FINANCIAL ADMINISTRATION OF THE FIRM FIN 5043930

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Public and Private Sectors in Public Finance
58th Congress of the International Institute of
Public Finance Helsinki, Finland, 26th -29th
August 2002
International Institute of Public Finance
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From State To MarketA Survey Of Empirical
Studies On Privatization
Presented by
William Megginson Professor Rainbolt Chair in
Finance University of Oklahoma wmegginson_at_ou.edu h
ttp//faculty-staff.ou.edu/M/William.L.Megginson-1
Member,Global Advisory Committee on
Privatization Italiam Minsitry of Economics and
Finance
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Papers Co-Author, Publication Outlet And Sponsors
Co-authored with Jeffry M. Netter Associate
Professor of Finance Adjunct Professor of
Law The University of Georgia USA
Published in Journal Of Economic Literature
(June 2001) http//papers.ssrn.com/sol3/papers.cfm
?abstract_id262311
Sponsored by
The New York Stock Exchange
and The Paris Bourse
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Seek To Answer Eight Questions

• How Much Privatization Has Actually Occurred?
• Why Have Governments Embraced Privatization?
• Has Privatization Improved Firm Performance?
• Is Impact Different in Transition Countries?
• How Have Governments Chosen to Privatize?
• How Do Political Factors Impact Privatization
  Terms--Especially Share Issue Privatizations?
• How Has Privatization Impacted Stock Market
  Development Individual Share Ownership?
• Have Investors Benefited From SIPs?
• What Are The Key Lessons of Privatization?

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Brief History Of Privatization

• FRGs Adenauer Government Actually First (1961)
• Small British Petroleum, Other Sales (1977)
• First Thatcher Government (1979-83)
• The Turning Point British Telecom (Nov 84)
• Chile Shows Privatization Possible in DCs (80-85)
• The French Chirac Government (1986-88)
• Privatization Spreads To Asia (NTT 1987-88)
• Telefonos de Chile Pioneers ADRs (1990)
• European SDs Embrace Privatization (Since 1993)
• Privatized Firms Key To European Capital Market
  Transformation (1998-2000)

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Brief History Of Privatization

• Privatization Now Established Policy In W Europe
• Has stalled recently with market decline
• Political Moment for New Round of Privatization
  in W Europe Has Arrived
• Financial moment has not Key problem for govts
• Ongoing (Fitfully) In Japan, Developed Asia
• Largest Future Programs In Developing Countries
• Ongoing, Painful Consolidation In CEE
• Both serious shift back to state ownership
  unlikely
• Two Key Countries In Years Ahead China India
• Key Industry To Watch Petroleum (OPEC)

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Privatization ProceedsUS Billions, 1988-2001
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The Impact of Privatization

• Has Significantly Reduced States Role in OECD
• SOEs Effectively Eliminated From UK Economy
• Rapidly Shrinking Role In Other OECD
• SOEs Have Declined, But Not States Overall Role
• Transition Economies Have Been Transformed
• SOE Role Cut Up To Two-Thirds In Eastern Europe
• Russia Privatized, But Not Commercialized
• Much Less Change In DCs Until Recently
• Little Change In Africa, Latin America Thru 1991
• Much Has Probably Happened Since 1991
• Little Impact Thus Far In China, India

9
SOE Share Of GDP, By Region
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Why Have Governments Embraced Privatization?

• Poor Economic Performance of SOEs
• State Ownership Theoretically Defensible
• In Practice, Often Highly Inefficient
  Politicized
• Chronic Under-Investment Due To PSBR
• Unending Need For SOE Subsidies
• Up To 10 Of GDP In Some Countries
• Pervasiveness Of Soft Budget Constraints
• Revenue Govts Can Raise From Privatization
• Fiscal Impact Of Privatization Very Positive
• Cannot Be Sole Reason Due To Tax Trade-Off
• Empirical Support For Private Ownership

11
Academic Research Supporting Private Over Public
Ownership

• Boardman Vining (JLE 89)
• Vining Boardman (PubCh 92)
• Boycko, Shleifer Vishny (JFE 94, EJ 96)
• Ehrlich, Gallais-Hamonno, Liu Lutter (JPE 94)
• Majumdar (PubCh 96)
• Kole Mulherin (JLE 1997)
• Lin, Cai Li (AER 98)
• Shirley Walsh (WB 2000)
• Dewenter Malatesta (AER 2001)
• LaPorta, Lopez-de-Silanes, Shleifer (JF 2002)

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Is There An Alternative To Privatization?

• Literature Stressing Competition Over Ownership
• Yarrow (1986) Kay Thompson (1988) Bishop
  Kay (1989) Vickers Yarrow (1991)
• Studies Showing Improvement w/o Privatization
• Sachs (AER 92) Early Russian Experience
• Pinto, Belka Krajewski (BPEA 92) Poland
• Li (JPE 97) China Majumdar (PubCh 96) India
• Unanswered Question Would Performance Improve
  Even More With Privatization?
• Wallsten (2000) Priv With Dereg Best For
  Telecoms
• Also May Be Needed At Least To Lock In Gains

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Governments Use Three Basic Methods To Privatize

• Direct (Asset) Sale Sale Of A Company To Another
  Firm Or Group Of Investors For Cash.
• Share Issue Privatizations (SIPs) Public
  Offering of Common Stock Currently Owned By
  Government.
• Voucher Privatization Exchangeable Vouchers
  Distributed To Citizens For Free (Or At Reduced
  Cost). Convertible Into SOE Shares.

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One Study Examines Choice Between SIPs And Asset
Sales

• Megginson, Nash, Netter Poulsen (WP 2002)
  Examine Choice of public (SIPs) or private (asset
  sales) capital market for privatizations for
  2,477 sales over period 1977-2000, raising 1,189
  bn.
• SIP is More Likely (1) The larger the firm (2)
  The stronger are S/H rights and legal tradition
  (3) For more profitable firms (4) The less
  developed are cap markets (5) The more equal the
  income distribution.
• Asset Sale More Likely (1) The more stable the
  government (2) By right-wing govts (3) The more
  developed the national capital market (4) The
  more unequal the income distribution in the
  country.

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Characteristics Of SIPs Versus Asset Sales
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Has Privatization Improved Firm Performance?

• 44 Studies Examine Performance Changes Using
  Accounting Or Real Output Data
• Examine Transition, Other Economies Separately
• 12 Single-Country Or Single-Industry Studies
• Britain, Argentina, Mexico, Canada, Chile
• Telecommunications, Airlines
• 12 Pre- Vs Post-Privatization Studies Using SIPs
• Only SIPs Generate Post-Issue Fincl Reports
• Severe Limitation Since Small Minority Of Sales
• 20 Empirical Studies Of Transition Economies
• 12 Examine CEE 7 Study FSU 1 China

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Single-Country/Industry Case Studies
Non-Transition Economies

• Galal, Jones, Tandon Vogelsang (WB 92) Perform
  Counter-Factual Analysis Of 12 Mostly-Regulated
  Firms From 4 Countries. Performance Improved Net
  Welfare Gains In 11 Firms Equal To 26
  Pre-Divestiture Sales. Workers Mostly Gained.
• Martin Parker (MDE 95) Examine 11 British
  Firms Divested 1981-88. Control For Business
  Cycle Effects. Mixed Results Improvement Before,
  Not After Divestment. Privatization Itself Not
  Helpful.

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Single-Country/Industry Case Studies
Non-Transition Economies

• Ramamurti (WD 97) Examines 1990 Privatization Of
  Ferrocarilla Argentinos. Performance Improved
  Labor Productivity Up 370 Employment Declined
  78.7 Services Improved Subsidies Cut.
• Newberry Pollitt (JIE 97) Test whether The
  1990 Privatization/Restructuring of Britains
  CEGB Was Worth It. Mixed Results Performance
  Improved, But Only Shareholders Benefited.
  Permanent Cost Reduction Of 5/Year. Worth It,
  But Not Done Well.

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Single-Country/Industry Case Studies
Non-Transition Economies

• Eckel, Eckel Singal (JFE 97) Examined Impact
  On Competitors of BAs Privatization. Performance
  Improved Competitor Stock Prices Decline 7
  Fares On Contested Routes Drop 14.3.
• LaPorta Lopez-de-Silanes (QJE 98) Studies 218
  Mexican Firms Privatized Thru 1992. Performance
  Improved Output Increased 54.3 Employment
  Halved Wages Up 40 Point Profit Increase Need
  For Subsidies Eliminated (Were 12.7 Of GDP).

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Single-Country/Industry Case Studies
Non-Transition Economies

• Wallsten (JIE 2000) Performs Econometric
  Analysis of Telecom Reforms in 30 African Latin
  American Countries, 1984-97. Mixed Results Priv
  Alone Not Helpful, Unless Coupled With Effective,
  Independent Regulation. Increasing Competition
  The Single Best Reform, Competition With
  Privatization Best Overall.
• Galiani, Gertler Schargrodsky (WP 2001)
  Examine Privatization of Argentine Water Services
  In 1990s. Performance Improved Find Access,
  Quality Coverage Increases and Child Mortality
  Falls Significantly After Privatization.

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Single-Country/Industry Case Studies
Non-Transition Economies

• Laurin Bozec (2000) Compares Productivity And
  Profitability of Two Large Canadian Rail
  Carriers, Before After 1995 Privatization of
  Canadian National (CN). Performance Improved
  Total Factor Productivity of CN Increased
  Steadily.
• Gupta (WP 2002) Studies Changes in Performance
  Productivity for 80 Indian SIPs, from 1990-98.
  Performance Improved Even Though Almost All Only
  Partial Sales. Attribute To Stock Market
  Monitoring Of Managers.

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Pre- Versus Post-Privatization Performance Change
Studies (SIPs)

• Megginson, Nash van Randenborgh (JF 94)
  Compare Pre- Vs. Post-Privatization Performance
  Of 61 Firms Sold By 18 Countries From 1961-89.
  Performance Improved Profits, Output,
  Efficiency, Cap Exp, Div Up Employment Unchanged
  Or Up.
• Boubakri Cosset (JF 98) Compare Pre- Vs.
  Post-Privatization Performance Of 79 Firms From
  14 Developing Countries,1980-92. Performance
  Improved Profits, Output, Efficiency, Cap Exp,
  Div, Employment Up Significantly Leverage
  Reduced.

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Pre- Versus Post-Privatization Performance Change
Studies (SIPs)

• DSouza Megginson (JF 99) Update MNR Study For
  90s Examine 85 Firms From 26 Countries.
  Performance Improved Profits, Output, Efficiency
  Up, Leverage Employment Down Significantly Cap
  Exp Up Insignificantly More Telecoms During
  1990s.
• Boubakri, Cosset Guedhami (WP 2001) Test
  Performance Changes For 189 SIPs from Developing
  Countries, 1980-97. Performance Improved
  Significant Increase In Sales, Profits,
  Efficiency, Capex Leverage. Simultaneous
  deregulation, Market Opening Enhances Improvement.

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Pre- Versus Post-Privatization Performance Change
Studies (SIPs)

• Dewenter Malatesta (AER 2001) Pre- Vs. Post
  Priv Performance Of 63 Large SIPs, 1981-94, Over
  Short Long-Term Event Windows. Mixed Results
  Signif Rise In Output Profits (Using NI)And
  Signif Drop In Leverage, Labor Intensity--After
  Privatization, But NOI Only Rises Prior To
  Divestiture.
• Boardman, Laurin Vining (WP 2000) Study 9
  Canadian Firms Privatized 1988-95. Performance
  Improved Profits More Than Double Efficiency
  Sales Rise Significantly. Leverage Employment
  Fall Significantly, Capex Increases
  Significantly.

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Pre- Versus Post-Privatization Performance Change
Studies (SIPs)

• Bortolotti, et al (TP 2002) Examines 31 Telecom
  Sales, 25 Countries Via SIP, 1981-98. Performance
  Improved Profits, Output, Capex, Number of
  Lines, Average Salary Increased Significantly
  Leverage Decreased. Employment Insignificant
  Change.
• Chong Lopez-de-Silanes (WP 2002) Study Labor
  Force Downsizing After Privatization For 308
  Sales In 83 Countries 1982-2000. Voluntary
  Downsizing Neg Assoc With Priv Prices, Due To
  Adverse Selection. Skill-Based Retrenchment Most
  Efficient. 78 Of Firms Downsized Prior To
  Privatization.

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Three Directly-Comparable Studies Using SIPs
Yield Consistent Results

• Megginson, Nash van Randenborgh (JF 94),
  Boubakri Cosset (JF 98), And DSouza
  Megginson (JF 99) Use Identical Methodology
• Compare Pre- To Post-Privatization Performance
• Compare Average Values From (1,3) to (-3,-1)
• Use Identical Empirical Proxies
• But Examine Largely Non-Overlapping Samples
• BC Examine LDCs, MNR DM Mostly OECD
• Combined Have 211 Firms From 42 Countries

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All Three Studies Show Significant Performance
Improvements

• Profitability (NI/Sales) Increases From Average
  8.6 Before To 12.6 After Privatization, With
  Over 67 Of Firms Improving. Significant
  Improvement.
• Efficiency (Real Sales Per Worker) Increases
  From 97 To 116 of Year 0 Level, And 81 Of
  Firms Improving. Significant Improvement.
• Output (Real Sales) Increases From 94 To 177
  of Year 0 Levels, And 80 Of Firms Improve.
  Significant Improvement.

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All Three Studies Show Significant Performance
Improvements

• Leverage (Total Debt/Total Assets) Falls From
  0.48 Before To 0.44 After Privatization, And 67
  See Leverage Declines. Significant Improvement.
• Dividends (Cash Dividends/Sales) Dividends Rise
  From 2 To 6.5 of Sales Over 80 Of Firms
  Experience Increase. Significant Improvement.

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Only Differences Between Studies Employment
Capital Spending

• Capital Investment (Cap Exp/Sales) Rises In All
  Three Studies, From 14 To 19 After
  Privatization, And Over 60 Show Increases, But
  DM Not Significant. Significant Improvement.
• Employment ( Employees) MNR And BC Show
  Increases DM Shows Significant Decrease, Overall
  Average Little Change (286 Worker Increase, From
  22,936). Mixed Results But Little Evidence Of
  Mass Layoffs.

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Empirical Studies of CEE Transition Economies

• Pohl, Anderson, Claessens Djankov (WB 97)
  Study Extent Of Restructuring By 6,300 Private
  And Public Firms In Eastern Europe During
  1992-95. Performance Improved Privatization
  Sharply Increases Restructuring Likelihood And
  Success.
• Smith, Cin Vodopivec (JCE 97) Using 22,735
  firm-years of data from Slovenias spontaneous
  privatization (1989-92), study impact of
  ownership on performance. Ownership Is Critical
  Each point rise in foreign S/H associated with
  a 3.9 rise in value-added, and for employees
  with a 1.4 rise.

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Empirical Studies of CEE Transition Economies

• Dyck (AER 97) Tests Treuhands role in
  restructuring privatizing eastern Germanys
  SOEs. Performance Improved privatized firms
  much more likely to have brought new
  westernmanagers into key positions than were
  companies that remained state-owned.
• Frydman, Gray, Hessel Rapaczynski (QJE 99)
  Compare 128 Privatized Firms 90 SOES From
  Eastern Europe During 1990-93. Performance
  Improved But Only For Outsider-Controlled Firms.
  Privat adds 18 points to growth rate if sold
  to a domestic FI12 points if sold to a foreign
  buyer.

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Empirical Studies of CEE Transition Economies

• Claessens Djankov (EER 99, JCE 99) Examine
  impact of ownership concentration on performance
  for 706 Czech firms privatized 1992-97. Ownership
  Is Critical concentrated ownership is associated
  with higher profitability and labor productivity.
• Frydman, Hessel Rapaczynski (WP 2000) Are 506
  privatized Czech, Hungarian, Polish mfg firms
  controlled by outsiders more entrepreneurialable
  to increase revenuesthan insider controlled
  firms or SOEs? Performance Improved but Ownership
  Is Critical product restructuring by firms owned
  by outside investors is significantly more
  effective.

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Empirical Studies of CEE Transition Economies

• Harper (JFR 2001) Studies changes for 174 firms
  privatized in the first (1982), and 380 firms in
  the second, Czech voucher privatization waves.
  Performance Declined after both waves, but worse
  after first (1992).
• Lizal Svejnar (WP 2002) Use 1992-98 Panel Of
  Czech Industrial Firms. Foreign Owners
  Significantly Improve Performance of Privatized
  Firms, But Czech Owners Unsuccessful. Ownership
  Is Critical.

34
Empirical Studies of Privatization In Former
Soviet Union

• Barberis, Boycko, Shleifer, and Vishny (JPE 96)
  Surveys 452 Divested Russian Shops. Performance
  Improved But Ownership Is Critical Only Improves
  If New Managers Brought In Who Are Willing To
  Restructure. Shows Need For New Human Capital.
• Earle Estrin (WP 98) Do privatization,
  competition hardened budget constraints enhance
  Russian firms efficiency. Performance Improved
  but Ownership Is Critical A 10 point rise in
  private ownership raises real sales/employee
  3-5. Subsidies reduce the pace of restructuring
  in SOEs.

35
Empirical Studies of Privatization In Former
Soviet Union

• Djankov (JCE 99) Tests if ownership structure
  impacts restructuring for 960 firms privatized in
  six newly independent states, 1995-97.
  Performance Improved but Ownership Is Critical
  Foreign ownership promotes restructuring at high
  ownership (30) mgrl ownership promotes
  restructuring at low (negative in between.
• Djankov (JCE 99) Studies how different
  privatization methods affects restructuring in
  Georgia (92 firms) and Moldova (149 firms).
  Performance Improved But Ownership Is Critical
  buy-outs (Moldova) promotes restructuring
  voucher privatized Georgian firms do not
  restructure more rapidly than SOEs

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Empirical Studies of Privatization In Former
Soviet Union

• Black, Kraakman Tarassova (SLR 2000) Surveys
  the history of privatization in Russia, with some
  case studies. Performance Declined Insider
  privatization was catastrophic preventable.
• Pivovarsky (IMF 2001) Using Data On 376 Med
  Large Ukrainian Firms, Studies Relationship
  Between Ownership Concentration (OC)
  Performance. Finds OC and Foreign Ownership
  Associated With Better Performance Than Domestic
  Owners. Ownership Is Critical.

37
Empirical Studies of Privatization In Former
Soviet Union

• Djankov Murrell (JEL 2002) Surveys
  Privatization And Restructuring In 26 Transition
  Economies. Once More Finds Performance Improved
  But Ownership Is Critical. Foreign Outsider
  Bloc Ownership Promotes Restructuring Atomistic
  And/Or Worker Ownership Hinders Restructuring.
  Residual State Ownership Surprisingly Helpful.
• No Chinese Privatization Study Yet Published, But
  WPs Show Generally Negative Results.
  Interpretation Ambiguous, As Govt Never
  Surrenders Control.

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Privatizations Impact On Stock Market
Capitalization

• Total World Market Cap Rose From 3.38 Tr In 1983
  To 35.0 Tr in 1999, Perhaps 22 Trillion Now
• Mkt Cap Of SIPs Rose From
• 117 of 2000 Business Week Global 1000 Are SIPs
• SIPs 11.1 Of Total, 26.0 Of Non-US Mkt Cap
• 74 of BW Top 200 Emerging Markets Firms SIPs
• Largest--And 11 Of 15 Largest--Firms All SIPs
• SIPs 49.0 Of Emerging Market Capitalization
• Under-states True Importance Of SIPs
• Play Very Important Bellweather Role
• SIPs Usually A Countrys Largest Cap Firm
• Also Most Actively Traded--Usually By Wide Margin

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World Stock Market Cap 1983-2001
40
SIPs Often Nations First, Second, And/Or Third
Most Valuable Stock
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Privatizations As Equity Issues

• 10 Largest Share Offerings Are All SIPs
• 29 0f 31 Largest Are SIPs
• 31 SIPs Larger Than 6 bn
• 800 SIPs Have Raised 750 bn Since 1977
• 135 SIPs Have Raised More Than 1 bn
• Differences From Private-Sector Issues
• Typically Pure Secondary Offerings
• Highly Politicized Offer Terms Share
  Allocations
• SIPs Almost Always Nations Largest Share Issue
• True For Every Major Country Except U.S.

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The Largest Share Offerings In Financial History
Are All SIPs
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Share Issue Privatization And Individual Stock
Ownership

• Many Governments Try To Create Equity Culture
• Design Offer Terms To Maximize Individual S/Hs
• Allocate Shares To Favor Citizens Over
  Foreigners, Encourage Individual Ownership
• Large SIPs Often Create 1 Million Shareholders
• France Tel 3.9 Mn, Deutsche Tel 3 Mn, Credit
  Lyonnais 3.4 Mn, Tel Italia 2 Mn, Endesa 2 Mn
• New S/Hs Often Own Shares In Only One Company
• Must Create Governance System To Protects S/Hs
• Major Problem In CEE--Especially Russia
• Democratic Govts Sensitive To Small S/H Losses

44
Share Issue Privatization And Individual Stock
Ownership (Continued)

• Boutchkova Megginson (FM 2000)Compare Of S/Hs
  In SIPs To Private Cos With Closest Mkt Cap
• WorldScope Disclosure 6,400 Firms With S/Hs
• Of S/Hs Very Skewed 250K S/Hs
• 55 Of 89 Non-U.S. Firms 500,000 S/Hs Are SIPs
• SIPs Have Signif More S/Hs Than Private Firms
• Key Finding Large Numbers Of S/Hs Not Stable
• Firms With 250K Init S/Hs Drop By 20 In 6 Yrs
• Individuals Sell To Institutional Investors
• Foreigners Now Own Half Of Many Europn SIPs
• May Help Create Funded Pension System

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Relative Number of Shareholders Over A Six Year
Period After A SIP
1.6
1.4
1.2
1.2
1
1
0.8
0.8
0.6
0.6
0.4
Year 0
Year 1
Year 2
Year 3
Year 4
Year 5
Year 6
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Relative Number of Shareholders Of Non-Privatized
Firms Over A 9 Year Period
1.6
1.6
1.4
1.4
All
1.2
1.2
100,000
1
1
250,000
0.8
0.8
0.6
0.4
Year 0
Year 1
Year 2
Year 3
Year 4
Year 5
Year 6
Year 7
Year 8
Year 9
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The Key Lessons Of Privatization Research

• Role of SOEs Has Been Reduced, Not Eliminated.
• Share Of Global GDP Now About 6
• Academic Research Now Strongly Favors Private
  Over State Ownership.
• World Bank, IMF Now Encourage Privatization
• Deregulation Helpful, But Not An Alternative
• Privatization Clearly Improves Fimss Efficiency,
  Profitability, Investment, Output Fincl Health.
• Impact On Employment Less Clear-cut
• Privatization Does Not Always Work
• Govts Often Try To Retain Effective Control

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The Key Lessons Of Privatization Research

• Bringing New Human Capital Into Divested Firms
  Seems To Be Critical For Success.
• Key Reason For Russian Programs Failure
• Institutional Support Also seems Critical
• Govts Use Three Basic Privatization Techniques.
• Voucher Privatization The Least Effective
• Reasons For Asset Sale/SIP Choice Under Study
• SIPs Are Finely-Tuned Political Instruments.
• Govts Sacrifice Revenue Max For Political Ends
• Investors Have Benefited From Privatization
• But Large Past Gains Unlikely To Continue