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Politics, Instability, and International Investment Flows

Art Durnev

University of Iowa - Henry B. Tippie College of Business

March 13, 2011

In this paper, we analyze the role of political instability for the organizational form of foreign investment, i.e. whether it has the form of a majority- or minority-owned investment. We focus on the instability generated by the change of the party in power in a democratic system, rather than on the risk of change of political regime or expropriation risk associated with this change. The central trade-off in our theoretical model is the following: in majority-owned establishments, a foreign investor retains the control and enjoys fewer agency problems, while for minority-owned investments or joint ventures domestic partners of a foreign investor can lobby the government for some preferential arrangements, such as firm-specific tax breaks. Political instability decreases the payoff to political connections in the future and, therefore, decreases the attractiveness of minority-owned investments. The implications of our model are supported by empirical tests using three different sources: a World Bank survey of small firms in developing countries, aggregate BEA data on U.S. foreign affiliates, and SDC mergers and acquisitions data.

Number of Pages in PDF File: 35

Keywords: political instability, investment

JEL Classification: G15, G18, G38, K42, O43

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Date posted: March 14, 2011  

Suggested Citation

Durnev, Art, Politics, Instability, and International Investment Flows (March 13, 2011). Available at SSRN: https://ssrn.com/abstract=1785033 or http://dx.doi.org/10.2139/ssrn.1785033

Contact Information

Artyom Durnev (Contact Author)
University of Iowa - Henry B. Tippie College of Business ( email )
5020 Main Library
Iowa City, IA 52242-1000
United States
(514) 398-5394 (Phone)
(514) 398-3876 (Fax)
HOME PAGE: http://www.artdurnev.com
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