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The Political Economy of Corporate Governance By MARCO PAGANO AND PAOLO F. VOLPIN* We analyze the political determinants of investor and employment protection. Our model predicts that proportional electoral systems are conducive to weaker investor protection and stronger employment protection than majoritarian systems. This predic- tion is consistent with international panel data evidence. The proportionality of the voting system is significantly and negatively correlated with shareholder protection in a panel of 45 countries, and positively correlated with employment protection in a panel of 21 OECD countries. Other political variables also affect regulatory outcomes, especially for the labor market. The origin of the legal system has some additional explanatory power only for employment protection. (JEL G34, K22, K42) Recent works on corporate governance show ment protection. We investigate whether a large differences in the degree of investor pro- political theory can explain the observed inter- tection between countries, correlated both with national differences in regulation. This question the development of capital markets and with the has an obvious bearing on the issue of legal ownership structure of firms.1 These studies reform, because understanding the determinants take the degree of investor protection as exog- of regulation in a given country is a prerequisite enous. Laws result from the political process, to predicting its evolution. however, which in turn responds to economic Currently, the consensus explanation of the interests. In this sense, le