Privatization: Types of Investors

An important part of a privatization plan are policy decisions regarding what type of investors will be sought and how much of the company will be sold to different types of investors.  Potential investors can be classified into six categories: There are different policy considerations associated with each type of investor.  Consider how you would allocate the stock of Kenya Airways among these different classes of investors.

Employees of the firm

Winning the acquiescence of employees is essential to successful privatization.   Proposing to sell shares on favorable terms to employees can give help give employees an interest in seeing that privatization goes forward.  Moreover, employee stock ownership helps to emphasize the link between employees' rewards and the performance of the company.  On the other hand, too much employee stock ownership can hinder enterprise restructuring and bias investment decisions.  In addition, like any investor, an employee benefits from diversifying his or her portfolio of assets.  A job is typically an important asset for an individual, and a job is subject to firm specific risks, among other risks.  Thus an individual gains benefits from diversification by holding stock in companies other than the company in which he or she works.  Put simple, if the company at which the individual works shuts do, the employee will not lose both a job and a value of a stock investment in the company.

Strategic industry partner

State enterprises often need new technology and managerial expertise as well as capital.  A strategic industry partner is another firm in the same or a similar industry as the enterprise to be privatized.  Attracting such an investor can be crucial to turning around a state enterprise.  Such an investor is expected to not just buy shares in the company, but also to play an active role in transferring industry-specific expertise to improve the privatized enterprise's performance.   Evaluating bids from potential strategic partners typically involves evaluating many criteria in addition to the aggregate cash value of the bid.  Such an evaluation process is more subjective than a straight cash sale and it is more susceptible to corruption.  Strategic investors also typically want to be assured of a certain amount of influence over key decisions of the firm.  Moreover, because the strategic investor brings non-cash assets to the transaction, selling shares to a strategic investor typically does not maximize the government's revenue from the sale of shares.

Domestic institutional investors

Domestic institutional investors are typically banks, insurance or pension funds, and wealthy individuals.  While such investors do not have industry specific expertise, to the extent that a particular investor owns a significant share of stock, the investor has an incentive to devote effort to monitoring and reviewing the performance of the enterprise.   When a share offering is complex or includes unusual conditions, marketing to a few institutional investors, who are willing and able to understand the details of the sale may be more appropriate than trying to sell to a larger pool of investors.  Some institutional investors expect to sell their shares of a privatized company over a relatively short term, while others may buy and hold shares.

Foreign institutional investors

Foreign institutional investors are likely to have similar characteristics to domestic institutional investors. Nonetheless, there are policy relevant implications of the choice between domestic and foreign institutional investors.   Foreign institutional investors may be able to tap larger amounts of capital than domestic institutional investors.  Involving foreign investors may also insure world standards in information disclosure and managerial accountability.  On the other hand, involving foreign investors potentially will allow foreigners to reap the benefits from an appreciation in the value of the enterprise's.  Such a concern is particularly relevant if, for some economically sensible reason, the offering has to be made at a "low" price.

Domestic general public

The general public is often able to and interested in investing in an enterprise if shares are appropriately priced and the enterprise presents a credible plan for future growth.  Achieving widespread domestic public ownership of shares stimulates the development of domestic financial markets important in raising further capital.  In addition, because the success of private enterprises is linked closely to sound general economic policies, achieving widespread share ownership helps to develop a domestic constituency for sound economic policies.  However, dispersed share ownership increases the importance of state administrative capacity to prevent various forms of financial market fraud.  In additional, widely dispersed share ownership lessens shareholders' incentives to undertake the costs of monitoring and reviewing the enterprise's performance (the free rider problem).

Foreign general public

The foreign general public offers the widest possible base of investors from which to attract investment.  However, meeting the regulatory standards for marketing shares to the public in a number of different countries requires considerable managerial expertise.  In addition, attracting foreign portfolio investors may increase capital account volatility and macroeconomic risks.

Investor Types in the Kenya Airways Privatization

As part of the privatization of Kenya Airways, 3% of the companies shares were reserved for employees.  A decision was made to try to attract a strategic investor.   KLM made the winning offer and became a strategic investor holding 26% of Kenya Airways.  In the Initial Public Offering, 12% of Kenya Airways shares were allocated to domestic institutional investors and another 14% was allocated to international institutional investors.  The Kenyan general public acquired 22% of Kenya Airways, with over 113,000 Kenyans investing in the company.  The government of Kenya retained 23% of the company.
Questions for Discussion
  1. What characteristics of Kenya Airways are most important for determining how to allocate its shares among different types of investors?

  3. How do you think Kenya Airways shares should have been allocated among different investor types?  Explain the policy rationale for your preferred allocation.

  5. What should be done with the remaining government share (23%) of Kenya Airways? Why?

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