INTERNATIONAL CORPORATE DIFFERENCES: MARKETS OR LAW?

Current differences in international corporate ownership and governance systems reflect primarily differences in the efficiency of capital markets, not differences in corporate law. Law is an output of this process, not an input. In countries where financial markets are more efficient, there is both less law and greater investor protection. Unlike nations in Asia and most of Europe, the U.S. and the U.K. have large and efficient capital markets, with no restrictions on cross‐border capital flows. It is thus notsurprising that when American and English banks, mutual funds, and insurers are allowed by law to increase the concentration of their holdings, they don't do so. With efficient markets, there is no money to be made by holding undiversified blocks in public corporations. If public markets were inefficient, entrepreneurs would arrange for large blocks of stock (or take companies private), just as they grant powers of control to venture capitalists. The effect of law on corporate governance and ownership is far less pronounced in America than in Europe and Japan. Restrictions on U.S. banks aside, corporate law in the United States is “enabling”–that is, it lets people do largely what they want in organizing, managing, and financing the firm. Corporate law in Europe and Japan is much more “directory.” And there is a straightforward explanation for this difference: When capital markets are efficient, the valuation process works better, which in turn provides investors with stronger assurances of fairness. When markets are less efficient, some substitute must be found–law, perhaps, or the valuation procedures of banks. Thus, banks play larger corporate governance roles in nations with less extensive capital markets–and corporate law, as the European Union's company directives show, is more restrictive. European corporate law is today about as meddlesome and directory as U.S. law in the late 19th century, before U.S. capital markets became efficient.