Working Paper: CEPR ID: DP7073
Authors: Yongmin Chen; Ignatius J. Horstmann; James R. Markusen
Abstract: There exist two approaches in the literature concerning the multinational firm's mode choice for foreign production between an owned subsidiary and a licensing contract. One approach considers environments where the firm is transferring primarily knowledge-based assets. An important assumption there is that the relevant knowledge is absorbed by the local manager or licensee over the course of time: knowledge is non-excludable. More recently, a number of influential papers have adopted a property-right view of the firm, assuming the application abroad of physical capital, the owner of which retains full and exclusive rights to the capital should a relationship break down. In this paper we combine both forms of capital assets in a single model. The model predicts that foreign direct investment (owned subsidiaries) is more likely than licensing when the ratio of knowledge capital to physical capital is high, or when market value is high relative to the book value of capital (high Tobin's-Q).
Keywords: FDI; Holdup; Knowledge Capital; Outsourcing; Physical Capital
JEL Codes: F2; F23; L2; L22; L23
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| physical capital intensity (E22) | licensing or outsourcing (L24) |
| knowledge capital intensity (E22) | establishing subsidiaries (FDI) (F23) |
| ownership of physical capital protects returns on knowledge capital (P14) | preference for FDI in knowledge-intensive industries (F23) |
| stronger protections for knowledge capital (O34) | incentive for licensing increases relative to FDI (F23) |
| ratio of knowledge capital to physical capital (E22) | choice between FDI and outsourcing (F23) |
| market value relative to book value of capital (Tobin's q) (G31) | choice between FDI and outsourcing (F23) |