Working Paper: NBER ID: w9426
Authors: Itay Goldstein; Assaf Razin
Abstract: The paper develops a model of foreign direct investments (FDI) and foreign portfolio investments. FDI is characterized by hands-on management style which enables the owner to obtain relatively refined information about the productivity of the firm. This superiority, relative to portfolio investments, comes with a cost: A firm owned by the relatively well-informed FDI investor has a low resale price because of a lemons' type asymmetric information between the owner and potential buyers. Consequently, investors, who have a higher (lower) probability of getting a liquidity shock that forces them to sell early, will invest in portfolio (direct) investments. This result can explain the greater volatility of portfolio investments relative to direct investments. Motivated by empirical evidence, we show that this pattern may be weaker in developed economies that have higher levels of transparency in the capital market and better corporate governance. We also study welfare implications of the model.
Keywords: No keywords provided
JEL Codes: F0; F2; F3; G0
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| FDI inflows (F21) | investment stability (G31) |
| management efficiency of FDI investors (F23) | volatility in investments (G11) |
| increased transparency (G38) | volatility differences between FDI and FPI (F21) |
| increased transparency (G38) | volatility in FPI relative to FDI (F23) |
| FDI management efficiency (F23) | lower resale prices due to asymmetric information (D82) |