Greenfield Investment or Acquisition? Optimal Foreign Entry Mode with Knowledge Spillovers in a Cournot Game

The theoretical literature on FDI and knowledge spillovers has predominantly focused on the firms ’ choice between greenfield investment and exports. This is somewhat surprising since almost 80% of all FDI relates to M&As. The few studies that investigate the choice between greenfield investment and M&A with knowledge spillovers almost exclusively focus on North-South issues where knowledge only runs one way and firms from the developed countries are the only ones that expand abroad. However, since most M&As are conducted in a North-North setting, we find good reasons to develop a model that allows foreign entry running both ways. In this paper, we identify the optimal foreign entry mode in a two country, two firm Cournot model with asymmetric technology levels and country sizes. If a firm enters the foreign market through greenfield investment, it has to pay a fixed investment cost and its technology level is reduced in the foreign market due to knowledge transfer costs. If a firm enters through acquisition, it must offer the other firm a sufficiently high acquisition price in order to get an acceptance. If the bid is accepted through a bargaining process, the acquirer becomes a monopolist in both markets using the best technological practice adjusted for transfer costs. Our model does not include exports as a strategic option, thus the model is best suited for studies of firms operating in service sectors or sectors where there are high fixed export costs. JEL classifications: L13, F23, O31, O38