Firm Heterogeneity and FDI with Matching Frictions

Firm-evel data often show different modes of market access by firms with the same productivity levels, which is a mere knife-edge case in the basic firm heterogeneity model. This paper examines the foreign direct investment (FDI) decisions of individual firms with a simple framework, where firms and managers have to make matches for production. We find that predicted distributions of FDI firms are much more akin to real data than those suggested by the basic firm heterogeneity model, namely, there exists a range of firm productivities in which more productive firms may export while less productive firms may undertake FDI. Such a range of firm productivities becomes wider when either matching frictions increase or trade costs decline. Furthermore, matching frictions hurt production efficiency more for productive FDI firms than for less productive FDI firms.