Common agency and state-owned enterprise reform

This paper applies a common-agency model to demonstrate why recent enterprise reforms that assign the State Asset Supervision and Administration Commission (SASAC) a greater role in running Chinaʹs state-owned enterprises (SOEs) are apt to fail. In a theoretical framework, we show that local principalsʹ incentive payments are likely to clash with those of SASAC as local SOE principalsʹ promote social stability and SASAC bolsters SOE efficiency. A second-best outcome requires a social planner to restrict actions by local principals and to impose taxes/subsidies to address inter-principal externalities. In the long run, the simplest solution is to privatize SOEs and find a public-sector funding source for promoting social stability.