Institutions and Innovation: Theory and International Evidence
Abstract
We present a model of the design of institutions for regulating innovative activities of private corporations. Each country is characterized by its own legal system. Informational limitations faced by the social planner precludes complete contracting with private firms, and hence invasive regulation. Corporate innovation creates positive and negative externalities whose societal impact depends on the sharing rule between the firm owners and the society at large. In our framework, the social planner in each country takes into account the legal system in place, and designs a menu of organizational forms and an optimal rate of corporate taxation. Since the legal regime affects the extent to which the owners of firms are held responsible for the negative externalities they impose, unlimited liability may discourage corporate innovation in strong legal regimes. Limited liability, however, might be accompanied by excessive innovation. Firms choose their organizational form and level of innovation consistent with private optimality. With the optimal institutional design for each country, the private choices of innovation levels are aligned with social optimality. Optimally designed corporate tax rate in each country is shown to be a decreasing function of its legal effectiveness. Using data from 63 countries over 2003-2018, we document supporting evidence. Tax strategies implemented by multinational companies (MNCs) have the potential to get around the constraints of institutional design. We highlight some policy implications of our model for regulating domestic firms and MNCs.
Bio
Kose John is the Charles William Gerstenberg Professor of Banking and Finance at New York University, Stern School of Business. He holds a Ph.D. from University of Florida. He has also taught at the University of Chicago, Columbia University and Institut d’Etudes Politiques de Paris (Sciences Po). He has won several awards, including the Batterymarch Fellowship in 1983 and the Jensen Prize for the best paper published in 2000 in the Journal of Financial Economics. He is on the Nomination Committee for the Nobel Prize in Economics for last several years. He is the author of two books (on futures markets and dividend policy), and the editor of 26 books and special issues in finance Journals on topics such as FinTech, financial stability, financial distress, and valuation of distressed securities; corporate governance; and investments innovations in finance. He has published over 102 research articles in the major finance and economics journals. His recent research focuses on innovation, institutions, banking, financial crisis, corporate governance, top-management compensation, and financial distress, valuation of distressed claims and comparative bankruptcy and governance systems. He served as the president of the Financial Management Association International during 2014-15. He also serves as the program chair of the Association of Financial Economists (AFE). He has been a mentor and advisor to 106 doctoral students who are finance professors and finance practitioners all over the world.
