Networked capital: indirect investment and BIT formation

Abstract

Why do states participate in bilateral investment treaties (BITs)? In this article, I examine the role of indirect investment on BIT formation. Indirect investment flows are an important aspect of the global investment regime that are underexamined by research focused on direct flows only. Indirect flows play an important role in affecting incentives for BIT participation because firms channel investment through intermediary destinations to take advantage of existing BITs. I argue that governments are more likely to participate in BITs when states expect to access groups of capital exporting states through second order links. When selecting BIT partners, states evaluate expected indirect foreign direct investment (FDI) flows by considering characteristics of a potential partner's second order FDI partners. States are thus more likely to participate in BITs when expectations for indirect flows are high. I use a variety of analyses to demonstrate evidence in favor of my hypotheses. I find evidence that indirect flows affect the likelihood of BIT formation and increase dyadic FDI flows. This research provides a novel explanation for BIT formation and contributes to research on indirect capital flows, treaty shopping and BIT formation.