Institutional distance and foreign direct investment

This paper studies the link between foreign direct investment (FDI) and
institutional distance. Using a heterogeneous firms framework, we develop a theoretical
model to explain how institutional distance influences FDI, and it is shown
that institutional distance reduces both the likelihood that a firm will invest in a
foreign country and the volume of investment it will undertake. We test our model
using inward and outward FDI data on OECD countries. The empirical results
confirm the theory and indicate that FDI activity declines with institutional distance.
In addition, we find that firms from developed economies adapt more easily to
institutional distance than firms from developing economies.