Partial privatization and screening

Abstract

It is shown that the government, in privatizing state owned enterprises, can use partial privatization as a screening mechanism to elicit private information from the manager about the firm's value. Although some new owners do not have maximum incentives, this screening contract allows the government to maximize its privatization revenues.

Acknowledgements

We wish to express our gratitude for the helpful discussions we had with Lawrence Lau, John McMillan, Yingyi Qian, Scott Rozelle, Steve Tadelis, and seminar participants at Stanford University, Hong Kong University of Science and Technology, the Chinese University of Hong Kong, and the American Economic Association Annual Meeting. We are also grateful to The Chinese University of Hong Kong for research grants.

Notes

See Nellis (1999) and Djankov and Murrell (2002) for privatization in various countries.

Governments do care about revenue. In the case of China, local governments rely on these firms to generate fiscal revenues (Qian and Weingast, 1997). Even if governments are not concerned about revenue, they care about equity in the redistribution of wealth. They do not want a few insiders stripping state assets by buying cheap SOEs (Black et al., 2000).

In this paper, firm quality is not differentiated from manager ability. Managers are good either if they have an inherent ability to manage firms and make them perform better, or if they are the managers of firms that ex ante have a high potential to earn future profits (but this potential is unobserved by outsiders).

See Laffont and Tirole (1986) for the classical model of the tradeoff between ex ante information revelation and ex post moral hazard.

Risk neutrality is not central to the argument in this paper. A risk averse manager or even a risk averse official could have been taken. But since the focus of the paper is not on risk sharing, risk neutrality simplifies the analysis.