The Law and Finance School: What Concept of Law?

Abstract

Since its inception in the late 1990s, the Law and Finance School has underscored the crucial importance of law in determining firm-level corporate governance features. This paper provides a comprehensive review of 20 years of LFS literature. Comparing the LFS’s underlying ‘concept of law’ to the most important legal theories, it shows that in spite of the centrality of law, the LFS is based on a surprisingly ‘thin’ theory of law. In particular, the LFS has very little to say about the mechanism that links law to firm-level practices. In other words, while a great deal of effort has gone into empirically showing that law matters for corporate finance and governance outcomes, much less effort has been spent on the question how we would expect law to matter. The paper argues that this is a major neglect that not only limits the theoretical contribution of the LFS, but also undermines empirical strategies used to test the link between law and economic outcomes. In this sense, contrary to existing criticisms of the LFS, the main issue is not that the LFS overstates the importance of law, but rather that it does not take law seriously enough. The paper shows that this has important implications for empirical research and develops empirically testable propositions regarding the link between law and corporate governance practices.