Question Bank International Business

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Chapter 07
Foreign Direct Investment

True / False Questions

1. (p. 242) A firm becomes a multinational enterprise when it undertakes foreign direct investment. TRUE
2. (p. 242) Licensing involves the establishment of a new operation in a foreign country. FALSE

3. (p. 242) If a firm that makes bicycles in Germany acquires a French bicycle producer, Greenfield investment has taken place. FALSE
4. (p. 242) The amount of FDI undertaken over a given time period is known as the flow of FDI. TRUE

5. (p. 242) The total accumulated value of foreign-owned assets at a given time is the inflow of FDI.

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FALSE

6. (p. 242) FDI is seen by executives as a means of circumventing future trade barriers. TRUE

7. (p. 244) Historically, most FDI has been directed at the developed nations of the world as firms based in advanced countries invested in the others' markets. TRUE

8. (p. 246) The total amount of capital invested in factories, stores, office buildings and the like is referred to as the stock of FDI. FALSE

9. (p. 246) The largest source country for FDI has been China.

FALSE

10. (p. 247) About 27 percent of the world's largest 100 nonfinancial multinationals in 2004 were American companies. TRUE

11. (p. 247) In developing countries, about one third of FDI is in the form of mergers and acquisitions. TRUE
12. (p. 248) In 2004, about two thirds of FDI stock was in service industries. TRUE
13. (p. 249) As compared to exporting and licensing, FDI is the more expensive and risky. TRUE
14. (p. 250) Internalization theory is also known as the market imperfections approach. TRUE
15. (p. 250) One of the problems of licensing is that it may result in a firm's giving away valuable technological know-how to a potential foreign competitor.

TRUE
16. (p. 251) An oligopoly is an industry composed of a limited number of large firms. TRUE

17. (p. 252) When two or more enterprises encounter each other in different regional markets, national markets or industries regional competition occurs. FALSE
18. (p. 252) According to Vernon, location specific advantages can help explain the nature and direction of FDI. FALSE
19. (p. 253) Dunning, in the eclectic paradigm theory, suggests that a firm must establish production facilities where foreign assets or resource endowments necessary to the production of the product exist. TRUE

20. (p. 254) Pragmatic nationalism traces its roots to Marxist political and economic theory. FALSE

21. (p. 254) Classical economics and the international trade theories of Adam Smith and David Ricardo form the basis for the free market view. TRUE

22. (p. 255) The free market view argues that FDI is a benefit to both the source country and to the host country. TRUE
23. (p. 255) Countries adopting a pragmatic stance pursue policies designed to maximize the national benefits and minimize the national costs. TRUE
24. (p. 256) An aspect of pragmatic nationalism is the tendency to aggressively court FDI believed to be in the national interest by, for example, offering subsidies to foreign MNEs in the form of tax breaks or grants. TRUE

25. (p. 257) Foreign direct investment can make a positive contribution to a host economy by supplying capital, technology and management resources that would otherwise not be available and thus boost that country's economic growth rate. TRUE

26. (p. 258) There is research supporting the view that multinational firms often transfer significant technology when they invest in a foreign country. TRUE

27. (p. 258) Jobs created in local suppliers as a result of the MNE's investment and jobs created because of increased local spending by employees of the MNE are examples of direct employment effects of FDI. FALSE

28. (p. 258) Host country citizens that are employed by an MNE following an FDI are an example of an indirect effect of FDI. FALSE

29. (p. 259) A country's balance of payments accounts keep track of both its payments to and its receipts from other countries. TRUE

30. (p. 259) A current account deficit exists when a country imports more than it exports. TRUE

31. (p. 259) In recent years, the U.S. has run a persistent balance of payments surplus. FALSE

32. (p. 260) Host governments sometimes worry that the subsidiaries of foreign MNEs may have greater economic power than indigenous competitors. TRUE

33. (p. 261) FDI does not benefit the host country's balance of payments if the foreign subsidiary creates demand for home-country exports of capital equipment, intermediate goods or complementary products. FALSE

34. (p. 262) The term offshore production refers to FDI undertaken to serve
the home market. TRUE
35. (p. 263) Countries cannot prohibit national firms from investing in certain countries for political reasons. FALSE

36. (p. 264) The two most common methods of restricting inward FDI are ownership restraints and performance requirements. TRUE

37. (p. 265) The WTO has been very successful in efforts to initiate talks aimed at establishing a universal set of rules designed to promote the liberalization of FDI. FALSE

38. (p. 266) Licensing is a good option for firms in high-tech industries where protecting firm-specific expertise is of paramount importance. FALSE

39. (p. 266-267) Typically licensing will be a common strategy in oligopolies where competitive interdependence requires that multinational firms maintain tight control over foreign operations so that they have the ability to launch coordinated attacks against their global competitors. FALSE

40. (p. 267) Licensing is more common in fragmented, low-tech industries in which globally dispersed manufacturing is not an option. TRUE

Multiple Choice Questions

41. (p. 242) FDI occurs when a
A. Domestic firm imports products and services from another country B. Firm ships its product from one country to another
C. Firm invests in the stock of another company
D. Firm invests directly in facilities to produce and/or market a product in a foreign country

42. (p. 242) A Greenfield investment
A. Is a form of FDI that involves the establishment of a new operation in a foreign country B. Involves a 7 percent stock in an acquired foreign business entity C. Involves a merger with a foreign business

D. Occurs when a firm acquires another company in a foreign countr 43. (p. 242) If General Electric, a U.S. based corporation, purchased a 50% interest in a company in Italy, that purchase would be an example of a(n) A. Minority acquisition

B. Outright stake
C. Majority acquisition
D. Greenfield investment

44. (p. 242) The amount of FDI undertaken over a given time period is A. The flow of FDI
B. The stock of FDI
C. The FDI outflow
D. The FDI inflow

45. (p. 242) The stock of FDI is
A. The amount of FDI undertaken over a given period of time
B. The total accumulated value of foreign owned assets at a given time C. The flow of FDI out of a country
D. The flow of FDI into a country

46. (p. 242) FDI has been rising for all of the following reasons, except A. The globalization of the world economy
B. The general increase in trade barriers over the past 30 years C. Firms are trying to circumvent trade barriers
D. There is a shift toward democratic political institutions and free market economies

47. (p. 244) Historically, most FDI has been directed at the _____ nations of the world as firms based in advanced countries invested in A. Underdeveloped, underdeveloped countries
B. Developed, underdeveloped countries
C. Developed, each other's markets
D. Underdeveloped, each other's markets
48. (p. 244) The U.S. has been an attractive target for FDI because of all of the following reasons, except A. Its small and wealthy domestic markets
B. Its dynamic and stable economy
C. Its favorable political environment
D. Its openness to FDI
49. (p. 244) Identify the incorrect statement regarding the direction of FDI. A. Historically, most FDI has been directed at the developing nations of the world B. During the 1980s and 1990s, the United States was often the favorite target for FDI inflows C. The developed nations of the EU have received significant FDI inflows D. Recent inflows into developing nations have been targeted at the emerging economies of South, East and Southeast Asia 50. (p. 246) Africa is not a popular destination for FDI because of all of the following reasons, except A. Political unrest in the region

B. Armed conflict in the region
C. Liberalization of FDI regulations
D. Frequent policy changes in the region
51. (p. 246) The total amount of capital invested in factories, stores, office buildings and the like is summarized by A. Gross fixed capital formation
B. Total investment capital
C. Total tangible investment
D. Gross depreciable investments
52. (p. 246) The largest source country for FDI since World War II has been A. Japan
B. China
C. The United States
D. The United Kingdom

53. (p. 247) Most cross-border investment is
A. In the form of Greenfield investments
B. Made via mergers and acquisitions
C. Between American and Japanese companies
D. Involved in building new facilities
54. (p. 247) Which of the following is not a reason why firms prefer to
acquire existing assets rather than undertake green-field investments? A. Foreign firms are acquired because those firms have valuable strategic assets B. Firms make acquisitions because they believe they can increase the efficiency of the acquired unit by transferring capital, technology or management skills C. Even though Greenfield investments are comparatively less risky for a firm acquisitions always yield higher profits D. Mergers and acquisitions are quicker to execute than green-field investments 55. (p. 247) In developing nations most FDI inflows are in the form of A. Mergers

B. Greenfield investments
C. Acquisitions
D. Non-profit organizations
56. (p. 248) The sector composition of FDI shows that by 2004 approximately _____ of FDI stock was in service industries. A. One fourth
B. One third
C. Two third
D. Half
57. (p. 248) The rise in FDI in the services sector is a result of all of the following, except A. The general move in many developed countries away from manufacturing and toward services B. Accelerating regulations of services

C. Many services cannot be traded internationally
D. Many countries have liberalized their regimes governing FDI in services 58. (p. 248) When strategic assets such as brand loyalty, customer relationships or distribution systems are important, _____ investments are more appropriate. A. Merger and acquisition

B. Greenfield
C. Portfolio
D. New construction
59. (p. 249) _____ involves granting a foreign entity the right to produce and sell the firm's product in return for a royalty fee on every unit sold. A. Horizontal FDI
B. Licensing
C. Vertical FDI
D. Greenfield investment
60. (p. 249) In a licensing arrangement, the _____ bears the risk and cost of opening a foreign market. A. Licensee
B. Licensor
C. Acquiring firm
D. Greenfield investor
61. (p. 250) Identify the theory that seeks to explain why firms often prefer foreign direct investment over licensing as a strategy for entering foreign markets. A. Internalization theory
B. Internationalization theory
C. Perfect markets theory
D. Small markets theory
62. (p. 250) According to the internalization theory, all of the following are drawbacks of licensing as a strategy for exploiting foreign market opportunities, except A. Licensing does not grant control over manufacturing, marketing and to a licensee in return for a royalty fee B. Licensing may result in a firm's giving away its know-how to a potential foreign competitor C. Licensing does not give the firm the tight control over manufacturing, marketing and strategy that may be required to profitably exploit its advantage D. A firms capabilities such as the management, marketing and manufacturing are often not amenable to licensing 63. (p. 250) ______ is also known as market imperfections theory. A. Internationalization theory

B. Internalization theory
C. Perfect markets theory
D. Small markets theory
64. (p. 251) If four firms control 80 percent of a domestic market, then ______ exists. A. An oligopoly
B. A monopoly
C. An oligarchy
D. Vertical integration
65. (p. 251) According to Knickerbocker
A. The firms that pioneer a product in their home markets undertake FDI to
produce a product for consumption in a foreign market B. When a firm that is part of an oligopolistic industry expands into a foreign market, other firms in the industry will be compelled to make similar investments C. Combining location-specific assets or resource endowments and the firm's own unique assets often requires FDI D. Impediments to the sale of know-how increase the profitability of FDI relative to licensing 66. (p. 252) The eclectic paradigm was developed by

A. F. T. Knickerbocker
B. Adam Smith
C. Raymond Vernon
D. John Dunning

67. (p. 252) When two or more enterprises encounter each other in different regional markets, national markets or industries, there is A. Vertical integration
B. Horizontal integration
C. Multipoint competition
D. Monopolistic competition

68. (p. 252) The product life cycle suggests that
A. Often the same firms that pioneer a product in their home markets undertake FDI to produce a product for consumption in foreign markets B. When a firm that is part of an oligopolistic industry expands into a foreign market, other firms in the industry will be compelled to make similar investments C. Combining location-specific assets or resource endowments and the firm's own unique assets often requires FDI D. Impediments to the sale of know-how increase the profitability of FDI relative to licensing 69. (p. 253) The _____ suggests that a firm will establish production facilities where foreign assets or resource endowments that are important to the firm are located. A. Product life cycle

B. Strategic behavior theory
C. Multipoint competition theory
D. Eclectic paradigm

70. (p. 253) Advantages that arise from using resource endowments or assets that are tied to a particular location and that a firm finds valuable to combine with its own unique assets are known as A. Location specific advantages

B. Resource specific advantages
C. Competitive advantages
D. Directional advantages

71. (p. 253) John Dunning, a champion of the eclectic paradigm, argues that A. The firms that pioneer a product in their home markets undertake FDI to produce a product for consumption in a foreign market B. When a firm that is part of an oligopolistic industry expands into a foreign market, other firms in the industry will be compelled to make similar investments C. Combining location-specific assets or resource endowments and the firm's own unique assets often requires FDI D. Impediments to the sale of know-how increase the profitability of FDI relative to licensing

72. (p. 254) According to the _____ view of FDI, MNEs extract profits from the host country and take them to their home country, giving nothing of value to the host country in exchange. A. Imperialist

B. Conservative
C. Free market
D. Radical

73. (p. 254) Which of the following is not a reason that the radical position of MNEs was in retreat by the end of the 1980s? A. The strong economic performance of those developing countries that embraced capitalism rather than radical ideology B. The collapse of communism in Eastern Europe

C. The generally abysmal economic performance of those countries that embraced the radical position D. A growing belief in many capitalist countries that MNE's tightly controls key technology and that important jobs
in the MNEs' foreign subsidiaries go to home-country nationals

74. (p. 255) According to _____ international production should be distributed among countries according to the theory of comparative advantage. A. The radical view
B. The eclectic view
C. Pragmatic nationalism
D. The free market view
75. (p. 256) A distinctive aspect of _____ is the tendency to aggressively court FDI believed to be in the national interest by, for example, offering subsidies to foreign MNEs in the form of tax breaks or grants. A. The dogmatic view

B. Pragmatic nationalism
C. The radical view
D. The conservative view

76. (p. 257) When a company brings capital and/or technology to a host country, the host country benefits from the A. Competitive effect of FDI
B. The resource transfer effect of FDI
C. The balance of payments effect of FDI
D. The effect on competition and economic growth

77. (p. 258) When jobs are created in local suppliers as a result of the FDI and when jobs are created because of increased local spending by employees of the MNE, the MNE has a _____ effect on employment. A. Direct

B. Indirect
C. Inward
D. Outward

78. (p. 259) A _____ keeps track of a country's payments to and its receipts from other countries. A. Federal payments ledger
B. Current accounting system
C. Checks and balances account
D. Balance of payments account

79. (p. 259) The _____ tracks the export and import of goods and services. A current account deficit or trade deficit as it is often called, arises when a country is importing more goods and services than it is exporting. A. Current account

B. Debit account
C. Surplus account
D. Capital account

80. (p. 261) Three costs of FDI concerns of host countries arise from all of the following except A. Adverse effects on competition within the host nation
B. Adverse effects on the balance of payments
C. The perceived loss of national sovereignty and autonomy
D. Debit on the current account of the home country's balance of payments
81. (p. 262) FDI undertaken to serve the home market is known as A. Greenfield investment
B. FDI substitution
C. Offshore production
D. Home market FDI
82. (p. 263) Double taxation is
A. Charging double taxes in the home country
B. Charging double taxes in the host country
C. Taxation of income in both home and host country
D. Paying income taxes at twice the normal rate

83. (p. 264) _____ are controls over the behavior of the MNE's local subsidiary. A. Performance requirements
B. Ownership restraints
C. Double taxation laws
D. Greenfield restrictions

84. (p. 267) Licensing would be a good option for firms in which of the
following industries? A. High-technology industries in which protecting firm-specific expertise is of paramount importance and licensing is hazardous B. Global oligopolies, in which competitive interdependence requires that multinational firms maintain tight control over foreign operations C. Industries in which intense cost pressures require that multinational firms maintain tight control over foreign operations D. In fragmented, low technology industries in which globally dispersed manufacturing is not an option

85. (p. 267) _____ is essentially the service industry version of licensing, although it normally involves much longer term commitments. A. Franchising
B. Subsidizing
C. Greenfield investment
D. Patenting

Essay Questions
86. (p. 242) Discuss the connection between foreign direct investment and multinational enterprises?

Foreign direct investment (FDI) occurs when a firm invests directly in new facilities to produce and/or market a product in a foreign country. The U.S. Department of Commerce states that FDI occurs whenever a U.S. citizen, organization or affiliated group takes an interest of 10 percent or more in a foreign business entity. Once affirm undertakes FDI, it becomes a multinational enterprise.

87. (p. 242) What are the two forms of foreign direct investment? The two forms of FDI are Greenfield investment or establishing a new operation in a foreign country and mergers and acquisitions whereby a company expands internationally through an existing firm. Acquisitions can be minority, majority or a 100% ownership position. 88. (p. 242) Discuss the trends in FDI over the last 30 years. Be sure to differentiate between the stock of FDI and the flow if FDI. The flow of FDI refers to the amount of FDI undertaken over a given period, while the stock of FDI refers to the total accumulated value of foreign-owned assets at a given time. Over the last 30
years there has been a marked increase in both the flow and the stock of FDI in the world economy. Over this period, the flow of FDI accelerated faster than the growth in world trade and world output. 89. (p. 242) Discuss the reasons for the growth in FDI over the last 30 years. FDI has grown more rapidly than world trade and world output for several reasons. First, many companies see FDI as a means of circumventing potential trade barriers. Second, political and economic changes in many of the world developing nations has been encouraging FDI. Finally, the globalization of the world economy is having a positive impact on the volume of FDI as firms now see the whole world as their market. 90. (p. 242-248) What is a Greenfield investment? How does it compare to an acquisition? Which form of FDI is a firm more likely choose? Explain your answer. FDI can take the form of a Greenfield investment in a new facility or an acquisition of or a merger with an existing local firm. Research shows that most FDI takes the form of mergers and acquisitions rather than Greenfield investment.

Mergers and acquisitions are more popular for three reasons. First, mergers and acquisitions are quicker to execute than Greenfield investments. Second, foreign firms are acquired because those firms have valuable strategic assets. Third, firms make acquisitions because they believe they can increase the efficiency of the acquired firm by transferring capital, technology or management skills. 91. (p. 248) Discuss the shift in FDI from manufacturing to services. What is driving the trend? Over the last twenty years, the sector composition of FDI has shifted from extractive industries and manufacturing toward services. By 2004, some 66 percent of the stock of FDI was in services. Four factors are driving the shift to services. First, the shift reflects the general move in many developed economies away from manufacturing and toward service industries. Second, many services cannot be traded internationally and FDI is a principal was to bring services to foreign markets. Third, many countries have liberalized their regimes governing FDI in services making the option more attractive to firms. Finally, the rise of Internet-based global telecommunications networks has allowed some service enterprises to relocate some of their value creation activities to different nations to take advantage of favorable factor costs.

92. (p. 249) Consider why firms selling products with low value-to-weight
ratios choose FDI over exporting. Products with low value-to-weight ratios such as soft drinks or cement are frequently produced in the market where they are consumed. When transportation costs are added to production costs, it becomes unprofitable to shift such products over a long distance. For firms that can produce low value-to-weight products at almost any location the attractiveness of exporting decreases and FDI or licensing becomes more appealing. 93. (p. 250) Discuss the market imperfections explanation of FDI. What is its relationship with internalization theory? Market imperfections or factors that inhibit markets from working perfectly, provide a major explanation of why firms prefer FDI to either exporting or licensing. In the international business literature, the marketing imperfections approach is referred to as internalization theory. According to the theory, FDI will be preferred when there are impediments that make both exporting and the sale of know-how difficult and/or expensive. 94. (p. 250) What is licensing? How does it work?

Licensing occurs when a domestic firm, the licensor, licenses to a foreign firm, the licensee, the right to produce its product, to use its production processes or to use its brand name or trademark. In return, the licensor collects royalty fees on every unit the licensee sells or on total licensee revenues. The licensor also benefits from the arrangement in that the licensee bears the cost and risk of expanding into a foreign market. 95. (p. 250) Compare and contrast the advantages of foreign direct investment over exporting and licensing. A firm will favor foreign direct investment over exporting as an entry strategy when transportation costs or trade barriers make exporting unattractive. Furthermore, the firm will favor foreign direct investment over licensing (or franchising) when it wishes to maintain control over its technological know-how or over its operations and business strategy or when the firm's capabilities are simply not amenable to licensing, as may often be the case. 96. (p. 251) Consider the notion that FDI flows are a reflection of strategic rivalry between firms in the global marketplace. What is the main limitation of the theory? The strategic behavior approach to explain FDI was initially expounded by Knickerbockers who argued that in an oliogopolistic industry, a "follow the leader" mentality will prompt firms to pursue FDI when another firm in the industry has already done so. However, the theory fails to explain why the first firm decided to undertake FDI, rather than export or license. 97. (p. 252)

What is multipoint competition? How do firms respond to multipoint competition? Multipoint competition arises when two or more enterprises encounter each other in different regional markets, national markets or industries. Economic theory suggests that firms will try to match each other's moves in different markets to try to hold each other in check. If a firm is successful with this strategy, the firm will ensure that a rival does not take a commanding position in one market and then use the profits generated in that market to underwrite competitive attacks in other markets. 98. (p. 252) Explain the product life cycle theory and its connection with FDI. The product life cycle theory, developed by Ray Vernon, suggests that the same firms that pioneer a product in their home country will undertake FDI to produce a product for consumption in foreign markets. According to the theory, firms will invest in industrialized countries when demand in those countries is sufficient to support local production. They subsequently shift production to developing countries when product standardization and market saturation give rise to price competition and cost pressures. Investment in developing countries, where labor costs are lower is seen as the best way to reduce costs. 99. (p. 252-253) What are location-specific advantages? How do they help explain FDI? Location specific advantages are advantages that arise from using resource endowments or assets that are tied to a particular foreign location and that a firm finds valuable to combine with its own unique assets. Natural resources such as oil and minerals for example, are specific to certain locations. Firms must undertake FDI to exploit such foreign resources. 100. (p. 253) Explain John Dunning's position on FDI. What is the eclectic paradigm? John Dunning has argued that to fully understand FDI it is important to consider the role of location specific advantages.

According to Dunning, a firm will be prompted to undertake FDI in an effort to exploit assets that are specific to a particular location. Dunning's theory, the eclectic paradigm, combines the arguments of internalization theory with the notion of location-specific advantages to suggest that combining location-specific assets or resource endowments and the firm's own unique capabilities often requires the firm to establish production facilities where the foreign assets or resource endowments are located. 101. (p. 254-256) Discuss the various political ideologies and their impact on foreign direct investment. The radical view writers argue that the multinational enterprise (MNE) is an instrument of imperialist domination. The free market view argues that international production should be distributed among countries according to the theory of comparative advantage.

The pragmatic nationalist view is that FDI has both benefits and costs. The radical view has a dogmatic radical stance that is hostile to all inward FDI The free market view is at the other extreme and based on noninterventionist principle of free market economics. Between these two extremes is an approach called pragmatic nationalism. 102. (p. 257-262) Discuss the benefits and costs of FDI from the perspective of a host country and from the perspective of the home country. The main benefits of inward FDI for a host country arise from resource-transfer effects, employment effects, balance-of-payments effects and effects on competition and economic growth. Three costs of FDI concern host countries. They arise from possible adverse effects on competition within the host nation, adverse effects on the balance of payments and the perceived loss of national sovereignty and autonomy. The benefits of FDI to the home (source) country arise from three sources. First, the home country's balance of payments benefits from the inward flow of foreign earnings. Second, benefits to the home country from outward FDI arise from employment effects. Third, benefits arise when the home-country MNE learns valuable skills from its exposure to foreign markets that can subsequently be transferred back to the home country. The most important cost/concern of FDI for the home country centers on the balance-of-payments and employment effects of outward FDI.

103. (p. 266-267) Describe the situations when licensing is not a good option for a firm. Licensing is not a good option in three situations. First, licensing is hazardous in high-tech industries where protecting firm-specific expertise is very important. Second, licensing is not attractive in global oligopolies where tight control is necessary so that firms have the ability to launch coordinated attacks against global competitors. Finally, in industries where intense cost pressures require that MNEs maintain tight control over foreign operations, licensing is not the best option. 104. (p. 267) What is franchising? What type of firm uses
franchising as a means of expanding into foreign markets? Franchising is essentially the service-industry version of licensing. With franchising, the firm licenses its brand name to a foreign firm in return for a percentage of the franchisee's profits. The franchising contract specifies the conditions that the franchisee must fulfill if it is to use the franchisor's brand name. Franchise agreements usually have a longer time commitment than do licensing arrangements. Franchising is common in the fast food industry because fast food cannot be exported, because franchising minimizes the costs and risks associated with opening a foreign market, because brand names are relatively easy to protect, because there is no compelling reason for a firm to have tight control over franchisees and because fast food know-how is easily transferred.

105. (p. 267) How useful are the product life cycle theory and Knickerbocker's theory of horizontal FDI to business? The product life cycle theory and Knickerbocker's theory of horizontal FDI to business are not particularly useful from a business perspective because the theories are descriptive rather than analytical. The theories are useful for explaining historical patterns of FDI, but they do a poor job of identifying the factors that influence the relative probability of FDI, licensing and exporting.