Financial Pressure and the Behaviour of Public Enterprises Under Soft and Hard Budget Constraints : Evidence from Italian Panel Data

This paper studies the effect of the hardening of the budget constraint on the behaviour of public enterprises. Drawing from finance theory, we provide empirical evidence of a change in behaviour of public enterprises between soft and hard budget constraint regimes by investigating the financial discipline enforced by debt across the two regimes. Using a panel of Italian state-owned manufacturing firms, we undertake a natural experiment exploiting a shift of budget regimes in the late 1980s. Consistent with the theoretical predictions, the results show that state firms do respond to financial pressure by increasing productivity and reducing employment in a hard budget constraint environment