Environmental liability and privatization in central and Eastern Europe: Toward an optimal policy

It has been estimated that the costs of remediating contaminated sites in Central and Eastern Europe (CEE) will be very high. These contingent environmental liabilities have emerged precisely at the time CEE countries are attempting to privatize their capital stocks, creating major challenges for privatization agencies. It is also generally agreed that an inadequate handling of these liabilities in the past has reduced sales of state-owned enterprises in Central and Eastern Europe. This paper uses an analytical model to identify optimal policies for minimizing the damage to privatization processes from environmental liabilities. Policy simulations are conducted which evaluate the effects of the use of liability indemnifications and environmental audits on privatization sales, prices and government revenues net of environmental costs. The major finding of the paper is that goals to mitigate the effects of environmental liability on privatizations and maximize government net revenues from privatization sales require equivalent environmental liability policies. Both goals require optimal provision of information and indemnifications to investors, and moreover it is found that the two policies are complementary rather than substitutes.