Bureaucracy and financial markets

Recent research on financial market development has focused on the nature of the legal system. The law and finance literature, however, exclusively focuses on the abuse of management power as a major cause of shareholder expropriation. We examine the role of the administrative capability of the state in providing and guaranteeing the institutional foundations for financial market development. The characteristic feature of bureaucracy is predictable, calculable and methodical performance. Our analysis of the linkage between bureaucratic quality and financial market development confirms our hypothesis that arm's length finance not only needs a reliable legal environment, but also bureaucratic effectiveness (1) We provide evidence that state bureaucratic performance plays a crucial role in determining financial market development; (2) We find that legal origin plays an indirect role, as it affects the financial market development through the channel of the quality of state bureaucratic performance, but it does not exert a direct and independent effect. © 2009 Blackwell Publishing Ltd.