Shareholder Protection and Stock Market Development in France (1852-2007)

BEYOND LEGAL ORIGINS: SHAREHOLDER PROTECTION AND STOCK MARKET DEVELOPMENT IN FRANCE (1852-2007)

Frédéric Serpoul1 December, 15, 2009; revised June, 15, 20132

Working Paper presented at the European Historical Economics Society Conference, London School of Economics and Political Science (September, 6th-7th, 2013).

ABSTRACT

This paper is the first long-run historical analysis of stock market development and minority shareholder protection in France (1852-2007). For this purpose, we have constructed a unique time series of shareholder protection indices (anti-director rights and securities law) and relied on triangulated and extensive secondary time-series data on French stock market development.

Our analysis indicates that, contrary to the predictions of the influential ―Law and finance‖ theory, formal investor protection was not a crucial determinant of stock market development in France from 1852 to 2007. In addition, beyond its conceptual shortcomings, ―Legal Origins‖ theory is not able to account consistently for differences in levels of shareholder protection between Civil law France and Common law countries across the century. Furthermore, the evidence provided suggests that trade openness alone was not a critical contributor to the development of French equity markets in the period considered.

Rather, we suggest that a political explanation, which incorporates the preferences of social classes and interest groups, the distinct impact of political institutions, as well as the pre- existing or concomitant complementarities among economic institutions, may be a better option in explaining the variance in stock market development in France over time.

1 This paper is derived from a master‘s research project undertaken at the Saïd Business School, University of Oxford (2009), under the supervision of Dr Ventresca (Wolfson College, Oxford). As of Dec‘09, the author was affiliated with Wadham College, University of Oxford. The author is currently affiliated with Standard Chartered Bank. The findings, interpretations, and conclusions expressed in this paper are entirely those of the author. Author‘s contact details: [email protected] ; [email protected]. 2 I am very grateful to Dr Ventresca (Wolfson College, Oxford and Saïd Business School) for his valuable guidance. I am particularly indebted to Dr Hautcoeur (Ecole Normale Supérieure, PSE and EHESS) and Dr Bozio (UCL) who kindly provided me with their own primary research data and datasets. In addition, I benefited greatly from discussions with Dr Mayer (Wadham College, Oxford and Saïd Business School), Dr Sgard (Sciences-Po Paris) and Dr Sussman (Wadham College, Oxford and Saïd Business School) All errors are the responsibility of the author.

“Les lois sont toujours utiles à ceux qui possèdent et nuisibles à ceux qui n’ont rien”, Jean- Jacques Rousseau (Du Contrat Social, 1762).3

Introduction

Building on the intuitions of Bagehot (1873) and Schumpeter (1912), a growing body of theoretical and empirical research suggests that financial ―development‖ is a central determinant to economic growth (See e.g. King and Levine, 1993; Demirguc-Kunt and Maksimovic, 1998; Jayaratne and Strahan, 1996; Mishkin, 2006, p.25). In particular, stock market development, that we will define as the ease with which any entrepreneur or company with a sound project can obtain equity finance4, plays a key role in financing new and innovative firms with little tangible assets, central to the Schumpeterian ―waves of creative destruction‖ of capitalism (Rajan and Zingales, 2003). Nevertheless, despite its presumed benefits, the development of equity markets varied substantially across time and countries. In addition, empirical evidence indicates that the levels and changes in financial development across countries and time cannot be reduced to mere differences in the demand for finance. These two observations suggest that, contrary to neoclassical economics tenets, there may be ―structural impediments‖ to the supply of finance rising to meet the demand for finance in the economy (Rajan and Zingales, 2003). In particular, an increasing influential body of literature sees investor protection as the key ―structural‖ determinant of variance in financial development, and especially in stock market development. (See La Porta et al., 1997, 1998; Modigliani and Perotti, 2001).

In this context, a historical analysis of investor protection and stock market development in France, a country that experienced a ―great reversal‖ (Rajan and Zingales, 2003) in the development of its stock markets and that created a legal system that presumably constrain investor protection, may improve our general understanding of the determinants of these two critical variables. This paper is the first attempt to analyze the long-run evolution of shareholder protection and stock market development in France. In particular, we will address the following research questions: Can shareholder protection account for the evolution of stock market development in France? How can we explain the ―great reversals‖ in the development of French stock markets over time?

Following a brief review of the literature and of our research design in Section 1, Section 2 will present a new time series of investor protection and stock market development in France. Section 3 will attempt to test dominant theories of financial development in the French context. Finally, Section 4 will provide preliminary lessons arising from the French case and potential venues for future research.

3 Can be translated as: Laws always benefit those who own and harm those who own nothing. 4 The definition of a ―developed‖ stock market is often not fully addressed in the literature. We consider stock market development as a normative rather than a descriptive concept, in line with the ―financial development‖ literature. Many authors tend to evaluate the level of development of stock markets based on the ―large‖ ex post size of public equity markets in the economy. Given the alternatives for external finance available for firms, we believe that an ex-ante concept of ―stock market development‖, defined as the ease with which firms can raise equity capital to finance positive NPV projects, is a better alternative than an ex-post measure. Such approach gives rise to ―operationalization‖ and measurement issues. (See Section 3).

1. SECTION I: Literature Review: shareholder protection and financial development

1.1 Limitations of private ordering mechanisms in corporate finance

According to early standard finance theory (Early Modigliani-Miller theorem, 1958), arbitrage between prices of financing instruments in a perfect capital market ensures that capital structure was irrelevant, absent tax (and, later, financial distress). The inability of this theory to make sense of the diversity in financial systems led to reconsider the two key assumptions of standard finance theories. Information is not the same for every agent, especially investors and managers. Contracts cannot specify ex ante and enforce ex post all contingencies. (Grossman and Hart, 1980)

These limitations to the complete market model are particularly acute for corporate governance. Indeed, the extent to which managers (―Agents‖) maximize the residual claim of the shareholders (―Principals‖), will be affected by information asymmetries (Jensen, 1986) and contract incompleteness problems.

Due to transaction costs (Coase, 1937; Williamson, 1975), information asymmetries (Jensen and Meckling, 1976) and incompleteness of contracts (Grossman and Hart, 1980) as well as collective action dilemma (facing dispersed investors to monitor managers), the effectiveness of private ordering, advocated by the Law and Economics literature (Stigler, 1971), may be limited. Indeed, even the purest Coasian solutions of private contracting need impartial instruments to enforce elaborate contracts 5 (Modigliani and Perotti, 2001). Furthermore, transaction costs may not necessarily be lower in the case of purely private contracting. (La Porta et al, 2008).

Overall, given the ambiguity of the theory with regards to the relative efficiency of private ordering and public regulation (or their complementarities) for financial contracts, the literature resorted to empirical analyses of corporate governance and financial development.

1.2 Determinants of stock market development

The combination of the theoretical development on agency costs between shareholders and managers and the empirical evidence of structural impediments to supply of savings meeting the demand for finance have led researchers to consider the role of structural factors in explaining both financial development and the diversity of financial systems across countries.

According to the Law and Finance theory (See: La Porta et al., 1997, 1998, 2003, 2008; Beck et al. 2003), law is the critical factor that explains stock market development. In particular, in different cross-sectional analysis (1990‘s), La Porta et al. showed that legal protection of minority shareholders from expropriation from controlling shareholders and managers was correlated with the development of equity markets.

The literature points to two key explanations in the observed correlations. First, taking into consideration agency costs and information asymmetries, potential shareholders should pay a

5 Asymmetric information is a key impediment to optimal private arrangements. Aghion and Hermalin (1990) pointed out how regulation could improve the efficiency of private contracting by reducing the need for costly signalling equilibria. (See also: Modigliani and Perotti, 2001).

3 higher price to equity issued by firms with higher protection mechanisms from insiders and firms will find it easier to raise external finance in a jurisdiction with better minority shareholder protection. Second, when minority shareholder protection is low, controlling shareholders/entrepreneur will be reluctant to disperse control rights to outsiders in order to maintain their high private benefits of control (See Zingales, 1995; Bebchuk, 1999). Accordingly, La Porta et al. (1998) showed that concentrated ownership was positively correlated with low investor protection in the mid-1990‘s. Indeed, since dispersed minority shareholder face collective action dilemma and a free rider problem in monitoring managers, concentrated shareholders are better able to discipline managers (i.e.prevent shirking, stealing; maximize shareholder value) than dispersed shareholders when minority shareholder protection is low. (Demsetz and Lehn, 1985).6

In contrast to the ―Law and Finance‖ theory, a promising line of research has started to emphasize complementary or substitute forms of investor protection such as trust (Franks et al., 2006; Mayer, 2008), and culture (Stulz and Williamson, 2001) that may also promote diffuse ownership and the development of stock market in the economy.7

1.3 Determinants of shareholder protection

Given the posited importance of shareholder protection for stock market development, the literature has also tried to better explain the sources of the significant variance of shareholder protection across countries. Broadly speaking, existing research point out to two main categories of investor protection determinants: legal origins on the one hand and politics on the other hand.

In their theory, La Porta et al. (1998) explain that the ―Legal Origin‖ of a country determines its subsequent levels of shareholder protection. Indeed, robust empirical evidence from the 1990‘s suggests that countries with Common Law origins have markedly higher levels of minority shareholder protection than countries with Civil Law origins.

A second stream of the literature emphasizes the role of politics as drivers of shareholder protection. Indeed, contrary to the predictions of the Law and Finance theory, the seminal paper from Rajan and Zingales (2003) has shown that stock market development in Civil Law countries were not less developed than in Common law countries in the past. In this view, financial development is ultimately determined by the outcomes of interest group politics. In particular, for Rajan and Zingales (2003), openness in capital and trade removes the incentives of domestic incumbents to repress financial development and investor protection. Roe (1994, 1999, 2003, 2007) attributes the difference in investor protection to the strength of labour power, as mediated through the left/right partisan political struggles, with the former likely to better protect inside labour at the expense of minority investors.

6 Concentrated owners however forego some diversification benefits that can accrue to dispersed shareholders. 7 To our knowledge the following countries were subject to in-depth historical analyses of financial development: Germany (Franks, Mayer and Wagner, 2006), UK (Franks, Mayer, Rossi, 2006), Japan (Franks, Mayer, Miyajima, 2007), Italy (Aganin and Volpin, 2003) and Brazil (Musacchio, 2007).

1.4 Contribution to existing research

Our research is the first long-run historical analysis of the determinants of stock market development and investor protection in France.8 We will seek to answer two key research questions: To what extent can shareholder protection account for the variance in the development of equity markets in France? How can we explain the ―great reversals‖ in the development of French stock markets?

In section 3, we test whether associational and causal relationships predicted by the main theories of financial development, Legal Origins theory and Trade Openness theory, do indeed hold over time in France. The theories being evaluated were chosen based on their robustness in explaining cross-sectional patterns, their influence in scholarly literature and policy-making, and their parsimony.9

The combination of the quantitative/qualitative designs, coupled with the consideration of the complex idiosyncrasies of a single country case, will enable us to go beyond deductive theory testing and provide inductively preliminary generalization in section 4.

The French case is of particular relevance for debates on the determinants of financial development:

First, France constitutes a ―critical‖ case (Yin, 2003, p.39) to test the validity of the Legal Origins theory, the dominant thesis of financial development in policy and scholarly debate. Indeed, Civil law originated from France, with the Napoleonic codification of 1804, on the remnants of the Roman legal tradition.10

Moreover, by definition, France is the only civil law country where civil law was not ―imposed‖ or transplanted in some forms. Consequently, the analysis of the French case would yield valuable insights to the debate by separating impacts attributable to ‗civil law‘ per se (contentions of the theory), from other impacts, such as the consequences of legal transplant processes in other geographies.

In addition, the focus on the French case is defendable on the grounds of the country‘s relative importance in the world economy (7% of World GDP in 1870, 5% in 2001, Maddison, 2001) and financial markets (Third largest equity markets in 1913; Rajan and Zingales, 2003). The presence of a sizeable outlier to the major theories of financial development should lead us to question the existing theories in their current form.11

8 A very different type of contribution from Lamoraux and Rosenthal, who analyzed the flexibility of organizational forms in 19th century France (2005), on the basis of Hilaire‘s contributions (1986). 9 See references to LLSV in the EU Commission and World Bank reports. By definition, the longitudinal data design test can assist in testing time-invariance and, as a consequence, the general validity, of the associations between variables predicted by the theories. In addition, in comparison with a cross sectional design, a longitudinal time-series design enables us to better deal with the ambiguities of causal inference, by improving our understanding on the time order of variables. 10 One may argue that the analysis of the French case may not be a strict test of the Legal origins thesis significance because legal origin is in effect held constant when focusing on a single country. However, the in- depth and longitudinal study of the French case will enable us to test critical inferences with respect to relationships between legal origins (held constant) and financial development.

2. SECTION II: A new time series - the evolution of Shareholder Protection and Stock Market Development in France (1852-2007)

2.1 Data: Stock Market development: definition, measurement and sources

2.1.1 Defining stock market development

There are many dimensions that may be used to evaluate the ―development‖ of stock market such as stock market size, liquidity, volatility, institutional development, or international integration (Demigurc-Kunt and Levine, 2008).

According to standard finance theory, financial development would be deemed to occur when any positive Net Present Value project/asset would be able to be funded through external finance, regardless of the project/asset‘s owner (i.e. regardless of the owner economic net worth or his family, social and political networks and affiliations). Following Rajan and Zingales‘ definition (2003), financial development would also be characterized by the ability of the financial system to evaluate risks adequately and allocate them to the parties that can best bear them, at a low cost. Accordingly, stock market development would be deemed to occur when any issuer in need of equity finance would be able to finance positive NPV projects without constraint.

However, this definition is not amenable to operationalization and ex-post observations. We will therefore consider two crude proxies for stock market development: the standard Domestic market capitalization to GDP and the not-so-standard Domestic issues/Corporate Gross Fixed Capital Formation.

2.1.2 Measuring stock market development

2.1.2.1 Domestic market capitalization to GDP

This measure refers to product of share price and the number of share outstanding for all domestic stocks traded on the exchanges of France. It therefore includes a value component (share price as Present Value of future cash flows of the listed firm) and a volume component (companies listed on the exchange). It captures the size dimension of stock market development.

The drawback of this measure is that it does not capture the development in terms of liquidity. Large markets may be large but not ―active‖ (Levine and Sverkos, 1998)

In addition, the evolution of Market Cap/GDP is more difficult to interpret because of the large number of factors that can affect this ratio, such as market valuations derived from investors‘ expectations and changes in volume of listed company (e.g. nationalization; indirectly, variations in firms‘ share of GDP).

Ideally, the External Market Cap/GDP, with external market capitalization defined as the proportion of minority shareholders owning publicly listed firms would be a much more valuable indicator in the context of our study. However, detailed historical ownership data on public shareholdings in France is minimal, fragmented and hardly reliable.

Domestic stock market capitalization data 12 is sourced from primary exchange data collections from Arbulu (1998) for 1852-1900 (only ordinary shares and Paris exchange)13, Hautcoeur (1994)14, Petit (2001) and Bozio (2002) for 1900-1945 (―Côte officielle‖ record for Paris, Coulisse, Lille primary data and estimates from secondary sources for other regional exchanges) and SBF/Euronext for 1945-2007 15 (reliable). It adjusts for various shortcomings in the data used in earlier economic and financial studies that solely relied on often contemporary secondary sources. In fact, the data source used by Rajan and Zingales in their seminal 2003 paper (i.e. Saint-Marc, 1965, 1975, quoted in Bouvier, 1970) is likely to include domestic and foreign stocks 16 and relies on indirect estimates of capitalization, inferred from government tax revenue on dividends and aggregate estimated average dividend yield applied to all listed companies, which contributed to their overestimation of pre-1914 capitalization.17

Unfortunately, GDP figures18 reflect value-added in metropolitan France (with temporary exclusion of Alsace-Lorraine in 1871-1918 following the Prussian annexation) while colonial companies domiciled/deriving substantial cash flows from the French Colonial Empire were indiscriminately classified as ―French‖ companies in the exchange records from late 19th century to early 1960‘s (estimated to c.19% of capitalization in 1946; c.9% in 1955; Bozio, 2002). Also, provincial and Coulisse exchanges (underestimation of probably 10-15%, Arbulu, 1998) data were not available for 19th century data.

2.1.2.2 Domestic equity issues to Corporate Gross Fixed Capital Formation

This indicator refers to the amount of equity capital raised through initial public offering or seasoned equity offering by domestic companies, as a percentage of corporate domestic investment measured as corporate Gross Fixed Capital Formation (GFCF). Corporate Gross Fixed Capital Formation is equal to the total value of producers‘ acquisitions of fixed assets, net of disposals. This is our preferred measure because the decision to issue equity by firms (and to subscribe to equity issues by investors) is more likely to be sensitive to marginal changes in the environment and investor protection than is stock market capitalization.

Yet, this indicator has several shortcomings:

12 See Appendix for details on sources. 13 Approximate underestimation of c.15% 1852-1900. (Bozio, 2002). 14 Hautcoeur (1994) collected ordinary shares valuations for 1901, 1913 and 1928 for the Paris exchange primary ―Côte Officielle‖ source. Under the ―ESF‖ programme, Petit (2001) and Hautcoeur extended the data collection to all shares from the ―Côte Officielle‖ of the Paris exchange from 1920 to 1938. Petit (2001) further collected detailed shares data for the Lille exchange for the 1900-1962. This data was sourced from Bozio (2002). 15 Aggregate capitalization data are from ―l‖Année Boursière‖, collected from Bozio (2002). Post 2001 data collected from Euronext. 16 Rajan Zingales‘s 78% market cap/GDP in 1913 includes foreign stock (Bouvier and Saint Marc as source, See Bozio, 2002). 17 The method would also underestimate market capitalization because far from all listed companies pay dividends. 18 We benefited from the latest advances in economic history research to obtain reasonably accurate GDP estimates. See Toutain (1996) for the on-going debates on the reliability of previous GDP estimates for 19th century French GDP data, which, unsurprisingly, bear large variance across estimates (e.g. Levy-Leboyer, Crouzet and Toutain).

First and foremost, existing data reconstructed for corporate investments and, particularly, equity issues, still bears limited reliability prior to 1939.

In addition, the indicator excludes net working capital investments and does not normalize for listed companies investments. 19 Furthermore, it tends to be highly cyclical (Pagano et al.1998). Moreover, the macro-economic nature of this indicator does not allow us to capture valuable insights such as company location, size, sector or offering type (IPO vs Seasoned) factors. Indeed, empirical studies have shown that equity issues are driven by a multiplicity of other factors beyond external financing need, such as, inter alia, age of firms, nature of their assets (Zingales, 1998), market timing and balance sheet rebalancing (Pagano et al., 1998), enhanced stock-trading liquidity (Zingales, 1995), efficient transfer of controls (Roell, 1996) or takeovers operations motivations (Franks and Mayer, 1996).

Finally, by normalizing gross fixed capital formation by corporate investment (i.e excluding government, households and agricultural investments), we are in effect trading conceptual rigor for comparability. Due to the uniqueness of our indicator in the literature, we are not able to compare it with the (already) very limited historical work on financial development, notably the paper from Rajan and Zingales (2003).

Equity issues from 1892 to 1936 are derived from Hautcoeur dataset (1994), which was generated from detailed manual collection of Paris exchange data for French companies (i.e. regional bourses and Coulisse not available: possibly 15%-20% and 10%-5% underestimation for pre-1939 period and 1940‘s-1970‘s, respectively). Unlike the SGF and Credit Lyonnais statistics, the sources of most economic and financial historians to date, the Hautcoeur data adjusts for the incidence of issuance premia, free shares, actual (rather than nominal) values of shares and actual payments of issued capital (Marnata, 1973; Hautcoeur, 1994). Equity issues for 1936-1939 and 1950/1960 were sourced from Sauvy (1984) and Rajan and Zingales (2003) respectively. Yearly equity issues after 1974 collected from Paris Bourse/Euronext official records are deemed reliable.

Corporate Gross Fixed Capital Formation data was calculated from various macro-aggregates from Carré, Dubois and Malinvaud (1972) for 1892-1896, Bourguignon and Levy-Leboyer (1985), Villa (1993) for 1892-1949 and INSEE for 1949-2007.

2.1.2.3 Other measurements considered

The Domestic listed company per capita indicator (Appendix B) does not appear to be a very valuable proxy of financial development because it tends to reflect more the evolution in the productive structure of the economy rather than financial development per se (See Chandler, 1990).

Valuable indicators such as Trades/Market Cap and Trades/GDP, liquidity, voting premia (Dyck and Zingales, 2004), Tobin‘s Q (La Porta et al., 2002), and ownership dispersion (La Porta et al., 1999) could not be calculated based on the existing data.

19 This is acceptable since our focus is on the size of stock market financing in the economy rather than the micro-determinants of firms‘ financing decision.

2.1.2.4 Conceptual considerations

In some sense, a more fundamental caveat of our two indicators is that they do not fully capture the substitutability between equity financing and other forms of external finance.

Refinement of Modigliani-Miller irrelevance theorem (1958) points out to the existence of trade-offs or preference in firms‘ financing decision. Trade-off theory posits that firm‘s capital structure is a result of optimization between tax and financial distress costs. Pecking order theory (Myers and Majluf, 1984) documents that, mainly as a result of information asymmetries, equity issues are likely to occur after accumulated internal finance 20 and external debt means of financing were exhausted. In light of those theoretical considerations, without data on debt (bank/bonds), it is difficult to know whether equity markets rise because of relative disadvantage of debt markets/bank/Government financing rather than because of intrinsic improvements that favour equity markets.

Nevertheless, stock market development is a ―purer‖ indicator of financial development to the extent that it is normally closer to an arm‘s length market than other type of external financing alternatives, such as bank finance and arguably bond finance (Hellwig 2000, Rajan and Zingales, 2003), and hence more likely to be influenced by institutional factors and private ordering issues. Similarly, a growing body of theoretical work (Boyd and Smith, 1996; Allen and Gale, 2000) and empirical studies have emphasized complementarities and positive correlation between stock market development and the development of financial intermediaries (Sylla, 1998).

In fact, in France, in 1945-2007, corporate bond capitalization/GDP was positively correlated with stock market capitalization/GDP (Bozio, 2002), while in pre-1914 France, the largest equity issuers (34% of offerings in 1871-1918, Arbulu, 1988) and stock market capitalizations were actually banks (in 1913: Banque de France, Credit Lyonnais and Societe Generale; Hautcoeur, 1994).

Therefore, the potential shortcoming inherent in our narrow focus on stock market development without due consideration of the evolution of alternative sources of external finance, may not be as critical as initially feared.

2.2 Data: Shareholder protection: definition, measurement and sources

In order to address our research objective, we have built a unique dataset on shareholder protection, from primary and dispersed secondary sources, covering the 1852-2007 period:

2.2.1 Defining and measuring shareholder protection

Shareholder protection can be defined as the set of mechanisms through which outside investors protect themselves against expropriation by the insiders.

In order to ease operationalization concerns, and to ensure comparability and engagement with the existing literature, we have restricted our measurement to „formal‟ institutions of shareholder protection. As a result, the presence of shareholder rights against majority

20 We have tried to control for internal finance availability in our study with a very crude proxy. (Cf infra).

9 shareholders and directors as well as the disclosure, liability and enforcement regulations pertaining to equity issuances were used to measure shareholder protection.

The first set of measures of shareholder protection is the LLSV index of shareholder rights (La Porta et al., 1997) deemed to protect shareholders from managers/directors and controlling shareholders. This includes an index to capture the separation of ownership and control rights (―One share one vote‖) and an index for ―Antidirector rights‖: (1) Shareholders are allowed to mail their proxy votes to the company (2) Shareholders are not required to deposit their shares prior to the General Shareholders‘ Meeting. (3) Cumulative voting or proportional representation of minorities in the board of directors is allowed (4) Existence of oppressed minorities mechanism. (5) Minimum percentage of share capital that entitles a shareholder to call for an Extraordinary Shareholder Meeting is less than or equal to 10%. (6) Preemptive rights of shareholders waived by a shareholder‘s vote.

The second set of measure of shareholder protection considered over the 1852-2007 is the 3 ―LLS‖ indices of ―securities laws‖ (La Porta et al. 2004):

- Disclosure requirements index: (1) Prospect; (2) Compensation; (3) Shareholders; (4) Inside ownership; (5) Contracts Irregular and (6) Transactions indicators.

- Liability standards index: (1) Liability standard for the issuer and its directors; (2) Liability standard for the distributor; and (3) Liability standard for the accountant indicators.

- Public Enforcement standards index: (1) Supervisor characteristics index (2) Rulemaking power index; (3) Investigative powers index (4) Orders index and (5) Criminal index.

One obvious shortcoming to this set of measurement is that it does not take into account enforcement of legal rules. Nevertheless, historical evidence suggests that the rule of law and the efficiency and integrity of enforcement of laws and contracts in courts in the period considered, with the exception of the Second Empire (1852-1870) and World Wars period (1914-1918; Vichy regime), were not lower than in the UK or the US (David, 1985). In the modern era, France ranks marginally above the US or the UK in terms of contract repudiation, corruption (>US) or rule of law (>UK) (La Porta et al, 1998). Besides, empirical evidence on late 20th century data suggests that enforcement and rule of law are robustly correlated with economic development, which was comparable between UK (arguably), US, Germany and France (Levine, 1997).

A second limitation stems from the ‗default‘ nature of corporate law. Companies, through the design and amendment of their charters, could contractually grant stronger shareholder rights than the ones prescribed by the company laws, which define minimal shareholder protection provisions. Yet, it appears from our (limited) secondary sources on corporations and financial history that, in effect, the laws tended to exert constraint on majority shareholders and directors in their drive to exploit minority shareholders. We are not aware of instances of corporate charters granting substantially larger minority shareholder protection than the one prescribed by the corporate laws, apart from documented incidences of voting caps, graduated voting schemes and statutory dividends (usually 5%) (Lyon-Caen and Renault, 1916).

2.2.2 Data and sources: constructing a new time series of shareholder protection in France (1852-2007)

In order to construct the time series of shareholder rights and securities regulations according to LLSV and LLS indices, we have relied to multiple and triangulated sources. In the absence of specific studies on the subject by legal scholars and historians alike, we have relied on fragmented evidence from contemporaneous legal treatises from the 19th and 20th centuries, such as Planiol (1905), Planiol et al. (1942), Houpin and Bosvieux (1907, 1929, 1935) Lyon- Caen and Renault (1891, 1916, 1924), Ripert (1951, 1981), Thaller (1898, 1903), Aubry and Rau (1922), Hémard et al. (1972), Ripert and Roblot (2002), Guyon (1996), Cozian et al. (2005), Merle (2003, 2007) and Bonneau and Drummond (2005) as a tool to preliminarily identify potentially relevant laws and jurisprudence.

This initial identification phase was followed by detailed primary data analysis of all relevant laws, decrees and regulatory rulings from the French Government official gazettes from 1852-2007 (Gazette du Palais, Sirey) and jurisprudence records (Mestre et al. 1995, Legifrance, Vergé, 1877). We have also made use of comments and discussions of lawmakers and experts (included in Gazette) and major official parliamentary/government reports (Rousseau, 1893; Vienot, 1995, 1999; Bouton 2002; Conseil d‘Etat, 2001).

2.3 Findings: Evolution of shareholder protection and stock market development 1852-2007: a new time series

2.3.1 Stock market development:

2.3.1.1 Stock market size Market Capitalization/GDP observations and stylized facts

We can identify from our dataset four broad phases of stock market development, defined as Domestic Market Capitalization/GDP.

Figure 1: Evolution of domestic stock market/GDP (1852-2007)

Market Cap/GDP in France (1852-2007)

140%

120%

100%

80%

60%

40%

20%

Domextic Stock Stock Domextic marketcap/GDP 0%

1851 1870 1920 1924 1928 1932 1936 1958 1962 1966 1970 1974 1990 1994 1998 2002 2006 1902 1906 1910 1946 1950 1954 1978 1982 1986 Market Cap/GDP (Author's Calculation: Bozio, 2002+Arbulu,1988+Toutain,1985+LevyLeboyer, 1965+Villa, 1993+INSEE+Euronext) Market Cap/GDP (Rajan/Zingales, 2003)

- c.1890-c.1930: Rapid development

From 1890‘s to 1930, following an extremely rapid development in the 1850‘s and 1860‘s, the stock market becomes a major source of financing for the French economy, rising to approximately 55% of GDP in the Belle-Epoque period prior to World War 1, and gradually returning to high levels of capitalization in the 1920‘s (50%) following the post-World War I short recession and high inflation (c.15%). Equities were notably driven by the high domestic savings rates, inexistent (pre-1917) then low (from 1917) corporate and dividend tax rates21, low relative real returns on government bonds (negative real returns in 1914-1922), acceleration of economic growth and the increased capital needs of the second industrial revolution.

- c.1930-1939: Moderate decrease

The 1930‘s are characterized by decrease of capitalization levels to approximately 30% of GDP in very adverse economic (great depression in 1932-1936) and political conditions (nationalizations of railroads and armaments by the Popular Front Left government in 1936/37).

- 1946-c.1985: Marginal contribution to the economy in a State-controlled financial system

From 1945 to mid-1980‘s, despite a temporary peak of market capitalization to moderate levels (approx.30% of GDP) in the late 1950‘s and early 1960‘s, the stock market played a marginal role in the French economy in a context of very high economic growth (5.1% annually). Critically, the 1946 and 1981 nationalizations had the consequence of withdrawing the largest firms from the Paris Stock Exchange. 36% of market capitalization at 1938 valuations in 1945 (Moreau-Neret, 1957, p.183) and 17% of Market capitalization in 1981 (Bozio, 2002) were nationalized. Remaining firms that were not state-owned relied primarily on State funds (FDES) and banks (the largest three were also nationalized) for external financing. In 1949, bank and direct State financing accounted for 32% and 41% of firms total financing respectively (In 1966: 41% (bank) and 35% (State) of total corporate financing in 1966) (Hautcoeur, 1999)22

- c.1985-2007: Radical shifts in the French financial system

From mid-1980‘s, following the Socialist-initiated radical change in macroeconomic policy (i.e. inflation and supply side focus, liberalization of credit, prices and interest rates controls), major privatizations programmes undertaken in 1986 and 1993-2000 (equivalent to 7% and 10% of market capitalization respectively; OECD, 2001) and increased global capital and trade integration of the French economy (end of capital controls in 1986), the stock market underwent very rapid and intense development, with capitalization to GDP ratio increasing substantially to more than 100% of GDP in the late 1990‘s and close to 90% of GDP in 2004- 2007.

21 Tax neutrality at personal investor level: dividend and interest tax rates on personal Income at 12%. We are not aware of capital gains preferential tax treatment at the time. (Levasseur and Olivaux, 1981) 22 Double Tax credits on dividends in 1960/1978, which in effect increased substantially the after-tax equity returns.

Overall, the broad historical trend is not exactly one of ―U‖, as characterized by Rajan and Zingales (2003). The drop between the 1930‘s and 1950‘s is not linear and the levels of capitalization reached in 1990‘s are markedly higher (approximately 40 percentage points) than levels reached in early 1900‘s.

2.3.1.2 Stock market as a source of external finance for investments: Equity issues/Gross Fixed Capital Formation (GFCF)

Figure 2: Equity Issues/Corporate Investments (1892-2007)

Domestic Equity issues/Corporate Gross Fixed Capital Formation in France (1892-2007)

25.0%

20.0%

15.0%

10.0%

5.0%

0.0%

1892 1895 1898 1901 1904 1907 1910 1913 1930 1933 1936 1939 1960 1969 1974 1977 1992 1995 1998 2001 2004 2007 1921 1924 1927 1980 1983 1986 1989 Domestic Equity issues/Corporate Gross Fixed Capital Formation (Source, SGF/Credit Lyonnais, Hautcoeur data set, 1994; Villa 1993, INSEE)

- c.1895-c.1913: sharp increase of equity issues as a source of investment finance from 5% to approximately 20 % prior to the first World War in a context of decreasing internal financing rate 23.

- c.1918-c.1927: decrease of equity issues as a source of investment finance (mean=11%).

- c.1927-c.1930: historical peak of the reliance on equity issuance to investments (24%), under improved economic conditions (Poincaré policy of inflation control; growth).

- 1930‘s-c.1985: minor contribution of equity issues as sources of investment finance. (mean=4%).

- c.1986-2007: equity issues rise to become again a major source of investment financing (mean=15%).

23 Driven by increased capex rather than lower margins.

To summarize, our two indicators of stock market development (Size and Equity issues/ investment) point out to the following stylized observations: (1) The importance of stock market development from c.1890-c.1930 (2) The lack of stock market development from 1945-c.1985 (3) The substantial development of equity markets financing from c.1985 onwards.

2.3.1.3 Stock market development in a comparative perspective:

Figure 3: Comparative stock market development 1913-1999

Stock market development by legal families 1913-1999 (Adapted and modified from Rajan & Zingales, 2003)

160% 146% 135% 140% 120% 102% 100% 88% 90% 85% 77% 80% 62% 67% 60% 62% 58% 60% 43% 38% 40% 24% 25%

20% 13% 10% Domesticstock market cap/GDP

1913 1929 1938 1980 1990 1950 1960 1970 1999 2007 France (Per Author's various sources) Avge Civil Law (Brazil, Belgium, Egypt, France, Italy, Holland) (Source: R&Z, 2003, updated for France data per Author's) Avg Common Law (Aust, South Africa, UK and US) (Source: R&Z (2003))

The use of new data for France and a broader perspective on the evolution of stock market development yield interesting observations. The French stock market was indeed very developed in early 1900‘s both from an internal historical perspective as well as a comparative perspective.

Nevertheless, contrary to the claims of Rajan and Zingales (2003), the French stock markets have never been consistently as developed as the British and American stock markets, even in the late 19th century and early 20th century24. In addition, after excluding for key outliers in the data used by Rajan and Zingales (2003)25, on average, civil law stock markets did not seem more developed than stock markets in common law countries in 1913. However, in line with Rajan and Zingales interpretation on ―great reversals‖ (2003) (per the limited sample) the data suggests the contribution of stock markets to the financing of civil law countries (France in particular) was significantly lower in the 1930‘s-1970‘s period than in the early 20th century, particularly relative to common law countries.

25 Per Rajan and Zingales data (2003), in 1913, India had an estimated 2% market cap/GDP while Cuba had an estimated 219% market cap to GDP, materially skewing the Common law and Civil Law averages (For more concerns around the data used by Rajan and Zingales (2003). As a result, Rajan and Zingales reach the conclusion that equity markets in Civil Law countries were more developed than in Common Law countries in 1913.

2.3.2 Shareholder protection in France: a new time series(1852-2007)

As highlighted in figure 4 below, Shareholder rights26 (1 share/ 1vote (0-1) and Antidirectors rights (0-6) indices) display an increasing trend from 1852 (0) to 2001 (5), with five critical junctures in 1867, 1933, 1960‘s (1961-66), 1986 and 2001, and an acceleration of reforms towards stronger investor protection in the late 20th century.

Figure 4: Evolution of shareholder rights in France (1852-2007)

With regards to securities regulation (Disclosure requirements, Liability standards and Public enforcement standards), as summarized by figure 5 below, our data suggests shareholder protection reached high levels in the 1980‘s following notable increases in 1907, 1935, 1966- 67 and 1986.

The key changes in shareholder protection and securities regulation are highlighted in table 1 below (See appendices C and B for further details).

26 We will call ―Shareholder rights‖ the combination of Antidirectors rights and 1 share/1 vote rights. We will call ―Shareholder protection‖ the combination of shareholder rights and securities laws indices.

Figure 5: Evolution of Shareholder protection in terms of Securities laws (1852-2007)

Securities Law Indices in France (1852-2007) (Source: Author's coding; see text/appendices for sources) 0.90 Disclosure Securities Law I: France (1852-2007) 0.80 0.75 0.77 0.75 0.77 Liability Securities Law II: France (1852-2007) 0.70 0.67 Enforcement Securities Law III France (1852-2007) 0.63 0.60 0.53 0.53 0.50

0.40 0.33 0.33 0.30 0.22 0.22 0.22 0.22 0.22 0.22 0.22 0.22 0.20 0.17 0.17 0.17

0.10

0.00 1851 1867 1907 1935 1961 1967 1986 1989 2001 2007

Table 1: Major changes in Shareholder Protection in France (1852-2007)

I. Shareholder rights Source and Date of Change

Never (0) (Note:Capped at 10 votes per shareholder since 1867. 1933: Proportionality of votes to shares subscribed as "public order" measure. One Share one Vote Exception (art.1 for shares held for 2 years by same shareholder). 1966: extension of voting rights according to time of holding (2 years) but gvnt proposed cap increase to 5 (rejected by Parliament)

Proxy voting by mail Law of 03/01/1983, implemented by Decree (n°86-584) 14/03/1986): +1

Shares not blocked before meeting Law NRE 2001 Prevents shares blocking +1 Law of 1867 art.15 + Commerce Code (Corporate Interest) (e.g. See Cools, Cumulative voting OR Proportional representation 2005) Jurisprudence "Piquard" of Cour de Cassation (supreme court) 1961 "Piquard" +1; Note: LLSV did not include in their index in 1998,2000. Oppressed minorities mechanism (Right of Action OR right of appraisal) French concept of "Abuse of Majoriy" and "Corporate interest" enable minority shareholders to litigate against the majority to taking action against company interest and minority Preemptive rights for sh (vote) to prevent dilution Decret-Lois (Decree with legal force) 08/08/1935 +1 % of share capital to call EGM at 10% Law of 24/07/1966 +1

II. Securities markets Laws 1. DISCLOSURE REQUIREMENTS 1907: +0.17, 1967: +0.17=>0.33, 1989: +0.33 => 0.67 Prospectus Law of 30/01/1907 Law NRE 15/05/2001 (Instructions COB/AMF for disclosure Compensation in prospectus requirements) SH ownership structure Law of 1966 Law NRE 15/05/2001 (Instructions COB/AMF for disclosure Inside ownership by directors requirements) Irregular contracts outside ordinary course of business Never Index of prospectus disclosure requirements for transactions with Law of 02/08/1989 related parties 2. LIABILITY STANDARDS 1807: +0.22 , 1907 =>0.22 (Art.1382 Civil Code per jurisprudence) 1966/67: +0.63 (notably Art. 6-7-1 28.09.1967 ordinance); 3. PUBLIC ENFORCEMENT 02/08/1989: +0.1 => 0.73

- 1852-1867: The limits of private ordering mechanism (Shareholder rights: 0)

Prior to 1867, shareholder rights were neither sanctioned by the legislator nor greatly protected by the jurisprudence (Commercial Code, 1807, Art.14-67). Due to rigidities in limited corporation incorporation laws, shareholder protection was mostly left to private contractual arrangements. The Napoleonic code of 1807 authorized two types of organizational forms with rights to issue shares. The ―Société en Commandite par Actions‖, a limited partnership with shares, and the ―Société Anonyme‖, a limited company with limited liability for shareholders (Hilaire,1986,p.220). The incorporation of ―Sociétés Anonymes‖/Limited corporation was subject to drastic government approval through the ‗Conseil d‘Etat‘ (Hilaire, 1986, p.221; 15 per year, Hilaire, 1986, p.232-33).

In response to the difficulty to obtain government approval to incorporate as ―Sociétés Anonymes‖ in a context of accelerating economic growth and industrialization, French entrepreneurs chose to incorporate extensively as ―Commandite par Action‖, which also became the main shares issuers (―Commandite fever‖; Ripert, 1912, 1981; Freedmann, 1993).

Shareholder protection according to the LLSV composite index was equal to 0, since most issues were made through ―Commandites‖ where shareholder rights were mainly left to contractual arrangements between parties. Overall, despite minimal form of protection from fraud granted by the jurisprudence in the 1850‘s-1860‘s (Hilaire, 1986, p.214-226) and the Conseil d‘Etat insistence on voting caps for the incorporation of the few ―Sociétés Anonymes‖ (10-20 votes per shareholders, according to Lefebvre-Teillard, 1985, p.210), the decentralized exercise of free contracting between entrepreneurs, managers and internal shareholders and external shareholders, in such a weakly regulated environment, did not lead to arrangements protecting minority investors.

- 1867-1935: Recognition of the need to protect shareholders (Shareholders rights: 1)

The free trade treaties with Belgium (1857) and, critically, Britain (1860 and 1862) signed by the liberal regime of Napoleon III27 and the gradual acknowledgement by the Saint-Simonian Imperial government (1852-1870) of the various shortcomings of ―Commandites‖ as an efficient vehicle for French industrial development, led to impetus for change in French company law. Following the decrease of capitalization requirements for Sociétés Anonymes (1863) and, critically, the end of government approval for Sociétés Anonymes incorporations (24/07/1867 law)28, the legislator prescribed stricter organizational and functioning rules for ―Sociétés Anonymes‖ with the seminal law of 24/07/1867.

With this law, the concept of the company limited by share capital, uniting limited liability, separate personality and dual governance structures (board, shareholder meetings), was already in place in France. Protection against fraud was increased by the need to pay 25% (50% for bearer shares) of subscribed capital and increase penalties. (Szramkiewicz, 1989, p.320).

The new corporate form enjoyed considerable success, especially for larger firms (976 ―Sociétés Anonymes‖ incorporations vs 143 for ―Commandites‖ in 1881, Freedmann, 1993, p.12).

By 1867, shareholder protection according to LLSV index was equal to 1 (See Houpin, 1907, p.1 to p.145: Proportional voting for directors). Interestingly, explicit government guarantees for default for sectors deemed ‗strategic‘ such as railroads and canals were also in place to reassure bond and equity investors.29 (Arbulu, 1988).

A critical departure from LLSV‘s ratings cast doubt on the authors‘ characterization of French law as rigid. Proportional voting provisions that would facilitate the election of directors by minority shareholder are indeed not mentioned in statutory laws and codes. Yet, the ―validity of clauses of proportional representation is generally admitted in French case law‖ (Cools, 2005), well before the 1966-67 Reforms (See: Decree-Act of 1937; Guyon, 1996; Freyria, 1951, p.419). Hence, the ‗proportional voting‘ index should equal 1 from 1867 to 2007 instead of 0 for La Porta et al. (for mid-1990‘s).

Even though, proxy voting was explicitly allowed (art.28 of 1867 Law), in practice the use of intermediaries without formal ex-post control of their powers greatly limited its benefits for minority shareholders (―Blank‖ proxy see Houpin, 1907, p.71).30

Interestingly, although shareholder protection according to LLSV index remained stable in the 1867-1933 period, at the margin, shareholder rights did not evolve in a linear fashion. For example, in 1903, multiple voting shares were formally authorized (Law of 16/11/1903) with a voting cap of 10 votes per share, thereby degrading the formal rights of minority shareholders. Yet, by 1933, French corporate legislation recognized the principle of ―one share-one vote‖ explicitly. Authorized multiple voting shares were deemed an exception to this principle and were capped at 2 voting rights per share, subject to prior holding period of 2 years (Law of 19/11/1933).

In practice, a large obstacle to minority shareholder protection was the increasing usage of multiple voting rights by managers and founding shareholders, permitted by the 1903 law, and, until 1933, the restriction of attendance of general meetings to holders of minimal shares in charters (typically 20-40 shares thresholds; Lyon-Caen and Renault, 1916; Hannah, 2007). According to A.Sauvy (1984, p. 148), in 1928, 24% of companies listed in the Paris exchange had issued multiple voting shares with documented large uses in Chemicals (39%) and Electricity (40%) sectors. Widespread allocation of underpriced 31 founder‘s shares to insiders 32 (with ―superdividends‖ subordinated to preferred/common stock dividends) contributed to value expropriation, at the expense of minority shareholders. Non-listed founder shares of the Paris bourse listed companies accounted for 18% (1890) to 12% (1936) of total shares of Paris listed company (Hautcoeur dataset, 1994). Anecdotal evidence of abuse of minority shareholders by managers and/or majority shareholders is widespread (e.g. La Houilliere Bleue case (1932) Sauvy, 1984, p.148.; 130 MF ―Rochette‖ (1908), Freedemann, 1993, p.56).

Despite efforts towards mandatory disclosure of basic financials and corporate acts (Law of 30/01/1907) and towards accounting harmonization (Law on intangibility of accounting

29 From 1883, as mentioned by Viller, 1955, p.189, cited in Hautcoeur (1994): statutory dividends could benefit from Government guarantee in exchange of an increase of 32% surtax on dividends (to be confirmed by further research). 30 Because LLSV index is Proxy by MAIL, not intermediary, index rating is still 0. 31 Underpriced by means of undervaluation of initial ―goodwill‖/intangible assets of founders, in a context of lax accounting and auditing rules.

18 methods across accounting periods), the lack of accounting standards and the absence of controls on the independence and qualifications of auditors restricted the actual impact of these measures for investors.

Specific protection of external investors with respect to equity offerings were rudimentary, as indicated by the low score in disclosure (0.17 after the 30/01/1907 law mandated the issuance of a prospectus with all equity offering) and liability standards (0.22, art.1382 Civil Code), below the securities law protection provided in Britain from 1929 (0.67 in disclosure laws and 0.33 in liability standards indices; Franks et al., 2006).

- 1935-1961: Responding to abuses of majority shareholders and managers (Shareholder rights: 2)

Shareholder rights improved significantly in the mid-1930‘s through changes initiated by the Laval government 33 , in a context of increased scandals involving minority shareholders abuses (Sauvy, 1984, p.180-185), economic recession and acute political tensions arising both from the far-Right (1934 movements) and from the Left (Communist and Socialists Popular Front strategy 1935/36). In particular, as a result of the 1935 laws which granted preemptive rights to shareholders in order to prevent majority shareholders abuses (dilution)34, LLSV shareholder right index rose to 2.

Other less significant changes to investor protection regimes occurred in the 1930‘s:

First, 1935 ―Decrees–Acts‖ significantly increased penal liabilities of directors (Penal Code, art.405-406; modifications of art.15 1867 law) for fraud, inadequate information disclosure, instances of fictitious ―apports en nature‖35.

In addition, information and disclosure rights were strengthened. Prospectus and basic periodic financial information for the Coulisse (informal) stock exchange were regulated for the first time. To improve independence and technical ability of financial auditors, firms that wanted to issue shares had to select auditors from a government-sanctioned list of qualified auditors. (Laws of 1937).

Finally, the decree laws recognized the specificity of public offerings and issued strict guidelines on prospectus information content, validity (increased sanctions) and communication (―Demarchage‖ laws) between the public, issuers and intermediaries.

From the late-1930‘s to the late 1950‘s, apart from improvements in the disclosure regime (e.g. public chart of account in 1946/47, increase in information requirements for public registry in 1959), no major changes to shareholder protection for both shareholder rights and equity issuance regulation regimes occurred.

35 A form of ―sweat equity‖.

- 1961-1985: Modernizing corporate law and strengthening minority shareholder rights (Shareholder rights 4)36

Case law developments and the substantial statutory reforms of 1966/67 brought about substantial improvements in shareholder protection with the provision of Oppressive minority mechanism indicator (+1) and the right to call an Extraordinary General Meeting with 10% of shareholders votes (+1, Law of 1966). As a result, shareholder rights rose from 2 to 4 in the beginning of the period (1960‘s) where the changes were prevalent.

The provision of ‗oppressed minority mechanism‘ is of particular interest because of our diverging analysis compared with La Porta et al.‘s (mid-1990‘s). In another illustration of the ―adaptability‖ of French Civil law (overlooked by La Porta et al.), oppressive minority mechanism were consecrated by the supreme private law court (―Cassation‖), by applying the theory of ‗majority abuse‘, derived from the Civil Code (art.1382), art.19 of the 1867 law and subsequent doctrinal developments which were based on the principle of ‗corporate interest‘. (Ripert and Roblot, 2002, p.168; Case ―Piquard‖ of 18/04/1961). As analyzed by both French (See e.g. Guyon, 1996; Schmidt, 2004; Frison-Roche, 2006) and foreign scholars (Cools, 2005), this jurisprudential evolution granted unequivocally minority shareholders the right to challenge the decisions of management in courts, not unlike ―fiduciary duties‖ standards in US law.

In addition, the 24/07/1966 law and its various 1966/67 decrees brought about the largest changes in French corporate law since the 1867 company law with higher institutionalization of ―S.A‖ governance, the introduction of a new organizational form (German-type dual board corporation), the creation of stricter regime for firms willing to issue public shares (―APE‖), improved rights for third parties, shareholders, increased penal liability regime for directors and prohibition of founder‘s shares (Mestre, 2005, p.29)

Moreover, according to securities laws pertaining to equity issues (LLS index), reforms in securities law (Law of 1967) brought moderate positive changes in disclosure (0.17 to 0.33) and public enforcement standards (0 to 0.53). The regulatory agency modeled on the SEC created in 1967 despite initial modest mandate and means (information certification), widened its powers significantly over the 1970‘s-80‘s to include ―protection of investors‖ and the ―functioning of the financial markets‖.

Nonetheless, we would be mistaken in concluding that the 1960‘s substantial reforms were the signs of an inexorable historical trend towards very strong protection for minority shareholders in France. Indeed, our analysis of parliamentary debates shows that a large proportion of deputies, government members and experts also aimed at weakening minority shareholder rights, by attempting (unsuccessfully) to increase the cap for voting rights per share from 2 to 5 and by widening the wedge between control and cash-flow rights at the benefit of insiders. (See Hemard et al., 1972 p. 248).

- 1985-2007: Towards highly protected minority shareholders (Shareholder rights 5-6)

Authorization of proxy voting by mail (voted in 1983 by Socialists but only implemented by decree by the Right government in 1986: +1) and the end of blocking of shares before Shareholder meetings were part of a broader and conscious reforms by both Left (1983/84

20 juncture) and Right governments to develop the Paris Exchange, a market for corporate control37 (Takeover law of Law of 02/08/1989: mandatory bid at 33% threshold), minority shareholders rights (+2, to 6, well above 3, the world median according to La Porta (1998) cross-sections), involvement of employees in governance, non-executive directors in boards, as well as stricter liability, control and disclosure regimes (Law NRE 2001: disclosure: 0.67; liability: 0.22; enforcement: 0.73).

By 2001, the level of antidirectors rights and securities regulation that protect minority shareholders in France is at par with its common law American and British counterparts, and among the highest in the world. This domestic trend has been reinforced by an increased focus on stronger minority shareholder protection, market for corporate control and disclosure requirements at the European Union level since the 1990‘s, as illustrated in particular by the EU directives on financial instruments (1993), prospectus (2003), transparency (2004) and takeover (2005).

In sum, the corporate governance regime in France gradually granted formal protection to minority shareholders to levels not markedly different than the ones enacted and enforced in the US and Britain in the late 20th century. However, our historical depiction illustrates the complexity and the non-linearity that drives the evolution of laws, policies and jurisprudences of investor protection. Such observations should already caution us against overly deterministic structural approaches to account for the emergence and dynamics of change in investor protection.

2.3.3 Ownership patterns: tentative stylized facts

According to La Porta et al., dispersion of ownership is strongly related to stock market development. Unfortunately, the absence of any primary data and reliable sources prevented us from considering this critical variable.

Preliminary anecdotal evidence tends to suggest that shareholding was dispersed in France in the early 1900‘s in, at least, the banking, transport (railways and canals) and utilities sectors, which accounted for 79% (1880) and 52% (1920) of market capitalization (Arbulu, 1988; See Neymark, 1911, cited in Gallais-Hamonno et al, 2007, p.411; Hautcoeur 1994; Hannah, 2007). Observations such as the documented instances of small lot of shares even trading at a premium to larger lots of shares (Hannah, 2007)38, the reduction in statutory minimal share price (from 500F to 100F in 189339, Hilaire, 1986), partial firm-level ownership records (e.g. in 1900, the four largest shareholders of Paris-Lyon-Mediterrannee railway held 0.2% of shares, Hannah, 2007; In 1908, shareholders with more than 25 shares accounted for 13% of the six largest railway companies, 82% of Credit Foncier bank held less than 10 shares, Gallais-Hamonno et al., 2007, p.504) or the increase of equities as a share of assets in inheritance records for households from 9% to 39% between 1871 and 1915 (Michalet, 1968, p.100), may all be indicative signs of ownership dispersion for larger firms (i.e. railroads, finance, utilities, canals, i.e. 60% of capitalization).40

38 It raises the issue of private benefits of controls premia (no data available). 39 25 F for small firms. 40 Smaller industrial firms (probably c.50% of market cap) though seem to have remained in the hands of insider-family control (Hannah, 2007).

The change to widespread blockholding patterns for large firms seemed to have occurred in the aftermath of the Second World War, along with nationalizations and the emergence of a new social system of production.

Following the 1983-85 “tournant de la rigueur” of the Socialists‘ economic policy in conjunction with the increased cross-border capital and trade (e.g. end of capital controls in 1986, European common market), the privatizations of 1986-88 brought about a transition to a ―noyaux durs‖ pattern around UAP-BNP and Paribas-AGF, characterized by cross- shareholdings among the largest firms in France and significant government-owned stakes retained in CAC40 firms (Goyer, 2003). Most SME‘s remained family-controlled. (Windolf, 1999).

In the mid-1990‘s to 2007, in a context of increasing liberalization and integration of French financial markets41, cross-shareholdings of the largest French firms were gradually liquidated to dispersed households and institutional (mainly foreign) investors (46% (2006) and 39.2% (2008) of CAC40 owned by foreign shareholders; Banque de France, 2009).

41 O‘Sullivan (2007) documents that the increase in seasoned stock offerings on the French stock markets in the late 1990‘s-2000 were driven by acquisition and international expansion financing motives, a result of increased product market competition. The intense competition from Europe and the world may explain the decision by leading CAC40 financial institutions to unlock their previous cross-shareholding patterns in the late 1990‘s to access larger pools of external finance, notably from foreign institutional investors.

3. SECTION III: Shareholder protection and stock market development in France in light of dominant theories of financial development

The detailed description and analysis of the evolution of stock market development and investor protection in France over the 1852-2007 will enable us to evaluate the explanatory power of dominant theories of financial development with regards to the French case: the Law and finance theory in its ―LLSV‖42 Legal Origins variant and the Political Economy of Openess and Incumbent theory.

3.1 Legal Origins and investor protection

3.1.1 Testing the Legal Origins theory in the French context:

Two key hypotheses implied by the Legal Origins theory will be tested in order to assess the link between investor protection and stock market development on the one hand and the link between legal origins and investor protection on the other hand.

- H1: Legal investor protection is monotonically related to stock market development: (Shareholder protection => Stock market development)

Figure 6: Stock market development and shareholder protection (1852-2007)

Stock Market Development and Shareholder Rights in France (1852-2007) (Source: Shareholder protection: author's coding; Stock market data: see appendix A) 120% 7

100% 6 Market Cap/GDP 5 80% 4

% 60% Equity Issues/Investment 3 40% 2 20% 1 Shareholder protection (1sh=1v +Antidirector

0% 0 rights)

1851 1902 1924 1932 1954 1962 1970 1978 1986 1994 1910 1946 2002

As highlighted by figure 6 above and, as suggested by the comparison of stock market development indicators under low shareholder protection (1852-1933) and under high shareholder protection (1966-2007) (per appendix B-2), shareholder protection and stock

42 We refer to ―LLSV‖ and ―LLS‖ to allude to La Porta, Lopez-Silanes, Shleifer and Vishny, and La Porta, Lopez-Silanes, and Shleifer respectively. We prefer the precise term ―Legal origins‖ to the broader ―Law and finance‖ one to characterize their theory.

23 market development do not appear to be positively correlated, contrary to the Legal Origins predictions.

To confirm our graphical analysis, we regressed stock market development (defined as market cap/GDP and equity issues/corporate investment) on shareholder protection and securities law, along with relevant control variables (See appendix E for output):

Based on graphical analysis (trending), partial autocorrelations functions and formal testing for unit root in all of our data series through Augmented Dickey Fuller tests (Appendix E-1), it appears that most of our time series data exhibit non-stationarity. This characteristic invalidates standard assumptions for asymptotic analysis. The time series should ideally warrant Granger-causality or Hacker and Hatemi-J methods. In our case, the differencing our time series (mostly first order) enabled us to ―stationarize‖ our data and to regress ―changes on changes‖, except when dummy variables were used.

Shareholder protection was measured either as the LLSV/LLS indices (1 share/1 vote; antidirector rights; Securities I Disclosure, Securities II Liability Standard and Securities law III Public Enforcement indices) or as a dummy (1 for low investor protection from 1852-1933 and 1 for high investor protection from 1961-2007, i.e. above LLSV average of Civil Law 2.33 in their mid-1990‘s cross regression (1998)).

Appendix E-2 provides regression coefficient estimates of shareholder protection in relation to market cap/GDP as the dependent variable, with ―controls‖ for log GDP/capita at constant price (proxy for demand for finance), inflation rate (expected to be negatively correlated to stock market per Bordo and Rousseau, 2007), corporate tax rate (tax shield benefits of debt and capture of enterprise value by government), as well as a dummy for the nature of the French social security/retirement system (pay-as-you go state funded after 1945-46 expected to be negatively correlated with incentives to invest in equities for pensions; retirement and healthcare left to households individual savings decisions pre-1945).

Appendix E-3 provides regression coefficient estimates of shareholder protection in relation to equity issues/investment (the dependent variable), with notable ―controls‖ for yearly changes in log GDP/capita, inflation rate, market timing (proxied by stock index, excluding dividends to capture only capital gains), a very crude and incomplete proxy for the need for external finance ((1-Retained Earnings)/Corporate investment, whose major caveat being that it does not account for net working capital, tax and most critically listed vs unlisted firms43), corporate tax rate as well as a social security/retirement system dummy.

We were unable to control for critical factors such as variations in corporate sector share of GDP, personal investor tax factors (relative personal tax on dividends, capital gains and interest income), and relative protection of debt/bond holders vs equity holders. At a more fundamental level, the theory testing exercise is limited by the low variability of investor protection variables in our dataset.

Based on our analysis, shareholder protection (i.e shareholder rights and securities law) was not positively correlated (at a statistically significant level) with stock market development in

43 Very crude proxy: Assumes somewhat unreasonably that listed firms have the same external finance need that all firms of the economy. No detailed data on listed firm is yet fully available.

1852-2007.44 The hypothesized prediction of the Legal Origins theory that investor protection be monotonically related to stock market development does not seem to hold in France.

Because the French case exhibits limited variance, we sought to compare our observation with other countries for which there some, albeit limited, data available. Based on very preliminary and very limited data on UK, Germany, Japan and France, investor protection (i.e. shareholder rights and securities law) do not seem to be correlated (with stock market development in our 1913-1999 cross-sections. (Figure 7)45

Figure 7: Antidirector Rights and Market Cap/GDP 1913-1999

Antidirector Rights and Market/Cap GDP 1913-1999 in France, UK, Germany and Japan. (Rights: Fr Author's coding (2009); UK (Franks et al.2005); Ger (Franks et al 2005);Jp (Franks et al. 2009)) / Market Cap/GDP from Rajan and Zingales (2003) excl. France) 2.5

1.5

1 y = 0.047x + 0.5371 R² = 0.016

Stock Market/GDP Stock 0.5

0 0 1 2 3 4 5 6 Antidirector Rights

- H2: Shareholder protection in Civil Law origins France was consistently weaker than in Common Law origins Britain (Legal Origins=>Shareholder protection)

To test the second hypothesis implied by the Legal Origins theory, we have compared investor protection in France with Britain in the first half of the 20th century (data available).

Based on LLSV theory, we would indeed expect the higher level of investor protection in common law countries in the 1990‘s to hold across time, at least for Britain and France, which are the locus classicus of each legal family and are endowed with comparable levels of economic development.46

As illustrated by Figure 8 below and Appendix D, investor protection was higher in France than in Britain in 1867-1948 and 1967-1980 with respect to Antidirectors rights and in 1907- 1929 with respect to Securities Law.

We are unable to draw any statistical inferences on legal families based on such a low sample and such limited controls. However, our preliminary data indicates that shareholder

45 To be confirmed by future research. 46 According to Toutain (1996), GDP per capita in Britain was only 12% higher than in France. (approx.31% for Maddison (2001).

25 protection measured in terms of anti-director rights in Civil Law countries was not lower than in Common law Britain in the first half of the 20th century.

This preliminary evidence is difficult to reconcile with the LLSV thesis that Civil Law Legal Origin, inherited in the 12th (or 18th) century, explains the subsequent lower levels of shareholder protection for Civil law countries in comparison with Common law countries.

Figure 8: Antidirector rights in comparative perspective (1913-1938)

Shareholder rights Securities Law I Securities Law II (Liability Country Legal Family (Antidirectors + 1 sh/1v) (Disclosure) Standard)

1913 1929 1938 1913 1929 1938 1913 1929 1938 US Common Low?; x ? ? ? N/A N/A N/A N/A N/A N/A UK Common 1.00 1.00 1.00 0.00 0.67 0.67 0.00 0.33 0.33 France Civil-French 1.00 1.00 2.00 0.17 0.17 0.17 0.22 0.22 0.22 Brazil Civil-French 2.00 2.00 2.00 N/A N/A N/A N/A N/A N/A Italy Civil-French 1? 1? 1? N/A N/A N/A N/A N/A N/A Germany Civil-Germanic 1.00 1.00 1.00 0? 0? 0? 0.5? 0.5? 0.5? Japan Civil-Germanic 1.00 1.00 2.00 0.00 0.00 0.00 0.00 0.00 0.00 Avge Civil 1.17 1.17 1.50 N/A N/A N/A N/A N/A N/A

Avge French Civil 1.33 1.33 1.67 N/A N/A N/A N/A N/A N/A Sources: US: Lamoureux et al. (2006); UK: Franks, Mayer, Rossi (2008)/ Rajan Zingales (2003); France: own author's calcul. (2009); Brazil: Musacchio (2008)/ Goldshmidt (1985); Italy: Paganin & Volpin (2003)/Rajan Zingales (2003); Germany: Franks, Mayer and Wagner (2005) / Rajan Zingales (2003); Japan: Franks, Mayer and Miyajima (2009)/Rajan Zingales (2003)

3.1.2 Substantive critique of the Legal Origins theory

Our time series analysis may cast some doubt about the ―time invariant‖ impact of legal origins as a determinant of financial development. Consequently, it becomes critical to complement our basic empirical analysis with a conceptual critique of Legal Origins, in the French context. Three issues will be addressed:

- What is meant by ―Legal Origins‖? (i.e. common vs civil law distinction) - Why does Legal Origins matter? (i.e. source of persistence) - How does Legal Origins matter? (i.e. channels of influence)

3.1.2.1 What is meant by Legal Origins? The Civil Law/Common Law distinction may not be relevant to investor protection laws

Proponents of the legal origins thesis postulate that legal origins as defined by the legal family (notably common and civil law) are crucial in explaining financial development. Drawing upon analysis of comparative law and history, we will suggest that the common vs civil law distinction may not be of great relevance in explaining different levels of investor protection.

We do not reject the notion of legal traditions across legal families (Civil and Common). We do not also aim at refuting the possibility of path-dependence in legal origin. What we critique is the use of Civil, Scandinavian, Germanic or Common categorizations of legal origins by LLSV in support of their thesis on investor protection determinants. The necessities of econometric analysis (i.e. coding of legal origins exogenous variable) have led

26 the authors to assume that legal systems are monolithic and internally consistent. In contrast, we posit that investor protection laws did not appear to be historically determined by the Civil/Common legal origin of the country in which they were enforced: First, commercial and securities laws do not seem to embody the main characteristics of Civil law and Common law ―ideal-types‖ highlighted by La Porta et al. (i.e. state employed judges, greater reliance on legal and procedural codes, preference for state regulation over private litigation for Civil law vs. independent judges and juries and weaker reliance on statutes for Common law). Indeed, as pointed by Dam (2006, p.33) and Carbonnier (1992, p.148), most modern laws governing shareholder protection and securities laws in common law countries, especially from the late 20th century (the time of the cross-sectional analysis from La Porta et al.), were a result of statutory laws, not judge-made law (e.g. in US: Securities Act 1933, Uniform code 1952, Sarbanes-Oxley 2001.in UK: FSA).47

Second, the concepts of ―legal traditions‖ and ―legal family‖ by no means imply that all constituent laws are consistent with the characteristics of their ―legal family‖. In fact, legal scholars acknowledge that commercial laws may not fit within the broader legal tradition that influenced contracts, family or torts laws.48 According to Merryman, a leading American comparative law scholar and the very source that the LLSV authors rely on to legitimate their categorizations on legal tradition, ―microsystems of laws‖ have grown within legal system (Merryman, 1985, p.152). They ―differ ideologically from the Code and in this sense are incompatible with it‖ (Merryman, 1985, p.152). Merryman further illustrates his claim with an analysis of the evolution of labour laws in civil law countries. He shows that ―whereas the traditional civil codes left it to private individuals to pursue their own interest (…) the new provisions embody policy choices and are designed to further specific social objectives.‖ (p.153). As a result, ―special legislation is heterogeneous, diverse and pluralistic, in contrast to the formal and ideological coherence of the Civil Code.‖ (p.153).

We can extend Merryman‘s analysis of labour laws to investor protection laws. In France, Civil codes prescriptions on contracts and ―civil‖ corporations were indeed superseded by commercial codes that did not bear much philosophical resemblance to the 1804 Civil Code and its Roman influences. Indeed, as emphasized by leading French legal scholars such as Ripert (1912, 1981), Thaller (1898) and Carbonnier (1969; 2004, p.263), the very legal characterization of the ―corporation‖, as considered by the doctrine, the legislator and the courts in the late 19th century, experienced radical changes. The corporation indeed evolved from being considered a ―contract‖ (i.e. the Roman Civilist view) to being considered an ―institution‖ (i.e. a radically novel view).

Third, influences on commercial and securities laws in particular cannot be reduced to the Common law/Civil law distinction made by LLSV. The French company law of 1867 was explicitly influenced by the English joint-stock company act of 1855/56 while the SARL (LLC) law of 1925 was a transplant of the Germanic law (Hilaire 1986). According to Zweigert and Kötz (1998), Civil Law Brazil commercial code was principally derived from the German legal code (1998, p.118). Mattei also shows that the Commercial Code of ―Civil- Germanic‖ law Japan was mainly derived from US (Illinois) laws as a result of the American occupation. (Mattei, 1997, cited in Dam, 2006, p.44). Another related point, which is surprisingly absent from most of the literature, is that many elements of modern investor protection and securities laws in the late 1980‘s-1990‘s are being influenced by European

48 This not surprising given that ―legal traditions‖ are didactic tools, not scientific categories.

Union legislation. EC/EU Directives are obviously not easily fitted within the Common/Civil/Germanic/Scandinavian legal family categories. Hence, Civil law countries were not necessarily regulated by ―Civil‖ law determined codes in commercial and financial matters.

3.1.2.2 Why does Legal Origins matter? Questioning the persistence of legal origins effects:

Refined proponents of the Legal Origins theory have attempted to explain the pervasiveness of Legal Origins over time. Typically, these efforts take the form of analyses of historical narratives of formative events at the Origins, whether it be a Coasian bargain between the King and the landed aristocrats in 12th-13th century (Glaeser and Shleifer, 2002) or the liberal revolutions in the 17th-18th centuries (La Porta et al, 2008) junctures. These original conditions are deemed to have shaped and crystallized the essential characteristics of the Civil/Common laws, which bear pervasive influence over time49. The LLSV authors justified the persistence of Legal Origins as follows: ―it is that system, as defined by Zweigert and Kotz, (1998), with its codes, distinctive institutions, modes of thought and even ideologies, that is very slow to change‖ and, later, ―It is this incorporation of beliefs and ideologies into the legal and political infrastructure that enables legal origins to have such persistent consequences for rules, regulations, and economic outcomes.‖ (La Porta et al, 2008).

While we agree that Law, and probably Legal Origins could matter, we do not share LLSV‘s conjecture that crystallized Legal Origins are the crucial cause of variance of cross-national investor protection/financial development today: Is ―the incorporation of beliefs and ideologies in the legal and political infrastructure‖ 500 or 200 years ago so strong as to have sustained political, economic and societal revolutions and shocks (e.g. end of feudalism, secularization, rise and fall of liberal regimes, great depression, world wars, industrial revolutions…)?

The analysis of persistence of Legal Origins would require a deep multifaceted analysis of ―Legal tradition‖ well beyond the scope of our work. Our more modest objective is to question LLSV‘s assumptions, in light of what social science could teach us about ―persistence‖ phenomena:

First, from a historical perspective, even the core ideological and institutional characteristics of the Legal Systems at Origins that were deemed to have ―crystallized‖ at origins according to LLSV have in fact experienced significant change and even reversals:

Consider for example the evolution of the role of the judiciary, a critical ideological and institutional difference that cut across the two legal families ―at origins‖ (and today) according to La Porta et al. (2008) and Glaeser and Shleifer (2002). While courts are not formal sources of law in Civil Law today, and were indeed acting as ―automata‖ of the Legislature (Montesquieu: ―mouth of the law‖) during the French Revolution and early 19th century, the French courts have asserted very strong interpretative powers in order to complement the general and abstract principles of the Civil and Commercial Codes in the course of the 19th and 20th centuries, in a stark deviation from Rousseau‘s and Robespierre‘s original ―ideology and beliefs‖.

The far-reaching judicial interpretations of art.3, art.544 (Bayard 1915 case on ‘abuse of law‘), art.1382 (Civil liability and compensation) and art.1134 (Contracts) of the Napoleonic Codes are critical examples of the often understated importance of the judge in French law (Carbonnier, 1992; Barrere et al., 2006). As Merryman (1996) puts it: ―What the judges actually did, however, was build a body of law based to some extent on earlier French law, nourished by French legal scholarship, but built largely through their own decisions.‖ Thus, contrary to LLSV‘s persistence accounts, the role of the judiciary in France has been the subject of radical change from its medieval/revolutionary Origins.

Second, if the ―incorporation of belief and ideologies‖ into a ―political and legal infrastructure‖ suffice for the core characteristics of the law to persist, one may question why other earlier legal systems endowed with some form of ideological consistency and institutionalization elements such as medieval jus commune, canonical law or even, the original Roman law, in its codified Justinian version, did not crystallize into La Porta‘s ―Legal Origins‖ variable.

Third, more fundamentally, La Porta et al.‗s claim that the mere existence of ―systems‖ and ―belief and ideologies‖ could in itself translate into persistence is difficult to reconcile with theoretical developments on culture and institutions in economics, history and sociology:50Naturally, our point is not to highlight any social science scholarship that would not substantiate the singular conception of persistence in La Porta et al. Rather, we argue that even in the most ambitious observers and theorists of persistence in social science, we do not find any claim that systems and ―beliefs and ideology‖ alone can sustain persistence:

Rational-choice economics and political science have emphasized the importance of equilibria states to sustain institutional arrangements, resting on the absence of Pareto- improving alternatives, not the mere existence of ideologies, systems and culture (however important) alone, as suggested by ―LLSV‖. (e.g. Nash Equilibrium: Aoki, 2001); multiple Equilibria models in increasing returns processes (Arthur, 1994); punctuated equilibrium (Elredge, 1999)). Even so, equilibrium does not necessarily equate persistence: advanced models emphasize how change is possible either through ―joint-belief‖ shifts (Aoki, 2001) or the lack of congruence between de jure and de facto power in economic and political institutions (Acemoglu and Johnson, 2005).

Similarly, the copernician revolution in historical science involving ―longue durée‖ and structuralist concepts, led by the Braudel and the ―Annales School‖, has led to emphasize persistence in the very long run through geographical and demographic ―infrastructures‖, not the cultural ―superstructures‖ or mentalités. (Braudel, 1959)

Conversely, despite what some of its proponents claim, the Legal Origins view of persistence is also at odds with the key insights of path-dependence. In our view, path-dependence is a theory of change (bounded change but change nonetheless), not a theory of persistence. As North puts it (1990, p.99) ―Path dependence is a way to narrow conceptually the choice set and link decision making through time. It is not a story of inevitability in which the past neatly predicts the future‖. We could indeed examine claims of path-dependence for Legal Origins but this would contradict the very point made by La Porta et.al. According to their

50 It is important to note that our objective here is not to arbitrarily select theories that do not fit well with the Legal Origins claim. This would be a vacuous epistemological exercise. Rather, we are aiming at showing that even the strongest theories of persistence in social science do not fit with La Porta et al‘s claims. The problem is that La Porta et al. fail to provide a ―new‖ theory that can explain their claim.

29 thesis, Legal Origins matter precisely because their core characteristics ―crystallized‖ at origins through the effects of ―beliefs and ideologies‖ and system-like characteristics of the law, not because they were the starting point of a bounded evolutionary process.

Overall, the critical argument behind the persistence of Legal Origins is far from being unequivocal. Those authors may need to confront some of the evidence to better explain why Legal origins could indeed persist over time and bear larger consequences than other subsequent factors of changes in the history of financial systems.51

3.1.2.3 How does Legal Origins matter? Assessing the “Political” and the “Adaptability” channels of influence

Later contributions from major proponents of the law and finance thesis (See e.g. Beck et al. 2003; La Porta et al, 2008; Glaeser and Shleifer., 2002) identified two channels through which legal origins influence financial development: the Political Channel and the Adaptability Channel. 3.1.2.3.1 Challenging the Political Channel of influence of the Legal Origins:

According to the ―Political channel‖ view (See La Porta et al. 1999/2008, Beck et al., 2003, Glaeser and Shleifer, 2002), ―legal traditions differ in terms of the priority they attach to private property rights versus the rights of the State‖. (Beck et al., 2003). Under this view, the civil law tradition tends to promote ―the development of institutions that advance State power with adverse repercussions on financial development.‖ (Beck, et al. 2003). ―Civil legal tradition, then, can be taken as a proxy for an intent to build institutions to further the power of the State.‖ (La Porta et al., 2008). Financial development is restricted in ―Civil law‖ countries because of State rent-seeking opportunities that arise from the intrinsic characteristics of the civil legal tradition, most notably constrained judicial independence and discretion and lack of decentralized adjudication (juries) (Djankov et al. 2002).

Firstly, an independent and decentralized judiciary may not be the only nor the optimal venue to constrain the State‘s ―Hobbesian‖ predatory inclinations. Constitutionally defined veto players, separation of powers (e.g. bicameral institutions, judicial review) as well as competitive electoral regimes can ―credibly commit‖ the State not to rent-seek. (North and Weingast, 1989).

The theory would need to accommodate the fact that even common Law countries such as US, Canada and Australia had to embed their property rights and checks and balance into statutory constitutional rules, without solely relying on courts discretion, not to mention that in most Common Law countries, the legislature can overrule judge-made law.

What‘s more, the judge-made law process is not necessarily immune from rent-seeking. According to Coffee (2001), ―in the late nineteenth century, U.S. law was characterized by a high level of judicial corruption.‖ Empirical research in Law and Economics shows that even formally independent life-tenured judges in modern Common Law US could even be significantly influenced through the strategic selection of cases settlements made by interest

51 The clear reference to cultural/ideology crystallization that we could envisage is 19th century French evolutionary anthropologists, later discredited by Levi Strauss and Durkheim.

30 groups (Cross, 2005).52 In the same way, in France, the venality and corruption of feudal courts, that were in fact advancing the narrow political and economic interests of the landed aristocracy at the expense of the King and his subjects, were a major determinant behind the 1789 revolutionaries‘ strict stance on judicial control (Merryman, 1996; Carbonnier, 1992, p.235).

Even if LLSV do not make this argument to defend their thesis, one could still argue, on a variation of Olson (1965), that the diffuse nature of court powers (i.e. multiple courts) would reduce the influence of private interest group on their powers. On the other hand, should, for some reason (e.g. cognitive shifts, endowment changes, exogenous shocks), a pro-equity market majority arise, Civil Law may be better at implementing welfare-enhancing changes in favour of minority shareholders through the power and decisiveness of the centralized state law-making process and apparatus.53

Overall, La Porta et al. do not provide a theory to explain why the State would be necessarily opposed to minority investor protection (a fortiori since it may be sometimes beneficial to the government bureaucracy, the median voter or even the majority because of aggregate welfare enhancement, financial development, higher economic growth and tax revenues)54. They do not explain how State rent seeking per se would differ from interest group rent-seeking (or are the latter using the State to rent-seek?) or why a powerful and independent judiciary would be immune from wielding its power in favour of corporate insiders and at the expense of minority shareholders.

In effect, historical evidence suggests that the French inherited ―legal tradition‖ did not prevent ―formally dependent‖ administrative and civil courts to demonstrate behavourial independence from the executive and the State interests (e.g. development of judicial review powers of the ―Contentieux‖ section of ―Conseil d‘Etat‖, ―Conseil d‘Etat‖ Canal ruling of 1962 against President de Gaulle at the apex of his power 55 , Minit foto decision - characterized as a ―jurisprudential Coup d‘Etat‖-, or the censure of retroactive laws by the Civil supreme Court against the executive and legislative branches on 23/01/2004. See Braibant et al., 2005; Merryman, 1996; Barriere et al., 2006). Likewise, decentralized juries, a critical protection from the Sovereign for Glaeser/Shleifer (2002), have had for the most time larger powers in France than in England or US in penal matters (Barriere et al., 2006) while, in England, juries were in fact limited to defamation and fraud cases (David, 1985).

Thus, LLSV assumption that State power is intrinsically detrimental to investor protection is conceptually controversial. Further, their characterization of the judiciary as a dependent agent of the ―Leviathan‖ (Hobbes) in Civil Law France is not fully confirmed by detailed historical observations. We may add that the direct involvement of the State in the economy, measured as government expenditure/GDP, was not significantly higher in France than in the UK in the first half of the century (Tanzi and Schuknecht, 2000).56

52 For instance, the New Deal statutory venue of reforms have been interpreted by many historians as a response to interest group influence on the courts (Yarnold (1990) , cited in Cross (2005)) 53 See the role of State-led development in East Asia in the 1970/80‘s (Wade, 2003; Johnson, 1983); See also: Rajan and Zingales (2003) 54 One can counterargue this claim by highlighting the existence of collective action dilemma (Olson, 1965). 55 The ―Contentieux‖ section of the Conseil d‘Etat grew over the 19th and 20th century as a de facto venue for judicial review for acts of the executive or legislative. 56 1920: 28% vs 26%; 1945: 29% vs 30%.

3.1.2.3.2 Challenging the Adaptability Channel of influence of legal origins

According to the ―adaptability channel‖ view (See La Porta et al., 2008), ―legal traditions differ in their ability to evolve with changing conditions‖ and ―legal traditions that adapt efficiently to minimize the gap between the contracting needs of the economy and the legal system‘s capabilities will more effectively foster financial development than more rigid systems‖ (Beck, et al. 2003). Proponents of the Legal origins thesis postulate that Civil law is less ―adaptable‖ than Common law.

Fundamentally, the large reliance on statutory laws by both common law and civil law countries for commercial matters weakens the ―adaptability‖ argument of La Porta et al, especially since it is aimed at accounting for mid-1990‘s observations. (Unless one argues that common law statutes were still impregnated by common law legal ―culture‖ and judge- made law precedents.)

Furthermore, the ―Hayekian‖ claim that ―judge-made‖ law is more conducive to adaptability of the legal system, by producing the most necessary and the best rules with the benefit of individual cases57 is problematic. Research in Law and Economics (Kessler, 1996) shows that factors such as asymmetric information between parties mean that the litigated cases may in fact be a skewed and not a representative sample of real world disputes. Thus, even if the common law were to set the most adaptable rules for the cases that came before courts, nothing ensures that these marginal cases would govern optimally the broader cases to which they will apply (as an ex-ante constraint to private behaviours). In addition, judge-made law is constrained by the case evidence, which prevent them to consider wider economic externalities that may arise from a specific case (Cross, 2005).

To summarize, our quantitative and conceptual analysis of the Legal Origins theory points out to two key conclusions. Firstly, the theory fails to account adequately for the evolution of investor protection and sock market development over time in France. Secondly, the theoretical foundations that eventually sustain their claims with regards to the existence of legal origins, their persistence and the superiority of its attributes, are not fully consistent with historical evidences.58

57 Reference to information disadvantages of a central planner vs decentralized agent (Hayek,1960) 58 Theoretical indeterminacy.

3.2 Political Economy: Openess-driven Interest Group theory

The political economy ―interest group‖ thesis of Rajan and Zingales (2003) should yield the following indirect testable implication:

- H1: For a given demand for external financing, stock market development is positively correlated with high capital and trade openness.59

Figure 9: Openess and stock market development in France (1852-2007)

Market Cap/GDP and Openess in France

(1852-2007) (1914-1918 and 1939-1945 excluded) (Sources: Villa 1993; Bourguignon/LevyLeboyer, 1975; INSEE; Taylor, 1989) 120%

100% Exogenous Cross-Border 80% Capital Mobility (1=high; 0=low)

60% Market Cap/GDP % GDP % 40% Trade Openess 20% (Exports+Imports)/GDP

1890 1906 1924 1930 1948 1954 1966 1972 1984 1990 2002 1851 1912 1936 1960 1978 1996

As highlighted in figure 9, on its own, the theory does not work very well to explain the substantial increase in market cap/GDP in the 1920‘s and the delays in stock market development from 1984-1990‘s, where the loci of political mobilization around privatization/nationalization policies were likely to have outweighed any potential effects of openness.

The theory in its strong form would need to emphasize the role of incumbent industrial interests in the nationalization and privatization waves, which does not seem to sustain detailed historical analysis. Indeed, (at least for nationalizations, that arouse from the 1944-46 as a grand bargain between Christian-democrats, Gaullist and Communists).

To refine our initial observation, we regressed stock market development on trade openness, with differencing transformation to stationarize the data:

Across different specifications (See appendix E-4 for market cap/GDP as dependent variable and appendix E-5 for equity issues/investment as dependent variable), we have notably controlled for log GDP/Capita, inflation rates, a dummy for exogenous cross-border capital mobility, based on the mean absolute level of Current Account to GDP in fourteen major economies over the century (Taylor, 1998), interaction between demand for financing and

59 We cannot test for incumbent actions directly.

33 openness, and interaction between the latter and exogenous capital mobility, as well as a dummy for the retirement system. We have also included the annual stock market index (excluding dividends, i.e. gross capital gains/appreciation) for the equity issue/investment indicator to capture market timing considerations, in line with empirical research from Pagano et al. (1998).

Prima facie, changes in trade and capital openness in France did not appear to be positively correlated (at a statistically significant level) with changes in stock market development over the 1852-2007 period. In its strong and strictest form, the key prediction of Rajan and Zingales‘(2003) theory -i.e. incumbents‘ weakened opposition in cases of both trade and capital openness will be conducive to stock markets development- does not seem to adequately account, on its own, for the evolution of stock market development in France over time.

Nevertheless, our observations do not enable us to reject the theory in a weaker form. Openness may well matter in a more subtle way which we cannot capture, by determining gradual shifts in economic interests and structures that may not be immediately observable due, for example, to the stickiness of political institutions in mediating interests or social /cognitive inertia. In fact, parliamentary archives indicate that ―protection against foreign ownership‖ was a recurring justification for lower shareholder rights, from the 1867 law (Gazette 1867: driven by free trade with Britain) to the 1966 laws (Hemard, 1972, p.265).

3.3 Section 3: Summary

Our analysis suggests that Legal Origins theory does not appear to be able to account for the difference of stock market development and shareholder protection when assessed from a historical perspective. In addition, the Legal Origins common law/civil law distinction may not be relevant to shareholder protection, and even if it were, the persistence and the benefits flowing from Common Law Origins are not clearly established. In addition, openess-driven interest group theories may not be able to account adequately for the evolution of shareholder protection and stock market development in France.

What, then, can the idiosyncrasies of the French case teach us with regards to the determinants of shareholder protection and stock market development?

4. SECTION IV: Discussion -- Preliminary lessons and questions arising from the French case

4.1 Determinants of minority shareholder protection: discussion and tentative inductive generalization

4.1.1 What determines laws governing shareholder protection? Preliminary inferences from the French case

The first unequivocal implication arising from our analysis is that ―legal origin‖ is not an appropriate explanatory variable for the laws governing minority shareholder protection.

A second implication that arises from the volatile historical evolution of shareholder protection in France is that politics, broadly defined as the struggle among groups and individuals mediated by political institutions, is undoubtedly a more suitable point of departure to explain shareholder protection than ―structural‖ theories of financial development, which rely on time-invariant explanatory variables such as culture or legal origins.

4.1.2 When does formal minority shareholder protection matter? Distributional effects of shareholder protection and relative efficiency of legal investor protection

As shown in our analysis, the development of vibrant and deep equity markets from c.1890 to c.1930 in France suggests that legal minority shareholder protection may not be a necessary prerequisite for the development of stock markets. This does not imply that information asymmetries or agency issues were not important at the time. One explanation put forward by Franks et al. (2004) in their analysis of Britain could be that informal substitutes to formal legal protection mechanisms, such as trust, may have reduced the risks and cost of expropriation of minority shareholders by insiders. (cf. infra for considerations on the determinants of stock market development).

We are not arguing that formal shareholder protection does not matter. On the contrary, corporate governance regulation is one of many instruments that may be used by interest groups to further their interest. Formal minority shareholder protection may matter to the extent that other informal means of protection have become relatively less efficient.

This conjecture is of great importance for the research agenda in corporate governance. Indeed, a large body of literature assumes that legal minority shareholder protection is a critical intervening variable in explaining stock market development and dispersion of ownership. Thus, refined political economy theories such as Roe‘s (2003), Gourevitch and Shinn‘s (2005), Pagano and Volpin‘s (2005), and to a certain extent Rajan and Zingales‘ (2003), rest upon the unchallenged, sometimes implicit, assumption that formal investor protection ultimately determines ownership patterns and the development of stock markets. This approach has led the political economy research agenda in corporate governance to turn its attention to the emergence and persistence of formal minority shareholder protection, without due consideration to other structural determinants of stock market development and informal substitutes to shareholder protection. This myopic focus on formal shareholder protection determinants as a key intervening variable for financial development is one of the

35 reasons behind the inability of those theories to make sense of the history of financial development in France.

Hence, we can expect laws and regulations governing shareholder protection to matter for interest groups to the extent they are an efficient means to financial development or repression (e.g. overcome the information asymmetries or externalities inherent in financial markets, cf Section 1), or rent captures (i.e. maximize private interests). If indeed formal shareholder protection may not be the most efficient means to financial development/repression, why would rational interest groups or the State allocate finite political or economic capital to an inefficient, or suboptimal, means (formal shareholder protection) to their ends (e.g. raise capital at a lower price for investors, limit outsiders protections for managers and majority shareholders, minimize expropriation risk for outsiders…)?

Obviously, as illustrated by the collapse of the Cartel des Gauches government in 1926 on the issue of capital taxation, interest groups and preferences (in this instance: investors and financiers aptly named by center-left prime minister Herriot ―le mur de l‘argent‖60) did exert significant influence in shaping corporate and economic laws and regulations. But we can speculate that when workers, owners and investors have other higher priority preferences, the lawmaking process defining shareholder protection may not have been the subject of intense interest groups struggles and influence.61

This remark in turn calls for more refined political economy theories that incorporate a ―resource based‖ view of actors to better model how actors allocate their finite economic and political resources to achieve competing objectives.

4.1.3 Beyond the principal-agent relationship: the embeddedness of shareholder protection

The relative efficiency of shareholder protection instruments (formal vs informal, private bonding vs laws) is likely to be conditioned by the deeper social, political and economic structures in which they are embedded. In particular, a pre-existing set of economic and social institutions may impact substantially the efficiency of formal protection.

Finance research tends to consider corporate governance issues from a principal-agent relationship and, accordingly, focuses on minority shareholders and managers/controlling shareholders.62 Beyond the effects of the polity in determining investor protection regime, we need to consider the importance of the broader institutional arrangements in which investor protection is nested. Obviously, market-funded pension systems are critical factors in the development of a constituency for higher shareholder protection and financial development. The self-reinforcing effect of market-funded pension systems could not occur in France due to the emergence of a comprehensive public social security system following the Second

60 The literal translation of ‖le mur de l‘argent‖ would be ―the wall of money‖. 61 As a matter of fact, our partial analysis of parliamentary records during the discussion of the 1880‘s-1900‘s company law and laws governing protection of shareholders may have been left to largely technical commissions and committees, mainly driven by legal scholars and motivated by technico-legal and, sometimes moral, reasons. Further research could identify the extent to which political debates on investors rights were not dominated by economic interests and considerations. 62 We may also re-consider the ―completeness‖ of labour contracts, which may broaden the debate on corporate governance.

World War. More generally, ―Varieties of Capitalism‖ (Hall and Soskice, 2001) or ―Régulation‖ theories (See Boyer and Saillard, 2002) documented the existence of mutually reinforcing complementarities within different economic systems (Coordinated vs Liberal for the VOC theorists), notably in price and wage setting mechanisms, financial structures (―patient capital‖), labour relationships and education systems. (Hall and Soskice, 2001).

Hence, an important agenda for future research is to better understand the determinants of the relative efficiency, and therefore the preferences of interest groups/the State63 with respect to competing mechanisms of investor protection (and or rent captures). A related research agenda could consider why and how substitute forms of investor protection can become less prevalent. Furthermore, we need a better understanding of the way institutional complementarities arising from the linkages of shareholder protection with an existing set of economic and social institutions can impact shareholder protection and its relevance.

Improved understandings of these issues are needed before a superior political economy theory of corporate governance regulation can be proposed.

4.2 Determinants of Stock market development: idiosyncracies of the French case and venues for future research

4.2.1 Idiosyncrasies of the French case: preliminaries inferences on the ―great reversals‖ in French stock market development (1944-46 and c.1985)

Our time series data suggest that the development of French stock markets have experienced dramatic reversals at two critical junctures: the immediate post-war period64and the mid- 1980‘s. How can we explain these reversals? What were the key factors that shaped the policies and laws that inhibited (1944-1946) or promoted (c.1985) stock market development?

The generalisable value of the French case with regards to our understanding of structural determinants of stock market development is limited. Indeed, one critical determinant of stock market development in France appears to be the direct, conscious and contingent actions of the State. Nationalizations (1936, 1945-46, 1981-1982) and, conversely, privatizations (1986-1987; 1993-2002) were crucial obstacles and factors behind the development of equity markets in France in the 20th century:

Firstly, as indicated earlier, nationalizations directly reduced market capitalization levels substantially in 193665, by 36% in 1944-46 (at 1938 valuations)66 and by 17% in 198267 (Vessilier, 1983; Bozio, 2002). Privatizations in 1986-87 and 1993-2002 gradually restored a significant proportion of these firms to the public markets. (See for example Biais and Perotti, 2002).

64 We could have included the late 1930‘s but most countries experienced a similar decrease in stock market development during the great depression. 65 1936: nationalizations: railroads and armaments industries. (Vessilier,1983) 66 1944-46 nationalizations: Bank of France central bank, the fourth largest banks and the largest insurers, coal, gas and electricity, air and maritime transport industries and a significant portion of the automobile and aeronautics industries : Houillères du Nord et du Pas-de-Calais (Dec 1944), Renault (Jan 1945), Gnome and Rhône (May 1945), air industry (Jun 1945), Banks (Dec 1945). (Vessilier, 1983) 67 The 1981-82 nationalizations include 12 large industrial conglomerates and 39 commercial and investment banks. (Vessilier, 1983)

Secondly, the nationalized financial and industrial sector created a powerful constituency in the economy and the polity that made access to external finance and the competitive positions of challengers and new entrants very costly from the 1950‘s to the mid 1980‘s period.68

Thirdly, privatizations, beyond their direct impact, can improve stock market valuations by reducing the political risk related to commitment to market-oriented policies. (Perotti and Von Oijien, 1999).

4.2.2 Towards a more systematic account of ―great reversals‖

Given the importance of nationalization and privatization events for the development of stock markets in France over the second half of the 20th century, it has become critical to better understand the ultimate determinant of these policies in the context of financial development theories:

We argue that privatizations/nationalizations episodes in France are not easily amenable to structural claims by dominant financial development theories that regard the law/legal origin69 (La Porta et al. 1997) or the openness of the economy (Rajan and Zingales, 2003) as key drivers of financial development. In fact, Attlee‘s government in post-war Common law Britain also nationalized a portion of the British industry, albeit on a smaller scale and duration than in France. Furthermore, the large 1982 nationalizations in France occurred in a context of high capital and trade openness (exports and Imports at 46% of GDP in 198170).

On the other hand, focus on partisan left-right struggles as drivers, such as Roe‘s theory (2003), insufficiently account for nationalization/privatization policies. In effect, privatizations, driven largely by the objective to reduce increasing government and social security public debts, continued under Jospin‘s left governments in 1997-2002.71

More generally, nationalizations and privatizations processes need to be considered within a broader set of economic institutions, economic policies and accumulation regimes that emerged during these critical junctures of 1944-46 and the mid-1980‘s. The 1944-46 juncture witnessed the rise of a ―Statist‖ “dirigiste” economic system with the State acting as the ―visible hand‖ of the market in industrial, labour, financial and macroeconomic matters. The mid-1980‘s were characterized by the rise of stock market development and economic and

68 This point is all the more relevant given the nationalizations of key financial institutions in 1945-46 and in 1981-82. In addition, public sector financing needs crowded new entrants financing: until the mid-1980‘s, restricted access to foreign capital could not compensate for the limited availability of domestic savings for new entrants/challengers. Besides, beyond the limited access to finance, most managers in powerful SOE‘s were previous members of the technocratic or political elite who had usually served in the French higher administration and/or governments before being appointed. The close social, personal and cognitive ties of the management of SOE with the policymakers made them more likely to be heard by policymakers than private sectors challengers or new entrants. 69 Another interesting consideration with respect to the State rent seeking orientation assumed by the Legal Origins theorist : the government did not appear to seek to expropriate or fail to compensate equity holders at ―fair‖ values, at least for periods where market values were easily observable (i.e. 1982) (See Vessilier, 1983 for details of compensation for shareholders of nationalized firms). 70 1852-2007 mean of trade openness = 30% as per our reconstructed data. 71 The argument that privatization helps to raise cash for the government is related to the privatization‘s impact on productivity. If the public ownership is optimal, then government‘s best option is to maintain the firms in public ownership and receive the stream of free cash flows. If the government has liquidity issues, it should issue debt (or raise taxes). The privatization proceeds are high only when the new private owners are more efficient (or at least expect to be more efficient).

38 financial liberalization. As highlighted earlier, notably because of increasing returns, path- dependency and institutional complementarities that arise from a pre-existing and/or combined set of economic institutions, the determinants of financial development may only be fully captured if we consider the broader political economy of the ―social system of production‖72 in which financial systems are embedded.

4.2.2.1 1944-46 critical juncture: preliminary inferences

The emergence of the ―dirigiste‖ Statist economic institutions in the post war era, together with the nationalization policies, which resulted in a significant decline in the role of equity markets as a source of corporate financing in the 1945-80‘s period, cannot be apprehended without reference to the impact of the second world war.

At the end of the war, a large portion of capital owners and bourgeois elites were discredited by their active collaboration with the Vichy government. Conversely, active participation in the Resistance, to a large extent unified under De Gaulle by 1944, became the new source of legitimacy (if not of legality; see Hamon, 1984). In effect, Communists and Gaullists played a pivotal role in the Resistance movements, which translated into large representation and influence in the provisional government of the French republic (1944-46), which initiated the French “dirigiste‖ model (nationalizations, the creation of the Plan and the welfare system). As pointed by Asselain (1983), nationalizations were agreed upon consensually in 1944 as part of the National Resistance Council programme (which directed the provisional government policies) across Christian democrats, Gaullists and Communists without significant interference from capital-owners and with widespread popular support in 1945. (See also Mayeur, 1984, p.92 and Margairaz, 1991, p.807-844).73

Further political economy research should enable us to analyse rigorously how these dramatic shifts in political legitimacies resonated with more fundamental structural changes in endowments and preferences of various classes (notably capital-owners, workers, bureaucrats).

One hypothesis could be that a cross-class coalition between a middle class of workers (less invested in financial assets) and an elite group of bureaucrats could have been a key driver behind the Statist ―dirigiste” configuration of the French economic policies in 1944-46 and the lack of development of stock markets in the subsequent periods.

In particular, the dramatic reduction in financial assets relative to the ―human‖ capital held by the middle class (i.e. non inflation-indexed instruments, typically government bonds and stocks) may have meant the ―median voter‖ had a preference for corporatist policies and corporate governance rules protective of labour rents.74 We can speculate that the State was the most efficient route to increase labour rents for the middle class due to the traditional weakness and ideological and political radicalism of organized labour in France. In addition,

72 We borrow the concept ―Social system of production‖ from Hollingworth and Boyer (1997). 73 Discussion of the determinants of the persistence, rather than the mere emergence, of the State-led economic system in France is beyond the scope of our analysis. It is highly probable that the lack of shareholders and the implicit coalition of workers, State bureaucrats and managers prevented the rise of a constituency for shareholder protection and stock market development. 74 The middle class was pivotal because a large share of the political preferences were polarized. The Communists enjoyed around 30% of the popular vote in the immediate aftermath of World War II. (See Mayeur, 1984 for example)

39 contrary to financial capital returns, the returns on ―human capital‖ cannot be fully diversified or insured (Perotti and Von Thadden, 2003). Such ―incompleteness‖ of human capital markets could have translated into a lower risk tolerance for the agents with relatively higher human capital endowments and firm-specific human capital investments. The importance of non-diversifiable human capital assets and related firm-specific investments could have led the ―median voter‖ to favour State-controlled governance, which is more likely to reduce corporate risk taking than shareholder dominated governance systems, as well as more intense State-led insurance and redistribution schemes (to be confirmed by future research).

4.2.2.2 Mid-1980‟s critical juncture: preliminary inferences

Understanding the determinants of the mid-1980‘s critical juncture financial development and privatizations policies in France is an arduous task due to the complexities inherent in institutional change and dynamics.

Preliminary evidence suggests that political preference for France‘s European Community commitments over the preservation of the ―dirigiste‖ model was the proximate cause for the dramatic 1983 shift in Mitterrand‘s economic policies towards liberalization, higher shareholder protection and stock market development (Levy et al., 2006; Loriaux, 1997; Hall, 1986).75

It is true that the state-led ―dirigiste” approach to economic and industrial policy had become less efficient once postwar reconstruction and catch-up à la Solow was achieved (Cohen, 1989). 76 Moreover, Mitterrand‘s Socialist policies in a context of adverse global macroeconomic conditions had led to high inflation levels and increased public debt in 1981- 1983. In particular, it is highly probable that the government growing need to finance its growing fiscal deficits and debt had led policymakers to acknowledge the need to develop liquid domestic financial markets. Similarly, government and social security debt financing was a key rationale in the privatizations drives of 1986-1988 and 1993-2002 (O‘Sullivan, 2007). Nevertheless, as highlighted by numerous authors (Levy et al. 2006; Hall 1986; Cameron 1996; Favier and Martin-Roland 1996, Attali, 2005), the alternative to the 1983 ―tournant de la rigueur‖ (i.e. devaluation, exchange controls, and continuation of Statist and Socialist policies and arguably ―financial repression‖) was strongly contemplated by Mitterrand, who had a largely unconstrained and swift decision making power under the French majoritarian ―semi-presidentialist‖77 institutions.78

In effect, the 1983 policy shift, a plausible immediate determinant of the ―great reversal‖ in stock market development in the mid-1980‘s, can be characterized as an eminently political decision, driven by the balancing of broader ideological considerations (i.e. French European commitment versus domestic socialism), and made possible by the ―majoritarian‖ nature of

75 As highlighted by Levy et al. (2006), ―President Mitterrand was forced to choose, therefore, between France‘s traditional statist growth strategy and European solidarity. His advisors were divided into two basic camps. (…) After much agonizing, Mitterrand opted for the latter camp, and the process of “dirigiste” rollback began.‖ 76 In shipbuilding, for example, it was estimated that each job paying 100,000 francs in annual wages cost the government 150,000 to 450,000 francs in subsidies (Cohen, 1989. p. 230-231, cited in Levy et al., 2006) 77 See Duverger, 1971 for the concept of ―Semi-presidentialism‖ in Constitutional Law (5th Republic regime). 78 This is another example of the importance to consider independent effects of political institutions in conjunction with the endowments and preferences of interest groups and society in shaping policy.

40 the Fifth Republic (See Lijphardt for a classical typology of political systems, 1999; See Pagano and Volpin, 2005, for a thorough review of the impact of political institutions).

Our macro-level approach to the explanation of the great reversals is not to deny the independent role of micro actors (i.e. managers of large Cac-40 French firms) who played a subsequent key role in the development of French financial markets in the late 1980‘s and 1990‘s, through their secondary equity issuances and their autonomous decisions to unravel the previous cross-shareholding networks between large French firms and financial institutions (Culpepper, 2005). These managerial behaviours were driven by the need for scale and the pursuit of aggressive non-organic growth strategies in increasingly competitive product markets (O‘Sullivan, 2007). Yet, we argue that the subsequent stock market development of the 1990‘s could not have occurred without the prior policy shift of the mid- 1980‘s. Thus, further research is needed to identify the extent to which the 1983 critical juncture was a political decision driven by ideological considerations rather than a mere manifestation of the growing (unsustainable?) inefficiencies of the Socialist and Statist economic policies in an open economy, in place since 1981 and the postwar period respectively.79

In sum, our preliminary inferences (to be confirmed by future research) suggest that the ―great reversals‖ of French stock market development in 1944-46 and the mid-1980‘s may have been ultimately determined by politics, as mediated through political institutions (1944- 46 juncture: cross-class coalition of workers and bureaucrats against investors Mid-1980‘s juncture: commitment to European project under majoritarian political institutions), rather than by time invariant structural determinants proposed by leading financial development theorists (e.g. openness or legal origins).

4.2.3 Potential generalizations arising the French case: the development of the stock market in the absence of formal investor protection (1852-c.1930)

As mentioned earlier, the generalizable value of the French case in the post-war era is limited since contingent political events, arising on the back of the exceptional shock of the war and ideological considerations, seem have been the key factors behind the 1944-46 and mid- 1980‘s ―great reversals‖ of financial development policies in France.

Nevertheless, the 1852 to 1930 period, where private ordering and market mechanisms were reasonably unconstrained, may provide us with potentially universal lessons on the determinants of financial development.

The French case provides preliminary indications that legal protection and openness alone may not determine financial development. This leads to a puzzle: how then can we explain the development of stock markets in the late 19th century and early 20th century in France?

79 The study of the determinants of stock market development and shareholder protection in the late 1980‘s and 1990‘s in the literature may not be as good a focal point as the analysis of the earlier great reversals of the mid- 1980‘s (1983 macroeconomic shift and 1980‘s privatizations). Indeed, it is likely that the privatizations and stock market development arising from the mid-1980‘s great reversals subsequently created a constituency of shareholders, who in turn promoted shareholder protection and policies favorable to stock market development. O‘Sullivan (2007) and Culpepper (2005) in particular emphasize the importance of managerial autonomy in deepening change in the late 1990‘s with cognitive shifts in the managerial class and the need for external capital for French large firms in order to fund overseas acquisition and scale in increasingly competitive product markets.

Notwithstanding the lack of data, a few venues for future research can be identified:

Contrary to these predictions, anecdotal evidence suggests that block-holding in the largest listed firms did not occur in France in the earlier century despite the absence of formal protection. (Cf section 2). Moreover, French households invested heavily in equities. In this context, the key issue is to understand whether or not firms were actually constrained or priced-out for capital ex ante.

A promising source of research may be to try to estimate the increased returns required by dispersed shareholders to compensate for agency costs and information asymmetries. For example, Hautcoeur (1994) notes that diffusely owned Railroads (approximately 35% of capitalization in 1880-1914) did not elicit to make use of the optional government guarantee on dividends80 (Viller, 1955,p.185 cited in Hautcoeur, 1994). At least, we may infer that the incremental tax cost brought about by this guarantee 81 was higher that the increase in expected return required by dispersed investors who face information asymmetries/agency risks/costs.

If indeed future research confirms that ownership concentration did not occur, the first category of potential explanations could be that other substitutes to legal shareholder protection partially mitigated the twin problems of information asymmetries and incomplete contract that allow managers‘ shirking and expropriation.

Trust may be a plausible source of protection (See Mayer 2008). The building of trust in France may have been more difficult than in the UK. Indeed, while presumably shareholders were geographically dispersed (40% of households owning stock in 1913), the board of directors and the stock exchange listing of large firms, with the notable exception of mining, were disproportionately located in Paris (85% of market capitalization excluding mining in Paris Bourse).82

Short of trust, maybe reputation could also account for the dispersion of large firms, who are more likely to return to the market for external financing, in contrast with the medium-size industrial firms, whose capital raising is mostly ―sunk‖. With regards to dividend, aggregate yields in most advanced economies (as highlighted in appendix F, at a macro level, i.e. not controlling, inter alia, for dramatic changes in tax regimes and industry-composition of stock markets) were not higher in the early 1900‘s than later in the century (Dimson et al., 2002). Further research at a microeconomic level is needed to measure the long-term micro- evolution of dividend yields. This will the extent to which dividend payout behaviors could be a result of the lack of formal investor protection (i.e. minority shareholders unable to extract dividend payments from insiders), as predicted by the ―outcome‖ agency model of La Porta et al. (2000) rather than a substitute for effective legal protection as predicted by classical agency theory (i.e. firms committing to higher payouts to limit the cash in the hand of insiders and commit to future equity issues in the future with outsiders.).

Another substitute to formal protection could be that intermediaries surmounted the collective action dilemma of dispersed minority shareholders, by using proxies to actively control

80 Only the cash-constrained Orleans Railroad apparently made use of the guarantee. (Haucoeur, 1994). 81 Source not triangulated (Viller, 1955 briefly cited in Hautcoeur, 1994). To be confirmed. The authors mentions 32% increase on tax on dividends. 82 Future venue for research: evidence on the absence of price discrimination in takeovers and retention of directors of target boards in merged firms could be also operational indicators of trust. (See Franks et al., 2006 )

42 directors. The very limited evidence indicates that French banks, unlike their German counterparts (Franks et al. 2006), did not play such an active role in the management of large firms. (Bouvier, 1970).

Alternatively, one may address the stock market development question through the investor‘s portfolio perspective, not the firm‘s perspective. The increase in age expectancy, in revenue per capita combined with the absence of State retirement and extensive welfare provisions from the Government in the 1850‘s-1930‘s period provided strong incentives to save and invest for French households.83 It may well be that in relative terms, even though the risk, hence required return on stocks, were higher in the absence of strong legal protection, the portfolio allocation to domestic stock made sense from a diversified portfolio perspective maybe because of the lack of attractive risk-adjusted return alternatives. Indeed, empirical evidence suggest that inflation may not have been correctly anticipated in bonds in the period, resulting in long periods of negative ex post bond returns (negative ex-post real returns)84. The documented French capital outflows towards foreign securities, notably Russian bonds before 1917 (Hautcoeur and Le Bris, 2008), may indicate that investors were not only looking for diversification benefits (lower shareholder protection but presumably low correlation of Russian equity returns with their French portfolio returns) but also for higher real yields. In this perspective, it would be interesting to compare the optimal diversified portfolio allocation to French equities with the actual allocation in 1890-1913.

Conclusion

Our analysis indicates that formal investor protection was not a crucial determinant of stock market development in France from 1852 to 2007. In addition, beyond the conceptual shortcomings of the Law and Finance theories, it appears that ―Legal Origins‖ cannot account consistently for the differences in levels of shareholder protection in civil law France and common law countries in the 20th century. Finally, the evidence provided suggests that capital and trade openness alone was not a significant factor in the development of French equity markets in the late 19th and 20th century.

Rather, a political explanation which incorporates the preferences of social classes and interest groups with respect to the distributional impact of shareholder protection, the distinct impact of political institutions and political actors, as well as the pre-existing or concomitant complementarities of economic institutions, may be a better option in explaining the great reversals that characterized the evolution of stock markets in France (1944-46 and mid 1980‘s). In particular, we hypothesize that the political, economic and social consequences of the Second World War provided impetus for a “dirigiste” economic system where the role of stock markets was marginalized. We also suggest that the gradual changes in the “dirigiste” economic system and economic policies in the mid 1980‘s, which indirectly laid foundations for future developments of equity markets in France, were primarily driven by broader political and ideological considerations rather than by economic intentions or interest group influences (to be confirmed by future research)85.

83 No public pension system at the time. 84 Ex ante is not available but widespread negative ex-post returns on bonds suggest inflation was not adequately anticipated by investors at the time. 85 Identifying whether political and ideological decisions were determined by economic variables is critical to sustain this claim (future research).

With this perspective, two distinct directions for future research could further deepen our understanding of the French case, with significant implications for corporate finance theory and economic policy.

First, future empirical research is needed to explain the development of stock markets in the absence of formal investor protection in France. The macro focus of our historical analysis and the absence of shareholding ownership firm-level data did not enable us to address this critical question. It would be of particular interest to examine the extent to which firms were actually constrained for capital in the earlier century, and confirm the existence of functional substitutes for formal investor protection in this period. This would require a thorough microeconomic firm level analysis of financing decision and the collection of detailed ownership patterns of French public firms in the 1880-1960 period.

Second, further research is required to provide a more rigorous understanding of institutional emergence and change in corporate governance and economic institutions. As emphasized in our study of the French case, a superior explanation of shareholder protection determinants and stock market development cannot restrict itself to the isolated study of financial contracts and relationships. Potential institutional complementarities and increasing returns processes among economic institutions condition the impact and efficiency of corporate governance institutions and investor protection. This raises questions about purely functionalist and rational-instrumental interpretations of corporate governance institutional emergence and design (i.e. the emergence and design of institutions explained by the dominant actors‘ objectives they serve). 86 Moreover, our understanding of the evolution of corporate governance and financial markets may necessitate a more subtle holistic theory of exogenously and endogenously-generated institutional change, that perhaps, apart from Marx‘s immense contribution, has eluded social science.

86 A substantial question is to understand the genesis of complementary and internally congruent institutions, for which accounts relying on a grand design by a provident actor are not plausible.

References

Acemoglu, D., Johnson, S., Robinson, J., 2001. The colonial origins of comparative development: an empirical study. American Economic Review 91:1369-1401. Acemoglu, D., Johnson, S., Robinson J., 2005. The Rise of Europe: Atlantic Trade, Institutional Change and Economic Growth. American Economic Review 95 (2005): 546-579 Aganin, A., Volpin, P., 2003. History of Corporate Ownership in Italy, ECGI - Finance Working Paper No. 17/2003. Aghion P. and Hermalin B., 1990. Legal restrictions on private contracts can enhance efficiency. Journal of Law, Economics and Organization. Allen, F., Gale D., 2000. Comparing Financial Systems, Cambridge, MA: MIT Press. Aoki, M., 2001. Toward a comparative institutional analysis, Cambridge, Mass.; London: MIT Press. Arbulu P., 1998. Le marché parisien des actions au XIX° siècle: performance et efficience d‘un marché émergent, Unpublished Doctorate Thesis, University of Orléans, France. Arthur, B., 1994. Increasing returns and path dependence in the economy. Ann Arbor: University of Michigan Press. Asselain, J. 1983. La dimension sociale des nationalisations de 1982. Revue Economique, vol 34 n.3 p.536-576. Attali, J., 2005. C‘était Francois Mitterand. Paris: Fayard. Aubry, C., Rau, C., 1922. Cours de droit civil français d‘après la méthode M. Carl Salomon Zachariae,1897-1922, 12 vol. Bagehot, W., 1873. Lombard Street, Homewood, IL: Richard D. Irwin, (1962 Edition). Barrière et al., 2006. Les droits de tradition civiliste en question : à propos des rapports Doing business de la Banque mondiale, Association Henri Capitant. Paris : Société de législation comparée. Bebchuk, L. 1999. The rent protection theory of corporate ownership and control. Unpublished working paper. Harvard Law School, Cambridge, MA. Bebchuk, L., Roe, M., 1999. A theory of path dependence in corporate ownership and governance. Stanford Law Review 52, 127-170. Beck, T., Demirguc-Kunt, A., Levine, R., 1999. A new database on financial development and structure.Unpublished working paper 2784. Washington: The World Bank. Beck, T., Demirguç-Kunt A., and Levine R., 2000. A New Database on Financial Development and Structure, World Bank Economic Review 14: 597-605. Beck, T., Demirguç-Kunt A., and Levine R., 2003. Law and Finance: Why Does Legal Origin Matter?. Journal of Comparative Economics 31: 653- 675. Beck, T., Demirguç-Kunt A., and Levine R., 2005.Law and firms' access to finance. American Law and Economics Review, 7: 211-252 Biais, B., Perotti E., 2002. Machiavellian Privatization. The American Economic Review, 92(1): 240-258. Bonneau, T., Drummond, F., 2005. Droit des marchés financiers, Thierry Bonneau et France Drummond, Paris : Economica. Bordo, M, Rousseau P., 2006. Legal-political factors and the historical evolution of the finance-growth link. European Review of Economic History 10: 421–444. Bourguignon, F., Levy-Leboyer, M., 1985. L'Economie Française au XIXe siècle: Analyse macro-économique. Paris : Economica. Bouvier, J. in Braudel F. and Labrousse E.(eds), 1970, Histoire économique et sociale de la France, IV, Paris: PUF. Boyd, J. H., Smith B., 1998, The evolution of debt and equity markets in economic development, Economic Theory, 12: 519-560.

Boyer, R., Hollingsworth, J. (Eds). 1997. Contemporary Capitalism: The Embeddedness of Institutions. Cambridge: Cambridge University Press. Boyer, R., Saillard Y. (Eds.), 2002. Théorie de la Régulation. L‘état des savoirs. Paris : La Découverte. Bozio, A., 2002. La Capitalisation Boursière Au XXème Siècle, Unpublished DEA Thesis, Paris : ENS/ENSAE/EHESS. Braibant, G, Delvolve, P., Genevois B., Long M. and Weil P. 2005. Les grands arrets de la jurisprudence administrative. 15th edition. Paris: Dalloz. Braudel, F, 1959. Histoire et Science Sociale: La Longue durée. Histoire ESC. Braudel, F., Labrousse E. (eds.), 1980. Histoire économique et sociale de la France, IV, 2, Paris : PUF. Cameron, D., 1996. Exchange Rate Politics in France, 1981-1983: The Regime-Defining Choices of the Mitterrand Presidency. In The Mitterrand Era: Policy Alternatives and Political Mobilization in France. Anthony Daley. New York: NYU Press: 56-82. Cameron, R., 1961. France and the Economic Development of Europe, 1800-1914. Princeton University Press, Princeton. Carbonnier J., 1992. Droit civil, Introduction, Tome 1 and 2, 21th ed. Paris : Presses universitaires de France. Carbonnier, J., 2004. Droit Civil, Tome 1 and 2, Quadriges Manuel. Pres Paris : Presses universitaires de France. Carbonnier, J., 1988. Flexible Droit, Paris: Librairie générale de droit et de jurisprudence. Carre, J., Dubois P., and Malinvaux E., 1972. La croissance francaise : un essai d'analyse economique causale de l'apres-guerre, Paris : Editions du Seuil 709 p. Cozian, A. Viander et Deboissy F., 2005. Droit des sociétés. 18th ed., Litec. Chandler, A.1990.Scale and scope: the dynamics of industrial capitalism.Cambridge, MA: Harvard University Press. Coase, R., 1937. The nature of the firm, Economica 4, 386-405. Cools, S., 2005. The real differenece in corporate law between the United States and Continental Europe: Distribution of Powers. Delaware Journal of Corporate Law. Vol. 30, No. 3, pp. 697-766. Coffee, J., 2000. Convergence and its critics: what are the preconditions to the separation of ownership and control? Unpublished working paper. Columbia University, New York. Coffee, J., 2001. The rise of dispersed ownership: The roles of law and the state in the separation of ownership and control. Yale Law Journal, 111, 39-44. Cohen, E., 1989. L'Etat brancardier: Politiques du déclin industriel (1974-1984). Paris : Calmann- Lévy. Conseil d‘Etat, 2001. L‘influence international du droit français, Paris : La Documentation Française. Cross, F., 2005, Identifying the Virtues of the Common Law. Austin: U of Texas Law, Law and Econ Research Paper No. 063. Culpepper, P., 2005, Institutional Change in Contemporary Capitalism: Coordinated Financial Systems since 1990. World Politics, 57 (2), pp. 173 - 199 Dam, K., 2006. The law-growth nexus : the rule of law and economic development, Washington, D.C. : Brookings Institution Press. Damaska, M., 1986. The Faces of Justice and State Authority: A Comparative Approach to the Legal Process, New Haven, CT: Yale University Press. David, P., 1985. Clio and the economics of QWERTY. American Economic Review 75 (May): 332-7. Demirguc-Kunt, A., Maksimovic, V., 1998. Law, finance, and firm growth. Journal of Finance 53, 2107-2138. Demirguc-Kunt, A., Levine R., 2008. Finance, Financial Sector Policies, and Long-Run Growth. Commission on Growth and Development, Working Paper No. 11, 2008, Washington DC: The World Bank.

Demsetz, H., Lehn K., 1985. The Structure of Corporate Ownership: Causes and Consequences, Journal of Political Economy, 93: 1155-175. Dyck A., Zingales L. , 2004. Private Benefits of Control: An International Comparison, Journal of Finance, vol. 59, no. 2, pp. 537-600. Dimson E., Marsh P. and Staunton M., 2002. Triumph of the Optimists: 101 Years of Global Investment Returns. Princeton, NJ: Princeton University Press. Djankov, S., La Porta, R., Lopez-de-Silanes, F., Shleifer, A., 2002. The regulation of entry. Quarterly Journal of Economics 117, 1-37. Duverger, M., 1971. Institutions politiques et droit constitutionnel. Paris: PUF. Elredge, N. 1999. The Pattern of Evolution. W. H. Freeman, New York. Favier, P., Martin-rolland, M., 1996. La decennie Mitterand. Volume IV: Les defis. Paris : Seuil. Franks, J., Mayer C., 1996. Hostile takeovers and the correction of managerial failure. Journal of Financial Economics 40:163-81. Franks, J., Mayer C., and Miyajima H., 2007. Evolution of Ownership: The Curious Case of Japan. Mimeo, Waseda University. Franks, J., Mayer C., and Rossi S., 2004. Ownership: Evolution and Regulation. Institute of Finance and Accounting Working Paper FIN 401, London Business School. Franks, J., Mayer C., and Rossi S, 2006. Spending Less Time with the Family: The Decline of Family Ownership in the UK. In Randall Morck (ed.) A History of Corporate Governance Around the World: Family Business Groups to Professional Managers. Chicago and London, University of Chicago Press and NBER. Franks, J., Mayer C., and Wagner H., 2006. The Origins of the German Corporation—Finance, Ownership and Control.Review of Finance 10-4. Freedman, C.E., 1979. Joint-Stock Enterprise in France 1807–1867: From Privileged Company to Modern Corporation. Chapel Hill: University of North Carolina Press Gallais-Hamonno, G., Hautcoeur P. (Eds)., 2007. Le marché financier français au XIXe siècle. Paris : Publications de la Sorbonne, vol.1 and vol.2. Gazette du Palais, Paris: Gazette du Palais. Glaeser, E., Shleifer A., 2002. Legal Origins. The Quarterly Journal of Economics 117-4: Goldsmith, R., 1985. Comparative National Balance Sheets: A Study of Twenty Countries, 1688-1978, University of Chicago Press, Chicago. Gourevitch, P., Shinn J., 2005. Political Power & Corporate Control: The New Global Politics of Corporate Governance. Princeton, N.J. and Oxford: Princeton University Press. Goyer, M., 2003. The Transformation of Corporate Governance in France. Brookings Institution, US-France analysis Series. Greenwood, J., Jovanovic, B., 1990. Financial development, growth, and the distribution of income. Journal of Political Economy 98, 1076-1107. Grossman, S., Hart O., 1980. Takeover bids, the free rider problem, and the theory of the corporation, Bell Journal of Economics 11, 42-69. Grossman, S., Hart, O., 1986, The costs and the benefits of ownership: A theory of vertical and lateral integration, Journal of Political Economy 94, 691-719. Grossman, S., Hart, O, 1988, One-share-one-vote and the Market for Corporate Control, Journal of Financial Economics 20, 175-202. Guyon, Y., 1996. Droit des affaires : t. 1, Droit commercial général et sociétés, Paris : Economica, 1996. Hall, P., 1986. Governing the Economy: The Politics of State Intervention in Britain and France. New York, Oxford University Press. Hall, P., Soskice D. (Eds), 2001. Varieties of Capitalism: The institutional foundations of comparative advantage. Oxford: Oxford University Press. Hamon, L. Légalité-illégalité-légitimité.Espoir n°47, 1984. Hannah, L., 2007. The Divorce of Ownership From Control from 1900: Re-calibrating Imagined Global Historical Trends. Tokyo: CIRJE Discussion Papers, University of Tokyo, Japan.

Hautcoeur P., 1994. Le marché boursier et le financement des entreprises 1890-1939. Paris: Unpublished Doctoral Thesis, University of Paris-I. Hautcoeur P., 1999. L'autofinancement : questions de méthode et tentative de cadrage macro- économique pour la France (1914-1990), Entreprises et Histoire: 55-77. Hautcoeur P., Le Bris D., 2008. A Challenge to Triumphant Optimists? A New Blue Chips Index for the Paris Stock-Exchange (1854-2007). Paris: ENS. Working Paper Paris School of Economics 2008-21. Hayek, F., 1960. The Constitution of Liberty. Chicago, IL: The University of Chicago Press. Hellwig, M, 2000. On the economics and politics of corporate finance and corporate control. In: Vives, X. (Ed.), Corporate Governance: Theoretical and Empirical Perspectives. Cambridge University Press, Cambridge, pp. 95-136. Hemard, J., Terré F. and Mabillat P., 1972. Societés Commerciales. t.1, Paris, Dalloz, 1972. Houpi, C. 1907. Traite général théorique et pratique des sociétés civiles et commerciales. Paris : Larose et Tenin. Houpin, C., Bosvieux H., 1929. Traité Général théorique et pratique des sociétés civiles et commerciales et des associations (avec formules). Sirey. Hilaire, J., Introduction historique au droit commercial, Paris : Presses universitaires de France, 1986. Jayaratne, J., Strahan, P., 1996. The finance-growth nexus: evidence from bank branch deregulation. Quarterly Journal of Economics 111, 639-670. Jensen, M., Meckling W., 1976.Theory of the firm: managerial behavior, agency costs and capital structure, Journal of Financial Economics 3, 305-360. Kessler D. et al., 1996. Explaining Deviations from the Fifty-Percent Rule: A Multimodal Approach to the Selection of Cases for Litigation, 25 Journal of Legal Studies. 233, 242-243. King, R., Levine, R., 1993. Finance and growth: Schumpeter might be right. The Quarterly Journal of Economics 108, 681-737. Lamoreaux, N., Rosenthal J., 2005, Legal regime and contractual flexibility : a comparison of business‘s organizational choices in France and the United States during the era of industrialization, American law and economics review, VII (1), pp. 28-61. La Porta, R., Lopez-de-Silanes, F., Shleifer, A., Vishny, R., 1997. The legal determinants of external finance. Journal of Finance 52, 1131-1150. La Porta, R., Lopez-de-Silanes, F., Shleifer, A., Vishny, R., 1998. Law and finance. Journal of Political Economy 106, 1113-1155. La Porta, R., Lopez-de-Silanes, F., Shleifer, A., Vishny, R., 1999a. The quality of government. Journal of Law, Economics, and Organization 15, 222-279. La Porta, R., Lopez-de-Silanes, F., Shleifer, A., Vishny, R., 1999b. Investor protection: origins, consequences, and reform. Unpublished working paper 7428. NBER, Cambridge. La Porta, R., Lopez-de-Silanes, F., Shleifer, A., 1999c. Corporate ownership around the world. Journal of Finance 54, 471-517. La Porta, R., Lopez-de-Silanes, F., Shleifer, A., Vishny, R, 2002. Investor Protection and Corporate Valuation. Journal of Finance 57, 1147-1170. La Porta, R., Lopez-de-Silanes, F., Shleifer, A., Vishny, R, 2006. What Works in Securities Laws?. Journal of Finance 61-1: 1–32 La Porta, R., Florencio Lopez-de-Silanes, and Andrei Shleifer. 2008. The Economic Consequences of Legal Origins. Journal of Economic Literature. Lefebvre-Teillard, 1985. La Societe Anonyme au XIXeme siecle, Presses Universitaire de France. Levasseur M., Olivaux J., 1981. Théorie du financement des entreprises et évolution de la fiscalité française. Revue économique, Vol. 32, No. 3, 490-512. Levine, R., 1997. Financial development and economic growth: Views and agenda Journal of Economic Literature Vol.35.. Levine, R., Zverkos., S., 1998. Stock Markets, Banks, and Economic Growth. American Economic Review, 88(3), 537-558.

Levy J. et al. (Eds.), 2006. The State after Statism: New State Activities in the Age of Liberalization. Cambridge: Harvard University Press. Lijphart, A., 1995. Patterns of democracy : government forms and performance in thirty-six countries. New Haven : Yale University Press. Loriaux, M., 1997. Capital Ungoverned. Ithaca, NY: Cornell University Press. Loriaux, M., 1997. France after Hegemony: International Change and Financial Reform. Ithaca, NY: Cornell University Press. Lyon-Caen C., Renault L., 1924, Manuel de droit commercial, Paris (14th ed. 1891) Maddison, A., 2001. The World Economy: a Millennial Perspective. OECD Development Centre. Marnata, F., 1973. La Bourse et le financement des investissements, Paris: A. Colin. Margairaz M., 1991. L'Etat, les finances et l'économie. Histoire d'une conversion, 1932-1952. Tome 2, Paris : Comité pour l'histoire économique et financière de la France / IGPDE. Mattei, U. 1997. Comparative Law and Economics. Ann Arbor, MI, University of Michigan Press. Mayer, C, 2008, Trust in Financial Markets, European Financial Management 14, 617-632. Mayeur J., 1984. La Vie politique sous la Troisième République (1870-1940). Paris : Éditions du Seuil Points-Histoire. Merle O., 2003. Droit commercial sociétés commerciales. Paris: Dalloz. Mestre J., Putnam E. and Vidal D., 1995. Les grands arrêts du droit des affaires. Dalloz. Merryman, J., 1985. The civil law tradition : an introduction to the legal systems of Western Europe and Latin America / John Henry Merryman: Stanford University Press, 1985. Merryman, J., 1996. The French Deviation, The American Journal of Comparative Law, Vol. 44, No. 1, 109-119. Moreau-Neret O., 1957. Les valeurs françaises depuis 1940. Sirey. Michalet C., 1968. Les placements des épargnants français de 1815 à nos jours, Paris : PUF 1968. Mishkin, F., 2006. The Next Great Globalization: How Disadvantaged Nations Can Harness Their Financial Systems to Get Rich. Princeton: Princeton University Press. Mitchell, B., 1995. International Historical Statistics. Stockton Press, London. Modigliani F., Miller M., 1958. The cost of capital, corporation finance, and the theory of investment, American Economic Review 48, 261-297. Modigliani F., Perotti E., 2001. Markets versus Bank Finance: Legal Enforcement and Investor Protection. International Review of Finance, 1 (2), 81-96. Musacchio, A., 2007. Experiments in Financial Democracy: Corporate Governance and Financial Development in Brazil, 1882–1950. Unpublished book manuscript, Harvard Business School Musacchio, A., 2008. Can Civil Law Countries Get Good Institutions? Lessons from the History of Creditor Rights and Bond Markets in Brazil. Journal of Economic History 68, 80-108. Musacchio, A., 2008. Do Legal Origins Have Persistent Effects Over Time? A Look at Law and Finance around the World c. 1900. Harvard Business School Working Paper, No. 08-030. Myers, S., Majluf N., 1984. Corporate financing and investment decisions when firms have information that investors do not have, Journal of Financial Economics 13,187-221. North, D, 1990. Institutions, institutional change and economic performance , Cambridge : Cambridge University Press. North, D., Weingast, B. 1989. Constitutions and Commitment: The Evolution of Institutions Governing Public Choice in Seventeenth-Century England. Journal of Economic History 49, 803- 38 832, Olson, M., 1965. The Logic of Collective Action. Cambridge: Harvard University Press. O'Sullivan M., 2007. Acting Out Institutional Change: Understanding the Recent Transformation of the French Financial System. Socio-Economic Review, Vol. 5, Issue 3, pp. 389-436. Pagano, M., Panetta, F and Zingales L., 1998. Why Do Companies Go Public? An Empirical Analysis, Journal of Finance, American Finance Association, vol. 53(1), pages 27-64, 02. Pagano, M., Röell A., 1998. The Choice of Stock Ownership Structure: Agency Costs, Monitoring, and the Decision to go Public, Quarterly Journal of Economics 113, 187-225.

Pagano, M.., and Volpin, P., 2001. The Political Economy of Finance. Oxford Review of Economic Policy 17, 502-519. Pagano, M., Volpin P.. 2005., The Political Economy of Corporate Governance. American Economic Review 95-4: 1005-1030. Perotti, E., Von Thadden, P., 2006. The Political Economy of Corporate Control and Labor Rents. Journal of Political Economy 114-1: 145–175. Perotti E. Von Oijen P.. 1999. Privatization, political risk and stock market development. CEPR discussion paper 2243. Petit O., 1984.The origins of French planning: a reappraisal.Contributions to Political Economy Volume 3, Number 1, 65-84 Petit, M., 2001, Base de données ESF 1920-1939 – Actions, note méthodologique Petit, M., 2001. Indices actions de la bourse de Lille 1900-1960 (Université de Lille 2) Piketty, T., 2001. Les Hauts revenus en France : Inégalités et redistributions 1901- 1998. Planiol , M., 1905. Traité élémentaire de Droit civil, Paris : LGDJ. Planiol, M., 1924. Traité élémentaire de Droit civil, Paris : LGDJ, 9th ed. (1922-1924). Planiol M., Ripert G., and Boulanger, J., 1942. Traité élémentaire de droit civil, Paris, R.Pichon et R. Durand-Auzias, Posner, R.,1973. Economic Analysis of the Law. Boston, MA: Little-Brown. Rajan, R., Zingales, L., 1998. Financial dependence and growth. The American Economic Review 88, 559-586. Rajan, R., Zingales, L., 1999. The politics of financial development. Unpublished working paper. University of Chicago, Chicago. Rajan, R., Zingales, L., 2003. The Great Reversals: The Politics of Financial Development in the Twentieth Century, 69 Journal of Financial Economics, 5, 43. Ripert, G., 1951. Aspects juridiques du capitalisme moderne, Paris : Libraire générale de droit et de jurisprudence. Ripert, G., 1981. Traité élémentaire de droit commercial, Paris : Librairie générale de droit et de jurisprudence. Ripert, G., Roblot, R., Traité de droit commercial, t. 1, vol. 2, 18th éd. par M. Germain,, L.G.D.J., 2002 Roe, M., 1994. Strong Managers and Weak Owners: The Political Roots of American Corporate Finance.Princeton University Press, Princeton. Roe, M., 1999. Political preconditions to separating ownership from corporate control. Unpublished working paper. Columbia Law School, New York. Roe, M., 2003. Political Determinants of Corporate Governance. New York and Oxford: Oxford University Press. Roe, M., Siegel J., 2007. Political Instability and Financial Development.Mimeo, Harvard Law School and Harvard Business School. Roell, A., 1996, The decision to go public: An overview European Economic Review 40, 1071- 1081 Rousseau, J., 1993, Du Contrat Social, Folio Essais, Gallimard, Paris. Saint-Marc, M., 1974. Introduction aux statistiques monétaires et financières françaises (1807- 1970). Revue internationale de l‘Histoire de la Banque, n° 8. Saint-Marc, M., 1986. Le financement du développement industriel français de 1945 à 1985 Revue d'économie industrielle, Année 1986, Volume 35, Numéro 1 Sauvy, A.. 1984. Histoire Economique de la France entre les deux guerres. Paris: Economica. Schmidt, D., 1994. Les conflits d‘intérêts dans la société anonyme, Paris: Joly editions. Schumpeter, J., 1982. The theory of economic development. Social science classics series, Transaction Publishers. Stigler, G., 1971. The theory of economic regulation. Bell Journal of Economics and Management Science 2, 3-21.

Stulz, R., Williamson, R., 2001. Culture, openness, and finance. Unpublished working paper 8222, NBER, Cambridge. Sylla, R. 1998. US securities markets and the banking system, 1790-1840. Federal Reserve Bank of St Louis Review 80 (May/June), 83-98. Szramkiewicz, R., 1989. Histoire du droit des affaires, Paris, Montchrestien,1989. Tanzi, V., Schuknecht, L., 2000. Public spending in the Twentieth Century: A Global Perspective. Cambridge University Press, Cambridge. Taylor, A., 1998. Argentina and the world capital market: saving, investment, and international capital mobility in the Twentieth Century. Development and Economics 57,147-184. Thaller, E., 1898., Traité élémentaire de droit commercial, Paris, A. Rousseau. Thaller, E., 1903. De la réforme de la loi des sociétés par actions, Revue Politique et parlementaire, Vol. 35, n° 103-105, pp. 82-125. Thaller, E., 1910, Traité élémentaire de droit commercial, Paris, A. Rousseau. Thaller, E., 1903. De la réforme de la loi des sociétés par actions, Revue Politique et parlementaire, Vol. 35, n° 103-105, pp. 82-125. Toutain, J., 1996. Comparaisons entre les différentes évaluations du PIB de la France 1815 à 1938, ou l‘histoire quantitative a-t-elle un sens ?. Revue économique, pp. 893-919. Toutain, J., Lebreton A., 1997. La croissance française, 1789-1990. Nouvelles estimations, Histoire economique quantitative. Vergé, C., 1877, Les Codes Annotés. Code de Commerce annoté et expliqué d‘après la jurisprudence et la doctrine. Paris: Bureau de la Jurisprudence générale. Vessilier, A., 1983. Aspects financiers des nationalisations. Revue Economique, Vol.24-3, pp 466-495. Vienot, M , 1999. Rapport Viénot, Rapport du comité sur le gouvernement d'entreprise, AFEP- MEDEF, juillet,1999. Villa, P., 1993. Une analyse macroéconomique de l'économie française au XXe siècle, Paris : CNRS Villa P., 1997. Séries macro-économiques historiques, Paris :INSEE, INSEE Méthodes, N°62-63. Villers, R., 1955. Le développement des valeurs mobilières du milieu du XVIIIe siècle a 1914. Doctoral Lecture. Paris. Williamson, O., 1985. The Economic Institutions of Capitalism. NY: The Free Press. Windolf, P.,1999. L´evolution du capitalisme moderne - La France dans une perspective comparative. Revue française de sociologie 40, pp. 501-529. Yin, R., 2003, Case Study Research: Design and Methods. Sage Publications. Zingales, L., 1995, Insider Ownership and the Decision to Go Public. Review of Economic Studies, 62(3), pp. 425-48. Zweigert, K., Kötz, H., 1998. Introduction to Comparative Law. New York, NY: Oxford University Press.

Internet databases/data sources www.insee.fr www.euronext.fr www.cepii.fr / http://www.cepii.fr/francgraph/bdd/villa/mode.htm www.banque-france.fr www.oecd.com www.imf.org www.legifrance.fr

APPENDIX

APPENDIX A: Key variables description and sources

A-1 Table 1: Stock Market Development and Key Macroeconomic variables:

Key Variables Description/Comments Source (I) Stock Market Development

(i) Market Cap: 1852-1900: Arbulu (1998); 1900-2001 (Bozio, 2002); 2002-2007 (Euronext, 2009). (ii) GDP: Source: 1871-1890 Nominal Growth rates GDP from Levy-Leboyer and Bourguignon Domestic Market Capitalization of Regional and Paris exchanges/Current (1985) applied to Nominal GDP 1890 Villa (1993) to overcome Market Cap/GDP Nominal GDP substantial difference in GDP estimates between 19thc/20th century. 1890-1949 P.Villa (1993); 1949-2007: source INSEE comptes et indicateurs economiques + www.insee.fr. (Pre 1960 fitted to New Francs 1960 nominal)

(i) Equity Issues: 1892-1907: Credit Lyonnais Statistics modified by Hautcoeur (1994), 1907-1936: SGF corrected by Hautcoeur French Stock Market Equity issues (IPO or Seasoned equity offerings) by (1994), 1936-1939: Credit Lyonnais in Sauvy (1984); 1967-1971: Equity issues/Corporate Gross Fixed Capital Formation French Listed firms/Domestic Corporate Gross Fixed Capital Formation Dubarle, Mouchotte (1973); 1950/60 Rajan and Zingales (ten year (Listed and non listed firms: macroeconomic aggregates) data points as % of GDP, retro calculated), 1974-2007 Paris Bourse/Euronext annual reports. (ii) Corporate Gross Fixed Capital Formation: 1890-1949 : Villa (1993); 1949-2007: INSEE

Key Variables Description/Comments Source

(iii) Control Economic and Financial variables

Logarithm of GDP per Capita valued at French Francs 1995. A proxy for Log GDP/Capita Constant Francs 1995 1850-1990 Toutain (1997); INSEE (2009) demand for finance.

1852-1900 Levy-Leboyer and Bourguigon (1985); 1900-2001 Piketty (2001); Inflation rate Domestic French CPI . 2001-2007 INSEE.

This is the "Taux d'Autofinancement" as per INSEE typology with "Gross Savings/FBCF": It is equivalent to (Net Income - Annual Dividends + Depreciation/Amortizations)/Gross Fixed Capital Formation. Very crude and unsatisfactory proxy for the following reasons: (i) Accounting measure, not Source: 1890-1896: Carre Malinvaux (1972) p.424 ; 1896-1949 Villa; Hautcoeur (1999)"L‘autofinancement : théorie, questions de méthode cash flow since it excludes working capital variations. (ideally, Cash Flow et tentative de cadrage macroéconomique; 1949-2007 INSEE before Capex) (ii) Ex post investment is determined by available internal External Finance need as a % of expost Investment (1- (Retained finance given imperfection of financial markets. (See e.g. pecking order Earnings/Corporate Investment) Crude Proxy pour la France (1914-1990)", Entreprises et Histoire, n°22, oct. 1999, 55-77 for theory) (endogeneity problem) (iii) Mixes operating and financing policy of confirmation of pre 1914 estimates and 1918-1929 estimates. 1930-1938: P.Villa the firm by substracting dividends and interests. (iv) Critically: only aggregate (1993) Productivité et accumulation du capital en France depuis 1896, OFCE, data from all French firms: assumes that the internal financing and investment INSEE for 1949-2007 estimates patterns are the same for listed and non listed. Yet, it is likely that listed firms are subject to selection bias (Bias in firms going public), and hence are not representative of all the firms in the economy.

Corporate Tax Rate %. Data N/A to adjust for the net impact of taxation on Corporate Tax Rate % financing decisions of firms by considering personal investor taxation. (div vs Pre-1973 corporate tax rates: Hautcoeur (1994); Levasseur and Olivaux (1981) capital gains, double tax credits…)

Source: Levy Leboyer and Bourguignon (1985), A.Sauvy and Annuaire statistique Openess (X+M)/GDP Nouveaux FF Sum of Export and Import current Francs/ GDP current Francs INSEE from 1949-2007

Mean historical absolute value of current account over GDP over five year intervals for a sample of fourteen developed countries for 20th century as Exogenous Capital Mobility (0 = low capital mobility when C/A GDP calculated by Taylor (1998). We presume the existence of "exogenous" Taylor (1998). IMF for 1998-2007 data below 2%; or 1=high capital mobility when C/A >above 2% dummy) capital mobility when the average Current Account to GDP of major world economies is above 2%.

Stock Market Price Index Annual REAL Return (Capital Gains only, Stock Market Real (inflation-adjusted) Price Index CAC40 (top 40 excl.Dividends, inflation adj.) corporates in French Stock Exchanges), i.e. excluding dividends returns.

Dividend Yield Annual Dividend yields for CAC40 listed companies in the French exchanges.

Dummy Retirement system (1 if no State retirement pay-as-you-go Dummy to capture the availibility of a comprehensive State basis (Repartition), 0 if pay-as-you go State retirement system ) Pension/Retirement scheme.

Dummy to capture investor protection (Shareholder rights and securities law) Dummy for lower investor protection (1852-1933) when Shareholder rights are above 2.63, i.e. average World Antidirector rights as per LLSV (1998).

Dummy to capture investor protection when Shareholder rights are below Dummy for higher investor protection (1962-2007) 2.63, i.e. average World Antidirector rights as per LLSV (1998).

A-2 Table 2: Shareholder Protection Key Variables Description/Comments Source (II) Investor Protection Indicators definition as per La Porta et al. (1997, 1998, 2004)

II.1 Shareholder Rights

Shareholder Rights (Antidirector rights Index+1 Share = 1 vote) Aggregate index sum of (1 Share 1 Vote and Antidirectors-rights aggregate Author's analysis from French Law (Doctrine, Codes, Jurisprudence) France (1852-2007) index): from 0 to 7

Equals one if the Company Law or Commercial Code of the country requires that ordinary shares carry one vote per share, and zero otherwise. Equivalently, this variable equals one 1 Share 1 Vote when the law prohibits the existence of both multiple-voting and non-voting Author's analysis from French Law (Doctrine, Codes, Jurisprudence) ordinary shares and does not allow firms to set a maximum number of votes per shareholder irrespective of the number of shares she owns, and zero otherwise. (La Porta et al., 1998)

Aggregate index sum of: Proxy by mail, Shares not blocked, cumulative Antidirector Rights Index (aggregate) voting/proportional representation, oppressed minorities, preemptive rights Author's analysis from French Law (Doctrine, Codes, Jurisprudence) for sh. Vote and % share capital to call EGM. From 0 to 6.

Equals one if the Company Law or Commercial Code allows shareholders Proxy by mail to mail their proxy Author's analysis from French Law (Doctrine, Codes, Jurisprudence) vote to the firm, and zero otherwise.

Equals one if the Company Law or Commercial Code does not allow firms to require that Shares not blocked before meeting shareholders deposit their shares prior to a General Shareholders Meeting Author's analysis from French Law (Doctrine, Codes, Jurisprudence) thus preventing them from selling those shares for a number of days, and zero otherwise.

Equals one if the Company Law or Commercial Code allows shareholders to cast all of their votes for one candidate standing for election to the board of directors (cumulative voting) or if Cumulative voting or proportional representation the Company Law or Commercial Code allows a mechanism of Author's analysis from French Law (Doctrine, Codes, Jurisprudence) proportional representation in the board by which minority interests may name a proportional number of directors to the board, and zero otherwise.

Equals one if the Company Law or Commercial Code grants minority shareholders either a judicial venue to challenge the decisions of management or of the assembly or the right to step out of the company by requiring the company to purchase their shares when Oppressed minorities mechanism they object to Author's analysis from French Law (Doctrine, Codes, Jurisprudence) certain fundamental changes, such as mergers, assets dispositions and changes in the articles of incorporation. The variable equals zero otherwise. Minority shareholders are defined as those shareholders who own 10 percent of share capital or less.

Equals one when the Company Law or Commercial Code grants shareholders the first Preemptive rights for sh (vote) to prevent dilution opportunity to buy new issues of stock and this right can only be waved by a Author's analysis from French Law (Doctrine, Codes, Jurisprudence) shareholders‘ vote, and zero otherwise.

It is the minimum percentage of ownership of share capital that entitles a shareholder to call % of share capital to call EGM at 10% Author's analysis from French Law (Doctrine, Codes, Jurisprudence) for an Extraordinary Shareholders‘ Meeting. It ranges from one to 33 percent.

A-2 Table 2: Shareholder Protection (cont.)

II.2 Securities Law Author's analysis from French Law (Doctrine, Codes, Jurisprudence) The index of disclosure equals the arithmetic mean of: (1) Prospect; (2) Compensation; (3) Shareholders; (4) II.2.1 Disclosure Securities Law I Author's analysis from French Law (Doctrine, Codes, Jurisprudence) Inside ownership; (5) Contracts Irregular; (6) and Transactions. II. Liability standard

Prospectus Equals one if the law prohibits selling securities that are going Prospectus to be listed on the largest stock exchange of the country without delivering a prospectus to potential investors; equals zero otherwise.

Compensation An index of prospectus disclosure requirements regarding Compensation the compensation of directors and key officers.

An index of disclosure requirements regarding the Issuer=s equity ownership structure. Equals one if the law or the listing rules require disclosing the name and ownership stake of each shareholder who, directly or indirectly, controls ten percent or more of the Issuer=s voting securities; equals one-half if reporting requirements for the Issuer=s 10% shareholders do not include indirect Shareholders ownership or if only their aggregate ownership needs to be disclosed; equals zero when the law does not require disclosing the name and ownership stake of the Issuer=s 10% shareholders. No distinction is drawn between large-shareholder reporting requirements imposed on firms and those imposed on large shareholders themselves.

An index of prospectus disclosure requirements regarding the equity ownership of the Issuer=s shares by its directors and key officers. Equals one if the law or the listing rules require that the ownership of the Issuer=s shares by each of its director and key officers be disclosed in the Inside Ownership prospectus; equals one-half if only the aggregate number of the Issuer=s shares owned by its directors and key officers must be disclosed in the prospectus; equals zero when the ownership of Issuer=s shares by its directors and key officers need not be disclosed in the prospectus

An index of prospectus disclosure requirements regarding the Issuer=s contracts outside the ordinary course of business. Equals one if the law or the listing rules require that the terms of material contracts made by the Irregular Contracts Issuer outside the ordinary course of its business be disclosed in the prospectus; equals one-half if the terms of only some material contracts made outside the ordinary course of business must be disclosed; equals zero otherwise.

An index of the prospectus disclosure requirements regarding transaction between the Issuer and its directors, officers, and/or large shareholders. Equals one if the law or the listing rules require that all transactions in which related parties have, or will have, an interest be Transactions disclosed in the prospectus; equals one-half if only some transactions between the Issuer and related parties must be disclosed in the prospectus; equals zero if transactions between the Issuer and related parties need not be disclosed in the prospectus.

A-2 Table 2: Shareholder Protection (cont.)

The index of liability standards equals the arithmetic mean of: (1) Liability standard for the issuer and its II.2 Liability Securities Law II Author's analysis from French Law (Doctrine, Codes, Jurisprudence) directors; (2) Liability standard for the distributor; and (3) Liability standard for the accountant.

The index of liability standards equals the arithmetic mean of: (1) Liability standard for the issuer and its directors; (2) Liability standard for the distributor; and (3) Liability standard for the accountant. Index of the procedural difficulty in recovering losses from the Issuer and Liability standard its directors in a civil liability case for the issuer and for losses due to misleading statements in the prospectus. We first code its directors separately the liability standard

Index of the procedural difficulty in recovering losses from the Distributor in a civil liability case for losses due to misleading statements in the prospectus. Equals one when investors are only required to prove that the prospectus contains a misleading statement. Equals two-thirds when Liability standard investors must also prove that they relied for distributors on the prospectus and/or that their loss was caused by the misleading statement. Equals one-third when investors must also prove that the Distributor acted with negligence. Equals zero if restitution from the Distributor is either unavailable or the liability standard is intent or gross negligence.

Index of the procedural difficulty in recovering losses from the Accountant in a civil liability case for losses due to misleading statements in the audited financial information accompanying the prospectus. Equals one when investors are only required to prove that the audited financial information accompanying the prospectus Liability standard contains a misleading statement. Equals two-thirds when investors must for accountants also prove that they relied on the prospectus and/or that their loss was caused by the misleading accounting information. Equals one-third when investors must also prove that the Accountant acted with negligence. Equals zero if restitution from the Accountant is either unavailable or the liability standard is intent or gross negligence.

A-2 Table 2: Shareholder Protection (Cont.)

The index of public enforcement equals the arithmetic mean of: (1) Supervisor characteristics index; (2) Rulemaking II.3 Enforcement Securities Law III Author's analysis from French Law (Doctrine, Codes, Jurisprudence) power index; (3) Investigative powers index; (4) Orders index; and (5) Criminal index.

Equals one if a majority of the members of the Supervisor are unilaterally Appointment appointed by the Executive branch of government; equals zero otherwise.

Equals one if members of the Supervisor cannot be dismissed at the will of Tenure the appointing authority; equals zero otherwise. Equals one if separate government agencies or official authorities are in Focus charge of supervising commercial banks and stock exchanges; equals zero otherwise.

Supervisor The index of characteristics of the Supervisor equals the arithmetic mean of: characteristics (1) Appointment; (2) Tenure; and index (3) Focus.

stock exchanges. Equals one if the Supervisor can generally issue regulations regarding primary offerings and/or listing rules on stock exchanges without prior approval of other Rule-making governmental authorities. Equals onehalf power Index if the Supervisor can generally issue regulations regarding primary offerings and/or listing rules on stock exchanges only with the prior approval of other governmental authorities. Equals zero otherwise.

An index of the power of the Supervisor to command documents when investigating a violation of securities laws. Equals one if the Supervisor can generally issue an administrative order commanding all persons to turn Document over documents; equals one-half if the Supervisor can generally issue an administrative order commanding publicly-traded corporations and/or their directors to turn over documents; equals zero otherwise.

An index of the power of the Supervisor to subpoena the testimony of witnesses when investigating a violation of securities laws. Equals one if the Supervisor can generally subpoena all Witness persons to give testimony; equals one-half if the Supervisor can generally subpoena the directors of publicly- traded corporations to give testimony; equals zero otherwise.

Investigative The index of investigative powers equals the arithmetic mean of: (1) powers index Document; and (2) Witness.

A-2 Table 2: Shareholder Protection (Cont.)

An index aggregating stop and do orders that may be directed to the Issuer in case of a defective prospectus. The index is formed by averaging the sub-indexes of orders to stop and to do. The sub-index of orders to stop equals one if the Issuer may be ordered to refrain from a broad range of actions; equals one-half if the Issuer Orders issuer may only be ordered to desist from limited actions; equals zero otherwise. The sub-index of orders to do equals one if the Issuer may be ordered to perform a broad range of actions to rectify the violation; equals one-half if the Issuer may only be ordered to perform limited actions; equals zero otherwise. We disregard orders that may be issued by Courts at the request of a private party in a civil lawsuit.

An index aggregating stop and do orders that may be directed to the Distributor in case of a defective prospectus. The index is formed by averaging the sub-indexes of orders to stop and to do. The sub-index of orders to stop equals one if the Distributor may be ordered to refrain from a broad range of actions; equals one-half if the Distributor may only be ordered to desist from limited Orders distributor actions; equals zero otherwise. The subindex of orders to do equals one if the Distributor may be ordered to perform a broad range of actions to rectify the violation; equals one-half if the Distributor may only be ordered to perform limited actions; equals zero otherwise. We disregard orders that may be issued by Courts at the request of a private party in a civil lawsuit.

An index aggregating stop and do orders that may be directed to the Accountant in case of a defective prospectus. The index is formed by averaging the sub-indexes of orders to stop and to do. The sub-index of Orders accountant orders to stop equals one if the Accountant may be ordered to refrain from a broad range of actions; equals one-half if the Accountant may only be ordered to desist from limited actions; equals zero otherwise. The sub-index of orders

The index of orders equals the arithmetic mean of: (1) Orders issuer; (2) Orders index Orders distributor; and (3) Orders accountant.

An index of criminal sanctions applicable to the Issuer=s directors and key officers when the prospectus omits material information. We create separate sub-indexes for directors and key officers and average their scores. The sub-index for directors equals zero when directors cannot be held Criminal criminally liable when the prospectus is director/officer misleading. Equals one-half if directors can be held criminally liable when aware that the prospectus is misleading. Equals one if directors can also be held criminally liable when negligently unaware that the prospectus is misleading. The sub-index for key officers is constructed analogously.

An index of criminal sanctions applicable to the Distributor (or its officers) when the prospectus omits material information. Equals zero if the Distributor cannot be held criminally liable when the prospectus is misleading. Criminal Equals one-half if the Distributor can be held criminally liable when aware distributor that the prospectus is misleading. Equals one if the Distributor can also be held criminally liable when negligently unaware that the prospectus is misleading.

An index of criminal sanctions applicable to the Accountant (or its officers) when the financial statements accompanying the prospectus omit material information. Equals zero if the Accountant cannot be held criminally liable when the financial statements accompanying the prospectus Criminal are misleading. Equals one-half accountant if the Accountant can be held criminally liable when aware that the financial statements accompanying the prospectus are misleading. Equals one if the Accountant can also be held criminally liable when negligently unaware that the financial statements accompanying the prospectus are misleading.

The index of criminal sanctions equals the arithmetic mean of: (1) Criminal Criminal index director; (2) Criminal distributor; and (3) Criminal accountant.

APPENDIX B: French Stock Market Development Indicators - Key variables trends (1852-2007)

B-1 Stock Market development time series:

Market Cap/GDP (1852-2007) 120%

100%

Market Cap/GDP 1852- 80% 2007 (i) Market Cap: 1852-1900: Arbulu (1998); 1900-2001 60% (Bozio, 2002); 2002-2007 (Euronext, 2009). (ii) GDP: Source: 1871-1890

Market Cap/GDP Market 40% Nominal Growth rates GDP from Levy-Leboyer and Bourguignon (1985) 20% applied to Nominal GDP 1890 Villa (1993)

1851 1901 1908 1921 1928 1951 1958 1972 1979 1993 2000 1965 1986 1935 Domestic Listed Companies/Capita in France (1913-2007) 45 40 35 30 25 20 Domestic Listed 15 Companies/Capita 10 5

Domesticlisted Companies/Capita

1938 1966 1972 1978 1981 1987 1990 1996 1999 2004 2007 1969 1975 1984 1993 1913 Equity Capital/ GFCF Corporate sector in France (1892-2007) 25%

20%

Equity Capital/ GFCF Corporate 15% sector (Source: (i) Equity Issues: 1892-1907: Credit Lyonnais Statistics modified by Hautcoeur 10% (1994), 1907-1936: SGF corrected by Hautcoeur (1994),

EquityIssues/GFCF 1936-1939: Credit Lyonnais in 5% Sauvy (1984); 1967-1971: Dubarle, Mouchotte

1892 1904 1912 1925 1933 1937 1970 1980 1988 1992 2000 1900 1908 1921 1929 1960 1976 1984 1996 2004 1896

B-2 Stock Market Development and Shareholder protection levels – comparatives:

Market Cap/GDP and Sh. Protection (Source: see text and appendix A; n=102) Low Shareholder protection (1852-1933) (Antidirector rights+1sh/1v ≤1) High Shareholder protection (1966-2007) (Antidirector rights+1sh/1v ≥ 4)

45% 40% 42% 40% 36% 35% 0.33 30% 25% 23% 20% 0.16 15% 10% 5% 0% Mean Stock Market Median Stock Standard Dev Stock Cap/GDP Market/GDP Market Cap/GDP

Equity issues/GFCF and Sh.Protection (Source: see text and appendix A; n=86) Low Shareholder protection (1892-1933) (Antidirector rights+1sh/1v ≤1) High Shareholder protection (1966-2007) (Antidirector rights+1sh/1v ≥ 4) 12% 10% 10% 10% 10% 8% 8% 0.07 6% 0.05 4% 2% 0% Mean Equity Median Equity Standard Dev Equity issues/GFCF issues/GFCF Issues/GFCF

APPENDIX C: Key laws pertaining to Shareholder protection

(i) Shareholder rights (antidirector rights and voting rights) Civil Code 1807 General principles of company law and contractual nature of company Societes Anonymes need government authorization to incorporate, through Conseil d'Etat (Supreme 1807 to 1851 "Societe Anonymes" (Limited Company) administrative court) Societes en Commandites par Actions (Limited Partnership) incorporation possible without Council 1807 to 1851 "Societes en Commandites par Actions" (Limited Partnerships) of State approval. Societes Anonymes (Ltd Companies) can be incorporated without Council of State authorization if Law of 17/07/1856 Capital > 20 Million Francs. Regulation of Commandites par Actions (Limited partnerships) Law of 24/07/1867 End of government authorisation to incorporate limited liability companies (Societes Anonymes). Shares of Societes Anonymes (Ltd Co) must be fully paid at issuance to become tradable as Bearer Law of 1893 modifying Law of 24/07/1867 shares; Initial capital subscribers are liable to capital calls for 2 years following initial subscribtion. All Societes Anonymes deemed of "commercial" nature (not civil). Authorizes shareholders who do not qualify to attend the AGM to form groupings to attend and vote Law of 1893 modifying Law of 24/07/1867 in AGM. Law of 16/11/1903 Authorisation of multiple voting shares, capped at 10 votes per shareholders. Law of 16/11/1903 Prohinition to exclude any shareholders from General Meetings. Law of 22/11/1913 Majority and not unanimity needed to modify corporate articles of association. Law of 23/01/1925 Grouping of shareholders for acton against directors authorized when > 10% of votes. Law of 03/12/1926 Control of Agiotage in stock exchange Law of 31/08/1927 Prohibition of trading of founder's share before 2 years Law of 23/01/1929 Prohibition of excluding minority shareholders from AGM Law of 23/01/1929 Founder's shares Law of 30/01/1930 Enhanced Publicity of statutes in J.O (Official Journal of the Republic) Law of 19/06/1930 Regulation of Banker profession Prohibition of multiple voting rights in principle with one exception: double voting if shares have Law 13/11/1933 been held for 2 years. Decret Loi 30/10/1935 Intagibility of method of financial statements Decret-Lois (Government ruling) 30/10/1935 Specific rules for companies with public ownership: preemptive rights Decret-Lois (Government ruling) 30/10/1935 Mandatory use of bank as underwriter for capital issuance > 10 Million Francs. Disclosure, voting rights and penal liabilities for directors Administrateurs when breaching duties Decret-Lois (Government ruling) 30/10/1935 and corporate interest. Obligation to choose Commissioners of Accounts ("CAC") from government approved listing to Decret Loi du 31/08/1937 certify accounts to Shareholders and AGM Law of 1947 Standardized Chart of Account for companies (Plan Comptable General) Ordinance of 04/02/1959 Creation of BALO (mandatory information registry for corporations) Jurisprudence from Cour de Cassation Cass Com 18/04/1961 "Piquard" Reaffirms liability of directors when breaching fiduciary duties. New Company Law modifying Law of 1867: increased security of third parties (nullity of companies are limited)/Increased protection of shareholders (information disclosure, mandatory external auditor, Law of 24/07/1966 with reinforced prerogatives), minority shareholder rights/ Increased penal liability for directors/Voting rights allowed to be capped by insiders. Law of 31/12/1970 Stock options for employees Law of 24/10/1980 (80-834) Preferred shareholders attendance of assemblies (without voting rights). Law of 03/01/1983 Shareholdings for Employees encouraged. Law of 03/01/1983 (83-363) Authorization of proxy Law (implementation decree in 1986-88 only) Law of 03/01/1985 (85-11) Consolidated accounts for groups. Law of 03/01/1985 (85-21) Stock Option for employees encouraged. Decree (n°86-584) 14/03/1986 (Special Decree Conseil d'Etat Decree) Proxy voting application decree. Ordinance (n°86-1135) Employees representatives member of the Board of Directors allowed. Groupings of Shareholder with voting rights >10% can designate an expert to assess management of Law of 23/06/1989 the company and litigate to court as an association. Separation of the functions of chairman of the board and CEO, strengthened the control function of the board, higher level of transparency with respect to remuneration, and by increased rights of Law NRE 2001 minority shareholders and employees rights (preemptive share capital in case of equity issuance, increased inclusion in corporate governance bodies and decision making).

Law of 17/01/2002 Mandatory board membership through at least one representative for employees owning more than 3% of capital. Creation of AMF (Financial Markets Authority) with enhanced securities regulation power on information and functioning of financial markets, as a result of merger of COB (securities regulator) Law of 2003 on Financial Security and CMF. Creation of High Council of Legal Audit (Haut Conseil du Commissariat aux Comptes) to monitor the accounting profession. Increased information requirements between board and shareholders. Law of 2005 on Financial Modernization Increased control and information on CEO and Directors compensation.

(ii) Securities Law (disclosure, liability and public enforcement) Law of 17/07/1856 Law of 30/01/1907 Mandatory publication to official public registry for all listed companies. Decret Loi 30/10/1935 Liability of directors in disclosure in equity issuance "relatif au demarchage de l'epargne" Creation of public regulatory agency "COB" to ensure faithful reporting/prospectus for issuing Ordinance 07-833 28/09/1967 (COB instructions for dislosure requirements) companies, with sanction powers. Laws of 1970 Strict prohibition of insider trading and increased penal liabilities. Law of 14/12/1985 (n°85-1321) Modifying securities law Law (n° 87-416) of 17/06/1987 Savings

Law (n°88-1201) 23/12/1988 Creation of open ended fund vehicles "OPCVM" and "FCP" to promote the development of institutional investors.

Law (n°89-531) 02/08/1989 Security and transparency of financial markets Increased power for Securities regulator: COB can issue rulings and sanction accordingly, conditional upon validation of Ministry of Finance, so as to ensure faithful information and adequate functioning of financial markets.

Law (n°89-531) 02/08/1989 Security and transparency of financial markets Takeover tender offer must be announced when an outsider has bought 33.3% of shares. Decree (n°90-263) 23/10/1990. Administrative sanctions from COB and recourse in justice of COB decisions Law n°90-1002 07/1/1990 Participation of employees to profits. Law (n° 96-597)02/07/1996 Creation of council of financial markets regulator along COB COB ruling (n°96-01) 08/11/1996 COB control of opposition to issuance

(iii) Securities Law: Market for Corporate Control Law (n°89-531) 02/08/1989 Security and transparency of financial markets Mandatory Takeover tender offer must be announced when an outsider has bought 33.3% of shares. Extensive disclosure obligations on shareholders, acting alone or jointly, when they pass (in either Numerous COB rulings and other laws (1990's) direction) a thresholds of holdings either voting rights or capital.

(iv) EC/EU Major Directives Directive on information of listed companies 15/02/1982 Standarization and enhancement of information for listed firms (financial and corporate information) Directive on funds 20/12/1985 Directive on investment services in financial instruments 10/05/1993 Directive on Prospectus (2003) Standarization and enhancement of Prospectus requirements Directive Transparency (2004) Standarization and enhancement of information for listed firms (financial and corporate information) Directive Takeover (2004) Standarization and enhancement of takeover regulation to facilitate market for control

(v) Other laws relevant to corporate governance Creation of another form of corporate structure along 'Societes Anonymes" (Limited companies). Law of 07/03/1925 Societes en Commandite par Actions (Limited Partnerships): "Societes a Responsabilites Limitees" very popular form, not able to raise public equity. Laws 1987-1988 Creation of derivatives markets (MATIF, MONEP) at the Paris Stock Exchange End of "Compagnie des Agents de Changes" ministerial monopoly agents status (Stock exchange Law of 22/01/1988 agents/broker organization) transformed into a company "Societes des Bourses Fracnaises" (French Stock Exchange Company)

(vi) Corporate Governance Codes Voluntary compliance (non mandatory => most listed companies comply on a voluntary basis)

Vienot I (1995) Improvements concerning the board of directors (stronger independence, a higher degree of formalization, better information, an improved evaluation), the board committees (audit, Vienot II (1999) remuneration, and nominating committees), the independence of legal auditors, and financial information. Bouton Report (2002)

APPENDIX D: French Shareholder Protection evolution in comparative perspective

D-1 Antidirector Rights

Antidirector Rights: France in Comparative perspective (1852-2007) (Source: France: Author's coding, 2009;UK: Franks, Mayer, Rossi, 2006; Ger: Franks, Mayer, Wagner 2005; JP: Franks, Mayer, Miyajima, 2009) 7

6) 5 -

4 France Britain 3 Germany 2 LLSV IndexLLSV (0 Japan 1

0 1851 1861 1867 1899 1907 1935 1938 1948 1950 1954 1967 1975 1980 1985 1986 1989 2001 2007

D-2 Securities Law

Securities Law: Disclosure France and UK (1852-2007) (Source: author's calculations; Franks, Mayer, Rossi, 2009) 0.9 0.8 0.7 0.6 Disclosure Securities Law 0.5 I: France (1852-2007) 0.4 0.3 Securities Law I 0.2 Disclosure UK (1852- 0.1 2007)

0.0

1851 1867 1929 1935 1948 1961 1989 2001 2007 1967 1986 1907

Securities Law: Liability Standards in France and UK (1852-2007) (Source: author's calculations; Franks, Mayer, Rossi, 2009) 0.80 0.70 0.60 0.50 Liability Securities Law 0.40 II: France (1852-2007) 0.30 Securities Law II Liability 0.20 UK (1852-2007) 0.10

0.00

1867 1907 1935 1948 1967 1986 1989 2007 1929 1961 2001 1851

Securities Law: Public Enforcement in France and UK (1852-2007) (Source: author's calculations; Franks, Mayer, Rossi, 2009) 0.90 0.80 0.70 0.60 Enforcement Securities 0.50 Law III France (1852- 0.40 2007) 0.30 Securities Law III: 0.20 Enforcement UK (1852- 0.10 2007) 0.00

APPENDIX E: Statistical Analysis

E- 1 ADF statistics for selected data

Augmented Dickey-Fuller Unit Root Test on Market Cap/GDP

Null Hypothesis: D(tseries) has a unit root Exogenous: Constant Lag Length: 0 (Automatic Based on AIC, MAXLAG=10)

t-Statistic Prob.*

Augmented Dickey-Fuller test statistic -8.851617 0.000000 Test critical values: 1% level -3.497091 5% level -2.890616 10% level -2.582362

*MacKinnon (1996) one-sided p-values.

Augmented Dickey-Fuller Test Equation Dependent Variable: D(tseries,2) Method: Least Squares Date: 11/30/2009 Time: 8:41:47 PM Included observations: 100 after adjusting endpoints

Variable Coefficient Std. Error t-Statistic Prob

D(tseries(-1)) -0.880687 0.099495 -8.851617 0.000000 C 0.006908 0.008811 0.784007 0.434927

R-squared 0.444290 Mean dependent var -0.001558 Adjusted R-squared 0.166436 S.D. dependent var 0.116902 S.E. of regression 0.087589 Akaike info criterion -2.012517 Sum squared resid 0.751846 Schwarz criterion -1.960414 Log likelihood 102.625846 F-statistic 78.351130 Durbin-Watson stat 1.981797 Prob(F-statistic) 0.000000 Augmented Dickey-Fuller Unit Root Test on Equity/Investment

Null Hypothesis: D(tseries) has a unit root Exogenous: Constant Lag Length: 1 (Automatic Based on AIC, MAXLAG=10)

t-Statistic Prob.*

Augmented Dickey-Fuller test statistic -10.393550 0.000002 Test critical values: 1% level -3.512357 5% level -2.897212 10% level -2.585874

*MacKinnon (1996) one-sided p-values.

Augmented Dickey-Fuller Test Equation Dependent Variable: D(tseries,2) Method: Least Squares Date: 11/30/2009 Time: 8:40:14 PM Included observations: 82 after adjusting endpoints

Variable Coefficient Std. Error t-Statistic Prob

D(tseries(-1)) -1.570851 0.151137 -10.393550 0.000000 D(tseries(-1),2) 0.426160 0.101976 4.179030 0.000075 C 0.002805 0.004883 0.574437 0.567304

R-squared 0.632305 Mean dependent var -0.000005 Adjusted R-squared 0.387175 S.D. dependent var 0.071921 S.E. of regression 0.044160 Akaike info criterion -3.366100 Sum squared resid 0.154058 Schwarz criterion -3.278049 Log likelihood 141.010097 F-statistic 67.926058 Durbin-Watson stat 2.050387 Prob(F-statistic) 0.000000

E-2 Regression output and correlations -- Legal Origins testing: Market Cap/GDP and Shareholder Protection in France (1852-2007) (n=98): (Sample specifications)

E-3 Regression output and correlations -- Legal Origins testing: Equity issues/investments and Shareholder Protection in France (1852-2007) (n=84)

E-4 Regression output and correlations -- Trade Openness testing: Market Cap/GDP and Trade Openness in France (1852-2007) (n=98) (Sample specifications)

E-5 Regression output and correlations -- Trade Openness testing: Equity Issues/Investment and Trade Openness in France (1852-2007) (n=82) (Sample specifications)

APPENDIX F: Other relevant macroeconomic and financial variables:

Comparative Dividend Yields (Source: Dimson et al., 2002) 8.0% 7.0% 6.0% 5.0% 4.0% 3.0%

DividendYield 2.0% 1.0% 0.0% 1900 1950 2000 France 3.8% 5.8% 1.1% Germany 5.8% 2.5% 1.6% Britain 4.2% 4.2% 2.4% US 4.5% 7.3% 1.1%

French Corporate Tax Rate % (Source: Statutory rates: Pre-1973 corporate tax rates: Hautcoeur (1994); Levasseur and Olivaux (1981)) 60%

50%

40% French Corporate Tax Rate % (Statutory 30% % rates: Pre-1973 corporate tax rates: 20% Hautcoeur (1994); Levasseur and Olivaux 10% (1981))

1851 1902 1910 1932 1949 1957 1965 1973 1981 1997 2005 1989 1924

Openess (X+M)/GDP Nouveaux FF in France (1852-2007) (Source: Levy Leboyer and Bourguignon (1985), A.Sauvy and Annuaire statistique INSEE from 1949-2007) 0.60 0.50 Openess (X+M)/GDP 0.40 Nouveaux FF in France (1852-2007) 0.30 (Source: Levy Leboyer 0.20 and Bourguignon (1985), A.Sauvy and

0.10 Annuaire statistique Export+Imports/GDP 0.00 INSEE from 1949-

2007)

1902 1910 1924 1932 1957 1965 1973 1981 1997 2005 1949 1989 1851