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Financial constraints and foreign direct investment: firm-level evidence

Author

Listed:
  • Buch, Claudia M.
  • Kesternich, Iris
  • Lipponer, Alexander
  • Schnitzer, Monika

Abstract

Low productivity is an important barrier to the cross-border expansion of firms. But firms may also need external finance to shoulder the costs of entering foreign markets. We develop a model of multinational firms facing real and financial barriers to foreign direct investment (FDI), and we analyze their impact on the FDI decision. Theoretically, we show that financial constraints can affect highly productive firms more than firms with low productivity because the former are more likely to expand abroad. We provide empirical evidence based on a detailed dataset of German domestic and multinational firms which contains information on parent-level financial constraints as well as on the location the foreign affiliates. We find that financial factors constrain firms’ foreign investment decisions, an effect felt in particular by firms most likely to consider investing abroad. The locational information in our dataset allows exploiting cross-country differences in contract enforcement. Consistent with theory, we find that poor contract enforcement in the host country has a negative impact on FDI decisions.

Suggested Citation

  • Buch, Claudia M. & Kesternich, Iris & Lipponer, Alexander & Schnitzer, Monika, 2014. "Financial constraints and foreign direct investment: firm-level evidence," Munich Reprints in Economics 19977, University of Munich, Department of Economics.
    • Handle: RePEc:lmu:muenar:19977
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    JEL classification:

    • F2 - International Economics - - International Factor Movements and International Business
    • G2 - Financial Economics - - Financial Institutions and Services

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