Protection of minority interest and the development of security markets

Franco Modigliani and Enrico Perotti

Managerial and Decision Economics, 1997, vol. 18, issue 7-8, 519-528

Abstract: While excessive regulation is an obstacle to the development of financial markets, we argue that lack of basic rules or poorly enforced regulation may explain the relative importance across countries of banking and security markets in financing firms. A selective or arbitrary enforcement transforms legal rules into an exclusionary good; arm's length market exchanges become unreliable. As a result, transactions tend to become intermediated through institutions or concentrated among agents bound by some form of private enforcement. Provision of funding shifts from risk capital to debt, and from markets to institutions with long term relations.

Securities, as standardized arm's length contractual relationships, are most vulnerable to poor enforcement. We show that when small investors' rights are poorly protected, the ability of firms to raise equity capital is impaired, and as a result, profitable new ventures will be forsaken. This suggests a conflict of interest over regulatory standards between the controlling shareholders in listed firms and new entrepreneurs. More generally, fewer firms will be financed with outside equity, resulting in a low capitalization relative to GNP and a predominance of internal (unlisted) equity and bank lending over traded securities.

We present some supporting evidence on the correlation between investor protection and development of security markets. We rely on a price measure, the premium on voting stock, which is related to the control premium. In countries where this premium is large, corporate financing is dominated by bank lending and equity markets are much smaller. Although the sample size is limited, the correlation is quite strong. © 1997 John Wiley & Sons, Ltd.

Date: 1997
References: Add references at CitEc
Citations: View citations in EconPapers (31)

There are no downloads for this item, see the EconPapers FAQ for hints about obtaining it.

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:wly:mgtdec:v:18:y:1997:i:7-8:p:519-528

DOI: 10.1002/(SICI)1099-1468(199711/12)18:7/8<519::AID-MDE857>3.0.CO;2-M

Access Statistics for this article

Managerial and Decision Economics is currently edited by Antony Dnes

More articles in Managerial and Decision Economics from John Wiley & Sons, Ltd.
Bibliographic data for series maintained by Wiley Content Delivery ().