Since the late 1990s, a “law and finance” literature emphasizing quantitative comparative research on the relationship between national legal institutions on the one hand and corporate governance and financial systems on the other has achieved academic prominence. An important tenet of the law and finance literature is that corporate law “matters” in the sense it does much to explain how durable and robust equities markets develop. While “law and finance” has an important forward-looking normative message, namely that countries must enact suitable laws to reach their full economic potential, the thesis that corporate law influences stock market development seems to be well-suited to offer insights into if, when and how a country develops a corporate economy widely held companies dominate. Law and finance thinking implies that this should not occur in the absence of corporate law providing significant stockholder protection. In Questioning “Law and Finance”: U.S. Stock Market Development, 1930-70, recently published on SSRN, we draw upon events occurring in the United States to cast doubt on this logic.
Posts Tagged ‘Financial development’
In our recent NBER working paper, The Evolving Importance of Banks and Securities Markets, we evaluate empirically the changing importance of banks and securities markets as economies develop. In particular, we focus on assessing whether economies increase their demand for the types of services provided by securities markets relative to the services provided by banks as countries grow. To empirically test whether the economic development “returns” to improvements to both bank and securities market development change as economies grow, we use data on 72 countries over the period from 1980 through 2008 and aggregate the data in 5-year averages (data permitting), so that we have a maximum of six observations per country. We use several measures of bank and securities market development, including standard indicators such as bank credit to the private sector as a share of gross domestic product (GDP), the value of stock market transactions relative to GDP, and the capitalization of equity and private domestic bond markets relative to GDP.
In a recent World Bank working paper, Measuring Financial Inclusion: The Global Findex Database, we provide the first analysis of the Global Financial Inclusion (Global Findex) Database, a new set of indicators that measure how adults in 148 economies save, borrow, make payments, and manage risk. Well-functioning financial systems serve a vital purpose, offering savings, credit, payment, and risk management products to people with a wide range of needs. Inclusive financial systems—allowing broad access to financial services, without price or nonprice barriers to their use—are especially likely to benefit poor people and other disadvantaged groups. Without inclusive financial systems, poor people must rely on their own limited savings to invest in their education or become entrepreneurs—and small enterprises on their limited earnings to take advantage of promising growth opportunities. This can contribute to persistent income inequality and slower economic growth.
Until now, little had been known about the global reach of the financial sector—the extent of financial inclusion and the degree to which such groups as the poor, women, and youth are excluded from formal financial systems. Systematic indicators of the use of different financial services had been lacking for most economies.
The Global Financial Inclusion (Global Findex) database provides such indicators, measuring how people in 148 economies save, borrow, make payments, and manage risk. These new indicators are constructed with survey data from interviews with more than 150,000 nationally representative and randomly selected adults age 15 and above. The survey was carried out over the 2011 calendar year by Gallup, Inc. as part of its Gallup World Poll.
Over the past year a record number of governments in Sub-Saharan Africa changed their economy’s regulatory environment to make it easier for domestic firms to start up and operate. In a region where relatively little attention was paid to the regulatory environment only 8 years ago, regulatory reforms making it easier to do business were implemented in 36 of 46 economies between June 2010 and May 2011. That represents 78% of economies in the region, compared with an average of 56% over the previous 6 years.
Worldwide, regulatory reforms aimed at streamlining such processes as starting a business, registering property or dealing with construction permits are still the most common. But more and more economies are focusing their reform efforts on strengthening legal institutions such as courts and insolvency regimes and enhancing legal protections of investors and property rights. This shift has been particularly pronounced in low- and lower-middle-income economies, where 43% of all reforms recorded by Doing Business in 2010/11 focused on aspects captured by the getting credit, protecting investors, enforcing contracts and resolving insolvency indicators.
IFC recently joined 28 other development finance institutions (DFIs) – with combined assets of approximately $852 billion – to launch the Corporate Governance Development Framework. This new initiative provides DFIs with a common set of tools to evaluate the governance of their client companies, many of whom work in some of the world’s most challenging markets.
The framework helps DFIs strengthen their due diligence processes and work with their clients to improve weak areas in their corporate governance. By adopting a common approach, signatory DFIs will set consistent standards for corporate governance and common expectations from clients.
Corporate governance helps companies operate more efficiently, gain access to capital, and safeguard against corruption and mismanagement. It makes companies more accountable and transparent to investors and enables them to respond to legitimate stakeholder concerns, such as responsible environmental and social practices. As providers of financing to companies in emerging markets, DFIs play a significant role in promoting good corporate governance across a broad range of regions and sectors. Our hope is that by working together, we can help make corporate governance a cornerstone of sustainable development.
Recently, in the Law, Economics, and Organization Seminar here at the Law School, I presented my paper, co-authored with Rodney Ramcharan, entitled Landed Interests and Financial Underdevelopment in the United States.
In our paper, we explore how the structure of banking across counties in the United States was shaped in the early part of the twentieth century by local landowners, who wanted to limit free access to credit. We focus on banks because they were, and in many areas, still are, the most important source of local finance. Likewise, we focus on the influence of landowners because agriculture was still a key sector at that time in the U.S. economy, and agricultural interests were a powerful political constituency. From a research design standpoint, this focus is also appropriate because we believe we can isolate exogenous factors that determined the nature of land holdings. Specifically, counties varied in the extent to which land holdings were concentrated or widely distributed. In part, the distribution of land holdings was driven by rainfall, with large-scale plantation-like agriculture being favored in areas with high rainfall, and small scale farming in areas with moderate rainfall. Therefore, in some counties, a few large farmers held much of the land, while in other counties land was widely dispersed among many smaller farmers. Large, wealthier landowners had reasons to restrict access to credit by limiting the spread of banks, and had the economic and political power to implement those interests.
We find that landed interests appeared to be an important influence in constraining bank competition and thus limiting access to finance. We provide a variety of tests showing that their impact was most pronounced in situations where they had the greatest incentive and ability to exert influence. We also argue that our results cannot be easily explained as resulting from the supply of banking services responding to the underlying demand. Finally, we show these constraints on financial development persisted long after the interest groups driving them faded away.
While our paper is on financial development, it has broader implications. A recent trend in explaining the underdevelopment of nations has been to attribute it to the historical weakness in their political institutions such as democracy and constitutional checks-and-balances. While U.S. political institutions in the 1920s were far from perfect, they were also far from the coercive political structures that are typically held responsible for persistent underdevelopment. Yet even in the United States, we find large variations in the development of enabling economic institutions such as banking between areas that had different constituencies but were under the same political structures. The significant, and potentially adverse, influence of constituencies even in such environments suggests that fixing political institutions alone cannot be a panacea for the problem of underdevelopment.
The full paper is available for download here.
At last week’s Law and Economics Seminar, Mark Roe presented a fascinating new paper (coauthored with Jordan I. Siegel) called Political Instability and Financial Development. Unlike previous work, which largely attributes financial development to legal origin, Professors Roe and Siegel argue that political stability, at least in part, explains differences in development across countries. The Abstract explains:
Political instability impedes financial development and is a primary determinant of differences in financial development around the world. Conventional measures of political instability–such as Alesina and Perotti’s well-known index of instability and a subsequent index derived from Banks’s work–persistently predict a wide rang of national financial development outcomes for recent decades. These results are quite robust to legal origin, to trade openness, to latitude, and to other measures that have obtained prominence in the past decade. These findings are for a range of key financial outcomes for all available years and for all available countries over several decades–data that has been previously examined only partially. Surprisingly, despite the widespread view in the law and finance literature of legal origin’s importance, not only is political stability highly robust to legal origin, but, for many years, our results for key indicators and specifications neither show Common Law to be consistently superior nor French Civil Law to be consistently inferior to other legal families in generated strong financial development outcomes. The robust significance of political stability tells us that there are powerful channels to financial development running through political stability that go a long way toward explaining cross-country differences in financial development.