Personal Networks, State Financial Backing, and Foreign Direct Investment

• Published date: 01 June 2023
• DOI: http://doi.org/10.1177/00104140221139382
• Author: Seungjun Kim
• Date: 01 June 2023
• Subject Matter: Articles

Article

Comparative Political Studies

2023, Vol. 56(7) 1000–1028

© The Author(s) 2022

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DOI: 10.1177/00104140221139382

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Personal Networks, State

Financial Backing, and

Foreign Direct

Investment

Seungjun Kim

Abstract

The “new, new trade theory”argues that f‌irm-specif‌ic attributes such as size

explain why large f‌irms predominantly engage in foreign direct investment

(FDI) and thus reap most of the rewards of globalization. However, studies

have neglected the importance of f‌irms’political inf‌luence over core f‌inancial

institutions. I argue that large f‌irms engage in greater FDI in part because of

their political connections, which allow them to receive government loans in

support of FDI. Using a unique, hand-coded dataset that includes 4936

directors of South Korean f‌irms and these f‌irms’FDI announcements, I show

that f‌irms that place elite f‌inancial off‌icials on their boards engage in greater

FDI than f‌irms without such board-member connections. Therefore, the

outsized gains that large f‌irms receive from globalization are dependent on

their political ties to their home government.

Keywords

foreign direct investment, political connections, state f‌inancing

University of California Merced, Merced, CA, USA

Corresponding Author:

Seungjun Kim, University of California Merced, 5200 North Lake Rd, Merced, CA 95343-5001,

USA.

Email: skim408@ucmerced.edu

Foreign Direct Investment (FDI) can be very lucrative for f‌irms. Halliburton, a

US-based oil company, received a $7 billion contract to reconstruct Iraq’s oil

infrastructure after the Iraq war.

1

Skypower, whose headquarters are in

Canada, concluded a $1.3 billion contract with Uzbekistan in 2018 to build

1000 MW of solar energy production facilities throughout the country.

2

Global f‌irms can benef‌it not only from being awarded investment contracts,

but also operating the resulting facilities, which increases long-term revenues.

However, FDI involves signif‌icant costs (Foley & Manova, 2015, 125–

126). Most of these are up-front, f‌ixed costs that often go toward building

production or service facilities. Likewise, various non-economic factors, such

as unstable political situations or weak property rights, can raise the risk of

FDI projects.

3

Most FDI projects only become prof‌itable several years after

the project is completed. Therefore, the signif‌icant up-front costs of FDI, and

the long time horizon of its prof‌itability, prevent many f‌irms from entering the

global market.

Political economy models show that only the most prof‌itable f‌irms can

afford to bear the costs of FDI (Antr`

as & Helpman, 2004;Helpman & Yeaple,

2004;Melitz, 2003). Large f‌irms are often best able to do so. They can provide

differentiated products or deliver skill-intensive services at low prices because

they are able to leverage economies of scale. By contrast, many smaller f‌irms

cannot take advantage of economies of scale and so must sell similar products

at higher prices (Bernard et al., 2003). Ultimately, large f‌irms can monopolize

the market for certain products by undercutting their competitors with low

prices, allowing them to further increase their prof‌its in both foreign and

domestic markets. Consequently, it is believed that only the largest f‌irms that

generate the most prof‌its are able to serve foreign markets through costly FDI.

FDI research has not fully explored the political power of large f‌irms.

4

Firms are not apolitical actors that are insulated from governments

(e.g., Fisman, 2001). Instead, they frequently lobby their government to obtain

preferred policies (Grossman & Helpman, 1994). In turn, many governments

incentivize domestic f‌irms to engage in FDI to boost national economic

performance (Kalinowski & Cho, 2012;Shi, 2015). One of the common

methods of doing so is by making credit easily available through state-owned

banks (Danzman, 2019).

I argue that state-subsidized f‌inancing acts as a f‌inancial incentive for

certain f‌irms to engage in FDI. Beyond just directly reducing the immediate

f‌inancial burdens of FDI, state-subsidized f‌inancing also functions as risk

insurance. Political events, such as contractual breaches and expropriations by

host governments, degrade the value of f‌irms’foreign assets. The home

government can directly cover these losses with access to cheap credit or cash

payments. This insurance reduces the political risks of FDI and thereby

ensures its long-term prof‌itability. Therefore, I expect f‌irms, particularly large

ones, to enhance their government lobbying efforts to secure such

Kim 1001