Abstract

Firms often form a cross-border alliance by only partially owning the equity. When and why do firms choose cross-border partial equity ownership (PEO)? Under which conditions should a government permit cross-border PEO? To address these questions, this paper develops a model of cross-border PEO where a foreign firm forms a cross-border alliance with a home firm to avoid trade costs and endogenously sets the equity level to maximize joint profits. We find that when the cost difference between home and foreign firms is moderate, these firms choose PEO in order to shift the production across PEO firms most effectively. We also show that while PEO decreases welfare by increasing market price, the benefit of improved production efficiency in PEO firms can dominate the cost of weakened market competition, which gives a government incentive to permit PEO. Finally, our analysis reveals that trade liberalization has a critical effect on the optimal equity levels for firms and a government, yielding novel policy implications.