What Works in Securities Laws?

Summary of working paper 9882
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Public enforcement appears to play a small role in the development of stock markets...Private enforcement systems foster greater investor confidence and ultimately more robust securities markets.

In What Works in Securities Laws? (NBER Working Paper No. 9882) Rafael La Porta, Florencio Lopez-de-Silanes, and Andrei Shleifer compare securities laws in 49 countries to evaluate their effect on the development of stock markets. This analysis focuses on the provisions of the securities laws governing initial public offerings, distinguishing between private enforcement of laws through investor lawsuits, and public enforcement through regulatory action. The authors examine the relationship between these laws and various measures of stock market development, and interpret these relationships in terms of prevailing theories of securities laws.

In pursuit of their data, the researchers enlisted the aid of securities lawyers in each of the 49 nations in the study. These specialists supplied information regarding the relevant laws and binding judicial precedents applicable to an offering of shares to be listed in each country's largest stock exchange in December 2000.

To evaluate private enforcement of securities laws, the researchers analyzed the requirements for issuers, underwriters, and auditors to collect and to disclose information about security offerings, and the liability if they fail to do so fully. They also considered who legally bears the burden of proof in regard to a claim of negligence, misinformation, or omission in a prospectus. To assess public enforcement, the researchers evaluated the degree of independence enjoyed by the securities market's supervisory agency, its rule-making and investigative powers, and the scope of sanctions that are applicable to violations of securities laws.

As measures of financial development in each country, the researchers considered the ratio of stock market capitalization to GDP, the number of publicly traded companies relative to population, the value of initial public offerings relative to GDP, a survey measure of the ease of raising equity, the premium paid for control in corporate control transactions, the quality of accounting information provided by firms, and ownership concentration in the largest firms. The study controlled for the level of economic development, the efficiency of the judiciary, and the quality of corporate law.

La Porta, Lopez-de-Silanes, and Shleifer begin by comparing securities laws in common and civil law countries. In the private enforcement area, the authors note, common law countries have more extensive mandatory disclosure requirements and make it easier for investors to recover damages from stock issuers and their agents. In the public enforcement area, these differences are smaller for supervisor independence and greater for investigative powers, non-criminal, as well as criminal sanctions.

In an average country, public enforcement appears to play a small role in the development of stock markets. For example, the supervisor's investigative powers and the strength of criminal and non-criminal sanctions matter for only a narrow set of outcomes. But stock market development is strongly associated with such private enforcement measures as extensive disclosure requirements and a relatively low burden of proof on investors claiming improper or inadequate disclosure from issuers. This leads the researchers to conclude that private enforcement systems foster greater investor confidence and ultimately more robust securities markets.

La Porta, Lopez-de-Silanes, and Shleifer affirm that investor protections clearly matter. By introducing extensive disclosure requirements and facilitating recovery of investor losses, securities laws reduce the costs of private contracting and litigation, and in this way promote financial development. The authors recognize that different mechanisms of social control of business are effective in different countries and markets. But in regard to securities markets, they say, the evidence suggests that the most effective arrangement is private enforcement of public rules, which encourages private recovery of damages by investors harmed by promoters.

-- Matt Nesvisky