How to Successfully Privatize State-Owned Enterprises

The high costs and poor performance of SOEs led many governments to turn to privatization as a solution. The new private owners are expected to increase SOE efficiency and decrease financial demands from the government.

There are many reasons for poor SOE performance. SOE management may not see a downside to poor operational performance, and ongoing subsidies reinforce this belief. An unlevel playing field with the private sector will further shield SOEs and their management. At the same time, SOEs have often been burdened with noncommercial objectives, such as employment creation and regional development, making further subsidies necessary. Behind this mix of privileges and hindrances is the same force: political inference in the operation of SOEs and a tendency for those in government to see them as tools for various purposes, not as efficient sources of service delivery. Agency (or conflict of interest) and other corporate governance problems found in all large organizations compound these issues.

Privatization is also seen as a tool to encourage and facilitate private sector investment, generate revenues for the state, reduce the administrative burden on the state, and distribute ownership more widely to the population.

Privatization had been the main option for commercial SOEs in various regions in the 1990s and 2000s. The 2008 financial crisis, however, led to a gradual transition away from straight privatization to mixed ownership arrangements, especially in larger and more complex SOEs, and to the deepening of capital markets through initial public offerings of SOEs. Enhancing the corporate governance of large SOEs in infrastructure and other sectors also became a priority to attract private investment.

The easiest SOEs to privatize are in competitive sectors. Those in the manufacturing, hospitality, and retail sectors will typically sell faster and most likely yield clear economic benefits. Domestic and international competitions will foster efficiency, and reforms, such as trade and market liberalization, can make privatization more effective for these SOEs.

SOEs in regulated or monopolistic sectors can be more challenging. While some monopolistic sectors, like telecommunications, have been privatized successfully with the right regulatory framework in place, others, like power transmission, water, finance, and mining, have been more difficult. Inadequate regulation can lead to harm for consumers after privatization.

Privatizing noncompetitive SOEs successfully requires several steps. Competitive and noncore assets need to be separated and, in some cases, sold separately. Regulation for pricing, minimum service standards, and in other areas, as needed, must be established.

SOEs may require restructuring prior to sale. This can involve changes in the legal form; new management; shutting down, separating, or splitting off part of the SOE that will not be sold or sold separately; government equity injections and reassignment of liabilities; and reductions and changes to the labor force. It can also involve new investments for modernization or rehabilitation. Smaller SOEs may need less restructuring and can be sold “as is.”

Accurate valuations can be difficult. Technical appraisals seldom correctly estimate the market price. SOE valuations are tricky in countries where the operating environment is changing rapidly. This is also true in countries where accurate financial statements are not readily available or where the market is thin. Overvaluation and unrealistic expectations on the part of government can also create delays. Overpricing shares in a public offering may also lead to failure.

Overcoming financing constraints can be a challenge. The constraints may stem from weak financial systems. This can also be the case when privatization is rushed during a crisis, and market conditions are at their worst. Sensitivity about foreign ownership is also an issue.

Legal and institutional framework. Creating a framework typically entails developing important aspects of business legislation, such as property law, competition law, corporate law, and dispute settlement. It also involves modifying the legislation on SOEs to be divested and organizing the privatization process. It is crucial to implement relevant laws in a credible and efficient manner. Responsibilities for privatization lie with the political leadership, which defines objectives, sets priorities, takes major decisions, and oversees the program.

Sequencing of privatization. Many countries started with small and medium-sized SOEs in commercial sectors that are easier to privatize. Large SOEs in infrastructure and other strategic sectors proved more complex and more likely to require significant prior organizational and financial restructuring and careful management of social implications. A key lesson from global experience is that the transparency and integrity of the privatization process should not be compromised for speed.

Parallel reforms. Successful privatization programs have been accompanied by pro-competition product market regulation reform and the development of sound regulatory frameworks. Fostering competition by opening sectors to domestic and foreign private investment and trade is a complement to SOE restructuring and privatization in achieving dynamic growth and efficient market outcomes.

Corporate governance improvements. Some of the measures include establishing sound legal and regulatory framework for SOE corporate governance, creating proper arrangements for effective state oversight and accountability, developing a sound performance monitoring system, promoting financial and fiscal discipline, professionalizing SOE boards, enhancing transparency and disclosure, and protecting shareholder rights in mixed ownership companies.

Transparency and political commitment. Transparency is achieved through clear and simple selection criteria for evaluating bids, clearly defined competitive bidding procedures, disclosure of purchase price and buyer, well-defined institutional responsibilities, and adequate monitoring and supervision of the program. Lack of transparency can lead to a political backlash and is often associated with poorly structured sales.

Strengthening country preparedness.  Establish stable macroeconomic framework and the capacity to regulate in relevant sectors. The more market-friendly the business environment, the greater the benefits.

Building institutional capacity. Prepare for financial restructuring, labor restructuring, and establishment of regulatory bodies, especially for privatization in such sectors as infrastructure, energy, and banking. Strengthen the capacity for drafting, negotiating, monitoring, and enforcing contracts in the post-privatization phase.

Tackling corruption. Adopt integrity pacts between contracting authorities and operators bidding for SOEs and set clear guidelines and due diligence procedures to protect sensitive commercial information and ensure transparency. Create a register of all contracted parties that captures basic information and develop e-procurement tools.

Acknowledging and addressing the complexity. Have a more coordinated and connected approach to the public and private sides of development that considers the spectrum of private and public solutions, taps a variety of financial options, incorporates global lessons and good practices, and addresses equity and affordability for consumers.

Asian Development Bank (ADB). 2022. Privatization of State-Owned Enterprises: A Summary of Experience. The Governance Brief. Manila.