TABLE 17.2
Importance of institutions and legal framework for fi
nancial systems
Main Theoretical Arguments
Empirical Research
Institutions
Better protection of creditor rights increases the
breadth and depth of capital markets.
Laws and their enforcement infl
uence the extent
to which insiders can expropriate outside investors who fi
nance fi
rms. Credibly pledging
collateral reduces asymmetric information problems.
Shareholder and creditor
- rights indices (for 49 countries with publicly traded companies)
increase opportunities for external fi
nance (La Porta
et al.
1997a, 1998).
Creditor rights and law enforcement are also positively correlated with bank
development (Levine 1998, 1999), fi
rms’ ability to raise capital (Kumar
et al.
2001;
Beck
et al.
2003), effi
ciency of equity markets (Morck
et al.
2000), effi
ciency of
capital re
- allocation (Beck and Levine 2002; Wurgler 2000), corporate and bank
valuations (Claessens
et al.
2000, 2003; La Porta
et al.
2000) and ability to fund
faster
- growing fi
rms (Demirgüc
- Kunt and Maksimovic 1998), and fi
rms with less
collateral (Claessens and Laeven 2003).
Law enforcement and creditor protection also reduces credit cycles and currency and
banking crises (Johnson
et al.
2000; Galindo
et al.
2001, 2004; Boucher 2004).
Legal
framework
Alternative view: strict protection of creditor
rights (e.g. right to repossess collateral) might be ineffi
cient and may impede continuation
of effi
cient projects. Pro
- creditor rights reduce
risk
- taking incentives for entrepreneurs.
Protection of creditors reduces their incentives to screen projects and to discourage investment by overconfi
dent entrepreneurs.
Legal framework and corporate governance: by
shaping fi
rms’ incentives, a weak protection
of creditor rights and weak law enforcement might encourage adoption of remedial rules, higher ownership concentration, and excessive reliance on tangible and liquid assets.
Extending La Porta
et al.
’s (2000) exercise by including additional macroeconomic
controls, Padilla and Requejo (2000) fi
nd that, although an effi
cient judicial system
improves the size and effi
ciency of the credit market, the effect of creditor protection
is inconclusive. By extending the sample (15 additional developing countries), Galindo and Micco (2001) fi
nd that the positive effect of creditor protection does
hold, even after controlling for macroeconomic variables.
Countries with weak laws and enforcement tend to introduce remedial rules such as
mandatory dividends and reserve requirements (La Porta
et al.
1998), display more
ownership concentration (Zingales 1994; La Porta
et al.
1998; Claessens
et al.
2000;
Himmelberg
et al.
2000; Roe 2000; Caprio
et al.
2003; Dyck and Zingales 2004),
and invest more in tangible assets (Claessens and Laeven 2003) and liquid assets (Pinkowitz
et al.
2003).
Other institutions
(trust or social capital)
Trust: increasing the perception that others will
cooperate facilitates cooperation in large and impersonal markets.
Social capital and fi
nancial development are strongly connected in Italy
, according to
household data (Guiso
et al.
2000). Beyond Italy (in a sample of 48 countries), trust
is positively correlated with the size and activity of fi
nancial intermediaries, bank
effi
ciency
, and stock and bond market development (Calderón
et al.
2001).
Source: Fergusson (2006).
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