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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. Vesa Kanniainen & Christian Keuschnigg, 2000. "The Optimal Portfolio of Start-Up Firms in Venture Capital Finance," CESifo Working Paper Series 381, CESifo Group Munich.
  2. Klaus Schmidt, 1999. "Convertible Securities and Venture Capital Finance," CESifo Working Paper Series 217, CESifo Group Munich.
  3. Casamatta, Catherine, 2002. "Financing and Advising: Optimal Financial Contracts with Venture Capitalists," CEPR Discussion Papers 3475, C.E.P.R. Discussion Papers.
  4. Kaplan, Steven & Strömberg, Per Johan, 2000. "Financial Contracting Theory Meets The Real World: An Empirical Analysis Of Venture Capital Contracts," CEPR Discussion Papers 2421, C.E.P.R. Discussion Papers.
  5. Christian Keuschnigg & Soren Bo Nielsen, 2000. "Tax Policy, Venture Capital, and Entrepreneurship," Econometric Society World Congress 2000 Contributed Papers 1848, Econometric Society.
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  10. Poterba, James M., 1989. "Capital Gains Tax Policy Toward Entrepreneurship," National Tax Journal, National Tax Association, vol. 42(3), pages 375-89, September.
  11. Christian Keuschnigg, 2002. "Taxation of a Venture Capitalist with a Portfolio of Firms," CESifo Working Paper Series 813, CESifo Group Munich.
  12. Paul Gompers & Josh Lerner, 2001. "The Venture Capital Revolution," Journal of Economic Perspectives, American Economic Association, vol. 15(2), pages 145-168, Spring.
  13. Laura Bottazzi & Marco Da Rin, . "Euro.NM and the Financing of European Innovative Firms," Working Papers 171, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
  14. 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.
  15. Inderst, Roman & Mueller, Holger M, 2002. "Venture Capital Contracts and Market Structure," CEPR Discussion Papers 3203, C.E.P.R. Discussion Papers.
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  17. Kanniainen, V. & Keuschnigg, C., 2001. "Start-up Investment With Scarce Venture Capital Support," University of Helsinki, Department of Economics 503, Department of Economics.
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  21. James M. Poterba, 1989. "Venture Capital and Capital Gains Taxation," NBER Working Papers 2832, National Bureau of Economic Research, Inc.
  22. Paul A. Gompers & Josh Lerner, 1999. "What Drives Venture Capital Fundraising?," NBER Working Papers 6906, National Bureau of Economic Research, Inc.
  23. Tirole, Jean, 2001. "Corporate Governance," Econometrica, Econometric Society, vol. 69(1), pages 1-35, January.
  24. Robert Z. Ailber (ed.), 2001. "International Finance," Books, Edward Elgar, volume 0, number 525, April.
  25. McAfee, R Preston & McMillan, John, 1991. "Optimal Contracts for Teams," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 32(3), pages 561-77, August.
  26. Roger H. Gordon, 1998. "Can High Personal Tax Rates Encourage Entrepreneurial Activity?," IMF Staff Papers, Palgrave Macmillan, vol. 45(1), pages 49-80, March.
  27. Samuel Kortum & Josh Lerner, 2000. "Assessing the Contribution of Venture Capital to Innovation," RAND Journal of Economics, The RAND Corporation, vol. 31(4), pages 674-692, Winter.
  28. 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.
  29. Aghion, P. & Tirole, J., 1993. "On the Management of Innovation," Working papers 93-12, Massachusetts Institute of Technology (MIT), Department of Economics.
  30. Christian Keuschnigg & Søren Bo Nielsen, . "Public Policy for Venture Capital," EPRU Working Paper Series 01-06, Economic Policy Research Unit (EPRU), University of Copenhagen. Department of Economics.
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