Why Does the Law Matter? Investor Protection and Its Effects on Investment, Finance, and Growth





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    • McLean and Zhao are from the Alberta School of Business. Zhang is from the Chinese University of Hong Kong. For helpful comments we thank Campbell Harvey (the Editor), an anonymous Associate Editor, two anonymous referees, Michael Fishman, Michael Hertzel, Darius Miller, Randall Morck, Jeffrey Pontiff, seminar participants at the Chinese University of Hong Kong, Indiana University, ESSEC Business School Paris, Southern Methodist University, University of Alberta, University of Washington, and conference participants at the Financial Intermediation Research Society Meetings in Florence. We thank the Social Sciences and Humanities Research Council of Canada for financial support.


Investor protection is associated with greater investment sensitivity to q and lower investment sensitivity to cash flow. Finance plays a role in causing these effects; in countries with strong investor protection, external finance increases more strongly with q, and declines more strongly with cash flow. We further find that q and cash flow sensitivities are associated with ex post investment efficiency; investment predicts growth and profits more strongly in countries with greater q sensitivities and lower cash flow sensitivities. The paper's findings are broadly consistent with investor protection promoting accurate share prices, reducing financial constraints, and encouraging efficient investment.