Problems with empowerment to date
This policy framework is concerned with addressing market distortions that prevailed in SOEs and in the economy as a whole during the apartheid period. One of the most obvious of these distortions was the prohibition of substantial property ownership by black people. In general, Government views transformation as a process aimed at raising the level of basic living conditions enjoyed by the vast majority. Correcting past wrongs requires a systematic, genuine empowerment strategy to bring black people and others who faced discrimination into the mainstream of the economy, including into ownership, procurement and training relationships with SOEs and into more harmonious, productive relations with each other.
Government’s policy on restructuring SOEs should entail new, creative, diverse strategies for genuine empowerment so that SOEs more effectively spread the benefits of restructuring. These strategies of alternative service delivery (1) may include broadened ownership, training, procurement and self-management opportunities for black people, women and the disabled, both directly through involvement in SOE management and indirectly through widespread ownership opportunities. There are many ways to achieve this objective, and it would be a mistake to seek a single, one-dimensional approach, particularly given the unsatisfactory record of SOE-related empowerment strategies.
Correcting past wrongs and in the process rectifying market failures requires different techniques for empowerment and different institutional configurations than endured, generally through artificial protection, during the apartheid era. Since the early 1990s, black economic empowerment has been built on existing pyramid-type ownership frameworks (with stakes in conglomerates purchased at high share prices via high debt levels), or on special deals crafted for those with privileged access, there have been severe disappointments and even some failures. Indeed, the overall operating environment for black enterprise has been badly impaired as a result. Systems of ownership, control and access that may have worked to empower earlier generations of white entrepreneurs, strategic shareholdings for the sake of company control and artificial conglomeration, or blatant state patronage based purely on ethnicity, currently face enormous resistance and operational difficulties.
Partly because of factors beyond the control of practitioners, black economic empowerment (as well as some investment schemes aimed at women’s and disabled people’s interests) did not fare well in a turbulent period of dramatic currency volatility, interest rate increases, share price fluctuations, declining per capita GDP growth and the exogenous shocks of 1996–1998. Even into 1999 and 2000, when financial markets recovered, interest rates fell and growth improved, some important “black chip” holding companies and other special purpose investment vehicles suffered enormous losses. Beside the efficacy of the empowerment model utilised to date, there is also a growing concern that black economic empowerment has enriched a few fortunate players but left most constituents behind. Some of the problems considered below are structural (flowing from conditions not of the empowerment practitioners’ own choosing), while some reflect naive strategies and questionable assumptions behind empowerment orientated financial engineering.
The need for a more appropriate strategy is widely recognised. The Black Economic Empowerment Commission (BeeCom) suggests in a draft report that “the state’s privatisation and restructuring programme has failed in so far as empowerment objectives are concerned”.(2)
The BeeCom argues that “effective black participation has been hindered until now by a multitude of factors. Assets are privatised or restructured with the assumption that empowerment will flow from new black ownership, instead new owners have been confronted with debt burdened enterprises, a tough financing environment, and in some cases confused privatisation objectives and conflicting interests”.
Criticisms of the state’s commitment to black empowerment initially emerged over the specific neglect of black involvement when Telkom’s two main international Strategic equity partners were chosen in 1997 (although 10 per cent of Telkom’s shares were set aside for empowerment purposes, as described below).(3) The Airports Company empowerment stake was set at 10 per cent, but due to the high prices that the foreign bidders offered and a shortage of finance, only 4,2 per cent of the Airports Company shares were transferred to black owners.(4) In all these cases, empowerment strategies via equity stakes in SOEs have, understandably, been hampered by the fact that even small share options require expensive borrowed funds, given the lack of past opportunities for black bidders to accumulate capital.
Other frustrations emerged in SOE divestiture to black owners. The Sun Air privatisation included a substantial empowerment ownership/management component, but its liquidation highlights some of the arguments noted above about competition and pricing issues.(5) The attempted sale of Aventura resorts to a union investment company also collapsed due to difficulties in raising finance and, on two occasions, to the black bidder’s partners pulling out unexpectedly (a management contract with a major hotel company was negotiated instead).(6) The Alexkor diamond mine management contract included a strong empowerment component, but ran into serious difficulties when this was translated to prospective ownership owing to difficulties in raising finance.(7)
Other investment strategies launched from 1994–1999, including special purpose vehicles established by the Industrial Development Corporation to promote black firms,(8) and loan guarantee and credit enhancement schemes established by the Department of Trade and Industry (Khula and Ntsika), have been disappointing.(9)
While some smaller credit initiatives (e.g. NGO microcredit projects and the Land Bank Step-Up programme) have had impressive results,(10) many in the black business community consider these to be nowhere near the size, scale and sectoral relevance required to assure meaningful participation in SOE restructuring.
In sum, a more genuine empowerment strategy is required for black people, women, disabled people and other groups who have faced systematic discrimination in past years, via one or more of several options discussed below.
To avoid the problems discussed above, a variety of strategies and tactics described by the term “alternative service delivery” will be employed. Some of the alternative service delivery approaches will entail some degree of equity transfer or sale while other will focus primarily on changing operational responsibilities to ensure greater participation by employees and client communities.
A more multi-faceted approach to empowerment
Widely different conditions have prevailed in the existing SOE empowerment deals. None have been unequivocally successful, and some have been disastrous. A new approach is required, based on the strengths of the National Empowerment Fund vehicle (with its goals of broadened ownership), but adding further instruments as required, including procurement and subcontracting, training, managerial skills development and transfer, and a more imaginative role for worker and community investment and/or self-management.
With regard to ownership, there are many international examples of voucher systems, collective investment programmes and public offerings, as well as employee share ownership plans (ESOPs) and community-controlled trusts.
Beyond simply a change of ownership, several other appropriate strategies arise which, through operational reform, can also generate more genuine forms of empowerment. According to the BeeCom, “the current approach by government prescribes the acquisition of assets. A phased approach where empowerment is initially loaded at the operational level and then extended into the equity ambit once the asset is on a productive footing, could prove more effective”.(11) The inclusion of employees and communities in SOE restructuring plans is vital, not least because creating and enhancing “social capital” (roughly defined as the fabric of trust and mutual support that is recognised as vital to successful development)(12) is one of the South African government’s overarching socioeconomic objectives. This is particularly true in areas that have been subject to systematic violence and social tension. The role of each approach (broadening SOE ownership, SOE operational empowerment strategies, and SOEemployee/community “alternative service delivery” in strengthening social capital) is considered, in turn, below.
As described below, there are many reasons why restructuring SOEs for empowerment objectives via new forms of employee and community ownership and self-management make sense. From a pro-privatisation standpoint, David Binns of the US Foundation for Enterprise Development argues that:
… The strategic and political appeal of employee ownership in privatisation transactions is based on several key factors. Ownership can provide the work force with a direct financial incentive, mitigating employee opposition to the concept of privatisation. For employees and their unions, ownership offers a means to minimise job loss and adverse impacts of the transition from the public sector. It also provides opportunities for significant capital ownership and potential career enhancement through an immediate transition to private-sector employment. From the perspective of the government, employee ownership may offer improved employee relations, more efficiencies and greater cost reductions. The creation of an employee group as a viable bidder also can expand the competition base to acquire government assets or to out-source contracts. It potentially offers a seamless transition for the conversion from public to private ownership.(13)
A growing literature promotes the social and community benefits of worker ownership and self-management as being as important as a transformed site of production. According to a Ford Foundation and Kent State University group, broadening capital ownership:
Such social goals overlap closely with the South African Government’s aim of promoting genuine empowerment for those denied access to the benefits of ownership and management during apartheid. In the discussion that follows, alternative models of service delivery will be described in some detail. Given that these approaches have only been implemented in a few places and/or have only been recently adopted in others, it should, therefore, be accepted that the further development of such strategies would need to involve all stakeholders to provide models suitable for the South African context.
Broadening ownership
The National Empowerment Fund (NEF) Trust was established by the 1998 National Empowerment Fund Act to “facilitate the redressing of economic inequality which resulted from the past unfair discrimination against historically disadvantaged persons”.(15) It is the intention that the NEF Trust be capitalised primarily through receiving shares of SOEs undergoing restructuring. It has received shares with a nominal value of about R2 billion, and may receive up to10 per cent of the shares of other SOEs, with a nominal value of between R10–20 billion, making it potentially one of the most significant investment entities in the South African financial markets.(16)
The NEF Trust will promote its objectives through three different investment vehicles. First, it will have an investment trust that will market investment units to historically disadvantaged investors. The portfolio of this investment trust will include SOE shares and other investments to provide a competitively marketable and balanced portfolio. Currently, the unit trust approach is being explored, among other collective investment mechanisms, to develop an instrument that can provide small investors with affordable and accessible investment products.
Second, a portfolio trust will warehouse the shares of SOEs, which will thereafter be sold on to historically disadvantaged individuals and firms that seek a direct shareholding in these SOEs. Third, an equity management fund is envisaged to provide venture capital to encourage entrepreneurship among the historically disadvantaged groups through joint ventures, management buy-outs, outsourcing and other forms of spin-offs. The NEF is therefore likely to play a significant role in promoting many of the empowerment options discussed below, providing a range of investment vehicles from those accessible to small investors, to those available to SMMEs and larger firms originating from historically disadvantaged communities.
It is useful to consider how the broader goals and objectives of promoting the public good might coincide with the use of collective investment programmes and public offerings geared to empowerment. Funds considered under the category of “collective investment programmes” can be endowed through government owned equity, pension schemes and even unit trusts. Such programmes may not have as great a scope for ease of entry and exit as did the controversial Eastern European voucher schemes,(17)
Although the Eastern European evidence indicates that Government should proceed cautiously with such approaches, some voucher experts argue that the lack of familiarity with capitalist investing was the crux of the problem. They argue that “privatisation is more likely to succeed when people spend time thinking about what to invest in, learning about companies, picking mutual funds, or even deciding whether to sell their vouchers, than when they simply get pieces of paper to store under the pillow or in a bank”.(18)
Collective investment programmes with provisions protecting investments from easy liquidation may therefore be more advisable. As one World Bank official argues, under prevailing conditions such as:
… little or no understanding of share ownership, cultural barriers to individual accumulation of wealth, low degrees of literacy, and logistical constraints such as a highly disbursed and difficult to reach population. These factors produce prohibitively high transactions costs of secondary share trading, in which case a collective scheme which limits entry and exit (an investment trust, for example) might be preferable to a voucher-based approach.(19)
Malaysia’s (1971) New Economic Policy (NEP) “bumiputera unit trust scheme”(20) and Korea’s (1987) “People’s Share Program” public offerings of SOEs at deeply discounted prices for low-income groups(21) are probably the most successful precedents for spreading ownership through collective investment vehicles. However, in both cases, because there are large numbers of small-scale owners, beneficiaries have not exercised any real control either over an SOE in transition or even over the investment trust (which typically take the form of closed-end mutual funds and, hence, lack flexibility). Moreover, as the World Bank reported, in Malaysia,
… the program had the effect of severely dampening foreign direct investment in the economy, which declined throughout the early 1980s...[as a result] the government began to downplay the NEP guidelines in 1986 by relaxing foreign equity restrictions on companies established with foreign capital prior to 1986 and exempting all those established after 1986 from the NEP equity requirements entirely.(22)
Even if these issues are addressed through the appropriate design of such investment trusts, a major concern remains around the sustainability of the collective investment. If the real values of either privatised SOE shares (e.g. Iscor) or collective investments, marketed only to a particular group (e.g. Ikageng black empowerment shares initially issued in 1996), do not hold their value over time, a good-faith empowerment scheme runs the risk of becoming a vehicle for financial disempowerment. Even in South Korea, before the 1998 stock market crash, the global recession of the early 1990s caused extreme financial volatility.
This meant that many low-income investors who sold their shares in the two largest privatised enterprises in the People’s Share Program(23) were forced to sell shares at 65 per cent of their offer price. This, in turn, led the Korean government to cancel the programme.(24) At present, when overvalued share prices are the norm, it is worth considering whether the risks of collective empowerment schemes dependent upon buoyant stock market prices are worth the benefit.(25)
The use of Initial Public Offerings (IPOs) to promote empowerment in South Africa in the private sector has, however, been reasonably successful to date. In the case of five private sector offerings assessed by Deutsche Bank, (Deutsche Bank. 2000. Schemes to encourage retail participation, April.) four of the five have seen significant gains for the shareholders, with only one being “out of the money”. The schemes were also judged to have been properly marketed, providing adequate information and education to the potential investors. Each of these schemes used an option payment model that allowed shareholders to access shares for a modest upfront payment, with the balance due later. In three cases, the upfront subscriptions were considered accessible and, in the other two, an upfront subscription of only between R300–R600 was required, still making them accessible to many from historically disadvantaged communities.
The main problems identified with the schemes to date are that they provided little downside protection to shareholders, that they had no incentives to encourage long-term shareholding, that options were not tradable, and that options were redeemable on a single date (increasing the risk that shares would be sold off at that date to cover costs).
It would seem possible to design similar schemes for SOEs, in which the above problem areas could be addressed without much difficulty. It is proposed that similar option models be used with a variable redemption date and a redemption price decreasing with time, thus providing investors with incentives to hold onto their options. In order to limit the downside risk, options could be tradable.
Government would also need to consider whether to discount the shares, or to provide bonus shares to reward longer-term shareholding. The existing Post Office network may serve as a marketing facility, alternatively nationwide banks and/or shops could process applications and trading orders (via a link to a brokerage house).
Despite the hazards, increasing the ownership of SOEs should remain one crucial component of empowerment. The approaches discussed above should provide Government with a starting point in expanding the range of black shareholding. There must also be alternative means of addressing the other features of socio-economic transformation discussed previously, since this policy framework seeks an alignment of private, state and social interests. In addition to broadened ownership, operational empowerment and procurement also offer an alternative form of empowerment, as do a combination of ownership alternatives and self-management strategies. The next two sections deal with these options.
Operational empowerment
“Operational empowerment” describes the variety of processes related to active, hands-on participation in industries affected by SOE restructuring. These range from more meaningful access to state-regulated activities, training and skills development, affirmative action in management, to entrepreneurial opportunities through outsourcing, partnerships, procurement and easier access to financing.
By broadening the range of service delivery models to include greater worker, SMME and community participation, Government can help ensure that a broader grouping of the historically disadvantaged is empowered.
The recent Preferential Procurement Policy Framework (Act No. 5 of 2000), the 1997 Green Paper on Procurement, and the Affirmative Procurement Policy set out a comprehensive scheme for increasing the participation of historically disadvantaged people and enterprises in the activities of the public sector.(26)
In particular, since the policy and legislation provide adequate guidelines on how the services of such enterprises can be procured, they need not be repeated in this document. However, one policy issue that needs to be addressed here is whether the provisions of the policy and legislation should also apply to SOEs. It can be argued that making the provisions of the Act applicable to SOEs will hinder their ability to compete with other private sector firms in the same sectors. However, given that they should continue to dominate their sectors, they might be able to define the terms under which that market segment may function. Therefore, the provisions required by the policy and the Act are unlikely to make SOEs significantly less competitive.
It is estimated that the procurement budgets of state owned enterprises amount to between R40 and R60 billion.(27) It is, therefore, argued that unless the provisions of the policy and legislation are extended to the SOE sector, it is unlikely that Government’s objectives in drafting the policy will be fully realised. Government believes that the procurement policies of all SOEs should comply with all the principles of the Green Paper and Preferential Procurement Act. To ensure such compliance, the Department of Public Enterprises will lead an initiative to ensure that SOE procurement policies and procedures are aligned with Government policy on procurement, using the proposed shareholder compacts to initiate the process. The Department will also include the monitoring of procurement polices in its overall performance monitoring activities. To this end, it will require SOEs to include their preferential procurement status in their quarterly reports on performance. Finally, the Department will interact with the Department of Finance to ensure that appropriate regulations are put in place.
For the policy of preferential procurement to lead to genuine operational empowerment, the principles of the 1997 Green Paper have to be operationalised. In general, there should be provisions for direct preferencing for small-scale contracts, and the use of contract participation goals for medium- and larger-sized contracts (which may be satisfied through joint ventures or subcontracting).(28) Of course, depending on the sector, the thresholds that will apply for these two approaches will differ, requiring that Government’s procurement policies take into account their differential impact in the various sectors in which SOEs function. Critically, however, historically disadvantaged individuals are in each case given the opportunity to participate directly in productive and management activities and are not restricted to passive involvement as investors or “fronts”. Through the judicious use of targeting, using these two approaches, Government can ensure that the full spectrum of historically disadvantaged people (blacks, women or disabled persons) are included. In particular, it can use these two approaches to ensure that those who are retrenched in the restructuring process are favoured through the preferential procurement policies of SOEs, thus mitigating the short-term effects of such restructuring.
A critical operational constraint that prevents SMMEs from effective participation in SOE restructuring is inadequate collateral for financing. Even if procurement contracts become available, commercial banks in South Africa have been unwilling to consider financing the particular project because a contract does not offer sufficient repayment security. Indeed, a common concern in the small business sector is a lack of access to debt or equity financing. According to the Department of Trade and Industry’s 1998 policy paper, Financial access for SMMEs, insufficient competition is again a part of the problem:
… A key factor mitigating against increased investment in the SMME sector is the structure of the financial sector. The sector is composed of a concentrated formal banking sector targeting corporate accounts and competing with smaller niche banks and investment banks. Few second tier banking institutions exist that can absorb savings and extend credit to SMMEs. Furthermore, there is a dearth of strong alternative financial institutions providing credit to the self-employed for productive purposes.
A further concern is the risk aversion of institutional investors (particularly pension and insurance funds), who tend to focus on “safer” and larger investments which yield relatively few social and economic benefits. These investors have few social responsibility vehicles that effectively cross-subsidise from their wealthy clients to those requiring start-up support.
As a result, a large portion of the SMME sector does not have access to adequate and appropriate forms of credit and equity, or indeed to financial services more generally. In competing for the corporate market, formal financial institutions have structured their products to serve the needs of large corporates [sic]. Alternative financial institutions such as Non-Governmental Organisations (NGOs) offer a limited range of products and do not have the infrastructure to reach a significant number of SMMEs.(29)
Banks should, of course, be sufficiently confident of firms owned and managed by black, women and disabled South Africans to review and revise collateral requirements. However, given ongoing resistance, what other kinds of financing are available to help SMMEs gain more operational opportunities in SOE restructuring? One answer may come from the NEF, which is setting aside some venture capital to finance such initiatives. Another possibility may be through the enhanced use of social capital.
As Stiglitz and Ellerman argue:
… There is considerable experience in providing finance to micro and small businesses in developing countries ... One approach is to emphasize methods of “capitalizing social capital” to minimize the need for financial capital ... If workers were involved as co-venturers with an equity stake in the enterprise, then a substantial amount of the upfront finance would be replaced by their “sweat equity”. Their social capital (teamwork, cooperation and trust) would have been obtained by other means. Family-based startups, as seen with the overseas and mainland Chinese, provide other examples where social capital is obtained (based on familial relations) outside of expending financial capital in market relationships.(30)
Such a synthesis between alternative equity and empowerment vehicles is embodied in models such as ESOPs, as described next.
Employee ownership
Questions that have yet to be answered in the South African context are whether there is a harmonious combination of broadened ownership options for SOEs and operational empowerment through skills transfer and procurement and whether the broader (low-income, black, women, disabled) constituencies can be better served by SOE restructuring than they have to date. As the BeeCom complained of most empowerment exercises:
… There remain few examples of community or employee spin-offs to speak of (for instance, share schemes, community trusts and effective social responsibility programmes). Owners, who have been licensed on the basis of representivity or broadness of dividends, need to be tested against this. The question must be asked and should have been asked at the time of tender adjudications, what in particular are they doing for the members they represent? (31)
A major vehicle for alternative service delivery, which is worth considering as an option for future SOE restructuring, is ESOPs. This possibility should be considered alongside the broader social responsibility of SOEs (and society as a whole) to enhance social capital, as a critical component of overall empowerment. The idea of an ESOP is straightforward. The most important details are those associated with share prices, profit sharing, a requirement on length of shareholding, and taxation issues. At a more general level, however, what is most crucial is that the needed components of restructuring are recognised from the outset by worker-owners, who increasingly take on board self-management responsibilities.
Although worker ownership has been experimented with for centuries, the ESOP movement in its modern form began with US entrepreneur Louis Kelso’s post-war vision, which combined ownership and management with the innovation that large-scale debt (backed in some cases by pension funds) could leverage workers into positions of meaningful control.(32)
Earlier share ownership participation offered by corporations to workers were considered unsuccessful when, during the Great Depression, employee shareholdings (33) collapsed by 75 per cent in value from 1929 to 1932, and indeed fell to just 15 per cent of their 1926 value at a time when, facing mass unemployment, many workers were desperate to liquidate their shares simply to survive.(34)
By the mid-1930s, 90 per cent of the employee share plans had closed.(35) However, in addition to the overall financial crisis of the 1930s, the early plans faltered because they were mainly “beneficial ownership” without employee control.
The need to merge management with ownership is evident from more recent United States experience. According to the National Center for Employee Ownership:
… Studies consistently show that when broad employee ownership is combined with a highly participative management style, companies perform much better than they otherwise would be expected to do. Neither ownership nor participation accomplishes these significant gains on its own.(36)
This insight becomes a critical challenge for South African SOE restructuring, and there are many precedents to draw on from settings other than the United States. An important version of worker ownership and self-management exists in the Mondragon region of Spain, and has been initiated at scale in Quebec.
Sweden’s Meidner Plan aimed at building a large trust that would not only ensure worker self-management at the shop floor level, but also elevate key union representatives to the boards of companies.
In contemporary times, worker ownership and self-management is most common in the United States, where major firms like United Airlines, Starbucks, Crest, Ramada, Wal-Mart and others have majority or dominant worker ownership.
Indeed, more than 10 million American workers are part-owners of substantial stakes in their companies, and more than one-third of stock market investors made their first share purchase through their company plan. By the early 1990s, 15 per cent of Wall Street’s 7 000 listed companies had substantial worker ownership, averaging 12,2 per cent of shares. In half of these firms, employees were the dominant shareholders. By 1998, an estimated 9 per cent of all shares in United States’ stock markets were owned by workers. The United States’ legislative facilitation of such plans dating to the mid-1970s included 15 per cent discounts on share purchases by employees and the use of a tax provision (s.401k of the Internal Revenue Code) to promote joint employee/employer pension investments in ESOPs. Before the favourable tax and pension legislation, American ESOPs numbered less than 1 000, but within a decade there were nearly 6 000.(37)
The debate continues over how successful ESOPs are in relation to firms not owned by employees. In the United States, the main studies of motivational effectiveness do register impressive results for ESOPs (38)
This is particularly the case when other preconditions are in place: implementation of the ESOP with worker motivation as a primary objective, the existence of voting rights for employee share-owners, and employee motivation (39) Privatisation has also been accomplished through ESOPs in recent years. The first major experience was in the United States in 1974, when 15 per cent of Conrail railroad shares were sold to employees. In Britain, the 1983 sale of 90 per cent of National Freight to workers represented the first major SOE sale. These were successful examples, at least initially, until the original employees retired and cashed out their shares to ordinary members of the public in stock market transactions, at which point the nexus between ownership and self-management began to wane.
In an extreme way, the disjuncture between ownership and management was the tragic outcome of Russia’s stock voucher ownership experience of the early
1990s. An analyst of Russian privatisation ESOPs, Joseph Blasi, concluded after a study of 150 firms:
… The trends in corporate governance were so uniform that they do not require a detailed statistical analysis. The top managers have negated in a series of actions which essentially turn the firms into closed corporations, take them out of the market of corporate control, emasculate employees as shareholders, restrict outside access to information, and tightly control boards and shareholder meetings and registries.(40)
Additional problems associated with SOE-related ESOPs not grounded in self management, even in less corrupt western settings, were acknowledged by the Ford Foundation and Capital Ownership Group:
Most of the privatization [ESOP] systems have used employee ownership as a quick pass-through from state ownership to private corporate ownership, without creating lasting, capital-anchoring solutions. The European profit sharing systems are virtually voiceless and codetermination is statutorily a minority voice.(41)
However, experiences with privatisation-related ESOPs from other countries include success stories, even in Third World settings. In Canada, Chile, China, the Czech Republic, Egypt, France, El Salvador, Germany, Holland, Hungary, India, Jamaica, Poland, Russia, Slovakia, Slovenia, Venezuela and Zimbabwe ESOP movements have begun to show success at employee ownership and selfmanagement. Chile allowed workers to borrow 50 per cent of severance pay to buy 10–5 per cent of shares in 15 SOEs at a discount. Chinese village enterprises are increasingly worker and community-owned, instead of being controlled by the central state. More than 150 employee shareholder associations have formed in Egypt to buy SOE shares. El Salvador’s state-owned electricity company sold 20 per cent of its shares to workers at a 20 per cent discount and with a 50 per cent discount on interest rates for workers who borrowed to buy shares. France’s privatisation programme occurred in part through financial participation (profit sharing) schemes, in which 17 000 private companies also participate. In ex-East Germany, 10 per cent of management buy-outs of privatised companies entailed major employee ownership.
In Hungary, ESOPs have played a substantial role in 150 privatisations, based on a 15-year period for acquiring ownership, and loans available for up to 85 per cent of share values per worker. Jamaica’s privatisation programme includes tax deferral on shares for 25 per cent of the principal and 100 per cent of any interest charges associated with borrowing to buy. Poland’s discount of 50 per cent on privatised companies for ESOPs is enhanced by tax-free status on the shares once they are held for six years. In Slovakia, terms for employee purchase of privatised companies include a 10–15 per cent cash deposit but a 10–15 year repayment period on highly subsidised loans. Slovenia’s arrangements include a 20 per cent grant of shares to employees at no charge, 20 per cent to broad citizens’ funds, 10 per cent to the national pension fund, and 10 per cent to a national compensation fund, with the remaining 40 per cent sold to employee groups or to the general public.(42)
There are obviously many models, with differing technical details. If ESOPs and related community trusts are to succeed in meeting South Africa’s combined efficiency and social empowerment objectives, tapping the organic knowledge of workers and communities will be crucial in order to ensure that once a sale to an ESOP is made, the restructured SOE does not stagnate (as happened in many Eastern European cases during the 1990s). (43)
As Binns puts it:
… employees are more likely to invest their own money in the one company they know something about and where their own efforts can have the greatest impact .. Employees may be in the best position to determine the viability of the enterprise as an independent entity. Because they represent a readily identifiable buyer, sales to employees can be conducted more expeditiously.(44)
To illustrate the application of ESOPs to SOE restructuring, the most recent major example, that of the Irish SOE Telecom Eireann (TE), can be considered in detail as one of a series of potential models.(45)
The TE trade unions agreed to staff reductions and changes in working practices in exchange for a standard 5 per cent of TE’s share capital through an ESOP, as well as the option to purchase (through ESOP trustees) an additional 9,9 per cent of the TE share capital at a “fair market value”. The additional employee purchase was financed through employee pension contributions and a loan. TE was floated in an initial public offering in July 1999, and currently trades substantially above the ESOP purchase price. The total 14,9 per cent stake cost the 12 000 TE employees IR£1 billion, and is allotted to individuals through personal stakes over a five year period.
The seven ESOP trustees comprise four members nominated by the trade unions, two by TE and one independent. To assure overall co-operation, the Irish government also invoked a “lock-in” arrangement that allows TE, if necessary, to prevent sale of shares within five years of their transfer. In addition, the 9,9 per cent of shares purchased through pension fund and loan financing cannot be liquidated until the ESOP has paid the fund liabilities and loan interest. Those workers who voluntarily quit TE qualify for an allotment only for the period they are employed, while incoming workers only qualify for allotments after one year.
There are no other qualifications or differentials between the workers, however (based on pay, status or length of service). Assuming current share prices, each of the workers remaining with TE from 1999-2003 will be worth an additional IR£80 000. The ESOP is enhanced by an Approved Profit Sharing Scheme.
The merits of the TE model are described by the former general secretary of the Irish Communication Workers’ Union, David Begg:
… workers are stakeholders and have a vital interest in the fortunes of the Corporations in which they work. It is not unusual for people in authority to recognise workers as stakeholders but too often this is mere lip-service. In reality, to mean anything, workers’ influence must be backed up with economic power. This is where owning part of the equity of the corporation comes in because it gives workers financial clout which must be listened to.
Financial markets also favour the TE model. According to a key observer, Robert Oakeshott:
Although the initial reaction of the “financial community” was sceptical or even hostile, that later changed. The initial argument had been that a substantial employee shareholding would be a downward drag on the share price. After discussion and reflection, that view was apparently changed, and the “up to 14.9 per cent ESOP” came to be seen as a potential source of buoyancy in the share price rather than the opposite.
Binns argues that any state interested in SOE restructuring with a component of employee ownership should follow nine core lessons:
These policies and programmatic interventions will assure a more feasible environment for ESOPs projects when SOE restructuring occurs. However, beyond establishing a level playing field, there are numerous creative approaches that should also be adopted by Government, once the benefits they have demonstrated elsewhere are clearly translated to local SOEs. Once established, the following policy options will allow each SOE facing restructuring to tap into particular state support systems to assure successful worker and social ownership and management:
Tax benefits can be provided to companies on a sliding scale, depending upon quality and quantity of employee ownership and control.
The introduction of ESOPs in South Africa may, however, be complicated by the social structure of most enterprises that are segmented by racial and class divisions. Introducing ESOPs in such an environment, where the majority of skills and resources lie with minority ethnic groupings, will not ensure that participation is broadened sufficiently to address historical inequalities. The design of ESOPs will therefore need to pay much greater attention to overcoming these historical inequities without undermining the overall benefits associated with greater employee involvement across the range of employment categories in the firm.
Such ESOPs may need to provide further resources to empower and train underresourced and less skilled employees to participate more equally in the operations of the business.
Community trusts
A final area where participation can be enhanced in the restructuring of state enterprises is with community trusts. Such trusts seek to obtain the benefits of small economies of scale, resolve micromanagement challenges and incorporate the benefits of “social capital” and non-pecuniary gain within the production-distribution-consumption process. Community trusts include producer co-operatives, consumer co-operatives, mutual companies, not-for-profit firms and other avenues of collective activity that allow an enterprise to extend beyond the reach of the market.
Most community trusts are purchasing arrangements. The greater economies of scale associated with collective purchasing provide an incentive to establish cooperatives so as to enhance bargaining power in the market or to share overhead costs more efficiently. Community trusts may also take the form of, for example, pooling savings so that members of the trust can afford to borrow a much larger amount than would otherwise be available from a commercial financier. Pooled savings may also be used to ensure the provision of a service, for example electrification of rural areas, which would not be available to the individual consumer.
The best-known exercise in co-operative utility enterprise is probably rural electricity in the United States, dating to the New Deal era, but continuing today through the National Rural Electrification Co-operative Association. Currently, two thirds of the US land mass is electrified by consumer-owned rural co-operatives. These are not limited only to retail end-users. Electricity generation and transmission cooperatives emerged to supply local distribution co-operatives, and increased their share of the latter’s inputs from less than 20 per cent in 1960 to more than 50 per cent today. The core barriers to co-operative ownership (including high capital intensity, the need for state subsidies, risk, and a biased responsibility for enterprise capitalisation falling on older generations) were all provided for in supporting state programmes, legislation and funding sources.
There are important precedents for introducing community trusts to SOEs undergoing restructuring. These are mainly in areas associated with utility functions involved in the supply of electricity, telecommunications and transport. Non-profit co-operatives may be the only kinds of enterprises willing to reach out to sectors of the population for which markets are uneconomic. Given the geographic and social inequalities in the South African space economy, Government support for community trusts is vital. This may include provision of venture capital, technical expertise (business planning), and marketing information/linkages. Ultimately, however, the broader transformation of South African society should also entail a state commitment to investment in social capital, which is where the combination of employee-managed firms and community trusts may have its greatest potential.
Conclusion: encouraging empowerment
In the process of restructuring SOEs, the interests of society can be realised through aligning the objectives and processes discussed above, and through assuring that all restructuring processes account for the full set of public good issues associated with their operation. In previous sections of this policy framework, it was argued that SOE restructuring should seek, in part, to use state assets to correct market failures, particularly in cases where some goods or services are not produced or consumed with sufficient quantity and quality to maximise social welfare, hence requiring the state to act as provider or regulator of public goods. It was also proposed that SOE restructuring should seek to ensure that consumer welfare is not threatened by price discrimination associated with the privatisation, incorporation or deregulation of some SOE goods whose characteristics lend themselves to market failure. Hence active, creative regulation of SOEs that become subject to market discipline will be essential.
In addition, this policy framework proposes a multi-faceted approach to broader social empowerment through three kinds of intervention, informed by strategies of alternative service delivery in SOE restructuring processes:
Notes:
Langford, J. 1996. Power sharing in the alternative service delivery world. In Ford & Zussman. Alternative service delivery: transcending boundaries.
There are many different points of view about why empowerment strategies have faltered, but this document refers mainly to arguments presented by the Ramaphosa Commission on Black Economic Empowerment (BeeCom). Black Economic Empowerment Commission. 2000. BEE revisited: an opportunity for transformation. Pretoria: BeeCom.
Five support programmes launched in 1998 include a wholesale finance scheme, a low-interest-rate empowerment scheme, a takeovers and acquisitions scheme, group consortium finance, and a fish harvesting scheme. (Ibid., p. 38).
The “intense criticisms” of Khula recorded by the Beecom (p. 36) include:
First, Khula’s loan application assessment is too conservative, no different from those used by banks.
Second, the credit guarantee scheme has not changed the criteria used by financial institutions when they assess small business loans.
Third, Khula has paid little attention to institution building
Stiglitz and Ellerman define social capital as habits of teamwork, Cupertino, and reciprocal trust (see reference below).
Binns, D. 1999. Using employee ownership to facilitate federal privatization initiatives: a potential win-win scenario. Foundation for Enterprise Development, p. 1.
Ford Foundation, Capital Ownership Group and Ohio Employee Ownership Project. 1999. Broadening capital ownership in the global economy: creating an international network to develop policy options. Ohio: Kent State University, 3.
National Empowerment Fund. 1999. Business plan 1999–2004, June.
Given that most SOEs have not reached the market, it is both difficult and irresponsible to indicate a clear value of the shareholding, since the value will largely be determined by the market when (and if) the equity is made available to investors. The nominal estimates provided here are based largely onreadily available sources; the information in Table 2 is based on data from the Financial Mail
Johnson, S. & Loveman, G. 1995. Starting over in Eastern Europe: entrepreneurship and economic renewal. Boston: Harvard University Press; Shleifer, A. & Vishny, R. 1998. The grabbing hand: government pathologies and their cures. Cambridge: Harvard University Press.) but these programmes have been criticised because of the rapid recentralisation of ownership through voucher buy-backs. (Ellerman, D. 1998. Voucher privatization with investment funds: an institutional analysis. Policy Research Report No. 1924. Washington, DC: World Bank.
Boycko, M., Shleifer, A. & Vishny, R. 1994. Voucher privatization. Journal of Financial Economics,35: 255.
Bell, S. 1997. Sharing the wealth: privatization through broad-based ownership strategies. World Bank Discussion Paper 285. Washington, DC: World Bank.
Jomo, K.S. 1991. Whither Malaysia’s new economic policy? Pacific Affairs, 63: 4; Sieh Lee, M.L. & Lyn, C.K. 1986. Redistribution of Malaysia’s corporate ownership in the new economic policy. South East Asian Affairs. Singapore: Institute of South East Asian Studies.
There were two share offerings worth $8 billion, by priority (95 per cent, of which 20 per cent was to employees and 75 per cent to low-income people) and by general (5 per cent) allocations. The shares were undervalued, and in one case (steel) they tripled in price the day the general allocations became available on the local stock market. The mechanism entailed a means test for priority buyers who opened a savings account with the programme. There was a three-year time requirement on holding the shares prior to sale. For details, see Song, Dae-Hee. 1989. Three essays on Korean privatization policy. Seoul: Korea Development Institute.
Responsible for 22 per cent of the Korean stock market’s capitalisation.
For example, from April–September 1998, the Johannesburg Stock Exchange’s main share index suffered its worst-ever crash of nearly 50 per cent.
Preferential Procurement Policy Framework Act, Act No. 5 of 2000; Departments of Finance and Public Works. 1997. Green Paper on Public Sector Procurement Reform in South Africa. Pretoria: Government Printer
The gross domestic fixed investment figures (Reserve Bank Quarterly Bulletin, March 2000) reflect amounts of R18 billion for the public sector and R20 billion for SOEs for procurement for 1999. These figures do not, however, account for all procurement, as they are limited to residential, non-residential, construction works, machinery, transport and other equipment, but they at least indicate the relative significance of each of these sectors. The 1997 Green Paper on Public Sector Procurement Reform in South Africa quoted a 1995 figure of R56 billion for public sector procurement. If one uses this as a basis for estimating total procurement and assume that the proportions remain approximately the same, one can estimate the total procurement budget of SOEs to be between R40–R60 billion.
Department of Trade and Industry. 1998. Financial access for SMMEs. Pretoria: Government Printer, p. 3.
Stiglitz, J. & Ellerman, D. 2000. New bridges across the chasm: macro- and micro-strategies for Russia and other transitional economies. World Bank Discussion Document. Washington, DC: World Bank, p. 16.
The first Kelso-originated ESOP was the purchase in 1954of a small Californian newspaper by employees, originated in order to block a takeover by a larger chain. Many ESOPs emerged in the United States because of similar threats and, hence, were defensive in character prior to more facilitative pension-related legislation in 1974.
At peak, these were responsible for only 1 per cent of all outstanding stock ownership.
The dangers associated with overpriced shares in the contemporary setting are discussed below.
D’Art, D. 1992. Economic democracy and financial participation: a comparative study. London: Routledge, p. 87.
Rosen, C. 1998. An overview of ESOPs, stock options and employee ownership. Oakland: National Center for Employee Ownership, p. 1.
Blasi, J. 1993. Employee buyouts and employee ownership in the west: development and implications for transitional economies and privatization. Institute of Management and Labour Relations. New Brunswick: Rutgers University, 4; Rosen. (1988: 2); D’Art. Economic democracy and financial participation, p. 94.
The seminal study was Conte, M. & Tannenbaum, A. 1978. Employee-owned companies: is the difference measurable? Monthly Labor Review, July.
Blasi, J. 1995. Privatized enterprises in Russia: some initial observations. Foundation for Enterprise Development, p. 11.
Ford Foundation, Capital Ownership Group and Ohio Employee Ownership Project (1999: 3).
In addition, the confidence of having a local consumer market behind an ESOP can be very important. In general, community and consumer trusts are potentially useful, especially where utility SOE restructuring is concerned. In the United States, the National Rural Electrification system emerged during the 1930s New Deal era to help spread the benefits of the Tennessee Valley Authority hydropower schemes into low-income rural areas that were not otherwise commercially viable. A more recent innovation, Consumer Utility Boards, gives consumers a strong role in local tariff setting and environmental management in public and public-private utilities, with potential for ultimate ownership in the event of institutional restructuring.
Binns, D. 1998. Privatization through employee ownership: lessons learned from the international experience. Foundation for Enterprise Development, 1.
Information taken from Oakeshott, R. 2000. From lipservice stakeholders to real shareholders: why, how and to what extent its staff became significant shareholders in Telecom Eireann. Unpublished paper. London.
This term will increasingly be defined, not least because the World Trade Organisation and more transparent public management systems will force Government to more clearly specify subsidies and cross-subsidies, and to justify these as being in the public interest. Largesse is also considered to include major “bail-out” operations where a corporate or bank bankruptcy would have excessively destabilising effects.
Documentation for each of these techniques is provided in Ford Foundation, Capital Ownership Group and Ohio Employee Ownership Project (1999: 5–6).