Regional Trust, Liabilities of Foreignness and the Location Decision of Multinational Firms in Europe

Abstract

When investing in a foreign country, multinational enterprises face social, political and organizational information asymmetries. This liability of foreignness (LOF) introduces additional costs, threaten profitability and deter foreign direct investments. In this study we investigate if certain regions are better able to mitigate these liabilities, and therefore attract more greenfield investments. We identify regional trust, defined as the society average for interpersonal trust per region, as potential mediator of the LOF. Using European cross-sectional data from 2003-2011 on the number of cross-border greenfield investments and the regional level of trust, we confirm that the level of regional trust positively affects the number of investments that a region receives. The effect of regional trust is sizable (factor 1.65 and above per one unit increase in regional trust). Firms with a higher probability of facing a LOF (operationalized by geographic, institutional and genetic distance between the home and host country) more often locate in regions with a higher level of trust. We show that this result is robust against endogeneity.