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Economics and politics of alternative institutional reforms

Caselli, Francesco and Gennaioli, Nicola (2007) Economics and politics of alternative institutional reforms. 775. Centre for Economic Performance, London School of Economics and Political Science, London, UK.

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Abstract

We compare the economic consequences and political feasibility of reforms aimed at reducing barriers to entry (deregulation) and improving contractual enforcement (legal reform). Deregulation fosters entry, thereby increasing the number of firms (entrepreneurship) and the average quality of management (meritocracy). Legal reform also reduces financial constraints on entry, but in addition it facilitates transfers of control of incumbent firms, from untalented to talented managers. Since when incumbent firms are better run entry by new firms is less profitable, in general equilibrium legal reform may improve meritocracy at the expense of entrepreneurship. As a result, legal reform encounters less political opposition than deregulation, as it preserves incumbents’ rents, while at the same time allowing the less efficient among them to transfer control and capture (part of) the resulting efficiency gains. Using this insight, we show that there may be dynamic complementarities in the reform path, whereby reformers can skillfully use legal reform in the short run to create a constituency supporting future deregulations. Generally speaking, our model suggests that “Coasian” reforms improving the scope of private contracting are likely to mobilize greater political support because — rather than undermining the rents of incumbents — they allow for an endogenous compensation of losers. Some preliminary empirical evidence supports the view that the market for control of incumbent firms plays an important role in an industry’s response to legal reform.

Item Type: Monograph (Discussion Paper)
Official URL: http://cep.lse.ac.uk/
Additional Information: © 2007 F. Caselli and N. Gennaioli
Library of Congress subject classification: H Social Sciences > HC Economic History and Conditions
H Social Sciences > HG Finance
Journal of Economic Literature Classification System: O - Economic Development, Technological Change, and Growth > O1 - Economic Development > O11 - Macroeconomic Analyses of Economic Development
O - Economic Development, Technological Change, and Growth > O1 - Economic Development > O16 - Economic Development: Financial Markets; Saving and Capital Investment; Corporate Finance and Governance
G - Financial Economics > G3 - Corporate Finance and Governance > G34 - Mergers; Acquisitions; Restructuring; Corporate Governance
Sets: Collections > Economists Online
Research centres and groups > Centre for Economic Performance (CEP)
Departments > Economics
Rights: http://www.lse.ac.uk/library/usingTheLibrary/academicSupport/OA/depositYourResearch.aspx
Identification Number: 775
Date Deposited: 28 Feb 2008
URL: http://eprints.lse.ac.uk/3557/

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