Foreign Financing and the International Sources of Property Rights

Abstract

How do firms protect themselves against infringements of their property rights by their own government? The authors develop a theory based on international law and joint asset ownership with foreign firms. Investment agreements protect the assets of foreign firms but are not available to domestic firms. This segmentation of the property rights environment creates a rationale for international financial relationships between firms. By forming financial relationships with foreign firms, domestic firms gain indirect coverage from the property rights available to foreign firms under investment agreements. If a government is less likely to violate the property rights of covered foreign firms, it is also less likely to violate property rights for assets held jointly by domestic and foreign firms. This article presents systematic evidence from data on the activities of firms in countries that have investment agreements with the United States. International financial relationships between firms, through mergers and acquisitions as well as through bond and equity issues, are more common where property rights are weak. The theory suggests a political logic to the fragmentation of firm-ownership stakes across jurisdictions, offers an institutional explanation of international financial flows, and identifies new distributional consequences of international law.

Investment agreements and the fragmentation of firms across countries

“…While a growing literature highlights the political consequences of the fragmentation of production, we emphasize the fragmentation of firm ownership as a theoretically important, and empirically tractable, topic for future research. Accounting for the ownership structure of firms is relevant to the political balance between firms and governments (e.g., Betz and Pond 2019), and it provides a perspective on global investment flows that is distinct from theories of capital mobility and exit threats. Moreover, we provide a new rationale for the global expansion of firm boundaries, based on differences across countries in the participation in investment agreements.…”

“…The difference between governments and non-state actors in their authority to delineate the coverage of international law is becoming increasingly blurred in this context -as is the concept of the nationality of asset owners (Wellhausen 2014). Our paper therefore joins a growing literature on the role of non-state actors in an increasingly legalized and financialized global environment (Farrell and Newman 2016;Alter et al 2019;Betz and Pond 2019).…”

“…This latter category represents a growing share of investment disputes between firms and governments (Wellhausen 2016;Pelc 2017). In some cases firms derive protections from investment agreements that surpass the protections of domestic firms in the host country and of domestic firms in their home countries (Been and Beauvais 2003;Betz and Pond 2019). The value of these protections is underscored by the increasing availability of third-party financing from investors that anticipate large returns (Dafe and Williams 2020).…”

“…The firm finds a transit country that has an investment agreement with the target market. The firm then creates a subsidiary in the transit country and associates that subsidiary with its investment in the target market -most explicitly by making the subsidiary in the transit country the immediate owner of the investment in the target market or, taking advantage of the broad coverage of losses in many investment agreements, through financial instruments, such as bonds (Betz and Pond 2019). If the firm suffers losses in the target market, the associated subsidiary also suffers losses and the subsidiary may initiate arbitration under the investment agreement.…”

“…Instead of investing directly, these firms route about a third of their foreign assets through subsidiaries in third countries, separating the location of the immediate owner from the location of the ultimate owner. 2 With few exceptions, such as the global tax regime (Arel-Bundock 2017) and protection from own government predation (Betz and Pond 2019), the logic behind the disaggregation of ownership shares across countries remains a topic that is largely unexplored and not accounted for in existing theories. In particular, the ownership structure of firms is not well explained by existing theories of asset mobility, global value chains, and foreign direct investment.…”