Foreign equity participation under incomplete information

This paper demonstrates how an interaction between ownership rules and trade policy provides a rationale for a host government to impose local equity requirement (LER) on a foreign multinational. It presents a model where, in the presence of an import tariff, LER can serve as an effective instrument for a host government in removing any incentive for the multinational to mimic an inefficient firm when the government does not have complete information on the cost of the multi national's foreign unit. It is shown that the LER can increase national welfare by removing possible distortions under incomplete information. It is also shown that product market competition lowers the LER. (C) 2007 Elsevier B.V. All rights reserved.