Some credit booms result in financial crises. While excessive risk-taking could plausibly explain the boom-to-bust cycle, many investors do not anticipate increasing risk. We show that credit booms may be misunderstood as being driven by high productivity because opaque bank assets disguise risk incentives. Balanced funding relative to productive prospects can sustain prudent lending (good boom), whereas funding imbalances may induce high risk exposure and boost asset prices (bad boom) or lead to asset underpricing and insufficient lending (missed boom). Rational agents drawing inference from prices make mistakes that can amplify the effect of funding imbalances and propagate risk.

We study the interplay between a “one person-one vote” political system and a “one share-one vote” corporate governance regime. If shareholders push firms for more prosocial policies, political backlash may arise, undoing these initiatives. If public policy is frictionless, shareholder democracy becomes irrelevant: the political system fully offsets shareholder influence. With public policy frictions, prosocial corporations can mitigate regulatory shortcomings and enhance corporate public goods provision. Nevertheless, shareholder democracy can hurt citizens due to the representation problem: it favors the preferences of the wealthy. Investor diversification, pass-through voting, and corporate greenwashing have important implications for these trade-offs of shareholder democracy.