Abstract
Prior research presents mixed results for electoral impact on economic performance, thereby raising the question of whether electoral systems matter economically at all. We argue that electoral systems can conceivably generate a robust economic impact at the firm level. This argument is grounded in a recent scholarship on the political economy of corporate governance. Analysts discern electoral systems as a significant determinant of a country’s corporate governance regime and its two central components: investor and employment protection. Building on a wealth of research relating investor and employment protection to firms’ economic behavior, we develop the hypothesis that firm performance is stronger under plurality-majoritarian rules than under proportional rules. Our panel study of firms in 21 advanced democracies from 1989 to 2007 supports our hypothesis. Overall, this research helps to fill in an important gap in understanding of why it matters to choose one electoral system over another.
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Notes
Abundant research confirms the electoral impact on political representation and stability. See Gallagher and Mitchell’s (2005) volume for an extensive review.
The formal presentation of the model can be found in Pagano and Volpin (2005).
One can raise a concern about subsuming managers and controlling (large) shareholders under the general category of entrepreneurs, given that managers and controlling shareholders are often distinct and can have different economic incentives. However, it is important to note that PV’s model is based on a particular form of agency problem in the financial contracting environment, the form that most financial regulatory reforms in recent decades are instituted to address: the agency problem due to the tendency of insiders (managers and controlling shareholders) to expropriate outsiders (dispersed or minority shareholders). Studies show that controlling shareholders have the power and incentive to expropriate minority shareholders just like managers do (McLean et al. 2012; Shleifer and Vishny 1997). Then, even if managers and controlling shareholders are separated, the fundamental problem in the financial contracting environment remains the same: lack of credible commitment to protect minority shareholders’ cash flow rights. Therefore, the similarity of their incentives in relations with minority shareholders makes it defensible to subsume managers and controlling shareholders under a general category.
PV’s model can be faulted for ignoring other stakeholders like debt holders, retirees and unions. For the sake of parsimony, PV do not allow the presence of debt in formal modelling. However, they note that the insights of their model would not be substantively different even if they allowed the presence of debt. That is because, as noted above, their modelling is based on the agency problem between insiders and outsiders, where external debt and equity are not so different except for the possibly different degree of legal protection afforded to creditors and shareholders (Pagano and Volpin 2005, p.1009). Also, PV’s model can accommodate workers (both employed and unemployed) as retirees insofar as they invest in the firm, and explicitly subsume unions under the category of employed workers (Pagano and Volpin 2005, 1014).
This might be considered overly simplistic given that many proportional systems (and some plurality systems) indeed have more than two parties/blocs. However, this assumption makes it easy to solve the model’s optimization problem. Also, an extension of the model shows that increasing the number of parties does not change the general insights of the model (Suh 2012).
This assumption is commonly shared in the traditional partisanship school (Alt 1985; Hibbs 1977). Furthermore, the insider/outsider model of social democratic partisanship confirms that center-left parties (like Party B in PV model) are more likely to see employed workers as their core constituencies than unemployed workers (Rueda 2008).
The lesser ideological cohesion and hence greater swinging tendency of the constituent parts of the residual group is noted in prior research. For unemployed workers, it is either explicitly documented in the finding of the greater heterogeneity of their political preference (Lindvall and Rueda 2014; Marx and Picot 2013) or hinted in the findings of their low political participation (Anderson 2001; Verba et al. 2004) and their greater tendency to engage in non-partisan voting like economic voting (Fossati 2014; Singer 2011). The lesser ideological commitment of rentiers is studied to a more limited extent. However, analysts report the weak partisan commitment of institutional investors in their political contributions. For example, Bennett and Loucks (2001, p. 215) show that the political contributions of financial services industry for the Republican and Democrat parties in the United States are not significantly different.
This assumption is seemingly contrary to the common notion that parties under proportional rules do not necessarily try to maximize their vote shares but rather seek to build their niche on the political spectrum and win elections by joining post-election governing coalitions (Cox 1997). However, even in the case of winning by building niche, parties have a stronger incentive to appeal to their core constituencies. Note that the predictions of the model do not change as long as parties under these rules respond to their core constituencies more strongly.
Appendix Table 5 lists the countries included in the analysis.
This database covers publicly-held firms with over 90% of the world's market capitalization over 80 countries. It provides standardized financial statement information and consistent and comparable data which helps in cross-country firm analysis.
The index comprises four items: information practices including accounting rules and audit procedure, oversight practices as related to the board of directors and rules governing their fiduciary responsibilities, control practices including voting right rules, and managerial incentives which deal with manager compensation to align the conflict with the shareholders’ interests. Higher Scores indicate greater investor protection (Gourevitch and Shinn 2005). An alternative and more commonly used measure is the anti-director rights index by La Porta et al. (1998). Studies show that Gourevitch and Shinn’s index is the most up-to-date and the most finely calibrated measure of investor protection (Suh 2012). It is pertinent to note, though, that the pattern remains substantively the same no matter which measure we employ.
It is the employment protection legislation measure defined as the average of indicators for regular contracts (procedural inconveniences, notice and severance pay for no-fault individual dismissals, difficulty of dismissal) and short-term contracts (fixed-term and temporary). Higher scores indicate greater employment protection.
In particular, scholarly debate on the subject pits the Stein-Boix model (1970, 1999) against the Cusack–Iversen–Soskice model (2007). While the former suggests that right-wing parties choose the proportional system to guard against a rising left, especially when their constituencies are divided, the latter proposes that right-wing parties’ support for a particular electoral system depends on the country’s economic institutions and the level of coordination between business and unions in particular. In case of high-level coordination where right-wing parties see the benefits of consensual regulatory frameworks in labor market, they choose the PR system and concede its redistributive consequences. However, in case of low-level coordination, where right-wing parties feel threatened, they choose the plurality-majoritarian system to help contain left-wing parties.
For example, Roe (2003) claims that minority shareholder rights are less protected in countries where social democratic parties are strong. Cioffi and Höpner (2006) challenge this claim by observing that recent shareholder-friendly reforms in Germany, Italy, France and the United States were promoted by left-wing parties, even against opposition from right-wing parties. More recently, Callaghan (2009) identifies that there is no uniform pattern over time and across nations in how political parties are implicated in the corporate governance regime of a country.
However the legal origin approach is criticized for being mostly correlational (Pagano and Volpin 2005). Also, Rajan and Zingales (2003) offer historical evidence that common law countries have not always been conducive to strong investor protection. In fact, before the Great Reversal in the early decades of the Twentieth century, which refers to the significant change in the corporate governance regimes of industrial economies in the early decades of the twentieth century, investor protection was stronger in a civil law country like France than in a common law country like the United States.
We estimate our models in STATA. It is worth mentioning that our model estimation uses Restricted Maximum Likelihood (REML). Although Maximum Likelihood (ML) is the dominant approach in estimating variance components where the assumption of a normal density for the level-1 and level-2 disturbances informs the maximization of the likelihood function, it is downwardly biased, because no correction is made for the degrees of freedom consumed by estimation of fixed level-2 parameters. This bias is particularly strong in case of small samples of level-2 units as in our study. REML, an alternative estimator of variance components, corrects for this bias by accounting for the number of (fixed level-2) parameters estimators, losing 1 degree of freedom for each; therefore, REML is somewhat more preferable to ML in samples of small level-2 units (Steenbergen and Jones 2002; 225–226). We should also note that we run the analyses using the bootstrapping procedure to examine the robustness of the RMLE estimates. The results, available upon request, are substantively the same.
We excluded each of 21 countries in our sample at a time. The results for Electoral System, available upon request, were substantively the same.
In assigning the countries to each of these types, we follow Gallagher and Mitchell (2005).
It is incumbent to note that following the referee’s suggestion, we ran an additional analysis separating closed and open proportional systems. This was motivated by a key finding of McGillivray (2004) that due to differences in party strength some PR systems (with open lists) may act more like plurality system systems, compared to other PR systems (with closed lists). We divided the PR systems into closed and open types, and then ran our basic model (leaving aside majoritarian systems). The results were insignificant, meaning that firm profitability is not any distinct under closed proportional systems compared to open proportional systems. It is worth noting, though, that the insignificant result may have to do with the size of the sample. There were only three PR countries with open lists.
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Camyar, I., Ulupinar, B. Electoral systems and the economy: a firm-level analysis. Const Polit Econ 30, 1–30 (2019). https://doi.org/10.1007/s10602-019-09274-6
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DOI: https://doi.org/10.1007/s10602-019-09274-6