Essays on the Theory of Investment Subsidy

In this thesis, we investigate a firm's investment timing decision and choice of market entry mode under uncertainty and irreversibility. We investigate how a host country can affect the firm's investment decisions through providing investment incentives. The real options approach to valuation is applied, and three main theoretical contributions are provided in this thesis. First, we derive the optimal form of subsidy package and find that the optimal subsidy package should always compensate the firm for giving up the investment opportunity and making the investment immediately. By making a trade-off between the host country's incremental welfare benefits and the costs of the subsidy package, we obtain the optimal timing to provide it. We also examine the effects of preemption risk on the timing of investment and the value of a subsidy package. Second, we consider the timing of investment and the choice of entry modes. We evaluate the investment projects and derive the investment thresholds when the firm can choose between a joint venture (JV) and a wholly-owned subsidiary (WOS). We find that when there is no subsidy offered, the firm prefers a WOS, while the host country prefers a JV. When there are subsidies offered by the host country, we find that both the firm and the host country prefer a WOS. A JV will be preferred only if it has some distinctive welfare benefits that are not associated with a WOS, for instance knowledge transfer benefits. Last, we introduce product market competition into the problems of investment timing and choice of entry mode. We find that competition will not alter the conclusions we have obtained. The optimal mode of entry is a WOS, unless a JV has some distinctive welfare benefits that cannot be provided by a WOS.