Foreign direct investment, Corruption, Income tax treaties, F21, F23, H25, O17,

This chapter takes a different approach from earlier studies to determine how host-country governance affects U.S. foreign direct investment (FDI). Instead of looking at the effect on the amount of investment, it looks at the effect on the rates of return that companies require on their FDI. It shows that poor host-country governance, as indicated by indexes measuring corruption or political instability, causes U.S. companies to require a significantly higher rate of return on their FDI. There is no evidence that a bilateral income tax treaty with the United States reduces the required rates of return to U.S. FDI. This finding is consistent with theoretical predictions, particularly those of Sinn (1991, 1993), and with the conclusions reached by Blonigen and Davies (2001). Failing to include a variable for the quality of host-country governance can cause a simple cross-section regression to yield the misleading implication that a tax treaty encourages U.S. FDI.