Innovation and Creative Destruction in Emerging Markets: The Impact of State Commitments on Privatizing Telecoms

Research on processes of ?creative destruction? has characteristically focused on technological innovation and its simultaneously value-enhancing as well as value-destroying implications for firms and markets. Less attention has been paid to institutional innovation though it may have even more dramatic results for firms and markets. Transfer of ownership and control from state to private hands induces change in telecom firm incentives and behaviors, but the short- to medium-term performance implications for shareholders are in dispute. Research on enterprise privatization suggests that less state ownership and control as well as greater exposure to market forces increase enterprise value by aligning more closely its incentives and behaviors with those of profit-maximizing shareholders. An alternative view suggests a different relationship between states, markets and privatizing enterprises: Performance may improve when the state retains a substantial equity stake and commits to substantial intervention in relevant markets of privatizing enterprises. Such state policies signal to shareholders the state commitment to ensure adequate returns on their risky investment, thus, also engendering investor interest in other state assets up for privatization. These competing views imply different relationships between privatized enterprise performance, on the one hand, and state ownership and market experience ?what we call temporal distance from the date of initial privatization-- on the other. Less state ownership and greater temporal distance improve privatizing enterprise performance according to the mainstream view, but may detract from such performance according to the alternative view. We examine empirical support for these competing views with a sample of 15 privatizing telecoms drawn from both industrialized and emerging-market countries, We collect data on the cumulative abnormal returns (?CARs?) to shareholders associated with 205 major M&A, joint venture and alliance transactions announced between 1986 and 2001. Results indicated strong support for trends predicted by the alternative view, particularly for privatizing telecoms from emerging-market countries. In accord with the mainstream view, CARs for announcements by privatizing telecoms from industrialized telecoms are negatively related to the percentage of state ownership. By contrast and in support of the alternative view, CARs for announcements by privatizing telecoms from emerging-market countries are positive, statistically significant and substantial. Also consistent with the alternative view, we find that the effect of temporal distance on CARs is negative, and in the case of announcements by privatizing telecoms from emerging-market countries, statistically significant and substantial. Together, these results suggest that the alternative view may merit closer attention by researchers, particularly for privatizing enterprises in emerging-market settings. For the broader issue of institutional innovation and creative destruction, our results suggest that state policies and practices supporting gradual as well as credible privatization policies may mitigate investor concerns and increase the long-term benefits accruing to firms and markets from the transfer of assets and people from state to private hands.