Investors Facing Opportunistic Governments: Is it Really Good to “Know the Market” before Investing?

Abstract

When a government cannot commit to future policies, investors face the risk of opportunistic behavior in addition to uncertain market conditions. We show that although reducing market uncertainty is sometimes essential for investment, it may aggravate problems of opportunism. The better informed the investor is before investing, the more information the government can infer from observing that investment takes place, in turn enabling more efficient rent extraction. This signaling effect can dominate; if the investor receives “too accurate” information before investing, the only equilibrium is the one in which no investment occurs. JEL classification: D82; L51