The Impact of Foreign Investors’ Challenges to Domestic Regulations

We examine how foreign investors’ ability to challenge allegedly harmful host-country regulations before an international arbitral tribunal through investor-state dispute settlement (ISDS) affects regulatory policymaking and the value of foreign direct investment. Consistent with ISDS deterring costly host-country regulations, following an ISDS challenge of an industry-level regulation, the equity values of firms in the affected industry increase significantly. Domestic firms without ready access to ISDS also experience higher equity values, suggesting that our results are not driven by expectations of future damage awards. The results are concentrated in developed countries, where stronger legal institutions likely bind governments to their previous commitments to foreign investors. Additionally, capital expenditures by foreign firms in the host country fall before a case is filed and then increase significantly afterward. Taken together, our evidence suggests that ISDS deters domestic regulatory interventions that decrease the profitability of existing foreign direct investments in the host country.