Foreign multinationals and domestic innovation: Intra-industry effects and firm heterogeneity

•Looks at the impact of MNE investments on domestic firms’ innovation in the UK.•Focuses on domestic firms in the same industrial sector as foreign enterprises.•Employs a direct measure of capital inflows into the recipient economy.•Finds a positive effect on firms in sectors experiencing greater MNE investments.•Highlights how heterogeneity across domestic firms shapes the overall impact. This paper looks at foreign Multinational Enterprises (MNEs) investing in the UK and at their impact on the innovation performance of domestic firms active in their same sector. By employing data on Foreign Direct Investments matched with firm-level information the paper develops a direct measure of capital inflows at a three-digit industry level. In order to capture innovation in both manufacturing and services the paper relies on a broader proxy for firm innovativeness based on the Community Innovation Survey (CIS). The results suggest that domestic firms active in sectors with greater investments by MNEs show a stronger innovative performance. However, the heterogeneity across domestic firms in terms of internationalization of both their market engagement and ownership structure is the main driver of this effect.