DO INTERNATIONAL INVESTMENT AGREEMENTS PROTECT INVESTMENT ... · DO INTERNATIONAL INVESTMENT...

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DO INTERNATIONAL INVESTMENT AGREEMENTS PROTECT INVESTMENT? Petroleum Evidence Srividya Jandhyala* [email protected] Robert Weiner* [email protected] International Business Department George Washington University 2201 G Street NW, Funger Hall 401 Washington, DC 20052 26 August 2012 Abstract: Do international institutions institutions that transcend country bordersreduce MNEspolitical risk? We examine whether the presence of International Investment Agreements (IIAs), negotiated among countries for increased foreign investor protection, lowers political risk for MNEs. We argue that IIAs limit the ability of host governments to make discriminatory policy changes that adversely affect the value of firms’ investments. However, the need for IIA protection, and the ability to benefit from it, vary with firm characteristics, specifically financial resources and ownership. Using detailed transaction-level data for sale of petroleum reserves in 45 countries, we find that MNEs pay significantly higher amounts for assets protected by IIAs than similar unprotected assets, an effect moderated by the firm’s financial resources and state ownership. *We are grateful to JS Herold for data access, and the George Washington University CIBER for research support. We would also like to thank Heather Berry, Witold Henisz, Steve Kobrin, Noel Maurer, Jordan Siegel, Jennifer Spencer, and the seminar/conference participants at the Indian School of Business, The Fletcher School, Atlanta Competitive Advantage Conference, Academy of International Business, Academy of Management and the International Political Economy Society Annual Conferences for comments on earlier drafts of this paper. Paper contents are our sole responsibility.

Transcript of DO INTERNATIONAL INVESTMENT AGREEMENTS PROTECT INVESTMENT ... · DO INTERNATIONAL INVESTMENT...

DO INTERNATIONAL INVESTMENT AGREEMENTS PROTECT INVESTMENT? Petroleum Evidence

Srividya Jandhyala* [email protected]

Robert Weiner* [email protected]

International Business Department George Washington University

2201 G Street NW, Funger Hall 401 Washington, DC 20052

26 August 2012

Abstract:

Do international institutions – institutions that transcend country borders– reduce MNEs’ political risk?

We examine whether the presence of International Investment Agreements (IIAs), negotiated among

countries for increased foreign investor protection, lowers political risk for MNEs. We argue that IIAs

limit the ability of host governments to make discriminatory policy changes that adversely affect the

value of firms’ investments. However, the need for IIA protection, and the ability to benefit from it, vary

with firm characteristics, specifically financial resources and ownership. Using detailed transaction-level

data for sale of petroleum reserves in 45 countries, we find that MNEs pay significantly higher amounts

for assets protected by IIAs than similar unprotected assets, an effect moderated by the firm’s financial

resources and state ownership.

*We are grateful to JS Herold for data access, and the George Washington University CIBER for research support.

We would also like to thank Heather Berry, Witold Henisz, Steve Kobrin, Noel Maurer, Jordan Siegel, Jennifer

Spencer, and the seminar/conference participants at the Indian School of Business, The Fletcher School, Atlanta

Competitive Advantage Conference, Academy of International Business, Academy of Management and the

International Political Economy Society Annual Conferences for comments on earlier drafts of this paper. Paper

contents are our sole responsibility.

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Introduction

In April 2012 Argentina nationalized YPF, the local subsidiary of Spanish oil company Repsol, despite the

fact that Spain and Argentina have an International Investment Agreement (IIA), designed to protect

each country’s investment in the other. This paper examines IIAs empirically, asking whether MNEs act

as if they protect foreign investment. Such agreements are potentially especially important in natural

resources, because many resource-rich countries domestic institutions do not protect property rights.

Petroleum is of particular interest, as one of the largest industries for international trade and

investment (Weiner, 2005). Historically, MNEs have accounted for the vast majority of investment in

exploration, refining, and distribution. The industry is also especially vulnerable to property rights

violations. Foreign firms make large, upfront investments for licenses, resources, and transportation and

refining infrastructure. The upfront investments make them particularly vulnerable to the classical

“obsolescing bargaining” problem (Vernon, 1980). Once an investment is sunk, bargaining power shifts

from the foreign investor to the host country and the interests of the two parties diverge. When the

initial advantages of the MNEs erode, host country governments seek to renegotiate their initial

concession agreement to appropriate greater returns from the bargain (Vernon, 1971).

Natural resources are also particularly vulnerable as many countries viewed foreign control as

compromising their sovereignty (UNCTAD, 2004). The peak period of nationalization was the 1970s:

there was growing dissatisfaction with oil concessions signed prior to World War II, viewed as heavily

favoring the investors (Stevens, 2008). As in other industries, the outright nationalization of petroleum

FDI of the 1970s (Kobrin, 1987; Minor, 1994; Dunning, 1998) has largely been replaced by redistributive

policies, wherein countries have unilaterally shifted taxation and contract terms in their favor (Wint,

2005; Henisz & Zelner, 2010). Redistributive policies are often perceived as ‘creeping expropriation’ by

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foreign investors, whereas host-country governments and their constituents perceive them to be

legitimate public policy choices by a sovereign actor.

The oil-price boom of the last decade has seen increased concern over both outright and creeping

expropriation, o which the 2012 YPF nationalization is but one example. For example, in the year 2000,

ground was broken for the Chad-Cameroon oil pipeline – a collaborative endeavor involving three

multinational oil corporations (Exxon/Mobil, Petronas Malaysia, and Chevron), the governments of the

two countries as well as the World Bank. Once oil began to flow through the pipeline, the Chad

government unilaterally declared its intention to renegotiate the agreement by creating a national oil

company and expelling Chevron & Petronas (Gould & Winters, 2007; Click & Weiner, 2010).

In a similar vein, in 2006, Bolivia nationalized its oil and gas industry, while Ecuador used its troops to

take over Occidental Petroleum’s holdings and turn them over to state-owned Petroecuador (Click &

Weiner, 2010). Using forced contract renegotiations, Russia turned over BP and Shell’s petroleum

operations to local state owned companies (Economist, 2007). Venezuela mandated the sale of foreign-

owned assets, eventually leading Exxon and ConocoPhillips to exit the country.

Thus, property-rights protection is a central issue in the petroleum industry. Facing expropriation or

renegotiation, foreign investors could attempt to use the host country institutional system to protect

their assets. However, domestic institutions may be biased against foreign investors, or be viewed as

corrupt and inefficient. IIAs, however, may provide alternate mechanisms by which investors can protect

their assets or seek appropriate compensation in the event of adverse state action.

Host- and home-country institutions have long been shown to influence the strategic behavior of

multinational enterprises (MNEs) (Hoskisson et al, 2000; Garcia-Canal & Guillen, 2008; Meyer et al,

2009; Holburn & Zelner, 2010). Of particular importance are institutions that shape property rights,

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because they influence political risk and resource allocation in foreign investment (Kobrin, 1976; Murtha

& Lenway, 1994; North, 1990; Henisz & Delios, 2001; Loree & Guisinger, 1995).

By focusing on domestic institutions of home and host countries, the literature has largely ignored the

proliferation of international institutions – institutions that themselves transcend national borders –

governing foreign direct investment (FDI). International institutions are part of a broader, evolving

global environment; an additional level of analysis beyond the individual-country level. This

environment presents new challenges for global strategy (Ricart et al, 2004; Westney, 2011).

In this paper, we examine the effects of international institutions on foreign investment, focusing on

International Investment Agreements (IIAs). Since the mid-twentieth century, governments have signed

nearly 3000 IIAs, either bilaterally or multilaterally (UNCTAD, 2010). IIAs are aimed at altering the rules

governing FDI by providing extensive rights and protection for MNEs, while restricting host

governments’ actions (Neumayer & Spess, 2005; Buthe & Milner, 2009), and providing alternatives to

domestic courts to settle disputes (UNCTAD, 2004). However, some authors are skeptical of the

enhanced property-rights protection claimed for IIAs, arguing that they may be redundant (Yackee,

2009) or ineffective, because of the difficulty in enforcing claims against sovereign states (Rose-

Ackerman, 2009).

Our understanding of IIAs’ influence on investment, primarily drawn from literature in political science,

economics, and law, is limited. Empirical work is limited to aggregate country-level data. Recent studies

examining changes in FDI flows in response to IIAs cannot capture influence of IIAs on firm-level

decisions (Salacuse & Sullivan, 2005; Kerner, 2009; Hallward-Driemeyer, 2003, 2009; Tobin & Rose-

Ackerman, 2003). Moreover, these studies yield mixed empirical results, which could be due to country-

level aggregation, or because the benefits of IIAs apply only under specific circumstances. The

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effectiveness of IIAs as an institutional solution to political hazards faced by MNEs thus remains an open

question.

In contrast to the aggregate approach followed in the literature, we examine transaction-level

investment data in a single salient industry – petroleum. This is not only the single largest industry for

international trade and FDI (Weiner, 2005), but also one with large upfront capital costs and high

political salience making it especially prone to political risk (Kobrin, 1987). Drawing on the recent

strategy literature on firms’ varying abilities to operate under a given institutional environment (see, for

example, Capron & Guillen, 2009; Macher et al, 2011), we develop theory that suggests that the need

for IIA protection, as well as MNEs’ ability to benefit from such protection, should vary systematically

with firm characteristics. We explore two dimensions that theory suggests may be important, and for

which we have firm-level evidence –financial resources and ownership.

Our study makes three contributions to the strategy literature. First, we introduce and highlight the role

of international institutions in multinational investment, in contrast to the prior focus on domestic

institutions of home and host countries. Work on international institutions has focused narrowly on

corruption regulations (Cuervo-Cazurra, 2008; Jeong & Weiner, 2012) or coercive pressure of

multilateral agencies (Henisz, Zelner & Guillen, 2005). We broaden the discussion by examining property

rights, responding to Westney’s (2011: 379) call to examine “the global environment beyond the focus

on industry competition and other MNCs that has long dominated strategy models.”

Second, we provide direct tests of the effectiveness of international institutions in ameliorating political

risk using an asset valuation model. Although political risk arising from weak institutions’ inability to

limit the policy discretion of the host government has long been argued to be an important factor

limiting firms’ international expansion (Vernon, 1971; Kobrin, 1976; Boddewyn, 1988; Tallman, 1988;

Ring, Lenway & Govekar, 1990; Henisz, 2000a), its influence has largely been inferred from indirect

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outcomes such as capital flow, location choice, and entry mode. We examine transaction values – the

amount paid by firms buying petroleum reserves that are routinely traded on world markets.

Transaction value should be a cleaner and more accurate reflection of political risk than ex post

accounting measures, such as income or return on assets.1 By examining prices paid by firms in reserve

acquisitions, we are able to provide a direct estimate of estimate the value, if any, of political risk

protection offered by IIAs.

Finally, our analysis also contributes to the growing literature on organizational capabilities for assessing

and managing non-market risks (see, for example, Henisz, 2000b; Capron & Guillen, 2009; Holburn &

Zelner, 2010; Garcia-Canal & Guillen, 2008). While prior studies have shown that firms differ in their

ability to operate effectively under a given domestic institutional arrangement, our work examines how

firm characteristics allow for differential benefits from international institutions.

Political risk and foreign investment

International expansion strategy is influenced not just by market conditions but also by political factors

(Kobrin et al, 1980). Firms typically undertake large upfront investments in licenses, resources, and

infrastructure, making them vulnerable to the classical “obsolescing bargaining” problem. Once an

investment is sunk, bargaining power shifts from the foreign investor to the host country and the

interests of the two parties diverge. When the initial advantages of the MNEs erode, host-country

governments seek to renegotiate initial agreements to appropriate greater returns from the bargain

(Vernon, 1971). Governments can alter the profitability of foreign investment through outright

expropriation, or by altering contracts, regulations, taxes, tariffs, entry and exit rules, pricing, etc

(Henisz, 2000a; Garcia-Canal & Guillen, 2008; Holburn & Zelner, 2010).

1 Accounting measures are not consistently reported (or not reported at all) at a country level (Tallman 1991; Healy

et al 2011), and may also reflect realizations (or the absence thereof) of political hazards.

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Since the 1970s, creeping expropriations –unilateral changes in taxation or other contract terms in favor

of the host government – have largely replaced outright expropriations (Wint, 2005; Henisz & Zelner,

2010). Regulated industries such as petroleum, telecommunications, electricity, water, and banking,

however, continue to be especially sensitive to such risks (Garcia-Canal & Guillen, 2008). For example,

the Chad government nationalized the Chad-Cameroon pipeline once oil began to flow through it and

expelled the multinational companies responsible for commissioning it (Gould & Winters, 2007; Click &

Weiner, 2010). Similarly, Russia turned over BP and Shell’s petroleum operations to local state owned

companies using forced contract negotiations (Economist, 2007).

In addressing the question of how firms can protect themselves against post-investment policy changes,

the strategic management literature has identified the importance of political constraints on the

policymaking process (Henisz & Delios, 2001). Prior work has emphasized the role of strong domestic

institutions, such as constraints on the executive branch by other branches of government, and

independence of the courts and judiciary (Henisz, 2000b; Knack & Keefer, 1995). However, domestic

institutions may be biased against foreign investors. IIAs provide an alternative, international

mechanism by which host governments are constrained, and firms can protect their assets against

adverse policy changes.

International Investment Agreements: Theory

We refer to international institutions as those rules or principles that are negotiated between the home

and host countries either bilaterally or multilaterally (Ramamurti, 2001). Such principles establish

institutions that define the “rules of the game” (North, 1990:3), but are not confined to the boundaries

of any one country. Rather, their implementation either requires coordination among the members or

the establishment of a multilateral body, while resting on the foundations of national laws and

regulations. Examples include inter-governmental organizations (IGOs), international standard setting

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organizations, and cross-border associations of various types. Some observers have argued that these

have transformed the international business environment such that firms and nations are no longer the

only relevant levels of analysis, and that research should consider a model of global environment

populated by international institutions (Ricart et al, 2004; Westney, 2011).

We focus on IIAs – international agreements that establish rules governing property rights protection for

FDI. Typical agreements have clauses on ‘fair and equitable’ treatment, including ‘national treatment’

and ‘most favored nation’ treatment of foreign investment in the host country. These clauses entitle

foreign firms to be treated in a fair manner and on par with domestic firms, as well as firms from other

similarly protected countries. IIAs may protect contractual rights, guarantee the right to transfer profits

in hard currency to the home country, and prohibit or restrict the use of performance requirements

(Elkins, Guzman & Simmons, 2006). They also impose restrictions on discriminatory expropriation, and

policy changes that are not for a public purpose. In all cases, the foreign investor is guaranteed prompt,

adequate, and just compensation in accordance with the due process of law (Hallward-Driemeier, 2003).

Finally, and perhaps most importantly, IIAs provide the MNEs the right to take the host government to

international arbitration (UNCTAD, 2004) as alternative to local courts. International arbitration typically

occurs through the International Center for Settlement of Investment Disputes (ICSID) or the UN

Commission on International Trade Law (UNCITRAL). In this way, IIAs are sometimes seen as a

commitment mechanism by which host country governments signal their attitude towards protecting

foreign firms’ property rights. Appendix A provides a brief historical account of IIA evolution.

The most prominent of the IIAs are Bilateral Investment Treaties (BITs), signed between pairs of

countries (henceforth, dyads), establishing reciprocal terms and conditions for FDI. Since the first BIT

signed between Pakistan and Germany in 1959, over 2700 additional treaties have been signed involving

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almost every country in the world (Figure 1).2 BITs are also the most common instruments used by

foreign firms to file claims against host countries, with about 80 percent of known treaty-based investor-

state dispute-settlement cases initiated using a BIT (UNCTAD, 2009).3

In contrast to most FDI, the petroleum sector also has a multilateral treaty – Energy Charter Treaty (ECT)

– governing foreign investments. The ECT aims to create a level playing field for energy sector

investments, create a stable interface between the foreign investor and the host government, and

reduce the non-commercial risks of such investments to a minimum. Although it was initiated as an

effort to help secure Eastern European energy supplies for Western Europe (Konoplyanik & Walde,

2006), its membership in 2010 had grown to fifty-one states including non-European countries such as

Japan, Australia, and Mongolia.

ECT FDI-protection provisions are similar to modern BITs including clauses for investor-state dispute

settlement through international arbitration (Konoplyanik & Walde, 2006). Unlike BITs (where at least

one party in each dyad is almost always a developing country), the ECT also protects investments from

one industrialized country into another. This is potentially important, as firms have experienced adverse

changes in regulation even in countries where domestic policy constraints are relatively high. Examples

include the UK and Israeli governments changing tax rates on oil production (Manzano & Monaldi, 2008,

Levinson & Chazan, 2010), or oil-exporting provinces of Canada and the US raising royalties after

investment has been sunk.

Hypotheses

We hypothesize that IIAs, where present, allow MNEs to better manage political risk through three types

of assurances, thereby influencing the firm’s assessment of asset value.

2 As of 2008 about 13% of all home-host dyads had a BIT protecting foreign investment (UNCTAD, 2009)

3 Some cases are private; neither their filing nor resolution is public information.

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First, IIAs take effort to negotiate; successfully agreeing and signing an IIA can help build trust between

nations, reducing the likelihood of actions by host governments against MNEs based in signatory

countries (Rangan and Sengul, 2009), even when actions may lie outside the formal scope of the IIA.

Second, IIAs specifically outline the restrictions on host government’s actions towards property-rights

protection. Clearly specifying these rules may itself provide foreign investors with greater bargaining

leverage in negotiations with host country governments. For example, in mid-2010, UK-based Cairn

Energy agreed to sell its majority stake in an oilfield in Rajasthan, India, to Vedanta Resources, an Indian

company. The sale was stalled due to a dispute over oil royalties which were being paid in full by Cairn’s

equity partner – state-owned ONGC (Oil and Natural Gas Corporation) (Financial Times, 2011). Although

ONGC wanted the tax liability to be changed as a condition for state approval of the sale, Cairn disputed

the imposition of the extra financial burden. The presence of a UK-India BIT provided Cairn with an

additional negotiating tool. The Indian Ministry of External Affairs recognized that attempts to impose a

settlement in the dispute between Cairn and state-run ONGC would be considered as a denial of “fair

and equitable treatment” under the treaty, exposing the country to potential arbitration claims

(Economic Times, 2011).

Finally, IIAs allow foreign firms to seek international arbitration. If the MNE believes that a host

government has unfairly expropriated its assets, the firm can initiate international arbitration

proceedings at a neutral body such as ICSID without approval or support of home governments. Host

countries cannot prevent such proceedings from going forward; this is also an expansion of investor

rights. Unlike domestic courts, host governments have little control over the process or final decision of

the international arbitration tribunal (Elkins, Guzman & Simmons, 2006). Decisions have limited avenues

for appeal and cannot be amended by the domestic court system or legislation.

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By raising the host governments’ costs of expropriation or other policy changes that redistribute returns

from foreign investment, IIAs may act as an institutional mechanism by which firms can protect foreign

assets. These guarantees may provide a more favorable institutional context for foreign investment – it

provides greater certainty about the future treatment of assets by the state (Henisz, 2000a), reduces

transaction, search, and production costs (Akerlof, 1970; Khanna & Rivkin, 2001), and allows firms to

better specify property rights, monitor and enforce contracts, and appropriate higher returns from their

foreign assets (Levy & Spiller, 1994; Oxley, 1999).

Since assets protected by an IIA face reduced risks and a potentially higher rate of return, investors

should value those assets higher than similar but unprotected ones. Thus,

Hypothesis 1: Transaction value of foreign assets will be higher in the presence of an International

Investment Agreement.

Firm-level factors

Firms differ in their ability to operate effectively under a given institutional arrangement. Scholars have

described how a firm’s experience with a particular activity (see, for example, Capron & Guillen, 2009;

Xia, Baol & Delios, 2009; Henisz & Delios, 2001) or ownership structure (Garcia-Canal & Guillen, 2008)

moderates the influence of national level institutions. We extend this analysis to examine whether firm

characteristics also moderate the effect of international institutions.

Financial Resources: Strategy scholars have long debated the strategic advantages and disadvantages of

large firm size (see, for example, Gale 1972; Woo & Cooper, 1981; Chen & Hambrick, 1995). A central

tenant in this stream of work is that firm size is a proxy for resources available (Schuler & Rehbein, 1996)

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which in turn influence its capabilities, economic power, and strategic choices (Dean, Brown & Bamford,

1998).

In the upstream petroleum industry, reserves – underground discovered and commercially recoverable

quantities of oil and gas – are a key measure of financial resources. Reserves are a firm’s inventory of

future production, and hence closely related to firm valuation (Arnott, 2004; Osmunden, 2010). Bank

loans are also collateralized against reserves (Muñoz, 2009). Academic studies have established

significant relationships between petroleum firms’ borrowing capacity and their reserves (Chung, Ghicas

& Pastena, 1993), and between reserves and firm value (Misund et al, 2005).

Thus, we propose that firms with large petroleum reserves – which we categorize as firms with greater

financial resources – behave differently than those with fewer resources in examining the effectiveness

of IIAs. In particular, limited resources provide substantial disadvantages in effectively utilizing IIAs. An

IIA is effective only when an MNE’s ability and willingness to impose reputational and financial costs on

the host government in case of unfair treatment remains credible. A financially resource-constrained

firm may be less willing or able to undertake the costs involved in utilizing IIAs, for two reasons.

First, international arbitration is an expensive process and requires specialized intermediaries. UNCTAD,

(2009) estimated claimants’ arbitration costs and legal fees at $5-12 million (equal to 5-10% of our

median sample investment of $114 million); in comparison, the median equity-market value of publicly-

traded firms on the Toronto Stock Exchange (the exchange with the largest number of petroleum

listings) is about $19 million (as of 2nd quarter, 2012). Further, the burden of selection of arbitrators

itself falls on the parties to the arbitration, and in some cases, so does the choice of arbitration rules and

venue for arbitration. We argue that firms with larger reserves should be better able to absorb financial

costs associated with the use of IIAs and also have better access to specialized intermediaries, and thus

should be able to take better advantage of IIAs.

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Second, enforcement of arbitral awards by winning firms may also depend on their resources. In the

absence of supranational law enforcement, the jurisprudence and enforceability of awards is

questionable (Yackee, 2008). In the event that a host government does not pay, firms must rely on their

home governments for assistance, which can include diplomatic, political, or economic pressure, or

other forms of peaceful dispute settlement. Empirical studies have shown that ability to influence the

home government varies with firm size and financial resources (Macher et al, 2011; Chong & Gradstein,

2010). Greater resources allow the firm to become politically engaged (Schuler & Rehbein, 1997).

Thus if IIAs are effective, the positive effect on valuation of foreign assets will be higher for firms with

greater financial resources.

Hypothesis 2: Firm financial resources moderate the relationship between International Investment

Agreements and the transaction value of foreign assets, such that the relationship is stronger for firms

with greater resources.

Ownership: When a government owns a stake in a firm, the firm is less likely to need IIAs in protecting

its resources abroad. Rather, state ownership gives the firm a more tolerant risk attitude (Garcia-Canal

& Guillen, 2008; Megginson & Netter, 2001) and greater access to diplomatic mechanisms of dispute

resolution. Further, the home government may also put additional pressure on the host to resolve the

dispute by linking various issues in the state’s foreign policy to the dispute on hand. While it does not

preclude the use of international arbitration, this option gives state-owned firms a potentially less

expensive and more effective mechanism of dispute resolution. Non-state owned firms are less likely to

utilize this alternative mechanism and will thus value the protection offered by IIAs to a greater extent.

Thus, we propose that

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Hypothesis 3: State ownership moderates the relationship between International Investment

Agreements and the transaction value of foreign assets, such that the relationship is stronger for non-

state owned firms.

Empirical analysis

We test our hypotheses using worldwide transactions for petroleum reserves. As noted above, reserves

are simply inventory to be produced in the future; they are thus more homogenous and hence

comparable across firms than assets such as banks or organizational divisions. In addition, commonly

used metrics account for cost variations that affect reserve value, and widely quoted petroleum prices

serve to establish discounted-cash flows, allowing ready valuation of each asset. Finally, unlike most

other assets, petroleum reserves are actively traded in a global market, allowing us to exploit a database

of reserve-transaction announcements that include reported prices and reserve size.

Because reserves are central to firm valuation and borrowing capacity (Arnott, 2004; Muñoz, 2009),

considerable care is taken in the industry to determine reserve size. Specialist firms with expertise in

engineering and geology are used to audit reserves. Reserves are reported accordance with accounting

standards set out by inter alia, the US Securities and Exchange Commission, Canadian Securities

Administrators, State Commission for Reserves of the Russian Federation, Norwegian Petroleum

Directorate, and Society of Petroleum Engineers.

The exact size of each reserve, however, is unobservable; instead the industry employs probabilistic

definitions. Reserves are typically characterized as ‘proved’ (1P) or ‘proved + probable’ (2P). Proved

reserves refer to the quantity of oil and gas in the ground that is economically extractable at current

prices and costs with 90 percent probability. Probable reserves are similarly defined, but with 50 percent

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probability. All else equal, 1P transactions are more valuable; and we control for which figure is reported

in each transaction.

We use publicly-announced-transaction data collected and maintained by the US firm John S. Herold

Incorporated (JSH) for the period 2000-2007.4 During this time period, there were 2176 reserve deals of

at least $10 million, our threshold for analysis. We consider only transactions in which all reserves were

located in a single host-country, and the buyer (or buyer consortium) came from a single home-country

– resulting in 1954 transactions. After dropping deals with missing values, we retain 1592 observations.

Approximately three-fourths of these transaction are of assets located in the US or Canada. This

distribution is in part due to national regulations (some of the largest oil-producing countries like Saudi

Arabia, Kuwait, Iraq, Iran, and Mexico are not represented in the data because reserve ownership is a

state monopoly), and in part due to geology. Outside the US and Canada, much of the worldwide oil

reserves are offshore, where substantial scale economies result in large transaction sizes and fewer

transactions. With the exception of parts of the Gulf of Mexico, Alaska, California, and Newfoundland,

offshore drilling is prohibited in North America; and most transactions are for onshore reserves, which

can be economic on a smaller scale.5 In order to avoid our results being dominated by North American

transactions, we exclude them from our statistical analysis.

Our final sample consists of 409 observations. Table 1 shows the distribution of transactions by host

country (country wherein reserves are located) in the sample.

We follow the asset pricing model developed by Click & Weiner (2010), and model the value of a

petroleum reserve as

(1)

4 We are grateful to JSH (now a part of IHS Inc.) for permission to use the data.

5 Median deal size in North America is roughly $77 million, vs. $114 million outside North America.

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Where refers to the reserve value, R is the size of the reserve, and and are respectively

expected petroleum prices and costs over the life of the reserve. Costs are often estimated as

proportional to prices, both because the main component of cost is output taxes and royalties, and

because production costs tend to rise with prices.6 Thus, our specification for conventional reserves

transforms to

(2)

Rewriting in logarithmic form, and introducing international agreements, political risk, and other control

variables, we arrive at the equation that we estimate:

(3)

Dependent variable: Our dependent variable is the value of petroleum reserves in the ground on a per

barrel basis for each transaction. Following industry practice, we aggregate reserves of crude oil and

natural gas based on thermal energy equivalence – the energy in 1 barrel of oil is on average equal to

the energy in 6000 cubic feet of gas (Berry, Hasan & O’Bryan, 1998). Thus our dependent variable is

measured in equivalent barrels of oil.

Using the value per barrel of oil at the transaction level, rather than aggregate FDI flows as the

dependent variable allows us to mitigate potential endogeneity issues in estimation. Some authors have

argued that increased FDI flows in a host country may cause an IIA to be signed with the home country

as investors seek additional protection for their investment (Swenson, 2009; Aisbett, 2009; Kerner,

6 Petroleum production is heavily taxed worldwide, through a variety of fiscal structures. While complex and non-

linear in output, they are effectively linear in prices (Van Benthem and Stroebel 2010), motivating (2).

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2009). The possibility that IIAs are an effect, rather than a cause of FDI decisions, is unlikely to arise

here, as it would require that country level decisions regarding IIA partners are driven by transaction

values. The two-stage Heckman procedure described in the robustness tests supports this view.

Independent variables: Our independent variable of primary interest is the presence of an International

Investment Agreement (IIA). For every transaction, we create a dummy, IIA, coded 1 if the transaction is

protected by an international investment agreement, and 0 otherwise. Roughly 31 percent of our

sample transactions are covered by IIAs. We code the variable IIA to be 1 if the home and host countries

of a transaction either have a BIT (87%) or are signatories to the ECT (13%).

Our second variable of interest is a firm’s financial resources. As discussed above, we proxy for financial

resources using the size of a firm’s worldwide petroleum reserves. We use JSH’s classification of a firm’s

reserves as large, medium, or small, and create a dummy variable, Financial Resources, that is equal to 1

for firms with large reserves and zero otherwise.

The third variable in our analysis captures whether a firm undertaking FDI is state-owned. The dummy

variable Foreign State Ownership is coded 1 for foreign government ownership.

Control variables: We also include a number of control variables, broadly classified under three

categories – host country, transaction, and reserve.

Host country controls: We first control for the host country’s political risk. Political risk has been shown

to impact asset values (Click & Weiner, 2010); the greater the political risk in the host country, the lower

is the reserve value. Thus, we control for the extent of host country political risk using the political

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constraints (Polcon) measure (Henisz, 2000b).7 We also include a set of host country dummies to

capture other factors that vary by country and may impact the asset value (e.g: royalty and tax rates,

other cost factors, geographic distance, infrastructure quality).

Transaction level controls: We introduce a set of four controls at the transaction level. We differentiate

between asset purchases by domestic and foreign investors. Domestic investors may have access to

superior local information or different risk perceptions when compared to their foreign rivals which may

influence their assessment of asset value. To control for this, we include an indicator variable, coded 1

for all transactions in which the home country of the buyer is different from the host country where the

reserves are located, and 0 otherwise.

We control for whether the transaction involved a Merger or Acquisition (M&A), or a pure asset sale.

M&A entails purchase of an entire firm with all its assets and liabilities, or a fraction of the target firm’s

equity. Asset sales refer to specific reserve assets, and entail no claim on the seller’s equity8. Asset sales

are typically smaller in size and value than mergers and acquisitions; the sign of their effect on value per

barrel of oil is unclear.

Since the value of the petroleum in the ground should depend on its expected market price once

extracted, we follow Click & Weiner (2010) and include the expected future price of petroleum,

measured by futures strip prices (the average of futures prices of the nearest 36 months ahead) for

crude oil and natural gas on the New York Mercantile Exchange (NYMEX).

We consider the source of the transaction announcement (buyer or seller). Although reserves are

typically assessed by outside consultants, buyers may be systematically more optimistic in interpreting

reserve data and advice than sellers, and thus report larger reserves (Click & Weiner 2010). Thus, we

7 Our results are robust to using the alternate International Country Risk Guide (ICRG) measure of risk

8 Asset sales account for approximately 69% of all reserve transactions in our data

18

include a dummy variable that takes the value 1 for those transactions in which data are reported by the

buyer; we expect the coefficient to be negative.

Oil and reserve level controls: We include a series of controls for the quality of oil and the type of

reserve. These variables are expected to capture the physical characteristics of the reserve.

Since some transactions report proved (1P), while others report proved + probable (2P) reserve

volumes, we include an indicator for reserve-reporting type (Proved + Probable dummy). Reserves

estimated with lower probability are less valuable; and we expect this dummy variable to have a

negative coefficient.

Next, we include two variables to control for the quality of oil. First, we include a dummy variable for

heavy crude (Heavy Oil) because it fetches less in world markets than other types of oil; thus we expect

the coefficient of this dummy to be negative. Second, we construct a variable that represents the

percentage of natural gas in each reserve9. If oil and gas are identically priced based on their energy

equivalence, we would expect the coefficient of this term to be equal to 0.

Finally, we control for differences in extraction costs and technology employed to recover and process

the petroleum using a series of dummy variables. Excluding the onshore conventional process, we

include dummy variables for each of the following categories: coalbed methane, liquefied natural gas

(LNG), offshore shallow water, offshore deep water, frontier, and enhanced recovery production, and

diversified. Except for the last category, each of the other categories is costlier than conventional

extraction. Diversified refers to reserves with diverse characteristics; its effect on reserve value is

unclear.

9 Although our dependent variable is measured in equivalent barrels of oil, some authors have argued that the

ratio of the market values of oil and gas need not be equal to their energy ratios (Adelman & Watkins, 1995).

19

In addition to all the above controls, we finally include year dummies to account for any time specific

effects beyond oil price changes, as discussed above.

Results

We present the summary statistics for our sample and the correlations among the main variables in

Table 2. The mean value of petroleum in the ground (i.e., asset value) is exp(1.49) = $4.47/barrel of oil

equivalent and the mean market value is exp(3.77) = $43.69/barrel of oil equivalent.

Our main results using OLS models with robust standard errors are presented in Table 3. Model 1 of

Table3 includes all the control variables discussed above. Model 2 introduces the main IIA variable while

Models 3-5 show the interaction effects of IIA with Firm Resources and Foreign State Ownership.

Across the models, we observe that the host country political risk variables are not significant. We do

not interpret this as the lack of an effect of political risk; rather we contend that the effect of political

risk may be absorbed in the host country and year dummies. Turning to the transaction level controls,

we find that cross-border transactions are not valued higher than domestic ones while M&A

transactions are typically associated with higher value compared to pure asset sales. We also observe

that as the futures strip price of petroleum increases, the value of the petroleum reserve increases.

Consistent with our expectation, we find that the coefficient of the Proved + Probable dummy is

negative and significant. This suggests that investors value reserves estimated with a lower probability

to have a lower value. In addition, we find that the coefficient on the dummy for information being

provided by the buyer to be negative and significant, suggesting a discounting of such information.

We next examine the control variables capturing the physical properties of the asset. Looking at the

variables capturing the quality of petroleum reserves – Heavy Oil and % gas of proved reserves – we find

20

that the coefficient of the first term is not significant, while that of the second is negative and

significant. In an all-gas transaction, value per barrel of oil equivalent is 0.6% lower than an otherwise

similar all-oil transaction. Finally, we examine the variation in extraction costs as compared to

conventional reserves, and find that although some of the dummies are not significant, those that are

have the expected sign.

In Model 2, we introduce our main independent variable of interest – the IIA dummy. We find the

coefficient of this dummy to be positive and significant. We interpret this coefficient to suggest that the

presence of an IIA increases investors’ valuation of a foreign petroleum asset by approximately 27%.

Thus, we find support for first hypothesis.

The next two models (Models 3-4) include the two interaction terms of IIA with Financial Resources and

Foreign State Ownership respectively. In interpreting these interaction effects, we follow Brambor, Clark

& Golder (2006) who argue that we cannot infer whether a variable has a meaningful conditional effect

on the dependent variable simply by looking at the magnitude and significance of the coefficient on the

interaction term alone. In order to examine conditional hypotheses (such as the interaction effects

presented here), we need to perform conditional tests that take into account the coefficients of the

main and interaction terms together, and calculate the relevant standard errors (in addition to the ones

reported in the traditional regression table). In other words, the effect of IIA on the dependent variable

depends on the value of the conditioning variables (firm characteristics).

In order to assess the interaction terms in our models, we calculate the marginal effects of IIA under (1)

large and small conditions of the firm’s financial resources, and (2) state-owned and non-state owned

conditions of the firm’s ownership. These effects are presented, along with their corresponding

standard errors, in Table 4. We find that firms with large and small financial resources differ significantly

– for firms with large financial resources, the presence of an IIA increases their willingness to pay for

21

foreign petroleum assets by 43%. For firms with small financial resources however, there is a small but

insignificant negative effect. In Figure 2a, we plot this interaction effect. We interpret this finding to

suggest that financial resources interact with international institutions, and thus provide support for

hypothesis 2.

Similarly, we find that firms with and without state ownership differ significantly. For firms without state

ownership, the presence of an IIA significantly increases mean value of foreign petroleum assets by 30%.

For firms with foreign state ownership, this effect is insignificant. In Figure 2b, we plot this interaction

effect. We interpret this finding to provide support for hypothesis 3. This pattern of results is also

observed in the full model where we include both interaction terms simultaneously.

Robustness checks

We undertake a series of robustness checks to assess both competing explanations for our results, and

the validity of our empirical approach. We address theoretical issues first; statistical considerations,

including potential endogeneity and selection bias, follow.

Theoretical issues:

Strategy researchers have argued that the extent of vertical integration could have an important effect

on a firm’s performance (see, for example, Rothaermel, Hitt & Jobe, 2006), and hence its financial

resources. In the petroleum industry firms with the largest resources tend to be vertically integrated.

Thus, our results on firms’ financial resources may instead be due to vertical integration .We consider

this possibility by examining the effect of vertical integration both theoretically and empirically.

Although correlated with financial resources, the theoretical relationship between vertical integration

and political risk (and hence the value of IIA protection) depends on the role played by integration in a

firm’s strategy. Transaction-cost economics (which views integration as moving the supply chain inside

22

the firm to substitute for poorly functioning intermediate markets) predicts that political risk will impact

horizontal FDI and vertical FDI differently. Aizenman and Marion (2004) show that when FDI is vertical,

host countries have more bargaining power in renegotiating post-entry terms with MNEs, because of

potential costly disruption to the supply chain. Under horizontal FDI (where the MNE undertakes similar

activities across countries), in contrast, MNEs have more leverage from their ability to shift production

to other countries. Thus, vertical FDI is more vulnerable to political hazards than horizontal FDI, and

should value IIAs more. Hence, the transaction-cost view predicts that vertical integration moderates

the relationship between IIAs and asset value, such that the relationship is stronger for vertical FDI.

An alternative view is that integration can add value by leveraging firms’ intangible assets across vertical

stages, rather than internalizing the supply chain. Ramondo et al’s (2012) finding that vertical

integration in US MNEs is not associated with higher intra-firm flow of goods is consistent with this view.

Moreover, active trading by intermediaries is prevalent in crude oil markets (but not in natural gas), on

which integrated firms often rely (Smith 2009; Weiner 2006). In this view, the relationship between IIAs

and asset value would not differ between horizontal and vertical FDI.

In Table 5, we report the regression results that include the dummy variable Integrated (=1 for vertically

integrated firms, 0 otherwise). Model 1 weakly supports the view that the effect of vertical integration is

similar to that of financial resources – i.e. vertically integrated firms value IIAs but their non-integrated

counterparts do not. However, adding the vertical integration terms to our baseline model does not

alter the effects of financial resources reported earlier, while the effect of vertical integration is no

longer significant (Model 2).

Empirical issues:

23

Our empirical specifications above assume take IIAs as exogenous. Yet a literature in political economy

explains likelihood of signing an IIA by characteristics of the countries involved (Elkins, Guzman &

Simmons, 2006; Jandhyala, Henisz & Mansfield, 2011). IIAs as a policy response to underlying conditions

raise the possibility of endogeneity bias, e.g., if these conditions include lobbying by firms engaging in

FDI that wish to raise the value of their investments. Indeed, endogeneity has been shown to bias

estimate results of relationships between FDI flows and BITs, and may explain some of the mixed results

in the literature (Aisbett, 2009; Kerner, 2009).

We address endogeneity through a Heckman (1979) two-stage procedure. The first stage is a probit

model to estimate the likelihood of two countries’ signing an IIA. Table 6 reports results from our first-

stage-model, based on Jandhyala, Henisz & Mansfield (2011). The model’s explanatory variables are

proxies for vertical FDI potential (dyad per capita income difference), horizontal FDI potential (size of

dyad economies), diffusion of IIAs (total number of BITs and ECT members), geographic distance

between dyad countries, and dyad political risk (average dyad POLCON score)10.

Table 7 reports the second stage regression of transaction value on the variables in Table 3, augmented

by the Inverse Mills Ratio (IMR) as an indicator of endogeneity bias. The IMR coefficient is insignificant,

however, indicating the absence of such bias. Further, the coefficients of the IIA variable and its

interaction with firm size and foreign state ownership remain similar to those reported in the main

results.

A second concern is that non-IIA transactions are under-sampled. If IIAs add value by protecting FDI,

then selection bias may occur if observations not protected by IIAs (“non-IIA transactions”) fall just

below our threshold for sample inclusion. We address this potential selection bias by lowering the

threshold for non-IIA transactions. To be conservative (and hence err in the opposite direction of

10

The results reported in this table use all potential home-host dyads worldwide. We also estimated this model on the countries in our sample, with similar results.

24

oversampling non-IIA transactions), we chose $8 million as the threshold value for non-IIA transactions

(compared to $10 million for IIA-transactions)11. Lowering the threshold adds 7 non-IIA transactions to

the sample; but does not affect our empirical results above (Model 1, Table 8).

Next, we explore the different effects of IIAs for firms with greater and lesser financial resources by

undertaking a sub-sample analysis. Models 2 and 3 in Table 8 include only firms with large and small

financial resources respectively. In Model 2 (large financial resources sub-sample), we observe that the

coefficient of IIA is positive and significant. However, in Model 3 (small financial resources sub-sample),

the coefficient of IIA is not significant.

We explore a similar sub-sample analysis with foreign state ownership in Models 4-5 in Table 8. In

Model 4 (firms with foreign state ownership), the coefficient of IIA is not significant, while it is positive

and significant in Model 5 (firms without foreign state ownership).

A fourth concern may be that our results are confounded by including both BITs and ECT in the coding of

IIAs. While a BIT and the ECT provide similar protection for foreign investors, they also differ in some

ways. As the name suggests, BITs are bilateral in nature, signed between one home and host country.

They are also specifically designed to protect foreign investment. However, the ECT is a multilateral

agreement with a much broader scope, governing both trade and investment in the energy sector. In

our sample, the vast majority of transactions are protected by a BIT (87%). Thus, we restrict the next

model to only protection from BITs and include its interaction with Financial Resources and Foreign

State Ownership. In Model 6, we observe a pattern of results similar to that reported using the IIA

dummy although the results are significant only at the 10% level.

Another concern might be that our results are reflecting some differences between domestic and cross-

border transactions as we compare IIA protected cross-border transactions against both non-IIA

11

This effectively allows for IIAs to enhance asset value by up to 25 percent ($10 million/$8 million = 1.25)

25

protected cross-border as well as domestic transactions in our primary specifications. Since IIAs may

provide little or no protection for domestic transactions,12 we may be confounding the comparison set.

Thus, we restrict our sample to only cross-border transactions (those in which the buyer’s home country

is different from the country in which reserves are located). We find that the results are substantively

similar to those reported above, although the Foreign State Ownership interaction is no longer

significant.

Finally, we consider that some of the countries in our sample have very few transactions. With one or

two transactions per country, our results may be driven by cross-national differences rather than the

difference in IIA protection. Thus, in Model 5, we restrict our sample to those countries in which five or

more transactions are reported. This reduces the number of host countries in our sample from 45 to 18.

However, the results are consistent with those reported for the full sample. The presence of an IIA

increases willingness to pay for foreign assets by 45% for firms with large financial resources while this

effect is not significant for those with small resources. Similarly, IIAs increase the willingness to pay by

non-foreign sate owned firms by 33% while the effect is not significant for foreign state owned firms.

Taken together, our results support the argument that IIAs provide investor protection, but this effect is

moderated by a firm’s financial resources and foreign state ownership; IIA protection enhances value

only for firms with large financial resources, and those not owned by a foreign state.

Discussion

Political-risk considerations in foreign investment decisions have prompted many strategy scholars to

examine host-government policies and domestic institutional arrangements that may reduce the risks

12

BITs provide no protection for domestic investment. The ECT is less clear; e.g., foreign shareholders brought a claim under ECT against the Russian government after it expropriated domestic company Yukos.

26

for foreign investors. For example, prior literature has examined the strategic actions of developing

countries (Murtha & Lenway, 1994), legal policies (La Porta, Lopez-de-Silanes, Shleifer & Vishny, 1998),

political institutional arrangements (Henisz, 2000a), and electoral cycles (Vaaler, 2008) on the likelihood

of increased foreign investment.

However, there has been a scarcity of work examining the role of international institutional

arrangements as safeguards for investors. Yet international institutions for trade and investment are

rapidly proliferating; the World Trade Organization, Regional Trade Agreements, and Bilateral

Investment Treaties are all examples of international institutions that have significantly altered the rules

of international commercial transactions. As noted by Westney (2011: 380), we are witnessing “a

profound transformation of regulatory patterns, involving the decline of the state-centered regulation

that MNCs have become so adept at managing, in favor of an array of new regulatory modes” shaped by

states, international organizations, and civil society. Thus, in studying MNE strategy, we need to extend

our analysis beyond country-specific institutions (Ramamurti, 2001; Chan, Isobe & Makino, 2008).

Our analysis takes a step down this path. This study offers an empirical test of the effectiveness of IIAs in

protecting international investment. We demonstrate that MNEs value assets protected by IIAs higher

than similar unprotected assets; an effect that is moderated by a firm’s financial resources and

ownership. As discussed above, IIAs alter risk perception by providing extensive rights and protection for

MNEs, while restricting host governments’ discriminatory policy changes that expropriate the firm’s

assets. Thus, they provide an alternate, international mechanism by which host country political risk

may be lowered.

Our results also have implications for MNE managers evaluating their institutional environments.

Managers evaluating risk considerations in a potential host country need to take into account their

firm’s own characteristics in evaluating the benefits, if any, of institutional arrangements. Our empirical

27

analysis focuses on the petroleum sector. While studies of a single sector offer researchers a powerful

arena for testing propositions, they also raise the issue of generalizability of findings. Investments in

natural resources or regulated industries with large, upfront capital costs and high political salience are

especially prone to political risks. Thus, managers in these industries may be particularly sensitive to

national and international institutional arrangements. Exploring the role of IIAs across multiple

industries remains open for future research.

In addition, we need to explore how alternate mechanisms of property rights protection interact with

international institutional arrangements. International arbitration is an expensive process, and usually a

last resort for MNEs, as it severely restricts their ability to continue operating in the host country. Since

exploration and production of natural resources is a long term commitment, MNEs, especially small

firms, may seek alternate strategic mechanisms such as equity participation by the host government or

the involvement of other stakeholders for managing these risks (Maniruzzaman, 2009-10). For example,

a joint venture by a foreign investing firm has been shown to be a strategic tool in countries where

public expropriation hazards are high (Delios & Henisz, 2000). These mechanisms may substitute for IIAs.

Data limitations prevent us from exploring this, however, and it remains an open question.

While our analysis highlights the mechanisms by which IIAs can support foreign investors’ property

rights, some concerns have also been raised about the effectiveness of the protective dispute resolution

system. Although the number of investment-treaty disputes have risen in the last decade to over 300

(UNCTAD, 2009), the jurisprudence and enforceability of resulting awards is still in its infancy (Yackee,

2008). Managers may be particularly concerned that host governments may be unwilling or unable to

honor the arbitral decisions that go against them (Rose-Ackerman, 2009). Thus, uncertainty with regards

to implementation of IIAs and post-award behavior may reduce their value to investors. In future work,

28

we would like to explore how a country’s history and reputation in international arbitration influences

investors’ expectations of property rights protection.

Finally, we acknowledge that our explanations rely, in part, on inference. We attribute the positive and

significant effects of IIAs we find in the econometric analysis to increased property rights protection for

foreign investors without directly observing property rights mechanisms. Thus, a more granular

approach – examining specific motivations of asset valuation coupled with qualitative analysis – would

greatly enhance our understanding of the micro-processes and mechanisms that influence the strategic

choices of foreign investors.

29

Appendix A – Historical context of International Investment Agreements

Prior to World War II, investors’ recourse to nationalization of assets abroad was restricted to vague

customary international law and extra-legal enforcement mechanisms, including military force and

diplomacy. Following the war, many newly independent countries and the socialist-bloc countries chose

to close their economies to foreign investment and began to expropriate existing investment

(Vandevelde, 2009). Developing countries worked within the United Nations (UN) General Assembly to

pass the 1962 resolution declaring the right of nations to permanent sovereignty over their natural

wealth, which would be exercised for the well-being of the people of the state concerned, and the right

to expropriate foreign investment with limited or inadequate compensation (Newcombe & Paradell,

2009).

In response to the threat of uncompensated expropriation, developed countries began to establish IIAs

that guaranteed the rights of investors. The US, for example, built investment protection clauses into its

traditional Friendship, Commerce and Navigation treaties (Newcombe & Paradell, 2009). Led by the

Germans, the European countries began to sign BITs from the 1960s to promote and protect foreign

direct investment (Vandevelde, 2009). These treaties combined similar (and sometimes identical

standards) on the admission and establishment conditions for investment, and the protection of foreign

investment (Newcombe & Paradell, 2009). In addition, investors are given assurances regarding their

property rights through clauses that provide the right to take the host government to international

arbitration if its actions are deemed to substantially expropriate the business of the firm (UNCTAD,

2004) without the requirement to use that country’s domestic courts.

The rise of economic liberalism and the Washington Consensus (Williamson, 1990) coupled with scarce

private capital due to the debt crisis of the 1980s catalyzed a dramatic shift in the attitude of developing

countries towards foreign investors. Many countries began to actively seek foreign investment for

economic development and stabilization (Kobrin, 2005). In doing so, IIAs provided a commitment

mechanism by which developing country governments could signal their changing attitudes towards

property rights of foreign investors. As a result, the number of IIAs exploded in the 1990s (Jandhyala,

Henisz & Mansfield, 2011). By the end of 2009, there were over 3000 agreements governing

international investment negotiated either bilaterally or multilaterally (UNCTAD, 2010).

30

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34

Figure 1: Worldwide cumulative number of BITs signed, 1959-2008

Source: UNCTAD

0

100

02

00

03

00

0

Cum

ula

tive w

orl

dw

ide s

igne

d B

ITs

1960 1970 1980 1990 2000 2010year

35

Table 1: Countries of petroleum reserves transactions in the sample

Total number of transactions = 409

Asset Location Total Transactions Asset Location

Total Transactions

Algeria 6 Kazakhstan 24

Angola 3 Libya 3

Argentina 19 Mongolia 1

Australia 33 Netherlands, The 5

Azerbaijan 5 New Zealand 6

Bangladesh 3 Nigeria 1

Brazil 3 Norway 25

Cameroon 2 Oman 3

China 11 Pakistan 3

Colombia 10 Papua New Guinea 3

Congo 9 Peru 1

Croatia 1 Philippines 3

Denmark 5 Romania 1

Ecuador 6 Russia 77

Egypt 11 Sudan 4

France 3 Thailand 4

Gabon 4 Trinidad and Tobago 4

Germany 1 Tunisia 5

Guatemala 1 Turkey 1

India 3 Ukraine 2

Indonesia 34 United Kingdom 54

Ireland 1 Venezuela 4

Japan 1

36

Table 2: Summary Statistics and correlation table for the main variables

-1- -2- -3- -4- -5- -6- -7- -8- -9- -10- -11- -12- -13- -14- -15- -16- -17- -18-

Mean 1.50 0.31 0.68 0.12 0.43 0.64 3.78 0.30 0.36 0.04 19.55 0.35 0.02 0.03 0.14 0.03 0.03 0.01

SD 1.16 0.46 0.47 0.33 0.32 0.48 0.48 0.46 0.48 0.19 34.78 0.48 0.15 0.17 0.35 0.18 0.18 0.10

Min -2.92 0 0 0 0 0 2.99 0 0 0 0 0 0 0 0 0 0 0

Max 4.15 1 1 1 0.87 1 4.50 1 1 1 100 1 1 1 1 1 1 1

1 ln(V/R) 1.00

2 IIA 0.04 1.00

3 Resources -0.20 0.04 1.00

4 Foreign State Ownership

0.02 0.26 0.20 1.00

5 Host Polcon 0.25 -0.05 0.09 -0.07 1.00

6 Crossborder 0.17 0.50 -0.02 0.28 0.03 1.00

7 ln(Oil Strip Price)

0.35 -0.04 -0.33 -0.10 -0.14 -0.02 1.00

8 M&A 0.06 0.02 -0.11 -0.12 -0.10 -0.04 0.15 1.00

9 Proved + Probable

-0.22 -0.01 -0.02 -0.05 0.03 -0.04 0.22 -0.13 1.00

10 Heavy Oil 0.05 0.11 -0.02 0.11 -0.03 0.05 0.01 -0.05 -0.12 1.00

11 % Gas of proved reserve

0.04 0.02 0.03 0.05 0.26 0.02 -0.13 0.08 -0.42 -0.11 1.00

12 Buyer report 0.03 -0.06 -0.17 -0.11 0.04 -0.01 0.23 -0.08 0.09 -0.02 -0.12 1.00

13 Coal Bed 0.05 -0.10 -0.04 -0.06 0.20 -0.17 0.14 0.08 -0.04 -0.03 0.25 0.03 1.00

14 LNG -0.16 0.04 0.12 0.07 0.02 0.07 -0.13 -0.11 -0.04 -0.04 0.25 -0.10 -0.03 1.00

15 Shallow Water

0.24 -0.07 -0.09 -0.07 0.21 0.06 0.29 -0.14 0.21 -0.08 -0.03 0.10 -0.06 -0.07 1.00

16 Deep Water 0.00 -0.07 0.10 0.13 0.13 0.08 0.10 -0.12 0.20 -0.04 -0.04 0.09 -0.03 -0.03 -0.08 1.00

17 Frontier -0.17 0.09 0.03 -0.03 -0.16 -0.04 0.01 0.06 0.04 -0.04 -0.10 -0.05 -0.03 -0.03 -0.07 -0.03 1.00

18 Diversified 0.07 -0.01 0.02 -0.04 -0.04 -0.03 0.07 0.10 -0.02 -0.02 0.03 -0.07 -0.01 -0.02 -0.04 -0.02 -0.02 1.00

37

Table 3: OLS models with robust standard errors

Dependent variable = ln(Transaction value of petroleum reserves, per barrel)

-1- -2- -3- -4- -5-

IIA (H1)

0.2716* -0.0649 0.3007* -0.0328

(0.133) (0.214) (0.139) (0.216)

Financial Resources -0.1014 -0.0948 -0.2396+ -0.0915 -0.2432+

(0.103) (0.102) (0.126) (0.103) (0.125)

IIA * Financial Resources (H2)

0.5044*

0.5389*

(0.238)

(0.238)

Foreign State Ownership 0.2163 0.1467 0.0902 0.241 0.265

(0.160) (0.170) (0.168) (0.316) (0.308)

IIA * Foreign State Ownership (H3)

-0.154 -0.2919

(0.352) (0.347)

Host Polcon 0.1023 -0.0798 -0.1574 -0.0661 -0.1368

(0.506) (0.519) (0.505) (0.521) (0.506)

Crossborder 0.1159 -0.0217 -0.0026 -0.036 -0.0282

(0.100) (0.114) (0.116) (0.112) (0.114)

ln(Oil Strip Price) 1.0050* 1.0250* 0.9402* 1.0213* 0.9274*

(0.432) (0.432) (0.429) (0.431) (0.425)

M&A transaction 0.1783+ 0.1675+ 0.1495 0.1688+ 0.1508

(0.100) (0.101) (0.098) (0.101) (0.099)

Proved + Probable Dummy -1.0233*** -1.0521*** -1.0667*** -1.0537*** -1.0707***

(0.117) (0.121) (0.119) (0.121) (0.119)

Heavy Oil -0.198 -0.1953 -0.2219 -0.1888 -0.2113

(0.218) (0.212) (0.219) (0.212) (0.220)

% Gas of Proved Reserve -0.0060*** -0.0061*** -0.0061*** -0.0063*** -0.0064***

(0.002) (0.002) (0.002) (0.002) (0.002)

Buyer Report -0.2067* -0.2060* -0.2001* -0.2057* -0.1992*

(0.092) (0.092) (0.092) (0.092) (0.092)

Coal Bed -0.5369+ -0.5681* -0.6020* -0.5630* -0.5946*

(0.279) (0.271) (0.263) (0.270) (0.264)

Liquefied Natural Gas (LNG) -0.5929+ -0.5955+ -0.6276+ -0.5771 -0.5950+

(0.354) (0.353) (0.358) (0.354) (0.359)

Shallow Water -0.0243 -0.0002 -0.0312 -0.003 -0.0386

(0.152) (0.148) (0.148) (0.148) (0.147)

Deep Water 0.0678 0.1233 0.0906 0.1235 0.0888

(0.307) (0.311) (0.326) (0.312) (0.329)

Frontier -0.0968 -0.1417 -0.1612 -0.1439 -0.1665

(0.301) (0.299) (0.297) (0.300) (0.299)

Diversified 0.6189+ 0.6355* 0.6648* 0.6396* 0.6745*

(0.318) (0.285) (0.290) (0.284) (0.287)

Host Country Dummies Yes Yes Yes Yes Yes

Year Dummies Yes Yes Yes Yes Yes

Constant -1.9917 -1.9361 -1.5483 -1.9267 -1.5041

(1.406) (1.411) (1.410) (1.405) (1.395)

Number of Transactions 409 409 409 409 409

R-sq 0.6 0.61 0.61 0.61 0.62

Note: Robust standard errors in parantheses

+ p<0.1, * p<0.05, ** p<0.01, *** p<0.001

38

Figure 2a: Interaction Effect of IIA and Firm Resources

(Based on Model 3 in Table 3)

Figure 2b: Interaction Effect of IIA and Foreign State Ownership

(Based on Model 4 in Table 3)

1.3

1.4

1.5

1.6

1.7

1.8

Ce

ll M

ean

s ln(V

/R)

0 1International Investment Agreement

Resources = Low Resources = High

Graph of IIA * Resources interaction

1.4

1.5

1.6

1.7

1.8

Ce

ll M

ean

s ln(V

/R)

0 1International Investment Agreement

Foreign State Ownership = 0 Foreign State Ownership = 1

Graph of IIA * Foreign State Ownership interaction

39

Table 4: Effect of Change IIA = 0 to IIA = 1 (Based on Models 3-5 of Table 3)

Model 3 Model 4 Model 5

Financial Resources = Low -0.06

-0.06

(0.21)

(0.21)

Financial Resources = High 0.43**

0.46***

(0.14)

(0.14)

Foreign State Ownership = 0

0.3* 0.33*

(0.13) (0.13)

Foreign State Ownership = 1

0.14 0.04 (0.33) (0.32)

Note: Standard Errors in Parantheses + p<0.1, * p<0.05, ** p<0.01, *** p<0.001

40

Table 5: Robustness tests, OLS models with robust standard errors & Vertical Integration controls

Dependent variable = ln(Transaction value of petroleum reserves, per barrel)

-1- -2-

IIA 0.023 -0.2296

(0.167) (0.245)

Financial Resources

-0.2649+

(0.153)

IIA * Financial Resources

0.5991+

(0.315)

Foreign State Ownership

0.3123

(0.320)

IIA * Foreign State Ownership

-0.3063

(0.374)

Integrated -0.1727 -0.0602

(0.127) (0.143)

IIA * Integrated 0.3526+ 0.0787

(0.204) (0.240)

Host country level controls: Host Country Polcon 0.3679 0.3424

(0.538) (0.532)

Transaction level controls: Crossborder transaction -0.0142 -0.0442

(0.126) (0.125)

ln(Oil Strip price) 1.2743** 1.0940*

(0.465) (0.463)

M&A transaction 0.1942+ 0.1774+

(0.108) (0.107)

Buyer report -0.2305* -0.2173*

(0.102) (0.101)

Reserve level controls Yes Yes

Country dummies Yes Yes

Year dummies Yes Yes Constant -2.9187+ -2.1802

(1.496) (1.523)

Number of observations 367 367 R-Squared 0.59 0.6

Note: Robust standard errors in parantheses + p<0.1, * p<0.05, ** p<0.01, *** p<0.001

41

Table 6: Probit for Heckman Two-Stage Model

Dependent variable = Presence of an IIA (0/1)

All countries

Average of dyad POLCON scores 1.0436***

(0.028)

Vertical FDI - ln(abs diff of GDP/C of dyad) 0.0227***

(0.004)

Horizontal FDI - ln(sum GDP of dyad) 0.4537***

(0.009)

Horizontal FDI - ln((dyad GDP difference)^2) -0.0691***

(0.003)

Total worldwide BITs 0.0003***

(0.000)

Total worldwide ECT members 0.0079

(0.005)

ln(distance between dyad countries) -0.7414***

(0.008)

Constant -4.7422***

(0.218)

Number of observations 95,888

Pseudo R-square 0.29 Log likelihood -33790.64

Chi-square 18,059.39

Note: Standard errors in parantheses

+ p<0.1, * p<0.05, ** p<0.01, *** p<0.001

42

Table 7: Robustness Tests – Second stage OLS model with robust standard errors

Dependent variable = ln(Transaction value of petroleum reserves, per barrel)

-1- -2- -3- -4-

Inverse Mills Ratio (from first stage) -0.0138 -0.001 -0.0119 0.0035

(0.181) (0.178) (0.181) (0.178)

IIA 0.2704* -0.065 0.2996* -0.0325

(0.131) (0.213) (0.137) (0.215)

Financial Resources -0.0953 -0.2396+ -0.0919 -0.2431+

(0.102) (0.126) (0.102) (0.125)

IIA * Financial Resources

0.5043*

0.5390*

(0.238)

(0.238)

Foreign State Ownership 0.1493 0.0904 0.243 0.2644

(0.171) (0.168) (0.316) (0.308)

IIA * Foreign State Ownership

-0.1536 -0.2921

(0.353) (0.348)

Host country level controls: Host Polcon -0.0825 -0.1576 -0.0685 -0.1361

(0.517) (0.503) (0.520) (0.505)

Transaction level controls: Crossborder -0.1501 -0.0118 -0.1467 0.0042

(1.689) (1.665) (1.688) (1.661)

ln(Oil Strip Price) 1.0229* 0.9401* 1.0195* 0.9279*

(0.435) (0.431) (0.433) (0.427)

M&A transaction 0.1676+ 0.1496 0.1689+ 0.1508

(0.101) (0.099) (0.101) (0.099)

Buyer Report -0.2063* -0.2001* -0.2060* -0.1991*

(0.092) (0.092) (0.093) (0.092)

Reserve level control Yes Yes Yes Yes

Host Country Dummies Yes Yes Yes Yes Year Dummies Yes Yes Yes Yes

Constant -1.7885 -1.5377 -1.7995 -1.5413

(2.392) (2.357) (2.398) (2.363)

Number of Transactions 409 409 409 409

R-sq 0.61 0.61 0.61 0.62

Note: Robust standard errors in parantheses

+ p<0.1, * p<0.05, ** p<0.01, *** p<0.001

43

Table 8: Robustness tests, OLS models with robust standard errors

Dependent variable = ln(Transaction value of petroleum reserves, per barrel)

-1- -2- -3- -4- -5- -6- -7- -8-

Lower non-IIA threshold

Large Reserves

Small/ Medium Reserves

Foreign State

Owned Non Foreign

State Owned BIT Crossborder >=5

Transactions

IIA -0.031 0.5146** -0.2162 0.7423 0.3104*

-0.1818 0.0244

(0.214) (0.176) (0.331) (1.030) (0.145)

(0.241) (0.240)

BIT

-0.0831

(0.229)

Financial Resources -0.2176+

-0.9268 -0.0606 -0.2155+ -0.271 -0.2064

(0.129)

(1.122) (0.107) (0.122) (0.182) (0.136)

IIA * Financial Resources 0.5120*

0.5566* 0.4488+

(0.239)

(0.274) (0.258)

BIT * Resources

0.5036+

(0.259)

Foreign State Ownership 0.2572 -0.0825 1.8943**

0.3632 0.2275 0.2122

(0.295) (0.193) (0.559)

(0.303) (0.309) (0.391)

IIA * Foreign State Ownership -0.2826

-0.1498 -0.1939

(0.335)

(0.356) (0.425)

BIT * Foreign State Ownership

-0.4468

(0.363)

Host country level controls: Host Polcon -0.125 -0.1331 0.1713 -2.0876 0.2516 -0.0627 -0.4405 0.0957

(0.506) (0.607) (1.255) (2.147) (0.635) (0.504) (0.619) (0.542)

Transaction level controls: Crossborder 0.0032 -0.0662 0.147

-0.0318 0.0427

-0.0374

(0.119) (0.156) (0.254)

(0.115) (0.110)

(0.118)

ln(Oil Strip Price) 0.7587 1.0942* 0.7782 2.1058 0.9574* 0.9099* 0.9073 0.8258+

(0.462) (0.512) (0.747) (2.545) (0.449) (0.431) (0.555) (0.443)

M&A transaction 0.1618 0.1746 0.1694 1.1078 0.136 0.1547 0.3250* 0.1638

(0.098) (0.141) (0.223) (1.529) (0.103) (0.099) (0.130) (0.106)

Buyer Report -0.2204* -0.1954 -0.2765 -0.7828 -0.2295* -0.2118* -0.2674* -0.2451*

(0.093) (0.129) (0.193) (0.702) (0.097) (0.092) (0.115) (0.099)

Reserve level controls: Yes Yes Yes Yes Yes Yes Yes Yes Host Country Dummies Yes Yes Yes Yes Yes Yes Yes Yes

Year Dummies Yes Yes Yes Yes Yes Yes Yes Yes

44

Constant -1.0002 -2.2202 -1.5842 -4.9642 -1.8989 -1.549 -1.2896 -1.3283

(1.484) (1.682) (2.432) (9.383) (1.444) (1.410) (1.795) (1.464)

Number of Transactions 416 278 131 51 358 409 263 345 R-sq 0.61 0.63 0.68 0.92 0.62 0.61 0.63 0.6

Note: Robust standard errors in parantheses

+ p<0.1, * p<0.05, ** p<0.01, *** p<0.001