The political economy of bank- and market dominance

Legislation affects corporate governance and the protection of stakeholders versus investor claims. We allow the preference of a political majority to determine both the governance structure and the extent of stakeholder claims. In a society where median voters have relatively more at stake in the form of human capital rather than financial wealth, they prefer a less risky environment even when this reduces profits, as stakeholder rents are exposed to undiversifiable firm-specific risk. In general, stakeholders and lenders prefer less corporate risk, since their claims are a concave function of firm profitability. This congruence of interests will lead the political majority in such a society to support bank over equity dominance. As shareholdings by the median voters increase, the dominance structure will switch towards favoring equity markets with riskier corporate strategies and higher profits.