Justice Secretary Chris Grayling said “uncertainty” created by the investigation into the firm - the leading bidder to operate Hatfield, Moorland and Lindholme prisons - meant the process was being cancelled.
In a written statement to MPs, Mr Grayling said: “The House will recall that I made an announcement on July 11 2013 where I outlined that the leading bidder for these prisons was Serco, but that the award of this contract would be delayed as a result of the investigations into Serco’s operations. The investigations remain ongoing.
“The impact of the delay and the uncertainty this has created mean that for operational reasons we cannot postpone the outcome of the competition process any further.
“I have therefore decided that the competition for these prisons will cease and that all three prisons will be managed by HM Prison Service.”
Mr Grayling insisted that the Government remained “fully committed to a mixed market for public services, drawing on the best of public, private and voluntary providers to improve quality and secure value for money for the taxpayer”.
The Serious Fraud Office (SFO) has launched a criminal investigation after allegations emerged that Serco and another firm, G4S, overcharged the Government for tagging offenders, some of whom were found to be dead or abroad.
Both firms have been barred from winning new government contracts pending a wider review of their operations.
Serco said it understood that the “urgent need for change at these prisons means that the typical six-month period of mobilisation and transition to the private sector would not be in the best operational interest of the prisons”.
Acting group chief executive Ed Casey, who took on the role after Christopher Hyman resigned last month, said: “From meetings with the UK Government, it is clear that the operational needs of the prisons will be best served by the necessary changes being implemented without further delay.
“We are also continuing to make good progress across the various audits, reviews and our proposed corporate renewal programme within the timing previously communicated by Government.”
Frances Crook, chief executive of the Howard League for Penal Reform, said: “This is a welcome U-turn by the Government.
“Only two days ago, Serco admitted to MPs that it had been ‘ethically wrong’ to charge the taxpayer for tagging work it never did. Nobody wants companies that, by their own admission, have behaved unethically managing prisons, of all places.
“The Justice Secretary shouldn’t stop at these three prisons in South Yorkshire. He should go further and continue to reverse the justice privatisation tide currently being witnessed across the country. Private firms are often much better at winning lucrative contracts than delivering the goods.
“Something as important as taking away someone’s freedom should only be done by the state, answerable to voters, rather than by international private security firms, whose prime aim is to make a profit for their shareholders.
“Running prisons for profit means these multinationals cash in on others’ misery, making more money out of increased levels of crime and a greater number of people being held in overcrowded cells.”