Under New Ownership

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• Under New Ownership

Shahid Yusuf DECRG World Bank December 2005
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Enterprises and Growth

• Enterprise sector responsible for much of Chinas
  remarkable growth
• But cost of growth is high
• Investment equals 45 percent of GDP, the highest
  sustained rate of investment for any country in
  recent history.
• Most growth is from input of capital and labor.
  Share of total factor productivity increase is
  one quarter of overall growth. In industrial
  countries, share is one-half or more.

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Enterprises and Growth (contd)

• Cost of growth related to inefficiency and low
  profitability of many enterprises, especially
  SOEs.
• Enterprise problems imperil banking sector
• NPLs of banks amount to 9 percent of GDP, not
  including those taken over by asset management
  companies.
• Enterprise inefficiencies also reflected in high
  consumption of energy and raw material, and
  associated environmental damage.
• Enterprise efficiency and competitiveness good
  for growth and for overall welfare.

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Attributes of Successful Firms

• Quality of management and strategy focused on
  competitiveness to assure longer term growth.
• Organizational capability, especially
  adaptability and resilience in the face of
  shocks.
• Flexible internal labor market to maximize gains
  from training and efficient use of workforce.

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Attributes of Successful Firms (contd)

• Culture of innovativeness and openness to ideas.
• Emphasis on core strengths and effective use of
  subcontracting and outsourcing.
• Skills and readiness to operate internationally,
  to market abroad and manage a multicultural
  workforce.

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Do Chinese Firms Have these Attributes?

• Some do. Mainly private firms and joint ventures.
  Also a few SOEs (e.g., CIMC).
• Majority of SOEs do not.
• SOEs constrained by national/subnatoinal
  objectives, management skills, high degree of
  vertical integration, diversifed activities,
  labor market rigidities, lack of innovativeness,
  and localized or domestic market orientations.

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Why Do SOEs Matter?

• Share of state sector in industrial output
  shrinking now close to one-fifth.
• But, one-half of industrial value added is in the
  state sector.
• State sector holds two-thirds of net fixed
  assets.
• Absorbs nearly two-thirds of bank loans.
• Growth in total factor productivity is less than
  one-fifth of collectively or privately-owned
  enterprises.
• SOEs still strongly influence the performance of
  Chinas economy

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Fifteen Years of Enterprise Reform1980-95

• Enterprise reform dates back to early 1980s. Has
  been through several stages
• Negotiated profit retentions
• Simplified administrative controls
• Selling of above plan output
• Flexibility in hiring workers or contract
• Management contracting.
• Productivity gains from giving enterprises more
  autonomy disappointingly small.

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Is Privatization the Key

• Western countries adopted privatization in
  mid-1980s after other policies to reform public
  enterprises proved unsuccessful. Many transition
  economies followed from the early 1990s.
• By end 2002, privatizations had generated 1.1
  trillion for government, one-third in developing
  and transition economies.

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Is Privatization the Key (contd)

• On balance, privatization has helped raise
  profitability, labor productivity, growth of
  sales and sales per employee.
• Manufacturing firms have performed better than
  others. Also banks.
• One decades experience shows that fast reformers
  among transition economies, after initial
  difficulties, did better than slow reformers.

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Why Privatization Works

• Change in objectives clearer focus on
  profitability and growth.
• Market-based incentives reinforced by private
  ownership, displace administrative incentives.
• New management, stronger governance mechanisms
  and stronger minority shareholder rights.

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Why Privatization Works (contd)

• Competitive pressures from product market and
  financial markets.
• Greater flexibility in restructuring operations
  and hiring/firing workers.

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Pitfalls of Privatization

• Continuing significant government share and
  influence on decision-making a handicap
• Many companies initially go through a period of
  losses after privatization.
• External recruitment of management and BOD that
  exercises effective oversight important, or else
  governance remains weak.
• Ability to shed excess workers and sideline
  businesses and rationalize production vital for
  success.

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Chinas Strategy Since 1996

• Privatization, divestiture and closure of small
  SOEs.
• Start at corporatizing MLSOEs. Creation of
  Limited Liability Companies (LLCs) and Limited
  Liability Shareholding Companies (LLSCs).
• FDI in MLSOEs.

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Research Objective Comparing Impact of Ownership
on Performance

• Main objective of the empirical exercise is
• Did reformed enterprises perform better?
• If so, what were the main contributing factors?
• Factors associated with better performance were
• Ownership, competition, hard budget constraint,
  role of managers (appointment, turnover,
  incentives, autonomy), and corporate governance
  (shareholder meetings and board of governors).

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Data Description

• The data is based on survey conducted by China
  National Bureau of Statistics, Enterprise Survey
  Organization.
• Information collected from 736 firms for the
  period 1996-2001. Sample of enterprises drawn
  from five cities (Beijing, Chongqing, Guangzhou,
  Shanghai, Wuhan) and from 7 subsectors,
  electronic components, electric equipment,
  consumer products, vehicle and vehicle parts,
  garment, general machinery, and textile.
• Of these firms, 140 were never reformed, 266
  reformed, 330 were never SOEs.

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Estimation Strategies

• Used Cobb-Douglass production function (as most
  researchers of this topic do), along with city,
  industry, and year dummies.
• Also used panel regression to take full advantage
  of the both cross-section and time-series
  dimension of the data.

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Findings

• Ownership
• Firms with 100 state ownership perform the worst
  in all specification
• Joint venture firms are the best performers,
  followed by LLSCs and LLCs.
• Competition
• Paradoxically, firms in more competitive markets
  seem to perform less well than those faced with
  less competition.

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Findings (contd)

• Corporate governance
• Having a board of governors is performance-enhanci
  ng.
• Having a shareholder meeting also tends to
  improve performance, if and only if
  one-share-one-vote is instituted.
• Manager
• Firms with managers appointed by the government
  perform less well.
• Changing of managers did not have any effect.

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Findings (contd)

• Hard Budget
• A priori, one would expect a hard budget
  constraint to have a positive effect on
  performance, but such an effect not apparent from
  the tests

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Concluding Observations

• Study shows that if the objective is to raise the
  performance of firms, then ownership reform is
  desirable.
• Such reform should include at least the
  following
• Managers should not be appointed (or approved) by
  the government
• The shareholder meetings needs to align the
  financial stake and the voting rights
  (one-share-one-vote)
• There should not be any restrictions on the
  ownership (i.e. foreign ownership)

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Concluding Observations (contd)

• Full privatization better than partial
  privatization with continuing substantial
  government ownership or control rights.
• Successful privatization can be assisted by
  several complementary factors
• An effective national social safety net, and
  scope for flexibility managing enterprise
  workforce
• Adequate supply of experienced managers

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Concluding Observations (contd)

• Legal and audit institutions to sustain corporate
  governance, rules, minority shareholder rights,
  and bankruptcy laws
• Well functioning financial markets to discipline
  managers

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Thank You