Political Risk, Democratic Institutions, and Foreign Direct Investment

There is a renewed interest in how political risk affects multinational corporations operating in emerging markets. Much of this research has focused on the relationship between democratic institutions and flows of foreign direct investment (FDI). Yet the existing studies suffer from data problems that only allow for indirect evidence of the relationship between political institutions and political risk. In this paper I utilize price data from political risk insurance agencies to directly test how domestic political institutions affect the premiums multinationals pay for coverage against government expropriations and contract disputes. I find that democratic regimes reduce risks for multinational investors, specifically through increasing constraints on the executive. Utilizing qualitative evidence from investors, insurers, and location consultants, I explore the mechanisms linking democratic regimes with lower levels of political risk.

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