The recent economic challenges and failure of some countries that have experienced both increases in FDI and stock market activities have made scholars to raise issues with respect to the relation between FDI and stock market development. On one hand, there is the view that FDI tends to be larger in countries that are riskier, financially underdeveloped and institutionally weak, (Haussmann and Fernandez-Arias, 2000). Under this view, FDI is a substitute for stock market development-FDI takes place to overcome the difficulties of investing through capital market. According to this view, FDI should be negatively correlated with the development of stock market. In contract to this view, evidence from some countries showed that FDI flows into countries with good institutions and fundamentals and fuels the development of stock market through different channels.
This invariably implies that FDI and stock market may be complementary and not substitute; this was confirmed by the study of (Adam and Tweneboar in 2009) in a study of Foreign Direct Investment and Stock Market Development in Ghana. Also, the study on the role of Foreign Direct Investment and Stock Market Development in Pakistan by Ali Raza et.al in 2012 disclosed a positive impact of foreign direct investment along with other explanatory variables in developing stock markets of Pakistan. FDI can be positively related to the participation of firm in capital markets, since foreign investors might want to finance part of their investment with external capital or might want to recover their investment by selling equity in capital markets.
Also, given that foreign investors partly invest through purchasing existing equity, the liquidity of stock markets will likely rise, thus the value traded domestically and internationally might both increase depending on where these purchases take place. Apart from the aforementioned views, another view posits that FDI and stock market have no direct linkage with economic growth; rather they affect other growth determinants (saving, investment and consumption) of which their final effect depends substantial on the linkage between these intermediate variables and economic growth. In view of the foregoing, examining relationship between these variables and economic growth in Nigeria is imperative and compelling.
Theories of Foreign Direct Investment and Financial Sector Development
There are a number of factors which may explain a decision to invest in financial institutions abroad. This can generally be grouped as micro and macro factors as discussed below:
Virtually all existing theoretical paradigms focus on the comparison of benefits and costs of the investment decision. As with any kind of investment, the bank will face uncertainty about the expected profits of such decision, and even expected costs. On the cost side, Hymer and Zurawicki introduce the widely accepted notion that foreign banks face significant cost disadvantages when compared with local competition. These additional costs can arise as a consequence of cultural differences, legal barriers or increased control problems, just to cite a few examples. Therefore, in order to operate profitably in a foreign market, international banks must be able to realize gains that are unavailable to local competitors. These expected gains, to be realized when operating in a foreign financial sector, generally stem from (i) Competitive advantage factors, (ii) Efficiencies that cannot be attained operating exclusively in local markets; and (iii) Geographical risk diversification. payday loan online