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Unformatted text preview: Law and Finance Rafael La Porta, Florencio Lopez-de-Silanes, and Andrei Shleifer Harvard University Robert W. Vishny University of Chicago This paper examines legal rules covering protection of corporate shareholders and creditors, the origin of these rules, and the qual- ity of their enforcement in 49 countries. The results show that common-law countries generally have the strongest, and French- civil-law countries the weakest, legal protections of investors, with German- and Scandinavian-civil-law countries located in the mid- dle. We also find that concentration of ownership of shares in the largest public companies is negatively related to investor protec- tions, consistent with the hypothesis that small, diversified share- holders are unlikely to be important in countries that fail to protect their rights. I. Overview of the Issues In the traditional finance of Modigliani and Miller (1958), securities are recognized by their cash flows. For example, debt has a fixed promised stream of interest payments, whereas equity entitles its We are grateful to Mark Chen, Steven Friedman, Magdalena Lopez-Morton, and Katya Zhuravskaya for excellent research assistance; to Robert Barro, Eric Berglof, Bernard Black, Bertyl G. Bylund, Francesco DeNozza, Yoshikata Fukui, Edward Glaeser, Zvi Griliches, Oliver Hart, Martin Hellwig, James Hines, Louis Kaplow, Raghu Rajan, Roberta Romano, Rolf Skog, Eddy Wymeersch, Luigi Zingales, and three anonymous referees for comments; and to the National Science Foundation for financial support of this research. Documentation of the data on legal rules presented in this paper is available from the authors on request. [ Journal of Political Economy, 1998, vol. 106, no. 6] 1998 by The University of Chicago. All rights reserved. 0022-3808/98/0606-0006$02.50 1113 1114 journal of political economy owner to receive dividends. Recent financial research has shown that this is far from the whole story and that the defining feature of vari- ous securities is the rights that they bring to their owners (Hart 1995). Thus shares typically give their owners the right to vote for directors of companies, whereas debt entitles creditors to the power, for example, to repossess collateral when the company fails to make promised payments. The rights attached to securities become critical when managers of companies act in their own interest. These rights give investors the power to extract from managers the returns on their investment. Shareholders receive dividends because they can vote out the direc- tors who do not pay them, and creditors are paid because they have the power to repossess collateral. Without these rights, investors would not be able to get paid, and therefore firms would find it harder to raise external finance....
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