Investor Protection and Interest Group Politics

This post is from Lucian Bebchuk of Harvard Law School.

The Program on Corporate Governance has recently issued as a discussion paper my piece, co-authored with Zvika Neeman, entitled Investor Protection and Interest Group Politics. We develop in this paper a framework for analyzing how interest group politics influence investor protection levels. Our analysis identifies factors that impede desirable corporate governance reforms, and can help explain the ways in which investor protection levels vary around the world and over time. The abstract of the paper is as follows:

We model how lobbying by interest groups affects the level of investor protection. In our model, insiders in existing public companies, institutional investors (financial intermediaries), and entrepreneurs who plan to take companies public in the future, compete for influence over the politicians setting the level of investor protection. We identify conditions under which this lobbying game has an inefficiently low equilibrium level of investor protection. Factors that operate to reduce investor protection below its efficient level include the ability of corporate insiders to use the corporate assets they control to influence politicians, as well as the inability of institutional investors to capture the full value that efficient investor protection would produce for outside investors. The interest that entrepreneurs (and existing public firms) have in raising equity capital in the future reduces but does not eliminate the distortions arising from insiders’ interest in extracting rents from the capital public firms already have. Our analysis generates testable predictions, and can explain existing empirical evidence, regarding the way in which investor protection varies over time and around the world.

The full paper is available for download here.

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One Comment

  1. James McRitchie
    Posted Wednesday, December 19, 2007 at 6:19 pm | Permalink

    Interesting paper. I’d love to see your model used as the framework for an analysis of the recent action on proxy access at the SEC.

    Your paper highlights the fact that “the legal rules themselves are partly a product of an agency problem, as insiders might use direct corporate lobbying efforts in ways that serve their own interests.” Of course, institutional investors can’t influence regulatory activities using such corporate funds and this is one major reason why we lost access rights.

    One flaw in the paper, or at least I certainly hope it is a flaw, is the assumption “that individual investors, who invest in publicly traded firms either directly or indirectly through institutional investors, are too dispersed to become part of an effective organized interest group with respect to investor protection.”

    Apparently, that is what many would like us to believe. As I recall, the only representative of individual investors invited by the SEC to roundtable discussions on proxy access was Evelyn Y. Davis, who kept insisting she was “prettier” than Nell Minow. Yet, groups of individual investors in countries outside the US have been critical in achieving reforms and protections.

    On a State Department sponsored visit to Korea to discuss the need for corporate governance reforms several years ago, I visited with representatives of People’s Solidarity for Participatory Democracy (PSPD), specifically their Participatory Economy Committee. The PSPD uses shareholder proposals, civil and criminal lawsuits and lobbying to improve corporate governance. I’m sure many other countries have similar organizations.

    The United Shareholders Association, a now defunct group financed by Texas oilman T. Boone Pickens, played a largely positive role in the 1980s here in the United States and might have accomplished much more, had it continued.

    You should consider revising your model to include such a possibility, especially given the key role that individual investors play in several of your “predictions” (hypotheses).

    Prediction 5: Investor protection will be higher when the fraction of the electorate that directly or indirectly owns shares in public companies is large.

    Prediction 8: Investor protection will be higher when individuals investing (directly or indirectly) in public companies are more financially educated and when the media is more active.

    Prediction 9: Investor protection will be higher following scandals or crashes that make the problems of insider opportunism more salient.

    Clearly individual investors can have an important role to play in establishing investor protections, even if they were largely ignored in the SEC’s recent deliberations regarding proxy access.

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  1. By Archived News From December 2007 | Corporate Governance on Friday, December 7, 2012 at 8:49 pm

    […] But they didn’t. Are they protecting investors, as the law mandates, or protecting the vested interests that brought them to power or will reward them after service at the SEC? It would make an interesting case study for the framework outlined by Lucian Bebchuk and Zvika Neeman in a paper entitled Investor Protection and Interest Group Politics. (see also the Harvard Law School Corporate Governance Blog) […]