Mass Privatization, Management Control and Efficiency

We present a model where a government chooses the number of individuals to which ownership in a former state-owned firm shall be allocated. When making this decision the government maximizes the political support it gets from the firm’s incumbent manager and from potential shareholders, anticipating that a greater dispersion of shares reduces the control of the manager by the firm’s new owners. It turns out that shares will be allocated to the maximum number of individuals – and thus a policy of mass privatization will be implemented – if the manager’s utility enters the political support function with a higher weight than the welfare of the potential shareholders. The result of the political process, however, need not conflict with the objective of achieving a Pareto-optimal allocation. Thus we contradict a widely shared presumption that mass privatization schemes sacrifice efficiency to satisfy political constraints and show that they can be very attractive from an efficiency point of view.