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State Owned Firms: Private Debt, Cost Revelation and Welfare

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  • Pierre M. Picard

    () (CREA, University of Luxembourg and CORE, Universit é Catholique de Louvain)

  • Ridwan D. Rusli

    () (CREA, University of Luxembourg)

Abstract

In this paper we study the role of private debt financing in disciplining a state owned firm operating for a government that incurs a cost of public financing. We show that debt contracts allow the government to avoid socially costly subsidies by letting unprofitable state- owned firms default. Debt is never used when the firm and government share the same information about the firm. By contrast, when the state-owned firm has private information, the government has an incentive to use debt to reduce the firm's information rents. We identify the conditions under which a positive debt level benefits governments. They depend on the cost of public funds, the interbank funding rate, the share of foreign investors, the level and uncertainty of the firm's cost.

Suggested Citation

  • Pierre M. Picard & Ridwan D. Rusli, 2012. "State Owned Firms: Private Debt, Cost Revelation and Welfare," CREA Discussion Paper Series 12-10, Center for Research in Economic Analysis, University of Luxembourg.
  • Handle: RePEc:luc:wpaper:12-10
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    Keywords

    State-owned firms; privatization; debt; information asymmetry;

    JEL classification:

    • L33 - Industrial Organization - - Nonprofit Organizations and Public Enterprise - - - Comparison of Public and Private Enterprise and Nonprofit Institutions; Privatization; Contracting Out
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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