criminal sanctions administered by courts are less important than the existence of financial market regulatory or supervisor for the development of securities markets These three indicators of innovative capacity are not independent of each other. A highly mandatory corporate law limits the ability of private actors to reallocate rights and also limits the scope of judge-made law. The lack of private innovation and judge-made law may also affect adversely the rate of statutory legal change This may be somewhat counterintuitive because statutory legal change can serve to implement radical legal change almost immediately. However, to the extent that statutory law limits the ability of private actors to experiment with new legal forms and restricts the courts'ability to review these experiments, it limits the source of legal innovation to the legislature Kaplow(1997) argues that legislatures can collect relevant information that would allow hem to assess the demand for legal change. From this perspective, limiting the source of innovation to the legislature may not impede innovation. However, litigation may be superior to survey work in revealing critical information that may prompt a reversal in case law or an intervention by the legislature Conversely, a highly enabling law that gives private actors substantial discretion in allocating and reallocating control rights among themselves requires an effective neutral arbiter to resolve disputes among competing claims. The more innovations by private actors, the more difficult it is for courts to keep up with the pace of change and the more likely it is that legal systems will suffer from deterrence failure(Xu and Pistor, 2002) Therefore, highly enabling laws governing the corporate enterprise may result in market collapse, unless the legal system has sufficient capacity to create new institutions to make up for the deficiencies in law enforcement. Put differently, a highly enabling law
11 criminal sanctions administered by courts are less important than the existence of a financial market regulatory or supervisor for the development of securities markets. These three indicators of innovative capacity are not independent of each other. A highly mandatory corporate law limits the ability of private actors to reallocate rights and also limits the scope of judge-made law. The lack of private innovation and judge-made law may also affect adversely the rate of statutory legal change. This may be somewhat counterintuitive because statutory legal change can serve to implement radical legal change almost immediately. However, to the extent that statutory law limits the ability of private actors to experiment with new legal forms and restricts the courts’ ability to review these experiments, it limits the source of legal innovation to the legislature. Kaplow (1997) argues that legislatures can collect relevant information that would allow them to assess the demand for legal change. From this perspective, limiting the source of innovation to the legislature may not impede innovation. However, litigation may be superior to survey work in revealing critical information that may prompt a reversal in case law or an intervention by the legislature. Conversely, a highly enabling law that gives private actors substantial discretion in allocating and reallocating control rights among themselves requires an effective neutral arbiter to resolve disputes among competing claims. The more innovations by private actors, the more difficult it is for courts to keep up with the pace of change and the more likely it is that legal systems will suffer from deterrence failure (Xu and Pistor, 2002). Therefore, highly enabling laws governing the corporate enterprise may result in market collapse, unless the legal system has sufficient capacity to create new institutions to make up for the deficiencies in law enforcement. Put differently, a highly enabling law
provides a fertile ground for legal innovation. Unless a legal system proves capable of responding to the new challenges arising from legal innovation, this strategy may be self- defeating. The following propositions are derived from the above analysis. First, the more mandatory is a corporate law, the less legal innovation will take place. Second, the more enabling is a corporate law, the more legal innovation will take place. Third, the more enabling is a corporate law, the greater is the need for institutional innovation, in particular for new law enforcement agents We recognize that there may be different factors influencing the innovative capacity of legal systems. The constitutional system, including the allocation of legislative powers and the ease with which rulemaking powers can be delegated to other agents, e.g egulators, may influence the responsiveness and innovativeness of legal systems Moreover, political factors may hinder or support legal reform in corporate law Colombia's problems in maintaining political stability and fighting drug trade may have prevented a more proactive stand on issues related to matters of corporate law. We do not address these broad political and constitutional factors because they are beyond the scope of this research project. However, we do include a countrys history in developing its formal legal order into our analysis. Berkowitz et al. (2003)suggest that countries that have imported their formal legal order, rather than having developed it internally may suffer from the transplant effect. These authors show that legal transplants have weaker legal institutions than origin countries. In explaining their findings, they suggest that the ransplant countries may lack a demand for the legal order that is superimposed on them therefore, their governments may decide not to invest in institutions necessary to implement this order. Hence, we assert a fourth proposition that legal transplant countries 12
12 provides a fertile ground for legal innovation. Unless a legal system proves capable of responding to the new challenges arising from legal innovation, this strategy may be selfdefeating. The following propositions are derived from the above analysis. First, the more mandatory is a corporate law, the less legal innovation will take place. Second, the more enabling is a corporate law, the more legal innovation will take place. Third, the more enabling is a corporate law, the greater is the need for institutional innovation, in particular for new law enforcement agents. We recognize that there may be different factors influencing the innovative capacity of legal systems. The constitutional system, including the allocation of legislative powers and the ease with which rulemaking powers can be delegated to other agents, e.g., regulators, may influence the responsiveness and innovativeness of legal systems. Moreover, political factors may hinder or support legal reform in corporate law. Colombia’s problems in maintaining political stability and fighting drug trade may have prevented a more proactive stand on issues related to matters of corporate law. We do not address these broad political and constitutional factors because they are beyond the scope of this research project. However, we do include a country’s history in developing its formal legal order into our analysis. Berkowitz et al. (2003) suggest that countries that have imported their formal legal order, rather than having developed it internally may suffer from the transplant effect. These authors show that legal transplants have weaker legal institutions than origin countries. In explaining their findings, they suggest that the transplant countries may lack a demand for the legal order that is superimposed on them; therefore, their governments may decide not to invest in institutions necessary to implement this order. Hence, we assert a fourth proposition that legal transplant countries