The Impact of Legal and Political Institutions on Equity Trading Costs: A Cross-Country Analysis

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Abstract
We conjecture that macro-level institutional quality will affect equity trading costs through its impact on information risk and investor participation. A study of liquidity costs of 412 NYSE-listed ADRs from 44 countries reveals the following key findings. After controlling for firm-level determinants of trading costs, effective spread and price impact of trades are significantly lower for stocks from countries with better ratings for judicial efficiency, accounting standards, and political stability. Trading costs are significantly higher for stocks from French civil law countries than for those from common law countries. These empirical relations are economically significant. As an illustration, we estimate that the effective spread of a stock would decline from 1.3% to 0.5%, if the same stock is based in Sweden rather than in Venezuela. Overall, we show that trading costs depend on the quality of legal and political institutions in a stock's home country.

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