On the virtues of privatization when government is benevolent

This paper shows that privatizing a public firm can be welfare improving even if the government is a welfare maximizer. We consider a setup where the firm’s owner (a profit-maximizing entrepreneur or a benevolent government) employs a manager who can invent and implement an innovative production technology. Wage arrangements are optimal given the verifiable information, all parties behave rationally and the information structure is the same in both governance modes. Nevertheless, privatization turns out to be preferable in a wide variety of situations. Government ownership yields the first best if producing under the ‘old’ technology is not viable.