Which type of investment involves the acquisition of foreign assets for the purpose of controlling them?
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An international business investment Show
What is Foreign Direct Investment (FDI)?Foreign direct investment (FDI) is an investment from a party in one country into a business or corporation in another country with the intention of establishing a lasting interest. Lasting interest differentiates FDI from foreign portfolio investments, where investors passively hold securities from a foreign country. A foreign direct investment can be made by obtaining a lasting interest or by expanding one’s business into a foreign country. Lasting Interest and the Element of ControlAn investment into a foreign firm is considered an FDI if it establishes a lasting interest. A lasting interest is established when an investor obtains at least 10% of the voting power in a firm. The key to foreign direct investment is the element of control. Control represents the intent to actively manage and influence a foreign firm’s operations. This is the major differentiating factor between FDI and a passive foreign portfolio investment. For this reason, a 10% stake in the foreign company’s voting stock is necessary to define FDI. However, there are cases where this criterion is not always applied. For example, it is possible to exert control over more widely traded firms despite owning a smaller percentage of voting stock. Methods of Foreign Direct InvestmentAs mentioned above, an investor can make a foreign direct investment by expanding their business in a foreign country. Amazon opening a new headquarters in Vancouver, Canada would be an example of this. Reinvesting profits from overseas operations, as well as intra-company loans to overseas subsidiaries, are also considered foreign direct investments. Finally, there are multiple methods for a domestic investor to acquire voting power in a foreign company. Below are some examples:
Learn more about mergers and acquisitions with CFI’s mergers & acquisitions (M&A) modeling course! Benefits of Foreign Direct InvestmentForeign direct investment offers advantages to both the investor and the foreign host country. These incentives encourage both parties to engage in and allow FDI. Below are some of the benefits for businesses:
The following are some of the benefits for the host country:
For businesses, most of these benefits are based on cost-cutting and lowering risk. For host countries, the benefits are mainly economic. Disadvantages of Foreign Direct InvestmentDespite many benefits, there are still two main disadvantages to FDI, such as:
The entry of large firms, such as Walmart, may displace local businesses. Walmart is often criticized for driving out local businesses that cannot compete with its lower prices. In the case of profit repatriation, the primary concern is that firms will not reinvest profits back into the host country. This leads to large capital outflows from the host country. As a result, many countries have regulations limiting foreign direct investment. Types and Examples of Foreign Direct InvestmentTypically, there are two main types of FDI: horizontal and vertical FDI. Horizontal: a business expands its domestic operations to a foreign country. In this case, the business conducts the same activities but in a foreign country. For example, McDonald’s opening restaurants in Japan would be considered horizontal FDI. Vertical: a business expands into a foreign country by moving to a different level of the supply chain. In other words, a firm conducts different activities abroad but these activities are still related to the main business. Using the same example, McDonald’s could purchase a large-scale farm in Canada to produce meat for their restaurants. However, two other forms of FDI have also been observed: conglomerate and platform FDI. Conglomerate: a business acquires an unrelated business in a foreign country. This is uncommon, as it requires overcoming two barriers to entry: entering a foreign country and entering a new industry or market. An example of this would be if Virgin Group, which is based in the United Kingdom, acquired a clothing line in France. Platform: a business expands into a foreign country but the output from the foreign operations is exported to a third country. This is also referred to as export-platform FDI. Platform FDI commonly happens in low-cost locations inside free-trade areas. For example, if Ford purchased manufacturing plants in Ireland with the primary purpose of exporting cars to other countries in the EU. Additional ResourcesThank you for reading CFI’s guide on Foreign Direct Investment. To keep learning and advancing your career, the following resources will be helpful:
What is acquisition in foreign direct investment?It generally takes the form of acquiring a stake in an existing enterprise in the foreign country or starting a subsidiary to expand the operation of an existing enterprise of that country. FDI can take two different forms: Greenfield or mergers and acquisitions (M&As).
What are the types of foreign investment?Types of Foreign Investments. Foreign Direct Investment (FDI). Foreign Portfolio Investment (FPI). Foreign Institutional Investment (FII). What are the 3 forms of foreign direct investment?Three components of FDI are usually identified: equity capital, reinvested earnings, and intracompany loans. Other than having an equity stake in an enterprise, foreign investors may acquire a substantial influence in many other ways.
What is an example of foreign direct investment?A large Australian mining company acquires a smaller Angolan one for diversification. All are examples of foreign direct investment where a business decision is made to somehow take a stake or interest in a company by an investor located outside its borders.
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