Chapter 3. Measures to be undertaken before divesting
Prior to privatisation, public authorities will take preparatory steps for the company and possibly for the industry in which the state-owned enterprise operates to prepare for the transaction. This chapter covers: the legal changes required to go from a privatisation candidate to triggering the sell-off; appropriately staging the privatisation process to ensure success; pre-privatisation industry/company restructuring; addressing employee and stakeholder relations and concerns; deciding on the appropriate method of sale; and ensuring effective communication, transparency and integrity of the process.
Prior to privatisation, public authorities will take preparatory steps for the company and possibly for the industry in which the state-owned enterprise (SOE) operates to prepare for the transaction. This chapter covers the following areas: the legal changes required to go from a privatisation candidate to triggering the sell-off; appropriately staging the privatisation process to ensure success; pre-privatisation industry/company restructuring; addressing employee and stakeholder relations and concerns; deciding on the appropriate method of sale; and ensuring effective communication, transparency and integrity of the process.
Going from privatisation candidate to triggering the sell-off
To go from a privatisation candidate to triggering the sell-off, a number of legal changes will need to take place to formalise the sell-off. In many cases, this will include legal acts by parliament (e.g. the repeal, amendment and/or enactment of laws); sell mandates to government; new sector legislation; or revising specific SOE legislation (for example related to public policy objectives). The approach to legislation is largely a reflection of the existing legal framework, the way the SOEs are organised and the size and scope of the privatisation activity foreseen.
In general, two broad approaches to privatisation-specific legislation can be distinguished.
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Framework legislation: Some countries, especially those that still have ongoing privatisation programmes, have one unifying privatisation law, or a mosaic of laws bearing on privatisation processes. Under this approach, a comprehensive framework is put in place to address all aspects of the privatisation process, from the institutional and decision-making organisation to the disposal of the asset. The purpose of such legislation is to state the objectives of privatisation and the principles governing it, and to specify the institutional structure. In some cases, the legislation also seeks to provide for modalities of privatisation and to create special rights for the state post-sale, or conditions for the sale of shares to employees. Finally, a framework law usually contains a broad delegation of powers to the administration to deal with privatisation particularities. Typically, countries where the scale and scope of the privatisation activity has been large have adopted this approach because it provides the government with greater flexibility and predictability to formulate and implement privatisation policies.
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Transaction-based legislation: More infrequent privatisers generally have no overarching law for a privatisation programme, but in many cases pass a privatisation bill for each transaction, if this is required. A variation of the latter approach is employed in Japan, where legal authorisation is needed for privatisation, but can be combined with other legislative acts. Finally, some countries apply a more “public finance approach” according to which the conversion of corporate assets into financial assets is mostly a question of value-for-money, which does not require legal measures.
Whether or not parliamentary approval is needed varies across jurisdictions and may vary according to the level of ownership and control that is relinquished. For example, in Finland, under the State Shareholders and Ownership Steering Act, all decisions identifying the companies in which the state may relinquish its sole ownership (100% of the votes) or its control (minimum of 50.1% of the votes) of a given company are to be made by parliament. All other decisions on the sales of shares are made by the government.
It should be noted that some jurisdictions have taken additional steps to simplify privatisation procedures to avoid having to seek parliamentary approval for transaction-based privatisation depending on the nature of the transaction. This has helped to depoliticise the decision-making around privatisation as well as speed-up transactions when there is sufficient rationale, transparency and consensus around the government’s privatisation priorities.
In France recent changes to the privatisation regime have simplified privatisation procedures where a decree or ministerial approval is sufficient to pursue the transaction. The criteria for simplified procedures are often based on the level of ownership and control that is relinquished. The table below summarises the legal instrument(s) required based on the type of privatisation operation. As a general rule of thumb, where the privatisation involves the transfer of a majority of the company’s share capital, a large SOE (in terms of employment or turnover), or a company that has been under state ownership for over five years, a legal act and decree are required. For most other transactions, a ministerial decree is sufficient.
At the same time, it should be recognised that embedding privatisation in the legislative process could have important beneficial impacts on the transparency and predictability of the process. Even governments that are formally entitled to privatise state assets without specific legal authorisation, or that need only to seek the “approval” of parliament, have sometimes chosen to pass a sales act setting out the agreed modalities of privatisation (see Box 3.1). This has ensured that the privatisation process has secured legitimacy and agreement of stakeholders prior to embarking on the process.
Most countries have other specific rules applying to privatisation, for example provisions contained in public procurement rules, securities laws (in the case of public offerings) or general company law, which may naturally have ramifications for privatisation. However, these are not discussed in this section.
Appropriately staging the privatisation process
One of the key decisions facing privatisation officials relates to the staging of sales, in other words for how much and how fast the company should be sold. The decision as to whether the enterprise is to be sold in stages, or all at once, and how quickly is influenced by the interplay of the following factors: (a) company-related factors; (b) transaction-related factors such as the size of the asset and the absorptive capacity of the market; and (c) market structure and the existence of an adequate regulatory capacity.
Company-related factors - “Readiness”
Traditionally, many OECD governments have approached privatisation by starting with partial privatisation in order to increase total proceeds. Under this approach the state-owned enterprise is given an opportunity to improve its performance, build a track record in the market (particularly if investors are unfamiliar with the sector), overcome the price discounting arising from information asymmetries and fetch a higher price for the subsequent tranches. Furthermore, by retaining a stake in the company, the government can signal its confidence in the future of the company and its interest in maximising the value of its shareholding.
However, the success of this strategy is closely linked to government credibility in the market (see also Chapter 5 on good governance practices in cases of partial privatisation). If the partially privatised asset is vulnerable to government interference, this creates uncertainty for investors with adverse effects on the value of shares. It also means that the full benefits of privatisation in terms of improved efficiency may not be realised. It also does not result in full risk transfer to the private sector and could expose the government to moral hazard where the company is too big or important to fail. Nowadays, with less SOEs being listed in stock markets across the OECD area, sales strategies have shifted toward direct sales as the preferred sales methods.
One of the key questions the owner should determine is the “readiness” of the SOE to be privatised and that will depend on the company and its qualities. In Norway, the government systematically involves the board and management of wholly owned SOEs, through a steering group, to enlist their support before embarking on the privatisation process. The company’s management is asked to conduct a “readiness review”, which will evaluate whether the company has the appropriate corporate governance structures; strategy; reporting and disclosure practices; as well as capital structure. All these factors will be key to ensure the company’s value is increased should the privatisation transaction ensue; it may also lead to terminating the sales process should the owner determine the company is not “ready”. Some of the key areas to focus on include:
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Corporate governance: Does the company adhere to high standards of corporate governance, including the relevant code of corporate governance, or listing requirements?
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Strategy: Have the board and management streamlined the company? This may differ depending on the transaction mode selected (i.e. IPO, M&A, partial or full privatisation). The company will need to focus on identifying the main value drivers. For each transaction these will differ and the strategy must be “tailor made”. Moreover, much of the strategy pursued will depend on the sector in which it operates.
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Capital structure: The owner and board will need to deal with putting in place an optimal capital structure for the company. This might include defining a clear strategy and targets or adapting the state’s rate-of-return requirements and dividend policy.
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Non-commercial objectives: If the company is carrying out non-commercial objectives (e.g. public policy objectives, public service obligations, or an industrial strategy), the state will need to determine what will become of those objectives and how they will continue to be fulfilled (if relevant) following the transaction.
Based on the company’s “readiness”, the owner must then devise its own strategy for the transaction. This means being clear on: its own objectives and the level of ownership it may or may not wish to retain in the company; if it retains shares, what its strategy will be for the remaining shares it owns; the level of commercial/non-commercial objectives the company will retain, etc. Once “readiness” has been established, other factors will be important to determine whether the sale will go through including investor appetite and market conditions.
Transaction-related factors
Transaction-related factors such as the size of the asset and the absorptive capacity of the market also matter. In some cases the gradual approach to privatisation is dictated by the sheer size of the entity (too big to be sold in its entirety) and the limited absorptive capacity of the market, requiring that the sale be carried out in instalments.
Market-related factors
The market structure also matters. This means ensuring that the privatisation occurs in a context where there is adequate regulatory capacity to address potential concerns of excessive market power. A partial privatisation is often used as an interim step, even if the longer-term goal is full divestiture, to provide sufficient time for the development of the desired market structure along with the institutions that are necessary for the successful operation of the company.
Pre-privatisation industry restructuring
The consensus position among OECD countries is that a government should not privatise an SOE before an appropriate regulatory framework for the privatised entity has been established (it should be noted that this point is moot if those changes have already taken place well before the privatisation transaction). This implies that a privatising government needs to ensure that two separate, but related, regulatory frameworks are in place. First, an adequate competition or anti-trust regulation backed by effective enforcement mechanisms is needed. The consensus view is that privatised entities involved in any activity where competition on general market terms is feasible should be made subject to competitive pressures. This can be determined through a competition assessment (See OECD, 2009).
OECD, 2009 identified good practices with regard to pre-privatisation industry restructuring that can be summarised as follows:
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Governments should normally not privatise SOEs before an appropriate regulatory framework has been established. This framework includes anti-trust regulation to ensure competition where feasible and specialised regulation to oversee activities where an element of monopoly is likely to persist.
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Existing laws and regulations (including anti-trust and takeover rules) should apply to the privatisation itself. If exemptions are granted, such exemptions would need to be justified and fully disclosed in advance.
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The regulatory functions whose domain will be affected by privatisation need to be separated from the privatising unit, the state’s ownership unit and the executive powers. This can be obtained through the creation of an autonomous regulatory body outside the control of the executive powers or through, at least, a complete functional and legal separation within the state.
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Good practice calls for exposing as much as possible of an SOE’s activities to competition no later than at the time of privatisation. If monopoly activities necessarily remain the government faces a choice:
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Break up the company, sell the competitive parts and make specific regulatory arrangements for the rest;
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If the company is to remain vertically integrated during and after privatisation then there is a heightened need for independent and well-resourced regulation.
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Source: From OECD, 2009.
This leaves a residual role for the second important regulatory framework, namely sectoral regulation (for instance, third party access regulation) of activities that will necessarily involve an element of monopoly subsequent to privatisation. A further consequence of the consensus is that safeguards must be taken to ensure the independence of the relevant regulatory agencies in general and vis-à-vis any remaining ownership function that the government may retain. This underlines the primordial recommendation promoted by the OECD Guidelines on Corporate Governance of State-Owned Enterprises (“OECD SOE Guidelines”) to separate ownership and regulatory functions (OECD, 2009).
An additional issue is the degree to which the SOE considered for privatisation – or parts of it – can be subjected to competition. In the network industries, this is referred to as “structural separation”. SOEs in the network industries generally consist of many parts, some of which will remain monopolies. Through the process of structural separation, the latter parts are separated from those that are capable of operating in a competitive environment. In some past experiences where governments have privatised vertically integrated SOEs and introduced competition later, this has not been an effective strategy to achieve the long term goal of maximising economic efficiency through privatisation, as it simply creates a privatised monopoly with the potential for the monopoly to abuse its position (OECD, 2009).
In most cases, the government has opted to separate “commercial” parts of a utility, typically including the retail side of business, as part of the corporatisation process. What then happens depends on national preferences. These units may be privatised subject to standard competition policy safeguards, or they may be retained as independent subsidiaries of the SOE whilst their competition with private entities is introduced.
The European Commission’s Guidance Paper on state aid-compliant financing, restructuring and privatisation of state-owned enterprises helps to clarify instances of state aid when undergoing a privatisation process.
The EU has developed guidance clarifying the impact that state aid rules could have on the policies and decisions of member states undergoing economic adjustment programmes, which have committed to reducing the strain on public finances among others by restructuring and/or privatising SOEs.
For privatisations not to entail state aid, public authorities must ensure that they are done on market terms and that no advantage (typically in the form of foregone revenues) is given to the buyer and/or the sold undertaking. This is particularly the case for highly indebted companies, for which liquidation is a plausible option.
In order to identify or exclude the presence of state aid in the privatisation context, the Commission relies on the Market Economy Vendor Principle (MEVP), i.e. the assumption that a private vendor that intends to sell his company would do so for the highest possible price and without imposing conditions that would be liable to depress the price. When selling (assets of) a publicly-owned company, the member state – in order to exclude the presence of state aid – must in principle likewise behave as a market economy vendor seeking to maximise the revenues (or minimise the loss) from the sale.
In order to make the company more interesting for potential buyers, member states may decide to “clean” or restructure the asset side and/or liability side of the company’s balance sheet. These preparatory measures for the privatisation of SOE will in many instances entail state aid, possibly in the form of restructuring aid or as pure financial measures without any accompanying changes to the firm’s business or corporate governance model.
In particular, write-off of state debt, debt-to-equity/asset conversion and capital increases before privatisation will constitute state aid if they do not adhere to the principles explained above. Conversely, in the case of privatisation by IPO or sale of shares on the stock exchange, debt may be written off or reduced without this giving rise to state aid in the specific case where the proceeds of the flotation exceed the reduction in debt.
Source: European Commission (2012).
The final choice is whether the hard core monopoly elements of utilities SOEs should themselves be privatised. The retention of such “natural monopolies” under public control is widely supported by economic theory and in practice the main argument for transferring them to private ownership is normally a need to address major operational inefficiencies that have accumulated due to the public ownership. Privatising such enterprises highlights the need for independent and well-resourced regulation. A case in point is the so-called universal service obligations (USOs) that will normally follow this part of the enterprise. A means of treating USOs post privatisation will need to be established. If the SOE is corporatised, and perhaps sequentially privatised, then public service obligations are identified, costs funded and, ultimately, a contractual process is made to ensure fulfilment of those obligations to ensure competitive neutrality (OECD, 2012). In the case of a vertically integrated privatisation the state can impose USOs on buyers and let the competitive sale process sort the costing and funding out, however as mentioned this is not a preferred route (OECD, 2009).
Regardless of the restructuring option, special attention will need to be paid to the competitive conditions that it creates for potential or actual competitors on the market; and for the ultimate outcome to ensure competitive neutrality. In the case of the EU and European Economic Area countries, this is particularly important to ensure that any eventual restructuring does not result in violations of EU State Aid rules (see Box 3.3). A case study from the Latvian banking sector is an example of such pre-privatisation restructuring necessitated by EU State Aid rules (Box 3.3).
Sale of Citadele Bank
Parex Bank – the second largest bank in Latvia in terms of total assets (~EUR 5 billion at the time) – was severely hit by the financial crisis in 2008. The Republic of Latvia regarded the bank as being of systemic importance for the financial system, hence provided substantial state aid, including capital aid, liquidity aid and state guarantees. Given its extensive restructuring and banking experience the European Bank for Reconstruction and Development (EBRD) became a shareholder in Parex Bank (25% plus one share) in 2009. This immediately sent a strong positive signal to the clients of the bank and strengthened the bank’s viability.
As the European Commission has strict rules on exceptional cases in which governments can provide support to commercial entities, Latvia and Parex Bank undertook extensive commitments restricting the use of state aid in view of a complete disposal of state ownership within a strict timeframe.
In 2010, as per a restructuring plan approved by the European Commission, Parex Bank was split into a so-called “good bank” taking over all core assets (Citadele Bank) and a so-called “bad bank”, which kept the remaining non-core and non-performing assets (Reverta). Specific behavioural and disposal commitments remained in force for each institution.
In December 2013, the Latvian government approved a strategy for finding investors for Citadele Bank. A high-level Steering Committee comprising various stakeholders (relevant ministries, the EBRD, Citadele Bank) was set up to drive and supervise the sales process. At the outset a number of financial and non-financial (policy) objectives were defined and thereafter approved by the Latvian government including, inter alia, stability of the financial system, diversification of local banking capital sources, development of the local stock market, achieving the highest possible value and full compliance with EU state aid regulations.
Following an international tender, Société Générale and Linklaters were appointed as the investment bank and the legal advisor, respectively, to organise the sales process in line with best practices. Following a 12-month dual track (M&A and IPO) sales process, at the end of 2014 a group of highly reputable international investors led by the US investment firm Ripplewood acquired a majority stake in Citadele Bank. The EBRD retained its shareholding. The bank is still owned by the same shareholder group. The sale of Citadele Bank to private investors has fostered further development of the bank and benefited the Latvian financial sector.
Owing to the scale of the transaction and the considerable public funds involved, the sale of Citadele Bank attracted strong media attention and triggered public debate. A number of ex-post audits have been conducted to date (for example by the State Audit Office and the Parliamentary Investigation Commission) to evaluate the results of the sales transaction. Several key observations and conclusions can be drawn from the sales transaction itself and the results of the ex-post evaluations:
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Non-financial (policy) objectives are usually not communicated or explained sufficiently to the general public.
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The achievement of non-financial (policy) objectives is more difficult to measure and their impact is usually visible in the medium term, hence many ex-post reviews tend to focus excessively on evaluating only financial outcomes. Ex-post evaluations also tend to take into account information not available at the time of the actual transaction (“in hindsight”).
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Balancing strict confidentiality requirements usually applicable to M&A and IPO transactions with the need for high transparency in transactions connected with disposing assets directly or indirectly owned by the state has proven to be a challenge for all stakeholders involved.
Source: Submission from the Latvian authorities.
Pre-privatisation company restructuring, legal changes and other factors
Pre-privatisation restructuring is not a pre-requisite for all transactions, and is best handled on a case-by-case basis. The degree and need for company-specific restructuring is shaped by factors such as: the size of the enterprise; the planned method of sale; the structure of the market in which it operates; government objectives with respect to the envisaged market structure post-privatisation; and environmental impacts.
Typically, privatisation of larger companies and of those operating in monopoly sectors of the economy are preceded by company-specific restructuring. This process may or may not be part of broader changes as markets are liberalised and competition is introduced.
Pre-privatisation restructuring of SOEs is more commonplace prior to IPOs. However, in some cases restructuring may help attract more bidders to a trade sale auction and hence boost the proceeds. As discussed in previous sections, the market structure and the government’s objectives concerning the introduction of competition are other significant determinants of restructuring decisions.
Where restructuring occurs, it can pertain to (see also Figure 3.1):
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1. Strategic restructuring whereby the corporate performance, business strategy and focus of the company are considered. This might include making changes to board composition; and if the board so decides, making changes to the management composition to make a shift in management culture or putting in place new leadership with the right skills and a strong commitment to privatisation. It might also pertain to improving corporate governance practices and possibly bringing them in line with existing corporate governance codes and listing requirements, or revisiting the business plan or corporate strategy of the company. It might also involve ensuring the company is subject to certain levels of transparency and disclosure and has appropriate control systems in place on par with private sector peers.
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2. Operational restructuring pertaining to management or at the employment level. Where countries have strict employment protection laws or special employment regimes for public employees, restructuring may pertain to public sector employee contracts or the restructuring of pension liabilities. It may pertain to the issue of remuneration and the use of options in compensating company leadership, including share ownership.
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3. Financial restructuring. This may include restructuring of the corporate balance sheet to align the debt-equity ratio with the prevailing levels in the private sector. It might pertain to restructuring of liabilities, ensuring a sustainable and optimal capital structure and the general “cleaning up” of the company balance sheet in order to make it marketable and to increase its potential value. The state owner might also re-evaluate its rate-of-return requirements and dividend policy in view of a potential privatisation.
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4. Legal and regulatory restructuring. Changes to the legal form of the company may be necessitated to adapt to the regulatory requirements in the market place. This might relate to separating monopoly elements or “strategic” activities from SOEs prior to privatisation - this is often seen in the public utilities sector. There may also be a need to divest SOEs of certain assets prior to privatisation. This question has for example arisen: when the company had subsidiaries that were either incongruent with its own business plans and hence could complicate privatisation; when the subsidiaries were held jointly with enterprises other than the potential purchasers; and when the combined market share of the subsidiaries and the potential purchasers gave rise to antitrust concerns. In other cases this might pertain to separating assets of relevance to national security.
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5. Ownership restructuring. In countries with active privatisation programmes, a decision may be required to shift the exercise of ownership rights from one entity (e.g. line ministry) to an entity assigned by law to carry out the transaction (e.g. privatisation agency). Careful design of the process, including support from the highest level is necessary to ensure smooth transfer subject to agreed timelines.
Other factors to take into consideration during this phase include undertaking due diligence required prior the privatisation and specific risk mitigation plans to deal with them. Due diligence can cover all aspects of the transaction, including potentially environmental audit in case of residual environmental liabilities (Box 3.5).
This category also covers the separation of non-national security related assets which will not be slated for privatisation - for example non-corporatised assets such as real estate, or items of art or of public interest which would be potentially separated out prior to the privatisation.
SOEs that are subject to standard environmental rules may (like any other company) carry heavy environmental liabilities due to polluting activities in the past. National privatisation practices in respect of these appear to differ, with a majority of countries transferring these liabilities to the privatised entities, but a few (e.g. Austria, Slovak Republic and Sweden) under some circumstances either assuming the responsibility or compensating buyers accordingly. The national differences may reflect privatisation methods. In the case of the trade sale of an entire SOE, environmental liabilities would be the subject of buyer and seller due diligence and reflected in the ultimate sale price. Where SOEs are offered through IPOs to the public it may be politically less easy for governments to “wash their hands” of longstanding environmental liabilities. However, in that case they need to ensure themselves that any compensation paid to the SOE in this regard does not rise to the level of unintended (or, in the case of EU countries, illegal) state aid.
Source: OECD (2009).
Addressing employee and stakeholder relationships and concerns
As mentioned earlier, involvement and consultation with employees and labour representation early in the process is critical to ensure its success. Before undertaking a divestment, the state owner should be informed of the applicable labour laws and civil service codes and their impact on the treatment of SOE employees during and after the privatisation process. This varies significantly across countries. For example, in some North European and other countries civil service status cannot be rescinded, so if the employees of an SOE prior to privatisation have civil servant contracts then these contracts must either be grandfathered post privatisation or the individuals must be offered alternative employment. In other countries the SOE employees’ contractual situation and salaries are adapted to the conditions in the private sector, but they are offered mitigation measures such as direct financial compensation or employee shares.
In some countries job security is offered to the SOE employees of privatisation candidates. This can take the form of either employment retention guarantees as part of the state’s agreement with the buyer, or post privatisation controls. Such measures may be either generally offered or, more commonly, the state may have the option of applying them. Some examples are provided in Box 3.6.
Most countries do not report specific measures for the treatment of employees during and after privatisation. For those that do, a sample of national practices is provided below.
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In Turkey, the Privatisation Law establishes a number of compensation and mitigation schemes available to SOE employees that lose their jobs due to privatisation. These include a special “job loss compensation” in addition to the redundancy payment rules generally in force; rules on the reassignment of redundant staff within the affected organisation or among public institutions; social assistance supplements to eligible individuals; and pension bonuses to staff qualifying for early retirement.
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In the United Kingdom, if the status of employees changes as a result of the restructuring of the business, it is possible that for incumbent staff certain terms and conditions apply to protect employees’ rights. This pertains to the Terms and Conditions under the Transfer of Undertakings (Protection of Employment) [TUPE] Regulations 2006 (updated by new Regulations in 2014) which applies to organisations of all sizes and protects employees’ rights when an organisation they work for transfers to a new employer. The TUPE applies when employees are moving from government employment to private sector employment.
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In France, the legal framework applicable to privatisation does not include any special provisions for the treatment of affected workers. This treatment is subject to the common law of companies and to labour law (in particular where there is a transfer of an undertaking), or public employees may be the subject of discussions between the state and the acquirer of the public shareholdings in question. However, in certain procedures for the sale of securities, the state may wish, before the transfer, that the purchaser define a social project in the offer, including information on changes in employment in the company. Thus, in the specifications published by the state concerning the privatisations of the airport companies of Lyon and Nice, the state asked the purchasing candidates to present proposals on wage policy, profit-sharing and employee participation.
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In Germany, there is no general provision. Insofar as members of staff are civil servants benefitting from interminable appointment, their contractual entitlements must be respected and preserved. Provisions on the employment of civil servants post privatisation would require specific legal action. Examples in the past have included the transfer of civil servants to SOEs not slated for privatisation.
Source: OECD (2018).
Should a significant restructuring process be accompanied by a workforce reduction before or anticipated immediately following the sale, it is important to involve employee representatives at the enterprise level to discuss, anticipate and mitigate effects on employment and the company. Although this consultation happens at the enterprise level, the entity responsible for steering the transaction should ensure that the appropriate structures are in place to ensure meaningful information exchange, consultation and negotiation.
Separately, and as discussed in later sections of this report, some jurisdictions may incorporate special provisions (in terms of pricing; number of shares for "Minimum Lot"; preferred bonus share) for employees to participate in the privatisation process itself, specifically in the case of a public offering. In Italy’s recent IPOs involving SOEs (e.g. Italian Postal Services Group), a “special” tranche was addressed to employees residing in Italy to participate also in the retail Italian tranche of the offering reserved for domestic retail buyers. The orders were submitted to the intermediaries for a minimum number of shares (the “Minimum Lot for Employees”) or multiples thereof. The so-called Minimum Lot is lower than the ordinary one (for instance, 50 shares for the employees versus 500 shares for the retail investors) and the employees may have different bonus shares after a defined holding period (1:10 for the employees versus 1:20 for other retail investors).
Deciding on the appropriate method of sale
This section explores the merits and demerits of different privatisation methods, including their possible impact on privatisation proceeds, the market and corporate performance.
The choice of privatisation methods is guided, among other factors, by the size of the enterprises to be sold, market conditions and the objectives of the process. It should be noted that often the government will not have a menu of options to determine the sales method, as this will depend on the business and the government’s objectives, as well as the asset, market conditions and other external factors. The sales method and timing of the transaction may also change, or in some more extreme cases may be terminated mid-way through the process if the owner determines that its objectives and rationales (which will vary from transaction to transaction) set at the start of the process are not met.
Among countries, privatisation methods may also vary according to the relative maturity of the economy in which the privatisation is taking place. The post-transition economies have mostly sold off small SOEs through trade-sale auctions to strategic private investors. Most other countries have relied on share offerings to privatise large companies and trade sales to privatise smaller firms. Privatisation through management buy-outs has become rare, but it still occurs. The main privatisation methods, described in further detail in the sub-sections below, are as follows (Table 3.1):
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public share offerings in the stock market (see also special section below)
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trade sales/auction to private firms
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management and employee buy-outs
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a combination of more than one of the above methods.
It should also be noted that the ownership entity will have a varying degree of involvement in “steering” the privatisation transaction depending on the method of sale chosen. For example, for a merger and acquisition, the owner will typically be very involved in that process because it involves selling its shares. If divestment entails a public share offering, this process would typically involve the board and management, which would be selling the company on behalf of the owner. The level of advisory services will also be adjusted depending on the method of sale.
Public share offering
What is it?
Privatisation through public share offerings is an open competitive process whereby the shares of a company are floated on the stock market. Initial public offerings (IPOs) are the most transparent method of sale, but are also the most expensive approach due to the complexity of the process which also often requires more specialised expertise than for example trade sales, raising the likelihood that governments will need to draw on external advice. They require a great deal of preparation and planning, involve significant restructuring of the company, and draw heavily on the services of a vast array of advisors. These include lawyers, accountants, investment bankers, industry consultants, public relations professionals and marketing advisors. In addition to transferring ownership and raising funds for the selling shareholder (i.e. the government), public offers often raise additional capital for an enterprise through the issue of new shares and this capital can be used to grow the business, repay external debt, etc. (see Figure 3.2 and Special Section).
Depending on the size of the offering and the depth of the domestic capital markets, investors targeted for such IPOs could originate from the domestic market and/or international markets. Moreover, the listing itself could originate in the domestic stock market or abroad.
When is it most appropriate?
An IPO requires the enterprise being privatised to be of sufficient size and quality to justify a public sale of shares. Given the amount of preparation and the costs involved, public share offerings have typically been used to privatise larger companies with a potential for good performance and where there is sufficient market appetite. The company will also need to have governance and management practices that can sustain the scrutiny of investors and capital markets regulators. This means, for example, being able to comply with listing requirements1 and national corporate governance codes, reinforcing independent directors in decision-making and other such features which provide confidence and protection to investors and ultimately lead to a more transparent and efficient management.
Privatisation through share offering requires the existence of a relatively well-developed financial and legal infrastructure. This means stock markets that are relatively liquid and deep and a fairly sophisticated set of laws governing property rights, companies, insolvency and bankruptcy. In some cases, privatisation has in itself served as a vehicle for enlarging and deepening local capital markets.
Disadvantages?
Public offerings tend to produce dispersed shareholdings which in the absence of a well-functioning market for corporate control can deprive the company of strong governance. In terms of the revenues raised, public offerings are generally more expensive to execute compared to a trade sale due to the complexity of the transaction and reliance on specialised expertise, and could entail some degree of loss of revenue arising from discounting of shares and offering incentives.2 Moreover, IPOs/secondary sales are often more expensive than other sales because of the fee structure of underwriting banks which take on risk on behalf of the seller (see also Box 3.5).
Furthermore, public share offerings lack the degree of flexibility afforded by other forms of privatisation. For example, privatisation through a public share offering does not necessarily bring in expertise and experience from a specific strategic investor, who could for example introduce more efficient management methods, introduce new technology and know-how, enhance profitability, etc. For this reason, company restructuring may be necessary before undertaking the public offering process.
How does it work?
In the course of the IPO, shares are usually offered to retail and institutional investors, although this process is decided by the government, the company and the managers of the share issue on a case-by-case basis. In the case of share issue privatisations, most are fixed-price methods where the government decides on a share price a few weeks in advance of the offering date. Governments typically use tender offers or book-building for the institutional or foreign tranches. A fixed price method is popular with risk averse issuers; whereas governments may be more willing to use book building or auctions to maximise issue proceeds in subsequent offerings (Jones et al., 1999; OECD, 2016). In other cases, for example in Sweden, share price intervals are quite common with a ceiling. The interval can range between 5 and 6, and up to a 20 % difference between the lowest and highest offer price. Depending on the share demand the final offer price can be higher or lower. This is quite common for companies that are difficult to value prior to going public.
Secondary offering is the public offering of shares of an already listed company. It is used for example when companies are of such a substantial size that a sale of the targeted percentage to investors could not be made in a single transaction, or, more often, when governments want to further reduce their stake in a company following an IPO. The sales process may be less complex than that of the IPO; for example, setting a price for shares may be less difficult because the shares are already traded and have a market price.
Another form of secondary offering is through the process of accelerated book building (ABB) the government charges a number of financial intermediaries (typically investment banks) with placing tranches of shares of already listed SOEs with institutional investors. ABB is a technique mainly used for divestments of shares to institutional investors, which reduces preparation periods (less than a month) and execution window (a few days), allowing to minimise legal and other related costs. It does not require the presentation of a prospectus nor the creation of advertising campaigns. As such it can allow for flexibility and differentiated market exposure according to various implementation methods. The prices obtained may come at a discount relative to public offerings, but this is compensated for by the relative cheapness and speediness of the method (Box 3.7).
A separate form of share offering of a rarer nature involves capital increases by SOEs themselves. Such transactions are usually motivated by a perception that capital cover of the enterprise has become too thin and that there is an unwillingness – especially in the case of partly owned SOEs – on the part of the government to contribute fresh capital. Capital increases are also seen in combination with share offerings by the government itself, a method that may in practice be a close substitute to adjusting the capital structure of the SOE prior to privatisation (OECD, 2009).
In October 2014, the Italian Ministry of Economy and Finance announced its intention to sell a minority stake in the national electricity company (ENEL), to be carried out with the use of sale techniques suitable for a quick equity placement aimed, directly or indirectly, at institutional investors. Similar procedures were already used in the past and the Ministry was supported by a financial advisor - acting also as independent appraiser - and by a primary international law firm for what concerned the legal aspects of the deal. The sale of the fifth tranche of ENEL was carried out using a process of an Accelerated Book Building (ABB) with a backstop clause.
The ABB is considered a favoured technique due to minimised costs, maximum flexibility and quick execution period. In the case of ENEL the transaction was preceded by the identification of 14 banks which presented their price offers at the start of the transaction. The bids were for a fixed purchase and then were followed by a placement (on the market or with investors’ institutions) of a substantial quantity of the offered stake.
According to the Italian authorities, the backstop clause ensures a minimum level of the sale price and transfers risk for unsold amounts to the bank syndicate. In other words, the backstop assures that a defined amount of shares will be purchased even if there are not enough interested investors. By entering into a strong commitment of underwriting, the banks have full responsibility for the quantity of shares guaranteed, if they initially go unsold, and provide the necessary funds in exchange for the available shares.
Starting from October 2014, the Ministry of Economy and Finance has monitored the equity markets and the performance of the ENEL stock, in order to identify the most appropriate time window for the potential placement of 540 116 400 shares, equal to 5.74% of the entire share capital. On 25th of February 2015, due to the positive intra-daily performance of the security, the Ministry started the sale process, inviting the previously selected banks to present their bids.
Four banks offered the best backstop price, which involved a 1.2% discount compared to the closing price of the previous days and as such were selected as joint book runners. The deal yielded an overall income of around EUR 2.2 billion, used in the same year for buying back Italian Government Securities.
The price on the official market showed a slight reduction the day after the ABB, mainly due to technical reasons in the allocation process of the shares by the banks. However, in the following days, ENEL shares reached the maximum range of price in the period of last three years, which has been cited as a factor of success and “fair market value” sale by the Italian authorities.
Source: Submission from the Italian authorities
Trade sale/auction
What is it?
A trade sale involves the direct sale of shares of a state-owned enterprise or asset from the government to the buyer through negotiations or a process based on competitive bidding. In many cases, the buyer can be a strategic investor which has the same operations and its acquisition of that stake is in line with their overall expansion strategy. However, increasingly, private equity firms have also figured among buyers - especially prior to the global financial and economic crisis. The percentage acquired is often 100% of the company. In some cases, however, it can represent a minority stake in a privatised entity but would still require a substantial role in management.
When is it most appropriate?
Unlike public share offerings, trade sales are typically carried out with minimal legal restructuring, require less planning and are thus cheaper and faster to execute. This does not mean that they are not complex in their own right - because the (large) companies that are sold through a trade sale are often not fit for an IPO. In terms of prerequisites, trade sales also have the advantage of being feasible in the absence of a well-developed and sophisticated market environment.
A key specific benefit of a trade sale is the experience and know-how that a strategic or financial investor might bring. For this reason it is often used for the sale of small- and medium-sized companies and in companies that might benefit from the introduction of strong management and infusion of technology. Another potential benefit is that it can provide an avenue for promoting foreign direct investment, if this is a broader governmental objective.
Source: Submission from Swedish authorities.
It should also be noted that the state might pursue a dual track sale - in other words starting the process of privatisation with either a trade sale or IPO in mind. It can then decide on which process will be suitable and render the best price. A trade sale also costs less than an IPO and can thus be more cost-effective depending on the size and value of the company.
Disadvantages?
The sale of a stake to a strategic investor may not bring in the strict governance regime that a listed company needs to comply with, although it has to be noted that many such investors do impose such standards and discipline either because they are listed themselves in their home market or in some cases by virtue of their global/international profile.
In terms of process integrity the main drawback is that trade sales do not provide the same degree of transparency as public offerings and therefore they may potentially be prone to corruption, in particular when they are conducted through non-competitive processes. In this context a fully transparent process and the establishment of clear and detailed procedures for conducting negotiations and selecting buyers can go a long way in alleviating such concerns and help protect the integrity of the process.
The two main factors that may militate against trade sales of an entire enterprise are: (1) competition concerns related to the combined market share of the acquirer; and (2) the case where the SOE to be privatised is very large relative to the size of domestic (or, if the SOE operates internationally, relevant) markets and existing competitors.
How does it work?
There are two main types of trade sales used in privatisations: auctions (competitive bidding) and negotiated sales. Auctions have been more common and may be considered more transparent than negotiated sales. It is up to the government, the company and their advisors to choose the method most suited to the case at hand. Irrespective of the method chosen, it is vital for the process to be conducted in an organised and transparent manner, balancing revenue maximisation with other policy objectives.
Negotiated sales
Under this approach, the government has the flexibility to negotiate with buyers individually and to present a different set of conditions to each. This option might be well-suited where there are relatively small equity markets, and the number of potential buyers for an asset is limited thus rendering a competitive sale process uneconomic. The main drawback however is the possible lack of transparency. For this reason, the selection process must be transparent and clear rules need to be established to mitigate against the potential risk and perception of abuse.
Auctions (competitive bidding process)
The other approach to trade sales is through a competitive bidding process. This approach can take two forms. First, it can take the form of a simple price-based competitive bidding process where price is the sole criteria for the sale. The second approach involves a competition for a business plan design and an evaluation of the bid based on a combination of factors and not just price. Factors that may influence the choice of one method versus another include: the size of the asset; the nature of the product market and whether there is adequate competition; and the extent to which there may be continued need for public policy objectives such as universal service obligations.
Source: Adapted from OECD (2016).
Governments usually do not sell an entire SOE or even a controlling stake in an SOE in the initial offering. The main dividing line among government owners relates to whether the intent behind an IPO is an eventual full privatisation, a continued state majority ownership, or a significant minority ownership. Hybrid approaches are of course possible: some governments, at the time of IPO, defer decisions regarding possible secondary and tertiary offerings to a later date. The division can be described thus as follows:
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Continued government control of the listed entity is foreseen. In this case the main motives behind listing can be purely fiscal, or may reflect a strategy of relying on market mechanisms to lift the SOEs’ corporate performance.
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IPO is seen as the first tranche of a full privatisation. Large SOEs are usually privatised through listing rather than trade-sales. The pace of the privatisation process (i.e. of subsequent share offerings) may depend on a number of factors:
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Going slow. Where the SOE to be privatised is large relative to domestic capital markets there is a clear case for going slow in order to obtain the best price. Also, a gradual process allows time to upgrade corporate governance and regulatory frameworks, thus further boosting the valuation of the company. OECD (2009) showed that the largest privatisation proceeds from SOEs in the utilities sectors normally derive from the tertiary share offering.
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Going fast. If capital markets are liquid and have a high absorption capacity, and if the privatised company is perceived as well managed, then there is little incentive for governments to drag out the privatisation process. Some delays may, however, be necessary for practical reasons, such as settling legacy contractual and staff issues.
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When going to the stock market the government owner will be confronted with a series of decisions as to how to price and market its company’s shares, how to transfer control and how to allocate shares. Unlike private sector issuers, governments may pursue listing with different objectives than private issuers. This may be influenced by both economic and political factors, and governments may approach listing by placing various weights on these two competing goals. The relative importance of each goal is determined by the country’s unique motivation to list (i.e. historical, cultural, fiscal, etc.), which may have an impact on the pace, scope and structure of the listing process.
According to OECD (2016), over 90% of share-issue privatisations are oversubscribed. This is attributed to the fact that governments’ share allocations almost always guarantee significant portions of the offers to domestic and retail investors, as opposed to foreign and institutional investors. By discounting stock, governments also indicate that they are willing to accept lower proceeds resulting from privatisation. On the one hand, this can result in the IPO being criticised by opponents of privatisation, since in some cases discounted stock can give the impression that SOEs are offered for less than market value. On the other hand, it may provide political support for the process, and attract a larger share of domestic ownership, which may also help achieve other goals such as developing local stock markets. Discounting shares for employees may also build further support for privatisation with labour unions or employees.
On the flip side, government officials may pursue higher prices as a strategy to maximise proceeds from privatisation to meet specific fiscal objectives. Countries with less developed capital markets are more likely to discount shares in IPOs to promote broader share ownership
Generally, the benefits of listing can only be reaped in an environment where the stock market and legal system are sufficiently functional to establish effective corporate governance that protects the interests of all shareholders, especially minority shareholders (Wang et al., 2004). In other words, the intensity of capital market pressure will also depend on the extent to which individual shareholder rights are protected and enforced; and the extent to which the disciplining effect of non-state shareholders may be felt more strongly. The performance benefits yielded by going to the market should also be weighed with the level of market competition and deregulation.
Source: OECD (2016).
Management and employee buy-out
What is it?
Management and employee buy-outs (MEBOs) typically refer to privatisation through the sale of the enterprise to a new legal entity in which a significant, or majority, stake is owned by the employees and managers. The buyers may be only employees, or only managers, or a mix of the two. The transfer could involve all or part of the assets or shares in the company and the method by which the sale is financed may or may not involve a commitment of funds by the employees and managers.
When is it most appropriate?
It has been widely argued that the introduction of a significant amount of insider equity ownership can have a positive effect on corporate governance and efficiency in that it leads to closer monitoring of performance and helps align the employee and management incentives with those of the owners (converts agents into principals). Governments might encourage MEBOs as a means of improving corporate efficiency and gaining employee support for privatisation. MEBOs also tend to be suited to smaller companies.
Disadvantages?
This approach to sale can also have corporate governance weaknesses in that insiders may seek to pursue objectives such as job security and job-based utility and forgo the increase in the value of the company. This could be particularly the case where the acquisition of the stake has not involved a financial commitment by this group of buyers (i.e. the stake has been a giveaway) and where effective external monitoring by outsiders and hard budget constraints (e.g. through the lending financial institutions and the need to meet debt service payments) is absent. It also can restrict access to capital: if the business is acquired by its management team without the support of a financial investor, it may not be easy to raise equity if it’s needed. Furthermore, where employees are a heterogeneous group in terms of their skills, interests and objectives, effective decision-making can be hampered as a result of the need to reconcile conflicting objectives.
How does it work?
The transfer of part or all of the assets can take place through a purchase of the company by employees, management or both. In some cases the shares can either be given away or purchased by the employees/management. Financial institutions can also be involved as a source of credit or as buyers.
MEBOs are most often considered as part of a broader privatisation process whereby part of the stake in the company is sold to management and/or employees, with the remainder of the sale taking place through a negotiated sale, or as part of a competitive process.
Mixed sale
What is it?
Mixed sales typically combine trade sales with a public share offering and/or the sale of stakes to employees. In a mixed sale, privatisation usually begins with the transfer of some degree of control (66% of voting rights, i.e. a super majority; 51% absolute majority; or some relative majority, e.g. 33.5%) to a strategic buyer. It is then followed by the public offering of shares on the stock market. A third possible component is the placement of some portion of shares with the company employees, as a means of ensuring worker participation.
When is it appropriate?
Through this approach governments are able to achieve multiple objectives. For example, with a trade sale the company may undergo management changes and restructuring required before being publicly traded. After the new ownership structure has improved efficiency and created value in the company, further privatisation can possibly secure higher share prices in subsequent tranches. Furthermore, by having the trade sale precede the public offering, the government is likely to obtain a better price for the stakes sold than if it were to do it once the shares have been trading in the stock market, depending on how share price is determined.
Disadvantages?
A mixed process takes longer, will require additional advisory services and can be costly to execute. Furthermore, the success of a multiple-staged process, which culminates with a public listing, will require that the first stage of privatisation goes smoothly.
How does it work?
The order by which the different sale methods are combined varies. It is most common that the sale to a strategic investor precedes the public offering of shares. The success of this strategy is critically dependent on the government’s ability to ensure that good corporate governance practices are in place to protect minority shareholders. In the absence of such practices, shareholders might be abused by the controllers and as a result public offerings will lose credibility with damaging effects on capital market development.
Convertible bond
What is it?
A convertible bond gives the bond holder the option to exchange the bond for a predetermined number of shares in the issuing company. The issue of convertible bonds is a means to collect capital at a lower cost than the issue of ordinary bonds3. The issue price and nominal yield are set in advance which presupposes an implicit share value.
When is it appropriate?
This option is suitable to dispose of minority blocks and thus offers the possibility to gradually privatise. It can lend credibility to the government's willingness to dispose of its share in the company and thus generate positive expectations on the company's share value. Governments might resort to the issuance of convertible bonds also in times of stock market weakness (Ruozi, 1999).
In some jurisdictions it can support corporate governance reform and better financial discipline given the bond payment obligations that ensue before conversion to common stock. According to Ma (2004), Chinese companies have reportedly found convertible bonds easier to launch than share-purchase rights or additional share offerings, reflecting the character of the Chinese stock market and legal and regulatory environment. For example, convertible bond floor price attracts investor participation, which results in less underwriting risk as compared to common stock offerings. In earlier privatisation experiences of some European economies, convertible bonds were also used as an antecedent to privatisation via IPO.
Demerits?
This is a complex instrument and is not commonly used as a privatisation method. From the perspective of the seller, a demerit is that the investor decides when to exercise the conversion option (that is, when the option becomes exercisable). If the stock poorly performs, there is no conversion and an investor is stuck with the bond’s sub-par return (below what a non-convertible corporate bond would get); and ultimately the government does not achieve its objective to shed ownership gradually.
How does it work?
When issued it is just like a regular corporate bond, but with a lower interest rate. It postpones transfer of ownership for a period of time determined by the investor exercising the conversion option.
Ensuring effective communication, transparency and integrity of the process
Privatisation can be a contentious process in that it: brings about changes that erode the influence of bureaucrats and SOE managers; involves restructuring and the potential for loss of jobs; and has an impact on consumers for whom price and access to goods and services are likely to be altered. Therefore, it can face opposition from various stakeholders. Furthermore, privatisations give rise to risks of potential abuse by the participants in the process. This can severely undermine government credibility and set back reform efforts. For this reason, the communication and transparency around the transaction or broader privatisation programme should serve to enhance its integrity and gain credibility with potential investors and ensure public support. The government must also undertake key measures to ensure the integrity of individual transactions (covered in more detail in the special section below. See also Annex A).
One communication strategy that governments use is to ensure continuous and real-time information access on the privatisation process through online platforms. This is in particular practiced in jurisdictions where there is a complex privatisation programme involving a large number of transactions. For example, in Kazakhstan the Committee on State Property and Privatisation under the Ministry of Finance has created a special web-site publishing the main information on the performance, audit reports and number of employees of entities being privatised. Notification on bids are also posted for access by the general public.4
With regard to potential abuse of the transaction, special care should be taken to avoid collusion on the selling price between the buyer and the government official in charge of the privatisation. To mitigate these risks some jurisdictions have set up specialised privatisation commissions where the members are independent and can have no link with the transaction (see Box 3.9).
In France a designated Shareholdings and Transfers Commission, made of up independent experts, is a body responsible for ensuring the integrity of privatisation transactions. Its role is to protect public assets, make the selection of buyers transparent, ensure that company valuation and price setting are done in a transparent manner (in some cases it also sets the price), give opinions on sales and offer ex-post evaluations of privatisations.
The Commission is made up of seven members. Members are appointed for a non-renewable six-year term of office by Prime Ministerial decree and are chosen “for their economic, financial and legal skills and experience”.
Commission members must abide by certain rules to ensure their independence:
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They are bound by professional secrecy.
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Their duties “are incompatible with any tenure as member of a board of directors or supervisory board of a joint-stock corporation or any paid activity for such a company liable to make them dependent on any buyers”.
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For a period of five years following the end of their duties, they cannot “become a member of a board of directors or supervisory board of a company, or any of its subsidiaries, that has bid for shareholdings previously held by the government and cannot carry out a paid activity for such companies”.
The Commission, acting on behalf of the majority of its members (the chairman casts the deciding vote in the event of a tie), will remove any member who does not comply with the first two requirements above. Immediately upon taking office and for the term’s duration, all members must inform the chairman of their professional activities, positions held as corporate officers and any groups that they may represent. The very restrictive incompatibility rules are such that appointments generally go to individuals who are no longer directly involved in business activities.
The compensation and fees paid to Commission members are made public. A General Secretariat organises the work and prepares the Commission’s examination of the dossiers. The General Secretary is appointed by decision of the Minister for the Economy based on a proposal from the Commission chairman.
Source: Commission des Participations et des Transferts (2016).
This special section addresses the particular risks of corruption and rule breaking in each stage of the privatisation process and identifies red flags that policy makers should consider in each step of the privatisation process. A step-by-step guide is provided in Annex A.
SOEs are considered at risk of corruption for their common operation in high-risk sectors (e.g. extractive and network industries), engagement in high-value public procurements and inherent ties to public and political officials through their complex ownership structures. In particular, fraudulent activity and receiving bribes are considered most likely to occur and most impactful on SOEs (OECD, 2018, 2014; TI, 2017). Some consider privatisation as a policy lever for reducing the heightened corruption risks of the SOE sector. However, research shows that the effect of privatisation on corruption is inconclusive5. This is partly owing to the fact that the effect of privatisation on corruption will depend on the nature of the corruption risks facing SOEs, which are in turn partly dependent on the sector of operation and the social, economic and political context of the country. SOEs can be perpetrators of corrupt acts or conduits of abuse that can be facilitated or exacerbated by state ownership. Privatisation may reduce opportunities for rent seeking but does not deal with actors inclined to rent-seek within the political, public or private sectors.
Privatisation itself can be instrumentalised for personal or political gain: its vulnerability partly stemming from the large number of assets being transferred into private hands and through the spill over of the very behaviour that threatens the SOE sector. There are two main entry points of corruption in privatisation (Emmanuel, A. and S. Straub, 2011). First, corruption or undue influence can lead to a misinformed decision to privatise or the wrong candidate being selected for privatisation (for instance, the selloff of highly profitable monopolies), explored less in existing literature. Second, the right candidate may be chosen for privatisation but corruption threatens success and distorts the efficiency, effectiveness and economy of the process for the benefit of a few.
Managing corruption risks and red flags in the privatisation process
Guiding Principles. The decision to privatise is taken in a context of evolving governmental priorities, political cycles and changing paradigms about the value of public ownership. Measures must be taken to ensure that corruption – the abuse of power for personal or political gain – is not also a deciding factor. The risk of undue influence may be heightened where decisions need to be taken regarding sectors that are highly regulated, or conversely where regulatory capacity is lagging, with a large number of public policy objectives or where there are natural market monopolies and/or high-value public procurements. Adoption of the guiding principles outlined in Chapter 2 can help to reduce the risk of rent-seeking behaviour and undue influence in key decisions about privatisation.
Measures before divesting. The steps taken prior to divestment by both the company and public authorities are critical for ensuring success of the process. A transaction can fail well before it is executed. It is in this phase that upstream decisions are taken about the method of sale, industry is accorded adequate checks and balances and due diligence is undertaken on the candidate company. It is thus in this stage that corrupt actors may seek to manipulate the establishment of needed checks and balances that in order to increase rents and mask the eventual diversion of resources for personal or political gain. For instance, the selection of the method of sale could be influenced by their intrinsic degrees of transparency. IPOs are arguably the most transparent while direct sales are the least transparent. The seller needs to be mindful of the differences and adopt an appropriate risk mitigation strategy. If the seller reverts to trade sale or employee buyout, which may have less process integrity, additional safeguards may be required. Moreover, the selloff of a monopoly without structural separation can facilitate the abuse of a market dominant position and monopolistic rents.
Organising the process of privatisation. The actual process of privatisation should be steered by a centralised organ and may involve advice from an external party. Decisions must be taken about company valuation and potential buyers, and bids are handled. Adherence to good practices in the execution of privatisation, covered earlier, mitigates the risk of manipulating criteria for selloff, and distorting a fair bidding and awarding process. Corruption and bribery can threaten a fair acquisition price. One study found that privatisation by states that appear more corrupt will have a higher acquisition price (Bjorvatn, K. and T. Søreide, 2005). Collusion and bid-rigging will thwart fair competition. Finally, risks may arise through conflicts of interest or undue influence by external advisors (covered in Chapter 4).
Taking steps post-privatisation. Accountability is needed following the transaction to handle residual guarantees or liabilities and proceeds. Evaluation will assess compliance with the terms of privatisation that may include assessment of performance in the delivery of public services. Ex-post audit will assess propriety and value for money. Adherence to good practices in this phase, as outlined in Chapter 5, is doubly important for (i) its potential to detect irregularities in the privatisation process and (ii) providing ongoing assurance for upholding contractual terms and appropriate handling of profits from the divestment. Efforts may be made to influence any of these steps in order to mask a corruption scheme.
Source: Secretariat.
References
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Bjorvatn, K. and T. Søreide (2005), Corruption and privatization, European Journal of Political Economy, https://doi.org/10.1016/j.ejpoleco.2005.02.001.
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Cuadrado-Ballesteros, B. and N. Peña Miguel (2018), “Is privatization related to corruption? An empirical analysis of European countries”, Public Management Review, Doi:10.1080/14719037.2018.1444192
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International Organisation of Supreme Audit Institutions (1998), “Guidelines on Best Practice for the Audit of Privatisations – ISSAI 5210”, International Standards of Supreme Audit Institutions, www.issai.org/en_us/site-issai/issai-framework/4-auditing-guidelines.htm.
Jones, S., Megginson, W., Nash, R. C. and Netter, J. M. (1999), “Share issue privatizations as financial means to political and economic ends”, Journal of Financial Economic, 53, 217-253.
Koyuncu, C., H. Ozturkler and R. Yilmaz (2010), “Privatization and corruption in transition economies: A panel study”, Journal of Economic Policy Reform, https://www.researchgate.net/publication/227347872
Ma W. (2004), “Convertible Bonds: A New Approach to China's Stock Markets”, UC Davis Business Law Journal, Volume 5, Issue 1.
OECD (2018a), Privatisation and the Broadening of Ownership of SOEs: Stocktaking of National Practices, https://www.oecd.org/daf/ca/Privatisation-and-the-Broadening-of-Ownership-of-SOEs-Stocktaking-of-National-Practices.pdf.
OECD (2018b), State-Owned Enterprises and Corruption: What Are the Risks and What Can Be Done?, https://doi.org/10.1787/9789264303058-en.
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OECD (2015), OECD Guidelines on Corporate Governance of State-Owned Enterprises, 2015 Edition, https://doi.org/10.1787/9789264244160-en.
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Notes
← 1. It should be noted that listing requirements vary across jurisdictions and in some cases can be used as a reason to “shop around” for the lightest criteria.
← 2. Discounting stock price is a technique that may be used to provide political support for the process, and attract a larger share of domestic ownership, which may also benefit other goals such as developing local stock markets - this is particularly the case for countries with less developed capital markets. Discounting shares for employees may also build further support for privatisation with labour unions or employees. On the other hand, research by Pargendler et al. (2013) does not agree with the hypothesis that SOE share prices are “discounted” on the basis that private investors may be willing to accept risks of government involvement, and that the very nature of state participation can guarantee a steady supply of rents from its (sometimes) monopolistic exploitation of natural resources and public concessions. This is particularly the case in the oil sector.
← 3. However, convertibles are often more expensive than ordinary bonds when you take into account the cost of the equity option.
← 4. http://privatization.gosreestr.kz/en.
← 5. Existing literature has focused largely on the residual impact of privatisation on the economy, including on corruption. Studies are conflictual, with some finding it can reduce corruption and others that it can increase corruption, some finding no effect and others that it depends on timing and context (for instance, see Cuadrado-Ballesteros, B. and N. Peña Miguel (2018), Koyuncu, C., H. Ozturkler and R. Yilmaz (2010), Ramlogan-Dobson, C. and A Rodriguez (2008)).