Working Paper: CEPR ID: DP1891
Authors: Monika Schnitzer
Abstract: 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.
Keywords: foreign direct investment; sovereign risk; implicit contracts
JEL Codes: F2; F34; L14
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Uncertainty regarding returns (D81) | Underinvestment (G31) |
| Stable environment (C62) | Reduced likelihood of underinvestment (G31) |
| Spillover effects (F69) | Justification for tax holidays (H26) |
| Tax holidays (H26) | Sustainable investment levels (Q01) |
| Credibility of threat to shift production (L23) | Investment levels (G31) |
| Inefficient outside option (D61) | Underinvestment (G31) |
| Attractive outside option (G19) | Overinvestment (G31) |
| Stochastic returns (G17) | Investment sustainability (G31) |