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FDI and FPI - Strategic Complements?

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Author Info
Barbara Pfeffer () (Universität Siegen, Department of Economics)
Abstract

We show in a dynamic investment setting whether firms choose FDI or international portfolio investment (FPI) in the presence of stochastic productivity taking into account differences in flexibility of both investments. Isolated FPI and FDI investments are compared to combined FPI and FDI investments. FDI requires higher investment specific costs than FPI. Thus, it is not possible to adjust FDI to environmental changes every period. In contrast, FPI bears lower fixed costs and can be adjusted immediately to short-term changes in the environment. Additionally, as a result of the investors control position FDI yields a higher return than FPI. Hence, there is a trade-off between flexibility and higher return for firms deciding between FDI and FPI. We explore whether as a consequence of higher investment specific fixed costs and lower flexibility in the case of FDI, small firms prefer FPI and larger firms invest in FDI. We show that a combined strategy dominates the isolated strategy always in times. Further, combined international investment comprises a higher incentive for firms to invest in r&d-investment and consequently firm productivity increase faster than with isolated international investment. Depending on the success-probability and the correlation between the various investment possibilities, even small firms (low productivity) invest in FDI.

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Publisher Info
Paper provided by Philipps-Universität Marburg, Faculty of Business Administration and Economics, Department of Economics (Volkswirtschaftliche Abteilung) in its series MAGKS Papers on Economics with number 200812.

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Length: 37 pages
Date of creation: 2008
Date of revision:
Publication status: Forthcoming in
Handle: RePEc:mar:magkse:200812

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Related research
Keywords: FDI; Portfolio Investment; Risk Diversification; endogeneous Productivity;

Find related papers by JEL classification:
F21 - International Economics - - International Factor Movements and International Business - - - International Investment; Long-Term Capital Movements
F23 - International Economics - - International Factor Movements and International Business - - - Multinational Firms; International Business
G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

This paper has been announced in the following NEP Reports:

References listed on IDEAS
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  1. Elhanan Helpman, 2006. "Trade, FDI, and the Organization of Firms," Journal of Economic Literature, American Economic Association, vol. 44(3), pages 589-630, September.
    Other versions:
  2. Holt, Richard W. P., 2003. "Investment and dividends under irreversibility and financial constraints," Journal of Economic Dynamics and Control, Elsevier, vol. 27(3), pages 467-502, January. [Downloadable!] (restricted)
    Other versions:
  3. James R. Markusen & Keith E. Maskus, 2001. "General-Equilibrium Approaches to the Multinational Firm: A Review of Theory and Evidence," NBER Working Papers 8334, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  4. Gene M. Grossman & Elhanan Helpman & Adam Szeidl, 2003. "Optimal Integration Strategies for the Multinational Firm," Harvard Institute of Economic Research Working Papers 2024, Harvard - Institute of Economic Research. [Downloadable!]
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  5. Chuhan, Punam & Perez-Quiros, Gabriel & Popper, Helen, 1996. "International capital flows : do short-term investment and direct investment differ?," Policy Research Working Paper Series 1669, The World Bank. [Downloadable!]
  6. Joshua Aizenman & Nancy Marion, 2001. "The Merits of Horizontal versus Vertical FDI in the Presence of Uncertainty," NBER Working Papers 8631, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  7. Dunning, John H, 1973. "The Determinants of International Production," Oxford Economic Papers, Oxford University Press, vol. 25(3), pages 289-336, November. [Downloadable!] (restricted)
  8. Helpman, Elhanan & Melitz, Marc J & Yeaple, Stephen R, 2003. "Export versus FDI," CEPR Discussion Papers 3741, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  9. Assaf Razin & Ashoka Mody & Efraim Sadka, 2002. "The Role of Information in Driving FDI: Theory and Evidence," NBER Working Papers 9255, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  10. Gene M. Grossman & Elhanan Helpman & Adam Szeidl, 2005. "Complementarities between Outsourcing and Foreign Sourcing," American Economic Review, American Economic Association, vol. 95(2), pages 19-24, May. [Downloadable!]
  11. Assaf Razin, 2002. "FDI Contribution to Capital Flows and Investment in Capacity," NBER Working Papers 9204, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  12. Daron Acemoglu & Philippe Aghion & Rachel Griffith & Fabrizio Zilibotti, 2004. "Vertical integration and technology: theory and evidence," IFS Working Papers W04/34, Institute for Fiscal Studies. [Downloadable!]
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  13. Dixit, Avinash K & Stiglitz, Joseph E, 1977. "Monopolistic Competition and Optimum Product Diversity," American Economic Review, American Economic Association, vol. 67(3), pages 297-308, June. [Downloadable!] (restricted)
    Other versions:
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