What is FDI (Foreign Direct Investment)?

A foreign direct investment (FDI) indicates the operation made in a foreign economy to acquire lasting interest. It is needed a long-term relation between parent enterprise and a foreign affiliate and this parent enterprise should have significant influence on management of the foreign affiliate. Furthermore, this parent must have control over its foreign affiliate. In this case, control is defined as owning at least 10% of the ordinary shares.[1] 

FDI is referred to as long-term capital flow and differs from portfolio investment by taking place in kind, through the exchange of property (patents, technology or machinery) and by acquiring control of a company. It also differs from other kinds of international capital movements in that direct investment proceeds by the reinvestment of profits and accompanied by varying degrees of control, plus technology and management.[2]

According to OECD, the foreign direct investor and investment are defined as follows:[3]

“A foreign direct investor is an individual, an incorporated or unincorporated public or private enterprise, a government, a group of related individuals or a group of related incorporated and/or unincorporated enterprises which has a direct investment enterprise – that is, a subsidiary, associate or branch – operating in a country other than the country or countries of residence of the foreign direct investor or investors.”

“OECD recommends that a direct investment enterprise be defined as an incorporated or unincorporated enterprise in which a foreign investor owns 10% or more of the ordinary shares or voting power of an incorporated enterprise or the equivalent of an unincorporated enterprise. The numerical guideline of ownership of 10% of ordinary shares or voting stock determines the existence of a direct investment relationship. An effective voice in the management, as evidenced by an ownership of at least 10%, implies that the direct investor is able to influence or participate in the management of an enterprise; it does not require absolute control by the foreign investor.

“Although not recommended by the OECD, some countries may still feel it necessary to treat the 10% cut-off point in a flexible manner to fit the circumstances. In some cases, the ownership of 10% of the ordinary shares or voting power may not lead to the exercise of any significant influence while, on the other hand, a direct investor may own less than 10% but have an effective voice in the management. OECD does not recommend any qualifications to the 10% rule. Consequently, countries that choose not to follow the 10% rule in all cases should identify, where possible, the aggregate value of transactions not falling under the 10% cut-off rule, so as to facilitate international comparability.”

“Some countries may consider that the existence of elements of a direct investment relationship may be indicated by a combination of factors such as:

a) Representation on the board of directors;

b) Participation in policy-making processes;

c) Material inter-company transactions;

d) Interchange of managerial personnel;

e) Provision of technical information;

f) Provision of long-term loans at lower than existing market rates.

Other relationships may exist between enterprises in different economies which exhibit the characteristics set out above, although there is no formal link with regard to shareholding. For example, two enterprises, each operating in different economies, may have a common board and common policy making and may share resources including funds but with neither having a shareholding in the other of 10% or more.”

As seen from the definition of FDI by OECD, they point out the dominance on the management of the investment. They try to mention that an investment can be called as FDI if the management of the foreign direct investor is powerful enough. They have implemented a criterion as 10% of the shares should belong to the FD Investor in order to be strong enough in the management of the company.

The other sources also mention the same criteria that an investor can be called as a foreign direct investor if and only if:[4]

• There is a control through substantial equity shareholding.
• There is a shift of part of the company’s assets, production or sales to the host country. 

After this, we need to define what control is and how it is sustained. This differs from firm to firm. One firm can accept that they should have at least 51% stakes in order to control of a firm. One other firm may accept that the control is having enough stakes in order to talk and convince the other members in the board of management.

A foreign direct investor; an individual, a group of related individuals, an incorporated or unincorporated entity, a public company or private company, a group of related enterprises, a government body, an estate (law), trust or other societal organization or any combination of these should have the control or enough stake in order to affect the firm plans in the future

A FDI should be done professionally and with an already defined process. The following figure shows how FDIs are done. The investments should be:

• Planned through a complete business plan including detailed information on the company’s scientific/technical platform, product/service pipeline, intellectual property, business model, financials and competitive situation
• If the proposed opportunity is promising, the due diligence is started. Before the due diligence, the valuation of the company should be competed by the expers.
• The investment is completed by signing the contracts.

While FDI is done in an economy the immediate role for governments are as follows:

• To reduce the risks faced by investors through the creation of simple, transparent and non-discriminatory regulatory regimes. Such regimes should be built on clear and transparent rules; not discriminate on grounds of nationality; and be supported by a fair commercial justice system. The regimes should be based on modern business laws so that investors know their rights and obligations
• To institute competition policies and laws to ensure that the potential benefits of higher investment are not undermined by monopoly power or other market inefficiencies
• To ensure that the benefits of investment are enjoyed by all, including the poor, through appropriate taxation regimes as well as labour, competition and consumer rights laws.

FDI Process

(Source: BioPacific Ventures, “The Investment Approach”,

http://www.biopacificventures.com/investmentprocess.aspx

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[1] Ezgi Aksu, “Policy For Investment In European Union And Its Politico-Economical Consequances On Turkish Eonomy”, Master Thesis, Bahçeşehir University SBE, 2007, p.4.

[2] Devrim Dumludağ, “Foreign Direct Investment In Developing Economies And Turkey; The Role Of Institutions”, Master Thesis, Boğaziçi University Atatürk İlkeleri ve İnkılapları Enstitüsü, 2007, p.17.

[3] OECD, “OECD Benchmark Definition of Foreign Direct Investment”,  http://www.oecd.org/dataoecd/10/16/2090148.pdf

[4] Imad A. Moosa, Foreign Direct Investment: Theory, Evidence and Practice, US, Palgrave Macmillan, 2002, p.2.