Investment under uncertainty and the threat of nationalisation

This paper considers the case of a multinational corporation which holds the option to invest in a foreign country. The company incurs the investment cost and gains access to a volatile profit flow once the project becomes operational. Apart from the uncertain market conditions, the investor must also account for the threat of nationalisation by the local government. By employing a dynamic model that incorporates both market uncertainty and political risk we determine the optimal timing for investment and nationalisation, as well as the appropriate scale of the investment. We show that a greater nationalisation threat leads to smaller but also earlier investment. Our findings provide a theoretical explanation for the empirical observation that investors do not necessarily avoid industries susceptible to nationalisation. We argue that the threat of nationalisation leads to premature and undersized investments, rather than deterring them entirely.