What is the Role of Legal Systems in Financial Intermediation? Theory and Evidence
ECGI - Finance Working Paper No. 82/2005
IGIER Working Paper No. 283
Sauder School of Business Working Paper
TILEC Discussion Paper No. 2008-014
CentER Discussion Paper Series No. 2008-30
66 Pages Posted: 21 Feb 2005 Last revised: 22 Jan 2019
Date Written: March 1, 2008
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. confirm the predictions of the model.
Keywords: Financial intermediation, legal systems, investor behavior, corporate governance, optimal contracts
JEL Classification: G10, G18, K20
Suggested Citation: Suggested Citation
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