FDI Mode of Entry and Acquistion of Firms Specific Assets (Incomplete. Comments are welcome)

We develop a partial equilibrium model of Foreign Direct In-vestment (FDI) with oligopolistic competition where FDI emerges as an alternative to exporting when trade costs are high. Two ma-jor FDI modes are considered: mergers and acquisitions (M&A) and greenfield investment. Cross-border mergers arise as a means to acquire firm-specific assets that improve the competitive po-tential of the foreign firm in two ways: 1) they can reduce its op-erating cost in the market entered —efficiency-enhancing effect– and 2) they allow him to eliminate part of the competition in that market —competition-reducing effect. The benefit from the first effect depends on how sucessfully the foreign firm can integrate the target into its structure, whereas the competition-reducing effect always applies. We depart from previous models in that we endogenize the size of the target acquired, and show that if the foreign firm can choose its optimal target, acquisition is always profitable. Furthermore, M&A is preferred to greenfield, unless the investing firm is very efficient to start with or the specific as-sets are not very important in the market entered. We empirically test the model by estimating a probit model on FDI entries into U.S. manufacturing for the period 1981-93. Our results are con-sistent with the theory. Foreign investors seem to use M&A as a way to acquire specific assets, as the frequency of M&A is higher in sectors with high average advertising and RD intensities, and this effect is larger for anglosaxon countries. ∗I would like to thank Robert Feenstra, James Markusen, Giovanni Peri and Deborah Swenson for useful discussions and comments on earlier versions of this paper. Similarly, I would like to thank participants at the U.C.Davis Internationa