Abstract
The core of the new institutional economics pioneered by Douglass North is: the quality of legal and other institutions makes a difference to economic development and growth. The idea can be traced back further to the writings of Max Weber. Comparing the experience of industrializing countries of Western Europe with other countries, Weber argued that a rational legal system is a precondition for the emergence of capitalism. Their approach can be called Endowment Perspective: the legal system is seen as an endowment, created by fixed investment, which determines the path of development without itself being subject to change.
This perspective received a major impetus in the late 1990s and in the first decade of the current millennium through the works of LLSV [La Porta, Lopez-de-Silanes, Shleifer and Vishny,Journal of Political Economy,1998 vol. 106: pp.1113-55 ] and the subsequent works by them and their followers.
In their studies LLSV claimed that ‘better rules’, such as higher level of shareholder and creditor protection, fostered financial development. This position has been extremely influential among policy-makers since the mid-1990s, in conjunction with a literature claiming to show that financial development promotes economic growth.Strengthening shareholder and creditor rights as a precondition for financial market development has become a mainstay of global policy initiatives and national law reform programs.
In this perspective this paper uses recently created datasets (available online: http://www.cbr.cam.ac.uk/research/research-projects/completed-projects/law-finance-development/) measuring legal change over time in a sample of 28 developed and emerging economies to test whether the strengthening of shareholder rights in the course of the mid-1990s and 2000s promoted stock market development in those countries. It finds only weak and equivocal evidence of a positive effect of shareholder protection on market capitalisation, the value of stock trading, and the turnover ratio, and a negative impact on the number of listed companies. There is stronger evidence of reverse causality, in the sense of stock market development at country level generating changes in shareholder protection law. We conclude, firstly, that legal reforms were at least in part an endogenous response to stock market development and not simply a reaction to the generation of global standards; but, secondly, that the laws passed in response to the demand for shareholder empowerment did not consistently have the expected impact on financial markets, and may have had some negative and perverse results.