| Summary: | Legal systems provide the basic institutions for firms and markets to operate. Their quality can have important consequences on the size distribution of firms, who rely on them for contract enforcement. This paper uses the variation in legal system quality across states in Mexico to examine the relationship between judicial quality and firm size. Although the country has a single legal system, its implementation and procedures vary widely, while development outcomes there are more imbalanced and unequal than in any other country of the OECD. The effect of the legal system on inter-state firm efficiency is therefore examined. Building on Laeven and Woodruff (2007), this study uses economic census microdata and contract enforcement ratings to examine the impact of state-level legal institutions on firm and industrylevel outcomes. A robust effect of judicial quality is observed on the firm size distribution and efficiency, instrumenting for underlying historical determinants of institutions. Indicative evidence is found that the effect is strongest in more capital-intensive industries. Market size and distance-to-market are also found to matter for firm size outcomes, consistent with the new trade literature
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