Investment-driven mixed firms: partial privatization by local governments

We analyze partial privatization by local governments, driven by investment and credit constraints, and provide a theory of monopolistic mixed firms based on strategic interaction between local politicians and private shareholders. Minority participation by private investors—as empirically observed—arises endogenously in the model to prevent investment expropriation. We consider the example of water supply with perfectly inelastic demand and fixed-price regulation, coupled with price discretion at a local level. Welfare-maximizing local governments face a trade-off between the increase in consumers’ surplus and the reduction in costly public funds. Therefore, private shareholders choose investment to keep the government share at a threshold such that the politician always sticks to the price-cap and dividends are then maximized. To consider normative issues, we compare investment by mixed firms and by a social planner.