Two strands of theories on the relationship between business ownership and the firm’s cost of debt. The first one includes the theories of agency cost and moral hazard. Debtholders predict that government ownership leads to higher risk-taking. The agency cost theory maintains that bureaucrats or managers who control government-owned organizations have no direct ownership of the businesses’ assets. Consequently, they are not keen on ensuring that these organizations succeed.
Unlike the managers who run private institutions, these bureaucrats channel resources to personal growth at the expense of the businesses. The puny administrative inducements, coupled with misappropriation of resources due to manager-owner clash, results in state-owned firms performing poorly and assuming high risks (Barry et al., 2011; Berger et al., 2005; Iannotta et al., 2007; Sapienza, 2004; Shleiffer and Vishny, 1986, 1997). Borisova et al. assert that the poor management of government institutions has an indirect impact on the amount of debt that an organization takes.
The moral hazard theory argues that government-owned companies do not entirely assume the burden of the risks that they take. As a result, these firms are unlikely to shy away from risky activities (Iannotta et al., 2013; Gropp et al., 2014). Moral hazard arises when an individual has a penchant for taking risky actions because they will not bear the consequences of their behavior. In such a circumstance, the decision-maker is protected from the dangers emanating from their actions.
This theory attributes the lack of accountability to the risky behaviors that public servants exhibit. Based on this viewpoint, one of the advantages of state ownership (which cuts across most of the developed and developing nations) is that the government bears the costs, which state-owned enterprises (SOEs) incur. These risks include bailing out an institution that is on the verge of bankruptcy, injecting capital, and replacing non-performing assets. Hence, the bailout expectation of state-owned firms becomes an incentive for managers to take on excessive risks at the expense of creditors (Merton, 1977).
Alternatively, the theory of soft budget constraint entails that state-owned firms are always bailed out with state-owned banks (Kornai et al., 2003) due to the advantages that come with government ownership. National banks are said to enjoy government assistance like implicit and explicit guarantees, capital injection, and resolution of unbeneficial loans. Consequently, these financial institutions are more likely to engage in uncertain activities than private banks.
Nier and Baumann (2006) confirm that the entrenched government assistance aggravates business’ risk-taking motivation. For many years, scholars have blamed government-ownership for corporate ineptitude that is witnessed in public institutions. Shleifer and Vishny (1994, 1998) argue that governments use insider expropriation to attain political and economic goals like public support, contributing to inefficiency.
State-owned firms undertake risky projects to obtain competitive advantage resulting in a positive relationship between state ownership and corporate risk-taking activities. Many papers provide empirical evidence to support these arguments, for example, Farag and Mallin (2016). Moreover, according to Zhu and Yang (2016), state-owned firms might be associated with high risk-taking projects, which is caused by a potential moral hazard due to manager–owner conflict or soft budget constraint, which would lead to a high cost of debt as noted by Borisova et al. (2015)
The TASI started to fall dramatically at the end of February 2006 the market capitalization dropped to US$326.9 billion by the end of 2006, falling 49.72% from 2005.