This paper examines the joint effect of imports and inward foreign direct investment (iFDI), the two primary entry forms of foreign companies to the U.S. product market, on domestic firms’ capital investment decisions. We develop novel firm-level measures to gauge the impact of imports and iFDI. We show that increased import competition significantly reduces U.S. firms’ investment; in contrast, the effect of iFDI on investment is largely nonsignificant. Further analysis suggests that the negative effect of imports on investment is due to competition-induced decline in cash flows. And the nonsignificant result for iFDI can be partly attributed to technology spillovers generated by foreign multinational’s U.S. productions, which promote U.S. local firms’ innovation capacity and consequently offset the negative effect of foreign competition on investment. Overall, our results indicate that foreign competition plays a key role in shaping corporate investment policy and highlight the distinct implications of imports and iFDI on firm investment.

Introduction

The importance of capital investment for a country’s economic growth and financial development cannot be overstated. And understanding key determinants of a firm’s capital investment decisions is among the most fundamental objectives of corporate finance research. The globalization of product markets continues to shape corporate environments and could have profound impacts on firm investment. In the United States, the market share of foreign firms is more than quadrupled from late the 1970s to the early 2010s.1 It is also important to note that foreign penetration of U.S. market is a complex and multifaceted construct, and different forms of penetration could have divergent implications on corporate investment policy. However, despite extensive studies on how international trade affects firm survival and profit, the literature so far offers little firm-level evidence about the impact of foreign penetration on capital spending. In this paper, we set out to fill this important gap by examining how U.S. firms’ investment decisions react to the two primary forms of foreign penetration: (1) Foreign firms exporting home country-produced goods to the United States or (2) foreign multinationals directly setting up establishments in the United States or acquiring the ownership of U.S. domestic facilities to produce and sell. Prior studies have mainly focused on how the former, foreign exports, and the removal of related trade barriers (e.g., tariff reduction) affect U.S. corporate policies; however, the impacts of the latter form of foreign penetration have been largely overlooked. Furthermore, given the structural differences between foreign exporters and U.S. subsidiaries owned by foreign multinationals, it is important to distinguish the impact of U.S. imports from goods produced by U.S. affiliates of foreign firms.