By Christian Lundblad, Director of Research at the Kenan Institute, and Professor of Finance at UNC Kenan-Flagler Business School
The European Union has granted the United Kingdom a short extension on their anticipated Brexit deal. Now what?
There are a few possibilities, ranging from a new referendum to a “hard” Brexit to a further extension that would likely have to come from the United Kingdom formally stopping the clock. But the frank reality is that there is zero clarity on the roadmap going forward. At this point, the only thing I’m comfortable prognosticating is that Theresa May’s deal is dead and that she is likely going to depart before long. If you force me to assign probabilities, I see a new referendum or a full Brexit as relatively less likely, and I view the formal revocation of Article 50 – the act that triggered the timeline two years ago – as increasingly likely, given that it gives both sides a chance to kick the can down the road (and one should never underestimate any politician’s desire to do just that).
Despite all the chaos, we need to keep in mind that today’s business leaders, like those of any other time, are tasked with allocating scarce resources in the pursuit of value. Even in “normal” times, one of the major difficulties in successful value pursuit is the careful placement of a decision in the context of the external environment in which it resides. Brexit’s attendant murkiness makes this especially tricky—how can we properly articulate what the returns of a project, initiative or cross-border investment would look like across such diverse scenarios? What is the upside potential versus the downside risk, given such a wide range of outcomes?
These questions remind me of the day-to-day challenges of doing business in the emerging world, where we have long struggled with how to weigh the pursuit of value against the attendant institutional and political risks that largely define emerging markets. In my research* over the years, I’ve found that simply measuring the degree of political risk is challenging. The far trickier task that my authors and I have tried to tackle is the development of a method to intelligently shoehorn our usual tools for assessing value creation into an external setting characterized by institutional weakness as pronounced as what we see in the EM world. We also document that institutional and political risks impede external investment, and that asset valuations in such an environment are lower than they otherwise might be.
While these consequences are very real, business leaders must nevertheless be able to discriminate among EM projects on a risk-adjusted basis and have the courage to intelligently fire the bullet on the right ones. Remember that there are obviously very real opportunities in the EM world. Why should business decision-making in the face of Brexit be any different?
If one is instead paralyzed, one also correspondingly assumes that competitors will be equally paralyzed – this is the risk we take when uncertainty breeds inaction. But I firmly contend that inaction is the worst risk-taking of all. I encourage you to do the hard work of carefully articulating what a proposed project looks like across these varied scenarios, argue with your team about upside potential versus downside risk and describe relevant competitor responses. This is undoubtedly tough to do, but intelligent risk-taking is a business leader’s job. If there is enough there in the economics, murkiness notwithstanding, have the courage to fire the bullet.
Let’s return to the larger question. As an ardent defender of the institutions we have collectively built to foster global trade and finance, I find the outcome of the 2016 Brexit referendum highly lamentable. Indeed, while its origins are complex and demand careful consideration, I view the rise of populism across the world as a step backwards, insofar as the associated policy outcomes have engendered elevated uncertainty akin to what I’ve viewed throughout my career in the emerging world as an impediment. In a climate where the feedback effects between economic policy and political outcomes are strikingly proximate, it becomes challenging to characterize the external environment necessary for good business decision-making. Simply put, as populism has made business decisions harder, it has made things more costly.
Despite my strong conviction that the UK is better off in the EU, I have little hope it will remain. Given that it would likely rend British society further, remaining may not even be the best outcome. The UK has painted itself into a corner from which every way out is sure to alienate or enrage. For some, an extension would be viewed as a clear violation of the first referendum’s mandate. For others, a hard Brexit would be viewed as an unacceptable one-way street toward permanent economic and political cost. Unfortunately, none of the outcomes help in any way to mend the irreparable damage this self-inflicted catastrophe has inflicted upon British society. I sincerely hope the United Kingdom can at least find its way to a Brexit that is mildly palatable to as many as possible.
*Here are a few examples:
“Political Risk and International Valuation” with Geert Bekaert, Campbell R. Harvey, and Stephan Siegel, Journal of Corporate Finance, 2016, 37, 1-23.
“Political Risk Spreads,” with Geert Bekaert, Campbell R. Harvey, and Stephan Siegel, Journal of International Business Studies, 2014, 45, 471-493