This paper studies determinants of the decision to invest abroad. Among them, we follow the current mainstream theory of foreign direct investment so as to emphasize the stock of technological knowledge. We explicitly solve the optimal geographical composition (i.e. domestic vs. abroad) of the total production of companies. The analysis suggests that the relationship between technological knowledge and overseas production depends on relative prices of factors of production at home and abroad and on the elasticity of substitution between them. It is especially shown that under certain realistic assumptions, companies with a larger stock of technological knowledge have a lower proportion of production in developing countries, but have a higher proportion in developed countries exclusive of Japan. We test this hypothesis using corporate data of Japan's electric machinery industry. The empirical results are consistent with the theory. Besides the stock of technological knowledge, the paper investigates the explanatory power of other factors, such as company size, advertising intensity, and horizontal keiretsu.
Views expressed in the paper are those of the authors and do not necessarily reflect those of the Bank of Japan or Institute for Monetary and Economic Studies.