Legal Environments' Impact on Capital Markets: Equity and Debt Finance Compared, Appunti di Corporate Governance

Scarica Legal Environments' Impact on Capital Markets: Equity and Debt Finance Compared e più Appunti in PDF di Corporate Governance solo su Docsity! Corporate governance 4 November 2021 Discussion Legal Determinants of External Finance RAFAEL LA PORTA, FLORENCIO LOPEZ-DE-SILANES, ANDREI SHLEIFER, and ROBERT W. VISHNY* La porta e company Earlier have conjectured that the differences in the nature and effectiveness of financial systems around the world can be traced in part to the differences in investor protections against expropriation by insiders, as reflected by legal rules and the quality of their enforcement. Legal rules protecting investors and the quality of their enforcement differ greatly and systematically across countries. Common law countries protect both shareholders and creditors the most, French civil law countries the least, and German civil law and Scandinavian civil law countries somewhere in the middle. We also showed that richer countries enforce laws better than poorer countries, but, controlling for per capita income, French Civil law countries have the lowest quality of law enforcement as well. The broader question, of course, is whether they also have inferior opportunities for external finance and thus smaller capital markets. In this article we try to assess the ability of firms in different legal environments to raise external finance through either debt or equity. Presumably, the willingness of an entrepreneur to sell his equity, or to assume debt, depends to a large extent on the terms at which he can obtain external finance. For EQUITY, these terms are reflected by valuation relative to the underlying cashflows; For DEBT, they are reflected by the cost of funds. Countries whose financial systems offer entrepreneurs better terms of external finance would then have both higher valuations of securities and broader capital markets in the sense that more firms would access them. To the extent that better legal protections enable the financiers to offer entrepreneurs money at better terms, we predict that the countries with better legal protections should have more external finance in the form of both higher valued and broader capital markets. Measuring the size of financial markets-whether debt or equity-is a bit tricky, to address this problem, we supplement an aggregate stock market valuation measure with the number of domestic listed firms as well as the number of Initial Public Offerings (IPOs). Finally, we examine a sample of all firms from the WorldScope database, a subset consisting of the largest listed firms. We compare external finance across 49 countries as a function of the origin of their laws, the quality of legal investor protections, and the quality of law enforcement. We find strong evidence that the legal environment has large effects on the size and breadth of capital markets across countries. Our article, in contrast, focuses on the determinants of financial development, but does not follow through on its "real" consequences. Unlike the rest of the literature, then, our article aims to empirically establish the link between the legal environment and financial markets. DATA interested in the ability of companies in different countries to raise external funds in the form of either equity or debt. We use 3 measures of EQUITY FINANCE 1st variable looks at the ratio of stock market capitalization to GNP in 1994, but Conceptually, it is not appropriate to look at just the ratio of stock market valuation to GNP. So, For each country, we roughly estimate the average fraction of equity held by the insiders by looking at the country's 10 largest publicly traded nonstate firms, finding the combined ownership stake of the three largest shareholders in each of these firms, and averaging that stake over the 10 firms. Since we made this calculation for only the largest firms, and since we do not take account of cross- holdings, this procedure probably overestimates the share of equity held by the true outsiders. With all the roughness, this procedure is still conceptually preferred to looking at the uncorrected ratio of market capitalization to GNP. We look at two further measures of the extent of equity finance that focus more specifically on market breadth. 2nd number of listed domestic firms in each country relative to its population. 3rd number of initial public offerings of shares in each country between mid-1995 and mid- 1996 (the period for which we have been able to obtain the data), also relative to the population. These two variables obviously reflect the stock and the flow of new companies obtaining equity finance. It may make sense to look at both of them because the development of financial markets has accelerated greatly in the last decade, and hence the IPO evidence provides a more recent glance at external equity financing. DEBT FINANCE Finding data on debt finance is more difficult, since bank financing information is not readily available. But we have:  1 data on the total bank debt of the private sector in each country  2 data on the total face value of corporate bonds in each country. The aggregate of these two variables relative to the GNP is a plausible measure of the overall ability of the private sector to access debt finance. The fact that we are looking at the whole private sector rather than just corporations may actually be an advantage, since in many countries entrepreneurs raise money on their personal accounts to finance their firms. Although the principal focus of our analysis is on the aggregate data, we also develope measures of equity and debt finance in different countries. For each country, we use four measures of access of their WorldScope companies to capital markets. Equity variable: 1. median ratio of market capitalization to sales of the companies in the WorldScope sample for that country, corrected as in the aggregate data by the estimated share of equity of large companies held by outsiders. 2. median ratio of market capitalization to cash flow, again corrected for outside ownership. This is more easily interpretable. Debt variable: 3. median ratio of total debt to sales of all the firms in the WorldScope database in that country 4. median ratio of total debt to cash flow. mean is 1 per million people per year. The antidirector rights score is highly significant (Just as in Table V): moving from the French to the English origin mean raises the number of IPOs by 0.8. In contrast, one-share-one- vote is not significant when included alone, just like what we found in Table V. Results: The French and German civil law countries average 2 fewer IPOs (per million people) than the common law countries-more than a standard deviation of the IPO variable. Scandinavian countries, however, do not appear to have fewer IPOs in any of the specifications. The adverse effects of the French and German origin on IPOs remain once we include the antidirector rights score and the one-share-one-vote dummy. Overall the results in table 6 shows that our shareholder rights measures explain some of the variation in equity finance across countries, but that there is more to the origin effect than is captured by these measures. The regressions also confirm all our earlier results that civil law reduces the breadth of the stock markets. In Scandinavian countries, the IPOs picture is brighter than that for the number of listed issues. TABLE 7: present the results for our aggregated indebtedness measure. In the specification that does not include origin dummies, both the level of the nation's GNP and the historical growth of GDP are associated with higher total debt relative to GNP. But the statistical significance of these results does not carry over once origin is controlled for. In the specification without origin dummies, the coefficient on the creditor rights index is also statistically significant, but once is controlled for, this result loses significance, and the coefficient falls sharply. The effect of rule of law is more robust and has a large and statistically significant effect on the size of the capital market: the move form world mean to a perfect 10 is associated with a 20 % point increase in debt to GNP ratio, or 0.7 of a standard deviation. The origin effects are intersting Common law counties: French origin countries: German origin countries: Scandinavian origin countries: The overall results of Tables IV to VII are straightforward to summarize. We find that good law enforcement has a large effect on the valuation and breadth of both debt and equity markets. We also find large systematic differences between countries from different legal origins in the size and breadth of their capital markets. Whether measured by capitalization of equity held by outsiders, by the number of listed firms, or by IPOs, common law countries have larger equity markets than civil law, and particularly French civil law, countries, and at least part of the differences is captured by the differences in shareholder protections that we measure. The results add up to a rather consistent case that the quality of the legal environment has a significant effect on the ability of firms in different countries to raise external finance. Who gets the external finance? The analysis is based on aggregate measures of the valuation and breadth of markets. An alternative approach is to look at MICRODATA. The key issue about these data is that they cover primarily large firms that may have exposure to international capital markets, access to government finance, and captive banks. In this section, we attempt a very preliminary investigation of whether large firms are different, and in what ways. To this end, we examinate 38 of 49 countries, so we excluded the smaller ones. For rich countries WorldScope appears to cover 30-50 percent of the listed firms, whereas for developing countries, the share may be just a couple of percentage points (see the last column of Table VIII). TABLE 7  presents the results for the two debt and two equity variables developed for each country. Panel A  presents the data on country medians Panel B  shows the t-test of comparison between families Common law countries have a higher outsider-held capitalization of the largest companies than does any other group, with the difference being most pronounced for the Scandinavian and the French origin. However, the statistical significance of the results is considerably lower. When we normalize by cash flow rather than sales, we actually get that the German legal origin countries have the highest capitalization, in part because of ex- tremely high market valuations in Japan and Taiwan. Basically, the picture on equity for the largest firms is similar to the aggregate picture, but less pro- nounced. These results, incidentally, continue to hold if we consider, for each country, the median market capitalization to sales and to cash flow ratios, without correcting for the share of equity held by insiders. For both measures of debt, the differences between the English law, the French, and the Scandinavian origins essentially disappear, although debt of large companies in German origin countries remains the highest, especially relative to cash flow. That led to an important conclusion large publicly traded firms get external debt finance in almost all countries, regardless of legal rules. A possible reason for this is debt financing of the largest publicly traded firms comes from the government and its banks. C e D panels focus on the comparison of the results for large firms with our earlier results. Panel C  we order countries (bottom 25%) (middle 50%) and (top 25%) by their aggregate ratio of external market capitalization to GNP (variable in table 4). For each of this groups we compute - The average of the market capitalization to sales ratio - The average of the market capitalization to cash flow ratio The results confirm the consistency of the aggregate and large firm data for equity: countries with high aggregate outsider held market capitalization are also the countries with the relatively high relative valuation of the largest firms. Panel D  same calculation for the 2 debt variables used in panel A. The results is that for large firms our debt measure doesn’t vary as the aggregate measure: large publicity traded firms in countries with low aggregate debt don’t have low debt levels. CONCLUSION The legal environment matters for the size and extent of a country’s capital markets. A good legal environment protects the potential financers against expropriation by entrepreneurs and it raises their willingness to surrender funds in exchange for securities, and hence expands the scope of capital markets. The result shows that civil law countries, French CL in particular, have the weakest investors protections and the least developed capital markets, especially as compared to common law countries. The measures of investor protection considered in the paper does not fully account (non tiene pienamente conto) for outside investors' predicament (situazione degli investitori) in these countries. This article has further developed the theme that legal environments differ across countries, and that these differences matter for financial markets. What is it about the civil law family, and particularly about the French civil law subfamily, that accounts for the relative unfriendliness of laws to investors? Is it just by coincidence that these countries have investor-unfriendly laws? Or, have the laws been designed to keep investors relatively weak, and to assure family firms and the state a larger role in economic development? Alternatively, are poor laws just a proxy for an environment that is hostile to institutional development, including that of capital markets? From La porta  that public and private institutions are less effective in countries exhibiting low levels of trust among citizens. It is possible that some broad underlying factor, related to trust, influences the development of all institutions in a country, including laws and capital markets. We cannot resolve these issues now, but hope to address them in future work.