2011The political economy of residual state ownership in privatized

The political economy of residual state ownership in privatized firms:Evidence from emerging markets
Narjess Boubakri a ,Jean-Claude Cosset b ,Omrane Guedhami c,d,⁎,Walid Saffar e
a American University of Sharjah,UAE
b HEC Montreal,Montreal,Quebec,Canada H3T 2A7
c Moore School of Business,University of South Carolina,Columbia,SC,29223,USA
d Memorial University of Newfoundland,St.John ’s NL,Canada A1B 3X5
e
Olayan School of Business,American University of Beirut,11072020Beirut,Lebanon
a r t i c l e i n f o a
b s t r a
c t
Available online 24September 2010We investigate the political determinants of residual state ownership for a unique database of 221privatized firms operating in 27emerging countries over the 1980to 2001period.After controlling for firm-level and other country-level characteristics,we find that the political institutions in place,namely,the political system and political constraints,are important determinants of residual state ownership in newly privatized firms.Unlike previous evidence that political ideology is an important determinant of privatization policies in developed countries,we find that right-or left-oriented governments do not behave differently in developing countries.These results con firm that privatization is politically constrained by dynamics that differ between countries.
©2010Elsevier B.V.All rights reserved.
JEL classi fication:G32G38
Keywords:Privatization
Control structure Political institutions Performance
Emerging markets
1.Introduction
Privatization can be de fined as the deliberate sale by a government of state-owned enterprises (SOEs hereafter)or assets to private economic agents.This shift of ownership —and control —to private owners creates a change in the prevailing incentive structures,and puts greater emphasis on pro fits and ef ficiency (Boycko et al.,1996;Shleifer and Vishny,1997).The literature provides strong evidence on the dividends of privatization and the bene fits derived from private ownership as compared to government ownership (e.g.,Megginson et al.,1994;Boubakri and Cosset,1998;Boubakri et al.,2005b,c;D'Souza et al.,2005).1The evidence also suggests that performance is negatively related to the government's continued role in the firms.For example,in their research on a set of emerging markets,Boubakri and Cosset (1998)and Boubakri et al.(2005c)find that there is greater improvement in performance after privatization,which is more pronounced when the government relinquishes its control rights.These conclusions are echoed by Chhibber and Majumdar (1999),who find that privately owned firms in India are more ef ficient than those under mixed ownership or those run as SOEs.Shleifer and Vishny (1994)conjecture that when politicians maintain control over firms,privatizing cash flow rights will only reduce ef ficiency and increase corruption.According to this argument,to ensure successful privatization,the immediate transfer of control rights should be of primary importance (Boycko et al.,1996).2
Journal of Corporate Finance 17(2011)244–258
⁎Corresponding author.
E-mail address:omrane.guedhami@ (O.Guedhami).1
Please refer to Megginson and Netter (2001)and Megginson and Sutter (2006)for an extensive review of the literature.2
These ideas are largely echoed in the debate on transition,where the relative bene fits of a big bang approach compared to more gradual,sequenced reforms towards a market-oriented economy have generated wide interest among academics (see,for instance,Dewatripont and Roland,1995;Roland,2000;among others).The literature on privatization in transition economies is well summarized by Djankov and Murrell (2002)and Svejnar (2002).Note that we do not include firms from ex-communist countries in our study,as privatization in these countries is mainly conducted through vouchers distributed to citizens for free or at discounted prices,and not through typical methods such as asset sales or share
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In practice,however,privatization does not always seem to follow this idealized model,especially in developing (non-transition)economies.In an evaluation of the privatization experience of developing countries over the 1988to 2005period,Boubakri et al.(2008a)show that instead of immediately divesting all of their ownership,most governments divest only partially over time.Boubakri et al.(2005b)provide further evidence on this phenomenon in a study of the evolution of post-privatization ownership structure in a multinational sample of 209firms,mostly from emerging markets.They report that while privatization does lead to a drastic change in the ownership structure of SOEs,the transfer of ownership is mainly conducted through partial,staggered sales.Consistent evidence is also found by Gupta (2005),who shows that in India most privatization transactions are partial sales that leave the government in control,and by Fan et al.(2007),who show that in China the government is prohibited from selling its controlling stake in SOEs,which are thus privatized gradually by selling shares to minority investors.3
A possible rationale for continued government in fluence following privatization is provided by the theoretical model of Perotti (1995),who argues that partial privatization can signal the government's commitment to market-oriented policies.By relinquishing their control rights,governments signal that privatization is credible and implies no policy risk (i.e.,risk of interference in the operations of newly privatized firms —NPFs hereafter —either through regulation or renationalization).By retaining residual ownership,governments thus signal their willingness to share in any remaining policy risk.As a result,and according to Perotti's (1995)model,partial privatization is a political choice that depends on the characteristics of the government in place,that is,on political institutions.Based on this model,Biais and Perotti (2002)show that right-wing governments,whose objective is to ensure their re-election,signal their commitment to the median voter through partial privatization and underpricing.Similarly,Jones et al.(1999)show that the terms of share issue privatizations —allocation and pricing —are structured to achieve political and economic objectives.
The purpose of this study is to determine how political institutions in fluence post-privatization control structure in a large set of emerging markets.Our analysis consists of two parts.First,using hand-collected firm-level data,we examine the residual control of privatizing governments using four measures of control:direct ownership,ultimate ownership,golden shares,and political connection.To our knowledge,this is the first study to document,using firm-level data,residual state control in emerging economies along these various dimensions.We find that residual state ownership over a window of up to six years following privatization shows a signi ficant decline.However,the speed with which governments relinquish control appears to differ across industries and regions,and the state remains the controlling owner (holds more than 50%of the shares)in 46%of our sample firms.We further find that the method of privatization is correlated with residual state ownership;for instance,share issues on the stock market are associated with more gradual divestitures.In addition,governments tend to retain indirect control over NPFs through political connections (30.3%of our sample firms),and less frequently through golden shares (7.3%in our sample firms),which contrasts with Bortolotti and Faccio (2009),who document that 62.5%of a sample of OECD firms have golden shares (in 1996).
The second part of our analysis focuses on the impact of political governance on post-privatization control structure.More speci fically,we assess how political constraints and institutions in fluence the government's residual ownership in the six years following privatization.Motivated by prior research,we conjecture that as a redistributive policy,privatization is politically costly and hence is necessarily constrained by the strength of checks and balances,by government ideology,and by the political system in place.Our multivariate analysis,which controls for other potential factors in fluencing privatization design and corporate ownership structure,shows that the decline in state ownership is indeed associated with a country's political environment.For instance,residual state ownership is higher in parliamentary systems and under regimes with greater constraints on the executive (checks).Contrary to what is documented for OECD samples,however,the ideology of the executive does not appear to affect residual ownership.These results are robust to several additional tests,and taken together suggest that it is important to control for a country's political environment and legal infrastructure when assessing the corporate governance of NPFs.
Our paper makes two primary contributions to the literature.First ,our study extends prior work on the political determinants of privatization.Previous studies in this line of the literature focus largely on the country-level design of the privatization process.4For instance,Bortolotti and Pinotti (2008)conduct a country-level investigation of the determinants of privatization for 21advanced OECD economies,and show that the likelihood and extent of privatization are strongly positively associated with majority-rule political systems.Bortolotti and Faccio (2009)provide related evidence on the determinants of the control structure of OECD-country NPFs for the period 1996to 2000.However,by limiting attention to advanced economies,these papers'results may not generalize to emerging markets,where the public sector is relatively larger,where political institutions tend to exhibit less accountability,and where executives are less constrained and thus enjoy more latitude in decision making (Bortolotti et al.,2004;Klapper and Love,2004).Earlier studies by Bortolotti et al.(2001,2004)consider both developed and developing countries over the period from 1977to the mid-1990s and,using country-level data,examine the determinants of the decision to privatize,the method of privatization,revenues from divestiture,and the ownership share sold over the sample period.Yet while Bortolotti et al.'s (2001,2004)samples
3
Extant literature on the impact of government residual ownership on firm performance is mixed.For instance,while Gupta (2005)shows that the partial privatizations in India did observe improved performance despite post-privatization government control,Fan et al.(2007)show that continued government in fluence through political connections in China's partial privatizations is detrimental to performance.The authors conclude that:“…emerging economies …can learn from the experience of China's partial privatization that a government's reluctance to relinquish (or its desire to retain)even only a subset of its property rights with regard to its enterprises can have signi ficantly negative consequences on corporate governance and firm performance ”Fan et al.(2007:p.353).Evidence on newly privatized banks in developing countries (Boubakri et al.,2005a;Otchere,2005)indicates that privatization yields marginal improvements in post-privatization operating performance,which the authors attribute to continued government ownership.4
We are aware of two single-country studies on the subject.Clarke and Cull (2002)examine the determinants of the decision to privatize state-owned banks in Argentina,and Dinc and Gupta (forthcoming)investigate the role of elections in privatization design in India.Additional related papers include Dastidar et al.(2007)on policy reversals in India,Sapienza (2004)on the banking sector in Italy and Beck et al.(2005)on the banking sector in Brazil.
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include17emerging countries,these countries account for less than20%of their observations.Developing countries exhibit particular dynamics likely to affect the way privatization is implemented.5For example,political risk factors have more of an effect in developing countries than in developed countries(Boehmer et al.,2005).6To the extent that these factors affect government residual ownership, they are more likely to explain privatization outcomes in developing countries than samples based largely on developed markets may uncover.In this paper we extend this literature by using hand-collectedfirm-level data,runningfirm-level(in addition to country-level)analysis,considering indirect means of government control,namely,golden shares and political connection,and focusing exclusively on developing countries(27,from four geographical regions).Further,unlike Bortolotti and Faccio(2009),who consider the years1996to2000for all privatizedfirms regardless of their year of privatization,we examine the six-year window immediately following divestiture,when the influence of political factors is most likely to be strong.
Second,our study tests hypotheses related to two strands of literature.The literature on the political economy of privatization posits that government commitment to market-oriented policies can be signaled by partial privatization(Perotti,1995),and that right-wing-oriented governments,which are typically more committed and lessfiscally constrained,favor less state control in the economy and hence divest control more quickly(Biais and Perotti,2002).The literature on the political determinants of corporate governance argues that a country's legal institutions are the product of choices made by politicians(Pagano and Volpin,2005),but that ownership structure and concentration are determined by the nation's political orientation rather than the prevailing legal institutions(Roe,2003).By showing that a country's political institutions explain post-privatization ownership structure over and above the role played by its legal institutions,we bridge these two literatures and add to previous evidence in Boubakri et al. (2005b)and Guedhami and Pittman(2006),who show that the quality of a country's legal institutions shape post-privatization ownership structure at thefirm level.
The remainder of the paper is structured as follows.Section2develops our hypotheses on the relation between privatization design and political institutions.Section3discusses the data and the variables used in the study.Section4documents the post-privatization evolution of ownership structure and investigates its determinants.Section5summarizes ourfindings and concludes the paper.
2.The political economy of government ownership
Our study builds on the theoretical model of Shleifer and Vishny(1994).The authors describe several sources of political benefits that make politicians less willing to give up control over publicfirms.For example,to win political support,most public enterprises employ too many people,produce goods that favor politicians rather than consumers(one such example is the Concorde supersonic aircraft;see Shleifer and Vishny,1994),locate their production in politically desirable rather than economically attractive regions,and charge prices significantly below marginal costs.In a political economy framework,the decision to divest control is determined by the trade-off between the political benefits and costs of such a decision.The political costs of privatization,which are generally the costs of redistribution and the consequent discontent and loss of voters,are usually immediate.In contrast,the benefits of privatization,which derive from improved corporate efficiency,occur only in the future. Therefore,privatization will take place when the current value of political benefits from future efficiency gains is higher than the immediate political costs of redistribution.7In such instances,privatization is likely to be implemented gradually(Banerjee and Munger,2004).Clarke et al.(2005)contend that the costs,benefits,and design of a country's privatization program are thus all affected by the country's political institutions.
Describing the privatization process in several countries,Perotti and Guney(1993)find that,indeed,sales of ownership are generally gradual and staggered.They show that as the policy becomes more credible,sales will expand and revenues from privatization will rise.However,they document that even when governments seem willing to privatize,they put in place mechanisms such as golden shares and veto rights that give them ultimate control over several corporate decisions.8 Overall,prior evidence shows that,in practice,privatization is gradual and governments often retain control over thefirms. Perotti(1995)provides a theoretical rationale for this phenomenon.In particular,Perotti shows that gradual sales are used by governments to signal their commitment to the privatization policy,and to build investors'(and voters')confidence in their policy choices.To the extent that governments are unable to perfectly signal their commitment to future policy,however,retaining participation will be optimal as a signal of commitment as doing so indicates that the government is willing to share the residual risk with investors.Biais and Perotti(2002)also argue that credibility(commitment)is important for the government if it wants to gain the support of the median voter in future elections.
5For a thorough discussion of the privatization experience of developing countries,see Megginson and Sutter(2006).
6Indeed,Boehmer et al.(2005)find political factors to be relevant only in developing countries,whereas economic factors guide the decisions to privatize banks in both developing and developed countries(OECD).
7The war of attrition model of Alesina and Drazen(1991)provides further insights on the costs and benefits of policy decisions by focusing on what causes economic reforms to be delayed.The authors show that stabilization programs will be delayed in presence of two interest groups(i.e.,veto players)that bargain over the distribution of reform costs.Each player has an incentive to block the reform in an effort to get the other player to“give in”first,as the player who concedesfirst is likely to bear the bulk of the reform costs.Policy changes are thus implemented only when both players benefit from the change.
8In a large cross-country sample,Boubakri et al.(2005b)show that the average government stake declines substantially after privatization.In a related study by the same authors,Boubakri et al.(2005c)find that residual state ownership is higher in Asian countries compared to that in African,Latin American,and European countries.
In summary,these studies suggest that there is a link between the political orientation of —and constraints on —the government on the one hand,and the post-privatization control structure on the other hand.The political economy literature captures these aspects through the following dimensions.2.1.Ideology of the executive
According to Biais and Perotti (2002),right-wing governments are more committed to privatization programs than left-wing governments,and thus are more likely to transfer control immediately (while selling ownership gradually),to signal their willingness to bear residual risk.Thus,according to the authors,right-wing governments are more likely to sell larger stakes (i.e.,lower residual government ownership).This leads to our first hypothesis:
H1.Residual state ownership is positively (negatively)related to left-wing (right-wing)governments.2.2.The political system
A country's political system can generally be characterized by (a)the relationship between the executive and legislative branches and (b)the competitiveness of elections (Beck et al.,2001).The political system is presidential when there is a single executive elected by popular vote.Under this system,the president enjoys a large degree of independence from the legislature,and thus has a great degree of in fluence over the economic orientation of the country.In contrast,parliamentary systems are characterized by a concentration of power in the hands of the government (Persson and Tabellini,2000).
Under a presidential regime,since executive accountability is lower,the executive may pass reforms that are costly in the short run,such as asset sales,as he has the authority to do so (i.e.,veto players have less in fluence in the polity).On the other hand,the executive may decide that the government has more to lose from market-oriented reforms,and hence may take advantage of his independence from the legislature to delay the costs of the reforms by privatizing more gradually,allowing politicians to continue to extract large rents from the partially privatized SOEs.Thus,the relation between the political system and residual government ownership can go either way.We therefore state our second hypothesis as follows:H2.Residual state ownership is related to the political system.2.3.Political constraints
Beck et al.(2001:p.169)state that “a key element in the description of any political system is the number of decision-makers whose agreement is necessary before policies can be changed.”The magnitude of the costs associated with privatization (namely,the loss of political rents and privileges from owning SOEs,and the loss of voter support)is thus likely to depend on the degree of checks and balances constraining the executive.According to Tsebelis (1995,p.289),“the potential for policy change decreases with the number of veto players …”.The political science literature shows that higher checks and balances on policy makers reduce policy volatility by limiting the ability of such actors to alter policy unilaterally (Henisz,2004;Henisz et al.,2005).This in turn enhances the credibility of “policy initiatives ”,which is of particular concern in redistributive policies such as privatization.We thus posit that privatizations are more gradual under governments constrained by strong checks and balances.This leads to our third hypothesis:
H3.Residual state ownership is positively related to the degree of political constraints.3.Data and variables
In this section,we describe our sample,our empirical approach,and the variables used in the analysis.3.1.The sample
Privatization in emerging markets provides an interesting setting in which to test our hypotheses on the importance of political institutions in explaining the control structure of privatized firms.We use a sample of 221firms privatized in 27emerging markets over the 1980to 2001period.Our sample of privatized firms is mainly drawn from Guedhami et al.(2009).This novel database is particularly suited to our research objectives as it tracks residual state ownership in the years surrounding privatization (i.e.,one year prior to privatization,the privatization year,and the three years following privatization).We update this database to include ownership data for the six years after the first privatization as well as information on political connections and golden shares.
Table 1shows that the 221firms are located in four different geographical regions as categorized by the World Bank .In particular,40.72%are from Africa and the Middle East,21.27%from East and South Asia and the Paci fic,25.34%from Latin America,and 12.67%from Europe and Central Asia.The diversi fication across regions is important,because it comprises countries with different legal,political,and institutional environments and thus helps shed light on cross-firm differences in residual state ownership.Table 1also reveals that the sample is diversi fied across industries,with 25.79%in the financial sector,25.34%in the basic and petroleum sectors,and 16.29%in utilities.Further,82.35%of the sample privatizations occurred in the 1990s (including
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Table1
Distribution of sample privatizations.
Year Number Percentage
By year
198010.45 198110.45 19854 1.81 19864 1.81 19873 1.36 19883 1.36 19892310.41 199014 6.33 19912611.76 1992219.50 199311 4.98 1994188.14 1995167.24 19963616.29 19973013.57 19988 3.62 200010.45 200110.45
Total221100
By industry
Industry Number Percentage
Basic industries3616.29 Capital goods10.45 Consumer durables8 3.62 Construction2511.31 Finance/real estate5725.79
Food/tobacco198.60 Leisure10.45 Petroleum209.05 Services10.45 Textiles/trade10 4.52 Transportation7 3.17 Utilities3616.29
Total221100
By region
Region(countries)Number Percentage
Africa and the Middle East(8)9040.72
East and South Asia and the Pacific(8)4721.27
Latin America and the Caribbean(8)5625.34 Europe and Central Asia(3)2812.67
Total(27)221100
By method of privatization
Method Number Percentage
Private Sale4626.14
SIP13073.86
Total176100
Notes:this table provides descriptive statistics for the sample of221privatizedfirms used in this study.We report the distribution of sample privatizations by year, industry,region(as classified by the World Bank),and method of privatization.
2000and2001),compared to17.65%in the1980s.Thesefigures reflect the trend towards large-scale privatizations in emerging markets during the1990s.9Note that close to74%of thefirms were privatized through share issues while26%were privatized through private sales.These private sales are implemented either through an auction or directly to private(local or foreign) investors.
9When we examine the World Bank's updated list of privatizedfirms,wefind that30.48%of thefirms are from Africa and the Middle East,17.08%are from East and South Asia and the Pacific,42.35%are from Latin America,and10.09%are from Europe and Central Asia.We alsofind that20.52%of thefirms are from thefinancial sector and15.97%are utilities,and that80%of the privatization transactions occurred in the1990s.Thesefigures are close to those discussed in the text in reference to our sample.
3.2.The variables
Appendix A provides the de finition and data sources of the variables used in our study.These variables can be classi fied into four categories:privatization and state control variables,political economy variables,legal variables,and firm-and country-level controls.
3.2.1.Privatization and state control variables
To investigate the control structure of our sample of privatized firms,we focus on post-privatization ownership structure along the following dimensions:direct (observable)ownership,ultimate ownership,golden shares,and political connections.We hand-collect the ownership data from two main sources,namely,the offering prospectus and annual reports.We also use additional sources such as Worldscope ;the Asian,Brazilian,and Mexican Company Handbooks;the Guide to Asian Companies;Bankscope;and Orbis .Our sources of ultimate ownership data are Ben-Nasr et al.(2009)for privatized firms,Faccio and Lang (2002)for Portuguese firms,and Claessens et al.(2000)for East Asian firms.
Speci fically,we construct the following variables.(1)STATEOWN is the residual government ownership stake following privatization.(2)CONTROL is a dummy variable that takes the value of 1if the residual government ownership stake is greater than 50%,and 0otherwise.(3)STATE_ULTIMATEOWN is the government's ultimate control stake following privatization.We use the approach described in La Porta et al.(1999)to determine the ultimate control structure of privatized firms.By relying on voting rights,this approach allows us to identify the ultimate shareholders.Indeed,the government may divest more than 50%of the privatized firm but still control the firm indirectly through a pyramidal ownership structure that involves other state-owned-firms.(4)GOLDEN is a dummy variable that takes the value of 1if the government retains a golden share,and 0otherwise.10Even when a privatizing government relinquishes direct and ultimate control over the privatized firm,it may impose limits on corporate control by retaining a golden share that puts signi ficant constraints on the decisions of the firm.This practice is common in several developed countries as documented by Bortolotti and Siniscalco (2004).In contrast,very few developing countries have put such devices in place (exceptions are Brazil and Malaysia).(5)CONNECTED is a dummy variable that takes the value of 1if the firm is politically connected,and 0otherwise.Political connections emerge if the firm has politicians/bureaucrats on its board,or if the CEO is a politician.11In such cases the firm will not necessarily maximize pro fits,but rather will likely focus on the net political bene fits for politicians.The government may be more likely to divest ownership and control if the firm is politically connected because politicians will pursue their objectives on its behalf.However,if the firm is not politically connected,the government might have an incentive to privatize gradually in order to keep a hold on the firm's corporate decisions.
3.2.2.Political economy variables
We capture a country's political –economic institutions using the following variables,which come from Beck et al.'s (2001)Database of Political Institutions DPI (the World Bank)12:
The ideology of the executive is measured by LEFT,a dummy variable equal to 1if the executive branch is left-wing,and 0otherwise.We distinguish between right-and left-wing governments on the grounds that right-wing governments are typically more committed to market-oriented reforms and thus are more likely to relinquish control faster (i.e.,lower residual ownership).
The political system,captured by SYSTEM,is an index of the type of political system in the country:Direct presidential (0);strong president elected by assembly (1);and parliamentary (2).A presidential system is considered as having a tendency to be more authoritarian,with a strong separation of power.At the other end of the spectrum a parliamentary system exhibits no clear-cut separation of power between the legislature and executive.Given that more authoritarian governments are generally expected to be less inclined to conduct market-oriented reforms,they need to signal their commitment through gradual sales.
Political constraints,measured by CHECKS,are a proxy for the degree of political constraints within the government.This variable is calculated as “the number of veto players in a political system,adjusting for whether these veto players are independent of each other,as determined by the level of electoral competitiveness in the system,their respective party af filiations,and the electoral rules ”(Beck et al.,2001,p.170).A high degree of constraints and a resulting failure of political actors to cooperate increase the level of uncertainty regarding policy outcomes,as governments are less able to achieve a consensus regarding privatization design.We thus expect to observe more gradual privatization under governments that exhibit higher political constraints.That is,we expect CHECKS to be positively related to residual government ownership.
3.2.3.Legal variables
We include two legal variables in our analysis,namely,the International Country Risk Guide's assessment of a country's level of corruption,CORRUPTION ,and La Porta et al.'s (1998)legal origin variable,COMMON,which captures the legal origin of each country's
10
Following Bortolotti and Faccio (2009:p.2918),we de fine a golden share as “the set of the state's special powers and statutory constraints on privatized firms.Typically,special powers include i)the right to appoint members in corporate boards;(ii)the right to consent to or to veto the acquisition of relevant interests in the privatized companies;(iii)other rights such as the consent to the transfer of subsidiaries,dissolution of the company,ordinary management,etc.The above mentioned rights may be temporary or not.On the other hand,statutory constraints include (i)ownership limits;(ii)voting caps;(iii)national control provisions.”11
Politically connected firms are de fined as in Boubakri et al.(2008b:p.657)as follows:”a company is politically connected if at least one member of its board of directors (BOD)or its supervisory board is or was a politician,that is,a member of parliament,a minister or any other top appointed-bureaucrat.”12
We employ this database because it covers a wide range of political variables and enables us to use observations that date back to the 1980s.Below we evaluate whether our results are sensitive to using alternative databases such as that of Botero et al.(2004)and Marshall and Jaggers (2009).
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