Previous chapters investigated why multinational enterprises (MNEs) invest resources in facilities abroad at all. The focus now shifts to why they undertake capital expenditures abroad at the rates they do, and what explains their choice of methods of financing these expenditures. Their investment and financing behavior might differ from domestic firms for several reasons. Demands giving rise to their investments are geographically dispersed, based in imperfectly competitive markets, and raise important questions of option values. Their financing decisions are made in imperfect international capital markets that may be balkanized by variable exchange rates. In the long run, does the MNE enjoy an opportunity to arbitrage between national capital markets that are cleaved by transaction costs? In the short run, how do its money-management decisions respond to variations of exchange rates and short-term credit conditions?

The firm's balance-sheet identity and its changes over time provide a helpful framework for the analysis that follows (Stevens, 1972). A growing foreign subsidiary chooses to expand its assets – fixed (plant and equipment) or liquid (receivables, working capital). This expansion must be financed from some increase in its liabilities: retained earnings from its previous profits, new equity or loans from its parent, and borrowing from external sources (call it local borrowing). Similarly, the subsidiary's parent can expand its fixed or liquid assets in its home base, but also its investment in or claims on its subsidiaries.