The Quality of the Legal System, Firm Ownership, and Firm Size

55 Pages Posted: 20 Apr 2016

See all articles by Luc Laeven

Luc Laeven

European Central Bank (ECB); Centre for Economic Policy Research (CEPR)

Christopher M. Woodruff

University of California, San Diego (UCSD) - Graduate School of International Relations and Pacific Studies (IRPS)

Date Written: March 17, 2004

Abstract

Employment in developing countries is disproportionately concentrated in very small firms. Laeven and Woodruff examine the extent to which the distribution of firm size is related to the quality of the legal system using data from Mexico. They combine Lucas' (1978) model of firm size with Himmelberg, Hubbard, and Love's (2001) consideration of idiosyncratic risk in a framework in which the distribution of entrepreneurial talent and aversion to idiosyncratic risk combine to determine the optimal size of firms. Their data allows them to focus on the differential impact of the legal system on proprietorships and corporations. Moreover, by focusing on firms in a single country, the data draw attention to the importance of variation in the administration of justice and the enforcement of legal verdicts. The authors find that Mexican states with more effective legal systems have larger firms. A one-standard deviation improvement in the quality of the legal system increases the average firm size by about 10-15 percent. The impact of the legal system is greatest in sectors in which proprietorships dominate. This pattern is consistent with better legal systems increasing the investment of firm owners by reducing the idiosyncratic risk they face. All of these findings are upheld when the authors instrument for institutional variables using the log of indigenous population in 1900 and the active presence of the drug trade in the state.

This paper - a product of Financial Sector Operations and Policy Department - is part of a larger effort in the department to study the governance of firms.

Suggested Citation

Laeven, Luc A. and Woodruff, Christopher, The Quality of the Legal System, Firm Ownership, and Firm Size (March 17, 2004). Available at SSRN: https://ssrn.com/abstract=610287

Luc A. Laeven (Contact Author)

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Christopher Woodruff

University of California, San Diego (UCSD) - Graduate School of International Relations and Pacific Studies (IRPS) ( email )

9500 Gilman Drive
La Jolla, CA 92093-0519
United States
858-534-0590 (Phone)
858-534-3939 (Fax)

Here is the Coronavirus
related research on SSRN

Paper statistics

Downloads
197
Abstract Views
1,615
rank
173,736
PlumX Metrics