Privatization and Corporate Governance Before and After the 2007/9 Crisis: Lessons from Developing and Transition Countries*by Saul Estrin

LSE

*Presentation based on Estrin,S., Hanousek, J., Kocenda, E. and Svejnar, J., “The Effects of Privatization and Ownership in Transition Economies”, Journal of Economic Literature, 2009

Outline of Presentation Foreign investment, ownership and

governance in developing and transition economies

Policies, Institutions and Privatization Sequencing of Privatization Privatization and Company Performance Conclusions

Corporate Governance and Ownership

• In developed economies, most large firms are joint stock and important areas for research are the ways in which the principal (owner) controls the managers (agents). Issues include– Ownership concentration– Extent of managerial or employee ownership

• In developing and transition economies– Institutional context makes enforcement of agency contracts more

costly – leads to concentrated ownership (family or state)– Weak capital market institutions leads to emergence of diversified

firms (business groups)– Foreign owners may control a relatively large share of assets– With such concentrated ownership, many corporate governance

issues take the form of principal-principal conflicts

Foreign Direct Investment to Developing and Transition Economies

• Increasingly important share of global FDI – accelerated rather than slowed by crisis

• For the first time in 2009 FDI to developing economies overtook FDI into developed economies

• Remains highly concentrated to a few major transition and developing economies e.g. China, Russia, Brazil and India

Real GDP growth, %pa

-6

-4

-2

0

2

4

6

8

10

2004 2005 2006 2007 2008 2009 2010

World at PPP

Developed

Emergingmarkets

Global FDI inflows (US$ bn)

0

200

400

600

800

1,000

1,200

1,400

1,600

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

Developed

Em markets

Global FDI inflows (% of GDP)

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

Developed

Em markets

Small em club (FDI inflows, US$ bn)

0

20

40

60

80

100

120

140

160

Ch

ina

Ru

ssia

Ho

ng

Ko

ng

Bra

zil

Ind

ia

Sau

di

Ara

bia

Sin

gap

ore

Mex

ico

Tu

rkey

Ch

ile

2008

Some Evidence on Ownership Concentration in Transition and Emerging Markets

• Top 15 families own 62% of listed assets in Indonesia, 55% in Philippines, 53% in Thailand and 38% in Korea. (Peng 2007)

• On average in East Asia, 68% of listed companies are owned by a single controlling owner. This ranges from 77% in Korea to 40% in Thailand (Peng 2007)

• Top management derives from the family of the largest shareholder in 85% of listed firms in Malaysia and Indonesia, 81% in Korea and 80% in Taiwan (Peng 2007)

• In Russia in 2003, the 22 largest private domestic owners control 42% employment and 39% of sales (Guriev and Rachinsky 2005)

• These outcomes unlikely to be affected by recent crisis; if anything the converse

Purpose of JEL Study

To evaluate the economic effects of privatization, focusing on experiences in post communist countries and China

Transition economies as a laboratory of systemic change

Findings

Privatization to foreign owners raises efficiency; less clearcut in China because domestic ownership also raises TFP

Domestic private ownership raises TFP (but less than foreign ownership) in CEE and Ukraine but not in Russia

Findings Ctd

Ownership concentration important Worker ownership does not have negative

effect on performance New firms more efficient than existing ones,

especially foreign start-ups

Policies, Institutions and Privatization Megginson and Netter (2001) show privatization improves

company efficiency and profitability in developed economies

Results confirmed by Megginson and Sutter, 2006, for developing economies

Positive association between ownership concentration and firm performance in Asia (Heugens et al 2009)

Results stronger for foreign than domestic and “external” than “insider” owners

Private Sector Share of GDP

0102030405060708090

Czech Republic

Hungary

Poland

Slovak Republic

Slovenia

Estonia

Latvia

Lithuania

Bulgaria

Romania

Russia

Ukraine

Sequencing of Privatization

Govenments sequence privatization to Avoid transaction and congestion costs Reveal information about firms to buyers Avoid political opposition (gradualism) Avoid unemployment

Which Firms Do They Privatize First?Gupta,Ham, Svejnar (2008) Firms that are more profitable Firms with higher market shares Firms in industries subject to greater demand

uncertainty and in downstream industries (needing flexible management)

Important implications for reverse causality

Privatization and Company Performance Foreign Investors Domestic Owners Entrepreneurs

Methodological Issues

Previous studies -- astonishing variation in findings, from strong positive to strong negative effects of privatization on performance

Methodological Issues

Reasons partly methodological: early studies used small (unrepresentative) samples, unable to control for selection/endogenity, and data period too short

We use all available studies (150 plus) and categorize by estimation method

Our Approach

Look at studies in CEE, CIS and China Select studies that employ fixed effects or IVs to

handle the selection/endogeneity problem inherent in privatization

=> use 14 studies considered by Djankov and Murrell (2002) plus 20 additional ones

Foreign Direct Investors in Transition Economies

Focus on effects on level and rate of growth of TFP Profitability Revenues (scale) Other indicators (labor productivity, employment, wages,…)

Various measures used in each category => graphical analysis rather than meta-analysis

Foreign Direct Investors in Transition Economies

Privatization to foreign owners increase TFP or profitability in CEE and increases or has no effect in CIS

Domestic Owners in Transition Economies In CEE effect of domestic private ownership

on TFP is Positive but smaller than that of foreign ownership Greater in later period

In CIS the effect is nil or negative Reasons for previous ambiguity in literature is

failure to take account endogeneity/selection issues

Effects of Concentration and Employee Ownership on TFP

Concentrated (majority) private ownership – mostly positive effects on TFP (driven primarily by foreign ownership) Positive in CEE and Ukraine; negative in Russia

7 studies look at employee (insider) ownership effect on TFP => effects insignificant in 6 and positive in one Found negative in D-M (sensitivity to handling

selection bias and recalculations in D-M)

Effect of Private Ownership on TFP Growth in CEE

Overall -- small positive or insignificant effect Foreign ownership – insignificant Domestic private ownership – positive or

insignificant

Effect of Private Ownership on Level and Growth of Profit

Level of profitability Positive or insignificant effect in CEE Insignificant in (one study) in CIS

Rate of growth of profitability Insignificant effect in CEE Positive in (one study) in CIS

Effect of Private Ownership on Revenues (Scale)

Level of revenues Positive (and especially strong for foreign ownership)

effect in CEE Mixed effect in CIS

Growth of revenues Small positive effect of foreign ownership and

insignificant effect of domestic ownership in CEE Insignificant effect of (undefined) private ownership in

CIS

Entreprenerial Ownership

Sabirinova et al (2005) find foreign start ups less efficient than existing foreign owned firms, more efficient than domestic start-ups, which are more efficient than existing domestic firms

Entreprenerial Ownership

Commander and Svejnar (forthcoming) find domestic start-ups less efficient than foreign owned firms but not different from domestic or state owned firms.

Effects in China

Ltd. Number of studies, not very sophisticated methodology

Positive significant effect of foreign ownership on TFP

Results on effects of domestic nonstate ownership mixed but generally weakly positive for TFP and profitability

Domestic Owners in China

Tian and Estrin (2007) -- impact of private ownership is U-shaped Initially ROA decreases as private ownership

increases, and then rises

Explain by concentration of state ownership and benefits dominant state ownership can bring in China

Conclusions

Clearer picture is emerging from methodologically more sound studies on transitions economies

Despite reservations about the methods at the time, privatization not a failure when considered more than ten years hence

Conclusions 1

Privatization to foreign owners clearly raises performance relative to state ownership, and to domestic private ownership

Privatization to new domestic owners also raises performance if institutions are better developed, ie CEE (and China?) relative to Russia (CIS)

Conclusions 2

Reasons for Superior Performance of Foreign Owned Firms Access to top managerial skills and to world

markets Domestic ownership sometimes associated with

looting, tunnelling, defrauding minority shareholders, reducing performance

Privatization process initially prevented domestic ownership concentration; it took time to squeeze out dispersed shareholders

Conclusions 3

Results highlight importance of good management and corporate governance, access to world markets, presence of functioning legal and institutional system for company performance

Foreign firms bring in expatriate managers and train local ones

Conclusions 4

Foreign firms‘ corporate governance compensates for underdeveloped local institutions, laws and norms

They bring access to global distribution networks

Domestic owners can achive the same in time and are increasingly doing so