15: Love me tender
Alternatives to fixed-price privatization offers
The problem: maximising take-up and proceeds
How can governments maximize the proceeds from sales of state-owned assets while encouraging wider share ownership among the public? A sale by auction or tender might raise the largest amount of money, but smaller, unsophisticated investors do not understand this system as well as they understand a simple, fixed-price offering.
The idea: fixed-price and tender sales
Why not use both techniques at once? Sell part of your privatization stock at a fixed price, easily understood, and advertised to the general public. Sell another part to the institutions, by the tender process, by which they have to enter sealed bids specifying the number of shares they want and the price they are prepared to pay - taking the risk that if they bid lower than other people, they may end up with no shares at all.
Example: double-edged privatization
In pursuing its pioneering privatization programme, the Thatcher government of the United Kingdom solved this problem of wanting to maximize revenues and still involve the general public by splitting its privatization offers into these two different kinds of concurrent sales.
Like any auction process, tender sales maximize the proceeds from a sale, but they are not easy for untutored investors, such as ordinary members of the public, to understand. There is a certain amount of brinkmanship too: if institutions bid too low they might end up with no shares at all, but if they bid much higher than other bidders, they will have wasted a large part of their money. Again, this complexity puts off smaller investors, but not the banks, insurance companies and other big financial institutions.
When the bids for shares are opened and put into the order of amounts bid until the whole allocation is taken up, there emerges a 'striking price' at which bids above are satisfied but bids below are not. The aim of the sale managers is that this striking price should be close to that of the fixed-price offer: then they know that the fixed price does reflect the real demand for the shares.
In the UK tender sales were employed, among others, in the case of Britoil (November1992), BP (September 1983), Cable & Wireless (December 1983), Associated British Ports (April 1984), and Enterprise Oil (June 1984).
Assessment: a sophisticated tool
Tender sales can be a useful technique for maximising privatization proceeds. As in the sale of BAA, the tender sale strike price can be quite close to the actual opening price of shares offered at a fixed price.
However, tender sales have a mixed history. While they have often priced an issue reasonably accurately, they were sometimes under-subscribed, as in the case of BP, Cable & Wireless and Enterprise Oil - where there were not enough bids above the fixed or market price of the shares. Sale underwriters had to take up 65 per cent of the shares in Britoil, for example, due to the weak public demand for the shares caused by a slump in oil prices. But that is the underwriting risk they accept!
As the UK privatization programme developed, the government and its financial advisers became more skilful in pricing share issues. Various techniques were developed, including `bookbuilding' - ways to encourage large investors into the sale and to get some early impression of the demand for the offer - and 'clawback' - whereby some of the institutions' tranche could be sold instead to the public (or vice versa) if there were significantly more demand from one sector or the other.
There are also other ways of solving the problem. Governments often fret about obtaining the right price for the sale of state owned businesses, but as Dr Madsen Pirie notes in Blueprint for a Revolution, "The government will probably not get the price right whatever it does, and this is fortunately not very important." His proposal is that the government should sell only part of the stock at first - say, 51% - and allow the market to find the right price for them. If the stock is underpriced, the government can get a lot of its money back by selling subsequent tranches at the higher, market price, later on.
For further information:
- Bishop, Matthew and Kay, John (1988) Does Privatization Work? London Business School.
- Bishop, Matthew and Kay, John (eds) (1994) Privatization & Economic Performance: Oxford University Press.
- Curwen, Peter (1994) Privatization in the UK: The facts and figures Ernst & Young (London).
- Veljanovski, Cento (1987) Selling The State Weidenfeld & Nicolson.
- Pirie, Madsen (1992) Blueprint for a Revolution (download PDF 167kb): Adam Smith Institute www.adamsmith.org.
Copyright 2002: Adam Smith Institute
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