CASE Network Studies and Analyses 264 - Corporate Governance and Ownership Structure in the Transition: The Current State of Knowledge and Where to Go from Here

2 6 4
Barbara B³aszczyk, Iraj Hashi,
Alexander Radygin, Richard Woodward
Corporate Governance and Ownership Structure
in the Transition: The Current State of Knowledge
and Where to Go from Here
W a r s a w , D e c e m b e r 2 0 0 3

Materials published here have a working paper character. They can be subject to further
publication. The views and opinions expressed here reflect the author(s) point of view
and not necessarily those of the CASE.
This paper was prepared for the research project “Partnership for Corporate
Governance and Secondary Privatization in Transition”. The grant funding was provided
under the U.S. Agency for International Development SEGIR EP Contract No. PCE-I-00-
00-00014-00, reference Russia Task Order No. 803 Improvement of Economic Policy
Through Think Tank Partnership Project. The opinions, findings and conclusions or re
commendations expressed herein are those of the authors and do not necessarily reflect
the views of the U.S. Agency for International Development.
Keywords: corporate governance, privatization, enterprise restructuring, transition
economy.
© CASE – Center for Social and Economic Research, Warsaw 2003
Graphic Design: Agnieszka Natalia Bury
DTP: CeDeWu Sp. z o.o.
ISSN 1506-1701, ISBN 83-7178-320-5
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Contents
Abstract . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
1. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
2. Privatization and Enterprise Performance:
Theory and Evidence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
2.1. Ownership Concentration . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
2.2. Type of Dominant Shareholder . . . . . . . . . . . . . . . . . . . . . . . . 16
2.3. The Regulatory and Institutional Environment . . . . . . . . . . . . . 19
2.4. Methodological Issues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
3. Research Results for Three Countries . . . . . . . . . . . . . . . . . . 21
3.1. Slovenia . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22
3.2. Poland . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24
3.2.1. Companies Privatized by Management-Employee Buyouts. . . . 25
3.2.2. The National Investment Funds and their Portfolio Companies. 27
3.3. The Czech Republic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29
3.4. Endogenous Ownership Structure and Mass Privatization
in the Czech Republic and Poland . . . . . . . . . . . . . . . . . . . . . . 30
4. Conclusions and Policy Recommendations. . . . . . . . . . . . . . . 32
References. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42

Barbara B³aszczyk
Barbara B³aszczyk (born 1948) is a professor at the Institute of Economics of the
Polish Academy of Sciences. She is a co-founder and the President of the Board of
the CASE – Center for Social and Economic Research, Warsaw, Poland. Currently
she specializes in privatization, management and deregulation of the state sector.
Between 1989-1996 she was an advisor to the Polish government and the
Parliament. She is an author and co-author of numerous books and other
publications.
Iraj Hashi
Iraj Hashi (born 1946) is a professor of Economics at Staffordshire University
Business School, Stoke-on-Trent, United Kingdom. He has acted as consultant and
advisor to research institutions in Albania, Czech Republic, Kosovo, Poland, Romania
and Russia. He published many articles on enterprise restructuring, privatization,
bankruptcy, barriers to entry, and SME development.
Alexander Radygin
Alexander Radygin (born 1962) works for the Institute for the Economy in Transition
(Moscow, Russian Federation), where he is a Member of the Board and of the
Scientific Council, and the Head of the Division for Institutional Changes &
Ownership Structure. Since 1990, he has been actively involved in research and
decision making processes in Russia.
Richard Woodward
Richard Woodward (born 1967) is a member of the Council of the CASE – Center
for Social and Economic Research, Warsaw, Poland. He is also the External
Contacts Officer at CASE. He participated in numerous research projects on
privatization and restructuring of state enterprises in Poland and other post-
Communist countries.
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Studies & Analyses No. 264 – B. B³aszczyk, I. Hashi, A. Radygin, R. Woodward

Abstract
The purpose of the paper is to present the current state of knowledge on both
theoretical models and empirical evidence of interrelations between emerging corporate
governance mechanisms and ownership structure of privatized enterprises in post-
Communist countries. Section 2 contains extensive literature review on the subject. In
Section 3, the results of the research coordinated by CASE on post-privatization changes
in ownership structure of Polish, Czech and Slovenian enterprises are presented. In
Section 4, the Authors present conclusions and a few suggestions for policy makers.
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Studies & Analyses No. 264 – Corporate Governance and Ownership Structure ...

1. Introduction
Under the technological paradigm, including the neoclassical theory as propounded
by Oliver Williamson (Williamson, 1990), it is generally believed that there is no
pronounced relationship between the type of ownership and performance. Market
structure and competition are thought to be much more important for an enterprise’s
performance than differences between the asset owners. As Yarrow argues, “the
competitive and regulatory environment is more important than the question of
ownership per se. In competitive markets there is a presumption in favor of private
ownership. Where there is a natural monopoly, vigorous regulatory action is required”
(Yarrow, 1986).
For that reason, the evaluation of advantages of private firms over state-owned
enterprises has become a separate and critical issue. Defined more narrowly, it is a
question whether there is a positive relation between privatization and enterprises’
performance1. Most authors tend to answer this question in the affirmative, but
(notwithstanding ample theoretical and empirical literature) there is no consensus on that
issue yet. There are several arguments in favor of private companies:
– A social one: state-owned enterprises are a tool to remedy the faults of the market
through a price policy taking account of social marginal costs (Shapiro, Willig, 1988).
Such functions and costs have a negative impact on enterprise performance.
– A political one: political (bureaucratic) interference in the operations of an enterprise
results in excess employment, non-optimal choice of products, non-optimal allocation
and shortage of investments. These enterprises are more exposed to pressure from
interest groups at the expense of profit maximization (Shleifer, Vishny, 1994).
– A competition-based one: privatization enhances competition, which makes
enterprises operate more efficiently. Private companies are more subject to the
discipline of commercial financial markets (Kikeri et al., 1992).
– An incentive-based one: the managers of state-owned enterprises may not have the
appropriate incentives to work efficiently, or there is no adequate control over their
activities (Vickers, Yarrow, 1988).
It is conventional wisdom that privatized companies are more efficient than state-owned
ones. Even the process of preparation for privatization may in some cases (for
example, in Poland in the late 1980s and early 1990s) encourage the management to
improve productivity, as this boosts economic growth and investment. This idea has
6
1 For details see: Perevalov et al., 1999.

directly or indirectly dominated the reports of international organizations on transition
economies (EBRD, 1997; World Bank, 1996). But a closer look at the literature suggests
that privatization – any kind of privatization – in and of itself may not be sufficient to
improve company performance; that the type of privatization may matter.
In the early stages of the transformation of the majority of post-Communist
countries, various types of privatization schemes were applied in order to speed up the
privatization of the state sector and ensure social support for the privatization process. In
addition to classic commercial privatization methods “imported” from the West, these
schemes – based on the free or nearly free transfer of assets to certain segments of the
population – took the form of mass (voucher) privatization and management-employee
buyouts (MEBOs). Let us denote those schemes, which usually involved the
transformation of the ownership of a large number of companies according to some
general formula, by the term “wholesale privatization.” The common denominator was
the definition by the state (to a greater or lesser degree) of the ownership structures of
privatized enterprises, both by identifying future types of owners and, in some cases, by
determining the proportions of shares to be held by various types of owners. Additionally,
there was often a high degree of state involvement in the creation of various types of
investment funds, which became shareholders in privatized companies. As a result, in
countries where efforts were made to determine ownership structures from on high,
enterprises often found themselves with identical ownership patterns immediately
following privatization, regardless of their size, the markets in which they operated, or
other specific characteristics. For this reason, this method of privatization is often viewed
as “artificial”, unable to provide firms with “real owners” and to bring about improvement
in firms’ performance. One of the main criticisms is that wholesale privatization creates
diffuse ownership structures, which lead to poor corporate governance and the lack of
deep restructuring.
The question has therefore arisen as to what extent can wholesale privatization
accomplish the expected goals of privatization. Of course, the answer depends, among
other things, on how one defines these goals. The assumption behind privatization in
many parts of the world is that private ownership improves corporate performance. The
empirical evidence for this assumption comes from two kinds of studies. The first
compares the pre- and post-privatization financial and operating performance. A good
example is found in D’Souza and Megginson (1999). They compare the pre- and post-privatization
financial and operating performance of firms in 28 industrialized countries
that were privatized through public share offerings during the period from 1990 to 1996.
They document significant increases in profitability, output, operating efficiency, and
dividend payments, and significant decreases in leverage ratios of firms after privatization.
These findings suggest that privatization yields significant performance improvements.
7

The second strand focuses on comparing the performance of state firms with either
private (Boardman, Vining, 1989) or privatized (Pohl et al., 1997b) firms operating under
reasonably similar conditions. Additional evidence has been obtained recently by a
number of studies of post-Communist transition economies which, because of the
presence of large numbers of both state and privatized firms, have become a favorable
testing ground for the general claim that privatization leads to improvements in economic
efficiency. And if the aforementioned charges leveled against wholesale privatization are
justified, then one might suspect that this form of privatization fails to pass this test.
Another approach to this question is possible, however. One might argue that we do
not know what the characteristics of a “good” ownership structure or “good” corporate
governance system are, and that it is the flexibility of the ownership structure, and not
the structure itself, which is really crucial. In this view, it is important that the ownership
structure be able to adjust to the firm’s environment and characteristics. In other words,
rather than considering ownership structure as exogenous and given, and looking at its
impact on firm performance, we may view ownership structure as an endogenous
outcome of the behavior of value-maximizing economic agents operating in a specific
environment and subject to various constraints. This perspective could be traced back to
Coase. According to Coase, the allocation of property rights has no effect on economic
efficiency, provided they are clearly defined and there are no transaction costs, because
under such conditions people can trade their assets in order to achieve efficient
reallocations. A possible consequence of this approach could be that, in order to assess
the efficiency of a privatization strategy, we should be mainly concerned with the extent
to which the reallocation of property rights can take place.
The proponents of wholesale privatization could claim that their strategy relied on
the Coase theorem. They could argue that initial ownership structure does not matter,
and that what really matters is the agents’ ability to freely reallocate property rights.
However, the coasian result strongly depends on the availability of contracting and re-contracting
opportunities, backed by an established legal system and law enforcement. In
particular, the process of evolution of ownership structure is closely related to the ease
with which the original owners can maximize their gains by selling their shares (or claims)
to other potential buyers. Conditions of resale play a crucial role in enabling new owners
to gain ownership and control of firms by buying the claims of incumbent owners.2
Following up this argument empirically, we note that in countries where the
transformation process began relatively early, a “secondary” ownership transformation
8
2 Aghion and Blanchard (1998) implicitly take such a coasian view. They argue that while, ceteris paribus,
outsider ownership is more conducive to restructuring than insider ownership, the important point is the ease
with which the existing owners can transfer their ownership claims to others.

process has also been unfolding. (The terms “primary” and “secondary privatization”
which we use here are inspired by the analogy to primary and secondary capital markets).
Soon after the primary privatization, which was often of a very administrative nature,
many enterprises experienced changes in ownership which were influenced more by
market forces, the behavior of rational agents and newer, more sophisticated regulations.
The observation of these changes can provide us with important criteria for evaluating
the degree of maturity of the systemic transformation in those countries.
One can expect these secondary changes in ownership to occur in all privatized
enterprises since they represent an entirely normal feature of private firms in market
economies. Of particular interest, however, is the question of how these evolutionary
processes are unfolding in “schematically” privatized firms where the ownership
structure was originally set – to a greater or lesser degree – by the government. Can we
observe any general trends or patterns in these evolutionary processes, or are they varied
in different countries? Are new owners emerging in the secondary ownership
transformation process? Are firms moving towards a more concentrated ownership
structure? What factors determine the types of secondary changes? How rapid is the pace
of ownership evolution? Under what conditions is the evolution particularly rapid (e.g., in
cases of the appearance of a strategic investor)? If the pace of evolution is particularly
slow, can we identify factors inhibiting it? To what extent is state regulation or the
government itself the source of such inhibiting factors, and to what extent are other
actors – e.g., insiders – slowing the process down? Do secondary ownership
transformations lead to changes in corporate governance (changes in management style
or managerial staff) and the intensification of restructuring efforts? Do they affect the
financial performance of the companies?
A number of related questions are also of interest. One of the most important issues
is the problem of the mutual dependency of ownership concentration and structure on
the one hand and economic performance on the other. Here, we are concerned primarily
with the question of the endogeneity or exogeneity of ownership structure (i.e., is
ownership structure a factor determining economic performance, or is it determined
itself by performance and the factors which determine performance?). Another question
is the search for an efficient ownership structure and corporate governance model.
Finally, a very stubborn question concerns the role of governmental and quasi-state
institutions in secondary privatization and the influence of the state policy and residual
state property on the process.
In research conducted by the CASE Foundation (presented in Section 3), an attempt
was made to answer the above questions examining the cases of three Central European
transition countries – the Czech Republic, Poland, and Slovenia. Researchers were able
to identify the new owners emerging from the secondary privatization process in each
9

country examined, as well as to observe the trends in the evolution of ownership
structure and the degree of concentration. Moreover, they highlighted the factors behind
this evolution which lie within the regulatory environment of the companies. These
findings were based on large data sets assembled for each country and for each type of
large privatization scheme. The data sets, in turn, allowed us to assess the economic and
financial performance of companies undergoing secondary privatization. The time period
covered by these data sets, however, is too short to draw unambiguous conclusions
concerning the relationships between ownership evolution and performance.
2. Privatization and Enterprise Performance: Theory
and Evidence
Before the aforementioned research was conducted, there was already a rich body of
research in the broad area of privatization, enterprise restructuring, and corporate
governance in Central and Eastern Europe (for surveys see Carlin et al., 1995; Carlin, 1999;
Havrylyshyn, McGettigan, 1999; Nellis, 1999; Djankov, Murrell, 2002).3 However, it is very
difficult to compare or to generalize the outcomes of these studies since they used different
methodologies and samples (often non-representative) in different time periods and
countries with different environmental and regulatory conditions. However, one interesting
and surprising result of research conducted during the early phase of transition was that
privatization by itself seemed to have little influence on the adjustment and restructuring
patterns of enterprises. Whether privatized, state-owned or commercialized, the key
factors affecting the enterprise adjustment process seemed to be the degree of hardening
of budget constraints and increase in competition on product markets, and not the form of
ownership (Carlin et al., 1995). In the later stages of reform in the more advanced transition
countries (especially since 1994), a gradual differentiation in the restructuring patterns of
enterprises has been more and more visible. By 1997 there was evidence that privatization
10
3 Some studies on the countries examined in the research presented here include the following: for Poland,
a series of papers published by the Gdañsk Institute for Market Economics (D¹browski, Federowicz, Levitas,
1991, 1993; D¹browski, Federowicz, Levitas, Szomburg, 1992; D¹browski, Federowicz, Szomburg, 1992;
D¹browski, Federowicz, Kamiñski, Szomburg, 1993; Szomburg et al., 1994; D¹browski, 1996); Pinto et al.
(1993); Belka et al. (1995); Bouin (1997); Kamiñski (1997); B³aszczyk et al. (1997); Jarosz (1994), (1995), (1996),
(1997); for the Czech Republic, Mladek and Hashi (1993); Brom, Orenstein (1994); Coffee (1996); Katsoulacos,
Takla (1995); Kotrba (1995); Marcincin, Wijnbergen (1997); Matesova (1995); Mejstrik (1997); Mertlik (1997)
and Zemplinerova et al. (1995); and for Slovenia, Bohm, Korze (1994); Kanjuo-Mrcela (1997), and Simoneti,
Triska (1995).

mattered: the differences between privatized and state enterprises, measured by any
financial and economic performance indicators, were constantly increasing to the benefit of
the former (B³aszczyk et al. 1999, Pohl et al. 1997a, b). Differences between state and
privatized enterprises have emerged with respect to deep (strategic) vs. defensive
restructuring (Grosfeld, Roland, 1996). Most research has shown that the strategic
restructuring process, involving large investments and innovative technological changes, has
been possible only in privatized enterprises (especially those with foreign strategic
investors). There is also some evidence that non-privatized enterprises tend to consume
the largest part of labor productivity increases in wages while the privatized enterprises use
it for further investment (Grosfeld, Nivet, 1997).4 However, there is some controversy
about whether – and in what ways – the method of privatization used is a significant factor
differentiating the performance of privatized companies.5
A more detailed discussion of the literature on the effects of primary privatization on
enterprise performance follows below. However, we want to note here that little work
has been done on the post-privatization developments in ownership (i.e. secondary
privatization) and their impact on enterprise performance. The research summarized in
Section 3 seeks to address this gap in the literature. What did we know about secondary
privatization before embarking on that research? Literature on the beginning of
secondary privatization in the Czech Republic, largely consisting of trading of shares by
investment funds and often called the “Third Wave” (following the first and second
“waves” of the voucher privatization program), was largely limited to anecdotal evidence
(Mladek, 1996). In Poland, virtually the only research done in this area concerned the
gradual increase in concentration of shareholding in companies privatized by
management-employee buyouts (Jarosz, 1995,1996). In addition, at the time this project
was designed, too little time had elapsed since the initial privatization of many enterprises
to allow for a detailed evaluation of secondary transformations (and to some extent, this
continues to be the case in many enterprises). In the countries under consideration, the
transformation was already ten years old, and in most of the companies studied at least
five years had elapsed since privatization. This period of time was considered sufficient
for analyzing trends in the ownership changes which were underway. However, it is
questionable whether it was also sufficient to analyze the relationship between those
ownership trends and their impact on economic and financial performance. Moreover, it
11
4 For research showing positive effects of foreign investors see Smith et al. (1997), B³aszczyk et al. (1999)
and the aforementioned papers published by the Gdañsk Institute of Market Economics.
5 The difference between the conclusions of Pohl et al. (1997a, b) on the one hand and B³aszczyk et al.
(1997) (as well as most other research done in Poland) on the other is that the Polish research finds that not
privatization in and of itself but rather the methods of privatization have a strong influence on the quality of the
restructuring process.

is clear that not all the “battles” over ownership in the companies we studied have been
won and lost. Therefore, our report provides a picture of secondary privatization in an
advanced, albeit not yet completed stage. This fact should provide a stimulus for the
continuation of research in this area in the near future. Such research may indicate not
only further developments in the evolution of ownership structures, but additionally shed
more light on the relationship between the evolution of ownership structure and
enterprise performance.
We now turn to a more detailed review of the literature on the relationships between
the immediate post-privatization ownership structure and corporate performance,
focusing on certain critical issues such as the role of ownership concentration, the type of
dominant owner, and the regulatory and institutional environment, as well as
methodological issues.
2.1. Ownership Concentration
Beginning with the early work by Berle and Means (1932) and continuing into the
1980s, the literature studying the impact of ownership structure on corporate
governance6 and firm performance has focused on the advantages of ownership
concentration. This question has important implications for privatization policy, as policy
makers must decide whether it is better to distribute the shares of firms to large numbers
of individuals (as in the voucher method) or to concentrated groups of owners or even
single owners (e.g., through direct sales). The main concern was the cost of the
separation of ownership and control, or agency costs (e.g., Jensen, Meckling, 1976; Fama,
Jensen, 1983). The idea is that dispersed ownership in large firms increases the principal-agent
problem due to asymmetric information and uncertainty. Because contracts
between managers and shareholders are inevitably incomplete (future contingencies are
12
6 There are various definitions of corporate governance. It can be defined narrowly, as the problem of the
supply of external finance to firms (Shleifer, Vishny, 1997). It can also be defined as the set of mechanisms which
translate signals form the product markets and input markets into firm behavior (Berglöf, von Thadden, 1999),
or as the complex set of constraints that shape the ex-post bargaining over rents (Zingales, 1997). The control
of the firm does not necessarily equate with equity ownership; it also depends upon control exerted by debt-holders.
So, corporate governance may affect firm performance directly, via ownership and control, but also
indirectly, through the financial structure of the firm. According to an even broader view of corporate
governance, managers in firms characterized by the separation of ownership and control are constrained from
taking actions that are not in the interest of shareholders by several disciplining mechanisms, such as the threat
of takeovers, bankruptcy procedures and the managerial labor market. Competition on the product market is
often considered as another disciplinary device.

impossible to describe fully), shareholders must monitor managers. There is a
widespread consensus that a greater degree of control by an external shareholder
enhances productivity performance: more monitoring presumably increases productivity
(Shleifer, Vishny, 1986). When the equity is widely dispersed, however, shareholders do
not have appropriate incentives to monitor managers who, in turn, can expropriate
investors and maximize their own utility instead of maximizing shareholder value. Finally,
concentrated ownership in the hands of outsiders is also often advocated on the ground
that it facilitates the provision of capital.
In transition economies, conflicts between managers and outside (large and minority)
shareholders are on the rise. Problems and costs of shareholders’ control over the
managers in the framework of principal-agent relations (Hart, 1995) are aggravated by
the fact that managers – directly or through intermediaries – act as both insiders and
outsiders, in all possible meanings of these terms. One of the key problems here is that
of the share issuer’s transparency to potential investors as well as incumbent outside
shareholders. It should also be noted that in an illiquid emerging market the issue of a
choice between the “voice” mechanism and the “exit” mechanism (Hirschman, 1970) is
no longer a dichotomy. In fact, there are no alternatives here: if one cannot sell his or her
shares, then the role of the “vote” mechanism has to be enhanced.
More recently, the focus of the literature has shifted, and several theories have been
proposed to show the ambiguity of the effect of ownership concentration (Grosfeld,
Tressel, 2001). One of the obvious costs of concentration is the ability of the holders of
majority stakes to extract private benefits of control (Barclay, Holderness, 1989). La Porta
et al. (1998a) show that, in most countries, large corporations have large owners who are
active in corporate governance. Therefore, the main problem of corporate governance is
not monitoring the managers; the real concern is the risk of the expropriation of minority
shareholders. The same authors, in a comparative study of the effectiveness of legal
systems in 49 countries from the perspective of investor rights protection, find that
ownership concentration is a reaction (adaptation) to weak protection of investor rights
under the national corporate governance models (La Porta et al., 1998b).
A similar view has been expressed by Becht and Röell (1999), reviewing of corporate
governance in continental European countries where ownership structures differ significantly
from those of Anglo-Saxon countries, well known for their dispersed ownership patterns. In
most of the countries studied, companies tend to have large shareholders, and the main
conflict of interest lies between them and minority shareholders.
Second, concentrated ownership may negatively affect firm performance through
its impact on managerial initiative. If concentrated ownership provides incentives to
control the management, it may also reduce the managers’ initiative or incentive to
acquire information (Aghion, Tirole, 1997). In this perspective, Burkart et al. (1997)
13

view dispersed ownership as a commitment device ensuring that shareholders will not
exercise excessive control. If the principal is concerned with providing the manager
with the guarantee of non-intervention, he may choose to commit not to verify the
action of management. Such inefficient monitoring technology may stimulate
managerial activism (Cremer, 1995) creating, ex ante, powerful incentives for the
management. When managerial initiative and competence are particularly valuable
(which may occur when firms face high uncertainty), concentrated ownership may thus
turn out to be harmful.
Third, concentrated ownership implies lower levels of stock liquidity which, in turn,
weakens the informational role of the stock market (Holmström, Tirole, 1993). This may,
again, be more valuable in an uncertain environment (Allen, 1993), or when it is essential
to ensure that the management of under-performing firms changes hands. Finally,
concentrated ownership is costly for large shareholders because it limits diversification
and reduces the owners’ tolerance towards risk (Demsetz, Lehn, 1985; Heinrich, 2000).
Ownership dispersion allowing greater risk diversification may positively affect
investment decisions. Overall, Allen and Gale (2000) conclude that in the second best
world of incomplete contracts and asymmetric information, separation of ownership and
control can be optimal for shareholders.
What do we observe in practice in the transition economies? Practically all of them
demonstrate a trend towards high ownership concentration in the course of privatization
(a point to which we will return in Section 3, particularly in the conclusions). In the Czech
Republic, Hungary and Poland, 98% of medium-sized companies surveyed in the mid-
1990’s had a dominant shareholder (Frydman et al., 1997), with the average stake owned
by the main shareholder varying from 50% to 80%. In the former USSR republics there
is also a trend towards concentration. Data available on six countries show steady growth
in the managerial shareholdings (Djankov, 1999).
Concentrated ownership is closely related to outsider ownership. In 1998, according
to the data of a Russian survey conducted by the Higher School of Economics in Moscow,
on the average, the largest shareholder’s stake was about 28%, and the largest three
shareholders owned 45% (up from 41% in 1995). Moreover, in 43% of the companies,
three shareholders held over 50% (Dolgopyatova, 2000). According to the data of a
survey of 437 Russian enterprises conducted in 2000, in 85% of the enterprises of the
sample, none of the shareholders had even a blocking stake immediately following
privatization. In 38% of enterprises dominated by outsiders, two or three shareholders
had a more than 50% interest in 2000 (Bevan et al., 2001). However, the most obvious
trend that Russian companies show is an increase in stakes held by other industrial
companies. As a result, a majority stake in every tenth company is held by other industrial
companies (Simachev, 2001).
14

One of the most peculiar features of Russian industry is the combination of ownership
concentration with partial ownership dispersion (Dolgopyatova, 2000). Hence a certain
dualism of corporate ownership characteristics cited by various authors (as compared to
similar data on Western countries and other transition economies). The fact that Russia
lags somewhat behind the Eastern European countries may be due to some provisions of
anti-trust legislation (affecting acquisition of over 20% of shares) and corporate legislation
(affecting acquisition of over 30% of shares).
As for the relationship between concentration and economic efficiency, an example
of a formulation – and test – of the hypothesis of the effect of ownership concentration
on performance is found in McConnell and Servaes (1990). They examine the impact of
ownership structure on company performance in the largest European companies.
Controlling for industry, capital structure and national effects, they find a positive
relationship between ownership concentration on the one hand and the market-to-book
value of equity and profitability of firms on the other.
In a similar study for a transition economy, Grosfeld and Tressel (2001) test the
hypothesis of the ambiguous relationship between ownership concentration and
performance. For a sample of Polish firms listed on the Warsaw Stock Exchange, they
found that there is indeed a U-shaped relationship. Firms with relatively dispersed
ownership (no shareholder with more than 20% of voting shares) and firms in which one
shareholder has more than 50% of voting shares were found to have higher productivity
growth than firms with an intermediate level of ownership concentration. In Section 3,
we will review some studies of Central European data which show no relationship
between concentration and performance.
Other studies have found a less ambiguously positive relationship between
concentration and performance. For example, data from surveys of Czech firms provide
evidence that managers who were brought to privatized companies by outside owners
operated much more efficiently than those appointed by government agencies
(Claessens, Djankov, 1999a). Data on the operations of 706 Czech enterprises in 1991-
1995 suggest that concentrated ownership boosts the market value of a company,
thereby increasing its profitability. The authors of the paper in question also find that the
company’s main bank has a positive impact on the company’s performance through
indirect control over its investment fund (Claessens et al., 1997). In the Russian case, if
we assume (based on the findings of Leontief Center, 1996) that the earlier companies
were privatized, the higher the level of corporate ownership concentration (which is
generally consistent with the Russian trend), this constitutes evidence that companies
with concentrated ownership are more efficient.
Perhaps in the end the most appropriate view is the more nuanced one of Bolton and
von Thadden (1998), who argue that it is not simply a question of whether ownership
15

should be concentrated or not, but rather whether there are different levels of
concentration most appropriate for different stages in the life of the firm. We hope that
the research presented in Section 3 may shed some light on this question.
2.2. Type of Dominant Shareholder
Some authors do not find any consistent relationship between the post-privatization
ownership structure and the intensity of change (Linz, Krueger, 1998; Earle, Estrin, 1997,
based on surveys of Russian enterprises). Data on Ukrainian enterprises do not confirm
the existence of a clear relationship between the ownership structure and
change/restructuring either (Estrin, Rosevear, 1999). A paper on recent surveys of about
3000 companies in 20 transition economies analyzed the impact of privatization and
ownership structure on enterprise restructuring but found no clear answers. This is
attributed to the lack of information about enterprises before privatization (Carlin et al.,
1999). Interim data from an analysis of over 7,500 Russian industrial enterprises (Brown,
Earle, 1999) suggest that restructuring is in general very slow in companies of all forms of
ownership, and slower in private companies than in state-owned ones. The authors find
that privatization has an adverse effect on performance, but at the same time point out
that it would be wrong to attribute it solely to privatization, as state-owned enterprises’
performance is not much superior to that of other types of companies.
A number of authors have asked whether or not the type of owner who acquires a
firm in privatization is of any significance. A number of related questions have been posed,
and dealt with, in the literature: Are employees bad owners? Are foreign strategic
investors the best owners? What about investment funds?
In their study of some 700 Czech firms, Weiss and Nikitin (1998) showed that
ownership concentration by strategic investors other than investment funds has had a
positive impact on performance, while this has not been the case with ownership
concentration by bank-sponsored investment funds. Similar conclusions have been drawn
by Claessens and Djankov (1999b) in their study of a cross section of over 700 Czech
firms between 1992 and 1997.
In their above-mentioned study dealing with the effects of concentration, McConnell
and Servaes (1990) also test the hypothesis that the identity of large owners – family,
bank, institutional investor, government, and other companies – has important
implications for corporate strategy and performance. They find support for this
hypothesis. In contrast, the study by Grosfeld and Tressel (2001) mentioned earlier
examines these questions for a sample of Polish firms listed on the Warsaw Stock
16

Exchange and finds that the type of controlling shareholder does not affect the correlation
between concentration of ownership and productivity growth.
The beneficial role of foreign strategic owners in privatized firms has been highlighted
in many studies. In an early survey of Czech, Hungarian, Russian and Bulgarian companies,
Carlin et al. (1995) show the positive impact of foreign ownership on productivity
growth, a finding which has been confirmed by many later studies (including, for example,
Carlin, Landesmann, 1997). While Djankov (1999) found evidence that ownership by
domestic outsiders is not significantly correlated with depth of restructuring, he also
found that the positive impact of foreign ownership on restructuring only makes itself felt
when the foreign-owned stake is relatively large (over 30%). Smith et al. (1997) examine
the relationship between employee and foreign ownership and firm performance in a
sample of Slovenian firms. In addition to the unsurprising finding of the strong positive
effect of foreign ownership, they also find a positive (though much weaker) relationship
between employee ownership and enterprise performance. A percentage point increase
in foreign ownership is associated with about a 2.9% increase in value added, whereas a
percentage point increase in employee ownership increases value added by about 1.4%.
However, most available data suggest that difference between companies owned by
domestic insiders (employees and managers) and dominant outside investors is small
(Carlin et al., 1995). Frydman et al. (1997) found that in the Czech Republic, Hungary and
Poland private companies have made more progress in restructuring than state-owned
firms; however, firms controlled by outsiders are more or less on the same level as those
dominated by insiders. Brown and Earle (1999), analyzing the survey of over 7,500
Russian industrial companies referred to above, find that, on the whole, companies with
large insider stakes and stakes acquired through voucher auctions show a much slower
pace of restructuring than firms with stakes owned by holding companies and foreigners
and “golden shares” held by the state. However, the influence of vouchers, holding
companies and foreigners is highly uneven, and the impact of holding companies and
foreigners does not increase with an increase in their stake. According to Kuznetsov and
Muraviev (1999), their survey of the 103 best known Russian share issuers in 1995-1997
shows that the larger the stake of outsiders (both domestic and foreign), the higher the
productivity growth. By contrast, insider and state ownership results in low productivity.
Ownership by a state-owned holding company impedes productivity growth, though to
a smaller degree than state ownership.
A couple studies of Russian data find evidence which reflects more favorably on insider
ownership. In a detailed study by Bevan et al. (2001), the main finding as regards the
ownership-performance relationship is that difference in restructuring (performance)
between outsider- and insider-controlled companies is negligible, with the exception of
profitability, which is considerably higher in companies with insider ownership. This might
17

be explained by the fact that outsider dominance (especially if a company is part of a
vertically integrated group) often results in the switching of financial flows to other entities
and persistent (declared) losses. Similarly, Muraviev (2001), exploring the relationship
between ownership structure and data on financial performance (return on equity, return
on sales), finds a direct relationship between the insiders’ stake in the company and its
performance (no difference is found between management and employee ownership). In
contrast, there is an inverse relationship between performance on the one hand and
outsider-owned stakes (with the exception of foreign outsiders, for which the relationship
is positive) and the stakes of regional and local governments on the other.
In addition to the type and concentration of ownership, the replacement of old
management by new may be of crucial significance for the improvement of corporate
governance and enterprise performance. Investigating the relation between profits and
privatization, Claessens and Djankov (1999a) found that profitability and labor
productivity are both positively related to the appointment of new managers, especially
those appointed by private owners. Additionally, they find the equity holdings of general
managers to have a small positive effect on corporate performance. A study of the
transformation of Russian shops by Barberis (1996) confirms the positive impact of the
appointment of new managers on the restructuring process. The main conclusion is that
enterprise restructuring in transition countries requires new human capital, which can
best occur through management changes.
This conclusion may have important implications for privatization policy: if a
privatization method leads to the entrenchment of incumbent managers as holders of
significant blocks of shares, many necessary changes may be stifled. And such
entrenchment does indeed appear to be problematic in many transition countries.
Research has shown that groups that have obtained relative control over privatized
enterprises because of the particular design of privatization schemes may be more or less
willing to allow new dominant owners to emerge. In their study of ownership change in
privatized Estonian firms, Jones and Mygind (1999) argue that the initial dominant
ownership group is associated with a great deal of inertia, i.e., that the dominant group
retains its dominant position for quite a long time. A study of the role of managers and
employees in the development of ownership in privatized Russian enterprises has also
shown that managers have been hostile to outsiders and colluded with workers to keep
the outsiders out of their companies (Filatotchev et al., 1999). The question of
management entrenchment was of particular interest in the CASE research presented
here.
An important feature of voucher privatization in the Czech Republic, Poland and
Slovenia was the collective investment opportunities offered by numerous privatization
investment funds. Due to the activity of these funds, enterprise shares were, to a large
18

extent, not distributed amongst a large number of individual citizens, but rather
concentrated in the portfolios of the funds. In the Czech Republic, for example, one third
of the investment funds gained control of over two thirds of the total enterprise shares
obtained by all funds. Mergers and acquisitions of funds resulted in further ownership
concentration, and in an environment of lax regulation (as in the Czech Republic), this
afforded ample opportunities for the creation of very non-transparent equity networks
and thereby for the abuse of non-insider shareholders (Hashi, 1998).
In fact, while the Czech mass privatization was ostensibly designed to make outsider
ownership the rule, in practice management was often able to use voucher privatization
and the involvement of investment funds to retain a privileged position.7 Moreover,
Kocenda and Valachy (2001) offer further indirect evidence of significant insider
involvement in Czech voucher privatization, noting that Czech privatization investment
funds were often founded by manufacturing enterprises (it is reasonable to infer that
many of these enterprises set up funds in order to acquire shares in themselves, as it
were). An OECD report sums up this post-privatization situation when it states that the
Czech voucher approach to privatization produced ownership structures that were not
conducive to either efficient corporate governance or restructuring (OECD, 1998).
For these reasons, many conclude that Czech firms privatized through vouchers, in
which investment funds held the controlling stakes, have not been sufficiently or
consistently restructured. Weiss and Nikitin (1998) looked at financial performance in a
set of Czech firms and concluded that the concentration of ownership has significant
positive effects on performance except in the case of the funds, whose share in
ownership has no positive effect on performance. Mertlik (1997), highlighting the dual
role of partly state owned banks as owners (through bank-sponsored investment funds)
and creditors of voucher-privatized firms, argued that a large number of these firms had
not been subjected to the genuine rigor of market forces and not undergone serious
restructuring.8
2.3. The Regulatory and Institutional Environment
One area in which there is growing agreement is that privatization in and of itself is
not sufficient to bring significant change to companies; the environment (regulation,
macroeconomic stability, etc.) is also of critical importance. Shleifer and Vishny (1997),
19
7 See evidence cited in Woodward (1996).
8 Since then, the four largest Czech banks have been privatized, though the problem of enterprise debts
has not been completely resolved.

for example, survey research on corporate governance, with special attention to the
importance of legal protection of investors and of ownership concentration in corporate
governance systems around the world. Estrin and Rosevear (1999) explore whether
specific ownership forms have led to differences in enterprise performance in Ukraine.
Using profit, sales, and employment as performance proxies, they find that private
ownership per se is not associated with improved performance, suggesting that the
insufficiently reformed Ukrainian environment is at fault. Similarly, Djankov and Murrell
(2002) argue that the fact that it is more difficult to identify the effect of privatization on
firm performance in CIS countries than in CEE countries may be attributed to the lack of
some of the necessary complementary factors (e.g. in the regulatory environment) which
make privatization work.9
Drawing attention to the role of the general economic environment in which
privatization takes place, Nellis (1999) argues that the poor performance of mass
(voucher) privatization was related to environmental factors in the following ways:
– Investment funds tended not to punish poor performance of firms, since pulling the
plug would diminish the value of the assets of the funds’ owners – banks – if the latter
were forced to write off bad debts lent to those firms.
– Even though they did not own the firms to which they were lending, the partially state-owned,
state-influenced, weakly managed and inexperienced banks tended to extend
credit to high-risk, low-potential privatized firms and persistently roll over credits
rather than push firms into bankruptcy.
– The bankruptcy framework itself was weak and the process lengthy, further
diminishing financial market discipline.
– The lack of prudential regulation and enforcement mechanisms in the capital markets
opened the door to a variety of highly dubious – and some overtly illegal – actions that
enriched fund managers at the expense of minority shareholders, and harmed the
health of the firm; for example, by allowing fund managers to load firms with debt,
then lift the cash and vanish, leaving the firm saddled with debts it had not used for
restructuring a practice that became known as tunnelling.
2.4. Methodological Issues
Any attempt to review the empirical literature on the effects of initial ownership and
control structures on corporate restructuring and performance in transition countries
20
9 For an analysis of the complementarity between ownership and competitiveness of the firm’s
environment, see Grosfeld and Tressel (2001).

would be incomplete if it did not take note of serious problems with the comparability of
various studies. These studies employ different methodological approaches, different
performance measures, different time periods, etc. Moreover, a number of
methodological problems, notably that of selection bias, often do not receive sufficient
attention. This can lead to the formulation of conclusions on the basis of evidence that is
often questionable.
One example is Claessens and Djankov (1999b), who concluded that the more
concentrated the ownership, the higher the firm profitability and labor productivity, in
spite of the fact that the coefficient on profitability was found to be insignificant. Another
oft-quoted example is Frydman et al. (1999), who compare the performance of
privatized and state firms in the transition economies of Central Europe. While they do
control for various forms of selection bias, some of their conclusions become doubtful
when one looks at the makeup of their sample. For example, they argue that privatization
to outsider owners has significant positive performance effects, whereas enterprises
privatized by MEBOs do not differ from state enterprises in performance (i.e., the latter
form of privatization brings absolutely no benefits in terms of restructuring). However, in
their sample of 185 firms from three countries (Poland, Hungary, and the Czech
Republic), only 10 are majority-owned by non-managerial employees, and all 10 are from
Hungary. There were none from Poland, where this form of privatization was applied to
a much larger number of firms, and where employee-owned firms have been much more
thoroughly researched.
3. Research Results for Three Countries
As mentioned above, the CASE Foundation carried out research on secondary
privatization in three Central European transition countries.10 With the knowledge
presented in Section 2 as a starting point, three central goals were formulated for this
research. The first was to analyze the secondary ownership transformations of
enterprises privatized through wholesale privatization schemes in the three countries,
focusing in particular on:
21
10 This research was undertaken with support from the European Union’s Phare ACE Program 1997,
project P97-8201 R “Secondary Privatization: The Evolution of Ownership Structure of Privatized Companies”,
coordinated by Barbara B³aszczyk of the CASE Foundation in Warsaw. The content of the conclusions
presented here is the sole responsibility of the authors and in no way represents the views of the Commission
or its services.

– The scope and pace of secondary ownership changes;
– Trends in secondary ownership transformations (e.g., identification of types of
emerging new owners, changes in levels of concentration, etc.);
– Factors affecting the scope and pace of secondary ownership transformation as well as
selection processes for agents involved in those processes;
– Barriers to secondary ownership changes, especially those resulting from institutional
patterns and state regulations, and
– The effects of the regulation of primary privatization schemes on secondary
privatization processes.
The second goal was to formulate and examine (using statistical methods) hypotheses
concerning:
– Relationships between changes in economic performance and primary and secondary
ownership transformation, and
– Relationships between changes in corporate governance and secondary ownership
changes.
The third goal was to formulate recommendations for regulatory changes in the
countries studied and more general recommendations concerning the utility of various
alternative privatization schemes for other countries.
The research focused on three countries: the Czech Republic, Poland, and Slovenia.
Large enterprise-level databases each country were used to examine ownership changes
that had occurred since wholesale privatization was implemented. These were
supplemented by the analysis of the relationship between performance and ownership
changes in each type of wholesale privatization and in each country. Effort was made
wherever possible to ensure the maximum possible methodological uniformity across
countries, though for a variety of reasons (such as country specificities and data
limitations) this was not always possible.
3.1. Slovenia11
Under Slovenia’s mass privatization model, 20 percent of shares went to para-state
funds (the pension fund and the restitution fund), 20 percent of shares to privately
managed privatization funds in exchange for ownership certificates collected by them
from citizens, and most of the remaining shares were distributed to insiders (managers
and current and former employees). Of approximately 1,500 companies which were
22
11 See Böhm et al. (2001).

privatized under this program, only a few dozen acquired strategic owners, and very few
were privatized using initial public offerings.
As a consequence, three typical groups of companies were formed:
– public companies quoted on the stock exchange;
– non-public internal companies not quoted on the stock exchange, with employees
holding majority stakes, and
– non-public external companies not quoted on the stock exchange, with employees and
funds holding comparably large shareholdings.
In their analysis of ownership changes in Slovenian companies privatized under the
mass privatization program, the authors first presented concentration indices for those
companies at two points in time: the end of primary privatization and end of 1999. The
indices are: shares held by the single largest shareholder, the five largest shareholders,
and the ten largest shareholders (denoted as C1, C5, and C10 respectively) and the
Herfindahl index.12 Then, using a sample of 183 mass-privatized companies, they
presented the weighted averages of shares of various types of owners (state funds,
investment funds, managers and employees, domestic and foreign external investors) at
the time of completion of primary privatization at the end of 1999. They concluded with
a transformation matrix showing the transformation trajectory of firms grouped with
respect to their dominant shareholders at the time of privatization, i.e. how the number
of firms in each dominant ownership group has changed over time. They found that
concentration had been occurring, especially in companies held by insiders: between the
completion of privatization and the end of 1999 almost 40% of initial shareholders had
exited the companies privatized through mass privatization. Small shareholders, the state
and para-state funds had reduced their ownership stakes in these companies while
managers and strategic investors have increased them. But both of the latter groups were
accumulating their shares more intensively in companies not traded on the stock
exchange. And these were transactions made on informal markets, with limited
competition and transparency.
Another central problem that had emerged was the conflict between large
shareholders – para-state funds and privatization funds, lacking both the ability and
motivation for proper corporate governance – and small shareholders (largely insiders).
In many medium-sized firms these two groups had entrenched their positions and were
battling each other for control. There often seemed to be no way out of this battle, which
was distracting the attention of company actors from restructuring-related issues. A
further problem lay in the fact that the secondary privatization process had attracted too
few foreign investors, who had been deliberately excluded during primary privatization.
23
12 The Herfindahl Index is calculated as the sum of the squared shares of each owner.

To examine the relationship between ownership and performance, the authors used a
database containing financial and ownership information on 426 mass-privatized companies
for the period 1995-1999. These companies were divided into groups depending on
whether they were publicly traded, owned primarily by internal owners (management and
employees), or owned primarily by external owners (for the most part, state and
investment funds), and whether they had switched from one of these categories to another
in the period under consideration. In their analysis the authors were particularly interested
in identifying what they call the “owner effects” (the performance effects of staying in one
ownership category) and “agent/seller effects” (the performance effects of moving from
one ownership category to another). Performance indicators used in this analysis included
the growth in the labor force, sales and assets, and productivity, and the ratios of operating
profit, operating profit increased by depreciation, and net profits to sales revenues.
Correcting for selection bias, the authors regressed measures of performance on various
factors not related to the ownership structure which were thought to have an impact on
performance as well as dummy variables for different ownership groups of companies.
The authors found the secondary privatization process in Slovenia to have been
seriously flawed. It had had practically no positive effect either on economic efficiency or on
financial performance in the 1995-99 period. On the basis of their analysis, they concluded
that the major problems with the post-privatization ownership consolidation had been the
quality and transparency of the process and not its slowness. Factors that prevented fast,
transparent and effective secondary privatization stemmed from the corporate governance
and finance regime established in mass privatization. The legal and regulatory framework
adopted to guide secondary privatization postponed transferability of large volumes of
shares and applied standard rules for ownership concentration and consolidation of control
to privatized companies with tradable shares, even though only a fraction of them were
quoted on the stock exchange. Though presented as protection of small shareholders, such
restrictions and rules in fact hindered taking publicly traded companies and privatization
funds private (that is, buying out small shareholders and removing their shares from public
trading) in an orderly fashion. They were flagrantly abused in practice, while rules for voting
on legal changes and reorganizations of corporations (which, under the circumstances, may
be a better protection for small investors) had not been established.
3.2. Poland
The Polish privatization program included two “schematic” or “wholesale” methods:
MEBO and the National Investment Funds Program. Why, in our research, did we treat
24

MEBO privatization as a wholesale scheme, despite the fact that it was a bottom-up
privatization procedure, initiated by the managers and employees themselves? We did so
because the legal framework for this method was highly regulated by the government and
fairly strict criteria concerning the structure of ownership had to be met (specifically, it
was required that at least 50% of the employees of the state enterprise become
shareholders in the new company). Also, the preferences given for insiders in this type of
privatization influenced the lease/sale contracts to a great extent. For these reasons, the
ownership effects of this privatization probably diverged considerably from the
ownership structures that would have emerged without government regulation,
supervision and preferences. On the other hand, it should be noted that this privatization
path required much organizational and financial input from the buyers and differed
considerably in this respect from give-away methods. More importantly, the ownership
structures established by this procedure were simple and did not include the artificial
constructions of mass privatization schemes (e.g., the National Investment Funds).
3.2.1. Companies Privatized by Management-Employee Buyouts13
The vast majority of employee buyouts in the Polish privatization process have been
generated via the leasing variant of direct privatization, in which at least 50% of the
employees of the state enterprise being liquidated had to form a new company to lease
the assets of the old enterprise. By the end of 1998 lease-leveraged employee buyouts
represented about one third of the completed privatizations carried out under the
supervision of the privatization ministry, thus constituting the single most frequently used
privatization method in Poland (in terms of the numbers of enterprises privatized). Most
of the firms in this category are small- to medium-sized firms, usually with less than 500
employees.
In this study, 110 firms privatized by the lease-leveraged buyout method between
1990 and 1996 were analyzed. First, weighted averages of the shares of various groups
of owners (strategic investors, other domestic and foreign external investors, and various
groups of insiders) at the time of privatization and in 1997, 1998 and 1999 were
presented and analyzed. These changes were summarized in a transformation matrix.
Next, the evolution of C1 concentration was presented.
The ownership structure of Polish employee-leased companies, especially
immediately after privatization, was characterized by large holdings of dispersed insider
owners. Subsequently, the shares of non-managerial employees gradually declined, while
25
13 See Kozarzewski, Woodward (2001).

those of outsiders grew. The concentration of shares in the hands of managers was
expected from the very moment of privatization, although managerial holdings later
stabilized and even decreased somewhat in favor of outsiders.
In general, however, change was found to be incremental. Radical changes in the
ownership structure had been rare, and ownership structure seemed to be fairly inert. It
would, nevertheless, be wrong to conclude that significant change was not possible when
it was in the interests of the incumbents, as new strategic investors had appeared in about
10 percent of the sample by 1998. (It is, however, worth noting that there was a negative
relationship between the size of top management’s share and the appearance of strategic
investors; it appears that once managers had decisive control over the ownership
structure of a company, they were reluctant to relinquish it.) The most important factor
influencing the direction and the dynamics of ownership change was the economic
condition of the company, which, when it was poor, favored concentration and
“outsiderization” of ownership (as well as changes in corporate governance).
In an attempt to analyze factors affecting ownership changes generally, the authors
considered trends in ownership evolution by initial ownership structure, branch (industry,
construction, services, and trade), size (employment), and profitability. Next, they looked
at the relationship between ownership and the companies’ development prospects,
examining various measures of development-oriented activities, including investment
activity, expansion into new markets, etc., with particular attention to the correlations
between these variables and ownership variables.
There was some slight evidence that the extent of non-managerial employees’ share
in the ownership of the firm had a negative effect on economic performance in the early
1990s. In particular, there was a case – albeit a weak one – to be made for the claim that
companies whose employees constitute the dominant owners followed a policy favoring
consumption (wages, dividends and the like) over investment and development.
However, the situation in the companies is likely to be differentiated, with the
relationships between ownership structure and economic decision-making dependent on
many factors that the authors were unable to analyze here.
Finally, corporate governance in the employee-owned companies was examined,
with special attention devoted to the role and composition of the supervisory board and
the role of owners and top management in decision-making processes. Executive board
membership was found to be dominated by persons who had managed the companies
before privatization. Changes in top management had occurred most frequently in firms
in which over 50 percent of the shares were in the hands of outsiders.
Contrary to what one might expect from the process of ownership “outsiderization”,
the position of insiders in supervisory boards was markedly strengthened in 1998-99.
However, supervisory boards tended to be rather passive, not using all the powers they
26

were entitled to by law and company by-laws. The small role of owners in the decision-making
process was also striking. The owners most frequently acted as decision-makers
where ownership was concentrated in the hands of a strategic outside investor. The
general picture that emerged was thus one of consolidation of management’s power and
even managerial entrenchment.
3.2.2. The National Investment Funds and their Portfolio Companies14
The initial ownership structure was identical in each of the 512 companies privatized
in the National Investment Fund Program, so data analysis was not needed to describe it.
Ownership changes in the 1995-2000 period were analyzed by looking at how many
companies in the NIFs’ portfolios were sold to what types of investors (i.e., domestic
corporate, domestic individual, employee, foreign, other NIFs, public trading) in which
years. A great deal of attention was paid to the issue of changes in the ownership of the
funds themselves as well as the issues of corporate governance in the funds (management
costs, strategies, etc.).
Finally, the economic performance of NIF portfolio companies was compared with
other groups of companies in the Polish economy. NIF companies were also broken
down with respect to the type of owner that acquired (or kept) them and then compared
with each other using annual sales as the basis for comparison.
The authors demonstrated significant shifts in the ownership of the funds in the
secondary privatization stage and a strong tendency to ownership concentration. The
share of the State Treasury and small investors decreased significantly, while cross-holdings
between the NIFs and the shares of institutional domestic and foreign investors
increased.
The decreasing share of small investors (both individual and institutional) – i.e., those
holding less than 5% of the shares of a given NIF – was noted. At the beginning of the
program they had held 85% of the NIFs’ shares; by the beginning of 2001, their share had
dropped to 41% – less than half of its original level. By contrast, the share of large
investors had been rising. The share of institutional investors had jumped to 46% by the
end of 2000, mainly through the involvement of foreign investors. These trends were
found to reflect the progress of ownership concentration. Over a period of 2.5 years
(from June 1998 to December 2000), the C1 index (that is, the share of the single largest
shareholder) had increased from 5.41% to almost 24%, and the C3 index (the share of
the three largest shareholders) had increased from almost 7% to 42%.
27
14 See B³aszczyk et al. (2001).

As a rule, the NIF managers had not been particularly interested in restructuring their
portfolio companies themselves, strongly preferring secondary privatization (i.e., sale to
other investors). As of December 2000, over half of these companies (278) had found
new investors, including companies quoted on the stock exchange (27) or over-the-counter
market (12). In addition, at that time, 78 companies were under bankruptcy or
liquidation procedures (of which nine had already been liquidated at the time of writing).
Thus, in all, secondary privatization had affected 346 firms (out of a total of 512). The
most numerous new owners were domestic strategic investors (large domestic
companies), who had become shareholders in 134 companies. Foreign investors were in
second place with 57 firms. Individual private owners had taken control of 48 firms, and
employees had acquired 14 NIF companies.
A more detailed examination of the ownership structure of NIF portfolio companies
showed that the concentration of ownership had increased in these companies – more
slowly than in the funds, but still at a remarkable rate. By the year 2000, the largest
shareholders were in near-absolute control in about one third of the companies. The
economic and financial performance of the NIF companies had deteriorated in the early
stage of the program because of its delayed implementation and the lack of restructuring
activities during the waiting phase. In 1995, profitability had fallen rapidly and never
recovered. Much better results were achieved in 1999 by other groups of privatized
enterprises, and even by State Treasury companies.
Using the ratio of sales in 1999 to sales in 1995 as their measure, the authors looked
at the financial situation of NIF companies that had undergone secondary ownership
changes (i.e., had been sold to new owners) and found that the drop in sales had been
sharpest (ranging from 30 to 60%) in companies sold to domestic individuals and
employees. A significant decline was also experienced by companies which had not been
sold by the NIFs (i.e., where the largest block of shares still belonged to the leading NIF)
and by most companies which were publicly traded. Both types of companies continued
to lack a strong outside investor who could bring them capital, know-how, etc. The best
results were found in companies sold to domestic corporations and foreign investors
relatively early.
The success of the NIF Program, which in effect “privatized” the process of
privatization of the portfolio companies, was thus limited to cases where medium-sized
and large companies were rapidly sold to domestic corporations and foreign investors,
which helped those companies to at least maintain their market position. Where this had
not occurred, it seemed rather to have been a failure.
28

3.3. The Czech Republic15
Using a relatively large representative sample of voucher-privatized Czech firms, the
authors first showed the trends in these firms. The ownership data included the identity
and the equity holdings of up to seven largest shareholders for each company since 1996.
These owners were categorized into six types: other industrial groups or companies,
investment funds, portfolio companies (companies engaged primarily in buying and selling
of shares without any intention of interfering in management decisions), individuals,
banks, and the state.
The primary changes in ownership structure in the 1996-1999 period were first
calculated using three ownership concentration measures: C1, C5, and the Herfindahl
index. The authors also calculated the mean ownership position for each of the categories
of owners mentioned above. Additionally, the authors used density functions of
ownership concentration indices to paint a broader picture of ownership structure and
its changes during the period from 1996 to 1999.
To capture the relationships between the ownership changes described above and
various aspects of enterprise performance such as profitability, strength and size of the
firm, its financial position, and its scope of business activity, the authors carried out
regressions employing the ownership variables described in the foregoing as well as
various measures of profitability, financial strength, and sales. The performance variables
were regressed on various ownership variables as well as industry and sector dummies.
The Czech voucher privatization took place in the years 1991-95. While it was only one
of a number of possible methods of ownership transfer in the Czech privatization program,
the voucher scheme led to the wide distribution of share ownership in the Czech Republic.
Privatization Investment Funds (PIFs) had taken an active part in the implementation of the
voucher scheme and become the most important owners of equity in the immediate post-privatization
period. More than 400 PIFs had participated in the program. A significant
number were founded by various types of financial institutions, mostly state owned at the
time. Most of the rest had been set up by manufacturing companies. The 13 largest funds
had obtained control over 56% of all voucher points invested in the PIFs by citizens. Foreign
and domestic strategic investors had played a very limited role. This tendency toward
overwhelming fund dominance decreased somewhat after the second wave of voucher
scheme, when funds sold many of their shares to individuals and corporate entities.
In this early post-privatization period, heavy inter-fund trading rearranged the PIFs’
portfolios. This was carried out under almost complete lack of government intervention
29
15 See Kočenda, Valachy (2001).

by way of enforcement of legal provisions and regulations. The lax legal environment and
the absence of any notification and disclosure requirements facilitated a wave of mergers
and acquisitions, which contributed to further concentration of ownership. From 1996
onwards, ownership concentration in voucher-privatized companies continued to
increase and reached levels which were extremely high in comparison with many
developed countries. The most concentrated shares tended to be held by strategic
investors (although the number of firms with foreign strategic investors was still relatively
low in 1996-97), the lowest by banks and portfolio investment companies. PIFs had also
begun divesting the firms in their portfolios.
The authors examined shareholding patterns by investigating which of six types of
owners (i.e., manufacturing companies, banks, investment funds, individual owners,
“portfolio companies”16 and the state) constituted the single largest shareholder of these
companies. They found that manufacturing companies were the most stable type of
largest owner, followed by individual owners. Manufacturing companies also recorded by
far the largest ownership gains in this period. The most unstable type of owner was the
portfolio company.
In an econometric analysis of the impact of ownership concentration and the type of
dominant owner on firms’ performance, the authors concluded that ownership
concentration did not explain changes in company performance. Some positive
correlations were found between performance and the holding of the largest block of
shares by portfolio companies and individuals (as opposed to other types of owners).
3.4. Endogenous Ownership Structure and Mass Privatization in
the Czech Republic and Poland17
While the three country studies discussed above treated ownership concentration as
exogenous and tried to analyze its impact on firm performance, the authors of this
research took a different approach. They considered ownership structure as endogenous
and tried to determine how it adjusts to firm characteristics and to factors characterizing
firms’ environment.
The authors first presented the theory and empirical evidence showing the
ambiguous relationship between ownership structure and firm performance. Then, given
30
16 This term refers to a category of institutional investors whose strategy is solely to realize profits through
dividend payments or – more frequently – through capital gains and who normally have an intention of
participating in corporate governance.
17 See Grosfeld, Hashi (2001).

this ambiguous relationship, they argued that an assessment of the effectiveness of
wholesale privatization should not refer to concentrated ownership as a benchmark.
What is more relevant, they argued, is the possibility for the firm to adjust its ownership
structure to firm-specific characteristics and to its environment. Thus, flexibility of the
ownership structure is a virtue. The authors documented the significant reallocation of
property rights since the initial mass privatization in Poland and in Czech Republic,
showing that the ownership structure had evolved rapidly: it had become highly
concentrated, and the identity of the largest shareholders had changed quickly. So,
contrary to the concerns of the critics of mass privatization programs, the authors found
the inertia of the initial ownership structure to be quite limited.
The authors also interpreted the significant evolution of ownership structures in firms
privatized through mass privatization as an argument for treating ownership as
endogenous. They cited several authors (Demsetz and Lehn, 1985; Himmelberg et al.,
1999; and Demsetz and Villalonga, 2001) who have argued that even in more stable
environments the usual regression of firm performance on ownership concentration
would produce biased results. In firms privatized through wholesale schemes, this
endogeneity problem is particularly important. So instead of treating ownership as
exogenous, the authors considered various firm-specific characteristics and factors
characterizing the firm’s environment which might affect the evolution of ownership
concentration and the change in the type of largest shareholder.
The authors re-examined the evolution of ownership structure in firms privatized
through voucher schemes in the Czech Republic and Poland, focusing on the endogeneity
of ownership structure and the effect of the companies’ economic performance on
ownership changes. They showed that not only has there been a strong tendency towards
the concentration of ownership in fewer hands, but also a large-scale reallocation of
ownership rights has taken place among various types of owners. Starting from a highly
dispersed ownership structure, the large majority of voucher-privatized Czech companies
had found a dominant shareholder by the year 2000. In nearly half of them, the dominant
shareholder owned more than 50% of equity and had absolute control over the firm. In
Poland, too, the majority of companies involved in the scheme found dominant owners,
some 10% of them being foreign investors. Furthermore, manufacturing companies and
individuals had emerged as major dominant shareholders in both countries.
The authors maintained that ownership structure had evolved in response to competitive
pressures and constraints in the environment of the firms as well as firm-specific characteristics.
They saw the rapid increase in concentration as the owners’ response to firms’ conditions and
their long-term prospects. In particular, they found ownership concentration to depend on the
degree of uncertainty in the firm’s environment. The riskier the environment, they found, the
greater the tendency of firms to have more dispersed ownership. The authors suggested that
31

these results could be interpreted in the light of theories of the firm stressing the trade-off
between managerial initiative and shareholder monitoring and control. The greater ownership
dispersion they found in riskier environments leaves greater room for managerial decisions. An
important implication of this finding, they argued, is that concentrated ownership may not
always result in better corporate governance and control.
4. Conclusions and Policy Recommendations
As the overview of empirical research of the 1990s shows, complete consensus has
not been reached on any of the issues under consideration. Sometimes empirical data run
counter to generally accepted theoretical approaches. It seems there are only two points
where the results of almost all empirical research agree:
– the finding that there is a positive relationship between foreign investors’ stakes and
performance, and
– the finding that the role of employees as shareholders is neutral or negative.
Empirical results are mixed or inconclusive with regard to:
– the “contribution” of privatization to improvement of company performance (taking
into account the time of privatization and the size of the government-held stake in
companies with mixed ownership) and, in a broader perspective, the comparative
efficiency of state-owned and private companies;
– the impact of ownership concentration levels on performance, and
– the nature of the relationship between the dominant owner type (managers, outside
shareholders) and performance.
There are several reasons for this.
First, there is still a great deal of disagreement even in the theoretical discussion of
the issues. For example, while in 1999 Joseph Stiglitz wrote about the need to pay greater
attention to the role of insiders, who, in the context of the relationship between
ownership and management in transition economies can have a positive impact by
shortening agency chains (Stiglitz, 1999), in the same year the EBRD called for fighting
against the interests of the “entrenched insiders” (EBRD, 1999). And Oliver Williamson,
in a recently published overview of institutional theory pointing to the problems
engendered by privatization in Russia, links what he views as the flaws in the county’s
privatization strategy to policy makers’ adherence to the Grossman-Hart-Moore18 theory
of property rights (Williamson, 2000).
32
18 For details, see Radygin, Entov, Malginov et al., 2001.

Second, the (corporate) ownership structure emerging in many post-Communist
economies can still be assumed to be of a transitional nature; thus, it is too early to draw
conclusions about its gravitation towards a particular classical model (ownership and
corporate governance structure). In fact, various components of all traditional models can
be observed in the transition economies at the moment: relatively dispersed ownership
(but with an illiquid market and weak institutional investors, in contrast to the Anglo-
Saxon countries where dispersed ownership is most typical), a clear and sustained trend
towards ownership concentration (but without the adequate external financing and
efficient monitoring mechanisms characteristic of the European economies with highly
concentrated ownership structures), and elements of cross-ownership and emergence of
complex corporate structures of various types (but without gravitation towards any
particular type).
Clearly, this ill-defined character of the ownership and governance models evolving in
the transition economies hampers decision-making in the law and policy areas. One
example would be sufficient to illustrate this point. It is generally believed that a high need
for company transparency (information disclosure) is reached if shareholder base is broad
(i.e., concentration is low). If one assumes that the many stages of ownership redivision
that are to follow will result in highly concentrated ownership, then the requirements of
the law as to information disclosure (both current and new, more stringent ones) are
groundless. Certainly they are not properly complied with now.
Third, the issue of relations between affiliated entities and beneficiary ownership is a
difficult one. Given the actual ownership (control) structure and financial flows of many
big Russian companies (see Radygin, Sidorov, 2000), practically all initial data used for
empirical research – both in the issues of ownership (managerial as well as outsider) and
financial performance – may be called into question. Managerial property is a special
issue. It is clear that the managers’ stake shown in all surveys is highly misleading. The
actual power of managers in companies may be based on a relatively small stake (about
15% of shares is usually sufficient), even though there is an obvious trend towards
maximization, part of which occurs through affiliated entities. In this situation testing
classic hypotheses about the role of managers (e.g., the “convergence hypothesis” in
Jensen, Meckling, 1976, and the “entrenchment hypothesis” in Morck, Vishny, 1988) is
extremely difficult.
Fourth, there are serious difficulties associated with one of the classic econometric
problems – that of causality (the “endogeneity problem”). The problem is that the choice
of enterprises to be privatized cannot be considered accidental. Thus, privatization theory
most often proceeds from the assumption that it is inefficient enterprises facing crisis that
have to (should) be privatized (Vickers, Yarrow, 1998). But investors prefer to acquire
shares in efficient companies. This consideration must have played an important role in the
33

course of post-Communist privatization (Carlin et al., 1995). However, if there are any
real grounds for such assumptions, this is evidence of the unequal initial conditions of the
operation of privatized and non-privatized companies. Indirect evidence of the problem of
endogeneity can be found in the extent of insider ownership in many transition economies.
Russian survey data from 2000 demonstrate that insiders acquired larger stakes in
companies that had been characterized by higher performance (higher labor productivity
and profitability) in the pre-privatization period (Muraviev, 2001). Thus, given the
asymmetry of information, better performance of the companies where insiders have
larger stakes could reflect “cherry-picking” by the insiders in the course of privatization
rather than the superiority of insiders as a class of owners.
It is our hope that the research summarized in Section 3 can shed some light on these
questions. The main findings of the studies presented there can, in spite of a number of
differences between the experiences of the three countries studied, be summarized in
the following generalizations about how the process of secondary privatization unfolded
in those countries.
1. In the majority of enterprises privatized under mass privatization schemes in which
insiders were not officially privileged, extensive secondary privatization processes have
taken place (that is, new owners have taken control). The transfer of ownership to
new owners in insider-owned companies like the Polish employee-leased companies
and most privatized enterprises in Slovenia, however, remains limited to a minority of
such companies.
2. There is increasing concentration of ownership in almost all enterprises under
consideration.
3. Surprisingly, given the fairly broad, albeit far from universal, agreement among
economists dealing with corporate governance and the theory of the firm, the
aforementioned concentration process has not been accompanied by improvements
in performance. Only some of the companies in the Polish National Investment Fund
Program seem to exhibit such a relationship, and this was a relatively small group of
companies sold by funds relatively early in the program to strategic (especially foreign)
investors.
4. This result may be an indication that ownership evolution is first and foremost an
endogenous process determined by, rather than determining, the economic
performance of the enterprise. The concentration of ownership by large shareholders
is influenced by a variety of firm level factors as well as competitive pressures and
constraints experienced by them. The absence of a direct relation between ownership
concentration and performance may of course also be explained by the short period
of time which had elapsed between the acquisition of the companies by their new
owners and the time of the research.
34

5. The type of owner (i.e., “insider”, “outsider”, strategic or portfolio investor, domestic
or foreign) seems to be very important. A detailed analysis of the identity of the new
strategic investors emerging in the secondary privatization process is needed. Are they
foreign or domestic? Do they come from the same branch as the purchased enterprise
(thereby representing examples of horizontal integration), or do they have supplier or
customer relationship with the acquired company (thus constituting examples of
vertical integration)? Are they financial investors? What connections have they had with
the acquired firm in the past? What are the strategies underlying their acquisitions?
These are some of the questions that will be very important in further research.
6. The regulatory and institutional environment of the privatized enterprises is also
crucial – as crucial for the success of secondary privatization as it was for that of initial
privatization. Does this environment impede the entry of new owners, or does it
facilitate their appearance in the privatized companies? This is a very broad topic,
which was dealt with often and from various angles in our work, and we believe that
it, too, demands further, more systematic research in the future. When the legal,
regulatory, institutional and general economic environment is highly unfavorable, we
observe either blockages or pathologies in the secondary privatization process, as a
result of which the end results of this process turn out to be very different from those
expected by reformers. Some of these unexpected pathological results include the
creation of monopolistic structures and the entrenchment of owners who are
unwilling and/or unable to make the changes necessary to improve the economic
viability of their companies. Poorly designed privatization institutions do not fulfill the
roles assigned to them, but rather take on lives of their own and begin to create new
problems.
7. A cardinal example can be found in investment funds, which constitute one of the
central legacies, and one of the greatest problems, created by the privatization
schemes we investigated in this project. Emerging as a result of various mixtures of
spontaneity and state design in all three countries, they were originally intended by the
designers of privatization policies to solve the corporate governance problem in one
of two ways. First, they were to solve the principal-agent problem of an enormous
group of shareholders, extending to practically the entire population, by concentrating
managerial control in enterprises with widely dispersed ownership. Second, quite the
opposite, they were expected to sell their shares in companies quickly, allowing for
concentration of ownership in new hands and the elimination of the principal-agent
problem altogether. Investment funds have not lived up to either of these
expectations. They have had neither the capacity nor the motivation to engage in
active corporate governance, but instead have become major players in the economies
of at least two of the three countries we studied. Far from delivering improved
35

corporate governance and company performance, they have often been used in
schemes to drain companies of their assets (most notoriously in the case of the Czech
Republic, whose experience led to the formulation of the new concept of tunnelling).
8. Another important institutional factor is the regulation of capital markets. There has
been much commentary on the poor regulation of the Czech capital market and the
high-quality regulation of the Warsaw Stock Exchange (see, for example, Glaeser et al.,
2001), and it seems that the Slovenian exchange bears a number of disturbing
resemblances to the one in Prague. These problems often reduce the transparency of
the secondary privatization process, making it difficult for companies to raise new
capital and for the rights of minority shareholders to be protected.
9. The inertia of ownership structures frequently observed in our samples is not
accidental, but rather results from the entrenchment of incumbent owners
(particularly the insiders) that emerged in the primary privatization process and
frequently bar entry to all outsiders. Since the state can no longer exercise influence
on this situation from the position of an owner, it can only act through the creation of
new regulation, which could at least partially reduce some of the barriers to the entry
of new owners. On the other hand, with respect to the stability of insider ownership
noted above, it is likely that such ownership structures will remain both stable and
economically efficient in the case of small and medium-sized enterprises which make
up the majority of insider-owned companies in both Poland and Slovenia. As Chandler
(1996) notes, the separation of ownership from control was an efficiency requirement
for very large, multidivisional firms whose production processes were characterized
by significant economies of scale and scope, but was not necessary in industries whose
technologies allowed for combining relatively small firm size and efficiency.
Another issue worth commenting on at this point concerns the debate about whether
the ownership and corporate control structures emerging in the post-Communist
countries of Central and Eastern Europe would bear a greater resemblance to those in
Anglo-Saxon countries (where capital markets dominate) or to those of continental
Europe and Japan (characterized by concentrated ownership and the strong role of banks
in corporate finance and control). It seems that neither model is adequate to explain the
directions of development in these countries. Capital markets (with the exception of
Poland) lack the informational transparency provided by regulation in the Anglo-Saxon
countries. The degree of concentration, and its increase, as well as the role of financial
institutions, might suggest at first glance a similarity to the European or Japanese model.
However, these financial institutions are portfolio investors – funds, not banks – with little
or no interest in corporate governance, a fact which strongly distinguishes Central
Europe from Western Europe. In short, unlike either the Anglo-Saxon or the German-
Japanese system, the institutional environment created in Central European wholesale
36

privatization and its aftermath has brought neither the informational transparency
necessary for efficient markets nor the additional capital necessary for restructuring.
It is clear that the establishment of an efficient system of financial institutions,
primarily commercial banks, is crucial for the development of a national model of
corporate governance and finance. The weakness of such institutions in Russia, which
became obvious in the 1998 financial crisis, deprived earlier discussions of the nature of
the national model of corporate governance (Anglo-Saxon or German-Japanese) of all
meaning. In an environment with limited or non-existent mechanisms for inducing
managers to act in any interests other than their own, the potential role of banks as an
alternative mechanism of corporate control (Stiglitz, 1994, pp. 77-78, 189-190) becomes
largely irrelevant.
It is also worth calling attention to some of the nuances which, to varying degrees,
differentiate the three countries studied. The Slovenian situation presented here bears
much resemblance to that of Polish MEBO and NIF companies. Similarities are especially
striking with regard to the behavior of investment funds, managers and employees as
owners in the post-privatization phase, as well as with respect to the behavior of the state
(both as an owner and as a regulator). In the case of the latter, the Slovenian and the
Polish experience shows that it is difficult, if not impossible, for the state to refrain from
exercising the power it reserved for itself by maintaining residual property in the
privatized enterprises, as well as via its influence in the investment funds themselves. The
role of state golden shares in the Czech Republic and that country’s delays in the
privatization of banks are also evidence of a similar tendency. Both states have also shown
a tendency to make too many promises that they cannot keep, and to try desperately to
keep those promises by utilizing privatization revenues (which, ironically, gives the state
an incentive to keep as much residual property as possible, in order to have a reserve
from which it can deliver on such promises).
Moreover, in both Poland and Slovenia, generally speaking, weaker performers went
into the portfolios of investment funds via voucher privatization, companies with more or
less average performance became employee owned, those with the best performance
were often sold in IPOs. This seems to reflect both the aforementioned fiscal approach
to privatization and the attractiveness of such companies for investors; however, it is clear
that such a privatization strategy fails to bring new capital to the firms which need it most.
Another similarity between Poland and Slovenia lies in the fact that in both Polish and
Slovenian employee-owned companies we observe problems arising from the fact that
many people keep their shares after leaving their companies (due to retirement or other
reasons), and from the fact that shares are often not available for new employees hired
after privatization. The problems are due to perceptions that the most consumption-oriented
attitudes are exhibited by former (and not current) employees, and that new
37

employees (young, well-educated persons hired in the 1990s) are often the most valuable
in the firm. A possible solution is the creation of trust funds which would hold employee
shares on behalf of the employees, issuing shares to new employees and purchasing them
from those that leave the company.
Some important differences among the countries need to be mentioned as well.
These are:
1. Slovenian “employeeism”. The heavy emphasis on both codetermination (employee
representation on supervisory boards) and employee ownership in Slovenia was not
duplicated in any other transformation country. It seems that Slovenia has been unable
to find an appropriate balance between the regulation for various forms of employee
participation – those based on ownership and those based on employment. Slovenia
represents an extreme in this area. The Czech Republic, on the other hand, has
enacted the least “employeeist” legislation of the three countries studied here. Poland
lies in between these two extremes, having mandated employee representation on
supervisory boards in state-owned joint stock companies and – in companies
privatized by commercial methods – the allocation of 15 per cent of the shares to
employees free of charge. These trends seem to be connected with historical
differences between the respective countries reflecting the extent of workers’ self-management
ideology and practice under socialism. Workers’ self-management was
strongest in Yugoslavia, from which Slovenia broke away in 1991, somewhat less
strong in Poland (self-management legislation concerning state enterprises was
enacted in Poland in 1981, but workers’ councils were not really allowed to operate
freely in state enterprises until 1989), and non-existent in socialist Czechoslovakia.
2. The limited role of foreign investors in the Slovenian economy. This strongly
differentiates Slovenia from transformation countries like Poland, Estonia, and Hungary
(and, following the conclusion of voucher privatization, the Czech Republic). Perhaps
in the 1990s, with Slovenia’s GDP per capita being much higher than in other
transformation countries, Slovene governments felt they could afford this. One can
expect, however, that a failure to open the country more will have increasingly severe
adverse effects. At any rate, such opening will be made necessary by the process of
accession to the European Union.
3. There appears to be a difference between Polish and Slovenian employee-owned
companies with respect to the ownership structure most attractive to potential
strategic investors. As Böhm et al. (2001) write, strategic investors tend to be
interested in acquiring companies in which the ownership structure is concentrated. It
is probably safe to assume that such concentration means concentration in the hands
of managers. In the sample of Polish employee-owned companies studied by
Kozarzewski and Woodward (2001), the situation seems to be quite different. Here,
38

there is a negative correlation between the entry of strategic investors and the
concentration of shares in the hands of managers. In general, strategic investors seem
to prefer companies where shares are dispersed among a large number of employees
than those in which they are concentrated in the hands of a few managers (although it
might not be strategic investors’ preferences that are crucial here, but rather those of
managers – once they have achieved control, they may be reluctant to give it up).
Finally, we present a few suggestions for policy makers which emerged from this
research. First, a few remarks concerning investment funds and their role in privatization.
It is best if such funds are not set up by the state, and if they are, the compensation of
their fund managers should be strictly tied to performance. Given the scarcity of capital
and shallowness of capital markets in transition economies, as well as the desperate need
for pension reform in most such economies, privatization funds should not be kept
artificially separate from pension funds; in fact, it would probably even be a good idea to
encourage mergers between the two. In general, as much freedom as possible should be
allowed for the transformation of funds created for participation in privatization – into
open-ended funds, closed-ended funds, mutual funds, venture funds, etc. Policy makers
should realize that funds, if left to evolve freely, will take various forms in response to
different kinds of market incentives and varying preferences of their participants. This
process should be allowed to occur with a minimum of constraint. We will return to this
point in a moment.
Second, the importance of capital market regulation is paramount. Disclosure
requirements (e.g., requirements to disclose the size of blocks of shares held at certain
thresholds), strict bans on insider trading, mandatory bid rules (i.e., the requirement that
shareholders crossing certain thresholds should make offers to buy out other
shareholders), and other forms of regulation are necessary to maintain transparency of
the markets and transactions as well as protect minority shareholders’ rights.
What about regulating the funds themselves (e.g., limiting the percentage of a given
company that they can hold)? Having stressed the importance of capital market regulation
but also the importance of allowing funds to evolve freely, we would add that certain
regulations in force in more developed markets economies may be too restrictive in an
environment where there is a need for rapid secondary privatization (which may involve,
for example, taking companies private – that is, buying out the small shareholders in a
publicly traded company and its de-listing). EU takeover regulations, for example, may be
too restrictive for companies which are not publicly traded. It may also be useful to
encourage off-market transactions in certain situations, though such transactions are
generally strictly limited in strong regulatory regimes. In order to facilitate taking
companies private, such transactions should serve to allow outside financial investors to
39

exit in a fair and transparent fashion, and could include, for example, equity-to-debt
conversions. Finally, given the fact that although most funds are typically portfolio
investors, some have both the propensity and the competence to take active roles in the
governance and restructuring of the firms whose assets they hold. Regulators should
consider exceptions to the general practice of limiting the percentage of shares of a given
company that a given fund may hold (Simoneti, 1995).
In the transition environment, it is important that regulation take into account the fact
that there are different kinds of minority shareholders. While most such shareholders are
individuals with small stakes who cannot defend themselves, some minority shareholders,
with stakes of 10 to 40 per cent, are serious players battling for control over firms,
sometimes to the detriment of those firms. Some observers consider the potential for
abuses by large minority shareholders to have become a serious problem in Russia in
recent years.19 While these sorts of abuses are uncommon in Poland, some recent events
show that even well-regulated Central European markets like the Polish one are not
immune to such abuses.20
How, in such cases, is the regulator to protect the majority of shareholders from a
minority shareholder’s abuse of his rights? Is cumulative voting, which allows strong
minority shareholders to appoint directors and is a standard measure used to protect
minority shareholders’ rights, perhaps inappropriate in transition environments? We
believe this troublesome question requires further investigation.
Another point concerns employee ownership. Given that this has tended to become
a fairly widespread feature of privatized companies in almost all transition economies, it
might be a good idea to provide for employee trust fund mechanisms which would hold
employee shares on behalf of the employees, issuing shares to new employees and
purchasing them from those that leave the company. Such a mechanism might resemble,
for example, the Employee Stock Ownership Plans in the United States. The Slovenian
authors report that while a similar mechanism has been introduced in Slovenia, it has not
been availed of in a significant number of companies, and point to the lack of promotion
40
19 Some possibilities for hostage-holding are discussed in Radygin et al. (2002), pp. 70-71.
20 One such example is the case of Wólczanka, one of Poland’s leading clothing manufacturers
(Micha³owicz, 2002, 2003). An investor who had consolidated a block of 16 per cent of Wólczanka’s shares in
2000 had his representatives on the supervisory board elect a new vice president for capital investments. This
vice president, in turn, was responsible for the creation of a Wólczanka subsidiary called WLC Inwest, which
managed financial investments. WLC made a number of bad investments, leading to significant losses. The vice
president claimed that these poor investment decisions were in fact made by the investor who had nominated
him, who had conflicts of interest resulting from his shareholding position in companies whose shares were
purchased by WLC. Investigations were later initiated by both the Securities Exchange Commission and the
public prosecutor’s office.

of the mechanism via tax incentives. However, tax incentives are not the only means of
promoting this sort of arrangement (and it is debatable whether they are a desirable
one).21 Public education campaigns and training programs (e.g., for trade unionists) might
well prove to be sufficient in raising public awareness concerning the advantages of such
arrangements.
41
21 Certain tax incentives might be advisable when employee stock options are used as a form of retirement
insurance, but this would have to be part of a comprehensive pension reform.

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230 Markiewicz M., Prawne, operacyjne i instytucjonalne aspekty funkcjonowania NBP
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247 Rawdanowicz £., Poland's Accession to EMU - Choosing the Exchange Rate
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52
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257 Zoubanov N., Uneven Growth in a Monetary Union: on the Possible
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