Privatization, financial development, property rights and growth

Accepted Manuscript

Privatization, Financial Development, Property Rights and Growth

Isaac Marcelin, Ike Mathur

PII: S0378-4266(14)00117-4

DOI: http://dx.doi.org/10.1016/j.jbankfin.2014.03.034

Reference: JBF 4408

To appear in: Journal of Banking & Finance

Received Date: 9 September 2013

Accepted Date: 17 March 2014

Please cite this article as: Marcelin, I., Mathur, I., Privatization, Financial Development, Property Rights and Growth,

Journal of Banking & Finance (2014), doi: http://dx.doi.org/10.1016/j.jbankfin.2014.03.034

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http://dx.doi.org/10.1016/j.jbankfin.2014.03.034

http://dx.doi.org/http://dx.doi.org/10.1016/j.jbankfin.2014.03.034

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Isaac Marcelin*

&

Ike Mathur**, a

Abstract

This study analyzes how prevailing institutional arrangements i.e., property rights, contracting rights, political institutions, and corporate governance practices affect privatized firms’ performance, capital markets development, and economic growth. Most of the studies surveyed show that privatization enhances privatized firms performance, efficiency, and profitability, which percolates to economic growth. Privatized firms performed better in countries with better regulatory and legal frameworks. Partial privatization may be beneficial in countries with weak institutions, namely, the French civil law countries. The stronger the economic and the governing institutions, the easier it is for privatized firms to thrive and contribute to economic growth. Overall, privatization allows firms to achieve improved efficiency while driving the development of the financial sector.

JEL Classification: D86, L33, L38, O34, P14, P16, P26, P48

Keywords: Privatization, property rights, contracting rights, financial development, political institutions, law and finance

*Isaac Marcelin, School of Business, Management and Technology, University of Maryland Eastern Shore, Princess Anne, MD 21853, USA; TEL: 1-443-260-9530; FAX: +1-410-651-7719; E-mail: [email protected];

**, a : Corresponding author: Ike Mathur, Department of Finance, Southern Illinois University Carbondale, Carbondale, IL, 62901, USA; Tel: +1-618-581-1613; Fax: +1-618-453-5626; E-mail: [email protected].

Acknowledgements

We would like to thank two anonymous referees; Rexford Abaidoo; Dr Malokele Nanivazo (fellow at the United Nations University – World Institute for Development and Economic Research, UNU-WIDER); Wesley McNeese; LaVern McNeese; Michael Masoner; and Fassil Fanta for many insightful and helpful comments. We bear full responsibility for the views express in this study and any remaining errors.

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Abstract

This study analyzes how prevailing institutional arrangements i.e., property rights, contracting rights, political institutions, and corporate governance practices affect privatized firms’ performance, capital markets development, and economic growth. Most of the studies surveyed show that privatization enhances privatized firms performance, efficiency, and profitability, which percolates to economic growth. Privatized firms performed better in countries with better regulatory and legal frameworks. Partial privatization may be beneficial in countries with weak institutions, namely, the French civil law countries. The stronger the economic and the governing institutions, the easier it is for privatized firms to thrive and contribute to economic growth. Overall, privatization allows firms to achieve improved efficiency while driving the development of the financial sector.

JEL Classification: D86, L33, L38, O34, P14, P16, P26, P48 Keywords: Privatization, property rights, contracting rights, financial development, political institutions, law and finance

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1. IntroductionPrivatization of state-owned enterprises (SOEs), a contentious issue of public policy

debate, has long been topical in policymaking and academic arenas. The extant literature has credited the policy with effectively pushing inward the state’s frontiers while revitalizing and transforming SOEs into driving forces for economic growth and development (Li et al., 2011; Schuster et al., 2013). Privatization has been an integral part of the international polity mix, and a plausible policy prescription for decades (Dahl and Lindblom, 1953; Harvey, 2005; Bjørnskov and Potrafke, 2011). In essence, it deals with diversionary and loss-making SOEs in ways that address many of the underlying issues related to their inefficiency and lack of profitability. Economists are split on whether the state should involve in the provision of goods and services, and when necessary, the limits of such an involvement. As the debate on the merits of state ownership unfolds, this study intends to review the privatization literature from different perspectives including institutions, property rights, growth, and financial development to update the reader on the existing arguments as well as the prevailing empirical evidences.

Legal institutions and level of financial development make privatization through conventional techniques a real challenge (Rapacki, 2001; Harvey, 2005). Political concerns threaten both the freedom of actions granted to the newly-privatized firms and efforts to expand privatization programs (Cragg and Dyck, 1999). As Lopez-de-Silanes (1997) and Borisova and Megginson (2011) advocate for quicker privatization, others find evidence that privatization is a difficult process consisting of staggered sales rather than wholesale of SOEs’ assets or large-scale experiments of social engineering (Gupta, 2005; Fan et al., 2007; Bjørnskov and Potrafke, 2011); and one of the possible hindrances seems to be political and institutional realities (Boubakri et al., 2011; Dinç and Gupta, 2011).

Large amounts of research along with substantive surveys by Domberger and Piggott (1986), Megginson and Netter (2001), Djankov and Murrell (2002), Clarke et al. (2005), Estrin et al. (2009), and Fan et al. (2011) have been produced on privatization, yet results regarding the relation between privatization and firms’ performance and their efficiency do not lead to any definitive conclusion.1 One of the lessons drawn from the existing literature is that privatization, in most cases, at varying degrees, does lead to better performance. Our conjecture is that privatized firms’ performance and contribution to growth vary along institutional and property rights dimensions. Accordingly, this study focuses on the links between privatization and institutions to highlight some additional (specific) institutional features supporting privatized SOEs’ revitalization upon market infused new energy. More specifically, the study centers on institutions, property and contracting rights protection frameworks and how they incubate investments and growth through SOEs privatization; and surveys, though to a lesser extent, the links between the financial sector development and privatization.

With so many developing countries harboring backward institutional infrastructures, and

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1 See also Cavaliere and Scabrosetti (2008)

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privatization being such a multifaceted issue, it is important to analyze the program along several dimensions. These include the extent to which private property rights and contracting rights are safeguarded and their impact on the ability of the newly-privatized firms to restructure in conformity with market principles for greater efficiency and growth. Although there is no one-size-fits-all on the ways to actually make privatization work, the evidence supporting the superior efficiency of the privatized firms, while compelling, has been divided. One important missing link seems to be countries’ ways of doing business, or societal and institutional arrangements for raising large-scale finance (through SOEs privatization), and by extension, uncertainties surrounding financial contracts. Additional and contextual evidences, therefore, are needed before broader judgments can be envisioned.

Property and contracting rights are cross-cutting issues epitomizing a country’s institutional fabric. Bortolotti and Faccio (2009) conclude that the degree to which governments actually reduce their influence on privatized firms depends on the respective country’s legal and governmental systems. The extent to which governments relinquish control over the privatized firms may have broader impacts on the corporate governance regimes thrust upon the newly-privatized firms. Boubakri et al. (2011) assert that political institutions in place, namely, the political system and political constraints, are important determinants of residual state ownership in the newly-privatized firms. It is important to investigate the links between privatized firms’ performance along the dimensions of property rights protection and institutional quality and the implications for economic growth. What is the role played by political, property and contracting rights institutions in privatized firms’ performance? Would SOEs match private firms’ performance under any market structure had governments not interfered with their operations?

These perspectives may add to our understanding of cross-national differences in performances between incumbent SOEs and the newly-privatized firms. To address these issues, this study assembles different bodies of literature, revolving around the institutions hypothesis, maintaining that differences in countries’ economic performance (and by ricochet firms’ performance) are caused by a society’s structural makeup. Claessens and Laeven (2003) put forward that in markets with weak property rights laws, efficient asset allocation may be thwarted as returns on assets are not protected against competitors’ unlawful behavior as well as against predatory states.

Since political firms are predestined for political uses and corporate governance is weak at these firms subject to political interference from politicians, special pressure or interest groups; at root, reducing the influence of the state on these firms through privatization may weaken paternalistic and corrupt practices by public officials, the need for extra-legal payments, and the venues for output and employment decisions supplanted by political rather than economic rationale. Privatization may not only be a remedy for loss-making firms, but also a policy allowing the state to refocus its energy to its core competencies; especially, in many developing countries with large public sector and pervasive corruption. In addition, government’s partial ownership may serve as a tool to monitor managers of the newly-privatized firms in those countries where market corrections mechanisms are weak or nonexistent. With the

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government on the privatized firm’s board, this may be a type of private-public partnership, serving as some sort of guarantee for stakeholders.

The next section begins by examining the topic of privatization in a more general sense. It addresses the question of why private ownership is expected to deliver its produce more efficiently than do SOEs. The third section addresses the theoretical underpinnings of ownership forms. It presents some arguments on property rights protection and institutional quality and their impacts on the privatized firms’ performance. It further discusses some macro-effects of privatization. The fourth section inspects the links between privatization and financial sector development. The fifth section offers new perspectives on the issue of privatization; while the last section concludes with some policy suggestions.

2. Privatization: forms and trends Privatization may take several forms depending upon a country’s initial stage, public

sentiments, leaders’ ideology, depth of financial markets development, type and size of firms slated for privatization, market structures, and goals and objectives set by ruling elites. The many forms of privatization include divestment or the transfer of SOEs’ assets to private sector operators, frequently achieved through assets sales or auctions, spin-offs, liquidations, and reinstatement of the formerly nationalized SOEs into the private domain in accordance to market rules and principles. Privatization can be achieved through delegation or transfer of management and control of an incumbent SOE to the private sector. The new management team, therefore, is subject to market guidelines allowing it to adopt incentive structures and investment priorities that align with the firm’s objective function. It may also be achieved through shifting or via tender, a set of practices whereby the public sector induces private firms to expand into some activities through outsourcing or contracting out key production functions heretofore performed by SOEs.

Among the most popular forms are shares issue privatizations (SIPs), voucher privatization, employee buy-outs, corporatization, and private-public partnerships. Regardless the form retained to implement the policy, it culminates in an expansion of the share of the private sector in the creation of economic value added resulting from managing productive assets in an economy. In the broader sense, privatization is a characteristic of an economy where the number of private firms and the share of the private sector to GDP tend to rise; while the number of SOEs and the share of the public sector in GDP decline as new policies to incubate investments and sustain the growth in private ventures take shape.2 Several theorists3 consent that the state should look to the private sector to undertake the role of providing goods and services that can be produced more efficiently by private firms; and in fact, most view the policy as a positive sum game.

Privatization has been an integral part of the economic agenda of many countries, and there are strong indications that countries that have disengaged the state in direct management of

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2 See Bennett (2001) for a detailed discussion on measurement of privatization and related issues. 3 These include Adam Smith and Milton Friedman.

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SOEs will continue on that path. Revenues from privatization started to rise strongly since in the mid-1990s. Recent trends show that privatization is quite active, with the year of 2007, when 51 developing countries completed privatization deals worth US $132 billion, being particularly buoyant.4 Fig. 1 illustrates that total proceeds from privatization increased manifold by a whopping 173 percent in 2007 from their 2002 level. According to estimates by Megginson and Netter (2001), privatization had already topped over US $1 trillion by mid-1999, with annual proceeds growing steadily before peaking at over US $160 billion in 1997 in developing countries.5

[Insert Fig. 1 here] Comparing cross-national trends in privatization may be difficult due to the numerous

methods of privatization as well as SOEs’ own characteristics such as their intrinsic value. Bennett (2001) observes that actual net proceeds from privatization have often been disappointingly small because of slow program implementation,6 and due to a policy of starting with the smaller, more easily privatized enterprises and also because of the high costs of personnel termination payments, debt relief and consultancy fees. Proceeds from privatization may also be affected by the ability of government officials in charge of reforms to value the firms slated for privatization.

Economic problems, especially public sector indebtedness and mounting budget deficits compel governments to earmark privatization to raise revenues that can be affected to infrastructures, health, education, public safety, and the social safety net with the hope of collecting a stream of tax revenues from the privatized firms. In general, macroeconomic problems (such as slow growth and high degrees of public debt), right-wing parties in government, and the influence of institutions such as the EU and the IMF tend to increase the likelihood of privatization (Schuster et al., 2013). Previously, Harvey (2005) notes that in return for debt rescheduling the IMF and the World Bank require indebted countries to implement institutional reforms such as SOE privatization.

The many goals of privatization are generally concordant with wealth creation, economic efficiency and growth. Among other things, they include: (1) revitalizing inefficient SOEs by introducing market-based governance principles into their operation, (2) reducing the size of the public sector to free-up productive resources for enhanced economic value added both in terms of productive assets and human capital, (3) attaining fiscal stability by directing proceeds from sales of SOEs toward the budget while releasing pressures on governments’ budget, and (4) mobilizing resources, i.e., tap on domestic and foreign sources of finance (financial markets development) to finance investment and growth. Nonetheless, Banerjee and Munger (2004) note that the privatization policy is much more likely a crisis-driven, a last ditch effort to turn the economy around, rather than a carefully chosen policy with explicit long-term goals. The ��

4 From the privatization database by the World Bank: http://data.worldbank.org/data-catalog/privatization-database5 Their estimates include privatization deals from all over the world while ours include only those from developing countries.6 This view is shared by Lopez-de-Silanes (1997).�

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decision to sell SOEs is likely to depend not only on financial factors, but also on political costs and benefits (Dinç and Gupta, 2011).

Although privatization has been commonplace around the world, there remain important pockets of state involvement in producing goods and services. Spanning over banking, insurance, manufacturing, telecommunication, industry, healthcare, infrastructure, utility and other public services, governments continue to own productive assets, assumedly holding back innovation, investments, and economic growth and development. Specifically, Dastidar et al. (2008) point out that many assets slated for privatization remain in government hands mainly because of volatile political environments, a significant hindrance to large-scale privatizations.

3. Ownership theories 3.1. State versus private ownership: the state of an enduring debate�

In the aftermath of the Second World War the state was actively involved in entrepreneurial activities such as supplying certain goods and services, financing key industries through subsidies, and regulating public utility markets in most industrial countries (Schuster et al., 2013). SOEs were then tasked with achieving social welfare objectives and thereby improving on the strictly profit-seeking decisions of private enterprises, especially when monopoly situations or externalities create a divergence between private and social objectives (Shleifer and Vishny, 1994), at which point, SOEs were productively more efficient and constituted a means of curing market failures with pricing policies closer to social marginal costs (Boubakri et al., 2008). Accordingly, arguments for state ownership or control rest on market failure or a perception thereof (Prager, 1992), propelling countries to respond with the creation of SOEs (Atkinson and Stiglitz, 1980; Cook and Kirkpatrick, 1988; Shapiro and Willig, 1990); while privatization, in turn, is a response to the failings of SOEs (Megginson and Netter, 2001).

Over time, however, SOEs’ inefficiency became ostensible, and as a result, the justification for their continued existence has become a wedge issue dividing left- and right-wing governments, chiefly, on the role of government in the economy (Bortolotti and Pinotti, 2008; Bortolotti et al., 2004; Pitlik, 2007; Potrafke, 2010). Whereas right-wing governments have been more active in promoting privatization (Bortolotti et al., 2004; Bortolotti and Pinotti, 2008); leftist governments stuck to public ownership much more strongly (Bjørnskov and Potrafke, 2011). Particularly, Kikeri and Nellis (2004) and Elinder and Jordahl (2013) show that privatization of public services is mainly driven by government ideology and less by efficiency concerns, leading Prager (1992) to postulate that if indeed the private sector can provide efficiently produced goods and services in a broad variety of circumstances and public enterprises cannot or do not, then privatization becomes a goal worth pursuing.

Economists have long expressed their views on contemporary (political) economic restructuring and the role of the state in the provision of goods and services (see Atkinson and Stiglitz, 1980; De Alessi, 1987; Shapiro and Willig, 1990; Shleifer and Vishny, 1994; Jessop, 2002; Kikeri and Nellis 2004; Harvey, 2005; Boubakri et al., 2008; Elinder and Jordahl, 2013; among others). Ideologically, two opposing views on state ownership – the neoliberal and the

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anti-neoliberal – constantly debate over the economics of state ownership.7 Neoliberalism favors markets with minimal public involvements along with greater emphasis on individual choice to achieve economic and social wellbeing. The dominant argument for SOEs privatization is that these entities are victim from the tragedy of commons; as a result, they suffer from a lack of stringent oversight as opposed to their privately-owned counterparts where shareholders take an active role in establishing the framework within which managers exercise their powers to conduct themselves as prudent persons or risk to get fired or potentially face personal liabilities in addition to market corrective actions. The neoliberal economics views most forms of government interventions as interference into the voluntary contractual arrangements between parties (Prager, 1992; Jessop, 2002; Harvey, 2005; Sager, 2011). Shleifer (1998) draws a parallel between state and private ownerships. Empirically, though, if Boubakri et al. (2011) find little evidence that ideology plays a role in the decision to privatize; like Bjørnskov and Potrafke (2011), Obinger et al. (2013) find that political parties significantly shape national privatization trajectories in line with the classic partisan hypothesis; and that secular-conservative parties have pushed for privatization, while left-wing parties were more hesitant in selling-off the “family silver.”

Adherents to neoliberalism maintain that SOEs are inherently inefficient, and the solution to their failure rests in their dismantlement. This suggests that independent of countries’ institutions and governance architectures private firms will always be endowed with superior management along with better resource allocation to outperform SOEs. Naqvi and Kemal (2001) argue that by failing to exploit the best available production technology, SOEs suffer from innate inefficiencies; as a result, privatization tends to substantially increase their efficiency. Several theorists concur that economic liberalization and privatization lead to increased private sector productivity and efficiency; decentralization accompanied by administrative reforms leads to stronger democratic institutions, better governance, and more efficient public sector investment (Dent, 1991; Kohl, 2002; Ogden, 1995; Arnold and Cooper, 1999; Dardot and Laval; 2009; Morales et al., In press); resulted from market driven competition between providers of social services that promotes a better use and allocation of resources for higher economic growth (Riemsdijk, 2010).

Whereas neoliberal economics seeks to promote a sociopolitical project disengaging the state in the production and the provision of most goods and services through privatization, reduced regulation, laissez-faire, economic and exchange rates liberalization (Duménil and Lévy, 2000; Jessop, 2002; Tabb, 2003; Harvey, 2005; Stein, 2008; Merino et al., 2010; Morales et al., 2013); the anti-neoliberal view contends that it behooves the state to turn around large firms to produce at low costs for the public. Tabb (2003) and Harvey (2005) concur that neoliberalism has failed to bring more rapid economic growth, reduce poverty, and make economies more

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7 The superiority of private ownership over public ownership in achieving economic efficiency is manifest in five categories: (1) the firm’s objectives, (2) the firm’s flexibility to achieve its objectives, (3) the firm’s employee incentive schemes, (4) the nature of the firm’s budget constraint, and (5) the role played by the capital market (see Prager, 2001).

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stable, but succeeded in increasing the dominance of transnational corporations, international financiers and sectors of local elites – that is, in constituting and reinforcing a capitalist class.

The main consequence of the neoliberal project is to reinforce, legitimize and naturalize inequality while propping up the elite’s economic status (Merino et al., 2010). Several studies concur that the state focus should be on promoting a social and political framework to build a society of competing entrepreneurs (Foucault, 2004; Stein, 2008); where the latter take responsibility for any achievements or failures as a result of their behaviors as capitalists and risk-takers (Foucault, 2004). Some argue that managers in public firms do not suffer the economic consequences of their decisions, which reduces their incentives to reduce economic waste and maximize profitability (Arocena and Oliveros, 2012).8

Notwithstanding their neoliberal view, Black et al. (2000) lament the massive transfers of ownership from the state to the private sector that have been tarnished with important corporate governance failures ranging from empire building and insider trading (Russia) to excessive tunneling (the Czech Republic).9 Privatization in Latin America, especially of profitable SOEs, was generally unsuccessful at reducing fiscal imbalances (Pinheiro and Schneider, 1995), and did not dramatically improve services or reduce prices (see Bauer and Bowen, 1997; Loftus and McDonald, 2001), namely, in Chile and in Argentina.10

Although the performance of SOEs was seen to exacerbate balance of payments, the debt problems, in developing countries, and became the main targets of the first wave of privatizations that followed (Tan, 2012);�SOEs have been instrumental in spearheading the development and in shaping the industrialization path in many countries, namely in South East Asia. Amsden (1989) and Wade (1990) highlight the significant economic turnaround witnessed by Japan, Korea and Taiwan from the 1960s through 1980s; especially, through a series of traditional industrial policies operating through government interventions. Bjorvatn and Coniglio (2012) show that extensive government intervention is more likely to be successful when the initial level of development is low.11 Factors such as corporate culture, corporate governance, good institutions, low corruption practices and political interference might have played an important role in places where SOEs have been a success.

Boubakri et al. (2013b) find that relinquishment of government control, openness to foreign investment, and improvements in country-level governance institutions are key determining factors of corporate risk-taking in the newly-privatized firms. Kang and Kim (2012) report that privatized SOEs outperform firms controlled by the government. However, partial privatization appears to have a positive effect on corporate governance; non-controlling large

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8 Where property rights refer to the rights of individuals to the use of resources; these rights are established and enforced not only by formal legal rules and the power of the state but also by the social conventions that characterize society (De Alessi, 1987; Harvey, 2005).9 See Black et al. (2000) for a detailed discussion on the issues that have plagued privatization programs in Russia and in the Czech Republic.10 See Haglund (2010) for more details on this discussion. 11 However, the bankruptcy of Bear Stearns, Lehmann Brothers and Merrill Lynch in 2008 have shocked the United States government to undertake dramatic market intervention by the state, and a $700 billion U.S. dollar bailout, that resembles “industrial policy” in many other countries (Choi et al., 2010).

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shareholders of privatized SOEs and private enterprises seems to play active roles in corporate governance; leading proponents of state ownership to evoke the market mix hypothesis argument whereby competition is more relevant than property rights i.e. if SOEs brought the right product to the market at competitive prices they would match the performance of the privately-owned companies (see Sappington and Stiglitz, 1987; Stiglitz, 1994). �

One the main supporters of the market mix view, Stiglitz (1994), contends that the difference between public and private production is overblown. The real difference arises from commitments and incentives, for there are managerial incentives problems in market economies just as in planned economies. Earlier, Sappington and Stiglitz (1987) argue that the important difference between public and private ownership involves the residual rights of intervention. Under SOE, the government retains some authority to intervene directly in the delegated production arrangements and implement major policy changes when deemed necessary to do so; while under private ownership, special rights of intervention are afforded to creditors (in the event of bankruptcy), and to major financial interests. Later, Bozeman and Kingsley (1998) test the view that public sector managers are risk- averse, that risk aversion results in managerial ineffectiveness, and that, incentives should be provided to embolden public managers. �

Among the factors often evoked to explain SOEs’ strategic and managerial shortcomings include a reliance on the exchequer that trumps long run profitability and organizational viability, diverting the organization’s priorities in terms of which customers to target and its decisions on product differentiation, price, distribution, and promotion (Capon, 1981; De Alessi, 1987; EBRD 1995); resulting a slowness to adjust prices (Dobozi, 1993), and a lack of focus on exports, market share, and substantial new investments to deliver large improvements in enterprise performance and growth over the long run (EBRD 1995). Specifically, De Alessi (1987) asserts that SOEs engage in less revenue-increasing price discrimination, adopt fewer service categories and peak-related charges; relate prices less closely to the cost of supplying to different groups of consumers; change prices less frequently in response to larger changes in the relevant economic variables; and have rate structures that favor politically active groups.��

The intellectual argument often employed for these strategies is that they are consistent with these firms’ goal of maximizing social welfare in lieu of profits; especially, in response to market failures in many industries where significant spillovers exist (Sappington and Stiglitz, 1987; Shapiro and Willig, 1990; Laffont and Tirole, 1993; Boycko et al., 1996); while some fear the potential economic repercussions of private decision-making channeled through marketanarchy (Jessop, 2002), driven by the negative effects of creative destruction (Harvey, 2005), subsequent to SOEs privatization.

Kay and Thompson (1986) and Vickers and Yarrow (1991) consider competition as a channel to inject some market energy to achieve economic efficiency in the product markets, namely, through ownership change. Sheng and Haiyan (2002) highlight that Chinese SOEs were suited to early stages of mass production, but with the development of the economy, the problem of SOEs’ low efficiency became apparent; as these firms met with no competition from outside, they offered no rewards inside; as a result, they were characterized by poor management and

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sub-optimal resource allocation. Following their privatization, the Chinese privatized firms were granted natural rights to retained earnings and employees’ compensations. Employees’ interest became aligned to those of the firms, reaching thus their profit targets.

Stiglitz (2003) proposes devising a public system that leads to efficiency of the state sector by (1) benchmarking the competition to provide guidelines about how the public sector should be working, and (2) introducing competition in some parts of the public system to ensure that market mechanisms for efficiency in the public sector are adopted.12 More recently, Tan (2012) points out that the issue of incentives lies at the heart of privatization and is the main focus of property rights theory. By transferring residual control (decision rights) and thus residual returns (profit) to the private owner, clearly designated property rights provide incentives because the decision maker bears the full risks of his or her choices, and receives the residual (profit).

Managers of privately-owned enterprises (POEs) are assumed to have more incentive along with the flexibility to take on risk to create value lest they be removed from their position. Otchere (2009) notes that privatization appears to have encouraged excessive risk taking among privatized banks in developing countries.13 However, Cornett et al. (2010) report that state-owned banks operated less profitably, held less core capital, and had greater credit risk than privately-owned banks.�Previously, Prager (2001) stresses the ability of POEs’ management to take on risk supposes that the incentive structure of the private firm abstracts from the principal-agent conflict; and the role of the capital market presumes not only an effective market for corporate control but specific types of reactions in that market. Nevertheless, Jensen and Meckling (1976) argue that diffuse ownership inhibits shareholders’ control over management; while Sappington and Stiglitz (1987) insist that neither Congressmen nor minority shareholders directly control the daily activities of an enterprise that is, in principle, under their control. As a result, several studies raise some fundamental issues with owners’ ability to monitor management, namely, because of asymmetric information problems involving both types of organizations where managements enjoy significant discretion when negotiating contracts (Hart 1983; Willig 1985; Yarrow 1986; Stiglitz 1993).

3.2. State vs. private ownerships and firms’ performance Employing the social argument as a rationale to SOEs’ existence despite their

performance, public ownership advocates appear to provide an intellectual justification that suits the interests of the ruling elite while perpetuating the status quo ex-ante. While there has been an enduring debate on the merits of government involvement in business enterprises (Kay and Thompson, 1986; Megginson and Netter, 2001); several proponents of state ownership argue that ownership form plays an insignificant role in SOEs’ performance and that private firms hold no

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�In essence, this can be viewed by proponents of privatization that one of the most credible voices for state ownership has recognized the superiority of POEs’ management and/or market guided managerial principles.�13 Privatized firms are subject to other market instruments such as hostile takeovers, analyst following, rating agencies, short selling, and proxy fights that are quite effective at sanctioning poor performing privately-owned firms feed the excessive risk taking behaviors.

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inherent managerial advantage on SOEs for unwieldy bureaucracies characterize both forms of organizations (Vernon-Wortzel and Wortzel, 1989; Stiglitz, 1994). Still, there is ample evidence of enhancements in post-privatization productivity, performance, and profitability (Claessens and Djankov, 2002; Dong et al., 2006; Goldeng et al., 2008; Schmitz Jr. and Teixeira; 2008); and many studies explicitly document that privatized firms outperform their SOEs counterparts (Boardman and Vining, 1989; Boycko et al., 1996; Majumdar, 1996; Dewenter and Malatesta, 2001).

A survey by Shirley and Walsh (2000) reveals that only five out of fifty-two studies reviewed report that SOEs outperform their POEs counterparts, while thirty-two document superior performance of POEs, and fifteen studies fail to observe significant differences in performance levels between the two groups of firms. Similarly, Megginson and Sutter (2006) survey the literature on privatized firms’ performance in developing countries and report that most of the studies in their review find that privatization yields improvements in the operating and financial performance of divested firms, while only a handful document outright performance declines after privatization.

[Insert Table 1 here] In spite of the many drawbacks from numerous privatization experiences, Table 1 suggests that adherence to the state ownership view on the basis that SOEs can match the performance of POEs or the newly-privatized firms is at odds with existing evidences. The relationship between ownership and performance has received tremendous attention in academic research. Recently, Huang and Wang (2011), for a sample of 127 firms, show that firm’s performance improved significantly following government total ownership relinquishment. Among the arguments for SOEs’ continued existence include the need to curb high unemployment, (Shleifer, 1998); promote regional development (Kohl, 2002); and to exert control in some key sectors with natural resources (Grout and Stevens, 2003).

Explaining why performance between POEs and SOEs may differ, public economists evoke overstaffing (Boycko et al., 1996); differences in skills sets (Barberis et al., 1996); political constraints (Mar and Young, 2001); and agency problems i.e. separation of ownership and control (Arocena and Oliveros, 2012).14 In particular, Shleifer, (1998) insists that private ownership should generally be preferred to SOE when the incentive to innovate and to contain costs is strong with ownership being the source for capitalist incentives to innovate. A series of studies by Andrews and Dowling (1998), Boycko et al. (1996) and Djankov and Murrell (2002) concur that where SOEs deviate from profit-maximizing behavior, their economic performance is likely to be inferior to that of their POEs counterparts.

Boardman and Vining (1989) affirm that management of POEs is superior to that of SOEs.15 Vernon-Wortzel and Wortzel (1989) emphasize that the problem of SOEs is not ��

14 In addition to individual and organizational incentives evoked earlier by (Stiglitz, 1988; Prager, 1992; Shleifer, 1998; Cragg, 1999) 15 These authors raise skepticism that market mechanisms operating through private ownership, takeover threats, realign the performance of privatized firms.

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ownership, rather a lack of explicit goals and objectives fitting an appropriate organizational culture and system supporting and encouraging their fulfillment; and while in some circumstances, privatization, through the culture and system it promotes, may help in reaching an enterprise’s goals and objectives, may fail to do so in other cases. More intriguingly, looking at the role of markets as allocator of financial and economic resources, Prager (1992) maintains that when examining the effect of privatization in LDCs, investigators need to question whether it is the public sector or the market that has failed.

Despite abundant evidence of superior performance of private firms over SOEs, a consensus has yet to emerge on whether SOEs underperform POEs.16 SOEs might have fared better in impact evaluations had research in the field taken into account some of their societal role such as services provided to underserved communities in the provision of public goods with far-reaching impacts on the broader economy. Most research on the performance of the formerly SOEs use only traditional measures such as returns on equity (ROE), returns on assets (ROA),cost-effectiveness, and employee-output ratio, returns on sales (ROS), Tobin’s q, with, quite often, difficulty to reconcile many other performance yardsticks across firms and industries (see Wei and Varela, 2003; Alexandre and Charreaux, 2004; Laura and Silvia 2007; Mathur and Banchuenvijit, 2007; Cook and Uchida, 2008; Goldeng et al., 2008; Omran, 2009; Mrad and Hallara, 2012).17

Several studies (Caves and Christensen, 1980; Martin and Parker, 1995; Boubakri and Cosset, 1998; Alexandre and Charreaux, 2004) fail to find any evidence of SOEs being subpar efficient. Contrary, Knyazeva et al. (2013) report negative short term effects of privatization, which, however, disappear in the long run. Earlier, Ochere (2005) reports that privatized banks underperform their rivals over the long run. Many studies, however, document improvements in privatized firms’ performance (Megginson et al., 1994; Boubakri and Cosset, 1998; D’Souza and Megginson, 1999; Bortolotti et al., 2001; Gupta, 2005; Mathur and Banchuenvijit, 2007; Goldeng et al., 2008; Estrin et al., 2009; Dinç and Gupta, 2011; Fan et al., 2011; Mrad and Hallara, 2012).

Alexandre and Charreaux (2004) look at the efficiency of French privatization and analyze it in light of corporate governance theory, and find no evidence of the positive effect on efficiency often attributed to the privatized French firms. They argue that whatever positive value accrues from privatization is affected by the contextual, organizational, governance, and strategic variables that influence the privatization process. They further assert that, on the one hand, in certain firms, there is a restructuring prior to privatization, such as an equity issue or a downsizing;18 while, on the other hand, the effects of privatization might take a long time to occur; and the improvement in performance reflects the changes in the corporate governance

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16 See Shirley and Walsh (2000) and Table 1 17 Shirley and Walsh (2000) provide a list of early studies on privatized firms’ performance as well as performance measures and methods of evaluation. 18 Woodruff (2004) reports that in Poland, negotiation among potential shareholders and current enterprise stakeholders preceded privatization, whereas in Russia privatization procedures pitted these same groups against one another.

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system, the reconfiguration of the organizational architecture, and the implementation of a new strategy. Developing these systems or implementing these strategies can take time, often more than three years, because of the organization’s inertia. They confirm that privatization has a favorable effect on the performance for only a very small minority of the privatized French firms. Often, the effect is not significant, and of those results that are significant, about as many involve a loss of efficiency as the contrary. From that perspective, analyzing the scope and the effects of these reforms in the Chinese context, Aivazian et al. (2005) argue that they significantly boost SOEs’ performance and are a credible alternative to the privatization policy.

Bernier (2011) emphasizes that ownership is only one element of a complex system of relations between an SOE and its institutional environment where the role of the board of directors, the mechanisms of coordination, the role of senior civil servants, etc. come to play. Naqvi and Kemal (2001) add that there is no assurance, on a priori grounds, that the existing pattern of resource allocation will become any more efficient by merely privatizing SOEs’ assets. The authors insist that the locus of ownership of productive assets – i.e. whether public or private enterprise – is not a decisive factor in determining their rates of return. Even if SOEs’ inefficiency may be welfare enhancing (Cato, 2012), and privatization insufficient for improving firms’ productivity (Boubakri and Cosset 1998; Asaftei et al., 2008); in an earlier study, though, Boycko et al. (1994) emphasize that when properly structured, privatization may achieve the expected economic results independent of privatization methods and political influences.

Specifically, Boubakri and Cosset (1998) compare performance changes three-years before and three-years after privatization and find no evidence that privatization itself can improve performance of the formerly SOEs.19 A number of studies are inconclusive on whether there are improvements in performance following privatization (Megginson and Netter, 2001;�Djankov and Murrell, 2002; Harper, 2002; Omran, 2004; Megginson, 2005; Boubakri et al., 2005b; Otchere, 2005; D’Souza et al., 2005; Estrin et al., 2009). To these conflicting results in the extant literature, Shirley and Walsh (2000) and Megginson and Netter (2001) ascribe methodological, choice of empirical context, differences in measurement, and sampling problems. Specific issues have been raised in some studies on the performance of the privatized firms. Contrary to Bennett’s (2001) observation, many studies contend that: (1) better performing public entities and segments are more likely to be slated for privatization, leaving less efficient SOEs and loss-making segments in the state hands; and (2) successful privatizations are usually used as examples when promoting the policy (Bozec, et al, 2006; Estache and Fay, 2007; Tan, 2012; Knyazeva et al., 2013).

The factors driving privatized firms’ performance may also vary by level of economic development.20 A wide range of indicators affecting post-privatization firms’ performance has been identified in the existing literature with some similarities and differences across the economic development spectrum. Using a sample of 79 firms from 21 developing countries that

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19See D’Souza and Megginson (1999), and D’Souza et al., (2001) for more discussions on privatized firms’ performance.20 We are thankful to an anonymous reviewer to have raised this issue.

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have experienced full or partial privatization, over the period 1980 to 1992, Boubakri and Cosset (1998) attribute improvements in privatized firms’ performance to both full and partial privatizations, as well as stock market thickness. Other underlying factors driving the performance of the privatized firms in the developing world include foreign ownership (Bonin et al., 2005; Naceur et al., 2007); and polity and institutions (Fergusson, 2006). In addition, using a sample of 81 banks in 22 developing countries, Boubakri et al. (2005) identify type of owner, risk exposure and capitalization; while Megginson and Sutter (2006) argue regulated industries, restructuration after privatization, and shareholders’ protection; using a sample of 2164 privatized Polish cooperatives, Amess and Roberts (2007) point to governance and incentive mechanisms; and Li et al. (2007) argue managerial ownership. Also, Omran (2007) highlights greater government transfer of control for a sample of 12 Egyptian banks from 1996 to 1999; and more recently, Tsamenyi et al. (2010) point to changes in the accounting and control systems for two Ghanaian firms; while Cull and Spreng (2011) report a reduction of services to disadvantaged groups for 42 Tanzanian banks between 1998 and 2006.

The main drivers of privatized firms’ performance in developed countries include management tenure and internal control (Cragg and Dyck, 1999) for a sample of 112 state-owned, privatized, and publicly traded firms in the United Kingdom from 1970 to 1994; in Russia and in Spain, Filatotchev et al. (2001) and Cabeza-García and Gómez-Ansón (2011) point to higher ownership concentration in the hands of private investors; D’Souza et al. (2005) signal ownership structure for a sample of 129 share-issue privatizations from 23 developed (OECD) countries; IPO underpricing involving 6 IPOs and 16 SEOs for 22 issues in Spain (Farinós et al. (2007); market structure, corporate governance reforms along with incentives and compensation structures for privatized firms in the U.K. and in Norway, respectively (Cragg and Dyck, 2003; Goldeng et al., 2008); foreign ownership and country-level governance using a sample of 381 firms privatized from 26 emerging21 markets and 31 developed economies (Boubakri et al., 2013b); property rights and contracting rights protections (Knyazeva et al., 2013); while Sawada (2013) underlines higher risk taking using a sample of Japanese banks.

3.3. Ownership change, performance and growth While the literature is divided on the performance of the newly-privatized firms, Fig. 2

shows that, at the macro level, privatization is positively related to growth in industry value added. This suggests an increase in aggregate efficiency associated with privatization. Improvements in performance across many efficiency variables have been reported in several studies in the growing literature�(Boubakri and Bouslimi, 2010; Arocena and Oliveros, 2012).Although Alexandre and Charreaux (2004) question the methodology implemented in Boubakri and Cosset (1998), Boubakri et al. (2005b)�and Megginson et al. (1994) consisting of comparing performance before-and-after privatization (over 3-year periods), arguing that this method implicitly assumes that the influence of privatization occurs promptly, and that there is a rupture

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21 These include upper middle income countries

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or a shock leading to a relatively fast recovery of the firm’s performance, and that privatization is that rupture, there is tremendous support for the claim that privatized SOEs outperform their incumbent SOEs counterparts;22 Shirley and Walsh (2000), Mathur and Banchuenvijit (2007) and Jiang et al. (2009) confirm that the estimated increase in efficiency resulting from privatization stems from a greater focus by private owners on profit maximization as compared to governments, less inclined toward profits but the welfare of society at large.23

[Insert Fig. 2 here] These patterns of efficiency may have been picked up in growth in industry value added

as depicted in Fig. 2., which fits the larger scheme of economic growth highlighted in a series of academic research (D’Souza and Megginson, 1999; Megginson and Netter, 2001; Djankov and Murrell, 2002; and Boubakri et al., 2004; Boardman et al., 2013) who show that privatization generally improves profitability and productivity with implications for economic growth.24

Methods of privatization, especially voucher privatization, have been instrumental to economic growth in many transition economies due, in part, to the speed with which the links between firms and the state were severed (Bennett et al., 2007).25

Guedhami and Pittman (2011) find that SIP typically generates important spillover economic benefits. Cabeza-García and Gómez-Ansón (2011) report a positive relationship between FDI and privatization proceeds, market value of SIPs, and the proportion of SIPs in privatization transactions. SIPs appear to be instrumental in raising large scale finances for investments and growth. More recently, Saffar (In press) finds that the political system’s type, tenure, and cohesion explain the choice between privatizing with SIP or asset sale for 3,266 privatization deals from 100 countries over 1977-2006. Increases in productivity should deliver higher living standards (Harvey, 2005), and despite its controversial character, privatization has been credited with raising economic prosperity (Li et al., 2011), as private enterprise and entrepreneurial are mostly seen as keys to innovation and wealth creation.

Adams and Mengistu (2008) and Cook and Uchida (2003) find that privatization does not have any impact on economic growth. Specifically, Adams and Mengistu (2008) use a sample of 82 developing countries while Cook and Uchida (2003) analyze a sample of 63 developing countries. The former authors argue that country specific characteristics are more important in promoting growth than privatization per se; on the contrary, the latter maintain that privatization may have an adverse effect on growth, and for privatization to positively affect growth, regulatory reforms and effective competition are necessary. Kotz (2006) argues that compounded

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22 See Table 1 23 Prager (2001) recognizes that the POE shuns inefficiencies that reduce profits, since any increase in costs implies lower profits but the SOE, on the other hand, may be charged with profitability as one of its goals but is likely to be mandated to meet social and political goals as well. 24 Subrahmanyan and Titman (1999) suggest that privatization promotes efficient capital markets spurring economic growth.25 Lopez-de-Silanes (1997) studies the Mexican privatization program and finds that auctions net prices are low (54 cts/$) because (1) of prices sensitivity to auctions’ competitivity/limited participation; (2) lengthy privatization process is associated with lower premiums; (3)firms' prior restructuring measures absorb, on average, 33 cts/$.�

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with deregulation, privatization leads to suboptimal outcome both socially and economically. Contrary, Boubakri et al. (2005a) find that higher economic growth is associated with control relinquishment by the government, and foreign ownership significantly drives changes in profitability; privatization significantly drives efficiency, investment, and output; while yielding better results when stock market and trade liberalizations precede it.

Claessens and Djankov (2002) point to weaknesses in SOEs’ financial and economic performances in developing countries, where SOEs are more likely to add to the fiscal burdens. Chang and Grabel (2004) emphasize that government borrowing that was necessary to sustain SOEs in many countries contributed to the debt crisis of the 1980s. Opening with several striking facts, a key report on SOEs by the World Bank states that in Tanzania, central government subsidies to SOEs respectively account for 72 and 150 percent of central government spending on education and health. In Egypt, Peru, Senegal and Turkey, a mere 5 percent reduction in SOE operating costs would reduce the fiscal deficit by about one-third (World Bank 1995; see Chang and Grabel, 2004). Adhikari and Kirkpatrick (2002) argue that SOEs have been major borrowers in domestic and in foreign credit markets. When governments guarantee SOEs’ debts, if the financial performance of these firms deteriorates, this may have serious ramifications for governments’ budget.

Friedman (1993) argues that governments usually undertake economic activities desirable and crucial for improving quality of life when the need arises. When these activities become unprofitable or market forces, and needs for capital and technology threaten an SOE’s existence, the government is left with few options: Privatizing or finding another justification for a continued existence. Usually, to keep a failing private company afloat, investors have to draw from personal wealth; while a failing SOE has the government’s teats, through taxpayers, for its sustenance. In other words, a failing SOE, devoid of financial slack, has the government, which might assume the role of lender of last resort or face some political backlashes. When a private enterprise fails, it is a symptom of mismanagement, and such a firm has to file for bankruptcy, and eventually liquidate its assets unless rescued or bailed-out by the public sector. Advocates of private ownership may question whether people really have a voice in the SOEs; especially, in countries with extractive state apparatus. In such settings, state operated firms’ management will likely involve self-dealing due to lack of personal liability for directors breaching their fiduciary duty so long as they advance the agenda of their political clans. Shirley and Walsh (2000) argue that even well-intentioned governments may be unable to assure that SOE managers do their bidding despite what corporate governance theories suggest�

Low public sector performance drive SOEs’ losses as a result of inefficiency and mispricing that compounded with underinvestment, which tend to benefit the middle class at the expanse of the poor (Kessides, 2004; World Bank, 1994). As these firms become financially weak, this leads to chronic underinvestment and deterioration in service quality (World Bank, 1994). The most important determinants for economic stabilization and development in Bulgaria continue to include further acceleration of privatization and abolishment of monopolies, thus providing a well-functioning market economy to attract further foreign investments (Bitzenis,

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2003). Bennett et al. (2007) show that mass privatization contributes to higher investments and growth and is more likely to be chosen if the government is politically weak.

Although, Huang et al. (2010) conclude that the contribution of SOEs to economic growth in China, as detected in their sample, was not significantly different from that of POEs, others suggest that corruption may harm economic growth because it favors the state sector at the expense of the private sector and that improving the quality of local public governance can help to mitigate corruption and stimulate economic growth (Nguyen and van Dijk, 2012). Overall, this body of evidence suggests that better institutions along with government relinquishment of ownership allow market-led forces to coalesce to boost efficiency, investments, and economic growth.

3.4. State ownership, politic, and firms’ performance Research on corporate governance suggests that SOEs operate under political influence,

and this has a negative effect on these firms’ performance. To palliate the political effects on SOEs and depoliticize decision-making, the state must make a political decision26 (Vickers and Yarrow, 1991; Laffont, 2005; Martimort and Straub, 2009). Economists and political scientists have extensively studied the determinants of privatization as well as the forces impeding SOEs’ ability to efficiently use their assets and optimally allocate their resources (Bortolotti et al., 2004; Brune et al., 2004; Zohlnhöfer et al., 2008; Biais and Perotti, 2002; Perotti, 1995; Schmitt and Obinger, 2011; Schmitt, In press). The dominant trend suggests that political interferences in SOEs’ operations influence output targets, employment and price levels, and this may compromise these firms’ long term survival absent government’s subsidies at the expanse of investment and growth. In fact, Dinç and Gupta (2011) underscore that while the benefits of privatization, such as revenues from sale, financial market development, and efficiency gains, tend to be dispersed across the population, the costs of privatization, such as layoffs of surplus workforce and the loss of private benefits of control for politicians, tend to be concentrated among a small group. Shleifer and Visnhy (1994) and Boycko et al. (1996) agree that political interventions in favor of employments may trump competition and firms’ efficiency.

In addition to Shleifer and Vishny (1994) indicating that SOEs are more susceptible to pressure by interest groups, Berglof and Roland (1998) concur that SOEs are effective channels of redistribution for political dividends. There is consensus that SOEs tend to answer to political masters instead of market rationales (see Shleifer and Vishny, 1994; Clarke and Cull, 2002; Harper, 2002; La Porta et al., 2002; Cragg and Dyck, 2003; Megginson et al., 2004; Boehmer et al., 2005; Potrafke, 2010; Boubakri et al., 2011; Sager, 2011; among others). Consequently, wide divergences from profit-maximizing behaviors are not only possible, but also sometimes tactical through misappropriation of SOEs’ resources to advance some political agenda, oftentimes populist and inimical to growth. In countries with subpar institutions, e.g., SOEs might underperform because they are not only predestinated to pursue some sociopolitical agenda but also because they are at the frontline of ruling elites’ political survival. Whereas Harper (2002)

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26 Relinquish its stakes in the public firms

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suggests that stable environments both political and economic help privatized firms restructure and improve operating performance to attract foreign investors and capital even in less developed countries, Huang et al. (2010) underscore that SOEs help maintain social stability, which supports the development of non-state sectors through a positive externality.

Absent effective and stable institutions such as independent and well-functioning courts and a productive and politically-balanced Congress, it is difficult to presume that the political directorate will efficiently redeploy SOEs’ assets without political opprobrium. Government ownership is a tool to achieving political objectives through the provision of employment and subsidies to supporters in return for political contributions and votes (Shleifer and Vishny, 1994); it facilitates the pursuit of power and prestige, rather than the general interest and the efficiency of decision-making (Arocena and Oliveros, 2012). Previously, however, Bitzenis (2003) highlights that privatization is an alternative way of distributing and choosing means of generating wealth, so it may also be considered as a distribution of political and economic power over the long run.

To survive, private enterprises must respond to market signals. SOEs’ managers, on the other hand, are less constrained by market principles, finding it easier to obtain subsidies and mask their utility-maximizing behavior under the guise of fulfilling other social goals (De Alessi, 1987). SOEs with managers that are politically entrenched may succumb if they incur long run losses as managers have less incentive to tailor output and prices to cover their costs (on par with their competitors). Insofar, political firms across the industry spectrum appear to be less inclined toward revenue-increasing and marketing strategies matching the competition they face.�It is noteworthy that the principal argument for privatization is that profit orientation will raise firm efficiency and competitiveness (Brown et al., 2006).

Boehmer et al. (2005) and Clarke and Cull (2002) contend that politicians choose to privatize only when the political benefits of privatization outweigh the political costs. Otchere (2005) points out that economic restructuring generates a high degree of political instability because of the uncertainties associated with the transition from state apparatus to market-based economies. Swee-sum et al. (2007) note that while there are uncertainties associated with changes this does not suggest that opponents of privatization have a natural proclivity toward the status quo; rather, they might just be reluctant because they are afraid of the outcomes of the unknown. Consequently, if privatization does not lead to significant improvements in the living standard of the populations, this may catalyze the resurgence of hard-liners calling for renationalization.

3.3. Privatization and institutional quality Contrary to Alexandre and Charreaux (2004) who find a loss of efficiency for the

privatized French firms, Mrad and Hallara (2012) study the French privatization program with respect to residual government ownership, performance, and value creation. Their result have important implications on whether the state should transfer total control of the newly privatized firms; the consequences of such a transfer for these firms performance; the legal and institutional

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contexts in which state residual ownership is beneficial; and the alternative to outright privatization.27 Wei et al. (2005) attribute the counter-performance of the Chinese privatized firms the lack of property rights market and well-functioning legal framework. Previously, Black et al. (2000) suggest developing the institutions to control self-dealing is central to successful privatization of large firms.

Specifically, Mrad and Hallara (2012) show that very high levels of government ownership are associated with an increase in performance and value creation within the privatized firms, while low levels of this ownership are associated with a decrease in performance and value creation. Anderson et al. (2007) also find a positive effect of residual government ownership on the newly-privatized firms’ efficiency for a Mongolian sample – an effect their attribute to a weak institutional environment. In addition, a study by Gupta (2005) examines the impact of partial privatization of Indian SOEs where the state remained the controlling owner after privatization, and finds that partial privatization had a positive impact on profitability, productivity, and investment, arguing that the stock market can perform an important role in monitoring and rewarding managerial performance even when the state remains the controlling owner.

Other investigations, nonetheless, evidence that performance is negatively related to the government’s continued role in the firms and many countries proceed with their privatization in stages (Fan et al., 2007).28 Boubakri et al. (2013b) suggest that relinquishment of government control, openness to foreign investment, and improvement of country-level governance institutions are key determining factors of corporate risk-taking in newly privatized firms. Earlier, Boubakri et al. (2011) underscore that political institutions in place, namely, the political system and political constraints, are important determinants of residual state ownership in newly privatized firms. Still, it seems that government residual control may counter-balance institutional deficiencies for better performance outcomes in the newly privatized firms.

Bortolotti and Faccio (2009) report that in civil law countries e.g. governments tend to retain large ownership positions, while in common law countries they typically use golden shares. These results, along with (Gupta, 2005; Anderson et al., 2007; Mrad and Hallara, 2012), at their core, are quite puzzling given the amount of evidence on post-privatization improvements subsequent to government complete transfer of state ownership. Likewise, Tan (2012) argues that in the absence of competition, regulation, rather than ownership structure, is central to successful privatization, while Arocena and Oliveros (2012) maintain that transferring

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�Acemoglu et al. (2001) document the effects of institutions on countries’ economic performance and argue that in some colonies settlers managed to set up neo-European institutions with emphasis on protection of property rights and checks-and-balances against governments’ predatory and extortionary comportments; whereas in other places they created extractive states with a legacy of transferring resources from the colonies to their mainland. Those extractive states did not produce institutions protecting private property rights; and today’s institutions reflect those early institutions with implications for property and contracting rights.�28 However, Tan (2012) argues that by transferring residual control (decision rights) and thus residual returns (profit) to the private owner, clearly designated property rights provide incentives because the decision maker bears the full risks of his or her choices, and receives the residual (profit).

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SOEs to private hands eliminates the inefficiency traditionally attributed to public ownership and management.

Assessing the success of the institutional measures that have been pushed through to govern economic reforms across countries may be challenging. Some investigations reveal that privatized firms perform better in environments with strong property rights protection and low level of corruption (Clarke and Xu, 2004; Buia and Molinari, 2012). Fergusson (2006) notes that institutions, namely, rule of law, the degree of property rights enforcement as well as the constraints on the actions of powerful groups (including the state), generate incentives and opportunities for investment and can therefore spur or hinder economic growth. Kotz (2006) argues that a number of countries that undertook major privatization programs did not gain the benefits that had been promised due to serious economic and social problems subsequent to mass privatization; chiefly because of corruption, increased criminal activities coupled with theft of assets from formerly public enterprises, mass layoffs of workers, growing inequality, and disappointing performance by privatized enterprises.

Kelegama (2001) points to the Sri Lankan case typifying that in a weak regulatory and legal framework with low institutional capacity, poorly managed and badly conceived privatizations can compound the problems; and with weaker economic and governing institutions, it becomes more difficult for privatization to yield benefits. The author stresses the advantages of creating the right policy as well as strong legal and institutional frameworks as illustrated by the cases of Chile and Mexico where legal reforms attracted well-known private investors and ensured that privatization expanded competition and productive efficiency, rather than simply transferring rents from SOEs to private owners. Boubakri et al. (2005b) find that private investors are more inclined to hold larger stakes of firms in more stable political and social environments. They also find that investor protection and social and political stability explain cross-firm differences in ownership concentration, which might serve as a force to defend their rights in the face of political and legal uncertainties. In fact, lower levels of political risk and friendly institutional environments are significantly related to improvements in post-privatization performance (Boubakri et al., 2004).��

[Insert Fig. 3 here] Fig. 3 illustrates that privatization is not only positively related to growth but the

correlation is stronger in countries with better institutions. While privatization is positively related to growth in common law and in countries with socialist legal heritage, the association is weak and negative in French civil law countries. Fig. 3 along with results in Gupta (2005), Anderson et al. (2007), Bortolotti and Faccio (2009), Boubakri et al. (2011), and�Mrad and Hallara (2012) imply that in countries with weak property rights protection and poor institutions it may be beneficial for policymakers to proceed with partial privatization as market disciplines and institutions related to effective corporate governance may be either weak or nonexistent. Government membership on the privatized firms’ board (a form of private-public partnership) may serve as a type of guarantee for all stakeholders. Tanzi and Schuknecht (1997) expect

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positive welfare and growth effects of reducing the reach of the government in the economy in the long run, especially when reforms are “well-conceived.” Well-designed and implemented privatization programs go hand-in-hand with good institutions and lower corruption practices, a pattern likely to be observed in common law countries.

Fig. 3 fits the larger picture in the law and finance theory that common law heritage affords better institutions than does civil law with the former being more pro-growth and suitable for economic development. Firms in countries with lower political risk should exhibit better performance since the government refrains from reversing the privatization policy and interfering in the activities of the firm (Perotti and Oijen, 2001). When privatized firms are well managed and are noticeably economically transforming and expanding by increasing their share of GDP, it may be a step towards stabilizing a country, for, in some way, economic progress has the potential to ensure some level of democratic, human and political rights as well as political stability and social cohesion by averting social decay and political chaos.29

3.4. Privatization, property rights and contracting rights: a view Privatization, together with the institution of a strong legal base for protecting private

ownership, paved the way for the rapid emergence of private enterprise (Bennett, 2001). Disbanding the state ownership alone may not lead to the hoped-for results because in countries with fragile political institutions, powerful groups may get the upper-hand on the privatization process and embark on asset stripping in lieu of credibly restructuring SOEs as well as efficiently redeploying their assets. Sun and Tong (2003) underline that in the absence of a well-functioning property rights market, privatization can result in the transfer of public assets to private agents who do not use them any more efficiently than under the state ownership.

Weak property rights institutions coupled with unsophisticated financial markets may worsen assets’ stripping problems as SOEs’ sales would fetch prices well below their intrinsic values. Bjorvatn and Sbreide (2005) describe how corruption may affect the outcome of a privatization process both in terms of acquisition price and post-privatization market structure and therefore economic efficiency. Kelegama (2001) reports that in Sri Lanka an SOE valued at US $100 million was sold at only US $7 million on the ground that the government only wanted to get the privatization policy itself moving. Bennett (2001) warns that if the rate of privatization is forced beyond the institutional and professional capacity of a country, it is unlikely that it will result in the intended benefits. In Russia, e.g., privatization “auctions” were a giveaway of the most important companies at bargain prices to a few well connected “kleptocrats,” who got the funds to buy these companies by skimming from the government and transferred their skimming talents to the enterprises they acquired (Black et al., 2000; Shirley and Walsh, 2000). Bitzenis (2003) signals that the former Bulgarian authorities were determined to obtain ownership of

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29On Saturday November 12, 2011 the Italian parliament approves a restructuring package to save the country from economic collapse, which involves pension reform, which increases the retirement age from 65 to 67, the privatization and sale of SOEs’ properties, the liberalization of certain professions, and investment in infrastructure.

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state-owned property for themselves (or friends) at preferential prices and without public auction.

The market economy requires some body of laws governing contracts for efficient asset allocation.30 The law and finance theory, popularized by La Porta et al. (1998), maintains that the common law legal heritage is friendlier to private property rights as it recognizes that certain kind of contracts between transacting parties are enforceable through the judicial system regardless of their degree of formalism, and their non-observance bears costs to infringing parties. The theory holds that, unlike in common law countries contracting with the state involves much risk in French civil law countries. Protection of property rights and contracting rights is weaker in French civil law countries than in common law countries (Acemoglu and Johnson, 2005; Fernandes and Kraay, 2007; Marcelin and Mathur, 2014).

Property rights are a set of legal rights relating to individuals and/or institutions and their possession of assets (Claessens and Laeven, 2003; Marcelin and Mathur, 2014). They are integral components of any social system, for they are associated with rights of ownership of goods as the community, along with the state, recognizes one’s prerogatives to enjoy the benefits of ownership and exclude others from exercising those rights without fear of ownership risk. Ownership and property rights provide the intellectual justification for the privatization of the formerly SOEs on the premise that POEs can result in an efficient economy; yet they are never absolute, since the exercise of control over property may harm individual or social interests and so property rights typically have certain limits (Kotz, 2006). Confirming Kotz’ (2006) view, a study on the water privatization in Bolivia by Hailu et al. (2012) documents that access to water by low-income consumers increased under private provision, but the concessionaire failed to meet the targets stipulated in the contract. As a result, the tariff increases required for full cost recovery, which eventually led to public outrage that forced the government to renationalize the company.

Earlier, Demsetz (1967) emphasizes that the role of property rights in social systems is to help people form expectations when dealing with each other. Interactions between transacting parties need to be regulated within a legal setting, i.e., in congruence with Demsetz’ view, property rights are first recognized and then enforced within a judicial system to influence efficient asset allocation. Such a legal system should be in the vanguard of the struggle to safeguarding stakeholders’ interests in privatization and/or private-public partnerships. Kauffmann and Siegelbaum (1996) state that when the rights to cash flows from privatized assets can be impaired through the exercise of control rights by politicians and bureaucrats, the opportunity for extracting rents through the collection of bribes arises and competitive privatization can set the stage for lower incidence of corruption. Boubakri et al. (2009) report that that large-scale privatizations (progress and volume) increase the risk of corruption in developing countries but has no effect on the legal institutions of governance (i.e., law and order and investor protection), whereas SIPs appears to help curb corruption. Despite the growing

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30 Legal environment is positively associated with per capita growth, physical capital accumulation, and productivity growth (Levine and Zervos, 1998; Marcelin and Mathur, 2014).

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body of evidence pointing to the positive performance of the privatized firms in countries with good institutions and strong property rights protection,31 the latter, often considered exogenous, may be strengthened by privatization when the influence of bureaucrats on SOEs is lessened.

Whether privatization lowers corruption, strengthens institutions and property rights protection, as well as corporate governance, in developing countries, remains an inquiry of empirical relevance. Boubakri et al. (2009) underline that in developed countries, the progress and volume of privatization reduce the risk of corruption, and the method of privatization enhances the quality of law enforcement. Since political firms are used for political purposes and corporate governance is weak at these firms because of political interference; at root, reducing the influence of the state at these firms through privatization may weaken paternalistic and corrupt practices by public officials, the need for extra-legal payments, and the venues for output and employment decisions devoid of economic rationale. It may be the case that, privatization, is not only a remedy for loss-making firms, but also a policy to refocus the state energy to its core competencies; especially, in developing countries with large public sector and pervasive corruption.

Ownership change may positively influence property and contracting rights environments since increases in the number of private firms and greater participation of non-state operators in the creation of economic value-added may boost their political relevance; and therefore, their ability and legitimacy to claim more rights and prerogatives from the government. Privatization may, thus, drive changes in property rights protection. Expansions in private sector share of GDP favor the conditions for private firms to exert pressure on the property rights infrastructure since stakeholders with interests in sectors sensitive to those rights may lobby legislators either by formulating policy proposals or simply by demanding these changes even if it might take a long time for structural change to materialize. Private sector’s proposals may, indeed, lead to new policy implementation that will in turn impact the circumstances leading to their implementation. As Reynolds (1985) and Kotz (2006) suggest, property rights are inseparable from the right of property. This suggests a great causation between private property rights and privatization as privatization transfers new properties, new rights, and rights to properties to private investors.

Two main studies, Acemoglu and Johnson (2005) and Fernandes and Kraay (2007), establish the difference between property rights institutions, those institutions protecting the rights of citizens against predatory states and contracting institutions, set of rules, practices, and customs governing private contracts between private citizens. Specifically, these studies concur that the state predation manifests itself through corruption by state officials. As a result, the prevalence of corruption is a reasonable barometer to gauge institutional quality and its impacts on economic outcomes; especially, when contracting with the state. The association between corruption and privatization has been analyzed in the broader context of political institution.

Numerous contributions discuss the link between corruption and the decision to privatize (Coolidge and Rose-Ackerman, 1997; Shleifer, 1998; Shleifer and Vishny 1998; Laffont and Meleu, 1999), while Kaufmann and Siegelbaum (1997) analyze corruption and the optimal

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31 See Table 1

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design of privatization. When property rights are not clearly defined or incorrectly specified externalities may create allocation problems within a market system. Property rights protection involves also low corruption and extortion by managers and public officials. Where those rights are weak, some forms of privatization such as delegations, concessions, lease of SOEs’ assets, and production franchises may lead to social injustice as weaknesses in the property rights environment imply weaker enforcements and sanctions for any violations related to the execution of these contracts.

Another set of institutions affecting the course of privatization consists of contracting rights institutions, allowing firms to have their claims prevail in courts when litigations arise between firms and firms. In the privatization context, contracting rights protection may work like property rights protection in that firms may seek to challenge the legality of the state actions in case of expropriation, repatriation and reneging from previously established contracts by the state. In countries with effective institutions, property rights recipients can not only enjoy but exert their rights by seeking judicial enforcement or compensation for damages caused by third parties including the state.

Using a sample of 5,284 firm years of Chinese enterprises Wei et al. (2005) analyze the link between ownership structure and firm performance, and conclude that in the absence of competitive property rights and a well-functioning legal framework, partial privatization may be damaging to firm value due to expropriation of public assets by insiders. Like political rights, economic rights are a set of freedoms and protections governing ownership and exchanges. Economic rights have received less attention compared with democracy in the empirical literature (Che and Qian, 1998; and Goldsmith, 1995). Fig. 3 implies that beneath successful privatization programs maybe economic rights and the right of property.

4. Privatization and financial development With respect to financial development, there is an incipient body of literature stipulating

that it enables larger investments and more efficient allocation of capital, which lead to higher economic growth (Claessens and Feijen, 2006; Fergusson, 2006; Abu-Bader and Abu-Qarn, 2008; Marcelin and Mathur, 2014). The connotations between financial development and economic growth are well-established in the financial development literature (see Roubini and Sala-i-Martin, 1992; Levine and Zevros, 1998; King and Levine, 1993; Claessens and Laeven, 2003; and others). When disentangling the causal effects between financial development and growth, the law and finance literature relates the level of financial development to strength in property rights protection, which determines whether a country has the institutional heft to engage in large-scale privatization to achieve greater efficiency and economic growth.

An early assessment of the effects of financial development on the expansion of economic activities by Kuznets (1955) contrasts sharply with a survey by Fergusson (2006), which considers the institutions driving financial development and the notable effects on economic performance. Prevailing evidence also suggests that countries may not only achieve efficiency and growth through financial development, but also the process can be accelerated

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through SOEs privatization as a mean to jumpstart financial markets and further their capabilities for resource mobilization (Titman and Subrahmanyam, 1997; Perotti and Oijen, 2001; La Porta et al., 2002; Megginson et al., 2004).

Despite the corporatization effect that follows SOE privatization, the connection between capital market development and privatization, the deepening and widening of equity markets ascribed to privatization in early studies (Boutchkova and Megginson, 2000; Bortolotti et al., 2001; Perotti and Oijen, 2001; Clarke et al., 2005), there seems to be an important research gap on the impact of privatization on capital markets/financial development. In other words, there appears to be a need for additional investigations on the current landscape depicting the evolution of capital markets, privatization, and economic development. Nevertheless, Ben-Nasr et al. (2012) use 126 privatized firms from 25 countries in 1987-2003 to investigate the political determinants of cost of equity. Results indicate that cost of equity increases with government control; the cost of equity of newly-privatized firms is related to government stability (tenure) and the political system; privatized firms from countries with more democratic and more stable governments enjoy a lower cost of equity. Similarly,�Borisova and Megginson (2011) find that government ownership is associated with higher spread, and that the empirically proven benefits of privatization in areas such as profitability and efficiency, as well as the perception of increased firm competitiveness resulted in lower spreads for more fully privatized firms. Tan (2012) also posits that private owners tend to capture the benefits from cost reduction to earn a return on capital to finance investment (expansion).

Since the 1990s, Titman and Subrahmanyam (1997) indicate that privatization may help the development of capital markets by providing a critical mass of traded assets. Earlier, Yeaple and Moskowitz (1995) question whether privatization can even achieve such an objective, highlighting an academic void in the discussion of privatization effectiveness in deepening capital markets in countries where these markets already exist. Later, Boutchkova and Megginson (2000) report that market capitalization as a proportion of GDP and liquidity (number of traded shares) have significantly increased in countries with sizeable public offerings of privatized companies. Their results reveal that, outside of the United States, in terms of market capitalization, the newly-privatized firms are among the top largest listed companies.32

Fergusson (2006) argues that large and impersonal financial markets require not only an appropriate legal framework but also adequate enforcement of the rights and constraints of each of the parties involved in contracts; and regardless of the effect of creditor protection on financial development, a weak protection and enforcement of creditor rights shapes firms’ investment, and may encourage the adoption of remedial rules, higher ownership concentration and excessive reliance on tangible and liquid assets. Others concur that one of the possible bottlenecks in privatization is inadequate financial markets development driven by political institutions,

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32 Sheshinski and Calva (2003) also observe an increase in market capitalization to GDP across all income groups as a result of privatization. �

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reverberation of a country’s property and contracting rights infrastructures (Perotti and Oijen, 2001; Bortolotti et al., 2001; Boubakri and Hamza, 2007; de la Torre et al. 2007).

Kelegama (2001) suggests that privatization and the development of the capital market go hand-in-hand – each is necessary for the other. The author further argues that privatization brings in more funds to the capital market and stimulates it, and, on the other hand, the development of the capital market, namely emergence of unit trusts, flotation of debentures, etc., stimulates the privatization process. Fig. 4 indicates that privatization is positively related to market capitalization of listed companies, a commonly used measure of stock market development. Fitting the law and finance theory, the figure illustrates that the positive association between stock market development and privatization is stronger in countries with common law and socialist legal heritage than in French civil law countries.

[Insert Fig. 4 here] Boehmer et al. (2005) argue that privatization generally helps develop capital markets.

Perotti and Oijen (2001) insist that privatization through SIP can jumpstart stock markets development. Wei et al. (2005) report that China’s SIP over 1991-2001 involves exclusively primary capital-raising issues, while SIPs in other countries are mostly secondary issues where the proceeds go to the government as state revenues. A study by Boutchkova and Megginson (2000) reports a significant positive relation between stock turnover and the number of privatizations for asset sales and SIPs.33 Placing great importance in strong private and public enforcement over several other legal determinants, investors prefer SIPs in jurisdictions that relax the burden of proof in civil lawsuits and criminal prosecutions against auditors, leading to more credible financial statements (Guedhami and Pittman, 2011). In addition to Megginson et al. (2004) observing that privatization through SIPs is more likely in less developed markets in attempt to develop capital markets, SIPs appear to signal stronger commitments to privatization since it would be politically suicidal for politicians to takeover assets that have been purchased by the general public. This added credibility may attract foreign capital to boost investments and growth. In fact, Boubakri et al. (2013a) find a positive relation between FDI and privatization proceeds, market value of SIPs, and the proportion of SIPs in privatization transactions.

Countries with shallow capital markets may proceed with privatization of large SOEs in tranches. When a country fails to attract foreign investors, privatizing large SOEs at once might drain liquidity out of the economy and halt investments (in other sectors) and economic growth as financing costs for new projects would drive up.34 Boubakri and Hamza (2007) propose that countries that are confronted with an increased need of financing and limited savings, it is crucial that stock markets open to foreign investors to guarantee a rapid growth and an improvement in

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33 The most popular methods of privatization include voucher privatization, SIPs, and assets sale (Megginson et al., 2001). 34 Prager (2001) argues that the presence of active equity markets has a double impact: It induces management to strive for high profits and strong capital values to preempt takeover threats; and it enables the new set of owners to replace the management cohort who failed in their commitment to promoting profit, which ultimately leads up to an efficient and profitable operation; such incentives are absent for SOEs.�

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governance standards. Fergusson (2006) reveals that both formal and informal institutions are important for financial development; and a stricter protection of outside investors’ rights and higher levels of trust between citizens increase the depth, breadth and efficiency of capital markets.

5. State ownership vs. private ownership: new perspectives The debate on the fate of SOEs will continue to be of great relevance; especially, in

democratic societies where the choice between the state’s involvement in producing goods and services, the role of the public sector, and the burdening of the public sector with contingent liabilities are crucial issues in the public policy context. The discussion is likely to remain unsettled both ideologically and academically in the near horizon. At this juncture, with SOEs at the crossroads, it is important to empirically investigate what forms of privatization are much suitable in certain countries given their institutional capacity and their level of financial development. Despite early assessments by Megginson (2005), current trends do not suggest that capital markets are more developed, and this raises the question of what lessons have been learned from privatization experiences as pertained to the development of capital markets. Despite the great strides, it remains unclear whether privatization has propelled the expansion and development of the basic capital market institutions and governance practices.

It may be noteworthy investigating whether privatization has promoted financial market liberalization,35 and the implications for stock exchanges development, securities laws, the emergence of brokerage and investment houses, and deindustrialization; especially, in developing countries where these institutions are assumedly weak. Nonetheless, Clarke et al. (2005) argues that corporate governance problems might prevent state-owned banks from efficiently resolving market failures or politicians might use state-owned banks to raise their own welfare (for example lending to important constituents) rather than to correct market failures.

Where would a country with poor corporate governance, backward financial markets, and nonexistent operational stock markets find suitable resources (financial, legal, and human capital) upon which to tap to promote an active takeover market to ensure continued existence and performance of its privatized firms? Even in countries with relatively poor institutions, privatization may contribute, over the long run, to economic growth and indirectly to better institutions, cleaner public administration (lower incidence of corruption as sphere of political maneuvering is reduced), and stronger property rights protection. Privatization can unleash both the private and the government sectors. However, partial privatization may be optimal in countries with weak property rights protection and poor institutions.

In countries with efficient markets such as the United States, Canada and Europe, market disciplines might be severe. If a privatized firm is publicly traded, then shareholders are expected to short sale any poor performing company to readjust their portfolio. Other vehicles for market corrections include hostile takeovers and proxy fights, which may lead to management

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35 An attempt to answer this question has been made by Boubakri and Hamza (2007).

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replacement. Additional corporate mechanisms such as stock options and compensation schemes can align management of the formerly SOEs’ interests with those of shareholders. Except political, SOEs’ management faces only remote threats since they are rarely publicly traded. Where there are embryonic checks-and-balances systems, SOEs might be used as cash-cows by politicians who tend to utilize them to cement their political base. SOEs are foreordained to functioning in ways unparalleled to POEs.

6. Conclusion and policy prescriptions This study analyzes the effects of property rights, legal institutions on privatized firms’

performance, growth and financial markets development. State involvements in running firms fuel corruption and often result in the burdening of the public sector with contingent liabilities. From a public policy context, the discussion on whether the state should involve in production of goods and services is likely to remain unsettled both ideologically and academically in the near horizon. Results show that when the government abstains from operating firms, competitive forces congregate towards firms’ performance and growth. Where privatization is implemented, the regulatory or institutional framework is important to protect investors’ rights against unfair competitions and state predations.

Among the different forms of privatization, SIPs appear to be instrumental in raising large scale finances for investments and growth. In countries with weak property rights protection and poor institutions it may be beneficial for policymakers to proceed with partial privatization as market disciplines and institutions related to effective corporate governance may be either weak or nonexistent. Partial ownership may serve as a tool to monitor managers of the newly privatized firms. With the government on the privatized firm’s board, this may be a form of private-public partnership, serving as a form of guarantee for all stakeholders.

Developing countries will benefit immensely from strengthening property rights protection to ensure that privatized firms’ assets are protected and that they can be put to work efficiently to generate growth. Enhancing contracting rights laws to reassure investors that their investments are protected against the state apparatus, and that the state is under the jurisdiction of the courts may help investors form their expectations and increase their confidence when committing financial resources to large-scale projects without fear for their lives and their properties. Where contracts are not viable, that is, governments are able to repossess or confiscate privatized firms without fear of credible legal challenges, privatization may not be an effective policy and such a circumstance it is expected to contribute little to growth.

Since political firms are used for political purposes and corporate governance is weak at these firms because of political interference; at root, reducing the influence of the state at these firms through privatization may weaken paternalistic and corrupt practices by public officials, the need for extra-legal payments, and the venues for output and employment decisions devoid of economic rationale. Privatization may not only be a remedy for loss-making firms, but also a policy to refocus the state energy to its core competencies; especially in developing countries with large public sector and pervasive corruption.

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Overall, the evidence suggests that better institutions along with government relinquishment of ownership allow market-led forces to coalesce to boost efficiency, investments, and economic growth. To palliate the political effects on SOEs and depoliticize decision-making, the state must make the political decision of disbanding SOEs. Political interferences in SOEs’ operations influence output targets, employment and price levels, and this may compromise these firms’ long term survival absent government’s subsidies at the expanse of investment and growth. Wide divergences from profit-maximizing behaviors may be tactical to advance some political agenda, oftentimes populist and inimical to growth. In countries with subpar institutions, e.g., SOEs might underperform because they are not only predestinated to pursue some sociopolitical agenda but also because they are at the frontline of ruling elites’ political survival.

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Stud

y D

escr

iptio

n K

ey f

indi

ngs

Bou

bakr

i et a

l. (2

013a

)

Use

38

1 pr

ivat

ized

fi

rms

from

57

co

untr

ies

to

inve

stig

ate

the

impa

ct

of

shar

ehol

ders

’ id

entit

y on

co

rpor

ate

risk

-tak

ing

beha

vior

.

Res

ults

sho

w t

hat

stat

e (f

orei

gn)

owne

rshi

p is

neg

ativ

ely

(pos

itive

ly)

rela

ted

to c

orpo

rate

ris

k-ta

king

; hi

gh r

isk-

taki

ng b

y fo

reig

n ow

ners

dep

ends

on

the

stre

ngth

of

coun

try-

leve

l go

vern

ance

in

stitu

tions

. E

vide

nce

sugg

ests

tha

t re

linqu

ishm

ent

of g

over

nmen

t co

ntro

l, op

enne

ss t

o fo

reig

n in

vest

men

t, an

d im

prov

emen

t of

cou

ntry

-lev

el g

over

nanc

e in

stitu

tions

are

key

det

erm

inin

g fa

ctor

s of

cor

pora

te r

isk-

taki

ng in

new

ly p

riva

tized

fir

ms.

Kny

azev

a et

al.

(201

3)Pe

rfor

m a

cro

ss-c

ount

ry a

naly

sis

on p

riva

tizat

ion

deal

s in

the

Priv

atiz

atio

n B

arom

eter

and

the

SDC

dat

abas

es.

Find

po

sitiv

e pr

oper

ty

righ

ts

effe

cts

on

oper

atin

g pe

rfor

man

ce.

Spec

ific

ally

, a

one

stan

dard

de

viat

ion

incr

ease

in

the

inde

x of

pro

pert

y ri

ghts

pro

tect

ion

agai

nst

expr

opri

atio

n is

ass

ocia

ted

with

up

to

1.3%

hig

her

aver

age

prof

itabi

lity;

a o

ne s

tand

ard

devi

atio

n (0

.71)

dec

reas

e in

leg

al f

orm

alis

m

(tha

t bo

osts

con

trac

ting

righ

ts b

y ea

sing

con

trac

t en

forc

emen

t) i

ncre

ase

prof

itabi

lity

by a

1.4

5 pe

rcen

tage

poi

nts.

Saw

ada

(201

3)

Inve

stig

ates

the

eff

ect

of p

osta

l sa

ving

s pr

ivat

izat

ion

on t

he J

apan

ese

bank

ing

indu

stry

with

foc

us o

n th

e le

gisl

ativ

e el

ectio

ns u

sing

a S

UR

mod

el.

Res

ults

sho

w th

at p

riva

tizat

ion

of th

e po

stal

sav

ings

sys

tem

rai

ses

the

wea

lth o

f m

ega

bank

s bu

t not

th

at o

f re

gion

al b

anks

; pr

ivat

izat

ion

incr

ease

s th

e ri

sk t

o al

l of

ban

ks,

and

the

bank

s th

at a

re

depe

nden

t on

per

sona

l lo

ans

incr

ease

the

ir r

isk

in r

espo

nse

to t

he p

riva

tizat

ion

of t

he p

osta

l sa

ving

s sy

stem

.

Tu

et a

l. (2

013)

E

xam

ine

how

the

pol

itica

l co

nnec

tions

of

acqu

irer

s in

flue

nce

the

proc

ess

and

outc

omes

of

priv

atiz

atio

n in

C

hina

.

Res

ults

sho

w t

hat

polit

ical

ly c

onne

cted

acq

uire

rs r

ecei

ve p

refe

rent

ial

trea

tmen

t an

d ac

quir

e hi

gher

qu

ality

fir

ms

duri

ng f

ull

priv

atiz

atio

n. T

here

is

evid

ence

of

post

-pri

vatiz

atio

n tu

nnel

ing

from

tar

get

firm

s to

acq

uire

rs.

Exc

essi

ve t

unne

ling

by p

oliti

cally

con

nect

ed a

cqui

rers

is

asso

ciat

ed w

ith l

ower

pe

rfor

man

ce a

fter

pri

vatiz

atio

n. R

esul

ts s

ugge

st i

ndiv

idua

ls a

buse

the

ir p

oliti

cal

conn

ectio

ns t

o ex

ploi

t the

opp

ortu

nitie

s ar

isin

g fr

om p

riva

tizat

ion.

Ngu

yen

and

van

Dijk

(20

12)

Usi

ng d

ata

on (

SOE

s) i

n V

ietn

am a

nd t

hree

dif

fere

nt

mea

sure

s of

the

per

ceiv

ed c

orru

ptio

n se

veri

ty f

rom

a

2005

sur

vey

amon

g 74

1 pr

ivat

e fi

rms

and

133

SOE

s

SOE

s pe

rfor

m b

ette

r in

cor

rupt

env

iron

men

ts. C

orru

ptio

n m

ay b

e ha

rmfu

l to

econ

omic

gro

wth

be

caus

e it

favo

rs th

e st

ate

sect

or a

t the

exp

ense

of

the

priv

ate

sect

or a

nd th

at im

prov

ing

the

qual

ity

of lo

cal p

ublic

gov

erna

nce

can

help

to m

itiga

te c

orru

ptio

n an

d st

imul

ate

econ

omic

gro

wth

.

Din

ç an

d G

upta

(2

011)

Use

dat

a on

Ind

ian

priv

atiz

ed f

irm

s in

199

0-20

04 t

o in

vest

igat

e th

e in

flue

nce

of

polit

ical

an

d fi

nanc

ial

fact

ors

on t

he d

ecis

ion

to p

riva

tize

SOE

s us

ing

Cox

pr

opor

tiona

l haz

ard

regr

essi

ons.

Find

tha

t pr

ofita

ble

firm

s an

d fi

rms

with

low

er w

age

bill

are

likel

y to

be

priv

atiz

ed e

arly

. T

he

gove

rnm

ent

dela

ys p

riva

tizat

ion

in r

egio

ns w

here

the

gov

erni

ng p

arty

fac

es m

ore

com

petit

ion

from

op

posi

tion

part

ies.

Cho

i et a

l. (2

010)

Com

pare

1-,

3-,

and

5-y

ear

hold

ing

peri

od r

etur

ns o

f pr

ivat

izat

ion

IPO

s to

th

ose

of

the

dom

estic

st

ock

mar

ket

indi

ces

and

to t

hose

of

size

and

siz

e-an

d-bo

ok-

to-m

arke

t eq

uity

ra

tio

(BM

)-m

atch

ed

firm

s of

re

spec

tive

coun

trie

s us

ing

241

priv

atiz

atio

n IP

Os

from

42

cou

ntri

es in

198

1-20

03.

Res

ults

sho

w t

hat

priv

atiz

atio

n IP

Os

have

sig

nifi

cant

ly l

ess

cons

iste

nt a

bnor

mal

lon

g-te

rm s

tock

pe

rfor

man

ce r

elat

ive

to t

heir

siz

e- o

r si

ze-a

nd-B

M-m

atch

ed b

ench

mar

k fi

rms.

The

mar

ket

valu

es

priv

atiz

atio

n IP

Os

with

out

muc

h sy

stem

atic

bia

s af

ter

the

IPO

, in

con

tras

t to

pri

vate

com

pani

es’

IPO

s ou

tper

form

ed th

eir

dom

estic

sto

ck m

arke

ts in

the

long

-run

.

Che

(20

09)*

Pres

ents

a d

ynam

ic m

odel

of

priv

atiz

atio

n, d

rive

n by

im

prov

ed i

nstit

utio

nal

prot

ectio

n of

pri

vate

pro

pert

y ri

ghts

an

d co

nstr

aine

d by

th

e bu

yer's

fi

nanc

ial

cons

trai

nts.

SOE

is

mor

e ef

fici

ent

than

pri

vate

ow

ners

hip

whe

n pr

ivat

e pr

oper

ty r

ight

s ar

e in

secu

re.

Stro

nger

pr

oper

ty

righ

ts

crea

te

the

need

to

pr

ivat

ize.

Fa

ster

in

stitu

tiona

l de

velo

pmen

t ca

lls

for

earl

ier

priv

atiz

atio

n, b

ut it

als

o ha

s th

e po

tent

ial t

o ei

ther

cre

ate

or e

xace

rbat

e de

adw

eigh

t los

ses

asso

ciat

ed

with

inef

fici

ent p

riva

tizat

ion.

Han

ouse

k et

al.

(200

9)

Use

fir

m-l

evel

dat

a to

exa

min

e th

e ef

fect

s of

fir

m

dive

stitu

res

and

priv

atiz

atio

n on

cor

pora

te p

erfo

rman

ce

in th

e C

zech

Rep

ublic

usi

ng I

V te

chni

que.

Res

ults

sho

w t

hat

dive

stitu

res

and

priv

atiz

atio

n ha

ve a

neg

ativ

e ef

fect

on

the

perf

orm

ance

of

incu

mbe

nt f

irm

s be

caus

e of

the

wea

k co

rpor

ate

gove

rnan

ce,

wan

ing

gove

rnm

ent

coor

dina

tion

and

regu

latio

n, u

ncle

ar p

rope

rty

righ

ts, a

nd u

ndev

elop

ed le

gal a

nd in

stitu

tiona

l fra

mew

ork.

��

�

Okh

mat

ovsk

iy(2

010)

Com

pare

s th

e pe

rfor

man

ce c

onse

quen

ces

of b

oard

and

ow

ners

hip

ties

to t

he g

over

nmen

t w

ith t

he e

ffec

ts o

f bo

ard

and

owne

rshi

p tie

s to

SO

Es

in R

ussi

a.

Res

ults

sho

w t

hat

ties

to S

OE

s ar

e as

soci

ated

with

hig

her

prof

itabi

lity,

whi

le n

o si

gnif

ican

t di

ffer

ence

s ar

e di

scov

ered

for

fir

ms

with

dir

ect t

ies

to th

e go

vern

men

t.

Tab

le 1

: con

tinue

d

Schm

itt J

r. a

nd

Tei

xeir

a (2

008)

U

se d

ata

on m

iner

al f

irm

s th

at h

ave

been

pri

vatiz

ed i

n B

razi

l fro

m 1

986

thro

ugh

1998

.

Find

tha

t th

e pr

oduc

tivity

gai

ns f

rom

pri

vatiz

atio

n ar

e m

uch

mor

e ge

nera

l an

d w

ides

prea

d th

an h

as

typi

cally

bee

n re

cogn

ized

in

this

lite

ratu

re.

In a

sses

sing

the

pro

duct

ivity

gai

ns f

rom

pri

vatiz

atio

n,

the

liter

atur

e ha

s on

ly e

xam

ined

the

prod

uctiv

ity g

ains

acc

ruin

g at

the

priv

atiz

ed S

OE

s.

Don

g et

al.

(200

6)

Usi

ng p

anel

dat

a on

165

rur

al a

nd u

rban

fir

ms

from

N

anjin

g m

unic

ipal

ity a

nd i

ts e

nvir

ons,

inv

estig

ate

the

patte

rn a

nd c

onse

quen

ces

of p

rope

rty

righ

ts r

efor

m a

nd

priv

atiz

atio

n in

the

late

199

0s.

Find

tha

t pr

ivat

izat

ion

polic

ies

appe

ar t

o ha

ve t

arge

ted

the

wea

kest

fir

ms

in t

he u

rban

sec

tor,

w

here

as n

o co

rrel

atio

n is

fou

nd b

etw

een

perf

orm

ance

and

sel

ectio

n fo

r pr

ivat

izat

ion

in t

he r

ural

se

ctor

. Fo

r ur

ban

firm

s, t

he a

dopt

ion

of s

ome

degr

ee o

f pr

ivat

e ow

ners

hip

is a

ssoc

iate

d w

ith

sign

ific

ant i

mpr

ovem

ents

in p

rodu

ctiv

ity a

nd p

rofi

tabi

lity.

Wu

(200

6)

Use

s A

NC

OV

A m

odel

on

a sa

mpl

e of

34

priv

atiz

ed

SOE

s in

Tai

wan

to

exam

ine

the

effi

cien

cy t

he e

ffec

ts

of p

riva

tizat

ion

betw

een

1989

and

200

0.

Res

ults

sh

ow

post

-pri

vatiz

atio

n m

arke

t op

enne

ss

and

pre-

priv

atiz

atio

n co

rpor

ate

heal

th

are

posi

tivel

y re

late

d to

eff

icie

ncy

gain

s. M

arke

t de

regu

latio

n an

d SO

E r

efor

ms

in t

he p

olic

y de

sign

for

go

vern

men

t di

vest

ure

is i

ndis

pens

able

. E

ffic

ienc

y ef

fect

of

cont

inue

d st

ate

pres

ence

on

boar

ds i

s m

oder

ated

by

mar

ket

open

ness

. G

over

nmen

t in

volv

emen

t m

ay b

e tu

rned

int

o a

pass

ive

or e

ven

beni

gn f

acto

r fo

r m

anag

emen

t de

cisi

on m

akin

g if

mar

ket

com

petit

ion

is i

ntro

duce

d. S

tate

pre

senc

e on

boa

rds

beco

mes

less

cri

tical

to e

ffic

ienc

y ga

ins

in w

eakl

y co

ntes

ted

mar

kets

.

Aiv

azia

n et

al.

(200

5)

Exa

min

es w

heth

er r

efor

m p

rogr

am i

n C

hina

’s S

OE

s,

nam

ely,

cor

pora

tizat

ion

can

boos

t SE

Os’

per

form

ance

w

ithou

t pr

ivat

izat

ion

usin

g su

rvey

dat

a on

442

SO

Es

from

199

0 to

199

9.

Find

s th

at c

orpo

ratiz

atio

n ha

s a

sign

ific

antly

pos

itive

im

pact

on

SOE

per

form

ance

. T

he s

ourc

es o

f ef

fici

ency

eng

ende

red

by c

orpo

ratiz

atio

n ca

n be

tra

ced

to t

he r

efor

m o

f th

e in

tern

al g

over

nanc

e st

ruct

ure

of t

hese

fir

ms.

Eve

n w

ithou

t pr

ivat

izat

ion,

cor

pora

te g

over

nanc

e re

form

is

pote

ntia

lly a

n ef

fect

ive

way

of

impr

ovin

g th

e pe

rfor

man

ce o

f SO

Es;

suc

h re

form

s re

pres

ent a

pol

icy

alte

rnat

ive

for

coun

trie

s se

ekin

g to

res

truc

ture

SO

Es

with

out m

assi

ve p

riva

tizat

ion.

Bou

bakr

i et a

l. (2

005a

)U

se 2

01 f

irm

s in

32

deve

lopi

ng c

ount

ries

to s

tudy

w

hen

and

how

doe

s pr

ivat

izat

ion

wor

k.

Res

ults

sho

w t

hat

priv

atiz

atio

n yi

elds

bet

ter

resu

lts w

hen

stoc

k m

arke

t an

d tr

ade

liber

aliz

atio

ns

prec

ede

it. T

here

is e

cono

mic

gro

wth

ass

ocia

ted

with

con

trol

rel

inqu

ishm

ent b

y th

e go

vern

men

t, an

d fo

reig

n ow

ners

hip

sign

ific

antly

dri

ves

chan

ges

in p

rofi

tabi

lity.

Hig

her

impr

ovem

ents

in

effi

cien

cy

and

outp

ut f

or f

irm

s in

cou

ntri

es i

n w

hich

sto

ck m

arke

ts a

re m

ore

deve

lope

d an

d w

here

pro

pert

y ri

ghts

are

bet

ter

prot

ecte

d an

d en

forc

ed.

Tra

de o

penn

ess

is a

n im

port

ant

dete

rmin

ant

of t

he p

ost-

priv

atiz

atio

n in

crea

se in

inve

stm

ent.

Xu

et a

l. (2

005)

Use

a n

atio

nal

surv

ey d

ata

on t

he o

wne

rshi

p re

form

of

SOE

s in

C

hina

to

st

udy

the

effe

cts

of

redu

cing

po

litic

ian

cont

rol

and

agen

cy p

robl

ems

on a

num

ber

of

refo

rm o

utco

mes

.

Res

ults

sho

w th

at o

utco

me

mea

sure

s of

the

refo

rm’s

suc

cess

are

pos

itive

ly a

ffec

ted

by th

e re

duct

ion

of p

oliti

cian

con

trol

thr

ough

inc

reas

ing

the

firm

’s f

lexi

bilit

y in

lab

or d

eplo

ymen

t an

d by

the

m

itiga

tion

of

agen

cy

cost

s th

roug

h th

e in

trod

uctio

n of

m

ore

effe

ctiv

e co

rpor

ate

gove

rnan

ce

mec

hani

sms

such

as

one-

shar

e on

e-vo

te a

nd s

hare

hold

ing-

base

d bo

ard

stru

ctur

e co

mpo

sitio

n.

Meg

gins

on e

t al.

(200

4)

Exa

min

e th

e im

pact

of

po

litic

al,

inst

itutio

nal,

and

econ

omic

fac

tors

on

the

choi

ce b

etw

een

selli

ng a

n SO

E i

n th

e ca

pita

l m

arke

t th

roug

h (S

IP)

and

selli

ng i

t in

the

priv

ate

capi

tal m

arke

t in

an a

sset

sal

e.

Res

ults

sho

w t

hat

SIPs

are

mor

e lik

ely

in l

ess

deve

lope

d ca

pita

l m

arke

ts, f

or m

ore

prof

itabl

e SO

Es,

an

d w

here

the

re a

re m

ore

prot

ectio

ns o

f m

inor

ity s

hare

hold

ers.

Fin

ding

s su

ppor

t th

e im

port

ance

of

the

polit

ical

and

leg

al e

nvir

onm

ent

in t

he c

hoic

e of

whe

ther

to

priv

atiz

e th

roug

h an

SIP

or

an a

sset

sa

le; i

nves

tors

are

mor

e w

illin

g to

mak

e th

e su

bsta

ntia

l inv

estm

ent o

f pu

rcha

sing

an

SOE

thro

ugh

an

asse

t sal

e w

hen

they

per

ceiv

e a

favo

rabl

e po

litic

al e

nvir

onm

ent t

hat p

rote

cts

prop

erty

rig

hts.

Bae

r an

d B

ang

(200

2)**

Com

pare

pr

ivat

izat

ion

outc

omes

on

eq

uity

in

tw

o co

untr

ies:

Bra

zil

and

Rus

sia

whi

le t

akin

g in

to a

ccou

nt

the

inst

itutio

nal

diff

eren

ces

and

prop

erty

ri

ghts

pr

otec

tion

acro

ss th

e co

untr

ies.

In B

razi

l, on

ly a

sm

all d

omes

tic e

lite

was

abl

e to

bid

for

ass

ets

whi

le in

Rus

sia

only

a s

mal

l elit

e ha

d th

e co

nnec

tions

(bo

th p

oliti

cal

and

in t

he u

nder

grou

nd e

cono

my)

, w

hich

mad

e it

feas

ible

to

get

cont

rol

of m

ost

of t

he s

tate

mos

t pr

ofita

ble

form

er a

sset

s. W

hile

for

Bra

zil

the

exte

nt o

f th

e re

sults

fr

om p

riva

tizat

ion

on i

nequ

ity i

s lim

ited

to t

he a

bsen

ce o

f im

prov

emen

t of

dis

trib

utio

nal

equi

ty,

Rus

sian

pri

vatiz

atio

n se

ems

to h

ave

crea

ted

a de

epen

ing

divi

de b

etw

een

the

rich

and

poo

r.

Date post:	23-Dec-2016
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