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COASE VERSUS THE COASIANS*
EDWARD GLAESERSIMON JOHNSONANDREI SHLEIFER
Who should enforce laws or contracts: judges or regulators? Many
Coasians,though not Coase himself, advocate judicial enforcement.
We show that the incen-tives facing judges and regulators crucially
shape this choice. We then compare theregulation of nancial markets
in Poland and the Czech Republic in the 1990s. InPoland, strict
enforcement of the securities law by a highly motivated regulator
wasassociated with a rapidly developing stock market. In the Czech
Republic, hands-offregulation was associated with a moribund stock
market.
I. INTRODUCTION
At the heart of economists traditional skepticism about
gov-ernment regulation is the Coase theorem [Coase 1960].
Thetheorem states that when property rights are well dened
andtransaction costs are zero, market participants will
organizetheir transactions in ways that achieve efcient outcomes.
Whenthey can do so, it is not necessary for the government to
engage incorrective actions through taxes, regulations, or even
legalrules. Financial markets are often used to demonstrate the
Coasetheorems case against regulation. Advocates of the regulation
ofthese markets point to a variety of potential failures, such as
theability of security issuers to expropriate both potential and
exist-ing investors through misrepresentation or prot diversion.
Inves-tors fear of such expropriation prevents rms from raising
externalfunds, and keeps efcient projects from being
undertaken.
Not so, reply the Coasians. They point out that most securi-ties
transactions take place between sophisticated adults, andthat both
the buyers and the issuers of securities have availableto them a
vast range of private arrangements to achieve ef-ciency, including
contracts such as corporate charters, certica-tion by
intermediaries, and various forms of bonding. Such con-tracts
render most laws and regulations unnecessary [Stigler1964;
Easterbrook and Fischel 1991].
* We thank Alberto Alesina, Simeon Djankov, Oliver Hart, Louis
Kaplow,Lawrence Katz, Rafael La Porta, Florencio Lopez-de-Silanes,
Gerry McDermott,Randall Morck, Raghuram Rajan, Mark Ramseyer,
Steven Shavell, Peter Temin,and three anonymous referees for
helpful comments and the National ScienceFoundation and the
Massachusetts Institute of Technology EntrepreneurshipCenter for
nancial support.
2001 by the President and Fellows of Harvard College and the
Massachusetts Institute ofTechnology.The Quarterly Journal of
Economics, August 2001
853
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On the face of it, the Coasians argument is powerful. Yet
itcrucially relies, among other assumptions, on the possibility
ofeffective judicial enforcement of complicated contracts.
Judgesmust be able, and more importantly willing, to read
complicatedcontracts, verify whether the events triggering
particular clauseshave actually occurred, and interpret broad and
ambiguous lan-guage. These requirements on the judges apply as
strongly to thejudicial enforcement of laws, where the
interpretation and appli-cation of particular statutes requires
signicant investment. Inreality, courts in many countries are
undernanced, unmoti-vated, unclear as to how the law applies,
unfamiliar with eco-nomic issues, or even corrupt. Such courts
cannot be expected toengage in costly verication of the facts of
difcult cases orcontingencies of complicated contracts. Indeed,
even when con-tracts are restricted by statutes, the courts may not
have theresources or incentives to verify whether or how particular
stat-utes apply.
Financial contracting illustrates these problems. When is
theinformation that a rms manager fails to disclose to
shareholdersmaterial, and hence has to be disclosed because of a
statute ora contract? When does a corporation abuse minority
sharehold-ers, as opposed to just following the managers best
businessjudgment? When does a broker fail to engage in honest
tradingin executing customer orders? When does a manager trade
oninside information rather than simply happen to be lucky?
Theinterpretation of the contracts or statutes involving such terms
isexpensive, and requires powerful incentives to motivate an
adju-dicator to invest in understanding the case. Absent such
incen-tives, courts often postpone decisions, or simply let go the
poten-tial violators of rules and contracts.
An alternative strategy is the enforcement of legal rules
byregulators as opposed to judges. In our view, the crucial
distinc-tion between judges and regulators is that the latter can
be moreeasily provided with incentives to punish violations of
particularstatutes.1 Judges, in contrast, are by design more
independentand therefore harder to motivate. The stronger
incentives of theregulators have the benet of bringing about more
aggressiveenforcement than can be achieved through courts. Yet
these
1. The classic reference on the incentive of law enforcers is
Becker and Stigler[1974], to whose work we return below. A recent
survey of public enforcement oflaw by Polinsky and Shavell [2000]
scarcely pays attention to the incentives of theenforcers.
854 QUARTERLY JOURNAL OF ECONOMICS
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incentives also have the potential cost of excessively
aggressiveenforcement when regulators motivated to nd violations
penal-ize innocent suspects. There is thus a trade-off between
enforce-ment by judges facing relatively weak but unbiased
incentivesand enforcement by regulators facing stronger but
possibly biasedincentives.2
We present a theoretical model that sheds light on this
trade-off, and identies the circumstances under which enforcement
byjudges or regulators is preferred. The model shows that,
relativeto judges, regulators may be better motivated to invest in
under-standing the laws and circumstances of a case, but also
morelikelyif overmotivatedto reach politically desirable
decisionsat the expense of doing justice. The model also shows how
reduc-ing the costs of the investment in information by law
enforcerscan improve enforcement efciency.
We then illustrate the model by comparing the regulation
ofsecurities markets through corporate and securities laws in
Po-land, the Czech Republic, and to a lesser extent Hungary.
Inthese transition economies, nancial regulation was
designedessentially from scratch, and hence we can compare both
thedesigns of laws and regulations and their consequences. Themodel
bears in particular on the design of securities laws, sincethese
laws shape the incentives of market regulators as well asthe costs
of information acquisition by the enforcers.
We show that, in its securities law, Poland adopted a
morestringent regulatory stance than did the Czech Republic.
Thisdifference was reected not just in the general philosophies
ofregulation, but in the statutes and the mechanisms of law
en-forcement. In contrast to the Czech Republic, Poland
adoptedlegal rules highly protective of investors, mandated
extensiveinformation disclosure by securities issuers and
intermediaries,and created an independent and highly motivated
regulator toenforce the rules. We nd that this approach to
regulation inPoland has stimulated rapid development of securities
markets,and enabled a number of rms to raise external funds.
Theexpropriation of investors has been relativelymodest. In
contrast,the lax regulations in the Czech Republic, enforced by an
unmo-tivated ofce in the nance ministry, have been associated
with
2. Coase [1988, pp. 117118] recognized that regulation may be
preferred tojudicially enforced contracts as a method of regulating
some types of conduct:There is no reason why, on occasion, such
governmental regulation should not bean improvement on economic
efciency.
855COASE VERSUS THE COASIANS
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security delistings and a notable absence of equity nancethrough
a public market by either new or existing rms. Expro-priation of
investors has been rampant, and has acquired a newCzech-specic
name, tunneling [Coffee 1996, 1998, 1999; Pistor1999; Johnson et
al. 2000b]. Starting in 1996, the Czech govern-ment tightened its
regulations. Hungary adopted an intermediateregulatory stance, and
has shown an intermediate level of nan-cial development.
II. A MODEL OF ENFORCEMENT INCENTIVES
A. Basic Model
We consider a situation in which the government wishes topunish
particular conduct creating negative externalities, such
asnondisclosure of material information by a manager or
marketmanipulation by a broker. This task is assigned to an
enforce-ment ofcial (an adjudicator). The question we address is
whetherthe government wants this adjudicator to be a judge or a
regula-tor. In the case of a judge, we focus on the inquisitorial
legalsystem of civil law countries, where the judge must himself
un-dertake an investigation into the facts of the situation and
thelaw. The model we present focuses on the case where there is
alegal rule or law that restricts certain conduct. The question
ofwho should adjudicate, however, equally well applies to a
situa-tion in which two private parties such as an investor and a
brokercontractually agree on their conduct and have a dispute
onwhether this contract was followed.
Our general assumption is that the society does not have
fullcontrol over the incentives facing law enforcement ofcials. Its
abil-ity to reward them for enforcing the law is limited because
doingjustice is largely unveriable. Many of the rewards that
theseofcials receive for doing justice are intangible, including
self-es-teem and the respect of ones peers. On the other hand, the
govern-ment does have the ability to politicize the enforcement of
particularlegal rules by rewarding the enforcers for certain
outcomes such asnding violations. We are interested in the
conditions under whichthe government would choose such
politicization.
We consider an adjudicator (who can be a judge or a regula-tor)
examining a possible violation of a legal rule. For a cost c >0,
this adjudicator can undertake an investigationwhich forsimplicity
we call searchand nd out for sure whether a viola-
856 QUARTERLY JOURNAL OF ECONOMICS
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tion had taken place. We think of c as a personal cost to
theadjudicator, which includes the time he might otherwise
spendworking on other matters. The adjudicator has complete
discre-tion as to whether to penalize the potential violator, and
candecide to do so without searching and incurring the cost c.
The adjudicator derives a payoff of b from following the law,or
doing justice, which here means punishing a violator of the ruleand
letting go an innocent person. We can think of b as self-esteem or
long-run respect of the peers, which evidently mattersto judges
[Posner 1995]. We assume that, in the short run, thegovernment
cannot increase b, since it cannot verify whetherthe adjudicator
actually searches or makes correct decisions.Training judges and
building up their prestige presumably raisesb, but such policies
may take decades to pay off.
In addition, the adjudicator derives the payoff a from
eachsuspect he punishes whether or not this suspect actually
violatedthe rules. If a = 0, this adjudicator is only interested in
justice,and is not motivated by politics or short-run career
concerns. Ifa > 0, this adjudicator has a personal interest in
nding viola-tions. This can be so for a number of reasons. The
state may beconcerned with nding violators of particular rules to
achieve itsbroader political goals, such as ghting drugs or
persecutingparticular ethnic minorities. More narrowly, only
successful pun-ishments of violators may be recorded by the
superiors of anenforcer, and hence his future career or budget may
be deter-mined by the number of penalties he metes out. Still
anotherimportant reason why adjudicators may wish to achieve
certainoutcomes is that these improve their career opportunities
follow-ing government service [Glaeser, Kessler, and Piehl 2000].
Inprinciple, law enforcement can be heavily politicized, and a
couldbe a lot higher than b. We can also imagine the case where a
0, it never pays theadjudicator to sink the cost c and then ignore
the information heobtains and be either lenient or abusive. If he
searches, he alwayspunishes the violators and lets go the innocent.
But before search,it may pay the adjudicator to be either lenient
or abusive, de-pending on the magnitudes of a, b, c, and p.
To analyze the adjudicators incentives for enforcement, werst
consider his payoffs to the three strategies he can
pursue:leniency, abuse, and search. These payoffs are given by
(1) Leniency: (1 2 p)b;(2) Abuse: a + pb;(3) Search: b + pa 2
c.
These payoffs dene the optimal strategies of the enforcer,
assummarized in
PROPOSITION 1. Fix b and p. The following strategies are
followedfor respective parameter values:
Leniency: a # (1 2 2p)b and c $ (a + b)p;Abuse: a $ (1 2 2p)b
and c $ (b 2 a)(1 2 p);Search: c # (a + b) p and c # (b 2 a)(1 2
p).
These conditions divide the space of parameter values into
threeregions, as shown in Figure I.3
The interpretation of these conditions is straightforward.
Forlow-powered punishment incentives and high cost of search,
theadjudicator chooses leniency. For high-powered punishment
in-centives and high cost of search, the adjudicator turns to
abuse.He only searches for the truth as long as the cost of
investigationis low enough that, for low as, he prefers search to
leniency and,for high as, he prefers search to abuse.
Even this simple analysis in Figure I has several implica-
3. Note that if a > b, the only equilibrium outcome is
abuse.
TABLE I
Not Punish Punish Probability
Innocent b a 1 2 pGuilty 0 a + b p
858 QUARTERLY JOURNAL OF ECONOMICS
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tions. First, we can think of c as a measure of the efciency of
thejudicial system, the cost to the adjudicator of obtaining
informa-tion. In principle, c can be reduced through legal and
regulatoryreform. In the context of nancial markets, for example, c
can bereduced by improving accounting systems and disclosure by
issu-ers and intermediaries. The model implies that reductions in
thelevel of c always lead to increases in search. For high levels
of c,search may not be achievable. Increasing career or nancial
in-centives of the enforcers only moves the system from leniency
toabusea risk that a society may not wish to take if it prefers
theformer to the latter. Put differently, a relatively efcient
legalsystemwhich could potentially be designed using
appropriatelegal rulesis necessary for achieving just outcomes;
without it,it may be better to settle for leniency.
Second, for moderate and low levels of c, increasing incen-tives
for punishment may indeed have the effect of moving theadjudicator
from leniency to search. Even here, however, signi-cant increases
in a move the adjudicator out of search and intoabuse. This
analysis cautions against the Becker-Stigler [1974]
FIGURE IA Simple Model of Incentives for Enforcement
The adjudicators incentive for enforcement divides the space of
parametervalues into three regions: leniency, abuse, and
search.
859COASE VERSUS THE COASIANS
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enthusiasm for the high-powered enforcement incentives as
itshows the risk for abuse, particularly in inefcient legal
systems.
We can use this model to provide further comparative
staticsresults, summarized in
PROPOSITION 2. Assume that b > a and that p < 12 . An
increasein adjudicator professionalism, b, always 1) strictly
reducesthe region of abuse, 2) strictly increases the region of
search,and 3) diminishes leniency for low asto favor
searchandexpands leniency for high asat the expense of abuse
(Fig-ure II). An increase in the fraction of suspects who are
guilty,p, always 1) reduces the region of leniency, 2) expands
theregion of abuse, and 3) expands search for low asat theexpense
of leniency and reduces it for high asto favorabuse.
The intuition behind these results is straightforward.
Anincrease in the adjudicators concern for justice raises his
aver-sion to both letting the guilty go (resulting from leniency)
and
FIGURE IIComparative Statics: Adjudicator Professionalism
(b)
The adjudicators incentive for enforcement divides the space of
parametervalues into three regions: leniency, abuse, and search.
Increasing adjudicatorprofessionalism (b) reduces the region of
abuse.
860 QUARTERLY JOURNAL OF ECONOMICS
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punishing the innocent (resulting from abuse). As a
consequence,for a broader range of parameter values, he conducts a
search.Since with p < 12 most suspects are innocent, a higher b
makesleniency more attractive relative to abuse, further shrinking
thelatter region.
An increase in the guilty share of the population, p,
obviouslyexpands the range of abuse and contracts the range of
search. Forlow incentives, the attractiveness of search rises
relative to thatof leniency and hence the scope of search expands.
For highincentives, the attractiveness of search falls relative to
that ofabuse, and hence the scope of search contracts.
B. An Extension
In the basic model we assume that the fraction of violators,
p,is independent of the strategy the adjudicator pursues.
Moregenerally, we expect a behavioral response by the potential
vio-lators: fewer of them would violate the legal rule if the
adjudica-tor searches than if he is either lenient or abusive. In
this sub-section we briey consider such a behavioral response.
Suppose that there are many adjudicators, so that the deci-sions
of a particular adjudicator have no effect on the pool ofpotential
violators. Denote by P the fraction of actual violators inthe
population in the equilibrium where all the adjudicators areeither
lenient or abusive. This P must be the same in the lenientand the
abusive equilibrium, since in both cases the action of thepotential
violator has no effect on his fate. Denote by Q < P thefraction
of actual violators in the population in the equilibriumwhere all
the adjudicators search. If breaking a rule entails costs,the
likelihood of violations falls. An adjudicator chooses
betweenleniency, abuse, and search taking the behavior of other
adjudi-cators, and therefore P and Q, as given. In equilibrium,
thechoices of the adjudicators must be consistent with the choices
ofthe potential violators.
Figure III presents the structure of equilibria in this modelfor
different parameter values. There are now six regions. Asbefore,
the area of high search costs and low incentives, denotedby L, has
leniency as the only equilibrium. The area of highsearch costs and
high incentives, denoted by A, has abuse as theonly equilibrium.
The area of low search costs, denoted by S, hassearch as the only
equilibrium. In area X, there is a unique mixedstrategy
equilibrium, in which the fraction of actual violators isgiven by
p* = c/(a + b), adjudicators are indifferent between
861COASE VERSUS THE COASIANS
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search and leniency, and choose them in proportions that makep*
be the optimal response by the potential violators. In area Y,there
are three equilibria, including pure search, pure abuse, anda
mixture of the two with the fraction of actual violators given
byp** = 1 2 c/(b 2 a). The reason for multiplicity is that,
startingwith the mixed strategy equilibrium in this region, a
decision byone adjudicator to become more abusive can increase the
incen-tive of the potential violators to break the rule, making
abuserather than search more attractive for other adjudicators.
Fi-nally, in area Z, there are also multiple equilibria, including
pureabuse.
The addition of the behavioral response introduces the
pos-sibility of multiple and mixed strategy equilibria
(alternatively,different adjudicators do different things).
Nonetheless, the gen-eral thrust of the results, including our
principal point that pro-viding adjudicators with incentives is
desirable for moderate lev-els of investigation costs, is
preserved.
C. Implications
What does this analysis imply for the choice of optimal
en-forcement incentives? To begin, we can think of a = 0 as the
case
FIGURE IIIIncentives for Enforcement with Behavioral Response by
Potential ViolatorsThere are six different regions of
equilibria.
862 QUARTERLY JOURNAL OF ECONOMICS
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of true justice, which is perhaps provided by judges truly
inde-pendent of the government.We can alternatively think of high
asas regulators or prosecutors whose careers and budgets dependnot
only on doing justice, but also on nding violations. Onefurther
difference between judges and regulators might be thegreater
specialization of the latter, leading to lower search cost c,but
one can of course imagine specialized judges, as in the casesof
bankruptcy or family law. The intermediate as may perhapscorrespond
to civil law judges, who are part of the civil service andhence may
be dependent on the government, but who at the sametime have less
of an incentive to nd violations than regulators do[Ramseyer and
Rasmusen 1997]. Using this interpretation, thequestion becomes: Who
should enforce a particular legal rule?
The model illustrates the costs and benets of enforcementby
judges and regulators. The government must choose the in-centives
of an enforcer, namely a (so long as career concerns arenot
dominated by outside opportunities), to achieve two objec-tives.
The rst is to stimulate search, as opposed to leniency, andthereby
to punish the violators (this is the problem that Coasianslargely
ignore). The second objective is to achieve justice by notpunishing
the innocent (this is the problem that the advocates ofgovernment
regulation usually ignore). Increasing a has the bene-t of
stimulating search relative to leniency, and thereby makingit more
likely that the violators are punished, but also the costof
increasing the likelihood of abusethe punishment of theinnocent as
well as the violators without search. Put differently,turning the
enforcement of a legal rule over to an apolitical judgehas the
benet that the innocent would be rarely punished, but
ajudgeespecially a judge with a low bwould also tend
towardleniency. In contrast, politicizing the system and turning
theenforcement to a regulator moves it away from leniency
(providedthat this regulator is not captured, i.e., a > 0), but
risks abuse.
In principle, the government would wish to have judges withvery
high bsa very professional and motivated judiciary whichhas both
sufcient incentives to investigate and a strong interestin justice.
But this may not be possible. In this event, the modelsuggests that
the best enforcement strategyparticularly wheninvestigations are
personally expensive (though not prohibitivelyexpensive)may be to
have a regulator with a high enough a toget some search but not so
high as to risk abuse. How high an athe government chooses would
depend on how much it caresabout punishing the violators relative
to avoiding punishing the
863COASE VERSUS THE COASIANS
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innocent. Presumably, in the cases where punishing the
innocentis particularly expensive to the society, such as criminal
law, thecosts of abuse are sufciently high that most governments
wouldstill set a low and allocate adjudication to judges. In civil
situa-tions, however, the case for regulation is stronger, at least
whenc is moderately high. The other way of looking at this is
thatenforcement reforms which lower c are likely to stimulate
searchand lead to more efcient outcomes, regardless of whether a
judgeor a regulator handles the enforcement.
These predictions of the model relate to the case for
securitiesmarkets regulationmade by James Landis [1938], the
architect ofsuch regulation in the United States and one of the rst
SECcommissioners. Landis was skeptical that the courts were
moti-vated enough to punish dishonesty in security issuance and
trad-ing in a world where the opportunities for promoters and
insidersto expropriate investors were extensive. He thought that an
in-dependent and highly motivated SEC, whose only objective wouldbe
to assure the integrity of nancial markets, could do thisbetter. He
also argued that using regulators as adjudicators is abetter
strategy because they face lower costs of investigation.Lower costs
encourage search and make abuse less likely for agiven level of
incentives. The model can thus account for somebasic intuitions for
when regulation might be preferred to judicialenforcement.
In the following sections we examine the implications of
themodel for nancial regulation in Poland and the Czech
Republic(and to a lesser extent Hungary). We examine the reform in
twocrucial areas governing nancial markets: corporate law
andsecurities law. Corporate law deals in particular with the
rela-tionship between corporate insiders and shareholders, and
istypically enforced through private litigation. Securities law
regu-lates nancial markets. As such it also deals with some aspects
ofshareholder protection. In addition, securities law species
thestatus and the powers of the securities regulator and deals
withdisclosure of information by securities issuers and
intermediar-ies. Variation in the securities laws, therefore, can
be interpretedas variation in a and c in the model: a more
motivated regulatorwould have a higher a, and greater disclosure
would correspondto a lower c. We show that Poland and the Czech
Republic haveadopted very different strategies toward shareholder
protection,especially in their securities laws, and that these
strategies canbe interpreted in light of the model. Our evidence
suggests that
864 QUARTERLY JOURNAL OF ECONOMICS
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the greater success of nancial development in Poland than in
theCzech Republic might be related to the more appropriate
regula-tory stance in Poland, in line with the predictions of the
theo-retical analysis.
III. INITIAL CONDITIONS
In broad terms, Poland and Czechoslovakia share similarhistories
over the past 50 years. Both countries turned commu-nist and became
Soviet satellites shortly after World War II, andspent the next 40
years building socialism. In 1989 the twocountries spearheaded the
anticommunist revolution. In Poland,Solidarity won overwhelming
support in the June 1989 elections,and by September 1989 was able
to form a government. InCzechoslovakia the communists gave up their
leading role inthe country in the face of massive protests in
November 1989, andthe communist President resigned in December.
Free elections inJune 1990 completed a sequence of events that came
to be knownas the velvet revolution.
At the beginning of reforms, Poland had a larger populationof 38
million people, compared with 10.3 million in the CzechRepublic.
The Czech Republic in 1989 had per capita income of$5727 in
constant 1995 U. S. dollars compared with Polands$3045. Both
countries were fully industrialized, with an indus-trial structure
largely shaped by decades of Soviet-style centralplanning. Both
countries border on Western Europe and in par-ticular Germany,
although Warsaw is 569 miles from Frankfurtwhile Prague is only 261
miles away.
Both countries initiated economic reforms immediately
aftershedding communism. In Poland critical legislation on
liberaliza-tion was passed in the fall of 1989, and the key
measures cameinto effect on January 1, 1990. Small-scale
privatization began inMay 1990, although large-scale privatization
started with a whis-per in 1991, ran into political obstacles, and
spread over most ofthe 1990s. In Czechoslovakia reforms were also
initiated in early1990, with the devaluation of the currency,
budget cuts, andbanking reform. The formal reform package,
including price in-creases, started on January 1, 1991. The law on
large-scale pri-vatization was adopted on February 1, 1991.
Privatizationthrough vouchers took place in two waves: in 1992
(completed in
865COASE VERSUS THE COASIANS
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mid-1993) and 1993 (completed in 1994). Most rules of
privatiza-tion, including those on Investment Privatization Funds,
weredeveloped in 1991 [Coffee 1996].
Moreover, both countries were virtually nished withthese basic
reforms by 1994. They received virtually identicalscores on every
World Bank indicator of the pace of transition[de Melo, Denizer,
and Gelb 1996]. The European Bank forReconstruction and Development
also ranked them veryclosely (see Table II). Although the Czech
Republic moved morerapidly on large-scale privatization and so had
a somewhathigher share of its GDP generated in the private sector,
inmatters such as small-scale privatization, governance and
re-structuring, price and trade liberalization, competition
policy,banking reform, and nancial institutions, the countries
are
TABLE IICOMPARISON OF ECONOMIC REFORM POLICIES BY THE EBRD
PolandCzech
Republic PolandCzech
Republic PolandCzech
Republic
Transitionindicators 1997
Transitionindicators 1996
Transitionindicators 1995
Private sectorshare of GDP 65 75 60 75 60 70
Large-scaleprivatization 3+ 4 3 4 3 4
Small-scaleprivatization 4+ 4+ 4* 4* 4* 4*
Governance andrestructuring 3 3 3 3 3 3
Price liberalization 3 3 3 3 3 3Trade and foreignexchange system
4+ 4+ 4* 4* 4* 4*
Competition policy 3 3 3 3 3 3Banking reformand interest
rateliberalization 3 3 3 3 3 3
Securities marketand nonbanknancialinstitutions 3+ 3 3 3 3 3
Scale is from 1 (no reform) to 4+ (full reform).Source: European
Bank for Reconstruction and Development [1997, 1996, 1995].
866 QUARTERLY JOURNAL OF ECONOMICS
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neck and neck and very far advanced.4 In short, both
countrieswere rapid and thorough reformers in their emergence
fromcommunism, especially in comparison with other
transitioneconomies.
There are, however, two differences which we come back tobelow.
First, the Czech large-scale voucher privatization wasfaster and
more extensive than privatization in Poland, whichover time
utilized a variety of methods from direct sales to sharetransfers
to mutual funds. As a consequence, the number ofpublicly held
companies in the early 1990s was signicantlyhigher in the Czech
Republic than in Poland. Second, during thisperiod Poland grew
faster but also had higher ination than theCzech Republic. The
assessments of growth rates depend onexactly how they are
calculated. The level of GDP in Poland in1997 stood at 110 relative
to 100 in 1989, whereas in the CzechRepublic it stood only at 90.
Using constant 1995 dollars, how-ever, Polands advantage is
smaller.5 During 19921997 theCzech ination averaged 13.9 percent
per annum, while Polishination was signicantly higher at 26.5
percent.
In legal development, the two countries again appear similar.In
the universe of transition economies, both get perfect or
nearlyperfect scores, although these scores have only been kept
after1995. The European Bank for Reconstruction and
Developmentevaluates transition economies on the extensiveness of
laws(since 1996), effectiveness of laws (since 1996), and overall
legaldevelopment (since 1995). Table III, Panel A, presents the
scoresfor Poland and the Czech Republic, which again are close to
eachother and as high as those of any transition economy.6 The
legalsystems of the two countries, however, lagged behind those of
richmarket economies. Freedom House generates an index of equal-ity
of citizens under the law and access of citizens to a
non-discriminatory judiciary. In 19951996 both Poland and the
4. In 1997 the EBRD gave Poland a 3+ relative to the Czech
Republics 3 onsecurities markets and nancial institutions. We argue
below that the differenceshould have been larger.
5. The World Bank reports the level of real GDP using constant
1995 pricesbut calculates growth rates using the GDP deator. Given
the large changes inrelative prices during reforms, it is hard to
know which measure is better. Onevery available measure, however,
Poland has had more growth since 1989, andgrew signicantly faster
during the 19951998 period.
6. Pistor [1995] assesses the extent of legal development in a
number oftransition economies. She gives Poland and the Czech
Republic the same score,the highest (shared with Hungary) among all
the transition economies shestudies.
867COASE VERSUS THE COASIANS
-
Czech Republic received scores of 5 out of 10, compared with
7.5or 10 for the rich industrial countries.7 The 1997 World
Competi-tiveness Yearbook [IMD 1997] in its question on the legal
frame-work, gave Poland 4.16 out of 9 and the Czech Republic 4.66.
Thiscompares with 8.46 for the world leader, Singapore (and
overeight generally for rich industrial countries) and the low of
2.35for Venezuela. Finally, the 1996 Global Competitiveness
Report[World Economic Forum 1996], in its question on condence
inthe fair administration of justice, gives 2.93 out of 6 to the
CzechRepublic and 2.92 to Poland. This compares with the high of
5.78for New Zealand, and the low of 1.77 for Russia. All the
surveys,then, treat the judicial systems of the two countries as
aboutequally advanced, ahead of world laggards yet far behind the
richindustrial countries.
These results are echoed by the concerns of
knowledgeableobservers about the state of the judicial system in
the two coun-tries in the early stages of reform [Gray et al.
1993]. With respect
7. These numbers come from Economic Freedom of the World 1997,
by JamesGwartney and Robert Lawson, a publication of The Fraser
Institute, a conserva-tive think tank in Canada.
TABLE IIILEGAL ENVIRONMENT
Panel A PolandCzech
Republic PolandCzech
Republic PolandCzech
Republic PolandCzech
Republic
EBRD 1997 1996 1995
Extensivenessof laws 4 4 4* 4 n.a. n.a.
Effectivenessof laws 4+ 4 3 4* n.a. n.a.
Overall 4 4 4 4 4 4
Panel B
Wall Street JournalCEER survey
December 1997January 1998
December 1996January 1997
December 1995January 1996
February1995
Rule of law/legalsafeguards 9 8.7 9 8.8 9.1 9.1 n.a. n.a.
Legal framework 9.8 9.8
Scale for legal extensiveness and legal effectiveness is from 1
(no reform) to 5 (full reform).Scale for rule for law/legal
safeguards, and legal framework is from 1 to 10 (the highest/best
score).Source: European Bank for Reconstruction and Development
[1997, 1996, 1995], and Central European
Economic Review, a supplement of the Wall Street Journal Europe
(issues indicated in table).
868 QUARTERLY JOURNAL OF ECONOMICS
-
to Poland, Gray et al. [p. 109] write: Many of the newly
appointedjudges lack experience. . . . Developing such expertise
will taketime. Lack of experience and expertise creates uncertainty
in thebusiness population . . . With respect to the Czech
Republic,Gray et al. [p. 59] note: As in other Central and East
Europeancountries, judicial institutions in the Czech Republic are
ill pre-pared to cope with the rapidly emerging challenges of the
marketeconomy . . . Incapacity in the court system is likely to be
aconstraint for some time to come.
In summary, the economies and the economic policies ofPoland and
the Czech Republic share some remarkable similari-ties during the
1990s. The two countries emerged from socialismwith a need to
massively reorganize their economies and pro-ceeded to do so both
rapidly and effectively. In many crucialrespects, they followed
similar policies toward this goal, andachieved similar results,
especially compared with other, lesssuccessful, transition
economies.
IV. COMPANY LAW
Recent research shows that investor protection through com-pany
laws and commercial codes is an important deterrent ofexpropriation
of outside investors, and as such a key determinantof the
development of securities markets across countries [LaPorta et al.
1997, 1998, 1999, 2000; Johnson et al. 2000a]. Beforefocusing on
securities regulations, therefore, it is important tocompare Poland
and the Czech Republic along this dimension.8
La Porta et al. [LLSV 1998] propose six dimensions to evalu-ate
how well a commercial code (or company law) protects mi-nority
shareholders against expropriation by the insiders, andcombine them
into an index of shareholder protection. Table IV,Panel A, presents
and explains this index and its components forPoland and the Czech
Republic, based on their rst postreform
8. Polands law dates back to the code of 1934, which was modied
repeatedlythrough the communist era and in the early 1990s. The
Polish commercial codehas both German and French inuences [Gray et
al. 1993; Pistor 1999]. Althoughthe Czech Republic also had a
commercial code from the 1930s, its laws weremore thoroughly
abrogated than those of Poland during communism, and itaccordingly
adopted a new commercial code on January 1, 1992 [Gray et al.
1993].The principal inuence on the Czech commercial code was
German. In this andthe following sections, we examined the laws
adopted in the early 1990s, whichare relevant for nancial
development during the 1990s. Toward the end of thedecade, the laws
have been revised in both countries, particularly in the
CzechRepublic.
869COASE VERSUS THE COASIANS
-
TABLE IVCOMPARISON OF LLSV DIMENSIONS
SHAREHOLDER RIGHTS FROM COMMERCIAL CODES
Panel A
Poland CommentLLSVscore Czech Comment
LLSVscore
Proxy-by-mail No Article 405 (proxyin person isallowed)
0 No Article 185 0
Shares blockedbefore generalmeeting ofshareholders
Yes Article 399 (oneweek ahead ofmeeting)
0 Yes (one week aheadof meeting)
0
Oppressedminoritymechanism
Yes Articles 409 and414
1 Yes Can protestdecision ofgeneralassembly
1
Shareholders havepreemptive rightto new issues
No Not mentioned inPolish law
0 No Can be excludedby Articles ofAssociation(Article204(2))
0
Percent of votesneeded to callextraordinarygeneral meeting
10% Article 394 1 10% Article 181 1
Cumulative voting Yes Article 379A combination of
shareholderswith at least20% of theshare capitalcan elect aboard
member
1 No Articles 186 and200
51% of the votesis enough toappoint allthe directors.13 of seats
goto employeesif at least 500workers
0
Anti-DirectorRights index,calculated as inLLSV
3 2
870 QUARTERLY JOURNAL OF ECONOMICS
-
Denitions used in Panel A(from LLSV [1998]):
One share-one vote Equals one if the company law or commercial
code ofthe country requires that ordinary shares carryone vote per
share, and zero otherwise.Equivalently, this variable equals one
when thelaw prohibits the existence of both multiple-votingand
nonvoting ordinary shares and does not allowsetting maximum number
of votes per shareholderirrespective of the number rms of shares
owned,and zero otherwise.
Proxy by mail allowed Equals one if the company law or
commercial codeallows shareholders to mail their proxy vote to
therm, and zero otherwise.
Shares not blockedbefore meeting
Equals one if the company law or commercial codedoes not allow
rms to require that shareholdersdeposit their shares prior to a
generalshareholders meeting, thus preventing them fromselling those
shares for a number of days, andzero otherwise.
Cumulative voting orproportionalrepresentation
Equals one if the company law or commercial codeallows
shareholders to cast all their votes for onecandidate standing for
election to the board ofdirectors (cumulative voting) or if the
companylaw or commercial code allows a mechanism ofproportional
representation in the board by whichminority interests may name a
proportionalnumber of directors to the board, and
zerootherwise.
Oppressed minoritiesmechanism
Equals one if the company law or commercial codegrants minority
shareholders either a judicialvenue to challenge the decisions of
management orof the assembly or the right to step out of thecompany
by requiring the company to purchasetheir shares when they object
to certainfundamental changes, such as mergers, assetdispositions,
and changes in the articles ofincorporation. The variable equals
zero otherwise.Minority shareholders are dened as thoseshareholders
who own 10 percent of share capitalor less.
Preemptive rights Equals one when the company law or
commercialcode grants shareholders the rst opportunity tobuy new
issues of stock, and this right can bewaived only by a shareholders
vote; equals zerootherwise.
Percentage of sharecapital to call anextraordinaryshareholders
meeting
The minimum percentage of ownership of sharecapital that
entitles a shareholder to call for anextraordinary shareholders
meeting; it rangesfrom 1 to 33 percent.
871COASE VERSUS THE COASIANS
-
commercial codes. Neither country allows proxy-by-mail
(scorezero), each requires that shares be blocked before the
annualmeeting of shareholders (score zero), and neither gives
sharehold-ers a preemptive right to new share issues (score zero).
They eachrequire 10 percent of the votes to call an extraordinary
share-holder meeting (score 1), and each provide the minority
share-holders with some opportunities to protest certain majority
deci-sions (score 1). The two laws differ in one important
dimensionusing this classication: the Polish law allows a signicant
(20percent and in some cases less) minority shareholder to elect
adirector. Under the Czech law, 51 percent of the votes are
enoughto appoint all directors. Overall, Poland ends up with a
score of 3out of 6 on anti-director rights, and the Czech Republic
with ascore of 2.
To put these scores in perspective, the highest actual
share-holder rights score in the LLSV [1998] sample of 49 countries
is5. Several common law countries, such as the United States,
theUnited Kingdom, and Canada receive this score. Belgium is
thelowest in the sample, with a score of 0, but several
countriesincluding Italy, Jordan, and Mexico get a score of 1. The
averagein the sample is 3. Thus, Poland is average in the world
inprotecting shareholder rights through the company law, while
theCzech Republic is below the average.
Some additional rules in the commercial codes, not studiedby
LLSV [1998], are also more protective of minority shareholdersin
Poland (Table IV, Panel B). Poland gives important rights
tosignicant minority shareholders (those with either 20 percent
ofthe votes or 20 percent of share capital). In Poland, but not in
theCzech Republic, this group can demand the appointment of
anadditional board of auditors, and not just a seat on the
supervi-sory board. This group can also check who attended the
generalshareholders meeting, thus keeping the management from
ma-nipulating the total number of the available votes. Both
countriesgenerally require supermajorities for important decisions,
suchas the change in the objectives of the company. Poland grants
ashorter term in ofce to directors (three years) than does theCzech
Republic (ve years). In one interesting regard, the Czechlaw is
more protective of minority shareholders. Article 185 of theCzech
1992 Commercial Code requires that a quorum of 30 per-cent of the
total possible votes be present at a general meeting
ofshareholders. The Polish Commercial Code does not set any
suchquorum (Article 401).
872 QUARTERLY JOURNAL OF ECONOMICS
-
TABLE IV(CONTINUED)
Panel B
Poland Czech Republic
Further rights ofshareholders Oneshare-one vote (forordinary
shares) andno limits on votes pershareholder
No Art. 404: canlimit votesof largeshareholders
No Can set max votesper shareholder(Article 180)
Supervisory board andmanagement boardboth elected byshareholders
meeting
Yes Articles 377and 366
Yes Articles 194 and200
Shareholdersrepresenting at leastone-fth of shares candemand an
additionalboard of auditors
Yes Article377(3)
No Not mentioned inCzech law
Shareholders with 10%of share capitalrepresented atgeneral
meeting cancheck the list ofattendance
Yes Article 403 No Article 185
Two-thirds majority ofgeneral assembly orvotes cast needed
forlarge purchases (overone-fth of sharecapital) within twoyears of
registrationof company
Yes Article 389 No Not mentioned inCzech law
Two-thirds majority ofgeneral assembly orvotes cast needed
tochange articles ofassociation or objectsof company
Yes Article 409each sharehas
onevotewithoutpreferencesorrestrictions
Yes Article 187
Term of board ofdirectors(management board)
3 years Article 366and 381
5 years Article 194
Bearer shares allowed Yes Article 345 Yes Article 155 and156
Preference sharesallowed (possiblywithout voting rights)
Yes Article 357 Yes Article 159
Quorum of votes neededto be present
None Article 401 30% Article 185
873COASE VERSUS THE COASIANS
-
In summary, Polands company law is somewhat more pro-tective of
minority shareholders than the Czech law. These dif-ferences in
themselves, however, do not appear to be signicantenough to account
for the differences in nancial developmentdocumented below.
V. SECURITIES LAW AND REGULATION
Despite the many crucial similarities, the two countries
fol-lowed different approaches to reform in terms of the
governmentsinterest in regulatory intervention. This difference did
not escapethe early observers of the two countries, who viewed
Czech eco-nomic policy as more laissez-faire than Polish economic
policy.For example, in each of the three years 1994 1996, the
conser-vative Heritage Foundation gave the Czech Republic a
perfect(from its perspective) score of 1 and Poland a mediocre
score of 3on its measure of regulationthe extent to which
governmentrestricts economic activity. Along similar lines,
Euromoney con-sidered Poland to be riskier for foreign investment
and lendingthan the Czech Republic, in part because property rights
wereless secure from government intervention.
These observers had every right to form such opinions basedon
the pronouncements about markets and market reform comingfrom
economic ofcials in the two countries. Vaclav Klaus, theCzech
Finance Minister and later Prime Minister, was both tre-mendously
articulate and unabashedly antigovernment in hisvision of reforms:
We knew that we had to liberalize, deregulate,privatize at a very
early stage of the transformation process, evenif we might be
confronted with rather weak and, therefore, notfully efcient
markets . . . Conceptually it wasat least for merather simple: all
you had to do was to apply the economic phi-losophy of the
University of Chicago [Klaus 1997, from a 1995speech]. Leszek
Balcerowicz, the champion of Polish reforms,was more cautious: The
capacity of the state to deal with variousproblems varies, mainly
because of varying informational re-quirements. On this basis, one
can distinguish on the one hand,the sphere of the states natural
competence (legislating andenforcing the law, dealing with other
states, for example) and, onthe other hand, its sphere of natural
incompetence (a massive anddetailed industrial policy, for example)
[1995, p. 176].
These differences revealed themselves most clearly in
theregulation of capital markets. The Polish Law of Public
Trading
874 QUARTERLY JOURNAL OF ECONOMICS
-
in Securities and Trust Funds was adopted on March 22, 1991,and
became effective in early April 1991. The Czech SecuritiesAct was
adopted in 1992, and became effective on January 1,1993. Although
this Act was passed after privatization hadstarted, nancial
institutions, such as Investment PrivatizationFunds (IPFs),
apparently did not lobby for or against it. In fact,the Czech rules
were established before privatization started andbefore the IPFs
existed, and only codied later [Coffee 1996].They were a product of
the governments economic philosophy,not lobbying.
In our analysis of securities laws, we focus especially on
twoissues. First, we show that there were signicant differences
inthe institutions of securities regulation in the two
countries,particularly with respect to the independence and the
power ofsecurities regulators. We interpret the greater
independence andpower of the regulator as an increase in the
parameter a in themodel: the incentives of the adjudicator. Second,
we show that theissuers and the intermediaries in the two countries
faced radi-cally different disclosure requirements, so that the
regulators hadvery different access to information. We interpret
the greatermandatory disclosure, and the use of intermediaries to
enforce itas reductions in the parameter c in the model: the cost
of search.
From this perspective on regulation, an examination of
secu-rities laws in Poland and the Czech Republic reveals
profounddifferences. To begin, the two laws differed in the
identity of thegovernment body supervising securities markets. In
Poland itwas an independent Securities Commission. In the Czech
Repub-lic such a commission was not established initially, and
marketswere supervised by the Capital Markets Supervisors Ofce of
theMinistry of Finance. The Ministry of Finance during this
periodwas rst under Klaus, and later, when he became Prime
Minister,remained indifferent to regulating securities markets.
Both su-pervisory bodies received the power to generate
regulations, toissue and revoke licenses, and to impose nes for
violations ofsecurity laws and regulations, but had to refer
criminal cases tothe public prosecutor. The criminal channel was
scarcely used ineither country. The fact that the Polish Securities
Commissionwas independent, and charged solely with supervision of
securi-ties markets, is likely to have provided it with greater
incentivesto nd violations than those faced by the Czech Ministry
ofFinance, with its much broader agenda.
A key difference in the structure of securities laws in the
two
875COASE VERSUS THE COASIANS
-
countries is in the emphasis on the regulation of
intermediaries.The idea of focusing the regulation of securities
markets on in-termediaries is sometimes credited to James Landis
[Landis1938; McCraw 1984], who reasoned that the U. S. SEC
couldmonitor neither the compliance with disclosure, reporting,
andother rules by all listed rms, nor the trading practices of
allmarket participants. Rather, the SEC would regulate
intermedi-aries, such as brokers, accounting rms, investment
advisors,etc., placing on them the burden of assuring compliance
withregulatory requirements by issuers and traders. By
maintainingsubstantial administrative power over the
intermediaries, includ-ing the power to issue and revoke licenses,
the Commission couldforce them to monitor market participants.
Moreover, the inter-mediaries would be relatively few in number,
and more concernedwith their own reputations with the SEC compared
with most ofthe issuers. By privatizing part of the enforcement of
disclosure tothe intermediaries, the regulator could reduce the
share of theenforcement costs he had to bear himselfa reduction in
c in ourmodel.
Table V compares the two laws from the perspective of
theregulation of nancial intermediaries. In the regulation of
indi-vidual brokers, Poland instituted relatively elaborate
licensingrequirements, accompanied by tests. Brokers were supposed
toengage in honest trading as interpreted by the Commission,
andcould lose their license. The Czech Republic had much more
proforma licensing of brokers, with easy exams, no warning
concern-ing honest trading and evidently no real power of the
Commis-sion to revoke licenses. The Polish Commission used the
broadhonest trading requirement, and its own power to interpret
it,to discourage brokers practices that might not have served
theinterests of clients.
Brokerage rms were also licensed in both countries butfaced
considerably stiffer regulations in Poland. For example,
theregulator received the right to access and inspect the books
ofbrokerage rms, and these rms had to disclose their
ownershipstructure, stay away from trading in the securities issued
by aparent or a subsidiary company, and retain organizational
andnancial separateness from banks which owned some of them.These
regulations did not exist in the Czech Republic. It is clearthat
the Czech Republic adopted a very hands-off stance towardbrokers
and brokerage rms, in contrast to Poland.
The Czech Securities law contained no regulation of invest-
876 QUARTERLY JOURNAL OF ECONOMICS
-
TABLE VREGULATION OF INTERMEDIARIES
Poland Czech Republic
Individual brokers
Licensed by securitiesmarket regulator
Yes Articles 18.2and 14.1
Yes Section 49
Must pass examadministered bysecurities marketregulator
Yes Article 14.1(4) No Section 49
Required to engage inhonest trading and actin the interest of
clients
Yes Article 17.1 No Section 49
License can be suspendedor revoked by SecuritiesCommission
Yes Article 16.2and 16.3
Yes Section 49
Brokerage enterprises
Licensed by securitiesmarket regulator
Yes Article 18.2 Yes Section 45
Securities market regulatorhas right of access andinspection
Yes Article 26 No Sections 4548
License can be suspendedor revoked by securitiesmarket
regulator
Yes Article 25.3 Yes Section 48(2)
Required to engage inhonest trading and actin the interest of
clients
Yes Article 25.2(3) No Sections 4548
Must not conduct otherbusiness with the samename
Yes Article 18.6 No Sections 4548
Must report who has morethan 5 percent of votingrights at
general meetingof shareholders
Yes Article 23.2 No Sections 4548
Must report any change ofvoting rights for oneperson above 2
percent
Yes Article 23.3 No Sections 4548
Bank engaged in brokerageoperations must haveorganizational
andnancial separateness ofdepartment for publictrading in
securities
Yes Article 24 No Sections 4548
Must not trade securitiesissued by parent orsubsidiary
company
Yes Article 31 No Sections 4548
877COASE VERSUS THE COASIANS
-
TABLE V(CONTINUED)
Poland Czech Republic
Investment advisers(rms engaged in advisory activity in the eld
of public trading)
Licensed by securitiesmarket regulator
Yes Article 33 No Not mentioned inthe Czech law
Must pass exam set bysecurities marketregulator
Yes Article 33.3 No Not mentioned inthe Czech law
Securities market regulatorhas right of access andinspection
Yes Article 33 No Not mentioned inthe Czech law
License can be suspendedor revoked by securitiesmarket
regulator
Yes Article 33 No Not mentioned inthe Czech law
Required to engage inhonest trading and actin the interest of
clients
Yes Article 33 No Not mentioned inthe Czech law
Must not conduct otherbusiness with the samename
Yes Article 33 No Not mentioned inthe Czech law
Must report who has morethan 5 percent of votingrights at
general meetingof shareholders
Yes Article 33 No Not mentioned inthe Czech law
Must report any change ofvoting rights for oneperson above 2
percent
Yes Article 33 No Not mentioned inthe Czech law
Bank engaged ininvestment advisoryoperations must
haveorganizational andnancial separateness ofdepartment for
publictrading in securities
Yes Article 33 No Not mentioned inthe Czech law
Must not trade securitiesissued by parent orsubsidiary
company
Yes Article 33 No Not mentioned inthe Czech law
Sources: Poland: Act of Trading in Securities and Trust Funds,
1991; Czech: Securities Act 1992.
878 QUARTERLY JOURNAL OF ECONOMICS
-
TABLE V(CONTINUED)
Poland Czech
Stock markets
Trading must take place ona stock exchange Yes Article 54.1
No
Section 50 of theSecurities Law
Securities regulatorcontrols stock exchangerules Yes No
Not mentioned inCzech law
Securities exchange shouldensure a uniform market Yes Article
57(1) No
Not mentioned inCzech law
Securities exchange shouldensure dissemination ofuniform
information onthe value of securities Yes Article 57(3) No
Not mentioned inCzech law
Agreements among anygroups to articiallyraise or lower the
priceof securities areprohibited Yes Article 64.3 No
Not mentioned inCzech law
Mutual funds
Mutual funds may beadministered solely bymutual fund companies
Yes Article 89.2 No
Not mentioned inCzech law
Mutual fund companies arelicensed by securitiesregulator Yes
Article 89 Yes Section 8
Mutual fund company canbe dissolved by securitiesregulator Yes
Article 98 Yes Section 37
Mutual fund companiesmust be joint stockcompanies Yes Article
90.1 No Section 2
Only registered shares areallowed in mutual fundcompanies (no
bearershares) Yes Article 92.2 No
Not mentioned inCzech law
Closed-end funds areallowed No Article 104 Yes
Founder limited to 10% ofshare capital Yes Article 93(1) No
Not mentioned inCzech law
Founder not allowed to beon Management Board Yes Article 93(1)
No
Not mentioned inCzech law
Publicly traded securitiesor governmentobligations Yes Article
107 No Section 17
879COASE VERSUS THE COASIANS
-
ment advisors; the Polish law contained substantial
regulations,including licensing. The Polish law restricted trading
to takeplace on a stock exchange, and regulated these exchanges
to
TABLE V(CONTINUED)
Poland Czech
No more than 5% of thefunds assets can be insecurities issued by
oneissuer Yes Article 108 No Section 17
Custodian banks (for mutual funds)
All fund assets must beentrusted to a trusteebank Yes Article
112.1 Yes Section 31
Trustee bank must makesure that sale andretirement
ofparticipation units in thefund are consonant withthe law and
house rulesof the fund Yes
Article112.2(2) No
Not mentioned inCzech law
Trustee bank mustcompute the net worth ofthe funds assets
Yes
Article112.2(3) No
Not mentioned inCzech law
Trustee bank must notexecute instructions thatare in conict with
thelaw or house rules of thefund Yes
Article112.2(4) No
Not mentioned inCzech law
Trustee bank must makesure income of the fundis made public
Yes
Article112.2(6) No
Not mentioned inCzech law
Trustee bank may not be afounder of the mutualfund company, or a
buyerof its securities, or theadministrator of thecompany Yes
Article 113.1 No
Not mentioned inCzech law
Mutual fund company maynot buy securities issuedby the trustee
bank or arelated company Yes Article 113.2 No
Not mentioned inCzech law
Source: Polish Act of Trading in Securities and Trust Funds,
1991; Czech Investment Companies andInvestment Funds Act April 1992
and Stock Exchange Act 1992.
880 QUARTERLY JOURNAL OF ECONOMICS
-
ensure some transparency in trading. The Czech law did
notinclude such regulations. The Polish law contained detailed
regu-lations of mutual funds, and in fact for several years the
entryinto this activity was severely limited. The Czech law took a
muchmore lenient approach again. Finally, the Polish law
containedstringent regulations of custodian banks, which are an
importantcheckpoint for changes in ownership that might facilitate
tunnel-ing. The Czech law again was less restrictive.
Finally, the Polish Securities law, to a much greater extentthan
the Czech law, established administrative procedures en-abling the
securities market regulator to discipline the interme-diaries
without recourse to the judicial system. The intermediariescould
then appeal the decisions of the regulator to administrativecourts,
but then they, rather than the regulator, had to face thedelays and
the inefciency of the judicial system. Because the judi-ciary in
neither country is corrupt, the regulators had little fear oftheir
lawful decisions being overturned.
Table VI compares the two original laws from the perspectiveof
the regulation of security issuers, especially in the area
ofdisclosure. Recall that greater disclosure of nancial
informationcan serve to reduce the cost of information acquisition
by a regu-lator or a judge. In Poland the introduction of
securities to publictrading required both permission of the
regulator and a prospec-tus. The Czech law required neither. The
Polish law requiredmonthly, quarterly, semiannual, and annual
reporting of nan-cial information; the Czech law only the annual
results. ThePolish law required disclosure of all material
information; theCzech law only that of signicant adverse
developments.
Financial results are one area where disclosure may be
im-portant; ownership structure is another. The Polish law
requireddisclosure of substantial minority shareholdings; the Czech
lawdid not. Indeed, under the original Polish law, a
shareholdercrossing 10, 20, 33, 50, 66, and 75 percent ownership
stakes hadto publicly disclosure his ownership. The lack of
disclosure ofminority shareholdings has been seen as a problem in
several WestEuropean countries, since it enables anonymous large
shareholdersto collude with management and expropriate minority
shareholders[European Corporate Governance Network 1997]. Finally,
the orig-inal Polish law also required a mandatory bid for the
remainingshares when a 50 percent ownership threshold was reached;
theCzech law did not. Such mandatory bids, combined with
disclosureof ownership, are intended to prevent the expropriation
of minority
881COASE VERSUS THE COASIANS
-
TABLE
VI
REGULATIO
NOFLISTEDCOMPANIES
Polan
dCzech
Republic
Regulation
oflisted
compa
nies
Introductionof
securities
into
publictrad
ingrequ
ires
perm
ission
ofthesecurities
regu
lator
Yes
Article
49No
Not
men
tion
edin
Czech
law
Introductionof
securities
into
publictrad
ingrequ
ires
aprospectus
Yes
Article
50.2
No
Not
men
tion
edin
Czech
law
False
statem
entin
prospectusisforbidden
Yes
Article
118
Yes
Section
79Mon
thly
reportingof
nan
cial
inform
ation
Yes
Reg.of
Sec.C
omm.an
dStock
Exchan
geNo
Not
men
tion
edin
Czech
law
Qua
rterly
reportingof
nan
cial
inform
ation
Yes
Reg.of
Sec.C
omm.an
dStock
Exchan
geNo
Not
men
tion
edin
Czech
law
Sem
iannual
reportingof
nan
cial
inform
ation
Yes
Reg.of
Sec.C
omm.an
dStock
Exchan
geNo
Not
men
tion
edin
Czech
law
Annua
lreportingof
nan
cial
inform
ation
Yes
Reg.of
Sec.C
omm.an
dStock
Exchan
geYes
Section
80
Obligationto
publishallmaterialinform
ation
Yes
Reg.of
Sec.C
omm.an
dStock
Exchan
geNo
Section
80just
sign
icant
adversedevelopm
ents
Constraints
onpu
rchasers/potential
controlling
shareh
olders
Transparency
ofow
nership
requ
irem
ent
Yes
No
CentreforSecurities
canchan
geow
nership
withoutdisclosure
Thresholdat
whichmustdeclarestak
e(percent)
None
10Yes
Article
72No
Not
men
tion
edin
Czech
law
20Yes
No
Not
men
tion
edin
Czech
law
33Yes
No
Not
men
tion
edin
Czech
law
50Yes
No
Not
men
tion
edin
Czech
law
66Yes
No
Not
men
tion
edin
Czech
law
75Yes
No
Not
men
tion
edin
Czech
law
882 QUARTERLY JOURNAL OF ECONOMICS
-
Form
ofdisclosure
requ
ired
toSecurities
Com
mission
Yes
No
Not
men
tion
edin
Czech
law
ToAnti-Mon
opolyOfce
Yes
No
Not
men
tion
edin
Czech
law
Tocompa
ny
Yes
No
Not
men
tion
edin
Czech
law
Com
panymust
announce
whoow
nsmorethan
10%
Yes
In2national
Polishnewspap
ers
No
Not
men
tion
edin
Czech
law
Thresholdat
whichmustmak
egeneral
offer
Must
mak
eofferifintendto
pass
specied
threshold
forow
nership
stak
eYes
Anyperson
whointend
sto
acqu
ire
shares
inonecompa
ny,
once
orby
way
ofrepeated
tran
sactions,
becomingwithin
12mon
thsthe
holderof
shares
inan
amou
nt
that
guaran
tees
him
reachingor
surpassing33
percentof
votes
atthegeneral
meeting,
shallbe
obligedto
doso
solely
byway
ofpu
blicinvitation
tosubscribefor
thesale
ortheexchan
geor
shares
...(Article
73)
No
Not
men
tion
edin
Czech
law
Must
mak
eofferifactual
ownership
stak
epa
sses
specied
threshold
Yes
Any
person
who
hasbecomeaholder
ofshares
inonecompany
representing
over
50percentofthe
votesat
thegeneralm
eeting,shall
beobliged,prior
toexercising
any
powersresultingfrom
therightto
vote,toannoun
cean
invitation
tosubscribeforthesaleor
exchange
oftheremaining
shares
inthat
company
(Article87).
No
Not
men
tion
edin
Czech
law
883COASE VERSUS THE COASIANS
-
TABLE
VI
(CONTIN
UED)
Polan
dCzech
Republic
Tenderofferrules
Not
allowed
tohidebehind
arelatedcompa
nyYes
Can
not
hide
behinddepen
dent
subject(Article
72(2),Article
73(2))
No
Not
men
tion
edin
Czech
law
Transactionsin
shareon
thestockexchan
geshou
ldbe
suspen
ded
Yes
Alltran
sactionsin
this
shareon
the
stockexchan
geshould
besuspended
No
Not
men
tion
edin
Czech
law
Tim
elimitforsubscribing
Yes
25da
ysNo
Not
men
tion
edin
Czech
law
Must
buyalltheshares
offered
Yes
No
Not
men
tion
edin
Czech
law
Speciedpriceforpu
rchase
...the
Com
mission
may
forbid
the
announcingof
theinvitation
if...the
priceofferedin
theinvitation
islower
by10
percentthan
theaverage
marketpricedu
ring3months
immediately
precedingthe
announcem
entoftheinvitation.
(Article74)
The
priceoffered...can
notbe
lower
than
thehighestpricepaid
therebyfor
theshares
inthelast
12months,or
whereno
such
pricewas
paidthe
averagemarketpricein
thelast
30days
before
thean
noun
cementof
the
invitation.T
hepriceshallalso
beregarded
asthevalueofthings
orrigh
tsintend
edto
begivenby
the
inviting
person
inexchan
geforshares
Conditionsunderwhichcangoprivate
Securities
Com
mission
must
approve
Yes
Not
specied
Sources:P
olishan
dCzech
SecuritiesLaw
s.
884 QUARTERLY JOURNAL OF ECONOMICS
-
shareholders in tender offers, since they force an acquirer to
buy outminority shareholders when he gains control.
This evidence shows that Poland chose to regulate its
secu-rities markets more stringently than the Czech Republic. In
linewith the model, its law provided for extensive disclosure of
nan-cial and ownership information, a way to reduce c and thus
tofacilitate regulation (as well as private governance). The
Polishreliance on nancial intermediaries to ensure nancial
disclosurecan also be seen as a reduction in c. Also in line with
the model,Poland relied on administrative control over markets by a
moti-vated securities regulator, an increase in a relative to
judicialenforcement. This could, in principle, motivate the
regulators tobecome informed and reduce the likelihood of leniency.
We nextconsider whether this approach worked.
VI. OUTCOMES
A. Qualitative Assessments
Stable prices, rapid privatization, and openness to the
Westcombined to generate favorable initial assessments of the
Czecheconomic reforms. By 1996, however, there was mounting
evi-dence of systematic expropriation of minority shareholders
byInvestment Privatization Funds and company insiders colludingwith
them. Coffee [1996], who rst presented his paper in 1994,drew
attention to such expropriationwhich came to be knownas tunneling.
In a typical scheme, the managers of an IPF holdinga large stake in
a privatized company would agree with themanagers of this company
to create a new (possibly off-shore)entity, which they would
jointly control. The IPF might then sellits shares in the company
to this entity at below market price,thereby expropriating the
shareholders of the IPF. The companycould also sell some of its
assets or its output to the new entity,again at below fair value,
thereby expropriating its own minorityshareholders. These
arrangements between corporate managersand their large shareholders
(IPFs) enriched them at the expenseof minority investors in both
the rms and the IPFs (see Coffee[1996, 1998] for a discussion of
tunneling in the Czech Republic).
The laxity of the securities law accommodated tunneling.First,
since transactions did not need to take place on an ex-change,
large blocks of shares could change hands off the ex-change at less
than the prevailing market price. Even on an
885COASE VERSUS THE COASIANS
-
exchange, there was no guarantee of price uniformity.
Moreover,brokers and brokerage rms had no restrictions on
facilitatingsuch transactions, nor did the custodian banks have any
regula-tory duty to stop them. Second, since there was no
requirement ofownership disclosure, the acquirers of large blocks
could remainsecret. Third, without a mandatory bid, these acquirers
had noobligation to buy out the remaining minority
shareholders.Fourth, the IPFs appear to have been under no
restrictions inpursuing such transactions, since their management
did not oweany clearly regulated duty to their investors let alone
to theminority shareholders of the companies they tunneled.
Fifth,there was no reason to disclose any nancial transactions
be-tween the new owner of shares and the company, since
suchtransactions were generally allowed and did not need to be
dis-closed except perhaps in the annual report several months
later.Finally, the minority shareholders had virtually no legal
recoursein stopping such expropriation except in a very few cases
whenthe oppressed minority mechanism came into play, and
evensubstantial minority shareholders could not elect their own
di-rectors to represent their interests.
During the mid-1990s, the heyday of tunneling in the
CzechRepublic, the regulators did very little to stop it. Part of
theproblem was the weakness of the laws. But equally importantwas
probably the lack of interest of securities regulators com-bined
with judicial ineffectiveness.
By 1996, it became widely believed that something had gonewrong
with the regulation of the Czech nancial markets. InMarch 1996 the
Central European Economic Review, a publica-tion of theWall Street
Journal, surveyed assorted brokerages andfund managers on corporate
governance in four transition econo-mies. The survey asked
respondents to comment on the disclo-sure of large shareholdings,
transparency of markets, quality ofreporting, protection of small
shareholders, and insider trading.The Polish market came out as the
best of the four, followed bythe Hungarian market. The Czech market
came third, ahead ofthe Russian market, which received the lowest
score on everydimension. The Polish market outscored the Czech
market onevery dimension, with large spreads on the disclosure of
owner-ship and transparency. Consistent with this general
assessment,the International Federation of Stock Exchanges admitted
theWarsaw Exchange as a full member as early as 1994 on thegrounds
that the regulation of securities markets met its stan-
886 QUARTERLY JOURNAL OF ECONOMICS
-
dards. As of this writing, the Prague Stock Exchange still had
notbeen admitted even as an associate member.
Financial scandals in Poland were typically less egregiousthan
those in the Czech Republic, and often invited an
aggressiveregulatory response. The best known Polish scandal
involves afailure of a large conglomerate, Elektrim, to reveal in a
prospec-tus an existing agreement to sell some shares in a
valuablesubsidiary to a third party at below market price
(allegedly as apayment for services). When the agreement came to
light, Elek-trims shareholders complained, and the Securities
Commissionquickly referred the case to a public prosecutor. The top
managerof Elektrim was forced to step down. The Elektrim case
illus-trates the crucial interaction between the corporate and
securi-ties law in the enforcement of investor rights. The failure
by thecompany to disclose possibly material information in a
prospectuswas the source of the Commissions investigation under the
se-curities law. This failed disclosure also brought about an
effort bythe outside shareholders to change the board of directors
usingthe commercial code, which ultimately brought down the
topmanager. This interplay between the securities law and the
com-pany law appears in other countries as well: the securities
lawforces disclosure, which in turn invites shareholder activism
us-ing the provisions of company law.
The Polish regulator has also been aggressive in its
admin-istrative oversight of the intermediaries. In 1994 Bank
Slaski,one of the largest Polish banks which owned the largest
broker atthe time, was privatized. In response to the evidence that
thebrokerage arm of the bank favored the insiders in
allocatingshares in this privatization, the regulators took away
its broker-age license. This was done against opposition from the
Ministry ofFinance.
The available evidence shows that the Polish regulators re-lied
on the actual legal rules to protect investors; it was not
justtheir ideology that made a difference. In the cases we
examined,they relied on specic rules to promote disclosure that did
notexist in the Czech law, consistent with the view that reductions
inc matter. The Polish regulator was also evidently motivated
topolice the market aggressively, consistent with the view that
alevel of a above that of the judges may be benecial.
Importantly(and in line with the model), the Polish regulator also
had thepower, and not just the motivation, to punish the violations
ofrules.
887COASE VERSUS THE COASIANS
-
B. Quantitative Assessments
Table VII presents basic indicators of stock market develop-ment
in Poland and the Czech Republic. In terms of capitaliza-tion, the
Czech market in 1994 was twice as large as the Polishmarket, thanks
to the more than 1500 rms listed on the Praguestock exchange as a
result of privatization. As a share of GDP, theCzech market in 1994
was ve times larger than the Polishmarket. By 1998, the valuation
of the Polish market increasedalmost sevenfold. The valuation of
the Czech market increaseduntil 1996, but then fell, and the market
ended up at roughlydouble its 1994 value. Over this period the
Polish market rose to14.1 percent of GDP, although the Czech market
capitalizationremained a larger share of GDP, at 24.2 percent.
Table VII also presents the number of listed companies inPoland
and the Czech Republic. It separates the Czech companiesinto those
trading on the main market (most liquid), those trad-ing on the
secondary market (with more limited disclosure andoccasional
trading), and those listed on the free market (withhardly any
disclosure and infrequent trading). The listed Polishcompanies are
separated into those trading on the main marketand those trading on
the parallel (again, less liquid) market. The
TABLE VIISTOCK MARKET SIZE IN POLAND AND THE CZECH REPUBLIC
Marketcaptialization
MarketCap./GDP Number of issues listed
PolandCzech
Republic PolandCzech
Republic Poland Czech Republic
US $m, end of year End of year End of year
Mainmarket
Parallelmarket Total
Mainmarket
Secondmarket
Freemarket Total
1991 144 0.19% 9 0 91992 222 0.26% 16 0 161993 2706 3.15% 22 0
22 3 0 966 9691994 3057 5938 3.30% 14.9% 44 0 44 34 0 990 10241995
4564 15664 3.84% 30.8% 65 0 65 62 6 1630 16981996 8390 18077 6.23%
32.0% 83 0 83 42 51 1535 16281997 12135 12786 8.95% 24.6% 143 0 143
45 58 217 3201998 20461 12045 14.10% 24.2% 198 20 218 10 94 179
283
Sources: Polish numbers are from the International Finance
Corporation 1998 and 1999 and includeNational Investment Funds;
Czech numbers are from the Prague Stock Exchange webpage and the
Inter-national Finance Corporation 1997 and 1999.
888 QUARTERLY JOURNAL OF ECONOMICS
-
vast majority of Czech companies barely traded, and most of
therms trading on the free market were delisted by the late
1990s.The number of rms on the main market, having risen to 62
in1995, fell all the way down to 10 by 1998, with most of the
rmsbeing transferred to the less liquid secondary market. By
1998,most listed Czech rms had been either delisted or transferred
toan exchange with only limited liquidity. In contrast, despite
amuch lower initial level, the number of listed Polish rms
rosesteadily over time, and hardly any rms were transferred to
theparallel market.
Figure IV reports the number of Czech and Polish stocks overtime
included in the IFC Investable Index compiled by WorldBanks
International Finance Corporation, the maker of standardemerging
market indices. The IFC Investable Index generallyincludes only the
stocks liquid enough that foreign investors canpractically take
positions in them. This Index for Poland startedout with 9 stocks
in 1992 and rose to 34 stocks in 1998. In theCzech Republic the
Index included ve stocks in 1993 and onlythirteen in 1998. Almost
all of these thirteen stocks were eithergovernment or foreign
controlled. The value of the IFC InvestableIndex in Poland, having
started below that in the Czech Republic,has by the end of 1998 far
surpassed it (Figure V).
Perhaps the most signicant indicator of success of a nan-
FIGURE IVNumber of Stocks in IFC Investable Index in Poland and
the Czech Republic
889COASE VERSUS THE COASIANS
-
cial market is how effectively it enables rms to raise
capital.Table VIII presents data on the number of initial public
offerings(for cash as opposed to vouchers) in the Czech Republic
and
FIGURE VMarket Capitalization of Stocks in IFC Investable Index
in Poland and the
Czech Republic
TABLE VIIIINITIAL PUBLIC OFFERINGS (FOR CASH)
Czech Republic initialpublic offerings
Poland initialpublic offerings
Issued aspart of
privatization
Issued byprivate
companies
Issued aspart of
privatization
Issued byprivate
companies
1991 0 0 9 1992 0 0 5 21993 0 0 4 21994 0 0 8 141995 0 0 6
151996 0 0 3 151997 0 0 10 361998 0 0 5 52Total 0 0 50 136
Figures do not include the National Investment Funds that were
listed on the Warsaw Stock Exchange,or public issues for vouchers
in the Czech Republic.
Source: Polish data are from the Warsaw Stock Exchange; Czech
data are from Pioneer investment fund.
890 QUARTERLY JOURNAL OF ECONOMICS
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Poland. It also distinguishes between offerings of shares in
pri-vatizing companies coming into public ownership through
ota-tion, and offerings by new private companiesthe latter
beingperhaps a more effective indicator of a markets
effectiveness.Between 19911998 no Czech company sold equity for
cash aspart of initial privatization, whereas 50 Polish companies
did.9
This is not surprising, since the Czech Republic has followed
anoncash privatization strategy. At the same time, the data
showthat no private Czech company had done an IPO on the
Pragueexchange. By comparison, 136 nonprivatizing companies hadgone
public on the Warsaw exchange. This is perhaps the stron-gest
evidence of the differential effectiveness of the two markets.
What about the total amount of capital raised on the
stockexchange, by both already listed and newly admitted
companies?Table IX presents the data since 1996. These numbers are
moredifcult to interpret since there have been several rights
offeringsin the Czech Republic, for which data are not available.
The dataagain show that no new or already listed Czech company
raisedequity funds on the exchange through a public offering. In
con-trast, the Polish data show rapidly growing equity nancing
byboth new and already listed rms. In 1998 over U. S. $1 billion
ofnew equity funds was raised on the Warsaw exchange.
9. A foreign-controlled mobile phone company, Ceske
Radiokomunikce,raised $134m in 1998 by issuing Global Depositary
Receipts in London.
TABLE IXNEW LISTINGS AND EQUITY CAPITAL RAISED
NEW EQUITY CAPITAL RAISED BY DOMESTIC COMPANIES MILLIONS OF U.
S. DOLLARS
CzechRepublic Poland
CzechRepublic Poland
Total capitalraised through public
issues
Total capitalraised throughpublic issues
Total capitalraised throughpublic issues
Alreadylisted
companies
Newlyadmittedcompanies
Alreadylisted
companies
Newlyadmittedcompanies
On PragueStock
Exchange
On WarsawStock
Exchange
1996 0 0 319 67.5 0 386.51997 0 0 547.4 438.6 0 9861998 0 0
818.6 328 0 1146.6
Source: International Federation of Stock Exchanges (FIBV),
www.bv.com.
891COASE VERSUS THE COASIANS
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This evidence is consistent with both the reading of the lawsand
the qualitative assessments. The regulated Polish stock mar-ket
grew faster, maintained greater liquidity, and has been abetter
source of capital for rms than the less regulated Czechmarket.
After a period of hostility toward any criticism of its
policiestoward the stock market, the Czech government introduced
anumber of reforms starting in 1996. These included disclosure
ofblockholdings, greater regulation (through disclosure and
other-wise) of investment funds, restrictions on trading off the
ex-change, some separation of investment and commercial banking,and
nally, in April 1998, the creation of an independent Secu-rities
Commission.
VII. DISCUSSION
The quantitative and the qualitative evidence both point
tosignicant problems in the Czech nancial system. Still, we
onlyhave one comparison, and our analysis of even this case is
subjectto alternative interpretations. Here we discuss some of
theseinterpretations.
To begin, our assessment of the Czech situation may be
undulyharsh. Overall, the Czech economy performedwell during the
1990sas the transition indicators show. Did the Czech rms simply
avoidthe stock market and raise capital elsewhere?
Although we have no data showing that the lack of equitynance
has undermined investment by Czech rms, there is noevidence of
effective substitute sources of external nance. TheCzech banks have
lent predominantly to the largest rms, andhave themselves been
subject to governance problems and tun-neling, as evidenced by
their huge nonperforming loans. If any-thing, the banking problems
exacerbated rather than cured thelack of equity nance. The venture
capital industry is also moredeveloped in Poland than in the Czech
Republic.
Industrial production grew faster in Poland than in theCzech
Republic. Between 1991 and 1998 the index of industrialproduction
fell from 113.3 to 109.7 in the Czech Republic, androse from 73.6
to 127.4 in Poland. Much of that growth in Polandcame from new rms,
often relying on external equity nance.More generally, the
available evidence from other countries sug-gests that stock market
development is associated with faster
892 QUARTERLY JOURNAL OF ECONOMICS
-
economic growth and better resource allocation [Levine and
Zer-vos 1998; Beck, Levine, and Loayza 2000; Wurgler 2000].
A second concern holds that the Czechs may have only fol-lowed a
different strategy of stock market development: oat allthe
companies you can through privatization, and then see whichones
survive market selection. As part of becoming private, rmscould
always commit, in the Coasian style, to charters that wouldobligate
them to treat investors well, and thus facilitate externalnance in
the future. Even if the Czech strategy resulted inmassive delisting
of shares and investor losses in many rms, thettest rms, with most
market-friendly charters, survived. SuchDarwinian arguments were
made by the Czech reformers in theearly 1990s. Indeed, the Czech
market still has more listed com-panies than Polands, and their
aggregate value is still higher asa share of GDP. Is this approach
to market development obvi-ously inferior?
We believe that it is. In the 1990s the Czech market saw notsome
Darwinian selection of the ttest rms, but rather tunnel-ingthe
diversion (both legal and illegal) of assets from both goodand bad
rms. Coasian contracts bonding rms to treat investorswell did not
materialize. The survival of the theft-proof rms isnot an efcient
mechanism of economic selection. The most ef-cient rms might be the
most attractive to tunnel, making themthe least rather than the
most likely to survive. Such tunnelingwas not expected either by
the Czech reformers or the investors inthe Czech rms. Moreover, the
cost of tunneling has been theinability of both new and existing
rms to raise equity capital,which is perhaps the markets main
function. It is hard to con-sider this outcome a success even if
the government had expectedDarwinian selection.
Even if one agrees that the Czech stock market has not
func-tioned admirably, one can still object to our inference that
the lack ofregulation is to blame. The leading alternative culprit
is mass pri-vatization in theCzech Republic, which led to the
listing of hundredsof rms on the stock market. But privatized rms
have generallyoutperformed those remaining in government hands in
the CzechRepublic [Claessens 1997; Claessens and Djankov 1999;
Frydman etal. 1999] as elsewhere [Megginson and Netter 2001]. If
anything,privatization could have jump-started nancial markets.
Moreover,if the regulation had focused on intermediaries as it did
in Poland inthe 1990s, the large number of listed rms would not
have been aproblem so long as the number of intermediaries was
small. Indeed,
893COASE VERSUS THE COASIANS
-
much of the tunneling in the Czech Republic was perpetratedby
relatively few IPFs and related intermediaries, which could
inprinciple have been regulated with limited resources.
Ultimately,the arguments come back to the Czech failure to protect
investorsthrough the regulation of intermediaries.
Assuming that the regulation of nancial markets was in-deed
inadequate in the Czech Republic, and that this inadequacyhad some
costs, why has the system not adapted in other ways tothis
regulatory failure? Several such adaptations come to mind.Perhaps
private associations of market participants could havebeen created
to enforce good conduct among members. Perhapsthe Prague Stock
Exchange could design its own, private regula-tions to protect
investors, similar to those of Germanys NeuerMarkt [Johnson 2000].
Perhaps the Czech companies could optinto more protective legal
regimes, including those abroad,thereby committing themselves to
good conduct and accessingexternal nance. Perhaps the Czech
companies could individual-ize their corporate charters and
incorporate good standards ofconduct into these charters: in
principle, a Czech company couldagree to ad