In this paper, we examine how R&D costs, technological spillover, market size, and
ownership constraint affect the choice of foreign entry, R&D level, and host country’s
welfare. In a full foreign ownership model, the foreign firm tends to raise the likelihood
of choosing direct entry when the R&D spillover is larger. The R&D investment
decreases when its spillover effect becomes larger. In an extreme case, when the typical
domestic firm fully absorbs foreign technology, the foreign firm always provides more
R&D under acquisition than under direct entry. In addition, for the foreign firms as well
as the host country, there is no difference between choosing direct entry or acquisition
when the market is extremely competitive. With regulation on foreign ownership, the
R&D spillover creates the possibility of choosing direct entry for the foreign firm,
which is different from the results obtained in Mattoo et al. (2004).