A Signalling Model of Firms' Foreign Direct Investment Relocation Decision
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.
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