Journal of Development Economics 78 (2005) 133 – 155

www.elsevier.com/locate/econbase

Bank privatization in Argentina: A model of political

constraints and differential outcomes
George R.G. Clarke, Robert Cull*
Development Research Group, The World Bank, United States

Received 1 March 2001; accepted 1 June 2004

Abstract

Although case studies suggest that political constraints affect bank privatization transactions,
these constraints have been neither theoretically modeled nor econometrically tested. This paper
presents a simple model of the tradeoffs governments and buyers face during these transactions. In
addition to price, the buyer is concerned about solvency and profitability following privatization.
Similarly, politicians are concerned about layoffs and service coverage. We apply the framework to
provincial bank privatizations in Argentina, finding that provinces with fiscal problems were willing
to accept more layoffs and guarantee more of the privatized bank’s portfolio in return for a higher
price.
D 2005 Elsevier B.V. All rights reserved.

JEL classification: L33; G21

Keywords: Argentina; Bank privatization; Political economy

1. Introduction

In recent years, many studies have looked at the relative performance of publicly and
privately owned enterprises. Several authors have suggested that privately owned
enterprises might outperform publicly owned ones, both because political incentives

* Corresponding author. Room MC3-449, Mail Stop MC3-300, The World Bank, 1818 H Street NW,
Washington, DC 20433, United States. Tel.: +1 202 473 6365; fax: +1 202 522 1155.
E-mail address: rcull@worldbank.org (R. Cull).

0304-3878/$ - see front matter D 2005 Elsevier B.V. All rights reserved.
doi:10.1016/j.jdeveco.2004.06.010
134 G.R.G. Clarke, R. Cull / Journal of Development Economics 78 (2005) 133–155

may distort the behavior of public managers and because corporate governance problems
might be more severe for publicly owned firms.1 Empirical work has confirmed the
theoretical predictions, indicating that privatized firms are often more efficient than
comparable public enterprises and that many enterprises have become more efficient
following privatization.2 However, although privatization has often improved firm
performance, the gains have often been modest and sometimes non-existent. At different
times and in different places, dispersed ownership, entrenched interests, weak regulation
and supervision, a lack of competitive pressure, and soft budget constraints have provided
sub-optimal incentives for private owners.3 Further, contract provisions restricting the
behavior of the new owners – for example, preventing them from firing surplus workers or
from closing unprofitable product lines or branches – have often led to sub-optimal
performance. This suggests that the question of how to privatize is, in many cases, at least
as important as whether to privatize.
Given the problems associated with some types of privatization, it is important to
understand why governments have adopted sub-optimal approaches. However, relatively
few studies have looked at the factors that affect privatization decisions and design. There
are some exceptions. In particular, World Bank (1995) identifies a number of features of
the policy environment that coincide with successful privatization, López-de-Silanes
(1997) looks at factors that affect privatization prices, and Clarke and Cull (2002) identify
political factors that affect the timing of privatization. However, these papers do not
formally analyze the factors that affect the design of the privatization agreements or
contracts.4 Without a better understanding of the motivations and the constraints faced by
the politicians, it is difficult to assess why governments adopt particular privatization
strategies and whether other, more promising, methods would be politically feasible.
One reason why little attention has focused on the factors that affect politicians’
decisions is that few privatization episodes offer enough variation across comparable
privatization contracts. Within a single country, most privatization decisions are made by
the central government and although incentives may vary over time, the changes are not

1
For example, Laffont and Tirole (1991) suggest that governments may expropriate investment from public
enterprises, might impose multiple, fuzzy and changing objectives on public managers, and might be susceptible
to interest group pressure. Further, Kornai (1980, 1986) notes that without the threat of bankruptcy, public
managers typically have less incentive to manage well than their private counterparts do. Finally, without the
threat of corporate takeovers, and since they do not typically own stock or stock options, public mangers have less
incentive to adopt a long-term focus on productive efficiency. Stiglitz (1985), however, notes that informational
asymmetries between potential acquirers and firm managers mean that the disciplining effect of takeovers is likely
to be small.
2
See, for example, López-de-Silanes (1997), Mueller (1989), and Vining and Boardman (1992) on the first
point and Galal et al. (1994), Kikeri et al. (1992), La Porta and López-de-Silanes (1997), Megginson et al. (1994),
and World Bank (1995) on the second.
3
For example, among the transition countries of Central and Eastern Europe, several studies have found that the
persistence of extensive insider (worker or manager) ownership is associated with poor post-privatization
performance (Carlin and Landesmann, 1997; Frydman et al., 1999; Jones and Mygind, 1999; Pohl et al., 1997).
4
Jones et al. (1999) find that share issue underpricing is influenced by governments’ desires to trade off sales
proceeds to achieve share allocations and restrictions on the control rights of shareholders that reflect policy
objectives. Because that study focuses on share issues, most observations come from developed countries. None
of the banks studied here were privatized by issuing shares to the public.
 G.R.G. Clarke, R. Cull / Journal of Development Economics 78 (2005) 133–155 135

likely to yield sufficient variation along important dimensions for formal analysis. Cross-
country analysis of privatization contracts provides more variation in political incentives,
but measuring differences across political and institutional environments in a consistent,
meaningful way is often difficult. In this paper, we study the provincial bank privatizations
of the 1990s in Argentina, an episode that resolves many of these problems. Privatization
decisions were made by the provincial governments, providing us with variation along
several important dimensions, including fiscal performance of the province, bank
performance and the political incentives facing important players, while keeping other
institutional details similar. To our knowledge, this is the first attempt to theoretically
model how political incentives affect the features of bank privatization contracts and to test
whether the outcomes adhere to the model’s predictions.
The paper is organized as follows. Section 2 offers background on the bank
privatization process in Argentina and describes the bank privatization contracts. Section
3 provides a simple theoretical framework to illustrate the tradeoffs that provincial
politicians face in crafting these agreements. Section 4 empirically tests some of the key
predictions of the model and Section 5 concludes.

2. Background

2.1. Provincial banking in Argentina

At the beginning of the 1990s, all Argentine provinces owned at least one bank.5 The
publicly owned provincial banks performed poorly in terms of portfolio quality, the
efficiency with which they generated income, and their return on assets (Clarke and Cull,
1999, 2000). Although it might seem that poor performance should have encouraged
privatization, the federal system in Argentina reduced provincial politicians’ incentives to
privatize. In particular, the provincial banks provided the provincial politicians with a
cheap source of funds to finance their operations and for patronage. The provincial
governments could borrow from the public provincial banks, which would then discount
the loans to the Central Bank of Argentina.6 Further, if the provincial banks found
themselves insolvent, they could rely upon the Central Bank to bail them out. This meant
that provincial governments had little incentive to monitor management closely and could
use the banks to finance favored programs at relatively low cost.
This arrangement ended in the early 1990s, when the newly elected Menem
administration implemented the Convertibility Plan. The main pillar of the Convertibility
Plan was the April 1991 Convertibility Law, which pegged the new Argentine peso to the
U.S. dollar and forced the Central Bank to restrict the monetary base to the dollar value of
international reserves.7 The Convertibility Law, and the new 1992 Charter of the Central

5
Twenty provinces owned only one bank and three provinces owned two banks. Several provinces and private
sector entities jointly owned an additional bank.
6
Dillinger and Webb (1999, p. 6) note that the provinces financed about 60% of their credit needs through the
provincial banks in 1990.
7
See World Bank (1998) for a discussion of the Convertibility Plan and its impact on the financial sector.
 136
G.R.G. Clarke, R. Cull / Journal of Development Economics 78 (2005) 133–155
Table 1
Terms of the provincial bank privatizations
Province (bank) Object of sale Branching Employees Duration of Portfolio guarantees
service contracts
Chaco (6/94) 60% Class A shares Maintain service Keep at least 715 workers 20 years None
Entre Rı́os (12/94) 60% Class A shares Maintain service, closures Up to 700 (of 1500) 7 years Up to $26 million
require approval early voluntary retirement maximum
Formosa (9/95) 60% Class A shares Maintain service – 10 years 35% recovered
residual assets
Misiones (12/95) 100% Class A shares – No dismissals in first 5 years Up to $16 million
6 months; b30% of maximum
workforce after
Rı́o Negroa (2/96) Determined by bidders – – 10 years Up to 80% of portfolio
or $50 million
Salta (3/96) 75% Class A shares Maintain similar geog. – 10 years None
coverage
Tucumán (3/96) 75% Class A shares Maintain service Workforce V200 at transfer 10 years Up to $32 million
San Luis (5/96) 100% Class A, B shares Maintain service – 10 years $16 million deposit
from province, up to
5 years
Santiago del Estero 95% Class A, B shares Maintain service Job re-training program, 10 years None
(7/96) z1 year
San Juan (7/96) 75% Class A shares Maintain similar geog. – 10 years None
coverage
Mendoza (7/96) 90% Class A shares Maintain all branches Keep at least 600 workers 5 years Can substitute privatized
assets for residual assets,
up to $20 million
Mendoza (Prevision 90% Class A shares Maintain all branches Keep at least 500 workers 5 years Can substitute privatized
Social) (7/96) assets for residual assets,

G.R.G. Clarke, R. Cull / Journal of Development Economics 78 (2005) 133–155

up to $10 million
Municipal de Tucumán 100% Class A, B shares Maintain service Keep at least 70 workers 10 years Can shift some assets to
(10/97) the residual
Jujuyb (1/98) 80% of capital Maintain all branches Keep at least 170 workers 10 years Fund created with 35%
recovered residual assets
Santa Fe (5/98) 90% of class A shares Maintain service in all Keep at least 1500 workers 5 years Up to $43 million
branches or through paid guaranteed by a bond
representatives
Santa Cruz (6/98) Not available Not available Not available Not available Not available
Source: Fondo Fiduciario para el Desarollo Provincial (FFDP).
a
Rio Negro—Portfolio guarantees and flexibility with respect to the object of sale were modifications to original pliego. Pliegos were initial announcements by the
provinces of the proposed terms of sale.
b
Jujuy—The original pliego was altered to allow for a higher share of capital to be transferred to the new owner, less stringent restrictions regarding firing, and slightly
more generous guarantees.

137
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Bank that supported it, profoundly affected the provincial banks, by preventing the Central
Bank from rediscounting loans and from guaranteeing bank deposits. Because they could
no longer rely upon the central bank to bail depositors out in the case of bank failure, the
Convertibility Plan made owning a poorly performing provincial bank significantly less
attractive.
These changes encouraged several provinces to re-evaluate privatization and by the
time the dTequila CrisisT hit Argentina in December 1994, six provinces had authorized the
privatization of their provincial banks. The Tequila Crisis accelerated privatization
decisions further by imposing substantial fiscal costs upon the provinces and aggravating
solvency problems at the poorly performing provincial banks. Taking advantage of the
external shock, the Federal Government, with the assistance of the World Bank and the
Inter-American Development Bank, created the Fondo Fiduciario to further encourage
privatization. This federal agency extended loans to the provinces to help them privatize
their provincial banks. Since provinces could only receive loans after they had privatized
their banks, there was no risk that they would use the funds to re-capitalize the banks while
retaining ownership.
Under the Fondo Fiduciario program, the provinces split the public provincial banks
into two parts—a healthy bank to be privatized and a residual entity containing non-viable
assets. Although the individual cases varied, the basic strategy was to shift the most
attractive assets to the privatized bank and then to match those assets with liabilities up to
the point that the privatized bank’s net worth met Argentina’s prudential standards. Since
the recovery of residual assets would not be quick enough, or on such advantageous terms,
to cover all residual liabilities, the provinces needed a way to meet a substantial portion of
their short-term residual obligations. The provinces used the loans from the Fondo
Fiduciario to do this by converting short-term obligations to long-term loans. From a
political perspective, financing obligations in this way was presumably beneficial, as the
yearly loan payments due to the Fondo Fiduciario are less eye-catching than short-term
obligation payments would have been. More practically, at this time, the provinces likely
could not have afforded to pay off the short-term obligations immediately.
With this new incentive, and an uncertain liability hanging over their heads, many
additional provinces decided to privatize. By the end of 1997, almost half of the twenty-
seven provincial banks had been privatized and several other privatizations had been
authorized but not completed. This series of privatizations provides a unique opportunity
to study the factors that affect privatization decisions. Although other players, for example
the Federal Government of Argentina, the Central Bank of Argentina and international
donors, indirectly influenced the decisions, the provincial government made the final
choice.

2.2. Provincial bank privatization contracts

Because the negotiations were principally over the level of assets and liabilities that the
purchaser would assume, the prices fetched in the completed privatizations were relatively
low compared to the face value of the assets transferred. Table 1, therefore, focuses on
non-price features of the privatization agreements. In the Argentine context, two important
opponents to privatization – bank employees and residents of underserved (mainly rural)
 G.R.G. Clarke, R. Cull / Journal of Development Economics 78 (2005) 133–155 139

areas – were bought off through agreements to limit layoffs and requirements that the
banks maintain service. Based upon a review of the requirements imposed on the
purchasers of the privatized banks, it appears that limits on layoffs and branch closings
were the rule rather than the exception (Table 1). Of the sixteen contracts, half restricted
the number of employees that could be dismissed and another required the purchaser to
implement a job re-training program. Three of the contracts stipulated that the private
purchasers maintain the existing branch network and ten permitted the closure of branches,
but required that the purchaser maintain service provision in all locations served at the time
of privatization. These contract features strongly suggest that the political buyoffs present
in other privatizations were also evident in Argentina.
As noted above, the public provincial banks were chronic money losers with poor
quality asset portfolios. To pass a substantial share of their low-quality assets onto a
private purchaser while imposing branching and labor restrictions would have been
difficult, if not impossible, without concessions on other dimensions. The most attractive
of these were the service contracts that were awarded to purchasers to provide banking
services to the provinces and guarantees as to the quality of the acquired assets. The
service contracts, which, among other things, provide income to the private owners for
coordinating the payments activities of the provincial government, varied in duration from
5 to 20 years. Ten of the sixteen agreements provided service contracts of at least 10 years.
In interviews, the new private owners confirmed that these contracts are of vital
importance, as an abnormally high share of the privatized banks’ income is generated from
services (see Clarke and Cull, 2000).
In many cases, however, the service contracts were not attractive enough to entice
private banks to acquire assets of dubious quality. Rather than verify the quality of
individual assets, which would have been time-intensive, many provinces guaranteed a
substantial share of the assets transferred to the privatized bank. In six cases, the province
guaranteed assets up to either a fixed dollar (peso) limit or a certain share of the total assets
acquired. In two other cases, private owners were able to substitute assets from the residual
entity for privatized assets during a trial period and in another, the buyer could shift low-
quality assets to the residual entity for a period of time. Finally, in two cases, the guarantee
was set as a fraction of the residual assets recovered. Presumably, since the owner of the
privatized entity was also charged with managing the residual entity, the idea was to
increase their incentives to recover residual assets. Only four cases did not guarantee the
privatized asset portfolio at all.
Table 2 shows the size of the privatized and residual entities for the sixteen completed
privatizations that relied on Fondo Fiduciario assistance.8 The most striking feature is the
size of the residual entities. In only four of fifteen cases for which data are available did the
province manage to transfer more than half of the pre-privatization assets to the purchaser
and one of these (Entre Rı́os) is somewhat misleading. Both Entre Rı́os and Chaco had

8
We refer to the cases listed in Table 2 as provincial bank privatizations throughout the paper. One of the
sixteen, Municipal de Tucumán, is referred to as a municipal rather than a provincial bank in Argentina. Because
municipal bank privatizations were also eligible for Fondo Fiduciario assistance, we include that case in our
analysis. Data for another, the Santa Fe privatization, were not yet available as of our last visit to Buenos Aires
(January 1999).
 140
G.R.G. Clarke, R. Cull / Journal of Development Economics 78 (2005) 133–155
Table 2
Sizes of privatized and residual entities
Bank Privatized entity Residual entity Percent transferred to private owner (%) Residual
Assets Liabilities Assets Liabilities Assets Liabilities Asset recovery As percent
(million pesos) (million pesos) (million pesos) (million pesos) (million pesos) (million pesos) (million) of assets (%)
Chaco 42.9 34.5 245.3 233.1 15 13 0a 0
Entre Rı́os 425.5 414.5 0.0 0.0 100 100 – –
Formosa 26.5 11.5 135.7 244.9 16 4 5.2a 4
Misiones 67.2 57.8 133.9 340.8 33 14 6.1 5
Rı́o Negro 59.4 47.4 379.2 402.6 14 11 6.0 2
Salta 42.9 41.0 70.0 68.4 38 37 17.6a 25
Tucumán 66.9 56.9 261.7 262.9 20 18 5.3 2
San Luis 38.6 38.6 29.7 81.8 56 32 1.7 6
Sant. Estero 43.8 43.5 199.6 227.3 18 16 7.5 4
San Juan 173.9 158.9 78.6 175.3 69 48 2.3 3
Mendozaa 335.1 326.9 666.6 666.6 33 33 14.3 1
Prevision Social 62.9 41.0 292.1 292.1 18 12 – –
Municipal de Tucumán 38.2 32.2 38.1 25.7 50 56 NA NA
Jujuy 35.7 33.7 206.9 218.7 15 13 NA NA
Santa Fe – – – – – – – –
Santa Cruz 157.9 142.9 37.7 126.9 81 53 NA NA
Source: Fondo Fiduciario.
a
Province also refinanced some (less than 10%) of residual assets. Refinancings are not included in the recovery figures presented here.
 G.R.G. Clarke, R. Cull / Journal of Development Economics 78 (2005) 133–155 141

nearly finalized their privatizations before the Fondo Fiduciario became operational. A
desire to provide some fiscal relief to these early privatizers enabled them to enter the
program after the fact. Because most details of these two privatizations had been worked
out, however, neither transaction was typical of those that followed. In particular, Entre
Rı́os transferred all pre-privatization assets to the purchaser, and later used Fondo
Fiduciario assistance to guarantee some of them.
In summary, in addition to negotiating over price, the provincial politicians appear to
have had additional incentives and constraints. In particular, many of the contracts
restricted the new owners’ ability to lay surplus workers off and close unprofitable
branches. However, to entice buyers, the provincial governments were willing to sweeten
the terms of privatization by assuming responsibility for low-quality assets through the
residual entities, guaranteeing assets allocated to the privatized bank, and providing the
new owners with service contracts. In the next section, we attempt to model some of these
trade-offs to explore factors that influenced individual outcomes.

3. A simple model of bank privatization

3.1. Conceptual framework

Our basic premise is that political and economic constraints dictate the timing and
design of bank privatizations. This will help us understand the second link in the
framework—how political and economic constraints affect features of the privatizations
including privatization contracts (see Fig. 1). We begin our study of privatization contract
features with a simple theoretical model. We will then use the sample of Argentine bank
transactions to test our predictions.

3.2. Theoretical model

Since many of the public banks were insolvent – or close to insolvent – at the time of
sale, the provincial governments often considered restructuring the banks before the sale.
For example, many of the banks were significantly overstaffed or had inefficient branch
networks. Since the private buyers might want to reduce these problems by laying surplus
workers off or closing branches (often in rural areas), the provincial governments had to
decide how much cost-saving restructuring they would allow. Another fundamental
restructuring problem was handling the mountain of non-performing assets in the state-
owned banks’ portfolios. As Verbrugge et al. (2000, p. 15) note:
bEffective methods of dealing with bad loans prior to or during the privatization
process are essential. This problem is especially severe in situations where
uncollectable loans are outstanding to state-owned enterprises.Q
Argentina’s relatively successful provincial privatizations centered on the creation
of residual entities for the low-quality assets and liabilities not assumed by the
private purchaser. Rather than adopting this approach, the Governments could have
sold the insolvent state-owned banks in their entirety to whoever bid the least negative
142 G.R.G. Clarke, R. Cull / Journal of Development Economics 78 (2005) 133–155

Political and Economic

Constraints:
Bank Quality
Fiscal Situation
Labor Unions
Local Banking Sector

Contract Features:
Re-capitalization
Timing of Bank Residual Entities
Privatization Branch Closings
Labor Shedding
Asset Guarantees

Post-Privatization
Performance

Fig. 1. Effect of political and economic factors on privatization decisions.

price.9 Whatever the method, however, most sources agree that handling accumulated bad
loans is a vital aspect of bank privatization. In addition to increasing sales price, restructuring
might also make the bank more attractive to better quality buyers, who might be worried
about the effect that buying a large non-performing portfolio would have on their own credit
rating.
Many of the decisions associated with privatization are affected by political
considerations. For example, it seems plausible that governments that are willing to
remove most, or all, of the non-performing loans from the banks’ portfolios will be able to
demand more attractive terms from buyers along other dimensions. For example, they
might then be able to demand fewer layoffs or impose greater service requirements (e.g., in
rural areas). On the other hand, if the government retains a large stake in the bank after
privatization, the buyer might demand concessions along other dimensions.
The theoretical model below summarizes the tradeoffs faced by two agents, a government
and a potential buyer, in the sale of an insolvent state-owned bank. Although the model does
not capture all the tradeoffs facing the players, it captures many of the features discussed
above. The purchaser is concerned about the probability that the privatized bank will remain

9
Ramachandran (1995) points out that this is essentially the approach taken by the Resolution Trust
Corporation in the United States.
 G.R.G. Clarke, R. Cull / Journal of Development Economics 78 (2005) 133–155 143

solvent, the profits earned if the bank does so, and the price paid for the assets and liabilities it
assumes. We denote the probability of solvency f(x r ), which we assume is bounded between
zero and one and weakly decreasing in x r (i.e., as the purchaser assumes more risky assets,
the probability of insolvency increases).10 This implies:
Bf
0bf ðxr Þb1 and that V0: ð1Þ
Bxr
The purchaser’s expected profit stream is composed of interest income from its portfolio
of non-guaranteed assets minus the privatized bank’s operating costs.11 We denote income
on the assets assumed by the purchaser h(x r ) and we denote the cost of managing the
portfolio as c(x r ). We assume that the income from the portfolio is weakly increasing in x r
(i.e., individual assets have an expected value greater than or equal to zero). We also
assume that the cost of managing the portfolio is weakly increasing in x r. That is:
Bh Bc
hðxr Þz0; z0; cðxr Þz0 and z0 ð2Þ
Bxr Bxr
Patronage jobs are denoted wL where w is the wage paid to employees and L is the
number of employees. Note that these workers do not contribute to production, and thus
the labor costs associated with true production are subsumed in c(x r ). The buyer’s payoff
from purchasing the privatized bank will be:
Pb ¼ sð f ðxr Þhðxr Þ  cðxr Þ  wLÞ  Pb ð3Þ
where s ~ [0. . .1] is the purchaser’s ownership share and P b is a lump-sum payment paid to
the government. Note that P b could, in principle, be negative (i.e., the buyer might require
the government to pay it for taking control of the privatized bank). In practice, however,
governments are often wary about selling banks at very low or negative prices for political
reasons. For example, the public might not be aware of the real value of the bank’s assets
and might suspect that politicians are receiving bribes from purchasers when the
government sells assets for a negative (or very low) price.
We assume that the purchaser must receive its reservation profit level, p̄, to take control
of the bank. That is:

Pb ¼ sð f ðxr Þhðxr Þ  cðxr Þ  wLÞ  Pb ¼ p̄ ð4Þ

The reservation profit level might depend upon the fixed costs the buyer faces if it assumes
control of the bank and on the level of competition for the bank.12 That is, as more bidders
are involved in the bidding process, any individual buyer will have less leverage over the
government, and thus its reservation profit level falls. With many identical buyers and no
fixed costs, we would expect p̄ to fall to zero, with the winning bidder paying its share of
profits to the government.

10
This is consistent with the observation that, in practice, buyers tended to assume safer assets, while riskier
assets were placed in the residual entity.
11
For tractability, the guaranteed assets themselves do not enter into this simple model.
12
This might happen, for example, if different buyers have different fixed costs (e.g., if there is some random
distribution of fixed costs). López-de-Silanes (1997) found that privatization prices in Mexico increased as
bidding became more competitive.
144 G.R.G. Clarke, R. Cull / Journal of Development Economics 78 (2005) 133–155

The government derives fiscal benefits from three sources. First, it will earn a share of
the privatized bank’s profits from its retained ownership in the bank.

Pg ¼ ð1  sÞ½ f ðxr Þhðxr Þ  cðxr Þ  wL: ð5Þ

It will also receive the lump-sum payment for the bank

Pb ¼ sð f ðxr Þhðxr Þ  cðxr Þ  wLÞ  p̄ ð6Þ

Finally, it will receive some revenue from recovery of residual assets, denoted g(x res),
where x res is the quantity of assets in the residual entity managed by the government and it
will expend some resources to recover these assets, c res(x res). We assume g(x res) is
(weakly) increasing in x res (i.e., the probability that any asset will be recovered is greater
than or equal to zero) and that costs are also weakly increasing in x res (i.e., there are
positive costs associated with recovering assets). Formally, this implies:
Bg Bcres
gðxres Þz0; z0; cres ðxres Þz0; and z0 ð7Þ
Bxres Bxres
We also assume that the government is worse than the private buyer at recovering
assets and is no better at managing the residual assets than the private buyer would
be—if this were not the case, the government would retain control of all assets. This
implies:13
hVðxr ÞNgVð x̄x pub  xr Þ ð80 Þ

cVðxr ÞVcVres ð x̄x pub  xr Þ; ð800 Þ

where x̄pub denotes the total assets of the public bank prior to privatization. The final
component of the government’s optimization function is the benefits it receives from
patronage jobs at the privatized bank, which we denote k(L). We include this component in
the government’s constraint because limits on layoffs have been a recurrent feature when
crafting politically feasible privatizations. We assume that k(L) is increasing in L (i.e., that
the government prefers to preserve as many patronage jobs as possible) but is increasing at
a weakly decreasing rate (i.e., that the marginal value of the patronage jobs become less as
the number of jobs increases). Formally, this implies:
Bk B2 k
k ð LÞN0; N0; and b0: ð9Þ
BL BL2
We assume that the government chooses x res and L to maximize the following:

MAX Ug ¼ KM ½gðxres Þ  cres ðxres Þ þ Pg þ Pb  þ KL k ð LÞ

xr ; xres ;L ð10Þ
subject to xr þ xres ¼ x̄pub :

13
We assume that the total value of assets recovered is increasing as additional assets are passed to the private
buyer. That is, we assume total recovered assets, g(x̄ pub  x y ) + h(x y ), are increasing in x r. Similarly, we assume
that the total cost of managing the portfolio, c(x r ) + x res (x̄ pub  x r ) is weakly decreasing in x r.
 G.R.G. Clarke, R. Cull / Journal of Development Economics 78 (2005) 133–155 145

K L and K M are constants that map the benefits that the government receives for protecting
jobs and the fiscal benefits related to the transaction into the government’s utility
function.14 The constraint implies that the assets of the original public bank end up in one
of two places: as non-guaranteed assets assumed by the purchaser or as assets that remain
with the government in the residual entity. Substituting Eqs. (5), (6) and the constraint into
(10), the government’s problem becomes:

MAX Ug ¼ KM ½gðx̄ pub  xr Þ þ f ðxr Þhðxr Þ  wL  p̄ cðxr Þ  cres ðx̄ pub  xr Þ
xr ;L

þ KL k ð LÞ ð11Þ

Because the government cares about the profits that both it earns, through its residual
ownership of the bank, and the profits earned by the buyer, which affects the price that
buyer is willing to pay, its maximization problem is not affected by its residual
ownership.15
Equilibrium bank privatization contracts are characterized by two first order conditions
which must be jointly satisfied:

BUg
¼  KM w þ KL kVð L4Þ ¼ 0 ð12Þ
BL

BUg
¼ KM ½  gVðx̄ pub  x4Þ
r þ f Vðx4Þhðx
r r þ hVðx4Þf
4Þ r ðx4Þ
r  cVðx4Þ
r
Bxr
þ cres
V ðx̄ pub  x4Þ
r ¼ 0: ð13Þ

This simple framework captures many of the salient tradeoffs underlying most bank
privatizations. The equilibrium contracts are described in terms of the assets assumed by
the purchaser, the assets retained by the government and the jobs preserved by the
government. In short, (12) implies that government maximizes a weighted average of its
net income and the value of patronage jobs. By definition, fiscal income is equal to the
expected net income of the bank minus the cost of patronage jobs. However, the net
income of the bank depends only on the risky assets assumed (x r ), and not the level of
patronage jobs (L). Thus (13) implies that x r is determined independent of the relative
weights given by the government to monetary resources and patronage jobs (K M and K L ).
By contrast, (12) implies that L depends on the K’s, since it affects fiscal income through
the privatization price.

14
We follow the model in Shleifer and Vishny (1994) in assuming that the government does not necessarily act
in the public interest. They assume that, because the public is disorganized, politicians can cater to interest groups,
such as labor unions, rather than the median voter. In our model, this concept is captured by K L , the per worker
benefit of an additional bank employee. Fiscal benefits to politicians, which need not be spent on projects that
promote the public interest, are captured by K M . Although K L could be included in k(L), it is useful to separate
the two to derive results in the section on comparative statics.
15
In practice, governments might retain ownership of the bank to ensure board representation—which might
make it easier to have influence over the bank’s actions especially if boards value consensus. Further, some
residual ownership might also reassure the private buyers that the government will not act opportunistically
following privatization (i.e., because the government has a stake in the bank after privatization).
146 G.R.G. Clarke, R. Cull / Journal of Development Economics 78 (2005) 133–155

3.3. Comparative statics

From this framework, we generate comparative static results that describe how the
equilibrium contract varies with respect to the government’s fiscal situation (through K M ),
the political strength of workers and unions (through K L ), the government’s ability to
recover residual assets (through g(x res)), the income generated on risky assets assumed by
the private entity (through h(x r )), and the prospects for the future solvency of the
privatized entity (through f(x r )). In this section, we highlight a handful of the predictions
from the model, which we then test in the next section of the paper.

3.3.1. Jobs protected by the government

From Eq. (12), we find:
KM w
k Vð L4Þ ¼ ð14Þ
KL
Since k is a concave function (i.e., B2 k=BL2 b0), kV(L) is decreasing in L. Consequently, L*
will fall as K M and w increase, and will increase as K L increases. Since K M represents the
value that the government places on the fiscal returns from privatization — cash income
from the sale and future profits from its continued shareholding (1s) in the privatized
bank – the first result suggests that governments that place a high value on the fiscal
benefits of the transaction (relative to the value of retaining surplus labor) will require that
fewer excess workers are retained. Conversely, as the importance of labor increases (i.e.,
K L increases), governments allow fewer layoffs.
In the empirical analysis that follows, we include two variables to control for fiscal
pressures on the government—the (lagged) provincial deficit, which is province specific,
and a dummy variable indicating whether the privatization took place before or after the
Tequila Crisis. Based upon the previous analysis, we would expect provinces with fiscal
problems to protect fewer jobs than provinces with stronger finances. Further, since the
crisis had a strong negative impact on provincial finances, we would expect that there
would be fewer layoffs in privatizations that took place prior to the crisis.16
It is interesting to note that neither K M nor K L appears to affect the equilibrium level of
the public bank’s assets assumed by the privatized bank (x*r ). When Eq. (6) is solved for
x*(see
r next subsection), x*r is not affected by either of these variables. The intuition behind
this is that although governments respond to changes in K M and K L by adjusting L*,
changes in these variables do not affect the relative division of assets between the residual
entity and the privatized bank. Instead, changes in K M and K L affect the price that the
buyer is willing to pay for its share of the privatized bank. From Eq. (6):
Pb4 ¼ sð f ðx4Þhðx
r r  cðx4Þ
4Þ r  wL4Þ  p̄

Consequently, P b * is a decreasing function of L*. Since x*r is unaffected by changes in K M

and K L , increases in K M (or decreases in K L ), which result in decreases in L*, result in the

16
Note that since provincial deficits are lagged, they will not fully control for the effects of the crisis on the
fiscal situation of the province, especially since many of the privatizations occurred in the year after the onset of
the crisis.
 G.R.G. Clarke, R. Cull / Journal of Development Economics 78 (2005) 133–155 147

buyer paying a higher price for the bank. That is, as money becomes more important (or
labor becomes less important) to the government, it accepts a greater number of layoffs but
receives a higher price for the privatized bank.

3.3.2. Assets assumed by the purchaser

From Eq. (13):

f Vðx4Þhðx
r r þ hVðx4Þf
4Þ r ðx4Þ
r  cVðx4Þ
r ¼ gVðx̄ pub  x4Þ
r  cres
V ðx̄ pub  x4Þ:
r ð15Þ

As noted above, since this does not depend upon K M or K L , changes in these variables
will not affect the equilibrium x*. r In this section, we are interested in how changes in
f(x r ), g(x r ) and h(x r ) affect the assets assumed by purchaser in equilibrium x*. r We
assume:
xr
f ðxr Þ ¼ 1  bs ð16Þ
x̄ pub

hðxr Þ ¼ br xr ð17Þ

gðxres Þ ¼ brs ðx̄ pub  xr Þ ð18Þ

Conditions (1), (2) and (7) imply that 0 V b s V 1, b r N 0, and b rs N 0. Condition (8V) implies
that b r N b rs . For simplicity we also assume that the private owners and managers of the
residual entity are equally good at managing their respective portfolios and that there are
constant returns to scale in managing assets.17 That is, we assume:

cðxr Þ ¼ c̄xr ð19Þ

cres ðx̄ pub  xr Þ ¼ c̄ðx̄x pub  xr Þ ð20Þ

where c̄ is a constant. Under these functional form assumptions (and denoting
bs4 ¼ bs =x̄xpub ), Eq. (15) implies:

ð1  bs4x4Þb
r r  br x4b
r s4 ¼ brs

This implies:
ðbr  brs Þ
x4r ¼ : ð21Þ
2br bs4

Increases in b*s will lead to lower equilibrium values of x*r (see Eq. (21)); as the
probability of default increases, the buyer will assume a smaller proportion of the public
bank’s assets. In times of crises, we would generally expect the probability of default to

17
This is a reasonable assumption because, in many cases, the owner of the privatized entity was responsible for
managing the residual portfolio for the province in return for a percentage of assets recovered.
148 G.R.G. Clarke, R. Cull / Journal of Development Economics 78 (2005) 133–155

increase and, therefore, we might expect the prospects for solvency to become dimmer.
Although b r and b rs might decrease during a crisis (i.e., both the residual entity and the
private bank will recover a smaller share of assets during a crisis), the two effects should
largely cancel out if they are of similar magnitudes. For example, if b r and b rs both fell by
10%, there would be no net effect on the equilibrium level of x*. r
Increases in b rs will also result in lower equilibrium values of x*r (see Eq. (21)). When
the residual entity is relatively good at recovering assets (i.e., when b rs is relatively close
to b r ), it will assume a greater share of the public bank’s assets (i.e., the privatized bank
assumes a smaller share of the public bank’s assets). The intuition is that because the
privatized bank can become insolvent, whereas the residual entity has no insolvency
constraint by definition, the government will place a larger proportion of assets in a
residual entity that is managed effectively.
Increases in b r will result in higher equilibrium values of x*. r

Bx4r 1 b b b
¼  r 2 rs ¼ 2rs N0: ð22Þ
Bbr 2br bs4 2br bs4 2br bs4

This means that when the privatized bank is relatively good at recovering assets, it will
assume a greater share of the former public bank’s assets. If we take b r to be an indication
of the ability of the buyer to manage the portfolio, this suggests that provinces that are able
to attract stronger buyers will generally allocate a greater share of assets to the privatized
bank. As a proxy for this, we will use the size of the public provincial bank relative to the
provincial banking sector. In remote provinces, the public provincial banks typically
dominated the local banking sector and it was very difficult to attract qualified buyers.
Since we would expect b r to be lower in these provinces (i.e., we would expect the buyers
in these provinces to be weaker), we also expect the buyers to assume a smaller share of
the portfolio.

4. Empirical results

In this subsection, we empirically test some of the predictions of the theoretical

model, looking at the characteristics of the banks and provinces that affected the
privatization contracts. Although the Argentine case offers a relatively high number of
bank privatizations by international standards, we acknowledge at the outset that the
low number of observations inherent in this type of study severely limits our ability to
control for all potentially relevant factors that might have affected contract provisions.
We are primarily interested in factors that might affect either the preferences of
policymakers (i.e., that might correspond to K M and K L in the theoretical model), the
risk associated with banking (i.e., that might correspond to b s ) or the attractiveness of
the bank to potential buyers (i.e., that might affect the quality of buyer and, therefore,
influence b r ).
To test the model, we use data for the fifteen privatizations described in Table 1. The
Fondo Fiduciario, the Banco Central de la República Argentina and the World Bank
 G.R.G. Clarke, R. Cull / Journal of Development Economics 78 (2005) 133–155 149

provided data on the terms of the privatization contracts, bank performance and other
province-level variables. The model that we estimate is:

yi ¼ a þ bxi þ ei ð23Þ

where i is the index for different banks, y i represents the contract provisions, x i represents
province- and bank-level characteristics, and e i is an error term. As noted, the small
number of observations severely limits our ability to specify a complete model, test
plausible variables and control for demographic factors that might affect contract
provisions.
The contract provisions studied that relate directly to the theoretical model are:
restrictions on layoffs (L); the percent of public bank assets taken by the privatized bank
rather than put into the residual entity (x r ); and the price paid relative to size of the bank
( P b ). The simple stylized theoretical model neglects some aspects of the privatization
contracts that might be of interest. In particular, we also model econometrically the
percent of privatized assets guaranteed by the province and the length of the service
contract. We do not look at branching restrictions because there was not enough variation
to estimate a model with this as the dependent variable.18 In general, we would expect
policymakers to prefer fewer layoffs, smaller guarantees and a higher price. Although it
is not immediately clear that politicians would prefer shorter to longer service
contracts, as discussed above, the new owners had a strong preference for longer
contracts. Since we do not observe uniformly long contracts, this suggests policy-
makers preferred some limits. One plausible reason for this might be that policymakers
believed they could reduce the price of these services in the future through competitive
bidding.
The independent variables include two that might proxy for politician’s preferences
(i.e., K M and K L ) and three variables that might affect the probability of insolvency
(b s ) or how attractive buyers find the bank, which might in turn affect the quality of
the buyer (b r ). The variables proxying for the preferences of provincial policymakers
are the political affiliation of the governor and a measure of the province’s fiscal
deficit. Although the preferences of other politicians (i.e., the legislature) might also
affect contract provisions, past work has suggested that the political affiliation of the
governor appears to be a reasonable proxy for preferences regarding bank
privatization in Argentina.19
We find that provinces with governors who were members of the Partido Justicialista
(PJ) tended to allow fewer layoffs, provide smaller guarantees, have relatively smaller
residual entities and grant shorter service contracts (see Table 3). However, they did
receive a lower price for the privatized bank, although the coefficient on this variable is

18
That is, if we estimate a simple probit model with a dummy variable indicating branching restrictions, there
are only two cases with no restrictions (see Table 1). A multinomial model would go far beyond the data
constraints.
19
Clarke and Cull (2002) find that this variable tends to be more highly significant in determining the likelihood
of privatization than the political affiliation of the provincial legislature. Further, in practice, when a single
opposition party had a majority in one or both chambers of the legislature, the governor belonged to that party.
150 G.R.G. Clarke, R. Cull / Journal of Development Economics 78 (2005) 133–155

Table 3
Effect of political variables on restrictions in contract
(1) (2) (3) (4) (5)
Estimation method Tobit Tobit Tobit Least squares Least squares
Dependent variable Minimum percent Percent of Percent of Price over Length
of workers that assets assumed portfolio pre-privatization of service
new owners by privatized guaranteed by assets contract
must keep bank provincea
Number of 15 14 14 15 15
observations
Degrees of freedom 10 9 9 10 10
Constant (t-stat) 0.512 0.238 0.650** 0.040 7.994**
(1.77) (1.54) (2.26) (1.82) (3.64)
Dummy indicating 1.308*** 0.275** 0.720*** 0.005 5.090**
PJ Governor (3.35) (2.32) ( 3.44) (0.27) (2.93)
(t-stat)
Net worth of public 0.910 0.480 2.557* 0.031 1.442
provincial bank (1.03) (1.05) ( 1.96) (0.46) (0.21)
(as percent of
liabilities) (t-stat)
Lagged provincial 8.037*** 0.553 1.458** 0.125** 1.605
deficit (over (3.72) (1.77) (2.53) (2.65) (0.34)
revenues) (t-stat)
Loans by public 1.965** 0.619** 0.484 0.024 10.654**
bank (as percent (2.71) (2.28) ( 0.85) (0.65) (2.91)
of loans in province)
(t-stat)
Dummy indicating 2.132*** 0.442** 0.285 0.025 2.449
before Tequila (3.99) (2.96) ( 1.37) (1.22) (1.20)
Crisis (t-stat)
R 2 (pseudo-R 2 for 1.12 2.59 0.69 0.51 0.67
Tobit regressions)
a
Excludes guarantees as percent of recovered residual assets.
* Indicates significance at 10 percent level.
** Indicates significance at 5 percent level.
*** Indicates significance at 1 percent level.

insignificant (model 4). The negative coefficient is suggestive of a tradeoff between price
and the other contract features.20
The size of the province’s fiscal deficit might also affect the preferences of policy
makers. First, the fiscal deficit might affect how policymakers weight different provisions.
For example, they might be more willing to trade off restrictions on layoffs and guarantee
a greater part of the loan portfolio in return for a higher price (i.e., they might have

20
Still, the results for the other contract features indicate that provinces with PJ governors did well on nearly all
dimensions. It is possible that banks privatized in provinces with non-PJ governors were, on average, less
attractive overall. If this poor performance is not captured by the performance measure included in the regression
(i.e., net worth of the public provincial bank before privatization), the dummy for PJ governor might be proxying
for performance. In other words, it may be best to think of the PJ variable as a control for bank quality, and focus
on other explanatory variables to describe the tradeoffs that were made to facilitate these transactions.
 G.R.G. Clarke, R. Cull / Journal of Development Economics 78 (2005) 133–155 151

relatively low values for K L and relatively high values for K M ). Further, provinces with
large fiscal deficits might put greater emphasis on the speed with which the transaction is
completed (i.e., to quickly receive privatization proceeds and reduce the drain of
supporting the public bank). The results in Table 3 support these hypotheses. Provinces
with high deficits imposed fewer restrictions on layoffs and guaranteed more assets, but
received a higher price (relative to the size of the bank before privatization).21 Although
they tended to privatize a greater share of the public banks’ assets (see column 2), this
result is not statistically significant. The sign on that statistically insignificant coefficient is
also consistent with the theoretical model.
The regression also includes a dummy variable indicating whether the contract was
written before, or after, the Tequila Crisis.22 This variable might proxy for several different
effects in the theoretical analysis. First, the province’s finances deteriorated significantly
after the Tequila Crisis. To the extent that the lagged deficit variable does not fully capture
the financial pressures on the province, this variable might partially reflect increases in
K M . Since the crisis probably increased financial pressures on the province, we would expect
more layoffs following the crisis. The empirical results are broadly consistent with this—the
positive coefficient on the dummy indicating that the privatization took place prior to the
crisis indicates that there were fewer layoffs prior to the crisis. The crisis, and the resulting
deposit loss, might have also increased the risk of insolvency (i.e., increased b s ). This, in
turn, should have resulted in fewer assets being transferred following the onset of crisis. The
results in Table 3 are also broadly consistent with this—the positive coefficient on the
dummy indicates that a higher share of assets was transferred prior to the crisis (column 2).
A final reason for including this variable is that the early privatizations were started
before the Fondo Fiduciario was operational. However, it is not immediately clear what
effect the Fondo Fiduciario would have on contract provisions. For example, it might
improve contract provisions (in the view of provincial policymakers) by reducing the
pressure for quick privatizations, since the province would have to worry less about the
bank deteriorating while it was waiting to be privatized. However, viewing the Fondo
Fiduciario as a sort of free lunch program ignores the evolving bargaining situation
between the provinces and the federal government. Since many poorly performing public
provincial banks lost considerable deposits during the Tequila Crisis and, therefore,
required liquidity injections from federal sources, provincial politicians were in no position
to request many favors. Their banks were adversely affecting the provinces’ fiscal
situations, they needed immediate relief, and they would have to accept the terms on which
it was offered. Indeed, Fondo Fiduciario employees worked closely with provinces to draft
the terms of sale and they determined the amounts to be disbursed to each province.23 In

21
We measure price relative to pre-privatization assets because that measure is a better indicator of the eventual
size of the privatized entity. The privatized banks have grown very quickly since privatization and it seems likely
that they will be similar in size to the public banks once they reach equilibrium. We are presuming, therefore, that
buyers’ bids primarily reflected the future value of conducting a banking business in the province (while retaining
the name of the provincial bank, rather than as a new entrant).
22
The Tequila Crisis began as an exchange rate crisis, following the devaluation in Mexico in December 1994.
However, the loss of confidence also affected other Latin American countries, which led to shrinkage of
Argentina’s domestic economy and a run on many poorly performing domestic banks.
23
The terms of sale and the disbursements were also subject to World Bank approval.
152 G.R.G. Clarke, R. Cull / Journal of Development Economics 78 (2005) 133–155

these ways, Fondo Fiduciario involvement might have actually increased pressure on the
provinces to act more quickly.
These results are interesting when combined with results in Clarke and Cull (2002) on
the timing of privatization, which indicated that the external shock of the Tequila Crisis
and poor bank performance increased the likelihood of privatization. Here we find that the
Tequila Crisis is correlated with worse contract provisions from the viewpoint of
provincial policymakers. This suggests that if policymakers wait until an external crisis or
poor performance forces the province to privatize, then the outcome will be less good from
their viewpoint. They will be able to guarantee fewer jobs, will be left with larger residual
entities, and will be forced to guarantee more of the privatized bank’s assets. However,
some post-privatization performance data in Clarke and Cull (2000) show that the early
privatizations were among the least successful. In the end, the best privatization outcomes
may only come about when political decision-makers have fewer choices.24
The analysis includes two variables to proxy for the attractiveness of the bank and the
general riskiness of banking in a given province—the net worth (relative to liabilities) of
the public provincial bank before privatization, and the size of the public bank relative to
the size of the provincial banking sector. With regard to the first variable, it seems
reasonable that potential buyers would be more interested in a public bank if they believed
that the bank was already operating relatively efficiently. For example, stronger
performance might suggest that the bank’s staff or assets are better quality. In the context
of the model, this might suggest that b r is higher (i.e., the new private owner will be able
to recover a greater share of assets after privatization). However, it might also suggest that
the residual bank might also perform better post-privatization (i.e., that b rs is also higher).
The net impact on the assets transferred to the privatized bank (and through this the price)
is therefore indeterminate, depending on the magnitude of the two effects. The expected
correlations between the length of the service contract, guarantees and the quality of the
public bank are, for similar reasons, also unclear. For example, although provinces might
have to sweeten the deal with poorly performing banks by providing longer service
contracts, they might also be less wary about signing long contracts with better quality
provincial banks.25 Similarly, it is unclear whether they will guarantee a greater or smaller
share of the portfolio—although the new private owners will presumably require fewer
guarantees if they believe the quality of the portfolio is higher, policymakers will be less
concerned about guaranteeing assets under the same conditions. In practice, the
coefficients on this variable are statistically insignificant in four of the five regressions.
The second variable is the size of the public bank’s loan portfolio relative to the size of
the provincial banking sector. The public provincial banks were quite large relative to the
provincial banking sectors—typically accounting for between 40% and 70% of total
lending in the province (Clarke and Cull, 2000). If large provincial banks were able to
exploit significant market power, then we might expect greater competition for these banks
and for them to attract higher quality bidders. Consequently, prices might be higher and the
privatized banks might assume a greater share of the public bank’s assets (because the

24
A more charitable interpretation would be that, in cases where a politician already recognizes the benefits of
privatization, a crisis might help her win support for that position.
25
The implicit assumption is that higher quality public banks are likely to become high quality privatized banks.
 G.R.G. Clarke, R. Cull / Journal of Development Economics 78 (2005) 133–155 153

bidders are higher quality). The market power potentially exercised by the public
provincial banks that we allude to is not the type that leads to restricted output (credit) and
higher prices (interest rates).26 We mean, rather, that they could drive private competitors
from the market, perhaps through issuance of credit at subsidized interest rates. In places
where they had done this effectively, the private owner of the provincial bank might have
anticipated little competitive threat, at least in the near term. Because provinces would no
longer be able to manipulate interest rates directly (and could not do so indirectly through
regulation), they may have felt most justified in extracting rents from bidders in those
places where the provincial bank had most dominated the pre-privatization provincial
landscape.
In practice, the reverse seems true—provinces with dominant public banks managed to
impose fewer restrictions on layoffs and assumed a greater share of the public bank’s
assets and liabilities. The coefficient on the length of the service contract was also positive
and significant. This is consistent with the previous two results—contract provisions were
more generous to the buyer when the bank was relatively large. This could be because
public provincial banks tended to be especially large (relative to the banking sector) in
sparsely populated rural provinces, which tend to be unattractive banking environments.27
The coefficients on the size of the public bank relative to the provincial banking sector
were insignificant in the other two equations (price and percent of the portfolio that was
guaranteed).

5. Conclusions

Despite the importance of the issue, little attention has been paid to how the incentives
of politicians affect privatization contracts, perhaps because it is difficult to find the
evidence necessary for analysis. Argentina’s provincial bank privatizations of the 1990s
offer a unique opportunity to study these issues. During this privatization episode, different
provincial politicians, who faced different constraints, crafted agreements with private
purchasers for the sale of their loss-making public banks. Since the privatization contracts
differed substantially in some regards, this provides an opportunity to explore how the
different incentives and constraints facing different decision makers affected contract
design. In this paper, we present a simple theoretical model that illustrates the trade-offs
faced by self-interested (rather than purely welfare-maximizing) politicians in creating
these contracts.
Although we recognize that our sample is quite small, the empirical evidence supports a
number of the theoretical predictions. For example, politicians in provinces with poor
fiscal health were able to preserve jobs for fewer bank employees and received higher
payments for their banks. In addition, the evidence suggests that the Tequila Crisis meant
that politicians could protect fewer jobs and had to assume a higher share of their public

26
The poor performance of the public provincial banks strongly suggests that they were not dprofit maximizingT
in this sense.
27
The correlation between population density and percent of assets in the province held by the provincial bank
was 0.55 and was statistically significant at higher than a 1% significance level.
154 G.R.G. Clarke, R. Cull / Journal of Development Economics 78 (2005) 133–155

banks’ assets. Finally, our model predicted that when buyers had less expertise in
managing a loan portfolio, smaller portions of the loan portfolio would be transferred to
the privatized bank. In locations where the provincial bank dominated the local financial
landscape, and buyers were presumably difficult to attract, this appears to be the case.
An important issue not explicitly addressed in this paper is how contract design affects
post-privatization performance. In practice, this is difficult to fully assess in Argentina due
to the relatively short post-privatization experience for most banks and because the banks
are still going through an equilibration process as they refocus their business activities
towards commercial lending. However, there is some evidence that banks privatized after
the Tequila Crisis have performed better than those privatized before the crisis. This
suggests that the Crisis may have wrought some unforeseen benefits by tying politicians’
hands. While this conjecture clearly awaits further empirical validation, by explicitly
incorporating the incentives facing politicians into the analysis, future work might be able
to begin to address the question of why some privatizations are more successful than
others.

Acknowledgements

We would like to thank Stefan Alber, Lee Alston, Paul Levy, Jo Ann Paulson, and
seminar participants at the Annual Meetings of the Public Choice Society and Social
Science History Institute at Stanford University for helpful comments and suggestions. For
providing data and many helpful discussions we are indebted to Javier Bolzico, Andrew
Powell, Gabriel Caracciolo, Maria Hernandez, Andrea Molinari, Laura DTAmato, Juan
Barale, Horacio Fernandez, and Jorge Lombardi of the Central Bank of Argentina; Rogelio
Frigerio, Alejandro Caldarelli, and Enrique Scala of the Fondo Fiduciario; and Raul
Benitez and David Rosenblatt of the World Bank. All remaining errors are ours. The
findings, interpretations, and conclusions expressed in this paper are entirely those of the
authors and do not necessarily represent the view of the World Bank, its Executive
Directors, or the countries they represent.

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