Essays on political and corporate governance

In this dissertation, I investigate issues of governance and incentives in the firm and policy contexts. In Chapter I, titled "All on Board: Corporate Governance and Co-Determination", I examine a model of corporate behavior under shared governance, also known as co-determination, in the form of employee-elected representatives on a firm's board of directors. Employee and shareholder representatives engage in sequential bargaining over the firm's labor, capital, production, and financing decisions. If the firm has market power and as long as employee representatives (e.g., a union) have an interest in increasing labor, a limited increase in employee representation on the board will result in an increase in labor and output, an ambiguous and small effect on capital expenditures, and a decrease in monopoly deadweight loss with no effect on wages, which is in line with previous empirical estimates of the effect of co-determination. In the presence of risk of costly default and tax advantages of debt, limited employee control can reduce socially inefficient reliance on debt over equity. However, if employees elect most or all of the board representatives, then the firm will instead choose to increase wages and may not be able to commit to repay equity, increasing the proportion of debt in its capital structure. In Chapter II, "The Medici Vicious Circle", I investigate the hypothesis that wealth and power accumulation can reinforce each other using a dynamic model of political economy in which a policymaker can redistribute wealth and affect the identity of future policymakers. I show that individual incentives for wealth accumulation can lead to the instability of "democratic" (i.e., median voter optimal) outcomes and generate high levels of wealth inequality even if it reduces welfare. I develop a novel probabilistic approach to the definition of power and the analysis of its accumulation: political power in the model is defined as the likelihood of one's optimal policy being implemented. The framework's flexibility allows me to compare a wide range of political institutions in terms of short and long run wealth and power inequality dynamics. In particular, the presence of democratic procedures can greatly reduce the accumulation of power and result in a more equal wealth distribution. To my knowledge this is the first paper to adopt such an approach to political power and I believe it can be used in future research to analyze concepts beyond wealth and inequality. I also show that the cost of power acquisition (i.e., the ability to influence future policy) can have a non-monotonic impact on welfare and inequality. A low cost of power acquisition results in high long run inequality as policymakers redistribute both wealth and power in favor of themselves. However, increasing the cost of power acquisition beyond a certain threshold can also lead to higher long run inequality, as it limits the persistence of all policies, including those that are socially optimal. In Chapter III, "Down Round Avoidance in Venture Capital Contracts", I study contracts between firms backed by venture capital and their investors, with a focus on the incentives determining the set of contractual provisions offered to investors. Although a substantial number of firms use similar contracts throughout their lifetime, some choose to give additional privileges to select investors. Using a dataset of 1783 rounds of financing of 313 firms, I show that avoidance of "down rounds", i.e., drops in issue price of newest shares relative to the issue price in a previous round, is a crucial factor in this decision, increasing the observed probability of a firm giving a new investor more rights by over 20%. Such behavior results in a transfer of wealth from existing investors to founders, in particular through the avoidance of strong anti-dilution provisions triggered by down rounds. Combined with anecdotal evidence suggesting that existing investors are typically involved in the raising of new funds, this result sheds light on the bargaining process between investors and founders, implying that the main value of strong anti-dilution provisions comes from the additional bargaining power for existing investors when the firm performs poorly.

Keywords: Business.
Advisor: Admati Anat R.
Callander Steven
Sugaya Takuo