Foreign Direct Investment and the Role of Financial Restrictions

Considering uncertainty about future productivity and the costs of entering foreign markets, the literature of the Multinational Firm has been surprisingly silent about the financing of foreign activities. The implicit assumption is that financial markets are fully developed and that firms can either finance foreign operations internally and/or with incurring an external finance premium. This assumption is clearly at odds with the large literature on financial restrictions that in particular smaller firms are facing. If cross-border investments involve fixed costs and if firms have insufficient internal funds at their disposal, entering foreign markets may be too costly for some firms. Small firms might be particularly affected since, for these firms, information asymmetries tend to be pervasive.

Therefore, this research project will provide new firmlevel evidence on the role of financial frictions an credit constraints on firms’ foreign expansions.

In the seminal paper by Melitz (2003) firm productivity is the key variable affecting a firm´s ability to expand abroad, financing (or other) constraints are not considered. In a more recent paper, Manova (2006) uses a Melitz-type model to analyze the impact of credit-constraints on the decision to export. Her results suggest that, given a firm´s productivity level, possible financing constraints could deteriorate a firm´s possibilities to export.

We depart from the existing literature in two important ways: First, instead of aggregating the data, we use plant level data. Second, in the lines of Helpman et al. (2004) we broaden the scope of internationalization strategies in order to examine both, the decision to export as well as the decision to make FDI in a single empirical framework. We will make use of the IAB Betriebspanel, a detailed plant-level survey of German establishments, which provides representative information on key aspects of firm behavior.