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Gerhard Schnyder

Anna Grosman

Kun Fu

Mathias Siems

Ruth V. Aguilera

January 4th, 2022

Legal perception and finance: when the perception matters more than the actual law

3 comments | 16 shares

Estimated reading time: 3 minutes

Gerhard Schnyder

Anna Grosman

Kun Fu

Mathias Siems

Ruth V. Aguilera

January 4th, 2022

Legal perception and finance: when the perception matters more than the actual law

3 comments | 16 shares

Estimated reading time: 3 minutes

How people perceive the quality of the law can affect companies in many ways. Gerhard Schnyder, Anna Grosman, Kun Fu, Mathias Siems, and Ruth V. Aguilera explore the underdeveloped role of legal perceptions in initial public offerings (IPOs), when companies list their shares in a stock exchange. They find that what drives IPO valuation is how shareholder protection laws are perceived, rather than the actual quality of the legal protection. 


 

It is often said that perception matters more than the actual underlying rule. Say you try to discipline a child, and you write a set of rules on the kitchen board, about their screen time, homework, house chores etc, but it stops there – you do not consistently monitor how the child abides by the rules, or discipline the child in case of misbehaviour. Over time, the child’s perception of these rules will be different from what the rules actually are. Thus, what matters in the end, if you want your child to follow the rules, is the perception of these rules. For the parent, the implication is that what matters is the signal that the rules send and how the child perceives that signal.

In an economic context, this analogy from a parent’s everyday life highlights the importance of focusing on the perception of law and how it matters for companies relative to the actual law. In a recent article on legal perception and finance, we argue that the perception of the quality of law should be considered alongside the quality of law and firm-level corporate governance practices. We focus on Initial Public Offerings (IPOs) across a large number of countries, and find strong support for the claim that the perception of the quality of law is more important than its actual quality to explain the post-IPO firm value. This effect remains no matter whether the law’s quality is correctly perceived or misperceived.

One of the novelties of our study is the focus on “legal signalling” which we model theoretically and test empirically. This view focuses on the impact that law has on the legitimacy (as opposed to the efficiency) of economic activities. Laws can have an impact on economic activity through increased efficiency and decreased transaction costs (the standard view). Yet, the law can also have an impact on behaviours by influencing people’s perception of a given legal system or the companies operating in it. We call this aspect “legal perception”. The legal signalling view suggests that laws are not just transaction-cost reducing devices, but also legitimacy-creating devices that signal adherence to certain expected norms and behaviours to market participants.

Based on the actual and perceived quality of minority shareholder perception in various countries, Table 1 shows that adding perception to the actual quality of law is important, because by far not all countries’ legal rules are correctly perceived. Indeed, there is approximately the same number of countries in each category (correctly perceived low-quality law, correctly perceived high-quality law, misperceived low-quality law, and misperceived high-quality law. In the case of Australia, for example, minority shareholders are objectively not particularly well protected according to international standards. Indeed, Australia’s shareholder protection laws score below average in our sample. Yet, the perception of the quality of its shareholder law is above average indicating a mismatch between perception and actual law..

Table 1. Perception of law in 54 home countries
Correctly perceived low-quality law Correctly perceived high-quality law Misperceived low-quality law Misperceived high-quality law
Argentina* Belgium Australia Bulgaria*
Bangladesh* Canada Finland Chile*
Brazil* Denmark France India*
China* Hong Kong Germany Pakistan*
Cyprus Ireland-Rep Luxembourg South Korea
Egypt* Israel Netherlands Spain
Greece Japan Oman* Thailand*
Indonesia* Malaysia* Saudi Arabia* Turkey*
Italy Malta Sri Lanka*
Jordan* New Zealand Switzerland
Kenya* Norway
Kuwait* Singapore
Mexico* South Africa*
Nigeria* Sweden
Philippines* Taiwan
Poland* United Kingdom
Russian Fed* United States
Tunisia*
Vietnam*
35.2% 31.5% 18.5% 14.8%
(19 of the 54 home countries) (17 of the 54 home countries) (10 of the 54 home countries) (8 of the 54 home countries)

Notes: * denotes emerging economies. Source: Legal Perception and Finance: The Case of IPO Firm Value, British Journal of Management

Our research multi-level framework is presented in Figure 1. All of the hypotheses address the underdeveloped role of legal perception in IPOs, be it on its own (H1), or in conjunction with the actual quality of the law (H2a and H2b) and with firm-level corporate governance (H3).

Figure 1. Research model and hypotheses

Source: Legal Perception and Finance: The Case of IPO Firm Value

Our results provide strong support for the basic insight of the legal signalling view that what drives IPO valuation is not so much the actual quality of legal shareholder protection, but rather the perception of its law. In the case of strong actual legal shareholder protection, the effect of legal perception on IPO valuation is stronger if the perception is aligned with positive law than when the quality of law is misperceived.

We also find that in negatively perceived countries (perception below the average), higher levels of firm-level corporate governance affect IPO value. In other words, corporate governance practices can compensate for the negative legal perception. In positively perceived countries, firm-level corporate governance mechanisms do not impact the positive relationship between perception and valuation. One interpretation is that for such countries, the legal framework may be considered sufficient to guarantee a reasonable level of shareholder protection for investors. This hints at the contextual nature of the firm signalling effect, which depends not only on the level of actual legal shareholder protection, but also on its perception. It also supports the idea that firm signalling does not always have an impact on a firm’s reputation. Our study hints at the shortcomings of existing theorisation of the role of law in the economy and suggests that measures of legal quality based on ‘black letter law’ may be insufficient to account for the role the law plays in the economy.

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About the author

Gerhard Schnyder

Gerhard Schnyder (Ph.D. Lausanne) is a professor of international management & political economy at Loughborough University London and a research associate at the Centre for Business Research, University of Cambridge. His current work focuses on state-business relations and the political economy of populism in particular in emerging market contexts. His recent work was published in Organization Studies, Business & Society, New Political Economy, and Journal of International Management, Global Strategy Journal, among others.

Anna Grosman

Anna Grosman (Ph.D., Imperial College, UK) is a senior lecturer (eqv. associate professor) in innovation and entrepreneurship at Loughborough University London. Her research falls at the intersection of corporate governance, corporate finance and international business with a special emphasis on contemporary state capitalism, and corporate governance issues of state-affiliated organisations, such as corporate political ties, board independence, and board effectiveness. She has published in Journal of International Business Studies, Journal of World Business, British Journal of Management, and Corporate Governance: An International Review, among others.

Kun Fu

Kun Fu (Ph.D., Bocconi University, Italy) is a senior lecturer (eqv. associate professor) of innovation and entrepreneurship at Loughborough University London. Her research interests lie in the fields of strategic entrepreneurship and technology innovation. Her research tries to develop better understanding on how entrepreneurial firms react to their contexts and examines the outcomes of this process such as firm creation, growth, technology innovation and diversification. Some of her research has been sponsored by British Academy, the Leverhulme Trust, Sino-British Fellowship Trust.

Mathias Siems

Mathias Siems (Ph.D., LMU Munich, Germany) is a professor of private law and market regulation at the European University Institute (EUI) in Florence, Italy, and a research associate at the Centre for Business Research, University of Cambridge. Previously, he was a professor at Durham University and the University of East Anglia, a reader at the University of Edinburgh, an associate professor at the Riga Graduate School of Law, a Fulbright Scholar at Harvard Law School, and a Jean Monnet Fellow at the EUI.

Ruth V. Aguilera

Ruth V. Aguilera (Ph.D., Harvard University, US) is the Distinguished Darla and Frederick Brodsky Trustee Professor in global business at the D’Amore-McKim School of Business at Northeastern University and a visiting professor at ESADE Business School. She is interested in research at the intersection of strategic organisation and international business with a focus on comparative corporate governance an corporate social responsibility.

Posted In: Economics and Finance

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