Stephen Choi

Legal Origin(Common v. French

Civil)

Antidirector Rights

Stock Mkt Cap / GDP

# Listed Dom. Firms / Pop.

# IPOs / Pop.

Ownership Concentration

Presence of Controlling SHs

Dividend Payouts

Corporate Valuation

Enforcement levels

1. Coding Errors – Spamann (2008)

◦ 33 of the 46 country-level observations used in LLSV (1998) antidirector rights were incorrect

◦ correlation between corrected and original values is only 0.53

◦ inconsistent treatment of exceptions in the LLSV (1998) coding

◦ corrected antidirector rights index is no longer significantly correlated with legal origin or stock market size (as measured by market capitalization to GDP, listed firms per capita, or IPOs per capita)

2. Other Areas of the Law More ImportantAntidirector Rights Index

(1) the ability to mail in a proxy vote

(2) the lack of a requirement that shares must be deposited prior to proxy voting

(3) the availability of cumulative voting

(4) the presence of “legal mechanisms against perceived oppression by directors” against minority shareholders(5) the “preemptive right to buy new issues of stock”(6) whether “the percentage of share capital needed to call an extraordinary shareholders meeting” is at or below 10%

How important relative to other investor protections(at least in U.S.)

Vague…Lots of variation

2. Other Areas of the Law More ImportantAntidirector Rights Index

(1) the ability to mail in a proxy vote

(2) the lack of a requirement that shares must be deposited prior to proxy voting

(3) the availability of cumulative voting

(4) the presence of “legal mechanisms against perceived oppression by directors” against minority shareholders(5) the “preemptive right to buy new issues of stock”(6) whether “the percentage of share capital needed to call an extraordinary shareholders meeting” is at or below 10%

What about:∙ Securities Regulation∙ Private enforcement - Class Actions? - Derivative v. Direct?∙ Anti-takeover - Poison Pill?

U.S. scores only a 2 out of sample max. of 5 corrected antidirector rights score (Spamann 2008)

3. Legal Origin Causality?

United States “Common Law” Regime

- Extensive federal bureaucracy- Federal Securities Regulation

--Codified--Extensive SEC Rulemaking

More like common law

- Rule 10b-5 antifraud liability

Not like common law - Mandatory Disclosure (10-K, 10-Q, 8-K, etc)

- Regulation FD

- Sarbanes Oxley Act (CEO Certification Prohib. on auditors Internal Controls Penalty for restatement Prohib. on certain loans PCAOB)

3. Legal Origin Causality?Rajan and Zingales (2003) - Level of financial development in France was greater than that of the U.S. in 1913

Coffee (2001) - Markets developed first; investor protections second in the U.S. at end of 19th centuryCheffins (2000) - Similar story for U.K. as for U.S.

Roe (2006) - War and destruction explains variation in capital market development in 20th century

3. Legal Origin Causality?Other Factors Correlated with Legal Origin

-Initial Endowments (Beck et al. 2003a)

-Ethnolinguistic Heterogeneity and religious makeup of a country (LLSV 1999)

-Culture (Licht et al. 2005; Stulz and Williamson 2002)

Intuitive

Managers or controlling shareholders expropriating investments

Government expropriating profits at any time through exorbitant taxes or corrupt practices.

Secure Property Rights

Private contracting

Rule of law

Gompers, Ishii, and Metrick (2003) [U.S.]◦ 24 governance provisions from IRRC

Bebchuk, Cohen, and Ferrell (2004) [U.S.]◦ 6 provision “entrenchment” index

Staggered Boards Limits to shareholder bylaw amendments Supermajority voting for mergers Supermajority voting for charter amendments Presence of poison pill Presence of golden parachutes

Cheung, Rau, and Stouraitis (2006)◦ Hong Kong listed companies◦ Non-operating earning items◦ Acquisition of assets from firm’s main owners◦ Consideration paid with stock◦ Cash assistance by firms to third parties◦ Likelihood of expropriation higher where owner is

in mainland China – Rulings in Hong Kong are not enforceable in China.

Bulgaria’s experience limiting financial tunneling◦ Dilutive Equity Offerings and Below-Market Freezeouts

post-1998 privatizations

◦ Atanasov, Black, Ciccotello, and Gyoshev (2007) Bulgaria’s 2002 securities law reforms preemptive rights and appraisal rights mandatory tender offer rule majority of the minority shareholders vote to approve the

terms of a mandatory tender offer minimum “fair” price in tender offer increase in the powers of the Bulgarian Financial Supervision

Commission

No more dilutive offerings and below-market freezeoutsValuation of firms at high risk of tunneling increase

Controlling Self-Dealing◦ Djankov, La Porta, Lopez-de-Silanes, Shleifer

(2005) Lex Mundi firm survey Minimum (mandatory) legal requirements for self-

dealing transaction Aggregate Self-Dealing Index (ASDI) Public Enforcement (formal maximum fines and

criminal sanctions for self-dealing transactions)

ASDI is higher in common law countriesASDI is correlated with larger capital markets

Lex Mundi Survey Questions

◦ (1) who approves the transaction◦ (2) what needs to be disclosed to the board of directors or

supervisory board, the shareholders, the stock exchange, and the regulators

◦ (3) what are the duties of officers, directors, and controlling shareholders

◦ (4) how the transaction’s validity could be challenged◦ (5) what causes of action are available if Buyer suffers

damages◦ (6) what needs to be proved under each cause of action◦ (7) who has standing to sue under each available cause of

action◦ (8) available of direct and derivative suits◦ (9) access to information and discovery rights; and ◦ (10) fines and criminal sanctions

Importance of Transparency

La Porta, Lopez-de-Silanes, and Shleifer (2006)◦ Focus on regulation of IPOs from attorney surveys

Disclosure Securities Liability Authority (Formal) of Securities Regulatory Authority

◦ Greater disclosure requirements and securities liability positively related with greater market capitalization, more publicly traded firms, and IPOs (also with lower cost of capital – Hail and Leuz (2005)).

◦ Formal securities regulatory authority powers generally not significantly related

Procedural Formalism (and Delay)◦ Djankov et al. (2003b)

Lex Mundi survey (tenant eviction case and bounced check collection)

Procedural Formalism Index Richer countries have lower level of Formalism More formalism correlates with longer duration More formalism predicts lower enforceability of

contracts, higher corruption, as well as lower honesty, consistency, and fairness of the system

Procedural Formalism Index◦ (i) professionals versus laymen◦ (ii) written versus oral elements◦ (iii) legal justification◦ (iv) statutory regulation of evidence◦ (v) control of superior review◦ (vi) engagement formalities, and ◦ (vii) independent procedural actions

Examples of Securities Arbitration in U.S.◦ Choi, Fisch, and Pritchard (2008)

La Porta, Lopez-de-Silanes, Pop-Eleches, and Shleifer (2004) (LLPS)◦ Judicial Independence (judge tenure, judicial decisions as

source of law)◦ Judicial Constitutional Review power (rigidity of the

constitution and power to review law for constitutionality)

Judicial independence is correlated positively (and significantly) with greater economic freedom

Judicial review is correlated positively and significantly with greater political freedom.

English Common Law positively related with judicial independence

Jackson (2007)◦ United States is outlier in amount spent on financial

regulation

◦ Common law jurisdictions spend more than civil law countries on financial regulation

◦ United States is outlier in the level of actual public and private enforcement actions and recoveries (and has a vigorous class action lawsuit system)

Jackson and Roe (2007)◦ Strong relationship between greater levels of public

enforcement and greater financial development (particularly with stock market capitalization )

Fauver and Fuerst (2006)◦ Employee representatives on the board bring with

them information and expertise, making them powerful monitors of managers

Desai, Dyck and Zingales (2007) ◦ Greater enforcement of the tax laws works to

reduce the ability of those in control to expropriate private benefits of control and therefore may increase the market values of companies

Berkowitz, Pistor, and Richard (2003)◦ Indirect (not directly from origin country) and

unreceptive transplants result in a lower level of legality

Pagano and Volpin (2005)◦ More proportional the voting system of a country, the

lower the level of investor protections and the stronger the level of employment protections

Rajan and Zingales (2003)◦ Financial and business incumbents in a country oppose

financial development because with financial development typically follows greater competition.

◦ The ability of incumbents to block financial development however is lessened as a country’s economy increases both cross-border trade and capital flows.

Policy Levers◦ Antitrust Policy

◦ Trade Policy

◦ Foreign Investment Policy

◦ Reducing the Level of Governmental Intervention in the Economy

The Problem with Governmental Intervention◦ The availability of government rents will place a

premium on private entities that are best able to capture such rents, even if the entities also result in greater expropriation of private benefits of control. Bertain et al. (2002) Leuz and Oberholder-Gee (2006)

◦ Government officials may intervene in the economy to capture rents for themselves—at the expense of investor and societal welfare Shleifer and Vishny (1993) Djankov, McLiesh, Nenova, and Shleifer (2003a)

Choi and Kim (2002)◦ Reduces opposition from entrenched controlling

interests

◦ Allows for experimentation and new information

◦ Increases incentives for regulators and limits rent-seeking opportunities

Examples◦ Neuer Markt

◦ Novo Mercado

U.S. Evidence◦ Romano (1985)◦ Daines (2001)◦ Bebchuk and Cohen (2001)

Outside U.S.◦ Pistor and Xu (2005)

Competition between specific regions in China

What will companies choose?

◦ Reese and Weisbach (2002) French civil law firms cross-list into U.S. more than

English common law firms Subject themselves to SEC public filing requirements Greater incidence of post-listing equity offerings

What will companies choose?

◦ Siegel (2005) Mexican firms cross-listed in U.S. on Level II/III ADR

did not have lower propensity of insider asset taking compared with Level I/IV ADR firms

Very infrequent SEC and private enforcement in U.S. against Mexican firms

Law Matters

Key is to determine what law matters

Minimum Preconditions

What other preconditions?◦ Developing support for investor protections