Academic journal article Brigham Young University Law Review

"Law and Finance": Inaccurate, Incomplete, and Important

Academic journal article Brigham Young University Law Review

"Law and Finance": Inaccurate, Incomplete, and Important

Article excerpt

"On the face of it, shareholder value is the dumbest idea in the world. Shareholder value is a result, not a strategy. . . . Your main constituents are your employees, your customers and your products."

- Jack Welch, former CEO of General Electric


While virtually all scholars of corporate governance agree that national differences exist in corporate governance practices and their efficacy, debate continues regarding the relevant dimensions of difference and how to best explain them. In this Essay, we argue that the strong conceptual and empirical link between law and finance as proposed within the legal origins theory and fully launched in a series of articles by LLSV2 is inaccurate, incomplete, and yet important. At the least, it is important to get a clearer view of the field such that we may better understand the broader scope of the "law-finance" relationship, particularly as the law and finance theory has had demonstrated effects on international policy developments.

A number of scholars have effectively demonstrated the key shortcomings of this theoretical and empirical unidirectional linkage from law to finance.3 We do not need to review that literature here, but we find it convincing. And, in response to some of their critics, La Porta, Lopez-de-Silanes, and Shleifer have rectified some of their strong and prescriptive former claims.4 In this Essay, we discuss in Part II what we have learned from this agitated debate with so many policy and real life ramifications, why it is important to conceptualize a larger and more complex picture of the proposed law-finance causality, what we can learn from existing research on comparative systems in social science, and what we need to study next in the field of research of legal systems and economic sociology. In Part III, we discuss why it is important to get "law and finance" right.


A. Complementarities Matter

One could take multiple routes to illustrate the principle that looking simply at the characteristics of the legal system to explain economic outcomes is incomplete. One limitation is, perhaps, the methodological tools we use to analyze these questions. For instance, it seems rather narrow to summarize the advanced industrialized countries into two stylized systems: liberal market economies and coordinated market economies, which happen to correspond nicely to the common and civil law dichotomy. Perhaps the explanation for simplicity is the methodological limitations we face in comparative corporate governance research and comparative law - namely, a large number of potential explanatory variables and a small number of cases. Kogut and Ragin put it well when discussing the limited diversity within varieties of capitalism and their empirical rejection of the hypothesis of a direct relationship between rule of law and financial development. They state that "[c]ontrary to silver bullet theories, many studies recognize that economic systems are varied and that there is more than one path to wealth."5

Organizations are widely conceived as complex systems of interdependent factors, but empirical methodology often poorly reflects such interdependence. For example, standard linear models, such as regression analysis, treat variables as competing to explain variation in the outcome rather than focusing on how causes may combine in specific cases to create outcomes. Meanwhile, case studies have an important tradition in organizational research, but such studies face the challenge of generalizing across cases or using cases effectively to better "contextualize" the boundary conditions of existing theories. Recently, new innovations in comparative research methods have been developed and applied to the comparative study of corporate governance at the organizational or national level. In particular, a number of newer small-n and set-theoretic methods, such as Qualitative Comparative Analysis ("QCA"), have been applied to cross-national data (where n is small)6 or to organizational analysis where causation is complex and there is more than one path to an outcome. …

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