SSE/EFI Working Paper Series in Economics and Finance
Will Privatization Reduce Costs?
Abstract: I develop a model of public sector contracting based on
the multitask framework by Holmström and Milgrom (1991). In this model, an
agent can put effort into increasing the quality of a service or reducing
costs. Being residual claimants, private owners have stronger incentives to
cut costs than public employees. However, if quality cannot be perfectly
measured, providing a private firm with incentives to improve quality
forces the owner of the firm to bear risk. As a result, private firms will
always be cheaper for low levels of quality but might be more expensive for
high levels of quality. Extending the model to allow for differences in
task attractiveness, I find that public firms shun unattractive tasks,
whereas private firms undertake them if incentives are strong enough.
Keywords: Privatization; public sector contracting; incomplete contracts; contracting out; (follow links to similar papers)
JEL-Codes: H11; H40; L32; L33; (follow links to similar papers)
29 pages, March 5, 2007
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