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Capital Structure of Foreign Direct Investments: A Transaction Cost Analysis

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  • Asmund Rygh

    (Alliance Manchester Business School)

  • Gabriel R. G. Benito

    (BI Norwegian Business School)

Abstract

Transaction cost theory (TCT) plays a major role in theorizing about the boundaries of the multinational enterprise (MNE), and is increasingly being applied to intra-MNE governance. We apply TCT to capital structure decisions for MNE subsidiaries. According to TCT, equity and debt are not just financial instruments, but alternative governance structures. Equity is useful for projects involving specific assets that do not serve well as collateral, and for knowledge intensive activities where information asymmetry and public good issues make external financing more costly. We study under what conditions MNE headquarters may wish to partially re-introduce market mechanisms inside the MNE through the use of external or internal debt to finance subsidiaries. This can allow economizing on governance costs and strengthen subsidiary manager incentives, but may be inappropriate if subsidiary assets are MNE-specific or subsidiary-specific. Empirically testable propositions are developed.

Suggested Citation

  • Asmund Rygh & Gabriel R. G. Benito, 2018. "Capital Structure of Foreign Direct Investments: A Transaction Cost Analysis," Management International Review, Springer, vol. 58(3), pages 389-411, June.
    • Handle: RePEc:spr:manint:v:58:y:2018:i:3:d:10.1007_s11575-017-0335-x
    DOI: 10.1007/s11575-017-0335-x
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