SFB 303 Discussion Paper No. A - 179

Author: Bös, Dieter
Title: Privatisation and People's Capitalism
Abstract: People's capitalism is a costly matter. Shares of privatised firms have to be sold at high discount to attract as investors those lower-income earners who would not have thought of buying shares. A high discount, however, gives an incentive to sell the share soon after flotation to enjoy a quick profit. This can be prevented by loyalty bonuses given to those who retain the shares for a longer time.The present paper analyses the behaviour of private investors and the government policy in such a case. In a simple two-period model we distinguish three different states of the world:

  1. the quick-profit case, where no private investor retains the shares of the privatised firm for more than one period;
  2. case "two-one-zero", where there are two-period shareholders, one-period shareholders and others who do not buy any share of the privatised firm;
  3. people's capitalism, where all private investors retain the shares for two periods
A welfare-oriented government which is highly interested in welfare and less interested in cash revenue from privatisation, only chooses case "two-one-zero". Both the quick-profit case and people's capitalism require a government which ranks cash revenue more highly than welfare. A welfare oriented government, moreover, always is a "two- period government ", it is particularly interested in the number of two-period shareholders. Hence it will choose a comparatively low issue price to attract first-period shareholders, but also offer a high bonus to render the second-period investment attractive. In any case, the shares are sold at a price below the dividend payments which are expected to accrue to the shareholders. This implies an underpricing if at the first day or flotation the expected future dividends are lower than the value of the share at this day (which, of course, might be the case at an imperfect capital market). We conclude that underpricing is more probable if the government is welfare-oriented.
Creation-Date: March 1989
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