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Institutions sans frontières: International agreements and foreign investment

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Abstract

We examine whether the presence of International Investment Agreements (IIAs), negotiated among countries for foreign investor protection, lowers political risk faced by multinational enterprises (MNEs). Drawing on research from international business, political science, and international law, we argue that IIAs increase expected future cash flows, and hence the value of foreign assets, by limiting the ability of host governments to make discriminatory policy changes. However, the need for IIA protection, and the ability to benefit from it, varies with firm characteristics. Using detailed transaction-level data for sale of petroleum assets in 45 countries, we find that MNEs pay significantly higher amounts for those protected by IIAs than similar but unprotected assets, an effect moderated by the firm’s reserve size and state ownership.

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Notes

  1. Studies include: international law (Salacuse & Sullivan, 2005; Yackee, 2008, 2010; Newcombe & Paradell, 2009), economics (Egger & Pfaffermayr, 2004; Egger & Merlo, 2007), and political science (Elkins et al., 2006; Kerner, 2009; Jandhyala et al., 2011; Neumayer & Spess, 2005; Hallward-Driemeier, 2009).

  2. In a recent example, the Argentine Government nationalized Spain’s Repsol-YPF in 2012, after the company announced a major oil discovery (BBC, 2012). Since Repsol’s investment was protected by an IIA between Spain and Argentina, the company filed for international arbitration, seeking $10.5 billion in compensation (Webber, 2012).

  3. Clauses include “fair and equitable treatment,” “national treatment,” and “most favored nation treatment.”

  4. Some cases are private; neither their filing nor resolution is public information.

  5. The ECT’s remit is broader than petroleum investment, encompassing protection of trade and transit in the energy sector (Konoplyanik & Walde, 2006).

  6. Less than 3% of IIA-protected transactions in our sample are covered by both BITs and the ECT.

  7. Reputation for creditworthiness is a subject of debate in the literature on sovereign debt default and repayment (see Panizza et al., 2009 for a survey). Tomz (2007) shows that reputational considerations have affected decisions to repay sovereign debt, whereas changing access to international capital markets have not.

  8. The World Bank’s ICSID is the most popular venue for international arbitration (UNCTAD, 2009). Disputes are also filed under the United Nations Commission on International Trade Law (UNCITRAL), Stockholm Chamber of Commerce, and the Permanent Court of Arbitration.

  9. In an example of the use of an IIA in the petroleum industry, US-based Burlington Resources filed for arbitration against Ecuador with the ICSID in 2008 to challenge a new law requiring it to pay high taxes on windfall profits from its two reserves in the Amazon region. An ICSID ruling found that Ecuador unlawfully expropriated the firm’s investment https://icsid.worldbank.org/ICSID/FrontServlet?requestType=CasesRH&actionVal=showDoc&docId=DC2777_En&caseId=C300, accessed 27 November 2012.

  10. We are grateful to JSH (now a part of IHS Inc.) for permission to use the data.

  11. The large representation of the United States and Canadian transactions is in part due to national regulations and in part due to market factors. In some of the largest oil producing countries (e.g., Saudi Arabia, Kuwait, Iran, and Mexico), petroleum is a state monopoly; hence, they are not in the data. Nearly 75% of the recorded transactions are for assets located in the the United States and Canada, which unlike the rest of the world are home to numerous small, domestic oil companies. These transactions are overwhelmingly domestic; outside the region, cross-border deals account for more than 60% of the sample. We include North American cross-border transactions in our robustness checks.

  12. Crude oil and natural gas are often found together, and many reserves include both. Their extraction and distribution techniques and costs differ, however; we include control variables for the percentage of gas in the reserve, as well as indicators for gas that is difficult to extract or transport, discussed below.

  13. Note that when they have FDI in several countries, MNEs in principle can “treaty shop” for protection through host-country BITs with countries of their subsidiaries, rather than with their home country. Jurisdiction (hence protection) of FDI under such third-country BITs has been found to be problematic, however (Skinner et al., 2010), and is ignored in our work.

  14. Although our dependent variable is measured in equivalent barrels of oil, some authors have argued that the ratio of the market values of oil and gas need not be equal to their energy ratios (Adelman & Watkins, 1995).

  15. We thank anonymous referees for suggesting these alternative size measures.

  16. Another potential source of endogeneity arises from treating investing firms as exogenous. Governments may favor certain firms, either those larger or more experienced (and hence more likely to have financial or technological capability), or less likely to file for arbitration under IIAs (e.g., Japanese firms do not file under ICSID; see Wells & Tsuchiya, 2011). We do not address this, as it would reduce their political risk even without IIAs, and bias against finding significant results. We thank an anonymous reviewer for this point.

  17. The results reported in this table use all potential home–host dyads worldwide. We also estimated this model on the countries in our sample, with similar results.

  18. This effectively allows for IIAs to enhance asset value by up to 25% ($10 million/$8 million=1.25).

  19. BITs do not protect domestic investment. The ECT is less clear; for example, foreign shareholders brought a claim (not resolved at this writing) against the Russian government after it expropriated domestic company Yukos.

  20. We repeat this test including cross-border transactions occurring in North America, and find similar results.

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Acknowledgements

We are grateful to JS Herold for data access, Anthony Cannizzaro for research assistance, and the George Washington University CIBER for research support. We thank Heather Berry, Daniel Blake, Witold Henisz, Steve Kobrin, Lauge Poulsen, Noel Maurer, Jordan Siegel, Jennifer Spencer, Paul Vaaler, Lou Wells, the editor (Donald Lessard), anonymous reviewers, and seminar/conference participants at the Indian School of Business, The Fletcher School, IE Business School, National University of Singapore, Singapore Management University, ESSEC Business School, Baruch College, University of Miami, Atlanta Competitive Advantage Conference, Academy of International Business, Academy of Management and the International Political Economy Society Annual Conferences for comments on earlier drafts of this paper. Paper contents are our sole responsibility.

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  1. ESSEC Business School, Singapore

    Srividya Jandhyala

  2. George Washington University, Washington, DC, USA

    Robert J Weiner

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Correspondence to Srividya Jandhyala.

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Accepted by Donald Lessard, Guest Editor, 30 October 2013. This paper has been with the authors for one revision.

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Jandhyala, S., Weiner, R. Institutions sans frontières: International agreements and foreign investment. J Int Bus Stud 45, 649–669 (2014). https://doi.org/10.1057/jibs.2013.70

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