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Investor protection and business creation

Author

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  • Ari Hyytinen

    (Research Institute of the Finnish Economy ETLA & Etlatieto Ltd)

  • Tuomas Takalo

    (Bank of Finland)

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.

Suggested Citation

  • Ari Hyytinen & Tuomas Takalo, 2004. "Investor protection and business creation," Finance 0404021, University Library of Munich, Germany.
    • Handle: RePEc:wpa:wuwpfi:0404021
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    More about this item

    Keywords

    investor protection; start-up financing; private equity market; entrepreneurship; corporate finance;
    All these keywords.

    JEL classification:

    • E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage

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