Abstract
In some countries, banks are firms' key source of financing. In others, firms look mainly to financial markets to meet their financial needs. Why should this be so? This paper provides an explanation tied to legal traditions. Civil-law courts are less effective than their common-law counterparts in resolving conflicts because they have less flexibility in interpreting the laws and creating new rules. Banks emerge in these economies as primary contract enforcers, leading to bank-oriented financial systems. Furthermore, because common-law courts enforce laws effectively, providing them with more detailed creditor and shareholder protection laws has a greater impact on the development of financial markets compared with civil-law systems.
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