Spinoffs and Privatization Affect Firm Performance in Emerging Markets
In emerging markets, graft among financial company managers and individuals who assume ownership of newly privatized companies may result in poor corporate performance.
ANN ARBOR, Mich.—In the United States and other advanced-market economies, corporate spinoffs generally have had positive effects on firm performance, as in the case of the breakup of AT&T.
However, in the Czech Republic and other former Soviet satellites with accelerating emerging-market economies, the effects of spinoffs and privatization on corporate performance have been largely unknown—until now.
A new study of parent and spinoff companies in emerging markets by Professor Jan Svejnar of the University of Michigan's Ross School of Business reveals that while spinoffs do increase firm profitability, the effects of privatization are much less clear-cut than originally thought.
Results show that privatization can improve—or worsen—corporate performance, depending on the resulting ownership structure. These findings have important implications for countries where restructuring is taking place and large state-owned enterprises are being broken down into smaller units owned by industrial firms, financial companies or individuals.
Svejnar and colleagues Jan Hanousek and Evzen Kocenda examine the Czech Republic, which started in 1990 as an almost completely state-owned, controlled and trade-protected economy, with a corporate sector dominated by large state-owned enterprise (SOE) conglomerates.
Over the course of five years, the country rapidly opened itself to trade and liberalized prices, and by 1995, it was transformed into an overwhelmingly privately owned market economy. Most of the large SOE conglomerates were broken up, and the number of medium and large industrial firms more than tripled as a result of numerous spinoffs and new companies entering the market.
In their analysis, the researchers use firm-level data on early enterprise performance from 1990, firm splits from 1991-1992 and post-spinoff, post-privatization performance from 1995-1996. Their dataset contains 131 spun-off units corresponding to 44 parent companies, and 780 firms that did not experience any spinoffs. They also employ three indicators of corporate performance: unit labor cost (labor costs/sales) and two measures of profitability—operating profit over labor costs (profit/labor costs) and operating profit per share (profit/equity).
"Overall evidence shows that spinoffs have a positive effect on performance," said Svejnar, the Everett E. Berg Professor of Business Administration and professor of corporate strategy and international business and business economics. "Presumably, this is by eliminating prior inefficiencies, such as the diseconomies of scale of large SOE conglomerates, weak managerial incentives, information asymmetries and a lack of focus on core competence."
Study results show spinoffs increased both measures of firm profitability and the scale of operations (sales), but did not impact unit labor costs significantly.
Privatization proved to be a different matter, however. The researchers found that the effect of privatization was influenced by the type of new ownership structure and whether the firm was a spinoff. Reducing state ownership had limited positive effects on the profitability of firms that did not experience spinoffs, but no significant impact on the spun-off units.
When industrial companies assumed new ownership, cost efficiency was improved in both the spun-off units and the firms without spinoffs, and profitability was either increased or not hampered. However, when financial companies or individuals became owners, there was generally no improvement in profitability or efficiency, and in some cases, there was a significant decline in performance. Svejnar, Hanousek and Kocenda attribute this disappointing outcome to tunneling (looting) by managers and/or owners in an environment of waning government controls, unclear property rights and corporate governance, and weak market-oriented legal framework.
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