International
Investment
Ing. Tomáš Heryán, Ph.D.
International Business Finance
FIU/NAIFA
• Commercial loans
– Primarily take the form of bank loans issued to foreign businesses or governments
• Official flows
– Generally refer to the forms of development assistance that developed
nations give to developing ones
• Foreign direct investment
– International investment in which the investor obtains a lasting interest in an
enterprise in another country
• Foreign portfolio investment
– Investment more easily traded, may be less permanent, and do not represent a
controlling stake in an enterprise
Principal categories of international investment
International Investment (International Business Finance – presentation 08)
• Foreign direct investment (FDI) occurs when a firm invests directly in new
facilities to produce and/or market in a foreign country
• FDI is investment in which the investor obtains a lasting interest in an
enterprise in another country
• Technically, the threshold for FDI is ownership of “10 percent or more of
the ordinary shares or voting power” of a business entity
• Once a firm undertakes FDI it becomes a multinational enterprise
• FDI includes all kinds of capital contributions, such as the purchases of
stocks, as well as the reinvestment of earnings by a wholly owned
company incorporated abroad and the lending of funds to a foreign
subsidiary or branch
Definition of direct investment
International Investment (International Business Finance – presentation 08)
• Hungry Dragon Toys, a Chinese company, is sitting on a lot of
cash. The company’s board of directors decides to take some of that
money and purchase Cooperative Chemical, a plastics company in
New Jersey. Hungry Dragon, a foreign investor, now owns a U.S.
subsidiary company. Hungry Dragon’s ownership of Cooperative
Chemical is substantial and more likely to be long term. Hungry
Dragon is unlikely to sell if the U.S. economy faces a temporary
downturn. Therefore, FDI is considered as relatively stable form of
international investment.
Example of foreign direct investment
International Investment (International Business Finance – presentation 08)
• Cross-border transactions and positions involving equity or debt securities,
other than those included in direct investment or reserve assets
• The characteristic feature of portfolio investment is their negotiability
– Their legal ownership is readily transferable from one unit to another unit by
delivery or endorsement
• Negotiable instruments are designed to be traded on organized markets
• Can be bought and sold, which makes them a efficient, flexible way of
raising and investing money
• Comes from many diverse sources such as a small company’s pension or
through mutual funds held by individuals
Definition of portfolio investment
International Investment (International Business Finance – presentation 08)
• John Yamashita, a Japanese citizen, purchases one hundred shares
of stock in General Motors (GM). John now owns part of a U.S.
corporation, the shares of which are part of his personal investment
portfolio. John is eligible to receive dividend payments from GM,
participate in shareholder decisions, or sell the stock for a
profit/loss. John’s share of GM is very minor, and his chief concern
is not the long-term profitability of the company but the short-term
value of his stock. He might therefore sell his share quickly if the
share price goes up or down significantly. Hence, portfolio
investment is usually more volatile than FDI.
Example of foreign portfolio investment
International Investment (International Business Finance – presentation 08)
Distinction between direct and portfolio investment
International Investment (International Business Finance – presentation 08)
Foreign direct investment Foreign portfolio investment
Long-term investment Generally short-term investment
Investment in physical assets Investment in financial assets
Aim is to increase enterprise capacity or
productivity or change management control
Aim is to increase capital availability
Leads to technology transfer, access to
markets and management inputs
Results in only capital inflows
Flows into the primary market Flows into the secondary market
Does not tend to be speculative Tends to be speculative
Direct impact on employment and wages No direct impact on employment and wages
Abiding interest in management Fleeting interest in management
Composition of private capital flows (bil. USD)
International Investment (International Business Finance – presentation 08)
• Acquisition of existing company
– Purchase an existing company in the foreign country
– Can be done through privatization, sell of to competitor, or merger
– E.g. Starbucks purchases an existing UK firm “British Coffee” and sells
coffee/tea/desserts under the name “Starbucks”
• Establishment of new company
– Usually in the form of Greenfield investment
– Set up a new company “from the ground up” in the foreign country
– Hyundai invests money in Czechia and builds a new plant to produce cars
Forms of foreign direct investment
International Investment (International Business Finance – presentation 08)
• Subsidiary
– Company in the foreign country is entirely controlled/owned by one single
company
– Full competencies and decision power
– Usually slightly different name than maternal company
– Independent book-keeping, profit taxed in host country
• Branch
– Organizational unit in the maternal company‘s structure
– Limited competencies and decision power
– Similar name like maternal company
– Unified book-keeping with maternal company, profit taxed in home country
Forms of foreign direct investment
International Investment (International Business Finance – presentation 08)
• Joint venture
– Occurs when two or more companies together form a new company in the
host country
– Each of the participants is responsible for profits, losses and costs associated
with it
– The venture is its own entity, separate and apart from the participants' other
business interests
– In the international context, usually occurs when one (or more) foreign
company and one (or more) local company join to form a new company
Forms of foreign direct investment
International Investment (International Business Finance – presentation 08)
• Investment in the “same” industry as a firm operates in at home
• Reasons for horizontal FDI
– Transportation costs
– Market imperfections
• Impediments to exporting
• Impediments to sale of know-how
– Strategic behavior
– Product life cycle
– Location specific advantages
Horizontal foreign direct investment
International Investment (International Business Finance – presentation 08)
• Investment in a downstream supplier (backward) or upstream purchaser
(forward) as compared to the business that the firm operates in its home
country
– Backward investment is more common than forward
• Reasons for vertical foreign direct investment
– Strategic behavior
– Market imperfections
• Impediments to know-how
• Investments in specialized assets
Vertical foreign direct investment
International Investment (International Business Finance – presentation 08)
Foreign direct investment inflows 1980-2008 (bil. USD)
International Investment (International Business Finance – presentation 08)
Foreign direct investment inflows 2005-2018 (bil. USD)
International Investment (International Business Finance – presentation 08)
FDI inflows by region 2014-2016 (bil. USD)
International Investment (International Business Finance – presentation 08)
FDI inflows by component 2007-2016 (in %)
International Investment (International Business Finance – presentation 08)
FDI inflows top 15 host and home economies (bil. USD)
International Investment (International Business Finance – presentation 08)
• Radical view
– “Imperialist” extraction of host country wealth
– Implication: Always bad for the host country
• Free market
– Different countries have different comparative advantages; best to allow countries to
engage activities for which they do so most efficiently
– Implication: Always good when countries are specializing in activities for which they
have a comparative advantage
• Pragmatic nationalism
– Belief that FDI has costs and benefits, and whether to engage in FDI depends on
whether the benefits exceed the cost
– What are the costs and benefits to the host country?
Political economy of foreign direct investment
International Investment (International Business Finance – presentation 08)
• Resource transfer effects
– Capital: MNE invests capital in foreign markets
– Technology: Research supports that MNEs do transfer technology when they
invest in a foreign country
– Management: When MNEs invest and manage in a foreign country, they often
transfer management skills to the host country’s workforce
• Employment effects
– MNEs, by investing in foreign countries, can create employment opportunities
for the local workforce
– But: Acquisition vs. Greenfield Investment
Benefits to the host country
International Investment (International Business Finance – presentation 08)
• Balance of payments effects
– FDI can have beneficial and negative effects on a country’s balance of
payment.
• Initial capital inflow
• Substitute for imports
• Inflow of payments from export of goods and services
• Effect on competition
– Efficient functioning of markets require adequate level of competition
between producers
Benefits to the host country
International Investment (International Business Finance – presentation 08)
• Adverse effects on competition
– MNEs may have “too much” power and kill off competition
• Adverse effects on balance of payments
– After initial inflow of capital, subsequent outflow of capital from the earnings
of the FDI
– FDI may import inputs from abroad
• National sovereignty and autonomy
– Key decisions that affect the host country’s economy may be made by a foreign parent
that has no real commitment to the host country
Costs to the host country
International Investment (International Business Finance – presentation 08)
• Benefits
– Stream of income from foreign earnings
– FDI may import intermediate goods or inputs for production from the home
country, creating jobs
– MNEs may learn skills from exposure to foreign countries
• Costs
– Initial capital outflow (but often set off by future stream of foreign earnings)
– Current account suffers if FDI is to serve home market from low-cost
production location
– Current account suffers if FDI is a substitute for direct export
– FDI a substitute for domestic production
Benefits and costs to the home country
International Investment (International Business Finance – presentation 08)
• Cheaper production factors
• Reduction of foreign trade costs
• Better tax system
• Reduction of foreign exchange risk
• Diversification of inputs, outputs, profit
• Better legal system
• Following of business partners
• Host country government incentives and subsidies
Factors stimulating foreign direct investment
International Investment (International Business Finance – presentation 08)
Labor costs in the EU
International Investment (International Business Finance – presentation 08)
International labor costs
International Investment (International Business Finance – presentation 08)
Productivity of labor
International Investment (International Business Finance – presentation 08)
Annual working hours (2012)
International Investment (International Business Finance – presentation 08)
Worth of one working hour (2012)
International Investment (International Business Finance – presentation 08)
Corporate tax rates (combined) in OECD countries (2015)
International Investment (International Business Finance – presentation 08)
Following business partners in automobile industry
International Investment (International Business Finance – presentation 08)
• Economical expectations and reality
• Success of economical proposals of government
• Political instability and terrorism
• Foreign conflicts
• Corruption in government
• Importance of army and church in politics
• Power of legal tradition
• Conflicts between nationalities and minorities, civic war
• Development of political system
• Quality of bureaucratic system
Foreign direct investment risks – political
International Investment (International Business Finance – presentation 08)
• Insolvency or unfavorable structure of debt
• Delay of payable supplying loans
• Governments non acceptation of its liabilities
• Losses of foreign exchange control
• Expropriation of private investments
• Inflation risk
• Ratio of debt service to annual export
• Covering of one month import by net foreign currency reserves
• Payment discipline of importers
• Share of goods and services export on current balance amount
• Percentage difference between official and „black“ exchange rate
Foreign direct investment risks – economic and financial
International Investment (International Business Finance – presentation 08)
A.T. Kearney FDI confidence index
International Investment (International Business Finance – presentation 08)
Ernst &Young FDI attractiveness in Europe
International Investment (International Business Finance – presentation 08)
THANK YOU FOR YOUR
ATTENTION
J