Privatization,bureaucracy, and risk aversion

The role of governmental risk aversion in the decision to privatize the production of goods and services has not been examined closely. Using a model of a risk-averse, single-service Niskanen bureaucrat, we determine the conditions under which a bureaucrat will prefer to privatize rather than produce in-house. If the private-sector firm is risk neutral, the result will be a fixed-fee contract with complete insurance. If the private-sector firm is risk averse, the result will be a cost-plus contract with the degree of cost sharing determined by the bureaucrat's share of total risk aversion. In both cases, the bureaucrat's sponsor may affect the likelihood of privatization by manipulating the rewards and penalties imposed on the bureaucrat.