Rafael La Porta, Florencio Lopez-de-Silanes, and
Andrei Shleifer
Harvard University
Robert W. Bishny
University of Chicago
Presentation by Dae-hee Kim
I. Overview of the Issues

Traditional Finance(1958)
 SECURITIES are recognized by CASH FLOWS

Recent Financial Research (1995)
 SECURITIES are defined by the RIGHTS they bring to their owners

Co-Authors’ View
 LAW and the QUALITY of its enforcement are potentially important
determinants of WHAT RIGHTS SECURITY HOLDERS HAVE and
how well these rights are PROTECTED
The differences in legal protections of investors in
different countries are key to the different ways firms
are financed and owned
I. Overview of Study

Empirical Study on 49 Countries
 how their laws differ
 how their quality of enforcement varies
 whether they matter for corporate ownership patterns

Legal Family Tree
Civil Law
(Roman)
Commercial Laws
Common Law
(English)
French
German
Scandinavian
II. Countries, Legal Families, and Legal Rules
COUNTRIES

Samples: countries with some nonfinancial
firms traded on their stock exchanges
 49 countries from Europe, North/South America,
Africa, Asia, Australia
 No socialist or “transition” economies
 Included if
○ on the basis of both WorldScope and Moody’s
International samples,
○ had at least 5 domestic nonfinancial publicly
traded firms with no government ownership,
○ in 1993
II. Countries, Legal Families, and Legal Rules
LEGAL FAMILIES
Commercial Laws (49 samples)
Common Law
(English)
Civil Law (Roman)
French
(21 samples)
German
(6 samples)
Belgium, Netherlands, (part
of) Poland, Italy, (Western)
Germany
Near East, Northern, subSaharan Africa, Indochina,
Oceania, French
Caribbean,
Luxembourg, Portugal,
Spain, (part of) Swiss
cantons, Italy
Scandinavian
(4 samples)
Austria,
Czechoslovaki
a, Greece,
Hungary, Italy,
Switzerland,
Yugoslavia,
Japan,
KOREA
China (Taiwan)
Four Nordic
Countries
(Similar but
separate from
French and
German)
(18 samples)
US, Canada,
Australia,
India etc.
II. Countries, Legal Families, and Legal Rules
LEGAL RULES

Co-authors only regard laws pertaining
to investor protection, esp. company and
bankruptcy/reorganization laws
 Legal relations b/t corp. insiders & corp.
 Legal relations b/t corp. & certain outsiders
(creditors)
II. Countries, Legal Families, and Legal Rules
LEGAL RULES

Co-authors do not discuss
 Merger and takeover rules
○ except indirectly by looking at voting mechanisms
 Disclosure rules
○ except quality of accounting standards
 Regulations imposed by security exchanges
○ except exchange-imposed restrictions on the
voting rights for the shares that companies can
issues if they are to be traded on the exchange
 Banking and financial institution regulations
II. Countries, Legal Families, and Legal Rules
SOME CONCEPTUAL ISSUES
?
Skeptical that legal rules are binding in most instances, since firms can opt out
! It may be costly for firms to opt out of standard legal rules, since
investors might have difficulty accepting nonstandard contracts and
judges might fail to understand or enforce them
?
Whether more restrictive rules are necessarily more protective of shareholders
than the alternative of greater flexibility
! Unless enforcement is perfect, simple, restrictive, bright-line rules
which require only a minimal effort from the judicial system to
enforce, may be superior
?
Even if legal rules matter, these rules could merely be reflecting the differences in some other,
exogenous conditions across countries
! Countries typically adopted their legal systems involuntarily.
Even when they chose a legal system freely, the critical
consideration was language and broad political stance of the law,
rather than the treatment of investor protection. Therefore, the
legal family can be treated as exogenous to a country’s structure
of corporate ownership and finance.
If legal rules, financing and ownership patters are all found to differ
substantially across legal families, there is a strong case that legal
families, as expressed in the legal rules, actually cause outcomes.
III. Shareholder Rights
to Consider for Investor Protection
1.
Remedial Rights

One-share-one-vote rule
•
Better protection when dividend rights are tightly linked to voting rights
Antidirector Rights
2.
①
Voting by shareholder or authorized representative vs. mail proxy vote directly to firm
②
Require shareholders deposit their shares with company or financial intermediary prior to
a shareholder meeting, to be kept in custody
③
Allow cumulative voting for directors or have mechanisms of proportional
representation on the board, by which minority interests may name a proportional
number of directors.
④
Give minority shareholders legal mechanisms against perceived oppression by
directors
⑤
Grant preemptive right to buy new issues of stock, which can be waived only by a
shareholder vote
⑥
Percentage of share capital needed to call an extraordinary shareholders’ meeting:
Low (Japan 3%) vs. High (Mexico 33%)
Right to Mandatory Dividend
3.

May be legal substitute for the weakness of other protection of minority shareholders.
III. Shareholder Rights
Findings
 Common-law countries afford best legal protections to shareholders
 French-civil-law countries afford worst legal protections to shareholders
IV. Creditor Rights
to consider for (secured) creditor protection
1.
Secured creditors can pull collateral from firms being
reorganized without waiting for completion of
reorganization
2.
Assure secured creditors the right to collateral in
reorganization
3.
Creditor consent is needed to file for reorganization (as
opposed to Chapter 11)
4.
Management is replaced by a party appointed by the court
or the creditors
5.
Remedial creditor rights measure: the existence of a legal
reserve requirement which forces firms to maintain a
certain level of capital to avoid automatic liquidation
IV. Creditor Rights
Findings
 Common-law countries offer creditors stronger legal protections
against managers
 French-civil-law countries offer creditors the weakest protections
 On some measures, countries in the German-civil-law family are
strongly pro-creditor
 Scandinavia, in overall, is a bit lower than that of the German family
but higher than that of the French
 Evidence indicates that these results are not a consequence of
richer countries’ having stronger investor rights; creditors have the
weakest protections in these countries
V. Enforcement
Criteria (and Findings) for determination of protection
A strong system of legal enforcement could substitute for weak rules since
active and well-functioning courts can step in and rescue investors abused
by the management.

Private credit risk agencies for the use of foreign investors interested in
doing business in respective countries

Law enforcement proper: Efficiency of judicial system, Rule of law
Scandinavian
German-CL
Common-L
French-CL

Government’s stance toward business: Corruption, Risk of expropriation
and Likelihood of contract repudiation by government

Quality of a country’s accounting standards
Scandinavian
Common-L
German-CL
French-CL
V. Enforcement
Findings

Level of per capita income may have a more
important confounding effect than it did for the
laws themselves.

By every single measure, richer countries
have higher quality of law enforcement.

Once income is controlled for, French-civil-law
countries still score lower on every single
measure
VI. Ownership

Hypothesis: Companies in countries with poor investor
protection have more concentrated ownership of their
shares
 Large, or even dominant, shareholders who monitor the
managers might need to own more capital, cetris paribus, to
exercise their control rights and thus to avoid being expropriated
by the managers.
 When poorly protected, small investors might be willing to buy
corporate shares only at such low prices that make it
unattractive for corporations to issue new shares to the public.
Highest
French-CL
54%
Common-law
43%
Scandinavian
37%
Lowest
German-CL
34%*
* Led by East Asia, where company law has been significantly influenced by US
VII. Conclusion

Laws differ markedly around the world
 Though in most places they tend to give investors a rather
limited bundle of rights


Law enforcement differs a great deal around the world
The data support the hypothesis that countries develop
substitute mechanisms for poor investor protection
 Some are statutory, others regarding ownership concentration
 Good accounting standards and shareholder protection
measures are associated with lower concentration of ownership
CIVIL LAWS
French
Legal Investor Rights
Weaker
Protection (Shareholders, Creditors) Weakest
Quality of Law Enforcement
German/
Scandinavian
Lowest
COMMON
LAWS
Stronger
In Between
Strongest
Highest
Next Highest