In column (4), we use the value of the private credit to GDP ratio in 1980. The activities of MNEs at that time were much smaller than they are now, and therefore less likely to influence financial development in source and destination countries.<sup>59</sup> Despite losing nearly half of our sample due to missing data, our main results are unaltered. The relative volume of FDI in financially vulnerable sectors tends to be higher between countries which structurally have a high level of financial development.

In column (5), we adopt an instrumental variables (IV) approach to address any potential endogeneity bias. In line with the rest of the literature, e.g. Rajan and Zingales (1998) and Kroszner et al. (2007), we use as instruments for the two financial development-ED interaction terms the interactions of legal origin dummy variables with the ED variable.<sup>60</sup> Given our use of a nonlinear model, we implement a control function approach instead of the standard two-stage least squares estimator.<sup>61</sup> The negative sign of the coefficients on the two residuals in column (5) suggests that the effects of SFD and DFD on the relative volume of bilateral FDI in financially vulnerable sectors may have been underestimated, as reflected in an increase in the size of the coefficients on both interaction terms. Evidence of endogeneity is stronger for DFD; the coefficient on the residuals of the first-stage regression for the DFD-ED interaction term is statistically significant at the 5% level. The first-stage _F_ -statistic indicates that the instruments are relevant, with a value well above the threshold identified as Staiger and Stock (1997) to qualify an instrument as strong ( _F ≈_ 10). However, doubts have been raised about the validity of using legal origin dummy variables as exogenous instruments for financial development (Manova, 2013).<sup>62</sup> Results of column (5) should therefore be interpreted as simply showing that our findings are robust to a common IV approach in the Finance and Growth literature.

In column (6), we replace our outcome-based measure of financial development, the private credit to GDP

> 59For instance, using FDI data reported in Lane and Milesi-Ferretti (2007) for 132 countries, the median inward FDI inflows to GDP ratio and the median inward FDI stock to GDP ratio were equal to 0.35% and 5% respectively in 1980. In 2000, the corresponding figures were 1.76% and 24%.

> 60Data on legal origin dummy variables come from La Porta et al. (1999).

> 61This consists of including the residuals of the first-stage regressions, estimated by OLS, in our econometric model. If the instruments are valid, the inclusion of the first-stage residuals controls for the potential endogeneity of the suspect variables, parameters are consistently estimated (as long some assumptions are satisfied), and the statistical significance of the coefficients on the two control function terms provides the basis for a robust (to assumptions) endogeneity test (Wooldridge, 2010).

> 62These doubts are supported by a Sargan-Hansen test of overidentifying restrictions, reported at the bottom of Table 2, which rejects the null hypothesis that all instruments are uncorrelated with the error term. To carry out this test, we use GMM estimation. Results are very similar to those obtained with the two-step procedure that we adopted in column (5).

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