The effects of changes in corporate governance

and restructurings on operating performance:

evidence from privatizations
DSouza, Megginson & Nash (2007)

Privatization: sale of previously state-owned enterprises to private owners; has

transformed the global economic landscape
Privatization involves changes in corporate governance due to changes in
ownership:
Corporate governance changes: ownership changes from privatization should
help to redefine the firms objectives and the managers incentives thereby
impacting post-privatization performance
1. Changes in ownership: privatization redefines the firms objective function.
- State-ownership: typically involves multiple and conflicting objectives, while
privately owned firms are more focused on profit maximization
Hypothesis 1: Privatizations that generate the largest amount of private ownership
will experience the greatest financial improvements

Foreign ownership: amount of foreign investors may affect the degree of

post-privatization performance improvement since it has accounted for an
increasing share in privatization revenues in developing countries

Hypothesis 2: Firms with more foreign ownership will have stronger efficiency
gains

Employee share ownership: can contribute to changes in post-privatization

performance as generally employees are unlikely to support valuemaximizing restructuring efforts. Therefore, a negative relation between
employee ownership and post-privatization performance is expected

Hypothesis 3: Employee ownership will negatively affect post-privatization

performance

2. Changes in upper management: replacing often politically appointed

managers of SOEs with a professional businessperson should lead to
performance improvements

Hypothesis 4: The infusion of new managements will lead to stronger postprivatization performance

Transferring the firm from government control provides greater

entrepreneurial opportunities, such as restructuring: divestitures,
acquisitions and recapitalizations
1. Restructuring: when fully state-owned, firms typically take on financial and
organizational structures designed to meet multiple, sometimes politically
motivated objectives. Following privatization, firms become more focused on
profitability and wealth maximization. Privatization is often an initial step in a
transformation process whereby the state-owned firm becomes reconfigured
to compete as a private enterprise; restructuring is a common part of this
transformation
Hypothesis 5: Restructurings will increase improvements in post-privatization
financial performance

Macroeconomic and institutional environment (control factors):

1. Level of capital market development: state-owned firms may be less
efficient because they are immune from capital market scrutiny and as a
result managerial performance is inadequately monitored. Upon privatization,
the public trading of shares introduces the discipline of the capital market.
However, the intensity of capital market pressure depends upon the size and
sophistication of the nations financial system. Therefore, firms whose shares
trade in more sophisticated and active equity markets should display the
strongest performance improvements
2. Legal system: for managers to feel the full disciplining pressure of the
capital market, the rights of the individual shareholder (particularly voting
rights) must be enforced by the countrys legal system. Shareholders in
common law countries may benefit from much stronger legal protection than
those in civil law systems. Markets affording greater shareholder protection
are consistently larger and more efficient
3. Political and economic environment:
- Government incentives: whether a divesting government is committed
(to privatization and economic reform) or populist (selling SOEs just to
raise money) can influence the performance of privatized firms
- Sophistication of the economy and level of income: when higher
countries are more likely to have a market-friendly policy framework,
thereby increasing the chances of successful privatization

4. Discipline of the product market: having to compete with other firms for
customers and market share may provide the pressure required to stimulate
greater efficiency and profitability

Reasons for restructuring:

1. Response to external shocks: heightened sensitivity to external shocks
may contribute to greater restructuring activity by newly privatized firms
- Substantial changes in legal, political or regulatory systems: ownership
and institutional transformation brought about by privatization should
represent such a shock in most countries
- Economic conditions (recession) and product market pressures
(competition): newly privatized firms face larger threats from these
forces since privatization frequently involves the weakening of
regulatory protection and the reduction of state subsidies
2. Desire for efficiency improvements: restructuring generally increases
efficiency by transferring assets to firms that can put the resources to a
better use. Furthermore, restructuring frequently involves the elimination of
negative synergies (by removing assets that are performing poorly or are no
longer a strategic fit)
3. Pursuit of new opportunities: restructurings directly result from firms
desire to pursue new strategies and prospects, which are created by evolving
economic conditions
4. Changes in corporate strategy:
- Expansion: as privatization creates growth opportunities, newly
privatized firms may engage in an expansion strategy to pursue this
potential
- Contraction: streamlining or re-focusing on a core business (e.g.
divestment)
Forms of restructuring:
1. Organizational/operational restructuring (Org/Op): reorganization of
the firms production methods and/or management structure
- Closing, consolidating or overall reorganizing of production facilities
- Modernization of operations and changes in management structures
2. Acquisitions and divestments (A&D):
- Acquisitions: cause expansion and may represent efforts by newly
privatized firms to take advantage of opportunities created by the
transfer from state control
- Divestments: cause contraction and may represent efforts to shed
unprofitable units and downsize to a more efficient functional form.

Here: asset sell-offs (selling a division or major facility to an outside

party)
3. Financial restructuring: typically involves a reduction in the leverage of
the newly privatized firm
- Debt pay-offs
- Debt write-offs
- Leverage-reducing recapitalizations (debt-equity swaps)
- Major refinancing or restructuring of a loan

Results table 3:

Following privatization, firms experience significant increases in profitability,

efficiency and real output in the 3-year post-privatization period, compared to
the average values from the 3-year pre-privatization period