The Benefits of Privatizing State-Owned Enterprises

Posted: June 28, 2007 at 12:00 am

 

THE BENEFITS OF PRIVATIZING STATE-OWNED ENTERPRISES

 

Ever since the Margaret Thatcher government of the United Kingdom popularized the concept of “privatization”, as a means by which governments sold state-owned enterprises to private investors beginning in 1979, their growth has been phenomenal in number and size throughout the world. Allied with this growth, has been the debate on how best to achieve these privatizations.

 

Three methods have been identified and employed: Asset sale privatizations; share issue privatizations (SIPs) and voucher privatizations. The latter have been used primarily in formerly communist bloc countries whereby citizens were given vouchers at very low prices that were convertible to shares in the privatized entities.

 

Asset sale and share issue privatizations

 

The focus of my discussion in this article will be asset sale and share issue privatizations. An asset sale privatization is the sale of a state- owned enterprise to a private firm or to a small group of people and a share issue privatization is the sale of equity shares to the public through a recognized stock exchange.

 

A World Bank study done in 2002 found that 2,477 privatizations were completed in 108 countries, including Jamaica, between 1977 and 2000. Of these, 1,536 or 62% were done by asset sale and 941 or 38%, by share issue. Significantly, of the USD 1.2 trillion raised from these privatizations, the fund allocation was exactly reversed. Thirty-eight percent was realized from asset sales while 62% came from share issues.

 

Share issue privatizations raise substantially larger funds, even though, governments typically sell an average of about 35% of their ownership stake through SIPs, compared with at least twice that proportion through asset sales. An average SIP was found to generate USD 794 million compared with USD 289 million for an asset sale privatization. Over 90% of the largest common stock offerings over the period came from SIPs. This should be of interest to governments that find it necessary to raise funds for vital budgetary matters.

 

The Jamaica government’s privatization by share issue of National Commercial bank (51% in 1986); Caribbean Cement Company (89.6% in 1987) and Telecommunications of Jamaica, now Cable & Wireless (52.1% in three phases between 1987 and 1989), realized total proceeds for government of J$907 million. Using dividends paid out as a proxy for profitability, only one of the companies paid dividends in the amount of $0.47 in 1988 compared with a total of $2.15 in 2006. And, the total shareholders among the three companies have grown from under 20,000 in 1986 to more than 85,000 today.

 

By contrast, the government realized J$ 301 million from fifteen privatizations through sale of assets from 1981 to 1996.

 

Benefits of Share Issue Privatizations

 

The World Bank study also found that the following were among the impacts of share ownership privatization on the enterprises: increased profitability; improved labour efficiency and productivity; increased output; and greater access to capital. These are obvious indicators for better chances of long-term success for these enterprises and their potential for contributing to the economy.

 

According to a 2002 UNDP study entitled, “Lessons in Privatization,” share issue privatizations are more likely to be successful when they are designed to result in broad-based ownership; contribute to human development; improve people’s choices; and contribute to the eradication of poverty.

 

Share issue privatizations of state-owned enterprises have provided the financial leverage for the development and strengthening of capital markets worldwide but more so in developing markets. The emergence and maintenance of a healthy capital market is essential to assist a country to meet its long-term financing needs. A few of the indicators that one would look for to determine the health of a capital market are: the rate of growth in market capitalization; growth in the number of listed entities; increase in number of persons holding shares; and increased market liquidity.

 

 

Enhanced profitability in privatized entities is usually driven by several factors, among them: re-definition of company objectives with greater attention to financial outcomes; improved accountability and heightened incentives among managers; and, closer monitoring by profit-oriented shareholders

 

Share issue privatization has also contributed to bringing other benefits to our market. It has encouraged the government to undertake or to reinforce capital market reforms to ensure: increased transparency; increased protection of minority shareholder rights through upgraded legislation and strengthened financial regulatory authorities. 

 

Perhaps more importantly, share issue privatizations have demonstrated that they can facilitate public-private sector partnerships that work.

 

Marlene Street-Forrest

GeneralManager, Jamaica Stock Exchange

 

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