A tale of two property rights: Knowledge, physical assets, and multinational firm boundaries

Abstract

The theory of multinational firm boundaries has been shaped by two major paradigms: an earlier one, emphasizing the role of integration in preventing the dissipation of knowledge, and a more recent one, stressing the role of firm boundaries in mitigating underinvestments into relationship-specific assets in the face of contractual incompleteness. This paper develops a novel model encompassing both approaches in a unifying framework. The model predicts that the attractiveness of integration increases in the importance of the parent firm's knowledge capital and decreases in the importance of the affiliate's physical capital in a joint production process. Furthermore, stronger intellectual property rights (IPR) protection in the affiliate's country is predicted to mitigate the effect of knowledge intensity on the attractiveness of integration. I test these hypotheses using unique panel data on more than 100,000 firm pairs worldwide. In line with the model's predictions, knowledge-intensive parent firms choose higher ownership shares in their affiliates, yet this relationship is less pronounced the stronger the IPR protection in the affiliate's country. In addition, higher physical capital intensity of the affiliate is associated with lower ownership shares. These findings are robust to controlling for unobserved heterogeneity across countries, industries, and firms, providing strong support for the unifying theory of multinational firm boundaries.