Cross Investment Theory
(E. M. Graham). Graham noted a tendency for cross investment by European and American firms in certain oligopolistic industries; that is, European firms tended to invest in the United States when American companies had gone to Europe.
He postulated that such investments would permit the American subsidiaries of European firms to retaliate in the home market of U.S. companies if the European subsidiaries of these companies initiated some aggressive tactic, such as price cutting, in the European market.
The Internalization Theory
Is an extension of the market imperfection theory. By investing in a foreign subsidiary rather than licensing, the company is able to sent the knowledge across borders while maintaining it within the firm, where it presumably yields a better return on the investment made to produce it.
Other theories relate to financial factors. Robert Aliber believes the imperfections in the foreign exchange markets may be responsible for foreign investment. He explained this in terms of the ability of firms from countries with strong currencies to borrow or raise capital in domestic or foreign markets with weak currencies, which, in turn, enabled them to capitalize their expected income streams at different rates of interest.
Structural imperfection in the foreign exchange market allow firms to make foreign exchange gains through the purchase or sales of assets in an undervalued or overvalued currency.
One other financially based theory (portfolio theory) was put by Rugman, Agmon and Lessard. These researchers argued that international operations allow for a diversification of risk and therefore tend to maximize the expected return on investment.
Rugman and Lessard have further argued that the location of the foreign direct investment would be a function of both the firm's perception of the uncertainties involved and the geographical distribution of its existing assets.
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