Advantages & Disadvantages of Disinvestment

Disinvestment is an action which an organisation or the government takes to liquidate its stake in the company, generate assets sale, or its subsidiary. It also means reducing the capital expenditure to reallocate resources into other meaningful areas within an organisation or government-funded project. Irrespective of its results, the primary objective of disinvestment is to maximise returns on investment. In the following sections, we will delve deeper into what disinvestment is, its primary objectives, what are the merits and demerits of disinvestment, and why companies undertake such corporate actions.

Topics Covered

• What are the Primary Objectives of Disinvestment?
• Types of Disinvestment
• What are the Advantages & Disadvantages of Disinvestment?
• Why Do Companies Disinvest?
• Conclusion

What are the Primary Objectives of Disinvestment?

Disinvestment is an action a company or the government takes to sell or liquidate its shareholding in a public sector company. The primary objectives of disinvestment revolve around optimising resources, enhancing economic growth, and improving the overall efficiency of public sector enterprises. One of the foremost aims is to reduce the financial burden on the government or the company, freeing up resources that can be channeled into more productive areas.

Disinvestment also serves as a means to promote private sector growth and competition. By reducing the government’s stake in certain sectors, it encourages private ownership and fosters a more competitive market environment. This can lead to increased efficiency, innovation, and improved service delivery.

Another significant objective is to retire public debt. Funds generated from disinvestment can be utilised to pay off existing debts, reducing the burden on government finances. Additionally, the process can create new assets and generate employment opportunities, contributing to economic growth.

Disinvestment can enhance market discipline and regulatory oversight by encouraging private ownership and participation in public-sector enterprises. This can result in better governance and management practices, which in turn can improve the performance and profitability of these enterprises.

Overall, the primary objectives of disinvestment encompass reducing financial burden, promoting private sector participation, enhancing market competition,improving economic efficiency, and fostering growth across various sectors of the economy.

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Types of Disinvestment

In 1999, the Indian government set up the Department of Disinvestment, later named the Department of Investment & Public Asset Management, a dedicated department that functions under the Finance Ministry. The government sets disinvestment targets for each Union Budget and changes them yearly. The targets vary according to the disinvestment policy of the government.

There are three types of disinvestment, including the following:

1. Minority Disinvestment: With this type of disinvestment, the government retains a majority stake in the company of more than 51%. Therefore, the company’s control lies in the management’s hands. Since public sector companies are meant for citizens, the government wants to build company policies while taking care of the public interests. Usually, the government auctions a minority stake in the company to potential investors or invites public participation by announcing OFS (Offer for Sale).
2. Majority Disinvestment: In this type of disinvestment, the government retains the company’s minority stake of less than 50% and gives up the majority stake. The government makes such decisions based on policies and strategies. Sometimes, it consolidates the resources of two companies to improve operational efficiency.
3. Complete Disinvestment: It is a type of majority disinvestment where the buyer gets 100% control of the company, and the enterprise turns into a private company.

What are the Advantages & Disadvantages of Disinvestment?

The primary objective of disinvestment is to put assets and resources to optimal use and unleash the inherent potential of public sector enterprises. The disinvestment policy of the government aims at modernising the PSEs, creating new assets, retiring public debt, and generating employment. The merits and demerits of disinvestment are as follows:

Advantages

• Releases public resources locked in public units and re-employs them into areas with high social priorities, such as healthcare, welfare, family, etc.
• Reduces public debt with threatening proportions
• Enhances outflows of scarce resources to sustain the unviable public sector units
• Facilitates transfer of commercial risk to taxpayers’ money that they locked in the public sector
• Releases resources like workforce for optimum utilisation in the social sector
• Exposes the companies to market regulations and helps them gain self-reliance
• Results in wider wealth distribution by offering private company shares to employees and small investors
• Benefits the capital market by increasing liquidity and depth in floating stocks, giving investors options for an early exit, establishing accurate valuation benchmarks, and raising funds for private company expansion and other projects
• Increases economic activity to open up the public sector to private investments, overall benefitting the economy, tax revenues, and employment
• Relieves consumers with better quality products and availability of more choices

Disadvantages

• Sometimes, the amount raised via disinvestment is too meagre, and the released money is not utilised as expected.
• Profit-making public sector units may rob the government of nice returns through disinvestment. Further, if the disinvestment department wants to avoid commercial risks, it will not retain equity in PSUs after disinvestment.
• The non-availability of the workforce does not hinder the growth of the social sector. However, the government must ensure that the market disciplines and regulates private firms to protect the public interest.
• The public sale of shares does not affect the disinvestment programme. Earlier, they attracted limited employees and did not benefit employees and small investors.
• Institutions hold disinvested PSU shares with little floating stocks. The present disinvestment policy of the government through strategic partnerships fails to achieve these goals.

Why Do Companies Disinvest?

Companies disinvest to raise capital to reduce their financial burden or meet their particular needs. Sometimes, the objective of disinvestment is to attract investments from private investors. As it is a great way to reduce debt, disinvestment improves a company’s chances of long-term growth and contributes to the nation’s development. Furthermore, it allows the open market to own a larger portion of PSUs, developing a robust capital market over time. Simply put, the main objectives of disinvestment include the following:

• Improve public finances
• Reduce the government’s financial burden
• Encourage private ownership
• Maintain and promote market competition
• Fund growth and development programmes
• Depoliticise non-essential activities

Other than these, disinvestment is a great way to finance a surged financial deficit, raise funds for large-scale development, boost consumer spending, reduce debt, and initiate social programmes.

Conclusion

Disinvestment is a financial strategy that the government and many companies use to enhance efficiencies and promote competition across sectors. However, it is important to know the merits and demerits of disinvestment to ensure social welfare. The owners must exercise caution and maintain their presence in the sectors to safeguard strategic interests and social obligations in the sectors.

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Abstract: Unlocking Potential: Exploring the Pros and Cons of Disinvestment. Learn why organisations embrace this strategy, its impacts, and considerations for a balanced approach.