The Effects of Financial Development on Foreign Direct Investment

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...

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Bibliographic Details
Main Authors:	Desbordes, Rodolphe, Wei, Shang-Jin
Format:	Policy Research Working Paper
Language:	English en_US
Published:	World Bank Group, Washington, DC 2014
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://hdl.handle.net/10986/20515

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Summary:	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.