The Signaling Value of Legal Form in Debt Financing

Abstract

Deregulation of capital requirements does not only lead to an increase in entrepreneurship, it also entails a substantial substitution effect where entrepreneurs are more likely to opt for a legal form with low instead of high paid-in capital. In this paper, we show that firms that choose for a limited liability company with low paid-in capital experience a lower access to debt financing compared to their high paid-in capital counterparts. These findings are robust to using different estimation techniques, including a difference-in-difference and regression discontinuity design. Our findings are consistent with the idea that credit providers use the entrepreneur’s legal form choice as a screening device to sort out perceived high-risk firms from low-risk firms. Our findings contribute to a more nuanced understanding of the impact of deregulation of capital requirements on newly established firms