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> Academy of Management Review
2000, Vol. 25, No. 3, 581-590.
EXPLAINING
THE
VARIANCE
IN THE
PERFORMANCE EFFECTS OF PRIVATIZATION
ALVARO CUERVO
Universidad Complutense de Madrid
BELtN VILLALONGA
University of California at Los Angeles
Agency and public choice theories of privatization indicate that a privatized firm's
performance will improve on average, but they do not include an explanation of the
observed variance in this result. We argue that organizational and contextual vari-
ables need to be considered in order to explain that variance. We develop a model and
propositions about the changes that privatization triggers in the firm's management,
governance structure, goals, incentives, control, strategy, and organization.
Twenty years ago, governments from all over
the world set out to privatize their state-owned
enterprises, with the hope that private owner-
ship would improve those firms' performance
and the overall efficiency of the economy. At the
same time, academics set out to provide justifi-
cation for this hope by offering answers to the
question of why privatization should lead to im-
proved performance. The cumulative evidence
over this time, however, has come to show that
these hopes have not always been fulfilled.
Hence, a more relevant research question at this
point in time seems to be why might privatiza-
tion not lead to improved performance?
The agency and public choice theories that
underlie most of the available research on pri-
vatization indicate that, on average, a privatized
firm's performance will increase. Yet, the empir-
ical evidence suggests that the variance in post-
privatization performance is substantial enough
to merit investigation in itself. The latter is im-
portant, for it might provide insights to manag-
ers and policy makers about ways to implement
privatization so as to maximize the subsequent
performance improvement. The extant privatiza-
tion literature, however, does not provide any
explanation for this variance.
In this article we argue that the observed vari-
ance in the effects of privatization on corporate
performance cannot be explained without a dy-
namic consideration of the relevant organiza-
tional and contextual variables. Accordingly,
we develop a model and a set of testable prop-
ositions about some of the internal changes that
privatization might trigger within a firm. We
also identify some contingency factors that
might influence the ultimate effect of these
changes on performance. As a result, our model
is consistent with the observed variation in pri-
vatization outcomes for the firm, and with it we
predict relationships between the several cir-
cumstances and performance outcomes.
The article is organized as follows. First, we
define our key constructs and succinctly review
the extant literature. Next, we present our model
and propositions. Following this, we briefly
comment on the managerial and policy implica-
tions of our research and then conclude the
article.
LITERATURE
REVIEW
We define privatization as the sale of a state-
owned firm to the private sector and corporate
performance as the firm's financial and operat-
ing efficiency. It must be noted that the defini-
tion of performance is one over which there is
little agreement in the management field in
general (Barney, 1996: 30)-and little agreement
for state-owned firms in particular (Ramamurti,
We are deeply indebted to special issue editor Shaker
Zahra and to three anonymous reviewers for their substan-
tive contributions to this article. We also thank Alvaro Cu-
ervo-Cazurra, Zulima Ferndndez, and Bill McKelvey for their
comments on earlier drafts. Financial support for the first
author from Becas Complutense del Amo and for the second
author from the Fulbright Commission, Fundaci6n Caja de
Madrid, Fundaci6n Ram6n Areces, and the Ph.D. Program
Office of the Anderson School at UCLA is also gratefully
acknowledged.
581
582 Academy of Management Review July
1986). Nevertheless, because efficiency is the
central performance concept in economics, to
which most of the work involving comparison of
private and state-owned firms belongs, it is the
most prevalent in this literature.'
Theoretical Perspectives
Both agency and public choice theorists argue
that private ownership is superior to state own-
ership and that privatization should, therefore,
lead to improved performance. Agency theorists
focus on the different agency problems and so-
lutions to them that are available under each
form of ownership. Managers (agents) in both
private and state-owned firms are assumed to
maximize their own utility, rather than that of
the organization or its owners (principals). In
private firms this divergence is reduced through
external mechanisms, such as markets for man-
agers, capital, and corporate control, and inter-
nal mechanisms, such as managerial participa-
tion in ownership, reward systems, and the
board of directors. In state-owned firms these
mechanisms are virtually absent. Moreover, the
owner-manager relationship is broken down
into two other agency relationships-the public
as owners-to-politicians and politicians-to-
managers-which effectively reduces the incen-
tives for monitoring managers' behavior. Thus,
the agency rationale for privatization is that it
induces changes in corporate governance and
managerial incentives, which, in turn, lead to
improved performance (B6s, 1991; Cornelli & Li,
1997; Laffont & Tirole, 1993; Sappington &
Stiglitz, 1987; Schmidt, 1996; Shapiro & Willig,
1990; Vickers & Yarrow, 1988).
Those who hold the public choice view of pri-
vatization focus more specifically on the first
part of the double agency problem in state-
owned firms-that between the public and pol-
iticians. State-owned firms are predicted to be
low performers, because politicians impose ob-
jectives on these firms that might help them to
gain votes but might conflict with efficiency
(Buchanan, 1972; Niskanen, 1971). For the gen-
eral public (the ultimate owners of the firm), the
costs of monitoring this behavior likely offset
the benefits. This is not the case, however, for
such interest groups as trade unions, which
makes state-owned enterprises an easy target
for rent-seeking activity. Accordingly, privatiza-
tion is expected to trigger a change in the goals
of the firm and in the bargaining power of the
different actors in the political market, increas-
ing the search for efficiency and reducing social
considerations (Shleifer & Vishny, 1994). This
leads to reduced salaries (Haskel & Szymanski,
1993), increased worker effort (Haskel & Sanchis,
1995), and/or reduced employment (Boycko, Shlei-
fer, & Vishny, 1996) and thereby to improved
corporate performance.
In addition, a few authors have analyzed how
certain organizational characteristics, such as
culture (Bishop & Thompson, 1992), objectives,
business nature and location, organizational
structure, management, and labor (Martin &
Parker, 1997), differ across public and private
firms and how these characteristics are likely to
change as a result of privatization. The effect of
these changes on the privatized firm's perfor-
mance, however, has not been clarified in this
literature.
Empirical Evidence
Most of the empirical research about private
versus state ownership has been in the form of
cross-sectional comparisons of both types of
firms in industries in which they coexist (see the
reviews of Borcherding, Pommerehne, & Schnei-
der, 1982; Borins & Boothman, 1985; Boyd, 1986;
De Alessi, 1980; Domberger & Piggott, 1986;
Martin & Parker, 1997; Millward & Parker, 1983;
Pestieau & Tulkens, 1993; Vickers & Yarrow,
1988; Vining & Boardman, 1992; and Yarrow,
1986). A metareview (Villalonga, 2000) of the 153
studies included in the above reviews shows
that although a simple count of results would
give a considerable edge to private ownership
(there are 104 studies in favor, 14 against, and 35
neutral), the cumulative evidence is not conclu-
sive. A similar inference can be made by looking
at privatization case studies (Galal, Jones, Tan-
don, & Vogelsang, 1994; Martin & Parker, 1997;
Vickers & Yarrow, 1988) and at the more recent
1 Attention to the financial dimensions of the privatized
firms' performance (i.e., profitability) instead of, or in addi-
tion to, the operating or productive efficiency dimension is
characteristic of more recent empirical studies (e.g., Bou-
bakri & Cosset, 1998; Cragg & Dyck, 1999; Megginson, Nash,
& Van Randenborgh, 1994). It must be noted, however, that
profitability results from both productive efficiency and mar-
ket power (Cuervo, 1997; Ramamurti, 1986). Hence, an exclu-
sive focus on profitability as a performance indicator is
justified only in competitive environments.
2000 Cuervo and Villalonga 583
longitudinal studies of privatization in devel-
oped economies (Andrews & Dowling, 1998;
Cragg & Dyck, 1999; Haskel & Szymanski, 1993;
Megginson et al., 1994), in developing countries
(Boubakri & Cosset, 1998; La Porta & L6pez de
Silanes, 1997), and in Eastern European econo-
mies (e.g., Barberis, Boycko, Shleifer, & Tsu-
kanoza, 1996; Dyck, 1997).
These studies reveal that although theorists
have predicted that a privatized firm's perfor-
mance will improve, after privatization, on aver-
age, the variance across real-world empirical
tests is substantial. Fortunately, the empirical
literature helps uncover some of the variables
that may explain this variance. For instance, in
imperfectly competitive environments, effi-
ciency appears to depend more on regulation
and competition than ownership (Vickers & Yar-
row, 1988; Yarrow, 1986). In transition economies
the absence of a stable legal framework for
property rights and bankruptcy, the prevalence
of voucher privatization with its associated
problems, the absence of capital markets with
an effective control capacity, and the ineffi-
ciency of many input and output markets raise
doubts about the applicability of major privat-
ization theories to this context (Barberis et al.,
1996). DeCastro and Uhlenbruck (1997) show that
the country characteristics of privatized firms
from former communist, less developed, and de-
veloped countries significantly affected privat-
ization policies and, in turn, firm strategy and
performance.
We also see that in organizational research
about state-owned firms, scholars have identi-
fied some of the internal variables that are
likely to change after privatization. Nonetheless,
a systematic analysis of the organizational and
contextual factors that give rise to the observed
variation in privatized firms' performance is
missing. The static and "black box" approaches
that have prevailed thus far offer an incomplete
view of the issues that privatization raises for
firms. Agency and public choice theorists at-
tribute the predicted effect of privatization on
performance to certain constructs (corporate
governance/incentives and goals, respectively).
The content of these constructs, however, has
not been specified. Researchers also have not
articulated the organizational change process
that variations in these constructs presumably
induce or the external contingencies that might
affect their impact on performance.
PRIVATIZATION,
ORGANIZATIONAL
CHANGES, AND PERFORMANCE
To address this gap in the literature and to
encourage further research, we propose a dy-
namic model of the changes that privatization
triggers within a firm. By complementing
agency and public choice theories of privatiza-
tion with insights found in research on corporate
governance and strategic change, we explain
why the performance increases predicted in ex-
tant privatization theory exhibit the high vari-
ance we observe. The gist of the model, captured
in Figure 1, is that privatization is a discrete,
exogenous change that triggers a series of en-
dogenous changes in a firm's strategy and or-
ganization, which, in turn, directly affect perfor-
mance. These changes are enacted by the firm's
management, which also undergoes a transfor-
mation as a result of privatization-through re-
lated changes in the firm's goals, incentives,
and governance structure, and through the re-
placement of the prior top management team
itself.
Management Replacement
The replacement of preprivatization manag-
ers, especially the CEO and top management
team, can be a major catalyst in the internal
change process. Many of the organizational
changes that we discuss below directly affect
the firm's managers. Existing managers might
be reluctant to impose or even allow some of
these organizational changes, either because
the changes constrain their actions or simply
because the managers do not understand the
need for them (Martin & Parker, 1997). This resis-
tance to change is part of the more general in-
ertia phenomenon (Hannan & Freeman, 1984). At
the top management level the simplest and
most effective way to break this inertia is by
replacing the managers, as suggested by the
evidence from studies of acquisitions (Parrino,
College, & Harris, 1999), corporate turnarounds,
and strategic change in general (Rajagopalan &
Spreitzer, 1997). To the extent that strategic and
organizational changes increase the privatized
firm's performance, management replacement,
by enabling such changes, might thus be a cru-
cial determinant of postprivatization perfor-
mance increases.
584 Academy of Management Review July
FIGURE 1
A Model of Privatization, Organizational Changes, and Performance
P2
Contextual factors
Deregulation
Liberalization
Privatization method
Prior restructuring
Management\
a-: - / ~replacement P 5WA
Priv-t~zc~tio~ <Changes in goals, Changes in strategy,
P4t
,<=Bg \ <|/<incentives, and control structure, and culture
Changes in /
corporate
governance
Note: For simplicity, the boxes in this figure contain only the broad groups of constructs to which each of the propositions
of our model (P1 to P5) refers, in correspondence with this section's headings. The precise content of these boxes and the
relationships among them are discussed in more detail within the text.
Moreover, the new managerial team might
bring in resources and capabilities previously
not available to the firm (Castanias & Helfat,
1991). This is particularly true in the context of
privatization, where managers in state-owned
firms in general have a different set of skills
than their private counterparts. As Barberis et
al. (1996) have noted, preprivatization managers
might have the "wrong" skills, because they are
good at dealing with politicians and not at fac-
ing competitive market conditions. These au-
thors' public choice argument, thus, comple-
ments agency theory, inertia, and resource-
based arguments for expecting management
replacement to have a positive effect on postpri-
vatization performance. We therefore propose
the following.
Proposition 1: Privatization leads to
greater performance increase when
the privatized firm's top management
team is replaced.
Contextual Factors
In the context of privatization, management
replacement is likely to be contingent on at least
three factors: (1) the method of privatization
used, (2) the degree of prior restructuring, and
(3) the deregulation and liberalization of the eco-
nomic environment. First, the method of privat-
ization determines who the new owners are and
what the degree of political interference is that
remains after privatization. If voucher privatiza-
tion is carried out, as happened in several East-
ern European countries, control is left in the
hands of insiders. These insiders, who are the
managers and workers in the firms, may be mo-
tivated to maintain and protect their own posi-
tions. They are unlikely to initiate fundamental
strategic changes and might only perform cos-
metic surgery. If outsider privatization is under-
taken instead, either through a public offer or
through a direct sale to another firm, manage-
ment is more likely to be replaced-particularly
in the latter case, as is suggested by the re-
search on mergers and acquisitions (Larsson &
Finkelstein, 1999) and strategic change (Rajago-
palan & Spreitzer, 1997).
We note that agency and public choice theo-
ries of privatization yield conflicting predictions
with respect to the method of privatization.
Agency theory indicates that insider privatiza-
tion (management/employee buyout) will be
more effective than outsider privatization, since
it creates a greater alignment of interests be-
tween new owners and managers (who are the
2000 Cuervo and Villalonga 585
same). Public choice theory indicates the oppo-
site, since insiders' goals are closer to politi-
cians', particularly with respect to employment
and investment. In our model changes in corpo-
rate governance affect performance only to the
extent that they affect managerial actions, re-
flected in strategic changes, which are those
that directly affect performance. A fundamental
enabler of these changes is management re-
placement-which insider privatization, how-
ever, rules out. Hence, our model on this point is
in agreement with the public choice prediction
that, other things being equal, outsider privat-
ization will lead to greater performance in-
creases than insider privatization.2
The public choice view highlights as well the
importance of the political interference that
might remain in the privatized firm, which is
also determined by the method of privatization
used. Political interference can take several
forms. For instance, in the British privatization
program, the government frequently kept a
golden share in privatized utilities, giving the
government the right to veto major decisions
regarding "strategic" issues or questions of na-
tional interest. In the French case, political in-
terference often took the form of a hard core of
corporate shareholders, chosen by the govern-
ment for financial or technological reasons, to
whom controlling stakes were sold directly. An-
other form often used is to condition a firm's sale
on the buyer's agreement to follow a certain
business plan. These and other forms of political
interference constrain the new owners' decision
power, including their ability to replace firm's
management.
The second contingency is the possibility that
top management be replaced before privatiza-
tion, as part of the prior restructuring under-
taken by the government so as to command a
greater price for the firm (L6pez de Silanes,
1996). In this case the process of organizational
change and, hence, increases in performance
might begin before privatization. If this hap-
pens, the likelihood of the top management
team being replaced again after privatization
will be low, since those managers will take part
of the credit for the performance improvement
achieved.
Third, the entrenchment of preprivatization
managers favored by insider privatization, dif-
fuse ownership structures, or political interfer-
ence in any of its forms will be limited by capital
markets, if these have an effective control ca-
pacity. Hence, the deregulation and liberaliza-
tion of the economic environment affects man-
agement replacement insofar as it enables the
correct functioning of capital markets. To sum-
marize the effect of these contingencies, we pro-
pose the following.
Proposition 2: The privatized firm's top
management team is more likely to be
replaced when the new owners are
outsiders, when political interference
is low, when top managers have not
been replaced prior to privatization,
and when capital markets play an ef-
fective control role.
Changes in Goals, Incentives, and Controls
Public choice and agency theorists emphasize
goals and incentives (or control), respectively,
as the central variables upon which the privat-
ization-performance relationship hinges. The
following discussion highlights the links among
the specific changes that one might expect in
these variables, thereby showing how the two
theories actually complement each other.
It is widely recognized that the goals in pri-
vate firms are clear and are related to profit
maximization and value creation for sharehold-
ers. In state-owned firms, however, the goals are
usually blurred, multiple, conflicting, and unsta-
ble and include both financial and political ob-
jectives (Cuervo, 1997). An observable conse-
quence of this difference in goals is the
difference in their measurement. The measure-
ment serves as a basis for establishing incen-
tive schemes and internal control mechanisms.
The financial objectives of private firms are opera-
2 As a caveat to this prediction, we must note that there is
an obvious asymmetry of information between insiders and
outsiders regarding the firm. Insiders, who are better in-
formed, will only become owners of the firm they work for
when there is clear potential for performance improvement
after privatization. Thus, a sample selection bias appears
that should be accounted for in order to test this implication.
The problem is more salient in such countries as Russia,
where insiders controlled the privatization process and,
thus, ensured that outsiders gained dominant shareholdings
only in the worst firms (Barberis et al., 1996). Moreover, when
markets are inefficient and the institutional and contractual
systems are not well developed, outsiders have problems
achieving control of the firms.
586 Academy of Management Review July
tionalized by accounting measures or by mar-
ket-based measures, such as stock prices.
Incentives and control systems aimed at
aligning managers' interests with sharehold-
ers' can be operationalized in a similar man-
ner. Managers typically prefer that their com-
pensation be linked to accounting-based
performance measures, rather than to market-
based measures. This is because the latter
reflect future expectations, rather than past
actions, and, unlike accounting statements,
cannot be manipulated by managers. Share-
holders tend to favor market-based incentives
for managers, because they better reflect cre-
ated value and precisely because they cannot
be manipulated by managers. As a result of
this discrepancy between the preferences of
managers and those of shareholders, incen-
tive schemes in private firms are commonly
based on both kind of measures; examples are
shares and stock options ownership by man-
agers, threat of dismissal if income or market
performance is low, or some combination of
these (Shleifer & Vishny, 1997).
In state-owned firms political objectives are
difficult to operationalize, and financial objec-
tives are only operationalized by accounting
measures. Consequently, market-based mea-
sures gain relative importance as a result of
privatization.
The linkage between incentives and control
systems and goals usually increases with pri-
vatization. The possibility of promotion is the
primary incentive used in state-owned firms.
This incentive is linked to pre-established em-
ployment categories and union participation-
not to observable outcomes (Haskel & Sanchis,
1995). Likewise, control in public firms is purely
formal and administrative and is exercised by
different government agencies. With privatiza-
tion this practice is replaced with a more objec-
tive and outcome-based control system. There-
fore, we propose the following.
Proposition 3: Privatization prompts
the firm to make incentive schemes
and control mechanisms more out-
come based and more market based.
Changes in Corporate Governance
Agency theorists contend that the incentive
schemes of private firms are likely to be more
effective than those of state-owned enterprises.
Nevertheless, the basic premise of principal-
agent models-that optimal incentive contracts
will emerge-has not been corroborated by em-
pirical evidence, which shows that inefficient
compensation arrangements are widespread
among private firms (e.g., Barkema & Gomez-
Mejia, 1998;
Jensen & Murphy, 1990). Once again,
public choice theory can be used reinforce the
argument for what is, in principle, an agency
theory prediction. On the one hand, objectives in
state-owned firms are multiple and subject to
political bargaining (Boycko et al., 1996). Estab-
lishing incentive systems linked to financial
performance, thus, is unlikely. On the other
hand, pay scales are limited to those of civil
servants, thus creating a ceiling on pay levels
(Haskel & Szymanski, 1993). In addition, manag-
ers in state-owned firms have more freedom to
escape pressures imposed by incentive schemes
(Shleifer & Vishny, 1994).
Control mechanisms in private firms also can
be expected to be more effective than those in
state-owned firms, since the internal control de-
partments and boards of directors who exercise
control in private firms usually are better in-
formed than their counterparts in state-owned
firms. The objectives of boards and internal con-
trol departments also are more aligned to those
of firm owners' than are the objectives of exter-
nal agencies in general. As predicted in agency
theory, we thus expect changes in incentives
and controls to result, on average, in improved
performance for the privatized firm. We also
want to highlight, however, two potential
sources of variance that are pointed out in the
literature on corporate governance in private
firms.
First, certain ownership structures might be
better for performance than others, but greater
ownership concentration is not always prefera-
ble (Demsetz & Lehn, 1985). In fact, empirical
evidence shows that when ownership concen-
tration increases beyond a certain point, the
control benefits of large shareholders are more
than offset by the costs of their search for private
benefits of control (Shleifer & Vishny, 1997). For
example, the sale of state-owned enterprises to
controlling shareholders having nationalistic,
financial, or even technological objectives may
not always have the desired effect on perfor-
mance, because these shareholders might well
pursue their private goals, as opposed to putting
2000 Cuervo and Villalonga 587
pressure on managers to maximize the firm's
value.
Second, not all boards are equally effective in
exercising control over managers. Relevant
causal variables include size, insider-outsider
composition, rules of behavior, and chairman-
CEO separation (e.g., Dalton, Daily, Ellstrund, &
Johnson, 1998; Zahra & Pearce, 1989). Accord-
ingly, we propose the following.
Proposition 4: The privatized firm's
goals and incentive schemes lead to a
greater performance increase when
there is an intermediate level of own-
ership concentration and no large
shareholder domination and when
boards effectively perform their con-
trol role.
Changes in Strategy, Organization, and
Culture
One of the largest sources of variance in the
performance effects of privatization comes from
the changes in strategy and organization that
can occur with privatization. Managers gener-
ally have greater incentives to invest under pri-
vate ownership than they do under state owner-
ship. Under state ownership, managers
rationally foresee that any potential benefits
from their investments can be expropriated and
will not likely affect their compensation (Laffont
& Tirole, 1993). Losses, however, might threaten
their job. Hence, any strategy requiring substan-
tial investments is, from the point of view of
managers, one of "high risk, low return" and,
thus, unlikely to be undertaken. Under private
ownership, however, the risk of losing one's job
is offset by the increase in compensation that a
successful strategy is likely to generate.
Furthermore, in state-owned firms the deter-
mination of a firm's activity and location is
constrained both politically and geographi-
cally by the state as owner. Location, for ex-
ample, generally is limited to the home coun-
try. When such constraints disappear as a
result of privatization, a firm can expand the
scope of its activities and/or geographic mar-
kets, thus taking advantage of the opportuni-
ties arising in the environment to exploit and
further develop its resources and capabilities
(Penrose, 1959).3 International mergers might
be particularly desirable for the privatized
firm, because mergers with firms in other
countries reduce sociopolitical and union
pressures on the firm by increasing its free-
dom in the design of strategy. Furthermore, the
host markets a firm enters through merger are
less likely to retaliate or to impede entry if the
firm is private rather than state owned. This
clearly affects foreign markets, since the na-
tionalistic sentiments often voiced when local
firms (especially large ones) are sold to a for-
eign company are likely to be magnified if the
buyer is a foreign state. But it also affects
product markets, where incumbent firms may
worry that the entrant will use its unlimited
public funding to support or cross-subsidize
its activities into their industry and compete
unfairly with them.
Changes in a firm's strategy at the business
level also should be expected when a firm is
privatized. Anderson, de Palma, and Thisse
(1997) have shown mathematically that privat-
ization in differentiated industries results in a
wider product variety, because the state-owned
firm, by keeping prices low, effectively acts as
an entry deterrent so that consumers enjoy less
variety. To the extent that consumers value va-
riety, privatization, thus, will result in increased
levels of efficiency. It must be noted that this
greater product diversity has to come not only
from different firms entering the industry but
also from a wider range of products being of-
fered by the firm, so that there is, indeed, com-
petition within each product niche. Anderson et
al.'s model indicates, then, that in order for a
given firm to be able to offer a greater product
variety, more innovative and less focused strat-
egies are required at the business level. In ad-
dition, following the argument above-regard-
ing managers' incentives to invest-managers
are more likely to undertake such strategies af-
ter privatization than before. Thus, we offer the
following proposition.
3 One might argue that corporate refocusing strategies
are even more likely given that many state-owned firms
were conglomerates. Note, however, that seldom are those
conglomerates privatized as a whole. Rather, they are typi-
cally restructured prior to their privatization, and their busi-
ness units are sold independently. Therefore, it is these
stand-alone business units that we expect to engage in
scope-enhancing strategies as a result of privatization.
588 Academy of Management Review July
Proposition 5a: Privatization prompts
a firm to engage in scope-enhancing
corporate strategies and in more in-
novative and less focused business
strategies.
Strategic changes of this kind cannot take
place in isolation from changes in other organ-
izational variables. Specifically, the privatized
firm's organizational structure is likely to be-
come more decentralized as incentives and pri-
vate ownership substitute for direct supervision
from headquarters. By releasing managers from
politicians' control, privatization may free man-
agers to exercise their latent managerial talent
(Shleifer & Vishny, 1994). Middle-level manag-
ers, for example, whose main role under state
ownership was one of mere administrative con-
trol, might find their jobs content filled as they
become responsible for implementing changes
and for coordinating and motivating the teams
they supervise.
Likewise, the privatized firm's corporate cul-
ture can be expected to change in accordance
with the other internal variables considered
(Bishop & Thompson, 1992). For instance, with
the switch from political to financial goals and
to more outcome- and market-based incentives,
the firm is likely to move from a production
orientation to a customer orientation-that is,
from a focus on inputs to a focus on output mar-
kets (Cuervo, 1997; Martin & Parker, 1997). Thus,
we offer the following.
Proposition 5b: Privatization prompts
the firm to adopt a more decentralized
organizational structure and a greater
customer orientation.
MANAGERIAL
AND POLICY
IMPLICATIONS
The high variance observed in postprivatiza-
tion performance has important implications for
managers and policy makers. It shows that the
increase in the privatized firm's performance
cannot be taken for granted by either group.
Rather, privatization calls for a number of deci-
sions that may facilitate the attainment of such
increases and broader socioeconomic goals.
Thus, if a monopolistic firm is privatized without
concurrent changes in competition and regula-
tion, its goals and strategy will change in direc-
tions different from those suggested in our prop-
ositions. Namely, prices will increase, output
will decrease, new owners and top-level man-
agers will have no incentive to lead the firm into
new markets, middle-level managers will not
assume a more prominent role, and consumers
will suffer from the privatized firm's greater
freedom in exercising its market power, as op-
posed to benefiting from a greater customer ori-
entation. Our earlier discussion about insider
versus outsider privatization indicates that pol-
iticians should also bear in mind the long-term
consequences of the different privatization
methods available to them.
Similarly, if the top management team is not
replaced when a firm is privatized, internal
changes are likely to take longer to be imple-
mented, if they are implemented at all. Hence, a
privatized firm's performance increase might
not be observed as expected, or at least not by
the time expected. Also, the expanded opportu-
nities opening up to a privatized firm's manag-
ers, in terms of corporate and business strate-
gies, may carry with them increased expected
returns but also increased risks. These and other
examples show that there are important practi-
cal insights to be gained by investigating the
variance in the performance effects of privatiza-
tion, rather than considering only the changes in
average performance.
CONCLUSION
We have analyzed why the performance in-
creases predicted in privatization theories are
not always observed in practice. By making
agency and public choice views of privatization
more precise, we have offered several proposi-
tions that may serve to test the theories in com-
bination and against each other. By bringing
organizational and contextual variables into a
dynamic model of privatization, we have opened
the black box between privatization and perfor-
mance that has so far constrained our under-
standing of this relationship. Because the study
of the variance in postprivatization performance
has important implications for managers and
policy makers, not to mention national econo-
mies, we hope other scholars will join our effort
to explain this variance.
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Alvaro Cuervo is a professor of business economics at the Complutense University of
Madrid and a member of the Advisory Council for Privatization to the Government of
Spain. He received his Ph.D. from the Complutense University of Madrid. His current
work focuses on privatization, strategy, and corporate governance.
Bel6n Villalonga is a Ph.D. candidate in the Anderson Graduate School of Manage-
ment, the University of California at Los Angeles. Her research interests are in
corporate strategy and corporate governance, particularly the performance effects of
diversification, ownership structure, and privatization.
