Defining Foreign Direct Investment

A foreign direct investment (FDI) is a purchase of an interest in a company by a company or an investor located outside its borders.

Generally, the term is used to describe a business decision to acquire a substantial stake in a foreign business or to buy it outright in order to expand its operations to a new region. It is not usually used to describe a stock investment in a foreign company.

Foreign direct investments (FDI) are substantial investments made by a company into a foreign concern.

The investment may involve acquiring a source of materials, expanding a company’s footprint, or developing a multinational presence.

Companies considering a foreign direct investment generally look only at companies in open economies that offer a skilled workforce and above-average growth prospects for the investor. Light government regulation also tends to be prized.

Foreign direct investment frequently goes beyond capital investment. It may include the provision of management, technology, and equipment as well.

A key feature of foreign direct investment is that it establishes effective control of the foreign business or at least substantial influence over its decision-making.

In 2020, foreign direct investment tanked globally due to the COVID-19 pandemic, according to the United Nations Conference on Trade and Development. The total $859 billion global investment compares with $1.5 trillion the previous year.

And, China dislodged the U.S. in 2020 as the top draw for total investment, attracting $163 billion compared to investment in the U.S. of $134 billion.

Foreign direct investments can be made in a variety of ways, including opening a subsidiary or associate company in a foreign country, acquiring a controlling interest in an existing foreign company, or by means of a merger or joint venture with a foreign company.

The threshold for a foreign direct investment that establishes a controlling interest, per guidelines established by the Organisation of Economic Co-operation and Development (OECD), is a minimum 10% ownership stake in a foreign-based company.

That definition is flexible. There are instances in which effective controlling interest in a firm can be established by acquiring less than 10% of the company’s voting shares.

Foreign direct investments are commonly categorized as horizontal, vertical, or conglomerate.

With a horizontal direct investment, a company establishes the same type of business operation in a foreign country as it operates in its home country. A U.S.-based cell phone provider buying a chain of phone stores in China is an example.

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