In a series of articles beginning in 1996, economists Rafael La Porta, Florencio Lopez-de-Silanes, Andrei Shleifer, and Robert Vishny ("LLSV") created a sensation among legal academics and finance scholars by proposing that "countries with poorer investor protections, measured by both the character of legal rules and the quality of law enforcement, have smaller and narrower capital markets." The initial excitement among legal scholars waned quickly when we read LLSV and found the methodology wanting. But finance scholars have not abandoned the project, and recent work in the area has made substantial improvements.

My colleague John Ohnesorge just alerted me to the latest paper on this topic, which comes from a young German legal scholar. Here is the abstract from Holger Spamann, On the Insignificance and/or Endogeneity of La Porta et al.’s “Anti-Director Rights Index” Under Consistent Coding (working paper March 2006):

I re-code the “Antidirector Rights Index” (ADRI) of shareholder protection rules from La Porta et al. 1998 for 46 countries in 1997 and 2005 with the help of local lawyers. My emphasis is on consistent coding; I do not change the original variable definitions. Consistently coded ADRI values are neither distributed with significant differences between Common and Civil Law countries, nor predictive of stock market outcomes. The revision of the variable definitions in Djankov et al. 2005 salvages some of the original results, but reinforces severe endogeneity concerns regarding the index components that drive the remaining significant results. I review the other index components and conclude that the ADRI is unlikely to be a valid measure of shareholder protection. Results derived with the ADRI in the literature may have to be revisited. Along the way, I develop some general guidelines for consistent coding.

I have read only the first part of the paper, but Spamann already displays much greater understanding for the nuances of law than LLSV. (That's not surprising, of course, since Spamann is getting his SJD at Harvard.) Here is one example that appears early in the paper: "Perhaps the most basic question for coding of legal variables like the ADRI is whether only mandatory rules, or all default rules, or even optional rules should be counted." This is obvious to lawyers, but was not explicit in LLSV.

If you are interested in LLSV and its progeny, this paper looks to be worth a read.

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