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How does Investors' Legal Protection affect Productivity and Growth?

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  • Binyamin Berdugo

    () (Department of Economics, Ben-Gurion University of the Negev)

  • Sharon Hadad

    (Ben-Gurion University of the Negev)

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    Abstract

    This paper analyzes the implications of investors' legal protection on aggregate productivity and growth. We have two main results. First, that better investors' legal protection can mitigate agency problems between investors and innovators and therefore expand the range of high-tech projects that can be financed by non-bank investors. Second, investors' legal protection shifts investment resources from less productive (medium-tech) to highly productive (high-tech) projects and therefore enhances economic growth. These results stem from two forces. On one hand, private investors' moral hazard problems (in which entrepreneurs shift investors' resources to their own benefit), and on the other hand innovators' risk of project termination by banks due to wrong signals about projects' probability of success. Our results are consistent with recent empirical studies that show a high correlation between legal investors' protection and the structure of the financial system as well as the economic performance at industry and macroeconomic levels.

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    File URL: http://www.ec.bgu.ac.il/monaster/admin/papers/0908.pdf
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    Bibliographic Info

    Paper provided by Ben-Gurion University of the Negev, Department of Economics in its series Working Papers with number 0908.

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    Length: 38 pages
    Date of creation: 2009
    Date of revision:
    Handle: RePEc:bgu:wpaper:0908

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    1. Hicks, J. R., 1969. "A Theory of Economic History," OUP Catalogue, Oxford University Press, number 9780198811633, September.
    2. Chakraborty, Shankha & Ray, Tridip, 2006. "Bank-based versus market-based financial systems: A growth-theoretic analysis," Journal of Monetary Economics, Elsevier, vol. 53(2), pages 329-350, March.
    3. Wurgler, Jeffrey, 2000. "Financial markets and the allocation of capital," Journal of Financial Economics, Elsevier, vol. 58(1-2), pages 187-214.
    4. Carlin, Wendy & Mayer, Colin, 1999. "Finance, Investment and Growth," CEPR Discussion Papers 2233, C.E.P.R. Discussion Papers.
    5. Haidar, Jamal Ibrahim, 2009. "Investor protections and economic growth," Economics Letters, Elsevier, vol. 103(1), pages 1-4, April.
    6. Alwyn Young, 1998. "Growth without Scale Effects," Journal of Political Economy, University of Chicago Press, vol. 106(1), pages 41-63, February.
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    8. Chenggang Xu & Haizhou Huang, 1999. "Institutions, Innovations, and Growth," American Economic Review, American Economic Association, vol. 89(2), pages 438-443, May.
    9. Bencivenga, Valerie R & Smith, Bruce D, 1991. "Financial Intermediation and Endogenous Growth," Review of Economic Studies, Wiley Blackwell, vol. 58(2), pages 195-209, April.
    10. de la Fuente, Angel & Marín Vigueras, José Maria, 1995. "Innovation, 'Bank' Monitoring and Endogenous Financial Development," CEPR Discussion Papers 1276, C.E.P.R. Discussion Papers.
    11. King, Robert G. & Levine, Ross, 1993. "Finance and growth : Schumpeter might be right," Policy Research Working Paper Series 1083, The World Bank.
    12. Franklin Allen & Douglas Gale, 1999. "Diversity of Opinion and Financing of New Technologies," Center for Financial Institutions Working Papers 98-30, Wharton School Center for Financial Institutions, University of Pennsylvania.
    13. Knetsch, Jack L., 1992. "Preferences and nonreversibility of indifference curves," Journal of Economic Behavior & Organization, Elsevier, vol. 17(1), pages 131-139, January.
    14. King, Robert G. & Levine, Ross, 1993. "Finance, entrepreneurship and growth: Theory and evidence," Journal of Monetary Economics, Elsevier, vol. 32(3), pages 513-542, December.
    15. King, Robert G. & Levine, Ross, 1993. "Finance and growth : Schumpeter might be right," Policy Research Working Paper Series 1083, The World Bank.
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