We set up a dynamic adverse selection model to explain how career concerns
may induce managers in state-owned enterprises (SOEs) to restructure their
firms, It is shown how government monopsony power over managers led to the
ratchet effect under a socialist economy, even under reforms coming short o
f privatization. The introduction of a managerial labour market, through pr
ivatization, introduces competition for managers and eliminates the ratchet
effect, thereby inducing managers to restructure. The model is consistent
with the empirical evidence of SOEs restructuring in transition economies.
(C) 2000 Elsevier Science B.V. All rights reserved. JEL classification: D29
; H39; P29.