Pricing Institutional Distance: Project Finance in Different Institutional Environments

Research demonstrates that differences in institutions are at the core of the liability of foreignness. Scholars typically conceptualize and measure those differences as an ‘institutional distance’ between countries on cultural, political, and economic dimensions; and studies now show that institutional distance increases risks for firms operating in global markets. Although we have learned a great deal from studies that explicate the strategic and performance risks associated with institutional distance, we understand less than we should about how institutional distance translates into financial risks, and how to express those risks in a financially meaningful way. In this study, we fill that gap by examining how companies (i.e., banks) price institutional distance risks in a sample of 5,649 project finance deals from 2000-2012. Consistent with the underlying theory, we find that banks systematically vary the interest rates that they charge on large-scale project finance loans to account for cultural, political, and economic distance. We describe how managers of (non-financial) multinational corporations might use these findings to help insulate themselves from institutional risks.