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Abstract
This paper examines the impact of corruption on foreign direct investment
(FDI). It argues that corruption results not only in a reduction in FDI, but also in
a change in the composition of country of origin of FDI. It presents two key
findings. First, corruption results in relatively lower FDI from countries that have
signed the Organization for Economic Cooperation and Development
Convention on Combating Bribery of Foreign Public Officials in International
Business Transactions. This suggests that laws against bribery abroad may act as
a deterrent against engaging in corruption in foreign countries. Second,
corruption results in relatively higher FDI from countries with high levels of
corruption. This suggests that investors who have been exposed to bribery at
home may not be deterred by corruption abroad, but instead seek countries
where corruption is prevalent.
Journal of International Business Studies (2006) 37, 807822.
doi:10.1057/palgrave.jibs.8400223
Keywords: corruption; foreign direct investment; international management
Introduction
Host country corruption discourages foreign direct investment
(FDI). Corruption, the abuse of public power for private gain,
creates uncertainty regarding the costs of operation in the country.
It acts as an irregular tax on business, increasing costs, and
distorting incentives to invest (Shleifer and Vishny, 1993; Mauro,
1995; Wei, 2000a) Many empirical studies provide support for this
idea, as they find that corruption in the host country is negatively
related to FDI (e.g., Wei, 2000a, b; Habib and Zurawicki, 2002;
Lambsdorff, 2003).
However, some scholars have argued that corruption can have a
positive impact on investment by facilitating transactions in
countries with excessive regulation (Huntington, 1968; Leff,
1989). Investors who greatly value their access to a certain asset,
for example a permit, will pay for this access (Lui, 1985). Some
empirical studies do not find a negative relationship between
corruption and FDI, and some even report a positive relationship
(e.g., Wheeler and Mody, 1992; Henisz, 2000). Moreover, some
countries with high levels of corruption, such as China or Nigeria,
are the recipients of a great deal of FDI. Corruption does not keep
FDI out of very corrupt countries. This fact begs the question of just
how corruption affects FDI.
In this paper, we argue that corruption results not only in a
reduction in FDI, but also in a change in the composition of
country of origin of FDI. We suggest that not all foreign investors
care about corruption in the host country. Although corruption has
a negative impact on FDI because of the additional uncertainty and
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the absolute difference between the level of corruption in the host country and in the home country
had a negative impact on FDI. Voyer and Beamishs
(2004) analysis of Japanese FDI found that corruption had a negative impact on FDI per capita,
especially in developing nations.
However, not all empirical studies have observed
a negative relationship. For example, Wheeler and
Mody (1992) found no relationship between risk,
which includes corruption, and foreign investment
by US firms. Hines (1995) analyzed US FDI, and his
results showed that corruption in the host country
did not affect the level of total inward FDI,
although it had a negative impact on the growth
of FDI after the passage of the Foreign Corrupt
Practices Act (FCPA) of 1977. Henisz (2000) found
that, for US firms, corruption tends not to affect
their investments, and in some cases it increases
the probability of investing in the foreign country.
FDI
Hypothesis 2
Home country with
high corruption
Figure 1
Theoretical framework.
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Research design
We test the hypotheses using data on bilateral FDI
inflows from 183 home economies to 106 host
economies. By including such a large number of
home countries, we are able to analyze how the
relationship between corruption and FDI varies
depending on the characteristics of the country of
origin of FDI. Previous studies of the impact of
corruption on FDI have analyzed FDI either from
one country only, or from a limited number of
home countries, usually developed or OECD countries, which tend to have low corruption. In
contrast to these studies, we use a large number of
host countries to be able to compare countries with
laws against bribery abroad and countries with high
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Table 1
Variable
Measure
Source
Dependent variable
Ln FDI inflows
Independent
variable of interest
Host country
corruption
Home country
with laws against
bribery abroad
Home country
with high
corruption
Control variables
Ln GDP
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Method of analysis
Following Wei (2000a), we used a double-log model
with quasi-fixed-effects and one-year lag to analyze
the data. In the double-log model, we applied
natural logs to the dependent variable (FDI) and the
independent variable (GDP, distance) to ensure the
homoscedasticity of the error term (Wei, 2000a, 4).
We used a quasi-fixed-effects specification whereby
we controlled for the home country using a dummy
indicator for each country. These home country
dummies were designed to capture characteristics
of the home country that may affect its FDI abroad,
including its economic size and level of development. We did not include dummies for host
countries because doing so would eliminate the
possibility of estimating the impact of corruption
on FDI. The dependent variable was measured at
the end of 1999, because this is after the legislation
barring bribery abroad was signed (November 1997)
and came into effect (February 1999). The independent variables were measured one year earlier
(1998) in order to account for the time lag that
occurs between the decision to invest and the
actual FDI. Finally, because the log of FDI takes
positive values, we used a Tobit specification
(Tobin, 1958; Maddala, 1983). We used a modified
Tobit specification because the log of zero is
undefined (for a discussion of this model see Eaton
and Tamura, 1995; Wei, 2000a). Therefore the
specification of the empirical model we used is
the following:
Ln FDIijt g1 Host country corruptionjt1
g2 Home country with high corruptionit1
Host country corruptionjt1
g3 Home country with laws against
bribery abroadit1
Host country corruptionjt1 Xijt1 beij
where Xijt1 is a vector of the control variables; g1,
g2 and g3 are the parameters of interest; b is a vector
of other parameters; and e is the error.
Table 2
Mean
3.424
1.000
1
0.327***
0.434
0.334***
0.018
0.497
1.928
52.456
0.997
0.531
0.476
0.236
0.350*** 0.037+
0.060*
0.210
0.053*
10
11
12
13
14
0.628***
0.437*** 0.480***
0.025+
0.291*** 0.161***
0.030+
0.108***
0.068*** 0.042*
0.200***
0.215***
0.011
0.033
0.146*** 0.080***
0.092***
0.010
0.115***
0.362
0.040+
1
0.048**
0.733***
1
0.053**
0.060**
0.188***
1
0.040*
0.325*** 0.193*** 0.205***
1
0.136***
0.059**
0.080***
0.276*** 0.174***
1
0.004
0.010
0.005
0.440***
0.092*** 0.130***
0.064**
0.131***
0.200
0.689
0.124*** 0.030
0.025
0.252***
0.450***
0.017
1.138
0.139***
0.496*** 0.079***
0.079***
0.004
0.041*
0.158***
0.047*
0.201***
0.134*** 0.010
0.003
0.097*** 0.050**
+
0.003
0.037
0.062** 0.044*
0.081***
0.090***
0.229***
0.026
0.007
0.063**
0.033+
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1
0.220***
0.125***
1
0.440***
0.145***
0.320*** 0.336***
0.008
0.021
0.095*** 0.0008
0.087*** 0.028
1
0.528***
815
1. Ln FDI inflows
2.230
2. Host-country
2.500
corruption
3. Home country
0.252
with high
corruption
0.546
4. Home country
with laws against
bribery abroad
5. Ln GDP
18.628
6. Population
32.676
7. Ln Distance
7.858
8. Landlocked
0.328
9. Island
0.253
10. Common
0.059
border
11. Common
0.155
language
12. Common
0.046
colony
13. Ever colonial link
0.042
14. Restrictions
2.389
on FDI
15. Restrictions
2.681
on trade
Std. dev.
Variable
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Results
Table 2 presents the summary statistics and correlation matrix. The average bilateral FDI inflow is
US$508 million, with a maximum of US$116,605
million from the UK to the US. Of the 183 countries
for which we have FDI data, 36 countries are
classified as having laws against bribery abroad
and 117 are classified as having high corruption.
Although some of the variables show high correlation coefficients, the analyses are not subject to
multicollinearity. The variance inflation matrix
suggested not using natural logs for the population
measure in order to reduce its multicollinearity
with the GDP measure.
The results of the analysis appear in Table 3.
Model 1 shows the analysis with only the control
variables. Models 2 and 3 show the partial analyses.
Model 4 shows the full analysis. We discuss the
results of the full analysis. The results support
Hypothesis 1 and Hypothesis 2. First, the coefficient of the product of the indicator of countries
with laws against bribery abroad and host-country
corruption is negative and statistically significant
(Po0.05), supporting Hypothesis 1. In other words,
in comparison with FDI from other countries, FDI
Alternative explanations
We argued that not all investors care about
corruption: while FDI from countries with laws
against bribery abroad is deterred by host-country
corruption, FDI from countries with high levels of
corruption is attracted by host-country corruption.
However, there do exist some plausible alternative
explanations. We analyze four that warrant discussion, and show that none appear to be supported.
The first alternative explanation is the idea that
the majority of FDI of OECD countries, which
represent the worlds highest-income nations, goes
to other OECD nations, and that the majority
of FDI from low-income countries goes to other
Table 3 Results of the analyses of the change in the relationship between corruption and FDI depending on the characteristics of the
country of origin of FDI
Model 1
Model 2
Model 3
0.575*** (0.129)
0.345*** (0.081)
0.480*** (0.067)
0.008*** (0.001)
0.833*** (0.089)
0.039 (0.190)
0.479w (0.250)
0.709* (0.292)
0.542* (0.226)
0.197 (0.510)
0.714* (0.320)
0.218w (0.125)
0.027 (0.072)
4.843*** (1.515)
1073.09***
0.228
1881.762
0.078 (0.124)
0.493*** (0.066)
0.008*** (0.001)
0.725*** (0.091)
0.089 (0.188)
0.545* (0.247)
0.623* (0.289)
0.602** (0.223)
0.261 (0.503)
0.752* (0.316)
0.209w (0.124)
0.031 (0.071)
4.037** (1.506)
1092.42***
0.232
1802.099
Model 4
0.323* (0.162)
0.707*** (0.181)
0.460* (0.219)
0.443*** (0.084)
0.464*** (0.066)
0.009*** (0.001)
0.799*** (0.090)
0.088 (0.189)
0.488* (0.249)
0.529w (0.294)
0.581* (0.226)
0.307 (0.507)
0.672* (0.321)
0.253* (0.125)
0.031 (0.072)
5.144*** (1.510)
1079.68***
0.232
1778.227
0.170 (0.160)
0.473*** (0.066)
0.008*** (0.001)
0.756*** (0.092)
0.112 (0.189)
0.515* (0.249)
0.543w (0.293)
0.602** (0.226)
0.281 (0.506)
0.676* (0.320)
0.244w (0.125)
0.030 (0.072)
4.719** (1.519)
1083.64***
0.233
1776.249
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Public Officials in International Business Transactions does not have the strong impact suggested,
and that the variable instead captures the concentration of FDI from OECD countries into other
OECD countries. As we indicated above, we control
for home country and for the size of the host
country. The distribution of FDI inflows does
not support the notion that OECD countries invest
only in other OECD countries. They are the largest
investors not only in other OECD countries,
but also in non-OECD countries.
We conducted additional tests to analyze whether
the Convention has been effective in altering the
sensitivity of FDI from countries that signed it to
host-country corruption. To explore this, we ran an
additional test (available upon request) comparing
the sign and statistical significance of the coefficient of the interaction between the indicator that
the country has signed the OECD Convention and
the level of host-country corruption before and
after the Convention came into force. This analysis
is inspired by Hiness (1995) study of the effectiveness of the FCPA. We observe that the coefficient
is not statistically different from zero in the
time period before the Convention came into
force (years 1997 and 1998), but it becomes
negative and statistically significant (Po0.001)
after it came into force (years 1999 and 2000). We
conducted an additional analysis that separates the
G7, all of which signed the Convention, from other
countries that signed the OECD Convention to
check that the previous results are not driven by
FDI from the largest source countries, which are
also low-corruption countries. We find that the
coefficient of the interaction between the indicator
that the country is in the G7 and the level of hostcountry corruption is not statistically different
from zero in 1997, it becomes negative and weakly
statistically significant in 1998 (Po0.1), and
becomes statistically significant (Po0.001) in
1999 and 2000. We also find that the coefficient
of the interaction between the indicator that the
country signed the Convention but is not in the G7
and the level of host-country corruption is positive
and statistically significant in 1997, becomes not
statistically different from zero in 1998, and
becomes negative and statistically significant in
1999 (Po0.05) and in 2000 (Po0.01). We interpret
these results as support for the idea that the OECD
Convention has altered the sensitivity to hostcountry corruption of investors from countries that
signed the Convention. Nevertheless, we acknowledge that there are variations in the effectiveness of
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819
Acknowledgements
The paper benefited from suggestions by the Guest
Editor Peter Rodriguez, three anonymous reviewers,
the discussant Marty Meznar, Chuck Kwok, Kendall
Roth, Annique Un, and the audience at the JIBS
Focused Issue Workshop in Phoenix, Arizona. The
School of Global Management and Leadership at
Arizona State University at the West campus, Lally
School of Management and Technology at Rensselaer
Polytechnic Institute, the Department of Economics at
Rensselaer Polytechnic Institute, and the Center for
International Business Education and Research at
Thunderbird, The Garvin School of International
Management, provided financial support for the
Workshop. Funding from the Center for International
Business Education and Research at the University of
South Carolina is gratefully acknowledged. All errors
remain mine.
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820
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Appendix
Home and host countries
Host countries
Algeria, Angola, Anguilla, Argentina, Armenia,
Aruba, Australia, Austria, Azerbaijan, Bahamas,
Barbados, Belgium/Luxembourg, Belize, Benin,
Bermuda, Bolivia, Brazil, Brunei, Bulgaria,
Burkina Faso, Burundi, Cambodia, Cameroon,
Canada, Cape Verde, Central African Republic,
Chad, Chile, Colombia, Comoros, Costa Rica,
Cuba, Czech Republic, Denmark, Djibouti,
Dominican Republic, Ecuador, El Salvador,
Eritrea, Estonia, Ethiopia, Finland, France,
Gambia, Germany, Greece, Guatemala, Guyana,
Haiti, Honduras, Hungary, Iceland, Ireland, Italy,
Jamaica, Japan, Kazakhstan, Korea, Kyrgyzstan,
Latvia, Lithuania, Macau, Macedonia, Malawi,
Mali, Mauritius, Mexico, Moldova, Mongolia,
Morocco, Mozambique, Myanmar, Netherlands,
Netherlands Antilles, New Zealand, Nicaragua,
Norway, Panama, Paraguay, Peru, Poland,
Portugal, Russia, Rwanda, Saint Kitts Nevis, Saint
Lucia, Sierra Leone, Slovakia, Slovenia, Somalia,
Spain, Suriname, Sweden, Switzerland, Tanzania,
Trinidad Tobago, Tunisia, Turkey, Uganda, UK,
Uruguay, US, Uzbekistan, Venezuela, Zambia,
Zimbabwe.
Home countries
Afghanistan, Albania, Algeria, Andorra, Angola,
Anguilla, Antigua Barbuda, Argentina, Armenia,
Aruba, Australia, Austria, Azerbaijan, Bahamas,
Bahrain, Bangladesh, Barbados, Belarus, Belgium/
Luxembourg, Belize, Bermuda, Bhutan, Bolivia,
Bosnia Herzegovina, Botswana, Brazil, British
Virgin Islands, Brunei, Bulgaria, Cameroon,
Canada, Cape Verde, Cayman Islands, Chad,
Channel Islands, Chile, China, Colombia,
Congo, Cook Islands, Costa Rica, Croatia, Cuba,
Cyprus, Czech Republic, Denmark, Dominica,
Dominican Republic, Ecuador, Egypt, El Salvador,
Estonia, Faeroe Islands, Fiji, Finland, France,
French Polynesia, Gambia, Georgia, Germany,
Gibraltar,
Greece,
Grenada,
Guatemala,
Guernsey, Guinea-Bissau, Guyana, Honduras,
Hong Kong, Hungary, Iceland, India, Indonesia,
Iran, Iraq, Ireland, Isle of Man, Israel, Italy, Ivory
Coast, Jamaica, Japan, Jersey, Jordan, Kazakhstan,
Kenya, Kuwait, Kyrgyzstan, Laos, Latvia, Lebanon,
Liberia, Libya, Liechtenstein, Lithuania, Macau,
Macedonia, Malawi, Malaysia, Mali, Malta,
Marshall Islands, Mauritania, Mauritius, Mexico,
Moldova,
Monaco,
Mongolia,
Morocco,
Myanmar,
Nauru,
Nepal,
Netherlands,
Netherlands Antilles, New Caledonia, New
Zealand, Nicaragua, Nigeria, Niue, North Korea,
Northern Marianas, Norway, Oman, Pakistan,
Palau, Panama, Papua New Guinea, Paraguay,
Peru, Philippines, Poland, Portugal, Puerto Rico,
Qatar, Reunion, Romania, Russia, Saint Kitts
Nevis, Saint Vincent Grenadines, San Marino,
Saudi Arabia, Serbia Montenegro, Seychelles,
Sierra Leone, Singapore, Slovakia, Solomon
Islands, South Africa, South Korea, Spain, Sri
Lanka, Sudan, Suriname, Swaziland, Sweden,
Switzerland, Syria, Taiwan, Tajikistan, Tanzania,
Thailand, Trinidad and Tobago, Tunisia, Turkey,
Turkmenistan, Turks and Caicos, Uganda, UK,
Ukraine, United Arab Emirates, Uruguay, US
Virgin Islands, US, Uzbekistan, Vanuatu, Vatican,
Venezuela, Viet Nam, Wallis and Futuna, Western
Samoa, Yemen, Zambia, Zimbabwe.
Home countries that do not appear in the list of host
countries
Afghanistan, Albania, Andorra, Antigua Barbuda,
Bahrain, Bangladesh, Barbados, Belarus, Bhutan,
Bosnia Herzegovina, Botswana, British Virgin
Islands, Cayman Islands, Channel Islands,
China, Congo, Cook Islands, Croatia, Cyprus,
Dominica, Egypt, Faeroe Islands, Fiji, French
Polynesia, Georgia, Gibraltar, Grenada, Guernsey,
Alvaro Cuervo-Cazurra
822
Accepted by Lorraine Eden, Army Hillman, Peter Rodriguez, Donald Siegel and Peter Rodriguez, Guest Editors, 17 April 2006. This paper has been with the
author for two revisions.
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.