Corporate Ownership, Financial Transparency, and Access to Finance


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The private ownership of productive assets that characterizes capitalism relies on an institutional foundation nonexistent in the immediate post-communist systems. In particular, capitalist systems provide for legal protections that allow the pooling of capital with controlled risk for investors and a potentially important new source of financing for productive entities. Building those systems, however, requires reforms much deeper than stroke-of-the-pen passage of laws. Investor confidence-indeed fundamental fairness-requires corporate transparency and accountability. In the West, systems that have been in existence for centuries are yet to be perfected, a fact made clear by the wave of governance and accounting scandals that have occupied the headlines in recent years. The relative infancy of the systems in transition countries poses an even greater challenge.

This chapter uses the case studies of firms that were undertaken in each of the SEE8 (the eight countries that are the subject of this study) in the summer of 2002 and the data from the 2002 EBRD and World Bank Business Environment and Enterprise Performance Survey (BEEPS2) to examine the elements of the basic paradigm of corporate governance and access to finance, as well as the impact that both have on investment and growth in the region.1 Certain core aspects of corporate governance have been the subject of a great deal of attention since the early days of the transition-namely, the basic questions of company law, legal forms of organization, and maintenance of minority shareholder rights (see Mesnard 2001). The essence of how legal provisions influence the incentives of managers and owners in the postsocialist world is much better understood now than a decade ago. This chapter will, for this reason, not dwell on these aspects of corporate governance but will focus instead on issues of financial transparency and accountability.

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As described in chapter 2, in many countries of South Eastern Europe (SEE), the principal method of privatizing firms was the management-employee buyout (MEBO), a system that left ownership primarily in the hands of insiders. The reliance on insider-centered privatization schemes left a legacy of fragmented ownership, limited incentives to restructure, and in most cases no new infusion of capital for the enterprises. In some instances, the resulting ownership structures led to fundamental conflicts of interest. In the former Yugoslav Republic of Macedonia, inter-locking ownership between banks and enterprises is reported to lead to misuse of available credit. In the countries of the former Yugoslavia, the tradition of self-management similarly led to powerful domination by employees, an effect that persists today, making fundamental restructuring and retrenchment of the enterprises more difficult. In some cases, privatization to insiders also facilitated the nontransparent award of state assets to the well connected. The informal ties between politicians and the new enterprise owners presented the fundamental conflict of interest-politicians had an incentive to use their powers for the benefit of certain enterprises, rather than for the whole of society, whereas enterprises tended to make decisions based on political, rather than profit-maximizing, criteria. Although insider privatizations are no longer the norm in some of the countries of SEE, the legacy of past decisions lingers.

The disposition of the bloated state-owned enterprises that epitomized central planning has coincided with the emergence of new firms that have provided the engine for employment, income generation, and growth in many countries. New firms and revitalized old firms alike require financing for their activities. Although the public trading of shares of corporatized enterprises potentially provides an avenue for the largest firms to raise equity capital, such firms still require day-to-day working capital. For medium-size and small companies, financing options are even more limited, and providers of debt financing require some assurances that their funds will be repaid. Systems that support financial transparency and accountability help provide peace of mind for creditors.

At first blush, the relationship between financial transparency and performance seems straightforward: Firms with more transparent finances should have an easier time securing financing for their activities and should ultimately grow faster. Indeed, cross-country research has found that, in countries with strong, well-enforced disclosure requirements, costs of capital are lower (Hall and Leuz 2003). Across the countries of SEE this pattern also seems to hold. Two rudimentary indicators of financial transparency-the degree to which firms believe that they adhere to International Accounting Standards (IAS) and the degree to which they claim to use external audits-are useful for explaining variation in growth at the country level. As we discuss in the next section, in somePage 223 cases such perceptions may represent wishful thinking, but they nevertheless are useful for the variation in practices they reveal.


Figure 5.1 shows the average penetration of IAS and external audits, as reported by firms in each country in BEEPS2, mapped against the average gross domestic product (GDP) growth rate in each country in 2002, the same year as the survey. Of course, economic growth is complex, and no pretense is made that firms' perceptions of adherence to certain accounting and auditing practices provide the sole impetus to growth. Yet the positive partial relationship between these rudimentary indicators of reform and economic performance suggests the usefulness of this element of reform. Although the positive relationship evident in figure 5.1 is encouraging in the sense that it shows that patterns that hold in the rest of the world also hold in SEE, the chart begs further questions. Why is there so much variation in the reported levels of financial transparency across the countries of SEE? How are firms within a country rewarded for their efforts at improving financial transparency? How does financial transparency translate into improved financing opportunities for the firms themselves?

We will first discuss the forms of ownership of firms in the sample and then present the degree of transparency and accountability evident in the way the firms present their financial statements. Next, we will examine the financial modalities used by firms for their sales and purchases and the means by which they finance their activities. Finally, we will explorePage 224 the link between institutions of financial transparency and firm-level investment and growth and make some summary policy recommendations flowing from the analysis.

Forms of Ownership

One of the key features of early transition reform strategies-and one that persists today in some countries-is the privatization of state-owned enterprises. The motivation for the push toward privatization came, in part, from the desire to give the population a stake in the new system and thereby reduce the probability of backsliding on early reforms. But there was also a very real economic imperative founded on the idea that ownership matters. Specifically, private owners would be more likely than politicians to push enterprise managers to maximize profits. The politicians' motivation, for example, to maintain employment levels at all costs and to direct production toward certain buyers at submarket prices could lead to inefficiencies, soft budgets, and passive management. Privatizing state-owned assets was envisioned as a way to bring managerial incentives in line with market demands. A large body of research has confirmed that, by and large, private ownership leads to greater enterprise restructuring (Djankov and Murrell 2002).

In designing programs for the privatization of state assets, reformers were quickly confronted with conflicting goals-speed, revenue, fairness, and transparency are not all achieved by the same methods of privatization. Another goal, getting ownership into the hands of effective owners, also proved crucial. Empirical research has confirmed, for example, that concentrated ownership is associated with better firm performance (Frydman and others 1999).

As discussed in chapter 2, privatization has proceeded more slowly in SEE than elsewhere in Europe. In some cases, war (as in Bosnia and Herzegovina, Croatia, and Serbia and Montenegro) or political financial crises (as in Albania) have contributed to the slowness. In other cases (as in Romania), powerful unions have at times resisted privatization of industrial enterprises, and key enterprises remain under the control of the state.

The overall extent of privatization in SEE varies. Although it is difficult to compile an objective indicator of progress toward privatization, the European Bank for Reconstruction and Development (EBRD 2002) provides a subjective measure that helps illustrate the variations (see figure 5.2). Every country has progressed further in privatizing small...

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