Law and finance in transition economies

This paper offers the first comprehensive analysis of legal change in the p rotection of shareholder and creditor rights in transition economies and it s impact on the propensity of firms to raise external finance. Following La Porta et al. (1998), the paper constructs an expanded set of legal indices to capture a range of potential conflicts between different stakeholders o f the firm. It supplements the analysis of the law on the books with an ana lysis of the effectiveness of legal institutions. Our main finding is that the effectiveness of legal institutions has a much stronger impact on exter nal finance than does the law on the books, despite legal change that has s ubstantially improved shareholder and creditor rights. This finding support s the proposition that legal transplants and extensive legal reforms are no t sufficient for the evolution of effective legal and market institutions. JEL classification: G15, K22, K42, O16, P51.