An increase in the share of foreign direct investment (FDI) in equity raises the profitability of FDI-receiving companies, according to a Reserve Bank of India Working Paper.
The FDI in equity also influences the capital structure of the company by bringing down the leverage of the company.
‘The share of FDI in equity is found to be negatively associated with the capital structure, which is captured by debt-to-equity ratio, long-term debt to total assets and short-term debt to total assets ratio.
‘In other words, an increase in FDI results in a decrease in the leverage of the company,’ RBI officials Haridwar Yadav, Vishal Shinde and Samir Kumar Das, said in the Paper.
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Liquidity ratios
Apart from the FDI share in equity, the size of the company and liquidity ratios also positively impact profitability, but the age of the company has a negative impact on the same.
The age and size of a company may also determine profitability — older FDI-receiving companies and smaller FDI-receiving companies are likely to be less profitable, the authors said.
The officials observed that the size of the company is positively associated with profitability, suggesting that larger FDI-receiving companies are likely to have higher profitability.
‘This is because in larger companies, the management is often more focused on preserving/ improving its reputation, which helps in attracting greater FDI.
‘Larger companies are better placed to take advantage of the increased FDI funding owing to the economies of scale and the cost-effective nature of their operations,’ they said.
Hence, FDI plays a greater role in enhancing the profitability of larger companies as compared to smaller companies.