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B School
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Attracting foreign capital
Why foreigners invest less in poorly governed firms
Issue Date - 30/04/2012
When firms say no to foreign capital
Given the study’s indication that poor governance is a substantial deterrent to foreign investment, firms could potentially obtain more funding from abroad if they alter their ownership structure or improve their disclosure practices to make it easier for foreigners to evaluate their companies. Regulators and governments aiming to substantially attract more foreign investment also can change the set of rules and laws that encourage insider control and opaqueness in the first place, such as weak investor rights.

However, it is unclear whether all firms would be willing to make changes especially if they have other sources of capital that do not require more transparency. Whether firms want foreign capital depends also on the country’s political system and the way firms get domestic financing.

In a another study undertaken by me and Felix Oberholzer-Gee of Harvard University, we look at the role of political connections in firms’ financing strategies in Indonesia, and find that political connections and global financing are actually substitutes. Firms with access to bank loans through close ties with former President Suharto’s regime were not very interested in foreign capital. Instead, these well-connected firms favored low-cost loans from state-owned banks and disliked the accountability and scrutiny that comes with publicly traded securities.

Thus, opening capital markets in this environment may not necessarily lead to more foreign investment because there is no incentive for firms to make themselves more attractive to foreigners by improving corporate governance. Institutional reforms that support good governance may not be sufficient either in encouraging foreigners to bring in more capital as long as firms do not have to raise money from arm’s length sources that force them to become more transparent. Institutional reform and political reform go hand in hand.


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