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Economics and Politics of Alternative Institutional Reforms

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Author Info
Francesco Caselli
Nicola Gennaioli

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Abstract

We compare the economic consequences and political feasibility of reforms aimed at reducingbarriers to entry (deregulation) and improving contractual enforcement (legal reform). Deregulationfosters entry, thereby increasing the number of firms (entrepreneurship) and the average quality ofmanagement (meritocracy). Legal reform also reduces financial constraints on entry, but in addition itfacilitates transfers of control of incumbent firms, from untalented to talented managers. Since whenincumbent firms are better run entry by new firms is less profitable, in general equilibrium legalreform may improve meritocracy at the expense of entrepreneurship. As a result, legal reformencounters less political opposition than deregulation, as it preserves incumbents' rents, while at thesame time allowing the less efficient among them to transfer control and capture (part of) the resultingefficiency gains. Using this insight, we show that there may be dynamic complementarities in thereform path, whereby reformers can skillfully use legal reform in the short run to create a constituencysupporting future deregulations. Generally speaking, our model suggests that "Coasian" reformsimproving 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 oflosers. Some preliminary empirical evidence supports the view that the market for control ofincumbent firms plays an important role in an industry's response to legal reform.

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Paper provided by Centre for Economic Performance, LSE in its series CEP Discussion Papers with number dp0775.

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Date of creation: Jan 2007
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Related research
Keywords: financial economics; deregulation; meritocracy;

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Find related papers by JEL classification:
G34 - Financial Economics - - Corporate Finance and Governance - - - Mergers; Acquisitions; Restructuring; Corporate Governance
O11 - Economic Development, Technological Change, and Growth - - Economic Development - - - Macroeconomic Analyses of Economic Development
O16 - Economic Development, Technological Change, and Growth - - Economic Development - - - Financial Markets; Saving and Capital Investment

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References listed on IDEAS
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Nicola Gennaioli & Alberto Martin & Stefano Rossi, 2009. "Institutions, Public Debt and Foreign Finance," Economics Working Papers 1170, Department of Economics and Business, Universitat Pompeu Fabra. [Downloadable!]
  2. Besley, Timothy J. & Ghatak, Maitreesh, 2009. "The de Soto Effect," CEPR Discussion Papers 7259, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
  3. Djankov, Simeon, 2008. "The Regulation of Entry: A Survey," CEPR Discussion Papers 7080, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
  4. Ana Fernandes, 2008. "Endogenous Political Economy: On the Inevitability of Inefficiency under the Natural Resource Curse," Diskussionsschriften dp0802, Universitaet Bern, Departement Volkswirtschaft. [Downloadable!]
  5. Timothy Besley & Maitreesh Ghatak, 2009. "The de Soto Effect," STICERD - Economic Organisation and Public Policy Discussion Papers Series 008, Suntory and Toyota International Centres for Economics and Related Disciplines, LSE. [Downloadable!]
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