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What is Economic Exposure?
As the number of businesses participating in international markets grows, the threat of economic exposure grows as well. Economic exposure is the risk of doing business abroad. Some of the more common risks include a fluctuation of exchange rates, unstable governments and shaky economies. The possibility that foreign countries will not honor their debts is another factor. Another consideration is the increased expense of protecting the health and safety of employees. These factors have an effect on a company's cash flow and earnings, but the long-term earning potential from doing business abroad makes the risks acceptable to many businesses.
One example of economic exposure is if a company strikes a business deal with a small foreign nation and that nation becomes embroiled in a civil war. There is then a high probability that the country will not honor its debt obligation to the business. Depending on which side wins, the standing government might renege on the previous arrangement. On the other hand, even if the country does not change leadership hands, it might be burdened with the expense of restoring the country and therefore, the money to repay debts might not be available.
Companies who assume the risk of economic exposure hedge the risk with options for stock, currency or commodities. An option means the company has the right to buy or sell owned options or use them as leverage or protection. As leverage, the option allows the company to control its equity in the foreign deal. When used for protection, the option protects the company from market fluctuations. It also offsets losses from economic exposure. The value of the option is negotiated at the onset of conducting business with the foreign company or government.
When a company buys into an option, it usually does so for an amount equivalent to the original investment, and the option is for a set duration. If the company opts to not exercise its option right within the negotiated time frame, the option expires. An option is a right and not an automatic position that a company must take.
Most companies that choose to do business abroad are not there for the short term. These are long-term investments that the company anticipates will generate decent revenue in the future. A company looking for a quick turnaround investment might be better served investing in its home country. The inherent risk of economic exposure could be too great for a quick turnaround.
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![Economic exposure is the risk of doing business abroad.]()
By: Rehan QureshiEconomic exposure is the risk of doing business abroad.
Discussion Comments
@MrMoody - Yeah, I believe that exchange risk is one of the most volatile variables in deciding whether to open up operations overseas overnight. Everything is measured against the dollar.
As the dollar strengthens or weakens, it has an impact on the value of our imports and exports. I believe that in the right circumstances it can work in our favor, tightening up the trade deficits for example, but most of the time it’s just a roll of the dice.
@starrynight - I agree. It just seems too risky for companies to jump into international business. There are so many things that could go wrong - changes in economic and tax laws, big changes in the economy of the country. These changes plus the ones mentioned in the article could greatly affect the health of one's company in a foreign land.
@starrynight - I lived in Indonesia in 1998, the year that riots broke out in the streets over the collapse of that nation’s currency. It was called the Asian meltdown.
Prior to the meltdown, some American companies had decided to open up their operations in Indonesia. One such company was Wal-Mart, which had a presence in the mall near where we lived.
With the collapse of the currency market economic conditions went south very fast; soon angry rioters were in the streets, pillaging any visible, remaining signs of prosperity. Wal-Mart was one such sign.
Rioters burned one whole side of the Wal-Mart building and smashed the glass panes in the mall.
Long story short, Wal-Mart made a strategic decision then to pull out of Indonesia. They may have returned since, I don’t know, but they got a good lesson in foreign exposure risk.
@starrynight - International business does sound like a risky proposition. I can understand why some businesses want to strike out into the international market because the payout can be great as well.
Having business owners insurance can also help deal with the transaction exposure. Every insurance company does their business insurance a little bit different though, so if your business is operating internationally be sure to read your policy thoroughly.
It seems like the operating exposure for doing business abroad would just be too great for many companies. In addition to all the other problems the article mentions, the exchange rate for the dollar isn't very favorable. I suppose some companies don't mind taking the risk but I wouldn't do it!
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