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http://ssrn.com/abstract=11063
 
 

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Privatization with Political Constraints: Auctions versus Private Negotiations


Zsuzsanna Fluck


Michigan State University - Department of Finance

Kose John


New York University (NYU) - Department of Finance

S. Abraham Ravid


Yeshiva University - Syms School of Business

April 1997

New York University, Center for Law and Business, Working Paper No. 98-007

Abstract:     
This paper investigates the design of privatization mechanisms in emerging market economies. We identify an emerging market economy by the political constraints that limit the set of viable privatization mechanisms. Our objective is to explain the striking diversity of privatization mechanisms observed in practice and the frequent use of an apparently suboptimal privatization mechanism: private negotiation.

We develop a simple model wherein privatization is to be carried out by a government agent who plays favorites among bidders and is potentially disciplined by forthcoming elections. We find that it is the degree of political constraints that determines which mechanism is more successful in raising funds. If the political environment is such that the privatization agent himself aims at raising the fair value for the company, then privatization auctions and private negotiations are equally successful in raising public revenues. If, however, political constraints distort the agent's incentives, then one mechanism outperforms the other. In particular, if the distortion is moderate, then private negotiations can raise more value for a successful enterprise than privatization auctions. In this case the agent may play favorites among the bidders, but to the extent he cares about the price, he will use his bargaining power to negotiate his target price. If, however, the distortion is severe so that the agent lacks sufficient motivation to raise a fair price for the company, then privatization auctions will outperform private negotiations. Even though the agent may play favorites among the bidders, he would not put pressure on the bidders to raise the price during negotiations. In a privatization auction, in contrast, the presence of other bidders, regardless of how informed they are, induces competition and places a lower bound on the equilibrium winning bid. We further find that information disclosure laws may have negative welfare implications: they may help the privatization agent to collude with some of the bidders to the disadvantage of noncolluding bidders. Our theory provides further regulatory implications for privatization procedures in emerging market economies.

JEL Classification: G30, G38

working papers series


Not Available For Download

Date posted: July 11, 1997  

Suggested Citation

Fluck, Zsuzsanna and John, Kose and Ravid, S. Abraham, Privatization with Political Constraints: Auctions versus Private Negotiations (April 1997). New York University, Center for Law and Business, Working Paper No. 98-007. Available at SSRN: http://ssrn.com/abstract=11063

Contact Information

Zsuzsanna Fluck
Michigan State University - Department of Finance ( email )
Eli Broad Graduate School of Management
315 Eppley Center
East Lansing, MI 48824-1122
United States
517-353-3019 (Phone)
517-432-1080 (Fax)
Kose John (Contact Author)
New York University (NYU) - Department of Finance ( email )
Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States
212-998-0337 (Phone)
212-995-4233 (Fax)
S. Abraham Ravid
Yeshiva University - Syms School of Business ( email )
United States
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