The Utility of Privatization
Private ownership is more beneficial than public ownership for an economy and society. Economic theory stipulates this, and experience both in Lithuania and abroad further corroborates this argument. Governments are less effective than private agents at managing property because they have less incentive to do well and confuse economics with politics, using public property for solving day-to-day political concerns. Moreover governments provide subsidies, loans, and loan guaranties for public enterprises, thereby reducing transparency of public finance and increasing the tax burden on private companies.
The implications of mismanagement are greater for a private agent because he risks his own property rather than someone else’s. His profits reflect an increase in his own rather than someone else’s wealth. Likewise, his losses reflect a decrease in his own wealth, not somebody else’s. Thus, a private owner has more incentives than a public property administrator to work efficiently and productively. The analysis conducted on the performance of Lithuanian companies verifies this statement.
Similar results are shown by investigations that examined the impact of privatization on enterprises’ performance in Central and Eastern Europe and Latin America. Investigations revealed that privatized enterprises, in comparison with state-owned ones, use resources in a more effective way, more rapidly restructure themselves and develop product markets.
Privatization goals are not laid down in the Lithuanian law. However, the State Property Fund (the main performer of privatization in Lithuania) has declared several goals, namely to privatize state property for the maximum price, to ensure a transparent, high-speed privatization process while not aggravating the problems of unemployment, ensuring large investments, and creating conditions for the development of capital markets. The aims are fine. However, while efforts are focused on ensuring large investments and preserving jobs instead of leaving this to the market, other aims – such as a maximum price, transparency and speed – suffer. Even worse, the measures designed to ensure a high rate of investment and preserve jobs in privatized companies distort market relationships instead of creating them. The key criteria and strategic objective of privatization is to create conditions for a free operation of market forces. This attracts maximum effective investment and creates a maximum number of well-paid jobs. Therefore the main aim of privatization should be defined as privatization for the highest price without any legal constraints inhibiting free market performance.
Critics pay attention to the fact that privatization increases unemployment. It is true that newly privatized companies often reduce the number of employees. However, this is aimed at increasing the efficiency of a company. If the efficiency were not increased, it would mean not only the waste of resources, but a higher probability of bankruptcy as well. Transferring money from taxpayers into the hands of inefficiently functioning state enterprises does not solve the problem of unemployment either. This problem requires other solutions. Reduction of the tax burden and liberalization of the market are the solutions. Indeed, analysis performed by the Property Fund shows that some privatized enterprises created new jobs. These results became possible due to a more efficient use of resources and successful development of new markets for their products.
Opponents of privatization also criticize the acquisition of state property by foreign investors, arguing that this hampers the formation of local capital, and earned profits travel abroad. Privatization of large companies by foreign investors is often a result of the low financial capability of local investors and of current privatization policy to sell state owned stock in one parcel and not through the stock exchange. However, the participation of foreign investors should be welcomed. It increases both competition and price. Taking into account the fact that the purchaser takes the risk of losses upon himself, his expectations are rational and reasonable. The property that was acquired for a bigger price is likely to be employed more efficiently.
The fear that foreign investors will repatriate profits does not have much justification either. Foreign investors bring their own resources to Lithuania Even if profits are repatriated, this does not necessarily mean that Lithuanians will become poorer. On the contrary, earned profit results in increased wealth of the Lithuanian people, since the earned profit shows how much society values the services of the privatized company. As was already mentioned, the higher the price of the privatized company, the higher the expectations of profits and therefore utility for the society. Restricting foreign investments would be the same evil as restricting Lithuanian investments. In order to attain better privatization results, investors must not be discriminated against based on their country of origin.
Privatization of infrastructure enterprises is frequently criticized on the ground that such enterprises have a monopoly status. However, during the last decade, due to market liberalization, rapid development of technology, and other factors, many businesses – for instance, telecommunication, energy production, and public transport – have been deprived of their monopoly status. In foreign countries these businesses are being partially or fully privatized and restrictions on market entry are being removed. Experience reveals that privatized enterprises function more efficiently. The consumer is also better off after privatization, since he obtains the opportunity to choose higher quality, cheaper products. On the other hand, there are businesses – for instance, water supply, electricity, etc. – where it is extremely difficult to achieve competition because the state itself maintains a monopoly there. However, even in these cases, privatization would improve the allocation of resources and reduce the cost of supplied services, particularly if restrictions are removed. When legal restrictions on competition are eliminated, it becomes evident that competition in the marketplace is achievable and that the monopoly is not entirely “natural.”
Therefore, neither the supposed increase in unemployment, the possible growth of foreigners’ influence, nor privatization of large infrastructure entities can be regarded as a danger or harm resulting from privatization. The true harm to society and effective market performance arises when, in addition to property privatization, citizens’ freedom of choice is “privatized.” Such mistakes when privatization is accompanied by the granting of certain privileges have been made in Lithuania too. For instance, during the privatization of “Lietuvos Telekomas” amendments to the Law on Telecommunications were passed granting the telecom monopoly rights in terrestrial communications. During the privatization of “Mažeikių nafta” oil refinery the state obliged itself to provide loans amounting to approximately 1.2 million Litas; to extend loan guarantees worth 284.5 million Litas; to reduce tariffs for the use of services of the Klaipėda Oil Terminal and the Lithuanian Railways; and, if necessary, to increase import duties on fuel. So, although the sale of enterprises is deemed to be positive, the processes accompanying privatization of individual enterprises are not always desirable. If such dangers are to be avoided, no restrictions should be placed on other entities and no privileges should be granted to companies under privatization.
Privatization failures have nothing in common with inefficiency in the marketplace or private sector; rather, they are caused by inappropriate methods of state property privatization and restrictions imposed on free market relationships.
It is often said that the privatization process is nearing its end and that there are just a few infrastructure items and remainders of stock in several companies to be sold. This is true, but only in the short term. The current Plans for privatization do not include “enterprises of special designation” that are engaged in the supply of public utilities. Moreover, liberalization of market relationships and privatization are still needed in such businesses as healthcare, education, retirement provision, and social security. Because of the inefficient use of resources, as well as the poor quality of services, these sectors are in very bad shape and need major improvement. Moreover, there remains a large amount of property that has yet to be privatized, such as land, forests, water resources, and roads.
An overview of the privatization process in Lithuania, privatization methods and related problems follows. Possible solutions to these problems are provided.
An Overview of the Privatization Process
The First Round
Two rounds of privatization of state property were envisioned. The first round of privatization was launched in September of 1991. State property was sold for investment vouchers that were distributed free of charge to all Lithuanian citizens. Other natural and legal persons could purchase state property for cash. State property was sold through open and closed subscription of shares, open and closed auctions, restitution, “best business-plan” tenders, and by other methods.
During the first stage of privatization, 5,714 objects were sold for 3.4 billion litas. A total of 2,928 objects were privatized by share subscription, 2,726 entities were sold in auctions, 12 entities through “best business-plan” tenders, and 48 objects for freely convertible currency.
The first round of privatization was designed to create conditions for every Lithuanian citizen to take part in privatization and to become an owner and, by doing so, to ensure social justice. For this purpose, a large portion of state property was sold only for vouchers and only to Lithuanian citizens. The large-scale voucher privatization permitted the formation of a wide layer of private owners. On the other hand, a large number of inexperienced small shareholders and restrictions placed on foreign investments prevented a fast and efficient restructuring of enterprises. Even more, in some cases established privatization rules were circumvented.
The Second Round
Presently, Lithuania is in the second phase of privatization. The second round was launched in August of 1996. The State Property Fund is responsible for conducting privatization of state property. The responsibilities of the State Property Fund include taking over and administering stated-owned shares in enterprises that are included in the privatization list, representing the state in the privatization of state property, preparing entities for privatization or hiring privatization consultants, identifying and negotiating with potential investors, and concluding and supervising the execution of privatization transactions. Municipalities may delegate these functions to the State Property Fund. Eleven municipalities (out of a total of 60) have already delegated the said rights and obligations to the Property Fund.
The Privatization Commission, which is accountable to the Parliament of Lithuania, is charged with the supervision of the privatization of state and municipal property as well as approving privatization programs and transactions. If municipalities choose to privatize municipal property on their own account, the municipal council must establish a privatization commission to perform the said functions. If the Privatization Commission does not approve a privatization transaction, the Property Fund must submit it for approval to the Government of Lithuania. Decisions of the Government are deemed to be final.
The main feature of the second round of privatization is that privatization is based on cash sales. Foreign and local investors have equal rights in privatization of state and municipal property. The Law on Privatization of State and Municipal Property defines several methods of privatization of state and municipal property (hereafter referred to as state property). Real estate entities are privatized by public auction or lease with the right to purchase. Public shares in enterprises are sold by public tender, through direct negotiations, by public auction, public sale of shares on the stock exchange or by transfer of control of state-owned enterprises.
The method of privatization is selected depending on the size of an enterprise, the area of its activity, the quantity of shares, etc. Privatization may be organized according to special laws. For example, special laws were passed to regulate the terms and procedures of privatization of the Mažeikių Nafta oil refinery. Public shares in three enterprises were sold according to the Law on Public Trading. Special laws are to be passed for the privatization of state-controlled commercial banks.
During the second phase of privatization (covering the period from August 1996 until October 1999), a total of 1,119 items were sold for 2.8 billion litas. A total of 1,053 objects were sold in public auctions, 26 objects were privatized by public sale of shares, 24 objects through public tender, four items were sold through direct negotiations, and 12 entities through lease with the right to purchase. In October 1999, investors pledged to preserve 2,300 jobs (for three to five years) and to invest 1.638 million litas in their privatized entities.
At the end of 1999, the privatization list comprised 3,100 objects. Of these, 2,128 items represented public blocks of shares in enterprises. A large part of these public blocks of shares (1,465 blocks of shares) accounted for less than 20 percent of the whole capital. The state has controlling interest in 159 enterprises.
The experience of the second round of privatization indicates that in many cases privatization is slow, many objects cannot be sold in the first attempt, enterprises intended for privatization have large debts and losses. Very often already privatized enterprises are put in preferential conditions.
The results of privatization depend largely on what methods of transferring state-owned property to private hands are used. Problems caused by improper methods of privatization are examined further in the study. These problems are divided into two groups: general and specific problems. General problems refer to the preparation of objects for privatization and concerns common to different methods of privatization. Specific problems are related to individual methods of privatization.
General Problems of Privatization
Selection of Items for Privatization
The privatization process is extremely complex, time consuming, and costly. One of the primary reasons for this is that a number of small transactions are being carried out, and this requires a great deal of time and other resources. Privatizing small blocks of shares of different companies in one parcel may solve this problem. It would be possible in this way to transfer state property into private hands more quickly, and to reduce the overall costs of the privatization process as well.
A major obstacle to privatization is the fact that a portion of entities have a special legal status, e.g. enterprises of special designation, public organizations, , and budgetary institutions. Privatization of these entities is very complicated and, regretfully, has been put off without any economic justification. Therefore, we propose to alter the existing regulations and to extend privatization to these entities by diminishing existing restrictions on privatization and by restructuring these entities into enterprises.
Selection of Municipality Property for Privatization
The Law on Privatization grants the rights for municipalities to decide which property to include in the privatization list. Some municipalities are particularly opposed to the privatization of their controlled assets, especially if these are used for commercial purposes. Therefore, the law should provide for an automatic release of municipality-owned property for privatization. The majority of municipal-shares and buildings must be privatized on a compulsory basis. As long as the requirement for automatic privatization is not introduced, a large quantity of commercial entities will remain public property and, consequently, will not be utilized in the most effective manner. Moreover, because there is an unclear dividing line between state and municipal functions and budgets, both the responsibility and financial burden related to these public properties will fall on the state and the taxpayer.
Enterprise Restructuring before Privatization
Thirdly, the Law on Privatization assigns the Property Fund the right to restructure state-owned enterprises if such restructuring enhances the prospect of its privatization or increases its selling price. Although a policy like this may seem logical, it harbors a number of pitfalls. The concept of restructuring an enterprise in order to improve its performance provokes much criticism, since it is the goal of privatization to ensure a more efficient means of company performance. Therefore, restructuring must be left to the private owners of a company.
Quite often restructuring is used as a pretext for postponing privatization. Loans are drawn and guarantees are granted on behalf of the state. However, there are no guarantees that restructuring will eventually help achieve desired results, or that the Property Fund will take responsibility for the success or failure of the restructuring process. Experience both in Lithuania and abroad indicates that the restructuring of an enterprise is a lengthy process. While enterprises are being restructured, their performance is aggravating and assets are dissipated. Foreign research findings show that the state would generate more revenues by privatizing companies without any prior restructuring. For instance, while the privatization process was being initiated with “Lietuvos kuras,” the enterprise incurred losses of millions litas. Once the privatization process was completed, the company’s debts totaled 133 million litas, and the company was sold for one litas. Controlling agencies confirm that state-held companies are being plundered. This is illustrated by violations that took place in both “Lietuvos kuras” and “Lietuvos energija”.
Enterprise restructuring is justified only when the goal is to split a company into several independent entities in order to reduce the company’s monopoly position. However, in such cases it is important to ensure that the restructuring will not delay privatization, and that the state will refrain from undertaking tasks that private owners can perform. It is equally important to remember that for competition to achieve results, legal conditions must exist for free market entry and exit, rather than a given number of market participants.
Selection of Privatization Consultants
The Law on Privatization allows the Property Fund to hire consultants in accordance with the Law on Public Procurement in order to perform duties related to the privatization process. The methods of public procurement permit the establishment of qualification requirements for consultants, and the assessment of bids not only by price, but also by technical criteria.
It is assumed that this method will result in the selection of the best consultant for the job. However, in every privatization case, privatization executives are allowed to set up different qualification requirements for the privatization consultants. However, no objective methodology exists to set up qualification requirements. Such requirements merely reduce the transparency of privatization, invite corrupt practices, increase the cost of services, and consequently the cost of the entire privatization process. The assessment of bids by price and technical criteria may allow proposals that do not fulfill the state’s needs and overestimate consultants’ capabilities. Moreover, this method could potentially allow the leaking of confidential information and corruption. To ensure efficient privatization, it is necessary to eliminate all qualification requirements applied to consultants. Technical requirements regarding proposals (not assessment criteria) must be set up before announcing the tender, and bids must be assessed by price. In addition, it is necessary to draft a contract stipulating all commitments of the consultant concerning services rendered.
Minimal Price
All methods of privatization laid down in the Law on Privatization authorize the Property Fund to set up a minimum selling price for shares. If shares are not sold for this minimum price, the privatization is halted. In this case the Property Fund has two options: either to prepare a new privatization program and lower the price or to propose to the Government the removal of these shares from the privatization list.
Placing a minimum limit on the price of shares is expected to prevent investors from knocking down the price. However, protracted privatization can hardly lead to an increase in the value of shares. A large number of entities slated privatization was not sold in the first attempts. Only after the price was considerably reduced were these objects finally sold. Such limits only protract privatization, increase costs, and create more work for privatization executives. Shares should be sold at market price, even if it seems rather low. Otherwise, the state will have to shoulder the burden of delayed privatization. In order to receive higher revenues from privatization, the state must refrain from placing any restrictions on investors’ participation in the privatization process and from assuming any additional obligations towards for the privatized entity.
If this is unacceptable, there remains the necessity to improve the methodology of setting up a minimum price. The aim should be to achieve a price level similar to the market price. The comparative value method should be utilized, as it allows a share price to be established at a level that is the close to the market price. Other methods listed in the Law on Privatization may be used only when the comparative value method cannot be applied.
Assessment of Investors’ Credibility
If privatization takes place through direct negotiations, public tender, or by public auction, the Property Fund may request competent state institutions to examine the credibility of potential investors. However, there are no criteria that could be used to examine the credibility of investors and deem them unreliable. The conclusions of the state institutions are not made public.
A lack of transparency creates conditions for corruption and speculation, and discredits the idea of privatization. For instance, during the privatization of “Vakarų laivų remontas” in 1998, one foreign company was deemed unreliable and consequently was not allowed to participate in the privatization of the enterprise. The company publicly blamed the privatization executives with corruption. Ironically, the company that won the tender offered the purchased shares to the company that had been declared unreliable.
An assessment of a potential investor’s reliability cannot ensure full protection from all supposed threats. Therefore, such assessments might be applied only in exceptional cases. Criteria used to determine the credibility of potential investors and deem them either reliable or unreliable should be made public. This would increase transparency of the privatization process as well as reduce opportunities for corruption and speculations.
Privatization Methods
Public Tender and Direct Negotiation
According to the Law on Privatization, public tender and direct negotiations are the methods of privatization by which one or several items are sold to the investor who has offered the highest price and the best investment proposal. Public tenders and direct negotiations are used to privatize controlling shares in large enterprises. Privatization through these methods stipulates to the investors special requirements regarding the preservation of jobs and duration of investment.
In order to participate in direct negotiations, a potential investor must fulfill special qualification requirements prescribed by the state. The negotiations are divided into two stages. During the first stage the Commission on Direct Negotiations lists the potential investors according to their proposed purchase price and amount of investments. During the second stage the Commission negotiates with these potential investors to amend their proposals. If after the first stage there are more than two potential buyers, the Commission has the right to select the two best offers and hold negotiations with these investors. The contract goes to the bidder who has offered the highest price and the best investment proposal.
When public tenders are used as a method of privatization, the number of participants is not restricted and the qualification requirements are not applied. The winner of a public tender is the investor who has made the highest bid and offered the best investment proposal. The Commission may engage in negotiations with this potential investor in the hopes of amending the investor’s proposal. However, when the proposals of different potential investors are similar, or the difference between their proposals does not exceed 15 percent, the commission may begin negotiations with several of candidates.
It is intended that special requirements for investors and applied privatization procedures will attract credible investors and ensure a high level of investment However, due to the reasons outlined below, these privatization methods do not always bring the desired results.
Qualification Requirements
Qualification requirements are applied when “strategic” investors are sought. A “strategic” investor is described as a credible company with a high level of efficiency and a large amount of experience in a specific field of business. Because of these qualities, it is expected that the “strategic” investor will restructure and manage a newly privatized enterprise better than an “ordinary” investor.
The concept of a “strategic” investor is ambiguous. As is the case when selecting a privatization consultant, privatization executives have the right to set up different qualification requirements in individual cases of privatization. An objective methodology in choosing the “strategic” investor does not exist, so the qualification requirements are established arbitrarily. Qualification requirements reduce the transparency of privatization, allow corruption, and restrict investors’ ability to enter the marketplace. Moreover, if an investor is granted the status of “strategic” investor, it is possible for him to negotiate with state representatives for preferential business conditions.
The hunt for a “strategic” investor is justifiable only when private owners carry out the search. However, the state as an owner is not driven by the same motives. Therefore, this method of privatization is difficult to implement in practice, and it may have negative implications.
Requirements to Preserve Jobs
Quite often a lack of modern production technology and management in state-owned enterprises inhibits the ability to operate at an efficient level. Therefore, newly privatized companies must introduce new production technology and restructure their management. Consequently, a reduction in the number of jobs is unavoidable. In hopes of avoiding the problem of unemployment, the state requires investors to maintain, for a certain period of time, the same number of jobs that existed before the privatization process took place. However this means additional social guarantees for employees of newly privatized enterprises. However, employees are entitled, through employment contracts, to many social guaranties in case the restructuring of a production process and/or work organization is implemented.
The job preservation requirements place a heavy burden on society, since these requirements result in the reduction of the entity’s price and lower privatization revenues. This policy seems unfair in respect to other employees. Moreover, it does not solve the problem of unemployment. The problem is only put off, since the investor is only required to preserve a fraction of the total number of jobs for a limited period of time, usually from 3 to 5 years.
Investment Requirements
The aim of investment requirements is to assure the continuity of enterprise performance, to introduce new management and production technology, and to supply higher quality, lower price products for consumers. However, in market conditions, an investor is forced to invest an optimal amount of resources necessary to attain efficiency without any commitments to the state.
Other shortcomings are revealed when the state creates special business conditions for a newly privatized enterprise. For example, during the privatization of state-owned shares of “Lietuvos telekomas” the “strategic” investor assumed obligations to preserve nearly 10,000 jobs and to invest 900 million litas in the company. The state granted the enterprise monopoly rights in terrestrial communications. The granting of these monopoly rights will hardly increase the company’s efficiency.
Assessment of Proposals
Given the aim of increasing the amount of investment in a newly privatized enterprise, the state agrees on a lower selling price on condition that the investor increases investment in the enterprise at a later date. To that end, privatization rules stipulate that the winner of a public tender must be an investor who offers the highest price and the largest amount of investments.
This condition involves a certain amount of risk, because the possibility remains that the potential investor has no credible business plan. This is especially true in cases when an investor knows that these commitments may be avoided. In this case, the investor may not fulfill his commitments, and the state may sustain substantial losses. As a result, the need may arise to privatize the problematic company a second time.
The experience of other countries proves that investors frequently breach such commitments. For example, in Germany every fifth enterprise that is privatized in this way does not obtain the amount of investment initially agreed to between the investor and the state.
One additional problem must be mentioned. According to Property Fund data, the purchasers of “Alytaus Tekstilė” refused to fulfill their obligations when the enterprise was not allowed to work in three shifts. So, there was a need to amend their privatization contract. This shows that obligations may be declined not only because investors may be unwilling to comply, but also because it may be impossible to list all necessary privatization conditions in a contract, especially given the continually changing nature of governmental policy. In this case obligations become meaningless.
Partial Acquisition of Shares The winner of in a public tender or direct negotiations may choose to acquire shares in parts; however, he will be obliged to pay interest equal to the average interest rate on time deposits in commercial banks. The existing situation entails two potential pitfalls. First, as was already mentioned, by creating preferential conditions, the state risks selling enterprises to investors with unreliable business plans. Second, the investor is allowed to acquire all stocks over a five-year period, which means that the actual period of privatization is extended to five years.
Negotiations for Amending Proposals
Privatization rules allow privatization executives to engage in negotiations with potential investors in hopes of achieving better proposals concerning the purchase price and the amount of investments. This may help achieve some improvements in the investors’ proposals. However, confidential information may be lost and the potential for corruption increased. This possibility is illustrated by the privatization of “Klaipėdos Hidrotechnika” when a potential investor, who in the first stage had produced the highest bid and had not amended its proposals in the second stage, did not win the tender and accused privatization executives of corruption.
Public Sale of Shares
According to the Law on Privatization, the public sale of shares is a method of privatization in which shares are sold on a stock exchange without quantitative restrictions to the number of buyers or the amount of shares purchased. The sale price is determined according to the market supply and demand ratio.
If this method of privatization is used, no special requirements are applied to investors regarding qualifications, amount of investments or the preservation of jobs. Shares are bought and sold publicly on the stock exchange through public trading intermediaries, or brokers.
Privatization executives maintain that the public sale of shares is used to promote the development of the capital market. However, this method is used strictly for the privatization of small state-owned share packages.) A full third of such privatization transactions comprised share packages that formed a mere 2 percent of the entire share capital of the privatized companies. Blocks from 2 to 10 percent of the share capital constituted another third, and the remaining third comprised parcels of 10 to 50 percent. In 1999, the state sold share packages of 26 enterprises through the National Stock Exchange. This amounted to only 0,92 percent of the total turnover of shares on the stock exchange. So, the declared aim was not achieved.
The development of the capital market through the public sale of shares should not be the main goal of privatization. The main reason for employing this method is the fact that trading procedures on the stock exchange ensure open, transparent and fast privatization. Moreover this method helps to sell state property for the highest possible price.
According to the Law on Privatization, the public sale of shares may be applied only in privatizing open join stock companies. The law forbids the sale of shares of closed joint stock companies. The main reason for this, according to privatization executives, is the fact that shares of closed joint stock companies are not the items of public trading. Therefore, the shares of closed joint stock companies are sold through other methods, most often by public auction. The difference between public auction and public sale rests only in the mechanism of selling. At the same time, the principle behind these methods – to sell publicly – remains valid in both cases. Therefore, it is unreasonable to prohibit the sale of closed joint stock companies’ shares by public sale of shares. Creating additional mechanisms of privatization and additional work for privatization executives is costly and ineffective. Shares of closed joint stock companies should be sold through public sale, provided that all shares are sold in one parcel.
The rules and procedures applied to the public sale of shares contain two main shortcomings. Through the application of this method, as is the case with other methods, one has to set up a minimum price for shares. This problem was already discussed earlier in the study.
The Lithuanian Securities Commission’s resolution on the rules of submitting, registering and executing a tender offer as well as resolution concerning cases when a tender offer is not to be announced stipulate that “a mandatory tender offer” is required from a person who has acquired more than 50 percent of the accountable issuer’s votes. This requirement is not applied, however, when state property is privatized. Although this may increase the value of state-owned shares and, consequently, privatization revenues, exceptional conditions are created for the state as compared to other market participants. In order to even out the conditions for all market participants, it is necessary to apply the requirement regarding “mandatory tender offer” in privatization of state-owned property.
Privatization executives maintain that the primary weakness of the public sale of shares is that the infrastructure of the stock exchange does not ensure effective advertising of entities intended for sale. However, this argument is not justified, since there are no obstacles preventing the Property Fund from advertising such entities.
Public Auction
According to the Privatization Law, public auction is a method of privatization whereby the number of potential buyers is not limited and the privatization contract is concluded with the investor who has offered the highest bid. Public auctions are used to sell state-owned shares of open and closed joint stock companies as well as real estate and movable property. Shares are sold in one parcel. Investors may be subject to special qualification requirements and requirements regarding the amount of planned investments and the preservation of jobs.
Open auction has some advantages as compared to direct negotiation and public tender. However, open auction is slower and less transparent than if compared with the open sale of shares. Also, this method permits the application of requirements regarding investment, preservation of jobs, and investors’ qualifications. Even if these requirements are removed, state-owned shares in open and closed join stock companies should be sold by public sale of shares. Open auctions may be used to privatize state-owned real estate and, in exceptional cases, shares.
Privatization of large items and infrastructure enterprises
Special procedures are applied for the privatization of blocks of shares in large companies and infrastructure enterprises. Such entities are privatized in several stages by applying a combination of privatization methods, including public tenders, direct negotiations, the public sale of shares, and transfer of control of state-owned enterprises.
During the first round of privatization, a certain portion of shares is to be sold by public tender or through direct negotiations. Investors must meet special qualification requirements as well as requirements related to their future investments and the preservation of jobs. In the second round the strategic investor may purchase the remaining public shares. If the strategic investor does not obtain all the shares, the remaining shares are to be sold on the stock exchange. The state has the right to retain the so-called golden share granting extra non-property rights.
Other Methods
State property may be privatized by lease with the right to purchase and by the transfer of control of state-owned enterprises. These methods are used only in special cases, when an entity was not privatized in the first attempt or in combination with other methods (the transfer of control). The aim of these methods is to make the privatization process simpler. However, there would be no need to apply these methods if the problems analyzed in study were removed.
In Lithuania, state property may be, and in some cases is, privatized not only by the Law on Privatization, but also by special laws or rules. For instance, “Mažeikių nafta” oil refinery was privatized and state-owned commercial banks are to be privatized according to special laws. Evidence shows that such privatization is less transparent, and investors have the possibility to negotiate preferential conditions and various other benefits with the state. As a rule, regulations prescribed by special laws are less strict than the primary legislation on privatization. In order to ensure efficient privatization, general rules should be applied to the privatization of state property, except when state property is privatized according to the Law on Public Trading of Securities.
Conclusions and Proposals
The aim of privatization should be to privatize state property for the highest possible price without creating legal restrictions to free market performance. Consistent with this aim, privatization should be completed not only in the sectors of commerce and manufacturing, but also in infrastructure, the healthcare system, education, culture, social security, and other sectors. The creation of monopolies or other preferential rights for newly privatized companies should be avoided in the privatization process.
The success of privatization depends directly on the method of privatization that is used. The privatization of state property starts by including an entity in the privatization list and preparing a privatization program. Municipalities have the right to judge for themselves what items are to be placed on the privatization list, and the Property Fund decides on the preparation of a privatization program. Such opportunities to make discretionary decisions hampers the privatization process, therefore it would be more efficient to automatically incorporate entities in the privatization list as well as automatically privatize entities that are on the list. First of all, the state must sell entities in which it owns small blocks of shares as well as enterprises in such areas as commerce, public catering, tourism, and other fields where private companies are already operating.
Enterprise restructuring can be justified only in cases when the goal is to split a company into several independent entities in order to reduce the company’s monopoly position. However, such restructuring is necessary only in exceptional cases, since monopolies are harmful only when they protected by law It is important to ensure that restructuring does not delay privatization, that the state refrains from undertaking tasks that can be performed by private owners, and that legal conditions exist for free market entry and exit. In all other cases the restructuring of a company should be left to the private owner.
Existing rules regarding the selection of privatization consultants are not transparent and allow for the selection of consultants whose proposals do not necessarily match the state’s needs and the consultant’s capabilities. No restrictions should be placed on potential consultants’ participation in a tender. Requirements applicable to tender bids (rather than assessment criteria) should be established before announcing the tender, and bids should be assessed based on price.
In order to ensure efficient privatization, methods of privatization should be transparent, and privatization should be conducted in a quick manner. No potential investors should be restricted from participating in the privatization process. In Lithuania, state property is privatized by direct negotiation, public tender, public auction, public sale of shares, transfer of control of state-owned enterprises, lease with the right to purchase, and by special laws.
Direct negotiations and public tenders restrict the opportunity for potential investors to participate in the privatization process. These methods do not ensure open and transparent privatization. Lengthy privatization procedures protract the sale of state property. “Strategic” investors have the opportunity to negotiate preferential conditions. The benefits received from “pledged” investments and preserved jobs are short-termed. These requirements restrict investors’ future activities and create the need for control. As a consequence, these methods do not achieve the desired results and should be repealed.
The inconsistency and fragmented regulation related to the privatization process create another set of concerns. When privatization of a certain entity is subject to some specific rather than general rules, it becomes less transparent, and investors have the opportunity to negotiate preferential conditions and benefits. In order to ensure efficient privatization, the general rules of privatization should be applied to the sale of all state property, with an exception only in cases when state property is privatized according to the Law on Public Trading of Securities.
The most effective ways to private state property are the public sale of shares and public auction.
Immovable property and, in exceptional cases, shares should be privatized by public auction without placing any requirements regarding investors’ qualifications, the amount of future investments or job preservation. In all other cases state-owned shares should be sold only on stock exchanges and at market price. The requirements of “mandatory tender offer” should be applied when open join stock companies are privatized.
Privatization on the stock exchange eliminates the need for new state institutions to implement and supervise the privatization process and thereby helps save both time and money. The use of a transparent trading system in the stock exchange would increase the efficiency and pace of privatization. If privatization is conducted on the stock exchange, more potential investors are involved, and shares are sold for the highest possible price. In addition, the use of the stock exchange in privatization of state property significantly accelerates the development of the capital market.
