Foreign Market Entry Strategies under Asymmetric Information*

Nastasi, Alberto; Reverberi, Pierfrancesco

doi:10.1111/j.1467-9396.2007.00681.x

Cited by 2 publications

(1 citation statement)

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“…Long, Raff, and Stähler () consider a model with imperfect knowledge about rivals' production costs, but they rule out FDI in order to focus on export behavior and the role of R&D under private information. In Katayama and Miyagiwa (), product quality is unknown and FDI is used to signal quality to consumers, whereas in Nastasi and Reverberi (), a firm uses FDI as a signaling device to deter market entry. In a model of asymmetric information about demand conditions, Moner‐Colonques, Orts, and Sempere‐Monerris () show that firms may have an additional incentive to undertake FDI: to obtain more accurate demand information in the foreign market.…”

Section: Introductionmentioning

confidence: 99%

Foreign direct investment as a signal

Koska

Long

Stähler

2017

Rev International Economics

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This paper models oligopolistic competition among potential multinational firms in an environment of firm heterogeneity, incomplete information on costs, and strategic interactions. We show that foreign direct investment is more likely if it can serve as a signal of productivity in an environment of incomplete information as firms would like to avoid sending a low productivity signal. Our model shows that this effect is strong enough such that foreign direct investment can be an optimal foreign entry mode even if trade costs are zero. | IN TRO DUCT IO NWhy has foreign direct investment (FDI) become the major driver of economic integration although trade has been liberalized at the same time? FDI has become more important than trade, as evidenced by the fact that sales by foreign affiliates have outnumbered export since 1980s. How can trade liberalization be aligned with the surge in FDI? In this paper, we explore how FDI as a signal of productivity contributes to the proliferation of multinational enterprises. To do so, we discuss FDI in the context of incomplete information. We know that multinationals' large R&D investments and intensive use of professional and technical workers generate proprietary knowledge (patents, blueprints, technical know-how, or reputation), and are considered as an important source of firm heterogeneity.1 But most models employ monopolistic competition, which by definition lacks strategic interactions, or consider FDI in a world of complete information. Given that multinational firm boundaries are drawn such that rival firms should not exactly know the value of specific assets, it seems natural to ask what the effect of incomplete information is. For example, if a local firm observes the establishment of a foreign subsidiary, but does not know its productivity, it may nevertheless rationally infer that it now faces a strong rival. Thus, the observation of a foreign firm's FDI will have an effect on domestic firm behavior. It is this effect we are interested in: what happens if FDI sends a message of high productivity in an environment of firm heterogeneity? We explore this effect in two ways. First, we compare the case where FDI sends a signal, which influences rival's output decision, with the case where output decisions must be made prior to the observation about FDI. 2 We show that, for a given fixed FDI cost, both the probability of FDI and the expected industry output are greater under the signaling scenario. Second, we compare the FDI signal with the case of complete information, and we find that incomplete information with the signaling ability makes firms more aggressive on average. The reason is that a firm wants to avoid being perceived by its rival as a low productivity firm, and this incentive makes firms more likely to undertake FDI even if their productivity is not very high, compared with the case of complete information in which productivities are known. Most importantly, this signaling effect is so strong that FDI may even occur when trade costs are zero. Thu...

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Section: Introductionmentioning

confidence: 99%