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

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We use data on ownership structures of large corporations in 27 wealthy economies to identify the ultimate controlling shareholders of these firms. We find that, except in economies with very good shareholder protection, relatively few of these firms are widely held, in contrast to Berle and Means’s image of ownership of the modern corporation. Rather, these firms are typically controlled by families or the State. Equity control by financial institutions is far less common. The controlling shareholders typically have power over firms significantly in excess of their cash f low rights, primarily through the use of pyramids and participation in management.

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Corporate Ownership Around the World

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?

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Financial development and economic growth : views and agenda

The paper develops a simple model of corporate ownership structure in which costs and benefits of ownership concentration are analyzed The model cornpares the liquidity benefits obtained through dispersed corporate ownership with the benefits from efficient management control achieved by some degree of ownership concentration The paper reexamines the free-rider problem in corporate control in the presence of liquidity trading, derives predictions for the trade and pricing of blocks, and provides criteria for the optimal choice of ownership structure THE RECENT INCOMPLETE CONTRACTING approach in corporate finance has considerably improved our understanding of how small firms determine their capital structure The basic setting considered in this line of research is one where a founder-manager seeks funding from one or several financiers The main premise is that the founder-manager, in her dealings with the financiers, is primarily concerned with maintaining her private benefits of control For small firms these are often quite large relative to the financial returns Thus, for a small firm the problem of determining the financial structure often reduces to the problem of how to obtain fundingr while giving away as little control as possible to the financiers Of course, most financiers insist on some form of protection, so that the final compromise reached in most financial contracts for small firms is one resembling a debt contract (or a venture capital contract), which protects the founder-manager's control as long as the firm is performing adequately' This perspective for small firms does not extend naturally to large firms because the private benefits of control of the managers for large firms are likely to be small relative to the firm's monetary returns, so that protection of these benefits is not an overriding consideration Moreover, large firms

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Blocks, liquidity and corporate control

term contracts, asymmetric information between investors and firms can make it impossible to implement profitable long-term projects. The paper characterizes the structure of optimal, renegotiation-proof contracts for unmonitored and monitored finance. Monitoring by investors, although itself subject to distorting incentive constraints, is shown to be able to overcome the short-term bias of investment and thus to lengthen the firms' planning horizon. I. INTRODUCTION An important question in the literature on corporate finance in the recent years has been whether the dependence on outside finance can force firms to undertake inefficient amounts of investment. Little work has been done, however, on the impact of outside finance on the quality of investment. The present paper studies this issue in the context of a question which has attracted considerable attention in the financial press and in the economic policy debate: can the dependence on outside finance lead a firm to undertake inefficient myopic investments?' To do this, the paper studies a dynamic model of financial contracting that allows one to characterize the choice of a firm's investment horizon. It points to information asymmetries as responsible for investment myopia, discusses the costs and benefits of monitoring as a reaction to it, and characterizes the optimal dynamic debt structure for unmonitored, as well as for monitored finance. According to standard financial theory, the market sees through the corporate veil and encourages the choice of efficient projects. In response to this, an important recent literature has developed more explicit theories of financial contracts and their role for the behaviour of imperfectly informed and strategically acting economic agents.2 This paper builds on this literature and analyses the problem of optimal financial contracting for a firm that wants to raise capital for a risky long-term investment project. The framework used to study the issue is a simple two-period contracting model, complicated by the interplay of hidden-characteristics and hidden-action problems on the side of the firm. More specifically, the probability distribution of project returns is assumed to depend on the intrinsic quality of the project, as well as on the investment horizon and effort chosen

Long-Term Contracts, Short-Term Investment and Monitoring

Asymmetric information, bank lending and implicit contracts: the winner's curse

We study the problem of financial contracting and renegotiation between a firm and outside investors when the firm cannot commit to future payouts, but assets can be contracted upon. We show that a capital structure with multiple investors specializing in short-term and long-term claims is superior to a structure with only one type of claim, because this hardens the incentives for the entrepreneur to renegotiate the contract ex post. Depending on the parameters, the optimal capital structure also differentiates between state-independent and state-dependent longterm claims, which can be interpreted as long-term debt and equity. © 1994 by the President and Fellows of Harvard College and the Massachusetts Institute of Technology.

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Short-Term versus Long-Term Interests: Capital Structure with Multiple Investors

The rapidly growing literature studying the relationship between legal origin, investor protection and finance has stimulated an important debate in academic circles. It has also generated a cottage industry of applied research and strong policy statements. This paper discusses the implications, in particular for developing and transition countries, from this literature. Our general conclusion is that its focus on the plight of small investors is too narrow when applied to these countries. We argue that this group is unlikely to play an important role in most developing and transition countries. External investors may still be crucial, particularly in transition countries, but they are more likely to come in as strategic investors or creditors. The paper also proposes a broader paradigm including other stakeholders and mechanisms of governance in order to better understand the problems facing these countries and generate policy implications that compensate for the weaknesses of capital markets.

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Ernst-Ludwig von Thadden

Papers

Blocks, liquidity and corporate control

Long-Term Contracts, Short-Term Investment and Monitoring

Asymmetric information, bank lending and implicit contracts: the winner's curse

Short-Term versus Long-Term Interests: Capital Structure with Multiple Investors

The Changing Corporate Governance Paradigm: Implications for Transition and Developing Countries