Evidence for the Effect of Monitoring Costs on Foreign Direct Investment
A proposed reason for the significant inverse relationship between distance (both physical and cultural) and foreign direct investment is the increased costs for a parent firm to monitor an affiliate when there is greater distance between them. We provide the first direct test of this hypothesis using O*NET data on occupational skills to construct industry-level measures of the importance of monitoring-related skills. We then exploit this cross-industry variation to examine whether physical and cultural distances have a greater impact on cross-border M&A in industries where monitoring-related skills are more important. Using data on worldwide cross-border M&A activity from 1985 through 2014, we find significant evidence for the effect of monitoring costs on cross-border M&A activity. We also show that the relatively low importance of monitoring-related costs in manufacturing industries compared to those in other sectors is an important factor in explaining why cross-border M&A in manufacturing is so large despite its relatively small share of the modern economy.
We thank Ron Davies, Nick Sly, and participants of seminars at the Baruch College and the University of Oregon for helpful comments. Any remaining errors or omissions are our own. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.
Bruce A. Blonigen & Anca Cristea & Donghyun Lee, 2020. "Evidence for the effect of monitoring costs on foreign direct investment," Journal of Economic Behavior & Organization, vol 177, pages 601-617.