Business investment, the user cost of capital and firm heterogeneity

Alari Paulus

No wp2022-2, Bank of Estonia Working Papers from Bank of Estonia

Abstract: The sensitivity of business fixed investment to one of its key determinants, the user cost of capital, has been little investigated with firm-level data that captures firm heterogeneity to the full extent. I study the determinants of business fixed investment in Estonia, using the universe of business statements for non-financial firms in 1994-2020 from administrative records. The results with various panel data models provide strong support for a theoretical long-term relationship between the gross investment rate, and changes in production output and the user cost of capital. I find that the capital stock is modestly responsive to changes in output and the user cost of capital, with elasticities less than 0.5 in absolute size, and that different estimation strategies yield broadly similar results. Elasticities differ by firm size, but sectoral variation is relatively limited. User cost elasticities also exhibit notable variation over time, while output elasticities are much more stable. I also find that investments in machinery and equipment are more elastic than investments in buildings and structures.

Keywords: business investment; user cost of capital; corporate taxation; firm panel data (search for similar items in EconPapers)
JEL-codes: D22 E22 H32 (search for similar items in EconPapers)
Date: 2022-03-24, Revised 2022-03-24
New Economics Papers: this item is included in nep-bec, nep-cfn, nep-cwa, nep-eur, nep-fdg, nep-mac and nep-tra
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