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Start-ups, venture capitalists, and the capital gains tax

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  • Keuschnigg, Christian
  • Nielsen, Soren Bo

Abstract

A model of start-up finance with double moral hazard is proposed. Entrepreneurs have ideas but lack own resources as well as commercial experience. Venture capitalists provide start-up finance and managerial support. Both types of agents thus jointly contribute to the firm's success, but neither type's effort is verifiable. We find that the market equilibrium is biased towards inefficiently low venture capital support. In this situation, the capital gains tax is particularly harmful. The introduction of a small tax impairs managerial advice and leads to first order welfare losses. Once the tax is in place, limitations on loss off-set may paradoxically contribute to higher quality of venture capital backed entrepreneurship and welfare.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Public Economics.

Volume (Year): 88 (2004)
Issue (Month): 5 (April)
Pages: 1011-1042

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Handle: RePEc:eee:pubeco:v:88:y:2004:i:5:p:1011-1042

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Web page: http://www.elsevier.com/locate/inca/505578

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References

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  1. Steven N. Kaplan & Per Stromberg, 2000. "Financial Contracting Theory Meets the Real World: An Empirical Analysis of Venture Capital Contracts," NBER Working Papers 7660, National Bureau of Economic Research, Inc.
  2. Keuschnigg, Christian & Nielsen, Soren Bo, 2000. "Tax Policy, Venture Capital and Entrepreneurship," CEPR Discussion Papers 2626, C.E.P.R. Discussion Papers.
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  23. Kanniainen, Vesa & Keuschnigg, Christian, 2004. "Start-up investment with scarce venture capital support," Journal of Banking & Finance, Elsevier, vol. 28(8), pages 1935-1959, August.
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