Tuesday, August 27, 2013

Three Papers on Protection of Investor Rights

Debt Enforcement Around the World by Simeon Djankov, Oliver Hart, Caralee McLiesh, and Andrei Shleifer.

"We present insolvency practitioners from 88 countries with an identical case of a hotel about to default on its debt, and ask them to describe in detail how debt enforcement against this hotel will proceed in their countries. We use the data on time, cost, and the likely disposition of the assets (preservation as a going concern versus piecemeal sale) to construct a measure of the efficiency of debt enforcement in each country. We identify several characteristics of debt enforcement procedures, such as the structure of appeals and availability of floating charge finance, that influence efficiency. Our measure of efficiency of debt enforcement is strongly correlated with per capita income and legal origin and predicts debt market development across countries."
It is amazing how long it can take to start a business or collect an undisputed debt, and also how greatly the amount of time varies from place to place. As these authors observe, no matter where they look in the world, the resolution of the insolvent hotel (a simple, single asset case) is "extremely time consuming, costly, and inefficient."

The Nordic and common law countries are the best at debt enforcement, while French law are the worst. Also, French law countries and poor countries are most likely to deviate from absolute priority of the senior secured creditor. In Singapore, Netherlands, and Japan, enforcing the debt only costs about five percent of the estate. In Turkey and Angola, enforcement is so costly that less than seven percent of the estate is left!

Tunnelling by Simon Johnson, Rafael La Porta, de Silanes, and Andrei Shleifer.
"Tunnelling is defined as the transfer of assets and profits out of firms for the benefit of their controlling shareholders. We describe the various forms that tunnelling can take, and examine under what circumstances it is legal. We discuss two important legal principles -- the duty of care and the duty of loyalty -- which courts use to analyze cases involving tunnelling. Several important legal cases from France, Belgium, and Italy illustrate how and why the law accommodates tunnelling in civil law countries, and why certain kinds of tunnelling are less likely to pass legal scrutiny in common law countries."
French/civil law countries seem to be systematically inferior to common law countries for investing, because this paper finds that civil law is less protective of minority shareholders, specifically in the legal treatment with respect to looting by insiders.

I do not understand why investors tolerate these legal regimes where the rules of the game put them at a disadvantage. The goal of investing is to receive coupons, payments of cash, not annual reports with nicely escalating accounts (that you will never touch). Investing in Brazil or China is like buying a noncumulative preferred stock. They are trick securities, unsafe at almost any price.

What Works in Securities Law? by Rafael La Porta, de Silanes, and Andrei Shleifer.
"We examine the effect of securities laws on stock market development in 49 countries. We find almost no evidence that public enforcement benefits stock markets, and strong evidence that laws facilitating private enforcement through disclosure and liability rules benefit stock markets."
This is a tricky one because there are so many variables. I am pretty sympathetic to the idea that private enforcement works better, though. But for private enforcement to really work you need efficient, fast, predictable courts.

That is why the first two papers are important, the acid test of a country's property rights and legal system. Can you collect your collateral when a company fails to repay you? Can you stop a crooked management from looting a company? In many countries, the answer to both is "no".

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