Host-country Risk Dynamics and Foreign Direct Investments

Abstract Country risk is an important determinant for foreign direct investment (FDI) decisions. Over the lifetime of an FDI project, country risk can change due to political, social, or economic events in a country. However, how changing country risk influences FDI decisions has not been fully investigated. Therefore, the goal of this study is to provide a theoretical conceptualization of how dynamic risk developments affect FDI. We follow a financial theoretical perspective and base our propositions on discounted cash-flow models. We propose that a positive trend in country risk, where country risk is expected to decrease over time, increases FDI probability. What is more, we propose that predictability of this trend positively moderates this effect, but that high amplitude and high frequency in risk changes reduce the positive effect of a positive trend on FDI. Finally, our theoretical model proposes that firms of different size can manage dynamic risk developments differently: large firms can better deal with high-amplitude changes, whereas small firms can better deal with high frequency changes in country risk. With this study, we want to contribute to a better understanding of how dynamic environments influence investment decisions and introduce a long-term perspective of country risk.