Interactions between domestic and foreign investment

This paper examines the domestic and foreign fixed investment expenditures of a sample of U.S. multinational firms to explain empirically each type of investment and to determine whether there are significant interactions between them. Models exhibiting two types of interactions, one, financial and the other, production-based, are explored theoretically and empirically. The financial interaction is the result of a model which assumes a risk of bankruptcy and its associated costs; under these circumstances, the firm faces an increasing cost of capital as a function of its debt/equity ratio. Domestic and foreign invest-ment are interdependent, since, in competing for finance, each affects the cost of capital in the other location. Production interactions can arise when, because of start-up costs or other factors that produce nonlinear cost functions, it may become profitable to shift production from the home to the foreign location. The hypotheses are tested on data covering the domestic and foreign opera-tions of seven multinational firms for a period of 16 to 20 years. The firm-level investment functions fit reasonably well for both domestic and foreign expenditures; an interdependence between domestic and foreign investment was confirmed frequently through the finance side, but only once via production