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Regulatory Measures to Dismantle Pyramidal Business Groups: Evidence from the United States, Japan, Korea, and Israel

A central challenge in the regulation of controlled firms is curbing rent extraction by controllers. As independent directors and fiduciary duties are often insufficient, some jurisdictions give minority shareholders veto rights over related-party transactions. To assess these rights’ effectiveness, we exploit a 2011 Israeli reform that gave minority shareholders veto rights over related-party transactions, including the pay of controllers and their relatives (“controller executives”). We find that the reform curbed controller-executive pay and led some controller executives to resign or go with little or no pay in circumstances suggesting their pay would be rejected. These findings suggest that minority veto rights can be an effective corporate governance tool.

Corporate science in America emerged in the interwar period, as some companies set up state-of-the-art corporate laboratories, hired highly skilled scientists, and embarked upon basic research of the kind we would associate today with academic institutions. Using a newly assembled dataset on U.S. companies between 1926 and 1940 combining information on corporate ownership, organization, research and innovation, we attempt to explain the rise of corporate research. We argue that it was driven by companies trying to take advantage of opportunities for innovation made possible by scientific advances and an underdeveloped academic research system in the United States. Measuring field-specific scientific backwardness in several different ways, we find that large firms, business group-affiliated firms, and firms close to the technological frontier were more likely to initiate scientific research. We also find that companies in monopolistic or concentrated industries were more likely to engage in basic research. Corporate research was positively correlated with novel and valuable patents, and with market-to-book ratios. For companies choosing to do so, investment in corporate research seems to have paid off. The results shed light on the link between corporate organization, market structure and corporate science.

Research Summary: Control‐magnifying (pyramidal) business groups—multiple tiers of partially‐owned listed affiliates and fully‐owned private affiliates, a dominant organizational form around the world—are virtually absent in America today. Using newly‐assembled historical data, we show that such groups were ubiquitous in the U.S. economy in the 1930s. They came under attack because of their economic and political sway: Some New Deal reforms—proscriptions against public utilities pyramids, intercorporate dividend taxes, and rules governing investment companies—were explicitly aimed at deterring existing groups and preventing new ones from forming. Others, for example, estate taxes and securities law reforms, may have also worked against them. No single reform triggered the immediate dissolution of groups; they broke up under an ongoing anti‐big business sentiment. These events offer lessons for policymakers today. Managerial Summary: Most listed U.S. firms are “standalone”—they do not control, and are not controlled by, other listed firms. Control‐magnifying (pyramidal) business groups—multiple tiers of partially‐owned listed affiliates and fully‐owned private affiliates (e.g., Samsung or Tata)—are ubiquitous around the world but virtually absent in United States. In such groups, the combination of multiple tiers and partial ownership enables control over vast corporate empires. Using newly‐assembled historical data, we show that the U.S. corporate ownership as we know it today is a recent phenomenon: pyramidal groups were common in United States of the 1930s. President Roosevelt, who regarded their economic and political power as excessive, initiated a sequence of reforms which appears to have worn these groups down and probably also kept new ones from forming. JEL CLASSIFICATION: G3, G34, G38, N22.

Concerned with excessive risk-taking, regulators worldwide generally prohibit performance-based fees in pension funds. Presumably, competition can substitute for incentive pay in providing incentives for fund managers to serve their clients’ interests. Using a regulatory experiment from Israel, we compare the performance of three exogenously-given long-term savings schemes: Funds with performance-based fees, facing no competition; funds with assetsunder- management (AUM)-based fees and virtually no competition; and funds with AUM-based fees, operating in a competitive environment. Funds with performance-based fees exhibit the highest risk-adjusted returns without assuming more risk. Competitive pressure is not associated with similar outcomes, suggesting that incentives and competition are not substitutes in the retirement savings industry.

A central challenge in the regulation of controlled firms is curbing rent extraction by controllers. As independent directors and fiduciary duties are often insufficient, some jurisdictions give minority shareholders veto rights over related-party transactions. To assess these rights' effectiveness, we exploit a 2011 Israeli reform that gave minority shareholders veto rights over related-party transactions, including the pay of controllers and their relatives ("controller executives"). We find that the reform curbed controller-executive pay and led some controller executives to resign or go with little or no pay in circumstances suggesting their pay would be rejected. These findings suggest that minority veto rights can be an effective corporate governance tool.

We document the prevalence around the world of increased stock price comovement experienced by companies when added to major indices, and shed new light on the causes of this phenomenon. Using newly-constructed and extensive data covering forty developed and emerging markets over the last decade, we document that in most, though not all, countries, when added to a major index, a firm’s return experiences a postinclusion increase in comovement with the rest of the index, reflected in both a higher beta (especially if the pre-inclusion beta is less than one) and greater explanatory power of the market return (higher R 2 ). Stock turnover and analyst coverage also typically increase upon inclusion. Using a variety of empirical tests, we find that the demand-based view of comovement (the category/habitat views of Barberis, Shleifer and Wurgler, 2005) provides a good explanation for many of our findings. Some results, though, suggest that information-related factors are also important.

Using a newly constructed data set, we compare sources of funds and investment activities of venture capital (VC) funds in Germany, Israel, Japan and the UK. Sources of VC funds differ significantly across countries, eg banks are particularly important in Germany, corporations in Israel, insurance companies in Japan and pension funds in the UK. VC investment patterns also differ across countries in terms of the stage, sector of financed companies and geographical focus of investments. We find that these differences in investment patterns are related to the variations in funding sources – for example, bank and pension fund backed VC firms invest in later stage activities than individual and corporate backed funds – and we examine various theories concerning the relation between finance and activities. We also report that the relations differ across countries; for example, bank backed VC firms in Germany and Japan are as involved in early stage finance as other funds in these countries, whereas they tend to invest in relatively late stage finance in Israel and the UK. We consider the implication of this for the influence of financial systems on relations between finance and activities.

Concerned with excessive risk taking, regulators worldwide generally prohibit private pension funds from charging performance-based fees. Instead, the premise underlying the regulation of private pension schemes (and other retail-oriented funds) is that competition among fund managers should provide them with the incentives to make investment decisions that would serve their clients’ long-term interests. Using a regulatory experiment from Israel, we compare the effects of incentive fees and competition on the performance of retirement savings schemes. Taking advantage of a unique institutional setup, we compare three exogenously-given types of long-term savings schemes operated by the same management companies: (i) funds with performance-based fees, facing no competition; (ii) funds with AUM-based fees, facing low competitive pressure; and (iii) funds with AUM-based fees, operating in a highly competitive environment. We find that funds with performance-based fees exhibit somewhat higher risk (depending on the measure used) but significantly higher risk-adjusted returns. By contrast, we find no evidence that competitive pressure leads to improved performance. We conclude that incentives and competition are not perfect substitutes in the retirement savings industry. Our analysis also suggests that the pervasive regulatory restrictions on the use of performance-based fees in pension fund management may be costly for savers in the long-run and should be reconsidered.

We examine the link between minority shareholders' rights and corporate governance by studying institutional investors' voting patterns in a concentrated ownership environment. Institutions rarely vote against insider-sponsored proposals even when the law empowers the minority. Institutions vote against compensation-related proposals more often than against related party transactions even when minority shareholders cannot influence outcomes. Potentially conflicted institutions are more likely to vote for insiders' proposals than stand-alone investors, regardless of their effect on outcomes. A plausible conclusion is that empowering minority shareholders affects the selection of proposals but not actual voting; another is that empowering minority shareholders is ineffective without addressing conflicts of interest. Copyright 2013, Oxford University Press.

We calculate abnormal stock returns for Japanese non-financial companies around major events associated with the banking crisis (1995–2000), and find that not all companies were equally sensitive to the malaise of the banking sector: the most affected were small, leveraged, low-tech companies with low credit ratings and low market to book ratios. This is consistent with ‘‘credit crunch’’ theories (companies with limited access to financial markets are sensitive to changes in bank lending) and with claims that innovation is rarely financed by bank debt. We do not find much evidence on the alleged misallocation of loans to support ailing bank clients.

Regulators worldwide take the view that competition - and not performance-based fees - should play a dominant role in aligning the interests of retirement savings fund managers with those of their clients. We use a regulatory experiment from Israel to examine the effects of incentive fees and competition on performance. Taking advantage of a unique institutional setup, we compare three exogenously-given types of retirement savings funds operated by the same management companies: (i) funds where fees are performance-based; (ii) funds where fees are based on assets under management (AUM) operating in an environment with very weak competitive pressures; and (iii) funds where fees are AUM-based and the environment is highly competitive. We find that funds with performance-based fees exhibit high returns, high risk and high α. By contrast, when comparing the average performance of funds with AUM-based fees in competitive and less competitive environments, we find no significant differences (except that funds in a competitive environment charge lower fees). We conclude that incentives and competition are not perfect substitutes in the retirement savings industry. We also conjecture that the ubiquitous regulatory restrictions on the use of incentives in fund management may be inefficient, and should perhaps be reconsidered.

We revisit the evidence on the relations between institutions, the cost of government debt, and financial development in Britain (1690–1790) and find that interest rates remained high and volatile for four decades after the Glorious Revolution, partly due to wars and instability; British interest rates co-moved with those in Holland; Debt per capita remained lower in Britain than in Holland until around 1780; and Britain did not borrow at lower rates than European countries with more limited protection of property rights. We conclude that, in the short run, institutional reforms are not rewarded by financial markets.

This paper analyzes yield spreads on sovereign debt issued by emerging markets using modern data from the 1990s and newly-collected historical data on debt traded in London during 1870–1913, a previous “golden era†for international capital market integration. Applying several empirical approaches, we show that the co-movement of spreads across emerging markets is higher today than it was in the historical sample. We also show that sharp changes in spreads today tend to be mostly related to global events, whereas country-specific events played a bigger role in 1870–1913. Although we find some evidence that economic fundamentals, too, co-move more strongly today than at that time, our interpretation of the results is that today’s investors pay less attention to country-specific events than their predecessors did in 1870–1913.

Using an enhanced version of the standard investment model, we estimate how institutions affect financial frictions at the firm (micro) level and, through the required rate of return, at the country (macro) level. Based on some 78,000 firm–year observations from 40 countries over the period 1990–2007, we show that good shareholder rights lower financial frictions, especially for firms with large external finance relative to their capital stock (e.g., small, growing or distressed firms). However, creditor rights generally do not affect financial frictions. It thus appears that in explaining cross-country differences in firm investment, frictions related to shareholder rights (e.g., shirking or “tunneling”) are more relevant than debt-related frictions (e.g., limited liability or collateral constraints).

How do firms that go public decide whether to list on a major stock exchange or locally? Using a unique data set on Israeli IPOs in the US and Tel Aviv, we show that companies that list in the US are young and overwhelmingly high-tech oriented. We argue that high-quality innovative firms are willing to incur additional costs associated with listing in the US in order to reveal their value and distinguish themselves from firms that issue stock back home. Costs of listing in the US include first day underpricing and relinquishing corporate control.

Using standard Industrial Organization tools, we analyze the relation between competition in arm's length financial markets and the prevalence of close bank-firms ties. We show how the degree of competition between financial intermediaries affects the intensity of relationships between banks and client firms, and explore the idea that investment in bank-firm relationships can be used stra- tegically by incumbent multi-product (universal) banks to limit competition in arm's length markets. The analysis implies that reforms designed to facilitate entry of new intermediaries may actually induce incumbent banks to increase investment in relationship banking, so that regulatory entry barriers are replaced by entry barriers created endogenously, namely, there is "path dependence" in the market structure of financial systems. This result suggests that increased (potential) competition in the financial services industry will not always destroy bank-firm relationships but, on the contrary, may actually strengthen them.

We investigate the effect of the establishment of modem institutions on the risk premium associated with Japanese government bonds traded in London between 1870 and 1914. While most institutional innovations failed to elicit an immediate market response, the adoption of the gold standard did significantly reduce the perceived risk associated with Japanese bonds. In addition, some geopolitical events, especially the military victory over Russia, improved Japan's debt capacity. We conclude that well-understood monetaly rules and military achievements matter more for foreign investors' perception of a country than do modem state institutions, at least in the short run. M /[uch has been written about the role of institutions in promoting economic growth. The establishment of a modem judicial, economic, governmental, and parliamentary structure can change the way a country is perceived by foreign investors, thus lowering the cost of foreign borrowing, facilitating capital inflow and thereby fostering growth. We will test this theory by correlating various political events of the Meiji period (1868 to 1912)-surely one of the most dramatic cases of institutional change in modern history with the risk premium associated with Japanese government debt traded in London. Most reforms, including the establishment of a central bank and the promulgation of a modem constitution, did little to affect the way Japan was perceived by British investors, at least in the short run. The only institutional reform that clearly led to an immediate improvement in Japan's "credit rating" was the adoption of the gold standard, which

Much has been written about the Japanese "model" of corporate governance. Indeed, Japanese-style corporate governance has been described as an efficient alternative to corporate governance mechanisms available in the West, and as a model for developing economies. As opposed to American-style corporate governance, in which hostile takeovers and managerial incentive schemes play a major role, Japanese firms have traditionally relied on monitoring by large shareholders and banks. This article describes the evolution of corporate governance in Japan since the Second World War, and surveys the empirical evidence on its performance. Although there is substantial evidence on the effectiveness of the Japanese system, there is also evidence on its significant shortcomings. The article also evaluates the effects of the current macroeconomic and banking crises on corporate governance in Japan, and suggests possible directions for future changes, which are likely to make Japan more similar to the USA in this respect. Copyright 2000 by Oxford University Press.

Despite significant capital-market reforms in the mid-1980s, the Israeli government and banks continue to play an unusually dominant role in Israeli financial markets. Israeli banks operate as merchant banks and, through pyramid structures of ownership, control large segments of manufacturing, construction, insurance, and services. In addition, the banks dominate all facets of the capital market, including underwriting, brokerage, investment advice, and the management of mutual and provident funds. Because of this dominance by the banks, several important mechanisms of corporate governance are missing. There is no effective market for corporate control; institutional investors have little incentive to monitor corporate managers; and those managers in turn have little incentive to improve firm performance and increase shareholder value. To be sure, there has been an impressive wave of IPOs on the Tel Aviv Stock Exchange (TASE) in the 1990s. But those firms' stocks have substantially underperformed the market since going public, and many “higher-quality” Israeli firms have chosen in recent years to list their securities on the NASDAQ and not at home. The main reason the most promising Israeli firms go public in the U.S. is because that is where U.S. and other foreign investors want to buy them; such investors want the assurances that come with the U.S. corporate governance system.

We examine the effects of bank-firm relationships on firm performance in Japan. When access to capital markets is limited, close bank-firm ties increase the availability of capital to borrowing firms, but do not lead to higher profitability or growth. The cost of capital of firms with close bank ties is higher than that of their peers. This indicates that most of the benefits from these relationships are appropriated by the banks. Finally, the slow growth rates of bank clients suggest that banks discourage firms from investing in risky, profitable projects. However, liberalization of financial markets reduces the banks' market power. THE CLOSE RELATIONSHIP BETWEEN manufacturing firms and financial institutions in Japan has recently been at the center of the debate on the appropriate financial system for the reforming economies of Eastern Europe. As opposed to the Anglo-Saxon separation of finance and industry, long-term ties between main banks and their client firms (involving bank loans, bank equity holding, and some bank-appointed personnel), which are common in Japan and Germany, have often been described as a growth-oriented financial system that could serve the needs of developing and reformed economiies better than anonymous capital markets modeled after the Arnerican and British financial systems. The claim that close ties between investmentoriented banks and industrial firms could help overcome the difficulties of "relative backwardness" dates back to Gerschenkron (1962) who investigates European development. Rosovsky (1961) applies Gerschenkron's framework to the analysis of Japanese growth. More recently, Aoki, Patrick, and Sheard (1994), Hoshi, Kashyap, and Loveman (1994), and Teranishi (1993), among others, portray the close ties between finance and industry in Japan as an important factor in the international competitiveness of modern Japanese

This paper uses data from a report submitted to General MacArthur in order to examine the effects of a large scale reform in corporate control in Japan following World War II. The analysis indicates that reformed firms tended to perform worse than their industry peers due to diffuse postreform ownership structure and limited monitoring of managers. Evidence on the reappearance of corporate groups in Japan a few years after the end of the American reforms suggests that the keiretsu and their Main Banks are economically rational institutions. Furthermore, Main Banks may have served as a mechanism through which new, postreform, ownership-monitoring was created. J. Japan. Int. Econ., March 1995, 9 (1), pp. 154–173. Harvard Academy for International and Area Studies, 1737 Cambridge Street, Cambridge, Massachusetts 02138.

We investigate the relations among country-specific institutions, financial frictions, and firm-level investment decisions. Imposing structural restrictions, we consider the effects of institutions (such as shareholder and creditor rights) on firm investment through two channels: the cost of capital at the firm (micro) level; and the required rate of return at the country (macro) level. Using a panel of 75,000 firm-years from 48 countries for the period 1990-2007, we find that: (i) country-level institutions affect firms’ investment behavior; (ii) shareholder rights affect financial frictions and investment more than other institutions (e.g., product market competition, creditor rights) do; and (iii) effects are especially pronounced for small firms with large financing needs, suggesting that stronger shareholder rights lead to a more efficient allocation of capital.

This paper examines investment in foreign technology by Japanese tirms, using previously unexplored data on technology transfer to Japan. The relationship between the acquisition of foreign technology and firm size, liquidity and affiliation with a corporate group, or keiretsu, is analyzed. Our results indicate that the number of licensing agreements a firm signs is positively and strongly related to its size, although the relationship is concave. We also find that liquidity is an important consideration in the firm’s decision to invest in foreign technology. Keiretsuaffiliated firms acquire relatively more foreign technology than independent firms, suggesting that corporate groups have played an important role in Japan’s technological progress.

We examine the role of institutional investors in corporate governance in an environment where ownership is concentrated. The presence of dominant shareholders alters the role of institutional investors by limiting their voting influence; by shifting the focus from shareholder-manager conflicts (when ownership is dispersed) to conflicts between controlling and minority shareholders (when ownership is concentrated); and by creating new potential conflicts of interest when business groups are present. Using hand-collected data on voting by institutional investors in Israel, which adopted far-reaching measures to empower minority shareholders, we find that: (1) Institutional investors rarely vote against insider-sponsored proposals even when the law grants them special voting power; (2) Institutional investors are more likely to vote against compensation-related proposals than against other related party transactions even when minority shareholders lack the power to influence outcomes; and (3) Institutional investors with potential ownership and business-related conflicts of interest are less likely to vote against insider-sponsored proposals than stand-alone institutional investors, both when minority shareholders have power and when they do not. One interpretation of these findings is that the power granted to the minority plays a role only in the selection of proposals brought to a vote but not in voting on existing proposals; another is that, in order for institutions to play a valuable role in corporate governance, granting voting power to minority shareholders is unlikely to be effective unless conflicts of interest are addressed.

We document the prevalence around the world of increased stock price comovement experienced by companies when added to major indices, and shed new light on the causes of this phenomenon. Using newly-constructed and extensive data covering forty developed and emerging markets over the last decade, we document that in most, though not all, countries, when added to a major index, a firm’s return experiences a post-inclusion increase in comovement with the rest of the index, reflected in both a higher beta (especially if the pre-inclusion beta is less than one) and greater explanatory power of the market return (higher R2). Stock turnover and analyst coverage also typically increase upon inclusion. Using a variety of empirical tests, we find that the demand-based view of comovement (the category/habitat views of Barberis, Shleifer and Wurgler, 2005) provides a good explanation for many of our findings. Some results, though, suggest that information-related factors are also important.Revised version of a paper formerly circulated as CEPR Discussion Paper: http://ssrn.com/abstract=1311176

Financial frictions have been identified as key factors affecting both short-term economic fluctuations and long-term growth. An important policy question therefore is whether institutional reforms can reduce financial frictions and, if so, which reforms are best? We address this question by empirically investigating the effects of institutions on financial frictions using a canonical investment model. We consider two channels by which frictions affect investment: (i) through financial transaction costs at the individual firm (micro) level; and (ii) through the required rate of return at the country (macro) level. Using a panel of 75,000 firm-years across 48 countries for the period 1990-2007, we examine how, through these frictions, institutions affect investment. We find that improved corporate governance (e.g., less severe informational problems) and enhanced contractual enforcement reduce financial frictions affecting investment, while stronger creditor rights (e.g., lower collateral constraints) are less important.

We study how financial systems and institutional environments affect investment efficiency using a sample of some 300,000 firm-years from 48 countries. Based on a canonical investment model, we identify two possible channels by which institutional environments may affect investment: firm-level financial frictions and the macro-level required rate of return. We find that a good institutional environment, in particular strong corporate governance, reduces financial frictions and lowers the required rate of return, thereby enhancing efficiency in capital allocation. This result is broadly consistent with previous literature, but the mechanism identified here is novel and more precise.

The sources of finance for industrial development include (i) banks, (ii) securities markets, (iii) internal finance, (iv) alternative sources of finance such as angel finance, trade credit, families, and friends, and (v) governments. All four countries had sophisticated financial systems and all four grew successfully. The fact that they had different financial systems suggests that if there is an optimal financial structure for a country it does not lead to a significantly greater level of growth than other possible structures. The experiences of the four countries considered suggest that a variety of financial structures can lead to high rates of growth in real per capita GDP.

We study how financial systems and institutional environments affect investment efficiency using a sample of some 300,000 firm-years from 48 countries. Based on a canonical investment model, we identify two possible channels by which institutional environments may affect investment: firm-level financial frictions and the macro-level require rate of return. We find that a good institutional environment, in particular strong corporate governance, reduces financial frictions and lowers the required rate of return, thereby enhancing efficiency in capital allocation. This result is consistent with the notion that good corporate governance plays an important role in reducing the overall cost of external finance, although the mechanism outlined here is novel.

We study the effects of a regulatory change that induced the unification of most dual class shares in Israel in the 1990s. Specifically, we follow the evolution of ownership structure in a sample of 80 companies that unified their dual-class shares, and compare it with a control sample of firms that maintained their dual share structure at least until 2000. Our main findings are as follows. First, controlling shareholders offset the dilution of voting rights they incurred upon unification by: 1) increasing their holdings prior to the unification (ex-ante preparation), and 2) by buying shares afterwards; by the end of the sample period their voting power was only marginally lower than in the control sample. This offsetting result suggests that marginal voting rights may be important to controlling shareholders even beyond the 50% threshold. Second, share unifications were not associated with much change in the identity of controlling shareholders. Third, the proportion of firms affiliated with pyramidal business groups in the sample of unifying firms was lower than in the population of listed firms as a whole and not different from that in the control sample, suggesting that pyramidal ownership structures did not replace dual class shares. Finally, unifying firms did not exhibit a substantial improvement in their performance and valuation in comparison with the control sample.

We investigate whether cultural differences between professional decision makers affect financial contracts in a large data set of international syndicated bank loans. We find that more culturally distant lead banks offer borrowers smaller loans at a higher interest rate and are more likely to require third-party guarantees. These effects do not disappear following repeated interaction between borrower and lender and are economically sizable: A one-standard-deviation increase in cultural distance, approximately the distance between Canada and the United States or between Japan and South Korea, is associated with a 6.5 basis point higher loan spread; the loan spread increases by about 23 basis points if the bank-firm match involves culturally more distant parties, for example, from Japan and the United States. We also find that cultural differences not only affect the relation between borrower and lender, but also hamper risk sharing between participant banks and culturally distant lead banks. This paper was accepted by Brad Barber, Teck Ho, and Terrance Odean, special issue editors.

The Japanese success in securing loans in Western financial markets during the Russo-Japanese War is considered to be a substantial factor in Japan's victory. Over the years, Jacob H. Schiff's account of the "Jewish motive" that informed his assistance to the Japanese has become the accepted version in historical research and, as such, has not aroused any critical discussion. One possible reason for this uncritical approach is that it fits into accepted ideological rubrics, such as "Jewish solidarity" or "Jewish financial power". The ideological nature of this accepted version, however, is unveiled when juxtaposed with scholarly discussion of the anti-Russian policies of yet another Jewish banking family, indeed the most powerful one, the Paris Rothschilds. Like Schiff, the Rothschilds, too, imposed financial sanctions against Russia in order, so they proclaimed, to bring about a change in the tsarist policy toward the Jews. Keywords: anti-Russian policies; Jacob H. Schiff; Japan; Jewish solidarity; Paris Rothschilds; Russo-Japanese War

This concluding chapter reiterates three main themes emphasized in the book. The first is that institutional and political reforms seldom reduce the cost of capital quickly; other types of events, especially wars and episodes of politically-motivated violence, have a far more immediate and pronounced impact on the cost of borrowing. The second theme is that country-specific developments played a more important role in determining spreads in 1870-1913 than they did in the 1990s, as reflected in the high co-movement of bond spreads today. The third theme is that the existence of institutions aimed at resolving debt crises may have contributed to the continuous expansion of the international bond market in the 19th century, but creditor coordination is likely to be less effective today.

This chapter conducts a case study of spreads on sovereign bonds issued by Japan and Russia, two countries that introduced the gold standard in 1897. It is shown that Japanese spreads were relatively unaffected by the establishment of some of Japan’s most important institutions, including the promulgation of the Meiji Constitution in 1889, which explicitly guaranteed the protection of property rights and the rule of law. The only institutional reform that led to an immediate improvement in Japan’s ‘credit rating’ was the adoption of the gold standard. Japan’s war with Russia (1904-1905) and its successful outcome had a far more visible impact on spreads than most institutional reforms. The chapter also conducts a case study of the British-Dutch interest differential around the Glorious Revolution. It shows that developments regarding war and peace had a far greater impact on borrowing costs than institutional reforms.

This chapter focuses on co-movement of spreads across different countries, and on the frequency of crises shared by more than one country — contagion. Overall, co-movement of spreads among emerging markets was far higher in the 1990s than during the pre-World War I era. Sharp changes in spreads (or crises, defined in a number of ways) during the 1990s typically affected many countries at the same time, whereas global crises were virtually non-existent in the historical sample. An examination of whether co-movement was driven by common economic fundamentals showed that emerging markets in the past were more different from each other than their counterparts are today: they tended to specialize in a small number of export commodities. Differences in co-movement between the two periods were not driven solely by economic fundamentals, and may be accounted for by differences in investor behavior, particularly the presence of large investment funds today versus many individual investors in the past.

This chapter relates sharp changes in spreads on sovereign bonds of emerging economies to news articles in the London Times and the Investor’s Monthly Manual for the period 1870-1913, and to news articles in the Financial Times for the 1994-2002 period. News articles are classified into several categories (good economic news, bad economic news, news on institutional reforms, news on instability and wars, etc.). The first part of the analysis identifies the types of news that caused sharp changes in bond spreads. The second part identifies dates of sharp changes in spreads and attempts to find news items that explain them. It is shown that the relationship between news and spread changes was stronger in the period before 1913 than it is today. The category of news that matters most is instability and wars, followed by economic news. Despite the importance attached to institutional changes today, news about investor friendly reforms typically have little impact on bond spreads.

This chapter describes the pre-World War I London market for sovereign bonds issued by emerging countries, and compares it with the corresponding market today. It shows that the London market was large, active, and liquid, far larger than the corresponding market of today. Moreover, investors were able to rely on timely and comprehensive information regarding borrowing countries. The chapter then discusses the construction of the data sets used in the book, and analyzes the behavior of bond spreads in the historical and modern samples.