Direct Foreign Investment: Costs and Benefits

By Richard D. Robinson | Go to book overview

share in project benefits, though, is the result of many factors in addition to the balance sheet definitions of participation. These include local taxes, financial incentives, and threats to appropriability of profits.

The resulting sharing rules are important determinants of the efficiency of FDI along three dimensions: managerial incentives, risk spreading, and contract stability. All deserve careful attention in the design and operation of control systems and incentives for FDI. Every investment should be examined in terms of the sharing of risk and reward and not just the stated ownership percentages and financing structures.

The risk spreading and incentive implications of foreign share financing are important at an aggregate, national level, as well as at a project or enterprise level. Our conceptual framework suggests that most developing countries should include some form of share financing in their external financing, even though they recently have relied more heavily on general obligation finance. The extent to which share financing is important depends on the country's overall obligations relative to its likely foreign exchange earnings, its comparative advantage in bearing particular risks, and on the extent to which it wants to shift some of the responsibility of its selection and execution of projects or programs to foreign interests.

Even if these aggregate-level considerations are not strong in a specific case, a country may want to employ substantial foreign share financing in order to make up for incomplete internal mechanisms for spreading risk and creating appropriate managerial incentives. In such cases, though, an important further consideration is whether the form of the foreign share financing employed will stimulate or retard the development of appropriate domestic markets. 22


NOTES
1.
A critical assumption underlying this conclusion is that there exist complete, perfect markets for spreading and pooling risk within an economy. If this is not the case, risks that are diversifiable at the level of the economy will be borne by some individuals and, hence, will have negative welfare impact.
2.
In simple terms, the net present value rule states that a firm should accept a project when the value of future cash flows, discounted at rates that reflect the time and risk parameters determined in the market, is greater than zero. For a clear discussion of its rationale, see Brealey and Myers ( 1984).
3.
This point has long been recognized in practice, but only recently has been incorporated in the academic literature on FDI. See in particular Kogut ( 1984).
4.
For a fuller discussion of this point, see Lessard ( 1979). For an empirical examination of MNCs' transfer pricing practices in Asian countries, see LeCraw ( 1984).
5.
An example is the case where a foreign firm operating as a branch is able to off- set start-up expenses of a local venture against its foreign tax liabilities while an indigenous firm must carry these losses forward until the project becomes profitable.

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