Discussion paper

DP12646 Financial constraints, institutions, and foreign ownership

This paper examines how external finance dependence, financial development, and institutions influence brownfield foreign direct investment (FDI). We develop a model of cross-border acquisitions in which the foreign acquirer's choice of ownership structure reflects a key trade-off between easing target credit constraints and the costs of operating in an environment of low institutional quality. Using a dataset of cross-border acquisitions in emerging markets, we find evidence supporting the central predictions of the model that: (i) a foreign firm is more likely to fully acquire a target firm in sectors that are more reliant on external finance, or in countries with lower financial development/higher institutional quality; (ii) the level of foreign ownership in partially foreign-owned firms is insensitive to institutional factors and depends weakly on financial factors; (iii) the share of foreign acquisitions in all acquisition activity is also higher in external finance dependent sectors, or financially underdeveloped/high institutional quality countries; and (iv) sectoral external finance dependence
accentuates the effect of country-level financial development and institutional quality. The theory and empirical evidence provide insight into the interaction between the financial, institutional and technological determinants of North-South brownfield FDI.


Berman, N, R Alquist, R Mukherjee and L Tesar (2018), ‘DP12646 Financial constraints, institutions, and foreign ownership‘, CEPR Discussion Paper No. 12646. CEPR Press, Paris & London. https://cepr.org/publications/dp12646