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Project: Law, Finance and Development (Completed)

Principal Investigators: Simon Deakin, John Armour, Ajit Singh
Visiting Fellow: Prabirjit Sarkar
Research Associates: Beth Ahlering (PA Economic Consulting), John Buchanan (CBR), Nina Cankar (University of Ljubljana), Dominic Chai (Manchester Business School), Gerhard Schnyder (Birkbeck, University of London), Priya Lele (Ashursts LLP), Viviana Mollica (Queen Mary, Univerity of London), Sonja Fagernäs (University of Sussex), Mathias Siems (UEA).
Project dates: 2005-09
Funding: ESRC; Newton Trust; Japanese Ministry of Education COE grant to ITEC, Doshisha University, Oxford-Man Institute of Quantitative Finance

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Aims and Objectives

This project has been concerned with the question of how legal rules and institutions shape financial development and economic growth. For the past decade or so, legal reforms worldwide have followed a consistent pattern. Shareholder rights and corporate governance standards have been strengthened in the belief that this would lead to more dispersed share ownership and more liquid capital markets. Creditor rights have been enhanced with a view to fostering banking sector development and flows of private credit. Labour laws, by contrast, have been subject to deregulation aimed at creating more flexible labour markets. A theoretical underpinning for these developments was provided by the so-called legal origins hypothesis, which claims that legal systems affect long-run patterns of economic growth. Systems with a common law origin are said to favour market-facilitating laws, whereas those with roots in the French, German or Nordic civil law tend towards an activist role for the state. These underlying differences of regulatory style are reflected in the contents of the laws governing the business enterprise, and in cross-national differences in economic performance. As applied by the World Bank through its Doing Business Reports, this approach has directly influenced policy initiatives in dozens of countries.

There are problems with the legal origins hypothesis which the project set out to address. The most serious is that evidence for the claims it makes rests on quantitative indicators of legal systems which offer a purely cross-sectional view of the law (mostly of the content of laws as they were in the late 1990s). This is to assume that laws change relatively little and that the rank order of countries, in terms of the impact of regulation on business, does not alter much. In this context, CBR project addressed a need for longitudinal data on legal change and for case studies which could provide a more in-depth and nuanced view of the forces driving the law reform process at country level, and its effects.


We produced new datasets charting legal change over time in the areas of shareholder protection, creditor protection and labour regulation. We used indices with up to 60 indicators to code for the law of five significant countries (France, Germany, India, the UK and the US) for 36 years (1970-2005), and reduced-form indices of 10-12 indicators to code for a wider sample (25 countries) for the period 1995-2005. The coding methods used marked an advance on previous studies, by incorporating a wider range of legal and regulatory variables and taking into account the different ways in which regulatory rules can be expressed (as mandatory rules or as 'defaults' applying in the absence of contrary agreement). We then used time-series and panel data econometric analysis to test for correlations between the scores in the indices and economic performance variables.

The data we collected give a somewhat different picture of the state of the law than that provided by the early legal origins papers. We see considerable change in the area of shareholder protection and corporate governance, with civil law systems 'catching up' with their common law counterparts, in particular over the decade to 2005. This suggests that lock-in through legal origin has not been much of an obstacle to the formal convergence of systems. For creditor protection, we do not find such a clear common law/civil law divide, and a less clear convergence trend. In labour regulation, there is a more distinct common law/civil law divide but not much evidence of convergence of systems.

Our econometric findings call into question aspects of the legal origin hypothesis and its use by policy-makers. We find that increases in shareholder protection have not led, on the whole, to greater stock market development. This suggests that a 'one size fits all' approach to corporate governance reforms, stressing elements of British and American practice - the role of independent boards and the market for corporate control - may not be working as intended, in particular in civilian systems. On the other hand, we have some evidence that a strengthening of shareholder rights has a positive impact on stock market growth, and changes to the law of secured credit may be assisting banking development in emerging markets. In the area of labour law, we find little or no evidence to support the claim that deregulation leads to superior economic outcomes. On the contrary, at least for civilian systems, we find that the strengthening of dismissal protection has positive impacts on productivity growth, and that working time reforms may help to foster employment growth. In the US, a strengthening of dismissal laws led to higher productivity growth but reduced employment growth.

Our case studies confirm the view that there is no single best model for the laws governing the business enterprise. We show how the reception of Anglo-American norms in civilian and developing systems has often been incomplete and with unanticipated effects. There has been convergence of form, but not of function. Political structures have greater explanatory power than legal origin in accounting for the nature of legal change, but there is also a need to understand the role that institutional forces play in shaping and changing the preferences of interest groups.

The project was completed in 2009. It produced over thirty significant publications and the findings were extensively disseminated to researchers and policy makers. The datasets we created are already being used by the wider research community and we will extend them in future work. The project was given a grade of 'outstanding' in an ESRC assessment in 2010 and one of the principal project outputs, 'How do legal rules evolve? Evidence from a cross-country comparison of shareholder, creditor and worker protection' by Armour, Deakin, Lele and Siems was awarded the ECGI Allen and Overy prize for legal research on corporate governance in 2010.

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