Removing the Bloc from Joint Ventures in Eastern Europe
Warren, Hugh A., Risk Management
The changes occurring in Eastern Europe during the past few months have augured a dramatic restructuring of the economic and political systems that have existed there since the end of World War II and the advent of the Cold War. These changes present an enticing challenge and opportunity to companies investing in joint ventures in that part of the world.
The preponderance of U.S. investment in Eastern bloc countries is situated in Hungary, with six companies-Digital Equipment Corp., General Electric Co., General Motors Corp., Rank Xerox, U.S. West and American International Group-set up to do business. Japan and West Germany are running neck and neck, each with three companies making a stake in Hungary: Suzuki, Sharp and Minolta; and AEG, Allianz and Colonia, respectively. Companies from France, Italy, Korea and the United Kingdom have invested there as well. The Soviet Union, Poland and East Germany also have attracted investment, with Bulgaria attracting one investor, Japan's Arai Electric. So far, only Czechoslovakia and Romania lack investors.
The Eastern bloc represents a market of approximately 420 million people, compared with 320 million in the European Economic Community and 250 million in the United States. It is an area undergoing change and uncertainty, but with each passing day these countries lurch toward becoming democratic, free-market societies. However, due to the history of the past 40 years the long-term prospects for stability and free markets remain unclear. The desire of many multinationals based in the United States and elsewhere to invest immediately in this region creates a need to deal with several risk management issues.
For the first time since the introduction of its economic plan in the 1920s, the Soviet Union in 1987 passed a joint venture law allowing foreign equity holdings. Joint ventures are now also allowed in Hungary, Czechoslovakia, East Germany and Bulgaria. In addition, the East German government has indicated that it may allow majority foreign stakes in joint venturesan exception to a previously planned 49 percent foreign investment ceiling. The Czechoslovak joint venture law is more restrictive than the Polish or Hungarian statutes. Hungary's laws are the most liberal and have thus attracted the most investment.
The joint venture in Hungary between Raba, the state-owned truck manufacturer, and General Motors will allow GM, after an investment of $100 million, to own 67 percent of the venture's equity and appoint management. At a furious pace private companies from many countries are creating joint ventures with government-owned entities throughout the region. Aside from the problem of qualified management, skilled labor and repatriation of profits, there is tremendous risk of failure in establishing a business venture in countries changing from centrally planned to market-oriented economies. Therefore, investing companies must be concerned with the risk management aspects of protecting jointly owned assets and managing joint liabilities.
Because of the rapid changes occurring in Eastern Europe, it is difficult to specify the requirements for insuring joint ventures on a country-by-country basis. It is, however, useful to understand the insurance environment. Eastern European countries that permit investment in joint venture companies do not allow non-admitted insurance; coverage for the joint venture must be written by the state-owned insurer or insurers in that country. Also, compulsory insurance coverages do not exist in some countries, so it is up to the joint venture management to decide which exposures to insure. Therefore, the risk manager must impress upon joint venture senior managers, who may be accountable to the host ministry or company, the importance of adequately insuring assets and exposures.
In the Soviet Union, for example, property damage insurance for joint ventures is compulsory. Conversely, liability coverage is not compulsory for third parties, products or automobiles, which are only insured by approximately half the population owning cars. …