Do firms benefit from capital inflows?

In 2014, foreign investors invested more than one trillion U.S. dollars into emerging countries. Of those inflows, 90 billion U.S. dollars came in the form of equity financing. On aggregate, capital inflows may have helped developing countries invest and grow, even despite the associated volatility they might entail. But we still do not know how those inflows are transmitted within an economy once they arrive.

In a recently published World Bank working paper, Calomiris et al. (2018), we study those channels of transmission. In particular, we focus on the reaction of firms when foreign capital arrives. Ours is the first study, of which we are aware, that examines the links between capital inflows and investment using issuance-level data.

This is not an inconsequential question. Foreign capital might go into purchasing existing securities, such as outstanding shares, held by domestic residents. The domestic holders of that equity would benefit from the added demand for their assets, but the effects on the firms would be less obvious. Alternatively, foreign capital might also go into funding corporations that benefit from a reduced cost of capital.

In this new research, we argue that capital inflows tend to benefit a relatively small group of large firms that issue when capital enters a country. This is not driven by firms suddenly requesting more financing. Instead, firms seem to be responding to shocks to foreign investors that become more willing to invest domestically. These firms then use the newly raised capital to expand their operations. However, more research is needed to understand the possible channels of transmission to other, smaller firms that do not tap those foreign funds.