The effect of public involvement on firm inefficiency: evidence using Japanese private firms

The purpose of this paper is to investigate the effect of public involvement on firm inefficiency. Public involvement is defined as the actions taken by governments to control firm management, as expressed in regulation and public ownership. We make the following three contributions. First, we show public involvement is an important determinant of the inefficiency of private firms. Although public involvement has been shown to influence firm behavior in public or regulated sectors, existing studies in the private sector tend to ignore its effects. Second, we analyze firm inefficiency rather than firm performance by focusing on cost factors. Previous work tends to use performance measures such as return on assets or return on equity rather than inefficiency measures to judge a firm’s management level. Performance measures are problematic, however, in that they are affected by not only cost factors but also demand factors. Therefore, we must separate these factors when we analyze a firm’s management. Third, we use a stochastic cost frontier model for the estimation. Although this is a suitable approach for estimating firm inefficiency, it is rarely used for private firms. Our results suggest that public ownership increases firm inefficiency while regulation decreases firm inefficiency. It is also clear that the effect of public ownership is not significant in the manufacturing industry, while it is strongly significant in the nonmanufacturing industry. This shows the importance of studying the effect of public involvement in the private sector.