The Impact of Foreign Investors' Challenges to Domestic Regulations

Abstract

We examine how foreign investors' ability to challenge allegedly harmful host-country regulations before an international arbitral tribunal through investor-state dispute settlement (ISDS) affects regulatory policy-making and the value of foreign direct investment. Consistent with widespread deterrent effects on costly domestic regulation, following an ISDS challenge of an industry-level regulation, the equity values of firms in the industry affected by the challenged regulation increase significantly (by approximately 84 basis points in our baseline specification). Domestic firms without ready access to ISDS also experience higher equity values, suggesting that our results are not driven by expectations of future awards of damages. The results are concentrated in developed countries, where stronger legal institutions are likely to more firmly bind governments to their previous commitments to foreign investors. Also consistent with ISDS constraining costly regulatory interventions, we find that, for case-industry firms, capital expenditures in the host country fall in the years before an ISDS case filing and then increase significantly after a case is filed. Taken together, our evidence suggests that the ISDS system deters domestic regulatory interventions that decrease the profitability of foreign direct investment.

Keywords: Investor-State Dispute Settlement, Stock Returns,Regulatory Environment, Spillover Effect, Foreign Investment