Changes in political affinity and firms’ subsidiary investments

Abstract

Firms’ foreign investments are to a large extent influenced by the political environment in their foreign locations. A recent stream of literature has focused on the bilateral relations between countries as antecedents of multinational firms’ new investments. So far, this literature has not examined changes in existing investments due to the ongoing development of political relations. Thus, we investigate the effect of changes in countries’ bilateral political affinity on multinational firms’ foreign subsidiary investments. Political affinity is defined as the extent to which countries have similar national interests in global affairs. We argue that firms' decision to increase or decrease subsidiary investments is significantly influenced by political risk embedded in the political relationship between home country and subsidiary country. Changes in political affinity between a firm's home and subsidiary country can lead to increased subsidiary coordination costs and heightened expropriation risk. Analyzing 1606 US public firms and their ties to 142 different subsidiary countries from 2000 to 2015, we find that a positive (negative) change in political affinity leads to an increase (decrease) in firms' foreign subsidiary investment. We further explore these effects, finding that a more stable (unstable) political environment in the foreign location positively (negatively) moderates these effects.