The Financial Economics of Privatization

By William L. Megginson | Go to book overview

7
Privatization’s Impact on
Financial Market
Development

Although governments usually adopt privatization programs primarily to raise revenue, and in order to improve the economic efficiency of former stateowned enterprises, most also hope that privatizations implemented through public share offerings will develop their national stock markets. Successful promotion of national stock market development can yield significant political and economic benefits. The political benefits include the creation of a (presumably grateful) class of citizen/shareholders, plus the reflected glory resulting from the growth of an internationally recognized capital market. Countries and governments that are able to attract international investors to their stock markets tend to attract other types of international investment as well, especially foreign direct investment. All governments, therefore, wish to develop a reputation as being “investor friendly,” since this has a halo effect on how a government is perceived in many other political arenas.

As it happens, good politics can also be good policy in this case, since recent economic research shows that large, efficient capital markets promote rapid economic growth. Studies by Levine (1997), Demirgüc-Kunt and Maksimovic (1998), Levine and Zervos (1998), Rajan and Zingales (1998), Subrahmanyam and Titman (1998), Beck, Levine, and Loayza (2000), Henry (2000), Wurgler (2000), and Bekaert and Harvey (2000) and others have now conclusively documented such a direct link between capital market development and economic growth. A looming demographic crisis in the pay-as-you-go pension systems of many European and Asian countries has also lead to a dawning realization that efficient and liquid capital markets are a prerequisite for developing a funded pension system. Therefore, governments have adopted share issue privatization programs at least partly as a means to jumpstart the growth of these markets.

In spite of the obvious importance of capital market development, and of privatization’s potential role therein, we are aware of only two academic studies that (indirectly) attempt to document or empirically examine this process. Domowitz, Glen, and Madhavan (2000) examine the dynamics of external corporate

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