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DISCUSSION PAPER SERIES

No. 2888

COMPETITION, CORPORATE GOVERNANCE: SUBSTITUTES OR COMPLEMENTS? EVIDENCE FROM THE WARSAW STOCK EXCHANGE Irena Grosfeld and Thierry Tressel

TRANSITION ECONOMICS



ZZZFHSURUJ Available online at: www.cepr.org/pubs/dps/DP2888.asp and http://papers.ssrn.com/paper.taf?abstract_id=278565

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ISSN 0265-8003

COMPETITION, CORPORATE GOVERNANCE: SUBSTITUTES OR COMPLEMENTS? EVIDENCE FROM THE WARSAW STOCK EXCHANGE Irena Grosfeld, DELTA, Paris Thierry Tressel, DELTA, Paris Discussion Paper No. 2888 July 2001 Centre for Economic Policy Research 90–98 Goswell Rd, London EC1V 7RR, UK Tel: (44 20) 7878 2900, Fax: (44 20) 7878 2999 Email: [email protected], Website: www.cepr.org This Discussion Paper is issued under the auspices of the Centre’s research programme in Transition Economics. Any opinions expressed here are those of the author(s) and not those of the Centre for Economic Policy Research. Research disseminated by CEPR may include views on policy, but the Centre itself takes no institutional policy positions. The Centre for Economic Policy Research was established in 1983 as a private educational charity, to promote independent analysis and public discussion of open economies and the relations among them. It is pluralist and non-partisan, bringing economic research to bear on the analysis of medium- and long-run policy questions. Institutional (core) finance for the Centre has been provided through major grants from the Economic and Social Research Council, under which an ESRC Resource Centre operates within CEPR; the Esmée Fairbairn Charitable Trust; and the Bank of England. These organizations do not give prior review to the Centre’s publications, nor do they necessarily endorse the views expressed therein. These Discussion Papers often represent preliminary or incomplete work, circulated to encourage discussion and comment. Citation and use of such a paper should take account of its provisional character. Copyright: Irena Grosfeld and Thierry Tressel

CEPR Discussion Paper No. 2888 July 2001

ABSTRACT Competition, Corporate Governance: Substitutes or Complements? Evidence from the Warsaw Stock Exchange* In this Paper we analyse the impact of product market competition and ownership structure on corporate performance. We focus on the firms listed on the Warsaw Stock Exchange, which are either privatized or newly created firms. First, we study the separate effects of competition and ownership concentration on firm-level productivity growth. Next, we investigate their interaction: are they substitutes or complements? We take care of the crucial problem of potential endogeneity of explanatory variables by using GMM estimators proposed by Arellano and Bond (1991). We also control for several types of selection bias that could affect the productivity levels and productivity growth. Our results show that product market competition has a positive and significant impact on performance. Concerning the effect of ownership concentration, we find a U-shaped relationship with performance. Firms with relatively dispersed and relatively concentrated ownership have higher productivity growth than firms with an intermediate level of ownership concentration. The type of the controlling shareholder does not explain this correlation between concentration of ownership and productivity growth. Finally, product market competition and good governance tend to reinforce each other rather than act as substitutes. Competition has no significant effect on performance for the firms with ‘poor’ governance; on the contrary, it has a significant positive effect in the case of firms with ‘good’ corporate governance. JEL Classification: D24, G32, L10 and P20 Keywords: competition, corporate governance and productivity growth

Irena Grosfeld DELTA ENS 48 Boulevard Jourdan 75014 Paris FRANCE Tel: (33 1) 4313 6328 Fax: (33 1) 4313 6310 Email: [email protected]

Thierry Tressel DELTA ENS 48 Boulevard Jourdan 75014 Paris FRANCE Tel: (33 1) 4344 3710 Fax: (33 1) 4313 6310 Email: [email protected]

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* A previous version of this Paper was prepared for the Phare ACE Research Project P97-8131-R ‘Competitive Pressures and Enterprise Adjustment on the way to EU Accession’. We are grateful to Philippe Aghion, Wendy Carlin and Patrick Sevestre for helpful comments and to Wioletta Nawrot for excellent research assistance. Submitted 30 May 2001

NON-TECHNICAL SUMMARY Different reform strategies adopted during the last ten years in transition economies have included a mixture of competition and privatization policies. One of the main issues has been to create an environment that stimulates entrepreneurial initiative, as well as one that provides adequate incentives in the former state-owned sector. One of the views formulated today is that privatization strategy failed to create adequate corporate governance arrangements and that ownership transformation could have been postponed. Competition, it is argued, turned out to be more important than ownership and it should therefore have been put at the centre of the transformation strategy from the very beginning. More attention, the argument goes, should have been given to managerial incentives and supervision rather than to ownership changes per se. In particular, mass privatization is often viewed as having important perverse effects: by freely transferring assets to certain groups of the population, it creates vested interests which can block further reforms (Russia) or brings about rigid and, most often, dispersed ownership structures unable to provide efficient monitoring mechanisms. In the absence of good corporate governance arrangements, competition, it is argued, could be considered as a substitute: it could provide managers with appropriate disciplinary mechanisms. In this Paper we use the available data on the non-financial firms listed on the Warsaw Stock Exchange to analyse the impact of competition and corporate governance on firm performance. First, we study the separate effects of competition and ownership concentration on productivity growth at the firm level. Next, we investigate their interaction: are they substitutes or complements? The substitution effect would mean that, when corporate governance is weak, competition plays an important role as a disciplinary device forcing managers to improve performance and reduce slack. Alternatively, if agency costs or other problems of corporate governance are not too severe, the role of competition in stimulating managerial efficiency may be more limited. On the other hand, if competition and corporate governance were complementary, they would reinforce each other – market competition would enhance the effectiveness of corporate governance, and vice versa. In such a case, product market competition alone might not be sufficient to reduce production inefficiencies in an environment with poor corporate governance. Our empirical strategy follows Nickell et al. (1997): we take care of the crucial problem of potential endogeneity in explanatory variables by using GMM estimators proposed by Arellano and Bond (1991). Our estimate control for unobserved fixed effects, which in turn allow us to control for several types of selection bias that could affect the productivity levels. For instance, it is not

likely that initially more productive firms might have had specific ownership structures, as fixed effects should capture such initial differences in the level of productivity. Moreover, we control for industry fixed effects affecting the rate of productivity growth. Hence, it is unlikely that the ownership structure (and the correlation with performance that we identify) simply reflects industry characteristics (such as industry specific trends of productivity). Our results show that competition has a positive influence on productivity growth in our sample of Polish firms. This result suggests that, as claimed by many economists today, product market competition may be an effective way of ensuring efficient restructuring and productivity growth during the transition. Concerning the effect of ownership concentration, which turns out to be quite high in Poland, we find a U-shaped relationship with performance. Firms with relatively dispersed ownership (no shareholder with more than 20% of voting shares), and firms in which one shareholder has more than 50% of voting shares, have higher productivity growth than firms with an intermediate level of ownership concentration. The type of the controlling shareholder does not explain this correlation between concentration of ownership and productivity growth. We show that when the CEO, a bank or a National Investment Fund controls the firm, the type of the controlling shareholder has an independent negative effect. Finally, we find strong evidence that the impact of product market competition depends on the ownership structure of the firms considered: competition has a stronger impact on the firms having a relatively dispersed or highly concentrated ownership structure. To the extent that, in our sample, such ownership structures are associated with higher productivity growth, this can be considered as evidence that competition policies and ownership changes should be promoted simultaneously, and that attention should also be given to the ownership structure resulting from the privatisation process. Our results are based on measures of competition that are less than perfect; the fact that we obtain the same results with different measures suggests, however, that they are indeed robust. They support the claim that a transition strategy that focuses solely on competition may not be successful if it is not accompanied by efficient ownership changes. Such a result may have important policy implications. It supports the argument that privatization can reinforce the beneficial impact of competition and should not, therefore, be postponed. One of the advantages of the transition environment was that efficiency gains to be realized were large, which makes it easier to identify the interaction between different mechanisms affecting productivity growth. This may explain why our results are more significant than those of previous studies.

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