Regulatory Dualism as a Development Strategy: Corporate Reform in Brazil, the U.S., and the EU

Abstract

Countries pursuing economic development confront a fundamental obstacle. Reforms that increase the size of the overall pie are blocked by powerful interests that are threatened by the growth-inducing changes. This problem is conspicuous in efforts to create effective capital markets to support economic growth. Controlling owners and managers of established firms successfully oppose corporate governance reforms that would improve investor protection and promote capital market development. In this article, we examine the promise of regulatory dualism as a strategy to diffuse the tension between future growth and the current distribution of wealth and power. Regulatory dualism seeks to mitigate political opposition to reforms by permitting the existing business elite to be governed by the old regime, while allowing other firms to be regulated by a new parallel regime that is more efficient. Regulatory dualism goes beyond similar but simpler strategies, such as grandfathering and statutory menus, by incorporating a dynamic element that is key to its effectiveness, but that requires a sophisticated approach to implementation. A paradigmatic example of regulatory dualism is offered by Brazil’s “New Market” (Novo Mercado), a voluntary premium segment within the São Paulo Stock Exchange that allows companies to commit credibly to significant protection of minority shareholders without imposing reform on companies controlled by the established elite. Yet regulatory dualism as a strategy for capital market reform is not unique to Brazil, nor is it suited just to developing countries. The long-standing U.S. approach to state-level corporate chartering is arguably better understood as a form of regulatory dualism than – as is the custom – as a form of regulatory competition, and the same can be said of EU corporate law post-Centros. The dramatic failure of Germany’s Neuer Markt illustrates some of the pitfalls of regulatory dualism. If thoughtfully deployed, however, regulatory dualism holds substantial promise in overcoming political barriers to reform, not just of corporate governance and capital markets, but of other economic institutions as well.