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Reluctant Privatization

Reluctant Privatization. Bernardo Bortolotti ( Università di Torino and FEEM ) Mara Faccio ( Vanderbilt University ). Background. From 1977 to 2004, US$1.26trn revenues and 4,500+ privatization deals in more than 100 countries

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Reluctant Privatization

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  1. Reluctant Privatization Bernardo Bortolotti (Università di Torino and FEEM) Mara Faccio (Vanderbilt University)

  2. Background • From 1977 to 2004, US$1.26trn revenues and 4,500+ privatization deals in more than 100 countries • Global State-owned Enterprise (SOE) value added (% GDP) decrease from 9% to 6% • SOE market capitalization US$3,310bn Source: Privatization Barometer

  3. Background

  4. Two basic questions • Did governments give up control in privatized firms? • If they did not, does governments’ reluctance affect firm value?

  5. Definition We define Reluctant Privatization as: A privatization of a State-owned Enterprise (SOE) characterized by the trasfer of ownership rights without a (corresponding) transfer of control rights

  6. Reluctant Privatizations, Italy • In December 2003, the Italian MEF corporatized Cassa Depositi e Prestiti (CDP), a public financial institution, and then trasferred stakes in Eni, Enel, Poste Italiane, and STM to CDP. • 30% of CDP was privatized to a consortium of Italian banking foundations. • €13.1bn privatization revenues cleared by Eurostat to amortize public debt.

  7. Reluctant Privatizations, Italy

  8. Reluctant Privatizations, Italy

  9. Research Design • Did governments give up control in privatized firms? • We analyze empirically the evolution of ultimate control rights (from end-1996 to 2000) in privatized companies as opposed to a control sample. • If they did not, does governments’ reluctance affect firm value? • We estimate the (adjusted) performance of privatized companies as a function of (government) control rights.

  10. Theoretical Predictions The political interference theory (Shleifer and Vishny, QJE1994) Governments run SOEs to achieve political objectives (high employment, high wages, etc.) and forgo maximizing profits. H0: Government control rights are not negatively discounted in market values.

  11. Novelty • Huge literature on performance of privatized companies (Megginson and Netter JEL02 survey). • To our knowledge, our paper is the first to study in combination • ultimate control (La Porta et al JF02, Tian WP02) • additional control devices (golden shares) • adjusted performance using a control sample at the company level (Dewenter and Malatesta AER01, Lopez-de-Silanes QJE96)

  12. Data • 141 companies privatized by public offerings before 31/12/1996 in OECD countries • Complete ownership data for 1996 and 2000 • 104 privatization prospectuses to identify statutory constraints and additional control devices • Balance sheet data for the period 1996-2000 Main sources: SDC Platinum, WordScope, Datastream, national exchanges, etc.

  13. Measuring Control Rights • We rely on ultimate control (voting) rights (weakest link concept, 10% cut off) • Six types of ultimate owners: • a family or an individual • the State • a widely-held financial institution • a widely-held corporation • a miscellaneous investor • a cross-holding (A company that does not have a controlling shareholder at the 10% cut-off is classified as widely-held).

  14. Examples: Lufthansa AG, 1996 Deutsche Lufthansa AG 1.03% 0.4% 37.45% 1.77% 10.05% Deutsche Postbank AG Deutsche Bahn AG KfW State of North Rhine-Westphalia MGL 100% 100% 80% Federal Republic 44.5% 44.5% Bayerische Landesbank Girozentrale Dresdner Bank AG 50% 50% 100% State of Bavaria Association of Bavarian Saving Banks Allianz AG Govt. direct ownership: 1.77% Govt ultimate control rights: 50.7%

  15. Examples: SGS-Thomson Microelectronics, 1996 SGS Thomson Microelectronics NV 69.4% SGS Thomson Micr. Holding BV 100% SGS Thomson Micr. Holding NV 50% 50% FT2CI MEI Srl 49.9% 50.1% 50.1% 49.9% Thomson-CSF SA FT1CI IRI Comitato SIR 58% 51% 49% Thomson SA CEA Industries France Telecom 100% 100% 100% 100% Italian Government SOGEPA CEA 100% 100% 100% French Government Govt. direct ownership: 0% Govt ultimate control rights: 100%

  16. The control sample • First-best: a) country b) sector and c) +30% range of market cap • 68% of cases • Second-best: a) sector and b) +30% range of market cap • 30% of cases • Third-best case: a) country and b) +30% range of market cap • 1 case

  17. The largest shareholders in privatized companies

  18. Control rights in privatized vs control sample

  19. Golden Shares Governments may enjoy control power in partially or even in fully privatized firms through golden share provisions (GSP) GSP typically involve: • Special powers to the public shareholder (veto or agreement on M&A, representatives in BoD, etc.) • Statutory constraints in the company bylaws to curb private ownership rights (ownership limits, voting caps, national control provision, etc.)

  20. Golden Shares GSP are widespread in several countries, highly correlated, and tend to persist overtime. Not surprisingly, they are typically concentrated in “strategic” sectors, such as aerospace and defence, oil and gas, and utilities. The rationale is the protection of relevant national interests (the “public” counterpart of poison pills).

  21. Golden Share Provisions

  22. Main results on control rights (Summary) • In 2000, the government is the largest ultimate shareholder in 30% of privatized companies. • These companies are much more tightly controlled than their private peers. • In 2000, the government controls “directly” (through stakes) or indirectly (through GSP) 62% of privatized companies (65% in 1996). • Thus, governments privatized SOEs but did not relinquish control •  Reluctant privatization

  23. Market valuation • Does govt. reluctance affect valuation? • First, we study the evolution of the adjusted market valuation (market-to-book ratio) in sub-samples of govt vs non govt controlled privatized companies. • Second, we perform panel data estimation of M/B as a function of government’s (residual) control rights.

  24. Market valuation (M/B): descriptive analysis

  25. Market valuation (M/B): econometric analysis Govt. controlled firms have higher (adjusted) M/B than firms privatized more fully. A thorough empirical test needed. We estimate the following model: Where STATE is the covariate for government ultimate control rights, SPECIAL is a GSP dummy, and a vector of (pair-specific) control variables

  26. OLS results (random effects)

  27. Endogeneity of market valuation • Abnormal market performance typically drives privatization, especially when govt. is in financial distress. • 2SLS estimation relaxing the exogeneity of govt. stakes. • Choice of IV: Political-institutional variables (majoritarian vs consentual pattern of democracy), the partisan orientation of privatizing governments, public finance conditions. • These IV are valid: strongly correlated with stakes, but uncorrelated with the error term.

  28. 2SLS estimates of M/B

  29. Summary of results • Government stakes do matter for valuation. But – quite surprisingly – higher stakes are associated with higher valuation differentials. • Impact not negligible: a 10 percent increase in voting rights (approx a standard deviation change) brings about 0.6 (25 percent) increase in adjusted M/B. • Therefore, fully divested companies appear less valuable than companies where government owns large stakes.

  30. Robustness test I: agency costs • Higher performance in government controlled firms may be explained by lower agency costs. • State ownership may not be valuable per se, but simply because the government – as large shareholder – reduces management entrenchment. • By the same token, firms privatized more fully may benefit from lower political interference, but these benefits may be offset by the costs of ownership diffusion.

  31. Robustness test I: agency costs • We add two variables to control for ownership concentration by: • ΔCONC = difference in voting rights of the largest shareholder (any type) in privatized and matching firm • ΔCONC2 to test for non-linear effects We run cross-section regressions for 1996 and 2000, for which we have complete ownership data.

  32. Robustness test II: IPO effect • Treatment and control sample firms are all listed but a newly privatized firm may have a lower valuation than an established private company with a long history of stock trading. • We control for IPO effects by: ΔIPO = difference between the calendar year of the IPO of the privatized and matching firm

  33. Robustness tests: 2SLS results

  34. Conclusion • We find evidence broadly consistent with the concept of “Reluctant Privatization”. Indeed, privatizing government do not give up control in SOEs. • Quite surprisingly, government reluctance does not attect negatively market valuation. • The null hypothesis on political interference cannot be rejected. • Interpretation: “Grabbing hand” story very relevant at the intial stage of the process. But the government as large shareholder in privatized firms may also provide benefits such as contracts, favourable regulation, and stability

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