Optimal degree of foreign ownership under uncertainty

This paper studies the determinants and consequences of equity ownership in multinational affiliates. We construct a multi-period model of foreign direct investment with incomplete contracts and uncertainty to analyse the size of equity stakes. The productivity of a multinational parent and its supplier is unknown initially to both sides and revealed only after joint production. This kind of match-specific learning implies a dynamic market for corporate equity with considerable impact on reallocation within narrowly defined industries and trading activity. We identify heterogeneity in productivity to be the key determinant of foreign equity shares, which in turn determine the intensive margin in firm imports and business survival. We test the implications of our theory with plant-level data on ownership shares and find support for the model.