Working Paper: CEPR ID: DP12646
Authors: Ron Alquist; Nicolas Berman; Rahul Mukherjee; Linda Tesar
Abstract: This paper examines how external finance dependence, financial development, and institutions influence brownfield foreign direct investment (FDI). We develop a model of cross-border acquisitions in which the foreign acquirer's choice of ownership structure reflects a key trade-off between easing target credit constraints and the costs of operating in an environment of low institutional quality. Using a dataset of cross-border acquisitions in emerging markets, we find evidence supporting the central predictions of the model that: (i) a foreign firm is more likely to fully acquire a target firm in sectors that are more reliant on external finance, or in countries with lower financial development/higher institutional quality; (ii) the level of foreign ownership in partially foreign-owned firms is insensitive to institutional factors and depends weakly on financial factors; (iii) the share of foreign acquisitions in all acquisition activity is also higher in external finance dependent sectors, or financially underdeveloped/high institutional quality countries; and (iv) sectoral external finance dependenceaccentuates the effect of country-level financial development and institutional quality. The theory and empirical evidence provide insight into the interaction between the financial, institutional and technological determinants of North-South brownfield FDI.
Keywords: foreign direct investment; foreign ownership; cross-border mergers and acquisitions; financial development; external finance dependence; institutional quality; emerging markets
JEL Codes: F21; F23; G34; L24; L60
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| external finance dependence (O19) | likelihood of full foreign acquisitions (F23) |
| low financial development (O16) | likelihood of full foreign acquisitions (F23) |
| high institutional quality (L15) | likelihood of full foreign acquisitions (F23) |
| institutional quality (L15) | level of foreign ownership in partially foreign-owned firms (F23) |
| financial factors (G29) | level of foreign ownership in partially foreign-owned firms (F23) |
| external finance dependence (O19) | share of foreign acquisitions in all acquisition activity (F23) |
| financial development and institutional quality (O43) | share of foreign acquisitions in all acquisition activity (F23) |
| sectoral external finance dependence (F39) | effects of country-level financial development and institutional quality (O43) |