Business Creation and the Stock Market

Abstract

We claim that the stock market encourages business creation, innovation, and growth by allowing the recycling of "informed capital." Due to incentive and information problems, new start-ups face high flotation costs. Sustaining a tight relationship with a monitor (bank, venture capitalist) allows them to postpone their going public decision until profitability prospects are clearer or incentive problems are less severe. However, monitors' informed capital is in limited supply and the earlier young firms go public the quicker this capital is redirected towards new start-ups. Hence factors that lead to the emergence of a stock market for young firms also encourage business creation. Given the role of new businesses in innovation, our theory suggests a novel linkage between financial development and growth.

Keywords: Start-ups, Financial Life Cycle, Going Public, Venture Capital, Growth

JEL Classification: E44, G32, O40