Privatization with Political Constraints: Auctions Versus Private Negotiations

40 Pages Posted: 7 Nov 2008

See all articles by Zsuzsanna Fluck

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

Multiple version iconThere are 2 versions of this paper

Date Written: January 1999

Abstract

This paper investigates the design of privatization mechanisms in emerging marketeconomies characterized by 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 negotiations. 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 privatenegotiations 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 enterprisethan 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 fairprice for the company, then privatization auctions will outperform private egotiations. 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 an auction, in contrast, the presence of other bidders,regardless how informed they are, induces competition and places a lower bound on theequilibrium winning bid. We also show 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 non-colluding bidders. Our theory provides further regulatory implications for privatization procedures in emerging market economies.

Suggested Citation

Fluck, Zsuzsanna and John, Kose and Ravid, S. Abraham, Privatization with Political Constraints: Auctions Versus Private Negotiations (January 1999). NYU Working Paper No. FIN-99-006. Available at SSRN: https://ssrn.com/abstract=1296389

Zsuzsanna Fluck (Contact Author)

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

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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