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 Commercial Laws Civil Law (Roman) French German Scandinavian Common Law (English)

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) Civil Law (Roman) French (21 samples) Belgium, Netherlands, (part of) Poland, Italy, (Western) Germany Near East, Northern, sub- Saharan Africa, Indochina, Oceania, French Caribbean, Luxembourg, Portugal, Spain, (part of) Swiss cantons, Italy German (6 samples) Austria, Czechoslovaki a, Greece, Hungary, Italy, Switzerland, Yugoslavia, Japan, KOREA China (Taiwan) Scandinavian (4 samples) Four Nordic Countries (Similar but separate from French and German) Common Law (English) (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 2. Antidirector Rights 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%) 3. Right to Mandatory Dividend 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  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  Government’s stance toward business: Corruption, Risk of expropriation and Likelihood of contract repudiation by government  Quality of a country’s accounting standards 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. French-CLCommon-LGerman-CLScandinavian French-CLGerman-CLCommon-LScandinavian

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. Lowest German-CL 34% * Scandinavian 37% Common-law 43% Highest French-CL 54% * 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 LAWSCOMMON LAWS FrenchGerman/ Scandinavian Legal Investor Rights WeakerStronger Protection (Shareholders, Creditors) WeakestIn BetweenStrongest Quality of Law Enforcement LowestHighestNext Highest