Impact of Privatization on Firm’s Performance
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Published: Thu, 01 Mar 2018
Privatization throughout the 1980’s has been considered to be the solutions to the problems associated State Owned Enterprise (SOE)s both in the developed and developing economies and even in the socialist economies (Vickers and Yarrow 1995). In reality privatization is an economies policy and other times a political policy that is difficult to achieve mostly when is implemented in a corrupt setting like in most developing countries. However it is wise for a competitive and well regulated business environment structure to be established before privatization takes place.
In recent times there has been a significant increase in the privatization of SOEs. Megginson et al (2004), suggest that political persuasion by government as a result of poor and unsatisfactory financial and operational results by SOEs has cause the transfer of ownership to private investor who will impact their business discipline in order to improve the level of performance for the newly privatized SOEs. While Aktan (1995) suggest that privatization goes beyond the sale of SOEs, assets or shares to individuals or private firms but in a broad meaning, it is to restrict government role and function in providing economic activities and put forward some methods or policies in order to strengthen free market economy.
Privatization is often meant to be the transfer of control and ownership of government asset or firm to private investors. It could be partial or whole, through private placement or public offer of share via the capital market as well as through the distribution of vouchers. The major purpose of privatization is to grow and develop the economic by creating competition that can bring about efficiency ***. It will be right for the logical argument of this research study to compare or examine the different view of academics on what privatization means.
Parker et al (2005) states that privatization is used to cover many arrays of different policies like liberalization, commercialization but in one of its studies, Privatization in Developing Countries: A Review of the Evidence and the Policies lessons, suggest that privatization means the transfers of productive asset from the state to the private sector, but also stressed that the most important factors to be considered is the introduction of effective competition and regulatory measures alongside with existing firms and for government to accept the political changes that occurs when privatization takes place. While, Beesley (1997) suggest that privatization is the formation of a company’s act company and the subsequent sale of at least 50percent of the total shares of a company to private shareholders. However it is obvious now that privatization starts with the government transfer of its assets or a controlling share to private investors or shareholders in order to stimulate economic development.
Privatization as an inherent part of government efforts to rationalize the SOEs. It’s mostly done to reduce the burden on National Budget, improve efficiency of individual enterprise and ensure wider distribution of business ownership among its citizens and other foreign investors. However in most cases it brings about the introduction of market force (Demand and Supply forces) into the economy. Privatization can be set up to achieve different objectives depending on the Political, Economy and Social condition of each individual Country. This is due to the fact that what is applicable in the UK for instance will most likely not applicable in Russia due to the differences in techniques or method of privatization, general government objectives, SOEs condition, firms sectors activities and the countries characteristics.
According to Bennett (2003) there are different methods used during privatization, either one used has its own advantage and disadvantage. The share option method is the mostly used method, it involves the sales of SOEs through the issue of shares to the public through stock market. For this method to be successfully implemented, the local country privatizing its SOEs must have an established Stock market where the trading of these shares should take place. Also there should enough public awareness to sell shares. While the private placement option which involves the sale of SOEs to the highest bidder helps government rise substantial revenue but the issues involved here, is the highest bidder will always want to get back their money back in time by exploiting the consumers. This option is mostly done in developing countries where there stock market is still very weak and there are trying to get foreign investor to invest. Lastly the voucher method which is common with Eastern European countries like, Russia, Czech Republic etc, tends towards alleviating poverty. It involves the allocation of SOEs shares to virtually all local qualified citizens of a state in order for both the poor and rich to be co-owners of the SOE. But in most case the poor ones are more likely to sell their share to the rich one who will then have a controlling stake.
1.1 Background to the Study
The telecoms industry is a sizable sector offering a wide range of products and services as well as employment opportunities across virtually all professional, skilled and unskilled discipline in the economy. However the industry has expanded and develop rapidly since late 1980’s, in the 1990’s and even more rapidly in most recent times due its consistency in constant need for Research and Development (R&D), technological change on both the service providers and suppliers sides respectively in other to satisfy its market and be more efficient to maximize profitability.
The telecommunication industry whether in a developed or developing economies has had its impact towards the growth and development of virtually all parts of an economy ranging from the political, social, financial, technological sectors over its 100 years of existence. However like every other service providing sector, it provides services to the local market and international market where business strategic is always aimed at gaining competitive advantage in the existence of competition and tight regulatory business environment in terms of providing service to users, expanding its economies of scale and scope and equity expansion.
Many countries grant monopoly power to their local telecoms but establish an office that will regulate their activities and in other cases some merge their postal services and telecoms services together, example is the United Kingdom (UK). The UK Telecommunication has been in existence dating back to 1879, with its first telephone exchange established in Coleman Street, London. 1896 saw the Post Office take over the private sector trunk services while in 1912, all national telephone company exchange was controlled by the Post Office as a monopoly supplier of telephone service in the UK. The Post office had two departments the postal service and telecom. As a rule as stated by Ratto-Nielsen, telephone operations, the postal service where subsidized while labor union where paid high rents to organize labor.
However in 1969, the Post office become a State Public Corporation and after the Carter Report of the Post Office Review Corporation was published, the 1981 the British Telecom’s Act 1981 became law and the postal and telecoms of the Post Office became the responsibilities of two separate Corporation namely;
- The Post Office and British Telecom’s (BT)
- Cable and Wireless, which was privatized.
While BT was created as a Public Corporation charged with the responsibilities for Telecommunications, Supplies, Installations and Maintenance. The first competitive rivalry in the industry was the granting of license in 1982 to Mercury Communication Limited (MCL) to operate a fixed Link network in order to compete with BT. This only made a little impact as BT has a huge competitive advantage over MCL because it already had the market share, established and experienced Skilled employees and existing contracts with leading telecoms equipments manufacturers and service providers to operate and even if a year later both where give the advantage to operate without rival firms providing fixed link networks in the UK for seven years
The Government White Paper published, proposed for the sale of 51percent of BT and the creation of a telecoms regulatory body, to be named Office of Telecommunication (Oftel) whose duties where to supervise all the activities going on in the telecoms industry and to also prosecute those who do not comply with the set rules and regulation of the industry as well as protect services users from exploitation. Two years later Oftel was signed into law and then administration of Margret Thatcher creating BT as a Limited Company wholly owned by the Government as BT Plc but was later privatized by selling off 50.2percent Shares to the Public.
BT is one of the world oldest telecommunication Firm and dates back to be the first ever British telecom firm which also had the sole monopoly of providing telecom services in the UK with the backup of British Government. During the period, from 1878 the UK telephone service was been provided by the private sector companies, National Telephone Company (NTC) who were also faced with competition from the General Post Office (GPO) and in 1896 the GPO took over operation of the telephone service from and became a monopoly market for the in 1912 controlling the entire telecoms market in the UK.
In 1965, some finding made by a working party was presented to the government which there found substantial enough. This lead them to split GPO into two divisions; the Post and Telecommunication which gave birth to BT and five units Post, Telecommunication, Savings, Giro and National Data Processing Services respectively. The Post Office act of 1969 made the Post Office to be controlled by the government and established as a public corporation. This gave them the sole right to run the telecoms system with listed power to authorize others to run such systems. However the Post Office retained its telecommunication monopoly.
The Carter Committee of 1977 suggest for the restructuring of the Post Office into two separate units and further renaming of the Post Office to British Telecom’s but it also remained a part of the Post Office. In 1981, the introduction of British Telecommunication act transfer the provision of telecommunication from the Post Office as a resulting establishing two different corporations a bold step to create competition in the utility industry (Telecoms). This empowered the trade and industry ministry and the British Telecom’s the right to grant Licenses to other telecoms operators to run telecommunication systems therefore creating competition in the sector.
However, in July 1982 the government officially announced her intention to privatize BT by selling up to 51 percent of BT shares to private investors. In 1984, more than 50 percent of BT was sold to the public through share option, then the largest ever most successful SOE privatization exercise in the history of privatization leaving the government with just forty 47.6 percent. This was about the most radical and the largest scale privatization exercise ever had in the history of Britain. However most investor where scared that it was going to fail. It was but in 1991 the government share of BT was reduced to 21.8 percent by rising up to £5 billion and creating about 750,000 new shareholders of BT.
In reality, the privatization of BT opened the telecoms market for other operates to come into the market, invest in the sector and breaking the monopoly advantage had by BT over the years by fighting for market shares through intense competitive business environment. This however forced BT into having fairer business policies, improved technology to optimize productivity as well as to raise its level of efficiency as government regulatory body would introduced a price cap system. On the other side this allowed other firms to spring up and compete with BT in the telecom sector bringing about maximum utilization of available resources, cost cutting and efficiency. Telecoms consumers where the most rewarded people as operator gave them the best deals ever in order to gain market shares. BT Plc is now run in over 170 countries all over the world and faced with about 150 other telecoms operator. This has forced them virtually to constantly to research and develop their existing technology as well as acquire new ones in order to keep pace with their consumers new and market share.
1.2 Rationale for this Study
In this research study aims to examine the impact of privatization in the telecom sector in the UK post privatization era. Also it will examine if the method of privatization contributes to both the operational and financial performance***
1.3 Objectives to the Study
My objectives will be subdivided into two sections aimed at determining to what extends privatization affected BT performance in terms of one; financial performance
- By looking the determinants working capital management,
- Share price movement and it covariance relative to the telecoms sector and FTSE 100 and
- Financial annual report
Secondly; operational performance
- Level of efficiency
- Market Share strategy
- Competition and Regulation
There are inevitable limitation to this research study caused by the different economy situation post privatization era of BT. This can be ranging from some systematic economy problems to specific economy problems that can either be a general issue associated with all other sectors of the economy or rather that has to do alone with the telecoms sector or BT performance over time. Also political issues that arise for political interference in BT or the telecom sector which can either be from change of government.
Finally as a research study there will be minor statistical error but this research study still represent a substandard measurement of BT post privatization operational and financial performance within the very dynamic, rapid, competitive and volatile telecom sector indices and the FTSE 100 at large.
1.5 Research Questions
Why would one witness a difference in performance in terms of operational and financial factors when a firm is managed by government compared to when been managed by the private individual or investors?
1.6 Structure of the Study
In Chapter two, this study will focus on the methods of privatization while chapter three of this research is literature review which includes theoretical framework and a review of relevant literatures. The theoretical framework will look at the different theories of privatization, how those theories where applied during privatization and the impact it had in the telecoms sector. Also the literature will critically review the impact of privatization in the telecoms sector focus mainly on the operational and financial performance of SOEs before and after privatization. While Chapter four will discuss the methodology adopted to achieve this study. Chapter four will be analysis of data’s and stating of findings. Finally Chapter five would be conclusion.
2.0 Methods of Privatization
This chapter will focus on the different methods of privatizations ranging from share issue method to voucher or the mass method and finally the asset sales method. It will also discuss the justification why a particular method is chosen rather than the other toward the achievement of privatization exercise and finally the advantage and disadvantages of each method used.
2.2 Share Issue Method
This method of privatization involves the sale of all or part of SOE to investor through a public share offer which are similar to initial public offer (IPO) in the private sector via the stock market. This is structured to raise money for the government, divest them also from ownership and for them to achieve political objectives. However in the words of Megginson (2005) this method is the largest and most successful method to transfer SOEs to private ownership. Yet it is the most dramatic because if it turns out successfully or fails respectively it becomes the most political and economy bad or good decision depending on what happens.
However, the process of using this method involves the passing through three steps;
How to transfer control: This involves whether to sell the whole SOEs strategically to the public once or step by step. If the last option is chosen then government will have to determine what percent should be sold initially and subsequently but the most important thing here is for the government to put up tight regulation to control corporate decisions after the privatization exercise.
How to price the offer: The pricing decision requires whether government should do the pricing by tender offer, a booking-building exercise or a fixed price but whatever the decision government makes it must be in advance. However the government always issue out SOEs share below the true market value as an incentive to encourage investors to buy shares.
Finally, how to allocate the shares: This depends on who the government intends to favor most, it could be the employees, labor unions or potential investors and even foreign investors. Also it could make use an investment banker as lead underwriter or favor national champion.
Meanwhile this method of privatization needs the existence of a capital market and also has some comparative advantage over the other methods which is rationale behind why it can be used in some situation rather than the others. In most case SOEs share prices are underpriced relative to the market price, hence foregone government revenue that will make investor make a premium on top of there investment
The needs to expand the stock market operational capacity to accommodate new issued equities
- Can raise huge amount of revenue for the government
- The strategy employed can be use to create wealth evenly for local investors by allocating a set percentage of share to every region within the country. This usually occurs in situation where there is less inequality of income
- The use of share option, most likely develops the capital market.
- It is also used when the SOE to be privatized is large and profitable. For example BT,
- It also transforms the size and efficiency of both the nations’ investment banking sector and its capital market.
- It is time consuming to organize
- It is extremely expensive to coordinate due to the fact that before the share are put to sale the government have to hire and pay consultants
3. Transaction cost is another issue. It include cost of sales, advertising, underwriting.
2.3 Asset Sales Method
This method involve the sale of the whole or part of SOE clearly for cash to individual investors, group of investors or an existing corporation with or without experience in that sector (Meggison 2005).
Vuylsteke et al (1995), suggest that transaction here can occur in different forms from direct acquisition by a similar corporate firm or private placement to targeting various institutional investors. However there are different procedures to follow in this method of privatization exercise. This includes; firstly the full competitive process which involves a privatization process of pre-qualification of bidders to win the final bid to take-over the said SOE. While the second procedure involves the use of direct negotiations between investors and government representatives to take-over the said SOE which usually involve the search for a larger number of investors.
Both process would usually involve the investor who are either new or have an excellent record of both operational and financial performance in the past. This though is not a major concern for the government or standard to win the bid but can only be as confidence booster for both the government, SOE labor unions and management. However the governments have strict interest in the bidders that can meet their financial requirements as well as all other agreement without violating.
- It brings about a speedy and flexible negotiation towards the sales of SOE between the individual or group of investors and the government body that is interested in the transfer of the SOE to private hands.
- It can yield more revenue for the government as the highest bidder wins the ownership of SOE to be privatized
- It is the most reliable method of privatization in economies where the stock market is underdeveloped as well as encourage to a great extend property right theory.
- It attracts Foreign Direct Investment (FDI) cash flow income into the economies of the local country.
- It can also bring about innovation in technology, management skills and expertise especially when these SOE are bought over by foreigners.
- It is the least transparent method of privatization as the government might only target to sell to the group of investor that favors they own political objectives.
- It can bring about exploitation as the new investor might be under pressure to pay back loans and t the same time maximums profit within a short period of time.
- The group of investors or individual investor might not have the required technical expertise or skill and experience to run the new privatized SOE. These are mostly common with local investors favored by the government or are new in business.
2.4 Voucher Method
This is also known as mass privatization, usually common in Eastern Europe. It is a method whereby eligible citizens of a nation can use vouchers that are distributed free or at nominal cost. This gives holders the right to bid for stake for SOE’s or other assets been privatized. This method is mostly used in transition economies like in the Central and especially Eastern economies respectively to bring about fundamental change in the ownership of business asset in these economies, although not always change in effective control (Meggison 2005).
However, low income distribution level prompted most nations in Eastern Europe to adopt this method of privatization as it became clear that the only viable way to privatize and maintain significant domestic ownership was the voucher method if not only individuals with the wealth to acquire shares which were communist, criminal and foreigners would buy up everything. (Parker and Saal 2003)
This method of privatization as suggested by Boycko, Shleifer and Vishny (1994) shows that the reason to purse and specifically design the program is largely dictated by politics. This involves the divestment of SOE through the distribution of vouchers to a nation’s citizenry that people can use to bid for the SOEs on offer. This method has been used in mass privatization exercise programs mostly in transaction economies in the Czech Republic, Russia and other Eastern and Central Europe countries. However this method has been really successful in the past but most recently are failing because there do not attract new capital or management to the privatized SOEs. Experience has also shown that it do not provide effective ownership structure for the new privatized SOE instead insiders end up controlling most of the more valuable companies and ordinary investors receive claims of the weakest and least promising SOEs.
- It ensures a wide share of shares ownership, where as a lot of people would have been too poor to buy and own a share.
- It yielded no cash inflow to the government or firms and thus there were no transfers of technology, capital and expertise from foreign investors or multinational companies to the privatized companies.
- It also gave the new owners of the privatized who where existing managers and employee little incentives to effectively restructure the firms operation and reduce the amount of staff needed in order to cut cost.
- In most cases, government never gave up the full control of important privatized companies to private owners other than managers because government still heard a majority shareholding and thus felt that the firms will be too strategic to be left unsupervised. This was because government wanted to ensure that no serious staff cut which would have impact on operational restructuring as the exercise was politically rational but economically deliberate.
- Government allowed the politicization of credit extension also made the newly privatized firms continue to enjoy soft budget constraint for an infinite amount of time also contributed to one of the weakness of voucher privatization.
3.0 Theoretical Framework and Literature Review
The privatization of SOEs has over time been a big and important issue in the growth and development of the economy. This has lead to the development of many theories which explains the ideas behind what is expected in principle and practice in privatization exercise.
This chapter will however discuss the relevant theoretical and empirical literatures of this research study objectives and rationale. This involves critically examining the theories that have been developed over time by different authors and how their impact privatization as regards the objectives of this study. This will also state why privatization is vital for the growth and development of some sectors and why, it will not in some other sectors within the economy. Finally, analysis on how privatization affects the performance of a firm will also be discussed.
3.2 Factors Determining Privatization
SOE were highly inefficient and grow at a very slow pace, too much bureaucratic issue can cause no room for quick decision making, innovative changes. Also constant government political intervention as well as administration changes is an issue. It is also over dominated by the power of Labor Trade Union (Veljnovski 1987). However after the successful privatization of BT in 1984 by the Thatcher’s administration, it became an economic policy that can be used to reduce the financial pressure on government budget as well as the concern to prevent SOEs from failing in terms of its inefficient use of financial and operational resources. But could this be a means to wealth creation for investors, who through the spread and acquisition of shares ownership, restructuring and refocusing of SOEs economic objectives as well as cutting of trade labor unions influence and power will see SOE to maximize both there operational and financial performances.
An argument that must be stressed here is that of the difficulty in interpreting the indictors of both operational and financial performance of SOEs post privatization within and outside the business environment economy. Take for example; poor financial performance may be consistent with high rate of internal efficiency if the formal is as a result of government policy of price control. However, since SOEs frequently respond to anticipated market failures, profit maximization and similar related measures might not necessary, be a reliable indicator for their poor performances over time (Ramanadham 1993). Rather this study will support that failure of SOEs, could be as a result of rapid demand for their goods and services faced by their steady but slow growth to reach maximum productivity movement rather than to totally shift production function to meet all demands and avoid poor operational and financial performance.
Yarrow (1986), however argued against privatization stating that competition and more forceful accountability will even be better than privatization in promoting both financial and operational efficiency but his argument has a limitation, it only focused on a small number of company within UK. Ramanadham (1993) pointed out that the objective of privatization is realized more if it becomes successful within a short period of time either by stock market price rise or increase in the level of efficiency or productivity bringing about instance economic growth and development. But when reverse is the case (if it fails), which happens some time it even makes privatization more undesirable. So it is best re-engineer SOE by over hauling it, as well s to set up a transparent regulatory frame work to remedy what might be a failure when the objectives of privatization are not met as anticipated in order to level the firms operational and financial performance post privatization.
In a further argument by Megginson et al (1994) whose strong support from recent theoretical and empirical perspective, that private firms will always outperform SOEs stating that privatization itself will always increase both the financial and operational efficiency of firms irrespective of the business environment. While another view by Moore (1992) who argued that the act of privatization promotes economic efficiency and public confidence (one of the major objectives of property right theory) in the system of industrial capitalism and thus SOEs should be sold off before efficiency gains can be realized. He also argued that the success of privatization transforms business attitude towards ownership, economic responsibility and towards the improvement of corporate performances. It also allows government play an important role of regulation the business environment leaving the ownership of firms in the hand of investors and individuals who will perform better as there are faced with scare resource and market forces.
It is clear now that different factors can lead to privatization especially when SOEs has underperform operationally and financially causing political pressure, budget deficit and waste of scare resource for the government and even to the extent of administrative failure.
3.4 Evaluation of the theories of Privatization
Principal Agent Theory
Vickers and Yarrow (1995) points out that a problem exist in the principal agent theory as the principal interest greatly lies in profit maximization and high return for investment therefore this aim might conflict with that of the agent who might pursue other objectives apart from profitability. Further stating that since the formal do not have full information concerning what is happening within the SOE and cannot fully control the attitude of the agents who might be over ambitious and purse his own objectives, this will certainly create monitoring problems for the principal. This in fact creates both financial and operational problems directly or indirectly.**
However when shareholders can influence the behaviors of agents (management) through vote as the only way to keep them in check, the agent might however work at a more efficient level and focus on a set objective towards profit maximization. On the other hand when the rate of efficiency increases, it leads to higher revenue which is mostly one of the objectives, to brings about higher income and dividend for its shareholders.**
Property Right Theory
This is a set of right to control assets. It is a consequently grants of authority made to an investor or a group of investors through right of issue of share or control either public or private and acknowledged by other persons or organizations (Lindblom, 1977)
De Soto (2006) argues that lack of formal property right is what has kept developing economies from been developed stating that it limits the amount of goods and services that can be exchanged in the market in order to have a sustainable long term economy growth. While Easterly (2001) opinion is quite similar to the views of Soto, Easterly suggests that property right is a s
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