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Financial structure, productivity, and risk of foreign direct investment

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  • ZHANG, Jiarui
  • HOU, Lei

Abstract

This study investigates how heterogeneous firms choose their lenders when they raise external finance for Foreign Direct Investment (FDI) and how the choice of financing structure affects FDI activities. We establish an asymmetric information model to analyze why certain firms use private bank loans while others use public bonds to finance foreign production. The hidden information is the productivity shock to FDI. Banks are willing to monitor the risk of FDI, while bondholders are not; hence, banks act as a costly middleman that enables firms to avoid excessive risk. We show that firms’ productivity levels, the riskiness of FDI, and the relative costs of bank finance and bond finance are three key determinants of the firm’s financing choice. Countries with higher productivity, higher bank costs, or investment in less risky destinations, use more bond finance than bank finance. These results are supported by evidence from OECD countries.

Suggested Citation

  • ZHANG, Jiarui & HOU, Lei, 2014. "Financial structure, productivity, and risk of foreign direct investment," Journal of Comparative Economics, Elsevier, vol. 42(3), pages 652-669.
  • Handle: RePEc:eee:jcecon:v:42:y:2014:i:3:p:652-669
    DOI: 10.1016/j.jce.2013.06.002
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    Cited by:

    1. López, José Joaquín, 2017. "Financial frictions and productivity: Evidence from Mexico," The Quarterly Review of Economics and Finance, Elsevier, vol. 66(C), pages 294-301.
    2. Haga Elimam, 2017. "Determinants of Foreign Direct Investment in Saudi Arabia: A Review," International Journal of Economics and Finance, Canadian Center of Science and Education, vol. 9(7), pages 222-227, July.
    3. Yang, Zhenbing & Chen, Zhuo & Shi, Qi & Yan, Bing, 2021. "Does outward foreign direct investment increase debt ratio? Firm-level evidence from China," Structural Change and Economic Dynamics, Elsevier, vol. 57(C), pages 1-12.

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    More about this item

    Keywords

    Bank finance; Bond finance; Productivity; Risk; Foreign direct investment;
    All these keywords.

    JEL classification:

    • F21 - International Economics - - International Factor Movements and International Business - - - International Investment; Long-Term Capital Movements
    • F23 - International Economics - - International Factor Movements and International Business - - - Multinational Firms; International Business
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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