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Profit Sharing under the Threat of Nationalization

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  • Di Corato, Luca

Abstract

A multinational corporation engages in foreign direct investment for the extraction of a natural resource in a developing country. The corporation bears the initial investment and earns as a return a share of the profits. The host country provides access and guarantees conditions of operation. Since the investment is totally sunk, the corporation must account in its plan not only for uncertainty in market conditions but also for the threat of nationalization. In a real options framework, where the government holds an American call option on nationalization, we show under which conditions a Nash bargaining leads to a profit distribution maximizing the joint venture surplus. We find that the threat of nationalization does not affect the investment threshold but only the Nash bargaining solution set. Finally, we show that the optimal sharing rule results from the way the two parties may differently trade of rents with option values.

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Bibliographic Info

Paper provided by Swedish University of Agricultural Sciences, Department of Economics in its series Working Papers with number 58292.

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Date of creation: 2010
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Handle: RePEc:ags:suaswp:58292

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Keywords: Real Options; Nash Bargaining; Expropriation; Natural Resources; Foreign Direct Investment; International Relations/Trade; Resource /Energy Economics and Policy; C7; D8; K3; F2; O1;

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  1. Schnitzer, Monika, 1999. "Expropriation and control rights: A dynamic model of foreign direct investment," International Journal of Industrial Organization, Elsevier, vol. 17(8), pages 1113-1137, November.
  2. Christa N. Brunnschweiler & Erwin H. Bulte, 2006. "The Resource Curse Revisited and Revised: A Tale of Paradoxes and Red Herrings," CER-ETH Economics working paper series 06/61, CER-ETH - Center of Economic Research (CER-ETH) at ETH Zurich.
  3. Roderick Duncan, 2006. "Price or politics? An investigation of the causes of expropriation ," Australian Journal of Agricultural and Resource Economics, Australian Agricultural and Resource Economics Society, vol. 50(1), pages 85-101, 03.
  4. Ephraim Clark, 2003. "Pricing the Cost of Expropriation Risk," Review of International Economics, Wiley Blackwell, vol. 11(2), pages 412-422, 05.
  5. Michele Moretto & G. Rossini, 1994. "Shut Down Option and Profit Sharing," Working Papers 190, Dipartimento Scienze Economiche, Universita' di Bologna.
  6. Eduardo Engel & Ronald Fischer, 2008. "Optimal Resource Extraction Contracts under Threat of Expropriation," Levine's Bibliography 122247000000001833, UCLA Department of Economics.
  7. Kobrin, Stephen J., 1987. "Testing the bargaining hypothesis in the manufacturing sector in developing countries," International Organization, Cambridge University Press, vol. 41(04), pages 609-638, September.
  8. Long, Ngo Van, 1975. "Resource extraction under the uncertainty about possible nationalization," Journal of Economic Theory, Elsevier, vol. 10(1), pages 42-53, February.
  9. Michael Tomz & Mark L. J. Wright, 2008. "Sovereign Theft: Theory And Evidence About Sovereign Default And Expropriation," CAMA Working Papers 2008-07, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
  10. Clark, Ephraim, 1997. "Valuing political risk," Journal of International Money and Finance, Elsevier, vol. 16(3), pages 477-490, June.
  11. Nash, John, 1950. "The Bargaining Problem," Econometrica, Econometric Society, vol. 18(2), pages 155-162, April.
  12. Michele Moretto & Gianpaolo Rossini, 1996. "Profit sharing regulation and repeated bargaining with a shut-down option," Review of Economic Design, Springer, vol. 2(1), pages 339-368, December.
  13. Bradford L. Barham & Jean-Paul Chavas & Oliver T. Coomes, 1998. "Sunk Costs and the Natural Resource Extraction Sector: Analytical Models and Historical Examples of Hysteresis and Strategic Behavior in the Americas," Land Economics, University of Wisconsin Press, vol. 74(4), pages 429-448.
  14. Duncan, Roderick, 2006. "Price or politics? An investigation of the causes of expropriation," Australian Journal of Agricultural and Resource Economics, Australian Agricultural and Resource Economics Society, vol. 50(1), March.
  15. Cox, John C. & Ross, Stephen A., 1976. "The valuation of options for alternative stochastic processes," Journal of Financial Economics, Elsevier, vol. 3(1-2), pages 145-166.
  16. Brennan, Michael J & Schwartz, Eduardo S, 1985. "Evaluating Natural Resource Investments," The Journal of Business, University of Chicago Press, vol. 58(2), pages 135-57, April.
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