With global investors searching for higher returns in international markets, what is the role for investor protection in developing international financial markets and real economies?

Extract

[...] With global investors searching for higher returns in international markets, what is the role for investor protection in developing international financial markets and real economies? Investors need to be protected against expropriation, as they may not be able to recover the expected returns from the company in the event of expropriation by controlling shareholders or management. The protection of outside investors against expropriation by shareholders and management therefore requires a set of mechanisms that make up corporate governance. Expropriation can take various forms: theft of profits, sale of production, assets or shares to another company at below market price, or diversion of the company's business opportunities, or favouritism in installing one of the family members in key management positions, or overpaying executives. [...]

[...] However, the very nature of investor protection, and more generally of financial market regulation, depends very much on the legal structure of each country and the origin of its laws. For La Porta et al. (20005), reform of investor protection, which may take the form of more protective legal regimes or more significant changes to the legal structure, is therefore fundamental and results in significant benefits. With the globalization and integration of financial markets, these reforms are even more necessary today than in the past. [...]

[...] When investors' rights are extensive and well enforced by regulators or the courts, investors are willing to finance companies. On the other hand, when the legal system does not protect outside investors, corporate and financial governance do not function properly. Jensen and Meckling (1976, p. 311) thus recognise the role of the legal system in economic activity. Legal protection for outside investors makes expropriation less effective. Conversely, in the absence of investor protection, creditors and shareholders can appropriate a company's profits. [...]

[...] Under these conditions, investor protection legislation influences a company's external financing possibilities. There are differences in legal protection between countries, due to judicial, political and historical factors. Legal protection for investors is therefore a key pillar of corporate governance. Strong investor protection signals greater security of property rights against political interference in some countries. Moreover, empirical evidence suggests that high investor protection is associated with effective corporate governance, large capital markets, dispersed share ownership and efficient allocation of capital between firms. [...]