Financial Conditions and Investment During the Transition: Evidence from Czech Firms

In this paper, we examine net investment during the early stages of transition using micro data on the population of medium and large industrial firms in the Czech Republic during the 1992-95 period. We examine the relevance of alternative models of investment and test if investment behavior varies across categories of ownership and with the legal status of firms. Our analysis of depreciation leads us to the conclusion that replacement investment displays a similar pattern in many ownership-legal form categories of firms. Retained profit is found to be a major determinant of new investment and the estimate is statistically significant even when we use the most robust fixed effects estimates based on one-year differences. We find that enterprise profitability has a strong positive effect on investment in all types of firms except for privately owned-limited liability companies and foreign owned and mixed ownership firms. These results are consistent with the financing-hierarchy and credit-rationing hypotheses which indicate that domestic firms cannot easily borrow investment funds externally and that net investment varies with retained profits. Firms take into account various stock measures of internal finance. In particular, a stock of cash, receivables, receivables overdue, payables, and payables overdue systematically affect net investment.