Legal Determinants of the Return on Equity

51 Pages Posted: 29 Feb 2000

See all articles by Davide Lombardo

Davide Lombardo

European University Institute

Marco Pagano

University of Naples Federico II - Department of Economics and Statistics; Centre for Studies in Economics and Finance (CSEF); Einaudi Institute for Economics and Finance (EIEF); Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI)

Date Written: October 1999

Abstract

Recent work documents that better legal institutions are associated with broader equity markets. We investigate whether international differences in legal institutions also help explain the international cross-section of expected stock returns. We document three main regularities. First, total stock market returns are positively correlated with overall measures of the quality of institutions, such as judicial efficiency and rule of law, but have no relationship with measures of shareholder rights, controlling for risk. Second, dividend yields and earning-price ratios also correlate positively with judicial efficiency and rule of law, but negatively with shareholder rights' protection, controlling for risk and expected earnings growth. Thirdly, the excess return on new issues is negatively associated with the quality of accounting standards. We interpret the positive effect of the overall quality of institutions on equity returns as capturing the resulting curtailment of private benefits and increase of profitability, under imperfect international integration of stock markets. The negative impact of shareholders' legal protection and of accounting standards can instead be seen as resulting from the implied reduction in shareholders' auditing and monitoring costs.

Keywords: Law, enforcement, shareholder protection, corporate governance, return on equity

JEL Classification: G12, K22, K42

Suggested Citation

Lombardo, Davide and Pagano, Marco, Legal Determinants of the Return on Equity (October 1999). Stanford Law and Economics Olin Working Paper No. 193; and University of Salerno Working Paper No. 24. Available at SSRN: https://ssrn.com/abstract=209310 or http://dx.doi.org/10.2139/ssrn.209310

Davide Lombardo

European University Institute ( email )

Badia Fiesolana
Via dei Roccettini 9
I-50016 San Domenico Fiesole, Tuscany 50014
Italy

Marco Pagano (Contact Author)

University of Naples Federico II - Department of Economics and Statistics ( email )

Via Cintia - Monte S. Angelo
Napoli, 80126
Italy
+39 081 675306 (Phone)
+39 081 7663540 (Fax)

Centre for Studies in Economics and Finance (CSEF) ( email )

Via Cintia
Complesso Monte S. Angelo
Naples, Naples 80126
Italy

Einaudi Institute for Economics and Finance (EIEF)

Via Sallustiana, 62
Rome, 00187
Italy

Centre for Economic Policy Research (CEPR)

London
United Kingdom

European Corporate Governance Institute (ECGI)

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

HOME PAGE: http:/www.ecgi.org

Register to save articles to
your library

Register

Paper statistics

Downloads
1,820
Abstract Views
7,843
rank
8,391
PlumX Metrics