This paper uses a panel data framework to examine whether foreign firms in the UK have higher levels of productivity and set higher wage rates than domestic ones ceteris paribus, or whether this is due to unmeasured characteristics. Its main finding is that foreign firms are more productive, by between 8 and 15 per cent, being particularly efficient in their use of capital. These advantages feed through into the wage levels of their employees, whose wages are higher as a result, effects that are particularly pronounced for firms from the United States.

Peter W. Wright

Sourafel Girma

Steve Thompson

English

Research Papers in Economics

The Economic and Social Review, Vol. 33, No. 1, Spring, 2002, pp. 93-100
Why are Productivity and Wages Higher in
Foreign Firms?*
SOURAFEL GIRMA
University of Nottingham
STEVE THOMPSON
University of Leicester
PETER W. WRIGHT**
CEPR and University of Nottingham
Abstract: This paper uses a panel data framework to examine whether foreign firms in the UK
have higher levels of productivity and set higher wage rates than domestic ones ceteris paribus,
or whether this is due to unmeasured characteristics. Its main finding is that foreign firms are
more productive, by between 8 and 15 per cent, being particularly efficient in their use of capital.
These advantages feed through into the wage levels of their employees, whose wages are higher
as a result, effects that are particularly pronounced for firms from the United States.
I INTRODUCTION
I
t is a stylised fact of the multinational enterprise literature that, on
average, foreign-owned companies outperform domestic firms (Dunning,
1989; Caves, 1996; Doms and Jensen, 1998). It is, furthermore, a proposition
that is very widely accepted among policy makers and one that provides the
major justification for national or regional industrial policy in countries, such
as Ireland and the UK, respectively, that offer major incentives to secure
foreign direct investment. However, there remains a strand within the FDI
93
*An earlier and more extensive version of this paper (“The Productivity and Wage Effects of
Foreign Acquisition in the UK”, available from the authors) was presented at the 28th Annual
Conference of the European Association for Research in Industrial Economics in Dublin,
September 2001. The authors are indebted to several participants at the Conference, especially
John Sutton, for comments on the likely intrinsic differences between foreign and domestic
acquisitions and in this brief paper have tried to address some of these. Financial support from
the ESRC, under grant R00221779, and the Leverhulme Trust, under programme grant F114/BF,
is acknowledged with gratitude.
**Contact Author: e-mail Peter.Wright@nottingham.ac.uk
08. Girma article  25/6/02  3:07 pm  Page 93literature that suggests a less sanguine assessment of foreign-owned firms
may be appropriate. On this view most, if not all, of the apparent superiority
of these firms is explained by industry selection biases and unobservable input
differences – see below – that are not controlled for in the typical cross
sectional comparisons. This brief paper reports some results from a study that
seeks to circumvent the usual measurement difficulties by considering the
effects of changes  in ownership, including moves to foreign ownership, on
productivity and wages. The paper then offers a brief preliminary analysis of
the causes of the productivity and wage changes that have been isolated. 
The current research uses an unbalanced panel of 1,102 UK firms, over
the period 1989-1994. Among the sample, 460 experienced acquisition, foreign
or domestic, over the period while ownership of the rest, again domestic or
foreign, remained unchanged across the same interval. The derivation of our
sample and a description of the data sources are given in Section II below.
However, at the outset we note that the sample’s summary statistics appear to
be entirely consistent with the conventional wisdom on the apparent
superiority of foreign-owned firms. For example, Table 1 contrasts
employment, wages and labour productivity across foreign and domestic
owned companies in the sample. It can be seen immediately that the foreign
firms are larger than domestic firms, pay a higher average wage (10.3 per
cent) and exhibit greater levels of labour productivity (28.8 per cent). 
Observed productivity/wage differentials in favour of foreign-owned firms,
such as those shown above, have been interpreted in the literature as
supportive of the “technology transfer” interpretation of FDI. Incoming
multinationals are assumed to bring with them certain, largely intangible,
assets that are then used to offset any advantages of incumbency possessed by
domestic firms. These assets may include technological knowledge, brand
name capital and superior organisational capabilities. These productivity
advantages then feed through into wage rates by increasing any surplus that
might be available for distribution through bargaining. Although this might be
partially counteracted by the firm’s multinational status, which may move the
bargaining outcome in favour of the company, the former effect is supposed to
dominate.
These propositions, although widely accepted, encounter problems when
subjected to econometric testing. Observable differences in foreign and
domestically owned enterprise performance appear to be matched by other
large differences at the plant, firm and industry levels. There is also good
reason to expect that foreign and domestic firms differ in unobservable
characteristics such as capital vintage, which may generate performance
differences but are not attributable to multinational ownership per se.
Further, multinational entrants may select into more productive industries
94 THE ECONOMIC AND SOCIAL REVIEW
08. Girma article  25/6/02  3:07 pm  Page 94leading to bias in parameter estimates (Tybout, 2000). While the inclusion of
additional controls would help to ameliorate these problems, the specification
of appropriate control variables is normally problematic (Griffith, 1999),
generally requiring information not included in the standard data sets. This
can lead to bias in estimated coefficients.
The use of data that contains information on take-overs offers a potential
solution to this problem. If foreign take-over leaves most industry and plant
characteristics unchanged, at least in the medium run, then any productivity
and wages subsequent to an acquisition can be attributed to the change in
ownership status. Firms subject to domestic acquisition, and those subject to
no ownership changes, can also serve as useful controls in such an analysis. 
II DATABASE CONSTRUCTION AND ECONOMETRIC METHODOLOGY
The source of information relating to acquisitions and other firm level
variables in this paper is the OneSource database of private and public
companies in the UK from 1989-1994. A firm is identified as being acquired at
year t if its status changes from being independent to being a subsidiary of
another firm. The sample consists of 331 domestic and 129 foreign
acquisitions, comprising 36 by American multinationals, 64 by EU-based firms
and 29 by acquirers from other countries, including Japan. An industry-
stratified random control sample of 642 firms was drawn from the population
WHY ARE PRODUCTIVITY AND WAGES HIGHER IN FOREIGN FIRMS? 95
Table 1: Sample Characteristics of Domestic and foreign-owned Firms in UK
Manufacturing Industry: Average Employment, Wages, and Labour
Productivity
Variables 1989 1994
Domestic
Employment 414 (1,650) 327 (1,369)
Wage rate 11.35 (3.87) 13.29 (4.31)
Labour Productivity 72.45 (163.77) 74.48 (96.77)
Foreign
Employment 549 (1,641) 434 (1,098)
Wage rate 12.71 (3.90) 15.22 (4.40)
Labour Productivity 104.68 (137.67) 118.28 (154.24)
Notes: 
(i) Variables are in real terms with standard deviation in parentheses. Wage rate
and labour productivity are in £000.
(ii) The wage rate is defined as the wage bill per worker and labour productivity
is sales per worker.
08. Girma article  25/6/02  3:07 pm  Page 95of foreign and domestic subsidiaries that did not experience a change in
ownership during the sample period.1
In order to estimate the ceteris paribus impact of ownership change on the
level of productivity the following equation was estimated:
qit = α't + β'1 kit + β'2 lit + β'3 mit + f'i + δ'1 Dit + δ'2 Fit + εit (1)
Where i and t index firms and time periods respectively, q, k, l, m are the
logarithm of output, capital, labour and intermediate inputs.2 In addition,
year dummies (α't) are included to control for aggregate shocks, and firm-
specific fixed effects (f') for permanent differences across firms. Separate
dummies for take-overs by foreign (F) and domestic (D) companies are
included to allow for the possibility that domestic and foreign acquisitions may
have differing impacts on total factor productivity. 
Similarly, we estimate an equation of the following form for wages:
wit = αt + βXit + f i + δ1 Dit + δ 2 Fit + εit (2)
Where X is a vector that controls for observable changes that are correlated
with wage rates such as firm size,3 four-digit industry average wages and
productivity.
III EMPIRICAL RESULTS
Table 2 reports panel regression results for the total factor productivity
equations. After controlling for firm fixed effects and autonomous technical
changes (via time dummies), we find an 8 per cent difference in total factor
productivity due to foreign acquisition. 
Column 2 investigates the effect on production further, by allowing foreign
acquisition to additionally impact on the marginal productivity of the factors
of production. The results indicate that the marginal productivity of capital
has doubled in the post foreign acquisition period. This is in contrast to the
impact of the marginal productivity of labour, which has if anything slightly
decreased, though this effect falls short of conventional significance levels.
Note that this less constrained equation indicates even larger total factor
productivity effects for foreign take-overs of some 14 per cent.
96 THE ECONOMIC AND SOCIAL REVIEW
1 Full details of the sample and control firms are available from the authors on request.
2 Capital (fixed assets) is defined as net (of depreciation) book value of equipment, plant and
machinery, fixtures and fittings and vehicles.
3 Proxied by fixed assets.
08. Girma article  25/6/02  3:07 pm  Page 96WHY ARE PRODUCTIVITY AND WAGES HIGHER IN FOREIGN FIRMS? 97
Table 2: The Impact of Ownership on Marginal Factor and Total Factor
Productivity
Fixed Fixed Fixed Fixed Fixed
Effect no Effect with effect IV no effect IV with effect IV with
Interaction Interaction Interaction Interaction Interaction
(1) (2) (3) (4) (5)
TFP effects
Horizontal 0.011 0.113 0.024 0.165 0.147
(0.80) (1.37) (1.64) (1.85) (1.63)
Non-Horizontal –0.026 0.092 –0.016 0.128 0.112
(2.77)** (1.94) (1.63) (2.52)* (2.18)*
Foreign 0.082 0.140 0.086 0.146
(6.81)** (2.37)* (6.28)** (2.11)*
USA .148
(4.75)**
Non-USA .065
(4.09)**
Labour  0.511 0.516 0.510 0.517 0.515
(59.72)** (58.99)** (59.64)** (58.85)** (40.70)**
Acquisition Interactions
Horizontal –0.034 –0.042 –0.043
(1.79) (2.12)* (2.17)*
Non-Horizontal –0.025 –0.042 –0.043
(1.94) (3.01)** (3.05)**
Foreign –0.050 –0.040
(2.77)** (1.88)
USA 0.072
(0.43)
Non-USA 0.001
(0.00)
Capital 0.027 0.025 0.027 0.025 0.020
(5.69)** (5.03)** (5.76)** (4.97)** (3.36)**
Acquisition Interactions 
Horizontal 0.009 0.008 0.010
(0.64) (0.53) (0.69)
Non-Horizontal –0.001 0.006 0.008
(0.08) (0.66) (0.87)
Foreign 0.025 0.017
(2.21)* (1.33)
USA 0.10
(2.11)*
Non-USA 0.041
(0.55)
Intermediate Inputs 0.383 0.382 0.382 0.382 0.384
(73.61)** (73.57)** (73.51)** (73.47)** (73.14)**
Hausman Test p-value .7402 .6452
Observations 9,648 9,648 9,648 9,648 9,648
Number of firms 1,102 1,102 1,102 1,102 1,102
R-squared 0.76 0.76
Notes: (i) Absolute values of t-statistics are given in parentheses. * Significant at 5 per cent; 
** significant at 1 per cent.
(ii) Capital intensity is measured as fixed assets per worker. 
(iii) Coefficients on acquisition dummies in the level and growth equations are percentage and
percentage point differentials respectively.
08. Girma article  25/6/02  3:07 pm  Page 97In column 3, the possible endogeneity of the acquisitions dummies4 in the
production function is controlled for by using a fixed effects instrumental
variables (IV) estimator. In this procedure,5 instruments for acquisition are
generated using a multinomial logit model that predicts the probability of
take-over. The results show that the “standard” and IV fixed effect approaches
yield remarkably similar estimates, confirming the finding that foreign take-
overs lead to increases in total factor productivity and in the marginal
productivity of capital. In the IV model, however, no discernible change in the
marginal productivity of labour is found. The Hausman tests find no
systematic differences in the coefficient estimates between the standard and
IV fixed effect models, and we find no evidence that foreign companies
systematically acquire higher/lower total factor productivity firms.
Finally, since Conyon et al. (2001) suggest that horizontal acquisitions
may impact differentially on performance to vertical or diversifying acquisi-
tions we also distinguish domestic acquisitions according to whether they are
horizontal or  non-horizontal. Non-horizontal acquisitions appear to lead to
productivity increases of 12 per cent, an improvement that is not matched by
horizontal acquisitions.
Table 3 presents the results from the fixed effects panel estimation of the
wage equations. Controlling for firm size, industry wages, firm fixed and
industry fixed effects (column 1) indicates that companies acquired by foreign
firms experience an increase in wages of 3.44 per cent, which is in contrast to
the fall of 2.11 per cent in those acquired by domestic companies. However
once labour productivity is added to the vector of control variables (column 2),
the wage premium due to foreign acquisitions disappears. This would seem to
indicate that the impact of foreign acquisitions on wages is entirely driven by
superior levels of productivity associated with foreign ownership. 
The experience of firms acquired by domestic firms is markedly different.
Column 2 indicates that wages are reduced following acquisition ceteris
paribus which, in conjunction with the previous table that shows no positive
impacts on efficiency from domestic acquisitions, indicates a transfer of
surplus away from workers to shareholders as suggested by Shleifer and
Summers (1988). Looking at the type of domestic acquisitions, horizontal
mergers are followed by a significant ceteris paribus pay cut, an effect that
survives controlling for productivity.
98 THE ECONOMIC AND SOCIAL REVIEW
4 “Excluded” instruments used to predict probability of acquisitions were lagged (relative) wages
and profits, sectoral concentration and foreign direct investment and firm size.
5 Vella and Verbeek (1999) have recently shown that this type of instrumental variable approach
generates estimates comparable to Heckman’s (1978,1979) endogeneity bias corrected OLS
estimator.
08. Girma article  25/6/02  3:07 pm  Page 98Table 3: The Impact of Ownership Changes on Wage Rates by Type of
Acquisition
Endogeneity Corrected
(1) (2) (3) (4)
Industry wage .09 (7.92) .05 (4.93) .05 (5.03) .065 (3.77)
Fixed assets .004 (1.84) .01 (3.75) 0.01  (3.91) .019 (3.37)
Domestic – 2.10 (3.13) – 2.17 (3.79)
Foreign 3.38 (3.42) 0.00 (0.00)
USA 0.00 (0.00) 1.60 (0.52)
EU –1.50 (1.18) –1.28 (0.51)
Other Foreign .10 (.51) 1.60 (1.05)
Horizontal –3.50 (4.48) –3.20 (1.83)
Non-horizontal –.80  (1.29) .40 (0.32)
Labour Prod. .30 (5.42) 0.29 (52.30) 0.29 (11.44)
Employment –.019 (3.96) –.020 (1.58)
Year Dummies Y Y Y Y
No. of observations 9648 9648 9648 9648
Notes: (i) The coefficient on acquisition dummies gives the percentage change in wage
rates following ownership change.
(ii) Absolute values of t-stats are given in parentheses.
Since it has been mooted that multinationals of some nationalities are
more strongly associated with the transfer of work practices than others,
Tables 2 and 3 also distinguish by whether the foreign acquirer originates in
the US. Table 2 column 5 indicates that although the increase in total factor
productivity is observed across all types of foreign acquisition, the greatest
increase is observed for US firms. 
Turning to wage changes, once labour productivity is controlled for the
wage effects of acquisition remain insignificant regardless of the country of
origin of the acquirer. This again suggests that the wage premiums observed,
especially in US (4.7 per cent) and other foreign firms (3.9 per cent), is
primarily because of productivity differentials rather than because of internal
redistributions of income. 
V CONCLUSION
This short paper presents some results from a study that looks at the
question of why foreign firms have higher levels of productivity and set higher
wage rates than domestic ones. By using a panel framework it has controlled
for unobserved factors that might lead to measured productivity and wage
differentials unrelated to ownership. Its main finding is that foreign firms are
WHY ARE PRODUCTIVITY AND WAGES HIGHER IN FOREIGN FIRMS? 99
08. Girma article  25/6/02  3:07 pm  Page 99more productive than domestic ones, by between 8 and 15 per cent, being
particularly productive in their use of capital. These advantages feed through
into the wage levels of their employees, whose wages are higher by 4-5 per
cent, a differential that is entirely explained by the greater levels of
productivity. These effects are particularly pronounced for firms from the
United States. We observe, without further comment, the irony that the
foreign acquisition of UK companies is often fiercely denounced in the British
press, whilst its consequences appear to be thoroughly beneficial!
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100 THE ECONOMIC AND SOCIAL REVIEW
08. Girma article  25/6/02  3:07 pm  Page 100

Breach of Trust in Hostile Take-overs”,

Comparing Wages, Skills and Productivity Between Domestically and Foreign-owned Manufacturing Establishments in the United States”

Dummy Endogenous Variables in a Simultaneous Equation System”.

Estimating and Interpreting Models with Endogenous Treatment Effects”,

Manufacturing Firms in Developing Countries: How Well Do They Do, and Why?”,

Multinational Enterprise and Economic Analysis, Cambridge:

Sample Selection Bias as a

Specification Tests for the Multinomial Logit Model”,

Using the ARD Establishment Level Data to Look at Foreign Ownership and Productivity in the United Kingdom”.

Why are Productivity and Wages Higher in Foreign Firms?

Why are Productivity and Wages Higher in Foreign Firms?

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