Ceris-CNR Working paper 10/2000

INVESTMENT, CASH FLOW AND MANAGERIAL DISCRETION IN STATE-OWNED FIRMS
Evidence across soft and hard budget constraints

Elisabetta BERTERO* Laura RONDI*
(London School of Economics) (CERIS-CNR)

LSE Financial Markets Group Special Paper, n.119, November 1999

Revised 23 May 2000

Abstract

In this paper we extend to state-owned enterprises the empirical work on investment-cash flow sensitivities. Our sample is a panel of Italian state-owned manufacturing firms over the period 1977-1993. The distinctive element of public firms’ financial environment is the budget regime under which they operate. Our analysis of Italian institutions identifies a switch from a soft to a hard budget constraint regime in 1987, for which a critical determinant was Italy’s attempt to qualify for EMU. We estimate a number of models of investment with additional cash flow terms and test for parameter constancy across budget regimes and the business cycle. We find that there is a positive correlation between investment and cash flow also for public firms, but only when the budget regime is soft. We argue that excessive managerial discretion is likely to be responsible for this correlation. We also find that the switch to a hard regime brings about an important change in the investment decisions of this panel of public enterprises.

Key words: Capital markets imperfections, public enterprises, investment and cash flow, soft-budget constraint, business cycle, managerial discretion, Italian firms.
JEL classification: G32, L32, M40, G31, E32

SCARICA QUESTO WP

 

*London School of Economics, Houghton Street, London WC2A 2AE - UK
Tel. +44 20 7 955 7549; Fax +44 20 7 955 7420. E-mail: E.M.Bertero@lse.ac.uk

**CERIS-CNR Institute for Economic Research on Firms and Growth, National Research Council
Via Avogadro, 8, 10121 Turin - Italy
Tel. +39 011 560 1209; Fax: +39 011 562 6058. E-mail: L.Rondi@ceris.to.cnr.it

We gratefully acknowledge comments and suggestions from Luigi Benfratello, Robert Carpenter, Charles Goodhart, Steve Nickell, Giovanna Nicodano, Bruce Petersen, Alessandro Sembenelli, participants of the XXV EARIE conference, Copenhagen and of the DIP seminar series at the University of Turin. Elisabetta Bertero gratefully acknowledges financial support from the Nuffield Foundation.