Can Civil Law Countries Get Good Institutions? Creditor Rights and Bond Markets in Brazil, 1850-2003

Can we assume that the effect of early institutions is persistent over time? Work by La Porta, Lopez de Silanes, Shleifer, and Vishny, also known as the “law and finance” literature, implicitly argues that the legal tradition countries inherited or adopted in the far past has an important long-term effect on financial development. They argue financial development is related to the extent countries legally protect shareholders and creditors. Also, they find that countries that use the common law legal system have (on average) better investor protections than most civil law countries. I test three hypotheses that stem from the law and finance literature. First, I test if strong creditor rights are actually related to having larger bond markets once we look at a long time series. I look at the relationship between these two variables using data of creditor rights and bond market development in Brazil since 1850. I find support for this part of their argument. Second, I explore the supposed persistent relationship between legal origin and creditor rights. I argue that the variation in creditor rights is too large for us to believe that legal origin has a path-dependent and “stable” relationship with these rights. I provide a political economy explanation of the variation in creditor rights since 1850 in Brazil. Finally, I ask if the significant variation in creditor rights over time in Brazil is a case-specific phenomenon or if it in fact reflects a general trend in legal protections for creditors across countries. I do this by showing the state of creditor-right protections in a small cross-section of common and French civil law countries in 1910. I find a near reversal of relationships between legal origin and creditor rights in 1910: French civil law countries had stronger creditor rights than most of the common law countries included (except the U.K.).