FOREIGN DIRECT INVESTMENT IN FINANCIALMARKET

Following the globalization trend, the financial sector seems to have drastically increased their foreign direct investments in recent decades. Nonetheless, it is evident and well documented that financial firms are far more passive in global diversification than non-financial firms. In terms of value, Berger, DeYoung, Genay, and Udell (2000) document that, even though both the domestic and cross-border transactions have increased rapidly, the gap between domestic and foreign M&A in financial sectors has actually widened over the period 1990-1998. Domestic M&A values have been consistently over 25 times higher than those of international M&As in financial industries (their data source is Securities Data Company). Also, Focarelli and Pozzolo (2001) note that the cross-border M&A deals among banks are only about half of those among non-financial firms in the 1990s. The phenomenon is especially puzzling. There appears to be plenty of motives for banks to extend their presence abroad. For instance, Saunders (2000) identifies favorable factors for globalization specific to U.S. banks: the use of the dollar as an international medium of exchange, capital flows to offshore branches and subsidiaries of U.S. banks caused by political risk concerns, the U.S. domestic banking activity restrictions, and improvements in technology and communications. This paper intends to investigate the reasons for such inertia. The conventional FDI framework may shed some light on this issue. One answer may lie on the nature of the banking business in which ownership advantage is relatively modest and internalization is not critical, compared to its manufacturing counterpart, as well as their differences in financial aspects.

Specifically, common determinants leading to foreign direct investments (FDI) decisions by both U.S. financial and manufacturing industries are investigated in this paper. The comparison of the FDI determinants between financial and manufacturing industries should shed some light on why financial institutions are not as active as manufacturing firms in increasing their overseas presence. The results show interesting differences in foreign direct investments by U.S. firms in financial and manufacturing industries. The standard internalization variables are generally less important as motives for international investments by financial firms than for manufacturing firms. There is also evidence that international investments by financial firms are less affected by risk variables than those by manufacturing firms. Certain financial variables such as free cash flow and cost of capital are significant for both financial and manufacturing FDIs.

This paper is organized as follows. The determinants of FDI in financial sectors and a comparison to those in manufacturing industries are discussed in the next three sections, including a review of the related work and discussions of methodologies and empirical results. The final section is devoted to addressing the main findings and their implications.