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DP3914 The Political Economy of Bank and Equity Dominance

Author(s): Enrico C Perotti , Ernst-Ludwig von Thadden
Publication Date: May 2003
Keyword(s): corporate governance , bank centered system , social insurance , political economy , median voter , corporate investment
JEL(s): G28 , G31 , G32 , G34
Programme Areas: Financial Economics
Link to this Page: www.cepr.org/pubs/dps/DP3914.asp

Legislation affects corporate governance and the return to human and financial capital. We allow the preference of a political majority to determine both the governance structure and the extent of labour rents. In a society where median voters have relatively more at stake in the form of human capital rather than financial wealth, they prefer a less risky environment even when this reduces profits, as labour rents are exposed to undiversifiable firm-specific risk. In general, labour and lenders prefer less corporate risk, since their claims are a concave function of firm profitability. This congruence of interests can lead the political majority to support bank over equity dominance. As share-holdings by the median voters increase, the dominance structure will move towards favoring equity markets with riskier corporate strategies and higher profits.

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