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3rd ANNUAL INTERNATIONAL BUSINESS RESEARCH FORUM

3rd ANNUAL INTERNATIONAL BUSINESS RESEARCH FORUM

INSTITUTIONS AND INTERNATIONAL BUSINESS

INSTITUTIONS AND INTERNATIONAL BUSINESS

March 22-23, 2002, Temple University, Philadelphia

March 22-23, 2002, Temple University, Philadelphia

The Choice of Public Versus Private Capital Markets: Evidence From

Privatizations

The Choice of Public Versus Private Capital Markets: Evidence From

Privatizations

Jeffry Netter

Annette Poulsen

William Megginson

Robert Nash

Issues Studied by Privatization ResearchIssues Studied by Privatization Research

• How much privatization has actually occurred?

• Why have governments embraced privatization?

• Has privatization improved firm performance?

• How have governments chosen to privatize?

• How do political considerations impact terms of privatizations?

• Privatization impact on stock market development?

• Have investors benefited from SIPs?

• What are the key lessons of privatization?

• Studies surveyed in Megginson and Netter, JEL 2001.

A Brief History Of PrivatizationA Brief History Of Privatization

• FRG’s Adenauer government actually first (1961)

• Small British Petroleum, other sales (1977)

• First Thatcher government (1979-83)

• The Turning Point: British Telecom (Nov 84)

• Chile shows privatization possible in DCs (80-85)

• French Chirac Government (1986-88)

• Privatization spreads to Asia (NTT 1987-88)

• Telefonos de Chile pioneers ADRs (1990)

• Fall of communism CEE; voucher privatization (1991)

• European SDs embrace privatization (since 1993)

• Privatized firms key to European Capital market transformation (1998-2000)

Privatization Proceeds, 1981-2000($US Billions)

Privatization Proceeds, 1981-2000($US Billions)

The Economic Impact of PrivatizationThe Economic Impact of Privatization

• Has significantly reduced State’s role in OECD

– SOEs effectively eliminated from UK economy

– Rapidly shrinking role in Western Europe, Asia

• Transition economies have been transformed

– SOE role cut up to two-thirds in eastern Europe

– Russia privatized, but not commercialized

• Much less change in developing countries

– Little change in Africa, Latin America thru 1991

– Non-OECD Asia has actually increased

– Much has probably happened since 1991

• Little impact thus far in China, India

SOE Share Of GDP, By RegionSOE Share Of GDP, By Region

02

468

101214

1618

Low Income

Lower-middlesIncomeUpper-middle Income

High Income

Why Have Governments Embraced Privatization?

Why Have Governments Embraced Privatization?

• Poor economic performance of SOEs

– State ownership often highly inefficient & politicized

– Chronic under-investment due to PSBR

• Unending need for SOE subsidies

– Up To 10% Of GDP in some countries

– Pervasiveness of soft budget constraints

• Empirical support for private ownership

• Revenue govts can raise from privatization

– Fiscal impact of privatization very positive

• SIPs’ impact on capital market liquidity & capitalization

Governments Use Three Methods To PrivatizeGovernments Use Three Methods To Privatize

• Sale of State Owned Enterprises to the public

• Share Issue Privatization: sale in public capital market to retail and institutional investors

• Asset sale: sale in private market to existing private firm or small group of investors

• Voucher: broad distribution of shares to the public (like SIP) but at very low cost

• Tremendous variation within each type

Which Method To Use?Which Method To Use?

• Governments consider both political and economic factors in selecting divestment method

• Must balance multiple objectives including garnering political support and raising revenue

• Jones, Megginson, Netter, and Nash (1999) and others show how political factors influence the design (and underpricing of SIPs)

• Boycko, Shleifer, Vishny argue that unique environment in Eastern Europe made voucher privatization only feasible method of privatization

Public Or Private Capital Markets?Public Or Private Capital Markets?

• We examine the choice between using a public capital market (SIP) or a private (asset sale) transaction

• Choice helps us understand privatizations and the use of markets

• Also important corporate finance implications for public (capital market) vs private market financing

Choice Between Private and Public Capital Markets

Choice Between Private and Public Capital Markets

• We hypothesize that the choice is a function of three types of economic, political and firm-specific factors

– Market Considerations

– Political and Legal Environment

– Firm-Specific Characteristics

Market ConsiderationsMarket Considerations

• Degree of market development has several potential effects on choice of privatization method

• If primitive, it is difficult for SIP to work -- hard to find buyers, hard to price

• However, privatizations can develop markets

• SIPs create shareholders and make development of the market irreversible

• Income distribution can also affect market choice: The more unequal, the more costly is use public capital markets

Political and Legal EnvironmentPolitical and Legal Environment

• Refers to the degree of legal protection of property rights and shareholder rights

• Government’s protection of property rights (from itself and other parties) and long-term viability of contractual relationships affect choice of market

• Hypothesize that greater respect for property rights and more stability of contracts make it more likely privatization is through an asset sale. It is much more difficult to engage in post-transaction opportunistic behavior with a SIP

Firm-Specific FactorsFirm-Specific Factors

• Characteristics of the firm will affect the choice between public and private capital markets

– Information effects: a well-developed literature

examines the impact of information asymmetries on the choice of how to raise capital

– Expected post-performance of the firm: SIPs are publicly traded and firms; governments very interested in assuring that they perform well after privatization

– SOE’s industry: governments are sensitive to privatizing firms in strategic industries. They may want to exercise control over the buyer.

Data & Empirical AnalysesData & Empirical Analyses

• Sample: 2,447 privatizations, worth $1.19 trillion, from 1977 through 2000

– Privatization International plus World Bank Privatization database (supplemented by contacts with privatization and exchange officials)

– 938 SIPs, worth $745 billion

– 1539 asset sales, worth $445 billion

ExclusionsExclusions

• We do not analyze vouchers or data from communist or formerly communist countries

– Voucher data is very limited

– Theoretically, communist and formerly communist countries are so different they should not be included in regression analysis (See Megginson and Netter (2001))

– Our results are robust if we include the data from the communist and formerly communist countries on SIPs and asset sales

Table 1: Summary StatisticsTable 1: Summary Statistics

Variable Full Sample SIPs Asset Sales

# of Privatizations 2477 938 1539

# Countries 108 78 96

Average (median) % of Enterprise Sold

59.3% (55%)

34.8%

(25%)

74.2%

(90%)

Average (median) amount of offering in U.S. $ million

$480.2

($46)

$794.0

($105)

$288.9

($31)

Average (median) value of total enterprise in US$ million

$2,149.9

($103)

$4625.9

($476)

$640.8

($45.5 M)

Total Value of All Offerings in US$ million

$1,189,480 $744,794 $444,686

Tables 2, 3, 4 – Summary StatisticsTables 2, 3, 4 – Summary Statistics

• We provide details on the sample based on the year of privatization, industry of the SOE, region of the world

• Privatizations increased dramatically in the 1990s:

• Telecoms privatizations are 40.9% of the assets but 7% of the transactions. They are 46% of the value of assets sold through SIPs and 32% of asset sale value

• Utilities and manufacturing, mining and service represent about 20% of the value each

• Western Europe is 55% of the value (29% of number)

• Asia/Australia is 26% of the value (18% of the number)

• South America is 12% of the value (22% of number)

Regression AnalysisRegression Analysis

• For ease of exposition, we place each explanatory variable into one of three categories: market characteristics, political and legal characteristics, firm-specific characteristics

• We estimate logit regression where the dependent variable is 1 if the SOE is privatized through a SIP and 0 through an asset sale

• We perform numerous tests of robustness (various samples, specifications, etc.)

Market CharacteristicsMarket Characteristics

• Considering the importance of the degree of market development and socio-economic conditions

• Turnover ratio (value of shares divided by market capitalization) is the proxy for degree of market development

• GNI (PPP adjusted) per capita proxies for overall development and income

• Gini coefficient measures income distribution: lower numbers more equal income distribution

• Market Index proxies for hot market

Market Characteristics: ResultsMarket Characteristics: Results

• Turnover Ratio coefficient and GNP per capita coefficients are negative; less developed more likely to use SIP. Turnover coefficient sometimes significant, GNP per capita coefficient is always significant

• This is consistent with Subrahamanyam and Titman (1999) that SIPs are used to develop capital markets

• The GINI-coefficient coefficient is significantly negative -- more unequal income less likely to use SIP. This is consistent with Biais and Perotti (2001) that SIPs are more costly when income is more unequal

• Market Index positive and significant – hot market more likely SIP

Political and Legal EnvironmentPolitical and Legal Environment

• There are a host (and more all the time) of variables attempting to measure the political, legal, and cultural characteristics of a country and its legal system.

• We use these to measure:

– the respect for property rights,

– the enforceability of contracts and

– the ability of government to credibly commit to these in the future.

Political and Legal Environment (Continued)Political and Legal Environment (Continued)

• Right Wing government

– higher value, more government respect for property rights

• Stability of government Index

– higher value, more ability to commit, less likely SIP

• Shareholder rights index

– legal protection of minority shareholders

– more shareholder rights, more likely SIP

Political and Legal Environment: ResultsPolitical and Legal Environment: Results

• Note variables are correlated and one must be careful with signs

• Right Wing variable: more respect for property rights, less likely to choose SIP

• Stability of government: insignificant

• Shareholder rights index: never significantly different from zero

• Inclusion of any index does not affect the impact of other variables.

Firm Specific CharacteristicsFirm Specific Characteristics

• Log of firm size– Bigger the firm, the more likely to choose SIP

• Return on Sales of SOE – Governments would choose SIP for most profitable

firms

• Strategic Industry– Governments might be reluctant to sell strategic firm in

public market

Firm Specific Characteristics: ResultsFirm Specific Characteristics: Results

• Log of firm size

– larger firms more likely to use SIP

• Return on Sales of SOE

– higher return on sales more likely to use SIP (relatively few observations however)

• Strategic Industry

– never significant

SummarySummary

• Choice between public and private capital market:

• Governments are more likely to use public market when public market is less developed, and when income is relatively equal

• Right Wing Governments are more likely to use private capital markets

• Governments use public capital markets for the larger and more profitable SOEs

World Stock Market Capitalization, 1983-2000World Stock Market Capitalization, 1983-2000

1983 1986 1989 1992 1995 1999 2000

05

101520253035

Developing Countries

Other Developed

United Kingdom

Japan

United States

$USTrillion

Growth of World Stock Market Trading Volume, 1983-1999 (Value Traded $Bn)Growth of World Stock Market Trading Volume, 1983-1999 (Value Traded $Bn)

Total Value Of Shares Traded, $Bn

Countries 1983 1989 1995 1999

Developed Countries $1,203 $6,297 $9,170 $35,188

United States 797 2,016 5,109 19,993

Japan 231 2,801 1,232 1,892

United Kingdom 43 320 510 3,399

Developing Countries 25 1,171 1,047 2,321

Total World $1,228 $7,468 $10,216 $37,509

Capital Markets Have Grown Enormously--Both Absolutely & As Percent Of GDP

Capital Markets Have Grown Enormously--Both Absolutely & As Percent Of GDP

Stock Mkt Capitalization As % Of GDP

1990 1999

Low Income 10.9% 31.7%

Middle Income 19.4 41.1

High Income 56.4 138.7

France 25.9 103.0

Germany 22.2 67.8

Japan 98.2 104.6

United Kingdom 87.0 203.4

United States 55.1 181.8

World 50.7 119.0

The Largest Share Offerings In Financial History Are All SIPs

The Largest Share Offerings In Financial History Are All SIPs

Nov 87 Nippon Tel & Tel $40.3 bn

Oct 88 Nippon Tel & Tel 22.4

Nov 99 ENEL 18.9

Oct 98 NTT DoCoMo * 18.4

Oct 97 Telecom Italia 15.5

Feb 87 Nippon Tel & Tel * 15.1

Nov 99 Nippon Tel & Tel 15.0

Jun 00 Deutsche Telekom 14.7

Nov 96 Deutsche Telekom * 13.3

Oct 87 British Petroleum 12.4

Nov 97 Telstra * 10.5

SIPs Often The First, Second, And/Or Third Most Valuable In A Nation’s Stock Market

SIPs Often The First, Second, And/Or Third Most Valuable In A Nation’s Stock Market

Country Largest Second ThirdAustralia x xDenmark xFrance x x

Germany xItaly x x xJapan x xNew Zealand xPortugal x x xSpain x xBritain xFinland xHong Kong x

Relative Number of Shareholders Over A Six Year Period After A Share Issue PrivatizationRelative Number of Shareholders Over A Six Year Period After A Share Issue Privatization

0.4

0.6

0.8

1

1.2

1.4

1.6

Year 0 Year +1 Year +2 Year +3 Year +4 Year +5 Year +6

<100,000

All

>100,000

>250,000

>500,0000.6

0.8

1

1.2

0.4

0.6

0.8

1

1.2

1.4

1.6

Year 0 Year +1 Year +2 Year +3 Year +4 Year +5 Year +6 Year +7 Year +8 Year +9

All

<100,000

>100,000

>250,000

Relative Number of Shareholders Of Non-Privatized Companies Over A 9 Year PeriodRelative Number of Shareholders Of Non-

Privatized Companies Over A 9 Year Period

0.8

1

1.2

1.4

1.6