Approaches to privatization: established models and a U.S. innovation.

• Author: Chang, Stanley Y.

The pros and cons of four privatization models are charted, comparing approaches that have been used in Great Britain and New Zealand with the old standby - contracting out - and a United States innovation.

Governmental units today are often confronted with a major dilemma: there are growing demands from their constituents for more and better services along with an increasing inclination for tax limitation, if not tax reduction. Limitations on the property taxing authority of state and local governments, compounded with the simultaneous dwindling of federal shared revenues and other subsidies, puts these governments in a constant search for alternative financing sources. Among those alternatives, privatization is an option receiving growing attention. Indeed, President Bush signed an Executive Order on April 30, 1992, to remove regulatory impediments and encourage state and local governments to sell or lease their infrastructure assets obtained with federal assistance to private investors.

Privatization enables private enterprises to perform what has been an exclusively public task or a government dominant function. While gaining popularity, privatization is still a somewhat sporadic event rather than a growing trend in the United States. There has been, however, a systematic effort in the United Kingdom and a national compaign in New Zealand to privatize government operations. Governments have found privatization, when properly implemented, useful in reducing public expenditures, increasing efficiency, raising capital, and/or providing improved services.

Because of the diverse goals and endemic needs of governments, the privatization process varies greatly. Two outwardly similar situations may call for different procedures implemented in different stages, over different time spans. Government finance officers and accountants in both the public and private sectors have been heavily involved in the privatization process. Their potential responsibilities span all of the stages of the transition, and the manner in which they discharge these responsibilities impacts everything from early planning to completion. In addition to various levels of planning, they are involved in such activities as asset valuation, service, pricing and contract negotiation.

Government officials involved in privatization must thoroughly understand the various approaches and processes if they are to ensure a smooth transition that achieves the goals of all concerned. Because the privatization of a governmental function is not commonly part of a finance officer's/accountant's career training or experience, the necessary level of understanding is seldom present when the need first arises. Lessons can be gleaned from the experience of others, however. While the individual process may need to be tailor-made, commonality of methodologies can generally be observed.

This paper summarizes three general privatization models used in the United Kingdom, New Zealand and the United States. The authors have recently experienced a fourth alternative, which incorporates some of the elements of the other three but remains unique in many respects. This new privatization approach is contrasted with the other models. The authors do not suggest that any one method is superior to another, for clearly, the goals of the government and other relevant constraints should dictate which privatization methodology,may be most appropriate in any given situation.

Based on their roots and history, the four approaches introduced in this paper are referred to as 1) the British Model, 2) the New Zealand Experience, 3) the Old Standby and 4) a United States Innovation. Each of these approaches is separately described, with a discussion of some relevant advantages, disadvantages and examples. Exhibit 1 summarizes the major features of the four methods.

The British Model

The outright sale of government assets is probably the most common form of privatization in the United Kingdom.(1) Two primary pricing conventions have been used. Fixed-price stock offerings make single-priced shares available to the public. Tender stock offers, however, do not fix stock prices in advance; thus the price is determined by market forces.

In a sale of assets, the entity to be sold follows typical private-sector procedures. These include, among others, developing a prospectus, identifying underwriters and issuing houses, and selecting the stockbrokers. Since the market values of assets to be sold often are unknown in a governmental environment, determining the fair market value to use in a fixed-price offer or establishing the minimum bid in a tender offer can be difficult and expensive.

In England, it has been found that fixed-price offers tend to undervalue the assets, despite governmental efforts to establish a fair price.(2) A major reason for this phenomenon is that the underwriters also are often the prime bidders, and any shares not sold can be purchased by the underwriters at bargain prices. Thus, there is a built-in incentive for the underwriters to refrain from bidding, which leads to underpricing of assets.

Advantages. The advantage of this public offering method is that there are many accountants, bankers, underwriters and issuing houses who are familiar with the process. It should thus be relatively easy for a governmental...