Legal Determinants of the Return on Equity

Davide Lombardo and Marco Pagano

No 2275, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: Recent work documents that better legal institutions are associated with broader equity markets. We investigate whether international differences in legal institutions also help explain the international cross-section of expected stock returns. We document three main regularities. First, total stock market returns are positively correlated with overall measures of the quality of institutions, such as judicial efficiency and rule of law, but have no relationship with measures of shareholder rights, controlling for risk. Second, dividend yields and earning-price ratios also correlate positively with judicial efficiency and rule of law, but negatively with shareholder rights' protection, controlling for risk and expected earnings growth. Thirdly, the excess return on new issues is negatively associated with the quality of accounting standards. We interpret the positive effect of the overall quality of institutions on equity returns as capturing the resulting curtailment of private benefits and increase of profitability, under imperfect international integration of stock markets. The negative impact of shareholders' legal protection and of accounting standards can instead be seen as resulting from the implied reduction in shareholders' auditing and monitoring costs.

Keywords: Corporate Governance; Enforcement; Law; Return On Equity; Shareholder Protection (search for similar items in EconPapers)
JEL-codes: G12 K22 K42 (search for similar items in EconPapers)
Date: 1999-11
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (22)

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Working Paper: Legal Determinants of the Return on Equity (2000)
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