AbstractCapital flight associated with the onset of a financial crisis in a country is often accompanied by an inflow of capital associated with foreign direct investment (FDI). Our paper provides a theoretical framework for this puzzle, and draws wider conclusions on the welfare effects of foreign takeovers. When fundamentals deteriorate, the return that can be pledged to portfolio investors is limited by the incentive constraints of the managers. Only with direct control by investors can the surplus in the project be unlocked. It is precisely during crises that there is the conjunction of the loss of control by incumbent domestic managers, and the lack of domestic capital to take over failing firms. Foreign investors can take over failing firms and capture the surplus, even though they value the assets less. Our theory is consistent with FDI inflows during financial crises being associated with the acquisition of stakes that grant control, rather than simply being acquisitions of cashflow stakes, and is also consistent with the subsequent 'flipping' of the FDI assets, where the asset is sold to investors with higher valuations once the crisis abates.
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Bibliographic InfoPaper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 6319.
Date of creation: May 2007
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Find related papers by JEL classification:
- D61 - Microeconomics - - Welfare Economics - - - Allocative Efficiency; Cost-Benefit Analysis
- E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
- G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
- G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
- G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
This paper has been announced in the following NEP Reports:
- NEP-ALL-2007-06-02 (All new papers)
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