In hindsight, that stability just masked increasing tensions that were brewing below the surface, and suddenly exploded in late 2010 early 2011.40 Just as instability is not innately negative, the study of noncommercial risk has been shortchanged partly due to a perception that it is only a risk of loss. As Robock highlights, as in the case of other types of risk, political risk can result in gains as well as losses.41 A negative connotation not only handicaps the ability of noncommercial risk analysis to correctly assess investment environments but it also handicaps corporate leadership, and as noncommercial risk assessment is only as useful as its ability to assist corporate leadership in creating value, this is therefore unsatisfactory. Noncommercial risk necessarily deals with future uncertainties, and although uncertainties may do damage, if addressed accordingly noncommercial risk may also present great opportunity in the form of a competitive advantage. This is the case with oil and natural gas giant Chevron, which has developed a framework for collecting, understanding, and utilizing noncommercial risk information about local political actors to better engage and influence the local communities in which it operates. Chevron in fact believes its methods are of such value and so effective that when recently asked to cooperate in the development of a best practice teaching study led by Wharton Business School Professor Witold Henisz it claimed that this process was a source of competitive advantage that they preferred not to have publicized.42 It is just such a process that this paper aims to produce. The focus on the negative nature of noncommercial risk has resulted in its being separated from profit making. A business plan or investment is conceived, is evaluated for possible risks to the plan, and, if it passes the "test,", is implanted. The staged nature of such "planning" often means that a company first determines what it would like to do and only then considers whether it should not do it; behavioral economics suggests that the bar for do not will already have been lowered by the decision to do. This decision-making structure revolves around the notion that a dollar earned is sweeter than a dollar saved, though of course in absolute terms the two are of equal value. In addition, this approach does not lead to a focus on the risks that result from the plan, but rather a focus on the risks to the plan. Investing is an action and reaction process; it is circular, and noncommercial risk is as much community feedback, i.e. how a group feels about the business plan, as it is something already present in the system. As such, noncommercial risk should be incorporated into the decision-making process earlier, along with other forms of risk analysis, as it is a method of maximizing money and planning for the results of implementation.

Comment [LW46]: Isnt instability a part of noncommercial risk? Formatted: Highlight

Comment [WT47]: Crisper

Comment [LW48]: Can you rewrite this paragraph so that it is more straightforward? Is the point that the ability to manage community risk well can give a firm a competitive advantage over its rivals? If so, why quibble over definitions. Just make the point and illustrate it.

Comment [LW49]: I dont know why this paragraph is associated with definition.

39 Nassim Nicholas Taleb and Mark Blyth, The Black Swan of Cairo: How Suppressing Volatility Makes the World Less Predictable and More Dangerous, Foreign Affairs 90 no.3 (2011), www.fooledbyrandomness.com/ForeignAffairs.pdf: 33. 40 The IRGC index is a measure of overall political risk in a country. The index was developed by consulting for Political Risk Services (PRS) and includes political, social, economic and financial variables. 41 Stefan H. Robock, Political Risk: Identification and Assessment, Columbia Journal of World Business, Vol. 6 Issue 4 (1971): 7. 42 Witold J. Henisz, Network-Based Strategies and Competencies for Political and Social Risk Management in Global Projects, in Global Projects: Institutional and Political, 374.

Although the definition of noncommercial risk presented earlier is the most common, there are numerous others. Perhaps the earliest understanding of pure political risk is that of the Catalogue School, which during the 1970s sought to catalogue types of political risks. Still an important "school of thought" that plays a role in almost all noncommercial risk literature, the Catalogue School is decidedly limited in its value and is conceptually flawed.43 At issue is the School's simplistic understanding of noncommercial risk as a set of specific isolated actions. The definition of noncommercial risk presented by Weston and Sorge is representative of such thinking: Political risks arise from the actions of national government which interfere with or prevent business transactions.44 This definition is rooted in the misconception of political risk as nothing more than government intrusion in the marketplace, a notion that has its own philosophical roots in a simplistic laissez faire understanding of the economy as best left alone and self-regulating. Such a position assumes that markets are independent entities that are forced to interact with non-market actors and nonmarket signals, thus constructing a bifurcated image of the relationship between political systems and economic markets.45 Although the deregulation of the 1990s attempted to create such a bifurcation, economies always exist within the context of political systems. As Jarvis and Griffiths highlight, this artificially disembeds markets and business relations from their socio-political contexts and sees all political activity as negative, market distorting, and detrimental to business profitability.46 A second understanding of political risk, the Structural-Functional School, rests on the assumption that certain states are more prone to political risk than others, due to political structure and organization. With this view of political risk comes the idea that a topology of nation states and associated risks can be created. Such a topology could then be used to form predictive models of future risks based on correlations between states in reality and the state as it exists in academic literature. At issue is what Nassim Taleb, author of The Black Swan, refers to as platonicity, or the tendency to confuse the map for the territory.47 The hope of Structural-Functional analysis was for the discovery of relationships between the discrete stages of economic and political development and the risks that firms might be subject to when investing in such situations. According to Jarvis and Griffiths, while not a predictive tool that could be correlated to specific future risk events, structural-function analysis could provide insights into the risk associated with specific stages in the political modernization cycle.48 Besides confusing theory with reality, the Structural-Functional approach to noncommercial risk also presumes a specific developmental trajectory for the nation state. The result is the implicit claim that development equals stability and thus lower noncommercial risk, and that undeveloped equals unstable and thus high noncommercial risk. This is the two-fold error of confusing instability with risk, as discussed earlier, and the assumption that liberal democracy is the final developmental stage of the nation state. Neither assumption is certain or even clearly supported by observation. A third and final interpretation of political risk worth mentioning is the Methodological School. Arising during the 1980s, the Methodological School rejected the grand theorizing of the Structural-Functionalist School, and instead sought to develop an explanatory schema with predictive capacity, plus methods to evaluate the risk environment in relation to industry- and

Comment [LW50]: Presumably, a made-up name? Id put in quotation marks, in that case..

Comment [LW51]: Sounds accurate. Is the point that it is wrong, doesnt include all political risks, or that it doesnt cover all noncommercial risks?

Comment [LW52]: Id stay away from this controversy. It doesnt add anything to your paper. One could say that changes in government intervention pose risks to the firm, whether or not they are beneficial to the economy. Comment [LW53]: Arent you on the third? You need to separate the definitions from other points, such as the one about a firms being able to turn to an advantage its ability to manage certain kinds of risks. I thought that was a good point, but completely out of place. Comment [LW54]: Your term? Comment [LW55]: This isnt a definition, is it, but rather an analysis? Or, an assumption that is aimed at causality, not definition. Comment [LW56]: Not definition. Comment [LW57]: But you seem to be confusing definition with both, no?

Comment [LW58]: This all belongs somewhere else in the paper if at all. Its about what others think cause certain kinds of risks, or how those risks can be predicted; its not definitional, I believe. Comment [LW59]: Your term? Comment [LW60]: NOT definition

43 44

Jarvis & Griffiths. Learning to Fly: The Evolution of Political Risk Analysis 11. Fred V. Weston and Bart W. Sorge, International Managerial Finance (New York: Richard Irwin, 1972), p.

60. Jarvis & Griffiths. Learning to Fly: The Evolution of Political Risk Analysis 11. Jarvis & Griffiths. Learning to Fly: The Evolution of Political Risk Analysis 11. Confusing theory for reality, an all too common occurrence in all social sciences especially with built in abstractions such as political risk, a term that is itself an abstraction as separating out economics and social-cultural issues from political issues is impossible. 48 Jarvis & Griffiths. Learning to Fly: The Evolution of Political Risk Analysis 14.
46 47 45

project-specific applications.49 While numerous approaches have been developed, all with varying degrees of utility, none has become widely accepted. Most Methodological approaches are reliant on qualitative techniques and as such depend upon the ability and expertise of analysts. At issue for political and country risk is the fact thatN none of these approaches is complete, or completely without merit. Each suffers from specific shortcomings. Clearly, the Catalogue School has identified some specific threats, such as expropriation, but other concerns such as labor and social unrest do not fall as neatly into discreet categories and can take on many forms and functions in society. The initial probabilistic definition presented assumes far too much ability to translate soft social variables into hard quantitative facts. Another shortcoming of the above definitions appears to be the focus on macro- and/or country-level concerns. This is clearly on display when one transitions from defining political risk to operationalizing political risk. Noncommerical Risk is in the Relationships, not the Location As should be clear from the above discussion, defining noncommercial risk and collecting the relevant information for assessment is a challenge. The different schools that I have described suggest different approaches by firms to noncommercial risk. According to the Catalogue School, for example, Should corporate leadership should perhaps create a list of possible threats. (as the Catalogue School might suggest)? [et cetera] Should they focus on volatility in the potential market? Or perhaps they should attempt to modal out possible scenarios? Depending on how you define noncommercial risk, you come up with a different answer, and this makes for an especially difficult corporate planning session, made even more so if multiple outside consultants operating from different perspectives are employed or if information is collected mostly from managers on the ground who are unfamiliar with any formal theoretical structure of noncommercial risk.50 As previously mentioned, a common thread running through all the above definitions is that they overlook the fact that noncommercial risk is often a result of corporate action, not simply an ever-present risk in a political and social-cultural environment, as Henisz puts it in his essay Network-Based strategies and Competencies: The likelihood that a political or social actor will seek to alter the revenue stream of a corporation in a manner inimical to shareholders is typically neither a country- nor industry specific risk. Rather, the largest determinant of the risk of an adverse event is often the strategy of the investors. How do they enter? With whom do they ally? Who do they hire and from whom do they source materials and credit? One what terms? Where do they sell? What do they do with their returns? What are their future investment or expansion plans? What sort of public relations, corporate social responsibility, and government affairs strategy do they pursue?51 This is just what happened to Freeport MacMoRan as a result of its decision to protect the health of locals, a strategy that resulted in a loss of at least $48 million. In short, the strategic decisions made by most firms in regards to foreign operations may result in the creation of noncommercial risks as a result of the perception by local communities of the strategic decision. In most cases, how a secondary stakeholder reacts to an issue can transform a strategic decision on the part of a firm into a noncommercial risk. This understanding of noncommercial risk, as a companygenerated risk that creates a feedback loop, highlights the key missing element of the previous

Comment [LW61]: Nothing is at issue, no?

Comment [LW62]: They are much more than definitions. Formatted: No Spacing Formatted: No Spacing, Indent: First line: 0" Formatted: No Spacing Comment [LW63]: Thats not the lead sentence for this paragraph. The paragraph tries to draw the policy implications from the various schools youve described not definitions, to be sure. Comment [WT64]: Clearer Comment [LW65]: Model?

Comment [LW66]: Not Comment [LW67]: Hardly inherent in the definitions, when thats what is being discussed. Youve made this point earlier. Why not consolidate the various sections/paragraphs on it? This chapter needs some serious effort at organization. Make an outline now of what youre trying to say in it. (And drop side debates that arent necessary to your thesis.) Formatted: No Spacing, Left, Indent: Left: 0", Right: 0", Tab stops: Not at 5.5" Formatted: No Spacing

See: David Hertz and Howard Thomas. Practical Risk Analysis: An Approach through Case Histories. According to PwC 70% of the worlds largest multinational corporations relay on local managers for the vast majority of their information on noncommercial risks to potential projects. 51 Witold J. Henisz, Network-Based Strategies and Competencies for Political and Social Risk Management in Global Projects, in Global Projects: Institutional and Political, 357
50

49

definitions: recognition that a companys strategies impact affect the people of the country and local communities in which a firm operates, rather than only the other way around.52 Once this overlooked factor is taken into account, it is clear that the most often-overlooked actor in noncommercial risk is the firm itself, and the most often overlooked analysis is that of the firm and its relationship with secondary stakeholders. In absence of secondary stakeholder assessment, a noncommercial risk assessment cannot be considered complete. Additionally, if noncommercial risks do indeed arise as a result of corporate action, as Henisz believes, an analysis of those secondary stakeholder risks is essential for any successful risk mitigation strategy, and a corporation gaining influence over them is thus a key step in achieving success. Going forward, this paper will focus on operate under the assumption that a particular kind of noncommercial risk is that is best defined as follows: the risk posed by the reactions of secondary political and social-cultural stakeholders to a firm's investment strategy/business plan regarding a specific project. Chapter Four: Shortcomings of the Political and Country Risk Index We now have a working definition of the noncommercial risk that is the subjectdof this paper. This definition recognizes both the role played by a firms strategy in creating risks and the central influence of individual stakeholders in the process. The next step in operationalizing this definition is building an understanding of how the risks and a firm's strategy interact, forming a more complete picture of who secondary stakeholders are, and then finally following this all up in chapter four with a framework for operationalizing both the definition and the model, yielding for developing an education/influencea strategy for a firm to help mitigate its noncommercial risk. Just as the definitions presented previously failed to provide an adequate guide for the kind of information corporations should seek to collect for a noncommercial risk assessment, so too did they fail to lay the groundwork for that informations assessment. Our The definition we are now operating under does just that by making the central focus of our analysis is on the network of secondary stakeholders within a firm's operating environment. as well the firm's strategy, thus linking political and social issues with the strategy a firm employs to create value. This is an essential leap and allows for a direct assessment of the potential impact of delays, disruptions, or adverse actions by secondary stakeholders on a firm's investments and operations. Conversely, the failed definitions of noncommercial risk presented in the last chapter have generally not resulted in a reevaluation of firm strategy, but rather in the most common of noncommercial risk assessment methodologies, the country risk ranking, which is difficult or impossible to link to a firm's bottom line, or even to an individual project. As this chapter will show, the country risk ranking is not only an inadequate lens through which apply noncommercial risk, as it does not assess sources of corporate risk, but is also not helpful in crafting a noncommercial risk mitigation strategy. It is only through the integration of stakeholder theory into the discussion of noncommercial risk that these shortcomings can be addressed. The Political and Country Risk Index As Llewellyn Howell highlights in his Handbook of Country and Political Risk Analysis, political risk and country risk indices and textual analyses have been common in both popular business magazines like Fortune and The Economist and in professional business journals like the Journal of International Business Studies for more than 40 years.53 According to Bouchet, Clark, and Groslamert, this is the result of the fact that it is much easier to estimate a relative level of risk than an absolute level of risk, once a rating has been established, it is more than straightforward for
52 Tamara Bekefi and Marc J. Epstein, Integrating Social and Political Risk Into Management DecisionMaking, 45. 53 Llewellyn D. Howell. The Handbook of Country and Political Risk Analysis: ___

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Comment [LW68]: Can you do better than secondary? I rewrote this because there are other kinds of noncommercial risk that you are not addressing. Thats fine. You cant do them all. But its not very useful to define the term as if it includes only what youre addressing. As said above, this chapter needs a major rewrite. Comment [WT69]: Formatted: No Spacing Formatted: No Spacing, Left Formatted: No Spacing, Indent: First line: 0" Comment [LW70]: Not really a step in operationalizing the definition. Comment [LW71]: OK Comment [LW72]: This is chapter four. at the end of his chapter? Comment [LW73]: Point made

Comment [LW74]: I really dont understand this paragraph. Can you break it up so that each point it makes (whatever they are) is separate and clear? Formatted: No Spacing Formatted: No Spacing, Indent: First line: 0" Comment [LW75]: Does author really italicize JIBS and not Fortune and The Economist?

the international manager to determine an appropriate required rate of return by comparing with similar existing investments in other countries.54 Despite the fact that many advancements in identifying political, economic, and social variables have been made, these indices still fail to present a clear path forward for the management of political and country risks, as is demonstrated by the number of firms that operate successfully in unstable or politically risky countries that rank low on various lists published on a yearly bases. Some prime examples are Exxon Mobil, which has for years operated successfully in places such as Equatorial Guinea and Chad, or any of the many oil and natural gas firms currently operating in Nigeria. At its most basic level, the county risk ranking is very simple; in practice, though, it the simplicity provides cover for numerous subjective decisions. Utilizing a ranking in corporate strategy is based on the underlying assumption that careful data collection and analysis can generate rules for anticipating politico-economic events in a robust way that does not depend on problematic theory.55 This ignores the fact that one of the primary causes of noncommercial risk is corporate strategy, so a purely outward-looking analysis is unlikely compensate for an illconceived strategy. The assertion is also faulty, as the use of data requires the careful selection of which data to use, implying some underlying theory regarding which variables matter. Is GDP per Capita important? What about measures of free speech, or perceptions of societal corruption like those used by Transparency International? Furthermore, how theseis data are is assembled requires additional theory. Consider IHS, a UK-based research and consulting firm that publishes widely-used country risk rankings. Their ranking is based on the following formula:

Comment [LW76]: This is a run-on sentence. Quoted correctly?

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Comment [LW78]: Why bury this? Isnt this your main point?

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This risk ranking is calculated using a geometric mean: each risk is squared before it is weighted and then summed, and then the square root of the overall risk number is taken. The result is that a firm with a political risk ranking of 1 and an economic risk ranking of 3 (IHS rankings are out of 5) ends up with a higher rating then a country in which both political and economic risk are ranked as 2. According to IHS, this formula penalizes countries whose single risk categories that exhibit high variance.56 That may or may not be a good decision, but IHS has clearly made a decision based on an underlying theory about what makes a country more or less risky. Furthermore, the IHS formula, like most risk rankings, is comprised of data selected by experts and weighted according to expert opinion, experience, and observation, and then aggregated, most commonly into a numerical or letter grade. Regardless of the data selected, the key to a successful risk ranking is thus strongly subjective expert judgment, rather than a wellarticulated underlying theory with guiding principles.57 The IHS Political Risk variable, for example, includes a sub category called Institutional Permanence, a measure of the maturity of a political system; of course, maturity in the eyes of some is immaturity to others. Therefore, risk rankings are dangerous not merely because they are subjective in nature but because they present themselves as having a quantitative rigor they do not in fact possess. In the end, the most important aspect in the creation of a risk ranking is the expert who created it and his or her judgment. Moving Noncommercial Risk Assessment from a Focus on Environment to a Focus on Stakeholders Throughout the previous discussion of the shortcomings of noncommercial risk assessment methodology the weakness common to all methods was a confusion regarding the cause of a firms
Michel Henri Bouchet, Ephraim Clark, and Bertrand Grosslambert. Country Risk Assessment, 80 William Louis Ascher, Limits of Expert Systems for Political-Economic Forecasting, Technological Forecasting and Social Change 36 (1989): 139. 56 James Auger and Farid Abolfathi, IHS Country Risk Methodology (London: IHS, 2013): 4. 57 Michel Henri Bouchet, Ephraim Clark, and Bertrand Grosslambert. Country Risk Assessment, 90
55 54

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noncommercial risk. Because firms analysis fails to properly identify the root cause of noncommercial risk firms usually also fail to find an appropriate solution to mitigating the risk. The disjointed attempts by a firm to demonstrate that it is a social conscious through CSR programs do not prevent noncommercial risks, that have little or nothing to do with a firm being social conscious, from arising and thus leading to the inhospitable operating environments CSR efforts seek to prevent. The cause of noncommercial risk is how a firm operates in an environment not the environment itself, an oversight of most, if not all, noncommercial risk assessment methodologies. To address this shortcoming analysis must shift focus to the identification, evaluation, and assessment of stakeholders and stakeholder relationships. By reorienting the focus of analysis from the environment in which a firm operates to the stakeholders with whom a firm interacts a firms analysis guide a risk analysis determine how to navigate and shape the public and private political and socio-cultural spheres in which they operate. Through this reorientation of analysis firms can better account for the range of relationships, responsibilities, and interactions of stakeholders they engage with. Such analysis will enable firms to prioritize and identify the key risks to their strategy and adjust accordingly. Finally, such an analytical shift changes the nature of noncommercial risks, it turns them from environment factors present in the operating environment that are beyond the ability of a firm to address to risks that can be influenced through engagement and adjustments to corporate strategy. The implementation of stakeholder theory as a tool for understanding noncommercial risk requires an understanding of why a stakeholder would take adverse action against a firm. Stakeholder theory states that a stakeholder will seek to influence a firm as a result of an expectations "gap" between the performance of a firm and the expectations of the performance according to the stakeholder. It is because of failure to identify stakeholder expectations that most CSR efforts fail to create placid operating environments for firms. The gap is exacerbated over time, increasing the risk of adverse action by stakeholders over the lifecycle of a project. Identifying the underlying expectations of stakeholders should thus be at the root of a firms risk mitigation strategy. It thus stands to reason that the failure to satisfy a stakeholders expectations, not a firms project in and of itself, is thus root cause of noncommercial risk. A Sequenced Approach to Crafting CSR Strategies to Counter Noncommercial Risk Addressing all of these issues in a static model is difficult, especially given the clear need for context-specific knowledge. As such, it is necessary to recognize that best practice can only ever be a general road map and not a specific prescription, though as the interviewed stakeholders above noted, engagement must be formalized, structured, and professional in order to achieve success. Given these factors, we propose that the following five-step process be followed. Firms must look inward and articulate clearly their own goals and strategy for a project. Firms must collect atmospherics/information on the local communities that their project is going to affect. Firms must analyze and align project goals and strategy with the apparent socialcultural and political norms of the principal secondary stakeholders as much as possible; this should be done before a firm's strategy and plans are shared with the local community in order to reduce the perception of foreignness. A firm should initiate engagement with secondary stakeholders in two ways: first with educational activities exploring the nature of a projects industry, the timeline of typical projects and the economic impact of projects on communities and secondly with project-specific updates and town-hall style meetings that enable the collection of secondary stakeholder inputs on project specifics, these are listening meetings that must come after education. Sequence is important.

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Comment [LW80]: But the first step was to have clear goals and strategy. Are you saying the third step is to circle back and revise them??

Finally, firms should review and prioritize the inputs, suggestions, demands, and potential threats from secondary stake holders, all should be prioritized based on impact on value creation of a project for the firm. Some issues should be addressed in a direct and forthright manner; some issues will require changes to the plan, and other issues should be noted but dismissed (this is the most difficult category of issues). Once completed, the whole process should begin anew. At all times every the affect and success of every effort should be measured and its progress towards a predetermined goal should be measured. The repetitive nature of this process cannot be overstated, it should be repeated as frequently as possible, with an emphasis on education and radical transparency, both of which will earn respect and increase the ease of conversion to a firms position. Additionally, if risk rankings were an effective measure of noncommercial risk, rankings and corporate losses due to political risk, as a rough measure of a ranking's accuracy, would correlate highly with a country's position in that risk ranking. This is not the case, as was shown by Howell and Cheddick when they examined the correlation between the rankings produced by the Economist Intelligence Unit/BERI Political Risk Indices/Political Risk Services and a database of corporate losses from political causes. The study found a very low correlation between the political rankings of a country and losses resulting from political issues in that country.58 Specifically, it produced correlation coefficients of 0.33 for the Economist ranking, 0.51 for the BERI rankings, and 0.57 for the PRS ranking.59 Howells 1992 study focused on the Economist rankings and included economic variables rankings, and interestingly Howell found that the correlatioin between political variables correlations with and politically-induced losses improved when economic variables were included. The finding , supported supporting the claim that divisions such as political risk, social-cultural risk, and economic risk are artificial and have abstractions of little practical value.60 Although the numerous aforementioned shortcomings are significant, the principal shortcoming of the country risk ranking is the obvious lack of stakeholder analysis. Given that, noncommercial risk arises from the interaction of a firm and the stakeholders present in the operating environment, rather than simply being present within the environment itself, the preferences, goals, and desires of individual stakeholders as they relate to investment plans and decisions must be analyzed. Such sophisticated network analysis is common in the National Security establishment as well as diplomatic organizations such as the State Department that regularly engage in complex negotiations over issues with obvious non-financial stakeholders in which influence is the currency, but is uncommon in the corporate world. As Witold J Henisz of Wharton Business School suggests, although a growing number of companies, particularly those with a history of being targets of a negative stakeholder campaign, are realizing the benefits of such a proactive and sophisticated stakeholder relations strategy, it remains far from the norm.61 In order to accomplish this type of analysis it is essential to once again move beyond the existing understanding of how noncommercial risk impacts affects a firm, an understanding that is implicit in analysis such as a risk index. The causality is confused when a risk index assumes that the risks are present within the environment a firm operates in rather than as a result of a firm's operations. Additionally, an index is suggestive of the risks being a set concern, unchanging over time, when in fact they are constantly changing. Finally, it assumes that a firm is a taker of the
58 It is important to note that in this study only the correlation between political variables and losses was examined, economic variables, which play a role in all three rankings were not examined. 59 Llewellyn Howell and Brad Chaddick, Models of Political Risk for Foreign Investment and Trade, The Columbia Journal of World Business 29 no. 3 (1994): 89. 60 Llewellyn Howell, "Political Risk in Southeast Asia: A Perspective Through the Economist Model." Presented at the Third Biennial Southeast Asia Business Research Conference, Ann Arbor, Michigan, May 16, 1992. 61 Witold J. Henisz, Network-Based Strategies and Competencies for Political and Social Risk Management in Global Projects, in Global Projects: Institutional and Political, 362.

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Comment [LW81]: Practical, or explanatory?

Comment [LW82]: This is your major point again, its buried. Organize the previous paragraphs to support this point! I suspect some of what they contain will then seem nice, but not relevant to the point youre making. To be sure, a few diversions are ok, but they should be described as such, so the reader doesnt lose the thread of an argument by trying to understand their relevance to the big points.

risks present in an environment and therefore incapable of affecting them, when in fact a firm is very much capable of influencing the risks it is exposed to. Stakeholder Theory and Noncommercial Risk Management In order to employ the previously discussed definition of non-commercial risk, and address the aforementioned shortcomings of standard analysis methods, it becomes necessary to bring stakeholder theory into the discussion of noncommercial riskunderstand the relationship between non-commercial risks associated with secondary stakeholders, we need to understand what others have to say about the relationship of stakeholders with .. . Stakeholder theory broadly argues that an organization has relationships with many constituent groups that can engender and/or support a firm's operations and plans if that firm meets and addresses its goals and concerns.62 In general, the literature on stakeholder theory literature advises management to keep the relationships among stakeholders in balance. When these relationships become unbalanced, some stakeholders may seek to disrupt a firms operations and thus the stakeholders themselves create noncommercial risk for a firm. This is why noncommercial risk is said to be endogenic in this paper, which is to say that noncommercial risk arises, at least partly, from within a firms strategy, unlike in a risk index in which the risk is viewed as exogenousic. Unlike in most literature on stakeholder theory, though, the focus of this paper is on secondary, as opposed to stakeholder study in relation to noncommercial risk has to be for secondary as opposed to primary stakeholders. Primary stakeholders include, for example, : financial backers, shareholders, and customers of a firm. , just to name a few. As illustrated demonstrated previously, however, it is the secondary stakeholders from whom noncommercial risks most frequently arise: the NGOs, community activists, local politicians, for example. and so forth.63 Which secondary stakeholders do and do not deserve or require management attention depends on a careful evaluation of relationships between organizations and stakeholders, based on several factors including but not limited to transactions, power dependencies, and legitimacy of claims. Through identification, evaluation, and assessment of stakeholders and stakeholder relationships, firms can best determine how to navigate and shape the public and private political and sociocultural environments in which they operate, and in so doing, account for the range of relationships, responsibilities, and interactions in their strategy formulation and implementation.64 As Freeman observes, investigating how stakeholders, in this case secondary stakeholders, may try to influence a firm's investment strategy or business plan is critical knowledge for a manager, as risk mitigation necessitates at least a general understanding of how individuals and organizations in an operating environment will react to a given strategy.65 Although a firm may not be focused on local stakeholders, largely because traditional political risk literature focuses on macro issues, the stakeholders often act as "spoilers".
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Comment [LW83]: Whose? Tough sentence to understand. Comment [LW84]: Does this say anything? Does article on theory really propose this? Comment [LW85]: Endogenous?

See: Evan and Freeman, 1993 and Freeman, 1984. Additional secondary stakeholders of concern include, but are not limited to local host governments, local employees and labor unions, local competitors and trade associations, local communities (those not directly associated with the company through business relationships), other non-governmental organizations (NGOs), opposition political parties, and local community activists, especially those focused on environmental issues. 64 Identifying Who Matters: Mapping Key Players in Multiple Environments, California Management Review 42 (2000)___ 65 __________
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Of great importance to the proper implementation of stakeholder theory as a tool for understanding noncommercial risk is the understanding of why a stakeholder would take adverse action against a firm. Stakeholder theory generally holds that a stakeholder will seek to influence impact a firm as a result of an expectations "gap" between the performance of a firm and the expectations of the performance according to the stakeholder. It is because of this gap that many CSR and FPIC efforts come up short. This gap is exacerbated over time, increasing risk over the lifecycle of a project. As one secondary stakeholder from Peru interviewed by the World Economic Forum for a project seeking to address responsible mineral development stated, a disconnect between company timeline and the time required to develop long-lasting, effective community solutions leads to quick fixes storing up future problems.66 An example of just such a situation is the Yanacocha Gold Mine in the aforementioned stakeholder's home country of Peru. The Yanacocha mine was originally a joint venture between Newmont Mining Corporation, Compania de Minas Buenaventura of Peru, and the IFC. At the time of construction the mine represented approximately 18% of total global gold reserves. When the project first started in 1992, it enjoyed significant local stakeholder support as the mine brought with it significant economic benefits in the form of well-paying jobs and improved infrastructure. As time went on, though, and the nature of the project changed (the mine was originally meant to be small scale, but as a result of several extraordinary finds expanded into a massive project), stakeholder's concerns shifted and a gap between the expectations of essential stakeholders and company performance opened up. In the case of the Yanacocha mine the principal stakeholders that became the source of noncommercial risks for Newmont were local community activists concerned about the environmental impact of the mine on local water resources, a concern that had not previously arisen held when the project was small and local residents who believed the mine was impacting the region's traditional agriculture and pastoral identity, and disrupting traditional social structures and land and labour markets.67 To this day, Newmont and fellow operators have failed to overcome community opposition to an expansion of the project and have remained incapable of re-securing the social license to operate. This example of a performance gap, which increased over time as the project and community evolved, highlights another issue that noncommercial risk indexes fail to incorporate: the changing nature of risks, and the fact that noncommercial risks are a lifecycle issue for projects and firms. In many cases, noncommercial risk is industry-specific, or, as is more likely in this case, firmspecific. Some firms may suffer losses resulting from the adverse action of the host government or local politicians or NGO-inspired protests, while others may not be influenced or become targets of any of these groups. It is thus essential to understand, from a risk mitigation perspective, that the underlying reason stakeholders act against some firms and not others is a result of a firms failure to satisfy the desires of stakeholders or address those stakeholder interests and not, as previously discussed, because the risk is implicit in the operating environment. Therefore, identification of the stakeholders' interests is the key to a successful influence strategy that mitigates non-commercial risk.

Comment [LW86]: Did they go to the local community? Often they dont. And they vary from the construction period to the exploitation period, with the number of jobs going down, of course.

Comment [LW87]: Unclear. Is this when the project was small (impact on traditional ) or later? Rewrite. Comment [LW88]: Might the risk not be inherent in the project itself? Isnt the idea of FPIC rather nave, in some cases? Can it not be the case that there is no way to make some projects come out in the interest of the local community, but they may be in the national interest? The construction of a dam may require moving a village and destroying its ag fields. No nice talking will make the community happy with this. But the country needs electricity. Thats why we have imminent domain laws. On the other hand, in the US theres some confidence on the part of the general public that the owner whose land is taken will be compensated justly (although the owner may not believe it, he cant easily organize support for a rebellion). And the owner has options of buying something else or investing in financial markets for income. Neither may exist in some developing countries. Thus, the recent emphasis on the provision of livelihoods for displace individuals or communities, rather than simply monetary compensation.

66 World Economic Forum. "Stakeholder Perceptions and Suggestions." Responsible Mineral Development Initative (World Economic Forum: Geneva, 2010): 64 67 (Development without conflict)

Different stakeholders naturally have different interests to which that firms need to be responsive. to. For example, the local government may want firms to invest in the local community to speed the economic development, to increase employment, and to abide by laws and regulations. Local employees and labour union may focus their attention on the benefits associated with employment. Local communities, NGOs, and activists may wish that firms be environmentally responsible and to respect local culture and customs. Local political opposition parties may not care what a firm does, and view every choice a firm makes as an opportunity to realize their goal of returning to power. Although time-consuming and not easy to accomplish, these desires must be determined and sorted through. Prioritization of stakeholder demands becomes the most important issue as not all stakeholders can be satisfied. The interests of different stakeholders on a firm may be consistent. For example, almost all stakeholders wish firms to be good corporate citizens in the host country; to abide by the host country's laws, regulations, and business routines; to respect host country's social and commercial culture; to support the host country's charities; and to develop the host country's economy and increase employment. However, the interests of different stakeholders may also conflict with each other. For instance, local customers or consumers may wish that firms compete fully with local enterprises so that consumers can enjoy high quality goods and services at lower prices. But host competitors and trade associations may not want competitionbecome dissatisfied, since their interest may be challenged or even their very survival threatened. Consequently, firms should develop different strategies to deal with the "consistent" interests and "conflicting" interests., respectively. Again, in most of the academic literature on noncommercial risk, the host government's intervention in the operation of a foreign firm is identified as the principal source of noncommercial risk.68 However, such an analysis overlooks the very damaging actions of secondary stakeholders against foreign firms. In fact, different stakeholders may take different actions against foreign firms. For instance, although a sovereign governments nationalization of a foreign firm is the most talked about noncommercial risk and the most easy risk to transfer via insurance, more common examples of noncommercial risk are employee and labour union strikes; NGOs publishing negative reports and organized local opposition; local competitors lobbying or pressing the host government to control imports and establish new entry barriers; local customers or consumers boycotting MNE's goods or services; and criminal gangs robbing and kidnapping MNE's employees. These are very much risks that, if they materialize, interrupt daily business, a concern not covered by political risk insurance, and largely not transferable. Compared to macro-risks such as war and nationalizations, which are easily transferred via insurance to external parties and generally affect all firms to some degree regardless of whether they are a targeted firm or not, noncommercial risks are generally firm-specific due to the intervention of the local governments and secondary stakeholders targeting the result of specific corporate strategies, or the adverse actions of other non-governmental actors. As such, foreign firms should aim to build long-term good relationships with all the stakeholders, especially local secondary stakeholders, and in doing so avoid adverse actions against them. However, in some cases firms cannot meet the claims of stakeholders because the claims are too much or compete with one another. Under such situations, a noncommercial risk is most likely present. In these cases firms should take a more active approach to shaping and influencing stakeholders in order to alleviate the negative effect of such noncommercial risks. The next chapter will look at how to begin addressing such as situation in light of the new definition of noncommercial risk that is our focus and apparent the importance of secondary stakeholders; additionally we will examine two models for addressing these issues from within the extractive industries. Chapter Five: Building a Framework for Assessment and Strategy
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Comment [LW89]: The and must be wrong. Why is this related to invest in the local community? Comment [LW90]: What happens when the Poro bush school is right on top of the ore deposit? Comment [LW91]: Those in power may view the firm as a threat to their position, as well. Father Momis, on Bougainville, viewed the Bougainville mine as a threat to his and the churchs power. The company could spend money on propaganda that he couldnt match. And the clinics opened by the mining company threatened the churchs maternity clinics. (I am not kidding.) Comment [LW92]: ?

Comment [LW93]: Youve already dealt with this. This must be misplaced paragraph. Put it with wherever you first make this point and tell what your thesis is about. Comment [LW94]: Make the items in the list parallel in grammatical structure.

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Comment [LW95]: Do you mean meddle in local politics?

See: Fitzpatrick, 1983 and Kobrin, 1979.

Thus far we have clearly identified several aspects in noncommercial risk that have significant impact on how a firm should think about risk mitigation. The first is that political and social risks arise as a result from within of a firms strategy, not simply from given conditions; , and secondly, that commonly employed methods of political and social risk assessment fails because these approaches do not identify stakeholders, and instead focus on assessing the environment in which a firm operates in as a proxy. It is also clear that a firm cannot obtain a social license, which is to say cooperation for operations absent noncommercial risk interference, without recognizing the first fact and through addressing the demands of secondary stakeholders. The principal question before us therefore is: how do we meld take the recognition that noncommercial risk is a result of corporate action, meld it with stakeholder theory to , and create a framework for mitigating risk mitigation through via corporate influence of on secondary stakeholders? Understanding the risk a firm faces requires first gaining an understanding of the secondary stakeholders impacted affected by investments and projects, but it also will become clear from interviews with stakeholders that, beyond understanding, engagement is the key to avoiding the expectations gap that leads to noncommercial risk. As one secondary stakeholder interviewed by the World Economic forum as part of Responsible Mineral Development Project reported, successful investment could be achieved by raising awareness, promoting transparency, stakeholder engagements and [improving] capacity of stakeholders all of which is seen to be instrumental in bridging the gap of perceptions and expectations.69 Furthermore, stakeholders interviewed as part of the same World Economic Forum process noted that genuine consultation and early stage stakeholder engagement strategy is crucial to success and that one reason such engagement does not occur is because very few stakeholder management tools are available,, inhibiting progress because negotiations of community level agreements require [a] structured participatory process.70,71 Although the aforementioned shortcomings and oversights have received some attention by firms, especially those that have become targets of litigious NGOs, operationalization of these facts has fallen far behind risk management methodologies that address issues that are fiscal or economic. Many large multinationals, and all major international mining or oil and natural gas firms, have created CSR offices or have formed a bureaucracy within the risk management operations. UnfortunatelyYet, these positions are often more about compliance with codes of conduct that firms have signed up for (another form of "window-dressing") thanas they are about actually managing and understanding the complex political and social risks that firms are actually confronted with. As Witold Henisz notes in his essay Network-Based Strategies and Competencies, there is a lack of analytical tools to generate indicators of policy risk from these massively complex systems,, which limits the ability to extend enterprise risk modeling frameworks to cover political and social risks.72 What is needed then is a process for the assessment of stakeholders, along with a road map for constructive engagement that would allow firms to gain an understanding of the diverse preferences that a community's stakeholders have and therefore positively influence their opinions of a project or investment. This task is difficult in two respects: first in the identification of stakeholders who count, as briefly addressed in the previous chapter, and second, in the need to influence the behavior of individuals who a firm has no direct control or relationship with. As Henisz notes political and social actors possess a far wider range of objectives then simply profit maximizing, and they are often agents of or otherwise dependent upon the favor of other political
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Comment [LW96]: These are two rather clear points. It would be nice to organize much of the earlier part of the paper simply to make and support them. Comment [LW97]: Weird term. Comment [LW98]: Is influence what you mean? Maybe. Just not sure. Is engagement a part of influencing? Comment [LW99]: I know: impacted is now regularly used to mean to have an impact on. I am sufficiently old fashion that I prefer affected. Do what you want, however.

Comment [LW100]: Fix Comment [LW101]: Need to decide on British or American comma usage (and, occasionally, spelling). Comment [LW102]: An you operationalize facts?

Comment [LW103]: Is this intended to be critical? If not, Id choose another word.

Comment [LW104]: Is CSR really supposed to manage risk? I suppose so, at least indirectly. But is that its main charge?

World Economic Forum 201, 33. World Economic Forum 201, 56 71 It is worth noting that although many NGOs are currently pushing for broader adoption of Free Prior and Informed Consent, with an emphasis on the consent of local populations (a hurdle often too high for firms to cross) it is often only consultation that local communities are looking for, as the quotes presented suggest. 72 Witold J. Henisz, Network-Based Strategies and Competencies for Political and Social Risk Management in Global Projects, in Global Projects: Institutional and Political, 367.

and social actorseach with their own blend of political, social and economic objectives.73 Influencing such a diverse community of stakeholders is complex. This returns us to the reality that influence strategies designed to influenceaddress individual stakeholders may run counter to the desires and needs of other secondary stakeholders. We are once again also confronted with the fact that a firm's political and social risks will arise from the strategy the firm employs, and they will continue to arise from the strategies a firm employs to address noncommercial risks. This dynamic in many ways is similar to the problem of measurement in quantum mechanics. The minute one tries to determine, measure, and/or locate the position of a subatomic particle, the act of measuring influences its location, and the information is incorrect.74 So it is with noncommercial risk: the minute a risk is determined, assessed, and a solution applied, new information and new solutions to new risks must be determined. Failure to recognize this feedback loop would undermine efforts at risk mitigation, and it thus makes the management of noncommercial risk an ongoing process that, just like corporate planning, must occur throughout the lifecycle of a project. According to a diverse group of stakeholders avoiding the expectations gap between stakeholder and firm is best accomplished through Stakeholder engagement and consultation mechanisms that are formalized and structured to allow constructive and meaningful dialogue and discussion75 This statement is supported by other stakeholders who voice similar sentiment: Need for more effective community engagementas well as willingness to really understand and meet community and cultural needs, and Rigorous and professionalconsultation and early stage stakeholder engagement strategy is crucial.76 As noted there is a gap in both the literature and the understanding of noncommercial risk that has resulted in firms struggling to properly engage with secondary stakeholders largely because, as one stakeholder said very few stakeholder management tools are available.77 This is unfortunate as broader engagements and communication can change negative perceptions amongst stakeholders of foreign investment and projects.78 Addressing all of these issues in a static model is difficult, especially given the clear need for context-specific knowledge. As such, it is necessary to recognize that best practice can only ever be a general road map and not a specific prescription, though as the interviewed stakeholders above noted, engagement must be formalized, structured, and professional in order to achieve success. Furthermore stakeholders interviewed as part of the World Economic Forum Responsible Mineral Development Initiative tended to highlight the understanding gap and the lack of knowledge by communities about not just the projects in their own communities but also the breadth, scope, and complication of the extractive industries as a whole. Education is where the focus of engagement needs to be and where engagement can be the most influential. Given these factors, we propose that the following five-step process be followed. This process is based on both case study research and a careful reading of stakeholders responses in interviews that were part of the Responsible Mineral Development project run by the World Economic Forum. Quotes with stakeholders interviewed that are telling and supportive of the ideas expressed in each step are included below. If firms follow the five basics steps outlined below, they would not only

Comment [LW105]: Can you break down the tasks cleanly? Youre saying something about identifying stakeholders, about the fact that the interests of stakeholders make conflict with those of others, etc. Somehow, they get all mixed up. Try dealing with these points one at a time, and perhaps under clear subtitles. Comment [LW106]: Come on: reader has seen this repeatedly. You dont need to repeat it here. Comment [LW107]: That is not parallel to the dilemma in quantum mechanics. There, the very act of measurement affects the thing being measured. Youre not saying that identifying a risk makes the risk greater or less, are you? Formatted: No Spacing, Indent: First line: 0", Adjust space between Latin and Asian text, Adjust space between Asian text and numbers

Comment [LW108]: Maybe. Is it not possible that there are real and inevitable conflicts of interest? Will education really overcome them?

73 Witold J. Henisz, Network-Based Strategies and Competencies for Political and Social Risk Management in Global Projects, in Global Projects: Institutional and Political, 367. 74 This is referred to in quantum mechanics as the "observer effect, although commonly confused with the Heisenberg Uncertainty Principal. The observer effect states that: the act of observing a phenomenon with instruments necessarily alters the state of when the instruments are measuring in some manner. For example checking the pressure in an automobile tire by definition changes the pressure as it can only be done by letting out some of the air, the volume of which is the source of the pressure. 75 World Economic Forum 2010, 46 76 World Economic Forum 2010, 53-56 77 World Economic Forum 2010, 56 78 World Economic Forum 2010, 56

successfully engage with most secondary stakeholders but also gain a degree of positive influence, and in doing so mitigate significant noncommercial risks:
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Step One: Firms must look inward and articulate clearly their own goals and strategy. This step is warranted given the endogenousic nature of noncommercial risk. A stakeholder from Peru clearly articulated this need in stating that there was a need for companies to work internally to ensure all management teamsunderstand the business risks associated with social and environmental issues and improve capacity on stakeholder engagement and cultural understanding.79 Step Two: Firms must collect information on the local communities that their project is going to affectimpact. In this stage a firm should focus on people, relationships, and atmospherics within project impact zones. This step is supported by recognition that noncommercial risks become very real threats to firms as the gap between an individual stakeholder's perceptions of what a firm must do to maintain support and what a firm actually does grows. Step Three: A firm must analyze and align its project goals and strategy with the social-cultural and political norms of the principal secondary stakeholders as much as possible; this should be done before a firm's strategy and plans are shared with the local community, in order to reduce the perception of foreignness. Step Four: A firm should initiate engagement with secondary stakeholders in two ways: a. [verb?] Educational activities that teach secondary stakeholders about both the industry and life cycle of projects within thea firm's industry and instructs the secondary stakeholders about the scope and timing of the benefits and costs to be derived from projects. Education is essential because, as one stakeholder from Papua New Guinea stated, local people may lack capacity to understand and develop realistic expectations regarding a new operation at its early stages.80 Absent realistic expectations, a performance gap between expectations and performance is almost certain to arise. [verb?] Project-specific communication b. that outlines a firms plan, strategy, goals, and benefits. Both steps should be executed widely and freely within the community of secondary stakeholders and throughout the process a firm should collect inputs, demands, and costs related to achieving buy-in from secondary stakeholders. The importance of the education and communication step to a firms success cannot be overstated, as an Indonesian stakeholder commented: Education of local communities around exploration and mines sites is critical to developing a social license and can influence the formal licensing process.81 The importance of the education component was repeated over and over again by stakeholders interviewed in the World Economic Forum responsible Mineral Development project [what should be initial caps?]. In the case of mining, and thus surely in any other complex global industry, a lack of understanding about the industry and the nature of projects, and thus what realistic expectations of benefits should be was the principal impediment to success. Step Five: Finally, a firm should review and prioritize inputs, demands, and costs and begin to address them in a direct and forthright manner, while always attempting to measure the impact of efforts. Once completed, the whole process should begin anew. Shell and Malampaya 82
World Economic Forum 2010, 64 World Economic Forum 2010, 50 World Economic Forum 2010, 40 82 The exact details of Shells engagement process are not known, but the importance of both long-term engagement and education are clear from publically available information. The process was lengthy and Shell began engaging with community stakeholders as early as 1996, a full two years before construction began. It is also known that Shell took a very structured approach to community engagement in order to make full use of the information obtained during the process. The strategies used to obtain the social license to operate in this case included many activities that would fit into one or more of the steps outlined above: committee outreach and interviews with key
80 81 79

Comment [LW109]: Does this sentence really support the need to articulate goals and strategy? Doesnt obviously do so.

Comment [LW110]: But first sentence doesnt imply anything about perceptions of community. It just says company should learn something (information) about local communities that will be affected. Comment [LW111]: But the first step was to have clear goals and strategy. Are you saying the third step is to circle back and revise them?? Formatted: No Spacing, Space After: 0 pt, No bullets or numbering

Comment [LW112]: If they dont have the capacity, how is education going to help? Perhaps you mean capacity on their own? Formatted: No Spacing Comment [LW113]: But might costs to local community in fact outweigh benefits? Is it not nave to think that a community will accept costs burdens for the national interest just because they are educated or receive communications? Formatted: No Spacing, Space After: 0 pt, No bullets or numbering Formatted: No Spacing, Space After: 0 pt Comment [LW114]: Is the process itself not threatening to some who hold power? How do you deal with a Father Momis who thought education was undermining his and the churchs influence (as it probably was)? Comment [LW115]: Should a diamond mining company that gives 5% of its equity to local community explain to the community that it will be decades, if ever, that they receive dividends?? That the investor will make sure of that, by taking cash out through service of affiliate loans, transfer pricing, reinvestment in other projects, and so on? Comment [LW116]: I have no clue what this means. Formatted: No Spacing Formatted: No Spacing, Adjust space between Latin and Asian text, Adjust space between Asian text and numbers

One firm that has successfully navigated a stakeholder engagement in a way that is roughly similar to that outlined above is Royal Dutch Shell and its Philippine subsidiary, Shell Philippines, during the development of the Malampaya Deep Water Gas to Power Project. The Malampaya Gas project was a large-scale natural gas and energy infrastructure project off the coast of Palawan Island in the Philippines. The project was initially conceived of in the early 1990s, construction commenced in 1998, and the project became operational in 2002. The project was, at the time, the most significant foreign investment in the Philippines, totaling $4.5 billion, and was jointly owned by Shell, ChevronTexaco, and the Philippines National Oil Company, with Shell leading development. The goal was to use the natural gas from below the seabed, transported some 500 km via pipeline, to fuel a natural gas-fired power plant that would produce approximately 30% of the Philippines is total power demand, roughly 2700 MW of electricity [unclear is this total, or total for this plant? The number suggests its for this plant, but the sentence suggests its for the country]. The project was structured such that Shell and ChevronTexaco each owned and financed 45% of the project, while the Philippines National Oil Company owned and financed the remaining 10%. Shell and Chevron each expected to earn $6.7 billion from the project [over x years] while the Philippines National Oil Company expected to earn $600 million, in addition to at least $10 billion in service contracts. The project was to be developed in four phases: first, a concrete gravity structure was to be built that would form the foundation of the offshore drilling platform. This would be followed up with installation of the platform at the offshore extraction site, after which the 504 km pipeline would be constructed, and then finally the natural gas power plant would be built. Throughout the process, Shell showed great interest in obtaining a social license to operate so as to avoid public backlash. This eagerness was likely the result of Shell's previous experiences with a Philippines-based natural gas terminal project that was beguan without consulting local communities, an oversight that was credited with bringing about a situation in which Shell had difficulty obtaining the permits necessary for the continued operation of the facility. As a result, the project experienced lengthy delays and finally closed down in entirety after a year of operation. Shell thus recognized the advantages and desirability of securing public acceptance, in addition to previous experience that the Philippines had several regulatory requirements with respect to community participation that prompted Shell to actively engage the community. The Shell example is a good case for this study, as members of the development team report that many in the local communities iaffectedmpacted by the project were opposed to the project at the onset, before any engagement, and so Shell was required to not simply to influence and shape secondary communities to soften their perspectives but to actually change minds.83 Shells experience in Malampaya is also useful to examineinstructive because Shell prioritized education and engagement, as well as stationed teams in local communities for extended periods of time.84 One of the areas of greatest concern for Shell was the island of Mindoro, due to its being situated between the site chosen for the power plant and the gas field, and thus in a location through which that a pipeline would have to be run. transect it in some way. Shell initially conceived of three possible routes for the pipeline from the natural gas field: a direct deep-water route (which was problematic due to the depth very of the deep water around Mindoro Island), an overland route (that cut through Mindoro Island), and an indirect route (through shallow water directly off the

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Comment [LW117]: Not a sentence, as far as I can tell. Anyway, rewrite it. Formatted: No Spacing, Indent: First line: 0" Comment [LW118]: Splitting an infinitive with two words is really too much!

opinion leaders and decision-makers, information dissemination and education and communication activities, townhall meetings and education events with participation surveys. The entire process was structured, rigorous, and repeated, with information from each step being applied in the next and the whole process being repeated continuously throughout the ongoing life of the project.
83 84

Sohn, Development Without Conflict, 63. Sohn, Development Without Conflict, 21-22

coast of Mindoro Island).85 Regardless of the route chosen, Mindoro would be impactedaffected, and it was thus a key sphere of project influence, warranting extra time and effort in stakeholder understanding on the island. In choosing to focus on Mindoro, Shells actions highlight an important shortcut for identifying impacted affected stakeholders: delineating a project's geographic spheres of influence, or impact zone. In search of best practices, it is important to note that a focus on spheres of project influence would reveal secondary stakeholders directly affected by a project. In a 2007 paper by the IFC entitled Stakeholder Engagement: A Good Practice Handbook for Companies Doing Business in Emerging Markets, the IFC refers to the identified geographic zones as impact zones.86 By identifying impact zones, firms can begin to immediately to prioritize secondary stakeholders. In the case of Malampaya, Mindoro was a geographically essential area and thus its stakeholders were also of paramount importance. In order to address the concerns of the Mindoro community, Shell conducted an intensive information, education and communication campaign and held many educational town hall meetings that allowed for direct engagement and discussion with the population, developing trust.87 In addition, in order to alleviate concerns that Mindoro would not benefit from the project, Shell agreed to provide Mindoro a grant of about US$1 million which was distributed through seven Mindoro NGOs that presented project proposal.88 This is worth noting for two reasons. First, the Malampaya project cost about $4.5 billion and so financially placating the Mindoro community cost less than .1% of the project's cost. Additionally, as Mindoro was a key staging ground for aspects of the project, local opposition could have resulted in delays such as the prevention of equipment and material from moving freely. Shell estimated that delays in laying the pipeline would cost $400,000 a day, and when the pipeline was completed no delay costs had been incurred.89 The pipeline was eventually completed ahead of schedule, which resulted in further savings of $4-$6 million, and while not all is attributable to the avoidance of noncommercial risk it would likely not have happened in the presence of significant risk. A second important element worth noting is the inclusion of local NGOs in the process. Although companies like Shell are rarely completely new to the secondary stakeholders in the local communities their projects affect,impact, they are strangers, viewed skeptically and untrusted, and the firm's foreignness works against it.90 By engaging with local NGOs Shell connected itself with organizations that helped associate it with preexisting positive forces in the community and allowed Shell to develop trust, empower stakeholders and created a shared identity with stakeholders.91 Although Shells efforts in Malampaya were successful, it was not without missteps that could have been avoided with more careful planning. Shell needed to build a very large dry dock in Sitio Agusuhin in order to construct the gravity structure on which the natural gas pumping platform would sit. The area that was chosen for the dry dock was also the home of approximately 142 families of fisher folk, most of whom had lived at the site for many years, if not their whole lives, but who were also technically "squatters.". Rather than recognize them as a community within an impact zone, thereby engaging with the community directly, educating them about the benefits to them from the project, and discussing their options, Shell relied on the Philippine government to evict the fisher folk.

Comment [LW119]: Whats the shortcut?

Comment [LW120]: This paragraph is really wandering. Why isnt identifying the affected stakeholders, or physical area affected, one of the steps?

Comment [LW121]: Who judged the proposals? Did anyone oversee their implementation? How does company know which the community (which part of it?) wants these, as opposed to something else? Comment [LW122]: Wont they soon be back for more? Comment [LW123]: This paragraph mixes up a lot of things, in seemingly no particular order. The threats and the actions, for example, seem to be scattered through it.

Comment [LW124]: Does it matter which NGO? Some likely have their own agendas. And some are tied to particular leaders and some are threats to particular leaders. Some arent going to be happy with the investor no matter what he does. Comment [LW125]: Whats that?

Comment [LW126]: Were there any? There arent always benefits to some local community!!!

Sohn, Development Without Conflict, 24. Rachel Kyte, Stakeholder Engagement: A Good Practice Handbook for Companies Doing Business in Emerging Markets, (IFC: Washington, DC, 2007): 15. 87 Sohn, Development Without Conflict, 22. 88 Sohn, Development Without Conflict, 22. 89 Sohn, Development Without Conflict, 25. 90 Lite Nartey, External Stakeholder Engagement: Transforming Corporate Social Responsibility from Principle Rhetoric to Theoretically Grounded Practice. 9 91 Lite Nartey, External Stakeholder Engagement: Transforming Corporate Social Responsibility from Principle Rhetoric to Theoretically Grounded Practice. 6.
86

85

Unsurprisingly, related communities, in which the residents of Sitio Agusuhin had family and friends, whose existence more direct contact on the part of Shell would have revealed, reacted negatively, eventually bringing the Roman Catholic Church and the World Bank into the fight. Shell had clearly overlooked the network of ties the fisher folk of Sitio had and the potential power of the network, instead assuming that the fisher folk could not possibly bring dangerous secondary stakeholders support.92 Shell quickly regrouped and responded with compensation packages for the families along with other benefits such as microfinance loans, but all did not run smoothly. Some families demanded larger compensation packages; Shell successfully refused the higher demands, but to this day the relocated community is still dissatisfied with the results and argue that the compensation was unfair, as they did not understand the process by which Shell assessed what they were owed (suggesting a lack of necessary education). Additionally, the benefits such as the microfinance loan programing have not run smoothly in part due to the hurried nature with which the program was put into place. Many of these issues could have been addressed by engaging with the community as stakeholders with a network, rather than assuming that a government eviction would go without a hitch, and by engaging early. Although a ground level stakeholder analysis might not have revealed the ties that eventually brought the Catholic Church and World Bank into a fight over 142 families living on a remote beach in the Philippines, engagement in the community would have presented Shell with more information of the fine granular nature that would have revealed useful insights into the community's thinking about the project. It is only through direct engagement with local stakeholders within an impact zone that firms can begin to identify potential conflicts, incompatibilities, and sources of future gaps in perception of what benefits should be and what the actual benefits from a project will be. Additionally, local engagement in every impact zone ensures ongoing communication and information exchange. One of the most important reasons for local engagement is collection of what the US military refers to as Atmospherics. Broadly speaking, atmospherics are insights into cultures, perceptions, values, beliefs, interests and decision making process of individuals and groups within a community.93 Although firms may be tempted to think of this information as the kind that can be obtained from experts employed by political risk consulting firms such as Eurasia Group or Control Risks, they would be mistaken. The detailed knowledge necessary for productive engagement is very granular, and requires on-the-ground experience with a community's people. US military experiences in places such as Afghanistan and Iraq should serve as a warning to firms that operate under the assumption that what they need to know to successfully engage can be learned from afar. Although the US military has "baggage" that many multinational firms investing in far-flung places do not, the baggage and goals of each are not all that dissimilar. The experience of the US military has been that the distant analyst can struggle for months, sometimes years to assemble intelligence products that accurately depict tribal and political associations, but an on-the-ground presence can answer many of these questions in a few meetings with locals.94 In short, firms should look at trips to impact zones much as the military might, as essential information collection and targeting operations in which key stakeholders and groups in the community can be identified and targeted for key stakeholder engagements. The Malampaya example demonstrates several important ideas. It demonstrates that a stakeholderfocused engagement process targeting secondary stakeholders works. Although the details of Shell's process are not known, the general guiding principles can be inferred, and the outcome was positive. The World Resource Institute estimates, based on interviews with Shell personnel, that
Sohn, Development Without Conflict, 23. David Petraeus, Counterinsurgency FM 3-24, (Washington: Department of the Army, 2006): 80. 94 Michael Gallagher, Human Intelligence in Counterinsurgency: Persistent Pathologies in the CollectorConsumer Relationship, Small Wars Journal, http://smallwarsjournal.com/jrnl/art/human-intelligence-incounterinsurgency-persistent-pathologies-in-the-collector-consumer-re (June 5, 2011): 3
93 92

Comment [LW127]: Or suggested that they really didnt get enough! Or suggesting that compensation, in the Western sense, doesnt work when people are driven from the jobs or lands they know. Thus, the newer concept of livelihood.

Comment [LW128]: Firms dont travel. People do. Who should do this? Should the firm hire specialists? Anthropologists? (Can the firm manage anthropologists, who are usually antagonistic toward investors?) Consultants? If so, with what skills? Bougainville Copper used an anthropologist (didnt help much). Mittal (Liberia) used a community development specialist, who served as an intermediary between local communities and mining company.

the engagement with local stakeholders cost the firm approximately $6 million while the benefits from savings from potential delays or benefits accrued from the ahead-of-schedule completion of project elements was $50 and $72 million. The table below details the World Resource Institute estimates:
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Activities Community Engagement Including Educational Operations, Compensation for Families and Microfinance Loans Total Costs

Costs (Millions of US Dollars) 6

Activities Construction Ahead of Schedule Contractual Penalties Avoided Project Delays from Laying Pipelines Avoided Total Benefits

Costs (Millions of US Dollars 36 10-30 4-6 50-72

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It is possible to learn several important lessons that are essential to a successful engagement and education/influence strategy from Malampaya. First is prioritizing engagements with stakeholders based on impact zones, a simple reading of the geography that a project will impact. Although it is not clear whether Shell thought about the project in this way, impact zone analysis would have highlighted Mindoro Island as a key area of focus, as Shell did, and would have also highlighted Sitio Agusuhin as a key site of stakeholders for engagement, which Shell overlooked. Additionally, Shells experience in Malampaya demonstrates the importance of not relying on the government for relationships with local stakeholders, substituting direct engagement and the necessity of educational engagement. Finally, the Sitio Agusuhin misstep demonstrates the importance of bringing all these ideas together and engaging at the earliest practical stage with impacted stakeholders, as delay only increases costs. In short, Malampaya is a display of stakeholder engagement that was successful, roughly followed the suggested steps outlined above and additionally demonstrates the utility of more tactical practices a firm can utilize in engagement such as identifying impact zones and collecting atmospherics. Further Insights into Successful Engagement for Anglo-American SEAT An essentialM missing from the element of the Shell case study are is the exact details of the process that Shell underwent that enabled it to engage with stakeholders. How exactly did Shell build and maintain its stakeholder network? How did it identify key stakeholders (although we suspect that that they did so via a process similar to the proposed impact zone targeting), and through what channels of communication did it engage? When Shell was approached about this by?, it responded in much the same way as Chevron did to Witold Henisz when he requested further insights into Chevron's approach to the project in Nigeria: providing details of the process, and evidence of its value, would reveal a source of competitive advantage. It is known, though, that Shell uses the case as a teaching example during the planning stages of other projects. Although neither Shell nor Chevron have made their respective processes public, mining firm Anglo-American has, in the form of the Socio-Economic Assessment Toolbox (SEAT). In 2012 Anglo-American released its third update to its SEAT methodology. According to AngloAmerican management, its chief goal is to maximize shareholder value, and this is best accomplished by not losing time or money to the delays and missteps that may result from manageable risks, such as the noncommercial risks we have been discussing. Since SEAT was first deployed in 2003 by Anglo-American, it has been used in 50 operations in 16 countries. In the SEAT process we can see many of the ideas discussed in the previous discussion of Shell in Malampaya.

Comment [LW129]: Did the government (central) have some commitment to help? Did it not fulfill that commitment? If not, because it didnt have the skills or didnt want to do so?

Comment [LW130]: But you proposed a series of steps. I cant find them in this case study. Formatted: No Spacing Formatted: No Spacing, Indent: First line: 0"

Comment [LW131]: Shell shifted from an it, in previous sentence, to a they in this sentence. Decide.

Comment [LW132]: Nice business jargon. They mean make as money as they can.

The SEAT process contains 8 Steps and 23 sub-steps, and the 8 basic steps are outlined below:
Step 1: Profile the Anglo American Operation Step 2: Profile the community and engage with key stakeholders to identify key issues Step 3: Identify and assess social and economic impacts of the Anglo operation and assess existing management measures and social investment initiatives Step 4: Share results of impact assessment with stakeholders and develop recommendations for management issues Step 5: Development of a management and monitoring plan for issues, including formulation of key performance indicators (KPI's) Step 6: Improve the implementation and contribution of non-core activities Step 7: Post Closure Planning Step 8: Prepare soci-economic report and feedback to community
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In this process we can see a few of the steps that Shell appears to have engaged in, as well as steps proposed in this paper's five-step process. For example, steps 1 and 2 are recognitions of the fact that noncommercial risk arises from a firms impact on a community and is not inherent in the environment. Both steps are similar to the first stage Anglo American SEAT KPIs proposed in this paper. An interesting innovation not Number of facilities (or sites) improved / maintained discussed in the Shell case that is important to the Number of facilities built success of an engagement process is the assessment of Number of permanent jobs supported existing management measures and social investment Number of permanent jobs created initiatives and the development of key performance Number of temporary jobs created (annual FTE basis) indicators. Both of these efforts, related to an Number of partner staff trained assessment of a firm's own strategy and its impact on Number of community members trained the community, are essential innovations in the process Number of beneficiaries of education projects of corporate engagement that make the Anglo Number of beneficiaries of health and welfare projects American SEAT methodology an industry-leading Number of beneficiaries of water and sanitation process for stakeholder engagement, and thus the projects mitigation of noncommercial risk. Number of beneficiaries of sports, arts, culture and heritage projects A critical assessment of the success and failures Number of beneficiaries of capacity development of a firm's own engagements is difficult and the projects development of useful measures of progress is perhaps Number of beneficiaries with improved livelihoods Number of beneficiaries of improved housing even more difficult than a more general assessment; Number of beneficiaries of community development nevertheless, it is well worth the time and effort. One projects of the reasons for the difficultly is what has been Number of beneficiaries of energy projects described by Frank Ridzi, in his paper Managing Number of beneficiaries of disaster and emergency Expectations When Measuring Philanthropic Impact: A relief projects Number of businesses created Framework Based on Experience as the ripple effect. Number of businesses supported Ideally firm efforts will involve limited expenditures Total number of employees in firms currently supported outside of education and engagement, but a limited Annual turnover of businesses currently supported degree of philanthropic like activity is to be expected. Number of new livelihoods projects created As such the idea of the ripple effect applies well in the Number of existing livelihoods projects supported assessment of both the engagement and any subsequent Number of houses built activities. Number of houses upgraded or maintained Number of community development projects Frank Ridzi describes the effect in the delivered following way: Tonnes of C02 avoided / abated / offset For instance, standing at the edge of the pond you can choose to jump in at a variety of locations. You can
Power generated (kWh) per annum Power saved (kWh) per annum Length of waterways improved / protected Area of land / surface waters improved / protected
(ha) Tonnes of waste avoided / reused / recycled

Comment [LW133]: Why are your five steps better than these 8?

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strategically jump in near to shore and directly help individuals who need assistance. You would expect the effects of that investment to ripple through the lives of those individuals, but to get those ripples to reach through the entire pondto where you would be able to measure the height of this ripple on a community levelyou need to help a large number of individuals (i.e., make a huge splash). Furthermore, to be able to measure that impact it would have to be clearly tied to your efforts. Otherwise the foundation might fall into the trap of taking credit for the work of others.95
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Measures of Effectiveness: The critical step in a successful noncommercial risk mitigation strategy. The one factor that makes successful engagement and management of noncommercial risk more difficult is measuring the effectiveness of such efforts. The failure to do is often the root cause of the uncoordinated initiatives most companies claim as their CSR efforts. Absent good measures of success and failure, firms cannot properly assess the value creation of noncommercial risk mitigation efforts. As a result noncommercial risk lacks meaning within the broader context of a firms long term corporate or project strategy. take -away from this quote should be that a firm needs to carefully measure both Despite the importance of measurement it will remain on of the effect of the huge splash that their initial investment makes as it ripples through the entire community, the effect of education and engagement (likely a much littler splash that ripples less) and the effect of subsequent activities (likely the littlest splashes). Luckily for firms engaged with local communities ripples build on each other. In physics, interference is the phenomenon by which two waves or ripples in a pond superpose to form a resultant wave or ripple of greater or lesser magnitude. If properly timed and properly executed, both of which depend greatly on knowing where a firm stands with community (a question of measurement of impact) firm efforts experience interference and or build on each other, turning ripples of social unease into a wave of community support. Ango-American clearly understands the importance of measurement to achieving such and end, as is demonstrated by the emphasis placed on measurement, and uses the subsequent data in the execution of project designed to achieve social license to operate and thus avoid noncommercial risk. SEAT process The SEAT process requires that project management report on approximately 32 different pre-established KPIs, as part of the SEAT methodology, as listed in the accompanying text box. Although these KPIs represent a good start, and would by themselves be progress over simply not measuring the impact of engagement, they come up short in conveying the very real positive impact that foreign investment operations can have on host communities and thus secondary stakeholders. The primary challenge of measurement the most difficult tasks in the management of noncommercial risks principally because is that KPIs for noncommercial riskmeasures of effectiveness must be tailored to the can only be templated to a limited degree. They must be situation n and operating environmentspecific. NeverthelessAlthough, bBroadly speaking, they can should be divided into three categories that can provide further guidance as to what they are attempting to measure, : social measures, informational measures, and economic measures, the specific dependent and independent variables being assed will always depend on the mix of secondary stakeholders that pose a risk to a firm and the nature of its project..96 Social measures
95 Frank Ridzi, Managing Expectations When Measuring Philanthropic Impact: A Framework Based on Experience, The Foundation Review 4 no. 4 (2012): 103. 96 These are categories based on those proposed by Lieutenant Colonel David Kilcullen in his papers Notes on Operation Metrics for Irregular Warfare and Counterinsurgency and adjusted to fit the different demands of foreign investors looking to invest in difficult environments that may become hostile. Additional insight has been garnered from Guidelines for Measuring Success in Counterinsurgency by S.N. Bjelajac

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Comment [LW134]: rewrite

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Comment [LW135]: Measuring measures? Maybe some rewording?

should indicate the progress and impact of a firms relationship with local stakeholder institutions (governments, NGOs, etc) and seek to measure the success of any programs they implement in corroboration with these stakeholder institutions. For example, Shell should have created a social return-on-investment measure for its donations to local NGOs in Malampaya. One approach to this would be for Shell to work with the NGOs to create a social return on donations forecast, and then track how closely the actual returns over time follow the expected returns. Information measures should attempt to evaluate the perception of a firm amongst important stakeholders. This is, in essence, a measure of the degree to which a firm is "winning hearts and minds. This is most easily accomplished with direct polling of the population, and slicing and dicing of polling information into useful categories, much as political strategists do with polling information during elections in the US. Identifying which groups are supportive of firms operations and which are not can yield valuable information about what needs to be done to win over stakeholders not yet supporting a project. The media is also a valuable source of information. The degree to which firms receive unsolicited, voluntary support in the press and public media, for example, could be used as an indicator of the intensity and sincerity of support amongst the population. Another important aspect of informational measures is related to education. As noted in the previous Shell case, much of the company's efforts were in education and town hall meetings. The degree to which local communities need to be educated about a firms investments and project ideas cannot be overstated; in fact, education is one of the key engagements that can occur between a firm and secondary stakeholders. Many perceptions about the negative actions of foreign investors and much of the hostility towards a project can be overcome with simple informative endeavors. In the 2010 World Economic Forum Responsible Mineral Development Initiative, one of the key findings of the consultation with stakeholders throughout the mining industry was that secondary stakeholders (in this case principally local communities, civil society, and local government) had limited expertise and understanding of the value of mining projects and where that value came from. Luckily, measuring the success of such educational endeavors is easier than measuring other stakeholder engagements. The general effectiveness of education engagements can be determined by the size of ongoing company events, in essence taking the pulse of the willingness of stakeholders to continue to attend and engage with the firm. Absenteeism at follow-up events is a clear indication that that stakeholders have not been receptive to what is being discussed and to what a firm is trying to say. Furthermore, enthusiastic engagement at educational events, participation with questions and back and forth dialogue is a positive, not a negative. Finally, economic measures should indicate the impact a firms money is having on local stakeholders, for example measures of the effectiveness of the microfinance loans made by Shell to the relocated families of Sitio Agusuhin. Measuring effectiveness of stakeholder engagement will remain a difficult pursuit largely due to the complex and ambiguous natures of such a task. For this reason, it is important that firms measure as much as possible. Susan Stout, retired manager of the World Banks Results Secretariat, recently cautioned to Melinda Tuan during research for a project conducted on behalf of the Bill and Melinda Gates Foundation that: there is incredible silver bulletism around in the donor (and perhaps foundation) worldsseeking that one special number that will tell us if we are succeeding or failing. This is driven by bureaucratic fantasy, not reality. The chances that we could come up with a metric that avoids an inevitably subjective process of judgment and choice are infinitely small (else politics would be a much simpler and boring topic). Its usually driven by a desire to define a bottom line that will do for philanthropy and public sector management what profit/loss statements do for the private sector. Its just not going to happen that way."97
97 Melinda Tuan, Measuring and/or Estimating Social Value creation: Insights into Eight Integrated Cost Approaches (Bill & Melinda Gates Foundation Impact Planning and Improvement,2008) http://www.gatesfoundation.org/learning/documents/wwl-report-measuring-

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Nevertheless it is essential to understanding what aspects of engagement are successfully influencing stakeholders and shaping their perspectives of a firms project and investments. Additionally, measures of success allow for meaningful and credible targeting of both stakeholder engagements and anything that might follow from that engagement.
Comment [LW136]: Maybe the issue of measuring success should be a separate section?

estimating-social-value-creation.pdf