Financial Development, Growth Volatility and Information Asymmetry in Sub‐Saharan Africa: Does Law Matter?

• DOI: http://doi.org/10.1111/saje.12176
• Published date: 01 December 2017
• Date: 01 December 2017
• Author: Muazu Ibrahim,Paul Alagidede

FINANCIAL DEVELOPMENT, GROWTH VOLATILITY AND

INFORMATION ASYMMETRY IN SUB-SAHARAN AFRICA:

DOES LAW MATTER?

MUAZU IBRAHIM*

†

AND PAUL ALAGIDEDE

†

Abstract

We re-examine the law–finance theory relying on 33 countries in sub-Saharan Africa over the

period 2004–2011. Our evidence suggests that legal origin significantly explains cross-country

differences in financial development and economic volatility. More importantly, relative to civil

law, English common law countries and those in Southern Africa have higher financial sector

development both in terms of financial activity and banking efficiency on the back of lower vola-

tility. While private credit bureau positively (negatively) affects financial development (economic

volatility) with economically large impact for English legal legacy countries, the latter effect is

contingent on the form of legal origin suggesting that, the establishment of information sharing

offices per se may be insufficient in taming growth vagaries.

JEL Classification: K42, C32, O43, P48, K10

Keywords: Law, financial development, volatility

1. INTRODUCTION

Indeed, the current literature on finance-law nexus has left much space for engagement in

at least three areas: (i) re-positioning the debate where the issue of financial development

and banking system efficiency is lower; (ii) examining the role of legal origin in influencing

information sharing for both financialsystem activity and the fundamental role of financial

institutions to transform mobilised deposits into credit for economic agents; and (iii)

examining the moderation role of legal origin in information asymmetry-economic volatil-

ity nexus. Our study makes significant contributions to existing literature in several ways.

First, given the evolving legal systems in the sub-region on the back of narrow financial

markets, shocks and volatility, we engage the literature by empirically re-examining the

law–finance theory and the fundamental role of information sharing in financial develop-

ment measured in terms of financial activity and efficiency. Second, we also examine how

legal origin interacts with information asymmetry in explaining cross-country differences

in economic volatility in sub-Saharan Africa (SSA). This study therefore presentsa case for

the imperativeof introducing the previously missing links into the law–finance literature.

A growing body of literature highlights financial development as a key factor in pro-

moting economic growth (Levine, 1997; Beck et al., 2000; Hassan et al., 2011; Ibrahim

and Alagidede, 2016) and reducing economic volatility (Denizer et al., 2000; Ibrahim

* Corresponding author: Lecturer, School of Business and Law, Department of Banking and

Finance, University for Development Studies, Wa, UPW 36, Ghana. Tel: 1233 208004800.

E-mail: imuazu@uds.edu.gh or ibrahimuazu@gmail.com

†

Wits Business School, University of the Witwatersrand

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C2017 Economic Society of South Africa. doi: 10.1111/saje.12176

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of Economics

and Alagidede, 2017). Recent studies identify legal origin as important factor influencing

cross-country differences in financial development and growth (La Porta et al., 1998;

Levine, 1998; Beck et al., 2003). More importantly, the law–finance theory suggests that

common law countries have better prospects for financial development than civil law

countries. The reasons are that common laws are more likely to protect the private prop-

erty rights relative to the State, and they tend to be dynamic to changing country land-

scape (La Porta et al., 1998; Beck and Levine, 2003).

There is literature proffering that limited access to finance has been on account of

higher information asymmetry (Triki and Gajigo, 2014; Asongu et al., 2015). Conse-

quently, the desire to increase financial access and financial development has led to the

establishment of information sharing offices notably the private credit bureaus (PCBs)

across SSA countries with the intent of reducing information asymmetry between bor-

rowers and lenders in the financial markets. Indeed, some authors (Batuo and Kupukile,

2010; Allen et al., 2011) have argued that the establishment of information sharing offi-

ces is based on the premise that, the limited access to finance (and financial development

more generally) by prospective borrowers is constrained by such factors (namely eligibil-

ity of bank lending, physical access and affordability) that can be explained by informa-

tion asymmetry.

Theoretically, information sharing offices are expected to serve as agents of financial

intermediation by narrowing information gap between borrowers and lenders. According

to Jappelli and Pagano (2002), by reducing information asymmetry, these information

sharing bureaus are able to increase competition and reduce bottlenecks in access to

finance thus aiding in efficient capital allocation. However, recent literature on informa-

tion asymmetry (see Asongu et al., 2015) has doubted the ability of these information

sharing offices to inspire competition in the financial sector for increased financial access.

For most part, studies on information asymmetry and financial development (Iva-

shina, 2009; Houston et al., 2010; Tanjung et al., 2010) have failed to (i) engage the cru-

cial role of law in financial development in the light of evolving legal systems in SSA and

(ii) incorporate the concept of finance given the role of banking institutions in trans-

forming mobilised deposits into credit for productive investment. On the other hand,

the law–finance theory literature in Africa (see for instance Asongu, 2011) has been situ-

ated around its implications for economic growth and welfare without examining how

legal origin explains cross-country differences in economic volatility. More tellingly, how

effective law shapes and/or limits information sharing in growth volatility remains an

unexplored area of research in SSA. We therefore bridge these research gaps relying on

data for 33 SSA countries spanning 2004–2011.

Our evidence suggests that legal origin significantly explains cross-country differences

in financial development and economic volatility. More importantly, English common

law countries have higher financial sector development both in terms of activity and effi-

ciency accompanied by low growth volatility. Not only is the relationship between the

interaction term of legal origin and PCB on volatility negative and statistically significant,

it is economically large for the English legal legacy countries. However, juxtaposing the

impact of PCB on volatility on one hand and that of transmission channel on the other

suggests that, the establishment of information sharing offices per se may be insufficient

in taming growth vagaries. We argue that it is the effectiveness of law that is exceedingly

relevant in faltering economic volatility. Thus, relative to countries with lax legal systems,

those that enforce contracts effectively, protects private property and lender rights have

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