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Performance of Privatized Enterprisesand Impact of Partial Privatization in aDeveloping Country: Case of Sri LankaSuren Peter a , E. J. De Bruijn b & Kami Rwegasira ca University of Kelaniya , Sri Lankab University of Twente , The Netherlandsc Maastricht School of Management , The NetherlandsPublished online: 10 Mar 2010.

To cite this article: Suren Peter , E. J. De Bruijn & Kami Rwegasira (2010) Performance of PrivatizedEnterprises and Impact of Partial Privatization in a Developing Country: Case of Sri Lanka, Journal ofTransnational Management, 15:1, 46-68, DOI: 10.1080/15475770903583286

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Performance of Privatized Enterprises andImpact of Partial Privatization in a Developing

Country: Case of Sri Lanka

SUREN PETERUniversity of Kelaniya, Sri Lanka

E. J. DE BRUIJNUniversity of Twente, The Netherlands

KAMI RWEGASIRAMaastricht School of Management, The Netherlands

This study investigates the performance of privatized enterprises ina single sector, namely the plantation sector in Sri Lanka. Thestudy provides an insight into the impact of privatization in thecontext of a developing economy and the impact of State andprivate ownership on enterprise performance. The panel dataenabled the comparative study of enterprise performance underState ownership and management, State ownership and privatemanagement and, private ownership and management. It wasrevealed that after controlling for industry effects, privatizationhad led to significant increases in profitability, efficiency, capitalinvestment, and output while employment levels had declined.Results were robust when checked for deliberate underperfor-mance. Contrary to the proponents who espouse partial privatiza-tion as a solution to nationalist opposition to divesting of Stateassets, evidence indicates that induction of private managementunder State ownership had not been able to produce significantimprovement in performance.

KEYWORDS management, partial privatization, performance,privatization, South Asia, Sri Lanka

Received June 2009; revised July 2009; accepted August 2009.Address correspondence to Suren Peter, Senior Lecturer, Department of Industrial

Management, University of Kelaniya, Sri Lanka. E-mail: suren@kln.ac.lk

Journal of Transnational Management, 15:46–68, 2010Copyright # Taylor & Francis Group, LLCISSN: 1547-5778 print=1547-5786 onlineDOI: 10.1080/15475770903583286

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INTRODUCTION

Privatization or denationalization as it was formerly known has been visiblein many forms around the world over the past 50 years. Nationalization wasused as an economic policy tool by almost all governments in the world,except perhaps the United States. The argument was that all productiveeconomic assets should be vested under government control in order tosafeguard it against external influences so that people of all strata could haveequal access to that product or service at a reasonable cost.

When the United Kingdom became industrialized in the nineteenthcentury, very few companies were controlled by the State. However, justprior to World War I, strategic industries like the coal mines where keyresources needed for the war effort were located in were nationalized. Theseenterprises were run efficiently enough that even after the war was over, itwas felt that there was no need for it to be transferred back to private hands(Miller, 1997). The public sector grew rapidly during this period. In Britain,government expenditure as a percentage of GNP was around 8% in 1890,12% in 1910, 29% in 1932, 38% in 1961 and peaked in the mid 1970s with49% (Yarrow, 1999).

Enterprises have been run profitably around the world by the State, butthese have been more the exception than the rule. World Bank estimatesshow that in the years between 1989 and 1991, losses in SOEs accountedfor 9% of GDP in Argentina, 8% in former Yugoslavia, and more than 5%on average in selected sub-Saharan African countries. In 1991 around 30%of SOEs ran at a loss in China, while the consolidated government andenterprise deficit was around 8% of GDP (Yusuf & Hua, 1992). Alarmingly,a survey by the World Bank in 1988 revealed that in 25 developing countriesthe median contribution of the SOEs to the overall public sector deficit was48% (Adam, Cavendish, & Mistry, 1992). Budgetary costs of SOEs in terms ofGDP were 11% in Sri Lanka and 10% in Zimbabwe (Cowan, 1990). Obviouslythe nationalization programs were not providing the desired results andgovernments could not go on sustaining them, wasting precious public fundsthat could be channeled into much-needed infrastructure development.

In an effort to improve performance, a number of countries that haveSOEs as main drivers of the economy have tried to implement reforms inselected sectors. The reforms included exposure to competition, levelingthe field with regard to access to capital, re-orientation of goals, noninterfer-ence of the State in operational decisions, and development of institutionalmechanisms to align goals of the managers. Though cases of improvedperformance have been documented (World Bank, 1983), in the long runthese companies continued to run at a loss. These were mainly due toproblems of implementation and more importantly the State lacking thediscipline and motivation to sustain SOE reforms in the long term (Kikeri,Nellis, & Shirley, 1992).

Privatized Enterprises in a Developing Country 47

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It was the launch of the successful initial public offering of BritishTelecom by the Thatcher government in the United Kingdom that startedoff the privatization process and revolutionized how people viewed theconcept of privatization. It was the first time denationalization was conceivedas part of the overall policy of a government. Privatization had at last comeof age.

Privatization spread rapidly to the developing countries in South America,Africa, and South Asia. The reasoning behind the nationalization process inAsia and Africa were slightly different from those in the Western nations, sincemost of these nations were just gaining independence and the motivation fornationalization was to prevent the colonial masters from exerting influenceover the productive assets through private investors (Guislain, 1997). UnitedStates Agency for International Development attributes this ideological changeto the third world itself. Those countries that had adopted a market-basedeconomy had prospered versus those countries adopting socialist policies(McPherson, 1987). However, compared to the more developed nations thepace of privatization there was slow, and in the initial phase only the relativelysmall and low valued firms were divested. Larger privatizations have lateremanated from countries such as Bangladesh, Brazil, Chile, Gambia, Malaysia,Mexico, Nigeria, Sierra Leone, Singapore, and Venezuela.

Various studies have looked at performance of privatized enterprises,with the performance levels found to vary depending on the level ofdevelopment in the countries under study (Kikeri, Nellis, & Shirley, 1992;Galal, Jones, Tandon, & Vogelsang, 1994). The studies in the developingcountries and especially in South Asia are still very limited.

This study examines the performance of 15 privatized enterprises in theplantation sector in Sri Lanka. These State-owned enterprises were initiallyhanded over to private managers through management contracts and thensubsequently sold to private entrepreneurs during the period 1992 to 1999.However, privatization for this study is defined as the transfer of majorityownership from the public to the private sector.

The main agricultural crops of tea, rubber, and to a lesser extent coconut,contribute significantly to Sri Lanka’s economy. They are estimated to occupyabout 900,000ha or 41% of total cultivated land in the country. These threecrops contribute around a third of total export earnings, 15% to 20% of budget-ary revenue, and employ about 15% of the country’s workforce. Tea andrubber are produced almost exclusively for export while coconut exportsaccount for around 20% of nuts produced (Plantations Restructuring Unit, 1992).

Privatization in Sri Lanka was first announced as a State policy in 1987and was given legal status by the enactment of two legal bills in parliament.They are (1) the Public Corporations Act No. 22 of 1987 for the conversion ofgovernment owned business units into public corporations and (2) the PublicCompany Act No. 23 of 1987 for the conversion of public corporations andgovernment-owned business units into public companies.

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The Public Investment Management Board was established in 1989 (laterrenamed as Public Investment and Management Company) to manage theprivatization process. However, the privatization of industrial enterprises wasto be handled by a special unit at the Ministry of Industries. Plantation privatiza-tion was entrusted to the Plantation Restructuring Unit and the National Trans-port Commission, since it was felt that there were industry-specific complexitiesthat had to be faced. However, in 1995, under a new government, the PubicEnterprise Reform Commission (PERC) was established as the sole authorityto undertake all privatizations (Salih, 2000). The first privatization after the pass-age of the act took place in 1989 and a total of 92 enterprises have since beenprivatized up to 2006 with a total value of approximately US$ 777 million.

The total losses for JEDB and SPC, the two main plantation holdingcorporations of the State, during the ten-year period from 1982 to 1991was more than US$ 3 million. Debt equity levels were between 200 and300% respectively, with the situation aggravating further in 1992 with operat-ing losses totaling more than US$ 15 million (PERC Annual Report, 1996).Average yields and labor productivity were far below our major competitors,India and Kenya. The burden on the cash-strapped State to subsidize themwas increasingly becoming a key concern. The size of the corporationsmaking them unwieldy and unmanageable, lack of accountability in manage-ment, overly bureaucratic and centralized system of planning and control,and shortages of specialist skills were reasons cited by the State for therestructuring of the sector in 1992 (Plantations Restructuring Unit, 1992).

The plantation estates coming under the State were clustered and leasedto newly formed, 23 Regional Plantation Companies (RPCs). The extent inland was 260,000 ha with 290,000 people being employed at the time of thistransaction. At this time, the State called for bids from the private sector tomanage the 23 RPCs for a fee. While retaining ownership, the State handedover these companies to private management agents in 1992 on a five-yearcontract. In 1995, it was decided to divest shares in the RPCs. The modalitiesvaried somewhat, though predominantly it was completed in three stages.They were (1) sale of 51% to 60% stake to a strategic investor; (2) 30% tobe sold to the public through an initial public offering, and (3) distributionof 10% free to employees.

The 23 RPCs were categorized as either profit making or loss making,based on the year-end financials of 1994. Eight of the RPCs were categorizedas profitable and were offered to the managing agents at market clearingprice established through an offering initially on the Stock Exchange. Sevenof the loss-making RPCs were offered on the stock exchange on an all ornothing basis and five were sold to pre-qualified bidders based on technicalcapability. The remaining three enterprises were not offered for sale becausethey were performing satisfactorily (PERC, 1999).

The majority stake was offered as an incentive to overcome issues ofState interference and to encourage transfer of technology and capital

Privatized Enterprises in a Developing Country 49

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investment in the enterprise; the public share offering was to boost thecapital markets and encourage wider share ownership, while the employeeownership plan was to provide incentive to the labor unions, which wereagainst the privatization concept, to embrace and support the concept(Knight-John & Athukorala, 2005). Of the 23 companies under the State,majority stakes were sold in 20 of the companies, while 16 of thesecompanies have gone public through share offerings. The four remainingcompanies have not gone public due to poor market conditions. The contra-dictory statements emanating from State officials on their view of privatiza-tions and the lack of interest among potential investors due to the countrysituation has meant that three enterprises still remain under State control.

The plantation sector privatization was significant in that it was thesingle largest sectoral privatization undertaken by the State. With countriessuch as Kenya emerging as major tea producers in the world, and thestrategic importance of the sector to the local economy, it was imperative thatthe viability of the plantation sector was quickly reestablished. For Sri Lankato remain competitive, the estates would have to boost productivity, improvework norms, and increase yields (PERC Annual Report, 1996). It was decidedthat this will be possible only by bringing in private sector participation inthe sector.

PRIVATIZATION PERFORMANCE

The literature on privatization performance has been mixed. Overall, theresults have shown that privatization has indeed improved performance,though studies showing either a decline or no significant improvementcontradict the belief that ownership by itself is a significant factor in drivingperformance in enterprises. A majority of the studies have been on thedeveloped nations and only recently have studies been focusing on thedeveloping nations and in South Asia in particular where a large numberof privatizations have taken place.

Eckel, Eckel, & Singal (1997) examined the effects of privatization ofBritish Airways (BA) from the reaction of investors to its privatization onthe competitor’s stock price. They found that stock prices of U.S. companiesfell 7%, while the airfares on routes served by BA fell a significant 14.3%. Thisimplied that investors perceived that a privatized BA would be able tooperate more efficiently than prior to privatization, thus having a negativeimpact on its direct competitors in the future. The consumers also benefitedsince they found that prices of fares were also down, indicating improvedefficiency levels in their own enterprises.

Martin and Parker (1995) examined 11 British firms privatized during1981–1988. Using return on capital employed, and the annual growth invalue added per employee hour they found mixed results with fewer than

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half the firms registering gains after adjusting for business cycles. Importantlythey found evidence that results started to improve prior to privatization, butnot afterward as commonly thought. They hypothesize that this could havebeen due to the signaling effect of privatization on these enterprises.

Boubakri and Cosset (1998) in one of the more comprehensive studiesof post-privatization performance in developing countries, examined thechanges in financial and operating performance of 79 enterprises from 21developing countries that were fully or partially privatized during the period1980 to 1992. They note that many of these countries are ‘‘inhibited byembryonic financial markets, weak regulatory capacity, and a public sectorthat accounts for a large share of the GDP.’’ The objective of the study wasto assess whether enterprises privatized in this economic environment andinstitutional setting would provide variable results when compared to thestudies done on more developed countries. The sample was fairly welldiversified with countries at different levels of development included froma wide geographical area.

In an effort to isolate the effects of privatization from other changes in themacro economy, which is common in developing countries, the authors usedmarket adjusted figures. They found that for both unadjusted and market-adjusted performance measures significant increases in profitability, operatingefficiency, capital investment spending, output, employment, and dividends.They also find that the results were relatively stable when they broke up thesample into fully versus partially privatized enterprises, competitive versusnon-competitive industries, control versus revenue privatizations. However,in the case of the upper-middle income versus low-income and lower-middleincome countries, the magnitude of the increase in performances was lower.This suggests that other factors common to such countries may be affectingthe realization of the full benefits of privatization in these countries.

La Porta and Lopez-de-Silanes (1999) undertook one of the most com-prehensive single country studies on the benefits of privatization. Drawingfrom a candidate list of 233 nonfinancial privatizations in Mexico, they exam-ined a total of 218 State Owned Enterprises (SOEs) privatized between 1983and 1991. They compared the 1993 figure for each of the indicators and com-pared it with the four-year average figures prior to privatization. In order toisolate the effects of privatization, the authors used a control sample of privatefirms within each industry.

SOEs that were highly unprofitable on average quickly turned aroundtheir performance. Operating income to sales, which was �15.46% at preprivatization, jumped to þ8.65%, while net income to sales jumped from�36.32% to þ3.64%. Efficiency drove the rise in profitability. Average costswere down 21.149%, average sales per employee doubled, and operatingincome per employee rose dramatically from N$1.67 to N$54.17. This againwas driven by the job cuts. Employment of both white–collar and blue-collarworkers was down by almost 53%. This is contradictory to the findings of

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Megginson, Nash, % van Randenborgh (1994), who found that levels ofemployment had actually gone up. The composition of the two samplesmay explain the differences. It was found that employment figures werefalling even at the pre privatization period. The State may have already beenpreparing the enterprise for sale and the true loss of jobs would have beenmuch greater had it not been that the study covered only a four-year preprivatization period. The authors also find that capital investment shows amoderate increase. This is unexpected since it is generally believed that SOEshave idle capacity and hence will not require new investment. However indeveloping countries, most of the equipment may be obsolete or needmodifications, requiring the infusion of fresh capital. Even though therewas a cut in the workforce of more than 50% and only a modest rise in capitalstock, the sales or output levels have grown spectacularly by more than 50%.They caution that this rise could have been due to SOEs’ under pricing, orState subsidizing prices, or corruption, or sheer incompetence. However,they find that only 5% of the increase in operating income to sales ratios isexplained through real price increases. Importantly, they also find that onaverage an enterprise goes from receiving a small subsidy to paying almostN$25,000 in tax revenue in 1993.

The results indicate that the large rise in profitability and efficiency werenot primarily due to the macroeconomic changes that the country was under-going, with only 20% of the increase in sales attributable to it. They foundthat after under-performing industry counterparts during State ownershipthe SOEs were now statistically undistinguishable from other private sectorcompanies in 1993.

Boubakri and Cosset (2002) conducted a study of 16 enterprises privatizedin Africa, namely Ghana, Morocco, Nigeria, Senegal, and Tunisia. They foundthat profitability had increased by 1% to 3%, though not statistically significant,64% of enterprises had increased their return to equity, while 44% of the sam-ple enterprises increased their return on assets. However, the increases are lesssignificant than those shown in the more developed countries and are more inline with the Boubakri and Cosset (1998) study of the sample on low-incomecountries. Output or sales surprisingly showed a decline that is uncharacteristicof even the studies on developing countries. One possible explanation couldbe that since these less developed countries have beenmore subject to politicalinfluence than those in the developed countries, the outputs may have beendeliberately raised to meet political objectives and not commercial needs.Further, capital expenditure has risen, possibly showing that new investmentin technology was needed to compete in newmarkets and restriction on accessto capital markets have been broken, and leverage levels had come down mar-ginally in line with previous studies. However, caution should be exercisedwhen evaluating the results since the samples of enterprises are small.

Mohammed Omran (2004) found in a study comprising 54 newlyprivatized Egyptian enterprises that performance does not exhibit significant

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improvement when compared to control enterprises under State ownershipsimilar to those that were privatized during a period from 1994 to 1998. How-ever, one possible reason for this could be that the privatized enterprisesimproved their performance and as a spillover effect had an impact on theexisting State-owned enterprises.

Gupta (2005) analyzed the impact of privatization on performance in341 manufacturing and service sector public enterprises in India. The sampleincluded enterprises that have not yet been privatized, which served as animportant control group. The Indian privatizations were unusual to other stu-dies in that all privatizations were partial, in that control rights were nothanded over and remained under State control and all the enterprises werepublicly listed. The unique nature of the dataset provided the opportunityof isolating the effect of management monitoring through the capital market,since, ownership had not changed. Previous studies had to deal with boththe ownership effect and the listing effect on enterprise performance. Per-formance was analyzed through broad measures of profitability (sales,accounting profits) and efficiency (employment, average product of labor,return to labor). The results indicate a 59 percentage point increase in salesand a 22 percentage point rise in profits. Investment has declined whilereliance on State subsidies lessened. The author has also analyzed the varia-tions in performance that arise from the level of equity that is in private handsand found that a 10 percentage point increase in private equity would lead toa 27 percentage point increase in sales, a 27 percentage point increase inprofits, a six percentage point increase in average product of labor and eightpercentage point increase in returns to labor. However, employment had notdeclined since labor restructuring had not taken place due to controllinginterest still remaining under State control. The results correspond closelyto previous results showing positive contribution except for the employmentindicator that corresponds more closely with La Porta and Lopez de Silanes(1999) and Boubakri and Cosset (1998). Further, in contrast to previousstudies indicating improved performance prior to privatization, due to thesignaling effect (Dewenter & Malatesta, 2001), the revenue and profitabilityfigures in this case has been actually falling in the years prior to privatization.

The improvement in performance cannot be attributed to change of own-ership, since control rights still remain under State control. Instead, the listing ofthe sharesmay have beenmore likely the source for this improvement. She alsofinds evidence to support those sectors where competition was more intenseand reported improved performance than those in less competitive sectors.

METHODOLOGY

A matched pair methodology approach has been used with the panel dataanalyzed over a seven-year period, comprising of a three-year window prior

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to privatization and a three-year window after privatization. This approachwas first used by Megginson, Nash, & van Randenborgh (1994) and hasthereafter been used by La Porta and Lopez-de-Silanes (1999), Boubakriand Cosset (1998), D’Souza and Megginson (1999), Omran (2004) and othersto study performance changes of privatized companies. The three-year timehorizon matches the situation in Sri Lanka, where the time of relinquishingmanagement control of the companies, to the time of relinquishing owner-ship is also a three-year period.

For this study, performance is assessed using accounting measures withproxies for output, profitability, operating efficiency, investment, and on theaspect of the effect on overall employment. This is based on Megginson,Nash, & van Randenborgh (1994), Boubakri and Cosset (1998), D’Souzaand Megginson (1999), and others who have used these same measures.The mean value of each performance variable is measured both pre- andpost-privatization, excluding the year of privatization. Post-privatizationperformance is compared to the pre-privatization performance over aseven-year window (from year �3 to þ3). Since the direction and the mag-nitude of the matched pairs can be determined, the Wilcoxon Matched-PairsTest is used to analyze the differences in the pre- and post-privatizationperformance.

The transformation of the enterprises from State owned and managed,to State owned but privately managed, to private ownership and manage-ment enabled the verification on a single data set the impact of ownershipon performance of enterprises. The above same methodology was used toassess the effect of ownership on performance.

Barber and Lyon (1996) found that the test statistic is well specifiedwhen sample enterprises are well matched to control enterprises of similarpre-event performance. They found that performance-matched methods per-form as well as size-matched methods in samples of small-sized enterprises.They are of the opinion that size and pre-event performance is more impor-tant than the industry it operates. However, in an industry that has manyexternal factors affecting enterprise performance, it was decided that the con-trol enterprises be picked from the industry itself. The variation of prices inthe global commodity market and its effect on enterprise performance alsoprompted this selection. Two of the three enterprises still under State owner-ship and management acted as the control group. Although in terms of assetsize they are smaller in comparison, these enterprises were withheld by theState as they were deemed to be performing satisfactorily.

Profitability was measured using three proxies; (1) return on sales(ROS), (2) return on assets (ROA), (3) return on equity (ROE). Efficiencywas measured on a logarithm scale and was measured by (1) sales peremployee (SLEMP), (2) income per employee (INEMP), (3) inflation adjustedsales per employee (RSLEMP). The proxies for investment were (1) capitalexpenditure to sales (CESAL), and (2) capital expenditure to assets (CEAST).

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Leverage was measured using (1) debt to equity (DEQ), and (2) debt to totalassets (DTA). Changes in employment levels were measured as the totalnumber of employees (EMPL) while output was measured by the inflationadjusted sales figures.

DATA SET

Data was collected through a combination of a detailed questionnaire andinterviews of key personnel in the enterprises. The questionnaire was firsttested in the field by sending it to selected personnel in the industry forcomments and feedback. This feedback was then used to finalize the ques-tionnaire that was finally distributed by mail to all 23 enterprises that wereheld by the government of Sri Lanka prior to 1992, which constituted theuniverse under study. Information provided by these enterprises was thencorroborated and elaborated through interviews of selected personnel. Inorder to triangulate the financial and operating performance of the datacollected, selected publications from the Ministry of Plantation Industries,Ministry of Finance, and the Department of Statistics were used. Seventeenenterprises responded to the questionnaire, which was 74% of the totalenterprises with respondents distributed evenly among the different owner-ship types as seen in Table 1. Table 2 provides a summary of the enterprisesby average assets, turnover, and employment.

To verify whether respondent bias could have influenced the overallfindings Wilcoxon Signed Rank test was generated for each ownership typebased on average assets, turnover, and employment. The results did notindicate any differences in the groups for both respondents, and nonrespon-dents. Since 20 of the 23 enterprises were fully privatized, with a fair mix ofprofitable and unprofitable enterprises among them, selection bias isexcluded.

EMPIRICAL FINDINGS AND ANALYSIS

The process of privatization followed by the Government of Sri Lanka wasthat initially bids were solicited from private sector companies to managethe enterprises. Initially the 23 enterprises were handed over to private sector

TABLE 1 Summary of Respondents and Nonrespondents by Ownership Type

Ownership type Total enterprises Respondents % Nonrespondents %

Public quoted 16 12 75 4 31Private 4 3 75 1 25Government 3 2 67 1 33Total 23 17 74 6 26

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management in 1992, without the Government of Sri Lanka divestingownership. Ownership was only transferred in selected enterprises begin-ning from 1995 through 1998. For this study, though management controlwas divested first, we recognize that full privatization had taken place onlyafter the divestiture of ownership.

Pre-and post-privatization of enterprise performance is initiallycompared. Subsequently, in order to address the question that ownershipis not a contributory factor for enterprise performance and only managementcan influence performance, performance of these enterprises are comparedpre and post introduction of private management.

Performance of Privatized Enterprises

It was expected that privatization would lead to improved profitability,efficiency, investment, and output, while employment levels will be rationa-lized and therefore expected to decline.

The performance figures have been controlled for external changes thatmay have contributed to overall performance by a control group. The overallfigures for profitability, efficiency, investment, employment, and output isshown in Table 3.

PROFITABILITY

Transfer of ownership from the State to the private sector should theoreticallyimprove the profitability of the enterprise as private owners have greaterincentives and motivation to better manage available resources and therebyimprove the overall profitability. Empirical evidence to a great extent hassupported this hypothesis as discussed previously. As depicted in Table 3,all the profitability measures show a dramatic improvement in performanceafter privatization. The mean ROS changes from 8.4% (8.8%) to 18.2%(16.3%), ROA changes from �1.2% (0.1%) to 9.9% (8.0%) while ROEchanges from �15.6% (�6.8%) to 8.3% (6.6%). The results are all significant

TABLE 2 Summary of Respondents and Nonrespondents by Assets, Turnover andEmployment

Ownershiptype

Respondent Nonrespondents

Avg.assets

(Rs. Mill.)

Avg.turnover(Rs. Mill.)

Avg.employment

Avg.assets

(Rs. Mill.)

Avg.turnover(Rs. Mill.)

Avg.employment

Public quoted 467 402 16,824 711 466 20,711Private 572 429 18,138 390 624 24,978Government 168 40 2,175 150 62 1,833Total 468 385 16,155 564 425 18,276

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TABLE3

Perform

ance

ofPrivatizedState-O

wnedEnterprises

Variables

NMean

before

(median)

Mean

after

(median)

Mean

chan

ge

(median)

Z-statistics

fordifference

inmedian

(after-before)

Percentage

offirm

sthat

chan

gedas

predicted

Z-statistics

forsignifican

ceofproportion

chan

ge

i.Profitability

Netinco

me=Sales

15

10.70%

(11.93%)

16.59%

(15.71%)

5.89%

(3.78%)

3.01

80%

0.035

Return

onassets

15

0.67%

(1.47%)

8.15%

(7.59)

7.48%

(6.12%)

3.41

100%

0.000

Return

onequity�

11

�15.60%

(�6.80%)

8.34%

(6.64%)

23.94%

(13.44%)

2.76

91%

0.012

ii.Operatingefficiency

log(Sales=Employee)

15

�0.66(�

3.67)

2.45(3.55)

3.11(7.22)

3.35

93%

0.001

log(NetInco

me=Employee)

15

�0.06(0.34)

3.84(3.86)

3.90(3.52)

3.41

100%

0.000

log(Real

Sales=Employee)

15

�0.75(�

3.56)

2.63(3.44)

3.38(7.00)

3.41

100%

0.000

iii.Labor

log(Totalemployment)

15

4.05(4.05)

4.02(4.04)

�0.03(�

0.01)

�3.07

87%

0.007

iv.Investment

Cap

ital

expense=Sales

15

�4.10%

(�5.10%)

3.02%

(6.30%)

7.12%

(11.40%)

3.35

93%

0.001

Cap

ital

expense=Assets

15

2.79%

(1.58%)

6.08%

(3.30%)

3.29%

(1.72%)

2.67

73%

0.118

Debt=Equity�

11

36.69%

(33.05%)

61.31%

(48.32%)

24.62%

(15.27%)

1.60

64%

0.549

Debt=Assets

15

9.78%

(8.08%)

11.33%

(8.26%)

1.55%

(0.18%)

0.51

53%

1.000

v.Leverage

Debt=Equity�

11

36.69%

(33.05%)

61.31%

(48.32%)

24.62%

(15.27%)

1.60

64%

0.549

Debt=Assets

15

9.78%

(8.08%)

11.33%

(8.26%)

1.55%

(0.18%)

0.51

53%

1.000

vi.Output

log(Real

sales)

15

8.57(8.59)

8.62(8.61)

0.05(0.02)

2.90

87%

0.007

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at the one percent level. It is noted that a statistically significant proportion offirms, namely 80%, 100%, and 91% of the firms have positive changes in ROS,ROA, and ROE respectively as predicted. The data strongly point to a positiveimpact in profitability for privatized enterprises. The findings are consistentwith Omran (2004), Megginson, Nash, & van Randenborgh (1994), Boubakriand Cosset (1998) and D’Souza and Megginson (1999). But the mean changesrecorded here for profitability are on average higher than those reported inthe above studies. It should be noted that the number of enterprises in thecurrent study are smaller than those listed above, though they were notconfined to a single sector. The sample comprise nearly 75% of the totalenterprises privatized in the plantation sector and therefore do not have tocontend with sector-specific factors affecting the results.

When the sample is separated out to those privatized and those stillunder State ownership, we find that those under State ownership haveimproved performance together with the privatized enterprises (seeTables 3 and 4). This is similar to the findings published by Omran (2004)in Egypt. It appears that there is a knock-on effect of privatization on existingState enterprises. This could be possibly attributed to the increasedproductivity of the enterprise due to the induced fear among its staff thatthe enterprise itself may face privatization if it did not improve performance.The State’s lifting curbs on products and markets, placing price restrictions,and restricting interference with the management in the day-to-dayoperations of the enterprise could also have led to this improvement. Thefeedback from the interviews confirms that the latter is the most significantfactor.

EFFICIENCY

Private ownership will provide better incentives for managers to optimizeand productively use the available resources. All the efficiency measureshave shown significant improvement over the two periods. Sales peremployee (SLEMP) improved from �0.7 (�3.7) to 2.5 (3.6), Income peremployee (INEMP) improved from �0.06 (0.34) to 3.84 (3.86) while real salesper employee (RSEMP) increased from �0.8 (�3.6) to 2.6 (3.4). The improve-ments in all the proxies are significant at the 1% level.

In the case of INEMP and RSEMP all enterprises have shown positivechanges in efficiency. Even in the case of SLEMP a significant proportionof 93% of enterprises have shown improvement. Therefore, the data stronglyindicate a positive impact in efficiency for privatized enterprises. Efficiencyimprovement has been driven by the reduction in employment levels thathave taken place as is seen later. The results are again consistent withMegginson, Nash, & van Randenborgh (1994), Boubakri and Cosset (1998)and D’Souza and Megginson (1999) while in the Omran (2004) study SLEMPdoes not show a significant improvement.

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TABLE4

ComparisonofPerform

ance

ofState-O

wnedan

dState-M

anagedEnterpriseswithState-O

wnedButPrivately

Man

agedEnterprises

Variables

NMean

before

(median)

Mean

after

(median)

Mean

chan

ge

(median)

Z-statistics

(PValue)for

difference

inmedian

(After–Before)

Percentage

offirm

sthat

chan

ged

aspredicted

Z-statistics

forsignifican

ceofproportion

chan

ge

i.Profitability

Return

onsales

16

6.74%

(7.51%)

�6.79%

(�5.86%)

�13.53%

(�13.37%)

�3.360.001

6%

0.001

Return

onassets

16

6.18%

(6.26%)

�4.70%

(�3.16%)

�10.88%

(�9.42%)

�3.460.001

6%

0.001

Return

onequity�

12

9.33%

(9.00%)

�12.83%

(�5.00%)

�22.16%

(�14.00%)

�2.980.003

6%

0.006

ii.Operatingefficiency

log(Sales=Employee)

16

4.38(4.37)

4.61(4.58)

0.23(0.21)

3.460.001

94%

0.001

log(Netinco

me=Employee)

16

2.84(3.23)

�2.27(�

3.29)

�5.11(�

6.52)

�3.360.001

6%

0.001

log(Real

sales=Employee)

16

4.51(4.51)

4.51(4.48)

�(�

0.03)

�0.160.877

44%

0.804

iii.Labor

log(Totalemployment)

16

4.16(4.24)

4.08(4.14)

�0.08(�

0.10)

�2.690.007

94%

0.001

iv.Assets

&investment

Cap

ital

expense=Sales

16

7.19%

(5.98%)

10.85%

(10.09%)

3.66%

(4.11%)

2.530.011

75%

0.035

Cap

ital

expense=Assets

16

4.91%

(4.74%)

6.41%

(5.85%)

1.50%

(1.11%)

1.370.171

50%

0.388

v.Output

log(Real

sales)

16

8.67(8.75)

8.59(8.63)

�0.08(�

0.12)

�2.740.006

13%

0.004

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CAPITAL INVESTMENT

When privatization takes place, in order to improve efficiency and maximizeresource usage, it is expected that any new investment is curtailed. However,in developing countries such as Sri Lanka, because of lack of financialresources the investment in upgrading equipment and other infrastructurefacilities in these State enterprises are limited. Therefore, it is expected thatthe new ownership will invest in assets in order to repair or replace old ordilapidated facilities. For this study, capital investment was restricted toinvestment in agricultural field development as this would be critical forthe long term sustainability and viability of the plantations sector. With thescarce resources available from the State, it was hypothesized that investmentin field development would be lacking.

CESAL and CEAST have both shown improvement over the two periods.CESAL improved from �5.4% (�5.3%) to 10.0% (�1.6%) while CEAST hasimproved from 2.1% (1.5%) to 5.0% (2.9%). The results are both significantat the 1% level. In the case of CESAL, a significant proportion of 93% ofthe enterprises have shown a positive improvement. Seventy three percentof enterprises showed improvements in CEAST, though the result is notstatistically significant. The results indicate that the privatized enterpriseshave substantially increased investment in the agricultural fields in order toimprove long term productivity.

The results from other studies in these respects show mixed results.While the Megginson, Nash, & van Randenborgh (1994) study showed aninsignificant increase, D’Souza and Megginson (1999) revealed an insignifi-cant decrease. Only the Boubakri and Cosset (1998) study, which was in asimilar developing country, setting showed that post-privatization, therewas a significant increase in capital investment.

LEVERAGE

State enterprises were dependent on State funds or guarantees to sourcefunds for its operations. With the changes in ownership, the long-term objec-tives changing from a social to a commercial outlook, and the constraintsplaced by governments on State-owned enterprises raising funds in the finan-cial markets being lifted, it was expected that the balance sheet would berestructured. Since they now will not have access to subsidized funding,the cost of borrowing in the capital markets will drive these enterprises tosource lower cost equity funding. Megginson, Nash, & van Randenborgh(1994), Boubakri and Cosset (1998), D’Souza and Megginson (1999),D’Souza, Megginson, & Nash (2001), Gupta (2005), Boubakri and Cosset(2002), and Omran (2004) lend support to this hypothesis.

Debt to equity (DEQ) has gone up from 36% (33%) to 61% (48%) whiledebt to total assets (DTA) has marginally changed from 10.4% (8.1%) to

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12.2% (9.2%). However, both results are not significant while the proportionof enterprises showing increase in debt are 4% and 53% for DEQ and DTArespectively which are also not significant.

Though the results are not significant, they indicate a counter to ourhypothesis and previous studies discussed where leverage levels havedecreased significantly as enterprises source competitive financing. A poss-ible explanation for this occurrence could be that the state of developmentof the capital markets in Sri Lanka is low and thus the ability to source equitycapital is very restrictive. Kikeri, Nellis, & Shirley (1992) have recorded evi-dence that one of the major differences in developing economies to the moredeveloped countries in terms of privatization performance is the state ofdevelopment of capital markets. The Colombo Stock Exchange has only237 companies listed with total market capitalization of around US$ 1 billion.The number of active participants is under 10,000 (CSE Data Library, 2006).The undeveloped capital markets may therefore be a possible explanationfor this anomaly.

EMPLOYMENT

Possible cutbacks in employment levels of privatized enterprises are one ofthe main concerns that governments face when evaluating privatizationpolicy. In developing countries this problem is acutely felt with low-incomelevels and almost no other support for the unemployed like unemploymentbenefits and skill upgrading. However, there is no theoretical and empiricalconsensus with regard to the impact of privatization on the level ofemployment (Omran, 2004).

A bloated workforce is expected to be one of the main areas of concernfor private owners, as State-owned enterprises have been used by rent-seeking politicians to further their political agendas through offers ofemployment in these State enterprises. Private owners are immediatelyexpected to rationalize staff levels in order to improve productivity levelsof the enterprise.

The average level of employment drops from 11,483 (11,125) to 10,640(10,900). The result is significant at the one percent level. Overall, 94% of theenterprises in the sample showed declines in employment levels and the pro-portion change is also significant at the 1% level. Therefore, a clear link couldbe inferred that declines in employment levels are linked to the privatizationprogram. This drop in employment is very significant since the plantationenterprises are highly unionized and rent seeking and was controlled by acoalition partner of the ruling government.

The results are similar to the findings of La-Porta and Lopez-de-Silanes(1997), Laurin and Bozec (2001), D’Souza and Megginson (1999) and Gupta(2005), which showed that employment levels had declined subsequent tochange of ownership. However, they are contrary to Galal, Jones, Tandon,

Privatized Enterprises in a Developing Country 61

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& Vogelsang (1994), Megginson, Nash, & van Randenborgh (1994), andBoubakri and Cosset (1998), which showed that, in fact, employment levelshave risen. However, the majority of the countries included in the samplefrom the latter three studies came from middle- to higher-income countries.A country’s level of economic development, regulatory environment, type ofindustry involved, level of interference by political actors and the markets forthe products, may explain the variation seen in the employment levels.

OUTPUT

Privatized enterprises are expected to increase their sales output due to liftingof restrictions placed on the enterprise from the state, to develop and marketnew products, access new financing sources and better incentives (Megginson,Nash, & van Randenborgh, 1994). Output as measured by the inflation-adjusted sales figures before and after private owners were brought in showsan increase from 8.57 (8.59) to 8.62 (8.61). The results are significant at the 1%level. Eighty seven percent of the enterprises showed increases in output andthe proportion change is also significant.

The results are similar to those by Megginson, Nash, & van Randenborgh(1994), La-Porta and Lopez-de-Silanes (1997), Boubakri and Cosset (1998),D’Souza and Megginson (1999), and Boubakri and Cosset (2002) amongothers. Even the study done on partially privatized enterprises in India byGupta (2005), finds support for this hypothesis.

The results clearly indicate that privatization has significantly improvedperformance in terms of profitability, efficiency, capital investment, andoutput. A key factor to emerge from the initial findings is the reduction inlabor levels despite the regulatory framework not being conducive to layoffs.

Partial Privatization and Enterprise Performance

It is argued that ownership structure is not a key driver of performance;rather it is the management that would enhance the operational and financialperformance of the enterprise (Jensen, 1987; Peng & Heath, 1996). Therefore,it was decided to test whether an inhibiting factor for State enterprises tounderperform is the management in these institutions. A lack of motivation,incentives, and State interference is a reason cited for poor performance. Bybringing in private sector managers it is argued that the enterprises willimprove performance as they are evaluated and subject to the disciplinaryeffects of market forces, notwithstanding ownership issues.

Therefore, hypothesis developed to verify changes in the financial andoperating performance for the case of privatization are also applied in thisinstance to verify whether the changes envisaged for privatization aresimilarly seen in the case of bringing in private management to run thesestate owned enterprises without changing the ownership structure.

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Arguments abound in the literature on whether ownership actuallymatters (Cuervo & Villalonga, 2000; Andrews & Dowling, 1998; Boyd,1994; Rediker & Seth, 1995). In the developing economies the full impactof external managers running enterprises based on purely economic reasonsmay not be apparent, since the State from time to time may interfere with themanagement of the enterprises since the goals of the actors in the State maynot be aligned with pure profit motive. Therefore, it is expected that therewould be no significant improvement in profitability, efficiency figures,and output. Since field development would be immediately identified tobe of strategic importance for the very survival of the enterprise an increasein investment is expected. However, investment is expected to be greatlycurtailed by the lack of financial resources available with the State. Sinceownership still rests with the State, employment levels are not expected toshow a significant change.

All the profitability measures show a drastic decline in performance overthe period as seen in Table 4. The mean change in performance ranges froma high of �0.11 (�0.09) for ROA and a low of �0.22 (�0.14) for ROE. Allstatistical tests are significant at the one percent level for all the proxies.The decline in performance is seen over 94% of sample enterprises andthe proportion change is also significant at the one percent level.

The expected efficiency improvement is also mixed. Private manage-ment has improved SLEMP from 4.38 (4.37) to 4.61 (4.58) while RSEMPhas showed no change. The improvement in SLEMP was statistically signifi-cant at the 1% level. However, INEMP showed a drastic decline with thefigure decreasing from 2.84 (3.23) to �2.27 (�3.29) in line with the decreasein profitability. This gain is significant at the 1% level. The increase in SLEMPis supported by 94% of the enterprises while the decline in INEMP is alsosupported by 94% of the enterprises in the sample. The results are even lessimpressive when we consider that employment levels were significantlyreduced during this period.

A sustained capital investment program was important to build up someof the fields in the estates. However, since the management contracts werefor a short period of five years, private management is not expected tochannel resources with a longer-term perspective. Both CESAL and CEASThave improved from 7.19% (5.98%) to 10.85% (10.09%) and 4.91% (4.74%)to 6.41% (5.85%) respectively. However, only the improvement shown inCESAL is significant at the 5% level. The proportion of enterprises that haveshown improvement in CESAL proxy is 75% with significance at the 5% level.On the other hand improvements in CEAST are shown by only half of theenterprises in the sample.

In developing countries like Sri Lanka, SOEs tend to be used moreoften for political reasons and thus these enterprises tend to be overstaffed.Therefore, it is expected that management will carefully evaluate efficiencylevels and will be more proactive in at least curbing or cutting back on excess

Privatized Enterprises in a Developing Country 63

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staff. However, with ownership retention by the State, any shedding ofexcess labor was not expected.

The average level of employment (logarithm) drops sharply from 4.16(4.24) to 4.08 (4.14). The result is significant at the 1% level. Overall, 94%of the enterprises in the sample showed declines and the proportion changewas also significant at the 1% level. The result is significant in that, though theState still retained ownership, it has through its proxies seemingly encour-aged layoffs.

The decline in employment levels in comparison with the previouscase where privatization has taken place is more pronounced. It isassumed that the rationalization of employment levels had already takenplace before privatization and thereby the declines under privatization arenot as pronounced.

Private management should be better motivated and have access to keyresources in order to boost output. The inflation adjusted sales (logarithm),however shows a decline with sales dropping from 8.67 (8.75) to 8.59(8.63). The result is significant at the one percent level. Further, this declinein output was seen in over 87% of the enterprises in the sample and theproportion change is also significant at the one percent level.

These data indicate that private management has not been able toimprove performance under State ownership, but have improved theirperformance under private ownership. A possible explanation for this under-performance could be that private managers deliberately underperform sothat they could purchase the enterprises when they are privatized in thefuture. Therefore, in order to verify whether this could be a possible reasonfor the results seen in the study, the sample was divided into enterprises thatwere purchased after managing them themselves and those enterprisespurchased by unrelated parties. In the case under review, of the total of 17respondent enterprises, nine of them had been bought over by the privatesector enterprise that was managing it under State ownership.

Initially, the results of the two groups when it was under State owner-ship and management and under State ownership but private managementwere evaluated to verify whether there were any significant changes inperformance of the enterprises during this time. Subsequently the samegroups were evaluated after privatization in order to verify whether therewas any significant ‘‘excess’’ performance of these enterprises once owner-ship was transferred to them. The nonparametric Mann-Whitney U testwas used to verify significant differences in performance of the twosubgroups.

As noted previously, there was a significant drop in performance whencomparing the performance of the enterprises under State ownership andmanagement and after the introduction of private management to theseenterprises. However, when you compare the two groups as seen inTable 5a, except for the performance indicator sales per employee, all other

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indictors show that no statistically significant difference exists in performanceof the two groups. This indicates that the drop in performance has beenwidespread across the full sample and not restricted to those managed byprivate managers who subsequently purchased the enterprise.

This finding is further reinforced when comparing post-privatizationperformance under private ownership and management to the previousperiod under private management and State control. As seen in Table 5b,all the 12 indicators show that there was no significant difference in perform-ance of the two groups. That is, no significant improvement occurred inperformance of these enterprises when compared to the previous period.If private managers had deliberately underperformed, then once the enter-prises were bought over, it would be reasonable to expect to see an unusualimprovement in performance once ownership was transferred. Deliberateunderperformance by private sector managers in order to reduce the pur-chase consideration is thus ruled out. The privatization performance resultstherefore are robust in the light of possible deliberate underperformance.

CONCLUSION

The research study documents the performance of enterprises in theplantation sector that were privatized in Sri Lanka. This sector was selected

TABLE 5a Test for Differences in Performance of Enterprises that Were Managed andSubsequently Bought Over by the Same Management and Those Bought Over by OtherPrivate Enterprises Before Privatization

ROS ROA ROESales peremployee

Net incomeper employee

Mann-Whitney U .223 .368 .123 .030 .315Real Sales Capital Expenditure

to SalesCapital Expenditure

to Total AssetsEmployment

Mann-Whitney U .153 .081 .560 .634

TABLE 5b Test for Differences in Performance of Enterprises that Were Managed andSubsequently Bought Over by the Same Management and Those Bought Over by Other Priv-ate Enterprises After Privatization

ROS ROA ROESales peremployee

Net incomeper employee

Mann-Whitney U .564 .336 .223 .441 .564Real Sales Capital Expenditure

to SalesCapital Expenditure

to Total AssetsEmployment

Mann-Whitney U .124 .700 .923 .336Real Sales per Employee Debt to Equity Debt to

Total AssetsMann-Whitney U .501 .465 .211

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because of the importance of the sector to overall economy of the countryand, importantly, 20 of the 23 plantation enterprises, which were ownedand managed by the State, were privatized. As a first step of moving towardprivatization, these enterprises were partially privatized by handing themover to private management while retaining State ownership and then onlysubsequently fully privatized. This provided the opportunity of not onlystudying the effect of privatization on the enterprises but also assessingwhether introduction of private managers to these State enterprises coulddrive similar changes in performance without a change of ownership.

For privatized enterprises significant increase in output, profitability,operating efficiency, and investment is documented. Employment levelshave also decreased significantly. The results support previous findings,especially in the developing nations, where privatization has improved thefinancial and operating performance of these enterprises. Though resultsare not shown here, the performance of enterprises under full privateownership and management significantly exceeded the performance of theenterprises when they were under State ownership and management.

Significantly in this study we have been able to evaluate whether bring-ing in private sector management to manage these State enterprises will bringin improved efficiency while the State retains ownership of the enterprises.On the contrary, when the enterprises were initially handed over to privatemanagement while still retaining State ownership, enterprise performancedeteriorated. Profitability and output declined significantly while operatingefficiency showed mixed results. However, capital investment showed anincrease. The drop in employment levels was even more significant thanthe drop after the enterprise was handed over to private owners. Even ifthe State did not want to be directly involved in the layoff of workers, theyseem to have given tacit encouragement for the private management torationalize the manpower requirements. The results were robust even whenevaluated for deliberate underperformance. Though the study is restricted toa single industry and is constrained by the size of the control sample, theresults reinforced by the feedback received from stakeholders add credenceto the argument that the poor performance of SOEs may not only be drivenby lackadaisical and poorly motivated incompetent employees, but the Statedistorting and influencing the long-term objectives of the enterprise to suittheir rent-seeking activities.

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