IM/U2 Topic 15 Direct Investment
Direct investment, more commonly referred to as foreign direct investment (FDI), refers to an investment in a foreign business enterprise designed to acquire a controlling interest in this enterprise. Direct investment provides capital funding in exchange for an equity interest without the purchase of regular shares of a company’s stock.
The purpose of foreign direct investment (FDI) is to gain an equity interest sufficient to provide control of a company. In some instances, it involves a company in one country opening its own business operations in another country, while in other cases it involves acquiring control of existing assets of a business already operating in the foreign country. A direct investment can involve gaining a majority interest in a company or a minority interest large enough to provide the investor with effective control of the company.
Direct investment is primarily distinguished from portfolio investment, the purchase of common or preferred stock shares of a foreign company, and by the element of control, that is sought.
Control can come from sources other than an investment of capital, though the control of such things as technology is merely critical inputs. In fact, foreign direct investment is frequently not a simple monetary transfer of ownership or controlling interest but also involves complementary factors, such as organizational and management systems or technology.
Foreign direct investments can be made by individuals but are more commonly made by companies wishing to establish a business presence in a foreign country.
Examples of Foreign Direct Investment
Foreign direct investment takes many forms in actual practice but is generally classified as either a vertical, horizontal, or conglomerate investment.
A vertical direct investment is one where the investor adds foreign activities to an existing business, such as in the case of an American auto manufacturer establishing dealerships or acquiring a parts supply business in a foreign country.
Horizontal direct investment is perhaps the most common form. In horizontal investments, a business already existing in one country merely establishes the same business operations in a foreign country, such as in the case of a fast food franchise based in the United States opening restaurant locations in China. Horizontal direct investment is also referred to as greenfield entry into a foreign market.
The conglomerate type of direct investment, the least common form, is where an existing company in one country adds an unrelated business operation in a foreign country. This is a particularly challenging form of direct investment since it requires simultaneously establishing a new business and establishing it in a foreign country. An example of conglomerate direct investment might be an insurance firm opening a resort park in a foreign country.