Do Legal Origins Have Persistent Effects Over Time? A Look at Law and Finance around the World c. 1900
Executive Summary — A significant number of recent papers find legal origins to be strongly correlated with current indices of rule of law, financial development, the regulation of entry and labor, and the concentration of ownership, among other things. Few studies, however, have explored whether correlations between institutions and economic and financial outcomes hold in the past. For this reason, we cannot be certain that the alleged persistence of the effects of these institutions passes the scrutiny of history. This paper examines specifically the relationship between legal origins and financial development by analyzing countries' legal traditions and the extent of investor protections and financial development over time. Key concepts include:
- Circa 1910, the protection of shareholders did not rely strongly on government or court enforcement of shareholder rights.
- In many countries, companies reliant on outside financing had to win investor trust by either building good reputations or writing strong protections for small shareholders into their company bylaws.
- The findings of this paper do not imply that legal origin cannot be a significant explanatory variable of the differences observed in financial development today. Instead, they suggest a need for more research into how shocks of the 20th century triggered a political process that led to state intervention and regulation, which ended up making legal origin matter more.
How persistent are the effects of legal institutions adopted or inherited in the distant past? A substantial literature argues that legal origins have persistent effects that explain clear differences in investor protections and financial development around the world today (La Porta et al, 1998, 1999 and passim). This paper examines the persistence of the effects of legal origins by examining new estimates of different indicators of financial development in more than 20 countries in 1900 and 1913. The evidence presented does not yield robust results that can sustain the hypothesis of persistence effects of legal origin, but it is not powerful enough to reject it either. Then the paper examines if there were systematic differences in the extent of investor protections across countries, since that is the main channel through which legal origin affects financial development, and shows that all the evidence supports the idea of relative convergence in corporate governance practices across legal families circa 1900. The paper concludes that, if the evidence presented is representative, the variation observed in financial development around the world today is likely a product of events of the twentieth century rather than a consequence of long-term (and persistent) differences occasioned by legal traditions.