Learning Objectives

• Define Privatisation

• Practical and Theoretical Background of Privatisation

• Privatisation Experience

• Privatisation and Improvements of Management Control and Performance

Define Privatisation?

• The most common and useful definition is `change of ownership of enterprise from public sector to private sector'. But politicians and other people equate privatisation with commercialisation and deregulation.

• ‘Deregulation ' or ‘Liberalisation' includes the liberalisation of entry into activities previously restricted to the public sector and abolition of import controls (Cook and Kirkpatrick, 1988).

• Liberalisation also includes removal of distortions in labour markets, capital markets, product markets and market development (Cook Paul., 1986).

• The term 'commercialisation' include injection of private sector management practice like decentralisation or division of organization structure, introduction of incentive plans and balance sheet restructuring (Kay et al, 1986).

• A French social scientist, Andre Delion, used privatisation as four types of measures like ownership change, deregulation, liberalisation of government policy towards the private sector and the application of private sector management methods or criteria to the public sector.

• But in economic terms privatisation remains in the transfer of ownership and /or control of the avenues of supply of goods and services from the public sector to the private sector (Adam et al, 1992; Roth, 1987).

• Eventually, under this definition, privatisation excludes commercialisation and liberalisation but includes 1) The outright or partial sale of assets by the state 2) the transfer of assets to the private sector under leasing arrangements and 3) the introduction of management contracting arrangements.

Why Privatisation is Important to Management Control Research?

• Advocates of privatisation consistently presume that ensuing superior management controls will induce better performance (Vickers and Yarrow, 1988).

• Assumed private management control including accounting control techniques is superior and can be established in privatised companies.

• Few Empirical research on this claim especially in less developed countries (Cook and Kirkpatrick, 1995).

• Despite desired outcomes being contingent upon management control practices in their underlying theories of privatisation, development economists display little interest in empirically studying their intricacies .

Background of Privatisation in LDCs

• PUBLIC SECTOR FAILURE

• INTERNAL POLITICS

• EXTERNAL PRESSURE

PRIVATISATION ARGUMENTS – Theoretical Justifications

• Productive Efficiency Theories - Productive efficiency stems from micro-economic theories of property rights and agency within contractual relationships (Adam et al., 1992),

• Allocative Efficiency Theory – It covers the macro-economic effects of privatisation upon public finances, capital markets and private sector investments (Cook and Kirkpatrick, 1995).

Property Right Theory• Property right theory expounds that managers minimise costs if

their rewards are directly related to economic performance (Furubotn and Pejovich, 1972).

• Private owners induce more efficient managers through managerial controls and incentives that maximise profits and thence the value of property rights.

• There is a missing link between ownership and management control in the public sector as no-one has an incentive to do this: perceived costs will outweigh benefits since the latter do not accrue to individuals (Hanke, 1986).

• In contrast, if private sector owners do not produce efficient management controls or buy and sell assets to compete effectively they will suffer market failure or a takeover. Because public assets are not individually owned they lack transferability characteristics (Hanke, 1986, p. 16) and are buffered from competitive forces.

Agency Theory

• Agents act self-interestedly therefore principals must structure incentives to make them act in congruence with their aims.

• It is argued that principal‑agent relationships in the private sector are simple compared to the public sector, as shareholders have access to information to monitor management and sanction its actions accordingly (Adam et al, 1992).

• In an efficient capital market, failure to perform to potential leads to low share values making the company liable to hostile takeover bids.

• This threat creates a self‑regulating incentive scheme (Jensen and Meckling, 1976) which is absent in the public sector.

• Moreover, performance-related pay systems, central to agency theory, are more difficult to implement and devise in public sector organisations than private sector ones (Rees, 1985).

Allocative Efficiency• Public enterprises are often created to improve income distribution and

resource allocation within an economy through investment in modern technology.

• Neo-classical economists claim that public enterprises cannot match levels of allocative efficiency achieved under market competition, as the pursuit of personal goals by politicians, managers and workers within state enterprises diverts performance into other channels.

• Competition enhanced by private ownership is seen as essential for allocative efficiency as it reveals information crucial to efficient input usage (Adam et al., 1992). Without these market references principals cannot determine the correct amount and performance of management or the appropriate rewards.

• A profit fall could be due to lower demand or managerial inefficiency: in a market profit and price information from competitors enables principals to analyse and react to such situations whereas weakened competition produces weaker signals of input-output links important to internal efficiency.

• This enables management of public enterprises to enjoy a tranquil life under monopoly (Adam et al., 1992).

• Privatisation advocates see public financing, allocative efficiency and privatisation as intertwined. Privatisation is claimed to reduce net budgetary transfers, eliminate contingent external debt liabilities and reduce the adverse effects of deficit financing.

Critique of Privatisation – Theoretical Problems?

• Productive Efficiency Theories – Principal Agent Relationship

• Principal – Agent may be relevant for classical small firms but in the modern large limited liability corporation the property rights of owners are diluted.

• Diluted ownership in modern big corporations reduces owners' control over managers: Managers have considerable discretionary power to further their own interests (Commander and Killick, 1988; Adam et al., 1992).

Agency Theory - Critique

• Critics argue that this contains assumptions of dubious empirical validity.

• In practice access to complete information rarely prevails; information processing is highly complex; and conflicts within organizations create transmission barriers.

• Perfectly competitive markets are unlikely to occur in developing countries where poorly organized capital markets prevail.

• Relationships and motivations are more complex than agency theory envisages and possibly beyond its scope to model them, for example trust is ignored (Armstrong 1991, Neu, 1991).

• Links between a manager's efforts and outputs in terms of profitability are frequently more difficult to identify and measure than is alluded to.

Allocative Efficiency – Can it really be achieved through privatisation?

• Critics counter that allocative efficiency is possible with public enterprises, as competition is a result of market structure and state policy not ownership.

• Deregulation, liberalisation and the establishment of market competition are not essential or sufficient conditions for privatisation programmes, though they may be linked to its success (Jackson and Palmer, 1988).

• The fiscal effects of privatisation are misconceived, especially the role of privatisation in reducing budget deficits by eliminating financial subsidies and uneconomic activities (Adam et al., 1992). Subsidies stem from budget policy rather than the enterprises executing it (Ramaswamy, 1988):

• Subsidies could continue after privatisation, e.g. price support to farmers. Also, when privatisation reduces budget support for loss‑making enterprises ascertaining liquidity needs is difficult: governments must examine each case individually and tailor remedial measures according to circumstances (Ramaswamy, 1988).

Privatisation Experience in Developed Countries– General Findings

• Empirical research on the effects of privatisation in developed countries is inconclusive.

• For example, Wright et al. (1993) found that a privatisation through management buy-out had several positive impacts upon performance.

• Critical studies pointed out that privatisation policies have produced massive transfers of public wealth into private hands. Some illustrations below:

• Shaoul’s (1997) study of the UK privatised water industry found: whilst water privatisation yielded no efficiency gains, workers lost jobs, consumer prices rose, and infrastructure deteriorated. She concludes that ‘‘while the government’s case for privatisation rested upon efficiency and benefits for all, the real effects of privatisation was the redistribution of wealth to the new owners.’’(p.500-01).

• Arnold and Cooper (1999) reported: “The UK government received only £13.1 million in cash proceeds for a port that was resold 18 months later for £103.7 million. The managing directors of the management buy-out team and banking interests that financed the buy-out were the major beneficiaries of the privatisation. Medway’s chief executive, personally made £12 million on the resale of Medway Ports, nearly as much as the £13.1 million the Treasury collected from the privatisation” (p.145).

Privatisation Experience – General Findings

• Empirical research on the effects of privatisation in LDCs is also inconclusive (Cook and Kirkpatrick, 1995).

• Some studies have found that SOEs have lower profitability than their private sector counterparts in the same industry (Ayub and Hegstod, 1986; Killick, 1983; Kim, 1981; Funkhouser and MacAvoy, 1979)

• But other studies have found the public sector to be more efficient (Ramaswamy, 1988; Wortzel and Wortzel, 1989).

• Potts (1995) examined denationalisation and production efficiency in Tanzania finding improved, effective and innovative management after privatisation in two states but in others organisational effectiveness declined.

• Weiss (1995) found no significant evidence that SOEs had inferior performance to private enterprises.

• Karatas's (1995) comparative evaluation of pre- and post-privatisation company performance based on financial measures such as turnover, profit margins, and productivity. He found it difficult to demonstrate that privatisation impacted upon performance.

Privatisation and Management Control

• Privatisation/ownership changes assume the following:

- Superior management control including accounting will materialise.

- More transparent accounting and improved economic performance will follow.

- Facilitate broader development goals such as increased investment, GDP, productivity and employment.

What is Superior Management Control?

• Incentive based control• Market driven budgets• Politics free control• Bureaucracy free control• Managerial and employees’ involvement in

control• Transparent control system• Proper accountability and responsibility for

managers and employees

Does The Superior Controls – Western Management Control Techniques – Make any sense In LDCs?

• Asechemie (1997) argued profit to owners or concepts of wages are irrelevant in Nigerian Society particularly in informal sector

• Wickramasinghe and Hoper (2002) argued Western management controls are not conducive to local culture in Sri Lanka

• Perera (1989) argued that accounting including management accounting in its current forms is inapplicable to LDCs largely due to differences in business environments, ownership structures, users of accounting information, and attitudes towards disclosure.

• Peasnell (1993) called for more research on ‘what accountants actually do’ in Third World countries rather than imposing any ideas which developed in Western Countries

• Perera (1975) takes an eclectic but deterministic perspective to a Sri Lankan context portraying how the economic environment, namely, the capital market, taxation, regulation of accounting, and accounting education and training

• Tsamenyi (1997) argued management controls are shaped by local culture are ethnic conflicts in Ghana

Does The Superior Controls – Western Management Control Techniques – Make any sense In LDCs?

• Velayutham and Perera (1996) cultural orientations are important in shaping management controls.

• Japanese management controls are distinctly different than Western management accounting techniques – target costing and kaizen costing

• Abdeen (1980)concluded that the Western management accounting techniques are applicable in Syria.

• Chan and Lee (1997) found, to some extent, Western concepts of controls are applicable in Chinese companies.

Does Superior Management Controls

emerge in Privatised Companies?• Very few studies are conducted• Some of the findings are as follows:• Wickramasinghe (1996) argued the following:

– Reduction of bureaucracy– Introduced modern private management control but without any success– Could not solve the rural problem such absenteeism

• Uddin and Hopper (2002) argued the following:– changes of ownership altered controls towards more commercial ends to a

degree. – Production and marketing systems were improved and speeded up, partly

through computerisation. – Tighter work targets were imposed with effective monitoring. – Private owners instituted ad hoc and arbitrary controls over employees

reinforced by punitive sanctions.– The emergence of family controls– Control hardly rely on proper incentive systems, transparent budgetary control

system

Does the new controls in privatised companies Facilitate broader development goals

• Broader development goals include increased investment, GDP, productivity and employment

• Wickramasinghe (1997) did not find any improvement in profitability or productivity at the enterprise level

• Martin, (1995) reported When Telmex, a telecommunication in Mexico, was privatised, foreign buyers made gains of $12-billion in share values in the first year, largely because tariffs increased so much: on the other hand ‘‘the big losers are consumers, worse off by $33-billion’’.

• Uddin and Hopper (2003) ( 13 privatised companies were studied) found the following:

– privatisation has not increased returns to society: privatised companies’ contributions to state revenue declined in real terms and as a proportion of value added.

– Transparent external reports failed to materialise as required by law and there was evidence of untoward transactions affecting minority shareholders, creditors, and tax collecting institutions.

– Commercial profitability of the companies are more or less unknown due to lack of transparency

– Employment did not increase rather decreased

Why Expected Management Controls (Western!) are Different than the Actual Controls in Privatised

Companies?• Assumptions of Superior Management Controls (often lacking in

less developed countries):– Market-based strategies, – pricing and resource allocation decisions; – Detachment of state activities from enterprise management; – Relatively efficient capital markets able to sanction managers pursuing

sub-optimal policies; – A transparent, well-enforced structure of accountability and regulation; – Relatively unconstrained capital rationing; – Employees who base decision-making on organisational criteria rather

than personal or political considerations • Different cultural values• Politics• Trade unions