The Standardization of Law and Its Effect on Developing

G-24 Discussion Paper Series

UNITED NATIONS CONFERENCE ON TRADE AND DEVELOPMENT

UNITED NATIONS

CENTER FORINTERNATIONALDEVELOPMENTHARVARD UNIVERSITY

The Standardization of Law andIts Effect on Developing Economies

Katharina Pistor

No. 4, June 2000

G-24 Discussion Paper Series

Research papers for the Intergovernmental Group of Twenty-Fouron International Monetary Affairs

UNITED NATIONSNew York and Geneva, June 2000

CENTER FOR INTERNATIONAL DEVELOPMENTHARVARD UNIVERSITY

UNITED NATIONS CONFERENCE ONTRADE AND DEVELOPMENT

Note

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The views expressed in this Series are those of the authors anddo not necessarily reflect the views of the UNCTAD secretariat. Thedesignations employed and the presentation of the material do notimply the expression of any opinion whatsoever on the part of theSecretariat of the United Nations concerning the legal status of anycountry, territory, city or area, or of its authorities, or concerning thedelimitation of its frontiers or boundaries.

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iiiThe Standardization of Law and Its Effect on Developing Economies

PREFACE

The G-24 Discussion Paper Series is a collection of research papers preparedunder the UNCTAD Project of Technical Support to the Intergovernmental Group ofTwenty-Four on International Monetary Affairs (G-24). The G-24 was established in1971 with a view to increasing the analytical capacity and the negotiating strength of thedeveloping countries in discussions and negotiations in the international financialinstitutions. The G-24 is the only formal developing-country grouping within the IMFand the World Bank. Its meetings are open to all developing countries.

The G-24 Project, which is administered by UNCTAD’s Macroeconomic andDevelopment Policies Branch, aims at enhancing the understanding of policy makers indeveloping countries of the complex issues in the international monetary and financialsystem, and at raising the awareness outside developing countries of the need to introducea development dimension into the discussion of international financial and institutionalreform.

The research carried out under the project is coordinated by Professor Dani Rodrik,John F. Kennedy School of Government, Harvard University. The research papers arediscussed among experts and policy makers at the meetings of the G-24 Technical Group,and provide inputs to the meetings of the G-24 Ministers and Deputies in their preparationsfor negotiations and discussions in the framework of the IMF’s International Monetaryand Financial Committee (formerly Interim Committee) and the Joint IMF/IBRDDevelopment Committee, as well as in other forums. Previously, the research papers forthe G-24 were published by UNCTAD in the collection International Monetary andFinancial Issues for the 1990s. Between 1992 and 1999 more than 80 papers werepublished in 11 volumes of this collection, covering a wide range of monetary and financialissues of major interest to developing countries. Since the beginning of 2000 the studiesare published jointly by UNCTAD and the Center for International Development atHarvard University in the G-24 Discussion Paper Series.

The Project of Technical Support to the G-24 receives generous financial supportfrom the International Development Research Centre of Canada and the Governments ofDenmark and the Netherlands, as well as contributions from the countries participatingin the meetings of the G-24.

THE STANDARDIZATION OF LAW ANDITS EFFECT ON DEVELOPING ECONOMIES

Katharina Pistor

Kennedy School of GovernmentHarvard University

G-24 Discussion Paper No. 4

June 2000

viiThe Standardization of Law and Its Effect on Developing Economies

Abstract

A widely used tool in law and development programmes is the supply of well-designed lawsfrom the outside. This method of law development has now been embraced by internationalorganizations as a way to improve the legal framework for global markets. The InternationalMonetary Fund (IMF) has endorsed attempts by various organizations to develop legal standardswith special emphasis on corporate and financial institution laws. The common idea behindthese attempts is that the supplied laws once incorporated into domestic legal systems willimprove the existing legal framework, and thus further economic development. This paper takesissue with this concept of law development. It argues that for developing effective legal systems,the contents of the supplied laws is of only secondary importance to the process of lawdevelopment and the compatibility of the new laws with pre-existing conditions, including existinglegislation and legal institutions. Three factors account for this: (i) only a few rules arefreestanding, i.e. can be fully understood and enforced without reference to other legal termsand concepts; (ii) law is a cognitive institution, and the application and enforcement of rules isdetermined by the perception of new rules by users and enforcers in the receiving country; and(iii) effective law enforcement is a function of the extent of voluntary compliance and availableresources in a given country. A closer analysis of the rules whose standardization is currentlyproposed for building an international financial architecture shows that the implementation ofthese standards and their effectuation will require more efforts by the law receiving countriesthan underwriting them, if the goals of standardizing the law are to be achieved. The paperdiscusses the implications for countries wishing to attract foreign investments by adopting thenew standards, and makes some proposals for creating more effective legal systems in the areaof financial law.

ixThe Standardization of Law and Its Effect on Developing Economies

Table of contents

Page

Preface ............................................................................................................................................ iii

Abstract ........................................................................................................................................... vii

I. Introduction .............................................................................................................................. 1

II. The perfect construction of law through international standardization ............................ 2

III. The interdependence of rules .................................................................................................. 5

A. National model ..................................................................................................................... 6B. Lowest cost denominator ..................................................................................................... 7C. Synthetic concept ................................................................................................................. 7

IV. Law as a cognitive institution ................................................................................................. 8

V. Law enforcement ...................................................................................................................... 8

VI. Standardizing law for the international financial architecture ........................................... 9

A. International Accounting Standards................................................................................... 10B. IOSCO Objectives and Principles of Securities Legislation ............................................. 10C. IAIS Insurance Principles, Standards and Guidance Papers .............................................. 12D. OECD Principles on Corporate Governance ..................................................................... 13

VII. Implications for developing countries .................................................................................. 14

VIII. Conclusion ............................................................................................................................... 17

Notes ........................................................................................................................................... 17

References ........................................................................................................................................... 19

1The Standardization of Law and Its Effect on Developing Economies

I. Introduction

The integration of markets has gone hand inhand with a proliferation of efforts to harmonize keyaspects of the law relating to finance and trade. Fol-lowing the recent financial crises in Asia, Russia,and parts of Latin America, the International Mon-etary Fund has embarked on improving the interna-tional financial architecture, with special emphasison the legal framework for corporate finance andcorporate governance.

The vehicle for building the legal architecturefor global markets is the harmonization of law aroundthe globe by way of developing legal standards.1

These standards may be incorporated into interna-tional conventions, bilateral treaties, or retain thenon-binding form of recommendations. The expec-tation is that standardization will accelerate theprocess of legal convergence, with the double ben-efit of reducing transaction costs for transnationalinvestors and increasing the quality of legal in-stitutions in countries whose institutions are lessdeveloped. This expectation is based on the assump-tion that convergence towards international legalstandards will improve the institutional environmentin the receiving country. The standards proposed havea clear normative agenda. At least at face value,2 theirpurpose is not simply to harmonize in order to re-

duce transaction costs and to benefit from economiesof scale, but to improve domestic legal institutions.3

The paper takes issue with this approach toreforming domestic legal systems. The proposedstandards often do not hold what they promise, aswill be further discussed in chapter VI. More impor-tantly, the paper questions the assumption that legalharmonization will result in improvement of legalinstitutions. It argues that the quest for developingan optimal set of legal rules ignores a central featureof successful economic development, namely the con-stant change, innovation, and adaptation of institutionsand organizations in a competitive environment. Thestandardization of “best practice” or “efficient” lawreplaces the Schumpeterian process of “creative de-struction” with the ideal of the “perfect construction”of law. Instead of improving domestic legal systems,standardization or harmonization may in fact under-mine the development of effective legal systems. Thereason for this can be found in two essential featuresof legal systems. First, the interdependence of legalrules and concepts that comprise a legal system, andsecond, the fact that law is a cognitive institution.The interdependence of legal rules means that thereare only very few rules that can be understood andapplied without reference to other legal rules or con-cepts. This implies that standardized rules can berealized and enforced only if other bodies of law al-ready exist in the standard receiving legal system, or

THE STANDARDIZATION OF LAW ANDITS EFFECT ON DEVELOPING ECONOMIES*

Katharina Pistor

* I should like to thank the participants of the G-24 Technical Group Meeting in Lima, 2–4 March 2000, as well as the participantsat the MacArthur Transnational Economic Security Workshop at MIT, for their comments and suggestions.

2 G-24 Discussion Paper Series, No. 4

if additional law reform efforts are made. Withoutensuring complementarity between the new law andpre-existing legal institutions, harmonization maydistort rather than improve the domestic legal frame-work.

The notion that law is a cognitive institutionmeans that for it to be effective and actually changebehaviour, it must be fully understood and embracednot only by law enforcers, but also by those usingthe law, i.e. its “customers”, or legal intermediaries,including courts, judges, etc. The external supply ofbest practice law, while facilitating more radicalchange than might be feasible without externalpressure, sterilizes the process of law-making frompolitical and socio-economic development, andthereby distances it from the process of continuousadaptation and innovation. The process of legal in-novation depends on the availability of informationnot only about the contents of legal rules – some-thing international legal standards do provide – butalso about their functioning in the context of a livinglegal system. The perfect construction of law by le-gal experts for wide dissemination can deprive lawmakers and law enforcers in the receiving countriesof the knowledge of living law, which is context-specific. Moreover, the imposition of rules from theoutside – not a new experience for most developingcountries, as the history of colonization exemplifies– may also lead to domestic resistance. Thus, irre-spective of the quality of the supplied legal standards,the paper questions the feasibility of using this ap-proach for developing effective legal systems, i.e.legal systems that are capable of effectively enforc-ing laws and adapting them to a changing domesticand international environment.4

The development of effective domestic institu-tions is crucial for the governance of global markets,because without a supranational enforcement system,law enforcement is dependent on local institutions.Even in cases where disputes are settled by inter-national arbitration tribunals in accordance withinternational arbitration standards, domestic courtswill need to recognize the award. Domestic bailiffs,court enforcers, sheriffs, etc., will need to seize as-sets, freeze bank accounts, or take other actions toexecute the award should the parties fail to complyvoluntarily. Thus, the standardization of law does notsolve the problem of transnational transactions be-ing governed by multiple jurisdictions. At best, itmay reduce uncertainty about the substance of theapplicable law. Standardization, however, is not aguarantee for uniform interpretation and enforcementof set standards.

A more fundamental issue that is not addressedin this paper is whether the areas of the law currentlytargeted by IMF standardization claims are in factthe most relevant areas for legal reforms by devel-oping countries. While there is some empiricalevidence that equity markets are important determi-nants of economic growth (Levine and Zervos, 1996;Levine, 1998),5 comparative data also suggest thatcountries need to cross a certain threshold in theirincome levels before viable securities markets cantake off. More importantly from the point of view oflegal development, most of the proposed reformsdepend on the existence of a fairly developed andwell functioning legal infrastructure. Without thisinfrastructure, reforms in the proposed areas of ac-counting standards, securities legislation, insuranceregulation, and even corporate governance will re-main at the surface. In most of this paper, however,we shall not question the relevance of reforms in theseareas of the law, but focus on the question whetherthe desirable improvements in domestic legal insti-tutions can be achieved by adopting legal standards.

The paper is organized as follows: chapter IIgives an overview of the most important stand-ardization efforts for the international financialarchitecture that are currently underway, assesses thejustification for harmonizing law in these areas, andreviews the debate about the costs and benefits ofharmonization versus regulatory competition; chap-ter III discusses the problem of the interdependenceof standardized rules within the pre-existing legalsystem; chapter IV introduces the concept of law asa cognitive institution; chapter V discusses the pro-pensity of newly introduced standards to affectbehaviour, i.e. the problem of law enforcement; chap-ter VI applies this framework to the legal rules thatform the core of the international financial architec-ture; chapter VII discusses the possible implicationsfor attracting foreign investments by countries thatsubscribe to standardized rules, and develops somepolicy proposals for improving the effectiveness oflegal institutions as an alternative or complement toadopting standardized rules.

II. The perfect construction of lawthrough international standardization

The current trend towards globalization of mar-kets has not invented but re-enforced the idea ofdefining a common core of legal standards. The mostprominent example for legal harmonization of finan-cial market regulations is the Basle Capital Accord


of 1988, which established capital adequacy rulesfor banking engaging in cross-border activities.6 Theintegration of financial markets, in particular themassive flow of international capital to emergingmarkets, has exposed the legal and institutional en-vironment of these countries to pressures they wereoften not able to withstand.7 In response to the recentfinancial crises in emerging markets, the governanceof markets, firms and intermediaries has become thefocal point of attention.

The legal standardization efforts identified bythe International Monetary Fund to be of primary im-portance for the international financial architecture,in addition to banking regulation, include account-ing, auditing, bankruptcy, corporate governance,insurance regulation and securities market regula-tion.8 Various entities are involved in developing legalstandards for these areas of law. Some are professionalinterest groups whose members come primarily fromthe private sector. An example is the InternationalFederation of Accountants (IFAC). Others recruittheir members from national regulatory agencies.Both the International Association of Insurance Su-pervisors (IAIS) and the International Organizationof Securities Commissions (IOSCO) represent thiscategory of international standard setters. In addi-tion, several multilateral organizations are involvedin building the legal architecture for global markets.The United Nations Commission on InternationalTrade Law (UNCITRAL) has a long record of de-veloping model laws and international conventions,9

and has recently adopted a Model Law on Cross-border Insolvency. UNCITRAL collaborates with theWorld Bank and the International Bar Association(IBA) in developing a model law for domestic bank-ruptcy law. Finally, the Organization for EconomicCooperation and Development (OECD) has recentlyadopted standards for corporate governance, theso-called “Principles of Corporate Governance”. Inaddition, the OECD has developed a separate set ofcorporate governance principles for transition econo-mies. The World Bank is also engaged in improvingthe framework for corporate governance in many ofits lending countries.

A common feature of the above listed stand-ardization efforts is their non-binding nature. All takethe form of recommendations directed at the mem-bers of their organizations. In cases where sovereignStates are members, the addressees of the standardsare law makers. Where members are primarily pri-vate parties – as is the case with the InternationalAccounting Standards Committee (IASC) – thestandards pursue, at least implicitly, a dual goal: a

bottom-up dissemination of standards through theiradoption by individual companies and firms, and alobbying effort for legislative change to incorporatethe organization’s standards into domestic law.10

Another feature of the financial law standardsis that they tend to be general in nature rather thanspecific, and leave ample scope for their interpreta-tion to law makers and law enforcers. Rather thanharmonizing highly specified rules, the standards aimonly at establishing the principles for such rules. Thismeans that there is no attempt to force a single set ofrules – the perfect law – upon sovereign law makersaround the world. In principle, countries can there-fore choose not to adopt these standards, and are freeto modify them where appropriate. Yet, the aim ofstandardization is to minimize deviations from thestandards, lest the very purpose of standardization isundermined. Most standard setters are therefore quiteexplicit about the need to abide as closely as possi-ble by the standards.11 Moreover, the endorsementthat legal standardization has received from the IMFstrongly suggests that these standards may serve toassess the quality of domestic laws in the future. Italso leaves open the possibility for them to be usedas conditionalities in loan agreements.

The voluntary and non-binding nature of legalstandards reduces the degree to which law will actu-ally be harmonized across jurisdictions, and byimplication it reduces the possible savings for trans-national investors as a result of the standardizationeffort. However, it gives countries greater scope fortaking an active role in the reception of these stand-ards and their transformation into domestic law. Thisrequires that domestic law makers have a good senseof the purpose of the proposed rules and the alterna-tive choices for detailed rule-making they may entail,which in turn presupposes familiarity with living le-gal systems. The supply of ready-made standards todomestic law makers does not facilitate, and mayactually impede, the acquisition of this knowledge.Legal standards developed at the supranational levelare typically distilled from legal practice in individualcountries, without their merits having been tested ina functioning legal system. The generality of stand-ards may also disguise the fact that they often entaila substantial reallocation of rights with importantimplications for the political economy of enforcingthem within a domestic setting. At the same time,their generality opens up the possibility for subscrib-ing to them without necessarily implementing them.12

This makes not only monitoring of compliance diffi-cult, but also misguides investors, who may take thefact that a country has formally subscribed to a stand-


ard as evidence that the law is in fact used and en-forced in a certain way. Alternatively, investors maytake the signals for what they are – formal or crea-tive compliance with international standards. Whilethey may perfectly understand that this does not nec-essarily increase the security of their investments inthe long term, they will at least have covered theirback vis-à-vis their own superiors and ultimately theirinvestors.13 However, if subsequent experience re-veals that these assumptions are wrong, this mayincrease rather than reduce uncertainty as to how toassess the investment environment of a given coun-try. Conversely, countries that are actually complyingin practice with these standards may experience sig-nalling problems, as the law on the books will looseits signalling power.

Developing international legal standards andadapting legal systems around the world to thesestandards is a costly undertaking, and thus requiressome justification. The harmonization or standardi-zation of law can be questioned on principle grounds,irrespective of the area of the law in question andthe quality of the standards that may emerge fromthe effort. This is the topic of the debate over thecosts and benefits of harmonization versus regula-tory competition in producing better rules from aneconomic efficiency point of view.14 This debate haslong focused on law development within domesticlegal systems, in particular federal systems, buthas more recently also embraced the topic of lawdevelopment in a global economy. Advocates of har-monization claim that minimum standards are neededto prevent a race to the bottom between different ju-risdictions. Countries around the world compete forcapital and, in order to attract foreign capital, theywill tend to offer lax rules in the relevant areas oflaw, including tax, torts, environmental protectionand financial market regulation. Moreover, harmo-nized legal rules will lower transaction costs, andtherefore foster international trade and commerce.Proponents of regulatory competition argue that har-monization will result in sub-optimal rules: Differentreasons are put forward to support this point of view.The process of selecting legal standards that are tobe harmonized may lead to the choice of the lowestcommon denominator, instead of the most efficientrule. Where there is little certainty about the rightchoice, as in most cases, harmonization will lock alarge number of jurisdictions into sub-optimal rulesand prevent flexible adaptation to better rules and tochanging circumstances. Instead, competition be-tween regulators will lead to a race to the top andbring about efficient rules, because experience willteach regulators that in the long term they will ben-

efit from adequate protection of investors and a highquality legal system.

Some authors have developed a more attenu-ated assessment of the relative costs and benefits ofharmonization versus regulatory competition.15 Theyargue that both harmonization and regulatory com-petition tend to lead to indeterminacies and thus tosuboptimal legal rules, albeit for different reasons.In the case of legal harmonization, the diversity ofopinions and the necessity to compromise lead toindeterminacy. When experts are in charge of devel-oping legal standards, they may have incentives toensure the need for their services in the future. Theuse of open-ended terms typically requires furtherexpert consultation, and indeed can be frequentlyfound in private law-making activities.16 But regula-tory competition may also lead to indeterminacies.17

Once a regulatory system has established a head startover others, it benefits from rules that can be inter-preted and applied only within that regulatory regime.Superior legal expertise of attorneys and judges is animportant asset that is not easily emulated by otherjurisdictions.18 This advantage can be re-enforced bydeveloping rules that require their expertise. An im-portant implication of this debate is that the outcomeof the law-making process is not independent of thatprocess.

But the quality of the law that results from de-centralized or centralized law-making may not be theonly reason for or against harmonizing law, or de-veloping international standards for certain areas ofthe law. From the menu of possible justifications forharmonization efforts (Leebron, 1996: 51–66), wechoose the ones that are relevant for the assessmentof those standards this paper focuses on, includingjurisdictional interface; the presence of externalities;the non-efficiency of unilateral rules; political econo-mies of scale; and transparency.

An important justification for harmonization isthe interface of different jurisdictions in cases thatinvolve more than one jurisdiction and the difficultyin reconciling different legal regimes. The UNCITRALModel Law on Transnational Bankruptcy is a caseof interface harmonization of legal rules. No attemptis made to standardize domestic rules for all bank-ruptcy cases. The goal is to reduce transaction costsand increase certainty only for those cases that are atthe interface between different jurisdictions withoutnecessitating far-reaching domestic change.

The International Accounting Standards (IAS)pursue a dual role. They seek to establish a common


set of accounting standards independent of domesticlegislation, and to convince domestic law makers toadopt these standards. The latter goal is intended toimprove local institutions, but it is not a necessarycondition for achieving the first goal. This goal canbe justified primarily on grounds of economies ofscale and transparency. If all companies in the inter-national market disclose their financial informationaccording to the same standards, transparency willbe greatly increased and transaction costs reducedfor investors as well as for firms monitoring eachother’s activities.

The other standardization efforts listed abovetarget primarily domestic legal institutions, eventhough the standards of IOSCO and IAIS also aim atimproving collaboration between national supervi-sors in coping with cross-border transactions. Thestandardization of domestic securities market regu-lation could be justified on the grounds that negativeexternalities of movements in the stock market inone country or region of the world should be avoided.The 1997/98 financial crisis in Asia had a strongcontagion effect on other emerging markets. Studieshave shown that the quality of domestic law hasplayed an important role in buffering the effects ofthe crisis. Countries with better laws on the booksand more effective legal institutions were more likelyto weather the storms of the crisis than countrieswhere shareholder protection was only weak on thebooks as well as in practice.19 Another justificationwould be that the fungibility of securities makes itdifficult for each country to unilaterally enforce itslaws.20 Thus, there is a strong theoretical possibilityof a race to the bottom, as issuers may prefer coun-tries with loose regulations over countries withstricter ones. Available evidence, however, does notsupport this proposition. On the contrary, there seemsto be a strong trend to migrate to stricter regimes(Coffee, 1999a; Romano, 1998). As far as the insur-ance industry is concerned, interface jurisdictionmakes a strong case for harmonization. In both cases,however, the efficacy of harmonized rules will de-pend to a large extent on the ability of differentcountries to enforce them. To the extent issuers wishto migrate to weak regulatory regimes, weaknessesin enforcement can create incentives for migrationsimilar to weak laws on the books.

The development of best principles for corpo-rate governance could be justified on the groundsthat political economies of scale can be used to jus-tify legal harmonization in this area of law (Leebron,1996, note 4: 63). Changes in the existing corporategovernance regime may be difficult due to political

stalemate. This problem could be solved by shiftingjurisdiction to a supranational body, or by providingprinciples from the outside. However, the enforce-ment of legal standards thus introduced depends onsubstantial domestic support as well as additionalinstitutional change, and the supply of legal stand-ards may not be sufficient to accomplish this. Asecond argument in favour of standardizing princi-ples of corporate governance could be that theyprevent governments from adopting rules that clearlyserve only some interests, thus making these rulesmore transparent (Leebron, 1996, note 4: 65). On thedownside, however, standardization reduces thechoices for domestic law makers in developing theirown legal solutions, which might be a better fit forthe problems they face, or for the institutional ca-pacities they have. Moreover, the harmonization ofstandards still leaves ample room for ambiguity whentranslating them into specific domestic rules, and is noguarantee for the standards being enforced in practice.

Thus, although there are good justifications forharmonization, at least in some of the areas of thelaw mentioned, the test for the success of harmoni-zation efforts will be the enforcement of the new laws.This leads us to the basic proposition of this paper:Even if it were possible to design the perfect law orto develop the best standards for a particular area ofthe law, the incorporation of this law into a domesticlegal system is per se not a guarantee for it to becomeeffective. For the latter, the process of law-making,the compatibility of the new rules with pre-existingones as well as with given economic and politicalconditions, and the existence of constituencies witha demand for these rules is more important than thecontents of the supplied rules.

In the end, this argument favours decentralizedlaw-making and, by implication, regulatory compe-tition over harmonization. But the point is not thatregulatory competition consistently produces supe-rior law, but that it produces law in a way that itsrelevance will be understood domestically and thatinnovations and adaptations will take place endo-genously through the process of socio-economic andpolitical change.

III. The interdependence of rules

The purpose of standardizing legal rules is toachieve conformity in the contents and quality of lawacross different countries. Additional expectationsare usually associated with the standardization of law,


including lowering transaction costs for market par-ticipants, improving the quality of legal institutionsin some countries, and ensuring consistency in theapplication, interpretation and enforcement of thelaw. This chapter demonstrates that even the primarypurpose of standardizing legal rules – conformity inthe contents of law across countries – is difficult toachieve. The reason is that only very few rules arefreestanding and do not require further explanationin the form of explicit or implicit references to otherrules, legal terms or concepts. In principle, the moreexplanations or cross-references a rule requires, themore difficult it is to achieve conformity.

A good example for free-standing rules aremost, although not all, traffic rules. The rule that acar comes to a stop at an intersection does not re-quire further explanation. The use of traffic signalsis a means to facilitate the recognition of this rule indifferent countries, but adds nothing to the rule it-self. We shall ignore the possibility that this rule isenforced differently in different countries (i.e. insome the police may not intervene when cars slowdown rather than bringing the vehicle to a completestop, while in others they may insist on a full stop).The point is that no further references to other legalrules or concepts are needed to convey the full con-tents and meaning of the rule (although differentenforcement practices may change its meaning overtime). Some traffic rules require, if not a referenceto other legal concepts, at least clarification. An ex-ample is speed limits that apply only under certainconditions, i.e. when the road is wet, in foggy weather,etc. Courts in most countries have had to clarify thethreshold for “wetness” or “fog”. This creates thepossibility for diverging contents of seemingly iden-tical rules. In some countries, a road is said to be wetonly once a seamless layer of water has formed, whilein others a few drops of rain may suffice.

More complexity is added when a rule is notfree-standing but its meaning can be understood onlyin conjunction with other legal concepts. We callthese “dependent rules”. A simple example of a de-pendent rule is “do not steal”. The critical term is“stealing”. An example for defining stealing takenfrom the German criminal code is “the taking of analien object by breaching someone else’s possession”.A host of further questions arises from this defini-tion, and real world cases demonstrate that theapplication of the very simple rule “do not steal” doesin fact raise questions, such as what is an object?Does it include electricity or gas? For example, is itstealing if somebody hooks his home to an electric-ity line without contract and payment? What is alien?

Only objects that are clearly owned by somebodyelse, or also those the “offender” co-owns, or thosethat are part of a common pool? What is a breach ofpossession? What happens if the original owner has“lost” his property?

If we want to standardize the rule “do not steal”as a legal one that will be consistently applied acrossdifferent jurisdictions, we need to agree on some ofthe basic concepts behind this rule. Otherwise stand-ardization will remain at the surface of very diverselegal concepts that give a different meaning to iden-tical rules when applied in different contents. Thissuggests that the standardized rule must include ref-erenced legal concepts. There are several possibleways to go about this. First, one can use the conceptsof a particular national legal order. Second, one cantry to find the lowest common denominator of thediverse legal concepts that are in use in the jurisdic-tions that participate in the standardization effort.And, third, one can try to create new concepts thatsynthesize different legal concepts. The three ap-proaches have different tradeoffs, which are dis-cussed below.

A. National model

The choice of a particular national legal ordermay reduce the costs of adaptation, as at least onecountry already complies with the new standards.However, at least if adopted by States, this approachsmells of domination, or legal imperialism. Politicalreasons therefore make it unlikely that this approachis taken openly, although the search for common de-nominators or a new synthesis often disguises theinfluence of a particular national legal order. Politi-cal factors should be taken seriously, not only becausethey may delay or dwarf the standardization effort,but because they will have a strong impact on recep-tion of the standardized rule. If a legal standard isrejected for political reasons, it is unlikely that sub-stantial efforts will be made to enforce it. But thereare also other reasons for questioning the efficacy ofthis approach for legal standardization. Most impor-tantly, foreign national concepts may be inconsistentwith the pre-existing legal and social concepts in thelaw-receiving country. Several outcomes may resultfrom this mismatch of new and old concepts. First,the new concept may come to dominate over timeand replace pre-existing ones. This would lead toconvergence of law as a result of standardization.Second, new and old concepts may coexist with eachother. This leads to a segmentation of the legal order


and reduces rather than increases certainty, becausethe jurisdiction of different bodies of case law, theirrelation to other legal rules, as well as their contents,will need to be determined on a case-by-case basis.Third, the new legal concept might be ignored andleave no traces on the domestic legal order, eventhough it is on the books. Only in the first case can itbe expected that the introduction of standardizationwill generate the desired effects, but ex ante thisoutcome is undetermined. A different question iswhether companies opt for foreign legal systems forindividual transactions. Choice of law as well aschoice of forum (the place where disputes should beabjudicated) clauses are common in transnationalcontracts, and frequently parties choose a jurisdic-tion that is not the home jurisdiction of either party.The choice of a particular legal system may entailadditional costs as transactions have to be tailor-madeto it, and lawyers with specific knowledge of thatsystem need to be hired. However, having a fall-backoption for issues the contract does not cover andreferring to a system that is known to be highly de-veloped and fairly consistent may well be worth theprice.

B. Lowest cost denominator

The lowest common denominator (LCD) ap-proach is frequently used for standardizing the law.It avoids some of the problems of choosing a par-ticular legal order because, at least in theory, the LCDshould be compatible with pre-existing concepts andrules. However, this approach limits the scope ofstandardization. The minimum standards that areestablished do not preclude diversity in different ju-risdictions. On the positive side, they may raise thelevel of legal rules in countries whose pre-standardi-zation laws did not meet the minimum standard. Onthe negative, they may lower the level of legal stand-ards in jurisdictions that had already developed higherstandards. This does not necessarily prevent a coun-try from raising its national standards, but marketforces may force regulators to stick to the commondenominator. Moreover, raising standards may beprevented by other rules of international or regionaltrade, as they could be interpreted as entry barriersin disguise which violate the principle of free trade.Recent trade disputes between the European Unionand the United States about the export of beef meattreated with hormones exemplify different prioritiesconcerning consumer protection versus free trade.European Union case law is full of examples thatshow the difficulties in balancing the goal of creat-

ing a common legal framework for the Europeanmarket on the one hand, and, on the other, nationalgovernments seeking to ascertain their prerogativeover areas of the law that for various reasons aredeemed to be of “national interest”. Similar conflictscan be expected for other standardization efforts, andshould be taken into consideration when determin-ing the areas and scope of standardized law.21

C. Synthetic concept

A compromise between these two approachesis to create a new legal concept based on compara-tive research and to incorporate it into the standard-ized rule. This approach is appealing because itavoids, or at least mitigates, some of the politicalproblems of using a particular national legal order,mentioned above. It can also be regarded as an im-provement to the LCD approach because it raises thelevel of the standardized rule beyond this minimumlevel, and thus reduces the likelihood that some coun-tries will see the need for more stringent nationalregulation. Yet, as with all compromises, some ofthe problems outlined for the national model and theLCD approach remain. For example, there is littleguarantee that the synthesis will be a better matchfor pre-existing legal institutions than foreign na-tional solution. Moreover, the coalition of countriesthat pushes through the synthesis may be met withsimilar political resistance as the choice of a nationalmodel. In comparison to the LCD approach, the levelof the standardized rule may be higher, but not sub-stantially, as a synthesis is based on a compromise.In addition, new problems arise. Most importantly,the new synthetic concept is, as the name implies, anartificial product that has not been tested in any le-gal system. The new concepts will need to be clari-fied in future case law. Judges and other law enforcersin the different jurisdictions lack a common point ofreference to interpret these concepts, and this in-creases uncertainty for the end users of the law. It istherefore not surprising to find that they frequentlyopt out of internationally standardized rules and pre-fer to choose a specific legal order to govern theirtransactions. An example is the Vienna Conventionon the International Sale of Goods (CISG). Avail-able evidence suggests that in the few cases wherecourts have applied the Convention, both parties wereapparently unaware that this Convention governedtheir transaction (Walt, 1999). Parties realizing thatthey might be subjected to it frequently opt out of itby including a provision in the contract that explic-itly denies the application of the CISG.22 The reason


for opting out is that the uncertainties involved ininterpreting the new terms and concepts included inthe Convention are deemed to be too high (Walt,1999).23 By contrast, where standardization is basedon an existing national model, that national legalsystem may be used as a reference point for furtherclarifications. And where the LCD approach is used,judges may resort to comparative research to iden-tify and interpret legal concepts referenced in the law.Newly created synthetic concepts, by contrast, needto be interpreted from scratch. Legal experts whohelped to design them may participate in this proc-ess, but this raises the spectre of making future legaldevelopment dependent on a small group of more orless arbitrarily chosen experts. It may also createmoral hazard problems, as experts may try to ensurethat their services will be needed in the future whendesigning the standardized rules in the first place(Schwartz and Scott, 1995).

IV. Law as a cognitive institution

The interdependence of legal rules and the char-acteristic of law as a “cognitive institution” areclosely related.24 Because most rules are not free-standing, they can be understood only in the contextof a given legal order. Information about the exist-ence of a norm and its contents is a prerequisite forany impact of the law beyond a shelf life. This prob-lem can be overcome by improving legal informationsystems.25 An additional requirement is that legalrules be understood. This is a serious constraint forlegal transplantation, because – as Sunstein put it –“the meaning of legal statements is a function of so-cial norms, not of the speaker’s intentions” (Sunstein,1996a: 2050).26 In other words, however perfectlydesigned a law that is supplied from the outside maybe, its impact is ultimately determined by how it isunderstood by law makers, law enforcers, and lawusers at the receiving end.

Assuming that a cognitive gap exists betweenany rule that is supplied and the understanding ofthat rule by its end-users, and that this gap impedesthe effectiveness of transplanted rules, the questionarises as to how to close this gap. One approach takenin the literature is to make appropriate changes onthe supply side, for example by supplying simple,bright-line rules rather than detailed complex ones.27

An alternative approach is for the law to spell out indetail the rights and responsibilities of the relevantparties. This is supposed to have beneficial educa-tive effects on the recipients of the law.28 A bright

line approach could be sufficient if the problem wasmerely an intellectual, not a cognitive, one. It is pos-sible to argue that in many countries the legalprofession is not sufficiently trained and highly so-phisticated rules may not be understood for thisreason. However, it is also true that even the sim-plest rule acquires different meanings in differentcontexts. Take, for example, the simple rule “do notsteal”, we have discussed above. How should thisrule be applied in relation to communal property? Isovergrazing of the commons captured? Where shallthe line between normal use and overgrazing bedrawn? What about takings by people who are notmembers of the social group which shares the com-mons? As discussed in the previous chapter, it ispossible to define the concepts that the rule “do notsteal” refers to in more detail. This will certainlyclarify the scope of application of this rule, but itmay also render the rule useless in contexts that areoutside its scope.

V. Law enforcement

The idea behind the standardization of law isthat well-designed legal standards once adopted bydomestic governments will change the behaviour ofindividuals and entities, and thereby influence thepath of future economic development. The adoptionof a law, however, is not a guarantee that it will in-deed affect behaviour, or that it will affect behaviourin the intended fashion. While informal rules of be-haviour, or norms, survive only if a sufficiently largenumber of people comply with them, formal law mayremain on the books, even if ignored or contradictedby actual behaviour.

The enactment of a new law that is designed tochange behaviour can have essentially four outcomes.First, the law may be ignored. Existing behaviouralpatterns are not changed and, as a result, the law doesnot have any impact. Second, the law may be ob-served formally, but be circumvented in practice. Thishas been aptly called “creative compliance”.29 Crea-tive compliance is relatively easy, where the new lawis ill-specified and general terms leave much roomto interpretation. The scope of behaviour that can besubsumed under such a law is broad. Courts typi-cally try to define the limits of such expansiveinterpretation by taking recourse to the spirit of thelaw or the intention of the law makers. These con-cepts, however, are themselves unspecified andsubject to varying interpretations. Creative compli-ance is also possible when rules are highly specified.


In fact, McBarnet and Whelan, who coined this term,have defined it as “the use of formalism to avoidlegal control” (Belcher, 1995). Formalistic applica-tion of the law often contradicts its spirit. Examplesinclude the holding of elections to buttress the claimthat a country is a democracy, even though only in-cumbents may stand for office; the convocation of ashareholder meeting at a remote place, which onlypre-informed shareholders are able to reach on time;or the exclusion of critical shareholders under theguise of formalistic violations of the law.30

Third, law may be designed so that it appliesonly selectively. Examples for explicit exemptionsinclude a waiver of strict liability rules, and the im-plementation of safety or environmental standardsfor certain sectors. Frequently, however, exemptionsare implicit. An exemption from the application ofan otherwise general rule can be granted by definingthe scope of its application in a fashion that excludespotential target groups, which may render the entirerule ineffective. An example is a provision in theGerman corporate law that denies liability of man-agement for wrongful conduct if the conduct wasapproved by a majority vote taken at a shareholdermeeting. Since German companies are often control-led by friendly blockholders, such a vote may not bedifficult to come by. The provision in essence ex-empts management from liability vis-à-vis minorityshareholders.31 Even when a law applies universally,enforcement may be selective. In tax matters Statesmay wish to spare sectors that are key to the economyand/or have good political connections. Finally, thefourth and – from the standpoint of law makers – mostdesirable outcome is that the new law may be used andapplied indiscriminately in the intended fashion.

The propensity of the law to affect behaviourdiffers in the four scenarios. A law ignored has noimpact on actual behaviour. A law that leads to crea-tive compliance has an impact on behaviour, but notthe intended one. The expected effect of the law istypically not achieved. Instead, economic agents de-vise schemes to neutralize its impact. The net resultmay well be a welfare loss, as the circumvention strat-egies may create additional costs. The selectiveapplication of law does change the behaviour of thosewho either voluntarily comply with, or are subjectedto (selective) enforcement. The selectivity of lawenforcement may over time erode the force of thelaw and lead to widespread creative rather than truecompliance. This will be the case when those whobear the costs of compliance cannot reap its benefits,because they will accrue only if a sufficiently largenumber of other agents comply as well. An example

is compliance with disclosure requirements. Eventhough this is costly for firms, they may benefit fromcomparing their information with that of othermarket participants and from reading the market re-sponses to the disclosed information. However, thesebenefits accrue only if a firm is not alone in disclos-ing its information.

When voluntary compliance cannot be ensured,to be effective law has to be enforced by the State.One may regard voluntary compliance and Stateenforcement as substitutes. In fact, they are comple-ments. To be effective State enforcement dependson high levels of voluntary compliance. Only in thiscase can resources be bundled to enforce the lawagainst deviant behaviour. If deviant behaviour iswidespread, law enforcement will be ineffective. Thereverse is also true. Thus, the fact that most disputesin every day life are solved without reverting to Stateenforcement agencies is, at least in part, dependenton the belief that, if this failed, State enforcementwould in fact be available.

VI. Standardizing law for theinternational financial architecture

In this chapter, we apply the above analysis tothose legal rules that currently form the core of thestandardization efforts endorsed by the IMF (see chap-ter II above). We shall exclude the UNCITRAL Modellaw on cross-border insolvency, because the targetof this model law is limited to transnational casesand the improvement of domestic legal institutionsis not the primary purpose of this harmonization effort.

The purpose of this analysis is to establishwhether the incorporation of the standardized rulesare likely to lead to an improvement in the domesticlegal system or not. This would require, first, thatthe standards be used for assessing the quality of thedomestic legal framework. In other words, the stand-ards should offer independent guidance, whichimplies that key concepts are included in the stand-ards themselves. Second, we shall check the extentto which the major standardized rules are free-stand-ing, or else whether they are dependent on domesticor synthetic legal concepts. Free-standing rules willbe the easiest to incorporate, as they do not requireextensive additional reform efforts to make pre-ex-isting rules compatible with them. Reference todomestic systems may increase the likelihood that astandard will be used and applied in future, as wellas questions as to whether the overall goal of thestandardization effort can be achieved. References


to synthetic concepts incorporated in the standards(or related documents) will achieve the harmoniza-tion of the law on the books, but as discussed above,they may be difficult to interpret and enforce.

A. International Accounting Standards

Of the different legal standards discussed in thispaper, only the International Accounting Standardsare free-standing. The immediate objective of thesestandards is to formulate an independent set of ac-counting standards for worldwide use by companies(IASC, 1999, note 41: 29). The harmonization ofaccounting standards around the world is a secondobjective, but this is not a prerequisite for the firstobjective to be realized. In essence, IAS can be com-pared to the artificial language Esperanto. Esperantodoes not replace local languages, but functions as anindependent medium for communication. While Es-peranto has not been a success, there is evidence thatfirms in many jurisdictions have decided to disclosetheir financial data both according to domestic stand-ards and according to IAS. This is costly for companiesand a good reason to harmonize the rules over time.But the goal of IAS can be achieved irrespective ofharmonization, as they offer an additional set ofstandards that facilitates international comparisons.In order to create a free-standing body of rules, theIAS include principles of accounting, its purposes,as well as detailed rules about how to enter informa-tion for specific items, including inventories, costsfor research and development, employee benefits, andthe like. It is certainly possible (and indeed quitelikely) that not everything of relevance is included,i.e. that IAS have gaps. But this feature they sharewith any domestic legal rule. The difference to de-pendent rules is that the meaning of the IAS can bederived from reading the IAS alone and no furtherreference to other rules, legal concepts or entire bod-ies of law needs to be made. In the light of the aboveanalysis, this bodes well for harmonization. Althoughdomestic law makers may, for whatever reasons, stickto their own accounting standards, firms have at leastthe option to use IAS in addition to the local ones.This might be costly, but the rewards in the form ofgreater recognition on the international market maywell be worth it.

B. IOSCO Objectives and Principles ofSecurities Legislation 32

The IOSCO Objectives and Principles of Secu-rities Legislation (IOSCO Principles) include only

the basic principles of securities legislation and re-fer to a host of other guidelines and recommendationsthat were developed by IOSCO. We shall ignore mostof these other guidelines for the purpose of this analy-sis, although it should be noted that they often providethe concepts that the general guidelines discussedhere refer to.

The IOSCO Principles explicitly state that theefficacy of the proposed rules will depend on thescope and quality of the general framework for com-mercial law. Thus, they are making these rulesdependent not only on specific rules included in otherstatutes, but on the broader legal framework. Annex3 to the IOSCO Principles lists those parts of thelegal framework which, according to IOSCO, are ofspecial importance. The list includes company, com-mercial, and contract law; tax laws; bankruptcy andinsolvency laws; competition law; banking law; andthe entire system for dispute resolution. For each areaof the law, IOSCO lists those aspects that are ofparticular relevance to securities regulation. With re-spect to company law, special company formation,the duties of directors and officers, regulations oftakeover bids and other transactions intended to ef-fect a change in control, laws governing the issueand offer for sale of securities, disclosure of infor-mation to security holders to enable informed votingdecisions and disclosure of material shareholders arelisted. For commercial and contract law, the IOSCOPrinciples include private rights of contract, facilita-tion of securities lending and hypothecation, propertyrights, including rights attaching to securities, andthe rules governing the transfer of those rights. Forother areas, the reference is more opaque. With re-spect to tax laws, the Principles note the importanceof clarity and consistency, “including, but not lim-ited to, the treatment of investments and investmentproducts”. And for dispute resolution systems, “a fairand efficient judicial system (including the alternativeof arbitration or other alternative dispute resolutionmechanisms)” as well as the “enforceability of courtorders and arbitration awards, including foreign or-ders and awards” are noted as prerequisites foreffective securities regulation. In sum, securities leg-islation rests on the existence of a comprehensiveand effective legal system.

Without questioning the interdependence ofsecurities legislation with other parts of the legalsystem, it is at least worth considering whethereffective securities legislation could serve as a func-tional substitute to other legal provisions that maynot be working quite as well. The concept of a func-tional substitute is well known in comparative law,


where scholars have long asserted that identical le-gal problems may be solved by different legal rulesand/or institutions.33 A simple example is the treat-ment of trusts as a contract or a property right.Economic analysis of the details of these legal con-cepts in civil and common law systems reveals that,irrespective of this fundamental difference, they per-form essentially similar functions (Hansmann andMattei, 1995). One proposition made in the compara-tive corporate governance literature – of particularrelevance to the questions addressed in this paper –is that weak enforcement of minority shareholderrights in the general court system could be substi-tuted by effective securities market legislation.34 Thesuccessful migration of firms from home markets thatprotect shareholder rights only weakly to marketswith strong securities regulations is taken as an indi-cation for the host jurisdiction offering substitutelegal protection. The interesting point about this ex-ample is that migrating companies take the homecorporate law with them, but subject themselves tomore stringent securities regulations. Observers ofcapital market development in transition economieshave found that effective securities market regula-tion has been more important in promoting marketdevelopment than minority shareholder protection.35

Results from a study using data from 24 transitioneconomies confirm these findings. In fact, the qual-ity of securities market legislation is the only law onthe books variable that has a (marginally) signifi-cant impact on securities market development in thesecountries.

The major lesson from these findings is thatdespite the fact that IOSCO itself draws attention toother parts of the legal system as a prerequisite forthe efficacy of the proposed standards, it is at leastworth considering whether strong securities marketregulations could substitute for weaknesses in otherareas. Yet, it is important to consider the tradeoffs ofinvesting in one part of the legal system with limitedimpact on others when resources for legal reform arelimited.

Beyond a general reference to other areas ofthe domestic legal system, the IOSCO Principlesexplicitly reference three types of rules: (i) specificdomestic legislation; (ii) domestic politics and theaccountability of government agents; and (iii) syn-thetic legal concepts developed in other IOSCOregulations. The very fact that they do so demon-strates the breadth and complexity of legal reformthat will be necessary to make securities legislationwork. In addition, the examples show that in the enddomestic law makers are in many cases left to

decide for themselves the appropriate level of regu-lations.

References to domestic legislation include theuse of legal concepts that imply further definitions.An example is the problem of conflict of intereststhat, according to IOSCO Principles, is relevant, inparticular for self-governing organizations and man-agers of collective investment schemes (CIS).36

Where the boundaries are to be drawn between per-missible actions and those that are clearly considereda conflict of interests is up to each legal system. Inmost countries, the final demarcation of this line isleft to the courts, as it is difficult to come up with adefinition for codifying a rule that is both sufficientlyabstract to include a range of potential cases and yetstill specific enough to be enforceable. Other exam-ples include more general references to regulations,including accounting standards, the regulation of CIS,intermediaries, or banks.37 Further guidance is givenin some additional IOSCO guidelines. However, inseveral instances, regulators are warned that a par-ticular issue needs to be regulated, but no guidanceas to the possible contents is given. The IOSCO Prin-ciples state, for example, that the level of disclosurerequired for corporate control differs from jurisdic-tion to jurisdiction.38 While this statement is certainlytrue, it is of little guidance for law makers in devel-oping markets in deciding on an appropriate level ofdisclosure for their country.39

In several instances, the IOSCO Principles gofar beyond references to specific parts of the domes-tic legal system, but reference the quality of theoverall legal system, or the legal and political gov-ernance system. In an attempt to define the meaningof “accountability of the regulator”, the Principlesstate that this implies:

• a regulator that operates independently ofsectoral interests;

• a system of public accountability of the regula-tor;

• a system permitting judicial review of the regu-lator’s decisions.

These are important conditions, which pointdirectly to the political structure and the realizationof the rule of law in a given country. A system per-mitting judicial review of decisions of the regulatorcertainly does not imply that all acts of the State needto be subject to judicial review, but certainly thoseof the securities market regulator. The issue of pub-lic accountability of the regulator raises a host ofquestions about the effectiveness of legal constraints


and other mechanisms of accountability, includingappointment, dismissal and disciplinary procedures.Taken seriously, making the securities market regu-lator accountable would in many countries requirefar-reaching political reforms.

Finally, in a few cases, the IOSCO Principlesreference synthetic legal concepts. An example is thereference to regulation of collective investmentschemes (CIS). IOSCO has adopted separate guide-lines for CIS which include a definition of this term.40

It is quite comprehensive and tries to include thevariance of investment funds that deal in securitiesfound in a large number of countries (or at least thosethat were most influential in drafting the guideline).At the same time, it is limited by excluding closed-end funds and “schemes investing in property/realestate, mortgages or venture capital”.41 There are twoproblems with this approach. First, the definition ofwhat comprises a collective investment scheme isbased on partial empirical observation. It is derivedfrom investment schemes common in developedmarkets, but is likely to exclude many other struc-tures that already exist or may arise in other markets.Second, the regulation of one class of investment(open-ended funds that invest in securities), but notothers, can create distortions. Promoters of schemesthat fall under the definition of the guideline willcertainly try to find ways around them when con-fronted with adjustment and compliance costs.

To summarize, the IOSCO Principles cannot becharacterized as free-standing rules. They referenceother laws and legal concepts, including domesticlaws and synthetic concepts found in other IOSCOPrinciples. In addition, they call attention to howclosely related a well-functioning regime for regu-lating securities market is with the political systemand the existence of absence of mechanisms of ac-countability. A general agreement to adopt thesestandards and comply with them can therefore behardly more than a memorandum of understanding.Without additional reforms, including reforms aimedat enhancing the accountability of State agents,change will not be achieved.

C. IAIS Insurance Principles, Standardsand Guidance Papers 42

The most striking aspect about the IAIS Insur-ance Principles, Standards and Guidance Papers(IAIS Principles) is that they fail to define what con-stitutes an insurance business. The introduction tothe Principles explicitly refers this to future work. In

lieu of a common definition of insurance business,the Principles leave the definition of insurance busi-ness entirely to domestic law. This, of course, is notonly an open invitation to creative compliance,43 butdefeats the very purpose of legal harmonization.Thus, the IAIS Principles fail to meet the first crite-rion we established at the outset of this analysis,namely that standards can be used to assess the qual-ity of the domestic legal framework.

The inability to find a common definition canin part be attributed to the wide variety of risks thatmay be insured against, which distinguishes this sec-tor from other financial industries. It certainly reflectsthe diversity of insurance activities in IAIS membercountries and the difficulties in reconciling differ-ences in commercial practice and regulatory activitiesof different countries. This of course raises the morefundamental question whether standardization insuch a diverse sector is at all meaningful. It is prob-ably safe to say that until a common definition ofwhat constitutes an insurance business is agreedupon, the Principles are unlikely to have any seriousimpact. Take, for example, the general licensing prin-ciples established by IAIS. The basic notion is thatcompanies wishing to underwrite insurance in thedomestic insurance market should be licensed (IAISPrinciples: 5). However absent a definition of whatinsurance business means, it is simply impossible todetermine whether or not countries comply with thelicensing requirement. A provision that states that“licence refers to the authority to operate business inthe domestic market, which under domestic law isdefined as insurance business” (IAIS Principles:30 (5)) is as meaningless as a provision that wouldallocate the right to define the scope of legal protec-tion of trade marks to their users. The Principlesrecognize that differences in the definition of insur-ance business can lead to supervisory problems,especially where cross-border operations areconcerned (IAIS Principles: 31 (13)). Yet, they con-template excluding certain activities from theapplication of the IAIS Principles – without havingestablished the scope of their applicability in the firstplace. Thus, insurance activities that are limited asto the possible number of policyholders or to a geo-graphical area shall be exempted from the applicationof the Principles. The phrasing of the exemption sug-gests that the drafters of the Principles had to bow topressure from members in whose countries non-li-censed insurance activities proliferate: “The reasonfor this fact [the exclusion] could be that the insuredsums do not exceed certain amounts, or that lossesare compensated by payments in kind, and that theactivities are pursued following the idea of solidar-


ity”. It is not difficult to imagine how non-licensedinsurance activities could mushroom under the pre-text that they pursue the idea of solidarity. Moreimportantly, to include exemptions in regulations thatdo not define the scope of the regulation is a mean-ingless exercise. Without clearly stating whether thecriteria used to justify the exclusions (number ofpolicyholders, sums involved, purpose or motivationof activity) are relevant for defining the scope of in-surance business regulations, they can hardly be usedfor justifying an exemption from their application.

Given that the IAIS Principles fail to provideeven a common lowest denominator for the type ofactivities that will be governed by these principles,what can possibly be accomplished by the new stand-ards? They establish a number of proceduralrequirements for setting up and licensing insurancebusinesses as well as for the withdrawal of the li-cence. These include provisions on the type ofinformation that should be submitted when applyingfor a licence; an ultra vires provision that activitiesoutside the approved scope of business are notpermissible; minimum capital requirements; the sub-mission of a business plan; as well as detailedinformation about the members of the board of di-rectors, including professional education, training,and past employment (IAIS Principles: 33). But with-out a clear demarcation of the types of activities thatshould be subject to these requirements, they are onlychecklists for a possible scope of regulation, whichcan be determined only once we know what an in-surance business is.

D. OECD Principles on CorporateGovernance 44

Whereas the IOSCO and IAIS Principles canbe characterized as a combination of LCD approachesto legal reform with some attempts to establish syn-thetic concepts, the OECD Principles on CorporateGovernance (OECD CG Principles) take a more radi-cal approach. They use economic rationales as anormative agenda and deduce specific rules for share-holder protection.45 The principles establish theconcept of “basic shareholder rights” and explain thiswith the statement that “equity investors have cer-tain property rights” (OECD CG Principles: 12). Inother words, the essence of equity investment is theacquisition of property rights and the OECD CG Prin-ciples derive the basic shareholder rights fromapplying the property rights concept to a publiclytraded firm. Yet, the CG Principles raise similar ques-

tions as to their precise meaning and the scope oftheir application as do the IOSCO or IAIS Princi-ples. The CG Principles state that “basic” shareholderrights include the right to:

• secure methods of ownership registration;

• convey or transfer shares;

• obtain relevant information on the corporationon a timely and regular basis;

• participate and vote in general shareholdermeetings;

• elect members of the board;

• share in the profits of the corporation.

Each of these rights requires further explana-tion, i.e.:

• When are methods of ownership registrationsecured?

• Is the right to convey or transfer shares violatedif the transfer is subjected to approval by othershareholders and/or the board of directors?

• What is relevant information?

Some guidance is given in the Annotations tothe CG Principles for answering these questions, butthe task of translating the principles into specific lawsand interpreting their meaning is left to domestic lawmakers and law enforcers.

The advantage of standards that are derivedfrom abstract principles rather than consisting merelyof a synthesis of existing legislation is that they of-fer standards for assessing the quality of the law indifferent countries. The disadvantage is that the prin-ciples from which they are derived may have little todo with existing practice, and the remedies they of-fer could therefore be quite ineffective. In particular,the CG Principles “focus on governance problemsthat result from the separation of ownership and con-trol” (OECD CG Principles: 2). This certainly reflectsthe classic paradigm within the corporate governanceliterature.46 Yet, an increasing number of empiricalstudies suggest that in most countries the separationof ownership and control is not the key issue. Con-centrated ownership is much more common than hadearlier been assumed (La Porta et al., 1998, 1999).Where a controlling shareholder is present, however,ownership and control is not separated. Differentproblems may arise in this situation, which may re-quire different legal solutions. The protection ofminority shareholders against blockholders, forexample, will be more important than protecting


minority shareholders against management, as man-agement is effectively controlled by a blockholder.Even if the blockholder is only a disguise for de fac-tor managerial control, the target of the rules shouldprobably be the blockholder, rather than management.

An example for how misleading the CG Princi-ples may be when analysed in the light of real worldcorporate governance problems, particularly inemerging markets, is their treatment of “stake-holders”. This term loosely refers to all parties witha stake in the firm that are not shareholders and in-cludes investors, employees, creditors and suppliers(CG Principles, Annotations: 18). The only guidanceas to how to handle the interests of these variousstakeholders is that “where stakeholder interests areprotected by law, stakeholders should have the op-portunity to obtain effective redress for violation oftheir rights”. And the annotations add that “the legalframework and process should be transparent andnot impede the ability of stakeholders to communi-cate and to obtain redress for the violation of rights”.

It is difficult to apply these general statementsto real world cases and figure out what the appropri-ate legal response to such cases could be. The moststraightforward case is employee codetermination.Where the law gives employees the right to partici-pate in the company’s board and to vote on issues ofbusiness strategy, these rights should be enforced.Interestingly, the OECD CG Principles are silent onwhether codetermination is desirable and fail to ad-dress the potential conflict between shareholderproperty rights and the legal rights allocated toemployees under such a scheme. For all otherstakeholders, the rights that could possibly be pro-tected by law and should therefore be enforced areambiguous.

Take, for example, the family-controlled foun-dation, which is only a subsidiary of, say, a chaebolin the Republic of Korea, and holds only a minoritystake in the parent company. Yet, this foundationcontrols key business decisions and, in particular, theprocess of nominating and electing the chief execu-tive officer of the parent company, who may be, butdoes not need to be, a member of the family.47 Is thisfoundation a “stakeholder”? What legally protectedrights does it have and what is the meaning of anunrestricted right to communicate among stake-holders in an environment where deals amongdifferent members of the controlling family are com-mon place? Another example is the influential role alocal government might have on corporations thatare located within its jurisdiction. Is the government

a stakeholder? If yes, the wording of the OECD Prin-ciples could be interpreted restrictively to mean thatonly those rights that are protected by law should berespected. This could be used by a corporation todefend its interests against political interference. Butcertainly there will be provisions in the local consti-tution that give the government the right to takeappropriate measures to enhance the public good. Arethese legally protected rights?

These examples demonstrate that the attemptto derive specific rules from economic “truths” isnot without flaws. The solutions thus arrived at aremeaningful only if the theoretical assumptions aboutthe main corporate governance problems are consist-ent with reality. To the extent this is not the case,they offer little guidance to law makers for solvingreal world problems.

VII. Implications for developing countries

This chapter addresses the question of whatimplications the adoption of the above legal stand-ards may have for the propensity of countries, inparticular developing countries, to attract foreigninvestors and to participate in global markets. At theoutset, three points are worth stating. First, harmo-nization or standardization of law is not necessaryfor international trade and investment to take place.Most transactions today take place using law thathas not been harmonized or standardized. Second,the areas of the law that are at the core of the IMFstandardization claims are important for attractingfinancial investors, in particular portfolio investors.Their relevance to foreign direct investment, how-ever, is less evident. Analyses of the flow of foreigninvestments and data from surveys of investorsaround the world clearly show that a functioning le-gal system for contract enforcement and effectivelegal constraints that limit arbitrary State power areimportant determinants for investment decisions(WEF, 2000). While this does not mean that im-provements in financial market legislation are notimportant, countries with limited resources availablefor law reform clearly need to make a choice andtarget their reform efforts to areas that will bring thehighest returns. Third, the adoption of legal stand-ards in any area of the law, including financial law,is not sufficient for creating an effective institutionalframework to enhance a country’s ability to attractforeign investment or create effective buffers againstthe contagion effects of a future crisis. The third pointrequires further explanation.


The underwriting of international standards forthe said areas of the law may serve as a signal toforeign investors that a country is indeed complyingwith these standards. Past experience shows that oncea crisis hits, investors will pull out where they mighthave serious doubts about the effectiveness of legalinstitutions and their ability to protect their claims.At this point, they will not be misled by formal indi-cators, but take a closer look at the ability of countriesto actually enforce these rules. Improvements in thelegal infrastructure can serve as a buffer against suchswings, but only if this infrastructure is perceived tobe effective.

The signalling function of internationally agreedlegal standards is likely to erode if too many coun-tries practice formal compliance, rather than realcompliance. The question is not whether or not for-eign investors will find out how effective legal insti-tutions are, but only when. This creates a dilemmafor countries intending not only to adopt internationalstandards, but also to engage in further reforms. Be-cause institutional reforms are generally slow, theirpayoffs will take some time to materialize. In themeantime the positive signal that adoption of thestandard may have originally sent is likely to be un-dermined by crises in economies that have pursuedmerely a formal compliance strategy. Investments inextended legal reforms may be lost. Indeed the cred-ibility of international legal standards could well beundermined.

The best strategy to counter this downwardslope seems to be for countries not only to signal theadoption of formal legal standards, but also to en-sure that they have the capacity to enforce the newlyadopted laws and in fact to demonstrate this capac-ity. A selective approach to legal reforms tied in withinstitutional reforms and the allocation of sufficientresources to ensure their success would be a promis-ing strategy. Successful reforms will re-enforce eachother. Effective enforcement of new laws will en-hance the credibility of legal institutions and raiseinvestors’ confidence in financial markets. This willalso attract investors willing to make longterm com-mitments. By contrast, the best laws on the booksmay have little impact on the development of finan-cial markets and their credibility in the eyes ofdomestic or foreign investors. A recent study thatinvestigates the relation between legal reforms andfinancial market development in transition economiesdemonstrates this point. The substantial improve-ments in the law on the books as measured by avariety of legal indicators by and large have had lit-tle impact on the development of capital markets.

By contrast, the effectiveness of legal institutions hada much higher correlation with increases in marketcapitalization and improvements in liquidity (Pistoret al.,1999).48

Thus, the key to success for any given countrywill be the establishment of effective legal institu-tions. In part, this depends on the resources that areavailable, including financial and human resources.Where these resources are not available, or otherobstacles stand in the way of effectuating financiallaw, a country should consider whether it is ready toexpose itself fully to the winds of international fi-nancial markets.49 Resources, however, are not theonly consideration. In addition, the process of legalreform needs to ensure that a sufficiently large do-mestic constituency is engaged in this reform. Aswas pointed out in the previous chapter, the efficacyof law enforcement depends on the level of volun-tary compliance, and this in turn depends on thesupport for law reform by local constituencies. Re-search on the propensity of countries to developeffective legal institutions suggests that a strong de-mand for law reform is more important for thelong-term development of effective legal institutionsthan the quality of the laws on the books (Berkowitzet al., 2000).50 These results hold when controllingfor today’s levels of GDP per capita, suggesting thatthe effectiveness of legal institutions is not deter-mined only by a country’s wealth.

A key element for successful reforms is accessto information on the scope of legal solutions thatexist to tackle a particular problem and the condi-tions under which these solutions may or may not beenforceable. This information is not easily available.The proposed standards for reforming the financialarchitecture certainly do not provide it. Instead, theyrely on ambiguous guidelines and extensive refer-ences to synthetic concepts, that are in need of furtherclarification.

In the light of these considerations, this paperargues that a new approach to reforming legal sys-tems in developing countries and emerging marketsis warranted. Instead of having legal standards de-veloped by legal experts or professional interestgroups, law makers around the world should be givenaccess to alternative legal solutions found in livinglegal systems. This would enable domestic agents toidentify problems and find solutions that are adequateand potentially effective, given the institutional con-straints of their country.

Law makers in the Republic of Korea, for ex-ample, will want to know how other countries with


large business groups solve the problem of protect-ing minority shareholders in these groups. Differentjurisdictions have experimented with different ap-proaches. Common law countries use takeover codesto protect shareholders in transactions that could di-lute their previous holdings. They are less concernedwith minority shareholders that have decided to keeptheir stakes, unless blockholders misuse their domi-nant role. Germany, by contrast, has developed acomplex legal regime for business groups in an at-tempt to protect minority shareholders in companiesbelonging to business groups. The reason for thesedifferent approaches can be found in diverging policychoices in the process of company formation duringindustrialization. In the United States, strong anti-trust rules prevented close contractual or equityrelations between firms, and thereby promoted ei-ther full integration or separation. Germany, bycontrast, allowed the formation of cartels and thussaw the emergence of groups of companies intercon-nected by equity holdings, and explicit or implicitcontractual arrangements.51 Countries that have busi-ness groups may want to consider legal systems thathave developed ex post controls, because they havealready foregone preventing the emergence of suchgroups ex ante. By contrast, the OECD CG Princi-ples focus on ex ante rather than on ex post controls(OECD CG Principles, Article 1.D).

Irrespective of their initial conditions, all coun-tries should have access to information on howdifferent legal systems create mechanisms of account-ability for common problems. A case in point is boardmembers failing to comply with their obligations.The OECD CG Principles include a list of responsi-bilities of the board. However, they do not offer so-lutions to the vexing question as to how members ofthe boards shall be incentivized to take these respon-sibilities seriously, and what redress shareholdersshould obtain against members who fail to live up totheir legal duties. Legal solutions range from dis-missal with or without cause, compensation plans asincentive devices, rules on frequency of board meet-ings, and the way to direct or derivative shareholdersuits. Law makers in the receiving country will needto address these issues in order to design proceduraldevices, without which the law cannot be enforced.52

Similar points can be made for the other areasof the law discussed in this paper. In the absence of acommon definition of insurance business under theIAIS Guidelines, it is crucial that countries obtainaccess to information on what constitutes insurancebusinesses in different countries, why some activi-ties are included, and others excluded. It is commonly

known that in legal matters “the devil lies in the de-tails”. These details are not included in the discussedstandards. In fact, by definition broad legal stand-ards avoid these details. The laws to be enacted bydifferent countries, however, will need to be muchmore specific.

What is needed, therefore, is a market for in-formation about the scope of legal solutions to solvecomparable problems, including information on howthese solutions are tied into the general legal frame-work and the enforcement institutions. This wouldallow law makers to consult not only the laws fromdeveloped market economies, but also those of neigh-bouring countries, or other transition economies.They could identify elements from different systemsand use this to develop a legal product they under-stand, and can afford. Moreover, other constituencies– professional organizations, self-governing bodies– should have similar access to information thatwould put them in a position to participate in thedebate on which solution might be the best suited totheir country. Access to different domestic legal sys-tems is currently impeded not only by languagebarriers, but also by the idiosyncrasies of differentlegal systems. This makes it often difficult to locatethe legal rules that address a particular problem, andto understand their links to other parts of the system.These problems are exacerbated by legal terminol-ogy, which differs from jurisdiction to jurisdiction.

Yet, it is not impossible to overcome these bar-riers. Japanese law makers in the late nineteenthcentury were able to debate in detail on whether theFrench, German, or English common law systemwould be more appropriate for them.53 They receivedexperts from Europe and sent delegations to variouscountries to learn about their economic and legalsystems. Law makers throughout the world shouldhave an easier task to obtain relevant information.Travel certainly has become more convenient. Moreimportant, however, information technology offersopportunities for making legal information availablearound the globe. In fact, a wealth of legal informa-tion is already available on the web. The greatestobstacle for accessing and using this information islanguage barriers and, perhaps even more impor-tantly, differences in the structure of legal systemswhich make it difficult to locate the rules or relevantcase law that deal with a particular problem. Dif-ferent legal systems use different grammars fororganizing their laws. However, these problems arenot insurmountable, at least not if resources weremade available for new legal information systemsrather than being used for creating general standards.


VIII. Conclusion

The objective of this paper was to assess thestandardization efforts of financial laws that are cur-rently under way. Because standardization is costly,the paper first analyses the possible justifications forstandardizing different areas of the law, includingcross-border insolvency cases, accounting standards,securities regulation, insurance regulations, andprinciples of corporate governance. While good ar-guments can be found to justify these standardizationefforts, the likelihood of their having any beneficialimpact hinges on additional factors. The new stand-ards need to be fitted into domestic legal systems.Most of them are not free-standing, but their mean-ing and interpretation depends on pre-existing rulesor rules that will still need to be established. As dis-cussed above, the IOSCO principles are quite explicitabout the interdependence of the proposed rules withdomestic ones. In addition, the effectiveness of theserules will depend on the efficacy of enforcement in-stitutions. Given this close relationship between moststandardization efforts – the IAS being the only ex-ception to this – and the comprehensiveness andeffectiveness of the domestic legal system, the paperasks whether standardization is the best strategy forimproving domestic legal institutions. It suggests thatthis is not the case. The reason is that the process ofstandardizing rules makes it necessary to eitherdevelop synthetic concepts to bridge differences be-tween different legal cultures, or to agree to the LCD.Neither result offers clear-cut solutions for domesticlaw makers, economic agents as the law consumers,or law enforcers. Instead, they need to give meaningto these concepts by relating them to pre-existinglegal concepts, or interpreting them from scratch. Insome cases, the process of standardization defeatsits very purpose. An example is the IAIS guidelines,which include a comprehensive reference to domes-tic legal systems for defining the object (“insuranceactivity”) for which standardized rules are to be de-veloped. On a more theoretical level, the paper arguesthat, to be effective, law needs to have local con-stituencies with a strong interest in and understandingof the laws. This is a prerequisite for the new lawsto become part of the continuous process of legalchange, without which the formal legal system willremain largely irrelevant. It is also important forensuring high levels of voluntary compliance withthe law, and thus for its effectiveness. In sum, thepaper warns against viewing legal standards as apanacea for building effective legal systems aroundthe world.

Notes

1 The use of the term “standards” should not be confusedwith quality and product standards as a regulatory tool.We use this term to refer to the nature of a legal rule, inparticular the level of specificity. For details see belowchapter IV. We use the terms standardization and harmo-nization interchangeably, but note that standardization isa weak form of harmonization. A strong form would re-quire that detailed legal rules be unified across differentjurisdictions. For a discussion of the cost and benefits oflaw development using legal standards versus legal rules,see Kaplow (1992).

2 One may, of course, take the view that the standards arean insurance device for foreign investors. If high-risk coun-tries can be forced to adopt internationally accepted legalrules, foreign investors can no longer be blamed for mis-guided investment decisions. I would like to thank DavidWoodruff for this point.

3 On the distinction between normative and non-normativeharmonization quests, see Leebron (1996: 50). He distin-guishes between pure “non-normative harmonizationclaims”, which are “neutral with regard to which ruleshould be chosen as the basis of harmonized rule”, and“pure harmonization claims” that aim at implementing thesame policies or rules in all countries. Most harmoniza-tion claims, according to (1996), contain non-normativeand normative claims, i.e. they can be referred to as mixedclaims.

4 The importance of effective legal institutions – i.e. thosethat are capable of enforcing existing rules and actuallydo this – has also been stressed by Cornford (1995).

5 For a more comprehensive analysis of the relation betweenfinancial market development and economic growth, seeGoldsmith (1969: 561).

6 For a discussion of the 1988 standards and the proposalsfor their revision, see Cornford (2000).

7 This has become apparent in particular in regard to theAsian Financial Crisis. For an analysis of the quality ofthe legal framework as an explanatory variable for theextent to which different countries have been affected bythe crisis, see Johnson et al. (1998). By contrast, Huangand Xu (1999) offer an analysis that focuses less on legaldesign, and more on the financial institutions in an envi-ronment with and without soft-budget constraint.

8 The agencies involved in these efforts and a short sum-mary of the areas of the law standardized by them can befound at: http://www.imf.org/eternal/standards/agency.htm.

9 The Conventions include, among others, those on: theLimitation Period in the International Sale of Goods (NewYork, 1974/1980); the Carriage of Goods by Sea (Ham-burg, 1978); Contracts for the International Sale of Goods(Vienna, 1980); International Bills of Exchange and In-ternational Promissory Notes (New York, 1988); and theRecognition and Enforcement of Foreign Arbitral Awards(New York, 1958). The Model laws include the UNCITRALModel Law on International Commercial Arbitration(1985); on International Credit Transfers (1992); Procure-ment of Goods, Construction and Services (1994); and onElectronic Commerce (1996). For a detailed status reportof the signature and ratification of the various conven-tions see website: http://www.uncitral. org/english/texts/index.htm.

10 The IASC, for example, stresses the need for internationalharmonization in light of the huge costs created by thecurrent multiplicity of accounting standards, and advo-


cates the adoption of International Accounting Standardsfor developed as well as developing countries. See website:http://iasc.org.uk/frame/cen1_4.htm.

11 Art. 12 of the Guide to Enactment of the UNCITRALModel Law on Cross-border Insolvency, for example, ex-plicitly states that while countries are free to make anychanges they see fit, “.. in order to achieve a satisfactorydegree of harmonization and certainty, it is recommendedthat States make as few changes as possible in incorporat-ing the model law into their legal systems”.

12 Subscribing to legal standards as used in this paper doesnot imply any formal process of ratification. As notedabove, most of the standards discussed in this paper arenot mandatory. We use the term “subscribing” loosely torefer to any type of commitment a country makes to thesestandards, including public statements that they governlaw reform efforts.

13 See Woodruff (1999) for a similar point relating to legalreforms in Russia.

14 The literature is voluminous and can only be partially ref-erenced in this context. In the area of corporate law,Buxbaum and Hopt (1988) and Buxbaum et al. (1991)give an overview of the main arguments for and againstharmonization. See also Romano (1993) and Bebchuk(1992). A similar debate is currently underway for securi-ties legislation. See Romano (1998) for further references,as well as the contributions in Barfield (1996), and espe-cially White (1996). An endorsement of the Europeanharmonization strategy may be found in Warren (1990:185). More cautiously based on an analysis of the achieve-ments of harmonization are the contributions in Ferrarini(1998).

15 Compare Kamar (1998), who focuses on the purportedsuperiority of the Delaware corporate law. For a more gen-eral argument see Gillette (1998).

16 See Schwartz and Scott (1995) for a detailed analysis ofprivate law-making involving legal experts.

17 This is exemplified with the case of the Delaware corpo-rate law by Kamar (1998:16).

18 A good example is the case of Nebraska, which copiedthe Delaware corporate statutes word by word, but wasnot able to attract corporations. This has been attributedto positive network externality of the Delaware system,which could be replicated. See Kamar (1998: 16).

19 Johnson (1998: note 8). The level of legal protection inthis context refers to the quality of shareholder and credi-tor rights, as measured by La Porta (1998). The effective-ness of legal institutions refers to the assessment of thefunctioning of the judiciary, the ability to enforce con-tracts, and the likelihood that governments will upholdcontracts and not expropriate property, as well as the ab-sence of corruption (see ibid).

20 For a detailed discussion of externalities and non-efficiencyof unilateral rules, see Leebron (1996, note 4: 54, 55). Fora summary of the arguments against harmonization of se-curities legislation, see below.

21 It is interesting to note that the European Union, after firsthaving attempted to harmonize law in detail, has increas-ingly reverted to establishing minimum standards only andto support law-making and law enforcement at the lowestappropriate level (principle of subsidiarity).

22 Since, upon ratification of the Convention, it becomes partof the domestic law of a given country, an explicit state-ment of this sort is required to opt out of it. See Walt (1999,note 27).

23 Since a clarification of these terms and concepts requiresthat many parties look into the question and seek clarifi-

cation of the terms, this practice might well render CISGineffective, even though all parties may benefit in the longterm from a uniform sales law for transnational transactions.

24 This term was coined by Means in his study of the under-developed law in Columbia (Means, 1980).

25 The extent of technical assistance required in this regardcan range from introducing law reports that report newcase law to computerized information systems.

26 For a more elaborate statement of this point see alsoSunstein (1996b: 925). While his argument deals prima-rily with social norms, the point is also applicable to for-mal law.

27 For this approach see Hay et al. (1996), based on theirexperience with legal reforms in the Russian Federation.

28 See Black et al. (1996), and Black and Kraakman (1996)for a discussion of the educative function of law whichthey employed when drafting the model for the 1996 Rus-sian corporate law.

29 Belcher (1995) quoting McBarnet and Whelan, whocoined this term.

30 For a selection of cases that violate shareholder rights byusing and misusing provisions of the corporate law, seeBlack et al. (1999).

31 See §117, section 7, of the German joint stock companylaw (AktG).

32 September 1998. The Securities Principles can be foundon IOSCO’s home page (www.iosco.org).

33 Zweigert and Kötz (1998) developed a functional approachto comparative law in general. For a critical assessment ofthis approach see Frankenberg (1985).

34 On this point see especially Coffee (1999a).35 In chronological order these papers are: Pistor (1999 –

the paper was originally presented at the IRIS Conferenceon the Value of Law in Transition Economies, 5 March1999); Coffee (1999b); and Johnson and Shleifer (1999).Johnson and Shleifer include more indicators than Pistor(1999), but come to very similar conclusions.

36 As will be further discussed below, CIS refer to mutualfunds and other types of investment funds.

37 See p. 26 of the IOSCO Principles for these examples.38 See section 10.5, p. 25, of the IOSCO Principles.39 The IOSCO Principles mention that the said rules typi-

cally set the threshold well below a controlling interest.This is certainly of some help, but the contents of the finalrule obviously depend on how a controlling interest is de-fined.

40 IOSCO Principles for the Regulation of Collective Invest-ment Schemes, October 1994. Available on the IOSCOwebsite (htp//:www. iosco.org/public_docs/).

41 The definition of CIS is “an open and collective invest-ment scheme that issues redeemable units and invests pri-marily in transferable securities or money market instru-ments”.

42 December 1999. The Insurance Principles can be foundon the IAIS webpage (www.iaisweb.org).

43 Domestic law makers may officially support IAIS Princi-ples, but define insurance business in such a way that onlya few activities are actually governed by the Principles.

44 April 1999.45 The approach is not consistently followed. In the Annota-

tion to the “basic shareholder rights”, the OECD CG Prin-ciples state: “This Section can be seen as a statement ofthe most basic rights of shareholders, which are recog-nised by law in virtually all OECD countries” (CG Princi-ples: 12).

46 This literature was greatly influenced by Berle and Means(1932). For a critique of this paradigm and suggestions


on how to expand the research on corporate governance,see Berglöf and von Thadden (1999).

47 On corporate governance problems in the Republic ofKorea, see Kim (1996). A description of the pyramidalstructure that can be found in the Republic of Korea’schaebols is included in La Porta et al. (1999).

48 The various legal indicators used in this study and thevariance of these indicators across different transitioneconomies is discussed in Pistor (2000).

49 In the aftermath of the Asian financial crisis, the restric-tion of portfolio capital inflows has been widely discussedas a possible policy option.

50 The authors focus on the introduction of formal legal sys-tems in the nineteenth century and distinguish betweencountries of origin – i.e. countries that developed theirformal legal systems internally – and transplant countries.The latter are further divided into transplants with (recep-tive) and without (unreceptive) a demand for the new law.Origins and receptive transplants today have more effec-tive legal institutions than transplant countries.

51 For a historical analysis of the development of firms andlegal responses between 1870 and 1933, see Spindler(1993).

52 The design of such rules or course does not guarantee thatthe law will be enforced, but is still an important prereq-uisite.

53 See Haley (1991: 67) for a discussion of Western legaltransplants to Japan during the Meiji restoration.

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The Standardization of Law and Its Effect on Developing