Privatization and Financial Performance: Can Value Be Created by Privatizing State Owned Enterprises in the Middle East \u0026 North Africa (MENA) Region?

$Page 1: Privatization and Financial Performance: Can Value Be Created by Privatizing State Owned Enterprises in the Middle East \u0026 North Africa (MENA) Region?$
Volume 3, Issue 1 2008 Article 1

Journal of Business Valuation andEconomic Loss Analysis

Privatization and Financial Performance: CanValue Be Created by Privatizing State OwnedEnterprises in the Middle East & North Africa

(MENA) Region?

David Dawley, West Virginia UniversityJamal Ibrahim Haidar, Cass Business School, City

University, London

Recommended Citation:Dawley, David and Haidar, Jamal Ibrahim (2008) "Privatization and Financial Performance: CanValue Be Created by Privatizing State Owned Enterprises in the Middle East & North Africa(MENA) Region?," Journal of Business Valuation and Economic Loss Analysis: Vol. 3: Iss. 1,Article 1.DOI: 10.2202/1932-9156.1027

Unauthenticated | 193.55.102.233Download Date | 1/8/13 1:42 PM

Privatization and Financial Performance: CanValue Be Created by Privatizing State OwnedEnterprises in the Middle East & North Africa

(MENA) Region?David Dawley and Jamal Ibrahim Haidar

Abstract

This study investigates the impact of privatization on value creation in State OwnedEnterprises (SOEs) in the Middle East and North Africa (MENA) region. A multi-case studyapproach, using quantitative and qualitative data, is used to rectify the findings of prior SOEprivatization research by taking a finer-grained analysis into the conditions that determine post-privatization performance. This study addresses the research question, "What is the effect ofprivatization in terms of value creation for State Owned Enterprises in the Middle East and NorthAfrica (MENA) region?" Value creation is measured in terms of profitability, operating efficiency,capital expenditures, and leverage. Using quantitative performance metrics to assess valuecreation, we also use qualitative data to show that post-privatization value creation depends onspecific strategic initiatives as well as government policy toward competition. Our overallconclusion is that privatizing SOEs can be beneficial in the MENA region but must coincide withstrong government reform policies, and certain financial and managerial strategies.

KEYWORDS: MENA, privatization, SOE, restructuring, and value creation


The Middle East and North Africa (MENA) countries are facing significant economic and financial challenges because they are developing and emerging countries in terms of increasing standards of living, human development, industrial bases, and national income levels. Historically, the governments of MENA countries have been responsible for planning, organizing, and controlling most of the activities of public institutions. Unfortunately, The World Bank calculations reveal that annual budgets are not being met, investor trust is low, and unemployment levels are high. Macroeconomic problems in the MENA have been blamed on deficiencies in infrastructure, State Owned Enterprise (SOE) management, and corruption (World Bank, 2003).

For example, aging and inefficient infrastructure in the telecommunications, electricity, water, and energy industries leave MENA countries with the highest prices in the world, while yielding extraordinarily low levels of customer satisfaction. Additionally, SOE mismanagement is widely blamed for performance shortfalls. Corruption can be cited as a major culprit in lax tax policies that yield low collection rates. Inept governments are also blamed for inordinate expenditures.

In many cases, poor management and weak capitalization of SOEs have been blamed on the lack of SOE efficiency and financial viability (Road, 1997). One often cited goal of SOEs was purely a political motivation to provide employment and this intention often conflicted with maximizing profits (Megginson, 2000). The World Bank has suggested that inefficient SOE financial performance in MENA countries has been attributed to a lack of budget constraints (World Bank, 2003). Inefficient budget constraints in the region were represented by inefficiencies in credit (e.g., providing SOEs with low cost, low interest loans), taxes (e.g., exempting SOEs from paying taxes), and prices (e.g., SOEs provide services to other governmental institutions with lower than market prices) (Megginson, 2001). Deficit spending has engendered budget deficits and increasing public debt levels in MENA countries. The budget deficits and high levels of public debt are causing a real burden to the poor and middle class citizens, simply because they are prompting tax rates to rise even though personal incomes remain stable.

In an attempt to create more value in SOEs over the last few decades, many governments have recently explored restructuring though privatization. Privatization is a transfer of assets (often in shares) from the government to private owners. Several private consulting organizations, including the Kuwait Privatization Project Holding Company and the Islamic Corporation for the Development of the Private Sector have organized and have some documented success (www.zawya.com). Unfortunately, the extant academic privatization literature offers mixed findings regarding any positive effects of privatizing a SOE. To make matters worse, there have been no published studies of this genre

1

Dawley and Haidar: Privatizing State Owned Enterprises


to date that include MENA SOEs. Therefore, the purpose of this multi-case study is to contribute to the international valuation literature by examining the effects of privatization on creation of value in MENA SOEs. Specifically, this case study examines the effect of privatization on value creation for four SOEs operating in the Middle East and North Africa (MENA) region. The countries examined are Tunisia, Morocco, Saudi Arabia, and Jordan. The central research question is: What is the effect of privatization on the financial performance of SOEs in the MENA region? Ninety percent of the total dollar value of privatized infrastructure SOEs between 1988 and 2003 in the MENA region is examined.

This multi-case study is organized as follows: First the extant privatization literature is reviewed. Second, the methods used in the case study are explained. Third, the results from the study are reported. We conclude the study with a discussion of the results and suggestions for further research and policy makers.

THE RELATIONSHIP BETWEEN PRIVATIZATION AND FINANCIAL PERFORMANCE OF SOEs

Recently, many journal articles and books have been written about the relationship between privatization and financial performance of SOEs in countries such as the Czech Republic, Ukraine, China, Benin, Poland, Hungary, India, Ireland, Vietnam, Kyrgyzstan, and Slovenia (e.g., Gupta, 2005; Frydman et al. 1999; Smith et al., 1999). For example, Gupta (2005) reported a positive impact of partial privatization on the profitability and efficiency of Indian firms, largely due to a change in management and competition policies, and reducing agency problems. In a large-scale privatization study in the Czech Republic, Hanousek and Kocenda (2003) found that privatization is associated with enhanced performance. La Porta and Lopez-de-Silanes (1999) found that privatization in Mexico led to a short-term gain in operating income, but also to higher prices and massive lay-offs. In a study of privatization in Poland, Hungary, and the Czech Republic, Frydman et al. (1999) reported that privatization was associated with sales and productivity gains only if outsider ownership controlled the restructured SOE. On the other hand, Beck et al. (2005) found that profitability measures of privatized Nigerian banks did not significantly beat the performance measures of their non-privatized peers and that privatization didn’t improve performance of the banks that were privatized. In a study of Slovenia firms, Smith et al. (1997) reported evidence of diminishing productivity gains after privatization.

To date, very few papers have been published about the topic regarding the MENA region and those papers that have been published have focused on SOEs in Egypt. For example, Omran (2004a) provided some new insight into the impact of privatization on SOE performance in 69 Egyptian privatized firms, documented significant decline in leverage and employment, and found

2

Journal of Business Valuation and Economic Loss Analysis, Vol. 3 [2008], Iss. 1, Art. 1

DOI: 10.2202/1932-9156.1027


https://www.researchgate.net/publication/24091674_When_Does_Privatization_Work_The_Impact_Of_Private_Ownership_On_Corporate_Performance_In_The_Transition_Economies?el=1_x_8&enrichId=rgreq-dc97440c-25b1-4bb8-9965-7f04d0f90f48&enrichSource=Y292ZXJQYWdlOzIyNzM3ODU3OTtBUzo5ODkxMzEyMTk5NjgxM0AxNDAwNTk0MTM0ODMz

https://www.researchgate.net/publication/222556340_Bank_Privatization_and_Performance_Empirical_Evidence_from_Nigeria?el=1_x_8&enrichId=rgreq-dc97440c-25b1-4bb8-9965-7f04d0f90f48&enrichSource=Y292ZXJQYWdlOzIyNzM3ODU3OTtBUzo5ODkxMzEyMTk5NjgxM0AxNDAwNTk0MTM0ODMz

https://www.researchgate.net/publication/238066472_Performance_Consequences_of_Privatizing_Egyptian_State-Owned_Enterprises_The_Effect_of_Post-Privatization_Ownership_Structure_on_Firm_Performance?el=1_x_8&enrichId=rgreq-dc97440c-25b1-4bb8-9965-7f04d0f90f48&enrichSource=Y292ZXJQYWdlOzIyNzM3ODU3OTtBUzo5ODkxMzEyMTk5NjgxM0AxNDAwNTk0MTM0ODMz

significant increases in profitability, operating efficiency, capital expenditures, and dividends. In a later study Omran (2004b) found that a sample of 54 privatized SOEs did not outperform a control group of non-privatized SOEs.

Other studies have examined the relationship between privatization and financial performance using data from different regions. For example, D’Souza et al. (2005) documented significant increases in profitability, efficiency, output, and capital expenditure in several Organization for Economic Cooperation and Development (OECD) countries, particularly in France, Italy, and the United Kingdom. Likewise, Cabanda and Ariff (2002) found general operating efficiency, output, and productivity gains among three privatized telecommunications firms in Japan, Malaysia, and the Philippines. However, these authors also found both positive and negative changes in post-privatization profitability and capital expenditures among countries. Research by Boubakri et al. (2005) suggested that post-privatization performance differs between developed and developing countries. Sanni Yaya (2004) examined the impact of privatization policies on the performance of public organizations in West Africa and concluded that privatization yields a minimal increase in performance.

In short, the aforementioned research suggests that the relationship between SOE privatization and financial performance is unclear. While some researchers concluded that privatization can be an effective tool in enhancing SOE performance (e.g., Omran 2004a), others found that SOE privatization is ineffective (e.g., Boubakri, 2005). Still others concluded that performance differences vary by country (e.g., D’Souza, 2005). The remaining researchers found that performance changes in post-privatized SOEs performance are minimal. A major goal of this study is to rectify prior privatization research by taking a finer-grained analysis, through a multi-country, multi-case study approach, into the conditions that determine post-privatization performance.

To carry out this case study and to find answers to the central research question, the data collected are used for comparing the pre and post-privatization financial performance, operating efficiency, capital expenditures, and debt levels of the four enterprises that are included in the sample. After this quantitative comparison, we detail our qualitative approach by explaining the strategic and governmental policy differences that affect the privatized SOEs.

Data and Methodology Privatized SOE financial performance has been measured in many ways, including profitability, operating efficiency, capital expenditure, leverage risk, and cost of labor. Specifically, return on sales (ROS), return on assets (ROA), and return on equity (ROE) have all been used as measures to analyze profitability (Omran, 2004a, 2004b; Boubakri et al. 2005; D’Souza et al. 2005; Boubakri and Cosset, 1998; Hanousek and Kocenda, 2003). The absolute levels of these three

3



https://www.researchgate.net/publication/222668224_Liberalization_Corporate_Governance_and_the_Performance_of_Newly_Privatized_Firms?el=1_x_8&enrichId=rgreq-dc97440c-25b1-4bb8-9965-7f04d0f90f48&enrichSource=Y292ZXJQYWdlOzIyNzM3ODU3OTtBUzo5ODkxMzEyMTk5NjgxM0AxNDAwNTk0MTM0ODMz

https://www.researchgate.net/publication/247829034_Performance_Gains_through_Privatization_and_Competition_of_Asian_Telecommunications?el=1_x_8&enrichId=rgreq-dc97440c-25b1-4bb8-9965-7f04d0f90f48&enrichSource=Y292ZXJQYWdlOzIyNzM3ODU3OTtBUzo5ODkxMzEyMTk5NjgxM0AxNDAwNTk0MTM0ODMz

ratios were of interest to us because a firm may have high revenue growth but a poor level of absolute performance. An advantage of using changes in ROS is that it avoids the problems associated with different methods of accounting. By measuring change, accounting effects would be substantially eliminated assuming that the same methods were used to generate pre- and post-privatization results. Further, by using ROS, inflation effects are eliminated, since the numerator (net income) and the denominator (sales) usually inflate at the same rate. Return on assets (ROA) or return on equity (ROE) are calculated by dividing net income, expressed in home currency, by assets (ROA) or equity (ROE).

Sales, sales growth, profit efficiency (EBIT/ Cost of labor), sales efficiency (Sales/ Cost of labor) and asset turnover have been used to assess the operating efficiency of SOEs before and after their privatization (Omran 2004a, 2004b; La Porta and Lopez de-Silanes, 1999; D’Souza et al. 2005; Boubakri and Cosset, 1998; Frydman et al. 1999). We use capital expenditures (CE), capital expenditure per sales (CE/Sales), and capital expenditure per total assets (CE/TA) to measure capital spending. Pre and post privatization leverage are assessed using total debt/total assets (TD/TA), and total liability/total equity (TL/TE).

According to the World Bank privatization database, 18 SOEs that operate in the infrastructure sector were privatized in the Middle East & North Africa between 1988 and 2003. Table 1 shows the complete population and brief explanatory information of those infrastructure SOEs. Due to data unavailability, our sample considers four firms in the telecommunications industry. Nonetheless, these four firms made up a substantial portion (90%) of the infrastructure privatization proceeds between 1988 and 2003 according to the World Bank privatization database.

4


DOI: 10.2202/1932-9156.1027


Table 1. All privatized MENA infrastructure SOEs, between 1988 and 2003.

Transaction Value

Country Year of privatization Name

(US$ millions)

Egypt 1996 Telemisr 12

Egypt 1998 Egyp. Maritime works-Martrans 13

Egypt 1998 Egypt, Arab Rep. Mobile Telephone Services Company (EMTSC) 53

Egypt 1998 Egypt, Arab Rep.ian For Marine Supplies 5

Egypt 1998 United Arab stevedoring 9

Egypt 2001 Sharm El Sheikh Airport 125

Jordan 2000 Jordan Telecommunications Company 508

Morocco 1993 CTM International Bus Co. (CTM-LN) 27

Morocco 1993 Societe Petroles du Maghreb (PETROM) 16

Morocco 1993 TOTAL MAROC 32

Morocco 1994 Compagnie Marocaine des Transports-Lignes Nationales 6

Morocco 1997 Lyonnais des Eaux de Casablanca n/a

Morocco 1998 National Gaz n/a

Morocco 2000 Maroc Telecom 2,110

Oman 2000 Barka Power and Desalinization Project 475

Saudi Arabia 2003 Saudi Telecom 4,080

Tunisia 1999 Societe de Transport de Marchandises 1

Tunisia 1998 Sotetel 3

We contacted the finance departments of all 18 privatized SOEs and spent several months making appointments, international telephone calls, and sending data-request letters to key people in the finance departments of all target SOEs. The complete financial data required to perform this study could only be culled from four privatized SOEs. Thus, the final sample consists of four privatized companies (22% of all firms, 90% of the total dollars of infrastructure privatized).

5



Table 2 reports the final sample of privatized SOEs along with relevant explanatory information.

Table 2. Final sample.

We use one-tailed t-tests (at the p < .05) acceptance level to detect significant changes between the pre- and post-privatization periods. The main data sources used in the multi-case study were annual reports, information obtained through telephone interviews with the respective finance departments, on-line access to databases, the World Bank privatization transactions database, and various news sources – mainly the Arab Database Center of Assafir newspaper. The World Bank privatization transactions database and business press were invaluable in helping us understand the environment in which each SOE operated and to relate the numerical figures to the business strategies reported.

Our data set includes two year pre- and four year post-privatization financial information. Annual reports were evaluated to qualitatively assess stated business plans. All monetary numbers are listed home country currency. The accounting standards remained the same set during the periods considered because the firms remained majority owned by the government and was subject to the same reporting requirements as before privatization.

RESULTS

The first round of empirical analysis compares pre-privatization with post-privatization financial profitability, operating efficiency, capital expenditures, and leverage for the four MENA enterprises considered in this case study. Table 3 lists the pre and post privatization metrics and shows tests of significance for each metric comparison.

Country Company Industry % Sold Year Total $ value of the transaction (in millions)

Morocco Maroc Telecom Telecommunication 30 2000 2110 Tunisia Sotetel Telecommunication 36 1998 3 Jordan Jordan Telecom Telecommunication 48 2000 508 Saudi Arabia Saudi Telecom Telecommunication 30 2003 4080

6


DOI: 10.2202/1932-9156.1027


Table 3. Changes in Performance before and after Privatization

Measures Company Mean Before After Test of

significance Profitability

Maroc Telecom 22.1 29.7 +2.18* Sotetel 5.5 11.0 +2.00

Jordan Telecom 24.5 12.4 -3.07*

ROS

Saudi Telecom 16.5 33.3 +5.22*

Maroc Telecom 10.1 18.8 +3.53*

Sotetel 5.5 9.0 +1.49

Jordan Telecom 14.8 12.4 -0.56

ROA



Sotetel 17.2 15.3 -0.26


ROE


Efficiency Maroc Telecom 2.27 5.28 +2.72*

Sotetel 0.35 0.72 +1.86

Jordan Telecom 2.09 3.04 +0.61

Profit Efficiency (EBIT/ Labor cost)


Maroc Telecom 6.73 12.76 +3.93*

Sotetel 3.13 4.06 +1.59


Sales Efficiency (Sales/ Labor costs)


7



Table 3 (continued). Changes in Performance before and after Privatization


significance Efficiency (continued)


Sotetel 1.61 0.89 -0.06


Asset Turnover


Maroc Telecom 7600 17442 +4.97*

Sotetel 22700 40181 +1.36

Jordan Telecom 272176 316098 +2.43*

Sales Growth

Saudi Telecom 21664 30110 +3.18*

Capital Expenditures Maroc Telecom 1711 2338 +0.80

Sotetel n/a n/a n/a

Jordan Telecom 5398 4925 -.020

Capital Expenditures (CE)

Saudi Telecom 5505 4270 -2.85*

Maroc Telecom 0.22 0.13 -1.56

Sotetel n/a n/a n/a


Capital Expenditures/ Sales

Saudi Telecom 0.15 0.10 -2.71*

Maroc Telecom 0.08 0.09 +0.08

Sotetel n/a n/a n/a


Capital Expenditures/ Total assets


8


DOI: 10.2202/1932-9156.1027


Table 3 (continued). Changes in Performance before and after Privatization


significance Debt

Maroc Telecom 0.26 0.06 -5.94*

Sotetel 0.59 0.12 -7.04*


Total Debt/ Total Liabilities


Maroc Telecom 0.79 0.09 -9.31*

Sotetel 2.28 0.78 -2.28*


Total Debt/ Total Assets


Post-privatization Profitability Post-privatization profitability was measured by ROS, ROE, and ROA. Each indicator was compared to its pre-privatization average level. Two firms showed post privatization profitability improvements, while the other two firms did not. Maroc Telecom and Saudi Telecom showed significant profitability improvements in ROS (t = 2.18, 5.22), ROA (t = 3.53, 5.11), and ROE (t = 2.35, 2.63) after privatization. On the other hand, Jordan Telecom had significant decreases in ROS (t = -3.07) and ROE (t = -2.25). Sotetel showed no significant change in post-privatization ROS, ROA, and ROE.

To better understand why these four SOEs differed in post-privatization performance, we turn to a qualitative analysis to better understand contextual factors. We reviewed all SOE annual reports, the Arab Database Center of Assafir newspaper, regional business press, and the World Bank privatization transactions database to provide qualitative insight into the post-privatization context of our four firms.

We found three major factors that help to explain the lower post privatization profitability found in Sotetel and Jordan Telecom. First, we determined that Sotetel and Jordan Telecom, unlike Maroc Telecom and Saudi Telecom, were not able to meet the stated goals of their marketing strategies. In the post-privatization annual reports, all four firms outlined elaborate marketing

9



programs designed to build a broader subscriber base; these programs were deemed to be critical in boosting profits. In the case of Sotetel and Jordan Telecom, the target levels of subscribers were not met. This was further evidenced in that pre versus post-privatization sales growth of Sotetel (38%) and Jordan Telecom (9%) was considerably less than that for Saudi Telecom (50%) and Maroc Telecom (229%). Additionally, the decline in profitability in Jordan Telecom was in part attributed to the fact that a major increase in spending on selling and administration did not have a significant impact on revenues.

Second, Sotetel and Jordan Telecom, unlike Maroc Telecom and Saudi Telecom, were not to keep pace with changing and increasingly sophisticated technology, and with increasing service level expectations. Third, we found a relatively low level of competitive regulations in Morocco (Maroc Telecom) and Saudi Arabia (Saudi Telecom) compared with greater competitive regulations in Tunisia (Sotetel) and Jordan (Jordan Telecom). For example, after an extensive policy debate in Jordan, the decision was made in favor of licensing only one additional network operator to compete with Jordan Telecom – and this venture has enjoyed very limited success. The second mobile service provider to date in Jordan is MobileCom, a wholly owned subsidiary of Jordan Telecom. Clearly competition in Jordan remains very limited. Similarly, Sotetel faced no new competition in the first four years after privatization.

On the other hand, Maroc Telecom faced a much greater competitive landscape that included the newly formed Casablanca-based mobile telecommunications firms Méditel and Wana. Both firms were very successful and quickly became the second and third largest telecommunication firms in Morocco. In Saudi Arabia, Saudi Telecom’s monopolization was immediately broken up by the creation of Mobily. By the end of 2006, Mobily was touted as the fastest growing mobile operator in the MENA. As of this writing, Mobily’s subscriber base topped 6 million users.

Increased competition has been shown to positively affect privatized firms by promoting an increase in proactive profit maximizing strategies (Alchain, 1977; Stano, 1975) whereby privatized firms have been shown to yield economic benefits (D’Souza and Megginson, 1999). Moreover, increased competition increases managerial incentives for operating efficiency. We attribute the relative performance enhancements to Maroc Telecom and Saudi Telecom in part due to a more competitive environment.

In short, the Saudi and Moroccan privatizations fared better than those in Tunisia and Jordan. We attribute the effective internal strategies (i.e., marketing, managerial responsiveness to making technological improvements, and improving service levels) and increased competition as key factors explaining their post-privatization profitability performance over that of the other two SOEs. It should also be noted that both Saudi Arabia and Morocco have much larger populations

10


DOI: 10.2202/1932-9156.1027


(28 & 33 billion) than Jordan and Tunisia (6 & 10 billion). Further, Saudi Arabia boasts a per capita GDP of four times greater than Morocco and Jordan, and two and a half times greater than that of Tunisia.

Post-privatization Operating Efficiency The operating efficiency in each SOE was examined using sales, sales growth, profit efficiency (EBIT/ labor cost), sales efficiency (sales/ labor cost), and asset turnover (sales/average total assets). In terms of sales growth, revenues showed marked improvements in all firms and significant improvements in three out of four. Given the rapid growth in telecommunications in the 1990s, sales growth was expected. In sales efficiency, profit efficiency, and asset turnover, only Maroc Telecom and Saudi Telecom showed significant improvements.

In terms of revenue growth, sales grew considerably after privatization in all four SOEs. Although sales grew by only 9% for Jordan Telecom, the average post-privatization sales were 1.38 times, 1.44 times, and 2.29 times greater than pre-privatization levels in the Tunisian SOE (Sotetel), Saudi SOE (Saudi Telecom) and Moroccan SOE (Marcoc Telecom) respectively. We attribute these sales increases to several qualitative findings.

First, each of the privatized SOEs was able to expand by investing in new subsidiaries. Shortly after privatization in 2003, Saudi Telecom acquired the three firms Alhatif, Aljawwal, and Saudi Data, in an effort to boost subscribers. The acquisitions proved instrumental in helping Saudi Telecom push its subscriber base to 11 million in December, 2005 – a milestone that vaulted the company into the world’s top fifteen telecommunications companies. Similarly, Sotetel acquired Cameroon's telecommunication company, Camtel, and Maroc Telecom acquired the Mauritanian Telecom Company, Mauritel. Second, after privatization, more services and products were introduced as the industry moved to modernize. For example, Saudi Telecom formed partnerships with Alcatel, Cisco Systems and Lucent Technologies to create an advanced broadband network in Saudi Arabia in 2005. In the same year, Saudi Telecom unveiled a new service whereby the Internet could be accessed via satellite. In 2002, Maroc Telecom spent $645 million to develop and expand Internet access into narrow areas through fixed telephone cables. Interestingly, in the first four years following privatization, Jordan Telecom entered into no new partnerships and offered only enhancements to existing services.

Third, we identified several successful initiatives aimed at improving customer relationships. For example, in 2002 Maroc Telecom allocated $75 million to finance teaching, training and qualifying information technology employees. In 2004, Saudi Telecom was lauded for offering employee incentives of up to three months salary in the form of a bonus in a bid to stop them defecting to Etisalat, a company soon to become Saudi Arabia’s second telecommunications

11



network. Jordan Telecom had no documented success in its customer loyalty and customer service programs in 2001 and 2002.

Fourth, the demand increased at Sotetel, Saudi Telecom, and Maroc Telecom improved economies of scale as fixed cost (as a percent of sales) dropped. For these firms, subscription prices subsequently dropped fueling even more demand. In 2004, Saudi Telecom reduced its international internet access fee by 45%. The increase in economies of scale were further aided by cost reductions (e.g., a 50% decrease in the cost of SIM chips), and lowered international SMS (i.e. mail message) costs. Fifth, all SOEs increased their marketing expenses and created marketing plans to increase or protect market share in their respective industries. This was particularly apparent in Saudi Arabia which became the fastest growing telecommunication sector in the MENA region in 2001 and 2002. During this period, the telecommunications industry in Saudi Arabia grew 172%.

In empirical studies of the effects of privatization, Omran (2004a), D’Souza and Megginson (1999), Boubakri and Cosset (1998), Eckel et al. (1997), and Megginson et al. (1994) reported efficiency improvements following privatization. The summarized figures in Table 3 only give partial support to these findings. Post-privatization profit efficiency (EBIT/Cost of labor) improved 2.32 times, 1.39 times, 1.4 times and 1.26 times at Maroc Telecom, Saudi Telecom, Sotetel, and Jordan Telecom, respectively. The improvements were statistically significant at Maroc Telecom and Saudi Telecom at the p < .05 level and at Sotetel at the p < .10 level. Jordan Telecom showed a non-significant improvement in profit efficiency. Sales efficiency improved in the same fashion. These figures are consistent with Frydman et al. (1999), Anderson et al. (1997), Smith et al. (1997) and Cabanda and Ariff (2002) who documented a significant positive relationship between privatization and sales and profit efficiency.

We attributed profit and sales efficiency improvements of the three firms to improved policies of hiring employees (of three of the four SOEs in our study), as well as post-privatization employee training and development programs. Before privatization, training and development programs were seemingly void in all four SOEs. A lack of training and development likely stymied motivation, skills development, and thus productivity. After privatization, employee training programs were associated with increased productivity in three of the four SOEs. Further, Saudi Telecom allowed its employees to purchase stock at favorable rates at the time of privatization (stock options are not permitted in Tunisia, Morocco, and Jordan). Stock ownership became an incentive to improve employee efforts and increase productivity.

We found evidence of increased post-privatization asset turnover levels in Maroc Telecom (t = 3.93) and Saudi Telecom (t = 3.12). Asset turnover at Jordan Telecom and Sotetel decreased, albeit by insignificant amounts. These SOEs

12


DOI: 10.2202/1932-9156.1027


(Jordan Telecom and Sotetel) affirm Boardman and Laurin’s (2000) study that contends that firms not subject to the discipline of competitive pressure, would be less likely to benefit from privatization. As mentioned earlier, Jordan (Jordan Telecom) and Tunisa (Sotetel) had industries with very limited competition in the post-privatization period. As expected, Jordan Telecom and Sotetel did not substantially lower their pricing in the post-privatization period, but increased competition prompted their Saudi Arabian and Moroccan counterparts to do so. A more thorough examination of Jordan Telecom’s and Sotetel’s income statements provides evidence that they did not reduce their costs (as a percent of sales) of operations and inputs. The same costs significantly decreased in their two counterparts who faced a more vigorous competitive environment.

Several empirical studies (e.g., Megginson et al., 1994; LaPorta and Lopez-de-Silanes, 1999) reported that efficiency gains are significantly greater for firms in more competitive markets. The increase in asset turnover levels in the Saudi (Saudi Telecom) and Moroccan (Marcoc Telecom) corroborates the aforementioned research. Competitive regulations notwithstanding, we found evidence of far-reaching competition facing Saudi Telecom and Maroc Telecom. For example, new non-Saudi Gulf region competitors emerged in the case of Saudi Telecom, and new North African competitors entered Maroc Telecom’s market.

To summarize, the study reports an increase in sales because the four SOEs expanded and invested in new subsidiaries, introduced new products and services, improved customer relationships, decreased prices, benefited from the overall growth in the telecommunication industry. Also, profit and sales efficiency increased in part due to successful training and development programs that were implemented and because employees and managers were urged to gain a more vested interest after gaining options to buy shares in their enterprises. In contrast to their peers, the Jordanian and Tunisian SOEs exhibited lower levels of asset turnover largely due to stable pricing levels and a general lack of cost reduction.

Post-privatization Capital Expenditure Levels We measured capital expenditures using spending on capital equipment (CE), CE/ sales and CE/ total assets. While capital expenditure data was not available for Sotetel, only Saudi Telecom showed a significant decrease in capital spending. The changes in capital expenditures were minimal and statistically insignificant for Maroc Telecom and Jordan Telecom. This general finding contradicts empirical research which reports significant increases in post-privatization capital spending (Boubakri and Cosset, 1998; D’Souza & Megginson, 1999; Megginson et al. 1994). This is especially surprising given that capital expenditures are relatively high in the telecommunications industry.

13



In order to better understand why capital spending decreased at Saudi Telecom and remained relatively stable in the other SOEs, we returned to a qualitative analysis. From this, we determined that the SOEs used acquisitions and partnerships to beef up infrastructure. For example, Saudi Telecom set up partnership distributors to offer prepaid and postpaid services as well as information services such as research and development. Moreover, Saudi Telecom (immediately after privatization) set up a partnership with Compaq to manage its current data network and future expansions. Jordan Telecom acquired a local data communications operator to position itself as an integrated communications services provider. Insomuch as Maroc Telecom increased its capital spending (however insignificantly), we found that the increase in capital expenditures was due to the necessity to upgrade aging fixed networks and make them internet-ready. The other companies were internet-ready at the time of privatization. From this, we conclude that privatization does not necessarily increase capital spending. Rather post-privatization capital expenditures depend on acquisitions and partnering activity subject to the needs of the individual companies.

Post-privatization Leverage This multi-case study examines the leverage ratios of the four enterprises used in this study. In particular, we concentrate on the total debt to total assets (TD/TA) ratio, and total liabilities to total equity (TL/TE) ratio. Table 3 shows a general and significant decrease in the use of debt financing by all firms. With respect to the research question related to whether privatization changes financing patterns, our findings are that after privatization, the use of debt decreased in all firms. Privatized firms are argued to no longer have the advantage of borrowing funds at a favorable SOE rate, but they gain the opportunity to access the domestic and international equity markets (Bradley et al. 1984). Therefore, debt ratios are expected to decline following privatization. Omran (2004a and 2004b) and D’Souza et al. (2005) documented significant decreases in the debt levels of privatized firms. However, Omran (2004b) found that debt levels in privatized firms decreased less than in a matched sample of SOEs. This finding casts some doubt on the overall theory that privatization reduces debt levels. Decreased reliance on debt indicated that the privatized organizations we studied shifted their focus to the use of internal funds. Our qualitative analysis revealed that internal funds (retained earnings plus depreciation) were able to cover most of the cash needed for the different kinds of investment (including the high expenses of research and development). Moreover, internal financing and raising equity became more desirable than pursuing external debt for the following reasons. First, governments were still the dominant owners of all enterprises and reported that one main privatization goal was to reduce debt

14


DOI: 10.2202/1932-9156.1027


levels. Second, managers in the MENA region tend to prefer having long term careers with one company. Therefore, MENA financial managers try to optimize their financing strategies and to keep governments satisfied with the financing decisions that they make. Third, managers will continue to make the best out of the financial regulatory reforms that are being taken in their countries, especially those related to exempting equity investors from taxes on dividends. For example, Moroccan corporations can distribute tax free dividend to all common stock shareholders. In Tunisia, dividends paid by companies to shareholders are not taxed, and investments made in certain companies may be tax-deductible. We cite the above as reasons for debt reduction in our sample to augment the general tenet that privatized firms gain access to international equity markets and thus automatically reduce their debt levels.

A Note about Privatization and CEO Turnover From the corporate finance and agency theory literature it is argued that shareholders of SOEs can only influence management through government agents whose interests in the firms, unfortunately, may be subordinate to their political agendas and objectives. An oft-cited Middle Eastern SOE agency problem involves the national Lebanese electricity SOE, EDL from the early 1990s through 2002 (Abdelnour, 2003). Management at EDL proved to be heavily influenced by the previous and current ministers of energy in Lebanon. In this case, the ministers also held positions in the Lebanese Parliament. In an effort to ensure parliamentary re-election, the ministers used EDL to offer free services to many selected citizens in exchange for votes. Similar circumstances were said to exist in many MENA SOEs especially most of those operating in Libya, Egypt, Yemen, and Syria. In all cases, agency problems are blamed for lack of revenue growth, quality decreases, profitability declines, and increases in costs, debt, and budget deficits. As a result, governments sought advice from international financial advisors on how to improve the affected SOEs.

From an agency perspective, we fully expected that privatization would include CEO turnover and that new management would aid the plight of SOEs in the manner described above. Our supposition was only half right. Table 4 indicates that a new CEO was installed in three out of the four SOEs, but performance and efficiency gains did not necessarily follow. The results summarized in Table 4 show that performance enhancements were found at Maroc Telecom (CEO turnover) and Saudi Telecom (no CEO turnover), but not at Jordan Telecom (CEO turnover) or Sotetel (CEO turnover). Thus, our sample showed no relationship between CEO turnover and post-privatization performance. Further, we found no evidence of pre-privatization agency problems (from our review of the press) and thus no post-privatization agency solutions.

15



Table 4. Privatization, CEO Turnover, Financial Performance and Operating Efficiency

CEO Turnover

Financial Performance Improvements?

Operating Efficiency Improvements?

Firm ROS ROA ROE Sales Efficiency

Profit Efficiency

Asset Turnover

Saudi Telecom

No Yes Yes Yes Yes Yes Yes

Maroc Telecom

Yes Yes Yes Yes Yes Yes Yes

Sotetel Yes No No No No No No Jordan Telecom

Yes No No No No No No

DISCUSSION AND CONCLUSIONS The central research question of this case study is “What is the effect of privatization on the creation of value via financial performance in SOEs in the MENA region?” Our main goal was to examine quantitative and qualitative empirical evidence of SOE privatization and help to explain the mixed findings of researchers before us. Even though the sample considered in this case study is relatively small, it still represents 22.2% of the total population and 90% of the total dollar activity spent in privatizing infrastructure SOEs in the MENA 21 countries from 1998 to 2003. Results from this case study provide insight into how strategic changes and government regulations that accompanied infrastructure SOEs’ privatization in the MENA region influenced their financial performance.

In general, we find that privatization, depending on the environment where it is implemented, can have positive or negative effects. Significant profitability and efficiency improvements were found in SOEs that offered new services, employed effective marketing and acquisition strategies, and operated in environments where government policy encouraged greater competition. We also found that that debt levels decreased after privatization in all four enterprises. Further, we found no evidence that capital expenditure levels increase in SOEs after being privatized. Unlike prior literature (Boubakri and Cosset, 1998; D’Souza & Megginson, 1999; Megginson et al., 1994), we contend that changes in capital expenditures are firm and industry-dependent. A holistic assertion that privatization necessarily leads to an increase in capital spending cannot be made without examining privatization on a case by case basis.

The results corroborate research by supporters of privatization, but only where the aforementioned strategies are implemented and governments encourage competition. In the MENA countries – Morocco and Saudi Arabia - where

16


DOI: 10.2202/1932-9156.1027


specific customer service, partnering, acquisition, and marketing initiatives were enacted and competition regulations were enforced, profitability and efficiency levels were positively affected positively after privatization. Taking into account these results, the evidence affirm that strategic changes have to be implemented and competition regulations need to be enacted immediately after privatizing a SOE. This will help produce the value creation – mainly financial proceeds to governments and better service to citizens - in privatizing any of the SOEs in the MENA region.

Limitations and Future Research Directions The sample size in this analysis does not allow us to make far-reaching generalizations outside this study. Additionally, the governments of the MENA countries - where privatization was affecting performance positively - were adopting programs of economic reform in the same period that privatization was taking place. Thus, the improvement of financial performance in the privatized SOEs may be linked to the factors that were affecting the economies of the countries in general and not solely to privatization. Moreover, the analysis conducted in this study was limited to a short (6 year) period of time. Thus it is very possible that the SOEs which didn’t have positive results were still burdened with the constraints left behind by their previous organization.

We also recognize that accounting methods often vary by country and might not represent completely consistent measures. However, our four MENA companies are all members of the International Federation of Accountants (IFAC). The IFAC is a global organization for the accountancy profession that was organized to promote standardized auditing, reporting, and governance standards. One major goal of the IFAC is to help generate comparable and reliable accounting information to help investors and creditors. Accordingly, IFAC members are required to adhere to International Accounting Standards (IAS) as dictated by the International Accounting Standards Board (IASB). Saudi Telecom, Jordan Telecom, Maroc Telecom, and Sotetel all reported using IAS during the timeframe in this study. Another notable limitation is that there are cultural differences among the organizations in our sample.

We contend that internal SOE managerial reform should precede (or coincide with) privatization in order to maximize the benefits of privatization. This point of view should warrant further investigation and research since the methodology employed here is not based on an asset-pricing model and risk-return characteristics of the companies were not given consideration in the study.

Moreover, this case study suggests several avenues for future research. For example, a study can be done to investigate the reasons of failure of public sectors by using an alternative methodology and considering a wider range of variables that would help to describe the context of the privatization for each company as

17



well as the different types of privatization. Another important question is the relative impact of the Islamic law of human conduct, Sharia on privatized SOEs. Sharia regulates all matters in the lives of Muslims, including business and business reporting. This law (applicable to all companies in this study) requires transactions to be lawful. A common expectation in the social responsibility literature is that Muslim firms are held to a higher level of social responsibility than their western counterparts. However, recent research suggests that Sharia compliance does not necessarily lead to more socially responsible behaviors in Muslim firms than it does in non-Muslim firms (Maali, Casson, & Napier, 2006). Nevertheless, there is some variance in the application of Sharia among Muslim countries and firms (Maali et al. 2006). While it is beyond the scope of this study, future studies might consider the relative adherence to Sharia among Muslim firms.

Further, a future study can test stock market reactions in the countries that implemented privatization in the MENA and have an accessible stock market database. We think that a study considering a longer time frame and more firms than that considered here would help corroborate (or refute) our findings in this study. Finally, detailed research can be conducted to check whether the present value of the financial proceeds from privatization in the MENA countries exceed the present value of the possible revenues that could be generated by SOEs and transferred to governments’ budgets, and not to investors, in case SOEs are not privatized.

Conclusions After collecting and analyzing all quantitative and qualitative data, it is difficult to offer one succinct answer to the central research question from the events and observations made of the recent infrastructure privatization in the MENA region. Policy makers in the MENA region need to know the strengths and weaknesses of each of their SOEs, and assess whether privatizing an SOE is the necessary step to be taken toward the goal of value creation. Policy makers should not blindly follow the advice of international organizations and economic advisors because privatization alone is not a magic bullet that can solve the economic problems of the MENA countries. Instead, privatization policy should be viewed as one of contingency where value creation can only exist to the extent that post privatization strategies (e.g., marketing) can be successfully implemented and competition can be encouraged.

18


DOI: 10.2202/1932-9156.1027


REFERENCES

Abdelnour, Z. ‘The Corruption behind Lebanon's Electricity Crisis.’ Middle East Intelligence Bulletin, 2003, 5 (8-9), pp: 14-16.

Alchian, A. Economic Factors at Work. 1977 Indianapolis, IN: The Liberty Fund.

Anderson, S., de Palma, A., and Thisse, J. (1997). ‘Privatization and Efficiency in a Differentiated Industry.’ European Economic Review, 1997, 41(9), pp: 1635-1654.

Beck, T., Cull, R. and A. Jerome. ‘Bank Privatization and Performance: Empirical Evidence from Nigeria.’ Journal of Banking & Finance, 2005, 29 (8/9), pp: 2355-2379.

Boardman, A. and Laurin, C. ‘Factors Affecting the Stock Price Performance of Share Issued Privatizations.’ Applied Economics, 2003, 2 (11), pp: 1451-1464.

Boubakri, N., Cosset, J., and Guedmani, O. ‘Liberalization, Corporate Governance and the Performance of Privatized Firms in Developing Countries.’ Journal of Corporate Finance, 2005, 11(5), pp: 767-790.

Boubakri, N., Cosset, J. ‘The Financial and Operating Performance of Newly Privatized Firms: Evidence from Developing Countries.’ The Journal of Finance, 1998, 8 (3), pp: 1081-1110.

Bradley, M., Jarrell, G., & Kim, H. ‘On the Existence of Optimal Capital Structure: Theory and Evidence.’ Journal of Finance, 1984, 39, pp: 857–878.

Cabanda, E. and Arif, M. ‘Performance Gains through Privatization and Competition of Asian Telecommunications.’ ASEAN Economic Bulletin, 2002, 19(3), pp: 254- 279.

D'Souza, J., Megginson, W., and Nash, R. ‘Effect of Institutional and Firm-Specific Characteristics on Post-Privatization Performance: Evidence from Developed Countries.’ Journal of Corporate Finance, 2002, 11(5), pp: 747-766.

Eckel, C., Eckel, D, and Singa1, V. ‘Privatization and Efficiency: Industry Effects of the Sale of British Airways.’ Journal of Financial Economics, 1997, 43, pp: 275-298.

Frydman, R, Gray, C., Hessel, M., and Rapaczynski, A. ‘When Does Privatization Work? The Impact of Private Ownership on Corporate Performance in the Transition Economies.’ Quarterly Journal of Economics, 1999, 114(4), p: 1153-1191.

Gupta, N. ‘Partial Privatization and Firm Performance.’ The Journal of Finance, 2005, 15(2), pp: 987-1015.

19



Hanousek, J. and Kocenda, E. ‘The Impact of Czech Mass Privatisation of Corporate Governance.’ Journal of Economic Studies, 2007, 30(3/4), pp: 278-294.

La Porta, R., & Lopez-de-Silanes, F. ‘The Benefits of Privatization: Evidence from Mexico.’ Quarterly Journal of Economics, 1997, 114, pp: 1193–1242.

Maail, B., Casson, P., and Napier, C. ‘Social Reporting by Islamic Banks.’ Abacus, 2006, 42, pp: 266-289.

Megginson, W., and Kay, S. ‘Privatization.’ Foreign Policy, 2007, 118, pp: 14-28.

Megginson, W. ‘From State to Market: A Survey of Empirical Studies on Privatization.’ Journal of Economic Literature, 2007, 39(2), pp: 321-389.

Megginson, W., Nash, R., & Randenborgh, M. ‘The Financial and Operating Performance of Newly Privatized Firms: An International Empirical Analysis.’ Journal of Finance, 1994, 9, pp: 403–452.

Omran, M. ‘Performance Consequences of Privatizing Egyptian State-Owned Enterprises: The Effect of Post-Privatization Ownership Structure on Firm Performance.’ Multinational Finance Journal, 2004a, 8(1-2), pp: 73–114.

Omran, M. ‘The Performance of State-Owned Enterprises and Newly Privatized Firms: Does Privatization Really Matter?’ World Development, 2004b, 32(6), pp: 1019-1041.

Road, S. Investing in Egypt. 1997, London: Committee for Middle East Trade. Sanni Yaya H. ‘From State to Market: The Impact of Privatization on the

Performance of State-Owned Enterprises: A Multiple Case Study in Benin.’ Perspective Afrique, 2005, 1, pp: 59-89.

Smith, S., Cin, B., and Vodopivec, M. ‘Privatization Incidence, Ownership Forms, and Firm Performance: Evidence from Solvenia.’ Journal of Comparative Economics, 1997, 25(2), pp: 158 – 180.

Stano, M. ‘Executive Ownership Interests and Corporate Performance.’ Southern Economic Journal, 1975, 42, pp: 272–278.

World Bank. ‘Better Governance for Development in the Middle East and North Africa: Enhancing Inclusiveness and Accountability, 2003. World Bank: Washington, DC.

http://www.zawya.com, last accessed on August 28, 2007.

20


DOI: 10.2202/1932-9156.1027


Privatization and Financial Performance: Can Value Be Created by Privatizing State Owned Enterprises in the Middle East \u0026 North Africa (MENA) Region?

Documents