Privatization and the Rise of Global Capital Markets

Financial Management (Financial Management Association), Winter, 2000 by Maria K. Boutchkova, William L. Megginson

William L. Megginson [*]

We examine the growth in global capital market valuation, trading volume and security issuance over the past two decades. After estimating the impact of share issue privatizations on the growth of stock markets, we find that privatizations have significantly increased market liquidity, as measured by the turnover ratio. We examine the effect privatizations have had on the pattern of share ownership by individuals and institutional investors and find that privatizations have dramatically increased the number of shareholders in many countries. However, the extremely large numbers of shareholders created by many share issue privatizations are not a stable ownership structure.

By any measure, the past two decades have been a golden age for financial capitalism. Two of the most dramatic manifestations of capitalism's intellectual and economic ascendancy have been the rapid growth in the total value and trading volume of the world's capital markets (especially stock markets) and the spread of privatization programs around the world. From fairly humble--and extremely controversial--beginnings during Margaret Thatcher's first British government in the early 1980s, privatization has developed into a robust, even orthodox, economic policy tool that at least 100 national governments have adopted to one degree or another. This popularity is at least partly due to the fact that privatization programs can generate a great deal of revenue for governments, without having to raise taxes or cut spending programs. In fact, Gibbon (1998, 2000) reports that the cumulative value of proceeds raised through privatization programs by governments exceeded $1 trillion sometime during the second half of 1 999, and the amount of such revenue raised each year is now roughly $140 billion.

Although governments usually adopt privatization programs primarily to raise revenue, and in order to improve the economic efficiency of former state-owned enterprises, most also hope that privatizations implemented through public share offerings will develop their national stock markets. Recent economic research (Levine (1997), Demirguc-Kunt and Maksimovic (1998), Levine and Zervos (1998), Rajan and Zingales (1998), Subrahmanyam and Titman (1999), Beck, Levine and Loayza (2000), Henry (2000), Wurgler (2000) and Bekaert and Harvey (2000)) has given added impetus to this objective by conclusively documenting a direct link between capital market development and economic growth. A looming demographic crisis in the pay-as-you-go pension systems of many European and Asian countries has also lead to a dawning realization that efficient and liquid capital markets are a prerequisite for developing a funded pension system. Therefore governments have adopted share issue privatization programs as a means to jump-start the growth of these markets.

In spite of the obvious importance of capital market development, and of privatization's potential role therein, we are aware of only two academic studies that (indirectly) attempt to document or empirically examine this process. Domowitz, Glen and Madhavan (2000) examine the dynamics of external corporate financing choices and find that privatization activity is initially followed by foreign equity issuance, but eventually leads to a higher level of domestic bond issues. Bortolotti, Fantini and Scarpa (2000) examine governments' choices between selling privatization share offerings domestically versus externally. While both of these studies examine the impact of privatization issues on subsequent external financing, and the Bortolotti, et al paper indirectly measures privatization's impact on stock market development, the current study focuses much more directly on privatization's role in market development and patterns of stock ownership. This paper is organized as follows. Section I documents that capital market-based finance has in fact been increasing in importance, both absolutely and relative to financial intermediary-based finance, in both developed and developing countries over the past decade. Section II examines the impact of privatization programs-- particularly share issue privatization (SIP) programs--on capital market development since the early 1980s. Section III surveys existing academic research to determine whether SIP investors have earned significantly positive excess (market-adjusted) returns on the shares they purchase over both short-term (first trading day) and long-term (one-, three-, and five-year) holding periods. Section IV evaluates the impact of SIPs on individual and institutional share ownership in non-US stock markets, and Section V concludes the study and offers a few policy implications of our findings.

I. The Rise of Capital Market-Based Finance

It has become something of a truism to assert that capital markets are "winning" the contest with financial intermediaries (especially commercial banks) to become the dominant sources of external financing for companies throughout the developed world. Like most truisms, there is a large grain of truth in this assertion. Unlike most truisms, there is very little reason to also say, "on the other hand..." since, as we will document below, capital markets are in fact winning the present and seem likely to dominate the future of corporate finance in developed and developing countries alike.