Privatization and Corporate Governance: The Lessons from Securities Market Failure (1999)

1. INTRODUCTION: CORPORATE GOVERNANCE REDISCOVERED A specter is haunting the neo-classical theory of the corporation.1 It is the specter that matters-that a positive theory of the fmn is incomplete unless it incorporates and explains the role of legal variables. Recent research on corporate governance has found systematic differences among nations in ownership concentration, capital market development, the value of voting rights, and the use of external finance.2 More importantly, these differences seem to correlate closely with the strength of the legal protections given minority investors.3 In turn, this level of legal protection seems to depend upon, and vary systematically with, the nature and origins of each nation's legal system. In particular, legal systems seem to vastly outperform legal systems (and particularly French systems) in providing investor protections and, in turn, encouraging capital market growth and ownership dispersion. Most importantly, this new scholarship has found that the size, depth, and liquidity of securities markets correlates directly with the quality of the legal protections given to shareholders.4 In consequence, because the nature and quality of legal protection differs widely across nations, the corporate world subdivides today into rival systems of dispersed ownership and concentrated ownership, with different structures of corporate governance characterizing each.5 A paradigm shift is now underway in the manner in which financial economics views corporate governance, with the new scholarship emphasizing both the centrality of legal protections for minority shareholders and the possibility that regulation can outperform private contracting.6 Although this Article recognizes the importance of this transition, it is far more skeptical about whether this new scholarship has identified the critical elements that have given the common law nations a comparative advantage over the civil law world. Here, a mystery remains, One possibility is that substantive differences in corporate may matter far less than differences in enforcement practice. In turn, enforcement may depend more upon the strength of the incentives to assert legal remedies than upon the availability of legal remedies themselves. Even this hypothesis, however, oversimplifies, because once one examines closely the differences among various systems of corporate governance, the assumed homogeneity of even legal systems begins to break down. Another possibility is that differences in substantive corporate are less important than the differences in the level of regulation that different nations impose on their securities markets.7 Under this latter hypothesis, the focus shifts from the minority shareholder to the investor generally. The critical question becomes: Does local establish adequate disclosure and market transparency standards, restrict insider trading, and regulate takeovers and corporate control contests adequately? If it does, then arguably the exposure of shareholders to unfair self-dealing transactions at the corporate level may have only a second-level significance. This Article finds considerable evidence in the Polish and Czech experiences to be consistent with this hypothesis. Inadequate securities regulation plays the primary role in explaining privatization failures, but the Article also finds some evidence to suggest that deficiencies in Czech corporate contributed to the systematic looting of Czech companies by their controlling shareholders. Even if the critical protections upon which minority shareholders depend have not yet been clearly identified, the available data still strongly support the interpretation that matters; that in some not yet well-understood manner, certain legal systems have encouraged dispersed ownership, while other systems have rendered it an unstable and transient phenomenon. This new emphasis on legal variables has potentially subversive implications for at least some aspects of neo-classical corporate finance theory. …