On the causes of soft budget constraints: Firm-level evidence from Bulgaria and Romania

Since Kornai (1980), the adverse effects of soft budget constraints have been well-documented in the literature. More recently, several theoretical explanations for the presence of soft budget constraints have been put forward. The purpose of this paper is to empirically test these theories on the causes of soft budget constraints. We therefore use a panel data set, consisting of company account data for Bulgarian and Romanian manufacturing firms, covering the period 1995–1999. Our results suggest that the probability of finding soft budget constraints importantly depends on the degree of competition within the sector and on the ownership structure of the firm. We further find that sociopolitical concerns about employment increase the probability of soft budget constraints, but only when firms are loss making. Thus, our empirical results largely confirm the hypotheses that competition, privatization, and firm size matter in explaining soft budget constraints, as is suggested in the theoretical models on the causes of soft budget constraints.