The Economic Consequences of Legal Origins
Professor Andrei Shleifer
Harvard University and NBER
BarcelonaJanuary, 2007
Modern Theory of Corporate Finance
• Earlier research on CG focused on such problems as:• Managerial consumption of perquisites (Jensen and Meckling 1976), • Managerial effort (Holmstrom 1979), and • Over-investment in pursuit of growth (e.g., Baumol 1959, Jensen 1986).
• Last 20 years: Modern theory of corporate finance focuses instead on the ability of corporate insiders to divert corporate wealth to themselves or “private benefits of control” (Grossman and Hart 1988, Hart 1995, Zingales 1994).
• Most firms are not “Bearle-and-Means” (1932) corporations: They have owners who control and run them (LLS 1999)
• Those in control– controlling shareholders or managers– have the power to divert corporate wealth to themselves through self-dealing in various forms:1. Executive perks, excessive compensation, and loans to officers2. Transfer pricing and Asset stripping;3. Targeted issuance or repurchase of securities; and4. Diversion of corporate opportunities.
Modern Theory of Corporate Finance
• Empirically, such diversion has been investigated in several contexts:• U.S. savings and loans crisis (Akerlof and Romer 1993), • Asian & Mexican financial crises (La Porta, Lopez-de-Silanes, and Zamarripa
2003, Johnson et al. 2000a), • Legal disputes over tunneling (Johnson et al. 2000b),• CG during transition from socialism (Glaeser et al, 2001) and reform in
developing countries (Lopez-de-Silanes 2003). • Estimating private benefits of control from voting premia and the treatment of
controlling shareholders in takeovers (Nenova 2003, Dyck and Zingales 2004).
• Economists have followed Legal scholars (Clark 1986) pointing to the crucial role of law in the control of investor expropriation: Self dealing limits external finance and leads to financial underdevelopment.
Modern Theory of Corporate Finance
• Initial research argues and shows that differences in legal investor protection across countries shape the ability of insiders to expropriate outsiders, and thus determine investor confidence in markets and consequently their development (LLSV 1997, 1998, 2000).
• “Law and Finance” made three contributions:1. Investor protection explains the development of financial markets. 2. As a result of colonial transplantation, legal origin is exogenous. Moreover,
legal origin is correlated with investor protection. 3. Legal origin is the explanation of the observed differences in investor
protection.
• The current debate is about:1. The theoretical grounding of the measurement of investor protection, and2. Whether LO is at the heart of investor protection. Alternative explanations
include culture, the media, and politics.
The Regulation of Self-dealing
• Goals:1. Develop a measure of investor protection that is both theoretically grounded
and describes how societies regulate the self-dealing problem. 2. Examine whether anti-self-dealing measures are linked to development of
financial markets and which regulatory approaches work best.3. Identify the determinants of the regulation of self-dealing; Test for
alternative theories of what explains investor protection4. Shed light on what makes common law different from civil law.
• Two impractical approaches to self-dealing:1. Laissez faire -- Leave self-dealing unregulated and let courts sort it out.2. Prohibit all self-dealing transactions.
• Most countries choose to regulate self-dealing through:1. Private enforcement mechanisms; and / or 2. Public enforcement.
Methodology
Simple transaction (purchase of equipment) between two entities (“Buyer” and “Seller”) controlled by the same shareholder (“Mr James”), who is on the board of both firms.
• Key Problem:• The proposed transaction may have a business purpose.
• For example, purchasing the equipment may lead to expanded sales.• James is on both sides of the transaction and may benefit if Buyer acquires overpriced
equipment from Seller.
The Proposed Transaction
Seller Co.Buyer Co. buys equipment from Seller Co.
Mr. James owns 60% of Buyer Co. shares
Mr. James owns 90% of Seller Co. shares
Mr. James
Buyer Co.
The Regulation of Self-Dealing
1. Replicate conditions in an arm’s-length transaction:• Disclosure and approval requirements by law before Buyer acquires Seller’s trucks• Immediate disclosures after the decision to enter the transaction has been made.
2. Empower shareholders to seek remedy for expropriation through the courts:• Since even a duly approved and disclosed transaction may damage Buyer, litigation
may be necessary to obtain restitution. • So, we keep track of how easy it is for shareholders to obtain redress through the
courts when the transaction damages Buyer if all disclosure and approval requirements are met. Crucial, since the laws of most countries provide harsh penalties for breaking disclosure and approval requirements.
• Factors that affect the odds that the plaintiff prevails in court include liability standards and the right to compel evidence.
3. Provide fines and criminal sanctions to those who expropriate:• Strength of public enforcement with fines and sanctions applicable to Mr. James and
those in charge of approving the transaction.
The Questionnaire & its Process
• In cooperation with 9 law firms, we designed an tested a questionnaire covering:1. who approves the transaction; 2. what needs to be disclosed, when and to whom (e.g., Board, Shareholders, etc); 3. what are the duties of officers, directors, and controlling shareholders; 4. how the transaction could be rescinded, and by whom; 5. what causes of action are available to recover damages;6. what needs to be proven under each cause of action; 7. who has standing to sue under each available cause of action; 8. availability of direct and derivative suits; 9. access to information and discovery rights; and 10. fines and criminal sanctions.
• We received answers, and back-up laws or precedent, from 102 of the 115 law firms• We read the laws and coded the respondents’ answers.• We conducted follow-up conference calls with the lawyers to seek clarifications• We asked respondents to confirm our coding of the data• We have confirmed our coding for 72 countries (99.3% of market cap in 2003)
Key Clarification: The Scope
• We consider garden-variety self-dealing transactions, in which the controllers of companies make choices that may benefit them at the expense of other investors, but follow the law regarding disclosure and approval procedures. All legal approvals and required disclosures were met
• We are not dealing with cases of corporate crime such as Enron or Parmalat: To stop such cases, every country uses harsh criminal punishments.
• We are interested in a very different situation: • If a controlling shareholder wants to enrich himself but also follow the law,
how difficult is it for minority shareholders to thwart the deal before it goes through and to recover damages if it is carried out?
• This is one of the key problems of corporations around the world and one of the main objects of corporate governance.
Data
1. Approval and Ex-Ante Disclosure requirements
2. Ex-Post Disclosure and Burden of litigation
3. Public enforcement
4. Measures of stock market development.
Legal Origin Distribution
Legal Origins = English
= French
= German = Scandinavian = Socialist
Ex-Ante Control of Self-DealingEx-Ante Ex-Post Public Enforcement Regulation and Income Outcomes Results
CountryApproval by disinterested shareholders
Disclosure by Buyer
Disclosure by James
Independent review
Ex-ante disclosure
Ex-ante private control of self-dealing
United Kingdom 1 1.00 1.00 1.00 1.00 1.00United States 0 1.00 1.00 0.00 0.67 0.33Average English origin 0.48 0.62 0.95 0.48 0.68 0.58
France 0 0.00 0.50 0.00 0.17 0.08Spain 0 0.33 1.00 0.00 0.44 0.22Average French origin 0.19 0.30 0.63 0.19 0.37 0.28
Germany 0 0.33 0.50 0.00 0.28 0.14Japan 0 0.33 1.00 0.00 0.44 0.22Average German origin 0.14 0.38 0.43 0.36 0.39 0.27
Sweden 0 1.00 0.00 0.00 0.33 0.17Average Scandinavian 0.00 0.73 0.40 0.20 0.44 0.22
Average Civil Law 0.16 0.37 0.55 0.24 0.38 0.27World Average 0.25 0.44 0.67 0.31 0.47 0.36
Common vs. Civil 2.98 2.28 4.73 2.05 4.23 4.00French vs Common 2.31 2.68 3.74 2.31 4.05 3.42French vs German 0.36 0.62 1.60 1.23 0.20 0.15French vs Scandinavian 1.04 2.36 1.28 0.01 0.59 0.46
Common vs. Civil 0% 3% 0% 4% 0% 0%French vs Common 3% 1% 0% 3% 0% 0%French vs German 72% 54% 12% 22% 84% 88%French vs Scandinavian 30% 2% 21% 95% 56% 65%
T-Stat -- Significance level
T-Stat (numbers in bold are significant at 10%)
Ex-Post Control of Self-DealingEx-Ante Ex-Post Public Enforcement Regulation and Income Outcomes Results
CountryDisclosure in periodic
filings
Standing to sue
RescissionEase of
holding Mr. James liable
Ease of holding approving body
liable
Access to evidence
Ease of proving wrongdoing
Ex-post private control of self-dealing
Anti-self-dealing index
Australia 0.80 1.00 0.33 0.00 0.50 0.75 0.45 0.63 0.76United Kingdom 1.00 1.00 0.50 1.00 0.50 1.00 0.80 0.90 0.95United States 1.00 1.00 1.00 1.00 1.00 0.75 0.95 0.98 0.65Average English origin 0.78 0.90 0.52 0.62 0.74 0.75 0.70 0.74 0.66
France 0.80 1.00 1.00 0.00 0.50 0.25 0.55 0.68 0.38Spain 0.60 1.00 0.00 0.50 0.50 0.25 0.45 0.53 0.37Average French origin 0.42 0.56 0.08 0.30 0.34 0.43 0.34 0.38 0.33
Germany 0.40 1.00 0.00 0.50 0.50 0.25 0.45 0.43 0.28Japan 0.80 1.00 0.00 1.00 1.00 0.75 0.75 0.78 0.50Average German origin 0.56 0.86 0.00 0.39 0.46 0.51 0.44 0.50 0.38
Sweden 0.40 1.00 0.00 0.50 0.50 1.00 0.60 0.50 0.33Average Scandinavian 0.56 0.80 0.00 0.60 0.50 0.80 0.54 0.55 0.39
Average Civil law 0.47 0.67 0.05 0.35 0.39 0.49 0.39 0.43 0.35World average 0.56 0.74 0.19 0.43 0.49 0.56 0.48 0.52 0.44
Common vs Civil 3.89 2.12 6.95 3.02 4.35 4.26 6.40 6.05 6.29French vs Common 4.13 2.80 5.18 3.24 4.26 5.58 6.72 6.26 5.86French vs German 1.37 1.97 1.13 1.06 1.59 1.12 2.09 1.98 0.98French vs Scandinavian 0.89 0.99 0.67 2.30 1.47 4.15 2.77 1.73 0.73
Common vs Civil 0% 4% 0% 0% 0% 0% 0% 0% 0%French vs Common 0% 1% 0% 0% 0% 0% 0% 0% 0%French vs German 18% 6% 27% 30% 12% 27% 4% 5% 33%French vs Scandinavian 38% 33% 51% 3% 15% 0% 1% 9% 47%
T-Stat (numbers in bold are significant at 10%)
T-Stat -- Significance level
Public EnforcementEx-Ante Ex-Post Public Enforcement Regulation and Income Outcomes Results
Applicable fines Prison term Applicable fines Prison term
Australia 1.0 5.0 0.0 0.0 0.5United Kingdom 0.0 0.0 0.0 0.0 0.0United States 0.0 0.0 0.0 0.0 0.0Average English origin 0.43 1.14 0.33 1.43 0.32
France 1.0 5.0 0.0 0.0 0.5Spain 1.0 3.0 1.0 3.0 1.0Average French origin 0.44 2.39 0.34 1.98 0.42
Germany 1.0 5.0 1.0 5.0 1.0Japan 0.0 0.0 0.0 0.0 0.0Average German origin 0.50 3.36 0.36 2.64 0.48
Sweden 1.0 2.0 1.0 2.0 1.0Average Scandinavian origin 0.60 2.40 0.60 0.80 0.55
Average civil law 0.47 2.66 0.37 2.05 0.45World average 0.46 2.22 0.36 1.87 0.41
Common vs Civil 0.32 1.94 0.31 0.81 1.15French vs Common 0.06 1.57 0.08 0.66 0.84French vs German 0.38 0.90 0.09 0.72 0.42French vs Scandinavian 0.66 0.01 1.09 0.95 0.60
Common vs Civil 75% 6% 76% 42% 26%
T-Stat
T-Stat -- Significance Level
Country
Disclosure and approval requirements were metApproving parties Mr. James Public
enforcement index
Results Development of Stock Markets
Economic Effects:Stock Market Cap and Self-Dealing
CountryStock market
capitalization to GDPListed firms per
million populationIPOs to GDP
Block premium
Ownership concentration
Average English origin 85.5 32.6 3.7 4% 44%
Average French origin 42.0 19.6 1.7 16% 55%
Average German origin 48.9 24.2 4.8 15% 34%
Average Scandinavian 90.4 69.4 3.4 2% 37%
Average Civil law 48.6 25.7 2.54 14% 49%World average 59.4 27.7 2.97 11% 47%
Ex-ante anti-self-dealing 32 ppts 1.7 ppts -9 ppts
Ex-post anti- self-dealing 34 ppts 67% 1.8 ppts -10 ppts -9 ppts
Anti-Self Dealing Index 33 ppts 51% 2.0 ppts -10 ppts -9 ppts2 sd = Belgium or Taiwan --> Sing (ex-post)
Table VIII: Economic Impact of Indicators
Table VII: Economic Impact of Indicators
Anti-Self-Dealing Index and Block Premium
• Figure VI: Partial-regression leverage plot of Block Premium against the index of anti-self-dealing, controlling for Log GDPpc and efficiency of the judiciary..
Netherlands
Venezuela
Philippines
Egypt
Mexico
Germany
Brazil
Switzerland
Austria
Norway
SwedenSpain
Turkey
Korea (Rep.)
JapanDenmark
Czech Rep.
France
Argentina
PolandFinland
United States
Portugal
PeruItaly
Taiwan
Chile
Indonesia
ColombiaSouth Africa
Canada
Israel
New Zealand
Thailand
Australia
Hong KongSingapore
MalaysiaUnited Kingdom
-.2
0.2
.4R
esid
ual b
lock p
rem
ium
-.4 -.2 0 .2 .4Residual anti-self-dealing index
coef = -.17912243, (robust) se = .07763217, t = -2.31
Anti-Self-Dealing Index and Ln Firms / Pop
• Figure VII: Partial-regression leverage plot of Log listed firms per million people against the index of anti-self-dealing, controlling for Log GDPpc and efficiency of the judiciary..
Tunisia
Netherlands
Ukraine
Venezuela
Ecuador
Panama
Jordan
Mexico
Uruguay
Egypt
GermanyHungary
PhilippinesSwitzerland
Iceland
Bolivia
GreeceLuxembourg
AustriaBrazil
KenyaCroatia
SwedenNorway
Latvia
Spain
France
Lithuania
El SalvadorDenmarkCzech Rep.
Jamaica
Japan
Argentina
Korea (Rep.)
Slovak Rep.
Turkey
Uganda
Poland
Zimbabwe
Finland
Russia
KazahkstanBelgium
Romania
Italy
Portugal
Sri Lanka
Nigeria
Pakistan
United States
PeruTaiwan
India
Morocco
Chile
Ghana
Colombia
Canada
IndonesiaIreland
Israel
Bulgaria
South AfricaAustralia
China
New Zealand
Hong Kong
Thailand
Singapore
United Kingdom
Malaysia
-4-2
02
4R
esid
ual L
n(f
irm
s-t
o-p
op
ula
tio
n)
-.6 -.4 -.2 0 .2 .4Residual anti-self-dealing index
coef = 1.0847465, (robust) se = .48839839, t = 2.22
Anti-Self-Dealing Index and IPOs/GDP
• Figure VIII: Partial-regression leverage plot of IPOs-to-GDP against anti-self-dealing in regressions controlling for Log GDPpc and efficiency of the judiciary..
NetherlandsJordan
Ecuador
Venezuela
Mexico
Philippines
Germany
Egypt
Switzerland
Uruguay
Greece
Brazil
NorwayAustria
KenyaSweden
Japan
Denmark
Spain
Korea (Rep.)
France
Turkey
Argentina
Zimbabwe
United States
Belgium
Finland
Nigeria
Sri Lanka
Portugal
PakistanIndia
Taiwan
Italy
Peru
Chile
IrelandIndonesia
South Africa
Canada
Colombia
IsraelNew Zealand
Hong Kong
Singapore
Australia
United Kingdom
Thailand
Malaysia
-4-2
02
46
Resid
ual IP
Os-t
o-G
DP
-.6 -.4 -.2 0 .2 .4Residual anti-self-dealing index
coef = 4.1412864, (robust) se = 1.7922779, t = 2.31
Anti-Self-Dealing Index and Ownership Concentration
• Figure IX: Partial-regression leverage plot of Ownership Concentration against ex-ante (left) & ex-post (right) anti-self-dealing, controlling for L(GDPpc) & efficiency of the judiciary..
NetherlandsPhilippines
Japan
France
Egypt
Ecuador
Korea (Rep.)
GermanyDenmark
Jordan
Switzerland
United States
Austria
Sweden
Greece
Spain
Finland
Venezuela
Uruguay
Nigeria
KenyaBrazil
Sri Lanka
India
TurkeyMexico
Pakistan
PortugalNorway
Belgium
Zimbabwe
Italy
Peru
Argentina
Taiwan
Canada
Chile
Israel
Ireland
Singapore
New Zealand
Hong Kong
Indonesia
South AfricaMalaysia
United KingdomAustralia
Colombia
Thailand
-.4
-.2
0.2
.4
Resid
ual ow
ners
hip
concentr
ation
-.5 0 .5 1Residual ex-ante control of self-dealing
coef = .00438356, (robust) se = .05628251, t = .08
Netherlands
Venezuela
Mexico
Jordan
EcuadorNorway
Uruguay
BrazilGermany
Greece
Argentina
Egypt
Switzerland
Kenya
Philippines
Sweden
Austria
ColombiaSpain
Turkey
Denmark
Zimbabwe
Korea (Rep.)
South Africa
Japan
Belgium
Indonesia
France
Australia
Thailand
Taiwan
Ireland
Finland
Italy
New Zealand
Hong Kong
Chile
Peru
United Kingdom
United States
Portugal
Singapore
Pakistan
Nigeria
Malaysia
Sri Lanka
India
Israel
Canada
-.4
-.2
0.2
.4
Resid
ual ow
ners
hip
concentr
ation
-.4 -.2 0 .2 .4Residual ex-post control of self-dealing
coef = -.18501913, (robust) se = .06574837, t = -2.81
Table XInstrumental Variables Regressions
Stock market capitalization to GDP
Block premium Ln Firms / Pop IPOs / GDPOwnership
concentrationLn GDP/POP 19.6642
a-0.0192 0.6347
a1.0529
a-0.0288
b
[4.3327] [0.0166] [0.0981] [0.2187] [0.0125]
Time to collect on a bounced check -7.0659 0.0449b
0.1738 0.7530 0.0391[6.1241] [0.0226] [0.1455] [0.6423] [0.0274]
Anti-self-dealing index 144.0127a
-0.1340c
1.6940b
6.0566b
-0.1546[47.5366] [0.0720] [0.7966] [2.5357] [0.1067]
Constant -133.3304a
0.1209 -4.6080a
-13.0748a
0.5961a
[49.1809] [0.2638] [1.3773] [4.9534] [0.1840]Observations 72 39 72 49 49R-squared 0.40 0.30 0.46 0.36 0.27
Ln GDP/POP 0.0385b
[0.0154]Time to collect on a bounced check -0.0438
[0.0335]
English legal origin 0.3148a
[0.0500]Constant 0.2514
[0.2445]Observations 72R-squared 0.45Observations 72R-squared 0.43Robust standard error values in brackets
Panel A: Second-stage regression results
Panel B: First-stage regression results for anti-self-dealing index
Public Enforcement and Stock Market Capitalization
• Figure VIII: Partial-regression leverage plot of stock market capitalization & index of public enforcement, controlling for Log GDPpc and efficiency of the judiciary.
Netherlands
IcelandIreland
Brazil
Norway
Jamaica
Jordan
Slovak Rep.
Sweden
Finland
Singapore
IndonesiaMorocco
Philippines
UgandaSri Lanka
South Africa
Kenya
Zimbabwe
Turkey
Lithuania
Spain
Czech Rep.KazahkstanItalyHungary
GhanaRussia
Luxembourg
Tunisia
New Zealand
BelgiumRomania
Switzerland
Germany
France
India
Uruguay
TaiwanAustralia
Israel
Canada
Portugal
Chile
Peru
LatviaVenezuelaCroatia
United Kingdom
EgyptArgentinaPoland
China
Colombia
Denmark
UkraineBolivia
Bulgaria
Japan
Korea (Rep.)
Nigeria
Ecuador
Austria
Greece
El SalvadorPanama
Thailand
Malaysia
Mexico
Hong Kong
PakistanUnited States
-100
0100
200
300
Resid
ual S
tock-m
ark
et-
capitalization-t
o-G
DP
-10 0 10 20Residual prison term for Mr. James
coef = 1.2903484, (robust) se = 1.7627707, t = .73
The transaction is not disclosed
Italy
Iceland
Finland
Japan
Ireland
United States
United Kingdom
Taiwan
Hong Kong
NetherlandsArgentina
New Zealand
VenezuelaSlovak Rep.HungaryPanama
Colombia
Jamaica
Lithuania
BulgariaTurkey
Thailand
South Africa
Egypt
Jordan
Sri Lanka
El Salvador
Kazahkstan
PhilippinesChinaIndonesia
KenyaNigeriaGhana
PeruBolivia
Australia
France
Belgium
Greece
Uruguay
MexicoKorea (Rep.)CroatiaBrazil
Zimbabwe
India
Switzerland
Uganda
Denmark
PakistanLuxembourg
Austria
CanadaSweden
Norway
Israel
Germany
PortugalSpain
Singapore
Poland
Czech Rep.
Chile
Latvia
Malaysia
RomaniaEcuadorRussiaMoroccoUkraine
Tunisia-1
00
0100
200
300
Resid
ual S
tock-m
ark
et-
capitalization-t
o-G
DP
-.5 0 .5 1Residual index of public enforcement
coef = -13.808845, (robust) se = 14.548057, t = -.95
All requirements are met
Public Enforcement
• Table XI and Figure X show that public enforcement is not associated with more developed stock markets.
• Advocates of public enforcement may dismiss our findings by:
1. Arguing that what deters self-dealing is the probability that criminal sanctions will actually be imposed (rather than their mere existence). Unfortunately, we lack data on actual enforcement practices to test this.
We have used Bhattacharya and Dakou (2002) but does not work. Divided Rich versus Poor countries, but does not work.
Conjecture that a proxy for actual enforcement would have a hard time fitting the data since criminal sanctions are simply unavailable in roughly half the sample (32 countries) and this group exhibits enormous variation in the size of stock markets (e.g. Hong Kong vs. New Zealand).
2. Perhaps a better reason to be cautious about our findings here is that the criminal sanctions most relevant to the development of stock markets may be those applicable under different case facts (e.g., failure to disclose) than ours.
Alternative Theories
Politics
Politics and Investor Protection
• Investor protection may be determined by politics rather than legal origin [Pagano & Volpin 2005, Perotti & von Thadden 2006, Roe 2000, Rajan & Zingales 2003)]. • Proportional electoral systems are conducive to weaker investor protection than
majoritarian systems.
• Table XVII Panel A: • Common law countries have sharply higher anti-self-dealing scores. • Proportional representation is associated with lower anti-self-dealing scores. • When both are included, only the latter is statistically significant
But multicollinearity makes it difficult (corr -.46).
• So, we run univariate regressions for common and civil law countries separately using proportional representation to explain anti-self-dealing regulation (Panel B). Proportional representation is insignificant in both regressions.
• Split into countries above and below the median competitiveness of the legislature (Panel C). If common law is a proxy for electoral rules, it should not predict the development of securities markets in non-democratic countries. Instead, common law is a significant predictor of the anti-self-dealing index in both sub-
samples.
Proportional Representation in different Legal Origins
• Figure XI: Partial-regression leverage plot of anti-self-dealing index against proportional representation in common law countries (left graph) and civil law ones (right graph) in regressions that control for (log) income per capita and efficiency of the judiciary.
Canada
Zimbabwe
Singapore
Thailand
United Kingdom
Kenya
Malaysia
PakistanUganda
United States
Jamaica
Ghana
New Zealand
Australia
India
Sri Lanka
South Africa
Nigeria
Israel
Ireland
-.4
-.2
0.2
.4
Resid
ual anti-s
elf-d
ealing Index
-1 0 1 2Residual proportional representation
coef = .00284464, se = .0445713, t = .06
Common law countries
Morocco
Egypt
Jordan
Philippines
Chile
Tunisia
France
Korea (Rep.)
Taiwan
Mexico
Japan
El Salvador
Czech Rep.
Greece
SwitzerlandBrazil
Hungary
Germany
Bolivia
Spain
Italy
Iceland
Austria
Finland
Norway
Luxembourg
Venezuela
Denmark
Argentina
Belgium
Indonesia
TurkeyPeru
Uruguay
Ecuador
Netherlands
Poland
PortugalRomania
Colombia
Bulgaria
Sweden
-.4
-.2
0.2
.4
Resid
ual anti-s
elf-d
ealing Index
-2 -1 0 1Residual proportional representation
coef = .00701639, se = .02258909, t = .31
Civil law countries
Legal Origin in different Democratic Regimes
• Figure XII: Partial-regression leverage plot of anti-self-dealing against legal origin for countries with high (left graph) and low (right graph) competitiveness of the legislature in regressions that control for (log) income per capita and efficiency of the judiciary.
Norway
Switzerland
Belgium
Denmark
Greece
Czech Rep.
AustriaNetherlands
Korea (Rep.)
IcelandGermany
France
Colombia
BrazilLuxembourg
Sweden
Japan
Portugal
Mexico
Italy
Venezuela
Finland
South Africa
New ZealandUnited Kingdom
India
Australia
Canada
Ireland
Israel
United States
-.4
-.2
0.2
.4R
esid
ual anti-s
elf-d
ealing Index
-.5 0 .5 1Residual legal origin
coef = .41683502, se = .05142007, t = 8.11
High competitiveness of the legislature
Spain
Turkey
Chile
Peru
Uruguay
Argentina
Ecuador
Philippines
Taiwan
Bulgaria
Morocco
Hungary
Indonesia
BoliviaJordanEgypt
Tunisia
El Salvador
Poland
Romania
Ghana
Malaysia
Sri Lanka
Thailand
Zimbabwe
Singapore
Uganda
Jamaica
Pakistan
Kenya
Nigeria
-.4
-.2
0.2
.4.6
Resid
ual anti-s
elf-d
ealing Index
-.4 -.2 0 .2 .4 .6Residual legal origin
coef = .19178978, se = .08203781, t = 2.34
Low competitiveness of the legislature
Conclusions
• Constructed a new index of shareholder protection for 72 countries (so far). • Addresses specifically the protection of minority shareholders against self-dealing
transactions benefiting controlling shareholders. • Better grounded in theory than index of anti-director rights (LLSV 1997, 1998)
• Anti-self-dealing index exhibits same properties as both the anti-director rights index, and the indices of shareholder protection through securities laws (LLS 2006).• It is sharply higher in Common law than in French civil law countries. • Statistically significant and economically strong predictor of stock market
development across countries.
• Results support findings in earlier work, but also show that theoretically-grounded measures of investor protection are closely tied to financial development.
• The quality of investor protection is not merely a proxy for non-legal institutions and politics. Law indeed does seem to matter for finance. • Does not mean that non-legal institutions and politics are unimportant • Only that legal rules are not mere proxies for these institutions.
Implications:Progress in the last 10 years
1. Measurement of Investor Protection2. Interpretation of Legal Origin3. Regulatory Strategies and Policy Reform
Implications for the Measurement of Shareholder Protection
• 4 measures of shareholder protection with different methodology and different situations • So, what is “the best” measure for researchers to use?
No clear answer measures are highly correlated with each other.
• But some differences:
1. Measures from securities laws: (49 countries)• “Work” best in terms of predicting stock market outcomes• Appropriate for studies of protection of investors buying securities, as opposed to
corporate governance per se.
2. Anti-director rights index: (72 countries) • Advantage of continuity with many previous studies;
3. Anti-self-dealing index: (72 countries) • Greater conceptual clarity in general, and relevance to the pervasive problem of corporate
self-dealing (or tunneling) in particular. crucial• If self-dealing is the central problem of corporate governance in most countries, the law’s
effectiveness in regulating this problem is the fundamental element of shareholder protection.
Correlations
Ex-a
nte
priv
ate
cont
rol s
elf-d
ealin
g
Ex-p
ost p
rivat
e co
ntro
l sel
f-dea
ling
Jail
Jam
es --
no
disc
losu
re
Publ
ic e
nfor
cem
ent
Anti-
self-
deal
ing
inde
x
Antid
irect
ors
inde
x (re
vise
d)
Disc
losu
re in
pr
ospe
ctus
Pros
pect
us li
abilit
y
Mar
ket
capi
taliz
atio
n to
G
DP
Ex-post private control self-dealing 0.3553
Anti-self-dealing index 0.8777a 0.7597a
Jail James -- no disclosure 0.1093 0.2030 0.1800Public enforcement -0.1591 0.0010 -0.1102 0.0487
Antidirectors index (revised) 0.3607 0.5879a -0.0360 0.0908 0.5522a
Disclosure in prospectus 0.5104b 0.6875a 0.2310 -0.1528 0.6733a 0.5916a
Prospectus liability 0.2213 0.5694a 0.0998 -0.0681 0.4247 0.4469 0.5479a
Market capitalization to GDP 0.2886 0.4554a 0.2393 -0.0099 0.4341b 0.2753 0.4938b 0.4262
Block premium -0.3412 -0.4758 -0.0286 0.2126 -0.4580 -0.2440 -0.5839b -0.4529 -0.4765
Ln(Firms / POP) 0.0671 0.4136b 0.1410 0.1664 0.2587 0.3206 0.4681c 0.4180 0.4940a
IPOs / GDP 0.2861 0.4195 0.2200 0.0344 0.3941 0.2227 0.4368 0.4246 0.6537a
Ln(GDP/POP) -0.0116 0.3284 0.2391 0.1694 0.1602 0.0718 0.1367 0.1700 0.5537a
Implications for the Interpretation of Legal Origin
I. Examination of legal rules gives further insight in pronounced differences in the way Common and Civil law protect investors:
1. Confirmation of Johnson et al. (2000) conjecture that common law is more suspicious of conflicted transactions, and subjects them to closer scrutiny: Greater disclosure and more arms-length approval.
2. Central difference between common and civil law: Ex-ante transparency in self-dealing.
3. Approaches appear to derive from long-standing legal principles which over time are incorporated into the statutes that we actually observe.
II. Broader vision:• Results are consistent with Djankov et al. (2003) that common law is distinguished from civil
law by its encouragement of private solutions to problems of “disorder.” • Statutory law aims to reduce costs of private solutions, not replace w/ public ones. • Mandatory disclosure and arms-length approval are very clear examples of this broader
strategy of social control of business associated with common law.
Implications forRegulatory Strategies & Policy Reform
• Taken at face value, our work has implications for corporate governance improvement:
1. The Public sector has a role to play as designer of the rules:• Countries with successful stock markets give shareholders the information they need and the
power to act – including both voting and litigation -- on this information.• No evidence that successful countries rely heavily on fines and criminal sanctions (LLS, 2006).
2. Specific Recommendations for policy reform:• Combine full disclosure of self-dealing transactions with the requirement of approval by
disinterested shareholders – inexpensive and straightforward to implement. Need to set a lower bound, particularly because of concentrated ownership But, no real reason for it not to work in rich or poor or civil law countries
• Combine on-going disclosure of self-dealing transactions with a relatively easy burden of litigation placed on the shareholders, also benefits stock market development – more difficult to implement. Success may depend on general structure and efficiency of legal systems