Bernardo Bortolotti (Università di Torino and FEEM)

Mara Faccio (Vanderbilt University)

Reluctant PrivatizationReluctant Privatization

2

Background

From 1977 to 2004, US$1.26trn revenues and 4,500+ privatization deals in more than 100 countries

Global State-owned Enterprise (SOE) value added (% GDP) decrease from 9% to 6%

SOE market capitalization US$3,310bn

Source: Privatization Barometer

3

Background

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Western Europe

Global Privatization Revenues, 1977-2004

Source: Privatization Barometer

4

Two basic questions

Did governments give up control in privatized firms?

If they did not, does governments’ reluctance affect firm value?

5

Definition

We define Reluctant Privatization as:

A privatization of a State-owned Enterprise (SOE) characterized by the trasfer of ownership rights without a (corresponding) transfer of control rights

6

Reluctant Privatizations, Italy

In December 2003, the Italian MEF corporatized Cassa Depositi e Prestiti (CDP), a public financial institution, and then trasferred stakes in Eni, Enel, Poste Italiane, and STM to CDP.

30% of CDP was privatized to a consortium of Italian banking foundations.

€13.1bn privatization revenues cleared by Eurostat to amortize public debt.

7

Reluctant Privatizations, Italy

35,00%

10,30%

6,65%

10,00%

10,30%

30,00%

100,00%

60,98% 50,63%

30,32 % 20,32%

100,00% 65,00%

32,33% 32,33%

70,00%

MEF

Enel

Eni

Finmeccanica

Cassa Depositi e Prestiti

ST Microelectronics

Poste Italiane

Private banking Foundations

8

Reluctant Privatizations, Italy

Pre CDP Post CDP Pre CDP Post CDP

Cassa Depositi e Prestiti 100,00 70,00 100,00 70,00

Enel 60,98 50,63 60,98 60,98

Eni 30,32 20,32 30,32 30,32

Finmeccanica 32,33 32,33 32,30 32,30

Poste Italiane 100,00 65,00 100,00 100,00

STMicroelectronics (via Finmeccanica) 0,00 0,00 16,95 16,95

Sources: MEF, CDP and Privatization Barometer

*These shareholdings are limited to stakes involved in transfer to CDP

Direct shareholdings (%) Control Rights (%)Companies

MEF - Department of Treasury, Direct shareholdings* and Control Rights

9

Research Design

Did governments give up control in privatized firms?– We analyze empirically the evolution of ultimate

control rights (from end-1996 to 2000) in privatized companies as opposed to a control sample.

If they did not, does governments’ reluctance affect firm value?– We estimate the (adjusted) performance of

privatized companies as a function of (government) control rights.

10

Theoretical Predictions

The political interference theory (Shleifer and Vishny, QJE1994)

Governments run SOEs to achieve political objectives (high employment, high wages, etc.) and forgo maximizing profits.

H0: Government control rights are not negatively discounted in market values.

11

Novelty

Huge literature on performance of privatized companies (Megginson and Netter JEL02 survey).

To our knowledge, our paper is the first to study in combination– ultimate control (La Porta et al JF02, Tian

WP02)– additional control devices (golden shares)– adjusted performance using a control sample

at the company level (Dewenter and Malatesta AER01, Lopez-de-Silanes QJE96)

12

Data

141 companies privatized by public offerings before 31/12/1996 in OECD countries

Complete ownership data for 1996 and 2000 104 privatization prospectuses to identify statutory

constraints and additional control devices Balance sheet data for the period 1996-2000

Main sources: SDC Platinum, WordScope, Datastream, national exchanges, etc.

13

Measuring Control Rights

We rely on ultimate control (voting) rights (weakest link concept, 10% cut off)

Six types of ultimate owners: − a family or an individual − the State − a widely-held financial institution − a widely-held corporation− a miscellaneous investor− a cross-holding

(A company that does not have a controlling shareholder at the 10% cut-off is classified as widely-held).

14

Examples: Lufthansa AG, 1996

Deutsche Lufthansa AG

DeutschePostbank AG

DeutscheBahn AG

KfW State of NorthRhine-Westphalia

MGL

1.03% 0.4% 37.45% 1.77% 10.05%

Dresdner Bank AG

BayerischeLandesbank Girozentrale

44.5%44.5%

Association ofBavarian Saving Banks

State of Bavaria

Allianz AG

100%50% 50%

Federal Republic

100% 100% 80%

Govt. direct ownership: 1.77%

Govt ultimate control rights: 50.7%

15

Examples: SGS-Thomson Microelectronics, 1996

Govt. direct ownership: 0%

Govt ultimate control rights: 100%

SGS Thomson Microelectronics NV

SGS Thomson Micr. Holding BV

SGS Thomson Micr. Holding NV

FT2CI MEI Srl

Thomson-CSF SA FT1CI

Thomson SA

SOGEPA

CEA Industries France Telecom

IRI Comitato SIR

Italian GovernmentCEA

French Government

69.4%

100%

50% 50%

49.9% 50.1%50.1% 49.9%

58% 51% 49%

100% 100%

100% 100% 100%

100% 100%

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The control sample

First-best: a) country b) sector and c) +30% range of market cap 68% of cases

Second-best: a) sector and b) +30% range of market cap 30% of cases

Third-best case: a) country and b) +30% range of market cap 1 case

17

The largest shareholders in privatized companies

Panel A: Privatized Firms

Time period Number of firms

State Family Widely held corp.

Widely held

financial

Miscell. Cross-holdings

Widely held

End of 1996 141 34.75 16.31 2.84 17.02 1.42 0.00 27.66 End of 2000 141 29.79 19.86 4.26 9.93 4.96 0.71 30.50

Diff ’00-‘96 -4.96 b 3.55 1.42 -7.09 b 3.55 b 0.71 2.84

Panel B: Matching Firms

Time period Number of firms

State Family Widely held corp.

Widely held

financial

Miscell. Cross-holdings

Widely held

End of 1996 141 0.00 35.46 2.13 19.86 4.96 0.00 37.59 End of 2000 141 0.00 28.37 8.51 11.35 8.51 1.42 41.84

Diff ’00-‘96 0.00 -7.09 c 6.38 b -8.51 b 3.55 1.42 4.26

Panel C: Difference between Privatized and Matching Firms

Time period State Family Widely held corp.

Widely held

financial

Miscell. Cross-holdings

Widely held

Diff end 1996 34.75 a -19.15 a 0.71 -2.84 -3.55 c 0.00 -9.93 c

Diff end 2000 29.79 a -8.51 c -4.26 -1.42 -3.55 -0.71 -11.35 b

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Control rights in privatized vs control samplePanel A: Privatized Firms

Country Number of firms

Mean Median 1st quartile 3rd quartile Government Control Rights

End of 1996 141 27.80 19.99 0.00 51.00 51.27 (N=49) End of 2000 141 25.51 16.16 6.02 42.15 52.18 (N=42) Diff ’00-‘96 -2.29

Panel B: Matching Firms

Country Number of firms

Mean Median 1st quartile 3rd quartile Private Control Rights

End of 1996 141 21.10 11.92 0.00 31.60 15.67 (N=49) End of 2000 141 26.37 13.40 5.90 33.35 17.76 (N=42) Diff ’00-‘96 5.27 b

Panel C: Difference between Privatized and Matching Firms

Country All Firms (Mean)

Government- Controlled Firms

Diff end 1996 6.70 b 35.50 a

Diff end 2000 -0.86

34.42 a

19

Golden Shares

Governments may enjoy control power in partially or even in fully privatized firms through golden share provisions (GSP)

GSP typically involve:

Special powers to the public shareholder (veto or agreement on M&A, representatives in BoD, etc.)

Statutory constraints in the company bylaws to curb private ownership rights (ownership limits, voting caps, national control provision, etc.)

20

Golden Shares

GSP are widespread in several countries, highly correlated, and tend to persist overtime.

Not surprisingly, they are typically concentrated in “strategic” sectors, such as aerospace and defence, oil and gas, and utilities.

The rationale is the protection of relevant national interests (the “public” counterpart of poison pills).

21

Golden Share Provisions

Non-gov’t controlled

All Privatized Firms 1996 2000

N (%) N (%) N (%)

Golden share 104 62.50 65 66.15 71 64.79

Of which:

Special Powers: 104 39.42 65 46.15 71 45.07

Ownership Limit 99 33.33 61 42.62 67 40.30 Voting Cap 99 24.24 60 25.00 66 22.73 Foreign Ownership Limit 99 12.12 61 14.75 67 13.43 Foreign Voting Cap 97 7.22 60 8.33 66 7.58 National Control 105 9.52 66 9.09 73 8.22 Location/Directors’ Nationality 104 9.62 65 12.31 72 11.11

22

Main results on control rights (Summary)

In 2000, the government is the largest ultimate shareholder in 30% of privatized companies.

These companies are much more tightly controlled than their private peers.

In 2000, the government controls “directly” (through stakes) or indirectly (through GSP) 62% of privatized companies (65% in 1996).

Thus, governments privatized SOEs but did not relinquish control

Reluctant privatization

23

Market valuation

Does govt. reluctance affect valuation?

First, we study the evolution of the adjusted market valuation (market-to-book ratio) in sub-samples of govt vs non govt controlled privatized companies.

Second, we perform panel data estimation of M/B as a function of government’s (residual) control rights.

24

Market valuation (M/B): descriptive analysis

Year 1996 1997 1998 1999 2000

Panel A: Whole Sample

Privatized firms 1.72 1.92 2.39 2.62 2.21

Matching firms 2.96 3.31 3.51 3.91 2.82 Difference Means (A) – (B) -1.20 a -1.38 a -1.12 a -1.28 a -0.61 c T-stat -5.46 -4.93 -3.15 -2.93 -1.74

Panel B: Gov’t Controlled (as of end ‘96) vs. their Peers

Gov’t Controlled 1.73 1.97 2.16 2.39 2.00

Matching firms 2.28 2.49 2.80 2.98 2.48 Difference Means (A) – (B) -0.55 a -0.52 c -0.63 -0.59 -0.48 T-stat -2.86 -1.99 -1.56 -0.90 -1.19

Panel C: Non-Gov’t Controlled (as of end ‘96) vs. their Peers

Non-Gov’t Controlled 1.72 1.90 2.52 2.73 2.32 1.43 1.66 2.00 2.10 2.00

Matching firms 3.22 3.71 3.91 4.36 3.00 2.37 2.92 2.64 3.05 2.31 Difference Means (A) – (B) -1.50 a -1.81 a -1.39 a -1.63 a -0.68 T-stat -4.95 -4.64 -2.76 -2.86 -1.36

25

Market valuation (M/B): econometric analysis

Where STATE is the covariate for government ultimate control rights, SPECIAL is a GSP dummy, and a vector of (pair-specific) control variables

itiitittiit SPECIALSTATExMB '

itx

itx

Govt. controlled firms have higher (adjusted) M/B than firms privatized more fully. A thorough empirical test needed.

We estimate the following model:

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OLS results (random effects)Dependent variable ΔMB

(1) (2) (3) (4) (5)

ΔDEBT -0.375 -0.388 -0.591b -0.381 -0.604b

(-1.27) (-1.32) (-2.25) (-1.29) (-2.30)

ΔCAPEX -0.014 -0.014c -0.003 -0.014c -0.004

(-1.57) (-1.61) (-0.36) (-1.67) (-0.47)

ΔASSETURN 2.246a 2.158a 3.431a 2.039a 3.398a

(4.07) (3.9) (5.32) (3.60) (5.24)

ΔSIZE 3.505a 3.539a 3.598a 3.538a 3.630a

(6.11) (6.17) (6.28) (6.13) (6.32)

STATE 1.902 3.044b 2.075 3.100b

(1.36) (2.18) (1.47) (2.21)

SPECIAL 0.726 -0.207

(0.76) (-0.19)

PETROLEUM 0.327 0.703

(0.23) (0.45)

TRANSPORTATION -1.145 -2.314c

(-0.91) (-1.61)

UTILITIES 0.548 1.032

(0.57) (0.87)

YEAR DUMMIES Yes Yes Yes Yes Yes Nobs 355 355 275 355 275 R-sq: within 0.183 0.185 0.281 0.184 0.281 Wald 2 65.01 66.86 92.54 68.34 97.50 Prob. 0.000 0.000 0.000 0.000 0.000 Hausman χ2 6.53 8.75 3.96 11.74 2.63 Prob. 0.588 0.461 0.914 0.228 0.977

27

Endogeneity of market valuation

Abnormal market performance typically drives privatization, especially when govt. is in financial distress.

2SLS estimation relaxing the exogeneity of govt. stakes.

Choice of IV: Political-institutional variables (majoritarian vs consentual pattern of democracy), the partisan orientation of privatizing governments, public finance conditions.

These IV are valid: strongly correlated with stakes, but uncorrelated with the error term.

28

2SLS estimates of M/B (1) (2) (3) (4) Dependent variables STATE ΔMB STATE ΔMB STATE ΔMB STATE ΔMB

ΔDEBT -0.033 -0.080 0.002 0.795 -0.036 -0.083 0.001 -0.868 (-1.11) (-0.11) (0.08) (-1.04) (-1.20) (-0.12) (0.05) (-1.15)

ΔCAPEX -0.0001 -0.013c -0.00006 -0.003 -0.0001 -0.014c -0.00004 -0.004 (-0.43) (-1.71) (-0.17) (-0.43) (-0.42) (-1.80) (-0.10) (-0.51)

ΔASSETURN -0.029 1.592a -0.016 3.12a -0.037c 1.397a -0.018 3.089a

(-1.35) (3.10) (-0.53) (4.78) (-1.68) (2.62) (-0.60) (4.73)

ΔSIZE 0.029 3.619a 0.049c 3.59a 0.028 3.600a 0.050c 3.556a

(1.29) (6.80) (1.84) (6.10) (1.26) (6.74) (1.85) (6.10)

STATE 5.862b 7.066b 6.200b 6.227b

(1.95) (2.16) (2.07) (2.00)

SPECIAL 0.067 0.320 0.054 -0.766 (1.58) (0.33) (1.11) (-0.70)

POLINST -0.105a -0.111a -0.107a -0.117a (-7.13) (-5.75) (-7.13) (-6.03)

PARTISAN -0.016b -0.019b -0.017b -0.020a (-2.20) (-2.29) (-2.34) (-2.39)

DEBT/ GDP -0.095 -0.092 -0.100 -0.108 (-1.39) (-1.10) (-1.45) (-1.29) SECTOR DUMMIES No No No No Yes Yes Yes Yes

YEAR DUMMIES Yes Yes Yes Yes Yes Yes Yes Yes Nobs 298 298 228 228 298 298 228 228 Wald 84.00 76.07 78.00 85.00 94.00 78.66 87.00 90.58 Prob. 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 Sargan 2 1.431 0.342 1.431 0.342 Prob. 0.489 0.843 0.489 0.843 Hausman χ2 9.95 -20.05 19.07 28.95 Prob. 0.354 0.025 0.001

29

Summary of results

Government stakes do matter for valuation. But – quite surprisingly – higher stakes are associated with higher valuation differentials.

Impact not negligible: a 10 percent increase in voting rights (approx a standard deviation change) brings about 0.6 (25 percent) increase in adjusted M/B.

Therefore, fully divested companies appear less valuable than companies where government owns large stakes.

30

Robustness test I: agency costs

Higher performance in government controlled firms may be explained by lower agency costs.

State ownership may not be valuable per se, but simply because the government – as large shareholder – reduces management entrenchment.

By the same token, firms privatized more fully may benefit from lower political interference, but these benefits may be offset by the costs of ownership diffusion.

31

Robustness test I: agency costs

We add two variables to control for ownership concentration by:

ΔCONC = difference in voting rights of the largest shareholder (any type) in privatized and matching firm

ΔCONC2 to test for non-linear effects

We run cross-section regressions for 1996 and 2000, for which we have complete ownership data.

32

Robustness test II: IPO effect

Treatment and control sample firms are all listed but a newly privatized firm may have a lower valuation than an established private company with a long history of stock trading.

We control for IPO effects by:

ΔIPO = difference between the calendar year of the IPO of the privatized and matching firm

33

Robustness tests: 2SLS results

(1) (2) (3) (4) Dependent Variable: ΔMB 1996 2000 1996 2000

ΔDEBT -0.482 -2.129 -1.016 -1.934 (-0.28) (-1.50) (-0.43) (-1.31)

ΔCAPEX 0.012 -0.080b -0.002 -0.079c

(0.73) (-1.98) (-0.14) (-1.86)

ΔASSETURN 1.881b 1.469 1.208 0.720 (2.22) (1.08) (1.32) (0.56)

ΔSIZE 1.973 2.957a 6.213b 3.528a

(0.94) (2.67) (1.91) (2.93)

STATE 7.848c -1.658 6.931b 3.989 (1.77) (-0.14) (1.99) (0.67)

ΔCONC -0.025 0.011

(-1.04) (0.21)

Δ(CONC2) 0.0002 -0.001 (0.37) (-0.63)

ΔIPODATE -0.010 -0.023 (-0.53) (-1.16) Nobs 73 50 62 47 F-stat 1.96 3.03 1.88 3.22 Prob. 0.074 0.011 0.101 0.011 Sargan 1.615 2.120 0.669 0.780 Prob. 0.446 0.346 0.715 0.677

34

Conclusion

We find evidence broadly consistent with the concept of “Reluctant Privatization”. Indeed, privatizing government do not give up control in SOEs.

Quite surprisingly, government reluctance does not attect negatively market valuation.

The null hypothesis on political interference cannot be rejected.

Interpretation: “Grabbing hand” story very relevant at the intial stage of the process. But the government as large shareholder in privatized firms may also provide benefits such as contracts, favourable regulation, and stability