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The Proper Scope of Governments When Costs are Contractible

  • Dalen, Dag Morten
  • Moen, Espen R

We discuss the relative merits of public and private ownership. Our starting point is the analysis of Hart, Schleifer and Vishny (HSV), who apply an incomplete contract framework to study the difference between private and public ownership. Our analysis departs from HSV’s model in two aspects. First, we allow for cost-sharing contracts between the government and the firm. Second, we assume that the manager of a private firm may incur additional costs in order to produce private benefits, or perks (alternatively, this may reflect cross-subsidization). Managers in publicly owned firms do not have the same opportunity to produce perks, as the government when it owns the firm can monitor the manager’s costs more closely. The cost-sharing contract allows the government to govern the incentives for cost reductions in a privatized firm, and the government can thereby reduce the private firm’s incentives to dump quality in order to save on costs. This comes at a cost, however, as a low-powered incentive contract increases the manager’s incentives to consume perks. We show that if quality dumping is important, public ownership is still preferable to private ownership.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 3992.

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Date of creation: Jul 2003
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Handle: RePEc:cpr:ceprdp:3992
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  1. Oliver Hart, 2003. "Incomplete Contracts and Public Ownership: Remarks, and an Application to Public-Private Partnerships," Economic Journal, Royal Economic Society, vol. 113(486), pages C69-C76, March.
  2. Andrei Shleifer, 1998. "State Versus Private Ownership," Harvard Institute of Economic Research Working Papers 1841, Harvard - Institute of Economic Research.
  3. Anke S. Kessler & Christoph Lülfesmann, 2001. "Monitoring and Productive Efficiency in Public and Private Firms," FinanzArchiv: Public Finance Analysis, Mohr Siebeck, Tübingen, vol. 58(2), pages 167-, February.
  4. David E. M. Sappington & Joseph E. Stiglitz, 1987. "Privatization, Information and Incentives," NBER Working Papers 2196, National Bureau of Economic Research, Inc.
  5. Holmstrom, Bengt R. & Tirole, Jean, 1989. "The theory of the firm," Handbook of Industrial Organization, in: R. Schmalensee & R. Willig (ed.), Handbook of Industrial Organization, edition 1, volume 1, chapter 2, pages 61-133 Elsevier.
  6. Jean-Jacques Laffont & Jean Tirole, 1991. "Privatization and Incentives," Working papers 572, Massachusetts Institute of Technology (MIT), Department of Economics.
  7. Besley, Timothy J. & Ghatak, Maitreesh, 2001. "Government versus Private Ownership of Public Goods," CEPR Discussion Papers 2725, C.E.P.R. Discussion Papers.
  8. Hart, Oliver & Shleifer, Andrei & Vishny, Robert W, 1997. "The Proper Scope of Government: Theory and an Application to Prisons," The Quarterly Journal of Economics, MIT Press, vol. 112(4), pages 1127-61, November.
  9. Schmidt,Klaus M., 1991. "The costs and benefits of privatization," Discussion Paper Serie A 330, University of Bonn, Germany.
  10. Shapiro, C. & Willing, D.R., 1990. "Economic Rationales For The Scope Of Privatization," Papers 41, Princeton, Woodrow Wilson School - Discussion Paper.
  11. Jensen, Michael C. & Meckling, William H., 1976. "Theory of the firm: Managerial behavior, agency costs and ownership structure," Journal of Financial Economics, Elsevier, vol. 3(4), pages 305-360, October.
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