Foreign direct investment, corporate governance and mode of entry

One of the most outstanding features of the trend toward globalization has been the increased importance of foreign direct investment (FDI) flows around the world. This study estimates the determinant of FDI flows using the gravity equation, controlling for the importance of both the traditional gravity variables (size, distance, common language) and other institutional variables such as shareholder protection, openness to FDI flows and corporate tax. The purpose of this research is to identify the factors considered by multinational firms when deciding to establish foreign affiliates. The appropriate level of ownership and shareholder protection, in particular, will be considered as central issues when multinationals decide to invest abroad through joint venture or merger & acquisition. Specifically, this paper estimates the determinants of location of foreign direct investment flows using an OECD dataset on bilateral FDI flows between 29 source countries and 61 host countries, in the context of a gravity model. An index of shareholder protection developed by Pagano and Volpin (2005) on an expansion of La Porta et al. (1998) is used as a measure of corporate governance, and a country’s openness to FDI, as developed by Shatz (2000), is used to measure administrative openness to FDI. Empirical results seem to validate the hypothesis that the a culture supportive of corporate governance and an openness to foreign investors have a positive effect in attracting FDI flows. In this empirical analysis, I will also consider five dummies that capture the link between changes in openness patterns and shareholder protection measured. The positive and significant coefficients on the interaction of shareholder protection and different level of openness to FDI flows indicate that foreign investors are more attracted to countries that impose fewer ownership restrictions associated with more efficient corporate governance mechanisms. Then, open market and investment regimes are particularly powerful instruments to attract investment in general and FDI in particular.