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A simple model of corporate international investment under incomplete information and taxes

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  • Mondher Bellalah
  • Zhen Wu

Abstract

This paper extends the theory of corporate international investment in Choi (J. Int. Bus. Stud. 20: 145–155, 1989 ) in an environment where the segmentation of international capital markets for investors or the presence of agency costs provide some independence to corporate decisions. The model shows that the real exchange risk, the competition between firms in different markets and diversification gains affect corporate international investment. By accounting for the role of information as defined in the models of Merton (J. Finance 42: 483–510, 1987 ), Bellalah (Int. J. Finance Econ. 6: 59–67, 2001a ) and Bellalah and Wu (Int. J. Theor. Appl. Finance 5(5): 479–495, 2002 ), the model embodies different existing explanations based on economic and behavioral variables. We show in a “two-country” firm model that real exchange risk, diversification motives and information costs are important elements in the determination of corporate international investment decisions. The dynamic portfolio model reflects the main results in several theories of foreign direct investment. Our model accounts for the role of information in explaining foreign investments. It provides simple explanations which are useful in explaining the home bias puzzle in international finance. Using the dynamical programming principle method, we provide the general solution for the proportion of firm’s total capital budget. We also use a new method to get explicit solutions in some special cases. This new method can be applied to solve other financial control problems. The simulating results are given to show our conclusion and the influence of some parameters to the optimal solution. The economic results can be seen as a generalization of the model in Solnik (J. Econ. Theory 8: 500–524, 1974 ). Copyright Springer Science+Business Media, LLC 2009

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  • Mondher Bellalah & Zhen Wu, 2009. "A simple model of corporate international investment under incomplete information and taxes," Annals of Operations Research, Springer, vol. 165(1), pages 123-143, January.
    • Handle: RePEc:spr:annopr:v:165:y:2009:i:1:p:123-143:10.1007/s10479-007-0307-9
    DOI: 10.1007/s10479-007-0307-9
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    References listed on IDEAS

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    1. Mondher Bellalah, 1999. "Valuation of futures and commodity options with information costs," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 19(6), pages 645-664, September.
    2. Rene M. Stulz, 1999. "Globalization of Equity Markets and the Cost of Capital," NBER Working Papers 7021, National Bureau of Economic Research, Inc.
    3. Solnik, Bruno H., 1974. "An equilibrium model of the international capital market," Journal of Economic Theory, Elsevier, vol. 8(4), pages 500-524, August.
    4. Black, Fischer, 1974. "International capital market equilibrium with investment barriers," Journal of Financial Economics, Elsevier, vol. 1(4), pages 337-352, December.
    5. Kang, Jun-Koo & Stulz, Rene M., 1997. "Why is there a home bias? An analysis of foreign portfolio equity ownership in Japan," Journal of Financial Economics, Elsevier, vol. 46(1), pages 3-28, October.
    6. Joshua D. Coval & Tobias J. Moskowitz, 1999. "Home Bias at Home: Local Equity Preference in Domestic Portfolios," Journal of Finance, American Finance Association, vol. 54(6), pages 2045-2073, December.
    7. Stulz, Rene M, 1981. "On the Effects of Barriers to International Investment," Journal of Finance, American Finance Association, vol. 36(4), pages 923-934, September.
    8. Jongmooo Jay Choi, 1989. "Diversification, Exchange Risks and Corporate International Investment," Journal of International Business Studies, Palgrave Macmillan;Academy of International Business, vol. 20(1), pages 145-155, March.
    9. Bellalah, Mondher & Jacquillat, Bertrand, 1995. "Option Valuation with Information Costs: Theory and Tests," The Financial Review, Eastern Finance Association, vol. 30(3), pages 617-635, August.
    10. Mondher Bellalah & Zhen Wu, 2002. "A Model For Market Closure And International Portfolio Management Within Incomplete Information," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 5(05), pages 479-495.
    11. Rudiger Dornbusch, 1980. "Exchange Rate Risk and the Macroeconomics of Exchange Rate Determination," NBER Working Papers 0493, National Bureau of Economic Research, Inc.
    12. Adler, Michael & Dumas, Bernard, 1983. "International Portfolio Choice and Corporation Finance: A Synthesis," Journal of Finance, American Finance Association, vol. 38(3), pages 925-984, June.
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    Cited by:

    1. Mondher Bellalah & Akeb Hakim & Kehan Si & Detao Zhang, 2022. "Long term optimal investment with regime switching: inflation, information and short sales," Annals of Operations Research, Springer, vol. 313(2), pages 1373-1386, June.
    2. Mondher Bellalah, 2018. "On information costs, short sales and the pricing of extendible options, steps and Parisian options," Annals of Operations Research, Springer, vol. 262(2), pages 361-387, March.
    3. Hui, Eddie C.M. & Wang, Guangchen, 2015. "A new optimal portfolio selection model with owner-occupied housing," Applied Mathematics and Computation, Elsevier, vol. 270(C), pages 714-723.
    4. Huang, Zongyuan & Wang, Haiyang & Wu, Zhen, 2020. "A kind of optimal investment problem under inflation and uncertain time horizon," Applied Mathematics and Computation, Elsevier, vol. 375(C).
    5. Bellalah, Mondher & Bradford, Marc & Zhang, Detao, 2016. "A general theory of corporate international investment under incomplete information, short sales and taxes," Economic Modelling, Elsevier, vol. 58(C), pages 615-626.
    6. Mondher bellalah, 2018. "Pricing derivatives in the presence of shadow costs of incomplete information and short sales," Annals of Operations Research, Springer, vol. 262(2), pages 389-411, March.
    7. Mondher Bellalah & Shujuan Ding & Zhen Wu, 2012. "Corporate Optimal Investment Under Incomplete Information: A Real Option Method," The Review of Finance and Banking, Academia de Studii Economice din Bucuresti, Romania / Facultatea de Finante, Asigurari, Banci si Burse de Valori / Catedra de Finante, vol. 4(1), pages 007-014, June.
    8. Bellalah, Mondher, 2016. "Shadow costs of incomplete information and short sales in the valuation of the firm and its assets," The North American Journal of Economics and Finance, Elsevier, vol. 37(C), pages 406-419.

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