Are Polish firms risk-averting or risk-loving?: evidence on demand uncertainty and the capital-labour ratio in a transition economy

Robert Lensink, Victor Murinde and Christopher Green

No 99E13, Research Report from University of Groningen, Research Institute SOM (Systems, Organisations and Management)

Abstract: This paper investigates the effect of demand uncertainty on the capital-labour ratio of non-financial firms in Poland in order to infer the firms’ risk behaviour. A generic model is used to characterise a utility maximising firm in a transition economy with demand uncertainty and imperfect competition. It is assumed that labour is completely variable and capital is quasi-fixed. The demand for capital, and hence the capital-labour ratio, derives from the optimisation of expected costs and the firm’s pricing and output decisions, and crucially depends on the sign of the covariance term i.e. the firm’s risk behaviour. The main proposition of the model is that if firms are risk-loving, an increase in demand uncertainty increases the capital-labour ratio, whereas the capital-labour ratio would decrease when a firm is risk-averting. The model is estimated using data from a cross-section of 148 non-financial firms in Poland. The results unambiguously show that there exists a significant positive relationship between demand uncertainty and the capital-labour ratio. This finding suggests that Polish firms are risk-lovers. The evidence may have important implications for the needed set of regulations and corporate governance in Poland as part of the necessary economic reform.

Date: 1999
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