Does judicial quality matter for firm performance?

Abstract

A sound legal environment is said to be good for business to the extent that it protects property rights, enforces contracts, and ensures the consistency of policies. By lowering uncertainty and contracting costs, a better judiciary is expected to encourage business investments. We test if this hypothesis holds in the Philippine setting by examining whether and how judicial quality is significant to firm-level growth. We construct a quantitative measure of judicial quality, a Judicial Quality Index, using principal components analysis on a diagnostic survey dataset of judges across 13 regions, and we use this in a regression analysis of firm-level growth using data from micro, small, and medium enterprises across 34 Philippine cities. 

We find that higher judicial quality has no independent effect on firm growth. But it does reduce the effect of “bribes” or informal payments, which are typically offered by firms to overcome inordinate delays in government processes or to gain an advantage in business. It therefore makes a positive but indirect contribution to firm performance. In the presence of a better quality judicial system, there is a less compelling need for firms to engage in informal payments to “grease the wheels of commerce”. 

JEL classification: C38, C36, D02, D73