A proposal for using incentive precommitments in public enterprise funding

Abstract

Among the central problems of less-developed countries (LDCs) is the poor performance of their public enterprises (PEs) and the seemingly limited ability of governments and other agencies to improve this performance. This paper proposes that project agencies be induced, as a part of the initial financing of PEs, to undertake specific types of precommitments (a precommitment to liquidate the project if its ex-post performance falls below some threshold level, and a precommitment to link a non-negligible part of employee compensation to actual performance). Our proposal is not guaranteed to improve PE performance, because there are no perfect solutions to what is inherently a politically difficult problem. Nevertheless, we argue that as long as public enterprises exist (independent of whether this is a good idea or not), a precommitment to use performance-based incentives is likely to improve their performance. We discuss the primary sources of PE losses, compare their probable magnitudes, and explain how various precommitments are likely to ameliorate such losses. Our proposal is aimed at stimulating more thought on this subject and is addressed to a broad audience.

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