HOW DO LEGAL RULES EVOLVE? EVIDENCE FROM A CROSS-COUNTRY COMPARISON OF SHAREHOLDER,CREDITOR AND WORKER PROTECTION Centre for Business Research,University Of Cambridge Working Paper No.382 European Corporate Governance Institute Law Working Paper No.129/2009 by John Armour Simon Deakin Lovells Professor of Law and Finance Centre for Business Research University of Oxford University of Cambridge Oriel College Judge Business School Building Oxford OX1 4EW Cambridge CB2 1AG Email:john.armour@law.ox.ac.uk Email:s.deakin@cbr.cam.ac.uk Priya Lele Mathias M Siems Ashurst LLP and The Norwich Law School Centre for Business Research University of East Anglia University of Cambridge Norwich NR4 7TJ Judge Business School Building Email:mathias.siems @gmx.de Cambridge CB2 1AG Email:lelepriya@hotmail.com This working paper forms part of the CBR Research Programme on Corporate Governance. It can be downloaded without charge from the Social Science Research Network elec- tronic library at:http://ssrn.com/abstract=1431008 Further information about the Centre for Business Research can be found at the following address:www.cbr.cam.ac.uk Electronic copy available at:http://ssrn.com/abstract=1431008
Electronic copy available at: http://ssrn.com/abstract=1431008 HOW DO LEGAL RULES EVOLVE? EVIDENCE FROM A CROSS-COUNTRY COMPARISON OF SHAREHOLDER, CREDITOR AND WORKER PROTECTION Centre for Business Research, University Of Cambridge Working Paper No. 382 European Corporate Governance Institute Law Working Paper No. 129/2009 by John Armour Lovells Professor of Law and Finance University of Oxford Oriel College Oxford OX1 4EW Email: john.armour@law.ox.ac.uk Simon Deakin Centre for Business Research University of Cambridge Judge Business School Building Cambridge CB2 1AG Email: s.deakin@cbr.cam.ac.uk Priya Lele Ashurst LLP and Centre for Business Research University of Cambridge Judge Business School Building Cambridge CB2 1AG Email: lelepriya@hotmail.com Mathias M Siems The Norwich Law School University of East Anglia Norwich NR4 7TJ Email: mathias.siems@gmx.de This working paper forms part of the CBR Research Programme on Corporate Governance. It can be downloaded without charge from the Social Science Research Network electronic library at: http://ssrn.com/abstract=1431008 Further information about the Centre for Business Research can be found at the following address: www.cbr.cam.ac.uk
european corporae ernance institute ecg How Do Legal Rules Evolve?Evidence From a Cross-Country Comparison of Shareholder, Creditor and Worker Protection Law Working Paper N.129/2009 John Armour July 2009 University of Oxford,Oxford-Man Institute of Quantitative Finance and ECGI Simon Deakin University of Cambridge and ECGI Priya Lele Ashurst LLP and University of Cambridge Mathias M Siems University of East Anglia(UEA)and University of Cambridge John Armour,Simon Deakin,Priya Lele and Mathias M Siems 2009.All rights reserved.Short sections of text,not to exceed two paragraphs,may be quoted without explicit permission provided that full credit,including notice,is given to the source. This paper can be downloaded without charge from: http://ssrn.com/abstract=1431008. www.ecgi.org/wp
Electronic copy available at: http://ssrn.com/abstract=1431008 Law Working Paper N°.129/2009 July 2009 John Armour University of Oxford, Oxford-Man Institute of Quantitative Finance and ECGI Simon Deakin University of Cambridge and ECGI Priya Lele Ashurst LLP and University of Cambridge Mathias M Siems University of East Anglia (UEA) and University of Cambridge © John Armour, Simon Deakin, Priya Lele and Mathias M Siems 2009. All rights reserved. Short sections of text, not to exceed two paragraphs, may be quoted without explicit permission provided that full credit, including © notice, is given to the source. This paper can be downloaded without charge from: http://ssrn.com/abstract=1431008. www.ecgi.org/wp How Do Legal Rules Evolve? Evidence From a Cross-Country Comparison of Shareholder, Creditor and Worker Protection
european corporate governance institute ECGI Working Paper Series in Law How Do Legal Rules Evolve?Evidence From a Cross-Country Comparison of Shareholder, Creditor and Worker Protection Working Paper N.129/2009 July 2009 John Armour Simon Deakin Priya Lele Mathias M Siems The work reported here was carried out at the Centre for Business Research,University of Cambridge,as part of the 'law,finance and development'project (http://www.cbr.cam.ac.uk/ research/programme2/project2-20.htm). We gratefully acknowledge funding from the ESRC's'World Economy and Finance'Programme, the Newton Trust,and the EU Sixth Research and Development Framework Programme(Integrated Project 'Reflexive Governance in the Public Interest').We are also grateful for comments from participants in seminars at Berlin,Cambridge,Doshisha,Leicester,the LSE,Manchester,NYU, Texas and York,where earlier versions of this work were presented.We also thank Bernie Black, Brian Cheffins,Frederique Dahan,Sonja Fagernas,Katharina Pistor,Prabirjit Sarkar and Ajit Singh for helpful comments and discussions,and Rose-Alice Murphy,Viviana Mollica and Phil Fellowes for outstanding research assistance.The remaining errors are entirely our responsibility. John Armour,Simon Deakin,Priya Lele and Mathias M Siems 2009.All rights reserved.Short sections of text,not to exceed two paragraphs,may be quoted without explicit permission provided that full credit,including notice,is given to the source. Electronic copy available at:http://ssrn.com/abstract=1431008
Electronic copy available at: http://ssrn.com/abstract=1431008 ECGI Working Paper Series in Law Working Paper N°.129/2009 July 2009 John Armour Simon Deakin Priya Lele Mathias M Siems How Do Legal Rules Evolve? Evidence From a Cross-Country Comparison of Shareholder, Creditor and Worker Protection The work reported here was carried out at the Centre for Business Research, University of Cambridge, as part of the ‘law, fi nance and development’ project (http://www.cbr.cam.ac.uk/ re search/pro gramme2/project2-20.htm). We gratefully acknowledge funding from the ESRC’s ‘World Economy and Finance’ Programme, the Newton Trust, and the EU Sixth Research and Development Framework Programme (Integrated Project ‘Refl exive Governance in the Public Interest’). We are also grateful for comments from participants in seminars at Berlin, Cambridge, Doshisha, Leicester, the LSE, Manchester, NYU, Texas and York, where earlier versions of this work were presented. We also thank Bernie Black, Brian Cheffi ns, Frederique Dahan, Sonja Fagernäs, Katharina Pistor, Prabirjit Sarkar and Ajit Singh for helpful comments and discussions, and Rose-Alice Murphy, Viviana Mollica and Phil Fellowes for outstanding research assistance. The remaining errors are entirely our responsibility. © John Armour, Simon Deakin, Priya Lele and Mathias M Siems 2009. All rights reserved. Short sections of text, not to exceed two paragraphs, may be quoted without explicit permission provided that full credit, including © notice, is given to the source
Abstract Much attention has been devoted in recent literature to the claim that a country's 'legal origin'may make a difference to its pattern of financial development and more generally to its economic growth path.Proponents of this view assert that the 'family'within which a country's legal system originated-be it common law, or one of the varieties of civil law-has a significant impact upon the quality of its legal protection of shareholders,which in turn impacts upon economic growth,through the channel of firms'access to external finance.Complementary studies of creditors'rights and labour regulation have buttressed the core claim that different legal families have different dynamic properties.Specifically,common law systems are thought to be better able to respond to the changing needs of a market economy than are civilian systems.This literature has,however,largely been based upon cross-sectional studies of the quality of corporate,insolvency and labour law at particular points in the late 1990s.In this paper,we report findings based on newly constructed indices which track legal change over time in the areas of shareholder,creditor and worker protection.The indices cover five systems for the period 1970-2005:three'parent'systems,the UK,France and Germany;the world's most developed economy,the US;and its largest democracy,India.The results cast doubt on the legal origin hypothesis in so far as they show that civil law systems have seen substantial increases in shareholder protection over the period in question.The pattern of change differs depending on the area which is being examined,with the law on creditor and worker protection demonstrating more divergence and heterogeneity than that relationg to shareholders.The results for worker protection are more consistent with the legal origin claim than in the other two cases,but this overall result conceals significant diversity within the two 'legal families',with different countries relying on different institutional mechanisms to regulate labour.Until the late 1980s the law of the five countries was diverging,but in the last 10-15 years there has been some convergence,particularly in relation to shareholder protection. Keywords:legal origin,corporate governance,company law,insolvency law,labour law JEL Classifications:G38.K22.K31.P50 John Armour University of Oxford-Faculty of Law Oriel College Oxford,OX1 4EW,United Kingdom phone:+44 1865 286544,e-mail:john.armour@law.ox.ac.uk Simon Deakin University of Cambridge-Centre for Business Research(CBR) Top Floor,Judge Business School Building Trumpington Street Cambridge CB2 1AG,United Kingdom phone:+44 1223 335243,e-mail:s.deakin@cbr.cam.ac.uk Priya Lele Ashurst LLP Broadwalk House 5 Appold Street London,EC2A 2HA,Great Britain e-mail:lelepriya@hotmail.com Mathias M Siems University of East Anglia(UEA),Norwich Law School Norwich NR4 7TJ,Norfolk,United Kingdom HOME PAGE:http://www.uea.ac.uk/law/msiems e-mail:mathias.siems@gmx.de
Abstract Much attention has been devoted in recent literature to the claim that a country’s ‘legal origin’ may make a difference to its pattern of fi nancial development and more generally to its economic growth path. Proponents of this view assert that the ‘family’ within which a country’s legal system originated—be it common law, or one of the varieties of civil law—has a signifi cant impact upon the quality of its legal protection of shareholders, which in turn impacts upon economic growth, through the channel of fi rms’ access to external fi nance. Complementary studies of creditors’ rights and labour regulation have buttressed the core claim that different legal families have different dynamic properties. Specifi cally, common law systems are thought to be better able to respond to the changing needs of a market economy than are civilian systems. This literature has, however, largely been based upon cross-sectional studies of the quality of corporate, insolvency and labour law at particular points in the late 1990s. In this paper, we report fi ndings based on newly constructed indices which track legal change over time in the areas of shareholder, creditor and worker protection. The indices cover fi ve systems for the period 1970-2005: three ‘parent’ systems, the UK, France and Germany; the world’s most developed economy, the US; and its largest democracy, India. The results cast doubt on the legal origin hypothesis in so far as they show that civil law systems have seen substantial increases in shareholder protection over the period in question. The pattern of change differs depending on the area which is being examined, with the law on creditor and worker protection demonstrating more divergence and heterogeneity than that relationg to shareholders. The results for worker protection are more consistent with the legal origin claim than in the other two cases, but this overall result conceals signifi cant diversity within the two ‘legal families’, with different countries relying on different institutional mechanisms to regulate labour. Until the late 1980s the law of the fi ve countries was diverging, but in the last 10-15 years there has been some convergence, particularly in relation to shareholder protection. Keywords: legal origin, corporate governance, company law, insolvency law, labour law JEL Classifications: G38, K22, K31, P50 John Armour University of Oxford - Faculty of Law Oriel College Oxford, OX1 4EW, United Kingdom phone: +44 1865 286544, e-mail: john.armour@law.ox.ac.uk Simon Deakin University of Cambridge - Centre for Business Research (CBR) Top Floor, Judge Business School Building Trumpington Street Cambridge CB2 1AG, United Kingdom phone: + 44 1223 335243, e-mail: s.deakin@cbr.cam.ac.uk Priya Lele Ashurst LLP Broadwalk House 5 Appold Street London, EC2A 2HA, Great Britain e-mail: lelepriya@hotmail.com Mathias M Siems University of East Anglia (UEA), Norwich Law School Norwich NR4 7TJ, Norfolk, United Kingdom HOME PAGE: http://www.uea.ac.uk/law/msiems e-mail: mathias.siems@gmx.de
1.Introduction Much attention has been devoted in recent literature to the claim that a country's legal origin'may make a difference to its pattern of financial development and more generally to its economic growth path.Proponents of this view assert that the family'within which a country's legal system originated-be it common law,or one of the varieties of civil law-has a significant impact upon the quality of its legal protection of investors,which in turn impacts upon economic growth,through the channel of firms'access to external finance.Complementary studies of,amongst other things,creditors' rights and labour regulation have buttressed the core claim that different legal families have different dynamic properties.Specifically,common law systems are said to be better able to respond to the changing needs of a market economy than are civilian systems.This literature has,however,largely been based upon cross-sectional studies of the quality of various aspects of corporate and financial law at particular points in the late 1990s.Whilst some correlations between patterns of financial development and legal institutions have been established,the issue of causation remains contentious. Given this background,at least two types of study can potentially contribute to our understanding of the links between law and financial development.One approach,which focuses on outcomes,would be to investigate the links between legal rules and indicia of financial market development,and economic development more widely,over time.This would call for the construction of time series data on legal variables of interest.Quantitative methodology could be used to test the hypothesis that changes in legal rules precede financial market development(or indeed the inverse).A related approach,focusing more on mechanisms,might examine the way in which the strength of the protection of particular types of constituency changes over time.Panel data comprising some civil and some common law countries would allow for examination of whether there are systematic differences in the pattern of evolution in different legal systems.If,as posited,the mechanisms of legal evolution are significantly different in common and civil law systems,we would expect to see change occurring at different speeds,and plausibly in different directions,in systems of each variety.Conversely,we might not expect to see as much variety between members of the same legal origin as between members of different legal origins. This paper follows the second approach outlined above.Further,it uses a quantitative methodology,which may also be called 'numerical comparative law'or 'leximetrics'(Siems 2005a;Lele and Siems 2007a).We present new longitudinal indices of legal rules applicable to business enterprise-grouped
1 1. Introduction Much attention has been devoted in recent literature to the claim that a country’s ‘legal origin’ may make a difference to its pattern of financial development and more generally to its economic growth path. Proponents of this view assert that the ‘family’ within which a country’s legal system originated—be it common law, or one of the varieties of civil law—has a significant impact upon the quality of its legal protection of investors, which in turn impacts upon economic growth, through the channel of firms’ access to external finance. Complementary studies of, amongst other things, creditors’ rights and labour regulation have buttressed the core claim that different legal families have different dynamic properties. Specifically, common law systems are said to be better able to respond to the changing needs of a market economy than are civilian systems. This literature has, however, largely been based upon cross-sectional studies of the quality of various aspects of corporate and financial law at particular points in the late 1990s. Whilst some correlations between patterns of financial development and legal institutions have been established, the issue of causation remains contentious. Given this background, at least two types of study can potentially contribute to our understanding of the links between law and financial development. One approach, which focuses on outcomes, would be to investigate the links between legal rules and indicia of financial market development, and economic development more widely, over time. This would call for the construction of time series data on legal variables of interest. Quantitative methodology could be used to test the hypothesis that changes in legal rules precede financial market development (or indeed the inverse). A related approach, focusing more on mechanisms, might examine the way in which the strength of the protection of particular types of constituency changes over time. Panel data comprising some civil and some common law countries would allow for examination of whether there are systematic differences in the pattern of evolution in different legal systems. If, as posited, the mechanisms of legal evolution are significantly different in common and civil law systems, we would expect to see change occurring at different speeds, and plausibly in different directions, in systems of each variety. Conversely, we might not expect to see as much variety between members of the same legal origin as between members of different legal origins. This paper follows the second approach outlined above. Further, it uses a quantitative methodology, which may also be called ‘numerical comparative law’ or ‘leximetrics’ (Siems 2005a; Lele and Siems 2007a). We present new longitudinal indices of legal rules applicable to business enterprise—grouped
along the dimensions of shareholder protection,creditor protection,and labour regulation-for five countries,over a 35 year period.These are three parent systems,the UK,France and Germany;the world's most developed economy, the US;and its largest democracy,India. Our findings in this paper focus on the patterns of change within and between the indices we have constructed.We do not find that there are significant differences between the way in which legal change,as measured by our indices, occurs in civil and common law jurisdictions.Instead,our results also show that the pattern of change differs depending on the area of law under examination,with creditor rights and labour rights demonstrating much more divergence and heterogeneity than shareholder rights.We interpret this as casting doubt on the plausibility of the mechanisms that have been said to underpin the links posited between legal origins and financial development.The pattern of legal change in civil and common law countries implies that differences in the 'adaptability'of legal systems to changes in the wider economic context are unlikely to be a significant explanatory factor. The rest of this paper is structured as follows.In section 2,we review the law and finance research programme and motivate our current enquiry by identifying gaps in our understanding.Section 3 explains the methodology employed in the construction of our new longitudinal indices of legal institutions.Sections 4,5,and 6 present results relating to the development, respectively,of legal rules protecting shareholders,creditors,and employees. Section 7 synthesises the principal results and concludes. 2.The 'law and finance'research programme and its limitations 2.1 Principal claims Systematic research on the relationship between a country's legal institutions and its corporate governance and financial systems began only in the late 1990s with the pioneering and highly influential work of La Porta,Lopez-de-Silanes, Shleifer and Vishny ('LLSV':see La Porta et al.,1997,1998,1999a,1999b, 2000,2006,2007,2008;Johnson et al.,2000;Djankov et al.,2003,2007,2008; Glaeser and Shleifer,2002,2003;Botero et al.,2004).This literature connects with other recent work on the relationship between financial system and economic development (see Levine,1997;Beck et al.,2003a,2003b;Berkovitz et al.,2003;Pistor et al.,2003,Claessens and Laeven,2003).Moreover,this research has a significant practical importance because the World Bank uses it in order to asses and promote a particular way of legal development (World Bank,various years). 2
2 along the dimensions of shareholder protection, creditor protection, and labour regulation—for five countries, over a 35 year period. These are three ‘parent’ systems, the UK, France and Germany; the world’s most developed economy, the US; and its largest democracy, India.1 Our findings in this paper focus on the patterns of change within and between the indices we have constructed. We do not find that there are significant differences between the way in which legal change, as measured by our indices, occurs in civil and common law jurisdictions. Instead, our results also show that the pattern of change differs depending on the area of law under examination, with creditor rights and labour rights demonstrating much more divergence and heterogeneity than shareholder rights. We interpret this as casting doubt on the plausibility of the mechanisms that have been said to underpin the links posited between legal origins and financial development. The pattern of legal change in civil and common law countries implies that differences in the ‘adaptability’ of legal systems to changes in the wider economic context are unlikely to be a significant explanatory factor. The rest of this paper is structured as follows. In section 2, we review the law and finance research programme and motivate our current enquiry by identifying gaps in our understanding. Section 3 explains the methodology employed in the construction of our new longitudinal indices of legal institutions. Sections 4, 5, and 6 present results relating to the development, respectively, of legal rules protecting shareholders, creditors, and employees. Section 7 synthesises the principal results and concludes. 2. The ‘law and finance’ research programme and its limitations 2.1 Principal claims Systematic research on the relationship between a country’s legal institutions and its corporate governance and financial systems began only in the late 1990s with the pioneering and highly influential work of La Porta, Lopez-de-Silanes, Shleifer and Vishny (‘LLSV’: see La Porta et al., 1997, 1998, 1999a, 1999b, 2000, 2006, 2007, 2008; Johnson et al., 2000; Djankov et al., 2003, 2007, 2008; Glaeser and Shleifer, 2002, 2003; Botero et al., 2004). This literature connects with other recent work on the relationship between financial system and economic development (see Levine, 1997; Beck et al., 2003a, 2003b; Berkovitz et al., 2003; Pistor et al., 2003, Claessens and Laeven, 2003). Moreover, this research has a significant practical importance because the World Bank uses it in order to asses and promote a particular way of legal development (World Bank, various years)
The La Porta et al analysis is based on an empirical and theoretical evaluation of different legal systems,and has been conducted at two discrete levels of generality.The first,and more 'micro',hypothesis,is that the greater the protection afforded to minority shareholders and creditors by a country's legal system,the more external financing firms in that jurisdiction will be able to obtain (the 'quality of law'claim).If good legal institutions can reduce the risk of investor expropriation ex post,then investors will be more willing to advance funds ex ante.The second,and more 'macro',hypothesis,is that the quality of legal institutions varies systematically with the 'origin'of a country's legal system-that is,whether it falls into the Anglo-American common law',or Napoleonic (French-origin),German or Scandinavian 'civil law'systems (the 'legal origins'claim).La Porta et al contend that legal origins thus determine the financing of corporate growth,and through that and other channels,the nature of the financial system and ultimately,perhaps,overall economic growth. A key step in the empirical methodology has been to quantify variations,across countries,in the extent to which certain types of legal rule exist.The resulting indices allow the particular economic correlates of institutional persuasions to be discerned.The cross-sectional regression results accord with the predictions of both the quality of law and the legal origins claims.Specifically,countries using the French civil law system exhibit systematically less protection for minority shareholders,which is in turn correlated with concentrated share ownership;and corporations in common law countries (with stronger shareholder protection)pay out more dividends and have higher share prices than firms in civil law countries. Whilst the intuition underlying the quality of law'claim seems straightforward, it is less obvious why better'quality law should tend to be associated with common law systems.Two mechanisms have been articulated which may underpin the common law's alleged superiority (Beck et al.,2003a,2004;and Levine,2003;Botero et al.,2004).One hypothesis (the 'adaptability'claim) concerns the way in which new rules are produced.Civilian systems are characterised by wide-ranging codification of legal rules,whereas common law systems are distinguished by their reliance on incremental change through the accumulation of judicial precedent.It may be that this ability to shape the law on a case-by-case basis helps to render legal regulation more adaptable to changed circumstances.In contrast,civilian legal systems may suffer from excessive rigidity,as changes may only be made infrequently through legislation.Associated with this is a difference in 'regulatory style':common law systems,it is said,favour market solutions-contract and private 3
3 The La Porta et al analysis is based on an empirical and theoretical evaluation of different legal systems, and has been conducted at two discrete levels of generality. The first, and more ‘micro’, hypothesis, is that the greater the protection afforded to minority shareholders and creditors by a country’s legal system, the more external financing firms in that jurisdiction will be able to obtain (the ‘quality of law’ claim). If good legal institutions can reduce the risk of investor expropriation ex post, then investors will be more willing to advance funds ex ante. The second, and more ‘macro’, hypothesis, is that the quality of legal institutions varies systematically with the ‘origin’ of a country’s legal system—that is, whether it falls into the Anglo-American ‘common law’, or Napoleonic (French-origin), German or Scandinavian ‘civil law’ systems (the ‘legal origins’ claim).2 La Porta et al contend that legal origins thus determine the financing of corporate growth, and through that and other channels, the nature of the financial system and ultimately, perhaps, overall economic growth. A key step in the empirical methodology has been to quantify variations, across countries, in the extent to which certain types of legal rule exist. The resulting indices allow the particular economic correlates of institutional persuasions to be discerned. The cross-sectional regression results accord with the predictions of both the quality of law and the legal origins claims. Specifically, countries using the French civil law system exhibit systematically less protection for minority shareholders, which is in turn correlated with concentrated share ownership; and corporations in common law countries (with stronger shareholder protection) pay out more dividends and have higher share prices than firms in civil law countries. Whilst the intuition underlying the ‘quality of law’ claim seems straightforward, it is less obvious why ‘better’ quality law should tend to be associated with common law systems. Two mechanisms have been articulated which may underpin the common law’s alleged superiority (Beck et al., 2003a, 2004; and Levine, 2003; Botero et al., 2004). One hypothesis (the ‘adaptability’ claim) concerns the way in which new rules are produced. Civilian systems are characterised by wide-ranging codification of legal rules, whereas common law systems are distinguished by their reliance on incremental change through the accumulation of judicial precedent. It may be that this ability to shape the law on a case-by-case basis helps to render legal regulation more adaptable to changed circumstances. In contrast, civilian legal systems may suffer from excessive rigidity, as changes may only be made infrequently through legislation. Associated with this is a difference in ‘regulatory style’: common law systems, it is said, favour market solutions—contract and private
litigation-over 'top down'regulation and enforcement through government agencies in civilian systems. A second hypothesis(the political'claim)focuses on the greater independence accorded to the judiciary under common law than civilian systems.The Napoleonic Code in particular seeks to enshrine constitutionally the primacy of the legislature over other branches of government;the legislature also controls judicial appointments and tenure.In contrast,the judiciary in common law systems typically have greater ability to review the legitimacy of executive acts, and the terms and processes of their appointments give them greater independence.These differences,it is thought,will make common law judges less susceptible to influence by the legislature,and better able to protect individual property rights from rent-seeking activity by the state (Mahoney, 2001;Rajan and Zingales,2003). 2.2 The quality of law'claim and its limitations Indices have been constructed by La Porta et al for a range of different aspects of the law relating to business organisation.In the approximate order in which these were published,they include: G) Shareholder rights (as against company directors-'antidirector rights'-and as against majority shareholders-'minority protection') and creditor rights (LLSV,1997,1998) (ii) Regulations governing firm start-up (Djankov et al,2002) (iii） Contract enforcement (Djankov et al,2003) (iv) Securities regulation (La Porta et al,2006) (V) Labour regulation (Botero et al,2004) (vi)Public creditor protection mechanisms (overlapping with the earlier 'creditor rights')(Djankov et al.,2007). (vii)Self-dealing rules (overlapping with the earlier 'antidirector rights') (Djankov et al,2008). (viii)Bankruptcy procedures (overlapping with the earlier 'creditor rights') (Djankov et al,2007). The methodology has evolved over time,so that a number of limitations in the earlier studies have been ameliorated.However,significant unresolved issues remain. First,for any index to render a meaningful representation of the comparative qualities of underlying legal rules,it is essential that the coding should be accurate and consistent:that is,the numbers used to signify the presence or 4
4 litigation—over ‘top down’ regulation and enforcement through government agencies in civilian systems. A second hypothesis (the ‘political’ claim) focuses on the greater independence accorded to the judiciary under common law than civilian systems. The Napoleonic Code in particular seeks to enshrine constitutionally the primacy of the legislature over other branches of government; the legislature also controls judicial appointments and tenure. In contrast, the judiciary in common law systems typically have greater ability to review the legitimacy of executive acts, and the terms and processes of their appointments give them greater independence. These differences, it is thought, will make common law judges less susceptible to influence by the legislature, and better able to protect individual property rights from rent-seeking activity by the state (Mahoney, 2001; Rajan and Zingales, 2003). 2.2 The ‘quality of law’ claim and its limitations Indices have been constructed by La Porta et al for a range of different aspects of the law relating to business organisation. In the approximate order in which these were published, they include: (i) Shareholder rights (as against company directors—’antidirector rights’—and as against majority shareholders—’minority protection’) and creditor rights (LLSV, 1997, 1998) (ii) Regulations governing firm start-up (Djankov et al, 2002) (iii) Contract enforcement (Djankov et al, 2003) (iv) Securities regulation (La Porta et al, 2006) (v) Labour regulation (Botero et al, 2004) (vi) Public creditor protection mechanisms (overlapping with the earlier ‘creditor rights’) (Djankov et al., 2007). (vii) Self-dealing rules (overlapping with the earlier ‘antidirector rights’) (Djankov et al, 2008). (viii) Bankruptcy procedures (overlapping with the earlier ‘creditor rights’) (Djankov et al, 2007). The methodology has evolved over time, so that a number of limitations in the earlier studies have been ameliorated. However, significant unresolved issues remain. First, for any index to render a meaningful representation of the comparative qualities of underlying legal rules, it is essential that the coding should be accurate and consistent: that is, the numbers used to signify the presence or
absence of particular legal rules,and/or their strength,should be applied in a way that in fact corresponds to the underlying state of the law,and that is consistent across different legal systems.This desideratum would seem to be obvious,but the highly specific and textured nature of legal knowledge is such that it is often difficult for a non-specialist to achieve an accurate characterisation of legal rules.When the coding of LLSV's 'shareholder rights' indices were checked by independent experts,numerous coding errors were revealed (Spamann,2006.2008;Braendle 2006;Cools 2005),to the extent that the principal results are no longer regarded as being entirely robust,even by members of the LLSV research network (Djankov et al,2005). Secondly,the expansive nature of most countries'laws means that selectivity is called for:the factors coded to form the index must act as proxies for the quality of the underlying legal rules.A further potential source of bias concerns the selection of variables to be coded.It is desirable that variables should be selected in accordance with a functional theory about their likely impact on corporate finance practices.However,the more limited the selection,the greater the risk that they will fail to reflect the generality of the underlying legal rules, or that their choice may be subject to a(probably unconscious)home country bias'on the part of the researchers constructing the index,either of which will skew the resulting comparisons.LLSV's 'shareholder rights',creditor rights' and securities law'indices have been criticised on these bases (Berglof and von Thadden,1999;Armour et al,2002;Siems 2005b;Braendle,2006;Cools,2006; Lele and Siems,2007a;Ahlering and Deakin,2007).These problems have been ameliorated in some of the later indices through consideration of a wider range of variables:the Botero et al.(2004)index of labour regulation,for example, consists of 60 variables,and has been shown to produce outcomes which are consistent with indices drawn up using different methodologies,such as large- scale surveys of the opinion of lawyers and industrial relations practitioners (Chor and Freeman,2005). Thirdly,the empirical results supporting the quality of law claim are,by themselves,difficult to interpret.They rely primarily on cross-sectional analyses,using the various legal indices as independent variables regressed onto firm-level data about corporate finance and ownership structures.Whilst these establish correlations consistent with the theoretical predictions,their cross- sectional nature means they are ambiguous as to the direction of causality. Whilst 'good quality'legal rules could enhance investment,it is also plausible that financial structure influences the creation of legal norms. 5
5 absence of particular legal rules, and/or their strength, should be applied in a way that in fact corresponds to the underlying state of the law, and that is consistent across different legal systems. This desideratum would seem to be obvious, but the highly specific and textured nature of legal knowledge is such that it is often difficult for a non-specialist to achieve an accurate characterisation of legal rules. When the coding of LLSV’s ‘shareholder rights’ indices were checked by independent experts, numerous coding errors were revealed (Spamann, 2006. 2008; Braendle 2006; Cools 2005), to the extent that the principal results are no longer regarded as being entirely robust, even by members of the LLSV research network (Djankov et al, 2005). Secondly, the expansive nature of most countries’ laws means that selectivity is called for: the factors coded to form the index must act as proxies for the quality of the underlying legal rules. A further potential source of bias concerns the selection of variables to be coded. It is desirable that variables should be selected in accordance with a functional theory about their likely impact on corporate finance practices. However, the more limited the selection, the greater the risk that they will fail to reflect the generality of the underlying legal rules, or that their choice may be subject to a (probably unconscious) ‘home country bias’ on the part of the researchers constructing the index, either of which will skew the resulting comparisons. LLSV’s ‘shareholder rights’, ‘creditor rights’ and ‘securities law’ indices have been criticised on these bases (Berglof and von Thadden, 1999; Armour et al, 2002; Siems 2005b; Braendle, 2006; Cools, 2006; Lele and Siems, 2007a; Ahlering and Deakin, 2007). These problems have been ameliorated in some of the later indices through consideration of a wider range of variables: the Botero et al. (2004) index of labour regulation, for example, consists of 60 variables, and has been shown to produce outcomes which are consistent with indices drawn up using different methodologies, such as largescale surveys of the opinion of lawyers and industrial relations practitioners (Chor and Freeman, 2005). Thirdly, the empirical results supporting the quality of law claim are, by themselves, difficult to interpret. They rely primarily on cross-sectional analyses, using the various legal indices as independent variables regressed onto firm-level data about corporate finance and ownership structures. Whilst these establish correlations consistent with the theoretical predictions, their crosssectional nature means they are ambiguous as to the direction of causality. Whilst ‘good quality’ legal rules could enhance investment, it is also plausible that financial structure influences the creation of legal norms.3
Reference to legal origin offers a potential resolution to this causal ambiguity The various cross-sectional results based on the LLSV indices show that higher than average quality corporate,securities and labour laws are associated with common law systems;French civilian systems,on the other hand are associated with lower than average quality legal norms(in the sense defined here).As legal origin is,for most countries in the world,exogenous-deriving from whichever of the western powers colonized the country in question-this arguably supports the view that law drives financial development,rather than vice versa (La Porta et al,1997).It is appropriate therefore to consider the 'legal origins'claim in more detail. 2.3 The legal origin'claim and its limitations By 'legal origins',La Porta et al.do not mean the legal rules themselves,but rather the 'infrastructure'of the legal system,'such as the legal codes,legal principles and ideologies,and elements of the organization of the judiciary'(La Porta et al.,2008:288)in a given country.In the latest formulation of their claim,La Porta et al.suggest that legal origins include not just the formal insti- tutions of the legal system but also 'the human capital and beliefs of its partici- pants'(2008:286).They also suggest that legal origin can be broadly con- ceived as 'a style of social control of economic life'(2008:286).This is the context in which they argue for a bifurcation between the common law and civil law systems.Thus the 'civil law is associated with a heavier hand of govern- ment ownership and regulation than common law...[and with]greater corrup- tion,larger unofficial economy,and higher unemployment',while the common law is 'associated with lower formalism of judicial procedures and greater judi- cial independence than civil law',indicators which are 'in turn associated with better contract enforcement and greater security of property rights'(2008:286). Legal origin was initially used as an instrumental variable in order to address the problem of endogeneity,or in other words,the possibility that economic fac- tors were influencing the content of legal rules rather than the other way round (La Porta et al.,1998;Beck et al.,2003a).*In their more recent work,La Porta et al.suggest that legal origin cannot be regarded as a good instrument for the quality of legal rules because it is likely to affect economic outcome variables in a number of different ways.In particular,they suggest that legal origin,unders- tood in the broad sense of 'regulatory style',could be influencing the economy not through the quality of legal rules alone,or even predominantly via this route,but through alternative aspects of the legal infrastructure,such as en- forcement mechanisms (La Porta et al.,2008:299)or prevailing modes of legal interpretation (La Porta et al,2008;300).However,even if legal origin is no longer regarded as a good instrument for verifying the quality of law claim,La 6
6 Reference to legal origin offers a potential resolution to this causal ambiguity. The various cross-sectional results based on the LLSV indices show that higher than average quality corporate, securities and labour laws are associated with common law systems; French civilian systems, on the other hand are associated with lower than average quality legal norms (in the sense defined here). As legal origin is, for most countries in the world, exogenous—deriving from whichever of the western powers colonized the country in question—this arguably supports the view that law drives financial development, rather than vice versa (La Porta et al, 1997). It is appropriate therefore to consider the ‘legal origins’ claim in more detail. 2.3 The ‘legal origin’ claim and its limitations By ‘legal origins’, La Porta et al. do not mean the legal rules themselves, but rather the ‘infrastructure’ of the legal system, ‘such as the legal codes, legal principles and ideologies, and elements of the organization of the judiciary’ (La Porta et al., 2008: 288) in a given country. In the latest formulation of their claim, La Porta et al. suggest that legal origins include not just the formal institutions of the legal system but also ‘the human capital and beliefs of its participants’ (2008: 286). They also suggest that legal origin can be broadly conceived as ‘a style of social control of economic life’ (2008: 286). This is the context in which they argue for a bifurcation between the common law and civil law systems. Thus the ‘civil law is associated with a heavier hand of government ownership and regulation than common law . . . [and with] greater corruption, larger unofficial economy, and higher unemployment’, while the common law is ‘associated with lower formalism of judicial procedures and greater judicial independence than civil law’, indicators which are ‘in turn associated with better contract enforcement and greater security of property rights’ (2008: 286). Legal origin was initially used as an instrumental variable in order to address the problem of endogeneity, or in other words, the possibility that economic factors were influencing the content of legal rules rather than the other way round (La Porta et al., 1998; Beck et al., 2003a).4 In their more recent work, La Porta et al. suggest that legal origin cannot be regarded as a good instrument for the quality of legal rules because it is likely to affect economic outcome variables in a number of different ways. In particular, they suggest that legal origin, understood in the broad sense of ‘regulatory style’, could be influencing the economy not through the quality of legal rules alone, or even predominantly via this route, but through alternative aspects of the legal infrastructure, such as enforcement mechanisms (La Porta et al., 2008: 299) or prevailing modes of legal interpretation (La Porta et al., 2008; 300). However, even if legal origin is no longer regarded as a good instrument for verifying the quality of law claim, La
