This paper examines legal rules covering protection of corporate shareholders and creditors, the origin of these rules, and the quality of their enforcement in 49 countries. The results show that common law countries generally have the best, and French civil law countries the worst, legal protections of investors, with German and Scandinavian civil law countries located in the middle. We also find that concentration of ownership of shares in the largest public companies is negatively related to investor protections, consistent with the hypothesis that small, diversified shareholders are unlikely to be important in countries that fail to protect their rights.

Law and Finance

This paper examines legal rules covering protection of corporate shareholders and creditors, the origin of these rules, and the quality of their enforcement in 49 countries. The results show that common-law countries generally have the strongest, and Frenchcivil-law countries the weakest, legal protections of investors, with German- and Scandinavian-civil-law countries located in the middle. We also find that concentration of ownership of shares in the largest public companies is negatively related to investor protections, consistent with the hypothesis that small, diversified shareholders are unlikely to be important in countries that fail to protect their rights.

This paper surveys research on corporate governance, with special attention to the importance of legal protection of investors and of ownership concentration in corporate governance systems around the world.

A Survey of Corporate Governance

This article surveys research on corporate governance, with special attention to the importance of legal protection of investors and of ownership concentration in corporate governance systems around the world. CORPORATE GOVERNANCE DEALS WITH the ways in which suppliers of finance to corporations assure themselves of getting a return on their investment. How do the suppliers of finance get managers to return some of the profits to them? How do they make sure that managers do not steal the capital they supply or invest it in bad projects? How do suppliers of finance control managers? At first glance, it is not entirely obvious why the suppliers of capital get anything back. After all, they part with their money, and have little to contribute to the enterprise afterward. The professional managers or entrepreneurs who run the firms might as well abscond with the money. Although they sometimes do, usually they do not. Most advanced market economies have solved the problem of corporate governance at least reasonably well, in that they have assured the flows of enormous amounts of capital to firms, and actual repatriation of profits to the providers of finance. But this does not imply that they have solved the corporate governance problem perfectly, or that the corporate governance mechanisms cannot be improved. In fact, the subject of corporate governance is of enormous practical impor

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This paper documents that strategies which buy stocks that have performed well in the past and sell stocks that have performed poorly in the past generate significant positive returns over 3- to 12-month holding periods. We find that the profitability of these strategies are not due to their systematic risk or to delayed stock price reactions to common factors. However, part of the abnormal returns generated in the first year after portfolio formation dissipates in the following two years. A similar pattern of returns around the earnings announcements of past winners and losers is also documented

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Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency

In Bordalo, Gennaioli, and Shleifer (2012a)— henceforth, BGS (2012a)—we described a new approach to choice under risk that we called salience theory. In comparisons of risky lotter ies, we argued, individuals’ attention is drawn to those payoffs which are most different or salient relative to the average. In making choices, individuals overweight these salient payoffs relative to their objective probabilities. A simple for malization of such salience-based probability weighting provides an intuitive account of a variety of puzzling evidence in decision theory, such as Allais paradoxes and preference reversals. Salience theory naturally lends itself to the analysis of the demand for risky assets. After all, risky assets are lotteries evaluated in a context described by the alternative investments available in the market. An asset’s salient payoff is naturally defined as one most different from the average market payoff in a given state of the world. We present a simple model of investor choice and market equilibrium in which salience influences the demand for risky assets. This model accounts for several time series and cross-sectional puzzles in finance in an intuitive way, based on its key implication that extreme payoffs receive disproportionate weight in the market valuation of assets. We focus on four well known puzzles. First, salient thinking leads to a preference for assets characterized by the possibility of high, salient payoffs that are overweighted by investors. One

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Salience and Asset Prices

Insolvency practitioners from 88 countries describe how debt enforcement will proceed against an identical hotel about to default on its debt. We use the data on time, cost, and the likely disposition of the assets (preservation as a going concern vs. piecemeal sale) to construct a measure of the efficiency of debt enforcement in each country. This measure is strongly correlated with per capita income and legal origin and predicts debt market development. Several characteristics of debt enforcement procedures, such as the structure of appeals and availability of floating charge finance, influence efficiency.

Debt Enforcement Around the World

We collect data on the rules and practices of financial and conflict disclosure by politicians in 175 countries. Although two thirds of the countries have some disclosure laws, less than a third make disclosures available to the public. Disclosure is more extensive in richer and more democratic countries. Disclosure is correlated with lower perceived corruption when it is public, when it identifies sources of income and conflicts of interest, and when a country is a democracy.

Disclosure by Politicians

In a variety of situations, governments regulate undesirable activities by controlling quantities rather than charging taxes. Blue laws prohibit all liquor sales on Sundays rather than impose higher taxes on that day. Zoning restrictions limit commercial construction in residential areas rather than charge for nuisance to neighbors. Anti-smoking and anti-trust laws restrict rather than tax particular conduct. Fishing and hunting rules allow hunting during particular time periods rather than tax the catch. Pollution controls impose limits rather than tax emissions. Quantity regulations are common in the financial sphere as well. In the United States, banking regulations for many years prohibited interstate banking, as well as ownership of investment banks by commercial banks. In many countries, commercial banks are limited in the amount of various activities they can pursue, such as real-estate investments or borrowing in foreign currency. In some countries, banking laws prohibit all lending to the parties related to the owners of the bank, the so-called related lending, rather than impose liability rules on loans to related parties that are found to be fraudulent or unsafe (Rafael La Porta et al., 2000). Despite this common practice, economists generally prefer taxes (and liability rules) to quantity controls (and property-rights rules) (Robert Ellickson, 1973; Louis Kaplow and Steven Shavell, 1996, 1997; Nathaniel Keohane et al., 1998) as the instrument for reducing undesirable conduct. When explaining why quantity regulations are so pervasive, they first make the political-economy argument that quantity restrictions are favored by incumbent firms that wish to deter entry (James Buchanan and Gordon Tullock, 1975). But this argument is not general: it does not explain such quantity restrictions as blue laws and hunting and fishing regulations, which affect all market participants equally. Some academics also argue that, because certain activities, such as smoking, are seen as morally wrong by the community, their level is regulated at zero. In other instances, however, such as pollution and hunting, positive but limited levels of activity are allowed, inconsistent with the moral argument that the reason for quantity regulation is the special attraction of zero. In this paper, we present an alternative reason for quantity regulations: one from the perspective of a benevolent government. We begin with the observation of Gary Becker and George Stigler (1974) that law enforcement is not free, but is fundamentally an economic problem. Throughout human history, and throughout the world today, there are chronic problems of under-enforcement (witness the low level of tax compliance in much of the developing world) and over-enforcement (by politically motivated prosecutors or regulators). An analysis of Pigouvian taxes versus quantity restrictions must recognize that, in reality, neither policy is free and automatic to enforce. In general, the choice of policies itself can facilitate or discourage enforcement, in two ways. First, policies can shape the incentives for enforcement. Second, policies can influence the costs of enforcement. In our earlier work (Glaeser and Sheifer, 2000; Glaeser et al., 2001), we have focused on incentives and shown that quantity regulations can be used as an optimal instrument to raise the rewards to law enforcers for identifying violations. Here we focus not on the incentives for the enforcers, but on the costs of finding violations: these costs are often lower in the case of quantity restrictions. We show that, even when quantity regulations, unlike taxes, restrict some socially efficient conduct, the reduced costs of identifying violations can enhance enforcement and overall efficiency. Such reliance of quantity regulation is especially important when private enforcement is crucial, as in the case of enforcing * Department of Economics, Harvard University, Cambridge, MA 02138. We thank the National Science Foundation for financial support and Louis Kaplow for extremely helpful comments.

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A Reason for Quantity Regulation

We compare "real business cycle" and increasing returns models of economic fluctuations. In these models, business cycles are driven by productivity changes resulting either from technology shocks or from crucial building blocks that give both types of models hope of fitting the data. These building blocks include durability of goods, specialized labor, imperfect credit and elastic labor supply. We also present new evidence on co-movement of both outputs sand labor inputs across sectors and on the increasing returns model is easier to reconcile with the data than the real business cycle model.

Andrei Shleifer

Papers

Salience and Asset Prices

Debt Enforcement Around the World

Disclosure by Politicians

A Reason for Quantity Regulation

Building Blocks of Market Clearing Business Cycle Models