The Differential Impact of Public and Private Governance Institutions on the Different Modes of Foreign Investment

Abstract

This paper examines the respective impacts of public and private governance institutions on foreign direct and foreign portfolio investment inflows. We present two hypotheses: (1) there is a strong correlation between the quality of a country’s public governance institutions and the amount of foreign direct investment (FDI) received while the quality of its private governance institutions has no further discernible impact on this correlation; (2) there is a strong correlation between the quality of a country’s public governance institutions and the amount of foreign portfolio investment (FPI) received while the quality of its private governance institutions has a further positive impact on this correlation. Our findings, which are based on panel data analysis, show both hypotheses to be valid.

KeyWords:

• Public governance institutions
• private governance institutions
• foreign direct investment (FDI)
• foreign portfolio investment (FPI)
• multinational corporations (MNCs)
• institutional asset managers (IAMs)

JEL classification:

• F21
• G11
• G38
• O16

Notes

1.  FDI is often associated with technological and managerial know-how transfer to local companies, and positive effects on competition, employment, wage levels and exports (OECD 2002), while FPI is seen as beneficial as it provides host countries with additional savings and potentially improves the efficiency of their financial markets (Errunza 2001).

2.  For a recent example see the special issue Global Perspectives on Entrepreneurship: Public and Corporate Governance from the journal Corporate Governance: An International Review. In the literature private governance is generally identified with corporate governance.

3.  Wu et al. (2012) subsequently add a third governance category, ‘family-based,’ which refers to relatively poor countries that have neither effective public ordering systems (like ‘rule-based’ societies) nor extensive informal networks (like ‘relation-based’ societies). However, this addition does not substantially alter Li and Filer’s original analytical framework and conclusions in so far as a ‘family-based’ governance environment is also identified as a weak environment that hinders FPI inflows.

4.  FDI is commonly ‘defined as an investment involving a long-term relationship and reflecting a lasting interest and control’ with the aim to expand business activities and to gain at least partial control over the foreign entity (UNCTAD 2007, 245) The long term nature of FDI is also emphasised by Azzimonti and Sarte (2007) who make the point that ‘a distinctive characteristic of FDI is that once an investment has been made, a foreign investor cannot prevent the government in the host country from changing the environment in which the investment decision was made’ (287)

5.  FPI is defined as investment in fixed income securities and equity holdings below 10%. According to Wilkins (1999) FPI is a form of investment in which ‘the investor does not intend to manage the activity in which the investment is made’ (56) and that ‘tends to be prompted by financial returns that are higher abroad than those at home’ (58)

6.  Much of what is said here about IAMs also applies to the top echelons of the world’s HNWIs who tend to mimic the portfolio management techniques of IAMs for the same purpose of maximising risk adjusted returns. For data regarding both the overall size of the wealth of HNWIs and the size of their foreign portfolio investments see Goda (2014) and Goda and Lysandrou (2014).

7.  At the time of writing, Australia, Austria, Belgium, Canada, Chile, Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Iceland, Ireland, Israel, Italy, Japan, Korea, Luxembourg, Mexico, Netherlands, New Zealand, Norway, Poland, Portugal, Slovak Republic, Slovenia, Spain, Sweden, Switzerland, Turkey, UK, and the US were member countries of the OECD.

8.  According to IMF (2012) the following 25 counties can be regarded as EMEs: Argentina, Brazil, Bulgaria, Chile, China, Colombia, Estonia, Hungary, India, Indonesia, Latvia, Lithuania, Malaysia, Mexico, Pakistan, Peru, Philippines, Poland, Romania, Russia, South Africa, Thailand, Turkey, Ukraine, and Venezuela. Chile, Estonia, Hungary, Mexico, Poland and Turkey are also member of the OECD and Venezuela was excluded to ensure a balanced sample. Hence, we include 18 EMEs in addition to the OECD countries.

9.  The World Economic Forum only provides comparable public and private governance data from 2006 onwards, while 2012 was the last date when all of these data were available at the time of writing.