Three essays on the political economy of corporate governance

Empirical studies in international corporate governance consistently find that in countries with poorer investor protections controlling shareholders are more common and financial markets are less developed. A number of explanations for this correlation have been suggested, most notably, the effects of the legal origin and country's institutions (La Porta et al., 1998) and the role of politics and ideology (Roe 2003). The main shortcoming of the existing literature is that either the investor protection level or the degree of ownership concentration are assumed to be exogenous. In contrast, this dissertation explores how higher levels of outside ownership, better protection of outside investors, and more developed financial markets arise simultaneously and endogenously in a political lobbying equilibrium.; This dissertation explicitly models entrepreneurs' decisions to sell their companies' shares to outside investors, when entrepreneurs anticipate that doing so creates a political interest group which will lobby the government for stricter investor protection regulation. Higher levels of investor protection safeguard the interests of outside investors not only from managerial incompetence, but also from the abuses by company founders, namely, the entrepreneurs themselves. When stricter regulation improves management quality and increases firm profitability, company shares become more valuable to outside investors. Consequently, entrepreneurs obtain higher revenues from selling their companies' shares to outside investors. On the other hand, stricter investor protection regulation also limits private benefit extraction by corporate insiders. When the reduction of private benefits is not offset by higher revenues from raising outside capital, company founders prefer lower levels of outside ownership and investor protection. Better protection of outside investors reduces the agency costs from both personal corruption and poor management. This dissertation explores how the friction between these two sets of incentives determines both the structure of corporate ownership and the quality of investor protection regulation.