Transparency, Risk, and FDI

• Author: Matthew DiGiuseppe,Colin M. Barry
• DOI: 10.1177/1065912918781037
• Published date: 01 March 2019
• Date: 01 March 2019
• Subject Matter: Articles

https://doi.org/10.1177/1065912918781037

Political Research Quarterly

2019, Vol. 72(1) 132 –146

© 2018 University of Utah

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DOI: 10.1177/1065912918781037

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Article

Although there has been exponential growth in total for-

eign direct investment (FDI) over the last thirty years, it

remains unevenly distributed, especially among develop-

ing countries. Why is this the case? The most prominent

explanation centers on political risk. Political risk comes

in various forms (Graham, Johnston, and Kingsley 2016),

each carrying its own set of concerns for foreign inves-

tors. But the root of the problem is that direct investment

entails a significant and long-term commitment on the

part of the firm. Capital that is liquid ex ante becomes

relatively illiquid ex post, after it has been turned into

buildings and machinery and a trained workforce.

Multinationals are acutely aware that, once the costs of

investment are sunk, those resources become vulnerable

to instability and violence, regulatory burden, unfair

treatment, or outright theft by the host government

(Vernon 1971). Multinational corporations (MNCs) are

thus risk-averse, avoiding countries where such threats

are perceived as more likely to be realized (e.g., Busse

and Hefeker 2007).

Although this explanation certainly has merit, it also

has two key flaws. The first is empirical. Even a quick

scan of the data reveals that MNCs regularly invest in

“higher risk” countries, evidencing their willingness to

tolerate less friendly political environments under the

right conditions. Indeed, recent large-n research casts

empirical doubt on the received wisdom (Arel-Bundock

2017), suggesting that there is still ample room to improve

our understanding of how political risk shapes patterns in

capital flows. The second flaw is with the logic. Most

political risk arguments implicitly assume that firms are

unable to protect themselves against risk, necessitating

that they avoid it altogether when feasible. This is unreal-

istic. Firms are capable of adapting to different environ-

ments, and have developed means to manage different

types of risk (Delios and Henisz 2003; Henisz 2000;

Kesternich and Schnitzer 2010). If we relax the assump-

tion that firms are helpless, it allows for the possibility

that risk-aversion varies by firm and circumstance.

We contend that risk-aversion is, in part, a function of

political transparency. Effectively and efficiently shield-

ing against risk requires reliable knowledge of the host

site. In other words, MNCs investing abroad are dealing

not only with a risk problem, but an information problem.

Managing the former is contingent on solving the latter.

Transparency is one such solution. Greater transparency is

an attractive feature in general, as it reduces uncertainty

781037PRQXXX10.1177/1065912918781037Political Research QuarterlyBarry and DiGiuseppe

research-article2018

1University of Oklahoma, Norman, USA

2The University of Mississippi, University, USA

Corresponding Author:

Matthew DiGiuseppe, Department of Political Science, The University

of Mississippi, University, MS 38677, USA.

Email: mrdigius@olemiss.edu

Transparency, Risk, and FDI

Colin M. Barry1 and Matthew DiGiuseppe2

Abstract

A central theme in the foreign direct investment (FDI) literature is that political risk deters investment. The empirical

record, however, is mixed. multinational corporations (MNCs) continue to invest in high-risk countries. We argue it

is not merely about the level of risk, but rather firms’ ability to quantify risk. When MNCs can confidently assess both

the nature and the degree of the threats present, they can take appropriate measures to hedge against them. This

should increase their willingness to invest, even in higher risk environments. We contend that the ability to accurately

quantify risk is a function of political transparency. Among opaque countries, we expect risk to exert a deterring effect

on FDI, as commonly theorized. Among more transparent countries, however, we expect that risk is a less salient

concern for MNCs. We test this argument using firm-level data on the foreign operations of some of the world’s

largest multinationals between 1995 and 2008. The evidence supports the argument. Risk has a strong negative effect

on the likelihood of investment at lower levels of transparency, but the magnitude of this effect weakens at higher

levels of transparency. This pattern is consistent across multiple types of political risk, and is most pronounced in

nonextractive (relative to extractive) industries.

Keywords

FDI, risk, transparency