the financial and operating performance of china's newly privatized firms

The Financial and Operating Performance of China's Newly Privatized FirmsAuthor(s): Zuobao Wei, Oscar Varela, Juliet D'Souza and M. Kabir HassanSource: Financial Management, Vol. 32, No. 2 (Summer, 2003), pp. 107-126Published by: Wiley on behalf of the Financial Management Association InternationalStable URL: http://www.jstor.org/stable/3666339 .

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The Financial and Operating Performance of China's Newly

Privatized Firms

Zuobao Wei, Oscar Varela, Juliet D'Souza, and M. Kabir Hassan*

This study examines the pre- and post-privatization financial and operating performance of208 firms privatized in China during the period 1990-97. The full sample results show significant improvements in real output, real assets, and sales efficiency, and significant declines in leverage following privatization, but no significant change in profitability. Further analysis shows that

privatized firms experience significant improvements in profitability compared to fully state- owned enterprises during the same period. Firms in which more than 50% voting control is

conveyed to private investors via privatization experience significantly greater improvements in

profitability, employment, and sales efficiency compared to those that remain under the state's control. Privatization seems to work in China, especially the more private firms become.

Privatization as an economic reform measure has swept the globe during the past twenty years, as more than one hundred countries of all economic and political persuasions have launched ambitious programs to privatize once state-owned enterprises (SOE) (see Megginson and Netter, 2001). These programs have contributed to nondebt financing of the public deficit, attracted foreign capital and technology, and promoted the return of flight capital (Perotti and Guney, 1993). Over the last two decades, privatizations have transformed the structure of corporate ownership and dramatically increased the number of shareholders in many countries (Boutchkova and Megginson, 2000), including China. Indeed, China's share issue privatizations (SIP) of SOEs have been a catalyst to the development of its stock markets. This ongoing program in the world's most populous country with the highest number of SOEs is yet to be fully implemented.

An important milestone of the Chinese economic reform was establishment of the Shanghai Stock Exchange in 1990 and the Shenzhen Stock Exchange in 1991, helping to institutionalize China's privatization program.' The number of listed companies increased from 10 in 1990 to 1,160 by year-end 2001. Listed companies represented a total market capitalization of renminbi yuan (RMB) 4,809 billion as of year-end 2000 (approximately US$586 billion) and had raised cumulative capital of RMB780 billion (US$95 billion) by year-end 2001. The presence of over 54 million shareholders in China by year-end 2000 may be the strongest evidence of the credibility of its privatization program (see Table I).

The published evidence on China's economic reform has focused mainly on the effectiveness of various reform measures, although several authors have examined issues related to China's privatized firms.2 Gul (1999) finds state ownership to be positively related to debt financing and dividend policy and growth opportunities to be negatively related to debt financing and dividend policy. Qi, Wu, and Zhang (2000) find post-issue return on equity positively related to institutional ownership and

'Naughton (1995) provides a comprehensive survey of China's economic reform during 1978-1993.

2See Groves, Hong, McMillan, and Naughton (1994) and Liu and Zhuang (1998).

The authors wish to thank the anonymous referee and the Editors for comments that substantially improved the quality of the paper Our study is made possible with the generous help from Shenyin & Wanguo Securities Co., Ltd., the largest investment bank in China.

*Zuobao Wei is an Assistant Professor of Finance at the University of Texas at El Paso, Oscar Varela and Kabir Hassan are Professors of Finance at the University of New Orleans, and Juliet D'Souza is an Assistant Professor of Finance at Clayton College & State University.

Financial Management * Summer 2003 * pages 107 - 126



Table I. Summary Statistics of China's Stock Market and Overall Financial Performance of the Listed Firms*

Year 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 Number ofListed Firms •

Shanghai 8 8 29 106 171 188 293 383 438 484 572 646 Shenzhen 2 6 24 77 120 135 237 362 413 465 516 514 Total 10 14 53 183 291 323 530 745 851 949 1088 1160

Nr mber of Firms 18 40 58 70 85 101 106 108 114 112 x .th B shares $

,umber of Investors 4 10 8 6 15 23 25 32 54

,million) Capital Raised in the 4.59 0.5 9.41 37.55 32.68 15.03 42.51 129.49 84.01 94.52 210.21 116.81 Year (billion RMB) Cumulative Capital 4.59 5.09 14.5 52.05 84.73 99.78 142.27 271.76 377.77 450.29 660.50 777.31 Raised (billion RMB) Market Capitalization 104.81 353.10 369.06 347.43 984.24 1752.92 1950.56 2647.12 4809.09 (billion RMB) State Ownership (%) 41.38 49.06 43.31 38.74 35.42 31.52 34.25 36.11 38.87 Mean Performance ofListed Firms Return on Sales 10.65 23.06 12.75 9.57 8.72 9.21 7.45 7.89 7.13 (ROS, %) Return on Assets 4.99 7.52 6.47 4.91 4.44 4.84 3.76 3.90 3.55 (ROA, %) Return on Equity 14.28 14.68 13.15 10.78 9.59 9.69 7.45 8.23 7.63 (ROE, %) Leverage (total debt to 65.02 48.76 50.80 54.41 53.72 50.06 49.49 52.57 53.49 total assets, %) Earnings per Share 0.35 0.36 0.31 0.25 0.23 0.24 0.19 0.20 0.20 (RMB/share)

'Values compiled or calculated from the Statistical Yearbook of China 2001 and from the official website of CSRC (China Securities Regulatory Commission, equivalenl to the SEC in the US): http://www.csrc.gov.cn/CSRCSite/deptlistcom/stadata/stadata.htm tIndicates year-end figures.

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Wei, Varela, D'Souza, & Hassan * Performance of China's Newly Privatized Firms 109

negatively related to state ownership. Wei and Varela (2003) also document a negative relationship between Tobin's q and state equity ownership in China's newly privatized firms.

Substantial empirical evidence on privatization in other countries has also been developed over the past decade. Eckel, Eckel, and Singhal (1997) study the privatization of British Airways. Barberis, Boycko, Shleifer, and Tsukanova (1996) study the divestment of 452 Russian retail businesses in the early 1990s. Claessens, Djankov, and Pohl (1997) examine ownership and governance issues of 706 Czech firms that were mass-privatized during 1991 and 1992, and Aggarwal and Harper (2000) study the auction process and equity valuation issues of the Czech voucher privatization.

Bortolotti, D'Souza, Fantini, and Megginson (2002), in a single-industry study, investigate performance changes following the privatization of 31 national telecommunications companies. Sun and Tong (2002) study 24 Malaysian share issue privatizations (SIP) during 1983-1997. The results from both single-country and single-industry studies overwhelmingly show performance improvements following privatization.

Several well-cited studies examine performance changes in a multi-country, multi-industry setting. Megginson, Nash, and Randenborgh (1994) (hereafter MNR) compare the pre- and post-privatization financial and operating performance of 61 companies in 18 countries and 32 industries over the period 1961-1990, and find performance improvements without an employment loss. Galal, Jones, Tandon, and Vogelsang (1994) find net welfare gains in 11 of 12 privatization ventures in the UK, Chile, Malaysia, and Mexico. Boubakri and Cosset (1998) (hereafter BC) study 79 companies in 21 developing countries that were fully or partially privatized from 1980-1992. They find significant improvements in financial and operating performance following privatization. D'Souza and Megginson (1999) (hereafter DM) also show significant improvements in post-privatization performance.

Multi-country studies so far include no firms from China, except for D'Souza and Megginson (1999) with inclusion in their sample of one Chinese firm. Yet the Chinese economy, already the second-largest in the world on a purchasing power parity basis, is poised to become more influential in the years to come. China's privatization program, if fully carried out, may be the largest industrial ownership transformation ever undertaken, affecting more than 200,000 SOEs and 100 million urban workers (see Wei, Varela, and Hassan, 2002). As Megginson and Netter (2001) point out:

The evidence from China suggests that enterprise restructuring, concentrating on improving the allocation of property rights and incentives, can yield large benefits even without privatization. Naturally, this begs the question whether economic reform coupled with privatization could lead to even greater performance improvements. Unfortunately, there is little evidence on this question and it would be very difficult to develop such evidence. (p. 338)3

Our primary objective is to determine whether the effects of China's share issue privatizations (SIP) are consistent with the evidence elsewhere. The Chinese program is different in two important respects from privatization programs examined by MNR, BC, and DM, among others. First, the Chinese program involves exclusively primary, capital-raising SIPs. That is, a firm retains the capital that is raised, while capital raised by firms in MNR, BC, and DM mostly flowed to the government. Second, the Chinese SIPs occurred in an environment characterized by immature capital markets, weak corporate governance and managerial incentives, and routine political interference with firm management (Dorn, 2001).

3This is mainly due to the difficulty of obtaining reliable data from China.



110 Financial Management * Summer 2003

We examine the pre- and post-privatization financial and operating performance of 208 Chinese firms that were privatized in 1990-1997. We further investigate the effects of retained state ownership on firm performance and compare long-term and short-term performance changes following privatization.

Overall, our results show that real output, real assets, and sales efficiency improve while leverage declines significantly following privatization, consistent with MNR, BC, and DM. We do not find significant changes in profitability pre- versus post-privatization, contrary to MNR, BC, and DM. And employment declines significantly in the long run. Our results further show that, on a comparative basis, firms where voting control has been passed to private investors experience significant relative gains in profitability, efficiency, and employment over those with majority state shares following privatization.

I. Sample and Data, Hypotheses, and Methodology

We utilize a matched pair methodology for our full sample and sub-samples using performance hypotheses explicitly stated by the Chinese government.

A. Sample and Data

The full sample consists of 208 firms that completed public share offerings in China during the period 1990-1997. Of this total, 166 firms listed on the Shanghai Stock Exchange (SHSE) and 42 on the Shenzhen Stock Exchange (SZSE); 40 issued both A and B shares, and the others only A shares.4

The data for the sample firms are obtained from their offering prospectuses and annual reports, provided by the Corporate Finance and International Business Division of Shenyin & Wanguo Securities Co., Ltd., China's largest investment bank. We required that there be a minimum of three years of pre- and post-privatization accounting data, and that completion of the public share offerings occur during the period 1990-1997. The required 1987-2000 consumer price index (CPI) values for China come from the official website of the Asian Development Bank (ADB).5

We obtain for all firms at least three years of post-privatization employment data. For a subsample of 82 firms, we also obtain three years of pre-privatization employment data, enabling us to analyze employment changes following privatization. Seven years of post-privatization employment and accounting data for a subsample of 81 firms enable us to analyze and compare short-run and long-run performance.

An important characteristic of the Chinese program is that the state retains substantial ownership influence in many of the privatized firms. The government held an average of 38.87% state ownership in all listed companies as of year-end 2000 (Table I). In our sample, state ownership ranges from 0 to 88.58%, with an average of 37.36%. Of the 208 firms, only 46 were fully privatized, with zero percent state shares, and 76 had more than 50% state ownership. These data characteristics enable us to compare the effect of retained state ownership on performance.

4Both A and B shares are RMB-denominated shares listed on either Chinese stock exchange. A shares can be subscribed to and traded only by Chinese residents. Prior to February 2001, B shares could be subscribed to and traded only by foreign investors. Transactions are made in US dollars for B shares listed in Shanghai and in Hong Kong dollars for those listed in Shenzhen. Both A and B shares have the same voting rights.

5Website: http://www.adb.org




B. Hypotheses

The explicit Chinese government objectives of privatizing state-owned enterprises include: raising capital for the firm; reducing government subsidies to inefficient SOEs; improving efficiency through market discipline and competition; optimizing industrial structure through efficient allocation of resources; and defining and transferring property rights.6 Hence, following Megginson, Nash, and Randenborgh (1994), Boubakri and Cosset (1998), and D'Souza and Megginson (1999), we predict improvements in real output, real assets, profitability, and sales efficiency, and declines in leverage following privatization for the sample firms in this study.

Galal, Jones, Tandon, and Vogelsang (1994), MNR, and BC all find that employment increases, but DM find declines in employment following privatization. Boycko, Shleifer, and Vishny (1996) theorize that overemployment is a major factor in the inefficiency of SOEs. Wei et al. (2002) document that overemployment is a significant cause for the underperformance of SOEs among manufacturers in China. One worrisome aspect of privatization for the Chinese government is the potential loss of employment and its negative impact on social stability. In fact, privatized firms may hire more workers with post-issue increases in capital investments. And managers may be reluctant to lay off redundant workers because of political pressures, as the state retains substantial influence in many of the privatized firms in China. We would argue that net employment change before and after privatization is ultimately an empirical question in the case of China.

Overall, MNR, BC, and DM all report greater efficiency gains for firms whose control was transferred to private investors. We also expect greater performance improvements for Chinese firms when private owners gain voting control. The objectives of SOEs are different from the profit-maximization objectives of private investors. State governments have social and political objectives, so it is to be expected that the level of ownership retained by the state following privatization should affect the performance of newly privatized firms.

The proxies for the economic characteristics and the hypotheses tested in this study are summarized in Table II.

C. Methodology

Our tests follow the matched pair methodology of pre- versus post-privatization comparisons as in D'Souza and Megginson (1999), allowing for an analysis of post- privatization performance changes. We begin by calculating performance measurement proxies for every company over a six-year period, from the three years before to the three years after privatization, and then calculate the mean value of each variable for each firm for the 3-year before and after periods. As the year of privatization (year 0) includes phases of both state and private ownership, we exclude it from our mean calculations. We use the Wilcoxon signed-rank test to examine for significant differences and improvements between pre- and post-privatization performance of our firms, and use a proportion test to examine whether at least 50% of the firms show the predicted results.

The ratios use nominal data. To compute real sales and sales efficiency (revenue per employee), we deflate the sales data using the appropriate consumer price index (CPI) values. When we aggregate across companies, we follow MNR, BC, and DM to normalize each year's observation relative to that in year 0, the year of privatization. We use the same method in computation of net profit level and real asset changes.

6Source: Chinese Securities Market Yearbook 1994, p. 52.



112 Financial Management * Summer 2003 Table II. Testable Predictions

This table details the economic characteristics we examine and defines the empirical proxies and the predicted changes. A and B stand for "after" and "before". The question mark in the employment relationship indicates an empirical question due to the competing arguments cited in the text. Sales efficiency is computed by using inflation-adjusted sales figures divided by the year-end number of employees. Deflated sales per employee is normalized to equal 1.00 in year 0 (the year of privatization) so other years' figures are expressed as a fraction of per capita output in the year of divestment. Net profit level, real sales, and real assets are computed similarly.

Characteristic Proxy Predicted Relationship Profitability Return on Sales (ROS) = Net Income / ROSA > ROSB

Sales Net Profit Level (NPL) = Net Income NPLA > NPLB After Taxes

Output Real Sales (OUTPUT) = OUTPUTA > OUTPUT a Nominal Sales / Consumer Price Index Real Assets (ASSETS) = Total Assets / ASSETSA > ASSETSB CPI

Employment Total Employment (EMPL) = Total EMPLA ? EMPLB Number of Employees

Operating Efficiency Sales Efficiency (SALEFF) = Sales / SALEFFA > SALEFFB Total Employment

Leverage Debt to Assets (TDTA) = Total Debt / TDTAA < TDTAB Total Assets

We also study the effects of retained state ownership on performance changes following privatization. We partition the full sample into two subsamples, namely, control and no- control firms. Control firms are firms where the voting control has been passed to private investors (with less than 50% state ownership) after privatization and no-control firms are those still under the state's control (with 50% or more state ownership).

The Wilcoxon test is used as before, and the Kruskal-Wallis test is used to examine for significant differences in performance between the two independent subsamples. The Wilcoxon test is also used to examine differences between performance changes in the long run and the short run.7

Finally, using regression analysis, we examine the effects of other variables, including offering date, offering size, headquarters location, and state and foreign ownership. One variable of interest is the date, because in conjunction with our long-run versus short-run analysis, this can provide insight into the effects of the overall trend of declining profits in China, especially with respect to return on sales as shown in Table I.8

7Megginson, Nash, Netter, and Schartz (2000) study the long-run return to investors in share issue privatizations. They find statistically significant positive net returns for domestic, international, and US investors for different holding periods compared to the relevant benchmarks.

8We thank an anonymous referee for bringing this trend and the associated issues to our attention. For example, Zhu (1999) documents significant profitability declines for both state and non-state sectors in China, attributing this decline to increased economywide competition as Chinese markets open up and become more competitive.




We examine this issue further by providing profitability and performance comparisons between fully state-owned enterprises and a subsample of the privatized firms.

II. Empirical Results

Table III provides the results for the full sample. Table IV provides results for the control and no-control firms, and Table V the results for the short-run and long-run subsamples. Regression results are in Table VI and the profitability and performance comparisons of state-owned and privatized firms in Table VII.

A. Profitability Changes

We use two profitability proxies to measure pre- versus post-privatization profitability changes, namely return on sales (ROS) and net profit level (NPL).9 The pre- versus post- privatization change in ROS is statistically insignificant according to the Wilcoxon test, although the mean (median) arithmetically changes from 17.12% (11.21%) pre- to 12.71% (12.24% ) post-privatization. It is no surprise, however, that both the Wilcoxon and proportion tests show significant increases in net profit level from a normalized mean of0.69 pre- to 1.23 post-privatization (see Table III).

The control versus no-control analysis also shows statistically insignificantly changes in ROS for both subsamples following privatization, although arithmetically the control firms' mean ROS increases from 13.97% pre- to 14.17% post-privatization, and the no-control firms' declines from 17.91% pre to 12.50% post. The Kruskal-Wallis test shows that the control firms experience significantly greater profitability improvements (at the 1% level) over no- control firms following privatization (see Table IV).

The long-run versus short-run analysis, to the contrary, shows statistically significant changes in ROS (at the 5% level). There are increases in the short run (three-year post- versus three-year pre-privatization averages), but declines in the long run (seven-year post- versus three-year pre-privatization averages). The Wilcoxon test also shows that the difference between the long-run and short-run post-privatization average ROS is negative and significant (at the 1% level), declining from a short-run mean of 14.39% to a long-run mean of9.11% (see Table V). The observed relative decline in long-run ROS may be related to the overall trend of declining profits in China.

B. Output and Assets

Results for the full sample show that real sales (OUTPUT) increase from a normalized mean of 0.81 pre- to 1.24 post-privatization, significant (at the 1% level) by the Wilcoxon signed rank and proportion tests. Real assets (ASSETS) also increase significantly (at the 1% level) following privatization (see Table III).

The control versus no-control analysis also shows that real sales increase significantly (at the 1% level) for both subsamples, although the Kruskal-Wallis test shows no significant

9ROS is a preferred measure of profitability, because the components of the ratio are current-dollar measures. We also analyzed pre- and post-privatization return on equity (ROE) and return on total assets (ROA) for the full sample, and found that both ROE and ROA decline significantly following privatization. This is consistent with the literature related to initial public offerings (IPO) by private firms that documents post-issue profitability decreases. ROE and ROA are not the appropriate measures of profitability for primary share issue privatizations because primary offerings, like IPOs, bring fresh capital into the firm for expansion of equity and assets, mechanically raising the denominators of these ratios.




Table III. Results of Tests of Predictions for Full Sample

The table presents, for each empirical proxy, the number of usable observations, the mean and median values of the proxy for the three-year periods before and after privatization, the mean and median change in the proxy's value, and a test of significance of the mean change. The Wilcoxon signed rank test (z- statistic) is the test for significance of the change in mean values. The final two columns detail the percentage of firms whose proxy values change as predicted, and a test of significance of the change (t- statistic). Sales efficiency is computed by using inflation-adjusted sales figures divided by the number of employees each year. Deflated sales per employee is normalized to equal to 1.00 in year 0 so other years' figures are expressed as a fraction of per capita output in the year of divestment. Net profit level, real sales, and real assets are computed similarly.

Z-Statistic for Percentage t-Statistic for

Mean Mean Mean Difference of Firms that Significance Before After Change in Means Changed as of Proportion

Variables N (Median) (Median) (Median) (p-value) Predicted Change Profitability Return on 206 17.12 12.71 -4.41 -0.04 52.92 0.84 Sales (ROS) (11i.21) (12.24) (1.10) (0.97) Net Profit 204 0.69 1.23 0.54 6.66*** 72.55 7.22*** Level (NPL) (0.55) (0.90) (0.35) (0.00) Output Real Sales 208 0.81 1.24 0.43 7.14*** 71.15 6.73*** (OUTPUT) (0.77) (1.01) (0.24) (0.00) Real Assets 208 1.19 1.58 0.39 6.30*** 77.66 9.32***

(ASSETS) (0.47) (1.17) (0.70) (0.00) Employment Total 82 4414 4478 64 1.15 47.32 -0.77 Employment (1949) (2258) (309) (0.25) (EMPL)

Efficiency Sales 82 0.71 0.96 0.25 5.15*** 74.39 5.06* Efficiency (0.69) (0.85) (0.16) (0.00) (SALEFF) Leverage Total Debt 206 51.51 35.59 -15.92 -8.24*** 77.29 9.37* to Total (59.47) (41.71) (-17.76) (0.00) Assets (TTrA) ***Significant at the 0.01 level.

*Significant at the 0.10 level.

difference in real sales changes between the two groups (Table IV). We also find significant real sales increases (at the 1% level) for both short-run and long-

run changes. Normalized real sales increases from a mean of 0.55 pre- to 1.02 post-privatization in the short run, and to 0.96 in the long run. In a comparison of the long run to the short run, the Wilcoxon test shows that relative real sales decline significantly in the long run (at the 10% level) (Table V).



Table IV. Comparisons of Performance Changes for Control and No-Control Firms

Control firms are firms with less than 50% state shares and no-control firms are those with 50% or more state shares. The table presents, for each empirical proxy, the number of usable observations, the mean and median values of the proxy for the three-year periods before and after privatization, the mean and median change in the proxy's value, and a test of significance of the mean change. The Wilcoxon signed rank test (z-statistic) is the test for significance of the change in mean values. The final three columns present the Kruskal-Wallis results for differences between the control subsample and the no-control subsample. Sales efficiency is computed by using inflation-adjusted sales figures divided by the number of employees each year. Deflated sales per employee is normalized to equal to 1.00 in year 0 so other years' figures are expressed as a fraction of per capita output in the year of divestment. Real sales is computed similarly.

Z-Statistic for Mean Difference in Means

Mean Before Mean After Change (After-Before) Kruskal-Wallis Results for Differences Variables N (Median) (Median) (Median) (p-value) Between Subsamples

Mean Rank KW Test Control No-Control Statistic

Subsample Subsample (p-value) Return on Sales (ROS) Control 123 13.97 14.17 0.20 1.41

(9.44) (11.95) (2.51) (0.16) 105.8 83.2 7.30* No-Control 71 17.91 12.50 -5.41 -1.07 (0.00)

(14.39) (12.33) (-2.06) (0.29) Real Sales (OUTPUT) Control 132 0.77 1.22 0.45 6.05"

(0.71) (1.01) (0.30) (0.00) 108.2 98.1 1.33 No-Control 76 0.89 1.27 0.38 3.83" (0.25)

(0.82) (1.01) (0.19) (0.00) Employment (EMPL) Control 57 2943 3104 161 2.34**

(1794) (2943) (119) (0.02) 45.2 33.0 4.62** No-Control 25 7770 7611 -159 -1.13 (0.03)

(4791) (4961) (170) (0.26)

**Significant at the 0.05 level. *Significant at the 0.10 level.

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Table IV. Comparisons of Performance Changes for Control and No-Control Firms (Continued)

Z-Statistic for Mean Difference in Means

Mean Before Mean After Change (After-Before) Kruskal-Wallis Results for Differences Variables N (Median) (Median) (Median) (p-value) Between Subsamples

Mean Rank KW Test Control No-Control Statistic

Subsample Subsample (p-value) Sales Efficiency (SALEFF) Control 57 0.70 0.97 0.27 4.66*

(0.67) (0.86) (0.19) (0.00) 44.5 34.7 2.95*** No-Control 25 0.74 0.91 0.17 2.05** (0.08)

(0.71) (0.78) (0.07) (0.04) Total Debt to Total Assets (TDTA) Control 128 49.88 33.62 -15.93 -6.56"

(55.57) (39.52) (-17.00) (0.00) 102.1 105.9 0.20 No-Control 76 54.25 37.90 -16.35 -5.07* (0.65)

(60.49) (43.47) (-17.02) (0.00)

***Significant at the 0.01 level. **Significant at the 0.05 level.


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Table V. Comparison of Long-Run versus Short-Run Performance Changes

Long-run performance is measured by the comparing the seven years post-privatization average to the three years pre-privatization average. Short-run performance is measured by the comparing the three years post-privatization average to the three years pre-privatization average. The table presents, for each empirical proxy, the number of usable observations, the mean and median values of the proxy for the three-year period before privatization, and for the seven- and three-year periods after privatization, the mean and median change in the proxy's value, and a test of significance of the mean change. The Wilcoxon signed rank test (z-statistic) is the test for significance of the change in mean values. The final column presents the Wilcoxon test results for differences between the long- run and short-run for the same firm (z-statistic). Sales efficiency is computed by using inflation-adjusted sales figures divided by the number of employees each year. Deflated sales per employee is normalized to equal to 1.00 in year 0 so other years' figures are expressed as a fraction of per capita output in the year of divestment. Real sales is computed similarly.

Z-Statistic for Z- Statistic for Difference in Mean Difference in between Long Term and Short Term

Mean Mean (After- (7 year post-privatization average - 3 Mean Before Mean After Change Before)/ year post-privatization average)

Variables N (Median) (Median) (Median) (p-value) (p-value) Return on Sales (ROS) Long Run 80 13.86 9.11 -4.75 -2.26**

(8.69) (7.81) (-0.88) (0.02) -4.85*** (0.00)

Short Run 80 13.86 14.39 0.53 1.98** (8.69) (11.87) (3.18) (0.05)

Real Sales (OUTPUT) Long Run 81 0.55 0.96 0.42 3.10***

(0.43) (0.64) (0.21) (0.00) -2.24** (0.03)

Short Run 81 0.55 1.02 0.47 4.96*** (0.43) (0.88) (0.45) (0.00)

Employment (EMPL) Long Run 62 4009 3808 -201 -1.07

(1956) (2118) (162) (0.28) -3.25*** (0.00)

Short Run 62 4009 4074 65 0.73 (1956) (2433) (477) (0.47)


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Table V. Comparison of Long-Run versus Short-Run Performance Changes (Continued)

Z-Statistic for Z- Statistic for Difference in Mean Difference in between Long Term and Short Term

Mean Mean (After- (7 year post-privatization average -3 Mean Before Mean After Change Before)l year post-privatization average)

Variables N (Median) (Median) (Median) (p-value) (p-value) Sales Efficiency (SALEFF) Long Run 62 0.56 0.96 0.40 3.47***

(0.44) (0.77) (0.33) (0.00) 0.85

Short Run 62 0.56 0.99 0.43 4.22*** (0.39) (0.44) (0.82) (0.37) (0.00)

Total Debt to Total Assets (TDTA) Long Run 81 55.83 42.98 -12.86 -4.93***

(60.58) (44.35) (-16.24) (0.00) 4.39***

Short Run 81 55.83 38.22 -17.61 -6.13*** (0.00) (60.58) (39.35) (-21.23) (0.00)

***Significant at the 0.01 level. **Significant at the 0.05 level. *Significant at the 0.10 level.

Co

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C. Employment Changes

Employment changes are calculated for the 82 firms that have three years pre- and post- privatization employment data. The Wilcoxon test shows an insignificant increase in employment for the full sample, despite an average increase of 64 employees per firm after privatization (Table III).

The control firms within this sample experience a significant increase in employment (at the 10% level), with an average increase of 161 employees per firm following privatization. The no-control firms experience an insignificant average decline of 159 employees per firm. The Kruskal-Wallis test shows the difference in employment changes between control and no-control firms is significant (at the 10% level) (Table IV).

Employment levels rise in the short run and decline in the long run, although insignificantly, with an average short-run increase of 65 employees and a long-run decline of 201 employees per firm. The Wilcoxon test shows that these differences are significant (at the 1% level), as post-privatization employment declines from the short-run average of 4,074 employees per firm to the long-run average of3,808 employees per firm (Table V).

D. Efficiency Changes

Sales per employee is one proxy for sales efficiency. For the 82 firms with both three years pre- and three years post-privatization employee data, the Wilcoxon test shows efficiency increases significantly (at the 1% level), from a normalized mean of 0.71 pre- to 0.96 post- privatization. The proportion test shows that 74.39% of the firms significantly improve their efficiency (at the 1% level) as predicted (Table III).

Sales efficiency increases significantly for both control (at the 1% level) and no-control firms (at the 5% level). The Kruskal-Wallis test further shows that the control firms experience significantly greater efficiency gains (at the 10% level) than the no-control firms (Table IV).

Sales efficiency also increases significantly (at the 1% level) over both the short and long run, from a normalized mean of 0.56 pre- to 0.99 post-privatization in the short run, and to 0.96 post-privatization in the long run. The relative differences between the long- and short-run efficiency changes are insignificant by the Wilcoxon test (Table V).

E. Leverage

We use total debt to total assets (TDTA) as a proxy for leverage. The Wilcoxon and proportion tests show significant declines in leverage following privatization (both at the 1% level). Leverage declines from a mean of 51.51% pre- to 35.59% post-privatization (Table III). Because of the primary nature of China's SIPs, most of this decline is due to new equity capital, although some of the decline may be attributable to higher retained profits.

Similarly, the control and no-control subsamples experienced significant declines in leverage after privatization (at the 1% level) by the Wilcoxon test. The Kruskal-Wallis test shows no significant differences in the declines between the two sets of firms (Table IV).

The Wilcoxon test also shows that leverage declines significantly (at the 1% level) in post-privatization short- and long-run periods. Compared to the post-privatization short- term average of38.2%, long-run leverage rises significantly (at the 1% level) to an average of 42.98% (Table V). While leverage declines in the short run due to privatization, it may increase on a relative basis in the long run, because post-privatization growth may ultimately require more debt.




F. Regression Analysis and Results

We use multivariate ordinary least squares regression analysis to examine the impact of other factors, including offering date, headquarters location, offering size, and state and foreign ownership, in the observed pre- versus post-privatization performance differences of our firms. The regression takes the form:

A% = fo + f/DATE + /2LOCATION + /3SIZE + /4STATE + /JsFOREIGN + e

where the dependent variable A % represents the average pre- versus post-privatization percentage change in the five performance measures: changes in return on sales ( A ROS), in real sales ( A RS), in leverage (A LEV), in sales efficiency ( A SEFF), and in employment ( A EMPL). Five separate regressions are performed, one for each variable.

The independent variables include: an offering date dummy, equal to one for firms privatized in 1995-1997 and zero in 1990-1994 (DATE); a geographic location dummy, equal to one for firms headquartered in Shanghai, Shenzhen, or Beijing, and zero otherwise (LOCATION); the offering size as the logarithm of the RMB amount of shares sold to the public (SIZE); the percentage of equity ownership retained by the state after privatization (STATE); and the percentage of foreign ownership in the privatized firms (FOREIGN).

The offering date dummy DATE may be related to general profitability declines in China, in that more recent privatizations may reveal less profitability. The geographic location dummy LOCATION is included because it is possible that firms headquartered in economically more advanced regions might experience greater performance gains because of better educated workforce and more efficient management than those headquartered elsewhere. We investigate the effects of state and foreign shares on the performance changes following privatization while controlling for the offering size.

The results are in Table VI. Firms privatized in 1995-1997 indeed experience significant declines in profitability ( A ROS) compared to those privatized in 1990-1994. This result is consistent with our long-run versus short-run analysis.

Firms headquartered in Shanghai, Shenzhen, or Beijing experience significantly greater gains in real sales (A RS) and sales efficiency (A SEFF), indicative perhaps of a better educated workforce and more efficient management in these regions. The results also show that offering size (SIZE) is significantly negatively related to changes in profitability ( A ROS) and real sales ( A RS).

State ownership (STATE) is significantly negatively related to changes in real sales ( A RS), in sales efficiency ( A SEFF), and in employment (A EMPL), consistent with our control versus no-control analysis. The results, however, show that foreign ownership (FOREIGN) is significantly positively related to changes in profitability ( A ROS) and significantly negatively related to changes in leverage ( A LEV), consistent with Smith, Cin, and Vodopivec (1997).10

G. Profitability of SOEs versus Privatized Firms

The overall trend toward declining profits in China may bias our results. While we find no significant change in profitability after privatization for the full sample, the long-run versus short-run analysis and the regressions point to some intertemporal declines in profitability.

'0oIn their study of 3,792 privatized firms in Slovenia, Smith, Cin, and Vodopivec (1997) find a significantly positive relationship between profitability and foreign ownership.




Table VI. Regression Analysis Results

The regression equation is:

A% = fo + /IDATE + fl2LOCATION + f3SIZE + /,4STATE + IisFOREIGN + e

Where:

A% = represents percentage changes of five performance measures pre- versus post-privatization, including changes in return on sales (AROS); real sales (ARS); leverage (ALEV); sales efficiency (ASEFF); and employment (AEMPL); DATE = Offering date dummy; equals one for firms privatized in 1995-1997 and zero if privatized in 1990-1994; LOCATION = Geographic location dummy; equals one for firms headquartered in Shanghai, Shenzhen, or Beijing, and zero elsewhere; SIZE = offering size; equals the logarithm of the RMB amount of shares sold to the public; STATE = percentage of equity ownership retained by the state after privatization; and FOREIGN = percentage of foreign ownership in privatized firms. t-statistics are in presented in the parenthesis.

Dependent Variable AROS ARS ALEV ASEFFt AEMPLt Independent Variable Intercept 2.33328**' 5.1967"** -29.8315 -0.0401 8.7802

(3.298) (2.802) (-1.513) (-0.089) (0.294) DATE -0.3459** 0.4948 1.4432 0.0676 1.1864

(-2.433) (1.400) (0.385) (0.714) (0.190) LOCATION 0.0085 0.7089* 1.3571 0.3810*** -2.7782

(0.058) (1.870) (0.441) (3.680) (-0.406) SIZE -0.5103** -1.0280* 3.3654 0.0478 3.7939

(-3.001) (-2.269) (0.698) (0.432) (0.519) STATE 0.0016 -0.0104* 0.0845 -0.0036* -0.3225***

(0.645) (-1.688) (1.294) (-2.056) (-2.805) FOREIGN 0.0079* 0.0041 -0.2315* -0.0037 -0.1828

(1.707) (0.321) (-1.6826) (-1.260) (-0.941) N 201 208 197 82 82 Adjusted R2 6.04% 4.33% 0.42% 17.80% 5.18%

tThere are 82 firms in our sample with both three years pre- and post-privatization employment data, enabling us to calculate changes in sales efficiency and employment before and after privatization.



To explore this problem further, we obtain another matched subsample of 41 fully state- owned and 41 privatized firms for the period 1994-1999 to compare their profitability and net income." The idea is that privatization may be associated with improved performance, even in light of general declines in profitability, if the privatized outperform the fully state-owned firms. The results are in Table VII.

The privatized firms by the Wilcoxon test experience no significant change in profitability

"The 41 privatized firms are from our full sample and were privatized in 1996. The 41 fully state-owned firms were obtained from China's Top 100,000 Enterprises, a database published by All-China Marketing Research Co., Ltd, a subsidiary of the Statistical Bureau of China. These firms were randomly selected with the provision that they had to satisfy the following constraints. They had to be fully state-owned with the required accounting and employment data for the period 1994-1999, and 1996 asset size comparable to that of the privatized firms.




Table VII. Performance Comparisons between SOEs and Privatized Firms

The performance comparisons are between 41 fully state-owned firms and 41 firms privatized in 1996. The mean (median) values before and after year zero (1996) are calculated separately for each group. The before calculation uses a two-year average (1994-1995) and after a three-year average (1997-1999). The table presents, for each empirical proxy, the number of usable observations, the mean and median values of the proxy before and after year zero, the mean and median change in the proxy's value, and a test of significance of the mean change. The Wilcoxon signed rank test (z- statistic) is the test for significance of the change in mean values. The final three columns present the Kruskal-Wallis results for differences between the SOE subsample and the privatized subsample. The mean before and mean after values for net profit level (NPL), real sales, and sales efficiency (SEFF) are all normalized using the year zero (1996) value.

Z-Statistic for Difference in

Mean Mean Mean Means (After- Before After Change Before) Knskal-Wallis Results for Differences

Variables N (Median) (Median) (Miedan) (p-value) between Susanples Mean Rank KW Test

Privatized SOE Statistic Subsanrple Subsan e (p-value)

Retun on Sarles Privatied 41 11.47 5.46 -6.01 0.43

(10.23) (11.00) (0.77) (0.67) 46.2 36.8 3.25**

SOE 41 1251 1.53 -10.98 -3.85*** (0.07) (8.62) (5.89) (-2.73) (0.00)

Net Profit Level lewi Privatized 39 0.79 1.59 0.80 3.44**

(0.59) (1.14) (0.55) (0.001) 48.7 327 9.40***

SOE 41 1.64 1.00 -0.64 -1.28 (0.00) (1.25) (0.95) (-0.30) (0.20)

Real Sales Privatized 41 0.99 1.60 0.61 3.04***

(0.99) (1.51) (0.52) (0.00) 49.5 33.5 9.17**

SOE 41 1.31 1.01 -0.29 -2.62*** (0.00) (1.23) (0.95) (-0.28) (0.01)

Privatized 41 4660 4784 124 248*** (1862) (1914) (116) (0.01)

48.9 34.1 7.97*** SCE 41 2638 2635 -3 -1.114 (0.00)

(1594) (1426) (-168) (0.26) Sales Fciency

Privatied 41 0.71 0.84 0.13 3.04*** (0.68) (0.73) (0.06) (0.00)

51.1 31.9 13.32"** SOE 41 1.35 1.06 -0.29 -2.86*** (0.00)

(1.23) (1.01) (-0.22) (0.00)





but a significant increase in net profit level after privatization. In the same period, the fully state-owned enterprises experience significant declines in profitability but no significant change in net profit.

On balance, the Kruskal-Wallis test shows that the profitability and net profit of the privatized firms improved significantly over the state-owned firms during the post-privatization period. In fact, the Kruskal-Wallis tests show, for all performance measures employed, that privatized firms outperform those fully state-owned (Table VII).

III. Discussion and Analysis

The key findings related to profitability, employment and state equity ownership are worth further discussion.

A. Profitability

Our full sample results show that profitability does not change significantly following privatization of firms in China (Table III). This result is surprising. The literature provides persuasive evidence of profitability improvements following privatization elsewhere (see Megginson, Nash, and Randenborgh (1994), Boubakri and Cosset (1998), and D'Souza and Megginson (1999), for example). There is a general trend toward declining profitability in China. This finding is confirmed in some of our subsample results, with declining profitability in the long run (Tables V and VI).

Further analysis, however, reveals that our privatized firms outperform those that are fully state-owned, including with respect to profitability (Table VII). In this regard, our finding is not inconsistent with those in MNR, BC, and DM. Indeed, the absence of significant declines in profitability in our full sample is itself surprising, given that these are primary SIPs floated in an environment with overall declining profitability.12

B. Employment and State Shares

One apprehension among government officials regarding privatization is its potential negative impact on social stability should significant employment loss occur. Our full sample results show no significant change in employment after privatization (Table III), although for a subsample with long-term employment data, employment declines significantly in the long run (Table V). These findings are indicative of the Chinese desire for a gradual approach to economic reform in general and to privatization in particular. Indeed, the state continues to hold substantial ownership in many firms even after privatization, with an average 38.87% ownership in all listed firms as of year-end 2000 (Table I) and 37.36% ownership in our full sample.

The government's influence may lead firms for the sake of social stability not to immediately lay off workers after privatization, but rather to do so gradually over time. Substantial ownership interest in privatized firms may reflect China's reluctance to fully commit to a rapid pace of privatization, including ownership transformation and property rights allocation.

"The primary capital-raising nature of the Chinese SIPs, as opposed to the mostly secondary SIPs examined in MNR, BC, and DM, may also account for some of the observed profitability declines. Mikkelson, Partch, and Shah (1997) and Jain and Kini (1994) document post-IPO profitability declines. Jain and Kini (1994) further point out window-dressing of accounting numbers as a potential reason for the post-issue profitability decline of IPO firms. And it may be easier to manipulate accounting numbers in China than in the developed economies where most SIPs take place.



124 Financial Management ' Summer 2003

And the state not merely retains substantial ownership in many privatized firms; its political interference continues (Dorn, 2001). The problems with state-owned enterprises largely remain, such as agency costs, soft-budget constraints, weak managerial incentives, and corruption (Zhu, 1999).13

Our control versus no-control comparisons show that firms less than 50% state-owned after privatization experience significantly greater gains in profitability, sales efficiency, and employment over those with a majority of state share ownership following privatization (Table IV). And our regression analysis shows that state ownership is significantly negatively related to real sales, sales efficiency, and employment changes (Table VI).

Privatized firms and the private sector may be able to absorb a portion of workers laid off from the state sector, were the state to allow a larger role in the economy for the private sector and greater access to more of total investment capital. In this case, the state would need to strengthen property rights and corporate governance, reduce state ownership and associated political influences, and reform and privatize the banking industry.'4

As Dorn (2001) states:

As long as the state has majority stake in enterprise ownership, investment decisions and managerial appointments will be politicized. (p. 65).

IV. Summary and Conclusions

We have compared the pre- and post-privatization financial and operating performance of 208 firms whose ownership was privatized in China during the period 1990-1997. For the full sample, we find significant improvements in real output, real assets, and sales efficiency, and significant declines in leverage following privatization, consistent with the published privatization literature. Surprisingly, we also find no significant change in profitability.

On the one hand, most research points toward profitability gains after privatization. On the other, there is a general trend toward decreased profitability in China. The latter is borne out in some of our privatization subsamples but the evidence is offset by the higher profitability of privatized firms compared to completely state-owned enterprises.

Most important, we find that firms in which more than 50% voting control is conveyed to private investors via privatization experience significantly greater improvements in profitability, employment, and sales efficiency over those that remain under the state's control. The results we document suggest that privatization works in China, especially when control is passed to private investors.

Our work is only a first step in understanding the relatively young Chinese privatization program. Adding to the body of evidence from China, the world's most populous country with an increasingly influential economy, would increase our understanding and complement other evidence on privatization.E

'3The state's substantial ownership interest may also reflect a political compromise between conservatives who want to limit private ownership and reformers who believe in decentralization and market economy as the route to China's prosperity. Jones, Megginson, Nash, and Netter (2001) also argue that politicians routinely use SIPs as financial means to achieve certain political ends.

'4The state sector's share of industrial output amounted to only about one-third of the total in 1995, but it received more than two-thirds of the total investment capital (Wei et al. 2002). The Chinese government has allowed private ownership in most sectors since the start of the reform, but still tightly controls the entire banking industry (Dorn, 2001).




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