Law and Finance: Why is Common Law Superior?

In yesterday's post, I outlined the legal-origin or law-and-finance hypothesis, which argues that economies with a common-law legal origin have better financial development, investor protection laws, etc.. But why is common law better than civil law?

According to the legal-origin school, Civil law is viewed as inferior to common law because it is devised by academics and legal philosophers, whereas common law emerges from the process of judges resolving specific and real business disputes in a pragmatic manner. The infrequent revisions of civil-law codes means that they can quickly go out of date, whereas the common law can easily respond to new business environments and practices. Civil law is also subject to greater interference from politicians than common law.

But why did differences emerge between English common law and French civil law? According to the legal-origin school, there are two possible explanations. One explanation is that during the bloodless Glorious Revolution in England, lawyers were on the winning side, whereas in France, they were on the losing side. As a result, there was no judicial independence in France and government administration was expanded to cope with social problems. The second explanation is that differences between the two legal systems emerged in the medieval era. Whilst England was relatively peaceful in the medieval era, France faced both internal and external threats. As a result, dispute resolution was decentralized in England (with local juries and magistrates), whereas state-employed judges resolved disputes in France.

How Valuable Are Connections?

Daron Acemoglu, Simon Johnson, Amir Kermani, James Kwak and Todd Mitton have written a paper on whether firms connected to Timothy Geithner benefited from these connections. They do so by looking at how stocks of these firms reacted to the announcement that he was a nominee for Treasury Secretary in November 2008. They find that there were large abnormal returns for connected firms. Below is the paper's abstract and the full paper is available here . The announcement of Timothy Geithner as nominee for Treasury Secretary in November 2008 produced a cumulative abnormal return for financial firms with which he had a connection. This return was about 6% after the first full day of trading and about 12% after ten trading days. There were subsequently abnormal negative returns for connected firms when news broke that Geithner's confirmation might be derailed by tax issues. Excess returns for connected firms may reflect the perceived impact of relying on the advice of a small ne...

Boom and Bust: A Global History of Financial Bubbles

Boom and Bust: A Global History of Financial Bubbles, co-authored with my colleague Will Quinn , is forthcoming in August. It is published by Cambridge University Press and is available for pre-order at Amazon , Barnes and Noble , Waterstones and Cambridge University Press .

Bank Runs in Greece

Deposit withdrawals in Greece have been substantial over the past two years. However, the failure of Greece's politicians to form a coalition government has resulted in deposit withdrawals accelerating - click here and here for more on this. Depositors are rightly concerned about the exit of Greece from the euro and the subsequent devaluation of their deposits. The puzzle for me and many others is why are there so many deposits still remaining in the Greek banking system. One reason is that the Greek banking system is being kept alive by massive injections of money from the ECB. Will the ECB continue to support the Greek banking system in the face of a mass withdrawal of deposits? I doubt that there is the political will in Germany for this as the Bundesbank already has a huge exposure to Greece (as well as Spain and Italy) through the ECB's internal Target 2 system.

Finance: Past, Present and Future

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