Alfred Marshall Lecture Shareholder Protection, Stock Market Development, and Politics

Marco Pagano and Paolo Volpin

Journal of the European Economic Association, 2006, vol. 4, issue 2-3, 315-341

Abstract: This paper presents a political economy model in which there is mutual feedback between investor protection and stock market development. Better investor protection induces companies to issue more equity and thereby leads to a broader stock market. In turn, equity issuance expands the shareholder base and increases support for shareholder protection. This feedback loop can generate multiple equilibria, with investor protection and stock market size being positively correlated across equilibria. The model's predictions are tested on panel data for 47 countries over 1993-2002, controlling for country and year effects and endogeneity issues. We also document international convergence in shareholder protection to best-practice standards, and show that it is correlated with cross-border mergers and acquisitions activity, consistent with the model. (JEL: G34, K22, K42) (c) 2006 by the European Economic Association.

Date: 2006
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