Essays on foreign direct investment

When multinational firms consider investing abroad, among others, two important choices are (1) whether to invest and (2) how to organize foreign production. The two chapters in this dissertation study, both theoretically and empirically, these two choices.;In chapter 1, I argue that multinational activity is not just a privilege of large firms. Models with fixed entry costs and heterogeneous productivity such as Melitz (2003) and Helpman, Melitz and Yeaple (2004) predict that only firms above a certain size or productivity threshold should engage in international trade or foreign direct investment (FDI). Chapter 1 shows that this prediction is not supported by the data: the share of Taiwanese multinationals with foreign investments in both developing and advanced economies is smoothly increasing in firm size. I then argue that this fact can be explained by introducing entry cost heterogeneity to the model, which allows smaller firms to engage in multinational activity if their associated fixed costs are low. This framework also predicts that, relative to the standard model, (1) the effect of expanding foreign markets on multinational activity is reduced, because new entrants in foreign markets are on average smaller; (2) policies which reduce entry costs have a smaller effect on total sales of the firms investing abroad and their extent of global investments.;In chapter 2, I construct an incomplete contract model to study how the similarity of firms' knowledge capital affects the choice of organizational forms. Knowledge capital is a broad term including human capital, patents, blueprints, and proprietary knowledge, and marketing assets like trademarks, brand names. My model yields three main results. (1) If two firms are complimentary in two types of knowledge capital (so that one has a higher level in one type of knowledge capital and the other has a higher level in the other), joint venture is the optimal organizational form. This is because giving both firms partial ownership provides sufficient incentives for each of them to maintain the knowledge capital that they have comparative advantage in. (2) If one firm dominates the other, the optimal organization is for the dominant firm to wholly own the integrated company. This creates the highest incentive for the most productive firm to invest on both margins. (3) if two firms are sufficiently similar in both types of knowledge capital, separation is optimal as the benefits of integration are small. Empirical results using data on the integration strategies of Taiwanese multinational firms provide suggestive evidence which is consistent with these predictions.