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Financial structure, productivity, and risk of foreign direct investment

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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.

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[Zhang, Jiarui] University of Munich, Germany ; China Europe International Business School, China [Hou, Lei] Capital University of Economics and Business, China


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Source

Journal of Comparative Economics

ISSN:0147-5967

Year:2014

Issue:3

Volume:42

Page:652-669

Powered by JCR@2014

ESI Discipline:ECONOMICS & BUSINESS;

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