The Pi-Tan. -99. Privatization Challenge A Strategic, Legay ,d Institution"" A nlalysis of Ite t'onEl xExperience PIERRE GUISLAIN The Privatization Challenge WORLD BANK REGIONAL AND SECTORAL STUDIES The Privatization Challenge A Strategic, Legal, and Institutional Analysis of International Experience PIERRE GUISLAIN 'fhc World Bank Washiniqton, D.C. (© 1997 The International Bank for Reconstruction and Development / The World Bank 1818 H Street, N.W., Washington, D.C. 20433 All rights reserved Manufactured in the United States of America First printing January 1997 The World Bank Regional and Sectoral Studies series provides an outlet for wvork that is relatively focused in its subject matter or geographical coverage and that contributes to the intellectual foundations of development operations and policy formulation. Some sources cited in this paper mav be informal documents that are not readily available. The findings, interpretations, and conclusions expressed in this publication are those of the author and should not be attributed in any manner to the World Bank, to its affiliated organizations, or to thc members of its Board of Executive Directors or the countries they represent. The material in this publication is copyrighted. Requests for permission to reproduce portions of it should be sent to the Office of the Publisher at the address shown in the copyright notice above. The World l3ank encourages dissemination of its work and will normally give permission promptly and, when the reproduction is for noncommercial purposes, without asking a fee. Permission to copy portions for classroom use is granted through the Copyright Clearance Center, Inc., Suite 910, 222 Rosewood Dr., Danvers, Massachusetts 01923, U.S.A. Pierre Guislain, a lawyer and economist by training, is Principal Private Sector Development Specialist at the World Bank. Since 1984 he has advised many governments in Africa, Asia, and Eastern Europe on the design and implementation of privatization programs. In his current assignment he promotes competition and private participation in infrastructure sectors. Cover design by Sam Ferro and Sherry Holmberg Library of Congress Cataloging-in-Publication Data Guislain, Pierre, 1957- [Privatization. English] The privatization challenge: a strategic, legal, and institutional analysis of international experience / Pierre Guislain. p. cm. - (World Bank regional and sectoral studies series) Rev. translation of: Les privatisations. Includes bibliographical references and indexes. ISBN 0-8213-3736-X 1. Government business enterprises-Law and legislation. 2. Government ownership-Law and legislation. 3. Privatization-Law and legislation. 4. Government business enterprises. 5. Government ownership. 6. Privatization. 1. Title. II. Series. K1366.G85513 1997 346 '.067-dc2O [342.667] 96-34223 CIP Contents Preface xi Introduction I Historical Background 3 Explanatory Factors 6 Definition of Privatization 10 Structure of the Study 12 1 Defining a Privatization Strategy 15 Objectives of Privatization 16 General Country Characteristics 20 Political Setting 20 Economic and Social Setting 21 Institutional Setting 22 Country Risk 22 Characteristics of a Sector 23 Sector Structure 23 Other Sector Features 23 Can All Sectors or Activities Be Privatized ? 24 Characteristics of the Enterprise 26 Legal Status of the Enterprise 26 Size of the Enterprise 28 Defining an Approach 28 Regional Trends 29 Sequencing Reforms 30 Communication and Public Relations 30 Conclusion 31 2 Privatization and Basic Legal Norms 33 Constitutional Requirements 33 Limits on the Scope of Privatization 34 Parliamentary Approval 36 1 vi Thil Privatization Challengc Limits on the Discretion of the Government 38 Control of Constitutionality of Privatization Legislation 39 International Law 40 Conclusion 43 3 Privatization in a Market Economy 45 Property Rights 46 Past Nationalizations 48 Future Expropriations 52 Intellectual Property 52 Protecting and Promoting Competition 53 Nondiscrimination against the Private Sector 53 Price Liberalization 54 Monopolies and Antitrust Provisions 54 Deregulation 55 Foreign Trade Legislation 56 Major Aspects of Business Law 56 Contract Law 56 Company Law 57 Accounting Law 60 Liquidation and Bankruptcy 61 Transfer of Liabilities 66 Foreign Investment Legislation 67 Securities Legislation 68 Banking 71 Taxation 72 Currency and Foreign Exchange 73 Social Legislation 73 Labor Legislation 74 Employee Ownership 77 Pension Entitlements 78 Pension Fund Reform 78 Social Safety Net 80 Environmental Law 81 Dispute Settlement Mechanisms 83 Foreign Legislation 85 Conclusion 86 4 Privatization and Public-Sector Management 89 Identifying the Legal Owners 89 Exercise of Ownership Rights 91 Alienation of Public Enterprises and Shareholdings 91 Alienation of l'ublic Assets 92 Prohibition of Alienation 94 Prior Restructuring of Public Enterprises 95 Contractual Obligations 96 Financial Restructuring 97 Abolishing Discriminatory Practices 99 Contents vii Corporatization 101 Breakup of Public Enterprises 105 Prior Restructuring: Lessons from Mexico 106 Liquidation of Public Enterprises 107 Public Finance Legislation 107 Conclusion 108 5 The Privatization Law 111 A Law or Subordinate Instruments? 112 Scope of the Legislation 115 General Legislation 116 Specific Legislation 118 Valuation and Sale of Enterprises to be Privatized 118 Valuation 119 Authorized Techniques 121 Selecting Buyers 124 Restrictions on Buyer Selection 127 Special, or Golden, Shares 129 Preferential Schemes 132 Preemptive Rights and Other Employee Benefits 132 Advantages Granted to Other Categories of Buyers 135 Choice of an Equitable Scheme 136 Financing 137 Financing Arrangements 137 Debt-Equity Swaps 138 Allocation of Privatization Proceeds 140 Transitory Provisions 143 Amendments 144 Conclusion 145 6 Institutional Framework for Privatization 149 Role of Parliament 149 Institutional Structure 152 Political and Implementation Bodies 154 Privatization Agencies and Units 163 SOE Management and Restructuring Bodies 164 Valuation Bodies 164 Local Governments 165 Other Bodies 167 Coordination of Implementation Authority 167 Control of the Privatization Process 170 A Posteriori Controls 170 Prosecution of Fraud and Corruption 171 Compliance with Buyers' Obligations 173 Staff of Privatization Bodies 173 Recruitment 174 Incentives 174 Conflicts of Interest 175 viii The Privatization Challenge Financing the Privatization Process 176 Privatization Funds 177 Privatization Funds in Mass Privatization Programs 179 Establishment of Privatization Funds 184 Purposes of Privatization Funds 185 Regulation of Privatization Funds 186 Preliminary Lessons 188 Role of Advisers 190 Economic, Financial, and Technical Advisers 190 Legal Advisers 192 Conflicts of Interest Facing Advisers 196 Conclusion 198 7 Privatization of Infrastructure 203 Historical Overview of Infrastructure Sectors 204 Water 204 Energy 205 Transport 206 Telecommunications 209 Market Structure, Competition, and Divestiture 211 Unbundling a Sector 212 Yardstick Competition 214 Structural Reforms in the Water Sector 215 Structural Reforms in the Energy Sector 217 Structural Reforms in the Transport Sector 225 Structural Reforms in the Telecommunications Sector 228 Range of Organizational Options 242 Special Issues in Infrastructure Privatization 242 Techniques for Infrastructure Privatization 242 Constitutional and Legislative Restrictions 246 Legislation for Infrastructure Privatization 247 Prior Restructuring and Corporatization 250 Choice of Strategic Partners 251 Public Flotation 255 Golden Shares 256 The Regulatory Framework 258 Objectives of Regulation 258 Enterprises Subject to Regulation 259 Activities Subject to Regulation 260 Award of Concessions and Licenses 260 Content of Concessions or Licenses 262 Tariff Regime 265 Consistency between Regulatory Reform and Privatization 269 Regulatory Institutions 271 Conclusion 283 8 Meeting the Privatization Challenge 287 A Strategic Challenge 287 Three Tiers of Privatization 288 Conitents ix Changing the Role of the State 289 Defining Objectives 291 Decisions Based on Thorough Analysis 291 A Clear Strategy and Clear Priorities 292 Protecting Stakeholder Interests 294 A Political Process 295 Is a Privatization Law Necessary? 296 Role of Advisers 298 A Multidisciplinary and Empirical Approach 299 Appendix: Privatization Legislation, by Country 301 Glossary 335 Bibliography 343 Geographic Classification of References 369 Specialized Journals 379 Internet Resources 381 Subject Index 385 Geographic Index 393 Index of Enterprises, Agencies, and Other Organizations 397 Figures 1. Range of Privatization Techniques 12 7.1 Unbundling Sectors into Their Component Activities 214 Tables I Large Privatizations in Industrial Countries, 1991-96 4 2 Large Privatizations in Developing and Transition Countries, 1991-96 5 5.1 How Some Countries Have Overcome Specific Obstacles to Privatization 113 5.2 Privatization of Ministry of Defense Enterprises in Argentina 123 6.1 Institutional Framework for Privatization in Argentina and Peru 156 6.2 Institutional Framework for Privatization in Malaysia and the Philippines 158 6.3 Institutional Framework for Privatization in France, Germany, and Poland 160 6.4 Features of Privatization Funds in Selected Countries 181 7.1 Infrastructure Networks: Privatization Mode and Sector Reform in Selected Countries 245 x The Privatization Challenge 7.2 Constitutional Restrictions on Infrastructure Privatization 248 7.3 Prequalification Criteria for Privatization of Telecommunications Companies 254 A.1 Country-Specific Privatization Sites on Internet 382 Boxes 1 Positive Results of Privatization 9 1.1 Privatization and Economic Reform in Peru 16 1.2 Objectives of Privatization 18 1.3 Legal Status of Public Enterprises or Shareholdings 27 2.1 Principles Guaranteeing the Rule of Law 34 2.2 Ownership Provisions of Socialist Constitutions 35 2.3 Impact of International Agreements on Privatization: The Case of KLM 42 3.1 Compensation of Former Owners in Hungary 51 3.2 Bankruptcy Law: Hungarian, Czech, and Polish Approaches 64 3.3 The Flotation of Slaski Bank 70 3.4 Company Valuation by Advisers to Potential Investors 88 4.1 Public Domain Legislation in Morocco 93 4.2 Corporatization in New Zealand 103 5.1 The Bolivian Capitalization Law 125 5.2 Restrictions on Foreign Participation in Privatization 130 5.3 Golden Shares in France 131 5.4 Preferential Allocation of Shares to Employees 133 5.5 Allocation of Privatization Proceeds in Selected Countries 141 6.1 Blocked Institutions in Bulgaria, 1990-95 153 6.2 Privatization Mutual Funds 178 6.3 Advisory Fees in Privatization Transactions 193 7.1 Telecommunications in Chile, 1880-1996 210 7.2 Recent Privatizations in the Telecommunications Sector 233 7.3 Basic Features of a Telecommunications License or Concession 264 7.4 Impact of Regulatory Changes on Share Price 272 Preface This book builds on my earlier work, in particular, Les privatisationis: un defi stratgiqtluc, juridique et itstituttionnttel (Brussels: De Boeck Universite, 1995) and Divestiture of State Enterprises: An Overv,iew of the Legal Framework (World Bank, 1992). It is primarily a reference document for professionals and poli- cymakers who design or take part in privatization programs-government officials; staff of privatization agencies; managers of public enterprises; investors; and legal, economic, financial, and other advisers. The privatization of public enterprises, economic sectors, or entire econo- mies raises strategic, legal, institutional, and economic issues and chal- lenges. This book approaches privatization from a multidisciplinary and multisectoral point of view, with an emphasis on the legal and policy dimen- sions of the process. It draws on the experience of countries on every conti- nent to illustrate specific problems, issues, and solutions. The aim is neither to extract universal lessons nor to present a how-to manual for privatization. Rather, this book seeks to reveal the dynamic character of a process that is still relatively new, demonstrate the complexity of the problems that can arise during this process, and examine the efficacy of solutions that have been attempted. I wishl to thank Celine Levesque and Michel Kerf for their invaluable con- tributions. Cline did much of the research that went into this book and updated the bibliography and the legislation listed in the appendix. Michel contributed extensively to the earlier French edition and provided useful comments on this updated and revised edition. I am grateful also to the many other people who helped in the preparation of this work, especially Donna Verdier, who copyedited the final manu- script; Lucy Foit, who handled the composition; Alex Green for his transla- tion work; and Warrick Smith for comments on chapter 7. Thanks go also to De Boeck Universite for its publication and successful marketing of Les pri- vatisations and to the World Bank-in particular, Magdi Iskander, Michael Klein, and the Office of the Publisher-for supporting this long-term project. Finally, this book would not have been possible without the support and patience of my wife, Marie-France, and children, Charles and Anne-Sophie. xi xii The Privatization Challenge The views expressed in this book are my own, however, and should not be ascribed to those people whose assistance is acknowledged above or to the organizations that offered their support. Introduction In recent years privatization has expanded at a pace that would have been hard to predict only ten or fifteen years ago. More than 100 countries, across every continent, have privatized some of their SOEs. Argentina, Chile, Colombia, Mexico, and Peru in Latin America; Malaysia, Pakistan, and the Philippines in Asia; France, the United Kingdom, and Central and Eastern European countries in Europe; as well as Cote d'Ivoire, Morocco, Nigeria, and Togo in Africa are but a few examples. Equally striking is the sheer volume of transactions. In 1994 and 1995 annual gross revenues from privatizations worldwide were estimated to be on the order of $80 billion.1 Five years earlier (in 1989), the total was $25 bil- lion. Between 1988 and 1993, over 2,600 privatization transactions with sale value exceeding $50,000 were recorded worldwide (excluding eastern Ger- many); these generated receipts of $271 billion, far in excess of the $150 bil- lion that such operations brought in up to 1988. Of these 2,600 privatization transactions, close to 900 were carried out in 1993, against only about 60 in 1988. Developing and transition countries accounted for much of this tre- mendous growth (see Sader 1995). To these figures must be added tens of thousands of local transactions, many of them relating to small businesses, restaurants, and workshops,2 together with tens of thousands more enterprises transferred to private share- holders under ambitious mass privatization programs implemented in many transition countries, notably Russia and the Czech Republic. In just over two years, Russia succeeded in privatizing between 12,000 and 14,000 medium- sized and large enterprises with a total of over 14 million employees-that is, about half of Russia's industrial labor force. In the process, about 40 million 1. All dollar amounts are current U.S. dollars, unless otherwise specified; a billion is a thou- sand million. 2. Nearly 100,000 small businesses and enterprises were privatized in this way between 1991 and 1994 in Russia alone (see Lieberman and Rahuja 1995, p. 25). l 2 The Privatization Challeng,e Russian citizens became shareholders for the first time (see Lieberman and Nellis 1995, p. 1). In Germany, as part of the radical economic transformation that followed the fall of the East German communist regime and reunification, over 15,000 enterprises were sold or liquidated between 1990 and 1994. An additional 91,000 transactions involved restitution of property to former owners, as well as the transfer of real estate, shops, and restaurants. New investment commitments stemming from the program implemented by the Treuhan- danstalt reached about $130 billion.3 Privatization in one form or another has been undertaken at all times. In Thailand, for example, the prime minister issued regulations concerning the sale of SOEs or SOE shares in 1961. Chile launched a major (though not very successful) privatization program in 1974.4 The British program launched in 1980 by Margaret Thatcher, however, is the major forerunner of the current privatization phenomenon, and it has so far raised about $100 billion. Successive trends or waves may be observed in privatization worldwide. In the first wave, privatization focused largely on industrial, financial, and commercial ventures. Infrastructure sectors and activities followed in a sec- ond wave, starting near the end of the 1980s; a third wave, touching munici- pal or local services, is gaining strength. The next wave is only starting to emerge, reaching the social sectors, including health and education, and administrative activities, The privatization phenomenon has not been confined to countries with a liberal ideology. Major privatization programs are found in countries with a long capitalist tradition and in countries in transition from a centralized to a market economy, as well as in developing countries, including some that remain under communist regimes, such as China and Cuba. The pro- grams of the transition countries are, as would be expected, often much more ambitious. Nevertheless, some industrial countries, including New Zealand and the United Kingdom, and several developing countries, including Argentina and Mexico, have implemented privatization pro- grams that are radical in terms of scale as well as scope. Nor have privatization programs been homogeneous. A variety of strate- gies have indeed been adopted and implemented. A wide range of tech- niques has been used, most drawn from experience with corporate mergers 3. It should be noted that the overall deficit of the Trcuhalndatnstalt, caused primarily by the high cost of physical and financial restructuring, severance paiyments, environmental liabilities, and other obligations of the former state-owned enterprises (oys), exceeded $160 billion by the time the agency closed its doors at the end of 1994. 4. The first privatization program of the Chilean military government was an econlomic and financial failure. Owing to the economic crisis of the early 1980s, the governlment had to take back many enterprises that had been privatized just a fv w years earlier, between 1974 and 1979. This was due in large part to the excessive concentration of shareholders within a few large con- glomerates that were deeply in debt as a consequence of, in particular, the acquisitions carried out under the privatization program. These enterprises taken back by the government were later reprivatized, beginning in 1985. Introduction 3 and acquisitions, though some are truly new techniques designed to meet specific privatization objectives. Widespread share ownership has thus been promoted directly or indirectly through mass privatization programs in transition countries, through a capitalization program in Bolivia, and through financial incentives offered to emplovees and small shareholders in many countries. Finally, privatization affects practically all economic sectors. Even activi- ties traditionally reserved for the public sector are increasingly being entrusted to private operators.5 As tables 1 and 2 illustrate, almost all large transactions of the past six years have occurred in "strategic" sectors that traditionally used to be publicly controlled: utilities, such as telecommunica- tions, power, or gas; natural resources, including hydrocarbons and mines; railways; steel; and financial services, including banking and insurance. Despite this worldwide explosion of privatization, the state sector remains strong in many countries, in particular in developing countries where SOEs drain national budgets and continue to dominate many activi- ties. A recent study published by the World Bank found that "notwithstand- ing the sale of some very large firms, the state-owned enterprise share of developing market economies has remained stubbornly high since 1980, at about 11 percent of GDP [gross domestic product], even as it fell in the indus- trial countries from about 9 percent to less than 7 percent." Further, "The state-owned enterprise sector is larger and the problems associated with it are more severe in the world's poorest counitries, where SOEs account for 14 percent of GDP," and "in sum, although the potential gains from privati- zation and other reforms are substantial, only a few [developing] countries have reformed their state-owned enterprises successfully" (World Bank 1995b, p. 2). Privatization has been on the agenda of many governments for over a decade now and is likely to remain a key policy instrument in many countries for decades to come. Historical Background The current wave of privatization follows a long period characterized by nationalization and growth of the size of the public sector in the economy. Like today's privatizations, these nationalizations took place in practically every area of economic activity and in a great majority of countries. The United States is among the few countries that was only marginally affected by this trend. In western Europe, the surge in nationalization began in the years imme- diately preceding the second world war and continued after the war ended. In France, for example, the first nationalizations took place under the Front 5. The privatizations carried out in these sectors often exhibit special features, which are addressed in chapter 7. 4 The Privatization Challenge Table I Large Privatizations in Industrial Countries, 1991-96 Percentage Amount Country Sector Enterprise (date) private ($ billion) Australia Electricity Five distribution 100 6.2 (Victoria) companies (1995) Two generating companies (1996) 100 3.8 Belgium Telecom Belgacom (1995) 49.9 2.5 Denmark Telecom TeleDanmark (1994) 48.3 3.3 France Petroleum Elf-Aquitaine (1994 100 8.8 and 1996) for 47.7% Banking BNP (1993) 100 4.8 for 72.9% Insurance UAP (1994) 100 3.3 for 50.3% Steel Usinor Sacilor (1995) 64 3.0 Germany Telecom Deutsche Telekom 26 13.3 (1996) Italy Energy ENI (1995-96) 31 9.8 Insurance INA (1994-96) booa 6. la Japan Railways JR East (1993) 62.5 8.9 JR West (1996) 68 4.5 Tobacco Japan Tobacco 33 7.7 (1994 and 1996) Netherlands Telecom KPN (1994-95) 55 7.8 Spain Petroleum Repsol (1989-96) 90 >5.0 United Telecom British Telecom 100 22.8 Kingdom (1984-93) Electricity National Power 100 10.0 and PowerGen (1991 and 1995) Scottish Power 100 3.7 (1991) Railways Railtrack (1996) 100 3.2 United Telecom 102 PCs licenses 100 7.7 States (1995)b 493 PCs licenses 100 10.2 (O 996)b a. Includes a $2.1 convertible bond issue representing the remaining 34.4 percent state shareholding (June 1996). b. Through federal auctions for personal communications svstem licenses (see chapter 7). Sources: Public documents. Introduction 5 Table 2 Large Pnvatizations in Developing and Transition Countries, 1991-96 Percenttage Amou nt Country Sector Enterprise private ($ billion) Argentina Telecom Telecom Argentina 100 1.8 (1990-92) Telef6nica de Argentina 100 1.5 (1990-91) Electricity SEGBA, Hidronor, AEE 51-100 > 3.5 (1992-96) Gas Gas del Estado: split into 70-100 > 2.9 ten enterprises (1992-95) Petroleum YPF (1993) 61 3.0 for 45.3/ Brazil Electricity Light Servicos de 51 2.2 Electricidade (1996) Steel Usiminas (1991-94) 9( 2.0 CSN (1993) 81.9 1.5 Cuba Telecom Ectesa (1994) 49 1.4 Czech Telecom SPT (1995) 27 1.5 Republic Germanya Mines Mibrag (1993) 100 1.9 Laubag (1994) 100 1.4 Electricity VEAG (1994) 100 5.2 Tourism InterHotel Group (1992) 100 1.3 Hungary Electricity Two power generation 34-49 1.3 and six distribution companies (1995) Telecom MATAV (1993-95) 75 1.7 for 67% Indonesia Telecom Indosat (1994) 32 1.0 PT Telkom (1995) 19 1.7 Malaysia Electricity Tenaga Nasional Berhad 23 1.2 (1992) Mexico Banking Banamex (1991) 70.7 3.2 Bancomer (1991) 62.6 2.5 Telecom Telmex (1990-94) 100 7.5 for 51lS Railways Northeast Line (1996) 80 1.4 Peru Telecom CPET and Entelperu 95 3.1 (1994-96) for 59% Singapore Telecom Singapore Telecom (1993) 11 2.7 Taiwan Steel China Steel (1989-95) 52.5 3.0 Venezuela Telecom CANTV (1991 and 1996) 100 2.9 a. Former German Democratic Republic. Sources: Public documents. 6 I he Privatization Challenge Populaire governments of 1936-37 (armaments, aviation, railways); the movement resumed immediately after liberation withi the nationalization of coal mining, air transport, electricity, gas, banks, and insurance companies. In Italy, too, state control of the economy tightened before the outbreak of the second world war: in 1933 the government created the Istituto per la Ricostruzione Industriale (ORI), a public holding company which by 1939 had absorbed the biggest banks and held large shareholdings in the iron and steel industry, among others. In the 1930s nationalization was directly linked in many countries to the rise in nationalism. In central and eastern Europe, nationalizations were imposed under Soviet influence after the second world war. During the same period many Latin American countries also decided to base their development strategy on state-owned enterprises. In Argentina, for example, the government nationalized the telephone company in 1946 and at about the same time acquired six railway companies owned by British, French, and Argentine investors. The power sector was nationalized later. Similarly, the decolonization movement in Asia and later in Africa fos- tered growing nationalization as the new states sought to regain control of their productive assets from foreign enterprises. In the 1960s and 1970s, on the morrow of their independence, most African countries, including many with socialist or Marxist-Leninist regimes (such as Angola, Benin, Congo, and Tanzania), undertook large nationalization programs. Over the past twenty years, however, we have witnessed a sharp reversal of the nationalization trend, spurred by a new international economic and political environment and by other factors described below. The average number of annual nationalization operations, which peaked in the first half of the 1970s, has fallen steadily since then and is now extremely small. Over the same period, the volume of privatization operations has accelerated, surpassing the volume of nationalizations around 1980 and growing expo- nentially in the past few years. Explanatory Factors The reasons for the decline of nationalization activity vary, of course, from country to country and even from one enterprise to another. One reason, however, stands out: SOEs have generally posted disappointing perfor- mances (see World Bank 1995b; Muir and Saba 1995; Shirley and Nellis 1991; see also chapter I in this volume). Although some of them function well, many others are notoriously inefficient. They manage to survive through tariff protection against competing imports, preferences in public procure- ment, exclusive rights, preferential access to credit (often at state-owned banks), government guarantees, tax exemptions, and public subsidies. Cre- ated to alleviate the shortcomings of the private sector and spearhead the development of the national economy, many soEs in fact helped stifle the local private sector and fostered economic stagnation. They often serve lfltrwt)lctioll 7 political objectives or purposes and consequently suffer frequent interfer- ence by government and bureaucrats. In somt countries they have also con- tributed to income redistribution in favor of the relativelv well-off over the poor, who generally lack access to both the jobs the SOEs provide and their products. Almost everywhere, the burden SO5 s impose on state finances has become untenable. Was privatization the only way to redress this state of affairs? Several empirical studies have compared the performance of public and private enterprises, but the results vary. Some conclude that an enterprise's effi- ciency is determined not so much by its public or private character as by the regulatory structure and the degree of conmpetition under which it operates.6 Others find tllat private ownership leads to greater productivity.7 Some reforms designed to give SOBs greater autonomv and expose them to stiffer competition, without privatizing their ownership, have produced encouraging results. In most cases, however, such reforms have proved impossible to sustain, and after initial improvements the situation of the SOEs consequently deteriorated further (see, tor example, Kikeri, Nellis, and Shirley 1994, pp. 246-47). The challenge is to bring about sustainable improvements in enterprise performance, and many governments today regard privatization as the only means available to accomplish that. Another important reason for the move to privatization is that most gov- ernments find themselves facing deep budget deficits and public finance cri- ses. The state no longer has the financial resources either to offset the losses of SOFs or to provide the capital increases necessary for their development. Privatization can be the answver, as illustrated by the United Kingdom, where in 1981 Solis that have since been privatized cost the treasury £50 mil- lion a week; these same companies nowv contribute £55 million a week in taxes (see Elmvnioc1tl, February 1996, p. i). A radical reform of public finances, involving an overhaul of the public sector, may also be needed to satisfy international obligations or aspirations. This applies in particular to member states of the European Union (t U), wlo are constrained by EU rules 6. See, for example, Borcherding, Pomnmerehiln, and Schneider 1982; De Alessi 1482. For a survey of the litterature on the effects on economic performanice of privatization, deregulation, and competition. see Kwoka 1996. The importance ot competition and of an overall environ- ment conducive to economic efficiency and de\ iLIopnient of the private sectoir is furtlher dis- cussed in chapters 3 and 7. 7. A study' on productivity growth and firm owner>hip in the airline sector looked at 23 air- lines withl varying levels of private and public ownership over the period 1973--83. The authors indicate that their "empirical analysis shows, indeed, that a switch from state to private owner- ship unambiguously raises the rates of productivity' groLWth, or cost decline, whereas its effect on the levels of productivity and unit cost may be ambiguous in the short run. It further indi- cates that partial privatization of fully state-owned enterprises would produce a substantially smaller marginal improvement ir, productivity growtth than complete privatizationi would. The estimates show that a full switch from state to privati ownership mav increase the rate of cost decline by as much as 1.7 percent per year" (Ehrlich and others 1994, pp. 1007-0)8). See also note 91 in chapter 7. 8 U/ic Priuratizatioti Challecnge in their ability to subsidize state enterprises and must comply with strict fis- cal requirements imposed by the Maastricht treaty to qualify for member- ship in the monetary union. It also applies to countries that have committed to structural adjustment programs with the World Bank or the International Monetary Fund. Rapid changes in the international economy have also helped hasten the decline of the typical SOF. Globalization of the economy, accelerated techno- logical innovation, and growing integration of markets compel businesses to adopt highly flexible strategies and continuoutsly adjust them to changing cir- cumstances. That may, among other things, require the formation of alliances with foreign partners in the area of technology, procurement, or trade, or even through cross-shareholdings or integration in initernational groups. SOEs are notoriously ill-placed to function so flexibly and to forge such alliances. Furthermore, the ideological debate on economic management and priva- tization has evolved substantially in response to the growing globalization of the economy and to the end of the cold war and confrontation between socialist and capitalist models of development. This narrowing of ideologi- cal schisms has produced a more pragmatic approach to economic reform, of which privatization forms part. This trend has been strengthened by the positive experience with privatization, as described in box 1. Finally, in some economic sectors the reasons evoked to justify state inter- vention no longer exist. In infrastructure sectors (telecommunications and electricity generation, for example), technological and other developments have made it possible to introduce competition into activities formerly thought to be natural monopolies, thus obviating the justification for the survival of large public monopolies (see chapter 7). In other sectors, such as air transport, the rules of the game have simply chaniged and SOEs have been unable to adjust.8 The foregoing explanations for the surge in priv-itizations all relate to the supply side. To these must be added demand-related factors, namely, growing investor interest. Detailed analysis of this emerging demand is beyond the scope of this study, but it is clear that it stems, first, from the globalization of the economy and the sharp growth in foreign investment flows, especially toward developing and transitioni countries, and, second, from the advent of new types of investors. These include in particular large infrastructure companies, which until recently were almost all national 8. The European airline industry offers a telling example of the burden SOES place on govern- ments and taxpayers; it also illustrates the relative inefficiency of sots and their handicap in operating competitively An article in the Waill Strect Journal ranked the ten largest European air- lines by level of state ownership and profitability. The fivc (southerni European) airlines with majority state sharelholdinig all posted losses in 1994, while thc five privatelh run airlines all posted profits. Meanwh1ile, state subsidies to state-owned airlin,'s have been staggering: "In the past four years, Air France, Olympic, TAP, Iberia and Sabena of Belgium received subsidies totalinig $9.2 billion" ("Among European Airlines, thet Priv'atizedl Soar to the Top. Government- Owned Carriers Milk State Subsidies but Still Struggle," Wall Si r''t Journal, 19 uly 1995). Initroductioni 9 Box I Positive Results of Privatization In a study published in June 1994, Galal, Ione, Tandoni, and Vogelsang per- formed an in-depth analysis (about 600 pages) of the effects of twelve privati- zation operations carried out in Chile, Malavsia, Mexico, and the United King- dom. They studied four airlines (Aerorncxict). British Airways, Malaysian Airline Systems, and Mexicana de Aviacion); three telecommmunications com- panies (British Telecom, Compania de Telefonos de Chile, and Telefonos de Mexico); two power companies (Chilgencr and Enersis); a carrier (National Freight); the container port of Kelang; and a lottery (Sports Toto Malaysia). The purpose of the research was to compare circumstanices before and after privatization by factoring in a hypothetical model representing what would probably have happened without privatization. The authors sought to distin- guish the gains and losses due to privatization from those attributable to other factors. They calculated the impact on the selling counitrv; on the buyers (domestic and foreign); on workers, user<, and( consumers (domestic and for- eign); and on the competitors of the privatiztd SOI-. In eleven of the tvelve cases examined, the net effects of privatization were positive for the enterprise, as well as for the national economy and the wnrld economv. The exception was the privatization of the airline Mexicana, where the nega- tive effects on buyers and users outweighed tlte benefits to the governlmelnt; the net effect on the employees of the compan\ w\as zero. This operatioll nega- tively affected the entire economv and foireign buvers atid Llsers (see also note 28 in chapter 3). In none of these twelve cases did the wvorlers as a whole find themselves worse off upon completion of the process. The study also stresses the major benefits of the economic liberalization measures that accompanied these privatizations and those of the regulatory framework set up for the privatita- tion of the infrastructure companies. Yet one cannot extrapolate to conclude that privatization will always have a positive effect. The situation of thle four countries in question (one industrial country and three of the most prosperous developing countries) may, for exam- ple, differ greatly from that of a poor country or one in economic transition. In another study published in 1994, Megginson, Nash. and Van Randen- borgh compared the pre- and post-privatization performance of 61 enterprises in 18 different countries, which were privatized between 1901 and 1990) by public offering. The authors conclude that these enterprises, as a whole, posted substantial performance gains (increases in sales, investment, produc- tivity, profits and dividends, and reduction in d1ebt) following theiir divestiture. These gains were accompanied by an increasiI nmIber of jobs. monopolies or quasi monopolies that invested little if at all abroad but today aggressively invest outside their countries of origin. They also include private investment funds and institutional investors who allocate part, or even the entirety, of their resources, to acquiring holdinlgs in priva- tized companies (see box 6.2 on mutual funds that invest in privatized companies). 1 ( 'le Priu'otizati (ol Chalhulge Growing privatization offerings by governments around the world and growing private investor interest and experience are clearly reinforcing each other. Definition of Privatization The term "privatization" can have different meanings. At one level it refers to the privatization of a public enterprise, whether through divestiture or other techniques. In a narrow sense, privatization implies permanent trans- fer of control, whether as a consequence of a transfer of ownership right from a public agency to one or more private parties or, for example, of a cap- ital increase to which the public-sector shareholder has waived its right to subscribe.9 A broader definition of enterprise-level privatization includes any mea- sure that results in temporary transfer to the private sector of activities exer- cised until then by a public agency. Such definition therefore also covers: * Subcontracting, whereby the public agency that previously conducted the activity now subcontracts its execution to a private party; this subcon- tracting can cover an entire public service, such as trash collection, or only part of the activity, such as water or electricity meter reading and billing * Management contracts, which may or may not be performance-based; in these cases there is a temporary transfer of management responsibility without transfer of owniership or real transfer of (ontrol (see, for example, World Bank 1995b) e Lease of state-owned enterprises, equipment or assets, including lease- and-operate or affl rnage contracts in the infrastructure sectors; if the lease includes an option to buy, however, the operation could be regarded as a divestiture * Concessions (see chapter 7), as well as build, operate, and transfer (BOT) contracts (see Augenblick and Custer 1990), often used for the privatiza- tion of infrastructure sectors with monopolistic characteristics. At another level is privatization of a sector. Sector privatization is predi- cated on the introduction of private entry, often by abolishing public monopolies or other barriers to entry. It often includes, but does not have to, privatization at the enterprise level. The award of a cellular telecommunica- tions license or of airline routes to a private firm may not be accompanied by 9. It matters little whetlher the assignment or transfer takes place by payment (sale) or some other means (free distribution of shares, for example). Nor does it matter whether the public agency is the state, the government, a ministry, a governmenit department, a local authority, an enterprise effectively owned or controlled by the public sect(or or any other public entity. The term divestiture is sometimes used restrictively to refer to a transfer of securities (sol. shares) or assets from the public sector to the private sector; a capital inc.rase by an soF may thus qualify as a privatization though not as a divestiture. Introduction 11 the divestiture of all or part of the incumbent operator, for instance. Simi- larly, independent power producers may be invited to build and operate power stations without any change in the ownership of the state utility.)0 This opening up is often, but not always, accompanied by the introduction of real competition among operators in the market (see the section in chapter 1 on the characteristics of a sector and chapter 7). At a third level, the term privatization can have an even wider connota- tion, to include the privatization not just of enterprises and sectors but of an entire economy. The degree of privatization of a given economy wil]l depend on the extent of prior state ownership and control and the scope of the reform program undertaken. Transition countries have by necessity embarked on the broadest programs of this kind, of which enterprise and sector privatizations form an integral part (see the section in chapter 1 on general country characteristics, and chapter 3). But other countries have also undertaken farreaching reforms to transform their economies. In New Zealand, for example, the government program addressed the liberalization of foreign trade, financial markets and labor as much as it did the reform of the telecommunications and air transport sectors and the restructuring and privatization of many public enterprises and activities (see Duncan and Bol- lard 1992). Although each is separate and distinct, these three tiers of privatization are by no means sealed off from one another. On the contrary, there is close interaction among them. First of all, the strategy adopted for the upper lev- els will largely determine that applied at the lower levels. A privatization strategy for an SOE must be consistent with the country's sectoral and mac- roeconomic strategies. Often, the privatization of an enterprise will make sense only as a component of a sectoral or macroeconomic program. Privati- zation is thus an instrument of these more comprehensive approaches rather than an end in itself. Furthermore, a dialectic movement is at play: specific divestiture experiences contribute to the development or fine tun- ing of sectoral and general strategies, which cannot be defined unalterably at the start of a reform program. These privatization techniques can also be classified according to the level of investment responsibility and the degree of risk transferred to the private sector, and to the relative irreversibility of the privatization transac- tion. These factors are in turn directly and positively linked to the magni- tude of the financial commitment made by the private operator and, where relevant, to the duration of the tran5fer of responsibility to the latter. Figure 1 illustrates the gradation of different techniques for private sector participation, ranging from subcontracting, which requires very little 10. BOO (build, own, and operate) contracts may also be an instrument of sector privatization. Boo contracts are usuallv based on a license to build an infrastructureand to supply the related services. Unlike BOT contracts, ownership of the plant remains in private hands. When BOO (or BOT) contracts are accompanied by an exclusive purchase contract awarded by the local public service enterprise, they are more a form of subcontracting. 12 The Privatization Challenge Figure 1 Range of Privatization Techniques \SupplyTechnicala Sub- Manage Perfor- and civi)assistance) contract- )ment mance- Leasg- DoT n works cntracts ig contracts based cfrtae) ss cntracts (MC) MCs Public -- - Responsibility for investments and risk allocation -- 1' Private o 0 Duration (years) of private involvement cc o investment, involves little risk and can easily be terminated, all the way to total divestiture, in which the activity and its assets are permanently trans- ferred to the private sector.11 To the various forms of privatization depicted in this figure must be added joint-venture companies, which can be cocontractors in any privatization arrangement; the private shareholding in these companies may range from under 1 percent to over 99 percent. Other techniques of sector privatization exist as well, such as the promotion of new entry through licenses, permits, or authorizations of varying duration granted to private operators. Finally, it should be noted that what we call privatization goes by other names in some countries, often because privatization was deemed to be politically too delicate a term. Thus, for example, one speaks of capitalization in Bolivia (see box 5.1), peopleization in Sri Lanka, and equitization in Viet Nam. The terms "commercialization" of Canadian National (the railway company) and "strategic consolidation" of Belgacom (the Belgian telecom- munications company) were used to refer to the recent privatization of these companies. In the Netherlands, on the other hand, the term privatization has been used not only to designate what is classified here as such but also to describe the process of corporatizing an SOE that continues, however, to be owned by the state (see chapter 4 for a discussion of corporatization of SOEs). Structure of the Study The sequencing of the chapters of this book follow the sequence of steps in preparing a privatization program. First described is the backdrop to priva- tization, followed by a discussion of the broad principles of design of a privatization strategy. Next examined is the constitutional, legal, and regu- ll. It should be noted that this work does not emphasize actual sale techniques or transac- tional issues. That is not, of course, to detract from the importance of the transaction aspect of privatization. On the contrary, selecting and implementing the appropriate techniques is extremely important. A good strategic, legal, and institutional framework will serve little pur- pose if the actual transactions are handled unskillfully by inexperienced or inadequately quali- fied officials. That said, the innumerable problems that can arise when structuring a privatiza- tion operation and during the ensuing negotiations are, by and large, similar to those encountered in the course of corporate mergers and acquisitions. Introductioni 13 latory framework: what was it before privatization began, and how much must it be altered to allow or to facilitate privatization operations? Follow- ing this in-depth diagnosis is an analysis of the key provisions that autho- rize and regulate the privatization process and a description of the institu- tions and actors involved. A discussion of the privatization of infrastructure sectors, a very topical subject, precedes the concluding chapter. The main themes and issues of the book are presented as follows. Chapter 1. Every strategy must start by clearly stating the objectives that are being pursued, because these determine the approach taken and choices made. The political setting and the specificities of the concerned country, sector, and enterprises similarly have a decisive impact on the nature of the program. Chapter 2. A country's constitution and the treaties to which it is a party can limit the privatization options available to it. They cannot be ignored. Chapter 3. If it is to succeed, privatization must place the divested enter- prise in a stimulating economic environment. Clear rules are needed to gov- ern the functioning of a market economy. This often means amending exist- ing rules or even creating them from scratch. Examples are the basic rules recognizing private ownership, protecting competition, permitting the establishment and winding up of commercial companies, and regulating financial markets. Some of these rules, such as the provisions governing public offerings, also have a direct bearing on the privatization process itself. Chapter 4. Privatization deals with transferring to the private sector SOEs or activities hitherto carried out by the public sector. The rules governing the conduct of these activities by the public sector hence also must be examined. This applies in particular to legislation concerning public property, SOEs, and public finances, which often also determines the steps the government needs to take to prepare the SOE for privatization. This chapter completes the overview of the environment that exists before privatization yet still directly affects efforts to privatize. Chapter 5. The decision to privatize having been taken, it is important to ensure that the process is duly authorized and regulated. In many countries this is done by enacting a privatization law. This law may be either general or specific and may contain numerous provisions relating, in particular, to the topics discussed in the preceding chapters. Chapter 5 is devoted to the basic enabling provisions of privatization legislation, that is, those authoriz- ing and regulating the process and defining its scope. Chapter 6. The institutional framework for privatization, usually pre- scribed in the privatization legislation, is studied in chapter 5. An entire 14 rhe Privatization Challenge chapter is devoted to this subject in view of its importance and the great diversity of approaches taken. Even the best privatization legislation is worthless without a suitably designed institutional framework for imple- mentation. In addition to national privatization agencies and committees, chapter 6 deals with privatization funds, which play a major role in mass privatization programs. The final section is devoted to privatization consult- ants, including legal and financial advisers. Chapter 7. Some sectors have features that affect the way in which they can be privatized. Chapter 7 explores the special case of the privatization of infrastructure sectors, with special emphasis on telecommunications. Since the specificity of these sectors is (or was) due mainly to their monopolistic features, the analysis focuses on the strategic and economic issues that must be considered before addressing legislative and legal questions. Chapter 8. In this concluding chapter the many facets of the privatization process are reviewed. The main challenge facing policymakers and govern- ment officials is not so much to sell an enterprise at a good price as to use this opportunity to achieve broader objectives such as a more competitive national economy. The main body of the text is followed by detailed references to privatiza- tion laws and regulations enacted in over 100 different countries (appendix); a glossary of legal and other terms used in this book; a four-part bibliogra- phy (by author, by country or region, specialized journals, and internet resources); a subject index; a geographic index; and an index of enterprises, agencies, and other organizations. 1 Defining a Privatization Strategy Developing a strategy is often regarded as the first step in a privatization program. In fact, since most privatization programs are an integral part of more comprehensive economic reform, the first step should be to define the key objectives driving the government's overall economic program. The privatization strategy then becomes a substrategy geared to the objectives of the broader reform program. Most former ct ntrally planned economies, as well as, for example, Argentina, Chile, Mexico, New Zealand, Peru (see box 1.1), and the United Kingdom, opted for radical economic reform witl privatization as one of its main pillars.1 Moreover, the sale of SOEs should rarely be an end in itself, but rather one instrument of economic policy among others. Some authors argue that privatization can be an objective in itself for transition countries on the road from a command economy to a free market economy, particularly the ex- Comecon countries. If privatization is understood in its broadest sense as the privatization of the economy, then this would indeed be right. If, how- ever, it is understood as simply the saIt of s,UEs, then it should be seen as a necessary component of a broader program aimed at establishing a market economy. In transition countries, the sale of SOEs is essential for the forma- tion of a market economy, whereas in manis other countries governmiients may feel that they have other optionis available to achieve their policy objectives. Developing a privatization strategy involves identifying government objec- tives, analyzing the existing constraints on execution of the program, and decid- ing on an approach to achieve the objectives whlile taking the constraints into account. The next section of this chapter is devoted to defining the objectives of a privatization program. The section that follows deals with political con- straints, and others address the constraints specific to the concerned country, 1. See the geographic listing in the bibliographv fl r turtlher reading oi each of these counl- tries. On central and eastern Europe and tht former S, Oviet Uniioni, see, in particular, World Bank 1996b. 16 Flite Privatizati(an Challenge Box 1.1 Privatization and Economic Reform in Peru In "Peru Opens Up Economy with Deluge of Laws," the Fiiniacial Dimes wrote that a "1 0-day deluge of 126 laws, more than half of them intended to stimulate private investmenlt, has brought about the most radical reorientation in the 1'eruvian state for more than 2(0 years.... State monlo?opolies have been elimi- nated, private individuals and companies may now compete directly with the state in such varied areas as telecommunications, the generation and transmis- sion of electricity, and the provision of postal and railway services. They may apply for concessions to administer state-owned hospitals, airports and even schools. There is what ministers call an aggressive plan to sell off public compa- nies, whiclh have drained the Peruvian exchequer of iup to $2.5bn annually." The article also quoted tlen-prime minister Alfonso de los I leros on the impor- tance of these reforms relative to Peru's terrorism problem: "Much more impor- tant is an adequate legal framework. If these decrees suirvive, then investment, both national and foreign, will come" (Finaacial Timies, 2(1 November 1991, p. 8). The reforms have indeed survived: many SOEs, including the telecommunica- tions and power companies, have been privatized, raising over $4 billion and generating investment commitments or plans of equal magniitude; SOE subsi- dies have been cut from their astronomical prereform levels ($4.2 billion in fis- cal 1989-90); interest rates and exchange rates have been liberalized; the quota- tion of Peruvian debt on secondary markets has risen from 5 percent to 60 percent and more of face value; the securities exclhange index has soared; inflation has been brought under control, dropping from over 7,00() percent in 1990 to about 11 percent in 1995; foreig investtmienit has risen substantially, and real GDI' rose by ain average of more than 8 percent a year from 1993 to 1995. These impressive results, however, lhave been achieved at the cost of severe restriction of political freedoms: in April 1992 parlianment was dissolved, half the members of the Supreme Court were dismissed, an.d strict control was insti- tuted over television programs, all in the name of [he fight against terrorism. It is said, also, that income distribution worsenied ovrer this period. Soirces: I'I' licaiioni isI 1 Decem ber 1993, pp. '0(-9 1[ 1'ii itin i , (st Vim's, 211 November 1991, 19 February 1994, and 7 March 1996. sector, and enterprise. The final section briefly describes regional trends and discusses issues concerned with implementation of a privatization) strategy. Objectives of Privatization Defining privatization objectives is an important exercise that should be under- taken as early as possible. Many privatization programs have foundered when clear objectives were lacking or where conflicting objectives were simulta- neously pursued. The definition of objectives is not an easy task, however, and it is made no easier by the multiplicity of possible objectives and actors with different, often conflicting, interests. A list of the olbjectives most commonly pursued, explicitly or implicitly, by privatizing governmiiients is given in box 1.2. Definiing a PrivatiZation Strategy 17 As mentioned in the introduction, the current wave of privatizations is largely a response to the financial crisis facing many governments. Conse- quently, budgetary matters and short-term revenue maximizationl tencd to be high on the list of governmental objectives. These may, however, lead to sub- optimal policies and privatization techniques. A recent editorial stated that "privatization carried out just to raise monev-not based on1 a broad vision of how the economy should work-is a recipe for failure" (Eutroinoncly, Feb- ruary 1996, p. 5). Privatization is also a response to the unsatisfactory performance of S.)Es and to an increasingly competitive international environment. Raising enterprise and economy-wide efficiency should hence rank higih among the objectives of a privatization program, and priority should be given to meth- ods that maximize such efficiency. Opening the economy to domestic and international competition, removing barriers to entry, and breaking up out- dated monopolies are important measures in this respect. Governments should select the techniques and approaches that are best suited to their objectives. Where efficiency and maximization of privatiza- tion revenue are sought, a call for bids is generally preferable to direct nego- tiations witlh a single investor. As for privatization techniques, free vouchers or discounted employee shares may not be appropriate instrumenits if the main objective is to maximize revenue, but they may well serve the political objectives of the program. Similarly, a public flotation may be the right tech- nique to promote widespread share ownerslhip and stimulate financial mar- kets, but that course involves the risk of diluting share ownership and thus control of the enterprise, and it will not ne essarily generate optimal tech- nology transfers. Mass transfers of shares to all citizens may achieve the objectives of widespread share ownerslhip ind, where appropriate, speed, but not promote those of efficiencv, revenue maximization, foreign invest- ment promotion, or technology transfer. The chosen objectives will have significant implications not only for the choice and structuring of legal instruments and techniqutes but also for the need for measures preceding privativation.2 Maximizing economic effi- ciency will often call for preprivatization reforms that, for example, break up the SOE to foster competition, eliminate monopolies and other barriers to entry in the sector, and, in cases of privatization of monopolistic sectors, establish a regulatory framework. Although maximizing economic efficiency will normally be one of the main objectives of a privatization programi, in practice other considerations of a political, social, or financial nature also influence the choices of the authorities. The debates aroused by the L .K. privatization program illus- 2. The choice of objectives is not the only dLe terrining factor. S.o too are the time frame adopted for implementation of the privatization proce>s, the scope of the priv,atization program (number of enterprises, aggregate value of the program, and size relaitive to that of the private sector in the economy), the specific target lev els for eal h of these objet ives, and a series of otlier factors discussed later in this book. 8 f'lhc Privatization Challengc Box 1.2 Objectives of Privatization Efficiency and Development of the Economy * Create a market economy-the key objective in economies in transition * Encourage private enterprise and expansioni of the private sector in general * Promote macroeconomic or sectoral efficiency and competitiveness * Foster economic flexibility and eliminate rigidities * Promote competition, particularly by abolishing monopolies * Establish or develop efficient capital markets, allowing better capture and mobilization of domestic savings * Improve access to foreign markets for domestic products * Promote domestic investment * Promote foreign investment * Promote integration of the domestic econonmv into t he world economy * Maintain or create employment Efficiency and Development of the Enterprise * Foster the enterprise's efficiency and its domestic and international compet- itiveness * Introduce new technologies and promote innovation * Upgrade plant and equipment * Increase productivity, including utilization of industrial plant * Improve the quality of the goods and services prodiuced * Introduce new management methods and teams * Allow the enterprise to enter into domestic and internationlal alliances essential to its survival Budgetary and Financial Improvements * Maximize net privatization receipts in order to fund government expendi- tures, reduce taxation, trim the public sector deficit, or pay off public debt * Reduce the financial drain of the SOEs on the state (in the form of subsidies, unpaid taxes, loan arrears, guarantees given, and so on) * Mobilize private sources to finance investments that can nlo longer be funded from ptublic finances * Generate new sources of tax revenue * Limit the future risk of demands on the budget inherenit in state ownership of businesses, including the need to provide capital for their expansion or to rescue them if they are in financial trouble * Reduce capital flight abroad and repatriate capitfl already transferred Income Distribution or Redistribution * Foster broader capital owniershlip and promote popular or mass capitalism * Develop a national middle class * Foster the economic development of a particulkr group (ethnic or other) in society * Encourage employee ownership (also important for efficiency reasons) Defining a Privatization Strategy 19 - Restore full rights to former owners of property expropriated by previous regimes * Enrich those managing or implementing prixatization projects (rarely an admitted objective) Political Considerations * Reduce the size and scope of the public sector or its share in economic activity * Redefine the field of activity of the public sector, abandoning production tasks and focusing on the core of governmental functions, including the cre- ation of an environment favorable to private economic activity * Reduce or eliminate the ability of a future government to reverse the mea- sures taken by the incumbent government to alter the role of the state in the economy * Reduce the opportunities for corruption and misuse of public property by government officials and SOE managers * Reduce the grip of a particular party or group (communist party, iornen lkla- tura, or labor unions, for example) on the economy * Raise the government's popularity and its likelihood of being returned to power in the next elections. trate rather well the tension between conflicting goals. Many of the larger companies that were privatized were sold as monopolies or near-monopo- lies (especially British Telecom and British Gas) or with a dominant position in their market (British Airways). Reasons commonly given for this approach include the desire to proceed quickly, to secure the cooperation of SOE managers who otherwise might try to obstruct privatization, to attract large numbers of small shareholders, and to maximize sales revenue. Many commentators think that the U.K. government should have created greater competition in the concerned sectors before privatization, even at the price of a longer preparation period or lower sales proceeds. Later privatizations, such as those of the electricity and water companies, were preceded by breakup of the sector in order to create a more competitive environment.3 Similarly, postprivatization intervention bv U.K. regulators reduced the scope and duration of the monopolistic privileges originally granted to the privatized enterprises. Privatization objectives need to be consistent not only among themselves but also with other objectives of the government. For example, some countries 3. The competition in question is yardstick competition rather than true market competition, because the water and electric power distribution enterprises were granted a monopoly. Com- petition in the market was established in power generation, however. On this topic, see chapter 7. See also Yarrow 1986, Graham andi Prosser 1 S9 1, pp. X9 ff. 20 The Privatization Challenge discriminate against foreign investors by barring or restricting their participa- tion in the privatization program, and they simultaneously adopt new legisla- tion to promote foreign investment and send cabinet members or other digni- taries around the world in quest of fresh foreign capital. Such discrimination in the privatization process may even be contrary to the provisions of the country's own foreign investment law. The multiplicity and sometimes mutually incompatible nature of the objectives make it essential to rank them. Setting objectives, however, is not a purely abstract exercise. It is primarily a political matter, requiring specific tradeoffs. Social or political concerns may, for example, dictate second-best solutions, which are still worth pursuing when the first best approach, from an economic point of view, is not an acceptable one politically. Nonetheless, privatization is often not the best or most efficient policy instrument to pur- sue social or political objectives.4 A privatization strategy has to be assessed in light of the objectives pur- sued. Most privatization methods and techniques are not inherently good or bad, but merely more or less well suited to the pursuit of one or more spe- cific objectives. The more objectives there are, the more complex the entire privatization process. Flexibility must be built into the system, especially at the implementation level, when multiple objectives exist. This calls for transparent procedures and accountability of decisionmakers. General Country Characteristics Privatization strategies need to be pragmatic and tailored to the specific cir- cumstances and characteristics of the country concerned. The political, eco- nomic, social, and institutional setting and the risks associated with the interaction of all of these must be carefully analyzed. The great variance in the privatization experience of transition countries illustrates this rather well (see also chapter 3). Political Settinig As privatization is above all a political process that can radically disrupt the sit- uation of various stakeholders, one should anticipate possible or likely obsta- cles to the program. Indeed, reluctance or resistance both within and outside the government and the privatization agencies can often hinder the privatiza- tion process or limit its scope. Such opposition can stem from a variety of con- cerns, including: (a) the preservation of national sovereignty or independence; 4. Yarrow observed ten years ago that "privatization is also advanced as a weapon for reduc- ing trade union power, encouraging wider share ownership, redistributing wealth and improv- ing the public finances. However, there are other policy instruments better suited to achieving these objectives" (Yarrow 1986, p. 323). Defining a Priz'atization Stratnegy 21 (b) the desire to retain national control over certain activities or interests per- ceived to be strategic; (c) the sense that state ownership is needed to safeguard the "public interest"; (d) the fear that wealth might become concentrated in the hands of a few private parties; (e) a distrust of the private sector or certain seg- ments of it; and (f) the protection of bureaucratic or other vested interests. Since new laws tend to reflect existing political forces, most of these considerations will be addressed in privatization legislation, as the following chapters show. An in-depth study of these political arguments would exceed the scope of this book. It must be stressed, however, that minimizing political constraints and building a consensus are crucial to the success of privatization opera- tions. That success depends above all on a firm commitment on the part of the country's leaders. Many commentators have made the point, for exam- ple, that Argentina's ambitious privatization program could not have been carried out with such success had President Menem and his government not espoused it so clearly and supported it so vigorously (see, for example, Alexander and Corti 1993, p. 3). Similarly, the roles of Margaret Thatcher in the United Kingdom and presidents Fujimori in Peru and Salinas de Gortari in Mexico were critical to the success of ambitious liberalization and privati- zation programs in their countries. Econaomic anid Social Setting Many countries consider the privatization route to be a way to extricate themselves from an often prolonged recession or from a severe public finance crisis, characterized by large budget deficits and a growing public debt. Not surprisingly, these countries resort to privatization mainly for budgetary reasons and tend to choose approaches that maximize revenues in the short run, sometimes to the detriment of more efficient and competi- tive solutions. The urgency of financial needs also explains the lack of medium- and long-term economic analysis in many privatization strategies. As for the social context, here again short-term constraints tend to domi- nate. The potential social impact of privatization is often calculated in terms of layoffs or lost jobs, yet the problem of excess labor, which is often caused by poor public management, would have to be remedied even in the absence of a privatization program. Moreover, the social factors usually taken into consideration focus more on short-term job losses resulting from necessary restructuring than on longer-term job creation generated by a more flexible and dynamic economy Even so, the potential short-term social impact of a major economic reform and privatization program, as well as its political consequences, should not be underestimated. Governments will often have to prepare and adopt support measures to dampen the restruc- turing shock and help workers manage the transition to other jobs. Involv- ing workers in the privatization process by seeking their inputs and giving them incentives to support the program has also proven useful (see chapters 3 and 5). 22 The Privatizat ion Challengec Institutionial Setting A country's institutional setting is determined by its administrative, com- mercial, and legal traditions and practices; the competence of its public administration; and the degree of corruption in the system, among other things. The preparation, implementation, and follow-up of privatization programs may be quite taxing on a country's institutions and civil service. Privatization is primarily a public transaction or process initiated by a gov- ernment and conducted by politicians, civil servants, and SOE managers, all of whom have little or no relevant experience and many of whom may not have the right incentives to carry out the program. Institutional and human factors, absorptive capacity, and the way in which a government attempts to overcome its inexperience in these matters all play a decisive role in the suc- cess or failure of a privatization program (see chapter 6). Country Risk In a country with a weak or otherwise unattractive political, economic, social, and institutional environment, the government, in the role of seller, will have to develop a long-term strategy to reduce the risks run by investors. The level of risk that investors face determines their interest in the privatization pro- gram. The higher the perceived risk, the more difficult it will be to implement the program. In the short run, measures may have to be adopted to encourage venture-capital investment at the cost of lower privatization revenue because such investment can help rekindle the economy and establish a track record. The longer-run objectives of the strategy will be to reduce uncertainty and risk levels, eliminate the main obstacles to the development of a market economy, and create an environment conducive to private sector investment. The gov- ernment's credibility is vital to the success of such a strategy, and that credibil- ity must be earned. Each successful transaction contributes to a positive image. Although some countries, such as Argentina, Colombia, or the Philip- pines, seem to have succeeded in moving up this ladder, others have been less successful. Indeed, some former Soviet republics and a few central and eastern European countries, as well as several African countries, have suf- fered fickle policies, internal unrest, programs called into question or can- celed, and a certain distrust of the private sector in general and of foreign investors in particular. This has greatly reduced their credibility and compli- cated and slowed the implementation of their privatization programs. More technical, or at least less political, country risks should also be noted. In a country whose accounting rules and practices do not conform to international standards, for example, buyers will be less willing to take over the liabilities of an SOE, and the government may have no choice but to privatize the SOE by sell- ing off its assets and liquidating the remaining shell. Similarly, the absence of organized capital markets or weak financial institutions may make it more dif- ficult to privatize by way of a public flotation or even to rely on domestic sav- ings. In countries with nonconvertible currencies, an SOE with foreign exchange earnings will be easier to sell than one with only local currency revenue. Dcfinihzg a Priz'atizatioti Strategy 23 Characteristics of a Sector Privatization techniques are influenced by market structure, as well as by other sector-specific characteristics. Most sectors or activities currently man- aged by the state or other public entities can be privatized. Sector Stryuctuire, The structure of a market or sector may be determined mainly by economic or by legal variables, as the case may be. Legal variables dominate, for exam- ple, in the presence of legally sanctioned monopolies; in this case, the law forbids anyone except the holder of the monopoly franchise to engage in specified activities. The economic side dominates in cases of natural monop- oly, where only one company could survive. The two do not necessarily overlap, however. In some countries natural monopolies are not legally pro- tected, whereas elsewhere activities that are not natural monopolies are shielded by the protective barrier of a monopoly franchise. If increased efficiency is a primary objective oJ privatization, then the options for restructuring a monopolistic SOE should be examined first. One way might be to divide the SOF into several competing entities. When legal or regulatory provisions are responsible for the monopolv position and prevent or seriously restrict entry by new businesses into the protected sector, these should be repealed or relaxed. Where it is not practical or desirable to eliminate the monopoly before privatization, it will often bc necessary to enact provisions regulating the conduct of the enterprise after it has been privatized. These laws may take the form of general rules of conduct prohibiting uncompetitive behavior (as was the case in New Zealand, wlhere ordinary competition law limits the power of all enterprises, including infrastructure companies, to abuse their dominant position) or of sector-specific regulations governing pricing and other critical aspects of the monopolistic activities (see also chapter 7, particu- larly the section dealing with market structure, competition, and divestiture). Other Sector Featutres Until recently, in every part of the world the telecommunications sector was dominated by national or regional monopolies. As a result, most countries lacked domestic investors with relevant sector experience. Countries such as the United Kingdom, which had a national company that inspired investor confidence and operated in a relativelv mature market, have opted for a public flotation. Other countries have generally sought a strategic investor with the required experience and have therefore had to focus on foreign companies. For their part, these foreign companies were often limited in the scope of their activities and investments bv their owI1 regulatory frame- work. The likelihood of finding private investors with experience in running a telephone company in a country other than their own, particularly in a developing country, was rather slim until the earlv 1990s. The situation is 24 The Priatizatiou Challengte different today, however, because of the recent worldwide trend to deregu- late and privatize telecommunications (see chapter 7, including box 7.2). In many infrastructure sectors, such as toll roads or water distribution, for example, operating receipts are mainly, or even solely, in local currency. That situation could constrain financing options for a privatization operation. In many service activities, including software or data processing, profes- sional services, the media, and some skilled repair aind maintenance activi- ties, for example, fixed assets are of secondary importance. Instead, the staff, trademark, and license to exercise the activity represent the core of a com- pany's value. In these cases a privatization operation cannot be imple- mented successfully without the support of the employees, the principal asset of the enterprise. Privatization of state-owned banks also raises a host of specific legal issues that are often settled by special legislation, is was the case in Belgium and Italy, for example. Specific approvals must be sought from the national banking regulatory agency and, if foreign subsidiaries are involved, from foreign regulators as well. These few example;s show how the SOF's sector of activity may inifluence the privatization process. Can All Sectors or Activities Be Prizmatized? Different terms are used to refer to sectors or activities that are deemed to be ineligible for privatization. In some countries, reference is made to strategic or vital economic sectors or activities. In others, the view is that natural monopolies should not be privatized. The magic word, in particular in Latin countries, may be public services, a concept that may embrace the large infrastructure sectors discussed in chapter 7, as well as commercial services like the postal service and such functions as education, health, social secu- rity, justice, and national defense. The term "public service" itself is ambiguous, to say the least; it has never been precisely defined and it is often used stubjectively 5 To some, privatizing a public service is tantamount to selling off the lamily jewels or abandoning a key role of the state. Confusion very quicklv surrounds the distinction 5. The term public service has bten used to describe, among other things, services provided by public-sector entities (for example, public administrations and SoEs); services provided under the control, regulation, or jurisdiction of the government or a public agency; services paid for, financed, or guaranteed by the government or a public agelncy; and services provided to the public or in the public interest. The debate on the evolving nature of public services is particu- larly heated in France, where case law of the Conseil d'Ftat often determines the attributes of public services. "Depending on the meaning gixven to it, thl concept of public service is more or less extensive" (leanl Rivero, Droi adminiistratif, 11 th c1 ., sec 448, Paris, Dalloz). A report submit- ted in February 1996 by a special task force on the specificity of French-style public services set up by .lrime Minister juppO concluded that Fran(e should uiot hide behind doctrinal quarrels on the notioni of public service; instead, more competitio'n is needed in these services and France must undertake reforms matching EuRmpe's overall liberali/,ition trend. See Fina7ncital Tincs, 28 February 1996. Defining a Privatization Stritegi/ 25 between the concept of services rendered to the public and accessible on a nondiscriminatory basis, and that of services provided by the government or a public enterprise. This semantic drift, this merging of two different con- cepts, unnecessarily complicates the debate about how certain services should be provided to the public. This is particularly the case in countries with an administrative traditiojn influenced bY the French and in formerly socialist countries.6 In addition, wvhat is subsumed under such terms changes over time, even within the same country. In Peru, for example, President Fujimori and his privatization minister have argued that privatization of utilities and natural resource companies would not endanger national security or strategic inter- ests, as had been previously argued, but that on the contrary those interests were threatened most of all by the huge losses and liabilities built up by SOEs (see Financial Titmies, 17 March 1996). Setting aside terminology and its political or emotional overtones, one can venture that all activities that can be adequately described in contractual terms and whose performance can be measured can also be privatized. Tllis includes a priori all production of goodds and services, even structurally money-losing activities, provided the requLiredL subsidies can be channeled to the private provider. A few examples may illustrate the far reaclhes of privatization. Consider postal services, organized in most countries as a core governmental monopoly. The Netherlanids has already privatized KPN, a holdinig company tha t includes the postal service as well as the telecommunications company. Argentina, Ger- many, Lebanon, the Philippines, the United Kingdom, and otlher countries are also working on the privatization of their postal svstems; and, on March 1, 1994, Swveden abolished its postal monopolv and opened the sector, including basic letter delivery, to competition; five private conmpanies have since been registered and entered the market to compete vx itlh the incumbent SC11.' 6. The econormic literature is more precise and usefil in the definition of tlhe coimcept of public good, whichi applies to oinly a few public services. To quallify as a public good, an asset or ser- vice must possess certain features. For example, it niust be impossible (at least in practice) to exclude specific people from using it (nonexcludabilitv), ind there nm,ust be nonlrivalrv in con- sumption, which implies that its consumptioni by onl per-am in ino wav prevents its consump- tion by others (no crowding-out effect). Few infrastructure activities can be regarded as public goods: examples include traffic signaliig, street lightiig, and traffic control (see Kessides 1 943) However, the fact that a service is indeed a public good in no wa vimplies that it should be pro- vided by a public agency. See the example of T'riitx House, a private corporation with public duties established in Britain in 1566 to build and operate ]ighthouse> (or franchise private par- ties to do so), withi light tolls or fees being collected at ti e poirts bv cu>toms officials (Samuel Brittan, "Symbolism of Lighthouses," iii Fiunoicil siici', 6 November 1 9t5). 7. Sweden l'ost remains an sorL corporatized inl 19194 see also the rulinigs of the European Court of Justice and the decisions of the Furopean Comnmission limiting the area reserved to national monopolies by excluding express shipping servi, es. among others, and also the Com- mission's green paper on partial devgulation of postlI services ( oiM 91 476 final). 'here las also been much talk about privatizing the postal service in the United States, whiere mail delivery became a government monopoly folloinvig the enactment n 1845 of the P'rivate E.xpress Statutes. 26 The Priz'atization Challigt'n't Administration of justice would seem to be the perfect example of a pure state function, but even here private provision is a viable and often-used option, as evidenced by, for example, the frequent recourse to private arbi- tration and other alternative dispute resolution mechanisms. In France, the United Kingdom, the United States, and other countries, privatization has spread also to the management of prisons, and private security companies are growing at a rapid pace all over the world, oftein substituting for or com- plementing the state's police force. Publication of a country's official gazette is another example of an activity that can be privatized. Social security (see chapter 3), air traffic control (see the section in chapter 7 on the transport sector), or regulatorv activities (see the section of chapter 7 on regulation) provide other illustrations, as does tax or customs administration. Customs administration was privatized in Indonesia and Latvia. Customs warehouses are managed by private operators in an increasing number of countries. In Mexico "banks are entrusted with being the sole receivers of tax payments and with putting all the information from the returns on tape. Moreover, the private sector was authorized to print and distribute tax returns, registration and notice forms" against a fixed fee schedule (Jenkins 1994, p. 78). Withholding of income taxes by employers or of taxes on interest or dividends by financial institutions are other examples of partial privatization of the tax function. Even tax collection can be priva- tized in some cases, with public authorities selling their tax claims to private collectors (see Byrne 1995). Saying that something can be privatized does not mean that it should be privatized, however. In each instance, one should analyze the costs and ben- efits of public versus private provision of a given service, including the asso- ciated transaction costs, as well as economic, financial, political, social, and other aspects. Characteristics of the Enterprise Characteristics specific to an enterprise can also dictate, up to a point, the measures that need to be taken to prepare for and implement privatization of an SOE. Some of these characteristics, such as the nature of government ownership, the financial situation of the enterprise, and any applicable envi- ronmental or labor obligations and constraints, are developed in the follow- ing chapters. This section deals with the legal status and size of SOEs. Legal Status of the Enterprise The legal status of SOEs to be privatized varies greatly and affects the choice of privatization techniques. Box 1.3 distinguishes between three types of SOEs and state holdings, going from entities with limited autonomy from the government to companies in which the government is an ordinary, noncon- trolling shareholder. Entities organized under public law range from minis- Defining a Priviatizatio,o Strategy 27 Box 1.3 Legal Status of Public Enterprises or Shareholdings Public-Law Entities * Government departments or ministries, and divisions thereof, without dis- tinct juridical personality * Autonomous entities with their own budget but without separate juridical personality * Public agencies with juridical personality * Statutory corporations, public establishnments and national corporations, which may be subject in part to private-sector laws SOEs Organized under Private Company Law * Joint-stock companies wholly owned by the public sector (state and/or public agencies) * Joint-venture companies whose shareholders include public entities and private partners (local and/or foreign) * SOE subsidiaries organized under private law Minority Shareholdings * Private enterprises in which the state or other public entities have a minor- ity or noncontrolling stake. tries without distinct juridical personality to public-law companies with juridical personality; state-owned enterprises organized under private law include joint-stock companies and subsidiaries of other SOEs;8 and compa- nies in which the state or public sector is a shareholder, though not a control- ling one, are usually not included under the heading of SOF-." This classification does not necessarilv imply, however, that public-law bodies are subject to public law in everv aspect of their organization or operations, nor that private-law SOEs are totally outside the jurisdiction of public law. The main question this classification raises is whether owner- ship of the enterprise to be privatized can be transferred without its prior transformation into a new legal entity. Public-law bodies are usually set up as such by law. They may have to be made subject to company law (that is, private law) before they can be transferred to the private sector as legal S. Some legal systems allow public-law enterprises to ertablish subsidiaries organized tinder private law. In France and countries with legal 5ysterms based on the French system, etablissc- metits poU/iCs (public establishments) are often authorized to set up such subsidiaries. This allows them to circumvent restrictions imposed on public-law entities. 9. The name given to a particular form of s5F v.aries from one legal system or country to another. What matters is nOt what the class of enterprise is called but xvhat its intrinisic charac- teristics are. In this book, public enterprise and -( I are svIonIvmous unlless otherwise specified. 28 The Privatization Challenge entities.10 Another available option is to sell the assets of the SOE to private buyers without transferring the SOE itself. There are many other types of SOES that may be governed by special rules. These include (a) municipal enterprises, which may be organized under public or private law; (b) party-owned enterprises, which raise special prob- lems, especially in one-party states with a certain degree of confusion between party and state, particularly with respect to ownership rights; (c) socialist cooperatives, which may be deemed to be public or private; and (d) armed forces enterprises, which often have a privileged and sometimes secretive status. The legal status of an SOE may have a bearing on the applicability of many other laws, particularly in the areas of labor, social security, and taxation, which can themselves affect the course of the privatization process. This matter is considered further in the chapters that follow. Size of the Enterprise Finally, and rather obviously, the size of the SOE to be privatized is critical, too. The issues involved in privatizing, say, a small restaurant or grocery store are far different from those that arise when a national telephone com- pany or a major cement works undergoes privatization. Many transition countries have adopted a two-stage method of privatization, focusing first on small privatizations before moving on to larger operations (see World Bank and CEUPP 1994; Earle and others 1994). Cze(hoslovakia, Ukraine, and other countries have even enacted separate laws providing for different privatization techniques for each group (see the list of privatization laws in the appendix). Defining an Approach Once the objectives and constraints have been identified, the next step is to ascertain what reforms need to be undertaken to achieve the government's objectives. In every country a multitude of measures could be adopted to improve the environment for economic activity in general and the imple- mentation of privatization projects in particular, but not all reforms can be implemented at once. Measures essential to the success of the privatization process have to be given priority. Pursuit of the i.leal environment can only lead to endless delays and gridlock. 10. The law organizing such public bodies or the specitic law governing the public-law sok to be privatized usually precludes transfer of ownership to the private sector. In that case the law in question will have to be amended or abrogated to allow the SOE to be privatized as a legal entity. See the sections of chapter 4 dealing with the exen ise of ownership rights and the restructuring of public enterprises. Defining a Privatization Strategy 29 Regionial Trends Broadly speaking, countries in different regions of the world have adopted different approaches. Former socialist countries have had to privatize their entire economy. A market economy had to be created almost from scratch. The need to create a shareholding class and the political imperatives of the reform process, together with the difficulty of arousing investor interest in turbulent times, has led some countries in central and eastern Europe and in the former Soviet Union to adopt a completely novel approach to privatiza- tion. First, private ownership had to be authorized and encouraged. To facil- itate large-scale and speedy transfer of productive assets from the public to the private sector, the traditional privatization techniques had to be supple- mented by new techniques, such as transfer of SQE shares to the entire popu- lation under mass privatization programs (see chapter 6). The French and British privatization programs also aimed at widespread share ownership. Both countries, however, could rely on established capital markets and securities exchange mechanisms. Thanks to the substantial financial and human resources at its disposal, the United Kingdom was able to undertake from 1980 onward a particularly innovative privatization pro- gram affecting nearly all sectors, including the most strategic ones (see chap- ter 7). In the United Kingdom, privatization was part of an ambitious eco- nomic reform program, whereas the French program was more self- contained and limited in scope: utilities and transport sectors were not included, for instance. Other European countries, including Italy, Portugal, and Spain, have also relied heavily on public flotations. In Latin America the existence of major bottlenecks caused by the inade- quacy and poor state of public infrastructure has led some countries, such as Argentina, Chile, and Peru, to set up major programs of deregulation and privatization of so-called strategic sectors, such as telecommunications, elec- tric power, banking, and natural resources. These three countries and Mex- ico have also integrated their privatization programs into much more com- prehensive economic reform packages. In Asia the divestiture trend has not been as pronounced. Few countries there have adopted or implemented large divestiture programs,1l although some, including the Asian "tigers," a few traditionally socialist countries such as India, and countries still under communist svstems, such as China and Viet Nam, have adopted broader privatization approaches. These have included 11. The Philippines is among the leading Asian countries in terms of number and volume of divestiture. Since its inception in 1987, the privatization program has brought in about $6.5 bil- lion through transactions covering hundreds of enterprises and nooiperforming assets. The big- gest divestiture so far is the sale in 1994 of the oil comnpany Petron for a total of close to $1 billion, including about $575 million for 40 percent of the shares sold to Aramco and about $270 million from a public flotation of 20 percent of the shares that followed the Aramco deal. See Fioiiacial Timtics, 12 September 1994 and 30 November 1495. See also the section on recruit- ment of staff of privatization bodies in chapter o. 30 The Privatizatiot7 Challenge macroeconomic liberalization and opening of certain sectors (including infra- structure) to private investment through BOO, BOT, or concession contracts. In Africa, where most SOEs were in a state of virtual bankruptcy and lacked financial statements worthy of the name, privatization has often had to be effected through liquidation, thereby allowing buyers to acquire SOE assets without incurring the risks of large, uncertain, or contingent liabili- ties. Leaving aside the Middle East, which has lagged even further behind in this respect, Africa is the continent where, on average, the least progress has been achieved in privatization.12 Seque7tcing Reformts When the privatization strategy has been adopted, the timetable for the nec- essary reforms needs to be drawn up. The sequencing and pace of the priva- tization program will have to be thought through from the outset. Interac- tion with macroeconomic, sectoral, and SOE-level reforms, synchronization with any necessary support measures, congruence with adopted objectives and priorities, and compatibility with the absorptive capacity of institutions as well as markets all need to be considered. The nature of accompanying reforms and support measures may determine how well the main stake- holders and the public at large accept the privatization program. Some reforms may be prerequisites for the use of given privatization techniques. Where, for example, the government intends to sell an SOE as such, it may first need to corporatize the enterprise. If a public flotation is proposed, it may be necessary to strengthen the country's capital markets (these and other reforms that may be necessary are described in detail in subsequent chapters). On the other hand, some situations may accommodate privatization without the need for any other reform. In particular, the privatization of a limited number of industrial or commercial enterprises in market econo- mies, where shares can easily be sold on the securities exchange or through other well-established mechanisms, may fall inlto this category. Communication and Public Relations Having a good reform program may be a necessary condition for successful privatization, but it is not a sufficient one. One should also be able to sell the program to the major stakeholders. When preparing for privatization, the government and its advisers should try to involve the parties most directly 12. According to UNCTAD, Sub-Saharan Africa accounted for only slightly more than I percent of the $113 billion volunie of privatization transactions carried out in developing countries between 1988 and 1994. Notable privatizations include the successful flotation in 1994 on the London and Accra stock exchanges of over half of the governument of Ghana's shareholding in Ashanti Goldfields, which raised over $300 million, and the two-stage privatization of Kenya Airways: the Dutch carrier KL.M acquired a 26 percent stake in 1995, followed by a flotation on the local stock exchange in early 1996 (see Oxfo(rd Anolytica, 12 July 1996; see also the introduction.) Defitini,g a Prizvatization Strategy 31 affected as much as possible. It will take a substantial effort to convince political parties, SOE managers, unions and workers,13 civil servants, busi- nessmen, potential purchasers, and the population at large of the benefits of the program. Although achieving a broad consensus will not always be pos- sible, informing and educating the public and stakeholders about the priva- tization program and its effects is often a condition of success. A sustained effort on the part of government to explain the expected ben- efits of the privatization program and the reasons for choosing specific approaches and techniques can help greatly to build a relatively wide con- sensus. This public relations operation, whose importance is unfortunately not always recognized by governments and bureaucrats, should be system- atically integrated into the reform strategy On this point, recent studies have shown that privatization frequently benefits the majority of the parties affected, even those often described a priori as victims or losers (see box 1). That having been said, there will often be losers, especially when economies, sectors, or enterprises in need of radical restructuring are privatized.14 In these cases not even the best information campaign will succeed in persuad- ing those that will be most adversely affected. The government can, how- ever, hope to reduce their opposition by incorporating the necessary support measures into the privatization program and publicizing such measures. As the following chapters explain, a number of measures can be taken to address the concerns or dampen some of the most common objections of opponents of the transfer of SUEs to the private sector. To take only one example, transparent and competitive sale procedures should reassure peo- ple who fear that public assets are being transferred to private operators at prices well below their true value (see chapter 5). Such measures can effec- tively assuage these fears, however, only if their adoption is preceded by adequate publicity and discussion. Conclusion The wide diversity of possible objectives under privatization programs and the mutual incompatibility of some of them compel governments to make 13. Unions and workers are often opposed to privatization. However, this is not always the case. In Romania, unions were in favor of privatization and felt that the government was drag- ging its feet. The two main unions even organized a nationwide strike at the end of February 1994 to protest governmental delays in implementing the privatization program and reforming the social security system. The president of one of these two unions stated in an interview that he "very, very strongly supportlsl privatisatio-the taster, the better" (Friancial Tioncs, 3 May 1994). Trade union leaders in other transition countrie> have often supported privatizationl, whereas in industrial and developing countries opposition seems to be more common. 14. The program of restructuring and privatization of the East German economy was attended bv large-scale layoffs. Of the 4.1 million jobs in the enterprises in the Treuhandan- stalt's portfolio in 1990, only 1.5 million remained four vears later. Set Nen' 'llork Tinies, 12 August 1994. 32 Thc Pri vatization Challetige choices and define priorities. In the absence of explicit ranking of objectives, the default setting should be to give priority to economic efficiency. To that end, transfers of ownership from the public to the private sector should be accompanied as much as possible by action to open these sectors to domes- tic and international competition. After objectives have been defined, the constraints that could hinlder the process must be assessed. Each country will have a distinct set of con- straints, and it is important to tailor the privatization program to its specific environment. As experience has proved, even governmlents with identical objectives cannot pursue them with the same instrtuments in every case. Once adopted, the strategy needs to be operationalized. This calls for good sequencing and coordination of the variotus reforms and activities. Finally, the quality, timeliness, and presentation ot the government's public relations effort will often be decisive to the success of the operation. Privati- zation is, after all, as much a political as a commercial undertaking. The privatization challenge is first and foremost a strategic challenge. Indeed, the significance of privatization cannot be limited to the transfer of assets from a public sector owner to a new private one, nor to the revenues generated in the process. The real challenge of privatization is not so much to sell off an SOE, but to seize this opportunity to introduce much-needed economic reforms, whether of a macroeconomic or a sectoral nature, and to redefine the role of the government. This strategic approach can help change perceptions about privatization. Instead of a static process or a zero-sum game in which some win and others lose with no net benefit for the nation as a whole, privatization should be seen in a dynamic perspective in which the objective is precisely to increase overall social welfare. The emphasis in this chapter has been on tht formulation of a strategy rather than on the actual contents of one. The substance of privatization strategies is discussed in more detail in the following chapters. 2 Privatization and Basic Legal Norms The success of a privatization program is often a function of the soundness of its foundation, especially its legal foundation. The objectives of the program must be compatible with the constitutional provisions that underpin the legal framework for business activity in general and privatization in particular. They must also be compatible with the general principles of law and other norms establishing the rule of law and with certain provisions of international law, which may be binding on the legislator. If these basic legal norms hinder achievement of program objectives, the government must determine whether they can and should be amended. If they cannot be amended, the government may have to reconsider the program objectives or the choice of specific privati- zation techniques in order to accommodate these higher-order constraints. Box 2.1 summarizes basic principles commnon to most legal systems, which guarantee the rule of law. These principles form the basis of relation- ships between private economic agents and between them and the state or any part of the public sector. They are the pillars of what is often referred to as the rule of law (l'dtat tic tireOt in French) and contribute to a legal environ- ment conducive to private investment and hence to privatization. This chapter examines how a country's conistitution and certain provi- sions of international law may affect the privatization choices available to a government or legislator. Constitutional Requirements A country's constitution or fundamental law, wvhere such a document exists, may contain provisions that affect privatization operations either directly or indirectly. In the absence of a written constitution, provisions of a constitu- tional nature may well have the same effect. I Provisions of this kind may I. See the section in this chapter on limits on the discretion of tlle goveornment. See also Prosser 194i0 and Graham and Prosser 1991 for an in-depth examination of the constitutional requirements regarding privatization in the United Kingdom, which hals neo written constitu- tion, and in Francc. .33 34 I-lit Privatization Chaflctgen Box 2.1 Principles Guaranteeing the Rule of Law * Publicity of laws enables all parties concerned to be aware of the laws with which they are expected to comply * A clear and unambiguous legal framework allows the parties to know which laws apply to their situation and what their specific meaning is * IPredictability in applying laws reduces the risks associated with changes in their interpretation, implementation, or enforcement * Nondiscrimination in the application of laws implies that all parties that are in the same objective situation will have the same substantive rules of law applied to them * Means of legal redress and respect for due process cnsure access to indepen- dent appeal and dispute settlement procedures * Stability of the legal, political, and decisionmaking systems assures investors that the state or government will not unilaterally aind unfavorably alter the basic conditions on which these investors based their investment decisions. limit the scope of the privatization program, determine to whom decision- making authority belongs, or impose certain controls on privatization authorities, or address all three. Limits on the Scope of Privatizationi The constitutions of many socialist countries provided that all productive assets (including enterprises) were the property of the state or "of all the people," and granted the state (or public sector) special protection and priv- ileges as further described in box 2.2 (see also the section of chapter 3 deal- ing with ownership rights). These provisions were generally based on the 1936 constitution of the former Soviet Union, particularly article 4, and had to be repealed to enable privatization. Portugal's 1976 constitution even declared irreversible the nationaliza- tions that followed the April 1974 revolution. It had to be amended twice, in 1982 and 1989, to authorize the privatization of these SOES. The constitution of Bangladesh also had to be amended, by a decree issued in 1977 under martial law, to authorize privatization. Similar sweeping amendments had to be made in most transition countries, but also in other countries moving away from strong state control of the economy. Some constitutions continue to prohibit all private-sector activity in what are deemed to be strategic sectors. Until recently, article 177 of the Brazilian consti- tution gave the state a monopoly on prospecting for petroleum, natural gas, and other hydrocarbons; petroleum refining; import and export of petroleum products; sea transportation of domestic crude oil, and pipeline transportation of crude oil and natural gas regardless of origin. This monopoly wvas repealed in November 1995, but the constitutional amendment required implementa- tion legislation which, eight months later, had not yet been enacted. Article 27 Privatization and Basic LegaIl Normis 35 Box 2.2 Ownership Provisions of Socialist Constitutions Soviet Untiotn. Article 4 of the 1936 constitutioni proclaimed: "The economic foundation of the USSR is the socialist economic system and socialist owner- ship of the instruments and means of production, firm]y established as a result of the liquidation of the capitalist economic system, the abolition of private ownership of the instruments and means of production, and the elimination of the exploitation of man by man." Bnilgaria. Until its revision in April 1990, article 13 of the constitution stated: "The economic system of the People's Republic of Bulgaria is socialist. It is based on the public ownership of the means of production." An',(ola. Article 9 of the 1975 constitution stated. "The foundation of econiomic and social development is socialist ownership, consubstantiated in state own- ership and cooperative ownership. The state shall adopt measures permitting continuous broadening and coinsolidation of socialist relations of production." Guinia-Bissaii. The 1984 constitution describei the country as "a sovereign, democratic, secular, unitary, anti-colonialist and anti-imperialist republic" (article 1); the latter two adjectives have since been deleted. Its article 12, whichi has since been amended, declared the following to be state-owned assets: "the soil, subsoil, water resources, mineral resources, main energy sources, forests, basic means for industrial production, mass media, banks, insurance, roads and essential means of transportation." Mozatamiqwc. Until it was revised in November 1990, the constitution, adopted in 1975, stated: "In the P'eople's Republic of Mozambique the State economic sector is the leading and driving factor in the national economy. State property is given special protection land] its development and expansion is incumbent upon all state agencies, social organizations and citizens" (article 1(1). of the Mexican constitution contains similar restrictive provisions for hydro- carbons. The Mexican constitution- also originally contained a provision, amended in May 1990, prohibiting privatization of public commercial banks. Such constitutional provisions covering the ene rgy, water, and telecommunica- tions sectors, as well as transport infrastructure, are reviewed in chapter 7. Elsewhere, certain types of activities are reserved to the state, though partici- pation by private entrepreneurs is permitted through joint-venture companies or under concession, lease, or management contracts (see also chapter 7). This is common in the hydrocarbons sector, as for example in Bolivia, where the constitution provides that petroleum deposits are the property of the state, which may nevertheless entrust exploration and production to private opera- tors under concession contracts.2 Article 33 of the Indonesian constitution of 2. See article 139 of the Bolivian constitution. other examples are cited in chapter 7. Eveni though it does not have the same legal force, the preamble to the French constitution of 1946 also might be mentionied here; it states that "all assets, all enterprises whose operation has or acquires the characteristics of a national public service or of a de facto monop(oly must become collective property." The preamble to the 1958 constitLtlon explicitly refers to and confirms the principles set forth in the preamble of the 1940 con"titution. 36 The Privatization Challenge 1945 (reinstated by a 1959 decree) declares that "branches of production which are important to the State and which affect the life of most people shall be con- trolled by the State"; needless to say, such ambiguity regarding the covered sec- tors or activities, as well as the meaning of state control, has created problems.3 Finally, some constitutions may include other restrictions, such as limita- tions on foreign investment in specific activities (see also the section of chap- ter 5 dealing with restrictions on foreign participation). These could clearly also hinder privatization programs. Until its repeal by constitutional amendment of August 15, 1995, article 178 of the Brazilian constitution reserved coastal and internal shipping to national vessels, meaning vessels whose carriers, ship owners, captains, and at least two-thirds of the crew are Brazilian. Similarly, article 176, which restricted mining (exploration and production) to Brazilian-controlled firms, was modified on the same day and now requires only that the firm be established under Brazilian law and have its headquarters and management in the country; subsidiaries of for- eign companies qualify under these new standards. More generally, the same amendment also eliminated the constitutional discrimination in favor of "Brazilian firms of national capital," hence removing the basis for prefer- ential treatment of Brazilian-controlled companies in public procurement and other matters. Specific legislation had to be enacted to implement these amendments; provisional measures (that is, executive decisions to be later confirmed by parliament) for implementation were expressly disallowed. Parliamentary Approval The constitution or constitutional traditions of a country may provide that privatization must be approved by parliament. This is the case with article 34 of the French constitution of 1958, which states that the rules governing nationalization of enterprises and transfer of ownership of public-sector enterprises to the private sector shall be set by law. IThe constitutions of Benin, Morocco, Senegal, Togo, and other countries with a French legal tradition similarly require that the transfer of majority state-owned enterprises to the private sector be authorized in advance by parliament, by means of a law.4 3. This constitutional clause was used in 1980 to question the legality of a 1967 agreement between the government and ITT, which gave the local subsidiary Indosat a twenty-year exclu- sive operating license for international telecommunications, and to iustify the takeover of Indo- sat by the Indonesian government. See Wells and Gleason 1995, p. 48. 4. Benin: Article 98 of the constitution provides that the rules pertaining to nationalizations and transfers of enterprises from the public to the private sector are a matter of law. Morocco: Article 45 of the 1972 constitution (preserved in the 1992 constitution) declares that "the nationalization of enterprises and the transfer of entcrprises from the public to the private sector" are matters of law. Senegal: Article 56 of the constitution of March 7, 1963, statt s: "The National Assembly shall hold the legislative power. It alone shall vote the laws. The rules concerning ... nationalization of enterprises and transfer of enterprise ownership from the public to the private sector shall be established by law." As mandated by the constitution, law no. 87-23 of August 18, 1987, per- mits privatization of the SOEs listed in a schedule annexedL to the law. Priz'afization nonzd Basic Legal Norms .37 In some countries the role assigned to parliament is defined more pre- cisely. Not only must a law be enacted but it must also contain certain spe- cific provisions. The Paraguayan constitution, for example, requires that the law spell out the procedures for granting the preferential right to shares in the privatized enterprise to which its employees are entitled.5 The constitutions of other civil-law countries are silent on the subject. The principle of parallelism of forms, whiclh requires that the same instrument be used to undo something as was used to create it, would imply, however, that a law is needed to liquidate, and possibly also to privatize, an SOE that had been established by law (see also the section of chapter 1 on the legal status of enterprises). A country's constitution, legislation, or legal traditions may allow the government or other public agencies to priv,ttize without intervention by the legislature. In that case, no enabling legislation is legally required. This is the situation in most of the common-law countries, such as Australia, Malaysia, New Zealand, and the United Kingdom.6 In such systems it is generally considered that, in the absence of explicit prohibition, the govern- ment possesses inherent power to privatize public assets and enterprises without the need for special legislative authorization.7 It must be stressed, however, that enactment of a law may be necessary even when it is not required by the constitution. As the following chapters suggest, a law may be essential in order to amend certaini legislative provisions in force. Tlogo: Privatizations had been carried out without any special enabling legislation. Trte 1979 coLnstitution did not list privatizationi among the matters that are withiin the exclusive juris- diction of parliament. This situation changed, however, witlh the constitutional revisioni of October 14, 1992. The constitution's new article 84 provided that "the rules concerniing . .. nationalization of enterprises and transfer of ownerslhip of public-sector enterprises to the pri- vate sector" shall be set by law. The government prepared a draft law to that effect in 1994. In the end, a privatization ordinance "executed as a law of the slate" was adopted on June 10, 1994. 5. Article Ill of the 1992 constitution stipulates: "Whon the State decides to transfer public enterprises or its shareholdings therein to the private se, tor, it shall conler a preferential right on the employees and other operators directly connected wvith those enterprises. The manner in which this preemptive right is granted shall be regulated bv law." 6. "In New Zealand, unless there is specific legislation to the contrarv, the Government anid individual Ministers of the Government are regarded as having power to sell Government assets. A notable exception is section 11 of the Se) Att, which prohibits the sale or other disposal of shares in companies named in a schedule to the Act (heing the soFs established by virtue of that Act). This schedule included Post Office Bank l.imited and Telecom Corporation of New Zealand Limited, which have since been sold. Before their sale, the SoE Act was amended (in the case oLf Telecom, by the Finance Act 1990) to remove the name of those companies from the schedule to the SOE Act" (Williams and Franks, 1992, p. t 7, para. 200). 7. "The natural reaction of government lawyers is to legislate to achieve the result desired bv the Government. Commercial lawyers, on the other banld, do not normally have that luxury and therefore seek more commercial means of achieving their client's objective. With privatiza- tion, the Government is seeking to turn a Government Business Enterprise into a commercial enterprise operating in the market place in exactlv the same way as other corporations. .. When it comes to legislation, we should legislate to the ininimum degree necessary, rather than the maximum possible" (Sly and Weigall 1991, pp. fi6, h.7). 38 The Privatizat ion Challenge Malaysia and the United Kingdom, for example, had to enact laws to corpo- ratize SOEs organized under public law, so they might later be privatized.8 On the other hand, the objectives of privatization can sometimes be achieved without a law, despite explicit constitutional language requiring special legislation.9 Limits onz the Discretioni of the Goverintet Constitutional provisions may also help limit the extent of the government's discretionary powers regarding privatization. Comparison of the French and British examples is particularly instructive. II) First, the constitutional requirement that implementation of a privatiza- tion program be authorized by law subjects the French government to prior parliamentary control. In the United Kingdom, where this obligation does not exist, the government can sidestep such control unless a law is necessary for some other reason, which has most often been the case (see note 8). Valuation of the assets to be privatized also demonstrates an appreciable difference in constraints imposed on the French and U.K. governments. In France, the Constitutional Council, which is responsible for verifying the constitutionality of laws before they are promulgated,11 has ruled that the constitutional principle of equality among all citizens and article 17 of the Declaration of Human Rights, which mandates the payment of just com- pensation when property is confiscated, prohibit the transfer of public assets to private investors at less than real value. The council judged that enterprises to be privatized therefore had to be valued by independent 8. United Kingdom: Most privatizations have required legislation to turn the SOE into a limited liability company whose shares could then be sold (see the appendcix for a list of these laws). For SOEs already organized under company law, this conversion was not required, and privatiza- tion could proceed without prior parliamentary authorization, as was the case for British Petro- leum (see Graham and Prosser 1991, p. 83). Malaysia: For the partial divestiture of Port Kelang Container Terminal in 1986, special legis- lation "was passed by P'arliament to enable and facilitate the privatization exercise." The port authority did not possess the needed powers under the Port Authorities Act of 1963 to create a subsidiary governed by company law. The act therefore had to be amended to authorize the establishment of KC l (Kelang Container Terminal) as a subsidiary, a preliminary step to the sale of 51 percent of the capital of the new company to KK, jointly owned bv KN (a public enterprise, 80 percent) and l'OAI (an Australian private company, 20 percent). In addition, the Pensions Act of 1980 had to be amended to allow employees of the new company to keep their pension bene- fits accrued while working for the port authority. Seejones and Abbas 1992, chapter 13, notes 13 and 17; see also chapter 4 concerning the corporatization of soI s. 9. In cases where divestiture would require enabling legislation, but the government's pri- mary concerns are speed and ease of implementation, or whiere it wishes to avoid seeking parlia- mentary approval, enabling legislation may sometimes be dispensed with by using a method of transfer to the private sector other than divestiture, such as concessions or leases (see table 5.1). 10. This comparison draws on Prosser 1990(and Grahamii and Prosser 1991. 11. Article 61 of the constitution provides that a law may be submitted to the Constitutional Council by the president of the republic, the prime minister, the president of the assembly, the president of the senate, or a group of sixty deputies or senators. Prizatization annd Basic Legal Normt s 39 experts and that no sale be allowed at a price below that determined by these experts. In the United Kingdom, in contrast, privatization transactions are examined only after the fact by the National Audit Office and the Public Accounts Committee.12 Finally, the French Constitutional Council intervened again to try to regu- late use of the golden share technique by the minister of the economy (golden shares are discussed further in chapters 5 and 7). The privatization laws enacted in France in both 1986 and 1993 provide that, in any company to be privatized, the government may be granted a golden share that would enable the minister of the economy to reject any sales allowing a shareholder to amass more than a given percentage of the company's capital (see box 5.3). The council accepted the constitutionality of these provisions, but only on the condition that the minister justifv each use of this right of veto and the judiciary be empowered to overrule the minister's decisions. In the United Kingdom, where privatization conditions and procedures need not be authorized by law, the rules governing the use of golden shares are con- tained in the articles of association of the enterprise concerned. This contrac- tual arrangement limits the basis for judicial intervention. Some articles of association also contain provisions ruling out appeals of any kind (see sec- tion 40.12 of the British Gas articles cited in Prosser 1990) and explicitly stat- ing that no justification need be given if the government exercises the pow- ers conferred on it by such golden shares (see sections 43.k and 44.m of the Rolls Royce articles cited in Prosser 1990). Clearly then, there is no equivalent in the United Kingdom for the provi- sions in the French constitution that grant the parliament and Constitutional Council some control over the government's privatization activities. The benefits of the French system must, however, be weighed against the costs of procedures that could become cumbersome and lengthy. I3 Cotntroil of Conistitutioniality of Priv'atiZationi Legislationi In France, as illustrated in the previous section, a constitutional court may reviewv legislation before its promulgatioin. In Poland, President Lech Walesa referred to the constitutional court a new privatization law that had been approved by parliament in Julv 1995 over his earlier veto; grounds for referral were that it violated the separation of powers between the executive 12. The distinction between the French and British procedures is narrowing, however, under the influence of European law. For example, the financial terms of privatization transactions can be examined beforehand by the European Commission, pursuant to article 93 of the Treaty of Rome concerning state assistance. Thus the British government, wvhich had undertaken to inject £547 million into the Rover Group at the time o'f its buvout by British Aerospace, was compelled to limit its assistance to £294 million after intervention by the commission. 13. One may, for example, questioni the usefulness of the requirement found in some laws to carry out a systematic valuation of the enterprise in every privatization transaction. These issues are examined in greater detail in chapter 5. 40 S lite Privatizantiou Challc'n'< and legislative branches by requiring specific parliimentary approval for privatization transactions in numerous "strategic" sectors (see box 5.4 and Borish and Noel 1996, pp. 69, 156). The court ruled that this new law was indeed unconstitutional. Constitutional challenges to privatization legislation have become a regu- lar feature in Turkey. In July 1994 Turkey's constitutional court ruled that privatization enabling Law no. 3987, which authorized the government to privatize through the issuance of statutory decrees, was illegal because this power belonged exclusively to parliament. As a result of this ruling, the stat- utory decrees already issued to execute this law also become null and void, and the whole privatization program came to a new halt (see Finainlcial Times, 13 July 1994; Prizvatisation Yearbookk 1995, p. 158). A pruvious privatization law had already been struck down by the constitutional court. On February 28, 1996, the constitutional court annulled parts of Law n1o. 4000 authorizing the sale of up to 39 percent of the shares of Turk Telekom (see Middlet, East Eco- n1om)1ic Digest, 8 March 1996). In India, members of parliament, public interest groups, labor unions, and operators filed petitions with the supreme court contesting the govern- ment's telecommunications privatization policy and the award of specific licenses. The court ruled in February 1996 that policy matters were in the ambit of the legislative and executive branches, not of the courts. It rejected the petitions against the privatization program and upheld the validity of the bidding procedures and the government's powers to grant the disputed licenses (see Jouriral of Coinmmerce, 18 January 199h and 22 February 1996). Lawsuits contesting the constitutionality of privatization legislation or specific provisions thereof, or the government's right to privatize without enabling legislation, have also been filed in other countries. In Colombia, for example, the constitutional court ordered the suspension of the privatiza- tion of financial SOEs in the absence of enabling legislation (Wrivatisation Intcrinational, January 1996, p. 29). International Law The conduct of privatization transactions in a given country can also be affected by the international treaties and agreements to which it is a party.14 Many countries, on all continents, have entered into regional agreements on 14. The text or overviews of international economic agreements can be found in a number of publications, including: Inter,natiooal Economic Lawm Basic Docmi ments, I'hilip Kunig, Niels Lau, and Werner Meng (Eds.), Berlin-New York, Walter de Gruvter, 1989; Basic Documnents of hiterna- tional Economic Lau,, Stepheni Zamora and Ronald A. Brand (EdA), Chicago, Commerce Clearing House, 1990; and Accordis cc(monoiqtes ioternati onaux. RWpecrtoir e s accords et dcs inistittiioi is, l3er- nard Colas (Ed.), Notes et Etudes Documentaires, La Documentation Francaise, Paris, Wilson & Lafleur, 1990, whichi is a useful guide to such treaties and includes the countries that have acceded . Prizatizatiai anid Basic L.egal Nonrms 41 trade, customs controls, or broader economic integration. Examples are the European Union (EU), Mercosur (Latin America), Caricom (Caribbean), NAFTA (North America), and ASEAN (Southeast Asia). Such regional agree- ments often generate supranational law or foster harmonization of legisla- tion in their member countries. The impact on privatization of legal obligations deriving from the EU treaty, for instance, is verv significant, even though the treaty itself is neutral regarding type of ownership.15 The abolition of customs barriers, the liberal- ization of formerly monopolistic markets, and the imposition of common competition rules on private as well as public enterprises all foster the entry of private operators. Privatization is one of the options most governments must consider in order to reduce public-sector debt and deficits and meet the macroeconomic criteria set by the Maastricht treaty for joining the new European currency. Similarly, the scale of investmenits needed to upgrade water and sanitation systems to the newv European standards is such that many governments must draw in the private sector to help pay for and carry out such investments. Furthermore, manv provisions of European law will apply to the implementation of a privatization program. Examples include the rules on merger controls, the prohibition) of state aid to enterprises, and the prohibition of discrimination among nationals of member states of the European Union, which means, for example, that foreign nationals must be allowed to acquire holdings in the capital of privatized enterprises on the same footing as local citizens. Portugal and France were told to amend their privatization legislation to abolish limits imposed on shareholdings by investors from other EU1 member counltries (see box 5.2). Bilateral agreements may also raise special privatization issues. This is the case for the privatization of airlines. Bilateral agreements governing air traf- fic between the signatory states often require that "substantial ownership" or "effective control" of the designated coimpaniies be held by a signatory state or by nationals thereof (see Rapp and Vellas 1992, p. 51). An airline privatization that would transfer control to foreign investors could hence block the application of these agreelments anid result in the loss of some of the airline's main assets, that is, its routes. Thlere are wavs to limit this risk. For example, when British Airwavs wvas privatized a golden share was awarded to the government, which allowed it to oppose anv foreign acquisi- tion of shares. In the case of KLM, particularly strict measures were taken, as indicated in box 2.3: the government holds a call option thiat allows it to regain a majority shareholding if needed; in addition, the bylaws of the company provide that a majority of the members of the supervisorv board shall be nominated by the government. For similar reasons, the Belgian government limited the 15. Articleo222f theTreatv of Rormestates: "Thii Ire.itvs hall in no wayprejudice tile rules il Membesr States governing the systemn of propert, 'e rnership.` See als.o the section of chapter 7 regairding the European policv in the telecommunication'; sector. 42 7 he Priv'atizationl Chal'icige Box 2.3 Impact of International Agreements on Privatization: The Case of KLM K1LM was created in 1919 on a purely private basis. It was not until 1929 that a majority of shares was transferred to the state. In March 1986, on the eve of privatization, the state held 54.9 percent of the company's capital. The privati- zation procedure was original: the company bought back a portion of the state's shares and undertook to resell them, together with 12 million newly issued shares, to a bank syndicate commissioned to place them. This reduced the share of the state to 38.2 percent of the capital. In addition, specific mea- sures were taken to strengthen the government's control over the company, with the purpose, in particular, to prevent jeopardizing the bilateral air traffic agreements concluded between the Netherlands and other countries. The Dutch government signed an agreement with KI-M providing that the state would lose its majority interest in the share capital of KI M as a result of the issue of common shares by KLM and of the sale of common Kl.M shares by the state. A provision was included allowing the state to regain its majority interest at short notice, if that were desirable for reasons of air transport policy or to prevent an undesired accumulation of power in the general meeting of sharelholders. Under the agreement KLM granted the state the option to purchase 1 8,000,000 B preference shares. The State could exercise this option if necessary and rea- sonable, in particular when (a) "under one or more international agreements or one or more licenses granted by whatever country, liimitations or aggravating conditions would be imposed on the operation by KlM of scheduled services because substantial or majority ownership of KLNM would no longer be demon- strably Dutch"; or (b) it is necessary to prevent one person or company or a group of persons or companies from acquiring a stake in KLM that would result in an undesirable balance of power in the general shareholders' meeting. In addition, the government was granted, by virtue of an amendment to the company's articles of association, a majority of the seats on the supervisory board of the company, even though it is only a minority shareholder. The new paragraph 13 of article 20 of KLM's articles of association provides that "the State of the Netherlands shall appoint the smallest possible majority of the Supervisory Board". Source: Rapp and Vellas 1992, pp. 61-91. stake of Sabena it sold to Swissair in 1995 to 49.5 percent of the capital, with an option to increase it to 62.25 percent after the year 2000, when more lib- eral international rules may be in place.16 Techniques of this sort have the merit of allowing airlines to be privatized without requiring renegotiation of the many existing international agreements. The fact remains, however, that 16. See Fintancial Timnes, 28 February 1996. This takeover was approved by the European Com- mission in July 1995; one of the conditions was that new entry take place on the Brussels-Zurich route, wlhere the Swissair group (including Sabena) wouldl othecrwise have had a near monopoly. Privatizatioti tnd Basic Legal Norms 43 the limits they impose on shareholding by foreign investors may well reduce the benefits, in terms of revenue or efficiency, that such privatizations could otherwise vield.'7 Bilateral agreements in many other fields (concerning, for example, dou- ble taxation or investment promotion) can also affect privatization transac- tions by, say, partly covering gaps in the legislation of a signatory country, at least for investors of the other country. Finally, an interesting, if highly unusual, international agreement is the German Unification Treaty of 1990, which pursuant to its article 25 incorporates the East German privatization law, with some amendments, into German law. Conclusion The norms examined in this chapter are generally considered to have prece- dence over ordinary law. They are by and large binding on legislators and governments and cannot be amended except through lengthy and arduous procedures. Specific constitutional provisionis and certain treaties might therefore have to be amended, no matter how onerous this procedure might be, to facilitate implementation of the privatization program. This is particularly so for countries with socialist constitutions. Moreover, constitutional provisions may prohibit the privatization of an economic sec- tor such as natural resources or infrastructure, subject it to special rules and limitations, or restrict foreign investment. In many cases, however, suitable legal techniques are available to allow the legislator or government to cir- cumvent obstacles that may appear to be major constraints. Other constitutions allow privatization but make it conditional on partic- ular safeguards. Thus the constitutions or constitutional principles in many countries prescribe that a law be enacted to authorize the privatization of SOEs (or some of them). Privatization programs may be subject to control by the courts of their constitutionality. Nor should the importance of treaties and other international agreements be underestimated. Witness the impact of bilateral civil aviation treaties on airline privatization and of many provisions of EU law on privatization in member states. Finally, basic legal principles, including constitutional principles, matter because they establish the framework within which all activity (economic or other) takes place. They may inspire confidence or they may promote 17. A government preparing an airline privatization would rarely have the time to renegoti- ate all these bilateral air transport agreements in advance or to agree on a new interpretation. In some cases governments may agree to give a relatively wide interpretation to the terms 'sub- stantial ownership" and "effective control" contained in the agreements they have signed. A lower domestic shareholding could be regarded as adequate in certain circumstances (for example, when it constitutes a minority holding sufficient to block important decisions) See Rapp and Vellas 1992, p. 57. 44 The Privatization Challenge skepticism. A legal system that functions efficiently and guarantees respect for the rights of citizens and economic agents, especially regarding owner- ship and contracts, can only facilitate successful development of a market economy and the privatization process itself. 3 Privatization in a Market Economy A legal environment that fosters private-sector development is essential to the success of a privatization program.1 For example, rules defining and protecting ownership and ensuring fair competition among economic oper- ators, commercial law provisions affecting the privatization process itself (directly or indirectly), or legislation governing the functioning of the priva- tized enterprises wvill all have a substantial imnpact on the implementation of the privatization program. Because of their importance, some of the legal provisions examined in this chapter may need to be amended, suspended, or repealed to permit or facil- itate privatization. For example, measures that discriminate against the pri- vate sector will have to be abolished. Many countries have radically rede- fined the role of the state in the economy to create and maintain a level playing field that allows private entrepreneurs to engage in economic activ- ity free from unfair competition or interference from government agencies. In doing so, they have shifted the focus of state intervention: the public sec- tor is no longer directly involved in productix e activities; it now plays regu- latory and promotional roles.2 As mentioned in the introduction to this book, such a change is equivalent more to privatizing the entire economy than to privatizing an enterprise or a specific economic sector. It calls for major adjustments at all levels; hence, a strong political commitment is 1. Some counltries have attempted to privatize in the absence of minimum rules governinlg the functioning of a market economy That happened, for example, in Guinea immediately fol- lowing thie Sekou Toure era. A fairly large privatization program was implemented in 1XS8-87. In view of the uncertainties of the legislation in force, the privatization agreements had to be ratified by presidential ordiniance, giving theml force ot law. Despite this legal protectioni, the success of the program was less than complete: manv pr vatized enterprises ran inito difficulties in restarting productioni and achieving financial viabilitv. The countrv's generally unfavorable business climate played a considerable role in this outconie. 2. Even in core public services, the traditional role of the state has been radically revisited in many couuntries, with increasingly stronig participatioll Iw private operators in the provisioni of such services. On this subject, see chapters 1 and 7 4. 46 Thev Primatization Challenge essential not only to push through a legislative reform program that includes privatization but also to ensure its effective implementation. Rules that govern business activity in a country need to be reviewed before the launch of the privatization program to determine whether they are compatible with the proposed measures. This analysis should clarify whether the proposed divestiture program can be implemented within the existing legal framework or whether legislation must be modified to allow or facilitate privatization. Ideally, all the laws described in the following sec- tions would already be in place, providing a legal framework favorable to private-sector development in general and to privatization operations in particular. In practice, however, especially in developing and transition countries, the reform effort must focus on the core part of the legal framework that must be in place if the privatization process is to succeed. Any other approach would cause endless delay. The scope of such essential legal reforms will depend on the specific characteristics of each country and each privatization program. The relative importance of the shortcomings or inadequacies identified in relation to this ideal environment must first be established. Needed reforms should then be undertaken by directly amending the per- tinent legal instruments or by incorporating amending provisions in the privatization legislation. These amendments can be either general in scope or restricted to the privatizations carried out pursuant to the law. Many of the topics examined in this chapter have been covered by special provisions of privatization laws.3 This overview of the overall environment for economic activity starts with property rights, followed by competition policy and law. A broad range of laws affecting business activity is then covered, including contract law, com- pany law, accounting, and so on. A special section on social legislation cov- ers labor issues, employee ownership, and pensions. The chapter concludes with sections on environmental legislation, dispute settlement mechanisms, and foreign legislation. Property Rights Property rights are the backbone of a market economy and are normally pro- tected by a country's constitution or constitutional tradition. As discussed in chapter 2, some constitutions or legal systems, especially those of commu- nist countries, do not recognize the right to private ownership. In such cases the constitution will have to be amended to allow privatization to take place, 3. Chapter a deals only with the basic enabling provisions of such laws, namely those that authorize and govern the actual privatization process. Specific provisions enacted in many countries to remedy the deficiencies of the existing legal framnework are addressed in chapters 2 and 4 as well as this one. Priz?atizatiwi i ij a Markct Ecowwmlfnt 47 as happened in recent years in central and eastern Europe (1989-90), the former Soviet republics (1991-92), and other countries, such as Viet Nam (1992) and Guinea-Bissau (1991). In essence, privatization is the transfer of ownership over given assets from a public entity to a private one. Ownership rights are therefore vitally important.4 They encompass a bundle of legally recognized rights, in partic- ular the right to use and control assets (including voting rights), to draw eco- nomic benefits from ownership (return on assets, including rent, interest, or dividends), to dispose of such assets (for example, by selling, donating, or destroying them), and to transfer any of the above rights to others. These rights may be restricted by law, but not to the point where they would become meaningless. Hence, one can speak of full ownership only if the owner is able to exercise these various rights. Earlier reforms in many transition countries carried out before privatiza- tion exacerbated problems with property rights. Under the pure communist model, all property belongs to the state, vet during the transition process various stakeholders were given increasing elements of property rights. Managers and employees of SOEs were, for instance, given control rights that elsewhere would belong to the owners. These acquired rights could not be ignored at the time of privatization. In Poland, for example, the government could not sell SOE assets without the agreement of the workers' council of the SoE. "Attempts by the government in 1990 to abolish this right of veto through changes in the enterprise law provoked strong resistance by the Councils and could not get through the parliament. This shows that the question of ownership was by no means clear and that workers reasonably expected a preferential treatment in the course of privatization" (Albrecht and Thum 1994, p. 714). As part of the corporatization policy of Poland's 1990 privatization law, the state treasury became the legal owner of enter- prises while the workers' councils were dissolved. Successful privatization depends on the ability to transfer free and clear ownership titles. In preparing a privatization program, several items must be unambiguous: how ownership rights are defined in the country con- cerned; how private ownership rights are recognized and protected; what restrictions, if any, are placed on the transferability of those rights; how the titling, registration, and cadastre mechanisms function (or in what ways they are deficient); what enforcement mechanisms exist to protect the rights of individuals, and, particularly, how effective the judicial system is; what restrictions may be placed on foreigners with respect to the acquisition and exercise of ownership rights for certain types of property, such as land or other real-estate assets; and so on. It is important also to ascertain whether proper procedures exist to establish mortgages and other forms of collateral and to determine how effective foreclosure procedures are. 4. This section addresses private ownershiip; i,sues relating to public ownership are dealt with in chapter 4. 48 rhe Prizvaf ization Chlnllegllg Privatization legislation should remove any obstacles that arise when a country's property regime is unclear, ownership rights are not properly pro- tected, or restrictions are imposed on the acquisition of property by foreign- ers or other groups. If that is not feasible, or if doing so would excessively delay startup of the privatization program, other methods for circumvent- ing these obstacles might be considered, including contractual methods such as leasing (see also table 5.1). Past Nationalizations As noted in the introduction to this book, the current privatization wave fol- lows a long period of nationalization of private enterprises and assets. Privatization often reverses these transactions. Ascertaining the rights of former owners whose property was confiscated, expropriated, or national- ized may require detailed investigation. Did expropriation take place legally,5 and do the former owners (or their heirs) still possess legally pro- tected rights over the assets to be privatized? Were they properly compen- sated or indemnified, or do they have outstandinig financial claims against the state? Are there various categories of previous owners, and, if so, have they all been treated in the same way? Are the claims subject to a statute of limitations or some other time frame? This section focuses on the situation of former communist countries, where these have been particularly thorny issues, especially in view of the sheer scope of past nationalizations and the variety of nationalization regimes involved. Should a detailed analysis of these issues be required, and should it reveal that the previous owners still possess enforceable legal rights, a fair balance must be struck between these rights and those of other parties, such as cur- rent occupants or new owners in good faith, taking into account also the potential cost of restoring the situation that prevailed before expropriation. These matters will often have to be clarified or settled by means of law. Some countries have opted for restitution as a way to redress expropria- tions that took place illegally or without proper compensation. This formula may work satisfactorily where the expropriation laws were limited in scope and were applied relatively recently. In most other situations, however, assets are likely to become the subject of conflicting claims that will need to 5. Unfortunately, laws are not always fair. In sonie legal systems, unfair laws may also be ille- gal undercertaincoiiditions. Thietermn legally" mneansin iaccol dance witlh thc laws of the coull- try, whetier they are fair or not. Legality and justicea re two ditterent concepts. 6. In East Germany, for example, some assets were expropriated by the Nazi regime, othiers between 1945 and 1949 under the Soviet military goxvernnment, and still others after 1949 by the East German communist regime. Sonic of these expropriations were carried out pursuant to law and others by arbitrary decisioni of the governminct. Apprepriate compensation was paid in some cases but not in others. Statutes of limitation may appiv. Depending oln the circumstances of each case, the expropriated owiner (or the owiner's heirs) nia' or may not have legally pro- tected rights. Privatization il 7 a Market ICo17oiuly 49 be resolved. In some cases, titles or other documents evidencing previous ownership and transfers will no longer exist. Moreover, the previous owners may be deceased and different heirs may claim the same piece of property. The assets may have been developed, destroyed, or even leased or resold to a private party acting in good faith.7 In Romania, for example, no fewer thani 300,000 claims were filed in the courts as a result of restitution of alternative plots of land to former owners whose original land had, since expropriation, been converted to nonagricultural use (see World Bank 1996, p. 59). To make matters worse, the judicial systems of these countries are rarely able to ad ju- dicate the multitude of claims that restitutioni laws generate. To avoid over- loading the courts and to ensure more uniform treatment of claims, some countries have set up commissions or other special bodies to examine claims made by previous owners.8 Finally, because they foster substantial uincertainty about ownership rights, restitution laws can discourage investment, particularly foreign investment)9 It was mainly this consideration that led the German authori- ties to amend their system of restitution. Indeed, the German privatization law of 1990 initially made restitution the primary method of redress for owners whose property had been unjutstly confiscated. This formula proved to be impossible to apply, however, because most assets were the subject of conflicting claims; the privatization process ground to a standstill. The Ger- man parliament had to enact a "law to remove the obstacles to privatization of businesses and promote investment" tlanN of March 22, 1991). That law added a new article 3 (a) to the 1990 law on the settlement of disputed own- ership issues, authorizing fast privatizationi of assets essential for invest- ment or business purposes, regardless; of outstanding restitution claims. In a statement made in Washingtoni, D.C., on November 14, 1991, Birgit Breuel, then president of the Treuhandanstalt, stressed that new investors able to preserve jobs or provide additional investment should take precedence over former owners. Special provisions authorized the Treuhandalnstalt, for a specified period (to the end of 1992), to sell disputed assets while limiting the rights of the former owners to monetarx compensation from the Treu- handanstalt. This amendment substantially speeded up implementation of Germany's privatization program. 7. As Vaclav Klaus, then miniister of finance of ( ,ech,oslovakia, stated in a letter of June 21, 1991, to a Czech emigre, "It is not possible to ask for the, urrender of property from people who have acquired it from the State in good faith, i e. not through illegal means." S. See, for example, Ghana's 1479 d1ecree setting up a 'Confiscated Assets (Recovery and Dis- posal) Committee." See also Horn 1992, p. 2e, concerning East Germany: "Successful restitu- tions, however, amount onlv to 5 percenlt ofall restitutioll claims Ifiled bvl Spring 1992. More than one million of such claims have been filed, and the great majority has still to be channeled through a special bureaucracy, the offices on open question" of property." 9. See, in particular, Gelpern 1993, ppF.32; 2(-, which refers to a joint statement made in Czechoslovakia in February 1991 by 27 economist. deiouncing the burden placed on foreign investments by restitution laws. 50( The Primtizat inM Challengc Any country that opts for restitution must set a deadline for filing claims. After that deadline, it should be possible to privatize unclaimed assets with free and clear title; the rights of previous owners would either lapse or give rise to monetary compensation by the government."t' Such a measure would limit the spate of postprivatization suits by former owners against the new owners that occurred in Czechoslovakia and other countries, to the detri- ment of the privatization programs. In practice, the choice between restitution and compensation will be based largely on political and historical considerations. In Czechoslovakia, for example, where several laws have been enacted to deal with this matter, restitution was considered necessary to mark a definite break with a com- munist regime which, after the Soviet invasion of 1968, had become one of the most conservative in eastern Europe.'1 The laNw concerning the allevia- tion of certain injustices regarding ownership was probably one of the most popular and least controversial restitution laws, because it aimed at restor- ing assets confiscated from numerous small owners under nationalizations imposed on the morrow of the Soviet intervention of 1956. In Poland, on the other hand, the lack of special legislation concerning the rights of former owners is explained in part by the power of the unions, which are tradition- ally opposed to restitution on grounds of equity. Granting compensation makes it possible to indemnify former owners, who had been illegally or unjustly dispossessed, wvithout all the drawbacks associated with restitution. This route does, however, present other prob- lems. Budget constraints, in particular, can prevent governments from prop- erly compensating former owners, as has been the case in Hungary, for example (see box 3.1). This explains the low popularity of this system with dispossessed owners. Generally speaking, though, compensation is usually preferable to restitu- tion. Paying compensation is often both more efficient and more equitable than restitution. All affected parties can be treatedi in the same way, regard- less of the eventual disposition of the assets they *nce owned. By separating the assets to be privatized from the claims to which they give rise, compen- sation formulas allow the government to privati/e previously nationalized assets unencumbered. The buyers receive clear title, and any residual claims are pursued against the state (or another public entity), not against the new owner. Where appropriate, this system can be supplemented by granting the 10. The Bulgarian privatization law of April 1992 follows this procedurL: previous owners can file a restitution claim withini the two months following the date of publication of the deci- sion to privatize an enterprise. After that deadline, owners can no longer ask for restitution but only for compensation by the state. 11. Law no. 403/90 of October 2, 1990, pertaining to the allex iation of certain injustices con- cerning ownership (the small restitution law) dealt with prnperty confiscated after 1955; Law no. 87/91 of February 21, 1991, known as the extrajudicial rehabilitation law, or large federal restitution law, set February 25,1948 (the first day of the cmrnmnunist regime), as the relevant date for restitutioni purposes; and Law no. 229/91 of May 21 1991, diealt with the adjustment of rights pertaining to land and other agricultiral assets. Privatization in a Market Economy 5l Box 3.1 Compensation of Former Owners in Hungary Hungary is one of the few central and eastern European countries not using resti- tution. Owners of assets expropriated by the state after June 8, 1949 (that is, under the communist regime), had to be compensated under the 1991 compensation law. However, total compensation was capped at 5 million forints (about $50,000) and calculated at regressive rates, using a formula that takes account of location and size in the case of land and buildings and of number of employees in the case of businesses. Moreover, the government did not pav the compensation in cash but in the form of interest-bearing bonds negotiable on the securities exchange and usable for buying privatized public assets (including company shares). A 1991 article in the Washingfton Post, "Hlungary's Compensation Promise Proves Hollow for Many Claimants," stated: "The 'compensation bonds' are viewed skeptically because the government has not specified which companies or apartments they can be redeemed for. Manv Hungarians concluded that they would be offered only the worst of the state's assets. And just getting the dubious bonds is difficult because the government is demanding stringent documenta- tion for each claim.... Applicants must provide an array of documents that are difficult to obtain. Land deeds are essential, but many families lost them over the past four decades. Often the deeds were taken by the Communist authorities." Claims are examined by regional compensation offices whose decisions can be appealed to the courts. In addition, the former owners enjoyed a preemptive right to purchase their former assets when these were put up for sale by the government or some other public agency, except in the case of rental housing, where priority for purchase was given to tenants. Moreover, part of the equity of newly transformed enter- prises or of the proceeds from privatization was allocated to a compensation fund. The choice of compensation over restitution was explained in the preamble to the Hungarian law by the need to develop a market economy, which makes it necessary to minimize uncertainty about ownership of assets. The preamble also points out that former owners are not the only people to have suffered under the old regime. It is estimated that, as part of this program, compensation coupons with a redemption value of over 200 billion forints (over $1.5 billion) were issued to over one million Hungarians. The supply of state assets for which such couponls could be exchanged was, however, quite inadequate for some years, which severely depressed their market value. In early 1994 they were trading at about half their nominial value; brokers or other intermediaries bought them at a dis- count, hired people to stand in line at privatization auctions, and participated in such auctions using the compensation coupons at their face value to pay for privatized assets. On January 25, 1996, whenl Al'\ IR, the state holding alnd priva- tization agency, decided to set aside for coupon holders about 8 percent of the shares in the country's six power distribution companies and smaller percent- ages of other major energy companies, the price of the coupons jumped from 35 to 195 forints; by February 6, they had reached 257 forints, which wvas still only about a quarter of their face value. Soutrces: Finait cc, East E irope, 9 February 19'J%, pp. 9-0(1; Prica (>sa(ioti Xi'srbook 1995, p. 53; Eiromnonuc'i, March 1994, pp. 15-16; Wasihugton Post, 26 October 1991, p. A14. For a study of the main judicial means of redress before the enactment of this law, see "Hun- gary: The Constitutional Politics of Compensation. Soziet & East lErlincwani Lim' 2 (4), Colombia University, June 1991. 52 The PriVmatizotiOln Challen¢ge former owners a preemptive right to, for example, buy back their assets at the price offered by the highest bidder at auction. Future Expropriations Depending on specific country circumstances, investors may demand guar- antees against renationalization before they will commit themselves finan- cially. Acceptable legislation on the eminent domain right of the state, which spells out the government's expropriation powers, is crucial in this respect. In practice, all countries reserve the right to expropriate property, against fair compensation, if the public interest so requires (for the construction of major infrastructure projects-roads, ports, railways, airports, and so on- for example). These expropriation rights must, however, be limited in scope and subject to judicial review. The existence of suitable expropriation legislation does not in itself guar- antee that unfair or politically motivated expropriation will not take place: the legislation may be suspended or amended and the authorities may decide to ignore it. Investors will take due account in calculating their risk of any uncertainty about the powers that the authorities retain to expropriate assets or to amend this legislation. 12 Intellectual Property Investment decisions, whether made by foreigners or nationals, rely on the existence and effective enforcement of laws protecting intellectual property, including international agreements to which the country is a party and domestic laws concerning patents, trademarks, copyright, trade secrets, know-how, and licenses, among other things. The tax laws determine the extent to which revenue from the transfer of technology (royalties, for exam- ple) is taxed by the state. Many countries also have specific laws or provi- sions for the protection of intellectual property in specified sectors of the economy (pharmaceutical products, for example). In privatization transactions, investors will seek not only reassurance con- cerning the overall legislative framework for protection of intellectual prop- erty but sometimes also supplementary protection, which will not necessar- ily be consistent with the country's competition laws. Investors may also resist attempts by the privatizing government to compel them to transfer specific technology or licenses to the privatized enterprise. It is not uncom- mon for countries to simultaneously pursue a privatization program and a program to strengthen protection of intellectual property. For example, in 12. Insuranceagainst political and noncommercial risks can be obtained from the Multilateral investment Guarantee Agency (MIcA) anid also fromi nationIl or private insuranice entities. The World Bank (iioRD) also has a guarantee program covering political risks in the broader sense, including expropriation and noncompliance by a government or other poblic agency with its contractual obligations. Prin'aiz:ationt i/1 a Malarkct Eclmoim 13 1992 Peru embarked on a major privatization program; toward the end of that same year, it also set up a new agencv responsible for the protection of competition and intellectual property. All was part of an ambitious policv for economic deregulation and modernization.1 Protecting and Promoting Competition Yarrow made the point a decade ago already that "in general, competition and regulation are likely to be more important determinanits of economiiic performance than ownership. Hence, wh1ere there are deficiencies in these areas, the policy priority sh-ould normallv be to increase competition and improve regulation, not to transfer productive activities to the private sector. Indeed, preoccupation with the ownership question is likely to be damaging if it distracts attention from the more fundamiiental issues" (Yarrow 19'f86, p. 364). The protection of competition and, more generally, the creatioln and enforcement of a level playing field in the marketplace are among thle mnost important and complex functions of government, affectin,g many differenit areas of economic policy and law and calling for aI higl level of bureaucratic competence. Ireprivatization reforms and restructuring measures wvill often be required to create the requisite competitive environment (see also the sec- tion in chapter 4 on prior restructuring of I{M s). Nonid isc r itiitottiot asgainst the Private Scctor Absence of discriminatio)n between the private and public sectors is an essential part of competition policy and a particularly important factor in privatization transactions. The private sector must be allowed to compete with the public sector on an equal footing. This implies, among other things, removal of subsi- dies, including public loan guarantees, at least in the case of SOEs operating in competitive sectors (public finanice and 'i legislation); harmonization or alignment of the tax systems applied to SOI-s and private enterprises (tax legis- lation); uniform application of environmental law, labor law, and other legisla- tion affecting areas of economic life important to all enterprises; removal of entry barriers hanmpering the private sector (sector legislation); and equal access to public contracts (public procuremiienit regulations). Establislhment and main- tenance of this level playing field must be protected bv law. In some counitries- Brazil, for examnple-this type of guarantee is even found in thl con1stittution. 14 13. 1'ressure b tIhe U.S. government plaved m, sm,11 part in Peru- cftoron. to -trriAgtllLn mechansniss for the protectioll of intellectual p roperk l e A,dc Wall/ s /1r t s1ir, a, F; April 19'4, p. A9. Seealso bo\ 11. 14. Article 173 of th e 198S coinstitutioln pros idis tIhat urL hOC corporatlionl . joint-ven ture coni,- panies, and uther public entities that engage in economiic activitv are subject to the same legal system as private companies, inclucing labor and ta\ tule> (paragraph I ); in addition, public corporations and joint-venture compa nies shall niOt 'Injor ariv tax privileges that are 001 extenidetd to the private sector (paragraph 21 54 Tl17t Priz)atizatio" Chalk',izgt Abolishing preferential treatment for SOEs in public procurement is often a vital component of good competition policy. The public contracting system is important not only from the standpoint of public finances (cost control) and public ethics (fraud prevention). In most countries, the state and the public sector in general, including municipalities, SOEs, and other public entities, are by far the largest potential customers for goods and services. Retaining access to this market is of vital importance for an investor in a newly privatized company. A fair and transparent public procurement sys- tem, consistently applied, is the best guarantee for that investor. Price Liberalizationi Free and autonomous price setting by businesses-subject only to certain limits to prevent or penalize abuses-is essential to the sound functioning of a competitive market economy (see the section btelow on antitrust legisla- tion). Price liberalization should normally precede privatization, especially in countries witlh heavy price controls (central and eastern Europe in the early 1990s and India, for example). Without freedom to set prices, few investors would be interested in acquiring SOI s. Moreover, if an SOF were sold at a relatively low price because price controls were hampering profit- ability, subsequent price liberalization could produce windfall profits for the investors. This outcome would inevitably reflect badly on thie authorities, who would be accused of having sold off the SUE at a bargain price. Moiiopolies andl Anititruist Provisions To deter attempts to restrict competition, it may be necessary to enact laws applicable to public and private enterprises that would prohibit the estab- lishment of cartels, trusts, monopolies, and other restrictive business prac- tices. The introduction of such legislation might block certain privatization transactions that would have otherwise proceeded. For example, the acqui- sition of an SUO or other state-owned asset by one of its competitors could result in excessive concentration. The privatization process should not nor- mally lead to the simple conversion of public monopolies into private ones, or to the formlationA of monopolistic or oligopolistic situations whlere onle or a few companies control the relevant market without any countervailinig checks.15 Nevertheless, the formulationi and enforcemenit of competition rules involve a cost that sometimes outweighls thL benefits they produce. 15. Where natural monoppolies are privatized as such, thev wvill generally need to be regu- lated. This topic is examinied in greater detail in chapter 7, which deals with the privatization of infrastructure. Account also has to be taken of any es1isti1g tarift protecti(oin in evaluating mnioiopolistic or oligopolistic situations (see the section telxLMs oin foreign trade legislation ). Priviatiza th inl a M rAkct Frn mt in 55 The breakup of monopolistic SO;Es prior to their privatization, sometimes called demonopolization (see chapter 4), ought to be considered whether or not antitrust laws exist. This route, where feasible, is generally preferable to setting up a complex system of regulation to prevent abuse of dominant positions; this is especially true in couLntries with less than satisfactory administrative and judicial capacities. 1 In the presence of natural monopolies, regulation will often be indispens- able to prevent the monopoly company from extracting rents by restricting supply of its services and selling them at high prices or otherwise abusing its exclusive market position. In many countries public monopolies have not been subject to regulation, precisely because thev were thought (often wrongly) to serve the public interest rather than the profit motive. Privatiz- ing these monopolies calls for the establislhment of a regulatory framework for those activities that cannot be exposed to competition (see chapter 7). Where antitrust legislation does not exist or is ineffective, specific compe- tition rules mav also be inserted in tender doctuments and privatization con- tracts. Privatization agreements therefore sometimes include provisions that prohibit or restrict the company's potential for horizontal or vertical integra- tion through takeovers. Finally, it is worth noting that enforcement of antitrust or antimonopoly legislation is often entrusted to a speciali/ed competition commission or office, such as the German federal cartel office or the U.K.'s Office of Fair Trading and Mergers anid Monopolies Commission. Sector-specific competi- tion rules, on the other hand, are often subject to special regulatory bodies, as further discussed in chapter 7. Dclrcgiilat7ioii Many countries are burdened by a multittude of rules and institutions gov- erning the exercise of all economic activities. If these countries wish to attract investors, they should streamline these regulations and procedures for obtaining licenses and other official permits required to conduct busi- ness. For example, a rule that required the use of products of domestic origin might prohibit an investor from using traditional suppliers (including com- panies controlled by the investor); the investor might therefore lose interest in participating in the privatization programn. lb. In an article entitled k iforcmigri Ati7iw 7i act Le Ccidral [r Frpc , Michael Reynolds wrote thatdespite the recent enactment in Poland. lungarv and C'echoslovakia of competitioin laws modeled ojn European Communlitv legislation, newly-privatized enterprises will continue to operate in the cOntext of a heavily concentrated distribution system . It wvill take a long time to shake off bad habits acquired over orme 40t ve,1r, in a A stem rXwhere markets were shared out w,vith impunity, complete sector-, were dominated bx a s1cgle monopoly and eiterprrises traded on agreed pricUs fixed bv government ... fundunindeintal question is how effective will the enforcementofthese lawsbe? Many countries bave onipetition laisson the statutebook which are often quietlv ignored or eiforcedli half-eartedlyv F,iucil l,oici S, 26 September l91) , p. 14. 56 The PrizatiZation Challenge Since 1991 India has abolished many industrial licensing requirements in pursuit of its liberalization program. Similarly, as part of a broader economic reform program that includes privatization of most of the country's SOEs, President Menem of Argentina signed a decree in October 1991 abolishing dozens of government agencies, including some of the 36 or so agencies involved in regulating foreign trade, and eliminating the often petty con- trols that beset private business activity (see Financial Times, 1 November 1991, p. 8). Foreigni Trade Legislation Low or moderate external protection (for example, through low tariffs and nontariff barriers) fosters competition through imports. In their negotiations with government, however, investors will often try to have foreign trade legislation either applied or amended to their advantage, something that may conflict with the objective of an efficient and competitive economy. As an example, many investors have sought special protection against compet- ing imports. If a buyer is indeed granted exemption from the normal provi- sions of a country's foreign trade legislation, this should be done transpar- ently and factored into bid appraisal. An investor will obviously be willing to offer more for a company that is protected against competition from for- eign operators on the domestic market. This higher sale price, however, will normally be outweighed by the cost to the economy of granting this protec- tion.17 Investors will factor in more than tariffs and quotas; among other for- eign trade-related issues, they will consider export subsidies, import and export technical controls, and shipping formalities, as well as bilateral, regional, and multilateral trade agreements. Major Aspects of Business Law Laws governing business activity determine how attractive a country is for private investment. They also affect privatization operations directly. Conttract La0t Contract law and enforcement mechanisms for private contracts are a cor- nerstone of the legal framework of a market economy, because they deter- mine how ownership rights are transferred. One of the basic concepts of any legal system is described by the rule of pactc? so lit servanda, which reflects the obligation of the parties to honor the agreements they make. The subject is 17. Guinea, [ogo, and other countries have granted Xvery generous protection in certain priva- tization operations-for example, in the form of high import tariffs oni competing products. Prim tizatit)))ill a Ml7rket Eca tam ii 57 too broad to be studied here. Suffice it to say that contract law is crucially important to private-sector development and to privatization operations, which are always executed by means of contracts, typically tlhrouglh a com- plex set of closely interlocking contracts.1 8 COMn1 porn, a177 1 In principle, company law sets the basic rules for establishing, managing, operating, and liquidating companies. Company law authorizes the creation of companies with different types of legal status (with and without limited liability, joint-stock companies, and so on), grants them juridical personality, sets minimum capital requirements, lays down rules governing the sale or transfer of shares, defines the principles governing the distribution of pow- ers within the company (notably the functions and powers of the sharehold- ers' meeting, board of directors, managemenit, and employees), and so on. Generally speaking, company law empowers companies to depart from cer- tain default provisions of the law and to devise their own method1s of opera- tion, provided the company's shareholders ancd creditors are adequatelv protected. The importance of a good legislative framework governiing the operation of companies cannot be overestimated; this point is illustrated by the difficulties many transition countries have encountered because they lacked such a framework (see Gray and Hanson 1993). Privatization can be facilitated in some instances bv unbundling the rights deriving from SOE shares, for example, bv separating dividend and other income riglhts from control and voting rights, or by limiting the riglhts attached to certain classes of shares. Such modalities mav or may not be allowed, howvever, under existing companv or securities legislation. In some countries, such as Mexico and Jamaica, differenlt categories of shares hiave been issued with different rights; some of the holdings retained by the state in partially privatized companies have been stripped of voting rights wlhile they remain in government hands. A formula of this kind is particularly useful where the government wants to transfer an SOE to private conitrol but does not wish to divest the majority of its shares all at once, either because the capital market is insufficiently developed or because it is couniting on the new private management to improve productivity and boost the value of the stock before it puts a second tranche on sale.19 Likeivise, although 18. Moreover, in some econormic sectors, sLch am h0tel nagement, succestuJ pri\V.ti/tion may depenid on the possibility of concluding and enforcing special types of business contracts, such as management contracts, leasing, or franchi>ing. 19. Some investors may also think that continued state ¸hareholding in thie privatized comil- pany gives them additional comfort by reducing the risk that the companly mav be alfected by adverse governmental measures. No general answ,ver can be gi% en to the qtuestion of Whether continued state participation in the capital oif a privatized companv has a positive or negative effect on investor confidence and therefore on share pri. es. That will diependt largelv on the degree of control the government retains and on its reputation with investors. 58 Thc1 PriuatLatioo Challknge investors may in some instances not wish to mobilize funds sufficient to buy outright control, they may not invest at all tunless they have the right to appoint the company's management team and to designate a majority of board members and are protected by other special provisions, such as a higher quorum and qualified majorities for decisions at shareholder meet- ings. Company law should permit the adoption of such modalities, either by allowing the creation of different classes of shares or througlh other mecha- nisms. This techlnique has been applied in some piivatizationis of large infra- structure companies.2t0 Another technique, one that is much less reassuring to private investors, is the allocation to the state of golden shares, whichi confer powers exceeding those that exist under ordinary company or securities law even though the state may have a minority holding of only one share (see chapters 5 and 7). Another form of unbundling of rights (found in I rance, for example) is that of investment certificates issued by SOFs, wlhichi can be compared to preferred shares without voting rights. The purpose of these certificates was to raise private capital by offering investors an opportunity to share in the enter- prise's profits, but without granting them a correspondling share of control. Private shareholders in a joint-venture company with the government may be entitled, under company law and the company's owni articles, to approve all transfers of slhares to nonshareholders if the government chooses to divest itself of its holdings. They may also have preemptive rights. Where this is the case, the government may wish to consult the other shareholders first to explore the available options for restructuring or priva- tization. Moreover, some privatization laws provide for express derogation from ordinary company law to deny minority shareholders the right to block privatization transactions. 21 It mav be preferable to avoid provisions of this kind, however, because they amount to ii unilateral amendment by the government of a commercial agreement. Privatization can instead be an excellent opportuniiity to protect the rights of minority shareholders. This is particularly important where SOPs are privatized in full or in part by public flotation. I ack of proper protection of minority shareholders, especially small ones, mav either deter their partici- pation or create important political problems down the road. This is true whether the state (or public sector) remains the controlling sharelholder, whether the privatization includes the transfer of a controlling block to a 20. Examples include the privatizationi of Telmex (Mexl(o), MAIAV (Hoingary), and (iANrI'V (Venezuela), three telecommuniicatioiis companiies in wlhich, following a competitive bidding process, a private consortium was selecte d to take over control of the company withi a minority shareholding, with the state remainiing, at least in the iiihtial tage, the maajority sharelholder. See also chapter 7 on the choice of strategic partners. 21. See, for exampil, article 15 of Senegal's 1987 privati/.tion law, wLhiich provides that the provisions of tihe Civil Code requiring prior approval lby the other sharelholders of all sales to nonshareholders shall not apply to share transfers carriod out pursuant to thie privatization law. Priz'atization in a Mnthl-kt Eco mutt(iy 59 single shareholder or group of shareholders, or whether that controllinig stake is acquired on the secondary market following the flotation.22 Preemptive rights can be exercised bv the private as well as public share- holders in a joint-venture company. When public sector shareholders have such rights, one may encounter situations of privatization by omission. The government may decide to waive or not to exercise its right to subscribe to a capital increase in a company; where it has a majority shareholding, that omission mav even allow the company to pass into private control, as occurred in the privatization of Lufthansa, for example. The share of the German state in the airline fell from a controlling 51.4 percent of the capital before the 1994 capital increase to a miniority 41 percent afterward. The rules pertaining to the creation, operation, and sale of subsidiaries, affiliates, and branclhes also influence the choice of privatization technliques. This issue is an important one for maniy reason,s, amiong tllem: (a) the prolif- eration of SOE subsidiaries, subject in manv countries to ordinary company law;23 (b) the existence of state holding companies that are shareholders in a whole series of S(Es; and (c) the fact that private buvers of S(Es are often existing corporations, whlich) may vwish] to imnAe the aCqolired company a subsidiarv. On this point, it is interesting to note that the Treuhandanstalt has been involved in legal controversv concerninlg the extent of its liability for the debts of companies under its control. Indeed, according to German jurispru- dence, a parent company is liable for the debts of its subsidiaries if it inter- venes in their business affairs or fails to keep its assets clearly separate from those of the subsidiaries (see Horn 1992). The situation is more clearcut in 22. A case in point is the gradual divestiture b ts etwn 1987 and 1993 ot the Turkish goverin- nient's shareholding in (;ukurova Elektrik o. r,J,0, an inte! rated power utility. Shares weresold in several tranches, somes through the Istanbul stock exchange. others bv subscriptioin or through block sale. The government's retmaining shires N% crc sold in early 1993 to Rumeli Il-old- ing, a Turkishi family group with broad business interetsts. V A!S became onec of the counitry's most active stocks. In November 1995 management of th compaLny was placed undler thIe coni- trol of the energy miniistry following allegation, of widespread irregularities, incluLinig breach of its license and violation of the rights of minority hareholders The coi trolling Uzani family had used ( r,s's cash flow to) finance its other business interests, includiig the acquisition of cement factories and a mlobile telephone company, whilt dListributinig little or no dividends to minority shareholders. The investigatioll becaC me '- path-tinder cast inll Ipho0lding miinoritty sharehl)]der rights, as well as in regulatio if privati ed t mprani es" tfF,iu;t-kizl 'Jim , 7 No V't' - ber 1995). The Furkish capital markets board appOiintelt a new board, but following a deal struck between the government and the Uzan familk the latter regained conitrol of ci \S in lanti- arv 1996. A monthi later, a Turkish court suspended the new board following a clainm filed by the capital markets board as part of an attempt to force Rumili Holding to buv back the shares ( J,L bought in the cement and telephone companies. See P'ol i I-iic (s'i En,ftii( Tic'l,), 26 Januarv 1996; Powverv A.g ntumaber of countries. Potential buyers in privatization transactions are often less interested in the official accounts of an SOF than in a precise statement of assets and liabil- ities. They wxill in any event want to perform their owni valuation of the com- pany. Thley will waant to undertake a thorough audit of the financial situation of the SOr and will usually place little faith in its official accounts for several reasons: because the country lacks adequate accounting regulations, because the potential buyers are n1ot familiar witlh the accountinig standards (which may vary greatly fronm the standards tlhev are used to), or because the SOF's records and accounting practices are unIsatisfactory (see also the sec- tion on1 valuationi in chapter 5). In the case of a public flotation, on the other hand, individual investors lack both the opportunity and the means to examine the company's opera- tions and accounts personally. They have to rely on financial statements audited and certified by reputable indepenidenit auditors. Moreover, such PrivatiLati Wi in a a Marklt IEc iioiii t l auditing is normally a prerequisite for listing of the company's shares on a stock exchange. The example of Chinese privatizations is interesting. The Chinese authorities have opted for a nunmber of privatization techniques, including public flotations. When a companiv is to be listed on the Shanghai or Shenzhen securities exchange, the accotunts have to be reformulated for that purpose. For companies listed on the Hong Kong or New York exchange, the accounting and auditing rules are far stricter, with the result that the company must take much longer to prepare the accounlts and must seek assistance from internationial accountinig firms. The existence and effective enforcement of accounting rules consistelnt with generallv accepted international accounting principles will improve the prospects for success of the privatization program by increasinig trans- parency and predictability, and thereby reducing the buyers' risk.24 Liquitidatio/i i//Ili Ba7otkr-upl tculz Liquidation and bankruptcy are market-exit mechanisms throutglh wh1ich1 less efficient enterprises can be wound upL and resources released for more productive uses. They are also often used as privatization techniques. Though the two concepts overlap,25 they should be looked at as distinct privatization techniques. The term "liquidationi" applies to the wrinding uip of anl enlterprise wihenl, for whatever reason, its owners have decided.1 to dispose of it by selling its assets, paying off its debts, and sharing the proceeds among themselves pro rata to their respective shares. Throuiglh the liquidation process a gov- ernment can dispose of an SOE by transferring the ownership of its assets (and liabilities) rather than the enterprise itself. In most countries, liquida- tion is regulated by companv law.26 In the voluntary liquidation of a coim- pany, the owner is usually liable for any debts of the company outstandinig after the liquidation and dissolution procedure has been completed. Liqui- dation often facilitates speedy and efficient privatization bv avoidiy,g the formalities and complications of bankruLptcx. For that reasoni it is the pre- ferred privatization technique in manv countries, includ1ing Mexico in the initial phase of its privatization progranm and manv Sub-Sahiaran Africanl 24. For a more detailed discussion of aCcouing Iss us in Frin p)iza /ion, see bdideti/h i 1lon ot Acc'omitii7g Pr1-ollcms Alribig uittriois Pric'ati_c itcou i;i '-lir Coittiwni, Report of thie Secret. r''- General, United Nations Fconomic and Social Council. } /C lI//AC 3/I1L)92/5, 4 l2ebhrUaV 1 '92. 25. The term "liquidation" is used also to describe the stage of the hankrnptcv process in which the assets ofan insolventcompand .re' sold a nid he proceeds distribu led toits creditOrs and, where appropriate, its sharehiolders. 26. Il this context, investors will want to know tisiat ri tes would applI if they decided to liq- uidate their company voluintarily. Would they,, tor eta.nple, encounter restrictions oin sale' of assets or on repatriation of sale proceeds? Restrictioins ,t this kind, which are found in certain regulations relating to foreigin inveL'stmenIt or for-eignj; exchange operations, cai hinider the implementation of privatization operations. 62 The Priniti-fatio ho Cludlenge countries. Liquidation also tends to be the most practical privatization technique for SOEs witlh poor accounts or with unknowni, uncertain, or con- tingent liabilities. Bankruptcy, on the other hand, is not a recommenided privatization tech- nique.27 It has nevertheless been used in privatization operations in Mexico and other countries.28 Bankruptcy differs from liquidation in several ways. First, the bankruptcy procedure is managed or supervised by the courts, usually witlh the assistance of court-appointed trustees or receivers. Second, bankruptcy usually implies that the company is insolvent. The company's managers are sometimes required by law to file for bankruptcy if the com- pany loses the bulk of its capital or is unable to cotntinue to make payments; failure to file for bankruptcy may give rise to prosecution and penalties. Third, the procedure can be initiated by the creditors or the courts (or the public prosecutor), even over the objections of the ownier. The use of bankruptcy proceedings as a privatization technique assumes the existence of a smoothly functioning court system, a requirement that is lacking in many developing or transitioin countries where incompetenit, underequipped, or corrupt judicial institutions often hamstring this critical market-exit mechanism. Lengthy litigation is not uncommono in this area. In addition, many countries lack properly trained bankruptcy receivers to whom the courts can entrust the nmaniagemenlt of companies during bank- ruptcy proceedings. Moreover, since a companiy'.s creditors generally play the leading role in bankruptcy proceedings, choosing bankruptcy as the privatization technlique can hinder the pursuit of objectives otlher thani reve- 27. In Colombia, the assets of f'apelcol, a major paper manii tacturer that was placed under 'concordato" (similar to the "concordat" system in Frenchi commnercial l aw and the U.S. chapter 11 bankruptcy procedure), had to be taken out of bankruptcy proceedings by the ownier itself, a state-owned holding comiipaniy wlhich had becomne Papilcol's main creditor, before they could be transferred to a private company. 28. Aerormbxico was declared bankrupt in April 1988. In September 1988 a new compaly, Aerovias, withi capital of about 544,000(, was created with the bankruptcy receiver and the pilots' uinionl as shareholders. Aerovias took over the airline's operationis and conlMu3ded new contracts witlh the main unions, wlhichl represented a drastikally reduced work force. In the same month the receiver put Aerortnxico's assets up for sale The wiining bidder offered to buy miost assets, wvith tile exception of the aircraft, engine- anl uninleeded spare parts, together with 75 percent of Aerovias, leaving the other 25 percent t(i the pilots' uni)l. The bid also included leasing of the necessary aircraft. The bid was acCepted, and the sale contract was signed in Novemilber 1988. Adapted from Galal and other> 19914 (see also box I ). Followving their privatization, Mexicana and Aeromexico embarked on a commercial battle intensified by the arrival on1 the market of new air carriers. Mexicana rapidly rv into financial difficulties, bur- dened by the heavy debt incurred for 36 Airbuses. In Februar' 1993 Aeromtxico acquired cotl- trol of Mexicana, but did not succeed in restructuring and inte';rating it, and in turn found itself unable to meet its pavienwts in September 1994. The company was theni taken over by a conlsor- tium of crediitor banks, whiichi put in new management In lune 1996, following government approval, the two companies were merged; the government .ppeared to be concerned mainily with the health of the ban ks, whichl converted about SI bilIio n of debt into all equ1itv share of over 70 percent in the new company. See N 'i York 6im'> 6 Se ptember 1994; Will Streit iltuiriial, 3October 1994 and 4 June 1996; Joim nial ilm ebru ,rv 1995. Prinitizatiof ill (7 Mark-et Fojiotiitl p63 nue maximization]9 Finally, in manly countries, including those with cen- trally planned economies, where the great majority of SOE creditors are other public enterprises or agencies, distribution of the assets of a defunct enter- prise can be performed more effectively by the government, which is directly or indirectly the principal shareholder and creditor. It is important to ascertain whether the ruiles governing commercial liqui- dation, bankruptcy and insolvency effectixely applv to SUEs.3i1 If they do apply, one should ensure that these provisions are adequate to deal with potential SUE liquidations, especially from the standpoint of protection of private SOE creditors. The government mav decide to waive certain claims it may have against anl SUE (for example, tax arrears), to the benefit of the SOE's private creditors, especially its secured creditors; or it mav opt to remain legally liable for claims not honored bv the former SOE, including claims filed after it was dissolved. SOEs should as far as possible be subject to the same liquidation and bank- ruptcy laws, regulations, and practices as private enterprises. There is a dan- ger that more lenient rules or unequal application of rules common to both types of enterprises could allow loss-making UOEs to compete unfairly against other enterprises.31 Sudden application of commercial bankruptcy legislation to the entire SOE sector, however-unless preceded by in-depth financial restructuring of the soEs in question (especially those with nega- tive net worth)-could trigger a cascade of bankruptcies that threaten the survival of the government and its reform program.32 The challenge, then, is to strike the right balance between immediate and strict application of the bankruptcv rules to all troubled enterprises, onl the one hand, and a special regime that would allow teclhicalv bilankrupt SOUs to survive indefiniitely, on the other. Hungary, the Czech Republic, and Poland have attempted to meet this challenge in different wavs (see box 3.2). Hun-ary has accorded priority to 29. It should be noted also that effective bankrupti y legislation can represent a threat (or an incentive to perform vwell) for managers of both private lnd public enterprises. This threat or incentive dles not, however, come into play until theI emparnv s situation has deteriorated to tihe p(oint thilat it effectively faces the threat ot bankrupt_C 30. If commercial rules do not apply; the liquidation of si nF may be reggulated by a specialI law. See the section in chapter 4 on SOiI liquidatioin. 31. Crediitors, particularIv state-owned or state-conitrolled banks, may hovever be reluctant to initiate bankruptcy proceedings against w Ws Similarl i- ;it managers and board members often have., nio incentive to initiate liquidatiion procedure-. even it required to do so by law. In many countries, if they fail to comply wvith these legal obligations thevare unlikely to be pun- ished, whereas thev know that initiatiig liquidation will \ erv probably cost them their jobs. 32. Such could be the indirect result of a large-scale prt gram of corporatization of Sotis. The eftect wouuld not be simply to subject these enterprises to private company law; it would also bring them under other areas of business law; such as the bankruptcv laws. This fact is oftenl overlooked, how,vever. by advocates of across-th,-board serporaitization. Ate chapter 4 on corpo- ratizatiOn of 'sl-sh 64 I'~~~~~~~~~~~~~~~~~~lWlt, Privatiza7tion1 Chalclngi,} Box 3.2 Bankruptcy Law: Hungarian, Czech, and Polish Approaches Hungary: The Judicial Route Hungary opted to apply strict judicial bankruptcy procedures to enterprises in difficulty. The law of September 1991 on bankruptcy procedures, liquidation procedures, and settlemenit of accounts required managers to initiate bank- ruptcy proceed1ings as soon as an enterprise fell more than 90 days in arrears in the payment of any of its debts. The law provided for two alternative proce- dures: reorganization (called, deceptively, "bankruptcy") and liquidation. The reorganization procedure gave a debtor 60 days to prepare a plan for regaining solvencv. This plan had to be accepted unanimously by all the creditors, failing wlhich the liquidation procedure would automatically apply. The number of cases submitted to the courts soared from 528 in 1991 to 14,30)0 in 1992, and the increase in the number of enterprises forced to close their doors was manyfold. Of these 14,300 cases, onlv 4,400 related to reorgani- zation procedures; the rest were liquidation casts. Moreover, only one-third of the reorganization cases dealt with by the courts in 1992 effectively led to acceptance of the proposed plan by the creditors. Cascading enterprise clo- sures and bankruptcies had disastrous consequences for the commercial banks. Furthermore, as a result of the enormous increase in bankruptcies filed the courts became completelIy swamped. The lack of qualified bankruptcy judges and receivers-eight judges were responsible for 4,000 cases in Buda- pest in mid-1992-led to substantial delays in handling the cases. To address this situation, the law was relaxed through a September 1993 amendment: the bankruptcy procedure is no longer mandatory but only optional in cases of payment delays; and, for a reorganization plan to be adopted, it needs to be accepted by one-half of the creditors, provided they hold at least two-thirds of claims on the enterprise. By the end of 1994, the assets of about 510( medium or large SOES had alre,idy been transferred to the private sector by way of insolvency procedures. Czech Republic: Temporization In 1991 Czechoslovakia enacted a bankruptcy law, but the law had not, practi- cally speaking, been applied when a moratorium was imposed up to April 1993 on suits filed against state-owned enterprises (this protection was later extended several tirnes). Several technically bankrupt enterprises were included in the mass privatization program, hence the problem was transferred to the new shareholders. The bankruptcy law,,, hoxvever, could not be applied speedy application, by the courts, of strict bankruptcy rules. The procedure prescribed in the September 1991 law had to be relaxed in 1993, however, in an effort to reduce both the mountain of cases submitted to the courts and the number of enterprises compelled to close their doors. In the Czech Republic, the main focus has been on seeking solutions outside the courts and allowing troubled enterprises to be restructured. The risk here is that Prizatizat ion in a Market EcnowniiI p. to enterprises privatized by means of coupons in the two months follo wing privatization. With respect to other enterprises, rather than enforcing the bank- ruptcy laws, the Czech authorities chose to invite investors interested in buying SOEs to propose restructuring plans. The advantage of this svstem is that it does not overload the courts and tribunals and does not trigger mass liquidationis. There is a clear risk, however, of either shifting the restructurinig burden to investors ill-equipped to manage it (the voucher-holding public) or, for those SOBs not included in the mass privatization program, of failing to attract inves- tors and prolonging the burden of the soF on the state. As a result of these poli- cies, few bankruptcy procedures were initiated and even fewer completed. Between 1991 and 1995, only 282 bankruptcy proceedings were completed in the Czech Republic and a further 2,274 cases had been initiated "in stark contrast to the situation in Hungary and Poland, wvhere the number of insolvencies are up to 10 times higher" (Finianitcc Etst Europe, I December 1995). The low Czech num- bers have been attributed to lack of political will to force bankruptcies, ineffec- tive implementation of the laws, and lack of detail'd court procedures. Poland: An Alternative Approach The main Polish bankruptcy legislation dates back to 1934. In addition, the 1981 law' on SOEs, as amended in 1991, and the P'J90 privatization law provide for administrative procedures for SOE liquidation. These laws did not, how,- ever, contain provisions triggering compulsory recourse to bankruptcy pro- ceedings. The courts have had to deal wArith relatively feWv bankruptcy cases under the 1934 law. Significant changes were brought by the 1993 lavw on financial restructuring of state enterprises and banks, which gave banks the principal role in the restructuring of insolvent SOEs. Under the aegis of the banks, creditors are given four months within which to draw up a restructuring programn (concilia- tion procedure), typically involving debt-for-eqniity swaps, or to recommend liquidation through conventional bankruptcy proceedings before the courts pursuant to the 1934 legislation. The creditors' decision is bindinig provided it is supported by creditors with more than 50 percent of outstanding claims. This scheme provides real incentives for out-ot-court reorganization and allows state claims on the SOE to be included in the reorganization plan. Among the advantages of the Polish approach are that it avoids overloading the courts, sets a deadline for formulating a restructuring program, and enables the banks to gain experience in debt valuation and recovery. Souirccs: Gray IYY3a; Nestor and Thlomas 1q,,I ()[( 1) 1)99a: ft,iaiaic E(W P1frop., 1 December 1995. the reallocation of resources to more productive activities may prolong the survival of unhealthv or loss-making enterprises. Poland has opted for an intermediate course: banks with debtors in arrears can choose between (a) a conciliation procedure of limited duration that must culminate in a restruc- turing agreement and (b) application of the bankruptcy legislatio(n by the courts. 66 The Privatiztlti(lo ChInl'1ge Nestor and Thomas 1995 comment thus: "From a comparative point of view, there seems to be a tradeoff between the implementation of effective bankruptcy procedures and the adoption of mass, or 'voucher' privatisa- tion programmes. Where mass privatisation has been chosen, as in the Czech and Slovak Republics, application of effective insolvency procedures has been left to the 'post-privatisation' stage, so as not to delay transfer of ownership. Countries which have followed a more traditional 'sales' approach to privatisation, on the other hand, have been forced to introduce insolvency procedures at an early stage, as an alternative means of enforc- ing discipline on companies which have not vet been moved into private hands." In summary, worldwide experience indicates that recourse to court-led bankruptcy proceedings is not a particularly effective way to deal with insolvent SOEs. In many cases, especially where the creditors are other public sector entities, administrative liquidation is mor' effective and expedient. Where private creditors are involved, safeguards will be needed. Voluntary, creditor-driven reorganization plans may be the most promising approach. Indeed, liquidation of insolvent enterprises is a critical market mechanism, which, unfortunately, courts in most developing and transition countries courts are ill-equipped to administer. Transfer of Liabilitics Most legal systems specifically regulate the transfer of debts and obliga- tions, including contingent liabilities deriving, for example, from ongoing or potential litigation. In civil-law countries, debt transfers are normally sub- ject to the creditors' approval, without which the original debtor continues to be liable. Where privatization is carried out through sale of the original SUE (that is, the legal entity that incurred the debt), -whether by call for bids or through transfer of shares, the privatized company continuties to be the debtor and the situation of the creditors is not fundamentally altered. In some countries, such as Bulgaria, commercial law requires the seller of a company (the state in the case of privatization of an SOE) to give the companiy's creditors prior notice of the upcoming sale; unless the creditors agree otlherwise, the seller remains liable, even after the sale, for debts of the company contracted before privati- zation (see article 15 of the Bulgarian Commercial Code of May 16, 1991). If, on the other hand, the legal status of the SUE is changed-for example, through its corporatization (see chapter 4)-the creditors may not be satis- fied with their new status. The conversion of the original debtor from a pub- lic company with unlimited liability, implicitly backed by the full credit of the state, to a limited liability company organized under company law may reduce the security afforded to its creditors to the amount of the new com- pany's declared capital. Nonetheless, in Sri Lanka, Poland, and other coun- tries, laws governing the corporatizationi of public enterprises expressly call Prieatizatimii ill a Market Ectmnom 6 7 for the transfer of the former SOE's liabilities to the new company.33 On the other hand, Italian law stipulates clearly that in the case of a breakup or demerger of an SOE, for example, the state "shall be jointly and severally lia- ble for any debts of the company involved in the diemerger which have not been paid by the company liable for the debts." 34 Since in many instances sOPs that carry their existing debts antd obliga- tions would not attract any buyers, governments often prefer to clear off these debts either before corporatization of thc Sol (see, for example, article 62 of the Britislh Telecommunications Act of 1084) or as part of the prepara- tion or negotiation of the privatization transaction.39 Moreover, w here the SOF's original obligation was guaranteed by the state (as in the case of a World Bank loan, for example), this guarantee remains in force even if, following privatization, the newv owner is a private entity. Here again many legal systems do not allow th-e state to assign its guarantee obli- gation to a third party without the consent of the creditors. 3h If privatization takes place through the transfer of assets and liabilities and not of the com- pany itself or shares therein, the question of debt transfer may have to be set- tled case by case. For1'ipi bwe'tst,it'ent Letislation) Some aspects of the foreign investment regime concern all foreign investments, wvhile others apply to privatizations in particular. It is important tt) determine, among other things, wlhether the constitution ainld laws of the country properly 33. Si- Lai,,k: The corporatization law ot 19X7 autito,lZes conversion) of SiiFs into joinit-stock companies by adnministrative decision and provides that the liabilities of tht sotl are deemed liabil- ities of the new companv In practice, however, net privatization proceeds in Sri Lanka were lin- ited "because the government incurred considerable costs in settling the accumulated liabilities of PEs ipublic enterprisesl and1 paid compeinsationi to di'.placed workers prior to privatization" (UNCIADo 1995, p. 273.). Peilni,l: Article 8 (2) of the 199(o privatization law pro% ides that a company formed by conver- sion of a state enterprise assumes all the riglts a,nd liabi lities of the enterprise so converted. Ni'i zcahlntd See box 4.2 describing the State-Ow% ned Finterprises Act of 1056. 34. Article 11.1I e of Decree-Law nio. 332 of lay *1 19'I4. On the extent of state liability lor oS debts, see also the section on company laws above. 35. In an address to American, investors give-n in Wash iiigton. D.C., on November 14, 1091, Bir- git Breuel. then president of the Treuhlandanstalt, stated: "With respect to existing debts and envi- ronmental liabilities lof public enterprises to be privati/ed I, we will also nlegotiate flexibly. The exten tof our generosity will depend on the aftractis ene- of y sour proposal.... In and of itsi1f, the purchase price will not be the sole decisice2 factor The arnount of planned investment anld the number of guaranteed jobs is also important to us... t-lince its inception I in th' fall of 199t1. the Treuhanid has on average assumed S5' of the existing debt of businesse which hl.te been prn .va- tized." The Tretilianidanstalt ssas authoriied by the de.bt relief decree of September lo9t) to assume debts contracted by sotis before Julyl 1, lOot) Sealso chapter 4 ,n prior restructurilg. 36. In the privati/.tion of v st' the airline of thi, tate of 73o P'aulo Brazil. this dlifficulty was avoided by recquirinig the buver to repavy sssLts c-redit rrs and isYuIe .a counterguarantee backed bv hard assets to indeminnifv the state in the( event t1he state guarantee ss'as called 68 TIce Prin7fiot"in Cllallk'l;lgt protect foreigni investors;37 whetlher the current systemn discriminates against foreign investors by capping their holdings in local companies (to, for example, less than 20 or 50 percent of capital), ruling out foreign ownership of land (as does article 22 of Bulgaria's 1991 constitution), or prohibiting or restricting their activity in some of the sectors to be privatized;3s wliether the svstem guaran- tees repatriationi of profits and capital; wlhether the foreign investmelnt regime introduces undue discrimination against domestic investors by granting for- eigners tax and customs exemptions not available to domestic investors; whether the rules applicable to foreign investors arc stated in clear terms or wlietlher they are ambiguous and leave the administration wide roonm for dis- cretion;39 whether the regulations governing the relations between a parent com.pany and its local subsidiary are likely to deter foreigners from participat- ing in privatization; wlhether the benefits of the investment code (or similar leg- islation) apply to privatization transactions involving the transfer of ownerslhip of existing assets or only to investments involvinig the creation of new produc- tive assets; and, finally, whether the foreign investment laws and the privatiza- tionl laws of the country concerned reinforce or contrAdict each other. Srvcuritiu's legislhtion, Capital market development is a common goa] pursued by governments in privatization programs. When the program includes share flotations to the 37. Bradil: Article 5 of thie 1988 conlstitution guarantees a vast array of social, econtomic, and political rights, includinlg the right of private Ownership mnd the right to) fair prior compensa- tioni in the event of expropriation by the goxernmenit, but oniv lor Brazilians and aliens resident in Brazil. Nonresident aliens are nolt protected. Article 172 of the constitution provides that "the law shall regulate foreign capital investments, encourage reinvestment and regulate the repa tri- ation of profits, all on the basis of the national interest." Thes'e conistitutional provisions and various other provisionis of the privatization laws and regulations that discriminate against for- eigners have created difficulties for the implemientation of the government's privatizationi pro- grami. In respoise tio the low foreign participation alid disappointing receipts of the first priva- tization transactions, the government relaxed the restrictions (in participation by foreign investors. An'gola: Provisions like thlse of article It) of the 1973 coistitutiol are not particularly reassur- ing for foreign investors either. The article states: "The P'eople'' Republic of Angola shall recog- nize, protect and guarantee private activities and propertI, ev0n those of foreigners, as long as they are useful to the couintrv's economy and serve the interests of the Angolan people." On constitutional restrictions, see also box 2.2, box 5.2, and tiable 73. 38. As part of the preparation of its privatization program, Morocco repealed regulations adopted pursuant to the 1973 "moroccanizatiin" Ian l bV OpCinIg Up the banking, insurance, real estate, and livestock sectors, anid certain commercial and transportation activities, to for- eign investnment. As a result, foreign investmenit rose by 7 percenit in 1991 and a further 3;) percent in 1992. In 1993 the government decided to also lihb ralize tht petroleum distribution sector. See World Equity and tF( 1993. 39. In an article on flungary, the Fiuaulicial TPl's.^ reported that "government publication of a list of strategic companies in which foreign cointr(il would not be permitted may paradoxically have haid a beneficial effect. Clarifying the rules has made Officials less hesitant." Fillnmcial Timc1's, 301 October 1991, special section oni fHungary, p. VI I. PriVl tiZiltio)l ill a Markct Ecouoinyif 69 public at large (or at least to a large number of investors), buyers should be able to trade their shares on a secondary market. This does not, however, necessarily call for an organized securities exchange in the conventional sense of the term (that is, one with a trading floor, and so on). All that is required for a secondary market to exist is a system that allows private par- ties to transfer shares freely to one another and to obtain registration or rec- ognition of the transfer bv the issuing company. This market also needs to be regulated to protect investors.4') Although an established and properly structured financial market can facilitate privatization, it is not essential to the success of a privatization pro- gram. The absence of such a financial market will, however, narrow the range of available privatization options. Trying to set up such a market as a financial intermediary for privatization transactionis wvould usually mean deferring privatization longer than authorities can wait. On the other hand, it would be desirable to enact basic securities legislation oni the issuance and trading of shares and also on the operations of financial intermediaries (banks, brokers, traders, and so on). In the United Kingdom or France, w here structured financial markets already existed, privatization was instrumental in further developing and deepening of these markets by boosting total market capitalization, transac- tion volume, and liquidity and by encouraginig participation by new share- holders. France demonstrates also how special provisions might be inserted in securities legislation to facilitate the privatization process. The French securities exchange regulations have been amended to authorize the proce- dure knowni as book-building, whlich lets the investment bank or financial intermediary selling the state's shares obtain revocable commitments (decla- rations of interest) from potential investors before the actual subscription period. Preliminary approval can now be issued by the securities agency, allowinig the book-building operation to begin; a second authorization is issued only when the prospectus is finalized and the selling price of the share is determined. Reciprocally, the development of local capital markets can foster the suc- cess of privatization, especially by boosting the ability to mobilize local savings and therefore reduce dependenice on foreign capital. It is impor- tant, however, not to try to go too fast by flooding a newvly organized and small financial market with shares. The flotation of shares in Poland's Slaski Bank, described in box 3.3, illustrates the point. For lack of sufficient staff, registration of the shares of the Slaski Bank-a prerequisite for the sale of shares-fell far behind schedule; hundreds of thousands of share- holders found themselves prevented from selling shares when the price of 40. Under Crechoslovxakia's mass prix atization program (see chapter 9), a large number of shares had1 been placed on the market before Januarv I, 1993, the date thie securities law entered into force, without any accompanying prospectus fr the information of investors. Subse- quentlv, however, companies responsible for these share issues were forced to regulari/e them by publishing a prospectus a posteriori (see Goldstein ,nd H lorakova I993)3 7() TIit' PrivatiZation Challicgt' Box 3.3 The Flotation of Slaski Bank The privatization of Slaski, a major Polish bank, was one of the largest opera- tions in Poland's privatization program. Nearly 8&)(),0 persons bought shares in Slaski Bank, and these were listed on thie WarsaW securities exchange on Jan- uary 25, 1994. Very few investors were in a position to trade their shares that day, however Indeed, shares could notbe sold unless they had been registered, and the registration process had fallen far behind schedule. This delay was caused by a shortage of qualified brokers able to perform the registration (fewer thani 4(0 broker licenses had been granted in Poland). The delay was largely responsible for the substantial fluctuations that occurred in the value of Slaski shares. Owing to the lack of tradable shares, oniv (0.35 percent of the total shares changed hands on the first day, while the valuie of the share rose more thani thirteenifold. The price theni fell, causing frustration among many share- hiolders who had becn unable to sell. For hiaving floated these shiares on the exchange before most of the share- holders had an opportunity to register them, Slaski Bank, which itself lheld a broker's license, had its license revoked bv the securities commission. The commissioni gave Slaski six monthis to terminate its brokerage operations and asked the remaining brokers, wlho) were alreadv having enormous diffi- culty satisfying their owin clients, to continue Slaski Bank's activities in this field. Sortnrc': Fiuit(itc 01 Ttc,>, 7 FebrLary 1994 anL1 18 I r ikbur I 994. these shares was fluctuating widely. Problems of this kind hurt the credibil- ity of the privatization process in general, and they may alienate private investors. Measures can be taken to strengthen financial markets. Several govern- ments have decided, for example, to promote the development of large domestic institutional investors that can participate in the privatization pro- gram as buyers. In Italy various legislative measures were enacted to allow finanacial markets to play an increased role in the privatization process: pri- vate pension funds were authorized; a new Law nio. 344 of August 14, 1993, regulates the creation of mutual funds; and amendments were made to a 1936 banking law to allow banks to acquire Lup to 15 percent of the shares of industrial companies. The role of pension funids in this context is discussed further below. More generally, reforms that increase seconidary market liquidity and remove barriers to corporate takeovers should coontribute to better corpo- rate governance. Such reforms may be particularly relevant for countries with large mass privatization programiis or employee ownership schemes, wvhere established managemenit teams may have few incentives to provide value to their atomized shareholders (see also ESBLD) 1995, chap. 8). Prizvti:a tizOio iin a Ma t i rkctEontiit ,1 Banking Financial legislation diealing not only withl banking but also with collateral and sureties, credit, leasing, insuraice, and so on may affect the success of a privatization program. A sound comnmercial banking system is essential for mobilizing savings and financing economic activity. Efficient banking Imlecih- anisms make it possible, in particular, for investors to finance tiheir opera- tions and working capital and make speedv payments.41 Most privatizing governments have had to Strengthen their bankinig legis- lation so that commercial banks can play their role in a market econlomv; stronger mechainisms for bank supervision and adherence to interinationlal standards (including key prudential standards established by the Bank for International Settlements) have often been part of such reforms. I3anking legislation may also need to be amended to facilitate the implementation of the privatization program, for instance, bv enabling commercial banks to act as financial intermediaries for share issues in countries whiere no formal securities markets exist. Furthermore, banking laws mav need to be amended to allow the privati- zation of commercial banks themselves. In Pakistan, for example, the bank- ing law was amended to allow the privatization in 1991 of Muslim Commer- cial Bank and Allied Banks of Pakistan. On the other hand, the 1990 law that authorized bank privatization in Italv wvas not followved by Imluchl action to remove the Italian banking sector from overwhelming state control. In most socialist countries, the centrail bank acted as a commercial bank and no private banks were allowed. New legislation typically remiioved thie central bank's commercial banking activities and transformed state-oxwned banks into corporations. In flu-ngary, for example, bankiig reform vwas initi- ated in 1987 with the transformation of the lend1iniig departments of the ceii- tral bank into separate new state-owned bainks, which togethier vith two preexisting large state-owivned banks domi nated the commercial banking sector; 1987 also saw the first foreign-oxvned banks established in Hungary. The new law oni financial institution,s enacted in November 1991 authorized the privatization of state-owned banks, while limiting ownership by any one shareholder to a maximum of 29 percent (see sectioni 18.1 of Law, no. -r9 of 1991 on financial institutions). Restructuring of the banking sector is often hindered, especiallv in counI- tries whlere state-owned banks dominate, by luge noinperforiniig loanis t often insolvent public enterprises anid agenicies. In suchi cases bank reform becomes closely associated withi sOr reform in genieral. sot; rehabilitationi or privatization programs usually call for hardening the soi: s soft budget con- straints by ending privileged access to credit from banks controlled or guar- anteed by the state and bv forcing comimlercial banks to bear the full risks 41. An analvsi-, of the main issues in bankimg-wector reformi and privatization exc\edvd I he scopeofthivs ork but see Borish, Long, and Nocl NI' Lhorne I1'3; arllresnc 92). 72 Thc Pri'at tizati(v, Cl elult'l,t' associated with SOF lending. Restructuring and privatizing the banking sec- tor can hence greatly facilitate the entire privatization program by limiting the ability of soEs to incur additional debt. Meanwhile, a solution needs to be found for the banks' existing portfolios of noniperforming loans. Some countries, including Hungary, have cleaned up their banks' balance sheets by creating special-purpose companies to take over nonperforming loans, either as a self-standing restructuring measure or as a step toward subse- quent bank privatization. Others, such as Slovenia, have created a bank rehabilitation agency to take over all the troubled banks, while vet others have recapitalized the existing banks. Restructuring and privatizing banks should normally take place at the start of the reform program, for a healthy and dynvamic banking sector should contribute to the development of economic activity. Doing so, how- ever, can be complicated, politically difficult, and expensive, a fact that explains why some governments have preferred to leave the banking sector untouched in the initial stage. If not properly designed, bank privatization could cause privatized banks to become overextended, which might prompt another takeover by the state in order to avoid a major crisis in the financial sector, as happened in Chile and Mexico, for example. Taxation Investors and potential buyers are naturally concerned about the overall corporate tax burden and the predictabilitv of interpretation and enforce- ment of the tax laws. Businesses should be able to determine what taxes apply to them and to estimate the amount of the taxes they will have to pay. Certain techlnical aspects can also be important. They include the rules gov- erning transfer pricing between enterprises of a group (for example, betweeni a local company and its parent or sister companies established abroad); the rules governing the carrying forward of tax losses, which can greatly influence the choice of privatization technique;42 the tax treatment of loan interest and dividends; the tax implications of employee shareholding plans, leasing, franchising, and other privatization mechanisms, which in many cases will determine the chosenl technique; and, finally, the rules relat- ing to double taxation. The tax laws should be applied uniformly to private and to public enter- prises and tax advantages granted to SOEs in the competitive sectors of the economy should be abolished. Whether governnmenits should give special tax advantages to privatization transactions-for example, in investment legislation or in express provisions of the privatizatioln law-is a question that might arise. Although exemptions from stamp and registration duties oni share transfers will not usually affect governmnent reveenues seriously or 42. If the newv owniers are eligible for such carryovers, a loIss-making sol can be quite an attractive prop(osition. From the government's point of v iew, hiowvever, the highier sale price is offset by lower tax receipts in subsequent years. Prim tizatioui in a Marike!t Ecnom wny 73 give the beneficiaries a major competitive advantage (see, for example, arti- cle 15 of France's privatization law of August 1986), the same may not be true of temporary exemptions from corporate income taxes. Such exemp- tions are granted, for example, in Tunisia, where article 31) of Law no. 89-9 extends very generous tax benefits to privatized enterprises, notably exemp- tions from corporate income and capital gainis taxes (see also the section of this chapter on foreign investment). Similar provisions exist in the Philip- pines and other countries.43 ClurrencYa in!it Forcigni Exclhnalge Restrictions on foreign-exchange transactions, including allocation, availabil- ity, convertibility, repatriation, or registration of foreign exchanige, will gener- ally hamper efforts to attract foreign investors. In countries that dco not have a stable and convertible currencv, restrictions on domestic payments in foreign exchange, particularly remuneration of expatriate staff, pavments to domes- tic suppliers, and payments by customers ma' also be cause for concern. In the specific context of privatization operations, some governments have felt the need to establish a special, less favorable exchange rate for for- eign investors bidding on SOIs or their assets in order to offset what they perceived as an artificially depressed exchanlge rate, whichi would allow for- eign bidders to buy assets significantly below their value. Formulas of this kind should be avoided; they tend to be easy to circumvent and difficult to administer. This is true also of multiple exchanige rates of the kind applied in Russia, where the rate for foreign investments was about ten times higher than the market rate.44 Social Legislation The social climate of a country, including its labor legislation, pension regime, and social safety net, and of an enterprise is among the major deter- mining factors in any investment decision.45 The privatization program may contribute to a healthy climate bV involving emplovees in the preparation for privatization (see chapter 1), giving them the opportunity to become shareholders in their enterprise, and protecting workers' rights, while 43. Section 35 of the 1986 privatization law exempts the Asset l'rivatization Trust from all taxes and duties (including stamp aLid registration fees, trantfer taxes, and capital gains taxes) on the transfer of assets from government institutionlls to the trLut andl from the trust to private huvers. Thearticlealsoexempts such sales or transfers from all n -tnctions orconstraints that could derive from "the existence of any liens bv t,av of ,ave, chl,rge, or other assessmllelnts in favOr of the gov- ernment at the time of sale or transfer: provided, that the proceeds from such sale or transfer shall be subject to a tax len and first be applied to satisfx uch obligations, secured bv said liens." 44. If the purpose is to give domestic innvestors tl edge over toreign investors, this could also be achieved by' assigning a margin of preference to di(ttle%tlc bidders. 45. See World Bank I 995a, especially part fottr, fion' Calo Policy Cthoices Hlelp Workers in Periods of Major Change? 174 Hi,' Privatization Clfcny,alin avoiding unsustainable settlements or labor standards. Privatization can also be an opportunity to strengthen social legislation. Labor Legislatitl The labor regime applicable to SOF persoinlnel can be more or less conducive to implementation of the privatization program.46 First, public sector employees often enjoy special civil service benefits.47 These will normally have to be repealed and may be replaced by other, private-law benefits granlted by the nevw company. Plension entitlements are a case in point (see below). Similarly it may be necessary to confirm or modify other contractual (or statutory) rights of employees, including, in particular, wage levels, seniority rights, and other benefits. In manv cases the relevant legal princi- ple will be whletlher or not the employment relationslhip continues.48 Privatization agreements for enterprises or activities that are not trans- ferred as a going concerni-an SOF that will be liquidated, for example-may nonetheless provide for continuation of the contracts of selected employees. Under existing labor legislation in some countries, employees could be enti- tled to severance pay from the sot even if they are immediately rehired by the new company. In others, the above-mentioned principle of continuity in the employment relationship, legislation embodyinlg that principle, or spe- cific contractual provisions may prevent such double-dipping. Employees not relhired by the new company would continuLe to be formally employed by the old sol, wlhichi continues to exist legally uLntil it is dissolved even though it does not carry on any activity; thleir contractual or statutory rights are then settled as part of the liquidation process (see chapter 4). Labor law provisions determine the flexibilitv the investor has to set employee salaries and benefits, to hire and lay oft staff (including foreign staff), 46. In Brazil, ports wvere governed by 1937 legislation that ledl toCosts among the highiest in the world In January 1Q92, referring to privatization of the ports, tlie president of tNID\7S (the agency respolnsible for coordinatinig Brazil's privatization progrim) stated that the first priority was to modtierniie tile legislation 'or we shall never find huvets." In Februarv 1993, after two years of discussion, parliament enacted a new ports law. More than a year later, little progress had been made. implemilenitationi of the lawl had been frn en perlding a Ullionl appeal to the Snupreme Con rt on the constitutionality of the law. The on ilnS ale topposed to tra usfer of control of he ports to thIe Users, w I ich xvonIICd reduce tle uli Lioii role to le sOlIe function of representing their memribers in cotllective bargaining. Under the prnviou. regime (which is still being applied), the Unions decide the number andi identitv of the dcok kers assigned to loadi or uniload each vessel, and only affiliated dcockers can oibtain wN ork See I nanciti Timns, 21 January 1992, p. 24; lcilol of C,m,ncrcc, 15 April 1994. 47. In France, tor e xample, employees of thie n,ttional electri, ity company 0lt it) and of other SOI5S, i-sunlike their private sector colleagues, pay sociil se, urits taxes oin their base salary only and 110t o1n their iitv add itional benefits. 48. In Moroc co, for exawmlple, there is a legal presuimilptioIn ot continluitv of the employment relatiolshilip, despite ch1an1ges in the employers status, le it as a result of successioni, sale, tierger, split-up, a b-orphoiini transformati on, or othernviss "alt la bor contracts in effect on the day of sucih change remiain in f(orce betwveen the newVN emploeVr anld the staff ott tht enierprise" (article 734 of the O bligations and Conlracts Code). Priva tizathioh ihi a Markct FcI '111(11 i, 75 and, in general, to manage the enterprise's human resources. If overstaffing is severe, potential investors may well require that the government or the SOE lay off redundant employees before privatization, e specially if the legislation or the social climate makes it difficult for private employers to dismiss workers.49 The rights of laid-off workers, inclucdilng severance pay and1 unemploymelt benefits, mav vary significantlv depending on whether tlhey were laid off by the new private owners or by the ScOb before privatization; in the latter case, there will also be a difference depending on wvhether these workers were gov- erned bv general labor legislation or bv special puiblic-sector legislation. Tradeoffs may be necessary between the protection afforded by labor law to incumbent workers and the need to create nevw jobs. In Germany, for example, ordinary labor law restricts the acceptable grounds for dismissal; parliament has granted buyers of privatized eniterprises temporary exemp- tion from such restrictions, however, to facilitate implementation of the privatization program.5() On the other hand, the Treuhand has inserted a binding undertaking in many privatization contracts, unlder whichi the buyer guarantees to keep or create a specified nuLmber of jobs in the priva- tized company, subject to penalties (with the penialty amount specified in the contract) in the event of default (see Horn 1992, p. 19). Such a negotiated formula is generally preferable to protecting jobs by prohibiting all dismissals following privatization. In Pakistan, for example, under an agreement between government and unions, new owners were prohibited from laying off any emplovees in thie 12 months followinig priva- tization of an sor.5t In Malaysia, buvers oould neitlher modify the terms of 49. Staff reXductions at the P'eruvian airlint Aeroperu to ok place bef,,re privatization: its wvork force of 2.3ff)) for sv\ aircraft in 1 99l0 (a ratio of over Isto employees per aircraft, compared with a normal ratio of l(ott or 1 5( to oine) was reducedL to 901S b1y thIe time Of its privatiZation in January 1993. Also in Peru, the staff of the Cerro Verde miniie was reduced by1 half before its privatization in November 1 9-P. See wislimt,tou Post, 8 Deceniber 19-1 ilIe work force of thieM VeneZuelal air- line \ i AC 5, whichi had no less than 45tl emrpliv ec per ai rraift hti ir it' pvri-atizatii in i1n 19 had been reduced to 215 ;per plane two yearrs later R). A March 1901 law proviies for temporart exemption 1romm 'section lf 3 (a of thie (ernial Civil Code, which provides that the purchaser of assets constituting a husiness assumes, by operation of law, the employmiienit rights and obligation'. exiSfing at the time of the purchase. A change in control through an acquisitioin does not clnstitute 'cause' for thle dismissal of emplovees... The above-mentioned exemrption pr sIde'. that through DfeceLmrbr 31 I19'2 Sec- tion 613 (a) will not apply' in the case of acquisition' (it insoilvent eastern ( erma n busiitesses'' (Jones Day' 19, p. 3). See alIso note 14 in chapter 1 51. This prohibitioni, which ran through Pakistan's enritire 109)]-9* privatization program, stenimimed froiml an agreeiment betveenl government and unions, thie terims of wvlhichl were then) incorporated into bidding conditionsand sale contracts. Similar agreements were reached in 10]95 to stem laboro pposition to privatizatio n of parts of n sit theu wnaterriad powerstit ); for instarnet' the goverilmienit guaranteed the jobs of all tnmplovy,s of t' first power plant to he Oltld fit Kot Addu) and improved their pav and other working C0nditionFs before privatization. Tt'F situation was eveln miore acute wvith the second phase of the pri\ oi/ation of Sui Noirtherin Gas l'ipchlne, where tht' financial advisers COmplaillned about "substalntial politically inspirtd recruitmenlit" in 1995 antd wrote tfi the privatization commission about thl lir "'inlbility to explain such larget-scale job-crea tuin to prospective invt'stors" f()rt Ic/iI'i/U!. \ i N,tmbe'r I 905) 76 Tlhe) PrivatiZatimi Challcnge the employment contract nor dismiss employees of the privatized enterprise for five years after privatization. Similarly, in Sri Lanka, since March 1992 new owners lhave been required to extend the same benefits to employees, up to retirement age, that they enjoyed before privatization.t2 Uniform requirements of this kind make the privatization process unnecessarily inflexible and expensive. Nevertheless, some governments see them as essential for gaining the labor support deemed necessary to push through privatization. But the impact of uniform requiremnents has to be analyzed also in terms of the sometimes unsustainable precedients set for the economy at large, including the private sector. This mav be less of a problem, how- ever, where SOE wages are low in absolute terms as well as in relation to wages paid in the private sector. In industrial countries, labor legislation has been at the center of contro- versy in privatization programs. The case of France Thl6com is instructive. This enterprise, a central government service before 1991 and an autono- mous public-law establishment since then, is being transformed into a lim- ited liability company as a first step toward partial privatization. The con- version of France Tel6com's personnel from a civil service to a labor code regime and the fear of privatization-related layoffs have been a major stum- bling block, as evidenced by the postponement of the submission of the cor- poratization bill to parliament, following strong union opposition sup- ported by a strike in October 1993. The governmenit tried againi to take steps in preparation for privatization, which led to new strikes in December 1995 and April and June 1996, though each successive strike was observed by a decreasing number of employees, reflecting in part the concessions already made by the French government, including gtuarantee of civil service status and job security for employees and a commitmetnt that the company will remain at least 51 percent state owned.53 In Italy, a similar labor issue was settled at the time of transfer of the activ- ities of ASST (a government service) to Iritel (a private-law company) by 52. At the start of its privatization (peoplei/ation) program, Sri Lanka opted for a volunitary resignation bonus formula. This contributed to a drop in productivity because the best workers opted for the scheme and moved on to other jobs; the scheme had to be abandoned because too many employees wanted to avail themselves of it. The number of categories of eligible employ- ees was then reduced, an action that created social tension. The government finally decided to introduce a two-year protectioni against all dismissals, before extending this protectioti up to retirenmen t age. See UNC IAD, Report to) the Third MWstin1 of the W'rking Cormnroittei on Privatiza- tmos, Geneva, November 29-December 3, 1993; l'rokopenko 1995. 53. France is n(ot the only country whose telecommllunicationls privatizationi program has been blocked by social action. Other countries where this has happened include Colombia, where the discussioni of a bill to privatize the telecommunications comprany was suspended in April 1992 following major strikes bv the company's employees; Germany, where the posta1 service unioins held demonstrations and strikes to protest restructuring and.l privatization of postal services and telecommunications; and Greece, whiere unioni oppositioin and industrial action blocked theprivatizati(n of,49percentofoire in 1993, contributed to [tie failureofa subsequentattempt tO sell 25 percent in 1994, but failed to block the flotation ot S percent of o lts stock in March 1996 (see also the section on public flotation in chapter 7). Privatizatioin in a Markt-t Ecot trinn 77 allowing the personnel affected to choose either to join Iritel or to be reas- signed within the civil service. Of the 12,600 employees, 2,600 chose to remain in the civil service, about 1,000 took early retirement, and the rest opted for transfer to Iritel (see Gioscia 1993). In Belgium, the maintenance after privatization of the special civil service status of Belgacom's existing employees, national labor laws perceived to be restrictive, strong unioniza- tion of Belgacom employees, as well as unfunded pension liabilities exceed- ing $3 billion, were mentioned to explain BT's decision to withdraw from the bidding, but did not prevent two other consortia, including one led by win- ner Ameritech, from making bids (see Fiinancial Tinies, 12 December 1995). Finally, the scope of the employees' rights in the company, notably union rights and representation on the board of directors or on other managemenit organs, mav also affect privatization and investment decisions. If regula- tions governing union representation in SOEs differ from those governinig private companies, it may be necessary to negotiate transitional arrange- ments with the unions concerned. A major reason for initial union opposi- tion to Mexico's rail privatization program, for example, was the govern- ment's proposal to set up separate unions for each privatized rail company. Most privatizing governments have tried to involve workers and their unions in thie preparation and implementation of the privatization process. Enmployee, O 'nersiNp Whereas potential layoffs have tended to create labor opposition to privati- zation, potential employee owi-nership has hadl the opposite effect. A recent study on privatization in Poland illustrates the link between worker support and the extent to which employee ownership is likely to yield tangible bene- fits. Workers' councils in poorly performing firms (with a higher likelihood of bankruptcy or liquidation) generally opposed privatization and pursued aggressive wage policies. In the better performing SOIS, however, "the promise of participation in the privatized firms reduced the incentives for workers to carry out an excessive wage strategy" (see Albrecht and Thum 1994). Employee participation led not only to support for the privatization program but also to more reasonable xvage demands. Legislation may provide tax or other incenitives for the establishment of employee stock ownership plans (ES01's) or encourage other forms of worker participation in the ownership or control of their enterprise.54 Fur- thermore, many countries have earmarked a block of shares in enterprises to be privatized for subscription by their employees, antd in some cases 54. "Typically, an rsoll is structured as a separate legal entity to which a corporation sells shares.... What distinguishes an 11EOI' from other einplovee ownership programns is that shares are paid for partly or fully out of future corporate earnings-.. An ESOI' is largely a set of 'nles' governing the acquisitioni, allocation, and management of shares held for emplovees" (Gates and Saghir 1995, pp. v, 1). These authors mentioni lamaica, Hungary, and Pakistan among the countries that have used the FsAI techliique in their privitiiatioi program, See also Silithi 1994. 78 Th) Prtri ati ZtiO CIiallhtgc employees hiave been given incentives to take over their company. Employee participation in privatization typically figures among the key provisions of a privatization law (see chapter 5). Pension DEutitfflcnfts Investors also need to ascertain the situation of sol employees who contrib- uted to public-sector pension and insurance schemes. The conversion of their accumulated rights and benefits to a private scheme may be required as part of the privatization process. This often becomes a major stumbling block, especially wlheni the public pensioni system is not vested and self- financing and the government lacks the funds to transfer accumulated staff benefits to a pension fund. Some Latin American counitries have dealt with this problem by issuinlg state bonds anid hianding them over to the private pension funds. In Germany, a dispute between the government and Lufthanisa concerniing financing of the company's retirement obligations had to be settled before the privatization of the airline could proceed.55 And pensioni financing turned out to be one of the most delicate issues in the restructuring of the German post and telecommnuniications company (see the section on prior restructuring in chapter 7). The problem of transferrinig staff from a public to a private retiremenit system is a common one in privatiza- tion operations.56 Penisiotn Funditl Reforuii A privatization program can also provide the impetus to transform a typi- cally state-run, centralized pension system into a private, more decentral- ized one. The portability or transferability of pensions of employees moving from the public to the private sector or from one private enterprise to another may need to be facilitated. More professional and efficient manage- ment will often need to be broug,ht in to manage these growing finalncial assets.57 55. Nonparticipation by' the state in the increase in ILufthansa's capital would reduce its share in the companiy's capital from 51 4 percent to 41 percent. Once this share falls below 5() percent, the government is no longer under the obligation to contribute to the employees' retiremenlt funid. The agreement reaclhed provides for withdrawal by L ufthansa from [he public pension fund and the creatioln of a new fund, to be financed bv l.ufth unsa. The amount of the capital to be invested in Lufthansa's pension friid to enable it to mieet its existing obligations was of the order of i)m 4 billion (over $2.5 billion). The government agreed to provide half of this, with the other lhalf to be borine by the company. See Fiu,c(iui 7Tiun>, 5 May 1994 and 201 September 1994. 56. See, for example, the Canadian law of January M3,1 19')1), authorizing the divestiture of Nordion International Inc. and Theratronics Internation,al limited; articles 19 through 11 contain transitory provisions oni retirement benefits. 57. The followinig sources were used for this section on pelisions funds: Vittas 1996; Conlrad1t 1993; Cioscia 1993; Sharma 1992; LatinFiniance 1992, p 6,2; litiilFinaucc ('supplemnent), Septellm- ber 1995, pp. 45-49; Fimoaulh Timut's, 31) June 1993, 17 Mairch 1944, and 18 JanIary 199h, ( t)Ji of A)ildi utica, 11 August 1994; Th on ticnomsist, II December 1')93. Priza tiza t bin in a Ma rkl't FE IXIIii 7 Chile has plaved a pioneer role in this field, In 1981, Chile privatized its pension system and entrusted management ot social contributions to pri- vate companies (tciniStradiraS d/' tmldos tit, pc'isioiit's, or AH's) owned bv domestic and foreign investors. Incumbent wo rkers could opt to stay in the state pension system or switch to an AF.l. Inl 1)8, the law on pension funds was amended to allow the AF['s to invest up to 30 percent of their funds in the equity of privatized enterprises. The pension funds became by far the largest institutional purchasers of shares of -s)Fs privati/ed between 1985 and 1990, including major companies such as CThilmetro, Endesa, Schwager, and CTC. In 15 years the AF's have come to manage accu mulated assets total- ing about $25 billion, which is eqLuivalenit to close to half of Chile's GDP' (up from a mere I percent of CDI' in 198 l ). The \MPs are "commonlv credited with plaving a central role in more than doubrling domestic savings, froIml around 14 per cent at the beginning of the l9l)s to 27 per celit" in 1995 and with the development of a stronig domestic capital market (Fiinacial Timl(es, 18 January 1996). Chile's large social security dLeficit has fallen by two-thirds. Workers can choose their AFI' and freelv switch their pensioni accounits. Competition among funds has kept commissioins relativelv low and has encouraged good overall performance relative to the stock market. Yet despite these impressive results, problems remaii. Manv employees are not current in their payments to their plans. Intenie competition betweeni funlds and legal restrictionis on loyalty bonuses have resulted in high turnover, with people switching from one plan to another (in Chile about a third of all accounts are switclhed each year). For the first time in their historv the Altls made negative real returns of 2.5 percent in 1995; pensioners who opted to take programmed monthly withdrawals from their pension fund account rather than convert their accumulated benefits into a fixed annuity from a life insurance company may therefore see a nignificant drop in their retire- ment income. Chile's experience has encouraged other countries, including 1'eru, Colombia, and Argenitina, to follow its example, A similar schemlie was intro- duced in Peru in September 1993, in parallel wvith the country's ambitious privatization program. The director of the regulatorv agency for Chile's peni- sion funds was in direct contact withl his Peruviani counterpart, and the' eighlt AFl's competing for the contributions of Peruvian emnplovees are all linked to companies or AFPs operating in Chile. There is an important difference, how- ever, between the two models: workers in Chile have beeni required since 1981 to belong to one of the private penision) funds, but Pertxvian workers affiliated with the public social security system can choose between) that sys- tem and the new private funds. The Peruvian private funds experieniced some initial difficulties: in the first year, some 800,000 workers-onlv two-thirds of the expected number- opted for the private funds. Low membership levels, delVs in the issuaLnce bv government of bonds representinig workers' share in the public penision scheme, an unfavorable tax regime, delavs in payment by emplovers and government, and high start-up costs an1d ad%vertising expenses fueled by 8(1 Thlex Priratization Challenige competition amoiig funds, caused the AFPs to post losses that were larger than anticipated. Some consolidation took place: two mergers reduced the number of Peruvian AFPs from eight to six, mostly backed by large interna- tional financial institutions. Moreover, the scarcity of financial instruments on the Peruvian market prevented AFP's from complying with the invest- ment allocation quotas imposed by law. Investment in Peruvian shares was hampered by cumbersome risk-classification procedures required by law: AFI's can only invest in securities rated by newly established rating agencies, whose assessment initially had to be confirmed by the AFP investment eval- uation committee. The enactment of Law nio. 265504 of July 18, 1995, which abolished some APP-specific taxes and put the AFPS on equal footing with the public sector pension system, gave the private funds a new start, however. Finally, Bolivia, Italy, and Singapore have also taken measures to stimulate capital markets by strengthening the role of pension funds in the broader context of their privatization programs.58 Social Safety Net Staff redundancies, as discussed above, are not so much a consequence of privatization as of poor SOP management leading to overstaffing. These SOEs would have had to be restructured and streamlined sooner or later, even without a change of ownership. In many countries, especially socialist ones, SOEs provided employees unemployment insurance (in the form of guaran- teed jobs) and many social services and benefits, inicludilng health, education, and housing services. As part of the transition to a market economy, these services and benefits have to be shifted from the enterprises to a national social security scheme, which does not guarantee employment or provide social services but instead guarantees a minimum safety net. Citizens falling below the thresholds of the scheme are eligible for support. Such a safety net and other social measures are often an essential component of the privatiza- tion program; unfortunately, their design and implementation are not simple matters, especially when public finances are in short supply. 58. 1/nivia: Article 7 of the 1994 capitalizationi law (see box *t 1j provides for the transfer to pension funds (to beset up for the purpose) of slares of the s( . referred tlin article2. Article 7 further provides that these pension funds will be managed by administrators selected follow- ing international calls for bids; a tender for the selectioni of twx private pension) fund adminiis- trators (AF'S) was launched in late 1996. Following an intern.itional competitive tender, Cit- itrust Ltd. had previouslv been choseni as the fiduciarv administering the pensionl funds pending such selection. About 3.2 millionl citizens will in this vniv indirectly become sharehold- ers for the first time; complemilenitary private pensionl plans will ailso be offered by the Alrvs. italy: Decree-L.aw nlo. 124 of April 21, 1993, authorizes the establishment of private pension funds. Singapor': The regulations governing use of the resource- of the central provident fulid (equivalent to a pension fLund) were amended in 198( toaillow withdrawals for the purchase of listed securities approved by the ci'F board. Prin tization in, a Market tEconota tl m1 Environmental Law Environmental law and privatization interact at several different levels. 59 How well the enterprises to be privatized have complied with the existing environmental regulations must be ascertained first of all. They may have been exempt from this legislation or, more simplv, they mav have violated it. In any event, buyers will have to find out what it will cost to compensate those who may have suffered from pollution, to correct the situation, and to end ongoing violations; they will also need to establish who will have to pay for this. Uncertainty about the extent of environmental liability was one of the main reasons for the slow start of the German privatization program. The legislation had to be amended to allow regional governments to release investors from liability for enviroinmental damage caused by SQEs before they were privatized, and the Treuhand had to absorb the bulk of the related cost.6") The same thing happened in Poland, where the government was sur- prised bv the number of investors demanding the inclusion of specific indemnitv clauses in SOQ takeover agreements (see Greenspan-Bell and Kolaja 1993, pp. 943-44). Potential buyers will want to ascertain the precise extent of their liability for environmental damage or violations of environmental legislation com- mitted by the former SOE, especially in polluting industries such as chemi- cals, mining, or steel. Some of these liabilities may be known and quantifi- able, while others may arise only after privati/ation.h1 Uncertainty about the extent of the environmental damage caused by the SOE to be privatized or about the buyers' present or future liabilitv explains the lack of interest by investors in some privatization programs)"2 59. See, in particular, World Bank 1994a; CGoldeniman 199L3 and 0'I94; Greenspan-Bell and Kolaja 1993. 61. "A strict application of West German environmental lawvs would have resulted in the shutdown of a major portion of East German industry v. The'Environment Framework Act' provides that purchasers of industrial plants or titler commercial real propertv in eastern Ger- many may be released from liability for environmental llamage s caused by the operation of the plant or use of the property before July 1I 199). Applications for such releases must be filed bv March 29, 1942. A release will be granted if it is justified in lighit of the interest of the inivestor as balanced against the public interest in env irotnmental protection. The IMlarch 1991Q privatiza- tion Amendments now prlvide for the release Jf civil la,w claims of private partiesas well asd public lawv claims of the government. Previoiusly, liabilities for civil lawv claims could not be releasedl in this manner. In addition to liability mrleases, which are issuable onlv after approval by the relevant German state, in estors can obtaii indemnification fronm the Treuhall- danstalt svith respect to past envirornmeintal liabilities" (lones Day 1991 pp. 1-2) 61. For example. thie companv's liability lto its elmploVees or to the local population for dis- eases ctntracted consequent upon acts of pollution coinniitted tiver a long ptriod or several years ago. 62. An example is the failure in May 1994 of the ittempt to privatize C'entromin.f a large min- ing enterprise in Peru. See Finanicial Timm's. 17 Mav 1994 Tn'o vears later the company still had no t been privatized. 82 Thc Priza tiZation Challciingt This problem can be resolved in several ways. The first and simplest alter- native is to exempt the privatized enterprise from all liability for the conse- quences of acts of omission or commission on the part of the sol, while leav- ing this liability with the old shareholder, that is, the state. A second alternative is to privatize the enterprise with all its rights and obligations intact but place a cap on environmental liability, above which the govern- ment would compensate the buyers, or else to negotiate some other division of responsibility between government and buver. In a third scenario, the buyers assume all the obligations of the enterprise they acquire and reflect the continlgenit liabilities risk by offering a lower purchase price. Each alternative has advantages and disadvantages that need to be assessed in light of the enterprise to be privatized, the privatization tech- nique to be used, and the sector and country conicer ned. Th-e first alternative will be the obvious choice wlhen dealing with polluting enterprises for wlhiclh it is difficult to assess the extent of environmental liability. The second alternative inv'olves somiie degree of negotiationi and therefore does not lend itself to privatizationi by public flotationi, for example. The third alternative is a good choice wlhen the enterprise is not a heavv polluter or the liability can be easily quantified; it will, however, usually be shunined wlhenl the envi- ronimental liability regulations and jurisprudence are either not very clear or not well developed. Even wlhere the law or the agreemiienits provide that the new owniers incur no liability, buyers would be well advised to ensure that the government will effectively assume its responsibilities as previous ownier. The next step is to ascertain what rules applv when an enterprise's plant is not in compliance with environmenital regulations. While buyers slhould not normally receive special exemnptions, they are often given a certain time limit witlini wlhich to make the necessary investmnents to bring the plant into compliance. The cost of these compliance measures is normally borne by the buyer. This was the approach taken in lPoland, among other countries (see Greenspan-Bell and Kolaja 1993). Finally, potential buyers will also want to know what new environmen- tal regulations could affect their future obligations. The greater the uncer- tainty on1 this point, the lower the price they will be ready to offer for the enterprise. l'rivatizationi can thus offer a uniqtue opportunity to modernize a counitry's enlvironimental legislation. This can he all the more desirable wlhere a transfer of activity from the public to the private sector could oth- erwise lead to increased pollution (for example. as a result of increased capacity utilizationi of the privatized plant) If such reform takes place before privatization, the costs it entails for private operators will be reflected in the amounts of the bids received. If reform is deferred, the new owners will tend to) oppose it, because it would raise their production costs. It should also be noted that the privatization program can have a very positive environmental impact by speeding up the replacement of obsolete and pollutinig techniologies with more recent "green" techllologies. Similarly, Priz,atiza ti ln ini a Markct Ecra,o mmy S3 by eliminating the direct and indirect subsidies often received by SOEs, privatizations can promote more rational utilization of resources with, once again, a beneficial impact on the environment. Moreover, privatization can foster better compliance with environmental standards; too often, SOEs were exempted from existing legislation or else got preferential treatment through lax enforcement. The issues raised in this section will normally have to be dedlt with through specific provisions in the environmental legislationi, the privatiza- tion legislatio n, or the privatizatio haid neverthele(ss been privatized, together witi 17, othercompaniies (see [atinbiniance 1 99, p. (>2). Rn;sia: 'ihe loans-for-shares scheme (see note 49 in chapter (t) is at the origili of some of those disputes. Following Une,simbank's takeover of Norilsk \ickel, management of the companv filed suit to invalidate the loans-for-shares scheime, lut their clamni was rejecteLd bv( tie Moscow arbitra tion court onF tebru,rv 27, 1l99h (see liat icst, ',n It 'l/tni; a?i, March I9)Y6, p. 231. 86l The I1ricat I i, Chat hi f s, through a public flotation on the Budapest stock exchange. The foreign shareholders feared that the public offering price would be lower thani the price they had paid, which would have forced Amt.ritech to write downi its investment in MATlAV and post a corresponding loss on its balance sheet to conform to U.S. accounting legislation. In December 1995 the cash-strapped Hungarian government finally sold an additional 37 percent to Deutsche Telekom and Ameritech, with the understanding that they would reduce their stake later througlh public flotation. Similarly, in the case of privatization of a banik with foreign subsidiaries, the government should normally consult the foreigni regulatory agencies, which may have to approve the effect of the cJhange in ownerslhip on the subsidiaries. More generally, privatization transactionis can raise problems in another country on competition grounlds, even whel the privatized comll- pany is not in violation of competitioni law in the country in whichl it is established. For large privatization operations that d raw on1 interniationial capital, shares of the enterprise to be privatized are sometimes placed on foreign capital markets either at the same time as the domestic market flotation or in a second stage. The securities regulations of the counitries concerned will then apply. Many privatization operations in the United Kingdom were accompanied by private or public placements in the United States using the American Depository Receipts (ADR) technique.")7 The same techniqLue was used in the privatization of numerous companies, particularly telephone companies, in Argenitinia, Chile, New Zealand, Indonesia, Mexico, and Vene- zuela (see A itcricaii Depository! Rcccipfs anid Prioatiul,ahs, Bank of New York, 1991). Legislative provisions have also been adopted in China to facilitate direct offering and listing of shares of Chlainese public enterprises on the Hong Kong securities exchange (see Salbaing 1993. and the section above on securities legislation). Conclusion This chapter has illustrated how various aspects of a country's legal envi- ronment not usually directly associated with privatization can nevertheless substantially affect a privatization program. lo trv' to privatize an enterprise in a general environment hostile to the private sector would usually be to court immediate failure. The factors discussed in this chapter that can con- tribute to the success of a privatizationi program include, among others, rec- ognition and protection of private owvnerslhip, elimination of all forms of dis- 67. An AN Di is a security issued by a U.S. bank in U .S. currency in exchange for shares of the foreigin company deposited with it or in a foreign bank. Fhik Security circulates as a bearer doc- unlclit representinig tHe shares deposited. Onlc Aiw )nm reprsent One share of tili foreign coml- pany or multiple shlares (for examiple, ten shares). Prizatnaizt aill a Aa M-rkcf Echiithitl S 7 crimination against the private sector, introdluctioni and protection of competition, a corporate law regime fostering the creation and efficient functioning of commercial companies (as well as the liquidation of insolvent ones), development of financial markets, strengtlhening of social security schemes, management of environmental liabilities, and settlement of dis- putes. For transition countries, in particular, reforms have been neededl in all or almost all categories reviewed in this chapter, amounting to the privatiza- tion of the national economy as a whole. Although some of these factors ma' affect the privatization process only indirectly, others will have a direct impact. 'roperty law is a case in point, as changes in legislation may result in transfers of assets from the public back to the private sector, especiallv in countries that have experienced heavy nationalizations. Moreover, many privatization transactions will be gov- erned by corporate law, in particular in the Lase of SUOts organiized under pri- vate law. Foreigni investment legislation mav well determine to wlhat extent foreigners can participate in the privatization process, whiereas securities legislation will normally applv to privati/ation throughi public offerinigs. Similarlv, labor and social legislation will often plav a kev role in privatiza- tion operations. One should, hlowever, bear in mind that it would be pointless to trv to document and remedy all the shortcomings id.entified in all of the areas dis- cussed in this chapter. The scope of the retorm program to be undertakeni will depend mainly oni each country's specific situation: a co untrv emergilng from a centrally planned economic system, for instatnce, wvill have to create a whole new framework for economic activitv. The government's legal advisers will need to id1entify the laws, regula- tions, practices, and institutions that pose major obstacles to privatiza- tion. Once these problems have been identified, their eliminationi mullst be assigned high priority. This will be achieved in some cases by repealinig or amending the relevant legislationi, and in otlhers by inserting specific provisionis in a privatization law. Other problems will inevitably arise during implementation of the program: tht-duia: Clt lari fyi ng Ow nershi p right s is a partici a rly difficult problem in the suc- cessor states ot the former Yugoslavia because (if th ditffuse nature of owniersh-ip of public enterprises. Article I of the privatization law of the RepubliR of Slovenia (November 11, 1992), is oiforma tive oni this point: 'This law regulates the owe rshil tr,)nsformnation of enterprises with social capital into enterprises witth knov\ n Owners. 3. Consider, for example, the case of the Iast (ermanl municipalities whichi claimed, ulsuccess- fully, ownership ol the electricity companies established on their territory The power contract (Stromnvertrag) concludI1d bv the two preunification f (nainat governments prescribed that onxlv 49 percent of the capital of these comnpanies could be helld bv municipalities, the majority holding of 31 percent belonging, pursuanit to this agreeteullt, to the Wist German electricity companies. The Triuloh latdtalusil ac ordiiigl'v comrpletedi thle sale If ihei ponier distribution compi lies of the foitrmer Fast Gierm,any in FebrUary 1994 by selling the thre( companies of Ihuringia to iayerni- werk, West CGe;rmaiiv's third electricity ( ompatly; the sille ol the East German electricity gelnerat- ing cotmpanv ,1(v to a consortium cOrimprisiig Ba verniverk oind P'reUssell Elektra was completed in Septemhber 109-I. See also table 2, andt 1 juiit1 I' lic,i, I( F biruarv 1994 and 7September 1994. Pri.n7tizatioi ii aiid PVilclw-Scctor Ma,miagcoci i 91 often complicated by past nationalizations or expropriationls (see chapter 3). Prior clarification of ownership rights is obviously critical for a smooth implementation of the privatization process. Exercise of Ownership Rights Once the legal owner is identified, the next step is to ascertain who has the power to exercise the owner's rights. Two separate questions are involved here, though the distinction betweeni themii is not always well understood: Which entity is authorized to exercise the ovx'ner's rights? And, which offi- cial(s) within that entity has such authority? Indeed, the state, public bodies, and public enterprises are able to exercise their riglhts only through the agency of dulv authorized persons. For a privatization transaction, it must be clear to w*hom the power to alienate or transfer ownerslhip has been coIn- ferred (see also chapters 5 and 6). If no provisions in the legislation governing public enterprises or assets spell out who has legal capacity to sell soi\, otlher parts of the country's legal framewvork miglht provide guidance. In Ne,x Zealand, for example, in the absence of specific legislation to the contrarx, thle governmenet or specified ministers are deemed to be authorized1 to sell public assets (see chapter 2 anl box 4.2). The same situation prevails in m)ost (ommunon-lawv countries. No matter wlho is authorized to sell in the namne of the state, that authlori- zationi (whether express or tacit) slhould blce unambiguous in order to pre- clude legal disputes on the subject. Aliin i atitu) of Pii (lic En7torprises a7ln Sliatrcli/ldi . s The legislation governing SlOEs sometimes explicitly authorizes their privatization bv subjecting it to specific, antd usually verv basic, rules. The Mexican program, one of the most ambitious an1 successful privati- zation programs, is based largely on the provisions of the public enter- prise law of 1986.4 Article 32 of that laws provides that wvhen an sol ceases to be of strategic importance, or when the public interest or the natiolnal economy so requires, the minister responsible for privatization shall, tak- ing into account the views of the concerned sectoral ministries, propose to the government the sale of the state's holdings in the enterprise. Arti- cle 32 further provides that in the evenit of such a sale, the employees of the SOE shall enjov a preemptive riglht. Article 68 states that thle sale of shares mav be carried out through1 the stor k exchanlige or througlh finan- cial instituLtions, on the basis of guidelines issued jointly bV the minister 4. More [han St percenit of the 1,15i st it . in the g' Vri-rTm.1t's portfolik) at the beginniniig of the prOgram were liquidated or Lold in thi\ wav, bringin ,g in tot,l receipts of over 521 billion bet ween 1988 and 1i ) (I te most active period otf the piogrna). L,oe Nci, Yiork 7ilillt , 27 October 19 a3. 92 Ti' Prizatizalimio Chall'on'e of programming and budget and the minister of finance and public credit. These two articles form the legal basis for most Mexican privatiza- tion operations. Similar provisions are found in the SLUE legislation of other countries; in some cases, they have been replaced witlh more spe- cific privatization legislation.5 Existing legislation may also impose specific legal forms. The principle of parallelism of forms, according to whiclh the same legal instrument that was used to establish an SOE should be used to abolisli or transform it, could mandate the use of specific and sometimes different legal instruments to privatize SoEs in a given country. This principle, wchich is not universal, is sometimes given legal sanction. An exanmple is found in Togo, where article 36 of Organic Law no. 82-5 of June 16, 1982, on joint-venture compa- nies, states that "if an SOE has been established pursuant to a nministerial decree issued by the Council of Ministers, it can only be privatized or liqui- dated followiing the same procedure." Moreover, SUE laws often contain provisions governing (a) the acquisi- tion and transfer by the state (or other public agencies) of holdings in joint- venture companies and (b) the creation and triansfer of subsidiaries of SUEs. These laws may also limit the right of SOES to bIuy or sell slhares of other companies. Although such restrictions can slow the privatization process, they may be essential in order to prevent abuses, to avoid creeping rena- tionalizations, or to subject such sales to commnon rules and regulations. Privatization laws sometimes carry these restrictions, too (see chapter 5). Alienation of Puiblic Assets The alienation of public assets is often governed by administrative law, spe- cific legislation on public property or public finance legislation. In countries with French legal influence, such as Morocco (sce box 4.1), a distinction is 5. In Biirtmili, for example, article 6 of Decree-l-aw nio 1/)27 of September 1988, wlich sets the legal framewvork for public-law companies and joint-veniture companies under private law, provided that state participations can be alienated onEl by presidential decret issued on the advice of the minister of finance and of the minister with jurisdiction over the soit to be priva- tized. This general provisioni was replaced by Decree-Law uvo. 1/21 of August 12, 1991, oni privatization of public enterprises, whicl delegates the pow 'r to privatize to the governimlenit, regulates the privatization procedures, and empowvers t[ie mmi ister of finance to sign the deed of sale on behalf of the government In Gnim'a, article 7 of Ordina nce no. 91/0)25 if Marclh 991 n the instituLtiollaI frarmew,ork for public enterprises provided that "the state's shares in public eniterprises are managed by a spe- ciali/ed department of the Ministry of f coniomic Affairs aid Finance. This department may transfer all or part of these participations to private persels), and turned Yilr into one of Latin America's most efficient energy producers. After losing $6 billion betweeni 1981 and 1989, YIPtl posted a net profit of 5706 million in 1993 despite a fall in oil prices. YIVF's public flotation, com- pleted in July 1993, Was an enormous success, bringing in ox er 53 billion. Jose Estenssoro died in a plane crash in May 1995. See International Fi, sunny Rei 'itii, Rkci'ia'v of the Year 199.3, p. 168; tIn' Vcoloeoliot, 2 lulv 1994, pp. 62-63; liill Stnrftc IJonal, 5 May 1195. Prizntiwtitoni invd Public-Sechtor Maniagiement 97 owed to the former SOE: the benefit of state guarantees regarding obligations of the SOE; and so on. Such universal succession could jeopardize the success of some privatiza- tion operations. Indeed, buyers may be unwilling to assume certain obliga- tions of the former SOE, even if they are giveni recourse against the seller. This would be the case in particular for continlgent, uncertain, or undisclosed obligations. This problem can be circumvented, however, at the corporatiza- tion or privatization stage by limiting the new company's obligations to those expressly listed in the agreements setting it up; the state would remain responsible for residual obligations. Changes in labor regime or levels are often required as part of the prior restructuring of an SOE, whether because the SOE was overstaffed, civil ser- vice or other exceptional elements were part of the SOE personnel regime, or other reasons. As mentioned above, the managers of an SOU will occasionally have to be terminated either because they do not support the restructuring and privatization program or because they do not have the skills required to manage the process. Where layoffs have been necessary, the choice has been between dismissing redundant employees before privatization or letting the new owner eliminate the redundancies and pay the required severance com- pensation, in return for a lower sale price. These and other labor issues aris- ing in the context of privatization have already been addressed in chapter 3. Some ongoing contracts may also need to be renegotiated to allow or facil- itate privatization. These may range from management or operating con- tracts to simple procurement contracts. As an example, one of the first steps taken by Germany's Treuhandanstalt in preparation for the privatization of Interhotel was to cancel an operating contract betxveen that company and a hotel group from the western part of the country; the contract was worded so that the hotel group could have obtained control of Interhotel for a very mod- est initial investment (see Financial Timiies, 22 November 1991). To avoid such problems, some privatization agencies or holding companies require that an enterprise to be privatized submit all major contracts for prior approval. Fiinancial Restructuring Public enterprises are often technically insolvent or in a state of bankruptcy. Financial restructuring may thus be needed before privatization. The prob- lem arises especially with corporatization, when SOEs are transformed into companies organized under private, commercial law (see below in this chapter). That transformation means that the public enterprise immediately becomes subject to existing business legislation, including the provisions on maintenance of social capital and bankruptcv. As a result, neither corporati- zation nor privatization may be sustainable if not preceded or accompanied by in-depth financial restructuring. Financial restructuring,7 will typically involve cleaning up the balance sheet by removing excess debt; deciding on the treatment of state-guaranteed obli- gations; renegotiating ongoing agreements with banks, donors, and other 98 Thc Privatii tiMl C7inll7t' lg, creditors (particularly wlhen these agreements contain clauses limiting the transferability of the SoI or its assets); and setting up financial systems and preparing new financial statements in accordance with generally accepted accounting principles. In order to attract private investors, a government will sometimes have to consider writinig off all or part of the SOE's debts to the state or other public entities. I SuchI debt write-offs were commoni, for instance, in many of the large U.K. privatizations. An empirical study' of Mexican privatizations showed, however, that debt reduction programs had no impact on net priva- tization proceeds; in other words, the hig]her sale price was canceled by the cost incurred by the government in absorbing the debt (see Lopez-de- Silanes 1996). Prior debt reduction, thouLgh often neutral from a financial point of view, may be needed politically. Indeed, success is often judged by the amount of gross privatization proceeds rather than by net revenue. Also, giving buyers moniey to take over an SO) witlh negative net wortlh may not be politically palatable, whereas a positive cash sale after debt restructuring may not be froxvned upon. In some cases the state may also have to take over or guarantee some of the debts contracted by the SOU with third parties, or guarantee that the obli- gations to be borne by the privatized company will not exceed a specific ceil- ing.12 The impact that Paris and London club agreements on public and commercial debt rescheduling have on such imeasures, as well as the conse- quences of such1 measures on the market discounit of soU and state debt, must be carefully considered. Although creditors often prefer sovereign debt to nonguaranteed debt of an SOU, this is not always the case. This issue has created some controversy in the preprivatizationi restructuring of some African telecommunications companies. The question was whiether debt of the former telecommunica- tions department of the central governm-ent slhould continiue to be treated as state debt (trading at deep discounts) or be transferred to the books of the newly established and corporatized teleconmmll Liicationis company. A trans- fer to the new company would m1ost likely have increased the market value of the debt significantly, because claims against the telecommunications company could be enforced more easily anid from abroad. Some have suggested that in transition countries debt should be added to the balance sheet of SUEs before their privatization. This somewhat unortho- dox approach may be justified in those countries wlhere the state corpora- tized its enterprises witlhout transferring the related outstanding debt to the SOFs, which meant that the balance sheet of man v corporatized SU)Es was not I I Where the state continues to be a creditor ol a privatliedi 5013 som0 governmenits hdave kept a certain diegree of conitrol over the manigemnitI of the privati/ed elterrprise, through a 'olderi share or othier tec(hniques, in order ito ciiu ; repa.ynwii (,ee note 32 in hapter 5). 12 Such a garanitee will usually be requested whelin tle magnitude of il heLs's liabilities is inot precisely known at the timile of privatization, is str es-ed in the section ot ci hpter . on enlvi- ronmental law. Prini tiza_,7oii inldlt lh0fic-SctOr Mal,i,7cnc ott 99 sufficientlv leveraged.'3 This outcome should, however, lead to a higher sale price at privatization and thus would not reqtuire the addition of debt. The problem is more serious during the period leading up to privatization, wlhell SOE managers may have too much free caslh flowv and few incentives to use it in the best interest of the companv or shareholder(s); weak corporate gover- nance of S(ls further compounds the problemil. In Germniay, nearly all public enterprises vwere converted to private-law companies as of Julv 1, 1990 (see articles 11 ancd I 2of the June 1990 privatiza- tion law). The Treuhandanstalt became the sole shareholder of the former combines (the equivalent of holding companies or conglomerates) reorga- nized into joint-stock companies, wlile the component enterprises of the combines wvere converted into limited liabilit\ companies held by these new joint-stock companies. Under a separate 1990 laws the new companies were required to drawt up their opening, balance sheet in deutsche marks (see Horn 1992, pp. 15-18). This involved revaluing all their assets anid liabilities. If their liabilities exceeded their assets, the shareholder (the Treuhandanstalt or a joint-stock company belonging to it) had to dLecide whether or not to cover the shortfall. If it decided to cover the losses, the shareholder then had to replenislh the new companv's capital to bring it up to the minimum level required by law. Accordingly, the Treuhandanstalt had to take over a large amount of debt and inject fresh capital into manv SOEs, a fact that helps explain its large borrowing requirements and a deficit exceeding 250 billion DM at the end of its term (see also note 35 in clhapter 3 and the sectionl in chapter 6 on1 finanicinig the privatization proce ss). In New Zealand also, the privatization of many SOks was preceded bv financial restructuring carried out as part of the corporatization process. One of thie purposes of this restructuring was to start off the corporatized "CEs wvith opening balance sheets and accolunits conformiiing to generally accepted accounting principles and subject them to the same financial disci- pline as enterprises in the private sector (see Franlks 1993, and box 4.2). Abcilithing Discu imiuitonit Prancti,s An essential objective of prior restructuring should be to abolish all preferential treatment or exceptional rights and obligations of S;ors. The playing field should be level for these enterprises and those in tlhe private sector (see the section in chapter 3 on protecting and promoting competition). All special privileges granted to the SUEFs to be privatized wvill need to be abolished, includinig subsi- dies, tax and customs exemptions, state guaran tees (express or implied) on their borrowinigs, preferential treatment in the award of public contracts, access to 13. Ill aditlion to being onaorthodox, this approach mv in some coiunitries be illegal, espe- cially if creditors are exposed to additional rkk,i,k a r, still of Ihi transfer. See a15s the section above in this chapter diealliig ih iai sOtid1st a cti i)tt1 pra ittices, as wetl as t . thetit ,L chap- ter 3 oin franufer of IiJblifiel. I(O( Hic Priz'oati:_ation C11l1111cligi reduced prices for specific inputs (utilities or petroleum, for example), exemp- tions from the application of competition law, special labor law provisions, and any other advantage or form of protection. This policy was followed in most privatizations carried out in New Zealand.14 Similarly, in Belgium the state's guarantee of the public-sector financial institutions was removed and these insti- tutions were integrated in the deposit insurance sclheme covering private banks before their privatization (royal decree of March 1, 1995; see Vincent 1995, p. 12). Obligations borne by SCUEs but not by their private competitors should also be eliminated. In many countries, SOYs have traditional]v performed social or noncommercial functions without adequate government compen- sation, such as supplying goods and services to specific regions or categories of customers at a loss; or providing health, edtucatioin, 1ousin1g, and other social services to employees and their families and sometimes even to an entire village (especially in the formerly communist countries). These social activities, generally performed at a loss, are often cross-subsidized by earn- ings from other activities. Subsidies of this kind are possible, however, only when the enterprise enjoys a monopoly or some other form of protection. Without protection, competitors of the SOE could stipply goods and services at a lower price and thereby undermine the verv base of the cross-subsidiza- tion system. Where such social functions are assigned to an SOE by law, these legal provisions will have to be abolished before privatization. These func- tions can either be assigned to other public entities or dealt with by way of service contracts between the government aind private providers. 15 Finally, in order to bring the status of the SOEs to be privatized int) line witl that of private-sector enterprises, it may be necessary as part of the restructur- ing process to limit government interference in CIEO operations. General or specific SOF legislation sometimes includes provisions that limit S. In the ( iech Republhk and Germany, however, the same agency combined both functions. 1(06 rle' Prinitizatiolt COa(l 'i(i ','t SOEs and established new companies to which assets and liabilities of the former SoEs have been selectively transferred; in exchange, the funds received shares in these new companies. fin a second stage, the fund in turn transferred these shares to private investors. This twvo-stage procedure offers many advantages. First, it eliminates the need to draw up a detailed inven- tory of the assets and liabilities of the old solE before privatization. Second, it makes it possible to divide the old SOE into smaller companies, consolidate the assets of different enterprises into one company, and sell separately any real estate not essential to the operations of the enterprise. Third, it assigns to the fund the legal responsibility for laying off redundant employees and for doubtful debts, environmental obligations, and so on. Fourth, the fund assumes responsibility for any remaining obligations, known or unknownl, of the old soEG, henice obviating reliance on burdenisomne bankruptcy or liqui- dation procedures. The new companies established by the fund can then start their operations and be privatized under good conditions. Prior Rcstr icti riiiig: Lessoins froin Mcxice In a recent empirical study of the privatization of 361 Mexican companies, Lopez-de-Silanes 1996 analyzed six areas of SOF restructuring before privati- zation-namely, management, labor, debt, efficiency programs, investment, and deinvestment-and their final impact on net prices. This study provides some interesting guidelines for wliat type of prior measures might be worth undertaking. "For instance, the results suggest that it is worthwhlile to replace the CEO wvith a 'privatizer' whose task is to clean up the company, to reduce the waste of resources, and to get the firm oni the block as quickly as possible. Labor downsizing before selling has a positive marginal effect on [net pricel, while debt absorption has no impact. Investing or embarking on efficiency programs before the sale actually decreases Ithe net pricel; the government does not get its money's worth and the performuanice of the company remains the same. In contrast, cutting the flow of resources and postponing large investment programs, or de-investing, fares better in terms of premiums." The author also found that "direct costs of prior restructuring policies are quite substantial, amounting to an average of 30'4, of the sale price. Addi- tionally, restructuring measures such as efficiency and investment programs slow privatization. Delays in privatization come at a substantial cost, partic- ularlv when subsidies poured on SOms can quickly add up to outweigh privatization revenues.... The empirical estimates in this paper point to a premium for speed and restructuring measures that expedite privatization and halt the drain of resources. The key lesson is. do not do too much, sim- ply sell" (Lopez-de-Silanes 1996, pp. 3, 29). Liquidation of Public Enterprises Liquidation of an SOE is a common (and ultimate) form of sot restructuring. It is also a widely used privatization techlnique. It often refers to the disposal Priuntatzt i iniillt Vi'li ic-Scc torF Matigcini1111i11 (7 of the shell, consisting mainly of debts and other obligations remaining after the core assets and selected liabilities of the former SOE have been trans- ferred to one or more new companies after corporatization, breakup, or privatization.24 It may also refer to thie winding down of an entire SUE, whether or not it was still a going concern. Different laws may apply, depending on whether the SOE was governed by private law, in which case liquidation usuallv takes place under company law and commercial banikruptcy law (see chapter 3), or bv public law, in which case bankruptcy is not possible and liquidation is governed by other rules. Some countries, including Senegal, Togo, and Viet Nam, have enacted specific legislation governing the liquidation and banikruptcy of SUEs. 2 Elsewhere, for example in Guinea, where liquidationi has been the main privatization teclhniique, or in Italy (see Decree-Law, no. 340 of July 1992 con- cerning liquidation of EPIM), a law may be required to liquidate certain SOEs.2' Finally, in other countries suchi as 1'rance case law is the main source of law applicable to the liquidation of various tvpes of public establishments (see Bienveniu 1993; Conseil d'Etat 1989). Public Finance Legislation Budget and public finance laws may also contain provisions governing privatization. For example, the Canadian finance legislation requires that a law be enacted by parliament before an sUE can be privatized.27 In other countries, suclh as Malaysia and New Zealand, the discussion and approval of the budget or annual finance law is the main vehicle for parliamentary involvement in the privatization process; the privatization strategy of the New Zealand government established after the 1990 elections tllus consti- tutes ann1ex 5 to the 1991 budget law submitted to parliament. In addition, a country's public finance regulations may apply to the allo- cationi or use of receipts of privatization. Even where the privatization laws 24. As part of the privatization of the teleclri-muIlIcati,,ns compan)v the Argentinie fderal government enacted Decree no. 2762/91(1 etting up a liquicdaltion comnmis-ion responsible for ensuring fulfillment of the governmenit's remainin,g ablicatioits lter transfer of IEN I' Is staff and main1 a1ssets to the private sector. 25. See Senegal's Law nto. 84-64 concerning the 1ILuldatIon) of M1 ALigust 1, I1 94), Togo's Lawi no. 82-5 oni joint-venture companies llti is II, 1482), and ResoIlution no. 388 of Viet Nam's Couuncil of Ministers concerning the estalihisrnent andLl liquidatioin If so s (November 20, 1991). 26. See Guinean Ordinance nL. 3()6 PRG-Y5 ot Decemiler 12, 1985, mandating the closing down and liqluidation of 12 enterprises specified tlterein, and Ordinance no. 315 'RTG-85 of December 21, 19X5 maInMdating the liquidation of 14 miial retail stire.. Under the militarv regime in force in Guinea at that time, anl ordinance vas e juivalent to a lass. 27. See UN( IA.n, Ad Hoc WVorking GroIp on ( Conparati%e Eperiences Ivith Privatization, third session, November 2-December 3 1993.c,uLIntrv pre-entatil slibmltted bv Canada, p. 12. 1(IS Tinc Privatiztofino Chalh' 1c1i specify how the proceeds shall be allocated, other finance laws may apply (see the section in chapter 5 on allocation of privatization proceeds). In many countries with budgetary systems modeled on that of France, for example, public expenditures cannot be deducted from public revenues because the law does not allow either offsetting or contraction of expenditures and receipts; all public expenditures have to be authorized by parliament and committed, disbursed, and controlled by authorized officials pursuant to public expenditure regulations.28 Finally, public procurement regulations mav well apply to some contracts concluded by governm11enits as part of the preparation and implemlienltationi of the privatization program. Concession contracts or contracts for the recruitment of experts to advise the government on privatization (including attorneys, auditors, investment bankers, and other consultants) are likely candidates. Conclusion In the area of public-sector maniagemient and public law, just as in other areas discussed in earlier chapters, the privatization process is affected, directly or indirectly, by a multitude of rules and regulations. I'rivatization is a public act involving a transfer of assets ownedl by the public sector. It is also a public process managed by public agencies and officials. An important distinction needs to be drawn between the public agency with the right of ownership over the enterprises or assets covered by the privatization program (the state, municipality, or another agency or public entity), on the one hand, and the authorities enmpowered to exercise those ownership rights-in particular, the right to alienate enterprises and assets-on the other. The legal status of an ScE, as discussed above and in chapter 1, determines in part the measures required before privatization. Thus, if an SOI is already governed by private law, prior restructuring wvill likely address manage- ment, staffing, and finances (including appoinitinig a new c F0, dowinsizinig or "riglht-sizing" the labor force if necessary, cutting off subsidies, andl clean- ing up the accounts and balance sheet). The object is to be able to privatize a viable enterprise. It may also be necessary to renegotiate certain contracts or 28. in its 199i) annual report, the French (Cnur des t omptlvs (equivalent to the U.K. NAO or U.S. ( .AO) criticie.ed thie wa' in whiichi certaini expetnditurs t or public flotations and othier priva- tization operations (mainlly commissions, reioiburenwints , f expenses to financial intermediar- ies, and taxes) had beten deducted directly bv the finarcial intermediaries from the gross amount thiy received. Only the net proceeds of privatization wLre ultimately paid into thie trea- suryvs special privatization account, in direct violattiwn ol lji pronvisions of article 18 of the organic law relating to finanice laws" (Cour des ( oplt~ IOtl'l(, pp. 24--25). The Cour des Comptes a1su criticized the la,Lk O f traospari nc in Hie i naticial a.spect, oi debt-swvap opera- tions, particularlY the losses incurred in the redeto1ptioll ot 1,old-itdexed bon1ds. P riIfi:atimi: I 1 1i Pill ic-S ccor Mnalnagol,l cit 1(9 obligations. Similar issues arise wlhen the enterprise is governed by public law; in that case, it may also be necessarv to choose whether to corporatize the enterprise or to liquidate it. In all these cases, the old SOI maya have to be broken up to some degree and some of its activities or assets separated or demerged from its main activity. Existing discrimination toward the private sector, whether to the advantage or disadvantage of the S()E, will need to be eliminated. And proper attention will have to be paid to the management of the SOEs durinig the transitioni period leading to their privati/ation. The privatization process can be affected by other public-law provisions, such as public finance rules. Also in the domaini of public law are constitu- tional aspects of privatization (chapter 2), matters concerning the immunity of the state (chapter 3), and the privatization laws themselves, whlicil form the subject of chapters 5 and 6. This chapter ends the broad overview of the existing legal framework that may affect the privatization process, w1hich started with constitutional and international law (chapter 2), continued with thc analvsis of a broad range of laws affecting private business activity (chapter 3), and concluded with this discussion of legislation governing the public sector and its activities. A proper understanding of this preexisting legal framework and of its limita- tions is essential. The laws discussed heretofore often preclate privatization programs and were not enacted primarily for thie purpose of the privatiza- tion program. The following chapters will focus mlore directlv on1 the privati- zation process itself. 5 The Privatization Law Whether or not a country needs to enact a privatization law depends on its legal and political situation and the specific characteristics of the enterprises to be privatized. In some countries the governlment does not need any spe- cial enabling legislation tt) privatize, either because constitutional principles do not require a law (see chapter 2) or because SOE legislation or other laws provide the necessary legal framework (see chapter 4). Issues discussed in this chapter are germane wvhere a special privatization law is legally required or deemed to be politically desirable.2 Whetlher legally required or not, a law offers several advantages: it represents an immediate and concrete statement of explicit political support for and commitment to the privatization process, increases the accountabilitv of the executing agency, makes it more difficult to undo the reforms beiing implemenlted, and provides an opportunity to change (and improve) the existing business environment to facilitate privatization. Disadvantages comprise often lengthv delays in secur- ing parliamentarv approval, the possibilitv that the law's provisions may be too restrictive or inflexible, and the risk of parliamentary micromanagement (see the section in chapter 6 on the role of parliament). The contenit of privatization laws mav vary substantially. The core ele- ments of privatization legislation, namelv, the enabling provisions authoriz- ing and organizing the privatization process, are handled very differently from one law to another. It is essential that the law define in clear terms the respective spheres of responsibilitv of the various authorities that play a role in the privatization process, such as parliament, the governmeint, the privatization minister or agency, the management of the SC)Fs or other institutions involved. Mecha- nisms must be set up that make these aUthorities accountable for their 1 Moreover, public enterprises do not as a rule need .pccial laws to be able to privatize thieir assets or subsidiaries, as nzoted in chapter 4. 2. Even Nwhere privatization is legailvl authorized nolid r u (irrenit law a government wvill sonIe- times wvish to cover itself politically bv obtaminig tihe apron al of parliameint. Illl 112 Tlet Priz'atization Challetnge actions and create appropriate incentives and penalties to ensure proper execution of the privatization program. These questions, which are covered by almost all privatization laws, are examined more closely in chapter 6. Many privatization laws also contain provisions to remedy specific short- comings in the existing legislation, of the kind discussed in chapters 3 and 4.3 These can be described as facilitating provisions of the law, as opposed to enabling provisions. Furthermore, constraints that may rightly be regarded as obstacles to privatizatioin can sometimes be circumvented with a little imagination and creativity, as table 5.1 illustrates. Where the constraint was of a legal nature, it was circumvented without recourse to a law. [n some of these cases, such as the one involving coupons for the Pakistanii telecommunications com- pany, the chosen shortcut turned out not to be particularly successful. The issuance of coupons, vouchers, or bonds convertible into shares of a com- pany scheduled to be privatized later may unnecessarily complicate a priva- tization. Indeed, this technique, which is sometimes chosen to collect priva- tization revenues in advance of the actual transaction, creates new ownership rights that cannot be ignored at the time of privatization and may limit the available options. This chapter deals with the enabling provisions most frequently found in privatization laws.4 After a discussion of the maini legal instruments to effect privatization and of the scope of privatization laws, the following topics are addressed: the valuation of SOEs to be privatized, the selection of buyers, preferential schemes, financing of share purchases, allocation of privatiza- tion proceeds, as well as transitory provisions and amendments to privati- zation laws. A Law or Subordinate Instruments? Where privatization legislation is required, it mav be preferable to limit the provisions of the law to broad principles and leave the details and modali- ties of its application to subordinate instruments or decisions. No universal recipe exists, however, to determine which privatization provisions should be left to the discretion of the parties involved and which should be 3. In Peru, for example, article 7 (a) of Decree-Law no. 2612() of December 28, 1992, amending the privatization law of 1991 (Decree-Law no. 674), introducO,s an exception1 to ordinlary labor law for soi-s to be privati/ed, aimed at facilitating the personnel cuts that have to be made as part of the preprivatization restructuring process, whileartict, 7 c) provides for thieadoption of measures to allow regularization of ownership titles, permit>, licenses, and so on, of sotis. In Romania, article 73 of Law no. 58/1991 om privati/ation reluired the government to prepare a bill for the creation of a securities exchange; a low oUl securities and stock exchallges was enacted in August 1994. See clapters 3 and 4 for additional esamples. 4. A nonexhaustive list of worldwide privati/ation laws, dLcrees, and other regulations, cov- ering over 1I (1 countries, is given in the appendix. The Priva fiza fioi La zt 113 Table 5.1 How Some Countries Have Overcome Specific Obstacles to Privatization Conlstr azint Solution lColwitrl/ Ownership of land cannot Established joint-venture Viet Nam be transferred to a private companies whose public- enterprise sector partner held Lhe rights to land u-se Granted long leases Socialist cou ntries The state's ownership titles Concluded lease-sale contracts Nicaragua to certain assets are allowing assets to be trans- imprecise or disputed, ferred witlhout Immediate sale; making sale of these lessee was given an option to assets to private purchase these assets at the investors more difficult end of the contract The exercise of certain Conjcluded a concession contract Brazil, activities cannot be trans- providing for the transfer of Mexico ferred permanently to the assets to the concessionaire for private sector the duration of the conicessioni; assets shall be returnied to the contracting authority at the end of the contract The legal framework for The president of the republic ratified Guinea privatization is the privatization agreenlen ts ambiguous Privatization requires enact- Used a method other than divestiture China, ment of an enabling law, to transfer enterprises to private Viet Nam but the government does management (lease or concession not wish to support such contracts, for example) a law politically Privatization of the national Sold public coupons entitlinlg the l'akistan telecommunications holder to shares in the future priva- company requires a long tized compan,v with the under- period of preparation and standinig that the government would enactmenit of a law buy the coupons back at a specific price if the company was not privatized withinl two years Privatization of a company Planned to iSSule' state bonds conver- Turkey is blocked by political tible into shares of the new opposition and/or by company when it has beenl the courts privatized The government wvants to Sold a convertible bond with the Italxv sell a second tranche in conversion price set at or above a company whose market the 1'o price is below the original initial public offering (11i') price (tItl, &t)IIt IUII I1W1 to eI Mcolf1eool' /Ing p) 714 The Prinlt izatinl Challlelhge Table 5.1 (con tinued) Conistraint Solltionl Countrut A law is required to Public-law enterprise created sub- France privatize a piublic-lalw sidiaries organized Under private enterprise law, which can be privatized without any neted to alter their legal torm Shares have to be granted Issued nonvotinig shares for Bulgaria to the employees of the employees privatized enterprises, but the interested buyers do not want to share control The law provides that a By firm underwriting, a bank or lolanid capital increase that is other financial entity uLndXer- not fully subscribed took to acquire all the newly must be deemed issued shares, organize their resale null and void to third parties, and beir the attendanit risks included in the privatization law, in implementing decrees or regulations, in decisions of the competent authority (for example, the minister of finance or the chairman of the privatization agency), or in general guidelines. This decision will depend partly on the counitrv's constitutioinal, legal, and politi- cal system and traditions and partly on current political concerns, notably the degree of confidence parliament places in the government. The choice of the legal instrument to be used will also depend on several other factors, such as the objective to be promoted; customized and flexible approaches, as opposed to standardized and uniform ones; cenitralization, or some degree of decentralization, of the process; and a priori controls or accountability of the executing agencies through a posteriori conitroIs, These choices will have to be made at the start of the process, because thev will largely determine the design of the legal framework for privatization. The Frenchi legislation of 1986 affords an interesting, thouglh very specific, illustration of how identical provisions can find a place both in a privatization law and in implementing regulations. Article * of the first privatization law of 1986 authorized the government to legislate by ordinanice, pursuant to article 38 of the French conistitution. President Mitterrand (of the socialist party) refused, howtever, to sign the ordinance prepared by the government of his prime minister, Jacques Chirac (of the conservative majority coalition). To cir- cumvent this obstacle, the Chirac government submitted the text of the ordi- nance to the National Assembly in the form of a bill, that is, a draft law. This explains whvy two consecutive laws had to be cnacted, one in July and the other in August 1986, to enable the privatization program to be implemented. T/ic Privn tLtit)iu Lawzi, 113 Furtlhermore, a law should not be used to subtstitute for a proper privati- zation strategy, lest it be loaded with many considerations better left to sub- ordinate legal instruments. Some aspects of privatization, though essential from a strategic point of view-speed, timing, or the choice of a privatiza- tion technique-should normallv not be regulated bv law. Legislating such matters could easily become a straitjacket: a strategy can be adjusted fairlv easily to tailor it to changing circuimstances or to factor in the lessons drawn from new experience; a law cannot.5 Scope of the Legislation As the appendix illustrates, most privatizing countries have enacted specific privatization legislation, whether or not required to do so by the con1stittu- tion or by law. In the process thev have bad to choose between general legis- lation applicable to all SUEs to be privatized and a specific law for each suchl SOE or group of SOEs. In some cases the targeted ',Es are specificallv named; in others, thle law, addresses one or more categories of enterprises withlout naming themii. The scope of some laws, and henice the privatization mandate of the gov- ernment may also be limited in time." Restrictions of this kind, whiclh are usuallv found in laws with a positive list of privatizable enterprises, can have adverse effects. They can easilv weaken the government's positionl in negotiations with potential buyers, especiallv \heln the legal time limit is nearing expiration. 5. The l'uerto Rican Telephionie Autthoritv Act of April 1, 1'I)91) affords a goodl example of a privatization law that goes ijto excessive detail It included a Lnumber of higihly restrictive pro- visions, For example. it specified the minimiumi net proceeds fromil the sale of the comiipaniy, in this case $2 hillio mi net of the total debt at the date of sole and the sale costs; prioliibitedi aniiy increase in basic teleplihone service chargeos withiii three yeairs following privatization; prohib- itedi the buyer from dismissing any employee as a direct result of the sale; aid, as a condition for the sale, required parliament to enact laws establishing ai Permanenit FunId for the Develop- miiit ofEEducation, a Permanent Infrastructure Fund Li ee bx( 5), and thel 'uerto Rico Telecoiim- munications Regulatorv Commission and to ad opt a re(s Iution proposing a constitutional amenidmeiit. These reqluirements, particularIv the ni lini ifii sole price (which anionii tedl to about $3 billion), prevented corrpletion of negotiations xsith h interested bidders. Since the gov- ernmenit lacked room for miraneuver to accommodate ilte coiiceriis of bidders, it hiadi to take the company off the market. In February 1992 the I'uLerto Rican inthorities concluded an agreemeiit on privatization of II 1i the company providing iteriiatioiial and long-distance services, with Telef&inica of Spain, whichl thus became majority sharelhold,r in I 1 i 1179 perceiit of the capital). 6. See, for exaIIple, article I of the Moroccani privati/atii n lai of April 1qY9t, which sets the deadline for completion of privatizations at Deceimbtr 31 9t1 Ihe law was amended in Janu- ary 1995 to extend the deadline to Decemiber 3 1, 199ld, i thihi add tWO new 0enterprises to the list. See also article 4 of thie Frencih privatization law of JLilv I-in n, xhicli gaVe NMarch 1, 1 91 as the deadline. A new priVatl/ation la Wvas enactd in Io-n3 grintirig the government authiritv to pri votitac o ii et, set of sil ) an id modify mig tile I 96sf legslat tli i 116 Tlhe Priaittiojfio ChallenNte General Legislation A law of general scope should be considered if comzmon rules for all privati- zation transactions are deemed important. Such a law may confer a general mandate on the government or an agency to privatize SIOFs. This happened in the Philippines, where the law provides that it is up to the president of the republic to decide which state-owned assets or enterprises shall be priva- tized (see article IV of Presidential Proclarmation no. 5() of December 8, 1986). A law that confers broad authorization to) privatize without specifying the enterprises in question will generally define its scope of application either by defining "privatization" or other termns or bv prescribing inclusion or exclusion criteria.7 The privatization mantdate may thus be limited by excluding particular sectors or SOEs, as happened in the former East Ger- many, where the privatization law excluded, among other sectors, transpor- tation infrastructure, the postal service, and muniicipal enterprises. Another possibility is to specify the sectors in wllicih priv.atization is permitted with- out naming any particular enterprise.8 La desitgnatitig priV7tiable eCCterpriscs. A general law may list the SoFs that are to be wholly or partially privatized. Thlec government's authority to privatize is then usually limited to these-listed SOrs. Examples are found in Argentina (see the annex to Law no. 23696 of August 18,1989), Burkina Faso (12 SOEs), France (65 sovs in 1986 and 21 in 1993), Morocco (112 soms), Nige- ria (110 SOBs), and Senegal (27 SOis).9 Listing privatizable SOEs in the law is not necessarily a good solutioin, how- ever, because such a list limits the flexibility of the governm11ent. Constantly changing domestic and world market concdition,s may dictate priorities other than those originally prescribed in the law.. Moreover, designating specific enterprises can create uncertainty amoong the nmanagement and staff of the SOE. In the absence of schemes and incentives ensuLring their continued moti- vation and of strict corporate governance or control procedures, this uncer- 7. When a law states that it governs the transfer of assets, enterprises, or activities from the public sector to the private sector, these terms may need to be *tefined. P'rivate sector may, for example, be defined to exclude public enterprises, other punlblic entities, or state-controlled bod- ies from acquiring shares in the privatized enterprises. Somre definitions of public sector may lead to the inclCusion or exclusion from the scope of the law of categories of public enterprises, such as municipal enterprises or subsidiaries of public enierprises, for example. See also notes 27 and 54 below aind the glossary at the end of this book. S. See, for example, Bulgaria's Council of Minister- Decree no. 36 of A\pril 1t), 1991), authoriz- ing privatization of stores, workshiops, hotels, restiuranits, and other establishments in the trade, tourism, and service sectors. This decree has sinlceC been rescinded. 9. The list appended to the Frenchi law of IulV 2, 1 c56, comprised 65 enterprises, whlichi in fact constituted 28 different public groups. Of these, I3 grotup' wvere privatized between November 1986 and lanuary 988. This left 15 groups to be prisatized, whose number had fallen to 12 by 1993 following certain mergers. The 21 enterprises listed iii the annex to the law ofJ uly 21, 1993, comprised these 12 groups plus 9 new enterprises. The Prizvatization Lawzb 177, tainty can lower productivity or even trigger fraudulent activities. Long delays between the designation of an SOt to be privatized (or even rumors of such designation) and the actual implementation of the transaction have indeed led to a deterioration of the condition of the SOE, and sometimes even to pilfering and misappropriation of SOF assets by workers and managers. Some countries have issued decrees pursuant to the privatization law that list the enterprises to be privatized. In Mozambique, for example, an initial list of six SOEs was adopted by a decree of November 1991, with new SOPFs added in 1993 and 1994 by decrees taken pursuant to article 14 of the August 1991 privatization law. This method offers more flexibility than the designa- tion of SOEs in the law itself. By reducing the time between the annlounice- ment of privatization and the actual transaction, it also reduces the risk of deterioration in the SOE's situation pending privatization. Provisions applying to certaii tyiptes of privatinatioiis. A general law may apply also to privatization operations carried out by SoEs or state holding compa- nies, that is, to situations where the seller is not the state but a public enter- prise. In this case the law may provide for derogation from ordinary SOP or company law-for example, by requiring that all or part of the proceeds of privatization operations carried out by SOEs shall accrue to the national bud- get (see chapter 4 and the section in this chapter on allocation of privatization proceeds) or by conferring to the government the right both to sell shares held by an SOP in other companies and to receive the proceeds of that sale (see Gra- ham and Prosser 1991, p. 82, with respect to the U.K. oil and gas law of 1982). A general law may also subject different types of privatization to different regulations. In France, for example, the privatization laws of July 2 and August 6, 1986, as amended by the law of July 19, 1993, authorize three differ- ent privatization procedures. The procedures set forth in these laws apply to the enterprises listed in their annexes. The other enterprises fall into two cat- egories. First, prior legislative authorization is required to privatize majority state-owned enterprises (state ownership of 517 percent or more) and enter- prises that entered the public sector pursuant to a lawiY1 Second, an executive instrument suffices for enterprises in which the state directly holds less than 50 percent of the shares and for enterprises that became part of the public sec- tor without legislative approval; an executive instrument is used also in the case of the partial sale of shares of public enterprises in which the state is the majority shareholder and remains the majoritv shareholder after such sale.1 I 10. With the exception, however, of enterprises that became part of the public sector pursuant to legislative provisions but are held, directly or indirectly, bv enterprises included in the liist appended to the law of July 19, 1993. The transfer of enterprises ot this kind to the private sector must also take place in conformity with the prov isions of the law of July 1493 See article 2.1 of Law no. 93-293 of July 19,1993. 11. See Decree no. 91-332 of April 4, 1991, which lavw down the conditions under wvhich minority shareholdings in public enterprises canl be soldl See also Debene 1991; Richer and Viandier 1991; Saint-Girons 1991. 118N Flthe Prin'af ti:at"i Cha/lleng Specific Lcgislatioi Specific laws authorizing the privatization of one or more SOFs or of an entire sector have been enacted in Argentina, Belgium, Brazil, Canada, New Zealand, the United Kingdom, and several otlher countries.12 Such precisely targeted privatization laws tend to be used where the scope of the privatiza- tion program is limited or an SOE or group of SOPs poses special legal prob- lems that cannot easily be resolved in a general eniabling law.13 This would normally apply to the privatization of an entire sector, especially a higllly regulated sector such as the financial, natural resources, or infrastructure sectors (see chapter 7). In addition, some countries with a weak legal framework have turned to a very special tvpe of privatization law. Th-us in Guinea agreements for the sale of particular enterprises have been ratified bv presidential ordinance in order to give them full effect, notwithstandinig conflictinig provisions of other legislation. This enabled Guinea to start privatizing SOrs in 198f6 withi- out having to wait for a complete overhaul of its business legislation or the enactmenit of a privatization law, whiclh occurred only in 1993. Valuation and Sale of Enterprises to be Privatized Parliaments and governments often build safeguards into their legislation to ensure transparency of the process and reduce some of the risks typically associated witlh privatization.14 The law comnmonly imposes basic rules to be followed by the implementing agencies, particularly regarding prior valua- tion of SOFs, the use of specific sale techniques, and the procedures for select- ing buyers (see the following section). 12. Arg'citima combined both procedures: a general lawa +1f 1989 applying to the enterprises named therein, followed a few years later by specific law, for certain individual enterprises such as et: (thie oil company), Gas del Estado, and certain financial institutions. In (lgipuml, arti- cle 9S of the law of July 22, 1993, authorized the government to transfer the shares it held in four public financial ilnstitutions. In Bra_7/, a law was n)ot 1ne0eded legally speaking, to privatize VASP, the Sao Paulo state airline, but it was d1ecided for political reasons to seek the approval of the legislator in order to secure the Sao Paulo state government s cooperation, because it was feared that this operation wsoeIld meet with spirited politicca opp,isitio n (see I aw no. 0629 of Decem- ber27, 1989). See the appendix for a listingofotler specifik privatiation laws. 13, In the case of Petro-Canada, for example. the Canadian governnment did not wish to priva- tize 'CIA(, Petro-Canada's international assistan(e subsiliary. The specific law provided for the transfer of Petro-Canada's 1 IAC shares to the governmenil be fore privati/ation See the P'etro- Canadia P'ublic Participation Act of February I.9 I 14. lruguay s privati/ation law of October 1c)01, for ex,imple, sets forth a number of princi- ples that must governl priV atiza tioni operations: freedlomii if choice for consurmers, abolition of monopolies, fair competition, and adequate publicitv to ( nsure transparency of the privatiza- tion program. The' Prit'a I7inzttioi Laic 11' Valhationi Valuing public enterprises or public assets is a delicate operation, notably because public officials wish to avoid being ac( used of givinig away the fam- ily silver or selling off the crown jevels. Valuatioll affords theni political pro- tection in the event that the decision to sell at a given price is disputed ("It is the price at which the enterprise was valtuedi tv the auditors"). In practice, however, the valuations that hiighlv skilled eNperts proffer are often far off the enterprise's true market value, even in industrial countries. In some cases, overvaluation of the Su1lC has forcedl the cancellation or postponement of its privatization; this happened, for e\aimplc, in the cases of VSm., the Indian international telephonie company, and the Puerto Rican telecommu- nications companty. While setting a reference price is undeniably useftl, it may be preferable to obtain the right price through competiti\ e, transparent, and open sale procedures with wide disseminationi of informiation. A competitive proce- dure usually offers the governmenit better guarantees than does an expert valuation performed before the sale .1' Comlpetitive biddinig by several potential buvers, each of wvhich will perform its own valtiation of the enter- prise, should more accuratelv reveal thie true value of the eniterprise. This procedure is also speedier and clheaper. Maiiv countries have nevertheless enacted laws requiring prior valuation in all privatization transactions. Some tvpe of prior valuation may be justitied, however. In the case of an auction sale, the seller may want to set a reference or reserve price below which it does not wish to sell. For an initial ptublic offering (illo), prior valua- tion is needed to set the share price; this w,%as dotiei in most Fresnchl, Malaysian, 15. The public flotation otf \.NL Was canceled on M vlav 1, 194, in respoinse to negative reaction to the highi share price following market oMnidingss. Fhis price, which w-as set bv the govern- ment before the fall inl Indiani share prices, nvas appanrentl% nl the ranlge Rs 1,400-1t1 61)0, wliere,s the goverrimentNs financial advisers thought that thii, iu,rket was prepared to pay only Rs ,I111). The goivernment did nlot wish to lower its priLt for fetar f be ille accused o1 t sellilng tilh company at a discount to foreigners. This was a parthcularl\, .ensliv e issue tor thC governnrlet beCause a parliamentarv committee had just accused it of -,ellig certain holdings in 19 02 and 1993 at below their true nalue. Five months 1later the IIotation n-as rela unched the government instructed its bankers to) obtain a price of RIZs lii)-) 21) or 2 i percent less thanl the previous price, despite a rise in the' Indian stock exchanige of al,ut 2`3 percent since Mav. 'his second attempt also faltered. See Will Stlit Jiiiuinial, - Moii n 1904; Ft.ini,'iiigklm k4ikt- We-k, 26 September 1944; l4 i i 'niwk, 30 September 199Q4- With re.pcit to, w P'tierto Ricaii telephi1inC privatizatiin, see note 5 in this chapter. Ih-i. This metheod was chosel, for examiple. or Itie pi i ati/a ltions by auction of the municipal enterprises of the city ot L'viv, uwhichi mirkcd the .tart oif F krain<'s privatization program. The list of enterprises to be privatized w as published ea, I1 mnioth in the pres, to en1sure that invxes- tours were infOrmed (see article 5.2 of the prigrami it pirivati/ati,in ot municipal enterprises ot the city of L'viv for 1992, apprive-d by- rea nlUtiOll nt tin - mu1n1cipal c iii incil of the citn' fI'vlw on Septemiber NS, 1992). The value ofeach enierpris- ians lin deterimined exclusiely bn' the high- est bid made at the auction; the offering price wva, dclehllrate- -et relatively lont (ets article 6.13) of the above-mentiined program) Se e a,i, oi( I " Fl 120 The Privtfization Chall h'ge' and U.K. privatizations, for example.17 Th-e share price should be fixed as close as possible to the flotation date.18 This may require that the price result- ing from these valuations be adjusted in light of the results of a market sounding-for example, by means of the book-build ing procedure.19 In addition, rigorous valuation is absolutely essential when the enterprise is sold through a directly negotiated deal, and particularly when it is sold directly to its employees (employee or management buyout). Indeed, the government must arrive at a valuation without recourse to a market test. In many cases the initial valuation may be performed by the management of the enterprise itself, which has strong incentives to underestimate the value (for example by using the book value of the solt., whiclh is often only a frac- tion of its true market value). This has happened in many transitioni coun- tries, including Hungary and Viet Nam. Where a valuation is required, it should be car-ied ouit by independenit and qualified experts and in conformity with generally accepted valuatioin principles. The cost of the valuation should niot exceed the benefits it is expected to yield. Some countries have establishedl valuation commissions or other special bodies responsible for setting minimum prices; these are fur- ther discussed in chapter 6. Their common drawback is that members of such commissions have no real stake in the success of the privatization pro- gram; they tend to be concerned only about not selling too cheaply, and they often end up setting price floors that are too high. Valuation rules and principles established at the time of nationalization can also be helpful, at least where they were developed with due respect for the rights of expropriated owners (as in the case of the French nationaliza- tions of 1982; see Israel 1986). It is unwise, however, to try to prescribe a gen- 17. Both in Malaysia and in the United Kingdom, shares of otl s to be privatized appear to have been deliberatelyi uiderpriced. This was done in part to gna rantee the success of the flota- tion and enhance the popularity of the government. In M'lalaiia, one of the e xplicit objectives of the privatization program was to increase share ownershiip and redistribute wealth toward the Bumiputra maiority (as opposed to the Chiinese miiority, whi:h dominiiates businiess). ('airt of the shares had been reserved for Bumiputra investors. "On the basis of first-dav share price pre- mia, the average amounit of underpricing has been over 1(l7'. " and on the basis of the share price three monitlis after flotation the premiums still stood, on average, at 93 percent ()xtord Awdlyitica, "Malaysia: P'referential Privatisation,'" 27 Novemi'ber 19951. In thi t fritcd Kitigdotfl, after better-than-average performance in the initial years. total returns on shares in privatized companies haIve roughly kept pace with overall stock market performance. In Fraiic', where the government's tendency has been to maximize the sale price. shal- prices of privatized compa- nies have not fared as well; they are in mans' cases lower than a' wo anid have oin average under- performed the rest of the market. 18. The flotation by the Portuguese governmentit oit (IM'or, tiie country's largest cement pro- ducer, was a flop largely because the issue price hadi been set two months earlier. Meanwhile, the Lisbon stock exchange had dropped 15 percent. See fi't!,,'il f'ii,'(, 18 April 1995. 19. The book-building procedure is commonly used by invcstment banks in tihe United States to sell shares. It was also used in the public flotations of the Argentine petroleuni company Yl'l and in some French privatizationi operations, for example p 8ee, the section in chiapter 3 on accoulntilng law. The Priva?ti01io1 L1w 1721 erally applicable method of valuation. On the contrary, the method adopted will have to take into account the specific characteristics of the country, the sector to wlhich the SOE belongs, and the nature of the assets. The usefulness of a valuation performed in a country or sector where prices are not freely set by the market may, for example, seem rather dubious. Valuation methods used in privatization transactions are generally a combination of those com- monly used in corporate mergers and actluisitions-for example, net present value of an estimated stream of future cash flow (discounted cash flow analysis); replacement value of the enterprise; its book valuc; the liqui- dation value of the enterprise; comparisons with prices fetched in similar transactions or wvith market valuation of comparable (publicly traded) com- panies; and so on. To summarize, where a valuation is made, it should serve only as a guide to the selling agency. Legislation should not prevent this agency from con- cluding a sale at a price below the estimat e if, following a competitive selec- tion procedure, no acceptable bid lhas been received at or above the estimate. Prior valuation by independent professionals may, however, be useful by providing the sellers a reference price that can help them decide whether to accept the bids received, Independent valuation may also reduce the risk of collusion between the buyer and the officialN in charge of privati7ation. It should be required if the privatization is carried out without effective com- petition (see also the section in chapter 6 on valuation bodies). Autlhrizcd Tcchiiiquics All too often privatization laws and regulations prescribe the authorized privatization methods and techniques in restrictive terms. The better approach would be to investigate wlhat techlniques would be legally autho- rized in the absence of restrictions in the privatization legislation. Any nec- essary provisions authorizing other techniqLues or restricting the use of cer- tain methods, as the particular case may require, can then be added to the legislation. Implementinig regulations often prescribe the circumstances in wvhich particular techniques may be used. In practice, the legislator is usually neitlher familiar with privatizatioln techniqlues nor in a position to predict the various circumstances that may necessitate special methods for this or the other specific operation. The privatization law should therefore be drafted in broad terms, leaving the executing authority free to choose the appropriate methods of privatization or, at the least, authorizing a range of privatization technliqtues to fit the spe- cific needs of each case. Sales of shares held by the state or other public entities should be allowed, as well as capital increases, even without divestiture of state shares. A capi- tal increase, witlh or without accompanvijng sale of public holdinigs, would be called for, for instance, where the stI to be privatized urgently requires a new cash infusion. Liquidation should not be excluded from these options, because it is sometimes the only wav or the best way to privatize some SOES 122 fih IPrivatizatwio Clia'lleti' (see chapter 4). Privatization through public flotation on the stock exchange, although an option in the more sophisticated countries, would not be practi- cable in most developing or transition counitries. [he use of convertible bonds may also be on the menu of available options.-') And so on. Where, however, the law prescribes specific tecimiliques, the use of other techniques (not provided for in the law) should be allowed, subject to com- pliance with minimum conditions. One could, for instanice, require the prior approval of the competent minister or eveni of the council of ministers if noncompetitive privatization procedures are to be followed (for example, sale by directly negotiated contract). Such provisions are found in the legis- lation of Argentina, Czechoslovakia, France (see note 23 below), Nigeria, Poland, and other countries.21 The Argentinle example slhowvs h1ow' imp)ortant it is to avoid unduly restricting the range of privatization techniques that can be used. The diver- sity of legal status and economic cliaracteristics of the enterprises to be privatized has compelled authorities to res(rt to a wide range of techniques. This poinlt is illustrated byi table 5.2, which covers o(Ily a small portion of the privatization program, i ana ely, that relatin g to tlhe ministry of niational defense. Most privatization techniiques hlave been borrowed fron private comnmer- cial practices, where mergers and acquisitions are commiiion. Othier methods, however, are specific to sor privatization and miay have to be included in the privatization law if the governmenit intendcis to use' them. Privatization by free distribution of shares to the populationi, or b issuance of privatization vouchiers or coupons, are excellent examples (on this subject, see chapter 6). 20. Convertible bonds anid state bonlds With LLleiit wairrant- have been issued by various governments, redeemaible for shires Of the followving companies, aniong oti ers: Telmex (see note 49 in chapter 7), Italian insurance COmIpanv IN \ (see nite a1 in table 1), Brazilian power company c,Mm (iln lanuary 1994), Televisa o(t Mexico (in FcbrUdrV 1993), anid China Textile Maciniilery (in November 1993). Fhey have also been plannted otor the Turkish telecommunica- tiolns company. In addition, partially privati/zd s,01 such as 11 lekoni Mailay-i (in September 1994) hlave also issued convertible bonds. 21 Atr'5ctiua Article 17 of Law ni. 23hs9 of 1')89 sets forthI, non restrictive list of privatiza- tion methods, while article 1X prescribes the selection procedres toi be followed in all cases, laying particular emphasis on competition and transparellyc C7/(isl'ac,-iwkid: See article I() ot the La xof Februarv 2hI (91i oin the conditions of transfer of public assets to third parties. Nigerin Article 4 (3) of the P rivatization mni dCon mierci lii/, io Deccree of 19X8 provides that "whenever the Technical Commuittee is of thIe view that 11it *nterprise is not suitable for dis- posal by public issue ol shares, the echilni(al Committee haIll re, ommend to tle Fedceral Mili- tary Government the mode of disposal of suich enterprise Ilo tiditi Aiticle 23 (2) of the privati/ation lIa proviles I hat tine council of mi iiisters, actiig On the recommendation ol the iminiister of Ownership tranistfer s, tte axtithorize privatization proce- dures other than those proVideld for in article 23, nam1x,1Li V .L at aUction, public flotatiOn of securities, and compet1tive tender. Pursuant to this irti( 1e the council of ministers granted spe- cial aItthori/ataion allowilng the sale of twvo-thirds (if the sdwnr's of I'ol,t m Pila, a proxiucer of elec- tric light bulbs, t ithe tuDutch cm immlpa V l'hilips (See li.t i h)il s u iii Lie,, Uilv I 991 , p. 6). The Prinitiza ion Law, 123 Table 5.2 Privatization of Ministry of Defense Enterprises in Argentina Statits of (lit, soIl Examiplc Sale t'cchiq)ac Minority state participa- Petropol, Mononimros State's shares sold en bloc tion in the SOE's Vinilicos, Induclor, and to a private investor capital Polistir (all part of the Bahia B3lanca petro- chemicals cornple\) Majority state participa- Tandanor shipvard Differenit blocks of shares tion in the se F's sold to dlifferent investors capital Enterprises forming part Area Material Cordoba Corporati/ation to allow of the armed forces aiation ctompanx later salet of state's shares Unprofitable enterprises, Hipasam (mining) L)irect sale of SOE assets heavily subsidized by to the private sector the government Heavily indebted enter- Somisa (a large iron and Creation of a newv company prises steel enterpri',e) to be privatized, to) whici some of the assets and liabilities of the former enterprise were tranOs- ferred; other assets of the former sol% wvere sold directx,, and the debts not transferred to the newk entity continueLd to be tht government's responsibility Enterprises that do not Tamse Use of lease contracts own the land they occupv Large multipurpose Altos Hornos de Zapla Restructuring, before priva- enterprises that do (an iron andi steel tization, into V'arious not possess juridical company withi forest commercial companies, personality cesources for produc- eachi operating in a tion of blast furniace separate area of activity charcoal) Seofirc: De Kessler 19)t3, p 1 35. In addition, different techniques can be conmbined within) a given privati- zation operation. In France, a public offering was typically combined with a separate sale of a core shareholdinig to a grouip of strategic or institutional investors (see the next section). Many governments have tried to combine the benefits of transferring managemenit control to experienced in ternia- tional investors with national participation, especially in the case of large high-profile companies. To do so, Argentina, Mexico, and other coiuntries 124 The Prizvatization Challenge have used a staged approach to privatize their telecommunications compa- nies, first selling a controlling interest to a group of investors (including a telecommunications operator) and following this with public offerings (see the section in chapter 7 on special infrastructure privatization issues). For its part, the Bolivian capitalization law of March 1994 took an original approach: a capital increase to be subscribed by strategic investors who were selected competitively, accompanied by a transfer of the existing state shares to a new privately managed pension system, as further discussed in box 5.1 (see also the section in chapter 3 on pension fund reform). Selecting Buyers Selecting buyers is delicate, especially given the problems caused in many countries by corruption, nepotism, and discrimination against foreigners and certain minorities or ethnic groups. The law should lay down the broad principles for the selection of buyers, typically by mandating a competitive and transparent process. This involves rules on advertising the sale, eligibil- ity requirements, disclosure of information to investors, amount of time given investors to prepare bids, evaluation and selection, and so on.22 The selection of buyers may derive directly from the choice of privatiza- tion technique. If a company is privatized by wvay of public flotation, the selection process will be anonymous; all investors can subscribe and be allo- cated shares (with some exceptions, as noted below). If mass privatization is chosen, all eligible citizens will have the opportunity to buy or receive shares or coupons. Still, rules are needed to govern these processes; for public flota- tions, they derive from the securities legislation in effect (see chapter 3); for mass privatization, a specific legal and regulatory framework will be estab- lished (see chapter 6). Under other privatization techniques, the government or privatization agency may have more discretion in the choice of buvers. This is the case, in particular, for trade sales and for the selection of strategic or core investors, which are the preferred privatization technique for many SoEs. A tradeoff exists in these cases between tight rules that limit the discretion of the priva- tizing authorities and flexible processes which allow for negotiation between 22. PIuhlicitl: See note 23 below on reqluirements in French law Lligibiliti,: Article 5 of the Czechoslovak law on small privatizations provides that all persons wishing to participate in the sale at auction of a given e nterprise must, to be eligible, furnish a deposit of at least 10 percent of the offering price. Most privatizations of large infrastructure enterprises, for example, are subject to prequalification and other eligibility criteria prescribed by the lavw or its implementing regulations (see chapter 7 and table 7.4). Timectable: In Hungary, a tight bidding timetable leaving o nly 45 days for bidders to prepare and submit proposals, combined with repeated changes to the tender documents during that period, were said to be among the reasons for the cool response given by investors to the priva- tization of the electricity sector in November-Decernber 19X15 (see Finaicticl Timesn, 4 December 1995 and 6 D)ecember 1995). The Privatin:atioo Law 125 Box 5.1 The Bolivian Capitalization Law In light of the failure of past efforts to improve the performance of monopoly SOEs wvith performance contracts, the Bolivian government that took office in August 1993 opted for a more radical reform. It prepared a privatization pro- gram that was given legal status by enactment of Law no. 1544 of March 21, 1994, on capitalization. Article 2 of the law provides for the conversion of Yl'FB (hydrocarbons), ENTEI. (telecommunications), ENDE (electric power generation and transmis- sion), ENFE (railways), LAB (national airline), and ENAF (smelter) into compa- nies organized under private law, in which emplovees may become sharehold- ers. Article 4 provides that these new comiipaniies shall be 'capitalized" by means of a capital increase subscribed by private investors (domestic and for- eign). The number of new shares may in no circumstances exceed the total number of shares that existed before the capital increase; this means, in effect, that new investors cannot hold more than 5) percent of the capital of the com- panies privatized in this way. The new shareholders must be selected and the amount of their contribu- tions determined following international calls for bids (article 4). In June 1995 three of ENDE's power generation units were transferred to as many consortia, all led by U.S. power companies; EN1TEL was privatized to a group led by STET (the Italian operator) in September 1995; VASI' (a Brazilian airline) acquired the control of LAB in October 1995; Chilean investors took over ENFE in early 1996; and YI'FB was broken up and three international consortia were selected in December 1996 to take over the transportation unit (Enron/Slhell) and two oil and gas fields (Amoco, YPF), respectivelv. Article 6 empowers the government to transfer the shares it holds in the above-mentioned companies to the Bolivian adult population, free of charge. Article 7 states that this transfer must be carried out to the benefit of retirement funds that have to be set up pursuant to a special law on pensions (Lawv no. 1732 of November 29, 1996). The same article providees for a trust arrangement to be established pending the creation of these private pension funds. Two private pension fund administrators selected on a competitive basis will manage the collective capitalization fund and the individual pension accounts (see p. 8t). Through capitalization, the government gives up any claims on privatization proceeds, but gets the private sector to subscribe to capital increases whichi, owing to the state of public finanices, the government is no longer able to funtd itself. Moreover, the creation of retirement funLds should contribute to the social security needs of the citizens, help promote the development of Bolivia's finan- cial markets, and facilitate access by enterprises to domestic financing. Article 10 provides that the sectors covered bv this law will be governed by sector-specific legislation, and that a regulatory entity will be established by laxv. seller and buyer. Indeed, the use of an auction-type process leading to the award to the highest bidder can work only when all key aspects of the trans- action can be identified and defined as part of the bidding documents. This is easily done for simple transactions in competitive sectors. The preparation 126 'I/c' Pri,a tiZlatio CiaIIcnoti' of suclh exhaustive bidding documentation may not always be feasible or desirable in other instances, hoxvever. If all key aspects of the transaction have not been set and shared with all bidders before they submit their offers, postaward negotiation and modifi- cation of the bidding terms will render an auction-type award meaningless. If negotiations on substantive aspects of the deal take place after the selec- tion of the buyer, the emphasis should be on setting rules and procedures for evaluation, selection, and negotiation that are seen as fair and reasonably transparenit; privatization officials should be made accountable for their decisions; and they should be advised throughout this process by legal, financial, economic, and other experts wvith relevant experience and (1ualifi- cations. Examples of substantive aspects that are often negotiated after the award include the size of the labor force the buyer accepts to retain; invest- ment commitments; environmenital liabilities and:l commitmenits; payment terms; pricing formulas and other regulatory features (for regulated indus- tries); and so on. The use of nioytiaux dliirs in most Frenclh privatizations illustrates how the use of discretionary powers can easily become controversial. The govern- ment selected a core group of large in'dutstrial or financial shareholders (inot(auil diur) to wlhichi it sold a controlling stake in the company.23 The remain- ing shares were sold through public flotation. This procedure was intended to ensure a stable group of active shareholders and to preclude excessive shareholder dispersion as well as the risk of un conitrolled takeover. The core shareholders had to pay a premium above the pri( e at which the shares were sold to the public and they had to retain their shares for a specified period.24 Because the same hand-picked groups turned up in many of the core share- holding groups and, consequently, cross-sharehold ings were frequent, the procedure came under fire. It may be seen as a way for the government or a technocratic elite to maintain control over enterprises, even thouglh they have been privatized, and to keep the incumben)t management-typically recruited from the senior ranks of the civil servi( c-in place (see Le Mondte, 23. Iegally speaking, this was an exception, permitted bt article 4 oif the law of August 6, 1986, to the general rule of public placement of shares through the financial markets. It autho- ri/ed the minister of economy to choose the buyer without going throughi the financial markets, after consultation with the privatization commission and purua nt to a decree setting minimumii publicity conditions, including notification of the propo.ed privatization by publication at least one montlh before the deadline for receipt of bids in the official gazette (lournidl f?ficilt) and two financial newspapers ot wide circulation (Decree n1o. 86-114t) of October 24, 1 980). Article 4 wvas amended by article 5 of the law oftJuly 19, 1993, whichl strengtihened the role of the privati/atioll comm1ission byv providing that, in selecting buyers with0ut rnCOurSe to the m arket, the nisiister couldl heniceforthl act only in conformity vvith the advice given bv the privatization commission. 24. During the first privatitation wave of 1)986-58, the portion of the privatized company's capital sold to core shareholders was generally in the range ft 21-30) perceit of the capital, and the control premiumi1 remained modest, ranging from1 2i pen e nt above the pLublic offering price for l'aribas to 1(i percent for Matra. The premiuil lor XI I l (elevision network privatized pur- suant to a different law, was 73 percent (see Cour des ci (mphts 190), p. 27). Tle Priveti-iticii lainc 127 8 March 1994). It shields the enterprises frorm tihe rigor of mnarket discipline, in particular bv makinig hostile or foreign takeovers difficult or impossible. The core shareholding procedure was not popular with fund managers and other investors, who felt the interests of core shareholders and incumbenlt managers would prevail over thcose of noncore investors. Spain followed a similar approach wlhen it accompanied the sale of part of its remainillg shareholding in Telefonica witlh the creation of a group of core shareholders composed of three doomestic financial institutiolis. The selection process also affects o(ther a-pects of the privatization transac- tion: a traisparent, nondiscriiinatOr-, and competitive procedure for select- ing buyers should, for instance, vield a sellimg price in line witlh the current market value of the SOF and tlherebv obviate the cost of a prior valuation. It is important to let the implemenlitng agency adopt more precise regula- tions and tailor bid requirements to the features of each transaction.25 Dele- gation of these matters must, however, be accompanied by procedures ensuring accountabilitv of the agency and its officials, together with control and appeal procedures. Noncompliance witlh thie rules established for the bidding process may provide grounds for annulment of the selection. Rcstrictionis o)ni Bznyer Selectiton The privatization law should be free of unnecessary restrictions ofn the selec- tion of buyers. Some restrictions, suchi as the exclusion of public agencies as buyers of privatized enterprises, may, however, be nece,sary to protect the objectives of the program. Privatization laws often grant rights to SO() employ- ees and management, particularl, reserved share allocations and preemnptive rights, that may also conistraini the selection process (see next section). Restrictions on the buyer's nationality or other clharacteristics are found in a number of laws. Thev can often be circumivented by, for example, usinlg dummv companies; restrictions on tlle further resale of shares of privatized enterprises tend to be difficult to enforce. Some laws, nevertheless, intro- duce restrictions reflecting "national interests' or other government objec- tives (including industrial policy objectives), usuallv in the form of protec- tive measures against foreign takeover or control of privatized enterprises. Restrictions imposed on acceptable potenlial bLuvers lead to lower sale prices; they mav also scuttle the whole tran,s,iction.t, 25. For example, in certain rece,nt pn-vati/ati') operatioins n Argentita., bidders were required. to att.acli to their bid a1 signled C(lp it thlL o- inrj, t proposed to themn. iTh purpose ot this procedure was to avoid long anid difficult neghtiaritn, ,lter anniunincement of the winning bidder, as happenied in the privati/atioli of I NIl and the aiward oi the first railway' conces- sions. Such negotiationis canl substaiitialilx altter thill' 0iitioim Of YalIC an1d helceL itroLiuce new' factors n(ot taken iiito accouiit in bidder celection. ,ee \t(x\ander and ( orti jl)Q3, p 1t 26. Lopezc-de-SilanIeLs 10( f0ouiid in an (mpiricril tii'iv oo klexican privatization that restric- tions oi buver, InIcludingexclusion iof foreigi biu e,rs, ld iLIded lower thei alI price of priva- tied eriterprises 128 rin' Privatizati on Chalet/egt' Restitutionz of tnation?alized enterprises. Chapters 3 andi 4 explained the impor- tance of the existence of clear ownership rights to privatization and spelled out how these rights have been affected by earlier nationalization programs. As already discussed in chapter 3, in some countries the privatization law (or a separate "restitution" law) contains provisions entitling former owners or their heirs to ask for the restitution of their assets. This is, of course, the ulti- mate restriction on the selection of buyers for enterprises to be privatized. Exclusion of or limiitation on public-sector participation. In order to effectively reduce the role of the public sector in the economy, many countries, inctlud- ing Brazil, Bulgaria, Peru, Poland, Russia, and, indirectly, Jamaica have restricted the right of public-sector entities to participate in the privatization process by buying shares of other sOEs.27 The very object of the privatization law may also rule out the transfer of shares or assets to SOEs or other public entities. Thus, article I of the Moroccan privatization law of 1990 explicitly prescribes that the ownership of shares held by the state or other public agencies in the companies listed in an annex to the law shall be transferred from the public to the private sector. Moreover, some countries have inserted more restrictive rules under this head in their privatization laws to further support the objectives and consis- tency of the privatization program by limiting the creation of new SOEs. The same Moroccan law discussed above prescribes that, except when effected by law, the creation of any new public enterprise, subsidiary or secondary subsidiary of a public enterprise, and any new participation by a public enterprise in the capital of a private enterprise mtust be authorized, under penalty of nullity, by a government decree proposed by the minister for privatization (see article 8 of the 1990 privatization law). 27. Brazil: The steering committee set up pursuant tl) the privatization law adopted Resolu- tion no. 15 on August 19, 1991, setting an overall ceiting ot 15 percent on the proportion of the shares of a privatized enterprise that can be acquired by solts. Btulg7ria: Article 5 (4) of the privatization law of April 19'20 provides that public enlterprises in which the state or a muniicipality holds more than 51) perct nt ol the shares cannot participate in privatization operations withiout written authority, giveni on a case-by-case basis, from the privatii.ation agency. Pur[: Article 1 of Decree-Law no. 674 of Septemiiber 25, 1991, ( oniceriiing the promnotion of pri- vate investimient in s5ys, was amended by Decree-lIaw n). 261 21) ol December 28, 1992, by the addition of a second paragraph whichi defines "privaite investmiienit" as one that "derives from natiral or juridical persons, domilestic or foreign, publiic or priv. te, distitm( I front tiu' (criw I imi atfaf otd floiln tills' aclcnocica thlalt makc, upl ti nationalii publfic a or aiid til ftch'-oo'ncitl c)itcrpriscl (eirplia- sis added). This wording made it possible to excluIde the nlatiol df public sector withiout exclud- ing foreigin public enterprises. Russia: Article 9 of the privatization law provides that cntitics in wlhichi public sharelholders hold more thani 25 percent of the corporate capital cannot act as buyVers of privati/ed enterprises. Jtmlica1*7: T'he government pursued a similar goal, but indirecly: a law, abolished in 1991, lim- ited the share that any individual investor could acquire in the capital of the National ('ommer- cial Bank, which was partially privatized in 1986, to 7.5 ptercent with the object mainly, it seems, of preventing the government from regaining control of the ba uik in the future (see Plrivatisaitieu Ycbirlw)k 1992, p. 167). Tlhe Privatizatio)n Jaiz 129 Exclosions (o or liimlitationis oni foreign particih ition. It is not uncommon for legislation to include express restrictions on participation by foreigners, as illustrated by box 5.2. These restrictions are generallv detrimental to successful privatizati on operations. Tllis lesson has been learned by France and Brazil, among other countries: after introducing restrictions on foreign investors in privatiza- tions, they hadi to abolish theem. It is worth noting that the European Com- mission has exerted significant pressure on France and Portugal to lift such restrictions, which are contrary to EU law.28 1'he most stringent restrictions on foreign participation are found mostly in the ]egislation of countries whose privatization programs have not been particularly successful. Bv limiting the number of eligible buyers and excluding the potential buyers who typically possess the most resoutrces, these provisions reduce the likelihood of completing the sale on goo( terms. The situation is particu- larly paradoxical for poor or heavily indebted countries, which most need to attract foreign capital and often enact generous investment codes to appeal to those same investors (see the section in chapter 3 on foreign investment legislation). And restrictions are not limited to foreigni participation. In some coun- tries, the government excludes certain categories of citizens from the bene- fits of privatization by reserving sales to indigenous pOpulations.29 Spcecial, or Golden, Shores The "golden" share technique has been usetd by some countries, including France (see box 5.3), Belgium, Brazil, Malaysia, New Zealand, Spain, Turkey, and the United Kingdom, as a way to keep some degree of government coin- trol over a privatized company, mainly with respect to future transfers of shares.30t By allowing the government to veto some corporate decisions or 28. According to some observers, tihe French law also needed to be amended in view of thie absence of large private domestic institutional inv estors; raising foreign capital became a pre- condition of the success of a broad privatization program (see FinanicialT ouis, 30) June 1993). In Portugal, the former (social-democrat) governmeit used the option afforded by the 1991) priva- tization law to pot limits on foreign shareholdicng for specific privatizatioLns; legislation sub- mitted to parliament by' the newv socialist gox&ernment to abolishi these restrictions for n; inves- tors was, however, defeated in June 1996. The European Commissioln has threatened to take Portugal to the Europeani Court of Justice on this issue 29. In Malaysia, one of the main objectives of priv atizition, and mort generally of the govern- ment's economic policv, is to strengthen the economic power of the indigenous Malays, the Bumiputras, and to reduce the relative weight of thie local Chinese. Thus in most privatization operations only Bumiiiputra investors could act as buyers ot shares offered for sale by the gov- erinment (see Galal and others 1994; see also note 17 above). 30. In the case of British Airports Authority (BA), for example, the sale ofanairport by BA\ is subject to approval by the government1, whichi hold: the special or golden share. Generally speaking, this golden share empowers the government to block takeov'ers or foreign) sharehold- ing. See also the examples given in the sectioin ot hapt r, Ton golden shares. 130 TI,t' lit, 0 OtiZiatiol l C7alk cifgc Box 5.2 Restrictions on Foreign Participation in Privatization Brnzil. Article 13 of Law no. 8031 of April 1990) (and article 44 of Decree no. 724 of January 1993) limited hioldings by foreigners ito 40 percent of voting shares. This restriction has since been lifted, initially bv a provisional measure taken on October 26, 1993, and renewed every 30 days thereafter, allowing for- eigners to acquire 100 percent of the shares of privatized enterprises. More- over, the constitutional basis for discriminatinig against toreigi inivestors in certain economic sectors was abolished in August 1997*. The privatization pro- gram included other restrictions on foreign investments w;hen made by way of debt-equity swaps: funds invested throughl swvaps had to remain in Brazil for at least 12 years and foreign investors had to hold oni to the shares so acquired for at least two years, during whiichi they were not au thiorized to repatriate anly funds. In light of the low participation by foreigner- in the initial privatiza- tions, holwever, the Brazilian government reduced the 12-vear period by half and abolished the restrictiotn on transferability of shav es. Bit rkinulIis. Article l() of Ordinance no. 91 -0)044/1'IRES of July 1991 empow- ers the minister responsible for SOF1 supervision to rese rve in priority a share of each privatization for Burkinabe national1s. Cl,,7,. Article 9 of Ordinance no. 0 17/ lPR/92 of August 1992 on divestiture of SOF. holdinigs provides: "In the sale and/or transter of state-held assets, prior- ity shall be accorded to natural or juridical persons of Chad nationality. The regulation of the Minister of Commerce and Industrial Development issued pursuant to article 7 of this Ordinanice shall set the numilber or proportion of shares to be toffered in priority and als)l thle period of \ alidity of the olffer. Upon expiration of thiat period, sale of the remaining sharer sshall no longer be subject to this priority." C:ccIloslhc,akia. Article 3 of the law of October 199t) on small privatizations provides that only nationals of the Czech anid Slovak Federal Republic, and companies or othier legal entities wlhose owners or m iembers are all nationals, may become owners of enterprises and ass(ets pivati/Zed pursuanit to this law. The lavv on large privatization operations does nlot contain such a restriction. Irarnicc. Article 10 of the law of August 1980r lintited the total amount of shares transferred by the state to foreign per-ons, directly or indirectly, to 20 percent of the SOE's capital. This provision was first amnended by article 8 of the law of July 1993, wlhichi provides that this ceiling shall ntot apply to Euro- pean Union investors; an amendment ot April 12, 1 o9(, abolished the remain- ing restriction. Scnegai. Article 1 1 of Law no. 87-23 of August 1987 on sotE privatization pro- vides: "For each enterprise, the minister withi responsibility for the state port- folio shall set the proportion of shares that can be transferred in priority to nat- ural or juridical personis of Senegalese natinalihtv." share transfers, for example, this technliqu.qe prolongs state control beyond privatization, even though the state is nou only a minority sharelholder (sometimes with a single share). Golden shares are special shares created by law or by the company's articles of agreement lor the specific purpose of Tlt, Priz'atfLation Law 1,33 Box 5.3 Golden Shares in France Article 1() of the French privatizatioin lawv ot August 6, 198t6, authorized the minister of the econiomy to determinle, for eaich tof the 65 privatizable compa- nies listed in the annex toi Law,a nlo. 86-793 of July 2, 1986, wv hethfer protectioin of tihe national interest required that a special shiare be granited to the state alid, if so, to establish such1 a share. The companyv's articles then had1 to be amended accordingly. Article 1(1 provided: "Tlhe special share allows the Minister of thie Economy to approve shareholdings by any perso n or group of persons acting togethier exceeding 10'1Y of thie capital. The special share mav be permianentlv converted inlto an ordinary share at any timie bv order of the Minister of the Economiy. Such conversion shall normally take place automatically after five VearS. . . . In cases of violation of the provisions Of the first paragraph hereof, the holder(s) of the sharelholdinigs improperIv a quired may nlot exercise their voting rights and must transfer suc h shares withfin three monthis." In practice, however, there was little application of these pro isions in the period 1 986-88 and niost SlEs were privatized without recourse to this mechlanis. ()ther leg- islation in effect at the time empowered the government to co ntrol, and some- times block, undesirable takeovers (see p. S-319 above, aid Grahalnm and Prosser 1991, p. 154). Article 7 of privatization law no. 93-93 of July 1)9, 1993, widened the scope of application of the golden share provi9ions by abolishiing, fr exam- ple, the time limitation, It also) allows a referril to the ninestry of the econ- omy for approval in cases wvhere control threshiolds are exceeded by les than 1t) percent; these thresholds are no lonnger definied in the law but are prescribed by diecree on a case-by-case basis. In addition, one or two iionvot- ing representatives of the government cin be appointed by decree to the board of directors orsupervisory board ot pri( atized elterprises. Finally, the government can exercise a veto on comnpani decisioins concerning the trans- fer or pledging of assets, if such decisions hax e the potential to be detrimen- tal to national interests. The allocation of a golden share to the French government under the pro- poised Renault-Volvo merger was oine ot the reasons the VOIvo s1hareholders decided to reject the project in December 1993 On the other hand, it does lnot seem to have affected the success of the last privatization for whiclh a goldenl share was issued, namely that oif Elf in Mlarchl 199)4, although the presence iof two nonvoting government commnrissioneirs wi the board Of directors was, it seems, not well received by the international investors. according tlheir holder (the state or government) special rights that go well beyond those attached to ordinary shares. In some cases, they lapse at a pre- determined date. The rights attached to them nmust be describedl in the sale prospectus for the SC)E. The goldeni share technique has been frequ-ently used to enable govern- ments to conitrol future transfers of blocks of shares of privatized airlinies, so that anv future changes in shareholders do not brinig the' enterprise under foreign control, thereby causing it to lose the right to operate 732 The, Privatizationi Challenige certain international routes.31 It is also very commonly used in privatiz- ing infrastructure companies (see chapter 7). The rights conferred by golden shares are not, however, necessarily limited to controlling share- holder composition; they can extend to other decisions of the company, as they do in Senegal.32 Although they may be necessary in some cases (for example, airline privatizations), golden shares are by no means an essential feature of privatization laws. On the contrary, by interfering with the normal func- tioning of the market and blocking certain types of takeovers (their usual purpose), golden shares can diminish incentives for management performance and adversely affect the operating results of the privatized company. Preferential Schemes Privatization laws often allow or require the allocation of free or discounted shares in privatized companies to specific groups, including employees and small shareholders, as well as other special benefits. The reasons for such giveaways vary, but generally include the objective of winning the targeted groups over to the privatization cause. These benefits may, for instance, cre- ate worker support for privatization (or reduce their opposition) and favor- ably impress citizens before an election. Preenmptive Rights and Othier Employee Benefits NMany laws grant preferential terms to the employees of privatized SOES by earmarking part of the SOE shares, granting large discounts on the share price, or both, as illustrated by box 5.4. Some privatization laws encourage employee shareholding by authoriz- ing interest-free loans or deferred-payment plans for the purchase of shares; 31. The minimurn national shareholder percentage may vary from one treatv to anothier Brit- ish Airways, Malaysian Air System, VIASA (Venezuela), and Air New Zealand are among the airline companies privatized withl the allocation of a golden share to the government. See also the section of chapter 2 on interinational law and box 2.3 on tht privatization of KIM. 32. Senegal's privatization law authorizes the use of a special or golden share in certain cir- cumstances, mainly in order to protect the state's interests as c reditor of privatized enterprises that have repayment or guarantee obligations to the state. Article 14 of the law provides that "the Minister in charge of state holdings may decide by ministerial order that one of the shares held by the state in an enterprise to be privatizedl that has previously received loans guaranteed or onlenit by the state shall be converted to a special share carrying special rights.... The special share allows the Minister in charge of state holdings, uider conditiolis andl procedures to be prescribed bv decree, to ensure that the enterprise takes all necessary measures to provide for repayment of the loans guaranteed or oinlent by the state The Privatization Law 733 Box 5.4 Preferential Allocation of Shares to Employees In Ar'enftinn, a proportion of the shares, often about 10 percent, has generally been earmarked for employees under privatization operations. By May 1993 about 117,000 employees had acquired shareholdings in this way in 64 priva- tized SoEs. Employees are allowed to pav for the shares allocated to them out of dividends. The Banco de la Nacion Argentina is the depositary for these shares (see Prizvatisation Intcrntiional, May 1993, p. 31). In Bultkaria, articles 22 and 23 of the 1992 privatization law contain such pro- visions with respect to the privatization of SOEs organized under company law: article 22, which applies to SOEs organized as joint-stock companies, states that the discount is 50 percent and that up to 20 percent of the shares belonging to the state can be sold in this way; it caps the total value of the discount to which each worker is entitled at an amount determined according to the worker's seniority and salary and provides that these preferential employee shares will be nonvoting shares for the first three years. In Franicc, the privatization law of August 1986 prescribed that It) percent of the shares offered for sale had to be set aside for employees (and some former employ- ees). It authorized discounts for employees of up to 20 percent of the share price, with payment in installments over a maximum period of three years. Employees receiving a discount of over 5 percent could not, however, transfer their shares in the first two years, while those granted payment facilities were required to retain them until they had paid for them in full. In the case of Paribas Bank, for example. 10 percent of the shares sold were earmarked for employees (and former employ- ees); of these shares, one-third were sold at a discount of 20) percent with deferred payment (over two years) and two-thirds for cash at a 5 percent discount. In addi- ton, free shares could be allocated to employees who retained their shares for at least one year beyond the mandatory holding period (in the case of Paribas, one free share for each share bought and held for a year following full payment) and to small shareholders who kept their shares for a specified minimum period (18 months in the case of Paribas). Cour des Comptes 1990 (p. 27) estimated the total cost of these benefits to employees and small shareholders (in revenue forgone) at just over FF 1 billion for employee discounts and just over FF 5 billion for free shares, that is, total benefits of over FF 6 billion, equal to about $1 billion. The priva- tization law of July 1993 retains the discounts and deferred payment facilities for employees. It provides, however, that shares cannot be transferred for two years when a discount has been given (even of less than 5 percent of the share price). In Poland, article 24 of the privatization law provides that up to 20 percent of shares be reserved for workers of the company at a 50 percent discount on the sale price to the general public (Polish citizens). The aggregate value of the dis- counts granited to employees of a company is capped, however. A new privati- zation law was prepared by the government, enacted by parliament, vetoed by President Walesa, and reconfirmed by parliament overruling the veto on July 21, 1995. Feeling that the law infringed on the powers of the executive, the president asked the Polish constitutional court to review it. The court "ruled against a por- tion of the legislation that said the government must offer part of a company's shares to employees for free. Instead, the court said the government should sell the shares to employees for half the price offered to investors." Following this ruling the government announced that it would submit a new bill to parliament; the new privatization law was enacted in August 1996. See Ccntral European BuIsinecss WeckA-, 1-7 December 1995; see also pp. 39-40 above. 134 Tlit7 Pri'atizatiouti ChalIenge some even allow shares to be paid for out of future dividends. Loans and installment plans have drawbacks, however, and should not be granted for the bulk of the share purchase.33 These advantages are sometimes com- bined, as in Slovenia, wvhere managers and workers enjoy a very generous preferential scheme encompassing some free shares as well as discounts and deferred-payment facilities.34 Moreover, some countries have promoted the outright takeover of enter- prises by their employees (see EBRD and CEFIN 1993). Russian legislation has probably been the most generous in this respect. It offered the workers' council of corporatized SOEs three choices: (a) to receive 25 percent of the shares free of charge and 10 percent at a subsidized price; (b) to buy 51 per- cent of the slhares at a price equivalent to 1.7 times their book value (far below their true value, especially considering Russia's high inflation rate); or (c) for small enterprises only, to enter into a management contract enti- tling managers to obtain 20 percent of the shares at book value if thiey meet contractual terms and giving all employees the right to another 20 percent at a 30 percent discount to book value. This third formula was rarely chosen in practice. Since the second option was by far the o)ne most favorable to the workers, it is no surprise that more than 70 percent of the enterprises con- cerned chose it, thereby allowing employees Uiaid managers to acquire al percent of the shares at a fraction of their normal price and protect them- selves against any hostile takeover bv outside investors.35 Anothler 29 per- cent of the companiy's shares was typically sold in a second stage through voucher auctions. 33. The Slovak government lias been criticized fot- selling setls to managers and workers and giving them ten years to pay for their acquisition; this allows theml) to control these enterprises withi very little money diownI, while using the company's cash flow to pay tht government instaliliments. WVIhere the company provides loans to its enmployees to bue shares, the total amonlit should remain small relative to the company's ioverall eluity so that the interests of its creditors and its otlier shareholders are not adverselv affected. In the privatization of Telmex, the labor UnlioIn was able to borrow funds at a loss rate (6' ) from) Nafinsa, a puiblic financial institution, to fina nce the acquisitioni of 4.4'X of the conpan y's stock. See also the secti on on Argentina in box 5.4; the section below on financing; and the part of chapter 3 on employee ownershiip legislation, including i (11's. 34. See Fiticuit/ cI'iasl , 12 April 1994. The fact that the enterprises of thie former Yugosla- via were largely self-managed by their staffs helps explain this generosity. The previous regimes had vested employees with) quasi property rights thalt could not be ignored I'riva- tization througil maiiagemenit-employee buvouts ha, alsit been commio in Slovenia and Croatia. 35. See Lieberman and Rahuija 1995, pp. 13-15. A 199- studv by the London Business School, confirminlg the shift of control from the state to compan>y insiders, "founad that among a random sample of privatised Russian companies, workers held 48' otf the shares, managers 21'4 aiid outsiders 2()' In 65'.' of privatisetd firmis, workers held a dominanit share" (lit,' ICIotwin. 18 November 1995). This same scenario also took place in Kvrgyzstan anti other fornier Soviet republics that had baseti their privatization legislation on thie Russian model (see the sectiotn below on the cboice of an equitable schiemtand the section i l chapter 6 dealing with c n1fii ts of interest). The Primf izati iit Lawt, 1.35 In the United Kingdom, National Freiglht was sold to its emlplovees in 1982. In Mexico, the trade unions were given a preemptive right in privatiza- tions that allowed them to buv a conmpalnv bv matching thle hIighest bid obtained in competitive bidding.3At Legislation in Bulgaria andi Iran also pro- vide for employee buyout scheimies.-I Preferential share schemes for emplovees nmav be xvell suited for large enterprises organized as joint-stock companies. buit thev are less so for small firms. Employee buvouts, on the other hand, miav be put together for small firms more easilv than for large ones. Fuirth(ermnore, sonme investors maiy want to be sole owners or may not want emplovee particip.ation in the man- agement of the company, especially where a companv reqtuires a lot of restructuring." Other investors mavx view eimployee participatioil ill the company's capital as a contributioni to a better social climate, highlier producU- tivity, and sometimes also as a safeguard adgailst future renationalization (see Gates anid Saghir 1995, p. 8). Finallv, in most transitioni countries, prefer- ential rights may be a reflection or confirmatioin of thc rights wvorkers ancd managers already enjoy, whether de jure or citd facto, over their enterprise before its privatization (see Bovcko, Shlciter, adc Vishinv Ii'$,). Advma c l sGinsirt to h fi c) Ot r Ca tc\'aric's of. 8i/itlc Discounts, rebates, free share dlistribLutionis, concessional financinig facili- ties, or preemptive rights have been offered not only to emplovees. They have, for example, been granted to citizens as part of mnass privatization programs (see chapter 6); to lessees, as in Cztchoslovakia; or to tenants, as in Hunrgarv*.I9 A great many countries have granted suchI a1d1van1taMgCes to shareholders as well, including France, Indonesia, Italv, Spain, and the 36. Sixteen enterprises were sold to their respective eplt'x'ee1. u molts under this proxvision during the 1 980-'31 period . Resale of the enterprise wvas 'rohibItted tO avoid possible improper practices, such as ain agreemenlt betwVCeei an1 illtere'tt'ted l\'ver alnd the tl110in o llider Which tlie buver would purchaase the enterprise atter the urini hald e\rlcised its right, thurthvb guaraliltee- ing the acqiuisition of the enterprist withillt hiddlltg al ti the risk of r.i'.iig flxe aictioii prl( (see CGalal and others I994). 37. Article 31 of Bulgaria's 192 priexti/atioi It pl-L-re-trlhs thi., WhCere the enterprise to he privatized is neot incorporated unider private lawN, tIe cnmilivet' of the entterprise m,v hid bii in i auction or tencder sale, on the c(I dition that a t lea l *tl p-rceL lt iif the cit pllIOeVs participaIt . Ili the event that thev offer the highiest price, thex Will t' si IC( t(d Js bUh y'rs aiid iv Ill hi gru [i'd .a S3t percent disc, iLnt iOn their hi I price. In Iran, prik Atii itoii d eerie niii. .25 / F tlf I er marks 33 ptercent of the shlares of eniterprises pritaiti/cd in the iiUtoittrinig s't ,cr for tivt's .1 grants them ia right of first refusal ov er the renmainitg t0? p1 en i ut. 38. To add rt's such cotinceri , the l3 lgoirarim . i tr'ij% i1l wO, stJ. i pItdllt,.i tht a ris gi Vl)iiti empiloet' sn preterential terms Iwuld be no 'vo 'img ft r LI Ih-ret-Nv,r pt riol (articles 22 1, ud 23.2 of the 1)9) law ). 39. Sei' article 165 til ei [ii'mall-SCal,I' rlVi/ti/,tioll tt l Otec CiisltiV lkl.,il Which giV1 ti'sless a right f first refusal tvith respect to prOpertv the\ Irn' IL-sing l \ giVing Iltlm an (i ilp(rttinitv Ii' purchase it hietore it is put up tior auction The ile pri, e is the risirt e priCL'e thit Would haive been set t auiction (artli'-C St. tin Hungarv, see hi\) . I 136 Thc P rie)afiz titofil Challcng United Kingdom.4t1 Article 16 of Argentina's privatization law (-1989 law on state reform) lists six categories of buyers eligible for preferential treatment: in addition to employees, thie law lists current shareholders, habitual users of the services of the SOE to be privatized, producers of raw materials pro- cessed by the enterprise, and individuals and comnpanies that bring in new sales contracts to the enterprise. ChoicCof "t7i Equi,able Schenih The preferential-treatment schemes described above have implications for public finance and will therefore, as a rule, need to be autlhorized by or pur- suant to a law. The privatization legislation should set thle minimum require- ments applicable to these benefits or sclhenmes, because they involve not only a loss of revenue for the public treasury buti also a transfer of resources from the state to specific groups. If not properly designed, provisions of this kind can raise delicate prob- lems. The granting of benefits to employees, for example, raises questions of equity (why should employees of some SOF-s receive a benefit from the gov- ernmllenlt that is unavailable to the employees of other soFs, to civil servants, to farmers, or to the unemployed, to cite only a few), of efficiency (whether employee participation in thie capital of a company hielps boost efficiency), and of necessitv (whetlher benefits lhave to be granted to gain employees' sup- 40. Frooc: Biuyers who held their sliares for a specified period (lore or two years, deperiding on tht company) got additional shares distributed free oi chalge. ImlciiSii,: The sweetener used for the partial flotation ol P' kelkom included a 2.5 percenti dis- count for Indonesian investors and a one-for-ten bonis share redeemiiable after hlolding the stock f(r ole vear (see Fiiiaw iTinii sil ms, 12 September I Q9 and 2 November lc')5). Italti: In order to encourage small shareholders to participat' in the i NI pri\vatization, after the rather poor performance of other recenitly privalized compa,nies, the government offered a cre- a ive form offiraL urmce. "If the average IN share price in the 21 days at theenid oftlie 12-nmont l period following the issue is less than the issue price, the Trea-urV will reimburse the difference up to a tenth of the original price-provided that investors ht ve held their shares for the whiole period" (T'he itt 'omi;Is, IS November 1995). le-p te this eniticeimenrt, investor in terest turired out to be lowx'er than the) governmnent had hoped, and afte: -market performance was disap- pointilig, too. Spa il: InI the 1'995 flotationi of Tleftn ica shares, incentlv e, iir smallshareholders incltided, in addition to a 4 percent discouiint, one bonus share for tx erv iventy shares held for at least one 'ear followxing the flotation. Individual shareholders \x ho satbscribed to shares in Repsol, the energy company; were not only giv'en a 4 percent rebat( on the share price but also a guarantee by the state ItIat it would reimburse such investors (tip to 11 percent of the offering price) in case the share price dropped withinl the 12 months fol wing the offering (see Fi,iiicil T'imes, 2h January 1996). tUoitcd Kiiii(isum: Free shares were given to shareholders wiho kept their shares in electricity companies for three years, for example. Most large ptixati/ations were done through public offerings; many of these xvere also underpriced, wlhich is another way to provide immediate benefits to shareholders. )argely as a re.sult of the priX tiyiLio(n program, the number of share- holders roSe fromr about 2 million before thte 1984 BIritiIh Tl; tConi privati/atio n to ahout I m I- lion) in 1995. The Priz'atiatiau La 137 port and thereby ensure smooth execution of the privatization program). The difficulties are compounded when it comes to enacting detailed regulations.41 Preferential schemes and their related provisions are not essenitial features of privatization legislation. Nevertheless, provisiins allowing these benefits to be granted are found in many privatizatioin laws, because thev reflect the poli- cies of manv governments and are often intended to enlist the support and involvement of employees, other targeted groups, or the poptulationi at large in the privatization program. In some cases short-term electoral considerations will prevail over the broader efficiencv goals that should ideallv be central to the program (see chapter 1). Thus manv observers feel that the benefits granted in Russia to employees and managers of privatized enterprises were excessive and slowed the development of these enterprises by protecting and strengtlhening the positioin of the management teams of the former SOEis (see also the sectioin in chapter 6 on SOF managemenLt and restructuring bodies). Financing The rule in privatization programs should be thiat buvers of shares, assets, or enterprises pay for their acquisition in cash)42 Exceptions will normally have to be authorized by law, as thev represent beniefits or subsidies selectivelv granted by the government (see the section abNv e onl preferential sclhemes). Fi, in ci ig Arenmct ge tll UIts Almost all privatization laws or programs eimbody special finanicing tech- niques, wvhich can be divided into tw)o tvpes: deferred payment (seller financ- ing) and credit (bank financing). If the method of financing does not involve a subsidy-that is, if it has no adverse impact on public finances-no special leg- islation should be necessarv. When the concessional financing is available to all interested buyers, it forms part of the general terms and conditions (it becomes in fact a price factor) and no longer amOLun(ts to preferential treatment; therefore, unless the law provides ottherwise, no specific authorization slhould be reqLuired. Techniques have been developed to reduce some Of the risks associated with partial payment for shares. Where shares are paid for in installments, 41. Whicl emplovees should be eligibles for the (mnplovee shares cuirrenti einplislveL Eincludiing those hiredl recentiv; what should be the u etoft date?l; forrmer emplovees (minimuim number of vears of service'); retired staft; temporary staffo r nilv permanent employees; and so oin. flow many, shares will each emrpIltvee b.' entitle d to' [Vi thits depet1J onl leIngth of ser ve, salarv level, rank, or tither facto rs? Shoiuld the tra,ns brl litk o,f theste shir,s be reslricted (for exanIple, bv author/irig their sale only to othet emprnpiyi s, req uiring [hat the>' be relained for a miniimiuI periotd, requiring the holder to sel Ilie irars ton leaving h11e 1ompa ix,- and so in I Sh1Ould siares allocated without charge or at a 1nonmi ol pfICeJ be stripped oif voting rights? 42X See, fir examleI, article of the Senegalesi prix atiz,itioii aix which prsides that sax e or exceprtiona)lderogaition, authlorized bydecree, shares. itfcrdi Lorsale shall he pal for 0 cash' See alsol article 22 o f the 1 9(14 p ria atizatl ho Iav xx' f (i iong .is lt'ii h statets thdt th ftlusal parye shkill be) patid for in casl; the coi in iI if ministers mayt, liiixvev r, axih lxitt 'except tinls fr rsivi Ish,i reinlialdrs 138 The, Privnati- oltll Calle('11ng for example, the voting rights of shareholders who have not paid in full for their shares can be limited, and their shares may be, held in escrow until the last installment is paid. Dtf-VqiitfiY sicapJs P'ublic-sector debt instrumenits have been accepted in payment for privatiza- tion transactions, especially in heavily indebted countries, including Argen- tina, Brazil, Chile, Mexico, and the Philippines, but also in France and other less indebted countries.4) The key problem is to set the value of the debt (that is, for many developing or transition cotuntries, the discount rate that w,ill apply to securities that can be swvapped for shares). In Brazil, the dis- couint rate for debt-equity conversions was set at 25 percent in 1990.44 For the privatization of the Mexican steel companies, the conversion terms were set using a formula stipulated in the biddinlg documents. In France the privatization law stipulated that shares could be paid for by state debt secu- rities and investment certificates previoUsly issued by the soPs, the swap value of wlhichi wotuld be set by ministerial order.4 ' Each debt secuirity accepted in payment of shares will normally have its owjn swap rate, reflecting its market value Thle conversioni or discount rate slhould not include any implicit subsidy in favor of the buyer. It can be set either before thle privatization operation begins (for example, in the bidding 43. In addition, in the privatization of the Argentine Oil coiii polly YI' ^ a special tranche of 45 million shares ot A'r[ wais earmarked to be eechniged bx Argentinle pensioners for their ii(t(O\s, special obligations that had been issued by the stati at a favorable rate (15 percent above the average market valne at that time). The \ ic sha-res -iciluired in this way were held by a finiancial in,,titutiOcn and COLini n(ot be sold1 during the lirst vear. As a result, pensioners have acquired 13 percent of N ii anid the iioco\ discount has heen appreciably reduced. See nhtrolil- PanIII i,l,] Pionieiu Rex'ieX^i' Re2/'ieo a(f Pie '1Par ll '1 93, p . 171); World L.lutitv anld iii 993. p. 9). 44. Law no S031 of April 12, 1990), which regulates B)razil'-. privatizationi program, provides thadt, in additi(onl to) ca(Sh, s1hres in companies to be, priv tified may bhe paid tfr Using public sec- tor bonds or obl iga tions as well as fuLiids blocked in accou nt tit the ien tral bank. Re sol utioin nio. 14 ofilhe Denlationali/,ition i'rogra nr Stee ringC'ni miittec list t(het financial instrumenits thatca n be used to buy coixpanies being privatized and sets the rules [or thieir conversion into local cur- rencv. The, acceptable instlrtixntxs ilide blocked Itouds, x xioiIs public-sc(tor bonds, proiinis- sury niotes, pri-xii/za tioix certii ciC les, alnd stato r inrign .l i d onxistic detbt paper. l'rivati/atoin certificates, wihici (I-an be Lsedl only to p ax for shars In I I s b ewing privatized, were created pur- sualit to I ax no. S111 /90), xv"lich toreol t iixad n i-ia) alid o(her ixsiit-itioin to xcq)uire thenil (L egal l elter, P'inxleiro Neto Adcxogadios, Auigist lnxl Septe)ixlxer- 191.). O(n Septecxber 29, 1995, tlxe Central Baink lifled tlxe comnpulsory 25'; d iscouxnlt xffeo liixg >exeix types of loreign debt papers WIiheI used to pu rclI,ase state axssets", SU ch bonds I aUcl be a cepted ifi payixicnt at face value at certaini privati/axiii auctioixs; txis '"decision cLisLI a ix uxl-lediate appreciatioai of Brazilian debt papper inl th seconidarv marki et" r rwtti e tiisiis tiitc ru Ititio!a i), November IN 95, p. 7). 45 Article 5 of the law xof August 6, 1986, prox-iLles thlat th' swvap Value Of state txirds will be determixeLd lb\ theil- aVeLrage ixmarket vaxlie oii the stock eCxM 1ixge ovxer the precediig 20) market day,ys. Article c provxidcis tlxat tlxe ccixversiollx price of all iiixestincilt Icertificate of ali siL i (wlhicx ilwas isuxaly vtruct ured li ki a preferrod no invoti ug share) iito xix ordiniarv share of the co inparily will take inito accoiluit, oix thi one haxixd, the valui of vioting rights anki, xn tlIe tlxier, thi Vx1'xlu of the prefe'r- exci's altxdclxed to tHe corticicxtevs that nxxxv e' lo(st ill the cnvar ir- x. TPc Prki'tiafit Ha L a7 139 documentation) or at the payment date.46 Both methods involve difficulties. These include fluctuations in the market discount rate or exchange rate (or both) between publication of the bidding documentationi, opening of the bids, selection of the buyer, signature of the agreements, and the payment date; the effect of the privatization process on the discount rate itself; and, finally, the risks and costs incurred by the bidders who submit bids based on a debt swap, in terms of the possibility of obtaining the necessary debt instruments at the expected price, the availability and cost of risk-hedginig instruments, and the risk of acquiring debt securities without knowing whether the transaction they are intended to finance will actually take place. Debt-equity swvaps may be regulated by thle privatization law, public finance legislation (with respect to amortization of the public debt), a special law or regulations on debt-equity conversion (which may predate the priva- tization law and apply to the conversion of public-sector as well as private- sector debt), or provisions embodied in the bidding documentation for a particular privatization operation. The likelihood of carrying out these debt- equity swaps may depend on factors such as the specific terms of the origi- nal debt instruments being swapped (for example, loan agreements between the SC)E in question and its lenders, state debt to foreign banks, and1 state bonds) and the regulatory restrictions applying to the creditors (in many countries, for example, commercial banks are not allowed to hold shares in nonfinancial enterprises). The problem is a particularly complex one when foreign banks have to waive certain rights. Such a waiver had to be obtained, for example, in order to start the teniderinig procedure for privati- zation of the two Argentine telecommunications companies that succeeded ENTEL; 60 percent of their shares were sold in November 1990 for $214 mil- lion in cash and $5 billion (face value) in public-debt securities. Some countries have also issued special state obligations that can be either redeemed at the end of their term (as any other bonid or obligation) or used as payment for shares in enterprises privatized through public offerings. This was the case with the Balladur bonds in France in ] ')93 and witlh the 1996 Moroccan privatization bonds. Balladur bonds were four-vear bonds issued at a fixed rate (6 percent); they could be exchanged, with somiie tax advantages, into shares of the enterprises to be privatized. If trading above par value, their exchange value would be the market price, and thev could be exchanged at par if their market price fell lower; bonidlholders were given preference in the allocation of shares. The bond wvas a tremendous success, raising 31i) billion francs (over $20 billion). The interesting feature of the Moroccan bonds-a first tranche of whichl was issued in January 1996 and a seconid one in May 199h-is that pnivatizationi bondholders have an absolute prioritv in the allocation of shares. Privatization bonds are served first in case of oversubscriptiol. Cash sub,scriptions are served 46. The discount margin on th)e outstanding debt could also be inluded anmong the variables in the tendering procedure; this wvould unnece-sarilv oirmplicate the evaluation process, how- ever, bv making the comparison of the differen t thniln ci , bid, quite comple\. 140 The Privatization Challonie on a reduced basis to the extent that shares remain available, as happened in the public offering of 30 percent of the oil refinery SAMIR in March 1996. Privatiza- tion bonds of this type are a way to anticipate future privatization revenue, to raise funds at a lower rate than would be the case with a standard bond, and to strengthen the government's commitment to bring privatization transactions to the market. They also create a greater constituency for privatization, namely, bondholders who want to benefit from the conversion option. Allocation of Privatization Proceeds Many governments envision large receipts when they embark on a privati- zation program. The actual result is often disappointingly different. In many developing and transition countries, the net financial balance of privatiza- tion is likely to be negative; total privatization costs may well exceed the sale proceeds. In such cases the allocation of privatization receipts should not raise any controversy; all of the receipts are needed to defray the costs of the program, including, in particular, settling SOE debts, severance pay to redun- dant employees, and the services of advisers (see also chapter 6). Where total receipts exceed total costs, a prudent policy-bearing in mind that these proceeds are both nonrecurring and of a capital nature-would be to allocate net revenues to the reduction of public debt or possibly to other expenditures that may reduce the public deficit, such as the capitalization of social security funds, for example. Net privatization revenues should not, however, be used to finance current expenditures or the ordinary budget. The privatization strategy or program will usually specify how the sale proceeds are to be used. If the country's existing laws (including its public finance and public enterprise legislation) do not include such provisions, or if it is thought that they are not well suited to the needs of the privatization program, the privatization law should prescribe the allocation of proceeds. As box 5.5 shows, the allocation of privatization proceeds is often pre- scribed by law and hence is subject to control by parliament. Many countries have chosen to use the revenue from privatization to finance the costs of the privatization program. Allocation of net privatization receipts to debt reduc- tion is a sound policy pursued by some of these countries, as well as others such as Italy, where Law no. 432 of October 1993 creates a special privatiza- tion fund to be used to repay the public debt. Provisions in Bulgaria and Puerto Rico typify the illusions entertained by some parliamentarians regarding the amount likely to be raised through privatization. Defining the allocation of proceeds in such detail is ill-advised. It can create unrealistic expectations among the various categories of poten- tial beneficiaries. The actual amount available for allocation may very well be low, or even zero, because in many cases all or most of the sale proceeds will go to cover the costs of the privatization program. It also rigidifies the future financing priorities of the country, which can be detrimental to sound fiscal management. The Privaitizationi Law 141 Box 5.5 Allocation of Privatization Proceeds in Selected Countries Bulgaria. Article 6 (1) of the 1992 privatization law provides that privatiza- tion proceeds shall be paid into a special account to be used to finance five sep- arate funds: a privatization fund (to meet expenses); a mutual fund (whose shares shall be distributed to the population at large, to expropriated former owners, and to the social security funds); a social security fund; a reconstruc- tion and development fund; and an agricultural fund. France. Law no. 86-824 of July l , 1986 (first amendment to the finance law for fiscal year 1986), created a special treasurv account to receive all privatiza- tion proceeds. On the income side, the privatization account was to be credited with the receipts from the sale of shares, certificates, or other securities and rights concerning enterprises whose transfer to the private sector was autho- rized by law. This account was intended to receive only the proceeds of sale of shares or rights for enterprises covered by the privatization law, and not pro- ceeds of sales that could be carried out without parliamentary authorization, for example. On the expenditure side, the special account could be used for (a) public debt repayments through transfers to the national debt retirement fund, the national industry fund, and the national banks fund, and (b) capital contributions to SOEs through transfers to another special account. Of the 86 billion francs brought in by the 1986-88 privatizations, two-thirds was used to retire debt and one-third for SOF capital contributions. As in the other special treasury accounts, the transactions on this account were subject to parliamen- tary approval as part of the budgetary process. Including a special account of this kind in the ordinary budget procedure and subjecting it to scrutiny by par- liament were deemed essential to ensure transparency and compliance with the approved objectives and procedures (see Cour des Comptes 1990). Gcrmtianil. Article 5 (1) of the 1990 privatization law provides that "the Treu- handanstalt's receipts shall be used primarily for structural adjustment of the enterprises . . . and secondarily to make contributions to the State budget and meet the Treuhandanstalt's current expenditures. The receipts shall be used in agreement with the Council of Ministers." Article 25 of the August 1990 unification treaty provided that "the Treuhand's receipts may also be used, in individual cases, to alleviate the debt burden of the agricultural enterprises." Hjmogary. Article 6 of the 1993 finance law, enacted on December 17, 1992, provides that part of the receipts from privatization shall be allocated to the State Property Agency to defray expenses incurred in implementing the privatization program. It further provides that a share of privatization receipts shall be paid to three different funds: the employment fund, the regional development fund, and the fund for agricultural reconstruction and conversion. Mcxic). The sale of public enterprises yielded government receipts totaling over $21 billion, which were allocated practically entirely to repayment of the public debt. Newy Zealand and Unzitedl Kingdoim. The receipts from privatization operations are allocated to the national budget, allowing a significant reduction in the national debt of these countries. (box ctntln c's ()tI tIzt' t olloauItig page) 142 The) Privat izatiotn Chial o,v' Box 5.5 (contitiidt'ct) Philiplibics. Article 34 of Presidential Proclamation no. 50 provides that priva- tization receipts, net of the expenses incurred by the Asset Privatization Trust, form part of general government revenue and must be remitted to the treasury as soon as they are received. The trust is, lowever, "entitled to retain, upon approval by the Il'rivatization] Committee, suchi portion of the proceeds as may be necessary to maintain a revolving fund to be utilized for the payment of fees and reimbursable expenses and meetinig the costs and expenses incurred by the Trust in the conservation and disposition of the assets held by it." Puerto Rico. Thie law authorizing thie privatization of telecommunicationis provided that, out of total net receipts, at least $1 billion wvas to be allocated to the Permanent Fund for the Development of Edtucation and at least Si billion to the Permanent Inifrastructure Fund, the said funcds serving exclusively to finance projects in those two sectors. However, this triansactioin never material- ized (see note 5 in this chapter). Where special accounts or funds are established, the law or implementing regulations will prescribe how they are to be set up and the procedures for their operation and supervision. They will specify, for example, who decides on the use of these funds (parliament, the counlcil of ministers, a minister, the administrators of the fund, the director of the privatization agency) and how funds are to be invested. They will prescribe whether the funds shall be interest bearing and, if so, to wlhat account accrued interest shall be allocated and for what purposes it may be used. In most legal systems privatization receipts are conisidered to be public receipts governed by public finanice leg- islation, not receipts that the governiment can use without restriction. Expen- ditures financed out of these proceeds should iIhus be subject to public expenditure and accounting rules. The situation may be more complicated when it is an SOE itself that sells part of its assets-for example, a division, a plant, or a subsidiary-to private investors (see also the section in chapter 4 on exercise of ownerslhip rights). Under ordinary company law (and many public enterprise laws), the receipts belong to the seller-the SOE in this instance -which could defeat the purpose of the privatization program if, for example, the objective is to downsize the public sector or replenish the government's coffers.47 The state, as sole or majority shareholder of the SOE, should be in a positioni to recover the proceeds of these privatizations, of course, or at least part of them, in the form of divi- dends or repayment of amounts owed by the soi . In practice, however, this 47. Where the sale relates t(o shares newly issucd by the eniterprise unlder a capital increase, the proceeds of sale will of course accrue to the enterprise-. We can nonietheless spea k of privati- ation, even if this transactiocl does not in itself insolve m any sale of shares or assets by the gov- ernmenit. Moreover, if the privately subscribed capital increise dilutes sufficienitly the public sector's shareholIding, it may also result in the priv, tizati on of mia anagerient coiitrol. Ti, Priva tiza_h thm L a' 1 t43 may never come to pass if the mechanisms for corporate governance of the soF. are inefficient, the dividend policv is not clearly defined, or the board meem- bers and management engage in fraud or collusion. In some countries, the way in which the proceeds of sales of assets are to be distributedi is prescribed in the privatization rules.48 In othiers, including Brazil, the issue has sparked lively controversy between the finance ministrv anid the SOeP concerned.449 Transitory Provisions In view of thie complexity of privatization operations and their lengtlhy imple- mentation time, interim measures may have to be taken for the management of public enterprises and assets pending privati/ation. These mea1sures may1 include the replacement of the management team, possiblv by a new%, mana- ager or administrator with special powvers; a tran.sitionlal systemn to pllase out special SOF privileges and obligations; limitation- imnposed on ;ole managers' powers of alienation during the prepriv'atization period; modifications in the labor status of So)lu employees, includin,g layoffs biefore privatization; liquida- tion of what remains of the SOF. after its corporati/ation or its privatizationi through the sale of its assets; fulfillment of obligations for which the govern- ment continues to be responsible; and allocation of revenues and liabilities of the SOE that accrue during the transition period Ii-r between the signing of tlle privatization contract ancd the effective transfei of the eniterprise to its new owners, for exam?ple.5(t Such measures are ofteni ineluded in the legislation for a specific enterprise or sector, particularly w here- preprivati/ationl restructuLr- ing is required51 Tlhey may deal wvith different phases of the interim period1, from enactmient of the privatization law through corporati/ationi all the way to effective transfer of control over the eniterprise to its new owiners. Two or more privatization-relatetd law's could colntaill Iluttally contllradic- torv provisions, and newv laws could affect inpgling privati/ation procedures. 48. Bulgaria's transitional privta htiin legiI2,4kidln 0, rti 'I.11 ," (It Ire' HO ,,', l, 11 inilIJd Oll February 28, 1991) provided that, for ex,iiiple, 41) percent )Ii , pr *eds u t rto hi allicati'd (ii the enterprii', 3 perce1t hi a statedebt ,ervc fond,1, and 2i pwrczi't in. (hi Stat liii' 'tnwX'nrt l'nd. 49. Allocatioin of privalia tihin proceeds po ed mam, p ib em, in 13ra/il, uahere the giver n - ment's privati/tion prograim focused In the inlitial pldsC II the H',teel, t iI/er, aind p'tricherl.- ical sectors. 'etrobra s, the majority s iarhiholdir oft 1'etrLt ,rtiI ind Petroquisil Ia (the sol idilng comnpaniies for the fertilizer anLd petroLC hellmal c (Cti,ir rC's ti LCi\ lV ), (1hiM liI t [Iat it- a id I no t hi', treasury, should receive the sale procedbs. 5R. see, for examiple, Philippines Presiiiential Procla, ati, ino. 2O tf P IN,. whi,th containls e x- eral prroxisions, of this kilnd. Section 2'9 proxvidtis hamt a sse Iiiall,igericnnt d 3uri og tlie Lra nsitiomil period preceding privatization shall bh perforiiid hv th' vovie'rinet intituti(ni privlOUislV responsible for thoseassets, under terms and coinditioiis u -icd uipon with the goucrniiit. 51. The U K. Electricity Act otf 1989, for exa mpl', iicliid. i traniti[ioil prnoi isiiis coincerniniig, first, the prior restructuring ot power sector a-,si' hb cre,xting ieiw sucis-.or crompanis willch woultld theln be prixatiedi arnd, secolld, th' WavI ill who Ii the gWv' rni) iint ii ilterveene ii these newN companies w"hile i they are still whltillx isuied 1i t1i c rout n sui' thuO secLtiOins In1 chap1- ter 4 and chapter r onl prioir restructuring. 144 Pic Prituti:t ioJI Challellgc In Guinea, for example, a general telecormmunications law enacted on June 2, 1992, authorized the government to grant concessions for "the establishment, development, operation and maintenance of tbe pu blic network and tile provi- sion of all public telecommunications services" (article 5), and a new law laying downi the framework for SOE privatization was enacted on August 20, 1993. T'lhe question arose of the extent to which the procedures for privatizinig Sotel- guLi (the public operator) should conform to the riles laid down, by the new privatization law. The laws were interpreted in stuchi a way as to validate the steps alreadVy taken to initiate the privatizatiOn of Sotelgui before the new priva tiza tioa laxv entered in to effect, whiile subjecting all outstanding actions, including the organizatiozn of calls for bids and the ( onditions of sale, to the pro- visions of the new privatization law. Clear language in thle law can avert this type of ambiguity and uncertainity by specifying to) what extent earlier legisla- tion is abrogated, amended, suspended, or otherwi-.e declared not applicable. Amendments Although privatization programs are a relatively recent inlovation, many coun- tries hiave already amended their original privatization legislation. Already dis- cussed, for example, are the changes made to the Frencih legislation regardinig the privileges accorded to employees of privatized enterprises (box 5.4), the role of the privatization commmission in the selection ot buyers witilout recourse to the market (n(ote 23), the allocation of privatization proceeds (box 5.5), the limits imposed on foreign investment, and the features ot golden shares (box 5.3). The Frencih privatization law of July 19, 1993, makes firthier chaniges to the system institited in 1986, including provisions allowinig greater flexibility in privatiza- tion operations'52 The Czechoslovak and( Pc ruvlan legislation furnisih other examples of amenidimienits to privatization laws. In the first case, the amend- menits imposed new limits on the privati/ation process.54 In the latter, they were intended to make the process more flexible and expeditious.54 52. 'the 1'993 IaW aUtIlorizes transfer ut the capital Of I givU*n enterprise in successive trancles. It also authori/es installnaelt paymentts for shares, vvl. I.c, ing buver the optioll to transter such shares before fuilly paying for themil (see Report to the Scuoate ilo. 32-, pp. 32-33, 1992-93). 53. The Cz/echoslovak L.arge-Scale lprivati/ation Laxx ol I ebruary 26., 191, was anienided by another lawv dated Februiary 18, 1992. Thle latter provides iil pairtiCular (article I3) that, duriiig the first year followinig privati/ation, the privati/ed enterpr ise mav engage il only those activi- ties that thie t) i wa s antitiorioedi to carry out. Whc re thIn tr,tis;action relates to only one tillit of a privati/ed enterprise, thet law is even more stringent, proitibiting the pLursuit of any activity other thani that actually exerciseti within the s ot hefor' its priv atization. 54. In iPeru. rticte I of Decree-Law no 2n 12)) of )eceinber 28, 1992, arniends article I of Decree- tan no. 674 of September 25, 1991, ojn private invt-stnnitnt iAt -sit> to expres-lv allon' foreign sot-s to acqIuire shares in privatized enterprises (see note 27 abivce). In addition, article 4 of Decree- Law no. 2612t0 amends article 160 of Decree-l.aw no. h.4 it) illow '. otti!eniti.al decree torciin t to *sxvap at least 29 percent of tILir shares against privati/ation vom iiers diEtribute to all cltli/ens. l'arlia- ment aniounced that these vouchers couldi e repllaJ d hb 'pri\ atitation acountts (the work- inigs of wvhiichl were not defined) openied in sta t-o\% ned av\i11g1 banIks, T his 1nevxV caused the market Value of the privati/ation coupois to fall hV 2'i percent AlmCt i,ns ot shari's against vouchers were also suspended in the regiolns ot ( heIV,aht1i5 .1 k1d N ovi i virsk. sLe lI'rl. 'it ri_alioi litcrniatteodl Mav 1993* p. X; Tl, Lcouiiinnt, 24 July 1 -) 152 TIhe Privatization Challenge which culminated in the overthrow of the Supreme Soviet by force and the declaration of early elections in October 1993. The shutdown of parliament actually provided some momentum for privatization by forcing the stream- lining of the process. Before these events, the responsibilities for privatiza- tion had been divided between the Russian Federal Property Fund, respon- sible for sales and reporting to the Supreme Soviet, and the privatization ministry (GKI), responsible for policy and answering to the government. Fol- lowing the overthrow, the minister assumed the responsibility for oversee- ing both organizations and came to be in charge of both policy and sales. Much progress was made in this period. The Duma (lower house) that fol- lowed the Supreme Soviet in December 1993 was less powerful than parlia- ment had been, which provided more room for action on the privatization front. However, the communists' strong showing in the December 1995 par- liamentary elections and the hotly contested June 1996 presidential cam- paign increased the tension again between government and parliament (see Boycko, Shleifer, and Vishny 1995). Bulgaria provides another, less dramatic, example of the institutional stale- mate that can result from conflicts between government and parliament, as described in box 6.1. The French privatization laws of summer 1986 also offer an interesting example of conflict, this time between parliament and govern- ment, on the one hanid, and the head of state, on the other (see chapter 5). As a rule, parliaments will want to retain more control where the law gives a lot of latitude to the government. A law clearly limiting the set of enterprises that can be privatized and the privatization techniques and arrangements that can be used is less likely to contain provisions that allow parliament to inter- vene during implementation of the program. But a tightly drafted law con- straining the government's flexibility in implementing the program may well slow progress. A tradeoff exists, which will be particularly acute whlere politi- cal majorities in government and parliament dciffer and mutual trust is low. Institutional Structure Countries around the world have chosen a variety of institutional structures to implement their privatization programs. The role of the legislature and its interactioni with the executive were discussed in the previous section; the roles of the judiciary and specialized regulatory agencies are reviewed else- where in this book.(' 6. The respective conmpetence of parliament, government. anid oth-er bodies is sometimes dis- puted and referred to the courts for adjudication. Such clainms are often based on alleged viola- tions of the constitution, as discussed in the section on "onltrol ot constitLitionality in chapter 2. The importance of setting up efficient mechanisms to resolve disputes arising during or after privatization has also already been underscored in chapter 3. In addition, specialized regula- tory bodies may need to be established or strengthencd in the context of a privatization pro- gram, in particular in the infrastructure sectors (see the section on regulatory institutions in chapter 7). Instifuttioial Framnework for Privati_a tirn 153 Box 6.1 Blocked Institutions in Bulgaria, 1990-95 From February 1990, when Bulgaria's first post-Zhivkov government took office, privatization was a priority goal of successive governments. By May 1990 a privatization bill, drafted by the ministrv of economic reform, was ready. In addition, several decrees were issued in 1990 to allow the privatiza- tion process to be started without waiting for the new law to be enacted. Nev- ertheless, the lack of such a law and of an executing agency greatly hampered implementation of the initial phase of privatization. To speed the process, the council of ministers set up a privatization agency by Decree no. 16 of February 8, 1991. The agencv's function was ambigulous, however, and primarily of an advisory nature. A X\ear later the agenicy had still taken no major initiative, the smnall privatizationi program launched by the ministry of industry and commerce in 1991 had come to a halt, and the privati- zation law drafted in April 1990 and subnmitted to the national assembly in September 1990 had not vet been enacted, evein though the governnment had an absolute majority (over 80 percent from January to October 1991) in the national assembly. These delays were caused largely by political rivalries and compromises that reflected the lack of confidence among the groups involved: the parlia- ment, government, president, parties and factions, and privatization agency. The law wvas finially enacted bv the national assemblv on April 23, 1992, tvo years after the first draft was adopted bv the counllcil of ministtrs, and a neW privatization agency replaced the one set up in 1991. It then took several months to appoint the director genleral of the agency and the members of the oversight council. The year 1993 brought other institutional ups and downs. A new govern- ment decided to replace the members of the oversight council of the privatiza- tion agency who had been appointed by the previous government. The mem- bers filed suit against the decision. The court declared the replacement illegal because none of the causes for termination of functions (per article 12 of the 1992 privatization law) were present. The members were therefore reinstated, but then relieved of their functions once again by the government. Not surprisingly, Bulgaria's privatization program made little headwvay dur- ing this period. Only- two major privatizations took place betweenl 199(1 and 1993, both in the food sector: the sales of Tsarevi\ ni Produkti to a Belgo-Anglo- American consortium for $21) million plus 518 million in BulgarianL debt paper. and of Republika to Kraft Jacobs Suchard. Several factors contributed to this impasse, including intransigence on the part of the political authorities, precluding all compromise; conflict and mistrust between supporters and opponents ol the old regime; weakness of the two post-Zhivkov nonsocialist governments, vhich prevented them from dismantling the old communist networks; and commercial alliances among former comnmunist party leaders, formzer menmbers of the security forces, and SOE heads (party leaders and security personnel supplied the SOEs with raw materials and other goods in exchange for their products, which they then resold at colossal profits) In brief, these and1 other reasolns fostered the maintenance of the status quo, from wlhichi some reaped sub- stantial profits. (Nlly coWbltics imt f1lic tolic'u'lligq }(,l 154 T'lic Privatizatieu C/mile u' c Box 6.1 (coiitifilm'd) I'he following years (1994 and 1995) were, unfortunately, not much more pro- ductive, partly because of a new requiremenit to have eachl privatization deal cleared with the cabinet. The major deals of 1995 inclutded two breweries sold for about $5 million each and a cannerv. Governmnent turnover continued, leading to a total of half a dozen governments between 1989 and 1995. In June 1994 the privatization law was amended to) add a mass privatization program. A special agency, separate fromll thle privatizationa gency, waS set up to manage this voucher program; not mucih happenied in termis of actual privatizations, however, whether througih tradic sales or mass privatization. The list (If over 1,1()01 companies included in the mass privatization program was approved by parliament only in December- 1995, aiid the sale of privatization vouchers started in January 1996. During thlis period "thle Bulgarian state lost muLch of its capacity to monitor enterprise perfOrmance and management Managers ( hanneled enterprise assets and cash flow to themselves, leaving little to the state but liabilities. Losses of BiIl- garian state enterprises, w*hichi averaged mlore thin 12 percent of GDiP betweeni 1992 and 1994, were covered by loans fromii an increasingly insolvent bankinig system. Bulgarian observers concluded that unIclear property rights alrej turning from a legal to a major macroeconomic problem" (World Bank 1996b, p. 50). 'mla (Rex: Rva5 llu Findation I 994; WVaeimU ss andl direct descendants. but solely w,vith respect to enterprise s in whose valuation they have taken part 22. The ro.yal decree of October , 1-)92, concernin',4 the dtatC propert\ Valuation6 commissioll provides. Th. chairman and menbers of the c nmiss, ii mav not, while in office, and for a period of five 'tears following the end of their term, 1 Oiflice e\ercise (anv remunerated activity in the service of a company, valued by themil or of the buy r ot an asset ,old by the State." 23 The sann situation is found in the Kvrgv Republic In December 1(192, the Kyrgyw Supreme Soviet approved tht "concept of denationli/ation and privatization of assets belongilig to the State and the commuells for tin-e ear 1L)3 '' -1-This documenit lists three "stall- dard options" for distributing the shares ot privati/t'd e nterprises anmong various categories of sharehiolders No precise instructions wrere give1n. howex er. a, to the conditions unSder which a particular option was to bt adopted. Tile choiice . hece Otten left to the discretion of the privatization commissions, which are set up oin a cahare. held by the funds in the enterprises themselves (see articles 3 and 7 of Law no. 58 of August 14, 1991). This scheme was not too suc- cessful, and a new Law no. 55 on the acceleration) of privatization was enacted in June 1995. Under this law, new vouchers were given free of charge to citizens who had not converted their previously issued coupons. They were given until the en,) of 1995 to convert their vouchers at par into shares of an enterprise that was part of the mass privatization program or to entrust their vouchers to one of the five lrOs. This deadlinie had to be extended to March and April 1998 for conversions into company shares and into PoF shares, respectively-by mid-December only 7 percent of the nearly 18 million eligible Rormanians had subscribed shares (see Fituciil Thins, 20) December 1995). These deadlines had to be extended further On average about 30 percent of an enterprise's shares were exchanged for voucher., thouigh this could be increasted to 60 per- cent under certain circumstances. The remaining shares of the enterprise could be sold for cash at a predetermined price based on1 bNxok value. 38. Article 19 of the Romanian privatization law of kugust 1991 expressly provides that shares held by citizens in privatization funds cani be exchcianged on the securities exchanige under the conditions set forth in the law o0n the securitie's exchange. Law no. 52 of 1994 estab- lished the Rolmaniian Securities Exchange Commrssioit and the rules for operation of the exchangf. 186 The Priz,atization Challenge open-end and, where appropriate, from what date the fund must reimburse shareholders who wish to withdraw their capital.39 Third, the existence of privatization funds allows some concentration of voting power in privatized enterprises. Without such funds, shares would be dispersed among a multitude of small individual shareholders, who lack the cohesion to exercise their ownership rights effectively. For example, a fund can ensure that a core of professional investors is represented on the manage- ment body of the enterprise and thus minimize the adverse effects of atom- ized shareholding. Corporate governance is particularly important in transi- tion countries which, after decades of central planning, have few corporate managers capable of leading enterprises efficiently in a market economy. Regulation of Privatizationi Funds The regulation of privatization funds encompasses a wide range of issues such as licensing, minimum capital requirements, prudential investment limits, fee structure of management firms, corporate governance, informa- tion and disclosure requirements, and so on. Two general models for privati- zation funds have emerged. One, in which funds are set up at private initia- tive ("bottom-up"), involves minimal regulation; the second model, in which government creates the funds ("top-down"), requires substantial reg- ulation. Russia and the Czech Republic took the first approach; the privati- zation funds were established by private initiative, and only when their role as intermediaries became clearer was the regulation tightened to deal with discrete issues (the protection of shareholders against abuse on the part of fund managers, for example). In Poland and Romania, on the other hand, the top-down approach was chosen, leading to lengthy delays. The Polish funds were the centerpiece of the government's mass privatization scheme; much attention was given to the selection of the management team for each fund and detailed regula- tions, including prudential rules intended to protect investors, were formu- lated (see Lieberman and others 1995, p. 32). To avoid the appearance of for- eign control of the privatization program, the government appointed local supervisory boards for each of the 15 national investment funds (NIFs). This soon led to considerable tension between some management teams and their boards. A U.S. management group was even fired by its board. When another board threatened to fire its Japanese management team, the govern- ment stepped in and fired the board in an attempt to preempt dismissals at other NIFs (see Financial Times, 4 June 1996). 39. The shares in Czech investment funds issued in 1992 could not be redeemed before June 1994, when the funds could become open-end funds with variable capital. That restriction did not exist in the second wave. Because of deep discounts to net asset value of fund shares trading on the secondary market, voucher holders in the second wave opted predominantly for the liquidity afforded by open-end funds, though managers of these funds typically allowed redemptions only after two or three years (see Egerer 1995, 1. 32). Institutional Franme7workfor Prizvatization 187 Although direct government intervention in the launch of privatization funds has not produced laudatory results, such intervention is required to regulate fund activities. A satisfactory regulatory framework will protect fund shareholders while allowing the funds to become operational quickly and to perform their functions efficiently. It is important, for exanmple, to encourage fund shareholders to exercise their ownership rights and monitor the performance of the fund's management. There is indeed a risk that fund administrators may take advantage of the problem that originally justified their intervention, namely, the inability of an atomized or fragmented share- holder body to supervise enterprise managers effectively. The dispersal of the share capital of each fund among a multitude of small shareholders could allow fund managers to pursue their own interests and objectives, which may not coincide with the interests of the owners (namely, the maxi- mization of the fund's overall appreciation and return).40 Fund managers should report regularly to the shareholders on their activ- ities and performance.41 In many cases, other rules are prescribed to protect the interests of the shareholders, such as the requirement that the funds diversify their investments to limit their portfolio risk; limits may also be imposed on fund managers' fees, and their remuneration may be tied directly to the results achieved.42 In addition, in order to eliminate the risk of conflicts of interests, the law may prohibit fund managers from holding other functions.43 The issue of conflict of interest is prominent in the Czech Republic, where some think that the criteria for fund creation were too flexible and that banks should not have been allowed to set up funds. It is argued that these banks tend to give the enterprises in their portfolio preferential treatment in lending decisions; moreover, they are often reluctant to institute proceedings that could bankrupt enterprises in which they hold shares. On the other hand, some argue that close links between banks and enterprises have contributed 40. Over sixty years ago, Berle and Means 1933 drew attention to the fact that wide dispersal of a company's shareholder body could lead to a decline in the performance of its managers. 41. In Russia, for example, privatization fund managers are required to publish in the press, at regular intervals, a detailed financial report audited by an independent accountant (see arti- cle 40 of supplement 2 to the decree of October 7, 1992). In Romania also, the annual report of each privatization fund must be published in the press (see article 12 of the August 1991 priva- tization law). 42. In Russia, privatization funds were not allowed to invest more than 5 percent of their resources in securities issued by any given enterprise (see article 25 of supplement 2 to the decree of October 7, 1992); and the total annual remuneration of privatization fund managers may not exceed 10 percent of the aggregate value of the securities held by the fund (see article 34 of supplement 2 to the decree of October 7,1992). 43. See, for example, article 5 of Romania's August 1991 privatization law, which provides that an individual may not be a member of the board of directors for more than one privatiza- tion fund, nor simultaneously a member of the boards of a fund and an enterprise whose secu- rities are held by that fund. This and other conflict-of-interest provisions should be part of pru- dential rules; they are commonly found in legislation on securities and financial institutions, which normally govern these funds (see also chapter 3). 188 The Privatization Challenge to the strong performance of the German and Japanese economies. They maintain that a close relationship may, in transition economies, be less a con- flict of interest than a way for banks to learn about firm performance in an environment where information costs are high and collateral-based lending is fraught with uncertainty. Bank-sponsored funds therefore reduce lending risks and costs through lower information and monitoring costs, the argu- ment goes, as well as make it easier to solve problem loans (see Egerer 1995). Some countries have introduced provisions limiting the portion of the capital of an enterprise that can be held by any one fund. The Czech law of April 1992 on investment funds sets this limit at 20 percent. In Russia, the limit was first 10 percent and later raised to 25 percent (see St. Giles and Bux- ton 1995). These provisions seem inspired by the legislation of some Western countries, where investment funds are not supposed to play an active role in the management of the enterprises whose shares they hold.44 In central and eastern European countries, the usefulness of rules of this kind is more debatable. First, as stated earlier, it is important that privatization funds be able to participate actively in the management of privatized enterprises. Sec- ond, these rules are not essential either to prevent privatization funds from exercising monopoly power over specific economic sectors (competition law may be better suited to that purpose) or to ensure that they will always have diversified portfolios (a fund with substantial resources could hold a large portion of the capital of particular enterprises). However, a threshold of, say, 20 percent should normally allow the funds to build up an equity stake large enough to be represented on the board of directors. If the purpose of a ceil- ing is to limit the scope for manipulation or monopolization of shares of spe- cific enterprises at government-organized auctions, then reform of the auc- tion procedures to foster active and competitive bidding may be a better solution. Preliminiary Lessons The institutional and regulatory framework for privatization funds shapes the results. Funds set up with heavy government involvement are exposed to the hazards of the political process and to bureaucratic inertia. This is a serious drawback when mass privatization programs are adopted for their supposed speed of implementation and when delays cause deterioration of the situation of the enterprises to be privatized. More limited government intervention in the establishment of privatization funds may prove more efficient, as it did in the Czech Republic. To identify other factors that contribute to success with privatization funds, it may be helpful to consider the main purposes of these funds. The 44. In the United States, for example, the Investment Companies Act of 1940 makes it practi- cally impossible for a mutual fund to play any role other than that of passive investor (see Gray and Hanson 1993, p. 4). Institutional Framewzork for Prim'tizatioti 189 first objective is to diversify portfolios and to promote popular sharehold- ing. Poland, unlike the Czech Republic, has emphasized risk diversification through the mandatory use of government-sponsored investment funds; in doing so it has limited citizens' choice or initiative. Because the Polish scheme has been delayed for years, no lessons can yet be drawn from its operation. In the Czech Republic, where early interest on the part of the pop- ulation was low, the emergence of hundreds of market-oriented funds, extensive advertising, and promises of big returns boosted popular interest. In Russia, excessive insider ownership by managers and workers has pro- moted neither diversification nor meaningful popular ownership. A second objective in fostering privatization funds is to develop financial markets through popular participation in equity markets and promotion of financial intermediaries and institutional investors. The Prague Stock Exchange was revived in April 1993 after a fifty-year hiatus and an over-the- counter trading system has been created in the Czech Republic. Mass priva- tization contributed to the fast development of capital markets, but impor- tant problems remain, linked to the weakness of the banking system, lack of transparency, speculation about collusion and insider trading, widespread "off-market" transactions, and other factors (see Lieberman and others 1995, p. 8). In Russia, the capital markets and the related regulatory framework have been unable to cope with the results of privatization, mainly because of the speed and sequencing of reforms. The third objective of privatization funds is to provide an efficient corpo- rate governance structure, which cannot be achieved under mass privatiza- tion programs without some concentration in voting power. Questions remain with respect to the role that the funds effectively play in governance and enterprise restructuring. The Polish model has the potential to supply strong corporate governance at the enterprise level, as each investment fund has a controlling share in specific enterprises ("lead fund") and has the means to initiate and carry out enterprise restructuring. The model is too new to be evaluated yet, though the early tension between the NIF supervi- sory boards and their management teams doe,. not augur well. In most other transition countries, funds do not have the powers or majorities required to restructure enterprises (employee layoffs, selling of assets, and so on); in Russia and the Czech Republic, for instance, ceilings limit a fund's owner- ship stake in a single enterprise to 20 percent or 25 percent. Initial indica- tions suggest, however, that at least some Czech funds, notably those that have opted to concentrate their holdings in a limited number of enterprises, play an active role on the boards of directors of privatized enterprises and seek to upgrade the performance of those companies. Measures adopted to that effect include, for example, pressing for personnel cuts and for the replacement, in rare cases, of underperforming senior management (see, for example, Anderson 1994, pp. 21-22). Other issues of governance take the form of potential conflict of interest. In the case of the Czech Republic, the concern is with the concentration of ownership and economic power by the largest funds, dominated by the 190 The Privatization Challenge banking sector, and with cross-ownership between the funds and the banks. In Russia, a battle for corporate control is often fought between large invest- ment funds, individual investors, and the "insider" managers. Managers were granted generous share allocations at privatization and have protected themselves through antitakeover clauses and other schemes, which have contributed to inefficient management. In summary, privatization funds have an uneven track record. They have played a critical role in the fast transition to a shareholder-based sys- tem in the Czech Republic, for instance, yet in many other countries their role has not been significant. Funds created by or at the initiative of the government should gradually be emancipated from government involve- ment and become private investment funds governed by ordinary securi- ties legislation. Role of Advisers All governments that have successfully carried out a major privatization program have used the services of advisers. The selection of these advisers deserves special attention. The range of external expertise needed varies widely, depending on the type of country, the scope of the privatization pro- gram, the sectors and enterprises involved, and the internal capabilities of the privatization agency or other entities responsible for preparing and implementing the program. The kinds of advisers that may be needed to perform essential tasks are, among others, economists, lawyers, financial advisers (including auditing firms and investment banks), sectoral special- ists, and tax and labor experts. External advisers have assisted agencies and governments in preparing an enterprise for privatization, starting up the process, defining the techniques and procedures to be used in specific priva- tization operations, negotiating the transactions, and even in formulating an overall privatization strategy. Although the need for outside expertise may be greater in developing and transition countries than in OECD countries such as France, New Zealand, or the United Kingdom, the latter have systematically had recourse to outside advisers and experts to help prepare and manage their privatization pro- grams. Even the Treuhandanstalt, which had a staff of over 4,000 at the peak of its activity, turned to scores of lawyers, accountants, and other outside experts for advice and assistance. Economic, Financial, and Technical Advisers Problems arise if the right adviser is not brought in at the right time. Privati- zation should be driven by a strategy that focuses on increasing overall eco- nomic performance while protecting the legitimate interests of the different affected parties. This has implications for who should be asked for advice Instit utionial Frameuwork for Prizatizafioui 191 and when. Investment bankers, for example, are not particularly well suited or well placed to advise on broad economic and sector strategy. If such a strategy is supposed to drive the deal they are asked to structure and place, that should be defined up front with assistance from strategic advisers and economists. Key issues include the degree of competition and the type of market structure that will be introduced before or at privatization. Indeed, an enterprise with monopoly rents will be easier to sell, and will sell at a higher price, than one operating in a competitive environment. Govern- ments would generally be well advised to choose medium- and long-term benefits over short-term ones. That requires the right set of advisers inter- vening in the proper sequence and with the right incentives (see also the sec- tions below on advisers' conflicts of interest). Governments are sometimes sensitive to the nationality of advisers they retain and worried by the appearance of foreign influence on policymaking. But for many privatization operations-sector privatizations and transac- tions for which foreign investors or foreign flotations are considered, in par- ticular-recourse to foreign advisers is necessary. Countries do not always have the required national expertise, even for simpler transactions. A priva- tization program can contribute to the development of such expertise, how- ever. In Poland, for example, most of the consulting firms and investment banks hired by the ministry of ownership changes at the beginning of the privatization process were of foreign nationality; local expertise has devel- oped since then, and the ministry is increasingly using Polish experts. The selection of advisers may have significant implications for the way privatization will be carried out. Indeed, advisers (whether firms or individ- uals) come with specific experience and baggage, which will often be their reference point during their assignment. It is, for example, not surprising that the privatization of telecommunications operators in different countries has followed a similar path, because the same U.K. investment bank advised the different governments. Likewise, the trend in many East Asian countries to privatize through initial public offerings that are largely discounted and yield a substantial first-day premium has been linked to the use of privatiza- tion advisers from the United Kingdom, where a similar approach was cho- sen for many privatizations (see Oxford Ainalytica, "Malaysia: Preferential Privatisation," 27 November 1995). Advisers should, in general, be selected through a competitive process. This is often done in two stages: a general invitation asking for expressions of interest in the assignment leads to the prequalification of a short list of firms; those firms then participate in a formal tender process. Some govern- ments or privatization agencies decentralize and speed up the process by maintaining a list or roster of prequalified advisers; the various ministries, agencies, or local governments involved in the privatization program can then proceed with the selection of advisers without issuing a general call for bids. In most developing countries, as well as in countries in economic transition, the services of these advisers have been financed by bilateral or multilateral 192 The Privatizatioti Challeng^e development agencies, such as the World Bank and the African, Asian, Euro- pean, and Inter-American development banks. In many countries privatization receipts also have been used to defray the costs of this assistance (see chapter 5 on the allocation of privatization receipts and the section of this chapter on financing the privatization process). In any event, these costs will normally be amply offset by the benefits reaped from better-prepared programs and better- negotiated transactions. Box 6.3 illustrates various fee levels encountered in recent privatizations. LegalAdvisers This section focuses particularly on the role of lawyers, for two main rea- sons. First, the examination of the legal issues that arise in the various stages of the privatization process constitutes much of the content of this book; the role of lawyers in that process is obviously germane. Second, the role of the lawyer is all too often poorly understood, or else reduced to that of a legal adviser brought in at the closing stage to negotiate the privatiza- tion agreements. The role of lawyers. Three categories of lawyers are involved in privatiza- tions: public-sector lawyers, often belonging to the privatization agency, a ministry, or an SOE; independent lawyers advising the government, the SOE, the buyers, or other parties (local or foreign lawyers); and legal staff of inter- national financial institutions or development agencies assisting the country or the SOE with the privatization program. Governments and SOEs rarely possess in-house legal staff with the requi- site privatization qualifications and experience. This is true in industrial as well as in developing or transition countries. Countries as diverse as Argen- tina, Cote d'lvoire, France, Germany, New Zealand, the United Kingdom, and most of the central and eastern European countries therefore have made wide use of private law firms or legal consultants to advise them in their privatization operations. Legal staff of the World Bank and other donors and assistance agencies often help prepare and implement privatization programs, in particular by drafting the terms of reference of legal advisers recruited under World Bank-supported projects and by supervising their work. Their role is not to act as primary legal advisers to governments or FOEs but to help govern- ments of eligible countries, at their request, select advisers and finance their services. Local or foreign lawyers? Although the use of foreign lawyers is often unavoidable, it can pose political difficulties. It may clash with the interests of local lawyers who, while they may not always possess the required experience, are nonetheless eager to obtain these prestigious and often lucrative commissions. It may also give the appearance that the govern- ment is acting under pressure or control from abroad, especially when the Institutiona l Franeczwork for Privatization 193 Box 6.3 Advisory Fees in Privatization Transactions Fees of investment bankers often run 2-5 percenit in large public offerings. In the United States there is "a well-established fee schedule," which ranges from 7 percent for small initial public offerings (IPOs) to 2 percent or less for large secondary-block trades (Eurtwimoncif, February 1996, p. 40). The first offering of Telmex, the Mexican telephone company, in 1991 brought the investment bank 4.5 percent, but the second, a year later, only 3 percent. YPF, the Argentine oil company, was done for 4 percent in 1993. The subscription and administration premium in the public offering of shares in Lufthansa, the German airline, was apparently 1.5 percent, and the placement fees 2.1 percent of the transaction amount. For the public flotation of the second tranche of the privatization of the Peruvian tele- communications company, the government selected investment banks based on the lowest commission level requested; the winning bidder asked for 2.42 percent. In 1995 total advisory costs represented about 5 percent of total privati- zation revenue in Poland. The public flotation in November 1995 of a 15 percent stake in ENI, the Italian energy company, generated over $200 million in advisory fees, or about 5.3 percent of gross proceeds. High advertising expenses accounted for a significant part of this amount. Advi- sory costs represented 3.9 percent of proceeds from the first tranche of the British Telecom privatization, though only 1.8 percent for the third tranche. When the assignment requires significant upfront work to prepare the company (and sector) for privatization, twvo separate fees are typically agreed upon: a structuring fee, which mav be a fixed retainer or a time-based fee (or a combination), for example; and a placement or under- writing fee, typically a percentage of the transaction, which compensates the investment bank for its research and corporate finance staff, placement efforts (sales force, road shows, and so on) and involvement in making markets for the shares once issued. Secondary offerings are often easier and less staff-intensive than IPos, because the preliminary structuring has already been accomplished, the company is already under private managemetnt, and its shares are already traded on the stock exchange. Consequently, secondary offerings usually command lower fees. Similarly, public offerings tend to be more costly than private placements and trade sales. These two points are well illus- trated in the privatization of the Italian insurer INA: advisory costs for the IPO amounted to 4.25 percent of gross proceeds, whereas for the second tranche, which was sold through private placement, costs were about 0.25 percent. Finally, on the placement side, firm underxx riting involves an additional risk and thus higher fees. Sources: Euromonell, Gravy train gets bugged dowvn, February 1996, pp. 40-43; Fioonaial Times. 10 October 1994 and 31 January 1996; Priuatisaton Interzational, March 1996. 194 The Privatization Challenge private expertise is financed by donors. The costs associated with foreign law firms tend to be very high, with hourly fees often exceeding the weekly salary of official counterpart staff. Finally, hiring reputable international lawyers may constrain governments in their privatization approaches; indeed, such lawyers or firms may not want to be associated with dubious transactions. Prudent precautions can reduce this sensitivity to foreign advice. First, because the law is an expression of national sovereignty and therefore par- ticularly susceptible to the appearance of foreign influence, it will often be preferable not to recruit foreign lawyers to draft legislation. Foreign advisers can, however, give governments and parliaments valuable information about legislative experience in other countries. They can also offer com- ments and suggestions about legal instruments drafted by local officials. A good privatization law is not necessarily an elegant law, but it should be a law perceived as the expression of the national will. Second, it is important that the government clearly explain to the officials concerned and the gen- eral public why it is calling on foreign advisers and why this in no way impairs the independence of the country. Subordinated texts and contrac- tual agreements generally provoke less sensitivity to foreign advice than does the privatization law itself. It is not uncommon for local and foreign law firms to work together on privatization cases: the local firm contributes its knowledge of the country and its legal machinery and business practices, and the foreign firm offers its experience with similar operations in other countries. In practice, privatiza- tion tends to stimulate demand for the services of local private lawyers in important areas of business law, areas in which they had previously lacked the opportunity to gain much experience. Because local lawyers in many countries are unlikely to be familiar with the technical aspects of privatization operations, it may be useful to orga- nize basic and developmental training programs. These programs can address the specific needs of local lawyers, thus arming them with the skills necessary to make a positive contribution to the implementation of privatization.45 Legal contribution to strategy formulation. Lawyers need to be involved in the early stages of preparation of the privatization program, particularly so that they can identify obstacles that could obstruct privatization and devise ways to eliminate or circumvent them. Unfortunately, however, govern- ments, privatization agencies, SOE managers, and bilateral and multilateral assistance agencies are not unfailingly aware of the importance of upstream 45. Pertinent legal training is offered as part of the continuing education programs of many universities and by specialized legal training institutions, such as the Rome-based International Development Law Institute, and the Washington-based International Law Institute. Institutional Framework for Privatization 195 involvement of qualified and experienced lawyers who fully measure up to the demands of these complex tasks.46 A single group of legal advisers could conceivably possess the qualifica- tions and experience to provide the range of services required throughout the privatization process. The skills for assisting with the preparation of a comprehensive program, however, are likely to differ from those needed for executing the privatization operations. Upstream, governments seek lawyers with a good understanding of soci- etal choices and their economic and political implications. Since the advice these lawyers provide is factored directly into strategy formulation, they need to have a clear perception of local conditions and difficulties. To assess the propitiousness of the general environment for business activity and the specific measures that will need to be taken to facilitate privatization, legal advisers will usually have to take an empirical and inductive approach, starting by identifying day-to-day difficulties that hamper private business activity or any constraints on the government's choice of privatization tech- niques. In practice, as pointed out earlier, governments should not strive to create the perfect legal environment before starting privatization operations. Such an approach would give rise to endless delays and eventually doom the entire privatization process. Some lawyers, accustomed to a more theoretical or deductive approach, undertake a relatively exhaustive examination of all major legislative instru- ments, their objective being to recommend changes to bring those instru- ments into line with international standards. This approach can easily mask specific privatization problems in the country in question, which might stem from inability to ensure effective application of and compliance with the leg- islation, customary practices not codified by law, or restrictions imposed by unusual laws or regulations, to cite only a few examples. Lawyers involved in the development of strategy will therefore need to have a sharp aware- ness of the realities of business life and the political, administrative, and other constraints in the privatizing country. They will need to work in close collaboration with nonlegal advisers also involved at that stage and, if they are foreigners, with local lawyers. Legal assistanice in privatizationi transactions. A law firm should normally be retained to represent the government in each transaction, especially if a large enterprise or an enterprise in a regulated sector is to be sold. This is undoubtedly an arduous task, and one that calls for relevant experience in the field. Many law firms across the world have extensive privatization experience, often acquired in several countries. Preferably, the law firm 46. "Qualified and experienced legal counsel should be able to identify and anticipate obsta- cles, both legal and nonlegal, and, more importantly, devise ways to get around such obstacles and achieve the desired objective. Legal advisers that merely identify obstacles are of little value and, indeed, may be counter-productive in transactions of the complexity of most privati- zations" (Quale 1991,p. 25). 196 The Privatization Challenge selected will also possess experience in the sector in question. This is par- ticularly important for privatization in the infrastructure sectors, which are governed by special legislation and regulations presenting specific problems. It will sometimes be desirable for the SOE to have legal advisers of its own, especially if the transaction relates to only part of its assets; in this case the SOE, as seller of part of its assets, has an interest in the transaction that is independent of that of the government as owner of the SOE. Whatever the situation, the role of outside legal advisers is to fully protect the interests of the seller and to ensure that the objectives of the seller are achieved to the extent possible. Privatizing a large enterprise is one of the biggest and most complex commercial operations a government can undertake. Private buy- ers will often be assisted by attorneys highly skilled in the negotiation of transactions of this kind; the seller should be able to rely on equally quali- fied and experienced legal counsel. Conflicts of Interest Facing Advisers Investment bankers (or other financial advisers) and law firms could join forces with the aim of winning a contract to provide comprehensive advice on privatization. There are arguments both for and against such an association. On the one hand, conflicts of interest can arise when lawyers work for or as part of a team with the financial advisers (the investment bank), rather than for the seller (the government or the SOE). The terms of reference of legal advisers sometimes include advising the government in connection with the negotiation or execution of a contract with the investment bank. This role will not necessarily be performed independently and impartially where the lawyers are subcontractors or joint-venture partners of the invest- ment bank. Moreover, the government's interest may be better served by seeking differing points of view concerning the transaction.47 On the other hand, an integrated team can be useful in some aspects of the negotiation of transactions, for example by compelling the various advisers to present the government with a single approach. Conflicts of interest are less likely to arise, and the structuring of the advisory team becomes less important, when the assistance concerns upstream questions of strategy and legislation, provided the same team is not responsible for downstream transactions. In these circumstances, multidisciplinary teams comprising lawyers, economic and financial advisers, and other consult- ants will often be better placed to advise the government on a comprehen- sive strategy and action plan encompassing all aspects of privatization. Governmental resources (or lack of them) also can argue in favor of an alli- ance of legal and financial advisers: many governments have found that 47. It would not be untypical for one group, either the lawvers or the investment bankers, to be selected first and theni assist the government in the selection of the other group, however. Institiutional Framnework for Privatization 197 they are unable to adequately monitor and coordinate the activities of sep- arate consulting firms.48 Another factor can complicate an alliance of advisers: financial and legal advisers are remunerated in different ways. Investment bankers are typi- cally paid, at least in part, on the basis of a success fee (a percentage of the selling price) and lawyers are compensated for time spent on a project. The practice of billing solely on the basis of time may present incentives to raise as many questions and problerns as possible when lawyers review privati- zation legislation and when they prepare and negotiate transactions and contracts for privatization. This overcautious approach is a way to protect themselves from being accused of shoddy work (and from possible law- suits), but it is also a way to boost their billings. The investment bankers' success fee is not without problems either, and it too may create perverse incentives and conflicts of interest. This is particu- larly the case where investment bankers advise the government on basic policy issues underlying the transaction: their incentive may be to suggest the option that would yield the highest sale price and the largest success fee. It is not uncommon for investment banks to advise governments to maintain high protection or long exclusivity periods when such policies are economically unjustified. Examples include granting telephone companies to be privatized a monopoly on basic services (see the section in chapter 7 on increasing competition in telecommunications) and granting the priva- tized industry protection from imports or domestic competition (see the section in chapter 3 on protecting and promoting competition). The fee structure could also influence investment bankers to opt for the sector structure and reforms requiring the least work on their part to generate the fixed or success-based fees. Investment banks may face other conflicts of interest, which lawyers should point out to their clients. For example, a bank may represent several governments whose privatizations could compete with one another on the capital market, as would happen if two large telecommunications compa- nies were offered to the public around the same time; the bank would then have to choose which one of its clients would get the better time slot; its rep- resentation of multiple clients with competing interests could also affect the terms and conditions it suggests for the transactions. A conflict of interest can also arise if a bank acts as general financial adviser to the government on a privatization transaction while being in charge of underwriting the issue and placing the shares for that same transaction (see Graham and Prosser 1991, p. 92). As a firm underwriter it may, for instance, argue for a lower sale 48. In the process of privatizing the Buenos Aires Water Company, the Argentine govern- ment, which had split the assistance contracts among lawyers, technical consultants, and finan- cial consultants, experienced difficulty in coordinating these different teams. The Venezuelan government ran into the same problems during privatization of CANIV (the national telecomi- munications company); four different teams of advisers (on the economic, financial, legal, and telecommunications aspects) assisted in the privati/ation) operations. 198 The Privatization Challenge price so as to ensure full placement of the issue and minimize the risk of being left with unsold shares. Yet even these conflicts may pale compared with the more fundamental and worrisome conflicts that have emerged in the context of privatization transactions. For example, in the much publicized loans-for-shares program carried out in Russia in 1995-96, the banks that managed the tender process emerged as winners in those same tenders.49 Conclusion The formulation and implementation of a privatization program is a com- plex and lengthy undertaking. Successful execution calls for inputs from many participants with a variety of skills. It also requires that suitable insti- tutions be set up to implement and monitor the program and that opposi- tion to the program, if it exists, be overcome. Finding the right balance in the relationship between parliament and the executive has been a common problem in privatizations. Many parliaments are reluctant to delegate broad powers to the government, but parliamen- tary micromanagement comes at a cost: it can slow or even block the pro- cess. Broad delegation of powers usually requires either a strong executive or a wide-ranging consensus between parliament and the executive on the policies to be pursued. Specific institutions are often set up to act as executing agencies for large national privatization programs. The experience of the countries that have carried out such programs shows that these agencies can take various forms. There is no such thing as an ideal or universal model or blueprint; institu- tions have to be tailored to specific needs and environments. 49. Under the loans-for-slhares scheme, the Russian governmenit organized auctions in which banks competed to give the government loans backed bv shares as collateral. The loan was to be repaid by September 1, 1996; if it was not, the bank would have to sell the stake by December 1998, reimburse itself for the loan amount and keep 30 percent of the resulting capital gains, and return the other 701 percent to the state. The best-known example may be that of Norilsk Nickel, the world's leading nickel, cobalt, and platinum producer, with annual sales of about $3 billion and earnings of almost $7010 million. Uneximbank organized the auction for Norilsk Nickel, dis- qualified the highest bidder on the basis that it did not provide adequate guarantees, and won the stake for a 5170 million loan, less than half of the 8355 million offered by the highest bidder. "Tactics are primitive," reports Euromotety: "To thwart rival bidders (including Rossiyski Kredit, which offered to pay twice as much), the company insisted that those making an offer do so at the company's offices in Russia's hinterland. The company then proceeded to close the local air- port so that no other bidders could meet the requirements--hardly a model of transparency." Uneximbank thus gained control over 38 percent of Norilsk Nickel's shares and 51 percent of its voting shares. The management and new shareholders of Norilsk Nickel soon fell out, however, and by June 1996 Uneximbank had installed one of its own board members as acting chief exec- utive. See PriT'atisation Intcrnational, March 1996, p. 23; Rllnsiess CL'ttral Europe, February 1996, p. 16; Wall Strent Journa(l, 14 February 1996; see also note 66 in chapter 3. Institutioinal Framewvorktor Priz'atization 199 Nevertheless, some common lessons can and should be drawn from the privatization experience of other countries. Whatever the chosen institu- tional structure, certain conditions always have to be met. For example, to avoid the risk of gridlock, responsibilities should not be dispersed among many separate entities, and the allocation of overlapping responsibilities to competing agencies should be avoided. Creation of a separate group or agency with extensive powers and a clear mandate to manage the implementation of privatization operations seems to be the best solution, at least for countries with extensive privatization pro- grams. The choices range from a small team that manages the process but delegates execution of the transactions (such as the privatization unit in the Mexican ministry of finance) to large agencies with vast resources and a mandate to implement the program directly (such as Germany's Treuhand- anstalt). The German approach, although successful, will prove difficult to replicate; it relied on a strong and shared sense of urgencv, strong political commitment, and a huge and powerful privatization agency endowed with considerable human and financial resources. The choice of a small, central government team that delegates or contracts out important tasks to external experts, institutions, and firms will often be better suited to the needs of the privatization program and to the country's administrative capacity. Some call this the privatization of the privatization process. Central privatization ministries, agencies. and committees are not the only institutions to play a key role in privatization programs. Local authori- ties, government holding companies, enterprises to be privatized, financial institutions, or other agencies can also be called upon to manage certain operations. Small privatization projects are often carried out by municipali- ties or other decentralized bodies; such local privatizations may neverthe- less be part of an overall policy decreed by national authorities and imple- mented under their supervision. To be effective, agencies in charge of privatization need to have adequate and timely financing to hire outside advisers, prepare SOEs for divestiture, settle outstanding claims (where necessary), bring the companies to market, and so on. That funding should not be provided ad hoc for each transaction; it should largely be exempt from the burdensome a priori controls so com- mon for public expenditures. Allowing those in charge of privatization to use sale proceeds to cover these expenditures, subject to a posteriori con- trols, has proven useful in many countries. Whatever the institutional structure, staff working on privatizations will need to have the right incentives (financial rewards as well as penalties) and must be held accountable for their actions. Accountability requires clear objectives and mandates and transparent procedures. The privatization pro- grams of many countries owe their sluggislh progress to uncertainty about the mandate or policy to be carried out. Furthermore, an ambiguous man- date is likely to fuel dissension and power struggles among the various par- ties to the privatization. 20)0 P/ic' Prizvati7La i Au C/jjI/1; t1,y0 A clearly defined mandate that assigns the necessary powers to the priva- tization agencies can emanate only from the country's highest authorities. The fact is that even the best institutions, like the best strategies or the best legislation, can be effective only if they are backed by broad consensus and political commitment. Privatization programs are surrounded by conitro- versy in many countries, and civil servants will rarelv dedicate themselves to designing and implementing such programs unless the signal to do so comes unambiguously from the top. The president or prime minister-as head of the executive and the civil service-and the ministers and heads of privatization agencies or committees must give clear instructions to the responsible entities and staff, delegate the necessary powers to them, and publicly support the initiatives they take to implement the privatizatioln pol- icy and the legislation adopted by government and parliament. Mechanisms to minimize fraud or corruption are also needed, but care must be given not to burden the new institutions with a multitude of bureaucratic constrainits and procedures. Greater disclosure and publicity in the decisionmaking ant implementation processes, for example, can con- tribute to the transparency required to establish and maintain a reputationi for integrity without bogging down the entire process. In addition, resources will have to be set aside for monitoring the effective implementa- tion of the program (including, for example, the coimplianice of buyers with the obligations they have assumed). The privatization process has given birth to new institutions. Privatiza- tion funds, for example, were established in many transition countries to avoid the atomization of shareholding, give snmall shareholders greater voice in corporate bodies, improve corporate governiance, and develop financial intermediaries and markets. Similarly, new regulatory institutions have been set up in the context of infrastructure privatizationi programs, as discussed in chapter 7. Creating new institutions naturally involves the risk of their entrench- ment. Institutions tend to perpetuate their existence even after their justifi- cation has disappeared, in this case after the substantial completion of the privatization program. This risk can be mitigated. The law can include a provision stipulating that the entity shall be dissolved after a specified num- ber of years or upon completion of the core program. The German example springs to mind: the Treuhandanstalt took early action to reduce its staff and close many offices as a prelude to its own demise at the end of 1994. The risk of entrenchment will also be lower wlhere the main privatization body is a small central unit that contracts out much of its work. Finally, the importance of recruiting competenit external experts to advise governments cannot be overemphasized. As a rule, the staff of the privatiza- tion agency or bodies cannot be expected to muster the range of technical, economic, financial, legal, and other expertise necessary for executing the privatization program. Accordingly, external experts must help the govern- ment not only to negotiate the specific technical modalities of each privatiza- tion operation but also to formulate the overall reform strategy. 1ns [titlzti twiI Ftnia7ecork hfor Prito tifol ioi 201 The legal dimensions of privatization deserve special note. The range and complexity of the legal issues to which a privatization program can give rise are almost unlimited. In each country, for each major operation, govern- ments must retain the services of qualified, experienced, and independent lawyers to help them identify and resolve the legal problems that turn up at all stages of the process, from design to implemenitation and monitoring. It is the responsibility of these lawvers to facilitate the divestiture process by identifying difficulties before thev lead to gridlock and by suggesting ways to eliminate or alleviate those problems. Legal advisory assistance is neces- sary also to protect the interests of the seller in the negotiation and conclu- sion of major privatization operations. The economic angle also deserves attention. The privatization of sectors and enterprises offers a unique opportunity to remove barriers to entry and competition. The first step in preparing for a privatization will often have to be the design of sector reforms that promote greater efficiency and a better environmiient for economic activity. Advice from econo)mists is thus often critical at the early stages of the process, in particular when dealing with protected sectors. In short, privatization is a complex arid multidisciplinary undertaking that calls for close cooperationi among econiomiiists, financial advisers, law- yers, and other experts, as wvell as between these advisers and the officials they advise. 7 Privatization of Infrastructure The preceding chapters covered privatization operations in general, without differentiating between sectors and enterprises. Specific approaches and techniques need to be applied in some sectors, however, especially highly regulated ones. Infrastructure sectors such as power, gas, water, telecommu- nications, and transport are cases in point.1 All these infrastructure sectors are, or were, usually thought to exhibit monopoly characteristics; that is, one operator should be able to provide these services more efficiently than could several operators acting separately. Consequently, the fate of any one of these sectors became inextricably entangled with that of the public enter- prise that dominated it, which raises special issues for privatization. This chapter explores those issues and refers the reader to previous chapters for discussions of more general privatization issues that also apply to infra- structure enterprises. The paradigm of the monopolistic public enterprise has been losing ground and relevance since the early 1980s in the face of technological progress (which has, for example, substantially reduced sunk costs, and therefore economies of scale and barriers to entry, in many sectors), advances in economic research, and lessons from successful demonopolization and privatization programs in the United Kingdom and other countries. In partic- ular, such factors as the contestability of these sectors (or of some of their seg- ments), the potential capture of regulators, the adverse effects of lack of com- petition, and the inefficiencies inherent in many public management systems were rarely taken into account in cost-benefit analyses of monopoly reten- tion.2 It is becoming increasingly difficult to argue that the telecommunica- tions or power generation sectors, for example, are intrinsically monopolistic. 1. Special rules may also be necessarv to facilitate privatization of other sectors not covered here, such as natural resources (mines, hydrocarbons, ind so on) and the financial sector, for example. 2. Two seminal pieces in the economic literature on demonopolizationl and privatization are Baumol, Panzar, and Willig 1982 on the theorv of contestable markets and Stigler 1971 on the capture of regulators. f)3 204 The Privatization Challenge These economic, political and technological developments, combined with increasingly severe constraints on public finances, have generated a dual movement of demonopolization and privatization of infrastructure sectors. This movement has not been uniform, however. One set of coun- tries-mainly industrial countries (New Zealand, United Kingdom) and better-off developing countries (Argentina, Chile, Malaysia, Mexico), typi- cally with a relatively well-developed system of private ownership, at least embryonic capital markets, a liberal economic philosophy, and good stand- ing among foreign investors-privatized major infrastructure sectors rela- tively early on as part of broader privatization programs. Another group- most transition countries, most poorer developing countries (Bolivia and Cote d'Ivoire are among the exceptions), and those industrial countries that still apply relatively nationalistic or statist economic policies-has so far focused their privatization programs mainly on the commercial, industrial, and financial sectors. A brief historical overview of private sector participation in the infrastruc- ture sectors follows. Issues that arise in the context of infrastructure privati- zation, and in particular market structure and competition, special privati- zation techniques, and regulation, are examined next. Historical Overview of Infrastructure Sectors It is important to bear in mind that many large infrastructure services across the world have not always been public (see, for example, Foreman-Peck and Millward 1994; Klein and Roger 1994). In a few countries, infrastructure companies have always been and remain today in private hands. This is the case in the United States, which largely escaped the nationalization waves of this century. With a few exceptions such as water supply and sanitation ser- vices (which are often run directly by municipal enterprises), some electric utilities, and some railways taken over by the government following their bankruptcy, most infrastructure companies have always been private. Water In Paris, the brothers Perrier distributed water through wooden pipes in what was one of the first modern water systems (1782). The concession tech- nique became prevalent in France in the nineteenth century, which saw the establishment of two large, private water companies which still dominate the French and international scene (Compagnie G&n&rale des Eaux, founded in 1853, and Lyonnaise des Eaux, in 1880). The fact that France, a country that has championed the cause of public services and public enterprises, is among the few countries in which this sector has remained largely private is indeed noteworthy. Private water concessions were also granted in England and in many other European cities, such as Berlin (1856) and Barcelona (1867). "In 1800, private firms owned fifteen out of the sixteen waterworks Privatizationt of Infrastructure 205 that had thus far been constructed to serve the few and small cities of pre- dominantly rural United States."3 Private provision of water services was in no way limited to industrial countries. In Morocco, for example, the water distribution system was developed on a private basis starting around 1914, but after independence in 1956 concessions with private (French) operators were not renewed and municipal utilities were set up to take over the systems. A private company still provides more than one-third of Casablanca's bulk water supply, how- ever, based on a 50-year concession granted in 1949 and is negotiating for a concession to distribute water and power in Casablanca. In C6te d'lvoire, the water sector has been and remains private (on a lease, or affennagc, basis). In Guinea, it was run privately before the government took over, then it was reprivatized (also on an afferitnagc' basis) in 1989. Argentina, Belgium, Bolivia, Chile, Guatemala, Italy, Macao, the United Kingdom, and the United States are among the countries that have private water distribution companies at present, some of them privatized recently. Australia, Malaysia, and Mexico are among those with private water treat- ment and sewerage stations. Energy Gas utilities were established in the first half of the nineteenth century, pri- marily for lighting and heating purposes. London was the first city to install gas street lighting (in 1813). The Imperial Continental Gas Association, established in 1824 in London, soon spread to the continent. In 1818 Brussels gave a concession to a private company to build the first public gas lighting system on the continent. Other cities soon followed. In addition to street lighting, gas became a major source of industrial and household energy. The strategic importance of the gas industry started to wane with the advent of the power industry, only to regain some importance in the 1970s and after- ward with the introduction of natural gas (see Brion and Moreau 1995). The invention of the generator by Zenobe Gramme in 1869 and of the light bulb by Thomas Edison in 1879, as well as the introduction of alternating current by Westinghouse in the late 1881ls, all contributed to the develop- ment of franchises for street lighting, electric street cars, and power distribu- tion in the United States and Europe. In Belgium, Russia, and other coun- tries, private tramway companies, which converted from horse-drawn or steam carriages to electric power in the 1880s, used existing networks to bid 3. Jacobson and Tarr 1995, p. 11. Local governments rapidly took over, though, and their share rose from about 6 percent of waterworks in 180) to 53 percent in 1896. "By 1900, all but one of the eleven cities in the United States with a population of more thani 3300,000 had acquired or constructed a municipally owned waterworks" (p 11). Part of the reason for this shift toward municipal provision resulted from conflicts between cities and private waterworks about the latter's public service obligations to provide hydrants ,and adequate water volumes and pres- sure for fire fighting. 206 The Privatization Challenge for lighting and later power distribution concessions, hence becoming the precursors of the electric power industry. Private gas distribution companies in Belgium, France, and Portugal, to name a few, were also quick to enter this new business, because it was a direct threat to their established franchises.4 In the late nineteenth and early twentieth centuries, most electricity com- panies started out private.5 They have to a large extent remained private in Belgium, the United States, and some other countries. Colombia (in several stages, beginning in the 1930s), France (1945), Indonesia (1953), and Jamaica (1971), however, subsequently nationalized their power companies, while India and the Philippines opted to nationalize some, but not all, private power companies. In Argentina, Chile, Cote d'lvoire, and the United King- dom, events have come full circle: their power companies were initially pri- vate, then nationalized, and finally reprivatized. Nationalizations typically either represented a response to excessive frag- mentation of the electric power industry, which prevented integration of networks and the achievement of technically feasible economies of scale, or resulted from a failure in regulation or from ideological or nationalistic trends (see Klein and Roger 1994; Wells and Gleason 1995). The recent priva- tizations, for their part, came about for a number of reasons, headed by the huge investment requirements in this sector, estimated at over $100 billion a year for the developing countries alone, requirements that exhausted public treasuries cannot afford to finance. Transport The railways have a similar history of private involvement. In the United Kingdom, private companies built and operated the railways under charters granted by parliament. Horse traction was initially used until the Stockton and Darlington railway, inaugurated in 1825, introduced steam locomotives; it was also the first to carry freight as well as passengers and to operate as a common carrier railway open to all shippers. The railways were national- ized in 1914 for war-related reasons, privatized in 1921, renationalized in 1948 under British Rail, then finally unbundled and privatized in 1995-96. The U.S. railways were developed in the nineteenth century by private industrialists (in many cases with international bond financing), and they are mostly still private. A few were nationalized as a result of the bank- ruptcy of private operators; of those, Conrail has since been privatized 4. In 1894 the private company Gaz Beige offered the French city of Cambrai a substantial reduction in its gas tariffs in exchange for the city's award of a monopoly power distribution franchise (see Brion and Moreau 1995, p. 130). 5. This was the case with power companies in Argentina, Belgium, Brazil, Bulgaria, China, Colombia, France, Greece, India, Indonesia, Italy, Jamaica, the Philippines, Poland, Romania, Russia, Spain, Sri Lanka, Syria, Thailand, Turkey, the United Kingdom, the United States, and Venezuela, amonig others. See Roth 1987; Kessides 1993; Coxarrubias and Maia 1994; Brion and Moreau 1995. Prizuatizati(m of Infrastructiure 207 again, and Amtrak is still state-owned. Many concessions in the Austro- Hungarian Empire were granted to the private sector from 1836 onward, but the sector was nationalized in 1891 by the Hungarian government and in 1891 by the Austrian government (see Cameron 1961, pp. 209-21). In France, railway lines were also developed and operated by private interests in the nineteenth and early twentieth centuries, but were based on a national system established by the state as early as 1842; the basic infra- structure of the main lines was planned and financed by the state, whereas the superstructure (including ballast, tracks, signaling system, stations, and rolling stock) was provided and financed by private companies operating under a concession scheme. The whole system was nationalized in 1937, when the Soci&t& Nationale des Chemins de Fer FranQais was established. In Belgium, private investors were the dominant players in the early stages of railroad development, but the state gradually took over.6 Private French and British companies, among others, obtained conces- sions to build and operate railways around the world. In Argentina, the railways were by and large built and financed by British and French compa- nies starting in 1854, when the first concession was granted; they were nationalized against compensation by the Peronist regime in 1946-47 and reprivatized beginning in 1991 (see Kopicki and Thompson 1995, pp. 138- 39). Uruguay also granted concessions to British companies toward the end of the nineteenth century. In Mexico, the first railroad between the Pacific and Atlantic coasts was developed in 1906 by a private British company. Various rail concessions were granted by the former Ottoman empire, including a 1891 concession for a line between Beirut and Damascus (com- pleted in 1895). Finally, a number of African railways were privately devel- oped and operated, including the Benguela railway in Angola, completed in 1928 based on a 99-year concession granted in 1902 by the Portuguese government. The nineteenth century also saw the creation of tramway (streetcar) and subway companies. The first rail networks for streetcars were developed in the United States in the first half of the nineteenth century. Tramways were initially horse-drawn; steam engines started replacing them in the 1870s, fol- lowed by electricity in the 1880s and 1890s. By the turn of the century, pri- vate companies had developed and were operating tramways in manv cit- ies, including Richmond (Virginia), London, The Hague, Warsaw, Odessa, Salonika, Cairo, Rio de Janeiro, and Sao Paulo, to name but a few (see Brion 6. The state was active in the sector as early as 1834. In 1870, it operated 869 km out of the 2897 km network, or 30 percent, but by 1880 that percentage had increased to 68 percent, or 2792 out of 4112 km. Many concessions were bought back bv the state following public dissatisfactioni, includinig accusations of cherry-picking, inadequate in estments, and high private profits, but also for nationalistic or strategic reasons. "In 1868-69, .i French group tried to take over some lines of the Belgian railway network. This transaction was voided by the public authorities which created a diplomatic incident. The risk of seeing a key sector of the national economy under for- eign control haunts from then on1 Belgian public opinion ' (see Brion and Moreau 1905, p. 22). 20)8 Tht c Priza tiZatwion Callt'igt' and Moreau 1995). In the United States, streetcar lines, as well as elevated lines and bus lines, were largely private until the late 1940s.7 In ports, the public sector tradition has been long established and is still widespread. Port infrastructure has traditionally been financed and ownied by the public sector, but in many ports commercial activities have histori- cally been performed by private operators. In England, hiowever, privately owned and operated ports were established starting in the late seventeenth century and reached their peak in the ninieteentlh century. Around thle turn of this century the public sector started taking over control of thlese ports. Most U.K. ports were reprivatized after the 1981 transport act. In the United States, the ninleteentlh century also witnessed1 rapid expansionl of private port activity (especially by railway companiies), whlich led to certain abuses of dominiant positioni, restrained by a Supreme Court ruling of 1892. In France, local chambers of commerce were assigned a major role in port man- agement from the nineteenth century on. In Indiai, many ports were built and run by the East India Company, whiile the ports of langiers in Morocco and Beirut in Lebanon were developed by the private sector under the coIn- cession system (see Grosdidier de Matons 199r5). Mention should also be made of the constructioin of private tollroads in the United States in the early nineteenth centurv. Most of these were taken over by the states and counties by the 1860s, because canals and railways offered stiff competition, users could not be prevented froDm evading toll booths, and developers (unlike state and local gox ernments) were unable to capture the benefits of rising property values attributable to their road development efforts.8 Similarly, in some countries canals and aqueducts were built by private interests exercising the right to levy tolls on users of these infrastructures. A few large infrastructure works stand out, suclh as the 363-mile-long Erie Canal in the United States (1825), the Suez Canal (1860), and thle Channel Tunnel (1994), which were built and operated by the private sector. Investors in the Erie canal were hurt by a recession that started in 1837, the Sue/ canal was nationalized in 1956, and Eurotunnel, the owZner-operator of the Chan- nel Tunnel, is on1 the brink of bankruptcy. The P'anama Canal, for its part, was to be built and operated under a concession contract by the Panama Canal Company, founded in 1880. The company went bankrupt in 1889, however, and a new company set up in 1894 proved unable to raise the nec- 7. Because o,f their complexity and capital intensit'v, sLIIvIv lines were publicly financed in most cities, includinig Boston, New York, and P'hiladelphia, but thev were leased to private operators. Suejacobsonand Tarr 1995, pp. 9-1(). S. See Jacobson and Tarr 1995, p. 5, referring to Bruchey 1's,5, pp. 124-4). Jacobson and Tarr (p. 6) also point out that fro1m the late ninieteenithi century, private real Lstate developers built streets as well as wvater and sewerage systems as part of reslkteltidl developments in many' U.S. cities. These were most often turnied over to the local gox erillent LpoiH completion of the development, though in some instances tihe streets reiine,il private and were maintained by homeowner associations. Priiu ti:a tiea of hi,fras trztciric 209 essary capital to complete the works. The concession was finally sold to the United States; a treaty with the newly constituted state of Panama granted the United States full sovereigntv until 1994) over a ten-imiile-wide zoone along the canal.9 Tt'h'coi m1mmi catioiiS The first telegram was sent in 1844 from Baltimore, Maryland, to Washington, D.C., by Samuel Morse. Private companiies established telegraph links begin- ning in the mid-nineteentli century and telephone links toward the end of the nineteenth century. The period 1849-59 sawv the birth of at least half a dozen private companies whose purpose was to link different countries by telegraplh cable laid under the English Channel, between England and Ireland, and under the Mediterranean, the Atlantic, and thet Red Sea, to cite onilv a few examples. I" Most international telegraphv concessions awarded in the second half of the nineteenth century were for an tnlimilited duration, but included fixed-term exclusivitv rights. Whereas development of the international net- work was undertakeni mainly bv the private sector, in many countries (includ- ing Japan) domestic telegraph links were riu by, a state entitv from the start. The telephone was patented by Alexander Graham Bell in March 1876. By 1887, only a decade after its commercial introduction, this new communica- tions device was already in use in maniy countries; there wvere over 150,000 phones in the United States, 26,000 in the United Kingdom, 9,000 in France, and 7,000 in Russia, among others. While manv tele(ommunication's services were launched bv private companies, otthers were provided by the public sector from the outset (as in Japan, for example). Private telecommunications companies were often subsequently nationalized, as was the case in China and France, and in some cases finally reprivatized, as in Argentinia, Chile (see box 7.1 ), Jamaica, Mexico, and the United Kingdom. 1 Some coo ntries, how;ever, including the M Manyvottler public wrksconcessions and itto ibuild own, operate) or isi (build, operate, tranisfer) projects .are uLiicer negotiationl or inmplermeritationl in al1l infrasltructure sectors, inlL'Ld- ing roads and airports, all over theu world. 10. See Barty-King 1979, p. 10. Thu author mentions th.tt ot the wvorld total of 8,111!!) miles of telegraph cable in 1855, some 4,5(1) miles (56 percent vwere operated by the Electric Telegraph Company and 2,200) miles (27 percent) by' the English and Irislh Maginetit c(ompany 11. The U nited Kingdom is a particularly interestilng c,ise because two of the major telecomll- munications companies passed through this cv(yce. 1irst, ( abl anld Wireless, whose origin dates back to the mid-niiieteentlh century, xvas nationali/Ld Inl 1946-47 and reprivatized following a 1981 law. This compainv currenitlv runs, directlv or IhrouLlh subsidiaries, all or part of the tele- communications services in maniv countries, inclut.i ig sevevral Caribbean countries, several 1'acific islands, Hong Kong, Macao, Australiia, ierrt leoiterL, Latvia, and Sweden. Sincthtlie I 9NI teCecoluCnicatiOnS aidV, Cable andd W/ireless has been auithorited ltO optrate in theli United Kingdom in direct competition with iti, and it set tip ht,h Mlercurv contparnv for that purpose. The telecommunications sector wVas in fact larrgeiy proica in the United Kingdom unltil it w..s nationltihed in 1912, w reln ii bec thme l1,10a lit 1ttantp 011l Opv puLblic opera tor. Thc- sechtor became private again following the -1984 telecontmtnar is law authori/ing the priv,iti/,itioln of rti (see Bartv-Kinig 1979). 210 Thte Prizv t zatizin Ch1al(enge Box 7.1 Telecommunications in Chile, 1880-1996 Telephone service was introduced in Chile by the Compania de Telefonos de Edison in 188(). The company was acquired by International Telephone and Telegraph Corporation (ITT) in 1927. At that time there were 26,205 telephones in Chile, but the only intercity links were between Valparaiso and Santiago. In 1930, with the aim of promoting expansion of the network and integration of the various regions of the country, the government enacted Law no. 4791, which spelled out the rights and obligations of the telephone company newly set up under the name Compafnia de Telefonos de Chile (CTC); ITT held 80 per- cent of CTC shares. In exchange for a nonexclusive 50-vear concession, cTrc was required to modernize the network and interconnect certain regions. The law also provided that upon expiration of the concessioni, the governmenit could buy back the company, failing which the concession would automatically be extended for 30 years. (crc duly carried out the investments to which it had committed itself. Subsequently, however, the pace of expansion of the network slowed and CTC was accused of inflating its costs; this led the government to renegotiate its agreements with the company in 1958 and 1967, including new investments to be carried out. Meanwhile, in 1964 the government created ENTEL, held by the state holding companv CORFO, to provide long-distance and international services. The Allende government intervened directlv in the management of cTc from 1971 to the 1973 coup. Law no.4791/1930 was later repealed, and in 1974, despite the laissez-faire policy generally favored by the military government, CORFO acquired the shares of ITT in ClC. The government, having thus become the owner of both CTC and ENTEI, allocated the local communications market to CTC and the long-distance and international market to ENTEI., while the cross-subsidies between local and long-distance services strengthened the integration of the two companies. Rate increases during this period were often held below the inflation rate, and the two companies lacked revenue to develop the network and acquire new technologies. The year 1982 marked the start of sector restructiring that led to privatiza- tion of the two companies, broad liberalization, and introduction of a new reg- ulatory framework. The General Telecommunlications Law no. 18168/1982 promotes competition, allowing restrictions only on technical grounds to the number of enterprises that may be granted concessions. This law was amended in 1987 to prepare for the privatization of CTC and ENTEL. New provi- sions were added, defining the criteria to be used in determining telephone service charges and installing new regulatory agencies. Finally, in 1988 a majority of the government's shares in CTl C and EN YEL were transferred to the private sector. Noteworthy is that Telef6nica of Spain became sharelholder of CTC (44 percent) and ENTEL (20 percent). A ruling of the Chilean courts given pursuant to antitrust provisions forced Telefonica to divest one of its two par- ticipations. As a result, Telef6nica exchanged its ENTEL shares for shares of Cointel, the consortium controlling 60 percent of Telef6nica de Argentina. After having been shared between the public and private sectors (from 1964, when ENTEL was created, to 1974, when CT( was nationalized) and after a period entirely under state control (from 1974 to 1988), the telecommunications (N (xC ticus oil Ow ft(hl(ozcing pag4) Privatization of Infrastructtre 2?17 Box 7.1 (conitiniiied) landscape has changed dramatically. "Chile, which two decades ago began- boldly experimenting with free market economics, has become the world's proving ground in another field-fiber optics, personal phones, digital switch- ing, and other advances in telecommunications. More than any place in the world, Chile is the testing ground for howv to succeed in telecommunications" (Jot(wial of Comilmerce, 1 December 1995). Chile has one of the most competitive telecommunications markets in the world. CTC and ENTEL were privatized without monopoly. In long distance and international services, eight companies, five of them major players, are vying for customers. For each call customers dial a three-digit number to get access to the carrier of their choice. After a fierce price war pushed the price of an off- peak call from Santiago to New York down to about 23 U.S. cents per minute at the end of 1995, prices rose to about 75 cents in January 1996, which was still slightly cheaper than calls from New York to Santiago, and significantly cheaper than the $3 charged in neighboring Argentina for similar calls. Although competition has reduced margins, it has also led to a rapid increase in number of subscribers (penetration or teledensity rates have increased from 5 percent to over 12 percent since privatization in 1988) and to much higher volume, leaving most carriers with higher than expected profits. .Sources: Gala a3nd others 1994; Galal 1994; FI'iawutzl 1?)m', 18 Augu,n 1994; Reuter, 21 January 1998. United States and the Philippines, have never nationalized their telecommuni- cations sectors. The present decade is clearly marked by increased liberaliza- tion and privatization of this sector, a trend that, fueled by accelerating techno- logical innovation, is bound to spread even further. These examples from the water, energy, transport, and telecommunica- tions sectors illustrate that private participation in infrastructure is hardly a new phenomenon. Many public enterprises that have recently been priva- tized or that are up for privatization were, in fact, initially private. Infra- structure sectors that are now being opened up to competition often started out open to competition and private investment in the nineteenth or early twentieth century. Meanwhile, lessons can be drawn from history to avoid some of the mistakes that were made and that led in many instances to the nationalization of these sectors. Market Structure, Competition, and Divestiture After a brief general discussion of the need to rethink the infrastructure sec- tors by unbundling them, and of the use of yardstick or benchmark competi- tion as a regulatory tool, this section examines how competition and private participation have been introduced in the water, energy, transport, and tele- communications sectors, with a particular emphasis on recent experience in reforming telecommunications. As Yarrow 1P186 pointed out ten years ago, 212 The Privatization Challenge "such structural reforms should be evaluated and decided before any final decisions are taken on the ownership question: it is easier to change the framework of competition and regulation before privatization" (p. 364). Unbundling a Sector Privatizing a major public infrastructure monopoly is tantamount to priva- tizing the sector in which it operates. Strategic and policy issues should take precedence over the more transactional aspects of the privatization. Every infrastructure reform strategy should rest on a thorough analysis of the existing and potential market structures and the extent to which competi- tion can and should be introduced; the costs and benefits of a breakup of the existing monopoly also must be assessed. The benefits will derive mainly from competition (direct and indirect). The costs may include transition costs, higher transaction costs, and coordination costs (in particular, more complicated network planning, more difficult technical standardization, thorny conflicts between participants, and so on). One will need to deter- mine whether the advantages of a more competitive system-investments, quality, price, choice, satisfaction of demand, and so on-outweigh these costs. Similarly, advantages deriving from economies of scale generated by a monopolistic sector structure will need to be weighed against cost of ineffi- ciency caused by lack of competition and bureaucratic inertia (see World Bank 1994c; Kessides 1993). To determine those costs and benefits, it may be useful to break a sector or an enterprise down into its component parts to examine which activities are essentially monopolistic and which are of a competitive nature. Unbundling can be done through vertical separation, which refers to a breakup in the pro- duction chain between upstream and downstream activities, or between infrastructure and services. In the power sector, such unbundling translates into three or more distinct activities, namely generation, transmission, and distribution (as well as supply). In railways, it may lead to a separation in responsibility between track and transport services. Unbundling can also take the form of horizontal separation, which results from dividing a single activity of the incumbent monopolist, say, power generation or distribution, into separate companies, which may either compete directly in the market (as is increasingly the case in power generation) or retain a geographic monopoly and compete only indirectly (as is mostly the case for power distribution).12 12. Where the power sector is broken up into generation, transmission, and distribution com- ponents, there is usually no direct competition for customers, though distribution companies would normally compete against each other in buying power from generators or intermediar- ies. Where competition is expanded to reach customers, as is already the case in the United Kingdom for large customers and soon for all customers, the distributbon company becomes in effect a downstream transporter of power with the obligation to supply power provided by any other source. In such instances, supply becomes a fourth distinct component of the unbundled sector. Priz'atization of Inlfrastruictuire 213 The unbundling of infrastructure activities is presented in figure 7.1. It provides a highly simplified view of sectoral situations which may vary sub- stantially in space and in time. The table's grid structure forces the classifica- tion of every activity into one of four boxes, but some activities may shift to different places within the grid or overlap two boxes, depending on the spe- cific circumstances of the market or country. Thus, long-distance communi- cations is competitive in nature, whether analyzed from the standpoint of the physical infrastructure or the service. Electric power generation will often be monopolistic in a small market and competitive in a large one. Solid waste collection (not included in the table) is basically a transport service and therefore has competitive elements, but it also has strong economies of contiguity which give it monopolistic characteristics. Specific circumstances and policy preferences must determine whether a single provider or multi- ple providers should serve a given area; in view of limited economies of scale in waste collection, most cities can, however, be divided into zones served by companies competing for the right to provide the service. As figure 7.1 illustrates, physical infrastructures tend to have monopolistic characteristics, and services competitive ones.13 To the extent that infrastruc- ture and services can effectively be unbundled or separated, this analysis opens the door to solutions that otherwise may not have been identified. Indeed, the monopolistic characteristics that typically derive from the high sunk costs (fixed investment costs) of infrastructure do not necessarily carry over to the use of the infrastructure, that is, to services. For example, whereas telephone and electricity distribution or rail networks may have strong monopolistic characteristics, their use may be organized on a competitive basis. The figure also suggests that where there is competition in the market, gov- ernment intervention can be limited to ensuring that the market functions properly. This is typically done through provisions governing compliance with competition rules and technical standards. On the other hand, where the monopolistic element predominates, the government will have to choose between public and private supply of the service. By considering the private route, the government introduces the possibility of organizing competition not ii2 the market butfor the market through competitive bidding. 14 A private take- over (and, where an incumbent SOE is allowed to bid for the contract, the sim- ple threat of such takeover) may yield significant improvements in productiv- ity, among other benefits. Consumers will benefit from this competition for the market, especially where the lowest service price or tariff governs the selection of the operator. Where selection is based on the price the operator is prepared to pay the government for the right to provide the service (through a concession 13. See also World Bank 1994c, fig. 3.1, p. 62, and tables e.3 and 6.4, pp. 126-27. For a cross- country oLverview of market structure in the power, gas, railways, telecomnmunications, and water sectors, see Gray 1996. For a literature survey on privatization, deregulation, and compe- tition in infrastructure sectors, see Kwoka 1996. 14. For an analysis of the concept of competition for the market as opposed to competition in the market, see Chadwick 1855. On competitioni in network industries, see Klein 1496. 214 Thc Privatizat ion Chaltlege Figure 7.1 Unbundling Sectors into Their Component Activities Competitirv COOi[oll'ui ts' MonopoliSti c ,o1)OPpr'lI ts Phylsical Power stations P'ower transmission and infrastruict1l re Wireless and long-distanice distribution networks Water transport and distribution Warehouses, terminals Roads, rail track Port quays and channels Airport runways Scrzuict Telecommunication services P'ort or river dredging Passenger and freight trans- Traffic safety (all modes) portation (all modes) Stevedoring, handling Equipment supply Market oltionis Normally private Choice between private Competition in the market and public No special regulation Competition for the market Detailed regulation or license fee or divestiture proceeds, for example), competition for the market transfers these monopoly rents (or part of them) from the monopoly holder to the public authority. A well-structured bidding process should allow existing or expected monopoly rents to be extracted right from the start.t5 Yardstick Coinpetition Unbundling the provision of monopolistic services horizontally among differ- ent regional companies multiplies sources of information on the sector, new technologies, and ways of reducing operating costs. The regulator can thus control the operations of the regulated enterprises more effectively and bench- mark one operator's performance against that of others. Unbundling may help to leverage additional financial and human resources, diversify technological and managerial approaches, and spread risk. It may also make it easier to enforce bankruptcy against a defaulting public service provider, because other national companies with relevant expertise could easily take over operations. Argentina, which together with Chile and the LJnited Kingdom has been at the forefront of infrastructure reform, used this technique in several sectors. In addition to introducing competition in the market where it was deemed feasible, Argentines decided also to break up existing monopolies on a geo- graphic basis to create benchmark (or "yardstick") competition in most infra- 15. Competitive teruders or auctions do not, lowever, preldude the need for tinture regulaltion to address developments in the sector, behavior of the monopolist, otther unforeseeni events, or the enforcemenit of the terms of the concession or licenses A, tivities or market segments run on a monopoly basis should in particular be subject to regulation, regardless of wlhetlher the ser- vices are provided by a public or a private enterprise. set td,isectioni in this chapter on the reg- ulatory framework. Privatizatiot, of infrinstructurc 2 15 structure sectors. In the telecommunications sector, for instance, it was decided that direct competition should not be introduced immediately for basic telephone services previously provided bv ENTEI.. ENTEL was split between two geographic areas (north anid south, with Buenos Aires divided into two zo nes), served by two separate privatized companies.16 Although direct competition is (initially) not authorized for basic services, this geo- graphic division allows the regulator and the public to conmpare the perfor- mances of the two companies and exert pressurt on the less efficient operator. The same principle was applied to power and gas distribution companies. It had also been envisaged for the water supply sector, witlh the city of Buenos Aires to be divided into txvo areas for wlhich separate concessions would be awarded to different consortia.' The idea had to be abandoned, however, owing to the technical difficulty of separating the two existing interconnected networks and the delays in the privatizatioin process that would have resulted. Nevertheless, comparisoni is still possible between the private management performances of Aguas A rgentinas (tlhe concessionaire for the Greater Buenos Aires) and the Water comnpaniies of Argentina's othler cities, as well as with international norms. Structuirsal Reformiis iii tflit Water Sector Water is probablv the most monopolistic of all infrastructture sectors, which does not in itself imply that structural reforms hal ve no role to play. There is no general consensus, however, about hvliat the riglht structure may be with respect to unbundling water production, tranisport, distribution, treatment, and sanitation services (sewerage network and treatment plants). Nor is there a consensus on broader issues of water managemenit and pricing. 1 8 In some cases a single enterprise handles all these services; in others, different enterprises are in charge of different segments. Where different providers operate in the same 16. Four compaiues succeeded tNTll I: Telecom for the northern netwi rk and Telefdnica de Argentina for the southern network, each enjoving a termp rarv monopolv; and two companies held jointly by Telecom and Telefkinica-Telintar for iitei national telecommunications, which also enjoys a temporary monopolv; and another conipan.: for the suppIV of va1lue-a1dded ser- vices operating in compelition with othe r operators. 5ee also niotes 52, 53, and 73. 17. Note that in l'aris water distributioni is divided into two /ones for which lease (aff'ritni,(') contracts wvere awarded to different private companies: the Left Bank network is rin by sic, a subsidiary of LIyonnaise cles Eaux-Dumez, and the Rlight 1,ank network by ( rt', a subsidiary of Compagnie Generale ties Eaux. The two networks ire iiterconnected and transfers between them are metered and billed accordingly 18. See, for example, lilu,t and Lvynk 1995, whoi looked at the separation of the production and regulatory functions of the regional water antiloriliei before privatization. 'roductioni functions were privatized and a nationial Rivers Artthoritv was established "to oversee tvater resource management, controlling both pollutihn and ab'traction." The authors conclude that the lost econonies of scope between the regulatory anld prodfuction fuL1Ctions are considerable, perhaps even higher than the dynamic efficiency' ganus ichievable under a privati/ed xvattr industry. On water privatization, see also Bhatticltarv'ya', arker, and Ralfhee 1994; Ogden 1994; Spulber and Sabbaghi 1994; idelovitch and Ringsko,g ]9' Rivera 1996. 216 T'th Prizafizthlintio( Chalfentw) market, as may be the case for water treatment plants, they rarely compete directly for business; instead, they tend to be linked by long-term contracts with the water utility. So even thouglh there may be a multiplicity of companies operating in the sector, those companies usually do not compete directly in the market. Competition does exist in the award of contracts, however, and yard- stick competition can also be fostered, as discussed above. In the United Kingdom, private water sUpply companies existed before the 1989 privatization of the ten regional water companies of England and Wales; these smaller companies were called statutory water companies. The 1989 privatization was preceded by far-reachin-g restructuring that gave rise to independent, regional companies for wvater and sanitation.19 The price regime put in place was a variation of the price cap formula used in telecom- municationsc.21 Water utilities were allowed to increase their rates by more thlan the rate of inflation, so that they could make the huge investments required to upgrade capacity and bring water andi sanitation (quality up to the standards set by the European Commissioni directives on drinking water quality, bathing beaches, and urban waste water treatment. Water prices therefore rose sharply in the first five years following privatization. At the 1996 review, however, OFWAT (the regulator) imlposed tighter price caps. Also noteworthy is the authorization that OFW AT granted in 1996 to Anglian Water to supply water to a customer outside its geographic area, in what amounts to the first major dent in the moniopoly (f a water company.21 19. The water act of 1989 enabled privati/ation Mad established (IFWA[ (tile Office (If Water Services), headed by tle director general of water se rvrices. .iurtler regulation of the industry is found in the licenses, or "instruments of appointment." issued to eachi company ("undertaker"). See also the water industry act of 1991 for ecotniomiic regulation, and the water resources act of 1991 oi the Nationial Rivers Autholrity (for details, see Airmstrong, Cowan, and Vickers 1994). 2). The tariff form)ula is described as Rl' + K, where RPI is the retail price index and K the allowable price increase above inflation; the net allowabk' i m rease is a reflecCion of the recluired new capital investments minus the productivity improx emenits to be achieved by the operator. "The K-factors for the privatized ... Water and Sewerage Companies vary between 3 percenit for Yorkshire to between 6.5 percent to 11.5 percent for 'Sooth West, and for the water Only (pre- viously statltory) companies, between 3 percent for York to 22.5 percent for Tncdring. The K- factors for the Wvater and Sewerage Cormpanies are lower on iverage than for the Water Compa- nies due to the capital restructuring undertaken bv the. (iove rnment at privatisation. (enrerally this consisted of cash injectionis which enabled the companies capital expenditure programmes to be funded with smaller tariff increases. Since the Water ( orniparies were already in the pri- vate sector this rendered capital restructurinig infeasible. rlhe Golvernment, therefore, granted higler K-factors. The K-factors were set initially for teni ear- wvith a five year periodic review in 1994. There is also provision for interinm determinations oi reviews on K on an annual basis where significant deviations of the companies capital progr. nmnes from those expected occurs. The results of these determinations may involvt either vI,whack of allowance or additional passing througlh of unavoidable costs" (Hunt and I ynk 199-, p. 374). 21. Anglianll Water woould be allowed to supply a chic ken I arm currenitly served by neighbor- ing Essex and Suffolk Water. This would reqjuire com striictio{n of a pipe three miles long. Authority was granted unider the inset appointM1en1t scherne, which winS designIedl to foster competition between wzater companies for large user., narniely those using Over 251) megaliters of water per year. See Fiimimcn inl Tinic's, 17 June 1f99(0. Privati:o till n of Ihfrastrilhirlp 2 17 In 1993, after an international competitive biddinlg process, Argentine authorities privatized the Buentos Aires water supplv company 22 Five inter- nationial consortia, each headed by a strong European water operator, were prequalified. Two of them joined forces, and four bids were eventually received. The consortium led by Lyonnaise des Eaux, having bidL a price 27 percent below the tariff clharged by the former ScQ, was awarded the coIn- tract. All water supply and sanitation assets of Greater Buenos Aires were transferred to Aguas Argentinas, the concessionaire companiy formed by the wiinning consortium; Aguas Argentinas holdes a concession for thirty vears, after which the sectors, including the new investments made by the private operator, would revert to the ownier, the Argen tine governmlaenit (see Ide]o- vitch and Ringsk-og 1995). Striucturil Reforins iu tflit Eicr-gyx Scctor3 Unbundling of the sector, introduction of competition, and privatization have become common in electricity as well as gas. Eh'c tricit tl/. To instill competition, mobilize pri vate capital, anid take advan- tage of recent technological advances, maniy couuntries have decided to unbundle the power sector.23 Recent internationial experience has demon- strated that it is possible to introduce competition in the market, especially on the generation side. In other segments-distribution in particular-the case for natural monopolvy may appear stronger, tlhough competition can be introduced bv separating the commercial (selling) function from the wire or transport business. This is illustrated by the still unfolding liberalization program in the United Kingdom, NwhichI sIhouldl result in competitioln in all segments of the electricity markets except for the wire business, as wvell as bv experiments in New Zealand and elsewvhere. In the United Kingdom, privatization of the power sector in the early 1990s was preceded by sectoral restructuring that led1 to new, independent compa- nies.24 Different privatization formulas w,ere applied in Scotlanld, Nortlhern 22. See Decree 1443/91, which authorized the co(i,e-',i in st heme and schedule, and Decree 24018/91, which adjusted the schedule. 23. Technological innoVatio1ns include effi.ltent med umi1-capa1citV turbines (particularly combined-cycle gas turbines), which allovw plant stal idardi/ation and redLuce riss and ecO,no- mies oif scale in powver generationii anld therebr make it ca'ier ftir independent prod ucers to enter the sector. Moreover, adVanlCeS )1 COMputing power and d.tia processing-which facili- tate the dispatch ot electricity across tht netls'Ork and veitical.separation ot th e lectric power indlistrv-anid inl metrology (more sensitVe aJnd eLrtici Ct mne ters make the electricity distri- butioll sector nmore attractive to private operators. ( n power sector reform, see TenCenLbaLum, Iock, and Barker i992; Covarrubias and Maiai 199)4; N,1 h,ery I 994; Rknt 1994; Bacon 19)95; Gravy 1995. See also table 7.1. 24. The electricitv act of 1989 enabled privaitization itd competition in the sector: it also established the pot of director general of tlectriCity nLpp., heading theC Oftice of electricity reg- ilation ((1)[1 hI I 218 Tlit PrizatiZatioti Chialhl',g' Ireland, and England and Wales. The need for differentiated approaches stemmed mainly from the distinct characteristics of those networks. In England and Wales, the former Central Electricity Generating Board and Area Distribution Companies were restructtured into a National Grid Company (NGC), two power generation companies (National Power and PowerGen), and twelve regional electricity companies (RECs). The RECS were privatized in December 1990 and the generators in March 1991 (witlh a sec- ond tranche of 40 percent sold in March 1995). Shares in NCC were initially handed over to the RECS, which later divested them through a public flota- tion raising about $6 billion (NGCC had been valued in 1990 at about $1.5 bil- lion, or a quarter of the sale price five years later). Breaking up generation into only two large private companies controlling nearly 90 percent of generating capacity (the next largest producer being British Energy the nutclear producer privatized inl 1996) has not introduced sufficient competition in the market. Because he considered prices to be excessively high, the director general of electricitv supply has been trying to boost competition in power generation in Englantd and Wales.25 In his 1995 five-year review, the regulator imposed a one-time reduction of 11 to 17 per- cent in electricity distribution prices (the perCent,ige varied according to the circumstances of each REC), while limitinig ftuture increases to 2 percentage points below the inflation rate.26 Full competition is being introduced graduallv to the British power mar- ket. It started with competition to supply the pool, then expanded to compe- 25. In fact, an increase of over 20 percent in the "pool' price (the pool being the market mecha- nism where supply and demand are equalized) was largely responisible for an investigatiol by the regulator, whichi culminated in February 1994 with) an agreement under which National Power and PowerGeni would sell or divest some capacitv and accept price controls. In return, the regulator would not refer the htvo companies to the Monopoli s and Mergers Commission (MMu). In particular, National Power and PowerGen undertook to s,ll or diivest power stations equiva- lent to a capacity of 6000 megawatts (approximately 1l0 perctent of installed capacity in England and Wales) and to reduce their selling price to the pool by , percent for a period of two years, which ended on April I, 1996. Many observers felt that thlese oncessions were unlikely to be suf- ficient to create a true competitive market Since the producer price caps have just ended, it is still too early to evaluate the impact of this agreement oni competit ion in the market. Hlowever, during the time that "voluntary" price caps were in effect, the' maIrket saw substaiitial price volatility, whichi the regulator cites as evidence of the mar-ket power exercised by the two generators. Recent attempts at vertical integrationi by National Ploxer aiid l'owerGen throughi the proposed takeovers of, respectively, Southerin Electric and Midlanids F lectricity has raised additional coIn- cerns about the degree of competition in the U .K. power gene ration market. Tle MM( did recom- mend that the proposed transactions be cleared, largelyon the basis that they would help British firms compete abroad, but the governmnent (wisely) decid(d on April 24, 1996, to block these mergers. Suclh mergers wvould have abolished the separation between major generatioim and dis- tribution companies decided uponi at privatization, made the regulator's job much more difficult, and threatened already wveak competition. See Finooiual 7Th;o, 12-113 ebruary 14 February, 17 February, 4 March, 26 April, all in 1994, and 25 April 19)i9;se,, ilsoo Jonnil f C,iomm'rc', 16 Decemn- ber]1993; Fli'rey ltihJ)'s, April 1996; and the section in this chapter on the regulatory framework. 26. This decision became extremely controversial, becaIue it overrode anl earlier annloun1ce- ment on future price caps, to whiichl the stock exclrih,_e I,t, reacted favorabl', by considerably Priz,atizat io7 of Intfrastru-ctuirc 2 19 tition to supply very large customers, and later to medium-sized customers and, as of 1998, all retail customers.27 These broad reforms were implemented knly in England and Wales. Scot- tish Power was privatized in 1991 as a verticallv integrated company. Because Northern Ireland's network was not interconnected and was deemed to be too small to justify refoirms of the type applied in England and Wales, it was decided not to separate transmission and distribution. Privati- zation of power generation was effected by the sale of power statioins to investor consortia (and not by public flotation to the general public); the power stations privatized in this way rely on long-term power purchase agreements rather than on the short-ternm pool system of England and Wales. In Argentina, the power sector was restruictured radicallv in 1992 by sepa- rating generating, transmission, and distribution activities and organizing them under separate companies.28 The generating capacity of the federally- owned enterprises was shared among some 20 new companies, which were sold to competing private groups. These power generators, as well as new entrants, now compete vigorously in selling electricity. In fact, the transfer of (often poorly maintained) existing power stations to private investors led to very quick improvements in efficiency andi to a shift from excess demand to excess capacity. In addition, open entry allowed other investors to build new gas-fired plants close to Argentina's gas fields, providing even greater com- petition in the power supply market. As a result, wholesale) electricity prices dropped substantially before stabilizing at a level 40 percenit lower than at the time of privatization. Argentina has a competitive wholesale spot market for power adminis- tered by Cammesa, a ntonprofit entitv controlled by the government, the power companies, and major users. Large users (initially those who used over 5 megawatts, since lowered to 1 megawatt, and then to 0.1 megawatt) are allowed to bypass the distributors andi coiitract directly for their power tightening the caps. The positive reaction of the mnirkets, as well as informationi the regulator uncovered that had been withheld by some of the companies, contributed to the tightening. The shares of the RizFis dropped bv 23 percent olloxving the tinal decision, ancd those of the private generators by 4 percent. Part of the controvervy arose from the timing of the decision, which fell only one day after the state had sold its remaining shlare h eldings in National Power aind l'ower- Gen through a public flotation. See also box 7.4 27. Until March 1994, only about 50(1l customer'v with a peak demand in excess of I mega- watt had access to tile competitive market; this represented about 31) percent of electricity con- sumption. The limit was dropped from April 1994 to 1(1) kilowatts, adding about 50,t0t0l) new customers to the market, or about 20) percenit of total de,mand All customers would join the competitive market in 1998. However, "the timetable for niltroducinig competitioni into Britain's domestic electricity market in 1998 is being threateniedi bv a dispute over wlho should meet the estimated £30)0lm ($474m) bill for newv computer svstems" reL1uired to manage the extension of competition to all 22 million domestic customers (f masric TiTes, 13 November 1995). 28. Set Lawv no. 241)5 o0fJanuary 1992 on electricilt land lDecree 1398/92 (regUlation). See also Wall Strect Illrtil. 19 Julle 1996. 220 The Privatization Challenge' needs. Transmission companies earn a fixed fee for power transported. The concession for the high-voltage transmission network covering 14 of Argentina's 24 provinces was assigned on a monopoly basis to a new privatized company (Transener), and five smaller transmission companies were further divested in 1993. Distribution is provided by companies with a regional monopoly, some of which, including Edelnor and Edelsur, dis- tributors to Greater Buenos Aires, were also privatized in 1992 under 95- year concessions. Several provincial power companies have since been sold off as well. Retail tariffs are subject to a price cap formula. The Argen- tine experience has, by and large, been more profitable for distributors than for producers. Hungary opted to unbundle its power sector into seven nonnuclear power generation companies, whose privatization was initiated at the end of 1995; a transmission company (MVM), which also operates the country's only nuclear plant and is slated for privatization in 1997; and six distribution companies privatized in late 1995.29 International experience, as illustrated above, indicates that governments must carefully study how to open up the power sector to private investors. Should they, for example, separate generation, transmission, and distribu- tion and privatize them separately? If so, should they prohibit any company or group from controlling more than one of these market segments, as the Argentine and Peruvian authorities have done?3'! Or should shareholdings be authorized in more than one segment, as is the case in Belgium, Chile, and to a lesser extent England and Wales?31 Or should governments limit 29. The electricity privatization drive at the end of 1995 was only partly successful. The pro- cess was marked by tight timetables, last-minute changes in tender conditiolns, disagreements with local governments on their rights in these companies, as well as ambiguities in the license or concession terms and conditions and in the overall regulatory framework; all these factors contributed to lackluster demand and postaward litigationi. Five of the seven generating com- panies found nol responsive bidders, partly as a result of the governmenit's insistence of linking their sale with that of coal mines and of regulatory uncertainty. The sale in 1995 of a 24 percent stake in MVM was subsequently canceled by APV R r(the privatization agency) and its privatiza- tion had to be postponed to 1996 and later to 1997 because of continuing uncertainty regarding key regulatory issues (pricing, in particular) and delays in adopting a law on nuclear electricity. 30. See articles 30) to 33 of the Argentine electricity Law no. 240)65. Article 122 of Peruvian Decree-Law no. 25844 on electric concessions of Noxvember 1992 stipulates that generation, transmission, and distribution activities cannot be exercisedl at the same time by the same per- son or company, with the exception of specific cases provided in the law. 31. Belgiumi;: The power sector has always been predominantly private. O(ne company (Tract- ebel and its affiliate Electrabel), though not protected by a legal monopoly, supplies 92 percent of generation, controls the transmission network, and is a major shareholder (together with munici- palities) in many distribution companies, which are usually managed by Electrabel. In addition, Tractebel has a joint venture with SPE, the second largest generator, a municipally owned com- pany supplying about5 percent (f power. The European Commission has raised concerns about the lack of competition in the Belgian power market, in par ticular about Electrabel's practice of offering the municipal (or jointly owned) distribution compauies shares in Electrabel in exchange for extensions of up to 30 years of their almost exclusiv e power supply contracts with Electrabel. Priz,atization of Inifrastruictutre 221 competition and maintain more vertical integration? This may be done by divesting the existing SOE with its monopoly, as was the case in eastern Ger- many.32 Vertical integration is also maintained by limiting the role of new private power companies to supplying the national utility, as China, Malay- sia, Thailand, and other Asian countries are doing.33 Or, conversely, should the priority be to expose the sector to new entry and competition or to divest? Norway, for example, has a competitive power market, though Statkraft, the largest generator, remains state owned; Stat- nett was established as a separate state-owned transmission company own- ing and operating the grid and operating the pool system. In New Zealand, the distribution market was deregulated and competition allowed in 1992. In 1995-96 the state-owned ECNZ was split up into a transmission company (Transpower) and two generating companies, all state-owned. Prices have The competition commissioner wrote the company thait he had serious concerns that this would prevent the entry of new competitors in the market and he requested that they submit modifica- tions to these contracts within one month. See Finaniiicial Tioics, 12 March 1996 anid 4 June 1996. Chile: The holding company Enersis controls the main distribution companies (particularly Chilectra) and the major generating company, Endesa (which accounts for about 65 percent of installed capacity), which itself controls the central Chile transmission company. This situation, together with the weakness of the regulatory framework, creates conflicts of interest and dis- courages new companies from entering the sector It has also led to lawsuits between electric power-generating companies. See Bitran and Serra 1994 Englandl anti Wales: The regional electricity distributioni companies were the shareholders of the transmission company until 1995, when the latter wxas listed separately and floated on the stock exchange. This demerger was decided for corporate financial reasons, not regulatory ones. On the other hand, the attempted takeover of RiEcs by National Power and PowerGen was blocked by the government, despite endorsement of the kwe (see note 25 above). In 1995, how- ever, Scottish Power, a vertically integrated company supplyinig a limited amount of electricity to the Englislh market, was allowed by the government to take over an Englislh ]esc (Manweb) without prior referral to the MMC, which had been recommended by the regulator. See Finaucial Times, 13-14 April 1996. 32. The privatization in 1994 of the East German power sector came in for sharp criticism on this score; the public sector's monopoly was shifted to the private sector, thereby enlarging the area of domination of the private West German power utilities instead of breaking up the sector and introducing competition. In 1996 the German federal cartel office (competition commis- sion) urged the government to press ahead witlh liberalization, and, referring to the power utili- ties that are positioning themselves for the liberalization of the telecommunications market, the conmmission stressed that competition in the German telecommunications market would be effective only if companies such as RWE, VEB,A, and x i xc no longer had regionial electricity monopolies. In March 1996 the federal cartel office ruled against a contract giving KWE the exclusivity to supply power to Nordhorn, a towxn in Loss er Saxonv, and in so doing threatened to undermine the local monopolies that have prevailed in Germany for the last 501 years. The German utility companiies and municipalities fear that deregulation would dent the monopo- lies and privileges they enjoy in energy distribution; municipalities get handsome fees from the utilities in excshanlge for long-term exclusive supply contracts. See Firniift-ial Tinmes, 31 Januarv 1996 andi 5 March 1996. 33. In these cases, although there is new privatt entrv, there is neither divestiture nor real competition among operators. Instead, independent power producers supply the (public) util- ity based on long-term power purchase agreements; in elfect, the private generators are subcon- tractors of the utility company, which retains its monopolv 222 Tlihe Privatizatimti Cha1t(cnge been deregulated and legal restrictions to entry and competition in all seg- ments of the power sector have been removed. Limited divestitures of power stations were scheduled starting in 1996; some distribution compa- nies had already merged, opened up their capital, or been taken over by pri- vate companies. Issues of sequencing also arise. Australia, Peru, and the United Kingdom have, for example, privatized distributioni first atld generationi soon thereaf- ter, whereas other countries have started with generation (Bolivia, for exam- ple) or have managed both processes simultaneously (as in Argentina and Hungary).34 Finally, specific characteristics of a power system, in particular its size, may influence the choice of market structure; in a small system, for example, unbundling the sector and introdiucinig competition may not be an efficient solution (see Bacon 1995). The current trend is clearly toward unbundlin, and greater competition, although vested interests in many parts of the world are trying to block or delay this transition. As competition moves from the generation side to the wholesale or even retail side, issues of third-party access will more and more come to the front. Where an integrated public (o)r private) enterprise still controls the network, access rules are needed to force it to allow third parties to transmit electricity from a producer to a consumer over its grid and to stop it from charging exorbitant, deterrent rates for stuch access or engaging in other anticompetitive practices. The successive reform proposals tabled by the Eturopean Commission for the domestic gas and electricity markets since 1989 illustrate the current debate rather well. In the power sector, the objet tive of the reforms was to liberalize the sector, notably by separating generation, transmission, and distribution activities and granting large consuLners the right to buy their power from the suppliers of their choice (the grid company would be obli- gated to provide access to the network). These proposals have been met with strong opposition, especially from the Frenclh government and its state- owned, vertically integrated monopoly (EDV), wlhich insisted on restricting cross-border electricity trade within the Europeain Unioni by channiieling all transactions through a single national grid company. To overcome this opposition, the commission threatened to use its special powers to fight monopoly abuses. On the other hand, faced witlh worsening international competitiveness conditions, European industrialists, German ones in partic- ular, were pushing to liberalize the energy mrarkets; European elnergy costs 34. The United Kingdom first sold the 12 tEt sin 199(befort selling National Powerand l'ower- Gen in 1991. Similarly, the government of the state of Victoria in Australia decided to first priva- tize its distribution companies. The state "stunned finanCial markets by raising A$8.4 billion (US$6.2 billion) from the sale of its five regional pover distributioil aLth()rities over just four months" in the second half of 1995 (Privali'siti1th hJitl'r,imtilu;,L December 1995). Two large genera- tors were sold in 1996, raising anothier US$3.8 billio. Comp tition is to be introduced gradually, starting immediately with the state's 50 largest power users; 1V 200)( it should reach all residentia] customers. See also Financial Tinjic', S No\ ember 19915; r, i(. iJtw)i ) lIto nit, la.September 1993. Priwtizatioi of( lfrastrcicfur' 223 are, indeed, estimated to be about 40 percent higher than in the United States (see Jour7n0l of Cointinercc, 18 January 1996). In June 1996 an agreement was finally reached requiring a gradual opening of the power markets of member states, while leaving each country the choice between a competitive third-party access model and a single-buyer model under which cross-bor- der contracts would have to be concludecd with the national monopoly transmission company (vertically integrated monopolies would be required to unbundle their activities into separate generation, transnmission, and dis- tribution businesses). It is becoming more and more difficult for established SmEs to defend the concept of public monopoly, especially when the public operator is unable to meet the demand, as is the case in many developing countries, and third parties (industrialists, for example) are readv to contract with independent power producers on mutually agreed terms. Similarly, the transition of the power sector from what was seen as a natural monopoly into an increas- ingly competitive and market-driven field undermines those who try to oppose private power deals; the pretext that the price of private electricity may be higher than a long-run marginal cost estimated bv some national planning agency no longer holds water. Gas. The trend in gas is also clearly towrarcl unbundling, privatization, and, to a lesser extent, competition. British Gas was privatized in 1986 with only a limited upfront attempt to establislh a conmpetitive sector, however.35 This has produced several referrals to th-e Monopolies and Mergers Com- mission and regulator decisions. Postprivatization regulatory pressure has fostered greater competition and lower prices (a reduction of more than 20 percent in real terms since the privatization of B3ritish Gas). The culmination of these protracted battles between the coompanv, its regulator, the MMC, and the government was the gooverlnmenit's decisioni to allow full competition in the gas market by 1998, and the decision of British Gas in February 1996 to split itself into twTo companies, separating its tradiing business from its pipe- line, exploration, and international activ ities. 3t 35 The gas act of 1986 enabled privatization and established , )I-(,,S (the office of gas supply), which is headed bv the director general of gas supplv, and he Gas Consumers' Council. Xarrow 1986 noted that "the most worrying case is that of British lelecom and the projected privati/a- tion of British Gas w here little thought has been given to liim iting the abuse of monopoly power. Rather the regulatorv environmenit has been tailored to the needs of the existing management and to ensuring a successful share flotation" tp. 123 . the, ompetition and service (utilities) act of 1992 rectified the absenice of any requiremenit to promeote competition in the gas market. See, for further details, Armstroig, Cowan, and Vickcrs 1L94 36. The 1988 mm( report found that British G,as was lpracticiing extensive discrimination; it led to the opening of the industrial market to new competitor. Thle (991 Office of Fair Trading Gas Review concluded that the remedies implemented after the loS i Msm report had been ineffective at introducing competition. The 1993 MM( report concluded that self-_ustaininlg competition required complete separation) betveen trading and tronspm rtation and recommended the end of Brtish Gas' doiestic monopoly by 2002)2 I'he govenmielit uld .lnot follow these recommenidations. f"Ohltillib"I(II flit,1 / tiolI)tiov'mg p9a'xt 224 Thc P ritnatiatioti Chiill hiic In Belgium and Russia, privatization hias not yet been accompanied by unbundling or greater competition. The Belgian natural gas transport and dis- tribution network was developed by tlhe state through Distrigaz, a joint venture with Tractebel (a private energy and public services company); in 1994 the state sold its 50 percent share, giving Tractebel full control over the comnpany.37 Gay- prom was also privatized in 1994 and managed-pursuant to a special 1992 order of President Yeltsin-to escape breakup, thie fate of most other huge Rus- sian monopolies; it remains a vertically integrated (ompany, from exploration all the way to distribution, and has been d1escribed as a state witlhin the state.38 Argentina and Hungary, on the other hand, have clhosen to unbundle the sector before privatization. Argentina split its national monopoly SOP., Gas del Estado, into two transportation companies (tine serving northlern, the other southern, Argentina) and eight distributioni companies, whlichl were privatized in 1992.39 Hungary sold five regional gas distribution companies Instead, it decided that full competition had to be introduced bh 1998 and thal the company rather than break up, had to introduce an internal separation bkeTeen its trading and pipeline businesses. The company's decisioni to break tup was in part motivated b\ the hope that this action wouild reduce the regulatory pressure it was facing and place it in a betto r competitive positioni. As a result of new entry and competition in the inidustrial market, tle market share of British Gas had fallen to 35 percent by 1995. See /'mitunicial Timetc^s, 6 February 196; Armstr inig, (Iowan, and Vickers 1994. 37. In September 1994 the Belgian government sold S\i (tde state-owned holdinig comilpanly, whiichi held the gverimenit's 53! percent participation in D)istrig.l) to a consortium that included a financial holdingcompany and Tractebel, the private joint-veniture partner in Distrigaz; tie uinder- standing was that this participation would be transferred Irom the consortium to Tractebel, whici in tuiri would be obligated to transfer part of this stake to thti itercommunal gas companies (the local distribution companies, some of whiich are owned bv the municipalities onily, others in joiit venture with Tractebel) and to float 16.6 percent of Distrinca/ oin the stock exchange. Tllis transac- tion has been criticized for its complexity and lack of transparency. See Vincent 1995, pp. 9-i1. 38. About 35 percent Of the shares were auctitned as part oft ie voucher privatization programi, 135percent weressoldforasonigtoGGazpromnemploytes,anid JI(Ipercenttwerelboughltby(,aizpromii, primarily to be sold by management to foreign investors. After earlier failed attempts, about 9 percent was to be suld to foreign investors in late 1996, while the remaining I percent held by the company was being floated o0n the Russian miarket to e'tablisb a benchmark price for the planned international ofiferinig. As Gaxprom had I kept he ri 4t to veto secondary resale of its shares, it was one of the least liquid Russian stocks. The rest e I the shares remain state property until at least 1999. Gazprom profits amount to over Sn billion a year, on revenues of $211 to $25 billion. It controls over a third of the world's known gas reserves and supplies over half of Russia's harcd currenicy reserves. The privileges granted to I ;azprom and its managemrient art' attributed by many observers to the fact that the Russian prime minister, Victor Chernomyrdin, used to head thecompany. See Wtill Strnit oet'ial, 5 March 199o, iatincial 'Titnis, 5 September 1996. 39. See L.aw no. 240176 on the privatization of Gas dcl Fsttido and articles 2 and 3 of Decree no. 1189/92 of July 1992. The decree established Ilie neow c-impanies, transferreci the assets to these companies, atl defined th' sale proctss. D)ecree n( 1738/92 (as imenlided ty decree no. 2235/92) regulates transportation and distribution of na tural gas as a public servicet prices, import-export, enforcemenit authority, and general policy priniciples applicable to the priva- tized companies. Decree nos. 2451-24611 ol 1992 set theb ser icet cnditions tor gas distribution, includinig tariffs. Decree no. 1186/93 provides mt'asuress to necure free competition in th'e mar- keting of natural gas. The gas exploration and pr odu(ctioni business was already separate and part of y1n1, tht hytdrocarbots company privatized in 1"')3 Priiyatihatioi i)f hinfrastnic tur 25 to separate groups of investors in late 1995, as well as a stake in MOL, the national oil and gas company) These and other issues of market structure and competition need to be addressed in any privatization program dealing with the energy sector. The options that are chosen will be reflected in the privatization legislation, license and concession terms, and other privatization agreements. Strutctuirail Riformiis ini tflet Tratnsp)ort Sector Technology is drivinig change in the transport sector, too. Multimodal trans- port, containerization of shipments, and innovations in telemetry and sig- naling are all having a profound impact on the organization of the transport sector. Furthermore, the competition that a transport operator faces oftenl comes more from another mode of transportation than from a competitor in the same subsector. In tollroad conicessions, it is not uncommon to see restrictions imposed on the construction of roads that cotuld compete with the tollroad, as well as clauses dealing with competition from other modes (rail subsidies, for example). Railways face strong competition from truck- ing, as the deregulation of the rail and truckinig industries in the United States followinig the Staggers Act and the Motor Carrier Act (both of 1980) clearlv demonstrated. R,ail. The considerable advances made in the field of telemetry and sig- naling are radically transforming the organization and management meth- ods for railway companies by allowing tlhem, in particular, to substantiallv reduce their fixed investments through greater use of single-track lines, which in turn reduces the size of sunk costs and the monopolistic character- istics of the sector. They make it possible to keep track of a shipment when it moves from boat to train or truck, facilitating intermodal transport and just-in-time management. ln only a few countries is there effective competition between railway companies, but they compete almost everywhere with road, waterway, sea, and air carriers.4'1 Canada, the United Sta tes, and a few other countries do have competing railway lines. 41 In the l nited1 Kingd1om, however, the object of the ambitious (and controversial) privatization program launched by the railways act of 1993 is to cre ate competitioni betweeni rail- way carriers, notably by separating infrastructure from transportationi 4(. For tirthier reading on railway re form and pri atiz,ition bee Kopicki and Thompson I1995 Cavana 199)5; Eiclhengreen 19 95; Kessides anid Willig 199 41. There are two maj(or railroads in Canada, the privately owned Canadian Pacific and Carna- diain Natiotnal Railways, privatized in November 1 9in5 through a A 1 1i billion public offering oin the Toronto Exchange. The government has been inimplemileniting a parallel, gradual program of deregulation of the railwavs, reducing subsidies aid otihter torms of proutlcCi01. 226 The Privatization Challetnge activities.42 In Sweden also, competition has been introduced for rail ser- vices based on the separation of infrastructure and services. The Argentine government decided to privatize many railway lines to end the enormous losses suffered in this sector, wlhich exceeded $1 billion a year between 1987 and 1990. The sector was radically restructured following a 1989 decree. Concessions were granted on thie basis of competitive tender- ing for most of the potentially profitable services, including five freight net- works privatized between 1991 and 1993 and four concessions for the metro- politan Buenos Aires passenger transit service. The latter were awarded to those who submitted the lowest annual operating subsidy to provide the public service stipulated in the concession contra( ts; concession agreements were signed in January 1994. Many unprofitablt lines and activities were closed down or transferred to the provinces, and( a large part of the com- pany's real estate and other assets were sold off.43 New Zealand's loss-making rail company was sold in 1993 to a consor- tium of U.S. and New Zealand investors, and it has since returned to profit- ability. In the same year, Japan sold 62.5 percenit of its shares in one of its regional rail companies (East Japan Railways) through a public offering yielding close to $9 billion. Other recent privatizations include railway com- panies privatized through concessions in Cote dl1voire and Burkina Faso (December 1994), Bolivia (November 1995), atnd Brazil (March 1996). Fepasa, the freight division of the national railways, was privatized in Chile in 1995. In Mexico, a major rail privatization law was enacted in May 1995 and the first tenders for the privatization of lines were lauinched in 1996. Ports. In ports, containerizationi, door-to-door multimodal transport, and the rapid growth of international merchandise trade are among the factors that have forced ports to adapt. Two major institutional models have tradi- 42. A new company, Railtrack, owns, operates, and maint,ujs the rail infrastructure (includ- ing track and signaling system) and was privatize(d througih A public flotation in May 1996. The three freight companies and the postal carrier were boughit bv the same consortium led by Wis- consin Central, whicih paid a monopoly premium; the merger wvas approved on the basis that road haulage provides adequate competition to rail freighl. Passenger services were broken down into 25 franchises, some of which have already beeu privatized. In addition, British Rail was further broken dowin into three rolling stock leasing (ompanies, 13 rail infrastructure ser- vices companies, several enginieering companies, and vari,)us other companies, all of whicl) have been or are scheduled to be privatized. British Rails noncore businesses were sold off sep- arately, incilidinig its telecommunications subsidiary privati/ed in December 1995. In a separate move, the U.K. government awarded a 999-year conce.sion to a consortiumi- to build and oper- ate the channel tunnel rail link with London (see note 70 below). 43. Donaldson and Wagle 1995, p. 43, cite the case of i FI"'A, one of the five freight concessions, which was privatized in 1992. FFPl5SA has a 31)-year concessioI for a .531)1) km network. Productiv- ity improvements were considerable following privatizati, n; staff was reduced from 3,(X)() to 780 for the same freight volume. This renewed competition from rail led tihe truckinig industry to lower its own hauling tariffs by 20 to 31) percent, wshicih , learly benefits consumeis. See also Alexanderand Corti 1993, pp. 13-14; Kopicki and Thompson 1995, pp. 153-04; and ministry of economy resolitionis nos. 1386/92, 1457/92, h8/93, and 69/93 on railway conlcessiois. A rail- road commission was established to regulate the sector (see Decree nos. 18h3/93 and 455/94). Priz7ati:zation onf I71rastrtictulrc 927 tionally dominated, namely, the landlord port, where a separate entity- almost always a public-sector entity-is responsible only for the infrastruc- ture and not for services (which may be performed by private or public- sector companies, in competition or not), and service ports, where the port authority is an integrated entity responsible for infrastructure as well as services. lPorts are prime candidates for LnbuLndling and introduction of competition; this has clearly been the trend over the last decade.44 By separating the responsibility for basic infrastructure (such as piers, quays, and access channels) from service delivery, as landlord ports do, private-sector entry can be encouraged in commercial activities. The private sector can also be put in charge of some major fixed investments, including the construction and operation of container terminals. But the largest effi- ciency gains will be achieved by opening all or most activities (depending on the characteristics-size, in particular-of the port) to competition. In large ports, competition can be introduced between terminals; towage and cargo handling (stevedoring, warehousinig, forwarding, and so onl) are fun- damentallv competitive services. Airports. Similar forces are at work in other transport sectors, including airports. The successful privatization of British Airports Authority (BAA) in 1987 was the first major airport privatization. It is now being criticized on competitioni grounds: airports could have been sold separately to stimu- late competition, in particular in the London market. Moreover, the air- ports act of 1986 did not give the civil aviation authority (the regulator) the mandate to promote competition. Competition should in general be encouraged between airports, as wvell as within an airport, not only for handling, catering, restaurants, duty free shops, and other services but also betwveen terminals.45 Privatization can be, and has been, introduced even in activities that are still seen in many countries as basic state functions. Canada, which has force- ful policies for overall transport liberalization and privatization, sold its air traffic control system for $1.1 billion to Nav ( anada, a nonprofit corporation that on July 1, 1996, took over seven regional air traffic control centers, 44 air- port control towers, training facilities, and contracts with over 6,000 employ- ees. Nav Canada is governed by a board that includes representatives from the airline industry, federal government, employee unions, and general avia- tion, as well as members elected by these representatives. After a twvo-year 44. Examples of unbundling (if port activities or ol port privatization can be found in Argentina, Australia, Canada, Colombia, Hong Kong, Malaysia, Me\ijco, New Zealand, Pakistan, Philippines, Swedeni, Thailand, aid the United Kingdom (see Baird 1145; Thomas I994),anmong other countries. 45. Fxamples ot airport privati/ation can be found.l in Austria, Canada, Colombia, Denmark, Greece, Jamaica, Spain, the United Kingdom, and Vene/uela. Cameroon, France, Guinea, and Togo all have privately managed airports. For turther reading on airport privati/ation, see Kapur I '45 and Juan 14945. And Argentina, Auwtralia, a ad Mexico, amiong other countries, have recentliv luniched aimbitious airport privatizatiotn p eraurn,. 228 The Privatizationi Cihallenge transition period, the federal air transportation tax will gradually be replaced by fees and user charges set by the board of Nav Canada.46 ln all transport sectors, the first step is to break the monopoly down into its separate components, analyze each component or activity separately, deter- mine which ones are truly of a monopolistic nature, and decide Where com- petition can be introduced and what the effects of that introduction would be. Structural Reforms in the Telecommunicationis Sector The radical reforms that are under way in the telecommunications sector are driven largely by rapid technological innovation, increasing globalization, stiffer competition, and huge capital requirements. These and other forces have led most countries to open their telecommunications sector to competi- tion and private investment and to divest. After an overview of these broad themes, some of these country experiences are examined more closely, start- ing with the United Kingdom, which set the trend in more than one way, and the European Union, which illustrates how supranational norms may drive the liberalization of this sector. After a discussion of the U.S., Canadian, and New Zealand experiences and a review of the first major telecommunica- tions privatization of the former East bloc (Hungary), this partial review closes with a case study of a smaller country (Venezuela). The influential privatizations carried out by Argentina, Chile (see box 7.1), and Mexico, as well as reforms in other countries, are described elsewhere in this chapter.47 Increasing globalization. Recent developments in the telecommunications sector indicate that external factors are now playing a decisive role in setting government policies, leaving national authorities only limited room for maneuver.48 Technological breakthroughs-new wireless communications (cellular, microwave, radio), worldwide satellite and fiber-optic networks, 46. See Washington Post, 4 May 1996. This shift was motivated in part by the governmeint's desire to withdraw from operational activities and in part by the large investments that will be required to move air traffic control toward satellite-based guidance systems. 47. Argentina: The government raised $214 million in cash and $5 billion in debt securities (face value) for the sale to two consortia of 60 percent of the two successor companies to ENFEI. in 1990. In addition, it raised $830 million for 30 percent of Telef6nica in a 1991 in,o, and $1.2 bil- lion for 30 percent of Telecom in a 1992 iro; 10 percent of the shares were reserved for company personnel. See also, in this chapter, notes 16, 52, 53, and 73 and( table 7.3. Mexico: Telmex was privatized in 1990 with a seven-year exclusivity period. The companiy already had private shareholders before 1990. The government raised about $7.5 billion through the Telmex sale, including nearly $1.8 billion in 1990 for the initial sale of 20.4 percent to the con- sortium headed by Grupo Carso; $2.4 billion for a public offering of 15.7 percent of the shares in 1991; $1.4 billion for 4.7 percent in 1992; $1 billion for a 3 percen t tranche in 1993; and $550 mil- lion for convertible bonds relating to 1.5 percent of the shares in 1994. See also notes 76 and 99. 48. For further reading on liberalization and privatization of the telecommunications sector, see Ambrose, Hennemever, and Chapon 1990; Berenson 1991; Takano 1992; Chamoux and Stern 1993; Herrera 1993; Hill and Abdala 1993; Levy and Spiller 1N93; Smith and Staple 1994; Welle- nius and Stern 1994; Galal and others 1994; Parker 1994b; Ranmamurti 1996. Privatization Of l 7frastructu r7 9 expanding Internet access and services, vastly enhanced data compression techniques, and integration of communications and data processing-lead to much lower unit costs, fading of the distin tion between voice and data transmission, and, more generally, a move toward highly competitive sector structures.49 This makes the retention of monopolies increasingly untenable. These technological advances also underlie the globalization and diversi- fication of the industry. Telephone companies are expanding toward other communications subsectors, such as cable television and data processing. New companies are providing services (cellular and satellite, for example) complementing those furnished by the fixe(d network. Enterprises from other sectors are entering the telecommunications sector; these include, on the one hiand, companies with an existing fixed network that can be used (given certain investments) to transmit communicationis, such as cable TV operators, power and water companies, and railways; and on the other, media companies and other content providers 5(> The survival of many telecommunications conmpanies depends in part on international alliances that state-owned enterprises cannot easily form. Such alliances involve cross-shareholdings, designed to ensure their stability, that are difficult to bring about without private incorporation and management style. In addition, companies operating in countries that have already liberalized their telecommunications markets have a clear lead over others in an increasilngly competitive international marketplace. Operators that combine a monopolistic situation and state control are thus handicapped from the outset in this race. increasing coinlletition. In response to new developments, most countries are opening up their telecommunications sector.?1 They have allowed or will soon allow increased competition tlhrouglh the issue of new wireless licenses, in some cases in competition and in others in collaboration with the fixed-network telecommunications company or companies. The monopoly enjoyed by the dominant companies in value-aidded services, such as supply of terminals, paging, data services, or e-mlail, is cominig to an end in most 49. The recent invention of the callback switch has permitted the rapid emergence of compa- nies offering callback services from countries with low international rates (United Kingdom and United States) to users calling from high-rate countries, thiereby circumventing the national operator and often forcing it to lower its internationial rates. Another recently commercialized technology is fixed wireless, wlich makes it possible to, ompete witlh or supplemenit the local wire network at much lower costs than mobile cellu far telepphony. PT Ratelindo, an Indonesian company with private majority shareholdinig, is currentlx developing such a system in Jakarta. 50. Established companies with existing networks that have entered the telecommunications sector include Energis, the telecommunllicationis subsidiary of the U.K. National Crid comprany; BR Telecommunicatioms, a British Rail subsidiary priviti/ed in December 1995 (bouglht by Racal); Telecom D6veloppement, subsidiary iof the Frenclh railways; DBKonm, a subsidiary of Deutsche Bahn (railways), in which Mannesmann took .i 49 8 percent share in July 1996; andl subsidiaries and joint ventures formed by the German el ctric utilities swi:, \ FlBA, and yin,. 51. See Wellenius anid Stern 1994, pp. 587-674, for an aalytical overview( of the legal and reg- ulatorv frameework, operator ownershiip, and level of c mpetition in the telecommunLicationis sector in more thani 8(1 countries. 230 ThIc Priz'nt;Ztizatit Chall'Jng,e countries. Even basic wireline local phone service (the local loop), which until recently was considered a natural monopoly, has been opened up to competition in the United Kingdom since 1981, and more recently in Austra- lia, Canada, Chile, New Zealand, and the United States. To the extent monopolistic conditions or characteristics persist, the intro- duction of competition must usually be accompanied by special provisions to neutralize the dominant position exercised by the established operator through its control of essential bottleneck facilities. Such provisions will, for example, foster fair access to the network by third parties or force the main operator to lease lines to third parties on reasonable terms and conditions. To be successful, cellular operators or long-distance service providers have to be connected to the principal operator's fixed network; the technical details and the cost of that interconnection often determine the viability of third-party service. Rules need to be in place providing for nondiscrimina- tory access to the network, which implies in particular that where the domi- nant operator provides some of its services in competition with other opera- tors, it must grant them such access on the same technical and financial terms and conditions that it applies to its ownI use of the network. Whereas full monopolies covering most segments of the market were the rule until recently, the changes outlined above will most likely lead to the abolition of exclusivity rights in telecommunications. As a transition mea- sure, most telecommunications privatizations haIve, however, granted the privatized dominant operator some type of time-bound exclusivity. Such exclusivity typically covers basic telephonie servi(es and is limited to a fixed period, at the end of which the exclusivity expires and competition is autho- rized. The concept of basic service varies froni cotunatry to country and may include, in addition to the local wired loop (which is its core), all or part of other voice telecommunications services, particularly long-distanice and international communications. Where governmenits wish to grant tempo- rary protection to basic services, the scope ot such services should be defined as narrowly as possible. Furthermore, the dominant operator should be held accountable for meeting mininmLuM targets for providing these protected services; failure to perform could then lead to suspension or early termination of its exclusivity rights. Indeed, the incumbent, dominant operator should not be allowed to keep newv entrants from providing ser- vices that it does not, or cannot, provide (see Smith and Staple 1994). The duration of exclusive rights is often shorter than the term for a coIn- cession or license, which means that double time limits are imposed: at the end of the first time limit, the monopoly protectionl is abolished; the second time limit marks the expiration of the concession) contract or license itself (unless, of course, the license has been granted in perpetuity). The United Kingdom did not grant an exclusivity period, though BT remained protected until 1991 by a duopoly on basic services. In other countries, exclusivity periods have ranged from five years in Peru, seven to ten years in Argentiia (where the license is of indefinite duration), eiglht years in HIungary (twenty- five-year concessioni), and nine years in Vtenezutela (thirty-five-year conces- Prizvatization o)f Infrastructurc 231 sion), all the way to twenty-five years in jamait a, where the concession term and the monopoly period are the same (see the 1988 telephone act).32 The scope of the monopoly also varies, from the local network only (some local concessions in Hungary) throughi all basic services (Argentina, Mexico), to all services, including value-added services (Jamaica). The grant of temporary exclusivity is often explained by the need to rebalance the tariff structure to phase out cross-subsidization of local ser- vices by long distance and international services. Such rebalancing, it is argued, has to be done over time to avoid tariff shock and popular opposi- tion to the privatization. If monopoly protectioin were abolished before tariff restructuring, the dominant operator could n(ot compete with new opera- tors while continuing internal subsidization of local services. The argument is not convincing, however. A similar resuilt could be obtainied by adding a premium to the interconnection fees ciharged to other operators to compen- sate the dominant operator for monev-losing public service obligations; or the state could pay the dominant operator for these services in some fash- ion. The terms and conditions of interconniectionl are the crux of the matter. They can be designed to withdraw protectioni gradually, if that is deemed necessary. Another reason often cited to justifv an exclusivity period is that it is needed to finance the large investments requtired in many countries; such investments could not be financed as easily, some argue, unlder a liberalized regime, Whlichl would generate uncertainty. Yet agaiin the experience of couIn- tries that have liberalized belies the argumenit; some even fear that competi- tion will lead to overinvestment. The fact that telecommunications privatizations have been implemented without exclusivity periods or with only linmited, timebound ones under- scores the fast changes that are occurring in the sector. The exclusivity may be granted not because the sector is monopolistic but because, for political, social, technical, financial, or other considerations, a transition period is thought necessary to bring about changes gradually. The high sale prices fetched in telecommunications privatizationns indicate the large size of the monopoly rents resulting from sector regulations. International experience also illustrates tlhe benefits of competition on prices: 'According to the (JECI), business tariffs in coulntries where telephone 52. In Argentina, the monopoly(theexclusivity perio, I was initially setatonly two years, to be a utomatica lI y extended to seven years when the tw o omnpani es fl I fi lled their commitnients, which included the implementation of an ins estment program f about $5 billion ald certain service quality standards: the monopoly period could be extended by an additional three years if even higher targets are achlieved. The seven-year peri d expires in November 1997 and manY in government would prefer niot to grant the extrnsioin. Indeed, thougih the firms may meet their investment anti other commitments, tariffs renmanll verv high by international standards and are hampering the competitiveness of the Argentine economy. Meanwhile, comilpetinlg countries like Chile, whiere privatization has gonec with strong competition in the market (see box 7.1), have seen telephone tariffs plummet and has e increased the penetration rate (teleden- sity) much faster 232 ilic PrivatZatiol Challlenge service is still monopolised fell by 3.1 percent between 1990 and 1994; but they fell by 8.5 percent in countries that had introduced competition" (Thle Economiist, 9 December 1995). In summary, privatizing governments should clearly try to introduce as much competition as possible into the sector, as early as possible, even at the cost of a lower sale pric e. Private capital requireiments. Most developing and transition counltries face huge investment needs stemming from the low, density of the existing net- works (whiclh are reflected in low market penetration rates anid large, unsat- isfied demand) and from thie rapid economic grow th that the more vibrant of these countries are experiencing (with annual (,DI)' growth rates exceeding 10 percent in some cases). Promoting new investmtnts to speed up develop- ment of the network is therefore a matter of high priority. The experience of the last few decades demonstrates that the typical monopolistic public enterprise is not up to this challenge. The privatizatio>n of telecommiuniications comnpanies in Argentina, Hun- gary, Indonesia, Mexico, P'eru, and Venezuela required in each case hleavy new investments, together with improvements in service quality and pro- ductivity gains.53 The main purpose of regulation o f the sector in such coon- tries should be to foster investment rather thlan to control prices per se, whiclh may be a more appropriate priority for countries with mature mar- kets and higlh penetrationl rates. Divestiture. The important technological progress achieved in the tele- communications sector, the emergence of dynamic interniational private operators and major global alliances, and the impressive track record of countries that have liberalized and privatized the sector are leading an increasing number of countries toward privatization. Thus, as box 7.2 and table 7.1 slhow, in addition to the countries that have always had private telecommunications operators, suclh as the Phllilippines and the United States, many countries have recently privatized or partially privatized their telecommunications companies, wlhile otlhers arn currently preparing such 53. Arnoiitiiia: See article 10. 1.8 of Decree no. 62/90, mii D)ecree no. 677/91), as well as the terms and conditions of tenider documents for privatizatiorls. fiotigary: Notably, an increase in the line stock bv 15.5 percent a year over six years, connec- tion of all applicants within six monthis by 1997, automnat ion of the entire network, and develop- menit of HuIngary as a regional telecommunDjicationS hub. /,ild,iiisia: Collectivelv, the five consortia selected to ope,ratc basic telecomimunicationis service in five of seven regions under concessioni-type arrangement> had to install 2 millioni new lines over a four-year period; their contract, signed in October 1995, requires them to meet increas- ingly tight targets for service quality and performance. Peru: Notably, investimlenits of the order of 51.5 billion over five vears for the purpose of tri- pling the number of lines in service from the current 630i,t)i0t to 1I8 million, anid the introduction of telephioe service in all villages of over 5()) popilation (see Finacicl- Times, I March 1994). Vlein:iota: See the section belows till the privaibaationil uf Wi VenLu/lis telephione operator. Priza tiza titl of l1frns tr ictciric 2.3.3 Box 7.2 Recent Privatizations in the Telecommunications Sector In one group of countries, state-owned telecommniuniicationis companies have been privatized and control (thoughi not always a majority of shares or even a majority of seats on the board) transferred to the new private owners. These include Argentina, Barbados, Belgiumn, Bell/e, Bolivia, Chile, Congo, Cuba, Czech Republic, Dennmark, Estonia, Gibraltar. Guinea, Guyana, Flungary, Ire- land, Jamaica, Latvia, Mexico, Mongolia, the Netherlands (KIN' was the first post and telecommnunications company privatized without prior separation of these two activities), New Zealand, Peru, Senegal, Spain, the United Kingdom, and Venezuela (see tables 1 and 2 in the introduction for details on the largest of these transactions carried out betveen 1991 and 199h). Additional divesti- tures have pertained to long-distance, international, or satellite commun1ica- tion companies in Australia (Aussat), Canada (Teleglobe and Telesat), I'uerto Rico (11-), South Korea (Daecom), and Yemaeni (TeleYerrien International, in 1971), amonig other countries, as well a1 cellular telecommunication1s conpa- nies, notably in South Korea (Korea Mobile 'elecilm). In other couLntries, divestiture ot the doninaiait operator has been partial, with the government conitiniuinig to be the (ontrolling sharelholder. This was the case with (apaniese operator NlT, 35 percent of whose shares were sold in tlhree tranches betwveen 1986 and 1988 for a total of over $70 billioni; Telekom Malaysia, witlh a public flotation of 25 percent of the shares in 1991); Sin- gapore Telecom, where nearly 11 percent of the capital was sold in October 1993; I'akistan Telecommunications Corporation, for which the government issued coupoIns in September 1994 that represented 12 percent of the capital (these vvere eligible for conversion in1to sh,ires of the company followving its corporatization and privatization); Korea lFelekomil, with an offer of 1(1 per- cent of the capital limited to Korean investor, in February 1993. (only 3 per- cent found takers), and a 5 percenit tranclhe placed with domestic investors in 1994; Indosat, the Indonesian international operator, 32 percent of whose shares wvere sold througlh a public flotation on1 the New; York and Jakarta exchanges (October 1994); PT Telkorr, the domiestic operator, whose internia- tional initial public offering hlad to be curtaiiled at the last minlute because of weak demand (19 percenit of shares sold in November 1995); P'ortugal Tele- com, witlh an initial public offering in June 199); and a second tranche in June 1996, leaving the state witlh a SI percenit shareholding; Greece, wlhere the government finaliv managed to sell about 8 ptercent of m'rIs stock in Marclh 1996, after several more ambitious attempts ho d failed; Israel, xvhere 23 per- cent of Bezeq has already been sold; and ( ernm nv, where 2h percelit of Deut- sche Telekom wvas floated in No%vember I 49t0 Finally, many counatries have indicated their intention to) privatize their dominalit operator. These include (in addition to countries plannilig to sell sec- ond, third, or further tranches of telecorrimuni ations companies already par- tially privatized) Albania, Australi,, Brazil, Bulgaria, Colombia, Cote d'lvoire, Croatia, Ecuador, El Salvador, France, Gabon, (hania, Guatemala, I londuras, India, Italy, Jordan, Kenva, Lithuania, Madagascar, Moldova. Morocco, Nicara- gua, Panama, Poland, Rornania, Russia, Rwavida, Slovenia, South Africa, Sri Lanka, Sweden, Thailand, Turkey. Uganda. and Uzbekistan. 234 Fh, Privatizat ion Challeiigc privatization operations. Most of these have been accompanied by at least some form of sector liberalization. The Britislh appro-ach. In telecommunications, as in most other infrastruc- ture sectors, the United Kingdom has been a pioneer. The privatization of British Telecom (BT) in 1984 had added significance in that it set important precedents for future U.K. infrastructure privatizations, including use of public flotations instead of strategic sales, creation of a golden share, estab- lishmenit of a regulatory framework centered on an) independent regulator for the sector, development of the price cap formula, and so on.54 The major shortcoming of this process was that insufficient attention was given to the creation of a competitive environment at the time of privatiza- tion. BT had a legal monopoly on telecommunications services until the Brit- ish Telecommunications Act of 1981 established it as a corporation separate from the General Post Office, privatized C able & Wireless (C&W), allowed C&W to set up a subsidiary (Mercury) in the United Kingdom to compete with 13T in all segments of the market, and liberalized terminal equipment. Limited competition had thus been introduced even before BF's privatiza- tion in 1984. A second cellular license was issued in 1983 to compete with BT's Cellnet. Value-added services were also opened to competitioni. The duopoly policy, which was confirmed at the time of B3T's privatization, never provided strong competition to the incumbent moniopolist, however, and came to an end in 1991.55 Since then, cable companies, foreign telecommuni- cations firms, and others provide competition in all segments of the market, including the local loop, with one notable exception:i until 1996, interna- tional operators other than Bsr and Mercury werc not allowed to own and operate their owni circuits for international calls; they had to lease circuits from the former duopolists or pay them a fee for each call carried. The removal of this restriction allows other operators to connaect their calls directly to satellites, build their own interniational cables, and negotiate agreements with overseas operators. About 150 telecommunications licenses have nowv been granted and Br faces competitors in all segments of the telecommunications market. Under combined pressure from increasing competition and the regulator (OFTEL), telecommunications prices have fallen bv ovet 30 percent in real terms since 1984. 54. Some of these features had already beeni introduced by the telecommunications act of l981. The telecomnmnlicationis act of l984 enabled privatization of British Telecom and estab- lished the regulatory body; the office for telecormmonicationl, headed by the director genera] of telecommunications. Further regulation of British Tele(om is found in the network operating license granted to tol under the act. See also the sections below on public flotation, golden shares, the tariff regime, and theregulatory framevvork 55. See the duopoly review White Paper: Cm !]ticlitimi mI ( Is Ioitc' Peceommn!!icimot s flolici, f(or the, 199(0., Department of Tradeand Industry 1991). See for details Armstronig, Cowan, and Vick- ers 1994. Prizatizatio>i of I ifnastrttct re 2 35 Tlhe policy (if t/t' Eiiropean Uitioni. In Europe, a series of legislative instru- ments have been enacted by the European Commission and European Council providing for phased deregulation of the telecommunications sec- tor. Measures began in 1988 with terminal equipment (including computer modems and telephone handsets; Commissiou Directive 88/301 /EEC of May 16, 1988), followed by value-added ser ices in 19(0 (Commission Directive 90/388/EEC of June 28, 1990, on conmpetition in the markets for telecommunications services). Telecommunications markets were further liberalized throtugh open network provision in 1990 and 1992, and1 access through alternative infrastructure (suclh as railway and power utility net- works and cable television) for commercial services as of July 1996. The reforms will culminate with the introduction of full competition through opening up markets in voice teleplhonv and public network infrastrucure, effective January 1, 1998.56 Althou,gh article 222 of the Treaty of Rome requires that policies adopted by the European institutions remain neutral with respect to member states' choice of type of ownership (private or pulb- lic) of their enterprises, in practice few S,OEs are likely to be able to resist the onslaught of competition and the greater efficiency it requires. State-owned operators will not be able to hold on1 to their market share at the European level without radical reforms in the structure aind modus oper- andi of their enterprises, a change that will almost inevitably mean they will have to open up their capital base to private partners and tap the capital markets. What is mnore, European Unioni (F ) rules concerninag state aid sharply curtail the option of using public tunds to lhelp a national operator get back on its feet, EU competitioni rules limit mergers that reduce market competitioni, and European policies increasinggly require the separatioln of regulatory and operational functions. These and other factors explain the radical transformation of this sector, in particu lar the gradual abandonment of the national, monopolistic public enterprise paradigm. This evolution still needs to be rounded out bv detailed rules goxN erning mutual recognitiOn of licenses by EU' member countries, interconnection, and dispute settlement between European operators; even the establi-hment of a European regula- tory agency might be contemplated. It is notewvorthy also that, within the same I.L framework, member coun- tries have adopted very different strategies. At one extreme is the United 5h. See, on open n xehvork provision, Council Directiv2 91/ s7,/EFC, June 28, 199(0; Couninl Directiv '92/44,/EEC, June 5, 1992 on the applicatixm of open network provision to leased lines, amended bv Commissioni Decisioni 94/439/E[C; ind Co.incil Recommelendationi 92/3133/ [EC, June 5, 1992. The reforms to be introduced by luly I906 ,.nd lJanuary 1098, respectively, are set forth in Commission Directive 9h/ )/FC, March 1 A, Ili%, amending Directive 901/338/E1,C with regoard to the implementationl l full compiteition 111 telecolimumicaltions markets. This directive las well as the earlier ones) was issued1 bl the Commission uSilng its powVCers undler article 901 of the Tr atv of Romne, which afl1u, lht ch m n ni-,sollgent' the sector. In December 1993, following a call for bids prescribed by the tele- communications law (articles 4 and 5), the government sold a controlling block of shares in MATAV, the national telecommunications company, to the Magyarcom consortium (Deutsche Telekom and Ameritech) for $875 mil- lion.61 In addition, the European Bank for Reconstruction and Development and the International Finance Corporation together hold about 3 percent of the company's shares; these shares result from the conversion of debentures they bought to support the reform process and supply the company with urgently needed capital before its privatization. AIthough the government initially intended to include a second tranche of \4ATAV shares in its mass privatization program, it proceeded in December 1995 with the sale of an additional 37 percent to the Magyarcom consortiumn for $852 million; the pri- vate partners undertook to reduce their stake from f67 percent to about 51 per- cent by floating shares on the stock exchange at a later date. The MATAV concession runs for 25 years, including an exclusivity period of eight years, and covers basic service in 29 of the 54 national regions as well as long-distance and international services throUghoUt the country. The munici- palities were given the option of keeping the telephone services for their regioln within MAT'AV or offering them as separate concessions. A majority of municipalities in 25 regions chose the secondl option. The concessions for 23 of the 25 regions not covered by the initial MIATAV concession were awarded to the highest bidders in February 1994. Eight of these were awarded to MATAV and 15 to other companies; there were no takers for two of the regions.i2 These concessions have a twelve-and-a-half year tern, grant exclusive rights to pro- vide local telephone service for eiglht years, and make the concession holder eligible for a cable television license coverinig the same territory. Hungary's approach1 is described bv somie observers as a resolutelv modern approach that takes account of strategic and technological developnments in the telecommu- nications sector during the last few years; others thinlk of it as a political com- promise to overcome the municipalities' opposition to MATAV's monopoly. 61. This block of shares (30.2 percent) did not, in fact, give th(m effective control of the comn- pany. [Indeed, the consortium did not have majoritv representation either on the board of direc- tors or in the general shareholders meetiig. An esecuti\ e or management committee was, hovtw- ever, set up in wvhich the investors had two of the four seats plus a castinig vote. This committee, which reported to the board of directors, was respionsible lor day-to-day management of the company and implementation of its annual program. Ihe sale proceeds were allocated as fol- lows: $40i() millioin for a capital increase, $342 millioni paid lo the public holding company for the purchase of preexisting shares, and 5133 million paid to the ministry of communications as a concession fee (see Privatisaititm Iltetrntioenal, January 1994 p. 4, and lanurary 1996). 62. These conitracts were awarded to several consortia, le) byv among otlhers, the Coompagnie Cenerale des Faitx, Alcatel, and several American companies. They paid a total of $8(1 million for these 15 concessions and. undertook to invest nearlk 52t()i million during the first three years of their concessiot (see ritntatial Times, I March 1994 ,d I March 1994). MAI AV con1tillues to provide the service in the two regions that did not find( takors, thoughi not unider a concession. As a result of this process, MAIAV, which used to operate the whole national system, had to dixvest itself of the regional busi)nesses fir whii-lh i I did not ic in the concessi0l an.d transfer each one of themil to the coimmpeti ng bi dder or coinsortinLin th it iwo t Priratizafio (if lifrastritctcit ' 239 The privatization of the Veniezuelail oe1raYtar. C\NTV, the national telephone company of Venezuela, was set up in 1930 by private investors.63 In 1964 it was nationalized, merged witlh Venezuela's other telecommunications enterprises, and granted an operating monopoly. It was privatized in December 1991 by the sale of 40 percent of its shares for nearly $1.9 billioln, involving transfer of its management to a consortium comprising C(IFE, Telefdnica de Espafia, AT&T, the Caracas powver tompany, and a local bank.6'4 Why was the sale limited to 40 percent of the shares? First of all, the govern- ment wanted to sell only to a top-grade international operator capable of exe- cuting the ambitious investment and managemenit program set forth in the privatization documents. This meant a foreign company. Sale of a majority of the capital to a foreign consortium had1 been niled out for political reasons. Some mechanism therefore had to be devised to assure private investors that they could control the company with less thain Si) percent of thle shares.65 CANTV holds a 35-year concessioni, which can be extenided another 20 years, and enjoys a nine-year monopoly over the basic wired network and 63. The following sources were used for the case study i)n v \N 1s: C;i/anlg and Sabater 1994; Pisciotta 1994; Taylor and Vidal 1994; I,Ulo,li11c il Til'c. 29 Sieptember 1994 and 26 October 1995; New Yrk 'ork'ns, 21 June 1995. 64. Before submitting their financial bid, bidders hid to deliver all the privatization cointracts and related agreements (including the agreement c,-tabl ishing the biddiLig consortium), the revised bylaws of (AN x1', bid and performance bonds issu, d bh approved banks, and any other document related to the transaction, the wvhole duly signed. Fhibi made it impossible to equivo- cate or negotiate more favorable clauses after winning Ilit contract_ All these C docUloelIts, how- ever, together with the concession contract, had been prewgotiated with twvo consortia seltcted after a prequalification process (see table .3 for a0 list a Ot I reselction criteria). One cotistirliuni was headed bv ("IE the tither by Bell Atlantic ind Bell ( arnacda The final bid related solely to price, all the other factors having been set in the bidding dic umen1tation; any conidition or reser- vation expressed in a bid rendered it null and Xvild. 'I he bidd iitg rules called for all prequalified contenders Iboth conomrtia, in this Case) ti submit an en CMCl hpe in the fil] ronlld, whJether or not it included a bid. This was done to keep ,i bidder from le,irning how mmnx' remained in competition for the concession; indeed, if a bidder wier, t finmd out that it was the onilv ot, planning to make a formal offer, it might lower its bid. 65. cAN ,\ shares were divided inito four classes. C la,, \ coimprises the 40) perce1nt transferred to the winning consortium and confer> the right t6l appoint five out of nine members of the board of directors (up to the year 200)1 ); specific Idauses hillit the ability of the winning consor- tium to resell all or part of its shanms, or of (' Ir to rvdu c it,S participatiin ini the coinsortirim. Class B represents the 49 percent hield by the gtivernmelt and confers the rigiht to two seats onl the board; the government can sell its shares, for e\amp t by public flotation (suchi an olfering occurred in late 199(). The remaining 11 percent are C'i(s (' share> in) trust tor the benefit of CiANI\N employees and retirees, who may subscrile a specifiedc numbrer of shares (based on length of service and salary) and pay' for them in iiitall tents spread over nine years or moreC; tw-o directols are appointed bv the employee-s. One p,ircent of the class C' shires was to be bought by' tAN I iV and held in trust to create a bonus proigranic under which free shares would be awarded to certain employees based oin performante. lUOin subsequent transfer, class A, 13, and C shares automatically become class n shares, thait is, ordinarv sharesO without special privi- leges. To make certain changes in the bOats's a d0iible In tjoritv of class A and class B sharehold- ers is required By' falling beloiv the t-rilical thresh,id of *1) percent pubItc sharholdiog, c A is no longer subject to the laws governing public eniterpi 1ISt. 24( 7 lit' I rinl i:Latwion Chalict' ,Xt' long-distance and international communications. This temporary monop- oly was granted to rebalance rates and gradually phase out internal cross- subsidization, wlhereby long-distance anid interinational services supported costs of local services. The substantial margins realized in long-distance and international services were deemed necessary for the financing of the ambi- tious investment program required under the terms of the concessioni. The high selling price points to the existence of high monopoly renits and sug- gests that the exclusivity term could have been slhorter. All other services, notably terminals, private networks, value-added services, satellite links, and cellular, are excluded from the monopoly. The governmenit had, in fact, already granted a nationwide nonexclusive cellular conicessioni for 20) years (renewable) in May 1991 to the Telcel consortium11 for S1(07 million. A subsid- iary of CANTV provides cellular services in competitioni witlh Telcel. The concession agreements require CANTV to renew the network by installing new digital lines, converting old lines to digital, and increasing the number of public phones, among other obligations; this means that 3 million new lines and 600,000 replacement lines had to be installed durinig the first nine years of cAN'FVs concession. The agreements also require CANTIV to upgrade the service quality, especially by reducing the time needed to get a dial tone, shorteniing repair times, and raising the call completion ratio (the percentage of calls going through on the first attempt). Two years after privatization, CANTV had already invested more than $1 billion, installed 850,000 lines (an increase of about one-third), and connected 46(1,1)00) new subscribers, thus exceeding the requiremenits of its concession contract. Between 1991 and 1995 the penetration (teledensity) rate increased from less than 8 percent to over 11 percent. Service quality also improved greatly, as did the company's productivity, but profits did not. Economic crisis and other factors discussed below caused CANTV to lose money in 1994. In four years, through the end of 1995, C(ANTV investments exceeded S2 billion, or about $500 millioni a year; annual investments in telecommunications aver- aged about $80 million in the last three years of state owniershiip. Time constraints led the governmenit to incorporate most of the regulatory framework into the concession contract, whiclh was approved by the Vene- zuelan congress; it also issued a decree creating Conatel, the regulatory agency established as an "autonomous service" of the ministry of transpor- tation and communiications with limited powers and no autonoomous source of financing. Parliament never adopted the telecommunications law submit- ted by the government, which called for a new regulatory framework and a regulatory agency with greater autonomy and u ider powers. Consequenitly, the sectoral regulations established by decree remnainied in force. Tariffs were to be ad justed quarterly, following a formula linlked to the price index and applied to tlhree baskets of services. Thiese periodic adjustments have to be proposed by CANTV, recommended by Conmtel, and approved by the minis- ter of transportationl and communications. The lack of a regulatory organ with adequate institutional and financial autononmy probably remainis one of the major weaknesses of this transac- PrizntizOiot iu o(f flutfratu t;chr 24! tion. In 1994 relations between CANTV, on the one hand, and the regulator and government, on1 the other, became verv tense. New foreign exchange controls and government actions did not allow the company to buy dollars to service its debt, which led to defaults an.d debt rescheduling. Other mac- roeconomic policies taken from 1994 by the government, including the devaluation of the bolivar and the resulting galloping inflationi (about 60 percent), as well as a general recession, furtlher aggravated the plight of CANTV\ Public sector and government customers accumulated substantial arrears toxvard CANTV with bills exceeding 400 days, on1 average; unpaid public sector bills amounted to about $60 million; high inflation in the coun- try (over 50 percent) made the situation even wvorse for C-ANTV. It appears that the regulator blocked the rebalancing of rates and did not meet dead- lines to authorize some rate increases provided for in the privatization agreements; one of the quarterly increases was even, apparently, denied. Moreover, Conatel granted licenses to third parties despite the monopoly accorded to CANT\'. The government's replacement of the chairmanl of Cona- tel was yet another indication of the fragility of the regulatorv framework. The arrival in 1995 of a new regulator (appoii ted by government) and of a new Venezuelan CEE) (appointed by (AN \FV) seems to have introduced a period of more harmonious and constructive relations between the private operator, the government, and the regulator. 'eriocdic rate adjustments are again applied, CANTV's foreign debt has been restructured, and the company was in the black again in 1995. The government sold the state's remaining 49 percent shareholding in November 199h thlough an li' (4(1 percent) and an employee allocation (9 percent), raising over $1 billion. Towaird intcrntitonal nornis. As alreadv discussed, Eu norms are having a forceful impact on domestic European teleconimmLnicationls companies and markets; many countries, especially in southern Europe, would not be liber- alizing their markets were it not for these directives. The increasing global- ization of the telecommunlicationis industry has also been discussed; internia- tional mergers and alliances require the approval of regulators in the countries concernied, who mav condition their approval on stipulations that have a direct impact on sector structure and competition in countries out- side their jurisdiction. The U.S. EG, for exaimple, imposed conditiolis ol tile $4.2 billion investment bv France TIelcom and Deutsche Telekom for a 20 percent stake in Sprint. The new alliance cannot increase the number of lines to France and Germany until the two countries meet a series of demanids related to the liberalization of their telecomnLunications markets. In addi- tion, ECC approval may be revoked at any time if France and Germany do not comply with various undertakings, includ1ing liberalization of alterna- tive infrastructure by July 1, 1996, and remroval of restrictions on foreign investment. Interestingly, most of these unider-takings simply mirror obliga- tions Germanv and France already have purstuanit to existing F norms. The threat of withdrawal of FCC approval in this case boosts commnitment to effectivelv implemenit the agreed reforms. 242 The fPrivafizat ion Challengc Other signs attest to growing international norms in telecommunications. As a follow-up to the Uruguay Round, for instance, the World Trade Organization is hosting talks on telecommunications liberalization. This is a solid indication that competition rules and basic regulatory safeguards in the telecommuLnica- tions sector are increasingly moving toward internationalization. Range of Organ izationol Options Examples from the infrastructure sectors discussedi in the previous sections and summarized in table 7.1 illustrate the wide range of sector structures and privatization schemes, which must be tailored to the specific circum- stances and coinstraints of each country and sector, as well as to specific gov- ernment objectives and strategy. In most cases no track record exists yet, because most of these reforms have only recently been implemented and their costs and benefits are still being evaluated. Preliminary results, how- ever, demonstrate the promise of the proconipetitive approach and its supe- riority over the earlier paradigm of state-ownied nmonopolies. The privatiza- tion of infrastructure sectors is not an exact s(ience, and it will almost always involve adjustments and corrections. Countries like Argentina, Chile, and the United Kingdom have been pathbreakers; othfer countries should take advantage of the lessons of their experience. Special Issues in Infrastructure Privatization The general developments discussed in the first six chapters of this book apply also to the infrastructure sectors. Thley will not be reviewed here. A few issues, however, arise either differently or more acutely in these sectors, usually as a corollary of their unique characteristics. Special privatization techniques, specific constitutional and legislative issues, prior restructuring requirements, and various transactional matters that apply to infrastructure privatization are examined in turn. Technitles for lnifrastrictotre Privatfixation As discussed above, one of the specificities of infrastructure privatization is the priority that needs to be given to matters of sector structure and compe- tition. Additional and country-specific features may derive from the public service nature of infrastructure activities and from the special legal status that may be attached to sector assets. These special features have led to the development of specific privatization techniques. The term "privatization" is used to refer to a range of different thouglh often overlapping situations, each of which has several variations and covers, among other things, divestiture or privatization scsi stricto, which implies the permanenit transfer of the ownership of sector assets to the private sector; con- cessions and other fixed-term privatizations, wllichi typically limit the scope Printifi-za ti on f Ofifrsfri Ict I IV 243 and duration of the rights transferred ancd imply a return of the sector assets to the public authority at the end of the concession period; and new entry follow- ing demonopolization of the sector and introdLuctioni of competitiont'1 Divestiture and fixed-term privatization are tranisactional in nature. They involve the transfer of an existing enterprise to the private sector, which runs it at its owvn risk. In both cases the most valuable asset offered is not the plhysical infrastructure itself but the operating license, the right to provide the service. The terms "license" and "concession" are often used interchangeably, though they may have specific and differenit meDanings in given countries or legal systems. Concession often refers to a contract that grants an operating license, but it also includes a range of other special features. In many cotlul- tries, for instance, concessioils give the private operators only limited rights over the sector assets, falling short of legal ownership. This type of conces- sion is particularly well suited to situations whlere, for conIstitutional, legal, political, or other reasons, it is not possible to tranisfer ownerslhip of strategic sectors to private parties. In other countries, the ownership restriction applies only to foreigners and can be similarly circumvented. Concessions of this type can be constructed in a wax that mimics the features, and partic- ularly the incentives, of full private owniership. M'oreover, the term eoncessioili often implies, especially in] coulntries with a French-inspired legal tradition, the reLtrin of the enterprise or sector assets to the public authoritv (a return that could be postponed indefiniitely by extending or renewing the contract). In Argentina and Clhile, for example, concessions have been granted on a permanent basis, however(7 Withill concessions, a distinction is sometimes made dependiing on whether the operator is responsible for new investmenits in the sector or whether that responsibility remains with the public sector; the latter case is sometimes referred to as leasing, or affct'iia-ct.'8 Finallv, concessions may be deemed to 66. See also tile defillitionl of privatization given in thel itroduction. Thils book focuses on privatization in the sense of transferring existing ente rpris's or assets from the public to the pri- vate sector; build, owin, operate (Itio) or build, operate, tra isfer(io If) c ontracts, greenfield pub- lic works concessionis, and other such private infrastructiire schemes therefore fall o Mtside its scope. 67. See, in particular, article 3) of Chilean Decree-L iw n' 1 oft une 182 conceriiing the elec- tric power sector, which provides that 'definitive' concessions hiall be granted with indefinite duration. In Argentina, inidefinlite COncessions have been granted in the telecoimmunications sector. 68. In additioni to the specific features of conIcessionls hfo r1d in some legal svstems there may be a difference in forni between a license anid 3 concossiori; the tirst is a uiiiateral act anid the second is a bilateral or consensual contract. This ditcrene'' mav be deoVid of real implications, however, because the unilateral amendmenit ot a licenserPs a plublIc authlority generally requires the licensee's agreement (article I1 of the 198l LX K elcctri itV' act, for example, provides that the license may be amendled with the holder's consert, w,,henras French case law, for example, gives the p ublic authorities the right to alter the ter-ms If i concession contract unilaterallY when circumstances so require (the principle, of adaplatioii of service). In the United Kingdomi, provisions governing unilateral amendment of licens's a rv from sector to sector; it the regiUla- tor and the licensee disagree, the matter is u suallv relerred to the minister or to the Ksiti 244 ThJ' Prizvatizotiou Challentige be administrative rather than commercial contracts, which may have a wide range of important implications.69 Introduction of competition and new entry represent a third type of privatization, which results from the adoption of new sector structures and policies, as discussed in the previous section. In all three cases, private operators are given an operating license, that is, the right to provide the service. The three techniques often coexist in one privatization program. In Argentina, for example, the power sector was unbundled and liberal- ized, power stations were divested, and trnnsmission and distribution companies were privatized through concessions. In Indonesia, PT Telkom, the main telephone operator, was partially privatized in November 1995, a few weeks after having entered into "joint opeiations schemes" (akin to 15-year concessions) for the operation of five of its seven regions with pri- vate consortia; previously, a minority stake in Indosat, the international carrier, had been floated on the market and new entry had been allowed in most segments of the market. In the United Kinigdom, in addition to the unbundling and privatization of the railway system, the government awarded in March 1996 a 999-year concession to a private consortium to build and operate the high-speed rail link between London and the Chan- nel Tunnel; as part of the deal, the U.K. government agreed to provide sub- sidies and to divest and transfer to the private consortium large areas of railway land as well as its ownership interest in European Passenger Ser- vice, a joint venture of British Rail and the Belgian and French railways operating the Eurostar trains from London to Brussels and Paris.701 Table 7.1 shows the instruments that have been chosen in various sectors in several countries. As pointed out above, the distinction between divestiture 69. The Turkish government tried to avoid the application of administrative law to 1301 projects by submitting a bill to parliament that stated that a 1aol I contract was a nonconcession- ary coitract governed by private law; this text was adopted a nd became law (article 5 of the 101 laxv of June 1994). But this provision was struck down in 19015 by the constitutional court (deci- sion no. 1995/23, published in the Turkish official gazette no 22586 of March 20, 1996). Tle court ruled that this provision violated article 155 of the konstitution and that 30'1 contracts were in fact concessions and thus administrative contracts, iot private contracts. l3(1' contracts thus become subject to Turkish administrative law; disputes cannot be submitted to interna- tional arbitration. Tlis rulinig also has adverse tax implications for 1301 projects. This decision dealt vet another setback to the Turkishti a program and will make it more difficult for tile gov- ernment to attract private sponsors and lenders. Since then, the government has adopted a new I0OO (build, own, operate) model, which no longer imnplies the return at the end of the contract's term of the facilities built by private investors; the government hopes to escape the classifica- tion of projects developed under this new model as conces,ioll contracts subject to administra- tive law and other public law constraints. See Mi,lU, I 11st I n,ciifi. Rei1srts, June 1996; Pronvit & 7iTad Finiancc September 1996. 70. The concessioni was awarded on the basis of tht low,est level of cash subsidies demanded. The selected consortium bid £1A4 billion (52.1 billion) which was apparently £5011n million less than its rival. See Financiml Tini's, 1 March 1996; see also note 42 above, Table 7.1 Infrastructure Networks: Privatization Mode and Sector Reform in Selected Countries Sector Divestiture Concessioni and leasing Introduiction of competition in the market Telecommuni- Argentina; Chile; Cuba; Guinea Cook Islands; Guinea-Bissau; Indonesia; Australia; Chile; European Union; Hong cations Hungary; Jamaica; Mexico; Madagascar Kong; Mexico; New Zealand; Philippines; (wireline New Zealand; Peru; United Sweden; United Kingdom; United States voice) Kingdom; Venezuela Electric power Argentina; Australia; Bolivia; C6te d'lvoire; Guinea Argentina; Australia; Bolivia; Chile; (generation) Canada; Chile; Germany; New Zealand; Norway; Peru; Hungary; Pakistan; Peru; United Kingdom United Kingdom Gas transport Australia; Belgium; Hungary; Argentina Argentina; United Kingdom; United States and Latvia; Russia; United distribution Kingdom Water distr- uinited Kingdolm) Argenitina: Brazil; Central African United Kingdom bution Republic; Chile; Colombia; Cote d'lvoire; France; Guinea; Macao; Malaysia; Senegal Railways Bolivia; Canada; Japan; New Argentina; Brazil; Chile; C6te d'Tvoire- Sweden; United Kingdom; United States Zealand; United Kingdom; Burkina Faso; Mexico United States Note: The table includes onlv countries that have privatized by transferring existing public-sector facilities to the private sector, not those that have opened up the sector in question through greenfield concessions or BOT and BoO contracts only, such as Thailand (telecommunications) and China (power generation). For some countries and sectors it was not possible to ascertain precisely whether privatization (in the broad sense) had been effected by means of a permanent divestiture or a concession implying the return of sector assets to the granting authority. See also box 7.2 for additional examples of divestiture in the telecommunications sector. 246 The Privatizat ion Challenge and concession is somewhat artificial and arbitrary.71 Listed as concessions are mainly those transactions in which sector assets continue to belong to the state or another public entity (a municipality, for example) and revert to the state without market-based compensation at the end of the concession contract. A dif- ferent criterion might distinguish between transactions where the public sector remains responsible for major new investments in the sector (some, but not all, examples from the concession and leasing column of table 7.1) and those where this responsibility rests with the private sector (all the examples in the divesti- ture column, plus some of the ones in the concession and leasing column). What matters in the end is not what the transaction is labeled but what its terms and conditions are, in particular, the specific rights and obligations conferred, as well as the operator's incentives to improve the quality and efficiency of service delivery. Constitutionial and Legislative Restrictionts National constitutions often contain specific provisions concerning the infra- structure sectors, notably railways, telecommunications, and electric power (see table 7.2). Such provisions fall mainly into five categories. Some constitu- tions preclude any private ownership or operation of infrastructure sectors. Others enable the legislator to reserve certain activities to the public sector but do not spell out which ones. A third class of provisions does not allow the transfer of control over specific infrastructure sectors or enterprises to the pri- vate sector, while permitting noncontrolling private shareholdings. In a fourth group of countries, the constitution reserves these sectors to the state but does not prohibit the government from granting concessions to the private sector. A fifth type limits (or excludes) foreign participation in infrastructure sectors. Similar restrictions are sometimes found in laws or subordinate instru- ments.72 For example, although the Turkish constitution authorizes the 71. One would have to check, in particular, whether the right to operate is limited in time and, if so, what happens at the end of the prescribed concession or license term if it is not renewed (return of the sector assets to the public authority; sale to the new concession holder or licensee; free disposal by the company); the conditions that could lead to such failure to renew would have to be investigated, too. This information was not available for some of the country and sec- tor examples mentioned in table 7.1. 72. In Itah'y, four concessions have been granted to public or joint-venture companies under the telecommunications and postal services code, approved by I'residential Decree no. 156 of March 29, 1973. These concessions provide (article 4) that the public holding company [IP must hold a majority of the voting shares in each of the concession-holding companies. The creation of Tele- com Italia as a subsidiary of STET and the planned sector privatization require the amendment of these concession contracts (see Gioscia 1993). In Japan, the telecommunicati(ons law was amended in May 1992 to authorize participation by foreign investors in the capital of Nrr (up to 20) percent). U.S. legislation limits foreign participation in telecommunkation and air transport companies to 25 percent. Finally, Romania's enterprise restructuring law of luly 1990 prescribes that autonomous public-law units (rather than corporations) be set up in strategic sectors, including energy, postal services, and telecommunications; these units may, however, delegate the operation of those sec- tors to private companies under concession contracts. Prizvatizatioii of Inifrastructiure, 247 government to grant concessions, subject to approval by an administrative tribunal, the foreign investment law prescribed that foreigners may not hold concessions; this created serious problems for the government when it attempted to privatize the power and telephone companies. The restriction was abolished by the 1994 privatization law. In Indonesia, the telecommu- nications law authorizes private participation in the sector, but states that, with respect to basic services (local, long-distance, and international com- munications), only companies in which the public operator is a shareholder can be given a license. That is, the dominant operator is required by law to be a shareholder of its potential competitors, hardly a situation that is likely to foster sound competition (see article 12 of Indonesia's Law no. 3 of 1989 on telecommunications). Until May 1995, Mexican law prohibited foreign investment in the transportation, storage, and distribution of natural gas. Until August 1995, Italian law required that airports be operated by public or public-sector-controlled enterprises. Although restrictions on infrastructure privatization usually derive from constitutions or laws, Uruguay provides an interesting exception: it held a popular referendum on December 13, 1992, which led to suspension of part of the October 1991 privatization law, particularly the provisions authoriz- ing privatization of ANTEL, the teleplhone company. Legislation for InfrastructureL Privatization Only in rare cases are large infrastructure sectors or companies privatized without special legislation or regulations. Indeed, telecommunications, elec- tricity, gas, water, and transport privatizations are usually the subject of spe- cific legislation, which may take the form of sector- or enterprise-specific privatization laws or amendments to existinig laws.73 In addition, some countries have enacted cross-sectoral concessioni or BOT laws to govern the way in which concessions can be awarded to private operators.74 Whereas the industrial and commercial sectors lendc themselves to an omnibus priva- tization law, infrastructure sector privatizations generally demand specific provisions dealing with market structure, competition, and regulation, as well as provisions enabling the privatization. 73. See tile examples cited in the appendix. M'lost of Argentina's large infrastructure compa- nies, for instance, were privatized pursuant to specifih privatization laws, with the notable exception oif ENTFL, the telecommunications company; that privatization was governed by pro- visions of the state reform law of August 1948 and bv a series of decrees, most of which were specific to the telecommunications sector. 74. See, for example, the concession laws of Albanio ( 1995), Brazil (1995), Bulgaria (1995), Chile (1988, 1991), Colomibia (1993), Djibouti (1989). Hungary (1991), the Kyrgyz Republic (1992), Paniama (1986), 'eru (1991, 1996), and Turkev (19)8,1932)); the Tlai Royal Act on private participation in state affairs (1992); the Bol legislation 0( the P'hilippines (1990)), Turkey (1994), and Viet Nam (199.3); and the French law on transparency and preventionl of corrtuption in eco- nomic activities and public procedures (Ioi S,a)iit ot 1 9'0 I. Table 7.2 Constitutional Restrictions on Infrastructure Privatization RestrictioL Coutntry and sector Example No private ownership Germany; post and tele- Article 87 of the German constitution (concerning areas of direct federal administration) or operation communications provided that post and telecommunications were federal government undertakings; this provision was amended on August 30,1994, and a new article 143b was added; the separation of the postal services from the telecommunications company and their priva- tization were authorized El Salvador; post and tele- Article 110 of the constitution of El Salvador refers to post and telecomnmunications as ser- communications vices that have to be provided by the state or autonomous public bodies Option to reserve Italy; public services and Article 43 of the Italian constitution provides, for instance, that certain activities or cate- activities to the monopolies gories of activities relating to essential public services, energy, or monopolies may, in the public sector public interest, be reserved by law to the public sector (or to worker or consumer associations) Public sector to retain German;v railwavs Article 87e of the German constitution (privatization of federal railways) stipulates that control railways must be run directly by the federal administration or bv federally owned or controlled companies Brazil; telecommunications Article 21 of the Brazilian constitution defines the powers of the federal government and prescribed (section 11) that telecommunications fall within the competence of the national authorities, which may contract their operation under concession to companies controlled by the government. The government control provision was removed by con- stitutional amendtmient 8 of August 15, 1995, to permit the privatization of Telebras, but a law was still required to implement this new provision State retain controls Mexico; railways, telecom- Article 28 of the Mexican constitution was amended in 1983 to authorize the government but private munications, and other to grant concessions; this provided the basis for the privatization of Telmex in 1990. It concessions are sectors was further amended in February 1995 to allow the award of concessions in the railway allowed sector to private investors Brazil; power, air transport, Section 12 of article 21 of the Brazilian constitution prescribes that the right to operate elec- railways, waterways, tric power, air transportation, railways, navigable waterways, interprovincial and inter- roads, ports national roads, and ports are reserved to the federal government, which may, however, delegate their operation via a concession, authorization, or permit. This provision deals more with allocation of federal and provincial responsibilities than with divisions between public and private responsibilities El Salvador; ports, railways, Article 120 of the Salvadoran constitution states that concessions granted for port (quays canals and other public or jetties), railways, canals, or other public works cannot be granted for more than 50 works years, and that said public works have to be returned to the state in perfect operating condition and without indemnity at the end of the term Limit on foreign Philippines; public utilities Section 11 of article 12 of the Philippine constitution reserves the operation of public utili- ownership or ties to Philippine citizens and to corporations or associations organized under Philip- operation pine law, provided that at least 60 percent of their capital is owned by Philippine citi- zens. It further provides that foreign participation in the governing body of any such corporation or association be limited to the foreign investor's proportionate share in the capital and that all the executive and managing officers be Philippine citizens. Act no. 108, known as the antidummy law, prohibits the use of front men or corporations to circumvent this constitutional restriction. The provision became an obstacle for the planned privatization of the Manila water system, although government officials and their advisers hoped to circumvent the problem by granting an operating concession without ownership rights over the sector assets (see Finanicial Timiies, 30 January 1996). In the case of the independent power plants, Executive Order 215 provided that this nationality requirement was not applicable to generating companies that sold their power to the National Power Corporation or another government distribution agency (see Independenzt Energy, November 1994, pp. 35-38). 250 Thfe Privatization Challenge The choice of legal instrument to define the new framework and rules governing the sector may depend largely on the country concerned, its tra- ditions, and any constraints (constitutional or other) that may exist with respect to the proposed reforms. Many investors feel more reassured when the key elements of the applicable regime are defined in a law as well as in privatization-related agreements. A law offers them the advantage of explicit political endorsement, which is not negligible, given the often politi- cally contentious nature of infrastructure privatization, while a contract offers them precise remedies and means for exercising their rights. Prior Restructuritig and Corporatization The privatization of large public infrastructure enterprises generally calls for prior restructuring measures, whether to reflect the new market struc- ture, to take account of public-law characteristics of the entity to be priva- tized, or to address other issues.75 The U.K. electricity law of 1989 illustrates this well. The first part of the law establishes the new sector framework, including sector structure, competition, and regulation. The second part deals with the reorganization of the power industry. It addresses the creation of new companies organized under company law,, whose shares are initially held by the government; transfer of the assets of the former public enter- prises to the new companies; winding up of the old entities and treatment of their debts and other obligations; management of the new companies before they are privatized; and other transitory provisions. It also includes provi- sions on the flotation of the power companies. The third part contains mis- cellaneous provisions concerning, for example, nuclear liabilities and pen- sion schemes. In Germany, the partial privatization of Deutsche Telekom in 1996 required, in addition to an amendment to the German constitution, radical restructuring of Deutsche Bundespost. It had to be split into three new com- panies responsible for telecommunications, postal services, and financial services; many other issues were settled, too, such as the responsibilities of the new companies for employee retirement (see the law of September 14, 1994, on reorganization of postal services and telecommunications). In summary, many issues are bound to arise, and have, as infrastructure enterprises are readied for privatization. These include not only the general enterprise-level preprivatization measures disctussed in chapter 4 (including financial, corporate, management, and labor restructuring) but also the enterprise restructuring measures needed to make the sector more competi- 75. The infrastructure service may have been organized a. a central administration agency or as a public-law enterprise, or as an enterprise governed by some public-law provisions. Corpora- tizing such an enterprise-that is, transforminig it into' a company organized under company law-before privatization can pose special problems, as discussed in chapter 4. See also chapter 1 and box 1.3 on the legal status of public enterprises. I'reprivatization labor and pension issues are discussed in chapter 3. Privatizat ioI of Inlfrastrufctuire 251 tive (including breakup of monopolistic enterprises and establishment of successor companies), as discussed in the section on market structure, com- petition, and divestiture in this chapter. Clhoice of Strategic Partners The placement of a controlling block of shares with strategic investors, usu- ally including an experienced operator, is a common technique in the priva- tization of infrastructure companies. The main purpose is to put the man- agement of the enterprise in the hands of companies with a proven track record in the sector. Many privatizations of telecommunications companies, for example, have been carried out through a two-tranche share issue: a first tranche is earmarked for strategic investors, followed by a second tranche offered to the general public. This was the formula planned by, for example, Argentina, Hungary, Mexico, Peru, and Venezuela. In four of these five cases, the private consortium acquired only a minority shareholding but nevertheless obtained control of the companv's management.76 Whereas Argentina, Mexico, Peru, and Venezuela have proceeded with public offer- ings, the Hungarian government in the end sold its second tranche to the strategic investors with an undertaking on their part to float part of that tranche at a later date.77 Similar two-stage privatizations are found in other infrastructure sectors also, including energy (Argentina and Peru, for exam- ple) and airlines.78 This two-stage approach has many advantages: it allows the selected investors to restructure the company and enhance its profitability by giving 76. This applies to MATAV (Hungary), where in a first stage the private consortium has had to accept more risk in holding only 3() percent of the shares and a proportionate number of board seats, while playing a more important role in the daV-to-diay runninig of the company (see the section above on telecommunications reform in Hungaryv; Telmex (Mexico), in which the gov- ernment sold the private consortium 20.4 percent of the capital, corresponding to 51 percent of the voting shares, that is, control of the company (the government had in fact restructured Telmex's capital, of which 44 percent was already in private hands, before the December 199(1 privatization, and only 40 percent of the shares carried voting rights; see Galal and others 1994, p. 419); Telefdnica del Peru, in which the strategic investors acquired 35 percent of the shares in 1994; and CANTV (Venezuela), in which the private consortium held 40 percent of the shares, but five out of nine seats on the board of directors (see the >ection on the privatization of C ANTV, above). In Argentina, however, the two winning consortia each held 6(0 percent of the shares in the acquired company from the onset. 77. See also the section on foreign legislation in chapter 3 and, in this chapter. note 47 and the section on telecommunications reform in Hungary. 78. Followinig an international competitive bid, Briti.h Airways was selected as strategic investor in Qantas, the Australian carrier, and acquired 25 percent of its stock. The Australian government sold its remaining shares (75 percent) on the Australian Stock Exchange in 1995. In August 1995, 50.1 percent of Ecuatoriana, the Ecuadorani airline, was sold to a consortium led by kASP (Brazil); in addition, the Ecuadoran law instructed the government to sell an additional 24.9 percent of its shares through a public offering within six months after the sale of the control block. 252 The Privatization Challenge them corporate control; it gives the government the opportunity to benefit from the upside potential through a higher sale price in a second tranche. It limits the amounts of funds investors need to raise up front and allows local investors to become shareholders of the privatized enterprise. This approach also presents some risks, however. Experience has shown that in quite a few cases the second-tranche public offering did not materialize as planned. Indeed, if the privatized company is doing well after the first tranche is sold to strategic investors, these investors often pressure the gov- ernment for a larger share, and the government itself may be tempted to keep its shares. If it is not doing well, a second tranche would probably have to be postponed for fear that the public offering would fail. The Bolivian capitalization program is a variation on the two-stage theme. Strategic investors are selected competitively to subscribe to a capital increase, and existing shares are transferred from the government to a trust fund that holds shares while the new mechanism for managing the citizens' pension funds is set up.79 In other cases, notably power companies in Argentina, Chile, and Germany, privatization took the form of sale of all or almost all the shares to strategic investors or groups of investors. New Zealand used a hybrid formula: follow- ing an international call for bids, all shares of Telecom New Zealand were sold in September 1990 to a U.S. consortium, with the stipulation that the consor- tium reduce its shareholding to a maximum of 49.9 percent within three or four years, partly by means of a public offering on the New Zealand market.80 The procedure for choosing a strategic investor in advance usually com- prises two stages: the stage of declaration of interest or prequalification, and the actual bidding stage. The selection rules normally include minimum selec- tion or prequalification criteria that allow the authorities to eliminate weak or unproven candidates, limit the number of eligible bidders, and ensure that the company selected has the necessary technical and financial resources to fulfill its commitments. Governments typically limit the number of prequalified bidders to three or four, because the costs associated with more bidders often exceed the benefits of additional competition. These include, for the bidders, the high cost of preparing bids, carrying out a rigorous due-diligence process, and negotiating the transaction; and, for the government, the cost of scarce time availability of key decisionmakers and officials and the escalating fees of 79. See box 5.1. The strategic investors selected in 1995 were S1 FT of Italy for the telecommu- nications company; VASI' of Brazil for the airline; three consortia headed by Dominion Energy, Energy Initiatives, and Constellation Energy of the United States, respectively, for the power generation companies; and, in early 1996, the Chilean company Cruz Blanca for the railways. 80. The sale in 1990 of all the shares of Telecom Corporation of New Zealand to Bell Atlantic and Ameritech brought in more than $5.25 billion (NZ$4.5 billion). The consortium also included New Zealand ihterests, which undertook to buy back nearly 10 percent of the shares by September 1993. By that date the two Baby Bells each held only 24.9 percent of the shares and the above-mentioned New Zealand interests only 3.3 percent. IPart of the balance was held by a U.S. group (5 percent) while the rest was distributed in the market following s05 in New Zealand, New York, London, and Sydney (see Donaldson 1094, pp. 255-56). Privatization of Infrastructurc 253 legal, financial, and other advisers. A high number of bidders reduces the like- lihood for each one of them of winning the bid, and hence reduces their will- ingness to invest in the preparation of a proposal. Table 7.3 summarizes the prequalification criteria used in the privatiza- tion of some telecommunications companies, chiefly in Latin America.81 In every case the seller clearly wanted to exclude, right from the start, any can- didate that did not combine great telecommunications experience and an excellent track record for performance and quality of service. Notable also is the alternative offered by Peru between the criterion of a minimum number of service lines and of minimum annual telecommunications revenues; this made it possible, for example, to avoid excluding companies like AT&T and MCI, which have great experience in long-distance and international ser- vices, but did not operate local telephone networks. Strict criteria of the type outlined in table 7.3 make it easier to dismiss less qualified firms with good political connections. Not all countries are as pre- cise as those in table 7.3 in their requirements, however. In selecting opera- tors for concession-type telecommunications contracts, Indonesia issued broad prequalification criteria, giving the selection committee discretion to decide which firms should be allowed to bid.82 Only the prequalified companies will be invited by the selling govern- ment to submit formal bids. After prequalification and before the issuance of formal bidding documents (or requests for proposals), governments may wish to consult the prequalified bidders on the proposed terms and condi- tions. The complexity of many infrastructure sectors, the lack of experience of privatizing governments, the uncertainty that may surround the existing facilities and operations, new technologies, and differing approaches and business methods of bidders are among the reasons to seek the input of bid- ders at this stage, as the governments of Argentina, Guinea, Jamaica, Peru, and Senegal, among others, have done for their infrastructure privatiza- tions. It is then up to the government and its advisers to decide how to take the suggestions of bidders into account in the final bidding documents. A broad range of final selection options are available, based at one extreme solely on the bid price and at the other on a combination of the bidder's tech- nical and financial proposals. Since the transaction relates to infrastructure services, the government cannot remain indifferent to the way the new own- ers plan to discharge public service obligations; an award to the highest bid- 81. As mentioned above, the decision to privatize AN TEI of Uruguay was submitted to a popu- lar referendum in December 1992, and was defeated. As a result, the company was not privatized. 82. The 1994 prequalification document stated that the applicant "must be able t) show thlat his group has the required technical capacity and capability, by providing evidence of their experi- ence with projects of similar complexity and size, as well as the availability of human resources and equipment." It also required evidence of financial strength. Although such criteria may sound overly vague and could have led to prequalificatioin of weak firms, most consortia prequal- ified by the Indonesian government included as a key member a major international telecommu- nications operator; all five contracts vvere awarded t. consortia with such strategic partners. 254 The Privatization Challenge Table 7.3 Prequalification Criteria for Privatization of Telecommunications Companies Peru Argentinia Hungary (Enitelperni Uruguay Veneziuela Critericoni (ENTEL) (MATAV) and CPT) (ANTEL) (CANTV) Number > 1 million > 2 millionb 2 2 million > 6 million of linesa Share of > 25' local digital exchanges Share of > 95V7, > 95 7c > 65% successful interna- tional calls Waiting > 85%. within ˇ90°YV within S2 billionb > $3 billiond > $5 billion revenue a. Installed or in service (or number of subscribers). b. Candidates had to meet either number-of-lines criterion or annual gross revenue criterion. c. Including domestic long-distance calls. d. Annual gross revenues from telecommunications services. Sources: Argentina: terms and conditions for privatization of the public telecommunications service, adopted by Decree no. 62/90 of January 5,199(0; Hu1ingary: PFI, April 16, 1993; Peru: merit and background prequalification document. July 1, 1993; Uruguay: Herrera 1993; Venezuela: public announcement in local press. Prizvntizationi of Infrastructure 255 der, irrespective of qualifications or business plan, would thus not be appro- priate. In one scenario, the buyer will be required to operate within a very strict framework laid down in the bidding documentation. This framework, which may be embodied in a concession contract or a schedule of conditions, for example, will generally be nonnegotiable to ensure that all bidders address a single, common set of specifications, the only variable being the bid price. Alternatively, the government could confine itself to enumerating the objectives to be achieved by the privatized company and leave it up to the bidders to determine how and under what financial conditions they pro- pose to achieve them. The first approach offers the advantage of transpar- ency and ease of appraisal, and the second that of greater flexibility and enhanced use of private-sector resources and solutions. Other variations abound; describing them all is beyond the scope of this work. Public Flotationi A number of large infrastructure companies have been privatized by means of a public flotation to the general public, effected in several tranches and without any prior or concomitant strategic share placement. Most of these were relatively well-run telecommunications companies of industrial coun- tries, such as Nippon Telegraph and Telephone (NTT), British Telecom (privatized in three tranches between 1984 and 1989), and Koninklijke PTT Nederland (KPN, two tranches in 1994 and 1995), as well as companies of dynamic developing countries, such as Chile, Malaysia, and Singapore.83 On the other hand, such attempts to privatize tend to be doomed unless an adequate regulatory framework is set up and the company is thoroughly prepared (or, where necessary, completelv restructured) for the flotation. Examples include Sui Northern in Pakistan (whose failed public flotation is discussed in box 7.4), Korea Telekom (out of the 10 percent offered in Febru- ary 1993, the Korean government found buyers for only 2 or 3 percent), and, to a lesser extent, FT Telkom in Indonesia.84 Similarly, in November 1994, the Greek government had to postpone the public offering of about 25 percent of OTE, the telephone company, in view of the weak interest on the part of international investors. Indeed, because OTE lagged technologi- 83. See box 7.2. In the power sector, 21 percent of Korea Electric Power was sold in 1989, and 23 percent of Tenaga Nasional Berhad (Malaysia) in 1992, through public flotations yielding about $ 2.1 billion and 51.2 billion, respective]v. In Chili. the full privatization of Chi]gener 1985-88 and Enersis 1985-87 was carried out through gradual sales to employees and pension funds and through the stock exchange (see Galal and others 1994). 84. In November 1995, the government had to cut the size and the price of its initial public offering down at the last minute in response to weak market interest. This was caused in part by the uncertainty surrounding the fate of the concession omtracts for the operation of the tele- communicationis networks in five of Indonesia's seven regions, which had only recently been awarded to international consortia. Because a large part of PT Telkom's cash flow and profits was expected to be generated by these concessions, uncertainty depressed the stock's prospects. Many observers attributed this flop to adxerse market conditions following the Mexican crisis Lcotonlclled on telt' f)lowo,v' p(age) 256 Thc Privatization Challenge cally, quality of service was mediocre, and the company would remain under public control, the Greek government would have had to accept a price below that of other recent telecommunication privatizations.85 Governments that privatize their infrastructure companies in several tranches typically do so in the hope that the later tranches will bring in higher receipts, reflecting performance improvements achieved by the new shareholders and better prospects for returns on investments. The chances that such a strategy will prove successful, however, depend in large measure on changes in the management and running of the company. Out of all the public flotations mentioned in this section, only the BT and KPN share offer- ings and the Chilean power privatizations have led to the transfer of corpo- rate control from the public to the private sector; they were also the most suc- cessful public flotations of this group. The mere flotation of a minority block on the stock exchange without transfer of control of the company to the new private shareholders is unlikely to substantially improve performance. Goldent Shares The U.K. privatizations have, as a rule, used the "golden share" technique. The creation of this special share was expressly provided for in the statutes of the company to be privatized, which had been amended before privatization (see also the section on golden shares in chapter 5). Generally speaking, a golden share gives the government the right to intervene to block changes in corporate control, takeovers, or foreign participations, as it did in the cases of Cable & Wireless, British Telecom, British Gas, British Airways, and BAA, for example.86 For these, and for power generating and transmission companies, (continucld) of December 1994 and a flooding of telecommunications issues on international markets, but these were known and already discounted factors. Another factor contributing to this problem- atic i'0 was the institutional arrangements for the flotation, in particular the excessive number of global coordinators and financial advisers involved in the transaction; the crowd included four foreign global coordinators and four Indonesian ones, as well as two advisers. 85. See Iouoia of Comne rce, 9 November 1994. An earlier attempt in 1993 to place 35 percent of OTF shares with strategic investors and 14 percent with the public was blocked by union opposition. A public share offering of 8 percent finally took place in March 1996, raising about $400 million. See also note 53 in chapter 3. 86. The 1984 prospectus for the sale of shares of Briish Telecommunications Plc described the rights attached to the golden share in the following terms: to attend and speak at shareholder meetings; to appoint up to two directors with the right to vote on issues of concern to the govern- ment; no right to share in the company's capital or profits; and repurchase value of one pound sterling. Similar provisions appear in the 1988 prospectLs for British Gas Plc, except for the right to appoint directors; in addition, the government's prior writteni approval must be obtained for the amendment of some provisions of the company's articles of association, particularly the one prohibiting any person from holding more than 15 percent of the company's capital. The 1987 prospectus for British Airways Plc describes how the golden shares will limit the right of foreign- ers to acquire shares in the company, because foreign conitrol co uld lead to loss of the right to oper- ate certain international routes. Finally, in the case of British Airports Authority, the sale of an air- port by the coompaniy (privatized in 1986) is subject to approvol by the holder of the golden share. Prizvatization of hiffrastructure 257 the golden share has no expiration date. In other instances, it expired on a specified date: December 31, 1994, for the regional water distribution compa- nies, for example, and March 31, 1995, for the regional electricity distribution companies. The flurry of takeover activity following the lapse of the golden share in the power and water distribution sectors attests to the strength of the rights given to the government by the golden share.87 The main motivation for indefinite golden shares was often national security, whereas fixed-term golden shares were intended primarily to allow time (about five years) for the management of the privatized companies to restructure their company without having to worry about possible takeovcrs. In New Zealand, the articles of Air New Zealand and Telecom were simi- larly amended to allow the government to retain a "Kiwi share" conferring special rights. The articles of Telekom Malaysia provide for a golden share entitling the government to oppose any decision that substantially affects the composition of the company's shareholding. In Italy, a decree-law intro- duces a provision into the statutes of public service companies granting the government a special share entitling it to oppose the acquisition or buildup by any person (or group) of shares exceeding 10 percent of the corporate capital of the company (or such lower percentage as may be determined by decree of the minister of the treasury).88 Other countries have also utilized this technique, including Belgium for the privatization of the gas distribu- tion company (see Royal Decree of June 16,1994, reserving a golden share in Distrigaz for the government) and Hungary for the privatization of power and gas companies.89 Where golden shares are needed, they should be defined in the narrowest sense possible by limiting the scope of extraordinary rights they confer to the government to what is strictly necessary, and by restricting the duration of those rights. Golden shares-especially where they are held by govern- ments without solid, credible track records-otherwise unduly restrict privatization and reduce privatization benefits, whether in the form of lower proceeds or less-efficient service providers. 87. This included, in the water sector, a $1.3 billion takeover of Nortlhumbrian Water by Lyon- naise des Eaux in 1995 and the takeover of Southern WVater by Scottish Power in 1996 (see note 117). In the electricitv distribution sector, 1995 saw the $3.8 billion takeover of Eastern Elec- tric by the Hanson conglomerate, the $1.7 billion takeover of Manweb by Scottish Power (an integrated utility), the $1.7 billion takeover of South Western Electric by Southern Company of the United States, the $2.4 billion takeover of power distributor Seeboard by Central & South West of the United States, the $1.3 billion takeover of South Wales Electricity by Welsh Water (now called Hyder), the $2.5 billion acquisition of Norweb by Northwest Water (since renamed United Utilities), as well as various other bids (see also above notes 25 and 31 and Financial Times, 13-14 April 1996). 88. See Decree-Law no. 389 of September 27, 1993 3 which had to be conifirmed by means of an ordinary law within 60 days after its promulgation. 89. In Hungary, the golden shares in the privatized utilities were transferred after privatiza- tion by the privatization agency to the ministry for industry and trade, which will exercise the related rights on behalf of the government (see Prizatisaliion Intetiationat(, March 1996, p. 21). 258 The Privatizatioll Challenge The Regulatory Framework As noted before, the privatization of infrastructure companies offers a unique opportunity to introduce reforms in market structure, competition, and regulation. The discussion of regulation in this section will focus on important regulatory issues that arise in the context of privatization. A brief review of who should be regulated for what activities will be followed by discussions of specific regulatory instruments, consistency between regula- tory reform and privatization, and regulatory institutions.90 Objectives of Regulatiotn Public service regulation may have multiple objectives. These include the promotion of efficiency; the satisfaction of demand, notably by promoting investment; the protection of consumers and users, in particular, against monopolistic or other abuses by the operator(s); the protection or even pro- motion of competition, including protection of those competing with a dom- inant operator; the prevention of discrimination; and the protection of inves- tors against opportunistic government action. The primary purpose of economic regulation is to make up for the shortcomings of the marketplace. It should be distinguished from technical, safety, environmental, and other forms of regulation, although in practice these may often be intertwined. The regulatory focus in many OECD countries has traditionally been on prices or profits, the objective being to limit monopoly profits through regu- lation of price or rate of return, which is not an unreasonable objective in mature markets. This approach was often relatively static, however, without taking due account of dynamic efficiencies and with few or no built-in incentives for efficiency. The U.K. privatization experience has vividly illus- trated the extent to which public monopolies lead to vast inefficiencies; the size of the productivity enhancements obtained by allowing the privatized companies to keep the bulk of their cost savings has been surprisingly large (see the section below on the tariff regime). The objectives of regulation ought to be different in most developing and transition countries, though. The level of profits of the private operator should be only a second order of importance. The main challenge is to meet existing and latent demand for services. Hence, the primary objective of regulation should be to ensure that the operators (public or private) meet minimum per- formance standards, leading to an accelerated closing of the gap between sup- ply and demand. Consumers in most of these countries prefer a high-priced service to no service at all. Furthermore, distributional objectives or concerns can, if needed, be addressed through subsidies or other mechanisms. 90. For a more in-depth treatment of regulatory issues, see Beesley and Littlechild 1989; Train 1991; Veljanovski 1991, 1993; Beesley 1992; Laffont and Firole 1993; Levy and Spiller 1993; Lip- worth 1993; Bishop, Kay, and Mayer 1994; Armstrong, (Cowx\',l and Vickers 1994; Laffont 1994; Tenenbaum 1996. Privatization of Infrastrulctuire 259 Depending on the objectives to be met, regulation may focus on tariff pol- icy; direct and indirect subsidies; access to bottleneck facilities, including interconnection or network access by third parties; investment levels; per- formance targets; service quality and continuity; and so on. Most countries use a range of regulatory instruments (including specific stipulations in con- cession agreements or licenses and general rules) to govern the award of licenses, the oversight of the licensees, and, more generally, the rights and obligations of users, competitors, and other parties. Enterprises Suibject to Reguilation Economic activities can be regulated in different ways. Under public owner- ship, which is the most intrusive form of regulation, the state takes over the operation of the activity, enterprise, or sector. Under private ownership, the state regulates private economic agents tlirough various legal instruments (laws, regulations, licenses, contracts, and so on). Recourse to monopoly public enterprises has not proven to be a very successful form of regulation, largely because of principal-agent problems. Where a public enterprise operates in a competitive sector, however-even if it is in a monopolistic segment of that sector-its public nature should in no way exempt it from the same arms-length regulation that applies to private enterprises. Many have argued that where a monopolv is to be maintained, whether because the activity is a natural monopoly (a shrinking variety) or for some other reason, a public monopoly is in itself better than a private monopoly. Yet neither this nor the contrary thesis has ever been proven empirically, although limited attempts have been made.Y' Some private monopolies, such as the Philippines telecommunications company until recently, are notoriously inefficient, while others, such as the predivestiture AT&T, are relatively efficient.92 Even a private monopoly operating without oversight by a regulator may sometimes be preferable to the former public monopoly or to a (poorly) regulated private monopoly.93 In fact, the efficiency and 91. For a study confirming the doiminant view that private enterprises tend to be more effi- cient, see, for example, Galal and others 1994, which covers primarily infrastructure companies (see also box 1 and note 7 in the introduction to this book). For a contrary view, see Bhatta- charyva, Parker, and Raffiee 1994 who claim that their *conometric study of the cost behavior of 225 public and 32 private water utilities in the United States provides "evidence that public water utilities are more efficient than private utilities on average, but are more widely dispersed between best and worst practice." 92. The liberalization of the Philippine telecommunications market that started in the early 1991)s has resulted in a drop in P[LOr's market shar' from about 97 percent in 1991 to about 80 per- cent five years later. "Yet the sector is now growing so rapidly that l.l I's business is set to triple, from about Im telephone lines in 1994 to an estimated 3m by 2000" (Thc Economnist, 11 May 1996). Interestingly, deregulation and the resulting growth prospects have made it easier for P'LI to attract foreign investment than was the case in the days the company was protected bya monop- oly. See also Levy and Spiller 1993. On AT&r, see note 5S in this chapter. 93. See Roth 1987, p. 91, in which the author refers toa 1959 study that found that some unregu- lated private power companies in Latin America performed better than the regulated companies. 260 The Privatization Challenge behavior of a monopolistic enterprise, whether private or public, depends much on the framework in which it operates, and especially on the exist- ence of performance-enhancing incentives and penalties. Regulation should be imposed on infrastructure service providers (public or private) where a market failure exists and the benefits of regulation exceed its costs. SOEs should thus be subject, by and large, to the same regulatory frame- work as private enterprises.94 This becomes even more important when most infrastructure sectors are being opened to competition and new entry. If a sec- tor is opened up to new entry but the incumbent SOF retains monopoly power in one or more market segments (large or small), the SOE will have to interact or compete with other operators. This should be done on a level playing field, with a common set of rules, regulations, and enforcement mechanisms. Activities Subject to Regulation The scope of regulatory intervention is largely determined by market struc- ture and competition policy, which in turn depend on the specific character- istics of the sector and country concerned. While some activities or sector segments will be opened up to competition, others may remain monopolis- tic and will normally need to be regulated (see World Bank 1994c; Kessides 1993). Competitive activities will often be governed by the competition laws examined in chapter 3. In the transition from monopoly to competition, however, an active regulator may be needed to nurture nascent competition (maybe even by tilting the playing field in favor of new entrants) and to ensure that the (publicly or privately owned) dominant operator does not abuse its position. Where some activities of a privatized company are competitive and others are subject to regulation, the competitive activities are sometimes covered by the regulatory framework established for the monopoly activity This ensures, among other things, that the regulated activities do not subsidize the unregulated ones. Award of Concessions and Licenses Privatization of large infrastructure companies typically requires the issuance by the government or a regulator of concessions, franchises, licenses, authori- zations, or permits to investors. These terms for the authority to operate are often used interchangeably, though they may have specific and different mean- ings in given countries or legal systems (on licenses and concessions, see also the section above on techniques for infrastructure privatization). The most 94. France (the general directorate for regulation) and Germany have established regulatory frameworks for the oversight of their monopolistic soEs, but more as a prelude to demonopoli- zation of the sector than as a way to deal with any perceived shortcomings of the SOE. In Austra- lia, Chile, New Zealand, and other countries, corporatization ot SOEs has been accompanied by arms-length regulation of the corporatized enterprises. Privatizationi of Infrastructure 261 valuable asset offered for sale in an infrastructure privatization is not so much the physical infrastructure itself as the right to provide a service.95 The condi- tions governing the award of the concession or license may be prescribed either in the privatization law, a concession law, or the regulations governing access to these sectors, where such regulations already exist. They will normally be detailed in the bidding documentation, where such licenses are awarded com- petitively. The award of a privatization contract following a bidding process should automatically include the grant of the operating license; indeed, owner- ship of sector assets without the authorization to provide the service would be pretty much worthless (see also the section below on the powers of regulators). Similarly, the right granted by a license or concession to provide a public service sometimes requires access to other state-controlled resources or assets, which will need to be awarded as part of the license or concession or separately. This is especially so for the spectrum needed for wireless commu- nications. Recent auctions held by the FCC in the United States show how valuable these spectrum rights are: the treasury raised over $1 billion in two narrow-band PCS (personal communications services) auctions and close to $18 billion in two broad-band PCS ones, organized as simultaneous, multiple- round auctions between 1994 and 1996.96 The highest bidders got an operat- ing license, as well as exclusive rights over a specific part of the radio spec- trum, in their geographic area. Although no phvsical assets were transferred, this privatization of a portion of the airwaves counts among the largest privatization operations worldwide. Before these PCS auctions, licenses were awarded free of charge following an often lengthy administrative procedure in which firms competed for licenses and the embedded rents; firms that obtained licenses often sold them later at a handsome profit. New EU rules call for free entry in telecommunications, unless there are resource constraints, spectrum in particular, in which case individual licenses (in addition to the operator's genera] telecommunications license) will be required to get the right to the spectrum. Other examples of access rights that need to be guaranteed to give a licensee the full benefit of the license include the award of airport slots, which are necessary complements to airline routes, and, more generally, third-party access or interconnection rights in network-type sectors. 95. In some instances, however, including some port or railway privatizations, land available for development may be more valuable than the infrastructure business itself. 96. Narrow-band licenses are used for paging, data services, and similar applications, while broad-band licenses are suitable for cellular services. The first broad-band auction ended in March 1995 following 112 rounds of bidding for 99 rcs licenses and raised $7 billion; three pio- neer licenses had been awarded earlier without competition for about $700 million. The second broad-band auction ended in May 1996 following 184 rounds of bidding and yielded the trea- sury over $10 billion for 493 rcs licenses covering all the country in smaller geographic areas; they included preferential payment terms for small businesses, which had to pay only 10 per- cent down with the rest due over a ten-year period at a low treasury bill rate; the estimated dis- count embedded in these terms was 40 to 60 percent trom cash terms. See Waslington Post, 17 February 1996 and 7 May 1996; Cramton 1995. 262 The Privatizaztiooi Challenge Con tent of Concessions or Licenses The concession (or license) entitles the holder to provide a public service under defined terms and conditions, including price. The terms of a conces- sion should define the rights and obligations of the concessionaire (or lic- ensee) and limit the possibility of arbitrary or political interference in the day-to-day management of the enterprise. They should clearly specify the scope of the license (services covered, time period, and so on).97 In view of the chronic inefficiency and endemic underinvestment that characterizes infrastructure sectors in many countries, licenses will often require perfor- mance improvements as well as specific investment levels (see the section above on private capital requirements). By and large, though, the concession (or license) should focus on the results to be achieved by the service pro- vider and on the incentives and sanctions linked to the achievement of those results; the means of achieving the results are generally better left to the judgment of the private operator. The concession (or license) will also reflect (or even determine) the degree of competition in the sector and the rules governing such competition, including in many cases the scope of exclusivity rights, if any (see the sec- tion above on increasing competition in telecommunications). Thiird-party occess. In many infrastructure sectors, particularly in network industries, the most important part of the licensing terms and conditions may pertain to third-party access and interconnection. A major consideration in opting for unbundling the gas or power sector (through vertical separation of production, transmission, and distribution), for instance, is to simplify the regulators' task and the definition and enforcement of interconnection terms and conditions.98 In the United Kingdom, the complexity of third-party access and interconnection issues and their importance to create competitive markets were underestimated at the design stage of the power, gas, and tele- communications privatizations; they remain one of the most difficult and controversial aspects of the regulatory system. In most telecommunications reform programs the dominant operator loses its monopoly but radical unbundling does not usually take place. Fol- lowing liberalization the dominant operator is at the same time operator of the network and main competitor of would-be entrants asking for intercon- 97. See, for example, article 23 of the Brazilian concession law of 1995, which outlines the essential clauses to be included in concession contracts. 98. See the special issue of Oil & Gas-Law aind Tihxatioh Rec.owr, 13 (1), January 1995, on third- party access in the EL power and gas sectors. See also European Council Directive no. 91/440/ EEC of July 29, 1991, on community railway development, which includes provisions for third- party access to railway infrastructure; and European Commissioni decisions in Sealink/B&I-1loly- head] (November 8, 1988) on third-party access to port facilities, and l.eodoir Luropean/Sabcaia (OJ 1988 L317/47) on access to a computerized reservation system for air transport services. See also Laffont 1994. Privafizationz of Inifrastrinctn re 263 nection. In this context, how will new entrants be able to gain fair access to the network? Technical and financial issues are at the core of this question and must be addressed. Important technical matters include the specific locations where competi- tors can interconnect, the signalization scheme used to allow the interface between operators, the numbering plans (including the access codes given to various operators, the ease with which consumers can switch between carriers, and the portability of telephone numbers), and so on. The financial conditions of interconnection are also crucial. Access to the network or to bottleneck facilities should niormally be granted on terms and conditions not less favorable than those that apply for internal use. Intercon- nection prices may also include a public service fee or surcharge, so that other operators contribute financially to the public service obligations imposed on the dominant carrier or local monopoly; this has been the case in the United States, where interconnection charges billed to long-distance companies subsidize local services provided by the Baby Bells (see note 59 above). In Mexico, the negotiations between Telmex and new entrants on these issues illustrate the difficulty of this process and its huge economic and financial stakes.99 So do the many appeals filed by operators around the world against the access charges cf the doiminant oiperator.111t Reguiloit rln provisionis. Concessions and licenses are regulatory instru- ments; they set a priori the key regulatorv parameters for the sector. They may be revoked if the licensee fails to meet its obligations. They provide for oversight, by the public administration or a regulatory agency, of the way in 99. Terms and conditions of interconnection between TImex and the new entrants were to be negotiated between these parties in preparation of the liberalizati on of basic services in January 1997. In view of the impasse in negotiation, it was op to the Mexican ministry of communica- tions to set the interconnection conditiois. Cost was the omost critical point in these discussions. Telmex had proposed a connecti(n fee of 14.7 U S. cents per minute, while competitors initially suggested a fee between 1 and 1.5 cents. The ministry finally settled on an average of 5.32 cents in 1997, 4.69 cents in 1998, and 3.15 cents thereafter. Executives from competing firms feared that, as thisis an average for three different types ot interconnection (local, long distance in, and long distance out), Telmex would keep international rates significantly higher and local rates lower (see /romiat of Commerce, 25 April 1996 and 29 April 1996). The delays in coming to an agreement are to a large extent a result of the governnmient's failure to adopt binding interc(n- nection principles and rules, as well as of the absence ot a regulator whio could impose a bind- ing settlement oin the parties. The establishment of a new federal telecommunications commis- sion was planniied for late 199h. 100. In France, for example, following a complainit submitted to the director general of postal services and telecommunications (It11;1 ) by FR (,mi affiliate of the Compagnie G&nOrale des Faux wxhicih became the second operator of mobile telephones) against the interconnectioni charges billed by France Telecom, the minister of po,stal services and telecommunications ruled in june 1994 in favor of the private operator, compelling the public operator to reduce its public network access charges and also its line lease lharges by 41 to 62 percenlt (Lc, Noocll Ece,iomistc, 949, 1n June 1994, p. 45). See allso note 118 for a U.K. example. 264 The Privatization Challenge Box 7.3 Basic Features of a Telecommunications License or Concession The clauses of concessions or licenses varv substantially, of course, depending on the scope of services covered, the intensity of competition, and other coun- try and sector characteristics, but they do have some common features. The fol- lowing are typically found in concessions or licenses granted to the operator of a public telecommunications network. * Definition of the network to whichi the concession or license applies, clearly distinguishing betweeni this network and, where appropriate, other public networks, private networks, and terminal equipment * Definition of the services covered: for example, local exchange, long distance and international communications, wireless services (cellular or other), trunk radio, paging, Internet access, satellite communications, packet-switched data network, leased lines, private networks, telex, telegram, and so on * Definition of scope and duration of exclusivity, where exclusivity is granted * Qualitative and quantitative performance obligations, namely geographic coverage, nunmber of new connections, number of public telephones, maxi- mum percentage of faults tolerated, maximum repair time, and so on * Obligation to publish tariffs and to meet consumer demand on a nondis- criminatory basis * Social or public service obligations, such as free emergency numbers, infor- mation services, and services to the physically handicapped and hearing impaired * Prohibition of anticompetitive practices, such as linked sales, cross-subsidies, discrimination, and selection of subcontractors without prior public call for bids * Obligation to connect approved terminal equipment without discrimination and rules concerning the supply of equipment manufactured by the operator * Obligation to grant connection to other networks (interconnection) on rea- sonable conditions; formula to calculate the interconnection tariff, taking into account the cost of such service and, where applicable, a contribution to help finance the main operator's public service obligations * Tariffs and adjustment formulas, including determination of the baskets of services to which they apply * Code of good practice with respect to suppliers and consumers, including rules of confidentiality * Billing, metering, and recordkeeping requirements * Prohibition on dealing with a single foreign carrier when several operators are authorized to provide international services * Rules concerning the allocation, change, and portability of telephone numbers * Rights of way; use of or access to public or private properties allowing the operator to install and maintain cables and equipment; application of emi- nent domain rules, wvhere applicable * Payment by the operator of license or concessioni fees * Disclosure requirements; information to be provided to the regulatory agency; right of agency to perform controls as needed, including onsite verifications * Accounting and auditing rules and regulations Priratization iof Intfrastructutrc 265 * Award to operator of necessary permits, authorizations, and so on * Rules on assignment of concession or licenses, including (where applicable) limitations on foreign investment * Rules concerning the investigation of complaints * Action to be taken in the event of service interruptions or of default of the operator * Operator's responsibility and liability * Guarantees, warranties, performance bonds, and so on * Penalties * Conditions pertaining to termination, revocation, amendment, and renewal of the license or concession. Source: Adapted from Smith and Staple 1994, p. t8, who based their checklist primarily on the licenses or concessions of the dominant operating companies in the United Kiing- dom (B13), Mexico (Telmex), and Sri Lanka (L5Ir). The first tvo were already private, while sLr was still an SOC (it is being prepared for privati/ation). which the company is fulfilling its obligations, and they specify how rights and obligations may be amended to take accotunlt of new circumstances.1] Box 7.3 lists common clauses found in basic telecommunications conces- sions and licenses. Similar clauses may be found in concessions or licenses in other infrastructure sectors and for other telecommunications services. Depending on specific legal and administrative traditions, some of these clauses may be found in related agreements or instruments rather than in the license or concession itself; additional itemns will invariably be covered by the license or concession. Tariff Regimte The pricing system, particularly the tariffs and their adjustment formula, is typically the cornerstone of the regulatory mechanism. It will determine the returns investors can expect and the incentives they may receive to provide a quality service. This section deals primarilv wvith the tariff level and for- mula. Often of equal importance will be who will apply this tariff regime, what discretionary powers are given in this context, and how such discre- tion will be managed (see the section belotv on regulatory institutions). Most infrastructure sectors are not as monolithic as was once thought (see the section on market structure, competition, and divestiture). Some activities 101 See, in particular, the theories of Inprccozet circumstances unforeseen) ad ad foit prin Ice (right of government to act unilaterally) in French concession law. Article 12 of the 1'hilippine constitution limits franchise or license rights to a maxinium of St years and allows congress to unilaterally amend or repeal such au thorizalions xs hen lhe common good so requires. See also articles 14 thrOugh 17 of Colormbian Law no. 80) of 1993 on contracts with the state, which pro- vide for unilateral termination and modification ,f stale contracts, including concession con- tracts. See also no1te 68 above. 266 The Privatization Clhallenigte in a sector may be of a competitive nature, whereas others remain fundamen- tally monopolistic. Normally, only the prices of inoncompetitive services should be regulated, and restrictions should be imposed prohibiting an enter- prise from subsidizing its competitive activities with revenues from its regu- lated activities.)02 The introduction of separate cost accounting is often a first step in this direction.,113 The chosen tariff formula must be one that can be effectively applied by the competent authority. This presupposes, in particular, that the informa- tion needed by the authority to perform its functioin is available, that the authority can force the regulated enterprises to disclose such information, and that it can check its accuracy and reliability. The degree of complexity of the price adjustment mechanism should thus take account of the regulatory agency's technical resources and capacity. In other words, the regulatory mechanism should be tailored to the specific characteristics and constraints of the country and sector concerned. RPI-X. The following paragraphs explore the tariff formula adopted by the U.K. government in most of its infrastructture privatizations (see Beesley and Littlechild 1989; Lipworth 1993). That formula merits special attention for its innovative nature, for its key role in the U.K. infrastructure privatiza- tion process, and for the considerable influence it has had on regulatory thinking and on the design of regulatory schemes in privatizing countries. The U.K. formula-better known as the price cap or RPI-X formula-sets a cap or ceiling on the authorized periodic price adjustment of a specified basket of services at RPI-X, where RPI represents the inflation rate as mea- sured by the retail price index and X the productivity factor initially stipu- lated in the privatization prospectus. In the case of British Telecom, for example, the value of X was set originally (1984) at 3 percent, then raised by OFTEI. (the regulator) to 4.5 percent in 1989 (at the end of the initial five-year period prescribed in the license), 6.25 percent in 1991, and 7.5 percent in 1993.104 BT has thus been compelled by the regulator to pass more and more 102. 83"s licensecontains clauses prohibiting Bi from using its profits from regulated services to subsidize unregulated activities, such as the sale of telecommunications equipmenit. The pur- pose is to prevent 11 Ifrom competing unfairly with other equippment suppliers. The terms of the license similarly prohibit BT from charging third parties (competitors) a higher price for access or other intermediate services than it costs Bi to provide for its own services. 103. FU regulation no. 1893/91 (modifying regulation no. li 91 /69 dealing with public service obligations in the transport sector), for example, establishes the principle of suppression of pub- lic service obligations and their replacement with c ontracts niegotiated by the government and the transport company in instances where nonprofitable transport services are to be maintained for public policy reasons; it further requires separate accounting for such public service activities. 104. Indexing is to a basket of services, which was modified at each formula adjustment. Btt is free to alter the prices included in this basket, provided that the price of the overall basket, as a (weighted) average, declines in real terms at least by the value of X, the set productivity factor. Some services not included in thebasket are subject to other productivity factors (different value of X), while the price of yet another category of services is freely set by the operator. The percent- age of BrVs receipts subject to price control rose from1 55 percent in 1984 to 80 percent in 1993. Privatizntioi of INfrastructiire 267 of its productivity gains on to subscribers. Since the 1991 adjustment, the price cap formula has led to annual reductions not only in real prices but also in nominal prices. At the time of the first adjustment in 1989, BT agreed that the next review would be held in 1993, that is, a year earlier than initially planned, with a possible mid-term review in 1991 to reflect anv exceptional circumstances outside BT's control. The 1991 interim adjustment did take place to take account of, in particular, accelerated technological developments in the tele- communications sector. The value assigned to a productivity factor should be neither too high (to avoid discouraging potential buyers or the investments they may be pre- pared to make, or deterring the entry of new competitors) nor too low (to avoid either excessively low productivity gainis or excessive profits, high consumer prices, and reduced competitiveness of the national economy). Although the productivity adjustment should normally be negative (posi- tive productivity factor, preceded by a minus sign), it may be outweighed by some other factor, such as the extra cost of capital required when large new investments have to be made, as was require.l in the U.K. water sector to bring standards up to EU norms.l105 Choosing the level of productivity gains to be achieved is particularly dif- ficult at the time of privatization, because there is not enough information available to ascertain the productivity gains the privatized enterprise can obtain. The U.K. government in fact underestimated the inefficiency of the infrastructure SOEs to be privatized, or, more precisely, the potential produc- tivity gains the privatized companies would be able to achieve. Because it limited competition in the market (see the section above on competition, market structure, and divestiture) and did not create competition for the market, that is, for the right to buy the enterprises to be privatized, the gov- ernment was not able to extract the monopolv rents that remained in these sectors at privatization. Where competition cannot be introduced in the mar- ket, the best way to extract these rents is to use a competitive mechanism for the sale of the enterprise or of its shares, leaving it up to the bidders or to the marketplace to assess potential productivity gains. The first tranche of IBT was, however, sold in November 1984 by means of a public offering of three billion shares (50.2 percent of the capital), at the fixed price of E1.30 per share; the offer was three times oversubscribed. A similar mechanism was used in most U.K. infrastructure privatizations that followed. The factor X was scheduled to be revalued every four to five years, depending on the specific license provisions in each sector. The regulator may, however, decide at any time to amend the terms of a license, including the value of X, with the agreement of the regulated enterprise. In the event IOS. The formula used in the water privatization is referred to as RP-+K, where K represents the increase in the tariff needed in real terms to finance the sector's huge investment program. See the section above on water, and note 20. 268 The Privatization Challenge that the privatized company (BT, for example) opposes this adjustment, the matter may be submitted to the Monopolies and Mergers Commission; if the MMC declares the regulated enterprise to have acted contrary to the public interest, and if the minister of industry and trade does not object, the regula- tor may amend the license (see sections 12-15 of the telecommunications act of 1984; see also notes 25, 36, and 68 in this chapter). In the United Kingdom, a certain amount of bargaining can take place between regulator and regulated enterprise concerning not just the value of X but also the degree of competition in the market, the conditions of inter- connection, the information to be furnished, and even the very survival of the enterprise as such, as the regulator can threaten to go to the MMC asking that the enterprise be split into smaller entities. By allowing the enterprise to keep the benefits of any cost reductions it achieves between two relatively distant adjustments, the price cap formula provides real efficiency incentives which tend to be higher than under rate- of-return regulation (even when taking regulatory lag into account). The periodicity of the X factor modification may, however, bring this formula closer to the rate-of-return formula. Indeed, as part of the preparatory ana- lysis leading to the setting of a new X value, the regulator will assess the enterprise's rate of return; an "excessive" rate of return will inevitably lead to a higher X factor (that is, lower permissible rate increases); the profitabil- ity of the enterprise is thereby reduced to a rate the regulator deems reason- able in light of information obtained from the capital markets (industry averages for rate of return on equity, bond yields, and so on) and other sources. Another difference between RPI-X and the rate-of-return formula is that the administrative burden of the former is lighter, because it is less depen- dent on information supplied by the regulated enterprise itself, requires less verification on the part of the regulator, and allows the regulator's discre- tionary interventions to be spaced more widely. Some argue, on the other hand, that the administrative burden of price caps may be higher rather than lower, because in the end regulators need to perform the same analysis as that required for rate-of-return regulation, and they must forecast produc- tivity improvements over the next four or five years. Price caps may be better suited to industries experiencing constant tech- nological change, where the regulated enterprise will be able to benefit from productivity and profitability gains generated by the accelerated introduc- tion of new technologies. It is still too early, however, to pass final judgment on the respective advantages and disadvantages of these formulas. But it is clear that the price-cap formula is not without shortcomings and risks. Tenenbaum, Lock, and Barker (1992, pp. 27-28) note three such risks: (a) the regulator may try to reduce tariffs if the companies post profits that are higher than expected, and thereby reduce the incentive to cut costs; (b) the regulated enterprises may try to increase their profits by lowering service quality; and (c) the formula may not provide the desired incentives to carry Privatization of Infrastructure 269 out new investments. In addition, price caps tend to expose investors to greater regulatory risk. These risks are amplified in developing or transition countries whose reg- ulatory organs may not have developed a solid reputation for independence and professionalism. The main risk in these cases is that investors may not be prepared to accept a discretionary adjustment of X that could lead to heavy losses, or they may consent to invest only if the expected yield is very high, enabling them to recoup investments before the first adjustment of the X factor. Any long-term private investment in these sectors will be condi- tional on the existence of a reasonable and credible price adjustment mecha- nism that limits the risk of "administrative expropriation." From this point of view, a four- or five-year lag between regulatory reviews of the formula tends to be preferable to discretionary annual price adjustments. Moreover, investors may seek protection from arbitrary revisions by having rules or principles included in the applicable regulation or license to guide such revisions; they may also ask for provisions in their contracts allowing them to go to arbitration in the event a regulatory decision significantly alters the terms of the license or the balance of the contract with adverse effect on the company. Excess tariffs. In most countries, the posting of extraordinary profits-prof- its much higher than risk-adjusted market yields-by enterprises that enjoy some degree of monopoly will usually be politically untenable over the long term, regardless of the applicable contractual or regulatory provisions. The row over the profits and the compensation packages of senior executives of privatized water and power companies in the United Kingdom provides a recent illustration. It also points to new directions in regulatory design, in particular toward formulas that allow efficiency improvements to be shared between the operator and the users, which might make large profits more palatable politically. In response to this heightened sensibility, some British water utilities decided in 1995 to use part of their profits to offer voluntary rebates to their customers. Finally, as pointed out earlier, excessive importance should not be attached to the level of prices in countries where the priority is to stimulate investment and network expansion. In these countries it may indeed be preferable to have relatively high tariffs. An enterprise could then self- finance a large part of its investment program, and contractual or regulatory mechanisms could compel it to reinvest the "excess" tariff in the sector to meet demand. Consistenicy betweenz Regulatory Reformn and Prii'atization The regulatory framework governing the activities of the privatized enterprise should be put into effect before or, at the latest, at privatization. Regulatory reform and privatization processes thus need to be closely coordinated. 270 The Privatizationi Challenge Impact of regulationi on potential investors. Before they can calculate the price they are prepared to offer, investors will want to know the regulatory system under which the company will be operating.1(6 They will also have to form a view on how this regime can be expected to evolve in the years ahead. To meet these objectives, it may be desirable to anchor the regulatory frame- work securely in a law, which would give it greater stability than an execu- tive instrument. In Venezuela, the lack of such a law has probably been a fac- tor in the relative instability of the regulatory system, as discussed above in the section on the privatization of the Venezuelan telecommunications oper- ator. The regulatory framework can be spelled out in a sector-specific priva- tization law, in a special regulatory law, or in the law organizing the sector. Key provisions can be further stabilized by inclusion in the privatization or concession contracts, which require the consent of the investors to be modi- fied. A tradeoff exists, however, between stability and flexibility. A rigid framework, legislative or contractual, may reduce uncertainty, but it may also entail a cost, because mistakes are harder to correct and evolving cir- cumstances harder to take into account. To reassure investors, reduce the risk premium they factor into every investment decision, and obtain the best possible price for the enterprise or activity to be privatized, the government may have to promise not to alter the regulatory system substantially, or at least not to do so to the detriment of the investors. To be effective, however, this commitment needs to be cred- ible. Credibility could be enhanced by provisions in the privatization agree- ments or the license allowing the company to automatically adjust its tariffs based on a given formula, or by an undertaking that the government will compensate the operator (through a subsidy or tax break, for example) for any negative impact that results from governmental rejection or delay of a contractually agreed tariff increase. Failing this, the promise is unlikely to be 106. "How much should regulators reveal about their plans for industries under their super- vision?" asks The Econiom0iist. "Too little, and the regulated firms' managers, investors and com- petitors are obliged to make long-term decisions based on loo¸e guesswork. Too muchi, and reg- ulators find themselves prejudging issues they have had too little time to consider. In Britain these questions are politically sensitive right now, because the government is about to sell half its remaining 49'? stake in BT, the near-monopoly telephone company. Potential investors know that what Bl's regulator, OrFFti., decides over the next few years will affect its profitability much more than anything BIl's management is likely to dream up. So they want to know more about OF1E's intentions. The silence is the result of conflicting interests. As seller and policy- maker, the governmnent is pulled two ways. It wants to raise as much as it can for its shares, partly to curb its expanding borrowing requirement and partly to avoid accusations of a give- away. To do that, it needs to talk BI up. At the same time, it wants to be seen to be promoting competition in Britain's telecommunications industry, and to be equipping the regulator it cre- ated with the means to do its job. OFTEL itself is in a similar bind. Sir Bryan wants both to assert his independenice from the government and to avoid controversy that might lose him his job when he comes up for reappointment next June. The saime forces act upon any government, and any regulator, when state-owned industries go private" ("The Regulators' Bind: When Govern- ments Sell Their Stakes in Industry, Frankness is Best," Thi I conotnist, 2 November 1991, p. 18). In the end, tl-iruI did break the silence and made a statcment prior to flotation. Priz7atization of Infrastruictiure 271 taken seriously and bidders will submit lower bids. Governments with low credibility and an inadequate track record hence will usually have to offer more guarantees to attract private investors. Imnpact of regulation on buiycrs. Coordination between regulatory approach and privatization objectives extends to the very close link that exists between the key features of the concession and the behavior of the winning bidder. Imposition of excessively severe obligations with respect to the quality of the service to be provided by the privatized company (for example, very short repair times, or very high dial tone requirements or call-completion ratios for the telecommunications sector) or excessively low rates could compromise expansion and increased penetration of the network, which are prime objec- tives for most developing and transition countries. Imipact fof regulation otn the value of the privati2ctl complanly. The tariff or regu- latory formula also may be a function of the chosen privatization objectives and techniques. Where, for example, an enterprise is regulated by reference to a rate of return on capital invested, user charges may simply be jacked up to achieve the authorized (regulated) rate of return and maximize privatiza- tion receipts (this would not be the case if the rate of return were calculated on the historic book value of the companv, for example, which may differ widely from the price paid). The scope and nature of the controls that will be exercised after the gov- ernment withdraws will necessarily have a direct bearing onl the value of the company. Stricter regulation or lower protection against competition will inevitably reduce profits and therefore share value, which, as indicated ear- lier, is not necessarily a bad thing. Box 7.4 illustrates the fluctuations in the share price of regulated companies caused by amendments to the regulatory framework. A similar link between regulatorv framework and share price can be seen in the poor results of privatizationi operations launched in the absence of a well-defined and credible regulatory framework, as demon- strated, for example, by the less than successful privatization of Hungarian power companies at the end of 1995i; prices wvere lower than expected, and five of seven generation companies found no buyer at all (see Privatisation hIteratational, December 1995, p. 25, and March 1996, p. 21). ReguIlatory [nstitutions As shown in the preceding section, the establishment of a regulatory frame- work is a prerequisite for the success of an infrastructure privatization pro- gram. This section focuses on the regulatory agencies and the regulators.107 107. It is, however, impossible in this book to examine ill of the possible institutional and reg- ulatory alternatives. For a more thorough review, of issuLs of regulatorv desigin and institutions, see Helm 199L4; Neven, Nuttall, and Seabright 1993; Phillips 1993; Smith 1996. 272 Thie Privatization Challenge Box 7.4 Impact of Regulatory Changes on Share Price Regulatory decisions often have an immediate and sometimes dramatic impact on the stock market performance of thie regulated enterprises. For example, the shares of BAA (British Airports Authority) rose by 5 percent on November 18, 1991 (to the highest daily trading volume since share flotation in 1987), in response to an improvement in BAA prospects due to adoption of a new for- mula for the calculation of traffic user fees by the Civil Aviation Administra- tion. Similarly, British Gas shares fell by some 3 percenit on December 21,1993, after the government announced the abolition (partial from 1996 and total from April 1998) of the monopoly held by this companiv, privatized in 1986. The decisions of OFFEIR (the power regulator) have had a major impact on the share quotations of the companies affected. Thus tht market capitalization of the 12 electricity distribution companies of England and Wales rose from £14.8 billion to 15.9 billion (an increase of about 7.5 percent) following announcement by the regulator on August 11, 1994, of the new pricing system, which the mar- ket perceived as better than had been predicted; some people had expected the regulator to impose appreciably bigger price reductions. WVhen the same regu- lator announced on March 7, 1995, that the price regime would be tightened further than announced in August 1994, shares of the regional electricity com- panies lost nearly 23 percent of their value. This surprise announcement came the day after the U.K. government had completed the sale of its second and last tranche of shares of the two large power generators (PowerGen and National P'ow7er); those shares "tumbled more than 4'.V, in London trading, infuriating investors who bought the shares Monday, before Mr. Littlechild's bombshell" (Wnll Street Jouornal, 8 March 1995 and 30 March 1995) Finally, the share price of the Chilean telephonie company et - fell by 14 per- cent in one day following downward revision ot its tariffs by the Chilean regu- lator in March 1994. The New York stock exchange had to suspend quotation of c rc. The privatization of Sui Northern Gas Pipelines Ltd., a gas distribution com- pany in Pakistan, affords another illustration of the importance of setting up a clear regulatory framework before privatization. In 1992 the government launclhed the privatization of this company with a private placement of 20) per- cent of the shares with a strategic investor (gas operator) and 40 percent by a public offering underwritten by MvICb, a local commercial bank. The shortcom- ings of the regulatory framework were partly responsible for the failure of both the private placement and the subscription, and Mt B found itself with a large block of shares on its hands. The government and Mb B tried to interest multi- national companies in the purchase of these shares. but the negotiations broke down for the same reason-namelx; the share price was deemed too high in light of the uncertainty surrounding the regulatory system. P'otential buyers were prepared to pay the asking price provided that sectoral regulations were satisfactorily amended before the purchase; witlhout such amendment, they were not prepared to offer more than 40 to 60 perecnt of the asking price. Solrcos: See also Financial Tninss, 19 November 19, 1'991, 22 December 1993,9 March 1994, and 13-14 August 1994; OUxfard Analittici, 8 April 1994; Beesley and l1ittlechild 1989, p. 457. Privatizatioti of lInfraistruictuire 273 Tailoring t11e institutionial and regulatoryJ f7rmewzork to niationial conlditionis. The telecommunications sector has a rich fund of experience in privatization and regulation. As in other sectors, the United Kingdom created an interesting precedent when it privatized BT by establishing an autonomous, indepen- dent regulatory organ with decisionmaking powers (OFTIEL). Autonomous regulatory commissions find their origins in the mid-nineteenth century in the United States and the United Kingdom. They started out as advisory railways commissions, and the first autonomous regulatory commissions with decisionmaking powers were established by several American states in the 1870s. The U.K. model, and in particular the decisionmaking powers given to individual and independent regulators, should be seen in the proper con- text: the United Kingdom is a sophisticated industrial country with very strong, well-establislhed legal practices and traditions. In many developing and transition countries, the difficulty of designing an appropriate regula- tory framework is amplified by civil service regulations, practices, and sal- ary scales; political intervention; weakness of the judicial system; scarcity of trained managers; lack of relevant regulatorv experience; and other such constraints. It should also be noted that the U.K. model is currently being reassessed there. Many observers feel that the regulatorv process lacks transparency; that it has been excessively personalized; and that the powers of the regu- lators are too broad, while regulators themselves are not subject to control and many of their decisions are not open to appeal (see Veljanovski 1993, pp. 60-62). Some have proposed that the regulators be subject to parlia- mentary control to give the process more democratic legitimacy. Others feel that the increasingly competitive nature oif regulated sectors erodes the justification for separate sectoral regulatory agencies, and suggest that merger of these agencies, or even their absorption by the competition agen- cies, would in the longer run be a better solution (see Lipworth 1993, p. 57; Helm 1994). Levy and Spiller 1993 compared the performance of private telecommuni- cations operators in five countries. The authors concluded that the major determinant of telecommunications performance is a good fit between the mode of organization and regulation of the sector in a given country, on the one hand, and the country's administrative, judicial, and legislative prac- tices and traditions, on the other. In addition to rules that are clear and tai- lored to these practices and traditions, good svstems have three other char- acteristics: basic rules limiting the discretioniary powers of the regulatory body, restrictions on the power to modifv the existing system, and mecha- nisms for ensuring effective implementation of and compliance with these rules and restrictions. The study notes high private investment levels where these requirements are met, as in Chile (since 1987), Jamaica (before 1962 and since 1987), and the United Kingdom (since 1984), and low private investment if one or more of the conditions is not met, as in Chile (in thc 1950s), Jamaica (between 1966 274 The Privatization Challenge and 1975), and the Philippines. The authors postulate that the strong growth of private investment following the 1990 privatization of ENTrEL in Argen- tina, despite the lack of a clear regulatory framework, is attributable to the confidence inspired by the scope and success of the Menem administration's overall economic reform program. Another conclusion of the study is that a given system of regulation can be perfectly effective in one country and totally ill suited for another; a thorough analysis and understanding of a country's administrative, judicial, and legislative practices and traditions is essential to the design and implementation of an efficient regulatory scheme. Powvers of regulators. The authority or powers of regulatory bodies vary widely. The range goes from purely advisory bodies to bodies that award and police licenses, adjudicate disputes, and oversee the sector in general. Advisory bodies should not be discounted too easily as regulatory instru- ments.1(18 They offer a degree of transparency and inject analysis and debate in discussions that previously would have taken place in the secrecy of a ministerial cabinet. The advisory body can see its role and influence increased when the authority that is competent to make a specific decision (a minister, for example) is not only forced to seek its advice and take it into account, but also to justify any departure from such advice; furthermore, for certain matters, the competent authority may not be allowed to reach a deci- sion going against the opinion or advice received In a privatization context, the issuance of licenses is usually left to the gov- ernment as part of the divestiture process.'(' Indeed, the sale of a utility or infrastructure company without the licenses and permits needed to provide the public service would not make much sense. The postprivatization award of licenses, or modifications in existing licenses, may be left either to the governmenit agency that issued the original license, to that agency upon rec- ommendation of the regulator, to the regulator, or to some other mechanism. The power to modify or adapt the terms of concessions or licenses, if given to a regulator, is usually restricted, as discussed in the sections above on award and content of concessions or licenses. Regulators typically have the power to adjudit ate disputes between oper- ators or between users and operators. This ma)y be the most important func- 108. As mentioned above, U.S. regulatory commissions were initially established as advisory commissions, the Rhode Island Railway Commissiotn being the first one in 1839. The creation of the Hungarian energy bureau pursuant to the gas law of 1094 provides a more recent example of a regulator that can recommend but not set tariffs. 109. An exception is Bolivia, whiere even the initial licenses were granted by the regulatory agency. Capitalization (privatization) agreements signed by the government and the investors promised that such licenses would be issued. This approach is not recommended, however, because it adds an uninecessary element of uncertainty to tho privatization process. If the regu- lator does not issue the promised license, investors would n t be totally unprotected, however; they would still have contractual recourse against the goverinment. Prizatizat ion of Infrastructure 275 tion of a regulator when a sector is being liberalized and a dominant opera- tor controls bottleneck facilities and tries to use them to keep competitors out or at a significant disadvantage. Disputes on technical, financial, or tim- ing aspects of interconnection are cases in point. Regulators are also normally in charge of verifying compliance with the legislation in force as well as with the terms and conditions of concessions or licenses. To facilitate this task, legislation imposes strict disclosure require- ments on regulated enterprises and gives regulators broad investigative powers. They may also have the power to impose sanctions and penalties. Finally, regulatory bodies may be given the power to prepare and enact gen- eral norms and regulations applicable to the enterprises operating under their watch. Autonomoty antd indSepenidentcc of rcgulators. The independence of a regulatory body is worth little unless it is upheld against incursions by the regulated industry Cases of capture of the regulator by industry are indeed not uncommon. The problem is particularly acute where regulatory agencies are set up as part of the civil service in countries where this system (especially its personnel rules) does not allow for adequate remuneration of staff. In these cases, the independence of the regulatory staff is likely to be rapidly eroded by practices which, while undoubtedlv illegal, are nonetheless com- mon. By removing regulatory staff from civil service constraints, govern- ments may remunerate them in ways that better protect them from industry capture and that allow the agency to attract qualified candidates, hence enhancing the professionalization of the regulatory function. In addition, rules need to be laid down concerning conflicts of interest (for example, by prohibiting former staff of the regulatory agency from working for a regulated enterprise for a specified periodl after they leave the agency). Independence from industry also requires that, where S)Os are operating in the sector, the regulatory function be clearly separated from the exercise by the government of its SOE ownership functions. Where sectors were run as a public monopoly the confusion of operating and regulatory powers in a sin- gle entity or person was not uncommon; as the sector starts to open up to new entry, however, this situation quickly becomes untenable. An institu- tional setup that allows the same senior official to be regulator and represen- tative of the state's ownership interests in an SOE would not pass muster. 11) Ministerial regulation has been the tradition in numerous countries, includ- ing Indonesia, Japan, Malaysia, and many continental European countries.1 Ii It is losing ground, however, even in countries such as France and Germany where the regulatory function had typicallv been entrusted to a department or I11(. For an extreme example, consider Pakistan, where in 1995 the chairman of the board of the Pakistan Telecommunications Corporation was assignied the additional responsibility of chairman of the Pakistan) Telecommunications AuthoritN ]11. In Japan, for example, the ministry of postal services and telecommunicati(ons has to approve the tariffs of NIT, the dominant and partially privatized telecommunications operator. 276 The Privatization Challenge agency of the central government.1 12 The trend is clearly toward more autono- mous regulatory setups, separating regulatory agencies from government ministries. This is illustrated, for example, by conditions placed by the Euro- pean Commission on the approval of the alliance between Deutsche Telekom and France Telecom, and by the regulatory principles being negotiated at meetings of the World Trade Organization on telecommunications.]"3 Independent, autonomous regulatory agencies with decisionmaking powers may not be suitable for all countries, however. This may be especially true of countries with authoritarian governments, where in practice the head of state takes all important decisions affecting the country, whether legally empowered to do so or not. If the political independence of the regulatory organ cannot be ensured, creating a new agency with decisionmaking powers may needlessly complicate the management of the sector and the life of the operators by intro- ducing an additional actor and yet another level of uincertainty. 112. In France, the ministry of industry and telecommunications has been in charge of regu- lating telecommunications, including settling disputes between operators, even though it was also the supervisory ministry of France Telecom, the national telecommunications SOE. This setup is likely to change, however. Indeed, although the French government has traditionally been opposed to autonomous regulatory bodies, it is now moving in that direction. In a recent public consultation document on telecommunications, it stated, "While the experience acquired by the DC;IT since its foundation confirms the potential and the advantages inherent in the current transition towards a competitive market, the complete opening up of the French market to competition makes a new approach necessary. There appear to be two feasible solu- tions: the first is to entrust to an autonomous body the tasks of carrying out arbitration and imposing penalties, while regulation (i.e. regulation arising from the application of market ground rules) would be handled directly, as is the practice today, within a ministerial organisa- tion; the second would involve giving the regulatory body more independence from the Gov- ernment to enforce the ground rules, to act as arbitrator and to impose penalties.... To set up an autonomous regulatory body would be to adopt a similar approach to most of our partners. The independence of such a body would be guaranteed by the manner of appointment of its direc- tor(s), i.e. for a fixed term of office and not renewable. That body would also enjoy all the guar- antees necessary to its proper operation.... Powers related to regulation (settlement of disputes arising from network interconnection and licences, application of the schedules of terms and conditions, allocation of essential resources, monitoring of universal service provision) would fall within the remit of the regulatory authority by delegation under law or by decision of the Minister. Licences could be granted by the Minister on the basis of reports submitted by the reg- ulatory body (as in the UK) or directly by the regulatory body itself (as intended in Germany)" ("New Ground Rules for Telecommunications in France,' Ministere des Technologies de l'lnformation et de la Poste, October 1995, pp. 21-23). The government later submitted a bill to parliament that called for an independent regulatory commission to rule on competition issues and settle disputes between operators (public and private), while leaving the licensing of oper- ators to the government (Law no. 96-659 of 26 July 1996 on regulation of telecommunications). 113. Conditions imposed by the commission for its approval of the Atlas alliance between Deutsche Telekom and France Telecom, and of the Global One alliance between these two oper- ators and Sprint, included the effective liberalization by France and Germany of alternative infrastructure provision (and award of the first licenses to such providers), the sale by France Telecom of its German data network services subsidiary, nondiscriminatory access by compet- ing operators to their networks and facilities, separate accounting systems for the new alliances, and the prohibition of cross-subsidies (see Financial 7iincs, 18 July 1996; see also the section above on EU policy in the telecommunications sector). Privatizationi of In,frastriuctuire 277 The same does not hold for regulatory commissions with an advisory mandate. To the contrary, creation of an autonomous, independent commis- sion in this case may well constrain the arbitrariness of the political decision- makers. By requiring that such a body make recommendations on all key regulatory decisions, the ultimate decisionmaker may indeed make better- informed decisions and be more reluctant to rule in a way that demonstrates arbitrariness, discrimination, or cronyism. Publicity of recommendations can further strengthen the commission's influence and the decisionmaker's accountability. The specific institutional setup of a regulatorv agency also may affect its independence. Design issues include choices between a regulatory body responsible for several or all infrastructure sectors and a separate one for each sector; and between a single regulator and a collegial regulatory com- mission. The U.K. model, for example, provides for a single regulator, called director general, who heads an office with numerous staff. The U.S. model provides for a commission of regulators acting as a council; examples are the public service commissions that exist in most states, as well as the Federal Communications Commission and Federal Energy Regulatory Commission (FERC). Multimember commissions often provide greater safeguards against undue influence or lobbying and may limit the risk of rash or radical regula- tory decisions; in many developing and transition countries this consider- ation will outweigh the relative costs in terms of slower decisionmaking and lesser accountability of regulators. Another design issue is the way in which regulatory activities are financed: autonomy is strengthened by granting the regulator financing sources independent of the general budget, typically in the form of charges, fees, or levies on the enterprises or services subject to regulation. Publicity, transparency, and disclosure rules reinforce and protect the independence of the regulator. Finally, regulators are typically appointed by the government, although they often have to be confirmed by the legislature. In Bolivia, regulators are appointed by the executive from a list presented by the legislature.114 In some American states, such as Tennessee and Georgia, they are elected by the general population (this gives a large influence on regulatory matters to one specific group, namely, residential users of public services). Appoint- ment by the executive with legislative involvement (initiation or confirma- tion) gives the process more stability and authority. In order to avoid undue governmental interference in the regulatory business, the law often specifies that, once appointed to a fixed term (most often between four and seven years), regulators cannot be removed at the government's discretion. 114. Article 4 of Law no. 1600 (October 28, 1994) on the establishment of Sirese, the regulatory institution for the infrastructure sectors, stipulates that the president appoints the general superintendent in charge of Sirese from a list of candidates proposed by the senate voting with a two-thirds majority. Article 8 specifies the same appointment procedure for the sectoral superintendents. 278 The Privatizationt Challentge More or less discretion? In countries with administrative and judicial sys- tems short on resources or credibility, the use of detailed and relatively inflexible concession agreements backed by international arbitration proce- dures may be more likely to reassure investors than the creation of an auton- omous regulatory agency with rulemaking powers. Guinea and Cote d'lvo- ire both opted for this approach in privatizing their water supply and electric power sectors; the concession agreement was accompanied by a detailed schedule of obligations and conditions, leaving few aspects to be decided or agreed upon during execution of the contract. Detailed a priori regulation is better suited to relatively stable, technologically mature, and monopolistic sectors, such as water and power distribution, than to sectors undergoing rapid technological evolution, such as telecommunications. A balance has to be found for each country and each sector between prior definition of rules that can turn out to be highly restrictive and adoption of a more flexible framework that allows for evolution of the rules under the authority of a regulator but adds uncertainty. In certain circumstances (where regulatory institutions are weak, for example) and in some sectors (such as water), fairly precise upfront regulation may be preferable to more flexible rules subject to more discretion on the part of the regulator. Care must be taken, however, not to trim the powers of the legislator or regulator too much. In practice, whichever regulatory framework is adopted, protec- tion of the public interest will sometimes call for unilateral amendments. The challenge is hence to strike a healthy balance between the legitimate interests of the private operator and those of the community. In countries with weak institutions or poor track records, the tradeoff has to lean toward less discretion, lest investors decide to stay away. As a positive track record is built up, the regulatory framework can evolve toward more flexibility. Single or multisector agenicy? Should governments set up a regulatory body for each sector, as has been done in Argentina and the United Kingdom; a single agency for closely linked sectors such as gas and power, as in Hun- gary and the United States (at the federal level, FERC); or one multisectoral agency for all or most infrastructure sectors, as in Bolivia and the United States (public utilities commissions at the state level)? On the other hand, perhaps there should be no special regulatory body at all, as in New Zealand, where the Commerce Commission, the national competition agency, is in charge of economic regulation of the infrastructure sectors on the basis of the country's general competition rules.115 A multisectoral regulatory agency should contribute to a greater degree of coherence or consistency in the regulation of different sectors; it also allows 115. The commerce act of 1986 (section 53) provides, htowever, that the government can, under certain circumstances, control the prices of goods or s.rvices "in a market in which com- petitioli is limnited or is likely to be lessened," provided such o(ntrols are "necessary or desirable in the interests of users, or consumers, or, as the case may he, of suppliers." Privatization of Inifrastriuctiure 279 lessons from one sector to be applied to others, creates administrative econo- mies of scope, and may limit the risk of corruption or undue influence by a particular enterprise or ministry. It is particularly well suited for countries that lack the necessary financial, human, and administrative resources to equip separate agencies. Some argue that it does not promote the develop- ment of in-depth sector expertise, but this can be addressed by a degree of technical specialization within the agency Basic legal, economic, and finan- cial skills and experience are, in fact, largelv common to the various infra- structure sectors. Appeal p)roceduires. Whatever the regulatory mechanism in place, one should consider whether appeal procedures should be provided. In the United Kingdom, which has the longest and broadest postprivatization experience, the Monopolies and Mergers Commission-whose powers derive from privatization laws and general competition legislation-has several times been asked to hear disagreements between privatized com- panies and their regulators concerning amendments to the terms or condi- tions of licenses.11" The regulator has to take the reconmmendations of the MMC into account but is not required to follow them (except for certain sub- missions to the MMC concerning enterprises in the water and sanitation sector).11 7 British Gas and other companies complaini that their regulators have developed the habit of broadening the subject of an appeal to the MMC well beyond the original dispute, for example, bv questioning the very structure of the sector when the disagreement concerned only a tariff adjustment (see Lipworth 1993; Veljanovski 1993). Since the MMT can recommend that the pri- vate company be broken up, regulated companies tend to avoid involving it in their disagreements with the regulator. The threat of such recourse is hence a formidable weapon in the regulator's arsenal. Courts, on the other hand, 116. The regulators may refer companies to the Mmc. In addition, the director general of fair trading (ff-) is also allowed to refer privatized utilities to the Mmc for anticompetitive or monopoly practices. The secretary of state (the minister) h.s similar powers in the water sector, for example. One should also add that, in the case oI thu otur main airports, the MMc is auto- matically required to rule on the five-year tariff adjustinonts proposed by the Civil Aviation Authority (see McEldowney 1995). 117. Mergers of companies in the swater sector always hare to be referred to the MM(. This was done following the bid launched in March 1995 by Lvonnaise des Eaux on Northumbrian Water. The M M- report issued in july threatened to block the bid unless it guaranteed price cuts of up to 2t) percent. This report was used by the tradeb and industry secretary as a basis for fur- ther inquiries bv the water regulator. In the end, 1Lyonnaist's $1.3 billion takeover was allowed, provided it guaranteed a reduction of 15 percent in custoner s water bills over six years. In addition, "Lyonnaise has given undertakings not to bid for anotlher U.K. water company for I1) years. It must float at least 25 per cent of its U.K. water interests, which includes Essex and Suf- folk Water, by 2005" (FiiaHuiucial Timcs, 24 November 1995) Following this takeover, Northum- brian will be merged (under a single amended license) wvith Nortlh Fast Water, the statutory water comnpanly that was already controlled by i[vonn.aise. sew also notes 25 anld 31 on the role of MMc in power sector takeovers. 280 Vhc Privatizat iot Chaltcng't have so far played a relatively minor role in the United Kingdom. Il8 The U.K. appeals regime, with its role for the MMC, the otTr, the minister (or secretary of state), and, to a lesser extent, the courts, is rather idiosyncratic, however. It is, in part, a reflection of the decisionmaking powers of U.K. regulators. The design of an appeals regime should be a function of the specific institu- tional setup and legal traditions of a country; courts may play a role where they have or can reasonably acquire the expertise, integrity, and efficiency needed to settle appeals on regulatory matters More generally, in the design of a regulatory framework, the interests of speed and certainty (which lead to denying appeals against regulatory decisions or limiting the grounds and timeframe for filing such appeals) should be balanced against those of fairness toward regulated entities (and consumers) and accountability of the regulator. Privatizationi of tlhe regulatory fuuction. Conciliation and arbitration proce- dures play a very important role in private infrastructure contracts. They substitute for or complement the formal appeal or recourse mechanisms to higher-level government authorities, coturts, or special bodies. Most con- tracts include mechanisms for the prompt amicable settlement of problems or disputes that may arise in the course of their implementation (see chapter 3). Failing this, contractual provisions typically assign the settlement of disputes between the operator and the state or coniceding party to arbitra- tion, most often international arbitration. Because contracts often include regulatory commitments such as future tariff intreases, specific regulatory action or inaction could become a breach of contract by the state or conced- ing authority, which justifies recourse to arbitration. The threat of recourse to arbitration may be a powerful incentive to force compliance, although actual arbitration proceedings may also sound the end of the contract. Furthermore, much of the work traditionallv per formed by regulators lends itself very well to contracting out to private experts. Opponents of privatiza- tion sometimes take refuge behind the complexity of regulation and the pau- city of national capacity in many developing or transition countries to justify a continuation of public-sector provision of infrastructure services. Complex regulatory functions need to be performed professionally; where limited administrative capacity is indeed a binding constraint, at least in the short and medium term, privatization of regulatory tasks slhould be considered.1 19 118. One of the few suits was filed in December 1993, bv 'Mercury, the largest c(mipetitor of British Teleconm, against o(WtFL , which had just announced its determination on the interconinec- tion between 13 I and Mercury; it asked the court to define a n ,w formula for cailculating the net- work access charge it has to pay ini for transmitting its calls i their final destination (see Filmii- cial Timeics, 21 December 1993). 119. Moreover, even if regulatory tasks cannot be dischiarged adeL1uatelv (wihether by regula- tors, private auditors, or otherwise), keeping a public-sector imionopoly may not be the best pol- icy. First, as already argued, contracts antd licenses can be diesigned to increase the operator's incentives to act in the public interest; second, regulationi is needed for privaite as well as public operators; and third, even if regulatory capacities are xN eak ir nonexistent, ) private monopoly is not necessarily wvorse than a public one. Prinitization of 1nfrastruicture 281 Governmeints and regulators can, and often do, hire consultants, advisers, and experts to assist them in all aspects of their regulatory tasks. Such con- tracting out can also be taken one step further and formalized through, for example, performance audits or certifications performed by independenit verification companies under contract with the regulator. Auditors could be asked to certify that the information provided by the regulated companies to the regulator (including performance targets) is, in their opinion, fair and reliable, based on the checks they have performed and on their assessment of the systems the companies established to produce the required informa- tion. In addition, they could be asked to certifv that the regulated company is in compliance with the legislation in effect, as well as with the terms and conditions of its license or concession, and, if it is not so, determine the degree of noncompliance and the factors that may have conitributed to it. Their task could also include surveys of user satisfaction. Finally, auditors could measure the regulated companies' performance against key parameters, prepare time series showing trends, and compare these results with international norms. None of the listed functiolns implies any discretionary decisionmaking. What such audits would do, however, is pro- vide the decisionmakers with a sound analvtical basis for their decisions. By introducing a degree of transparency or publicitv in this process, wlhile respect- ing private and confidential information, the scope or likelihood of arbitrary decisions could be limited. Auditors wotuld be subject to ethical standards and liability, just as financial auditors or verification companies are. Their fees could be funded from the regulatory levv on the regulated industries. The degree of delegation of regulatory tasks to private companies canl be pushed even further, as decades of experience in the aviation area showv. Some countries have delegated their sovereign power to certify the airwor- thiness of aircraft to private companies. In Morocco, for example, the minis- try in charge of civil aviation has delegated this function to Bureau Veritas, a private company of international repute.12t1 This company delivers airwor- thiness certificates to all Moroccan aircraft, in. luding those of the national airline but excluding military aircraft. The company, wlhiclh is remunerated from fees paid by the controlled companies, makes periodic checks on suich aircraft, as well as on aircraft maintenance workshops and parts manufactur- ers establislhed in Morocco. Final authorit, still rests with the civil aviation authorities, but Bureau Veritas is authorized to take protective or preventive measures, such as temporarily withdrawinig the airwortlliniess certificate and immonbilizin,g the aircraft, pendinig decisiOtl from these authorities. Sclf-rcg'u lation. As mentioned above, regulation is a delicate and political undertaking, especially wheni it comes to the regulation of mon{opolies. The 12(0. See Decree no. 2-61-1 61 of J u v I), 1 0 on thc relgulation ot civil aviation, and ministe- rial rder no. 364-h7of Ma ' 3, 1(67. designating BureanLIVeritns fortlhe control ofaircraft airwor- thiness, including the issuance, renewal, and validation (of dirworthiness certificates. 282 The Privatization Challenge reputation of firms also is an important regulatory mechanism. Indeed, international infrastructure companies cannot afford to abuse their domi- nant position in some countries, lest their reputation and chances of winning new contracts be impaired in that country or abroad. In high-growth sectors, this type of self-regulation may sometimes be more effective than formal regulatory mechanisms. A free and critical press, as well as consumer and user associations, may further contribute to the effectiveness of the overall regulatory process. Balancing the costs and bentefits of regulationt. This overview of the regulatory issues that arise or should be considered while preparing an infrastructure sector for privatization cannot do full justice to this complex issue. There is no single blueprint for regulation. Regulatory reform must always be based on an analysis of the cost of regulation, which should not exceed its expected benefits. The concept of regulatory bodies independent of the industry and the government is undoubtedly attractive and worth pursuing. The fact remains, however, that in many countries it is difficult, if not impossible, to achieve that independence in practice, at least in the short run. Where this is the case, a gradual approach-which starts by giving an autonomous regu- latory body advisory powers and eventually other powers, as its track record, independence, and the confidence it inspires mount-may often be the preferred approach. Generally speaking, the regulatory framework must be able to reconcile profitability of the operator, continuity, and quality of the service while meet- ing two other often contradictory requirements. On the one hand, it must ensure compliance with the commitments entered into by the parties and hence reduce the inherent risk of investments of this kind; this calls for only limited discretionary powers. On the other hand, it must have enough flexi- bility built in to make adjustments when changing circumstances so require; this calls for a greater measure of discretion on the part of the regulator. Recent developments in U.K. regulatory policies and practices illustrate this difficult tradeoff. High profits and generous compensation packages for senior executives of regulated infrastructure companies have sparked pro- tests and become politically very controversial, particularly in the water sec- tor where the price cap formula adopted at privatization has led to signifi- cant tariff increases. These high profits, dividends, and bonuses result partly from efficiency gains achieved by the companies since privatization and partly from regulatory design mistakes (generous price caps and insufficient competition in the market). U.K. regulators have tried, especially in 1995 and 1996, to correct some of these problems by tightening the pricing formu- las, sometimes considerably, while leaving the regulated companies the opportunity to make reasonable returns and the incentives to innovate and pursue additional productivity gains. The difference between a priori assumptions used to set the regulatory framework and the a posteriori assessment of how that framework has lived Prizatizatioi (if Itifrastruictutre 283 up to reality is inherent in the regulatory process. Governments designing a privatization program, and regulators thereafter, will never have all the information they need to make their decisions, while regulated enterprises will always tend (at least publicly) to underestimate the productivity gains that can be achieved and to withhold, to the extent they can get away with it, information to the contrary Finally, regulatory capacities may also affect the choice of market struc- ture and competition rules. A difficult balance may need to be struck between a theoretically optimal structure and one that is manageable in light of the country's traditions and institutional and human capabilities. The introduction of competition into a sector may simultaneously facilitate and complicate the regulator's task. It facilitates it by, for example, creating dif- ferent operators with differing interests who will be quick to denounce any abuses committed by their competitors; multiple operators also give regula- tors more reference points for evaluating operators' performance and possi- ble productivity improvements. Yet the introduction of competition compli- cates regulation by requiring the regulator to monitor a larger number of companies and to arbitrate disputes among these operators concerning access to the network, predatory pricing, and other matters; in addition, there may be a positive correlation between the number of operators and the number and complexity of these disputes. Conclusion The quality and competitiveness of infrastructure services is increasingly becoming a key factor in the competitiveness of countries, which can no longer afford to be dragged down by underperforming public monopolies. Privatization of infrastructure sectors has thus become a high priority for an increasing number of governments around the world. It raises specific issues, which have warranted this special chapter. The discussion has focused on how issues of market structure, competition, and regulation may affect the privatization process, given recent and ongoing developments. The economic policy choices made in these areas are crucial in deciding on the legislative and regulatory frameworks that will govern infrastructure privatizations. Infrastructure sectors are subject to rapid changes in technology, ideology, economic conditions (notably through the introduction of growing competi- tion), geopolitics (the artificial barriers between protected national territories are steadily falling), and so on. These sectors relied until recently almost entirely on public funds to finance their investments, but the public finance crises in many countries, combined with huge investment requirements (especially in high-growth countries), have made private-sector participa- tion indispensable. Furthermore, the poor performance of most public enter- prises and their inability to offer a qualitv service and meet demand have encouraged many governments to turn to the private sector for the provision 284 The Privatization Challenge of infrastructure services. These and other developments have led to the need for radical reforms, encompassing both privatization and demonopoli- zation of infrastructure sectors. The pendulum has swung more than once over the choice between public or private ownership in these sectors. The recent trend toward privatization and demonopolization, though, is not likely to be a passing fancy. It is a phe- nomenon that reflects profound ideological, technological, and economic changes. Moreover, the largely positive experience of pioneering countries should encourage other countries to promote greater private participation and increased competition in these sectors. The privatization trend should be further strengthened by the emergence of a global industry for infrastructure services. This industry, which did not exist ten years ago, owes its existence to the reforms discussed in this chap- ter. These reforms have generated and then amplified the demand for pri- vate infrastructure services. They have also helped create the supply, first by forcing enterprises that previously enjoyed a national monopoly in a given sector to compete and become more efficient, and by allowing them to diver- sify geographically and sectorally and, second, bv encouraging new opera- tors to enter these previously highly protected sectors. The early reformers, such as Chile and the United Kingdom, have given their national infrastruc- ture services companies a lead in the international markets. Finally, interna- tional infrastructure groups have a reputation to protect, so that they can maintain and develop their activities in the countries where they operate and win new contracts elsewhere. This is a valuable form of self-regulation. Experience with privatization in infrastructure sectors indicates that clear definition of objectives from the very outset is even more important here than elsewhere. Where the objectives are to improve service levels, satisfy a growing number of users, and boost the international competitiveness of infrastructure services and hence of the national economy, divestiture (with the receipts it brings in) will very often be less important in itself than effec- tively demonopolizing and opening up the sector to new enterprises that compete with the hitherto dominant (public, private, or privatized) operator as well as with other new entrants. A recent report of the European Compet- itiveness Advisory Group, chaired by former Italian premier Carlo Ciampi, expressed this in the following terms: "What matters most is not so much that the ownership-and management-of public utilities moves from the state to the private sector, as that competition is introduced and extended wherever possible" (Financial Times, 13 December 1995). The emphasis and priority should thus be on opening the sector to private entry and competition (privatization of the sector), rather than on the trans- actional aspects of the divestiture of one or more SOEs. Legal monopolies and other barriers to entry will need to be abolished; constitutional provi- sions may need to be amended or abolished. The privatization of large infra- structure companies offers the government a unique opportunity to rethink the entire organization and structure of the sector. Activities or services that were provided by an integrated, monolithic enterprise will be unbundled Privatization of 1nlfrastructutre 285 and competition introduced in those segments that can sustain it. Such reforms have to be implemented up front; it is indeed much more difficult to alter the structure and operating rules of the sector after privatization, because such changes would inevitably affect private ownership rights. Introducing competition in the market presupposes, however, that gov- ernments are willing to accept that such competition may lower the selling price of an SOE. This immediate shortfall in earnings for the public treasury will usually be made up rapidly through the effects of faster economic growth resulting from more efficient infrastructure sectors and, more directly, through the elimination of SOE subsidies and the collection of taxes and levies on the activities and profits of the enterprises operating in the privatized and liberalized sector. Where competition cannot be introduced in the market, as tends to be the case for water supply, for example, it should at least be introduced for the market-that is, for the right to supply the service on an exclusivity basis. Properly structured tenders or auctions will allow the government to extract part of the monopoly rents for the benefit of the treasury and the consumers. Yardstick competition can then be used as a regulatory tool to compare the performance of the monopoly operator with that of operators in other regions of the country and with international norms; the regulator can use such comparative information to justify tougher performance targets or tar- iff adjustments at the time of regulatory review. The importance of good coordination and sequencing of the sectoral reform and privatization programs cannot be stressed too strongly This may be particularly difficult where different government agencies are responsible for privatization and sector reform. Such consistency is needed in the period leading to privatization, as well as after privatization. Because infrastructure investments tend to be of a long-term nature, investors need guarantees even more than in other sectors. One of the best guarantees is a good regulatory framework, preferably established by legis- lation and backed by strong political commitment. This framework will have to be known before the bidding process starts and licenses or conces- sions are awarded, and it must effectively be in place before or at privatiza- tion. Investors will often seek additional comfort by including key regula- tory features (such as the price regime) into their contractual agreements with privatizing governments. Governmental failure to comply with such rules as stipulated would give investors recourse rights, often through inter- national arbitration. Design of the regulatory framework needs to take into account institu- tional capacities, as well as administrative and judicial traditions. Choices have to be made between regulatory bodies with decisionmaking powers and those with only advisory powers, between multisectoral and single- sector agencies, between agencies headed by a director and those led by a commission. The integrity of the regulatory process must be protected by rules guaranteeing due process, transparency, and accountability. Many countries, particularly developing and transition countries with little or no 286 The Privaltization Challetnge regulatory track record, may wish to adopt a light-handed system of regula- tion with limited discretionary powers and to contract out much of the reg- ulatory control and verification work to reputable private auditors. It is the government's task to introduce the degree of competition and market access best suited to the country and sector and to strike the proper balance between highly detailed licenses or concessions and a more flexible regime in which the regulatory agency has wider discretionary powers. These country and sector characteristics must therefore shape an approach that deals harmoniously with the scope for competition within the sector (structure), the competition rules (laws and regulations), and the country's institutional capacities and traditions (institutions). Governments will rarely hit upon the ideal design or solution in the first go-around. Some trial and error should be expectedt, as illustrated by the his- tory of infrastructure privatizations in the United Kingdom. The govern- ment has to decide on an approach that takes due account of the factors dis- cussed in this chapter, and then take the plunge, so to speak, leaving any necessary adjustments for later when the reform is implemented. As stressed earlier, particularly in chapter 6, external experts have a valu- able contribution to make as advisers on privati/ation. Their assistance is even more important in the reform of strategic sectors. Very few govern- ments have experts on staff to handle demonopolization, competition, restructuring, privatization, and regulation in these sectors. Governments that have successfully privatized large infrastructure enterprises have done so with the assistance of economists, lawyers, financial experts, and sector specialists. The complexity of the necessary market structure studies, the legislation and regulatory framework to be put in place, the bidder selection procedures, the drafting and negotiation of licenses and contracts, and the design of effective incentive mechanisms, as well as the multiple and often contradictory interests at play, are all factors that point to the need to recruit high-level advisers right from the start of the reform program. Infrastructure privatization is a relatively newv and still evolving field, and it would be premature to venture definitive conclusions. The various approaches tried over the past fifteen years need to be evaluated and com- pared to determine which ones promise the most under what circumstances for efficiency, service quality, innovation, satisfaction of demand, and public service generally. Whatever the result, the fact is that many factors dis- cussed in this work-the explosion of investment needs in the infrastruc- ture sectors worldwide, the poor state of public finances in most countries, the rapid growth of large private infrastructure companies operating on an international scale, and the steady breakup of activities traditionally regarded as natural monopolies-are fundamentally changing the way in which infrastructure services are delivered and managed. The picture in five, ten, or fifteen years will most likely be verv different from the present one, but it will surely feature much greater private-sector participation and sharper competition. 8 Meeting the Privatization Challenge Since the launch of the U.K. privatization program in the early 1980s, the privatization wave has swept over the world, touching every continent, every political system, and every sector. Its emphasis has moved gradually from the industrial, commercial, and financial sectors to the infrastructure sectors and then to municipal services; it has only recently started to reach education, health, and administrative activities. This book seeks to shed light on this global trend and to draw preliminary lessons from the experi- ence acquired so far. Its focus has been the strategic, legal, and institutional aspects of privatization, with the legal framework as the common backdrop for much of the analysis. A Strategic Challenge The real challenge of privatization is not just to sell an enterprise or shares. Much more, it is to seize the opportunity to refocus the role of government and public administration, increase economic efficiency, and adapt an enter- prise, a sector, or the economy as a whole to the fast-changing requirements of the international economy. This challenge is inherent in all privatization programs, though its magnitude and intensity differ from case to case. More radical reforms are often needed, for instance, in developing and transition countries. A privatization program may offer an excellent opportunity for strength- ening and deepening financial markets, for example. In sectoral privatiza- tions the breakup of monopolies and the introduction of competition will often rank as high priorities. The privatization of a specific enterprise may call for the unbundling of its activities and for its piecemeal privatization. A privatization strategy can, and should, meet challenges of this type. It should not be bound by the static view of privatization as a zero-sum game in which some win and others lose, without any net gain in overall social welfare. To the contrary, privatization should be seen as a dynamic process whose objective is precisely to yield this net gain. 257 2388 7lic lrizatti:atio i Chalne'g Three Tiers of Privatization This book identified three main tiers of privatization and many different approaches. The first tier is divestiture, the mechanism by which ownership or control of an enterprise is transferred from the public to the private sector. This micro approach focuses primarily on the privatization transactions and the legal and institutional framework needed to facilitate them. The main divestiture issues were discussed in chapters 5 and 6, mainly from legal and institutional perspectives. Other challenges arise in the privatization of infrastructure sectors; these were examined in chapter 7. Here, the government must not only prepare a given enterprise for privatization but also reconsider the entire structure of the sector. The aging paradigm of public enterprise monopolies will have to be discarded and replaced by a sector structure that is more dynamic, com- petitive, and open to the private sector. Rapid clhanges are taking place in the infrastructure sectors, particularly in the telecommunicationis sector, which is undergoing a radical revolution leading to intensified competition and increased private participation, but also in the energy and transport sectors. Ports, airports, railways, and power companies can no longer be seen as monolithic, monopolistic entities; rather, they represent a range of separable activities (infrastructure and services). Parts of this unbundled whole may well still have natural monopoly characteristics that make direct competition uneconomical, but most of the constituent activities (services, in particular) can generally be organized on a competitive basis. Prior sector restructuring is an essential precondition for privatization of most large infrastructure enterprises. Finally, after privatization at the enterprise and sector levels, follows privatization of the economy. The strongest case, of course, is the systemic conversion) from a command to a market economv that followed the collapse of the centralized planning systern developed by the former U.S.S.R. and copied by its satellites. Privatization of the economy is not limited to the so- called transition countries, however. Indeed, many developing countries also had heavily centralized and bureaucratic economic management styles, which have increasingly come under attack. Ev-en in industrialized coun- tries, there is rarely ground for complacency. Substantial reforms may be needed to make these economies more flexible and dynlamic, as convincingly demonstrated by the economic reform and privatization program launched in 1984 by the Labor government of New Zeealand. The lackluster perfor- mance of many European economies in the first half of the 1990s illustrates the cost of not seizinig the opportunity to strengthen market mechanisms. Privatization should be viewed against the backdrop of the international- ization of the economy, which further restricts the options for resolving the chronic difficulties of SOFs. This globalization, which is reflected in new norms of international law, is broadening the very definition of the relevant market for goods or services. It increasingly rendiers illegal the subsidies and Meetin(g tDll PrivatL:atitn) Challenge 289 tariff protection enjoyed by many SOEs, and it fosters the development of flexible enterprises able to adjust quickly to constantly evolving interna- tional markets. These three tiers of privatization, with the added opportunities and con- straints stemming from the internationalization of economies, are separate yet at the same time interlinked: separate, in that the problems arising at each level differ in nature, and interlinked, in that the success of reforms at each level helps determine success at the other levels. By and large, the truly effective programs are the ones in which the government introduced and coordinated the necessary reforms at each level in a coherent and mutually supportive way. The very term "privatization" is broad and flexible: privatization of an enterprise is not the same thing as privatizationi of an economy. Some coun- tries prefer not to use the term publicly at all, even thouglh the policies they follow are undoubtedly privatization policies; otlhers apply the term to pro- grams that do not directly involve the private sector but only mimic its incentives. The dividing line between public sector and private sector is becoming increasingly blurred. Joint-venture (public and private) enter- prises have long existed in many countries, and special techniques for pri- vate participation in the delivery of "public' services-concession, lease (afferinagc), contracting out, management contract, and other forms of part- nership betweeni the public and private sectors-are flourislhing. Changing the Role of the State Privatizing does not in any way imply putting a country's entire economy in the hands of the private sector and abdicating the role of the state. On the contrary, privatization offers governments a unique opportunity to refocus their action by shifting the emphasis from activities perceived to be strategic (a concept that has been used to justifv the nationalization of agriculture or bakeries, for example) to core governmenital responsibilities. Examples are national defense, security, justice, foreign affairs, and taxa tion, although in each of these cases governimental responsibilitv should not rule out private sector participation. The creation of an enabling environment that nurtures the physical and social infrastructLres e.ssential to economic growth and social well-being remains another important role of the state. As they with- draw from the role of producer and refocus, governments are increasingly becoming catalysts, promoters, regulators, and redistributors (of wealth). Meanwhile, the responsibility for productioin of goods and services is shift- ing to those who have a comparative advantage in this area, namely, the pri- vate sector. The state's withdrawal from productive activities accompanies its assumption of responsibility for other, often new, activities. The regulation of infrastructure sectors previously run as public monopolies is a case in point. These new responsibilities are quite different from those of a producer 290 Thc Privatization Challenge or service provider, however. Transforming an operational or planning ser- vice into a regulatory entity may be problematic: the needed skills are differ- ent and so is the culture. Regulation is an intrinsically delicate task, involv- ing, as it does, difficult tradeoffs between often divergent interests. Setting up efficient and independent regulatory mechanisms is a major challenge in the privatization of regulated sectors. Establishing this function at arms length not only from the regulated industry but also, as much as possible, from political and bureaucratic interference should enhance its effectiveness. Although autonomous and independent commissions may be worth pursuing in most countries, in some cases they might be given an advisory rather than decisionmaking role. In countries with authoritarian regimes where independence from the government or head of state may exist on paper but not in fact, for instance, this approach may be appropri- ate; it can also be a first step to establish the credibility of such commissions. Regulatory issues and analyses tend to converge across infrastructure sec- tors, and multisectoral commissions or agencies should be considered, par- ticularly in countries with limited administrative capacities. Attention should also be given to the design of a transparent regulatory system open to inputs from key stakeholders. In this context, most countries may wish to consider privatizing at least some regulatory activities. Government officials are not necessarily well suited to perform many of the rather technical control and verification func- tions on which regulation of infrastructure sectors rests. Much as indepen- dent private auditors are called upon to audit the finances of companies, or inspection companies to check on import and export transactions, most of the actual regulatory controls could be delegated to private auditors. This could include verification of information provided by regulated enterprises (public or private), compliance by such enterprises with their licenses or concessions, achievement of performance targets or other indicators, and so on. Auditors could also usefully evaluate the performance of such enter- prises relative to others in the sector, nationally as well as internationally, and recommend actions to be taken by the regulator or government. Private regulatory auditors could be hired and paid from the proceeds of a regula- tory fee levied on private and public operators. The regulatory task can be facilitated in noninstitutional ways, such as the introduction of domestic competition and the globalization of the economy. To maintain or strengthen the competitiveness of their economies, countries are opening up protected domestic markets and exposing them to competi- tion. By creating a greater number of economic agents with typically diver- gent interests, this may considerably lighten the regulatory burden. Invest- ments by international companies that have a reputation to protect may further contribute to a healthy regulatory environment. Redefining the role of the state may often require amendments to the con- stitution, as discussed in chapters 2 and 7. This has happened in all transi- tion countries but also in many other countries, on every continent and with Meetintg the Priatizat ion Clialltngec 291 governments of every persuasion. It requires broad political support and may be a lengthy, although often essential, process. Defining Objectives All too often the objectives of a privatization program are not clearly spelled out. Lack of transparency in government policvmaking or disagreements over the objectives to be pursued are among the causes. Defining and agree- ing on objectives is an essential stage in the process, however; to omit it is to court failure or, at the very least, to risk poor policy choices and suboptimal outcomes. Privatization objectives should form an integral part of the broader objectives of the economic reform program. Many privatization programs appear to focus more on revenue generation than on the longer-term gains that more radical restructuring of the enterprise or sector concerned would bring. Although preoccupation with the budget is understandable, revenue generation should be a major privatization objective only in competitive and nonprotected sectors. For infrastructure and other public services, the primary objective should be to provide the consumers and the economy with more competitive services, whether in terms of qcuality, range of services, price, or volume. Social objectives also often have high pri- ority, but they may be pursued more effectivelv through appropriate comple- mentary measures and programs than through the privatization process itself. Decisions Based on Thorough Analysis The process of transferring enterprises from the public to the private sector calls for skilled analysis and judgment at everv stage. If a privatization oper- ation is to succeed, the main obstacles and co nstraints must first be identi- fied and then eliminated, as discussed in chapters 2, 3, and 4. Once the government's objectives have been defined, a broad range of legal instruments will need to be analyzed to determine whether they allow privatization and fit with its objectives or whether they need to be amended, suspended, or repealed to allow or facilitate privatization. Public enterprise laws and the legal status of the SOEs to be privatized must, for instance, be conducive to privatization or be amended. The rules governing the creation and operation of public agencies (which may apply to the privatization agency), civil service regulations, public finance legislation, legislation on state or public property, and other aspects of public and administrative law also deserve attention. Where the ownership of certain public enterprises or assets is in dispute, as is often the case with formerly nationalized enterprises, the rights of the vari- ous parties will have to be determined. To succeed, privatization must take place in a legal and institutional environment characterized by respect for the rule of law and proper recognition and protection of the rights of citizens and 292 The Prizatization Challenge private economic agents, especially private property rights which are the cornerstone of a market economy. Discrimination between the private and public sectors must be eliminated to create a level p]aying field for all. A country's business climate, its legislation, and its track record with investors are decisive factors in investment decisions, foreign or domestic. A good business environment can only facilitate privatization and enhance its chances of success. To create this environment it may be necessary to abolish a monopoly, protect and promote competition, enforce compliance with con- tracts, regulate (or deregulate) a sector, reduce import and export restric- tions, streamline procedures for incorporating companies, facilitate foreign investment, simplify the tax system, guarantee foreign exchange convert- ibility and repatriation, and speed up the settlement of disputes, to cite only a few critical issues. It will also be necessary to take stock of existing busi- ness norms and practices and their applicability to the proposed privatiza- tion operations. Of particular importance is legislation governing mergers and acquisitions, liquidation, insolvency, bankruptcy, financial transactions, and securities markets. Elements of a country's basic legal framework that are not directly connected with privatization may nonetheless have far- reaching effects on its implementation. A thorough analysis is even more important when it comes to highly regu- lated sectors, such as infrastructure. In addition to the overall assessment of the business environment, an economic analysis of the effects of the existing sector structure and regulations on sector performance will be required. Where such review indicates, for example, that the lack of competition ham- pers the sector's (and, more important, the economy's) performance, privati- zation will need to be preceded by reforms in sector structure and competition rules. The size and technical characteristics of the sector may be an important factor in such an analysis; this would be the case, for example, in the power sector where small networks that are not or are poorly interconnected may not allow for immediate introduction of competition in the market. Relevant country comparisons are a useful tool for such investigations and should include countries that have successfully implemented reforms in the relevant areas. Nevertheless, analysis and furtlher study should not become a pretext for inaction or timid reforms. Reforming governments will never have all the information at their disposal that one would ideally wish to have before reaching a decision. Nor will they be able to remove all existing con- straints and obstacles to create a perfect environment. An empirical approach to this analytical or investigative task starting from an assessment of the most binding constraints and obstacles will often yield more relevant and useful results than a systematic review of all relevant laws and regulations. A Clear Strategy and Clear Priorities Ideally, a legal and regulatory framework fostering private sector activity in general and privatization in particular will alreadv be in place. In most devel- Mectintg teic Privatization Clalleng,e 293 oping and transition countries, however, this will not be the case. Reform must focus on those legal instruments that absolutely have to be in place if privatization is to succeed. To proceed in any other way would result in end- less delays. The content of the basic reform program will depend on the spe- cific situation of each country, including the legal framework in place, the scope and nature of the privatization program, the administrative and other capabilities to implement the program, and the political context. Imprecise property rights, arbitrary application of the law, and weak financial markets, to take only a few examples, can hinder the smooth execu- tion of privatization operations. The elimination of these constraints should therefore be part of the package of basic reforms. Where they cannot be elim- inated, the government may need to find creative ways to achieve its objec- tives despite these legal obstacles. An example is the leasing technique, which allows a private operator to use state assets that the government can- not transfer immediately, either because it is not allowed to transfer owner- ship or because its ownership rights are disputed. Similarly, where the SOEs to be privatized include enterprises protected by monopolies, the government's strategy should be to open the sector to com- petition and private entry. In the case of natural monopolies (such as water distribution), a reform strategy may include horizontal unbundling: a regu- lator's task will be made easier if information on costs, service levels, tech- nology, and other relevant parameters can be obtained from several opera- tors, each with regional exclusivity. Ranking these obstacles, with the most constraining ones at the top of the list, is a first step. Reform priorities have to be set in light of the ultimate objectives. Those reforms that are essential to the success of privatization and are consistent with the general economic reform program should be undertaken first; the others may be implemented in parallel with or after privatization, but they should generally not hold up the process. Proper sequencing of the reforms is important. Deregulation and liberal- ization of prices and foreign trade, for example, will have to precede privati- zation, especially in countries where private initiative is hamstrung by com- pulsory licensing, protectionist trade policies and practices, or price controls. If investors cannot freely set their prices and operate their own enterprise, few of them will be interested in buying an SOE. On the other hand, if a public enterprise were to be sold despite this unfavorable environ- ment, any subsequent price deregulation or liberalization could yield the investor a windfall profit; the privatization authorities would probably be accused of having sold off the SOE at a bargain price, however, which could harm the entire program. The converse will often happen when foreign trade is liberalized after privatization: the disappearance of protection can instantly lower the value of the privatized enterprise, unfairly harm the buyer's interests, and undermine the credibility of the government and its privatization program. Regulatory reform and privatization also have to take place in the correct sequence. To be able to calculate the price they are prepared to pay, investors 294 The Privatization Challenge will need to know under what regulatory system and rules the company will be operating. This means that these will have to be established before privatization. Uncertainty about the applicable regulations will inevitably cool investor interest and lower the selling price. In addition, in the case of privatization in a regulated sector, investors will want to know not only the structure of the sector, degree of competition, and regulatory system at privatization but also how these are likely to evolve. Stability of the regula- tory system, enshrined in a law and guaranteed, where appropriate, by a credible undertaking on the part of the government not to substantially alter the system (at least not to the detriment of the privatized company) for a specified period, can help attract investors. The effectiveness of a privatization program may be a function of the pace of its implementation. Speed is of the essence: windows of opportunities often do not stay open very long. An attempt to go too fast may backfire, however, as a result of inadequate preparation and design, lack of response from investors, or lack of support from key constituencies. A drawn-out pro- cess, on the other hand, may lead to the deterioration of the SOEs slated for privatization, the loss of momentum and support for sometimes painful reforms, and the scuttling of the overall program. Protecting Stakeholder Interests The role of government in a privatization operation cannot be reduced to that of a holding company selling some of its assets. Indeed, the state's inter- ests as seller may conflict with its obligations to protect the public interest or to promote economic efficiency. Where that happens, the public interest and economic efficiency should prevail. Issues arising in the context of corporate mergers and acquisitions are thus only a subset of those that characterize SOE privatizations. The attitude of private investors and their response to a privatization pro- gram-and hence the success of the program-will depend to a large extent on how well the government prepares and implements the program. This implies, among other things, that legislation must support and reflect the program's overall strategy, allow and facilitate its implementation, and fos- ter the development of an overall environment conducive to private invest- ment. It is no secret that capital, being mobile, moves to those countries with a sound business environment. A major objective, then, of the privatization program ought to be to reduce the uncertainty that potential private inves- tors face. New investors are not the only stakeholders, however. Because privatiza- tion programs are part of the process of refocusing or reinventing govern- ment, they can be expected, like all reforms, to meet with opposition from those who fear they may lose by the change. Such programs entail adjust- ment costs which, while they cannot be avoided entirely, can often be miti- gated through complementary policies. Many countries have taken ancillary Meetimig t1zt Prizvatizationi Cliallenge 295 measures of this kind to soften the impact of privatizations on the more vul- nerable groups of the population. Privatization experience has highlighted the importance of i and labor- law reforms. Where public enterprises are overstaffed, appropriate mea- sures (such as recruitment freezes, severance, and reassignment) must be taken right from the start to deal with this issue, lest the privatization pro- gram be delayed or compromised. Officials from sector ministries and SOF managers may feel that privatization threatens their influence and perhaps even their jobs. Measures may have to be taken to give the affected employ- ees, managers, and officials incentives to press forward with implementa- tion of the reforms or, where appropriate, to defuse their opposition; sever- ance bonuses and free or preferential shares are among the most common incentive measures. Privatization may also have to be accompanied by amendments to labor legislation and structural reforms in social security and pension regimes. A well-prepared privatization strategy should include a social component. Similarly, where the government wishes to bolster the confidence of the private sector, it will have to take care to preserve the rights of SOE creditors. This may be particularly complex where the debt is owed to private credi- tors or where the privatization affects the discount at which it trades. Responsibility for obligations and acts of commission or omission on the part of the SOE before its privatization, such as pollution, may need to be clarified. Should they be incumbent on the government (as the former owner) or on the enterprise and its buyers? Finally, the government must ensure that the legitimate interests of other parties are protected; for exam- ple, private shareholders may have preemptive rights when the government sells its shares in a joint-venture company. A Political Process Privatization is a political process managed (or at least supervised) by gov- ernment and politicians. It is often also a controversial policy. Unconditional and unwavering commitment from the highest political authorities, includ- ing the president (or head of state) and the prime minister, is thus a prerequi- site for the success of a privatization program. The political nature of this process requires that it be conducted with integrity and transparency to avoid both possible abuses and accusations of favoritism or fraud. The design and implementation of privatization programs are typically the responsibility of civil servants. Difficulties encountered in privatization programs are often a consequence of weak institutional capabilities in the legislative, executive, or judicial branches of government. The importance of establishing efficient institutional structures and mechanisms and of provid- ing involved officials with the right set of incentives to ensure effective implementation of privatization programs was stressed in chapter 6. Many countries have established privatization agencies or teams to that effect. 296 1eLI Prizatizzation Challeintg There is, however, no blueprint for institutional design and different solu- tions have worked well in the context of different countries or programs. International experience shows that clear responsibilities and mandates, streamlined processes, access to resources and advisory services, political support, and accountability of privatization officials may matter more than the organizations themselves. Public sector agencies and jobs will often disappear; overcoming bureau- cratic hostility and inertia may be a precondition for success. Remaining staff need to be motivated and those leaving may be offered compensation or reassignment. A certain degree of realism should prevail when it comes to setting expectations for speed and success in administrative reform. Institu- tions-large, public-sector bureaucracies, in particular-do not change overnight; in many countries, it may be advisabl1, at least initially, to con- tract out part of the privatization process itself. Because privatization is a political program, it needs support not only from the groups directly affected but also from the general public. This requires, among other things, that the program yield benefits for consumers (shorter waiting times for telephone connections, for example, or better ser- vice quality or introduction of new services) and for taxpayers (as a result of, for example, abolition of SOE subsidies and reduction of public debt). These benefits need to be explained to all the parties concerned, including the gen- eral public. A good public information campaign, explaining in particular the costs and benefits of the proposed privati/ation program and h1ow it fits into the government's overall economic reform program could contribute substantially to the success of the policy. Is a Privatization Law Necessary? Whether a country needs to enact a privatization law or can do without one depends on several factors: the political situation and legal traditions of the country, the scope of its privatization program, and the nature of the enter- prises to be privatized. Two different issues have to be addressed: does legis- lation need to be enacted to authorize or facilitate privatization, and if so, should the new provisions take the form of amendments to the pertinent laws or be grouped together in a specific privatization law? Some countries have opted to enact privatization laws even when privati- zation could have been implemented without amending the existing legisla- tion. This may have the advantage of mobilizing explicit political support and commitment in favor of privatization from the very start. It may confer a stronger, clearer mandate on the government and agencies in charge of implementing privatization and make them more accountable. A privatiza- tion law also provides an opportunity to introdluce changes in legislation that, although not required for commencing the process, may substantially facilitate it. On the other hand, a privatization law involves risks, including potentially long delays in getting parliament approval, the sometimes exces- Mertetin tlit, Privntizat[it)) C/lill/c;ges 297 sively restrictive scope of legislative provisions, and a tendency on the part of some parliaments to interfere too much in the implementation of privati- zation transactions. Furthermore, special legislation may not be needed for the transfer of the subsidiaries, participations, or assets of SOEs or public holding companies. Where a law is necessary or desirable, it mav be preferable to limit its pro- visions to the minimum needed to ensure efficient privatization. New legis- lation will be required for operations that cannot be executed (or cannot be executed efficiently) under existing law. Privatization laws will often embody provisions designed for remedying the main gaps in the rules regu- lating the market economy or the functioning of the public sector or for introducing support measures deemed necessary for the success of privati- zation. Provisions of this kind represent what mav be called facilitating pro- visions, as opposed to the enabling provisions u1utlorizing the privatization process itself. The scope of the necessary legislative amenidmiienlts is much broader when it comes to privatizing sectors that were under public monopoly. In such instances, provisions establishing the old monopoly will need to be repealed and replaced by a new sectoral organization; new rules governing the entry of operators into the sector and the terms of their access to any remaining bottleneck facilities; and new institutions and mechanisms to regulate the demonopolized sector. The complexity and sector-specificity of many of these provisions have often led to sectoral privatization laws. The privatization law proper should reflect the broad political lines of the privatization strategy and program. It should also endow the government or privatization agency with the required implementation powers, and it should avoid restrictions that may unduly tie the hands of the executing agencies and slow down the process. The legislation must allow adequate flexibility (for example, in the choice of the privatization technique best suited to each case), while providing basic safeguards guaranteeing the integrity and efficiency of the process. Success of the program hinges on, among other thinlgs, a basic consensus among parliament, government, and head of state on the scope and broad lines of the program; a clear mandate given to the executing agencies along with the powers necessary for fulfill- ing that mandate; and unambiguous, flexible, and competitive privatization procedures applied in a transparent manner by officials accountab]e for their actions. Furthermore, subordinate legal instruments should be used where they are equally or better suited, leading to greater latitude in actual implementa- tion. Examples of subordinate instruments include not only decrees, imple- menting regulations, directives, and administrative decisions but also con- tractual agreements negotiated with buvers. The danger is, however, that under similar circumstances different deals might be struck with different buyers, which could undermine the legitimacv of the process. A final important point is to guard against legislative optimism. Even if the legislator could correctly predict the major problems that might arise 298 Thle Privatization Challengec during execution of the privatization program and set up the optimal legal framework for handling privatization, the program's success would not be guaranteed. The legislation would still need to be applied effectively, which assumes that the necessary institutions and resources exist or are put in place and that each operation is prepared, structured, negotiated, and exe- cuted competently and with integrity. The institutional challenge of privati- zation is hence twofold: to develop good strategies and good programs, and to set up efficient institutions and mechanisms through which to implement them. These strategies, programs, institutions, and mechanisms, as well as the underlying legal framework, need to be adaptable and able to respond to lessons of experience and changing circumstances. Role of Advisers The broad range of policy and legal issues that shape and affect the privati- zation process are, by and large, new for governments. Government admin- istrators rarely have all the skills and experience required to analyze these new issues and to address them effectively. Outside experts with specialized skills and knowledge of the experience of other countries are almost always called for. Economists, lawyers, financial advisers, and other consultants have thus played an important role, and worked toward a common goal, in privatizations in most countries. Proper coordination and integration of these advisory inputs is important and often difficult. Infrastructure privatization affords a good illustration. Economic analysis should normally set the stage for strategy formulation, although legal and other technical input is also needed from the outset. Once the broad strategy, including breakup of monopolistic sectors and introduction of competition, has been adopted, lawyers and financial advis- ers will tend to take the lead from economists and policy advisers as the privatization transactions are implemented. A multitude of laws and regulations need to be taken into account or amended as part of the preparation of a privatization program, and lawyers have a creative role to play in this exercise. Their job is to find ways to imple- ment privatization despite any obstacles, not just to draw attention to those obstacles without recommending ways to address them. Lawyers will, of course, also have a central, and more traditional, r ole to play in drafting doc- uments and advising the seller and the btuyer in negotiations on the reams of agreements and contracts pertaining to privatization transactions. Many of the special provisions of privatization laws discussed in this book have been addressed in these contractual documents rather than through legislation. Once a privatization operation has been completed, guarantees are required to ensure compliance by all of the parties with the terms of the privatization agreements. Efficient enforcement mechanisms will be needed, disputes will have to be settled, and noncompliance penalized. The new regulatory framework may need to be fine-tuned and amended to bet- Meeting the Prizvatization7 Challenge 299 ter tailor it to new or unexpected developments. All of this will require inputs from experts. In brief, the scope and complexity of the legal issues to which privatiza- tion programs can give rise are practically unlimited; they concern both public and private law and domestic, international, and foreign law. To meet this challenge, privatizing governments must secure the services of quali- fied, experienced, and independent lawyers to help them identify and resolve critical problems for each operation. This is a necessary but not a suf- ficient prerequisite for success: necessary, because law is at the heart of the privatization process, though not sufficient in itself, because the legal aspects of privatization are only one component among many others to be taken into consideration. A Multidisciplinary and Empirical Approach Political, administrative, legal, economic, financial, technical, social, and other dimensions of privatization are equally important and directly affect the design of the privatization program, the content of the privatization leg- islation, and the way program and law are implemented. Law is not an end in itself; it is a reflection of social and political values and priorities. The purpose of this book is to contribute to a better integration of the stra- tegic, economic, political, legal, and institutional aspects of privatization. Law was used as the common thread throughout, though greater emphasis was placed on economic analysis in discussing the reform and privatization of infrastructure sectors. Most economic liberalization and privatization programs require amendment of existing legal norms to make them suitable for new strategies and policies. The analysis was based not on a review or comparison of privatization-related laws but on the actual experiences of many countries, the problems encountered, and the solutions applied, the good ones as well as the not-so-good ones. This multidisciplinary and comparative overview of privatization experi- ence has shown that each country needs to tailor its approach to its specific objectives and constraints. This means that there is no universally applicable model privatization program or law. Nevertheless, the process can be sub- stantially enriched by examining the lessons drawn from other countries' experience. This book contributes to the dissemination of these lessons of experience. Appendix Privatization Legislation, by Country This list of privatization legislation is not exhaustive It encompasses laws, decrees, and regulations currently in force and others that have since been abrogated or amended. Wherever possible, the references contain the correct title and the date of the instrument; some titles are translations, while others describe the content of the instrument. Some references are taken from newspapers or journal articles and are not necessarily accurate. Albania Law no. 7512 authorizing and protecting private ownership, freedom to engage in independent private activities, and privatization 1August 10, 1991) Decree no. 22 promulgating Law no. 7512 of August it), 1991 (August 15,1991) Council of Ministers Decision no. 307 on the rights and duties of the National Privatization Agency and the Commission for Preparation of the Privatization Process (August 29, 1991) Council of Ministers Instruction no. 3 on the organization) of the work and implementation of the transition from public to private ownership through auction sales (August 30, 1991) Law on commercial companies (November 19. 19n2) Law no. 7698 on restitution of property to and compensation of former owners (April 15, 1993) Law no. 7699 on compensation to former owners ot agricultural land (April 15,1993) Decree no. 248 of the Council of Ministers on the acceleration of privatization (April 1993) Decree no. 47 of the Council of Ministers onI evalua tion of state-owned property (May 1993) Land Law (June 1993) Law on foreign investment (November 1993) Decree no. 93 of the Council of Ministers on the transformation of state-owned enterprises in to commercial companies (Februarv 1994) 30)1 302 The Privatization Chal1enge Decision no. 234 on measures for the acceleration of privatization of small and medium-sized enterprises (May 24, 1994) Decree on the issuing and distribution of privatization vouchers (March 1995) Law no. 7971 on public procurement (July 26, 1995) Law no. 7973 on concessions and participation (if the private sector in public services and infrastructure (July 26, 1995) Law no. 7979 on investment funds (July 26,1995) Algeria Decree no. 87.266 on the creation and organization of the National Planning Council (December 8, 1987) Law no. 88.01 on public enterprises (January 12,1988) Law no. 88.02 on planning (January 12,1988) Law no. 88.03 on Participation Funds (January 12, 1988) Ordinance no. 95.22 on the privatization of public enterprises (August 26, 1995) Argentina Law no. 22177 authorizing the national government to privatize state-owned enterprises and assets (March 4,1980) Law no. 23696 on state reform (August 18,1989) Law no. 23697 on the state of economic emergency (September 15, 1989) Decree no.1105/89 implementing Law no. 23696 of August 18,1989 (October 1989) Decree nos. 377/89, 570/89, 769/89, and 824/89 implementing Law no. 23697 of September 15, 1989 (1989) Decree nos. 731 /89, 59/90,60/90, 61/90, 62/90,420/90, 575/90, 636/90, 677/90, 1130/90, 1185/90, 1229/90, 1230/90, 1948/90, 1967/90,1968/90, 2096/90, 2332/ 90, 2344/90, 2345/90, 2346/90, 2347/90, 2762/90, and 778/91 on privatization of ENTEL Decree nos. 575/90,105/90, 1948/90, and 2074/90 Law no. 23883 on the creation of a national fund to finance private production activities (October 24, 1990) Decree nos. 1443/91 and 2408/91 on the privatization of the Buenos Aires water supply company (1991) Decree no. 2515/91 Law no. 24045 (December 31,1991) Law no. 24065 on electricity (January 16,1992) Law no. 24076 on regulatory framework for the gas ind ustry and privatization of Gas del Estado (June 12,1992) Decree no. 999/92 on potable water supply and sanitation services concessions (June 18, 1992) Decree no. 1189/92 on establishing new gas companies (July 1992) Decree no. 1398/92 implementing Law no. 24065 of January 16,1992 (August 11, 1992) Decree 1738/92 implementing Law no. 24076 of June 12,1992 (September 18,1992) Law no. 24145 on privatization of YPF S.A. (hydrocarbons) (November 6,1992) Appendix: Privatization Lcgislatioin, bki CotnTtnri 303 Law no. 24155 on privatization of the National Savings and Insurance Bank and the National Development Bank (1 992) Decree no. 2108/92 on privatization of Aceros Parana S.A. (1992) Decree 2255/92 regulating the transportation and distribution of natural gas (December 7,1992) Decree no. 2339/92 creating the National Railways Regulatory Commission (December 4,1992) Decree nos. 2451/92 through 2460/92 on the transportation and distribution of natural gas (1992) Decree nos. 51/92, 214/92, 839/92, and 2514/92 Decree no. 2792/92 approving the by-laws of Encotesa (December 1992) Resolution no. 551/92 (as amended by Resolution no. 873/92) setting the conditions and procedures for debt-for-shares swaps (1992) Ministry of Economy resolution nos. 1386/92, 1457/'12, 68/93, and 69/93 on railway concessions Decreeno. 1108/93 implementing Law no. 24145 of November 6,1992 (May31,1993) Decree no. 1186/93 on measures to secure free competition in the marketing of natural gas (June 9, 1993) Decree no. 1863/93 on the creation of the National Commission of Railway Transportation (September 1, 1993) Decree no. 454/94 on the creation of the Arbitral Tribunal of Railway Transportation (March 24,1994) Decree no. 455/94 on the jurisdiction of the National Commission of Railway Transportation (March 24,1994) Armenia Law on ownership (October 31,1990)) Decree of the Supreme Soviet on the principles of privatization (February 13, 1991) Law on privatization and denationalization of state-owned enterprises and projects under construction (August 27, 1992) Australia Law on public enterprises of the State of New South Wales (1989) Austria Amendment to the second nationalization law (July 2, 1987) Azerbaijan Law on divestiture and privatization (January 1993) Law on enterprises (July 1994) Law on privatization (July 21,1995) Bahamas, The Public Utility Commission Act (1993) 304 Tnh' Privatizatioin Challenge Belarus Law on property ownership in Belarus, and implemeniting decree (November 9, 1991) Law on divestiture and privatization of state-ownied property (January 19, 1993) Supreme Council decree on implementationi of the law oni divestiture and privatization of state-owned property (January 19, 19'3) Law on registered privatization vouchers (July 7, 1 993) Regulation defining the methods of sale of shares and othlir state property (May 1994) Belgium Law on the organization of the public credit sector and standardization of the supervision and conditions of operation of credit establishments (June 17, 1991), as amended by royal decree of September 27,1993, bv law of December 27, 1993, and by royal decree of April 7, 1995 Royal decree oni the State Plroperty Valuation Commission (October 8, 1992) Law containing fiscal and financial provisions (July 22, 1993), as amended by law containing various social and other provisionis (December 21, 1994) Royal decree approving amendment of the bylaws of the Societe Nationale de Credit a l'Industrie (May 30, 1994) Royal decree instituting a golden share in Synatom reserved to the government (June 10, 1994) Royal decree instituting a golden share in Societe Nationale de Transport par Canalisations reserved to the government (June 0, 1994) Royal decree establishing the Societe Federale d'lnvestissenment (June 1i), 1994), as amended by Royal decree of September 16, 1994 Royal decree institutinig a golden share in Distriga/ reserved to the government (June 16, 1994) Royal decree containing various provisions pertaining to the Societe Federale d'lnvestissement and privatization of the Soci6te Nationale d'lnvestissement (June 16,1994) Royal decree regulating the procedures for transfer of government-held shares in the Societe Nationale d'lnvestissement to the Caisse Generale d'Epargne et de Retraite-Hlolding (July 20, 1994) Royal decree on the acquisition of quoted shares of Distrigaz (July 2), 1994) Royal decree amending the bylaws of Societe Nationale de Credit a l'Industrie and regulating the transfer of government-held shares in the Societe Nationale de Credit a lI'ldustrie to the Caisse Generale d'Epargnc et de Retraite-l-lolding (July 20, 1994) Benin Law no. 88-005 on the creation, organization, and functioning of public and semipublic enterprises (April 26, 1988) Decree no. 88-351 defining privatization techniques, procedures, and responsibilities (1988) Decree no. 89-15 setting up a privatization bids appraisal commission (1989) Appendix: Privatization Lcx'isfationi, hY Cont ritrn .305 Law no. 92-0223 (replacing Decree no. 88-351) laying down the basic principles of denationalization and transfer of ownershiip of enterprises from the public to the private sector (August 6, 1992) Decree no. 92-340 on the composition, organization, and functioning of the technical commission on denationalization and transfer of ownership of enterprises from the public to the private sector (December 7,1492) Bolivia Supreme Decree no, 210)60 (August 29, 1985) Supreme Decree no. 22836 on public enterprise reorg,nization and state participation in mixed enterprises (June 14, 19n1) Law no. 1330 on privatization (May 1992) Supreme Decree no. 23171) on implementation of Law no. 1330 (June 1992) Law no. 1544 on capitalization (March 21, 1994) Law no. 1601(0 on the system for sector regulation (SIRISE) (October 28, 1994) Supreme Decree no. 23985 on implementation of Law no. 1544 (March 30, 1995) Electricity Law (December 1994) Supreme Decree no. 23991 on public enterprise reorganization (April 10, 1995) Law no. 1732 on private pension funds (November 29,199o) Brazil Decree no. 91991 containing provisions on the proces of the privatization of enterprises under the direct or indirect control of the federal government, and other measures (November 28, 1985) Decree no. 95886 on the Federal Divestiture Program (March 29, 1988) Law no. 6629 authorizing the executive of the State of Sao P'aulo to transfer control of the capital of Viac,lo Aerea Sao Paulo S.A. (December 27,1989) Law no. 8018 on privatization vouchers (April 11, 1990) Law n1o. 8031 authorizing the National Destatization Program (0NI)) (April 12,1990), as amended and consolidated bv Decree no. 724 (lanuary 19,1993) and further modified by provisional measures no. 327 (June 24, 1993), no. 415 (January 21, 1994), and no. 432 (February 23, 1994) Decree no. 99463 appointing BNDES for implementation of the l'NI) (August 16, 1990) Decree no. 99464 on privatization of Usiminas (AAugust 16,199() Decree no. 99469 regulating the privatization procedure (August 1990) Provisional measure no. 299 interpreting Law no. 8031 of April 12, 199(0 (October 1, 1991) Law no. 8250 on l'ND (October 24, 1991) Law no. 863(0 on port operations (February 25, 1993: Decree no. 1068 (1994) Law no. 8987 on public services concessions (February 13, 1995) Law no. 91)74 on the modernization of public service regulation, especially in the electric sector (Julv 5, 1995) 306 The Privatizatiotn Challengle Bulgaria Decree no. 56 on economic activity (January 9, 1989) Decree no. 36 on the development of private and individual initiative in commerce, tourism, and services (April 10, 1990) Decree no. 16 establishing the privatization agency (February 8, 1991) Decree no. 42 on the adoption of regulations for auctioning state and municipal property (March 14, 1991) Law on the conversion of state-owned enterprises into private companies (June 27, 1991) Law on the restitution of nationalized real estate property (February 5, 1992) Law on the restitution of property expropriated under the aegis of previous laws (February 5, 1992) Law on transformation and privatization of state and municipal enterprises (April 23, 1992) Decree no. 105 on the adoption of regulations for the auction sale and valuation of assets subject to privatization (June 15, 1992) Law regulating small-scale privatization (January 1993i Decree on preferential participation (1993) Decree for the establishment of a fund to cover privatization expenditures (1993) Law on mass privatization (June 9, 1994), as amended on December 1, 1995 Law on concessionis (1995) Burkina Faso Ordinance no. 91-0042/PRES (1991) Ordinance no. 91-0044/PRES authorizing privatization of 12 enterprises and creating the Privatization Commission (July 17, 1991) Decree no. 91-0385/MC[M on the composition, organization, and functioning of the Privatization Commission (September 26, 1991) Burundi Decree-Law no. 1/027 defining the organic framework of public-law companies and private-law joint-venture companies (September 28,1988) Decree-Law no. 1 /21 on the privatization of state-ownied enterprises (August 12, 1991) Decree-Law no. 100/133 on appointment of the Inter- Ministerial Privatization Committee (August 13, 1991) Ministerial Ordinance no. 120/321 prescribing the competitive bidding procedures for the privatization of state-owned enterprises (October 4, 1991) Cameroon Law no. 89/030 authorizing the president of the republic to legislate by ordinance with respect to the privatization of public and semipublic entities (December 29, 1989) Appetdix: Privatization Legislation, by Country 307 Ordinance no. 90/004 on the privatization of public and semipublic enterprises (June 22, 1990) Decree no. 90/1257 on implementation of Ordina nce no. 90/004 of June 22,1990 (August 30, 1990) Decree no. 90/1423 on the privatization of certain public and semipublic enterprises (October 3,1990) Canada Canada Development Corporation Act (June 30, 1971) Atlantic Fisheries Restructuring Act (November 30, 1983) Financial Administration Act (June 29, 1984) Act authorizing divestiture of Northern Transport Company Ltd (June 28, 1985) Canada Development Corporation Reorganization Act (December 20,1985) Act authorizing divestiture of Canadian Arsenals Company Ltd (May 1, 1986) Act authorizing divestiture of Canadair Ltd (December 19, 1986) Act authorizing alienation of assets of the Northern Canadian Energy Commission located in the Yukon (March 26, 1987) Teleglobe Canada Reorganization and Divestiture Act (April 1, 1987) Eldorado Nuclear Ltd Reorganization and Divestiture Act (July 28, 1988) Act concerning public participation in the capital of Air Canada (August 18, 1988) Nordion and Theratronics Divestiture Authorization Act (January 30,199t0) Petro-Canada Public Participation Act (Februarv 1, 1991) Canada Reorganization and Divestiture Act (December 17,1991) Debt Service Account and Debt Reduction Act (June 18, 1992) Cape Verde Law no. 52/111/89 demarcating ownership in economic sectors (July 13, 1989) Law no. 47/IV/92 on privatization (July 5,1992) Decree no. 116/92 creating an advisory agency to the government on privatization (September 17,1992) Chad Ordinance no. 017/PR/92 authorizing divestiture of state enterprises (August 29, 1992) Decree no. 460/PR/MCDI/92 concerning the technical commission on the organization and functioning of divestiture (1992) Chile Decree-Law no. 2564 on civil aviation (March 1979), as amended by Law no. 18243 (September 1983) Decree-Law no. I on electricity services (June 22, 1982) Law nos. 18398 and 18401 on popular capitalism (1985) Law no. 18747 on labor capitalism (1988) 308 The Privatization Challenge Decree-Law no. 381 on concessions (1988) General Law no. 18168 on telecommunications (October 2,1982), as amended by Law nos. 18482 and 18591, Decree-Law no. 1 of 1987, and Law nos. 18681 (December 31, 1987) and 18838 (September 30,1989) Decree-Law no. 382 on sanitation services (June 21, 1989) Law no. 18922 on electricity services (January 30, 1990) Decree-Law no. 164 on infrastructure concessions (July 22, 1991) Supreme Decree no. 240 on regulation to Decree-Law no. 164 of July 22,1991 (April 1992) Law on electric concessions (November 6,1992) Law no. 19252 modifying Decree-Law no. 164 on infrastructure concessions (October 11,1993) China Regulation implementing on an experimental basis the registration of Chinese business groups (May 4, 1992) Standard Opinion of the State Committee on Economic Restructuring on joint-stock companies (May 15,1992) Measures on implementing the transformation of the operational mechanism of state-owned commercial enterprises, promulgated by the Ministry of Commerce, the State Economic and Trade Office, and the State Commission for Restructuring the Economic System (November 6,1992) Provisional regulationls promulgated by the State Council on the issue and sale of shares (April 22, 1993) Addendum to the Standard Opinion issued by the State Committee on Economic Restructuring (May 24, 1993) Colombia Decree nos. 2132,2139, 2140, and 2142 (1992) Law no. 35 on the privatization of financial-sector entities (January 5, 1993) Law no. 37 authorizing shareholding by private investors in the cellular mobile telephone service (1 993) Law no. 80 on contracts of the public administration (October 28, 1993) Law no. 142 on residential public services (1994) Law no.143 on electricity (July 1994) Law no. 226 on alienation of state-owned shares (1995) Congo Law no. 21-94 on the framework for privatization (August 10, 1994) Decree no. 94-424 on the organization and functioning of the Privatization Committee (September 1, 1994) Decree no. 94-425 on the implementation procedures tor the privatization of public enterprises (September 1, 1994) Decree no. 94-426 on valuation of enterprises (September 1, 1994) Appendix: Privatization Legislation, by Countr y 309 Decree no. 94-427 on the level of participation by the state and other subscribers (September 1, 1994) Decree no. 94-428 on the conversion of debt into shares (September 1, 1994) Decree no. 94-429 on the conditions of eligibility for participants in the privatization program (September 1, 1994) Decree no. 94-430 on exceptions to the cash payment principle (September 1, 1994) Costa Rica Law no. 6955 on public-sector financial equilibrium (February 24, 1984) Law no. 11060 on the Regulatory Authority for Public Utilities (national electricity services transformation) (October 31, 1990) C&te d'Ivoire Decree no. 87-197 authorizing transfer of the government's holding in the capital of Societe Ivoirienne des Tabacs (February 6, 1987) Decree no.90-1610 authorizing transfer to the private sector of shares and participation held by juridical persons under public law, creating entities responsible for the program of privatization and restructuring of the parastatal sector, and defining the implementing procedures for that program (December 28, 1990) Order (arrete) no. 002 appointing the members of the l'arastatal Sector Privatization and Restructuring Committee (June 3,1991) Law no. 94-338 on the privatization of state-owned shares and assets in certain domestic public enterprises and establishments (June 9, 1994) Decree on implementing procedures for Law no. 94-338 of June 9,1994 (1994) Decree no. 94-520 on the composition, functioning, and responsibilities of the Privatization Committee (September 21, 1994) Croatia Law on the transformation of enterprises with social capital (April 18,1991), revised 1993, 1994 Czechoslovakia Law no. 105/90 on private enterprise by citizens (and supplement thereto) (April 18, 1990) Law no. 403/90 on the alleviation of certain injustices with respect to property (October 2, 1990) Law no. 427/90 on the transfer of ownership of certain state-owned assets to other juridical or natural persons ("Small-Scale Privatization Law") (October 25, 1990) Czech National Council Law on the jurisdiction of the institutions of the Czech Republic with respect to the transfer of state property to other juridical or natural persons (November 15,1990) Law no. 87/91 designed to redress results of injustices committed during the period 1948-89 ("Extra-Judicial Rehabilitation Law" or "Restitution Law") (February 21, 1991) 310 The Privatization Challenge Law no. 92/91 on the conditions of transfer of state property to other persons ("Large-Scale Privatization Law") (February 26, 1991) Czech National Council Law no. 171/91 on the jurisdiction of the agencies of the Czech Republic with respect to the transfer of state property to other persons, and on the Czech Republic Assets Fund (April 23,1991) Law no. 172/91 on transfer of ownership from the government of the Czech Republic to municipalities (April 24,1991) Law no. 229/91 on adjustments to ownership rights pertaining to land and other agricultural assets (May 21,1991) Slovak National Council Law no. 253/1991 on the jurisdiction of the agencies of the Slovak Republic with respect to the transfer of state property to other persons, and on the Slovak Republic Assets Fund (May 24,1991) Government Decree on the issue and use of investment coupons (September 5, 1991) Law on the conditions of transfer of state property to other persons, amending and supplementing Law no. 92/91 of February 26, 1991 (February 18, 1992) Law no. 248/92 regulating privatization investment funds and investment companies (April 28,1992) Czech Republic (see also Czechoslovakia) Law no. 222 on energy (1994) Djibouti Law on economic and social objectives, 1990-2000 Company Law (1988) Law on exclusive concessions (1989) Law authorizing the privatization of specified public enterprises Dominican Republic Law no. 14-90 authorizing private-sector participation in electric power generation and distribution (February 1990) Ecuador Law no. 50 on modernization of the state, privatization, and delivery of public services by the private sector (October 21, 1993) Executive Decree no. 1335 establishing the Ministry of Finance unit responsible for modernization of the state (January 5, 1994) Egypt, Arab Republic of Law no. 230 on joint-venture companies (1989) Law no. 203 on public-sector commercial enterprises (June 19,1991) Prime Minister Decree no. 1590/1991 on the implementing regulations for Law no. 203 of June 19,1991 (1991) Law no. 95 on capital markets (June 1992) and executive regulations (April 1993) Appendix: Privatization Legislationl, by Countriy 311 El Salvador Amendment to the 1983 constitution, allowing private enterprises to manage public services (1994) Estonia Law on privatization of state-owned enterprises in the service, trade, and food sectors (December 13, 1990) Law on the principles of property reform (with implementing decree) (June 20, 1991) Law on land reform (November 1991) Law on foreign investment (1991) Resolution signed by the chairman of the Supreme Council prescribing the conditions and procedures for the privatization of ,tate and municipal property (August 13,1992) Resolution of the chairman of the Supreme Council on commencement of the sale of shares of state-owned enterprises (August 13, 1992) Law on bankruptcy (November 1992) Decree no. 36 on the procedure for the restitution of illegally expropriated property (February 5, 1993) Law on privatization (June 17, 1993) Decree on the issue of privatization vouchers (November 1993) Law on securities market (September 1993) Property Law (December 1993) Accounting Law (July 28, 1994) Government decree on procedures for public offering of shares in state-owned enterprises (August 1994) Government decree on investment funds (August 1994) Finland Guidelines of the Council of State on the capitalization of state-controlled companies (June 23,1994) France Constitutional Council Decision no. 86-207 on the enabling law authorizing the government to take various economic and social measures (June 25 and 26, 1986) Law no. 86-793 authorizing the government to take various economic and social measures (July 2, 1986) Law no. 86-912 on the procedures for implementation of the privatization decided on by Law no. 86-793 of July 2,1986 (August 6, 1986) Decree on the appointment of members to the Privatization Commission (September 9,1986) Decree no. 86-1067 on freedom of communications (September 30,1986) Decree no. 86-1140 on the application of Law no. 86-912 of August 6,1986 (October 24, 1986) 312 The Privatization Challenge Decree no. 86-1141 on the application of article 1 0 of Law no. 86-912 of August 6,1986 (October 25, 1986) Instruction no. 4 B-5-86 on privatization, portfolio, and shares of enterprises (November 12, 1986) Instruction no. 5 G-15-86 on system governing private capital gains on the transfer of securities and social rights with respect to privatization (December 15,1986) of the Privatization Commission (January 14,1987) Order (arrete) prescribing the procedures for privatization of Compagnie Financi&e de Paribas (January 16, 1987) Order (arrtef) setting the exchange values of debt paper assigned in payment for the shares of Compagnie Financi&e de Paribas transferred by the government by public offering for sale of January 19,1987 (January 16, 1987) Instruction no. 2 0-3-87 on stamp duty and assimilated duties, and powers of representation of shareholders at general meetings on the privatization of certain enterprises (March 6, 1987) Instruction n(o. 5 F-15-87 on benefits accorded to employees under privatization operations and other issues relating to exempted salaries, wages, pensions, and annuities (August 24, 1987) Instruction no. 2 0-7-87 on stamp duty and assimilated duties, and transfer of the national program company "Television Francaise 1" (September 1,1987) Decree no. 88-1054 on the Public Enterprises Valuation Commission (November 22, 1988) Law no. 89-465 amending Law no. 86-912 of August 6,1986, on implementing procedures for privatization (July 10, 1989) Law no. 90-560 on corporatization of the Regie Nationale des Usines Renault (July 4, 1990) Decree no. 91-332 on minority opening of public enterprise capital (April 4, 1991) Law no. 93-122 on prevention of corruption and transparency in economic activities and public procedures (1oi Sapin) (January 29,1993) Law no. 93-923 on privatization (July 19, 1993) Decree no. 93-930 on the application of Law no. 93-923 of July 19, 1993 (July 21, 1993) Order (arrete) setting the swap value of government debt paper (6 percent, July 1997) assigned in payment for the shares of Banque Nationale de Paris transferred by the government through public offering on October 5, 1993 (October 4, 1993) Order (arrNe') prescribing the procedures for privatization of Banque Nationale de Paris (October 4,1993) Decree no. 93-1190 on the election of the members of the bid opening commission for the award of local public service concessions (October 21, 1993) Opinion of the Privatization Commission on the minimum value of Rhone-Poulenc (November 10, 1993) Order (arr2teC) prescribing the procedures for privatization of Rh6ne-Poulenc S.A. (November 15,1993) Order (arrite) setting the swap value of government debt paper (6 percent, July 1997) assigned in payment for the shares of Rhone-Poulenc transferred by the government through public offering on November 16,1993 (November 15,1993) Appendix: Privatization Legislation, by Country 313 Decree no. 93-1296 on the application of article 10 of Law no. 86-912 of August 6, 1986, as amended, on privatization procedures and certain rights pertaining to golden shares (December 13, 1993) Decree no. 93-1297 amending Decree no. 86-1141 of October 25, 1986, on application of article 10 of Law no. 86-912 of August 6, 1986, on privatization procedures (December 13, 1993) Decree no. 93-1298 instituting a golden share reserved to the government in Societe Nationale Elf Aquitaine (December 13, 1993) Circular on jurisdiction (saisiie) for application of article 10.1 of Law no. 86-912 of August 6, 1986, on privatization procedures, as amcnded by Privatization Law nlo. 93-923 of July 19, 1993 (April 5, 1994) Opinion of the Privatization Commission on the minimum value of Union des Assurances de Paris (April 21, 1994) Order (nrrNte) prescribing the procedures for privatization of Union des Assurances de Paris (April 25, 1994) Law no. 94-679 on various economic and financia I provisions, particularly articles 17 and following, on company law and Air France (August 8, 1994) Law no. 95-127 on public procurement and concessions (February 8, 1995) Decree no. 95-635 on annual reports on price and quality of water and sewerage services (May 6, 1995) Law no. 96-659 on regulation of telecommuniications (July 26, 1996) Gabon Law on privatization (February 13, 1996) Georgia Law on the privatization of state enterprises of the Republic of Georgia (with implementing decree) (August 9, 1991) Government decree on the sale by auction of state-owned propertv (May 28, 1992) Decree of the State Council on the government program of privatization of state- owned enterprises of the Republic of Georgia (August 18, 1992) Government decree on the government program of privatization of state-owned enterprises of the Republic of Georgia (August 25, 1992) Presidential decree on large-scale privatization (May 1994) Decree on widening employee rights upon the transformationl of state entities into joint-stock companies (May 1994) Law of the Republic of Georgia on foreign investment (1995) Germany Law on privatization and reorganization of publicly owned assets (Treuhandgesetz, or Trusteeship Law) (June 17, 1990); this law was adopted by the East German parliament before reunification. Unification Treaty (August 31, 1990), particularly article 25. incorporating the Treuhandgesetz (Trusteeship Law) into German Ilw and amending it; and annex 314 The Privatization Challenge containing the law on the settlement of outstanding ownership questions (amended in March 1991) Omnibus Law on the elimination of obstacles to the privatization of enterprises and on investment promotion (March 22, 1991) Law on the restructuring of enterprises under Treuhandanstalt administration (Spaltungsgesetz of April 5, 1991) Law on the finalization of the privatization activities of the Treuhand agency (August 9,1994) Law modifying the Basic Law (Gesetz zur Anderung des Grundgesetzes) with an insertion on public oversight and ownership of post and telecommunications (August31, 1994) Law on the construction and financing of federal roads and motorways by private enterprise (August 1994) Law on the new organization of postal services and telecommunications (September 14,1994) Ghana Divestiture of state interests (implementation) Law 1993 (January 5, 1993) Greece Law no. 1892/90 (1990) Law no. 2000/91 on denationalization (1991) Law on the privatization of telecommunications (I 994) Guinea Ordinance no. 306 PRG-85 on the privatization of industrial-type public enterprises (December 12, 1985) Ordinance no. 318 PRG-85 applying the reorganization measures cited therein to certain specified enterprises (December 21, 1985) Decree no. 194-PRG-86 on liquidation of commercial-type public enterprises (October 7,1986) Ordinance no. 0/91/025 on the institutional framework of public enterprises (March 11, 1991), as amended by Ordinance no. O/92/022/PRG/SGG (May 26,1992) Decree no. D/92/133 prescribing the conditions of application of Ordinance no. O/ 91/025 of March 11, 1991 (May26,1992) Law no. L/92/016 on the general regulation of telecommunications (June 2, 1992) Law no. L/93/037 prescribing the rules for privatization of public enterprises (August 20, 1993) Decree no. D/93/208 on application of the public enterprises privatization law (October 21, 1993) Guinea-Bissau Council of Ministers decree creating the public enterprises reform management unit (UGREP) (February 28,1990) Appendix: Privatization Legislation, by Country 315 Honduras Decree no. 161-85 on privatization covering procedures applicable to four institutions (October 10, 1985), as amended by Decree no. 178-92 of October 30, 1992 Decree nos. 03-93 and 04-93 on the extension of the application of Decree no. 161-85 and its regulations to all public institutions and on the creation of the Consultative Commission for Privatization (September 7, 1993) Decree no. 135-94 mandating the government to propose a plan for the privatization of Hondutel and a framework for managing telecommunications in Honduras (1994) Decree-Law no. 153-94 containing the framework law for the electricity sector (November 26,1994) Hungary Law no. 24 (company law) (1988) Law no. 13 on conversion of management organizations and business associations (May 30, 1989) Law no. 5 on private enterprise (1990) Law no. 7 establishing the State Property Agency to manage and utilize state property (Oanuary 26,1990), amended by Law no. 53 of July 25, 1990 Law no. 8 on the protection of property entrusted to state enterprises (january 26, 1990) Law no. 18 amending Law no. 13 of May 30, 1989 (1990) Law no. 72 amending Law no. 13 of May 30, 1989 (September 11, 1990) Law no. 74 on privatization (alienation, utilization) of state-owned companies engaged in retail trade, catering, and consumer services (September 18,1990) Law no. 16 on concessions (1991) Law no. 25 on partial compensation for damage caused by the state to citizens' property (compensation law) (June 26,1991), as amended by Law no. 50 of 1991 Law no. 69 on financial institutions (November 30,1991) Law no. 24 on partial compensation for confiscation of citizens' property by the state pursuant to laws enacted between May 1, l939, and June 8, 1949 (April 7, 1992) Law no. 39 on concessions in the field of transport and water management (1992) Law no. 44 on employee's share ownership program (June 1992) Law no. 54 on the sale, utilization, and protection of assets of which the state is provisional owner (1992) Law no. 72 on telecommunications (November 23, 1992) 1993 budget law regarding use of privatization receipts (December 28,1992) Law no. 41 on gas supply (March 29, 1994) Law no. 48 on the production, transport, and supplv of electric energy (April 6, 1994) Law no. 39 on the sale of state-owned enterprises (Mav 9,1995) India Sick Industrial Companies (Special Provisions) Act (1985), as amended in December 1991 316 The Priv'atization Challenge Indonesia Law no. 3 on telecommunications (April 1, 1989) Presidential Decree no. 37 on private participation in the electricity sector (1992) Government Regulation no. 8 on private participation in the telecommunications sector (1993) Government Regulation no. PP 20 on foreign investment (May 19,1994) Iran, Islamic Republic of Decree no. 5283/T 109H on the policy of transfer of government-owned shares and public enterprises and organizations (June 19, 1991) Decree no. 61164/T 466H on privatization of industrial enterprises (February 9,1992) Decree no. 121 3/T I 8H amending Decree no. 5283/T 109H of June 19,1991 (April 24, 1992) Decree no. 8456/T 87H on privatization of mines (May 13, 1992) Resolution no. 113 DSh on privatization of agricultural enterprises (June 15,1992) Decree no. 34/785 on privatization of the tourism industry (August 9, 1992) Decree no. 51021 /T 490H replacing the Privatization Commission set up by Decree no. 5283/T 109H of June 19, 1991, by a Secretariat (December 27,1992) Israel Law amending the law on state-owned companies (August 1993) Italy Law no. 218 on privatization of banks (July 31, 1990) Decree-Law no. 356 on privatization of banks (November 20, 1990) Law enabling BOTs in electricity generation (1991) Decree-Law no. 386 on the conversion of public enterprises (December 1991) Law no. 35 on conversion of government holding companies, liquidation of government holdings and transfer of public assets that may belong to the private sector (anuary 29, 1992) Law no. 58 on reorganization of the telecommunications sector (January 1992) Law no. 149 (February 18, 1992) Decree-Law no. 333 (July 11, 1992), ratified by Law no. 359 on the corporatization of public enterprises (August 8,1992), as amended by Decree-Law no. 332 (May 31, 1994) Decree-Law no. 340 on liquidation of EFIM (Ente lartecipazioni e Finanziamenti Industria Manifatturiera) (July 18, 1992) Decree-Law no. 365 (August 14,1992) Decree-Law no. 124 creating private retirement funds (April 21, 1993) Decree of Chairman of Council of Ministers establishing the Standing Consultative and Guarantee Committee on Privatization (June 30, 1993) Law no. 344 creating mutual securities investment funds (August 14, 1993) Decree-Law no. 350 (September 10, 1993) Appendix: Privatization Legislation, by Cotintry 317 Decree-Law no. 389 on privatization (September 27, 1993), renewed by Decree-Law nos. 486 (November 29,1993), 75 (January 31,1994), and 216 (April 1, 1994) Law no. 422 converting Decree-Law no. 350 of September 10, 1993, into a law (November 8,1993) Decree-Law no. 332 on rules for acceleration of procedures for the retirement of share holdings of the State and public authorities in public limited companies (May 31, 1994) Law on the establishment of regulatory authorities (November 1995). Jamaica Telephone Act (1988) Law on employee's share ownership program (1994) Japan Telecommunications Business Law (December 1984) Law restructuring the national railways (November 1986) Kazakstan Law of the Kazak Soviet Socialist Republic (SSR) on denationalization and privatization (with implementing resolution) (July 1991) Presidential decree on the program of denationalization and privatization of state property for 1991-92 (first stage) and the voucher scheme for privatization of state property in the Kazak SSR (1991) Resolution no. 101 of the State Committee of the Kazak SSR on state-owned property (August 1, 1991) Law on protection of and support for private initiative (March 1993) Presidential decree on the program of denationalization and privatization of state property for 1993-95 (second stage) (March 5, 1993) Law amending the law of the Kazak SSR on denationalization and privatization (April 1993) Presidential Decree-Law no. 2721 on privatization (December 23,1995) Kenya Decree prescribing the institutional framework for the Parastatal Reform and Privatisation Programme (1992) The State Corporations (Privatization Exemptions) Order (1992) Korea, Republic of Law on the management of enterprises in which there is public shareholding Kuwait Decree no. 131 establishing the Kuwait Telecommunications Company (1992) 318 The Privatization Challenge Kyrgyz Republic Law on sale by competitive bidding and sale by auction (August 7,1991) Decree of the president on denationalization and privatization of state-owned property (August 7, 1991) Law on general principles of denationalization, privatization, and private initiative in the Kyrgyz Republic (December 20,1991) Decree on urgent measures to speed up denationalization and privatization (January 27, 1992) Law on concessions and foreign-concessioned enterprises in the Kyrgyz Republic (March 6,1992) Law on the State Property Fund (July 1, 1992) Law on denationalization and privatization of state-owned property in the Kyrgyz Republic (January 12, 1994) Decree of the president on the establishment of the Enterprise Reform and Resolution Agency (May 1994) Lao People's Democratic Republic Council of Ministers Decree no. 17/PCM on the conversion of state-owned enterprises to some other form of ownership (March 16, 1990) Decree of the Prime Minister no. 47/PM on the establishment of a permanent privatization committee (March 9, 1993) Latvia Law on entrepreneurial activity (September 26, 1990) Law on state enterprises (December 12,1990) Law on the privatization of agricultural enterprises and fishery collectives (with implementing decree) (June 21, 1991) Supreme Council resolution on the concept of privatization of state and municipal property and the preparatory program (March 3,1992) Law on the order of privatization of state and municipal property (June 16,1992) Law on the transformation of state and municipal property into statutory companies (September 1992) Law on state and municipal privatization funds (December 1992) Law on privatization of state and municipal property (February 1994) Law on the state property fund (February 1994) Law on state and municipal privatization commissions (February 1994) Lithuania Law on the initial privatization of state-owned property (February 28, 1991) Enabling decree to the law of February 28,1991 (March 14, 1991) Decree no. 238 on reorganization into smaller units of state enterprises and state stock corporations which are being privatized (June 19,1991), amended in part on June 24, 1992 Appendix: Privatization Legislationi, by CoI/11try 319 Law on the privatization of unprofitable state enterprises (July 23, 1991) Law on privatization of the property of agricultural enterprises (July 30, 1991) Law on the privatization of primary wealth (1991), as amended on December 18, 1991 Law on foreign investment (November 1991) Law on employee participation in privatization (May 1992) Law on the terms and conditions of restitution of ownership rights (1993) Law on mutual funds and investment companies (1943) Law on state enterprises not to be privatized or corporatized before the year 2000 (December 1994) Law on special purpose companies and their sphere of activities (Februarv 1995) Law on privatization of state and municipal property (July 1995) Macedonia, former Yugoslav Republic of Law on the transformation of enterprises with social capital (June 1993) Madagascar Law no. 93-001 on institutional reform of the telecommunications sector and the postal services sector (postal, money order, and checking services) (January 21, 1994) Malaysia Federal Roads (Private Management) Act (1984) Amendment to the Telecommunications Act of 1950 (1985) Electricity Supply Act (1990) Ports Privatization Act (1990) Airport and Aviation Services (Operating Company) Act (1991) Postal Services (Successor Company) Act (1991) Railways (Successor Company) Act (1991) Slaughterhouses Privatization Act (1993) Sewerage Services Act (1993) Mali Decree no. 88-21 /P-RM establishing a fund for laid-off employees of public enterprises (1988) Decree no. 88-34/AN-RM authorizing opening up the capital of state-owned and joint-venture companies (February 27, 1988) Ordinance no. 91-014/P-CTSP laying down the basic principles of the organization and functioning of industrial and commercial-type public establishments and state-owned companies (May 18,1991) Decree no. 91-051 /AN-RM prescribing the standard1 form and content of the bylaws of industrial and commercial-type public enterprises and the procedures for their legal dissolution (1991) 320 The Privatization Challenge Mauritania Ordinance no. 90-90 containing the bylaws of public establishments and public corporations and governing relations between these entities and the state (April 4, 1990) Mexico Federal Law on parastatal entities (May 14,1986) Enabling regulations to the law on parastatal entities of May 14, 1986 (January 1990) New charter law of Pemex (July 16,1992) Law amending the law on electric power (December 1992) Law regulating railway services (May 12,1995) Law on telecommunications (May 1995) Amendments to article 28 of the constitution on the removal of government monopolies in the areas of railways and satellite communications (January 1995) Regulation on natural gas (November 8, 1995) Moldova Law no. 627/XII on privatization (July 4, 1991) 1993-94 privatization program (March 12,1993) Decree on measures to prevent illegal privatizations (March 12, 1993) Law on privatization (March 14, 1993) Decree approving the list of government assets to be offered for sale in the Republic of Moldova in 1993-94 (March 16,1993) 1995-96 Privatization Program (March 1995) Mongolia Law on privatization (May 31,1991) Law on economic entities (June 1991) Law on foreign investment (May 1993) Law on banks (June 1993) Law on securities (October 1994) Montenegro Law on transformation of property and management (1992) Morocco Law no. 39-89 authorizing the transfer of public enterprises to the private sector (April 11, 1990) Decree no. 2-90-402 implementing article 5 of Law no. 39-89 of April 11, 1990 (October 16, 1990) Appendix: Privatization Legislation, by Countity 321 Decree no. 2-90-403 on the powers of the minister responsible for implementing transfers of public enterprises to the private sector (October 16,1990) Decree no. 2-90-577 issued in application of article 7 of Law no. 39-89 of April 11, 1990 (October 16,1990) Decree no. 2-90-578 prescribing the working conditions for the Transfer Commission provided for in article 2 of Law no. 39-89 of April 1 I, 1990 (October 16,1990) Amendment to Law no. 39-89 of April 11, 1990 (Janua ry 1995) Mozambique Decree no. 21/89 allowing for the sale of state-owned assets through public competition and establishing the administrative organization for these sales (May 23,1989) Law nos. 13/91 and 14/91 on transformation of state enterprises (August 3, 1991) Law no. 15/91 establishing norms for the restructuring, transformation, and reorganization of the state-owned enterprises sector, including privatization and sale of enterprises, establishments, installations, and shareholdings of the state (August 3, 1991) Law no. 17/91 instituting public companies (August 3,1991) Decree no. 27/91 setting up an interministerial commission for enterprise restructuring (November 21, 1991) Decree no. 28/91 issued in application of Law no. 15/91 of August 3,1991 (November21, 1991) Decree no. 30/91 containing a list of enterprises to be privatized (November 26,1991) Law no. 17/92 clarifying article 16 of Law no. 15/91 of August 3, 1991 (October 14, 1992) Decree no. 20/92 on the creation of the Fund for Support of Economic Rehabilitation (August 5,1992) Decree no. 3/93 listing enterprises to be privatized under article 14 of Law no. 15/91 of August 3,1991 (April 21,1993) Decree no. 20/93 on the sale of shares to white-collar and manual employees (September 14,1993) Decree no. 4/94 listing enterprises to be privatized under article 14 of Law no. 15/91 of August 3,1991 (1994) Nepal Act no. 2050 on privatization (January 3, 1994) New Zealand State-Owned Enterprises Act 1986 (December 18,1986), as amended Telecommunications Act (1987) Telecommunications (Amendment) Act (1988) Telecommunications Regulations-International Services (1989) Telecommunications Regulations-Communication of Information (1990) 1991 Budget Act, Chapter 5 (Privatization Strategy) 322 The Privatizatiion Challenge Nicaragua Decree-Law no. 7-90 on the creation of Junta General de Corporaciones Nationales responsible for privatization of state companies (May 2,1990) Decree-Law nos. 11-90 and 23-91 on the procedure for claims filed by individuals whose property was confiscated by the previous regime (May 11, 1990 and 1991) Presidential Resolution no. 291-92 on instructions for privatization (October 15, 1992) Law no. 169 regulating the disposition of public/state property and the public services controlling entity (December 2,1993) Niger Decree no. 86-120/PCMS/MTEP/SEM approving the model bylaws of public administrative establishments (September 11, 1986) Decree no. 86-121 /PCMS/MTEP/SEM approving the model bylaws of public industrial and commercial establishments (September 11, 1986) Decree no. 86-122/PCMS/MTEP/SEM approving the model bylaws of public corporations (September 11, 1986) Decree no. 86-123/PCMS/MTEP/SEM approving the model bylaws of joint-venture companies (September 11, 1986) Nigeria Decree no. 25 on privatisation and commercialisation (July 5,1988) Decree no. 78 establishing the Bureau of Public Enterprises (1993) Pakistan Order on the transfer of establishments (1978, amended in 1990) Notification no. F.5 (1)-Adm-1/91 on the setting up of a Privatization Commission (January 22, 1991) Ordinance on the protection of economic reforms (1992) Notification no. F.5 (13)-Adm-1/93 on the reconstitution of the Privatization Commission (August 28, 1993) Ordinance no. 26 on the Debt Retirement Fund (1 993) Ordinance no. 51 on telecommunications (July 13, 1994) Panama Law on concessions (1986) Law no. 16 on privatization (June 14, 1992) Executive Decree nos. 197 (December 15,1993) and 352 (August 17, 1994) on implementing regulations to Law no. 16 of June 14, 1992 Paraguay Law no. 126/91 on privatization (December 30,1991) Appendix: Privatization Legislation, by Cotmtrv 323 Decree no. 13461 on implementing regulations to Law no. 126/91 of December 30, 1991 (May 8, 1992) Law no. 320 authorizing privatization of Lineas Aereas Paraguayas S.A. (March 29, 1994) Law no. 433 on privatization (September 27, 1994) Law no. 548 on the reappraisal and regulation of the assets of enterprises (April 21, 1995) Peru Decree-Law no. 647 authorizing the private sector to hold a minimum of 51 percent of the shares of Centromin, Hierro Peru, and Minero Peru (July 1991) Decree-Law no. 674 on the promotion of private investment in public enterprises (September 25,1991) Decree no. 675 authorizing privatization of Minpeco S.A. (October 2,1991) Decree-Law no. 758 on the promotion of private investments in public works and utilities (November 13, 1991) Supreme Resolution no. 071-92-EF/10 authorizing use of debt for privatization (June 1992) Decree-Law no. 25570 amending Decree-Law no. 674 of September 25,1991 (June 19, 1992) Decree-Law no. 25604 on protection of the assets of public enterprises in process of privatization (July 8, 1992), clarified in Supreme Decree no. 8-95-PCM of February 22, 1995 Decree-Law no. 25618 on enterprises owned by regional governments (July 16,1992) Supreme Decree no. 070-92-PCM on implementation of Decree-Law no. 674 of September 25,1991 (July 16,1992), clarified in Supreme Decree no. 72-92-PCM of August 12,1992, and modified in Supreme Decree no. 102-94-PCM of December 7, 1994 Decree-Law no. 25844 on electric concessions (November 6, 1992) Decree-Law no. 25897 on establishment of the private system of administration of retirement funds (1992) Decree-Law no. 26120 amending Decree-Law no. 674 of September 25,1991 (December 28, 1992) Supreme Resolution no. 009-93-EM implementing Decree-Law no. 25844 of November 6,1992 (February 25,1993) Supreme Resolution no. 033-93-PCM amending Supreme Resolution no. 070-92- PCM (May 14, 1993) Law no. 26286 amending Decree-Law no. 674 of September 25,1991 (lease property) (January 12, 1994) Supreme Decree no. 17-94-EF regulating the use of eligible obligations for the promotion of private investment in public enterprises (February 9,1994), clarified in Supreme Decree no. 11 7-94-EF of September 5, 1994 Law no. 26408 on Pescaperu (December 16,1994) Law no. 26438 amending Decree-Law no. 674 of September 25,1991 (January 6, 1995) 324 The Pri vatization Challenge Law no. 26440 on the organizations involved in the promotion of private investment (January 20, 1995) Supreme Decree no. 30-95-PCM on Mineral del Peru S.A. (May 11, 1995) Decree-Law no. 839 on the promotion of private investments in public works and utilities (August 20,1996) Philippines Presidential Proclamation no. 50 "Proclaiming and launching a program for the expeditious disposition and privatization of certain government corporations and/or the assets thereof and creating the Committee on Privatization and the Asset Privatization Trust" (December 8, 1986) Presidential Proclamation no. 50-A modifying Proclamation no. 50 of December 8, 1986 (December 15,1986) Operating guidelines of the Committee on Privatization on the Asset Privatization Trust (January 29,1987) Executive Order no. 127 on reorganization of the Ministry of Finance (1987) Executive Order no. 127-A creating the Corporate Affairs Group and for other purposes, including the Privatization Office (July 22, 1987) Guidelines of the Committee on Privatization on the privatization of government corporations (August 12,1987) Republic Act no. 6957 authorizing the financing, construction, operation, and maintenance of infrastructure projects by the private sector (BOT law) (July 9, 1990) Foreign Investments Act (1991) Republic Act no. 7181 extending the life of the Committee on Privatization and the Asset Privatization Trust (January 17,1992) Administrative Order nos. 8 and 9 directing the identification of idle government properties and recommending to the president an action plan for the disposition of such properties (1992) Executive Order no. 37 restating the privatization policy of the government (December 2,1992) Republic Act no. 7661 amending Republic Act no. 7181 of January 17,1992, and extending to June 30,1995, the completion of the priva tization program (December 23, 1993) Guidelines and regulations to implement Republic Act no. 7181 of January 17,1992, as amended by Republic Act no. 7661 approved by Committee on Privatization of Republic of the Philippines (March 3,1994) Republic Act no. 7718 amending and expanding Republic Act no. 6957 (BOT law) of July 9, 1990 (May 5, 1994) Implementing rules and regulations of Republic Act no. 6957 (BOT law) of July 9, 1990, as amended by Republic Act no. 7718 of May 5,1994 Water Crisis Act (uly 15,1995) Poland Law on the privatization of state-owned enterprises (July 13, 1990) Law establishing the Office of Minister of Ownership Changes (July 13, 1990) Appendix: Prizvatization Legislation, by Country 325 Decree-Law governing the specific sphere of activity of the Minister of Ownership Changes (November 14, 1990) Decree-Law governing the designation of state enterprises of special importance to the national economy (November 16, 1990) Law on foreign investment (June 14, 1991) Law on financial restructuring of state enterprises and banks (March 1993) Law on the national investment funds (April 30, 1993) Law on commercialization and privatization (July 21, 1995) Law on Toll Motorways (1995) Law on commercialization and privatization (August 30, 1996) Portugal Law no. 84/88 on privatization (July 20,1988) Law no. 11/90 laying down the framework for privatization (April 5,1990) Decree-Law nos. 372/93 (October 29,1993) and 379/93 (November 5, 1993) on municipal and multimunicipal services (water and waste) concessions Puerto Rico (see Uniited States) Romania Law no. 15 on the restructuring of state economic units as autonomous units and commercial companies (July 31, 1990) Land law (February 1991) Law no. 35 on foreign investment (1991) Law no. 58 on the privatization of commercial companies (August 14,1991) Government Resolution no. 643 approving the regulations governing the organization and functioning of the State Ownership Fund (October 8,1992) Law no. 77 on management and employee buyouts (August 1994) Law no. 52 on securities and stock exchanges (August 1994) Law no. 55 on the acceleration of privatization (June 1995) Russian Federation Law of the Russian Soviet Federal Socialist Republic (RSFSR) on ownership and property (December 24,1990) Law of the RSFSR on enterprise and entrepreneurship (December 25, 1990) Law of the RSFSR on the privatization of state-owned and municipal enterprises (July 3,1991) Decree of the RSFSR on procedures for implementing the Law on the privatization of state-owned and municipal enterprises (July 3,1991) Law of the RSFSR on personal privatization accounts and deposits (July 3,1991) Law of the RSFSR on privatization of housing and land (July 4,1991) Basic provisions of the 1992 program of privatization of state-owned and municipal enterprises in the Russian Federation (January 1992) 326 The Privatization Challenge Resolution no. 52 of the government of the Russian Federation on acceleration of the implementation of the 1992 privatization program (January 29, 1992) Law no. 2930 revising and amending the law on the privatization of state-owned and municipal enterprises in the RSFSR (June 5,1992) Decree no. 2980-1 of the Supreme Soviet approving the state program of privatization of state-owned and municipal enterprises of the Russian Federation for 1992 (June 11, 1992) Presidential Decree no. 721 on organizational measures relating to the corporatization of state enterprises and voluntary associations of state enterprises (July 1,1992) Decree no. 490 of the government of the Russian Federation on the procedure for implementation of the privatization vouchers scheme in the Russian Federation (July 15,1992) Resolution no. 547 of the government of the Russian Federation on measures for implementation of Presidential Decree no. 721 of July 1,1992 (August 4,1992) Presidential Decree no. 914 on the introduction of a privatization vouchers scheme in the Russian Federation (August 14,1992) Presidential Decree no. 922 on the special characteristics of corporatization of public enterprises, associations, and organizations in the energy and petroleum sector (August 14, 1992) Decree no. 708 of the government of the Russian Federation on the procedure for privatization and reorganization of enterprises and organizations of the agroindustrial complex (September 4, 1992) Law on the reorganization and privatization of state cooperatives of the agroindustrial complex (September 4, 1992) Law on the privatization of enterprises for initial processing of agricultural products, fish and sea products and enterprises that provide technical services, material, and support to the agroindustrial complex (September 4, 1992) Presidential decree on measures for the organization of a securities market in the process of privatization of state-owned and municipal enterprises (October 7, 1992) Decree no. 1186 on regulation of the voucher investment fund (October 7, 1992) Decree of the Supreme Soviet of the Russian Federation on the process for implementing the government program of privatization of state-owned and municipal enterprises in the Russian Federation for 1992 (October 9, 1992) Presidential decree on the development of a privatization vouchers scheme (October 14, 1992) Presidential decree on the sale of privatization vouchers for housing, land, and municipal property (October 14, 1992) Presidential decree on the use of privatization vouchers for social protection of the population (October 26, 1992) Presidential decree on the sale of privatized assets in exchange for privatization vouchers (November 4,1992) Presidential decree on measures for implementing industrial policy during privatization of enterprises (November 16,1992) Presidential Decree no. 1403 on the special characteristics of privatization and corporatization of public enterprises and production and research and scientific Aplpentdix: Privatization Legislation, by Con,itry 327 associations in the petroleum products refining and supply industries (November 17,1992) Decree no. 906 of the government of the Russian Federation on the procedure for decisionmaking on the privatization of enterprises by the government and the state committee for the management of state property and its territorial agencies (November 18, 1992) Decree no. 908 of the government of the Russian Federation on measures taken to ensure the furnishing of information to Russian and foreign investors concerning the privatization of state-owned enterprises (November 24, 1992) Presidential Decree no. 1484 on the special characteristics of privatization of the GAZ production association (November 30,1992) Presidential Decree no. 1519 on the special conditions for privatization of enterprises in Bryansk Oblast (November 30,1992) Decree no. 969 of the governmenlt of the Russian Federation amending the law on the reorganization of kolkhozcs and sovzkhloses and on privatization of the agricultural state enterprises (December 11, 1992) Decree on operational procedures for the privatization of enterprises (December 25, 1992) Decree no. 1702 on the corporatization and privatiz.tion of coal industry associations, organizations, and enterprises (December 30, 1992) Presidential decree on procedures for issuing 1992 privatization vouchers to certain categories of citizens (January 10, 1993) Presidential Decree no. 216 regulating the procedure for the circulation and cancellation of privatization vouchers (Febniarv 12, 1993) Decree of the Supreme Soviet of the Russian Federation on the implementation of the government program of privatization of state-owned and municipal enterprises for the year 1992 (April 28, 1993) Directive no. 654-R o(l the corporatization of producer associations in the coal industry (April 9, 1993) Decree no. 446 on the special characteristics of privatizing enterprises under the jurisdiction of the Ministry of Atomic Energv of the Russian Federation and managed by the said ministry, under the conditions of developing a market economy (April 15,1993) IPresidential Decree no. 640 on government guarantees protecting the rights of citizens of the Russian Federation to participate in privatization (May 8, 1993) Decree on execution of the public program of privatization of state-owned and municipal enterprises of the Russian Federation for the year 1992 (May 19, 1993) Decree no. 5234-1 on the implementation of clause 5.4 of the state program of privatization of state-owned and municipal ente rprises of the Russian Federation for the year 1992 (June 18, 1993) Decree no. 5310-1 on amendments and additions to certain decisions of the Supreme Soviet of the Russian Federation concerning qucstions relating to the privatization of state-owned and municipal enterprises (July 1,1993) Presidential decree on additional measures to protect the rights of citizens of the Russian Federation to participate in prlvatization (July 26, 1993) 328 The Privatization Challenge Decree of the Supreme Soviet suspending the decree of the president "on additional measures to protect the rights of citizens of the Russian Federation to participate in privatization" (August 6, 1993) Presidential Decree no. 1238 on the protection of the rights of citizens of the Russian Federation to participate in privatization (August 10, 1993) Presidential Decree no. 2284 on the state program of privatization of state and municipal enterprises of the Russian Federation (privatization program) (December 24, 1993) Law no. 1832-R on supervision of special investment voucher funds (July 1, 1994) Decree no. 1535 on supplemental measures to the state program of privatization of state and municipal enterprises (privatization program) (July 22, 1994) Presidential (special) decree on city government powers in the privatization of municipal enterprises (February 1995) Rwanda Law no. 2/96 on privatization and public investment (March 11, 1996) Presidential Decree no. 08/14 on the establishment of a National Commission for Privatization and Public Investment (May 3, 1996) Senegal Law no. 84-64 prescribing the procedures for liquidating public establishments, national companies, and joint-venture companies (August 16,1984) Decree no. 84-992 on application of Law no. 84-64 of August 16,1984 (September 11, 1984) Order no. 86-1370/MEF/DGT/ DP setting up a special (ommission on state divestiture (November 8,1986) Law no. 87-23 on the privatization of enterprises (August 18, 1987) Decree no. 87-1475 on the organization of the consultative committee on the parastatal sector (November 27,1987) Decree no. 87-1476 on the organization and functioniing of the special commission to monitor state divestiture (November 27, 1987) Decree no. 1477 on the responsibilities of the Delegation on Reform of the Parastatal Sector (November 27, 1987) Decree no. 88-232 regulating the procedure for public flotations in the transfer of government-held shares (March 4,1988) Decree no. 88-233 prescribing the conditions of competitive bidding in the transfer of government-held shares in enterprises to be privatized (March 4, 1988) Decree no. 89-179 amending Decree no. 88-233 of March 4,1988 (February 8,1989) Decree no. 89-927 on procedures for transfer of government-held shares under the privatization process (1989) Law no. 90-07 on the organization and supervision of parastatal enterprises and the supervision of legal persons governed by private law receiving financial assistance from public authorities (June 26,1990) Appendix: Privatization Legislation, lyt Count try 329 Serbia Law on privatization (1991) Singapore Economic Development Board (Transfer of Assets) Act (Cap. 190) Public Utilities Act (1995) Slovak Republic (see also CZechloslovakia) Law canceling the final wave of voucher privatization (July 1995) Law excluding strategic state-owned enterprises from the privatization process (July 13,1995) Slovenia Law on privatization (November 11, 1992) Law on denationalization (restitution of land and buildings) (1993) Law on commercial companies (May 27,1993) Law on investment funds and management companies (January 26,1994) Soviet Union (see also successor republics) Law on the principles of denationalization and prix atization of enterprises (July 1, 1991) Sri Lanka Act no. 23 on the conversion of public corporations and government-owned business undertakings into public companies (May 15, 1987) Sweden Law no. 1991/92:69 on the privatization of public enterprises and other matters (December 1991) Taiwan (China) Lawon theconversion of public to private enterprises (June 1991) and implementing decree (February 1992) Regulations on the preemptive right of employees of privatized enterprises (1992) Regulations relating to compensation granted to employees of privatized enterprises (1993) Tajikistan Law on property (December 5, 1990) Law on the denationalization and privatization of property in the Tajik Soviet Socialist Republic (SSR) (February 21,1991) 330 Thec Privatizat ion Challenge Decree on organization of the work on the denationalization and privatization of property in the Tajik SSR (April 16,1991) Tanzania Public Corporations (Amendment) Act (1993) Thailand Regulations relating to the divestiture of state-owned enterprises and shares thereof (March 17, 1961) Royal Act no. B.E. 2535 on private participation in state affairs (March 11, 1992) State enterprise asset transformation act (1992) Togo Ordinance no. 94-002 on divestiture of enterprises by government and other legal persons governed by public law (June 10, 1994) Decree no. 94-038 issued pursuant to Ordinance no. 94-002 (June 10, 1994) Tunisia Finance Law no. 85-1l)9, particularly articles 79 through 84, establishing the fund for restructuring of the capital of public enterprises (December 31, 1985) Law no. 87-47 on the restructuring of public enterprises (August 2, 1987), repealed by Law no. 89-9 of February 1, 1989 Law no. 89-9 on public portfolio and public enterprises (February 1, 1989) Decree no. 89-376 listing the enterprises deemed to be public in light of the nature of their activities and their capital structure (March 11, 1]989), repealed by Decree no. 90-1404 of September 5, 1990 Decree no. 89-377 prescribing the composition and functioning of the commission for rehabilitation and restructuring of enterprises in whih h there is government shareholding (March 15,1989) Decree no. 89-378 on representation of the government, local authorities, public establishments, and companies whose capital is wholly owned by the government in the management and decisionmaking organs of the public enterprises, and the procedures for exercise of jurisdiction over those enterprises (March 15, 1989) Circular no. 33 detailing privatization implementation procedures (June 21, 1989) Order of the prime minister prescribing the composition and functioning of the Public Enterprises Classification Commissioni (September 4, 1989) Decree no. 90-1404 listing the enterprises deemed to be public in light of the nature of their activities and their capital structure (September 5, 1990) Law no. 94-102 completing no. Law 89-9 of February I, 1989 (1994) Turkey Law no. 1326 on concessions of public interest (June 24 19(18) Law7 no. 2025 relating to concessions (June 25, 1932) Appenidix: Privatization Legislation, by Counitnt 337 Decree-Law no. 233 (1984) Law no. 2983 (1984) Law no. 3096 on private power BOT projects (December 19, 1984) Section 5 of Law no. 3291 on privatization of state economic organizations (May 28, 1986) Law no. 3465 on road projects BOTs (May 28,1988) Statutory Decree no. 414 defining the responsibilities of the public portfolio administration (1990) Statutory Decree no. 473 establishing the higher council of public portfolio administration (June 6, 1992) Law no. 3974 on BOT energy projects (March 1, 1994) Law no. 3996 on the provision of certain investments and services in the BOT model (June 8,1994), as amended by Law no. 40)47 (November 1994) Decree no. 94/5907 implementing Law no. 3996 of June 8,1994 (October 1, 1994) Law no. 4046 on arrangements for the implementation of privatization and amending certain laws and decrees with the force of law (November 24,1994) Law no. 4107 on telecommunications (Mav 6,1995) Turkmenistan Decree on the transfer to the Turkmen Soviet Socialist Republic of enterprises and organizations belonging to the Union within the territory of the republic (August 22, 1991) Law on denationalization and privatization of property in Turkmenistan (February 19, 1992) Presidential decree on voucher privatization (Mav 13, 1994) Uganda Law no. 9 on public enterprise reform and divestiture (August 4,1993) Ukraine Law on property (March 26,1991) Law no. 2163-XII on privatization of the property of state enterprises (with implementing decree) (March 4, 1992), as amended on July 7,1992, September 18, 1992, December 15,1992, and February 19, 1993 Law no. 2171-XII on the privatization of small state enterprises (with implementing decree) (March 6,1992), as amended on December 15, 1992, and February 19, 1993 Law no. 21 73-XII on privatization vouchers (March 6, 1992), as amended on July 7, 1992, and in 1994 Law no. 2269-XII on leasing the property of public organizations and enterprises (April 10, 1992), as amended on December 15, 1q92 Resolution of the Supreme Council of Ukraine approving the government program of privatization of the property of state enterprises (July 7, 1992), as amended on December 15, 1992, and Februarv 19, 1993 332 The Privatization Challenge Resolution of the Council of Representatives of the City of L'viv approving the program of privatization of the municipal enterprises of the city of L'viv for the year 1992 (September 18,1992) Decree of the Council of Ministers on the privatization of agricultural land (January 15,1993) Decree no. 51-93 on the special characteristics of the privatization of the property of the agroindustrial complex (May 17,1993) Decree no. 57-93 on privatization of the integrated public enterprise complexes and their structural subdivisions that have been leased (May 20, 1993) Decree on corporatization of large enterprises (June 1993) Presidential decree on financial funds and companies (February 1994) Moratorium enacted by parliament on privatization and implementation of buyout by enterprises under lease agreements (July 1994) Decree on privatization schedule for 1995 and foreign participation in the privatization of enterprises (June 27,1995) United Kingdom British Aerospace Act (1980) Civil Aviation Act (1980) for the privatization of British Airways Transport Act (1981) for the privatization of Associated British Ports Telecommunications Act (1981) for the privatization of Cable and Wireless Atomic Energy (Miscellaneous Provisions) Act (1981) for the privatization of Amersham International, British Nuclear Fuels Ltd, and National Nuclear Corporation Oil and Gas Enterprise Act (1982) for the privatization of Britoil and Enterprise Oil Energy Act (1983) Telecommunications Act (April 12,1984) for the privatization of British Telecom Transport Act (1985) for the privatization of National Bus Company Airports Act (1986) for the privatization of British Airports Authority Gas Act (1986) for the privatization of British Gas British Steel Act (1988) Water Act (1989) Electricity Act (July 27, 1989) Property Services Agency and Crown Suppliers Act (1990) Water Industry Act (1991) Water Resources Act (1991) Competition and Services (Utilities) Act (1992) Railways Act (1993) United States Law no. 5 providing resources for the education system and the development of the infrastructure of Puerto Rico by authorizing the sale of all assets of any nature, whether real property, personal property, or a combination thereof, that the Puerto Rican Telephone Authority owns in connection with operation of the Appendix: Privatization Legislation, by CountrY 333 communications system, excluding the Puerto Rico Corporation for Public Broadcasting; and so on (April 10, 1990) Act on the efficiency of combined surface transport (1991) Executive Order no. 12083 on infrastructure privatization (April 30,1992) Executive Order no. 12893 on private financing of infrastructure (1994) Uruguay Law no. 16211 on reform of state-owned enterprises (September 27, 1991) Decree implementing Law no. 16211 of September 27,1991, on Primeras Lineas Uruguayas deNavegaci6n Aerea (December 30,1991) Decree no. 718 creating CONTEL (December 1991) Decree no. 720 on privatization of Administraci6n de Telecomunicaciones (ANTEL) (December 30, 1991) Law no. 16246 authorizing the privatization of all port activities and suppressing the state insurance monopoly (April 23,1992) Uzbekistan Law on ownership (October 31, 1990) Law on denationalization and privatization (with implementing resolution of the Supreme Council, Resolution no. 107) (November 19,1991) Decree on the creation of a committee on state property management and privatization (February 10, 1992) Decree of the president for the acceleration of the enterprise reform program (January 22, 1994) Venezuela Presidential Decree no. 1826 establishing the National Telecommunications Council (September 5, 1991) Law on the Venezuela Investment Fund (January 1 *, 1992) Law no. 4397 on privatization (March 10, 1992), as amended August 1992 and October 31,1993 Decree no. 448 on Venezolana de Guayana (December 7, 1994) Viet Nam Regulations relating to major aspects of the basic procedures for the liquidation of public enterprises that suffer substantial losses, issued with Council of Ministers Decision no. 315 on improvement of production and commercial activities in the public sector (September 1, 1990) Council of Ministers Decision no. 330 revising Decision no. 315 of September 1, 1990 (October 23, 1991) Council of Ministers Decision no. 388 promulgating regulations goveming the establishment and liquidation of public enterprises (November 20, 1991) Council of Ministers Decision no. 462 on a plan to continue the process of management renovation in the basic economic units in 1992 (February 12,1992) 334 The Privatization Challenge Decisions of the Chairman of the Council of Ministers nos. 202 and 203 on the experimental corporatization of public enterprises (June 8, 1992) Ordinance of the Prime Minister no. 84/TTG containing instructions for speeding up pilot corporatization of public enterprises (March 4, 1993) Decree no. 87 enacting regulations on investment in the form of Build-Operate- Transfer (BOT) contracts (November 23, 1993) Bankruptcy Law (1994) Yugoslavia Law on social capital circulation and management (December 1989) Law on social capital (August 1990) Zambia Privatization Act (July 4,1992) Regulations on privatization (March 9,1993) Glossary These definitions are provided for the reader's conx enience only. They are not necessarily precise legal definitions and may not reflect the different meanings a term may have. Terms in italics refer to other definitions in this glossary. References to Black's are to Black's Lanzw Dictionary/, 5th ed. (St. Paul, Minn.: West Publishing Company, 1979). Many of the concepts or terms in this glossary are further described in the main text. Act (legislative). The term "act" is often short for "legislative act" or "act of parliament" and is a synonym for "law." Affermage. French term. Type of concession con tract in which the operator leases the sector assets from the public authority, which remains responsible for major investments. Arbitration. Extrajudicial dispute settlemenit procedure involving arbitrators chosen by the parties. Articles of incorporation. Basic document establishing a company and defining its corporate governance. Also articles of association. Auction. Public sale of property to the highest bidder. Bankruptcy. Court-supervised procedure leading to the financial reorganization or liquiiatitioni of a company. Bankruptcy may be initiated by the conmpany, its creditors, or other parties when a company is no longer able to pay its debts as they become due. See also ii7solzvci'c/i. Bid; bidding. A quotation setting forth the prict. that a bidder is willing to pay for an asset or share or for the right to carry out an activitv. In bids for coitcessions, the price may be the tariff demanded1 by the bidder to provide a service. See also hteder o,ffert. Bilateral agreement. Often used to refer to agreements between two sovereign nations (for example, civil aviation agreements, double taxation treaties, or investment treaties). Build, operate, transfer (BOT). Contract by which one party (typically a private operator or consortium) agrees to build, finance, operate, and maintain a facility or system (such as a water treatment plant or tollroad) for a specified period of time, and then transfer said facility or system to the party that awarded the contract, typically the state. During the period of operation, the ownership of the facility or 335 336 Tie Prioatization Challengc system may be with the public authority or with the private operator; in the latter case, the contract is sometimes referred to as a build, own, operate, transfer (BOOT) contract. A BOT contract in the infrastructure sector is in essence a public works Concession contract. Build, own, operate (BOO). Similar to a BOT, though the private party has full ownership riglhts over the sector assets or facility and does not have to transfer them back to the public authiority. Bylaws. "Regulations, ordinances, rules or laws adopted by an association or corporation or the like for its government" (Black's). Collateral. Asset that is pledged as security for the repayment of a debt. Commercialization. Introduction of commercial objectives and practices into the management and operations of an SOE. Commercialization does not usually imply a change in legal status. See also corporatization. Company. A legal entity created by stockholders (whether individuals, companies, or other legal entities) to carry on business activities, which exists independent of such stockholders. See also corporatioin and puiblic conmpany. Compensation. The act of giving indemnification, making whole, or giving back an equivalent or substitute of equal value (Black's). Monetary compensation paid to a (previous) ownier for property taken by the state. See also conifiscation and cxpropriation. Competition for the market. Competition for the right to supply a service, often with exclusive rights (for example, competition for a water distribution concession). Competition in the market. Competition between firms vying for consumers withinl a given market (for example, competition in sale of telephone equipment). Concession. A contractual arrangement between the state (or other public entity) and a private operator (called a concessionaire) requiring the latter to operate a public service, such as a power or water distribution system, for a specified period of time and at its own risk. The concessionaire is typically also in charge of building (or expanding) and financing the related physical infrastructure, though in somne concessions (sometimes referred to as affcrinag') new investmenits remain the responsibility of the public sector. A BOT is a concession for a project requiring the construction of new facilities. Conicession is sometimes used as a synoniym for franchise or license. Conciliation. A form of amicable dispute settlement requiring the consent of both parties to the solution. Condemnation. IProcess of taking private property for public use through the power of eminent domain (Black's). Many constitutions require that "just compensation" be paid if property is condemned. See also confiscationi and cxprl)npriation. Confiscation. Seizure of private property from their owners without compenisation. Confiscation is sometimes the result of a criminal conviction of the property owner, sometimes because the use or possession of the property Was contrary to a law. Contingent liability. See liability. Corporation. A legal entity created by or under the laws of a state (Black's). Sometimes classified as a public corporation, created and owned by the state or another public body, or as a private corporation, created by private persons for Glossar n 337 private purposes. When created by law, public corporations are sometimes referred to as statutory corporations. Corporatization. The transformation of a state-owned enterprise or business asset into a public corponrtion organized tinder company law. Often also the first step in the privatization of an SO. Cross-subsidy. Subsidy from one product or service line to another one, often within one enterprise, such as in the cross-subsidizalion of rural services by urban ones, or of local telephone services by long-distance services. Decree. An executive order, which is usually subordinated to a law. Secondary or derived legislation, as opposed to primary legislation (that is, a law enacted by the legislature). Depending on the legal regime, decrees may be issued by the president, the council of ministers, the prime minister, or another cabinet member. Demonopolization. The process of undoing or breaking up a monojipoyl by introducing competition in the mark-et. The breakup ol a national monopoly into a number of smaller geographical monopolies, howex er, is usually not referred to as demonopolization. Deregulation. The act or process of removing legal restrictions or regulations. Direct negotiation. A sale negotiated and concluded privately between the buyer and the seller, and not made by anictionj, tender, or other competitive bidding process. Dissolution. The termination of the legal existen e of a corporate or public entity. See also liquidation. Divestiture. In this book, transfer of public or state-owned property (including SOEs) to the private sector. In the United States, the 1984 breakup of ATF&T (a private company) is often referred to as the AT&I divestiture. Divestment. Liquidation or sale of parts of a firm. It is the opposite of a merger or acquisition. Due diligence. In corporate acquisitions (including privatization), refers to investigations by potential buyers into the business of the company to be acquired. Enabling legislation. Legislation giving the government (or another person or body) specific powers or authority. In the privatization context, legislation authorizing the government to privatize. Expropriation. The action whereby a state takes or modifies the property rights of an individual or business entity against comnpensation, in the exercise of state sovereignty. See also c017demtnationi and con fiscofitit. Going concern. An enterprise considered to be an economic u nit and an operational entity. In the sale of an enterprise as a going concern, the enterprise would typically be expected to continue transactin,g its normal business. Sale may be on a going-concern basis even if the ownerslhip of the legal entity as such is not transferred. Golden share. A share in a company allowing its holder (the state) to exercise specified exceptional rights with respect to the conduct of business of the company after its (full or partial) privatization. Initial public offering (lPo). First offering of shaires of a company on the market (usually through a stock exchange). Insolvency The state of a person (legal entity or physical person) that is unable to pay its debts as they fall due in the usual course of business, or that has liabilities in excess of a reasonable market value of its assets. Insolvency procedure is the term 338 The Privatization Challenge used in the United Kingdom for what is referred to as bnikrupticy procedures in the United States. Interconnection. See thlird-party access. Joint-stock company. A company with a capital (joint stock) that is divided into shares which are transferable by their owners. Used in this book to refer to incorporated limited liability shareholding companies equivalent to the French Soci&t6 Anonyme (SA) or the German Aktiengeselschaft (AG). See also corporation. Joint venture. "An association of persons jointly undertaking some commercial enterprise" (Black's). A joint venture may or may not be incorporated. This term is sometimes also used to refer to a conmpamy established jointly by the state and private partners or by domestic and foreign partners. Juridical person. A person or entity with separate existence under law. Equivalent to legal entity. Leasing. A contract whereby the owner of an asset (or enterprise), the lessor, provides the other party, the lessee, with the possession of and profits from such asset during a set period of time. Leasing does not transfer ownership of property unless it is accompaniied by a purchase option whichi is exercised. See also affenrnage!. Legislation. Used in a narrow sense, this term refers to laws (that is, acts of the legislature). In a broad sense, and particularly in civil law countries, it refers to laws as well as derived or secondary legal instruments (such as decrees and executive orders). Liability. Includes "almost every character of hazard or responsibility, absolute, contingent, or likely" (Black's). All the claims against a businiess enterprise, including wages or salaries, amounts due suppliers, dividends dec lared payable, taxes, long- and short-term obligations such as bonds and bank loans, and so on1. A liability is continigent when its existence depends on an unknowni oir future event, such as the outcome of litigation or the occurrence of environmental damage. License. Right awarded by the government or public authority to provide a service (for example, a cellular license). Limited liability company A company in which [he owners (stockholders) are liable for the debts of the company only up to the am oun t of capital coIntributed by them to the company. In some countries, this term is used in a more narrow sense to refer to a type of limiaited liability company that has fe-wer incorporatioll and legal requirements than joint-stock companies, often a company whose capital is not divided into shares (equivalent in this sense to the French SARL or the German Gmbh). Liquidation. "Winding up of corporation so that asscts are distributed to those entitled to receive them. Process of reducing assets to cash, discharging liabilities and dividing surplus or loss.... It is to be distinguished from ndissolution which is the end of the legal existence of a corporation. Liquidation mav precede or follow dissolution, depending on statutes" (Black's). See also boikriiptcy. Management contract. Contract transferring the responsibility for managing a company to a private party, whiclh receives a fee in exchanige for its services. The management contractor does not invest in the companiv. The contractor's compensation may be based in part on the performanice of the managed company. See also regic inWfress(T. Monopoly. A privilege or peculiar advantage vested in one person or business entity, conferring the exclusive right or power to conduct a certain activity or trade or to control the supply or sale of a particular good or utility to a "captive" market Glossanr 339 (Black's). A legal monopoly (as opposed to a de facto monopoly) is granted and protected by law. A situation of natural monopoly prevails when one producer can supply a given market at a lower cost than two or more competing producers because of heavy sunk costs or increasing economies of scale, for example (water distribution is a typical example). Nationalization. Confiscation or expropriation of a private enterprise or asset by the state, often pursuant to a nationalization law'. Offering. "An issue of securities offered for sale to the public or to a private group" (Black's). See also initial public offering, primryna offering, seconidary offring, pibhlic offering, and private placement. Ownership. Black's definitions of ownership include "collection of rights to use and enjoy propcrty, including right to transmit it to others," "the right of one or more persons to possess and use a thing to the exclusion of others," and "the exclusive right of possession, enjoyment and disposal; involving as an essential attribute the right to control, handle and dispose." Preemptive right. In company or securitit's law, the right, typically of a shareholder, to buy shares before they are offered to others. Primary offering. An issue of new shares or seenurities by a company, typically in the case of a capital increase; proceeds of the offering go to the issuing company. See also secondary offering. Private company. In this book, a company ownied by private parties (individuals or legal entities) and not by the state or another public body. A company with mixed ownership (some private and some public owniers) may be considered a private company if the public sector does not control it. Contrast a public enterprise or som, which is owned and controlled by a state or other public entity See also 1lblic company. Private placement. An offering made only to a limited number of persons for investment purposes and not to the public at large. Because they can be offered only to professional investors (for example, life insurance companies) and not to the public, secuirities laws often impose fewer constraints on such placements (no requirement to register the security with the securities commission, for example). Privatization. Any measure resulting in the transfer of ownership and/or control over assets or activities from the public to the private sector. This term is much broader than divestiture. Property. Black's definitions of property include '`ownership; the unrestricted and exclusive right to a thing; the right to dispose of a thing in every legal way, to possess it, to use it, and to exclude everyone else from interfering with it" and "the exclusive right of possessing, enjoying, and disposing of a thing." Public. As an adjective, this word has two main meanings in this book. It usually refers either to something related to the state or its instrumentalities, as in the case of public sector, public enterprise, and public corporation, or to something related to the population at large (the public), as in the case of pulblic cotmpanyi7 and public offering. This may create some confusion: a public companr, for example, is not a company owned by the public sector, but a public enterprise is an enterprise owned by the public sector. Public company A company whose shares are held by the public or a group of persons who do not otherwise have a common business interest. The shares are often traded on a securities market or stock exchange. 340 The Privatization Challenge Public domain. That which belongs to the public at large and is open to common use without payment of usage fees or royalties. In France and in countries with legal systems that follow the French civil law, the state's public domain refers to state-owned property that is dedicated to public use and enjoyment. Public domain property is usually difficult to privatize, often requiring prior legislative intervention. By contrast, the state's private domain property can be more easily alienated. Public enterprise. Enterprise owned by the public sector, including the state, municipalities, other public enterprises, or other public bodies. This term includes enterprises organized as governmental entities, public agencies, and companies. Though broader than SOE, it is often used in this book as a synonym for it. Public flotation. See public offering. Public offering. An offering of stock or securities to the public at large, in which any member of the public may participate, as opposed to a prizvate placement or offering. Securities issued in this way are usually traded on an exchange or other secondary market. Public offerings are generally regulated by law. Regie int&essee. French term. A management contract in which the remuneration of the contractor is based (at least in part) on performance. Restitution. Act of restoring or returning something to its rightful owner. Differs from compensationi in that the confiscated asset itself is returned to the (former) owner. Secondary market. Financial market in which securitics can be traded after their initial offering. Secondary offering. An offering of a large block of existing stock in a company, where the proceeds of the sale go to the owner-seller of the stock (that is, to the government in the case of the divestiture of an SOE). In contrast, primary offerings are issues of new stock. Securities. "Stocks, bonds, notes, convertible debentures, warrants, or other documents that represent a share in a company or a debt owed by a company" (Black's). Self-management. Socialist SOE management scheme under which employees and management of an SOE exercise the ownership rights of the state in their enterprise. SOE. State-owned enterprise. Often used interchangeably with public enterprise in this book. State holding company. SOE confining its activities to the ownership and holding of stock in other companies and to the management and control thereof. Strategic investor. An investor that intends to manage or control the acquired business. Tender offer. A bid or offer for the purchase of shares or assets, usually stated in monetary terms, although it may include other terms and conditions. It often constitutes the basis for negotiations with the seller. Tenders may be open to all investors or limited to a specified category or group of qualified or preselected investors. Tenders may also be organized to provide a service; in this case, selection may be based on the lowest tariff offered. Tender conditions. Seller's general conditions defining the terms under which interested parties may make an offer for the purchase of the shares or assets to be sold (or for the supply of goods or services). Third-party access. In energy and other networks, right given to third parties (large users, for example) to use existing networks to transport electricity or gas that Glossart 341 the user has procured independently; under third-party access rules, the network owner has the obligation to grant such access under specified conditions. In telecommunications, the term interconnection is used. Transition country. Country in transition from a command or centrally planned economy to a market economy, such as the republics of the former Soviet Union and central and eastern European countries. Unbundling. In reference to a sector or enterprise, segmentation or disaggregation of constituent activities into separable parts. Vertical unbundling refers to the separation of formerly integrated activities, as in the separation of power production, transmission, and distribution activities. Horizontal unbundling refers to the splitting up of a sector segment into multiple independent entities (for example, competing power generators or separate regional distribution companies). The term also refers to the separation of infrastructure services from the underlying infrastructure, as in the separation of responsibility between rail track and rail services. In reference to property rights, the delinking or separation of various attributes of property rights (for example, shares can be unbundled into voting rights and claim on cash flow). Underwriter. Typically, an investment bank that purchases an issuer's or seller's securities for resale. Under a firm commitment contract, an underwriter assumes the risks associated with the resale of a security (that the security will be undersubscribed, for example, or that it will not sell for the anticipated price); the investment bank does not accept such risk under a best-efforts contract. Voucher. A coupon, certificate, form, or other dLocument indicating that its owner may apply the amount specified on the voucher against future purchases or acquisitions of certain items, such as shares in former SoEs or state assets. Yardstick competition. Indirect competition, which compares the performance of firms not active in the same market, such as water distribution companies covering different geographical areas. Better performance by one firm can, for instance, be used to foster improved performance bv its peers. 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World Developmeint Repiort 1996: Fronii I'lan to Market. New York: Oxford University Plress. World Bank and CEUPI (Central European University Privatization Project). 1994. "Eastern European Experience withl Small-Scale Privatization." CFS Discussion Paper Series 104. Washington, D.C. World Equity and IFC. 1993. Privatization in Energin\' Mirkets. London: IFR Publishing. Yarrow, George. 1986. "Privatization in Theory and Plractice." Econot1mic Policy 2 (April): 324-77. Young, David S. 1991. "The Role of Business Valuation in the Privatization of Eastern Europe." Puiblic Enterprise 11(2-3): 201-8. Young, Ralph A. 1991. "Privatisation in Africa." Reciitew of Africani Politicail Econlomtfy 51 (July): 50-62. Geographic Classification of References DEVELOPING COUNTRIES General Adam, Cavendish, and MistrV 1992 Sader 1995 Ambrose, Hennemeyer, and Chapon 1990 Shiirlex and Nellis 1991 Augenblick and Custer 1990 Smith 1996 Bouin and Michalet 1991 Vuvlsteke 1988 Cook and Kirkpatrick 1988 World Bank 1994a Kikeri, Nellis, and Shirley 1992 World Bank 1995b Nankani 1988 World Bank 1996a Roth 1987 World Bank 1996b Sader 1993 World Equity and IF- 1993 Africa General Aheneand Katz 1992 Nellis 1986 Akuete and others 1992 Rhomari 1989a Drum 1993 Rhomari 1989b Grosh and Mukandala 1994 Schmid 1992 Guerraoui and Richet 1995 Smith 1994 Kerf and Smith 1996 Youlng 1991 Mwangi 1986 Algeria Bouzidi 1993 C.uerraoui and Richet 1995 Egypt Tesche and Tohamy 1994 Ghana Danso 1992 Guinea Rivera 1996 Suzuki 1992 369 370 The Privatizatiowi Challenge Morocco Guerraoui and Richet 1995 Niger Tankoano 199() Senegal Caveriviere 1990 Swaziland Sonko 1994 Togo Avassor 1990 Tunisia Guerraoui and Richet 1995 Saghir 1993 Latin America and the Caribbean General Baer 1994 Glade 1991 Baer and Birch 1994 1 {olden and Rajapatirana 1995 Baer and Conrov 1993 Idelovitch and Ringskog 1995 Baer and Conroy 1994 ILatin Fina nce (yearly supplement) Berenson 1991 ILieberrnan 1994 Castillo 1995 Ramamurti 1996 Covarrubias and Maia 1994 Shirley 1994 Flouret 1994 Smith 19)4 Argentina Alexander and Corti 1993 Levy and Spiller 1993 Baer and Birch 1994 Maciel 1992 Covarrubias and Maia 1994 Mooney and Griffith 1993 De Kessler 1993 Muller 1994 Gerchunoff 1992 Ramanadham 1994 Gerchunoff and Canovas 1995 RamamuLrti 1996 Herrera 1993 Rivera 1996 Hill and Abdala 1993 Vittas 1996 Idelovitch and Ringskog 1995 World Bank 1993 Bolivia Mallon 1994 Brazil Baer and Birch 1994 Pinheiro and Giambiagi 1994 Baer and Conroy 1994 Chile Baer and Birch 1994 Bitran and Serra 1994 Baer and Conroy 1994 Castillo 1995 Geographic Classification of Referenices 371 Covarrubias and Maia 1994 Luiders 1993 Galal 1994 Ramamurti 1996 Galal and Shirley 1994 Rivera 1996 Galal and others 1994 Sharma 1992 Hachette and Liuders 1993 Vittas 1996 Levy and Spiller 1993 Colombia Baer and Conroy 1994 Quale 1991 Covarrubias and Maia 1994 Rivera 1996 Costa Rica Covarrubias and Maia 1994 Cuba Haines 1995 Guyana Prokopenko 1995 Ramanadham 1994 Jamaica Covarrubias and Maia 1994 Prokopenko 1995 Levy and Spiller 1993 Ramamurti 1996 Mexico Baer and Birch 1994 Galal and others 1994 Baer and Conroy 1994 Lopez-de-Silanes 1996 Barnes 1992 Ramarnurti 1996 Castillo 1995 Rivera 1996 Galal and Shirley 1994 Voljc and Draaisma 1993 Peru Conradt 1993 Covarrubias and Maia 1994 Venezuela Gizang and Sabater 1994 Recio Pinto 1991 Pisciotta 1994 Taylor and Vidal 1994 Ramamurti 1996 Asia General Chen 1994 Smithi and Staple 1994 Gouri 1991 Bangladesh Bhaskar and Khan 1995 372 The Pri vatization Challenge China Bolton 1995 Milor 1994 Huchet 1993 Salbaing 1j093 Liufang 1995 Indonesia Chen 1994 Korea, Republic of Kim, Kim, and Boyer 1994 Malaysia Chen 1994 Jomo 1995 Galal and Shirley 1994 Malaysia 1991 Galal and others 1994 Parker 1994a Hensley and White 1993 Vittas 1996 Mongolia Denizer and Gelb 1993 Milor 1994 Pakistan Looney 1994 Ramanadham 1994 Philippines Chen 1994 Milor 199)4 Levy and Spiller 1993 Singapore Vittas 1996 Sri Lanka Prokopenko 1995 Ramanadham 1994 Taiwani (Clhina) Da Silva Cornell 1993 Syu 1 9975 Thiailand Cheni 1 '94 Central and Eastern Europe and the Former Soviet Union General Acs and Fitzroy 1994 Blommestein and Marrese 1991 Andreff 1992 Bohm and Kreacic 1991 Andreff 1993a Borish, Long, and Nel 1995 Andreff 1993b Borish and Noe 1996 Arbess and Varanese 1993 Bovcko, Shleifer, and Vishny 1994 Gcographic Classification of Referenccs 373 Buck, Thompson, and Wright 1991 Nu ti 1901 Clavel and Sloan 1991 GEE D 1993 Csaba 1994 OERD 1495a Dallago, Ajani, and Grancelli 1992 ORE D 1495b Demougin and Sinn 1994 Popova 992 EBI3D and CEEI'N 1993 Ramanadham 1994 English 1991 Richet 1993 Estrin, Gelb, and Singh 1995 Rider 1994 Ewing, Lee, and Leeds 1993 Rondinelli 1994 Feinberg and Meurs 1994 Rutledge 1995 Frydman and Rapaczynski 1994 Sarcevic 1992 Gelpern 1993 Schjelderup 1990) Goldenman 1993 Schmid 1992 Goldenman 1994 Shibata 1994 Gray 1993a Shirlev 1994 Gray 1993b Smith 994 Gray and Hanson 1993 Snoy 1493 Gray and Jarosz 1993 Thomas 1993 Guerraoui and Richet 1995 Thorni( 1993 Hyclak and King 1994 United Nations 1992 Im,Jalali, and Saghir 1993 Van Brabant 1991 Jackson and Bilsen 1994 Vuvlsteke 1988 Kiss 1994 Welfens and Jasinski 1994 Lee and Nellis 1991 World Bank 1996b Lieberman 1994 World Bank and CFUI'I' 1994 Lieberman and others 1995 World Equity and IFC 1993 Milor 1994 You ng 1991 Newbery 1994 Bulgaria Due and Schmidt 1995 Mintchev 1993 Jackson and Bilsen 1994 Czechoslovakia, Czech Republic, and Slovak Republic Anderson 1994 OECI) 1993 Appel 1995 o(ECl) 1995a Borish and Noel 1996 OEI) 199J5b Bouin 1994 Parker 1994a Czech Ministry 1993 17echota 1991 Dlouhy and Mladek 1994 I'rokopenko 1995 Earle and others 1994 Renziilli 1992 Egerer 1995 Rutledge 1995 Estrin, Gelb, and Singh 1995 Sacks 1993 Fogel 1994 Shafik 1993 Glick and Richter 1991 Svejnar and Singer 1994 Goldstein and Horakova 1993 Valbotnesi 1995 Jackson and Bilsen 1994 Varin 1993 Marcincin and Wijnbergen 1995 Willi,ims 1993 374 The Privatization Challenge Hungary Borish and Noel 1996 Laki 1995 Crane 1991 OECI) 1993 Earle and others 1994 OECD 1995a Estrin, Gelb, and Singh 1995 Richet and T6rok 1993 Gabor 1991 Rutledge 1995 Guerraoui and Richet 1995 Sandor 1992 Gueullette 1992 Sarkozv 1994 Hanson 1992 Tesche and Tohamy 1994 Inzelt 1994 Thepaut 1992 Jackson and Bilsen 1994 Valentinv 1991 Kazakstan oE c D 1995b Latvia Rozen felds 1993 Lithuania OECI) 1995b Poland Albrecht and Thum 1994 Michalski 1991 Blaszczyk and Dabrowski 1993 Milor 1994 Borish and NoMl 1996 Nuti 1991 Earle and others 1994 OFCD 1993 Estrin, Gelb, and Singh 1995 OECD 1995a Greenspan-Bell and Kolaja 1993 OECD 1995b Harder and Taylor 1993 Pliszkiewicz 1992 Jackson and Bilsen 1994 Rivera 1996 Jedrzejczak 1991 Rutledge 1995 Johnson, Kotchen, and Loveman Slupinski 1990 Krawczyk and Lopez-Lopez 1993 Wilson 1i91 Lissowska 1993 Wilson 11)93 Romania Earle and Sapatoru 1994 Lhornel 1993 Jackson and Bilsen 1994 Russian Federation Barberis and others 1995 Johnson and Kroll 1991 Bim 1994 Joskow, Schmalensee, and Bogdanowicz-Bindert and Ryan 1993 Tsukanova 1994 Bornstein 1994 Lieberman 1993b Boycko, Shleifer, and Vishny 1995 Lieberman and Nel]is 1995 Buck, Filatotchev, and Wright 1994 McFaul 1995 Crosnier 1992 McFaul and Perlmutter 1995 Dimitriyev and 1Petkoski 1994 Milor 1W194 Giemulla 1995 Nelson mnd Kuzes 1994 Hedley 1992 OER D 1995a Intriligator 1994 OE D 1995b Geographic Classification of Rcferenccs 375 Petkoski 1994 Raftopol 1993 Petkoski and Yamnova 1994 Schneider 1993 Slovenia Ellerman, Korze, and Simoneti 1991 Prokopenko 1995 OECD 1995a Ukraine IFC 1993 Prokopenko 1995 Milor 1994 Yugoslavia Drouet 1992 Vukmir 1991 INDUSTRIAL COUNTRIES General Baily and Pack 1995 Guerraoui and Richet 1995 Bizaguet 1988a Kramer and others 1993 Button and Weyman-Jones 1994 Lovrette and d'Ormesson 1987 Chadwick 1859 McConville and Sheldrake 1995 European Conference of Ministers Neven, Nuttall, and Seabright 1993 of Transport 1993 Rapp and Vellas 1992 European Conference of Ministers Thiry 1994 of Transport 1995a Unitetd Nationis 1992 European Conference of Ministers of Transport 1995b Australia Martin 1995 Sly and lVeigall 1991 Belgium Brion and Moreau 1995 Nuchelmans 1992 Bouchard 1991 Vincent 1995 Canada Bouchard 1991 Richardson 199(0 Garant 1990 Stanburv 1985 Prokopenko 1995 Denmark Kat/iielsotn 1990 France Andreff 1992 Bizaguet 1988b Andreff 1993b Bouchard 1991 Baudeu 1987 Boutard-Labarde 1987 376 Thec Privatizatioti ChalIcnge' Brousolle 1993 Lee and Bartos 1987 Cameron 1961 Loyrette and d'Ormesson 1987 Cartelier 1992 Marcilhacv and Dangeard 1987 Conseil d'Etat 1985 Martinand 1994 Conseil d'Etat 1989 Morean 1987 Cour des Comptes 1990 Prosser 1991) Debene 1991 Rapp 1986a Delahave 1987a Rapp 1986b Delahaye 1987b Rapp 1987b De Sarrau 1987 Raynaud-Contamine 1987 Durupty 1988 Redor 1992 Durupty 1993 Richer and Viandier 1991 Guerraoui and Richet 1995 Richer and Viandier 1993 Heald 1995 Saint-Girons 1991 lsrael 1986 Schlesser 1992 Germnany Balasubramanyam 1994 McKenna & Co. 1992 Dodds and Wichter 1993 OECD 1995a Elling 1992 Samson 1993 Jones Day 1991 Santini and others 1986 Konig 1988 Steindorff 1993 Laurin 1993 Israel Gurkov 19'94 Italy Gioscia 1993 Santini and others 1986 Japan d'Ormesson 1987 Santini and others 1986 Fukui 1992 Takano -1992 Oniki and others 1994 New Zealand Cavana 1995 Franks 1993 Donaldson 1994 Galal and Shirley 1994 Duncan and Bollard 1992 Williams and Franks 1992 Norway Covarrubias and Maia 1994 Spain Baer and Birch 1994 Santini and others 1986 Dehesa 1993 Villar Rojas 1993 Sweden Prokopenko 1995 Turkey Kjellstrom 1990 Geograplhic Classification of References 377 United Kingdomn Armstrong, Cowan, and Vickers 1994 Liu 1995 Baily and Pack 1995 Magliveras 1991 Baird 1995 Marci]hacy and Dangeard 1987 Beesley and Littlechild 1989 McConville and Sheldrake 1995 Bennett and Cirell 1992 Millward and Singleton 1995 Bishop, Kay, and Mayer 1994 Ogden 1994 Bishop, Kay, and Mayer 1995 P'arker 1994b Buck, Thompson, and Wright 1991 I'arker 1994b Covarrubias and Maia 1994 I'rosser 1990 Dnes 1991 Ramanadham 1994 Dnes 1993 Richardson 199() Foreman-Peck and Millward 1994 Salaun 1990 Foster 1992 Santini and others 1986 Galal and Shirley 1994 Thomas 1994 Galal and others 1994 Tyson 1995 Heald 1991 Veljanovski 1991 Helm 1994 Veljanox ski 1993 Howles and Harvey 1993 Villar Rojas 1993 Hunt and Lynk 1995 White 1994 Kay, Maver, and Thompson 1986 White 1995 Levy and Spiller 1993 White and Tough 1995 Lipworth 1993 United States Baily and Pack 1995 Cramton 1995 Bhattacharvya, Parker, and Kodrzycki 1994 Raffiee 1994 Lopez-ie-Silanes, Shleifer, and Chandler and Feuille 1994 Vishnv 1995 Covarrubias and Maia 1994 Noll an.1 Owen 1994 Specialized Journals The following reports or magazines focus specifically on privatization: Carnegie Couinicil Privatization Project, published by the Carnegie Council on Ethics and International Affairs (1 70 East 64th St., New York, N.Y. 10021) Interintiotial Prizvatization Uidaie, published monthly by Financial Market Research, Inc. (P.O. Box 33, Castleton-on-Hudson, N.Y. 12033) Michigan Privatization Report, published quarterly by Mackinac Center for Public Policy (119 Ashman Street, P.O. Box 568, Midland, Mich. 48640) Privatisation International, published monthly by Privatisation International Ltd. (Suite 510, Butlers Wharf Business Centre, 45 Crulew Street, London, England SEl 2ND) Privatization Watch7, published monthly by the Reason Foundation (3415 S. Sepulveda Blvd., Suite 400, Los Angeles, Calif. 90034) Puiblic Works Financing and Public Works Financing Interniational, published monthly (154 Harrison Ave., Westfield. N.J. 07090). Some yearbooks and other annual publications provide an update of the state of privatization around the world or in specific regions of the world: Prigatization in Latin America, Miami, Fla., supplement to LatinFinance Annual Report on Prizatization, Reason Foundation, Los Angeles, Calif. Privatisation Yearbook, Privatisation International Ltd., London A number of journals have published special issues focusing on privatization: Coluimbia louirnial of World Buisiness 29(l), focus issue on privatization, spring 1993 Droit et Pratiquc dii Commerce International 13(3), spec ial on privatization, 1987 Euronmoney, February 1996, special issue on privatization Hastings Internzationial and Comuparative Lawt, Review 14(4), "Privatizations: Trends and Developments of the Early 1990s," 1994 International Financial I.aw Revie,t) September 1992, special supplement on privatization 379 380 Thie Privatization Challeng'e International Finanicial Lazw, Review, April 1994, "Privatization: A World Privatization Guide" Puhblic Enterprise 11(2-3), thematic issue on privatization in reforming socialist economies, 1991 Quarterly RevieW of Eco1omics and Finance 33 and 34, "Latin America: Privatization, Property Rights, and Deregulation," 1993 and 1994, respectively Reflefs et Perspectives de la Vie Econoomique 32(3-4), "Privatisation et restructuration des entreprises en Europe de l'Est," 1993 RCv7c de Droit des Affaires tinternationalcs 3, 1987 Revue econornique 47(6), "Les privatisations: Un etat des lieux," 1996 Revie InternaltionaL' d7e Droit Fconotnique 3, 1992 Internet Resources Privatization information is available through a broad variety of sites on the Internet. These sites may change frequently and new ones are added constantly. Some sites are updated regularly, others not. The information below. is provided for illustrative pur- poses only to help the reader start an Internet search.' It is in no way an exhaustive listing of available information. A more direct way to search for privatization mate- rial that should yield additional and more up-to-date information is to use Internet search engines. The table below highlights some of the existing country-specific privatization sites. Depending on the country, a site may include the address and contact numbers of the privatization agency, office, or ministry; details on the minister or head of the agency; the text or reference of the privatization legislation; a description of the pro- gram; profiles of companies to be privatized; ongoing tenders, and so on. Embassies and consulates, in particular in the United States, may have Internet sites with useful information on the country's privatization program. See, for exam- ple, in addition to the examples given in table A.], the February 1996 issue of the newsletter of the consulate of Mexico in New York ( itv Additional country-specific sites may be found in a variety of ways, including links to national government servers through and to Russian and East European sites through for example. An increasing number of on-line sites and newvsgroups provide information on privatization. Registration is required to gain access to several of these sites. Sites equipped with search engines allow the user to track the available information. Search engines may be sensitive to spelling differences. Where British rather than American spelling is used, the search should be for privatisation (with an 's'). Privatization Middle East & North Africa is issued on-line every Monday . The Privatization Monitor is a Mexican Web site with many links to otlier privatization sites worldwide . *The author wishes to thank Omer Karasapan for his Coltributionl to this overview of Internet resources on privatization. .38X 382 The Priv'atization Challenge Table A.1 Country-Specific Privatization Sites on Internet Countr y Internet site Brazilianl privatization program (information from CLC, the Brazilian stock exchange's clearing system) Bulgarian Privatization Agency (see also ) Croatian Privatization Ministry Estonian Privatization Agency Hungarian Privatization Agency (Ministry of Finance) Lithuanian State Privatization (see also Agency ) Macedtnoian Privatization Agency Romaanian Development Agency (see atso (see also (information provided by the ) Ministry of Foreign Affairs) Uganda, Privatization Unit of the Ministry of Finance & Economic Development Zambian Privatization Agency (see also ) Privatization information is also available through many sites that are not specifi- cally dedicated to this subject matter. The "Business Monitor Online" provides information on international trade and investment, including privatization. The information available is provided by lawyers, accountants, banks, consultants, gov- ernment bodies, and so on . TradePort, a Califor- nia-based site, gives access to economic and business information on many coun- tries . Several private organizations or foundations promoting privatization worldwide have home pages listing their activities and publications. This is the case, for exam- ple, of the Adam Smith Institute in London , the Cato Institute in Washington, D.C., or the Center for International Private Enterprise also in Washington, D.C. . Internet ResourLes 383 Multilateral and regional organizations also maintain sites that contain informa- tion about privatization. The World Bank's Web site is at . The International Finance Corporation at <¸http://zu'u'.ifb.org>. The Multi- lateral Investment Guarantee Agency (MIGA) of the World Bank Group provides information on privatization programs and investment opportunities through IPAnet, its "on-line global investment marketplace" . The Asian Development Bank may be reached at , the Inter-American Development Bank at , the European Union at , the OECD at , the UN Industrial Develop- ment Organization at , the IntLrnational Telecommunication Union at , and so on. Manv bilateral aid agencies with privatiza- tion programs are also on-line, as is the case with USAID (). Searches on privatization (or privatisation) will often yield projects supported by such agencies, publications, seminars, conferences, and so on. This is only the tip of the iceberg. The Internet will offer many more sources of information on privatization to those patient enough to surf. Subject Index Access rights 261, 297. ScL' also Third- Appeal 34, 39, 127, 263, 273-274, 279- party access 280 Accounting 60-61, 86, 98-99, 101, 103, Arbitration 26, 83-83, 244, 269, 278, 280), 108, 120, 142, 169-170, 183, 264, 266, 285, 335 276 Articles of incorporation 335. See bylaws Administrative capabilities. Set, Public Auction 51, 52, 119, 122, 124-126, 134- administration 135, 144, 179-181, 184, 188, 198, 214, ADRs 86 261, 28-5, 335 Advisers 126, 140, 174-175, 190-198, Audit. See Advisers (financial), Regula- 252-253,280-281, 286, 298-299, 382 tion (privatization of), Valuation of economic 190-192, 201 enterprises financial 119-121, 182, 190-192, 196- 197, 256 Banking sector 3-5, 24, 35, 68, 70-72,86, legal 37,87-88, 192-197 11)1), 105, 128, 154, 155, 163-165, 187- Advisory fees 142, 176, 192-194, 197, 19() 252-253,281 Bankruptcv 61-66, 97, 107, 2(14, 214, Affermane 10,12, 205, 215, 243, 289, 335. 292, 335 See also Leasing Barriers to entry 1(), 17, 2(01, 203, 221- Airlines 6, 1), 11, 41-43, 62, 67, 75, 125, 222,260,284 227,246,251-252,262,281 Benchmark competition. See Competi- Airports 129, 166, 227-228, 247, 256, tion (yardstick) 261,272,279,288 Bidding process 40, 55, 5o, 75, 80, 85, Allocation of privatization proceeds. Se lH'-122, 124-132, 135, 138, 139, 161, Privatization proceeds 164-165, 171, 174, 175, 191, 198, 213, Allocation of responsibilities 152, 154, 214, 217, 220), 226, 232, 239, 251-255, 155, 164,167-170, 173, 199, 285, 296 261, 285, 335 Amendn7ents Bilateral agreement 41-43, 56, 335 constitutional and legislative 34-37, Bonds 5, 58, 78, 138, 184. See also Con- 46, 64, 95, 144-145, 146, 149, 247, vertible bonds, Privatization bonds 248, 290, 296-297 Book-building 69, 120 of company bylaws 102, 256 Budget deficit 7, 17-19, 21, 1411-141 of license or concession 243, 246, 267, Budget law. SeL P'ublic finance legisla- 268, 271-272, 278,279 tion Antitrust legislation 54-55, 86, 88, 211), Build, operate, transfer (BOT) 1()-12, 213,218,221,223, 235, 260 243-245, 247, 335-336 385 386 The Privatization Challenge Build, own, operate (BC)O) 11-12, 243- Constitution 33-40, 43, 46, 53, 67-68, 245,336 84, 89, 95, 130, 152, 242, 246-250, 264, Bureaucracy 21, 60, 168, 188, 200, 288, 290 290 Constitutionality of privatization 38- Business law 22, 56-73, 122, 194, 277, 40, 74, 84-85,133, 150,171, 244 292 Contract law 54, 56-57, 265 Buyer selection 124-132. See also Bid- ContractUal obligations 52, 56, 74, 96- ding process 97,98, 104, 109,173 Bylaws 41-42, 58, 88, 102, 130-131, 183, Control of the privatization process 36- 239,256-257,336 40,116,146,149-152, 170-173,186 Convertible bonds 112-113, 122, 228 Capital increase 7, 10, 59, 114, 121, 124, Corporate governance 41-42, 58-60, 70, 125,142, 238 94, 99,143, 164,169,184-189,238,259. Capital markets. Sec Financial markets See also Golden share, Minority share- Capitalization program 12, 80, 124, 125, holders 252,274,305 Corporatization 12, 38, 47, 63, 66-67, 71, Centrally planned economies. See Social- 76, 90, 97, 99, 101-105, 107, 233, 250- ist countries, Transition countries (in 251, 260, 337 Geographic Index) Corruption 19, 22, 54, 95, 116-117, 124, Collateral 47, 188, 198, 336 143, 169, 171-172, 200, 247, 279, 295 Commercialization 12,101,122,336 Coupons (vouchers) 112-113, 122, 124, Communist party 2, 28, 48, 50-51, 153, 134, 151, 179-190, 233, 341. See also 172 Mass priva tiza tion Company law 38, 57-60, 63, 66-67, 87, Creditors 57, 61-67, 98-99, 132,134,139, 94, 99,101-105, 107, 142 295 Compensation of former owners 38,48- Cross-subsidization. See Subsidies 52, 68, 207, 336. See also Restitution Currency 24. 61, 73, 86,138, 224, 241, 292 Competition Customs 26, 41 in infrastructure sectors 10-11, 203, 204, 212-214, 215-245, 291-294, Debt of public enterprises 30,59-60,61- 336 67, 77, 90, 97-99, 101, 105, 107, 123, protection of 53-56 132,138-1 39, 141,166, 168, 250, 295 yardstick 19, 214-215, 281, 283, 285, Debt reduction 9, 18, 41, 98, 105, 138- 341 141, 296 See also Antitrust, Market structure, Debt-equity swaps 62, 65, 108, 130,138- Monopoly, Regulation 140 Competitive bidding. See Bidding Demonopolization 337. See also Competi- Compliance with buyers' obligations tion, Monopoly, P'ublic enterprise 82-83, 173,160,200 (breakup), Restructuring Concession 10, 12, 35, 38, 166, 204-210, Deregulation 55-56, 99-100, 1)03-104, 213-215, 217, 220, 225-226, 230-232, 213, 221-222, 225, 235-237, 259, 292- 238-241, 242-249, 255, 260-265, 271, 293, 337. Sce also Competition, Regu- 274-275, 278, 286, 289, 336 lation Concessional financing. See Subsidies Disclosure 60-61, 120, 186, 187,200, 266. Condemnation 336. See also Expropria- See also Publicity tion Discrimination Confiscation 336. Sete also Expropriation against foreign investors 19-20, 36, Conflicts of interest 134, 175-176, 187- 67-68, 127, 129-132, 239, 241, 243, 190, 196-198, 221, 270, 275, 294 246-2l9 Suibject Index 387 against the private sector 45, 53-54, Failed privatizations 2, 9, 74, 119, 165, 63, 86, 99-100, 109, 246-249, 292 185, 255-256, 271, 272 against SOEs 100 Finance ministry 92, 143, 155, 160, 162, competitive 223, 230-231, 258, 264, 163,167, 168,171, 177 266 Financial markets 11, 68-70, 71-72, 78- Dismissal. Scc Overstaffing 80, 125, 185-186, 189, 268, 272, 287, Dispute settlement mechanisms 26, 34, 293 83-85, 157, 274-275, 280-281, 292. Scc Financial restructuring 2, 65, 97-99, also Appeal, Arbitration, Judicial svs- 101 -1)6, 250 tem, Litigation Financinig Dissolution. Sgc Liquidation acquisitions 137-140, 144, 261 Divestiture 9-12, 38, 91-92, 94, 101, the privatization process 99, 140-143, 121-127, 165, 168, 222, 232-233, 236 176-177,192, 199 122-124, 659, 684, 222, 2322337. 236 ao Flucttuation of share price 70, 120, 218- 242-246, 259, 284, 288, 337. Sec- (1/sC 219, 271, 272 Privatization Foreign exchange. See Currency Divestment 337 Foreign investment 20, 36, 41-43, 48-49, Due diligence 88, 252,337 61, 67-68, 73,83-86,87,127, 129-132, 239, 241, 243, 246-249, 256-267 Economic Foreign legislation 85-86, 241 efficiency 17-18, 32, 282, 287, 294 Foreign trade 11, 56, 293. Sce also Glo- reforms 8, 15-16, 29, 56, 87, 274, 287- balzation 288, 293. See also Sequencing Franc hise. See Concession Economies of scale 203, 206, 212-213, Fraud. Scc Corruption 217 Electricity 4-6, 10, 90, 143, 205-206, Gas 3, 5, 6, 34, 205-206, 213, 219, 223- 212-213, 217-223, 243, 245, 250, 272, 225, 245, 256-257, 262, 272, 278 292 GlobKilization 8, 228-229, 241-242, 284, Eminent domain. See Expropriation 288-290 Employee Going concern 74, 75, 95, 101,107,337 benefits 38, 47, 74-78, 100, 104, 132- Golden share 39, 98, 129-132, 234, 256- 137 257, 337 ownership 17-18, 37, 60, 70, 77-78,91, Guaranltees 6, 52, 53, 66-67, 87, 97-100, 120, 132-135 13",136 267,271,294 Sce ilso Emplovment, Labor law, Hydrocarbons 3, 34-35, 68, 123, 125, Labor unions, Overstaffing H4 ao 3, 223 Employment 9, 31, 49, 74-77, 80, 141, 14u,203,224 173,175,295 Immunitv of the State 84, 109 Enabling legislation. Sev Business law, Infrastructure companies 8-9, 229, 281- Privatization law 2I82, 284, 291) Energy sector 4, 34, 35, 102, 246, 251. See Infrastructure privatization 203-286, also) Electricity, Gas, Hydrocarbons 288-292, 298 Environment 6-7, 67, 81-83, 88, 10)6, historv 204-211 173, 258,295 legislation 247-250 European Union law 39, 129-130, 216, objectives 18-19, 284 222,235-236, 276 teL hniques 242-246 Exclusivity rights 230-231, 238. Sec also Sc, also Competition, Market Struc- Monopoly ture, Regulation Expropriation 38, 48-52, 68, 93-94, 269. Initial public offering 337. Sec also P'ublic Secalso Compensation, Restitution flotation 388 The Privatizatio" Chlallen'ge Insolvency 337-338. See also Bank- Legal owners. See Property rights ruptcy, Liquidation Liability 59, 60, 61, 66-67, 81-82, 87-88, Institutional framework. See Privatiza- 96-99, 101-102, 106, 250, 281, 295, tion institutions, Regulatory bodies 338. See also Debt Insurance 4, 122 193 License 1 0- 2, 59, 88, 216, 225, 230, 234, Intellectual property 52-53, 88 238, 242-249, 260-265, 274-276, 279- Interconnection 215, 219, 222-223, 230- 281, 285-286, 338 231, 235, 237, 259, 262-263, 264, 266, Liquidation 37, 57, 61-66, 74, 87, 92, 95, 268,275,276,280,292,338 101, 107, 109, 155, 158-162, 168, 172, International 176, 250, 338 agreements 7-8, 40-43, 52, 132, 209, Litigation 39-40, 49, 59, 63-65, 83-85, 235 88, 12', 168, 220, 280 alliances 8, 18, 229, 232, 241, 276 Local government 28, 89-911, 128, 151, law 40-43,85,241-242, 288-289 165-166, 168, 191, 2(15, 208, 220, 224, Internet 229, 264, 381-383 238, 246, 249 Interpretation of laws 34, 36, 43, 72, 144 Investment bank. See Advisers Management compensation 190, 269,282 Investment funds 141, 142, 143, 151, Manfagemilenit contract 10, 35, 57, 96, 97, 160. See also Mutual funds, Pension 113, 134, 181-182, 289, 338 funds, Privatization funds Market structure 23, 191, 197, 211-215, Investment requirements 18, 96, 216, 215-242, 247, 250-251, 260, 279, 283, 225, 227, 228, 231, 232, 240, 243, 262, 286, 288, 292, 294 267-269 Mass privatization 1, 17, 64-66, 124, Investors 22,19(0, 270-271, 292-294 151, 154, 177, 179-190 foreign. See Foreign investment Mining 5, 36, 75, 81, 85, 10(), 123, 198 institutional 9, 70, 78-80, 123, 125, Minority shireholders 12, 42-43, 58-59, 127, 177-178, 186, 188-189, 255- 117, 129-'130, 251 256 Monitoring. See Compliance with buy- small 18, 60, 132-133, 135-137, 179- ers' obligations, Contr(ol of the priva- 180,185-187, 200, 255-256 tization process strategic 23, 58, 123-127, 251-255, Monopoly 10, 19, 23-25, 34-35, 54-55, 272, 34(0 10(1, 1()5, 191, 197, 203, 209, 211-215, 216-242, 248, 258-260, 262-263, 267, Joint venture 12, 27, 53, 58-59, 92, 94, 278, 283-286, 288, 292-293, 297, 338- 107, 196, 220, 224, 244, 246, 289, 295, 339 338 Moratorium. See Restrictions on privati- Judicial system 24, 26, 34, 38-39, 49, 55, zationt 62-66, 83-85, 94, 273-274, 279, 280 Multidisciplinary approach xi, 196, 201, Juridical person 27, 57, 89-90, 123, 163, 299 338 Municipality. See Local government Mutual funds 9, 70,141, 177-178, 188 Labor law 74-77,88, 100, 295 Labor unions 21, 31, 40, 50, 62, 74-77, Nationalization 3, 6, 34, 37, 48-52, 120, 134,135,167,175-176, 227, 256 128, 204-211, 289, 291, 339 Lawyers. See Advisers Natural resources 3, 118, 203 Layoffs. See Overstaffing Nondiscriminationi. See Discrimination Leasing 10, 12, 35, 38, 57, 71, 72, 123, 135, 172, 205, 215, 226, 243, 245, 246, Obstacles to privatization 20, 43, 48-49, 289,293,338 87, 112-114, 146, 194-195, 249, 292, Legal assistance. Se Advisers 293, 298, 299 S ubject Iind,ex 389 Opposition to privatization 20-21,76-77, benefits 7, 9, 18-19, 189, 232, 234, 242, 84-85,118,132-137,167,222,294-296 259, 286, 287. Sec also Performance Overstaffing 21, 31, 67, 74-77, 80, 97, of privatized enterprises 104, 106, 109, 112, 115, 173, 296 bonds 139-140 Ownership rights. See Property rights committees and commissions 154- 163, 164,165,168-170,177 Parliament 36-40, 94, 107-108,111,114- definition 10-12, 101, 242-244, 288- 115, 119, 133, 140-142, 145-146, 149- 289, 339 152, 153, 157, 160, 161, 167, 170-172, explanatory factors 6-10, 284 184, 198, 206, 277, 296-298. See also funds 177-190 Privatization law historv of 2, 3-6, 204-211 Payment. See Debt-equity swaps, Fin- institutions 22, 92, 111-112, 149-201, ancing of acquisitions 273-274, 295-296 PCS licenses 4, 261 law 38-40, 41, 46, 48-50, 58, 67, 68, 72- Pension 73, 87, 92, 99, 1(02, 105, 111-147, entitlements 38, 78 149-154,163-170,172,175,185,187, funds 78-80, 124, 125, 140, 252, 255 194,225,247,261,270,279,296-298 Performance minister 25, 91, 122, 160-162, 163, 165, of privatized enterprises 7, 9,104, 106, 168, 199 120, 258, 267, 269,272,290 objectives 3, 16-20, 38, 105, 114, 127- of public enterprises 3, 6-9, 17, 102- 129,142,145-146, 164,176,179,189, 104,106,117,125,154, 164,165,256, 255, 258-259, 271, 284, 287, 291, 258, 267 294, 299 Political of a sector 3, 10-11, 23-26, 34-36, 40, commitment 21, 45-46, 198-200, 250, 68, 1])5, 116, 118, 143, 146, 163-164, 270, 285, 295-296 191, 193, 195-196, 203-204, 211- objectives 7, 19, 20, 98, 119, 120, 129, 215, 242-243, 246-250, 260, 262- 132, 137,179,239 263,267,270,278,284-286,288-289, process 16, 19, 20-21, 149, 153-154, 292 170,188, 277, 289-291, 295-296 of the economy 11, 15-16, 29, 34, 39, Popular capitalism. See Investors (small) 45-87,163,172, 179,288-289, 292 Ports 25, 38, 93, 166, 208, 214, 226-227, of the regulatory function. See Regu- 249,261,262,288 lation Postal service 25, 76, 100, 102, 104, 116, proceeds 1-2, 4-5, 17, 67, 90, 98, 108, 158, 226,236,246,248,250 117, 140-143, 146, 161, 166, 176- Preemptive rights 37, 51, 58-59, 91, 127, 177, 179, 192,199, 214, 238, 271, 291 132-136, 295, 339. See talso Employee scope 10-12, 24-26, 34-36, 115-118, ownership, Minority shareholders 154, 190, 293, 296-297 Prequalification criteria 253-255 speed 38,61, 69, 94,106,115, 119, 15()- President (of country) 21, 25, 39, 45, 92, 151,153,169,173,175,179,188-189, 114,116,118, 200, 246, 295 195, 293-294, 296 Price caps 216, 220,266-269, 282 strategy 2, 11, 15-32, 107-108, 115, Price liberalization 54, 293 140, 145, 190-191, 194-195, 284- Prisons 26 286, 287, 292-294, 296, 297, 299 Privatization techniques 2-3, 10-12, 17, 29-30, 42, agencies 20, 142, 154, 155, 156-162, 58-59, 61-62, 72,77,86,98,105,107, 163, 164, 167-169, 176-177, 199- 112, 115, 117, 121-124, 129-131, 200, 295-297 144, 152,155-157,159,163,175,203, agreements 45, 55, 74, 83, 85, 92, 113, 242-246, 251, 256-257, 271, 289, 139,154,163,168,192,195-196,225, 293, 297. Setc also Advisers, Staff of 241, 250, 270, 274, 285, 298 privatization bodies 390 The Privatization Challenge Property rights 34-35, 46-53, 56-59, 88, Railways 3, 4-5, 6, 12, 77, 93, 100, 125, 89-95, 108, 112, 128, 134-135, 159, 127, 166, 204, 206-207, 212-214, 225- 161, 163, 164, 243, 248-249, 285, 291- 227, 229, 237, 245, 248-249, 252, 261- 293, 339. See also Intellectual propertv 262, 274 Public administration 22, 24-26, 93-94, Ratification 45,94, 113,118, 150,157,168 101, 108-109, 154, 163, 171-172, 199, Referendum 151, 247, 253 263, 268, 273-274, 278, 280-281, 285, Regulation 287,291, 295-296 impact of 269-272 Public assets (sale) 92-94, 95, 172 of competition 53-56 Public domain 92-94,340 of infrastructure sectors 9, 213-215, Public enterprise 258-283, 289-290,293-294 breakup 19, 23, 55, 67, 95, 105-106, of privatization funds 124, 183, 186- 107, 109, 212-215, 216-221, 223, 188,189-190 224, 226, 250-251, 287 privatization of 280-281, 286, 290, creation 33-37, 57, 91-92, 128, 245- 298-299 246 self 281-282, 284 definition 340 Regulatory bodies 271-282 exclusion as buyer. See Restrictions advisory 274, 277, 290 legal status 26-28, 38, 60, 66, 89, 90, appeal 279-280 93, 95, 97, 101-105, 108-109, 114, autonomy 240, 269, 273, 275-277, 123, 125, 250, 291 282,290 legislation 37, 91-92, 94, 95, 100, 1(09, decisions 218, 221, 223, 241, 261-269, 140, 246, 291 272,279 management 58, 94, 96, 97, 100, 103, establishment 240, 241, 273-277,285 106,109,120,137,143,153-154,164, multisectoral 278-279, 285 167-169,175-176,259 powers 240, 273, 274-275, 278, 279, privatizable24-26,115-118,131, 180 286 28, 135, 146 Reputation 57, 200, 269, 270, 282, 284, 290 size ,,,Restitution 2, 48-50, 128, 340 See also Constitution, Corporate gov- Restrictions ernance, Corporatization, Divesti- Relctictions ture, Nationalization, Perfor- on buyer selection 127-129 on privatization 35-36, 43, 46-48, 92, mance, rivatizat9on, Restructur- 3, 94-95, 103, 115, 121, 127-132, ing, Valuation 144, 146, 243, 246-249,297. Public finance legislation 53, 92, 107- on public-sector participation 27, 92, 108, 139-142, 150 116, 127-128, 144 Public flotation 17, 29-30, 58-59, 60-61, on share transfers. See Transferability 68-70, 86, 101, 119-120, 122-124, 126, See also Constitution, Discrimination 136, 167, 178-179, 191, 193, 218, 226, Foreign investment, Golden share, 228, 233, 234, 236, 241, 250-252, 255- Investors 256, 267, 340 Restructuring of enterprises 23, 53, 67, Public interest 21,24, 52, 55,91,236, 248, 71-72, 78, 80, 95-107, 162, 164, 168- 265,268,278,280,294 169, 189, 212-242, 250-251, 288. See Public offering. See Public flotation also Liquidation Public procurement 36, 54, 97, 108 Risk Public relations 30-31, 180,1 94, 296 for governments 11-12,137-138 Public service 10, 24-26, 35, 45, 93, 205, for investors 11-12, 20-21, 22, 34, 52, 224, 226, 231, 242, 248, 253, 257, 258, 61,80-82,88, 114,138-140,185,189, 261-266,274,286,289,291 193, 268-271,277 See also Electricity, Gas, Transport, Roads 35,93, 166, 208, 214, 225, 249 Telecommunications, Water Role of the State 19, 24-25, 45, 53, 289- Publicity 31, 34, 118, 124, 126, 200, 277, 291 281,283 Rule of law 33-34, 291, 294 Subject Index 391 Sale price Telecommunications 3, 4-5, 23, 35-36, determination 38-39, 119-121, 155- 40, 58, 76, 100, 107, 112-113, 115, 119, 157, 165 122, 193, 209-211, 215, 221, 228-242, tradeoffs 56, 72, 97-99, 106, 232, 285, 245, 248, 250-256, 259, 261-263, 264- 294 265,273-274, 276, 278, 383 See also Fluctuation of share price Television 122,126, 238 Secondary market 69-70, 138, 186, 340. Tender 340. See also Bidding See also Financial Markets, Securities Third-party access 218-219, 222-223, exchange 230-231, 235, 237, 259, 262-263, 264, Sector ministries 91, 167, 168, 295 266, 268, 275, 276, 280, 340-341 Sector strategy. See Privatization of a Transferability of shares 57-60, 61, 68- sector, Strategic sectors 70, 133, 137. See also Golden share, Securities exchange 29, 30, 51, 61, 68-70, Securities law 86, 91, 112, 167,169, 178, 179,185,189 Transformation into commercial com- Securities law 57-59, 68-70, 80, 86, 112, panies. Sete Corpora tization 124,172,188, 190, 340 Transition. See Transition countries in Self-regulation. See Regulation the Geographic Index Sequencing of reforms 16, 30, 66, 72, Transitory provisions 78, 143-144, 230- 189,212,222,285,293-294 231, 250 Shipping 34, 36, 123, 225 Transparency 20, 31, 54, 56, 61, 118-119, Smallshareholders. See Investors (small) 122, 124, 126-127, 141, 146, 171, 174, Social aspects 17-21, 80, 100 189, 198-200, 224, 247, 255, 273-274, Social legislation 73-80, 87 277, 281, 285, 291, 295 SOE. See Public enterprise Transport 25, 35, 36, 166, 203, 206-209, Spectrum auction. See PCS licenses 225-228, 266. See also Airports, Ports, Staff of privatization bodies 156,158, 160, Railways, Roads, Shipping, Waterways 173-176, 190, 192, 199-200,295-296 Treaty. See International agreements State holding company 6, 26-27, 59, 90, Trustee 62, 80, 125,179, 252 92, 94, 99, 105, 117, 155, 160, 164, 167, 170,177,184,224,297,340 Unbundling 341 State-owned enterprise. See Public of enterprise. See Public enterprise enterprise (breakup), Restructuring of enter- Strategic sectors 3, 24-25, 34, 102, 243, prises 289 of ownership rights 57-58 Subordinate instruments 112-115, 246, of sector. See Privatization of sector 297 Underwriters 197, 341 Subsidiaries 36, 38, 59, 68, 72, 86, 94, 103, 116, 118, 128,215,229,234,276, 297 Valuation of enterprises 38-39, 60-61, 88, Subsidies 25, 41, 83, 99-100, 104, 106, 118-121, 157, 161-162, 164-165, 168, 109, 123, 134-135, 171, 225-226, 231, 170,175,190,267,271-272,281,290 235, 236-237, 240, 244, 258-259, 263- Vouchers. See Coupons 264, 266,276, 285, 288 Support measures 20, 21, 30-31, 297 Waste collection 10, 204,213 Water 10, 35, 41, 197, 204-205, 208, 214, Tariff regime 216-218,220, 231-232, 234, 215-217, 229, 245, 249, 259, 267, 269, 240, 258, 265-269, 270, 279, 282, 285 278, 279, 282, 285 Taxation 26, 43, 52, 53, 72-73, 99, 244, Waterways 20)8-209, 249 285,289,292 Technology 8, 104, 203-211, 217, 225, Yardstick competition 341. Seealso Com- 228-229, 253,268, 278, 283 petition Geographic Index Africa 6, 22, 30, 61, 98, 207, 369 Bulgaria 35, 50, 66, 68, 90, 95, 102, 105, Albania 96, 164,233, 247, 301 114, 116, 128, 133, 135, 140-141, 143, Algeria 302, 369 153-154, 166, 233, 247, 306, 373, 382 Angola 6, 35, 68,207 Burkina Faso 116, 130, 226, 245, 306 Argentina 5-6, 21-22, 56, 79, 85-86, 95- Burundi 92, 175, 306 96, 102, 107, 116, 118, 122, 123, 127, 133, 136, 138-139, 150, 156-157, 165- Cambodia 95 166, 192-193, 197, 204-207, 214-215, Cameroon 227, 306-307 217, 219-220, 224, 226, 227-228, 230- Canada 78, 107, 118, 166, 179, 225, 227- 232, 245, 247, 251-254, 274, 278, 302- 228, 237, 245, 307, 375 303, 370 Cape Verde 307 Armenia 303 Central African Republic 245 Asia 6, 29, 191, 221, 371 Central and Eastern Europe. See Eastern Australia 4, 37, 205, 222, 227, 230, 233, Europe 245,251,260, 303,375 Chad 130, 307 Austria 207, 227, 303 Channiel 208, 209, 244 Azerbaijan 303 Chile 2, 9, 29, 72, 79, 86, 138, 155, 204- 206, 210-211, 214, 220-221, 226, 243, Bahamas 303 245, 247, 252, 255-256, 260, 272-273, Bangladeshi 34, 371 307-31)8, 370-371 Barbados 233 China 29, 61, 113, 206, 209,221,3(08,372 Belarbos 230 C'olombia 22, 40,62, 76, 79, 164, 166, 206, Belarus 3(14 227, 233, 265, 308, 371 Belgium 4, 41-42, 77, 100, 118, 129, 165, Congo 6, 96,137, 233, 308-309 175, 177, 205-207, 220, 224, 236, 245, Costa Rica 309, 371 257,3(14,375 C'te d'lvoire 192, 20)4-21)6, 226, 233, Belize 233 245, 278, 309 Benin 6, 36,304 CroaIia 134, 233, 30)9, 382 Bolivia 3, 35, 80, 124-125, 204-205, 222, Cuba 5, 233, 245, 371 226, 233, 245, 252, 274, 277-278, 305, C'zech and Slovak Republic. Sec Czech- 370 oslovakia Brazil 5, 34, 36, 53, 67, 68, 74, 85, 113, Czech Republic 5, 64-65, 66, 163, 181- 118, 128, 130, 138, 143, 155, 226, 233, 183,184-190,233,310,373 245, 247, 248, 262, 305, 370, 382 Czeclhoslovakia 49, 50, 55, 64, 65, 69, Buenos Aires 10(1, 197, 215, 217, 220, 102, 105, 122, 124, 130, 135, 144, 166, 226 18i), 181-183, 184-19(, 30)9-310, 373 ,393 394 The Privatization Challe'nge Denmark 4,227,233,375 India 29, 40, 94, 56, 119, 171, 206, 208, Developing countries 3, 5, 9, 46, 62,122, 233, 315 140, 190-192, 204, 206, 223, 232, 258, Indonesia 5, 26, 35-36, 86, 135-136, 206, 269, 271, 273, 280, 369 232, 244, 245, 247, 253, 255-256, 275, Djibouti 247, 310 316, 372 Dominican Republic 31(0 Iran 135, 316 Ireland 233 Eastern Europe 15, 29, 47, 163, 177, 190, Israel 233, 31h, 376, 382 192, 372-373, 381 Italy 4, 6, 60, 67, 70, 71, 76-77, 80, 94, Ecuador233, 251, 310 102, 107, 113, 135-136, 140, 171, 193, Egypt 94, 310, 369 205-206, 233, 246-248, 257, 316-317, El Salvador 233, 248-249, 311 376 England. See United Kingdom Ivory Coast. See C6te d'lvoire Estonia 233, 311, 382 European Union 7-8, 25, 39, 41, 129, Jamaica 57, 77, 128, 206, 209, 227, 231, 216,222,235-236, 241, 382 233, 245, 253, 273, 317, 371 Japan 4, 209, 226, 233, 245-246, 275, 317, Finland 311 376 France 3, 4, 6, 24-27, 29, 36, 38-41, 69, Jordan 233 74, 76, 107, 108, 114-117, 119-120, 126-127, 129, 130, 131, 133, 135-136, Kazakstan 180, 317, 374 138-139, 141, 155, 160-162, 170, 192, Kenya 30, 233, 317 204, 206-208, 222, 227, 236, 241, 243, KeYa 233, 255, 317, 372 245, 247, 260, 263, 265, 275-276, 311- Kuwait 317 313,375-376 Kyrgyz Republic 134,175,247,318 Gabon 233, 313 Georgia 313 Lao PDR 90, 318 Germany 2, 4-5,31,43,48,49, 59, 75, 76, Latin America 29, 78 253-254 370 78, 81, 90, 97, 99, 116, 141, 160-162, Latvia26,233,245,318,374 164, 166, 171, 173, 175-176, 192-193, Lti 6232538 7 199, 221, 233, 236, 241, 245, 248, 250, Lebanon 25, 208 252,260,275-276,313-314,376 Lithuania 233, 318-319, 374, 382 Ghana 30, 49, 233,314,369 Great Britain. See United Kingdom Macao 205, 245 Greece 206, 227,236, 255-256, 314 Macedonia 319, 382 Guatemala 205, 233 Madagascar 233,245, 319 Guinea 45, 56, 90, 92, 107, 113, 118, 144, Malaysia 5, 9, 38, 75-76, 107, 119-120, 168, 174, 205, 227, 233, 245, 253, 278, 129, 132, 158-159, 191, 204-205, 221, 314,369 227, 233, 245, 255, 257, 275, 319, 372 Guinea-Bissau 35, 47, 245, 314 Mali 319 Guyana 233, 371 Mauritania 320 Mexico 5, 9, 21, 26, 35, 57, 61, 62, 72, 77, Honduras 233, 315 86, 91-92, 96, 106, 113, 127, 135, 138, Hong Kong 227, 245 141, 163, 166, 171, 193, 204-205, 207, Hungary 5, 50, 51, 55, 63-65,68, 71-72, 226-228, 231-233, 245, 247-248, 251, 77, 85-86,120, 124, 141,150,166, 169, 263, 320, 371, 381 170, 171, 207, 220, 224, 225, 237-238, Moldova 172, 233, 320 245, 247, 254, 257, 271, 274, 278, 315, Mongolia 180, 320, 372 374,382 Montenegro 320 Geographic Index 395 Morocco 36, 68, 74, 93, 115-116, 128, Sio Paulo 67,118, 207,305 139-140, 155, 164-165, 177, 205, 208, Senegal 36, 58, 100, 107, 116, 130, 132, 233, 281, 320-321, 370 137, 233, 245, 253, 328, 370 Mozambique 35, 117, 321 Serbia 329 Sierra Leone 209 Nepal 321 Singapore 5, 80,233, 255, 329, 372 Netherlands 4, 12, 25,41-42, 233, 236 Slovak Republic 66, 134, 150, 184, 329, New Zealand 11, 23, 37, 86, 100, 101- 373 105, 107-108, 141, 192, 221-222, Slovenia 72,90,105,134,164,233,329,375 226-227, 237, 245, 252, 257, 278, 321, Socialist countries 25, 29, 34-35, 71, 80, 376 90, 113. Set' also Transition countries Nicaragua 113, 233, 322 South Africa 233 Niger 322, 370 Soviet Union 15, 22, 29, 34-35, 47-48, Nigeria 102,116,122,322 90,175, 179,184, 288, 329,372-375 Norway 221, 245, 376 Spain 4, 127, 129, 135-136, 204, 206, 210, 227, 233, 236, 376 OECD member countries 4, 29, 190, 258, Sri La nka 12, 66-67, 76, 102, 206, 233, 375 39 7 Swaziland 370 Pakistan 71, 75, 77, 112-113, 163, 167- Sweden 25, 226-227, 233, 236, 245, 329, 168,171, 227,245, 272, 275, 322, 372 376 Panama 171, 208-209, 233, 247, 322 Taiwan (China) 5,150,329,372 Paraguay 37, 322-323 Tajikis,tan 329-330 Peru 5, 16, 21, 25, 29, 53, 75, 79-80, 83, Tanzania 6, 330 112, 128, 144, 155, 156-157, 176, 178, Thailand 2, 221, 227, 233, 245, 247, 330, 193, 220, 222, 230, 232-233, 245, 247, 372 251, 253-254, 323-324, 371 Togo 36-37, 56, 92, 107, 227, 330, 370 Philippines 22, 29, 73, 84, 116, 138, 142- Transition countries 5, 15, 28, 46, 47, 57, 143, 155, 158, 159, 168, 170, 174, 206, 62, 3, 66, 87,98,105, 120, 122,135,140, 227, 232, 245, 247, 249, 259, 265, 274, 156, 164, 172, 177-190, 191-192, 204, 324,372 232, 258, 269,271, 273,280,341 Poland 39, 47, 50, 55, 63-65, 66-67, 69- Tunisia 73, 169, 330, 370 70, 77, 81-82, 90, 114, 122, 128, 133, Turkey 40, 59, 85, 113, 129, 168, 206, 233, 150, 151, 160-162, 168, 172, 173, 180, 244, 246-247,330-331,376,382 181-183, 184, 186, 189, 191, 193, 233, Turkmenistan 331 324-325,374 Portugal 34, 41, 120, 129, 206, 233, 236, Uganda 168, 233, 331, 382 325 Ukraine 95,119,180, 331-332, 375 IPuerto Rico 115, 119, 140, 142, 171, 332- United Kingdom 2, 4, 7, 9, 17, 19, 26, 29, 333 37-39, 69, 86, 98, 102, 120, 129, 136, 141, 17(0, 178, 192, 203-209, 214, 216- Romania 31, 49, 102, 112, 164, 169, 181- 219, 221-222, 223-227, 234, 243-245, 183, 184, 185, 186-187, 233, 246, 325, 250,256-257,262,266-269,270,272- 374, 382 273,277-278, 279-280, 282, 332, 377 Russian Federation 1-2, 60, 73, 85, 90, United States 3-4, 25-26, 166, 193, 204- 95, 128, 134, 137, 151-152, 163, 166, 2019, 225, 232, 236-237, 241, 245-246, 170, 175-176, 180, 181-183, 184, 186- 261, 263, 273-274, 277-278, 332-333, 190, 198, 205-206, 224, 233, 245, 325- 377, 383 328, 374-375,381 Uruguay 118, 207, 247, 253-254, 333 Rwanda 233, 328 Uzbekistan 233, 333 396 The Privat izafion Challengc Venezuela 5, 75,86,132,164,166,197,227, Yemen 233 239-241,245,251,254,270,333,371 Yugoslavia 90,134, 334, 375 Victoria 222 Viet Nam 29, 47, 90, 94, 107, 113, 120, Zambia 179, 334,382 171-172,247,333-334 Index of Enterprises, Agencies and other Organizations Aeromexico 9, 62 BT. See British Telecom Aeroperu 75 Bureau Veritas 281 AFt's 79-80, 125 Aguas Argentinas 197, 215, 217, 302 Cable & Wireless 209, 234, 256, 332 Air France 8, 313 Cammesa 219 Air New Zealand 132, 257 Canadian National 12, 225 Alcatel 238 CANTV 5, 58,197, 239-241, 251, 254 Allied Banks of Pakistan 71 CEAS 59 Ameritech 77, 85, 86, 238, 252 cr-.m; 122 Amtrak 207 Centromin 81, 323 ANTEL 247, 253, 254, 333 CFI'RI 155-157 APV RT 51,170, 220 Chilectra 221 Asset Privatization Trust 158-159, 324 Chilgenier 9, 255 AT&T 85, 236, 239, 253, 337 Clhina Steel 5 Chlina Textile Machinery 122 BAA 129, 227, 256,272, 332 Cimpor 120 Banade 157 Compagnie Generale des Eaux 204, 215, Bancoaner 5 238, 263 Bayernwerk 90 Conatel 240, 241 Belgacom 4,12, 77, 236 Conrai 206 Bell Atlantic 239, 252 COI'RI 144,155-157, 176 Bell Canada 237, 239 coRFo 94,155, 210 BNDEs 74, 155, 305 Cour des Comptes 108,133,170 BN iP 4, 312 ( RT( 237 British Aerospace 39, 332 C 9 N 2 British Airways 9, 19, 41, 132, 251, 256, ciic9, 79, 210211, 272 332 British Energy 218 Deutsche Telekom 4, 85, 86, 233, 236, British Gas 19, 39, 223-224, 256, 272, 238, 241, 248, 250, 276 279,332 Distrigaz 224, 257, 304 British Petroleum 38 British Rail 206, 226, 229, 244 EC NZ 221 British Telecom 4, 9, 19, 136, 193, 209, Ectesa 5 223, 230, 234, 255, 256, 265, 266-268, Ecuatoriana 251 270, 273, 280,332 Edelnor 220 397 398 Thle Privatization Challetnge Edelsur 220 Korea Telekom 233, 255 EDF 74, 222 Kl'N 4, 25, 233, 236, 255, 256 EFIM 107, 316 Elf-Aquitaine 5, 131, 313 LAB 125 Endesa 79, 221 Laubag 5 Enersis 9, 221, 255 Legamex 172 ENDE 125 Light (Brazil) 5 ENFE 125 Lufthansa 59, 78,193 ENI 4,136,193 Lyonnaise dex Eaux 204, 215, 217, 257, ENTEL Argentina 85, 107, 127, 139, 150, 279 215, 228,231,232,247,254,274, 302 ENTEL Bolivia 125 Malaysian Airlines 9, 132 ENTEL Chile 210-211 MAATAV 5, 58, 85, 86,169, 238, 251, 254 ENTEL Peru 5, 254 Matra 126 European Commission 25, 39, 42, 129, MC I 236, 237, 253 216,220, 222, 235-236, 262, 276, 383 Mercury 1 78, 209, 234,280 Mexicana de Aviaci6n 9, 62 FCC 237, 241, 261, 277 Mibrag 5 Fepasa 226 MIGA 52, 383 FEPSA 226 MMC 55, 218, 221, 223, 243, 268, 279, 280 FERC 277, 278 MOL 225 FIV 164 Muslim Commercial Bank 71, 272 FOPRI 176 MVM 220 France Telecom 76, 229, 241, 263, 276 NAO 39,108, 170 Gas del Estado 5, 118, 224, 302 Napocor 249 Gazprom 224 National Freight 9, 135 GTE 239 National l'ower 4, 218, 219, 221, 222, 272 Hondutel 315 Nav Canada 227-228 HungarHotels 171 New Zealand Coal Corporation 100 NGC 218, 229 Iberia 8 NIFs (Poland) 181-183, 186, 189 ICSID 84 Norilsk Nickel 85, 198 IFC 383 NT1 233, 246, 255, 275 IFI 164 Iglopool 172 OECD 383 INA 4,122, 193 OFFER 217-219, 221, 272 Indosat 5, 36, 233, 244 OFGA'. 223 Interhotel 5, 97 OFT 55, 223, 279, 280 IRI 6, 246 OFTEI 234, 261-269, 270, 273, 280 Iritel 76-77 OFWAT 216 ITT 36, 210 Ol E 76, 233, 255-256 ITU 383 Pakistan Telecommunications Corpora- Japan Railways 4, 226 tion 112, 233, 275 Japan Tobacco 4 Panama Canal Co. 208-209 I'apelcol (2 KLM 30,41,42 I'aribas 126,133,312 Korea Electric Power 255 Petro-Canada 118, 307 Enterprise, Agencies and othier Or,ganizationis Index 399 Petrofertil 143 Telefo'nica de Argentina 5, 210. Sce also Petroquisa 143 T'NTFL Argentina PLDT 259 Telef6'nica de Espafia 115, 127, 136, 210, f'OFs (Romania) 181-183,185 236, 239 Port Kelang 9, 38 Telef6nica del Peru 193, 251. See also Portugal Telecom 233, 236 ENTI. I' 1eru PowerGen 4, 218, 219, 221, 222, 272 Teleglobe 233, 307 PT Telkom 5,136, 233, 244,255-256 Telekom Malaysia 122, 233, 257 Telia 236 Qantas 251 Telmex 5, 9, 58, 134, 193, 228, 248, 251, 263 Railtrack 4, 226 Tenago Nasional Berhad 5, 255 RECs 218-219, 221, 272 TFI 126, 312 Renault 131, 312 ~~~Ti IA. Sce Treuhandanstalt Renault 131, 312 TLD 11 5, 233 Repsol 4,136 Transener 220 RWE 221, 229 Tractebel 220, 224 Treuhindanstalt 2, 31, 49, 59, 67, 81, 90, Sabena 8,42, 262 97, 99, 141, 160-163, 166, 171, 173, SAMfIR 140 175, 176,177,190,199, 200,313-314 Scottish Power 4, 219, 221, 257 Turk 'elekom 40,122 SEGBA 5, 220 SFR 263 UAP 4, 313 Singapore Telecom 5, 233 USAS 85 Sirese 277 Usiminas 5, 85, 305 Slaski Bank 69, 70 Usinor Sacilor 4 SNCF 207, 244 SNI 224, 304 VASI' th7, 118, 125, 251, 252, 305 Sotelgui 144 VEAG 5,90 Sprint 236, 241 VFBA 221, 229 SPT 5 V W; 221, 229 STET 125, 246, 252 \ IASA 75, 132 Sui Northern Gas Pipelines 75,255,272 VSNL 19 WAIPt)A 75 'I'elebras 248 World Bank 8, 52, 67, 84, 192, 383 Telecom Argentina 5. Sec also) ENTEL WTO 242, 276 Argentina Telecom Italia 246. See ailso Iritel, STET YPF 5, 96, 118, 120, 125, 138, 193, 224, 302 Telecom New Zealand 37, 100, 237, 252, PI'FB 125 257 TeleDanmark 4 ZI'TF 179 I i ii i I I i THE WORLD BANK 1818 H Street, N.W. Washington, D.C. 20433 USA Telephone: 202-477-1234 Fascimile: 202-477-6391 Telex: MCI 64145 WORLDBANK MCI 248423 WORLDBANK Cable Address: INTRAFRAD WASHINGTONDC World Wide Web: http://www.worldbank.org/ E-mail: books@worldbank.org Other World Bank Regional and Sectoral Studies The Informal Sector and Microfinance Institutions in West Africa, edited by Leila Webster and Peter Fidler Financing Government in the Transition: Bulgaria. The Political Economy of Tax Policies, Tax Bases, and 7ax Evasion, edited by Zeljko Bogetic and Arye L. Hillnian Decentralization of the Socialist State: Intergovernmental Finance in ITransition Economies, edited by Richard M. Bird, Robert D. Ebel, and Christine I. Wallich Population in Asia, Warren C(. Sanderson and Jee-Peng Tan Education in Asia, Jee-Peng Tan and Alain Mingat Indigenous People and Poverty in Latin America: An Empirical Analysis, George Psacharopoulos and Harry Anthoniy Patrinos H 7 021 3 6 13736 9 7I80821 337363