Research Discussion Papers, Bank of Finland
No 17/2003:
Investor protection and business creation
Ari Hyytinen ()
and Tuomas Takalo ()
Abstract: We study the effects of investor protection on the
availability of external finance, entrepreneurship, and creation of new
firms in an equilibrium search model of private capital markets. In
addition to search frictions, we examine contract frictions, specifically
interim and ex post moral hazard problems stemming from entrepreneurs’
possibilities to expropriate financiers. In our model, the government
chooses the level of investor protection that determines the
transferability of match surplus between entrepreneurs and financiers. The
results indicate that anything that increases (decreases) entrepreneurship
also increases (decreases) the creation of start-ups. The effect of
investor protection on the creation of start-ups thus hinges on the
relative importance of various search and contract frictions. Only when
investor protection has a sufficiently large impact on the ex post moral
hazard problem relative to the interim moral hazard does strengthening
investor protection enhance start-up creation. We also find that search
frictions dilute the beneficial effect of investor protection and that
contract frictions modify the standard Hosios condition for efficiency.
Keywords: investor protection; start-up financing; private equity market; entrepreneurship; corporate finance; (follow links to similar papers)
JEL-Codes: E50; G21; G24; (follow links to similar papers)
36 pages, August 12, 2003
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