Private or public? A taxonomy of optimal ownership and management regimes

Abstract

We develop a theory that explains the difference between public and private ownership for the case of firms that are well approximated by an owner\managed or closely held form of firm. The theory is based on government monitoring and control of actions that potentially allow managers to divert value to themselves. More ‘public’ firms are synonymous with greater control of such actions, but generate greater bureaucracy costs. Therefore managers of public firms face flatter commercial incentives than managers of private firms. Flat incentives can be socially desirable when commercially productive activities generate large social harms relative to profit, but are undesirable when these activities are either benign or create external social benefits. The model we develop is flexible and has wide practical application. We provide a mapping between the qualitative characteristics of an asset, its main use – including public goods characteristics, and spillovers to other assets values – and the optimal ownership and management regime. The model is applied to single and multiple related assets. We address questions such as; when is it optimal to have one of a pair of related assets public and the other private; when is joint management desirable; and when should a public asset be managed by the owner of a related private asset? We show that while private ownership can be judged optimal in some cases solely on the basis of qualitative information, the optimality of any other ownership and management regimes relies on quantitative analysis. Application to emergency services, toxic waste disposal, retail product innovation, and vertical production chains (such as airports and water provision) are discussed.