2025 Theses Bachelor's

A BIT of Regret: Modeling the Development Consequences of Investor-State Dispute Settlement as a Signal of Investment Readiness

Lander, Sophia

Recent studies have called into question the fairness of the investor-state dispute settlement (ISDS) system given the system’s unique one-sidedness, exceedingly large settlements awarded to investors, and less-than-opaque reporting mechanisms. These critiques raise important questions about the incentives for states to include ISDS provisions in bilateral investment treaties (BITs) as well as the potential consequences of doing so. I hypothesize that states experiencing instability adapt to (and therefore more prone to investment uncertainty) signal to investors that they are open to foreign direct investment (FDI) by including ISDS provisions in BITs. Using a signaling model I study the difference in effects between stable and unstable states in the effects inclusion of ISDS provisions in a BIT. I find empirically the existence of a pooling equilibrium where unstable states ‘mimic’ the stable states’ action of including ISDS provisions in a BIT. Studying the effects of each of the model’s parameters on the equilibrium results indicates that risk–be it the costs associated with implementing ISDS or the risk to investors associated with their foreign investments–is the significant driver of state-level decisions regarding ISDS. Under conditions of high risk, it becomes non-optimal for unstable states to include ISDS in a new BIT, regardless of FDI prospects. I use Monte Carlo simulations to test the long-term effects of risk on the inclusion of ISDS. The simulation results reveal optimal stopping strategies (as a function of state GDP) for unstable states’ inclusion of ISDS. The paper concludes by examining the model’s applicability to outliers in the ISDS system: India and Venezuela.

Keywords: investor-state dispute settlement, development, signaling games, foreign direct investment