Schaffer, Mark Edwin
(1990)
A theory of bailouts of firms and enterprises, with evidence from Polish industry.
PhD thesis, London School of Economics and Political Science.
Abstract
This thesis examines a number of aspects of a government policy of rescuing firms or enterprises that are in difficulties, with particular attention to the East European context. The first part of Chapter 2 examines a concept introduced by Janos Kornai, the "soft budget constraint", and argues that it should be interpreted as a state policy of bailouts of enterprises in financial difficulties. The second part of the chapter examines the effect on incentives of a state policy of bailouts, arguing that in principle a bailout policy has an ambiguous effect on enterprise performance. Chapter 3 looks at the causes behind a government policy of bailouts. A game-theoretic model is presented in support of the argument that a cause of a bailout policy may be that the government is unable to make a credible commitment not to bail out an enterprise. The model also shows that if the government can acquire a "reputation for toughness", its threat of "no bailouts" may be credible. The phenomenon of "storming" or rush-work to meet a deadline is also analysed. In Chapter 4 a model of economic natural selection is developed. The model demonstrates that profit-maximisation does not "summarise appropriately" the conditions for firm survival. If firms have market power, profit-maximisers are not necessarily the best survivors. The economic model presented derives from the biologists' "evolutionarily stable strategy" (ESS) model. An appendix presents a version of the ESS model for finite populations. Finally, the thesis looks at empirical evidence on financial bailouts using data from the 500 largest enterprises in Polish industry, 1983-88. Chapter 5 discusses the data and the tax/subsidy system. Chapter 6 looks at how these enterprises were subsidised, and presents evidence, based on econometric estimates of government subsidy policy, that subsidies were used to rescue loss-making enterprises.
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