Definition of investor protection

Actions to encourage honest advertising of financial products, and to prevent fraud to make sure that investors do not lose money if their investments default (are not repaid).

Source: Longman Business English Dictionary

Investor protection is defined by the extent to which the commercial law and its enforcement protect investors from expropriation by company insiders.

Investor protection is usually measured by indicators that quantify explicit protections awarded to shareholders and creditors by corporate, bankruptcy, and reorganisation laws, as well as the quality of law enforcement.

Examples of such explicit protections are those that impact the shareholders’ ability to vote down directors, including whether to allow shareholders to vote by proxy or vote by mail. Allowing shareholders to vote by proxy or by mail decreases the costs for small shareholders to manifest their dissent.

There are also provisions that impact the ability of secured creditors to take possession of their collateral in bankruptcy. In many countries there is an automatic stay upon bankruptcy, meaning that creditors cannot repossess their collaterals and reduces creditor protection.

Differences in investor protection across countries are substantial and are believed to be responsible for differences in the development of financial markets and ultimately for differences in economic development.

Example
In April 2002 investor protection in Italy worsened as a result of a decree issued by Berlusconi’s government, which downgraded the crime of ”false communication by corporate executives” from felony (serious crime) to misdemeanor (minor offence), punishable at most with a pecuniary fine. This reform lowered corporate executives’ incentives to tell investors the truth about the state of their companies.

Source: Gian Luca Clementi, assistant professor of economics, NYU Stern School of Business