International investment agreements in bilateral treaties or free trade agreements allow investors to bring compensation claims when their investments are hurt by new regulations addressing environmental or other social concerns. Compensation rules such as expropriation clauses in international treaties help solve post-investment moral hazard problems such as hold-ups, thereby helping to prevent inefficient over-regulation and encouraging foreign investment. However, when social or environmental harm is uncertain pre-investment, compensation requirements can interact with National Treatment clauses in a manner that reduces host government welfare and makes them less likely to admit investment. A police powers carve-out from the definition of compensable expropriation can be Pareto-improving and can increase the level of foreign investment.
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