Insider Ownership and Capital Constraints: An Empirical Investigation of the Credit Rationing Hypothesis in Estonia

• Author: Bersant Hobdari
• Date: 01 November 2008
• Published date: 01 November 2008
• DOI: http://doi.org/10.1111/j.1467-8683.2008.00709.x

Insider Ownership and Capital Constraints: An

Empirical Investigation of the Credit Rationing

Hypothesis in Estonia

Bersant Hobdari

ABSTRACT

Manuscript Type: Empirical

Research Question/Issue: This study investigates the impact of insider ownership on investment rates using a large and

representative sample of Estonian f‌irms.

Research Findings/Results: Using a unique and rich panel data for a large and representative sample of f‌irms from Estonia

between 1993 and 2002, we f‌ind that investment rates of employee-owned f‌irms are positively related to measures of

internal funds and negatively related to measures of external funds, indicating that these f‌irms are f‌inancially constrained

in carrying out their investment. Further, the probability that these f‌irms operate as f‌inancially constrained is high and

consistent over time. When manager-owned f‌irms are considered, they are found to face barriers to access of external

f‌inancing.

Theoretical Implications: Our empirical results suggest that barriers to accessto capital are an important determinant of the

decline of employee-owned f‌irms in Estonia. In addition, agency conf‌licts with potential providers of capital constrain

manager-owned f‌irms access to external funds and their ability to carry out investment projects.

Practical Implications: This study offers insights to policy makers interested in designing policies easing f‌irms’ access to

capital and improving the governance system within which f‌irms operate. In addition, it suggests practical implications to

owner managers interested in mitigating agency conf‌licts and attracting outside investors.

Keywords: Business Form, Insider Systems, Share Ownership, Corporate Governance

INTRODUCTION

The importance of liquidity constraints in f‌irms’ real

investment decisions has long been the focus of eco-

nomic research (Stein, 2003). The literature f‌inds that access

to capital is not unlimited and is determined by the degree

of informational asymmetries between f‌irms and providers

of capital and agency costs caused by managerial discretion.

One standard approach to assess the substitutability of inter-

nal and external sources of f‌inance is to investigate the sen-

sitivity of investment for different categories of f‌irms. The

aim of this literature is to identify f‌irm level indicators, such

as dividend payout ratios, bank aff‌iliation, membership in

f‌inancial conglomerates, f‌irm size, f‌irm age, or governance

structures, which approximate for the severity of capital

market imperfections and explain the observed differences

in investment behaviour acrossf‌irms (Fazzari, Hubbard, and

Petersen, 1988; Bond and Meghir, 1994; Goergen and Ren-

neboog, 2001).

While the information asymmetry and agency costs argu-

ments are made without reference to particular institutional

environments, it is expected that these problems will be

more severe in Central and Eastern European Countries

(CEECs). The economic transformation that CEECs went

through is characterized by infantile and illiquid capital

markets and a weak banking sector. Although both sectors

have experienced substantialgrowth and improvement over

time, they still remain weaker in f‌inancing and disciplining

f‌irms than their counterparts in developed countries.

These premises imply an important role for f‌irm’s owner-

ship structure and concentration in determining its access to

f‌inance, cost of capital and, subsequently, investment rates.

The extant literature, however, says little on the role of dif-

ferent ownership structures on investment decisions, since

Assistant Professor,Department of International Economics and Management,Copen-

hagen Business School, Porcelænshaven24A, 2000 Frederiksberg, Denmark. Tel: +45

38152518; E-mail: bh.cees@cbs.dk

536 CORPORATE GOVERNANCE

Volume 16 Number 6 November 2008 © 2008 TheAuthor

Journal compilation © 2008 BlackwellPublishing Ltd

doi:10.1111/j.1467-8683.2008.00709.x