Financial liberalization under weak regulation is often followed by …nancial crises. We argue tha... more Financial liberalization under weak regulation is often followed by …nancial crises. We argue that this may be the deliberate outcome of lobbying interests capturing the reform process. Liberalization may be designed to provide fragile …nancial access to new entrants by limiting investor protection, resulting in …nancial deepening rather than broadening access to capital. Interestingly, lobbying may deliberately worsen …nancial fragility. Poor investor protection limits access to re…nance after a shock, forces ine¢ cient default and exit by more leveraged entrepreneurs, thus protecting more established producers. We provide supporting evidence that industry exit rates and pro…t margins are higher in more corrupt countries during banking crises.
This paper investigates the determinants of underpricing at initial public offerings in the Hunga... more This paper investigates the determinants of underpricing at initial public offerings in the Hungarian Initial Public Offerings (IPO) market in 1990-1998, a period of transition from socialist to market economy and immaturity of the domestic capital market. The evidence suggests that political issues played a significant role in the process: we have found greater discount at privatization IPOs than at private issues, and a positive relation between underpricing and the proportion of shares offered for compensation coupons. These findings reinforce the hypothesis that governments in transition may pursue political objectives by selling shares at discount. Besides, the results show larger initial returns at early IPOs compared to later issues, which implies a negative relation between the discount and the maturing of the capital market. Most of the asymmetric information theories, empirically justified for well-developed stock markets, receive no support. Some results suggest that the transition related determinants of underpricing disappear as the securities market becomes more mature.
This Discussion Paper is issued under the auspices of the Centre's research programme in Financia... more This Discussion Paper is issued under the auspices of the Centre's research programme in Financial Economics and Transition Economics. Any opinions expressed here are those of the author(s) and not those of the Centre for Economic Policy Research. Research disseminated by CEPR may include views on policy, but the Centre itself takes no institutional policy positions. The Centre for Economic Policy Research was established in 1983 as a private educational charity, to promote independent analysis and public discussion of open economies and the relations among them. It is pluralist and non-partisan, bringing economic research to bear on the analysis of medium-and long-run policy questions. Institutional (core) finance for the Centre has been provided through major grants from the Economic and Social Research Council, under which an ESRC Resource Centre operates within CEPR; the Esmée Fairbairn Charitable Trust; and the Bank of England. These organizations do not give prior review to the Centre's publications, nor do they necessarily endorse the views expressed therein. These Discussion Papers often represent preliminary or incomplete work, circulated to encourage discussion and comment. Citation and use of such a paper should take account of its provisional character.
Investor confidence is a major determinant of financial integration for emerging markets and thei... more Investor confidence is a major determinant of financial integration for emerging markets and their stock prices. We investigate whether privatization also has a significant effect on emerging stock market development through the resolution of policy risk. We argue that a sustained privatization program represents a major test of political commitment to market oriented reforms and to safer private property rights. The evidence suggests that progress in privatization gradually leads to increased confidence as measured by perceived policy risk. Moreover, increased confidence has a strong effect on local market development and excess returns. We conclude that, while liberalization is a necessary condition for market development, the resolution of policy risk resulting from successful privatization has been an important source for the rapid growth of stock markets in emerging economies.
This paper studies optimal …nancial contracts and product market competition under a strategic tr... more This paper studies optimal …nancial contracts and product market competition under a strategic transparency decision. When …rms seeking outside …nance resort to actively monitored debt in order to commit against opportunistic behaviour, the dominant lender can in-‡uence corporate transparency. More transparency about a …rm's competitive position has both strategic advantages and disadvantages: in general, transparency results in higher variability of pro…ts and output. Thus lenders prefer less information dissemination, as this protects …rms when in a weak competitive position, while equityholders prefer more disclosure to maximize pro…tability when in a strong position. We show that bank-controlled …rms will be opaque, while shareholder-run …rms prefer more transparency. In fact, we can predict a clustering of characteristics associated with bank dominance: opaqueness, low variability of pro…ts, slightly reduced average pro…ts, uncertainty about assets in place, and relatively high …nancing needs all should be observed jointly for bank controlled …rms.
Can a wealth shift to emerging countries explain instability in developed countries? Investors ex... more Can a wealth shift to emerging countries explain instability in developed countries? Investors exposed to political risk seek safety in countries with better property right protection. This induces private intermediaries to offer safety via inexpensive demandable debt, and increases lending into marginal projects. Because safety conscious foreigners escape any risk by running also in some good states, cheap foreign funding leads to larger and more frequent runs. Beyond some scale, foreign runs also induce domestic runs in order to avoid dilution. When excess liquidation causes social losses, a domestic planner may limit the scale of foreign inflows or credit volume.
Politicians in ‡uence the allocation of …nance either directly via state banks, or indirectly via... more Politicians in ‡uence the allocation of …nance either directly via state banks, or indirectly via private banks using banking regulation or creditor rights. With state ownership of banks, entrepreneurs may form coalitions to bribe politicians to obtain scarce loans. With private ownership of banks, interest groups may lobby to in ‡uence creditor rights to limit access to less established …rms. When public accountability and judicial independence are low, politicians prefer state ownership of banks. Politicians can extract more rents from competing coalitions when having direct control. The reason is that regulation only allows politicians to target certain types of entrepreneurs while direct control enables them to separate individual entrepreneurs. Beyond a certain threshold of public accountability and judicial independence legal risks from bribing become too high and it becomes politically optimal to to shift to lobbying on regulation by privatising banks. Access to …nance and entry increase with public accountability and tends to be greater under private ownership of banks. We also consider bribing to allow non-repayment of state bank loans, and discuss the intermediate case of private banks lending only to their owners.
External finance is critical for less established entrepreneurs, so poor investor protection can ... more External finance is critical for less established entrepreneurs, so poor investor protection can hinder competition. We model how lobbying by incumbents may reduce access to finance in countries where politicians are less accountable to voters. In a broad cross-section of countries and industries, we find that (i) the number of producers and entry rates are positively correlated with investor protection in financially dependent sectors, and (ii) countries with more accountable political institutions have better investor protection.
This Discussion Paper is issued under the auspices of the Centre's research programme in FINANCIA... more This Discussion Paper is issued under the auspices of the Centre's research programme in FINANCIAL ECONOMICS. Any opinions expressed here are those of the author(s) and not those of the Centre for Economic Policy Research. Research disseminated by CEPR may include views on policy, but the Centre itself takes no institutional policy positions. The Centre for Economic Policy Research was established in 1983 as an educational charity, to promote independent analysis and public discussion of open economies and the relations among them. It is pluralist and nonpartisan, bringing economic research to bear on the analysis of medium-and long-run policy questions. These Discussion Papers often represent preliminary or incomplete work, circulated to encourage discussion and comment. Citation and use of such a paper should take account of its provisional character.
The paper studies risk mitigation associated with capital regulation, in a context where banks ma... more The paper studies risk mitigation associated with capital regulation, in a context where banks may choose tail risk assets. We show that this undermines the traditional result that higher capital reduces excess risk-taking driven by limited liability. Moreover, higher capital may have an unintended e¤ect of enabling banks to take more tail risk without the fear of breaching the minimal capital ratio in nontail risky project realizations. The results are consistent with stylized facts about pre-crisis bank behavior, and suggest implications for the optimal design of capital regulation.
We describe how, during the 17th century, the business corporation gradually emerged in response ... more We describe how, during the 17th century, the business corporation gradually emerged in response to the need to lock in long-term capital to profit from trade opportunities with Asia. Since contractual commitments to lock in capital were not fully enforceable in partnerships, this evolution required a legal innovation, essentially granting the corporation a property right over capital. Locked-in capital exposed investors to a significant loss of control, and could only emerge where and when political institutions limited the risk of expropriation. The Dutch East India Company (VOC, chartered in 1602) benefited from the restrained executive power of the Dutch Republic and was the first business corporation with permanent capital. The English East India Company (EIC, chartered in 1600) kept the traditional cycle of liquidation and refinancing until, in 1657,
We argue that in an unreliable enforcement regime, transactions tend to become intermediated thro... more We argue that in an unreliable enforcement regime, transactions tend to become intermediated through institutions or concentrated among agents bound by some form of private enforcement. Provision of funding shifts from risk capital to debt, and from markets to institutions with long term relations. When minority investors' rights are poorly protected, the ability of firms to raise equity capital is impaired, leading to less finance for new risky ventures. More generally, fewer firms will be financed with outside equity, resulting in a low capitalization relative to GNP and a predominance of internal (unlisted) equity and bank lending over traded securities. We report some supporting evidence on a small set of countries on the correlation between investor protection and development of security markets. We use existing measures of investor protection and corruption, as well as a price measure, the premium on voting stock, which is related to the control premium. In countries where the voting premium is large, corporate financing is dominated by bank lending and equity markets are much smaller. The other indicators are also consistent with our hypothesis, although the sample size is limited.
Does demand for safety create instability ? Secured (repo) funding can be made so safe that it ne... more Does demand for safety create instability ? Secured (repo) funding can be made so safe that it never runs, but shifts risk to unsecured creditors. We show that this triggers more frequent runs by unsecured creditors, even in the absence of fundamental risk. This e↵ect is separate from the liquidation externality caused by fire sales of seized collateral upon default. As more secured debt causes larger fire sales, it leads to higher haircuts which further increase the frequency of runs. While secured funding combined with high yield unsecured debt may reduce instability, the private choice of repo funding always increases it. Regulators need to contain its reinforcing e↵ect on liquidity risk, trading o↵ its role in expanding funding by creating a safe asset.
We show how a technological shift to intangible capital can account for major economic and financ... more We show how a technological shift to intangible capital can account for major economic and financial trends since 1980. Intangible investment requires the commitment of highskill human capital, which is paid with deferred promises on future cashflows. As deferred human capital income is not tradeable, the amount of investable assets in the economy falls. The general equilibrium effect is a gradual fall in interest rates and a re-allocation of excess savings into rising valuations of existing assets such as real estate. The concomitant rise in house prices and wage inequality leads to higher household leverage.
Financial liberalization under weak regulation is often followed by …nancial crises. We argue tha... more Financial liberalization under weak regulation is often followed by …nancial crises. We argue that this may be the deliberate outcome of lobbying interests capturing the reform process. Liberalization may be designed to provide fragile …nancial access to new entrants by limiting investor protection, resulting in …nancial deepening rather than broadening access to capital. Interestingly, lobbying may deliberately worsen …nancial fragility. Poor investor protection limits access to re…nance after a shock, forces ine¢ cient default and exit by more leveraged entrepreneurs, thus protecting more established producers. We provide supporting evidence that industry exit rates and pro…t margins are higher in more corrupt countries during banking crises.
This paper investigates the determinants of underpricing at initial public offerings in the Hunga... more This paper investigates the determinants of underpricing at initial public offerings in the Hungarian Initial Public Offerings (IPO) market in 1990-1998, a period of transition from socialist to market economy and immaturity of the domestic capital market. The evidence suggests that political issues played a significant role in the process: we have found greater discount at privatization IPOs than at private issues, and a positive relation between underpricing and the proportion of shares offered for compensation coupons. These findings reinforce the hypothesis that governments in transition may pursue political objectives by selling shares at discount. Besides, the results show larger initial returns at early IPOs compared to later issues, which implies a negative relation between the discount and the maturing of the capital market. Most of the asymmetric information theories, empirically justified for well-developed stock markets, receive no support. Some results suggest that the transition related determinants of underpricing disappear as the securities market becomes more mature.
This Discussion Paper is issued under the auspices of the Centre's research programme in Financia... more This Discussion Paper is issued under the auspices of the Centre's research programme in Financial Economics and Transition Economics. Any opinions expressed here are those of the author(s) and not those of the Centre for Economic Policy Research. Research disseminated by CEPR may include views on policy, but the Centre itself takes no institutional policy positions. The Centre for Economic Policy Research was established in 1983 as a private educational charity, to promote independent analysis and public discussion of open economies and the relations among them. It is pluralist and non-partisan, bringing economic research to bear on the analysis of medium-and long-run policy questions. Institutional (core) finance for the Centre has been provided through major grants from the Economic and Social Research Council, under which an ESRC Resource Centre operates within CEPR; the Esmée Fairbairn Charitable Trust; and the Bank of England. These organizations do not give prior review to the Centre's publications, nor do they necessarily endorse the views expressed therein. These Discussion Papers often represent preliminary or incomplete work, circulated to encourage discussion and comment. Citation and use of such a paper should take account of its provisional character.
Investor confidence is a major determinant of financial integration for emerging markets and thei... more Investor confidence is a major determinant of financial integration for emerging markets and their stock prices. We investigate whether privatization also has a significant effect on emerging stock market development through the resolution of policy risk. We argue that a sustained privatization program represents a major test of political commitment to market oriented reforms and to safer private property rights. The evidence suggests that progress in privatization gradually leads to increased confidence as measured by perceived policy risk. Moreover, increased confidence has a strong effect on local market development and excess returns. We conclude that, while liberalization is a necessary condition for market development, the resolution of policy risk resulting from successful privatization has been an important source for the rapid growth of stock markets in emerging economies.
This paper studies optimal …nancial contracts and product market competition under a strategic tr... more This paper studies optimal …nancial contracts and product market competition under a strategic transparency decision. When …rms seeking outside …nance resort to actively monitored debt in order to commit against opportunistic behaviour, the dominant lender can in-‡uence corporate transparency. More transparency about a …rm's competitive position has both strategic advantages and disadvantages: in general, transparency results in higher variability of pro…ts and output. Thus lenders prefer less information dissemination, as this protects …rms when in a weak competitive position, while equityholders prefer more disclosure to maximize pro…tability when in a strong position. We show that bank-controlled …rms will be opaque, while shareholder-run …rms prefer more transparency. In fact, we can predict a clustering of characteristics associated with bank dominance: opaqueness, low variability of pro…ts, slightly reduced average pro…ts, uncertainty about assets in place, and relatively high …nancing needs all should be observed jointly for bank controlled …rms.
Can a wealth shift to emerging countries explain instability in developed countries? Investors ex... more Can a wealth shift to emerging countries explain instability in developed countries? Investors exposed to political risk seek safety in countries with better property right protection. This induces private intermediaries to offer safety via inexpensive demandable debt, and increases lending into marginal projects. Because safety conscious foreigners escape any risk by running also in some good states, cheap foreign funding leads to larger and more frequent runs. Beyond some scale, foreign runs also induce domestic runs in order to avoid dilution. When excess liquidation causes social losses, a domestic planner may limit the scale of foreign inflows or credit volume.
Politicians in ‡uence the allocation of …nance either directly via state banks, or indirectly via... more Politicians in ‡uence the allocation of …nance either directly via state banks, or indirectly via private banks using banking regulation or creditor rights. With state ownership of banks, entrepreneurs may form coalitions to bribe politicians to obtain scarce loans. With private ownership of banks, interest groups may lobby to in ‡uence creditor rights to limit access to less established …rms. When public accountability and judicial independence are low, politicians prefer state ownership of banks. Politicians can extract more rents from competing coalitions when having direct control. The reason is that regulation only allows politicians to target certain types of entrepreneurs while direct control enables them to separate individual entrepreneurs. Beyond a certain threshold of public accountability and judicial independence legal risks from bribing become too high and it becomes politically optimal to to shift to lobbying on regulation by privatising banks. Access to …nance and entry increase with public accountability and tends to be greater under private ownership of banks. We also consider bribing to allow non-repayment of state bank loans, and discuss the intermediate case of private banks lending only to their owners.
External finance is critical for less established entrepreneurs, so poor investor protection can ... more External finance is critical for less established entrepreneurs, so poor investor protection can hinder competition. We model how lobbying by incumbents may reduce access to finance in countries where politicians are less accountable to voters. In a broad cross-section of countries and industries, we find that (i) the number of producers and entry rates are positively correlated with investor protection in financially dependent sectors, and (ii) countries with more accountable political institutions have better investor protection.
This Discussion Paper is issued under the auspices of the Centre's research programme in FINANCIA... more This Discussion Paper is issued under the auspices of the Centre's research programme in FINANCIAL ECONOMICS. Any opinions expressed here are those of the author(s) and not those of the Centre for Economic Policy Research. Research disseminated by CEPR may include views on policy, but the Centre itself takes no institutional policy positions. The Centre for Economic Policy Research was established in 1983 as an educational charity, to promote independent analysis and public discussion of open economies and the relations among them. It is pluralist and nonpartisan, bringing economic research to bear on the analysis of medium-and long-run policy questions. These Discussion Papers often represent preliminary or incomplete work, circulated to encourage discussion and comment. Citation and use of such a paper should take account of its provisional character.
The paper studies risk mitigation associated with capital regulation, in a context where banks ma... more The paper studies risk mitigation associated with capital regulation, in a context where banks may choose tail risk assets. We show that this undermines the traditional result that higher capital reduces excess risk-taking driven by limited liability. Moreover, higher capital may have an unintended e¤ect of enabling banks to take more tail risk without the fear of breaching the minimal capital ratio in nontail risky project realizations. The results are consistent with stylized facts about pre-crisis bank behavior, and suggest implications for the optimal design of capital regulation.
We describe how, during the 17th century, the business corporation gradually emerged in response ... more We describe how, during the 17th century, the business corporation gradually emerged in response to the need to lock in long-term capital to profit from trade opportunities with Asia. Since contractual commitments to lock in capital were not fully enforceable in partnerships, this evolution required a legal innovation, essentially granting the corporation a property right over capital. Locked-in capital exposed investors to a significant loss of control, and could only emerge where and when political institutions limited the risk of expropriation. The Dutch East India Company (VOC, chartered in 1602) benefited from the restrained executive power of the Dutch Republic and was the first business corporation with permanent capital. The English East India Company (EIC, chartered in 1600) kept the traditional cycle of liquidation and refinancing until, in 1657,
We argue that in an unreliable enforcement regime, transactions tend to become intermediated thro... more We argue that in an unreliable enforcement regime, transactions tend to become intermediated through institutions or concentrated among agents bound by some form of private enforcement. Provision of funding shifts from risk capital to debt, and from markets to institutions with long term relations. When minority investors' rights are poorly protected, the ability of firms to raise equity capital is impaired, leading to less finance for new risky ventures. More generally, fewer firms will be financed with outside equity, resulting in a low capitalization relative to GNP and a predominance of internal (unlisted) equity and bank lending over traded securities. We report some supporting evidence on a small set of countries on the correlation between investor protection and development of security markets. We use existing measures of investor protection and corruption, as well as a price measure, the premium on voting stock, which is related to the control premium. In countries where the voting premium is large, corporate financing is dominated by bank lending and equity markets are much smaller. The other indicators are also consistent with our hypothesis, although the sample size is limited.
Does demand for safety create instability ? Secured (repo) funding can be made so safe that it ne... more Does demand for safety create instability ? Secured (repo) funding can be made so safe that it never runs, but shifts risk to unsecured creditors. We show that this triggers more frequent runs by unsecured creditors, even in the absence of fundamental risk. This e↵ect is separate from the liquidation externality caused by fire sales of seized collateral upon default. As more secured debt causes larger fire sales, it leads to higher haircuts which further increase the frequency of runs. While secured funding combined with high yield unsecured debt may reduce instability, the private choice of repo funding always increases it. Regulators need to contain its reinforcing e↵ect on liquidity risk, trading o↵ its role in expanding funding by creating a safe asset.
We show how a technological shift to intangible capital can account for major economic and financ... more We show how a technological shift to intangible capital can account for major economic and financial trends since 1980. Intangible investment requires the commitment of highskill human capital, which is paid with deferred promises on future cashflows. As deferred human capital income is not tradeable, the amount of investable assets in the economy falls. The general equilibrium effect is a gradual fall in interest rates and a re-allocation of excess savings into rising valuations of existing assets such as real estate. The concomitant rise in house prices and wage inequality leads to higher household leverage.
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Papers by Enrico Perotti