The choice of ownership structure in transition economies: incomplete contract approach

Tatyana Yuryevna Dobryanskaya

ISU General Staff Papers from Iowa State University, Department of Economics

Abstract: This thesis focuses on ex post efficiency of vertically integrated enterprises under different ownership structures, given that complete contingent contracts cannot be written. Unforeseen contingencies, unverifiable terms, costs of enforcement, and a lack of common language all contribute to contracts being incomplete. These characteristics of contracts provide incentives to acquire ownership, since ownership is a source of power when contracts are in dispute and is a way of securing residual property rights. We use the incomplete contract approach to study the choice of ownership structure after privatization and we consider the transition economy of Russia as an example. The Russian economy is characterized by asset market failures and capital market imperfections, and the initial allocation of property rights can have a substantial effect on the future economic performance of enterprises. In the model we make a number of assumptions: complete contracts cannot be written, asset and capital markets are imperfect, and payoff of the firms are interdependent on the levels of the managers' investments (efforts), the firm's assets are complimentary and the relationship-specific investments may be investments in physical capital. Whether the manager produces or not he gets his share of the joint venture's profit. The ownership may change hands if managers sign the contract on creating a joint venture. In this case both managers have the incentive to invest more since they share final surplus. Given these assumptions, we show that joint ownership for vertically integrated enterprises is optimal.

Date: 1999-01-01
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