The Proper Scope of Government Reconsidered: Asymmetric Information and Incentive Contracts

Abstract

We revisit the contract-theoretic literature on privatization initiated by Hart et al. (1997). This literature has two major shortcomings. First, it is focused on ex-ante investment incentives, whereas ex-post inefficiencies which are ubiquitous in the real world cannot be explained. Second, ownership does not matter when incentive contracts can be written. Both shortcomings are due to the fact that this literature has studied the case of symmetric information only. We explore how asymmetric information leads to different kinds of ex-post inefficiencies depending on the ownership structure. Moreover, we show that under asymmetric information ownership matters even when incentive contracts are feasible.

Keywords: incomplete contracts, privatization, control rights, asymmetric information, investment incentives

JEL Classification: D86, D23, D82, H11, L33