Abstract

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This paper examines how domestic distortions affect firms’ investment strategies abroad. The study documents two puzzling findings using firm-level data from China. The first is that private multinational corporations are less productive than state-owned multinational corporations, and private firms are more productive than state-owned enterprises overall (selection reversal). The second is that there are disproportionately fewer state-owned multinational corporations than private multinational corporations. The paper builds a theoretical model to rationalize these findings and yields rich empirical predictions. The key insight of the model is that discrimination against private firms domestically incentivizes these firms to produce abroad to implement institutional arbitrage, which results in easier selection into foreign direct investment for private firms. Moreover, the model shows that selection reversal is more pronounced in capital-intensive industries and regions with more severe discrimination against private firms, both of which receive empirical support from the data.