Events

Mr Johannes Matt
Ph.D. Candidate in Economics
London School of Economics

This paper analyses how financial regulation that reduces investors’ willingness to take risk impacts economic growth. I study a regulatory reform that tightened risk requirements on British
pension funds and led to a large divestment from equity markets. To leverage the reform as a natural experiment, I collect and digitise new security-level holdings data for a large fraction of
the pension sector. I then study how pension funds’ equity divestment affected firms’ investment decisions. Firms more exposed to pension investors before the reform experienced a persistent fall in stock prices and a rise in risk premia. In response, these firms cut their capital and R&D expenditure and reduced the share of long-term investment. Motivated by these findings, I introduce a new growth framework that combines Schumpeterian growth with segmented equity markets. A limited number of risk-averse investors hold stocks in incumbent firms who invest in risky innovation. Reducing investors’ risk-taking capacity raises the market risk premium, reduces incumbent R&D, and can dampen firm entry in general equilibrium when the rise in the risk premium is sufficiently strong. I calibrate the model to my estimated firm-level investment elasticities and simulate the impact of the pension reform on growth. Pension schemes’ equity sell-off, which was equivalent to approximately 3 percent of market capitalisation, generated a 0.14 percentage-point drop in annual growth.