Eleventh Plenary Session of the OECD Advisory Group on Privatisation (AGP)

Organisation for Economic Co-operation and Development

Organisation de Coopération et de Développement Économiques

in co-operation with the Italian Treasury

Banks and Privatisation

Framework conditions, methods and processes of privatisation: Lessons from the trade sale of an Austrian bank

by Karl Aiginger and Peter Mooslechner

Rome, 18 and 19 September 1997 Banks and Privatisation Rome, 18 and 19 September 1997

FRAMEWORK CONDITIONS, METHODS AND PROCESSES OF PRIVATISATION: LESSONS FROM THE TRADE SALE OF AN AUSTRIAN BANK*

by Karl Aiginger and Peter Mooslechner**

1. Introduction: How not to privatise a bank?

On January 12, 1997 the Austrian government decided to sell its controlling 48.6 per cent stake (which represents 70 per cent of the bank’s voting rights) in Creditanstalt, Austria’s second-largest bank, to Bank Austria, the largest Austrian bank. This decision ended a more than six-year attempt to privatise Creditanstalt, characterised as “possibly the longest privatisation saga in history”1 The privatisation process of Creditanstalt has received widespread attention in the international financial community and was heavily criticised in the financial press. Despite Austria having done a lot in privatising large parts of its state-owned economy, it raised serious questions about Austria’s willingness to privatise. The government’s attempt to sell Creditanstalt has been derided as a lesson in how not to privatise.2

Unfortunately the discussion of the problems in the process of privatising Creditanstalt focused nearly exclusively on political factors and arguments. Of course, political considerations and political views on how to privatise the

*. Paper presented at the OECD Symposium on "Banks and Privatisation", Rome, 18-19 September 1997. **. Karl Aiginger, Austrian Institute of Economic Research (WIFO); and Peter Mooslechner, Oesterreichische Nationalbank Economic Analysis Division 1 “Death of a bank”, Euromoney, March 1997. 2 “Creditanstalt: How Not to Privatize a Bank”, The Wall Street Journal Europe, September 21, 1995.

second-largest Austrian bank played an important role, because Austria’s coalition politicians couldn’t agree on how to dispose of the government’s shareholding in the bank. But it has also to be emphasised that - from an economic point of view - several structural factors and specific framework conditions contributed seriously to the problem.

In particular, it should be noted that the issue of public ownership and privatisation is part of the much wider economic discussion on corporate governance, although it is now a widely held view that the government should generally not be the owner of companies in competitive sectors, such as in the banking industry. On the other hand, privatisation may not be seen an end in itself. It is part of a larger trend towards rebalancing the relationship between public and private sectors and is seen to contribute to the overall efficiency of an economy within this framework.

In this paper we shall argue that there are a number of economic reasons why the privatisation of Creditanstalt turned out to be much more complicated than expected. One main point in this respect is that the process of privatisation - and in particular the privatisation of a major bank - is closely related to the corporate governance structure of a country, to the ownership structure, the mechanism of control and the particular role of banks in this mechanism. A second important aspect is the problem of conflicting goals. As it is well known privatisation always has many aims - ranging from maximising budget revenue to promote share ownership and improve corporate governance - and it is always a very difficult task for the government to decide on the trade-offs when the objectives announced come into conflict with one another. To solve these conflicts in a sustainable way is not only important from an economic point of view but also for the political and social acceptability of privatisations.

Against this background the following two sections of the paper focus on the historical dimension. Section 2 summarises the attempts to privatise Creditanstalt, Section 3 illustrates the history of public ownership in the Austrian economy in general, section 4 describes the successful experience of privatising large industrial firms in Austria. Section 5 discusses the fundamental differences between the main two types of financial systems and, in particular, their consequences for the privatisation framework and relates this to the structure of ownership and corporate governance in Austrian banking. In sections 6 to 8 we try to evaluate some of the specific elements creating additional major difficulties in the case of Creditanstalt: These elements are the role of strategic and large shareholdership as well as the development of capital markets (section 6), the problem of foreign ownership

(section 7) and - last but not least - the particular importance of using a privatisation agent given these specific framework conditions (section 8). Finally, section 9 tries to draw some tentative conclusions based on this analysis.

2. The Creditanstalt privatisation story - A brief chronology of the attempts to sell Creditanstalt-Bankverein

In April 1991 the Austrian parliament passed a law empowering the Minister of Finance to sell the state owned stakes in two big commercial banks - Creditanstalt-Bankverein and Österreichische Länderbank - on the best terms possible. The law encouraged the use of capital markets for the placement of Creditanstalt shares, but the proposals to make secondary offerings of shares on the international markets turned out to be rather unsuccessful. Österreichische Länderbank was taken over by Zentralsparkasse und Kommerzialbank Wien (Z) to form Bank Austria, the largest Austrian bank.

General Electric Capital Corporation turns out to be the first serious foreigner interested in Creditanstalt in 1992 but the Creditanstalt board was hostile because it thought that GECC would only be interested in consumer finance. At the same time some interest in entering the Austrian banking market was also shown by Bayerische Vereinsbank, one of the largest German banks. Later on Creditanstalt sold its stakes in two foreign banks to Vereinsbank and its wholly owned subsidiary Mercurbank to GECC. Therefore both bidders showed no further interest in Creditanstalt.

The first concrete Austrian offer came in from Raiffeisen Zentralbank (RZB) for the Austrian co-operative banking group in 1993 with further backing from an unnamed foreign partner. Creditanstalt’s board opposed the plan because they saw a diminution of capital in the planned reverse take-over. The government rejected the RZB proposal as well since RZB was not willing to reveal its foreign partner.

Early in 1994 Credit Suisse emerged as a potential buyer. At the same time EA-Generali, a close partner of Creditanstalt, began to construct a defensive, largely domestic consortium, bringing together some of Creditanstalt’s best clients and partners. This - so called - “Austrian consortium” was joined later on by Erste Österreichische, a leading savings bank. The consortium received open support from Creditanstalt’s management board. It offered 7.2 bln. ATS for 37 per cent of voting shares, Credit Suisse said it wanted to buy 20 to 30 per cent at once and take full control later on. But after open resistance from CA’s

management board, from the employees of Creditanstalt and negative public reactions Credit Suisse withdrew its bid in September. The Minister of finance said he was very much in favour of the Credit Suisse offer, but - given the resistance of CA’s management and employees - it would almost have been a hostile take-over. He hired Booz-Allen & Hamilton as adviser.

During the first month of 1995 Germany’s Allianz Holding and Bayerische Hypotheken- and Wechselbank AG submitted an offer for Creditanstalt and the Austrian consortium raised its bid. With Allianz and Bayernhypo the last foreign bidders withdrew their interest due to problems of getting enough information from Creditanstalt on the economic situation of the bank. The new Minister of Finance hired J.P. Morgan as the government’s adviser. J.P. Morgan valued the stake in Creditanstalt owned by the public sector at 18 bln. ATS, including a control premium of about 6 bln. ATS. On September 7 an invitation to tender was published in the Financial Times. The government invited new bids by October 9. It was clearly stated - based on the preconditions agreed upon by the Austrian parliament - that Creditanstalt will be sold to the highest bidder, but that the deal must safeguard national interests and contribute to a restructuring of the banking sector. In other words, the government had to reconcile three possibly conflicting criteria in the privatisation process. In October the coalition government resigned and a new election was called. This put the sale of Creditanstalt on ice well into 1996.

By mid 1996 Erste Österreichische proposed a holding company to control the majority of Erste and Creditanstalt. Creditanstalt’s executives rejected the plan by asking for a “proper valuation” of both banks. The new Minister of Finance gives the consortium a deadline to submit a final bid by the end of August. But Erste leaves the consortium and the rest of the consortium submitted its own bid which was rejected. The bidding was re-opened with an updated valuation by J.P. Morgan and a November 15 deadline. Just before that date Erste rejoined the consortium and together they made a new offer. The consortium and two other bidders started due diligence at Creditanstalt and the Minister of Finance fixed December 16 as final bid deadline. By December 16 three bids came in, one by the consortium, one by entrepreneur Karl Wlaschek, who just sold his foodstore group, and - surprisingly - one by Bank Austria, Austria’s largest bank. Bank Austria always denied to be interested in Creditanstalt and rumours about a bid since summer weren’t taken seriously. The bid was re- opened to allow all three bidders to improve their offers and a new deadline of January 10 was set.

The consortium and Bank Austria raised their bids during the first days of 1997 but gave no details. The government coalition partners held a political meeting on the sale of Creditanstalt on January 11/12 and after 11 hours of discussion they agreed on the purchase of Creditanstalt by Bank Austria, mainly because Bank Austria’s bid was higher than the two rival offers. Bank Austria offered 17.2 bln. ATS, 863 ATS per share compared to only 14.3 bln. ATS bid by the consortium. The sale contract with Bank Austria included a 17 point agreement on specific framework conditions of the sale, for example, that Creditanstalt would not be merged into Bank Austria for five years and that Bank Austria itself would be taken out of public control step by step.3

What are the main conclusions that can be drawn from this story and what are the stylised facts behind them that are important from an economic point of view? There are three main points which more or less determined the outcome and the problems in the privatisation process of Creditanstalt:

• The first point are the criteria set by the Austrian parliament. Based on these criteria - mentioned in the international invitation to tender in detail - the Austrian government had to fulfil certain preconditions. The law governing the Creditanstalt privatisation process says that the government has to sell to the highest bidder, at the same time another part of the law clearly says that the majority of Creditanstalt should be kept in Austrian ownership and that the deal should contribute to the restructuring of the country’s banking system.

Many of the bids, including that by the Austrian consortium, appeared to fall well short of the government’s stated aims. For example, most of the bids failed to meet the objective of using the Creditanstalt privatisation to speed up the rationalisation of Austria’s banking system. Taking these framework conditions seriously, the Bank Austria offer finally made the best sense: It provided the government with the most money, kept Creditanstalt in Austrian ownership, and offered the best scope for reducing the over-capacity in the banking system.4

3 For details on this 17-point agreement see “Death of a bank”, Euromoney, March 1997, p.47. In the meantime, the remaining stake of the federal government in Bank Austria was sold to the public through an agent. 4 See for example “The jinxed Austrian bank”, Financial Times, December 20, 1996.

• The second important element was the objective to keep the Austrian roots of Creditanstalt. It must be underlined that this objective was also set by the Austrian parliament and that the view not to sell the second-largest bank to a foreigner is shared by an overwhelming majority of the population. One may argue that it would not have been possible to get public support for Creditanstalt’s privatisation at all if this objective wouldn’t have been met. On the other hand a precondition that more or less excludes the option of considering foreign bids clearly limits the possibilities available. This may be illustrated by the fact that despite the attempts to “reopen” the tender several times the government was left with only one serious candidate - the Austrian consortium - most of the time. However, the problem of foreign bids is also closely related to the structure of Austrian financial markets and to the dominant role of banks on the stock as well as on the capital market. It has to be discussed in the wider context of broadening share ownership and the capacity of the Austrian equity market.

• Last but not least - and perhaps one of the most crucial elements - Creditanstalt’s management board played an important and very active role in the whole process of privatisation. It can be questioned if this was the role executives of a company to be privatised should play in an ownership change. While the government favoured a single large buyer, Creditanstalt did not. They favoured a wide distribution of shareholders as, for example, enjoyed by Deutsche Bank. CA’s management didn’t like the idea of a large controlling shareholder, especially another large bank. Over the years Creditanstalt had seen at least four possible foreign bids and one very serious national offer. They were always rejected immediately because of such strong views on the independence of the bank, the only way of privatisation accepted would have been in terms of non-core shareholders. This is illustrated by the fact that the only two solutions supported by the board were (i) a general secondary offering of shares and (ii) the Austrian consortium. Both solutions would - in economic terms - have created a mainly management dominated bank with no strategic shareholder at all.

3. The history of public ownership in the Austrian economy

The public sector has traditionally played a strong role in the Austrian economy, as well as in issues of education, culture and law. One reason for this may be the positive and progressive impact of the enlightened monarchy in the nineteenth century (“aufgeklärte Monarchie”), which at this time led to the

development of a rather efficient bureaucracy in Austria. On the other hand, Austria did not produce a large stratum of innovative and dynamic entrepreneurs during the second half of the nineteenth century, but in contrast, experienced a lacklustre phase of liberalism. More recent roots for the high level of government interference may be that the wide-ranging bureaucratic structures of the former Austro-Hungarian Empire were concentrated within the small Austrian Republic following W.W.I, and that the economy stagnated between the two wars. After W.W.II, Austria needed and engineered a strong government in the form of a stable “grand coalition” uniting the conservative and socialist parties, and - parallel to the two blocs - the highly centralised “social partners”.

There are estimates that near the end of the seventies, 25 per cent of the gross national product was produced by publicly owned firms 5. The lack of large private companies and a very underdeveloped capital market characterised the other side of the coin. The major commercial banks were - at least partly - owned by the government, particularly the two largest, Creditanstalt and Österreichische Länderbank. These banks had considerable stakes in big manufacturing and construction firms.

While public ownership in infrastructure had long been a common feature of European economies, maintaining a large share of public ownership in manufacturing up to the nineties was an Austrian speciality among Western market economies6. For most of the public owned companies nationalisation can be traced back to 1946, just after the end of World War II. Socialists had - to some extent - favoured nationalisation for ideological reasons, but the conservative People's Party joined in on that goal in part because no potential Austrian owners were available, and partly to regain sovereignty and to protect

5 Aiginger 1985, p 41. The figure was 25 % for the total economy, excluding public consumption in the numerator, but using GNP in the denominator. If we add the public consumption in the denominator, the share of public ownership increased to 37 %. 6 Comparing ownership structures across countries is a difficult empirical issue. The share of public ownership in manufacturing in Austria is definitely higher than in Germany or Sweden. Comparing the share of public firms with France, the United Kingdom and Finland does not create a clear picture. Studies cited in Aiginger 1985 report approximately equal shares of about of 11 - 13 % of employees for France, the United Kingdom, Italy and Austria in an international study. On the other hand public ownership in all its different forms, including bank subsidiaries, state monopolies and co-operative associations amounted to 19 % according to the Austrian statistics.

the property of former German firms from the grip of the Allied Powers, during Austria’s period of limited sovereignty, from 1945 - 55. German ownership did exist in 1945 mainly for two reasons: some of the largest Austrian manufacturing firms were founded by the Nazi regime, other firms were expropriated during the Nazi regime; the former owners were forced to leave Austria.

In sectors in which natural monopolies traditionally were supposed to exist, it is well known that there are two alternative methods of dealing with market failure: public ownership or regulation. Instead of choosing between these two options, Austria installed the double grip: ownership plus a regulatory process embedded in the bureaucracy of a ministry, with supporting roles played by the trade union and employers' organization. To some extent this governance structure led to a predominance of political over economic goals but, at the same time, it implied a rapid rebuilding and expansion of capacities, which proved extremely important for Austria's recovery process after World War II. Later on, many of the well-known inefficiencies of cost plus regulation became apparent; investment decisions were made according to regional demands and political lobbying, increasing capacity became a more important goal than innovation and service orientation.

These negative judgements are, of course, being made with the benefit of historical insight. It has to be stressed that the system had operated very successfully for three or four decades. The first twenty years after the war were a period of remarkable recovery in Austria. But, as the system continued over decades, the potential increase in the productive efficiency of large firms, and their Schumpeterian potential for innovation, were more than outweighed by the Leibenstein slacks and allocative inefficiencies, since profit-seeking managers, firms and political parties decreased the incentive to equate resources and demands (allocative efficiencies), while cost plus regulation inhibited the search for low cost technologies and innovation.

Several attempts to reduce public interference were made. There was a limited wave of privatisation in the late fifties. Several firms, in particular located in the eastern part of Austria, had been German-owned during the War and were later managed by the Russians during the occupation period. In the late fifties, the need for restructuring the ownership of these firms was unavoidable. Some of them were sold to private owners, and some were privatised by a stock offering specifically targeted at employees and middle income investors (“Volksaktie”). Minority shares of the two large nationalised banks were also offered to the public, although the government retained the voting rights.

Today this experiment is considered to have been - at best - moderately successful. There was no popular, widespread attitude towards investment in stocks. Most of the shares were held by large or institutional buyers within a short period. But what seems particular interesting is that about four decades ago the attempts to privatise large stakes in enterprises owned by the public sector were more or less limited by the same structural features as at the end of the nineties.

The eighties brought with them a new wave of privatisation. The motives were mixed. Efficiency was among them, the conservative Peoples Party joined a coalition government and supported privatisation as a political goal, but - as in many other countries - raising revenues for reducing the federal budget deficit was the driving force. The volume of privatisation in the eighties may have amounted to ATS 30 bn; but about two thirds constituted the restructuring from one public owner to another. The main objective was to reduce the federal deficit, a secondary issue was the upcoming idea that efficiency and innovation would be supported by private stakes 7. During this process public ownership shares in the two large banks were reduced several times as well, but the intended general privatisation of the Austrian banking system turned out to be much more difficult than expected.

4. How to privatise firms: selling the majority of five large Austrian industrial firms

The governing structure of the public firms in Austrian manufacturing8 changed several times over the last four decades. Sometimes the firms were directly

7 For a summary of attempts at privatisation between 1987 - 90, see Siegl, 1990. The figures cited do not include specific attempts at privatisation in the nationalised industry sector. During this period, a minority share of the oil company was sold to the public, the ownership of a pharmaceutical firm and an electrical firm was transferred to foreign investors. But at the same time, the nationalised firms purchased just as many firms, in an attempt to restructure and to internationalise, so that we consider this phase as one of restructuring, but not of (net) privatisation. The OECD (1997) calculates revenues for privatisation US$ 32 million, increasing to US $ 1.2 bn in 1996, but this includes only privatisation by public offerings, not by trade sales. The figures for the OECD are US $ 24.7 bn, resp US $ 68.4 bn. 8 There are several types of public ownership of manufacturing firms in Austria. The largest type is the so called “Verstaatlichte Industrie”. This 10 Copyright © OECD. All rights reserved Banks and Privatisation Rome, 18 and 19 September 1997

governed by a ministry, sometimes separate agencies were installed with limited freedom in decisions. In the early seventies a stock company (ÖIG, then ÖIAG) was created as a holding company for individual firms; 100 per cent of the shares remained in government hands. Different steering methods were tested. First the holding company was designed as a loose financial holding, later it was transformed into a holding to implement strategic goals. In the beginning of the seventies, all the firms within an industry were integrated in branch holdings.

Following the large losses suffered by the firms during the eighties a new step towards reform9 changed the rules of management rather dramatically. The government announced a last subsidy; any further losses would have to be covered by privatisation. The leverage of the holding over the individual subholdings and firms was increased by defining the newly created Austrian Industries (AI) as a holding company. The vision was to form a large, professional, Austrian, multi-industry conglomerate, which was planned to go public within three to five years. Positive restructuring took place during the following years, the quality of decision-making processes and management was upgraded, the firms invested in active internationalisation. The final stage of the Austrian Nationalised Industry and the privatisation experience started in 1993. The old holding was dissolved10, the new holding (ÖIAG) was explicitly stated in the law could give no orders to its subsidiaries, except those which where necessary for the promotion of the privatisation process.

sector is comprised more or less of those firms which were nationalised in 1946 by law (1. Verstaatlichungsgesetz 1946). The ownership rights were monitored by different ministries and then by different holding or operating companies, called ÖIG, ÖIAG, AI, and finally again ÖIAG. The second most important form is the indirect public ownership of firms, whose shares are held by nationalised banks. The number of firms held by the banks was reduced over time, but as of 1997, the largest European brick company and major Austrian firms in the vehicle and chemical industries, and specifically construction industries were still held by the banks. A third group includes the (former) state monopolies for tobacco and salt; a fourth sector of firms has been organised as cooperatives. 9 OIAG Gesetz 1986, OIAG Finanzierungsgesetz 1987 10 OIAG Gesetz und OIAG Finanzierungsgesetznovelle BGBL 973/1993. Technically, the holding Austrian Industries was merged with ÖIAG and thus disappeared.

The law declared that the goal of privatisation - and therefore the criteria for choosing between alternative offers and methods - is the amount of revenue gained by the seller. But the law added that the selling agency also had to “to consider that Austrian manufacturing firms and the value added in Austria should be maintained, if economically feasible.” This clause had to be realised and was made operational in the so called “privatisation concepts”, which were to be developed by the new holding and approved by the owner. The “Austrian clause” was made operational by establishing a “privatisation checklist”. This included an assessment of the long term business plans of the potential buyers regarding investment, employment, research activities and headquarters, the probability that the firms would continue to exist or even be upgraded, the role of the Austrian firms as a centre of competence, and the consequences for Austrian suppliers and consumers. The final purpose of the checklist is to assess whether the buyer will strip the firm, eliminate an unwanted competitor, use the acquired firm as a low cost supplier, or whether the bidder has a strategic interest in a quality partner with own core competencies. It does not contain a preference for the nationality of the buyer.

As of 1997, the majority of all of the five large holdings have been privatised. In each case a different method, speed or process was applied. All headquarters remained in Austria: The oil and gas company, OMV, found a strategic partner in IPIC, a company in Abu Dabi. The Austrian Technology group VA-Tech is a success story, now a large international engineering conglomerate with subsidiaries all over the world. VA Tech has a considerable cross ownership, so that the majority of Austrian owners is well established. BUAG is the result of a merger of Austrian and Swedish firms, and is under Austrian management. AMAG, Austria's largest aluminium firm, was sold in 1996 at a negative price to a joint venture consisting of the restructuring management and a large, private Austrian company. Many smaller firms were sold, some via management buyout, some to foreign firms with larger stakes in the industry, some to Austrian entrepreneurs. The privatisation experience is now considered to have been successful. The revenues are much higher than anticipated, the holding still owns a strategic investment in four of the five firms, and headquarters have remained in Austria.

To sum up, one can recognise the following specific features of the process:

• Privatisation was rationalised by the experience, that neither variant of public ownership proved able to control a large and diversified conglomerate.

• The former holding company, which initially was a financial holding and then a holding exerting a strategic influence on the individual firms, was transformed into a privatisation agency with the objective of relinquishing the majority stakes. For that purpose, but only for that purpose, it could intervene in the firms, with the stick being the necessity to pay back the old loans, and the carrot being an incentive contract for the management, if privatisation revenues exceeded planned revenues. To a great extent, the firms were restructured before privatisation, which helped increase the revenues from privatisation considerably.

• The maximisation of revenue was the main criterium for choosing the time and type of privatisation, since only high revenues would allow paying back more of the existing debt.

• A second criterium for choosing among potential buyers was the continuing operation of the privatised firms, specifically that of firms located in Austria, and the value added created by them. This criterium nearly equates a national preference clause. But the careful use of words, and the objective, allowed the law to pass the scrutiny of the EU competition agency. Preferring a buyer who can plausibly contend that he will continue the production in the same country and use the plants as the headquarters for international expansion was not seen as unfair. Headquarters are favourable for a country, since usually some of the functions with the highest wages and those most important for planning and restructuring are located near to the headquarter, and if firms are restructured the preferences of the headquarter have a stronger influence on the final shape of the firm. In this respect, the privatisation strategies definitely pre-selected the structure of the potential buyers.

• Privatisation succeeded insofar as all five companies were sold and the strategic ownership of all of them remained in Austria. This was achieved in a non-discriminatory fashion, no single question of fairness was raised in Brussels by a competitor.

The success of this process induced the Austrian government to use the holding, respectively its management team, for further privatisation plans. The holding was asked to privatise the Austrian Salt Company (Salinen AG) and the Austrian Tobacco Industry. The management team chairs the Austrian Post and Telekom Holding (PTBG), which has two goals: to repay old debts and to make the operative company (PTA) fit for competition and privatisation in 1999.

5. Bank ownership and the role of the banking system to the corporate governance mechanism of an economy

As it has been mentioned privatisation in general and, in particular, the privatisation of large banks has to be discussed in the wider context of corporate governance. The economic discussion of corporate governance structures is based on two stylised models: The outsider model provides little direct control to owners/shareholders, but to act primarily through the capital market. Where management performance is unsatisfactory, the value of a company will decline, investors will sell their shares and the probability for a company to be acquired by a competitor will rise. The insider model allows (major) owners/shareholders to exercise direct control over managers through a representation on the supervisory board.

Even from this rough distinction of the two basic mechanisms of corporate governance it becomes clear that the structure and development of financial markets determines the functionality of either model to a great extent.11 Thus banks play a special role in the governance mechanism of an economy, which is underlined by distinguishing between “market-based” and “bank-based” financing structures. In the U.S. and the U.K. the mechanisms of stock and capital markets dominate, whereas in continental Europe banks hold the key position.

Yet the economic literature dealing with corporate governance structures comes to different conclusions regarding to the respective efficiency of the two models. It is interesting to note that Anglo-American researchers stress the advantages enjoyed by the bank-based model through its “long-term commitment” (Stiglitz, 1985), while continental European academics, in particular from Germany and Austria (Edwards - Fischer, 1994), are attracted by efficiency aspects of the capital market mechanism. It appears that knowledge of the imperfections inherent in one's own model breeds a preference for key elements of the other model. Thus, in relaxing the functional separation in the financial services industry and abolishing the ban on interstate banking, the U.S. attempts to improve the competitiveness of its banks against the European universal banks. At the same time, European countries, convinced of the inadequacy of their capital markets and stock exchanges, pursue a strategy of accelerating their development.

11 See in particular Mayer (1990) and (1996).

Relating these developments to the framework conditions of bank privatisation, the banking sector plays an ambivalent role in the financial system: On the one hand, it is itself a central player in the corporate governance mechanism of an economy, on the other hand, its dominant role within the financial structure of an economy sharply restricts the potential development of a market-based system of governance.

Even if one is willing to accept the basic arguments in favour of a bank-based model of financing structures, one might well argue, drawing on the experience in Germany and Austria in the 1980s, that complementing the present universal banking system by some essential market-based elements might be beneficial for the economy as a whole and for the performance of the banking sector as well. Economies that have reached a certain level of development can not be expected to be efficient in the long-term without developed markets for ownership control, in particular broad stock and capital markets. Quite possibly, insufficient attention is paid so far to the fact that - at least to some extent - existing financial structures of a country are often determined by specific historical influences and therefore not equally suited to forthcoming stages of development.

At least in several OECD countries banks exert considerable control over corporate management; at the same time, banks are themselves the subject of ownership issues. Like other businesses, they have to search for an efficient ownership structure and adequate monitoring mechanisms. Therefore these issues are of particular relevance for economic policy and bank privatisation plays a very important role in this context.

However, the banking industry exhibits some specific features which make bank privatisation clearly different from the privatisation of other firms: banks assume a key position within the overall financial structure of an economy and play themselves a certain role within the scope of the corporate governance mechanism of a country; trends towards internationalisation and liberalisation of traditional market structures, market behaviour and ownership structures began earlier and are much stronger in financial markets; as a result, national market structures and their regulatory framework need to adapt, leading to substantial consequences for the competitive position of the banking system in many countries.

Given these conditions the state's retreat from ownership in banks is necessarily closely related to he discussion of corporate governance in the Austrian banking sector. When no large domestic investors were available after World War II, the Republic of Austria undertook to hold a controlling stake in some major banks in order to secure Austrian ownership. But public holding was further enlarged by the participation of the provincial governments in regional mortgage banks and liability obligations assumed by local governments in the savings banks sector (community savings banks). In addition, public ownership and influence was enhanced by the lack of proper “owners” of co- operative banks and the savings banks. In the true sense of the word and regardless of the legal form, “private” ownership was the exception rather than the rule in the Austrian banking system.

Table 1: Stylized Facts of Ownership in Austrian Banking (as of year-end 1996)

Rank Bank Total Assets Type of Bank and Ownership (bln. ATS)

1 BANK AUSTRIA 726 Savings bank, listed on the stock exchange, partly owned by private shareholders 2 CREDITANSTALT 639 Commercial bank, majority of voting rights held by the government 3 GIROCREDIT 338 Central institution of savings banks, owned by savings banks 4 OEKB 256 Specialised credit institution, owned by banks 5 RZB 244 Central institution of rural credit cooperatives, mutual ownership 6 PSK 244 Postal savings bank, government owned, to be privatised 7 BAWAG 239 Commercial bank, 49% foreign ownership 8 ERSTE 225 Savings bank, listed on the stock exchange 9 RLB NÖ-WIEN 84 Rural credit co-operative, mutual ownership 10 OBERBANK 84 Commercial bank, partly owned by Creditanstalt 11 ÖVAG 79 Central institution of industrial credit cooperatives, partly foreign owned 12 RLB OÖ 77 Rural credit co-operative, mutual ownership 13 BSPK-RAIFF. 67 Building society, owned by rural credit cooperatives 14 STMK.BK-SPK. 60 Savings bank 15 BSPK-SPARK. 60 Building society, owned by savings banks 16 S-LINZ 57 Savings bank 17 BSPK-WÜSTENR. 56 Building society 18 LHB TIROL 52 Regional mortgage bank, owned by regional government 19 INVESTKREDIT 50 Specialised credit institution, owned by banks

20 BTV 49 Commercial bank, partly owned by Creditanstalt Source: own compilation

Since the early 1980s, direct state ownership as well as the government's influence have been on the wane. This trend is bound to continue into the second half of the 1990s: as evidenced by the privatisation of the federal stakes in Creditanstalt and Bank Austria, the search for new ownership structures for the Postal Savings Bank, further steps towards privatising the regional mortgage banks, and changes in the legal structure as well as mergers in the savings and co-operative banking sectors. In parallel with the state's retreat from ownership, the Banking Act of 1979 initiated a first wave of mergers and acquisitions, contributing to a significant rearrangement of market and ownership structures.12 The number of legally independent banks declined by 400 (about one quarter) within just four years (1978 to 1982). A second wave of mergers in the early nineties was mostly the result of strategic preparations and adjustments undertaken by Austrian banks to the forthcoming common European financial market. The recent past has brought not only a marked growth in the number of mergers as well as in the number of banks involved, but also a significant participation of large banks in the ongoing change of the market structures.

It appears that the ownership structure of Austrian banks is undergoing a fundamental rearrangement of which the outcome and consequences are difficult to assess in their full scope. This development strongly reflects problems that have been accruing from the deficiencies of the historically grown corporate governance structure prevailing in Austrian banking. The core problem certainly is the fact that Austrian banks for decades have suffered from low profitability, primarily due to a production efficiency that is low by international standards. Features such as a dense network of branch offices and intensive competition for market shares are, however, also signs of specific governance conditions where the lack of strategic ownership commitment led to corporate strategies that were typically management-dominated. At the same time the banks' strong position in the Austrian financial markets prevented the capital market, and especially the stock exchange, from developing into a functional mechanism of managerial control exercised by profit-oriented owners.

In searching for a theoretically desirable ownership structure in the Austrian banking industry we therefore must not limit ourselves to specific dimensions,

12 See Mooslechner (1997) for a detailed description of these elements.

like the questions of public versus private or domestic versus foreign ownership. Of similar importance is the question of strategic ownership commitment, as expressed by the contrast between management- and ownership-controlled corporate structures. In the attempts to privatise Creditanstalt this turned out to be one of the key problems in the privatisation process. But given the narrow confines of the Austrian capital markets, in most of the cases the problem is once again typically reduced to the question of how much foreign ownership seems to be politically “acceptable”, as the capacity of the Austrian stock market doesn’t allow for an appropriate mobilisation of domestic capital.

6. Strategic ownership, the large-shareholder principle and the development of capital markets

Given the importance of imperfect market and information structures, large- shareholdership is considered the more efficient and competent form of external monitoring and screening of firms by their owners than dispersed ownership (Shleifer - Vishny, 1986). In general, strategic owners or large shareholders are expected to solve the agency problem between owners and management better, because they are not only better informed, but also maintain a longer-term interest in the firm than small shareholders. Thus, an important feature of large-shareholdership is not only the volume of the shares held or the type of ownership (majority ownership, blocking minority), but the willingness of the shareholders to carry out monitoring functions for others, small shareholders in particular. Privatisation on the basis of the large- shareholder principle of state-owned monopolies (e.g., telecommunications) may therefore, despite higher efficiency in monitoring, be socially more efficient only in combination with the liberalisation and opening of national markets to foreign competitors.

Economic literature has not yet given us a clear answer to the crucial question of what kind of large shareholders are most able to secure efficiency in corporate governance. Under certain conditions (such as the existence of potentially competitive product markets, lack of private large investors or institutional investors with long-term goals), a combination of large- shareholding and cross-shareholding within the business sector may turn out to be the best form of governance, particularly for large companies. This requires, however, that the most important social function of organised markets (such as stock markets), namely efficient investor recognition, be enhanced beyond the level observed in many countries, with North America and Great Britain being notable exceptions. 18 Copyright © OECD. All rights reserved Banks and Privatisation Rome, 18 and 19 September 1997

In contrast to the corporate governance advantages of strategic ownership, initial public offerings are usually seen as the most transparent method of privatisation. Therefore, transparency and efficiency of the privatisation process may prove to be conflicting objectives. From a governance perspective initial public offerings can only be held efficient, provided that the equity markets are deep enough and the market for corporate control is functioning. In Austria household savings tend to be held primarily in saving deposit accounts with the banking system. Consequently business investment is mainly financed by retained earnings and bank credit. While such a bank-based financing system may have its merits in enterprise monitoring and control, it is characterised by a lesser in development of capital markets: Stock market capitalisation, market trading volumes and the popularity of owning shares remain low in international terms, trading on capital markets is dominated by banks and insurance companies. Issuers on the bonds market are nearly exclusively public authorities and banks, the share of manufacturing companies is insignificant.13

Table 2: The Development of Financial Markets in EU-Countries

(Countries ranked by total assets)

Market Nominal value Assets of Total Number of direct value of of bonds credit assets shareholders equities outstanding institutions

as a percentage of GDP total population

Luxembourg 11 680 3594 4285 na Belgium 38 148 296 482 5 United 130 33 253 416 22 Kingdom Austria 13 60 229 302 4 Germany 49 85 223 357 6 Denmark 40 193 202 435 na France 32 63 199 294 10 Netherlands 104 81 197 382 6

13 Table 2 and figure 1 give some illustrations on differences in development and financial structure in EU-countries.

Portugal 44 63 192 299 na Spain 31 55 183 269 na Sweden 72 97 179 348 35 Italy 76 116 140 332 na Finland 35 43 135 213 19 Ireland 40 38 123 201 na Greece 15 65 103 183 na

EU weighted 60 77 210 348 na average

Sources: FIVB, IFS, Morgan Grenfell, OECD, various national sources, own calculations

The underlying causes of inadequately developed capital markets are diverse, but include factors as traditional preferences by the population towards “secure” savings instruments and perceived market inefficiencies. The Austrian government has begun to address these issues since the beginning of the nineties by providing a new legal and institutional set-up for capital markets. It is also a specific aim of privatisation programmes that they are intended to contribute to a widening of share ownership and to create a “share holder” culture in the population at large. In particular, large scale privatisation that is able to attract new shareholders should lead to increased market capitalisation, to more liquid capital markets and to increased interest of companies in the capital market.

In many countries governments initially feared that capital markets, especially stock markets, would be unable to absorb the increased supply of equity created by privatisation programmes. But these markets have demonstrated a remarkable capacity to expand over the years. Nevertheless, the situation of the Austrian capital markets imposes significant limits on public offerings. For example, the proportion of shareholders in the population of about 4 per cent has not increased significantly over the last two decades. The raise in market volume during this period was almost completely absorbed by institutional investors (including banks) and foreigners. This situation led to the expectation that an initial offering of the government’s stake in Creditanstalt would have necessarily resulted in an ownership transfer to foreign investors.

Figure 1: Financial Structure of EU Countries 100%

90%

80%

70%

60%

Assets of credit 50% institutions

40% Nominal value of bonds outstanding 30% Mar ket v alue of 20% equities as a percentage of Total assets 10%

Italy

Spain

France Ireland Austria Finland Greece Belgium Sweden Portugal Germany Denmark

average

Luxemburg

Netherlands EU weighted

United Kingdom

7. Privatisation and foreign ownership

During the process of privatisation various issues arise and not all of them have been addressed in the economics literature. One of these problems, also of particular importance in the case of Creditanstalt, arises when the potential buyers are foreign companies. The main arguments in favour of foreign investors are that, as large controlling shareholders, they may bring advanced technology, modern managerial skills, better product quality, and enlarged access to both product and financial markets globally. In other words, giving control to a foreign company may improve the value of the privatised firm. However, foreign control of the domestic firm may also impose costs on domestic shareholders, since the foreign majority shareholder may have objectives other than maximising the firm’s value. In particular, he may try to obtain large private benefits of control, which cannot be shared by domestic

shareholders. Majority ownership usually gives the foreign company enormous market power, in particular if acquisitions have significant strategic value in terms of market entry. For example, a foreign competitor may buy a state- owned firm just to close it down.

This concern has been voiced several times in the process of privatisation of Creditanstalt and has led the Austrian parliament to set an objective of “safeguarding national interest”. But similar arguments are often been used to justify the sale of control only to domestic shareholders rather than to foreigners. As an objective, the government strikes a balance between obtaining a high payment today (the “revenue” objective) and increasing the value of the firm in the future (the “efficiency” objective). Due to the potential private benefits accruing to controlling shareholders, these two objectives are not mutually consistent. But how can the government screen among potential buyers, given that the government is unable to know exactly their intentions?

Unfortunately, economic theory can contribute little towards solving the dilemma of weighting two almost incompatible objectives. Theoretical as well as empirical studies offer few starting points for a useful qualification between foreign and domestic ownership by economic criteria. Only by considering substantial market imperfections, i.e., the “assumption” of differences in the behaviour of foreign and domestic owners under the same conditions, arguments for limiting foreign ownership may be derived, an economic policy perceived desirable by almost all countries. Even in the U.S., foreign influence in a “key sector” such as the banking system is viewed critically (GAO, 1996), although almost no economic reasoning is given for the attitude. Traditional economic arguments used in favour of limiting foreign ownership could be external effects, which in the case of banking would relate primarily to the banks' specific position in the transmission process of monetary policy and to the stability of financial markets.

By assessing growing foreign ownership in Austrian banking it should also be taken into account that the consequences of foreign ownership for banks may be different from those in manufacturing. Many financial services, including those in high-end market segments, are basically customer-oriented services. For as long as these product features apply, product supply must be provided mainly at the place where demand occurs. In spite of the rapid development of modern communication technologies. The value of stable long-term customer- relations provide further support for this assessment. Unlike industrial companies, banks are to some extent curtailed in their efforts to separate production from demand. This rather limits the risks regarding employment

and incomes seen by governments that might otherwise accrue from foreign ownership.

Nevertheless, suppliers of financial services can and do shift central functions internationally. In particular this may affect high-end service components (ranging from product development to market analysis) as much as back-office work that is susceptible to standardisation (outsourcing of data processing tasks). The trend to concentrate corporate core functions at headquarters has certainly been stressed by the financial services industry recently.

Despite liberalisation of international capital flows and serious difficulties in arguing in favour of domestic ownership in economic terms, many countries still have - at least implicit - restrictions in force to prevent major national enterprises from falling under foreign control when they are privatised. But once privatisation has taken place and in particular in the case of a public offering, foreign investors have full access to shares available in the stock market.

8. The missing privatisation agent

In addition to certain aspects of unfavourable framework conditions mentioned so far the process of privatising Creditanstalt was heavily criticised for the failure to appoint a privatisation agent. In general, the organisation of decision- making is a key element of any privatisation process. The success of privatisation depends to a significant extent on the effectiveness of the institutional structures put in place. Of course, these structures will vary from country to country and from case to case. In a centralised approach decision- making is done by a single autonomous institution, with a clear mandate stating the main framework conditions of privatisation. Such a privatisation structure can overcome political and bureaucratic obstacles and act on a clearly defined and transparent privatisation time-schedule. The complete opposite approach is to split the privatisation process between the branch ministries, which will slow decision-making, create bottlenecks and challenge the coherence of the privatisation programme. Within these two basic options decision-making can be attributed to an existing government body, for example a specific ministry, or an independent institution can be set up to operate the privatisation process under its own responsibility.

In contrast to the successful privatisation of Austrian manufacturing firms, the process of privatisation was directly managed by the Minister of Finance in the case of Creditanstalt. Offers had to be made to him; he assessed the adequacy

of each offer. At the same time an agreement between the two parties of the ruling coalition declared that privatisation was a “sensitive issue” in which the Minister of Finance had to consult the Minister of Economics. There was also no definite political agreement between the two coalition parties as to what objectives the sale should follow in the case of conflicting aims - for example, whether the maximisation of revenues was the overriding goal or whether it was a necessary or warranted condition to demand that the purchaser be of Austrian nationality. In addition there was an understanding that the Creditanstalt had always been the bank belonging to the sphere of the conservative party, so that any decision against this understanding must lead into political difficulties.

What is to be learned from the privatisation story of Creditanstalt in this respect? A main conclusion for the process of privatisation is that the Minister of Finance cannot privatise a firm by himself. His attention to the problem of privatisation fluctuated over time. When budgetary problems or Maastricht criteria became urgent, the attention towards privatisation vanished. Every time a new Minister came in that resulted in an additional delay and in a new attitude towards the privatisation process. In addition, every Minister is a member of a political party, and as such he is exposed to a great amount of pressure from his own party and from his coalition partner.

It can be argued that the task of the politician should be reduced to specify the objectives, a rough time frame, and maybe the type of privatisation. Then, he needs to delegate the process to an agency or company, which can make professional decisions, according to the rules stated. The agency should have some temporary leverage over the firm to be privatised, the minimum being a close co-operation with the firm's supervisory board. Several times, the CA’s management board actively interfered to attract or thwart off offers from potential bidders. It preferred a public placement, because this type of privatisation would have permitted the largest manoeuvring capacity for the management and, of course, its continuation. Finally, the incentives for the privatisation agency should be such, that payment directly depends on the fulfilment of the criteria for privatisation, as declared by the owner. Most of these rules were fulfilled in the privatisation of the nationalised manufacturing firms, while almost none were obeyed in the privatisation process of Creditanstalt 14.

14 Only in the latest stage of the privatisation process most of the rules were fulfilled. In particular, the last tenders were guided by an international consultant in close collaboration with the bureau of the Minister of Finance.

It became very clear that one important difference between the successful privatisation in the Austrian manufacturing sector and the long-lasting privatisation story of Creditanstalt was that the first was delegated to a privatisation agent with the power to restructure firms. In contrast the latter remained under direct ministerial control up to the very last stage. Mainly due to this political element the rules of the game were very unclear most of the time, the principal was weak and his choices were limited by political considerations several times. The agent was reluctant to the objectives set by the owner, he sought to codetermine the buyer and the method of privatisation.

9. Summary and conclusions

The privatisation of an public owned enterprise is always a very difficult task. Because there are conflicting objectives - ranging from maximising budget revenue to promote share ownership - the government has to decide on implicit trade-offs when the aims announced come into conflict with one another. From an economic point of view it is of particular importance that the issue of public ownership and privatisation has to be seen as part of the much wider discussion on corporate governance.

The recent decision of the Austrian government to sell its controlling stake in Creditanstalt, Austria’s second-largest bank, has ended a six-year attempt of privatisation, criticised as a lesson in “how not to privatise”. But it also has to be emphasised that there are a number of economic reasons why the privatisation of Creditanstalt turned out to be much more complicated than expected. Stylised facts and specific framework conditions contributed seriously to the problem.

Historically the public sector has played a strong role in the Austrian economy. For most of the public owned companies nationalisation can be traced back to 1946, just after the end of World War II. Despite Socialists had - to some extent - favoured nationalisation for ideological reasons, the main impetus for establishing public ownership in large firms came from the fact that no potential Austrian owners were available and because nationalisation helped hold off the grip of the Allies on former Nazi German ownership.

In the case of the Austrian banking sector the discussion of privatisation is closely related to corporate governance. The ownership structure of the Austrian banking system is undergoing a fundamental rearrangement which strongly reflects problems that have been accruing from the deficiencies of the historically grown corporate governance structure. Thus it is important to take

into account that banks play a special role in the governance mechanism of an economy, which is illustrated by distinguishing between “market-based” and “bank-based” financing structures. Whereas in continental Europe banks hold the key position in financial markets, the mechanisms of stock and capital markets dominate corporate governance in the U.S. and the U.K. Therefore, it is also a specific aim of privatisation programmes in many European countries to attract new shareholders, to increase market capitalisation and to create a “share holder” culture in the population at large.

What can be learned from an analysis of Creditanstalt’s privatisation in this respect? The elements that have created major difficulties during CA’s privatisation process seem mostly related to the specific criteria set by the Austrian parliament and deal in particular with the problems of foreign ownership, the role of strategic shareholders and the importance of appointing a privatisation agent:

Mainly for political reasons the objective to keep the Austrian roots of Creditanstalt was an important element in the process. Because this goal is shared by an overwhelming majority of the Austrian population, one may argue that without stating this objective it would not have been possible to get public support for Creditanstalt’s privatisation. On the other hand a precondition that more or less excludes the option of considering foreign bids clearly restricts the possibilities available. However, the problem of foreign ownership is closely related to the structure of Austrian financial markets and has to be discussed in the wider context of broadening share ownership and the financing capacity of the Austrian equity market. It became very clear from the difficulties in getting attractive offers for Creditanstalt that many of the problems go back to the specific framework conditions set for the sale.

Perhaps one of the most crucial elements was the very active role played by Creditanstalt’s management board. While the government favoured a single large buyer, a strategic investor, Creditanstalt favoured a wide distribution of shareholders. Over the years Creditanstalt had seen some serious offers, but its management always immediately rejected because of such strong views on the independence of the bank. CA’s board acted more or less explicitly to create a management dominated bank and to prevent a strategic shareholder, especially another large bank. In terms of economic efficiency it has to be questioned if this is the role the management should be allowed to play in an ownership change.

Last but not least a main conclusion from the process of Creditanstalt privatisation is the impression that the Minister of Finance - at least under Austrian circumstances - cannot privatise a firm by himself. It can be argued that the task of the government as an owner should be reduced to specify the objectives, a rough time frame, and maybe the type of privatisation. Then, the process has to be delegated to an agent, who should have some temporary leverage over the firm to be privatised. The incentives for the privatisation agency should be such, that payment directly depends on the fulfilment of the criteria for privatisation, as declared by the owner. One important difference between the successful privatisation in the manufacturing sector of the Austrian economy and the long-lasting privatisation story of Creditanstalt was that the first was delegated to a privatisation agent with the power to restructure firms. In contrast the latter remained under direct ministerial control up to the very last stage of the privatisation process.

In general, it turned out that the framework conditions - ranging from the objectives of the privatisation set by the parliament to the specific features of the Austrian capital market and the handling of the privatisation process itself - must be seen as the main factors that enforced substantial limits upon the success of CA’s privatisation. This leads to the conclusion that the economic success of privatisation attempts is very much determined by various country- specific factors which have to be taken into consideration right from the beginning of the privatisation process.

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