COWLES FOUNDATION FOR RESEARCH IN
ECONOMICS Box 208281
COWLES FOUNDATION DISCUSSION PAPER NO. 1636 Optimal Resource Extraction Contracts under Threat of Expropriation Eduardo Engel and Ronald Fischer January 2008 The government contracts with a foreign firm to extract a natural resource that
requires an upfront investment and which faces price uncertainty. In states where profits
are high, there is a likelihood of expropriation, which generates a social cost that
increases with the expropriated value. In this environment, the planner's optimal contract
avoids states with high probability of expropriation. The contract can be implemented via
a competitive auction with reasonable informational requirements. The bidding variable is
a cap on the present value of discounted revenues, and the firm with the lowest bid wins
the contract. The basic framework is extended to incorporate government subsidies,
unenforceable investment effort and political moral hazard, and the general thrust of the
results described above is preserved. |
