Review of World Economics

, Volume 150, Issue 2, pp 393–420 | Cite as

Financial constraints and foreign direct investment: firm-level evidence

  • Claudia M. Buch
  • Iris Kesternich
  • Alexander Lipponer
  • Monika Schnitzer
Original Paper


Low productivity is an important barrier to the cross-border expansion of firms. But firms may also need external finance to shoulder the costs of entering foreign markets. We develop a model of multinational firms facing real and financial barriers to foreign direct investment (FDI), and we analyze their impact on the FDI decision. Theoretically, we show that financial constraints can affect highly productive firms more than firms with low productivity because the former are more likely to expand abroad. We provide empirical evidence based on a detailed dataset of German domestic and multinational firms which contains information on parent-level financial constraints as well as on the location the foreign affiliates. We find that financial factors constrain firms’ foreign investment decisions, an effect felt in particular by firms most likely to consider investing abroad. The locational information in our dataset allows exploiting cross-country differences in contract enforcement. Consistent with theory, we find that poor contract enforcement in the host country has a negative impact on FDI decisions.


Multinational firms Heterogeneity Productivity Financial constraints 

JEL Classification

F2 G2 



This paper represents the authors’ personal opinions and does not necessarily reflect the views of the Deutsche Bundesbank. This paper was written partly during visits by the authors to the Research Centre of the Deutsche Bundesbank as well as while Claudia Buch was visiting the CES Institute in Munich and the NBER in Cambridge, MA, and Monika Schnitzer was visiting the University of California, Berkeley. We gratefully acknowledge the hospitality of these institutions as well as being allowed access to the Deutsche Bundesbank’s Foreign Direct Investment (MiDi) Micro-Database. We also gratefully acknowledge funding under the EU’s 7th Framework Programme SSH-2007-1.2.1 “Globalisation and its interaction with the European economy” as well as funding by the German Science Foundation under SFB-TR 15 and GRK 801. Valuable comments on earlier drafts were provided by Paul Bergin, Theo Eicher, Fritz Foley, Yuriy Gorodnichenko, Alessandra Guariglia, Galina Hale, Florian Heiss, Heinz Herrmann, Beata Javorcik, Nick Li, Kalina Manova, Assaf Razin, Katheryn Niles Russ, Alan Taylor, Shang-Jin Wei, Joachim Winter, Zhihong Yu, participants of seminars at the Deutsche Bundesbank, Simon Fraser University, Vancouver, the University of California (Berkeley, Davis, San Diego), the University of Madison, the University of Munich, the University of Nottingham, the University of Stanford, the University of Washington, Seattle, at the San Francisco Fed, and at the ASSA Meetings in Atlanta. We would also like to thank Timm Körting and Beatrix Stejskal-Passler for their most helpful discussions and comments on the data and Cornelia Kerl, Anna Gumpert, and Sebastian Kohls for their valuable research assistance.


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Copyright information

© Kiel Institute 2014

Authors and Affiliations

  • Claudia M. Buch
    • 1
    • 2
  • Iris Kesternich
    • 3
  • Alexander Lipponer
    • 4
  • Monika Schnitzer
    • 5
  1. 1.Halle Institute for Economic Research (IWH)HalleGermany
  2. 2.University of MagdeburgMagdeburgGermany
  3. 3.University of MunichMunichGermany
  4. 4.Deutsche BundesbankFrankfurtGermany
  5. 5.Department of EconomicsUniversity of MunichMunichGermany

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