Law and Finance Matter: Lessons from Externally Imposed Courts

Brown, James R.; Cookson, J. Anthony; Heimer, Rawley Z.

doi:10.1093/rfs/hhw030

Review of Financial Studies 30 (3): 1019–1051

Law and Finance Matter: Lessons from Externally Imposed Courts

James R. Brown, J. Anthony Cookson, and Rawley Z. Heimer

Best Paper in Financial Markets and Institutions, FMA Annual Meeting.

Abstract. This paper provides novel evidence on the real and financial market effects of legal institutions. Our analysis exploits persistent and externally imposed differences in court enforcement that arose when the U.S. Congress assigned state courts to adjudicate contracts on a subset of Native American reservations. Using area-specific data on small business and household credit, reservations assigned to state courts, which enforce contracts more predictably than tribal courts, have stronger credit markets. Moreover, the law-driven component of credit market development is associated with significantly higher per capita income, with stronger effects in sectors that depend more on external financing.

Keywords: law and finance, contract enforcement, legal institutions, credit markets, economic growth, tribal courts, state courts, Native American reservations.

JEL codes: G21, K40, P48.

In brief

Predictable contract enforcement leads to stronger credit markets and higher incomes.

When Congress assigned state courts, rather than tribal courts, to adjudicate contracts on some Native American reservations, it created lasting differences in how predictably contracts were enforced. Reservations under state courts have stronger small-business and household credit markets. The part of credit market development driven by this legal difference is associated with significantly higher per capita income, especially in sectors that depend more on outside financing.

**Table 1.** Study at a glance
Panel A. Design
Question	Does predictable contract enforcement strengthen credit markets and raise incomes?
Setting	Congress’s assignment of state rather than tribal courts to adjudicate contracts on a subset of Native American reservations
Data	Area-specific data on small business and household credit
Method	Reservations assigned to state courts compared with those that kept tribal courts
Panel B. Main findings
Credit markets under state courts	Stronger
Per capita income	Significantly higher where law-driven credit development is greater
Where effects are largest	Sectors that depend more on external financing

Summarized from the paper. See the paper for exact estimates and specifications.

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Published version, Review of Financial Studies
Working paper version, SSRN
Accepted manuscript (open access), Iowa State University
DOI: 10.1093/rfs/hhw030

Brown, James R., J. Anthony Cookson, and Rawley Z. Heimer. 2017. “Law and Finance Matter: Lessons from Externally Imposed Courts.” Review of Financial Studies 30 (3): 1019–1051. https://doi.org/10.1093/rfs/hhw030.

@article{heimer2017law,
  author  = {Brown, James R. and Cookson, J. Anthony and Heimer, Rawley Z.},
  title   = {Law and Finance Matter: Lessons from Externally Imposed Courts},
  journal = {Review of Financial Studies},
  volume  = {30},
  number  = {3},
  pages   = {1019--1051},
  year    = {2017},
  doi     = {10.1093/rfs/hhw030},
  url     = {https://academic.oup.com/rfs/article/30/3/1019/2669944}
}

Topics: Legal institutions and financial development
Related papers: Growing Up Without Finance; Courting Economic Development

In brief

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