Why Does the Law Matter? Investor Protection and Its Effects on Investment, Finance, and Growth

McLean, R. David; Zhang, Tianyu; Zhao, Mengxin

doi:10.1111/j.1540-6261.2011.01713.x

Cited by 387 publications

(227 citation statements)

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“…We find that investment is more sensitive to cash flow in countries with an overall lower legal protection, in line with Mclean et al (2012). Most importantly, the findings suggest that FF firms are able to invest more than others and this effect is substantially larger in those countries where legal protections are lower.…”

Section: B2 Institutional Settingsupporting

confidence: 74%

“…In particular, the protection provided by legal institutions is a predictor of the costs of external financing (Almeida et al (2011)). This would in turn affect corporate financial and investment decisions too (Wurgler (2000); Love (2003); Mclean et al (2012); Mortal and Reisel (2012)). …”

Section: B2 Institutional Settingmentioning

confidence: 99%

“…Lower legal protection increases firms' expected asymmetric information and contracting problems which, in turn, negatively affects corporate financial and investment decisions (e.g., La Porta, Lopez-de-Silanes, Shleifer, and 9 Vishny (1997, 1998, 2000, and 2002Wurgler (2000); Love (2003); Mclean, Zhang and Zhao (2012); Mortal and Reisel (2012)). We expect financial flexibility to be more valuable for firms in these countries.…”

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confidence: 99%

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Financial Flexibility Across the Euro Area and the UK

2013

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Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Terms of use: Documents in EconStor may AcknowledgementsWe would like to thank the participants of the internal seminar at the European Central Bank (ECB) and at the Eastern Finance Association Meeting 2013. We are also thankful to an anonymous referee for useful comments. This research was conducted while Marchica and Mura were visiting the ECB, whose hospitality and support are gratefully acknowledged. The views expressed in this paper only reflect those of the authors and should not be attributed to the ECB. Annalisa Ferrando (corresponding author)European Central Bank; e-mail: annalisa.ferrando@ecb.int Maria-Teresa Marchica University of ManchesterRoberto Mura University of Manchester 1 AbstractWe use a large database of more than 685,000 European firms to show that financial flexibility attained through conservative leverage policies is more important for private, small, medium-sized and young firms and for firms in countries with lower access to credit and weaker investor protection. Further, using the recent financial crisis as a natural experiment, we show that financial flexibility status allows companies to reduce the negative impact of liquidity shocks on their investment decisions. Our findings support the hypothesis that financial flexibility relates to companies' ability to undertake future investment, despite market frictions hampering possible profitable growth opportunities. JEL Classification: G31, G32, D92Keywords: low leverage, financial flexibility, investment, cross-country analysis 2 Non-technical summaryIn an environment where capital markets are imperfect and the cost of external financing increases, companies may implement a conservative leverage policy to maintain "substantial reserves of untapped borrowing power" as pointed out by Modigliani and Miller (1963). This may allow them to access the capital markets in the event of positive shocks to their investment opportunity set.The purpose of our study is twofold. First, we investigate how a conservative debt policy aimed at maintaining financial flexibility can enhance corporate investment ability. Second, we study the value of financial flexibility across a very heterogeneous sample of both publicly traded and privately held firms that vary substantially in size, age, and quality of institutional settings.Our analysis is based on a rich database of more than 685,000 firms from eight euro area countries and the UK. We first identify financially flexible firms (FF) as those that...

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Section: B2 Institutional Settingsupporting

confidence: 74%

Section: B2 Institutional Settingmentioning

confidence: 99%

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confidence: 99%

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Financial Flexibility Across the Euro Area and the UK

2013

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“…The paper also contributes to the literature on the efficiency of capital allocation (Durnev et al, 2004, McLean et al, 2012, Morck eta al., 2011, Wurgler, 2000. Our paper is the first to provide evidence that differences in managerial traits, in particular gender, appear to have implications for the quality of the capital allocation process --a fundamental underpinning of economic growth (Bagehot, 1873, Beck et al, 2000, Greenwood and Jovanovic, 1990, John et al, 2008.…”

Section: Introductionmentioning

confidence: 90%

CEO Gender, Corporate Risk-Taking, and the Efficiency of Capital Allocation

2012

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We extend the literature on how managerial traits relate to corporate choices by documenting that firms run by female CEOs have lower leverage, less volatile earnings, and a higher chance of survival than otherwise similar firms run by male CEOs. Additionally, transitions from male to female CEOs (or vice-versa) are associated with economically and statistically significant reductions (increases) in corporate risk-taking. The results are robust to controlling for the endogenous matching between firms and CEOs using a variety of econometric techniques. We further document that this risk-avoidance behavior appears to lead to distortions in the capital allocation process. These results potentially have important macroeconomic implications for long-term economic growth. To investigate whether CEO gender still plays a role in financial and investment policies after explicitly accounting for self-selection due to unobservables, we employ a variation of the Heckman two-step approach: the treatment effects model. Our choice of an exogenous determinant of the propensity to select a female CEO is based on the familiarity of a firm's male directors with female CEOs. More specifically, our first stage instrumental variable is the fraction of firms with a female CEO and above-average risk-taking among all other firms in which the firm's male directors also serve as directors. We argue that it is unlikely that this familiarity, combined with above-average risk-taking (in other firms), will be correlated with 4 outcomes (in particular, risk-avoidance) except through its effect on CEO gender. The results of the treatment effects model provide little support for the notion that the differences in corporate risk-taking observed between firms run by female and male CEOs are due to self-selection. Thus, the results appear to be consistent with CEO gender influencing corporate risk-taking.To the extent that the documented differences in corporate risk-taking are driven by female CEOs imposing their preferences on corporate choices, the efficiency of the capital allocation process could be undermined. The paper also contributes to the literature on the efficiency of capital allocation (Durnev et al., 2004, McLean et al., 2012, Morck eta al., 2011, Wurgler, 2000. Our paper is the first to provide evidence that differences in managerial traits, in particular gender, appear to have implications for the quality of the capital allocation process --a fundamental underpinning of economic growth (Bagehot, 1873, Beck et al., 2000, Greenwood and Jovanovic, 1990, John et al., 2008.The rest of the paper is organized as follows. Section 2 describes the data. Section 3 investigates the relation between CEO gender and corporate risk-taking. Section 4 investigates the implications for the quality of the capital allocation process. Section 5 discusses the 7 economic reasons why CEO gender could impact risk-taking (including differences in risk aversion) and Section 6 concludes. DataMost of the data used in the paper are taken from Amadeus To...

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“…First, in addition to the investor protection proxy using GGI, we re-estimate the model using two alternative proxies of investors' rights protection that recent studies have frequently used (e.g., Bushman and Piotroski 2006;McLean, Zhang and Zhao 2012;Peek, Cuijpers and Buijink 2010). One is a comprehensive investor protection variable, PROTECT, which captures both the letter of the law and the strength of law enforcement, and the other is a public enforcement index, PUBENF.…”

Section: Other Robustness Checksmentioning

confidence: 99%

Does accounting conservatism improve the corporate information environment?

Zhang

2014

Journal of International Accounting, Auditing and Taxation

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This study investigates whether and how accounting conservatism improves the corporate information environment. We argue that conservatism facilitates the flow of firm-specific information from corporate insiders to outsiders and leads to a highquality information environment. Using the Basu (1997) model to capture the extent of accounting conservatism and firm-specific return variation to proxy for the quality of information environment, we find that conservatism is positively associated with the improvement of the corporate information environment in our sample of 43 countries. We also find that such an information role of conservatism is more pronounced in countries with weaker protection of private property rights, suggesting that conservatism substitutes for legal institutions in ensuring the quality of information environment. JEL classifications: G32; M41

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Why Does the Law Matter? Investor Protection and Its Effects on Investment, Finance, and Growth

Cited by 387 publications

References 95 publications

Financial Flexibility Across the Euro Area and the UK

Financial Flexibility Across the Euro Area and the UK

CEO Gender, Corporate Risk-Taking, and the Efficiency of Capital Allocation

Does accounting conservatism improve the corporate information environment?

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