Do financial and governmental institutions play a mediating role in the spillover effects of FDI?

We investigate the effects of foreign direct investment (FDI) on technological change in the Association of South East Asian Nations member countries. Our analysis underscores the pivotal roles that financial and governmental institutions play as mediators in the relationship between FDI and technological change. Our empirical results based on the 25 years panel dataset from 1996 to 2020 reveal that the rule of law, one of the sub-indicators of the Worldwide Governance Indicators, has a significant mediating effect in this relationship. Though financial institutions play a mediating role, FDI negatively affects financial institutions and positively affects technological change, meaning the suppression effect. To maximize FDI’s spillover effects, governments should facilitate the effective functioning of the rule of law and develop strategies to alleviate financing restrictions, which might hamper FDI. •FDI’s spillover effects occur at the societal level.•FDI can hinder the absorptive capability of financial institutions, reducing its total impact on technological change.•Conversely, FDI improves the absorptive capability of the rule of law, which enhances technological change.•Financial and governmental institutions play a mediating role in the relationship between FDI and technological change.