Corporate Governance RSS

  What State-Owned Enterprises Can Learn From the Private Sector 

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Better corporate governance of state-owned enterprises is becoming a priority in many countries in which the public sector still accounts for a sizable proportion of the economy. According to the Organization for Economic Cooperation and Development (OECD), good governance of state-owned enterprises is vital to a country's overall economic efficiency and competitiveness, and a prerequisite for economically effective privatization. But what strategies should a government adopt to achieve it?

To answer this question, Xavier Vives, Professor of Economics at IESE, analyzes the main problems of corporate governance in state-owned enterprises and proposes strategies for improvement, based on the internationally recognized guidelines published by the OECD.

According to Vives, "It is more difficult for state-owned enterprises than it is for private sector companies" for a number of reasons. First, while private sector companies have just one core objective, which is to maximize value, state-owned enterprises have several. And if these various objectives are not somehow made compatible, conflicts between interested parties can become intractable and make it impossible to assess corporate performance.

Moreover, state-owned enterprises have the problem of double agency. This means that besides the usual conflict between the interests of managers and owners, as in private enterprise, they also have to deal with conflicts between the interests of politicians or bureaucrats and citizens. According to Vives, "This can degenerate into either excessive political intervention or an inappropriately hands-off approach on the part of the state." The author stresses that when a state-owned enterprise has to compete on market terms, it needs to be reasonably efficient. "Otherwise it will exhibit a pattern of losses that make it politically unsustainable in the medium term."

For Vives, a third problem of state-owned enterprises are the conflicts of interest generated by the state's multiple roles as owner, regulator, and customer or supplier to its own enterprises. This, he says, can lead to "unfair discrimination or favoritism."

The OECD Principles
In 2005, the OECD published "Guidelines on Corporate Governance of State-Owned Enterprises", aimed at promoting efficiency and enhancing transparency in the public sector. In his paper, Professor Vives discusses some of the OECD's recommendations.

To begin, the OECD guidelines stress the need to establish a clear legal and regulatory framework for state-owned enterprises, one that is as close as possible to the guidelines for private sector companies, so as to avoid market distortions and establish a level playing field. According to Vives, this requires a clear separation between the different roles the state plays in the market, as business owner and as market regulator. With respect to financing, the OECD recommends that governments should avoid situations in which the state implicitly guarantees or automatically assumes responsibility for a state-owned enterprise's debts.

As majority shareholder, the state should actively exercise its ownership function. According to the OECD guidelines, hands-on and politically motivated ownership interference should be avoided as much as totally passive or distant ownership by the state. The best method for the exercise of state control is through a centralized entity that clarifies the state's ownership policy and orientation and ensures its consistent implementation. This entity should be accountable to Parliament.

In state-owned enterprises that have private shareholders, all shareholders should be treated equitably and have access to corporate information. This includes measures to foster the participation of minority shareholders and ensure that their rights and interests are respected. State-owned enterprises must also explicitly recognize their commitments to all stakeholders and acknowledge stakeholders' influence on corporate decision making.

For such transparency to become a reality, the OECD recommends that the reports on different aspects of state-owned enterprises' activities, in particular those that may entail a conflict of interest, be made public, and also that state-owned enterprises be subject to internal and external audits. The agency that oversees state-owned enterprises should provide aggregate information in an annual report.

Lastly, to improve the quality of oversight of state-owned enterprises, the OECD recommends that boards have the necessary authority to monitor management independently of government policy. To do this, the guidelines suggest that government should develop a structured nomination process that preserves boards' objectivity, professionalism and independence. Remuneration schemes for board members must also be designed to favor the long-term interests of the company and attract suitably qualified professionals.

To promote real strategic discussion and objective advice, boards should be made up of a small number of members, who should not also be managers of the company. And to preserve the board's independence with respect to management, the OECD recommends that the Chair of the board be separate from the CEO.

From Good Private Governance to Good Public Governance
In developing strategies to improve the corporate governance of state-owned enterprises, Professor Vives suggests that governments use the principles that guide private companies, though adapted to the specific circumstances of the public sector.

He acknowledges that corporate governance in the public sector faces three unique challenges: how to clearly define the state's ownership function; how to make the company's goals and performance more transparent; and how to empower managers and boards to make the right decisions. In the paper, he puts forward five proposals to overcome these difficulties:

  • Set clear objectives.
  • Introduce incentives based on market discipline.
  • Isolate the board and management from political influence.
  • Sufficient disclosure (transparency) by companies and by government.
  • Ensure there is sufficient competition in the product market.

Privatization and Competition
The author concludes with some reflections on competition and regulation in the context of the privatization of Spanish state-owned enterprises.

According to Vives, Spain has reached an advanced stage of privatization of public enterprise, but in doing so, it has not always created or maintained a market structure that favors competition. "An independent regulator is crucial, as privatization does not necessarily remove a state-owned enterprise from political influence if the enterprise operates in a regulated industry that depends heavily on government decisions," he points out.

Accordingly, Vives emphasizes the need for government to open up the board nomination process and introduce transparent, international competitive hiring, based on the candidates' merit, ability and professionalism.

This article is based on:  El buen gobierno de las empresas públicas
Publisher:  PPSRC - Public-Private Sector Research Center
Year:  2007
Language:  Spanish
Note:   The original article was published in the Brown Book on "La Administración Pública que España necesita", Círculo de Empresarios, Madrid, April 2007, pages 363-376.