Heterogeneous Firms in Trade: Quality Matters

This dissertation comprises three papers that separately study product quality in international trade, the governance’ effect on FDI and the agency problems in firms’ exporting decisions. The first chapter quantifies the contribution of differences in quality preferences to the differences in gains from trade across countries. The quantification demonstrates that variations in the strength of quality preferences across countries add to heterogeneities across countries in market competitiveness. If the quality channel is shut down, countries with stronger preferences for quality have larger degrees of underestimations in their losses from the trade barrier. Finally, gains from a universal rise in quality preference are unequal among countries, with larger economies generally gaining more than smaller economies. The second chapter proposes a theoretical model to micro-found firms’ optimal choice of FDI location, and sourcing and production, allowing for many countries, industries, and heterogeneous firms. We arrive at the main hypothesis that predicts an institutional complementarity pattern across countries in bilateral FDI flows at both the firm and country levels. We conduct an extensive test of the theory using worldwide bilateral FDI data at the firm level and at the country level. The results indicate a statistically significant assortative matching pattern in the institutional qualities of FDI origins and destinations. The third chapter incorporates financial constraints into agency problems of firms. We show that under the same conditions, managers of potential exporting firms around the export threshold exert more efforts in financially under-developed countries to induce their owners to export. This finding has very positive policy implications, as firms in financially under-developed countries can compete with their peers in financially developed countries by exerting more managerial efforts. We find clear empirical evidence for this theoretical prediction using World Management Survey data for more than ten thousands firms from around 20 countries during 1999 – 2010.