Company Performance in Ukraine: What Governs Its Success

Background: In a recent decade, a considerable literature has evolved concerning the impact of transition reform on firms in former socialist economies. Generally using longitudinal analysis, many studies have tried to estimate the extent to which these economies are moving towards market competition, the success or failure of privatization, dominance of insider or outsider ownership, and observable outcomes of other transition reforms. However, notwithstanding the many insights it has provided, this literature has often failed to reach a consensus on the effects of specific reforms and the extent to which a market economy is in place. Objective: This study attempts to shed light on the causes of post-reform differences in the performance of Ukrainian firms. The big question is what explains success or otherwise of firms in the transition economy of Ukraine? Using 1996-2000 longitudinal data for 1,211 firms in various ownership, competition, and restructuring conditions and controlling for industry, region and time fixed-effects, this paper addresses one component of this multidimensional issue. The narrow question for study is the effect of ownership structures (private vs. state, concentrated vs. diluted, insider- vs. outsider-dominant) and market competition on firm efficiency in Ukraine. Ownership and competition pose the central interest for study as they change firm behavior most considerably by transforming incentives for firms. Estimation of the effects of ownership and market structures on firm performance is the main research objective. Data and Methods: The universe population for the study is Ukrainian medium- and large-size industrial firms. It includes traditional firms that have been formed in the economy of the former Soviet Union, up to the onset of market reform in early 1990s. The sample represents 66% of the target population, which is the largest group of industrial firms, Ukrainian open joint stock companies. I collect data from several sources. Micro-data on firm ownership and performance come from the Ukrainian State Committee on Securities and Stock Exchange. Privatization-related data comes from the State Property Fund of Ukraine. It incorporates firm-level data on state shareholding, privatization methods, shares of privatized firms in the region and industry output and employment. Standard macro data comes from conventional sources: the State Statistics Committee of Ukraine and the National Bank of Ukraine. In the spirit of many prior studies, I evaluate firm performance by production rather than cost efficiency. Driven by the big question of study – what explains firm performance - I model firm productivity with standard production inputs, and observable factors that may most influence efficiency of firms in transition economy. In addition to ownership, I control for the role of market environment using market concentration (HHI) and import penetration variables. Firm controls include trade orientation, industry, location, monopoly status, privatization group, and time fixed-effects. Postulating randomly distributed individual specific terms across firms, I apply the G2SLS random-effects estimation approach. The instruments for ownership (prevalence of privatized firms in the region and industry output and employment, industry growth in the past period and the leased firm indicator) should purge the relation between the independent variable and error term. I conduct necessary tests to check the validity of instruments. The general estimation function can be written as follows: where i indexes firms, t periods and the are the estimation parameters. Results: In all specifications, the effect of privatization is overwhelmingly positive and significant. The difference in performance is large: a percentage point increase in private ownership implies 2% higher productivity per year. The parameter magnitude is even greater for firms with concentrated private ownership. Annual productivity growth for firms with concentrated ownership is on average 2-3% higher than for other private firms and 4% larger that for state firms. Outsider-concentrated ownership has a large positive impact on firm efficiency: 0.07-percentage point marginal difference in the performance of outsider-concentrated firms over firms with dispersed private ownership and 0.10-point difference over state-owned firms. No significant impact is found for insider ownership. Hence, firms with dominant outside shareholders perform best – the result that corporate governance theory predicts The estimates of market competition are insignificant in virtually all specifications. The results for import penetration are more stable but still inconclusive. Failure to find evidence on the significant effect of market structure may be explained by two factors. Competition is a recent phenomenon in Ukraine, and its effects may not be observable in the data yet. Another issue is methodological, and relates to the use of alternative measures of market competition and functional forms. I check the robustness of ownership and market competition estimates in various contexts. I instrument ownership and apply IV (2SLS) to estimate the cross-section data in 2000 and the pooled data. The results mostly correspond to those of the G2SLS random-effects estimation. I also estimate regressions for the sample without strategic enterprises, state monopolies and regulated industries. Finally, I add industry specific trends. In general, the sensitivity analysis gives estimates similar to those of the main specification. Conclusion: The findings are threefold. First, the study provides evidence for Ukraine that firm performance improves significantly with privatization. This effect is particularly strong when several private owners concentrate ownership. There is evidence that privatized firms with dominant outside shareholders are most efficient. Another finding is that market competition has little role in determining firm performance in Ukraine. This study has two contributions for public policymaking. Methodologically, it applies a combination of instrumental variables and random effects to control for biases in the estimation of causal effects when random assignment is not feasible. Substantively, it finds politically important evidence to the beneficial impact of privatization for Ukrainian firms. It indicates the critical role of establishing an effective mechanism of corporate governance, which shareholding with large owners assures best. Failure to establish such a mechanism, added to incomplete market institutions, will yield results different from those expected. The finding on the competition role suggests important need for further market reform. Political effort is required to ensure that Ukraine is moving towards competitive market and efficiency gains for the public benefit.