Enforceability and the Effectiveness of Laws and Regulations

Controlling shareholders in China can divert assets from listed firms or coerce firms to serve as guarantors on questionable loans. A new rule was enacted prohibiting diversion for ‘non-operational’ purposes, and firms complying with this rule experienced a reduction in related party transactions, an increase in investment and dividends, and better performance. Another contemporary rule aimed to standardize practice of firms providing loan guarantees, but had no impact on firms. Our results highlight the importance of enforceability: laws and regulations that can be enforced at lower costs are more likely to succeed, especially in countries with weak formal institutions.