Techniques of Privatization of State-Owned Enterprises J- Y / D 5 Public Disclosure Authorized Volume I Methods and Implementation FILECOPY Charles Vuylsteke

WTP- 88 WORLDBANK TECHNICALPAPER NUMIBER 88

Techniques of Privatization of State-Owned Enterprises J- y / d 5 Public Disclosure Authorized Volume I Methods and Implementation FILECOPY Charles Vuylsteke

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(List continues on the inside back cover) Techniques of Privatization of State-Owned Enterprises TECHNIQUES OF PRIVATIZATION OF STATE-OWNED ENTERPRISES

Volume I Methods and Implementation

Charles Vuylsteke

This volume (World Bank Technical Paper No. 88) reviews how privatization of state-owned enterprises has been accomplished by drawing upon a broad sample of experiences. It describes and illustrates methods which have been tried out and some of the available options.

Volume II Selected Country Case Studies

Helen B. Nankani

This second volume (World Bank Technical Paper No. 89) presents country case studies analyzing transactions carried out by seven countries with a significant record of experience, namely Canada, Chile, Italy, Malaysia, Spain, Sri Lanka, and Togo. They were written in support of the analysis of techniques of privatization presented in the first volume.

Volume III Inventory of Country Experience and Reference Materials

Rebecca Candoy-Sekse with the assistance of Anne Ruiz Palmer

This third volume (World Bank Technical Paper No. 90) contains an inventory of planned, ongoing and completed privatization transactions in 83 countries indicating the methods used. It presents data collected for the purpose of examining the record of experience with varying techniques of privatization. A systematic listing of relevant reference material is also included. WORLD BANK TECHNICAL PAPER NUMBER 88

Techniquesof Privatization of State-Owned Enterprises Volume I Methods and Implementation

Charles Vuylsteke

The World Bank Washington, D.C. Copyright () 1988 The International Bank for Reconstruction and Development/THE WORLD BANK 1818 H Street, N.W. Washington, D.C. 20433, U.S.A.

Technical Papers are not formal publications of the World Bank, and are circulated to encourage discussion and comment and to communicate the results of the Bank's work quickly to the development community; citation and the use of these papers should take account of their provisional character. The findings, interpretations, and conclusions expressed in this paper are entirely those of the author(s) and should not be attributed in any manner to the World Bank, to its affiliated organizations, or to members of its Board of Executive Directors or the countries they represent. Any maps that accompany the text have been prepared solely for the convenience of readers; the designations and presentation of material in them do not imply the expression of any opinion whatsoever on the part of the World Bank, its affiliates, or its Board or member countries concerning the legal status of any country, territory, city, or area or of the authorities thereof or concerning the delimitation of its boundaries or its national affiliation. Because of the informality and to present the results of research with the least possible delay, the typescript has not been prepared in accordance with the procedures appropriate to formal printed texts, and the World Bank accepts no responsibility for errors. The material in this publication is copyrighted. Requests for permission to reproduce portions of it should be sent to Director, Publications Department at the address shown in the copyright notice above. The World Bank encourages dissemination of its work and will normally give permission promptly and, when the reproduction is for noncommercial purposes, without asking a fee. Permission to photocopy portions for classroom use is not required, though notification of such use having been made will be appreciated. The most recent World Bank publications are described in the catalog New Publications, a new edition of which is issued in the spring and fall of each year. The complete backlist of publications is shown in the annual Index of Publications, which contains an alphabetical title list and indexes of subjects, authors, and countries and regions; it is of value principally to libraries and institutional purchasers. The latest edition of each of these is available free of charge from the Publications Sales Unit, Department F, The World Bank, 1818 H Street, N.W., Washington, D.C. 20433, U.S.A., or from Publications, The World Bank, 66, avenue d'1ena, 75116 Paris, France.

Charles Vuylsteke is senior counsel in the Legal Department of the World Bank.

Library of Congress Cataloging-in-Publication Data

Techniques of privatizationof state-ownedenterprises.

(World Bank technical paper ; no. 88-90) Includes bibliographies. Contents: v. 1. Methods and implementation/ Charles Vuylsteke -- v. 2. Selected country case studies / Helen Nankani -- v. 3. Inventory of country experience and reference materials / Rebecca Candoy-Sekse,with the assistance of Anne Ruiz Palmer. 1. Privatization. 2. Privatization--Casestudies. I. Vuylsteke, Charles, 1947- . II. Nankani, Helen. III. Candoy-Sekse,Rebecca, 1956- IV. Ruiz Palmer, Anne, 1954- . V. Series: World Bank technical paper ; no. 88-90.

HD3850.T436 1988 338.9 88-20699 ISBN 0-8213-1111-5 (v. 1) ISBN 0-8213-1112-3(v. 2) ISBN 0-8213-1113-1(v. 3) A B S T R A C T

This report was initiated largely in response to interest by member governments and staff of the World Bank for information on the practical aspects of privatization of state-owned enterprises. It reviews what is known about the recent experience of selected developing countries and developed countries. It describes and illustrates methods that have been tried and options that are available to governments. The report deals strictly with techniques (that is, how to privatize and not whether to privatize). The issues analyzed are the most recurrent in the process of implementing privatization.

The report, which consists of three volumes, is largely the result of a cooperative effort by various contributors within and outside the World Bank. Volume I, Methods and Implementation, relies extensively on Volume II, Selected Country Case Studies, and Volume III, Inventory of Country Experience and Reference Materials. I I A A - vii -

TABLE OF CONTENTS

Page No.

PREFACE ...... xi

INTRODUCTION AND SUMMARY ...... 1

PART I - METHODS OF PRIVATIZATION...... 7

1. BASIC METHODS OF PRIVATIZATION ...... 8

Public Offering of Shares ...... 11 Private Sale of Shares ...... 16 Sale of Government or Enterprise Assets ...... 20 Reorganization into Component Parts ...... 23 New Private Investment in SOE ...... 26 Management/Employee Buy-out ...... 29 Leases and Management Contracts...... 34

2. OVERVIEW OF THE EXPER:EENCEWITH PRIVATIZATION ...... 41

3. DETERMINANTS OF POSSIBLE TECHNIQUES...... 57

Objectives of the Government ...... 57 Current Organizational Form of the SOE ...... 59 Financial Condition and Record of Performance of the SOE...... 59 Sector of Activity of the SOE ...... 62 Strength of the Domestic Financial Markets ...... 68 Socio-political Elements...... 69

4. ANCILLARY ARRANGEMENTS ...... 71

PART II - SELECTED IMPLEMENTATION ASPECTS ...... 74

1. PLANNING AND MANAGEMENT ...... 75

Initiating Measures ...... 75 Organization of Departmental Responsibilities; Implementation Units ...... 80 Use of External Professional Services...... 87 Mandatory Procedures/Guidelines...... 90 General Business Environment ...... 91 - viii -

Page No.

2. READYING SOEs FOR PRIVATIZATION ...... 94

Enterprise Diagnosis ..... 97 Satisfaction of Legal Requirements ..... 98 Conversion of Legal Form ..... 100 Modification of Overall Legal Framework .. ... 101 Financial Restructuring ..... 101 Physical Rehabilitation ..... 107 Changes With Respect to Staffing ..... 107 Ensuring Cooperation of Management ..... 108

3. VALUATION AND PRICING ..... 109

4. DETERMINING FUTURE OWNERSHIP ..... 116

Partial vs. Full Privatization ..... 116 Widespread Distribution of Ownership ..... 121 Restrictions on Ownership Composition, 122 Controlling Interests or Foreign Ownership .... . 125

5. EMPLOYMENT ISSUES AND EMPLOYEE PARTICIPATION .. ... 129

Employment-Related Difficulties ..... 129 Remedies to Negative Employment Effects, and Employee Participation ..... 131

6. COST OF PRIVATIZATION ..... 138

Transaction Costs ..... 139 Residual Costs ..... 139

7. RESOURCE MOBILIZATION AND FINANCING PRIVATIZATION ..... 141

Capacity to Mobilize Private Resources/Domestic Financial Markets ..... 141 Acceptance of Payment Terms ..... 144 Direct Borrowing by Purchasers ..... 146 Debt-equity Swap Programs ..... 147 Institutional Investors and Holding Trusts .... . 149 Other Measures ..... 149 - ix -

ANNEX C MANDATORY PROCEDURES AND GUIDELINES FOR PRIVATIZATION Argentina, Bangladesh, Brazil, Chile, France, Philippines, Senegal, Tunisia ...... 157

ANNEX D RETENTION OF SPECIAL RIGHTS BY THE GOVERNMENT (Including Special ("Golden") Share)...... 165

ANNEX E RESULTS OF RECENT PRIVATIZATION ACTIVITY (Statistical TabLes)...... 168 * x -

LIST OF TABLES AND FIGURES

Page No.

Tables

Table 1 TECHNIQUES USED IN CERTAIN COMPLETED PRIVATIZATION TRANSACTIONS...... 45

Table 2 PRIVATIZATION OF PUBLIC UTILITIES AND SERVICES ...... 64

ANNEX E

Table I SURVEY OF ON-GOING AND COMPLETED PRIVATIZATION TRANSACTIONS BY TECHNIQUES USED ...... 169

Table II SURVEY OF PRIVATIZATION TRANSACTIONS BY SECTOR ...... 172

Table III REGIONAL AND COUNTRY SURVEY OF PRIVATIZATION OPERATIONS BY STAGE OF COMPLETION ...... 176

Figures

Figure 1 CHILE: CORFO'S PRIVATIZATION STRUCTURE ...... 84

Figure 2 ONGOING PRIVATIZATION OF MALAYSIA'S TELECOM ...... 95

Figure 3 PRIVATIZATION IN THE UNITED KINGDOM ...... 96

Figure 4 STEPS WITH RESPECT OF THE OFFERING OF CERTAIN EXISTING SHARES IN MISC (MALAYSIA)...... 106

Figure 5 JAMAICA - NCB - EMPLOYEE SHARE SCHEME ...... 134

Figure 6 SPECIAL ("GOLDEN") SHARE ...... 166 - xi -

PREFACE

The report contained in this Volume I was initiated largely in response to demand by Bank staff and client governments for information on the practical aspects of privatization. It reviews what is known about the techniques and implementation aspects of privatization by drawing upon the recent experience of selected developing countries and developed countries. It describes and illustrates methods which have been tried out and the options available to governments which have decided to proceed with privatization. The report deals strictly with techniques (i.e., how privatization has been accom-plished and not whether to privatize). The implementation issues analyzed are the most recurrent in the process of implementing privatization.

Privatization is not an end in itself. It would be superficial to regard privatization as a panacea for the various difficulties faced by the public sector in many economies, as if for instance a mere change of ownership or the introduction of private management would per se pave the road to financial and economic efficiency. Extensive efforts are underway in several countries to improve the modes of organization and enhance the performance results of state-owned enterprises, and privatization constitutes only one of several methods for such restructurings. The World Bank's involvement with privatization stems mostly from its support to such broader efforts. The report does not deal with the Bank's role in state-owned enterprise restructuring and privatization, nor with its relating policies on loan conditionality. But it is the substantial concentration of efforts by the Bank on helping to improve public sector efficiency that has led to this writing.

The report is illustrative rather than exhaustive in describing the techniques developed by various countries. The extent to which they constitute replicable options for other countries facing similar circumstances is a question to be approached with prudence, but also with a large degree of creativity. While Bank staff may provide further background details to interested governments, frequent exchanges of information are occurring also among official.s of governments of various countries. Mater- ials presented in Volumes II and III, published simultaneously with this report, may serve as a guide for further orienting such exchanges.

The one major difficulty encountered in writing this report has been the need to place proc(esses in context. The "whether" and "how" to privatize, more often than riot, ought to be interconnected decisions and, probably more so than they have been in a number of economies. However, the already voluminous set of references to country examples illustrating various techniques cannot deal to a very large extent with the vastly different situations encountered in individual countries. Neither does this report deal with the economic argument for or against privatization. - xii -

This complex subject has been and is currently being addressed by other work sponsored by the World Bank. Finally, it should be pointed out that many privatization transactions have aroused substantial debate and that several (including some referred to in this report) have been or are intensely controversial. Case illustrations in this report do not imply endorsement of the economic merits of specific transactions.

The report is largely the result of a cooperative effort by a large number of contributors within and outside the World Bank. However, the views expressed herein are those of the author only, and should not be attributed to the World Bank or to individual contributors.

Sources for this report include World Bank operational experience as well as surveys and studies of country experiences. The country case studies written by Helen Nankani (Consultant to the Bank) and the surveys of techniques applied world-wide prepared by Rebecca Candoy-Sekse with the assistance of Anne Ruiz Palmer were found to constitute such valu- able material that it was decided to publish them separately in companion Volumes II and III. All three contributed extensively to Volume I as well and Rebecca Candoy-Sekse prepared all statistical tables. Their very substantial contribution is gratefully acknowledged.

The author is greatly indebted to Anil Sood, who headed the World Bank's Industrial Restructuring Division, for his support and advice at all stages of preparation. Mary Shirley, Myrna Alexander and John Nellis, who have developed and managed much of the Bank's policy work on public sector reform, have contributed extensively. Anne Ruiz Palmer and Chantal Willot-Toussaint (Consultant to the Bank) have done major research, and Linda Thompson and Vivian Richardson have greatly assisted with the collection of materials. The author further acknowledges the helpful contributions and comments by other World Bank staff, and in particular, Mamadou Dia, Dennis Flannery, Alan Gelb, Pierre Guislain, Sven Hegstad, Ian Knapp, Roger Leeds (IFC), Ian Newport, Andres Rigo, John H. Stevenson (IFC), Jean van den Eynde (IFC) and Alan A. Walters. The author is grateful for the overall support of the Bank's Legal Department, the editorial suggestions made by Whitney Watriss (Consultant), and the great help of Nahed Mahmoud in overall processing and of Amina Andrews, Jean Cerick, Kathia Coupry, Jacqueline Hall, Mercedita Miguelino and others in typing various drafts of the report. Alfred Imhoff helped process the manuscript to the publication stage. Particular homage is paid to the late Mrs. Nahed Mahmoud whose loss has created great grief to the many of us who knew her.

Contributors outside the Bank include governmental and corporate offices in several countries who have graciously assisted with the preparation of the case studies and surveys contained in Volumes II and III.

The report includes several of the many useful and critical comments and suggestions made by David Heald (Glasgow Business School), and Alessandro Ovi and Alberto Pera (Istituto per la Ricostruzione - xiii -

Industriale, Roma). Finally, the author wishes to acknowledge contributions or suggestions by Thierry Aulagnon and Christian Noyer (Direction du Tresor, Ministere de l'Economie, des Finances et du Budget, Paris), Leo Konomis (Office of Privatization and Regulatory Affairs, Ottawa), Clare Pelham and Richard Bent (H.M. Treasury, London), Jose Juan Ruiz (Secretaria de Estado de Economia, Madrid), Richard Lloyd (Morgan Grenfell & Co., London), Guy de Selliers (Shearson Lehman Hutton Inc., New York), D.P. Savill (British Telecom, London), and Denis Bouvelle (La Lyonnaise des Eaux, Paris). I

I t I INTRODUCTION AND SUMMARY

Government initiatives in the area of privatization of state- owned enterprises (SOEs)l and assets have increased substantially in recent years. Many governments have effectively privatized SOEs. An even larger number have announced privatization programs but are only at the earliest stages of implementing them in any substantial way. In at least 83 countries, privatization is an inherent part of efforts to rationalize the SOE sector as a whole, in most cases to reduce their burden on the national budget, to improve the efficiency of individual enterprises, to assure wider distribution of business ownership, or to achieve a combination of objectives. The World Bank and other financing agencies have been providing support and financial assistance to facilitate these efforts, and an expansion of this area of activity is envisaged. The question increasingly has become not only whether to privatize, but also how to overcome or address the numerous difficulties associated with the process. There is now sufficient experience with privatization that it can be used as a tool for discussing or recommending appropriate techniques for use in developing countries. A few governments have already drawn on this experience to devise improved techniques for their own divestitures.

This report reviews what is known about the techniques of privatization. It uses the universally accepted term of "privatization" despite its vagueness. At the broadest level, privatization refers to the introduction of market forces into an economy. In this report, privatization covers more specifically the transfer of commercially oriented SOEs, activities or productive assests of the government (e.g. those in the fields of agriculture, manufacturing, and public services, such as transport and communications) to total, majority or minority private ownership or to private control. That is, it goes beyond the strict transfer of ownership to cover, as well, leases and management contracts. The meaning of the term for purposes of the report is narrowed down on page 8. By way of context, it is important to remember that privatization is often only an element of a broader economic policy (or reform) that may include deregulation and liberalization as weall.2

1/ SOE, as used in this report, refers to enterprises and/or productive assets owned fully or partially and directly or indirectly by the state.

2/ Privatization may be an element of broader economic policy comprising deregulation and liberalization with the emphasis generally as much on improving the efficiency of retained SOEs as on efforts to divest. Even when governments intend to continue state ownership, various measures can still be implemented to improve efficiency and reduce costs. See Mary Shirley, Managing State-Owned Enterprises (Washington, D.C.: World Bank, 1985) and Mahmood Ayub and Sven Hegstad, Public Industrial Enterprises. Determinants of Performance (Washington, D.C.: World Bank, 1986). -2-

To develop recommendations on or to assess divestiture programs, it is necessary to have an understanding of the steps that need to be taken. Similarly, a program's success or failure may well depend on the suitability of the methods of privatization chosen. Governments that have decided to initiate a broad privatization program or to privatize individual entities or activities often seek realistic assistance in how to proceed, what issues they may have to deal with and what solutions have been tried.3 These governments usually wish to analyze, consider and com- pare the policies and practices of other countries in addition to their knowledge and assessment of prevailing local business conditions.

This report is primarily based on surveys and studies of techniques applied worldwide. It also draws on the operational experience of the World Bank and other multilateral and bilateral agencies supporting SOE restructuring and privatization, discussions with governments and with private parties that have acquired interests in SOEs, and with parties who have advised on completed transactions (e.g., merchant banks and advisory groups). To the extent that it can be done, generalizations are drawn from a review of the relevant experience of selected developing countries and developed countries, complemented by actual examples of how different methods have been used and issues addressed. The focus is on how in practice a government can go about privatization rather than on whether to -undertake the effort at all.

Of necessity, the report provides a sample of privatization experiences rather than a set of blueprints that can be applied as is to clearcut situations. The use of appropriate techniques depends on a thorough understanding of constraints, obstacles, industry and market characteristics, etc. Each privatization transaction is different and needs to be designed to meet the specific characteristics and objectives of a country, enterprise and time, taking into account local administrative, political, economic, social and legal conditions of both the country and the enterprise(s) and assets targeted. It is clear from the review of country experience that creativity is a prominent and necessary ingredient of privatization.

This report is not an exhaustive review of privatization, a task beyond the scope of this project and one that would be duplicative of other work. Rather, it limits itself to specific techniques. In keeping with this approach, the report does not address the economic policy decision- making process that leads to a privatization effort, although the related debate may influence the choice of method. Nor does it cover why SOEs came into being, the causes of their generally poor performance and the theoretical debate as to what privatization can accomplish. Those issues

3/ Although the owner and seller is referred to as the government, it might actually be another party, such as a state-owned holding company. - 3 - are well covered in the literature.4 Similarly, it does not seek to establish economic criteria for measuring the results of privatization transactions such as, e.g., the risks of transferring state monopolies to private ownership. It further does not cover the efficiency aspects of privatized SOEs or sectors, and in particular the effects on competition and the needs for regulation.5 Finally, it refers to but does not go into detail on standard corporate divestiture procedures, since the focus is on SOE related issues.

The report contains an analysis of the specific methods and implementation procedures for the privatization of SOEs or productive assets of a government, as well as the issues each method is likely to raise; options for dealing with them are described mostly in reference to actual experiences. It is divided into two Parts. The first provides an overview of methods, the experience with privatization and the factors that affect the choice of method, while Part II goes into selected implementation aspects in more detail.

Principal Themes

Before proceeding to the text, it is useful to review briefly the principal themes which are addressed in our review:

o While some privatizations involve little more than the sale of shares on the stock exchange, most transactions are more complex. Privatization is a field that does not permit dogmatic treatment; every case must be examined on its own merits. The mechanics for privatizing the national airline in Malaysia will not, for example, be applicable to the privatization of a medium-size manufacturing enterprise in Togo. Rather, the choice of privatization techniques is generally a function of the government's objectives, the SOE condition and its sector of activity, and the country characteristics. Obviously, the profitability of an SOE is one of the determinants of how easy or how difficult its sale will be. The experiences of developed and developing countries alike demonstrate that privatization potential is not limited to strong performing SOEs. Where widespread share ownership is desired, a public offering should be the preferred method; but the near absence of financial markets and the concentration of domestic private capital and entrepreneurial expertise may not permit a public offering. When privatizing public utilities, regulatory aspects will

4/ Elliot Berg and Mary Shirley, Divestiture in Developing Countries, World Bank Discussion Paper No. 11 (Washington, D.C.: World Bank, 1985); and Richard Hemming and Ali Mansoor, Privatization and PublicEnterprises, IMF Occasional Paper, No. 56 (Washington, D.C.: International Monetary Fund, 1987).

./ See T. Sharpe, "Privatization, Regulation and Competition", Fiscal Studies, 5: 1, February 1987, pp. 47-60. - 4 -

be paramount. When setting the objectives of a privatization program, it may be necessary to allow for trade-offs, based on the feasibility of techniques relative to a given set of objectives. Privatization is not in all cases the sale of existing assets; it may be achieved through new private investment and a dilution of the state ownership. In this context, specific techniques, their advantages and determinants of applicability are described in Part I. o Serious constraints to privatization exist. The more difficult issues are commonly the financial condition and excessive liabilities of many SOEs (pages 59 to 62), and in some countries, a lack of financial markets (pages 68 to 69). These constraints are extremely limiting. Some creative approaches have been developed to these and other problems (such as, e.g., political opposition), but in many economies privatization transactions will be difficult to accomplish. Employment effects are commonly considered a major constraint to privatization as well, but SOE restructuring (as part of government austerity/adjustment programs) without privatization may similarly need to address the employment consequences rather than privatization per se. This does not mean that solutions should not be sought to the employment effects as part of the privatization process (pages 129 to 137). Similarly, the problems of excessive debt of many SOEs may need to be resolved irrespective of privatization, but specific solutions will need to be devised when governments undertake divestment.

o Practical approaches can be modeled that often accommodate to some extent both stated objectives and various constraints. Relevant approaches include the adaptation of basic techniques to specific constraints as well as combinations of various methods, as discussed in Part I on pages 11 to 44. The techniques most responsive to specific common issues are described in more detail in Part II. They include: intensive information campaigns and elaborate distribution networks for public offerings of shares in the case of weak financial markets; combinations of public offerings and private sales where the presence of a party or core group of shareholders that is strong financially and technically is necessary to turn around or sustain the SOE; and infusion of new private equity in SOEs needing rehabilitation coupled with the sale of government held shares. Where transfer of ownership is not desired or feasible at an initial stage, leases and management contracts have been used, often to be followed by transfer of ownership. Large-scale use has also been made in some countries of state and private joint ventures as a first step to privatization. o The ancillary arrangements accompanying a privatization transaction, as described on pages 71 to 73, are an inherent part of the basic method being applied. In some circumstances where the feasibility of a given type of transaction hinges on long-term commercial and fiscal advantages beyond those that otherwise apply to competitive industries under market conditions, government economic policy in this respect ought to be clarified before entering the transaction. o Every privatization undertaking needs to be carefully planned and managed (pages 74 to 93). The organizational capability and technical expertise must be there to initiate and implement the transaction. Various models have been adopted to organize departmental responsibilities to manage and implement privatization programs and implement individual transaction.s. The emphasis is generally placed on centralization, simplicity, flexibility, speed and transparency. When designing an action plan, it is advisable to assess the respective merits of alternative techniques. The process should be open. In most instances, it is helpful to adopt clear guiding principles or minimum standards with respect to implementation, such as in the areas of valuation, prequalification of purchasers, need for competitive bidding, terms of finance offered, etc. Such measures should be des:igned to ensure an orderly disposition, to maximize the return to the state, to preserve a fair process for the genera:L public and to assure that the purchaser is qualified to run the acquired enterprise productively.

O In determining the conditions for sales, pricing raises the difficult issue of trying to balance the need to maximize the proceeds wjith other objectives (pages 109 to 116). For instance, although a certain type of transaction, such as an employee buy-out, might yield the government a lower price, it might stil-L be preferable if it better addresses the government's economic, political and social objectives. o Wide variations exist in government policies with respect to the desirable level of private ownership. Whether partial rather than full privatization is sought, whether the avoidance of concentrated ownership is a major concern of the government, whether the aim is to achieve widespread ownership per se, or whether restrictions are justifiably to be placed on foreign ownership, there are a number of techniques which largely permit governments to implement such policies (pages 116 to 128).

O Private interest has not been limited to strongly performing SOEs. Governments have, through the application of appropriate techniques, privatized loss-making or weak-performing enterprises (page 59). However, many enterprises cannot be sold "as is" and are in need of some restructuring before they can be offered to investors. As investors may sometimes prefer to establish a totally new enterprise, the restructuring may involve the liquidation of the existing concern and the sale of its assets. Such restructuring poses difficult questions related to employment and the treatment of the liabilities of an SOE (particularly when the liabilities are excessive in relation to the asset value). Management issues must often be addressed as well. The extent of the necessary readying measures will depend largely on the financial condition of the SOE and the selected method of privatization (pages 94 to 108). Physi- cal rehabilitation, however, is usually not recommended. o There are wide variations also in the financial costs of various types of transactions or specific methods or procedures of privatization (pages 138 to 141). Costs include low pricing, e.g., to assure widespread share ownership, and the assumption of substantial portions of the liabilities of SOEs. Privatization may not yield full budgetary relief, and several cases are characterized by important residual liabilities for the state. PART I

METHODS OF PRIVATIZATION

SOEs must ultimately be disposed of one-by-one and each case must be examined on its own merits. Among various approaches, a government may opt not to sell the whole SCE as an entity, but to dispose of just one or more activities or subsidiar:ies. It may also not actually sell its existing holdings in the SOE, but open the capital to private participation and thereby dilute its own proportionate shareholding. While a number of SOEs have been sold with little or no restructuring, others have had to undergo extensive financial restructuring. But for many more, privatization of the entity as a going concern is not possible, or not attractive to the private sector 5 , and a fragmentation into component parts or the sale of individual assets is more appropriate. In other instances, a management contract or a lease rather than a sale is the most desirable method.

This Part I first examines the most common privatization transactions or methods. Most transactions observed fall under one of these basic types. Therefore they also constitute the main options or alternative approaches available to governments. Second, it looks at country experiences, in terms of the more frequently used transactions. Third, it lists the main factors that determine whether a particular method can be used. Last, it explains various ancillary measures that may need to be taken along with the privatization transaction.

5/ Nevertheless, the product or service to be provided by the SOE and the assets with which it is provided may be of interest to the private sector. - 8 -

1. BASIC METHODS OF PRIVATIZATION

The most commonly used methods of privatization are:

o Public offering of shares,

o Private sale of shares,

o New private investment in an SOE,

o Sale of government or SOE assets,

o Reorganization (or break-up) into component parts,

o Management/employee buyout, and

o Lease and management contract.

Several of these methods can bring about total divestiture or denationalization or can be implemented partially or gradually. Several combinations of the above exist as well. Partial privatizations often take the form of joint-ventures. Some methods, such as the French type concession system for utilities or public services, do not typically fit under one of the above basic methods, but are described under sector specific arrangements (see page 66).

The choice of a particular method will be dictated by the objectives being sought and other factors (see pages 57 to 70 on determinants of possible techniques), and will generally be based on an evaluation of alternative methods. This section is intended to describe the principal characteristics of each method.

Beyond the above methods of transfer to private control or ownership of SOEs or government productive assets, other actions6 are sometimes also referred to as privatization, or linked to it, that are not covered here but that ought to be mentioned:

- Introduction of competitive features into an SOE (e.g., performance-related incentives).

- Economic policy reforms, such as demonopolizing certain activities or liberalization (e.g., C6te d'Ivoire's recent decision permitting private operators to provide public transportation

6/ The reader is referred to D. Heald, Public Expenditure (Oxford: Basil Blackwell, Ltd 1987), Chapter 13, for what is probably the best summary of the separate concepts which have been grouped under the term "privatization." Heald examines separately privatization of financing, privatization of production of a service (e.g., contracting out), denationalization and load-shedding (i.e., privatization as meant in this report), and liberalization. - 9 -

in Abidjan alongside to Sotra, the SOE handling urban transport, and similar steps for the transport system of Rabat), or reducing regulatory constraints on business; these reforms may be combined with divesture of state-owned assets.

- Increased use of private sector financing of new activities, such as contractor equity financing (e.g., "Construct, own and operate contracts")7 or switching of the source of financing for the supply of a good or service from taxation to user charges (e.g., the North-South Highway in Malaysia to be financed by toll revenues).

- Revenue participation certificates or revenue bonds issued by the state or by state bodies (as were issued for the Bosphorus Bridge and the Keban Dam in Turkey).

- Privatization by "attrition" (e.g., an SOE operating as quasi- monopoly but not renewing investments, gradually permitting the private sector to invest in plants and related facilities and take over alL or part of the SOE's operations).

7/ There is an increased trend for the private sector to take equity in, provide management for and remunerating itself directly from new infrastructure projects which were traditionally public sector undertakings only. An increasing proportion of construction contracts now being tendered is on a build, own and operate basis or on a build, operate and transfer basis (BOT contracts provide for transfer of ownership to the state after a given period). Examples are found in the United Kingdom, Spain, Hong Kong, Pakistan, Singapore, Turkey, Thailand, Australia, Malaysia, United States. They cover mainly roads and bridges and power generation and distribution. Techniques are emerging for such arrangements under different sets of constraints and the role of lenders is being assessed. These are not within the scope of this report. An extensive body of documentation and expertise in this respect has developed recently. A summary of these specific methods may be provided separately at a later date. - 10 -

- Contracting out, i.e., substitution of private contractors or services for production by the state or municipalities (e.g., for refuse collection, building maintenance, etc.).8 and franchising. Contracting out normally follows applicable governmental procurement techniques and procedures.

- Full liquidation of an SOE with the assets ending up in the hands of private purchasers (other than cases referred to on pages 20 to 22) while the SOE's activity is wound up.

The following details the main characteristics of various methods of privatization, and highlights the principal factors which determine the application of each specific method and the main issues which arise under each of them.

Some examples of their use in various countries are also provided in the text, but the reader is mainly referred to Table 1 for a listing of examples of each method.

8/ A very important trend for contracting out has taken hold in several countries including the U.S.A. A United Kingdom law of 1986 requires six basic urban services to be contracted out on the basis of competitive tendering. Extensive literature exists on the subject. The President's Commission on Privatization in the U.S.A. has recommended on this subject that: "The Federal government should rely on the private sector for provision of commercially goods and services. Because contracting provides a means to procure the same level of service at reduced costs, it is not in the public interest for government to perform functions in competition with the private sector." The March 1988 Report of the Commission entitled "Privatization Toward More Effective Government" reviews the contracting out experience and procedures. See further Volume Three, Part II on "Contracting Out". - 11 -

Public Offering of Shares (Fall or Partial)

Characteristics

Under this transaction, the state sells to the general public all or large blocks of stock it holds9 in a wholly or partly owned SOE, which is assumed to be a going concern set up as a public limited company. Technically this transaction amounts to a secondary distribution of shares. When a government decides to sell only a portion of its holdings, the result is joint state/private ownership of the enterprise. The government may pursue this approach as a deliberate policy to maintain its presence or as first step toward full privatization. Where there is already private shareholding, the transaction may simply be a further privatization.

Many privatizations have occurred in which, prior or concurrently with the public offering, a private sale of blocks of shares was arranged (for reasons indicated below).

Procedures

While technically the public offering is a secondary distribution of existing government-held shares, it is commonly handled largely as a primary issue. A prospectus is prepared for the offering, and normally the services of an investment bank as adviser are required. The bank or a

9/ A clear distinction should be drawn between:

(i) offerings of existing government-held stock (true of most privatizations involving public offerings); and

(ii) new (primary) public issues of shares. The latter is another form of privatization, amounting to letting the private sector into the capital of the enterprise, generally through a capital increase with a consequent dilution of the government's interest, rather than a sale of the government's interest (and it is described under Section 5, "New private investment in an SOE"). Alternatively, or simultaneously, convertible debentures (no additional funds upon conversion) or warrants (brings in new funds when exercised) may be issued. (Warrants were used as incentives by the IRI holding in Italy and by Jamaica when selling its holdings in the Caribbean Cement Company (CCC)).

Both (i) ancd (ii) will often take place simultaneously, particularly in the case of enterprises needing recapitalization. Examples are provided on pages 41 to 44. - 12 -

syndicate may also underwrite the offering. The offering may be on a fixed price or on a tender basis.1 0 The shares may be marketed internationally or only domestically. In the case of a listed company whose shares are already traded, the government may simply sell the shares on the stock exchange. The offering may involve, aside from sales to the general public, incentives for employee participation. There may be restrictions on the size of individual shareholdings and on purchases by foreigners. In certain instances, shares may be distributed to employees or the general public for a token (see page 115).

To be eligible for a public offering, the SOE must comply with certain legal, financial and disclosure requirements, governed by the applicable laws of the country of offering (and usually enforced by a securities and exchange commission or similar agency). If an enterprise does not meet those criteria, it may need to be readied (see pages 94 to 97). For example, a public corporation, or a government department, may need to be transformed into a public limited company as was done for British Telecom and is being completed for the Malaysian telecommunications, respectively. If the enterprise is a strongly performing public limited company with an established record of profitability, the process will be straightforward and relatively simple.

Offerings may be underwritten (France, Malaysia, U.K.).ll Many developing country markets have no underwriting capacity to support an offering of any magnitude, while overseas underwriting is not feasible either. In such a case, the government as seller will necessarily take the risk of the sale on its own account. This was the case for the public offering of shares in National Commercial Bank in Jamaica.1 2

In large public offerings, one or more financial advisers and/or intermediaries must normally be retained. The transactions typically raise very substantial amounts of revenue (or equity in the case of primary issues) and the possibly substantial expense involved in necessary fees and commissions to investment banking firms and other intermediaries should normally be assessed in relative terms.

10/ The respective advantages of fixed price and tender offerings are described on page 112 in the section on valuation and pricing.

11/ See Mayer and Meadowcroft, "Selling Public Assets: Techniques and Financial Implications"; Privatization and Regulation: The U.K. Experience, edited by John Kay, Colin Mayer and David Thompson, (Oxford: Clarendon Press, 1986), for a discussion of the merits and costs of underwritings of privatization offerings in the U.K.

12/ John Redwood and Oliver Letwin, "New Directions in Privatization," R.M. Rotschild & Sons Ltd., manuscript, 1986. - 13 -

Preferred Applications/Special Features

Public offerings require that: (i) the enterprise be a sizeable going concern with a reasonable earning record or potential, or that it can be readied to become so; (ii) a full body of financial, management and other information is available or can be prepared for disclosure to the investing market; (iii) there is discernible liquidity in the local market; and (iv) either the equity markets are developed or there is some structured mechanism (inclucling a regulatory body) that can be made to function to reach, inform and attract (as well as protect) the general investing public. It meets a government's objective to encourage widespread share ownership.

Privatizations through public offerings have taken place in response to different objectives. The British Telecom and other offerings in the U.K. were the result of a deliberate policy of transferring ownership from the state to the public. The offerings of minority stocks of Italy's IRI in several companies are simply based on the group's financial strategy, but they also result in a transfer of ownership from the state to the public.

The main advantages of public offerings are that they permit widespread shareholding, allow the broader resources of the general investing public to be targeted, and are normally characterized by openness and transparency. For the above reasons, they are often also politically more palatable.

As an illustration of the elements determining the choice between public offering or private sale, the Public Sector Divestment Committee in Singapore1 3 recommends that: "(1) Unless there are special reasons such as the management wanting to take the business over, obligations to the original promoters, or the parcel of shares being too small, the mode should be random allocation through listing or secondary offer to the public"; and "(4) Where a secondary offer is inappropriate e.g. when Government is looking for a party who can take over the role of dominant shareholder, the mode should be selective tendering or direct negotiation." Public offerings are obviously designed to sell large participations or raise substantial new investment.

Implementation Issues

The following are the major implementation issues likely to arise in the public offering of SOE shares in certain developed and developing country environments.

Condition of the SOE. If the SOE is not presently a strongly performing public limited cornpany with a reasonable track record, a public

13/ Report of the Public Sector Divestment Committee, Singapore, February 28, 1987. - 14 - offering is possible only to the extent that prior restructuring and a turnaround in operations are a realistic option.

In a large number of cases, an enterprise needs to be carefully restructured or readied to make the public offering feasible. Experience shows that this need not be an obstacle where the enterprise clearly has a good earnings potential. The transformation of government entities such as the United Kingdom, Japanese, Malaysian and Sri Lankan telecommunications enterprises into public limited companies represented by shares is an example of such a readying process (see page 95 and following). Rather, the issue arises with respect to what specific steps can be taken to ready for privatization through public offerings enterprises that have no reasonable earnings potential in their present condition. Prior to the public offering of holdings in British Airways, the government took various steps to restructure the loss-making enterprise, which thereafter showed profits. The work force was reduced and new management methods were introduced, and various financial restructuring steps were taken as well.

Alternatively, a government may wish to privatize an SOE in two steps. In the first stage, it would sell a minority but controlling interest to an investor or core group of investors through a direct sale. The investor(s) would bring in the leverage necessary to turn the company around. Once the company had become profitable, the remainder of the government-held shares would be offered to the general public. The presence of a leveraged party may be paramount, in the case of SOEs which are inefficiently managed. The presence of such a core group, be it a strong technical partner or a sound investment management group, would also boost investor confidence. Similarly, in several French privatizations through public offering, a block of shares was sold to a preselected core group of shareholders (36.69 percent of the shares were so sold in the case of Compagnie Financiere de Suez).

Targeting ownership. If the objective is to achieve widespread share ownership or to target certain segments of the investing public, specific mechanisms (incentives, restrictions, etc.) need to be introduced to ensure those objectives are attained and maintained. Otherwise even a public offering may lead to a given investor or group of investors taking control of the SOE (even though, as indicated above, in several instances a "stable core" of a strong technical partner or institutional investor(s) may be desirable). Foreign ownership may need to be restricted. Employee participation in ownership may be encouraged (see pages 132 to 134).

Valuation and pricing. These issues need careful handling to ensure that adequate value is received. Their importance is enhanced by the need to avoid claims that the state has given away the public patrimony to purchasers who then enjoy a windfall profit. Relevant techniques are discussed on pages 109 to 116.

Absence of developed equity markets. Without strong equity markets, public offerings will not generate much response unless mechanisms - 15 - are devised that allow the general investing public to be reached. This was done in the Jamaican cases and the Turkish instance described on page 142. It is essentially the absence of an effective primary market or market substitute which might impede privatization. However, the absence of a secondary market would render an investment in stock of the privatized SOE illiquid and may in itself discourage investors. However, as described in page 142, there have been instances that cannot technically be characterized as public offerings in which shares in SOEs have been offered to and taken up by important segments of the investing public in developing countries without any structured equity market.

Nature of capital market regulation. An important question is whether, in an unsophisticated equity market, the government should take special precautions to avoid excessive financial risks for purchasers. This is a complex issue, and more so than can be acknowedged in this brief section. While the main purpose of capital market regulation is to ensure an adequate level of discLosure when offering securities, important questions arise as to the government's responsibility for protecting the interests of investors who may not have the benefit of advice from experienced intermediaries in a number of less developed capital markets. Disclosure requirements vary of course from one jurisdiction to the other. Serious attention must be paid by governments offering SOEs to relatively unsophisticated markets that unfamiliar investors not be led to judge the investment opportunity on the basis of too favorable or optimistic reporting. A recent prospectus for an equity issue to finance the expansion of a privatized industry in a West African country (with no regulatory agency supervising share issues) would astonish securities and exchange commission officials in countries with more regulated markets. However, the investing public in such a country may not respond well to an offering if the prospectus were to include the usual cautionary statements as they would be unfamiliar to them. Purchasers of shares must however be made aware of the inherent risks and not expect a government guarantee of return or of recovery of principal.14 It is advisable that, in addition to the government's assessment of the safety of the securities offered when processing an SOE for public offering, a securities commission or similar agency be able to pass indepeandent judgement when clearing securities for public offering. The absence of rating agencies in many developing countries adds to the need for governments to consider this issue carefully in the case of public offerings.

14/ In the case of the offering of the last slice of BP shares in the U.K. in 1987, the Government intervened in the market following "Black Monday". All shares were underwritten, and the Government maintained that the risk of insufficient applications was indeed the underwriters' risk. But because of the disturbed state of the market, the Bank of England was authorized to offer to repurchase shares at the price at which the shares where then trading, protecting holders against a further fall. Only a small portion was bought back. This was an exceptional measure which H.M. Treasury does not consider a normal policy. No other examples are known of such protective measures. - 16 -

Marketing. Alerting and educating the public is key to the successful subscription of a public offering.

Receptivity of capital market and crowding out effect. Large public offerings may prevent available resources and savings to be invested in the creation or expansion of other productive enterprises. This point cannot be analyzed within the scope of this report. Suffice it to say that when the volume of available resources, or the capitalization of the stock market, is not on the increase, large scale offerings may represent a threat. The French Minister of Economy, Finance and Privatization had indicated that, on the other hand, the proceeds of privatization permitted the state to reduce or amortize through specific allocations (see page 139) its borrowings in the market, thereby reducing the crowding out effect. Obviously the crowding out effect must be considered carefully when preparing public offerings and a phased approach (see page 78) may be a relevant tool to address this issue.

In some circumstances (e.g. the sudden downturn in stockmarkets in the fall of 1987) precautionary measures may be necessary and some privatizations through public offering may have to be postponed. Thus, France postponed the first trading of shares of the recently privatized financial group Compagnie Financiere de Suez (new stockholders would have been faced with a paper loss even before they would have paid for their shares). France further postponed the sale of Matra (which was scheduled to take place in November 1987), 15 percent of Air France as well as UAP (Insurance), and Germany postponed the offering of its interests in Volkswagen and VIAG (aluminum, chemicals). In the case of the £ 7 bn. sale of the U.K. Government's stake in British Petroleum, a floor price mechanism was put in place (whereby the Bank of England would acquire the shares underwritten by various banks as a safety net to protect the underwriters against the sudden crash of the stock prices which occurred in the fall of 1987), demonstrating that governments may need to intervene when capital markets become unresponsive.

Private Sale of Shares (Full or Partial)

Characteristics

Under this transaction, the state sells all or part of its shareholding in a wholly or partly owned SOE to a pre-identified single purchaser or group of purchasers. It is assumed the SOE is a going concern set up in the form of a corporation represented by shares. The transaction can take various forms, such as a direct acquisition by another corporate entity or a private placement targeting a specific group, for example institutional investors. The privatization can be full or partial, with the latter resulting in mixed ownership enterprises. - 17 -

A private sale of shares may also be carried out before, or sometimes simultaneously with, a. public offering.

Procedures

The sale of a government's shares in an SOE can be handled in a variety of ways. Two common ways are full competitive process, with prequalification of bidders, and direct negotiation, with ad hoc procedures for identifying potential buyers (often involving a wide investor search). Senegal's privatization law requires a competitive process.1 5 A law and implementing decrees in Argentina16 initiating the privatization of some manufacturing enterprise and petrochemical concerns, require individual calls for bids to purchase all of the state-held shares in these SOEs (unless preference rights of existing shareholders are exercised). When deciding whether to transfer ownership of the shares, the government will look at the purchasing party's general business reputation, financial strength, record of performance, etc. With a mixed enterprise, the government may simply agree to sell its shares to the existing private shareholder. The government's method may involve a staged process involving gradual disposal of shares. Often the purchaser is engaged in the same line of business or has some special interest (diversification, market, etc.) in the particular SOE. The sales potential of enterprises must be carefully assessed. All operational aspects and assets of the enterprise must be carefully reviewed (e.g., the SOE may occupy an attractive market niche which is underutilized or neglected). In preparing for the Rumasa group privatizations in Spain, much emphasis was placed on the potential of various companies.

While a sale of shares obviously implies that the enterprise would be sold as a going concern with all its assets and liabilities, readying activities such as balance sheet restructuring (e.g., alleviation of liabilities) may be carried out prior to offering the shares.

Discretionary procedures carry the danger of lack of transparency (apart from standard economic arguments in favor of auction-type mechanisms). The sale of SOEs is different from divestiture by private parties essentially in that a government seller must generally be concerned with the operation of the enterprise after the sale. A number of countries have introduced mandatory procedures or guidelines for private sales that cover matters such as price-setting, selection of purchasers (prequalification, bidding), uniform terms of finance, etc. (page 90 and Annex C give more detail on these procedures.) France has developed detailed procedures for the selection, on the basis of competitive bidding, of a group of stable investors to whom shares of SOEs will be sold prior to an offering of shares to the general public.

15/ The preamble of which specifically states the intent to avoid direct sales to predetermined buyers and the need for a transparent process -- see Annex C.

16/ See Annex C. - 18 -

As far as marketing procedures are concerned, as well as procedures for inviting and screening investor proposals, similar methods may apply to the private sale of shares, the sale of assets as well as the solicitation of new private investment by way of a capital increase of a SOE.

In the case of the Philippines, the Operating Guidelines of the Asset Privatization Trust provide minimum standards for bidding. The use of sealed bids must be followed; negotiated offers can be resorted to only if bidding should prove unsatisfactory, impractical or inappropriate under specific circumstances. In Argentina and Brazil various laws govern bidding (cum prequalification) and auction procedures (See Annex C). In the case of Togo, the Ministry of State Enterprises has formulated detailed guidelines for the purpose. They essentially provide for the preparation of a dossier (in terms of items to be addressed by interested parties) and a brochure for each enterprise, to be distributed through all available channels such as local and foreign banks, chambers of commerce and foreign trade offices, and embassies. Interested parties are invited to make a field visit; following initial contact, the Minister of State Enterprises authorizes plant visits and the gathering of further data and information. Upon receipt of an offer from an interested investor, the Ministry verifies if all elements specified in the dossier in respect of investor qualifications and contents of proposal are included. An Interministerial Commission them will meet to consider the investor's proposal. The best source to review bidding and auction mechanisms are the offering memoranda for particular transactions.

Private sales of shares are often used as a first step to, or in conjunction with, public offerings. This procedure may be an important step where the presence of a core of stable shareholders in the company is regarded as essential. It was used extensively in France.

Finally, there are a few instances where the private sale was used as a first step to wider share distribution. In the case of Montedison, in which ENI, Italy's energy sector holding company, had acquired a controlling interest of about 30%, ENI concluded an agreement for GEMINA, a largely private financial holding company, to acquire this interest; GEMINA further disposed of this interest to investors in the private sector. The private sale to holding trusts (see also page 149) might thus also be an intermediate step to further sales to the wider investing public.

Preferred Applications/Special Features

Because of their flexibility, private sales are the preferred method with weak performing SOEs or SOEs in need of strong owners with relevant industrial, financial, commercial and other experience and a high financial stake in the success of the firm. - 19 -

It may also be the only feasible alternative in the absence of developed equity markets, where no mechanisms can be developed for reaching the general investing public, and where the size of the enterprise may not justify a public offering.

One of the principal advantages of a private sale of shares is that the prospective owner is known in advance and can be evaluated, and may be selected based on ability to bring a number of benefits such as management, technology, market access and the like. In many instances, the future success of the operation may be as important to government as the proceeds from the sale. In some cases, a partial private sale may be a necessary first step to full privatization, as it brings in a leveraged party who is able to turn the company around so that it becomes attractive to investors. In addition, the private sale permits all the required flexibility to conclude special arrangements with a suitable purchaser as required by the SOE condition. E.g., even a SOE with a negative net present worth or uncertain market value may be attractive to a buyer with whom a special synergy exists (market share, technology, etc.). In some cases, it has even allowed for the payment of compensation to a buyer agreeing to acquire such an enterprise (IRI in Italy has done so). But the main advantage will usually be that a buyer may give other than market value to the SOE.

It is important to avoid, normally through provisions in a sale agreement, that a buyer would acquire an SOE with a view to dismantle it and sell the assets (unless th:is is regarded by the vendor as an acceptable outcome).

The private sale is, of course, much simpler in terms of disclosure and other legal requirements, than is a public offering.

Implementation Issues

The SOE may be in need of financial restructuring, such as alleviation of liabilities. Phys:ical rehabilitation of assets prior to sale seems to be a rare occurrence. Mechanisms for handling employment issues, particularly loss of jobs and government benefits, may need to be designed; most will carry some cost. To ensure a government's objectives are met and the public interest is served, mandatory procedures may need to be introduced to govern valuation, purchaser selection (prequalification, bidding process), etc. There usually is a need for government "distancing" in cases of partial privatization, to allay investor fears of continued interference.

There is a need to differentiate between denationalization or reprivatization exercises such as in Bangladesh, Chile (initial phases), Philippines (part of the portfolio to be privatized consists of non- performing assets acquired by state development banks), Spain (Rumasa) and Uganda, and first time privatizations. A company which was originally set - 20 - up as a private enterprise may present quite different characteristics from a typical SOE. Formerly private companies will normally already be in the required corporate form and may be in lesser need of prior restructuring. However, during government ownership, the work force may have grown too large, liabilities may have reached unsound levels, etc. These aspects would then normally need to be addressed prior to privatization, much as if this was a first time privatization.

A disadvantage of any private sale (of shares as well as of assets) is that it may give rise to criticism as to the selection of the acquiring party, particularly if a large number of transactions are so concluded giving rise to inadequate spread of wealth in the country. Strict mandatory procedures will tend to compensate this effect.

Pricing will be one of the most difficult areas, as with several other forms of privatization.

Sale of Government or Enterprise Assets

Characteristics

Under the previous two methods of privatization, the private sector purchased shares in an SOE that was a going concern. Here the transaction consists basically of the sale of assets, rather than shares in a going concern. A government may sell the assets directly; the SOE may dispose of major assets. Generally, while the purpose may be to hive off separate assets representing distinct activities, the sale of separate assets may be only a means of selling the enterprise as a whole. Thus, the assets may be sold individually or be sold together as a new corporate entity. Assets can only be sold privately (unless the government embodies the assets and activities into a new company established for purposes of privatization, in which case a public offering or private sale of shares is possible). In some cases, assets are not technically sold, but are contributed by the government to a new company formed with the private sector. The shares received by the government for this contribution may then be sold (see sale of shares, sections 1 and 2 above).

Procedures

The sale of assets can be based on open competitive bidding 17 or

17/ As in the sale of Compagnie Generale de Constructions Tel6phoniques concluded after competitive bidding on the basis of preset criteria and on the basis of a fixed price; all criteria were set forth in a detailed "Cahier des Charges." The offer for sale by public tender of 21 hotels by British Rail Investments Limited was organized along strict criteria spelled out in the comprehensive sales memorandum dated December 2, 1982. - 21 - carried out by auction. It can also be concluded after direct negotiation with a pre-identified party. In the latter case, it will often be preceded by a complex investor search. The reader is referred to the previous chapter on private sale of shares as many of the procedures will apply mutatis mutandis.

The sale of assets can take many diverse forms. This report looks only at a few of the more typical transactions, as observed in recent privatizations; the following scenarios have been observed.

(i) If it is desirable to privatize just part of an SOE, the enterprise may simply dispose of those assets with the core SOE remaining intact. Thus, this method is a useful way to downsize an SOE. (If distinct units are hived-off, then the transaction will rather be a break-up into component parts as described on page 23.)

(ii) If the intention is to sell the entire SOE but it is not saleable as a going concern (that is, through a sale of shares), it may have to be dissolved and liquidated and its assets sold (with or without accompanying liabilities) to a private party or parties, who will then create their own corporation toc take over all or part of the activities of the defunct SOE. This process is very common in privatization. As a rule, the assets and liabilities are separated, with the investor not necessarily assuming the latter. This was done by C6te d'Ivoire with the SIETO hotel company -- individual hotels were then transferred to municipalities and placed under management contract. The objective of several privatizations in Guinea was for the private sector to create new companies with private majority to embody government-owned assets. Bids had to be in the form of a feasibility study, showing the expected future operations of the company to be established. The assets of several dissolved SOEs in Togo were sold to new corporations. In the case of IOTO (oil products) and SODETO (detergents) the buyers are corporations with private foreign and Togolese participations. The plants of Societ6 de Marbrerie de Thala in Tunisia were sold (through competitive bidding) to a large Tunisian contractor. Liabilities were settled in chat the state dropped its claims on the company and thv creditor banks shared the proceeds of the sale; the zompany was dissolved and liquidated.

(iii) The enterprise may be saleable as a going concern but for other financial (e.g., tax) or legal reasons, a sale of assets is in the best interests of all parties.

When IRI sold Alfa Romeo to Fiat, i: did not convey it as a company. Rather, Alfa Romeo sold all its assets (plants, trademarks, etc.) - 22 - and transferred all its liabilities to a new company formed by Fiat-Lancia. The reason in the case of Alfa Romeo was that both the enterprise was not saleable as a going concern and that IRI wanted to keep Alfa Romeo as a shell company in order to write off its losses against other group profits.

Several aspects of the sale of assets are handled in ways quite similar to those for the sale of companies. For instance, comprehensive documentation is often required when open bidding is planned. Though not a prospectus, the documentation may be compiled according to similar standards.1 8 The marketing and investor screening procedures described under the previous section (Private Sale of Shares) may apply in the case of asset sales as well.

While such disposals often cover physical assets, they may involve a spin-off of certain activities or rights. They may also involve giving up a market share to a private party for compensation.

Preferred Applications/Special Features

By definition, a sale of assets involves a known party and in that sense it may have the same advantages as a direct sale of shares. In addition, it offers additional flexibility in that it may be more feasible to sell individual assets than the whole SOE or it may permit the sale of an SOE that might be extremely difficult to sell as a going concern. It should be borne in mind, however, that often this approach may result in residual liabilities for the government.

In many cases of SOEs that are not saleable as going concerns, the sale of assets is the preferred method, if not the only alternative. This method is possible because the enterprise's products and assets may be of relevance to a buyer in the private sector. In such cases, the government may decide to dissolve or dismantle the SOE and liquidate it by selling its assets and writing off its uncovered liabilities. The entity can then emerge as a private sector company. This method is also appropriate in some cases of privatization of SOEs that are not set up under company laws (unless a public offering is planned, in which case conversion to a public limited company is necessary).

In the case of Compagnie Generale de Constructions Telephoniques (CGCT) in France, the preferred method was the sale of assets (following dissolution) for a variety of reasons, principally the need to fragment the enterprise (see page 25).

Implementation Issues

The main implementation issue is how to handle existing liabilities. Unlike the sale of shares in a going concern, the assets are often

18/ See footnote no. 17. - 23 - sold without the corresponding liabilities. When the transaction involves simply the disposal of excess assets, no major problems arise. When the transaction involves full dissolution and liquidation of the SOE, most, if not all, of the issues associated with major restructurings will arise. For instance, full dissolution or winding up, in some instances the only alternative, is the most costly alternative, since it may involve settling all liabilities and laying-off all personnel. As with most transactions, however, there are many "hybrid" solutions. For instance, the enterprise may be dissolved and the assets sold, but under a contractual arrangement that obligates the buyer to rehire a substantial portion of the personnel or to assume certain liabilities subject to conditions prearranged with creditors.

Thus, the implementation issues very much depend on the actual situation.

The situation may arise of assets bought for purposes other than restarting operations (e.g., scrap value, shipping plant to another country, idling the assets to improve competitive position). If such purposes are undesirable, governments may wish to obtain specific commitments to preclude such a situation.

As with several other forms of privatization, pricing will be one of the most difficult areas.

Reorganization into Component: Parts (or Fragmentation)

Characteristics

This method involvess the breaking-up or reorganization of an SOE into several separate entities or into a holding company and several subsidiaries.19

Procedures

There are several possible ways to proceed that will depend on the legal form of the enterprise. Aside from the sale of some of the assets, as described above, the options include:

- Break up into several legal entities, as in the case of ENDESA, the state-owned power generating and distributing company in Chile.

19/ This technique can be regarded simply as a form of restructuring prior to privatization. However, since it is found to be a distinct action with many applications in developing countries, it is dealt with as a separate form of privatiz;ation. - 24 -

Transformation of the SOE into a holding company that acquires the shares of the subsidiary companies which have taken over the assets and liabilities of the original SOE (as happened in the case of Cooperative Wholesale Establish- ment in Sri Lanka). This method permits a gradual spin-off of some or all of the now smaller entities as purchasers are found. (A purchaser can buy several subsidiaries, but this method typically looks to a wider market for the transfer of ownership.)

Hiving off of some activities, with the government retaining others (e.g., the non-commercial ones). Such hiving off often amounts to a simple sale of assets. In the case of Turkish Airlines (THY) several activities were incorporated in new subsidiairies to be privatized before THY is privatized.

- The sale of productive facilities in single or groups of units rather than as a whole, as in the case of British Shipbuilders (this method was decided with the aim of encouraging competition after privatization).

Once one of the above steps is taken, privatization of the individual components may be carried out through any of the other methods.

A prime example of a hive-off is British Rail in the United Kingdom.2 0 British Rail had, in addition to its railway assets, a portfolio of interests in other industries where it competed directly with the private sector. British Rail decided in principle to privatize some of those activities, which included ferries, hovercraft, hotels, properties, con- sultancies, freight cars and advertising. A holding company, British Rail Investments Limited, was set up to acquire some of the non-rail activities, with the sole purpose of privatizing them. Many of the companies and assets occupied attractive market niches but were run down and badly managed. It was thought that small-scale entrepreneurs would take part in the privatization. One intended result of the removal of these operations from British Rail was to free more resources for its core railway operations. Although a few hotels were sold directly to private parties, it was decided to sell the remaining 21 by open tender (effectively an auction). In addition, the sea transport company, Sealink, was sold to a foreign company through competitive bidding. British Rail Hovercraft Limited (English Channel hovercraft ferry) was, after being merged with a Swedish firm, given to its work force for a nominal sum. Surplus property of British Rail is still being disposed of, and other privatization transactions are under way as well.

20/ Based on information provided by Morgan Grenfell & Co. Ltd. - 25 -

Components of British Leyland (The Rover Group) were privatized through different methods: a public offering for Jaguar, a management buy- out for Leyland Bus and Unipart, a hive-off of Leyland Trucks into a joint venture with DAF (Holland). The automobile businesses Landrover and Austin-Rover remain to be privatized. The disposal of Leyland Trucks relieved the Rover Group of an operation that was losing around £ 1.5 million a week, and of the £ 750 million debt that Leyland Trucks had accumulated. 2 1 Another example, among many others, of a fragmentation being retained as the most appropriate privatization method among other options, is the piecemeal salea of Madelipeche by the government of Quebec.22 A comparable example is the sale of CN Route (trucking and distribution services) by Canadian National Railways. Yet another example is the 100 percent privatization. of the stevedoring and transit operations of the Port of Conakry in Guinea which involved the sale of some assets and facilities and the lease of others.

Preferred Applications/Special Features

This method permits piecemeal privatization. It further permits different methods of privatization to be applied to different component parts, thereby possibly maximizing the overall process.

If an SOE incorporates too many activities that, in the aggregate, are not attractive to potential investors, whereas individual units would be, fragmentation is a possible alternative. Sometimes, a state wishes to sell only certain components of the SOE, while retaining others, as in the case of British Rail. Some port authorities that embody many different operations (general port services, stevedoring, transit, towing, etc.) have found that certairL activities are better handled by the private sector, which finds them attractive, whereas the global operation might not be.

Fragmentation of port operations is observed in Singapore, Guinea and other countries. In the case of Compagnie G6n6rale de Constructions Telephoniques (CGCT) in France, the government was intent on keeping only a central activity, whereas it wanted to divest most of the subsidiaries (about 98 percent of the assets).

Another reason for fragmenting an SOE may be that it is a monopoly and that the government would like to fragment it into separate enterprises to create competition. British Shipbuilders was mentioned as an example ot this. The questiona arises further in the U.K. in respect of the

21/ M. Pirie and P. Young, The Future of Privatization (London: Adam Smith Institute, 1987) p. 6.

22/ See "Privatization of Quebec Government Crown Corporations, Progress Report," distributed by Associate Minister for Finance and Privatization, March 1987. - 26 - electricity supply industry. The Central Electricity Generating Board (CEGB)2 3 could be privatized in several different ways, including among others: (i) as one unit (the preference of CEGB and its employees backed by unions) (possibly accompanied by revisions to the 1983 Energy Act to encourage competition in electricity generation); (ii) a sale of assets, power station by power station (or sale of some of them); or (iii) reorganize the CEGB into a few competing generating companies (seen as in the best interests of consumers). Another debate in the U.K. concerns the method for selling 12 electricity distribution boards. The reverse method is being considered here as a possible option appears to be lumping them together into a smaller number of companies.

Implementation issues

Once an SOE has been broken up into component parts, the further privatization method applied (private sale, sale of assets, management/ employee buy-out, etc.) will determine the issues which may arise. How- ever, the reorganization of an SOE into component parts may in itself present various issues arising under major restructurings, such as satisfaction of creditors' rights, employment issues, etc., which are dealt with in Part II.

New Private Investment in SOE

Characteristics

A government may wish to add more capital to an SOE (mostly for rehabilitation and for expansion) and achieve this by a capital increase opening equity ownership to the private sector. The main characteristic of such a privatization method is that the state is not disposing of any of its existing equity in the SOE. Rather, it increases the equity and causes a dilution of the government's equity position. The resulting situation will be joint private/government ownership of the enterprise (often referred to as joint venture). If the SOE is not wholly state-owned but, say, majority-owned, then the new capital subscription will simply result in a further dilution of the government's interest, possibly resulting in private majority holding.

In a large number of instances, the state has brought in the assets of an SOE (with or without accompanying liabilities) as a contribution in kind to the capital of a new corporation, while new private investors' cash contribution to the capital of the new corporation will

2_/ CEGB generates electricity in England and Wales and transmits it to 12 area boards which distribute and market electricity for consumers. In Scotland and Northern Ireland the electricity industry is vertically integrated. - 27 - permit necessary rehabilitation, restoration of working capital, or an expansion of the operations.

Normally, a new equity issue does not result in sales proceeds for the state.

Procedures

This type of privatization is accomplished through a capital increase24 of the SOE,2 5 although it may be carried out through a merger procedure as well. In many such instances, the SOE will be transformed into a mixed economy (state-private) company. The new share issue of the SOE may be handled through a public offer of subscription or private subscription. In either case, the normal procedures for corporate capital increases and new share issues, subscription and payment apply. In some instances, various classes of shares are issued depending on the objectives of the parties involved. For example, private investment may be more forthcoming if preferred shares are offered. It should be noted that a new equity subscription by the private sector may be handled in conjunction with the disposal of existing government shares.2 6 In a number of instances new private investment was applied to the initial capitalization of a new company embodying SOE or government assets.2 7

In the recent (December 1987) case of Soci6te des Industries Textiles Reunies (SITER), directly and indirectly owned by the government

24/ There are cases where, as part of financial restructuring measures, the capital is first reduced to absorb losses and subsequently increased to raise new equity money -- naturally, in such cases the end result may not be a substantial capital increase. E.g. , in the case of Societ6 Miniere de Spath Fluor et de Barytine (Fluobar) in Tunisia, the existing share capital was written down by more than a third representing the amount of accummulated losses; however a new equity issue (subscribed by t:he Arab Mining Company and the International Finance Corporation) re-increased the share capital (to a higher level than the initial). The Government's ownership was reduced from 95% to 45%.

25/ Depending on the existing capital structure, another option for the SOE needing additional funds would be a debt issue in conjunction with the sale of the government's shares. If the resulting offering could not be easily absorbed, yet another alternative would be to attach warrants to the debt securities. Of course, privatization would be deferred until the warrants are exercised (and no certainty exists that they will be exercised). But, then again, the technique can be applied to part only of the government's shares.

26/ Examples of this are provided on page 42.

27/ See page 21, paragraph (ii). - 28 - of Tunisia for 88 percent, a capital increase financed the modernization of the textile finishing mill and diluted the government holdings to 49 percent. SOGITEX, SITER's textile holding company, subscribed to it for further divestment of the shares to the International Finance Corporation (IFC), a French textile company,28 and private commercial banks.

Such a mode of privatization, unlike perhaps the sale of assets, and to a lesser extent, the sale of shares, is rarely carried out on the basis of competitive bidding. As in the above case of SITER, the selection process essentially involves the search for a reliable industry partner (except, of course, in the case of public offerings) prepared to make a substantial investment in the SOE.

Preferred Application/Special Features

This method is the preferred one for dealing with funding problems of under-capitalized enterprises. An SOE may be in need of additional capital, e.g., to increase its capacity or for rehabilitation. An example of this is the capital increase of Rh6ne-Poulenc (chemicals) in France. A new issue may be combined with an offering of existing government shares, such as in the case of the Compagnie Generale d'Electricite in France where the new share issue was to strengthen its balance sheet and help it absorb its takeover of ITT's telecommunications assets. In addition, it should be considered where the sudden sale of government holdings in several SOEs may be politically difficult to authorize and carry through, in that the transformation of an enterprise into a joint stock corporation with very limited private participation may be popular (e.g., investors provide equity financing to a debt-ridden public enterprise). Governments are likely to favor joint ventures with foreign companies so as to gain management and other expertise in addition to capital. Once the transformation has taken place, further privatization through a gradual transfer of government owned shares can take place more easily.

In some circumstances, this privatization method may be applied to strengthen SOEs which the government intends to keep in the state portfolio. E.g., the IRI group in Italy concluded a merger between SGS, a microelectronics company owned by the subholding STET, and the relevant division of Thomson (France).29 IRI holds that this type of privatization is an important tool to make certain industries more competitive.

There are cases where a secondary distribution should only take place after the primary issue has been completed. One situation is where the recapitalization is a precondition for the market even to consider investment or for the secondary share distribution to command an acceptable price.

28/ Whose investment was made through the IFC's GRIP facility (Guaranteed Recovery of Investment Principal) referred to on page 151.

29/ Thomson is still a SOE but included in the list of enterprises to be privatized. - 29 -

In summary, this will be the preferred method if a government's objective is both to reduce its proportionate shareholding or change the state/private mix in the SOE and if the enterprise is in need of capital.

Implementation Issues3 0

The new private investment in the SOE is normally achieved through a primary equity issue by an existing SOE. It can then be handled on the basis of a public offering or a private sale, and respective issues described in the discussion of these methods (pages 13 and 19 above) may arise.

New private invest.ment may be for the capitalization of a new company embodying assets transferred to it by the government, and implementation methods with respect to the sale of assets (page 22 above) may arise.

Management/Employee Buy-out

Characteristics3l

30/ A concern sometimes raisesdwith respect to this method of privatization is that it leads to an extension of the SOE's capital with no state divestment. This aspect, however, is outside the scope of this report.

31/ Another method of employee acquisition of interests in SOEs, the Employee Stock Ownership Plan (ESOP), through which employees can acquire important blocks of shares of SOEs, is discussed below in paragraph (b). The worker cooperative, however, is not discussed here. Workers' cooperatives normally would imply a higher degree of membership participation in management than management/employee buy- outs, where the employees simply are shareholders. Proposals have been formulated for setting up "Democratic Worker Ownership Trusts (DWOTSs)" largely along the model of the over eighty-five industrial cooperatives in Mondragon, Spain. Zimbabwe is reportedly drafting legislation for the purpose. These methods are not discussed here since there is no known use as yet of the method as a technique of privatization of SOEs, except in Niger. Since they might in the future constitute a valid method of privatization, the reader is referred to analysis made on the subject in various articles including K. Bradley and A. Gelb, Coopera- tion at Work: The Mondragon Experience, Heinemann Educational Books, London, 1983. Spanish edition: Cooperativas en Marcha: el Caso Mondragon, Ariel, Barcelona, 1985, and articles by the Industrial Cooperative Association, including D. Ellerman and P. Pitegoff, "The Democratic Corporation: The New Worker Cooperative Statute in Massachusetts," Review of Law and Social Change, Vol. XI, No. 3, 1982-1983, pp. 441-472. The reader is further referred to publications on employee acquisitions as a restructuring measure for enterprises in difficulty (see footnote no. 33 below). Many such measures may, if certain conditions are met, constitute desirable alternative forms of SOE reorganization. - 30 -

The term management buy-out (MBO) generally refers to the acquisition of a controlling shareholding in a company by a small group of managers. It often also designates a similar transaction where employees or management and employees acquire a controlling interest. This section focuses particularly on acquisitions by management and work force. For the sake of clarity, the transaction is referred to here as a management/ employee buy-out. The leveraged management/employee buy-out (LMBO) involves the use of credit to finance the acquisition, with the assets of the acquired company generally used as security.

As explained by Blackstone and Franks:

"the special characteristic of the financing arrangements for management buy-outs is that the financiers provide the bulk of the funds but take a disproportionately small proportion of equity; on the other hand, the buy-out team obtains a large share of the equity but provides a small proportion of the funding. High gearing ratios, where borrowings can be initially as much as five times the amount of share capital in the company, are not unusual and in some cases may even be higher than this. In such cases it is naturally important that the projected cash flow is sufficient to allow for the payment of large sums of interest and capital repayments without placing the viability of the business in jeopardy."3 2

There are not many examples of management/employee buy-outs in developing countries and the few known instances are described in (c) below. But cases like the leveraged buy-out of the National Freight Company Ltd. in the United Kingdom (described below in paragraph (c)) are essentially replicable. The management/employee buy-out constitutes a significant and promising technique for SOE privatization.

Procedures

There is more experience with employee buyouts outside of the privatization sphere, the experience of which is, however, directly applicable to acquisitions of SOEs.3 3 In most cases of buy-outs, a holding company is created through an equity issue subscribed to largely by management and employees. The holding company then acquires the SOE which is to be privatized, using equity funds and, in the case of leveraged buy-outs, substantial borrowed funds.

32/ Lance Blackstone and David Francks, Guide to Management Buy-outs, 1986-87 (London: The Economist Publications Ltd., 1986). See also M. Wright and B. Coyne, Management Buy-Outs (London: Croom Helm, 1986).

33/ Keith Bradley and Alan Gelb, "Employee Buyouts of Troubled Companies," Harvard Business Review, Sept.-Oct. 1985, pp. 121-130, and same authors, Worker Capitalism: The New Industrial Relations, (Cambridge, Mass.: The MIT Press, 1983). - 31 -

In the case of Nuova Utensileria Italiana (NUI), IRI's (Italy) relevant subholding sold the enterprise to a group constituted by the majority of the company's employees, not on a leveraged basis. An illustration of a leveraged management/employee buy-out is the sale in the United Kingdom of National Freight Company Ltd., a large company (approx. 30,000 employees) which was performing too weakly to permit a public offering. Instead it was acquired by a management/work force consortium created for the purpose. The consortium acquired the company for £ 53.5 million using a £ 51.0 million medium-term loan secured by the assets of the operating subsidiaries of the group. The balance as well as the transaction costs were financed by an equity share issue by the consotrium, of which over 80 percent was subscribed to by employees and pensioners of the company and their families. The average investment per worker is about £ 700 (1986 profits were several times the level before privatization; share value increased subsl:antially). Some government debt has been written off. Other cases in the United Kingdom include several shipyards of the former British Shiplbuilders Corporation which were privatized, including the Vosper Thorneycroft Shipyard through a management buy-out in 1985 and the Vickers ancd Cammell Laird war shipyards through a management/employee buy-out that same year. The average investment per worker was about £ 300. Interest-free loans for up to f 500 and further preferential loans were made to employees. In addition, the workers' consortium could buy stock at a preferential price of £ 1.0, whereas financial institutions, banks and pension funds had to pay five times that rate. Further in the United Kingdom, the Victualic Company (a leading European manufacturer of pipes and fittings) was sold by its parent, the state-owned British Steel Corporation, through a management/employee buy- out in 1983; and Leyland Bus and Unipart were bought-out by management from British Leyland (The Rover Group).

SOEs acquired through employee/worker and cooperative buy-outs in the first phases of Chile's privatizations did not remain in the workforce's hands -- enterprises encountered substantial financial difficulties or were sold to groups of investors. In recent Chilean privatizations, there are only two instances of 100% worker buy-outs: ECOM, a large computer firm, and EMEL, an electricity generating corporation (there are, however, as reported in Volume Two, a number of additional privatizations with substantial worker participation).

For the sole purpose of acquiring ECOM, workers formed a corporation, Sociedad Administrador.a de Empresas de Computacion S.A. (SAECOM). Since the capital provided by workers and employees was not enough for the purchase of ECOM the financial package was formed in the following way for the total price paid, which was about US1.5 million dollars equivalent: (a) retirement funds advanced: 10%; (b) loan from CORFO (the state holding corporation acting as vendor) with a maturity of 10 years at 5% real interest rate: 90%. The price for ECOM was set according to the value of liquidation of the corporation since it was the only feasible alternative - 32 - for CORFO. The guarantees for the CORFO loan were the assets of ECOM and the shares of SAECOM. When workers took control of ECOM, they begun a total restructuration of the company, which included major organizational changes, salaries and wages adjustment, a more aggressive commercial policy and sale or lease of disposable assets. The most important asset of ECOM, the main building, was leased and the offices moved to a smaller and less expensive building. The results are reportedly impressive. Though no alleviation of liabilities occurred, in six months of the new management losses of about US1.5 million dollars were turned into profits of more than US250,000 dollars in 1986 and for 1987. Profits are expected to reach about US900,000 dollars equivalent.

EMEL is a component part of ENDESA, the state-owned electricity power generating and distributing corporation, which was reorganized into several corporations for purposes of privatization. EMEL was the first electricity utility to be privatized, and the fact that it would be offered to its employees was regarded as a constitutive element of the decision to break up ENDESA. Performance of EMEL has improved after privatization.

In both the case of ECOM and that of EMEL, the vendor (CORFO, through its Normalization Unit -- see page 84) and the enterprise have repeatedly played an important role in easing the process and helping organize workers. Similar support has also been given to workers in partial acquisitions of various other SOEs.

In C6te d'Ivoire, Les Caoutchoucs de Pakidie (government-owned only for part of the capital) was acquired through a management buy-out. Local management bought out a French company (SCOA) -- with bank financing secured by the cash flow of the company. FOREXI, a 100% state-owned water prospecting and well drilling company, was sold entirely to Ivorian interests through a management buy-out. The management, faced with imminent firing as the company was being liquidated, organized itself to buy the enterprise from the government.3 4

In France, the Institut de Developpement Industriel (IDT), a large venture capital firm largely held directly and indirectly by the state, was sold in June 1987 to a new holding company in which the management and employees hold 50 percent. Purchase money was borrowed and financial guarantees were provided by six investors who, in exchange, obtained the other 50 percent of the holding's capital.3 5

Employee acquisition are strongly encouraged, and two small-scale transactions have recently occurred, in British Columbia (Canada).

34/ See the forthcoming case study on Cbte d'Ivoire by E. Wilson, under a joint UNDP/Kennedy School of Government project.

15/ Minist&re de l'Economie, des Finances et de la Privatisation, Les Notes Bleues, No. 342. - 33 -

Employee buy-outs require extensive programs to inform and educate workers as to the benef'its, and most employee buy-outs are management- led transactions.

There has been much discussion recently 36 on the possibilities of replicating the U.S. model of Employee Stock Ownership Plans (ESOPs) in other countries. ESOPs are a financing technique for the acquisition of shares by employees. They are used to foster employee participation but may also be used to organize a leveraged employee buy-out. By this method, employees may acquire stock without any payment (cash payment, salary deductions) on their part. The stock to be acquired may be newly issued shares to expand the capital base of the enterprise. Or it may be existing shares. The ESOP fund borrows from banks the necessary money to acquire the stock (and the bank has no recourse on the employees). It is the company which undertakes to provide the funds to the ESOP to service such borrowing. It is generally considered that either increased productivity (U.S. experience seem to indicate that enterprises with significant employee ownership have shown substantially improved performance results) or new earning capacity (in the case of a capital increase) or both will permit to generate the funds for servicing the loan. The major incentive in the U.S. for such a scheme is the tax advantage for the company in making the required contributions to the ESOP. ESOPs are a regulated trust device, similar to a pension fund. Banks also receive a tax incentive in respect of the income tax payable on interest profits generated by the ESOP loan.

The incentives fo:r ESOPs are not presently available in such a form in other countries. However, considerable interest exists in developing schemes which, adapted to specific countries' characteristics, might similarly encourage such plans.

Preferred Applications/Special Features

Management/employee buy-outs are a relevant means of transferring ownership to management and employees with little wealth or knowledge of share ownership and may be a solution for SOEs not otherwise saleable. They also constitute an enormous incentive to productivity. Clearly, it is a solution to the employment issues where the alternative is liquidation; the management/employee buy-out should minimize lay-offs and the substantial other costs of closing an SOE.

36/ See "Accelerating Private Ownership: The Role of ESOP's" in F. Ghadar, M.L. Hesley and T.H. White, Privatization for Development, (Washington, D.C.: International Law Institute, 1987.), pp. 643-705, including a Report to the President and the Congress by the Presidential Task Force on Project Economic Justice, October 1986, entitled U.S. Encouragement of Employee Stock Ownerslhip Plans in Central America and the Caribbean. - 34 -

Management/employee buy-outs require the presence of competent and skilled management and a committed and stable work force. A strong cash flow potential is usually a precondition for obtaining credit for a buy-out.

Implementation Issues

The application of the management/employee buy-outs of most interest is the leveraged one, i.e., involving the use of credit. The underlying element in the leveraged management/employee buy-out is the enterprise's cash flow and/or other security that can be provided. How- ever, the problem with many SOEs to be privatized often is precisely a weak cash flow and uncertain asset values. Therefore, in developing countries, new and creative financing techniques need to be developed by governments and perhaps financiers to permit buy-outs.

The buy-out can be very lucrative for the purchasers. It may also be risky. Workers in the National Freight Consortium in the United Kingdom have seen a tenfold gain in the value of their stock. For a number of reasons, the enterprise has shown improved results. However, not all cases may show such results. Stock ownership involves an inherent risk of loss and great care should be taken in evaluating its extent, particularly if the buy-out idea emanates from the government rather than the management/employees themselves. Any coverage of the risk by the government represents a possible residual liability associated with the privatization and also needs to be weighed carefully.

Under employee buy-outs, employees may more easily accept wage reductions on account of needed restructuring. However, if employees were subsequently to lose both their jobs and their stake in the enterprise, it might be felt that the government unduly exposed employees under privatization schemes.

Leveraged employee buy-outs could be encouraged through various forms of financing instruments, ranging from the acceptance of payment terms by the government vendor, to direct bank financing provided to employee consortia (possibly with supporting external repayment guarantees).

Leases and Management Contracts

Characteristics

Both leases and management contracts are arrangements whereby private sector management, technology and/or skills are provided under contract to an SOE or in respect of state-owned assets for an agreed period - 35 - and compensation. While there is normally no transfer of ownership3 7 and therefore no divestiture of state assets, these arrangements can be used to "privatize" management and operations and thereby possibly increase the efficiency and effective use of state assets.

Although sometimes regarded as an intermediate step toward full privatization, leases and management contracts are more often used as temporary measures, e.g. to return an SOE to an acceptable level of operations and profitability.323 The government may then decide whether to retain the SOE and operate it itself or to divest itself of the assets and operations, which would now be more attractive to, and command a better price from, the private sector. In either case, the injection of private management, presumably selected for its operational or other skills, represents an important and effective non-sale form of privatization.

While there are many variations, the basic differences between a lease and management contract can be summarized as follows:

IL/ The private lessee or contractor may sometimes take an equity participation in the enterprise or be given the option of purchasing shares at the end of the lease or contract. Depending upon the circumstances, equity participation or the option to take up shares may be viewed as an added incentive to the private operator or as the first step in the transfer of ownership to that operator. Transfer of full ownership after a lease or management contract is comparatively rare, whereas joint ventures are more common.

38/ If either a lease or management contract arrangement is continued for long periods of time (there are examples of management contracts extending for fifteen years), the state has presumably decided that the arrangement is convenient and profitable and that "privatization" should be limited to management and operations. - 36 -

Lease 3 8

The private operator leases assets or facilities owned by the state and uses them to conduct business on its own account. The lease sets forth the terms and conditions under which the lessee may operate these assets and facilities, the compensation that must be paid to the state, and the respective responsibilities of the parties. The key feature of a lease arrangement is that the lessee assumes the full commercial risk for operating the assets. Thus, if the state leases out coal mining facilities in return for an agreed payment, the lessee has to make the payment regardless of the profitability of the operation. In addition to the lease payment, the lessee is normally obliged to maintain and repair the assets in use or to share in that cost in accordance with an agreed schedule.

Unlike the management contractor, which assumes no financial responsibility for the enterprise's operation, the lessee suffers direct financial repercussions if it fails to use the leased assets or facilities in an efficient manner and to ensure effective management.

Under a lease, the lessee hires its personnel. The lessee may hire existing personnel and integrate them into its own work force, but in doing so would exercise complete freedom of choice. Under a management contract, the contractor may have wide powers over existing personnel, but they remain employees of the enterprise and are often subject to government pay scales and conditions. The difference in the extent of control over the work force (and the ensuing ability to upgrade its quality) can be quite wide between these two forms of arrangements and can affect the success of the operations under the lease or management contract.

Another distinguishing feature of a lease is that the lessee has unfettered control over the operation of the assets or facilities (subject to the maintenance and repair covenants), while the management contractor has only that control and authority specifically granted under the contract. In leasing assets, the state might relieve itself of immediate financial burdens, but it has to build sufficient safeguards into the lease to ensure that a viable asset base is returned at the end of the lease. This problem does not exist with a management contract because the state is financially responsible for the upkeep of the assets.

Leases may cover the essential assets of an SOE. They may also include certain assets or rights spinned off from the SOE as part of a restructuring plan (such as Air Mali's IATA air routes, which were assigned to another airline against the payment of royalties).

38/ A completely different transaction is the lease whereby the private party is the lessor and the government/SOE the lessee, for instance, when a government agency rents a fleet of vehicles or equipment from a private owner. Nearly 25 percent of the flight equipment used by all airlines is reportedly leased in this manner. This type of lease is not covered here. - 37 -

Management Contract3 9

The management contractor (normally a company in the same line of business as the enterprise) assumes responsibility under a contract to manage the enterprise for compensation. Unlike other arrangements providing for management services or technical assistance, the management group is given full management control and the authority to manage. The contractor derives its authority from the contract and must manage the operation within that confine.. Whereas a lessee pays the state for the use of assets or facilities, a management contractor is paid by the state for its management or other skills. While the contractor might be given extensive management powers and operational control, it has no financial exposure and receives its fee regardless of the profitability of the enterprise. (Where performance or incentive payments are part of the overall compensation package, these are forfeited if the level of performance or other criteria are not met.) The SOE continues to bear the full commercial risk and is responsible for all working capital and debt financing. To this extent, the state is not relieved of any financial burden and, in fact, takes on a higher short-term burden in the form of the management fee. The advantage of this arrangement is, however, that ownership is retained, a defined degree of control is maintained, and a high level of management and other skills is injected into the enterprise, enhancing its overall efficiency and profitability.

Comments

The distinctions between these two arrangements can be blurred depending on the specific terms. For example, a state may require a contractor to take an equity participation to ensure a deeper commitment or the lessee may negotiate a reduction in the rental fee if profitability falls below an agreed level.

Procedures

Lease

There are no standard procedures for lease arrangements, and they are therefore best discussecl by reference to actual cases. The main underlying features are normally the conduct of the business by the lessee, in its own name, the right to use specified facilities for a fixed period and the obligation to pay the owner (government or SOE) a fee for use of the assets. Variables may include the level of financial contribution by the lessee (e.g. investment for rehabilitation), performance bonds, maintenance/renewal obligations, duration, etc. Leases of equipment are sometimes substituted to outright sales as an asset-based financing device.

39/ The reader interested in detailed features and design issues related to the effective use of management contracts is referred to Sven Hegstad and Ian Newport: Management Contracts: Main Features and Design Issues, World Bank Technical Paper No. 65, Industry and Finance Series, (Washington, D.C.: The World Bank, 1987). - 38 -

This, however, is not considered here as it stems from financial, accounting or tax reasons more than the intent to derive specific operational benefits or to address the constraints described in this section.

Several leases which have been reviewed, including the lease by Togo of a steel mill to STS, a company controlled by foreign interests and in which local interests more recently also took a participation, and of dairy manufacturing facilities to a Danish group, and the lease of the Atlantic Hotel by The Gambia to a U.K. hotel company, have a 10-year term. The lessee may be given an option to buy, as in the abovementioned hotel lease in The Gambia.

Management Contract

Several factors will influence the design and structuring of a management contract arrangement.4 0 A clear agreement must exist on the intended objectives of the management role and the degree of authority and control to be vested in the prospective manager. Management contracts are found in many different business sectors. But they have found their widest application in the tourism/hotel industry, where they have become standardized in the sense that an accepted format and reasonably uniform provisions have evolved.

The choice of the management company4 1 is the most important element determining the results of the arrangement. In some instances, the management company is a joint venture company between a government or SOE and a private company. A properly structured remuneration package must be devised which will, in many cases, include three features: charges for the provision of the management company's personnel in accordance with agreed formulae, including a small profit element; agreed reimbursable costs; and incentive payments linked to profits, production or other appropriate formula. There is no term which is standard in management contracts, but if the management company makes no investment which it needs to recoup over a longer duration, three to five years is normal depending on the scale and complexity of the problems faced.

Preferred Applications/Special Features

Leases and management contracts are the principal method of privatization of an activity in situations where privatization of the ownership of the assets or SOE is not appropriate. However, both offer

40/ Described in detail in Hegstad and Newport, op. cit.

41/ The International Finance Corporation, jointly with other institutional investors and approximately 50 international companies, is establishing the African Management Services Company which will provide a coordinated package of management services offered, inter alia, to SOEs in the process of rehabilitation and/or privatization in Sub-Saharan Africa. - 39 - advantages which may in certain cases make their application preferable to other methods of privatization. The lease may also be used as an intermediate solution aimed at making a subsequent sale possible. Similarly, the management contract may also be an intermediate solution in turning an enterprise around for subsequent privatization of ownership. Several textile companies in Sri 'Lanka have been turned around into profitable ventures through management contracts; some are now being processed for public offering.

There are many situations in which the state may not be able or willing to divest itself of the ownership of an SOE or certain productive facilities but still wishes to see the activity taken over or managed by the private sector. (For example, the state may wish to retain ownership of the assets because of sovereignty considerations or simply because they are unsalable in the immediate future.) In those instances, leases and management contracts may be particularly attractive.

Leases and management contracts are tailored to meet specific circumstances. The choice of a lease as opposed to a management contract depends on the government's objectives and the state of the enterprise in question. If the enterprise is run-down and unlikely to respond to external management expertise (i.e., the fundamental business or markets have failed), it may choose to lease certain assets or facilities that can generate revenues. The lease is also an important alternative if all operations of the SOE had ceased. On the other hand, if the enterprise is merely in need of a short-term injection of management or other skills to restore it to profitability, a management contract might be appropriate.

Besides being a good intermediate solution (its primary advantage), the lease can be the preferred method because of a variety of other reasons such as tax advantages to the lessee, overcoming constraints to land title, as well as overall flexibility. It permits the introduction of timid investors to a venture to be privatized and it helps overcome financing constraints (particularly if the lessee does not have the cash resources or credit is not reXadily available).

Implementation Issues

Under both leases and management contracts, debt liabilities of the SOE or of the state with respect to the underlying assets will continue to be borne by the state. A management contract represents a cost, and only increased profitability will offset this cost. In the case of a lease, the lease fee paid to the state may not cover the debt liabilities. Moreover, under a management contract, the government may still need to inject funds to sustain operations. Maintenance/renewal obligations and other costs to be borne by the state and the private party, respectively, must be clearly defined.

Under the lease, there will be a need for the state to carefully assess the financial strength of the lessee on whose regular lease payments it will rely (and perhaps the state may wish to require payment guarantees). - 40 -

Under management contracts, the principal issue will be the actual reliability, skills and seriousness of the management contractor. - 41 -

2. OVERVIEW OF THE EXPERIENCE WITH PRIVATIZATION4 2

Privatization has taken drastically different forms in different countries. Some governments have resorted to a large extent to the sale of shares to the general public, while others have sold shares or assets of SOEs mainly to single buyers, and a large number have resorted to both. Public offerings are less frequent in Sub-Saharan Africa, mainly because of a lack of developed equity markets. A number of governments also have used "non-sale" privatization or what might be called "privatization of management" such as management contracts and leases. Of eleven industrial SOEs privatized to date in Togo, five were sold through the sale of assets and two through new private investment resulting in majority private interest, and the assets of another five were leased to private operators. There are first-time privatizations of SOEs originally established by the government, and there are ma-ny reprivatizations of companies acquired in the past by the state through nationalization, in satisfaction of debt to state banks, or otherwise. Some techniques have been introduced by or are predominantly utilized by certain countries. The French privatizations for instance, are characterized by (i) the combination of private sales of shares (or preplacement to create a core of known shareholders) with public offerings, (ii) the intervention of an independent privatization commission to set the transfer value and provide advice on various aspects of the privatization, (iii) the almost generalized practice of 100% divestment, instead of a gradual process as in several other countries, and (iv) the application of the proceeds from privatization (see page 139). Table 1 at the end of this section highlights the extent to which various basic privatization methods have been used in the sample of countries reviewed in Volume Three.4 3

42/ Annex E provides statistical data on country experience with privatization.

43/ Our survey indicates more than one thousand four hundred cases of privatization planned, underway or completed (excluding management contracts). A substantial number of presently planned transactions may not materialize. About 56 percent of these cases are either underway or are already completed with completed transactions comprising over a third of the documented cases (i.e. , about 530 SOEs have been privatized). The numerous companies sold under major reprivatization exercises such as in Bangladesh, Chile, Spain and several in the Philippines and Uganda are not counted in these numbers. It is recognized that a count in terms of assets, employment, or other parameters may be more informative than in terms of entities privatized, but the lack of data renders this task too extensive at this stage. Volume Three does, however, provide some data in this respect. Our data as well as Table 1 include SOEs in which the government held less than 50 percent of the capital but decided to further or fully divest itself of its holdings in the SOE. - 42 -

The results from the perspective of the state have varied. Several privatizations of weak SOEs, carried out through the sale of assets, have left the state with substantial residual financial liabilities (but often have eliminated operating subsidies). On the other hand, public offerings of strong performing SOEs have yielded substantial resources to the state. While statistical data of the effect of specific types of privatization on public finances would be useful, the level of information available has not permitted to develop them at this stage.

The description of basic methods in section A above does not cover all the options available to governments.4 4 Many variations and combinations have been designed and attempted to fit particular needs. For example, in a number of instances, secondary public or private offerings (sale of government-held shares to the private sector, i.e. , divestiture) have taken place in conjunction with a primary offering (new issue for raising additional equity, i.e., new private investment to dilute government ownership). In the case of Malaysian Airlines System Bhd. (MAS), an offer for sale of existing shares and an offer for subscription of new shares were handled concurrently. This approach was also adopted for the privatization of Compagnie Generale d'Electricit6 (CGE) in France and Singapore International Airlines, both through public offerings. Most privatizations in Guinea, through private sales, also involved substantial new equity contribution by investors. Similarly, the recent privatization of SEAT in Spain was achieved through a large capital increase taken up by Volkswagen. Volkswagen would take over existing shares before December 1990. In the above cases, the enterprises needed recapitalization. In the few years prior to the public offering of shares held by Canada, the Canada Development Corporation had attracted substantial new private equity so that ownership had increasingly shifted into the hands of private sector investors. In another instance, Societ6 Industrielle des Textiles (SITEX) in Tunisia benefitted from equity investments by the International Finance Corporation (IFC) and by Dominion Textile of Canada, largely applied to modernization of facilities. In a second phase of this privatization (which is ultimately to result in majority private ownership) the following

L4/ The French privatization law of August 1986 lists several possible methods of ownership transfer from the state to the private sector, namely: (a) sale of shares; (b) exchange of other securities such as non-voting preferred shares (titres participatifs or certificats d'investissement) for common shares (in the case of Societ6 G6nerale, Paribas and Compagnie Financiere de Suez, the holders of non-voting preferred shares had the option of exchanging them for ordinary shares); (c) waiver or sale of any preferred right to subscribe to an increase in capital; (d) increase in capital through the contribution of shares or other assets; (e) merger or split; (f) issuance of various other types of securities; and (g) dissolution or liquidation of the enterprise.

The Tunisian law of August 1987 on SOE restructuring lists several of the same privatization methods, adding that restructuring operations may take the form of sales of any assets of the SOEs. - 43 - steps are intended by SITEX's state-owned parent company: (i) a public offering of SITEX' shares on the Tunis Stock Exchange; (ii) a private placement with private institutional investors (Insurance, Banks) that have shown an interest in acquiring SITEX' shares; and (iii) stock option plans for the employees. These privatization plans hinge, however, to some extent on improved financial performance by SITEX which should result from the project financed by IFC. The privatization of Compafiia de T6l6fonos de Chile (CTC) provides yet another example of this. The growth needs of the sector and goals on telephone density imposed the need of heavy investments to be included in CTC's development plan. The privatization of CTC not only included the acquisition of shares from CORFO, the national holding company, but also the subscription by the new buyer to a capital increase, to be paid as needed.

In a number of cases, public offerings of existing shares have occurred in conjunction with private sales, where the presence of a pre- identified leveraged shareholder or "friendly core" of shareholders was necessary for a company whose remaining shares were eventually to be offered to the general public. This approach was also used in France, inter alia, for the privatization of Paribas and Matra, where a core group of friendly shareholders was put together, composed of institutional investors who are not at liberty to dispose of their shares for a specified period. In the case of Banque du Batiment in France, the government put together a group of institutional investors from the construction industry to buy 51 percent of the shares in advance of other investors.

Such a combination of private sale and public offering might also be appropriate to create certain patterns of ownership. In the case of Malaysian International Shipping Corporation Bhd. (MISC), a large part of an offering by existing shareholders (mostly Government and state governments) was reserved for and preplaced with "Bumiputra" institutions, a portion was reserved for sale to employees and the bulk of the shares was underwritten by merchant banks and offered publicly.

Sri Lanka and Malaysia developed some creative approaches, such as combinations of leases/private sales/public offerings and the use of management contracts as a first step to privatization of ownership. For purposes of privatizing the container terminal activities of Port Kelang in Malaysia, which were separ.ated from the Kelang Port Authority (KPA), a joint venture between KPA and the private sector was established to lease the relevant assets and acquire the container handling business from KPA. In Sri Lanka, improved performance was observed under management contracts concluded by textile enterprises; they were planned as an intermediary step to full privatization and some of these enterprises are now being processed for public offerings.4 5

As far as the nature of ownership is concerned, it is clear that public offerings have achieved widespread ownership. However, experience

45/ All the above transactions in Malaysia, Sri Lanka, as well as the ones referred to for Togo below, are described in more detail in Volume Two. - 44 - shows that private sales and new private investment as a privatization method permits ownership patterns for given SOEs not necessarily concentrated in the hands of one investor. Nor is privatization in weak financial markets limited to foreign investors. Togo and Guinea are examples of this.

Experience indeed reveals that carefully modelled practical approaches can come close to satisfying both stated objectives and various types of constraints. Most governments which have carried out a substantial number of privatizations have applied a broad mix of techniques, including the main techniques described in Part I of this report. This would be the case of countries as varied as France, Chile, and the U.K. The latter has offered shares of many SOEs to the general public, but an even larger number of British SOEs were sold through private sale of shares and assets, reorganization into component parts, etc. ,ABLEI TechniouesUsed in Certain Completed Privatization Transactions

COUNTRY 1. PUBLIC 2. PRIVATE 73.SALE OF 4. FRAGMENTATION5. NEWPRIVATE 6. MANAGEMENT/ 7(a).MANAGEMENT 7(b).LEASE OFFERING SALEOF ASSETS (incombination INVESTMENT$$ EMPLOYEE CONTRACT OF SHARES SHARES with1, 2 or 3) (Mostlyin BUY-OUT combinationwith 1,2 or 3)

Sub-SaharanAfrica: i Cameroon :Siricom(bricks) 1 Havecom(rubber) ;Socase ( Sucucam(sugar) i 1 ~~~~~~~~~~~(tertilizer)i Shippingline

CentralAfrican Republic ;Sicpad(pals oil))

CoteOlIvaire (Sitab(tobacco) :Sotrooal(industry) ;Sideco :Sietho)tourism) :LesCacutchoucs :Palmindustrie(oil) ;Atwaba Hotel :CMAC (distribution)~Sodefor (forestry) ; de Pakidie :Sodefor !SedanIvoire tTrituraf(soap) !Sonageci ~Forexi (drillingl!Sdepalm (nalm oil) (industry.~ i !~~~~Sogexi(diversified) (public works) :IctaVoyages ;Sietho :Sonaco(paper) i SathnHotel :API(agriculture) :Salci(agri-business) 1 Sareco(tourism) ;Seric(agri-business)

!Procaci(cocoa) !SHAC(exports) (mvoireConseil )Soderiz(agri-business) I i lH~~~~arzattanHotel :Abi(foundry) :CeramAnten (ceramics) I :Sotropal(matches) (BNEC(bank) I (IvoireOutils (tools) I

EquatorialGuinea ; LineasAereas :Empresade Energia i :~~~~AgenciaMaritima i :E.Transportes Lujo :EmpresaForestal lFabricaLadrillos

Gabon :Sonaga(insurance) (Societede Bois i ;~~~~~Pizo(oil)

Gambia !StandardBan1k (SenegambiaHotel i (SenegambiaHoteliFishing company !$PAShipyard & !AtlanticHotel ;CFAO(trading) Ferries (SeagullCold Stores :Sawmillcompany

Ghana i SugarEstates i ( (tategoldMining I ~~~~~VoltaAluminus :SugarEstates G6NTC(Trading) i i :~~~~~~~~~~~~~Ghaces(Cement)

Guinea sf rns aiKni !oauAirport of Conakry(Port of Conakry TABLE1 TechniquesUsed in Certain Completed Privatization Transactions

COUNTRY 1. PUBLIC 2. PRIVATE 3. SALEOF 4. FRAGMENTATION3. NEW PRIVATE 6. MANAGEMENT/ 7(a).MANAGEMENT 7(b).LEASE OFFERING SALEOF ASSETS )Incombination INVESTMENTUS EMPLOYEE CONTRACT OF SHARES SHARES with1, 2 or 3) (Mostlyin ROY-OUT combinationwith 1, 2 or 31

tEntaAllomettes (cigar))agri-basiness) SGuites i :~~~~~~~BriqueterieKankan !Maruis-Salants I !Partof Conakry :SacrerieBanian !SonacagCarreaua :Briqaeteriede !EntaTabac (cigarette) I Kobaya OUSBA(farm tools) :Ceramiquede ;Reem-Buinee(chemicals): Matoto i i :Sipag(flour mill) :HailerieDe Kasesa lSopag(oils) GSomoa L'Imprimerie(printing)Ilgat ;Sipeco(paints) OUsinesNodernes :Soprag(matches) de ConakryI :Snbragai(brewery) :SOFAB :U.Jusde Fruit (juice) OUsined dePanneaus i :~~~ScierieNOZerekore de Geredou i !Guitex(teotile) :Sukoba i i t~~~~~~SoprocimentlOani Faranah ii :(BuildingMaterial) i lCasserverieMaona i I !(Agri-business)

(Usinede The (Teal I :SOPEC(Chemicals) :QuininedeSerdou I(Agri-Business)( i :~~~~SocieteGuineenne i i i : ~~~~~deFabrication IiI I)SO6UIFAB) i

Kenya ii i ITeotile/sugarfirm :KenyaNeat

Liberia :NatlIron Ore i i !~~~~~~~LiberianIron

Malawi i i I :AirMalawi

Mali i :ITEMA(textile) i 1randB Hotel lAirMali !Tamali(tanning) ! Tavali(tanning) Mauritania !ONC(cinema) ;ProjectSucre ! Food/sugarcompany

Niger :CMAN(arts & crafts) ISNGTN (civil ISNGTN i Sonhotel ;Sonhotel ISopac(paper) I works) :Snoidep S5onidep ~ Sonidep :Sonidep(petroleum) Ii i SPEGH(hotel) :Sotramil(food)I :Soniteatil Ii :Leyma(insurance)I TABLE1 TechniquesUsed in Certain CompletedPrivatization Transactions

COUNTRY 1.PUBLIC 2. PRIVATE 3.SALE OF 4. FRAGMENTATION5. NEW PRIVATE 6. MANA6EMENT/7(a). MANA6EMENT 7(b).LEASE OFFERIN6 SALEOF ASSETS (In combination INVESTMENT$$ EMPLOYEE CONTRACT OFSHARES SHARES with 1, 2 or 3) (Mostly in BUY-OUT coebinationwith 1, 2 or 3)

RINI (rice milling) i i Nitra (freight) i i i ' )SNCP(hides & skin) (Sonhotel :INN(printing) 'Sonitan (tannery)

Rwanda :UsineAllumettes a

SaoTome E Principe : BelaVista Estate aUba BudoEstate

Senegal aSNCDS (fish processing) a aAgri-business fire :COSENAM(shipping) Housingcnmp;ny :SIV (textiles) ; Siscoma(farm tools) 1

Sierra Leone 'Natl PalmOil Natl PalmOil aHotels

Somalia Fishing company i State fires

Tanzania a ' aTanganyika Dyeing

Togo a ITT (textile) !Sotoma(marbles)) Hotel de la Paix SNS(steel mill) a !Togotex ITP (plastics) I l2Fenrier Hotel (Sotexaa(fare tools) i :Sodeto (oil) i aSarakawa Hotel STH(oil refinery) Sotcon(clothes) ' aBenin Hotel Soprolait (milk) IOT0(palm oil) I a a TropicanaHotel Sotcon

Uganda :MehtaSroup National Textile I Madhvani6roup Board :LonrhoUganda Ltd. !Brit. AmericanTobacco I a a a :DataShoes Ltd. a a a :MitchellCotts Ltd. a a

Zaire aShell Zaire i ir aire lMaritimeZairoise aPalmeza (pala oil) 'Cacaoza(cocoa) (Teacompanv (Sodimiza(mining) Palmoil company a ' a(Cocoa ' a a cospany i

Zambia :ZaZbiaBreweriesi ZambiaBreweries :Nitrogen Chemicals I TABLEI TechniquesUsed in Certain Completed Privatization Transactions

COUNTRY I.PUBLIC 2.PRIVATE 3.SALE OF 4.FRAGMENTATION 5.NEW PRIVATE i.MANAGEMENT/ 7(a).MANAGEMENT 7(b).LEASE OFFERING SALEOF ASSETS (Incombination INVESTRENTRA EMPLOYEE CONTRACT OFSNARES SHARES with1, 2 or3) (Mostlyin BUY-OAT combinationwith 0,2 or3) i i i l~~~~~~~~~~~IZambiaAirways

Asia::( Bangladesh (Over30 teotile i i (B.Machine Tools (millsreprivatized ii i

Indonesia ( (KrakatuSteel ( !Miningcompany i i i i :~~~~~~~~~~~Telecommunication

Japan (JapanAir Lines (TohokuCompany (cement): (JapanNational i JNR (JNR(railways) (ElectricPower Company ( Railways(JNRI ( i (NTT(Telecom) :NTT (Telecom) i

Korea,Republic :KoreaStock ExchangelSeveral banks : i (PohangIron & Steel:Korea Oil Company i :~~~~KoreaHeavyIndustry I i ft~~~~~~~~~KreanAirLines i i (KoreaStock Exchange ( II

Malaysia (HS (Airline) (GeneralHospital :Port Kelang :North Kelang Bypass (Port Kelang (MalaysiaShipping (Aerospace Industrial ( i (K.L.Kepong Inter- (Aerospace Industrial (NorthKelang Bypass (a change (NationalPark (PortKelang ( (Labuan Water Supply ( Facilities (SportsToto (lottery) ( i

Philippines i 115SOEs i

Singapore (SingaporeAirlines I (Portof Singapore ( i ! Portof Singapore (NeptuneLines ( II (BBS(hank) (Kenpel(shiprepair) I I(i ( (Intraco(trading) ( (IronA SteelMills ( (UIC(detergent) ( aI (SingaporePrinters ( ( (ResourceDevelopment: iiIII (EPB(publishing) ( i (SetscoServices (

(SADE(Dutyfree shop)) Iaai I

SriLanka (StateRubber lOept.of Machinery ( SugarCorporation (CWE (BOBOTeotile Corp. (National Milk Board i :~~~~~~CoastalEngineering ( CWE ! AirLanka (CWE(trading) ( (PropertyDev. ;Sugar Corporation (SOBOTile Factories I CementCorporation I F (~~~~~~~~~~~~~LankaCement TABLEI TechniguesUsed in Certain Completed Privatization Transactions

COUNTRY 1. PUBLIC 2. PRIVATE 3. SALEOF 4. FRAGMENTATION5. NEW PRIVATE 6. MANAGEMENT/ 7(a).MANAGEMCNT 7(b).LEASE OFFERING SALEOF ASSETS (Incombination INVESTMENTH$ EMPLOYEE CONTRACT OF SNARES SHARES with1, 2 or 3) (Mostlyin BUY-OUT combinationwith 1, 2 or 3)

i ~~~~~~~~~~~~~i:Ceramics Corporation: CeylonSteel Corp. :CeylonPlywood Corp.: F F ~ ~F ~ ~~F ~~~~~~600 Ceylon Silts

Thailand :ThaiAirlines 1SGEAlum Factory : : : 1SOCAlum Factory

PacificCountries; AmericanSamoa : RainmakerHotel ::::Fuel : storage F F ~~~~~~~~~Foodprocessing F :Marinera Ilway

Australia : PrimaryIndustry Bank :BelconnenMall : F ~~~~~CommonwealthServices:Williamstown Dock!

Fiji I FijiBroadcasting : : F Air Pacific

PapuaNew Guinea :AirNougini i

New Zealand :Petrocorp :Petrocorp : F ~~~~~Bankof New Zealand ::: F :New ZealandSteel : FF

Europe,Middle East andF NorthAfrica: Austria :Landerbank :OMV(petroleum)

Denwark !lryolitselskabet : (food)

Egypt : : CataractHotel i :~~~~~~~~~KalabashaHotel

Germany,Federal flIAG(alumuminum) : Lufthansa iFF Republic :VebaEnergy :Volkswagenwerk i :IVO(transport) i !Lufthansa:FFFFF ODVKB(bank)

France :StGobain (industry)!Matra : Matra ICompangie :1I1(industrial ![Waterdistribution !ElfAguitaine !Banquedo Batiment : Generale : holding) Isystems]F IBNP(bank) :AgenceHayas I:d'electricite:FF (Sogenal(bank) !CreditCommercial de : (C6E) :FF :Paribas(bank) France(C)) :CCF(bask) :CGCT(Telephone) : :F TABLEI TechniquesUsed in Certain CompletedPrivatization Transactions

COUNTRY 1. PUBLIC 2. PRIVATE 3. SALEOF 4. FRAGMENTATION5. NEW PRIVATE 6 MANAGEMENT/ 7(a). MANAGEMENT 7(b). LEASE OFFERIN6 SALEOF ASSETS (In combination INVESTMENFO$ EMPLOYEE CONTRACT OFSHARES SHARES with1, 2 or 3) (Mostly in BUY-OUT combinationwith 1, 2 or 3)

(PIMP(bank) TFI RBanquedu Batiment IParibas I AgenceHavas BIMP ( (C6E(power) Societe 6enerale (bank)) :Soc. Generale (bank(ICredit Agricola (bank) l TF1(TV channel) I I Financiere Suez II I Matra(aerosnace) I

Iceland ( ( Icelandair

Iraq : Supermarkets i *Petrol stations Car repair centers

Israel (Haifa Chemicals ( ( i Ilion Cables I (

IRI GROUP: IRI GROUP: I I Italy SIP (telecom) !BancoCentro Sud INUI (IRI) Cred. Fondiario ,SEIAF(cosputers) I I Aeritalia ,Himont(chemicals) I (Selenia(electronics)!Rivoira (gas) (SIRTI (telecom) ,Cogea(steel) I Autostrade ) I I (roadconst.) Alfa Romeo I I , Iltalcableitelecom) Cementir Ceeentir ENI 6ROUP: , i ((building materials)hLanerossi (textiles) 'Ansaldo Trasporti IME6 I ,Dalmine MhM I Alitalia Other Textile Companies; RancaCoemerciale Ilemobiliare Metanonoli , I Credito Italiano EFIMGROUP: ENI 6ROUP: Terse di Recoaro Saipem(Oil & 6as) Colowbani-Lusuco I 'Tai-Trimarin i I i i IAlcot I 'Panafin I ' Agri Alco i I

Morocco ( 'Sonamer(fishery) , (Several hotels (Several hotels Asmak(fishery) , I I IONP(fishery) llnternort (fishery) ( (BeniMellal (sugar) Natl SugarCo, Beht TABLEI TechniquesUsed in Certain ComoletedPrivatization Transactions

COUNTRY 1 PUBLIC 2. PRIVATE 3. SALEOF 4. FRARMENTATION5. NEW PRIVATE 6. MANAOEMENT/ 7(a).MANA6EMENT 7(b).LEASE OFFERIN5 SALEOF ASSEIS (In combination INVESIMENINB EMPLOYEE CONTRACT OF SHARES SHARES with 1, 2 or 3) (Mostly in BUY-OUT combinationwith 1, 2 or 3)

ISugar Co, Doukkala ICosumar(sugar) :SNCE(civil works)

Netherlands 'KLtl SERO(cutlery) NMB (bank) (Stichting Industrieel Oarantiefonds (financial trust)

Oman :OmanFlour Mills 1OmanCement Company I ,OmanRefinery Co. :Copper company

Spain '6esa (electricity) ' RUMASAgroup: INi group: (INIgroup: nHotasa(hotels) :Potasas Navarra Endesa(utilities) 6SaleriasPreciados ,SB (ball Ensersa(fertilizer))Mantequerias Leonesas bearings) ) U, oEnce(pulp & paper)l Loewe(fashion leatherl' (Inisel (high-tech) (Sherry companies INIgroun: ;Texhtl Tarazona Marsan(travel) IEntursa (catering) ICesquisa (chemicals) IIngenasa (biotech) ' ILa Luz (meat process) I ,Igfisa (frozen food) 'Frigsa (food) I 'Indugasa IInisa Secoinsa (computers) !Telefonica ISKF (ball bearings) , SEAT(car maker) ( (ENASA(trucks/buses) ' (San Carlos (goods) I I PATRIMONIOgroup: I ;Torres de Jerez (BancoAtlantico I Fenix Peningular I ,6arvey (wine) !Ibernaves (shipping' (HispanoAlemana

Seeder IPKBanken :Luxor If ------_--_ _------TABLE1 TechniquesUsed inCertain CompletedPrivatization Transactions

COUNTRY 1.PUBLIC 2. PRIVATE 3. SALEOF 4. FRAGMENTATION5. NEV PRIVATE 6.MANAGEMENT/ 7(a).MANAGEMENT 7(b).LEASE OFFERING SALEOF ASSETS (In combination INVESTMENTStt EMPLOYEE CONTRACT OFSHARES SHARES with 1, 2 or 3) (Mostly in BUY-OUT cDebinationwith 1, 2 or 3)

Sweden :PKBanken !Luxor i ' i i

Tunisia t !Hotel Ulysse ,harbrerie de 1SRT(transport) :Sitex (textile) Fluobar(aining) Thala(Marble) 1 !Siter (textile) Hotel Hannibal 'Fluobar

Hotel Miramar iI ------_------'Netas(Telecom) i Turkey !Teletas (telecom 1 equipment)

U.K. ,Cable6 Wireless Brit GasNytch Farm :Brit Rail Hotels !British Rail Hotels:Brit Aerospace!National BusCompany;Royal Navy Dockyards British Telecoo British Rail Hotels ;National BusCc, ' Natl Freight Coepanyl British Bas 'Sealink ' fLeylandBus AmershamIntl !International Aeradio ' ,Unipart (motor) British Aerospace !North SeaOil Licenses 3ritB Rail Hovercraft British Petroleum !International Computerst !DAB(buses) ;British Oil lFairey (engineering) 1 Istel (service) i !Ass.British Ports :Ferranti (electronics) 1 :British Shipbuilder:: EnterpriseOil Inmos(computer chips) ' BrookMarine Jaguar :British Sugar : Vosper British Airways :British LeylandTrucks SwanHunter British Airports !BritAir Helicopters Vickers 'Rolls Royce RoyalOrdnance (ares) ' British Shipyard ;British Shipbuilder: 'Victualic (pipes) Yarrow ' Hall Russell Scott Lithgow i ,National BusCompany UKPlant Breeding

NorthAmerica: Canada Federal ;Federal Soquip-Alberta 1N.Canada Power : Privatizations: Privatizations- 'PechesNewport ' ,C.D.C.(industrials)'N Transportation :Panofor ' 'CanadaFishery BDeHavilland (aircraft): ' ; ProductsInt'l. Kid CreekMines i ' 'Provincial 'CanadianArsenals i ' , ' Privatizations: :Canadair ' Ouebec 'PecheriesCanada Crustacesdes lles :Nansivik Mines ' , i, (Fishery) N.Canada Power ' ' Brande-Entree TeleglobeCanada ' ' (Fishery) 'CNRoute i I , Saskatchewan: Provincial ' 'Saskoil 1 Privatizations: ' TABLE1 TechniquesUsed is Certain Completed Privatization Transactions

COUNTRY 1.PUBLIC 2.PRIVATE 3. SALEOF 4.FRAGMENTATION 5. NEW PRIVATE 6. MANAGEMENT! 7(a).MANAGEMENT 7(b).LEASE OFFERING SALEOF ASSETS (Incombination INVESTMENTHH EMPLOYEE CONTRACT OFSHARES SHARES with1, 2 or3) (Mostlyin BUY-OUT combinationwith 1,2 or 3)

,Alberta: I . Quebec: !PacificWestern (RS0(sugar)I (transport) !Provigo I BritishColombia:lMadelipeche : i ;Bric - SGF(industry) i I !PechesNordiques i I ~~~~~Loavesm :Seleine I 3~~~~~!.Landry :i I :CrustacesIlies i :Grande-Entree I :Distex :Lundel :Filaq-SNA i

:PapiersCascades : :ScierieOutardes I lQuehecair L :Nordair : .BritishColumbia: : I: I ~~~~~UrbanTransport DevelopmentCorp. :III

U.S.A. :Conrail :Tomcat(Satellite) lComnat :Comnat :Comsat !Variouslanding rights :IiI

LatinAmerica & the Caribbean-,I Argentina : So)Jet Travel iI !SiatGas Tube i ;Austral(airline) I

Bolivia I Enta(transport) I I

Brazil (CRVD(mining) :Cia.Tecidos (textiles(lFabril (textiles):Eceu (public works): (Petrobras (AracruzCelulose (Engematic (Cia.Dragagens :Bancodo Brazil (Riocell (aeronautics) (dredging)II (Livrariae Editora (COR (chemicals) (Ramior(sugar) I :JoseOlimpio (Coperbo(robber) (CiaIncentivadoral II (Eletrosiderorgica(Inbrapel (paper) ()agri-business() BrasilesaS.A (HotelBlumenau (Hotelda Praia I (SIBRA) (PiratiningaNordeste (Cia Fiacoa e i : ~~~(machinery):TecePagee I :Nitriflex (textiles) Ii :M.Piratininga S.A. (CiaAmerica I (MetodoOrganizacao IFabril Ii I (consulting) :(Teotiles)IiI (Fermag(wining) (Engematic III TABLE1 TechniauesUsed in Certain Completed Privatization Transactions

COUNTRY 1.PUBLIC 2. PRIVATE 3. SALEOF 4.FRAGMENTATION S. NEW PRIVATE 6. MANAGEMENT/ 7(a).MANAGEMENT 7(b).LEASE OFFERING SALEOF ASSETS (Incombination INVESTMENT$$ EMPLOYEE CONTRACT OF SHARES SHARES with1, 2 or 3) (Mostlyin BUY-OUT obiainwith 1,2 or 3)

!FederaldeSeguros !(Aeronautics) ii ;S.A.)lnsurance) :lIensde PalmaS.A. (Agri-business) ;CiaTecidos Dona Isabel(Teutiles) :CELPAG(Pulp and Paperll (CiaNacional de TecidosNova America : SA (Textiles) !CaraibaMetais S.A :(Mining) lCosim(Iron and Steel) - -- - -………------I…I…I…I…I------Chile 1AFPSta. Maria(fund) :AFPUnion (fund) i i CTC(telephone) (Ecom (computer 1AFPProvida (fond) :Isapre Cruz (Insurance): i ( services) :Bancode Santiago:I5apre Lui5 Pa5teur ( Emel(pomer) :Bancode Chile ilsapreColmena 41 ;Entel(telecom) :BancoConcepcionn :Chilmetro :Bancointernacional (electricity):Banco Osorno lChilneger :BHIF(bank) (electricity)(Aetna Insurance lChilguinta :ConsorcioNacional (electricity):Inforsa (forestry) i !CAP(steel) :Indus(agri-business) (Soquimich O9CU(beverage) i (chemicals)(Copec (gas/fornstry) ilansa(sugar) ;Ladeco(airline) (Labchile !Panal(teotile) (pbarmaceutics(:Polpaico (cement) :Chilec(power) :Hucke-Mckay(food) :TelexChile fEmel(electricity) !Pilmaiquen(power) ;Enaex(explosives) :LanChile (airline) :Endesa(electricity)

Colombia :Bancode Colombia: (ind,holdings)

CostaRica ( SubproductosCafe iii

DominicanRepublic ( ( ( i ( :StateSugar Co

Grenada I GrenadaBeach Hotel TABLEI TechniquesUsed in Certain Completed Privatization Transactions

COUNTRY 1.PUBLIC 2.PRIVATE 3.SALE OF 4. FRAGMENTATION5. NEWPRIVATE 6. MANAGEMIENT/7(a). MANAGEMENT 7(b).LEASE OFFERING SALEOF ASSETS (Incombination INVESTMENT$$ EMPLOYEE CONTRACT OF SHARES SHARES with1, 2 or 3) (Mostlyin BUY-OUT combination)with 1,2 or 3)

Honduras MNetalsa(Utensils) ;Fundiciones,S.A.

Jamaica NCRGroup_(bank) lVersair (catering) :JamaicaBroad- :BananaMarketing :NationalSugar :JOS (busservice) !CaribbeanCement :NationalHotel i casting Company !PortAuthority !NationalHotel !JamaicaBroadcastinglZero ColdStorage i AirJamaica :RuralCold Storage :JamaicaBroadcasting :HanoverSpices i CornwallDairy :JamaicaOxygen !JamaicaFisheries I tei U....ica ) :JamaicaSypsum)mining) Hfellshire Fish Farm :Natl.Hotel Supplies :Gray'sInn :W.Indies Pulp & Paper I Palisades(tourism) !Trans-JamaicaAirlines I :FortClarence Beach :SergeIsland Dairies :Port Antonio Marina I :HellshireFish Farm :CocoaIndustry Board !CottonPolyester Co. !AriguanaboMills !Natl.Cassava Products :MechanicalServices !JamaicaFrozen Foods !MartinsTravel Service ;BananaCompany :BananaMarketing Co. !Jamintel(telecom)

Mexico :Bancomer(bank) !NacionalHotelera :Banamex(hank) !Renaultde Mexico

BFancaSerfin !V.de Automotivos I IBan amex :Bancomer :BancaSerf in !Minerade Cananew (copper)

H A largenumber of additionaltransactions areclose to completion and this table therefore is not fully representative.

Source;Volume III. - 56 -

Notes to Table 1

1. The table is largely based on Volume III of this Report.

2. A large number of transactions reported as privatizations in other sources but consisting essentially of the reprivatization of companies or assets recently acquired from the private sector by state banks in satisfaction of debt, or otherwise by the state as part of financial rescue operations by the state, are not included in detail. It is recognized, however, that techniques applied to such transactions may be of relevance to the privatization of SOEs.

3. A large number of additional transactions are close to completion and this table is therefore not fully representative. Tables set forth in Annex E provide further relevant data on techniques used. - 57 -

3. DETERMINAiNTS OF POSSIBLE TECHNIQUES

Methods and procedures for privatization will be largely determined by: (a) the objectives of the government; (b) the current organizational form of the SOE; (c) the financial condition and record of performance of the SOE; (d) the sector of activity of the SOE; (e) the ability to mobilize private sector resources; (f) the degree of development of the capital market; and (g) socio-political factors. A review of individual transactions indicates that no generalization can be made as to the relative weight of these elements in choosing how to privatize.

A caveat is necessary. The implication of this section should not be that simple solutions exist for every problem. As indicated in the country studies in Volume II of this report, certain techniques have been used unappropriately. Only the broad lines of possible determinants are provided here. The definition of an appropriate course of action with respect to an SOE is a substantially more complex exercise, possibly leading to a decision either riot to privatize (but possibly reorganize), or to divest through liquidation in certain cases.

Obiectives of the Government

The objectives of a government underlying a privatization program vary widely and may include the following (or combinations thereof):6

O budgetary relief from the financial burden (subsidies, debt service requirements) of SOEs, as well as relief from the administrative burden (management/control requirements);

° increased efficiency of SOEs (achievable even through partial privatization);

° implementation of policies stated at the time of the creation or the acquisition4 7 of SOEs; this is the stated policy of Argentina and Malaysia; in some countries such as the Philippines and Singapore, the government's rationale for withdrawing from certain SOEs is that the activity originally designed to play a catalytic role in the development of the economy, no longer needs to be undertaken by government which otherwise might increasingly be competing with the private sector;

46/ For a broader analysis on the rationale for divestiture of state-owned enterprises, see E. Berg and M. Shirley, op. cit.

47/ A number of reprivatizations in Bangladesh, Canada, Chile, the Philippines and other countries involved failing private enterprises which were acquired by the government with the intent of returning them to the private sector at the earliest possible opportunity. - 58 -

° greater revenue from state assets (normally this objective leads to methods that can maximize the sale price);

° improved business conditions by fostering the development of productive private enterprises;

° increased competition (e.g., competition can be fostered by selling production units or facilities singly or in small groups instead of as a whole); and/or

o development of wider business ownership (public offerings are the preferred method, particularly where wide distribution of share ownership is the intent, as in the more recent privatizations in Chile, as well as in France and the United Kingdom).

The economic strategy of several countries reviewed provides for a combination of objectives.4 The preamble to Senegal's 1987 Law on Pri- vatization states four objectives: autonomy and accountability of enterprise management; mobilization of public and private savings into productive investments; elimination or substantial reduction of subsidies to SOEs; and encouragement of widespread share ownership. The relative importance of a country's objectives will influence both the choice of SOEs to be privatized and the methods to be applied. In practice, privatization may meet several objectives simultaneously which will become intertwined in one program. The policy measures Fiji has adopted to rationalize inter- island shipping services, for example, aim at establishing a policy and regulatory framework to promote development of private sector shipping as well as reducing the government's fiscal burden by divesting surplus government vessels. There are few individual privatizations which will satisfy all governments' objectives, but it may be possible to achieve many objectives through a whole program of privatization. In Sri Lanka, privatization is part of a general process of liberalization and deregulation. It is not an objective Der se, but rather aims at stopping SOE losses, establishing broad based ownership (a strong middle class being an important element of political stability), and achieving worker participation.4 9 In Italy, IRI considered for sale enterprises (profitable or otherwise) which were not consistent with the basic aims of IRI's portfolio as well as money-losing enterprises that were a drain on IRI's resources.

48/ The stated objectives of Brazil's Federal Program of "Destatization" are: transfer of economic activities to private initiative, contribute to a reduction of the public deficit, convert external federal debt into equity investment, develop the capital market, achieve widespread capital ownership, increase competition through deregulation, render public services through concessions, and generally promote privatization of economic activities handled by SOEs, save for constitutional monopolies. it/ Address by R. de Mel, Minister of Finance of Sri Lanka, at the London Conference on Privatization, July 7, 1987, sponsored by the Adam Smith Institute. 559 -

Current Organizational Form of the SOE

The current organizational form of the SOE will heavily influence the necessary mechanical steps for transfer of its ownership and, therefore, also to a large extent the ease with which the process can be implemented. This report describes in some detail (pages 100 and 101) the readying process which frequently needs to take place under various conditions to change the organizational form. A public limited company whose shares are already being traded makes for a relatively simple privatization process, consisting only of offering additional blocks of shares currently held by tLhe state to the investing public through the stock exchange. This pattern held true for both Singapore International Airlines and some of the IRI privatizations in Italy. In the same category are companies that were once but are no longer traded, such as those initially denationalized in France; if the SOE is performing well, hardly any restructuring is necessary, although in some instances prior management changes were deemed necessary.

At the other end of the spectrum would be an SOE set up as a statutory corporation under an act of parliament or as a government department. Neither could be privatized in its present form but needs to be transformed into a stock corporation subject to ordinary company laws so that shares can be offered to the private sector. Legislation is necessary in such cases and personnel may need to be transferred from state to private employment regimes. The ongoing preparatory steps for the privatization of Jabatan Telekom Negara (JTN) in Malaysia illustrate the various issues that arise.5 0

Financial Condition and Record of Performance of the SOE

The profitability of a company obviously is one of the determinants of how easy or difficult its sale will be.

The experiences of developed and developing countries alike demonstrate that privatization potential is not limited only to strong performing SOEs. Loss-making SOEs (and some that have negative net worth) are being sold through a variety of techniques, with varying outcomes for their governments. The financial condition of an enterprise need not be the determining factor as to whether or not an enterprise can be sold, but to whom or according to what method, and at what price, it might be sold.5 1 Where a government, however, decides the SOE cannot be disposed of on

50/ They are described in detail in Volume Two: Malaysia.

51/ Whereas the SOE's economic viability is a determining factor. Several West African countries have classified some of their SOEs into a category of nonviable enterprises to be liquidated. - 60 - acceptable terms, it may resort to other permanent or temporary solutions, such as management contracts or leases and in some cases liquidation.

Obviously, public offerings are only feasible if the government is of the opinion that the companies can be offered as a secure long-term investment. In practice it has proven possible to turn loss-making SOEs into profitable enterprises and to sell them through public offerings. British Airways had to be substantially restructured to be transformed into an enterprise representing an attractive investment for the general public. It was readied for sale in part by the introduction of new operational practices and a reduction of the work force. In Sri Lanka, several loss- making textile companies were turned around through management contracts and are now being readied for public offering. In the case of the National Freight Company Ltd., the merchant bankers advising the government recommended postponing a public offering until steady profits could be shown5 2 (it was privatized shortly after through a management/employee buy-out). In several of the above cases, the government had to alleviate the liabilities of the SOEs. In France, Compagnie Generale de Constructions Tel6phoniques (CGCT), Credit Commercial de France (CCF) and Cr6dit du Nord (a subsidiary of Paribas) were all loss-making and were privatized after some restructuring (see page 105).

However, in the majority of cases, management/employee buy-outs left aside, such sales have been private ones involving financially and technically strong purchasers who could assure improved operations. In Canada and Italy, several privatized SOEs have been loss-makers. In France, Compagnie G6nerale de Constructions Telephoniques (CGCT), a heavily deficit ridden SOE, was sold through a sale of assets. The strength of the enterprise lied with its market position. In Spain, Rumasa group companies sold back to the private sector had excessive liabilities. In Togo, several enterprises sold to private investors had enormous liabilities out of proportion to the market value of the assets (and the assets of other such SOEs were not sold but leased). In the case of the hotel operations of British Rail, which were privatized with several other non-rail activities, their condition was characterized by: a lack of cash resources for investment in refurbishment and modernization; restrictions on management imposed by being part of a large centralized organization, subject to public sector conditions of service; increased competition in the hotel sector and a declining share of the business; and decreasing profitability. Private sale (by auction) was chosen as a more appropriate method than a public share offering for several reasons: the profits record was not good enough to support a flotation; a value that fairly reflected asset value was more likely to be achieved and a discount would have to be offered to attract investors in a public offering.5 3 Investors will acquire loss- making but potentially viable enterprises if they anticipate that certain

52/ Basil Yamey and David Stafford, Report on the Experience of Privatization in Great Britain (Rome: Direzione Centrale Studi e Strategie sulle Privatizzazioni, IRI, 1986).

L3/ Based on information provided by Morgan Grenfell & Co. Ltd. - 61 - restructuring measures will turn its earning potential around. And, indeed, the main criterion for a government as well might be the long-term viability (and for Spain it was, when reprivatizing Rumasa group companies, more important than a preference for Spanish buyers).

In some instances, governments intend to divest their shares when suitable levels of efficiency and profitability have been attained by an SOE. But an initial step may be new private investment into the SOE, as explained in the relevant sections on pages 26 to 29. In the case of Societ6 Miniere de Spath Fluor et de Barytine (Fluobar) in Tunisia, the first phase of its privatization involved financial restructuring (write down of share capital) and new equity contributions by institutional investors (the International Finance Corporation and the Arab Mining Com- pany).

SOEs in weak financial condition and with a poor record of performance could generally not be sold "as is". A number of restructuring measures will be necessary, falling under the general categories of management changes, reorganization, and, more often than not, alleviation of liabilities. All of those are described in some detail in a section of this report dealing with the readying process (pages 94 to 109). In many instances, however, it will be too difficult to sell such SOEs as going concerns, and often only the assets rather than shares can be sold, generally after the dissolution and liquidation of the SOE. In such cases, the government often has to absorb the liabilities (mainly debt but also tax arrears). Assets may only be salable at a fraction of their acquisition cost (particularly when the acquisition cost was initially way above the market value and, in addition, deterioration has occurred). There are indeed many instances where governments will not expect to recoup their original investment.

It is often argued that, while the cost of privatizing loss- making SOEs is high, the cost of keeping them may be even higher. This raises various questions on the economic argument for privatization, which this report is not addressing. But the high cost involved in financial restructuring raises two additional questions with respect to the decision making process.

The first is whether the government should restructure the finances of the enterprise prior to sale (thereby maximizing the level of interest in, and proceeds from, the privatization) or rather leave it to the purchasing party or parties to do. The level of the required investment and its recoverability will need to be assessed in detail. Second, prior restructuring may result in a substantial residual burden for the government after privatization through sale (a government may have disposed of its ownership, but stil:L be liable to cover service on debt it has assumed). This leads to two comments. On the one hand, residual liabilities should not be seen as a transaction cost: the debt is owed anyway by government (at least directly guaranteed debt) and is not a result of privatization per se). An informal evaluation of the overall potential and possible alternatives for privatizing certain unprofitable enterprises is a key element for a government in determining whether an enterprise is a - 62 - proper candidate for privatization through sale. Sometimes other measures, such as temporary retention, management contract or lease, winding up, etc. , should be considered instead. The section of this report on financial restructuring (pages 102 to 105) comments further on the treatment of SOE liabilities. Clearly, as the experience of several countries has demonstrated, the ultimate liquidation of non-viable SOEs may be the only available alternative. But it is again outside the scope of this report to discuss this issue.

Sector of Activity of the SOE

The sector of operation of an SOE shapes key aspects of its privatization. This would be true of several sectors.54 But this factor is best illustrated by recent privatizations of public utilities or public service SOEs.55 Several points ought to be highlighted with respect to public utility companies. First, while different privatization methods have been used, specific variations are emerging as particularly responsive to this sector that offer additional options for governments. Second, when public utilities are privatized, the interests of consumers must be adequately safeguarded. For instance, in the case of the sale of a utility, adequate licensing arrangements and regulatory mechanisms are necessary. In several countries 5 6 like the United Kingdom, Malaysia, Singapore and Thailand, utilities, ports, airlines, etc., are the first to be proposed for privatization. In France, a number of cities and municipalities had arrangements in place for private water distribution before any other recent privatization moves. The water and electricity authorities in the United Kingdom are currently also being targeted for privatization. In Sub-Saharan Africa, there have recently been moves toward pri- vatizating public services. Methods have ranged from public offerings (Chile's ENTEL and CHILEC, Malaysia's JTN, British Telecom, British Gas, Singapore Airlines), to the sale of assets (Port of Conakry in Guinea) to management contracts and leases (Gambia's GPA Shipyard and Ferries, Jamaican Broadcasting Company and other SOEs in C6te d'Ivoire, Malawi, Sri Lanka, and Zambia). A sample of privatizations for public utilities and services is provided in Table 2.

54/ E.g., land ownership constraints determine various aspects of the privatization of agri-businesses.

55/ For our purposes, public service sectors include electricity and gas, water, telecommunications, public transport, ports and roads, and hospitals and various other urban services.

56/ The absence of utilities on the privatization list of a number of other countries simply reflects in part the fact that they were never converted to state-ownership. About one-third of SOEs for sale and sold in OECD countries are public services. - 63 -

In the United Kingdom, the privatizationsof British Telecom and British Gas Corporationwere effected by creating a public limited company (plc) to take over the assets of the former public sector entity, followed by a public offering of blocks of shares by the government. The public utility character of these enterprises required basic accompanying measures, including: (i) some steps towards the termination of monopoly rights; (ii) establishment of a regulatory body; and (iii) granting of a license to the new plc imposing certain obligations (including pricing mechanisms) to ensure the qu.alityand continuity of the public service. The United Kingdom now has two models for such comprehensive packages, namely, the TelecommunicationsAct 1984 and the Gas Act 1986. The proposed privatizations of Water Authorities there are expected to follow these models in part.57 Similar techniqueshave been applied or are planned in Chile, Malaysia and Sri Lanka.58

57/ All these features can be further studied in available general and company specific documentation.

58/ See Volume Two for further details on Chile (Telex - Chile, Compafniade Telefonos de Chile), Malaysia (National TelecommunicationsCompany - JTN) and Sri Lanka (Sri Lankan TelecommunicationsDepartment), and for materials on the United Kingdom. See, in particular, Michael Webb, "Privatizationof the Electricity and Gas Industries," in D.R. Steel and D.A. Heald (Eds.), Privatizing Public Enterprises: Options and Dilemmas (London: Royal Institute of Public Administration,1984), pp. 87-100, which includes an analysis of regulationissues. Table 2: PRIVATIZATIONOFPUBLIC UTILITIES AND SERVICES

Infrastructure Country Energy/GasDistribution Water/Electricity Comsunications Transport (Ports, Roads) Other Services

Argentina Private Sale (U) Private Salett (C) Sale of Assets (P) Australia Lease(P) Austria Public Offering (C) Public Offering (P) Bangladesh Private Sale (P) Belgium Public Offering (P) Bolivia Sale of Assets (C) Brazil Public Offeringtt (C) (U) Public Offering (P) (U) Private Sale (U) Fragmentation(C) LeaseIC) Cameroon lManagesentContract (C) Canada Public Offering$$ (C) Private Salet (C) Private Sale (C) Public Offering (P) Give-Aways(U) Private Sale (U) Private Salett (C} Chile Private Salett (C) Private Salett (C) Private Sale (C) Public Offering (C) Public Offering (C) Employeebuy-out (C] China Public Offering (P) Cote DIvoire ManagementContract (C) Lease(C) Sale of Assets (C) Equatorial Guinea Private Sale (C) Fiji Public Offering (P) ManagementContract (C) Private Sale (C) France ManagesentContract/ Public Offering$ (C) Lease (C) Private Sale (C)

6ambia Fragmentation (P) Private Sale$ (P1 Public Offering (P) Lease$ (U) Germany,Federal Public Offering (C} Grenada Private Sale (P) Guinea Lease(C} ManagementContract (C) Leaset/Private Sale (C) Gulf States Private Sale (P) Iceland ManagementBuy-Out (C) Indonesia Lease (C) Israel Public Offering (PM

Italy Public Offering$$ (C) Public Offering (C) Jamaica Private Sale (C) Private Sale (C) ManagementContract (C) Lease$(C) Lease(C) Private Sale (U) Japan Private Sale (C) (U) Public Offering$ (C) Public Offering (Cl Fragmentation$ (C) Jordan Public Offering (P) Public Offeringt (P1 Korea Public Offering (P) Public Offering (P) Private Sale (C) Public Offerings (C) Liberia Private Sale (P) Malawi ManagementContract (C) Malaysia ManagementContract (C)Public Offering (U) Private Sale (Pj Private Sale$ (CISS Private Sale (C) Public Offering (C) ManagementContract (C) Private Sale (P) Lease (C) Mali Lease(C) Mexico Private Sale (U) Sale of Assets (U) Table 2: PRIVATIZATIONOFPUBLIC UTILITIES AND SERVICES

Infrastructure Country Energy/GasDistribution Nater/Electricity Communications Transport (Ports, Roads) Other Services

Netherlands Private Sale (C) NewZealand Public Offering IU) Frageentation (P) Sale of Assets (P) Niger Fragmentation$ (C) Private Salett (Ut Panaaa Private Sale (C) PapuaNew Guinea Public Offering (C) Peru New Investsent (P) Philippines Private Sale (P) Public Offeringt (P) Private Sale (U) Singapore Fragmentation(P) Public Offering (PI Public Offeringt (C) Public Offering$ (P) Spain Public Offering (C) Private Sale (C) Private Sale:: ManagementContract (C) Sri Lanka Private Salet (P) ManagementContract (C) Thailand Public Offering (P) Private Sale (U) Public Offering (C) Private Sale$ (P) Togo Private Sale (U)

Trinidad I Tobago Private Sale (P) Tunisia Fragmentation(Cl Turkey Public Offering (C) Fragmentationt(U)

USA Fragmentationt(C) Public Offering$$ (C) Private Sale (C)

UK Public Offering (P) Public Offering (C) EmployeeBuy-Outt (C) Public Offering (C) Public Offering (C) Private Sale (P) Public Offering (C) Fragaentation/ Private Salett (C) Public Offering (U) Zaire Private Sale (C) ManagementContract (C) Zaebia ManagementContractsSt (C)

Note; P=Wlanned,U=Undermay and CzCompleted;'Planned does not in all casesindicate a formal decision to proceed. I Various other techniques mereused in sameor other SOEs. St Other SOEsin various stages of completion. Source: VolumeIII - 66 -

France has used the "concession" and the "affermage" (generally translated as leasehold) contract methods with good results. They are being increasingly applied, aside from management contracts. The "affermage" works as follows: the private operator rather than the owner is legally responsible for the utility service, collects all water fees from consumers and takes the operational risk. It might be required to build into the water rates an amount to be remitted to the owner to cover all aspects of the financing costs of the assets utilized. It usually also must collect, on behalf of the government or municipality, and therefore build into the water rate, various taxes such as sewerage levies and local taxes. The government/owner retains specific rights of control. Increasingly, these methods are being applied in other countries. In Cote d'Ivoire in 1973, countrywide operation and maintenance of the water supply sector was entrusted by such a leasehold arrangement or "affermage" to the Societe de Distribution d'Eau de la C6te d'Ivoire (SODECI), a corporation owned by the Ivorian government (4 percent), SAUR (France) (46 percent), other French shareholders (2 percent) and Ivorian private shareholders (48 percent). SODECI's ownership was gradually shifted to Ivorian interests with its shares being traded on the Abidjan Stock Exchange. Proposals are being developed to privatize the sector further by having SODECI acquire all fixed assets and take financial responsibility as well for the urban water supply sub-sector under a concession contract under which SODECI would be responsible for all investments in the sub-sector. Proposals from private parties for similar arrangements (lease and equity) are being solicited in Guinea to result in the creation of a mixed economy company which will operate the water supply system in that country. The initial response has been positive.

The "concession" type of arrangement is applied in other countries as well. But the French concession invariably provides for full rights of ownership and use of the constructed facilities to revert to the government or the municipality, while this may not be the case in other countries such as, e.g., the U.S.A. where the private party has an unqualified and continuous right of ownership and use (except in the case of Build, Operate and Transfer Contracts see footnote No.7).

Contracts similar to the above-mentioned French model are also extensively applied in Spain (over 80 percent of all water distribution is handled under such arrangements). They are also in existence in Casablanca. Water distribution in Macao is handled under a concession arrangement with an 85 percent private company, Sociedade de Abastecimento de Aguas Macao (SAAM).5 9 A concession for electricity production and distribution is in existence in Vanuatu.

The "affermage" often is concluded for a period of 10 to 15 years, whereas the "concession" is concluded for longer periods of 20 to 30 years. This is because under the "concession" the private party has financed the underlying assets and needs to recoup its investment. How- ever, the arrangements used in France are examples of flexible approaches.

59/ Asian Water and Sewerage, December 1986, p. 5. - 67 -

In most instances, underlying assets had long been in existence. Under the "affermage" the private party may be requested to make investments for renewal. When a distribution system must be expanded (e.g., doubling the capacity of a water treatment plant), and the private party is to finance and construct these expanded facilities, then a concession contract will be entered into which will incorporate many elements of an "affermage" for the facilities already in existence.6 0

Most concessions are in the power and water sectors. It should be noted that the "concession" and "affermage" systems are not recently developed techniques. They have been utilized for over a century in France. They have, however, been considerably refined in recent years.

Port facilities lend themselves well to fragmentation into component parts or the hiving off of certain activities. For instance, stevedoring, transit and container activities can represent attractive proposi- tions for the private sector which may handle them more efficiently. A case at hand is Guinea where a substantial response was observed from private foreign operators in the privatization of various port operations.

Some governments have made policy decisions that retention of full state ownership is necessary for utility SOEs or SOEs providing an essential public service.6 1 As described above, others have found that the public utility character of an SOE's business requires the state to ensure the quality and continuity of a service at a reasonable price for consumers, but that this can be achieved by applying appropriate regulatory methods.62

While this paper is not concerned with the decision-making process on what to privatize or not to privatize, it should be observed that parties in developed and developing countries have argued that partial pri-

60/ Typical arrangements in France are detailed in Ivan Cheret, "Private Sector Role in Provision of Water Supply and Sanitation: Alternative Approaches," World Bank Seminar, January 1985. For a further description of alternative arrangements in other countries, see C. Vuylsteke, "Provision of Urban services Arrangements with the Private Sector," in Managenent Options for Urban Services, Report of a Seminar held at Cesme, Turkey, on November 11-20, 1985 (Washington, D.C.: The World Bank, 1986), pp. 301-347.

61/ Where categorized their SOEs into those of strategic importance and those of a purely commercial nature. Public utilities and other public services have often been classified in the strategic category not to be privatized (this is the case of Senegal, Togo and Nigeria) or in which the state must retain voting control (Brazil).

62/ Which raises the question ELs to whether the introduction of an adequate regulatory framework may not be more relevant in preserving the strategic character of su-ch enterprises than the extent of state- ownership. - 68 - vatization might represent a substantial gain in efficiency (were it only by the discipline instilled by having the private party represented on the board of directors) while safeguarding government's concern for strategic control.

In sum, in the case of utilities or strategic SOEs, a government can, depending on its objectives and concerns, limit the level of private participation in order to retain control; or retain specific limited powers both over the future ownership, control or conduct of the privatized company,6 3 and over the delivery of the utility service through appropriate licensing and regulations, contractual monitoring systems, etc. In practically all cases of privatization of a utility or public service, the basic steps include regulatory safeguards (including the establishment of a regulatory body and the granting of an operating license) to ensure that the service will continue to operate in the public interest. The costs (direct or indirect) of the proposed regulatory system and its efficiency will need to be carefully assessed.

As a last observation on this item, it should be noted that the interdependence of various sectors or at least the downstream effects of the privatization of one sector over another need to be clearly analyzed. The electricity generating industry in the U.K. reportedly6 4 is forced to buy 95 percent of its coal nationally (at prices higher than the world spot price for foreign coal). Obviously, the privatization of the electricity generating industry will have maior downstream effects on the possible sale of another SOE, British coal (also considered for privatization).

Strength of Domestic Financial Markets

The level of development of the capital markets in a country will determine whether certain privatization methods can be applied. The specific method needs to be suitable to the structure and liquidity of the capital markets and the sophistication of local investors. For example, if there are no channels for share distribution and, if the investing public is small in size, a traditional public offering of shares is often not feasible. Private sales to local and foreign investors are then likely to become the predominant method of sale. It appears, however, that based on the experience of Jamaica, Kenya, and two West African states with no equity markets at all, the prospects for raising local capital for privatization through public offerings or other mechanisms involving a broad section of the investing public are probably better than was previously thought. Therefore, the absence of a strong local capital market should not be thought automatically to preclude public offerings or at least private sales targetting a relatively wide group of investors. A more detailed account of this issue appears on pages 141 to 144. Based on the

63/ See Annex D on Special (or "golden") share.

64/ The Economist, November 21, 1987. - 69 - experience of Togo and Guinea, the lack of developed equity markets may lead to the private sale or the new private investment as the leading methods, but does not necessarily limit them to foreign investors as is often argued.

Socio-Political Elements

It should further be! recognized that the decision-making process may not be as neutral or pragmatic as the above theory may seem to indicate. The intensely political nature of the topic, the role of ideology and the influence of power groups or elites may play a preponderant role.

Political factors naturally greatly impact on the decision to privatize (see the recent interruption in the large scale French program). Political considerations also always influence and in some cases determine the mechanics to be applied. A foremost political and social issue is the possible need for retrenchment of the work force of an enterprise. In such cases, appropriate preventive or remedial mechanisms may need to be developed. A government's concern over concentration of ownership often leads to the adoption of mechanisms to ensure widespread share ownership. In the case of SOEs in weak financial condition, private investors may want the government to write off liabilities, and they may also not buy except at a substantial discount as compared to the assets' book value. Both such demands pose political difficulties.

The range of divestiture/privatization methods very often offers alternatives for dealing with socio-political constraints. While the sudden dissolution of several SOEs, or the sale of government interests in SOEs, may be politically difficult in given environments, transformation into joint stock corporations with new private equity provision may be both feasible and popular (e.g., equity financing provided by investors to debt- ridden public enterprises). Once the initial change has taken place, further privatization through a transfer of government-held shares at a later date is then possible at a lower political cost. A common question on (and often an argument against) privatization is its impact on pricing of the SOEs' product or service. Policy makers do argue that, generally speaking, there should be no reason for prices to go up, unless the SOE was operating in an uneconomic way (and in that case it could probably not be continued in the private sector unless a subsidy would be provided).

The above elements are likely to create substantial and active opposition by various interest groups in certain country environments.6 5 Well devised and large scale information campaigns explaining the advant-

65/ Interest groups comprise the general public (taxpayers, customers, voters), the SOE (management, employees), prospective investors, commentators and opponents (G. Grimstone, J. Henry Schroder Wagg & Co. Ltd. at London Conference on Privatization, July 7, 1987, sponsored by Adam Smith Institute). - 70 - ages of proposed privatizations are believed to be one important step to address their concerns. Even when the environment does not call for such nationwide campaigns, a careful presentation of the government's intent to the general public may be key to the initiation of a program to the satisfaction of constituent portions of the country. One West African government has chosen not to use the term "privatization" but rather "opening up of the capital" of SOEs to private interests (while in fact not limiting itself to one particular method of privatization). In some countries the term "restructuring" rather than "privatization" is used.

Ownership patterns are also central to privatization decisions.6 6 The actual concentration of domestic private capital and entrepreneurial expertise may not correspond to the government's objective of controlling certain economically strong groups. These include ethnic (e.g., Chinese Malays, Indian Fijians and Indian Africans), geographic (urban elites) and concentrated power groups (economic dynasties and political cliques). For example, the Malaysian government has attempted, in its divestiture program, to distribute corporate wealth among its nationals, particularly indigenous Malays (Bumiputra), through the National Unit Trust Scheme. As a result, it has allowed only the Bumiputra class to subscribe to blocks of equity shares of divested SOEs. However, such approaches may make the other ethnic (and foreign) groups resentful. In Western Samoa, only about 15 families have access to sufficient capital and business know-how to bid on large-scale privatization actions.6 7 Some countries, while interested in privatization, are fearful that government monopolies may only be replaced by private ones, in that there is an absence of a financially strong middle class.

66/ See pages 116 to 128 on "Determining Future Ownership."

67/ Charles Feinstein, "Privatization Possibilities among Pacific Island Countries," Research Report Series No. 2, Pacific Islands Development Program, East West Center. - 71 -

4. ANICILLARY ARRANGEMENTS

Many privatizations will require transaction - specific ancillary arrangements along with the basic methods described above. Already mentioned was that a regulatory framework may be required in the case of public services or strategic enterprises. Purchasers may seek various commitments from the governmeant so that they can operate their business satisfactorily. Governments may seek commitments from purchasers as to the future financial and economic behavior of a firm.

In some countries, state ownership of certain sectors has sometimes been taken as an alternative to regulation, such as with utilities and public services. However, a number of governments have increasingly come to the conclusion that the introduction of an adequate regulatory framework is the more effective control vehicle, rather than ownership. A regulatory framework generally includes the establishment of a regulatory body and licensing by the state (see page 163). When Guinea privatized the stevedoring and transit operations of the Port of Conakry, it instituted several ancillary arrangements, such as legislated standards for this profession (Code d'agreation) and specialized labor regulations for the port. In other words, specific sectoral arrangements may be required.6 8

As to commitments sought by purchasers, typical ones include freedom of transfer of capital and distributed income; assurances that the investor can wind up the firrm; and freedom from price controls. When Togo signed an agreement in view of the sale of textile mills to the Pen Africa Textile Corporation,6 9 the Convention d'Etablissement signed as part of the privatization arrangement provided, inter alia, for a stability of the legal regime, free transfer of capital and earnings, customs, tax and financial guarantees, and assurance that the government would not establish or encourage the establishment of other textile enterprises with the same line of products (the latter raising a number of question as to the government's intention with respect to competition in the sector).

Governments should be clear as to the assurances they are prepared to offer (relative to pricing and other policies that may affect returns). They should also develop a system for valuing the advantages sought, as those will affect the comparability of offers. In some instances, exorbitant advantages have been granted to purchasers, such as an exclusive market or undue protection against imports.

it/ Break-up of a monopoly may be required, preferably before privatization. See A. A. Walters, "Privatization", Manuscript, 1987; A. A. Walters, "Privat:ization: Some International Lessons", Paper presented at Fifth Annual Convention of Private Argentine Banks, August 1987; and R. Hemming and A. Mansoor, op. cit.

69/ See Volume Two: Togo. - 72 -

An area in which much bargaining takes place between purchasers and governments is the effective protection to be provided to SOEs to be privatized. Typically, governments either undertake to provide a protective tariff or maintain existing advantages as an inducement to purchasers. This approach is likely to lead to strains on the economy because it promotes highly protected industries.7 0

In many situations, few private investors or operators may be interested in acquiring or leasing an SOE or state-owned productive assets, particularly those that are not viable. The government may face the very difficult decision of whether or not to grant exorbitant advantages (e.g., protection from competition) that could result in viability from the operators' point of view and make a transaction possible. Without addressing that decision-making per se, it should be said that, when planning a given transaction, the ancillary advantages sought by purchasers need to be carefully weighed before the underlying transaction is approved. In one known instance, idle industrial facilities are being leased on a basis whereby the proceeds to the government will cover only a minute fraction of the respective debt service obligations (although there is no indication that a sale or other arrangement would have yielded a higher monetary return). The lessee has revitalized part of the facilities, put them into production and provided renewed though reduced employment. Expansion of the industry is now taking place, with private investment successfully raised in expanded facilities. Beyond the lease proceeds, the government may receive some tax benefits, while further unquantifiable benefits may accrue to the country in terms of a favorable climate for industrial development. On the other hand, the viability of the new operation is based largely on market exclusivity, linked with substantial protection against competing imports. Careful analysis of the foregone benefits to the government (e.g., import duties) and costs to the consumer (who might be otherwise able to buy competing imports for less) should be evaluated carefully in such instances. In other words, in reviewing ancillary arrangements, extreme care should be taken to evaluate the long-term costs and benefits to the country versus the immediate return of completing the transaction. Some new enterprises have emerged in West Africa with substantial protection effectively granting monopolies of production. In some instances the dissolution and liquidation of an SOE may be of more benefit to a country's economy even though a privatization might yield better immediate financial proceeds. Review of such ancillary arrangements are presently taking place in some West African states.

Some liabilities or contractual commitments of the SOE may need assumption by the government (other than debt liabilities covered under the "Readying Process" on pages 102 to 104). The case of the privatization of the Ontario government-owned Urban Transportation Development Corporation Ltd. illustrates this among other examples. The government was led to

70/ Deepak Lal, Martin Cane, Paul Hare and Jeffrey Thompson, ApPraising Foreign Investment in Developing Countries (London: Heinemann, 1975). - 73 - retain performance liability commitments for existing contracts,7 1 and retained the buyer as manager on a fee basis to handle these contracts.

When the government sells an enterprise directly through a private sale of shares or assets, it may be able to obtain specific commitments from a single, or consortium of, purchasers that could not easily be obtained if the shares were sold to the public.7 2 Part II of this report highlights on page 135 some privatization transactions that have included conditionality to maintain certain levels of employment. 7 3 The abovementioned Convention d'Etablissement in Togo for the privatized textile mills provides for a minimum level of employment at 6,000 workers after two years of operation, as well as preference for Togolese raw materials. Other undertakings have covered future financial investments such as in the SEAT privatization in Spain, and economic behavior and market commitments of the enterprise such as in Canada's privatization of de Havilland. The amount of notes payable by the Boeing Commercial Airplane Company on account of the purchase of the Canadian Government's shares in the Havilland Aircraft of Canadair Ltd. is to be reduced by Can. $1 for every Can. $5 of purchases by Boeing of Canadian goods and services under new orders. Shares retained by the Canadian Government in a holding company through which Bombardier Inc. acquired Canadair Ltd. are to be cancelled as Canadair invests in research and development or wins new export business. Several privatization transactions concluded by the government of the province of Quebec require certain levels of investment over time by the purchaser. Privatization agreements in Guinea, preceding the creation of a new company incorporating government assets, always stipulate investment obligations during the next five years, a deadline for the start of operations and a minimum production level.

71/ Christopher J. Maule, "Privatization - The Case of the Urban Transportation Development Corporation Ltd.," Business Ouarterly, November 1987.

72/ Robert A. Donaldson and Donald C. Ross, "Privatization from a Canadian Perspective," Paper presented at the International Bar Association Conference in New York, September 1986.

73/ Only realistic commitments should be sought. In one known instance, a government's attempt to privatize its national railway was frustrated by the introduction of excessive constraints, such as the retention of certain lines and of the existing workforce. - 74 -

PART II

SELECTED IMPLEMENTATIONASPECTS

Part II addresses selected implementationissues and reviews some tried solutions. Most issues must be viewed in the context of one of the basic methods of privatizationdescribed above.

The principal issues which arise in implementingprivatization can be grouped under the followingheadings:

o Planning and Management

o Readying SOEs

o Valuation and Pricing

o DeterminingFuture Ownership

o Employment Issues and Employee Participation

o Cost of Privatization

o Resource Mobilizationand Financing

These areas cover the most recurrent issues or constraints in implementingprivatization and need extremelycareful handling in the planning and implementationstages. 74 It is important to anticipate which of these issues are likely to arise in a proposed transactionand to evaluate the possible responses. Solutions or techniques analyzed here represent some of the main options for governmentsto apply.

74/ Those issues were selected principally in function of the types of questions which have arisen under World Bank operationalwork. - 75 -

1. P]LANNINGAND MANAGEMENT

The first issue those in charge of assessing proposed privatization programs will face is to determine the organization and capabilities of the agency or group to manage the process. This section reviews the institutional and other arrangements necessary to assure an orderly, transparent and expedient process. It analyzes first the procedures for initiating, planning, defining and authorizing a privatization program. Second, it reviews the organization of departmental responsibilities and the use of specialized implementation units. Third, it comments on the types of advisory and other needed external services. Fourth, it assesses the need for mandatory guidelines or procedures to govern the privatization process.

Initiating Measures

"Initiating measures" are meant to cover initial implementation measures, that is, after a government has redrawn the line of state ownership, or has determined the principles to govern the implementation of its policies in respect of its SOE sector.

The initial announcement of privatization is generally handled in two ways. In most instances, the government announces its intention to divest or privatize various sectors of the economy or substantial segments of the public sector as an element of economic policy. In a smaller number of cases, like in Spain, the government simply privatizes one or more enterprises, ad hoc, so as to improve their efficiency or for other reasons of economic rationality, without launching a broader privatization program and without having spent much time and effort preparing the policy or political terrain.

As an example of the first approach, Nigeria's Finance Minister announced privatization in his 1986 budget speech, as did Canada's Minister of Finance in 1985. Partic:ularly when the general public is targeted to acquire the state's interest, speedy action to foster and sustain the interest engendered by the announcement is essential. Even with private sales, the announcement ofE a privatization program should be quickly followed by implementation.

In Singapore, the Minister of Finance appointed a committee, the Public Sector Divestment Committee, to identify SOEs for divestment and put together a divestment programme (it submitted a com rehensive report in February 1987). Some countries have prepared (Turkey) 5 or are planning to prepare (Malaysia) detailed master plans for privatization. To move

75/ See a detailed commentary in R. Leeds, "Turkey: Implementation of a Privatization Strategy," Case Study for John F. Kennedy School of Government, Harvard University, draft. - 76 - rapidly, a country indeed needs to be clear in advance about the initial steps to be taken and have identified some initial viable candidates. If those conditions cannot be met, it is perhaps best to proceed case-by-case, rather than launching a general program. Even with a case-by-case approach, however, the government should announce its intentions publicly. Otherwise, critics may view the transaction as underhanded. In most countries, it is also necessary to continue publicizing the government's progress in varying degrees of detail.

Initial announcements should present the privatizations transparently and invite constructive discussions with all parties. Initial attempts at privatization in a West African country in the late sixties were severely criticized for lack of open debate and led to labor unrest and subsequent reversals of divestitures. The government now encourages extensive public debate with all relevant quarters. Brazil's new privatization decree contains provisions for full disclosure of privatizations 7 6 which are to be widely announced to ensure the public knows all the conditions. In the UJnited Kingdom, enormous media relations efforts have been deployed with respect to most instances of privatization. Initial announcements in British Columbia (Canada) stressed that processes (bidding system, valuation and all other appropriate details) would be very public.

Employment issues and other major concerns such as the concentration of capital in some countries must be addressed at the earliest stages. Major addresses on privatization, such as H. M. Hassan II's address at the opening of Morocco's spring parliamentary session on April 8, 1988, largely focus on these issues. The office responsible for privatization in one Latin American country observed the negative efforts of publishing lists of enterprises to be privatized without full information on rationales, methods and procedures, etc.

After a government has announced a privatization program or the privatization of selected enterprises in general terms, it will want to inform7 7 the market in somewhat more detail. One way is to issue a general statement of policy and then solicit interest in several SOEs. Malaysia's Guidelines on Privatization (1985) are designed "to inform the public as well as those who are in the business world about the concept and other issues related to privatization." These guidelines generally invite private business interests to submit proposals for privatization to a designated government office. In the Philippines, the Asset Privatization Trust issues general catalogues of SOEs or assets to be privatized and interested parties may request asset specific catalogues. Several

26/ Brazil's decree of November 1985 further requires "the operations to be analyzed and assisted by external auditors who will take steps to ensure the transparency and openness of all phases of the transaction."

77/ This section does not cover the information, to be provided as part of the transaction itself, such as information to be included in prospectuses. - 77 - governments' announcements have given rise to a broad preliminary interest from investors. This method is a relevant approach for initiating a program of privatization of SOEs by methods other than public offerings, such as private sales of shares or assets, and even management contracts and leases. However, the government should be satisfied that a reasonable level of private interest exists in the SOEs it intends to privatize.

Both general and case-by-case announcements are normally necessary when initiating a program of privatization of SOEs, whatever the method, but more essentially when public offerings are envisaged. As illustrated by the cases of France and the United Kingdom,7 8 as well as by the National Commercial Bank (NCB) privatization in Jamaica, widespread publicity provided sufficiently in advance helps educate the public and inform investors as to the public offerings. The massive and detailed information campaign conducted in connection with NCB led to a massive response (described further on page 142). Promotional campaigns with respect to the government's overall efforts at privatization can be extremely important as well, particularly if lack of response or even opposition is due to a lack of understanding. Socio-political constraints (see page 69) and interests of various groups must be addressed extremely carefully from the outset. Representatives of chambers of commerce and banking circles in at least two countries have noted that the government, when planning its privatization effort, did not consult sufficiently with the private sector.

While several of the above patterns of initiating measures illustrate what many practicioners would recommend as sound practices, and provided certain principles of transparency are maintained, no dogmatic approach should be taken in this respect. It is found that extensive announcements were made and initiating measures taken by several countries, while not much implementation action has taken place. Conversely C6te d'Ivoire has privatized 28 SC)Es without a formal or comprehensive plan and with modest publicity.7 9 Such an efficient ad hoc approach may however not be feasible or advisable in all countries, partly because of its lack of transparency.

78/ France's Saint-Gobain had retained an advertising agency (Publicis) to present the company to the public at large. Advertising for several enterprises was carried by television and the press. British Gas claimed its advertising campaign reached 98 percent of the adult population in the United Kingdom. Some countries, however, do not permit advertising in cotmection with public sales of shares (the case in Canada).

79/ Wilson, op. cit. - 78 -

Whatever the approach to privatization, careful planning and phasing of activities is important. The timing of offerings must take into account market conditions. When Chile began its privatizations, it conducted so many sales simultaneously that the financial markets were virtually flooded, while investors proved unable to sustain their acquisitions. Public offerings should be staggered, with careful selection of initial candidates to gain credibility. A state may do well to divest its shareholdings in even a single enterprise gradually. The privatization of Nippon Telegraph and Telephone (NTT) in Japan involved its conversion into a joint stock company, whose shares are eventually to be quoted on the stock exchange. While the government will remain the majority shareholder, it is expected to sell half its stake over a period of five years. British Telecom has completed the first stage of its privatization, with the government still to divest its remaining 49.8 percent holding. The French government has carried out about one-third (in terms of number of SOEs and asset value) in the first year of its five year privatization program, giving it the flexibility of holding some sales in view of the present stock market downturn. In the case of private sales, dialogue with representative sections of the private sector is extremely useful in identifying potential interest.

The selection of the first enterprise or enterprises for privatization through sale is, as noted, very important "as its success or failure will influence the future of the whole privatization plan", as Argentina's office in charge of privatization commented when offering Austral, the Argentine state airline, for sale. Similarly, when France's new conservative government debated during the summer of 1986 what to privatize first, Saint-Gobain was an obvious choice. Solid and well- managed, it seemed the most likely to appeal to a French stock market that had become more cautious. 8 0 Several investment bankers believe that a successful sale within a short time span after the start of a privatization program is very important. Niger decided to privatize the distribution operations of its National Petroleum Company first, as it entailed a relatively easy transfer of smaller units (gas stations) to local operators, giving some visibility to early success.

The first phase of a privatization program might well begin with relatively profitable firms so as to enhance market confidence and to

80/ The Economist, November 1, 1986. - 79 - demonstrate the government'scommitment. 81 The first French privatization, Elf Aquitaine, was a partial privatization,only (51 percent) to test the market, whereas subsequent cases followed the 100 percent privatization policy. In countries with active capital markets, it may also be possible to sell very quickly the shares of companies partially owned by the government and already listed on the stock exchange. Subsequently, the program should seek to maintiaininvestor interest through a variety of offerings, mixing types of ifirm,partial and full privatizations, and public offerings and private sales, in keeping with market conditions. The pattern and pace should be reviewed continuously.

The selection of first candidates for privatizationmay be determined by various socio-politicalfactors. In Egypt, the first SOEs to be privatized may be hotels, as these do perhaps not as greatly concern the population at large.

According to First Boston Corporation/CreditSuisse First Boston based on their experience of the Rumasa group privatizations in Spain, a detailed action plan, which should quickly follow the announcement of privatization, should include:82 objectives, timing, financing, foreign or domestic sale, treatment of minority shareholders, valuation of the companies prior to sale, preaparationof data for potential investors, studies of adjustments and prior changes that can increase the possibilities (and/or price) of a sale, analysis of the tax, legal and labor situation, and identificationof potential investors. As a basis for the detailed plan, it is advisable to carry out some form of cost/benefit

81/ But various other considerations may come into play. In the Philippines, the carefully drafted operating guidelines for the Asset Privatization Trust which were recently approved by the Committee on Privatizationprovide how the Trust should determine its priorities for disposal:

"Within the overall context of rendering productive once more idle or underutilized assets, the Trust, as a general rule, shall give priority to situations that would yield the maximum cash recovery in the shortest possible time; however, priority attention may also be considered under certain existing circumstances, such as where (1) the cost of conservation and/or maintenance of an asset is great, (2) the rate of deterioration of plant and equipment is rapid, (3) rehabilitation by new owners could immediately generate employment or have strong linkage with other industries, or (4) locational considerations apply, as in certain projects which may be the sole employment sources in their respective locales."

82/ First Boston Corporation, Book on Privatization. - 80 - analysis of alternative methods that meet the government's objectives.83

Authorization of privatization in a given country may be determined by existing legal requirements, such as those in the constitution. Usually there is some room for discretion, however. France passed special legislation authorizing a privatization program for a group of sixty-five SOEs (a separate law authorized the privatization of TF1, a television channel). A similar law was enacted in Senegal authorizing the total privatization of 13 "Soci6tes d'Economie Mixte" and the partial privatization of another 13 such enterprises. The United Kingdom needed separate pieces of legislation for practically every privatization. This led to delays of over one year for individual entities, whereas in France the processing time per entity is about three months from the decision to proceed to the actual offering. Turkey's law gives the executive branch the power to decide on privatizations. The care with which the authorization process is prepared can greatly influence the ease with which a privatization program is launched and implemented. Annex B presents the experience of selected countries in this respect.

Organization of Departmental Responsibilities: Implementation Units

A government needs analysis and informed advice on many issues, coordinated formulation of recommendations,prompt and expedient decision- making, as well as an effective implementation capability. The possibility for abuse must be minimized. The emphasis is generally placed on centralization, simplicity, flexibility, speed and transparency. No one organizational model for managing a privatization is appropriate in all circumstances.

Managing a privatization program requires a variety of skills. Some may be available within government departments, others must be hired from outside. 8 4 This section analyzes how departmental responsibilities have been organized and coordinated in practice. The following is a sampling of some of the organizational set ups which have been adopted.

Specialized Government Ministry. A number of governments have used a specialized ministry to carry out and coordinate the privatization program, such as in Canada (Office of Privatization and Regulatory Affairs as well as some provincial ministries: e.g., Quebec has an Associate Minister for Finance and Privatization). France had a "Ministre d6legu6 A la privatisation" until the privatization law of August 1987 -- responsibility was then transferred to the Ministry of Finance, Economy and Privatization (which has now been renamed since France's privatization program has been interrupted under the new administration). Where there is

83/ Mary Shirley of the Country Economics Department of the World Bank is undertaking a review of applicable methodologies in a sample of countries.

.1/ The next section 1 deals with the use of professional services. - 81 - a Ministry of State Enterprises, as in Togo, it may be assigned responsibility.

Permanent Privatization Committee. To ensure decision-making by consensus, some countries have set up a permanent governmental committee or commission to oversee privatization, or some specific aspects such as the valuation. In some cases it may be assisted by a specialized task force. Typically, the committee includes representatives of the ministries and public entities most concerned with the privatization exercise, but may also comprise personalities i-rom outside government. Brazil, Canada, the Philippines and Senegal established such committees and gave them principal authority to carry out their privatization programs. Brazil's decree of 1985 governing privatization establishes an Interministerial Privatization Council to administer the process. Its chairman is the Minister of State and Chief of the Planning Secretariat at the Presidency and it further consists of the Minister of Finance, the special Minister for Debureaucratization, the Minister of Industry and Trade as well as the sectoral minister overseeing any particular SOE to be privatized. The Council has a secretariat for technical and administrative support. The lead in the actual process is taken by the Minister of State responsible for the individual SOE. In August 1986, the Canadian Prime Minister established the Cabinet Committee on Privatization, Regulatory Affairs and Operations (CCPRAO), chaired by the Minister of State (Privatization) and Minister responsible for Regulatory Affairs. The Office of Privatization and Regulatory Affairs (OPRA.), reporting to the Minister, was set up in December 1986 to provide the required support and cohesion.8 5

In Senegal, the Special Commission for Supervision of Divestment (Commission Speciale de Suivi. du D6sengagement de l'Etat) has sole authority to recommend privatization measures to the government and to retain advisory services for that purpose. The Gambia set up a permanent task force comprised of representatives of the Ministry of Finance and Trade, the Ministry of Economic Planning and Industrial Development, and the National Investment Board (NIB), as well as the responsible sectoral ministries. The NIB is the lead agency, with responsibility for the detailed implementation. I]n Malaysia, an institutional machinery for privatization was set up, consisting of an Inter-Departmental Committee under the chairmanship of the Director General of the Economic Planning Unit (EPU). It has overall responsibility for "planning, monitoring, coordinating and evaluating" implementation of the privatization program. The Committee included members for such key agencies as the Treasury, Attorney General's office, the Implementation Coordination Unit and the EPU. In Sri Lanka, a Presidential Privatization Commission has been placed under the authority of the President and has among its members three of the chairmen of the best performing private firms in Sri Lanka. In the Philip- pines, the Committee on Privatization (COP), a Cabinet-level committee

85/ Varying arrangements exist in Canada for handling privatization at the provincial level. - 82 - headed by the Secretary of Finance, decides on what assets the APT (see below) will be asked to sell, and COP approval is required for all sales. Ghana has a Divestment Implementation Committee (DIC) that recommends action to the Government. France, Guinea, Kenya and Tunisia have used still other variations of the committee approach, with different responsibilities.

Sectoral Ministry. A number of countries have given the responsibility to privatize SOEs to the sectoral ministry or department most closely involved with their operations. In the United Kingdom and the United States, for example, principal responsibility for privatization was assigned to the Ministry (or Department, in the United States' case) of Transportation in the case of airlines (U.K) or railways (U.S.), or the Department of Trade and Industry in the case of telecommunications (U.K.), etc. In the United Kingdom, the Treasury plays a coordinating role that should ensure consistent decisions across individual privatizations and to preclude undesirable precedents.8 6 In the Philippines, the Committee on Privatization has delegated some of its authority to specific ministries in order to expedite the sale of enterprises reporting to them. In Brazil, as stated above, the lead role in detailed implementation will be taken by the sectoral ministry. Allowance needs indeed to be made for the relevant sectoral department or ministry to play a leading role since it knows most about the candidate.

Ad Hoc Privatization Units. Where privatization is restricted to specific companies or groups of companies and is not global policy affecting all SOEs, ad hoc implementation units have been used. The Spanish government, for example, set up a special unit, the Rumasa Repri- vatization Unit, under the leadership of a specially appointed director for re-privatization to conduct the sales of the Rumasa subsidiaries. Members of the unit were from the civil service, the private sector as well as from the Rumasa Group.

Privatization by the Parent Holding Company. In many countries, privatization is carried out by the parent or holding company, in some cases as a routine part of corporate operations. Certain governments have relied on the parent company to divest subsidiaries. In Tunisia, the textile holding company SOGITEX was requested by the Ministry of Industry and Commerce to proceed with the sale of 10% of its holdings in each subsidiary through public offering. The privatizations by IRI, the industrial state holding in Italy, are an example of privatization handled by the holding group often at its own initiative. IRI's Divestiture Committee, composed of IRI officers, had as its main functions to (i) state criteria for the selection of assets to be sold, (ii) coordinate the activities of the various sub-holding companies in the divestiture process, and (iii) be a reference point for potential buyers of enterprises. It recommended

86/ Craig Pickering, "The Mechanics of Disposal," in D.R. Steel and D.A. Heald (Eds.), Privatizing Public Enterprises: Options and Dilemmas (London: Royal Institute of Public Administration, 1984), pp. 45-58. - 83 - action plans but the final decision to sell rested normally with the responsible sub-holding owning the enterprise. The Committee could, however, withhold subsidy to monety-losingenterprises that had been recommended for divestiture. To varying degrees, the Philippines,Brazil and Turkey are also following this course. Obviously, the level of commitment of the professional management of the parent company to the goals of the proposed privatization is of paramount importance to the success of this approach.

Other Options. Some countries have adopted alternativesthat do not fit any of the above categories. As one example, Jamaica establisheda special secretariat within the National Investment Bank of Jamaica (NIBJ) to value and arrange for the sale or lease of publicly owned companies referred to it by the governmeant. At the present time, they have been given forty-five companies with action on at least half of them well advanced. Although the government is still finalizing its divestment policy, certain elements are clear. The government intends to transfer the shares of most public enterprises to a new subsidiary company to be set up under NIBJ. NIBJ will then offer shares or similar instrumentsin the new company to the public, thus effecting the divestment gradually. It is not clear whether there will be one holding company for all enterprises or whether there will be a series of individual companies under which like enterprises will be grouped, e.g., transport, hotels, telecommunications, and financial services. There is precedent for this arrangement, in that the NIBJ was the owner of the sh-aresand vendor in the case for instance of the privatization of the National Commercial Bank by public offering. In Turkey,87 privatization of the state economic enterprisesis to be decided by the Council of Ministers and the privatization of corporations, affiliated ventures, enterprises and enterprise units shall be decided by the Public Participation Fund. All SOEs to be privatized are deemed transferred to the Public ParticipationFund for disposal. It is believed that because the PPF is outside the normal bureaucratic structure, it will constitute an efficient privatizationvehicle.

In Chile, SOEs are broadly classified into state enterprises owned directly by the central government through ministries and goverment institutionsand public corporationsowned by Corporacion de Fomento de la Produccion de Chile (CORFO), the state development and holding corporation. CORFO has been viewed as the most appropriate entity to carry out government's privatizationpolicies, and a privatizationstructure, described in Figure 1, was set up within CORFO which has been responsible for most of the privatizationtransactions during the last several months.

Another possibility, in those cases where the candidate enterprise has the necessary capabilities and sophistication,will be for the government (or other entity acting as vendor) to appoint members of management to lead the process. To the extent management strongly favors the privatization,this may expedite the exercise.

87/ Law 3291 of May 28, 1986. - 84 -

Figure 1

CHILE: CORFO'S PRIVATIZATION STRUCTURE

CORFO'S COUNCIL*

Composition

President: Minister of the Economy

Members: Finance Minister Planning Minister (ODEPLAN) Minister Vice-President of CORFO Additional member appointed by the Executive

Function: Final responsibility for privatization strategies and decisions, as proposed by the Privatization Committee.

PRIVATIZATION COMMITTEE

Composition:

Members: Planning Minister (ODEPLAN) General Manager of CORFO Enterprises Manager of CORFO Normalization Manager of CORFO

Executive Secretary: Normalization Deputy Manager of CORFO

Function: Link between the Normalization Unit and the Council, supervising the implementation of actions approved by the Council.

NORMALIZATION UNIT

Composition:

The Normalization Unit is a Vice-Presidency within CORFO

Function: Carrying out of policies approved by the Council and implementation of the selected method. Oversees the whole privatization transaction, including prior restructuring of SOE (if needed), selection of investment bank or other financial intermediary, screening of prospective purchasers, negotiations if required, and collection of proceeds from sales.

* Has also the function of Board of Directors of CORFO. - 85 -

Most privatization programs fall into one or another of the organizational alternatives discussed above, or some combination of them. Some countries aim to have one organizational entity make the political decisions (i.e., establish overall policy and approve individual transactions), while a different, separate entity actually conducts the operational tasks associated with privatization, such as negotiations. The Committee on Privatization in the Philippines is responsible for deciding which SOEs will be sold and must approve all sales, while the Asset Privatization Trust, a government agency acting as Trustee of the National Government, is responsible for actually selling the assets and taking all the related actions (although government entities other than the Asset Privatization Trust may dispose of enterprises under them (e.g., the Philippine National Oil Company is authorized to privatize its subsidiaries) subject to approval by the Committee on Privatization). A Corporate Affairs Group comprising a Privatization Office was created at the Department of Finance, largely to provide assistance to the Secretary of Finance as Chairman of the Committee on Privatization. In Costa Rica, a trust with similar functions was set up to assist in the divestiture of companies held by Corporacion Costaricense de Desarollo (CODESA).

Other countries find that maximum authority must be placed with a given body or ministry to handle all aspects of privatization, subject to the scrutiny of an independent: commission with respect to certain aspects (such as, e.g., valuation). An example of the latter is France, whose organizational scheme has proven to be able to proceed speedily with the implementation of authorized transactions.

The administrative structure needs to be responsive to the interests of government, interested business circles and investors, and other relevant parties. It must be able to deal not only with the transfer of ownership aspects, but also with likely implication for competition and efficiency. It is not possilble at this stage to draw lessons from the experience of different countries with organizational structures for privatization. While various management models stand out, categorization is difficult because governments often try to be flexible and to allow for ad hoc solutions. At the same time, because privatization involves by necessity several government deparitments, to ensure adequate coordination, one party (ministry, committee, etc.) needs to be designated as the lead unit through a formal administrative instrument. Boards of directors and management often play a key role in the process jointly with the government- owner. There are various examples of this. Of course, management thereby becomes an interested party in the outcome of the process, particularly if they are given responsibilities in the selection of the acquiring party (which in turn will decide whether it needs to replace existing board and management). - 86 -

Most of the organizational structures described above are only at early stages of implementation of their programs. A scheme such as the one in the Philippines has not yet demonstrated its efficiency as the privatization program has barely been initiated. The countries where the implementation of privatization has been more speedy are seemingly those that have avoided the complexities of involving too many government departments other than through the membership of government ministers in a policy- making body (such as CORFO's Council in Chile). The privatization structures adopted in Chile and France have permitted efficient implementation of privatization decisions. Clearly, each country needs to devise its own approach based on factors such as the scope of the program, and the political and administrative characteristics of the country. If the scope of the privatization program is one of fundamental economic policy reform in the country, then the responsibility to carry it out will need to be placed at the highest levels of government. Or, the organizational set up is to have quick access to the highest levels of government.

It is sometimes argued that elaborate schemes for handling privatization may be counterproductive (and that privatization merely requires political will and a "get on with the action" attitude). It would be sim- plistic, however, not to recognize that in both developed and developing country environments, a minimum degree of checks and balances, coordination and transparency is necessary to try and protect the public interest when disposing of state assets. As described above, some schemes may attain these objectives without rendering the process too cumbersome.

There is no conducive evidence that, for instance, centralized decision-making power in one ministry yields better results than the committee approach. The centralized approach yields quick results, which is clearly an advantage. However, the potential for abuse is great, and the level of criticism subsequently levied may be politically costly, thus rendering future privatization more cumbersome. The trade-off between the two approaches is then often one of expediency versus potential for abuse and political back-lash. The abovementioned French approach addressed, to some extent, both concerns. Decision-making being centralized at the Ministry of Economy, Finance and Privatization, a key concern became to make the process as unquestionable as possible. Hence, the creation of the independent Privatization Commission, primarily charged with setting the valuation of the enterprises.8 8

88/ Edouard Balladur, Je crois en l'Homme plus au'en l'Etat (Paris: Flammarion, 1987) p. 87. - 87 -

Use of External Professional Services

With few exceptions,, governments have found it necessary or helpful to hire external assistance in preparing or carrying through privatization. Brazil's privatization decree of November 1985 actually requires that "In defining [a] privatization operation, the Minister of State concerned shall be advised by a consulting firm from the private sector."8 9 While the higher civil service will provide some of the required skills, outside advisers usually have to be hired to provide the requisite corporate divestiture skills.

The degree of reliance on external advisers is primarily a function of the type of transaction or transactions envisaged and of the specific tasks to be carried out. Advisers may also assist in developing the overall policy approach and basic orientation of a program. This section reviews in general terms the main areas of work and possible contributions of external advisers as well as common modes of remuneration.

Public offerings normally require a range of traditional investment banking services usually involved in large equity issues. They include readying the SOE for sale, advice on all aspects of the sale (including pricing), preparation of the documentation (prospectuses, etc.), and follow-up on the mechanics of the sale. The investment bank may simply advise, or in many cases it may be required to back up the sale (mostly by an underwriting). Recent United Kingdom, French and other privatizations effected through public offerings, most of them underwritten, illustrate the type of assistance provided. Well-established firms were selected as both financial advisers and underwriters. In most instances, the government and the enterprise to be privatized each used its own merchant bank and in addition hired legal advisers and auditors. In the public offerings of Malaysia Telekom and Malaysian Airline Systems, a local investment banking firm was selected in a joint arrangement with a major British investment bank. In Nigeria, the offerings for the privatization of three federal government-owned hotels are being prepared by established local merchant bankers. The International Finance Corporation (IFC) is presently preparing with a Tunisian merchant bank an underwriting of a block of shares of a majority state-owned textile company in Tunisia, to be offered to the Tunisian public so as to achieve private majority ownership of the company. The government-owned National Investment Bank of Jamaica retained

89/ The law further provides that, for this purpose, "the National Economic and Social Development Bank (BNDES) shall select and list consulting firms having an acknowledged reputation and a tradition of participating in activities involving capital transactions and transfer of voting control." - 88 - the services of an established British merchant bank, solely as adviser9 0 to help with the public offering of its holdings in the National Commercial Bank. Much of the bank's experience accrued in U.K. privatizations (employee share schemes, limitations on individual shareholdings, etc.) proved extremely relevant in the Jamaican context.

Other methods of privatization also need professional services. The required expertise often leads the government to seek the assistance of investment banks. The presence of a reputable merchant bank may reduce the possibility of underhandedness. In the case of private sales involving large corporate divestitures and where marketing skills are essential, governments have resorted to investment banks, a step taken by the Spanish government in the sale of the Rumasa group enterprises. Their tasks included: overall advice to the vendor, as well as advice on the establishment of an action plan for the sale of several specific companies, on their valuation, on financial readying measures, on the preparation of sales brochures, a search for and identification of potential buyers, an analysis and evaluation of offers, and consulting in the final negotiations. They acted as both financial adviser and financial representative. The key experience needed for private sales includes prior involvement with equity markets, a network of contacts through which to solicit investor interest, and involvement with divestiture techniques and corporate restructuring. Accountants and law firms generally must also be retained, as well as specific industry specialists. The industrial investment firm retained by the government of Guinea as financial adviser for the recent privatization of fourteen industrial SOEs was mandated to diagnose all industrial SOEs, locate potential buyers and initiate contacts, and assist the government in the negotiations. A law firm was retained under a separate arrangement. In C6te d'Ivoire, most private sales were, however, handled entirely without external advisors.9 1

Generally speaking, in the case of developing countries, the advisers should have experience adapting divestiture and financial techniques to local conditions. Often, some association between local and foreign advisers is the most appropriate arrangement with respect to both technical advice and development of the required network of contacts to solicit investor interest. Recent experience with direct sales in West Africa points to the need to not only address local as well as overseas interests, but also the regional investment community. When selecting large international firms, while they usually offer a vast reservoir of the skills that are usually key to the success of a transaction, special attention must be paid that they be equally well-equipped to follow through

90/ and not as underwriters; as the sale was limited to Jamaicans, but the local underwriting market could not support the offer at a realistic commission, the Government took the risk of the sale on its own account. J. Redwood and 0. Letwin, op. cit.

91/ E. Wilson, op. cit. - 89 - where the local or regional investors' market is to be addressed (particularly in the absence of structured financial markets).

In some instances, all a government needs is occasional assistance in selected fields. For instance, if a government envisages a management contract for a particular SOE, it may select one or more advisers to assist in reviewing proposals and negotiating contracts. Some transactions have been prepared with minimal external assistance, such as the proposed privatization of two textile mills in Togo, which essentially involved the sale of assets to a foreign group.

Governments have also elected to use external advisers to formulate their overall privatization program. The government of Turkey engaged the merchant banking unit of a large commercial bank to develop a privatization master plan that established a broad framework for privatizing approximately forty enterprises. At the same time, the government engaged another investment bank to prepare a privatization plan for the national airlines, to include a detailed review of the feasibility of several alternative methods of privatization. The Philippine National Oil Company hired a management consulting firm to advise it on the disposal of some subsidiaries. In the case of Guinea, the advising firm consulted with the government on both the overall program for industrial SOEs (including the definition of which enterprises to privatize) and, as mentioned above, on the detailed implementation measures for each enterprise.

Whether the advisory and implementation assistance can or should be delivered by one or more advisers depends largely on the size of the program.

Advisors can be selected through a variety of procedures. A bidding process has been followed in many instances. In some countries, priority was to be given to local firms, firms with local establishments, or joint ventures between local and foreign firms.

In private sales, a general rule of thumb is that the government ought to ensure the presence of capabilities at least equivalent to those of the private party with which it is negotiating. In most instances, the required capabilities include auditors, financial advisers, corporate legal counsel and industry specialists. Several large merchant banks have recently prepared briefing materials with respect to their capabilities in privatization, building on recently acquired experience in the field. Such materials constitute useful accounts of the capabilities which may be required.

As to remuneration, it can be handled on a commission basis for completed deals or on a fee basis. The latter option is used more frequently with transactions other than public offerings. However, a "success fee" arrangement can also be applied in private sales. Large public offerings in the United Kingdom involved both commissions (for underwriting and placement) and advisers' fees. Generally speaking, the fees then - 90 - amount to a percentage of the proceeds. In both the divestment of shares in Malaysian Arlines System Bhd. (MAS) and Malaysian International Shipping Corporation Bhd. (MISC), the underwriting commission was 1/2% of the offer price per share. In the case of MAS, a subscription offer, it was payable by the company. In the case of MISC, an offer for sale of existing shares, it was payable by the offerors. In the case of British Telecom, various commissions 9 2 (not including the sales commissions for stockbrokers) amounted to about £ 6 million (the net proceeds were about £ 3,600 million). The size of advisers' fees has raised political concerns in the United Kingdom with the opposition finding them too high. These, however, have been at levels similar to merchant banks' fees for corporate divestitures and equity issues in the private sector. The commissions for underwriters are still larger than the fees for advisers, but they are regarded as justified because the risk of undersubscription is taken off the government's hands. The recent privatization program in Guinea involved fixed fees (not including the legal fees) for the outside assistance for the privatization of its industrial enterprises that amounted to about $0.5 million at the point at which fourteen industrial SOEs had been privatized for an aggregate price of about the equivalent of $12.5 million.

It has not been possible to establish a trend in the relationship of fees to transaction proceeds in private sales (at least where the fees were not payable on a commission (or success fee) basis). Where a transaction results in the retention of residual debt liabilities by the government, the price is not a proper reference for the fees. The determination of what constitutes reasonable fees ought probably to be made in each case by reference to the overall benefits expected from a given privatization.

Mandatory Procedures/Guidelines

The procedures for privatization (particularly private sales) should safeguard the public's interest. Individual deals should be subject to clear minimum standards that ensure orderly disposition, maximum return to the state, a fair process for the general public and assurance that the purchaser is qualified to run the enterprise productively.

A number of governments such as Bangladesh, Brazil, Chile, France, the Philippines, Senegal and Tunisia have, when planning privatization, developed mandatory procedures for their programs. These involve mechanisms for setting floor prices, procedures for selecting purchasers (e.g., through bidding or direct negotiation, minimum qualifications, whether to limit purchases by non-nationals, etc.). They may also involve obligatory payment guarantees or various forms of security where the government provides the financing or accepts payment terms. These procedures

22/ Details on the amounts and method of computation are provided in B. Yamey and D. Stafford, Report on the Experience of Privatization in Great Britain, op. cit. - 91 - have been introduced not only by countries with large-scale privatization programs. As in many countries the initiation of any privatization requires legislative authorization, a law on privatization has been enacted spelling out the basic conditions applying to the process. In some cases where governments did not apply minimum criteria, they suffered adverse consequences. Chile's experience in its first phase of privatizations revealed that it needed to. formulate better prequalification criteria. Bangladesh, which accepted payment terms when reprivatizing a substantial number of firms, has suffered from defaults for which it did not have remedies, such as mortgages or other financial security.9 3 A privatization program in a West African country was seemingly criticized by some as tainted with favoritism and somewhat oblivious to procedures which had indeed been established.

Among the advantages of specific legislation or mandatory rules on the subject is the possibility of introducing strict requirements for the objective valuation of assets and for setting the sales price. In the absence of such rules for private sales, the door is open to a wide range of irregularities that might result in the state not getting a fair price. At the same time, there is no hard evidence that a comprehensive body of rules is essential for success. At a minimum, however, states embarking on divestiture/privatization will find it advisable to adopt some implementation criteria, such as standards for valuation and bidding, uniform terms of finance, etc., particularly if the authorization procedure provides wide discretionary powers to the executive branch of government. This is of particular relevance to countries planning to privatize a large number of entities.

Furthermore, the private sector is attracted by a practical and orderly framework that facilitates analysis by prospective investors on the basis of generally accepted business standards and that assures the fair- ness and subsequent stability of the proposed transaction.

Annex C provides further details on the mandatory procedures introduced by several countries.

General Business Environment

The broad economic and legal environment for doing business in a given country is critical to the success, and sometimes the feasibility, of privatization (just as it is a determinant of the level and success of private investment in general). Although not a focus of this report, the importance of the general business environment needs to be highlighted

23/ Asian Development Bank. Privatization: Policies, Methods and Procedures. Papers presented at, and a summary of, the proceedings at a Conference held or, 31 January - 1 February 1985 in Manila, Philippines (Manila: Asian Development Bank, 1985). - 92 - since the feasibility of any privatization technique will be heavily dependent on it.

Key factors in the business environment (such as the fiscal, monetary, trade, administrative and regulatory policies) need to be assessed when evaluating the feasibility of a privatization program in general and of specific methods. It is therefore an inherent part of the planning process. The development of the domestic capital market and the availability of vehicles to mobilize private resources are other important factors. The general regime for private investment raises many questions. For instance, are privatization transactions eligible for special incentives under the investment codes? The answer is generally no, since the codes apply to new investments only, not to buying into ongoing ventures. However, C6te d'Ivoire's investment code provides for incentives in cases of enterprise restructuring.

When assessing privatization alternatives or steps for specific enterprises, there is a need to review some basic country, legal and policy requirements and restrictions. For instance, are there limitations on foreign investment in terms of ownership, sector participation and capital remittances? In the case of management contracting, what do the procurement laws of the country require, and what performance obligations are required of managers? The tax regime may or may not be conducive to certain types of transactions (e.g., does it favor direct ownership of assets over stock ownership?). Do the company laws of the country protect minority shareholdings (othervise the raising of equity in, or the sale of existing shares to, the general public is not feasible). Where overall economic policies are a disincentive to private sector development, corrective measures may be necessary.

Some financial and legal features of a country may be obstacles to private interest in general, or to foreign private investment in particular. These include labor laws and hiring regulations; the income tax regime and import and export duties; foreign exchange controls (right totransfer capital, dividends and other funds); political risk (risk of expropriation or other measures affecting ability of the investor to control and operate his assets); immigration restrictions (limitations on foreign management); and even accounting standards and the availability and adequacy of information. Some countries (in West Africa, for instance) are characterized by extremely cumbersome procedures for setting up and admin- istering corporate structures. According to a recent study,9 4 the most crucial limiting factor in Africa is not the lack of entrepreneurship, but weaknesses in the policy environment which inhibit effective investment.

Approaches taken recently by several countries, including Brazil and Morocco, place privatization in a broader context of "modernization" of

94/ K. Marsden and T. B6lot, Private Enterprise in Africa (Creating a Better Environment), World Bank Discussion Papers, Washington, D.C., 1987. - 93 - the economy. The Moroccan Administrationis currently expected to present to its legislature draft laws introducingvarious accompanyingmeasures to privatization such as a reform of the stock exchange and relating intermediation,tax incentives to stock ownership and to the trading of shares on the stock exchange (designed also to address capital concentration concerns by encouraging widespread shareholding),certain reforms to the company laws, and antitrustprovisions.

The general point to be made is that the overall gains from privatization can be greater in a policy environment that encourages the efficient operation of private enterprises and that avoids giving special privileges to private parties acquiring or leasing SOEs or their assets. Thus, privatization may need to be accompanied by well-planned policy reforms that promote strong interest by the private sector and permit competition and efficiencypricing (that is, that avoid exclusivemarketing arrangements or monopolies, that reduce special privileges such as protection against competing imports, etc.). - 94 -

2. READYING SOES FOR PRIVATIZATION

SOEs whose shares are already listed on a stock exchange and being traded can sometimes be divested further by a simple government decision to sell. An existing shareholder in a joint stock company, fully familiar with the company's operations, may want to increase its stake by acquiring government shares. In these instances, no readying may be necessary. In the first case, the focus is on setting an appropriate offering price for the shares. In the latter case, a negotiation takes place that concentrates largely on the valuation of the enterprise to determine a mutually acceptable price for the shares.

Most readying activities will be taken in view of carrying through privatization as soon as they are completed. But, as was recommended by the Public Sector Divestment Committee in Singapore, it may be advisable to bring SOEs to a state of readiness so as to be in a position to seize privatization opportunities as they arise.

Few SOEs however are in a condition that permits sale or other transfers to the private sector without readying measures.

Based on a detailed preparatory analysis which will precede just about any divestiture, it will frequently be determined that the SOE is not salable on an "as is" basis, and a wide array of preparatory restructuring measures may be called for.9 6 Figure 2 illustrates the type of readying actions being taken with respect to Malaysia's Jabatan Telecom Negara, involving a conversion from government department to public limited company in view of a public offering; those steps are similar to those applied in several British privatizations and to those applied in the ongoing privatization of the Sri-Lankan telecommunications, presently a government department. Figure 3, providing a list of steps taken in several British privatizations, further illustrates this. They represent a rather typical set of readying actions for government public services to be sold by way of

96/ In a number of countries, the readying for privatization has included complete transformation and reorganization of weak performing SOEs into profitable autonomous and self-sufficient SOEs to the point of becoming an attractive investment for the private sector. Even though this demonstrates that SOE efficiency may be achieved through appropriate restructuring without divestment, it is often argued as well that private sector ownership is more conducive to the maintenance or furtherance of efficiency. This opens a debate on privatization as a condition of efficiency which is not within the purposes of this report. - 95 -

Figure 2

ONGOING PRIVATIZATION OF MALAYSIA'S ENTERPRISE

Initial SOE Readied SOE

JTN TMB

(Jabatan (Telecoms Telecom Malaysia Negara) Readying Steps: Berhad)

-Government Agency- -Wholly Owned Govern- ment Company-

o Incorporation/creation of a public limited company o Transfer of assets and liabilities o Transfer of personnel o Valuation of company's worth o Change in financial accounting systems o Establishment of regulatory framework (issues of subsidies and telephone charges) o Listing at the Kuala Lumpur stock exchange - 96 -

FIGURE 3

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Extract from Privatizationin the U.K., Background | SECWR 'P Briefing,H.M. Treasury,London, 1986. comn 1 - 97 - public offering.9 7 No format exists for private sales since they may range from a full reorganization of a company prior to sale as a going concern to a liquidation followed by a simple sale of assets.

This section comments on common steps in the readying process:

o Enterprise Diagnosis

o Satisfaction of Legal Requirements

o Conversion of Legal Form

o Modification of Overall Legal Framework

o Financial Restructuring (including measures with respect to excess liabilities)

o Physical Rehabilitation

o Changes with Respect to Staffing

o Ensuring Cooperation of Management

Enterprise Diagnosis

A first step in any privatization is normally a thorough examination of the SOE's finances and operations. Following this examination, preliminary values should be established for assets or shares and an initial determination on the relevant privatization method or methods should be made.

The enterprise diagnosis will first consist of a corporate finance analysis, covering the SOE's debt situation (and in particular the state's exposure with respect thereto), capital structure and past financial performance. Auditors may need to be retained to review the adequacy of financial statements and, in many instances, prepare financial state-

97/ Mr. G. Grimstone of J. Henry Schroder Wagg & Co. Ltd. described (as part of a presentation at the London Conference on Privatization on July 6, 1987, sponsored by the Adam Smith Institute) the basic steps for many privatizations as (i) legal/constitutional, i.e., change from statutory body into a company, (ii) commercialization, i.e., financial, management and other changes to make it a commercial type enterprise, and (iii) selling. Coopers and Lybrand, in a pamphlet distributed at the same conference, refer to the establishment of the SOE as a self- sufficient entity as "corporisation" indicating that the assets must be recorded and valued; pensions and other employee issues resolved; contractual obligations identified and an appropriate capital structure agreed. - 98 - ments in accordance with sound accounting practices. Indeed, some SOEs, especially in developing countries, are without adequate records, have over-valued assets and have lacked financial discipline. Additional work on accounts will be determined in part by the country's legal requirements (and their actual application). However, in many cases, existing company information does not meet the accounting requirements of potential purchasers or standards of the markets in which the sale is to be offered, and still further work may be necessary.

The diagnosis will further examine the SOE's past operations and market situation, possible special privileges granted to it as an SOE and their impact on performance, and the relevance of existing plants or other assets to potential investors, as well as the physical condition of these assets.

Naturally, the volume of diagnostic work and the amount of effort in presenting it in comprehensive form to prospective buyers will depend on the anticipated method of privatization. In many instances of private sale of shares or assets, prospective purchasers may also want to undertake their own detailed diagnosis.

Satisfaction of Legal Reguirements

It is necessary to ascertain existing creditors', shareholders', employees', and other third parties' rights. Loan (as well as guarantee) agreements (with development agencies as well as commercial banks) routinely include provisions prohibiting the sale or other disposal of the government's interests or loss of control under a minimum percentage without the creditor's consent. The Canadian government, for instance, could not reduce its ownership of the conglomerate Canada Development Corporation (CDC), below 10 percent of the voting shares without triggering certain remedies of CDC's creditors. CDC ultimately prepaid the loans to free itself from such restrictions; new loans were negotiated soon after.9 8 The reason these clauses are used is that the state is often considered a performance guarantor of the enterprise. Unless the SOE (or government guarantor) is prepared to prepay the outstanding loans, it is obliged to involve the creditors whenever such clauses are present, a situation that frequently pertains to the privatization of SOEs. Similarly, when assets are burdened with mortgages or liens, no transfer of individual assets may be possible without the consent of the creditor.

Another issue is government guarantees, which are commonly provided for SOE borrowing. What happens when the company is privatized? Will the guarantee be maintained? Most likely, the answer has to be yes, unless creditors are offered an acceptable substitute private guarantee

98/ Donaldson and Ross, op. cit. - 99 -

(see further page 102).99 Senegal requires the introduction of an "action speciale" (golden share) if the SOE is covered by government loan guarantees or if government loans have been onlent to it to assure repayment by the privatized enterprise (see Annex D).

The rights of existing shareholders also have to be taken into account. The charters of SOEs set up as mixed joint stock companies routinely contain restrictions on the transferability of all or certain classes of shares, provide for -preemptive rights of existing shareholders, and the like. These provisions have reportedly been a hindrance to some privatizations in Kenya, and in the Philippines the proposed purchase of Associated Bank from the government-owned Development Bank of the Philip- pines could not proceed because of such restrictions. Under the Brazilian rules governing the privatizaticin process, the presence of a requirement of existing shareholders' consent is one instance where direct negotiation rather than bidding is an accepted procedure for selecting the purchaser.

The exercise of preemptive or preferential rights of existing shareholders is often difficult to reconcile with the justified requirement that shares sales should be maximized through a bidding or other competitive process. Either the shares are first offered, on the basis of a predetermined price, to the existing shareholders - and then exceptions to bidding requirements must be accepted. Or existing shareholders are offered the first refusal at, or close to, a price resulting from the bidding - in which case potential bidders might become substantially less interested in participating in the bidding. Experiences vary. In the recent privatization of one industrial enterprise in Brazil, it was decided that preferential rights of minority shareholders could be exercised in accordance with the company's articles of association, on the same conditions as the winning bidder would have acquired the stock being offered. While it has not been possible to review the details of these transactions within the scope of this report, it is worth noting that the 1987 presidential decree authorizing the privatization of one chemical industrial company in Argentina, Atanor Compafnia Nacional para la Industria Quimica, S.A., provides that the existing shareholders may exercise their purchase option as provided by the articles of association during a period of thirty days following the date on which the responsible min:istry notifies them of the purchase price (determined on the basis of a specified method); shares not so bought are to be offered on the basis of bidding. In another instance, namely Carboquimica Argentina S.A. the relevant 1987 presidential decree does build the preferential rights: into the bidding process; the existing private shareholders, having participated in the bidding, are given the

99/ A related question is whether the SOE's ability to borrow will be affected by the lack of fut:ure government backing after privatization. In the case of Japan-NTT, credit lines have remained open with no change in the costs, but that is not always the outcome (Euromoney, 11/86). In Thailand, management fears that the cost of borrowing will increase after the proposed privatization of Electricity Generating Authority of Thailand (EGAT) and Thai Airways. - 100 - opportunity to match the highest outside bid, provided their own offer was not less than 90% of the bid to be equalled.

Other commitments of the SOE may also need to be satisfied, such as contracts with management and employees (pensions, allowances, etc.) and commitments to suppliers, contractors and customers.

The identification of all these requirements is an essential preparatory step to the sale of an enterprise or its prior restructuring (and in some cases before entering into leases and management contracts as well). The impact of these requirements may be close involvement by all relevant parties (creditors, employees/unions and others) in the privatization process, and/or additional costs to settle them (see page 138 on the costs of privatization). Satisfaction of all legal requirements is essential to avoiding continuing claims after a privatization.

Conversion of Legal Form

A very large number of, if not most, SOEs cannot be privatized in their existing legal form which then needs to be converted. The exceptions are enterprises that are already joint government/private where the government is selling all or part of its residual shareholding. A case in point is the mixed company in which the existing private party wants to increase its stake or in which other parties, satisfied with the company in its present form, want to buy in by acquiring government-held shares. Such was the case in Mali, where local private interests acquired government shares in Industries Textiles du Mali (ITEMA), which was already set up as a mixed limited company. The same situation pertains with a public limited company whose shares are already traded and in which the government decides to sell a further interest (e.g., Singapore International Airlines). Most other forms of privatization referred to in Part I require legal restructuring or complete transformations.

Legal restructuring may range from simple amendments to the articles of association to the dissolution of an enterprise and transfer of its assets and liabilities to a new corporate entity. When shares are to be offered to a private purchaser or to the general public, a number of specific legal steps may be required to convert the enterprise into a joint stock corporation or a public limited company. Where the entity is a non- stock enterprise (e.g., a statutory body established by an act of parliament), the government needs to convert it into a stock corporation under ordinary company law. British Telecom was, immediately before privatization, transformed from a public corporation into a public limited company. As a public corporation, BT had a quasi-governmental power to grant licenses under the monopoly it enjoyed; these powers were removed by legislation before privatization. Dissolution of a statutory body and the transfer of its assets usually require special legislation. Activities embodied in a government department or agency similarly require this transformation. Some countries have begun to transform government departments into commercial organizations as a preliminary step for possible future - 101 - privatization. Note that the transformation may raise many issues: when Malaysia Telekom was converted from a government department into an enterprise governed by ordinary company law, for example, issues arose relating to the changed personnel regime, transfer of pension fund inputs, etc. Sri Lanka has drafted special legislation to govern such conversions.

Prior to the privatization of Telex-Chile, telex and post operations were organized as a public service regulated by a law that gave the concession to the government. Under a new law, two enterprises were formed, owned by the Ministry of Transport and Telecommunications. When the Chilean Government decided to privatize Telex-Chile, the enterprise was transformed into an open corporation and its ownership was transferred to CORFO (see page 84). The transformation of the legal form of this enterprise entailed changes in its management structure and new accounting practices. The reorganization of an SOE into component parts may be a preliminary step to privatization. In Chile, the state-owned generating and distribution electricity utility was broken up, starting in 1985, into several smaller corporations. It was recently decided to privatize one of the corporations, PULLINQUE S.A. (and the process took no more than six months, the preparatory conversion work having been completed previously). The British National Oil Corporation was split into two components and the operational activities were privatized as Britoil.1 0 0

Modification of Overall Legal Framework

In many situations, conversion of the legal structure of the activity is accompanied by ancillary legal changes, such as revisions of special privileges (e.g., termination of monopolies), establishment of a licensing system, introduction of a revised regulatory system for utilities, and so forth. A more cletailed discussion is found in Part I under "Ancillary Arrangements" (page 71).

Financial Restructuring

Balance sheet restructurings and ancillary financial measures have been necessary for many SOEs privatized as going concerns (particulary where public offerings and sales of shares are involved). Other sometimes more far-reaching measures of a financial nature have been necessary with enterprises that cannot be privatized as going concerns (particularly in the case of dissolutions followed by the sale of assets and fragmentation into component parts). The amount of change necessary will vary from enterprise to enterprise depending largely on the manner in which it was

100/ The procedures through which this split occurred are described in a paper by Britoil's legal advisers, A.W. Baker and G.H. Daniel, "BNOC and Privatization: The Past and the Future", Journal of energv and National Resources Law, Volume I, No.3, 1983, pp. 149 - 159. - 102 -

operated. Most measures have had to do with the write-down of assets, alleviation of liabilities, recapitalization and spinning off of assets. These measures are described below. (Complete fragmentation, e.g., into component parts, is discussed elsewhere since it is a distinct privatization transaction in itself; related restructuring measures, however, include many of those described below.) It is very difficult to know the extent of justified restructuring, particularly for SOEs which are no longer self sufficient or profitable. Restructuring of a SOE prior to sale does not necessarily make it a going concern but may only establish the conditions under which an eventual going concern could be established, and it is particularly difficult to assess the extent to which that premium can be recouped in the sale price.

Asset write-downs. Assets of SOEs may appear on the books at inflated values. If that is the case, the market value of the company or assets represents a substantial discount. It will be perceived as too large by the opponents of a transaction where in effect it may not be. If write-downs are necessary, there is some advantage in completing this process early so that any political fall-out from the write-down is separated from the sale.10 1

Actions with respect to SOEs' debts (including government- guaranteed). If an SOE has excessive debt liabilities, the question arises as to whether it should be sold as is, in which case it may command only a minimal price (if it is salable at all), or whether the government should absorb all or part of the liabilities so as to provide the enterprise with positive or adequate net worth prior to sale. In other cases, there is no choice at all as the magnitude of the debts bears no relationship to the market and earning value of the assets.

There is no one preferred course of action with respect to enterprise liabilities; each situation has to be handled on its merits. In the re-privatization of Hotel Agrupados, one of the loss-making enterprises of the Spanish Rumasa group, the acquiring consortium of Spanish and foreign investors assumed total liabilities in addition to a high share price and provision of fresh equity to the company. In general, the total debt proposed to be absorbed by a purchaser is a major criterion in evaluating offers. On the other hand, prior to the sale of Canadair Ltd., the Canadian Government removed substantial liabilities from the company. Similarly, the government of Mali has chosen to settle substantial liabilities of SOEs to be privatized. In Costa Rica, CODESA, a government holding company, will assume outstanding debts of eighteen SOEs to be sold to a private sector trust. The United Kingdom government, as the original bor- rower, wrote off substantial debts of several SOEs, in each case replacing it by equity to improve their balance sheets. Other debts were renego- tiated. Japan will shoulder a substantial portion of the debt of Japanese National Railways as part of its transformation into several new companies

101/ W. Edmund Clark, "The Why, Who and How of Privatizing Canadian Crown Corporations" (Draft). - 103 - to be privatized. Austral, Argentina's domestic airline, would reportedly have been sold without its debt.

In the case of Empresa Nacional de Electricidad S.A. (ENDESA), the Chilean government took over substantial debt; however, in the case of Empresa Nacional de Computacion e Informatica (ECOM), which has been losing important sums in recent years, it was decided to privatize the corporation "as is" and indeed, the sales price agreed upon this leveraged worker buy- out was correspondingly low.

Debt restructuring mtay involve various type of arrangements such as: complete reorganization, with debt selectively assumed by new operating entities; rescheduling; repayment (possibly accompanied by a selective sale of some assets to finance it); direct buy-back of a discount; conversion into equity; and arrangements for a third (governmental) party to service the debt on behalf of the SOE, possibly as an interim arrangement. Assumptions of debt liabilities and reschedulings would require the consent of the creditors and will therefore involve negotiations with them.

Whether the liabilities are settled or assumed, such actions are often regarded as a cost of privatization. One reported reason for the Kenyan government's hesitancy in pushing forward with a privatization program is the size of the outstanding liabilities that would have to be settled. However the burden on the government ought not, in most cases, to be regarded strictly as a privatization related cost. Either the SOE is self-sustaining and chances are it can be privatized with its liabilities. But if it is not, and the chances of restoring its self-sufficiency are remote, possible uncovered debts may be the responsibility of government.1 0 2

To all extent possible, internal restructuring should be explored. The sale of real estate assets of STECM, a mecanical construction company of the SOTIMACO group in Tunisia, permitted excessive liabilities to be settled and shares in the company can now be sold.

In some instances, governments have decided they should be com- pensated in some way for assuming SOE debts prior to privatization. When selling Canadair Ltd. to Bombardier Inc., the Canadian government retained ownership of the Challenger business aircraft technology as Can. $1.2 billion of debt on its account had been incurred by the Government, and licenced its use to Canadair. In the privatization of British Telecom,

102/ The liability of a government for non guaranteed debts of its SOEs will depend on a number of factors, including the legal form of the SOE (i.e. , is it a puiblic law body or a limited liability stock corporation?). This important question cannot be analyzed in this report, but the reader is referred to J. -M. Pi Suner, "La mise en faillite des entreprises publiques," Annales de l'Universite des Sciences Sociales de Toulouse. Tome XXIII, 1975 pp 203-222, and Mark M. Christopher, "Piercing the Corporate Veil Between Foreign Governments and State Enterprises," Virginia Journal of International Law, Vol. 25, No. 2, 1985, pp 451-482. - 104 - some government-contracted loans were not transferred as debt to British Telecom to maintain an acceptable debt/equity ratio. Instead, the government retained preferred redeemable shares in the new company. Governments should carefully explore the conditions under which they would be prepared to maintain liabilities (or exposure through guarantees) on account of privatized SOEs.

In many instances, a government has on-lent borrowed funds (for instance from international lending agencies) to the SOE or has, as guarantor, serviced the debt of an ailing SOE and become a subrogated creditor. When the government is the creditor, there are various options for handling that SOE debt. One avenue is simply to cancel it. However, governments may, circumstances permitting, pursue other avenues that permit them to recover their investment at some stage. One possibility is for the government to convert the debt into equity. In so doing, it may be satisfied with a conversion into non-voting, non-participating preferred stock with a small, fixed dividend. A formula could be found for redemption, over time, of the stock. An example of a conversion by the government as creditor of debt into equity is found in the case of Industries Togolaises des Plastiques.

Relief by the government of an enterprises' liabilities must be seen as a readying measure to facilitate or permit a sale. In Italy, IRI attempted to make the sale of money-losing enterprises attractive by debt assumption or the provision of additional equity. Action with respect to liabilities is normally undertaken only after the government has satisfied itself of the absolute necessity of the action. Otherwise, privatization might become a process whereby creditors would be reimbursed for loans beyond their realizable value. One way to establish an upper limit for the debt to be assumed by the government is to estimate the liquidation value of the targeted SOE should it not be privatized.1 0 3

Other actions with respect to SOE debt might be taken, such as illustrated by the readying of the Caribbean Cement Company (CCC) in Jamaica. To make the company more attractive to prospective investors in this public offering, the government agreed to assume the foreign exchange risk on approximately US$62.3 million of CCC indebtedness owed to foreign creditors. This was coupled with a capital injection to strengthen the debt to equity ratio and a moratorium on a substantial amount of import duties.1 0 4

Finally, governments tend to forego privatization transactions that require new guarantees. The government of Mali rejected a proposal to create a new, partly private corporation to take over the assets and business of the liquidated national transport enterprise, CITRANS, because it

103/ L. Rapp has so argued. Lucien Rapp, Technigues de Privatisation des Entreprises Publiques (Paris: Librairies Techniques, 1986).

104/ Roger Leeds, Privatization in Jamaica: The Caribbean Cement Company, Center for Business and Government - John F. Kennedy School of Government (Cambridge, Harvard University, March 1988). - 105 - would have been required to provide its guarantee to a financial package for the new corporation.

Recapitalization. Once again, there are no set blueprints for addressing the problems of undercapitalized SOEs to be privatized. In some instances, it is preferable to sell the enterprise as is. The government of Spain used as one of the main criteria for evaluating offers for unrestruc- tured firms the readiness of the purchaser to inject fresh funds upon privatization. This same determinant applied in the privatization of two textile mills by Togo and in IRI's choice of Fiat's bid over Ford's for the acquisition of Alfa Romeo. Indeed, one of the relevant methods of privatization could be a new (primary) share issue to raise new equity (see pages 26 to 29) prior to or simultaneously with the sale of an enterprise. Most privatizations of industrial SOEs in Guinea involved the transformation of debilitated SOEs into a new corporation whose equity was to consist, on the one hand, of a government contribution in kind of the assets of the former SOE and, on the other hand, of an infusion of fresh equity by private investors (often resulting in 49 percent government and 51 percent private ownership). The government-held shares are then divested at a later stage (although in some instances divestiture takes place in parallel with the first transaction).

Cases where a government has decided to inject new equity itself to make a sale possible seem more rare. However, the recapitalization of Malaysian International Shipping Corporation Bhd. (MISC) is an example of existing shareholders (mostly governmental parties) providing new equity to finance MISC's fleet expansion and replacement and to provide additional working capital. It was largely recouped from the sale of governmental shares. Figure 4 provides, as an illustration, a summary of financial restructuring steps in the case of MISC. The privatization of Credit Commercial de France required prior financial restructuring to bring loan loss reserves to an adequate level. In the case of Credit du Nord (subsidiary of Paribas), the state, as minority shareholder, has, together with Paribas, subscribed to a capital increase to cover losses and forthcoming personnel lay-off costs. Similar arrangments were planned in respect of British Petroleum (BP).

Other. Various other balance sheet modifications may be appropriate. For instance, an SOE may be reshaped by removing certain assets. As discussed on page 24, the spin-off of assets or activities may, however, constitute a privatization transaction in itself. - 106 -

FIGURE 4

Steps with respect to the offering of certain existing shares in MISC.

(1) Pre-offering situation: Issued ordinary share capital of M$ 100,000,000 (as of June 30, 1986).

(2) Special issue of 25,000,000 shares of M$ 1 each to the Minister of Finance (Incorporated) representing the Central Government, capitalized from MISCs retained earnings and credited as fully paid (no new proceeds).

(3) Bonus issue 1:1 of 125,000,000 shares M$ 1 each to existing shareholders capitalized from retained earnings (no new proceeds).

(4) Creation of a Special Share for the Central Government to hold.

(2), (3) and (4) were completed on December 4, 1986, and increased the capital to M$ 250,000,000

(5) Rights issue 1:1 of 250,000,000 new ordinary shares of M$ 1 each to existing shareholders against payment of M$ 250,000,000. Total proceeds of M$ 247,000,000 (after deduction of share issue expense of M$ 3,000,000) to be utilized to finance MISC's fleet expansion and replacement and to provide additional working capital.

Resulting Situation of (1) to (5): - Cancellation of certain liabilities of MISC

- .Infusion of fresh funds into MISC for expansion and replacement of fleet

Five-fold increase in the number of issued ordinary shares, in the hands of the same shareholders (with an increase in the government's shareholding)

(6) Concurrently with (5), offering of 84,985,000 shares owned by 11 major shareholders to the Malaysian public at M$ 2.40 each, reducing the Government holdings (both Central and State Governments) from 60.80% to 48.60%.

Source: Volume Two, Part I and Prospectus dated December 29, 1986, for the Offer for Sale of shares in Malaysian International Shipping Corporation Bhd. - 107 -

Physical Rehabilitation

To the extent that physical assets are in need of rehabilitation, the question again is whether to do so prior to privatization or to leave the task to the purchaser. Detailed forecasts should be prepared in this respect. It is conceivable that physical rehabilitation may increase the sales potential of the enterprise and permit the cost to be recovered, but no example is known. The proposed operating guidelines for the Asset Privatization Trust in the Philippines provide that, as a general rule, the rehabilitation of assets prior to disposition should be avoided so as not to incur additional government exposure. The decision to sell the enterprise in its present condition is difficult, as its potential value may not be realized and the government may be criticized for disposing of national assets at low prices. On the other hand, it could be criticized for engag- ing in expenditures that may never be recovered. In any event, additional government investment prior to sale may not be realistic, given the financial constraints of a large number of governments interested in privatizing their SOEs. Nor may they be desirable, as potential investors may have different views on how to rehabilitate the company.

Physical rehabilitation and modernization through privatization occurs regularly. It frequently is financed through new private investment in SOEs. Examples are provided on pages 27 and 42.

Changes with ResRect to Staffin2

The legal situation with respect to personnel of state-owned enterprises (in terms of labor law and social security) needs careful review. Liquidation means laying-off personnel; privatization sometimes means a drastic reduction in the work force as a precondition of sale (e.g., SEAT in Spain), even in the case of management contracts (industry experience indicates that employment reductions are often necessary). The cost and timing may depend in part on whether personnel are under civil service or private labor laws (e.g., with respect to severance pay, etc.). Even when no lay-offs are involved, some personnel questions may arise as part of the readying process, as in the case of a change of legal form from a public corporation to a joint stock company. In such a case, complex questions may arise with respect to the transfer of personnel from civil service or quasi-civi:L service to private employment. In the case of Jabatan Telecom Negara in Malaysia, when the public corporation was transformed into a joint stock company, the disposition of the existing pension system was a major hurdle. Turkish legislation on privatization provides for the maintenance of entitlements in the State Retirement Fund. Because of potential labor rigidities, a prospective purchaser may insist on staff reductions prior to the acquisition. - 108 -

In view of the importance of personnel questions, the matter is more fully dealt with on pages 129 to 138 as part of wider employment issues arising under privatization.

Ensuring Cooperation of Management

The often read and overly simple conclusion that SOE management is generally hostile to privatization does not bear out in practice. However, problems with management cooperation may arise.

Preparing a large SOE for privatization can in most cases never be done without the full commitment by the enterprise's board of directors and top management. A supervisory ministry hiring investment bankers to implement the privatization without the consent of the board and management may be a possible mode of implementation if the enterprise is relatively small. However, in very large multibusiness, multiplant operations, it is a must that the preparation starts with assuring the full commitment of the enterprise's board of directors and top management. They would normally be given the task to prepare and implement the privatization plan or to provide extensive assistance and support.

If members of the board of directors are not committed to the privatization effort, they should leave their seats open for new directors who are prepared to carry this responsibility. As the Public Sector Divest- ment Committee of Singapore reported:1 0 5

"A number of GLCs [government-linked companies] including the larger ones have only civil servants and statutory board officials on their boards. The Committee recommends that action should be taken as soon as possible to change the composition of the boards of introducing new directors from the private sector. This can be an avenue for spotting executives who can be entrusted with the leadership of GLCs in future or can help in the search for new successor-owners for the GLCs.'

Among the agreements reviewed providing for the private transfer of controlling shareholdings in SOEs, several contain effectiveness conditions requiring the government vendor or the relevant holding to procure resignation letters from members of the board of directors. Similarly, a careful evaluation has to be made of the managing directors' commitment and ability to carry through the privatization plan. The Turkish government replaced a number of board members and managing directors of enterprises as they started to prepare these for privatization. In the United Kingdom, government has often brought in new senior management sympathetic to the

105/ Report of the Public Sector Divestment Committee, Singapore, February 21, 1987. - 109 - policy of denationalization.1 ()6 In most cases of British SOEs, businessmen had previously been appointed to the boards of directors. Japanese National Railways' top management, viewed by the government as not sympathetic to change, was replaced prior to privatization. In twelve of the twenty five SOEs to be privatized initially, the French government caused top management changes. However, in several, of IRI's privatizations in Italy, even when carried out by private sale, guarantees on managerial tenure were obtained by management in the readying process.

It is indeed extremely important, when an SOE is to be privatized as a going concern, that there be management commitment and responsibility for the privatization transaction.

Management may be in favor or against privatization for many different reasons. In the Cote d'Ivoire when PALMINDUSTRIE was incorporated under the company laws t:o allow for partial privatization, the transformation was well received by management as it permitted the enterprise to escape civil service salary alignment. The management of the Caribbean Cement Company in Jamaica, recently privatized through public offering, was strongly supporting Prime Minister Seaga's privatization program. This was largely due to the hampering government's interference in the company's operational and financial decisions.1 0 7

Management related actions yield much less clear conclusions than other readying measures. They vary greatly. In few instances of direct or private sale of shares will purchasers want to acquire the SOE "as is" and the key question which arises is whether the government should take responsibility for management changes or should leave it to the purchaser. Prior changes in management are more likely when the enterprise is being substantially restructured in view of a public share offering than is the case with private sales, where the new owner will want to restructure management to fit its needs.

3. V'ALUATION AND PRICING

Whether for the purpose of selling shares or assets, valuation and the resulting pricing are sensitive and difficult matters even where developed equity markets exist as shown, inter alia, by the recent experience of France and the United Kingdom. The French government's sale, among others, of shares in the state-controlled Elf-Aquitaine has drawn criticism from the opposition socialist: party because the opening price, set at 305 francs per share, rose to 339 francs shortly thereafter. The "Conseil d'Etat" has ruled, however, that the price as fixed was in keeping with the financial interests of the state. On the other hand, while too low a price

106/ C. Pickering, "The Mechanics of Disposal," in D. Heald, ed., Privatizing Public Enterprises: Options and Dilemmas, op. cit.

107! Roger Leeds, Privatizat:ion in Jamaica: The Caribbean Cement Company, op. cit. - 110 - does create a criticizable windfall for investors, too high a price might entail the failure of the privatization effort. In the case of the Sogenal bank in France, a premium of 80 percent was recorded on the first day of trading. The experience of several British public offerings have shown even more extreme changes between offer and trading prices. Invariably, substantial oversubscription of shares in many public offerings for privatization (C6te d'Ivoire, France, Jamaica, Malaysia, U.K.) possibly raises questions about their pricing, but at the same time the pricing may have been a determinant of their success. Numerous criticisms of price settings under public offerings must now be appreciated in the light of the evolution of stock prices in the last quarter of 1987. In private sales as well, pricing is a difficult issue. Cases are known where, despite the introduction of auction-based mechanisms, prices obtained by the national treasury may not have been adequate. This is particularly sensitive when assets change hands again quickly, giving initial purchasers large capital gains. In any event, taxpayers in any country will critically monitor state divestiture. The following is a summary rather than a detailed description of valuation techniques and pricing mechanisms.

The issue is very visible in public offerings. If the shares start trading at a premium (say 15-20 percent) shortly after the offering, the expected short-term returns are very enticing to investors. If the shares fall below the offering price as soon as (or shortly after) they start trading, investors will criticize the government and lose interest in further issues and in the privatization per se. However, share offerings on the market usually carry a discount. Average discounts may be in the 12%-20% range or even more in some countries. The question is not what the specific discount of an actual offering is but the extent to which there is or there should be a discernible discount for shares in SOEs10 8 (and governments should endeavor to explain this to the public so as to avoid some of the criticisms leveled at the offering price setting). As described in the Background Briefing materials on "Privatization in the United Kingdom," distributed by H.M. Treasury:

"Pricing a share issue is always a difficult matter of judgment, whether it is a state-owned or a privately-owned company that is being sold, especially when the company's shares have not been traded before or where there are no directly comparable companies. Moreover, it is impossible for any vendor to anticipate accurately the movements of the stock market between price fixing and the receipt of applications. The United Kingdom Government always seek the best professional advice available,

108/ See R. Buckland and E.W. David, "Privatisation Techniques and the PSBR", Fiscal Studies 5:3, August 1984; Roger Buckland, "The costs and Returns of the privatisation of nationalized industries", Public Administration, vol. 65, /autumn 1987, pp. 246-248; and Colin Mayer, and Shirley Meadoweroft, "Selling public assets: Techniques and financial implications", pp. 325-328, Privatisation and Regulation: The UK experience, edited by John Kay, Colin Mayer and David Thompson, Oxford: Clarendon Press, 1986. - ill -

both on pricing and on other aspects of sale. It has also shown that it is ready to experiment and innovate in the interests of achieving successful privatizations at a fair price for the tax- payer and the investors. However, the effect of privatization on the government's finances is incidental to the programme's main purposes, which are to increase efficiency and to widen share ownership to the benefit of the whole economy."

The Public Sector Divestment Committee in Singapore has recommended that the sale of shares not be rushed at the expense of satisfactory prices. Different economies will have different objectives, and for many developing countries, particularly those seeking relief from budgetary pressures, the financial effects will be paramount.

If less visible than in public offerings, the issue is at least as difficult, and sometimes more so, in the case of a private sale of an SOE (sale of shares or assets).

Only very rough guidelines can be set for SOE valuation. A value can be determined by reference to recent earnings or future earnings potential, dividend paying capacity, adjusted value of its assets, or various combinations of the above. Where liquidation of the enterprise is a possible alternative, the liquidation value may also be used. The practices of using book values, assessing n,et asset values, calculating the government's total investment, or discounting average maintainable (historical) profits are usually not adequate. Other more flexible methodologies --particularly discounted cash flow techniques -- could be envisaged, since these are based on forecasts of future performance and expectations of future earnings and better capture the variety of different factors that valuation should take into account. 1 09 In some cases, this approach may require exceptions to current mandato.ry provisions or rules governing the issuance or offering of securities. In assuming the potential of enterprises, all elements should be considered fully, e.g., companies and assets may occupy attractive market niches, which are presently underutilized or neglected, such as was the case of some British Rail subsidiaries. There are so many different circumstances, that any delineation of the required measures for valuation cannot be set. For some SOEs, the asset recording and valuation process involved in their transformation into a commercial type corporation will constitute the first step to establishing an enterprise value.

In a public offering, the net worth of a company will be taken as a reference value but may not be determinant since the public as an investor is principally interested in the earning value of the shares and

109/ Some entities may sell for less than their net worth, in recognition that they may still incur operating losses for some years during a turnaround period. - 112 - possible capital gains. When a private sale is envisaged, on the other hand, the net worth may become a preponderant element.1 1 0

Some countries' mandatory rules on privatization (see page 90) lay down detailed requirements on valuation. In France, the value of the enterprise or assets to be privatized must be determined by the Privatiza- tion Commission, which is composed of independent members; the valuation has to be published, and is to be carried out in accordance with objective methods consistently applied with respect to the sale of company assets. The process should take into account, with proper weighting in each case, the market value of securities, the value of the assets, the record of earnings, the existence of subsidiaries and the prospects for performance. The final offering price, determined by the Minister of Economy, Finance and Privatization, may not be below the Commission's valuation. Similar requirements with interesting variations are contained in Senegal's Law on Privatization and Tunisia's law on SOE restructuring. In the Philippines, proposed guidelines would require that standard formulae be used to establish a range of values, including appraised value, replication cost, capitalized earnings and other accepted methods. Serious efforts must be made to establish the realistic economic value of assets, especially those that appear to be overpriced acquisitions or overdesigned plant investments. On this basis, the Philippines' Asset Privatization Trust would be required to work out mechanisms for determining a fair floor bid price or a fair target bid price (in the Philippines, the rule will be to sell via bidding procedures).

In general, countries need to develop a practical approach for valuing enterprises or assets, with sufficient flexibility to permit the establishment of a price that corresponds realistically to the level of interest in the private sector. In most instances, the approach will use several criteria with proper weighting. The mandatory procedures in France and the Philippines illustrate this point.

With respect to pricing mechanisms, they depend on the type of transaction envisaged. Two methods have been used for public offerings. One is to offer the shares at a fixed price, to be set before the offering. The number of shares sold to each applying party is scaled down in proportion to total applications. The second is an offer by tender in which the striking price represents the balance between tenders made at different prices and the number of shares available, with all those who have tendered above the striking price receiving shares at the striking price.

The merits of each approach depend on several factors. A fixed price offering can result in an oversubscription that leads to accusations that the government sold at too low a price. However, based on the United Kingdom experience, where both methods have been used, the tender method

110/ Bernard Petit and Ghislain Garczynski, "Panorama des m6thodes actuelles d'evaluation lors des introductions en Bourse, Les Privatisations, Droit et Pratique du Commerce International," International Trade Law and Practice, 1987, Vol 13, p. 464. - 113 - has the inherent risk of constituting an unattractive method to investors. Particularly smaller investors are not encouraged by the greater complexity and uncertainty of the tender method. The tender method is probably less attractive if widespread share ownership is sought. Further, it does not as easily permit the introduction of special incentives such as discounts to encourage purchases by employees. On the other hand, it may yield a higher price, a significant advantage in the case of a small offer for which a very large interest is expected. The tender method may also be appropriate when the market-clearing price is particularly difficult to ascertain because of the uniqueness of the enterprise.1 1 1 In the case of the privatization of Nippon Telegraph and Telephone, the price for an initial block of shares was set through an auction, with further blocks of shares offered at a set price. An initial block of 51 percent of the share capital of Associated British Ports Holdings plc was sold at a fixed price, while a further block of 48.5, percent was subsequently sold by tender at a higher price. The difference in timing and the then strongly rising trends in the capital markets render these results of such experiences somewhat inconclusive. Both the British privatization program and IRI's (Italy) program of public offerings indicate that the fixed price offering is the more commonly used method. I't is said that allowing investors some opportunity to make capital gains initially encourages investments in further issues.112

As to private sales of shares or assets, one approach is competitive bidding or an auction, which leads to a price determination in line with the enterprise's or assets' market value. Governments may, however, wish to set a floor price in advance of calling for bids. Several privatizations recently completed in West Africa, e.g., Guinea and Togo, involved the establishment of new companies to which the government would sell or otherwise transfer assets. The transfer price was essentially determined by the company's profit potential. In the Philippines, the determination of what is an acceptable price for any particular asset will primarily be

111/ A general discussion on the respective merits of the two methods is contained in David Heald, "Privatization: Policies, Methods and Procedures," op. cit. An assessment of the experience of the United Kingdom with both methods can be found in B. Yamey and D. Stafford, Report on the Experience of Privatization in Great Britain, op. cit.

112/ It should be noted that the criticism leveled at price setting is usually a result of upsurging stock markets. Following "black Monday" on October 19, 1987, in.- France, and the continuing decline in stock prices, an investor who would have, on the day of offering acquired shares within the minimum individual allotments (10 shares in Saint- Gobain, 4 in Paribas, 6 in Sogenal, etc.) would have spent FF 17,000, whereas the value or his portfolio on November 4, 1987 would have been a mere FF 17,004.50 (Le Monde, November 6, 1987). - 114 -

based on what the earning capability of the asset is -- i.e., it will be along the P/E (price to earning) concept.11 3

Several factors may affect pricing. 1 1 4 In preparing for a particular privatization, as thorough a review as possible is necessary to identify the existence and impact of these factors. One is potential market response, a key determinant, in particular the level of investor interest11? and availability of financial resources. The profit record is another key determinant of the value of a company. Pricing has reportedly been a very difficult issue in the privatization of the Caribbean Cement Company in Jamaica, an SOE with a weak record of performance. It depended largely on intricate market judgements. A price was finally set leading to substantial market response to a public offering, even if it was undersubscribed. The extent to which investors perceive they can improve on performance of the SOE is in many cases a major factor as well. Various objectives of the government may affect the price, e.g., limitations on foreign holdings or on given groups of purchasers. If widespread share ownership or employee ownership is targeted, discounts and other incentives may lower the price. There are cases where a government opted for an employee buy-out to meet its objectives, even though a sale by competitive bidding might have yielded a better price. Social as well as political objectives may be preponderant and there are instances of shares in SOEs given to employees or to the public. The 1979 share give away of British Columbia Resources Investment Corporation (BCRIC) in Canada solved quite a number of problems, including the "we are asked to buy what we already own" argument, the possible failure of the privatization process, the interdependence of privatizing and raising capital, and the "sell out

113/ Doing business with the Asset Privatization Trust -- Policies and Procedures in effect as of April 13, 1987.

114/ See Giorgio Stefani, "Privatizing Public Enterprises in Italy: The Case of State Holdings," Annals of Public and Co-operative Economy, Vol. 57, No. 3, 1986, on the Italian experience: "all factors causing inefficiency or waste (such as excess personnel or obsolete plant) will produce a corresponding reduction in asset value on purchase unless public administrators are able to offer ancillary incentives such as installment payments, low-interest loans (for the payment of the purchase price) or a full order showing advantageous prices."

115/ A premium might be paid by a party with a specific interest (e.g., a strategic market niche). An analysis of the role of valuation and price is made in a paper prepared for the World Bank by L.P. Jones, P. Tandon and I. Vogelsang of Boston University, "The Ecomomics of Divestiture: Ex Ante valuation and Ex Post Valuation Development Research Department Discussion Paper,"April 1987. - 115 - to the rich" perception.11 6 Each Canadian citizen or applicant living in British Columbia for one year could receive five free shares in BCRIC, probably worth about $50 in tot:al at the time. At the same time, British Columbians would be able to buy up to 5,000 shares. The perception by the purchaser of the impact of certain regulatory mechanisms (e.g., demonopolization of utilities) is another important factor. A number of ongoing and completed privatization cases are public utilities. In these industries, many governments seek to achieve both wider competition and transfer of ownership to the private sector, and this double objective is usually best attained through tight regulations. But these in turn influence the price which the affected SOE can command. As a further indication of factors which influence pricing, in some instances which have been observed in West Africa the value of the transactions is probably as much in the market niche or possible exclusivity arrangements as in the actual physical assets of the enterprise.

The general business environment will be an important price determinant. If a crude price-earnings multiple is adopted as a method, a low multiple of earnings may be the way in practice how an investor will value a business if he perceives a high level of risk and requires his money back in say two or three years.

In the final analysis, realistic market values are what will normally set the price. In many cases, assets acquired at significant cost may have little market value. One problem is that, unless the original acquisition was made by an administration no longer in place, it may be politically difficult to admit loss on investments. At the same time, the theory that the fair price is market-determined should not be applied indiscriminately. An improperly structured privatization might yield a weak market response. An SOE with potential but with an unattractive record of performance may not yield its true value under a premature public offering. Invitations to bid on a private sale may not have adequately targeted the market. Valuation or price setting ought to be carried out in the full context of the detailed definition of optimum techniques in each specific case. The pricing of a given SOE may also need to be carried out in the full context of a broader privatization program and the government's objectives. One of the lessons derived from the United Kingdom privatizations is that it is more important to have an aura of success than getting the last penny for a given SOE -- this may indeed maximize the proceeds of an overall program in the long term. The experience of several governments yield the conclusion that, in view of the high cost of a failed offering, it may be better to err on the side of too low a price than too high.

The selection of the actual privatization technique for a given enterprise may largely determine its value and price. In privatizing

116/ See T.M. Ohashi and T.P. Roth, Privatization: Theory and Practice: Distributing Shares in Private and Public Enterprises, (Vancouver: The Fraser Institute, 1980); Part One: Privatization in Practice: The Story of the British Coluwbia Resources Investment Corporation, pp. 1 - 105. See also the prospectus for the public offering. - 116 -

British Rail's hotel operations, its advisers considered that the profits record was not good enough to support a flotation and to give a value which would fairly reflect the asset value. They then advised that a private sale by tender would yield a better price.11

Transfer of control to one party or groups normally implies that a premium would be paid for gaining control. The selection of a public offering of shares may involve a discount to ensure the full sale. Mechanisms to ensure and maintain widespread shareholding are, in the opinion of the securities regulatory agency in one country in Latin America now preparing new guidelines, essential to avoid that shares bought at a discount are then subsequently.concentrated in the hands of one party or group.

Finally, pricing for shares of one of the same SOE may vary according to the method used. In the sale of Banque du Batiment et des Travaux Publics in France, the negotiated private sale of blocks of shares to shareholders gaining at least a 5% participation was set at 110% of the public offering price.

4. DETERMINING FUTURE OWNERSHIP

This section analyzes techniques for determining the desirable level of private ownership (partial vs. total privatization). It also examines issues related to the nature of private ownership (such as how to achieve widespread distribution of ownership and how to restrict ownership or controlling interests, important questions in many countries).

Partial vs. Total Privatization

Privatization through a transfer of ownership can take place to varying degrees, generally depending on the government's objectives or market conditions. Governments usually retain partial ownership for purposes of control, for instance, over "strategic" sectors, or when the government's objective is to increase efficiency only, or when gradual privatization is called for. The specific reason for retaining partial ownership largely dictates the best method for doing so.

117/ Based on information provided by Morgan Grenfell & Co. Ltd. - 117 -

(a) Ownership and control. The extent of ownership in a company is normally the main determinant of operational control. Whether majority ownership is required or whether a lower level of ownership may provide sufficient control depends on both the provisions of the charter of the enterprise and the composition of the remaining slhareholdings. The charter or articles of association of a company may require a simple majority or a two- thirds or some other majority for various decisions. In some cases, one-third or less of the shares of an enterprise may provide a shareholder with a veto power.1 1 5 Moreover, where a shareholder's small (say 20 percent) shareholding is balanced against wide dispersion of the balance of the shares, chances are that this minority shareholder is the most leveraged party. The company's charter may also create different classes of shares.

When the government aims at maintaining partial ownership for control of overall operations of the company, it will aim for that level of ownership that affords the required voting power.11 6 Under the Brazilian decree on the process of privatization, voting control may not be transferred in respect of certain categories of enterprises (including activities linked to national security, state monopolies and basis economic or social infrastructure or producing inputs of strategic importance). Hence, a recent issue of convertible debentures by Vale do Rio Doce and a new equity issue by Electrobras were conducted in such a way that the government's position was reduced to the minimum necessary to maintain absolute voting control. In Spain, the government publicly offered shares in four SOEs but retained 51 percent. When it was decided in Chile to privatize the state sugar mill IANSA, a target of 49 percent divestment was on grounds, inter alia, of existing price supports for sugar. If, however, the government only wants a veto power over certain events to protect the national interest (foreigners gaining control, a particular investor/shareholder gaining a dominant position, etc), a minority position or even a symbolic ownership

115/ Until the recent offering of shares of Societ6 Nationale Elf Aquitaine, the French government's participation (being held through another SOE) was over two-thirds, giving its absolute control. The government has now reduced its participation to a simple majority which gives the private sector a blocking minority. The government did, however, introduce a special share to prevent any one party acquiring over 10 percent: without its specific approval.

116/ Even though partial privatization may obviously lead to instances where the lines of control are not clear. E.g., in Italy it is unclear whether IRI or the private sector now has control over such companies as Madiobanca (owned 60% by the market, and by a control syndicate -- 20% IRI banks and 20% private sector holders) and TELIT. - 118 -

of one share if special rights are attached to it (often called the "golden share" as applied, inter alia, in France, Malaysia, Senegal and the U.K., see Annex D) may be sufficient. To protect the national interest in key sectors, the government would usually establish a set of licenses and regulations for the respective industries.

The type of control to be retained not only determines the level of acceptable private ownership, but, naturally, also some of the methods to be adopted. Gambia's proposed strategy is that, in the case of enterprises with state guarantees of outstanding loans, the state should maintain at least a presence on the board of directors to safeguard its investment.

(b) Increased Efficiency. Because, as noted, the presence of a minority shareholder may increase efficiency by instilling a greater financial/management autonomy and discipline and counter- balancing excessive government interference, a government may divest itself of only a minority position. Italy's IRI group's partial privatizations have reportedly had the aim of restricting government interferences in certain enterprises.1 1 7 A government may also bring in a private partner to improve the enterprises's technical competence, market access, management expertise, etc. Sometimes the government will enter into a management contract with the minority private party, or conversely, the outside management contractor of an SOE may invest fresh equity as part of the overall arrangement, as did Heineken in Zambia Breweries. A private joint venture, the Sino-French Energy Development Co., has acquired from the government of Macao a 38 percent stake in the Electricity Company of Macao with the intent of increasing its efficiency and thereby achieving an attractive return. The investor also undertook a contribute to new investment in the company.

(c) Gradual Privatization. Partial privatization may simply be the result of gradual privatization. While the initial offering of shares of Malaysian International Shipping Corporation Bhd. (MISC) reduced the aggregate shareholdings of governmental parties from about 60.80% to about 48.60%, the offering prospectus announces their intention to divest additional shares at a later stage. Various other circumstances will lead a government to retain a partial majority or minority position based, not on a particular strategic role, but rather on capital market condition e.g., the absorptive capacity of investors. Partial privatization may also be the result of market response. In Jamaica, the public offering of Caribbean Cement Company was not fully subscribed, and the government was left holding about

117/ Financial Times Survey on Privatization, FT, September 16, 1987, p. 1. - 119 -

28 percent of the shares offered (in Jamaica, public offerings were not underwritten -- the government as vendor assumed all risks of the sale). This was largely attributed to the poorer record of the SOE, large financial costs in respect of recent investments burdening it, and somewhat uncertain prospects. It was believed that this situation was still more favorable than an offering of only say 50 percent of the shares (in that case, the offering would have been oversubscribed, possibly leading to accusations of a give-away). In the case of British Telecommunications, the government initially sold only a 50.2 percent interest, with the intention of selling additional shares later.1 18 The government of Japan decided to sell half its 15.6 million shares in Nippon Telegraph and Telephone in slices of 1.95 million shares over the next four years (for strategic reasons, the government will retain at least one-third of the equity). When a state holding company such as IRI in Italy sells shares through the stock exchange while still retaining a majority or minority position, the intent may be simply to raise capital within the group. Partial divestiture may also be the best alternative where total divestiture might unnecessarily polarize public opinion. For public offerings, market conditions are the main determinant of the size of a divestiture. A downturn in the stock market in October-November 1987 led the French government (intent on carrying out 100% offerings) to postpone the next slice of their program whereas other states may find it easier to pursue their programs through the selling of portions only of the enterprises capital through either secondary sales or primary issues.

Partial privatization usually results in a joint state-private companyll9 (or it may be the further privatization of an already joint state-private company). With mixed state-private enterprises, the nature of continued government involvement is of concern to the private party, especially in terms of the retention of rights beyond those that are normally attached to shareholding (and other than regulatory in certain instances). Private investors fear that a government may continue to pursue non-commercial goals for the enterprise or simply interfere with the operations and management of the company. Often, continuing government shareholdings is viewed unfavorably, although most potential investors will accept up to a certain level of government shareholding, provided it is

118/ On the "hybrid" character of this and other British privatizations, and the implication of control, see David Heald, "Will the Privatization of Public Enterprises Solve the Problem of Control?," Public Administration, 1985, Vol. 63, No. 1, pp. 12-17.

!L9/ Or "hybrid company", see D. Steel, "Government and the New Hybrids: A Trail of Unanswered Questions", Fiscal Studies, 5:1, February 1984, pp. 86 - 97. - 120 - counterbalanced by an equivalent or superior block of private shareholdings. If the government intends to distance itself from a company's management and operations, it should make that clear to investors and clarify the terms on which the government will continue as a shareholder. Some British privatizations included specific provisions for government's "distancing" or non-interference,1 2 0 but the precise legal status of such undertakings in prospectuses is not fully clear.

These issues need to be borne in mind by states wanting to encourage joint ventures. They will not be attractive to private investors if state control will take away autonomy from the enterprises as private investment could be frustrated through state intervention. Questions such as the composition of boards of directors, rights of appointment of management, rights of minority shareholders, etc., will all need to be addressed. In several African countries of French legal tradition (Mali, Senegal, Togo and Tunisia), legislation provides for various control and other rights of the state versus the private shareholder in a joint venture (Soci6te d'Economie Mixte, SEM) that go well beyond normal shareholder rights (even for SEMs in which the government has a minority holding). In the case of Mali, the government has now determined that SOE-related legislation should be concerned primarily with wholly state-owned enterprise, with SEMs governed solely by ordinary company laws. Since much of the Malian program will, at least in a first state, involve partial privatization with majority private shareholding rather than full privatization, any provision of excessive rights to the state shareholder is considered a potential deterrent to private sector interest. Tunisia's 1987 law on enterprise restructuring provides for special exemptions from laws on state control (particularly with respect to the "tutelle" and the states' procurement rules) for SOEs being privatized (provided the private participation reaches a minimum level of 67 percent of the company's capital).

120/ The British Telecom offering prospectus quotes a statement of the Secretary of State for Trade and Industry which reads in part as follows: "HM Government does not intend to use its rights as an ordinary shareholder to intervene in the commercial decisions of British Telecom. It does not expect to vote its shareholding on resolutions moved at General Meetings, although it retains the power to do so. The Government appointed Directors have no special powers and their duties, like those of all Directors, are to the company as a whole." A distancing provision appears in the offering prospectus of July 6, 1987, for a new share issue of Saskatchewan Oil and Gas Corporation (bringing the Province of Saskatchewan's shareholdings down from 58 percent of the voting shares to 46 percent). - 121 -

Widespread Distribution of Ownership

The promotion of wider share ownership among both employees and the general public has been a major objective of the privatization programs of several countries. As stated by the United Kingdom Treasury:

"This is part of the Government's policy of extending the ownership of wealth more widely in the economy, giving people a direct stake in the success of British industry, and removing the old distinctions between "owners" and "workers." The privatization programme has contributed much to the increase in the number of private investors in the United Kingdom; between 1979 and 1985 the number of shareholders probably doubled to at least three million and market research conducted in late 1985 suggests that the actual figure could be much higher. (British Telecom alone attracted over two million private investors, including one million who had never owned shares before.) And over eighty percent of employees have taken up

shares in their companies on privatization 121 *"

The United Kingdom trebled the number of shareholders through privatizations, while France's goal was to quintuple it (and spread ownership so widely that companies cannot easily be renationalized). Beyond increased share ownership, several countries have also aimed to develop their capital markets through privatization.

Further, in parallel with public offerings, countries have implemented mechanisms to avoid economic concentration of holdings, as explained on page 123 below.

Governments have deployed various techniques to encourage widespread share ownership. Several are relevant to countries intent on privatizing through public ofi-erings. They include phasing (so as not to crowd the market), allotment techniques, incentives to purchase and ad hoc distribution mechanisms. Phasing is equivalent to gradual privatization. Carefully weighted allotments have been used in recent privatizations to give priority to employees and small investors. The British Gas privatization is a case in hand. The planned initial allotment is for 40 percent of the offering to go to individual investors, 40 percent to British institutions and 20 percent to be offered abroad. However, if applications from individual investors reach twice their 40 percent allotment, shares from the allotments to institutions and foreign investors will be transferred to them, up to 64 percent of the total. Restrictions on individual shareholdings, as described in the following section, are

121/ "Privatization in the lJnited Kingdom," Background Briefing, H.M. Treasury, London, 1986. - 122 - themselves a method of allotment.122 As far as maintaining those initial allotments is concerned, incentives have been offered, such as loyalty bonuses for investors holding on to initial shareholdings for a minimum period of time (used by France with Saint-Gobain and the United Kingdom with British Gas). In Chile, loan advantages are eliminated if the buyer sells the shares to a third investor. The sales promotion techniques applied will largely influence the attainment of allotment targets.

Incentives to purchase used in recent public offerings include pricing at a discount, the remittance of vouchers against the price of utility bills (e.g., gas vouchers to purchasers of shares of British Gas), low minimum share investment, and payments in installments (on the latter, see page 144 on Financing of Privatization). The "Popular Capitalism" mechanisms applied in Chile are an example of a comprehensive incentive package.

Distribution mechanisms have proven to be a key element in achieving widespread share ownership, not only where developed capital markets and intermediaries exist, but also, and perhaps even more importantly, where these exist to a more limited degree. The NCB offering in Jamaica met with an unexpectedly high response, probably because the network for share distribution included 400 outlets for a population of only two million people (branches of local banks and post offices were used as collection and distribution points).1 2 3

Restrictions on Ownership Composition. Controlling Interests12 4 or Foreign Ownership

A large number of governments have restricted individual shareholdings in privatized enterprises to limit the potential for undesirable controlling interests or private concentration of economic power, both domestic and foreign. As described earlier, a public offering with well-devised allotment procedures is a main vehicle for achieving widespread shareholdings. This section reviews the mechanisms used by some governments, which can be divided into the following groups:

122/ E.g., in the case of the NCB privatization in Jamaica, the offer went straight from application forms to the issuance of registered stock certificates. The avoidance of allotment letters and partially paid shares made the administrative task much easier than has been the case with large public offerings in the United Kingdom. See J. Redwood and 0. Letwin, op. cit.

123/ Ibid.

124/ This section will not review the restrictions on private ownership per se as constituting obstacles to privatization due to a variety of policies, such as those restricting private sector access to the mining, manufacturing and public utilities. - 123 -

o Limitations on Individual Shareholdings

o Options with respect to Foreign Ownership

o Other

Limitations on Individual Shareholdings

It is necessary to differentiate between the sale of shares to the public and a sale of shares or assets to a single purchaser or a group of purchasers. In the latter case, the government selling the SOE or its assets selects the purchasers and may decide not to proceed with the transaction if certain prequalification criteria are not met. That is, the prospective purchasers are known in advance. When inviting the offers, the government or owner will indicate any restrictions to them. Restrictions may, in theory, also be placed on the power of the new private owner or shareholder to dispose of its interest (but it may not always be possible to limit the transferability of shares, nor would purchasers, in all likelihood, agree to such restrictions).

In the case of a public offering of shares, the purchasers are not known in advance, and the government may want to avoid certain patterns of ownership for general policy reasons or because of the characteristics of the enterprise (e.g., to avoid monopoly control in the case of public utilities).125 The techniquaes discussed below to limit shareholdings are, therefore, of particular relevance to public offerings.

A country's general legislation governing investmentsl2 6 may, as in the case of Nigeria (Nigerian Enterprise Promotion Act of 1977), restrict individual shareholdings. In many cases, however, such limitations prove counterproductive and cumbersome, especially if they apply to non-strategic enterprises for which the government wants the flexibility to sell larger blocks of shares. However, legislation limiting shareholding may be appropriate to a number of situations, which is why some countries have introduced such limitations under special privatization legislation. In carrying out its fourth privatization program in 1986,127 the government of Chile determined that diffusion of ownership was

125/ Of course, economic concentration may also be the result of the limited availability of capital in relation to the volume of transactions. See, for instance, Chile in Volume Two.

126/ Antitrust legislation is not covered here; it should be kept in mind, however, that the credibility of anti-trust (as well as other regulatory) mechanisms is intertwined with the desirability of privatization.

127/ See Volume Two: Chile. - 124 - essential, and it enacted special legislation for specific groups of enterprises providing that no investor could control more than 23 percent; more than 50 percent of the capital should be held by shareholders who own directly or indirectly no more than 10 percent; and at least 15 percent should be owned by 100 or more independent investors.

The French privatization law12 8 provides that, in the case of a public offering, the Minister in charge of Economy may rule that no party may acquire more than 5 percent of the shares offered. Further, if, for certain enterprises, the national interest so requires, a "special share" (see Annex D) may empower the Minister in charge of Economy to retain specific approval powers for shareholdings by any party or groups of parties exceeding 10 percent of the capital of an enterprise (or 5 percent in limited cases). The law sanctions any shareholdings in excess of specified limits by providing, first, that voting rights may then not be exercised and, second, that excess shares must be surrendered according to a specified procedure for forced disposition. In Senegal, the Law on Privatization mandates the Minister of State Participations to specify in each case the maximum number of shares allowable in the hands of one buyer or a group of buyers.

Restrictions may be incorporated in the specific legislation authorizing the privatization of a given enterprise or in the articles of association of the company to be privatized. In the United Kingdom, limitations on shareholdings were introduced, inter alia, in the articles of association of British Telecom and British Gas (public offerings) and Sealink (private sale), as part of the readying process. In the case of British Telecom, any party with an interest in voting shares of 5 percent or more of the total must notify the company of that interest. The directors of the company should thus be able to ascertain if the limit of 15 percent or more has been exceeded. Relating enforcement mechanisms are also provided for.1 2 9 In the case of the privatization of the Canada Development Corporation (CDC),1 3 0 limits were placed in the charter documents as to the permissible level of share ownership by any one shareholder or group of shareholders. Part of the readying for the privatization of National Commercial Bank (NCB) in Jamaica

128/ Law No. 86-912 of August 6, 1987, Articles 9 and 10.

129/ Summaries of such provisions on limitations of shareholdings can be found in the respective offering prospectuses, e.g., the British Telecom Offering Prospectus. Such measures must normally also be accompanied by the introduction of special securities (golden share) to ensure maintenance of these provisions in the charters of the enterprises (see Annex D).

130/ See Volume Two: Canada. - 125 - was the incorporation of provisions in the new articles of association limiting to 7.5 percent of thes total voting shares the number of shares in which any single shareholder cr group of shareholders acting in concert can have an interest. A similar 10 percent limitation was introduced with respect to Malaysian Airline System Bhd. (MAS). The detailed mechanisms are similar to those applied in the above-mentioned privatization in the United Kingdom.1 3 1

In privatizing all nationwide commercial banks, Korea restricted maximum equity holdings. In several Asian and African countries, governments are faced with the need to take into account the distribution of ownership among ethnic groups. A substantial number of shares of MISC in Malaysia (described on page 105) were reserved for and preplaced with Bumiputera institutions and not subject to the public offering. In the combined offer for sale and offer for subscription of MAS, the entire offer for sale of existing shares was reserved for government approved Bumiputera institutions.132

The main disadvantage of limiting single shareholders or blocks of shareholders to a few percent of the shares is that it prevents the concentration of ownership that enables shareholders to pressure management to improve its performance. To turn a company around, some core group may need to have and to use a large if not controlling stake in the enterprise. While perhaps not a serious issue with well-managed firms with a strong technical partner, it is of concern where the firms to be privatized are weak or under-performing, often the case in developing countries.

Options with Respect to Foreign Ownership

A number of governments have allowed foreigners to acquire interests in their SOEs. Some have done so with limitations in general instruments such as general investment laws or privatization laws, quite a number without limitations, and some with limitations only for specific enterprises or certain sectors. Other countries have limited foreign participation as a general policy (Brazil's mandatory privatization rules exclude foreign participation if voting control is to be transferred) or with respect to specific enterprises (Jamaica). Yet other countries, such as Senegal, have provided for general priorities to local investors but

131/ and are also provided for in the offering prospectus.

132/ The Unit Trust Scheme (Launched on April 20, 1981), aims in part, at the restructuring of Malaysian society so that a 30 percent share of the capital of private and public limited companies will be owned by the Bumiputera community. See Volume Two: Malaysia. - 126 - permit, within controllable limits, foreign participation. The record shows that many countries are quite successful at divesting to local investors; C6te d'Ivoire has reportedly transferred about half of its 28 privatized SOEs to Ivorian interests. In Guinea, a country without a capital market, several companies were either sold outright (SOCOMER, a fishing enterprise) to a local private company, or local investors acquired substantial interests.

Policy Restrictions on Foreign Participation13 3 Some countries restrict foreign investment in certain sectors, either on grounds of the political sensitivity of certain industries for reasons of national interest, or to reserve for local enterprises those industries with relatively simple technical and financial requirements (e.g., retail and wholesale trade). Nigeria has issued a list of industries in which foreigners may participate and to what degree, which varies according to the capital and technological requirements. A number of countries such as Mexico and the Philippines and most centrally planned economies restrict foreign investors to minority equity participation without specific government approvals. France's privatization law of August 1986 limits foreign participation for reasons of national interest. Some countries have declared a preference for local purchasers, although a primary criterion has been that purchasers be able to ensure the long-term viability of the enterprise (as in Spain and Italy, where there is heavy foreign participation).

Policy toward foreign investment in privatization depends to a large extent on the basic objectives of the government with respect to privatization. The problem in many economies will be that there are only a small number of corporate investors with the financial resources and management expertise required to acquire larger SOEs. It appears that, in terms of foreign participation, a large number of governments have followed very practical approaches, as illustrated below. They may want to secure the technological expertise and management capacity of foreign partners and investors to help the recovery of particular companies, or to enhance the flow of foreign investment which, in some countries, has fallen to very low levels. However, very low limits on the level of foreign holdings would deter foreign investors. Relaxation of the rules for their participation, particularly allowing them to take a significant minority interest, is likely to be a precondition of their involvement.

If foreign buyers are excluded, the result may be a lower price because of less competition, as well as foregone access to market know-how, technology, and the like. In many countries that have virtually no capital

133/ For a country-by-country description, see Foreign Private Investment in Developing Countries, IMF Occasional Paper 33 (Washington, D.C., 1985) Appendix II: Restrictions and Regulations Concerning Foreign Investment in the 25 Major Developing Country Borrowers. - 127 - markets, foreign money can be an important resource for privatization. However, the belief that countries with no developed capital markets have to divest to foreigners only could be partly dispelled by recent examples described on page 142. In general, the total exclusion of foreigners may be unproductive, although all the gains and costs need to be weighed. In particular, decisions on foreign participation may have a very heavy political content, and what makes business sense may simply not be feasible politically. A strong political debate arose when the Canadian government proposed transferring de Havilland Aircraft of Canada, Ltd. to the Boeing Company of the United States. In the end, Canada sold all the shares to Boeing because it felt that Boeing's technology, financial and marketing strengths gave de Havilland the best chance of a commercial success. A balancing of foreign and local investment is the best approach to this issue.

Implementing the Restrictions. Similarly to restrictions on individual ownership or shareholdings, restrictions on foreign participation will mostly be addressed differently depending on whether the privatization is a public offering or a private sale. There may, of course, be all encompassing restrictions as well.

As to general provisions, a number of countries have instituted general limitations on foreign investment. Others have done so in general privatization legislation.13 Originally, Malaysia limited foreigners to a 30 percent stake under the New Economic Policy (NEP). Recently, however, it has relaxed its limitation on foreign equity investment considerably, and investors now can have a majority (or more) share if a company is export-oriented, involves higher technology and does not involve the processing of non-renewable resources. This general relaxation of the foreign investment rules is expected to benefit the government's privatization program. In France, the privatization law sets a limit on foreign investment of 20 percent which can be lowered if national interest requires. Senegal's law on Privatization requires the Minister of State Portfolio to specify for each enterprise the proportion of shares to be transferred in priority to Senegalese buyers. The shares are then offered to the local market for a specified period.

Articles of association of enterprises to be privatized may contain certain specific restrictions as well. The articles of association of MISC in Malaysia, whose privatization is discussed elsewhere in this report, contain provisions giving the right to directors to refuse to register any transfer of shares which may result in foreign persons having

134/ The limitations can be applied to the level of participation by individual investors, although generally they apply to foreign investment in a given company in the aggregate. - 128 - an interest in the aggregate of more than 30% of the issued ordinary share capital. With respect to public offerings, such restrictions then further appear in offering prospectuses, such as in the case of the privatization of MISC in Malaysia and NCB in Jamaica. They would normally also have been introduced, as part of the readying process, in the charters of companies to be privatized.

As to private sales, general or ad hoc policies are easily implemented, as the purchasers are selected individually. Prequalification criteria may be the best vehicle. When the warship-building operations of British Shipbuilders were privatized (largely through management/employee buy-outs), foreigners were excluded from acquiring interests in view of the strategic nature of the activity. Practical approaches can be developed such as under the Operating Guidelines of the Asset Privatization Trust in the Philippines which provide that:

"Where the realizable price is equal, preference should be given to: (a) buyers who intend to rehabilitate an asset for productive utilization within the country, (b) buyers who are nationals or, in the case of corporations, the majority shareholdings of which are owned by nationals."

In the case of Compagnie Generale de Constructions Telephoniques (CGCT) in France (a sale of assets), only telephone operators could be interested, thus limiting the number of interested national investors. Therefore, several candidate buyers were 20 percent foreign joint ventures. The selection was made principally on the basis of long-term industrial interests of the country.

Other Procedures

Buy-back options, such as those retained by the Government of The Netherlands when privatizing KLM, 1 3 5 constitute another method of restricting certain patterns of possibly undesirable ownership. Arrangements for the privatization of another airline will include power of approval by the government of any resale of stock in the airline.

Special procedures were introduced by France in connection with the maintenance of a stable group of shareholders of SOEs to whom shares were sold privately ("noyau dur") prior to the public offering of further blocks of shares.

135/ The reasons and arrangements for ensuring the state's ability to regain majority ownership of the company are explained in KLM Royal Dutch Airlines' Prospectus of March 26, 1986. - 129 -

5. EMPLOYMENT ISSUES AND EMPLOYEE PARTICIPATION

The restructuring that many accompany privatization can result in retrenchment, and perhaps unemployment, or a new owner may reduce the work force in the short term in order to turn the company around. In certain cases, the single most important issue or obstacle to divestiture is the impact on employment. Labor commonly opposes privatization because of the potential effect on jobs. Privatization can be extremely difficult unless ways are designed to counter these situations. It should be noted generally that the employment issue often is a latent one with SOEs, which is not brought about by, but rather needs resolution under, privatization. Indeed, for many SOEs it may not be possible to attract private equity capital if excess employment issues are not resolved. This section reviews the issue of unemployment resulting from privatization, along with questions related to the transfer of employees from state to private sector labor regimes. Addressed first are the instances in which privatization results in unemployment or ot:her employment-related difficulties. Reviewed next are ways to minimize the negative effects on employment.

Employment-Related Difficulties

The type of privatization determines the range of employment problems likely to arise. In the sale of shares in part or in whole, employment contracts do not necessarily change, since the enterprise is transferred as a going concern. However, enterprise restructuring prior to a sale of shares may, as noted, affect employment. The sale of assets usually involves a major transformation (and possibly liquidation) of the business that may involve termination and possible reemployment by the purchaser (or transfer of the employment contract). The privatization of Japanese National Railways involves the gradual laying-off of 92,000 employees (almost one-third of the work force); the SEAT privatization in Spain likewise involved substantial employment issues.

Privatization does not necessarily involve severe employment issues.1 3 6 For instance, while experience in Canada indicates that there can be some job losses when a company is privatized, some privatizations have increased the need for new employees. This was the case with the Canadian government's sale of de Havilland Aircraft of Canada, Ltd. to the Boeing Company. 1 3 7 The British Telecom privatization did not, per se,

136/ In comparison with job losses in manufacturing in 1979-1981 and employment reduction in still-nationalized steel and coal enterprises, U.K. privatization have not been associated with heavy job loss. Nor have the sales of French SOEs.

137/ Minister of State (Privatization) and Minister responsible for Regulatory Affairs, Canada. - 130 - result in substantial lay-offs, but significant steps were still taken to deal ahead of time with the concerns of employees (see below). In fact, if the SOE to be privatized is in a growing industry, employment in the future may be enhanced by the privatization. Jaguar in the United Kingdom created two thousand additional jobs after privatization. British Airways reduced its staff from approximately 58,000 to approximately 38,000 as part of the readying process for privatization and soon thereafter increased it to approximately 42,000. In the case of British Telecom, an industry that involves rapid technological change, a slight gradual reduction in employment would be necessary, irrespective of ownership. On the other hand, in the case of inefficient enterprises whose work force has grown well out of proportion with needs and constitutes a significant burden, government divestiture, whether through liquidation or privatization, will result in a reduction in employment. Employment will be a much bigger problem in several developing countries than they have been under, e.g., U.K. or French privatization. Fears of unemployment are leading Sri Lanka to pace its privatization slowly. This situation has been observed by the World Bank in many instances in several West African countries where it has been asked to assist in rationalizing SOEs. It is mostly at the readying stage that overstaffing needs to be addressed, since investors may avoid enterprises with excessive work forces because of the difficulty of addressing labor issues after privatization. However, there may be instances where the excess employment issues are just left to the buyer to handle, like in the case of the Compagnie Gen6rale de Constructions Telephoniques (CGCT), a sale of assets. Various regulations required the initial absorbtion of all personnel by the party acquiring the assets.1 3 8 Substantial layoffs of about one-fourth of the work force subsequently took place. Employment issues also arise under management contracts at SOEs where overstaffing is a problem. In one case, a manager under a Jamaican contract required, as a precondition, that the owner effect a plan to sever personnel in excess of those required.1 39 Other problems connected with personnel, staffing policies and the right to hire and fire may become unduly difficult.

Even in the case of retained SOEs, current economic policy in many countries no longer supports chronic overstaffing or guaranteed employment on grounds of efficiency. In other works, the perceived negative employment effects or privatization would undoubtedly occur in any event as part of restructuring aimed at greater efficiency. In some countries, SOE reform per se has generated as much labor opposition as has

138/ Code du Travail, Art L. 122-12, provides for the continuation of labor contracts upon modification of the legal form of an enterprise, including succession, sale, merger, etc.

139/ S. Hegstad and I. Newport, op. cit. - 131 - privatization. For governments that can no longer support and inefficient SOE, privatization may be a way to avoid winding it up and liquidating it, in which case it is a solution to rather than a cause of employment problems.

Even where there is no probable or significant reduction in employment, the employees of an SOE may still oppose the privatization if they perceive that less employment security would result under private ownership, or if they would lose civil service or quasi-civil service advantages, benefits and the 'Like. As many developing countries do not possess the income maintenance system of developed countries, termination from (just as recruitment to) public employment tends to become very politicised. Pension benefits are a major issue as well, as illustrated by the privatization of Jabatan Telekom Negara in Malaysia and British Airways in the United Kingdom. For example, employee attitudes are strongly influenced by whether index-based pensions are to be maintained. It must be noted, however, that a switch from civil service to private employment is not always negatively perceived. In C6te d'Ivoire, the transformation of Palmindustrie into a Societe d'Economie Mixte (mixed state-private company) has been well receive-d by management as it permitted the company to escape the civil service salaries alignment.

Experience seems to demonstrate that in many circumstances it is absolutely essential to address employee concern at the earliest time of initiating and implementing a privatization program. Several governments, including Morocco and the Province of British Columbia in Canada, have carefully presented the issues in initial announcements (see page 76) on privatization. The weight placed on personnel factors will logically determine the degree of employee confidence in the privatization process.1 4 0

Remedies to Negative Employment Effects

With respect to remedies to negative employment effects, there are many options, a few of which are discussed below. Again, circumstances will dictate which approach or combination of measures is best.

Productive Dialogue. Productive dialogue with workers, workers' associations or unions addresses the merits and rationale of privatization. Measures to lessen the adverse consequences on employees should be widely publicized. It should also be explained that under any circumstances, government ownership of enterprises is no guarantee of continued employment. In recent years, some SOEs have, in fact, reduced their

140/ Specific experiences and possible alternative responses have been analyzed in a report "Privatization and Employment Policy" for the U.S. Agency for International Development by the Hay Group, Washington, D.C., February 1987. - 132 - employment substantially (e.g., Canadian National Railways). The long-term benefits of privatization should also be emphasized (particularly to trade unions), such as the possibilities for sustained or expanded employment as the private sector grows. Without reform, there is a risk that the enterprises would have to be closed at a later date. Workers are frightened by the privatization process, as they do not understand it. Management must make all necessary efforts to speak to them and alleviate unjustified fears. Even where employment was not a major issue, as in the case of the British Telecom privatization, the company still went to substantial lengths to try and alleviate employee fears and address union concerns. This type of dialogue is a fortiori even more important where severe employment problems are expected to arise.

In some cases, employees can become supportive of privatization schemes. If an ailing SOE with uncertain employment prospects is to be restructured and then privatized through a capital increase (i.e., a primary issue to new investors) as a first step in keeping the SOE afloat, employees may see the process of justified and desirable because it ultimately creates additional job security. Residual government-held equity may then be transferred to the private sector at a later stage with little resistance or with support from the employees.

Employee Participation in Ownership. Specific measures can be taken at the enterprise level to provide employees with incentives to support restructuring or privatization (these measures in turn lessen union concerns). One measure used in a number of privatizations is the reservation of shares for employee participation, with employees encouraged to participate. This was done for public offerings in Malaysia. As part of the privatization plans for several British companies, the government gave each employee a number of free shares, offered two shares for every one share employees bought outright, and gave them preferential allotments for the balance of shares. In the case of British Telecom, 96 percent of eligible employees applied for and were allotted shares. Ninety-four percent of British Airways' employees are shareholders in the privatized company (which also has a new profit-sharing plan for employees). Similar schemes have been used in all privatizations in France through public offering: 10 percent of the offerings were reserved for employees, who can purchase the shares at a 5 percent discount (or 20 percent if they hold the shares for two years). Canada similarly encourages employee share ownership programs. In the privatization of Teleglobe Canada, a condition of the sale was the setting up of an employee share plan (approximately 5 percent of the shares were to be offered to employees at a 10 percent discount with the benefit of interest free loans). In the case of Canada Fishery Products International Ltd., employees were given about 4 percent of the shares. The recently completed privatizations of the NCB and the Caribbean Cement Company (CCC) in Jamaica relied partly on a sophisticated employee share scheme (see Figure 5). As observed by the financial advisers in this transaction: "It was devised drawing on elements of the United Kingdom experiences but giving access to employees to buy for - 133 - bigger holdings than has been known in the United Kingdom." and "The response was overwhelming with virtually all employees taking up holdings in the reserved offer as wel:L as buying substantial numbers of shares on the open market."1 4 1

In Chile, a common procedure for workers' participation has been to use their retirement funds (which under labor laws can be advanced only up to 50 percent) in the form of cash or collateral for loans. In the case of Compafiia de Acero Pacifico (steel mill), workers equity reached 31 percent of the capital, for a purchase value of Chilean Pesos 2,894,000 financed 100 percent by CORFO (the national holding company) loans. In this case, workers have had the option to reverse their purchases from CORFO through a buy-back guarantee for up to three years. Such arrangements illustrate the extreme prudence which some governments have exercised when encouraging the acquisition of stock in SOEs by employees.

Whereas the employees of several French privatized SOEs have made substantial gains, problems have arisen in connection with the losses (following the stock market downturn of October 1987) sustained by a number of employees of Compagnie Financiere de Suez for which enterprise management has had to devise specific solutions such as special payment and credit facilities.

While offers of free shares may appear to conflict with the objectives of attaining the highest price, they do broaden the base of political support for privatization.

Public announcements and litterature in respect of government restructuring and privatization in British Columbia (Canada) have stressed that affected employees will be given fair treatment, and have emphasized and described in detail speacial incentives for employee acquisitions (including a 5 percent preference in bidding, and training and advice to interested employees)14 2 and announced special retirement schemes.

Reference should also be made to the U.S. experiments with Employee Stock Ownership Plans (ESOPs) and ongoing efforts at determining their replicability in other countries.1 4 3

141/ J. Redwood and 0. Letwin, op. cit.

142/ Assistance consists, inter alia, of up to one week's consulting time from a private firm to help a group of employees affected by privatization to develop a business proposal.

143/ See page 33 on management/employee buy-outs. - 134 -

FIGURE 5

National Commercial Bank of Jamaica - Employee Share Scheme

15. EMPLOYEE SHARE SCHEME

Approximately 13% of the shares offered for sale (3,916,440)are reserved under an Employee Share Scheme (hereinaftercalled "Scheme") for full-time employees of NCB Group and its subsidiaries. Under the Scheme each qualifying employee (called "Eligible Employee") regardless of seniority of years of service, will be entitled on application to acquire from the Trustees of the Scheme up to 2070 shares (called "Scheme Shares") on the followingpreferential basis:

MINIMUM PURCHASES& SHARES MULTIPLE OF PURCHASE PRICE

20 Free Shares 20 Free

350 Matching Shares 50, being 25 free 1 Free for each and 25 purchased share purchased at offer price

850 Discounted Shares 50 10% discount on the offer price

850 Priority Shares 50 Offer Price

2070

The purchase of Scheme Shares in each category is conditional upon the employee taking up his full complement of reserved shares in the preceding category or categories -- for example an employee must take up all his Free and Matching Shares before applying for Discounted Shares.

Payment

NCB has agreed to make a loan of up to approximatelyJ$10 million to the Trustees of the Scheme to enable them to take up the entire block of Scheme Shares mentioned above. Eligible Employees will pay the Trustees for Shares acquired under the Scheme either in cash or under an Easy Payment Plan or both. The Easy Payment Plan will enable an eligible employee to pay the amount due to the Trustee for his shares by way of salary deductions over a 24 month period.

Extract from Prospectus, N.C.B. Group Ltd., 1986, Offer for Sale by National InvestmentBank of Jamaica, Ltd. - 135 -

The Management/Employee Buy-out. Employee acquisition are often regarded as a restructuring measure to avoid employee layoffs. Certainly, this option leaves the work force more inclined to agree to restructuring measures as owners than they would have as employees, one reason buy-outs may succeed where other methods prove difficult. (See pages 29 to 34 for a review of the techniques for employee/worker acquisition of SOEs.)

Lessening the Adverse Conseguences on Employees. In all cases, country-wide measures to encourage employment may be considered the most effective palliative to negative employment consequences of privatization. They are not, however, within the scope of this report. Retrenchment may necessitate specific compensatory measures that entail considerable costs to the government and/or SOE. Such measures include severance pay and bonuses for employees who voluntarily resign. Proceeds from initial payments made to the government of Sri Lanka on account of the sale of two tile factories were applied to severance payments due to layed-off personnel. For the purpose of facing such and other costs, a special fund is being set up in Mali. Similarly, a fund for financing retrenchment was set up in Sudan. Reduction through attrition, early retirement and other common employment reduction measures can also be used to ease the transition. Basic welfare concerns and the need to deflect possible labor unrest call for the establishment of a support system for displaced workers and public officials. In some instances, governments are considered applying proceeds of privatization to retraining. Other measures include:

* Government absorption of employees. Out of a total workforce of 559 in Tunisia's Fluobar company (referred to on page 27) the government, having agreed with institutional investors on the number of surplus jobs (150), was expected to assume the cost of the wages of these workers while trying to find alternative employment for them elsewhere. In most of the recent privatizations of industrial SOEs in Guinea, the government retained in the civil service, as a transitional rneasure, the employees of the dissolved SOE who were not reemployed by the new private company.1 4 4 Such a measure would nevertheless be regarded as a costly palliative.

Special payments to emplovees retiring voluntarily or laid- off. British Airways established such a program as part of its readying for privatization. Severance packages were offered on a voluntary basis and approximately 22,000 employees took them (and reportedly, largely used them to set themselves up in small businesses; British Coal is

144/ A program has been developed, with French bilateral assistance, to retrain public sector employees and to support financially and technically those who elect, or have to, leave public employment. - 136 -

reportedly also helping excess employees set themselves up independently).

Payments to laid-off employees have varied from the minimum legally required severance pay to more generous ad hoc compensation.

Adjustments to pension benefits. In the case of British Airways, index linked pensions actually had to be bought out as part of the conversion from public service to private employment. The Turkish privatization law14 5 provides that personnel of SOEs to be privatized may, if they wish, be kept under the State Retirement Fund. In Canada, where Crown Corporation employees are members of the Public Service Superannuation Plan, the government requires the new owner to implement a new pension plan at least as generous as the norm for the industry in which the new company operates.146

Obtaining a commitment by the private purchaser to maintain employment. This was done in the case of Bangladesh's jute mills. In the case of two matchmaking industries in Bangladesh, the purchaser reportedly agreed not to lay off workers for two years so that attrition could play a key role. Further, excess equipment could be sold only if the acquiring party agreed to take related operating and maintenance personnel. The tender documents for the sale of British Rail Investments Limited contained provisions regarding staffing. The invitation to tender under the offer for sale by public tender for twenty-one hotels required a purchaser to take over the contracts of employment of each of the employees of the hotels. In addition, a purchaser was required to provide pension rights in respect of the future service of employees under overall not less favorable terms.1 4 7 These provisions reportedly substantially allayed the fears of trade unions. However, the introduction of conditions in respect of employment may render certain transactions extremely difficult to carry through. A major address by H.M. the King of Morocco on April 8, 1988, initiating a large scale privatization

145/ Law No. 3291 of May 28, 1986.

146/ Minister of State (Privatization) and Minister responsible for Regulatory Affairs, Canada.

147/ Such requirements were without prejudice to a purchaser's obligation to indemnify the vendor against any redundancy or unfair dismissal claim arising out of the sale. - 137 -

program specified that protective measures in respect of employment should include the postponement of some transactions and requirements for buyers to maintain employment in the short term. The "Cahier des Charges" for sale of enterprises or assets in Tunisia routinely include a requirement for bidders to commit themselves to take all personnel; in practice negotiations have in at least one case led to an agreement for absorption of about 80% of workers, with the vendor, a holding company, absorbing the remainder in other subsidiaries.

As another example of addressing employee concerns, the negotiations for the acquisition of the Urban Transportation Development Corporation Ltd. from the government of Ontario focussed to a large extent on employment levels and the retention of two specific manufacturing facilities. Other examples of this are certain privatizations of RUMASA group companies and t:he sale by the Italian holding ENI of the Lanerossi textiLe company.

Only partial solutions have been found to the very difficult problem of redeployment of redundant staff. Several privatizations have been handled without specific arrangements. Dissolved SOEs have simply laid-off all personnel, with legally required severance pay, leaving it up to a reconstituted new enterprise (acquiring the asset of the former) to re-employ all or part of the work force. Job retraining can offset some of the dislocation of labor reductions, but the experience with these programs is inconclusive. The more effective approach appears to be direct incentives to existing and potential employers in the private sector and the provision of adequate redundancy settlements directly to employees. The employee then has a safety net while attempting to find another job of even to start a small business. An information network and access to counselling for laid-off employees are also vital. The parallel development of business advisory services and credit facilities linked to enterprise restructuringl4 8 or privatization programs have potential to enhance the mobility of laid-off employees. Recent initiatives in developing countries like t:he Bureau d'Assistance a la Reconversion d'Agents de la Fonction Publique in Guinea should be reviewed shortly to assess their results.

It should be borne :Lnmind that, while purchasers may be willing to try to lessen the employment effects of privatization, they generally want a reduced purchase price as the quid pro quo. However, to the extent that a purchaser's proposed handling of the employment problems helps solve

1i:/ See Graham Todd, Creating New Jobs in Europe - How Local Initiatives Work, The Economist Intelligence Unit, Report No. 165, April 1984, including action by BSC Industry to help create jobs in areas affected by restructuring or closure of steel enterprises in the U.K. - 138 - certain critical issues, the foregone proceeds may be sound investment by the government. Greater reliance on the purchaser and/or privatizedSOE to help solve the employment difficulties can be envisaged.1 4 Incentives (tax or otherwise) to the SOE to absorb part of the cost might be appropriate.

6. COSTS OF PRIVATIZATION

This section analyzes the elements that have to be taken into account in assessing or establishing the cost of privatization.15 0 It is advisable for governments to carefully estimate the costs of different scenarios before deciding what course of action to follow. There further ought to be an effort at reporting a posteriori the actual costs of individual transactions. Reviewed first is the cost of the measures necessary to carry out a privatization transaction. Next, the possible residual cost of privatization are discussed, such as any continued budgetary burden related to liabilities that remain after privatization.151

149/ Under the sale of trucking and distribution services by Canadian National Railways, Route Canada, the purchaser, and CN worked together to minimize any adverse impact of the sale of employees through early retirement, relocation, financial assistance and placement in alternative jobs. See Privatizations to Date, "Information Kit" by Minister of State (Privatization) and Minister for Regulatory Affairs, Ottawa.

150/ It should be noted that several of the cost items referred to in this section may also apply in the case of the liquidation of an SOE.

151/ Not addressed here is the inherent cost to the government of accepting a lower sale price so that the transactions will go through (e.g., opting for an employee buy-out when competitive bidding would have yielded a better price, or setting a low price to achieve a wide distribution of shares). This question was addressed on page 109, dealing with valuation and pricing. - 139 -

Transaction Costs

The cost of a privatization transaction involves one or more of possible expenditures,F52 such as administrative costs, financial restructuring, physical rehabilitation and settlement of employment claims. The administrative costs include essentially advisory services (see page 87), but may include underwriting and brokerage commissions in public offerings and even brokerage commissions in private sales. In the Philippines, commissions will be paid to brokers who bring in winning bidders (and even other bidders under certain conditions). The financial restructuring costs may include the settlement or assumption of loan and other liabilities, or the conversion of government-held loans into equity and the recapitalization of SOEs prior to sale (see pages 101 to 105). In some instances, SOEs have significant tax arrears that the government may forego as part of the privatization transaction. Physical rehabilitation might be a cost, but generally the government would leave this to the purchaser (see page 107). Interim physical maintenance, on the other hand, is often a cost to the government. The settlement of employment claims may involve severance pay, pension plan funding and possible retraining (see page 135). The need to grant a discount in public offerings (see page 110) must be regarded as a transaction-cost in terms of foregone proceeds. The granting of payment terms at other than market interest rates also is a cost of concluding a transaction (see page 144).

Residual Costs

While this report does not go into the broader economic gains in efficiency that result from privatization transactions, it is important to note briefly the wide variation in the financial aspects of privatization in terms of the direct monetary outlays and receipts. Based on the country review, results range from enormous capital gains to the state, to sales of assets at a small fraction of the original cost with enormous residual liabilities on the state budget after privatization. Some illustrations follow.

In France, Saint-Gobain's shares were sold at a large premium relative to the cost of nationalization. The transaction costs amounted to only a fraction of the realized proceeds. Overall, the net proceeds were high, and there were no residual liabilities. It is noteworthy that in France, proceeds from privatization are not applied to financing the general budget. There were paid into a special account earmarked principally to reduce state debts

152/ Excluding the cost of planning and formulation of an overall privatization program. For more detailed coverage on estimating the full cost of the disposal of SOEs, see A. Waters, "Privatization: A Viable Policy Option?," in Privatization: Policies. Methods and Procedures (Manila, Philippines: Asian Development Bank, 1985). - 140 -

(including debts incurred on account of earlier nationalizations) and subsidiarily to subscribe to capital increases for purposes of restructuring other SOEs (including those to be privatized). Specific allocations are to be made to repurchase government debts in the bond market, and various maturities are paid off instead of refinanced.

In the United Kingdom, where the state transferred the telecommunications assets to a new public limited company, British Telecom, the transaction costs were only a fraction of the realized proceeds. However, some long term liabilities were not assumed by the new company.

In the case of the leveraged management/employee buy-out of the National Freight Company in the United Kingdom, the SOE was acquired for £ 53.5 million, but the net proceeds to government were only about C 5.0 million, largely because the government agreed to finance a deficiency in the pension fund.

With respect to Spain's Rumasa privatizations, liabilities were assumed by the purchaser in a limited number of instances. In the case of SEAT, the Spanish automobile manufacturer acquired by Volkswagen, the arrangements included a special fund at INI, SEAT's vendor, to cover contingent liabilities.

- Togo was left with substantial residual liabilities under suppliers' credits for the acquisition of its steel mill leased to a private operator, Soci6te Togolaise de Siddrurgie. The price agreed upon by Togo for the sale of textile plants to Pen Africa corresponds to a fraction of their cost. In many similar transactions, governments will continue to service guaranteed loans on account of facilities they no longer own.

- The terms of Malaysia's privatization of the container terminal at Port Kelang permitted the relating development loans to be paid off.

Two further observations need to be made. One relates to the major difference between the sale of shares (where the purchaser acquires asset and liabilities) and a sale of assets (where the purchaser generally does not take over the liabilities). In the latter instance, the purchase price may or may not cover the liabilities, and the state may or may not retire the liabilities from the proceeds of the sale. The second relates to the residual costs of privatization (such as continuing liabilities). A large residual does not necessarily mean that a transaction is not financially beneficial because it may still be less costly to sell the SOE - 141 - than to retain it. It may, however, create substantial problems in that the budgetary cost must then be recognized.

7. RESOURCE MOBILIZATION: FINANCING PRIVATIZATION

This last section reports on some of the techniques which can be observed as increasing or having the potential to increase the flow of private resources into privatization. It reviews actions taken to compensate for the weaknesses of some local financial markets. It reports on the extent of the use of payment terms and direct borrowing as a means of financing privatization ancd the very few instances to date in which debt equity swaps may have been instrumental in facilitating privatization transactions. Various additional measures to facilitate investments in privatized SOEs are also discussed. Some constraints to the mobilization of capital such as the lack of local entrepreneurship and nationalism or resistance to foreign investors are not discussed, as they are not the subject of this report. However, some policy considerations in respect of foreign ownership restrictions are discussed on page 125. Furthermore, the feasibility of various resource mobilization vehicles in a given country may also influence the initial privatization strategies. As stated in the Philippines' Operating Guidelines for the Asset Privatization Trust:

"In developing the disposition strategy for each assets, due consideration will be given to the availment of public securities markets, employee stock ownership plans, debt/equity swap plans and other possible sources o:E capital."

Capacity to Mobilize Private Resources/Domestic Financial Markets1 5 3

As described on page 68, the level of development and of liquidity of domestic financial markets, and especially equity markets, is a determinant of the method o:E privatization to be applied.1 5 4

Development here refers to the extent to which there is access to the general investing public or other investors for privatization purposes, which in turn depends on the availability of intermediaries for share distribution, other financial services, the sophistication of potential

153/ See David Gill, "Privatization: Opportunities for Financial Market Development." Paper presented at a Conference on Privatization held in Buenos Aires, Argentina on April 27, 1987.

154/ In several countries, long-running bull markets have expanded the possibilities of public offerings far beyond initial expectations; the present downturn may affect substantially the pace of future privatization decisions, although transactions in progress indicate continuation of programs. - 142 - investors, and the liquidity of the investing market.15 5 A public offering is difficult in the absence of an organized capital market or when there is a lack of local financial intermediation. Nevertheless, measures have been used that compensate for the weakness of capital markets. In the case of the NCB privatization in Jamaica, the government launched an elaborate information campaign about the public share offer, including the distribution of 200,000 copies (for a country of 2 billion inhabitants) of a question and answer sheet that described in basic terms the nature of shareholding and the stock market. A distribution mechanism was developed ad hoc which may be, relatively speaking, the most concentrated network ever assembled for a share issue.1 5 6 In the end, the offering was oversubscribed 2.7 times: "The offer has shown that liquidity is there under people's mattresses."1 57 A further public offering of an SOE in Jamaica, namely, the Caribbean Cement Company, also drew a large response, even though it was not fully subscribed (for reasons indicated on page 114). The sale of minority holdings in TELETAS in Turkey which drew a response by the public much larger than expected was also accompanied by creative and massive distribution and publicity efforts to compensate for the weakness of the capital market. That lesson was repeated in Kenya, when Barclay's Bank (not an SOE and reportedly a sound and profitable private firm) issued new stock to the public. The issue was seven times oversubscribed, subscribers included many first time rural Kenyan purchasers. Ultimately, the shares had to be distributed on a lottery basis. Whether public offerings are possible in other countries lacking organized financial markets (e.g., most of Sub-Saharan African except Kenya, Zimbabwe, Nigeria and C6te d'Ivoire) remains to be determined. Experience does show, however, that creative approaches are being undertaken successfully. 1 5 8 The recent capital increase of Societ6 Togolaise de Siderurgie (STS) (which is leasing a steel mill from the Government of Togo) to finance a new line of machinery was achieved through a public stock offering. This new issue of approximately US$1.3 million equivalent was largely subscribed by inter alia, 52 Togolese shareholders jj5/ Although it is desirable to describe specific alternatives at different levels of development of capital markets, doing so is beyond the scope of this report.

156/ J. Redwood and 0. Letwin, op. cit.

157/ Ibid.

158/ In one West African country, a group of businessmen very recently formed a six-member committee within the Chamber of Commerce to raise equity to create a new private bank, with representation from different ethnic groups. Each member undertook to distribute subscription forms to potential investors. By the close of the subscription period, nearly seventy-five local investors had subscribed to the issue for a total $1.6 million equivalent (including foreign exchange subscriptions representing capital repatriation). - 143 - including government officials, lawyers, doctors and business persons (including member of the well known group of shrewd and wealthy market or business women in Lome) (the InternationalFinance Corporation (IFC) also subscribed to the capital increase). Several of the recent privatizations of industrial SOEs in Guinea call for substantialshareholdings to be sold to Guinean investors. Typically,the SOE would first be transformedinto a joint venture in which a major private (overseas, regional or local) party would take a 51 percent position, often with new equity. The government would then "carry" shares representing its 49 percent holding for gradual disposal to local interests. The Gambia was partially successful in offering government shares in a bank and a trading company to the general public. The sale of blocks of shares in Industries Textiles du Mali to local investors shows that they can be attracted even in very undeveloped financial markets. However, in totally undeveloped or embryonic capital markets, they will often, but by no means always, be investors with specific business interests in the field of activity of the SOE to be privatized. As pointed out by Waters:159

"There is no point in complaining that organized local financial markets dlo not exist in many of the less developed nations. The process of raising funds for privatization can be the vehicle for recognizingthe existence of unofficial financial markets, and an incentive to permit the emergence of official ones. It provides an opportunityto create the missing organized financial structures."

An analysis of Asian Stock markets16 0 concludes that the Philippines,India, Pakistan and Sri Lanka would need more developed stock markets to facilitate the divestment of SOEs, and it explains that in Bangladesh the sale of enterprises to the private sector helped in the growth of the stock market.

Where funds cannot be raised as readily, creative approaches to increase investor interest in SOEs to be privatized must still be explored.

Public offerings should not be attempted if there is no recognizable liquidity in the local market. However, there sometimes are more investable savings than governments may recognize, and mostly they

159/ A.R. Waters, "Privatization: A Viable Policy Option?," in Privatization: Policies. Methods and Procedures (Manila: Asian Development Bank, 1985. Paper presented at the Conference held on 31 January - 1 February 1985 in Manila, Philippines.

160/ A. Rowley, Asian Stockmarkets: The Inside Story, Hong Kong: Far Eastern Economic review, 1987. - 144 - exist outside the banking system.161 They may be invested in other liquid forms, such as cash, gold, etc. One additional constraint on privatization in developing countries may be that the lack of a secondary stock market renders investment in shares very illiquid.

Acceptanceof Payment Terms

When disposing of their shares in SOEs or of assets, several governments have accepted payment terms, both in public offerings and private sales. Other governmentsare reluctant to do so.

The governments of Bangladesh, Canada (and the provinces of Quebec and Ontario), Chile, the United Kingdom, and Togo have all effected sales of state holdings by agreeing to payments over time. In acquiring all the shares of de Havilland Aircraft of Canada Ltd., the Boeing Commercial Airplane Company paid Can. $95 million in cash and is to pay a further Can. $65 million in successive installments. Seven year payment terms were agreed by the Central African Republic for the sale of the assets of Societ6 IndustrielleCentrafricaine de Produits Alimentaires et Derives (SICPAD). Installmentarrangements are described in detail in the offering prospectus of several United Kingdom SOEs, such as British Telecom and British Gas. Payments for British Gas are to be made in three installments: 71 cents at time of allotment (December 1986), 64 cents in June 1987, and 57 cents in April 1988. In the case of private sales, they will be evidenced by the sales agreement or by notes. One hundred percent financing is never accepted, and security is mostly required in private sales. Senegal's Law on Privatization specifically requires payment in full upon sale unless a special exception is granted by Decree. Security should be taken (it can take the form of bank guarantees,pledges of shares or mortgages). Bangladesh has experienced the danger of unsecured financing and the resulting lack of recourse in dealing with defaults. The machinery adopted for installmentsales of shares in the U.K. provides that shares so sold will be registered in the name of and retained by a custodianbank until fully paid for.

161! In several developing countries, there is a low utilization rate of banks for savings, particularlywhere holders are required by tax and other authorities to account for the source of their money. In such situations, the potential investing public will also be reluctant to purchase significant amounts of government stock, at it implicitly would disclose the level of its cash resources. Such problems have been identified in two West African countries as important factors that may stand in the way, if not of privatizationper se, at least of wide distribution of shares. The possible remedial actions greatly depend upon the circumstances. - 145 -

In Chile, the later privatization phases16 2 no longer permitted debt-led transactions as had been the case between 1975 and 1979. However, a recent example of a highly leveraged transaction would be the worker's buy-out of ECOM in Chile (see page 31), for the purpose of which CORFO (the national holding company acting as vendor) granted a loan for almost 90 percent of the sales value. In this case, the risk of a highly leveraged transaction benefitting the workers was weighed against closing down ECOM (the liquidation value of ECOM was low given its weak financial condition). The reprivatization of Chi-Le's two largest commercial banks is another example. CORFO was authorized by special law to capitalize U.S.$200 million equivalent in Banco de Chile and US$120 million equivalent to Banco de Santiago. In exchange, CORFO received new preferential shares, which were offered to the public. Payment terms were offered to prospective buyers up to certain limits (2 percent of the issued shares combined with further formulas). Purchases above the limit were allowed, but without payment terms. As the shares were offered as payment guarantee, sales of shares would accelerate payment. The above mechanism was thought justified since it would facilitate the sale of shares to the general public. The "popular capitalism" mechanism (as it is termed in Chile) permits in this case privatization of highly subsidized banks while not transferring the subsidy to specific buyers.

Purchases of shares in French privatizations have been on a cash basis. In one most recent case, the Compagnie Financiere de Suez, the government changed the procedure after the offering (following the Fall 1987 downturn in the stock market) allowing small investors to pay in two installments (one-half in November 1987 and the second in November 1988) with a prepayment requirement prior to selling the shares. The policy on payment terms is open for the future.

A number of privatization stock offerings such as in the U.K., and France have yielded a substantial premium which was of course greatly enhanced if seen as a percentage of initial outlay for acquiring the shares under installment arrangements. Extreme caution must however be exercised when selling shares on an installment basis. In the case of the privatization of Canada Development Corporation, the purchasers who acquired shares for Can. $11.50 in September 1985 found themselves making final payment in September 1986 for a share then trading at close to Can. $6.O0.l63 However, the shares were sold only through, and therefore upon the advice of, brokers, and the offering prospectus highlighted that the shares were not guaranteed by the government.

162/ See Volume Two for a full discussion.

163/ The reason for the unforeseeable price collapse was the deteriorating performance of CDC which was heavily concentrated in oil businesses. Afterwards, the price increased -- CDC stock was recently trading near Can. $15. - 146 -

Payment terms may be based on standard policies, but often also are the result of ad hoc considerations. The purchaser of the Ontario government-owned Urban Transportation Development Corporation Ltd. pays the government Can. $10 million in cash, as well as Can. $20 million income debenture bearing interest equal to 25% of pre-tax profits over the next ten years and becoming payable then.16 4

There are only limited indications of why governments have decided to provide or not to provide financing. The Philippines' guidelines for privatization by the Asset Privatization Trust provide some indications on the reasons why a government would be reluctant to accept installment payments except in special circumstances:

"As a rule, the Trust should not take a new portfolio position by selling on installment basis since this would impose the burden of multi-year account monitoring, lead to the possibility of subsequent foreclosure, or extend beyond the life of the Trust. For sales on an installment or deferred payment basis, the Trust should require a covering guarantee from acceptable financial institutions. Such a guarantee would further and establish the bankability of the transaction, and would allow the Trust to discount the receivable paper without recourse."

The Brazilian privatization texts simply provide that alternative forms of financing may be studied. In the case of the sale of a controlling interest in Eletrosiderurgica Brasileira S.A. (SIBRA), the bidding documents indicate that the vendor (BNDES, the national development bank) will provide financing for 80 percent of the purchase price over 12 years at 12 percent interest per annum (and monetary correction). A bank security may be provided instead of real or personal guarantees, but in no case will shares of SIBRA be accepted as security. Experiences elsewhere have indeed shown that, in case of default, pledged shares may lead to the undesirable result that the privatized SOE then may revert to government ownership. Bank guarantees have been sought by other countries in the sale of SOEs, including Costa Rica and Columbia.

Direct Borrowing

The decision to borrow for purposes of acquiring government-held shares or assets, or for making a new investment in an SOE, rests essentially with the purchaser. It is, therefore, not dealt with here in much detail. It should be noted, however, that the availability of credit sources may be a determining factor for a given transaction to proceed, whether a public offering is envisaged (see page 132 describing interest free loans for employees to buy shares), a private sale of shares or assets, an investment in new equity or even a leveraged management/employee

164/ C. Maule, op. cit. - 147 - buy-out. Investors will mostly rely on the banking sector for such financing and governments may consider encouragement measures such as rediscounting loans for this purpose. Lines of credit have been proposed in some countries for the financing of new (primary)equity issues of SOEs (and not for the sale of government shares since here the government may provide financing by accepting payment terms). Other governmentsthat have undertaken privatization have considered measures to enable or encourage bankers to provide financial assistance to purchasers. Commercial bank financings have been used in management/employee buy-outs and in the acquisitionby workers of substantialparticipations in the capital of SOEs offered for sale to the general public. Corporationsformed by workers for the purpose of acquiring shares in Chilectra Metropolitananegotiated with a commercial bank better conditions than the ones offered by CORFO, the Chilean national holding acting as vendor.

Debt Equity Swaps165

Debt equity swap techniques have been developed by a number of major debtor countries. 66 Basic techniques and their applications, benefits and possible drawbacks, in various countries are described in the literature on the subject. Debt equity swap schemes are in operation in Argentina, Brazil, Chile, Mexico, the Philippines and several other countries. Debt equity swaps are generally designed as debt relief mechanisms. But even though this is not their main purpose, they may facilitate privatization transactionsand, in that sense, are a relevant method of financingprivate investment in SOEs.

Detailed rules or provisions govern the transactions.167 Those of Chile, Mexico and the Philippines specify the eligible debt, the conversion procedures and eligible investments (including equity investments in national enterprises). Funds obtained through a swap may under certain regulations cover only a portion of the cost of a given investment. The remittance of the capital amount of the investmentmay not be permitted for a specified number of years, and remittancesof earnings may be limited.

165/ Debt Equity Swaps in this report do not include techniques for debt to equity conversionswhich may constitute a means for a creditor in an SOE to acquire equity in that SOE. One illustrationof this is the acquisition of a majority stake in Interbank in the Philippines by Shearson American Express.

166/ See Stephen Rubin, A Guide to Debt Equity Swaps, The Economist Intelligence Unit, Special Report No. 1104, September 1987; and Euromoney, January 1988, Supplement: Global Debt - The Equity Solution.

167/ Lee Bucheit, "Converting Sovereign Debt into Equity Investments," InternationalFinancial Law Review, September 1986, p. 30. - 148 -

The rules also specify priority uses (e.g. , in Mexico, the highest priorities and therefore the highest redemption prices go to buyers of privatized state-owned enterprises). Other countries (e.g., Argentina) have restricted the applications to new investment, thus not permitting debt equity swaps to finance acquisition of existing state participations in SOEs.

Not much detailed information is available on debt equity swaps resulting in the acquisition of equity in SOEs, and perhaps only a very few instances have occurred. Three privatizations in Chile (Chilquinta, Soquimich and Chilgener) were carried out through debt equity swaps under which American creditor banks of Chile acquired part of the participations offered. In Mexico, it is reported 168 that swaps have been applied to divest two small state companies, Porcelanas Euromese (ceramic tile) and Pescados de Chiagas (fish processing) to foreign investors; and that a plan existed for a conglomerate to acquire Mexican government foreign debt at a discount on the secondary market applying it to acquire a majority stake in Compania Minera de Cananea, a large copper mining industry; a salient feature of the latter transaction would be that the acquiring groups obtained financing from a foreign banking consortium. 1 6 9 New capital investment by a Japanese tractor company to increase its participation to majority holding in a joint-venture with a Mexican SOE was also made through a debt equity swap. Proposals have also been made by Citibank to convert debt claims into equity of two SOEs of which it is a creditor. In the Philippines, efforts are under way to divest a bank to local and foreign investors, involving equity made available through the debt equity swap scheme.

The increase in the return on marginal investments realized with debt equity swaps may constitute an incentive for investors with regard to privatization.

Recommendations have been formulatedl70 to encourage employee buy outs of SOEs, along the lines of U.S. type Employee Stock Ownership Plans (ESOPs), through the application of debt equity swaps. What is essentially being proposed is that equity in SOEs acquired by creditor banks be sold back to an ESOP on a leveraged basis. These conceptually very productive proposals should indeed be carefully examined as part of various possible financial instruments to finance leveraged employee buy- outs of the type described on pages 29 to 34, or to finance acquisitions of stock in SOEs by other acceptable purchasers.

168/ The information on Mexico and the Philippines is mainly drawn from S. Rubin, op. cit., pp. 106 and 82, respectively, which provides further details on the schemes provided for.

169/ The Economist, May 7, 1988

170/ See page 33. - 149 -

Institutional Investors and Holding Trusts

Measures can be taken, such as the modification of laws or charters governing pension funds, insurance companies and other institutional investors where they are presently restricted to a very narrow range of assets to foster required large-scale investments. Recent legislation in Chile now allows pension funds to invest in shares of selected state companies.

In a number of instances, governments or companies approach specialized institutional investors to take equity in SOEs which are in need of rehabilitation before they can be offered to the market, as illustrated on page 27 in the case of Fluobar in Tunisia.

In some countries, state-owned holding trusts and mutual investment funds are being considered (Guinea, Togo and others) to foster privatization. They would be designed to acquire and hold a number of SOEs and sell shares in the fund to investors who otherwise would not acquire shares in the individual SOEs. Or they may function as a caretaker holding. Apart from a trust set up for such purposes in Costa Rica with assistance by the U.S. Agency for International Development, no such fund is yet in existence and it is too early to comment on their usefulness. However, the experience with privately held holding trusts or even partially state controlled holding trusts such as Mediobanca in Italy (partially controlled by IRI) could be analyzed for relevance.

Other Measures

Other measures to increase the flow of private resourcesl7l for purposes of privatization would include, inter alia, the following:

o Tax incentives especially directed at privatization programs. Tax concessions introduced in Chile include a reduction of taxable income of investors by 20 percent of the value of SOE shares purchased as well as tax-free dividends on selected shares. Senegal's law authorizing selected privatizations specifically requires the Commission on Divestment to assess and propose any special incentives, namely tax incentives, to accompany any privatization. The granting of tax advantages obviously must be assessed very carefully as they in themselves may constitute a substantial budgetary cost and defeat policy objectives.

o Assistance provided by development organizations.

171/ Reference is made to a report by the former Industrial Restructuring Division (A. Kapur and K. Murphy, "Mechanisms for Promoting International Investment: and Know-How") which deals with overall measures to increase private foreign investment. - 150 -

The World Bank, the International Finance Corporation (IFC), the African Development Bank, the Asian Development Bank, and several bilateral development agencies, including USAID with the assistance of the Center for Privatization, have provided direct or indirect assistance in the restructuring and privatization of SOEs. Several references to IFC supported operations are made in the text.

The World Bank is presently establishing a new affiliate designed to complement its efforts to encourage the flow of investments for productive purposes, the Multilateral Investment Guarantee Agencsy (MIGA). MIGA will serve this objective by guaranteeing foreign investments in its developing member countries against non-commercial risks and by carrying out a wide range of advisory and technical assistance activities.

Covered non-commercial risks will include the risks of restrictions on the repatriation of investment proceeds in freely usable currency (transfer and inconvertibility risk), the risk of expropriation and similar measures, the risk of breach of contract by the host government in certain cases of denial of justice and the risk of war, revolution and civil disturbance. Guarantees will be available for equity investments and a broad range of contractual arrangements with equity features; these will include minority equity participations (possibly with a government or an SOE as majority partner), portfolio equity investments, as well as long- and medium-term leases, management contracts, franchising agreements, licensing agreements and turnkey contracts where contractors' returns substantially depend on the operating results of the project. Coverage is confined to new investments; draft operational regulations adopted unanimously by a preparatory committee which are to be submitted to MIGA's Board of Directors for approval clarify that this includes investments "that assist[s] the host country in restructuring its public sector."

As a result, MIGA will be adequately equipped to provide guarantees to foreign direct and portfolio investors in privatized enterprises; it may also extend its guarantee protection to nationals of the host country that acquire interests in privatized enterprises with funds repatriated from abroad. By enhancing the security of investments in privatized enterprises, MIGA may not only assist governments in attracting investors, but also enable them to launch privatization programs on terms more beneficial to them.

MIGA's potential support is not confined to divestitures of SOEs. Since its guarantee program, unlike that of most national investment guarantee agencies, encompasses both non-equity forms of direct investment and the breach of contract risk, MIGA can cover the interests of foreign parties to whom government operations or services have been contracted out. MIGA may, moreover, guarantee the interests of construction firms under build,operate, and transfer contracts. - 151 -

As part of its advisory services, MIGA may provide assistance to developing member governments in designing and implementing privatization programs. This assistance could extent to the marketing with potential investors of interest in enterprises earmarked for privatization. The provision of technical assistance could be combined with the provision of investment guarantees.

The Convention establishing MIGA entered into force on April 12, 1988. As of June 8, 1988, MICA counted 40 member states, including 12 industrial countries. An additional 36 countries had signed the Convention. MIGA's business organization is currently being established and the Agency is expected to be in full operation before the end of 1988.172

The International F:inance Corporation (IFC) has, in addition to its traditional financial services, introduced an arrangement referred to as Guaranteed Recovery of Investment Principal (GRIP) whereby the investor provides the funding, IFC makes the investment in its name and assumes the full risk of loss of principal (in U.S. dollars) for any reason; dividend income and capital gains on the investment are shared; and, at the end of an agreed period, the investor may decide to become full legal and beneficial owner of the shares, or to disengage from the investment with principal intact. An application of the arrangement in a privatization is referred to on page 27.£13

172/ For a comprehensive discussion of MIGA's history, features and initial policies, See I.F.I. Shihata, MIGA and Foreign Investment: Origins. Operations. Policies and Basic Documents of the Multilateral Investment Guarantee Agency (Boston: Nijhoff, 1988.)

173/ See J. Silkenat, "GRIP: Guaranteed Recovery of Investment Principal", International Financial Law Review, March 1988. - 152 -

ANNEX A. BASIC METHODS OF PRIVATIZATION -- SUMMARY

Methods Characteristics Procedures Public offering Distribution to the general public If SOE Is in required condition, standard of shares. of all or part of shares in public processing of public offering on the basis limited company (as a going concern). of prospectus. If not in required form or or condition, then readying process necessary. Offer can be on flxed price or tender basis.

Private sale Sale of all or part of government Sale may result from negotiation or competi- of shares. shareholding In a stock corporatlon tive bidding process. May be done ad hoc or (as a going concern) to a single entity may be subject to mandatory country proce- or group. Can take various forms such dures or guidelines on valuation, prequali- as a direct acquisition by another cor- fication, evaluation of proposals, terms of porate entity or a private placement payment, etc. In some cases, prior restruc- targeting institutional investors. Can turing necessary. Involves investor search. be full or partial privatization (i.e., transformation into joint venture).

Sale of Sale of assets (instead of shares). Alternatives: sale of assets by government; government Private sale. disposal of some assets by SOE; dissolutlon or enterprise of SOE and sale of all assets; other. Pro- assets. cedures for private sale of shares generally apply.

Fragmentation. Reorganization of a SOE into several Depends on structure of SOE. entities (or one holding company and several subsidiaries.) Each entity will be then be privatized separately.

New private Primary share issue subscribed by the Public offering or private issue of new investment private sector (dilution of govern- shares on basis of standard procedures for in SOE. ment's equity position instead of dis- new issues, possibly in conjunction with of shares). disposal of government equity. New private investment may be for capitalization of new company embodying assets transferred by government.

Management/ Acquisition by management and/or work- Negotiations by government, management, employee force of controlling interest in SOE. employees and lenders to cover wide range of buy-out. Leveraged management/employee buy-out issues. (LMBO) consists of purchase of shares on credit extended either by seller (government) or by financial institutions.

Leases and No ownership transfer. Under lease, fee No standard method; see actual cases in management is payable to owner of productive facil- text. contracts. ities; lessee assumes full commercial risk. Under management contract, owner pays for management skills, while manager has full management and operational corn- trol. Many variations exist. - 153 -

Preferred Applications and Special Featuires Implementation Issues -SOE sound going concern with reasonable earning poten- - Structure or condition of SOE may not permit tial or can be readied to become so. public offering; feasibility of restructuring -Objective is widespread ownership. to be assessed. -Existence of equity market or feasibility of struc- - Mechanisms necessary to achieve and maintain tured offering. wide-spread ownership and possibly limit -Generally more appropriate for larger offerings than foreign holdings. direct sale. - Pricing mechanism to be defined. -Often more acceptable politically. - Distribution mechanisms may need to be introduced to compensate for weakness of equity markets.

-Because of flexibility preferred method for weak per- - SOE may need prior financial restructuring; forming enterprises. difficult decision on whether to rehabilitate -In absence of equity market, may be only alternative prior to sale. for sale as going concern. - Employment. -Size of enterprise may not justify public offering. - Need for mandatory procedures. -Preliminary step to public offering when presence of leveraged party necessary to turn enterprise around. -New owner known and can be evaluated. Offers flexibility in negotiation, such as obtaining specific commitments from purchaser. Purchaser may bring benefits (management skills, technology, market access, etc.). -Implies SOS is sold with assets and liabilities (there are exceptiors).

-Where sale of shares not feasible or objective is sale - If assets are sold as a result of liquidation of individual assets. or major restructuring, related issues arise. -Permits privatization of SOEs not salable as going - Relating debt liabilitles often not assumed concern. by purchaser. -Often results in separation of assets and. liabilities.

-Where objective to privatize only certairn components; - Depends on privatization method applied to where SOE is a monopoly, and break-up will improve individual entities. competition; or where market will not absorb whole SOE. -Permits privatization of component parts when no taker for the whole. -Permits application of different methods to different parts.

-Applicable where primary objective not divestiture but - Implementatlon issues related to public offer- provision of new equity by private sectcr. ing private sale of shares or transfer of -Addresses funding problems of undercapitalized enter- assets may arise. prises. Offers flexibility: used as first step to, and in conjunction with, sale of governrment-held equity.

-SOE must typically have competent, professional man- - Cash flow or other security required as under- agement and skilled, stable workforce. lying element of LMBO. -Leveraged buy-out a means of transfer to management - Risk to employees. and employees even with limited wealth; incentive to productivity. -May be solution for SOE not salable otherwise. -May be solution to employment problems.

-May be preferred where privatization of ownership of - Continued financial liabilities of state government or SOE assets not appropriate. May be inter- with respect to ownership of assets. mediate solutions rendering subsequent sale possible. - Under management contract, owner may still -State unable or unwilling to transfer ownership to need to inject funds to support operations. private sector but wants private sector management. Malntenancelrenewal obligations. -May also be planned as an intermediate step to full privatlzation. - 154 -

ANNEX B

THE AUTHORIZATION PROCESS

Page 80 of the report states that the nature of the authorization process greatly influences the ease with which a privatization program is decided on and/or implemented. In some cases, authorization from the legislative branch is required, in others only from the executive branch. In other cases, the overall privatization program is authorized by law, with individual privatizations decided by a designated entity that may have been created for that purpose. Many constitutions include, among the matters that can only be decided by an act of parliament, the creation and dissolution of state-owned companies and the transfer of state bodies to private ownership. Many SOEs are created by a specific law (in other cases by decree or some executive order) and can only be dissolved by an equivalent instrument (although in some cases the charters of the SOEs contain specific provisions in this respect). Some countries have laws that require certain sectors to be state-controlled or require a state majority in these sectors. For state-owned enterprises governed by private company law, all steps relating to dissolution, liquidation, etc. (normally decided by a shareholders' meeting) are spelled out by their charters and company laws. Sometimes legislation or the charters of the SOEs organized as stock corporations impose restrictions on the transferability of shares. In some countries, both the central or federal government and state governments may be divesting shares or ownership and the requirements of both will need to be satisfied.

The ease with which certain divestiture/privatization programs or specific transactions can be initiated and completed depends largely on the type of authorizations involved. Analysis of this issue is only possible on the basis of specific situations, and no general conclusions can be derived. If legislative approval is required in a fully transparent democratic system, the authorization process may be very time-consuming because of potentially strong political opposition (e.g., if there are personnel lay- offs involved). In many tightly controlled one-party states that have a parliamentary system, however, the chief of state and the cabinet can obtain legislative approval with ease. The authorization process also involves a determination of which administrative branch or organization should handle the divestment program.

Typically, legislative authorization (at least for a transfer of ownership) is required in cases where:

o it is a constitutional requirement. For example, many of the constitutions of francophone African countries, such as in the case of Senegal, have adopted the French constitutional requirement that legislative consent is required to transfer enterprise ownership from the state to the private sector. The situation with respect to individual assets is, however, often open to interpretation; and - 155 -

o the SOE is constituted by a legislative instrument.

The enabling requirements may vary according to the nature of the transaction. The French privatization law referred to below sets different procedures depending on whether the state owns a majority of the capital. Management contracts and leases in many instances do not require specific authorizations (although management contracting may be subject to approval procedures set in the country's procurement laws).

The following examples illustrate the types of authorization requirements that may apply. While, on the one hand, countries are bound by their own legal system as described above, most have a certain degree of discretion in selecting the types of authorization methods and instruments to apply. For instance, if legislative approval is to be granted, it can be done case-by-case or in the aggregate, with the latter establishing that no further authorization is required for individual enterprises.

Individual Legislative Authorizations

Several of the United Kingdom's privatizations were based on an individual act (e.g., the Telecommunications Act 1984) that aimed at reorganizing the sector, transferring a government undertaking and vesting property to a new public limited company represented by shares, establishing a regulatory framework, authorizing the necessary licensing, etc. In France, the SOEs which are riot included in the list of 65 under the Law of August 1986, may of course be privatized if authorized by a special law.16 6

Overall Legislative Authorization

The French privatization laws of 1986 authorize and establish detailed procedures for a list of sixty-five SOEs in which the state has a majority interest. This authorization in the aggregate permitted expedient processing of individual privatizations. Senegal's privatization law of 1987 authorizes the sale of government's interest in twenty-six mixed economy enterprises, in full for some and partially for others. In the Philippines, Proclamation No. 50 of December 8, 1986, "proclaiming and launching a program for the expeditious disposition and privatization of certain government corporations and/or the assets thereof, and creating the Committee on Privatization and the Asset Privatization Trust," is the overall enabling legislation, designed to maximize the efficiency of the divestiture process. This instrument provides for the transfer of SOEs to an Asset Privatization Trust: and authorizes disposition under the authority of a Committee on Privatization. Turkey's Law No. 3291 of May 28, 1986, authorizes the Council of Ministers or a designated government agency,

166/ This would be the case for TFI (television shannel), Renault and Cr6dit Agricole. In France, minority interest divestments (e.g., the state's 35 percent holding in Total (petroleum)) did not require authorization by law. - 156 - depending on the nature of the enterprise, to decide on privatization. In Sri Lanka two bills recently passed parliament providing for the modalities of conversion of government-owned bodies into companies whose shares will initially be held by the Secretary of the Treasury in view of divestments.

Authorization by the Executive Branch

In most cases where legislative authorization is a prerequisite to state divestment and an umbrella law was passed for the purpose, the conditions of individual transactions must be authorized by an interministerial committee or by specific ministerial order. The Tunisian law on privatization provides that a ministerial committee must authorize any given sale transaction and specify its conditions. The actual sale then becomes effective by joint order of the Minister of Planning and Finance and the Supervisory Minister to which the enterprise is responsible.

No Legislative or Government Authorization

There are many circumstances in which no legislative approval or authorization is necessary. This would be the case in most instances where a government holding company sells its subsidiaries. The privatizations carried out by Istituto per la Ricostruzione Industriale (IRI) in Italy involved simple corporate decisions. Subsidiaries of directly government held SOEs in France may be privatized by the parent, but only after authorization of the Minister of Finance.16 7

General

Different governments may be guided by different concerns in devising the proper authorization mechanism. The aim should be to balance the need to assure expediency while maintaining safeguards to protect the public patrimony.

167/ Titre III of the Law of August 1986. - 157 -

ANNEX C

MANDATORY PROCEDURES AND GUIDELINES FOR PRIVATIZATION

Page 90 of this Report comments on the efforts of several states to develop clear minimum standards to ensure orderly disposition, maximize the return to the state, preserve a fair process for the general public and assure the qualifications of the purchaser to run the acquired enterprise productively. The following illustrates some of the main provisions of the mandatory rules in Bangladesh, Brazil, Chile (internal procedures of CORFO), France, the Philippines, Senegal and Tunisia. It should be noted from the outset that most countries which have developed general principles and guidelines have also recognized the need for flexibility at the implementation stage to allowr for the specific circumstances surrounding each SOE.16 8

Argentina

Law 22.177 of March 4, 1980, gives the Executive Power authority to proceed with partial or total privatization of SOEs. It provides for the overall methods and procedures while SOE specific decrees provide for the detailed technique to be applied to that SOE (several such decrees have been issued recently).

The Law also empowers the Executive to dissolve and liquidate SOEs and to appoint liquidators. Provincial governments are also authorized to privatize their holdins in S()Es. The Law provides for the basic methods which can be applied in Argentina (largely the divestment methods described in Part I of this report).

Implementation of privatization transactions is the responsibility of the Ministry to which the individual SOE is attached. The relevant Minister has authority to set the basis and conditions for sales in accordance with general conditions approved by the Executive. The Law provides for domestic or international bidding in the case of divestment. It further recognizes the need to permit certain provisions of SOE charters or articles of association to apply such as the exercise of preemptive rights of existing shareholders (see page 99).

The Executive may adopt various specific methods and procedures for accomplishing privatization. When bidding is not responsive, direct negotiations are authorized. Debt claims of the state (or state bodies) over SOEs may be rescheduled; the state may also subordinate itself to other creditors.

168/ Report of the Public Sector Divestment Committee, Singapore, February 21, 1987. - 158 -

The Law covers the modalities of compensation for affected employees. If the SOE to be privatized cannot provide the necessary funding, the state may provide special compensation.

The Law provides further that no legal proceeding or recourse can suspend or interrupt the process of privatization provided for in the Law.

Banzladesh

The required processing of the privatization of abandoned corporations16 9 was as follows:

(a) A Tender Committee examined the validity of tenders;

(b) A Scrutiny Committee verified the title and nationality of former owners; and

(c) A Working Group on Disinvestment examined the valuation of properties/assets/shares and made recommendations to a Disinvestment Board; and

(d) The Disinvestment Board made final decisions. For each corporation, a floor price called the "National Reserve Price" (NRP) had to be worked out as a basis for considering a tender offer. A corporation was the sold either at the NRP or to the highest bidder. The successful bidder was to pay a 25 percent down payment if the corporation was located in developed areas and a 20 percent down payment if the corporation was in a less developed area. The balance was to be paid in three or four equal annual installments depending on where the corporation was located. Payment of installments started after 24 months from the date of execution of a deed of agreement for sale.1 7 0

Brazill 7 1

In the early 1980s, Brazil launched a program to cut back the public enterprise sector. A Special Commission for Destatization was

169/ After independence in 1971, the government decided to take over enterprises abandoned by their owners.

170/ Shamsul Chisty, "Privatization in the Bank's Developing Countries: The Experience of Bangladesh," Conference on Privatization: Policies. Methods and Procedures (Manila: Asian Development Bank, 1985).

171/ The instruments referred to in this Section had, at the time of finalization of this report, been replaced by a new Decree No. 95.886 of March 29, 1988, governing the Federal Destatization Program; other new instruments are under preparation. Their review is not included in this report. - 159 - created in 1981 establishing certain procedures and restrictions in the processing of privatization at the federal level (privatization by state governments is not described here).

Decree No. 91-991 of November 28, 1985, established a new legal framework for the privatization process with the creation of an Interminis- terial Privatization Council. It consists of the following Ministers of State: the Chief of the Planning Secretariat in the Office of the President of the Republic, and the Ministers of Finance and of Industry and Trade, the Special Minister for Debureaucratization, and the Ministers who have corporations attached to their ministries which are included in the Privatization Program. The CoTuncil is assisted by a secretariat for technical and administrative support responsible for coordinating and monitoring all procedures included in the privatization program and which shall have the technical and administrative support of the SEPLAN (Planning Secretariat). The lead in the privatization process is taken by the Minis- ter of State responsible for the SOE to be privatized. Mandatory procedures for the transfer of SOEs to the private sector were defined in the above Decree as well as in the Interministerial Order No. 010 of January 15, 1986.

In defining the privatization operation, the Minister of State concerned must be advised by a consulting firm from the private sector. The privatization operation is widely announced in all phases. If voting control is transferred, acquisition of shares is limited to Brazilian citi- zens resident in Brazil or companies under Brazilian control. Operations are analyzed and assisted by external auditors. Transfer of operations is, whenever possible, to be implemented through the stock market, and incentives are granted to employees of the enterprises to facilitate the acquisition of shares. When the privatization operation is satisfactorily defined, the Minister concerned submits a detailed implementation proposal to the Interministerial Privatization Council which approves it. The Minister of State concerned then sends to the Council a detailed report on all stages of the process, widely disseminated and accompanied by the opinion of external auditors. The inclusion of state enterprises in the privatization program must be announced in the form of a Decree from the Presi- dent of the Republic upon recommendation of the Ministers of State.

Criteria for pre-qualification are: owners' experience, financial capacity to purchase and restructure the enterprise, if necessary, and technical or scientific capacity of the candidates. Pre-qualified candidates may visit the firm, examine its books and audit its reports. The Interministerial Privatization Council may choose among various bidding procedures: single offer to purchase (submission by qualified candidates of their respective bids in sealed envelopes), public purchase offer (or auction, mostly handled by one of the stock exchanges on a service basis) or direct negotiation (if there is only one qualified candidate, if juridical and contractual circumstanc:e so require or if contractual provisions stipulate that the admission of new partners depends on the consent of the other partners). If the highest bid is less than the floor price, the - 160 -

Council submits the matter to the President of the Republic who may decide whether to review the evaluation or to reopen the bidding.

Chile

As described on page 83 of the report, Chile's CORFO has been the vendor for a large number of SOEs under formal administrative arrangements.

While Chile has not, unlike other countries referred to in this Annex, specified mandatory procedures by law, CORFO's customary procedures merit mention. Over the years, and building on its several phases of privatization,1 7 2 CORFO has developed its procedures and criteria for purchaser selection. Though done on a case-by-case basis, consistency in the application of the procedures have resulted in implicit general procedures. Furthermore, minimum guidelines to which CORFO is subject in the restructuring of public entities, requires it to subject all dossiers for the transfer of property to the national credit office (Contraloria) for approval, adding to the consistency of the dossiers.

The following elements of the procedures are, inter alia, of interest:

Building on the results of earlier privatization, CORFO has strengthened requirements in respect of solvency of buyers and of the avoidance of property concentration. To increase the likelihood of maintenance of solvency, the buyers' financial condition is reviewed in detail at the bidding stage, including the method for raising the funds to finance the acquisition. Although accounting practices in Chile don't require consolidation of balance sheets of related corporations, CORFO does it, analyzing the complete financial profile of the group.

Specifications for prequalifying prospective buyers include:

o shareholders identification, board members of corporations, detailed financial statements of all related corporations (should be audited);

o areas of experience of the prospective buyer; and

o backing to finance the purchase, at the reference price given by CORFO.

Prequalified bidders are then invited to bid. Usually a bid bond of between 5 to 10 percent is required, and the same information requested in the prequalification process is again needed. It is required to provide more detailed information about financing the purchase.

172/ See Volume Two: Chile. - 161 -

In respect of the qualifications of buyers, the financial backing rather than other criteria is being stressed except in very limited cases (CORFO has sought an expertise in telecommunications in the case of CTC, a telephone corporation). Consistent methods have been adopted for price setting as well.

France

In France, mandatory procedures for privatization are described in Law No. 86-912 of August 6, 1986, applying to the 65 SOEs covered by the law of July 2, 1986 (other procedures may be provided for other SOEs).

The privatization of entities where the majority of capital belongs to the state requires a valuation by a Privatization Commission. The Commission has seven mem'bers who are appointed for five-year terms. They are chosen on the basis of their competence and experience in economic, financial or legal matters and are bound by professional secrecy.

Upon request of the Minister of Economy, the Commission establishes the value of the enterprise or assets to be privatized. Its valuation must be published. In the case of an exchange offer, the Commission must also be consulted regarding the value of the assets received by the State in exchange f'or its interests in the enterprise to be privatized. The offering prices and exchange parities are fixed by the Minister of Economy. They may not be below the values established by the Privatization Commission.

Privatization of most of the companies to be affected will occur through public offering in E'rance and abroad. However, the Minister of Economy may decide to do a private placement, subject to conditions to be established by decree that must be approved by the Council of State. Feasible procedures are provided for for private sales (of shares or of assets).

Certain restrictions on ownership are set down. Those are described on page 124 dealing with restrictions on ownership.

Preferential terms are to be offered to employees. Those are described on page 132 dealing with employment issues.

Philippines

In the Philippines, privatization is to be carried out through the Committee on Privatization (COP) and the Asset Privatization Trust (APT) created by Proclamation No, 50 of December 8, 1986. The broad organizational set up is described on page 85.

The COP identifies, by itself or with the assistance of APT and/or other disposition entities, the most appropriate entity to undertake the ultimate disposition of any asset transferred to it. Such entities may - 162 - include APT, a government financial institution (Development Bank of the Philippines and Philippines National Bank) or the parent government-owned corporation concerned, in the case of their subsidiaries.

Operating Guidelines for the discharge of APT's functions have been established by COP. They are summarized in a set of policies and procedures described in a booklet "Doing Business with the Asset Privatization Trust."

Standard formulae are used for the valuation of assets. Since the rule is to sell through bidding procedures, a floor price is determined for each corporation. Where the bidding procedure does not provide the basis for determining a fair floor bid price, a mechanism to determine a fair floor price is worked out by the APT and approved by the COP.

Cash is given preference and all bids must have a posted bond from an acceptable financial institution. The bidding rules and procedures to be followed for the disposition of any particular asset must be publicized and made known well in advance for the guidance of prospective bidders.

Sales of acquired assets17 3 to previous owners are discouraged, but not prohibited. However, previous owners should not be qualified for bidding where there are at least three bidders for an asset.

Senegal

Senegal's Law No. 87.23 of August 18, 1987,174 authorizing the sale of state holdings in several SOEs institutes a "Commission sp6ciale de suivi du d6sengagement de l'Etat" (Commission on Divestment) to assist the Ministre Charge du Portefeuille de l'Etat in carrying out privatization (its organization, functions, and powers are set by separate decree).

The Commission is the only body allowed to retain advisory services. It recommends any incentives (particularly tax incentives).

The Law requires that, unless justified by exceptional circumstances, the shares of an SOE be sold by competitive bidding (the specific procedures being set out by a decree). It provides guidelines on valuation. It provides further that, unless a special exception is granted by decree, shares must be fully paid upon transfer.

Special provisions are also included to limit ownership concentration (with the possibility however, to sell an enterprise to a

173/ Mostly assets and companies acquired by state-owned banks through foreclosure or otherwise in satisfaction of debt obligations.

174/ Journal Officiel No. 5192 of September 12, 1987. - 163 - single buyer or group of buyers to permit private sales) and to achieve the participationof local interestsand employees.

The creation of a special share (see Annex D) is mandatory in case the SOE has outstandingdebts guaranteedby the state.

The further practical modalities for selling shares in SOEs are to be specified as needed by Ministerialorder.

Tunisia

Tunisia's Law No. 87-47 of August 2, 1987,175 relating to public enterprise restructuring, supplemented by various other texts, sets the overall procedures for the restructuring/privatizationof SOEs in Tunisia. It authorizes the state to proceed with the transfer of all or part of its direct or indirect participationsin SOEs. The specific SOEs to be privatized must be designatedby decree.

Restructuring/privatization under the law includes the basic standard methods: (i) sale of all or part of state-owned (directly or indirectly) shares; (ii) exchanges (conversion)of securities; (iii) waiver or sale of the state's preferentialsubscription rights to new share issues; (iv) SOE mergers, absorptionsor splits; and (v) sale of individualassets.

The administrativeresponsibilities are as follows:

- an SOE Restructuring Commission (CREP) is responsible for valuation and determination of specific transfer conditions (pricing, payment terms, employee participation, foreign participation). It is a 7-member independent commission. It proposes the conditions of specific transactions to the Ministerial Commission.

- A Ministerial Commission authorizes the conclusion of any specific transactionand its terms. Any transactionbecomes effective only upon joint decision of the Minister of Plan and Finance and the Ministre de Tutelle.

- An ImplementationCommission ("Commissionde Suivi") at the stock exchange will follow up on the various measures required in cases of public offerings such as (i) listing; (ii) distribution of information;and (iii) actual sale of stock.

- In cases of private sales or sales of assets, the SOE and its supervisoryMinistry implementthe transaction.

175/ At the time of finalizationof this report, revisions to the provisions of this law were being considered. - 164 -

The law specifies some basic valuation principles and methods. To encourage widespread share ownership, special incentives may be granted to employees and former employees. Incentives includepriority allotmentswith favorable payment terms and the distribution of free shares (with limitations on further transfers). Other incentives may be granted such as a 5 year exemption of corporate income tax. Shares may be paid for up to 50% of their price by surrenderingsecurities (bonds) previously issued by the state.

Presumably to permit the alleviation of SOE debt liabilities,the law authorizes the state to waive its preferred creditor rights. But prior to such a waiver, the state may negotiate with creditors who would benefit from the waiver, compensatory arrangementssuch as reschedulingor partial cancellationsof debt claims, or the applicationof recovered debt claims to the acquisitionof interests in the SOE.

Special rights of control of the state over mixed state/private enterprisesprovided by state enterprise legislationmay be waived when the state's participationin a restructured/privatizedSOE is reduced below 50%. The waiver is for five years maximum, provided the acquiring party undertakes to acquire 67% of the capital after these five years (in which case no special state controls will apply). - 165 -

ANNEX D

RETENTION OF SPECIAL RIGHTS BY THE GOVERNMENT

Page 118 of the report comments on the elements determining the maintenance of some degree of governmental control over privatized SOEs.

Certain governments have determined that, in order to maintain control, they should not divest themselves of majority holdings in certain enterprises. This would often be the case for enterprises of strategic importance or in which the government finds that it needs to control its operations in the national interest.

Several alternative techniques exist whereby a government can retain powers of approval over key actions by an enterprise after it has become a minority shareholder or even after total privatization. It should be stressed, however, that these techniques are not a substitute for government control over the management and operations of the enterprise. Where a government wants to retain the rights of an ordinary shareholder, it should retain majority or equivalent control.

One technique is the special share (also called the "golden share"). In preparing or amending the charter of an enterprise as part of the readying process, a special share is created that can only be held by the government and that entitles it to special rights as described in the company charter. This technique was used in several of the United Kingdom privatizations through public offerings. An extract from the British Telecom Prospectus describing the special share appears in Figure 6. The French privatization law provides for the use of this technique (action specifique) in cases where national interest so requires, and it was also applied in in several public offerings of SOEs (Elf Aquitaine (petroleum), Havas (media), Bull (electronics), and Matra (includes armaments)). The Malaysian government retained a special share in the privatization of Malaysian Airlines System (MAS) and Malaysian International Shipping Corporation (MISC). This technique has not been used exclusively with public offerings, and it was applied in the privatization of Sealink in the United Kingdom, a private sale, on the basis of bidding, to a foreign company (which intends to offer Sealink publicly within a few years).

The special share normally enables the government to ensure that certain major decisions affeacting the operation of the enterprise are consistent with its policies. It typically entitles the government to receive notice of, and attend. and speak at, shareholders' meetings but not to vote at such meetings. It entitles the government, inter alia, to approve (or veto) specific variations of existing (strategic) provisions of the company charter such as dissolution, limitation on shareholdings, the nationality requirement of i:he chief executive officer, the issuance of voting shares that are not idential to the existing ordinary shares. It effectively controls takeovers. It further entitles the holder government - 166 -

FIGURE 6

Special Share

The Special Share may only be held by or transferredto the Secre- tary of State or another Minister of the Crown or any person acting on behalf of the Crown. The registeredholder for the time being of the Special Share (the "Special Shareholder")may require the Company to redeem the Special Share at its nominal amount at any time.

The Special Shareholderis entitled to receive notice of an attend and speak at all General Meetings and meetings of any class of shareholders but not to vote at such meetings. The Special Share confers no right to participate in the capital or profits of the Company save that on a winding-up the Special Shareholderis entitled to repayment of £1 in priority to other shareholders. However, each of the following proposals is deemed to be a proposed variation of the rights attaching to the Special Share and is only effectivewith the consent in writing of the Special Shareholder.

(a) The amendment,or removal, or alterationof the effect of all or any of certain specifiedArticles, being the Articles setting out certain definitions;the rights attaching to the Special Share; the limitation on shareholdings;the right of the Special Shareholderto appoint any person or nominate any existing Director as a Government Appointed Director and other provisionsrelating to Government Appointed Directors including the provision that the removal of Directors by resolutionof a General Meeting shall not apply to GovernmentAppointed Directors;the right of a Director to vote in respect of resolutionsof the Board concerningmatters in which the Crown may be interested;and certain of the procedures for the proceedings of the Directors including the appointmentof a Chairman, Deputy Chairman, and managing and executiveDirectors, their removal from such positions and their qualifications,in particular the requirement that any Executive Chairman or Chief Executive must be a British citizen.

(b) The issue of any shares with voting rights not identical to those of the ordinary shares subject to an exception for any shares which do not constituteequity share capital and which when aggregatedwith all other such shares carry the right to cast less than 15 per cent of the maximum number of votes capable of being cast on a poll at any General Meeting.

Extract from a section of the BRITISH TELECOM Prospectus dealing with various provisions of the Articles of Assocation of the Company.

Source: BRITISH TELECOM: Offer for Sale of Ordinary Shares. - 167 - to appoint a specified number cf directors of the company. The "Preference Share" in the case of MISC and MAS in Malaysia requires government consent for the disposal of certain major assets. In theory, a variety of actions could be subjected to the specific approval of the special share, so that its application could in principle be widened. In the case of Sealink, the government retained a golden share requiring the ships to remain under British flag and allowing for requisitioning in case of national emergency. In Senegal, the Law on Privatization requires introduction of an "action sp6ciale" through the modification of SOEs' charters where the SOE is still covered by government loan guarantees or if government loans have been onlent to it. The special share provides for rights designed to protect the state in ensuring that such loans are repaid by the privatized enterprise. However, in most cases, it was used principally as an instrument to preclude individual shareholders from acquiring controlling interests in an enterprise.

Another method for achieving government control over certain decisions of an enterprise is used with mixed enterprises (societ6s d'dconomie mixte) in countries with a French legal tradition. The establishing instruments or charters of these enterprises may provide that the state, even though it is only a minority shareholder, in addition to its rights as a minority shareholder, can control the decisions of the board of directors through the presence of a representative (commissaire du gouvernement) who, while having no voting power, has a veto power over decisions deemed contrary to the interests of the state. Such a technique has effects similar to those of the special share to the extent that the matters subject to veto power are carefully delineated, i.e., the articles of association must specify fully the terms and conditions under which the government can intervene. An open-ended power to veto would be regarded by investors as a threat to the autonomy of the enterprise (see also page 120 of the report) and would act as a disincentive to private sector participation.

The authorization and issuance of different classes of shares with different rights is another method of granting rights to the government beyond its proportionate shareholding. In cases of privatization through private sale, as with the creation of joint ventures, the government, as part of the readying process, and along with the private partner as part of the negotiation process, must decide what types of shares are to be authorized for the joint company, and what rights each type will confer upon the shareholder. In addition to common or ordinary shares, preference shares carrying special rights may be created. The special classes of shares may confer different rights as to dividends, participation in assets, etc. as well as to control, namely voting rights and rights to appoint a specific number of directors.1 7 6

176/ On the latter, see further: L. Rapp, op. cit., pp. 40-42. - 168 -

ANNEX E

RESULTS OF RECENT PRIVATIZATION ACTIVITY

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tU0133SAg SNN1135SN591NOI1ZIlV19d JO 23A49s 11 31951 TABLEI II REGIOMLAND COUNTRY SURVEY OFPRI VATIZATION OPERATIONS BYSTAGE OF CINItETION

.All Transactionsother than smaageset contracts :. NANASEENTCONTRACTS Of REGION/COUNTRY : PLANNED UNDERWAYCOMPLETED SUBTOTAL -Planned Underway Completed ORM TOTAL

Sub-SaharanAfrica: Benin : 13 2 0 15: 0 0 0 Is

Caaaroon I 0 2 3: 0 0 3 6

Cen.African Rep. : 0 0 1 1: 0 0 0 1

Catedivoire 0 0 33 33: 0 0 3 36

Equatorialguinea : 0 1 -6 7: 0 0 0 7

Saban : 0 0 3 3: 0 0 0 3

Saabia 9 6 7 21: 0 0 0 21

Ghana : 32 0 1 33: 0 5 3U

Guinea : 0 7 39 46: 0 0 1 4?

Kenya : 0 1 0 t1: 0 0 2 3 -4 Liberia : 10 I 0 It: 0 0 2 13

M4alai I 0 5 0 5: 0 0 16

Mali : 10 I 16: 0 0 1 1? ------…---…------Mauritania : 0 3 2 5: 0 0 16

Niger : 9 10 13 32: 0 0 1 33

Nigeria : 97 0 29: 0 0 0 9

Ruanda : 0 0 1 1' 0 0 0 1

SaoaTomeEPrincipe: 0 0 0 0: 0 0 2 2 ------…- - I…------Senegal : 33 2 4 39: 0 0 2 41

SierraLomws 0 0 2 2: 0 0 2

sealia : 0 0 2 2: 0 0 0 2

Swaziland 0 2 0 2: 0 0 0 2

Tanzaia 0 0 0 0I 1 0 0 1

------a … ……------……------…------Ugana : 5 0 1 6: 0 0 & 12 TABLEII I REGIONALAND COUNTRYSURVEY OF PRIVATIZATIONOPERATIONS BY STAGEOF COMPLETION

AllTransactions other than management contracts MANAGEMENTCONTRACTS Vt REGION/COUNTRY PLANNED UNDERWAY COMPLETED SUBTOTALPlanned Underway Completed GRAND TOTAL

Zambia 0 V I 1 U 0 6 7

TOTALfor REGION: 234 -45 137 416 B 0 47 471

Asia: Bangladesh a 0 1 9 0 0 1 t0

China 6 0 0 6 0 0 0 6

Indonesia 2 0 3 5 0 0 0 5

Japan 1 2 5 a 0 0 0 B

Korea,Republic 9 0 7 16 0 0 V 16

Malaysia 20 2 10 32 1 0 0 33

Nepal 6 0 0 6 0 0 0 6

Pakistan 3 10 1 14 0 0 0 14

Philippines -RI -N1 5 5 0 0 0 5

Singapore 37 3 15 55 0 0 0 55

SriLanka 5 0 B 13 0 0 B 21

Taiwlan 2 0 6 B 0 0 0 B

Thailand 5 2 2 9 0 0 0 9

TOTALfor REGION: 104 19 63 186 1 0 9 196

PacificCountries: AmericanSamoa 0 0 4 4 0 0 0 4

Australia 3 2 4 9 0 0 0 9

Fiji 2 1 1 4 1 0 0 5

NewZlealand 1 2 3 6 0 0 0 6

PapuaNeeGouinea 5 B 1 14 0 0 0 14

SolomonIslands 1 0 0 1 0 0 0

WesternSamoa 14 0 0 14 0 0 0 14

TOTALfor REGION: 23 11 5 39 1 0 0 40

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ISSN 0253-7494 Cover design by Bill Fraser ISBN 0-8213-1111-5