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Sovereign Risk and Volatile Systems of Rules

+ Kari Kohn

Countries with ineffective systems of rules, or poor governance, often face a high cost of capital. But recent research suggests that uncertainty about changes to the rules have an impact on the cost of capital as well.  In other words, if the rules of the game are constantly changing, investors demand more compensation.  In a DealBook post, Villanova Professor Michael Pagano summarizes the interesting findings from a recent paper he wrote along with Professors Pankaj K. Jain of the University of Memphis, Emre Kuvvet of Texas A&M.

What is surprising is that the most corrupt countries like Venezuela (which is at the very bottom of our list at No. 49) are actually better for investors than moderately corrupt countries like Morocco or Mexico.This finding points to a “perverse level playing field” where potential investors in these extremely corrupt countries know who is in charge and can thereby succeed and prosper. But in moderately corrupt countries, it is unclear who is in charge and how to play the game.
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