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Convergence across CG systems: an interest group theory of financial development

Primary aim: Examine if properties of the national CG systems have any significant influence on the development of national financial markets. Convergence across CG systems: an interest group theory of financial development. Underdeveloped financial markets in EME and DE:. Ownership and control

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Convergence across CG systems: an interest group theory of financial development

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  1. Primary aim: Examine if properties of the national CG systems have any significant influence on the development of national financial markets Convergence across CG systems: an interest group theory of financial development

  2. Underdeveloped financial markets in EME and DE: • Ownership and control • Companies in EME and DE usually controlled by one owner or • state-owned • Poor legal systems and investor protection Need to attract foreign investors and need of strategic investors to restructure firm • Many family-owned firms Concern about the succession and the growth Incompetent managements not replaced Conflicts within families • Few listed firms • Crony capitalism

  3. Explanations of financial developmen: • Demand for more and cheaper credit. • Supply side • National CG systems • Political bargaining • Countries more financially developed in 1913 than in 1980 and only recently have surpassed their 1913 level, i.e. CG systems not the only determinant • Modern CG systems rare before 1913 • In 1913 countries with Common Law Systems were not more financially developed than countries with other types of legal systems.

  4. Relations between different explanations: • ’Political bargaining’ and ‘CG system’ are complementary theories, but ’Political bargaining’ is a first order explanation • Developed financial system: • Respect for property rights • Accounting and disclosure system promote transparency • Legal system that enforces arm’s length contracts cheaply • This system can be associated with good CG, but cannot be implemented without governments that coordinate standard with the power of enforcing laws.

  5. Model of political bargaining: Pluralistic theory of politics • Interest groups in the financial sector and in industry (incumbents) • They combat the development of the financial markets because they dislike competition • These groups reduce their resistance, and the conditions for financial development become more favourable, when countries open to trade. • The combined openness of trade and capital flow is needed to remove the resistance to capital market development.

  6. Economic reasons for resistance and political bargaining: Resistance: • A positional rent: Since incumbents have privileged access to finance, anybody who wants to start a business has to sell it to the incumbents or get funds • If a country opens for trade, foreign entries drive down domestic rents and cash flows. • If competition in domestic and foreign markets can be avoided, there is little need of access to foreign capital. Abandonment of the resistance: • If foreign countries open up for trade, new outside opportunities appear, which increase the need of incumbents to invest more

  7. Financial development: Attributes: • The ease with which any entrepreneur or company with a sound project can obtain finance • The confidence with which investors anticipate an adequate return • The spread of risk letting risk rest, where it can best be borne • Provision of credits at low costs. Indicators: • Banking sector - the ratio of deposits to GDP • Equity issues - the ratio of equity issue by domestic firms to gross fixed capital formation • Capitalization - total stock market capitalization • Number of listed companies - number of publicly traded domestic companies per million of population.

  8. Hypotheses about incumbents’ resistance to financial development: • For any given level of demand for financing, a country’s domestic financial development should be positively correlated with trade openness at a time when the world is open to cross-border capital flows • The positive correlation between a country’s trade openness and financial development should be weaker when worldwide cross-border capital flows are low.

  9. Investigation of the hypotheses: • Correlated to capitalization? • Hyp. 1 • 1913 • Bairoch’s index (level of indust) + • Openness to trade + (insignific.) • Baroch’s index * Openness to trade + • Late 1990 • (the same as for 1913, but openness to trade • is also significant) • Hyp. 2 • Beginning and end of the period 1913-1997 • Baroch’s index * Openness to trade + • The intermediate period 1913-1997 • Baroch’s index * Openness to trade insignific. or -

  10. Conclusion with regard to global CG: • Development of financial markets globally depends on reforms of the national CG-systems • While interest group politics are important, both types of explanations are needed for a complete understanding

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