Monitoring and Productive Efficiency in Public and Private Firms

Abstract

The paper compares productive efficiency in public and private firms. We study a principalagent model in which the firm's manager is privately informed about a cost parameter and exerts unobservable cost reducing effort, while the owner can conduct costly audits to obtain information about the firm's cost. Without auditing, managerial effort (and therefore production efficiency) is strictly higher under public governance with a benevolent government. If auditing is possible, however, a profit-maximizing private owner always audits at least as frequently as a public principal. For small auditing costs, we find that monitoring decisions, managerial effort and welfare under both governance structures coincide. Conversely, when audits becomes more expensive, the public (but not the private) owner refrains from monitoring, and the private firm may produce more cost efficiently.

Ownership and Cost‐Sharing Contracts

“…Kessler and Lülfesmann () also assume that the owner gets access to inside information. However, they consider the case in which this information is available upon costly monitoring.…”