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Foreign firms have a more educated workforce and pay higher wages than domestic firms even after controlling for worker quality, at a given moment in time. This does not imply that foreign ownership improves the labor market outcomes of the workers since foreign investment may be guided by unobservable firm and worker characteristics correlated with schooling or wages. This paper asks whether foreign investors acquire firms with high human capital or wages, or whether foreign acquisition improves these outcomes. Using a matched employer–employee data set, I find that foreign acquisitions of domestic firms have small effects on the human capital and on average wages of the acquired firms. Instead, foreign investors “cherry pick” those domestic firms that are already very similar to the group of existing foreign firms.

A large empirical literature documents that, in the cross-section, foreign firms are larger, more productive, more capital intensive, pay higher wages and have a more skilled workforce than domestic firms. This suggests that foreign investors may have a positive effect on the welfare of the workforce of the host economy. This argument has been used to justify regional or national industrial policies to attract and secure foreign investment. But, while cross-sectional differences are large, they are not necessarily causal. For example, they may arise because foreigners acquire domestic firms that already have a more educated workforce and pay higher wages than the average firm, because foreign investment leads to an increase in the demand for skills and average wages of the acquired firms, or both. Disentangling correlation from causality is crucial for understanding the welfare effects of foreign investment in the host economy and for designing appropriate policies.

Foreign firms have a more educated workforce and pay higher wages than domestic firms even after controlling for worker quality, at a given moment in time. This does not imply that foreign ownership improves the labor market outcomes of the workers since foreign investment may be guided by unobservable firm and worker characteristics correlated with schooling or wages. Using a matched employer–employee data set of Portuguese firms during the nineties, I illustrate the importance of selection of foreign investment to high wage and high human capital firms and to isolate the effect of foreign ownership on several labor market outcomes. Existing empirical evidence for European countries is scarce and, apart from evidence for the UK, not much is known about the impact of foreign acquisitions on the labor markets outcomes. Portugal is an interesting case, as in the late 1980s and 90s there was a permissive legal framework for the operation of foreign firms that translated into generous amounts of FDI. Moreover, Portugal is a developed country although at the tail of the income distribution within the European Union. Therefore, the findings in the paper may be particularly important to understand the effects of foreign direct investment in the labor markets of the transition economies as they will soon join the European Union.