Viewpoint Note No. 156 November 1998 Naiess Botbakn Privatization in Developing Countries andJean-Claude Cosset An analysis of the performance of newly privatized firms The sample firms Privatization of state-owned enterprises has set out to determine whether privatization is Fully or partially become an important phenomenon in both beneficial in the economic environments and privatized during industrial and developing countries. Privatiza- institutional settings of these countries by 1980-92 tions have been occurring at an increasing rate examining how privatization affects firms' finan- Argentina over the past decade, particularly in developing cial and operating performance in a broad set Somisa (steel) countries, whose share in global privatization of developing countries. Bangladesh revenues rose from 17 percent in 1990 to 22 Pubali Bank Brazil percent in 1996 (The Fconomfist 1997). Most empirical studies of privatization have Companhia Agos focused on the industrial countries, with the Especiais Itabira Developing and industrial countries are not notable exceptions of Galal and others (1994) (steel) equally endowed with the factors likely to ensure and Megginson, Nash, and van Randenborgh Companhia the success of a privatization program, however. (1994; henceforth MNR). In a World Bank stLdy (electromechanical) The privatization efforts of most developing Galal and others (1994) assessed the welfare Companhia countries are inhibited by embryonic financial gains or losses resulting from the privatization Sider6gica de markets, weak regulatory capacity, and a pub- of twelve companies, operating mostly in non- Tubarao (steel) lic sector that accounts for a large share of GDP. competitive markets, in four countries: Chile, Goi6s Fertilizantes Many, particularly those with low per capita in- Malaysia, Mexico, and the United Kingdom. The (fertilizer) Usinas Siderurgica de come, lack some of the main ingredients for a authors reported net welfare gains in eleven of Minas Gerais (steel) successful privatization, such as capital, entre- the twelve cases and found no cases in which Chile preneurs, and competent managers. But some workers showed an overall loss from privatiza- Chilgener S.A. of these countries have large markets and fast tion. But as the authors pointed out, their sample Compania de Acero economic growth rates, features that make the was small and unrepresentative of the universe del Pacifico (steel, success of government divestiture more likely. of privatized firms in developing countries, and mining) This Note describes the results of a study that their findings should not be generalized. The MNR study covered a much larger sample, TABLE 1 POSTPRIVATIZATION PERFORMANCE: KEY comparing the pre- and postprivatization RESULTS FOR 79 COMPANIES PRIVATIZED IN 21 financial and operating performance of sixty- DEVELOPING COUNTRIES. 1980-92 one firms in eighteen countries (twelve indus- trial and six developing) and thirty-two industries IndicatsAveragechange(percent) in 1961-90. The authors presented strong evi- Indicators Average change (percent)___________________ dence that after privatization the sample firms Profitability +124 became more profitable, increased their real Efficiency +25 sales and investment spending, and improved Investment +126 their operating efficiency. The companies also Output +25 significantly reduced their debt levels and Employment +139 (+1.3) increased dividend payments. Perhaps more sur- Leverage -5 prising, they increased employment. These Dividend payout +44 results were generally unchanged when the authors partitioned the data into smaller LIU The World Bank Group * Finance, Private Sector, and Infrastructure Network 2l Privatization in Developing Countries Companiia de Telefonos de Chile (telecoms) Empresa Elbctrica de Melipilla S.A. (electricity) Empresa Nacional de subsamples. But as impressive as MNR's sample upper-middle-income countries and in low- Telecomunicaciones of privatized firms was. it included onlv a small income and lower-middle-income countries, full (telecoms) number of firms headquartered in developing and partial privatizations, and "control" and Greece Hellenic Bottling Co. countries (from three to twelve, depending on "revenue" privatizations. Control privatizations Heracles General the financial and operating performance are those in which governments surrender vot- Cement measure)-a sample too small for the results to ing control; revenue privatizations are those in India be considered indicative of privatization expe- which governments sell a minority ownership Bharat Petroleum rience in developing countries. stake and do not surrender voting control. (petroleum, petrochemicals) Hindustan Petroleum Sample and methods Higher profits (petroleum, petrochemicals) The study described in this Note considered As firms move from public to private owner- Industrial Credit and seventy-nine newly privatized firms, head- ship, their profitability should increase. In (Iinance) quartered in twenty-one developing countries, response to shareholders' wish to maximize Indian Petro- that experienced full or partial privatization profits, the managers of newly privatized firms chemicals Corp. during the period from 1980 to 1992. The sample can be expected to place greater emphasis on (petroleum, was well diversified, with wide geographical dis- profit goals. And privatization typically trans- p etro cherm ica Is) Steel Authority of India persion and different levels of country develop- fers both control rights and cash flow rights to Jamaica ment. The sample included low-income the managers, who then show a greater interest National Commercial economies (Bangladesh, India, Pakistan), lower- in profits and efficiency than in pleasing the Bank middle-income economies (Chile, Jamaica, Ni- government with higher output or emplovment. Radio Jamaica Ltd. geria, the Philippines, Thailand, Tunisia, Turkey), Korea Electric Power and upper-middle-income economies (Argen- The study's results showed significant improve- Malaysia tina, Brazil, Greece, the Republic of Korea, Ma- ments in profitability after divestiture. As mea- Cement industries of laysia, Mexico, Portugal, Singapore, Taiwan sured by the return on sales, profitability rose Malaysia Berhad [China], Trinidad and Tobago, Venezuela). The on average from 4.9 percent before privatiza- Cement sample firms were in different industries and tion to 11 percent after privatization. up 124 Manufacturer market structures (competitive and noncompeti- percent. Among the sample firms, 63 percent Edoran Otomobil tive) and varied in size. saw an increase. The subsamples showed simi- Nasional Berhad lar results, except for firms from low-income (automobiles) The study sought to determine whether priva- and lower-middle-income countries, which Malaysia Airlines tization is truly desirable in developing coun- showed an insignificant increase in profitability. System Berhad tries and whether the performance of newly Malaysia International privatized firms lived up to the expectations of Greater efficiency Shipping Corp. governments and development agencies. In Perusahaan Otomobil particular, it tried to determine whether priva- The greater emphasis on profit and the cuts in Nasional Berhad tized firms increased their profitabilitv, their government subsidies following privatization (automobiles) SyaricatTelekoms operating efficiency, their capital expenditures, can be expected to lead firms to use their Malaysia Bhd and their output. It also examined the effect of human, financial, and technological resources (telecoms) privatization on employment, capital structure, more efficiently. The study measured operat- Tenaga Nasional and dividend policies. To this end, the study ing efficiency on the basis of the sales effi- Berhad (electricity) compared the performance indicators of the ciency ratio (real sales per employee) and net Banamex (banking) sample firms for the three years before divesti- income efficiency ratio (net income per em- Bancomer (banking) ture and the three years after divestiture. ployee). Both ratios showed a significant in- Compania Mexicana crease following privatization (with the sales de Aviaci6n (airline) The studv examined the change in the financial efficiency ratio up 25 percent on average and Telefonos de Mexico and operating performance of the newly priva- the net income efficiency ratio up 63 percent), Nigeria tized firms for the full sample and for several rising for 80 percent and 70 percent of the AIICO (insurance) subsamples: firms in competitive and non- sample firms. Thus, overall, divested firms im- Crusader Insurance competitive industries, firms headquartered in proved their operating efficiency, achieving the Unipetrol (petroleum) Pakistan Millat Tractors Pak International Airlines Philippines most common objective of governments Higher output Hotel Enterprises of launching privatization programs. the Philippines Correctly conceived and implemented, privati- Philippine National Correctly ~~~~~~~~~Bank The increase in sales efficiency was significant zation can be expected to foster efficiency and Portugal for all the subsamples. This result for priva- investments and thus stimulate new growth and Banco Espirito Santo tized firms in developing countries is similar employment. The study's results confirm these e Commercial de to that of MNR for privatized firms in industrial expectations. Real sales rose significantly (up 25 Lisboa (banking) Banco Foncecas and countries. percent on average) with 76 percent of the sample Burney (banking) firms experiencing an increase. Relative to the Banco Portugues do The changes in both profitability and efficiency level in the year privatization occurred, real sales Atlantico S.A. were significantly larger for firms in upper- rose from an average of 96.9 percent before priva- (banking) middle-income countries than for those in low- tization to 122.2 percent after privatization. Banco Totta y Agores income and lower-micdle-income countries. (banking) Central de Cervejas This evidence lends support to Kikeri, Nellis, All the subsamples also showed significant in- (brewing) and Shirley's (1992) argument that high-income creases in real sales following privatization, with Companhia de or upper-middle-income countries should be sales rising for a large majority of firms (at least Seguros in a better position to privatize successfully. 68 percent in each subsample). This increase Tranquilidade in output reflects the increased productivity of (insurance) More investment the privatized firms. Portugues (banking) Imperio (insurance) Governments expect that greater emphasis on Higher employment Jornal de Noticias efficiency will lead newly privatized firms to (newspaper) increase their capital investment spending. Most state enterprises tend to be overstaffed. Mundial Contianga increase ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~(insurance) Privatized firms can also be expected to So newly privatized firms could be expected Petroleos de Portugal inctease their capital expenditures because they to cut employment following government (oil, energy) have greater access to private debt and equity divestiture and the reduction of subsidies in Sociedade Financeira markets (especially in fairly developed capital order to increase efficiency. But employment Portuguesa (Banco mark-ets) and more incentives to invest. To es- increased for 58 percent of the sample firms Uniao de Bancos timate capital investment, the study used the on average by 139 employees (1.3 percent). Portugueses ratio of capital expenditures to sales, which This evidence, combined with that of MNR, (banking) increased on average from 10.5 percent to 23.7 suggests that privatization does not necessar- Uniao cervejeira percent after privatizarion (up 126 percent). ily mean a decline in employment. As Kikeri, (brewing) Among the sample firms, 62 percent achieved Nellis, and Shirley (1992) predicted, the evi- Singapore DBS Land (real estate) an increase. MNR also clocumented an increase dence suggests that higher investment and ef- Keppel Corp. in this ratio. These results confirm the impor- ficiency lead to more output and employment. (shipbuilding) tance of privatization as an incentive to im- Neptune Orient Lines prove efficiency and increase investment. Amono the subsamples, the increase in em- Ltd. (shipping) ..1 . . ...Sembawang Shipyard ployees was significant for firms in noncom- (ship repairing, The postdivestiture increase in investment was petitive industries, for partial privatizations, for shipbuilding) equally significant for several subsamples- firms headquartered in low-income and lower- Singapore firms in competitive industries, firms operat- middle-income countries, and for revenue International Airlines ing in upper-middle-income countries and in privatizations. Employment increased for all the Taiwan (China) low-income and lower-middle-income coun- subsamples except firms operating in competi- China Steel Corp. Thailand tries, fully privatized firms, and control privati- tive industries, which, as expected, were more Thai Airways zations. But it was insignificant for firms in inclined to reduce employment. International noncompetitive markets. This evidence, com- Tunisia bined with that of MNR, suggests that in both Lower leverage and higher dividends Socidet Industrielle developing and industrial countries competi- Turkey tive environments spur newly privatized firms The switch from public to private ownership Adana Cimento to increase capital investment spending. can be expected to lead to reduced leverage, Sanayii (cement) zI Privatization in Developing Countries Arcelik (electronics) since the government's removal of debt guar- weaker improvements in performance for firms Bolu Cimento antees will increase firms' cost of borrowing in low-income and lower-middle-income (cement) and the firms will gain increased access to countries. Cerik Halat (metas public equity markets. As predicted, the study's Cukurova Elektrik results show that leverage, as measured by the Thus ownership seems to matter. Privatization (electricity) ratio of total debt to total assets, decreased sig- brings with it private owners who place greater Eregli Edemir (iron, nificantly (down 5 percent on average). Among emphasis on profit goals and carry out new steel) the subsamples, the decline was significant for investments that increase output and employ- simas Gida firms in both competitive and noncompetitive ment. Efficiency improves as a result and prof- (supermarkets) Kepez Elektrik industries, for firms operating in upper-middle- itability follows. These improvements cannot (electricity) income countries, for partially privatized firms, be attributed to the prevailing market struc- Migros Turk and for revenue privatizations. ture or the terms of share issue privatizations. (supermarkets) The study's results, combined with those of Oyse-Nidge Qimento Dividend payments can be expected to in- MNR, suggest that in both developing and in- (cement) Petkim Petro Kymia crease, since private investors, unlike govern- dustrial countries, newly privatized firms im- (petrochemicals) ments, generally demand dividends. As prove their performance. And among Petrol Ofisi predicted, the dividend payout ratio (dividends developing countries privatization appears to (petroleum) divided by net income) and the ratio of divi- yield the greatest benefits for companies head- Tofas Otomobil dends to sales showed significant increases quartered in those with high per capita income. Ticsaret (automobiles) (from 34 percent to 49 percent and from 2.8 Tiipras (petroleum) percent to 5.3 percent). Among the sample This note is based on a longer article by the authors, The Financial Trinidad and Tobago firms, 85 percent distributed more dividends and Operating Performance of Newly Privatized Firms: Evidence from Trinidad Cement Ltd. as a proportion of their net income, and 76 DevTelopingCountries,"JournalofFinanceS3fJune 1998): 1081-ti0. Venezuela percent more as a proportion of their sales. To take account of the possibility that some of the differences be- Nacional Telefonos The ratio of dividends to sales increased sig- tween preprihatization and postprivatization performance are due to de Venezuela nificantly for all the subsamples. This evidence, economywide factors, the study used bo:h performance measures (telecoms) combined with that of MNR, suggests that what- adjusted for market effects and unadjusted performance measures. The results obtained with market-adjusted performance measures con- ever the level of national development, newly finnjied the results obtaiined vwith unadjusted performance mneasures privatized companies increase their dividend but were generally less significant. payments markedly. References Conclusion Boycko, Maxim, Andrei Shleifer, and Robert W. Vishny. 1996. "A Theory of Privatization." EconoonicJourna/ 106: 309-19. The study examined the financial and operat- 7beEconomist. 1997. "Financial Indicators: Privatizahon. March 22, p. ing performance of a large sample of newly 125. Galal, Ahmed, LeroyJones, Pankaj Tandon, and Ingo Vogelsang. 1994. privatized firms drawn from a wide set of de- Wegfare Consequences of Selling Public Enterprises An Empirical To order additional veloping countries. For the full sample the study Analysis. New York: Oxford University Press. copies please call showed significant increases in profitability Kikeri, Sunita, John Nellis, and Mary Shirley. 1992. Privarization: The 202-458-1111 or contact s p Lessons ofExperience. Washington. D.C.: World Bank. Suzanne Smith, editor, operating efficiency, capital investment spend- Megginson, William L. . Robert C. Nashb and Manthias van Randenborgh. Room F6P-188, ing, output (adjusted for inflation) and employ- 1994. The Financial and Operating Performance of Newly Priva- The World Bank, ment, and a decline in leverage and an increase tizedFirms: An international EmpiricalAnalysis."JournalofFioiance iSiS H Street, NW,494052 Washigtree, .C. 20433, in dividends. The results were generally ro- Vernon-Wonzel, Heidi, and Lawrence H. Wonzel. 1989. "Privatizarion: or Internet address bust for the subsamples too: strong improve- Not the Only Answer" WorldDevelopment 17: 633-41. ssmith7@worldbank.org. ments in performance for companies operating The series is also available on-line in both competitive and noncompetitive envi- Narjess Boubakri (Naijess.Boubakrithec.ca), (www.worldbank.org/ ronments, for firms in upper-middle-income Ecole des Hautes Etudes Commerciales, htmIlfpdlnotes/). countries, for full and partial privatizations, for Montreal, Canada, andJean-Claude Cosset SPrinted an recycled control privatizations, and for revenue privati- (Jean-Claude.Cosset@fas.ulaval.ca), Universite paper zations. The study also found evidence of Laval, Quebec, Canada