The Limits of Discipline. Ownership and Hard Budget Constraints in the Transition Economies

Posted: 28 May 2001

See all articles by Roman Frydman

Roman Frydman

New York University (NYU) - Department of Economics

Cheryl W. Gray

World Bank

Marek P. Hessel

Fordham University - Gabelli School of Business

Andrzej Rapaczynski

Columbia Law School

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Abstract

The existing literature on soft budget constraints suggests that firms may be subsidized for political reasons or because of the creditors' desire to recover a part of the sunk cost invested in an earlier period. In all these models hard budget constraints are viewed as being, in principle, capable of inducing the necessary restructuring behaviour on the level of the firm. This paper argues that the imposition of financial discipline is not sufficient to remedy ownership and governance-related deficiencies of corporate performance. Using evidence from the post-communist transition economies, the paper shows that a policy of hard budget constraints cannot induce successful revenue restructuring, which requires entrepreneurial incentives inherent in certain ownership types (most notably, outside investors). The paper also shows that the policy of hard budget constraints falters when state firms, because of inferior revenue performance and less willingness to meet payment obligations, continue to pose a higher credit risk than privatized firms. The brunt of state firms' lower creditworthiness falls on state creditors. But the 'softness' of these creditors, while harmful in many ways, is not necessarily irrational, if it prevents the demise of firms that are in principle capable of successful restructuring through ownership changes.

Keywords: ownership, financial discipline, performance, transition

JEL Classification: G32, P17, P27, P31

Suggested Citation

Frydman, Roman and Gray, Cheryl W. and Hessel, Marek P. and Rapaczynski, Andrzej, The Limits of Discipline. Ownership and Hard Budget Constraints in the Transition Economies. Economics of Transition, Vol. 8, No. 3, November 2000. Available at SSRN: https://ssrn.com/abstract=264811

Roman Frydman (Contact Author)

New York University (NYU) - Department of Economics ( email )

19 West 4th Street
New York, NY 10012
United States

Cheryl W. Gray

World Bank ( email )

1818 H Street
Washington, DC 20433
United States
202-473-9188 (Phone)
202-522-1155 (Fax)

Marek P. Hessel

Fordham University - Gabelli School of Business ( email )

113 West 60th Street
New York, NY 10023
United States

Andrzej Rapaczynski

Columbia Law School ( email )

435 West 116th Street
New York, NY 10025
United States
(212) 854-3421 (Phone)
(212) 854-7946 (Fax)

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