What Role of Legal Systems in Financial Intermediation? Theory and Evidence

What Role of Legal Systems in Financial Intermediation? Theory and Evidence

Laura Bottazzi, Marco Da Rin, Thomas Hellmann

Series number :

Serial Number: 
082/2005

Date posted :

February 01 2005

Last revised :

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Keywords

  • Financial intermediation • 
  • legal systems • 
  • Investor behavior • 
  • Corporate governance • 
  • optimal contracts

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.

Authors

Real name: 
Laura Bottazzi