Download Dow Chemical’s Bid for PBB

The Economic Consequences
of Legal Origins
Professor Andrei Shleifer
Harvard University and NBER
Barcelona
January, 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 officers
2. Transfer pricing and Asset stripping;
3. Targeted issuance or repurchase of securities; and
4. 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, and
2. 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 protection
4. 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
The Proposed Transaction
 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.
Mr. James
Mr. James owns 60% of
Buyer Co. shares
Mr. James owns 90%
of Seller Co. shares
Seller Co.
Buyer Co.
Buyer Co. buys equipment from Seller Co.
• 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 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
Ex-Post
Public Enforcement
Regulation and Income
Outcomes
Results
Ex-Ante Control of Self-Dealing
United Kingdom
United States
Average English origin
Approval by
disinterested
shareholders
1
0
0.48
1.00
1.00
0.62
1.00
1.00
0.95
1.00
0.00
0.48
1.00
0.67
0.68
Ex-ante
private control
of self-dealing
1.00
0.33
0.58
France
Spain
Average French origin
0
0
0.19
0.00
0.33
0.30
0.50
1.00
0.63
0.00
0.00
0.19
0.17
0.44
0.37
0.08
0.22
0.28
Germany
Japan
Average German origin
0
0
0.14
0.33
0.33
0.38
0.50
1.00
0.43
0.00
0.00
0.36
0.28
0.44
0.39
0.14
0.22
0.27
Sweden
Average Scandinavian
0
0.00
1.00
0.73
0.00
0.40
0.00
0.20
0.33
0.44
0.17
0.22
Average Civil Law
World Average
0.16
0.25
0.37
0.44
0.55
0.67
0.24
0.31
0.38
0.47
0.27
0.36
2.98
2.31
0.36
1.04
T-Stat (numbers in bold are significant at 10%)
2.28
4.73
2.05
4.23
2.68
3.74
2.31
4.05
0.62
1.60
1.23
0.20
2.36
1.28
0.01
0.59
4.00
3.42
0.15
0.46
Country
Common vs. Civil
French vs Common
French vs German
French vs Scandinavian
Disclosure
by Buyer
Disclosure by Independent
James
review
Ex-ante
disclosure
Ex-Ante
Ex-Post
Public Enforcement
Regulation and Income
Outcomes
Results
Ex-Post Control of Self-Dealing
Disclosure
Ease of
Ease of holding
Ex-post
Standing to
Access to Ease of proving
Anti-selfCountry
Rescission holding Mr. approving body
in periodic
private control
sue
evidence wrongdoing
dealing index
filings
James liable
liable
of self-dealing
Australia
0.80
1.00
0.33
0.00
0.50
0.75
0.45
0.63
0.76
United Kingdom
1.00
1.00
0.50
1.00
0.50
1.00
0.80
0.90
0.95
United States
1.00
1.00
1.00
1.00
1.00
0.75
0.95
0.98
0.65
Average English origin
0.78
0.90
0.52
0.62
0.74
0.75
0.70
0.74
0.66
France
Spain
Average French origin
0.80
0.60
0.42
1.00
1.00
0.56
1.00
0.00
0.08
0.00
0.50
0.30
0.50
0.50
0.34
0.25
0.25
0.43
0.55
0.45
0.34
0.68
0.53
0.38
0.38
0.37
0.33
Germany
Japan
Average German origin
0.40
0.80
0.56
1.00
1.00
0.86
0.00
0.00
0.00
0.50
1.00
0.39
0.50
1.00
0.46
0.25
0.75
0.51
0.45
0.75
0.44
0.43
0.78
0.50
0.28
0.50
0.38
Sweden
Average Scandinavian
0.40
0.56
1.00
0.80
0.00
0.00
0.50
0.60
0.50
0.50
1.00
0.80
0.60
0.54
0.50
0.55
0.33
0.39
Average Civil law
World average
0.47
0.56
0.67
0.74
0.05
0.19
0.35
0.43
0.39
0.49
0.49
0.56
0.39
0.48
0.43
0.52
0.35
0.44
6.40
6.72
2.09
2.77
6.05
6.26
1.98
1.73
6.29
5.86
0.98
0.73
Common vs Civil
French vs Common
French vs German
French vs Scandinavian
3.89
4.13
1.37
0.89
2.12
2.80
1.97
0.99
6.95
5.18
1.13
0.67
T-Stat (numbers in bold are significant at 10%)
3.02
4.35
4.26
3.24
4.26
5.58
1.06
1.59
1.12
2.30
1.47
4.15
Ex-Ante
Ex-Post
Public Enforcement
Regulation and Income
Outcomes
Results
Public Enforcement
Disclosure and approval requirements were met
Approving parties
Mr. James
Applicable fines
Prison term
Applicable fines
Prison term
Australia
United Kingdom
United States
Average English origin
1.0
0.0
0.0
0.43
5.0
0.0
0.0
1.14
0.0
0.0
0.0
0.33
0.0
0.0
0.0
1.43
Public
enforcement
index
0.5
0.0
0.0
0.32
France
Spain
Average French origin
1.0
1.0
0.44
5.0
3.0
2.39
0.0
1.0
0.34
0.0
3.0
1.98
0.5
1.0
0.42
Germany
Japan
Average German origin
1.0
0.0
0.50
5.0
0.0
3.36
1.0
0.0
0.36
5.0
0.0
2.64
1.0
0.0
0.48
Sweden
Average Scandinavian origin
1.0
0.60
2.0
2.40
1.0
0.60
2.0
0.80
1.0
0.55
Average civil law
World average
0.47
0.46
2.66
2.22
0.37
0.36
2.05
1.87
0.45
0.41
1.94
1.57
0.90
0.01
T-Stat
0.31
0.08
0.09
1.09
0.81
0.66
0.72
0.95
1.15
0.84
0.42
0.60
Country
Common vs Civil
French vs Common
French vs German
French vs Scandinavian
0.32
0.06
0.38
0.66
Results
Development of Stock Markets
Economic Effects:
Stock Market Cap and Self-Dealing
Country
Average English origin
Stock market
Listed firms per
IPOs to GDP
capitalization to GDP million population
85.5
32.6
3.7
Block
premium
4%
Ownership
concentration
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
World average
48.6
59.4
25.7
27.7
2.54
2.97
14%
11%
49%
47%
Table VII: Economic Impact of Indicators
Ex-ante anti-self-dealing
32 ppts
Ex-post anti- self-dealing
34 ppts
Anti-Self Dealing Index
2 sd = Belgium or Taiwan --> Sing
33 ppts
1.7 ppts
-9 ppts
67%
1.8 ppts
-10 ppts
Table VIII: Economic Impact of Indicators
51%
2.0 ppts
-10 ppts
-9 ppts
-9 ppts
(ex-post)
.4
Anti-Self-Dealing Index and
Block Premium
Brazil
Mexico
.2
Austria
Czech Rep.
Korea (Rep.)
Venezuela
Israel
Portugal
Chile
Turkey
United States
Denmark
Italy
Peru
Argentina
Japan
Switzerland
Norway
Netherlands
0
Germany
Philippines
Sweden
Spain
France
Finland
Poland
-.2
Egypt
Singapore
New
Zealand
Hong
Kong
Malaysia
Colombia
United Kingdom
South AfricaThailand
Taiwan Indonesia
Australia
Canada
-.4
-.2
0
Residual anti-self-dealing index
.2
.4
coef = -.17912243, (robust) se = .07763217, t = -2.31
•
Figure VI: Partial-regression leverage plot of Block Premium against the index of antiself-dealing, controlling for Log GDPpc and efficiency of the judiciary..
4
Anti-Self-Dealing Index and
Ln Firms / Pop
Romania
Bulgaria
2
Slovak Rep.
0
Jordan Iceland
-2
Tunisia
HongMalaysia
Kong
Israel
Sri Lanka
Singapore
Latvia
Egypt
India
Luxembourg
Pakistan
Canada Australia
Zimbabwe
Jamaica
Spain
New Zealand
Lithuania
Greece
Korea
(Rep.)
South Africa
Chile
Croatia
Peru
Ukraine
Taiwan
Denmark
Thailand
United Kingdom
Panama
Norway
Kenya
El
Salvador
Sweden
Czech
Rep.
Finland
Switzerland
Nigeria
Bolivia
Philippines
Ghana
United States
Turkey
Ireland
Poland
EcuadorHungary France
Japan
Belgium
Kazahkstan
Indonesia
Portugal Morocco
Colombia
Netherlands
Austria
Germany
Uruguay
Russia
China
Venezuela Brazil
Argentina Italy
Mexico
-4
Uganda
-.6
-.4
-.2
0
Residual anti-self-dealing index
.2
.4
coef = 1.0847465, (robust) se = .48839839, t = 2.22
•
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..
Anti-Self-Dealing Index and
IPOs/GDP
United Kingdom
6
Taiwan
Greece
-2
0
2
4
Hong
Kong
Australia
Canada
Malaysia
-4
Netherlands
-.6
-.4
Switzerland
Italy
Sweden
Korea (Rep.)
Philippines
Kenya
Zimbabwe
Egypt
India
Pakistan
UnitedNigeria
States
Sri Lanka
Turkey Finland
Ecuador
Portugal
Jordan
Spain
Peru
Germany
Venezuela
Belgium
Chile
Brazil France
Mexico Japan Argentina
Uruguay
Norway
Austria
Denmark
-.2
0
Residual anti-self-dealing index
.2
Ireland Singapore
Indonesia
Thailand
South
Africa
Colombia
Israel
New Zealand
.4
coef = 4.1412864, (robust) se = 1.7922779, t = 2.31
•
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..
.4
.4
Anti-Self-Dealing Index and
Ownership Concentration
.2
Uruguay
Greece
Greece
Hong Kong
Singapore
TurkeyBelgium
New
Zealand
Egypt
Austria
Malaysia
Kenya
Brazil
Spain
Denmark
South Africa
Italy
Germany
Colombia
Netherlands
Philippines
Israel
Argentina
Indonesia
Jordan
Portugal
Sri Lanka
Peru
Zimbabwe
Venezuela
Norway Switzerland
Ecuador
Ireland
Chile
Thailand
Finland
Canada
France
India
United States
Sweden
Japan(Rep.)
Korea
Nigeria
Australia
United Kingdom
Pakistan
-.4
Taiwan
-.4
Taiwan
-.5
0
.5
Residual ex-ante control of self-dealing
coef = .00438356, (robust) se = .05628251, t = .08
•
Hong Kong
Mexico
0
Singapore
Mexico
Belgium
Turkey
New
Zealand
Egypt
Austria
Malaysia
Kenya
Brazil
Spain
Denmark
South Africa
Italy
Germany
Colombia
Netherlands
Philippines Argentina
Israel
Indonesia
Jordan
SriPortugal
Lanka
Peru
Zimbabwe
Venezuela
Norway
Ecuador
Ireland
Switzerland
Chile
Thailand
Finland Canada
France
India
United
States
Sweden
Japan
Korea
(Rep.)
Nigeria
Australia
United Kingdom
Pakistan
-.2
Residual ownership concentration
-.2
0
.2
Uruguay
1
-.4
-.2
0
.2
.4
Residual ex-post control of self-dealing
coef = -.18501913, (robust) se = .06574837, t = -2.81
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..
Table X
Instrumental Variables Regressions
Panel A: Second-stage regression results
Block premium
Ln Firms / Pop
IPOs / GDP
-0.0192
[0.0166]
0.6347a
[0.0981]
1.0529a
[0.2187]
Ownership
concentration
-0.0288b
[0.0125]
-7.0659
[6.1241]
0.0449b
[0.0226]
0.1738
[0.1455]
0.7530
[0.6423]
0.0391
[0.0274]
Anti-self-dealing index
144.0127a
[47.5366]
-0.1340c
[0.0720]
1.6940b
[0.7966]
6.0566b
[2.5357]
-0.1546
[0.1067]
Constant
-133.3304a
[49.1809]
72
0.40
0.1209
[0.2638]
39
0.30
-4.6080a
[1.3773]
72
0.46
-13.0748a
[4.9534]
49
0.36
0.5961a
[0.1840]
49
0.27
Ln GDP/POP
Stock market
capitalization to GDP
19.6642a
[4.3327]
Time to collect on a bounced check
Observations
R-squared
Panel B: First-stage regression results for anti-self-dealing index
Ln GDP/POP
Time to collect on a bounced check
English legal origin
Constant
Observations
R-squared
Observations
R-squared
Robust standard error values in brackets
0.0385b
[0.0154]
-0.0438
[0.0335]
0.3148a
[0.0500]
0.2514
[0.2445]
72
0.45
72
0.43
Public Enforcement and
Stock Market Capitalization
All requirements are met
300
300
The transaction is not disclosed
Hong Kong
200
200
Residual Stock-market-capitalization-to-GDP
Hong Kong
100
-100
0
United Kingdom
Singapore
Jordan
Luxembourg
Chile
Canada
Greece
China
Philippines
Pakistan
Kenya
Taiwan
Australia
Jamaica
Nigeria
India
Sweden
Indonesia
Bolivia Thailand
Netherlands
Ghana
Sri Lanka
Morocco
Peru
Egypt
Argentina
Uganda
Ukraine
France
Colombia
Russia
Spain
Poland
Ecuador
Bulgaria
BrazilItaly
Portugal
Hungary
Turkey
Romania
Israel
Slovak
Rep.
Kazahkstan
Croatia
Panama
Iceland
Czech
Rep.
Mexico
Belgium
Ireland
Latvia
Korea
(Rep.)
Lithuania
Venezuela
Germany
El Salvador
Uruguay
Denmark
Japan
Austria
New Zealand
Norway
Tunisia
-10
0
10
Residual prison term for Mr. James
coef = 1.2903484, (robust) se = 1.7627707, t = .73
•
South Africa
Finland
Malaysia
United States
0
South Africa
Finland
Zimbabwe
Switzerland
-100
100
Switzerland
20
Zimbabwe
Malaysia
United Kingdom
Singapore
Jordan
Luxembourg
Chile
Canada
Greece
China
Philippines
Pakistan
Kenya
Taiwan
Australia
Jamaica
Nigeria
India
United
States
Sweden
Indonesia
Bolivia
Netherlands
Thailand
Ghana
Sri Lanka
Morocco
Egypt Peru France Uganda
Argentina
Ukraine
Colombia
Russia
Spain
Poland
Ecuador
Bulgaria
Italy
Brazil
Portugal
Hungary
Turkey
IsraelRomania
Slovak
Rep.
Kazahkstan
Croatia
Panama
Iceland
Czech Rep.
Mexico
Belgium
Ireland
Latvia
Korea (Rep.)
Lithuania
Venezuela
Germany
El Salvador
Uruguay
Denmark
Japan
Austria
New Zealand
Norway
Tunisia
-.5
0
.5
Residual index of public enforcement
1
coef = -13.808845, (robust) se = 14.548057, t = -.95
Figure VIII: Partial-regression leverage plot of stock market capitalization & index of public
enforcement, controlling for Log GDPpc and efficiency of the judiciary.
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
.4
Civil law countries
.4
Common law countries
Singapore
United
Malaysia
New
Kingdom
Zealand
Bulgaria
Indonesia
.2
Residual anti-self-dealing Index
.2
Chile
Thailand
South Africa
Ireland
Israel
El Salvador
France
Italy
0
Uganda
Pakistan
Zimbabwe
Philippines
Egypt
Nigeria
Jordan
Tunisia
Sri Lanka
Denmark
Finland
Peru
Portugal
Romania
Turkey
Norway
Spain
Czech Rep.
Argentina
Sweden
Germany
Brazil
Switzerland
Poland
Luxembourg
Iceland
Greece
Austria
Netherlands
Uruguay
India
-.2
0
Japan
Korea (Rep.)
Australia
Ghana
United States
Canada
-.2
Colombia
Belgium
Taiwan
Morocco
Mexico
Hungary
Bolivia
Venezuela
Ecuador
Kenya
-1
0
1
2
Residual proportional representation
coef = .00284464, se = .0445713, t = .06
•
-.4
-.4
Jamaica
-2
-1
0
Residual proportional representation
1
coef = .00701639, se = .02258909, t = .31
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.
Legal Origin
in different Democratic Regimes
New Zealand
United
Kingdom
Low competitiveness of the legislature
.6
High competitiveness of the legislature
Singapore
.4
South Africa
Ireland
Australia
Israel
Thailand
United
CanadaStates
Colombia
Belgium
.2
India
Taiwan
Morocco
Peru
Romania
Turkey
El
Salvador
0
Japan
Korea
(Rep.)
Denmark
Finland
Portugal
Norway
Italy
France
Philippines
Egypt
Hungary
Uruguay
Jordan
Tunisia
Bolivia
-.4
-.4
•
Kenya
Ecuador
Venezuela
coef = .41683502, se = .05142007, t = 8.11
Jamaica
Poland
Luxembourg
Germany
Brazil
Switzerland
Iceland
0
.5
Residual legal origin
Nigeria
Uganda
Pakistan
Sri Lanka
Zimbabwe
Spain
Argentina
Czech Rep.
Sweden
Greece
Austria
Netherlands
Mexico
-.5
Ghana
Bulgaria
Indonesia
Chile
-.2
-.2
0
.2
Residual anti-self-dealing Index
.4
Malaysia
1
-.4
-.2
0
.2
.4
Residual legal origin
.6
coef = .19178978, se = .08203781, t = 2.34
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.
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 Protection
2. Interpretation of Legal Origin
3. 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.
Market
capitalization to
GDP
Prospectus liability
Disclosure in
prospectus
Antidirectors index
(revised)
Anti-self-dealing
index
Public enforcement
Jail James -- no
disclosure
Ex-post private
control self-dealing
Ex-ante private
control self-dealing
Correlations
Ex-post private control self-dealing 0.3553
Anti-self-dealing index
Jail James -- no disclosure
Public enforcement
0.8777a
0.1093
-0.1591
0.7597a
0.2030
0.0010
0.1800
-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
Market capitalization to GDP
0.2213
0.5694a
0.0998
-0.0681
0.4247
0.4469
0.5479a
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 selfdealing.
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 for
Regulatory 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