The Structure of Privatization Plans

Abstract

In recent years a vast transfer of state-owned assets to the private sector has taken place in many countries, irrespective of their level of development or the political affiliation of their government. Privatization is believed to improve economic incentives; attract managerial and technological resources from the private sector; broaden share ownership; and reduce public sector borrowing. In fact, privatization can be interpreted as an alternative form of public financing, a sort of equity financing to reduce the overhang of public debt, as the budget gains from the higher value of the firm under private ownership. In fact, the historical evidence indicates that state-owned enterprises have systematically drained public resources rather than contributed earnings, particularly in the Third World. We document strong regularities in privatization programs across several countries. The data indicate a predominance of partial, staggered sales. Even though transfer of control typically takes place rapidly, governments tend to retain a significant stake for long intervals of time. The paper also examines the traditional argument for gradual sales, namely limited market capacity, with a confidence-building rationale. Even after privatization restrains government interference, a firm is still exposed to the risk of adverse policy changes, particularly when it operates in a monopolistic market. A selling government will face investors' diffidence about its policy intentions after the sale; it may therefore structure the sale as to build policy credibility and maximize proceeds. To enhance investors' confidence, a selling government may signal commitment to current policy by retaining a stake in the firm for some time (while transferring managerial control), thus showing willingness to bear some financial cost of policy changes; as time passes,without a policy reversal, confidence and thus sale prices improve. In addition, early sales,may be deliberately underpriced in order to convince the market to absorb larger sales, which reduce the risk born by the government and therefore enhance policy risk. While the two explanations have similar empirical implications, our informal evaluation of the evidence appears more favorable to the reputation-building hypothesis than to the notion of temporary market capacity constraints. Presumably, the risk and the extent of policy change is largest for monopolistic industries or firms in protected markets, while firms operating in competitive markets are less subject to the threat of quasi rent appropriation. We find evidence that firms in such policy-sensitive sectors tend to be privatized with smaller initial sales and larger underpricing, and possibly requiring a longer time horizon before the share retained by the government can be sold. Complete sales are on average associated with manufacturing firms in competitive markets, while sales of utilities with potential monopolistic rents are more distributed over time. We document that retained stakes are explicitly meant to be sold gradually over a few years. Often, stakes in several firms are sold simultaneously, creating considerable government risk sharing across industries. The profile of privatization proceeds increases over time, suggesting gradual selling calibrated to build investors confidence. As policy credibility increases, larger initial sales become more frequent. We also document extensive underpricing, which is on average greater in privatization sales than in initial public offerings (IPO) of private firms. Underpricing appear to be largest for firms with large taxable rents, such as utilities. This is consistent with a signalling argument, since these firms are exposed to greater policy risk, and inconsistent with an asymmetric information explanation over asset values, since these firms tend to be large and well known relative to private IPOs.