The Effects of Financial Development on Foreign Direct Investment

This paper examines how financial development influences foreign direct investment. The direct and indirect sector-specific effects that source countries' financial development and destination countries' financial development can have on foreign direct investment are first identified in a conceptual framework. The presence and relative strength of these various channels of influence at the different margins of foreign direct investment are then empirically investigated using unique and underexploited sector-specific bilateral panel data on greenfield foreign direct investment over the period 2003-2006. Causality is established by applying a difference-in-differences approach that exploits the variation in financial vulnerability across manufacturing sectors. The overall effects of higher source countries' financial development and destination countries' financial development on the relative volume of bilateral foreign direct investment in financially vulnerable sectors are large, positive, and complementary. These effects appear to operate mainly at the intensive margin rather than at the extensive margin of foreign direct investment. There is also evidence of direct and indirect effects of financial development. The key findings are robust to the use of data on the number of bilateral Mergers\&Acquisitions transactions. Overall, the empirical results unambiguously indicate that a sophisticated and well-functioning financial system in source and destination countries greatly facilitates the international expansion of firms through foreign direct investment, especially in financially vulnerable sectors.

Bibliographic Details

Main Authors:	Desbordes, Rodolphe, Wei, Shang-Jin
Language:	English en_US
Published:	World Bank Group, Washington, DC 2014-10
Subjects:	ACCESS TO CAPITAL, ACCESS TO DEBT FINANCING, ACCESS TO EXTERNAL FINANCE, ACCESSIBILITY, ACCOUNTING, ACCOUNTING STANDARDS, ADVERSE SELECTION, ASSETS RATIO, BALANCE OF PAYMENTS, BANKING CRISES, BANKING CRISIS, BANKING SYSTEM, BANKRUPTCY, BANKRUPTCY LAWS, BANKS, BENEFICIARY, BILATERAL TRADE, BORROWING, BROAD ACCESS, CAPITAL CONTROLS, CAPITAL EXPENDITURES, CAPITAL INTENSITY, CAPITAL INVESTMENT, CAPITAL INVESTMENTS, CAPITAL MARKETS, CAPITAL STOCK, CAPITAL STRUCTURE, CASH FLOWS, CHECKS, COLLATERAL, CORRUPTION, COUNTRY DUMMY, CREDIT BUREAU, CREDIT CONSTRAINTS, CREDIT INFORMATION, CREDIT REGISTRY, CREDITOR, CREDITOR RIGHTS, CREDITORS, CROSS-BORDER TRANSACTIONS, DATA AVAILABILITY, DAY TRADING, DEBT, DEVELOPING COUNTRIES, DEVELOPING COUNTRY, DEVELOPMENT POLICY, DOMESTIC BANK, DOMESTIC BANKING, DOMESTIC CREDIT, DOMESTIC FIRMS, DOMESTIC INVESTORS, DUMMY VARIABLE, DUMMY VARIABLES, EARNINGS, ECONOMETRIC MODELS, ECONOMIC DEVELOPMENT, ECONOMIC GEOGRAPHY, ECONOMIC GROWTH, ECONOMIES OF SCALE, ENTREPRENEUR, EQUIPMENT, EQUITY FINANCING, EQUITY INVESTMENT, EQUITY STAKE, EXPENDITURES, EXPORTS, EXTERNAL BORROWING, EXTERNAL CAPITAL, EXTERNAL DEBT, EXTERNAL FINANCING, EXTERNAL FUNDS, EXTERNAL INVESTORS, EXTERNALITIES, FACE VALUE, FDI, FINANCIAL ADVANTAGE, FINANCIAL CONSTRAINTS, FINANCIAL DEVELOPMENT, FINANCIAL INSTITUTIONS, FINANCIAL INTERMEDIARIES, FINANCIAL INTERMEDIATION, FINANCIAL NEEDS, FINANCIAL SERVICES, FINANCIAL SUPPORT, FINANCIAL SYSTEM, FINANCIAL SYSTEMS, FINANCING NEEDS, FINANCING OBSTACLES, FIXED ASSETS, FIXED COSTS, FOREIGN AFFILIATE, FOREIGN AFFILIATES, FOREIGN ASSETS, FOREIGN BANKS, FOREIGN DIRECT INVESTMENT, FOREIGN FIRMS, FOREIGN INVESTOR, FOREIGN INVESTORS, FOREIGN LENDER, FOREIGN MARKET, FOREIGN MARKETS, FOREIGN OWNERSHIP, FOREIGN OWNERSHIP RESTRICTIONS, FOREIGN PRODUCERS, FUNDING SOURCES, GDP, GDP PER CAPITA, GROUP OF FIRMS, GROWTH OPPORTUNITIES, HOLDING, HOME COUNTRY, HOST COUNTRIES, HOST COUNTRY, HUMAN CAPITAL, INCOME, INCOME GROUPS, INDUSTRIAL COUNTRIES, INFORMATION SHARING, INFORMATIONAL ASYMMETRIES, INITIAL INVESTMENT, INSTRUMENT, INTANGIBLE, INTANGIBLE ASSETS, INTEREST PAYMENTS, INTERNAL FINANCE, INTERNAL FUNDS, INTERNATIONAL BANK, INTERNATIONAL TRADE, INTERNATIONAL TRANSACTIONS, INVESTMENT OPPORTUNITIES, JURISDICTION, LABOUR MARKET, LEGAL RIGHTS, LENDER, LENDERS, LIBERALIZATION, LOAN, LOCAL MARKET, MANUFACTURING INDUSTRY, MANUFACTURING SECTOR, MANUFACTURING SECTORS, MARKET CAP, MARKET SIZE, MARKETS DATABASE, MERGERS, MIDDLE-INCOME COUNTRIES, MIDDLE-INCOME COUNTRY, MNE, MNES, MORAL HAZARD, MOVABLE ASSETS, MULTINATIONAL, MULTINATIONAL ENTERPRISES, NATURAL RESOURCES, NEW MARKETS, NPL, OUTPUT, OUTSOURCING, PREFERENTIAL ACCESS, PRIVATE CREDIT, PRIVATE CREDIT BUREAU, PRIVATE SECTOR, PROPERTY RIGHTS, PUBLIC CREDIT, REGULATORY REQUIREMENTS, REPUDIATION, RIGHTS OF CREDITORS, RISK OF EXPROPRIATION, SEIZURE, SEIZURE OF ASSETS, SELF-FINANCE, SMALL FIRMS, SOURCE OF FUNDS, SOURCES OF FUNDS, STOCK MARKET, STOCK MARKET CAPITALIZATION, STOCKS, SUPPLY CHAIN, TANGIBLE ASSETS, TAX, TECHNOLOGY TRANSFERS, TRADING, TRANSACTION, UNDERDEVELOPED COUNTRIES, VALUE ADDED, VARIABLE COSTS, WAGES, WORLD INVESTMENT REPORT,
Online Access:	http://documents.worldbank.org/curated/en/2014/10/20302311/effects-financial-development-foreign-direct-investment https://hdl.handle.net/10986/20515
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