Financial structure, productivity, and risk of foreign direct investment

Jiarui Zhang and Lei Hou

Journal of Comparative Economics, 2014, vol. 42, issue 3, 652-669

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.

Keywords: Bank finance; Bond finance; Productivity; Risk; Foreign direct investment (search for similar items in EconPapers)
JEL-codes: F21 F23 G14 G21 G32 (search for similar items in EconPapers)
Date: 2014
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (5)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jcecon:v:42:y:2014:i:3:p:652-669

DOI: 10.1016/j.jce.2013.06.002

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