Foreign Direct Investment
1. A firm becomes a multinational enterprise when it undertakes foreign direct investment.
2. Licensing involves the establishment of a new operation in a foreign country.
3. If a firm that makes bicycles in Germany acquires a French bicycle producer, Greenfield
investment has taken place.
4. The amount of FDI undertaken over a given time period is known as the flow of FDI.
5. The total accumulated value of foreign-owned assets at a given time is the inflow of FDI.
6. FDI is seen by executives as a means of circumventing future trade barriers.
7. Historically, most FDI has been directed at the developed nations of the world as firms based
in advanced countries invested in the others' markets.
8. The total amount of capital invested in factories, stores, office buildings and the like is
referred to as the stock of FDI.
9. The largest source country for FDI has been China.
10. About 27 percent of the world's largest 100 nonfinancial multinationals in 2004 were
American companies.
11. In developing countries, about one third of FDI is in the form of mergers and acquisitions.
12. In 2004, about two thirds of FDI stock was in service industries.
13. As compared to exporting and licensing, FDI is the more expensive and risky.
14. Internalization theory is also known as the market imperfections approach.
15. One of the problems of licensing is that it may result in a firm's giving away valuable
technological know-how to a potential foreign competitor.
16. An oligopoly is an industry composed of a limited number of large firms.
17. When two or more enterprises encounter each other in different regional markets, national
markets or industries regional competition occurs.
18. According to Vernon, location specific advantages can help explain the nature and direction
of FDI.
19. Dunning, in the eclectic paradigm theory, suggests that a firm must establish production
facilities where foreign assets or resource endowments necessary to the production of the
product exist.
20. Pragmatic nationalism traces its roots to Marxist political and economic theory.
21. Classical economics and the international trade theories of Adam Smith and David Ricardo
form the basis for the free market view.
22. The free market view argues that FDI is a benefit to both the source country and to the host
country.
23. Countries adopting a pragmatic stance pursue policies designed to maximize the national
benefits and minimize the national costs.
24. An aspect of pragmatic nationalism is the tendency to aggressively court FDI believed to be
in the national interest by, for example, offering subsidies to foreign MNEs in the form of tax
breaks or grants.
25. Foreign direct investment can make a positive contribution to a host economy by supplying
capital, technology and management resources that would otherwise not be available and thus
boost that country's economic growth rate.
26. There is research supporting the view that multinational firms often transfer significant
technology when they invest in a foreign country.
27. Jobs created in local suppliers as a result of the MNE's investment and jobs created because
of increased local spending by employees of the MNE are examples of direct employment
effects of FDI.
28. Host country citizens that are employed by an MNE following an FDI are an example of an
indirect effect of FDI.
29. A country's balance of payments accounts keep track of both its payments to and its receipts
from other countries.
30. A current account deficit exists when a country imports more than it exports.
31. In recent years, the U.S. has run a persistent balance of payments surplus.
32. Host governments sometimes worry that the subsidiaries of foreign MNEs may have greater
economic power than indigenous competitors.
33. FDI does not benefit the host country's balance of payments if the foreign subsidiary creates
demand for home-country exports of capital equipment, intermediate goods or complementary
products.
34. The term offshore production refers to FDI undertaken to serve the home market.
35. Countries cannot prohibit national firms from investing in certain countries for political
reasons.
36. The two most common methods of restricting inward FDI are ownership restraints and
performance requirements.
37. The WTO has been very successful in efforts to initiate talks aimed at establishing a
universal set of rules designed to promote the liberalization of FDI.
38. Licensing is a good option for firms in high-tech industries where protecting firm-specific
expertise is of paramount importance.
39. Typically licensing will be a common strategy in oligopolies where competitive
interdependence requires that multinational firms maintain tight control over foreign operations
so that they have the ability to launch coordinated attacks against their global competitors.
40. Licensing is more common in fragmented, low-tech industries in which globally dispersed
manufacturing is not an option.
Multiple Choice Questions
41. FDI occurs when a
A. Domestic firm imports products and services from another country
B. Firm ships its product from one country to another
C. Firm invests in the stock of another company
D. Firm invests directly in facilities to produce and/or market a product in a foreign country
42. A Greenfield investment
A. Is a form of FDI that involves the establishment of a new operation in a foreign country
B. Involves a 7 percent stock in an acquired foreign business entity
C. Involves a merger with a foreign business
D. Occurs when a firm acquires another company in a foreign country
43. If General Electric, a U.S. based corporation, purchased a 50% interest in a company in
Italy, that purchase would be an example of a(n)
A. Minority acquisition
B. Outright stake
C. Majority acquisition
D. Greenfield investment
44. The amount of FDI undertaken over a given time period is
A. The flow of FDI
B. The stock of FDI
C. The FDI outflow
D. The FDI inflow
45. The stock of FDI is
A. The amount of FDI undertaken over a given period of time
B. The total accumulated value of foreign owned assets at a given time
C. The flow of FDI out of a country
D. The flow of FDI into a country
46. FDI has been rising for all of the following reasons, except
A. The globalization of the world economy
B. The general increase in trade barriers over the past 30 years
C. Firms are trying to circumvent trade barriers
D. There is a shift toward democratic political institutions and free market economies
47. Historically, most FDI has been directed at the _____ nations of the world as firms based in
advanced countries invested in
A. Underdeveloped, underdeveloped countries
B. Developed, underdeveloped countries
C. Developed, each other's markets
D. Underdeveloped, each other's markets
48. The U.S. has been an attractive target for FDI because of all of the following reasons,
except
A. Its small and wealthy domestic markets
B. Its dynamic and stable economy
C. Its favorable political environment
D. Its openness to FDI
49. Identify the incorrect statement regarding the direction of FDI.
A. Historically, most FDI has been directed at the developing nations of the world
B. During the 1980s and 1990s, the United States was often the favorite target for FDI inflows
C. The developed nations of the EU have received significant FDI inflows
D. Recent inflows into developing nations have been targeted at the emerging economies of
South, East and Southeast Asia
50. Africa is not a popular destination for FDI because of all of the following reasons, except
A. Political unrest in the region
B. Armed conflict in the region
C. Liberalization of FDI regulations
D. Frequent policy changes in the region
51. The total amount of capital invested in factories, stores, office buildings and the like is
summarized by
A. Gross fixed capital formation
B. Total investment capital
C. Total tangible investment
D. Gross depreciable investments
52. The largest source country for FDI since World War II has been
A. Japan
B. China
C. The United States
D. The United Kingdom
53. Most cross-border investment is
A. In the form of Greenfield investments
B. Made via mergers and acquisitions
C. Between American and Japanese companies
D. Involved in building new facilities
54. Which of the following is not a reason why firms prefer to acquire existing assets rather
than undertake green-field investments?
A. Foreign firms are acquired because those firms have valuable strategic assets
B. Firms make acquisitions because they believe they can increase the efficiency of the
acquired unit by transferring capital, technology or management skills
C. Even though Greenfield investments are comparatively less risky for a firm acquisitions
always yield higher profits
D. Mergers and acquisitions are quicker to execute than green-field investments
55. In developing nations most FDI inflows are in the form of
A. Mergers
B. Greenfield investments
C. Acquisitions
D. Non-profit organizations
56. The sector composition of FDI shows that by 2004 approximately _____ of FDI stock was
in service industries.
A. One fourth
B. One third
C. Two third
D. Half
57. The rise in FDI in the services sector is a result of all of the following, except
A. The general move in many developed countries away from manufacturing and toward
services
B. Accelerating regulations of services
C. Many services cannot be traded internationally
D. Many countries have liberalized their regimes governing FDI in services
58. When strategic assets such as brand loyalty, customer relationships or distribution systems
are important, _____ investments are more appropriate.
A. Merger and acquisition
B. Greenfield
C. Portfolio
D. New construction
59. _____ involves granting a foreign entity the right to produce and sell the firm's product in
return for a royalty fee on every unit sold.
A. Horizontal FDI
B. Licensing
C. Vertical FDI
D. Greenfield investment
60. In a licensing arrangement, the _____ bears the risk and cost of opening a foreign market.
A. Licensee
B. Licensor
C. Acquiring firm
D. Greenfield investor
61. Identify the theory that seeks to explain why firms often prefer foreign direct investment
over licensing as a strategy for entering foreign markets.
A. Internalization theory
B. Internationalization theory
C. Perfect markets theory
D. Small markets theory
62. According to the internalization theory, all of the following are drawbacks of licensing as a
strategy for exploiting foreign market opportunities, except
A. Licensing does not grant control over manufacturing, marketing and to a licensee in return
for a royalty fee
B. Licensing may result in a firm's giving away its know-how to a potential foreign competitor
C. Licensing does not give the firm the tight control over manufacturing, marketing and
strategy that may be required to profitably exploit its advantage
D. A firms capabilities such as the management, marketing and manufacturing are often not
amenable to licensing
63. ______ is also known as market imperfections theory.
A. Internationalization theory
B. Internalization theory
C. Perfect markets theory
D. Small markets theory
64. If four firms control 80 percent of a domestic market, then ______ exists.
A. An oligopoly
B. A monopoly
C. An oligarchy
D. Vertical integration
65. According to Knickerbocker
A. The firms that pioneer a product in their home markets undertake FDI to produce a product
for consumption in a foreign market
B. When a firm that is part of an oligopolistic industry expands into a foreign market, other
firms in the industry will be compelled to make similar investments
C. Combining location-specific assets or resource endowments and the firm's own unique
assets often requires FDI
D. Impediments to the sale of know-how increase the profitability of FDI relative to licensing
66. The eclectic paradigm was developed by
A. F. T. Knickerbocker
B. Adam Smith
C. Raymond Vernon
D. John Dunning
67. When two or more enterprises encounter each other in different regional markets, national
markets or industries, there is
A. Vertical integration
B. Horizontal integration
C. Multipoint competition
D. Monopolistic competition
68. The product life cycle suggests that
A. Often the same firms that pioneer a product in their home markets undertake FDI to produce
a product for consumption in foreign markets
B. When a firm that is part of an oligopolistic industry expands into a foreign market, other
firms in the industry will be compelled to make similar investments
C. Combining location-specific assets or resource endowments and the firm's own unique
assets often requires FDI
D. Impediments to the sale of know-how increase the profitability of FDI relative to licensing
69. The _____ suggests that a firm will establish production facilities where foreign assets or
resource endowments that are important to the firm are located.
A. Product life cycle
B. Strategic behavior theory
C. Multipoint competition theory
D. Eclectic paradigm
70. Advantages that arise from using resource endowments or assets that are tied to a particular
location and that a firm finds valuable to combine with its own unique assets are known as
A. Location specific advantages
B. Resource specific advantages
C. Competitive advantages
D. Directional advantages
71. John Dunning, a champion of the eclectic paradigm, argues that
A. The firms that pioneer a product in their home markets undertake FDI to produce a product
for consumption in a foreign market
B. When a firm that is part of an oligopolistic industry expands into a foreign market, other
firms in the industry will be compelled to make similar investments
C. Combining location-specific assets or resource endowments and the firm's own unique
assets often requires FDI
D. Impediments to the sale of know-how increase the profitability of FDI relative to licensing
72. According to the _____ view of FDI, MNEs extract profits from the host country and take
them to their home country, giving nothing of value to the host country in exchange.
A. Imperialist
B. Conservative
C. Free market
D. Radical
73. Which of the following is not a reason that the radical position of MNEs was in retreat by
the end of the 1980s?
A. The strong economic performance of those developing countries that embraced capitalism
rather than radical ideology
B. The collapse of communism in Eastern Europe
C. The generally abysmal economic performance of those countries that embraced the radical
position
D. A growing belief in many capitalist countries that MNE's tightly controls key technology
and that important jobs in the MNEs' foreign subsidiaries go to home-country nationals
74. According to _____ international production should be distributed among countries
according to the theory of comparative advantage.
A. The radical view
B. The eclectic view
C. Pragmatic nationalism
D. The free market view
75. A distinctive aspect of _____ is the tendency to aggressively court FDI believed to be in the
national interest by, for example, offering subsidies to foreign MNEs in the form of tax breaks
or grants.
A. The dogmatic view
B. Pragmatic nationalism
C. The radical view
D. The conservative view
76. When a company brings capital and/or technology to a host country, the host country
benefits from the
A. Competitive effect of FDI
B. The resource transfer effect of FDI
C. The balance of payments effect of FDI
D. The effect on competition and economic growth
77. When jobs are created in local suppliers as a result of the FDI and when jobs are created
because of increased local spending by employees of the MNE, the MNE has a _____ effect on
employment.
A. Direct
B. Indirect
C. Inward
D. Outward
78. A _____ keeps track of a country's payments to and its receipts from other countries.
A. Federal payments ledger
B. Current accounting system
C. Checks and balances account
D. Balance of payments account
79. The _____ tracks the export and import of goods and services. A current account deficit or
trade deficit as it is often called, arises when a country is importing more goods and services
than it is exporting.
A. Current account
B. Debit account
C. Surplus account
D. Capital account
80. Three costs of FDI concerns of host countries arise from all of the following except
A. Adverse effects on competition within the host nation
B. Adverse effects on the balance of payments
C. The perceived loss of national sovereignty and autonomy
D. Debit on the current account of the home country's balance of payments
81. FDI undertaken to serve the home market is known as
A. Greenfield investment
B. FDI substitution
C. Offshore production
D. Home market FDI
82. Double taxation is
A. Charging double taxes in the home country
B. Charging double taxes in the host country
C. Taxation of income in both home and host country
D. Paying income taxes at twice the normal rate
83. _____ are controls over the behavior of the MNE's local subsidiary.
A. Performance requirements
B. Ownership restraints
C. Double taxation laws
D. Greenfield restrictions
84. Licensing would be a good option for firms in which of the following industries?
A. High-technology industries in which protecting firm-specific expertise is of paramount
importance and licensing is hazardous
B. Global oligopolies, in which competitive interdependence requires that multinational firms
maintain tight control over foreign operations
C. Industries in which intense cost pressures require that multinational firms maintain tight
control over foreign operations
D. In fragmented, low technology industries in which globally dispersed manufacturing is not
an option
85. _____ is essentially the service industry version of licensing, although it normally involves
much longer term commitments.
A. Franchising
B. Subsidizing
C. Greenfield investment
D. Patenting
Essay Questions
86. Discuss the connection between foreign direct investment and multinational enterprises?
Foreign direct investment (FDI) occurs when a firm invests directly in new facilities to produce
and/or market a product in a foreign country. The U.S. Department of Commerce states that
FDI occurs whenever a U.S. citizen, organization or affiliated group takes an interest of 10
percent or more in a foreign business entity. Once affirm undertakes FDI, it becomes a
multinational enterprise.
87. What are the two forms of foreign direct investment?
The two forms of FDI are Greenfield investment or establishing a new operation in a foreign
country and mergers and acquisitions whereby a company expands internationally through an
existing firm. Acquisitions can be minority, majority or a 100% ownership position.
88. Discuss the trends in FDI over the last 30 years. Be sure to differentiate between the stock of
FDI and the flow if FDI.
The flow of FDI refers to the amount of FDI undertaken over a given period, while the stock of
FDI refers to the total accumulated value of foreign-owned assets at a given time. Over the last
30 years there has been a marked increase in both the flow and the stock of FDI in the world
economy. Over this period, the flow of FDI accelerated faster than the growth in world trade
and world output.
89. Discuss the reasons for the growth in FDI over the last 30 years.
FDI has grown more rapidly than world trade and world output for several reasons. First, many
companies see FDI as a means of circumventing potential trade barriers. Second, political and
economic changes in many of the world developing nations has been encouraging FDI. Finally,
the globalization of the world economy is having a positive impact on the volume of FDI as
firms now see the whole world as their market.
90. What is a Greenfield investment? How does it compare to an acquisition? Which form of
FDI is a firm more likely choose? Explain your answer.
FDI can take the form of a Greenfield investment in a new facility or an acquisition of or a
merger with an existing local firm. Research shows that most FDI takes the form of mergers and
acquisitions rather than Greenfield investment. Mergers and acquisitions are more popular for
three reasons. First, mergers and acquisitions are quicker to execute than Greenfield
investments. Second, foreign firms are acquired because those firms have valuable strategic
assets. Third, firms make acquisitions because they believe they can increase the efficiency of
the acquired firm by transferring capital, technology or management skills.
91. Discuss the shift in FDI from manufacturing to services. What is driving the trend?
Over the last twenty years, the sector composition of FDI has shifted from extractive industries
and manufacturing toward services. By 2004, some 66 percent of the stock of FDI was in
services. Four factors are driving the shift to services. First, the shift reflects the general move
in many developed economies away from manufacturing and toward service industries.
Second, many services cannot be traded internationally and FDI is a principal was to bring
services to foreign markets. Third, many countries have liberalized their regimes governing
FDI in services making the option more attractive to firms. Finally, the rise of Internet-based
global telecommunications networks has allowed some service enterprises to relocate some of
their value creation activities to different nations to take advantage of favorable factor costs.
92. Consider why firms selling products with low value-to-weight ratios choose FDI over
exporting.
Products with low value-to-weight ratios such as soft drinks or cement are frequently produced
in the market where they are consumed. When transportation costs are added to production
costs, it becomes unprofitable to shift such products over a long distance. For firms that can
produce low value-to-weight products at almost any location the attractiveness of exporting
decreases and FDI or licensing becomes more appealing.
93. Discuss the market imperfections explanation of FDI. What is its relationship with
internalization theory?
Market imperfections or factors that inhibit markets from working perfectly, provide a major
explanation of why firms prefer FDI to either exporting or licensing. In the international
business literature, the marketing imperfections approach is referred to as internalization
theory. According to the theory, FDI will be preferred when there are impediments that make
both exporting and the sale of know-how difficult and/or expensive.
94. What is licensing? How does it work?
Licensing occurs when a domestic firm, the licensor, licenses to a foreign firm, the licensee, the
right to produce its product, to use its production processes or to use its brand name or
trademark. In return, the licensor collects royalty fees on every unit the licensee sells or on total
licensee revenues. The licensor also benefits from the arrangement in that the licensee bears the
cost and risk of expanding into a foreign market.
95. Compare and contrast the advantages of foreign direct investment over exporting and
licensing.
A firm will favor foreign direct investment over exporting as an entry strategy when
transportation costs or trade barriers make exporting unattractive. Furthermore, the firm will
favor foreign direct investment over licensing (or franchising) when it wishes to maintain
control over its technological know-how or over its operations and business strategy or when
the firm's capabilities are simply not amenable to licensing, as may often be the case.
96. Consider the notion that FDI flows are a reflection of strategic rivalry between firms in the
global marketplace. What is the main limitation of the theory?
The strategic behavior approach to explain FDI was initially expounded by Knickerbockers
who argued that in an oliogopolistic industry, a "follow the leader" mentality will prompt firms
to pursue FDI when another firm in the industry has already done so. However, the theory fails
to explain why the first firm decided to undertake FDI, rather than export or license.
97. What is multipoint competition? How do firms respond to multipoint competition?
Multipoint competition arises when two or more enterprises encounter each other in different
regional markets, national markets or industries. Economic theory suggests that firms will try to
match each other's moves in different markets to try to hold each other in check. If a firm is
successful with this strategy, the firm will ensure that a rival does not take a commanding
position in one market and then use the profits generated in that market to underwrite
competitive attacks in other markets.
98. Explain the product life cycle theory and its connection with FDI.
The product life cycle theory, developed by Ray Vernon, suggests that the same firms that
pioneer a product in their home country will undertake FDI to produce a product for
consumption in foreign markets. According to the theory, firms will invest in industrialized
countries when demand in those countries is sufficient to support local production. They
subsequently shift production to developing countries when product standardization and market
saturation give rise to price competition and cost pressures. Investment in developing countries,
where labor costs are lower is seen as the best way to reduce costs.
99. What are location-specific advantages? How do they help explain FDI?
Location specific advantages are advantages that arise from using resource endowments or
assets that are tied to a particular foreign location and that a firm finds valuable to combine with
its own unique assets. Natural resources such as oil and minerals for example, are specific to
certain locations. Firms must undertake FDI to exploit such foreign resources.
100. Explain John Dunning's position on FDI. What is the eclectic paradigm?
John Dunning has argued that to fully understand FDI it is important to consider the role of
location specific advantages. According to Dunning, a firm will be prompted to undertake FDI
in an effort to exploit assets that are specific to a particular location. Dunning's theory, the
eclectic paradigm, combines the arguments of internalization theory with the notion of
location-specific advantages to suggest that combining location-specific assets or resource
endowments and the firm's own unique capabilities often requires the firm to establish
production facilities where the foreign assets or resource endowments are located.
101. Discuss the various political ideologies and their impact on foreign direct investment.
The radical view writers argue that the multinational enterprise (MNE) is an instrument of
imperialist domination. The free market view argues that international production should be
distributed among countries according to the theory of comparative advantage. The pragmatic
nationalist view is that FDI has both benefits and costs.
The radical view has a dogmatic radical stance that is hostile to all inward FDI
The free market view is at the other extreme and based on noninterventionist principle of free
market economics. Between these two extremes is an approach called pragmatic nationalism.
102. Discuss the benefits and costs of FDI from the perspective of a host country and from the
perspective of the home country.
The main benefits of inward FDI for a host country arise from resource-transfer effects,
employment effects, balance-of-payments effects and effects on competition and economic
growth. Three costs of FDI concern host countries. They arise from possible adverse effects on
competition within the host nation, adverse effects on the balance of payments and the
perceived loss of national sovereignty and autonomy.
The benefits of FDI to the home (source) country arise from three sources. First, the home
country's balance of payments benefits from the inward flow of foreign earnings. Second,
benefits to the home country from outward FDI arise from employment effects. Third, benefits
arise when the home-country MNE learns valuable skills from its exposure to foreign markets
that can subsequently be transferred back to the home country. The most important
cost/concern of FDI for the home country centers on the balance-of-payments and employment
effects of outward FDI.
103. Describe the situations when licensing is not a good option for a firm.
Licensing is not a good option in three situations. First, licensing is hazardous in high-tech
industries where protecting firm-specific expertise is very important. Second, licensing is not
attractive in global oligopolies where tight control is necessary so that firms have the ability to
launch coordinated attacks against global competitors.
Finally, in industries where intense cost pressures require that MNEs maintain tight control
over foreign operations, licensing is not the best option.
104. What is franchising? What type of firm uses franchising as a means of expanding into
foreign markets?
Franchising is essentially the service-industry version of licensing. With franchising, the firm
licenses its brand name to a foreign firm in return for a percentage of the franchisee's profits.
The franchising contract specifies the conditions that the franchisee must fulfill if it is to use the
franchisor's brand name.
Franchise agreements usually have a longer time commitment than do licensing arrangements.
Franchising is common in the fast food industry because fast food cannot be exported, because
franchising minimizes the costs and risks associated with opening a foreign market, because
brand names are relatively easy to protect, because there is no compelling reason for a firm to
have tight control over franchisees and because fast food know-how is easily transferred.
105. How useful are the product life cycle theory and Knickerbocker's theory of horizontal FDI
to business?
The product life cycle theory and Knickerbocker's theory of horizontal FDI to business are not
particularly useful from a business perspective because the theories are descriptive rather than
analytical. The theories are useful for explaining historical patterns of FDI, but they do a poor
job of identifying the factors that influence the relative probability of FDI, licensing and
exporting.