The strongPolitical Economystrong of Corporate Control and Labor Rents.pdfVIP

The Political Economy of Corporate Control and Labor Rents∗ Enrico C Perotti University of Amsterdam and CEPR Ernst-Ludwig von Thadden Universität Mannheim and CEPR July 2005 Abstract In a democracy, a political majority can influence both the corpo- rate governance structure and the return to human and financial capi- tal. We argue that when financial wealth is sufficiently diffused, there is political support for a strong governance role for dispersed equity market investors, and low labor rents. When financial wealth is con- centrated, a political majority prefers high labor rents and a stronger governance role for banks or large investors, even at the cost of profits. The intuition is that labor claims are exposed to undiversifiable risk, so voters with low financial stakes prefer investors who choose lower risk strategies. The model may explain the ”great reversal” phenom- enon in the first half of the 20th century (Rajan and Zingales, 2003). We argue that in several financially developed countries a financially weakened middle class became concerned about labor income risk as- sociated with free markets and supported a more corporatist financial system. We offer suggestive evidence using post WW1 inflationary shocks as the source of identifying exogenous variation. ∗We are grateful to Sudipto Bhattacharya, Pierre-André Chiappori, Julian Franks, Paolo Fulghieri, Peter Gourevitch, Tullio Japelli, Marco Pagano, Jean-Laurent Rosenthal, Paolo Volpin, two referees, and in particular to Howard Rosenthal for helpful comments. Thadden thanks the Swiss National Science Foundation for support through the NCCR FinRisk.