MICROFINANCE AS FDI: Distance and Investment in Microlending

In recent years, microfinance has increasingly been viewed as a potential mechanism to provide entrepreneurs and businesses at the bottom of the economic pyramid (Hart & Prahalad, 2002; Prahalad, 2010) with access to global capital markets. However, little research has been done to identify the antecedents of capital flows from developed economies to these businesses. This paper reviews prior work in international business and economics on gravity models of foreign direct investment (FDI) to identify mechanisms that might apply in the context of social investors providing microloans to foreign borrowers. We test our hypotheses using data from Kiva Microfunds (Kiva.org), and find that lenders are more likely to invest in borrowers that are socially close. We also find that, under certain conditions, lenders are more likely to invest in borrowers that are physically distant.