Ownership Structure and the Temptation to Loot: Evidence from Privatized Firms in the Czech Republic

Group. We thank Dun and Bradstreet for providing us with data. The views expressed are the authors' own and do not necessarily reflect those of the World Bank, its Board of Directors or the countries they represent. 2 Abstract This paper uses a new dataset to examine the issue of how the design of privatization affects outcomes. Prior studies of Czech privatization have focused largely on how the widespread distribution of shares through vouchers may have motivated the new owners to strip assets from privatized firms. We find evidence for static asset stripping, but also for what Akerlof and Romer (1993) call looting – borrowing heavily with no intent to repay in order to use the loans for private purposes. This occurred because the larger privatized companies had privileged access to credit from state controlled banks that had little incentive to enforce debt contracts. This finding has significant policy implications, namely that financial incentives and regulation are as important as ownership structure in privatization design. 3 1. Introduction Firms are likely to gravitate to ownership structures that yield the best performance. Those structures are likely to differ across industries or even across different firms in the same industry, so that one might expect little relationship between measures of ownership structure, such as concentration levels, and relative performance. Indeed, Demsetz and Lehn (1985) found that for a sample of U.S. firms there was no significant relationship between ownership concentration and profit rates. They noted, however, that ownership was relatively concentrated for the vast majority of firms in their sample. One could interpret those results as indicating that, in a country like the U.S., where equilibrium ownership structures have been achieved and protection of minority shareholders is adequate, small variations in concentration have little impact on profitability. However, more recent evidence casts doubt on the idea that, in general, there is no relationship between the ownership structure of a firm and its performance. Using Tobin's Q as the measure of firm profitability, Morck, Shleifer, and Vishny (1988) find a positive relationship between profitability and ownership for ownership shares in U.S. firms between 0 and 5 percent. For shares larger than 5 percent, they find a negative relationship. Shleifer and Vishny (1997) provides one possible interpretation of that finding: " [C]onsistent with the role of incentives in reducing agency costs, performance improves with higher manager and large shareholder ownership at first. Yet, as …