DECISION RIGHTS, RESIDUAL CLAIM AND PERFORMANCE - A THEORY OF HOW THECHINESE STATE ENTERPRISE REFORM WORKS

This paper is intended to model the process of shifting decision right s and residual claim from the central agent (government) to the inside members of the firm in China, and to analyze how the reform has impro ved performance of the state-owned enterprises. We show that the barga ining solution between the central agent and the firm is preferred to a one-sided solution, and that managerial discretion of state enterpri ses can greatly improve efficiency through both its direct incentive e ffect and indirectly hardening budget constraints. Further improvement of efficiency requires that authority of selecting management is tran sferred from bureaucrats to capitalists, which implies privatization o f the state enterprises. China is already well on its way.