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1 PROFITABILITY AND COST MANAGEMENT IN FORMER STATE OWNED ENTERPRISES IN VIETNAM ABSTRACT We provide evidence on the impact of privatisation and listing of former state owned enterprises (SOEs) in Vietnam, by examining changes in the profitability and cost management practices of a sample of former SOEs now listed on one of the two Vietnamese stock exchanges under the “Doi Moi” reform program. This evidence contributes to the literature by examining profit makeup at a component level, rather than on the aggregate basis which has been adopted in prior studies. This allows the development of richer insights than have previously been possible into the factors contributing to observed changes in post privatisation profitability. Keywords: privatisation, Vietnam, state owned enterprises, performance measurement JEL classification: L33, M48 2 i. INTRODUCTION It has been argued that the antecedents of the phenomenon which has come to be described as New Public Management (NPM) lie in conditions of economic and fiscal adversity (Gruening, 2001). Viewed through this lens, a key goal of new public management reform has been to improve economic efficiency and thus overall welfare by driving change through the public sector, with the result of leaner, more competitive, flexible, responsive and transparent government (OECD, 1994). In advanced jurisdictions characterised by high levels of private sector participation and integration with the global economy via trade and financing flows, the capacity of governments to wield strong control over the domestic economy is constrained. Consequently, the focus of much reform activity lies on that domain capable of being directly and profoundly influenced by government, the public sector (Lapsley, 2008). By contrast, many developing economies are characterised by low levels of private sector participation and weak integration into the global economic system. There, the role of government decision making and the influence of the state sector are typically more profound, particularly in socialist one party states (Chu, 2004). In jurisdictions characterised by relatively low international openness and high state sector dominance, the impact of public sector reform initiatives has the capacity to be of particular significance. However, while a wealth of literature focused on the impact and implications of public management reform in developed economies exists, comparatively little is known about the process and results of public management reform in lesser developed economies (Pollitt & Bouckaert, 2000). The literature on public management evidences the application of a wide variety of techniques towards the end of improving cost effectiveness and efficiency in government, including contracting out, commercialization, corporatization and privatization. Of these techniques, privatization has been perhaps most consistently employed throughout the world. Further, there is evidence to the effect that the application of this technique continues to become more widespread, with much of the growth in the use of the technique exhibited in emerging and lesser developed economies (Megginson & Netter, 2001). However, it is in relation to the effect of privatisation in these settings that the extant research literature is least clear. For example, Boubakri and Cosset (1998) studied a sample of companies from 3 developing countries which underwent full or partial privatization over the period from 1980 to 1992. Their results suggested that after being privatized, former SOEs increased sales, became more profitable, increased levels of capital spending, improved operating efficiency levels, had lower debt and increased dividend payouts. By contrast, Wei et al (2003) conducted a study of privatized firms in China, covering the period from 1990 to 1997. Their results suggest that after being privatized, the former state owned enterprises in their sample did not exhibit improvements in profitability. Studies of privatisation in Latin America (e.g Galal et al, 1994) and Eastern Europe (e.g Brezis & Schnytzer, 2003) have also thrown up inconsistent and inconclusive results in relation to the impact of privatisation. Thus despite the consistent recourse to the notion that privatisation is associated with improved enterprise efficiency and performance with consequential societal welfare benefits (e.g Bortolotti & Fantini, 2001) the empirical evidence on the subject is mixed, particularly as regards the experience of lesser developed and emerging economies. This paper contributes to the literature on public management reform and privatisation in lesser developed and emerging economies by providing detailed empirical evidence in relation to changes in post privatisation profit and cost management performance of a sample of former SOEs in Vietnam. The methodology employed draws on detailed firm level data, rather than high level aggregate data. Consequently, the paper contributes insights not only into the post privatisation profitability trajectory of former SOEs in Vietnam, but importantly, into the behaviour and changes in key profit driver vectors over the initial post privatisation period. In pursuing this objective, the remainder of the paper is structured as follows. Section 2 provides an overview of the background to the embrace of privatisation as an element of reform in Vietnam. Section 3 sets out details of the data drawn upon for the purposes of analysis and the research methodology employed. Section 4 comprises a discussion and analysis of the results of the study, whilst Section 5 sets out conclusions and incorporates suggestions for further research. 4 ii. REFORM AND PRIVATISATION IN VIETNAM In 1954, in the wake of the defeat of French forces at Dien Bien Phu, Vietnam was divided at the 17 th The stresses already evident by the mid 1970s were compounded by the decision to invade Cambodia in December 1978 (Vo 1990; Klintworth 1991; Fforde and Vylder 1996; Harvie and Tran 1997; Chu 2004). Along with the human casualties, the involvement in Cambodia cost substantially more in financial and material terms than had been anticipated (Klintworth 1991; Harvie and Tran 1997). These unanticipated costs included the resources necessary for maintaining troops in Cambodia and the need for parallel. The northern regime, which fell under the Soviet and Chinese sphere of influence, adopted a single party socialist mode of government, characterised by central planning, collectivization and nationalization. The southern regime, capitalist and nominally democratic, was a client state of the United States and its allies (Vo, 1990). With the defeat of U.S backed forces the south by northern forces in 1975, national reunification commenced. By late in that year, the united Politburo decided that Vietnam should move directly to the consistent application of a fully socialist model. Consequently, the centrally-planned economic mechanism which had previously applied in the North began to be implemented in the South. The task for economic development in this period was described as "…involving continued socialist construction in the North and transforming the South's capitalist economy to a socialist one" (Harvie and Tran 1997, p.34). This already complex task was rendered more difficult by the near collapsed state of the South Vietnamese economy by 1975 (Vo, 1990). Policy settings adopted in the immediate wake of reunification gave particular prominence to the ideal of rapid socialization and industrialisation. This soon resulted in the emergence of substantial distortions in the structure and functioning of the economy (Harvie and Tran 1997). Socialisation of ownership led directly to diminishing production levels in the agricultural sector. Simultaneously, most government investment funding was directed to industrial development. Set in the context of very high population growth rates, episodic food shortages emerged throughout the country (Fforde and Vylder 1996). 5 troop deployments to the northern border region to fight against Chinese forces which invaded as a means of "punishment" by China in retribution for Vietnam’s decision to invade Cambodia. Losses also included the loss of substantial foreign aid from the international community as a form of sanction consequential upon the decision to embark upon the Cambodian campaign (Fforde and Vylder 1996; Harvie and Tran 1997). Vietnam also suffered substantially as a result of the enforcement by the United States of a trade embargo which prevented Vietnam penetrating into international goods and capital markets. The generally weak economic conditions, combined with the impact of a series of material shocks caused substantial fiscal distress. For example, Vietnam suffered a sharp reduction in foreign loan and aid funding between 1975 and 1979, with receipts from these sources falling from 60 per cent of total funding in 1975 to 32 per cent in 1978. Over the same period, domestic source revenues did not grow at anywhere close to a sufficient pace to close the gap which resulted in the sudden fall in external source revenue (Harvie and Tran 1997). This triggered the onset of substantial fiscal stress, a matter of particularly high significance in a centrally planned economy in which the state plays a highly material role (Fforde and Vylder 1996). Resource shortages became endemic throughout the economy. Chronic shortages of resources in turn led economic entities to look for better ways to do business. This kind of spontaneous bottom-up pressure was described as "fence breaking" or "pha rao" in Vietnamese. In effect, this represented the emergence of widespread disobedience in the face of government issued economic edicts. This placed increasing stress on the government to conduct reform to avoid the collapse of the economy or having its authority substantially undermined (Fforde and Vylder 1996; Harvie and Tran 1997). Responses to this situation were evident in the edicts of both the Fourth Congress of the Communist Party of Vietnam (1979) and the Fifth Congress of the Communist Party of Vietnam (1982). However, the policy responses offered at the conclusion of both of these gatherings were minimalist and incrementalist in their orientation and had little impact on the worsening economic and fiscal situation (Le, Doanh D 1991). 6 However, the Communist Party of Vietnam’s Sixth Congress yielded a very different result. At the conclusion of proceedings, the following assessment of the state of the nation and its prior policy settings was offered by the Communist Party: “There has been a lacuna in assessing the economic situation, in determining objectives and setting the pathway of socialist development. In the five years from 1976 to 1980, we conducted an industrialization process without the presence of necessary supporting conditions; policy initiatives were marred by haste, relaxation in the degree of socialist transformation; and inadequate reconfiguration of obsolete economic mechanism. In a further five-year period from 1981 to 1985 there has been no serious implementation of the edicts of the Fifth Congress in relation to economic strategy […], new and serious mistakes have emerged in distribution and trade circulation […] There have been serious mistakes in guidelines, in macro policies, in steering and in implementation” 1 Undoubtedly, the Sixth Congress marked an important milestone and major turning point in the history of economic development of Vietnam (Harvie and Tran 1997; Chu 2004). Arguably, the most important element of the reformist agenda advanced during the sixth congress was the acceptance of non- socialist economic components besides state and collective ownership (Le, Doanh D 1991; Harvie and Tran 1997). . This self-assessment of the Communist Party of Vietnam has been seen as the main achievement of the Congress (Le, Doanh D 1991). At the congress, a new team of leaders was elected with responsibility to steer the economy to overcome problems such as chronic food shortages, hyperinflation, and structural imbalances in the economy. After the Sixth National Congress a comprehensive reform program, titled "Doi Moi" or Renovation was introduced. The objectives of this reform program were to liberalize and deregulate the centrally-planned economic mechanism (Harvie and Tran 1997). During the congress, the General Secretary of the Communist Party of Vietnam, Truong Chinh, commented on the problems faced by Vietnam and some of the factors which were perceived to have caused them, stating that: "… the state apparatus and those of the party and mass organization were left to grow too big, overlapping and dispersed" (Thayer, 1991, p.24). 1 (Cited from the Resolution of the Sixth Congress: http://www.cpv.org.vn) 7 So much was clearly stated in the Resolution of the Fourth Plenum of December 1987: "The state encourages and accepts the long-term existence and positive effects of the family, individual and private economies active in production and services; it guarantees the rights to property, to inherit and to legal income for people active in these sectors; it accepts their legal incorporation/identity and equality before the law in their production and business activities" (cited from Harvie and Tran (1997, p.49)). Thus, the decisions of the Sixth Congress cleared the path for the adoption of privatisation as a legitimate element of a sweeping set of economic reforms implemented from the mid 1980s onwards in Vietnam. At the beginning of “Doi Moi” in 1986, Vietnam had around 12,300 SOEs many of which were unprofitable and exhibited signs of substantial inefficiency. A concerted effort to attack this problem commenced in 1989 with the dissolution of many unprofitable SOEs and rearrangement of others through mergers or liquidation. As a result, by the beginning of 1992, the number of SOEs in Vietnam had declined to around 6,500 enterprises (CIEM 2002; Vu, Anh T. T. 2005). The process of privatization, or equitization as it is known in Vietnam was launched in 1992. The objectives of privatization included the creation of a new method for developing a multi-sectoral economy by diversifying the ownership structures of SOEs; the mobilisation of funds into shares of enterprises for development and the facilitation of SOEs restructuring with the aim of improving their performance and efficiency, thereby making them capable of maintaining a leading role in the economy (Le (1996) cited from Chu (2004)). The privatization of SOEs began to be brought into effect via the implementation of a pilot program which called for the transformation of a limited number of viable or potentially viable small scale, non strategic SOEs into private companies subject to Enterprise Law. This program was undertaken through share issues sold to employees at preferential prices, to private owners, and to foreign investors on a limited basis. However, because of gaps in the legal framework and the lack of a sense of urgency about the process, only five SOEs had been privatized by the end of 1995 (Webster and Amin 1998; Truong, Lanjouw et al. 2006). To increase the pace of privatization, the government promulgated Decree No. 28/CP in May, 1996. This disbanded pilot privatisation programs and defined a comprehensive set of policies relating to 8 the privatisation of SOEs. This Decree maintained the general principles of the pilot program and expanded the scope of privatization to all non-strategic small and medium-sized SOEs. It also required the agencies controlling SOEs such as ministries and people’s committees to select candidate enterprises for privatization (Truong, Lanjouw et al. 2006). This resulted in a measurable acceleration of the pace of privatisation, a process which continues to the present. However, despite this, there exists very little evidence in relation to the impact of privatisation in Vietnam which would assist in evaluating the effectiveness of the policy in that setting. Section 3 sets out details of the data and methodology employed within this study towards the end of partly filling that gap in the extant literature. iii. DATA AND METHODOLOGY The objective of this study is to provide detailed evidence pertaining to the impact on a key dimension of financial performance, profitability, of the transition from State-Owned enterprises to private venture. Thus, it was a necessary precondition for inclusion in the research sample that firms studied had originally been configured as SOEs and were subsequently privatised. A second qualifying criterion for inclusion in the research sample was the availability of financial statement data 2 Previous studies have documented the very poor levels of compliance among companies with their obligations in relation to the preparation and disclosure of financial statements, even though this is required , the key source of data relied upon for the purposes of the study. This was required because the research question addressed relates not just to the degree of observable change in profitability over time, but also the development of an understanding of the changes in key profit drivers. Only firm financial statements contain a sufficiently rich dataset to facilitate such a form of analysis. By the conclusion of 2007, Vietnam had completed the privatisation of approximately 3,800 SOEs (Nguyen 2007). Ostensibly, this suggests the existence of a potentially very large data set upon which to construct a study of the financial performance of former SOEs. However, in the context of Vietnam, obtaining reliable financial data relating to firms is difficult and often impossible. 2 Under Vietnam Accounting law, all financial statements have to be prepared in unified formats. 9 by law (Pham 2004; Truong, Lanjouw et al. 2006). This inconsistency in mode of presentation and availability of financial statements makes the execution of a research methodology based on a study of detailed financial disclosures challenging. Therefore, a further narrowing of the scope of the research sample was to limit the study to the inclusion of former SOEs which had obtained a listing on one of Vietnam’s stock exchanges. These firms face stricter disclosure standards and scrutiny of their compliance with reporting obligations, and are required to produce and make available audited financial statements in a standard format on an annualised basis (National Assembly of Vietnam 2006). The first stock exchange to come into existence in Vietnam was opened in Ho Chi Minh City in 2000 and is generally referred to by the acronym HOSE. Vietnam’s second public equity capital market opened in Hanoi in 2005 and is referred to as the Hanoi Securities Trading Centre - or HASTC. The listing eligibility criteria and rules applying to these two equity markets are essentially the same and there is evidence to suggest that the spread of firms in terms of size, industry and geography is comparable across both markets (NDCP 2007). Therefore, it was judged appropriate to include firms listed on both markets in the final research sample, where they met all stipulated sample selection criteria. By the end of 2007 there were total of 244 firms listed on HOSE and HASTC. Of these, 133 firms were listed on HOSE and 111 on HASTC. Among this group 213 firms had been SOEs prior to undergoing privatisation and listing. The remaining 31 firms had originated in the private sector. These were not eligible for inclusion in the research sample. Thus the potential research population consisted of the 213 market listed former SOEs in existence by the conclusion of 2007. In Vietnam, the accounting and reporting rules pertaining to financial services firms (e.g banks, insurers, investment firms, securities firms) differ substantially from those applicable to other types of organisation. This raised the prospect of data incompatability problems, and given the small number of such organisations in the context of the total potential research population, and the lack of viability of deriving a meaningful data subsample from these firms (given their small numbers), these too were excluded from the final research sample. There were 13 such listed firms by the conclusion of 2007. This left a total researchable population of 200 listed former SOEs, 104 of which were listed on HOSE and the remaining 96 on HASTC. 10 However, not all of these firms could be included in the final research sample. This is due to the nature of the research question being investigated. In short, the research focuses on evidence of change in financial performance (if any) associated with privatisation. However, given that it is unlikely that change in performance will be evident in the immediate wake of an entity’s transformation to a private firm, prosecution of the research question requires the existence of multiyear datasets. Further, given that according to the Vietnamese process, privatisation precedes listing (that is, the two events are not usually simultaneous, though they are typically broadly contemporaneous 3 Consequently, without 2006- and 2007-listing firms in the research sample, the remaining dataset consists of 6 listing year cohorts, including 5 firms listed in 2000; 4 firms listed in 2001; 10 firms listed in 2002; 2 firms listed in 2003; 3 firms listed in 2004 and 9 firms listed in 2005. None of these represent viable datasets to study in their own right. Consequently, for the purposes of data analysis, it was necessary to adopt a data pooling methodology. In essence, this approach obviates the problems inherent in small ), and the desirability of establishing performance baselines from which to gather evidence of change, the availability of pre listing financial statements was a necessary pre-condition for inclusion in the final research sample. Specifically, it in order to be incorporated into the final research sample, it was necessary that financial statement data for the two years prior to listing were able to be obtained. In the case of one of the 200 firms adverted to above, this was not possible, reducing the potential researchable sample to 199 firms. In examining this group of firms it is notable that the greatest majority of listings occurred in 2006 and 2007. In combination, these two years account for 166 of 199 potentially researchable firms. However, given the emphasis on the study of change over time, it was also necessary to exclude these firms from the analysis, given the lack of post listing year data for the 2007 listing cohort, and the very limited (1 year) post listing track record of the 2006 cohort. Ultimately, the minimum criteria required for inclusion in the research sample were the availability of 2 years of pre and post listing financial statement data. 3 By scanning the privatizing years and listing years for all of 200 firms in both securities trading centres, it shows that almost all firms privatized one or two years before listing. It is understandable in the context of Vietnam where the privatization process is gradual, cautious process and the stock market is very young. However, this led to the fact that it is impossible to capture the data in relation to the before-and-after privatizing point. This difficulty continues driving us to study the changes of financial performance of privatized firms caused by the listing event. In other words, instead of comparing the financial performance before and after privatizing we compare the financial performance of divested firms before and after listing year. [...]... overall cost of doing business (including selling & administrative costs) increased at both the two and three year mark post listing, compared to the pre listing position By contrast, trading and services firms aggressively reduced their cost of doing business 10 For example, at the two year point post listing, the gross profit margin of the manufacturing subsample had declined by 398 basis points compared... external pricing and cost pressure, not all of the financial fate of the sample firms lay in the hands of others 21 Among the variables studied, a number – including selling & administrative expenses and cost of doing business might be expected to be dominantly subject to the influence of internal decision making Yet in the face of in some cases severe gross margin capitulation, many firms in the research... experienced internal cost structure inflation, though at relatively modest rates, while trading and services firms sought and achieved material efficiencies in their cost of doing business It is not clear why this divergence in cost management outcomes between manufacturing and trading and services firms arose One conjectural explanation lies in the observation that the far steeper declines in post listing... ability to have insight the performance of firms in different industries Of 33 firms in the two-year post listing subsample there were 21 manufacturing firms with the remaining 11 firms falling into the category of trading and services organisations And among the 24 firms in the three-year post listing subsample there were 16 12 manufacturing firms and 8 which fell into the trading and services category... profit margins of trading and services firms over the same intervals This pattern, while contradictory on a prima facie basis, is able to be explained by the divergent experience of manufacturing firms compared to trading and services firms in relation to the management of non inventory related costs In summary, whilst manufacturing firms experienced smaller gross margin declines than trading and services... profit margins on the part of trading and services firms (when compared to manufacturing firms) may have driven a greater sense of urgency in seeking internal cost reductions amongst these firms Irrespective, sharpened cost management was not a universal characteristic of the firms studied 11 By contrast, cost of doing business in manufacturing firms increased by 6% in comparison to the pre listing year... lead to the expectation of increased profitability 14 However, as the data in Tables 1, 2 and 3 below demonstrate, the profitability of former SOEs in Vietnam (as measured by before tax net profit margins) suffered, rather than expanded post privatization and listing The first of these tables contains data pertaining to all firms included in the research sample, irrespective of industry membership It shows... also in relation to two industry sub samples Given the focus of the research on firm profit and cost structure, the variables of interest for the purposes of the study included; before tax net profit margin 4, gross profit margin 5, cost of goods sold, selling & administration expense and cost of doing business 6 Together, these allowed a detailed deconstruction of firm profit and loss functions, including... the pre listing year position Over the same period, cost of goods sold as a proportion of sales revenue increased by only 282 basis points A similar pattern is evident in the trading and services firm data This suggests that pricing side pressure as well as cost side pressure contributed to margin compression in many of the firms studied 16 (including selling & administrative costs) by in the order... year post listing and approximately 45% by the third year post listing 11 Overall, the profit and cost management performance of the former SOEs studied was mixed The data supports the proposition that declining post privatization profitability was driven substantially by exogenous factors (supply side cost pressure, pricing and margin pressure in the face of increased competition) Manufacturing firms . (-3 .21) -2 .546 (0.011) 66.67 (33.33) 24 11.97 (11.85) 9.11 (8.31) -2 .86 (-3 .54) -2 .543 (0.011) 79.17 (20.83) Gross profit margin 33 21.09 (19.34) 15.94 (14.02) -5 .15 (-5 .32). (-1 .34) -1 .724 (0.085) 69.70 (30.30) 24 10.70 (8.28) 9.24 (7.50) -1 .46 (-0 .78) -1 .229 (0.219) 70.83 (29.17) CODB on net sales 33 10.31 (8.89) 8.91 (7.60) -1 .39 (-1 .29) -1 .653. -4 .44 (-3 .74) -3 .319 (0.001) 76.19 (23.81) 16 11.56 (10.16) 8.50 (7.60) -3 .06 (-2 .55) -2 .637 (0.008) 87.50 (12.50) Gross profit margin 21 19.07 (19.25) 15.09 (13.94) -3 .98