An information-based trade off between foreign direct investment and foreign portfolio investment

Abstract

The paper develops a model of foreign direct investments (FDI) and foreign portfolio investments (FPI). FDI enables the owner to obtain refined information about the firm. This superiority, relative to FPI, comes with a cost: a firm owned by the FDI investor has a low resale price because of asymmetric information between the owner and potential buyers. The model can explain several stylized facts regarding foreign equity flows, such as the larger ratio of FDI to FPI inflows in developing countries relative to developed countries, and the greater volatility of FDI net inflows relative to FPI net inflows.

Surges and stops in greenfield and M&A FDI flows to developing countries: analysis by mode of entry

“…As shown in Albuquerque (2003), the share of FDI in total foreign equity flows is larger for developing countries than for developed countries, an empirical regularity explained by Goldstein and Razin (2006) with the high production costs in developed economies which imply that it is more beneficial to incur the fixed costs associated with FDI in developing countries than in developed ones. As FDI flows have become an important and often dominant source of finance in developing countries, concerns have grown that economic growth and macroeconomic stability might be harmed in countries exposed to extreme fluctuations of these flows (Lensink and Morrissey 2006;Herzer 2012).…”

“…1 FDI flows to the developing world also increased rapidly, although the developed countries generally received more FDI flows than the developing ones and host the majority of the inward FDI stock (UNCTAD 2011). Importantly, the volatility of FDI flows has increased tremendously over the past decades, especially in developing countries (Goldstein and Razin 2006;Neumann et al 2009). Despite the fact that FDI is regarded as one of the most stable types of capital flows (Lipsey 2001;Albuquerque 2003;Broto et al 2011), there have been distinct waves of FDI since the 1980s with corresponding surges and stops (Andrade et al 2001).…”

Information Immobility and Foreign Portfolio Investment

“…We conjecture that, relative to world investors, U.S. investors were initially better informed about countries in which there was more U.S. FDI. 1 The assumption that investors obtain enhanced information after FDI takes place is central to the FDI theory in Yuen (1998, 1999), Goldstein and Razin (2006), and Razin and Sadka (2007). 2 Moreover, we show that past U.S. FDI is indeed associated with current proxies of information flow between the United States and other countries.…”

Taxi, Takeoff and Landing: Behavioural Patterns of Capital Flows to Emerging Markets

“…This is informative on the pattern and relationship between capital inflows, with implications for accommodating macroeconomic policies in countries receiving inflows. The paper also addresses the predictions of conventional theory, that differences are associated with the maturity of the capital (long-term vs.short-term), with the information based trade-off model of Goldstein and Razin (2006), that differences are associated with the structure of the capital (equity vs. debt). In line with the latter, equity flows (FDI and portfolio) are less volatile and persistent, more predictable and less susceptible to sudden stops than debt flows.…”

“…According to the information-based trade-off model of Goldstein and Razin (2006), equity flows are expected to see lower reversals (FDI least and portfolio equity less) and hence they are more persistent and predictable.…”