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Multiple finances, margins of foreign direct investment and aggregate industry productivity

  • Lei Hou

    (PhD candidate at the Department of Economics, University of Munich, Germany)

  • Jiarui Zhang

    (PhD candidate at the Department of Economics, University of Munich, Germany)

Registered author(s):

    Based on a heterogeneous firm set-up, we model firms’ access to the internal capital market, bank finance as well as bond finance and investigate how firms’ adjustment among multiple sources of finance affects their performance in foreign direct investment and aggregate industry productivity. We find that when facing a bank credit shock (e.g. tighter bank lending), firms with different productivities react differently. Less productive firms exit from the foreign market due to a lack of funds while the more productive resort to bond finance to sustain their multinational status. The increased demand for bond finance as compensation for decreased bank finance by the surviving multinationals exacerbates the competition in the bond market and bids up the bond return rate, which triggers a Melitz-type selection effect through the bond market and brings aggregate industry gains. However, the divestment of those failing FDI firms and the consequently reduced bond financing demand mitigate this effect.

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    Article provided by Institute of Public Finance in its journal Financial Theory and Practice.

    Volume (Year): 36 (2012)
    Issue (Month): 1 ()
    Pages: 1-28

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    Handle: RePEc:ipf:finteo:v:36:y:2012:i:1:p:1-28
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