Licensing versus Direct Investment: A Model of Internalization by the Multinational Enterprise.

A firm must decide whether to serve a foreign market by exporting, building a foreign branch plant , or licensing the production to an existing foreign producer. The ex istence of reputations implies that any licensing agreement must prov ide a licensee with the incentive to maintain the reputation. This cr eates a motive for the firm to internalize transactions by building a branch plant (i.e., by becoming a multinational). The model reflects a more general notion that the inability of the firm to control a li censee's (agent's) actions can provide incentives for multinational a ctivity. This paper explores the determinants of the firm's mode of o peration as well as exploring the consequences of certain government policies.