Institutional complementarity across countries in bilateral FDI

Pao-Li Chang | Singapore Management University

This paper develops a theory on the institutional complementarity across countries in bilateral FDI activities. The marginal benefit for a firm to invest in informal institution is higher if it is based in a country of poorer institutions, as the informal institution becomes more useful (at reducing the fixed overhead cost) in environments where the formal institution is lacking.

Thus, firms based in the South with poorer institutional qualities will tend to invest more in informal institutions and are more relationship-based. The heavier investment in informal institution gives these firms an advantage in conducting FDI in countries of poorer institutional qualities (as the adverse effect of weak institutions at the destination on fixed cost is reduced by the firm-specific institutional investment).

Hence, all else being equal, the ranking of the MNE's home institutions predicts the ranking of the institutional qualities of their FDI destinations. I find robust empirical evidence for this theoretical prediction using bilateral FDI for 219 economies during year 2001-2010.