Adapting to Brexit: the Response of Corporate Structures to Geopolitical Uncertainty

Geopolitical uncertainty alters the incentives of firms to organise their corporate structure across borders, creating a distinct margin of adjustment in response to policy risk. We study this margin using the Brexit referendum as a quasi-natural experiment. We combine firm level data on parent-subsidiary links for UK and EU firms between 2011 and 2021 with measures of Brexit-related uncertainty and study changes in foreign subsidiary formation at the extensive margin. Following the referendum, there was an increase in the number of subsidiary formation from the UK into the EU, while the number of EU firms that expanded with subsidiaries into the UK dropped. UK firms establishing their first EU subsidiary after the referendum were systematically weaker ex ante than comparable firms that did so before the referendum. Increased Brexit-related uncertainty is associated with increased foreign subsidiary formation from the UK into the EU, driven primarily by small firms, alongside suggestive evidence of decreased domestic subsidiary incorporation by UK firms. We interpret these findings as evidence of a 'precautionary' foreign direct investment channel, operating through changes in the corporate structures of firms in response to geopolitical uncertainty.