PRIVATIZATION, RISK-TAKING, AND THE COMMUNIST FIRM

This paper studies alternative methods of privatizing a formerly commu nist firm in the presence of imperfect risk markets. The methods inclu de cash sales, a give-away scheme, and a participation contract where the government retains a sleeping fractional ownership in the firm. It is shown that, with competitive bidding, the participation contract d ominates cash sales because it generates both more private restructuri ng investment and a higher expected present value of revenue for the g overnment. Under weak conditions, the participation contract will indu ce more investment than the give-away scheme, and it may even share th e cash sales' virtue of incentive compatibility.