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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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

This paper develops a dynamic general equilibrium model that is intended to help clarify the role of credit market frictions in business fluctuations, from both a qualitative and a quantitative standpoint. The model is a synthesis of the leading approaches in the literature. In particular, the framework exhibits a financial accelerator,' in that endogenous developments in credit markets work to amplify and propagate shocks to the macroeconomy. In addition, we add several features to the model that are designed to enhance the empirical relevance. First, we incorporate money and price stickiness, which allows us to study how credit market frictions may influence the transmission of monetary policy. In addition, we allow for lags in investment which enables the model to generate both hump-shaped output dynamics and a lead-lag relation between asset prices and investment, as is consistent with the data. Finally, we allow for heterogeneity among firms to capture the fact that borrowers have differential access to capital markets. Under reasonable parametrizations of the model, the financial accelerator has a significant influence on business cycle dynamics.

https://papers.ssrn.com/sol3/Delivery.cfm/nber_W6455.pdf?abstractid=226200&mirid=1

The Financial Accelerator in a Quantitative Business Cycle Framework

In a simple model of borrowing and lending with asymmetric information we show that the optimal, incentive-compatible debt contract is the standard debt contract. The second-best level of investment never exceeds the first-best and is strictly less when there is a positive probability of costly bankruptcy. We also compare the second-best with the results of interest-rate-taking behaviour and consider the effects of risk aversion. Finally we provide conditions under which increasing the borrower's initial net wealth must reduce total investment in the venture. A great deal of effort has recently gone into the study of implicit contract models (ICM) in an attempt to explain the failure of competitive labour markets to generate efficient levels of employment. (See Hart, 1983, for a survey of this work and further references). Relatively little attention has been given to the theoretical analysis of capital market imperfections, a phenomenon we believe to be at least as important as labour market imperfections when it comes to explaining the inefficient use of resources, including "unemployment". In this paper we seek to fill this gap by analysing a model of credit contracts between firms that need outside finance in order to operate efficiently on the one hand and the institutions that provide the money on the other. We were led to this problem by our current interest in the question of what is the firm's budget constraint? In economies with complete markets, of course, this question does not arise in a meaningful form. But when markets are incomplete the firm does face a budget constraint of some sort at each date and the form of this constraint may crucially affect its behaviour. There is no intrinsic virtue in a budget constraint which requires the firm to repay all debts with probability one and, in fact, most legal systems allow for some insurance, in the form of bankruptcy, against low income states. Perhaps the central message of our work is simply that the question of the firm's budget constraint should be formulated as a contract problem. And under certain conditions, the form of the optimal budget constraint is the same as the standard debt contract with bankruptcy. But there is more to the analysis than that. We are naturally interested not only in the shape of the firm's budget constraint but also in its position. In other words, is there credit-rationing?

http://www.ww.uni-magdeburg.de/bizecon/teaching/ST_08/banks/Gale.Hellwig_Debt-contracts_RES52(2)1985_647-663.pdf

Incentive-Compatible Debt Contracts: The One-Period Problem

Financial systems are crucial to the allocation of resources in a modern economy. They channel household savings to the corporate sector and allocate investment funds among firms; they allow intertemporal smoothing of consumption by households and expenditures by firms; and they enable households and firms to share risks. These functions are common to the financial systems of most developed economies. Yet the form of these financial systems varies widely. In the United States and the United Kingdom competitive markets dominate the financial landscape, whereas in France, Germany, and Japan banks have traditionally played the most important role. Why do different countries have such different financial systems? Is one system better than all the others? Do different systems merely represent alternative ways of satisfying similar needs? Is the current trend toward market-based systems desirable? Franklin Allen and Douglas Gale argue that the view that market-based systems are best is simplistic. A more nuanced approach is necessary. For example, financial markets may be bad for risk sharing; competition in banking may be inefficient; financial crises can be good as well as bad; and separation of ownership and control can be optimal. Financial institutions are not simply veils, disguising the allocation mechanism without affecting it, but are crucial to overcoming market imperfections. An optimal financial system relies on both financial markets and financial intermediaries.

Comparing Financial Systems

Incentive-compatible debt contracts: The one-period problem

Financial Contagion Journal of Political Economy

Empirical evidence suggests that banking panics are related to the business cycle and are not simply the result of "sunspots." Panics occur when depositors perceive that the returns on bank assets are going to be unusually low. We develop a simple model of this. In this setting, bank runs can be first-best efficient: they allow efficient risk sharing between early and late withdrawing depositors and they allow banks to hold efficient portfolios. However, if costly runs or markets for risky assets are introduced, central bank intervention of the right kind can lead to a Pareto improvement in welfare. FROM THE EARLIEST TIMES, banks have been plagued by the problem of bank runs in which many or all of the bank's depositors attempt to withdraw their funds simultaneously. Because banks issue liquid liabilities in the form of deposit contracts, but invest in illiquid assets in the form of loans, they are vulnerable to runs that can lead to closure and liquidation. A financial crisis or banking panic occurs when depositors at many or all of the banks in a region or a country attempt to withdraw their funds simultaneously. Prior to the twentieth century, banking panics occurred frequently in Europe and the United States. Panics were generally regarded as a bad thing and the development of central banks to eliminate panics and ensure financial stability has been an important feature of the history of financial systems. It has been a long and involved process. The first cerntral bank, the Bank of Sweden, was established more than 300 years ago. The Bank of England played an especially important role in the development of effective stabilization policies in the eighteenth and nineteenth centuries. By the end of the nineteenth century, banking panics had been eliminated in Europe. The last true panic in England was the Overend, Gurney & Company Crisis of 1866.

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Douglas Gale

Papers

Incentive-Compatible Debt Contracts: The One-Period Problem

Comparing Financial Systems

Incentive-compatible debt contracts: The one-period problem

Financial Contagion Journal of Political Economy

Optimal Financial Crises