Abstract
ABSTRACT This paper provides theoretical justification and empirical evidence linking the mode of privatization of state assets in banks and industries to the quality of institutions of legal and financial governance that underpin financial development. The evidence from twenty-five states of Eastern Europe suggests that allowing foreigners to assume the role of strategic investors in banks and industries via direct sale methods of divestiture of state assets contributes to legal and institutional development, particularly a stronger and more impartial legal system, better quality of bureaucratic governance, and stronger legal protection of creditors, while insider privatization schemes, such as voucher privatization or management–employee buyouts, do not fulfill the same role. The empirical results are robust to instrumental variable analysis and to the inclusion of numerous economic and political controls for alternative explanations.
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