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Does Direct Foreign Investment Affect Domestic Firms' Credit Constraints?

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Ann E. Harrison
Margaret S. McMillan

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Abstract

Firms in developing countries cite credit constraints as one of their primary obstacles to investment. Direct foreign investment, by bringing in scarce capital, may ease domestic firms' credit constraints. Alternatively, if foreign firms borrow heavily from domestic banks, they may exacerbate domestic firms' credit constraints by crowding them out of domestic capital markets. One plausible mechanism by which this may happen is indirect. Foreign firms may be more experienced and have better financial ratios and thus, be a safer bet for lending institutions. Using firm-level data from the Ivory Coast for the period 1974-1987 we test the following hypotheses: (1) domestic firms are more credit constrained than foreign firms and (2) borrowing by foreign firms exacerbates the credit constraints of domestic firms. Results suggest that domestic firms are significantly more credit constrained that foreign firms and that borrowing by foreign firms aggravates domestic firms' credit constraints. By splitting the sample into state-owned (SOE) and privately owned domestic enterprises we are able to show that SOEs are less financially constrained than other domestic enterprises, consistent with the notion of a 'soft budget constraint'. Borrowing by foreign firms affects only privately owned enterprises. Finally, we explore possible explanations for the crowding out effect.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 8438.

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Date of creation: Aug 2001
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Handle: RePEc:nbr:nberwo:8438

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F2 - International Economics - - International Factor Movements and International Business
G3 - Financial Economics - - Corporate Finance and Governance

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  1. Jérôme Héricourt & Sandra Poncet, 2007. "FDI and credit constraints : firm level evidence in China," Documents de travail du Centre d'Economie de la Sorbonne bla07009, Université Panthéon-Sorbonne (Paris 1), Centre d'Economie de la Sorbonne. [Downloadable!]
    Other versions:
  2. Matthieu Bussiere & Georgios Chortareas & Rebecca L Driver, . "Current accounts, net foreign assets and the implications of cyclical factors," Bank of England working papers 173, Bank of England. [Downloadable!]
    Other versions:
  3. Peter Rowland, . "Foreign and Domestic Firms in Colombia: How Do They Differ?," Borradores de Economia 375, Banco de la Republica de Colombia. [Downloadable!]
  4. Arturo Galindo & Fabio Schiantarelli, 2002. "Credit Constraints in Latin America: An Overview of the Micro Evidence," Boston College Working Papers in Economics 537, Boston College Department of Economics. [Downloadable!]
  5. Peter Rowland, 2006. "Foreign and Domestic Firms in Colombia:," BORRADORES DE ECONOMIA 002740, BANCO DE LA REPÚBLICA. [Downloadable!]
  6. Goedhuys, Micheline, 2005. "Learning, Product Innovation and Firm Heterogeneity in Tanzania," Discussion Papers 07, United Nations University, Institute for New Technologies. [Downloadable!]
  7. Julian Fennema, 2006. "An Alternative Estimation Framework for Firm-Level Capital Investment," CERT Discussion Papers 0602, Centre for Economic Reform and Transformation, Heriot Watt University. [Downloadable!]
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