Since these issues imply that managers are, at best, imperfect agents in carrying out the goals of firm owners, they imply that a discussion of firm efficiency should consider managerial incentives separately from the intentions of owners.Vining and Boardman survey the empirical literature on firm efficiency under manager-controlled and owner-controlled organizational structures, and find strong evidence that owner-controlled firms are more efficient.They further argue that the problem of having management carried out by agents other than firm owners is more acute in the public sector, where firm owners – the citizens of a nation – are necessarily uninvolved in management decisions.By contrast, the private sector may possess a mix of manager-controlled and owner-controlled firms, and is therefore more efficient on average.Shleifer argues that the agency problem is more acute in state-owned firms even when they are compared to private firms that are manager-controlled, because a nation’s citizens are an intrinsically diffuse group who have limited ability to specify and monitor the behaviors of firm managers.Shapiro and Willig additionally suggest that public managers may be more likely to have personal goals that conflict with efficiency, as they tend to pursue political careers that benefit from goals such as maximizing the employment of the firm.Hart and Willig illustrate how agency problems are mitigated by competition: As the level of industry competition increases, owners gain useful information from observing other similar firms in the market, and are better able to gauge the extent to which their own managers are exerting efforts to reduce costs.If public firms suffer from greater information deficiencies in the absence of competition, due to their relatively poor ability to monitor firms, then the gains from observing other firms should be greater to them.Consequently, an increase in the level of industry competition due to an increase in the number of firms should increase the efficiency of state-owned firms relative to private firms.It is important to note that the effects of competition in mitigating agency problems are driven by information gleaned from comparable firms.Thus, ebb flow trays as both the similarity and number of direct competitors increases, efficiency gains should be realized.
By contrast, if a market is perceived to be competitive solely because of potential competition that has not manifested in direct competitors , or solely because of indirect competition from substitute markets where firms have different cost structures, then one would not expect efficiency gains through the agency channel.This argument is strengthened if central government term limits prevent repeated interactions with firms, so that politicians do not have a long-term interest in avoiding the moral hazard problem of public firms by punishing them for inefficient behavior.As competition levels rise, soft budget constraints may reduce the relative efficiency of state firms to private firms in two ways: First, if firm profits are reduced as the level of competition increases, then the danger of shutdown for a private firm increases with competition.Thus, private managers and employees faced with the prospect of unemployment and may increase their efficiency, regardless of whether contracting problems misalign their incentives when the threat of shutdown is less imminent.Second, public firms with soft budget constraints may not only be less responsive to losses brought on by competitive forces because they do not face a credible threat of shutdown, they may actually perform more poorly once they are subsidized by the government.Beyond the point when a firm relies on the government for support, its managers have little incentive to improve efficiency, as reductions in profit will be offset by increases in government funding,and increases in profit will be offset by reductions in government support.Note that the incentive problems created by soft budget constraints may be mitigated through contracting: both firm owners and the government bodies who fund state-owned firms have incentives to avoid managerial slack, since supporting a firm that makes losses detracts from other potentially beneficial projects.It is thus possible that governments could at least partially reduce the effects of soft budget constraints by rewarding managers for efficient behavior.However, as described in Section 1.2.1.1, specifying contracts may be especially challenging in public enterprises.Aside from agency problems and soft budget constraints, several other differences between private and state-owned firms are put forth in the literature.While these differences do not appear to be affected by the level of competition faced by firms, and are therefore not the focus of this paper, they are important because they affect level differences between public and private firms, and provide some context for the fact that the empirical literature largely finds private firms to be more efficient than private firms, independent of competition.In this section, I briefly describe the most important differences between state-owned and private firms that affect productive efficiency, but are not affected by the level of competition faced by firms.
Governments commonly and explicitly set goals for public firms other than profit maximization, and a subset of these goals may conflict with productive efficiency.An example can be found in public works programs and other government projects intended to provide employment opportunities: a government might employ more workers than are strictly necessary to produce a given level of output, if it is more committed to increasing employment than to minimizing costs.Similarly, a government may be more reluctant than a private firm to reduce the size of its workforce, should efficiency demand such reductions.For example, a common goal of public firm ownership is to address market failures caused by issues such as natural monopoly conditions.While a public firm designed to address monopoly problems would typically reduce prices and increase quantities relative to a private firm under imperfectly competitive circumstances, the direction of average cost changes is generally unclear as quantities are increased from the point of maximal profit.Moreover, such goals do not affect the underlying cost function that the firm follows, as a function of quantity.Similarly, a public firm with the goal of providing goods or services that are deemed to be under provided by the private sector need not be cost-inefficient in providing those goods or services.To accurately examine the literature on how competition affects the relative efficiency of state-owned and private firms, this study imposes a few constraints on the papers reviewed: First, I limit my survey to studies that compare ownership effects in non-transition economies, and therefore omit examples from China, the former Soviet Union, and parts of central and Eastern Europe.The main reason for this constraint is that economies transitioning from Communist structures simultaneously made many economy-wide changes, and separating the effects of regulatory changes, increased competition, and privatization programs is particularly challenging.In addition, as Megginson and Netter observe, “the data from transition economies is much worse and much more limited than from nontransition economies.” Second, I generally avoid studies that measure productive efficiency solely with metrics that combine revenue and cost data.Many influential studies on private and state-owned firm differences use statistics that depend on output prices to measure “efficiency”- such as marginal profit, return on assets, or the ratio of revenue to costs.While these measures are clearly important in gauging performance differences, they pose issues in measuring productive or cost efficiency that are compounded when efficiency is being compared across different competitive environments.As Boles de Boer and Evans point out: “profits and rates of return may not be good indicators of efficiency as they will reflect any departures from Ramsey pricing which may be possible because of the dominant position of the company.”
Private and public firms might also be expected to exhibit different price-setting behaviors as the level of industry competition varies, which affect any measures of efficiency that depend on prices.In particular, private firms with market power can profitably increase prices relative to the social optimum, while state-owned firms that have allocative efficiency goals might not.Then, measures of efficiency that are sensitive to output prices would overstate the relative cost efficiency of private firms in imperfectly competitive settings – since they would rise when revenues increased – and relative efficiency gains would attenuate as conditions approached perfect competition.Empirical evidence supports this expectation: Bonin, Hasan, and Wachtel use a number of measures to compare public and private bank performance, and find that public banks outperformed private banks in all measures that used costs alone.When measures that incorporated revenues and costs were instead used, private banks outperformed public banks.Both Caves and Christiansen and Laurin and Bozec study “TFP”differences between two Canadian railroads and use the same data, but reach different conclusions about their relative efficiencies.Laurin and Bozec use a TFP calculation that depends on revenue shares, and find that the private railroad is more efficient than the state-owned one.Caves and Christiansen intentionally choose a measure that uses output cost elasticitices instead of revenue shares due to the issues cited above,flood and drain tray and find no differences between the efficiency of the public and private railroad after 1987.Their conclusions differ presumably because of price differences, and not cost efficiency differences, between the railroads.Since it is ambiguous whether whether price-inclusive measures of relative efficiency are adjusting due to cost reductions or revenue increases, I focus on studies that include measures of efficiency based on output per unit of cost.However, I also consider evidence from studies that use price-inclusive efficiency measures in highly competitive environments, since price setting behavior should be limited or non-existent in these contexts.Table A.1 lists 21 studies that estimate the relative efficiency of private and state-owned enterprises, and that give indications of the level of competition studied.Of these, 9 studies examine firms in non-competitive environments; 7 studies examine competitive environments; 4 studies examine firms in monopolistically competitive or oligopolistic environments; and, 1 study examines firms in a variety of competitive environments separately.Where possible, I used four-firm concentration ratios for each industry to establish the competition level7 : Firms operating in industries with four-firm concentration ratios under 20% were deemed competitive; those with ratios between 30% and 80% were monopolistically competitive or oligopolistic; those with ratios above 80% were considered to be non-competitive.When four-firm ratios were not available, I used the number of industry competitors faced by firms, along with descriptions and assessments of the competitive environments provided by authors.
Aside from establishing the appropriate competition category for each study, author descriptions provided additional relevant details about the competitive environment, such as levels of indirect competition faced from substitute markets, any potential but unrealized competition faced from recently lowered barriers to entry, the extent to which firms competed internationally or regionally, the regulatory environment within which firms operated, and the extent of product differentiation within the industry.Because of the variance in methodologies and measures of efficiency, comparable measures of the extent of the efficiency gap between private and public firms were not available across studies.Nonetheless, by examining the porportion of studies that find significant differences between ownership types at each level of competition, a pattern emerges.Figure A.1 separates the 21 studies according to the level of competition they examine, and their findings on the relative efficiency of ownership types.7 of the 10 studies that take place in monopolistic settings find that private firms are more efficient than state-owned firms, while the other 3 find no significant differences in ownership types.In monopolistically competitive or oligopolistic environments, 3 of 5 of studies find private firms more efficient, and 2 find no differences; and, in competitive environments, only 4 of 8 studies find gains to private firms, 3 studies report no differences, and 1 study finds that public firms are more efficient.Clearly, no conclusions can be drawn from these coarse results alone.The studies vary widely in the number of firms they consider, the data they examine, and the methods they use.Additionally, contextual differences likely play a large role in explaining the variation in findings: Some studies examine static environments where state-owned and private firms co-exist, while others look at privatization programs that often occured along with market liberalization measures and regulatory changes.The governments running state-owned firms had a variety of stated and observed goals for their firms, different policies regarding subsidization of public firms, and may have differed in their abilities to monitor firm managers.Private firms may have been more or less efficient depending on the regulatory constraints under which they operated.To gain some insight into how competition might affect ownership differences, Section 1.3.3 reviews in greater detail the findings of the literature.While most studies considered in this paper examine firms within a single level of competition, I begin with the single study that separately examines ownership effects across both competitive and non-competitive environments.La Porta and Lopez-de-Silanes study the effects of privatization for 218 state-owned enterprises in Mexico.