The Optimal Government Shareholdings in Public Enterprises in the Process of Privatization

Governments usually hold stock in public enterprises that are in the process of privatization in order to preserve control when the government needs to intervene. The aim of this paper is to find the socially optimal government stock shares in the privatization process. We consider a market with a public enterprise and many domestic and foreign private firms. The marginal cost of firms is assumed to be constant. The main findings are as follows. Privatization is needed only when the production of the public enterprise is less efficient than that of private firms. This is in contrast to the findings of De Fraja (1991) and Matsumura (1998) that the public enterprise should privatize even when firms have identical cost structures. The government should reduce its stock holding in the public enterprise when the number of domestic private firms increases. However, if the number of domestic private firms is sufficiently large, the government should raise its stake in the public enterprise when the number of foreign private firms increases. Furthermore, with free entry and exit for domestic firms, the number of domestic private firms will increase as the degree of privatization increases.