Coping with the Leviathan. Minority Shareholders in State-owned Enterprises: evidence from Italy

The co-existence of State and private ownership is today becoming an increasingly relevant topic for scholars in finance and corporate governance. The partial (for strategic reasons), sometimes “reluctant” privatizations of companies previously under full State control in several countries (China included), the expanding activity of institutional investors and the growing relevance of external sources of corporate finance has generated a multitude of situations in which private shareholders are confronting with Governments as main blockholders. This has drawn scholars’ and practitioners’ attention towards the implications of this partnership in the field of corporate governance. As largely investigated by current literature in finance and corporate governance, State and private joint ownership of companies has multifaceted effects. State control can either improve corporate value and stability attracting external shareholders but can also raise several problems, included the mismanagement of corporate resources in order to achieve non economic goals. For both developed and developing countries willing to maintain to some extent State control over strategic activities at the same time recurring to stock markets, the issue of mixed ownership has thus recently became crucial, as well as the understanding of the internal governance dynamics of companies partially under State control. Turning to past experiences can be useful in this perspective: on the basis of new archival evidence available in the IRI archives in Rome temporarily available to scholars, this paper analyzes the internal governance and agency issues in a large Italian State-owned conglomerate characterized by the presence of a large number of minority, private shareholders between the 1950s and 1960s.

During that period – known as the Italian “economic miracle” - , at the very core of Italian economic and industrial modernization, a major role as engine of growth was played by the Istituto per la Ricostruzione Industriale (IRI – Agency for Industrial Reconstruction), legally a State-controlled body established in 1933 in charge of controlling the vast majority of State holdings in manufacturing services and banking, in the number of several hundred companies. After the war, these companies were fully involved in the effort of providing Italy with the necessary infrastructures for the development of the country, making huge investments in core and strategic sectors as steel, telecommunications, heavy mechanics and automotives, actually playing a major part in Italy’s industrial policy. The IRI group was a huge conglomerate structured in three-layers. At the top there was a super-holding (IRI) under governmental control. In its turn, the super-holding was controlling by statute at least the 51% of sectoral subholdings, each one in charge of controlling the third level, that of operating companies. From a corporate finance perspective, the three layers were supposed to play different roles: the super holding was in charge of providing financial resources under the form of the endowment funds provided by the State, while the sectoral holdings – all listed - were asked to raise additional funds issuing bonds, shares and through long term debts. The operating companies (some of which listed) had to be profitable, providing resources under the form of retained profits and, above all, short term debt. In terms of corporate control, then, IRI was a pyramidal group: far from being fully controlled by the State, private shareholders were present in high number – at the beginning of the 1960 nearly half-million people in total considering both the shareholders of subholdings and operating companies. Proudly, this was labeled as the “IRI formula”, based upon the idea of State control over companies in strategic industries plus private capitals willing to partner with superior organizational and strategic capabilities provided by skilled, professional managers.
The joint partnership between private capitals and State ownership seemed to work successfully since the beginning. The risks of the presence of such a large blockholder as the State, coupled with the de facto absence of minorities’ legal protection, were offset by the advantages for minorities deriving a) from the appointment of skilled managers actually able to turn companies profitable; b) by the fact that many IRI companies were monopolists in some fast-growing industries, as for instance telecommunications, something which was obviously attractive for small shareholders; c) by the idea that State-ownership was basically preventing these companies from the risk of going bankrupt and d) by the fact that IRI companies were paying dividends in line with those of other privately-held companies. This situation was going to last for relatively a long time, until the end

of the 1960s, when the relationships between the State and private ownership started to deteriorate, and private shareholders started to decline both in absolute number and subscribed capital. The reasons for the divorce were many. First of all, it was the main shareholder, the State, the first to give “bad signals” to the market. The capital provided by the State was always low and absolutely not enough to finance IRI’s ambitious strategies, and the conglomerate had to rely largely on debt – basically, short term debt – for its needs. The result was that while at the beginning of the 1950s paid-in capital was about one-fifth of the total amount of liabilities, fifteen years later it accounted for less than one-tenth. Second, and maybe more relevant, is the fact that the State as the main shareholders was increasingly expropriating minority shareholders. A telling episode happened after the nationalization of the electric energy sector, in 1962. Through the sub-holding Finelettrica, IRI was the main blockholder in several companies of that industry, together with around 50 thousand private shareholders. However, the compensations from the nationalization were not distributed under the form of major dividends, but used by IRI for rescuing other companies on the verge of bankruptcy, or in acquisitions in totally different fields, as food and beverages or mass distribution, and investments in the Southern regions.
The reason for the expropriation of minority shareholders of the IRI companies in absence of an appropriate protection for minorities was basically that IRI had been progressively changing its role and nature. From and industrial policy instrument it had been evolving into an agency for development and largely captured by politicians, increasingly asking IRI to rescue companies, save jobs and invest in underdeveloped areas of the country. The end of the partnership was also the end of the “IRI formula”, and of the once virtuous relationship between State and private ownership. IRI was however going to survive almost thirty years after this divorce, increasingly and heavily burdened by debts, but without never restoring the confidence of the public.
The IRI case provides some useful takeaways. The association between State and private ownership can have positive effects for minorities even in absence of specific legal provisions. State control means a reduction in uncertainty and can add value to the investment. However, agency conflicts may offset these advantages, once the main blockholder turns to non-economic goals. In this case, the sole alternative to exit for minorities seems to be the establishment of appropriate external and independent governance mechanisms, or a pressure on directors and managers exerted by lobbies and associations of minority shareholders. Neither of these solutions appeared to be feasible in Italy in the period considered, given the

prevailing corporate governance practices in the country both among privately and publicly held corporations.