Title: Home Bias in Foreign Direct Investment

Author: Kristina Vasileva

Institution: Cass Business School, City University London.

Date: May 2008

Subject area(s): Finance and Economics.

Relevance to other area(s): Behavioural and decision making psychology.

Project type: (part of ongoing) PhD thesis

Summary

Photo by: thinkpanama, Creative Commons, Flickr.We investigate home bias in corporate decision making in an international context. There is a strong preference for corporate managers to invest in surrounding countries and places of social and cultural familiarity. We investigate whether this tendency to invest in the familiar is also present in foreign direct investments. FDI data is on 5755 different bilateral country pairs and more than 50.000 observations for FDI inflows and outflows for the period 1981-2005. Corporate investors prefer destinations that are more familiar to them. They prefer to invest in countries near to their home country and ones that are part of the same economic union as and have a similar legal system to the one in their home country. Like investors in the equity markets, the managers who make the decisions in the corporations regarding FDI's are people influenced by their personal background and their location.

Datasets used

Organisation for Economic Cooperation and Development (2007): International Development Statistics, (Edition: 2007). ESDS International, University of Manchester.

World Bank (2007): World Development Indicators (Edition: 2007). ESDS International, University of Manchester.

International Monetary Fund (2008): International Financial Statistics (Edition: March 2008). ESDS International, University of Manchester.

Aims and objectives

The purpose of this research is to investigate familiarity bias in foreign direct investment (FDI). We expect that there is a strong preference for corporations to invest in surrounding countries and places of social and cultural familiarity. Corporate managers feel more familiar with countries with which they share a border, certain historical ties, or even a common past as parts of the same country in the past. Usually such historical ties lead to the existence of minority population which strengthens familiarity through a common language and culture. In addition to common languages, cultural familiarity is well approximated also by having same origin of the country’s legal system as well as being part of the same international economic or political unions.

Methodology

We estimate this general regression model:

FDI i,j,t = a + b1(γ1)i,t + b2(γ2)j,t + b3 (γ3)i,j,t + b4 (γ4)i,j,t + u

Where:

FDI i,j,t is FDI inflows or outflows;
γ1 – macroeconomic variables (GDP, GDP per capita, GDP growth rate, population, country trade openness);
γ2 – is for geographic proximity (distances, shared border, same continent);
γ3 – familiarity variables (common language, shared legal system origin, economic/political union membership, colonial relationship).  

Results/Outcome

Corporate decisions regarding foreign direct investments are prone to bias. Our results show that foreign direct investors prefer to invest in countries that are geographically closer to their home countries. Physical proximity is an indicator of cultural and linguistic familiarity in most instances. Foreign direct investors also prefer to invest in countries whose economic and legal systems are similar to their own. Institutional similarities are important indicators of business climate familiarity. We also find the size of the economy is a very important indicator and it is more important for the FDI outflows sending country while country openness for the FDI receiving countries.

Additional Information

Research presented as a poster at the 4th ESDS International Annual Conference which took place on 1st December 2008 at the Institute of Materials in London - see conference proceedings.