Privatesector P U B L I C P O L I C Y F O R T H E The World Bank February 1996 Note No. 68 The Privatization Dividend A worldwide analysis of the financial and operating performance of newly privatized firms William L. Surprisingly little direct empirical investigation has The theoretical work of Boycko, Shleifer, and Megginson, been done to see whether privatization is deliv- Vishny (1993) showed that privatization will Robert C. Nash, ering the expected results. The main constraint lead to effective restructuring of public enter- and Matthias has been getting postsale data for firms not pub- prises only if rights to both cash flow and con- van licly traded. Most of the early empirical work trol pass from the government into private Randenborgh looked at only a small number of companies from (particularly managers’) hands. Boardman and a single country (usually Britain) and therefore Vining (1989), comparing the performance of lacked statistical significance, making it hard to the 500 largest non-U.S. mining and manufac- draw strong conclusions. The consensus about turing companies in 1983, found, after control- privatization by the mid-1980s—to the extent that ling for the regulatory and competitive there was one—was summed up by Yarrow environment, that private firms are more prof- (1986), who argued that competition and mana- itable and more efficient. gerial accountability are more important than privatization in promoting economic efficiency. The most thorough empirical analysis of privati- zation is the World Bank study by Galal, Jones, More recent theoretical and empirical studies Tandon, and Vogelsang (1994). They analyzed have offered stronger support for the dual the postprivatization performance of twelve com- propositions that private firms outperform pub- panies (mostly airlines and regulated utilities) in lic firms and that privatization itself increases Britain, Chile, Malaysia, and Mexico to determine the operating efficiency of the divested firms. whether the transfer to private ownership in- creased efficiency—and, if so, how the costs and benefits of adjustment were allocated. Taking great care to isolate the effect of privatization, TABLE 1 POSTPRIVATIZATION PERFORMANCE: KEY RESULTS they compared the performance of the divested FROM 61 COMPANIES IN 18 COUNTRIES firm with what it would have been had the firm remained in state hands. Results showed net Indicator Average change welfare gains in eleven of the twelve cases— averaging, in present value terms, 26 percent of the firm’s predivestiture sales revenue. Profitability +45% Efficiency +11% As rigorous as the World Bank study was, how- Investment +44% ever, it examined only a small number of (mostly Output +27% regulated) firms from four countries. Thus, it only Employment +2,346 (+6%) partially overcame the basic problem that has bedeviled all empirical privatization studies— Dividend payout +97% obtaining truly comparable pre- and postprivat- Board turnover 46% ization data for a large, multinational, multi- industry sample of companies. The study de- Private Sector Development Department ▪ Vice Presidency for Finance and Private Sector Development The Privatization Dividend Sample firms scribed in this Note did overcome this problem. enue without surrendering control. The over- privatized through It limited its analysis to companies that were sold whelming majority of issues are pure secondary public share offerings, 1961–90 to the public through a share issue and thus for sales of government shareholdings. Thus, any sig- which comparable pre- and post-issue financial nificant results will not be the consequence of Austria and accounting data could be obtained (from the cash flowing to the firm from the share offering Länderbank OMV AG firms’ offering prospectuses and annual reports). (see table 1 for a summary of results). Verbund Although limiting a study to a relatively small Higher profits and greater efficiency Canada Fishery Products subset of firms would normally yield a serious International sample selection bias, that was not the case in Privatization is designed to substitute the single Air Canada this study, for two reasons. First, the largest and objective of maximizing profits for the typically Petro Canada most economically significant public enterprises mixed objectives of public enterprises, and ex- Chile usually can be privatized only through public posure to the benefits and penalties of monitor- CAP S.A. de Inversione share issues, and companies so privatized account ing by capital markets is expected to focus SQM Compañía Chilena for most of the assets and employees transferred employees on the task of raising revenues and Metropolitana de to the private sector during the study period. lowering costs. The study’s results showed that Distribución Electrica Second, companies sold publicly are the most profitability does increase significantly after priva- IANSA Laboratorios de Chile visible and politically sensitive privatizations, and tization, as measured by the return on sales (up it is the public’s perception of their postdivestment 45 percent). Profit margins expanded after privat- Denmark performance that will determine whether the ization for 69 percent of all firms. The subsamples Kryolit Selskabet Oeresund entire privatization program is judged a success showed similar results, except for firms in non- or a failure. competitive industries (regulated industries such France as utilities and banking), for which the increase Elf Acquitaine St. Gobain Tests, methods, and results in the return on sales was insignificant. Paribas Banque Industrielle & The study compared the pre- and postprivatiza- Both of the efficiency measures used, inflation- Mobilière Privée (BIMP) Sogenal tion performance of sixty-one companies in eigh- adjusted sales per employee (up 11 percent) Banque de Bâtiment et teen countries (six developing and twelve and net income per employee (up 32 percent), des Travaux Publics industrial) and thirty-two industries. It constructed showed significant increases following privati- Crédit Commercial de France a timeline of the operating results from the last zation for the full sample. Sales per employee Havas few years of public ownership through the first increased for 86 percent of firms and income Compagnie Générale years after privatization. And it tested for the re- per employee for 70 percent. Efficiency im- d’Electricité Societé Générale sults most governments expect: increased profit- provements were also the norm for most of Compagnie Financière ability, increased operating efficiency, increased the subsamples. The median increase in sales Suez capital investment spending, and increased out- per employee was significant for firms in com- Germany put. It also tested for a result that governments petitive industr ies, for full and partial Volkswagen hope for but generally do not expect to achieve: privatizations, for control (but not for revenue) VEBA AG privatization without lowering employment lev- privatizations, and for companies headquar- VIAG Deutsche Verkehrs els. The study tested for these results both for tered in OECD countries. And in all but the Kreditbank the full sample and for several subsamples: subsample of non-OECD companies, more Deutsche Siedlungs privatizations of firms in competitive and non- than half of firms (70 to 93 percent) increased und Landesrentenbank IVG competitive industries, full and partial output per employee. privatizations, privatizations involving firms head- Italy quartered in OECD countries and in developing More investment Banca Commerciale Italiana (BCI) countries, and “control” and “revenue” Saipem S.p.A. privatizations. Control privatizations are those in There are several reasons to expect that privat- Sirti which the government sells a controlling share ized firms will increase capital spending after Credito Fondiario Aeritalia or voting control, and revenue privatizations are divestiture. First, after their initial public offer- Nuovo Pignone those whose purpose typically is to raise rev- ing, these firms gain far greater access to private debt and equity markets than most public en- before divestiture to the average level after- Jamaica terprises ever have. Second, if privatization is ward was 27 percent, with 75 percent of firms NCB Group Caribbean Cement Co. accompanied by deregulation and market open- experiencing increases. All the subsamples ing (as often occurs), the newly private firms also showed significant growth in output af- Japan generally must make large investments to com- ter privatization. Japan Air Lines Nippon Telegraph & pete with other private firms. Third, public Telephone enterprises tend to emphasize labor over capi- Perhaps the most surprising and important find- tal inputs in their production processes, and ing of the study is that employment actually in- Malaysia Malaysian Airlines the combined influences of politicians, labor creases after privatization—by an average of Syarikat Telecom unions, and other interest groups tend to leave 2,346 employees (6 percent)—rising in almost Malaysia Berhard them employee-rich and capital-poor. And two-thirds of all firms. So why do union leaders Mexico years of financial stress often lead firms to de- almost always vehemently oppose privatization Teléfonos de México fer routine maintenance, which must also be programs? There are three possible reasons. First, made good after privatization. Fourth, the re- there have been many high-profile examples of Netherlands KLM moval of government control frees enterprises large-scale job losses before and after privatiza- Naamloze from pressure to overproduce politically attrac- tion. British Telecom, British Gas, St. Gobain, Vennootschap DSM tive but economically wasteful goods—and and Nippon Telegraph & Telephone all lost at New Zealand frees resources to be reallocated to higher-value least 5,000 workers after privatization, and Brit- Air New Zealand uses. Finally, to the extent that privatization ish Steel’s employment declined from 166,000 promotes entrepreneurship, newly private firms workers in 1979 to only 55,000 employees in Oman Oman Flour Mills have the incentive and the means to invest in the year it was privatized. Second, labor unions growth options (such as launching new prod- invariably face the prospect of converting from Republic of Korea ucts and services or pursuing acquisitions) both public to private sector unions, with all that that Pohang Iron & Steel at home and abroad. implies about their power to influence public Singapore enterprise policy and to extract wage conces- Neptune Orient Lines The study’s results showed significant in- sions from companies backed by the taxing Singapore International Airlines creases in the ratio of capital expenditures to power of a national government. Third, where Singapore National sales (up 44 percent), its proxy for investment privatization coincides with industry deregula- Printers intensity, with the ratio going up for 67 per- tion, management often comes under severe Keppel Corporation Sembawang Shipyard cent of all firms after privatization. For the competitive cost pressures—to which it responds first time, the results for subsamples reflected by pressuring its workforce for wage conces- Spain substantial differences. Capital expenditure ra- sions, work rule changes, or both. GESA Repsol tios rose significantly for firms in competitive industries, for full divestitures, for control Lower leverage and higher dividends Sweden privatizations, and for companies headquar- Procordia Swedish Steel tered in OECD countries. The increase was Most governments expect leverage (debt to eq- smaller, and insignificant, for firms in non- uity) ratios to drop after divestiture. Public en- United Kingdom competitive industries, for partial divestitures, terprises traditionally have extremely high debt British Petroleum British Aerospace and for revenue privatizations. With only levels, at least in part because they cannot sell Cable & Wireless seven observations for companies in devel- equity to private investors and must rely for fi- Amersham International oping countries, no strong conclusions could nancing on capital injections from the govern- Britoil Associated British Ports be drawn about this subsample, except that ment and retained earnings. As predicted, the Enterprise Oil investment spending did not decline. study documented a significant decline in le- British Telecom verage across both the full sample and the British Gas British Airways Higher output and more jobs subsamples. Also as predicted, it found that the Rolls Royce average ratio of dividend payout to profits in- BAA plc The tests showed that real sales increase after creases—from 23 percent to 46 percent after di- British Steel privatization. The mean increase in real sales vestiture. The ratio of dividends to sales shows United States from the average level during the three years an even greater increase. Conrail The Privatization Dividend Changes in ownership and control structure performance. The most likely explanation for these changes is that (even partial) private own- The study found considerable turnover on the ership allows the internalization of the benefits boards of directors of newly privatized firms. of performance improvements, and public list- Barely half (54 percent) of existing directors ing of shares allows these benefits to be capital- remain with a firm after its divestiture. To find ized into the price of the firm’s stock. Changes in out what the implications of this turnover are executive and employee compensation policies for firm performance, the study divided the may give the firm’s workers incentives to be more firms with data on boards of directors into two productive, but the study was unable to docu- groups—firms with 50 percent or greater turn- ment such changes with its data. It could only over among directors after privatization (high show that, for whatever reason, newly privatized director change) and firms with less than 50 firms improve their operating and financial per- percent change (low director change). It per- formance while maintaining employment.2 formed the same analyses for these two groups as for the other subsamples. In general, the This paper was first published in the Journal of Finance (vol. 49, no. 2, results for the firms with high director change June 1994). Another version is forthcoming in Terry L. Anderson and mirrored those for the full sample of compa- Peter J. Hill, eds., The Privatization Process: A Worldwide Perspective (Lanham, Md.: Rowman & Littlefield). nies and most of the other subsamples—in- 1 Furthermore, the study found little evidence that governments sub- creases in profitability, output per employee, sidize public enterprises while they are being prepared for privati- capital investment spending, employment, and zation, except for the French companies nationalized by the Mitterand government in 1981 and privatized by the Chirac government in dividend payout and a significant decrease in 1986–87. It found no significant examples of subsidies being paid leverage. By contrast, firms with low director after divestment. Well before privatization, however, governments change experienced significant (positive) often paid very large cash subsidies to public enterprises, usually to The Note series is an cover operating losses. For example, the British government paid open forum intended to changes only in output per employee and divi- more than £6 billion to British Steel during 1975–84 to cover the encourage dissemina- dend payout. Thus, changes in firms’ owner- firm’s immense operating losses, and gave at least as much to other tion of and debate on ship and control structur es, rather than public enterprises during the same period. ideas, innovations, and 2 The authors of this Note explore these issues in two later papers. best practices for government divestiture alone or cash infusions “Share Issue Privatizations as Financial Means to Political and Eco- expanding the private from share issues, seem to be the driving force nomic Ends” examines how governments adjust the pricing and sector. The views in explaining most of the study’s results. other terms of share offerings to achieve political and economic published are those of objectives, and “Determinants of the International Spread of Privati- the authors and should zation” analyzes how and why privatizations have spread so rapidly not be attributed to the Conclusions in recent years. Both papers are available from William Megginson, World Bank or any of its tel. 706 542 3648, email: wmegginson@cbacc.cba.uga.edu. affiliated organizations. Nor do any of the con- The study showed significant increases among clusions represent newly private firms in profitability, output per References official policy of the employee, capital spending, and employment. It World Bank or of its Boardman, Antony, and Aidan R. Vining. 1989. “Ownership and Per- Executive Directors also found that the financial policies of these firms formance in Competitive Environments: A Comparison of the Per- or the countries they start to resemble those typically associated with formance of Private, Mixed, and State-Owned Enterprises.” Journal represent. of Law and Economics 32: 1–33. private entrepreneurial companies—with lower Boycko, Maxim, Andrei Shleifer, and Robert W. Vishny. 1993. “A Theory Comments are welcome. leverage and higher dividend payout ratios. Al- of Privatization.” Working paper. Harvard University, Cambridge, Mass. Please call the FPD though the data did not allow precise documen- Galal, Ahmed, Leroy Jones, Pankaj Tandon, and Ingo Vogelsang. 1994. Note line to leave a Welfare Consequences of Selling Public Enterprises. New York: Ox- tation of the causes of these performance ford University Press. message (202-458-1111) or contact Suzanne improvements after divestiture, the study was able Yarrow, George. 1986. “Privatization in Theory and Practice.” Economic Smith, editor, Room to rule out price increases as a frequent source Policy 2: 324–64. G8105, The World Bank, of profitability increases.1 The pervasiveness of 1818 H Street, NW, Washington, D.C. 20433, these improvements and the fact that most share William L. Megginson, University of Georgia or Internet address sales did not raise cash for the firm suggest that (email: wmegginson@cbacc.cba.uga.edu), ssmith7@worldbank.org. privatization itself—the involvement of private Robert C. Nash, University of Baltimore, and 9 Printed on recycled investors in a firm’s ownership structure—has a Matthias van Randenborgh, J.P. Morgan, paper. strong effect on a firm’s operating and financial Frankfurt