The Quality of the Legal System, Firm Ownership, and Firm Size

Luc Laeven and Christopher Woodruff

The Review of Economics and Statistics, 2007, vol. 89, issue 4, 601-614

Abstract: We show that firm size is increasing with the quality of the legal system in Mexico. A 1-standard-deviation improvement in the quality of the legal system is associated with a 0.15-0.30 standard deviation increase in firm size. We also show that the legal system affects firm size by reducing the idiosyncratic risk faced by firm owners. The legal system has a smaller impact on partnerships and corporations than on proprietorships, where risk is concentrated in a single owner. All of the findings are robust to instrumenting for legal quality using historical conditions. By focusing on firms in a single country, the data draw attention to the importance of informal institutions. Copyright by the President and Fellows of Harvard College and the Massachusetts Institute of Technology.

Date: 2007
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