ABSTRACT
Public ownership is often believed to be inefficient because of insufficient incentives to cut costs. However, both state-owned enterprises and large private firms are usually led by a manager. Agency theory suggests that the manager of a welfare maximizing firm gets stronger incentives to cut costs than under profit maximization, at least if managers and other employees are driven by rewards and punishments only. However, we take potential intrinsic motivation and motivation crowding-out into consideration as well. The choice of pay schedule can then affect the presence of intrinsic motivation, which may explain why the empirical evidence on cost performance is mixed, and it has a stronger effect on output under public ownership. A fixed wage is optimal when intrinsic motivation is strong, but strong intrinsic motivation can also lead to exploitation. We also show that both output and cost efficiency are negatively affected if a public-sector activity is underfunded.
