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Start-ups, Venture Capitalists, and the Capital Gains Tax

  • Christian Keuschnigg

    ()

  • Soren Bo Nielsen

A model of start-up finance with double moral hazard is proposed. Entrepreneurs have ideas but lack own resources as well as commercial experience. Venture capitalists provide start-up finance and managerial support. Both types of agents thus jointly contribute to the firm's success, but neither type's effort is verifiable. We find that the market equilibrium is biased towards inefficiently low venture capital support. In this situation, the capital gains tax is particularly harmful. The introduction of a small tax impairs managerial advice and leads to first order welfare losses. Once the tax is in place, limitations on loss off-set may paradoxically contribute to higher quality of venture capital backed entrepreneurship and welfare.

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Paper provided by Department of Economics, University of St. Gallen in its series University of St. Gallen Department of Economics working paper series 2002 with number 2002-05.

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Length: 45 pages
Date of creation: Feb 2002
Date of revision:
Handle: RePEc:usg:dp2002:2002-05
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  1. Repullo, Rafael & Suarez, Javier, 1999. "Venture Capital Finance: A Security Design Approach," CEPR Discussion Papers 2097, C.E.P.R. Discussion Papers.
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  12. Catherine Casamatta, 2003. "Financing and Advising: Optimal Financial Contracts with Venture Capitalists," Journal of Finance, American Finance Association, vol. 58(5), pages 2059-2086, October.
  13. James M. Poterba, 1989. "Venture Capital and Capital Gains Taxation," NBER Working Papers 2832, National Bureau of Economic Research, Inc.
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  18. Roger H. Gordon, 1998. "Can High Personal Tax Rates Encourage Entrepreneurial Activity?," IMF Staff Papers, Palgrave Macmillan, vol. 45(1), pages 49-80, March.
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  21. Bengt Holmstrom, 1981. "Moral Hazard in Teams," Discussion Papers 471, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  22. Christian Keuschnigg & Søren Bo Nielsen, 2004. "Progressive Taxation, Moral Hazard, and Entrepreneurship," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 6(3), pages 471-490, 08.
  23. Christian Keuschnigg & Soren Nielsen, 2001. "Public Policy for Venture Capital," International Tax and Public Finance, Springer, vol. 8(4), pages 557-572, August.
  24. Masters, Adrian M, 1998. "Efficiency of Investment in Human and Physical Capital in a Model of Bilateral Search and Bargaining," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 39(2), pages 477-94, May.
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  26. Steven N. Kaplan & Per Stromberg, 2001. "Venture Capitalists As Principals: Contracting, Screening, and Monitoring," NBER Working Papers 8202, National Bureau of Economic Research, Inc.
  27. Kanniainen, V. & Keuschnigg, C., 2000. "The Optimal Portfolio of Start-up Firms in Venture Capital Finance," University of Helsinki, Department of Economics 486, Department of Economics.
  28. Hellmann, Thomas F. & Puri, Manju, 2000. "Venture Capital and the Professionalization of Start-up Firms: Empirical Evidence," Research Papers 1661, Stanford University, Graduate School of Business.
  29. Sahlman, William A., 1990. "The structure and governance of venture-capital organizations," Journal of Financial Economics, Elsevier, vol. 27(2), pages 473-521, October.
  30. Hellmann, Thomas & Puri, Manju, 2000. "The Interaction between Product Market and Financing Strategy: The Role of Venture Capital," Review of Financial Studies, Society for Financial Studies, vol. 13(4), pages 959-84.
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