Corporate Governance, Finance, and the Real Sector

Abstract

This paper presents a theory of the linkages between corporate governance, corporate finance and the real sector of an economy. We examine a model of industry equilibrium with endogenous entry. We show that poor corporate governance and low investor protection generates less competitive economies, populated by firms with more insider ownership and greater leverage. The quality of the corporate governance system can also affect an economy's industrial structure: better corporate governance promotes the development of sectors more exposed to moral hazard, such as the high-technology industry. We also show that entrepreneurs may have a preference for extreme corporate governance systems, where the quality of corporate governance and the level of investor protection are either very high or very low. This suggests that entrepreneurs operating in economies endowed with a corporate governance system of low-quality may have little or no incentive to seek (or to lobby for) an improvement of the governance system of their economy. Finally we show that financial liberalizations facilitate firm entry and the adoption of more productive technologies, promoting economic growth. Our stylized model generates predictions that are consistent with several observed empirical regularities.