NCPA - National Center for Policy Analysis

Common Law Protects Shareholders

April 19, 1997

Researchers at Harvard and the University of Chicago have completed a detailed look at the legal systems of 49 countries, and looked at the way that varying laws affect the size and breadth of capital markets.

Their paper, "Legal Determinants of External Finance," classifies countries into four different types of legal systems, based on the origins of their legal codes, their colonial histories and several other factors.

  • Those that rely primarily on English common law -- Britain, America, Canada, Hong Kong, Australia and Singapore -- base legal rules on case precedents and judges' opinions.
  • The alternative civil-law countries can be divided into three classifications: those based on the French model, the German model or the Scandinavian model.
  • The authors then constructed several indices of shareholders' rights, and classify each country according to which protections it has.

The results of the analysis are stark.

  • Common law countries are far more protective of shareholders than civil law countries.
  • Among civil law countries, those based on the French model -- including Indonesia, Mexico and Spain -- are by far the worst.
  • Common law countries are also more protective of creditors, although the gap over German law countries -- including Japan, South Korea and Taiwan -- is less pronounced, and they do a better job than civil law countries of enforcing the laws that are on their books.
  • In the typical common law country, the value of the stock market is around 60 percent of Gross Domestic Product -- while French law countries have an average market capitalization ratio of only 21 percent of GDP.

Common law countries have 35 listed companies for every 1 million population -- compared to only ten in French civil law countries.

So countries with common law legal systems treat investors well and companies have an easy time raising capital. Those with French civil law systems fail to protect investors as well, with predictable results.


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