IDEAS home Printed from https://ideas.repec.org/p/hhs/iuiwop/1104.html
   My bibliography  Save this paper

Stock Option Taxation and Venture Capital Activity: A Cross-Country Comparison

Author

Listed:
  • Henrekson, Magnus

    (Research Institute of Industrial Economics (IFN))

  • Sanandaji, Tino

    (Institute for Economic and Business History Research (EHFF), Stockholm School of Economics)

Abstract

The VC sector is interesting both in its own right and as a proxy for entrepreneurial finance in a broader sense. We highlight the tax treatment of stock options as an important factor for variations in the size of the VC sector. VC often relies on complex mechanisms and option-based contracts to mitigate incentive problems. Granting stock options to founders and key employees also allows credit-constrained start-ups to attract and retain top talent. This type of compensation cannot be unambiguously classified as either capital or labor income. Some tax systems treat stock options in VC-funded firms as employee compensation, which is subject to payroll taxes with high progressive rates, whereas others treat them as capital gains with low flat tax rates. The effective rate depends on tax practices and is not readily indicated by statutory taxes. The tax consultancy firm PwC calculated the effective tax rate for a standardized entrepreneurial case in 22 countries, which is supplemented with our own calculations for 16 additional countries. In this sample of 38 countries, we find a negative cross-country relationship between the effective tax rate on employee stock options and the rate of VC activity. This negative effect is stronger for countries with high R&D investments and weaker in countries with low R&D spending.

Suggested Citation

  • Henrekson, Magnus & Sanandaji, Tino, 2016. "Stock Option Taxation and Venture Capital Activity: A Cross-Country Comparison," Working Paper Series 1104, Research Institute of Industrial Economics, revised 09 Nov 2017.
    • Handle: RePEc:hhs:iuiwop:1104
    as

    Download full text from publisher

    File URL: https://www.ifn.se/wfiles/wp/Wp1104.pdf
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. Henrekson, Magnus & Sanandaji, Tino, 2013. "Small Business Activity Does not Measure Entrepreneurship," Working Paper Series 959, Research Institute of Industrial Economics, revised 26 Jan 2014.
    2. Ricardo J. Caballero, 2007. "Specificity and the Macroeconomics of Restructuring," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262033623, December.
    3. Patrick Bolton & Mathias Dewatripont, 2005. "Contract Theory," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262025760, December.
    4. Hart, Oliver & Moore, John, 1990. "Property Rights and the Nature of the Firm," Journal of Political Economy, University of Chicago Press, vol. 98(6), pages 1119-1158, December.
    5. Erik Hurst & Benjamin Wild Pugsley, 2011. "What Do Small Businesses Do?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 42(2 (Fall)), pages 73-142.
    6. George W. Fenn & J. Nellie Liang & Stephen D. Prowse, 1995. "The economics of the private equity market," Staff Studies 168, Board of Governors of the Federal Reserve System (U.S.).
    7. Steven N. Kaplan & Antoinette Schoar, 2005. "Private Equity Performance: Returns, Persistence, and Capital Flows," Journal of Finance, American Finance Association, vol. 60(4), pages 1791-1823, August.
    8. Josh Lerner & Antoinette Schoar, 2005. "Does Legal Enforcement Affect Financial Transactions? The Contractual Channel in Private Equity," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 120(1), pages 223-246.
    9. Matthieu Montalban & Nicolas Bedu, 2014. "Analysing the uneven development of private equity in Europe: legal origins and diversity of capitalism," Post-Print hal-01135283, HAL.
    10. Magnus Henrekson & Tino Sanandaji, 2015. "Superentrepreneurship and global imbalances: closing Europe’s gap to other industrialized regions," Chapters, in: Antonina Bakardjieva Engelbrekt & Moa Mårtensson & Lars Oxelheim & Thomas Persson (ed.), The EU’s Role in Fighting Global Imbalances, chapter 4, pages 58-88, Edward Elgar Publishing.
    11. Steven N. Kaplan & Per Strömberg, 2003. "Financial Contracting Theory Meets the Real World: An Empirical Analysis of Venture Capital Contracts," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 70(2), pages 281-315.
    12. Manju Puri & Rebecca Zarutskie, 2012. "On the Life Cycle Dynamics of Venture-Capital- and Non-Venture-Capital-Financed Firms," Journal of Finance, American Finance Association, vol. 67(6), pages 2247-2293, December.
    13. Kanniainen, Vesa & Keuschnigg, Christian, 2003. "The optimal portfolio of start-up firms in venture capital finance," Journal of Corporate Finance, Elsevier, vol. 9(5), pages 521-534, November.
    14. Philippe Aghion & Patrick Bolton, 1992. "An Incomplete Contracts Approach to Financial Contracting," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 59(3), pages 473-494.
    15. Josh Lerner & Antoinette Schoar, 2010. "International Differences in Entrepreneurship," NBER Books, National Bureau of Economic Research, Inc, number lern08-2, July.
    16. Vesa Kanniainen & Paolo M. Panteghini, 2013. "Tax Neutrality: Illusion or Reality? The Case of Entrepreneurship," FinanzArchiv: Public Finance Analysis, Mohr Siebeck, Tübingen, vol. 69(2), pages 167-193, June.
    17. Lee, Seung-Hyun & Yamakawa, Yasuhiro & Peng, Mike W. & Barney, Jay B., 2011. "How do bankruptcy laws affect entrepreneurship development around the world?," Journal of Business Venturing, Elsevier, vol. 26(5), pages 505-520, September.
    18. Black, Bernard S. & Gilson, Ronald J., 1998. "Venture capital and the structure of capital markets: banks versus stock markets," Journal of Financial Economics, Elsevier, vol. 47(3), pages 243-277, March.
    19. Raj Chetty & John N. Friedman & Tore Olsen & Luigi Pistaferri, 2011. "Adjustment Costs, Firm Responses, and Micro vs. Macro Labor Supply Elasticities: Evidence from Danish Tax Records," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 126(2), pages 749-804.
    20. Rafael Repullo & Javier Suarez, 2004. "Venture Capital Finance: A Security Design Approach," Review of Finance, European Finance Association, vol. 8(1), pages 75-108.
    21. Bascha, Andreas & Walz, Uwe, 2001. "Convertible securities and optimal exit decisions in venture capital finance," Journal of Corporate Finance, Elsevier, vol. 7(3), pages 285-306, September.
    22. Evsey D. Domar & Richard A. Musgrave, 1944. "Proportional Income Taxation and Risk-Taking," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 58(3), pages 388-422.
    23. Lerner, Josh & Schoar, Antoinette (ed.), 2010. "International Differences in Entrepreneurship," National Bureau of Economic Research Books, University of Chicago Press, number 9780226473093, December.
    24. Kaplan, Steven N. & Martel, Frederic & Stromberg, Per, 2007. "How do legal differences and experience affect financial contracts?," Journal of Financial Intermediation, Elsevier, vol. 16(3), pages 273-311, July.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Magnus Henrekson & Tino Sanandaji, 2018. "Stock option taxation: a missing piece in European innovation policy?," Small Business Economics, Springer, vol. 51(2), pages 411-424, August.
    2. Elert, Niklas & Henrekson, Magnus & Stenkula, Mikael, 2017. "Institutional Reform for Innovation and Entrepreneurship: An Agenda for Europe," Working Paper Series 1150, Research Institute of Industrial Economics, revised 16 Feb 2017.
    3. Henrekson, Magnus & Sanandaji, Tino, 2016. "Owner-Level Taxes and Business Activity," Foundations and Trends(R) in Entrepreneurship, now publishers, vol. 12(1), pages 1-94, March.
    4. Rin, Marco Da & Hellmann, Thomas & Puri, Manju, 2013. "A Survey of Venture Capital Research," Handbook of the Economics of Finance, in: G.M. Constantinides & M. Harris & R. M. Stulz (ed.), Handbook of the Economics of Finance, volume 2, chapter 0, pages 573-648, Elsevier.
    5. Andrew Metrick & Ayako Yasuda, 2011. "Venture Capital and Other Private Equity: a Survey," European Financial Management, European Financial Management Association, vol. 17(4), pages 619-654, September.
    6. Tereza Tykvová, 2018. "Venture capital and private equity financing: an overview of recent literature and an agenda for future research," Journal of Business Economics, Springer, vol. 88(3), pages 325-362, May.
    7. Cumming, Douglas & Johan, Sofia Atiqah binti, 2008. "Preplanned exit strategies in venture capital," European Economic Review, Elsevier, vol. 52(7), pages 1209-1241, October.
    8. Uwe Walz & Carsten Bienz, 2006. "Evolution of Decision and Control Rights in Venture Capital Contracts: An Empirical Analysis," FMG Discussion Papers dp585, Financial Markets Group.
    9. Ulrich Hege & Frédéric Palomino & Armin Schwienbacher, 2009. "Venture Capital Performance: The Disparity Between Europe and the United States," Finance, Presses universitaires de Grenoble, vol. 30(1), pages 7-50.
    10. Magnus Henrekson & Tino Sanandaji, 2015. "Superentrepreneurship and global imbalances: closing Europe’s gap to other industrialized regions," Chapters, in: Antonina Bakardjieva Engelbrekt & Moa Mårtensson & Lars Oxelheim & Thomas Persson (ed.), The EU’s Role in Fighting Global Imbalances, chapter 4, pages 58-88, Edward Elgar Publishing.
    11. Carsten Bienz & Uwe Walz, 2010. "Venture Capital Exit Rights," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 19(4), pages 1071-1116, December.
    12. Cumming, Douglas & Schmidt, Daniel & Walz, Uwe, 2010. "Legality and venture capital governance around the world," Journal of Business Venturing, Elsevier, vol. 25(1), pages 54-72, January.
    13. Cumming, Douglas J., 2005. "Capital structure in venture finance," Journal of Corporate Finance, Elsevier, vol. 11(3), pages 550-585, June.
    14. Wang, Lanfang & Wang, Susheng, 2012. "Economic freedom and cross-border venture capital performance," Journal of Empirical Finance, Elsevier, vol. 19(1), pages 26-50.
    15. Dietmar P.J. Leisen, 2012. "Staged venture capital contracting with ratchets and liquidation rights," Review of Financial Economics, John Wiley & Sons, vol. 21(1), pages 21-30, January.
    16. Douglas Cumming & Sofia Johan, 2007. "Advice and monitoring in venture finance," Financial Markets and Portfolio Management, Springer;Swiss Society for Financial Market Research, vol. 21(1), pages 3-43, March.
    17. Roman Inderst & Holger M. Mueller & Felix Münnich, 2006. "Financing a Portfolio of Projects," The Review of Financial Studies, Society for Financial Studies, vol. 20(4), pages 1289-1325.
    18. Christian Keuschnigg, 2003. "Optimal Public Policy For Venture Capital Backed Innovation," University of St. Gallen Department of Economics working paper series 2003 2003-09, Department of Economics, University of St. Gallen.
    19. Bottazzi, Laura & Da Rin, Marco & Hellmann, Thomas, 2009. "What is the role of legal systems in financial intermediation? Theory and evidence," Journal of Financial Intermediation, Elsevier, vol. 18(4), pages 559-598, October.
    20. Bottazzi, Laura & Da Rin, Marco & Hellmann, Thomas, 2008. "Who are the active investors?: Evidence from venture capital," Journal of Financial Economics, Elsevier, vol. 89(3), pages 488-512, September.

    More about this item

    Keywords

    Business taxation; Corporate governance; Entrepreneurship; Innovation; Institutions; Tax policy; Venture capital;
    All these keywords.

    JEL classification:

    • H25 - Public Economics - - Taxation, Subsidies, and Revenue - - - Business Taxes and Subsidies
    • H30 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - General
    • K34 - Law and Economics - - Other Substantive Areas of Law - - - Tax Law
    • L26 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Entrepreneurship

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:hhs:iuiwop:1104. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Elisabeth Gustafsson (email available below). General contact details of provider: https://edirc.repec.org/data/iuiiise.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.