The economics of large-scale infrastructure FDI: The case of project finance

In this paper a theoretical framework is developed to explain why multinational enterprises invest in infrastructure through the mode of project finance (PF) instead of using corporate finance. Infrastructure assets are susceptible to creeping expropriation from host governments, and to hold-up from concentrated suppliers/buyers. Corporate finance-based foreign direct investment (FDI) cannot fully mitigate these threats. However, PF-based FDI through strategic use of capital structure – chiefly high leverage and syndicate structure of debt – improves the bargaining position of firms in ex post recontracting negotiations. High leverage precommits cash flows, serves as a monitoring and early warning mechanism that reveals creeping expropriation, induces lenders to join renegotiations and reduces reported net profits. The syndicate structure of debt creates a reputation effect for host countries. High debt shields wealth from concentrated suppliers/buyers while separate incorporation in PF allows suppliers/buyers to hold equity stakes. This theoretical framework is tested by assembling a database of 200 investments worth $159.97 billion, by 167 firms, in 128 countries over 17 years. Sample selection bias is controlled for through Heckman probit specification. The hypothesis that PF-based FDI helps mitigate hold-up from concentrated suppliers/buyers finds strong support, while the hypothesis that PF mitigates country risk finds limited support.