DP1891 Expropriation and Control Rights: A Dynamic Model of Foreign Direct Investment

Author(s): Monika Schnitzer
Publication Date: May 1998
Keyword(s): Foreign Direct Investment, Implicit Contracts, Sovereign Risk
JEL(s): F2, F34, L14, O12
Programme Areas: Industrial Organization, International Trade and Regional Economics
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=1891

This paper studies the strategic interaction between a foreign direct investor and a host country. We analyse how the investor can use his control rights to protect his investment, if he faces the risk of ‘creeping expropriation’ once his investment is sunk. It is shown that this hold-up problem may cause underinvestment, if the outside option of the investor is too weak, and overinvestment if it is too strong. We also analyse the impact of spillover effects, give a rationale for ‘tax holidays’ and examine how stochastic returns affect the strategic interaction of investor and host country.