Scope and Limitations

Chapter 1
Introduction
1.1. Statement of the Problem
The 1980s were considered the era of privatization and the process still is ongoing with the
involvement of more and more governments and business communities around the world. In
developed and developing countries alike, privatization is one of the most revolutionary
innovations in the recent history of economic policy.
It was recorded that, at least 83 countries selected privatization as " the introduction of
market forces in to the economy" between 1980 and 1989
1
with a view to eliminate the major
sources of the poor performance of public sector enterprises: failure to cope with the changing
business environments, lack of autonomy, tight control and intervention by government, and little
emphasis on efficiency and profitability. In such a context, privatization free from these
weaknesses has been considered an effective instrument for improving the productivity,
profitability, and dynamism of a national economy.
Since the collapse of the socialist block several Eastern European countries such as the
former Czech and Slovak Federal Republic, the Republic of Poland, the Eastern Germany of the
Federal Republic of Germany have been committed to privatization not only for improving
efficiency reasons but also for ideological and social reasons. However, the ultimate objective of
the governments of Eastern Europe in undertaking privatization is to create a market economy. In
addition, by undertaking privatization they are seeking:
• the reduction of the power of the state in exercising control and influence over
enterprises;
• the creation of a class of managers who will run enterprises as commercial business;
• the introduction of share ownership (i.e. private property ownership) among the
population at large;
• increased efficiency in the utilization of the resources of enterprises;
• revenues for the government from the sale of assets.
The question increasingly has become not only whether to privatize, but also how to
overcome or deal with the numerous difficulties associated with the process. Although considered

as the only solution to the ineffectiveness of state-owned enterprises (SOEs) in many cases, the
privatization process can expect opposition not only from workers or labor unions but also from
political, industrial and financial communities or the public at large due to a number of industrial
relations problems, such as employment, job security, dismissal and retrenchment, income,
workers status, collective bargaining, labor disputes, and participation in decision making.
The mentioned issues have more important significance for Vietnam because the country
has just come out of the years of continuous wars and a weak economy of command type. The
1
CHARLES VUYLSTEKE, 1989, Techniques of Privatization of State-Owned Enterprises, United Nations
Publication, New York.
-2-
Vietnamese economy, relying mainly on more than 7000 SOEs, is facing with the chronic
ineffectiveness of these enterprises. There have been many attempts to improve the
performance of state sector by reorganization of production and service management. A number
of policies, which are in favor of the development of private sector, have been adopted. At the
same time, there has been also a growing concern towards a privatization program in Vietnam as
the country now is strongly committed to a free-market economy and the total integration to the
rest of the world. Several privatization projects were planned and implemented. None, however,
has been completely successful due to different reasons and obstacles such as: the
disagreements over the concept of privatization, the debates on implementation methods, and
the lack of necessary conditions for privatization (current status of accounting, legal
infrastructure, stock exchange, foreign investors' trading rights of shares bought, etc.).
1.2. Objectives
The objectives of this research are to give an overview on the major issues and problems
associated with the performance of public enterprises in Vietnam, related government policies
and administrative procedures, and, to anticipate future trends with a view to assess the
prospects of privatization in Vietnam. The specific objectives are to:
1) Summarize and introduce lessons on theoretical and practical issues in privatization in
several developing countries such as the former socialist countries in Eastern Europe
and Russia, Malaysia, Thailand, and Singapore. The major issues to be concerned with

are:
• rationale for privatization,
• the governments' policies,
• conditions for privatization (legal issues, market conditions),
• barriers to privatization,
• types of privatization,
• alternative strategies for improving the performance of SOEs
2) Provide an overview of the performance of state enterprise sector in Vietnam.
3) Assess the conditions for privatization options in Vietnam with regard to the lessons
abroad.
4) Discuss the prospects of privatization in Vietnam in the future.
5) Present conclusions and recommendations
1.3. Scope and Limitations
The number of studies on privatization in Vietnam has been very limited so far. The reasons
are the political regulations which reflect some skeptical thinking on the positive effect of
privatization at least in this development stage of the country and, the bureaucracy of the
administrative system. The most challenging reason is the newness of privatization and its
political and social aspects, which make it difficult for respondents or interviewees to give the
right answers or opinions on the issues in consideration.
-3-
The lack of reliable statistical data of economic development is another obstacle for the
research. As Vietnam is starting to build up a market economy, it is well understood that
accounting systems employed under the former planning mechanisms are unsatisfactory, in that
they do not give a reliable picture of enterprise financial positions.
Given the limitation of time and geographically separated location of Vietnam' major
development centers (Hanoi - Hai Phong - Ha Long and Ho Chi Minh City - Bien Hoa - Vung Tau),
the research will focus on state enterprises in the area of Hanoi. Although not considered the
economic capital of the country at present, Hanoi is the right place for the research in that it is the
capital of development policies and a large number of SOEs of different industries is located
there. The biggest industrial enterprises in Hanoi along with other enterprises in the northern

growth triangle Hanoi - Hai Phong - Ha Long are expected to form the backbone of heavy
industries of Vietnam in future. The results of the research, therefore, will have its importance for
the privatization in the whole of the country.
1.4. Research Methodology
The research framework is presented on Figure 1.1. It consists of the following
determinants:
1.4.1. Literature review
The review involves related literature published abroad as well as in Vietnam. Information
will be collected from UN publications, journals, newspapers as well as reports of government
and related ministries, organizations and firms in Vietnam.

1.4.2. Field research in Vietnam
• Objectives
On the basic of experience abroad, especially, the initial achievements of privatization in
Czech and Slovak Federal Republic, East Germany, Hungary, Poland and Thailand, the field
research in Vietnam will concentrate on the following issues:
-4-
CRITICAL ISSUES OF PRIVATIZATION
LITERATURE REVIEW
FIELD
RESEARCH
IN
VIETNAM
SITUATION ABROAD
ANALYSIS AND DISCUSSIONS
CONCLUSIONS AND
RECOMMENDATIONS
FURTHER RESEARCH
RECOMMENDATIONS
SITUATION IN VIETNAM

RESEARCH FRAMEWORK

Figure 1.1: Research Methodology Framework
-5-
• Policy options for the state enterprise sector
• Alternative strategies to privatization
• Criteria for selecting candidates for privatization
• Conditions/barriers for privatization
• Privatization planning and implementing
• Methodology of the Field Research
The field research in Vietnam is the centerpiece of this research study. The mentioned
situation suggests the objectives of the field research can be achieved based on qualitative
analysis of the data as received from interview and literature review.
Direct Interview
As much as possible officials, managers and experts at all levels of management were
tried for the interview as permitted by the time given to this research.
Indirect Interview
With a target number of 100 responses , the questionnaire was developed along the stated
objectives of the survey and mailed to selected respondents from a list of organizations and firms
in Vietnam (see Appendix A).
The questionnaire (see Appendix B) consists of 13 different topics concerning:
• Measures for improving the efficiency of SOEs;
• Option for dealing with the ineffectiveness of SOEs;
• Recognition of the ineffectiveness SOEs;
• Barriers to analyzing state enterprises' performance;
• State enterprises, privatization and corruption;
• Measures for fighting corruption;
• Benefits of privatization;
• Major barriers to privatization in Vietnam;

• Legal preconditions for privatization;
• Administrative body;
• Management team of privatization;
• Criteria for selection of privatization candidates;
• Preparatory measures for privatization;
Each topic (question) consists of a number of sub-questions, each of which offers the
respondents an opportunity to share their experiences and opinions regarding all aspects of the
mentioned issues.
To ensure the respondents' freedom for selecting the most suitable answer, questions of
importance-scale type were designed and anonymous answers were accepted. Possible answers
for each question range from the least support level to the highest support level, namely SD:
strongly disagree, DA: disagree , U: undecided or uncertain, A: agree, and, SA: strongly agree;
the scores of which are 1, 2, 3, 4, 5 respectively. The responses to each question are evaluated
on the basis of both score mean and the ratio of the support, opposition, or uncertainty.
-6-
1.4.3. Data Analysis and Discussion
On the basis of collected information from the field research, analysis will be made to
summarize the opinions of respondents on the issues in consideration and identify the
differences between the situations in Vietnam and abroad which deal with the privatization of
state owned enterprises. The purpose of the analysis is to combine suitable experience abroad
into specific context of Vietnam in order to describe prospects of privatization as a solution for
improving efficiency of state enterprises in Vietnam. The next step is to make recommendations
and suggestions for further research in this field of economic policy.
1.5. Organization of the Report
The report includes 5 chapters the contents of which are as follows:
Chapter I introduces the statement of the problem , objectives, scope and limitations as
well as the research methodology and the organization of the final report for the research study.
Chapter II contains the literature review of the most critical issues of privatization in and
outside Vietnam. The objectives of the literature review, as already mentioned, is to provide
theoretical and practical basis of privatization which are needed for this research study.

Chapter III highlights the salient features of Vietnam, the overall economic performance of
the country, especially, the performance of state-owned enterprises. The chapter also describes
policies and measures which have been adopted and applied so far by the government of
Vietnam in dealing with the ineffectiveness of state sector enterprises.
Chapter IV introduces the process of undertaking the survey in Vietnam and its results.
The chapter also presents the analysis of collected information from the survey and discussion.
Chapter V introduces the conclusions drawn from the research study and
recommendations for accelerating the privatization process of SOEs in Vietnam , and,
suggestions and recommendations for further research in this field.
References and appendices included in the report offer readers opportunites for a better
understanding of the material presented in the previous chapters of the report.
-7-
Chapter 2
Literature Review
2.1. Why Privatize?
2.1.1. Definition of Privatization
Privatization as defined by the United Nations is the process of "transferring the ownership
of the business or assets of state-owned enterprises to private sector", [UN. ECE, 1992]
2
. The
transfer of ownership from the public sector to the private sector could take place wholly or
partially. The Organization for Economic Cooperation and Development (OECD) regards
privatization as part of the process of regulating, where deregulation includes "the removal or
reduction of direct regulations governing entry to the sector, the type of products/services that
can be offered, pricing and exposure to competition. Deregulation can also mean limiting the
administrative burden of complying with statutory controls and regulations".
Privatization does not, of course, requires a majority stake to be held by any private owner
or group of owners. The state could even retain a majority stake, or some form of "golden
share" allowing it to control subsequent ownership transfer if it relinquishes effective
management control to one or more private owners [Hans J. Blommestein, 1993]. The state

could also retain the power to regulate certain, limited aspects of the firm's activity.
2.1.2. Rationale for Privatization
Salvatore Zecchini, the Director of OECD Centre for Cooperation with European Economies
in Transition (CCEET), 1993
3
, noted that privatization can serve multiple objectives, which can
be divided into five main categories: systemic, macroeconomic, sectorial (microeconomic),
political and social.
Systemic Objectives
• to create competition among enterprises in the market place
• to promote entrepreneurship and risk taking in economic activities
• to spur innovation in production and management
• to favor the development of new managerial class who is strongly committed to
achieving cost efficiency
Macroeconomic Objectives
In undertaking privatization governments are seeking:
2
UNITED NATIONS PUBLICATION, 1992, Legal Aspects of Privatization in Industry, Economic Commission for
Europe (ECE),Geneva.
3
SALVATORE ZECCHINI, 1993, Methods of Privatizing Large Enterprises, p 79, UN OECD, Paris
-8-
• solutions to the major macroeconomic imbalances ( external currents accounts deficits,
public budget deficits and inflation)
• draining the excess liquidity which was accumulated in the household and enterprises
• freeing the public budget from the responsibility of subsidizing a vast array of loss-
making enterprises
Sectorial Objectives
• to a more flexible use of labor and reallocation of labor forces
• liquidation of unviable firms and reallocation of their capital assets to other enterprises

• instrument for mobilizing capital and labor alike according to markets signals
• restructuring large monopolies by splitting them up in units or enterprises that would
compete each other
• import superior foreign know-how, management skills, foreign capital and new market
opportunities
• mean to retire foreign debts or can swap directly domestic equity against foreign debt
Political and Social Goals
• to terminate command-type economic and political system by curtailing or eliminating
the possibility of direct state intervention and interference into enterprises' management
• to deprive political parties of the base for active support, including financing which state
enterprises often represent
• to make redundant the large state bureaucracy
2.2. What to Privatize?
The choice of what to privatize or not, is a political issue in which economic considerations
are equally important as political and social ones. In the light of the economic objectives,
Governments should draw a few domain criteria for selection:
• First, governments should aim at improving the structure of domestic markets not
only by lowering barriers to entry but by actively favouring the proliferation of enterprises so as to
generate the maximum of competition in the market-place. The focus of privatization, therefore,
should be establishing proper market conditions by breaking up monopolies, splitting up huge
conglomerates in order to foster the emergence of viable units, expanding capital and labor
markets while making them more flexible, and eliminating an oppressive regulatory environment
which includes control prices, high taxes on firms and unwarranted restrictions etc.
• The second criterion to be followed is furthering the diffusion of private
entrepreneurship and good management. Both of them are less scarce than assumed but find
it difficult to manifest themselves because of the hard constraint of lack of capital or financing.
• The third criterion concerns the degree of operational difficulty that is encountered in
implementing privatization and in creating the surrounding economic conditions which can make
it successful. The absence of clarity in the legal framework, insufficient financing mechanisms,
rigidities in the use of the labor force and lack of other habitat condition can discourage demand

for public assets.
-9-
• The fourth criterion pertains to achieving the highest possible cost efficiency in the
production of public goods or services regardless whether they are marketable or not. (Salvator
Zecchini, 1993).
2.3. How to Privatize?
2.3.1. Types of Privatization
Privatization consist of a range of possibilities where progressively more aspects of
business enterprise is operated in private sector lines until and ultimately the ownership of that
enterprise totally becomes private ownership. It is possible to distinguish four types of
privatization:
• Ownership and management exclusively in the hands of the private sector
• Majority of shares held by the state and the management is divided according to the
basis of equity
• Majority of shares held by the state and the management is with the private sector
• Management of the enterprise is handled by the private sector to manage the
enterprise or the state-owned assets are to leased out to the private sector to manage
the enterprise.
Several authors [Asher, 1985; Low, 1984; Steel & Heald, 1984; Wettenhall, 1983; Wiltshire,
1987; and Thynne, 1989] used another approach to distinguish the four basic forms of
privatization, which involve changes, in whole or in part, in:
• the ownership of the organizational means, or of assets associated with those means,
by which particular functions are performed;
• the actual performance arrangements themselves, with no accompanying changes in
ownership or in sources of finance;
• the financial bases on which the performance of the functions is dependent, again with
no accompanying changes in ownership; and
• the extent to which the performance of the functions is open to competition from the
private sector organizations as a result of a deregulation and/or demonopolisation
initiative

This review is presented in Figure 2.1 . All these forms can relate to some, or all, of the
functions of either a ministerial organization, a statutory body, and/or a government company -
with the exception that, in the case of changes in ownership, a ministerial organization and a
statutory body, or those parts of these organization that are to be sold-off, have first to be
reconstituted as a government company before the transfer of ownership from the public to the
private sector can be facilitated.
2.3.2. Basic Methods of Privatization
Each from the above approaches of privatization can be implemented through a variety of
techniques which are not perfect substitutes for each other and involve different levels of
complexity. The most commonly used methods of privatization are:
-10-
• Public offering of shares
• Private sale of shares
• New private investment in an state enterprise (SOE)
• Sale of government or SOE assets
• Reorganization (or break-up) into component parts
• Management/employee buyout
• Lease and management contract
The choice of a particular method will be dictated by the objectives being sought and other
factors, and will generally be based on an evaluation of alternative methods. The search for the
approach that best meets the social and political goals of the country is often tantamount inimical
to the approach that is good for the development of the economy. Hence, " a combination of the
main approaches might be the solution that is less disadvantageous for the economy as whole,
given insufficient knowledge and experience about this process in these countries."
4
Divestiture is the most complete form of privatization, where the ownership, control and
operating authority of the organization are legally transferred to private entity
5
. Divestiture may
take place in several forms. The enterprises may be sold as ongoing business, either through a

stock sell to dispersed ownership or as a sell to one acquiring firm. Alternatively, the divestiture
may take the form of asset sales, where the business as the operating unit is broken down into
various assets, which are sold off separately.
4
SALVATORE ZECCHINI, 1993, Methods of Privatizing Large Enterprises, p 79, UN OECD, Paris.
5
H. RICKE, Telecommunication Journal, Vol. 58, pp. 711-715, March 1991
-11-
PRIVATE SECTOR
PERFORMANCE
- contracting-out
- leasing
- agency,franchising &
licensing agreements
PRIVATE SECTOR
FINANCING
- charging
- individual, group or
company backing
PRIVATE SECTOR
COMPETITION
- deregulation
- demonopolosation
PRIVATE SECTOR
OWNERSHIP
- employees
- members of the public
- companies
Figure 2.1
:

ORGANIZATIONS AND PRIVATIZATION:
A FRAMEWORK FOR ANALYSIS
ORGANIZATION
TYPES
FORMS OF
PRIVATIZATION
A MINISTERIAL
ORGANIZATION
(ministry, depatrment,
or intra-ministry/
intra-departmental agency)
- all (or main) functions
- only some functions
A STATUTORY BODY
(board, corporation,
commission, etc)
- all (or main) functions
- only some functions
A GOVERNMENT COMPANY
(wholly owned by a
government, statutory body,
or another government
company; or owned to the
extent that a government,
statutory body, or another
government company has the
dominant controlling interest)
- all (or main) functions
- only some functions
-12-

Source: Adapted from "Privatization: Singapore's experience in Perspective" by IAN THYNNE
and
MOHAMED ARRIF, Longman, Singapore, 1989.
Public Offering of Shares
This method, also called "public offer for sale", involves the sale of shares to the general
public fully or partially. In this case the price of shares is normally fixed. The main advantages of
public offerings are that they permit widespread shareholding, allow the broader resources of the
general investing public to be targeted, and are normally characterized by the openness and
transparency. For the above reasons, they are often also politically palatable.
The sale of shares can be in two forms: (a) - Stock exchange listing or (b) - Over the
counter" offer. If the Stock Exchange exists, the common practice would be to list the shares on
the Exchange as this will make it easier for investor to subsequently buy and sell shares. In the
early stages of privatization as in most countries of central and eastern Europe, a Stock
Exchange may not be fully operational, therefore, the sale may be implemented through the
branch network of a bank or a similar organization.
There are, however, requirements for this approach:
• The enterprise should be a sizable going concern with a reasonable earning record or
potential, or that it can be readied to become so.
• A full body of financial. management and other information is available or can be
prepared for disclosure to the investing market.
• There is a discernible liquidity in the local market.
• Either the equity markets are developed or there is some structured mechanisms
(including a regulatory body) that can be made to function to reach, inform and attract
(as well as protect) the general investing public.
Private Sale of Shares (Full or Partial)
This method allows the state to sell all or part of its shareholding in a wholly or partly owned
SOE to a pre identified single purchaser or a group of purchasers. The trade purchaser is a
company in similar line of business to the enterprise to be privatized, or a consortium.
Two common ways are full competitive process, with pre qualification of bidders, and direct
negotiation, with ad-hoc procedures for identifying potential buyers (often involving a wide

investors search).
There are a number of advantages under this method of privatization:
• The flexibility of private sales are the preferred method with weak performing SOEs or
SOEs in need of strong owners who has relevant industrial, financial, commercial and
other experience and a high financial stake in the success of the firm.
• It is considered the only feasible alternative in the absence of developed equity markets,
where no mechanisms can be developed for reaching the general investing public, and
where the size of the enterprise may not justify a public offering.
-13-
• Another principal advantage of a private sale of shares is that the prospective owner is
known in advance and can be evaluated, and may be selected based on ability to bring
a number of benefits such as management, technology, market access and the like.
• In some cases, a partial sale may be a necessary first step to full privatization as it
brings in a leveraged party who is able to turn the company around so that it become
attractive to investors.
• The private sale is, of course, much simpler in terms of disclosure and other legal
requirement, than is a public offering.
A disadvantage of any private sale (of shares as well as of assets) is that it may give rise to
criticism as to the selection of the acquiring party, particularly if a large number of transactions
are so concluded giving rise to inadequate spread of wealth in the country. In such a context,
strict mandatory procedures are required to compensate this effect.
Sale of Government or Enterprise Assets
A government may sell assets directly, the SOEs may dispose of major assets. The assets
may be sold individually or be sold together as a new corporate entity. The sale of assets can be
based on open competitive bidding or carried out by auction.
Because a sale of assets involves a known party it may have the same advantaged as
direct sale of shares. It offers the additional flexibility in that it may be more feasible to sell
individual assets than the whole SOE or it may permit the sale of a SOE that might be extremely
difficult to sell as a going concern. In many cases of SOE that are not saleable as going
concerns, the sale of assets is the preferred method, if not the only alternative. This method is

possible because the enterprise' products and assets may be of relevance to a buyer in the
private sector.
Reorganization into Operational Units (or Fragmentation)
This technique can be regarded simply as a form of restructuring prior to privatization.
However, since it is found to be a distinct action with many application in developing countries, it
is dealt with as a separate form of privatization. The method involves the breaking up or
reorganization of an SOE into several separate entities or into a holding company and several
subsidiaries. This method permits piecemeal privatization. It further permits different methods of
privatization to be applied to different component parts, there by, possibly maximizing the overall
process. The method is a preffered one,
• if an SOE incorporates too many activities that, in aggregate, are not attractive to
potential investors, whereas individual units would be.
• If an SOE is a monopoly, the government would like to split it into separate enterprises
to create competition.
New Private Investment in SOE
The government may wish to add more capital to an SOE (mostly for rehabilitation and for
expansion) and achieve this by a capital increase opening equity ownership to the private sector.
The main characteristic of such a privatization method is that the state is not disposing of any of
its existing equity in the SOE. Rather, it increases the equity and causes a dilution of the
-14-
government' equity problem. As a result, there will be the joint private/government ownership of
the enterprise which is often referred to as joint venture).
In a large number of instances, the state has brought in the assets of an SOE ( with or
without accompanying liabilities) as a contribution in kind to the capital of a new corporation,
while new private investor' cash contribution to the capital of the new corporation will permit
necessary rehabilitation, restoration of working capital, or an expansion of the operations.
This method is a preferred one for dealing with funding problems of under-capitalized
enterprises which are in need of additional capital, e.g., to increased its capacities or for
rehabilitation. It may be advantageous in certain countries to handover the management totally
even with majority shares owned by the state. There are arguments and evidence to believe that

after privatization if the private sector owns the majority shares it will not help much to improve
the efficiency of the enterprise. Majority shareholder namely, the state is still having the control
and influence over the management of the enterprise. As the main objective of privatization is to
improve the efficiency, it is important to consider handing over the management to the private
sector even if state owns majority of shares.In addition it should be considered when the sudden
sale of government holding in several SOEs may be politically difficult to authorized and carry
through, in that the transformation of an enterprises into a joint stock corporation with very limited
private participation may be popular. Government are likely to favor joint ventures with foreign
companies so as to gain management and other expertise in addition to capital. In some
circumstances, this privatization method may be applied to strengthen SOEs, which the
government intends to keep in the state portfolio.
Management/Employee Buy-out
Management/Employee buy-out is used to describe the acquisition of a controlling
shareholding in a company by a small group of managers/employees. The leveraged
management/employee buy-out involves the use of credit to finance the acquisition, with the
assets of the acquired company generally used as securities.
Lance Blackstone and David Franckce (1987) explained :
6

" the special characteristic of the financing arrangements for management buy-out is that
the financiers provide the bulk of the funds but take a disproportionately small proportion of
equity; on the other hand, the buy-out team obtains a large share of the equity but provides
a small proportion of the funding. High gearing ratios, where borrowings can be initially as
much as five times the amount of share capital in the company, are not unusual and in
some cases may even be higher than this. In such cases it is naturally important that the
projected cash flow is sufficient to allow for the payment of large sums of interest and
capital repayments without placing the viability of the business in jeopardy."
Employee buy-out requires extensive programs to inform and educate workers as to the
benefits, and most employee buy-outs are management-led transactions. It also requires the
presence of competent and skilled management and a committed and stable workforce.

6
LANCE BLACKSTONE and DAVID FRANCKC, 1986-1987, Guide to Management Buy-Outs
-15-
Management/employee buy-outs are a relevant means of transferring ownership to
management and employees with little wealth or knowledge of share ownership and may be a
solution for SOEs not otherwise saleable. The most important advantages of this method are:
• constitution of enormous incentives to productivity
• a solution to the employment issues where the alternative is liquidation
• minimizing lay-off and the substantial costs of closing an SOEs
• under this method, employee may more easily accept wage reductions on account of
needed restructuring
This method is supported by the following forms of financing instrument
• acceptance of payment terms by the government vendor
• direct bank financing
Leases and Management Contracts
Arrangements whereby private sector management, technology and/or skills are provided
under contract to an SOE or in respect of state-owned assets for an agreed period and
compensation. Several common points to be noticed regarding this form of privatization are:
• Normally, there are no transfer of ownership and, therefore, no divestiture of state
assets.
• This method can be used to "privatize" management and operations
• The method possibly increases the efficiency and effective use of state assets
• It is considered an important and effective non-sale form of privatization
Lease
Private operator leases assets or facilities owned by the state and use them to conduct
business on its account. The operator of the lease
• assumes full commercial risk for operating the asset
• is obliged to maintain and repair the asset
• hires its personnel
• has full control over the operation of the assets

Management Contract
Contract management is the transfer of the operating responsibility of a government'
operation, without transferring the legal title and ownership. These arrangements are usually for
the fixed period of time. (H. Ricke, 1991). Typically a firm with technical expertise will enter into a
contract to provide management services, while using the existing facilities, capital, asset and
personnel of the enterprises.
Management contractors assumes responsibility to manage the enterprise for
compensation. They are given full management control and the authority to manage and are paid
by the government for their management or other skills. They have no financial exposure and
receive its fee regardless of the profitability of the enterprise. Under management contract, SOE
-16-
continues to bear the full commercial risk and is responsible for all working capital and debt
financing.
There are, however, some advantages for the government and SOEs being privatized in
this method. They are:
• Ownership is retained in the hands of the government;
• A defined degree of control is maintained;
• High level of management and other skills is injected into the SOE, enhancing its overall
efficiency and profitability.
According to experience in many countries this form of privatization is the principal method
of privatizing an activity in situations where privatization of the ownership of the assets or SOE is
not appropriate.
2.4. Required Conditions and Barriers to Privatization
Privatization of state owned enterprises carried out like "garage sale" and with the wrong
reasons, under wrong conditions and in the wrong ways would reduce the public's confidence. If
it is done as the process of an integral part of the coherent strategy it could stimulate private
enterprises with benefits for consumers and the economy as a whole. (Donald Roth, 1993)
2.4.1. The Government's Commitment and Policy
The most important pre-condition for successful privatization is the commitment of the
government which should be reflected by transparent and consistent policies. The

commitment to private sector development in general and to privatization in particular is the key
requirement for any government who want to promote a market economy. The commitment of
the government is to ensure political stability, favorable economic policy for private enterprises,
nonpolitical interference, growth potential of the national economy and depth of the local capital
market. Donald Roth (1993) noted: "Evidence has shown that political will and political
decisiveness alone have not supported attaintment of long term capital investment and
successful privatization".
Political Aspect of The Privatization Process
Economic, financial, and technical analyses alone are inadequate to explain the direction
and outcome of these privatization decisions. Although privatization often begins with a plan
based on sound economic, technical or financial principles, it may not end that way, and politics
explains much of which happens in between. Without adequate involvement from the beginning
by the responsible government agencies, the projects are often hastily launched and quickly
become politicized.
"An adverse climate of government regulation may make privatization impossible or
unattractive. Price controls or other forms of government control may make it impossible for
the private sector to run enterprises profitably". (M. A. Ayub, 1987)
-17-
Institutional System of Privatization
According to experience in many countries, in order to co-ordinate the process of
privatization, it is advisable that privatization is supervised by the government For this purpose,
the government will establish new administrative institutions to be responsible for executing the
privatization program or will entrust this task to a department within its own administration.
De-Monopolization and the Creation of the Competitive Economic Environment
P.R Ligal (1992) pointed out:
"Ensuring a competitive environment is more important than changing ownership. It is the
value of the future stream of net earnings rather than the book value of the assets that one
should consider in privatization which depends heavily on the broader economic context
within which it will be carried out. The first task therefore must be to ensure that companies
are being privatized in an environment conducive to the business".

Under central planning, economies became highly monopolized, with concentration ratios,
and average size of firms considerably higher than in western industrial economies. Because of
the uncertainties caused by central planning, many enterprises had to internalize within their
company a number of functions that normally would have been the task of outside suppliers. The
privatization of these monopolies may have to be preceded by their de-monopolization in order to
prevent the newly privatized firm from exploiting its monopoly position. There are several
approaches for demonopolizing these enterprises such as breaking them up, making competition
more effective, etc.
Enterprise Restructuring
It is to put the enterprises onto a sounder footing before facing the realities of a market
economy, and has two aspects: physical restructuring of productive capacity; and financial
restructuring that is removing debts which, carried through into the private sector, would render
the new firms financially insolvent. The state and private sectors should together decide on how
the task of restructuring might be shared.
2.4.2. Capital Market
The lack of well developed capital markets is often taken to be one of serious constraints on
the large-scale, rapid divestiture of enterprises in Eastern Europe and in Asian developing
countries. The savings of the population appear to be insufficient to buy more than a fraction of
the existing capital stock. Often the potential buyers may not have enough money to buy the
assets on offer. They may wish to borrow the required funds but it is impossible for them to do so
because, in all of these countries the banking systems are weak and underdeveloped, and so are
their stock exchanges.
The administrative tasks of valuing and selling a enterprise are made more complex by a
general lack of competitive bidders and a failure to price the assets properly can lead to
accusation of corruption and favoritism. There are few of the specialized financial intermediaries
which can assist in advising enterprises on privatization. In several countries, yet again, the huge
size of the public sector implies that any attempt to sell its assets may dry up the financial
-18-
markets, leaving other firms short of funds to finance their investment projects. Therefore, it is
required that governments in these countries to take the view that the privatization program itself

should become the mechanism for the quick development of capital markets, and in particular,
securities markets.
2.4.3. Public Support and Social Obstacles
There are social obstacles in privatizing public assets or promoting private sector
participation such as in the field of labor relations and employment which were identified as being
critical to workers:(1) - loss of jobs due to cuts motivated by reorganization; (2) - preservation of
benefits already won; and (3) - concern on whether or not to be rehired by the new organization.

The fear of job losses and unemployment is a serious potential obstacle because there
is a fact that most SOEs are overstaffed and privatization will lead to redundancy. Robert Poole
(1992)
7
presented some methods used in the United States to deal with this problem. They are:
• Contractor preference requirement. The state can require that the company or
companies taking over give first preference in hiring to the displaced government
workers.
• Phased-in privatization. Another option is to implement privatization gradually, usually
on geographical district basis. Public employees displaced buy the first privatization can
be transferred to other not yet privatized district.
• Workers enterprises. Government employees in an enterprise slated for privatization
should always be given the option of forming a companies and bidding for the contract
in competition with the other bidders.
• Finally, whenever possible it is wise to give affected parties a stake in privatization. the
compensation of agency administrators can be based on achievement of maximum
level of performance per unit of money spent instead of on the size of the agency (as
measured in money and numbers of employees).
Another public concern is the possibility of corruption in privatization when choosing private
sector party to take over the SOE, or negotiating the valuation of the enterprise. The solution is to
have clear-cut, open bidding procedures and written, objective selection criteria and to make sure
they are followed. The problem of corruption is much less serious when privatization takes form

of "load shedding", whereby the state simply decides to cease provision of a particular service in
favor of leaving it to the market place.
2.4.4. Regulatory Problems and Legal Conditions
In order for privatization to be possible and successful legislative reform must be
researched, drafted, and enacted. Privatization are generally long term projects and are unlikely
to attract correct types unless they have the security of knowing that there would not be arbitrary
changes in the government policy. Legislation that poses a threat to security of tenure could
prohibit privatization. Legal infrastructure supporting and facilitating the process should be
established. Several laws such as company law, law on competition, etc. are to be worked out
and adjusted to cope with changes.
7
ROBERT POOLE, 1992, Political Obstacles to Privatization
-19-
Before privatization, the government officials who write the rules must understand the
conflicts between the goals of privatization. If primary goal is to attract enough capital to build the
infrastructure, then regulations must emphasize profitability over competition, consumer
protection or the achievement of the public policy aims. If the goal is to make public policy
elements more efficient, the regulator might want to introduce competition or set the pricing rules
so the utility earn more money if it cuts costs while still maintaining service standards. (Leonard
S. Hyman,1993)
Governments having the little experience with utility regulation need to be sensitive about
what can go wrong with the process. They can lose sight of the difference between form and
substance. If the host country develops a reputation for the inconsistency, investors will hesitate
to put more money there, and even may withdraw funds already there. Admittedly, a host country
sometimes strikes a poor deal for itself in setting the rules. However host government may wan
to consider that if it reneges on a deal after luring investors with an attractive arrangement, future
investors may stay away for fear they, too, could lose. to reiterate, countries unused to
regulation or long term planning have to understand one simple fact: they cannot privatize the
utility sector until rules are in place. (Apt Journal, Editorial, 1992, September)
2.5. Critical Issues of Privatization

2.5.1. Financial and Accounting Aspects of Privatization
Key Financial Decisions
Privatization requires that a number of key financial decisions be made by a government
both before and, in some cases, after a privatization initiative has been taken. As already well
known, privatization can take place in several forms, therefore, financial decision-making usually
have direct bearing on the extent, scope, and appropriate form of change in individual cases. The
key financial decisions and forms of privatization are presented in Figure 2.2 and explained
below.
• The Market Value for Private Performance (e.g., Contracting-Out) Arrangements
The first main form of privatization concerns the private sector performance of particular
public functions in accordance with service standards and fees established and paid by the
government organizations responsible for those functions. The examples of these are refuse
collection, public housing estates, etc.
Under such arrangements, the financial decisions that need to be made within government
involve the determination of market rates for these services.
•
The Fair Price for a Privately Financed (User-Paid) Service
In the case the government decides that users should pay for various services which
traditionally have been provided free of charge or for a nominal fee like the imposition of
economic fees for services provide by a state hospital, the decision here is one of determining
the appropriate levels of the fees.
-20-
•
The Rate of Return Target in Respect of Regulated Enterprises
(e.g., Natural Monopolies)
The third form of privatization, the deregulation and/or demonopolisation of public functions
that have been regulated and performed by state-run (natural) monopolies, requires reasonable
rates of return criteria to be consistent with the idea of economic profit. Guidelines for the making
of theses decisions will be cost of capital and rate of return theories in finance and accounting.
•

The Value or Worth of Divestible Assets
When privatization is the actual divestment of ownership of productive assets to private
individuals and corporations, the finical decision here include decisions as to the extent of private
ownership, and decision on the price for the transfer of that ownership.
2.5.1.2 The Process of Valuation
The process of valuation of an enterprise proposed for privatization can be presented
diagrammatically as shown in Figure 2.3.
First, the cash flows which the target organization could well generate in the future need to
be assessed on the basis of analyzing the financial performance of that organization in relation to
other firms in the same industry. The second step is the estimation of the relative riskiness of the
cash flows. This is done by a process of establishing the risk-free rate of return an adding to that
a risk premium rate - that is, R
f
+ risk premium = capitalization rate. Judging the risk premium
can be made by comparing the target organization with an enterprise (or enterprises) that is (are)
broadly similar in operational complexity and product market. The fair value is then derived by
discounting the benefit cash flows by the capitalization rate.
-21-
Ministerial
Organization
Statutory
Body
Goverment
Company
Private
performance
Private financing
Private competition/
deregulation
Private ownership

Decision on market value
for services rendered
Decision on economic
fee for service provided
Financial targeting
of rate of return
Valuation of assets at
the time of divestment
Figure 2.2: KEY FINANCIAL DECISIONS AND FORMS OF PRIVATIZATION
ORGANIZATION
TYPES
FORMS OF
PRIVATIZATION
FINANCIAL
DECISIONS
Source: Adapted from "Privatization: Singapore's experience in Perspective" by IAN THYNNE
and
MOHAMED ARRIF, Longman, Singapore, 1989.
•
Net Tangible Assets Methods
The fair value or price of the assets of an enterprise is estimated by first calculating the net
tangible asset per share, and then determining the market price of the assets in relation to the
prices of similar enterprises already operating in the market. The net tangible asset (NTA) per
share is:

Step 1: Total assets
- current liabilities
- long-term debit
- value of intangibles or goodwill
- assets to be written off

+ revaluation of assets
= Net tangible assets (NTA)
Step 2: NTA / number of shares = NTA per share
•
Price-Earnings Multiplier Methods
The price-earning multiple or ratio can be calculated from accounting records just as the
NTA can be. The earnings per share are calculated by estimating expected normal profits after
-22-
tax or by taking the current actual profit after tax, and then dividing the earnings figures by the
number of outstanding shares. This number (EPS) is then compared with the actual market price
of an enterprise similar to the organization in consideration. If the price-to-earning ratios of
comparable enterprises are known, one can convert the EPS of the target organization to an
estimate of the fair price of that organization' s shares as:
Price of share = P/E * EPS
The going price thus calculated can be taken as a guide to decide on the value of the target
organization for the purposes of divestment. This P/E method and the NTA method outlined
above rest on the reliability of the estimates of accounting-related numbers for NTA and EPS, as
well as on the condition of the capital market at the time of divestment.
•
Dividend Valuation Method
The third method of valuation is partly based on accounting records and partly rests on a
theory of valuation suggested by William (1938), which was subsequently expanded by Gordon
Shepiro (1956). The theory states that the price of a share (common stock) of an enterprise is the
present value of the future expected dividends of the enterprise discounted at a capitalization rate
appropriate for that enterprise. Therefore, the price of each of its shares is:
Price of share (P
o
) = D
i
/k

Figure 2.3: BASIC ELEMENTS OF THE VALUATION
Determine
the future
tangible
cash flows
(benefits)
Estimate
risk
premium
and risk
free rate
(RF)
Capitalise
cash
flows
Estimate
value
Source: Adapted from "Privatization: Singapore's experience in Perspective" by IAN THYNNE
and
MOHAMED ARRIF, Longman, Singapore, 1989.
where
P
o
: The current price of a share and, thus, the market value of that share
-23-
k : The capitalization rate, which equals the risk-free return plus risk premium
D
i
: Dividend in the year i

It may be assumed that an enterprises will declare either a finite number of same dividend
amounts or simply a finite number of dividends, which are expected to grow over the years at a
g-rate of growth. Under such conditions, the constant dividend model is:

Po
D
(1 k)
D
(1 k)
D
(1 k)
1
1
2
2
n
n
=
+
+
+
+ +
+
L
(1)

Po
( )
( )
( ) ( )

=
+
+
+
+
+
+ +
+
+
D g
k
D g
(1 k)
D g
(1 k)
0 1
2
n
n
n
1
1
1 1
1
1
2
L
(2)
This equation suggests that the market price of an organization targeted for divestment
may be found by estimating likely future dividends on the basis of the behavior of similar firms in

the market and by discounting the dividend cash flows at an appropriate capitalization rate. The
dividends figures can be calculated by first determining the EPS, and then estimating the likely
dividends based on the declared practice of the enterprise or on the basis of a likely dividend
policy.
There are two ways to estimate the capitalization rate. One method is based on the finding
of the average rate of return on shares of similar firms in the market. An alternative method is to
use an earning rather than a dividend stream model. The discount for the earnings is the average
cost of capital, which is :


K
(K )Debt
Assets
(K )Equity
Assets
a
d e
= +
where, K
a
is the average cost of capital taken over a recent time period
K
d
is the average cost of borrowing by the target enterprise
K
c
is the average rate of return on equity of similar enterprises
(as the enterprise in consideration will not have this figure)
The three methods of valuation presented above use data from the accounting records of target
organizations and comparable enterprises, plus relevant market data, in a careful step-by-step

process of determining the value of marketable shares. The valuation is conducted by a third
party who collects a fee for the professional service of valuation and who operates at arms
length from the target organization. This third party arrangement is a common practice in
Singapore and many other countries.
2.5.2. Legal Aspects of Privatization
Privatization requires a sound legal framework to be successful. The legal system of the
state concerned, especially the countries which are moving fro the centrally planned economy to
the market oriented economy, must be modified to facilitate such change and to allow individual
-24-
or corporate ownership whilst at the same time providing an environment inspiring confidence in
potential investors, both domestic and foreign.
The process of establishing such a legal framework involves filling the gaps in existing
legislation by the way of modification, introducing new laws where there are no existing provision,
and necessitating not only the introduction of a new framework but also removal of the existing
one by rescinding old laws. [UN. ECE, 1992]
8
. There are two stages for accomplishment of this
task, the first stage of which is the enactment of laws, and, the second one involves training
people to implement and interpret the new laws and to work in the newly created institutions.
Property Laws
Clearly defined property rights are the central to the operation of any market economy, and
are an essential precondition of privatization. Property Laws, first of all concerns guaranteeing
private property and committing the state to provide fair compensation for any assets that may
have to be nationalized in the future. The law relating to Real Property will need to address the
following questions and issues:
• What types of interest may be held by businesses and/or individuals- Leasehold or
Freehold?
• Whether companies and/or individuals are to be allowed to hold interests in real
property?
• Can foreigners or foreign controlled companies own property and if so to what extent?

• Provision should be made for the enforcement of both positive and negative rights
between adjoining and neighboring parcels of land.
• Planning controls
• Environmental controls
• Restitution claims for the former owners.
Laws Related to Status, Establishment and Functioning of Business Organizations
This group of laws includes Company Law, related provisions for the Types of Company,
Limited Liability and Contract Law. The laws governing business organizations should consider,
among others, the following:
• Separate legal personality for business organization. This concept allows the business
organization to operate as a legal person and forms the basis for the concept of limited liability.
• Limited liability concept concerns the measure of protection is to be offered to investors
from liabilities incurred by the business organization in which they invest. A common approach is
to limit the liability of investor to the sum of their investment (fully paid up).
• Types of business organization may exist:
- companies (joint stock companies) both public and private;
- partnerships both limited and unlimited; and
- sole traders, i.e., individuals trading alone without any form of corporate structure.
8
UNITED NATIONS PUBLICATION, 1992, Legal Aspects of Privatization in Industry, ECONOMIC
COMMISSION FOR EUROPE (ECE),Geneva.
-25-
• Foreign ownership. This is to deal with whether foreigners will be permitted to own
majority stakes in companies and to avoid effective control being obtained through the use of
nominee shareholders.
• Contract Law is to help private-owned enterprises to be able to trade with each other. The
law deals with the terms of a contract, the coming into existence of the contract, possibility of a
breach when one contracting party will be unable to meet its obligations. The law also concerns
the remedies and damages for the breach of contract.
Laws Necessary to Create the Legal Environment for Privatization

This group of laws includes:
• Insolvency Law, which is necessary to deal with those businesses failing to make profits
or to pay their creditors. The law designs the way in which outstanding creditors are paid from
the pool of the remaining assets to offset the negative effects created by insolvency
• Securities Law, which is required to create the necessary legal, regulatory and
supervisory framework for establishing a market trading securities, and, protection of and
securing the interests of investors. Provisions relating to the trading of securities should include
the following:
- Period settlement for transactions
- Establishment of market makers to hold quantities of particular shares, so that there will
always be an ability to buy and sell shares.
- Rules relating to the acquisition of substantial holdings in listed companies.
- Rules relating to the avoidance of false markets in shares and prevention of insider
trading in order to maintain a fair price for shares in listed companies and to prevent
insiders from profiting from unpublished, price-sensitive information.
- Rules governing the conduct and financial soundness of those whose business involves
dealing in shares.
• Tax Law. Privatization will require an overhaul of the taxation system to clarify several
important issues such as the rates for capital allowances and depreciation and loss carry
forward. The following taxes are the ones which most touch the process of privatization and the
ones where governments of the former planned economies might wish to address as a priority:
- The corporation Tax;
- Taxation of Dividends
- Taxes on Securities Transactions
- Tax Incentives
- Enforcement of Taxation
- Use of Double Taxation Agreements
• Competition Law. As already mentioned earlier, an essential precondition for
privatization, particularly with regard to former state monopolies, are laws which promote a
healthy competitive environment and ensure that enterprises once privatized do not maintain

their monopolistic position. Therefore, it will be necessary to have a competition or anti-trust law,
against monopolies, trade restraint and restrictive business practices.