The timing and the probability of FDI: an application to the US multinational enterprises

An 'option-pricing' model is employed to analyse when a firm should expand its production capabilities abroad. In a framework where the firm's profits are determined by some average of the attractiveness of the home and foreign countries, and attractiveness in each country follows differentiated Brownian motions, this paper derives an optimal trigger value for FDI. The model shows that, contrary to the NPV rule, FDI entry should be optimally delayed the greater the uncertainty surrounding the future path of attractiveness in both locations. The second part of the paper is devoted to empirically test the results of the model. Drawing on data of FDI from the US into a panel of developed and developing countries and using labour costs as a proxy for (the reciprocal of) attractiveness, our estimation overwhelmingly confirms the results of the model, namely that FDI entry events are negatively related to the uncertainty surrounding attractiveness.