Privatization as an agency problem: Auctions versus private negotiations

Abstract

This paper investigates the design of privatization mechanisms in emerging market economies characterized by political constraints that limit the set of viable privatization options. Our objective is to explain the striking diversity of mechanisms observed in practice and the frequent use of an apparently sub-optimal privatization mechanism: private negotiations. We develop a simple model in which privatization is to be carried out by a government agent, who plays favorites among bidders but is potentially disciplined by losing his private benefits of staying in office. 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 considerations distort the agent’s incentives, it may be that a seemingly transparent auction will raise less revenue, than opaque private negotiations. 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.