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A Discussion Paper No . A-515 Expropriation and Control Rights : A Dynamic Model of Foreign Direct Investment

This paper studies the strategic interaction between a foreign direct investor and a host country. We analyze 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 bargaining position of the investor is too weak and overinvestment if it is too strong. We also analyze the impact of spillover effects, we give a rationale for “tax holidays” and we examine how stochastic returns affect the strategic interaction of investor and host country. Journal of Economic Literature Classification Nos.: F2, F34, L14, O12.