2/2022 Alari Paulus. Business investment, the user cost of capital and firm heterogeneity
Working Papers of Eesti Pank 2/2022
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.
JEL codes: D22, E22, H32
Keywords: business investment, user cost of capital, corporate taxation, firm panel data
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The views expressed are personal and do not necessarily represent the official views of Eesti Pank or the Eurosystem.