Privatization and incomplete contracts

The author analyzes a theory of privatization from an incomplete contracts theory point of view The theory of incomplete contracts is applied to the problem of privatization in two ways. First, incomplete contracts theory explains why privatization itself matters. The Fundamental Privatization Theorem shows that privatization has no effect in the complete contracts world, therefore, incomplete contracts are necessary to explain the purpose of privatization. Second, the process of privatization can be understood in terms of the theory of incomplete contracts. This approach focuses on the analysis of privatization contracts itself. Different privatization methods influence the extent of privatization contract incompleteness and can therefore be compared from the efficiency point of view. The author presents an incomplete contracts model of privatization process. The model explores two aspects of privatization contracts: timing and price. It is shown that restructuring after privatization is usually preferred to the reverse sequence. In the former case, price can play a "strategic" role, influencing the restructuring effort of the owner, whilst this is not true in the latter case, as restructuring effort is a sunk cost in the time of privatization. The model shows that in general different methods of privatization contain different sources of incompleteness, therefore the state faces a trade-off between them.