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Law and Equity Markets: a Simple Model

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Abstract

We analyze how the law and its enforcement affect equity market equilibrium. Improvements in the legal system, while invariably associated with broader equity markets, have different effects on equity returns depending on the institutional change considered and on the degree of international stock market segmentation. The model is useful to interpret the results of recent empirical work, such as La Porta et al. (1997) and Lombardo and Pagano (1999). In particular, it can rationalize the observed cross-country pattern, whereby better institutions are associated both with broader equity markets and higher risk-adjusted returns on equity.

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Bibliographic Info

Paper provided by Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy in its series CSEF Working Papers with number 25.

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Date of creation: 01 Oct 1999
Date of revision: 09 Feb 2002
Publication status: Published in Corporate Governance Regimes: Convergence and Diversity, J. McCahery, P. Moerland, T. Raaijmakers and L. Renneboog eds. Oxford University Press, 2002
Handle: RePEc:sef:csefwp:25

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Keywords: law; enforcement; shareholder protection; corporate governance; return on equity;

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  1. P Martin & H Rey, 2000. "Financial Integration and Asset Returns," CEP Discussion Papers dp0451, Centre for Economic Performance, LSE.
  2. Davide Lombardo & Marco Pagano, 1999. "Legal Determinants of the Return on Equity," CSEF Working Papers 24, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy, revised 01 Dec 2000.
  3. Rene M. Stulz, 1999. "Globalization of Equity Markets and the Cost of Capital," NBER Working Papers 7021, National Bureau of Economic Research, Inc.
  4. Geert Bekaert & Campbell R. Harvey, 1997. "Foreign Speculators and Emerging Equity Markets," William Davidson Institute Working Papers Series 79, William Davidson Institute at the University of Michigan.
  5. Bekaert, Geert & Harvey, Campbell R, 1995. " Time-Varying World Market Integration," Journal of Finance, American Finance Association, vol. 50(2), pages 403-44, June.
  6. Lucian Arye Bebchuk, 1999. "A Rent-Protection Theory of Corporate Ownership and Control," NBER Working Papers 7203, National Bureau of Economic Research, Inc.
  7. Carlin, Wendy & Mayer, Colin, 1999. "Finance, Investment and Growth," CEPR Discussion Papers 2233, C.E.P.R. Discussion Papers.
  8. Fama, Eugene F & MacBeth, James D, 1973. "Risk, Return, and Equilibrium: Empirical Tests," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 607-36, May-June.
  9. La Porta, Rafael & Lopez-de-Silanes, Florencio & Schleifer, Andrei & Vishny, Robert, 2001. "Investor Protection and Corporate Governance," Working Paper Series rwp01-017, Harvard University, John F. Kennedy School of Government.
  10. Philippe Jorion & William N. Goetzmann, 1999. "Global Stock Markets in the Twentieth Century," Journal of Finance, American Finance Association, vol. 54(3), pages 953-980, 06.
  11. Colin Mayer & Wendy Carlin, 1999. "Finance, Investment and Growth," Economics Series Working Papers 1999-FE-09, University of Oxford, Department of Economics.
  12. Campbell R. Harvey, 1994. "Predictable Risk and Returns in Emerging Markets," NBER Working Papers 4621, National Bureau of Economic Research, Inc.
  13. 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.
  14. Fama, Eugene F. & French, Kenneth R., 1993. "Common risk factors in the returns on stocks and bonds," Journal of Financial Economics, Elsevier, vol. 33(1), pages 3-56, February.
  15. Rajan, Raghuram G & Zingales, Luigi, 1998. "Financial Dependence and Growth," American Economic Review, American Economic Association, vol. 88(3), pages 559-86, June.
  16. Jensen, Michael C. & Meckling, William H., 1976. "Theory of the firm: Managerial behavior, agency costs and ownership structure," Journal of Financial Economics, Elsevier, vol. 3(4), pages 305-360, October.
  17. Franco Modigliani & Enrico Perotti, 1997. "Protection of minority interest and the development of security markets," Managerial and Decision Economics, John Wiley & Sons, Ltd., vol. 18(7-8), pages 519-528.
  18. Harvey, Campbell R, 1991. " The World Price of Covariance Risk," Journal of Finance, American Finance Association, vol. 46(1), pages 111-57, March.
  19. Asli Demirgüç-Kunt & Vojislav Maksimovic, 1998. "Law, Finance, and Firm Growth," Journal of Finance, American Finance Association, vol. 53(6), pages 2107-2137, December.
  20. Ferson, Wayne E & Harvey, Campbell R, 1993. "The Risk and Predictability of International Equity Returns," Review of Financial Studies, Society for Financial Studies, vol. 6(3), pages 527-66.
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