Oxford University Press The Quarterly Journal of Economics

When Does Privatization Work?
The Impact of Private Ownership on Corporate

Performance in the Transition Economies
Author(s): Roman Frydman, Cheryl Gray, Marek Hessel and Andrzej Rapaczynski
Source: The Quarterly Journal of Economics, Vol. 114, No. 4 (Nov., 1999), pp. 1153-1191
Published by: Oxford University Press
Stable URL: https://www.jstor.org/stable/2586961
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WHEN DOES PRIVATIZATION WORK? THE IMPACT OF
PRIVATE OWNERSHIP ON CORPORATE PERFORMANCE
IN THE TRANSITION ECONOMIES*
RoMAN FRYDMAN
CHERYL GRAY
MAREK HESSEL
ANDRZEJ RAPACZYNSKI
This paper compares the performance of privatized and state firms in the
transition economies of Central Europe, while controlling for various forms of
selection bias. It argues that privatization has different effects depending on the
types of owners to whom it gives control. In particular, privatization to outsider,
but not insider, owners has significant performance effects. Where privatization is
effective, the effect on revenue performance is very pronounced, but there is no
comparable effect on cost reduction. Overlooking the strong revenue effect of
privatization to outsider owners leads to a substantial overstatement of potential
employment losses from postprivatization restructuring.
I. INTRODUCTION
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, exemplified by Megginson, Nash, and Van
Randenborgh [1994] and La Porta and Lopez-de-Silanes [1997],
compares pre- and postprivatization performance of selected
privatized firms. The second focuses on comparing the perfor-
mance of state firms with either private [Boardman and Vining
1989] or privatized [Pohl et al. 1997] firms operating under
reasonably similar conditions. Additional evidence has been ob-
* Lawrence Katz and Andrei Shleifer kindly read earlier drafts of this paper,
and their generous and insightful comments led us to substantial revisions and
improvements. We would like to thank Joel Turkewitz for his contributions to the
design and implementation of the survey instrument, and Mihaela Popescu for her
extraordinary assistance in the analysis of the data. We also thank Sarbajit Sinha
for computer support in the initial stages of research. Extraordinarily valuable
comments by two anonymous referees as well as helpful conversations with
William Baumol, Olivier Blanchard, Fabrizio Coricelli, Chris Flinn, William Greene,
Irena Grosfeld, Sam Peltzman, Edmund Phelps, Gerard Roland, and workshop
participants at the University of Chicago are also gratefully acknowledged.
The authors are indebted to the CEU Foundation, the Open Society Institute,
and the World Bank for supporting research on this paper. Roman Frydman
gratefully acknowledges the support and hospitality of the Hoover Institution at
Stanford University and the C. V. Starr Center for Applied Economics at New York
University. None of these institutions are responsible for the opinions expressed in
this paper.
? 1999 by the President and Fellows of Harvard College and the Massachusetts Institute of
Technology.
The Quarterly Journal of Economics, November 1999
1153
1154 QUARTERLY JOURNAL OF ECONOMICS
tained recently by a number of studies of the postcommunist

transition economies which, because of their by now large num-
bers of both state and privatized firms, have become an important
testing ground for the general claim that privatization is effective.
Earle et al. [1994] and Barberis et al. [1996] examined the
effectiveness of privatization of shops and other small establish-
ments in Central Europe and Russia, respectively. Privatization of
large enterprises has been studied by, among others, Kollo [1995];
Djankov and Pohl [1997]; Claessens, Djankov, and Pohl [1997a];
Grosfeld and Roland [19971; and Grosfeld and Nivet [19991.
Russian privatization has been analyzed in Boycko, Shleifer, and
Vishny [1995] and Earle and Estrin [1997]; Lieberman and Nellis
[1994] contains a number of essays on the restructuring of
privatized firms.
The present study, based on a panel of over 200 privatized and
state firms in the Czech Republic, Hungary, and Poland advances
the findings previously reported in the literature in several ways.
Our results suggest, first, that the concept of privatization of some
representative (average) firm obscures important cross-sectional
variations, since the performance effects of ownership transforma-
tions are significantly different depending on the type of owners to
whom control is given during the privatization process. Indeed,
the postprivatization performance of companies controlled by
certain types of owners is not significantly different from that of
state firms along any one of the dimensions we measured (the rate
of growth of revenue, employment, labor productivity, and costs
per unit of output), while that controlled by other types of owners
is in some respects significantly superior to that of both state
firms and the remaining privatized businesses. Lumping all these
firms together under the common umbrella of "privately owned"
firms and asking whether privatization "works" may thus not
approach the question at the appropriate level of generality, and
hide the "ambiguity" inherent in the process of privatization
[Frydman and Rapaczynski 1994].
In particular, our findings show that in the context of Central
Europe, privatization has no beneficial effect on any performance
measure in the case of firms controlled by insider owners (manag-
ers or employees), and that it has a very pronounced effect on
firms with outsider owners. Explanations of the differences in the
performance of insider and outsider firms have been previously
advanced in the literature [Frydman and Rapaczynski 1994;
Boycko, Shleifer, and Vishny 1996; Hansmann 1996], and while
WHEN DOES PRIVATIZATION WORK? 1155
some of them may be specific to the way privatization works in the

postcommunist societies, others may point to more general phe-
nomena. In any case, the disparate effects of transferring owner-
ship to insiders and outsiders may have important implications
for the design and effectiveness of privatization programs in the
transition economies.
Second, our study indicates that in those cases in which
privatization is effective, its effect is very different depending on
the examined performance measure. In particular, we show that
while the effect of privatization on revenue performance is very
pronounced for certain types of owners, there is no significant
effect of any type of ownership change on cost reduction. We
provide a more exhaustive explanation of this finding in another
paper, but we hypothesize here that the difference is related to the
way in which ownership affects attitudes toward risks and
uncertainty, and that it is of substantial importance for under-
standing the role of ownership in corporate performance.1
We also argue that our findings concerning the effect of
privatization on employment, together with the focus on the
impact of privatization on revenue performance, may require a
modification of the predictions, advanced in the literature [Blan-
chard 1997], of substantial privatization-induced employment
losses in the early stages of the postcommunist transition and
alleviate the oft-expressed fears that postcommunist ownership
reforms may be associated with a socially destabilizing threat of
massive unemployment.
Finally, the findings reported in this paper advance the
results of previous research by controlling for possible group- and
firm-specific differences between privatized and state firms and
among privatized firms with different types of owners. By obtain-
ing fixed-effect estimates of the various effects of privatization and
using different types of control groups, as well as by controlling for
changes in the macroeconomic environment, the study attempts
to deal with most kinds of selection bias that could potentially
affect its results. Thus, our conclusions are to a considerable
extent insulated against arguments that better firms might have
1. The importance of the distinction between cost and revenue restructuring

has been observed by Grosfeld and Roland [1997], who distinguished between
defensive (cost-related) and strategic (revenue-focused) restructuring, and conjec-
tured that a firm's ownership may affect the type of restructuring the firm
undertakes. Using those terms, we do not find that ownership affects the type of
restructuring undertaken but does affect the effectiveness of strategic (but not
defensive) restructuring.
been chosen for all or some privatizations, that state ownership

might have been maintained in order to shore up firms that could
not compete in the market, or that preprivatization restructuring
might have accompanied ownership changes.2
The paper is organized as follows: we begin with a description
of the sample and the specification of the model we use to estimate
the effects of privatization. We next show that looking at the
average effect of privatization, without disaggregating the effects
of different types of owners and controlling for selection bias, leads
to potentially misleading results. We follow by looking at the
effects of privatization for different types of firms and observe
systematic differences between the performance of insider- and
outsider-owned firms. We then perform a number of specification
tests to ascertain the robustness of these differences and examine
the impact of country and sectoral differences.
II. THE DATA
The present study is based on a survey of 506 midsize

manufacturing firms in the Czech Republic, Hungary, and Poland
conducted in the fall of 1994. To avoid problems inherent in
privatization of the industrial "dinosaurs" of the communist era,
the sample was drawn from firms employing between 100 and
1500 persons: the median 1993 employment in the sample was
about 350 full-time employees, and the median 1993 sales were
just above U. S. $6 million. The firms were drawn randomly from
the list of firms provided by the Central Statistical Office in each
country. However, since one of our objectives was to compare firms
with different types of owners, we set a maximum number of firms
to be selected from each ownership category (so that when a
maximum of firms with a certain type of owner was reached,
further firms with the same ownership type were excluded from
the drawing). In this sense, the ownership composition of the
sample may not reflect the composition of the parent populations.
Separate interviews (using different close-ended question-
naires) were conducted in each firm with the chief executive
officer, the chief financial officer, and the chief production officer,
2. The restructuring accompanying privatizations in the West sometimes had

very dramatic performance effects before any change in ownership: British Steel,
for example, is reported to have reduced its employment by 40 percent prior to
privatization without losing any revenues; British Airways reduced its labor force
by the same percentage, while actually increasing the number of flights [Djankov
and Pohl 1997].
each of whom was asked about matters in his particular area of

expertise. An additional questionnaire, requesting annual time
series data for the 1990-1993 period on revenues, labor and
material costs, employment, and taxes, was filled out at each firm
by the accounting department. For privatized firms, the question-
naire requested both pre- and postprivatization data within the
sample period.
Since we are interested in the performance implications of
privatization,3 we eliminated from the original sample all private
firms that were never state-owned (88 firms). The ownership
structure of 86 other firms was in doubt, and consequently, we
excluded them from the subsample as well.4 Of the remaining 332
firms, 87 firms did not provide complete enough data to allow for
an analysis of any aspect of their performance,5 and 27 firms
provided unusable or dubious data. Thus, the largest available
sample, used to evaluate the revenue performance, consists of 218
firms, 90 of them state and 128 privatized. (Since not all of those
firms provided data on all aspects of their performance, the
sample used to evaluate employment performance consists of 209,
and that used to evaluate cost performance of 171 firms.)
In terms of country distribution, 36 percent of the firms were
in the Czech Republic, 42 percent in Hungary, and the remaining
22 percent in Poland. The firms operated in both consumer (food
and beverages, clothing, and furniture) and industrial goods
sectors (nonferrous minerals, chemicals, textiles, and leather),
with 58 percent of privatized firms and 48 percent of state firms in
consumer goods sectors. Practically all state (90 percent) and
3. By a privatized firm we mean an enterprise (partially or totally) privatized

through a privatization of a predecessor state-owned company (or its part) in
which the combined holdings of private parties give them a blocking power. We
consider private parties to have blocking power if they control the percentage of
votes formally sufficient to block major decisions at the general shareholder
meeting. Note that this means that in some (15 percent) of the firms classified as
privatized in this paper, the state remains a majority shareholder. But otherwise
the high concentration of holdings in our sample makes the difference between
blocking and majority power of little significance.
4. Sixty firms in Hungary listed ownership types that we could not classify as
either state or private (primarily because of the presence of corporate entities with
unknown ownership). We also excluded all (26) firms privatized through leasing.
The nature of leasing in Poland and ESOPs in Hungary made it difficult for us to
categorize unambiguously the leased firms according to their ownership, espe-
cially when they were not employee-owned. We checked, however, that the
inclusion of these firms produced no significant changes in the results reported in
this paper.
5. We have no reason to believe that the incompleteness of data for certain
firms introduces any systematic bias "in favor" or "against" any group of firms. The
most common reason for incompleteness was lack of availability or an obvious
misunderstanding of the meaning of certain questions.
privatized (93 percent) firms faced domestic or foreign competi-

tion for their products.
All privatized firms in the sample had highly concentrated
ownership: except for privatization funds, the average holdings of
private parties in the position of the largest owner were majority
holdings. (The privatization funds were in the Czech Republic,
where legal regulations at the time of the survey capped their
individual holdings in any one firm at 20 percent. Even then, the
combined holdings of different funds in a single firm typically
added up to a majority.) This degree of concentration allows us to
identify the firm's ownership type with that of its largest share-
holder.6 Insiders (managerial or nonmanagerial employees) and
foreign investors were the most frequent among the owners (each
was the largest shareholder in about 25 percent of privatized firms),
followed by privatization funds (20 percent of privatized firms); the
state remained the largest owner in 15 percent of sample firms. (Full
distributions of sample firms by ownership type, country, size, and
industrial sector are provided in Appendixes 1-3.)
In what follows, we focus on four aspects of firm performance:
sales revenues, employment, labor productivity (revenue per
employee), and labor and material costs (per unit of revenues). In
the long run, it is profitability, of course, that provides the decisive
measure of overall corporate accomplishment. However, profits
are a very unreliable measure of short-term performance in the
initial stages of the postcommunist transition. The accounting
systems are in flux, disclosure mechanisms are very imperfect,
reporting histories are very recent, and there are no reliable
measures of the cost of capital embodied in the capital stock of the
enterprises. All of these factors constitute serious obstacles to
capturing differences in the profit performance of firms within a
single country, much less across different countries, and made it
impossible to collect reliable data and construct an acceptable
measure of profitability for the firms in our sample.
More importantly, the focus on the separate components of
profitability allows us to bring out the differential impact of
ownership on these components-particularly revenues and
costs-which we consider to be of considerable importance in
understanding the role played by ownership in corporate
performance.
6. The state as the largest owner provides an important exception. As we

explain later, when the state remains the largest owner in privatized firms, the
second largest owner (the largest private owner) is likely to be important.
Table I presents the summary statistics of the annual rates of

growth of revenues, employment, productivity, and labor and
material costs per unit of revenues for the firms in our sample over
the period of 1990-1993. The summary statistics clearly show the
TABLE I
DATA SUMMARIES (1990-1993)
Privatized firms
Average annual State
rate of growth of firms Preprivatization Postprivatization
Revenue
Mean -19.47 -15.62 -5.73
Standard deviation 20.37 23.77 25.54
Minimum -67.16 -57.35 -71.88
25th percentile -32.67 -29.51 -23.25
Median -21.82 -17.08 -8.01
75th percentile -7.70 -5.66 8.09
Maximum 89.15 78.12 80.41
Number of observations 224 100 197
Employment
Mean -9.98 -7.76 -5.80
Minimum -54.03 -46.21 -62.61
25th percentile -16.73 -13.08 -12.35
Median -7.70 -4.29 -4.51
75th percentile -1.65 -0.85 1.26
Maximum 21.01 43.27 51.42
Productivity
Mean -9.19 -7.58 -2.40
Minimum -52.41 -51.92 -54.50
25th percentile -25.19 -24.51 -21.42
Median -11.31 -8.19 -8.45
75th percentile 3.24 6.63 11.64
Maximum 93.67 96.25 98.37
Cost per unit of revenue
Mean 3.73 2.50 -0.78
Minimum -26.69 -35.98 -57.77
25th percentile -4.81 -6.43 -10.58
Median 2.60 0.00 -0.45
75th percentile 11.02 14.44 8.36
Maximum 59.89 41.72 59.42
extent to which the early stages of transition are characterized by

a downward pressure on all performance measures. The collapse
of the COMECON market for the products of many postcommu-
nist enterprises and the loss of other previously captive markets
shrank the revenue base of most firms (in each year between 1990
and 1993, over 80 percent of state and over 64 percent of
privatized firms lost revenues, with most of them losing over 25 of
their sales in the 1990-1991 period alone). With employment
reductions and cost cutting often insufficient to catch up with the
collapse of sales, the pressure of the transition drove up the costs
per unit of revenue.7
But if Table I shows the extent of the decline of performance of
all firms in the first four years of the transition, it also offers a
glimpse into the effect of ownership change: postprivatization
averages for privatized firms are higher than those for state firms,
showing considerable performance improvements, particularly in
terms of revenue growth.
III. ECONOMETRIC CONSIDERATIONS
We evaluate the impact of privatization on firm performance

using a standard panel data treatment evaluation procedure
[Ashenfelter and Card 1985; Heckman and Holtz 1989] with
privatization viewed as the "treatment" variable.8 The procedure
evaluates the group subjected to the treatment (privatized firms)
against the nontreatment group (state firms), while controlling for
potential pretreatment (preprivatization) differences between the two
groups. Annual rates of growth of performance measures (revenue,
employment, etc.) are used to evaluate the impact of privatization.
We begin with the following baseline specification of the
fixed-effects (FE) model. Let i index individual firms, j index their
ownership type as designated in this paper (e.g., state or priva-
tized, or privatized to a particular type of owner), t index time
(year), and let yijt, the outcome variable, be the rate of growth
performance measure for firm i between (t - 1) and t:
7. The decline in output and employment of state firms in the region has been
discussed by, among others, Blanchard, Commander, and Coricelli [1994]; Pinto
and van Wijnbergen [1994]; and Balcerowicz, Gray, and Hasi [1997]. Blanchard
[1997] reviews the evidence and provides further references.
8. Recent applications of this procedure include the evaluation of the effects of
strengthening workers' incentives on productivity in Chinese state-owned enter-
prises [Groves et al. 1994], the effects of arrests on employment and earnings of
young men [Grogger 1995], and the effects of malpractice liability reforms [Kessler
and McClellan 1996].
(1) Yjjt = Oj + PijtIj + Xijt-lW + Dctb

Pijt is the treatment variable equal to 1 if firm i operates as
ownership typej firm in period t and 0 otherwise. Xjjt-1 is the level
of a given performance measure at the beginning of the period for
which the rate of growth is computed (e.g., if the rate of growth of
revenue is computed for the 1991-1992 period, Xijt-1 is the level of
revenues for 1991), included to control for differences in the initial
conditions (such as firm size or extent of inefficiency).9 Dt is a set
of country-year dummies controlling for possible differences in the
macroeconomic environment of the three countries, and it is the
error term.
The fixed group effects ajss are assumed to capture group-
specific characteristics of cross-sectional ownership group j and
gauge the average performance of firms of ownership typej in the
absence of the privatization "treatment." c-j refers to the owner
ship group j used in the analysis rather than to the individual
ownership type of the sample firms. The fixed-effects specification
(1) assumes that firms grouped by ownership types have similar
distributions of unobservable characteristics that influence perfor-
mance outcomes and is intended to control for differences in such
characteristics between different ownership groups, such as those
between state firms and the various types of privatized companies
or those among privatized firms with different types of owners.
Equation (1) thus controls for possible selection bias stemming
from nonrandom selection of firms for privatization in general or
privatization to particular types of owners.
The coefficients of primary interest are I3's, which measure
the performance contrasts between privatized and state firms; we
term them the privatization (or ownership) effects. We estimate
these effects for (i) all privatized firms combined, (ii) privatized
firms controlled by different categories of owners (e.g., workers,
managers, privatization funds, or foreign investors), and (iii)
groupings of insider-owned and outsider-owned privatized firms.
We follow estimation of baseline specification (1) with a
9. In Table II we report the coefficients for the average impact of the level of
initial performance (across the ownership types). Separating these effects for
different ownership groups did not yield any significant differences or affect any
other results reported in this paper. For some general caveats concerning the role
of the initial level effect, see subsection VIJ.A below. In order to make sure that the
inclusion of the initial performance level variable in specification (1) did not yield
spurious results, we reestimated all results in this paper using alternative
specifications that did not include this variable. None of the reported results were
significantly affected.
number of additional specifications to test the significance of

sectoral and time-specific factors. Those specifications include
sector dummies Sij, and time to/from privatization dumm

In order to test whether the effects of privatization differ across
different sectors, time, and macroeconomic environments, we also
estimate specifications with variables interacting various combina-
tions of sectoral, time, country, and privatization dummies.
The validity of any assessment of privatization effects de-
pends critically on the ability to control for selection bias stem-
ming from possibly nonrandom selection of firms for privatization.
As we already noted, fixed-effect specification (1) controls for such
bias on the assumption that the firms within each ownership
group have similar unobserved characteristics correlated with
performance outcomes. But if an unobserved characteristic influ-
encing a performance outcome is not related to ownership (for
example, if better firms are privatized earlier), controlling for
ownership-type group fixed effects (atj's) does not control fo
resulting selection bias (in the example just cited, privatization
effects (A3j's) could reflect the stronger performance of the

privatized firms relative to those privatized later, rather than the
effect of privatization itself). To eliminate the possibility of this
kind of selection bias, we estimate (in Section VII) a model using
firm- (rather than group-) specific fixed effects ((x's).
But even the firm-fixed-effects model controls for selection
bias only to the extent that the unobserved firm characteristics
correlated with performance outcomes are indeed "fixed" (con-
stant over time) and are captured during the preprivatization
period by the performance measures we examine (the rates of
growth of revenue, employment, productivity, and cost). (This
assumption would be violated, for example, if some firms were to
have better management, but the effects of this would not be
visible in the firms' performance during the early period of the
transition because company turnaround takes some time.) We
deal with this problem in part by contrasting the 1990-1993
performance of firms privatized in the 1990-1993 period with that
of firms which were privatized later (in 1994) and thus were
selected for privatization (and presumably have all the character-
istics distinguishing selected firms from those that will remain
state-owned), but not yet privatized during the period of compari-
son. This test, in effect, compares the privatized firms with what
they would have been but for the fact of privatization.10 Even this
method does not take care of all potential forms of bias, such as
would occur, for example, if better firms were to be selected for
privatization, but this fact would remain undetectable in the
entire preprivatization period because management would inten-
tionally depress performance before privatization in order to be
able to acquire the firms at lower prices. We are, however, able to
exclude this possibility directly, by contrasting the preprivatiza-
tion performance of managerially controlled firms with that of the
firms controlled by other types of owners.
IV. AVERAGE EFFECTS OF PRIVATIZATION
Table II provides FE estimates of equation (1) for all four

performance measures, first for all privatized firms grouped
together (the left-hand side column in each section of the table),
and then separately for firms with particular types of owners.1
A. The Effects of the Transition
Before going farther, it is worth noting that the significance of

the initial level of performance in all equations reported in Table
II is common to all firms,12 and most likely related to the effects of
the transition. The significantly negative coefficients of the initial
levels of revenues and employment (which correspond to firm size)
suggest that the larger the firm, the harder it is likely to be hit by
the shock of the transition. This may reflect a generally true
proposition that larger firms tend to be more difficult to restruc-
ture, but the effect is probably exacerbated by the fact that the
larger firms were more likely to have had more bloated employ-
ment and to suffer from the COMECON collapse. In the case of
efficiency-related measures-cost and productivity-the initial
level of performance has a different meaning: the higher the
initial inefficiency (the higher the cost-per-unit-of revenue or the
lower the initial productivity), the easier it is to improve.13
10. The use of subjects selected for treatment in the future as a control group
for those already receiving it is the program evaluation procedure used in, for
example, Grogger [1995].
11. Recall that, unless otherwise noted, we identify the ownership type of a
firm with that of its largest owner.
12. But see footnote 8 and subsection VII.A.
13. The importance of initial productivity levels for later productivity growth
has been previously observed in Claessens, Djankov, and Pohl [1997a].
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We would also like to note that the group effects-which are

not reported in Table II-are negative in the revenue and employ-
ment equations and positive in the cost equation for all ownership
groups. This is in part expressive of the already mentioned
general downward pressure of the postcommunist transition on
all types of firms: the rapid marketization of the environment, the
collapse of the COMECON market, and the general shocks of
macroeconomic reforms depressed the employment and sales
performance and contributed to the rapidly rising costs of doing
business.
B. The Ambiguity of the Average Effects of Privatization
We begin by examining the "average" effect of privatization,

regardless of the type of owners that come to control the priva-
tized firms. This is the way most observers frame the question-
presumably because of its conceptual simplicity and practical
significance-and this is the question tested in most studies
reported in the literature.
On the face of it, the results in Table II appear to provide
considerable support for the proposition that privatization in
general simply "works," in that it significantly improves the
revenue and employment performance of the privatized firms.
The latter result seems particularly important, given that reform-
ist politicians in the postcommunist countries often feared the
social cost of privatization-induced unemployment; they might
thus be heartened to learn that apparently (and surprisingly) the
opposite is the case. Moreover, the employment benefits of privati-
zation appear not to come at the expense of declining labor
productivity or increasing costs per unit of revenues. Finally,
although most studies do not test for selection bias, the results in
Table II would suggest that there is no ownership-related bias in
the selection of firms for privatization, since the F-tests do not
show significant differences between group effects in any equation.
Nevertheless, there are problems with the claim that privati-
zation on average "works," and they suggest that the issue is not
being addressed at an appropriate level of generality. The prob-
lems become easy to see when the averages are disaggregated,
and the privatization effects in firms with different types of
owners are examined separately. Note, for example, that the
privatization effect in employee-owned firms is insignificant for all
performance measures, and except for greater employment growth,
the same is true in the case of managerially owned firms-
controlling for differences in preprivatization characteristics of

these types of firms, their postprivatization performance is thus
basically indistinguishable from what it would have been if they
had remained state-owned, except that some of them fail to
restructure employment. On the other hand, privatization is
estimated to add over eighteen percentage points to the annual
revenue growth of a firm privatized to a domestic financial
company and to raise its productivity growth by over sixteen
percentage points. Similar results obtain for firm transferred to
foreign owners, the annual revenue performance of which goes up
by over twelve percentage points after privatization. Despite the
fact that the relatively small sample of privatized firms with
particular types of owners makes for higher standard errors of
disaggregated results, the performance results of certain types of
privatized firms are also statistically different from each other:
the revenue and productivity performance of firms owned by
domestic financial companies, for example, is significantly higher
than that of the firms owned by managers. (The difference with
respect to worker-owned firms is equally pronounced.)
The concept of a "privatized company" thus appears to be a
heterogeneous collection of firms, some of which could be more
plausibly grouped together with state firms than with each other.
To lump them together is most likely to ignore the complexities of
the way in which ownership affects corporate performance in
favor of potentially misleading generalizations. Indeed, while
privatization is clearly extremely effective in some cases, the truly
interesting issue, both from a theoretical and a policy perspective,
is how they can be identified and properly analyzed. If this is not
done, privatization policy may have disappointing outcomes, with
sometimes negligible or no effect on performance.
Note also that privatization, when it does produce perfor-
mance improvements, works very differently with respect to
different performance measures. The improvements are the most
pronounced in terms of revenue growth.14 On the other hand, in no
category of ownership are there any significant gains vis-A-vis
state firms in terms of cost reduction. This differential impact of
privatization in terms of different performance measures is also
something to which attention must be paid, and the general focus
on whether privatization "works" may not be helpful in trying to
14. It might be noted here that our revenue data report only figures stemming
from product sales and do not include income from any sales of assets.
understand the nature of private ownership and its impact on

corporate performance.
V. OUTSIDER AND INSIDER PRIVATIZATION
The problems with the concept of privatization in general

raise the issue of the appropriateness of the level of generalization
at which the discussion of the effects of privatization should take
place. An obvious possibility would be to limit oneself to discus-
sions at the greatest available level of disaggregation which would
be both concrete and least susceptible to statistical and conceptual
inconsistencies. In what follows, we will look further at the effects
of privatization at this level.15 But there are important advan-
tages to some generalizations. The limitations of sample size
make it difficult to perform many significance tests at a highly
disaggregated level and a number of legitimate results become
unavailable. More importantly, generalization, even if not devoid
of risks, allows for conclusions of greater theoretical interest and
practical implications.
On the basis of a mixture of endogenous and exogenous
criteria, we believe that, at least in the context of the postcommu-
nist transition, the distinction between firms privatized to corpo-
rate insiders (management or employees) and those controlled by
outsider owners provides more consistent and informative gener-
alizations about the effect of privatization on corporate perfor-
mance than the concept of privatization in general.
The special character of insider versus outsider privatization
has been the subject of considerable discussion in the literature
concerning the region: e.g., Frydman and Rapaczynski [1994];
Boycko, Shleifer, and Vishny [1995]; Frydman, Pistor, and Rapa-
czynski [1996]; and Earle and Estrin [1996]. Generally speaking,
privatization programs that convey property rights to enterprise
insiders are much easier to execute from a political point of view,
and nearly all postcommunist countries have tried to make their
programs politically more acceptable by giving preferential treat-
ment to the managers and workers of the privatized enterprises.
Despite certain misgivings, the Russian reformers went the
farthest in this respect, conferring on enterprise insiders control
of about 70 percent of privatized firms, in the hope that secondary
15. See also Frydman, Gray, and Rapaczynski [1996] for a number of studies
discussing the characteristics of different private owners in the transition environ-
ment.
markets would later correct for any potentially suboptimal initial

ownership structure necessitated by the political compromise
required to make privatization a reality. The assumption behind
many such programs was the belief that, in the environment of
the postcommunist transition, the fact of privatization, with its
concomitant depoliticization and greater efficiency, is more impor-
tant than any particular way in which firms are privatized
[Djankov and Pohl 1997]. But in light of the preceding section, it
may be quite important to look at the relative performance impact
of insider and outsider privatization and separately examine their
effectiveness.
A. Insider-Owned Firms
In the contexts of other economies, grouping together firms

owned by managers and employees may be controversial, since
the drawbacks of employee ownership are more or less universally
recognized [Hansmann 1996],16 while managerial ownership, at
least at certain levels, is usually believed to be quite effective
[Morck, Shleifer, and Vishny 1988]. In the context of Eastern
Europe, however, managerial ownership has many special charac-
teristics. Managers had been selected under the old regime
according to criteria inapplicable in a market economy and their
mode of operation, shaped by the communist routines, may be
hard to change under the new conditions [Shleifer and Vasiliev
1996].17 Managers in the region are also rarely able to come up
with the capital necessary to acquire their firms under competi-
tive conditions, and they normally acquire their stakes on prefer-
ential terms offered by special programs designed to favor corpo-
rate insiders. For legitimacy reasons, such programs usually
include preferential terms for employees as well; indeed, some-
times, as in the leasing program in Poland they even condition the
managers' right to acquire their stakes on a certain level of
16. Despite the fact that employee ownership is considered ineffective by most
commentators, it has been argued by Earle and Estrin [1996] that employee
ownership in Eastern Europe is suitable for firms that, for political or other
reasons, cannot be privatized to other, more appropriate owners, since it is better
than continued state ownership. Our results cast doubt on the validity of this
argument and speak against the effectiveness of privatization programs that put
workers (or, for that matter, managers) in control.
17. Indeed, managerial turnover has sometimes been taken as a primary
indication of restructuring in the region [Frydman, Pistor, and Rapaczynski 1996],
and others [Barberis et al. 1996] have argued that the flow of new managerial
blood is the main engine of the greater efficiency of privatized firms. For evidence
that incentives may matter more than human capital, see Frydman, Hessel, and
Rapaczynski [1998].
employee participation [Frydman, Rapaczynski, and Earle 1993].

Although such ownership combinations are usually dominated by
managers, they may involve serious limitations on corporate
behavior [Frydman, Pistor, and Rapaczynski 1996]. All of these
factors probably explain the fact that firms owned by managers
and employees in our sample are statistically indistinguishable
from each other in terms of their postprivatization performance,
which makes it quite natural to look at them together.
As can be seen from Table III, the performance of insider-
owned firms as a group is not significantly different from that of
state firms, except for employment behavior, where insider-owned
firms tend to lay off fewer workers than state (and other priva-
tized) firms. Given the lack of significant improvement in revenue
and productivity performance (as compared with state firms), the
positive impact of insider privatization on employment, while
perhaps politically comforting, is a disturbing phenomenon, sug-
gesting more of a lack discipline than any desirable characteris-
tics of postprivatization employment behavior.
The hazards of insider ownership in the transition environ-
ment are apparent from the experience of Russian privatization.18
But our results suggest that a transfer of ownership to insiders
may also be ineffective in countries where the idiosyncrasies of
Russian privatization are absent.
B. Who Is an Outsider?
While the grouping of insider-owned firms, at least in the

context of the postcommunist transition, seems to make good
sense from both the substantive and statistical points of view, the
use of a general category of "outsider-owned firms" is potentially
more questionable. Clearly, the performance variability among
the outsider owners in our sample is quite large, and it is likely to
reflect the complexities of the ways in which different types of
ownership affect company behavior. For this reason, we begin by
examining separately the performance of firms with different
individual types of outsider owners and providing substantive
reasons for grouping them together. It should also be noted at the
outset that, except for the employment performance of foreign-
owned firms and the revenue performance of firms owned by
domestic nonfinancial companies, the performance results of all
18. As we already noted, Russian privatization made insiders dominant in

about 70 percent of privatized firms, and evidence cited in Earle [1998] points to
the absence of substantial improvements in the performance of insider-owned
firms in Russia. See also Frydman, Pistor, and Rapaczynski [1996].
TABLE III
PRIVATIZATION EFFECTS: OUTSIDERS VERSUS INSIDERS
Cost per unit

Revenue Employment Productivity of revenue
Privatization effects
Outsidersa 9.70* 1.51 9.16** -4.36
(3.64) (2.06) (4.19) (3.33)
Insidersa 0.68 7.72* -7.92 1.12
(5.28) (2.82) (5.78) (4.45)
Country-year effects
Czech Republic
Year 2 16.00* -13.08* 35.69* -0.96
(4.72) (2.55) (5.42) (4.80)
Year 3 17.13* -1.63 13.75* 2.51
(4.63) (2.51) (5.28) (4.39)
Hungary
Year 1 3.47 1.29 5.00 -1.99
(4.47) (2.33) (5.08) (4.31)
Year 2 12.63* -1.80 19.31* -4.06
(4.47) (2.37) (5.03) (4.20)
Year 3 8.87** -4.26*** 18.10* -5.01
(4.52) (2.40) (5.06) (4.24)
Poland
Year 1 3.03 -5.68*** 8.11 -3.59
(5.67) (2.92) (6.24) (5.30)
Year 2 10.35*** -9.36* 18.79* -7.18
(5.38) (2.83) (6.01) (4.97)
Year 3 9.98** -3.25 11.71** 0.19
(5.02) (2.66) (5.59) (4.64)
Initial level of -0.17* -0.29* -0.22* -0.19*
performance (0.05) (0.09) (0.05) (0.03)
Test statistics for n = 513; n = 493, n = 466, n = 347,
the model F= 7.05* F = 6.98* F= 8.14* F= 5.27*
adj R2 = 0.13 adj R2 = 0.14 adj R2 = 0.17 adj R2 = 0.14
Test statistics for F = 1.24 F = 0.45 F = 0.68 F = 0.42
the equality p = 0.29 p = 0.64 p = 0.51 p = 0.66
of firm effects
*p c 0.01, **p c 0.05, ***p c 0.10. Standard errors are in par

bold-faced. The initial levels of revenue are in US$1,000,000s, the initial employment is in 100's of full-time
employees, and the initial productivity is in US$1,000s per full-time employee. Year 1 refers to 1990-1991
period, year 2 to 1991-1992, and year 3 to 1992-1993. Group effects are not reported here.
a. A dummy variable set to 1 for the postprivatization performance of privatized firms where the given
type of owner is the largest shareholder, 0 otherwise.
outsider firms in our sample are statistically indistinguishable

from each other on all performance measures.
Foreign investors quite uncontroversially belong in the cate-
gory of outsider owners, and not unexpectedly, their presence
brings a significant improvement in revenue performance. If

anything, given the financial resources, managerial know-how,
and corporate governance expertise that is often believed to give
foreign strategic investors (and nearly all foreign owners in our
sample belong to this category) an instant advantage over other
owners, it may be a bit surprising that their impact is not
significantly stronger than that of any domestic outsiders. Our
data do not allow us to ascertain why this putative advantage does
not fully materialize. It may be that foreign owners are initially ill
at ease in an environment that is relatively alien to them; it may
be that the transfer of technological and managerial know-how
requires more time than our sample period allows; it is also
possible that domestic owners (at least those who act as real
agents of change) may have less restricted access to both external
financing and know-how than is often believed.
Foreign-owned firms also appear "softer" on employment
reductions than all other categories of firms: the privatization
effect for foreign-owned firms is the only significant outsider
ownership effect in the employment equation. Inasmuch as the
revenue performance of these firms is not significantly better than
that of firms controlled by other types of outsiders, the employ-
ment effect cannot be attributed to revenue growth, and the
absence of significant productivity gains tends to confirm some
"softness" of employment policies.
Again, our data allow only speculative interpretations of this
performance. It may be that foreign owners can afford a longer-
term perspective and are simply not as aggressive in cutting
employment as the "hungrier" domestic owners. It may also be
that foreigners are reluctant to fire workers in an environment in
which mistrust of foreign investors is common, or they may be
simply prevented from doing this by explicit or implicit agree-
ments in their purchase contracts.
The inclusion of privatized firms controlled by domestic
financial companies (in our sample primarily Czech privatization
funds) among the outsider-owned firms is not controversial either
in terms of substance or their performance. What does deserve a
separate note is the contrast between the performance of domestic
financial firms and domestic nonfinancial companies, especially in
light of the oft-expressed claims that financial investors are
generally less active than "strategic" investors. (The latter were in
fact given preferential treatment among investors by the privati-
zation authorities in Hungary and Poland.) Financial institutions
created in connection with mass or voucher privatization pro-

grams have sometimes also been viewed as "mutant" owners,
inherently passive and largely ineffective. The strong perfor-
mance of the firms in which privatization funds are the largest
owners tends to make such judgments look unfounded.'9
By comparison, the revenue growth of firms owned by domes-
tic nonfinancial companies is not only significantly slower than
that of firms owned by privatization funds but is not significantly
better than that of state- or insider-owned firms. (In fact, the
negative privatization effect for firms owned by domestic nonfinan-
cial companies, even if statistically insignificant, is the only case
in which the average revenue performance seems to lapse with
privatization.) Such performance may also provide some support
for a common belief that this type of ownership (frequently
cross-ownership) is sometimes a "defense tactic" used by insiders
in control of postcommunist enterprises to insulate themselves
from outside monitoring. For both of these reasons, grouping
firms controlled by domestic financial companies with the outsider-
owned firms may be questionable, since they introduce an element
of heterogeneity into the grouping and may in fact be masking
insider ownership. We recognize this problem, but it is not serious
in our sample: we have reestimated all the results reported below
both with and without the domestic nonfinancial companies
among the outsider owners and the significance of all the coeffi-
cients remained unchanged, while their magnitudes remained
very similar. Thus, although we follow the convention of including
domestic nonfinancial firms among outsider owners, none of the
results we report depend on this inclusion.
The performance of firms controlled by large individual
shareholders also appears less strong than that of some other
outsider-owned businesses. In fact, although the magnitude of the
privatization effect suggests that, on average, privatization to an
individual owner adds over 7.5 percentage points to the revenue
19. The Czech privatization funds have been the subject of much criticism.
Their performance has been blamed by some for the slowing down of the Czech
growth rate, and allegations of fraudulent asset diversions have been viewed as
undermining investor confidence in the Czech economy. We take no stand with
respect to these allegations, most of which are addressed to the behavior of the
Czech funds in the period after our study. For a discussion of the structure and
performance of the Czech privatization funds as well as potential problems facing
them, see Claessens, Djankov, and Pohl [1997b], and Coffee [1996]. It should also
be noted that despite the inclusion of country dummies in the equation reported in
Table II, the strong performance of privatization funds cannot be fully separated
from their Czech environment, since no contrast with financial institutions in
Hungary and Poland was possible in our sample.
growth of a firm and reduces its cost growth by over 8 percentage

points, neither of these coefficients is statistically significant.
Since most of the firms controlled by individuals in our sample
come from Hungary, where nontransparent "parking" arrange-
ments are quite common [Frydman, Rapaczynski, and Earle
1993], perhaps the effective ownership of these firms is less
clear-cut than it appears. Or perhaps individual owners in
Eastern Europe are financially more constrained, and conceivably
their presumably undiversified investments make them more
conservative and less innovative than other outsider owners. But
in any case, the inclusion of firms controlled by individuals in the
outsider-owned category is relatively unproblematic.
Last, the proper classification of partially privatized firms in
which the state remains the largest owner requires some discus-
sion. While in some countries partial privatizations may reflect
the governments' unwillingness to relinquish control of enter-
prises they consider of continued political or strategic importance,
continued partial state ownership in Central Europe, especially in
smaller firms like those in our sample, often results from the
state's failure to find appropriate new owners or from possession
of various partial holdings with respect to which the state has no
intention of exercising its governance rights. (In the Czech
Republic, for example, the state remained a partial owner if the
market for a firm's shares failed to clear in a complex multistage
voucher auction.) Consequently, the state as a partial owner is
often considered temporary, passive, and allowing the other
owners to take control.20 This view is supported in our data by the
fact that the CEOs of the sample firms in which the state was the
largest owner consulted about major decisions with the second
largest owner in 12 out of 16 cases, while the CEOs of the other
privatized firms did so in only 47 out of 97 cases (the difference is
significant at the p < 0.01 level).
If the hypothesis of state passivity is correct, it suggests that
the performance of privatized firms in which the state is the
largest owner has less to do with the state itself than with its
largest private partners. To verify this, we reestimated the
equation reported in Table II, while splitting the firms in which
20. Even with respect to enterprises in which the state is the sole owner,
neglect is often the rule. But whereas the state as a partial owner can free-ride on
the efforts of other owners, the firms controlled by the state as the sole owner suffer
from the absence of monitoring. For the behavior of the state as a partial owner in
Central Europe, see Pistor and Turkewitz [1996].
the state was the largest owner by the identity of the second
largest owner. The results confirm our conjectures: the perfor-
mance of firms in which the state is the largest owner depends on
the identity of the second largest shareholder; in fact, it parallels
very closely the performance of firms in which that shareholder is
the largest owner.21 The passivity of the state and the role of other
private owners in the companies in which the state is nominally
the largest owner thus makes it legitimate, we believe, to group
these businesses with the other outsider-controlled firms.22
C. Outsider-Owned Firms as a Group
The most important result in Table III is the strong impact of

privatization on revenue and productivity performance of the
firms privatized to outsider owners. Privatization to an outsider
owner adds, on average, nearly ten percentage points to the
annual rate of revenue growth of a firm23 and about nine
21. The privatization effects in terms of revenue and productivity for firms in
which the state is aligned with foreign owners or domestic financial institutions
are 17.21 (10.09) and 18.89 (12.09), respectively, and both are statistically
indistinguishable (p = 0.85 and p = 0.87, respectively) from the privatization
effects in firms in which these owners are the largest shareholders. But when the
state is joined by private nonfinancial firms, the two effects drop to 0.16 (10.51) and
6.61 (12.81), respectively, which are again statistically indistinguishable (p = 0.84
and p = 0.73) from the privatization effects for firms in which domestic nonfinan-
cial companies are the largest owner.
22. This special situation of Central Europe probably also accounts for the
difference between our results and those of the prior research from other countries
suggesting that partial privatization fails to produce any improvements in
performance and that mixed state-private firms often do worse than fully
state-owned companies [Boardman and Vining 1989]. In our sample, by contrast,
the magnitude of the ownership effect on the revenue and productivity perfor-
mance of the partially privatized firms is roughly comparable to that in firms
owned by foreign investors or private financial companies. Although the contrast
between partially privatized and fully state-owned firms remains insignificant, the
very large standard errors of the estimates for partially privatized companies are
likely to be due to the heterogeneity of the category of partially privatized
companies (stemming from the heterogeneity of the second largest owners).
23. The effect of privatization to outsider owners in the revenue equation
could not be attributed in any significant degree to mergers or acquisitions. Apart
from the impressive productivity growth that accompanies the revenue improve-
ments, there is also no evidence of any mergers or acquisitions in our sample. We
examined the annual revenue changes of all privatized firms in the sample, and for
all those that increased their revenues by over 25 percent within a single year, we
evaluated the employment changes. The highest annual employment increase
among those firms was about 18 percent, and it was a small firm that increased its
employment from 176 to 209 employees-hardly a merger-generated growth. The
next highest annual employment increases among the same group of firms were
14.5 percent and 2.5 percent, respectively, indicating no major mergers or
acquisitions in our sample. Another distortion could have been introduced if state
firms were more likely than privatized companies to split or otherwise contribute a
part of their assets to other entities. On this issue we have direct evidence, and it
excludes such a possibility: twenty privatized firms and only eleven state firms
contributed some portion of their assets to other entities, and the effects of these
percentage points to productivity growth. These effects are also

quite robust, driven neither by a handful of well-performing firms
nor by a few poorly performing state firms and they remain
virtually unchanged (9.22 (3.36) in the revenue and 9.99 (3.88) in
the productivity equation) when the data set is trimmed at the
fifth and ninety-fifth percentiles.24 Nor can these results be
attributed to possible performance "dips" in the years immedi-
ately preceding privatization either:25 adding a "time to privatiza-
tion" index in equation (1) yields revenue and productivity con-
trasts between outsider-owned and state firms of 3.11 (3.86) and
0.69 (4.40) one year prior to privatization and 3.65 (3.88) and 1.80
(4.12) two or more years prior, none of them significant.
Moreover, the revenue and productivity impact of privatiza-
tion among outsider-owned firms is not only pronounced but quite
immediate as well. We estimated equation (1) with the privatiza-
tion dummies Pijt decomposed to index the years since priva
tion. For outsider-owned firms, the privatization contrast in the
revenue equation was 8.54 (4.31) for the first year of postprivatiza-
tion performance (despite the fact that only a part of that year
properly belonged to the postprivatization period), and averaged
10.65 (3.94) for the following years, both contrasts significant; in
the productivity equation, the two contrasts were 9.42 (5.05) and
8.94 (4.56), respectively, both significant again.26
contributions on employment and revenue measures used in our equations were

similar for state and privatized firms.
24. In fact, the revenue and productivity effects survive removal of more
substantial portions of the worst state firms. When 10 percent of the bottom-
performing state firms are disregarded, the privatization effect in the revenue
equation remains at 9.80 (3.50), and with 40 percent of bottom-performing state
firms removed, it is still at 9.21 (3.84). Both of these values are significant at p <
0.05 (The removal of bottom-performing state firms, of course, changes the group
effects.) The productivity effects parallel these results. This means that our results
are not skewed by any possible survival (exit) bias due to a greater rate of
liquidations among this type of privatized firms (that might boost their average
revenue growth figures in our sample). Also, although we do not have any other
way of capturing precisely the differential impact of possible bankruptcies on state
and privatized firms, independent evidence in fact points to a significant number of
closures of state firms under state enterprise laws (particularly in Poland) and
relatively few closures (as opposed to reorganizations) of midsized and large state
or privatized firms under bankruptcy laws in the three countries [Balcerowicz,
Gray, and Hashi 1997], so that the existence of a bias due to greater exit of
privatized firms is not likely to begin with.
25. Such an effect could be expected if the state were to privatize to outsiders
firms that found themselves in temporary difficulties, which could then be
expected to end after privatization, without any lasting improvement in the longer
term performance record.
26. For insider-owned firms, the corresponding revenue contrasts were -3.78
(6.38) and 4.80 (6.19), and the productivity contrasts -6.84 (6.92) and -9.01 (6.90),
none of them significant.
It is important to note that the strong revenue and productiv-

ity impact of privatization to outsider owners is accompanied by
the absence of any pronounced employment effects: the privatiza-
tion contrast to state firms in the employment equation is both
small and insignificant. Indeed, privatization to outsiders does
not have a significantly negative effect on employment in the case
of any particular type of outsider owner, and as we have seen, it
leads to significantly fewer layoffs (as compared with state firms)
in the case of firms with foreign owners. This is quite important,
given the often expressed beliefs (or fears) that privatization
might lead to large and potentially destabilizing unemployment.
This fear was based on the assumption that private owners would
be more aggressive in their restructuring efforts and that, given
the endemic overmanning of the postcommunist enterprises, this
would necessarily involve large layoffs. That the firms privatized
to outsiders engage in significant restructuring is confirmed,
among other things, by the fact that they achieve significant
productivity gains relative to both state companies and the firms
privatized to insiders. But the gain does not seem to come at the
expense of increased unemployment, and the explanation for this
lies undoubtedly in the privatized firms' ability to improve their
revenue performance. In fact, even the difference in the employ-
ment effect of privatization to outsider and insider owners, despite
what we have interpreted as the lax employment behavior of the
latter, is not statistically significant. This means that the negative
impact on employment of both macroeconomic shocks and firm-
level restructuring is not exacerbated by effective privatization, at
least for midsized manufacturing enterprises.27
The link between the revenue and employment effects of
privatization suggests an alternative focus for theoretical analy-
ses of the effects of privatization on employment. Previous analy-
ses focused primarily on the cost-reducing aspects of restructur-
ing. (For example, in his model of the dynamics of employment
changes in state firms before and after privatization, Blanchard
[1997] predicts that the restructuring accompanying privatization
results in an initial drop of employment, followed by capital
accumulation and subsequent shifts of the demand for labor.) Our
evidence, however, suggests that omitting the strong revenue
27. That privatization of small businesses (mostly shops) does not necessarily
have a negative effect on employment has been observed by Barberis et al. [1996].
Their findings leave open the question of whether the absence of layoffs is linked to
the growth of sales or to other factors (such as employee ownership, for example).
effect of privatization to outsider owners substantially overstates

the employment losses from postprivatization restructuring. From
this perspective, effective privatization tends to make the U-shape
of the employment path, postulated by Blanchard, more shallow.
Beyond its theoretical implications, this result is also of
considerable practical importance, in light of the common concern
of reformist policy-makers in the region who fear that privatiza-
tion may add to their political difficulties. Our results indicate
that effective privatization (even when transferring ownership to
the type of owners likely to engage in aggressive restructuring) is
not a matter of trading off long-term benefits for short-term costs,
since the relatively immediate impact of such privatization on
revenue growth suggests that there may be no significant employ-
ment costs in this respect: once the macroeconomic reforms are in
place and the system of pervasive subsidization is stopped or
significantly reduced, privatization to effective outsider owners
seems to be the dominant employment strategy for state sector
firms in the transition economies.28
D. Macroeconomic, Sectoral, and Country Effects
The estimates of country-year effects reported in Table III

capture the effects of macroeconomic changes in the three coun-
tries on firm performance. As expected, the first year interactions
generally lack significance, while those for the subsequent years
tend to be significant (except for the cost equation), indicating that
part of the revenue and productivity performance improvements
can be attributed to changes in the macroeconomic environment
between 1990 and 1993. But since the baseline specification (1)
already includes country-year dummies, the significance of the
privatization effects reported earlier indicates that privatization
to outsider owners improves firm revenue and productivity perfor-
mance over and above any improvements due to better macroeco-
nomic conditions.
28. Large-scale direct or indirect subsidization of employment in state

firms-a common policy in many postcommunist countries-would, of course,
mean that privatization could lead to more unemployment, as was documented in
the case of Mexico by La Porta and L6pez-de-Silanes [1997]. A seemingly contrary
result in Megginson et al. [1994] was based on a small sample containing firms
that had laid off workers prior to privatization (so that later employment increases
are spurious). (We express no opinion here concerning any comparisons of the
employment effects of privatization with the employment effects of a policy
fostering the growth of a new (nonprivatized) private firms.)
In order to test for the presence of any sectoral effects, we also

estimated a number of additional specifications of equation (1)
involving sector indicators and their interaction with ownership
indicators. First, we augmented equation (1) with two-digit
industry dummies and found them generally lacking significance
and leaving the estimates of the privatization effects virtually
intact.29 We then modified the baseline specification (1) by includ-
ing interactions between ownership and sectoral dummies, but
regardless of the specification we used, we were not able to detect
any significant performance differences between different sectors,
and the magnitude and significance of the privatization effects
were not affected.30
We also looked separately at the effects of privatization in the
three countries. Given the similarities in macroeconomic effects
across countries, we modified the baseline specification (1) by
using additive (calendar) time dummies to control for macroeco-
nomic effects, while interacting the country and ownership vari-
ables. The results indicate that while the revenue effects of
privatization to outsiders are strongly significant in the Czech
Republic (15.77 (5.04)) and Poland (21.29 (7.81)), privatization is
somewhat less effective in Hungary. In fact, only when firms
controlled by domestic nonfinancial companies are excluded from
the category of outsider owners does the privatization effect in
Hungary (10.20 (5.43)) become significant, and the difference
between the three countries becomes insignificant (p = 0.23).
The apparent weakness of privatization effects in Hungary is
most likely explained by the peculiarities of the Hungarian
29. The revenue effect of privatization for outsider-owned firms (8.91 (3.67))
remained significant, as did the productivity effect (9.17 (4.23)); the employment
(1.33 (2.06)) and cost (-3.54 (3.32)) effects stayed insignificant. (For insider-owned
firms, the respective effects were -0.48 (5.37), -7.72 (5.92), 8.06 (2.85), and 2.52
(4.51).) Those estimates remained virtually unchanged when we combined two-
digit sector indicators into dummy variables identifying consumer and industrial
goods sectors. (The findings reported here are consistent with Pohl et al. [1997].)
30. We could not interact two-digit sector indicators with the ownership
dummies because of a small number of firms in the interactive groupings, so the
two-digit sectors were combined into dummy variables identifying consumer and
industrial goods sectors. With controls for ownership type-sector type fixed effects,
the revenue effects of privatization for outsider-owned firms in consumer (9.25
(4.20)) and industrial (11.70 (6.59)) goods sectors remained significant and not
significantly different from each other (p = 0.68), while the cost effects in the two
sectors (3.86 (3.98)) and (-0.55 (5.57)], respectively) were both insignificant and
statistically indistinguishable (p = 0.62) from each other. Similarly, there were no
significant differences for outsider-owned firms between the productivity and
employment effects of privatization in consumer and industrial goods sectors. We
also tested a variety of other groupings in order to make sure that the results do
not depend on any particular configuration.
privatization programs. In particular, many superficially "out-

sider" interests in the Hungarian web of cross ownerships and
other nontransparent control configurations may in fact reflect a
system of "parking" arrangements designed to safeguard insider
interests ([Frydman, Rapaczynski, and Earle [1993] and subsec-
tion V.B above).
VI. THE CONTRAST BETWEEN REVENUES AND COSTS
While the revenue and productivity performance of outsider-

controlled firms exceeds that of state and insider-controlled firms
by significant margins, the cost effects of privatization are insig-
nificant. The fact that the outsider-controlled firms as a group do
not achieve the cost-efficiencies often expected of privatization
confirms that our previous observation-that the cost effect of
privatization was insignificant for all particular types of private
owners-was not a statistical aberration.3' The reasons for this
difference between the revenue and the cost effect of privatization
are a matter of potential importance and deserve further research
and analysis.
Although uncertainty is quite ubiquitous in corporate prac-
tice, the results of cost-related changes tend to be known to
company insiders with a relatively higher degree of certainty than
those related to revenue generation. Cost-cutting measures are
often a matter of discipline and relatively standard procedures,
with outcomes that involve relatively predictable risks. Revenue
generation, on the other hand, is inherently oriented toward anticipat-
ing future decisions of other agents (customers and competitors) and,
for this reason, not only risky, but also subject to risks that are
hard or impossible to compute on the basis of past history.32
These characteristics of costs and revenues are particularly
true in the environment of the postcommunist transition. The
gross cost inefficiencies of the past-bloated expenditures and the
31. That differences in cost restructuring between state and privatized

enterprises are less pronounced than those related to other performance measures
is also consistent with the observation by Pinto, Belka, and Krajewski [1993], who
note that state enterprises engage in significant cost restructuring.
32. This does not mean, of course, that there are no risks involved in
cost-cutting measures, such as when, for example, decreased maintenance may
raise the risk of breakdowns, or that such risks are insignificant. What is being
claimed here is that these risks, not involving predictions concerning the behavior
of other parties, such as customers or competitors, tend to be better known and to
involve less radical uncertainty.
failure to follow elementary cost-saving production procedures-

are easily identifiable, as are, most often, their most obvious
remedies, which may be politically difficult, but are often a
relatively straightforward matter of managerial techniques.33 On
the other hand, the skills required to restructure the revenues of
most companies-when their old markets have collapsed, imports
have introduced overnight competition from the most advanced
world producers, and buyers have become more careful and
demanding-are not that different from those needed to start a
new business: with some additional constraints (such as the
existing labor force or the already available machinery), the
postcommunist firms must reinvent their products and find
markets in which they can be sold. Revenue restructuring, with
its emphasis on new markets and product innovation can thus be
expected to involve more uncertainty and less routine know-how
than cost-cutting measures.
Judging from the contrast between the effects of privatization
on revenue and cost performance (which are most likely also
responsible for the corresponding effects on productivity and
employment), firms with outsider owners may be, for some reason,
better at handling the unpredictable risks involved in revenue
restructuring. Although we postpone further analyses of this
hypothesis to another occasion, [Frydman, Hessel, and Rapaczyn-
ski 1998] we believe that the contrast between the rather striking
revenue effects of outsider privatization and the consistent ab-
sence of any cost effect is indicative of what privatization is likely
to achieve in general, and goes to the very nature of ownership
and the way it affects corporate performance.
Before proceeding further, it might be useful to provide a
graphic illustration of the impact of privatization on the revenues
and costs of outsider-controlled firms, estimated from the equa-
tions reported in Table III, as well as the contrast between their
performance and that of insider-controlled firms. Figure I shows
the estimated effects of privatization on revenue and cost perfor-
33. To the extent that decision making in state firms is politicized, which is
often seen as a hallmark of state ownership, it may impede efficiency-related (cost)
improvements. But, as we show elsewhere [Frydman, Hessel, and Rapaczynski
1998], politicization, while it does have this effect, is not present in all state firms
to the same degree, and its effect on cost reduction cannot be detected when an
average state firm is examined (although it may be responsible for the somewhat
lower magnitude of the privatization effect for outsider-controlled firms in the cost
equation in Table III). (No disaggregation of the average results for state firms'
changes their inferior revenue performance.)
1A
13 13_
9" 1 l1 12 19" on 199
Coda
IA- A
1m 9 am am 19m 1"a am ama
FIGuRE I
Effects of Privatization on Revenue and Cost Performance
mance of a firm privatized in 1990 relative to an otherwise

identical firm that remained state-owned during 1990-1993, with
the initial values for both firms set to be the same and equal to the
median values in the sample. In each case, the vertical axis
measures the ratio of the level of performance measure of a
privatized firm to that of a state firm. The horizontal axis is set
where the ratio equals 1, i.e., at the point where the privatization
effect is 0. (Shaded areas mark the confidence intervals around
the mean values of the privatization effects.)
VII. SELECTION BIs
A. Group-Level versus Firm-Level Controls

The estimates reported in Tables II and III control for
selection bias at the ownership-type level. Therefore, to the extent
that firms are picked for privatization (either in general or when
privatized to a particular type of owner) because they are in some
relevant sense "better" to begin with, the FE estimator of specifi-
cation (1) controls for such potential selection bias, and the effects
of privatization reported in Tables II and III are consistent even if
better firms were in fact selected for privatization in the first place.34
Specification (1), however, involves group-specific fixed ef-
fects. As such, it does not control for selection bias stemming from
the fact that firms grouped within a given ownership category
may differ among themselves with respect to some unobserved
characteristics correlated with performance outcomes. For ex-
ample, if different "cohorts" of privatized firms are of significantly
different quality (e.g., better firms are privatized earlier), control-
ling for ownership-type group fixed effects would still not yield a
consistent FE estimator of the coefficient of the privatization
dummy (the estimate could, e.g., reflect the stronger performance
of the earlier privatized firms relative to those privatized later,
rather than the effect of privatization itself). To eliminate the
possibility of this kind of selection bias, we estimate a model using
firm- (rather than group-) specific fixed effects.35
In estimating the firm fixed-effects model, we omitted the
initial level of performance variable. While external consid-
erations (discussed in subsection IV.A) convince us that the initial
level of performance is germane to firm performance in the
transition environment of Central Europe, the fact that the initial
level of performance is in the denominator of the dependent
variable yijt raises the possibility that its significance may be
spurious.36 (In any case, in this specification, the initial level of
performance is likely to be absorbed by the firm fixed effects and
time-country dummies.) The results are presented in Table IV.
The estimates are consistent with those for group-level
controls. In particular, the privatization effects for outsider-owned
firms in the revenue (9.62 (4.65)) and productivity (12.63 (6.56))
34. The F-statistics for the equality of the group effects, reported in Tables II
and III, test whether selection bias in fact exists. Since no differences in the group
effects among any of the groups of privatized and state firms are significant, the
presence of selection bias cannot be confidently affirmed in the case of any type of
privatized firms. Barberis et al. [1996] and Earle and Estrin [1997] adopt an
alternative method, using instrumental variables estimators, to control for
selection bias. Our data set does not contain variables that could be used as
appropriate instruments.
35. In this specification we omitted country indicators from all first-year
observations. The first year-country effects thus became absorbed in the firm fixed
effects, and the specification avoids the perfect collinearity between the full set of
country-year dummies and the firm fixed effects.
36. The specification we estimated thus was Yijt = oti + Pijtpj + Dct 8ct + sijt
(with all variables defined as in (1), except that Dct = 0 for all countries in the year
1990-1991).
TABLE IV
PRIVATIZATION EFFECTS CONTROLLED FOR FIRM FIXED EFFECTS
Cost per unit

Revenue Employment Productivity of revenue
Privatization effects
Outsidersa 9.62* 0.23 12.63** -5.10
(4.65) (2.79) (6.56) (5.57)
Insidersa -3.65 5.28 -9.63 0.81
(6.58) (3.54) (8.62) (7.42)
Country-year effects
Czech Republic
Year 2 15.40* -13.73* 37.00* -1.25
(4.34) (2.46) (5.95) (5.76)
Year 3 8.28*** -2.79 14.51** 1.62
(4.69) (2.63) (6.39) (6.06)
Hungary
Year 2 9.66* -2.69 14.14* -1.96
(3.29) (1.93) (4.49) (3.91)
Year 3 5.34 -4.65** 11.46** -1.53
(3.63) (2.13) (4.96) (4.43)
Poland
Year 2 6.41 -2.80 9.77 -4.38
(4.94) (2.67) (6.47) (5.39)
Year 3 4.22 3.45 1.23 1.83
(4.94) (2.67) (6.47) (5.39)
Test statistics for the n = 513, n = 493, n = 466, n = 347,
model F = 2.13* F = 1.90* F = 1.16 F = 0.92
adj R2 = 0.33 adj R2 = 0.28 adj R2 = 0.06 adj R2 = 0.04
Test statistics for the F = 1.76 F = 1.55 F = 0.82 F = 0.85
equality of p = 0.00 p = 0.00 p = 0.93 p = 0.85
firm effects
*p c 0.01, **p c 0.05, ***p c 0.10. Standard errors are i

bold-faced. The initial levels of revenue are in US$1,000,000s, the initial employment is in 100's of full-time
employees, and the initial productivity is in US$1,000s per full-time employee. Year 2 refers to 1991-1992, and
year 3 to 1992-1993. Group effects are not reported here.
a. A dummy variable set to 1 for the postprivatization performance of privatized firms where the given
type of owner is the largest shareholder, 0 otherwise.
equations retain their magnitude and significance, while those in

cost and employment equations remain insignificant. The privati-
zation effects for insider-owned firms are insignificant in all
equations.37
37. We have also tested more directly whether the effect of privatization in
our estimates could reflect the stronger performance of the earlier privatized firms
relative to those privatized later (rather than the effect of privatization itself) by
estimating equation (1) for late privatizers only, i.e., for firms privatized in 1992 or
1993, with state firms as a control group. This is a particularly stringent test, as it
gives firms privatized in 1993 less than a year to show results. Still, the estimates
are remarkably similar to those for the entire sample, reported in Table III. For
B. Early versus Late Privatizers
Another reason why selection bias could influence the results

reported in Tables II and III is that the effects of the group-specific
characteristics of privatized firms are taken into account by the
FE estimator only to the extent that they are adequately captured
by preprivatization performance and remain "fixed" over time.
Thus, if firms are picked for privatization because of some
features that are not reflected in preprivatization performance-
for example, because they have undergone some restructuring
that will not show for a while in their performance-the FE
estimator might not be able to control for their effect and will
ascribe it to privatization. It is impossible to control for all such
factors without identifying them and checking for each one
separately, particularly if their effects are never felt before
privatization. But if the performance effects of unobserved charac-
teristics do materialize with time, whether or not the firm is
privatized, changing a control group may allow controlling for the
bias they may introduce. Thus, for example, comparing privatized
firms not with firms that will remain state-owned, but with those
that have been selected for privatization (and thus presumably
possess all the characteristics that determine the selection), but
are not yet privatized, may allow one to control for additional
forms of selection bias and in effect compare the privatized firms
with what they themselves would have been but for the fact of
privatization. Accordingly, we estimated equation (1) to compare
the 1990-1993 performance of firms privatized before the end of
that period with a control group of firms selected for privatization
but not privatized until 1994. Estimated in this way (using a firm
fixed-effects model), the revenue effects of privatization for out-
sider-owned "early privatizers" (9.91 (5.60)) retain their magni-
tude and remain significant (p = 0.08).
The magnitude of the corresponding effect on productivity
(8.95 (8.28)) remains comparable to the estimate in Table IV, but
loses its significance. This is in part due to the fact that the
standard errors increase as a result of the large decrease in the
number of observations (from 466 in Table IV to 173 here). But the
loss of significance is also due to the fact that the fixed-effects
example, the revenue effect of privatization for outsider-owned firms (in a firm
fixed-effects model) was 9.30 (4.78), and the productivity effect was 13.00 (6.73).
model uses up a lot of degrees of freedom (and thus, ceteris

paribus, inflates the standard errors of all estimates), without
seeming to have, in this case, any advantages over the OLS model
(since it generates virtually identical point estimates of the
privatization and country-year effects and the F-test for the
equality of fixed effects has a very high p-value of 0.8838). When a
constant term is used instead of firm fixed effects, the OLS
estimate of the privatization effect in the productivity equation
(8.6 (4.8)) has virtually the same magnitude as in the fixed effects
model, but with the much lower standard error, it becomes
significant (atp = 0.08).
C. Insiders versus Outsiders
There is one more type of selection bias that deserves special

note. It is sometimes said to be a common practice in the
postcommunist countries that those who want to acquire a
to-be-privatized firm attempt, by hook and by crook, to ensure
that its preprivatization performance is as low as possible, so that
they can then buy it at a lower price. This type of bias, which
would never show in the firm's performance until after privatiza-
tion, would not be controlled for by the procedure we have followed
so far. It would be most likely to occur, however, in the case of
insider-controlled firms because it is the insiders who are most
likely to be able to control preprivatization performance. It may be
reassuring, therefore, to observe that even if the insiders in our
sample were getting somewhat better firms, it is in the case of
firms controlled by outsider owners that the privatization effect is
significant.
VIII. CONCLUDING REMARKS
The evidence presented in this paper suggests that the effects

of privatization on corporate performance, while often quite
powerful, are not automatic or uniform across different types of
firms or different performance measures. In the context of the
transition economies of Central Europe, this means that privatiza-
38. This is in contrast to the revenue equation, where the F-test allows
rejection of the equal fixed effects hypothesis atp = 0.00.
tion is effective in enhancing revenue and productivity perfor-

mance of firms that come to be controlled by outsider-owners, but
produces no significant effect in firms controlled by insiders.
Although these differences may be in some respects specific to the
Central European environment, they suggest that different types
of postprivatization owners may also have different effects on
performance in other contexts, and that both theoretical analyses
and policy prescriptions might have to be more cautious about the
correctness of broad generalizations.
We also observe that privatization, when it is effective, affects
differently the firm's revenue and cost performance-a difference
that we consider to be of potential importance for the understand-
ing of the nature of private property more generally.
APPENDIX 1:
DISTRIBUTIONS OF SAMPLE FIRMS BY YEAR OF PRIVATIZATION AND FIRM SIZE
Average
revenues Average
(US$ mi, employment
constant (full-time
Number of firmsa Privatized in prices) employees)
All 1990 1991 1992 1993 1994 1990 1993 1990 1993
All countries
Stateb 90 17.6 11.0 876 573
Privatizedc 128 14 20 49 37 8 17.6 13.4 726 554
Czech Republic
State 23 22.2 13.0 1343 797
Privatizedd 56 - 5 33 17 1 24.0 15.9 1072 740
Hungary
State 26 29.5 13.1 605 416
Privatized 66 12 11 16 20 7 14.7 10.8 550 405
Poland
State 41 8.0 8.6 734 544
Privatizede 6 2 4 - - - 19.5 19.5 1107 861
a. The sample descriptions given in this and appendixes 2 and 3 pertain to the sample of firms in the
growth of revenue regressions.
b. Including corporatized firms. Extensive tests revealed no significant performance differences between
state and corporatized firms in our sample.
c. Because many Polish firms that privatized early (before 1993) were privatized through leasing (and
thus excluded from our sample), most of the privatized firms in the subsample are in Hungary or the Czech
Republic.
d. In the Czech Republic, the year of privatization refers to the year in which the new owners assumed
control rather than the year during which the shares were formally distributed.
e. For Polish privatized firms, the 1990 revenue and employment levels were not provided. Those reported
in the table are averages of the first years for which the data were available.
APPENDIX 2:
SECTORAL DISTRIBUTION OF SAMPLE FIRMS
Number (percent) of
Industrial sector
(two-digit SIC code) State firms Privatized firms
Food & beverages 18 (20%) 44 (34%)

Clothing 12 (13%) 21 (16%)
Furniture 13 (15%) 9 (7%)
Textile 8 (9%) 17 (13%)
Leather 7 (8%) 6 (5%)
Chemicals 13 (14%) 9 (7%)
Nonferrous minerals 15 (16%) 21 (16%)
Other 4 (4%) 1 (1%)
All 90 (100%) 128 (100%)
APPENDix 3:
OWNERSHIP STRUCTURE OF PRIVATIZED FIRMSa
Firms in which Mean holdings when

the shareholder is the shareholder is
Shareholder the largest owner the largest owner
Foreign company 28 75%

Czech Republic 9 66%
Hungary 17 86%
Poland 2 40%
Private financial company 25 22%
Hungary 1 71%
Domestic nonfinancial company 12 71%
Hungary 5 71%
Poland 2 60%
Domestic individual 12 63%
Hungary 9 58%
Poland 1 80%
State (in privatized firms) 18 41%
Hungary 7 49%
Poland 1 60%
Managerial employees 19 77%
Hungary 13 71%
Nonmanagerial employees 11 69%
Hungary 11 69%
a. This appendix lists the largest owners for 125 privatized firms used in the analysis of the individual
ownership effects in Section V. Some firms had to be excluded from this analysis because the identity of the
largest private owner was missing.
DEPARTMENT OF ECONOMICS, NEW YORK UNIVERSITY, AND PRIVATIZATION PROJECT

THE WORLD BANK
GRADUATE SCHOOL OF BUSINESS, FORDHAM UNIVERSITY, AND PRIVATIZATION PROJECT
COLUMBIA UNIVERSITY SCHOOL OF LAW AND PRIVATIZATION PROJECT
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When Does Privatization Work?

The Impact of Private Ownership on Corporate

The assumption behind privatization in many parts of the

tained recently by a number of studies of the postcommunist

some of them may be specific to the way privatization works in the

1. The importance of the distinction between cost and revenue restructuring

been chosen for all or some privatizations, that state ownership

II. THE DATA

The present study is based on a survey of 506 midsize

2. The restructuring accompanying privatizations in the West sometimes had

each of whom was asked about matters in his particular area of

3. By a privatized firm we mean an enterprise (partially or totally) privatized

privatized (93 percent) firms faced domestic or foreign competi-

6. The state as the largest owner provides an important exception. As we

Table I presents the summary statistics of the annual rates of

extent to which the early stages of transition are characterized by

III. ECONOMETRIC CONSIDERATIONS

We evaluate the impact of privatization on firm performance

(1) Yjjt = Oj + PijtIj + Xijt-lW + Dctb

number of additional specifications to test the significance of

sector dummies Sij, and time to/from privatization dumm

effects (A3j's) could reflect the stronger performance of the

IV. AVERAGE EFFECTS OF PRIVATIZATION

Table II provides FE estimates of equation (1) for all four

A. The Effects of the Transition

Before going farther, it is worth noting that the significance of

CI) t L0 O~-4 ttoc0C00Q c~n

m~~~~~~~~b Ce LO CD t- L-/ m sNw - 0' D"t 0'

c o Q o CD 1> eD 0c COLO LCO t-tc L O LO LO 1 I t

1n4 1 1 $-' uC rI *0 co 1eD 1 00 W)e ots* sc.0cs

5.0 r-i c 0 c bD 0 ooX

C 0t cq C0 U~L .i 0Nul tm L Odi codc

CC C)~~~~~C)C) ~~~~~ ~ -, .)c

We would also like to note that the group effects-which are

B. The Ambiguity of the Average Effects of Privatization

We begin by examining the "average" effect of privatization,

controlling for differences in preprivatization characteristics of

understand the nature of private ownership and its impact on

V. OUTSIDER AND INSIDER PRIVATIZATION

The problems with the concept of privatization in general

markets would later correct for any potentially suboptimal initial

In the contexts of other economies, grouping together firms

employee participation [Frydman, Rapaczynski, and Earle 1993].

While the grouping of insider-owned firms, at least in the

18. As we already noted, Russian privatization made insiders dominant in

Cost per unit

*p c 0.01, **p c 0.05, ***p c 0.10. Standard errors are in par

outsider firms in our sample are statistically indistinguishable

brings a significant improvement in revenue performance. If

created in connection with mass or voucher privatization pro-

growth of a firm and reduces its cost growth by over 8 percentage

C. Outsider-Owned Firms as a Group

The most important result in Table III is the strong impact of

percentage points to productivity growth. These effects are also

contributions on employment and revenue measures used in our equations were

It is important to note that the strong revenue and productiv-

effect of privatization to outsider owners substantially overstates

D. Macroeconomic, Sectoral, and Country Effects

The estimates of country-year effects reported in Table III

28. Large-scale direct or indirect subsidization of employment in state

In order to test for the presence of any sectoral effects, we also

privatization programs. In particular, many superficially "out-

VI. THE CONTRAST BETWEEN REVENUES AND COSTS

1n4 1 1 $-' uC rI 0 co 1eD 1 00 W)e ots sc.0cs

CC C)~C)C) ~ ~ -, .)c

p c 0.01, p c 0.05, p c 0.10. Standard errors are in par

p c 0.01, p c 0.05, p c 0.10. Standard errors are i