Does effective democracy explain MNE location choice?: Attractiveness to FDI and cross-border M&As

Abstract

Are internationalization decisions of MNEs affected by the democracy levels of the host country? Democracy is a thicker construct that defines the credibility, stability, accountability and effectiveness of formal and informal institutions present in a country. Democratic nations are better governed. Democratization should, therefore, make locations more favorable for MNEs. Yet very little is known about the role of democracy. Using a unique sample of FDI and cross-border M&As, our paper, for the first time, provides global evidence of how effective democratization increases the attractiveness of the target county to foreign investment. We find a positive linear association of effective democracy with FDI and cross-border M&A inflows. Our analysis also differentiates between a paper (only rules) and effective (rules with implementation) democracy and identifies implementation as a critical factor in democratization’s attractiveness. Thus, this paper provides a key peg in the MNE location choice decision and has implications for firms and their stakeholders, M&A decision-makers, business leaders, and policymakers.