Fondazione Eni Enrico Mattei
Privatization and R&D
Performance:
An Empirical Analysis
Based on Tobin’s q
Federico Munari and Raffaele Oriani
NOTA DI LAVORO 63.2002
SEPTEMBER 2002
PRIV – Privatisation, Regulation, Antitrust
Federico Munari, University of Bologna, Italy
Raffaele Oriani, University of Bologna and LUISS Guido Carli, Rome, Italy
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Fondazione Eni Enrico Mattei
Privatization and R&D Performance:
An Empirical Analysis Based on Tobin’s q
Summary
In this paper, we analyze the impact of privatization on the firms’ R&D performance. We expect that, in the early period after privatization, path dependencies still negatively affect the efficiency of R&D operations. We test our hypothesis using a Tobin’s q measure and estimating a hedonic model, already adopted by several scholars to assess the impact of innovation related assets on the firm’s market value (Griliches, 1981). We estimate the regression model on an original panel data of 40 firms, including 20 firms privatized through public share offering in different countries of Western Europe over the period 1982-1997 that were matched at the country and industry level with 20 publicly held firms. Our results show that stock markets evaluate R&D investments of newly privatized companies less than R&D investments of industry-matched companies.governance
Keywords: Privatization, R&D Performance, market value, corporate restructuring JEL: G34, O32
Address for correspondence:
Federico Munari
CIEG - Dipartimento di Discipline Economico Aziendali
Università di Bologna
Via Saragozza 8
40123 Bologna
Phone: 051-2093954
Fax: 051-2093949
E-mail: munari@dea.unibo.it
Privatization and R&D Performance:
An Empirical Analysis Based on Tobin’s q
1. Introduction
In different countries, State-owned enterprises have historically played a main role in directing and q
ualifying the evolution of the national innovation systems, both directly, by means of their R&D investments and facilities, and indirectly, by means of their procurement strategies (Nelson, 1993). Over the last two decades, widespread privatization processes have consistently reduced the direct presence of the State as a major player in the economic arena (Siniscalco et al., 1999). Prior research on privatization experiences has generally shown that the change in ownership improves productive efficiency and profitability at the firm level, especially when it coincides with the opening-up of formerly monopolistic markets to competition (see Megginson and Netter, 2001, for a review)
On the contrary, scarce attention has been paid to assessing if and how privatization affects the managerial decision to carry on research and development activities, and hence the innovative performance of the firm. In general, as Parker (1998) points out, the dynamic efficiency gains associated to privatization, regarding investments, research and development and innovation, have been largely ignored, both in theory and in practice.
To this respect, some authors (Shleifer, 1998; Zahra et al. 2000) have argued that private ownership must be preferred to public ownership whenever the incentives to innovate and contain costs are strong and claimed that privatization processes can have a fundamental role
in establishing    a new set of organizational dynamics that promote innovation, entrepreneurship and the creation of new ventures. However, more recent studies (Katz, 2001; Munari, 2002; Munari et al., 2002) suggest that the State divestiture can be followed by a consistent restructuring and scaling down of R&D facilities and investments of former public enterprises, especially when the transfer of ownership is accompanied by the contemporaneous liberalization of formerly monopolistic industries, as in the case of public utilities.
In order to shed light on the effects of the State divestiture on the innovative and economic performance of newly privatized firms, in this paper we examine the relationship between privatization, R&D commitment and market value of the firm. In particular we choose the Tobin’s q, that is the ratio between the market value and the replacement cost of the firm’s assets, as indicator of the firm’s economic performance. Consistently, in order to estimate the impact of R&D investments on the performance of privatized firms, we recall the literature that has assessed the relationship between innovation and market value of the firm (see Hall, 1999 and Oriani and Sobrero, 2002, for a review).
Therefore, we first integrate at a theoretical level different fields of study concerning the economic performance of privatized companies, the impact of corporate governance on firms’ innovative efforts
and the relationship between knowledge assets and market value of the firm, in order to deepen our understanding of the long-run effects of privatizations on firms’ innovative performance. To empirically assess the issue, we then adopt a matched-paired research design and use data from a sample of 40 firms - including 20 privatized firms that were coupled at the country and industry level with 20 publicly held firms. The first group refers to a set of companies which were privatized through public share offering in different countries of Western Europe over the period 1982-1997. We examine in a regression framework the relation over time between Tobin’s q and R&D investments for privatized and privately owned matched companies, in order to gauge whether significant differences emerge between the two groups relatively to the expected contribution of knowledge capital to firm’s economic performance. We adopt panel data techniques in our analysis to address the problem posed by the unobserved firm heterogeneity. Moreover, we deal with the problem of the potential simultaneity between R&D investments and firm’s performance by estimating a simultaneous equations regression model.
Our findings are in line with the theoretical expectations about the existence of organizational inertia phenomena which retards the improvements in R&D performance within privatized companies. First, the simple descriptive analysis shows that in the early
years after the public offer privatized firms reduce the level of R&D investments, while their market valuation - expressed by Tobin’s q - rises, although on average it remains lower than the one of privately-owned matched companies. Secondly, the results of the regression analyses suggest that R&D investments by newly privatized companies are undervalued by the stock market compared to our control group. In fact, the relationship between Tobin’s q and R&D investments is always positive in the case of private companies, whereas for privatized companies the sign of the relation varies in the different estimation models we adopt. Moreover, even when the sign is positive for privatized companies, we do find that R&D investments appear to have a much larger impact on Tobin’s q in the case of privately-owned matched firms. We interpret this finding to support the claim of sub-optimal economic private returns from R&D resources within SOEs, and the idea that changes in the firm’s innovative and economic performance after privatization do not occur instantaneously, but require more time to be fully accomplished.
The rest of the paper is organized as follows. In Section 2 we first provide theoretical explanations to justify the expectation of relevant changes in R&D behavior and performance after privatization. We then turn to discuss the literature on financial market valuation of the firms’ knowledge assets and explain why the market value may result an useful indicator to assess the expected economic perfor
mance of the firm’s R&D activities after privatization. In Section 3 we describe the sample used in the empirical analysis and the technique adopted to build the industry-matched control group. Section 4 presents the estimation techniques we employ and the results of the different regression analyses. In the final section we draw main conclusions from the empirical analysis and discuss the implications for future research.
2. Theoretical background
2.1 The impact of privatization on firms’ R&D behavior
Given that R&D projects are typically risky, unpredictable, long-term oriented and idiosyncratic (Holmstrom, 1989), they inherently involve high agency costs and thus become a potential arena of acute conflicts of interest between executives and shareholders. Therefore, the characteristics of the firm’s governance and ownership structure significantly influence the undertaking and performance of innovation activities. Empirically, several studies have assessed the relationship between firms’ R&D investment decisions and
different aspects of their corporate governance system - such as the degree of ownership concentration, the presence and role of institutional investors, the composition of the board of directo
rs - although reporting mixed results in many senses (see Munari and Sobrero, 2002a, for a review of this literature).
Along this line of inquiry, we focus on the specificities of having the Government as the sole or dominant shareholder for R&D investments and on the impact of its divestment after privatization on innovation performance at the firm level. Conceptually, it is possible to advance two different but interrelated explanations to justify the expectations of consistent changes in the firm’s R&D behaviour following privatization (Munari, 2002; Munari et al., 2002).
The first argument deals with the different set of objectives of public and private entrerprises: at least theoretically, the attitude towards R&D activities within State-owned companies should be more oriented to fulfil general national goals of generating and diffusing the public good of knowledge rather than exclusively addressing business specific objectives, given the wider mission of maximizing social welfare. On the other hand, after the divestiture of the State, the privatized firm has no more implicit or explicit obligation to act in the interest of the public welfare or of the overall industry. This should push the management to reconsider the scope of R&D projects undertaken, by focusing on those most closely linked to the needs of the core business.
Secondly, if we relax the rather “heroic” assumption that SOEs seek to maximize public interest and recall the arguments of public choice theory (Niskanen, 1971; Buchanan, 1972), and property rights theory (De Alessi, 1987; Vickers and Yarrow, 1988) a possible  reduction of resources devoted to R&D after privatization may be rather ascribed to efficiency gains and to the elimination of wastes and duplication of resources characterizing the company under State ownership. Privatization produces an increased alignment of managerial incentives with firm financial performance, ultimately promoting a more efficient use of resources, which is likely to characterize the management of innovation activities as well. Indeed, most of the studies on the economic consequences of privatization generally show consistent efficiency gains and improvements in productivity after the divestiture of the State (La Porta and Lopez de Silanes, 1997; Megginson et al., 1994; D’Souza and Megginson, 1999; Dewenter and Malatesta, 2001).
Ultimately, these two different explanations converge in theoretically supporting the expectations of a reduction in R&D investments level after the State divestiture. Recent empirical evidence seems to reinforce this view. Using data from privatization experiences

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