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A Signalling Model of Firms' Foreign Direct Investment Relocation Decision

Author

Listed:
  • Rosa Forte

    () (CETE, Faculdade de Economia, Universidade do Porto)

  • António Brandão

    () (CETE, Faculdade de Economia, Universidade do Porto)

Abstract

The present work analyzes the multinational firm's decision concerning the relocation of production from a country where it is currently settled, to another foreign country, assuming that the government of this country has private information on his specific type (type G or type B, with the former reflecting better investment conditions than the latter) which is not available to the multinational firm (MNF). We develop a signalling model in which the foreign country's government (agent) signals the MNF (principal) about the amount of subsidy that it is able to grant, in order to motivate the MNF to relocate production. Comparing this situation with a situation of adverse selection we conclude that in the signalling model the MNF always relocates to a type G country whereas in adverse selection the MNF relocates only if the country has some characteristics, that is, the country must be the most efficient. In addition, the necessary subsidy is smaller than the subsidy demanded in adverse selection. Therefore, the foreign country government, by revealing the information concerning its type, can save in terms of the amount of subsidy that it has to grant. In this way, the influence of signalling on the MNF's relocation decision can explain the recent proliferation of Investment Support Agencies worldwide.

Suggested Citation

  • Rosa Forte & António Brandão, 2006. "A Signalling Model of Firms' Foreign Direct Investment Relocation Decision," CEF.UP Working Papers 0601, Universidade do Porto, Faculdade de Economia do Porto.
  • Handle: RePEc:por:cetedp:0601
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    1. Gordon H. HANSON, 2001. "Should Countries Promote Foreign Direct Investment?," G-24 Discussion Papers 9, United Nations Conference on Trade and Development.
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    Keywords

    Multinational firms; Relocation of production; Signalling model;

    JEL classification:

    • D21 - Microeconomics - - Production and Organizations - - - Firm Behavior: Theory
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • F23 - International Economics - - International Factor Movements and International Business - - - Multinational Firms; International Business

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