Columbia Law School The Center for Law and Economic studies 435 West 116St New York, NY 10027-7201 Working Paper No 231 Innovation in Corporate Law Katharina Pistor, Yoram Keinan, Jan Kleinheisterkamp mark d. west Forthcoming 2003 Journal of comparative economics This paper can be downloaded without charge from the Social Science research Network electronic library at http://ssrn.com/abstract=419861 An index to the working papers in the Columbia lay School Working Paper Series is located at http:/hwww.lanw.columbia.edwcenterprogramllanweconomics
1 Columbia Law School The Center for Law and Economic Studies 435 West 116th St. New York, NY 10027-7201 Working Paper No. 231 Innovation in Corporate Law Katharina Pistor, Yoram Keinan, Jan Kleinheisterkamp & Mark D. West Forthcoming 2003 Journal of Comparative Economics This paper can be downloaded without charge from the Social Science Research Network electronic library at: http://ssrn.com/abstract=419861 An index to the working papers in the Columbia Law School Working Paper Series is located at: http://www.law.columbia.edu/center_program/law_economics
Innovation in Corporate Law Associate Professor of law columbia law school 435 West 116 Street, New York, NY 10027 ng authorI Yoram Keinan JSD Candidate University of Michigan, Ann Arbor Jan Kleinheisterk Research associate Max Planck Institute for Foreign and Comparative Private Law Mark d. we Professor of li University of Michigan, Ann Arbor We would like to thank Konstantinos Kyriakakis for his help on the evolution of French corporate law Special thanks to Rick Messick, Peter Murell and Andrei Shleifer as well as other participants at the Conference on Appropriate Institutions held at the World Bank on 13 September 2002 for comments on an Associate Professor of law columbia law school Research Associate, Max Planck Institute for Foreign and Comparative Law, Hamburg Assistant Professor of Law, University of Michigan Law School
2 Innovation in Corporate Law1 Katharina Pistor+ Associate Professor of Law, Columbia Law School 435 West 116th Street, New York, NY 10027 [corresponding author] Yoram Keinan∗ JSD Candidate University of Michigan, Ann Arbor Jan Kleinheisterkamp# Research Associate Max Planck Institute for Foreign and Comparative Private Law Hamburg, Germany Mark D. West× Professor of Law University of Michigan, Ann Arbor 1 We would like to thank Konstantinos Kyriakakis for his help on the evolution of French corporate law. Special thanks to Rick Messick, Peter Murell and Andrei Shleifer as well as other participants at the Conference on Appropriate Institutions held at the World Bank on 13 September 2002 for comments on an earlier draft. + Associate Professor of Law, Columbia Law School. ∗ SJD Candidate, University of Michigan Law School. # Research Associate, Max Planck Institute for Foreign and Comparative Law, Hamburg. × Assistant Professor of Law, University of Michigan Law School
Abstract corporation with its key attributes of independent personality, limited liability and free o n most countries large business enterprises today are organized as corporations. Th tradeability of shares has played a key role in most developed market economies since the 9 century and has made major inroads in emerging markets. We suggest that the changing environment. We analyze a country's capacity to innovate using the rate or o resilience of the corporate form is a function of the adaptability of the legal framework statutory legal change, the flexibility of corporate law, and institutional change as indicators. Our findings suggest that origin countries are more innovative than transplant countries JEL Classification: G3 K2 N2 P5 Forthcoming in: Journal of Comparative Economics(2003)
3 Abstract: In most countries large business enterprises today are organized as corporations. The corporation with its key attributes of independent personality, limited liability and free tradeability of shares has played a key role in most developed market economies since the 19th century and has made major inroads in emerging markets. We suggest that the resilience of the corporate form is a function of the adaptability of the legal framework to a changing environment. We analyze a country’s capacity to innovate using the rate of statutory legal change, the flexibility of corporate law, and institutional change as indicators. Our findings suggest that origin countries are more innovative than transplant countries. JEL Classification: G3, K2, N2, P5 Forthcoming in: Journal of Comparative Economics (2003)
Corporate law and corporate governance are used in recent literature to explain differences in the performance of financial markets and firms. The objective of this research is to identify variables that account for diff in performance and to rectify deficiencies in corporate law and financial market development by changing these variables. Attempts to identify best legal practice and to develop legal standards that may be transplanted are endorsed by multinational institutions, such as the IMF and the World Bank(Pistor, 2002). This strategy receives empirical support in studies showing that the level of minority shareholder protection in laws on the books does indeed have a statistically significant impact on the development of financial markets as measured by standard indicators, such as market capitalization, liquidity, and the ownership concentration of firms(La Porta et al., 1997 and La Porta et al., 1998 ). These studies find hat countries belonging to the common law family have better minority shareholder protection on average than countries belonging to the German, French or even the Scandinavian civil law family. They also show that common law countries have better developed financial markets than do civil law countries Implicit in this analysis is a causal relation that runs from legal origin to the quality of law to financial outcome. However, a brief review of the history of corporate law in the mother country of the common law, England, shows that only a few of the indicators that account for the high level of minority shareholder protection in common law countries as measured in these studies were present at the time the first corporate statutes were enacted as table l indicates
4 1. Introduction Corporate law and corporate governance are used in recent literature to explain differences in the performance of financial markets and firms. The objective of this research is to identify variables that account for differences in performance and to rectify deficiencies in corporate law and financial market development by changing these variables. Attempts to identify best legal practice and to develop legal standards that may be transplanted are endorsed by multinational institutions, such as the IMF and the World Bank (Pistor, 2002). This strategy receives empirical support in studies showing that the level of minority shareholder protection in laws on the books does indeed have a statistically significant impact on the development of financial markets as measured by standard indicators, such as market capitalization, liquidity, and the ownership concentration of firms (La Porta et al., 1997 and La Porta et al., 1998). These studies find that countries belonging to the common law family have better minority shareholder protection on average than countries belonging to the German, French or even the Scandinavian civil law family. They also show that common law countries have better developed financial markets than do civil law countries. Implicit in this analysis is a causal relation that runs from legal origin to the quality of law to financial outcome. However, a brief review of the history of corporate law in the mother country of the common law, England, shows that only a few of the indicators that account for the high level of minority shareholder protection in common law countries as measured in these studies were present at the time the first corporate statutes were enacted as Table 1 indicates
Table 1: Minority Shareholder Protection in English l Prior to 1948, shareholders could vote by proxy only if this had been stipulated in the articles of incorporation no mention is made of proxy by mail No blocking of shares (-) Shareholder suit Direct suit implied in 1844; derivative action recognized nly in 1975 Preemptive rights Adopted in response to EU harmonization requirements. Shareholders re The 1862 law required 20 percent. more than 10 percent of total The threshold was lowered to 5 percent in 1948 stock can call extraordinary shareholder meeting Acts 1844 Note: () denotes that the relevant provision does not exist in the statutory corporate law This observation raises the issues of why some countries have developed these protective mechanisms while others have not and whether a set of static indicators can serve as a proxy for the quality of law. In this paper, we propose an alternative approach to assessing the quality of corporate law, namely, the capacity of a legal system to innovate. The more innovative and adaptable a legal system is, the more likely it is able to respond to a changing environment and thereby give firms the possibility to explore new opportunities while ensuring a minimum level of investor protection We use data on the evolution of corporate law in ten jurisdictions to explore this proposition. Each of the major legal families, namely, the common law family and civil law families of France and Germany, are represented For each family, we include origin countries, i.e. countries that developed their formal legal systems largely internally or with only limited borrowing, as well as transplant countries, i. e those that received their formal legal order from foreign sources. The four origin countries are France, Germany
5 Table 1: Minority Shareholder Protection in English Law Date of Enactment Comment Proxy by mail 1948 Prior to 1948, shareholders could vote by proxy only if this had been stipulated in the articles of incorporation; no mention is made of proxy by mail. Cumulative voting ( - ) ( - ) No blocking of shares ( - ) ( - ) Shareholder suit 1844 Direct suit implied in 1844; derivative action recognized only in 1975. Preemptive rights 1980 Adopted in response to EU harmonization requirements. Shareholders representing not more than 10 percent of total stock can call extraordinary shareholder meeting 1909 The 1862 law required 20 percent. The threshold was lowered to 5 percent in 1948. Source: English Companies Acts 1844 to present. Note: (-) denotes that the relevant provision does not exist in the statutory corporate law. This observation raises the issues of why some countries have developed these protective mechanisms while others have not and whether a set of static indicators can serve as a proxy for the quality of law. In this paper, we propose an alternative approach to assessing the quality of corporate law, namely, the capacity of a legal system to innovate. The more innovative and adaptable a legal system is, the more likely it is able to respond to a changing environment and thereby give firms the possibility to explore new opportunities while ensuring a minimum level of investor protection. We use data on the evolution of corporate law in ten jurisdictions to explore this proposition. Each of the major legal families, namely, the common law family and civil law families of France and Germany, are represented. For each family, we include origin countries, i.e. countries that developed their formal legal systems largely internally or with only limited borrowing, as well as transplant countries, i.e., those that received their formal legal order from foreign sources. The four origin countries are France, Germany