Partial Privatization and Firm Performance

Most privatization programs begin with a period of partial privatization in which only non-controlling shares of firms are sold on the stock market. Since management control is not transferred to private owners it is widely contended that partial privatization has little impact. This perspective ignores the role that the stock market can play in monitoring and rewarding managerial performance even when the government remains the controlling owner. Using data on Indian state-owned enterprises we find that partial privatization has a positive impact on profitability, productivity, and investment. WIDESPREAD PRIVATIZATION IN RECENT DECADES has generated a large empirical literature concerning the effect of ownership on firm performance. Most studies find that privatization has a positive impact on the profitability and efficiency of firms (see Megginson and Netter (2001) for a recent survey).1 The firms in these studies have had a majority of their assets privatized and control rights have been transferred from the government to private owners. Surprisingly, little is known about the effect of partial privatization where the government remains the controlling owner. This paper seeks to address this gap in the literature by investigating whether the performance of state-owned enterprises in India is affected by the sale of non-controlling equity stakes on the stock market. Understanding the impact of partial privatization is important because most privatization transactions of significant size are through partial sales of equity in the stock market. In a sample of share-issue privatizations from 59 countries, Jones et al. (1999) found that just 11.5% of the firms sold all of their capital ∗Nandini Gupta is from the Kelley School of Business, Indiana University. I am grateful to the Administrative Staff College of India for providing some of the data used in this analysis. This paper has benefited enormously from the comments of the editor, Professor Richard Green, and an anonymous referee. I also gratefully acknowledge the helpful suggestions of Pierre Azoulay, Sugato Bhattacharyya, Serdar Dinc, Bill Megginson Rick Harbaugh, Jan Svejnar; seminar participants at Columbia University, Indiana University, and the University of Michigan; and participants at the 2002 Transition Economics Conference, the 2002 AIB Annual Meeting, the 2002 FEEM Conference on Privatization, Corporate Governance, and Financial Markets, and the 2003 American Economic Association Meetings. All remaining errors are my own. 1 Recent studies that investigate the impact of share issue privatizations with transfer of management control include Boubakri and Cosset (1998), who find significant improvements following privatization in the operating performance of 79 firms from 21 countries. In contrast, using crosscountry panel data on 500 large firms, Dewenter and Malatesta (2001) find that earnings improve prior to privatization but decline subsequently.