Law and finance literature stemming from the works of La Porta, Lopez-de-Silanes, Shleifer and Vishny (LLSV) (1997, 1998) suggests that upgraded investor protection should promote the development of financial markets. Several authors suggest a critical role for investor protection improvements in supporting growth of emerging markets (e.g., Johnson, Boone, Breach and Friedman, 2000, Pistor, 2000, Glaeser, Johnsson and Shleifer, 2001, Mitton, 2002, La Porta, Lopez de-Silanes and Shleifer, 2006, and Mueller, 2006). However, some evidence concerning effects of the US Sarbanes-Oxley Act of 2002 (SOX) (e.g., Engel, Hayes and Wang, 2007, Litvak, 2007, and Zhang, 2007) casts a doubt on whether improvements of investor protection are always beneficial for financial market development, irrespective of their implementation costs.
This is reflected in the debate on pros and cons of increased transparency regulation following the recent financial crisis (e.g., Laux and Leuz, 2009, and Shaffer, 2010). There is also growing evidence (e.g., Spamann, 2010) that the results of law and finance approach are sensitive to the problems caused by the interpretation of law across countries and other large cross-country differences. The question of whether and how legal protection of investors matters might hence be more accurately explored in a clinical single country case. We present such an exploration, as we study an exceptionally large and long process of reforming corporate law that took place in Finland in the 1970s.
As in many other countries, financial market regulation was reformed in Finland in the aftermath of the crisis of the 1930s and has since then been gradually revised. In contrast, corporate law in Finland was still in 1970 based on an outdated but flexible Companies Act of 1895. The Finnish stock market during the 1970s was small and illiquid and comparable to many of today’s emerging markets. The focus of this study is the reform process leading to the new corporate law on January 1, 1980 and its effects on stock market development and availability of equity financing for Finnish firms. The goal of the reform was to substantially increase the regulatory outreach of the corporate law.
The reform process was exceptionally long, lasting over a decade, and its effects on the relationship between the corporations and their investors were large. Measured by the indices of shareholder and creditor protection created by LLSV (1997, 1998) and subsequently accommodated by Pistor (2000) and Glaeser et al. (2001) for an emerging country context, both investor groups received significant improvements to their protection against abuse by corporate insiders. Besides the effects captured by the investor protection indices, the reform brought about significantly tightened disclosure rules for Finnish companies. The most obvious potential economic costs of the reform were reduced corporate flexibility due to expanded regulation, and increased work load in corporate reporting.
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Reforming Corporate Law in an Emerging Market: The Case of Finland in the 1970’s
