Working Paper: CEPR ID: DP7853
Authors: Alessandra Bonfiglioli
Abstract: This paper studies the relationship between investor protection, entrepreneurial risk taking and income inequality. In the presence of market frictions, better protection makes investors more willing to take on entrepreneurial risk when lending to firms, thereby improving the degree of risk sharing between financiers and entrepreneurs. On the other hand, by increasing risk sharing, investor protection also induces more firms to undertake risky projects. By increasing entrepreneurial risk taking, it raises income dispersion. By reducing the risk faced by entrepreneurs, it reduces income volatility. As a result, investor protection raises income inequality to the extent that it fosters risk taking, while it reduces it for a given level of risk taking. Empirical evidence from a panel of forty-five countries spanning the period 1976-2000 supports the predictions of the model.
Keywords: income inequality; investor protection; optimal financial contracts; risk sharing; risk taking
JEL Codes: D31; E44; O16
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| better investor protection (G18) | risk sharing (D16) |
| risk sharing (D16) | lower income inequality (D31) |
| better investor protection (G18) | lower income inequality (D31) |
| better investor protection (G18) | risk taking (D81) |
| risk taking (D81) | increased income inequality (D31) |
| better investor protection (G18) | increased income inequality (D31) |
| risk sharing decreases income inequality when not accompanied by increased risk taking (F62) | lower income inequality (D31) |
| low investor protection (G24) | increased inequality (F61) |
| high investor protection (G18) | lower inequality (D63) |