The proper scope of governments when costs are contractible

In this paper, we discuss the relative merits of public and private ownership. Our starting point is the analysis of Hart, Schleifer and Vishney (HSV), who apply an incomplete contract framework to study the di¤erence between private and public ownership. Our analysis departs from HSVs model in two aspects. First, we allow for cost-sharing contracts between the government and the \u85rm. Second, we assume that the manager of a private \u85rm may incur additional costs in order to produce private bene\u85ts, or perks (alternatively, this may reect cross subsidiation). Managers in publicly owned \u85rms do not have the same opportunity to produce perks, as the government when it owns the \u85rm can monitor the managers costs more closely. The cost sharing contract allows the government to govern the in-centives for cost reductions in a privatised \u85rm, and the government can thereby reduce the private \u85rms incentives to dump quality in or-der to save on costs. However, this comes at a cost, as a low-powered incentive contract increases the managers incentives to consume perks. We show that if quality dumping is important, public ownership is still preferable to private ownership. Key words:Privatisation, ownership, incomplete contract