A Risky Investment on a Poor Governance Environment

A risky investment on a poor governance environment

It is widely believed that a country with weak laws and severe corruptions would not attract foreign investors. However, statistic shows the opposite way. Most investors would choose complete governance on their indirect investment but when it comes to direct investments, foreigners would prefer to invest in countries that have poor legal system. A poor governance environment attracts foreign direct investment because it has vast market opportunities.

China is perceived and known for its poor governance structure. But despite its poor legal system and rampant corruption, she has still been able to attract huge amounts of foreign direct investment. "In fact, China is one of the largest recipients of foreign direct investment among the world and it's threatening to overtake the number one position from the United States." (Pg. 297). Based on relation-based governance system in China, investors rely on private information and personal networks to conduct business. Whoever knowing and understanding how to use relation-based governance and knowing all the high authorities people will benefits tremendously in their business investments. For instance, in 1992, McDonalds signed a 20-year lease with the Beijing municipal government to open a restaurant in the prime location. But only two years later in 1994, the Beijing government told McDonalds to move out of the area. It is because a well-connected businessman, Li Ka-Shing from Hong Kong, wanted to build an office-shopping-residential complex on the same site. Li Ka-Shing has been a close friend of Chinese officials and somehow persuaded the Beijing government to hold the prime location for his investment. This case was brought to the court by McDonalds, and ultimately McDonalds lost the case even though they hold a valid 20-year lease contract. This injustice results from a relation-based society and it is a perfect example to demonstrate how to succeed in a relation-based environment using private protection mechanism.

On the other hand, in a rule-based environment, it provides a good legal system with a fair and transparent law and a good record of property rights protection. Investors rely on accountably public information to make their investment. Such example would be the United States government structure. Everything is written in black and white and investments and public information can be highly trusted when making direct and indirect investments.

Shaomin Li stated that investors need a three-step strategy to monitor their investments in a relation-based environment. Before the investments, choose partners that you have cultivated close connections or relationships to honor commitments. Next step is the tracking process. During this phase, investors should make sure that your partners are on the right track in fulfilling their promises. The last step is to monitor any cheatings or dishonesty. All three steps are essential in conducting business in a relation-based environment especially the first stage is the utmost important phase. Without this first stage, the probability of a company being cheated is much higher.

As a study in the China case, this country is one that has relation-based governance, meaning a government structure base solely on connections with higher officials.