Learning lessons on investor protection from Brazil’s economic history!

Amazing things economic/business historians discover. Aldo Musacchio of HBS has written a book on Brazil’s financial market history – Experiments in Financial Democracy: Corporate Governance and Financial Development in Brazil, 1882-1950,

Here is an interview where  author discusses the findings:

Sean Silverthorne: What does the book contribute to the literature in your field?

Aldo Musacchio: When I wrote the book, most of the discussion on corporate governance was focused on the legal system and the corporate laws of countries. The conclusions were a bit deterministic. If a country followed the French legal system, for instance, then corporate governance was supposed to be bad, and there was little debate about what companies or managers could do about it. For me this just sounded too simplistic.

Moreover, the focus on national laws led to policy recommendations that were sometimes too complicated to implement, which led to efforts by governments and development agencies toward reforming the legal system or improving the court system. There is nothing wrong with that, but what if the real agents of change were the corporations themselves—their founders or their current shareholders?

In the book I advance what I think is an overlooked point: Companies can overcome the shortcomings of the legal system in which they operate. If investor protections are weak in national laws, companies can offer protections in their bylaws that compensate for those weaknesses. It is easier to change a country one corporation at a time than trying to change legal practices. Once many corporations adopt strong investor protections in their bylaws, others have to follow.

Q: Why did you subtitle the book “Experiments in Financial Democracy”?

A: During the late 19th century, Alfred Neymark, a French statistician, conducted a series of studies on the size of stock markets across countries and on the ownership structure of railways and other companies in France. In one of his books he argues that France was the largest “financial democracy” in the world, because of the large number of shareholders that French railway companies had (not to mention the Suez Canal).

Since I found similar results in an effort by Brazilian corporations to attract small shareholders, I thought that Brazil was also a financial democracy. Yet, in Brazil there was a clear cycle: It started in the late 19th century and ended in the first two decades of the 20th century. Therefore, what I observed appeared to be more like an experiment. In terms of the book, the argument is that the experiment seemed to have worked to propel the diffusion of equity ownership and the growth of equity (and bond) markets.

Amzing bit. Basically because of better disclosures Brazil companies protected investors interest.

And why things changed in Brazil?

Q: The period after 1915 saw a major decline in Brazilian markets. What happened? Why didn’t investor protections persist?

A: I argue that ultimately what matters is the availability of capital. Brazil was a net importer of capital during the period 1870 to 1915, and firms were competing to attract shareholders or bondholders. After 1915, things changed rather rapidly. In a couple of decades the main source of capital was no longer the stock market: Bank credit was used to pay for short-term expenses, and credit from development banks was used for long-term capital needs. I also show that as inflation increased in the 1930s, real returns for investors were lowered significantly.

Read the whole thing. The author says salaries were high even then but because of high disclosures things were under control.

Finally her next agenda is as exciting:

Q: What are you working on now?

A: I’m working on a book that looks at governance and performance of state-owned enterprises in Brazil.

When we think about BRIC countries (Brazil, Russia, India, China), we sometimes don’t consider how important state-owned enterprises are in these countries. BRIC capitalism is very different from what we know in the United States. The state plays a big role in these countries, and credit for large-scale projects is channeled through government-owned banks.

In the 1990s, we thought all state-owned enterprises would disappear; research—theoretical and empirical—clearly showed that state-owned enterprises were inefficient monsters. Today, the evidence is a bit different. State-owned corporations in BRIC countries have managed to reform their corporate governance and become relatively efficient. Think about oil and banking: Among the 10 or 20 largest companies in the world, there are 8 or so state-owned enterprises from BRIC countries.

The book will explain why some state-owned enterprises are more efficient than others in Brazil as well as how much the country’s development bank, BNDES, has contributed to making the country a world superpower in agribusiness and manufacturing. I think that readers will understand the central role the state has played in the rise of Brazil as the darling of international investors. I hope the book can offer lessons for the reform of state-owned enterprises in other countries.

 

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