The legal and institutional preconditions for strong securities market

THE LEGAL AND INSTITUTIONAL PRECONDITIONS
FOR STRONG SECURITIES MARKETS
Bernard S. Black*
An important challenge for all economies, at which only a few have suc-ceeded,
is creating the preconditions for a strong market for common stocks and
other securities. A strong securities market rests on a complex network of legal
and market institutions that ensure that minority shareholders (1) receive good
information about the value of a company’s business and (2) have confidence
that a company’s managers and controlling shareholders won’t cheat them out of
most or all of the value of their investment. A country whose laws and related
institutions fail on either count cannot develop a strong securities market, forcing
firms to rely on internal financing or bank financing—both of which have impor-tant
shortcomings. In this Article, Professor Bernard Black explains why these
two investor protection issues are critical, related, and hard to solve. He dis-cusses
which laws and institutions are most important for each, which of these
laws and institutions can be borrowed from countries with strong securities mar-kets,
781
and which must be homegrown.
INTRODUCTION............................................................................................................. 782
I. INFORMATION ASYMMETRY BARRIERS
TO SECURITIES OFFERINGS .................................................................................... 786
A. Information Asymmetry and the Role
of Reputational Intermediaries ...................................................................... 786
B. The Core Institutions that Control
Information Asymmetry ................................................................................ 789
C. Additional Useful and Specialized Institutions............................................. 799
1. Useful Institutions.................................................................................. 799
* I thank the Organisation for Economic Co-operation and Development (OECD) for
financial support. I thank John Coffee, Rob Daines, David Ellerman, Ron Gilson, Jeff Gordon, Peter
Henry, Steven Huddart, Cally Jordan, Ehud Kamar, Michael Klausner, Ross Levine, Amir Licht,
William Megginson, Jamal Munshi, and participants in an OECD conference on Corporate
Governance in Asia, an International Monetary Fund workshop on Comparative Corporate
Governance in Developing and Transition Economies, the UCLA School of Law First Annual
Corporate Governance Conference, and workshops at the American Law & Economics
Association, Brazil Securities Commission, Brazil Stock Exchange, Korean Securities Law
Association, Seoul National University School of Business, Stanford Law School, University of
Missouri-Columbia Law School, and University of Sao Paolo Law Faculty for helpful comments
and suggestions. An earlier and shorter version of this Article was published as The Core
Institutions that Support Strong Securities Markets, 55 BUS. LAW. 1565 (2000). The research for this
Article was substantially completed as of October 2000. The citation style used in this Article
departs in some cases from the Bluebook citation system.

782 48 UCLA LAW REVIEW 781 (2001)
2. Specialized Institutions .......................................................................... 801
D. Which Institutions Are Necessary, Which Are Merely
Nice to Have? ................................................................................................ 803
II. PROTECTING MINORITY INVESTORS AGAINST SELF-DEALING.............................. 804
A. Self-Dealing as an Adverse
Selection/Moral Hazard Problem .................................................................. 804
B. The Core Institutions that Control Self-Dealing.......................................... 806
C. Additional Useful and Specialized Institutions............................................. 814
III. PIGGYBACKING ON OTHER COUNTRIES’ INSTITUTIONS........................................ 816
A. Estimating the Ease of Piggybacking ............................................................. 816
B. Can Substitute Institutions Facilitate Piggybacking? .................................... 830
IV. EMPIRICAL EVIDENCE ............................................................................................ 831
A. The Qualitative Case for Strong Securities Markets..................................... 832
B. Empirical Evidence: Investor Protection and Strong
Capital Markets ............................................................................................. 834
C. Empirical Evidence: Investor Protection, Capital Markets,
and Economic Growth .................................................................................. 835
V. STRONG AND WEAK SECURITIES MARKETS: A
SEPARATING EQUILIBRIUM?................................................................................... 838
VI. IMPLICATIONS ....................................................................................................... 841
A. Different Types of Monitoring: Investor Protection
and Firm Performance ................................................................................... 841
B. Competition Between Securities Regulators ................................................. 843
C. Convergence in Capital Markets
and Corporate Governance ........................................................................... 845
CONCLUSION: WHAT STEPS TO TAKE FIRST ................................................................ 847
REFERENCES .................................................................................................................. 849
INTRODUCTION
A strong public securities market, especially a public stock market, can
facilitate economic growth. But creating strong public securities markets is
hard. That securities markets exist at all is magical, in a way. Investors pay
enormous amounts of money to strangers for completely intangible rights,
whose value depends entirely on the quality of the information that the
investors receive and on the sellers’ honesty.
Internationally, this magic is rare. It does not appear in unregulated
markets. Aggressive efforts to mass privatize state-owned enterprises and
create stock markets overnight, in formerly centrally planned economies
like Russia and the Czech Republic, have crashed and burned.1 Investor-
1. See Bernard Black, Reinier Kraakman & Anna Tarassova, Russian Privatization and Cor-porate
Governance: What Went Wrong?, 52 STAN. L. REV. 1731 (2000); Edward Glaeser, Simon
Johnson & Andrei Shleifer, Coase v. the Coasians, 116 Q.J. ECON. (forthcoming 2001).

Legal and Institutional Preconditions for Strong Securities Markets 783
protective laws are important, but not nearly enough to sustain strong
securities markets. Russia, for example, has pretty good laws in theory, but
miserable investor protection in fact. Even among developed countries,
only a few have developed strong stock markets that permit growing com-panies
to raise equity capital.
This Article explores which laws and related institutions are essential
for strong securities markets. My goals are threefold: first, to explain the
complex network of interrelated legal and market institutions that supports
strong markets in countries, like the United States and the United Kingdom,
that have these markets; second, to offer a guide to reforms that can
strengthen securities markets in other countries; and third, to offer some
cautionary words about the difficulty of creating this complex network of
institutions, and the impossibility of doing so quickly. I also survey the
empirical evidence on the correlation between investor protection and
securities markets, and between securities markets and economic growth.2
I argue here that there are two essential prerequisites for strong public
securities markets. A country’s laws and related institutions must give minor-ity
shareholders: (1) good information about the value of a company’s
business; and (2) confidence that the company’s insiders (its managers and
controlling shareholders) won’t cheat investors out of most or all of the
value of their investment through “self-dealing” transactions (transactions
between a company and its insiders or another firm that the insiders
control) or even outright theft. If these two steps can be achieved, a coun-try
has the potential to develop a vibrant securities market that can provide
capital to growing firms, though still no certainty of developing such a
market.3
Individual companies can partially escape weak home-country institu-tions
by listing their shares on a stock exchange in a country with strong
2. There is only limited prior work on the prerequisites for strong securities markets. In
addition to the empirical studies discussed in Part IV, infra, see Bernard Black & Reinier
Kraakman, A Self-Enforcing Model of Corporate Law, 109 HARV. L. REV. 1911 (1996); Bernard S.
Black, Information Asymmetry, the Internet, and Securities Offerings, 2 J. SMALL & EMERGING BUS. L. 91
(1998); and John C. Coffee, Jr., The Future as History: The Prospects for Global Convergence in Corporate
Governance and Its Implications, 93 NW. U. L. REV. 641 (1999).
3. In Bernard Black, Is Corporate Law Trivial? A Political and Economic Analysis, 84 NW.
U. L. REV. 542 (1990), I argue that American corporate law is mostly trivial, in the sense that it
doesn’t significantly constrain the private contractual arrangements that a company’s shareholders
can choose for themselves. Some readers of this Article have commented on the tension between
the views expressed here and those expressed in my earlier article. A short answer is that I did not
claim then that all of securities law (as opposed to corporate law) was trivial, and I would find less
of securities law trivial today than I might have then. See id. at 565 (questioning the importance
of some securities rules, but recognizing that “federal [securities] rules are an important source of
nontrivial corporate law”).

784 48 UCLA LAW REVIEW 781 (2001)
institutions and following that country’s rules. But only partial escape is
possible. A company’s reputation is strongly affected by the reputations of
other firms in the same country. And reputation unsupported by local
enforcement and other local institutions isn’t nearly as valuable as the same
reputation buttressed by those institutions.
I don’t address here a third aspect of corporate governance—how good
a country’s institutions are at ensuring that managers are competent and
seek to maximize profits rather than (say) firm size or their own prestige.
Corporate governance debates in the United States and other developed
countries often revolve around this “value maximization” issue. But for
most countries, I believe, value maximization is worth worrying about only
after the more basic disclosure and self-dealing issues are addressed. Moreover,
I know of no countries that have good financial disclosure and good control
of self-dealing, that don’t also (and mostly thereby) have decent manage-ment
quality and profit directedness.4
The interdependence of many of the institutions that control informa-tion
asymmetry and self-dealing creates the potential for separating equilibria
to exist. In the first “lemons” equilibrium, most honest companies don’t
issue shares to the public because weak investor protection prevents them
from realizing a fair price for their shares. This decreases the average quality
of the shares that are issued, which further depresses prices and discourages
honest issuers from issuing shares. Political demand for stronger investor
protection is muted by the relative scarcity of outside investors. In the sec-ond
“strong markets” equilibrium, strong investor protection produces high
prices, which encourage honest companies to issue shares. This increases the
average quality of the shares that are issued, which further increases share
prices and encourages more honest issuers to issue shares. Outside investors
then generate political support for strong investor protection. This Article
can be seen as an attempt to develop minimum conditions for the “strong
markets” equilibrium.
The analysis developed here can inform several current corporate gov-ernance
debates. The first debate concerns the merits of bank-centered
versus stock-market-centered capital markets. That debate posits that bank-centered
markets offer strong monitoring of management, while stock-
4. Three additional justifications for treating value maximization as a secondary concern
are: First, unless managers know (and investors don’t) whether the managers are maximizing
profits, good management does not have the adverse selection structure of disclosure, nor the
combined adverse selection/moral hazard structure of self-dealing. It therefore doesn’t prevent
honest issuers from obtaining a fair price for the shares that they sell. Second, other forces,
notably product market competition, are often primary in encouraging good management. Third,
controlling information asymmetry and self-dealing will raise share prices, which will increase
managers’ private returns from a value maximizing strategy.

market-centered markets offer liquidity but weaker monitoring. I argue here
that stock-market-centered capital markets provide strong information
disclosure and control of self-dealing—monitoring dimensions for which
bank-centered capital markets are often weaker.5 Moreover, the standard
debate compares strong bank-centered capital markets to strong stock-market-
centered capital markets. It overlooks the many institutions that are
common to strong capital markets of any sort, as well as the complementari-ties
between a strong banking sector and a strong stock market.
My analysis can also inform the debate over the merits of competition
between securities regulators. If strong securities markets depend on a com-plex
network of market and government institutions, then the debate is
largely misplaced. Competition between securities regulators simply cannot
exist in anything like the pure form posited by the debaters. Finally, my analy-sis
is relevant to the debate over the extent of likely convergence in national
corporate governance systems. The institutions that support securities
markets coevolve and reinforce each other. Weakness in one can sometimes
be offset by strength in another. Formal legal rules are only part of a large
web of market-supporting institutions. This suggests that convergence will
sometimes be functional (different countries use different institutions to
accomplish similar tasks) rather than formal (different countries adopt
similar rules).
I address the prerequisites for a strong securities market in the context
in which they are most acute—a public offering of common shares, often by
a company that is selling shares to the public for the first time. Similar
though less acute issues arise when companies issue debt securities.
Part I of this Article explains why controlling information asymmetry
is critical for developing strong public stock markets and discusses which
laws and institutions are most important in doing so. Part II explains why
controlling self-dealing is also critical and discusses the somewhat different
laws and institutions that are central for this task. Part III explores the
extent to which companies can escape weak domestic laws and institutions
by relying on foreign rules and institutions. Part IV discusses the empirical
evidence of the connection between investor protection and strong securi-ties
markets, and between strong securities markets and economic growth.
Part V proposes that securities markets may tend toward either a lemons
5. Cf. MARK J. ROE, POLITICAL PRECONDITIONS TO SEPARATING OWNERSHIP FROM
CORPORATE CONTROL: THE INCOMPATIBILITY OF THE AMERICAN PUBLIC FIRM WITH SOCIAL
DEMOCRACY (Columbia Law Sch., Ctr. for Law & Econ. Studies, Working Paper No. 155, 1999),
available at http://papers.ssm.com/paper.taf/abstract_id=165143 (Social Science Research Net-work)
(focusing, unlike this Article, on manager incentives to increase firm value, but also arguing
that the large number of public American firms reflects U.S. success in controlling agency costs).

786 48 UCLA LAW REVIEW 781 (2001)
or a strong market equilibrium. Part VI develops the implications of my
analysis for the monitoring strengths of stock-market-centered and bank-centered
capital markets, competition among securities regulators, and the
convergence of corporate governance systems. I conclude by discussing
which steps a developing country should take first to strengthen its secu-rities
market.
I. INFORMATION ASYMMETRY BARRIERS TO SECURITIES OFFERINGS
A. Information Asymmetry and the Role of Reputational Intermediaries
A critical barrier that stands between issuers of common shares and
public investors is asymmetric information. The value of a company’s shares
depends on the company’s future prospects. The company’s past perform-ance
is an important guide to future prospects. The company’s insiders know
about both past performance and future prospects. They need to deliver this
information to investors so that investors can value the company’s shares.
Delivering information to investors is easy, but delivering credible infor-mation
is hard. Insiders have an incentive to exaggerate the issuer’s
performance and prospects, and investors can’t directly verify the information
that the issuer provides. This problem is especially serious for small com-panies
and companies that are selling shares to the public for the first time.
For these companies, investors can’t rely on the company’s prior reputation
to signal the quality of the information that it provides.
In economic jargon, securities markets are a vivid example of a market
for lemons.6 Indeed, they are a far more vivid example than George Akerlof’s
original example of used cars. Used car buyers can observe the car, take a
test drive, have a mechanic inspect the car, and ask others about their
experiences with the same car model or manufacturer. By comparison, a
company’s shares, when the company first goes public, are like an unob-servable
car, produced by an unknown manufacturer, on which investors
can obtain only dry, written information that they can’t directly verify.
Investors don’t know which companies are truthful and which aren’t, so
they discount the prices they will offer for the shares of all companies. These
discounts may ensure that investors receive a fair price, on average. But
consider the plight of an “honest” company—a company whose insiders report
truthfully to investors and won’t divert the company’s income stream to
themselves.
6. The obligatory citation here is to George A. Akerlof, The Market for “Lemons”: Quality
Uncertainty and the Market Mechanism, 84 Q.J. ECON. 488 (1970).

Discounted share prices mean that an honest issuer can’t receive fair
value for its shares and has an incentive to turn to other forms of financing.
But discounted prices won’t discourage dishonest issuers. Shares that aren’t
worth the paper they’re printed on are, after all, quite cheap to produce. The
tendency for high-quality issuers to leave the market because they can’t
obtain a fair price for their shares, while low-quality issuers remain, worsens
the lemons (adverse selection) problem faced by investors. Investors ration-ally
react to the lower average quality of issuers by discounting still more the
prices they will pay. This drives even more high-quality issuers out of the
market and exacerbates adverse selection.
Some countries, including the United States, have partially solved this
information asymmetry problem through a complex set of laws and private
and public institutions that give investors reasonable assurance that the
issuer is being (mostly) truthful. Among the most important institutions
are reputational intermediaries—accounting firms, investment banking
firms, law firms, and stock exchanges. These intermediaries can credibly
vouch for the quality of particular securities because they are repeat players
who will suffer a reputational loss, if they let a company falsify or unduly
exaggerate its prospects, that exceeds their one-time gain from permitting
the exaggeration. The intermediaries’ backbones are stiffened by liability to
investors if they endorse faulty disclosure, and by possible government civil
or criminal prosecution if they do so intentionally.7
But even in the United States, “securities fraud”—the effort to sell
shares at an inflated price through false or misleading disclosure—is a major
problem, especially for small issuers. Attempts by skilled con artists to sell
fraudulent securities are endemic partly because the United States’ very
success in creating a climate of honest disclosure makes investors (ration-ally)
less vigilant in investigating claims by persuasive salesmen about par-ticular
companies.
Most American investors still expect financial statements to be audited,
shares to be underwritten by an investment banker, and the prospectus to
be prepared by securities counsel. It helps if the issuer is listed on a reputable
stock exchange. But investors’ reliance on reputational intermediaries
merely re-creates the fraud problem one step removed. An environment in
which most reputational intermediaries guard their reputations creates
an opportunity for new entrants to pretend to be reputational inter-mediaries.
Merely calling oneself an investment banker will engender some
7. I use the terms “accountants” and “accounting firms” to include the auditing function that
accountants and accounting firms perform. But I refer separately to “accounting rules” and “auditing
standards.” On the role of reputational intermediaries in securities markets, see Ronald J. Gilson
& Reinier Kraakman, The Mechanisms of Market Efficiency, 70 VA. L. REV. 549, 595–607 (1984).

788 48 UCLA LAW REVIEW 781 (2001)
investor trust, because most investment bankers are honest and care about
their reputations. Investors (rationally) won’t fully investigate investment
bankers’ claims to have strong reputations. The other key intermediaries—
accountants and securities lawyers—can similarly trade on their profession’s
reputation (notwithstanding the occasional snide joke about whether that
reputation is deserved).
In the language of welfare economics, investment banking (or account-ing
or securities lawyering) involves an externality—any one participant
can’t fully capture its own investment in reputation. Some of the invest-ment
enhances the reputation of the entire profession. That externality
reduces incentives to invest in reputation. And new entrants can free ride
on reputational spillover from established firms.
The combination of ability to free ride on other investment bankers’
reputations and low entry barriers permits entrepreneurs—call them “bogus
investment bankers”—to call themselves investment bankers, intending to
profit by pretending that their recommendation of a company’s shares has
value. In effect, bogus investment bankers steal some of the value of their
competitors’ reputations, while also devaluing those reputations, because
bad reputations spill over to the rest of the profession just as good ones do.
The result is ironic: The principal role of reputational intermediaries is
to vouch for disclosure quality and thereby reduce information asymmetry
in securities markets. But information asymmetry in the market for reputa-tional
intermediaries limits their ability to play this role.8
There are several nonexclusive solutions to this problem. One is second-tier
reputational intermediaries, who vouch for the first-tier intermediaries.
Voluntary self-regulatory organizations (SROs) can play this role. A somewhat
stronger solution is mandatory self-regulatory organizations. In the United
States, for example, investment bankers must belong to either the New
York Stock Exchange or the National Association of Securities Dealers. A
member evicted by one is unlikely to be accepted by the other. Thus, a
mandatory SRO can put a misbehaving member out of business, not merely
deprive it of the reputational enhancement from voluntary membership.
8. From this perspective, stock exchanges play a surprisingly small information verifica-tion
role. Entry barriers are significant (though falling). Thus, exchanges shouldn’t face large
externalities in vouching for company reputation. Yet in countries with strong securities markets,
exchanges don’t look much beneath the surface of audited financial statements in deciding
whether to list a new company. Perhaps the constraints on misdisclosure imposed by other insti-tutions
are sufficient so that investors rationally don’t put much weight on an exchange listing,
and the exchanges respond to lack of investor demand by not closely examining new issuers. This
suggests a business opportunity for the major world exchanges: Companies from countries with
weak domestic institutions need reputational enhancement. Close exchange oversight could attract
those companies to major exchanges.

But SROs need to be policed too, lest they re-create the information asym-metry
at yet a third level. Low-quality intermediaries can form a lax SRO
to vouch for their quality, and investors will then have to figure out whether
the SRO is itself a bogus intermediary.9
A third solution combines liability of the intermediaries to investors
with minimum quality standards for intermediaries. Regulators license the
intermediaries, fine or revoke the licenses of misbehaving intermediaries,
and initiate criminal prosecution if an intermediary misbehaves intention-ally.
The greater sanctions available through the legal system, plus the
ability to collectivize the cost of enforcement (by spreading the cost of pri-vate
enforcement through a class action or derivative suit, and the cost of
public enforcement through taxes), may explain why liability and licensing
strategies mostly dominate over second-tier reputational intermediaries.
The resulting system, in which multiple reputational intermediaries
vouch for different aspects of a company’s disclosure, while the government,
private plaintiffs, and self-regulatory organizations police the reputational
intermediaries, can work fairly well. But it is scarcely simple. And it may
require ongoing government effort to protect reputational intermediaries
against bogus intermediaries who would otherwise profit from the spillover
of reputation to them.
This complex response to information asymmetry goes a long way toward
explaining why many nations have not solved this problem. Their
securities markets have instead fallen into what insurance companies call a
“death spiral,” in which information asymmetry and adverse selection com-bine
to drive almost all honest issuers out of the market and drive share
prices toward zero. In these countries, a few large companies can develop
reputations sufficient to justify a public offering of shares at a price that,
though below fair value, is still attractive compared to other financing
options. But smaller companies have essentially no direct access to public
investors’ capital.
B. The Core Institutions that Control Information Asymmetry
Countries with strong securities markets have developed a number
of institutions to counter information asymmetry. I list below the “core”
institutions that I consider most important. This list reflects my personal
judgment, based on experience in corporate law and capital markets reform
9. See Glaeser, Johnson & Shleifer (2001), supra note 1 (noting that Czech investment funds
formed self-regulatory organizations, “but some of their powerful members were themselves
engaged in tunnelling and opposed strong self-regulation”).

790 48 UCLA LAW REVIEW 781 (2001)
in a variety of countries.10 I present the list in an order that makes logical
sense, not in order of estimated importance. Part III combines this list and
the related list of core institutions that control self-dealing into a single
table.
Effective Regulators, Prosecutors, and Courts
(1) A securities regulator (and, for criminal cases, a prosecutor) that: (a) is
honest; and (b) has the staff, skill, and budget to pursue complex securities disclo-sure
cases.
Honest, decently funded regulators and prosecutors are essential. They
tend to be taken for granted in developed countries, but are often partly or
wholly absent in developing countries. Funding is often a hidden problem.
The securities regulator may have a minimal budget, or may be hamstrung
by salary rules that prevent it from paying salaries sufficient to retain quali-fied
people or to keep them honest.
Specialization is needed too. Even in developed countries, few prose-cutors
have the skill or interest to bring securities fraud cases. Some securi-ties
cases involve outright fraud—the company has reported sales or inventory
that don’t exist. An unspecialized prosecutor could potentially bring these
cases, but may prefer to prosecute muggers and murderers instead.
Moreover, many securities fraud cases require careful digging through the
company’s records to show how the insiders have twisted the truth, and skill
to present the fraud in convincing fashion to a court. And the insiders often
have the resources to mount a strong defense.
(2) A judicial system that: (a) is honest; (b) is sophisticated enough to han-dle
complex securities cases; (c) can intervene quickly when needed to prevent
asset stripping; and (d) produces decisions without intolerable delay.
An honest judiciary is a must for investor remedies to be meaningful, but
is often partly or wholly absent in developing countries. Decent judicial
salaries are needed if judges are to stay honest. Good training helps—
professionalism can be a bulwark against corruption. Honest prosecutors
10. My home country is the United States. I have also engaged in significant company and
securities law legal reform work in Armenia, Indonesia, Mongolia, Russia, South Korea, Ukraine,
and Vietnam, and comparative research in Britain and the Czech Republic. See Black, Kraakman
& Tarassova (2000), supra note 1; Bernard Black, Barry Metzger, Timothy O’Brien & Young Moo
Shin, Corporate Governance in Korea at the Millennium: Enhancing International Competitiveness,
(Report to the Korean Ministry of Justice, 2000), 26 J. CORP. L. (forthcoming 2001), available at
http://papers.ssrn.com/paper.taf?abstract_id=222491 (Social Science Research Network); Bernard
S. Black & John C. Coffee, Jr., Hail Britannia?: Institutional Investor Behavior Under Limited Regula-tion,
92 MICH. L. REV. 1997 (1994). Below, occasional footnotes use examples from these coun-tries
to illustrate points made in the text.

are an essential support for honest courts, lest a powerful defendant com-bine
a bribe if a judge is compliant with a personal threat if she is not.11
The same subtle securities fraud cases that call for specialized prosecutors
require sophisticated judges. The ideal would be a specialized court, staffed
by judges with prior experience as transactional lawyers. A court in a com-mercial
center, which sees a steady diet of business cases, is an acceptable
substitute.
Speed is important too. When insiders commit fraud, some funds can
sometimes be retrieved if the prosecutors can freeze the insiders’ assets
pending the outcome of a case that the prosecutors plan to bring. Other-wise,
the money is usually as good as gone. Beyond that, while courts
nowhere move quickly, differences in how fast they move affect the salience
of investor remedies. Moreover, many countries award no or inadequate
interest on judgments, which weakens the official sanctions.
(3) Procedural rules that provide reasonably broad civil discovery and per-mit
class actions or another means to combine the small claims of many investors.
Meaningful liability risk for insiders and reputational intermediaries
depends in important part on procedural rules that provide reasonably
broad civil discovery. Proving misdisclosure often requires information that
is buried in the company’s records. Also, an individual investor won’t often
incur the expense of a complex lawsuit to recover the investor’s small pri-vate
loss. It’s important to have class actions or another way to combine
many individually small claims.12 Contingency fee arrangements are a use-ful
supplement to the class action procedure.
11. A recent Russian example: the 1999 bankruptcy proceedings for Sidanko, a major oil
holding company, and Chernogoneft, a key Sidanko subsidiary. Chernogoneft went bankrupt
after selling oil to Sidanko, which failed to pay for the oil and then was looted so badly that it
went bankrupt itself. In the Chernogoneft bankruptcy proceedings, 98 percent of the creditors
voted for one external manager, but the local judge appointed a different manager with ties to a
Sidanko competitor, Tyumen Oil, and rejected a Chernogoneft offer to pay all creditors in full.
Tyumen bought Chernogoneft for $176 million (a small fraction of actual value), in what Sidanko
chairman Vladimir Potanin called “an atmosphere of unprecedented pressure on the court sys-tem.”
Indeed, a judge who issued an early ruling against Tyumen was beaten for his troubles. See
Rules of War, ECONOMIST, Dec. 4, 1999, at 65; Jeanne Whalen & Bhushan Bahree, How Siberian
Oil Field Turned into a Minefield, WALL ST. J., Feb. 9, 2000, at A21, (quoting Potanin); Lee S.
Wolosky, Putin’s Plutocrat Problem, FOREIGN AFF., Mar.–Apr. 2000, at 18, 30. I was an advisor to
a minority shareholder in Kondpetroleum (a second Sidanko subsidiary) in litigation against Sidanko
and BP Amoco for looting Kondpetroleum.
12. For example, South Korea has respectable rules on information disclosure and self-dealing,
and allows contingent fees. But its lack of a class action or similar procedure greatly weakens the
incentive for good disclosure. For discussion of Taiwan’s substitute for a securities class action, see
Lawrence S. Liu, Simulating Securities Class Actions: The Case in Taiwan, CORP. GOVERNANCE INT’L,
Dec. 2000, at 4.

792 48 UCLA LAW REVIEW 781 (2001)
Financial Disclosure
(4) Extensive financial disclosure, including independent audits of public
companies’ financial statements.
A stock market can’t thrive unless listed companies provide investors
with audited financial statements. The risk of fraudulent or seriously mis-leading
financial statements is too great. Audited financial statements provide
a critical reality check.
Whether audited financial statements and other disclosure require-ments
for public companies must be required by law or will emerge anyway,
through a stock exchange rule or common practice, is an oft-debated question
that I need not address here. This custom can emerge through stock exchange
rule or common practice, as it did in the United States.13 But a mandatory
rule might speed up this process. The case for mandatory audits and com-pliance
with a defined set of accounting rules becomes stronger, the weaker
a country’s reputational intermediaries (who can police the disclosure) and
disclosure culture are.14
(5) Accounting and auditing rules that address investors’ need for reliable
information.
Good accounting rules should be designed to provide information
useful to investors. This sounds obvious, but in many countries, accounting
rules are designed as much to facilitate tax collection as to inform investors
about value.15 The rules should facilitate comparing a company’s past per-formance
with similar companies, both in the same country and interna-tionally,
and should limit managers’ flexibility to choose among alternative
accounting practices in order to make their firm appear more profitable.
13. See Paul G. Mahoney, The Exchange as Regulator, 83 VA. L. REV. 1453 (1997); Marcel
Kahan, Some Problems with Stock Exchange-Based Securities Regulation: A Comment on Mahoney, 83
VA. L. REV. 1509 (1997); cf. Brian Cheffins, Does Law Matter?: The Separation of Ownership and
Control in the United Kingdom, 30 J. LEGAL STUD. (forthcoming 2001), available at http://papers.
ssrn.com/paper.taf?abstract_id=245560 (Social Science Research Network) (discussing London
Stock Exchange disclosure rules, which often preceded statutory requirements).
14. For pieces of the mandatory disclosure debate, see FRANK H. EASTERBROOK & DANIEL
R. FISCHEL, THE ECONOMIC STRUCTURE OF CORPORATE LAW 276–315 (1991); Anat R. Admati
& Paul Pfleiderer, Forcing Firms to Talk: Financial Disclosure Regulation and Externalities, 13 REV.
FIN. STUD. 479 (2000); John C. Coffee, Jr., Market Failure and the Economic Case for a Mandatory
Disclosure System, 70 VA. L. REV. 717 (1984); Paul G. Mahoney, Mandatory Disclosure as a Solution to
Agency Problems, 62 U. CHI. L. REV. 1047 (1995) and sources cited infra Part VI.B.
15. Russia, for example, has been unwilling to adopt International Accounting Standards
for precisely this reason. See Interview with Sergey Shatalov, First Deputy Minister of Finance, in
No More Delays, in the Move to IAS, ACCT. REP. (Int’l Ctr. for Accounting Reform, Moscow),
Jan.–Feb. 2000, at 1 (Deputy Minister Shatalov complains that International Accounting Standards
“do not specify in detail individual transactions . . . and the way to account for them for tax
purposes”).

Stricter rules aren’t always better. The accounting rules must strike a
sensible balance among investors’ desire for information, the cost of providing
the information, and companies’ concerns about giving detailed infor-mation
to competitors. Still, overly flexible rules can reduce comparability,
increase opportunities for fraud, and increase information asymmetry between
companies and investors.
Auditing standards must be rigorous enough to catch some of the out-right
frauds that occur, deter many potential fraud attempts, and discourage
at least some attempts at creative accounting.
(6) A rule-writing institution with the competence, independence, and
incentives to write good accounting rules and keep the rules up-to-date.
In many countries, the Finance Ministry writes the accounting rules.
It often writes rules that provide the information needed to collect taxes,
rather than the information needed to attract investment or manage the
business. Thus, the rule-writing task is best placed elsewhere—in a securities
commission or perhaps, as in the United States and Great Britain, in a quasi-public
organization that is loosely supervised by the securities commission
or another regulatory agency.16
Writing good accounting rules requires close knowledge of how com-panies
operate, understanding of the loopholes in the existing rules, appre-ciation
for changes in corporate practices, and the ability and incentive
to write new rules and interpret old ones with reasonable dispatch.17 This
offers some reason to vest rule writing in a quasi-public organization, rather
than a government agency. If the rule-writing body is private, its funding and
the manner of choosing its members must ensure that the agency isn’t overly
dependent on issuers, whose managers often prefer opaque disclosure,
especially about their own compensation.
Reputational Intermediaries
(7) A sophisticated accounting profession with the skill and experience to
catch at least some instances of false or misleading disclosure.
Audit requirements and accounting rules are no better than the account-ants
who conduct the audits and interpret the rules. Auditing and account-ing
are part science (following established rules), but in part remain a skilled
16. For an overview of U.S. and British practice in setting accounting rules and the advan-tages
and disadvantages of self-regulation, see BRIAN R. CHEFFINS, COMPANY LAW: THEORY,
STRUCTURE, AND OPERATION 372–420 (1997).
17. For some good examples of how accounting rules need to respond to changing business
practices, see Louis Lowenstein, Financial Transparency and Corporate Governance: You Manage
What You Measure, 96 COLUM. L. REV. 1335 (1996).

794 48 UCLA LAW REVIEW 781 (2001)
art. With the twist that the artist’s task is to paint an accurate picture,
while the subject pays the artist’s fee, often tries to persuade the artist that a
more flattering portrait is a true one, and can replace an artist who paints
too unflattering a portrait. Moreover, a minority of subjects are crooks who
will do whatever they can to mislead the artist and thus the investors who
will later view the portrait.
Professionalism is essential—to see the truth that the subject may try to
conceal and to resist the subject’s pressure for an overly flattering portrait—
if the portrait is to resemble reality and be comparable to other portraits
painted by other artists.
(8) Securities or other laws that impose on accountants enough risk of liabil-ity
to investors if the accountants endorse false or misleading financial statements
so that the accountants will resist their clients’ pressure for laxer audits or more
favorable disclosure.
Accountants are reputational intermediaries. When they audit and
approve financial statements, they also rent out their reputations for con-ducting
a careful audit that can catch some fraud and discourage attempts
at fraud, and for painting a tolerably accurate picture of a company’s
performance.
Liability risk reinforces the accounting firm’s concern for reputation.
It can persuade the firm to establish internal procedures to ensure that the
financial statements that it approves meet minimum quality standards. Liabil-ity
risk also provides a compelling response to a client that wants a less intru-sive
audit or more favorable accounting treatment than the accounting firm
proposes.
The liability risk doesn’t have to be great. Frequent, American-style liti-gation
isn’t needed. Perhaps a few lawsuits per decade, a couple of which
result in a significant payout (in settlement or after a verdict), are enough.
But without any liability risk, accounting firm partners will sometimes accept
the ever-present temptation to squander the firm’s reputation to gain or
keep a client.18
18. A recent Russian example involves an audit by a “big-five” accounting firm of a major
Russian oil company. The company was (notoriously) selling oil to its majority shareholder at
below-market prices, thus transferring profits from the company to the controlling shareholder.
These transactions violated Russian company law, which required the company’s minority share-holders
to approve these self-dealing transactions. A footnote to the company’s 1997 financial
statements disclosed mildly that these transactions “may” give rise to some liability by the controlling
shareholder to the company, with no mention of the amount (which was in the hundreds of
millions of dollars). A reputable accounting firm would never bless this paltry disclosure if it faced
meaningful liability to investors.

(9) A sophisticated investment banking profession that investigates securities
issuers because the investment banker’s reputation depends on not selling overpriced
securities to investors.
Investment bankers are a second key reputational intermediary. They
walk a fine line between selling an offering and overselling it. Their role
includes conducting a “due diligence” investigation of the issuer and satis-fying
themselves that the offering documents and “road show” presentations
reasonably portray the issuer’s prospects, the major risks of the investment
are disclosed, and the issuer’s managers are honest. For example, investment
banks routinely conduct background checks on company insiders and walk
away if the insiders have an unsavory past or dubious friends.
Investment bankers’ reputations are policed in a number of ways. Secu-rities
purchasers will remember if an investment bank sells them several bad
investments and avoid its future offerings. Investment banks track the after-market
performance of their own and their competitors’ offerings and happily
disclose competitors’ weak performance to potential clients. And when an
underwriter sells shares for a fraudulent company, which later collapse
in price when the fraud is discovered, this is a major embarrassment, not
soon forgotten by investors or the bank’s competitors. So too for a debt
offering that quickly goes into default.
(10) Securities or other laws that impose on investment bankers enough risk
of liability to investors if the investment bankers underwrite securities that are sold
with false or misleading disclosure, so that the bankers will resist their clients’
entreaties for more favorable disclosure.
Liability to investors can reinforce investment bankers’ concern for
reputation. Liability can persuade an investment bank to turn away mar-ginal
issuers. It can persuade the firm to establish internal review proce-dures
to ensure that its offerings meet minimum quality standards. And
liability risk provides a compelling argument that the investment bank can
offer to a client that wants more favorable disclosure than the bank proposes.
As for accountants, I make no claim that frequent litigation against
investment bankers is important. A few lawsuits per decade, a couple of
which result in a significant payout, could be enough. But if there is no liabil-ity
risk, individuals within a firm will sometime accept the ever-present
temptation to squander the firm’s reputation to gain a client and a fee.
(11) Sophisticated securities lawyers who can ensure that a company’s
offering documents comply with the disclosure requirements.
Securities lawyers are a third major reputational intermediary—albeit
less visible to investors than accountants or investment bankers. They walk
a fine line between accepting the positive-sounding statements that the
issuer wants to make and insisting on the need to disclose risks and problems.

796 48 UCLA LAW REVIEW 781 (2001)
The lawyers’ role in disclosure is likely to depend on whether compa-nies,
insiders, and investment bankers face meaningful liability risk. If so,
then companies and investment bankers will protect themselves by hiring
lawyers to write and review the key disclosure documents. The lawyers’
caution (deriving from the need to protect one’s client against liability) will
help to ensure good disclosure, even if lawyers face little liability risk them-selves.
Conversely, if companies and investment bankers face little risk,
they may forego hiring expensive securities lawyers to write disclosure
documents, or reject the lawyers’ cautionary advice, and disclosure quality
will suffer.
(12) A stock exchange with meaningful listing standards and the willingness
to enforce them by fining or delisting companies that violate disclosure rules.
Stock exchanges are a fourth important reputational intermediary.
They establish and enforce listing standards, including disclosure require-ments.
Investors use the listing as a proxy for company quality. Both
investors and exchanges understand that false disclosure by a few companies
will taint all listed companies. Historically, stock exchange listing rules
were an important factor in the rise of dispersed ownership in the United
States and the United Kingdom.19
Company and Insider Liability
(13) Securities or other laws that impose liability and other civil sanctions
on companies and insiders for false or misleading disclosure.
Reputational intermediaries are a second line of defense against securi-ties
fraud. The primary defense is direct sanctions against companies and
insiders who attempt fraud.
Companies often want to be able to issue shares in the future; insiders
want to be able to sell their shares at an attractive price in the future. That
gives insiders an incentive to develop the company’s reputation for honest
disclosure. But some of the time, the company needs funds now, or there
won’t be a next time. In game theory terms, the insiders are in the final
period of a repeated game. They have an incentive to cheat because there
won’t be a next round in which the cheating can be punished.20 At other
times, the insiders face a final period because their tenure in the company is
19. See Cheffins (2001), supra note 13; JOHN C. COFFEE, JR., THE RISE OF DISPERSED
OWNERSHIP: THE ROLE OF LAW IN THE SEPARATION OF OWNERSHIP AND CONTROL (Columbia
Law Sch., Ctr. for Law & Econ. Studies, Working Paper No. 182, 2001), available at http://papers.
ssrn.com/paper.taf?abstract_id=254097 (Social Science Research Network); Mahoney (1997),
supra note 13.
20. See generally ROBERT AXELROD, THE EVOLUTION OF COOPERATION (1984).

at risk, even if the company’s solvency is secure. Moreover, some con art-ists
will happily take whatever money they can raise this time, and then
hope to sell another company’s shares the next time.
Insiders’ incentives to puff their company’s prospects help to explain
the universal use in public offerings of reputational intermediaries, who
investigate and vouch for the company’s disclosure. Just as liability to
investors helps to ensure that reputational intermediaries behave as they are
supposed to, this liability helps to ensure that insiders disclose honestly in
the first place.
(14) Criminal liability for insiders who intentionally mislead investors.
For insiders, unlike reputational intermediaries, financial liability
alone is not a sufficient deterrent. Insiders often have little wealth outside
their firm or can hide much of their wealth out of investors’ reach. Moreover,
the prospect of disgorging one’s ill-gotten gains, with probability less than
one, won’t adequately deter crooks from attempting fraud in the first
instance. That makes criminal sanctions a critical supplement to financial
liability. At the same time, formal criminal sanctions are of little value
without skilled prosecutors who can bring complex securities cases.
Market Transparency
(15) Rules ensuring market “transparency”: the time, quantity, and price
of trades in public securities must be promptly disclosed to investors.
One key source of information about value that investors rely on is the
prices paid by other investors for the same securities. Investors then know
that others share their opinions about value. Transparency is a collective
good that must be established by regulation. Large investors prefer to hide
their transactions to reduce the price impact that their trades have. Some-times
a stock exchange will have enough market power to force all trades to
be reported to it. More commonly, the government must mandate prompt
reporting and require all trades to be reported in a single consolidated
source, lest exchanges compete for business by offering delayed or no price
reporting.21
21. For an effort to model the instability of market transparency, see Robert Bloomfield &
Maureen O’Hara, Can Transparent Markets Survive?, 55 J. FIN. ECON. 425 (2000). A technologi-cal
alternative to consolidated reporting could work for larger investors: Private providers can
collect prices from multiple exchanges and sell consolidated reports to investors. As more compa-nies
choose to be listed on multiple exchanges in different countries, the private solution may
dominate the regulatory solution of consolidated reporting (which can’t cross borders as easily).
But private providers can only report trades that the exchanges report to them, so prompt report-ing
must still be mandated.

798 48 UCLA LAW REVIEW 781 (2001)
(16) Rules banning manipulation of trading prices (and enforcement of those
rules).
Transparent market prices raise their own dangers. Especially in “thin”
markets, insiders can manipulate trading prices to create the appearance
that a company’s shares are highly valued, while dumping their own shares
on the market. Rules against manipulating trading prices are the principal
response to this risk. These rules need to be enforced by a specialized regu-lator,
because manipulation is notoriously hard to prove.22
Culture and Other Informal Institutions
(17) An active financial press and securities analysis profession that can
uncover and publicize misleading disclosure and criticize company insiders and
(when appropriate) investment bankers, accountants, and lawyers.
Reputation markets require a mechanism for distributing information
about the performance of companies, insiders, and reputational intermedi-aries.
Disclosure rules help, as do reputational intermediaries’ incentives
to advertise their successes. But intermediaries won’t publicize their own
failures, and investors will discount competitors’ complaints because they
come from a biased source. An active financial press is an important source
of reporting of disclosure failures. But libel laws that make it easy for
insiders to sue their critics (using company funds) can chill reporting. In a
country without honest courts and prosecutors, journalists are vulnerable to
cruder threats as well.23
Security analysts are another important source of coverage. They must
balance the need to maintain a reputation for objectivity against pressure
for positive coverage from companies (who can retaliate for negative cover-age
by cutting off the analyst’s access to soft information), and (for analysts
who are employed by investment banks) from their own employer not to
22. Daniel Fischel and David Ross argue that all, and Omri Yadlin argues that some,
manipulation should be legal. See Daniel R. Fischel & David J. Ross, Should the Law Prohibit
“Manipulation” in Financial Markets?, 105 HARV. L. REV. 503 (1991); Steve Thel, $850,000 in Six
Minutes—the Mechanics of Securities Manipulation, 79 CORNELL L. REV. 219 (1994) (criticizing
Fischel and Ross); Omri Yadlin, Is Stock Manipulation Bad?: Questioning the Conventional Wisdom
with Evidence from the Israeli Experience, 3 THEORETICAL INQUIRIES L. (forthcoming 2001). For
Yadlin, it is fine for General Motors to sell shares of Fisher Body in the market, for the purpose of
depressing the trading price so that General Motors can acquire all of Fisher Body at a lower price,
as long as the managers of General Motors believe that Fisher Body’s standalone value is lower
than its market price. The problem is that in any successful manipulation, including those that
Yadlin likes, informed investors profit and uninformed investors lose. Uninformed investing
becomes less profitable, which increases the information asymmetry discount that investors apply
to all shares.
23. For examples of physical retaliation by Russian businessmen against reporters and other
critics, ranging from beatings to murder, see Black, Kraakman & Tarassova (2000), supra note 1.

say nasty things about a client or potential client—in other words, about
any company at all! Nonetheless, analysts often uncover aggressive finan-cial
reporting by particular companies. The financial press can help ana-lysts
maintain a tolerable balance between disclosing bad news and pleasing
companies and their own employers, by rating analysts’ reputations among
investors.24
(18) A culture of disclosure among accountants, investment bankers, law-yers,
and company managers, who learn that concealing bad news is a recipe for
trouble.
In countries with strong securities markets, the sanctions against
misdisclosure reinforce a culture of compliance, in which a bit of puffing
is acceptable, but outright lying is not. Accountants, investment bankers,
and lawyers see themselves as professionals, and (mostly) behave accord-ingly.
Moreover, few managers will attempt clearly illegal actions, because
disclosure is the norm and others are occasionally disgraced or sent to jail
for falsifying financial statements.
This long list of institutions underscores the difficult task facing a
country that wants to develop a strong securities market. Formal disclosure
rules are important, but are not enough. The harder task is enforcing the
rules—both direct public enforcement and indirect enforcement through
private institutions, especially reputational intermediaries.
C. Additional Useful and Specialized Institutions
The list of core institutions in Part B reflects my personal judgment
about which rules and institutions are most important for ensuring good
disclosure. This part lists some additional institutions that I consider useful
but not core.
1. Useful Institutions
a. Licensing of reputational intermediaries. It’s useful for accountants
and investment bankers to be subject to a regulatory licensing scheme. I
don’t list regulatory licensing as a core institution because I believe that
for reputational intermediaries, private enforcement (through liability to
24. An American example is the analyst rankings published annually by Institutional Inves-tor
magazine. See The 1999 All-America Research Team, INSTITUTIONAL INVESTOR, Oct. 1999, at
109 (rankings available at http://www.iimagazine.com/research/99/aart/best.html). Analysts value
high rankings, which significantly increase their expected income and job mobility. On the role
played by analysts in reducing information asymmetry, see ZOHAR GOSHEN, ON INSIDER
TRADING, MARKETS, AND “NEGATIVE” PROPERTY RIGHTS IN INFORMATION (working paper,
2000).

800 48 UCLA LAW REVIEW 781 (2001)
investors) is likely to be more effective than public enforcement (through
regulatory sanctions). Even in countries with strong regulators, regulatory
sanctions are usually imposed only in egregious cases. Emerging economies
have fewer regulatory resources and better uses for those resources. Prose-cuting
insiders who commit fraud is often a higher priority for regulators
than sanctioning the intermediaries who merely failed to catch the fraud.25
b. Self-regulatory organizations. Self-regulation, through a voluntary or
mandatory self-regulatory organization that is itself subject to regulatory
oversight, is a useful supplement to government regulation of reputational
intermediaries. Just as liability to investors makes reputational intermedi-aries
more willing to insist on good disclosure, it makes the intermediaries
more willing to create a strong SRO and support the SRO’s efforts to disci-pline
errant members.
c. Lawyer liability. For securities lawyers, liability to investors is less
important than for accountants and investment bankers, and hence not
listed above as a core institution. Lawyers are already concerned about
liability because of their training and have an incentive to protect their
clients against liability. Lawyers have reputations to preserve too, and having
clients lose disclosure lawsuits isn’t good for business. But some risk of
liability to investors is a useful supplement to lawyers’ professional caution.
d. Independent directors. Investment bankers, accountants, and secu-rities
lawyers are the principal outside reviewers and writers of disclosure
documents. But independent directors can sometimes catch disclosure
problems that the intermediaries miss. The independent directors can be seen
as second-tier reputational intermediaries. Their incentive to review the
disclosure with a skeptical eye can usefully be reinforced by a touch of legal
liability to investors. But the independent directors shouldn’t face too much
liability risk, lest skilled directors refuse to serve. In countries where most
companies have a controlling shareholder, mandatory cumulative voting
can be useful because it allows minority shareholders to elect one or two
truly independent directors, and can strengthen a culture of director
independence.
e. Investment funds and related institutions. Investment funds (Ameri-cans
call them “mutual funds,” for some odd reason) are another useful
institution. They provide individual investors with diversification and some
protection against claims by con artists (who will have a harder time fooling
experts than novices). An investment fund industry can strengthen the secu-
25. For more general discussion of the reasons to believe that rules that can be privately
enforced are likely to be more effective in emerging countries than rules that require public
enforcement, see Black & Kraakman (1996), supra note 2, at 1929–43.

rities market by providing a source of investable funds, as well as market and
political demand for strong disclosure. I don’t list investment funds as a
core institution because, in my judgment, a healthy investment fund indus-try
is more a result than a cause of a strong securities market.
The investment fund industry relies on still other related institutions.
These include an investment fund law that protects the fund’s assets against
self-dealing by the fund managers, a regulator that polices the industry and
limits fund managers’ ability to make inflated claims of past or expected
future performance, and a financial press that rates fund performance.
f. Pension plans. Funded employee pension plans are a further useful
institution. Like investment funds, they are a source of investable funds
and market and political demand for good disclosure.
g. A sensible tax system. A confiscatory tax system (Russia’s, say) pre-cludes
honest reporting of profits, and thus precludes good disclosure. More
generally, private firms can be more aggressive than public firms in tax
planning and outright tax evasion. Thus, high tax rates weaken securities
markets by inducing more firms to stay private. And a high “stamp tax” on
securities transactions can shrink, perhaps dramatically, the size of the secu-rities
market.26
h. Other useful institutions. Even this further list of useful institutions
omits a number of institutions that support an advanced securities market.
Additional institutions include: compliance officers within investment
banks, who help to ensure that investment bankers’ desire for fees won’t
override concern for legal niceties or long-term reputation; an audit com-mittee
of the board of directors, which can give a company’s auditors some
protection against management pressure for lenient treatment; inside
accountants and lawyers, who are acculturated to honest disclosure and
help to make fraud harder to undertake; and so on.
2. Specialized Institutions
For particular types of companies or preferred stock and debt, addi-tional
institutions can be important, even crucial.
a. Venture capital. Investors in high-technology companies face severe
information asymmetry problems, because these companies often have
short histories, make highly specialized products, participate in fast-moving
26. See COFFEE (2001), supra note 19 (discussing Germany’s 1896 stamp tax); cf. Christopher
J. Green, Paolo Maggioni & Victor Murinde, Regulatory Lessons for Emerging Stock Markets from a
Century of Evidence on Transactions Costs and Share Price Volatility in the London Stock Exchange, 24
J. BANKING & FIN. 577 (2000) (reporting evidence that stamp taxes depress trading volume and
increase volatility).

802 48 UCLA LAW REVIEW 781 (2001)
industries, and have growth prospects (and thus value) that can’t be easily
extrapolated from past financial results. As a result, countries with strong
stock markets, such as the United States, have developed a specialized
institution—the venture capital fund—that funds high-technology com-panies
early in their life and functions in significant part as a specialized
reputational intermediary. Venture capital funds closely investigate com-panies
that seek funding, and then implicitly vouch for these companies
when they later raise capital in the securities markets.
Venture capital financing involves synergy between the venture capi-talists’
visible role in providing financial capital and their equally important
role in providing reputational capital and monitoring. For early stage, high-technology
companies, combining these three services dominates over the
alternative, offered by public securities markets, of providing financial capi-tal
without close monitoring, or the alternative of providing monitoring and
reputational capital without investing, which is a plausible institutional
arrangement that we don’t see.27
If developing a strong public stock market is hard, developing a strong
venture capital industry is harder still. Venture capital funds face a classic
chicken and egg problem in getting started—a venture capitalist can’t get
funding until he develops a reputation for making good investments, but
can’t develop a reputation without making investments. Thus, the initial
stages of industry development are likely to be slow.
b. Bond rating agencies. For bonds and other fixed-income invest-ments,
bond rating agencies such as Moody’s and Standard & Poor’s offer
quality ratings for different issuers. In the United States, rating agencies
more often follow the bond market than lead it. But the rating agencies are
a significant reputational intermediary in less-developed markets, where
they provide both company ratings and country-risk ratings that are not
easily or credibly obtained in another way.28
27. See Bernard S. Black & Ronald J. Gilson, Venture Capital and the Structure of Capital
Markets: Banks Versus Stock Markets, 47 J. FIN. ECON. 243 (1998); see also Thomas Hellmann &
Manju Puri, The Interaction Between Product Market and Financing Strategy: The Role of Venture
Capital, 13 REV. FIN. STUD. 959 (2000). For evidence on the role of venture capital funds as
reputational intermediaries, see Alon Brav & Paul A. Gompers, Myth or Reality? The Long-Run
Underperformance of Initial Public Offerings: Evidence from Venture and Nonventure Capital-Backed
Companies, 52 J. FIN. 1791 (1997), and Paul Gompers & Josh Lerner, Conflict of Interest in the Issu-ance
of Public Securities: Evidence from Venture Capital, 42 J.L. & ECON. 1 (1999).
28. For a recent negative review of the role played by rating agencies in American capital
markets, see Frank Partnoy, The Siskel and Ebert of Financial Markets?: Two Thumbs Down for the
Credit Rating Agencies, 77 WASH. U. L.Q. 619 (1999).

c. Money manager rating services. For money managers who manage
pension funds and other institutional assets, a cottage industry has arisen of
consulting firms who verify the money managers’ performance claims, and
a related industry that develops performance indexes against which the per-formance
of a money manager with a particular style or investment focus
can be measured.
D. Which Institutions Are Necessary, Which Are Merely Nice to Have?
My long list of core institutions for ensuring good disclosure, and the
additional core institutions for controlling self-dealing discussed in Part II,
raise an obvious question: Which institutions are really necessary, and
which are just extra frosting on an already tasty cake? Underlying that
question is American and British experience, in which strong securities
markets developed together with some of these institutions but predated
others. For example, the United States had active securities markets long
before it had a strong central securities regulator (though the states early
regulated securities offerings). The United States didn’t enforce insider
trading rules (an institution that I consider important for controlling self-dealing)
until the 1960s. In Britain, many stock promoters invested little in
reputation until perhaps the middle of the twentieth century, arguably after
Britain had already developed a strong stock market.29
The interrelationships among institutions—complements in some
respects, substitutes in others—mean that there is no simple answer to this
question. One must evaluate how important each institution is, both by
itself (to the extent feasible) and as part of an overall system. Consider
insider trading. Utpal Bhattacharya and Hazem Daouk report that an
enforced ban on insider trading raises share prices by about 5 percent, other
things equal.30 That suggests that such a ban is important enough to be
considered a core institution, but not absolutely critical. A stock market
can be strong without controls on insider trading; it will be stronger with
these controls.
On the other hand, local enforcement is critical, and therefore honest
courts and regulators are critical. A strong stock market cannot exist if
29. See Cheffins (2001), supra note 13.
30. See UTPAL BHATTACHARYA & HAZEM DAOUK, THE WORLD PRICE OF INSIDER
TRADING (working paper, 1999), available at http://papers.ssrn.com/paper.taf?abstract_id=200914
(Social Science Research Network).

804 48 UCLA LAW REVIEW 781 (2001)
major players can escape liability by bribing a judge to forgive their tres-passes,
bribing a prosecutor or a regulator to ignore them, or bribing politicians
to call off the prosecutors or regulators. I can’t prove this, but neither can I
think of any counterexamples.
II. PROTECTING MINORITY INVESTORS AGAINST SELF-DEALING
A. Self-Dealing as an Adverse Selection/Moral Hazard Problem
The second major obstacle to a strong public stock market is the
potential for insiders to appropriate most of the value of the company for
themselves—for 50 percent of the voting shares (less if the remainder are
diffusely held) to convey most or all of the company’s value.
Self-dealing can occur in many variants. But a useful division is
between:
(1) direct self-dealing, in which a company engages in transactions,
not on arms-length terms, that enrich the company’s insiders, their
relatives, or friends, or a second company that the insiders control;
and
(2) indirect self-dealing (often called insider trading), in which
insiders use information about the company to trade with less-informed
investors.
Direct self-dealing is a much more important problem than insider
trading. First, it’s far more profitable. Direct self-dealing lets insiders turn
(say) 40 percent ownership of shares into up to 100 percent ownership of
firm value, with little additional investment. Insider trading can’t produce
similar gains. For one thing, insider trading in significant volume requires a
liquid stock market, which countries that don’t control direct self-dealing
won’t have. For another, long-term buy-and-hold investors aren’t directly
harmed by insider trading. You can only be on the losing side of a trade
with an insider if you’re trading.
More critically, if direct self-dealing is hard to control, insider trading
in anonymous securities markets is even harder to control. Without the
institutions that control direct self-dealing, there is little hope of control-ling
insider trading. But the converse isn’t true. A country can control
direct self-dealing fairly well without making the additional investment
needed to address insider trading.
The potential for self-dealing creates a lemons (or adverse selection)
problem, which has the same structure as the adverse selection problem
created by asymmetric information. Investors don’t know which insiders
are honest and which will appropriate most of the company’s value, so they

discount all companies’ share prices. This creates a dilemma for honest
insiders who won’t divert the company’s income stream to themselves.
Discounted share prices mean that a company with honest insiders can’t
receive fair value for its shares. This gives the company an incentive to use
other forms of financing. But discounted prices won’t discourage dishonest
insiders. The prospect of receiving even a discounted price for worthless
paper will be attractive to some insiders.
This adverse selection by issuers, in which high-quality companies
leave the market because they can’t obtain a fair price for their shares while
low-quality companies remain, lowers the average quality of issuers. Inves-tors
rationally react by further discounting share prices. This drives even
more high-quality issuers away from the market and exacerbates adverse
selection. As with asymmetric information, failure to control self-dealing
can result in a death spiral, in which self-dealing and adverse selection
combine to drive almost all honest issuers out of the market and drive share
prices toward zero, save for a few large companies that can develop their
own reputations.
Self-dealing is a harder problem to solve than information asymmetry.
First, honest disclosure of information during a public offering of shares
can’t later be undone. In contrast, after a company sells shares, its insiders
have an incentive to renege on a promise not to self-deal and capture more
of the company’s value than investors expected when they bought the
shares. Again, insurance terminology is helpful—the incentive to renege is
known as moral hazard. This incentive is only imperfectly policed by the
insiders’ concern for reputation to permit future offerings by the company or
future sales by insiders of their own shares.31
Second, false or misleading disclosure in a public offering often occurs
in a formal disclosure document and thus leaves a paper trail. If subsequent
events reveal business problems that the company concealed, the disclosure
deficiencies will often be obvious enough to let investors and regulators
seek damages or other sanctions against the insiders and, if appropriate, the
reputational intermediaries. In contrast, self-dealing is often hidden. It
must be uncovered before it can be policed.
Third, a securities offering is a discrete event that lets investors insist
on participation by reputational intermediaries. Self-dealing lacks a similar
triggering event. The accountants’ annual audit is an important check on
31. For discussion of moral hazard in organizations, see PAUL MILGROM & JOHN ROBERTS,
ECONOMICS, ORGANIZATION AND MANAGEMENT 166–204 (1992).

806 48 UCLA LAW REVIEW 781 (2001)
self-dealing, and securities lawyers can play a role if they prepare the com-pany’s
public disclosure filings, but investment bankers recede into the
background.
Fourth, once a company issues shares at a discount, the insiders may
feel entitled to appropriate most of the company’s value for themselves.
They will resist any change in legal rules that limits this opportunity. An
example can illustrate why insiders can feel this way. Assume that
Company A has fifty outstanding shares worth $2 each (for a total value of
$100), all held by insiders. Outside investors may be willing to pay only
50¢ per share for additional shares, both because the investors don’t know
the company’s true value and because they expect insiders to appropriate
most of whatever value exists. Suppose that Company A issues fifty addi-tional
shares at this price. Company A now has one hundred shares out-standing,
fifty shares held by insiders and fifty held by outside investors, and
a total value of $125.32
If the insiders keep only 50 percent of the company’s value, they have
cheated themselves. Their shares will be worth only $62.50, while the out-side
investors’ shares will be worth $62.50—far more than the outside
investors paid. The insiders’ rational response is to self-deal enough to
capture at least 80 percent of the firm’s value—$100 out of the total value
of $125. They will not feel that they have cheated anyone by doing so, and
will fight legal and institutional reforms that might prevent them from
taking what they see as their fair share of their company’s value.
But in opposing reforms, insiders of already public companies reinforce
a system that won’t prevent them from taking more than 80 percent of the
company’s value if they choose—and some insiders will so choose. If a
national system permits substantial self-dealing, often in hidden forms,
there is no obvious way to ensure that investors get the fraction of any
particular company’s value that they paid for, or even to know what that
fraction is.
B. The Core Institutions that Control Self-Dealing
Just as successful securities markets have developed institutions to
counter information asymmetry, they have developed institutions to
counter self-dealing. My judgmental list of core institutions is presented
below, in an order that makes logical sense, not in order of estimated
importance. Some of these are the same institutions that control informa-tion
asymmetry; some are different. Part III combines this list and the list
32. This example is adapted from Coffee (1999), supra note 2, at 657–59.

of core institutions for controlling information asymmetry into a single
table.
Effective Regulators, Prosecutors, and Courts
Honest, decently funded judges, regulators, and prosecutors are, if any-thing,
even more critical for controlling self-dealing than for controlling
information asymmetry, because reputational intermediaries play a smaller
role for self-dealing transactions.
(1) A securities regulator (and, for criminal cases, a prosecutor) that: (a) is
honest; and (b) has the staff, skill, and budget to untangle complex self-dealing
transactions.
Insiders often use transactional complexity and multiple intermediaries
to hide their interest in a transaction, and anonymous offshore accounts to
hide insider trading. Proving a self-dealing case often requires developing
a chain of circumstantial evidence that will befuddle ordinary prosecutors,
or at least lead them to seek out easier cases. And insiders often have the
wealth to mount a vigorous defense.
(2) A judicial system that: (a) is honest; (b) is sophisticated enough to under-stand
complex self-dealing transactions; (c) can intervene quickly when needed to
prevent asset stripping; and (d) produces decisions without intolerable delay.
As for information asymmetry, honest, sophisticated, and decently paid
judges are basic and often absent, as is the courts’ ability to reach decisions
with reasonable dispatch and to freeze assets before they are moved offshore.
(3) Procedural rules that provide reasonably broad civil discovery, permit
class actions or another means to combine the small claims of many investors, and
accept proof of self-dealing through circumstantial evidence.
As for information asymmetry, meaningful liability risk requires not
just formal liability rules, but also procedural rules that provide reasonably
broad civil discovery. Class actions or another means to aggregate indi-vidually
small claims are also important.
The need for broad discovery is even more crucial for self-dealing than
for information asymmetry. For misdisclosure in a public offering, there
is usually a written disclosure document that will sometimes be false on its
face. In contrast, for self-dealing, insiders are dealing with themselves, or
(for insider trading) with an anonymous market. They can often avoid
a telltale paper trail. The judicial system must therefore permit wrongdoing
to be inferred from circumstantial evidence.33 Rules that shift the burden to
33. In Russia, for example, even if judges were honest, self-dealing could rarely be proven
because courts insist on documentary proof of almost all factual assertions.

808 48 UCLA LAW REVIEW 781 (2001)
insiders to disprove self-dealing (once suspicious circumstances are established),
or require the insiders to prove fairness (once self-dealing is established),
can be highly valuable.
Disclosure Requirements and Procedural Protections
(4) Securities or other laws that require extensive disclosure of self-dealing
transactions.
Insiders won’t voluntarily announce to the world that they are engaged
in self-dealing. Strong auditing standards and disclosure rules are needed,
because if self-dealing transactions can be hidden, none of the other protec-tions
will be very effective.
(5) Company or securities law that establishes procedural protections for self-dealing
transactions, such as approval after full disclosure by independent direc-tors,
noninterested shareholders, or both.
Disclosure alone will deter some self-dealing. But much self-dealing
will still take place if the underlying transactions are lawful. Thus, signifi-cant
self-dealing transactions should be subject to review by independent
directors, noninterested shareholders, or both.
In the United States, with a culture of independence for outside direc-tors
and skilled courts that can ferret out self-dealing when a shareholder
sues ex post, it may be sufficient to vest approval power solely in the inde-pendent
directors. But often, nominally independent directors won’t be very
independent in fact, especially when a company has a controlling share-holder,
at whose pleasure the directors serve. Thus, it can be valuable to give
approval power for larger transactions to noninterested shareholders.34
(6) Ownership disclosure rules, so that outside investors know who the insid-ers
are and interested shareholders can’t vote to approve a self-dealing transaction
that requires approval by noninterested shareholders.
Insiders have an incentive to disguise their ownership, both in a com-pany
and other entities that the company transacts with, to conceal a transac-tion’s
self-dealing nature. If noninterested shareholders have veto power over
self-dealing transactions, insiders have a further incentive to hide their share
ownership so they can pretend to be noninterested. Disclosure rules, plus
rules that treat affiliates of insiders as interested shareholders, can prevent
this practice.
More generally, if self-dealing is a significant risk, outside investors
need to know who the insiders are. This will help the outside investors deter-
34. For discussion of the choice between ex ante and ex post controls on self-dealing in a
transition economy, see Black & Kraakman (1996), supra note 2, at 1932–34, 1958–60.

mine how much to trust the insiders and enhance the insiders’ incentive to
develop reputations for not abusing their power.
(7) A good overall financial disclosure regime.
Good overall financial disclosure makes it harder to hide direct self-dealing.
Moreover, the better the information that the public has, the smaller
the profit opportunity from insider trading.
Reputational Intermediaries
(8) Requirements that a company’s accountants review self-dealing trans-actions
and report on whether they were accurately disclosed.
Insiders have a powerful incentive to hide self-dealing, despite formal
disclosure obligations. Unlike the situation when a company issues shares
to investors, there is no direct way for investors to insist that reputational
intermediaries review self-dealing transactions. Accountants are the obvious
intermediary that can play this role. Accountant review of self-dealing trans-actions
can emerge by law or by custom. But unless mandated, it will be
opposed by already public companies, and isn’t likely to emerge quickly.
If accountants review self-dealing disclosure, we will also need:
(9) A sophisticated accounting profession with the skill and experience to
catch some nondisclosed self-dealing transactions and insist on proper disclosure.
Insiders who are determined to self-deal can sometimes do so even
with an accountant looking over their shoulders. The insiders can disguise
a transaction, or their interest in the transaction, by running one or both
through multiple intermediaries. Thus, accountants must be sophisticated
enough, and auditing standards rigorous enough, to catch at least some of
the subterfuges.
Accountants can’t catch every instance of self-dealing. It would cost
too much for them to investigate every transaction. But this practical limit
only reinforces the need for skilled accountants who know which closets
the insiders are most likely to hide skeletons in, so the accountants can make
good use of their limited resources.
To ensure that the accountants do a good job, we will also need:
(10) Securities or other laws that impose on accountants enough risk of
liability to investors, if the accountants endorse false or misleading disclosure of
self-dealing transactions, so that the accountants will search vigorously and resist
their clients’ entreaties to let them hide or mischaracterize self-dealing transactions.
The reasons for liability risk are the same as for information asymmetry
generally. The accountants are hired and paid by the company. They inevi-tably
face pressure to overlook suspicious closets, accept dubious transac-tions
at face value, or accept incomplete disclosure of an admitted self-dealing

810 48 UCLA LAW REVIEW 781 (2001)
transaction. Professionalism is one bulwark against this temptation, but liabil-ity
to investors is an important bulwark for professionalism.
(11) Sophisticated securities lawyers who can ensure that companies satisfy
the disclosure requirements governing self-dealing transactions.
A disclosure document for a self-dealing transaction, developed to obtain
shareholder approval for the transaction, or annual disclosure that lists self-dealing
transactions during the past year, will commonly be prepared by
securities counsel. An important safeguard of accuracy is counsel’s willingness
to insist on full disclosure, conduct enough due diligence to satisfy themselves
that the disclosure is accurate, and warn insiders about the risks of partial
disclosure.
(12) Law or custom that: (a) requires public companies to have a minimum
number of independent directors; (b) ensures that they approve self-dealing trans-actions;
and (c) imposes on companies and independent directors enough risk of
liability if they approve self-dealing transactions that are grossly unfair to the
company so that the directors will resist the insiders’ pressure to approve these
transactions.
Approval by independent directors is an insufficient safeguard against
self-dealing transactions in countries where the directors’ independence is
in doubt, but this approval is still an important safeguard. The directors’
personal liability if they don’t behave independently is a central support for
this constraint. Company liability can help to persuade the independent
directors to reject transactions that aren’t on arms-length terms. Liability
also offers a powerful argument that the independent directors can use when
insiders propose a dubious transaction.
Independent directors must be given the benefit of the doubt when
they approve a transaction, lest the best directors decline to serve for fear of
financial liability. But if self-dealing is egregious enough, the need for liabil-ity,
to strengthen the directors’ backbones, outweighs the chill on their
willingness to serve. After all, the independent directors can always reject a
transaction, ask an outside expert to approve the terms as fair, or insist on
approval by noninterested shareholders.
Insider Liability
(13) Civil liability for insiders who violate the self-dealing rules.
Oversight by reputational intermediaries, and requirements that self-dealing
transactions must be approved by independent decision makers, are
important devices to enhance detection of attempted theft (for that is what
self-dealing must be understood as). But they are no substitute for direct rules
against theft and meaningful liability for thieves who are caught. The prin-

cipal civil sanction is liability to shareholders; regulators can also enjoin
future violations or bar offending insiders from being principals of public
companies.
(14) Criminal liability for insiders who intentionally violate the self-dealing
rules.
Return of ill-gotten gains is an insufficient remedy as long as insiders
can hide or spend most of their gains, especially because the probability of
detection is less than one. Damages equal to a multiple of the insider’s gains
are of limited effectiveness given limited insider wealth and the insiders’
ability to hide much of that wealth. Thus, criminal sanctions, enforced by a
specialized prosecutor, are an essential supplement to civil liability.
Institutions to Control Insider Trading
I have thus far focused on the institutions needed to control direct self-dealing.
I list next the additional core institutions that are needed to con-trol
insider trading.
(15) Securities or other laws that prohibit insider trading, suitably defined,
and government enforcement of those rules.
To be effective, a ban on insider trading must include a ban on tipping
others, as well as on trading yourself. The rules must be enforced, lest insid-ers
learn that they can violate the rules with impunity.35
(16) A stock exchange with meaningful listing standards, the willingness to
fine or delist companies that violate the self-dealing rules, and the resources to run
a surveillance operation that can catch some insider trading.
For direct self-dealing, stock exchange enforcement, through fines and
delisting (or the threat of delisting), is an important supplement to official
enforcement. For insider trading, the stock exchange is the institution that
is best able to monitor its own trading, looking for unusual patterns that
suggest insider trading. But running a good insider trading surveillance pro-gram
isn’t cheap. The New York Stock Exchange alone will spend $95
million this year on market surveillance, mostly aimed at controlling insider
trading.36
35. See BHATTACHARYA & DAOUK (1999), supra note 30 (reporting that (1) many coun-tries
have bans on insider trading that are never enforced, (2) enforced insider trading rules have a
measurable effect on share prices, which they estimate at 5 percent, and (3) unenforced rules have
no significant effect on share prices).
36. See E-mail from George Sofianos of the New York Stock Exchange, to Bernard Black
(July 27, 2000); see also Cheffins (2001), supra note 13 (noting that the London Stock Exchange
mounts over 100 major insider trading investigations annually and refers 30–40 cases annually for
possible criminal prosecution).

812 48 UCLA LAW REVIEW 781 (2001)
(17) Rules ensuring transparent trading prices.
Insider trading flourishes in the dark. The better the trading price is as
a guide to actual value, the harder it is for insiders to profit from trading
with outsiders. This requires not only general financial disclosure, but also
rules ensuring transparent trading prices.
(18) Rules banning manipulation of trading prices (and enforcement of those
rules).
Public reporting of trades lets insiders manipulate trading prices. “Pump
and dump” schemes, in which insiders of small companies use prearranged
transactions at rising prices to create the appearance of a hot stock, and then
sell their own shares at inflated prices, are an endemic problem even in devel-oped
markets. Enforcement of antimanipulation rules by specialized regula-tors
is the only remedy.
Culture and Other Informal Institutions
(19) An active financial press and securities analysis profession that can
uncover and publicize instances of self-dealing.
Insiders will self-deal less often, and accountants, securities lawyers,
and independent directors will be more vigorous in policing self-dealing, if a
country has a strong financial press that can publicize misdeeds. As for
information asymmetry, overly strong libel laws can chill press reporting.
Reports that uncover self-dealing will often come from securities
analysts rather than the financial press. The more prevalent self-dealing is
in a particular country, the greater the need for analysts to understand how
self-dealing varies from company to company, both to value companies and
to advise clients on which securities to buy.37
(20) A culture of compliance among accountants, lawyers, independent
directors, and company managers that concealing self-dealing transactions, approv-
37. Two Russian examples: First, the Troika Dialog investment bank publishes a weekly
news bulletin, On Corporate Governance Actions, that advises its clients in surprisingly blunt terms
about corporate governance shenanigans by Russian companies. See also JAMES FENKNER & ELENA
KRASNITSKAYA, CORPORATE GOVERNANCE IN RUSSIA: CLEANING UP THE MESS (Troika Dialog,
1999). Second, the Brunswick Warburg investment bank published a numerical ranking of the
corporate governance “risk” posed by Russian firms, with risk ratings ranging from 7 for Vimpelcom
(which publishes financial statements that meet U.S. accounting standards and has shares listed
on the New York Stock Exchange) to 51 for the subsidiaries of Yukos. See BRUNSWICK WARBURG,
MEASURING CORPORATE GOVERNANCE RISK IN RUSSIA (1999). Yukos’ misdeeds are recounted
in Black, Kraakman & Tarassova (2000), supra note 1.

ing a seriously unfair transaction, or trading on inside information is improper and
a recipe for trouble.
In countries with strong securities markets, the sanctions against direct
and indirect self-dealing are strong enough to reinforce a norm against this
conduct. That culture reduces the frequency of self-dealing and improves
the quality of the transactions that occur. Like the related norms support-ing
good disclosure and establishing value maximization as a managerial
goal, the norm and the supporting institutions likely develop together and
reinforce each other.38
To take a recent Russian example, it would never occur to an Ameri-can
oil company’s managers to propose (as Russian oil company Yukos did
in 1999) that the company sell its oil to unknown offshore companies for
$1.30 per barrel when the market price was $13. The managers wouldn’t
propose this, the independent directors wouldn’t approve it, and if it some-how
occurred anyway, the press would report the scandal, and the managers
would face both civil and possible criminal liability. In Russia, the press
reported some of the scandal, but the managers went ahead anyway.39
This list suggests the difficult task facing a country that wants to con-trol
self-dealing. Once again, rules on paper are necessary but not suffi-cient.
Enforcement is critical. Russia offers a good example. The Russian
company law contains reasonably strong procedural protections against self-dealing
transactions. But Russian companies routinely ignore the rules
because they aren’t enforced. Insiders hide self-dealing transactions, and
(sometimes corrupt) prosecutors and judges usually let the insiders off the
hook in the rare case when a transaction is exposed. Reputational
intermediaries—including major investment banks and accounting firms—
don’t face appreciable liability risk and sometimes choose to look the other
way and accommodate a major client, in ways they would never dream of in
their home countries.40
38. For discussion of the interplay between legal requirements and the U.S. social norm
against self-dealing, see Melvin A. Eisenberg, Corporate Law and Social Norms, 99 COLUM. L. REV.
1253, 1271–78 (1999). For discussion of why the trustworthiness of corporate actors depends
on the social context in which they operate, see Margaret M. Blair & Lynn A. Stout, Trust, Trust-worthiness,
and the Behavioral Foundations of Corporate Law, 149 U. PA. L. REV. (forthcoming
2001), available at http://papers.ssrn.com/paper.taf?abstract_id=241403 (Social Science Research
Network).
39. For more details, see Black, Kraakman & Tarassova (2000), supra note 1.
40. A Russian example: Goldman Sachs’ courting of Yukos and its controlling shareholder,
Mikhail Khodorkovski, despite warning signs that Khodorkovski was a crook and that a major
bank loan, syndicated by Goldman, was supported by guarantees from Yukos subsidiaries that were
illegal under Russian company law. Goldman executives later told the New York Times that they
thought Yukos acted legally under Russian law. My personal belief is that, with an eight-digit fee

The legal and institutional preconditions for strong securities market

The legal and institutional preconditions for strong securities market

Recommended

Recommended

More Related Content

What's hot

What's hot (7)

Viewers also liked

Viewers also liked (20)

Similar to The legal and institutional preconditions for strong securities market

Similar to The legal and institutional preconditions for strong securities market (20)

More from huongntt16

More from huongntt16 (20)

Recently uploaded

Recently uploaded (20)

The legal and institutional preconditions for strong securities market