SFB 303 Discussion Paper No. A - 374

Author: Schmidt, Klaus M., and Monika Schnitzer
Title: Privatization and Management Incentives in the Transition Period in Eastern Europe
Abstract: Privatization and Restructuring of large industrial companies is one of the most important and most difficult elements in the current transformation process of the economies in Eastern Europe. This paper develops a simple theoretical framework in which the impact of different governance structures on management incentives, the efficiency of restructuring, and the social costs of the adjustment process can be analyzed. The model allows for a comparison of many of the privatization proposals that have been put forward in recent years. The model predicts that immediate privatization of the firms will lead to strong incentives for managers to restructure but also to high social costs of bankruptcies and layoffs. If the government stays in control during the transition period the social costs of adjustment will be lower. However, in this case the manager faces a "soft budget constraint" and has less incentives to restructure. The model also gives some insights on which companies should be privatized first.
Keywords: Privatization, Principal-Agent Theory, Economic Reform in Eastern Europe
Creation-Date: June 1992
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