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Disinvestment and Firm Performance--A Comparative Analysis of Strategic Sale vs. Public Offerings by Indian Pubic Sector Enterprises.


The public interest theory of state-owned enterprise assumes that if monitoring of management is equally effective under both public and private type of ownerships, public ownership has some potential advantages over private ownership. It allows the government to achieve distributional objectives, and provides additional policy instruments to correct any discrepancy between the social and private returns. Moreover, presence of state-owned enterprises in high economies of scale and density sectors such as energy, water, communication, space research and defense reduces duplication of resource deployment and capital expenditure. However this theory does not take into account the enterprise agency problem. The key assumption concerning the agency problem, at the private enterprise level, is that private ownership is associated with a more effective incentive structure than public ownership; and there will be less scope under private ownership for managers and workers to pursue their own objectives at the expense of the shareholders. There exist several mechanisms such as shareholder's activism in the stock market, takeover bids and bankruptcy threat in the private sector which constraint agents to pursue their own objectives at the cost of the principals. In case of public ownership, the management of firms can be viewed as agents acting for the government to which they are accountable. Government monitors the performance of managers of public sector enterprises. As compared to private ownership, differences between managers and their immediate principals in state ownership arise from following facts:

(a) Principals (government) do not follow profit maximization objective.

(b) For wholly owned state enterprises, there is no listing of shares in the stock markets, and hence not market for corporate control.

(c) There is no direct equivalent of the bankruptcy constraint on financial performance.

Therefore, agency problem in case of public enterprises seems potentially to be more severe than the private ownership. In case of state owned enterprises, the full monitoring hierarchy includes voters, elected political representatives, bureaucrats, and the managers of these firms. This lead to a number of principal-agent problems. The political agency problem associated with the relationships between voters and the political decision makers is of particular significance (Naib, 2004). The politicians and/or civil servants responsible for monitoring public sector firms can be viewed as agents of the wider public (the principals). In practice, monitoring the performance of public sector firms is likely to be one of the trivial responsibilities of the political decision makers, and performance of a public sector firm may not have any bearing on the electoral prospects.

There exist considerable informational asymmetries between politicians and voters with reference to the management of public sector units (PSUs), which indicate that an efficiency improvement measures such as reduction in the unit costs may some time lead to worsening of the electoral prospects. On the other hand, there would be electoral benefits in setting politically sensitive, low prices even below variable costs, since the direct positive impact on consumers is more visible than the indirect negative effects arising out of giving subsidy to PSUs. Thus similar to enterprise agency problem which leads to managerial discretion, the political agency problem gives rise to political discretion. Therefore, political agency problem tends to weaken any general advantage of state ownership over the private ownership.

Disinvesting the state's stake in the state owned firms to either a strategic partner or offloading it to the general public or financial institutions, is considered as one of the effective solution to the agency problem of these firms. Sale of stake to the strategic partner is supposed to inculcate profit maximization objective in state owned firms and offloading minority stake to the general public and/or financial institutions is supposed to bring the firm under stock market monitoring mechanism, and better analyst coverage. Strategic sale and minority sale are the two key methods of disinvestment in government owned firms India. In minority sale, government retains the majority ownership and control over the company. Minority stakes are either offloaded through public offerings or auctioned off to the financial institutions. In strategic sale government offload the majority stake to typically a strategic partner and post disinvestment retains the minority stake in the firm. In the present paper, two modes of disinvestment are compared and contrasted for pre and post disinvestment performance of firms on certain parameters such as valuation, financial leverage, and operating efficiency.

Literature Review

The literature on empirical evidence on performance comparison between public and private ownership is vast, but there exist disagreement on their findings. In a review of the empirical literature on this issue, Millward (1982) concluded that there appeared to be no general ground for believing that managerial efficiency was lower in public firms. Boyd (1986) concludes that there is not systematic difference in the efficiency of the public and private sectors. Boardman and Vining (1989) suggests an edge for the private sector, but the results vary considerably across various sectors. Meyer (1975) randomly sampled 30 public and 30 private companies from the electric utilities in the U.S for three years 1967-1969. He consistently found that public sector was performing better than the private sector. Pescatrice and Trapani (1980) tried to provide a more precise comparison of the production efficiency of public and private utilities to assess whether significant cost differential arises from different behavioral objectives under different modes of ownership. They concluded that public ownership utilities were more efficient than the private ownership utilities. In another study, Fare, Grosskopf and Logan (1985), using a nonparametric, linear programming approach to study the relative performance of public and private electric utilities, concluded that there is no significant difference in overall efficiency between public and private utilities. Atkinson and Halvorson (1986) used an econometric model that allowed for the joint effects of ownership type and regulation on the shadow prices for inputs in the electric utility industry, to conclude that there is no significant difference in operating efficiencies of public and private firms.

In UK most empirical studies have focused upon competitive market structures where both public and private ownership coexisted. Pryke (1982) compares the two types of ownership in three industries: airlines, services and hovercraft, and the sale of gas and electricity appliances. He analyzed a range of productivity, profitability, and output variables, and concluded that private firms were found to be more profitable and efficient than their public sector competitors. Rowley and Yarrow (1981) found a slight deterioration in the productivity performance of the British Steel industry following the nationalization in 1966, coupled with more significant changes in the market share and in the rate of diffusion of new steel making process. Vickers and Yarrow (1988) compared profitability of public and private industrial firms in the UK from 1970 to 1895 and find that average for private firms consistently higher. Boardman and Vining (1989) compared the financial performances of private corporations, state owned enterprises, and mixed enterprises having partial ownership with state and partial with the private sector. They concluded that after controlling for a wide variety of factors, large mixed enterprises and state owned enterprises have perform substantially worse than similar private corporate. In terms of all profitability indicators, mixed enterprises perform no better and often worse than state owned enterprises. These results also suggest that partial privatization where a government retains some percentage of equity, may not be the best strategy. Boardman and Vining suggest that it may be on account of conflict between public and private shareholders in joint ownership leading to high degree of managerial 'cognitive dissonance' and accordingly partial privatization may be worse, especially in terms of profitability.

In India, important studies in this context are Bhaya (1990), Trivedi (1990), Jha and Sahni (1992), Sharma and Sinha (1995), Majumdar (1995), Kaur (1998), and Naib (2002). Bhaya (1990) concluded that barring the burden of the fixed capital over which the public sector management has not control, and despite of higher wages and administered prices over which the management has not control, efficiency in public sector is in no way inferior to the private sector. Trivedi (1990) used an accounting approach called 'Public Profitability at Constant Prices' to study performance of six public sector companies and 8 private sector cement companies. The procedure adopted for calculating public profit is that direct taxes, interest payments, depreciation are not deducted while calculating public profit. Nonoperating income such as interest, dividends, rent etc., are excluded from public profit. After making multiple adjustments to the data, Trivedi concluded that there is no significant difference in the mean public profitability for the public and private cement companies over a period of five years from 1977-78 to 1981-82. Jha and Sahni (1992) uses Annual Survey of Industries data for the years 1960-61 to 1982 83 for four industries: cement, cotton textiles, electricity, and iron. The latter two industries, they claim are primarily in the public sector while the first two are owned predominantly by private sector players. The authors find no evidence of allocative inefficiencies in general and each of them is relatively as efficient as one another. Sharma and Sinha (1995) have used a Cobb-Douglas production function to study productive efficiency, which combines both technical and allocative efficiencies for the cement industry in India. Using cross sectional data for 16 large cement companies of India of which 13 are in the private sector, and remaining 3 are in the public sector, they concluded that the public enterprises are not inherently less efficient than the private enterprises. Majumdar (1995) evaluated relative performance difference between the state-owned, joint sector and private sector of Indian industry. Using data envelopment analysis (DEA) to calculate firm-level efficiency for organized sectors of manufacturing industry from 1973-74 to 1988-89, author concluded that in aggregate state owned enterprises are less efficient than firms in the joint sector or the private sector. The joint sector firms are more efficient than state-owned firms, but less efficient than those in the private sector, while private sector is comparatively most efficient sector in Indian industry. Kaur (1998) compared total factor productivity (TFP) of 15 public and 15 private enterprises from diverse sectors, viz., aluminum, steel, fertilizers, engineering, drugs and chemicals, and consumer goods. The period covered for such comparison was 1988-89 to 1994-95. Author concluded that there was not much difference in the average annual growth rate of TFP between public and private sectors. Results also indicated that state owned enterprises operating in completive environments were performing far better the state owned enterprises operating in monopoly environment. Naib (2002) compared efficiency of 26 enterprises (13 public and 13 private) for a 12-year period from 1988-89 to 1999-2000. Study revealed that at the enterprise level there is little empirical evidence for general presumption in favor of either type of ownership. Naib (2003) evaluated the financial performance of divested state owned enterprises using certain financial ratios for two sub periods, before disinvestment, and after disinvestment. Author compared before and after disinvestment profitability, operating efficiency, leverage, dividend payout and liquidity for various state-owned firms in India. Results indicated statistically significant drop in profitability and leverage, statistically insignificant decline in operating efficiency, and statistically significant increase in dividend payout. The present paper focuses on financial performance of the divested state-owned enterprises with respect to the two methods of disinvestment, namely strategic sales and public offering. Two modes of disinvestment are compared and contrasted for pre and post disinvestment performance of firms on certain parameters such as valuation, financial leverage, and operating efficiency.

Methods of Disinvestment

Disinvestment involve transfer of ownership rights from public to private sector. Primarily two types of disinvestment options are used in India to privatize the state ownership in public sector enterprises, namely (a) public offering of share, and (b) strategic sale.

a. Public offering of shares (full or partial): Under this method, the state sells to the general public all or large block of its stocks, in a wholly or partly owned state owned enterprise. Technically this amounts to secondary distribution of existing government controlled shares to larger investor base in public. This method is generally used for a profitable, large scale enterprise. If the enterprise is not a strong performing firm, a public offering is possible only after it's restructuring and turn around. The advantages of public offering are that they permit wide-spread shareholding, normally characterized by simplicity and transparency. For these reasons it is politically more attractive. However, for generating good public response for state's offering of enterprise shares, there is a necessary condition of existence of a robust and responsive capital market. Another important issue in case of public offering is the timing of disinvestment. Crowding out effect of large public offerings may prevent available capital from being invested in creation or expansion of other productive enterprises. Thus public offerings should be planned in small trenches so that it does not result into herding effect. In international offerings, an offer to international investors is made through issue of sponsored depository receipts, which represent American Depository Receipts (ADRs) in US market and Global Depository Receipts (GDRs.) in other international markets. Despite being listed in US and other international market, a state-owned enterprise using a sponsored ADR will still have its revenue and profit denominated in its home currency i.e. Indian Rupees. International public offering was made in case of VSNL, MTNL, and GAIL. Offer on sale to public can be made through book building process. In public sector Maruti in June 2003 and in private sector, Bharati Enterprises in February 2002 made use of this method. Public enterprises like Videsh Sanchar Nigam Limited (VSNL), Mahanagar Telephone Nigam Limited (MTNL), and Gas Authority of India Limited (GAIL) were divested using the ADR route.

b. Strategic Sales (Full or Partial): Under this method of divestiture, the state's share of a firm is sold directly to private buyers. A direct sale can be carried out in two ways, (a) through competitive bidding, and (b) to a predetermined selected buyer. One of the principal advantages of the strategic sale of shares to a private buyer is that the prospective owner is known in advance and can be evaluated on the basis of his ability to bring in benefits such as management, technology, and market access. Moreover, the strategic sale permits all the required flexibility to conclude special arrangements with a suitable buyer. The strategic sale is much simpler in terms of disclosure than a public offering. Private placement with a strategic investor is an appropriate method of disinvestment when enterprises are not large enough to warrant a public share offering, and/or the state owned enterprise's weak performance can be turned around by means of its transfer to a financially strong and experienced buyer. In India, private placement of equity has been done in case of CONCOR and GAIL.

The advantage of disinvestment program should eventually be judged by its contribution to economic efficiency of the disinvested firm. There are good reasons for assuming that ownership of a firm will have significant effects on its performance, since change from public to private will change ownership structure, which in turn will alter the incentives available for the key stakeholders in the firm. Disinvestment also reduces political interventions in the management of the firm and bring the firm under the scrutiny of capital market.

Strategic sale to preselected buyer is supposed to inculcate profit maximization objective in state owned firms and offloading minority stake to the general public and/or financial institutions is supposed to bring the firm under stock market monitoring mechanism, and better analyst coverage. Further it is assumed that disinvestment will result in increase in profitability and improvement of operating efficiency. Based on the empirical results available on disinvestment, it is expected under both the methods of disinvestment namely, public offering and strategic sale:

(1) That the shift from public to private ownership will cause operating efficiency to improve.

(2) There will be improvement in valuation of the firm because of enhanced openness and transparency.

(3) There will be decrease in the proportion of debt in the capital structure both because of the state's withdrawal of debt guarantees and increase in enterprises cost of borrowings.

It is also expected that firms under disinvestment will respond differently to the different methods of disinvestment in terms of operating efficiency, leverage and valuation.

Data and Methodology

The data for state owned companies disinvested through public offerings and Strategic Sale, has been extracted through Capitaline and Thomson Reuters data bases. Pre and post disinvestment performance of state owned companies is compared on three parameters, namely operating profit, financial leverage, and valuation ratio. EV/EBITDA has been considered for capturing the effect of disinvestment on Valuation Ratio. This ratio has been selected as EBITDA value is pre-tax which moves it away from the discrepancies of tax structure across industries. This makes the companies comparable across industries. For Financial Leverage, Debt to Total Assets ratio has been used. For measuring operating efficiency of the firms, their Operating Profit on Sales Ratio (EBITDA/Net Sales) has been considered. Hypotheses formulation focuses on the financial characteristics which are examined for changes resulting from disinvestment. Symbols PRE and POST in the null hypotheses stand for pre and post disinvestment performance. Null and alternative hypotheses are provided below:

Formulation of Hypotheses:

(i) Valuation:

Null: VAL (PRE) = VAL (POST) Alternative: VAL (POST) > VAL (PRE)

(ii) Leverage:

Null: LEV (PRE) = LEV (POST) Alternative: LEV (POST) < LEV (PRE)

(iii) Operating Efficiency:


To test the hypotheses, above ratios were computed for 5 years before the disinvestment, and 5 years after the disinvestment. Having computed pre and post mean, t-test were conducted for testing significant changes in variables.

To study the performance of firms disinvested though public offering, eight firms namely Bank of Baroda, Union Bank, Bharat Earth Movers Limited, National Thermal Power Corporation (NTPC) Limited, Rural Electrification Corporation (REC) Limited, Power Grid Corporation of India, Engineers India Limited, and Oil and Natural Gas Corporation Limited (ONGC) are selected. Public offer was made for these firms from 2005 to 2012. The criteria for selecting these companies was that public offering of shares should be made through Follow-On Public Offer (FPO) as the valuation ratio for IPO firms could not have been calculated before their disinvestment.

To study the performance of firms disinvested through strategic sale method, four companies namely CMC Limited, IBP Limited, Indian Petrochemicals Corporation Limited, and Hindustan Zinc Limited are selected. These firms were disinvested to a pre-selected strategic partner namely Tata Sons Limited, Indian Oil Corporation Limited, Reliance Petro Investment Limited, and Sterlite Opportunities and Ventures Limited respectively. Disinvestment in these firms took place between 2001 and 2003.

Findings and Analysis

Table I and Table II presents before and after disinvestment data for valuation, leverage, and operational efficiency for the sample firms divested through public offerings, and through strategic sales respectively. Eight public enterprises namely, Engineers India Limited (EIL), National Thermal Power Corporation (NTPC), Power Grid Corporation India Limited (PGCIL), Rural Electrification Corporation Limited (RECL), Oil and Natural Gas Corporation (ONGC), Bharat Earth Movers Limited (BEML), Bank of Baroda (BOB), Union Bank of India (UBI) are considered for sample firms divested through public offerings, while four public enterprises namely, Computer Management Corporation (CMC), Indian British Petroleum (IBP), Indian Petrochemicals Corporation Limited (IPCL), and Hindustan Zinc Limited (HZL) are considered for sample firms divested through strategic sales. Strategic sales of the CMC, IBP, IPCL, and HZL were made to Tata Consultancy Services (TCS), Indian Oil Corporation Limited (IOCL), Reliance Petro Investment Limited (RPIP), and Sterlite Opportunities and Ventures Limited (SOVL) respectively.

Table I shows that mean value for valuation for firms divested through public offerings have decreased after disinvestment, while there is a marginal drop in the mean value of leverage, and operational efficiency. The results are contrary to the assumptions that disinvestment should results into better valuation, lower leverage, and better operational efficiency. In fact, post disinvestment valuation for most firms excluding EIL, RECL, and BEML has gone down, while no significant change is recorded in financial leverage. There was substantial improvement in post disinvestment operational efficiency for NTPC, and substantial decline in operational efficiency was recorded for BOB, while other firms show marginal changes in the measure, pre and post disinvestment.

Table II shows that for the sample firms divested through strategic sale, post disinvestment mean value for valuation measure has improved. There is substantial drop in mean value of financial leverage, and considerable improvement in operational efficiency. Valuation for all the sample firms except CMC has improved post divestment. Highest increase in valuation is recorded for HZL which was sold to Sterlite Opportunities & Ventures Limited. In line with the literature, substantial drop in financial leverage is recorded for all the sample firms divested through strategic sale. This drop in financial leverage can be attributed to perceived higher cost of borrowing for the strategic partners, as well as state's withdrawal of debt guarantees. Substantial improvement in operational efficiency is recorded for all the sample firm divested through strategic sale. However, HZL shows the most remarkable improvement in operational efficiency of roughly four times.

Table III shows the summary of results for valuation, leverage and operational efficiency for sample firms divested through public offerings, and strategic sale.

Sample of state-owned firms divested through public offering shows negative change in valuation, and positive change in financial leverage, and operational efficiency. The results are contrary to the theoretical arguments in the favour of disinvestment in the case of valuation, and financial leverage. It was expected that sale of government stake in these firms through public offering would bring these firms under stock market monitoring system and better analyst coverage, which in turn would lead to improved valuation and operational efficiency. However, none of the above result are statistically significant as the calculated value of t-statistics are lower than the t-critical value. Table III also illustrates that sample of firms divested through strategic sale shows positive change in valuation and operational efficiency and negative change in financial leverage, which is in line with the theoretical arguments that disinvestment of the government stake through strategic sale in the sample firms would lead managers to place greater emphasis on profit goals, improve operational efficiency, and unlock value. Post divestment financial leverage was expected to come down because of two reasons, (i) cost of debt would be higher for acquiring private players, and (ii) due to state's withdrawal of debt guarantee. Overall, firms show a trivial change in valuation, but remarkable improvement in operation efficiency after the divestment of government stake to the strategic partner. Post divestment reduction in financial leverage is also notable. Although, results are indicative, yet they are not statistically significant.


The immediate effect of divestiture is to substitute government as the sole monitoring and controlling authority with shareholders for the firm's management either fully or partially. In case of public offering of government stake, minority shareholders replace the government as owner partially, and the firm come under the stock market monitoring mechanism. When managers are performing poorly, there are signal through the stock market. The key component of the market oriented control mechanism is the firm's profitability, reflected in its stock price and particularly seen in comparison to its competitors. Sale of government stake to a strategic partner is likely to lead managers to place greater emphasis on operational efficiency and profitability, which in turn would lead to improved valuation.

Results of the paper suggest that strategic sale of government stake is more powerful tool to bring efficiency in the state enterprises than plain offloading of the government stake to the general public. Thus it can be concluded that stock market monitoring is a necessary but not sufficient condition to ease agency issues in public sector enterprises.

Paper received on July 12, 2017


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Himanshu Joshi

Associate Professor, FORE School of Management, New Delhi.
Table I.
Pre and Post Disinvestment Valuation, Leverage, and Operational
Efficiency for Firms Divested through Public Offering.

               Valuation      Leverage
Name of the        Pre           Post
Company         Disinvest.     Disinvest.

EIL                8.79           8.97
NTPC              12.18          12.15
PGCIL             12.87          11.05
RECL *            11.57          11.59
ONGC               7.17           6.27
BEML               9.95          10.48
BOB *             18.69          14.61
UBI *             17.40          13.35
Mean              12.32          11.05

               Operational Efficiency
Name of the        Pre           Post            Pre
Company         Disinvest.     Disinvest.     Disinvest.

EIL                 0              0            33.51
NTPC              0.387          0.350          29.27
PGCIL             0.647          0.648          89.40
RECL *              --                          97.28
ONGC              0.010          0.148          51.89
BEML              0.205          0.060          14.11
BOB *               --                          69.69
UBI *               --                          70.13
Mean              0.250          0.241          56.91

Name of the       Post
Company         Disinvest.

EIL               32.87
NTPC              37.51
PGCIL             90.39
RECL *            96.48
ONGC              44.16
BEML              15.06
BOB *             54.39
UBI *             62.74
Mean              54.20

* Leverage not computed for banking and finance companies.
Source: Table prepared by the author.

Table II.
Pre and Post Disinvestment Valuation, Leverage, and Operational
Efficiency for Firms Divested through Strategic Sale.

                Valuation       Leverage
Name of the        Pre            Post
Company         Disinvest.     Disinvest.

IPCL               5.29           5.55
IBP                5.39           6.30
CMC               21.62          19.98
HZL                3.65           7.34
Mean               8.99           9.78

               Operational Efficiency

Name of the        Pre            Post           Pre
Company         Disinvest.     Disinvest.     Disinvest.

IPCL               0.58           0.29          16.55
IBP                0.45           0.08           2.4
CMC               0.040          0.017           6.08
HZL               0.048          0.192          11.04
Mean               0.28           0.14           9.02

Name of the        Post
Company         Disinvest.
IPCL              16.89
IBP                3.37
CMC                6.16
HZL               43.42
Mean              17.46

Source: Table prepared by the author.

Table III.
Summary of results for Valuation, Leverage, and Operational
Efficiency for Sample of Companies Divested through Public
Offering and Strategic Sale.

Companies Divested through       Mean Before       Mean After
Public Offering                  Disinvestment     Disinvestment

Valuation (EV/EBDITA)            12.33             11.06

Leverage (Debt/Total Assets)     0.241             0.250

Operational Efficiency           54.20             56.91
(EBITDA/Net Sales)

Companies Divested through       Mean Before       Mean After
Strategic Sale                   Disinvestment     Disinvestment

Valuation (EV/EBDITA)            8.99              9.78

Leverage (Debt/Total Assets)     0.28              0.14

Operational Efficiency           9.02              17.46

Companies Divested through       Change in      t-Value
Public Offering                  Mean

Valuation (EV/EBDITA)            -1.27          0.754

Leverage (Debt/Total Assets)     + 0.01         0.194

Operational Efficiency           +2.71          1.068
(EBITDA/Net Sales)

Companies Divested through       Change in      t-Value
Strategic Sale                   Mean

Valuation (EV/EBDITA)            + 0.79         -0.714

Leverage (Debt/Total Assets)     - 0.14         1.135

Operational Efficiency           +8.44          1.05
(EBITDA/Net Sales)

Source: Table prepared by the author.
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Date:Apr 1, 2018
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