WORLD BANK TECHNICAL PAPER NO. 368 ^ / 0/, 0){ {, 1v, /.P/ Wi As,,1: 0/ t)/ Pd.t)// X(va:,o;/I/'' 0 WTP3(o8 Work in progress for public discussion AuS3 1qq 4 Privatization and Restructuring in Central and Eastern Europe A'--1(Ilt t,til(IPoio -pM/ Sfit'/ / SI )fS/ gF' / _ .Slf 5d,....~~~~~~~~~~~~~~~~ _ _ V Z t r RECENT WORLD BANK TECHNICAL PAPERS No. 286 Tavoulareas and Charpentier, Clean Coal Technologiesfor Developing Coluntries No. 287 Gillham, Bell, Arin, Matthews, Rumeur, and Hearn, Cotton Produiction Prospectsfor the Next Decade No. 288 Biggs, Shaw, and Srivastiva, Technological Capabilities and Learning in African Enterprises No. 289 Dinar, Seidl, Olem, Jorden, Duda, and Johnson, Restoring and Protecting the World's Lakes and Reservoirs No. 290 Weijenberg, Dagg, Kampen, Kalunda, Mailu, Ketema, Navarro, and Abdi Noor, Strengthening National Agricultuhral Research Systems in Eastern and Central Africa: A Frameworkfor Action No. 291 Vald6s and Schaeffer in collaboration with Errazuriz and Francisco, Suirveillance of Agricuiltuzral Price and Trade Policies: A Handbookfor Chile No. 292 Gorriz, Subramanian, and Simas, Irrigation Management Transfer in Mexico: Process and Progress No. 293 Preker and Feachem, Market Mechanisms and the Health Sector in Central and Eastern Europe No. 294 Valdes and Schaeffer in collaboration with Sturzenegger and Bebczuk, Sutrveillance of Agricultiural Price and Trade Policies: A Handbookfor Argentina No. 295 Pohl, Jedrzejczak, and Anderson, Creating Capital Markets in Central and Eastern Eturope No. 296 Stassen, Small-Scale Biomass Gasifiers for Heat and Power: A Global Review No. 297 Bulatao, Key Indicatorsfor Family Planning Projects No. 298 Odaga and Heneveld, Girls and Schools in Sueb-Saharan Africa: From Analysis to Action No. 299 Tamale, Jones, and Pswarayi-Riddihough, Technologies Related to Participatory Forestry in Tropical and Subtropical Cotuntries No. 300 Oram and de Haan, Technologies for Rainfed Agriclulture in Mediterranean Climates: A Review of World Bank Experiences No. 301 Mohan, editor, Bibliography of Publications: Technical Department, Africa Region, Jufly 1987 to April 1995 No. 302 Baldry, Calamari, and Yameogo, Environmental Impact Assessment of Settlement and Development in the Upper Leraba Basin No. 303 Heneveld and Craig, Schools Couint: World Bank Project Designs and the Quiality of Primary Eduication in Suib-Saharan Africa No. 304 Foley, Photovoltaic Applications in Rural Areas of the Developing World No. 305 Johnson, Education and Training of Accoutntants in Sub-Saharan Anglophone Africa No. 306 Muir and Saba, Improving State Enterprise Performance: The Role of Internal and External Incentives No. 307 Narayan, Toward Participatonr Research No. 308 Adamson, Bates, Laslett, and Pototschnig, Energy Use, Air Pollution, and Environmental Policy in Krakow: Can Economic Incentives Really Help? 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Anderson, Stijin Claessens, and Simeon Djankov The World Bank Washington, D.C. Copyright C 1997 The International Bank for Reconstruction and Development/THE WORLD BANK 1818 H Street, N.W. Washington, D.C. 20433, U.S.A. All rights reserved Manufactured in the United States of America First printing August 1997 Technical Papers are published to communicate the results of the Bank's work to the development community with the least possible delay. The typescript of this paper therefore has not been prepared in accordance with the procedures appropriate to formal printed texts, and the World Bank accepts no responsibility for errors. Some sources cited in this paper may be informal documents that are not readily available. 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. The World Bank does not guarantee the accuracy of the data included in this publication and accepts no responsibility whatsoever for any consequence of their use. The boundaries, colors, denominations, and other information shown on any map in this volume do not imply on the part of the World Bank Group any judgment on the legal status of any territory or the endorsement or acceptance of such boundaries. The material in this publication is copyrighted. Requests for permission to reproduce portions of it should be sent to the Office of the Publisher 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 copy portions for classroom use is granted through the Copyright Clearance Center, Inc., Suite 910, 222 Rosewood Drive, Danvers, Massachusetts 01923, U.S.A. ISSN: 0253-7494 Photo: World Bank / IFC The authors work on the Private Sector and Finance Team in the Europe and Central Asia/Middle East and North Africa Technical Department of the World Bank. Gerhard Pohl is manager of the team, Robert E. Anderson is senior private sector development specialist, and Simeon Djankov is a consultant to the team. Stijn Claessens is principal economist in the Office of the Vice President, East Asia. Library of Congress Cataloging-in-Publication Data Privatization and restructuring in Central and Eastern Europe evidence and policy options / Gerhard Pohl . . . [et al.]. p. cm. - (World Bank technical paper ; no. 368) Includes bibliographical references (p. ). ISBN 0-8213-3975-3 1. Privatization-Europe, Eastem. 2. Structural adjustment (Economic policy)-Europe, Eastern. 3. Europe, Eastern-Economic policy-1989- I. Pohl, Gerhard. II. Series. HD4140.7.P7525 1997 97-13342 338.947-dc2l CIP Contents Summary ..................... v Acknowledgments ..................... vii Introduction ..................... 1 What is industrial restructuring? ......................1 Case studies ......................2 Sample of firms ......................3 Measures of profitability ......................4 Measures of restructuring ......................7 Determinants of restructuring ......................8 Extent of privatization ......................9 Impact of privatization ......................9 Concentrated control over firms ......................11 Role of banks ..................... 14 Wage restraint ..................... 16 Financial restructuring ..................... 16 Impact on bank restructuring ..................... 19 Conclusions ....................... 20 References ..................... 23 III Tables Table 1: Characteristics of the database of industrial firms ...............................................3 Table 2: Profit/loss categories for Polish firms in 1995 .....................................................5 Table 3: Industrial firms categorized by degree of profit or loss .......................................6 Table 4: Transition matrix for Polish industrial firms (1992-95) .......................................7 Table 5: Measures of restructuring for industrial firms .....................................................8 Table 6: Measures of privatization, 1995 ......................................................... 9 Table 7: Labor productivity growth, 1992-95 ..11...................................... 1 Table 8: Average combined ownership of five largest owners . ........................................ 13 Table 9: Investment per worker ......................................................... 17 Table 10: Sources of net corporate financing in developed economies, 1970-89 .............. 18 Table Al: Results on privatization and financial discipline .............................................. 25 Table A2: Effects of ownership concentration in the Czech Republic ............... .............. 26 Table A3: Profit/loss categories for Bulgarian firms in 1995 ........................................... 27 Table A4: Profit/loss categories for Czech firms in 1995 ................................................. 28 Table A5: Profit/loss categories for Hungarian firms in 1995 .......................................... 29 Table A6: Profit/loss categories for Romanian firms in 1995 ........................................... 30 Table A7: Profit/loss categories for Slovak firms in 1995 ................................................ 31 Table A8: Profit/loss categories for Slovenian firms in 1995 ........................................... 32 Figures Figure 1: Median number of employees in sample firms by country (1992) .......................4 Figure 2: Change in total factor productivity ......................................................... 11 Figure 3: Organization of a bank controlled fund ......................................................... 14 Figure 4: Impact of ownership concentration and bank ownership on stock market valuation in the Czech Republic .......................................................... 14 Figure 5: Sources of privatization revenue -- end 1995 ................................................... 15 Figure 6: Labor productivity and real wage growth for privatized and state-owned firms (% p.a.) ......................................................... 16 Figure 7: Proportion of industrial firms unable to service their debt ... 17 Figure 8: Ratio of total bank debt to sales for industrial firms (1992) .............................. 18 Figure 9: Bad loan ratio for industrial firms ......................................................... . 20 Boxed text Box 1: Restructuring of firms in the Slovak Republic .......................................................2 Box 2: Mass Privatization in the Czech Republic, Poland, and Bulgaria .......................... 12 IV POHL, ANDERSON, CLAESSENS, AND DJANKOV Summary The countries in Central and Eastern improvement in profitability over this pe- Euirope must determine what policies will riod. most encourage enterprise restructuring, Privatization had a large impact on re- which is essential for the transition to a structuring. On average, a firm that has been normal market economy and for accession privatized for four years will increase pro- to the European Union. Restructuring in- ductivity 3-5 times more than a similar firm volves shedding surplus labor, manufactur- that is still in state ownership. ing higher quality products, finding new We found little difference in productiv- markets in Western countries, and spinning ity between privatized firms in countries that off social and unneeded assets. used mass privatization methods (Czech and Privatization is In this paper, we analyze the financial Slovak Republics, Poland) and in the other the key to restruc- and operating data (1992 to 1995) for more countries, which, until recently, have used turing. than 6,300 industrial firms in seven coun- standard (case-by-case) methods. In other tries of the region: Bulgaria, Czech Repub- words, either method of privatization for the lic, Hungary, Poland, Romania, Slovak Re- same period of time will (on average) show public, and Slovenia. We compare the extent the same degree of restructuring. of restructuring across firms in these seven Based on an econometric analysis of countries to determine which country's Czech firms, we found that firms with con- policies are most effective in encouraging centrated ownership have restructured more restructuring. All firms were previously than firms with dispersed ownership. Firms owned by the state and many still are. These with loans from and ownership ties to banks firms account for 40 to 95 percent of the restructured even more. This suggests that industrial employment in these countries. banks may be able to better monitor the In our analysis we examined the follow- performance of managers and encourage ing measures of restructuring: restructuring if they are both owners and * Profitability lenders to the firms. * Proportion of firms with a positive operat- There are two related policy questions ing cash flow, concerning the role of banks in the restruc- * Average operating cash flow as a percent turing of firms. The first question is whether of revenue, governments should recapitalize the large * Growth in labor productivity, banks (typically still state-owned) to com- G Growth in total factor productivity, and pensate for their bad loans. The second * Growth in exports. question is whether banks should be encour- The results were consistent for all six meas- aged to forgive (write-off) bad loans made ures. to firms. Enterprise managers often argue We next used econometric ana,lysis to that these two policies will allow them to identify the government policies that most restructure more easily. Differentprivati- encouraged firms to restructure. In this Our econometric analysis examined first zation methods analysis, we used as the measure of restruc- whether additional bank lending actually show similar re- turing the increase in total factor productiv- encourages restructuring. The results are suIts. ity (the increase in output relative to the mixed. In the early years of transition, addi- increase in all inputs). tional bank lending in all countries except iAsetinoa inputs),ntial progress tOwrI for Hungary was actually associated with a Although substantial progress towards decline in subsequent productivity and prof- profitability was made in five of the coun- declme is subst thatuctivityans wre tries (Czech Republic, Hungary, Poland itability. This suggests that bank loans were trieSlovak ch Republic, and Hungary, Pola, f not helping to restructure firms but were Slovak Republic, and Slovenia), thie firms financing their losses. By 1995, however, are not as profitable as those in a developed banks in five out of the seven countries market economy (in which typically 95 per- seemed to be making more sound lending cent of the firms are profitable). In contrast, firms in Bulgaria and Romania showed little PRIVATIZATION AND RESTRUCTURING v decisions and supporting restructuring. The We also found that the amount of bad exceptions were Bulgaria and Romania. loans and thus the need to recapitalize the When we divided the sample into privat- banks is declining in those countries with ized and state-owned firms, it turned out that rapid restructuring. We estimated the ability poor bank lending was associated with state- of firms in our data set to repay their bank owned firms. In all countries banks make loans based on their operating cash flow. sound lending decisions for privatized firms, We conclude that recapitalizing banks but continued to support ailing state firms. and encouraging them to forgive loans is We next examined firms burdened by unlikely to help firms restructure very much. large loans from banks that they cannot In fact, poor bank lending practices may currently repay. We found that high levels discourage restructuring and result in addi- Imprudent bank of indebtedness at the start of transition did tional bad loans. A safer course of action is lending is mostly not hinder restructuring. One reason is that to recapitalize banks only at the time of their to state-owned such firms may be under greater pressure to privatization and after a large share of en- frms restructure. Another related reason is that terprises are privatized. That way there is firms in the region seem to be ingenious at more certainty that new bank owners will finding sources other than loans from banks improve the quality of lending, support re- to finance restructuring. These sources may structuring, and avoid another increase in include loans from new private banks, cred- bad loans. its from foreign buyers, new equity, joint ventures, and, most importantly, the firm's own cash flow. VI POHL, ANDERSON, CLAESSENS, AND DJANKOV Acknowledgments This paper was written by Robert E. Aprahamian in Romania; Eva Kostrecova Anderson, Simeon Djankov, and Gerhard and Agnesa Szucsova in the Slovak Repub- Pohl, (World Bank, Europe and Central Asia lic; and Mojca Jancar and Romania Logar in and Middle East and North Africa Technical Slovenia for help with the data and data Department, Private Sector Development definitions. Alan Gelb, Cheryl Gray, Iraj and Finance Group), and Stijn Claessens Hashi, Elena Kotova and various seminar (World Bank, Office of the Regional Vice participants at the World Bank, University President, East Asia and Pacific). The opin- of Michigan, the Czech Economic Associa- ions expressed are not necessarily those of tion, and the European Bank for Recon- the World Bank. struction and Development provided useful We would like to thank Ying Lin and comments. Faten Hatab for the excellent research assis- For comments or further information, tance and Kiril Gatev and Petko Shishkov in please contact: Tel: (202) 473-8272; Fax: Bulgaria, Petr Kucera in the Czech Repub- (202) 477-8772; or e-mail: sdjankov lic; Csaba Tancsoz and Mihaly Kopanyi in gworldbank.org. Hungary; Jan Macieja in Poland; Arabela PRIVATIZATION AND RESTRUCTURING VID I Introduction Only through improvements in firm define what restructuring means and give productivity and profitability will there be examples from interviews with 21 firms in an increase in the overall standard of living the Slovak Republic. We then examine the in transition economies. One of the most change in firm profitability in these seven important tasks in the transition to a market countries over the period 1992 to 1995. In economy is the restructuring of formerly addition to profitability, we use five other state-owned firms. This restructuring can be measures to determine which firms have thought of as the initial transition from a restructured the most. highly distorted economy with many large Next, we use econometric analysis to loss-making firms to a normal market econ- determine which government polices most omy in which most firms are profitable. encourage restructuring. These policies in- Restructuring is also a precondition for clude speed of privatization, allocation of accession to the European Union, which is bank lending, and reduction of indebtedness. an objective of many countries in Central Finally, we examine the impact of bank and Eastern Europe. Firms in these countries lending on restructuring and the link be- must be able to compete with EU firms tween industrial restructuring and the health without the need for subsidies or excessive of the banking system. risk of bankruptcy and loss of employment. Restructuring of firms is also closely What is industrial restructuring? linked to the health of the banking system. Operational restructuring of firms means Restructuring is a complex process. that they can pay a larger share of their bank Firms in all countries must continuously loans and thus limit the bad loans held by restructure to maintain profitability in the banks. This may lessen or even eliminate the face of a changing economic environment, need to recapitalize the state-owned banks technological progress, and competition through government-led programs. Healthy from other firms. This continual restructur- firrms are a condition for a healthy financial ing leads to higher productivity and eco- system. nomic growth. We have obtained data on the perform- In the early years of the transition to a ance of industrial firms in seven countries of market economy, firms in Central and East- the region (Bulgaria, Czech Republic, Hun- em Europe experienced severe demand and gary, Poland, Romania, Slovak Republic, price shocks. Demand for their products and Slovenia). These countries have adopted from former socialist countries had declined, different policies to encourage restructuring; and they were forced to find new markets in thus these data can suggest which policies Western countries with higher quality stan- have been the most successful. In this paper, dards. Lowered trade barriers meant that Restructurig we summarize and extend our recent re- they faced increased competition from im- should be a con- search using data for 1992-1995,1 and we ported products in their home markets. Fi- shous proceson update our earlier study that was based on nally, all countries experienced severe eco- similar data for 1992-1994.2 nomic recession which led to lower domes- We analyze a number of important is- tic demand. sues concerning restructuring. First, we As a consequence of these shocks, many firms in the region became unprofitable. In I This includes Claessens et al. (1997a), Claessens et some cases, their situation was so desperate al. (1997b), Djankov and Pohl (1997), and Djankov that their sales revenue was not even ade- and Hoekman (1997). quate to pay their suppliers. They were 2 The original study, Pohl et al. (1996) was based on classified as "value subtractors" because the firm-level data for Bulgaria, the Czech and Slovak market value of their production was less Republics, Hungary, and Poland. than the cost of the materials used. If these PRIVATIZATION AND RESTRUCTURING 1 firms could not restructure their operations, Box 1: Restructuring of firms in the they were unlikely to survive. Thus one Bovak Repuc fundamental measure of restructuring is whether firms are able to become profitable The managers of 21 large Slovak in the new economic environment. industrial firms (19 of which were pri- In this paper, we make a distinction vate) were interviewed regarding the between operational restructuring and fi- steps they took to restructure their firms. nancial restructuring; operational restructur- These steps include: ing is the primary objective. 1. Labor shedding - The number of workers was reduced by 46 percent Case studies from 1991 through 1996, which im- OperaCosal (not proved cash flow and made revenue Operational (ntavailable for investment. financial) restruc- Restructuring involves many difficult 2. Wage stability The average real turing is the pri- changes in the operation of a firm. In order wage for all firms was almost constant mary objective, to gain an appreciation of the restructuring from 1991 to 1996 although there was process, we interviewed the managers of 21 considerable variability from firm to firm. large, mostly troubled firms in the Slovak 3. Spinning off social and unneeded Republic operating in a wide variety of in- assets - Most firms transferred to local dustries.3 governments such assets as housing, The extent of restructuring in these recreational facilities, and cafeterias; firms was substantial. In the early years of and they sold assets no longer needed transition, two-thirds had been large loss- such as inventories and surplus equip- makers and one-third were judged by man- ment and machinery. agement consulting firns to be nonviable. 4. New Westem markets -- In 1991, By the end of 1996, however, over two- only 9 percent of output was sold to thirds of them were profitable including Western countries. By 1996, the output one-half of the firms judged nonviable. had increased to 47percent. Generally In the early years of transition, the sales this occurred because the Slovak firm renethes eal herse ofirms transit uth sals had become a supplier or subcontractor revenues of these firms dropped; but byv oaWsenfr ahrta eln 1996,reveues (n costantdollrs) ha to a Westem firm rather than selling 1996, revenues (in constant dollars) had directly to final consumers. increased to the level of 1991. This suggests 5.rew poducts uaiire that managers had found new markets to New -Ioderto a supprto ment -- In order to become a supplier to take the place of those in former socialist a Westem firm, the Slovak firms had to countries. Labor productivity (measured by change their product mix and improve value added per worker) almost doubled quality standards. For example, two- from 1991 to 1996. Most of these firms had thirds of the firms have obtained an ISO domestic owners (the majority of which 9001 certificate for total quality assur- were current or former managers) and re- ance. ceived little foreign investment. The examples from the Slovak Republic owned firms that must restructure. These (Box 1) illustrate what a firm must do to firms must rely on their own skills and re- restructure and thus return to profitability. sources. The majority of managers and new owners This is not to minimize the value of were able to restructure their firms without foreign investment and the advice from large amounts of foreign investment, foreign Western management experts. Foreign in- management expertise, loans from state- vestors often bring skills that are in short owned banks, or government assistance. supply in transition economies (e.g., market- This is encouraging because outside assis- ing skills). Previous studies show, however, tance is unlikely to be available in large that foreign investors are usually attracted to amounts for the thousands of former state- firms with considerable market power that 3 Djankov and Pohl (1997a). 2 POHL, ANDERSON, CLAESSENS, DJANKOV Table 1: Characteristics of the database of industrial firms Czech Slovak Finn Characteristics Bulgana Republic Hungary Poland Romania Republic Slovenia No of Firms 828 706 1,044 1,066 1,092 905 727 No. of Employees, 1992 314,042 829,312 428,645 1,338,629 2,121,102 578,737 219,959 % of Total Industrial Em- ployment 48 64 41 45 91 93 90 Employment in Each Sector (°%) Food 12.0 5.4 11.2 8.7 8.4 13.7 10.4 Tobacco 0.8 1.5 2.6 1.1 1.6 0.8 1.9 Textiles 9.0 5.5 13.0 8.5 6.9 4.2 12.9 Apparel 5.1 2.3 3.7 1.9 1.1 3.4 5.8 Lumber 8.4 3.6 3.5 2.3 8.8 4.3 3.0 Fumiture 2.8 1.2 2.8 2.0 5.5 1.6 3.2 Paper 3.1 1.5 1.6 1.4 1.5 1.9 1.7 Printing 0.7 3.3 0.9 0.4 5.1 2.9 1.1 Chemicals 6.7 2.3 8.0 7.9 8.8 7.6 8.0 Petroleum refining 3.8 2.6 4.4 3.2 6.7 1.0 1.0 Rubber 1.9 1.4 4.3 4.5 1.6 2.7 2.2 Leather 3.5 1.5 2.5 2.6 3.3 3.0 3.5 Stone, clay, glass 2.7 14.6 5.4 7.6 3.7 4.6 1.5 Primary metals 6.2 7.0 9.1 10.6 1.8 4.8 13.5 Fabricated metals 2.9 9.8 3.9 4.6 10.3 14.6 4.0 Non-electrical machinery 17.5 16.2 5.6 15.2 9.2 10.0 4.1 Electrical machinery 4.3 3.0 10.9 3.2 3.6 5.0 14.1 Transport equipment 0.8 12.6 3.7 11.6 9.0 8.8 2.4 Instruments 7.6 3.8 2.3 2.2 2.2 4.1 5.3 Miscellaneous 0.2 0.9 0.6 0.5 0.9 1.0 0.4 have already restructured.4 It would be a mistake, then, for managers to rely on out- Sample of firms side assistance that may not be available.5 We measure the speed of restructuring 4 See Carlin et al. (1995) for a survey. using financial statements and operating information from a large sample of indus- 5 A recent study, Djankov and Hoekman (1997b), trial firms in seven countries of the region documents the altemative paths through which Czech (Table 1). These are all formerly or cur- firms obtained access to foreign technology. In many rently state-owned firms. In order to make cases, firms signed subcontracting agreements with (mostly) German and Austrian partners that later the sample excludes firms in the utilitys, resulted in joint ventures. As part of the agreements, the foreign counterparts advised Czech managers on banking, and agricultural sectors, and new appropriate technologies and suppliers and frequently private companies. trained their workers in the use of new equipment. PRIVATIZATION AND RESTRUCTURING 3 The number of firms in the sample for Figure 1: Median number of employees in each country ranges from 700 to more than sample firms by country (1992) 1,000. These firms account for a large share of the employment in the industrial sector l I (ranging from 40 percent to more than 90 Bulgaria_ 291 percent). The original sample for 1992 in- - cluded almost all industrial firms. Firms Czech Rep 409 were dropped from the original sample if data for some years were missing.6 Hungary 241 The proportion of firms in each indus- - trial subsector is similar from country to Poland 820 Our data set in- country. In most countries, there is a con- cludes most centration of firms in food, textiles, chemi- Romania 1,327 manufacturing cals, metals, machinery, and transport firms. equipment. Some countries, however, have Slovak Rep. 335 specialized in different subsectors, for ex- 4 ample, the Czech Republic in the stone, Slovenia 213 clay, and glass subsector, Slovenia in elec- l - ! trical machinery, and Bulgaria in nonelectri- 0 500 1,000 1,500 cal machinery. The size of a typical firm in terms of employment differs somewhat from country from country to country.7 We also focused to country with the largest firms found in on measures of restructuring that incorpo- Poland and Romania (Figure 1). This is not rate the most reliable elements of the data. surprising since these countries have the For example, we emphasize comparisons of largest economies. The average size of operating cash flow (sales revenue less cost manufacturing firms in the region at the start of inputs and wages). This measure does not of the transition was higher than in devel- into take account depreciation, debt service, oped market economies, but this was due to and taxes, which are more likely to differ the absence of small firms rather than the from country to country because of histori- predominance of very large firms. Very cal circumstances, differences in tax laws, or large firms account for a larger share of accounting standards. manufacturing and employment in devel- oped market economies than in the transi- Measures of profitability tion economies. In making comparisons between coun- The long term objective of restructuring tries, it is important that the accounting and is to improve the level of profitability of financial data for firms be based on similar firms to a level similar to mature market Data were ad- standards. We adjusted the data to reflect economies in which almost all firms are justed to be com- differences in standards both over time and profitable. Because a larger percentage of parable across firms in the transition economies are un- countries, profitable, it is useful to categorize the firms according to their degree of profitability or loss. 6 This exclusion of firms from the sample for lack of Polish firms in 1995 are used to illus- data appeared to be random, and not to introduce a trate this categorization (Table 2). The cate- significant bias. The sample would be biased if the dropped firms were primarily the worst performers; for example, large loss makers that ceased to function 7 The main adjustments to the data were to reflect or were liquidated. If this is important, it may overes- changes in the accounting for inventories (early in the timate the extent of aggregate restructuring in Bul- period, increases in inventory was counted as a sale), garia, Hungary, and Poland where (relatively) more and the fact that government subsidies were recorded firms were excluded from the sample. as sales. 4 POHL, ANDERSON, CLAESSENS, DJANKOV gories of profit or loss range from category ciation of the existing assets. This is not a A firms, which are profitable (after taxes) by payment to anyone else but reflects the fact international accounting standards, to cate- that revenue is not adequate to maintain the gory E firms, which are value subtractors. level of productive capital. (Table 2 shows The categories are ranked based on the pri- that 221 firms are in this category because ority of paying expenses. they have a negative income before tax.) * Category E firms do not earn enough * Category A firms can pay all of their revenue to even cover the cost of material costs, debt service, depreciation, taxes, and inputs much less pay any of the other operat- still have revenue left over. (Table 2 shows ing costs. (Table 2 shows that 15 firms in that 574 firms are in this category because this category have a negative operating they have a positive net income after tax.) margin.) Comparing the number of firms in Cate- Firms were cate- * Category D firms can pay their suppli- gory A for various countries (Table 3), the gorized according ers but cannot pay all of their workers. Czech Republic and Hungary had the high- to degree ofprofit (Table 2 shows that 126 firms are in this est percentage of profitable firms (74 per- or loss. category because they have a negative op- cent and 70 percent respectively) and Ro- erating cash flow.) mania and Bulgaria the lowest. In almost all * Category C firms can pay all of their countries, the profitability of firms has im- workers and suppliers but cannot service all proved significantly (Table 3). of their debts;, for example, they are behind But there is also a great deal of variabil- in their interest payments to banks. (Table 2 lty in performance. Some firms show an improvement in their profitability while shows that 13 firms are inthis categor others show a decline. This variability is because they have a negative cash flow after itra in a "transiTio marixfPlis debt service.) illustrated in a "transition matrix" for Polish * Category frms have enugh revenue firms (Table 4). Each row of numbers shows * (Category B firmns have enough revenue wvhich firms in a particular category in 1992 to cover all of their costs except for depre- moved to anothe r category in 1995 moved to another category in 1995 or stayed Table 2: Profit/loss categories for Polish firms in 1995 All Category Category Category Category Category Firms A B C D E Number of Firms 1,066 574 221 130 126 15 Employment: (1,000) 1,122 542 260 169 136 16 Employment % 100% 49% 23% 15% 12% 1% Loans Outstanding % 100% 43% 26% 14% 15% 2% Sales Revenue (mil. zloty) 93,655 45,761 28,459 11,244 7,116 1,074 (% of Revenue) In 1995 50 per- Sales revenue 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% cent of Polish minus cost of materials and energy 80.6% 79.1% 80.7% 80.9% 84.4% 119.3% firms were profit- = Operating margin 19.4% 20.9% 19.3% 19.1% 15.6% -19.3% able. minus wages and wage taxes 12.3% 9.3% 13.5% 16.6% 20.1% 8.5% = Operating cash flow 7.1% 11.6% 5.8% 2.6% -4.5% -27.8% minus net financial charges 3.2% 2.7% 2.9% 4.8% 4.6% 1.5% = Cash flow after debt service 3.9% 8.9% 2.9% -2.2% -9.1% -29.4% minus depreciation 5.0% 4.2% 6.4% 4.9% 5.0% 1.9% = Net income before tax -1.0% 4.7% -3.5% -7.1% -14.2% -31.3% minus income tax 1.3% 2.3% 0.3% 0.2% 0.3% 0.0% = Net income after tax -2.3% 2.4% -3.9% -7.3% -14.4% -31.3% PRIVATIZATION AND RESTRUCTURING 5 Table 3: Industrial firms categorized by degree of profit or loss (percentage of firms weighted by employment) Unprofitable Cannot Cannot Cannot Cannot Cover Service Pay all Pay all Profitable Depreciation all Debt Wages Suppliers Year A B C D E Total Bulgaria 1995 45 13 17 22 4 100 (828 firms) 1994 43 11 29 13 4 100 1993 22 18 23 32 5 100 In the Czech Re- 1992 28 10 31 27 4 100 public 73 percent offirmsareprof- Czech Republic 1995 73 19 6 1 1 100 itable. (706 fims) 1994 71 20 6 3 0 100 1993 63 25 10 2 0 100 1992 60 11 15 13 1 100 Hungary 1995 70 14 6 9 1 100 (1,044 firms) 1994 67 11 9 11 2 100 1993 67 9 8 12 4 100 1992 59 9 12 14 6 100 Poland 1995 49 23 15 12 1 100 (1,066 firms) 1994 45 23 16 14 2 100 1993 40 17 12 24 7 100 1992 37 16 16 21 10 100 Romania 1995 24 16 9 40 11 100 (1,092firms) 1994 23 13 11 40 14 100 1993 24 16 8 42 10 100 1992 30 7 9 41 12 100 Slovak Republic 1995 56 27 7 10 0 100 (905 firms) 1994 57 21 9 13 0 100 1993 51 22 12 13 2 100 1992 48 16 13 19 4 100 In Romania, only Slovenia 1995 64 17 9 8 2 100 24 percent of (727 firms) 1994 67 14 13 6 0 100 firms are profit- 1993 67 13 15 5 0 100 able. 1992 65 13 17 5 0 100 in the same category. Both the number of improvement and remained Category E firms and a percentage of the total is pro- firms. At the opposite end, the profitability vided. of some firms in Category A in 1992 de- Using Category E firms (the worst per- clined over the period. Of the 498 profitable forming firms) as an example, this matrix (Category A) firms in 1992, 333 firms (67 shows that 31 out of the 72 firms in this percent) remained profitable. The other 165 category in 1992 (43 percent) became prof- firms, however, became unprofitable and itable and moved into Category A by 1995. moved into the other four categories. Two of In contrast, 6 firms (8 percent) showed no the profitable firmns in 1992 actually moved 6 POHL, ANDERSON, CLAESSENS, DJANKOV into the worst loss-making category Thus the first measure of restructuring is the (Category E).8 percentage of firms (weighted by employ- Of the total 1,066 firms, 835 showed an ment) that have achieved at least a positive improvement or stayed the same while 231 operating cash flow. This is defined to be showed a decline. In comparing these matri- sales revenue less cost of inputs and wages. ces from one country to another, a matrix In Table 3, this would include all firms in with the largest numbers at or below the profit Categories A, B, and C. Conversely, diagonal (shaded area in Table 4) means that this measure also indicates the proportion of firms in that country are restructuring the firms in each country that are still large loss- most. In examining a similar matrix for makers. Once a firm has at least achieved firms in a developed market economy this level of profitability, it can use its op- (United Kingdom), we found most loss- erating cash flow to service some of its debt making firms improved or ceased operating. and invest in modernization and growth. * Operating cashflow. Although the first Table 4: Transition matrix for Polish in- measure of restructuring indicates how dustrial firms (1992-95). many firms remain large loss-makers, it says Number of Firms and Percent nothing about the profitability of all firms. by Profit and Loss Category To measure this, we used the operating cash 1995 flow as a percentage of sales for all firms in A B C D E Sum the sample. Operating cash flow is again A -3331 38 31 2 498 defined to be sales revenue less cost of in- -1 h19 L 8% 6% 0% 100% puts and wages. B 50 41 22 10 0 123 * Labor productivity. One of the most 41%/o sa%- 18% 8% 1 0% 100% difficult problems facing firms was the issue 1992 C -39 27 33 27 1 127 of surplus labor. As sales to their traditional 31% 211 26% 21% 1% 100% markets declined, firms either had to find D-121 : 47 . 33-- 39 6 246 new markets or lay off surplus workers. To 49% 19% 13%. 16% 2% 100% -9% 19% 13% 16%- ; 1oo% measure how firms coped with this problem, E 31- 12 19- B 7 we measure the annual change in labor pro- 43% 17% 6% 6% 8% 100% ductivity over the period. Labor productivity Total Number of Firms 1,066 is defined as value added (value of sales less cost of non-labor inputs measured in 1995 Restructurin g willors bt ianfenc by con- prices) divided by the man-hours of labor many random factors that cannot be con- mI d trolled, including quality of management, employed. location, initial conditions, sector, or just * Total Factor Productivity. This meas- plain luck. The large variation suggests that ures the success of a firm in increasing the although governments can put policies that productivity of all factors of production encourage restructuring in place, not all (labor, material inputs, and capital). In es- firms will show equal improvement. sence, an increase in total factor productiv- ity occurs when output increases more than Measures of restructuring the inputs increase. Because multiple inputs are involved, however, this measurement In addition to profitability, we have used has to be made using sophisticated statistical five other measures of restructuring: techniques. A companion paper explains the Positive operating cash flow. A com- techniques used.9 mon problem in the early days of transition was that many firms were large loss-makers. 8 The percentages in Table 4 are not identical to those 9 The measurement of both labor productivity and in Table 3 for Poland because the percentages in the total factor productivity are further described in Claes- earlier table are weighted by employment. sens et al. (1997b). PRIVATIZATION AND RESTRUCTURING 7 * Growth in exports. The firms in the * Rapid privatization. A firm would be region typically experienced a large decline either given away to all citizens (referred to in sales to their traditional markets in the as "coupon privatization" or "mass privati- former socialist countries. Thus an essential zation") or go through management buy- element of restructuring was to reorient outs. sales to Western markets. This required . Concentrated outside control over firms. firms to develop more sophisticated market- After the coupon privatization period in- ing techniques and to improve the quality of vestment funds controlled by the banks be- their products so that they could compete came the dominant owners of many firms in with Western companies producing the the Czech and Slovak Republics. In other same products. The success of firms in re- countries such as Hungary, Poland, and AM the restructur- orienting their sales to Western markets is Slovenia, many management/employee buy- ing measures measured by the increase in exports from outs took place. Finally, in Hungary and show similar re- 1992 to 1995. more recently in the Czech Republic and uSM&. For a given firm, the five restructuring Poland, some firms were bought by strategic measures tend to be highly correlated, but foreign investors. there are substantial differences in the pace . Limiting wage increases. Once a firm of restructuring across firms in the region restructures and improves its cash flow, (Table 5). Czech firms rank at the top using wage increases must be limited so that there most measures of restructuring. Hungarian, g Polish, and Slovak firms are close behind and further restructuringa Firms in Bulgaria and Romania rank at the andnurhe rescturing. boottom. Analyzing differences in enterprise - Financial discipline. A firm is more perform.Ancacross thffrese c nteriesema likely to restructure if neither the govern- performance across thlese countries may mn truhsbiis o h ak shed light on which policies most favor ment (through subsidies) nor the banks restructuring. (through loans) finance the firm's losses. This financial discipline (sometimes referred Determinants of restructuring to as a "hard budget constraint") forces firms to achieve at least a positive operating Now we examine how the economic cash flow. policies in those countries with the most * Maintaining debt obligations. Firms restructuring differ from those countries may have a greater incentive to restructure with the least restructuring. Some of the and thus service their debts if banks do not economic policies that appear to be posi- forgive or reduce those debts. tively correlated with restructuring include: Although they are important, the poli- Table 5: Measures of restructuring for industrial firms Firms Average with Operating Annual Annual Annual Positive Cash Flow Growth in Growth in Growth in Operating as % of Labor Total Factor Exports in Cash Flow Revenue Productivity Productivity 1995 prices (1995) (1995) (1992-95) (1992-95) (1992-95) Bulgaria 74% 1% -2% 0% 14% Czech Republic 98% 14% 7% 5% 22% Hungary 90% 8% 3% 4% 11% Poland 87% 7% 5% 5% 18% Romania 49% 1% -1% -1% 6% Slovak Republic 90% 12% 5% 5% 20% Slovenia 90% 10% 3% 1% 8% 8 POHL, ANDERSON, CLAESSENS, DJANKOV Table 6: Measures of privatization, 1995 World EBRD OECD Bank Industnial Firms (Rank) (Firrns) (Firms) (Firms) (Output) Bulgaria 2 15% 8% 7% Czech Rep. 4 87% 90% 89% 93% Hungary 4 82% 78% 67% 65% Poland 3 55% 46% 61% 60% Romania 3 20% 15% 12% Slovak Rep. 3 74% 79% 83% Slovenia 3 54% 41% 41% Sources: EBRD: Infrastructure and Savings, 1996, p.11. OECD: Trends and Policies in Privatization, 1996, p. 19. World Bank: From Plan to Market: World Development Report, 1996, p. 53. Industrial Firms: authors' estimates. cies we describe here are not solely respon- In Table 6 we include estimates of the sible for rapid restructuring. extent of privatization in the seven coun- Our database on large industrial firms in tries. Because of the complexities in measur- the region allows us to measure which fac- ing the extent of privatization, the various tors most influence restructuring in all seven measures are not always comparable across countries. To more accurately determine countries, but they all show similar rank- which economic policies allow for faster ings. We have also measured the extent of restructuring, we applied econometric privatization for those firms in our data analysis to the data (see Annex). This allows base. We define as "privatized" any firm us to separate the various government poli- that has more than 33 percent of its shares cies from the other factors including size, transferred to private investors (Table 6, last sector, and initial level of productivity that two columns). We measure the extent of also have an impact on restructuring. We privatization both by a simple count of the summarize the results in the following sec- number of firms classified as privatized and tions. a weighted average based on output to re- flect differences in size. Extent of privatization On all measures the Czech Republic, Hungary, and the Slovak Republic were Measuring the extent of privatization in ahead of the other four countries. At the a country is complicated, and cross-country opposite end, Bulgaria was almost com- comparisons are difficult. Does the measure pletely dominated by state-owned firms. Privatization is of privatization just count the number of the key to restruc- firms that have been privatized or does it Impact of privatization turing. take into account their size and importance? What firms are covered by the measure of The impact of privatization on restruc- privatization -- small firms, only medium turing is very large. As shown in Table 7, and large firms, industrial firms, agricultural labor productivity growth during 1992-95 firms, utilities, or banks? When is a firm averaged 7.2 percent per year, for privatized considered to be privatized -- when owner- firmslO, but -0.3 percent for state-owned ship is completely in private hands (100 firms. In other words, privatization accounts percent), only a majority ownership (51 percent), or merely a significant minority ownership (say 25 percent)? 10 Firms are taken as privatized if more than one third of their shares were in private hands by 1995. PRIVATIZATION AND RESTRUCTURING 9 Annex (Table Al) shows that privatization 1992-95 increases total labor productivity growth by (% p.a.) Privatized State- about 4.5 percentage points per year over a firms*' owned period of at least four years (we do not have firms estimates for privatization effects beyond Bulgaria 12.4 -1.4 that period). Czech Republic 8.6 -2.6 There is some evidence that managers Hungary 6.0 3.2 carry out restructuring even in anticipation Poland 7.5 1.4 of privatization if the government's com- Romania 1.0 -0.5 mitment to privatization is credible. For Slovak Republic 7.8 -4.1 example, in the Polish mass privatization Privatizedf-rtnA Slovenia 7.2 1.8 program, the 512 firms included in the pro- show high rates a A Firms privatized by 1995 gram began to show rapid improvement in ofproductivity a profitability in 1994 and 1995, compared to growth. for 70 to 90 percent of the labor productivity other state-owned firms, even though they for70 o 9 pecen ofthelabr podutlvty were not formally privatized until November growth observed in countries with large 1995 One e pla ation frthi ithtman- privatization programs. The exception is Hungary, where state-owned firms achieve agers improve their performance when they hungary, where state-owned firms achieve expect to be held accountable by new own- half the productivity gains of privatized eradwt to prove theirnablity as man- finn. B conras, incoutrie wih inig- ers and want to prove their ability as manag- firms. By . contras , in countries with insig- ers before privatization. Similarly, large nificant privatization (e.g., Bulgaria and privatization programs appear to have a Romania), productivity in state-owned firms positive impact on productivity in state- is deteriorating. owned firms, probably due to similar antici- Similar results were obtained if total pation and signaling effects. factor productivity (TFP) is taken as an in- dicator of restructuring. Figure 2 shows the Concentrated control over firms cumulative increase in total factor produc- tivity for privatized firms since the time of Experts and government officials often privatization and compares this with the argue, that the quality of privatization TFP gains for state-owned firms in the should not be sacrificed for the speed of sample. The econometric analysis in the privatization. This was the justification Figure 2: Change in total factor productiv- given for the slow pace of privatization in Figure 2Cn itafopd Iv- 3Bulgaria. Critics of mass privatization con- ity _ _ tend that fast privatization would result in Total factor productivity (%, cumulative) widely dispersed ownership by small inves- 13 T s tors who do not have the skill, experience, '12 11 capital, or incentive to restructure firms. Differentprivati- 10 They favor instead more conventional case- zation methods 8 t by-case privatization in which firms are sold show similar re- 8' to large investors (often foreign). sIts. 6 -/ Until recently, Bulgaria, Hungary, Po- sults. 5 /land, and Slovenia have relied primarily on 3 case-by-case privatization rather than mass 2 4 / y privatization. However, Poland recently I completed a limited mass privatization pro- ° ------- gram, and Bulgaria is now implementing a Years since privatization program (see Box 2 for a description). Ro- --+privatized firms .state-owned firms mania is revising and continuing its earlier program. If the arguments in favor of case-by- case privatization were valid, the economet- 10 POHL, ANDERSON, CLAESSENS, DJANKOV ric analysis would show that case-by-case privatization of a firm has a bigger impact Box 2: Mass Privatization in the Czech on their restructuring; i.e., the regression Republic, Poland, and Bulgaria coefficients for the privatization variable Mass privatization involves giving away would be smaller for mass privatized firms. ownership of state-owned firms to all citizens. Such a premise is not supported by the data. The Czech Republic pioneered this method in Mass privatization seems to result in the 1991 and had privatized more than 1,600 same speed of restructuring as other meth- firms by 1994 in two waves (the Slovak Re- ods. public only conducted the first wave). In some One explanation is that mass privatiza- cases, a portion of a firm's shares were re- tion did not result in dispersed ownership by served for sale using conventional methods. . * . ~~~~~~~~A citizen was given (for a nominal charge) a many small investors. The structure of own- A . Mass privatiza- coupon, which could be used to buy shares In Masritz- ership became concentrated, often in the a national auction in any firm included in the tion encourages hands of large investment funds or succes- program. restructuring as sor holding companies. In the Czech Re- Citizens could bid to buy shares with much as other public, for example, ownership concentra- their coupons in any of the firms. Altema- methods. tion (measured by the share of the company tively, they could decide to turn over their owned by the five largest owners) was al- coupons to an investment fund and thus ready high by 1993 and has increased sub- become part owner of a much larger and stantially since then. Ownership concentra- diversified portfolio. Almost anyone could tion is even higher in the Slovak Republic establish a fund. About 70 percent of the (Table 8). In the Polish mass privatization coupons were turned over to 550 funds, scheme, the ownership by investment funds which became the dominant owners of Czech was high by design. In each of the mass firms. privatized firms, 60 percent of all shares In Poland, about 512 firms (representing were given to the fifteen investment funds. only about 10 percent of all industry and construction in terms of sales) were recently mass privatized. In contrast to the Czech Table 8: Average combined ownership of program, the government exercised more five largest owners control over the ownership structure, which Czech Republic -- 706 firms from first and may have contributed to the fact that imple- second wave. mentation took five years. The government 1st Quarter 1993 50% distributed enterprise shares to 15 investment 1st Quarter 1996 65% funds with a "lead fund" that had a controlling Slovak Republic -- 623 firms from first stake (33 percent) in each company. The rest wave. was distributed to other funds, workers, and 4th Quarter 1993 52% the government (25 percent) for later sale. 4th Quarter 1995 73% The government held an international com- petition to select fund managers and speci- fied the terms of their management contracts. A complementary development in the Citizens were given a certificate entitling Ownership con- Czech and Slovak Republics has been the them to equal ownership in all 15 funds. centration accel- transformation of many investment funds By mid-1997, Bulgaria will implement a erates restructur- into holding companies. Instead of the funds program similar to the Czech program. Ap- ing. having small minority stakes in many com- proximately 1,050 firms are included. About panies, these new holding companies have 80 percent of the citizens have turned their large majority stakes in just a few compa- coupons over to approximately 100 invest- nies. The managers of the funds stated that ment funds. In contrast to the Czech pro- they wanted to be the dominant majority gram, the government is retaining a majority shareholder in fewer firms.1 l stake in many of the larger that are firms for sale using conventional methods. Thus, given the slow pace of conventional methods thus 11 Interviews with investment fund managers in the far and the current troubled economic situa- Czech Republic (March 1997) and Slovak Republic tion, privatization is likely to remain slow. (December 1996). PRIVATIZATION AND RESTRUCTURING 11 Figure 3: Organization of a bank controlled ample, the bank might require a firm to bor- fund row from the bank at high interest rates to the detriment of other shareholders. This dual role of banks as both (direct Bank and indirect) owners and lenders is common om7e S in many countries notably, Germany and . \lender Japan, and does not seem to impair enter- Management \ prise performance. In fact, such a bank Company __ . . would have a dual incentive both as an contract Finn owner and a lender to ensure that the firm restructured and became profitable. The Vouher owner bank may also have better information about the operations of firms when it is both a lender and an owner, thus improving its ability to monitor the performance of firm In 1996, there appears to have been management. further concentration of ownership in the We find that both concentrated owner- Czech and Slovak Republics through merg- ship and ownership by bank-controlled ers, acquisitions, and buyouts. This is some- funds encouraged restructuring in the Czech times called the "third wave" of privatiza- Republic. In this analysis, the measure of tion. In the Slovak Republic, for example, restructuring is the value that the stock mar- twelve of the former foreign trade compa- ket places on the company relative to the nies have become holding companies with book value of its assets (this ratio is called large ownership stakes in 146 industrial "Tobin's Q").14 In other words, if investors firms.12 believe that the company is restructuring A concentration of fund ownership and becoming profitable, they will bid up parallel to the concentration of firm owner- the prices of shares on the stock exchange. ship allows this transformation of invest- In our case, we are using investor's judg- ment funds into holding companies. Large ment about the extent of restructuring. investors have bought the shares of the As shown in Figure 4, the stock market funds on the stock markets, accumulated places a higher value on a company in the controlling stakes, and then -- at a general Czech Republic when ownership is more meeting of fund shareholders -- approved a concentrated.15 The value is increased fur- conversion of the fund into a holding com- ther if ownership is in the hands of bank- pany. controlled funds and increased further still if Many of these fumds and holding com- these banks are also the main lenders to the panies in the Czech and Slovak Republics company. Although conflicts of interest may are controlled by large domestic banks exist between the role of a bank as both Many investment (Figure 3). These banks own the manage- owner and lender to a company, investors funds have be- ment companies that established and now seem to believe that this is outweighed by come holding control the larger funds. There is concern the ability of the bank to monitor and con- companies. that these banks both lend to firms and con- trol the managers and thus encourage more trol the funds that own those firms. This restructuring. dual role could present conflicts of interest that might impair restructuring.13 For ex- 14 For a specific firm, Tobin's Q = [market valuation + total debt]/[net fixed assets + inventory]. Other 12 Trend, (1996). measures, such as profitability show similar results. 13 This point is elaborated in Coffee (1996). Inter- 15 This relationship breaks down when a single inves- views with the five largest bank-sponsored investment tor has more than 50% of the shares of a firm. This is funds by the authors (March 1997) showed that two of due to the weak minority shareholder protection in the the funds maintained strong links with their bank- Czech Republic. For earlier results see Claessens sponsor, while the other three acted independently. (1997). 12 POHL, ANDERSON, CLAESSENS, DJANKOV Figure 4: Impact of ownership concen- Hungary (see Figure 5). Instead, firms were tration and bank ownership on stock more often sold to local domestic investors, market valuation in the Czech Republic in many cases, the managers and employees of the firms. For example, in Poland, about 120 M v 2,500 small and medium state-owned firms were included in what was called Banks are majority owners "liquidation privatization." Most of these 110 and main lenders firms were purchased by managers and em- -4 ' / s ployees. There is considerable debate about 100 T whether management and employee-owned Banks are majority firms will perform better than mass privat- Banks are majority ]/ized firms. 90- owners i Role of banks 80 t We use econometric analysis to measure 70 T f r All firms the impact on restructuring of additional bank lending to firms. Theory and experi- ence in the region show that additional 60 -'--- l ----e --~ % lending can either encourage or discourage <30 30-40 40-50 50-60 60-70 >70 restructuring depending on the expertise, skills, and independence of the banks mak- Five owner concentration ratio. ing the loans. Additional lending will encourage re- structuring if the banks are skilled at evaluating the future performance of the Another explanation for the relatively companies that wish to borrow money. The high level of restructuring in those countries banks must be able to determine whether the that used mass privatization is that conven- firm managers will use the money to make tional case-by-case privatization did not profitable investments that help to restruc- result in higher quality owners that many ture the firm. Only then can the banks be had hoped for. Though detailed information confident that the firm will generate the on new owners is difficult to obtain, the necessary revenue to repay the loans. level of foreign participation in case-by-case Additional lending will discourage re- methods has been relatively low except for structuring if the banks lend money to firms that will only use it to cover current operat- ing losses (for example, wages) instead of Figure 5: Sources of privatization reve- making productive investments. Not only nue -- end 1995 are these bank loans not used for productive In early years, new investments, but they reduce the incen- bank lending dis- Bulgaria - 24% tive for firm managers to restructure. Be- d r cause the managers believe that bank loans turag e Czech Rep. 5% will be available to cover current operating turng. Hungary |:: ::::::-::::l :::- -:---:0: 58%losses, they avoid the difficult and painful actions (such as laying-off workers) neces- PolandI l 22% sary to reduce operating losses. In many countries of the region, the im- Slovak Rep. 13% proved quality of bank lending now encour- 0% 20% 40% 60% 80% 100% ages restructuring for three reasons. First, in c3ForeignO Domestic I order to control inflation, central banks have Source OECD, p. 25 reduced credit expansion so that banks have less to lend to loss-making firms. Second, PRIVATIZATION AND RESTRUCTURING 13 government officials have also learned that failed to restructure, and many banks are pressuring banks to lend for the purpose of insolvent because they continued to make covering firm losses and avoid worker lay- bad loans to these firms. off cannot continue without jeopardizing When we divided the sample into privat- macro-stability and quality of lending. ized and state-owned firms, the results show Third, the banks themselves have improved that poor bank lending is largely associated their skills and can better evaluate the re- with state-owned firms. In all countries, structuring plans of firms before lending to banks made much better decisions in lend- them. ing to private firms than to state owned As a result, the state-owned banks in firms. Lending to privatized firms was as- these countries have not increased their sociated with an increase in productivity By 1995, bank lending to firms. New private banks (often (with a time lag) already in 1992. lending infour foreign-owned) have stepped in to fill the out of seven gap, and they are more likely to have the Wage restraint countries encour- necessary skills to make good lending deci- aged restructur- sions. In the Slovak Republic, for example, Restructuring is likely to be encouraged ing. about 80 percent of the recent increase in if the work force does not initially absorb all ing. bank lending has come from new private of the productivity gains as higher wages. banks. Outstanding loans by state-owned As noted above, firms must finance a large banks has shown little increase. Although proportion of investment with retained this is sometimes viewed with concern -- earnings from current cash flow especially especially by firms who have traditionally when the financial system is weak. If wages borrowed from these state-owned banks -- rise slower than labor productivity, more this is probably desirable until the state- cash flow is available for investment. Put owned banks can improve their lending differently, a positive operating cash flow skills and become more independent. per worker only exists if labor productivity Our econometric analysisl6 supports (value added per worker) exceeds wages. In this view of the evolution of bank lending. the long run, the objective is to increase Early in the transition, bank lending did wages so that the workforce benefits from more harm than good. In 1993, for six of the the restructuring of firms. In the short run, seven countries we examined, an increase in however, wage increases may have to be bank lending to a firm was associated with sacrificed to encourage faster restructuring. either constant or declining productivity Our analysis shows that the large pro- (Hungary was the exception). Two years ductivity gains from privatization have been later, however, the quality of bank lending Figure 6: Labor productivity and real had improved in three more countries wage growth for privatized and state- (Czech and Slovak Republics, and Slove- owned firms (% p.a.) nia). Thus by 1995, in four out of the seven Labor productivit ty countries an increase in bank lending was associated with an increase (with a time lag) Bulgara firms, labor pro- in a firmr's total factor productivity. This 10 ductivity growth suggests that firms used new bank loans to I Slovak Rep. Cech Rep. leads wage finance restructuring rather than merely Poland SIovenia growth. cover current operating losses. 5 t In 1995, the data suggests that banks in , a Hungary Bulgaria and Romania were still making Romania oSlowenia0 Poland poor lending decisions. This is no doubt a 0BuIgara - Realawages cause of the current economic crises in Bul- Rep. garia. Many firms are still loss-makers be- * 0SIk Rep. cause they were not privatized and have l -5 0 5 10 15 16 Claessens et al. (1997b). pnvatiized linns ostate-owned fims 14 POHL, ANDERSON, CLAESSENS, DJANKOV largely retained by firms to finance produc- held to a level below labor productivity. If tivity-enhancing investments. For privatized labor productivity is increasing, wages can firms, labor productivity growth has been increase without impairing operating cash faster than real wage growth in all countries flow as long as they do not increase faster (above the diagonal in Figure 6). In contrast, than labor productivity. real wage growth in state-owned enterprises has exceeded labor productivity gains, Financial restructuring eroding internally generated financing. The rapid productivity growth in privat- In addition to operational restructuring, ized firms has led to rapid growth in real many firms in the region need financial wages. But since privatized finms main- restructuring. These are firms that cannot tained a larger margin between labor pro- service all of their outstanding debts; they Government wage ductivity and wage, they were also able to are technically bankrupt or insolvent. It is policies have been sustain high levels of investment per worker important to determine when and how this less successful (Table 9). financial restructuring should take place. than privatiza- There are close links between opera- tion. tional and financial restructuring. One link is TUS$ableu9: Ivesmen perchasing worer parity, that rapid operational restructuring will im- (US$ annual average purchasing power parity, prove the cash flow of a firm and reduce the (% p1a2) Privatized State- need for financial restructuring. The oppos- firms owned ing link is that financial restructuring may firms discourage operational restructuring depend- Bulgaria 2,790 90 ing on the circumstances. Czech Republic 3,290 470 The number of over-indebted firms in Hungary 2,990 460 the region is large but declining. We define Poland 1,880 410 firms as being over-indebted if they do not Romania 590 110 have adequate cash flow to service all of Slovak Republic 3,340 230 their debt. Using the profit and loss catego- Slovenia 1,690 310 ries shown in Table 1, these are the firms in categories C, D, and E. Figure 7 shows that the proportion of such firms in 1995 ranges The effects of privatization on wage re- fo iho oeta 0preti o straint have been more important than gov- manhigh of more than 60 percent in Ro- ernment~~ waeplce. Moto °h ee mania to a low of 6 percent in the Czech eminment wage pohlces. Most of the seven Repblic.'7 countries had a policy of limiting wage in- Ficinr creases. For example, the Czech Republic, iaca etutrn fafr a c take a number of forms. First, if the firm can Hungary, and Poland had each implemented restructure its operations to achieve a posi- an excess wage tax at some point in the tiuctperaing cas then e fir period 1991-1994. By 1995, all countries tlve operating cash flow, then the firm Retaned earn- had market-determined wages. Even though should continue in operation even though it ings and invest- govearnent-letermined wagerestrait a ied ph may not be able to service all of its outstand- ment are higher manly (or exclusively) to state-owned firms ing debts. In most cases, the lenders should in privatized marily (orowh e sinhel) sta statetorwnd figefrms. wage growth in the state sector was higher 17 This measure, however, can overestimate the fi- than in the private sector in both Hungary nancial difficulties of a firm in periods of high infla- and Poland. Bulgaria and the Slovak Re- tion. During high inflation, interest rates must increase public pursued more vigorous wage restraint to compensate the lender for the decline in value of in the state sector, but real wages still out- the loan. The high interest payment is partly a repay- stripped productivity in contrast to the pri- ment of the loan principal. In effect, high interest rates vate sector. force firms to rapidly repay a sizable proportion of A policy of limiting wages to encourage their outstanding loans in addition to the interest on investment does not mean than wages must the loans. Thus it is possible, for example, that the be constant. What matters is that they be financial situation of Bulgarian and Romanian firms is not as bad as portrayed in Figure 7. PRIVATIZATION AND RESTRUCTURING 15 Figure 7: Proportion of industrial firms ernization, or expansion. This inability to unable toservicetheirdebt borrow money is a common complaint of (weighted by employment) ___ firms in the region. On the other hand, if the T - banks are not qualified to undertake these Bulgaria __ 62% negotiations, there is a substantial risk that loans may be restructured or forgiven when, Czech Rep 29% in fact, the firm could repay them. Also, by l% _not reducing the firm's debt burden it may Hlungary 32% 1992 have a greater incentive to find ways to re- Poland _2 0% l47% , structure its operations and improve cash Poland 3 L 14%flow. Financial restruc- l Even worse, if a bank forgives part of its turing is usually Romania j loans, a loss-making firm may be able to done through ~j7- borrow additional funds that it cannot repay, dolunethryonego- ySlovakia ° 36% / which leads to even more bad loans held by tiations. n ego the banks.18 Large scale debt forgiveness Slowenia 22% could lead to relaxing the financial disci- 0% - . pline on firms (hard budget constraint) that 1 0% ~10% 20% 30% 40% 50% 60% 70% L_________ 1X___20__ 30__ 40______6____7___ has finally been achieved in most countries of the region. agree to forgive (write off) some debts in It should also be pointed out that firms exchange for this restructuring of the firm's in Western countries rely mostly on internal operations. Second, if the firm has little cash flow (retained earnings) to finance chance of achieving a positive operating working capital or new investments rather cash flow, the only alternative is liquidation: than bank loans (see Table 10). In contrast, The firm ceases to operate, employees are firms in the former socialist economies re- laid off, and its assets are sold to pay at least lied heavily on loans from state-owned some of its debts. banks and they now complain when this Although a well functioning bankruptcy level of financing is no longer possible. system is essential, most financial restructur- Firms in the region, like their Western ing of firms do not occur through the formal counterparts, must learn to finance their bankruptcy system. In Western countries, a investments through increasing their own high percentage of financial restructurings cash flow. occur through voluntary negotiations be- tween lenders and the firm. Only if the firm Table 10: Sources of net corporate must be liquidated is it essential for a bank- financing in developed economies, ruptcy court to supervise the sale of assets 1970-89 and distribute the proceeds to creditors. (percent) Gernany Japan UK US The proportion of What actions, if any, should govern- nternal 181 31 20 91 over-indebted ments in the region take to encourage fi- Bonds -1 5 4 17 firms is highest in nancial restructuring of over-indebted firms? Shares 1 4 -10 -9 Bulgaria and In Western countries, most financial restruc- Trade credit -2 -8 -1 -4 Romania. turing takes place through negotiations be- Other 10 0 -8 -13 tween private lenders (mostly banks) and private firms. However, in transition Early in the transition process, the level economies, most of the banks and many of firm indebtedness varied considerably firms are still state-owned. from country to country due in part to the On the one hand, delay in financial re- often ad-hoc nature of allocating invest- structuring may hinder operational restruc- turing. An over-indebted firm that could become profitable may not be able to bor- 18 See Kotzeva and Perotti (1996) for a survey of row funds to pay for working capital, mod- Bulgarian firms that show such behavior. 16 POHL, ANDERSON, CLAESSENS, DJANKOV ments under central planning. The ratio of Figure 8: Ratio of total bank debt to sales bank debt to sales (see Figure 8) for the for industrial firms (1992) industrial firms in our sample was high in the two countries in which firms have re- Bulgaria 8 % structured the least (Bulgaria and Romania) and high in the two countries with signifi- Czech Rep. 2 % cant restructuring (Czech and Slovak Re- _ 1 publics). This suggests that a high level of Hungary 14 indebtedness does not necessarily discour- Poland 0Ji-¶12% age restructuring. l 12l The econometric analysis at the firm Romania Fogvi1 26deb level supports this view. We tested whether Forgivitg debt a high level of initial indebtedness relative Slovak Rep. 25% mtay discourage to sales revenue hindered or encouraged operationalre- operational restructuring. The evidence sug- Slovenia , 18% structuring. gests that a high level of initial iindebtedness 0% 10% 20% 30% 40% either has no effect or actually encourages _______20%_ 30%_____ operational restructuring; i.e., the coeffi- cients for indebtedness in the regression Negotiated financial restructurings, equation were either insignificant or posi- however, do not eliminate the need for a tive. well functioning bankruptcy system to deal This conclusion is supported by the case with those firms that must be liquidated. 19 studies in the Slovak Republic. Most of Also banks may need to use the threat of these firms were highly indebted and thus swift bankruptcy and liquidation in order to had difficulty borrowing additional funds force reluctant firms to undertake a negoti- from the large Slovak state-owned banks. In ated financial restructuring. A good Com- many cases, they found alternative sources mercial Code is also necessary. of finance, most importantly, their own in- ternal cash flow. They had to undertake Impact on bank restructuring some restructuring to improve their cash flow, which was then used to finance further Although restructuring of firms is the restructuring. In addition to internal cash primary subject of this paper, countries of flow, these firms were able to obtain some the region also have to develop policies for outside financing from customers, from the privatization, restructuring, and recapi- foreign and domestic private banks, and talization of the former state-owned banks. through new joint venture arrangements that Even with good progress in enterprise re- were not burdened with past debts. structuring, many banks may end up bur- On balance, special government policies dened with loans made to firms unable to to encourage the financial restructuring of service those loans, i.e., pay interest or re- In western coun- firms may not be necessary. Financial re- pay the principal when due. Consequently, tries, internal structuring can wait until after banks have some banks may not be able to repay their cash flow is the been privatized and have developed the depositors and other liabilities. necessary negotiating skills and incentives. If the government adopts policies that largest source of These banks have little to lose by not forgiv- encourage restructuring, firms will be able finance. ing debt and much to gain if the firms can to repay more of their bank loans. This will restructure, become more profitable, and reduce the need to recapitalize the banking repay more of their debt. A government system and the consequent burden on tax sponsored program to encourage banks to payers. Enterprise restructuring is thus nec- forgive firm debt may actually slow down essary to improve the health of the banking restructuring because it would weaken fi- nancial discipline. 19 See Gray et al. (1996) for a study of the Hungarian experience. PRIVATIZATION AND RESTRUCTURING 17 system. Nevertheless, some recapitalization Figure 9: Bad loan ratio for industrial may be needed eventually for some banks. firms Another difficulty is how to predict the B47g%ia 1995 47% future profitability of firms. As the analysis *9 i 54 above of restructuring shows, the profitabil- Czech Rep. 1995 2% ity of firms in the region is changing much 1992 138% more rapidly (and randomly) than in mature Hungary 995 4% market economies and so is their ability to 992 33 service their debts. Polard 19 18% 46% To illustrate this point, we measure the Romania 1995 _42% ability of firms to service their debts. Our 1992 62% High level of in- measure is based on their operating cash Slaa 1 _995 17% debtedness does flow after paying wages and the cost of 992 not discourage inputs. This cash-flow can be used to service Sbenia1995 27% restructuring, at least part of the firm's debt. For a specific year, we calculated the - _ _ '_ _ _ present discounted value of this cash flow assuming that it grows at a real rate of 4 38 percent in 1992 to 12 percent in 1995. In percent per year thereafter.20 The real dis- contrast, the Bad Loan Ratio started higher count rate used is 9 percent. This is an esti- in Bulgaria and has only declined slightly. mate of the real lending rate charged by Although based on reasonable assump- banks in the region.21 We call this dis- tions, our estimate of the Bad Loan Ratio for counted value the Debt Repayment Capacity 1992 is high because operating cash flow for each firm. If it is less than the outstand- has grown faster than our assumption of 4 ing liabilities of the firm (bank loans, tax percent per year. Similarly, our estimate for arrears, accounts payable less accounts re- 1995 is too high because firms in the region ceivable, etc.), the firm cannot repay all of continue their rapid pace of restructuring. its liabilities unless it restructures so as to Conventional methods for estimating the improve its operating cash flow. We refer to bad loans of banks fail to recognize the this shortfall as the Uncollectable Liabilities rapid rate of restructuring in some countries for each firm. and they overestimate the financial difficulty Once the Uncollectable Liabilities of of banks and the cost of their recapitaliza- each firm is calculated, we sum over all tion. firms and divide by the aggregate Total One inference from this analysis of bad Liabilities. We refer to this ratio as the Ag- loans is that governments should not rush to gregate Bad Loan Ratio. Although bank recapitalize banks because it is almost im- loans only make up a part of the total li- possible to determine the true extent of their abilities of a firm, we assume that all liabili- bad loans while restructuring is ongoing. Conventional ties are paid off proportionally and bank Thus banks may receive an excessive re- measures of bad loans do not receive a priority. capitalization. Furthermore, recapitalization loans held by The Bad Loan Ratio had declined sub- of banks will increase their ability to lend to stantially by 1995 for most countries (Figure firms. Firms in the region must learn to rely banks are unrel- 9). In the Czech Republic, it decreased from more on their own internal cash flow and able_in transition less on bank loans. If recapitalization is economies. 20 In contrast to the estimated number of firms unable done prior to the privatization of the banks, to service their debts in Figure 7, this estimate of the improvement in their lending skills, and proportion of bad loans is not affected by inflation privatization of enterprises, there is the risk because an estimate of real cash flow is used. of additional bad lending decisions, relaxed 21 This is a simple average of the real bank lending financial discipline for firms, and slower rate in five countries (based on the producer price restructuring. index) as estimated in Borish et al. (1996), Table 14, Sometimes bank recapitalization is p. 35. combined with forgiving or writing off the 18 POHL, ANDERSON, CLAESSENS, DJANKOV bad loans to firms. However, we find little and Slovak Republics resulted in a much evidence that a high debt burden hinders more concentrated ownership structure than restructuring. was originally predicted. Control of these If it does prove necessary to recapitalize firms by large strategic owners (including the banks, this should be done as part of the bank sponsored investment funds) also en- privatization process. Only then can the couraged restructuring. government be certain that the banks will Second, we show that restraining wage use these additional resources to encourage increases to a level below increases in labor restructuring rather than to incur more bad productivity allows for more restructuring. loans that may require further recapitaliza- This increases the operating cash flow of tion. The private banks can then begin to firms, which can then be used to invest in negotiate a financial restructuring of over- modernization and expansion. As in mature Rapid restructur- indebted firms. Again, delay in recapitaliz- market economies, most of the capital for ing offirms will ing the banks or financially restructuring new investment must come from the internal help the banks. over-indebted firms is not likely to slow cash flow of the firm. down the pace of operational restructuring. Third, policies that increase bank lend- ing to firms (for example, recapitalizing the Conclusions banks) or that forgive debts of firms may do more harm than good. The empirical analy- One of the most important policy ques- sis shows that was in the early years of tions in the transition economies is what can transition, additional bank lending was most governments do to speed up the restructur- often associated with a decline in subse- ing of firms and thus hasten the transition to quent firm productivity. This suggests that a mature market economy. The data that we increasing bank lending to firms or forgiv- have collected on the industrial firms in ing their debts tend to reduce financial dis- seven countries of the region as well as case cipline and thus the incentives for restructur- studies provide some answers. ing. Only when banking systems are suffi- First, fast privatization is instrumental in ciently reformed and market-based do we encouraging restructuring. Less important is observe a positive effect of increased bank the method of privatization. Although case- lending on restructuring. Bad loans have by-case privatization might result in more Fourth, it may be best to delay bank re- declined in most foreign ownership, investment, and techni- capitalization. One important benefit of of the countries cal assistance, our case studies of Slovak rapid restructuring is the increase in the firms suggest that this is not necessary for ability of firms to repay their bank loans and rapid restructuring. This is fortunate because other liabilities. This reduces the need for such assistance is likely to be available for the government to recapitalize the banks in only a few firms even in those countries that order to protect depositors. The safest emphasize case-by-case privatization. In course of action is to recapitalize the banks most countries, firms were primarily sold to only as part of their privatization and to domestic investors (often managers and encourage them to negotiate the financial workers) rather than foreign investors. restructuring of firms including debt for- What is needed instead is concentrated giveness only after they are privatized. ownership. Mass privatization in the Czech PRIVATIZATION AND RESTRUCTURING 19 References Barbone, Luca, Domenico Marchetti, and Djankov, Simeon and Bernard Hoekman. Stefano Paternostro 1996. Structural 1997a. Trade reorientation and post- adjustment and ownership transformation: reform productivity growth in Bulgarian Poland's industrial performance in the firms Journal of Policy Reform early 1990s. World Bank Mimeo. (forthcoming) Borish, Michael S., Wei Ding, and Michel Djankov, Simeon and Bernard Hoekman. Noel. 1996. On the road to EU accession: 1997b. Avenues of technology transfer: financial sector development in Central foreign linkages and productivity change Europe, World Bank. Discussion paper in the Czech Republic. World Bank 345. Mimeo. Carlin, Wendy, John Van Reenen, and Toby Djankov, Simeon and Gerhard Pohl. 1997a. Wolfe. 1995. Enterprise restructuring in Restructuring of large firms in The Slovak early transition: Case study evidence from Republic. World Bank Working paper Central and Eastern Europe". Economics 1758. of Transition, 3: 427-458. Djankov, Simeon and Gerhard Pohl. 1997b. Claessens, Stijn. 1997. Corporate Governance Does privatization matter? Evidence from in the Czech Republic. Journal of Finance. Poland. World Bank Mimeo. (forthcoming) Gray, Cheryl, Sabine Schlorke, and Miklos Claessens, Stijn, Simeon Djankov and Szanyi. 1996. Hungary's bankruptcy Gerhard Pohl. 1997a. Ownership and experience, 1992-93. World Bank corporate governance: evidence from the Economic Review. 10:425-450. Czech Republic. World Bank. Working paper 1737. Kotzeva, Mariana and Enrico Perotti. 1996. Rational creation of financial arrears: Claessens, Stijn, Simeon Djankov and evidence from Bulgarian state managers. Gerhard Pohl. 1997b. Determinants of University of Amsterdam. Mimeo. restructuring of industrial firms in seven European transition economies. World OECD 1996 Trends and Policies in Bank Mimeo. Privatization, vol. III, no. 1. Claessens, Stijn and R. Kyle Peters. 1997. Pohl, Gerhard, Simeon Djankov and Robert Firm performance and soft budget Anderson. 1996. Restructuring of large constraints: the case of Bulgaria. industrial firms in Central and Eastern Economics of Transition. (forthcoming) Europe: an empirical analysis. World Bank Technical Paper 332. Coffee, John. 1995. Corporate governance in Central Europe and Russia: institutional Shleifer, Andrei and Robert Vishny. 1994. investors in transitional economies -- "Politicians and Firms," Quarterly Journal lesson from the Czech experience. World of Economics, 46: 995-1025. Bank Policy research paper 1450. Trend. 1996 Top 100 Slovak companies. Bratislava. December: p. 1 1. PRIVATIZATION AND RESTRUCTURING 21 Annex: Estimation procedure and variables Table Al We start with a standard neo-classical production function Yit = Tit [Lit Mt Kt where SL, SK and SM are the shares of labor, capital and material inputs' expenditures in total expenditure for firm i and the T term equals total factor productivity change. To avoid imposing cost minimization, we estimate the marginal product of each input as follows: Ay.t t i +=. +a .+sA +4 sksA + sit where Yi,t = In Yi,t - In Yi,t.l and similarly for lit, mi,t, and kit. All fl's are estimated over each industry (sector) s. The reported book value of fixed assets may be inaccurate and is unlikely to provide a good measure of the flow of capital services. Energy consumption is therefore used as a proxy for capital utilization. This correc- tion has a number of desirable properties and is particularly attractive in the transition context because it is a flow measure that does not depend on fixed assets. Total factor productivity (A i1, ) growth is then calculated as the sum of the residual and the firm-specific intercept. =^ ^ +^ tt I kt To properly control for other firm-specific factors, we augment the estimation as follows AY = Qia + A i s +A, + 4k Size;+ +,/5Privatizationit +fi6BankFinancing, t +A T4+4AT95 +v Firm-specific variables: Output - index of total quantity of goods sold defined as the value of sales deflated by the sector-specific producer price index in local currency. Labor inputs - average number of workers adjusted for the average number of hours worked. Material inputs - index of total material usage defined as the value of material inputs deflated by the sector- specific input price index in local currency. Energy inputs - index of total energy usage defined as the value of energy inputs deflated by the aggregate energy price index in local currency. PRIVATIZATION AND RESTRUCTURING 23 Size - we rank all firms in a given sector by employment in the base year (1992) and then divide them into quartiles. We use dummies for each quartile. This specification proxies for market power within each sector. Privatization - we divide all firms into cohorts depending on the number of years since their privatization. A separate dummy is used for each cohort. Bankfinancing - change in bank financing in the preceding year. Time - dummy variables for each year. Table A2 Firm-specific variables: Tobin's Q - the sum of market valuation plus total debt outstanding over the firm's replacement value (net fixed assets plus inventory). Profitability - gross (operating) profit over net fixed assets plus inventory. Leverage - ratio of assets to equity. Dummyfor first wave - 1 if the firm participated in the first wave of privatization, 0 otherwise. Concentration - sum of shares of the top five investors, each raised to the second power. Ownership - for each category (bank-sponsored investment funds, local strategic investors, etc.) the cumula- tive share of ownership in each firm. 24 POHL, ANDERSON, CLAESSENS, DJANKOV Table Al: Results on privatization and financial discipline (Dependent variable: Real Output Growth, panel regressions, random effects model) Country Bulgaria Czech Rep. Hungary Poland Romania SlovaK Rep. Slovenia All firms Constant -0.007 -0.037 -0.302* -0.029 -0.167* -0.033* 0.041* 0.055* (0.758) (7.341) (6.258) (0.612) (7.584) (4.235) (3.086) (2.128) Size Dummies included Yes Yes Yes Yes Yes Yes Yes Yes Sector-specific produc- Yes Yes Yes Yes Yes Yes Yes Yes tion function included Country x Time Dummies included Yes Dummy 1994 -0.107* 0.022* 0.035* 0.009* -0.054* 0.057* -0.123* (9.691) (2.722) (7.129) (1.989) (4.537) (6.354) (5.003) Dummy 1995 0.275 -0.021 0.031* 0.017* 0.182* 0.045* -0.058^ (0.296) (1.328) (5.668) (3.754) (8.029) (5.162) (3.258) Privatization Time Dummies 1st Year -0.033 0.063* 0.021* 0.011 -0.103* 0.044* -0.008 0.029* (0.825) (6.308) (2.462) (0.176) (3.798) (7.092) (0.325) (6.238) 2nd Year 0.152* 0.048* 0.039* 0.056* 0.086* 0.058* 0.079* 0.059* (4.245) (7.048) (5.207) (9.924) (3.126) (4.251) (6.945) (9.985) 3rd Year 0.109* 0.025* 0.021* 0.054* 0.077* 0.062* 0.068* 0.054* (3.448) (2.423) (2.815) (7.486) (2.668) (3.641) (7.782) (8.759) Bank Financing 1993 -0.011 -0.023* 0.125* -0.043* -0.011 -0.018 -0.011 -0.004 (0.827) (2.568) (9.537) (6.745) (0.839) (0.285) (0.329) (0.896) Bank Financing 1994 -0.010 0.008 0.139* 0.012** -0.055* 0.010 0.009 0.008 (1.285) (0.135) (9.892) (1.768) (3.621) (0.118) (0.542) (1.038) Bank Financing 1995 -0.028 0.018* 0.116* 0.015 -0.037* 0.021* 0.021* 0.013* (0.987) (3.048) (9.976) (1.095) (2.335) (3.285) (1.857) (1.978) Number of firms 828 706 1044 1066 1064 883 763 6354 Sample Size 2484 2118 3132 3198 3192 2649 2289 19062 Adjusted R2 0.682 0.907 0.839 0.769 0.629 0.672 0.826 0.798 The estimates are heteroskedasticity consistent. t-Statistics shown in parentheses. ** Significant at the 90 percent level. * Significant at the 95 percent level. PRIVATIZATION AND RESTRUCTURING 25 Table A2: Effect of ownership concentration In the Czech Republic (Dependent Variables: Tobin's Q, Profitability, panel regression, random effects model) Regression I Regression It Regression 111 Dependent variable Tobin's Q Prfit Tobin's Q Profit Tobin's Q Profit Leverage 0.061 -0.005 0.069 -0.005 0.059 -0.005 (13.462)- (4.618)^ (13.402)* (4.457)' (13.432)^ (4.459)* Dummy for First Wave 0.120 0.003 0.053 0.006 0.051 0.008 (6.178)^ (0.306) (2.415)^ (1.251) (2.285)* (1.192) Concentration 0.217 0.014 0.041 -0.061 0.011 -0.095 (Herfindahl Index) (2.185)r (0.648) (0.116) (1.937)^ (0.142) (1.952)^ By Ownership: Bank Sponsored IPFS 0.398 0.028 0.303 0.018 (4.415)^ (1.415) (3.305)' (0.415) Non-Bank Sponsored 0.068 0.011 0.068 0.011 IPFS (0.679) (0.452) (0.705) (0.468) Natonal Property Fund 0.311 0.024 0.312 0.022 (1.891)* (0.742) (1.598) (0.741) Local Strategic Inves- -0.215 0.059 -0.215 0.053 torS (1.574) (1.639) (1.568) (1.642)** Foreign Strategic Inves- 0.048 0.118 -0.033 0.122 toS (0.289) (2.807)* (0.204) (2.845)* Conflict-of-interest 0.123 0.0138 Dummy (4.065)* (1.686)* Sector Dummies Yes Yes Yes Yes Yes Yes Year Dummies Yes Yes Yes Yes Yes Yes Number of firms 706 706 706 706 706 706 Sample Size 2824 2824 2824 2824 2824 2824 R2 0.182 0.079 0.209 0.103 0.216 0.104 The estimates are heteroskedasticity consistent. t-Statistics shown in parentheses. Significant at the 90 percent level. * Significant at the 95 percent level. * POHL, ANDERSON, CLAESSENS, DJANKOV Table A3: Profit/loss categories for Bulgarian firns In 1995 Al Categoty Category Category Category Category Firmns A B C D E Number of Firms 828 351 117 124 191 45 Employment 314,042 140,168 41,963 52,146 68,772 10,993 Employment % 100.00 44.63 13.36 16.60 21.90 3.50 Loans outstanding % 100.00 32.11 10.25 18.52 26.58 12.54 Sales revenue (bil. leva) 277,610 169,494 30,433 37,627 31,911 8,143 (% of Revenue) Sales revenue 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% minus cost of materials and 74.19% 71.90% 75.14% 68.48% 82.16% 113.49% energy = Operating margin 25.81% 28.10% 24.86% 31.52% 17.84% -13.49% minus wages and wage taxes 15.41% 13.18% 17.67% 15.51% 24.75% 16.26% = Operating cash flow 10.40% 14.92% 7.19% 16.02% 4.92% -29.75% minus net financial charges 9.32% 3.49% 4.36% 26.39% 24.21% 11.81% = Cash flow after debt service 1.08% 11.42% 2.83% -10.38% -31.12% -41.56% minus depreciation 3.14% 2.68% 4.90% 2.39% 4.10% 5.73% = Net income before tax -2.06% 8.74% -2.07% -12.77% -35.22% -47.29% minus income tax 2.24% 3.50% 0.52% 0.15% 0.07% 0.55% = Net income after tax -4.30% 5.24% -2.59% -12.92% -35.29% -47.83% PRIVATIZATION AND RESTRUCTURING 27 Table A4: Profitloss categories for Czech firms In 1995 Al Category Categoty Category Category Category Firmns A B C D E Number of Firms 706 509 124 49 15 9 Employment 829,312 609,710 155,827 49,924 8,459 5,392 Employment % 100.00 73.52 18.79 6.02 1.02 0.65 Loans outstanding % 100.00 66.20 16.57 15.92 0.11 1.21 Sales revenue (mil. kroni) 568,307 463,680 77,731 22,350 2,951 1,593 (% of Revenue) Sales revenue 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% minus cost of materials and 69.61% 69.39% 68.52% 77.91% 68.83% 101.27% energy = Operating margin 30.39% 30.61% 31.48% 22.09% 31.17% -1.27% minus wages and wage taxes 14.19% 12.87% 21.17% 16.91% 34.33% 9.62% = Operating cash flow 16.20% 17.74% 10.31% 5.18% -3.16% -10.99% minus net financial charges 3.40% 2.63% 4.79% 14.44% 5.93% 4.38% = Cash flow after debt service 12.80% 15.11% 5.52% -9.26% -9.09% -15.37% minus depreciation 5.37% 5.02% 7.13% 6.50% 8.85% 4.22% = Net income before tax 7.43% 10.09% -1.61% -15.76% -17.94% -19.59% minus income tax 3.21% 3.91% -0.01% 0.00% 0.00% 0.00% a Net income after tax 4.22% 6.18% -1.60% -15.76% -17.94% -19.59% 29 POHL, ANDERSON, CLAESSENS, DJANKOV Table A5: ProfiVloss categories for Hungarian firms In 1995 All Category Category Category Category Category Firrns A B C D E Number of Firms 1,044 678 132 78 114 42 Employment 428,645 299,408 60,567 26,619 41,150 901 Employment % 100.00 69.85 14.13 6.21 8.96 0.85 Loans outstanding % 100.00 74.52 16.75 3.12 4.27 1.34 Sales revenue (mil. forints) 2,072,311 1,550,089 325,353 122,059 50,223 24,587 (% of Revenue) Sales revenue 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% minus cost of materials and 71.41% 69.22% 70.82% 75.42% 84.25% 103.34% energy = Operating margin 28.59% 30.78% 29.18% 24.58% 15.75% -3.34% minus wages and wage taxes 14.42% 13.24% 16.35% 18.24% 19.87% 16.32% = Operating cash flow *14.17% 17.54% 12.83% 6.34% -4.12% -19.66% minus net financial charges 6.69% 5.42% 8.53% 11.28% 11.16% 9.87% = Cash flow after debt service 7.48% 12.12% 4.30% - 4.94% -15.28% -29.53% minus depreciation 5.21% 6.23% 5.87% 6.98% 4.48% 5.64% = Net income before tax 2.27% 5.89% -1.57% -11.92% -19.76% -35.17% minus income tax 1.03% 3.24% 1.24% 0.00% 0.00% 0.00% = Net income after tax 1.24% 2.65% -2.81% -11.92% -19.76% -35.17% PRIVATIZATION AND RESTRUCTURING 28 Table AS: Proflt/loss categories for Romanian firms in 1995. All Category Category Category Category Category Firns A B C D E Number of Firms 1092 277 137 104 447 127 Employment 2,121,10 503,220 338,319 192,914 854,550 232,099 2 Employment % 100.00 23.72 15.95 9.09 40.29 10.94 Loans outstanding % 100.00 12.54 9.98 11.47 52.35 13.66 Sales revenue (bil. lei) 46,013 12,442 10,396 7,937 10,385 4,851 (% of Revenue) Sales revenue 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% minus cost of materials and 80.73% 68.05% 73.39% 82.49% 78.36% 131.18% energy = Operating margin 19.27% 31.95% 26.61% 17.51% 21.64% -31.18% minus wages and wage taxes 24.42% 20.02% 21.37% 12.63% 42.83% 22.16% = Operating cash flow -5.15% 11.93% 5.24% 4.88% -21.19% -53.35% minus net financial charges 3.81% 0.58% 2.00% 9.08% 4.04% 6.88% = Cash flow after debt service -8.97% 11.35% 3.24% -4.20% -25.22% -60.22% minus depreciation 5.65% 5.61% 6.93% 4.60% 6.22% 3.53% = Net income before tax -14.62% 5.74% -3.70% -8.80% -31.44% -63.75% minus income tax 1.53% 3.55% 0.68% 0.69% 0.93% 0.84% = Net income after tax -16.15% 2.19% -4.38% -9.48% -32.37% -64.59% 30 POHL, ANDERSON, CLAESSENS, DJANKOV Table A7: Profltloss categories for Slovak firms In 1995 All Category Category Category Category Categoty Finns A B C D E Number of Firms 905 319 250 80 241 15 Employment 578,737 322,241 157,648 41,958 53,301 3.589 Employment % 100.00 55.68 27.24 7.25 9.21 0.42 Loans outstanding % 100.00 51.09 18.87 12.01 16.60 1.44 Sales revenue (mil. kroni) 339,328 247,985 49,900 17,339 23,123 979 (% of Revenue) Sales revenue 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% minus cost of materials and 67.58% 67.45% 61.40% 74.82% 74.85% 115.59% energy = Operating margin 32.42% 32.55% 38.60% 25.18% 25.15% -15.59% minus wages and wage taxes 16.87% 12.33% 28.55% 22.32% 35.95% 26.67% = Operating cash flow 15.55% 20.22% 10.05% 2.86% -10.80% -42.27% minus net financial charges 1.02% -0.68% 3.49% 8.15% 7.77% 20.94% = Cash flow after debt service 14.52% 20.90% 6.56% -5.29% -18.57% 463.20% minus depreciation 6.89% 5.63% 10.20% 7.96% 12.10% 16.29% = Net income before tax 7.63% 15.27% -3.64% -13.25% -30.67% -79.50% minus income tax 4.84% 6.50% 0.38% 0.31% 0.22% 0.36% = Net income after tax 2.79% 8.77% -4.02% -13.56% -30.89% -79.85% PRIVATIZATION AND RESTRUCTURING 31 Table AS: Profitiloss categories for Slovenian firns in 1995 All Category Category Category Category Category Firms A B C D E Number of Firms 727 508 86 70 52 11 Employment 219,959 141,636 37,173 19,805 17,263 4,082 Employment % 100.00 64.39 16.90 9.00 7.85 1.86 Loans outstanding % 100.00 68.93 18.25 7.85 4.21 0.76 Sales revenue (mil. tolars) 2,368,239 1,795,788 252,715 192,054 96,185 31,494 (% of Revenue) Sales revenue 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% minus cost of materials and 78.47% 77.77% 74.65% 80.83% 86.38% 110.44% energy = Operating margin 21.53% 22.23% 25.35% 19.17% 13.62% -10.44% minus wages and wage taxes 12.17% 11.38% 15.79% 11.70% 18.58% 11.87% = Operating cash flow 9.36% 10.86% 9.56% 7.47% -4.96% -22.31% minus net financial charges 4.86% 3.46% 6.15% 12.38% 10.38% 11.49% = Cash flow after debt service 4.50% 7.40% 3.41% -4.91% -15.34% -33.80% minus depreciation 4.49% 4.33% 6.62% 3.47% 3.82% 4.95% = Net income before tax 0.01% 3.07% -3.21% -8.38% -19.17% -38.75% minus income tax 0.32% 0.43% 0.00% 0.00% 0.00% 0.00% = Net income after tax -0.31% 2.64% -3.21% -8.38% -19.17% -38.75% 32 POHL, ANDERSON, CLAESSENS, DJANKOV Distributors of COLOMBIA HAMtTt cALY NEWZEALAND ROMANIA SWiERLAUSi S tonlace LUda. 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(30 1) 384-1826 E-mail: maltltlwuse DMIF Fax (30 1) 364e254 RECENT WORLD BANK TECHNICAL PAPERS (continuted) No. 321 Srivastava, Smith, and Fomo, Biodiversity and Agriculture: Implicationsfor Conservation and Development No. 322 Peters, The Ecology and Management of Non-Timber Forest Resouirces No. 323 Pannier, editor, Corporate Governance of Piublic Enterprises in Transitional Economies No. 324 Cabraal, Cosgrove-Davies, and Schaeffer, Best Practices for Photovoltaic Houtsehold Electrification Programs No. 325 Bacon, Besant-Jones, and Heiclarian, Estimating Construction Costs and Schedutles: Experience with Power Generation Projects in Developing Countries No. 326 Colletta, Balachander, and Liang, The Condition of Youing Children in Suib-Saharan Africa: The Convergence of Health, Nuttrition, and Early Edutcation No. 327 Vald6s and Schaeffer in collaboration with Martin, Surveillance of Agricultlural Price and Trade Policies: A Handbookfor Paraguay No. 328 De Geyndt, Social Development and Absolute Poverty in Asia and Latin America No. 329 Mohan, editor, Bibliography of Publications: Technical Department, Africa Region, Jiuly 1987 to April 1996 No. 332 Pohl, Djankov, and Anderson, Restruictutring Large Indutstrial Firms in Centraland Eastern Eutrope: An Empirical Analysis No. 333 Jha, Ranson, and Bobadilla, Measuring the Buirden of Disease and the Cost-Effectiveness of Health Interventions: A Case Study in Guinea No. 334 Mosse and Sontheimer, Perfonnance Monitoring Indicators Handbook No. 335 Kirmani and Le Moigne, Fostering Riparian Cooperation in International River Basins: The World Bank at Its Best in Development Diplomacy No. 336 Francis, with Akinwumi, Ngwu, Nkom, Odihi, Olomajeye, Okunmadewa, and Shehu, State, Community, and Local Development in Nigeria No. 338 Young, Measurinig Economic Benefitsfor Water Investments and Policies No. 339 Andrews and Rashid, The Financing of Pension Systems in Central and Eastern Eutrope: An Overview of Major Trends and Their Determinants, 1990-1993 No. 340 Rutkowski, Changes in the Wage Strutctutre duiring Economic Transition in Central and Eastern Eutrope No. 341 Goldstein, Preker, Adeyi, and Chellaraj, Trends in Health Statuts, Services, and Finance: The Transition in Central and Eastern Europe, Voluime I No. 343 Kottelat and Whitten, Freshwater Biodiversity in Asia, with Special Reference to Fish No. 344 Klugman and Schieber with Heleniak and Hon, A Suervey of Health Reform in Central Asia No. 345 Industry and Mining Division., Industry and Energy Department, A Mining Strategyfor Latin America and the Caribbean No. 347 Stock and de Veen, Expanding Labor-based Methodsfor Road Works in Africa No. 350 Buscaglia and Dakolias, Jutdicial Reform in Latin American Courts: The Experience in Argentina and Eculador No. 352 Allison and Ringold, Labor Markets in Transition in Central and Eastern Eutrope, 1989-1995 No. 353 Ingco, Mitchell, and McCalla, Global Food Supply Prospects, A Backgrouind Paper Prepared for the World Food Suzmmit, Rome, November 1996 No. 354 Subramanian, Jagannathan, and Meinzen-Dick, User Organizations for Sustainable Water Services No. 355 Lambert, Srivastava, and Vietmeyer, Medicinal Plants: Rescuting a Global Heritage No. 356 Aryeetey, Hettige, Nissanke, and Steel, Financial Market Fragmentation and Reforms in Sub-Saharan Africa No. 357 Adamolekun, de Lusignan, and Atomate, editors, Civil Service Reform in Francophone Africa: Proceedings of a Workshop, Abidjan, Janutary 23-26, 1996 No. 358 Ayres, Busia, Dinar, Hirji, Lintner, McCalla, and Robelus, Integrated Lake and Reservoir Management: World Bank Approach and Experience No. 360 Salman, The Legal Frameworkfor Water Users' Associations: A Comparative Stuldy No. 361 Laporte and Ringold, Trends in Education Access and Financing duiring the Transition in Central and Eastern Eutrope No. 362 Foley, Floor, Madon, Lawali, Montagne, and Tounao, The Niger Houisehold Energy Project: Promoting Rutral Futelwood Markets and Village Management of Natuiral Woodlands No. 364 Josling, Agricultuiral Trade Policies in the Andean Group: Issutes and Options No. 366 Carvalho and White, Combining the Quiantitative and Quialitative Approaches to Poverty Measurement and Analysis: The Practice and the Potential No. 367 Colletta and Reinhold, Review of Early Childhood Policy and Programs in Suib-Saharan Africa THE WORLD BANK 1818 11 St-cct. N\. \\ish.inl.tl, D).(C. 20)433 l S \ I;L..iclil.i: 2402-477- 1234 I['LIc\: N( :1 04145 \()RI .I)I'\Nk \C(II 248423 \\OlI.1)I; \Nk \\ \Sl I I I)S 0-8213-3975- \\(,1-1(1 \\ i.l. \\.1h: II ttI): N\ \\.Xx,. \N M l L t' 1111 V4 ISBN 0-8213-3975-3