What it is:
Political risk is the risk of financial, market or personnel losses because of political decisions or disruptions. Also known as "geopolitical risk."
How it works (Example):
There are many environmental factors facing business. Besides market-based causes, business can be affected by political decisions or changes.
For example, political decisions by governmental leaders about taxes, currency valuation, trade tariffs or barriers, investment, wage levels, labor laws, environmental regulations and development priorities, can affect the business conditions and profitability. Similarly, non-economic factors can affect a business. For example, political disruptions such as terrorism, riots, coups, civil wars, international wars, and even political elections that may change the ruling government, can dramatically affect businesses’ ability to operate.
Political risks are faced equally by investors in international businesses and investment fund portfolios. These political risks are part of the estimation and disclosure of risk factors, usually found in a company or portfolio's prospectus.
Why it Matters:
Political risk can affect the operations and profitability of a business as directly and quickly as any financial, physical, or market risk factor. The impact of political risk is considered to be long-term because the risk rises over time, given the greater potential for events and changes over time. Although political risk is extremely difficult to quantify, companies and investors must examine and understand the potential for political risks by closely examining the location's history, political institutions, and political forces at work in the region.