A Study On The Relationship Between Financial System And Legal Institutions

Berle and Means wrote in their 1932 masterpiece that Darwinian evolution in the corporate ownership would be that all large corporations develop into the separation of ownership and control, resulting in the forming of financial system with developed capital market. In this system, there exists highly-dispersed ownership structure, developed and effective competitive financial market, rigorous disclosure standards, high transparency and market for corporate control being the main approach to corporate governance.However, when we turn our eyes on the structure of financial systems that matter in reality, we can find the divergence into two polar: one is the prophecy of Berle and Means that is represented by UK and US; the other, with concentrated ownership, weak security markets, slack disclosure standards, large shareholder-controlled corporates, and main banking playing the central roles in corporate governance, is represented by Japan and Germany. The academic circles call such a structure "puzzle of corporate governance" (Coffee, 2002, p.3).Now the academic circles provide various theories aiming at explaining such a puzzle, especially after the publications of a series of papers authored by La Porta, Lopez-de-Silanes, Shleifer and Vishny(thereafter, LLSV). They point out that the difference of investor protection by legal institutions determine the variety of financial system and exploit 49 countries data to examine the hypothesis, which opened the floodgate of a new perspective on the empirics of the law and finance literature. Moreover, basing on the same database, LLSV quantify the core index "investor protection", and find that investor protection in the French civil law countries is relatively weak, leading topless-developed capital market, while with strong investor protection, security market become the main channel to external finance in common law countries.But one of the difficulties of this approach lies in the policy-making aspect. Since only by strengthening the legal protection of investor can capital market be developed more effectively, then we have to deepen the legal reforms to meet the requirement ofinvestor protection; in other word, we have to transplant more legal institutions from common-law countries without considering the historical backgrounds and endowment variety. However the developments of all countries are path-dependent, there are no aversions to the legal reforms. The so-called "shock therapy" in Russia which is like a big-bang tell us that legal reforms must conform to some rules that govern the process, large-scale transplantation of other countries' legal institutions may lead to huge social costs and lose the have-been fruits of reforms.The other difficulty is the theoretical casual relationship between law, which is a part of economic infrastructure, and financial system, which a part of superstructure. Taking a synthesis perspective on the history of financial development, we can find that there must be financial activity first with the legal rules next and the role of law lies in the strengthening of financial development by creating the suitable environment, the emergency of law is scandal-induced. So Coffee(2001) provides the crash-then-law approach to the above puzzle and believe that the development of financial system is somewhat like "crash-then-law cycles".So, the question coming later is that what are the main forces behind these cycles? Why are economic developments reasons and legal evolution consequences? Lightened by Grossman-Hart-Moore incomplete contract framework, Pistor and Xu(2002) argues that law, as a social contract, is incomplete per se, that is, we can not write down all future contingencies in law. So we must allocate the residual law-making powers to fill the gap induced by the incompleteness of law, and the optimal allocation rule is the complementary role of administrative power to law-making power, which is as well pointed out by Coffee(2001), as one of the two deterministic factors(the other is the role of active investment banks), self-regulation by SEC and NYSE play the basic roles in framing the financial system structure. This approach throws much light on the reform of supervisory system in China's security market. This paper argues that we should perfect the private litigation procedure in security tort cases in order to deep the reforms toward the market-oriented financial system.