Large Shareholders, Private Benefits of Control, and Optimal Schemes of Privatization

We analyze optimal schemes for privatization of state enterprises when foreign investors are potential buyers. The highest bidders may not be the best large shareholders for the state enterprise, since their bid may only reflect their high private benefit of control. The government finds itself facing a trade-off between trying to obtain the highest possible payment (the "revenue" objective) and identifying the company which will operate better in the future (the "efficiency" objective). Therefore, ordinary auctions are not appropriate. Our optimal privatization schemes in many cases require the use of the number of shares sold as a crucial instrument to attract the most efficient investors.