Law and politics affect the financial structure of the public corporation, perhaps as much as economics. Law restricts financial institutions from holding large equity blocks and from networking the small blocks they do own. Impetus for these restrictions came from several sources: a public-spirited belief that financial stability would be fostered by financial fragmentation, American federalism (each state created its own insular set of financial institutions), rivalries between groups of financial institutions, and popular mistrust of powerful private financial institutions. The stability of many of these rules also derives from the political resistance that one would expect corporate managers and benefited financial institutions to offer to any change.

Ascertaining which enforcement mechanisms work to protect investors has been both a focus of recent work in academic finance and an issue for policy-making at international development agencies. According to recent academic work, private enforcement of investor protection via both disclosure and private liability rules goes hand in hand with financial market development, but public enforcement fails to correlate with financial development and, hence, is unlikely to facilitate it. Our results confirm the disclosure result but reverse the results on both liability standards and public enforcement. We use securities regulators’ resources to proxy for regulatory intensity of the securities regulator. When we do, financial depth regularly, significantly, and robustly correlates with stronger public enforcement. In horse races between these resource-based measures of public enforcement intensity and the most common measures of private enforcement, public enforcement is overall as important as disclosure in explaining financial market outcomes around the world and more important than private liability rules. Hence, policymakers who reject public enforcement as useful for financial market development are ignoring the best currently available evidence.

In a broad-based democracy, not all contracts will survive. Even some efficient contracts will be banned, if enough people dislike them. Thus if the average voter dislikes powerful private financial institutions, politics will, all else being equal, ban them. Interest groups cancel one another out. One group wants powerful financial institutions and another, such as small-town bankers, does not. The small-town bankers have a leg up in the political infighting, because popular opinion is on their side, leading to a ban on some arrangements that a less regulated economy might produce. Or, to recast the problem in agency cost terms, managers would like to be free from the oversight that powerful financial intermediaries might provide, and in the modern era, politicians might side with managers when the managers’ goals of thwarting takeovers align with a public wary of too many hostile takeovers. The politician can satisfy the managerial interest group and be popular at the same time. Agency costs move into the political arena; some contracts are banned, and whether the substitutes that arise are always perfect ones, without additional costs, is an open question. Law restricted the dominant financial institutions from the end of the nineteenth century onward. American banks were fragmented geographically, lacking the size to take big slices of capital of the large American firms emerging at the end of the nineteenth century. Banks’ products and portfolios have been further restricted: they were barred from the securities business and from owning stock. Their affiliates were also restricted in the stock they could own. Insurers could not buy stock for most of this century. Mutual funds cannot easily devote their portfolios to big blocks and face legal problems if they go into the boardroom. Pensions cannot take very big blocks without legal and structural problems; the big private pensions are under managerial control, not the other way around. These rule were neither random nor economically inevitable. While public interest goals of keeping financial intermediaries prudent and stable explain some of the rules, they do not explain all of them. Two dominant themes lay behind many of the rules: American public opinion, which mistrusted private large accumulations of power, and interest group politics. There were winners in fragmenting financial institutions. These winners had a large voice in Congress, and their goals matched public opinion. For example, small banks wanted to shackle large ones and succeeded in getting and keeping branching limits, banks on banks in the securities business, banks on bank affiliates’ moving outside of banking, and deposit insurance (which, by guaranteeing depositors that they will be paid if the bank fails, helps smaller, weaker banks more than it helps more solid, often bigger banks). These features of the political economy of American finance became foundational for corporate finance and the separation of ownership from control.

Strong financial markets are widely thought to propel economic development, with many in finance seeing legal tradition as fundamental to protecting investors sufficiently for finance to flourish. Kenneth Dam finds that the legal tradition view inaccurately portrays how legal systems work, how laws developed historically, and how government power is allocated in the various legal traditions. Yet, after probing the legal origins' literature for inaccuracies, Dam does not deeply develop an alternative hypothesis to explain the world's differences in financial development. Nor does he challenge the origins core data, which could be origins' trump card. Hence, his analysis will not convince many economists, despite that his legal learning suggests conceptual and factual difficulties for the legal origins explanations. Yet, a dense political economy explanation is already out there and the origins-based data has unexplored weaknesses consistent with Dam's contentions. Knowing if the origins view is truly fundamental, flawed, or secondary is vital for financial development policy making because policymakers who believe it will pick policies that imitate what they think to be the core institutions of the preferred legal tradition. But if they have mistaken views, as Dam indicates they might, as to what the legal traditions' institutions really are and which types of laws are effective, or what is really most important to financial development, they will make policy mistakes—potentially serious ones.