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Corporate Governance and Foreign Direct Investment Research Paper

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Updated: Apr 3rd, 2020

Definition of Foreign Direct Investment

Foreign direct investment has been defined in a number of ways by different scholars and different institutions. Moran (1999, p. 45) defines foreign direct investment as “An investment made to acquire lasting or long-term interest in enterprises operating outside of the economy of the investor.” It is important to identify some of the fundamental concepts in this definition. The definition brings out two important factors.

The first factor is that this is a long term investment. The second factor is that it is an investment made in an economy that is outside that of the investor. Chen (2011, p. 75) defines foreign direct investment as “An investment made by a company or entity based in one country, into a company or entity based in another country.”

One clear factor that comes out from this definition is that foreign direct can be made by a company or an entity. This means that individuals can directly participate in foreign direct investment as long as they follow the set criteria for investment.

Criteria followed in foreign direct investment

According to Weigel, Wagle and Gregory (1997, p. 56), foreign direct investment has gained popularity in various economies of the world as it is the best way of balancing the excess wealth in the developed economies, and the need for economic growth in the third world countries.

It allows people with excess wealth to invest in any country that they consider to have a potential market for their products. The criteria to be followed in foreign direct investment differ from one country to another. In order to understand some of the conventional criteria that one may need to follow when making foreign direct investment, it will be necessary to analyze methods used in foreign direct investment.

One of the most common methods of foreign direct investment that is used by large companies is mergers and acquisition. Large American companies have expanded their operations through this approach. Instead of starting a new facility, they would acquire an already established firm. Different countries have different criteria that a company should follow when planning to acquire a firm. Another common approach is acquisition of shares in an enterprise (Naggar 1990, p. 112).

This process is commonly used by individuals, though many companies also use it. In this strategy, the investor will choose a company that is experiencing positive performance in the market. The investor will need to follow the regulations set by the stock market of the relevant country. Each country has some specific regulations for a foreign investor, especially concerning taxation of the earnings from the shares invested.

The third approach that is used in foreign direct investment is equity joint venture. In this approach, the investor will identify a relevant company that is already in existence and form a partnership with it. When using these criteria, there are some specific steps that the two companies need to follow as per the set regulations in the host country (Naidoo 2002, p. 78). The investor will expand the size of the company by bringing in new structures and financial resource. The procedure to be followed varies from one country to another.

Reasons why investors look for foreign direct investment

The world has become a global village following transformation in the fields of transport and communication sectors. It is now possible for someone in London to monitor his or her business operations in Kuwait without having to travel to this country because of the new video conferencing technologies.

Similarly, a company can have its headquarters in New York, its production plant in Shanghai, and the market in Europe, South America and Asia-Pacific. Travelling from one country to another has also become easy as air and sea transport becomes more advanced. These advancements have made it easy for investors to consider exploiting the opportunities in countries other than their home country.

One of the main reasons why investors look for foreign direct investment is because of the increasing market competition. They look to expand their market shares by finding new markets for their products. Other investors use foreign direct investment from a speculative approach (Blaine 2008, p. 36).

They use this approach of investment as a way of spreading the risks. For instance, when investors spreads his investment to three or four countries, the ultimate aim may be to get cushioned when one or two of the companies are affected by the economic downturn in the host or home countries.

Many American investors have gone to China, India, and parts of Africa. They believe that in case there is a recession in the United States, their operations in other countries will cushion their investment in the United States, thereby eliminating serious financial loss that may be incurred if most of the investment were to be in the same country.

Overview of foreign direct investment in Kuwait

Kuwait’s economy has largely been reliant on exportation of oil to the global market. Kuwait is one of the few countries in this region that maintained a positive environment for foreign investors, especially those from the West. However, there was a policy that many considered to be restrictive towards foreign investors coming to the country.

According to Jones and Wren (2007, p. 53), Commercial Law No. 68 which was enacted in 1980 requires any investor to ensure that they give Kuwaiti partners up to 51% shares in their companies.

The government realized that this law forced some investors to consider going to other countries within the region that had investor-friendly laws. In 2001, the government enacted Foreign Direct Investment Law No. 8 to change some of the provisions of the Commercial Law in order to attract more investors, especially in the fields that the locals had limited intellectual capacity to handle.

According to Sader (2000, p. 78), “The Law created an exception to the Commercial Law by allowing foreigners to own up to 100% of a commercial entity in Kuwait where the entity operates in select industrial sectors such as infrastructure, insurance, hospitals, housing, tourism and entertainment.” This was seen as a deliberate move by this government to attract foreign investors to help expand its economy.

There are also a number of changes in the country’s investment laws and regulations. The time taken to register a business entity was significantly reduced, and many bottlenecks that existed before were eliminated. The government also introduced incentives such as land and tax holidays of up to ten years for companies willing to operate in specific industries within the economy.

The government has specifically been very supportive of companies in the construction sector. This move is meant to reduce the country’s reliance on oil, especially given the price fluctuations. This has resulted into massive increase in the number of foreign investors coming to this country.

Chart of foreign direct investment in Kuwait for last 15 years
Chart of foreign direct investment in Kuwait for last 15 years. Source (Askari 2014, p. 56)

Definition of corporate governance

Fernando (2009, p. 56) defines corporate governance as “The system of rules, practices and processes by which a company is directed and controlled.” This scholar says that this process basically involves balancing the interests of various stakeholders within a given company.

On the other hand, Joshi (2004, p. 48) defines corporate governance as “The mechanisms, processes and relations by which corporations are controlled and directed.” In both cases, it comes out clearly that corporate governance involves directing the company to ensure that the varying interests of various stakeholders are well-taken care of within an organization.

Relationship between foreign direct investment and corporate governance

There is a close relationship between foreign direct investment and corporate governance based on the definitions given above. For a foreign investor to be successful in a host country, it is important to have effective corporate governance structure. Corporate governance makes it possible for the investor to understand the interests of the stakeholders and to balance them in order to maintain smooth operations (Tricker 2012, p. 126).

Sometimes the interests of these stakeholders may be varied. For instance, the government may be demanding more tax, the investors increased premiums, employees higher salaries, and the research unit more financial allocations. These are conflicting interests that a firm cannot fulfill. Corporate governance helps in moderating these interests to fall within the financial capacity of a given firm.

Corporate governance at micro level

Corporate governance in micro level refers to management of the interests of stakeholders at a unit level. When referring to foreign direct investment, corporate governance at micro level may be viewed as management of stakeholders’ interests at a firm level.

The management will need to balance the interests of all the stakeholders at the unit level (Rezaee 2008, p. 45). This may involve understanding the needs of the employees, government entities, customers, and the business itself, and finding a way of meeting them without compromise. This enhances levels of satisfaction.

Corporate governance at macro level

Corporate governance at macro level involves managing the interests of the stakeholders from a wider perspective. Some large corporations operate in various countries with numerous plants and retail outlets (Calder 2008, p. 45). The management unit at the helm of such companies has various stakeholders to deal with. The requirements set by the government or local stakeholders in one country may vary a great deal from that in another country.

This means that the management will need to understand these interests at local level and find a local solution to a problem that is seen to be global. At macro level, there are also other issues that may need the attention of the management of such a firm. One of them is about pollution.

Environmental agencies may not put pressure on the managers at micro level. The pressure is always directed to the top management responsible for the strategic decision making of a firm. These environmental agencies are important stakeholders, and their interests must always be taken into consideration.

Effect of corporate governance on foreign direct investment

Corporate governance has a positive effect on foreign direct investment. When making decision to invest into a foreign country, the investor will rely on corporate governance to ensure that the interest of all concerned stakeholders is protected to avoid any confrontations (Martin 2006, p. 38). This will help to enhance smooth running of an entity.

List of References

Askari, H 2014, Middle East oil exporters: What happened to economic development, Edward Elgar, Cheltenham.

Blaine, H 2008, Foreign direct investment, Nova Science Publishers, New York.

Calder, A 2008, Corporate governance: A practical guide to the legal frameworks and international codes of practice, Kogan Page, London.

Chen, C 2011, Foreign Direct Investment in China: Location Determinants, Investor Differences and Economic Impacts, Edward Elgar Publishers, Cheltenham.

Fernando, A 2009, Corporate governance: Principles, policies and practices, Pearson Education, New Delhi.

Jones, J & Wren, C 2007, Foreign direct investment and the regional economy, Wiley, New York.

Joshi, V 2004, Corporate governance: The Indian scenario, Foundation Books, Delhi.

Martin, D 2006, Corporate governance: Practical guidance on accountability requirements: A specially commissioned report, Thorogood, London.

Moran, T 1999, Foreign direct investment and development: The new policy agenda for developing countries and economies in transition, Institute for International Economics, Washington.

Naggar, S 1990, Investment policies in the Arab countries: Papers presented at a seminar held in Kuwait, December 11 – 13, 1989, Wiley, Washington.

Naidoo, R 2002, Corporate governance: An essential guide for South African companies, Double Storey, Cape Town.

Rezaee, Z 2008, Corporate governance and ethics, Wiley, Hoboken.

Sader, F 2000, Attracting foreign direct investment into infrastructure: Why is it so difficult, World Bank, Washington.

Tricker, R 2012, Corporate governance: Principles, policies and practices, Oxford University Press, Oxford.

Weigel, D, Wagle, D & Gregory, N 1997, Foreign direct investment, International Foreign Investment Advisory Service, Washington.

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