Does ownership always matter?

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London School of Economics, London WC2A ZAE, V. Centre d'etude des Revenus ... This paper investigates the implications for company public ownership, in ...
International Journal of Industrial Orga

olland

4”*r L*

London School of Economics, London WC2A ZAE, V

Centre d’etude des Revenus et des Coiits, 75007Paris, France

The objective of this paper is to explain and illustrate the complex relationship between ownership arrangements and enterprise performance. It is commonly argued that efficiency will be lower in the public sector than the private because enterprise objectives deviate from maximisation of profits and because monitoring arrangements are inadequate due to the absenti of capital market discipline. We argue that public ownership does make the owner-manager relationship more complicated because the chain of principals and agems is expanded; ojectives are politically determined; and these are conveyed by a policy-making administrative structure to management. But the relative efficiency of pttblic as against private ownership actually depends on the eEp ll:cacv of capital market monitoring: on the political and constitutional svstem; on the inf~rrn9tinn L11.b L... _I.“.& &d sanctions available to policy makers; and on the nature of the management market. Variation in these factors can help to explain the different natures and roles of the public sector between countries.

This paper investigates the implications for company public ownership, in comparison with the effectiveness of th to be exercised by the capital market on private firms. our understanding of the different natures and roles sectors in different countries, especially in inspired our analysis. the last decade, changes in P ic policy in both countries.

sources of support are gratefully acknowledged.

pressures said

S. Estrin and V. Pkotin,

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Does ownership always matter?

towards privatisation, selling about 1E29billion worth of public assets to t te sector in 1979-90. France followed in 1986-88 by privatising e firms that the considerable nationalisation programme of 19 brought into the public sector. i This policy was discontinued in 11988but nationalised conglomerates continue to enjoy substantial flexibility in the acquisition and sale of part1y-owned subsidiaries. Some of the rationales put forward in ritain for ownership changes seem to be in direct contradiction with th arguments used in France. For example, an important aim of ritish privatisations was to improve the efficiency of the firms concerned y making them subject to the disciplining pressures of the capital market. Yet French nationalisations, also meant to improve efficiency, were seen precisely as a remedy to the deficiencies of the capital market [see de Bandt (1988)]. Differences in performance have been established between nationalised and privately owned firms in various countries although not always in the same direction [see, for example, Caves and Christiansen (i980), Pryke ( i982), Borcherding et al. (1982) and Bees (1984)], and performance changes associated with privatisation or nationalisation have been observed within particular firms in Britain and France. However, Molyneux and Thompson (1987) suggest that performance improved befire privatisation in several British cases. Nationalisation has been associated with performance improvement in France overall but no deterioration appeared after privatisation, which seems to have had a neutral or perhaps positive effect on most of the companies concerned [Encaoua and Santini ( 1989)J Efficiency differences between public and private firms have traditionally been attributed to differences in objectives and in the nature of markets upon which the :*vo types of firm trade. The tendency for public sector production to be clustered in markets with monopolistic or severely imperfect industrial structures has led to the suggestion that privatisation is necessary to introduce a measure of competition and market discipline into public sector * ies [see Littlechild (1978), Beesley and Littlechild j1983)]. x of nationalised firms operate in competition with the pr over group before privatisation in Britain; ETF Acquitaine ante). Furthermore, as Vickers and Yarrow (1985, 1988) stress, problems of misallocation deriving from market structure are logically distinct from the question of ownership form and can principle be dealt with by regulation rather than ownership form [see also acock ( 1984), Kay and erston ( 1984)].2 ‘This had raised the state’s share in the production of national output from around 11% to 16%.

ritain the debate shifted away from

S. Estrin and V. Pirotin, Does ownership always matter?

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The presence of mo nopolies in the public sector is related to t for nationalisatio ifferent objectives. and ‘under-investment’. arket failures, including natural monopolies, licy-makers have broadened the category to include the supply of products in ‘the nation interest’ such as arms manufacture, transport systems and infrastructure. istributional and equity goals have also been invoked [see ryke (1981), Rees (1984), If public and private sector firms were only distinguished by differences in objectives, it would Mow that a public corporation, given the objective of profit-maximisation, would perform as well as a capitalist firm, holding market structure constant. This would render privatisation unnecessary. Yet privatisers have grandiose claims. Privatisation, it is suggested, will reduce bureaucracy, waste and inefficiency. The argument is based on differences in the internal structure and incentives within the firm associated with ownership form. Public ownership is said to remove capital market incentives to monitor managers’ performance, allowing them to lead a ‘comfortable life’ [Pryke (1981)] at the expense of public resources [see, e.g. de Alessi (1980)]. This paper focuses on internal arrangements and the implications of the weakening of capital market pressures on the public sector. However, we will argue that the world is rather more complicated and that there are variations in the effectiveness of capital market monitoring as well as in institutional arrangements within the public sector and across countries. A now familiar approach to questions of internal organisation is that of principal-and-agent models. This emphasises the role of institutional arrangements in overcoming problems of information costs and risk sharing in situations where somebody acts on somebody else’s behalf for a remuneration [see Rees (1985b), Arrow (1986)]. ‘*hen o-wnership and management are separate, their particular institutional relationship -~-ill contribute to determine the firm’s actual behaviour, and the extent to which it deviates from its owners’ objectives. This suggests that different regimes of ownership, involving different agents, informational structures and incentives, may result in different behaviour regardless of the owners’ objectives. In the following s mechanisms of capital and managerial market

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Does ownership always matter?

and management do not coincide, as occurs i orporations, owners ‘commission’ management to act in ems may arise because managers have interests that f owners, and owners do not have complete information. order to generate a coincidence of interests, owners (the ‘principal’) will esign a contract incorporating in managers’ remuneration a set of rewards and penalties associated with optimal and suboptimal behaviour. Since the agreement is drawn up before the outcome is known, and the income to be shared is not exclusively dependent on management’s behaviour, the contract may provide for some risk-sharing. Owners’ ability to enforce behaviour consistent with their objectives depends on the information they can obtain, directly or indirectly, about the optimality of managers’ actions. henever management has an informational advantage, owners have to protect themselves against the risks of ‘hidden action’, see Arrow (1986) or adverse selection by managers. As information becomes costlier, more incentives will have to be incorporated into contracts, for instance by increasing the risk to management Grough higher penalties and rewards [Rees (1985a), Shave11 4 1979)]. In the private profit-rraaximising corporation, the informational and incentives structures are usually described as follows. Managers, who are paid to maximise profit for owners, are assumed to pursue prestige and power as well as monetary objectives. They will try to increase their benefits and to promote company growth at the expense of profit [Williamson (1963, 1980)]. s bear most of the risk, but cannot observe managers’ actions ey are kept informed of the company’s pe rmance by regularly ccounts and through the share price illward and Parker he company can also be compared with others in the same sector the impact of external events on its performance. ever-31types of sanctions and z-n-+;~~pc Ill~~rrr~. vu are used to induce managers to refit. The market for shares gives o*wncrs a since they can withdraw their assets by selling stock.

S. Estrin and K Ptrotin, Does ownership dways matter?

and use information are particularly public sector. The first is 5vhe number of small stockholders.

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numerous small shareholders are often seen as a pr group utility function [Rees (f98!5a)], but this ignores the economies of scale present in matters of information and decision&raking when information is costly. As remarked by aterson (f985), it may be too costly shareholder to