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We examine if a startup's legal form choice is used as a signal by credit providers to infer its risk to default on a loan. We propose that choosing a legal form with low minimum capital requirements signals higher default risk. Arguably, small relationship banks are more likely to use legal form as a screening device when deciding on a loan. Using data from Orbis and the IAB/ZEW Start-up Panel for a sample of German firms, we find evidence consistent with our hypotheses but inconsistent with predictions of several competing explanations, including differential demand for debt or growth opportunities.
Felix Bracht, Jeroen Mahieu and Steven Vanhaverbeke
15 December 2022 Paper Number POIDWP052
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