DP3914 The Political Economy of Bank and Equity Dominance

Author(s): Enrico C Perotti, Ernst-Ludwig von Thadden
Publication Date: May 2003
Keyword(s): bank centered system, corporate governance, corporate investment, median voter, political economy, social insurance
JEL(s): G28, G31, G32, G34
Programme Areas: Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=3914

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.