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

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

    (Tilburg University, Center for Economic Research)

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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Bibliographic Info

Paper provided by Tilburg University, Center for Economic Research in its series Discussion Paper with number 2008-30.

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Date of creation: 2008
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Handle: RePEc:dgr:kubcen:200830

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Web page: http://center.uvt.nl

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Keywords: Financial Intermediation; Law and Finance; Corporate Governance; Venture Capital;

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