Corporate Governance and Industrialization

Corporate governance distortions delay or even halt a country’s transformation into a modern innovation economy. We investigate the mechanism through a growth model that allows for agency issues within firms. Governance distortions raise the cost of investment and depress the incentives to set up new firms. Modest differences in governance account for large gaps in income: A 32 percent investment cost differential can explain the secular decline of Latin America income relative to that of the USA, and implies an industrialization delay of a third of a century. We obtain similar results for a large number of countries and macro-regions.