Working Paper: CEPR ID: DP5378
Authors: Marco Pagano; Paolo Volpin
Abstract: This paper presents a political economy model where there is mutual feedback between investor protection and stock market development. Better investor protection induces companies to issue more equity and thereby leads to a broader stock market. In turn, equity issuance expands the shareholder base and increases support for shareholder protection. This feedback loop can generate multiple equilibria, with investor protection and stock market size being positively correlated across equilibria. The model's predictions are tested on panel data for 47 countries over 1993-2002, controlling for country and year effects and endogeneity issues. We also document international convergence in shareholder protection to best-practice standards, and show that it is correlated with cross-border M&A activity, consistent with the model.
Keywords: Corporate Governance; Political Economy; Shareholder Protection; Stock Market Development
JEL Codes: G34; K22; K42
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| historical and political factors (N40) | shareholder protection and stock market development (G38) |
| changes in valuation of private benefits by workers (J32) | transitions between equilibria (D50) |
| shifts in firm profitability (D21) | transitions between equilibria (D50) |
| better investor protection (G18) | increased equity issuance (G24) |
| increased equity issuance (G24) | broader stock market (G10) |
| better investor protection (G18) | broader stock market (G10) |
| anticipation of better shareholder protection (G34) | more equity issuance (G24) |
| better shareholder protection (G38) | stock market development (G10) |