Restructuring Enterprises in Eastern Europe

The enterprise sectors of Eastern Europe are undergoing fundamental reform. This article evaluates alternative forms of corporate restructuring. It emphasizes differences in the sequence in which reforms are undertaken in different countries. In some countries, restructuring is being undertaken by the state before privatization; in some, restructuring is delegated to private-sector institutions before shares are offered to the public at large; and in others, public offers of shares are preceding restructuring. The article suggests that the recent theoretical literature on corporate ownership and vertical integration provides a useful framework for evaluating alternative sequences of reform. This points to four factors as being central to the reform process: contractual incompleteness between the state, investors and managers; complementarity between the assets of different stakeholders; the relative importance of assets; and the relative abilities of different stakeholders. The continuing role for the state in Eastern Europe is attributable to difficulties of contracting between the state and private firms and the complementarity between the assets of state and firms. The slow pace of privatization is due to poor public finances and inefficient bureaucracies. There is one country in which a substantial amount of restructuring has been undertaken by both the state and the private sector, however: East Germany. This paper documents in some detail the privatization process in East Germany. It notes that five parties have been central to the reform process: the state, the Treuhandanstalt, banks, Western companies and the incumbent management. It records a gradual transfer of control from the state to the management of firms. It argues that the central role played by banks and companies in restructuring reflects an important complementarity between their assets and those of former state-owned enterprises, and the fact that they can offer valuable advice to East German management. This raises the question of what East European countries that do not possess institutions with equivalent skills and resources should do. The experience of East Germany suggests that careful attention should be given to the governance of state agencies and private-sector institutions. The role of financial institutions in funding restructuring should be supplemented by non-financial companies providing management advice. Risk capital will not be available, initially, until East European enterprises have acquired adequate collateral or reputations. In the mean time, international agencies will play a central role in funding the transition.