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What is the role of legal systems in financial intermediation? Theory and evidence

  • Bottazzi, Laura
  • Da Rin, Marco
  • Hellmann, Thomas

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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Article provided by Elsevier in its journal Journal of Financial Intermediation.

Volume (Year): 18 (2009)
Issue (Month): 4 (October)
Pages: 559-598

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Handle: RePEc:eee:jfinin:v:18:y:2009:i:4:p:559-598
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/622875

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