The Quality of the Legal System, Firm Ownership, and Firm Size
Employment in developing countries is disproportionately concentrated in very small firms. The authors examine the extent to which the distribution of firm size is related to the quality of the legal system using data from Mexico. They combine Luca...
| Main Authors: | , |
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| Format: | Policy Research Working Paper |
| Language: | English en_US |
| Published: |
World Bank, Washington, D.C.
2013
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| Subjects: | |
| Online Access: | http://documents.worldbank.org/curated/en/2004/03/4065898/quality-legal-system-firm-ownership-firm-size http://hdl.handle.net/10986/14120 |
| Summary: | Employment in developing countries is
disproportionately concentrated in very small firms. The
authors examine the extent to which the distribution of firm
size is related to the quality of the legal system using
data from Mexico. They combine Lucas' (1978) model of
firm size with Himmelberg, Hubbard, and Love's (2001)
consideration of idiosyncratic risk in a framework in which
the distribution of entrepreneurial talent and aversion to
idiosyncratic risk combine to determine the optimal size of
firms. Their data allows them to focus on the differential
impact of the legal system on proprietorships and
corporations. Moreover, by focusing on firms in a single
country, the data draw attention to the importance of
variation in the administration of justice and the
enforcement of legal verdicts. The authors find that Mexican
states with more effective legal systems have larger firms.
A one-standard deviation improvement in the quality of the
legal system increases the average firm size by about 10-15
percent. The impact of the legal system is greatest in
sectors in which proprietorships dominate. This pattern is
consistent with better legal systems increasing the
investment of firm owners by reducing the idiosyncratic risk
they face. All of these findings are upheld when the authors
instrument for institutional variables using the log of
indigenous population in 1900 and the active presence of the
drug trade in the state. |
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