law and strongfinancestrong why does legal origin matter.pdf

Law and Finance: Why Does Legal Origin Matter? Thorsten Beck, Asli Demirgüç-Kunt and Ross Levine First Draft: May 2002 This Draft: November 2002 Abstract : New research suggests that cross-country differences in legal origin help explain differences in financial development. This paper empirically assesses two theories of why legal origin influences financial development. First, the “political” channel stresses that (i) legal traditions differ in the priority they give to the rights of individual investors vis-à-vis the state and (ii) this has repercussions for the development of property rights and financial markets. Second, the “adaptability” channel holds that (i) legal traditions differ in their ability to adjust to changing commercial circumstances and (ii) legal systems that adapt quickly to minimize the gap between the contracting needs of the economy and the legal system’s capabilities will foster financial development more effectively than would more rigid legal traditions. We use historical comparisons and cross-country regressions to assess the validity of these two channels. We find that legal origin matters for financial development because legal traditions differ in their ability to adapt efficiently to evolving economic conditions. Keywords: Law; Financial Development JEL Classification: G2, K2, K4, O16, P5 Beck (MSN MC 3-300) and Demirgüç-Kunt: World Bank, Washington, DC 20433 (tbeck@worldbank.org and ademirguckunt@worldbank.org respectively), Levine: Carlson School of Management, University of Minnesota, Minneapolis, MN 55455 (rlevine@csom.umn.edu). We thank Pam Gill for excellent research assistance. We thank without implicating Daron Acemoglu, Maria Carkovic, Simeon Djankov, Tim Guinnane, Simon Johnson, Paul Mahoney, Richard Messick, Jean-Laurent Rosenthal, Andrei Shleifer, and two anonymous refe