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Abstract
This dissertation examines three distinctive issues that concern the regulators and policy makers in the development of financial markets. It contains three stand-alone research projects within the context of law, finance and economic growth. Chapter 2 examines the dynamic relationship between banks and economic growth from the points of view of market efficiency and asset pricing theory. Publicly traded banks are broadly representative of a country’s banking sector, so that banking industry stock prices will broadly reflect the performance of a country’s banking sector. Because previous research has established that the institutional framework, as well as the aggregate size, of the banking sector can significantly affect economic growth, this chapter investigates whether the stock returns on a country’s banking sector contain information about future economic growth, and whether the specific country and institutional characteristics that affect the functioning of the banking system and market efficiency also influence this relationship. Using the data from 18 developed and 18 emerging markets, the chapter finds a significant and positive relationship between bank excess return and future economic growth in both the time-series and panel analyses. The chapter also finds that this positive relationship is significantly strengthened by the enforcement of insider trading law, by banking crises, by bank disclosure regulations and financial development, but is weakened by government ownership of banks.
Chapter 3 investigates the role of bank idiosyncratic volatility in economic growth and systemic banking crises. Using the same dataset from Chapter 2, this chapter finds an ambiguous relationship between bank volatility and economic growth in the time-series studies, which suggests that the effect of bank volatility on economic growth is more country-specific. In the panel analyses, the chapter finds a negative but very weak relationship between bank volatility and future economic growth. This negative relationship is magnified by banking crises and bank disclosure standards, but is alleviated by the government ownership of banks, the enforcement of insider trading law and financial development. The chapter goes further to examine whether bank volatility leads to the occurrence of systemic banking crises, and finds that the marginal effect of bank volatility on the probability of banking crises is very weak for the sample of all markets, and this result is mainly driven by the data from the emerging markets. However, bank volatility is a significant predictor of banking crises even after being controlled for macroeconomic indicators, which implies that market forces are more powerful in promoting the soundness of the banking system in developed markets. We also find that those macroeconomic and banking risk management indicators have different impacts on the probability of banking crises for the emerging and developed markets. Therefore, caution needs to be taken in interpreting the cross-country results of the studies on banking crises.
Chapter 4 studies the corporate governance issues in China, a significant developing country that has been neglected by the current law and finance literature. Incorporated with the legal environment and ownership structure of China’s listed companies, the chapter develops a simple game model to study a neglected aspect of current corporate governance literature: the expropriation arising from the mixture of weak investor protection, ownership concentration coexisting with ownership dispersion, and the absence of a controlling shareholder. The last two chapters find that government ownership undermines the positive link between bank excess return and economic growth, but alleviates the negative impact of bank volatility on growth as well. This chapter shows that government ownership is also a two-edged sword in corporate governance in China: it leads to a double-agency problem; however, the strong legal protection of State assets also increases the cost of expropriation. Using the data from 1996 to 2003, the chapter finds the empirical evidence consistent with the model. By analysing the puzzles in China’s stock market, the chapter suggests that improving the legal protection of investors is the key issue in the future development of the financial market.