This draft: January, 2004 WHO IS RUNNING THE IMF: CRITICAL SHAREHOLDERS OR THE STAFF? by Michele Fratianni* and John Pattison** Abstract The paper deals with the principal-agent relationship at the International Monetary Fund (IMF). We argue that residual control rights at the IMF are vested with the critical shareholders, the countries included in the G-7. This group controls vast financial resources and enjoys the highest regulatory and governance standards among IMF members. Imperfect incentives for monitoring and the complexity of the issues give staff and management a degree of autonomy. The evidence marshalled in the paper suggests that critical shareholders are in charge on those issues they care most about, leaving discretion to staff and management on peripheral issues. Key words: IMF, G-7, principal-agent relationship, critical shareholder, staff autonomy. JEL Classification: D71, F13, F15. *W. George Pinnell Professor of Business Economics and Public Policy, Indiana University, Graduate School of Business, Bloomington, Indiana 47405 (USA). Tel 812-855-9219, Fax 812-855-3354, Email [email protected]. **Senior Vice-President, Canadian Imperial Bank of Commerce, Commerce Court West, 199 Bay St., Toronto, Ontario, M5L 1A2 (Canada). Tel 416-980-5306, Fax 416-368-9826, Email [email protected]. INTRODUCTION The International Monetary Fund (IMF), as one of the Bretton Woods institutions, was designed to provide the public good of an efficient international monetary system. But over the years, the IMF has transformed itself into a multi-product institution: its output ranges from a good housekeeping seal of approval to member countries through so-called surveillance and conditionality lending all the way to technical assistance. Presiding over this wide array of activities are member governments, the shareholders of the IMF. But, as it is true of privately-owned corporations, these shareholders face a monitoring problem and may not be able to fully achieve what they wish. The purpose of this paper is to examine who is in charge at the IMF: the principal, the agent, or both. The key questions are: who sets the mission, who controls the agenda, who implements decisions, and how independent are management and staff from shareholders. The theme is not new. Vaubel (1986), for example, is an early proponent of bureaucratic growth of international organizations (IO) due to the fact that shareholders have small incentives for monitoring. Vaubel et al. (2003) corroborate this finding by estimating a larger-than-unity elasticity of staff size with respect to member states, without however controlling for the size and complexity of the output. Along the same lines, Barnett and Finnermore (1999) posit that international organizations, once created, develop their own agenda. Staff autonomy is grounded on the ability of the staff to retain control over vital information. Frey (1997), instead, emphasizes prestige and influence with reference groups as the main forces motivating the staff of IOs. Using this insight, Willett (2001, p. 323) reasons that “the environment of the IMF is much like that of central banks and finance ministries. As such, there would seem to be relatively little3incentive for key decision makers at the IMF to maximize staff size.” Nielsen and Tierney (2003) hypothesize that the IO agent (in their case the World Bank) retains some degree of autonomy so long as his actions are not greatly at odds with the principal’s preferences. When significant differences emerge, the principal finds an incentive to re-assert his authority and to bring about a change in the agent’s behavior. Martin’s (2003) study of the IMF combines elements of informational asymmetries and preference alignment between principal and staff. The principal delegates more autonomy to the staff when issues become more complex and the environment is riskier to the principal, for example during financial crises. On the other hand, if staff actions divert significantly from the principal’s preferences, staff autonomy declines. If shareholders trusted completely the agent, delegation would be complete and so would agent autonomy (Majone 2001). Clearly, we have not reached this stage at the IMF. The central message of our paper is that a core of shareholders at the IMF is in full control of the institution’s mission on the big issues and that staff autonomy is restricted in areas of marginal interest to the critical shareholders. The rest of the paper is organized as follows. Section II presents general considerations on the principal-agent relationship in the public sector. The key point there is that, while agency problems tend to be more serious in the public sector than in the private sector, the nature of the production function of the underlying institution determines agency costs and the restrictions placed on the agent by the principal. Section III discusses two sharp alternative hypotheses concerning the governance of the IMF: critical shareholders are in charge versus management/staff are in charge. We explore also that that the two hypotheses can co-exist but for different states of the world. Section4IV presents evidence obtained from the literature. The sum total of the evidence is more qualitative than quantitative given the nature of the topic. Conclusions are drawn in the last section. II. AGENCY COSTS AND THE PUBLIC SECTOR Casual observation suggests that agency problems and effective monitoring of the agent are more serious in the public sector than in the private sector. To begin with, corporations seek profit or shareholders’ wealth maximization. Government agencies, instead, have multiple objectives and have to resolve the difficult task of assigning weights to each of those objectives. Furthermore, objectives or their associated weights change because of the political process and the power of interest groups. While privately held corporations remain focused on the maximization of profits or shareholders’ wealth, the political process changes the rules of the game as political parties or groups, with different ideological agendas, alternate in power. In democracies, political control is contested at fixed dates or within fixed intervals. Elections are the equivalent of takeover bids in the private sector. Political takeovers can be interpreted in either of two ways. The first is that they give an opportunity to replace