Rafael La Porta

Investor Protection and Corporate Governance

Recent research has documented large differences among countries in ownership concentration in publicly traded firms, in the breadth and depth of capital markets, in dividend policies, and in the access of firms to external finance. A common element to the explanations of these differences is how well investors, both shareholders and creditors, are protected by law from expropriation by the managers and controlling shareholders of firms. We describe the differences in laws and the effectiveness of their enforcement across countries, discuss the possible origins of these differences, summarize their consequences, and assess potential strategies of corporate governance reform. We argue that the legal approach is a more fruitful way to understand corporate governance and its reform than the conventional distinction between bank-centered and market-centered financial systems.

Law and Finance

This paper examines legal rules covering protection of corporate shareholders and creditors, the origin of these rules, and the quality of their enforcement in 49 countries. The results show that common law countries generally have the best, and French civil law countries the worst, legal protections of investors, with German and Scandinavian civil law countries located in the middle. We also find that concentration of ownership of shares in the largest public companies is negatively related to investor protections, consistent with the hypothesis that small, diversified shareholders are unlikely to be important in countries that fail to protect their rights.

The Benefits of Privatization: Evidence from Mexico

Criticisms of privatization have centered around the possibility that the observed higher profitability of privatized companies comes at the expense of the rest of society. In this paper we focus on two of the most likely channels for social losses: (1) increased prices as firms capitalize on their market power; and (2) layoffs and lower wages as firms seek to roll back generous labor contracts. Using data for all 18 non-financial privatizations that took place in Mexico between 1983 and 1991 we find that privatized firms quickly bridge the pre-privatization performance gap with industry-matched control groups. For example, privatization is followed by a 24 percentage point increase in the ratio of operating income to sales. We roughly decompose those gains in profitability as follows: 10 percent of the increase is due to higher product prices, 33 percent of the increase represents a transfer from laid-off workers; and productivity gains account for the residual 57 percent. Transfers from society to the firm are partially offset by taxes which absorb slightly over half the gains in operating income. Finally, we also find evidence indicating that deregulation is associated with faster convergence to industry benchmarks.

Judicial Checks and Balances

In the Anglo‐American constitutional tradition, judicial checks and balances are often seen as crucial guarantees of freedom. Hayek distinguishes two ways in which the judiciary provides such checks and balances: judicial independence and constitutional review. We create a new database of constitutional rules in 71 countries that reflect these provisions. We find strong support for the proposition that both judicial independence and constitutional review are associated with greater freedom. Consistent with theory, judicial independence accounts for some of the positive effect of common‐law legal origin on measures of economic freedom. The results point to significant benefits of the Anglo‐American system of government for freedom.

Courts: The Lex Mundi Project

In cooperation with Lex Mundi member law firms in 109 countries, we measure and describe the exact procedures used by litigants and courts to evict a tenant for non-payment of rent and to collect a bounced check. We use these data to construct an index of procedural formalism of dispute resolution for each country. We find that such formalism is systematically greater in civil than in common law countries. Moreover, procedural formalism is associated with higher expected duration of judicial proceedings, more corruption, less consistency, less honesty, less fairness in judicial decisions, and inferior access to justice. These results suggest that legal transplantation may have led to an inefficiently high level of procedural formalism, particularly in developing countries.

Law and Finance After a Decade of Research

In the last dozen years, economists have produced a considerable body of research suggesting that the historical origin of a country’s laws is highly correlated with a broad range of its legal rules and regulations, as well as with economic outcomes. Much of this research has dealt with rules governing investor protection and their effects on financial markets. We summarize this evidence and attempt a unified interpretation. We also address several objections to the empirical claim that legal origins matter.