Many business owners, regardless of the size of their businesses, have tried to establish their presence in international markets for various reasons. Some try to explore foreign markets, some try to lower their production costs, and some simply try to manage regional economic risks by internationally diversifying their operations. Some of the business owners have successfully accomplished their objectives, but others have painfully failed to manage their oversea operations and learned very expensive lessons. In many cases, those who failed consider the differences in the legal systems of foreign countries and the cultural barriers.
The international economic environment has experienced major changes in recent years due to its rapid globalization. Many countries in Asia, Europe and Latin America that were not actively participating in international economy due to their socialist governments made transitions toward free enterprise and international integration. Multinational corporations broadened their territories and influences, and the international capital flows have increased. The rapid globalization has created a more volatile global market place. It has increased a country’s dependency on global economic environments and therefore made a country more susceptible to economic crises experienced by other countries. In addition, the increase in international capital flow and the risks involved in international financial transactions has made financial management more complex. Considering all these recent changes, it would be beneficial to find ways to adequately prepare yourself, as a business owner, for entering international markets.
As mentioned above, legal systems of foreign countries and the cultural barriers are factors you never should ignore. Whenever you are trying to enter international markets, the cultural barriers and how to get around these type of problems will be the first thing you will hear from people around you who have experiences in international markets. Unfortunately, there hasn’t been enough emphasis on the legal systems of foreign countries that might make crucial differences in the outcome of your business transactions. The legal system of the country will affect the corporate ownership structure and how your company will be financed as well as how your company will be operating in that country.
Unfortunately, these topics are too big and broad to be covered in one article. Therefore, it will be divided into four articles. The first will briefly introduce the basics of different legal origins and how they are related to the business environments. The second article will provide more detailed description of each legal system. The third article will introduce common misbelieves about cultural barriers. In addition, the last will provide some useful tips related to not-frequently-talked-about cultural barriers.
Legal Systems
The legal systems can be largely divided into two groups: the systems that are based upon Common Law and the systems based upon Roman Law (also referred to as Civil Law). The main difference between the civil law and the common law is how they operate. Civil Law relies upon professional judges, legal codes and written records. Common Law relies upon lay judges, broader legal principles and oral arguments. Many researches have also found that legal origins are closely related to the financial developments, and in many cases, economic developments of the country.
The categorization that is commonly used in the literature of financial development and the legal system is the one developed by LaPorta, Lopez-de-Silanes, Shleifer and Vishny (1997). They note that the most countries can be divided into four groups with different legal origins: English, French, German and Scandinavian. French, German and Scandinavian legal systems are all based upon Roman Law, and English legal system is referred to as Common Law. Legal system of every country can be divided into these four categories. Some of the examples are the followings.
English: UK, US, Canada
French: France, Belgium, Italy, Netherlands, Spain
German: Germany, Austria, Japan, Korea
Scandinavian: Denmark, Finland, Norway
Corporate Ownership
Corporate ownership is usually more dispersed in countries with common law origin. In other countries, corporate ownership is more concentrated. Equity control by financial institution is far less common and the firms are typically controlled by families or the States. The controlling shareholders typically have power over firms significantly in excess of their cash flow rights, primarily through the use of pyramids. This ownership structure difference is a result of “poor minority shareholder protection” of civil law system.
Financial Development
Researchers have found that different legal systems influence financial development of countries in various ways through their ability to adapt to changing conditions and an emphasis on comparative rights.
The countries usually have better-developed financial intermediaries if they have well-developed accounting standards, strongly secure creditors’ rights, and strongly enforce contracts. At the same level of development, Civil Law countries (especially with French legal origin) exhibit heavier regulation, weaker property rights protection, more corrupt and less efficient governments, and even less political freedom than do the Common Law countries. (La Porta et al. 1999, Djankov et al. 2000). Therefore, Common Law countries appear to have more developed financial industry than Civil Law countries.
Furthermore, the efficiency of financial intermediaries of Common Law countries and Civil Law countries show different relationships with national economic growth. Civil Law countries, especially the ones with French legal origin, usually show strong correlation between the efficiency of their financial intermediaries and their national economic growth while other countries show very weak correlation (Bryan Lee, 2002). Since the creditors’ rights are not well protected by the law, banks would be reluctant to aggressively locate new investment opportunities unless the opportunities are firmly supported by the strong economic growth. Because of similar reasons, venture investment activities are very weak in the countries with French legal origin as well.
Investor Protection
When you are trying to buy a company, or to start an entity in a foreign country to establish your presence, the first thing that you need to consider is if your rights will be protected. As mentioned a few times above, common law usually provides better protection than civil laws.
External Cap /
GNP # of Firms /
Million Population # of IPOs /
Million Population Debt / GNP
English 60% 35.45 2.23 68%
French 19% 11.89 0.28 56%
German 46% 16.79 0.12 97%
Scandinavian 30% 27.26 2.14 57%
World
(49 countries) 40% 21.59 1.02 59%
Source: Andrei Shelifer, Harvard University and NBER, May 2002
The above table describes some of the consequences of how different legal systems protect investors. One of the notable characteristics of French legal system is that it protects the creditors the least among all legal structures. As it is shown in the table, countries with French legal origin show the lowest numbers in each category.
Although each legal system provides different environments, the legal origin simply can’t be an indicator of where to operate internationally for a business owner. However, you can’t expect the similar legal structure, system or protection when you have an entity in a foreign country. You may argue “this is not how things work in US,” but most likely this argument will not produce any satisfying result when you try to structure a deal, negotiate a transaction or resolve a dispute. The bottom line is that you should respect and abide by the legal system of a country you operate in.
In order to have more clear understanding about what the differences these legal systems make mean to you as a business owner, more in depth description of each legal system will be necessary. The next article will provide details of each legal system and some examples of the consequences of not being familiar with the legal systems.
Bryan Lee is a Business Development Advisor at Dillon Schramm Associates, the Midwest office of Vercor. He has extensive experience in corporate restructuring, business development, and strategic alliance. He has provided services to various companies in China, Korea, and the US. He received his Ph.D in Economics from the University of Kansas, and currently is a Guest Professor of Gilin University in China.
