Why investors love state-owned enterprises

British Leyland, a state-owned automotive giant formed in 1968, aimed to be a national champion for the UK.  

But the state-owned enterprise faced insurmountable challenges, including inefficient management, labour strikes and product quality issues.

Despite a bailout from the UK Government, the company's financial losses persisted. It ultimately succumbed to bankruptcy.

The collapse stands as a cautionary tale, illustrating the formidable hurdles faced by state-owned enterprises (SOEs) in a competitive global landscape. 

Research indicates that SOEs are often less profitable and suffer from worse corporate governance than their private counterparts.

What are the advantages of state-owned enterprises? 

Despite these problems, other studies have shed light on why SOEs seem to enjoy easier access to capital, challenging conventional wisdom that worse financial performance would increase risk for investors and firms’ cost of raising funds. 

One paper found that Government-owned corporations paid less for their debt than private firms, for instance. What explains this divergence between economic theory and market reality?

In new research with Lukas Jakob, of the University of Tübingen, and Ulrich Schmidt, of the University of Kiel, we show that the perception of positive social benefits is one notable factor contributing to the funding advantage enjoyed by SOEs.  

The study details how investors, in addition to seeking financial returns, view supporting state-owned firms as a way to contribute positively to society.  

This sentiment leads financial backers to accept lower expected profits in exchange for the perceived societal impact of investing in SOEs. 

The findings offer valuable insights for governing bodies, policymakers and investors navigating the complex relationship between state ownership, societal impact and financial decision-making.

The traditional explanation for SOEs’ financing advantages has long been linked to Government guarantees. This safety net ensures that SOEs facing financial difficulties receive state support, reducing perceived risks for investors and lowering borrowing costs for the SOEs.

However, in the European Union (EU), explicit guarantees to commercial ventures are prohibited by law, challenging the conventional explanation for SOEs’ lower capital costs. 

So state-owned companies in the EU can and do default – and prudent investors should take note of this risk.

We argue that societal benefits play a crucial role in influencing investment decisions. Despite legal restrictions in the EU, the research shows investors are still inclined to support SOEs due to the perceived positive externalities they bring. 

In the case of British Leyland, the company provided significant employment opportunities and contributed to national pride through its role as a major British automotive manufacturer. 

We argue that the 'societal benefits explanation' not only affects SOEs’ funding, but also sheds light on why governments worldwide own more equity in companies and tolerate poor SOE performance.

Investors consider the well-being of other stakeholders, not just their individual profits. This aligns with the growing trend of socially responsible investing, where companies with positive societal impacts attract more support.

For instance, research shows socially responsible US companies pay less for their debt, and investment funds with poor sustainability ratings experience a net ouflow of capital.

The economic impact of state ownership is substantial, with SOEs accounting for trillions in firm value and employing millions worldwide, according to the OECD, a club of mostly-rich nations. Our paper defines SOEs as commercially active companies where the state owns at least 10 per cent of the capital. 

Why are there so many state-owned enterprises? 

Two contrasting views explain the prevalence of state ownership. 

The first view is that SOEs are controlled by politicians who use them to meet their own goals, like creating jobs, keeping voters happy or advancing political agendas. Because these goals may not prioritise making a profit, it can lead to inefficiencies and lower profits for the enterprises.

The second view suggests that SOEs are there to fix problems in the market. For instance, private postal companies like the UK's Royal Mail might avoid providing services in remote areas because the money they make from a few customers doesn’t cover the delivery costs. This also applies to industries like railways and electricity.

Even if the company's profit is lower, there are positive effects for the society it serves. So investors don't just get financial returns from SOEs like interest or dividends; there are also benefits that reach many citizens.

Echoing this, a recent PwC survey found that 37 per cent of private sector CEOs believe that state-owned firms are helpful to society in certain parts of the economy.  

To further gauge public attitudes towards SOEs, we conducted an online survey and a lab experiment. The findings revealed that people believe SOEs bring more societal benefits than private firms, influencing their willingness to invest in them.

The lab experiment further demonstrated that people invested a big portion of their money in an option that had lower expected profits but a positive impact on society.  

It helps explain why, when viewed as socially beneficial, SOEs can secure funding more easily. Investors are more open to choosing a less financially rewarding option if it leads to a positive social impact.

Additionally, the research revealed that when people were investing for a positive impact on society, they were not only concerned about the amount of money they could earn but also about how predictable and consistent those earnings were. They preferred options with more predictable returns.

But the level of unpredictability was less important when the investment had positive social benefits compared to investments focused solely on personal gains. Even if there was more risk involved in the individual investment, people were still willing to invest if it contributed to social good. 

So ultimately, despite the historical challenges faced by SOEs, the willingness of investors to prioritise positive societal impact alongside financial returns provides them with a unique advantage. 

Further reading:

Red letter day: What next for Royal Mail after losing Post Office monopoly?

Why measuring social impact is good for business

Investor preferences for positive social externalities and state-owned enterprises’ facilitated access to capital

Sebastian Olschewski is a Research Fellow at Warwick Business School and a Postdoctoral Research Assistant at Center for Economic Psychology at the University of Basel.

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