1 Determinants of Firm Level Technical Efficiency: A Stochastic Frontier Approach*

By using an empirical approach seldom used in this area for transition economies (namely, stochastic frontiers) we investigate the determinants and dynamics of firm efficiency. This approach allows us to simultaneously estimate the parameters of both the efficiency and the production function. We also use most unusual data--a representative sample of Estonian firms for the period 1993-1999 – and are able to address problems that plague much previous work, such as the endogeneity of ownership. Consequently our findings are more reliable and efficient than most previous estimates. Our main findings are that: (i) compared to employee and state ownership, foreign ownership increases technical efficiency; (ii) firm size and higher labor quality enhance efficiency, while soft budget constraints adversely affect efficiency; (iv) Estonian firms operate under constants returns to scale; (v) the percentage of firms operating at high levels of efficiency increases over time. As such our findings provide support for hypotheses that a firm’s ownership structure and its characteristics are important for it