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

L. Bottazzi, M. Da Rin, T. Hellmann

Research output: Contribution to journalArticleScientificpeer-review

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Abstract

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.
Original languageEnglish
Pages (from-to)559-598
JournalJournal of Financial Intermediation
Volume18
Issue number4
Publication statusPublished - 2009

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Investors
Financial intermediation
Legal system
Entrepreneurs
Venture capital
Double moral hazard
Prediction
Legal protection
Investor behavior
Empirical test
Empirical evidence
Venture capitalists
Fixed effects
Empirical analysis
Optimal contract

Cite this

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abstract = "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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What is the role of legal systems in financial intermediation? Theory and evidence. / Bottazzi, L.; Da Rin, M.; Hellmann, T.

In: Journal of Financial Intermediation, Vol. 18, No. 4, 2009, p. 559-598.

Research output: Contribution to journalArticleScientificpeer-review

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AB - 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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