Privatesector P U B L I C P O L I C Y F O R T H E The World Bank January 1996 Note No. 66 Finding Real Owners—Lessons from Estonia’s Privatization Program John Nellis The Estonian government has quickly privatized Progress more than 90 percent of its industrial and manu- facturing enterprises. The Estonian privatiza- By November 1995, the Estonian privatization tion agency, following the approach devised agency had concluded more than 400 sales con- by the German Treuhandanstalt (former staff tracts for medium-size and large industrial firms of which advise the agency), batches thirty to or parts of firms. 2 These sales generated about forty firms and advertises them for sale. The US$200 million in direct receipts—though much prime goal is to find “real owners” capable of of this is being paid in installments. Purchas- running a durable, productive firm. Purchase ers contracted to invest an additional US$160 offers are thus judged not only on price, but million in the divested firms and assumed at also on the quality of business plans submit- least US$130 million in liabilities. The privati- ted, particularly with regard to expected invest- zation agency estimates that the sales created ment and employment creation. Winning or maintained some 49,400 jobs—a significant bidders negotiate contracts formalizing their number in a country of 1.5 million people. commitment. No special concessions are made Besides infrastructure firms and a couple of to workers and managers in the affected firms, particularly difficult industrial cases (oil shale but they can and often do submit a bid and a and alcohol firms), there is not much left to business plan—and they have won the com- privatize. petition in some thirty cases. Small-scale privatizations and “leftovers” In seventeen sales (with more in progress), the Estonians have combined strategic investment More than 90 percent (over 1,100) of the small with voucher exchanges, a mix beyond the business units and assets in Estonia have been reach of most other transition economies. And divested through auctions, raising some US$23 now Estonia is addressing, earlier and more million. This process is regarded as substantially comprehensively than most other formerly com- complete, since the remaining items appear to munist countries, the complicated issue of in- be of little interest to investors. “Leftovers”— volving the private sector in the provision of unsold assets or parts of businesses resulting infrastructure services. from the tender method of sale—are constantly being created. Many have been divested, but So far, allegations of corruption and insider deal- several with severe financial or environmental ing—though not absent—have been fewer than problems are not moving and may never be sold. in most other transition economies. And al- Experience has not yet yielded a hard and fast though a fair number of sales have been to rule on how long to try to sell businesses be- foreign buyers, there has been little political fore giving up and liquidating them. Some have protest.1 Many observers thought that a transi- been sold even after a long stay in the leftover tion economy could not handle a privatization category. A good solution would be for the strategy as politically risky and as administra- privatization agency to set a “normal” period of tively intense. But the Estonians have proved sale—say, one year from tendering—after which them wrong. liquidation would start. Private Sector Development Department ▪ Vice Presidency for Finance and Private Sector Development Finding Real Owners—Lessons from Estonia’s Privatization Program Contract control stake to a strategic investor and offered varying minority stakes for vouchers—using a “Russian With 400 concluded contracts, the privatization auction” pricing mechanism that roughly agency’s postsale supervision process is being matches supply to demand. Fifteen similar ex- formalized. The agency reports no problems with changes are under way. This combined method investment and employment promises but does has several benefits. First and foremost, the have problems with installment payments of the scheme mixes the economic and financial gains purchase price.3 In December 1995, the agency of obtaining a core investor with the political said that seventy buyers were having difficulty in advantages of giving the public a chance to ac- meeting their payment schedule. Only once has quire shares and use its voucher accounts. A the agency repossessed a firm when the buyer scheme that allows people to trade vouchers failed to make payments. In effect, the govern- for shares (even if they quickly sell them) gen- ment is unwilling to renationalize on a large scale erates political support for the privatization pro- or declare the new private firms bankrupt. While gram by counteracting the claim that divestiture still insisting on the need for payment of the ob- benefits only the foreigner, the local elite, or ligation, controllers often give the new owners the politically well connected. This is important more time. Given these generous enforcement in Estonia, where claims that the privatization and supervision practices, would it have been process was nontransparent won votes in the preferable to maximize the purchase price and 1995 electoral campaign. Second, the trading of omit nonprice criteria? Agency officials say no; vouchers and shares and the activities of the they view investment and employment commit- investment funds promote the development of ments as legitimate, given the short time horizon capital markets. of so many investors in the region. But the method also has costs. Some critics say Public offerings and use of vouchers that since August 1994, when it was first decided to hold back a minority of shares in divested Two large and fifteen small “combination” sales firms for later exchange for vouchers, the pace have been concluded. These sales combine par- of contract conclusion has slowed. This could tial purchase by a strategic core investor with have occurred naturally, as sales reduced the sup- divestiture of a minority of equity through a pub- ply of better opportunities. But critics claim that lic offering limited to Estonians, who exchange investors were anxious about who the future mi- vouchers for shares. In the two large sales, in- nority owners would be, what their rights would vestment funds reportedly contracted with indi- be, how the public offerings would be conducted, viduals to use their personal vouchers to buy and how the government would vote its residual shares and then to sell their shares to the funds. shares in the interim. They say that prices paid Share prices were fixed, and both offerings were by core investors have fallen by a greater per- oversubscribed. Concerns have been expressed centage than prices for shares reserved for the that the investment funds, acting in concert, public offerings, that the uncertainty has caused gained a significant ownership stake cheaply, promised investment to decline, and that the core and concentrated ownership excessively, defeat- investors are striking deals with investment funds ing the goal of promoting diffused shareholding. to buy up shares for transfer, at a discounted But nobody was forced to sell his or her shares. price, to the core investors. The solution, say the And from the viewpoint of corporate gover- critics, would be to limit voucher use to buying nance, concentrated ownership by investment housing and land—the use originally intended funds is superior to widely diffused ownership for the vouchers—and allow the privatization by small shareholders. agency to focus on its proven strategy of selling whole companies to investors. But these views In the fifteen small combination sales now con- underestimate the political importance of the cluded, the privatization agency sold a majority voucher program. Privatization is everywhere and always intensely political. Estonia is but one of raise the vouchers’ depressed trading value, but many transition economies whose electorate has cost the government considerably in forgone replaced radical reformers with governments ad- revenue: as much as US$10 million to US$20 vocating more caution and prudence in reform, million in voucher value could be absorbed.) particularly in privatization. For all their complex- ity, schemes in which vouchers are exchanged Infrastructure and land for shares can provide the level of public sup- port needed to carry out privatization. Large infrastructure firms remain to be pri- vatized, including the port, the airline, the elec- Voucher value tricity company, and a majority share of the telecommunications company. If the combina- An unresolved problem in the Estonian privati- tion method were used in these sales, a large zation program is that the face value of the amount of voucher value could be absorbed vouchers outstanding far exceeds the likely value through even minority offerings. From a more of assets being sold. And even more vouchers technical perspective, some Estonians feel that are being created as restitution proceeds slowly. the need for investment capital in infrastructure According to estimates by the Ministry of Fi- firms is so great that few or no shares should nance, about 10.5 billion crowns worth of vouch- be reserved for free distribution against vouch- ers have been issued: 8 billion crowns in ers, but the politically constituted policymaking “national capital” vouchers, allotted to all citi- board of the privatization agency has not yet zens, and 2.5 billion crowns in “compensation” pronounced on this matter. In addition, ex- vouchers, given out for injustices suffered in the changing vouchers for land might use up a good Soviet period. The ministry calculates that the share of voucher value, but the mechanics of public has exchanged about 1.2 billion crowns land sale and exchange are only now being of vouchers for housing (70 percent of which elaborated, and the intention is to limit voucher has been privatized) and another 1.8 billion use to 50 percent of the price of a parcel of crowns of vouchers in privatization transac- land. Much time will probably pass before land tions—of which only about 100 million crowns sales start to absorb many vouchers. of vouchers were used in the two large combi- nation public offerings. A rough calculation Compensation bonds yields a face value for the remaining vouchers of about 7.1 billion crowns, or US$630 million. Yet another possible use of vouchers is purchas- The minority percentages held back from all the ing compensation bonds from the Compensa- firms remaining to be sold are unlikely to be tion Fund. This fund also receives half the large enough to absorb this outstanding stock after-expenses proceeds from privatization sales. of vouchers (though the problem is eased if the Ministry of Finance officials said that by June 1995, trading of vouchers allows their price to fall to 270 million crowns (about US$24 million) of clear the market). vouchers had been invested in these bonds, which are paying an attractive rate of interest. Citizens may use their vouchers in a variety of One worry is that the fund has to invest in long- ways (including simply selling them to any bid- term, high-risk restructuring of enterprises, rais- der). They may exchange them for shares in ing questions about the income stream that will companies or in investment funds, or they may be generated to pay interest on the bonds. And, use them to buy the housing in which they live, obviously, the more assets sold for vouchers and to purchase land, or to buy bonds from a Com- the more vouchers accepted for payment of in- pensation Fund. And in November 1995, it was stallments, the less income will be generated for announced that vouchers may be used at face the Compensation Fund to service the bonds. value for up to 50 percent of installment pay- Estonian governments have so far resisted the ments for privatized companies. (This should notion that vouchers might be redeemed at face Finding Real Owners—Lessons from Estonia’s Privatization Program value, so the inflationary potential of vouchers is eration needed will be privately supplied. But slight. But unless the government can speed up two changes of government have taken place the exchange of vouchers for land and shares, since this program was announced. Although exchanging vouchers for compensation bonds privatization will clearly continue—a majority may be the only recourse for many citizens. It stake of Estonian Airlines was recently put up would be politically embarrassing if the bonds’ for bid (with a closing date in January 1996)— market value fell sharply. there has been neither a formal acceptance nor a modification of the previous policy statement. What to do? It would be reassuring if the government re- confirmed its principles of infrastructure priva- To avoid a discounting of the vouchers from face tization: creating a market structure to promote value, the simple solution is to put more good competition where possible, imposing credible assets up for sale—and inform voucher holders and efficient regulation where necessary, and that they have until a certain date to arrange an locating core investors to provide governance. exchange. But this solution is hard to implement while questions persist about which assets are Conclusion up for exchange and under what conditions. Moreover, the government is unlikely to set a In scope and pace, Estonian privatization has deadline while vouchers are still being created been a success. No privatized firm has yet failed, by a slow-moving court process. But while the and the privatization agency reports that most voucher issue is complex and has the potential divested firms are expanding their employment. to cause some political problems, it should be The partially privatized telephone company has economically containable, given the range of improved the quantity and quality of service The Note series is an open forum intended to possibilities for voucher exchange and the “safety markedly since the involvement of private part- encourage dissemina- valve” of the compensation bonds. ners. But these promising results are tempered tion of and debate on by the fact that the seventy privatized firms ex- ideas, innovations, and best practices for Infrastructural complexity periencing problems with installment purchase expanding the private payments are only being admonished. Although sector. The views Before the 1995 elections, the Estonian govern- four of five privatized firms are current on their published are those of the authors and should ment had endorsed a privatization program to obligations, how long they will stay current if not be attributed to the divest most remaining infrastructure or prob- there is no penalty for nonpayment or partial World Bank or any of its lem industrial enterprises by selling the major- payment is another question. But this problem— affiliated organizations. Nor do any of the con- ity of shares to the purchaser able to guarantee though significant—is not overwhelming. clusions represent investments and effective management. The gov- official policy of the ernment argued, however, that these large com- 1 World Bank or of its The electorate’s dissatisfaction with some aspects of privatization Executive Directors panies first required reorganization to turn them contributed to the 1995 defeat of the incumbent coalition. But it or the countries they into joint stock companies, division into mar- could be argued that it was the few instances of insider trading, represent. rather than the scope and pace of the program or the involvement ketable parts, and the introduction of competi- of foreigners, that caused the dissatisfaction. Comments are welcome. tive forces or regulation. In almost all areas of 2 This section updates an earlier Note by the author (“Privatization in Please call the FPD infrastructure, the program recommended found- Estonia: Major Accomplishments and Remaining Problems,” Note Note line to leave a 19, July 1994). ing “holding-type stock companies” to oversee 3 Estonian purchasers can pay 20 percent down and the balance message (202-458-1111) or contact Suzanne reorganization and privatization. Some of what over a period of three to ten years. Foreign buyers supposedly Smith, editor, Room was proposed was accomplished. (At least one must pay all at once, but most create a local company to take G8105, The World Bank, advantage of the installment plan. action along those lines had predated the pro- 1818 H Street, NW, Washington, D.C. 20433, gram: a 49 percent share of the telephone com- or Internet address pany was turned over to a private consortium John Nellis, Senior Manager, Private Sector ssmith7@worldbank.org. in 1992.) Many business activities in the port of Development Department (member of the World 9 Printed on recycled Tallinn are already in private hands. And it is Development Report team, 1995–96) (email: paper. broadly accepted that any new electricity gen- jnellis@worldbank.org)