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

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 access to 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.