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AbstractThe internationalization of production requires multinational firms to determine a local content rate for their products made and sold in a foreign country. In this paper, we investigate the impact of a government's local content requirement (LCR) on the local content rate and pricing decisions of a multinational firm who competes with a local firm in a market. In an emerging market, the multinational firm increases his local content rate to comply with an LCR if the LCR involves a moderate threshold and a sufficiently large penalty tariff rate. Although a small penalty tariff rate cannot induce the multinational firm's compliance, a larger penalty tariff leads the firm to adopt a higher local content rate. When the multinational firm complies with the LCR, a higher LCR threshold or penalty tariff rate shifts away the multinational firm's demand and profit but may not benefit the local firm if the two firms' price competition is fiercer than their quality competition. In addition, if the two firms' quality competition is fiercer than their price competition, a large LCR threshold may still not benefit the local firm. In contrast, in a developed market, the multinational firm should increase his local content rate as the quality‐cost tradeoff ratio increases. The LCR plays the same effect on the multinational firm as that in an emerging market, whereas its effect on the local firm still depends on the relative intensity of the two firms' price competition versus quality competition, but under reverse conditions.