Equity Valuation in the Czech Voucher Privatization Auctions - Statistical Data Included

Financial Management (Financial Management Association), Winter, 2000 by Raj Aggarwal, Joel T. Harper

Joel T. Harper [*]

This is a study of the determinants of share pricing and demand in the path-breaking Czech voucher-based multiple-round mass privatization auction. The results presented here document that share valuation and demand in this auction were based on firm characteristics such as return on sales, sales growth, and ownership structure in the early rounds. However, such information declined in importance while auction results on share prices and trading volumes from prior rounds increased in importance as determinants of share prices and demand in later rounds. While share prices overshot or undershot in the early rounds, by round four they had stabilized and the market cleared successfully by the fifth and final round. These results are new evidence on the price discovery process in the Czech privatization auction and confirm the success of this auction in the efficient pricing and equitable distribution of enterprise shares.

Several formerly socialist countries have used mass privatizations to transform public sector enterprises into private business firms in the 1990s. These transfers of ownership have been unprecedented in scale and scope and have been major mechanisms for these formerly socialist countries to move from planned to market directed economies. The mass privatization carried out by Czechoslovakia (and subsequently the Czech Republic) was the earliest and one of the largest and most successful such programs (e.g., Gray, 1996). The first wave of Czech voucher mass privatization occurred in 1992 (a subsequent smaller auction occurred in 1994) and by the end of the voucher privatization about 85% of the state's assets had been privatized. This successful Czech voucher-based mass privatization not only transferred a large fraction of the Czech economy to private hands, it also created over six million shareholders. However, this privatization program had to overcome a number of challenges.

For instance, mass privatizations face a difficult "Catch 22" type of problem, i.e., how do you sell off major parts of an economy without well-developed financial markets and with inadequate domestic ability to make these purchases, but avoid selling significant proportions of domestic assets to foreigners at fire sale prices. Voucher mass privatizations were developed as a solution to this Catch 22 problem. In voucher mass privatizations, such as the one in the Czech Republic, state owned assets are distributed to a large proportion of the population generally through an auction using inexpensive widely available vouchers. [1]

For mass privatizations to be successful, formerly state owned firms must be valued fairly. But, enterprise valuation in mass privatization is a significant problem due, in part, to the fact that there is generally little verifiable information that is useful for asset valuation. Further, because the assets to be sold were managed with socialist procedures and goals, accounting and other firm level data, commonly used by investors for valuing firms, are perceived to be unreliable and are often inaccurate. In addition, there usually is considerable confusion about property rights, much macroeconomic uncertainty, and rapidly changing industry and competitive structures.

Under these conditions, and in the absence of a well-developed equity market, how do mass privatizations price the assets for sale fairly? One approach has been to use multiple round auctions to assist the price discovery process, especially as only limited information useful for enterprise valuation is available in an ex-socialist economy. In such cases, how do share prices and demand change in each round of the auction process and what are the determinants of such changes? This study examines how public assets were priced and the determinants of the price discovery process in each round of the 1992 Czech voucher-based mass privatization auction.

This study finds that while equity prices were based on company characteristics such as return on sales, sales growth, and other ownership characteristics in the early rounds, pricing in subsequent auction rounds was determined more by prior round outcomes regarding share prices and trading volumes and decreasingly by firm-specific information. In addition, the results presented here document that, in spite of some over- and under-shooting as in a cobweb model, most share prices stabilized by the third or fourth rounds. These results indicate that this Czech mass privatization priced shares efficiently especially as the ascending auction process effectively cleared the market by the fifth and last round.

Next, this paper reviews relevant prior literature and describes the Czech voucher auction for mass privatization. The subsequent section presents our pricing and trading volume models, the research design, and describes the data. Following that, empirical results on the determinants of share pricing and trading volumes in this ascending auction mass privatization are presented and discussed, and the final section provides some concluding remarks.