Weak Labor, Strong Securities Markets

A vital distinction between market economies is the degree to which ownership of large firms is separate from a firm's day-to-day management. What makes a company's owners willingly hand over control to professional managers? That question is increasingly urgent as wealthy countries-as well as many transition and developing economies-attempt to create the robust securities markets needed to boost investment, productivity, and growth.

Separation of ownership from management and effective securities markets reinforce each other. The underlying theory is straightforward: if bosses can steal, distant owners will not buy shares. The formalistic civil-law systems that prevail in continental Europe supposedly provide inadequate protection, so ownership remains concentrated. By contrast, Anglo Saxon common-law systems empower judges to interpret open-ended fiduciary rules on a case-by-case basis, thereby establishing legal precedents that are binding on managers.

But this is a weak explanation. Before World War I, Europe's civil-law countries were developing securities markets as fast as the US and the UK. Indeed, regulatory agencies like the US Securities and Exchange Commission (SEC) arose because common-law fiduciary duties failed to protect distant owners.

Insider trading, for example, was generally legal under the rules governing fiduciary duties in America's states, which back then played a dominant role. By contrast, the SEC is a rule-generating institution of the type that civil-law countries like France or Germany would have little difficulty creating if they wished to .