Effects of public ownership over firms' size and overstaffing problems

Abstract

A model is presented to analyse the impact of ownership over the problem of excess of employment generally found in public firms. A government has to provide a service or build an infrastructure, under uncertainty about the valuation of the project by consumers. Three possible ownership schemes are considered for the provision of this service: a state-owned firm, a private firm with a complete contingent contract, or a private firm with an incomplete contract. In all three schemes, the agent that chooses the size of the project is always the government, without any asymmetries of information. Even though multiple solutions are feasible and no definitive conclusion is found to be valid for all states of nature, an evaluation of outcomes shows that a private firm tends to underprovide infrastructure or services more often, while under public ownership the firm is typically larger. If incomplete contracting is added to the private firm case, the model exhibits solutions in which outcomes could be socially worse than those obtained by a public firm. Only changes in the voting behaviour of workers and contracting costs are required in this model to derive these results. Thus, the paper provides an example that ownership per se may have an effect on the size and efficiency of firms, even under symmetric information conditions, an extreme that has been generally denied in the literature on public firms and privatisation.