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Protection of minority interest and the development of security markets

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Author Info

  • Franco Modigliani

    (MIT Sloan School of Management, Cambridge, MA 02139, USA)

  • Enrico Perotti

    (University of Amsterdam and CEPR, Roeterstraat 11, 1018 WB Amsterdam, Netherlands)

Abstract

While excessive regulation is an obstacle to the development of financial markets, we argue that lack of basic rules or poorly enforced regulation may explain the relative importance across countries of banking and security markets in financing firms. A selective or arbitrary enforcement transforms legal rules into an exclusionary good; arm's length market exchanges become unreliable. As a result, transactions tend to become intermediated through institutions or concentrated among agents bound by some form of private enforcement. Provision of funding shifts from risk capital to debt, and from markets to institutions with long term relations. Securities, as standardized arm's length contractual relationships, are most vulnerable to poor enforcement. We show that when small investors' rights are poorly protected, the ability of firms to raise equity capital is impaired, and as a result, profitable new ventures will be forsaken. This suggests a conflict of interest over regulatory standards between the controlling shareholders in listed firms and new entrepreneurs. More generally, fewer firms will be financed with outside equity, resulting in a low capitalization relative to GNP and a predominance of internal (unlisted) equity and bank lending over traded securities. We present some supporting evidence on the correlation between investor protection and development of security markets. We rely on a price measure, the premium on voting stock, which is related to the control premium. In countries where this premium is large, corporate financing is dominated by bank lending and equity markets are much smaller. Although the sample size is limited, the correlation is quite strong. © 1997 John Wiley & Sons, Ltd.

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Bibliographic Info

Article provided by John Wiley & Sons, Ltd. in its journal Managerial and Decision Economics.

Volume (Year): 18 (1997)
Issue (Month): 7-8 ()
Pages: 519-528

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Handle: RePEc:wly:mgtdec:v:18:y:1997:i:7-8:p:519-528

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Web page: http://www3.interscience.wiley.com/cgi-bin/jhome/7976

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Cited by:
  1. Rafael LaPorta & Florencio Lopez de-Silanes & Andrei Shleifer & Robert W. Vishny, 1997. "Legal Determinants of External Finance," Harvard Institute of Economic Research Working Papers 1788, Harvard - Institute of Economic Research.
  2. Lombardo, Davide & Pagano, Marco, 1999. "Legal Determinants of the Return on Equity," CEPR Discussion Papers 2275, C.E.P.R. Discussion Papers.
  3. Nenova, Tatiana, 2006. "Takeover laws and financial development," Policy Research Working Paper Series 4029, The World Bank.
  4. Thomas Ahrens & Igor Filatotchev & Steen Thomsen, 2011. "The research frontier in corporate governance," Journal of Management and Governance, Springer, vol. 15(3), pages 311-325, August.
  5. Lombardo, Davide & Pagano, Marco, 1999. "Law and Equity Markets: A Simple Model," CEPR Discussion Papers 2276, C.E.P.R. Discussion Papers.
  6. Tulbure, Narcis & Catarama, Delia, 2009. "Institutional and Socio-Cultural Factors Explaining the Development of Mutual Funds. A Cross-Country Analysis," MPRA Paper 20341, University Library of Munich, Germany.
  7. Choy, HiuLam & Gul, Ferdinand A. & Yao, Jun, 2011. "Does political economy reduce agency costs? Some evidence from dividend policies around the world," Journal of Empirical Finance, Elsevier, vol. 18(1), pages 16-35, January.
  8. Burcin Yurtoglu, 2003. "Corporate Governance and Implications for Minority Shareholders in Turkey," Working Papers 2003/7, Turkish Economic Association.
  9. Muravyev, Alexander, 2009. "Investor Protection and the Value of Shares: Evidence from Statutory Rules Governing Variations of Shareholders' Class Rights in Russia," IZA Discussion Papers 4669, Institute for the Study of Labor (IZA).
  10. Iraj Hashi, 1997. "Mass Privatisation and Corporate Governance in the Czech Republic," Working Papers 003, Staffordshire University, Business School.
  11. Mueller, Dennis C. & Peev, Evgeni, 2007. "Corporate governance and investment in Central and Eastern Europe," Journal of Comparative Economics, Elsevier, vol. 35(2), pages 414-437, June.
  12. Stefano Demichelis & Klaus Ritzberger, 2007. "Corporate Control and the Stock Market," Carlo Alberto Notebooks 60, Collegio Carlo Alberto.
  13. Paolo, Santella & Carlo, Drago & Giulia, Paone, 2007. "Who cares about Director Independence?," MPRA Paper 2288, University Library of Munich, Germany.
  14. Mueller, Dennis C., 2011. "Entrepreneurship and Growth," Ratio Working Papers 170, The Ratio Institute.
  15. Huizinga, Harry & Zhu, Dantao, 2006. "Financial Structure and Macroeconomic Volatility: Theory and Evidence," CEPR Discussion Papers 5697, C.E.P.R. Discussion Papers.
  16. Doidge, Craig, 2004. "U.S. cross-listings and the private benefits of control: evidence from dual-class firms," Journal of Financial Economics, Elsevier, vol. 72(3), pages 519-553, June.
  17. Victor Dorofeenko & Larry Lang & Klaus Ritzberger & Jamsheed Shorish, 2008. "Who controls Allianz?," Annals of Finance, Springer, vol. 4(1), pages 75-103, January.
  18. Dennis Mueller, 2006. "Corporate Governance and Economic Performance," International Review of Applied Economics, Taylor & Francis Journals, vol. 20(5), pages 623-643.
  19. Igor Filatotchev & Rostislav Kapelyushnikov & Natalya Dyomina & Sergey Aukutsionek, 2001. "The effects of ownership concentration on investment and performance in privatized firms in Russia," Managerial and Decision Economics, John Wiley & Sons, Ltd., vol. 22(6), pages 299-313.
  20. Pereiro, Luis E., 2006. "The practice of investment valuation in emerging markets: Evidence from Argentina," Journal of Multinational Financial Management, Elsevier, vol. 16(2), pages 160-183, April.

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