1. Introduction

Following the financial liberalization attempted, especially during the 1980s, foreign direct investment (FDI) has being as more important catalyst for accelerating the economic growth. The economic activities are integrated during the transition economies among developing countries as well as ASEAN-5 countries. The formation of ASEAN Economic Community (AEC) at the Ninth ASEAN Summit in October 2003 represented an important milestone in ASEAN economic cooperation. It stimulates FDI inflows by reducing business costs associated with multinational activities in the ASEAN region that has always been a primary objective of the economic cooperation. Strengthening the financial sector with remaining stable economic condition may establish an attractive business environment for multinational firms to invest in the ASEAN-5 countries.

complied the regulation starting from 2005 onwards. The effect of regulatory quality is found as an incentive for quality of accounting information that benefited to all stakeholders. Thus, improving the regulatory quality of financial reporting enhances transparency that reducing the asymmetric information between

Nonlinear Effect of Financial Development and Foreign Direct Investment in Integration…

Early theories of the determinants of FDI were encompassed in eclectic approach [2]. The key requirements for FDI as follows: the firm must possess stable specific advantages; the firm must find it beneficial to utilize these advantages directly instead of selling or leasing them (so called as internalization advantages); and the firm must firm must find it profitable to combine these advantages with at least one factor input abroad (so that local production dominates exporting or locational advantages). These advantages include proximity to markets, specialized suppliers, evasion of protective barriers, and factor endowment advantages.

Financial development is found as one of the significant determinants of FDI [3, 4]. The financial markets are measured by the domestic credit provided by banks and domestic credit provided to the private sector as a percentage of GDP [5]. Domestic credit to the private sector refers to the financial resources provided to private sector through loans, purchases of non-equity securities, and trade credits and other receivable accounts. Meanwhile, the domestic credit provided by banks is nonguaranteed long-term commercial bank loans from private banks and other private financial institutions. The other measurement financial development is financial freedom as a catalyst for FDI inflows. Financial freedom is a measurement of banking security as well as independence from government control. The state ownership of banks and other financial institutions is seen as an inefficient burden, and political favoritism has no place in a free capital market [6]. Thus, the financial information quality also affected the investment efficiency because the investors need the information of financial health in the particular host countries [7]. Financial development, as better accounting and disclosure rules and better corporate governance, reduces the spread between domestic and foreign cost of capital [8]. It requires a sound financial reporting system that produces reliable and transparent accounting information for both domestic and foreign investors [9, 10]. Lack of financial reporting systems credibility is likely to have adverse effects on the ability of particular countries to attract foreign investments, because it retards the equity markets development [11]. In fact, the effect of financial development on economic growth, which enhances FDI inflows, is contingent the adoption of

The application of IFRS in host countries is considered a way to attract the FDI [13, 14]. IFRS leads to higher earnings quality and more foreign investment [15]. Furthermore, the short-run and long-run causality existed between IFRS adoption and FDI inflows [16]. The quality of financial reporting according to IFRS has potential to enhance transparency that reduces asymmetric information and cost for foreign investors [17]. IFRS adoption requires strong governance and internal controls within a bank to give confidence to the investors resulting in the quality financial information. The effect of regulatory quality is found as an incentive for quality of accounting information and compliance to the IFRS by firms. Hence, the financial statement act as organization's resume that indicate the strength of finance by banks in host countries. Quality of financial statement among bans in host countries will build good reputation that leads the confidence of decision maker from foreign firms. The information of financial development, that is, credit

investors and the financial institution in host countries.

DOI: http://dx.doi.org/10.5772/intechopen.86104

financial accounting quality by host countries [12].

43

2. Literature review

The trend of FDI inflows in ASEAN-5 countries fluctuate from year 1980 to 2017 as shown in Figure 1. There is high volatility in FDI inflows after the Asian financial crisis in 1997–1998 that leads FDI inflows dropped for Singapore, Malaysia and Indonesia, but increased for Philippines and Thailand. While Malaysia and Philippines drop in 2001 in another event of crisis, that is, bubble.com, but the FDI inflows to Singapore, Thailand and Indonesia are increased. The trend of FDI inflows among ASEAN-5 countries are however increases following AEC formation in 2003. The trend of FDI inflows dropped after the global financial crisis in 2007–2008, which affected ASEAN-5 countries, but its effects are delayed for Malaysia and Indonesia. Fluctuation of FDI inflows may reliance on the uncertainty of its enabler such as financial development in ASEAN-5 countries.

To materialize the benefit of FDI, thus, the role of financial development was found as an enabler of the FDI performance. There are five major functions of a financial system: producing information and allocating capital; monitoring firms and implementing corporate governance; meliorating risk; pooling the savings; and easing exchange [1]. These functions contribute to the stimulation of economic growth. Thus, the financial institutions and financial markets can exert a strong influence on economic development, where the incremental of economic growth enabling the FDI to perform better. Financial development is discovered as assistance to the FDI especially in technology transfer that needed more capital to funding the technology expenses.

It is important to consider the effect of financial development on FDI inflows are influenced by the quality of financial information. The investors would review the financial strength via the bank's financial report in the host countries. A quality of financial reporting relies on regulatory accounting standards through the International Financial Reporting Standard (IFRS). In general, ASEAN-5 countries already

#### Figure 1.

FDI inflows (% of GDP) in ASEAN-5 countries from 1980 to 2017. Source of data: UNCTAD website (Accessed on 9 March 2019).

complied the regulation starting from 2005 onwards. The effect of regulatory quality is found as an incentive for quality of accounting information that benefited to all stakeholders. Thus, improving the regulatory quality of financial reporting enhances transparency that reducing the asymmetric information between investors and the financial institution in host countries.
