Is There a Trade-Off between Protecting Investors and Promoting Entrepreneurial Activity? Evidence from Angel Financing

Abstract

This paper studies how changes in investor protection regulations affect local entrepreneurial activity, relying on the heterogeneous impact of a 2011 SEC regulation change on the definition of accredited investors across U.S. cities. Using a difference-in-differences approach, I show that cities more affected by the regulation change experienced a significantly larger decrease in local angel financing, entrepreneurial activity, innovation output, employment, and sales. I find that small business loans and second-lien mortgages became entrepreneurs’ partial substitutes for angel investment. My cost-benefit analysis suggests that the costs of protecting angel investors through the 2011 regulation change outweigh its benefits.

Keywords: Angel financing, Investor protection, Entrepreneurship, Innovation, IPO and acquisition

JEL Classification: G24, G28, L26, K22