Expected returns and expected dividend growth in Europe: Legal origin, institutional, and financial determinants

Abstract

This paper uses a present value approach to show that price movements for equity indices in a sample of European stock markets can be traced to legal origin, institutional, and corporate financial factors. The present value literature states that stock indices move due to changes either in discount rates, dividend growth, or a combination of the two. Empirically, little is known about the mechanism through which legal, institutional, and corporate financial factors influence these variables, especially in a European context. The current paper attempts to plug this gap in the literature. Using the state space approach, we show that although expected returns are highly persistent, expected dividend growth tends to vary across the sample. Movements in markets are mainly due to changes in the discount rate. However, there appears to be a difference in the proportion of movements attributable to discount rate and dividend growth components. Stock markets in civil law countries tend to have a stronger link with the dividend growth variables as well as market size and activity measures. Expected dividend growth is also driven by profitability factors in both types of country. By contrast, there is no strong evidence of corporate indicators influencing expected returns.

Legal origin and financial development: A propensity score matching analysis

“…Akin to other studies linking legal origin to financial, economic or even social outcomes (see, e.g., D'Amico & Williamson, 2015; Rambaccussing & Power, 2018), no normative statements or specific policy implications can be derived from our findings. This is because how nations' legal processes are organized and their historical traditions of governance (i.e., how they were founded or colonized by English common law or French, German, or Scandinavian civil law) -which is what the legal origin construct measures -clearly cannot be rewritten solely on the basis of evidence of how legal origin influences financial development or its main components (financial markets and financial institutions).…”

“…Finally, to determine the sensitivity of our results to the methodology employed (PSM), we also re-estimate the model using pooled Ordinary Least Square (OLS) (columns 1 and 2 of Table 8), a regression method commonly employed in empirical studies linking legal origin to financial, economic or social outcomes (see, e.g., D'Amico & Williamson, 2015; Rambaccussing & Power, 2018), and cross-section OLS (columns 3 and 4 of Table 8). At the cost of losing many country-year observations for the covariates, the latter cross-section OLS empirical exercise may be justified by the fact that our treatment variable (legal origin) is constant over time, hence we take averages (over the full sample period) of the outcome variable and covariates and use a crosssection of countries rather than a panel, as done, for example, by Beck et al (2003).…”

Role of institutions in promoting finance in emerging markets: A panel data analysis

“…An institutional approach in which property rights, legal contracts, and market prices are transparent creates a conducive financial environment [ 47 ]. Countries with high institutional factors such as shareholder rights, creditor rights, legal protection, and institutional index tend to have better stock market performance [ 48 ]. Strong protection of property rights has a strong impact on companies’ access to finance, and it confirms that corporate access to finance considerably mitigates the impact of such protection on business innovation [ 49 ].…”