Black economic empowerment regulation and risk incentives

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 regulatory constraints designed to incentivize firms to draw in previously disadvantaged citizens as shareholders without the need for them to provide much initial capital. We develop a dynamic model of corporate structure, in which the claims held by all participants are carefully valued. The regulations have succeeded in bringing in new investors. We explore why different types of firms have structured deals in different ways and we identify unintended consequences of the regulations. In particular, these deals induce wrong-way risk resulting in shareholders becoming risk-averse. The implications of these regulations and the resulting wrong-way risk are fully explored.