The Choice Between Private and Public Capital Markets: The Importance of Disclosure Standards and Auditor Discipline to Countries Divesting State-Owned Enterprises

Abstract

For a sample of 1,866 privatizations from 37 countries, we estimate the impact of disclosure standards and legal institutions that discipline auditors on the method chosen to divest state-owned enterprises. The agency conflict between minority and controlling shareholders can impede a government from privatizing by selling its stake to diffuse investors in the public capital market with a share-issue privatization (SIP) that typically generates important spillover economic benefits, rather than an asset sale to a small group of buyers. However, prior research implies that accounting transparency plays a natural role in preventing controlling shareholders from siphoning corporate resources by helping minority investors identify any diversionary practices. After controlling for firm-level and other country-level characteristics, we find that SIPs become more likely when countries mandate strict disclosure standards, although this result is sensitive to model specification. In comparison, we provide strong, robust evidence that SIPs are more likely in jurisdictions that relax the burden of proof in civil lawsuits and criminal prosecutions against auditors, leading to more credible financial statements. These core results remain after controlling for other aspects of the auditing environment and liability standards in securities laws. From a policy perspective, our cross-country research suggests that investors value reforms that subject auditors to more severe private and public enforcement over several other legal determinants, including enhancing disclosure standards.