Firms, Markets, and Hierarchies: The Transaction Cost Economics Perspective

By Glenn R. Carroll; David J. Teece | Go to book overview

CHAPTER NINE
Financing of Investment in Eastern Europe
A Theoretical Perspective

BENGT HOLMSTRÖM

Eastern Europe suffers from a worsening capital shortage problem. This paper studies ways to find the needed funds. It is argued that firm need funds in order to transform illiquid ideas into liquid claims, possibly through a chain of intermediaries. It shows that collateral (proven assets) plays the central role in increasing liquidity of liabilities and determining the firm's capacity to fund investments. A model is offered to illustrate how firm growth is limited by the net worth of its marketable assets. The analysis is extended to specialized assets for which the liquidation value is less than the on- going value. The important second variation of intermediation is also examined. A key feature of the intermediation model is that intermediaries themselves are constrained by their net worth. Some lessons are then drawn regarding the status and future of financing in Eastern Europe. The intermediation model suggests that granted the scarcity of capital, financing of investments will have to be more information- intensive: intermediaries will have to take a more active role in monitoring firms. Capital formation is likely to be a slow process, since the capital base is so small. Private investments will be geared towards smaller, safer and shorter-term projects. The logic of liquidity-constrained growth argues for letting small firms carry the brunt of the responsibility for future prosperity in Eastern Europe.


1. Introduction

In the aftermath of liberalization, Eastern Europe has suffered from a worsening capital shortage problem. The capital stock from the Communist era is outmoded and much of it is obsolete. One can expect unemployment to worsen as the process of privatization progresses and the capital base deteriorates further through shutdowns of plants and enterprises. To alleviate unemployment and set the economies back on a growth path, major investments in new technologies and capacity are required. The key question is

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