Firms

1. Firms MA EITEI May 27th, 2009

2. Privatization

3. Why should one privatize assets in transition countries? • Remember introductory lecture • Loosening of political control • Efficient new users - restructuring

4. What can one do? • Conventional way • auctions • investment tenders • direct sales • initial public offerings

5. Ad Auctions • Most efficient – the highest value bidder wins (on average) • Highest revenues for government • What if high-value bidders have low wealth ? – OK if perfect capital mkts • These bidders can make alliance with: - Bank -Foreign partner

6. Ad Sales • Might be unacceptable to voters - e.g. East & West Germany, Poles & Germans • Higher demands on preparation and very tight time pressure (RU, PL) • Relatively higher potential for manipulation

7. Mass privatization – basic intro • free transfer to citizens • high fraction of national economy is covered • political considerations very important at the time • done in CZ, SK, RU, PL, Lithuania, Mongolia Forms (usually combined) • Grant shares to insiders – workers and/or managers • Distribution of vouchers to whole population • Direct allocation of shares to mutual funds (PL)

8. Ad mass privatization – differences from conventional privatization • Private wealth was low and high revenues unlikely - Chile, Mexico, UK possessed substantial amount of private wealth - moreover these countries privatized few hundreds of firms only

9. Ad mass privatization • Yet here proceedings were NOT the (main) objective – Uneven distribution of wealth favored “old guys” – communists and criminals – Large segment had to benefit to ensure political stability • Scheme needed such that wealth was not limiting

10. Similarities across countries – blockholders welcome to ensure better governance • Allow insiders to acquire stake as thesewere politically important stakeholders – had low influence in CZ, SK, HU – high influence however in FSU • Compensating stimulation of investments by outsiders: • in CZ: Outsiders can make proposals, insiders had to involve them otherwise would be left out • in SU: Investment tenders - indirect way via tradability • in PL: Direct allocation to mutual funds

11. Differences across countries Voucher denomination • Points: -Clearly not currency, less money-like -Control of M supply -Risk of high discount in trading and perceptions of unfairness avoided • Currency: -Like security, clear promise of give-away -> political support -Stronger commitment to irreversibility

12. Differences across countries - Tradability • Non-tradable – Vouchers are MECHANISM, not securities and should be treated accordingly – Speculative excess of vouchers – High discounting • Tradability – Cash right-away – improve opportunities of large investors – development of financial markets and large investors

13. Voucher exchange - Auctions • Auctions are -efficient -produce market valuation -no bureaucrats to assign value -no corruption or price manipulation -give agents a choice and thus attract them

14. Voucher auctions • Requirements – Simple – Millions of people can take part in – Everybody should succeed in getting shares – Small investors do not end up paying more thaninstitutional investors

15. Czech(-oslovak) experience Small privatization from 1990 – very successful, 10thds of small and medium enterprises Large privatization in 2 waves – • larger enterprises • both nationals and foreigners involved • competing privatization proposals allowing for a number of methods • about 50% of companies in 1st wave did opt for a complete or partial voucher privatization

16. Czech(-oslovak) experience - Vouchers • vouchers distributed 1000pts for 1000CZK • investment privatization funds established • 5 rounds of bidding where shares were converted • general info on companies + price in points provided • pricing rule confidential

17. Czech(-oslovak) experience – Auction design • if excess supply – all shares provided + lower price in next bidding round • if excess demand smaller than 25% and enough IPF’s involved – adjusted # of shares provided • if excess demand larger than 25% or enough IPF’s involved – no transaction, points returned and higher price next round

18. Czech(-oslovak) experience – Results • about 90% of all participating shares sold • yet complete sale of only less than 20% of firms • only 3.5% of individuals’ and 0.3% of IPFs’ points not allocated

19. Czech(-oslovak) experience – Empirical study Švejnar and Singer (1994) • set of quantity and price regressions • firm- and industry specific variables • separate regressions run for IPFs and individuals. Why? • IPFs likely to invest more into info gathering • IPFs likely to influence management through blockholdings

20. Results – Round 1 • prices set at the same level • hence demand driven mainly by financial indicators • very high elasticities w.r.t. profitability • significant elasticity w.r.t. indebtness • size of firm: + for investors - for IPFs • presence of foreigners + impact

21. Results – Round 1 • supply of shares – proxy for probability of getting shares: strong + impact in case of Czech firms • Slovak firms generated insignificant and – impact coefficient reflecting lower demand for especially larger firms • privatization of Slovak firms driven less by traditional economic criteria

22. Results – Round 2 • additional info provided – adjusted prices and the extent of excess demand/supply • again negative share price elasticity, yet significant only in case of individuals’ demands for Czech companies • generally new info dampened the role of financial indicators

23. Results – Round 3 • the authorities learned excess demands in Round 2 and adjusted prices dramatically • price elasticities significantly negative

24. Results – Round 4 • significant changes occurred • split of Czechoslovakia • explicit plea to keep bids unchanged (instead of switching away from excess demand firms) • 2/3s of shares already sold

25. Results – Round 4 • hence share supply became + significant –> i.e. investors wishing to succeed • lagged demand/supply strongly positive • price elasticity mostly insignificant

26. Results – Round 5 • announcement of terminal round • processing of all transactions ensured through corresponding price adjustments • Consequence -> highly positively significant coef. on supply of shares • the same happened with lagged demand/supply coefficient • otherwise mostly insignificant patterns

27. Overall results • just 20% of all companies sold all shares, brute force used to terminate the process in round 5 • yet about 93% of all shares in fact sold • study published much too early after to judge the impact on economic performance

28. Overall results • estimations confirm a rational behavior of both individuals and IPFs: • given the extreme uncertainty 72% of individuals placed points into (diversified) IPFs • given equal prices in 1st round, financial indicators mattered • no sectoral preference in demand

29. Privatization and Restructuring • essential question dealt with the role of insiders and outsiders before and after privatization • Cornelli & Li (1995): firms could underperform even if insiders are involved in privatization • Blanchard & Aghion (1996): efficiency gains from insider privatization • Aghion et a. (1994): compensation for insiders desirable, privatization should even be delayed

30. Cornelli & Li (1995) • insiders are not the original owner, yet enjoy substantial control over a company • IPOs in market economies • insider likely to over-perform to boost share prices • the initial owner, the insider should get the revenues • here insider does not get anything

31. Cornelli & Li (1995) • hence no need for MNGs to restructure • might have the incentive to use remaining time for private benefits • Czech experience cited – enterprise break-ups • hence adjustment of incentives desirable – would anything change?

32. Cornelli & Li (1995) - Model • insiders are more likely to know the exact value of firm • outsiders do not know neither value nor effort of insiders • outsiders only share distribution of values and can update beliefs by observing pre-privatization performance • insiders decide on amount of restructuring as to manipulate privatization outcome

33. Cornelli & Li (1995) • trade-off for insiders: • restructuring benefits them after the privatization • restructuring might reveal true type of firm and increase share price

34. Cornelli & Li (1995) • however they have to share the surplus in the 2nd period and will underinvest • the channel even more pronounced when firms are very valuable: • hence delaying privatization both delays improved incentives and invites strategic behaviour of insiders • company indicators before privatization might be misleading

35. Cornelli & Li (1995) – Policy implications • maybe promise fixed proportion of revenues from privatization to insiders • or possibly other rewards based on privatization outcome • question remains as to what factors in privatization matter most – see Czech vouchers

36. Blanchard & Aghion (1996) • prevailing implicit assumption that competent outsiders exist • yet foreigners either not welcome or looking for best firms only • domestic outsiders rather inexperienced • should one prefer insider privatization then?

37. Blanchard & Aghion (1996) • remember distribution considerations • still, the case might be alive: • insiders privatization aligns control and property rights, i.e. improves matches of actions and rewards • if not able to restructure anyway – e.g. workers as insiders vs restructuring outlays -> higher incentive (as opposed to state) to look for the right outsider

38. Blanchard & Aghion (1996) • focus mostly on second (resale) argument, Reason: • insider firms generally unable to restructure • empirical evidence -> insiders dominate minority outsiders, hence raising minority equity capital difficult • restructuring expertise very costly

39. Aghion et al. (1994) • insiders politically important, i.e. privatization often has to be accepted rather than imposed • insiders trade-off between current and future payoffs • hence delaying privatization promotes insider restructuring as it brings in part of future payoffs

40. Empirics • Frydman, Gray, Hessel and Rapaczynski (1999) • relatively small sample of firms from the CZ, PL and HU • compare the performance of state-owned and privatized firms • outsiders overperform insiders concerning firm performance after privatization • foreign owners are not significantly better than domestic outsiders

41. FDI

42. Reasons for FDI • Capital moves in response to theexpectations of higher rate of return in newlocation • Demand factors: - response to large and rapidly growing markets - high income per capita

43. Reasons for FDI • Supply/Cost factors: - secure access to mineral or raw material deposits - advantage of low wages & labor costs - overcoming tariff and non-tariff barriers - defensive move to protect market share - risk diversification - protection of firm-specific knowledge or assets

44. Empirical evidence on FDI determinants In CEE region • market size and growth potential • for period 1991-93 - timing and method of privatization, relative labor costs, research intensity and existing trade linkages matter • risk, unit labor costs, host market size and gravity factors matter • risk perceptions in turn shaped mostly by private sector and industrial development, govt balance, gross reserves and corruption • announcements about different stages of the EU accession process also significant • trade liberalization, natural resource endowments

45. Empirical evidence on FDI determinants • Exception - in Garibaldi et al. (2001) for CEE and former Soviet Union, wages not having a robust effect • Disdier and Mayer (2004) - • 1843 location choices of French multinationals in Europe • location decisions in 2 steps: first they choose between Eastern and Western Europe, second they choose a country from selected region

46. Empirical conclusion • Both traditionaldemand and supplyfactors matter • In addition, institutional endowments and political impetus (reforms) are relevant

47. Potential Benefits in Host country – Direct effects at firm level • Provision of capital, technical and managerial skills -> restructuring • Realization of economies of scale and scope • Provision of access to overseas distribution networks

48. Indirect effects at firm or industry level • Productivity and knowledge spillovers to other companies, maybe whole industries • Employment/wage/working conditions’ shifts

49. Empirical evidence – EffectsEconometric issues • Effects likely to be country and time specific • Selection bias, industry effects and sample representativeness • TFP simultaneity • Measuring productivity: • mostly TFP • also labor productivity – • employment/real value added • revenue, employment and cost per unit of revenue

50. Direct effects • Unambiguous and convincing results • Significantly positive effects either on total factor productivity (TFP) or labor productivity • Damijan et al. (2003b) • the only exception regarding positive results, 10 countries using GMM • local firms grow faster than foreign affiliates in 4 out of 10 countries