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

This paper presents evidence that "social capital" matters for measurable economic performance, using indicators of trust and civic norms from the World Values Surveys for a sample of 29 market economies. Memberships in formal groups—Putnam's measure of social capital—is not associated with trust or with improved economic performance. We find trust and civic norms are stronger in nations with higher and more equal incomes, with institutions that restrain predatory actions of chief executives, and with better-educated and ethnically homogeneous populations.

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Does Social Capital Have an Economic Payoff? A Cross-Country Investigation

The author argues that the preponderance of theoretical reasoning and empirical evidence suggests a positive first order relationship between financial development and economic growth. There is evidence that the financial development level is a good predictor of future rates of economic growth, capital accumulation, and technological change. Moreover, cross-country, case-style, industry level and firm-level analysis document extensive periods when financial development crucially affects the speed and pattern of economic development. The author explains what the financial system does and how it affects, and is affected by, economic growth. Theory suggests that financial instruments, markets and institutions arise to mitigate the effects of information and transaction costs. A growing literature shows that differences in how well financial systems reduce information and transaction costs influence savings rates, investment decisions, technological innovation, and long-run growth rates. A less developed theoretical literature shows how changes in economic activity can influence financial systems. The author advocates a functional approach to understanding the role of financial systems in economic growth. This approach focuses on the ties between growth and the quality of the functions provided by the financial systems. The author discourages a narrow focus on one financial instrument, or a particular institution. Instead, the author addresses the more comprehensive question: What is the relationship between financial structure and the functioning of the financial system?

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Financial development and economic growth : views and agenda

We present a simple overlapping generations model of an asset market in which irrational noise traders with erroneous stochastic beliefs both affect prices and earn higher expected returns. The unpredictability of noise traders' beliefs creates a risk in the price of the asset that deters rational arbitrageurs from aggressively betting against them. As a result, prices can diverge significantly from fundamental values even in the absence of fundamental risk. Moreover, bearing a disproportionate amount of risk that they themselves create enables noise traders to earn a higher expected return than rational investors do. The model sheds light on a number of financial anomalies, including the excess volatility of asset prices, the mean reversion of stock returns, the underpricing of closed-end mutual funds, and the Mehra-Prescott equity premium puzzle.

https://ms.mcmaster.ca/~grasselli/DeLongShleiferSummersWaldmann90.pdf

Noise Trader Risk in Financial Markets

Analyses of the role of rational speculators in financial markets usually presume that such investors dampen price fluctuations by trading against liquidity or noise traders This conclusion does not necessarily hold when noise traders follow positive-feedback investment strategies buy when prices rise and sell when prices fall In such cases, it may pay rational speculators to try to jump on the bandwagon early and to purchase ahead of noise trader demand If rational speculators' attempts to jump on the bandwagon early trigger positive-feedback investment strategies, then an increase in the number of forward-looking rational speculators can lead to increased volatility of prices about fundamentals

Positive Feedback Investment Strategies and Destabilizing Rational Speculation

Analyses of rational speculation usually presume that it dampens fluctuations caused by "noise" traders. This is not necessarily the case if noise traders follow positivefeedback strategies-buy when prices rise and sell when prices fall. It may pay to jump on the bandwagon and purchase ahead of noise demand. If rational speculators' early buying triggers positive-feedback trading, then an increase in the number of forwardlooking speculators can increase volatility about fundamentals. This model is consistent with a number of empirical observations about the correlation of asset returns, the overreaction of prices to news, price bubbles, and expectations. WHAT EFFECT DO RATIONAL speculators have on asset prices? The standard answer, dating back at least to Friedman (1953), is that rational speculators must stabilize asset prices. Speculators who destabilize asset prices do so by, on average, buying when prices are high and selling when prices are low; such destabilizing speculators are quickly eliminated from the market. By contrast, speculators who earn positive profits do so by trading against the less rational investors who move prices away from fundamentals. Such speculators rationally counter the deviations of prices from fundamentals and so stabilize them. Recent work on noise trading and market efficiency has accepted this argument (Figlewski, 1979; Kyle, 1985; Campbell and Kyle, 1988; DeLong, Shleifer, Summers, and Waldmann, 1987). In this work, risk aversion keeps rational speculators from taking large arbitrage positions, so noise traders can affect prices. Nonetheless, the effect of rational speculators' trades is to move prices in the direction of, even if not all the way to, fundamentals. Rational speculators buck noisedriven price movements and so dampen, but do not eliminate, them. In this paper we present a possibly empirically important exception to this argument, based on the prevalence of positive feedback investors in financial markets. Positive feedback investors are those who buy securities when prices rise and sell when prices fall. Many forms of behavior common in financial markets can be described as positive feedback trading. It can result from extrapolative expectations about prices, or trend chasing. It can also result from stoploss orders, which effectively prompt selling in response to price declines. A

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Using data from the United Nations Comparison Project and the Penn World Table, we find that machinery and equipment investment has a strong association with growth: over l9&)?l95 each percent of GDP invested in equipment is associated with an increase in GDP growth of 1/3 a percentage point per year. This is a much stronger association than found between growth and any of the other components of investment. A variety of considerations suggest that this association is causal, that higher equipment investment drives faster growth, and that the social return to equipment investment in well functioning market economies is on the order of 30 percent per year.

Equipment Investment and Economic Growth

Using data from the United Nations Comparison Project and the Penn World Table, we find that machinery and equipment investment has a strong association with growth: over 1960-1985 each extra percent of GDP invested in equipment is associated with an increase in GDP growth of one third of a percentage point per year. This is a much stronger association than found between growth and any of the other components of investment. A variety of considerations suggest that this association is causal, that higher equipment investment drives faster growth, and that the social return to equipment investment in well-functioning market economies is on the order of 30 percent per year.

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J. Bradford De Long

Papers

Noise Trader Risk in Financial Markets

Positive Feedback Investment Strategies and Destabilizing Rational Speculation

Positive Feedback Investment Strategies and Destabilizing Rational Speculation

Equipment Investment and Economic Growth

Equipment Investment and Economic Growth