Institutional Protectiom and

the Economy
Emerging Markets
Jakob Arnoldi
Two questions:
1. Pyramiding vs
tunnelling? What is
difference?
2. Is what I talked about in
previous lecture
tunnelling?
Learning goals
• Get a better understanding of how corporate governance is rooted in
law and regulation (thus we will expand our knowledge of corporate
governance).
• Understand differences not only in terms of efficiency but also legal
(institutional) traditions and trajectories (understand how this is
related to the substitutions thesis, that is, how emerging economies
may grow economically in spite of poor corporate governance by
using substituting mechanisms.
Different intersecting themees

The Institutional voids versus

substitution institutional differences
thesis

How can emerging markets grow

without institutions?
 Corporate governance in emerging markets

Lacking regulatory protection Concentrated ownership.

of investors. Family ownership.
Information Hindered growth?
assymmetries/lack of
financial and accounting
transparency.
Inefficient markets for
corporate control.
Further consequences/indications of
problems:
1) Fewer publicly traded firms;
2) lower firm valuations;
3) lower dividends;
4) less information contained in stock prices;
5) inefficient firm strategies;
6) less R&D (smaller budgets);
7) expropriation of minority shareholders.
Obstacles for emerging markets
• Economic growth dependent on institutional support and market
intermediaries
• In particular:
1. legal support for transactions and ownership (contracts and
corporate governance).
2. Financial intermediaries (financial capital).

Emerging markets most often have neither. Poor corporate governance

is obstacle for growth.
How can (explosive) growth in emerging
markets then be explained?
1. Institutions are beginning to develop and have developed
sufficiently for growth to begin.
2. Firms use substituting mechanisms.
3. A combination of 1 and 2.

And a lot of questions/ debates derived from this:

Growth will not be sustainable without subsequent institutional development?
Institutions will develop similarly to institutional development in Western countries?
Question in today’s reading:
How could (can) China grow without institutional support (particularly
legal support and financial markets).
Only voids or also differences?
• Different legal traditions translates into different institutions
governing corporate governance.
• Some of these factors may well overlap with levels of institutional
development.

So a little detour: first we will look at some results of a study on how different degrees of legal protection of
firm owners is linked with legal traditions, and with varying degrees of protection, which in turn translates into
different ownership patterns.
Ownership structure and law
La Porta, R., Lopez-de-Silanes, F., Shleifer, A. and Vishny, R.W. (1998) ‘Law and Finance’, Journal of Political
Economy, Vol. 106, No. 6, pp. 1113-1155.

RQs:
• How well are investors protected by law?
• Does differences in legislation lead to differences in investor
protection?
• Does poor investor protection affect ownership structure?
Different legal traditions (families)
• Common (English)
• Civil (Roman)
• French
• German
• Scandinavian
Variables
La Porta, R., Lopez-de-Silanes, F., Shleifer, A. and Vishny, R.W. (1998) ‘Law and Finance’, Journal of Political Economy, Vol. 106, No. 6, pp. 1113-1155.

• Important variables (selected):

• Shareholder rights.
• ‘Anti-director’ rights.
• Creditor rights (e.g repossession of collateral).
• Rule of law/enforcement.
• Concentration of ownership.
Shareholder and ‘anti-director’ rights
La Porta, R., Lopez-de-Silanes, F., Shleifer, A. and Vishny, R.W. (1998) ‘Law and Finance’, Journal of Political Economy, Vol. 106, No. 6, pp. 1113-1155.
La Porta, Lopez-de-Silanes
Shleifer, and Vishny 1998)
Test of means - Shareholder and ‘anti-
director’ rights

La Porta, Lopez-de-Silanes
Shleifer, and Vishny 1998)
La Porta, Lopez-de-Silanes
Shleifer, and Vishny 1998)
La Porta, Lopez-de-Silanes
Shleifer, and Vishny 1998)
La Porta, Lopez-de-Silanes
Shleifer, and Vishny 1998)
Concentration of ownership

La Porta, Lopez-de-
Silanes Shleifer, and
Vishny 1998)
 La Porta, Lopez-de-Silanes

Concentration of ownership Shleifer, and Vishny 1998)

La Porta, Lopez-de-Silanes
Shleifer, and Vishny 1998)
Main findings
• Common law affords investors and creditors the most protection.
• French civil law affords the least protection.
• The less protection, the higher the concentration of ownership.
• Rights independent of economic development – enforcement is
dependent (and also somewhat dependent on legal tradition).
Summation
• Legal traditions impact on corporate governance.
• Protection afforded by corporate governance legislation impacts on
ownership patterns: weaker protection = more concentrated
ownership.
• Many civil law countries are underdeveloped.
• Agency problems are often P-P problems if corporate governance
regulation is weak.
How, then, do emerging
economies grow?
Sources of financing
 Cultural/network effects
”We believe the most important reason for the growth is the work of alternative
financing and governance mechanisms. Perhaps the most important mechanism is
reputation and relationships. Greif (1989, 1993)  argues that certain traders’ organizations
in the eleventh century were able to overcome problems of asymmetric information and
the lack of legal and contract enforcement mechanisms, because they had developed
institutions based on reputation, implicit contractual relations, and coalitions. Certain
aspects of the growth of these institutions resemble what works in China’s Private Sector
today, in terms of how firms raise funds and contract with investors and business
partners. In addition, Greif (1994)  and Stulz and Williamson (2003)  point out the
importance of cultural and religious beliefs on the development of institutions, legal
origin, and investor protection. Gomes (2000) demonstrates that a managerial reputation
effect can replace formal governance in an IPO firm, consistent with the evidence from
the Chinese venture capital industry (e.g., Bruton and Ahlstrom, 2002 ).”

F. Allen et al. / Journal of Financial Economics 77 (2005) 57–116: p. 96

Other* factors
• (local) Government support.
• Family business.
• Trade credits (ORECS).
• Financial support from Chinese expats (particularly Hong Kong and
Taiwan).
• Shadow banking system.
• Low entry barriers.
*none of these factors are in fact
unrelated to culture or networks.
Summation
• Corporate governance and finance crucial for economic growth.
• A set of informal mechanism can however substitute.