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Effectiveness of legal institutions in stock market development in sub-Saharan Africa

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Abstract

The law and finance theory posits that legal institutions are associated with stock market development. We examine the effectiveness of legal institutions in stock market development in 11 countries in sub-Saharan Africa for the period 2000–2014. Based on the two-stage least squares estimator, we find that the effectiveness of legal institutions does not promote stock market development in sub-Saharan Africa, after controlling for income, banking sector development, inflation, endowments, capital account liberalization, culture, and democracy. We provide empirical support for the law and finance theory by establishing that legal institutions explain cross-country differences in stock market development in sub-Saharan Africa.

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Notes

  1. Beck and Levine (2004) and Levine and Zervos (1998a, 1996) provide cross-country evidence on the growth-promoting role of stock markets. Stock market finance is a vital constituent of financial sector development. Gaffeo and Garalova (2014) show that stock market finance augmented with banking sector finance drives economic growth.

  2. The South African stock market is the leading stock market in sub-Saharan Africa and ranks among the top emerging stock markets in the world.

  3. In hospitable colonies, European settlers established institutions that prevent expropriation and give protection of private property rights while they established institutions that are lax in protecting private property rights and providing checks against expropriation in inhospitable colonies. Acemoglu and Johnson (2005) find that institutions that protect private property rights and reduce the risk of expropriation promote stock market development.

  4. Legal formalism refers to the extent to which formal rules cause delay of presentation of evidence, witnesses, arguments, and appeals as well as time taken to award judgment in a litigation.

  5. Presently, 23 countries have stock markets in sub-Sahara Africa. Botswana, Cote d’Ivoire, Ghana, Kenya, Malawi, Mauritius, Mozambique, Namibia, Nigeria, South Africa, Sudan, Swaziland, Tanzania, Uganda, Zambia, and Zimbabwe have stock market operations before 2000. Mauritius, Mozambique, Sudan, Swaziland and Zimbabwe are excluded from the sample due to data-related issues.

  6. These measures correspond to the measures used by Demirgüç-Kunt and Levine (1996) for the construction of INDEX1.

  7. The 2SLS estimator is invoked in Stata using Baum et al. (2007) ivreg2 command.

  8. These instrumental variables are possible factors that can account for cross-country differences in rule of law. GDP growth proxy for economic growth and the data is obtained from WDI.

  9. See Stock and Yogo (2005) for weak instruments test critical values.

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Acknowledgements

We would like to express gratitude to the editor and anonymous referees for their comments and suggestions which were useful in improving the quality of our paper. We bear responsibility for all remaining errors.

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Authors and Affiliations

  1. Department of Finance, University of Ilorin, Ilorin, Nigeria

    Olufemi Adewale Aluko

  2. Department of Finance, Ekiti State University, Ado-Ekiti, Nigeria

    Bolanle Aminah Azeez

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  1. Olufemi Adewale Aluko
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  2. Bolanle Aminah Azeez
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Correspondence to Olufemi Adewale Aluko.

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Aluko, O.A., Azeez, B.A. Effectiveness of legal institutions in stock market development in sub-Saharan Africa. Econ Change Restruct 52, 439–451 (2019). https://doi.org/10.1007/s10644-018-9233-x

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