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

Author

Listed:
  • 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)

Abstract

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.

Suggested Citation

  • Lei Hou & Jiarui Zhang, 2012. "Multiple finances, margins of foreign direct investment and aggregate industry productivity," Financial Theory and Practice, Institute of Public Finance, vol. 36(1), pages 1-28.
    • Handle: RePEc:ipf:finteo:v:36:y:2012:i:1:p:1-28
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    File URL: http://www.ijf.hr/upload/files/file/FTP/2012/1/hou-zhang.pdf
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    Cited by:

    1. Carsten Eckel & Florian Unger, 2023. "Credit Constraints, Endogenous Innovations, And Price Setting In International Trade," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 64(4), pages 1715-1747, November.

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