Multinational activity of European firms and heterogeneity

• Published date: 01 May 2018
• DOI: http://doi.org/10.1111/twec.12613
• Date: 01 May 2018

ORIGINAL ARTICLE

Multinational activity of European firms and

heterogeneity

Jos

e C. Fari~

nas

1

|

Ana Mart



ın-Marcos

2

|

Francisco J. Vel

azquez

1

1

Universidad Complutense Madrid, Madrid, Spain

2

UNED, Madrid, Spain

Funding information

Ministerio de Econom



ıa y Competitividad, Grant/Award Number: ECO2014-52051-R (National Research Program)

1

|

INTRODUCTION

This paper offers an empirical assessment of the multinational activity of European firms. It takes

the predictions of models of firm heterogeneity and FDI activity (see Antr

as & Yeaple, 2014 for a

recent state of the literature) as a reference to explore empirically basic characteristics of multina-

tional firms from 30 European countries. This analysis uses an original data set, based on ORBIS,

which links information of parent–affiliate pairs of firms. To organise our empirical work, we rely

on the literature starting with Helpman, Melitz, and Yeaple (2004) that combines two approaches

to the analysis of multinational activity: first, the proximity–concentration model of Brainard

(1993, 1997), where firms face a trade-off between transport costs with trade and fixed investment

costs with foreign investment, and second, the heterogeneity model of Melitz (2003) , where firms

differ in their productivity levels.

Our research concentrates on two sets of predictions. The first one refers to the factors that

influence the scope and the scale of multinational activity. According to these models, there is a

country-specific cut-off productivity level which determines both the number of foreign affiliates a

firm opens in foreign markets (scope) and the size of operations of these affiliates (scale). The sec-

ond prediction refers to the country characteristics, of both the home and the host country, that

influence the productivity cut-off and therefore the decisions that characterise the structure of

multinational activity that we observe across countries.

With respect to the first prediction, Helpman et al. (2004) have shown the existence of a sort-

ing pattern between exporting firms and firms that engage in FDI, the latter being the most pro-

ductive group relative to both exporters and firms serving the domestic market. Yeaple (2009)

shows that this kind of sorting also extends to the scope and scale of US multinationals: more

productive parent firms operate in a higher number of foreign markets and at a higher scale in

terms of the average sales of their subsidiaries. We test for the existence of this sorting, taking a

large sample of European multinationals as a reference. This analysis considers two perspectives.

The first one concerns the scope of multinational activity. We estimate the probability of invest-

ing in a foreign market as a function of parent firms’productivity. The second one concentrates

on the scale of the multinational activity. In particular, we examine the relationship between the

DOI: 10.1111/twec.12613

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©2018 John Wiley & Sons Ltd wileyonlinelibrary.com/journal/twec World Econ. 2018;41:1166–1195.

size of subsidiary firms, measured in terms of sales in f oreign markets, and their parent firms’

productivity.

Concerning the second prediction about country characteristics, it is common in the literature of

gravity equations to estimate the effect of country characteristics on aggregate flows of FDI acti v-

ity, using either bilateral flows of FDI or aggregate sales as well as the number of affiliate firms

operating in foreign markets as dependent variables (Brainard, 1997; Kleinert & Toubal, 2010).

An important feature of Yeaple (2009) is that country characteristics determine the product ivity

cut-off which drives the investment entry decision of firms in foreign markets. Therefore, the pro-

ductivity composition of firms with a multinational activity is influenced by the characteristics of

countries where they invest. This is the second prediction we examine. More specifically, we test

whether country characteristics that are associated in one direction with the volume of multina-

tional activity are related to the productivity levels of parent firms investing abroad in the opposite

direction. In short, country characteristics that encourage a greater volume of multinational activity

induce the entry of successively less productive firms. If this happens, country characteristics that

positively affect the volume of multinational activity, defined in terms of the value of affiliates’

production in foreign markets across two countries, should be negatively associated with the level

of productivity of the least productive parent firm entering the host country.

With the objective to test the previous sets of predictions, we build an original data set, based

on ORBIS, which links information of parent firms and their affiliates. The sample contains parent

firms with a manufacturing ISIC code as their principal activity and has at least one affiliate firm

operating abroad that is also active in a manufacturing activity. The sample has 15,055 multina-

tional parent manufacturing firms from 30 European countries, and these multinationals are imme-

diate owners of 55,583 manufacturing subsidiaries operating in 183 host countries. As the sample

of firms is representative of the population of European multinational firms, the analysis offers a

portrait of relevant aspects that have recently been highlighted by models of firm heterogeneity

and FDI activity.

Next, we review the basic empirical literature of this area and outline the main contributions of

our paper. The analysis of exporting and FDI decisions by heterogeneous firms starting with the

Helpman et al. (2004) model is the origin of much empirical literature that examines the sorting

between domestic, exporting and MNCs. Papers documenting this hypothesis include, among

others, Girma, G€

org, and Strobl (2004), Girma, Kneller, and Pisu (2005), Tomiura (2007),

Geishecker, G€

org, and Taglioni (2009), Arnold and Hussinger (2010), Castellani and Giovanetti

(2010), Gullstrand, Olofsdotter, and Thede (2016), Borin and Mancini (2016), Engel and Procher

(2012), Engel, Procher and Schmidt (2013) and Mart

ı, Alguacil, and Orts (2015), along with the

literature reviews by Greenaway and Kneller (2007) and Yeaple (2013).

An additional prediction of this literature of heterogeneous MNEs was introduced, as we have

already mentioned, by Yeaple (2009). The selection mechanism that exists between domestic firms,

exporters and firms with multinational production, predicted by Helpman et al. (2004) , also applies

to the scope and scale of multinational firms. One or both predictions have been examined empiri-

cally by Aw and Lee (2008) for Taiwanese firms, Yeaple (2009) for US multinationals, Geishecker

et al. (2009) for firms from 12 EU countries, Chen and Moore (2010) for French companies,

Damijan, Kostevc, and Rojec (2016) for nine new EU member states from Central and Eastern

Europe, Nishiyama and Tamaguchi (2013), Tanaka (2012, 2015) for Japanese firms and Shao and

Shang (2016) for Chinese firms. Most of these papers refer to the manufacturing sector, with a

few exceptions (Damijan et al., 2016; Tanaka, 2015) that also consider firms from the service sec-

tor. Concerning the scope hypothesis, most of the papers estimate a probability model of the deci-

sion to enter a given foreign market, but some others (see Geishecker et al., 2009; Tanaka, 2012)

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