Foreign Direct Investment and the Role of Financial Restrictions

Despite the costs firms face when entering foreign markets, the literature on multinational firms has been surprisingly silent about the financing of foreign activities. The implicit assumption in most models is that financial markets are fully developed and that firms can either finance foreign operations internally and/or by incurring an external finance premium. This assumption is clearly at odds with the large literature on financial restrictions which impede in particular smaller firms from operating abroad. 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.

This research project has provided new firm-level evidence on the role of financial frictions and credit constraints on firms’ foreign expansions. We departed from the existing literature in two important ways: First, we used plant-level data from the IAB establishment panel, which provides representative information on key aspects of firm behaviour. Second, in line with Helpman et al. (2004), we broadened the scope of internationalisation strategies in order to examine both, the decision to export as well as the decision to engage in FDI in a single empirical framework.