Bridge over ocean
16 August 2018 CFA Institute Journal Review

The Market Value of Government Ownership (Digest Summary)

  1. Clifford S. Ang, CFA

Motivated by the recent rise in state capitalism, the authors investigate the effect of government ownership on the valuation of a sample of East Asian publicly listed corporations. They find that government ownership leads to higher valuations but that the costs begin to outweigh the benefits when government control exceeds 50%.

How Is This Research Useful for Practitioners?

The recent increase in state capitalism globally, especially following government bailout programs and government participation in failing firms and institutions fueled by the 2008 global financial crisis, has sparked interest in the effect of government ownership on the value of government-owned firms.

One view is that government ownership is relatively risky because government investment can be a way for politicians to use firms to pursue objectives other than profit maximization. Another view is that government-owned firms can be relatively safe because they can be bailed out in times of financial distress, they have easier access to financing than private firms, and government shareholders can exert effective monitoring.

The authors find that even partial government ownership of a firm leads to a value premium relative to comparable, non-government-owned firms. Government control rights greater than 50% translate into lower market valuations. This result suggests that despite the benefits of government ownership, the costs begin to outweigh the benefits when the government has majority control of a firm. Additionally, the value enhancement is stronger in countries with better protection of investor rights or in countries with more-stable governments.

Another useful insight for practitioners is the mechanism by which the increased value is attained. The authors find that the higher valuations are obtained through a firm’s financing decision and, consequently, the effect of that decision on the lower cost of equity demanded by investors. As the authors note, this result means that the value generated by government ownership is not a result of enhancing the firm’s investment decision or growth prospects. Put differently, government ownership makes these firms safer in the eyes of investors.

How Did the Authors Conduct This Research?

The authors use ownership data from Carney and Child’s dataset, which identify the controlling shareholders as well as their voting rights in 1,386 publicly traded corporations from nine East Asian markets. These data are then hand-matched with financial data from the Compustat Global file. After excluding firms with insufficient data and financial firms, the authors obtain a final sample with 955 firms covering the 2006–2010 period.

To conduct their study, the authors estimate a regression of firm value on a proxy for government ownership, several common firm-level control variables (e.g., size, age, leverage), and industry and market fixed effects. The firm value variable equals the market/book ratio of the firm’s assets, where the market value of assets equals the market value of equity plus the difference between the book value of assets and the book value of equity. The authors use two alternative proxies of government ownership: (1) a variable that indicates whether the government is the largest ultimate owner and (2) a variable that denotes the domestic government’s percentage control in government-owned firms.

The authors acknowledge that endogeneity is a potential concern in their analysis—that is, the independent variables are correlated with the error term. They perform a number of robustness checks and find evidence in each one to support their main finding—that government ownership leads to higher valuations.

Abstractor’s Viewpoint

During times of crisis, investor appetite for risk is reduced and investors typically demand larger risk premiums to invest in troubled firms. The authors’ findings suggest that domestic government investment in troubled firms allays investors’ fears because the value premium is achieved through a reduction in the cost of capital demanded by investors. On the flip side, this finding implies that the troubled firm’s investment opportunities and growth prospects are unaffected by government investment. Accordingly, it appears that the greatest beneficiaries of government investment are those firms that can recover by taking advantage of existing investment opportunities that could be made profitable by having a lower crisis-period cost of capital.

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