Why Does the Law Matter? Investor Protection and Its Effects on Investment, Finance, and Growth

  • Author(s): R. DAVID MCLEAN, TIANYU ZHANG, MENGXIN ZHAO
  • Published: Jan 17, 2012
  • Pages: 313-350
  • DOI: 10.1111/j.1540-6261.2011.01713.x

ABSTRACT

Investor protection is associated with greater investment sensitivity to q and lower investment sensitivity to cash flow. Finance plays a role in causing these effects; in countries with strong investor protection, external finance increases more strongly with q, and declines more strongly with cash flow. We further find that q and cash flow sensitivities are associated with ex post investment efficiency; investment predicts growth and profits more strongly in countries with greater q sensitivities and lower cash flow sensitivities. The paper's findings are broadly consistent with investor protection promoting accurate share prices, reducing financial constraints, and encouraging efficient investment.

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