Quality of governance and corporate real investment: Assessing the impact of foreign aid

Abstract

AbstractDeveloping economies are the main recipients of foreign aid. Nonetheless, such countries must face trade‐offs regarding poor governance due to the inflow of foreign aid because aid hampers governance situations. Given that, the current study aims to examine the role of country governance in defining corporate investment decisions and to ascertain how this effect varies across those countries that receive substantial amounts of foreign aid. To test the hypotheses, we collect the financial information of non‐financial sector enterprises from seven economies and apply the generalized method of moments and two‐stage least square models. The statistical results reveal that governance has a positive influence on corporate investment choices. This positive effect is consistent across individual effects of foreign aid. However, foreign aid systematically deteriorates the governance quality of the host country, referring to donor agencies’ unnecessary interruption of the host country's institutional proceedings. This factor reduces institutional efficiency, which further deteriorates corporate investment. Our empirical analysis suggests that all the countries analysed should focus on better governance situations to promote industrial growth. Policymakers from these economies should ensure the effectiveness of foreign aid and introduce better governance practices to expediate industrial growth.HIGHLIGHTS Country level governance has a positive and significant impact on CI decisions. Foreign aid affects CI decisions positively. Foreign aid deteriorates the host country's governance quality. The interaction effect of country governance and foreign aid on CI is negative.