Fire-Sale FDI

Abstract

Financial crises are often accompanied by an outflow of foreign portfolio investment and an inflow of foreign direct investment(FDI). We provide an agency-theoretic framework that explains this phenomenon. We show that during crises, agency problems affecting domestic firms are exacerbated, and, in turn, external financing constrained. Transfer of control in the form of direct ownership of failedfirms' assets by alternate users can circumvent agency problems, but during crises, efficient owners (e.g.other domestic firms) face similar financing constraints. The result is a transfer of ownership to foreignfirms, including inefficient ones, at fire-sale prices. Suchre-sale FDI is associated with a flipping of acquired firms back to domestic owners once the crisis abates. These features of re-sale FDI find empirical support.