Does foreign direct investment affect host-country firms' financial constraints?

This paper finds foreign direct investment (FDI) significantly reduces the investment-cash flow sensitivity of United State firms. Using both an instrumental variable method and a quasinatural experimental setting, I identify a causal linkage from increased FDI to reduced investment-cash flow sensitivity. Further analysis indicates that the impact of FDI is because of the reduced liquidation value of physical assets that FDI causes. In turn, this reduced value restricts the borrowing capacity of domestic firms and their further capital investment. Increasing FDI also helps explain why the investment-cash flow sensitivity has declined over time. These findings together provide new evidence of the credit chain effect (Almeida and Campello, 2007) and the importance of FDI-induced financing difficulties on host-country firms' capital investments.