This paper -- a product of the Finance and Private Sector Development Division, Policy Research Department -- is pa't of a larger effort in the department to understand the links between the financial system and economic growth. The study was funded by the Bank's Research Support Budget under the research project "Stock Market Development and Financial Intermediary Growth" (RPO 679-53). Copies of this paper are available free from the World Bank, 1818 H Street NW, Washington, DC 20433. Please contact Paulina Sintim-Aboagye, room N9-030, telephone 202-473-8526, fax 202-525- 1155, Internet address psintimaboagye@worldbank.org. December 1996. (44 pages) The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development issues. An objective of the series is to get the findings out quickly, even if the presentations are less tban fully pollsbed. The papers carry the names of the authors and should be cited accordingly. Tbe findings, interpretations, and conclusions expressed m tbis paper are entirely those of tbe author. They do not necessarily represent the view of the World Bank, its Executive Directors, or the countries they represent

For over a century, economists and policy makers have debated the relative merits of bank-based versus market-based financial systems. Recently, however, proponents of the legal-based view of financial development have argued that the century long debate concerning bank-based versus market-based financial systems is analytically vacuous. According to this view, the critical issue is establishing a legal environment in which both banks and markets can operate effectively. This paper represents the first broad, cross-country examination of which view of financial structure and economic growth is most consistent with the data.

Transactions take place in the rm rather than in the market because the rm o ers agents who make speci c investments power. Past literature emphasizes the allocation of ownership as the primary mechanism by which the rm does this. Within the contractibility assumptions of this literature, we identify a potentially superior mechanism, the regulation of access to critical resources. Access can be better than ownership because: i) the power agents get from access is more contingent on them making the right investment; ii) ownership has adverse e ects on the incentive to specialize. The theory explains the importance of internal organization and third party ownership. A preliminary version of this paper circulated with the title \Implicit Property Rights in a Theory of the

HOSTILE TAKEOVERS invite strong reactions, both positive and negative, from academics as well as the general public. Yet fairly little is known about what drives these takeovers, which characteristically involve significant wealth gains to target firms ' shareholders. The question is where these wealth gains come from. We examine the sample of all 62 hostile takeover contests between 1984 and 1986 that involved a purchase price of $50 million or more. In these contests, 50 targets were acquired and 12 remained independent. We use a sample of hostile takeovers exclusively to avoid using evidence from friendly acquisitions to judge hostile ones, as many studies have done. We examine such post-takeover operational changes as divestitures, layoffs, tax savings, and investment cuts to understand how the bidding firm could justify paying the takeover premium. We also examine the possibility of wealth losses by bidding firms ' stockholders as the explanation for target shareholder gains. The analysis of post-takeover changes is complicated because once the target and the bidding firms are merged, it becomes impossible to attribute to the target the changes recorded in joint accounting data. As a consequence, we do not use such data, but rather focus on discussion in annual reports, 1OK forms, newspapers, magazines, Moody's and

Corporate governance in the United States changed dramatically throughout the 1980s and 1990s. Before 1980, corporate governance—meaning the mechanisms by which corporations and their managers are governed—was relatively inactive. Then, the 1980s ushered in a large wave of merger, takeover and restructuring activity. This activity was distinguished by its use of leverage and hostility. The use of leverage was so great that from 1984 to 1990, more than $500 billion of equity was retired on net, as corporations repurchased their own shares, borrowed to finance takeovers, and were taken private in leveraged buyouts. Corporate leverage increased substantially. Leveraged buyouts were extreme in this respect with debt levels typically exceeding 80 percent of total capital. The 1980s also saw the emergence of the hostile takeover and the corporate raider. Raiders like Carl Icahn and T. Boone Pickens became household names. Mitchell and Mulherin (1996) report that nearly half of all major U.S. corporations received a takeover offer in the 1980s. In addition, many firms that were not taken over restructured in response to hostile pressure to make themselves less attractive targets. In the 1990s, the pattern of corporate governance activity changed again. After a steep but brief drop in merger activity around 1990, takeovers rebounded to the levels of the 1980s. Leverage and hostility, however, declined substantially. At the same time, other corporate governance mechanisms began to play a larger role,

In a rational profit-maximizing world, banks should maintain a credit policy of lending if and only if borrowers have positive net present value projects. Why then are changes in credit policy seemingly correlated with changes in the condition of those demanding credit? This paper argues that rational bank managers with short horizons will set credit policies which influence, and are influenced by other banks and demand side conditions. This leads to a theory of low frequency business cycles driven by bank credit policies. Evidence from the banking crisis in New England in the early 1990s is consistent with the assumptions and predictions of the theory. * I am indebted to an excellent referee for comments that have improved this paper considerably. I thank

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We propose that dispersed outside ownership and the resulting managerial discretion come with costs but also with bene�ts. Even when tight control by shareholders is ex post ef�cient, it constitutes ex ante an expropriation threat that reduces managerial initiative and noncontractible investments. In addition, we show that equity implements state contingent control, a feature usually associated with debt. Finally, we demonstrate that monitoring, and hence ownership concentration, may con�ict with performance-based incentive schemes. I.

We develop a real options perspective to explore how an entrepreneur-friendly bankruptcy law can encourage entrepreneurship development at the societal level. If bankrupt entrepreneurs are excessively punished for failure, they may let inherently high-risk but potentially high-return opportunities pass. We suggest that a more entrepreneur-friendly bankruptcy law, informed by a real options logic, can encourage more active and vibrant entrepreneurship development. We also discuss the implications of the role of venture capital and stigma in the effectiveness of an entrepreneur-friendly bankruptcy law. Interest continues to grow in understanding how entrepreneurship can create value in a society. Much of this interest focuses on the role of risk taking by entrepreneurs and managers in creating economic value and, in particular, how barriers to the entry of entrepreneurs into the economy can be lowered (Busenitz, Gomez, &

Joseph Stiglitz, and two anonymous referees. The rapidly growing literature studying the relationship between legal origin, investor protection, and finance has stimulated an important debate in academic circles. It has also generated a number of applied research projects and strong policy statements. This paper discusses the implications, in particular for developing and transition countries, from this literature. We conclude that its focus on the plight of small investors is too narrow when applied to these countries. We argue that this group is unlikely to play an important role in most developing and transition countries. External investors may still be crucial, but they are more likely to come in as strategic investors or creditors. The paper also proposes a broader paradigm including other stakeholders and mechanisms of governance in order to better understand the problems facing these countries and generate policy implications that compensate for the weaknesses of capital markets.