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The Direct Effect of Corporate Law on Entrepreneurship

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  • Guzman, Jorge

Abstract

I estimate the impact of better corporate law on business formation by taking advantage of the adoption of the Model Business Corporation Act (MBCA) across US states in the post-war era. Conceptually, better law leads to a direct effect (more entrepreneurs start firms), and an indirect effect (a better local economy). States adopt new corporate law endogenously, making it difficult to estimate both effects. However, using the expansion of out of state firms into the state (who only gain from the indirect effect) allows controlling for the local economy and, under some assumptions, estimating the direct effect of the law. Difference-in-differences plots show no pre-trends using this approach. Better law increased the rate of new local corporations by 5\% per year, an estimate confirmed in robustness tests and two instrumental variables regressions. One tenth of the new corporations are substitutions from other firm types, and the rest net-new firms. Consistent with a mechanism whereby better law increases investor protection and entrepreneurship, states with more rudimentary institutions benefited more, and states that only did partial adoption of the MBCA saw no benefit.

Suggested Citation

  • Guzman, Jorge, 2020. "The Direct Effect of Corporate Law on Entrepreneurship," SocArXiv 967ph, Center for Open Science.
    • Handle: RePEc:osf:socarx:967ph
    DOI: 10.31219/osf.io/967ph
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