Black Economic Empowerment Contracts and Risk Incentives
47 Pages Posted: 11 Dec 2018 Last revised: 3 Dec 2019
Date Written: November 27, 2019
After the fall of apartheid in South Africa, Black Economic Empowerment emerged as a central policy, aimed at redressing the imbalances of the past by fairly transferring financial and economic resources to the majority of its citizens. Corporations voluntarily conduct Black Economic Empowerment deals in response to these regulatory constraints, which are designed to provide firms with incentives to draw in previously disadvantaged citizens. These deals use financial contracts and structures to dramatically alter the profile of the investor base of the firm, thereby enabling new investors to immediately participate as contingent shareholders, without the need for them to provide much initial capital. The magnitude of these deals not only significantly alters the capital structure of the firm but also affects investment opportunities. We develop a dynamic model of corporate structure, in which the claims held by all participants in a deal are carefully valued under a second-best policy, established by the original shareholders of the firm. The model allows us to trade off the benefits of doing a deal against the costs. We demonstrate that the regulations have succeeded in bringing in new investors. We also show, however, that the structure of these deals induces wrong-way risk, resulting in shareholders becoming risk-averse. The implications of these regulations, which attempt to broaden participation in financial markets, are fully explored.
Keywords: Government Policy and Regulation, Ownership Structure, Capital Structure, Wrong-way Risk, Risk Taking
JEL Classification: G320, G380, L51
Suggested Citation: Suggested Citation