Tutorial 1

Question 1

eclectic theory of foreign direct investment

Answer 1

• J Dunning in late 1970s
• For a firm to indulge in FDI, three conditions must be met
• Ownership, location, and internalisation advantage must be held by the foreign investor over the host country
• It’s in the firm’s best interest to combine the O and I advantages with thefactors of production located in the host country (location advantages (L))

Question 2

Ownership advantage

Answer 2

• Technological Superiority: Advanced technologies for global competitive advantage.
• Brand Equity: Strong brand recognition and trademarks.
• Managerial Expertise: Transferable superior management and organizational processes.
• Proprietary Knowledge: Exclusive knowledge and secrets for competitive leverage.
• These advantages must overcome the costs and risks of foreign market entry.

Question 3

Location advantage

Answer 3

• Economic Factors: Market size, access, stability, and growth prospects.
• Resource Accessibility: Availability of raw materials and cost-effective labor.
• Political and Legal Environment: Favorable policies, stability, and legal frameworks.
• Cultural and Social Factors: Cultural affinity and socio-cultural dynamics that ease entry.
• Location attributes must complement a firm’s abilities to enhance market performance.

Question 4

Internalisation advantage

Answer 4

• Cost Reductions: Lower transaction costs than outsourcing or licensing.
  Protection of Proprietary
• Information: Safeguards against competitive threats.
• Quality Control: Ensures global standards are met.
• Coordination Efficiency: Streamlines global operations and strategic alignment.
• Chosen when benefits surpass the costs and complexities of cross-border management.

Question 5

What are the motives of foreign direct investments?

Answer 5

• Franco et al. (2008) categorise motives into four primary categories:
• Market seeking
• resource seeking
• Efficiency seeking
• Strategic Asset seeking
• These motives are not mutually exclusive and often overlap

Question 6

Market seeking

Answer 6

• Companies invest in foreign countries to gain access to new markets or to maintain their presence in these markets.
• The motive is often to serve local markets directly, overcome trade barriers, respond to competition, or maintain market share.

Question 7

Resource seeking

Answer 7

• Firms invest abroad to access resources that are cheaper or better quality than those available at home.
• This includes natural resources like minerals or oil, agricultural products, or access to skilled and unskilled labor at lower costs.

Question 8

Efficiency seeking

Answer 8

• increase efficiency by reorganizing the production process across countries.
• This could involve relocating production to reduce costs, exploiting economies of scale, or using more advantageous economic environments for specific production stages.

Question 9

Strategic Asset seeking

Answer 9

• strategic assets such as technology, brand names, or organisational practices.
• This can also involve investing in foreign companies to acquire their capabilities or to preempt competitors

Question 10

Country Risk

Answer 10

• Country risk refers to the potential for a country’s economic, political, and social environment to adversely affect an investor’s profits or the value of their investments.
• This type of risk encompasses a broad range of factors including economic policies, currency stability, regulatory changes, and political stability.
• It’s a comprehensive measure that includes both sovereign and political risk as subcategories, affecting all forms of investment, not just government bonds or political contracts
• Example: Argentina’s economic crisis (2001-2002) led to severe economic instability, affecting all forms of investment due to recession and currency devaluation

Question 11

Political Risk:

Answer 11

• Political risk specifically relates to the likelihood that political decisions, events, or conditions will significantly affect the profitability of a business investment.
• This can include changes in government, legislative alterations, civil disturbances, corruption, and any form of government interference in the economy.
• Political risk is more focused on how governmental actions can affect business operations, unlike country risk which includes economic and social factors as well.
• Example: In 2007, Venezuela nationalized major oil projects, directly affecting foreign companies like ExxonMobil and ConocoPhillips.

Question 12

Sovereign Risk:

Answer 12

• Sovereign risk pertains to the risk that a government will default on its debt obligations or will not be able to meet its loan payments.
• This risk is specifically concerned with the ability and willingness of the government itself to meet specific financial obligations.
• Sovereign risk is often considered in the context of government bonds or any lending to the government.
• During the Greek debt crisis (2010), Greece struggled to meet debt obligations, requiring EU and IMF bailouts.

Question 13

Variables that Account for Sovereign Risk:

Answer 13

• Fiscal Balance: The health of a government’s budget, which affects its ability to service debt.
• Debt Levels: Overall public debt as a percentage of GDP, indicating the burden of debt.
• External Balances: Current account deficits, which can indicate a dependency on foreign capital.
• Political Stability: The stability and effectiveness of the government, which can affect its fiscal policies and debt servicing.
• Economic Performance: GDP growth rates and economic health, impacting tax revenues and public spending.
• Monetary Policy: Central bank policies, including currency stability and control of inflation.
• Legal System: The robustness of legal frameworks in enforcing contracts and handling defaults.