Examining the role of institutional quality
Global markets integration means that policy uncertainty in a national economy can have major ramifications across the world at a macroeconomic level. However, the empirical literature on the microeconomic channels that underlie macro relationships have been less studied. How do global firms reallocate assets across geographies in uncertain times? Are countries always negatively affected by foreign uncertainty, or are there instances where they might gain from it? Does institutional quality play a role in the intensity of policy spillovers?
This paper builds on the theory that policy uncertainty in a region makes the business environment for a firm risky, leading to investment decisions that are sensitive to geography. Data of mining firms suggests domestic economic policy uncertainty leads to relatively higher investment in foreign mines. And that the effect is greater when a firm’s country of domicile and that of its foreign establishment(s) are signatories to a bilateral investment treaty, thereby providing greater institutional quality for the firm’s operations.
Mining being a major source of income in many fragile economies, this research will help understand how policy uncertainty may actually positively impact business/economic activity in developing countries through reallocation of company assets. It will also help show whether institutional quality in developing countries will help attract those resources in times of uncertainty.
Arkodipta Sarkar is Assistant Professor of Finance, Hong Kong University of Science and Technology (HKUST), and former LBS PhD student in Finance. Arkodipta’s research focuses on empirical corporate finance, specifically the interactions between politics, policy and culture on financing and investment.