Privatization in Bank System
Category: Bank Management
Experience in the West and in the East shows that state ownership of firms does not provide the incentives for managers to behave in a profit-maximizing way and to undertake effort in order to restructure the firms they are responsible for. In privately owned firms, managers are subject to a system of carrots and sticks: if the firm performs well, managers receive bonuses (for instance, stock options), if they do not, they may lose their job. Ownership must be transferable on capital markets. Otherwise the performance of managers will not be reflected in increases and decreases of share prices, and both sticks and carrots cease to function. However, functioning financial markets are only a necessary, but not a sufficient condition. If managers are able to entrench themselves against outside interventions, owners and creditors cannot exert efficient corporate control and managerial incentives may be as weak as in SOE’s.
Privatization is very important for the activities of banks in the CIS as we will show in 2.3. The main consequence of the privatization policies that have been implemented in most CIS countries so far, is that managers have entrenched themselves against outsider influence, an that hence there is no efficient corporate control. The following privatization methods can be distinguished: First, spontaneous privatization, i.e. managers of SOE’s founded so-called “commercial structures” (mostly joint stock companies of the closed type) and transferred part of the assets of the SOE’s they were managing to these firms. This was only possible if bureaucrats from the responsible branch ministry rubberstamped these (at least slightly) illegal activities. Indeed, it appears that spontaneous privatization has often involved massive corruption and nepotism.
The second, and probably most important privatization method is the so-called insider-privatization. Governments chose this form of privatization in order to receive the support of political influential directors and workers’ collective of SOE’s. The procedure is as follows: First, firms were transformed into joint stock companies. Then, large blocks of shares (often majorities) were transferred to managers and workers. In the last step, it was planned to sell the remaining stocks by auctions or through emerging financial markets in order to raise cash for budgetary stabilization. However, it turns out that directors are managing to acquire these shares far below their value. Even if some outside ownership occurs, entrenched managers have so far been very successful in preventing any intervention from the outside.
This insider-privatization has ambivalent effects: productive and innovative managers take the initiative to restructure; others “sit and wait” and exert pressure on state institutions to subsidize. In the case of these latter, insider-privatization has even worsened the situation, since it has shifted the power away from the state and towards these managers. Capital flight can also be interpreted as a result of this form of privatization: assets are liquidated and transferred to foreign countries. According to the Financial Times, last year’s capital flight (22.3 bn $) from Russia was ten times greater than the inflow of foreign direct investment (2.2 bn $).
Finally, there is voucher privatization, a method in which every citizen receives the right to bid for shares of firms by making use of a privatization coupon that was distributed (almost) free of charge to all citizens. Since most citizens did not possess sufficient information about the profitability of firms, and often firms’ directors were trying to conceal respective information, vouchers were concentrated in investment funds. Some of these funds promised astronomic dividends, acquired shares, sold them on the market and took the money and ran. Others are today trying to get more influence in the firms in order to control managers, but face much resistance.
Privatization is hence just in the beginning. As long as secondary markets are not functioning, and shareholder rights are not enforced, unproductive “pseudo-private” managers will stay in control of many firms, and cannot be replaced by more productive ones.