Why Poland wins

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Why can Polish companies raise $1 billion a year by floating new stock in Warsaw while their counterparts in Prague come up with zilch? Andrei Shleifer of Harvard University thinks he has the answer and presented some of his latest research, joint work with Edward Glaeser and Simon Johnson, at the US Federal Reserve last month.
The answer, according to Shleifer, relates to quite diVerent approaches to Wnancial market regulation. Both Poland and the Czech Republic rejected communism in 1989 and quickly switched to similar market-building and stabilization policies. But Poland embraced strict enforcement by an independent Securities&Exchange Commission.
The Czech Republic took a hands-off approach, drawing inspiration from Chicago economist Ronald Coase, whose Coase Theorem states that markets produce efficient outcomes by themselves when property rights are well deWned and "transaction" costs are zero. Corrective action by government - through taxes, regulations or laws - isn't necessary.
But Coasians rely crucially on the courts to enforce complicated contracts in order to prevent companies from "expropriating" investors. And that's the nub of the problem, according to Shleifer and his colleagues. "Courts in many countries are underWnanced, unmotivated, unclear as to how the law applies, unfamiliar with economic issues, or even corrupt," said Shleifer.

For their part, regulators often have more reasons to crack down on violators. But there also are costs when they become too aggressive and punish the innocent.
Poland emphasized tight regulation of Wnancial intermediaries, in line with the US model established in the 1930s. James Landis, the original architect, thought that the US Securities&Exchange Commission wouldn't be able to monitor disclosure, trading practices and compliance by all listed corporations and other market participants. So he argued for an SEC that would regulate intermediaries - brokers, accounting Wrms, investment advisers - and wanted to place the burden on them of assuring compliance by issuing companies and traders. The SEC, with its substantial powers including the authority to issue and revoke licences, today can force intermediaries to monitor market participants.
Polish law requires monthly, quarterly, semi-annual and annual Wnancial reporting. Czech law required only annual disclosure. Poland also required disclosure of substantial minority shareholdings, Czech law did not. The lack of disclosure of minority shareholders has even been a problem in several west European countries according to a 1997 report to the EC by the European Corporate Governance Network. It has enabled anonymous shareholders to collude with management to expropriate other investors.
Expropriation of investors in Poland has been infrequent. But it was rampant in the Czech Republic, where it became known as "tunnelling". Managers of an investment fund with a large stake in a privatized company would agree with the company's management to create a new corporate entity - possibly oVshore - which they would jointly control. The investment fund then might sell its shares in the company to the new entity at below market price. And the company might sell some of its assets or its output to the new entity below fair value, thereby expropriating other shareholders. Czech regulators did little to stop tunnelling during its heyday in the mid-1990s. Weak securities laws were one problem. But Shleifer thinks that lack of interest on the part of Czech regulators in the Wnance ministry and judicial ineVectiveness were probably equally important.
For their part, Polish regulators responded to the occasional scandal in stern fashion. They took away the brokerage licence of Bank Slaski - one of Poland's largest banks - after evidence surfaced that it had favoured insiders in allocating the bank's shares when it was privatized in 1994.
And the Securities Commission quickly referred Poland's best-known scandal - leading to the failure of the Elektrim conglomerate - to a public prosecutor, and the CEO was forced to step down.
Today, the vast majority of Czech stocks are barely traded. The number of Wrms on the more liquid main market rose to 62 in 1995, but had fallen to just 10 by 1998. By contrast, the number of liquid Polish stocks has risen steadily over time and hardly any Wrms were transferred to the parallel market in Warsaw.
Poland scored highest when the Central European Economic Review, a Wall Street Journal publication, surveyed brokers and fund managers in 1996 about the state of corporate governance in four transition economies.
The Czechs came in third, beating only Russia. And the International Federation of Stock Exchanges admitted the Warsaw Exchange as a full member in 1994, but is yet to admit the Prague Stock Exchange as even an associate member.
Shleifer admits that the Czech economy performed well overall during the 1990s. But he could Wnd no evidence that Czech companies had found eVective substitutes for new stock issues.

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