We study the effects of red tape and corruption in a model of occupational choice, entry regulation and imperfect capital markets. Red tape is the set of rules and regulations that private agents are obliged to comply with in order to engage in entrepreneurial activity. Corruption is the payment of bribes to public officials for the purpose of circumventing red tape. Capital market imperfections are the asymmetries of information between borrowers and lenders about the returns to entrepreneurship. We show that both red tape and corrup- tion deter entrepreneurial activity, but that only corruption affects financial market outcomes, including the probability of bankruptcy and the costs of verifying bankruptcy claims. The existence of corruption compounds the effects of both aggregate uncertainty and capital market frictions, each of which compounds the effects of corruption. We examine the interactions between red tape and corruption when both are endogenous to the bureaucratic process.
