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The Government As Venture Capitalist: Organisational Structure and Contract Design in Germany's Privatisation Process
Abstract
This paper examines the role that organisation structure and contract design played in resolving economic and political problems that arose during Germany's privatisation process. We find that German officials structured organizations and contracts in a way that made credible the government's commitment to rapid privatisation. This credibility served to protect the process from political and social opposition. In addition, it enabled Germany to attract talented private sector managers to its privatisation effort. This began with the establishment of an independent privatisation agency, the Treuhand. It culminated with the creation of another set of independent organisations called Management KGs, to which the Treuhand outsourced part of its restructuring, management and privatisation work. The Treuhand provided funding to this effort, thus serving as a kind of venture capitalist.
... As Alchian (1977) points out, this is largely due to the lack of alienable residual claims. Using Jensen and Meckling's (1992) framework, Dyck and Wruck (1999) analyse the shortcomings of public sector firms in three areas: allocation of decision rights, performance measurement, and reward systems. Regarding the allocation of decision rights, public sector entities are at a disadvantage because governments find it difficult to credibly commit to a permanent set of rules. ...
... The work by Galal et al. (1994), Dewenter and Malatesta (2001) and Dyck and Wruck (1999), among others, suggests that while public ownership may be inferior to private ownership, it is possible to improve performance in the public sector through properly designed organisational structures and contracts. ...
... As noted above, there has been limited, if any, empirical research examining the relationship between CEO compensation and board structure in the public sector. However, as many countries go through the steps to corporatise public sector entities (e.g., Dyck and Wruck, 1999;and Black, Kraakman and Tarassova, 2000), politicians, regulators, public sector managers and researchers need to better understand how private sector-style boards operate in the public sector environment. In this study, we examine whether factors associated with board effectiveness in the private sector are also related to board effectiveness in the public sector. ...
We provide evidence on the relation between board structure and CEO compensation in public sector corporations in New Zealand. Using a sample of 80 New Zealand public sector companies, we find that similar to private sector studies, CEO compensation is related to board size, whether the CEO sits on the board, and director quality. We also find that a composite measure of board structure is significant. We conclude that, similar to the private sector, board structure is important in constraining CEO pay. Moreover, our results suggest that private sector-style board can be effective in a public sector context.
The potential of post-contractural apportunistic behavior for improving market efficiency through intrafirm rather than interfirm transactions is examined under the assumption that vertical costs will increase less than contracting costs as specialized assets and appropriable quasi rents increase. Vertical integration protects against the risk of contract cancellation and can create market power which is not generally referred to as monopoly. Contracts used as a alternative provide economically enforceable protection against opportunistic behavior. Solutions to opportunistic behavior problems can include joint ownership of common assets and condominium ownership of services. Economies of scale are major factors in some businesses, such as insurance. The complexities of ownership relations makes it difficult to assign higher costs to either the contract or vertical-integration approach. This suggests that economic analysis should be used to identify which is most advantageous for specific kinds of activities.
Certainly the introduction of product market competition into potentially competitive or, at least contestable, markets can improve performance. To take just one example, Morrison and Whinston (1986, 1986) estimate that even in the imperfectly contestable U.S. airline industry, the annual U.S. welfare gains from deregulation have been around $6 billion.
But this paper argues, and further buttresses empirically, that ownership also matters and matters a lot. This does not necessarily imply that private ownership is always preferable to public ownership. PCs also engage in rent-seeking where possible, but they will try to maximize realizable rents by (relatively) keeping down production costs. Of course, where there are massive economies of scale and scope, high entry barriers, or externalities, public ownership may be preferred. (see Vickers and Yarrow, 1988).
A non-trivial (although as this article has demonstrated, not an obvious) conclusion is that where competition is normatively appropriate, private ownership is preferable from an efficiency perspective. Given that major product markets have continued to become more concentrated in most countries (see, for example, Hart and Clarke, 1980), the relative importance of contestable ownership in inducing technical (if not allocative) efficiency is likely to increase.
Various means of creating a private sector have been used in transition economies, including restitution, privatization of state firms through sales or voucher schemes, and start-ups of new private firms. The privatization of state-owned firms raises questions regarding the viability of future corporate governance but, in combination with economic liberalization, it has induced state-owned firms to react to their new environment. Differences in the extent of privatization among countries reflect largely differences in the privatization of state-owned firms. Qualitative differences reflect differences in who the new owners of these firms are. Copyright 1996 by American Economic Association.
This paper deals with the privatization, restructuring, and liquidation of East German industrial firms. A partnership model is suggested for privatization where the Government's property trust (Treuhandanstalt (THA)) is made a silent partner of the private investors. The application of a general scheme of wage subsidies is rejected in the paper. Furthermore, the paper argues against restructuring policies of the Government's property trust and proposes to set decreasing limits on the trust's finances for the years following 1993. The decreasing financial inflow will force the Government's trust to close firms, and will also signal the commitment of the Government to liquidate the trust itself by, say, the year 2000.
The Stakes * The Architecture of Accountability * Privatization and Public Spending Evidence And Arguments * Organizational Form and Function * The Evidence On Efficiency * The Terms of the Privatization Decision Cases And Cautionary Tales * Lessons from the Pentagon * Local Service Contracting * The Private Prisons Debate * Business, Government, and Job Training Conclusions * The (Limited) Promise of Privatization
The German government rapidly privatized state owned enterprises thorough an auction mechanism with openness to all purchasers. Western German firms purchased most enterprises raising suggestions of inefficiency or corruption. This paper rationalizes the government approach, suggesting the key to understanding these elements of the economic transition is recognition of the need to select western management and transfer them to eastern enterprises. I demonstrate the importance of management selection through a model of adverse selection based on information advantages for private owners. Privatization can improve the quality and level of management in eastern enterprises, and these benefits can increase with the size of the transition. Evidence from East Germany supports the theoretical assumptions and is consistent with model predictions.
The foundations are being put in place for a revolution in the science of organizations. Some major analytical building blocks for the development of a theory of organizations are outlined and discussed in this paper. This development of organization theory will be hastened by increased understanding of the importance of the choice of definitions, tautologies, analytical techniques, and types of evidence. The two literatures of agency theory are briefly discussed in light of these issues. Because accounting is an integral part of the structure of every organization, the development of a theory of organizations will be closely associated with the development of a theory of accounting. This theory will explain why organizations take the form they do, why they behave as they do, and why accounting practices take the form they do. Because such positive theories as these are required for purposeful decision making, their development will provide a better scientific basis for the decisions of managers, standard-setting boards, and government regulatory bodies.
This paper integrates elements from the theory of agency, the theory of property rights and the theory of finance to develop a theory of the ownership structure of the firm. We define the concept of agency costs, show its relationship to the ‘separation and control’ issue, investigate the nature of the agency costs generated by the existence of debt and outside equity, demonstrate who bears these costs and why, and investigate the Pareto optimality of their existence. We also provide a new definition of the firm, and show how our analysis of the factors influencing the creation and issuance of debt and equity claims is a special case of the supply side of the completeness of markets problem.The directors of such [joint-stock] companies, however, being the managers rather of other people's money than of their own, it cannot well be expected, that they should watch over it with the same anxious vigilance with which the partners in a private copartnery frequently watch over their own. Like the stewards of a rich man, they are apt to consider attention to small matters as not for their master's honour, and very easily give themselves a dispensation from having it. Negligence and profusion, therefore, must always prevail, more or less, in the management of the affairs of such a company.Adam Smith, The Wealth of Nations, 1776, Cannan Edition(Modern Library, New York, 1937) p. 700.
Book description:
When communism fell in 1989, the question for most Eastern European countries was not whether to go to a market economy, but how to get there. Several years later, the difficult process of privatization and restructuring continues to concern the countries of the region. The Transition in Eastern Europe, Volumes 1 and 2 is an analysis of the experiences of various countries making the transition to market economies and examines the most important challenges still in store.
Volume 1, Country Studies, gives an in-depth, country-by-country analysis of various reform experiences, including historical backgrounds and discussions of policies and results to date. The countries analyzed are Poland, Czechoslovakia, Hungary, eastern Germany, Slovenia, and Russia. Written by leading economists, some of whom helped shape local and national reforms, this volume identifies common progress, common difficulties, and tentative solutions to the problems of economic transition.
Volume 2, Restructuring, focuses on specific issues of transition, including how to design labor market institutions, privatization, new fiscal structures, and bankruptcy laws; how to reorganize foreign trade; and how to promote foreign direct investment. The articles, written by experts in the field, will be of direct help to those involved in the transition process.
These volumes provide a standard reference on economic transition in the region for policymakers in Eastern Europe and in western countries, for international agencies concerned with the transition process, and for anyone interested in learning about the dramatic changes that have recently occurred in Eastern Europe.
This study compares the pre- and postprivatization financial and operating performance of 61 companies from 18 countries and 32 industries that experience full or partial privatization through public share offerings during the period 1961 to 1990. Our results document strong performance improvements, achieved surprisingly without sacrificing employment security. Specifically, after being privatized, firms increase real sales, become more profitable, increase their capital investment spending, improve their operating efficiency, and increase their work forces. Furthermore, these companies significantly lower their debt levels and increase dividend payout. Finally, we document significant changes in the size and composition of corporate boards of directors after privatization.
This paper examines the characteristics of incentive contracts in which the agent's payoff is not based on the principal's objective. The author shows that contracts based on such performance measures will not, in general, provide first-best incentives, even when the agent is risk neutral. The form of the optimal contract and the efficiency of this contract depend on the relationship between the performance measure used and the principal's objective. The model provides a simple and intuitive statistical measure. Applications to various incentive contracting situations, including the "gaming" of performance measures, the use of revenue-based sales commissions, and relative performance evaluation, are presented. Copyright 1992 by University of Chicago Press.
When should a government provide a service in-house and when should it contract out provision? The authors develop a model in which the provider can invest in improving the quality of service or reducing cost. If contracts are incomplete, the private provider has a stronger incentive to engage in both quality improvement and cost reduction than a government employee has. However, the private contractor's incentive to engage in cost reduction is typically too strong because he ignores the adverse effect on noncontractible quality. The model is applied to understanding the costs and benefits of prison privatization. Copyright 1997, the President and Fellows of Harvard College and the Massachusetts Institute of Technology.
This article develops a model of privatization using an incomplete contracts approach. We argue that different allocations of ownership rights lead to different allocations of inside information about the firm, which in turn affect both allocative and productive efficiency. Privatization is seen as a commitment device of the government to credibly threaten to cut back subsidies if costs are high in order to give managers better cost-saving incentives (a "harder budget constraint"). The cost of privatization is that allocative efficiency is distorted. Copyright 1996 by Oxford University Press.
Privatization shifts residual income and control to private investors, restricting redistribution and improving incentives; thus rapid privatization should be desirable. Empirically, however, the transfer of ownership, as opposed to control, is very gradual. The author offers an explanation based on investors' concerns about future interference. A government averse to redistribution retains a passive stake in the firm; the willingness to bear residual risk signals commitment. When a large government stake conflicts with the transfer of control, underpricing may be necessary for separation. Finally, when the required discount is large, a committed government may prefer not to signal, gaining credibility over time. Copyright 1995 by American Economic Association.
Eastern Germany: coming in from the cold
- G Akerlof
- A Rose
- J Yellen
- H And Hessenius
Akerlof, G., Rose, A., Yellen, J. and Hessenius, H., 'Eastern Germany: coming in from the cold', Brookings Papers on Economic Activity, No. 1, 1981, pp. 1–87.
Kohl target of mass protest in Leipzig', Financial Times
- Collitt
- Goodhart
Collitt and Goodhart, 'Kohl target of mass protest in Leipzig', Financial Times, 26 March, 1991, p.
Privatisierung und Sanierungsarbeit der Treuhandanstalt
- K Lichtblau
Lichtblau, K., 'Privatisierung und Sanierungsarbeit der Treuhandanstalt', Institut der Deutschen Wirschaft, Kö, 1993, pp. 63–65.
The Treuhandanstalt: taking a nation private', Kennedy School of Government Case C16-92-1120
- K Lundberg
- J Donahue
Lundberg, K. and Donahue, J., 'The Treuhandanstalt: taking a nation private', Kennedy School of Government Case C16-92-1120, Harvard University, 1992.
Holding-Konzeptionen fü das Sanierungsmanagement von Unter-nehmen in den Neuen Bundeslä', Unpublished Doctoral DissertationPrivatization, information and incentives
- M Rauschnabel
- D Sappington
- J Stiglitz
Rauschnabel, M., 'Holding-Konzeptionen fü das Sanierungsmanagement von Unter-nehmen in den Neuen Bundeslä', Unpublished Doctoral Dissertation, University of Gö, 1996. Sappington, D. and Stiglitz, J., 'Privatization, information and incentives', Journal of Policy Analysis and Management, Vol. 6 (4), 1987, pp. 567–582.
Privatization in East Germany', Unpublished manuscriptThe internal organization of government', Unpublished manuscript
- H W Sinn
Sinn, H. W., 'Privatization in East Germany', Unpublished manuscript, University of Munich, 1991. Tirole, J., 'The internal organization of government', Unpublished manuscript, Massachu-setts Institute of Technology.
Informationen Ausgabe
- Treuhand
Treuhand, 'Informationen Ausgabe', Treuhand Press Office, Vol. 3–4, 1991a.
Umsetzung fü Direktoren und Abtei-lungsleiter der Zentrale', Internal document
- Treuhand
- Zielvereinbarung
- Bonussystem
Treuhand, 'Zielvereinbarung und Bonussystem, Umsetzung fü Direktoren und Abtei-lungsleiter der Zentrale', Internal document, Treuhand, 17 January, 1992a.
Informationen Ausgabe', Treuhand Press Office
- Treuhand
Treuhand, 'Informationen Ausgabe', Treuhand Press Office, Vol. 15, 1992b. Vickers and Yarrow, 1988