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October 5, 2020 Should France privatize its airports? Aéroports de Paris which owns and manages Parisian international airports Charles de Gaulle and Orly is majority-owned by the French State. Last year the parliament voted a law that opens the door to the privatization of Aéroports de Paris. There is strong popular pushback against the privatization. An often-heard argument against privatization is that the State will sell the airports at a low price to private investors. How to value an airport? We apply the usual valuation principle we learn in finance classes: the value of an asset is the discounted sum of benefits the asset will generate. A key input in the valuation is the choice of the discount rate. An argument against privatization is that the State has a low cost of capital because it can borrow at a low interest rate. Therefore, it should apply a low discount rate to value assets such as the Parisian airports. By contrast, private investors use a higher discount rate. Since the State uses a lower discount rate, it values the airports more than private investors. The only way the State can sell the airports to private investors is by selling them at a price lower than its own valuation — which is a poor decision. This argument is misguided. The airports should be valued using the discount rate corresponding to the riskiness of the airport industry. As we learned since the Covid crisis, the air transport industry is not riskless. The State can borrow at a low interest rate because its other assets are quite safe (the State's main "asset" is its power to tax residents), but this is irrelevant for how much the State should value investments in risky assets. In fact, if the State holds too many risky assets, its cost of borrowing rises, so the State's cost of borrowing cannot be taken as a given (finance wonks will recognize here the Modigliani-Miller effect). Another way to see that the argument is misguided is to note that, if the State valued risky assets using its low cost of borrowing, it would have higher valuation for all risky assets than private investors and would end up buying all the assets in the economy! There is clearly a problem with this logic. Instead, the State should use the same discount rate as private, well-diversified investors, because the discount rate is determined by the riskiness of the asset being valued. This means that the State has the same valuation as private investors for given benefits generated by the airports. There exist valid arguments against privatization. These arguments are based on the fact that the benefits generated by the airports (which include the dividends but also the spillovers that airports generate on the local economy and on the environment) can be higher if airports are owned by the State than if they are owned by private investors. This view is supported by HEC finance professor Augustin Landier here (in French). |