Government Facilitating Investment And The Ownership Of The Firm

The production behaviors of the firm are not only related to their own decisions, but also related to the help of government facilitating investment(GFI henceforth). GFI can assist or improve the firm’s production. As a way of profit distribution, they can redistribute the ownership of the firm in renegotiation. In this paper, we mainly discuss such a question: If the government and the firm can redistribute the ownership of the firm in renegotiation, how will the ownership be allocated and what will both participants’ investment incentives change under different ownership structure?We have two participants: the government and the firm. We assume the government is benevolent and has no conflict of interests within the group and its commitment is credible. This is to simplify the analysis in order to focus on influence of redistribution of ownership on the investment incentives in renegotiation. Meanwhile, we assume the firm has initial ownership and products private goods. The firm with these characteristic can represent almost private firms in reality.This is no longer the ownership distribution within the firm, but under the “government-firm” circumstance. The most relevant research to our paper is the study of “public-private partnership”(PPP henceforth) using the incomplete contract theory. The differences are that, PPP mainly to improve the public services and the firm products public goods. In fact, this paper and PPP are two endpoints of a question.Chapter III describes the story behind the model and discusses how GFI affects firms and the degree of influence with an example of innovation ability of firms in China. The story is summarized as follows: The transaction costs which are related to GFI will enter into the cost-benefit analysis of the firm. Inappropriate GFI increases transaction costs by inhibiting the entrepreneurship, resulting in raising the innovation cost, declining the innovation revenue, which reduces the innovation ability of the firm. The solution is to change the “relative price” of innovation, including reducing the innovation cost and improving innovation revenue. This requires assistance of efficient GFI. Thus, we see that GFI has a wider impact on the firm.However, Chapter III only describes the impact of GFI on the investment incentiveofthefirmanddoesn’trelatetotheinvestmentincentiveofthegovernment.inaddition,italsoassumesthattheownershipinrenegotiationstillbelongstothefirmexogenous.inordertoprovideaformalanalysisforthestory,chapterivconstructsanincompletecontractingmodeltoanalyzetheinvestmentincentivesofthegovernmentandthefirmandtheoptimalownershipstructure.chapterivfoundseveralconclusions:Chapter IV found several conclusions:(1) In the benchmark model: If the government’s evaluation of output is positive, the investment level of the firm is always lower than the first best level. On the contrary, the firm will be over-investment. If the government’s evaluation is opposite to the firm and more sensitive, GFI may be consistent with the first best level, which means that a progressive government is existed theoretically and incomplete contract can also lead to efficient investment in our special circumstance. If the government’s evaluation is opposite to the firm but less sensitive, GFI may be over-investment when evaluation is positive or under-investment when evaluation is negative. Meanwhile, the firm holding ownership weakly dominates the government holding ownership.(2) Through the expansion of the benchmark model, we found that bargaining power is also an important factor that affects the investment incentives of both participants. Investment incentive of the firm is negative related to bargaining power and this relation is positive for the government. The stronger bargaining power government has, the greater its human capital loss is. We found that, however, the validity of those conclusions depends on the use of Nash Bargaining Solution. At the same time, the investment of the firm may also be consistent with the first best level if we relax the assumption of the firm’s output, but the optimal ownership structure is no longer the same. Either the firm holding ownership or the government holding ownership is likely to be optimal. The logic behind Chapter IV is that: In the situation where the bargaining power is symmetrical for participants and the government’s evaluation of output is positive, if the firm obtains the ownership in renegotiation, then the renegotiation benefit will not affect the marginal investment incentive of the firm. In other words, the firm will ignore or underestimate the role of the government in their investment incentive, resulting in firm’s insufficient investment. If the government obtains the ownership in renegotiation, although the firm will consider the role of the government, that is, renegotiation benefit will affects the marginal investment incentive of the firm; renegotiation cost will still reduce its investment incentive, resulting in firm’s insufficient investment. When the government’s evaluation of output is negative, if the firm obtains the ownership in renegotiation, then the firm will be over-investment because renegotiation brings a change of incentive which makes the firm’s investment incentive exceed the first best level. In the situation where the government’s evaluation of output is opposite to the firm, if the government obtains the ownership in renegotiation and its evaluation is more sensitive, then GFI may be consistent with the first best level because renegotiation brings a change of incentive which makes human capital loss has a special relation with bargaining cost and let the government’s investment incentive adjust to the first best level eventually. If the government’s evaluation is less sensitive, then GFI may be over-investment or under-investment because the lack of adjustment of human capital loss cannot match the changes of relative evaluation of the government. If we relax the assumption of the firm’s output, then firm’s investment could be consistent with the first best level as well because renegotiation will also bring a change of incentive which make the firm’s investment incentive adjust to the first best level. In the situation where the bargaining power is asymmetrical for participants, enhancing bargaining power of the firm will enhance its ability to share the government’s investment income which reduces both participants’ investment incentives. On the contrary, enhancing bargaining power of the government will save bargaining cost which enhances its investment incentive and the decline of the firm’s ability to share the government’s investment income will also stimulate its higher investment incentive. At last, the determination of optimal ownership structure is consistent with the classical proposition of incomplete contract theory, that is, the participant whose investment is more import should own the ownership. In this paper, different optimal ownership structures are all generated from this logic. Economic implications of this paper are as follows:(1) The government should limit its subjective preference and let the economic theory become the basis for decision making;(2) Policies cannot be “one-size-fits-all”. The government should analyze on a case-by-case basis, which require an economic decentralized government structure;(3) We should limit the bargaining power of big firms;(4) The government should protect the private property rights of private firms;(5) We should have greater respect for economic laws and firms’ wills and make the economic rationality and the entrepreneurship to guide innovation. This is the most effective way of innovation.