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Investor Protection and Business Creation

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  • Hyytinen, Ari
  • Takalo, Tuomas
Abstract
We study the effects of investor protection on the cost of external finance, entrepreneurship, and creation of new firms in an equilibrium search model of private capital markets. Besides search frictions, we emphasize moral hazard problems that stem from entrepreneurs' possibilities to expropriate financiers. Investor protection reduces the scope for moral hazard. However, it also constrains the freedom of entrepreneurs to choose projects and to run their own firms. Strengthening investor protection does not therefore always enhance business creation: the results indicate that only when investor protection has a sufficiently large impact on financiers' monitoring cost relative to entrepreneurial freedom does strengthening investor protection enhance start-up creation. We also find a general equilibrium effect, since search frictions amplify the adverse effect of investor protection on business creation.
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  • Hyytinen, Ari & Takalo, Tuomas, 2004. "Investor Protection and Business Creation," Discussion Papers 889, The Research Institute of the Finnish Economy.
    • Handle: RePEc:rif:dpaper:889
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    More about this item

    JEL classification:

    • E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage

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