Expropriation risk, investment decisions and economic sectors

- We use Real Options to study the effects of expropriation risk on firms' decisions.
- There are two economic sectors and one of them is essential for the economy.
- The firm's and the government's decisions interact with each other in the model.
- Firms accelerate both investment and abandonment decisions in this context.
- Governments offer a fairer indemnity in essential sectors due to expropriation cost.

We build a Real Options model to assess the importance of private provision and the impact of expropriation risk on investment timing, business values, governmental costs and social welfare. We consider two types of businesses (essential and non-essential) and two stages (operating businesses and investment opportunities) and answer questions regarding three main topics: the firm's reaction to expropriation risk, the government drivers to expropriate, and the welfare costs of expropriation. Our results show that responding to expropriation risk the private investor is driven to suboptimal investment decisions. When we endogenize the reputational costs of expropriation, our results show that the decision of the government to expropriate largely depends on the type of business being targeted. In terms of welfare, our results show that expropriation is always associated with a loss.