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The Domar-Musgrave phenomenon and adverse selection

Authors
Journal
European Journal of Political Economy
0176-2680
Publisher
Elsevier
Publication Date
Volume
7
Issue
1
Identifiers
DOI: 10.1016/0176-2680(91)90052-5

Abstract

Abstract In this paper, the incentive to increased risk taking caused by taxes on risky revenues (the Domar-Musgrave phenomenon) is revaluated. In a capital market equilibrium with adverse selection, the tax is not ineffective. An additional risk consolidation takes place within the collected tax proceeds. If owners of entrepreneurial firms cannot react via a change of ownership structure, then the tax directly affects the investment decision. In other cases, the tax induces firms' owners to cut back share issues.

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