Foreign Direct Investment (FDI) versus other entry modes has gained the attention of trade researchers and become one of the most debated topics in international economics. For the multinational enterprises (MNEs) investing overseas can enlarge product market, optimize the costs, and bring profits. On the other hand, the foreign entrants bring products, capital, technology, etc. for the host country.
MNEs investing in R&D with innovative technologies are likely to result in transferring valuable foreign technology to the host country. Blomström and Kokko (1997) denote that R&D spillovers occur when local firms benefit from MNEs’
superior technologies without having to incur a cost. To shrink the technological gap, local firms may learn the knowledge from MNEs by imitation (Lin and Saggi 1999).
Aitken and Harrison (1999) and Branstetter (2000) indicate that FDI provides an important channel to facilitate the diffusion of knowledge by overcoming geographic constraint.
The way of MNEs’ entry may change the technology level, domestic market structure, and the welfare of the host country. The two most important entry modes of FDI are: building a new establishment (direct entry or called Greenfield investment), or merging or acquiring an existing local firm (M&A). In both modes, the host country assets will be under the governance of MNEs. The increase in FDI through M&As has raised some concerns for policy makers who are anxious about MNE’s takeovers of domestic firms. As a result, many countries tend to encourage inflows of direct entry.
The entry mode choice of FDI has attracted much attention in economic research.
Buckley and Casson (1998) conclude that the market structure as well as the strength of market competition has crucial impact on the entry decision. Görg (2000) analyze the effect of market structure on the choice between Greenfield investment and acquisition in a Cournot-type setting. Bjorvatn (2004) considers the interaction between M&A, Greenfield investment and trade, and Nocke and Yeaple (2007) examine the choice of FDI mode between M&A and Greenfield investment. Müller (2007) shows that direct entry is the optimal mode of entry only if the technological gap between the competitors is sufficiently large. In larger markets, M&A is relatively favorable. Furthermore, he finds that the competition intensity within a market can influence the choice of entry mode. Qiu and Wang (2011) show that Greenfield investment incurs a fixed plant setup cost, whereas the foreign firm obtains only a share of the joint profit from a cross-border merger under the restriction of the FDI policy. It indicates that the trade-off is affected by market demand, cost differential, and market competition, among other things. The host country’s government
chooses its FDI policy to affect (or alter) the multinational’s entry mode to achieve the maximum social welfare for the domestic country.
The above studies did not consider the effects of endogenous R&D investment choice in the mode decision of entry by foreign firms. Mattoo et al. (2004) develop a three-stage game where FDI can occur through either direct entry or M&A. The foreign firm decides the R&D investment after choosing the mode of entry. The final stage of the game is the output competition in which the foreign firm competes in the host country with domestic firms. They find that the trade-off between technology transfer and market competition emerges as a crucial determinant of preferences. In addition, it indicates that the existence of the clash between the foreign firm’s choice and the host government’s ranking of the two modes of entry provides a rationale for
FDI restriction policies.
Tang and Yu (1990) examine entry modes including foreign direct investment, exclusive licensing, multiple licensing, joint venture, and a combination of joint venture and licensing. They show that even though the entering firm is able to charge the optimal licensing fee, foreign investment generates the highest profit and is the dominant entry strategy in many contexts. Recently, Raff et al. (2009) show that when Greenfield investment is also a viable option, MNE may prefer a joint venture to M&A, and M&A to Greenfield investment, provided that M&A and joint venture both involve sufficiently low fixed costs.
Although Mattoo et al. (2004), Mukherjee (2006) and Raff et al. (2009) provide models to discuss the relationship between mode of foreign entry and R&D, Ishikawa et al. (2009) examine the effects of technology transfer to JVs, elaboration of the role of R&D spillover acting on the choice of the entry mode and the affiliate of R&D activities is still much needed. As we’ve mentioned above, technology spillover always prevails with FDI; furthermore, the foreign firm and the host country care about mode preferences and social welfare, respectively. On such a basis, the model should be framed to account for the features which nowadays characterize the
internationalization process; capturing the effect of R&D spillover and the implication of equity restriction on foreign entry of FDI. Wang and Wang (2011) mainly extend Mattoo et al. (2004) by introducing R&D spillovers to characterize the prevalent phenomenon on FDI. It examines how investment costs, technological spillover, market size, and ownership constraints affect the choice of foreign entry, the host country’s welfare and R&D level in the industry.
In chapter two, we intend to explore how technological spillover affects foreign entry mode choice (Greenfield investment, JV, M&A, and Combination of licensing
with export), R&D level, and the consumer welfare. It finds that the strategic effect on profits decreases as R&D spillover increases in entry modes except licensing. R&D investment under M&A is always to be the highest one. Since the technology level in the industry depends on the individual firm’s investment, better technology is always chosen under M&A than other entry modes. For the foreign firms as well as the domestic consumer, the producers’ entry preference coincides with the consumer welfare when the technology spillover rate is in a certain range.
The literature on the social efficiency of entry in oligopolistic markets gets momentum with the work by Mankiw and Whinston (1986). It shows that free entry with scale economies is socially excessive in the oligopolistic markets. This result, often called “excess-entry theorem”, provides a justification for anti-competitive entry regulation, and has attracted attention of the researchers for long time.
As Vives (1988) suggests, whether entry is excessive or insufficient is not of purely academic interest. In many countries, governments take actions to foster or deter entry into particular industries. For example, in the post-war period, preventing excessive entry was a guiding principle in the Japanese industrial policy (see, for example, Suzumura and Kiyono, 1987; Suzumura, 1995). Komiya (1975) pointed out the industries such as petrochemicals and certain other chemical industries with a tendency to develop excessive competition, and it appears that the excessive-entry theorem can justify this phenomenon.
While these literatures mainly concentrates on industries with scale economies and symmetric cost firms, Ghosh and Saha (2007) provide a new perspective to this literature by analysing social efficiency of entry under cost asymmetry and no scale economies. They show that entry can be socially excessive even if there are no scale economies. Mukherjee A (2012) shows that exogenous cost asymmetry is responsible
for the result of Ghosh and Saha (2007). In a simple model with R&D investment by the more cost efficient firm, thus creating endogenous cost asymmetry, they show that entry is socially insufficient instead of excessive if the slope of the marginal cost of R&D is not very high. Hence, if the cost asymmetry is determined endogenously, the anti-competitive entry regulation policies may not be justifiable in the absence of scale economies. Considering symmetric cost firms, Zhao (2009) shows that if there are diseconomies of scale, constant economies of scale or weak economies of scale, entry of firms increases welfare. The excess-entry result of Ghosh and Saha (2007) and Mukherjee A (2012) suggest that the result of Zhao (2009) may not hold in the presence of cost asymmetries.
In chapter three, we extend Mukherjee (2012) and consider endogenous cost asymmetry created by the R&D investment of the incumbent firm. We show that whether entry is excessive or insufficient depending on the degree of knowledge spillover and the substitutability between the products. Furthermore, we show that if the spillover rate has a certain relationship with the substitutability between the products, then entry is socially insufficient in the endogenous cost asymmetry framework. This result is consistent with the conclusion of Mukherjee (2012).
Since the works of Bain (1956) and Sylos-Labini (1962), the issue of entry has received a great deal of attention. In an influential paper, Seade (1980) shows that while entry may increase or reduce the incumbents’ outputs, it always reduces their profits. This result is based on two important assumptions. First, pre and post entry product-market competition is characterized by Cournot competition. Second, all firms are symmetric in terms of production costs. However, often there are situations when neither of these assumptions holds. Spence (1977), Dixit (1980), Spulber (1981), Fershtman and Judd (1987) and Basu and Singh (1990), for example, pre-commitment
strategies by incumbent firms may help them to behave like Stackelberg leaders.
Further, cost asymmetry rather than symmetry is perhaps the empirical regularity.
Mukherjee and Zhao (2009) relax the two above-mentioned assumptions and examine the effects of entry on outputs and profits, in a simple framework of two incumbents and one entrant. Specifically, they allow the incumbents to differ in marginal costs, and assume that they compete in the Cournot fashion between themselves while behaving as Stackelberg leaders against the entrant. They find that the entry of a cost inefficient firm increases both the output and profit of the cost efficient incumbent, while it reduces the profit but has an ambiguous effect on the output of the cost inefficient incumbent.
In chapter four, we explore the possible strategies for the incumbents and the entrant respectively, and demonstrate that those strategies lead to a win-win result in the endogenous cost asymmetry framework if the coefficient of cooperation and the given cost difference have a certain relationship. We also show that the consumer surplus is better off in the presence of non-drastic R&D. This suggests that the entrant doing non-drastic cost-saving R&D leads to a three-way win result and benefits the whole society.