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Stock Option Taxation: A Missing Piece in European Innovation Policy?

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  • Henrekson, Magnus

    () (Research Institute of Industrial Economics (IFN))

  • Sanandaji, Tino

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

Abstract

Europe continues to lag behind the U.S. in venture capital (VC) activity and the creation of successful startups and has recently been surpassed by China. This is despite the fact that many European countries have deep financial markets, strong legal institutions and high R&D spending. We point to the tax treatment of employee stock options as an explanation for the stronger growth of the U.S. VC sector. As a response to high uncertainty and transaction costs, VC financiers have developed a model in which founders and key recruitments are compensated with stock options under complex contracts. Low tax rates on employee stock options further raise the relative returns of working and investing in innovative entrepreneurial firms and shift financial capital and talent to that sector. We measure the effective tax on stock options in VC-backed entrepreneurial firms in a number of developed economies. Countries with lower stock option taxation have higher VC activity and more high-growth expectation entrepreneurial activity. Based on these associations and the theoretical and empirical literature, we argue that more lenient taxation of gains on employee stock options can be a strategy for European countries to catch up in entrepreneurial finance. This tax policy would narrowly target entrepreneurial startups without requiring broad tax cuts. The favorable tax treatment of stock options allows the state to promote firms that rely on entrepreneurial finance and make use of these types of contracts without lowering taxes for other sectors of the economy.

Suggested Citation

  • Henrekson, Magnus & Sanandaji, Tino, 2017. "Stock Option Taxation: A Missing Piece in European Innovation Policy?," Working Paper Series 1168, Research Institute of Industrial Economics, revised 20 Feb 2018.
  • Handle: RePEc:hhs:iuiwop:1168
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    References listed on IDEAS

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    Cited by:

    1. Claire Economidou & Luca Grilli & Magnus Henrekson & Mark Sanders, 2018. "Financial and Institutional Reforms for an Entrepreneurial Society," Small Business Economics, Springer, vol. 51(2), pages 279-291, August.

    More about this item

    Keywords

    Entrepreneurship; Innovation; Institutions; Tax policy; Stock options; Venture capital;

    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

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