This paper analyzes the effects of demand risk on the location and sales structure of multinational firms. We build a structural model of horizontal FDI with firms that are heterogeneous in terms of risk aversion and productivity. Firms decide on the location of their production plants, the set of countries to serve from these plants, and the volume of sales for each plant. These decisions hinge both on the expected demand for each market and the correlation structure of demand realizations across destination markets. Ceteris paribus, markets that offer better hedging opportunities to multinationals induce larger sales and are more attractive locations for production. We use firm-level data for German multinational companies to estimate firm-specific risk aversion coefficients as well as other model parameters. We find that multinationals are heterogeneously risk averse. Finally, in a counterfactual analysis, we show how a reduction in tariffs for goods imported into China changes the trade flows to the other countries, the sign of the change depending on the correlation structure.
This paper studies foreign-market entry patterns in the professional services industry. We build a structural model of horizontal foreign direct investment (FDI) with firms that are heterogeneous in terms of service quality. Firms can choose to serve foreign markets via exporting, cross-border mergers (M&A), or greenfield investment. Greenfield investment and exporting are subject to the standard proximity-concentration tradeoff and, in addition, associated with uncertainty about foreign quality perception, while M&A resolves this uncertainty by allowing multinationals to get access to the demand of the acquired firm. Reproduction of high quality abroad potentially requires larger fixed entry costs, inducing high-quality service firms to export. The model is sufficiently flexible to accommodate different orderings of entry types in terms of firm’s service quality. We then structurally estimate the fundamental market-specific parameters of the model using firm-level FDI and trade data for a sample of German firms. We find that entry patterns are reversed compared to the standard sorting in manufacturing: only the firms providing the highest service quality export, while lower-quality firms conduct FDI. The relative sorting of M&A vs. greenfield FDI in terms of firm quality is market-specific and depends on the relative importance of uncertainty about quality perception, the structure of entry costs, and size of synergies associated with M&A. Finally, we calibrate the model equilibrium to the data on multinational and trade flows between the EU, the US, and the rest of the world. Simulation of the service-trade liberalization between the EU and the US, as planned for TTIP (Transatlantic Trade and Investment Partnership), shows that the reduction of non-tariff trade barriers and introduction of quality standards reallocate quality across entry alternatives, as well as make FDI a more prominent entry type.
Work in progress:
Joint with Niccolò Lomys
We study the role of diverse learning skills in games of competitive experimentation (e.g., an R&D race). We find that heterogeneous innovation abilities across competitors strongly affect the type and the magnitude of the inefficiencies that arise in equilibrium. As a consequence, industrial policies targeting inefficiencies in R&D should take into account the asymmetry in the firms’ learning process not to be detrimental.
Information about products available in the market plays a crucial role in determining consumers’ purchasing decisions. Market elaborates two responses to lack of information. On the demand side, consumers acquire information on the price and product features before any purchasing decision. On the supply side, firms make use of informative advertising. I study a horizontally differentiated duopoly where consumers do not observe ex ante the price and product characteristics and can engage in costly search activities in an ordered way. Firms are asymmetric with respect to their prominence and possibly transmit information by truthfully advertising prices and product features. The presence of informative advertising crucially affects the order in which consumers search over the available alternatives. I find that advertising incentives are larger for the non-prominent firm. For the consumers, the search effort saving induced by informative advertising comes at a cost of larger prices charged by the firms.