When times are bad, governments tend to welcome foreign direct investment, but they worry that they are selling the family silver for cheap. This ‘fire-sale FDI’ phenomenon, as Krugman called it in the 1990s, is a perennial concern of nations whose currencies have recently plummeted.
While colourful anecdotes abound – Sony’s purchase of Columbia Pictures in the 1980s, Michael Jackson’s purchase of a ski resort from a bankrupt South Korean industrialist – hard evidence is scant. Nevertheless, the inflow of foreign direct investment under fire-sale conditions raises crucial policy questions that have been subject to abundant debate (see, e.g., Mody and Negishi 2001; Loungani and Razin 2001; Aguiar and Gopinath 2005; and Acharya, Shin, and Yorulmazer 2011).
The difficult of identifying fire sales
Establishing definitive evidence of fire sales during emerging-market crises has proven challenging for a very simple reason. Testing for a ‘fire sale’, i.e. under-pricing compared to normal conditions, requires knowledge of how asset prices and cross-border transactions would have evolved in the absence of the crisis. As we have data from only one reality, providing such a counterfactual would require a complete structural model to simulate it. This model would have to explain both the volume of transactions and the prices at which the transactions occur.
On the pricing side, predicting asset prices even under normal conditions is a challenge, let alone during periods of financial stress. On the quantity side, establishing whether a transaction is related to a fire sale is also problematic for at least two reasons:
- First, it is easy to confound the surge in foreign investment to emerging markets with the global wave of acquisitions observed during the same period.
- Second, the crisis coincided with, and in some cases was the precipitating factor for, the deregulation of the market for corporate control in many emerging markets.
By focusing on data leading up to and during the crisis, as most studies to date have done, it is all but impossible to disentangle the effect of the crisis from the effect of reducing barriers to foreign ownership.
To overcome these challenges, we examine a large panel of corporate transactions spanning the period between 1990 and 2007 in sixteen emerging-market economies (Alquist, Mukherjee, and Tesar 2013). The rich variety of transactions in the database – in terms of the countries where the acquiring firms came from and the industrial composition of both acquiring and target firms – permits us to compare crisis-time cross-border transactions with domestic transactions in emerging markets and with a large sample of non-crisis transactions. Since banking and currency crises occurred at different times and in some countries but not in others, we are able to conduct direct comparisons between acquisitions that occurred during crises and those that occurred during normal times. Our findings shed fresh light on whether the acquisition of firms undertaken during crisis periods differ in fundamental ways from those undertaken during more tranquil periods.
Drawing on the literature, we hypothesise that during financial crises, emerging markets experience tightening credit conditions, a rapid deterioration in macroeconomic aggregates, and, in some cases, a sudden depreciation in the nominal exchange rate. All of these factors may cause domestic firms to face financial difficulties and, in the worst situations, may force them to sell some or all of their assets at prices below their fundamental value. Since most other domestic firms are in a similar predicament, the likelihood increases that the buyers of those assets are foreign. Such fire-sale acquisitions are also more likely to be driven by short-run, speculative motives rather than by long-term investment plans. We further postulate that foreign acquisitions are more likely to occur in financially vulnerable sectors and that crisis-time acquisitions would be resold quickly when asset markets recover following crises. These hypotheses are then taken to the data.
The first question we ask is, what kinds of firms made acquisitions during crises? We find that foreign firms increased their acquisition activity during banking and currency crises, confirming the findings of Aguiar and Gopinath (2005). This tendency is more pronounced for foreign non-financial acquirers targeting firms in the same industry. This finding runs counter to the view that the increase in foreign acquisitions is primarily driven by foreign financial firms acquiring either other financial firms or non-financial firms.
Delving a bit more deeply into this issue, we examine whether ‘external financial dependence’ of an industry meant that it would be the target of foreign acquirers during crises. It is well known that different industries rely to different degrees on banks or other intermediaries to finance their day-to-day activities (see Rajan and Zingales 1998). If such finance is harder to come by during crises, then we expect to observe more acquisitions by foreign firms in industries that rely more on external finance. However, the results from our analysis indicate that even though external finance-dependent sectors are more likely to be the target of foreign direct investment in general, this characteristic is unrelated to the occurrence of banking and currency crises in the target country.
Related to these patterns, some authors such as Acharya, Shin, and Yorulmazer (2011) have argued that foreign companies buy more of a target firm during crises because prices are lower and acquiring control circumvents informational asymmetries and corporate-governance issues. We find no evidence that controlling stakes (half or more of a firm) are acquired more often during crises or that these controlling stakes are larger.
Another observable implication of speculative behaviour is that the ‘marriage’ between the acquiring firm and its target is shorter if the transaction is concluded during the turbulence of crisis episodes, that is, targets acquired under fire-sale conditions should be sold off more quickly, or ‘flipped’, than targets acquired under normal conditions. Again, there is little evidence that crisis-time foreign acquisitions are flipped at faster rates than crisis-time domestic acquisitions. Mirroring our earlier findings, we also find that the degree of external finance dependence bears no significant relationship with the rate at which crisis-time acquisitions are flipped by foreign companies.
The last hypothesis that we test is whether foreign firms sell their crisis-time acquisitions back to domestic firms when the crisis abates. This would have important policy implications, as it could suggest that foreign investors reaped short-term capital gains from the crisis by buying low and selling high, but had no interest in making long-term investments in the country undergoing the crisis. The evidence we find is inconsistent with the flipping of crisis-time asset purchases by foreigners back to domestic owners after the crisis.
Overall, we do not find systematic evidence for several testable implications of the fire-sale foreign direct investment hypothesis. Our analysis reveals that acquisitions undertaken during crisis periods do not fundamentally differ from those undertaken during non-crisis periods.
Contrary to the conventional wisdom, fire-sale foreign direct investment and flipping of assets seem to be ‘business as usual’ rather than characteristic features of foreign direct investment undertaken during financial crises in emerging-market economies. In short, the fire-sale foreign direct investment notion may be, as they say, ‘all smoke, and no fire’.
Acharya, V, H Shin, and T Yorulmazer (2011), “Fire-sale FDI”, The Korean Economic Review, 27(2),163–202.
Aguiar, M and G Gopinath (2005), “Fire-sale foreign direct investment and liquidity crises”, Review of Economics and Statistics, 87(3), 439–452.
Alquist, R, R Mukherjee, and L. Tesar, "Fire-sale FDI or Business as Usual?" NBER working paper 18837. February.
Krugman, P (2000), “Fire-Sale FDI”, in S Edwards (ed.) Capital Flows and the Emerging Economies: Theory, Evidence, and Controversies, University of Chicago Press, 43–59.
Loungani, P and A Razin (2001), “How beneficial is foreign direct investment for developing countries?”, Finance and Development, 38(2).
Mody, A and S Negishi (2001), “Cross-border mergers and acquisitions in east Asia: Trends and implications”, Finance and Development, 38(1).
Rajan, R and L Zingales (1998), “Financial dependence and growth”, The American Economic Review, 88(3), 559-86.