We present a model of the effects of legal protection of minority shareholders and of cash-flow ownership by a controlling shareholder on the valuation of firms. We then test this model using a sample of 539 large firms from 27 wealthy economies.

In the last decade, economists have produced a considerable body of research suggesting that the historical origin of a country’s laws is highly correlated with a broad range of its legal rules and regulations, as well as with economic outcomes. We summarize this evidence and attempt a unified interpretation. We also address several objections to the empirical claim that legal origins matter. Finally, we assess the implications of this research for economic reform.

Data on corporate governance and disclosure practices reveal wide within-country variation that decreases with the strength of investors ’ legal protection. A simple model identifies three firm attributes related to that variation: investment oppor-tunities, external financing, and ownership structure. Using firm-level governance and transparency data from 27 countries, we find that all three firm attributes are related to the quality of governance and disclosure practices, and firms with higher governance and transparency rankings are valued higher in stock markets. All rela-tions are stronger in less investor-friendly countries, demonstrating that firms adapt to poor legal environments to establish efficient governance practices. PREVIOUS STUDIES SHOW THAT BETTER LEGAL PROTECTION for investors is associated with higher valuation of the stock market (La Porta et al. (2002)), higher valuation of listed firms relative to their assets or changes in investments (Wurgler (2000)), and larger listed firms in terms of their sales and assets (Kumar, Rajan, and Zingales (1999)). Furthermore, industries and firms in better legal regimes rely more on external financing to fund their growth

Outside the U.S. and the U.K., large corporations usually have controlling owners, who are usually very wealthy families. Pyramidal control structures, cross shareholding and super-voting rights let such families control corporations without making a commensurate capital investment. In many countries, a few such families end up controlling considerable proportions of their countries ’ economies. Three points emerge. First, at the firm level, these ownership structures, because they vest dominant control rights with families who often have little real capital invested, permit a range of agency problems and hence resource misallocation. If a few families control large swaths of an economy, such corporate governance problems can attain macroeconomic importance – affecting rates of innovation, economy-wide resource allocation, and economic growth. If political influence depends on what one controls, rather than what one owns, the controlling owners of pyramids have greatly amplified political influence relative to

We present a model of succession in a ¢rm owned and managed by its founder. The founder decides between hiring a professional manager or leaving management to his heir, as well as on what fraction of the company to £oat on the stock exchange. We assume that a professional is a better manager than the heir, and describe how the founder’s decision is shaped by the legal environment. This theory of separation of ownership from management includes the Anglo-Saxon and the Continental European patterns of corporate governance as special cases, and generates additional empirical predictions consistent with cross-country evidence. MOST FIRMS IN THE WORLD are controlled by their founders, or by the founders ’ families and heirs. Such family ownership is nearly universal among privately held ¢rms, but is also dominant among publicly traded ¢rms. In Western Europe, South and East Asia, the Middle East, Latin America, and Africa, the vast majority of publicly traded ¢rms are family controlled (La Porta, Lopez-de-Silanes,

This paper measures the value of corporate voting rights, specifically of the control block of votes, in a sample of 661 dual-class firms in 18 countries, in 1997. A consistent measure across countries is proposed. The measure is adjusted for takeover probability, block-holding costs, and dividend and liquidity differences between the share classes. The value of controlblock votes varies widely across countries. It is close to half of firm market value in South Korea, and close to zero in Finland. The value of control-block votes is interpreted as a lower bound for actual private benefits of the controlling shareholder. The legal environment, law enforcement, investor protection, takeover regulations, and power-concentrating corporate charter provisions explain 68 % of the cross-country variation in the value of control-block votes.

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Despite the dramatic reduction in explicit barriers to international investment activ-ity over the last 60 years, the impact of financial globalization has been surprisingly limited. I argue that country attributes are still critical to financial decision-making because of “twin agency problems ” that arise because rulers of sovereign states and corporate insiders pursue their own interests at the expense of outside investors. When these twin agency problems are significant, diffuse ownership is inefficient and cor-porate insiders must co-invest with other investors, retaining substantial equity. The resulting ownership concentration limits economic growth, financial development, and the ability of a country to take advantage of financial globalization. AT THE END OF WORLD WAR II, the financial markets of most countries were closed to cross-border trade in financial assets. Since then, many countries have sharply reduced such barriers. The liberalization of trade in financial assets is often called “financial globalization.” In neoclassical models, financial globalization generates major economic ben-

We provide a rationale for the use of pyramidal ownership (the control of a firm through a chain of ownership relations) that departs from the traditional argument of separating ownership and control. With a pyramidal structure a family uses a firm it already controls to set up a new firm. This allows the family to access the entire stock of retained earnings of the firm it controls and to share the security benefits of the new firm with the other existing shareholders of the original firm. Therefore, pyramids are more attractive when internal funds are important (e.g., due to the poorly functioning capital markets) and when the security benefits of the new firm are low; conditions that we show hold in an environment with poor investor protection. We also analyze the creation of family business groups (a collection of multiple firms under the control of a single family). Business group flourish when external markets are poorly developed because, in such cases, internal resources from the existing firms provide the family with a financing advantage vis-a-vis other competing entrepreneurs. Thus, the model predicts that in countries with poor investor protection family business groups should be common and they should be organized as pyramids. Because our model departs from the traditional argument for pyramids as a device to separate ownership and control, it can differentiate between pyramids and dual class shares even in situations in which the same deviation from one share-one vote can be achieved with either method. Unlike the traditional argument, our model is consistent with recent empirical evidence that some pyramidal firms are associated with small deviations between ownership and control. We also argue that pyramids can be an efficient organizational structure for the family if the availability of internal funds is sufficiently important, even though pyramids are associated with high levels of cash flow diversion. Other predictions of the model are consistent with systematic and anecdotal evidence on pyramidal business groups.

The statistical analysis of firm-level data on U.S. multinational companies was conducted at the International Investment Division, Bureau of Economic Analysis, U.S. Department of Commerce under arrangements that maintain legal confidentiality requirements. The views expressed are those of the authors