On the main determinants of startup investment in developing countries

In this article, we examine the timing of startup investment in developing countries. Specifically, by analyzing a representative firm through a real option approach, we study the effects on new business activities of four key distinctive features of emerging economies. These characteristics are well documented by the empirical literature, however a theoretical model explaining their effect is missing. First, a firm’s Earnings Before Interest and Taxes (EBIT) tends to be more volatile than in developed economies. Second, firms face a higher risk of sudden-death, either due to political expropriation or the withdrawal of support from multinational. Third, financial markets are generally more inefficient compared to those in developed countries. Fourth, Corporate Income Tax (CIT) rates are, on average, higher than in developed economies. By accounting for these features, we derive some relevant policy implications. Our findings suggest that policymakers seeking to stimulate economic activity should primarily focus on reducing riskiness, especially in terms of sudden-death risk, rather than EBIT volatility, while also enhancing financial market efficiency. Tax rate however plays a less significant role in facilitating new business establishment.