Seasoning the stock

Indian Express, 18 November 2009

The sale of shares of upto 60 public sector enterprises by the central goverment will have many advantages. Not only will the money raised bring down the fiscal deficit, there will be additional benefits arising from partial privatisation. Though the objective of the government seems to be primarily to bring its deficit under control, the disinvestment, especially of PSUs that are not yet listed on the stock exchange, could improve performance, corporate governance and investment by these companies. Selling 10 percent will lay down the foundations for price discovery and make the market ready for further sales of shares.

In India, there is a widespread belief that privatisation or disinvestment are a means for the government to raise resources. However, the key insight in the impact of disinvestment lies in the impact of privatisation upon GDP growth. Privatisation is important not so much because it brings some resources into the exchequer. It is important because it puts assets and workers into better hands. Both theoretical and empirical research literature has found positive benefits in terms of better output from the same resources when the labour and capital was put under the control of a private manager. Considering the large share assets and workers in India in the hands of government as the owner and manager, India could raise GDP growth simply through privatisation, where the same labour and capital would yield better output through superior management.

However, while privatisation is the best policy path to obtain better GDP growth, achieving privatisation requires leadership and political will. Valuation of loss making public sector enterprises is difficult and it is easy for the political opposition to criticise anything that is done under this agenda. The process of selling companies to a single buyer can make the political leadership vulnerable to accusations of corruption and favouritism. Processes of choosing the best management in terms of experience in the relevant industry can mean creating or supporting private monopolies in those sectors. In contrast, the public sale of shares of public sector companies does not pose these hurdles. It constitutes a low-hanging fruit and is politically much easier. This option is politically easier largely because the control of the firm stays with the government; politicians and bureaucrats continue to steal from the firm, employees do not feel insecure at the prospect of a new management coming in and the low quality top management teams of the PSU stay in place. All that is changed is that a small percentage of shares are sold off to the public. It looks like a win-win situation because the government raising money to spend more on its favourite programs without losing control over the company.

However, despite all the above difficulties, the sale of some shares, while retaining management control with the government, does have benefits. This is seen in evidence available not only from other countries, but also from India. Between 1991 and 2000 the central government partially privatised around 45 public sector enterprises. These enterprises were listed on stock exchanges but majority ownership and management remained with the government. A study of the impact of partial privatisation (`Partial privatisation and firm performance' by Nandini Gupta, Journal of Finance, 2005) finds that both the levels and the growth rates of profitability, labor productivity, and investment spending improved significantly following partial privatization. The author found that the decrease in government ownership increased sales, profits, and the average product of labor and returns to labor. In addition, investment spending on research and development and expenditures on fixed assets rose significantly following an increase in the private share of a firm's equity.

This evidence gives us hope that going beyond resource raising for the government, the Indian economy will gain through better utilisation of the labour and capital in the PSUs, when compared with the pre-listing state. The listing of unlisted PSUs seems to create market pressure on the management. The company's stock price becomes an instrument through which the market gives daily feedback on the performance of the company.

If a disinvestment transaction is structured so that employees get some shares, then it creates a new incentive structure. Compensation structures in the public sector are notorious for giving employees no incentive to cater to the interests of the firm. However, if even some employees have shares in the firm post-listing, then their wealth maximisation makes them interested in the affairs of the firm.

While this evidence for the early listings of the 1991-2000 period is optimistic, there is a role of caution, given the weaker state of the remaining PSUs. Many PSUs are all but dead as businesses; all that is there by way of value is assets such as real estate. Listing might not improve their performance; what is really required is true privatisation. The sale of assets of PSUs is going to be as controversial as the privatisation undertaken by Arun Shouries under the NDA government. It could come under similar attack as the possibility of corruption can be extremely large. Until governance structures and transparency in the functioning of the government in India are far better that those which exist today, the best option may be to leave some of these difficult decisions alone.

Finally, the Ministry of Finance has suggested that all listed companies should have a minimum 25% of shares held by the broad public. While many PSUs may, at first, have only 10% of the shares sold off to the public, this is the right stepping stone to immediately undertake. Within a few months, the market will have got a good sense of the price of these companies. Once the stock is `seasoned' in this fashion, it will be easy to follow through with the sale of another 15% of shares, so as to get to the 25% requirement which is to be applied to all listed companies.

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