We investigate the relationship between a country’s share of FDI in its foreign equity investments (FDI plus FPI) and its governance quality relative to that of the investors’ country. To achieve the policy objective of attracting FDI, poor countries are often advised to improve their governance structures. Contrary to this prescription, we find that as the governance quality of poor-governance host countries improves they do not necessarily attract higher FDI from desirable source countries but rather higher FPI. Consequently, their FDI share of foreign equity investments likely declines with marginal improvements in governance quality. Only after a sustained and meaningful improvement in governance quality can a low-quality host country reap the benefit of attracting greater FDI from investors in high-quality countries. In addition to its significant policy implications, our findings also help explain contradictory results of previous studies. 

Keywords: Governance quality; FDI; FPI.
JEL codes: F21 International Investment, F23 Multinational Firms, O43 Institutions and Growth​