This paper surveys research on corporate governance, with special attention to the importance of legal protection of investors and of ownership concentration in corporate governance systems around the world.

A Survey of Corporate Governance

This article surveys research on corporate governance, with special attention to the importance of legal protection of investors and of ownership concentration in corporate governance systems around the world. CORPORATE GOVERNANCE DEALS WITH the ways in which suppliers of finance to corporations assure themselves of getting a return on their investment. How do the suppliers of finance get managers to return some of the profits to them? How do they make sure that managers do not steal the capital they supply or invest it in bad projects? How do suppliers of finance control managers? At first glance, it is not entirely obvious why the suppliers of capital get anything back. After all, they part with their money, and have little to contribute to the enterprise afterward. The professional managers or entrepreneurs who run the firms might as well abscond with the money. Although they sometimes do, usually they do not. Most advanced market economies have solved the problem of corporate governance at least reasonably well, in that they have assured the flows of enormous amounts of capital to firms, and actual repatriation of profits to the providers of finance. But this does not imply that they have solved the corporate governance problem perfectly, or that the corporate governance mechanisms cannot be improved. In fact, the subject of corporate governance is of enormous practical impor

/pdf/a-survey-of-corporate-governance-36f3yobhy4.pdf

https://scholar.harvard.edu/files/shleifer/files/ip_corpgov.pdf

Investor Protection and Corporate Governance

The author argues that the preponderance of theoretical reasoning and empirical evidence suggests a positive first order relationship between financial development and economic growth. There is evidence that the financial development level is a good predictor of future rates of economic growth, capital accumulation, and technological change. Moreover, cross-country, case-style, industry level and firm-level analysis document extensive periods when financial development crucially affects the speed and pattern of economic development. The author explains what the financial system does and how it affects, and is affected by, economic growth. Theory suggests that financial instruments, markets and institutions arise to mitigate the effects of information and transaction costs. A growing literature shows that differences in how well financial systems reduce information and transaction costs influence savings rates, investment decisions, technological innovation, and long-run growth rates. A less developed theoretical literature shows how changes in economic activity can influence financial systems. The author advocates a functional approach to understanding the role of financial systems in economic growth. This approach focuses on the ties between growth and the quality of the functions provided by the financial systems. The author discourages a narrow focus on one financial instrument, or a particular institution. Instead, the author addresses the more comprehensive question: What is the relationship between financial structure and the functioning of the financial system?

/pdf/financial-development-and-economic-growth-views-and-agenda-1isr9l81uu.pdf

Financial development and economic growth : views and agenda

This paper develops a dynamic general equilibrium model that is intended to help clarify the role of credit market frictions in business fluctuations, from both a qualitative and a quantitative standpoint. The model is a synthesis of the leading approaches in the literature. In particular, the framework exhibits a financial accelerator,' in that endogenous developments in credit markets work to amplify and propagate shocks to the macroeconomy. In addition, we add several features to the model that are designed to enhance the empirical relevance. First, we incorporate money and price stickiness, which allows us to study how credit market frictions may influence the transmission of monetary policy. In addition, we allow for lags in investment which enables the model to generate both hump-shaped output dynamics and a lead-lag relation between asset prices and investment, as is consistent with the data. Finally, we allow for heterogeneity among firms to capture the fact that borrowers have differential access to capital markets. Under reasonable parametrizations of the model, the financial accelerator has a significant influence on business cycle dynamics.

https://papers.ssrn.com/sol3/Delivery.cfm/nber_W6455.pdf?abstractid=226200&mirid=1

The Financial Accelerator in a Quantitative Business Cycle Framework

In a simple model of borrowing and lending with asymmetric information we show that the optimal, incentive-compatible debt contract is the standard debt contract. The second-best level of investment never exceeds the first-best and is strictly less when there is a positive probability of costly bankruptcy. We also compare the second-best with the results of interest-rate-taking behaviour and consider the effects of risk aversion. Finally we provide conditions under which increasing the borrower's initial net wealth must reduce total investment in the venture. A great deal of effort has recently gone into the study of implicit contract models (ICM) in an attempt to explain the failure of competitive labour markets to generate efficient levels of employment. (See Hart, 1983, for a survey of this work and further references). Relatively little attention has been given to the theoretical analysis of capital market imperfections, a phenomenon we believe to be at least as important as labour market imperfections when it comes to explaining the inefficient use of resources, including "unemployment". In this paper we seek to fill this gap by analysing a model of credit contracts between firms that need outside finance in order to operate efficiently on the one hand and the institutions that provide the money on the other. We were led to this problem by our current interest in the question of what is the firm's budget constraint? In economies with complete markets, of course, this question does not arise in a meaningful form. But when markets are incomplete the firm does face a budget constraint of some sort at each date and the form of this constraint may crucially affect its behaviour. There is no intrinsic virtue in a budget constraint which requires the firm to repay all debts with probability one and, in fact, most legal systems allow for some insurance, in the form of bankruptcy, against low income states. Perhaps the central message of our work is simply that the question of the firm's budget constraint should be formulated as a contract problem. And under certain conditions, the form of the optimal budget constraint is the same as the standard debt contract with bankruptcy. But there is more to the analysis than that. We are naturally interested not only in the shape of the firm's budget constraint but also in its position. In other words, is there credit-rationing?

http://www.ww.uni-magdeburg.de/bizecon/teaching/ST_08/banks/Gale.Hellwig_Debt-contracts_RES52(2)1985_647-663.pdf

Incentive-Compatible Debt Contracts: The One-Period Problem

Incentive-compatible debt contracts: The one-period problem

On the aggregation of information in competitive markets

We examine the pervasive view that "equity is expensive," which leads to claims that high capital requirements are costly for society and would affect credit markets adversely We find that arguments made to support this view are fallacious, irrelevant to the policy debate by confusing private and social costs, or very weak For example, the return on equity contains a risk premium that must go down if banks have more equity It is thus incorrect to assume that the required return on equity remains fixed as capital requirements increase It is also incorrect to translate higher taxes paid by banks to a social cost Policies that subsidize debt and indirectly penalize equity through taxes and implicit guarantees are distortive And while debt’s informational insensitivity may provide valuable liquidity, increased capital (and reduced leverage) can enhance this benefit Finally, suggestions that high leverage serves a necessary disciplining role are based on inadequate theory lacking empirical support We conclude that bank equity is not socially expensive, and that high leverage at the levels allowed, for example, by the Basel III agreement is not necessary for banks to perform all their socially valuable functions and likely makes banking inefficient Better capitalized banks suffer fewer distortions in lending decisions and would perform better The fact that banks choose high leverage does not imply that this is socially optimal Except for government subsidies and viewed from an ex ante perspective, high leverage may not even be privately optimal for banks Setting equity requirements significantly higher than the levels currently proposed would entail large social benefits and minimal, if any, social costs Approaches based on equity dominate alternatives, including contingent capital To achieve better capitalization quickly and efficiently and prevent disruption to lending, regulators must actively control equity payouts and issuance If remaining challenges are addressed, capital regulation can be a powerful tool for enhancing the role of banks in the economy

/pdf/fallacies-irrelevant-facts-and-myths-in-the-discussion-of-475e96dl3d.pdf

Fallacies, Irrelevant Facts, and Myths in the Discussion of Capital Regulation: Why Bank Equity is Not Expensive

The past few years have shown that risks in banking can impose significant costs on the economy. Many claim, however, that a safer banking system would require sacrificing lending and economic growth. The Bankers' New Clothes examines this claim and the narratives used by bankers, politicians, and regulators to rationalize the lack of reform, exposing them as invalid. Anat Admati and Martin Hellwig argue that we can have a safer and healthier banking system without sacrificing any of its benefits, and at essentially no cost to society. They seek to engage the broader public in the debate by cutting through the jargon of banking, clearing the fog of confusion, and presenting the issues in simple and accessible terms.

/pdf/the-bankers-new-clothes-what-s-wrong-with-banking-and-what-haltba0c7v.pdf

The Bankers' New Clothes: What's Wrong With Banking and What to Do About It

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