Chapter 18 - Regulation and investment in fintech ventures

Abstract

This chapter shows how regulatory developments that are perhaps overly stringent can lead to entrepreneurial activity to develop in regions that are not overly constrained by regulation. This chapter examines the context of fintech (crowdfunding is just one component of fintech, and this chapter is broader than crowdfunding in its coverage of activity) venture capital (VC) investments taking place around the world, and the role of institutional factors in the international allocation of fintech VC. The evidence in this chapter shows a notable change in the pattern of fintech VC investments around the world relative to other types of investments after the global financial crisis. We show that fintech VC investments are relatively more common in countries with weaker regulatory enforcement and without a major financial center after the financial crisis. Also, we show that fintech boom is more pronounced for smaller private limited partnership venture capitalists that likely have less experience with prior VC booms and busts. These fintech VC deals are substantially more likely to be liquidated, especially when located in countries without a major financial center. This chapter builds on the institutions and corporate governance literatures by showing the importance of enforcement in driving relative differences in investment patterns and investor participation. For entrepreneurial start-ups, regulatory arbitrage drives investment into countries with a dearth of enforcement and regulatory costs. The chapter argues that the spike in fintech VC in certain countries is attributable to differential enforcement of financial institution rules amongst start-ups versus large established financial institutions after the financial crisis. Regulatory arbitrage in the context of fintech VC can spur booms and busts. Less experienced venture capitalists seem more prone to undertake investments that exacerbate boom and bust cycles. National governance is strengthened by the enforcement of regulatory standards, and corporate governance through investor experience and oversight can mitigate these swings and facilitate better investment outcomes.