FOREIGN EQUITY INVESTMENT RESTRICTIONS, CAPITAL FLIGHT, AND SHAREHOLDER WEALTH MAXIMIZATION - THEORY AND EVIDENCE

This article provides a theory of foreign equity investment restrictio ns. We consider a model where the demand function for domestic shares differs between domestic and foreign investors because of deadweight c osts in holding domestic and foreign securities that depend on the cou ntry of residence of investors. We show that domestic entrepreneurs ma ximize firm value by discriminating between domestic and foreign inves tors. The model implies that countries benefiting front capital flight have binding ownership restrictions such that foreign investors pay a higher price for shares than domestic investors. The empirical implic ations of this theory are supported by evidence from Switzerland.