Enrico C. Perotti

Resistance to Change

Established firms often fail to maintain leadership following disruptive market shifts. We argue that such firms are more prone to internal resistance. A radical adjustment of assets affects the distribution of employee rents, creating winners and losers. Losers resist large changes when strong customer goodwill cushions the consequences. Partial adaptation may lead winners to depart to form new firms with no goodwill, but no internal resistance.

Finance and inequality: Channels and evidence

We provide a framework to interpret the recent literature on financial development and inequality. In many developing countries, access to funding and financial services by firms and households is still very skewed. Recent evidence suggests that poor access does not only reflect economic constraints but also barriers erected by insiders. Inequality affects the distribution of political influence, so financial regulation often is easily captured by established interests in unequal countries. Captured reforms deepen rather than broaden access, as small elites obtain most of the benefits while risks are socialized. Financial liberalization motivated to increase access may in practice increase fragility and inequality, and lead to political backlash against reforms. Thus financial reforms may succeed only if matched by a buildup in oversight institutions.

Last Bank Standing: What Do I Gain if You Fail?

Banks are highly leveraged institutions, potentially attracted to speculative lending even without deposit insurance. A counterbalancing incentive to lend prudently is the risk of loss of charter value, which depends on future rents. We show in a dynamic model that current concentration does not reduce speculative lending, and may in fact increase it. In contrast, a policy of temporary increases in market concentration after a bank failure, by promoting a takeover of failed banks by a solvent institution, is very effective. By making speculative lending decisions strategic substitutes, it grants bankers an incentive to remain solvent. Subsequent entry policy fine-tunes the trade-off between the social costs of reduced competition and the gain in stability.

The Political Economy of Corporate Control and Labor Rents

In a democracy, a political majority can influence both the corporate governance structure and the return to human and financial capital. We argue that when financial wealth is sufficiently concentrated, there is political support for high labor rents and a strong governance role for banks or large investors. The model is consistent with the “great reversal” phenomenon in the first half of the twentieth century. We offer evidence that in several financially developed countries a financially weakened middle class became concerned about labor income risk associated with free markets and supported a more corporatist financial system.

Bank lending in transition economies

Bank privatization and tighter credit enforcement are believed indispensable to facilitate the Eastern European transition process. We analyze lending by value-maximizing banks, the only source of capital in the transition, faced by non-performing loans to the state-owned sector. We show that banks have a perverse incentive to fund former debtors, although less efficient and more risky than private firms, because they gain the potential repayment of previous debts. This leads to a lower productivity of investment and a greater concentration of risk; the expansion of more efficient private firms is delayed, leading to a slower recovery and a greater risk of financial crisis.

Security Markets versus Bank Finance: Legal Enforcement and Investors' Protection

When minority investors’ rights are poorly protected, the ability of firms to raise equity capital is impaired, leading to less finance for new ventures. Fewer firms will be financed with outside equity, resulting in a low market capitalization relative to GNP. External funding requires easily enforceable claims such as debt or requires long‐term relationships with institutions. Provision of funding shifts from risk capital to debt, and to a predominance of intermediated over market finance. We report supporting evidence for a few countries. To measure investor protection, we use a price measure, the premium on voting stock, 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.

Does father know best? A formal model of the paternal influence on childhood social anxiety

We explore paternal social anxiety as a specific risk factor for childhood social anxiety in a rational optimization model. In the course of human evolution, fathers specialized in external protection (e.g., confronting the external world) while mothers specialized in internal protection (e.g., providing comfort and food). Thus, children may instinctively be more influenced by the information signaled by paternal versus maternal behavior with respect to potential external threats. As a result, if fathers exhibit social anxiety, children interpret it as a strong negative signal about the external social world and rationally adjust their beliefs, thus becoming stressed. Under the assumption that paternal signals on social threats are more influential, a rational cognitive inference leads children of socially anxious fathers to develop social anxiety, unlike children of socially anxious mothers. We show in the model that mothers cannot easily compensate for anxious paternal behavior, but choose to increase maternal care to maintain the child’s wellbeing. We discuss research directions to test the proposed model as well as implications for the prevention and treatment of child social anxiety.

Lobbying on entry

We develop a model of endogenous lobby formation in which wealth inequality and political accountability undermine entry and financial development. Incumbents seek a low level of effective investor protection to prevent potential entrants from raising capital. They succeed because they can promise larger political contributions than the entrants due to the higher rents earned with less competition. Entry and investor protection improve when wealth distribution becomes less unequal, and the political system becomes more accountable. Consistent with these predictions, in a cross-section of 38 countries we find that greater accountability is associated with higher entry in sectors that are more dependent on external capital and have greater growth opportunities. Also, higher accountability and lower income inequality are associated with more effective legal enforcement, even after controlling for legal origin and per-capita income.

Inertial credit and opportunistic arrears in transition

In a transition economy, enterprise restructuring may exhibit a Laffer-curve response to tighter credit as a result of rational collective inertia. In the presence of a rigid production structure, unenforceable contracts and high adjustment costs, a contraction in credit finance subtracts more liquidity than enterprises can generate internally. Because unrestructured firms are forced to extend trade credit to illiquid buyers, an increase in their number increases the availability of forced supplier credit, in turn increasing the attractiveness of inertial behavior. As trade credit cannot be enforced, a critical mass of trade and wage arrears causes pressure for a collective bailout, thus validating inertial behavior even by reformable firms.

Strategic transparency and informed trading : will capital market integration force convergence of corporate governance?

Dominant investors can influence the publicly available information about firms by affecting the cost of information collection. Under strategic competition, transparency results in higher variability of profits and output. Thus, lenders prefer less transparency, since this protects firms when in a weak competitive position, while equity holders prefer more. Market interaction creates strategic complementarity in gathering information on competing firms, thus entry by transparent competitors will improve price informativeness. Moreover, as the return to information gathering increases with liquidity, increasing global trading may undermine the ability of bank control to keep firms opaque.