Abstract
This study investigates how the structure of a domestic firm-to-firm transaction network influences the foreign direct investment (FDI) decisions of embedded firms in the network. We theoretically describe firms’ FDI decisions using an incomplete information game that considers the firm-to-firm transactions of intermediate inputs and in which firms have an incentive to collocate with their trading partners in foreign markets. We show that the probability of a firm engaging in FDI increases with its Katz–Bonacich centrality, which is defined as aggregated accessibility to all other firms and represents expected profit gained from colocation with its partners. We empirically show that this prediction is supported using disaggregated inter-firm transaction network data on Japanese firms. We also extended both theoretical and empirical frameworks to consider the dynamic aspect of FDI. When we consider existing foreign affiliates, accessibility to prior investors in the transaction network, named Katz–Bonacich accessibility, positively influences FDI as well as Katz–Bonacich centrality.
Highlights
Many firms enjoy the benefits of extending their market or accessing cheap production resources from foreign direct investment (FDI)
This study investigated how the structure of a domestic market’s firm-to-firm transaction network influences the FDI of embedded firms
Our model begins by assuming that each firm trades intermediate inputs with its domestic transaction partners for describing colocation incentives of firms when they choose to conduct FDI
Summary
Many firms enjoy the benefits of extending their market or accessing cheap production resources from foreign direct investment (FDI). Our paper explicitly adopts the mechanism via which a transaction yields an additive profit compared to a new transaction and the mechanism via which each product price is endogenously determined to share the profit between the seller and the buyer, whereas previous network games begin with an ad-hoc payoff function The provision of such a microfoundation in the presented network game enables us to explain why the colocation of trading firms is beneficial, how the FDI incentive spreads across networks, and, more importantly, how FDI is affected by several structural parameters such as local procurement costs in domestic and foreign markets.
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