Many expected mass privatization to result in widely dispersed ownership and weak external governance of firms. But Czech investment funds --- now key players in equity markets --- are monitoring and influencing corporations on behalf of small investors. Meanwhile, a close relationship between Czech banks and corporations (with banks as both lenders and shareholders in investment funds) has reduced banks risk and their cost of getting information about and monitoring firms' performance.
Voucher privatization was expected to result in widely dispersed ownership with little effect on firms' governance. But in the first wave of privatization, more than 70 percent of Czech vouchers went to investment funds and the 10 largest Czech and Slovak investment funds (surveyed for this study) acquired roughly half of all voucher points.
And the large funds can influence corporate governance. A fund holding large stakes (up to 20 percent) in a single enterprise can appoint directors to the board, help select management, and otherwise monitor corporate decision-making.
A fund's actual role depends on the sponsoring institution's or individual's incentive structure. Foreign bank-sponsored and nonbank funds are stronger corporate monitors than funds sponsored by domestic banks.
Banks and investment funds lack the skills and incentives to initiate corporate restructuring, but funds with significant stakes can readily compare managers' performance and remove underperform-ing executives and can counterbalance the control of management and employees. Funds can also effectively monitor firms on behalf of groups of small investors.
After privatization, most Czech assets are now owned by funds affiliated with banks. In market economies, a close relationship between banks and enterprises may be seen as a conflict of interest. In transition economies --- where information costs are high because corporate performance is not transparent and where collateral-based lending remains fraught with uncertainty --- banks and funds have spontaneously developed a relationship as a way for banks to get information about firm performance. Bank-sponsored funds reduce banks' information and monitoring costs and hence lending risk and costs. They also facilitate the informal workout of problem loans.
This paper --- a product of the Finance and Private Sector Development Team, Technical Department, Europe and Central Asia, and Middle East and North Africa Regions --- is part of a larger effort in the Bank to analyze the restructuring in transition economies. Copies of the paper are available free from the World Bank, 1818 H Street NW, Washington, DC 20433. Please contact Darlene Brown, room H8-099, telephone 202-373-3542, fax 202-477-8772. (45 pages)
The full report is available on our FTP server.