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What is the Role of Legal Systems in Financial Intermediation? Theory and Evidence

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  • L. Bottazzi
  • M. Da Rin
  • T. Hellmann

Abstract

We develop a theory' and empirical test of how the legal system affects the relationship between venture capitalists and entrepreneurs. The theory uses a double moral hazard framework to show how optimal contracts and investor actions depend on the quality of the legal system. The empirical evidence is based on a sample of European venture capital deals. The main results are that with better legal protection, investors give more non-contractible support and demand more downside protection. These predictions are supported by the empirical analysis. Using a new empirical approach of comparing two sets of fixed-effect regressions, we also find that the investor's legal system is more important than that of the company in determining investor behavior.

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Paper provided by Dipartimento Scienze Economiche, Universita' di Bologna in its series Working Papers with number 613.

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Date of creation: Oct 2007
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Handle: RePEc:bol:bodewp:613

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