Privatization in the Global Economy:
    Financial and Accounting Linkages for Selected Cases

    Privatization: An Overview

    Among several of the factors that have contributed to make privatization such a big issue are:

    1. The successful economic performance of Japan and the Asian Newly Industrialized Countries (Korea, Singapore, Hong Kong and Taiwan). Their growth has been characterized by intense competition with a very significant role for the private sector..

    2. A growing recognition that other models, like the command economy as practiced in the former Soviet Union, or the import substitution model as practiced in Latin America, proved to be unsuccessful as these countries tried to be competitive in the world markets.

    3. The emerging "fourth industrial revolution" driven by information technologies. These technologies affect competitiveness in a wide range of industrial subsectors, and is largely absent in the developing countries and Eastern Europe. The pace of change and the commitment to research and development has made it impossible for many firms to remain under the control of the state, where decisions are politicized and response to the market pressures is sluggish.

    4. The role of state-owned enterprises (SOE's) in Latin America and other developing countries had become important in both the industrial and service sectors. The monopoly status of SOE's has generally bred inefficiency and lack of competitiveness, because among other things SOE's are generally characterized by: poor financial performance, overstaffing, dependence on subsidies, highly centralized organizations, exclusion of competitive imports, poor export performance, corrupt practices and being vehicles for capital flight.

    Among the objectives of privatization are:

    1. Get government out of business to the fullest extent possible, to strengthen private market forces and competition.

    2. Generate new sources of cash flow and financing for enterprises, such as increased domestic investment, return of flight capital, foreign direct investment, external lending and deepening of domestic capital markets.

    3. Reduce the government's fiscal deficit and its external and internal debt.

    4. Other objectives of privatization are: generate new sources of tax revenue, improve the quality of services and increase domestic and international business confidence.

    Among the lessons learned to date from privatization are:

    1. Privatization is an intensely political process, which needs a clear political mandate and leadership from the top.

    2. Economic reforms, like a stable macroeconomic environment, trade liberalization, price liberalization, financial sector reform, elimination of subsidies are important in a successful privatization program.

    3. Institutional failure has slowed many of the privatization programs. Ministries are asked to privatize billions of dollars of assets without trained staffs, technical assistance, computers, etc.

    4. Developing countries facing major privatizations with international implications, need expertise from investment banks, consulting firms, accountants and lawyers.

    5. Privatization has required a new set of laws. Establishing clear and enforceable property rights goes to the heart of the privatization process.

    6. Selling some shares to managers and workers is an important ingredient of successful privatizations.

    7. Foreign and local investors will participate in privatization if rules of the game are transparent and efficient.

    8. Privatizations are often a complex and difficult process. Government should avoid setting artificial timetables for their completion, without eliminating the pressure on the whole process. (Lieberman, 1993).

    Strategic decisions have to be made about the scope of privatization. What, how much and how fast to sell is very important to determine. Some governments started privatizing small and medium-size firms in competitive sectors. That was the case of Chile, Mexico and Poland.

    Other governments, like Argentina and Brazil, have given priority to the privatization of large SOE's. There are very important reasons to adopt this strategy and not the former, among them: large privatizations provide instant policy credibility and send clear signals of government commitment to financial markets and investors, additionally, the potential economic and financial benefit may be worth the risks, and finally privatizing a few large loss-makers can have an enormous budgetary impact. (The World Bank, Privatization: The Lessons of Experience, 1992).

     

    Basic Methods of Privatization

    The most commonly used methods of privatization are:

    • Public offering of shares

    • Private sale of shares

    • New private investment in a State Owned Enterprise (SOE)

    • Sale of government or SOE assets

    • Reorganization (or break-up) into component parts

    • Management/employee buyout, and

    • Lease and management contract.

    Beyond the above methods of transfer to private control or ownership of SOE's or government productive assets, other actions are sometimes also referred to as privatization, or linked to it, among them:

    • Introduction of competitive features into a SOE (performance-related incentives).

    • Economic policy reforms, such as demonopolizing certain activities or liberalization, or reducing regulatory constraints on business; these reforms may be combined with divestiture of state-owned assets.

    • Increased use of private sector financing of new activities, such as contractor equity financing ("construct, own and operate contracts"), or switching of the source of financing for the supply of a good or service from taxation to user charges (for instance, the North-South Highway in Malaysia to be financed by toll revenue).

    • Revenue participation certificates or revenue bonds issued by the state or by state bodies.

    • Privatization by "attrition" (a SOE operating as quasi-monopoly but not renewing investments, gradually permitting the private sector to invest in plants and related facilities and take over all or part of the SOE's operations).

    • Contracting out, that is, the substitution for private contractors or services for production by the state or municipalities and franchising.

    • Full liquidation of a SOE with the assets ending up in the hands of private purchasers. (Nankani, 1988).

     

    Implementation of Privatization Processes

    In the stage of preparing for sale, small and medium-size SOE's have few financial or economic gains from any type of restructuring, but in large enterprises and monopolies, restructuring (legal, organizational, and managerial changes) is often a necessary prelude to sale.

    Highlighting the main phases of preparing a SOE for sale, it is important to consider:

    • To make organizational and managerial changes

    • To clean up enterprise liabilities

    • To deal directly and quickly with excess labor

    • To avoid new investments

    The following stage in implementing the privatization process is the pricing and valuation of the SOE. In relation to this aspect, the main idea, is that it is important to let the market decide the sales price through competitive bidding procedures. Asset valuation is essential in this area. However, technical appraisals seldom estimate correctly the market price of assets. In developing countries SOE valuation is difficult due to: a changing macroeconomic environment, poor and unreliable financial data, and unacceptable commercial standards.

    Overvaluation and unrealistic expectation on the part of government create serious delays. Many governments have chosen to set asking prices on the basis of historical book value (they wish to recover at least what they put in), but this has often led to valuation of eroded assets that bear little resemblance to what any buyer will offer. (In some cases, the result might be undervaluation, since book values are not adjusted for inflation).

    Overpricing shares in a public offering is another recipe for failure. Prices have to be low enough to ensure demand, full subscription and distributing ownership.

    To offset potential political and financial costs, some countries offer discounts to small investors and ask higher prices from institutional investors. Government has also sold shares in trenches, typically started with smaller share offerings and higher discounts, over time, as commitment was demonstrated and private sector confidence increased, larger percentages were offered, and discounts declined. For instance, the first half of British Aerospace was sold in 1981 for 150 million pounds; in 1985 the second half was sold for 275.3 million pounds. (The World Bank, Privatization: The Lessons of Experience, 1992).

     

    The Role of Accountancy in Privatization

    The Big Six Accounting Firms

    Over the past decade, the major accountancy firms have emerged as dominant providers of privatization services. Privatization is a complex process whose aim is to improve resource allocation through more private ownership, more competition and a minimized state role in economic activity. Privatization can include: liquidation of assets, denationalization and deregulation of public monopolies, restructuring of enterprises, establishment of franchises, promotion of joint ventures, and in some cases the reform of the entire economy.

    The "Big Six" are: Arthur Andersen, Coopers & Lybrand, Deloitte Touche Tohmatsu, Ernst & Young, KPMG Peat Marwick, and Price Waterhouse. These firms are a very large multinational professional service organizations, that have become global business advisors with multiple skills. The role of these firms is related to their reputation and their experience in bridging the gap between public and private sectors. They know how a private sector firm allocates resources, works to earn profits, and maximizes shareholder value. They can communicate this experience to their public sector clients, and make clear what privatization has to achieve.

    The major customer of privatization services fall into four categories:

    • Ministries of privatization/state property agencies,

    • State-owned enterprise management,

    • Regulatory agencies, and

    • Bilateral and multilateral development agencies.

    The skills and various privatization services fall into five general categories:

    • Planning for privatization

    • Implementation

    • Advancing transactions (valuation of enterprises)

    • Enterprise restructuring

    • Establishing the regulatory framework

    Some of the factors that impact these types of services are:

    • Program's objectives

    • Implementing country's level of economic development.

    Many of the skills described above are not the exclusive domain of the "Big Six". There are other providers, like: investment bankers, strategy consulting firms, management consulting firms, law firms, public relations firms, and engineering firms. However, the "Big Six", approach their role as service's providers for privatization processes as project managers, they tend to integrate, to consolidate, and to relate all areas involved. Other providers are dealer makers, they work on a success-fee basis, which means that they take a percentage of the earnings from the sale. (Mastrangelo and McPhail, 1993).

    The Accounting Consequences of Privatization

    Accounting is implicated in devising privatization opportunities, and is also a central part of post-privatization regulatory frameworks.

    The current drive for privatization may strengthen pressures for harmonization of accounting practices and may lead to greater convergence of private and public sector practices. Remain issues of performance measurement, and of accountability, and other aspects related to the impact on management accounting. New organizational forms for privatized companies can also have effect on the construction of accounting numbers. These new forms of organization are at the beginning still under the influence of government directives and statutes, which shape basic accounting practices, and as they change because of privatization, so may change some of those practices. (Lapsley, 1993).

     

    Privatization around the World

    In General

    Since the beginning of the 1980's, privatization processes have spread around the world in different forms and with different intensity, achieving so far some of its original objectives, and having to cope along the way with many roadblocks derived from the political and social implications of the process, the skepticism of the population and the mixed results accomplished.

    In Italy, IRI raised 2.8 trillion liras between 1983 and 1985 by issuing shares in enterprises like Aeritalia Aerospace Company. In Spain, SEAT car firm transferred control to Germany's Volkswagen, and ENASA to America's General Motors. (The Economist, 1985).

    In June 1993, Argentina pulled off the largest Latin American privatization and one of the biggest global initial public offerings (IPO) in 1993 with a $3.04 billion sale of its most prized assets, the oil and gas giant Yacimientos Petroliferos Fiscales (YPF). At $19, the original 110 million shares were increased to 160 million shares. The deal was heavily oversubscribed internationally and locally. (Robinson, 1993).

    In Venezuela, an ambitious privatization program started in 1991 with the selling of VIASA, the Venezuelan airline, and CANTV, the state-owned telecommunications company, for 1.8 billion US$. Lately it has continued with the privatization of the State-owned steel company in December 1997 and the planned privatization of the entire aluminum sector in March 1998.Late in 1998 it is planned the privatization of the Venezuelan public electric power utilities.

    In other parts of the world privatization programs are continuing to have enormous success, but this research has dedicated a special subsection to the United Kingdom, because of its extraordinary success in privatization programs.

    Privatization in the United Kingdom

    Privatization was an issue that appealed to Margaret Thatcher in the early 1980's for a number of reasons. First, it offered a solution to the persistent fiscal deficit problem. Second, it promised to increase the efficiency of noncompetitive firms that were in the government's care. Third, it could extend stock ownership to a wider population. And, finally, it would reduce the size of government and its involvement in the private sector. The success of the privatization programs in the United Kingdom has become a model for many countries. (Rukstad, 1991).

    One rationale for privatization was competition and efficiency. Another rationale was "popular capitalism", that is the broadening spread of the ownership of property throughout society. (Schnitzer, 1991).

    One of the elements that characterized the privatization process in the United Kingdom was skepticism.

    The privatization programs in the United Kingdom had opposition from politicians, hostility within the industries to be privatized, resistance from the financial community and doubts in the population as a whole.

    The quickest and most effective way to overcome skepticism was to carry out a very big, very successful, and very visible privatization. This was done with the sale of British Telecom in 1984. From that event on, the United Kingdom privatization program started to develop at a fast pace. (Moore, 1992).

    Summarizing the overall program the following data is presented from 1979 to 1992:

    Privatizations

    Date

    Company

    Type of Sale

    1979

    British Petroleum

    43.7% shares

    1981

    Cable and Wireless

    94.4% shares

     

    British Aerospace

    100% shares

    1982

    Britoil

    100% shares

     

    Amersham International

    100% shares

     

    National Freight Corporation Management Buy Out

    MBO

    1983

    Associated British Ports

    100% shares

    1984

    Jaguar

    100% shares

     

    British Telecom

    76.1% shares

    1985

    British Shipbuilders

    MBO

    1986

    British Gas

    100% shares

     

    National Bus Company

    MBO

    1987

    British Airways

    100% shares

     

    Rolls-Royce

    100% shares

     

    British Airport Authority

    100% shares

    1988

    Rover Group

    Sold to British Aerospace

     

    British Steel

    100% shares

    1989

    Water/Sewage Companies

    100% shares

    1990

    Regional Electricity Companies

    100% shares

    1991

    Generating Companies

    100% shares

    1992

    Trust ports

    MBO

    (The Economist, 1993).

 

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