This article has been written by Shubham pursuing a Diploma in Corporate Law & Practice: Transactions, Governance and Disputes frok LawSikho.

This article has been edited and published by Shashwat Kaushik.

Introduction

Corporate governance refers to the guidelines and methods put in place by a governing body for overseeing how businesses operate. The main reason for corporate governance is to create an understanding between components of a business, like shareholders, management and directors, and to ensure its unhindered functioning. Corporate governance has become a necessity because of the competing businesses and their goal of succeeding with whatever means necessary. 

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Corporate governance can be dated back to around the 1800s in the United Kingdom, but it was only in the 1990s that it became noticeable to  mainstream economists because of the misconduct and unfair practices that came into light during this time, causing a stir among the consensus. Some of the popular incidents that made headlines in the 1990s were:

  1. The Cadbury Report (1992)
  2. The Greenbury Report (1995)
  3. The Hampel Report (1998)

It could be noticed that Britain’s economic scene has been going through turmoil in recent times, like dealing with issues like Brexit, climate change and the Covid-19 pandemic, yet still, the economy is somehow able to sustain this all only because of its control over state-owned enterprises (SOEs). SOEs are companies partly or fully owned by the UK government, with a minimum of 51% stake in them. These SOEs can be seen actively operating in many areas of the UK’s core economic functional fields like health care, education, energy, transport, defence, etc.

SOEs can have sizable economic and social impacts, as they have always operated in strategic sectors such as energy, transport, telecommunications and health care. However, they too face governance challenges, which in some cases are only specific to their business structure. Therefore, it is important that every SOE operating in any field follow high standards of corporate governance, such that it ensures a clear separation between ownership and management functions, establishes independent and competent boards of directors and implements effective internal and external audit mechanisms. Every SOE should also not fail to disclose its relevant financial and non-financial information to the public and by performing all these functions regularly and competently, every SOE operating on behalf of the state can enhance their performance, competitiveness and reputation and can also contribute to the economic growth and social welfare of the nation. 

OECD report on the SOEs in UK

The OECD report stated that there were about 103 big public companies in the UK which are state owned. These companies had a value of £146 billion and provided jobs to roughly 8,00,000 people in the country, generating employment in bulk and catering to around half of the nation’s population, according to an estimate.

Corporate governance for SOEs in the UK must deal with issues and chances distinct from those of a private enterprise operating in a similar space in the UK. SOEs observe issues like political interference, functioning based on polarised state ideology, consideration of social goals, public inspections, etc., and therefore need special practices designed just for their functioning for safety and clarity.   

The report states that the UK state does not prescribe one determined way to decide the goals of SOEs and hence the ways of creating them are also different in the region. The formation of such SOEs involves public groups that are not even a part of the department or in any way related to the executive officers, money making funds or corporations by law. Guidelines, laws, amendments and codes issued by the UK government are applicable to SOEs.

The UK government has issued various rules and guidelines from time to time but nothing specifically related to state-owned companies. The applicability of all these acts/ guidelines/ and codes is kind of similar to other forms of company operating in a similar space, but it does contain some provisions exclusively for the SOEs:

The Corporate Governance Code for Central Government Departments (2017)

This law mainly amends the 2011 edition of it passed by the UK government and mainly comments on the part and duties of the departmental boards on policy and performance. One of the rules states that the board must be fair in the appointment of ministers, big jobs and non-government outside members, which should be equal in numbers.

  • Risk management: The code highlights the need for risk management and internal control in the department and the need for a separate unit for such a function. It also provides how the board should get itself audited and analysed at regular intervals.  
  • Arm’s length bodies: The code comments that the board should make sure that it encompasses strong rules for its arm’s length bodies and should monitor their functioning the same as that of the department’s single plan.

The Code states that the board is vested with the option to choose between ‘follow or explain’. This means a department might not follow the code but then needs to explain why it didn’t follow it in its yearly governance statement attached to a monetary report. The code also expresses ideas such as the Nolan Principle, the Ministerial Code, the Civil Service Code, Managing Public Money, the Audit and Risk Assurance Committee handbook, and the relationship between departments and bodies not connected to them. The Code also discusses how ministries influence the policies of the organisations they run. This might involve SOEs and carrying out their departmental plan.

The UK Corporate Governance Code (2018)

This Code was published by the UK’s Financial Reporting Council. This Code is applicable to firms that are registered on the London Stock Exchange, which also includes some of the SOEs and hence applies to them too.

The Code is mainly divided into five sections, which are:

  • Board leadership and Company Purpose 
  • Division of Responsibilities 
  • Composition, Succession, and Evaluation
  • Audit, Risk and Internal Control 
  • Remuneration

It should be considered that the code is general and not exclusively directed towards SOEs and changes accordingly to the sector in which the SOE generally operates. The code also comments on how boardrooms should work, government ownership and control, being open about things and sharing information, and fair treatment of shareholders and other investors.

Code of Conduct for Board Members of Public Bodies 

These Rules chart down some behavioural boxes to checkmark for the directors and their duties in charge of these public groups. These rules are meant to tell the boards of these state enterprises what they should do for everyone, how they need to act in favour of all and what guidelines the board members must abide by. It also provides that the board members must also be well-versed in how a state-run company works. How to make public organisations and big companies more open and trustworthy.

UK Companies Act, 2006

This Act covers all the businesses operating in the UK and considers no exceptions for businesses, even if they are owned by the state. The law does consider that, along with the general compliance commitments, SOEs might have to consider some other duties, such as following public goals, offering public services or supporting national interests, which is distinct from what other businesses do to sustain, survive and prosper. The UK Companies Act 2006 does not have special rules for state-owned companies as such and generally directs all leaders to do general things like acting within their allowed roles, following and pushing the company’s success, staying clear of personal conflicts and conveying about any possible deals or plans they’re connected with.

The Public Services (Social Value) Act, 2012

This Act states that those in charge of these government run organisations must think about how to enhance services, goods or jobs to improve economic, social and environmental health in their sector. The law demands government organisations connect with their subject and make improvements in providing better services that will give good value at an affordable price.

This Act covers and comments on public service contracts and framework deals. The government needs to abide by this Act before it enters into any contracts or deals. The government needs to think about how it can get social good through what it wants, how it checks those things and how it manages its contracts. The Act also directs that at least 10% should be allocated for social value.

Sector specific regulations 

There aren’t any regulations specific to SOEs with respect to their business structure, but there are regulations applicable to SOEs that are sector specific. SOEs are regulated with rules and regulations depending on the industry they belong to and how much the government is involved in that sector. Some of the common regulations that apply to SOEs in the UK are:

  • Energy sector: The Petroleum Act 1998 and the Electricity Act 1989.
  • Water industry: The Water Industry Act 1991 
  • Transport sector: The Railways Act 1993, The Transport Act 1985 or The Road Traffic Act 1988.

These are specific to SOEs and the sector in which they are operating.

Assessing competence of corporate governance with respect to SOEs

Looking at the competence of the law governing SOEs in the UK, there are certain parameters that are to be considered to derive an assessment.

Board structure and composition

Assessing the board involves scrutinising the board’s diversity of members and their expertise, freedom from any external or internal manipulation and competence with the organisation’s business matters. This involves confirming the number of members required to meet the board criteria, along with all other requisites like the number of meetings to be held in a year and board resolutions or quorums for meetings, etc. It also involves the selection of board members, compensating them with the right remuneration in accordance with the remuneration limits, and having a check over their functioning and activities. The OECD Guidelines on Corporate Governance of State Owned Enterprises (2015) provide comments about how things should be run, like making sure that board members are selected in a transparent and regular manner, which could be backed by appropriate reasons and justified by their skills. Another requisite is that the members should be able to separate politics and management.

Transparency and accountability

The OECD Guidelines (2015) advise on conveying data relating to the transparency and accountability of the organisation and state that it’s necessary for SOEs to disclose such data to the general public. Maintaining transparency on the decision-making aspect of the SOEs and practices for accountability. Some of the details which a SOE should share with the general public are money performance, ownership structure and management controls. The code also suggests checking on the steps needed and taken to make sure SOEs are accountable for their decisions. 

Compliance and ethical practices

Keeping track of ethical behaviour and being aware of whether social well-being being followed or not. Tracking if the SOEs obey rules in their work, like laws about monetary holdings and external currency investments, environmental protection laws and labour laws. Guidelines from the OECD (2015) elaborate on these topics and give suggestions on them. 

Performance and impact

To evaluate the impact of the SOEs and their performance on society as a whole would require evaluating the financial performance of SOEs in terms of their profitability, efficiency, productivity, etc. whereas to evaluate their impact on public policy objectives, social welfare, environmental sustainability, innovation, etc. The OECD Guidelines on Corporate Governance of State-Owned Enterprises (2015) provide commentary and guidelines on these aspects of performance objectives and sufficient financial resources to achieve their objectives.

Importance of corporate governance for SOEs

Effective corporate governance is crucial for state-owned enterprises (SOEs) to operate in a transparent, accountable, and efficient manner. It helps align the interests of various stakeholders, including shareholders (the government), management, and the public. Here are some key points:

  1. Transparency and accountability:
    • Corporate governance ensures that SOEs are transparent in their operations, decision-making, and financial reporting.
    • It establishes clear lines of responsibility and accountability, making it easier to hold management and the board of directors responsible for their actions.
    • Transparent governance helps prevent corruption, mismanagement, and misuse of public funds.
  2. Alignment of stakeholder interests:
    • Effective corporate governance aligns the interests of different stakeholders in an SOE, including the government (shareholders), management, employees, and the public.
    • It ensures that decisions are made in the best interests of the organisation and the public good, rather than for the personal gain of a few individuals.
    • Alignment of stakeholder interests helps foster trust and confidence in the SOE.
  3. Efficiency and performance:
    • Sound corporate governance practices contribute to the efficiency and improved performance of SOEs.
    • Clear decision-making processes, effective risk management, and robust internal controls help SOEs operate more efficiently.
    • Good governance also promotes innovation, encourages entrepreneurship, and fosters a culture of continuous improvement.
  4. Compliance with laws and regulations:
    • Effective corporate governance ensures that SOEs comply with applicable laws, regulations, and ethical standards.
    • It minimises the risk of legal liabilities, fines, and reputational damage.
    • Compliance with laws and regulations helps SOEs maintain a positive public image and build trust with stakeholders.
  5. Attracting investment and capital:
    • Strong corporate governance practices make SOEs more attractive to investors, both domestic and foreign.
    • Investors are more likely to invest in SOEs that are transparent, accountable, and well-managed.
    • Good governance enhances the reputation and credibility of SOEs, making them more competitive in the global marketplace.
  6. Sustainability and long-term viability:
    • Effective corporate governance helps SOEs adopt a long-term perspective and make decisions that are sustainable in the long run.
    • It encourages SOEs to consider environmental, social, and governance (ESG) factors in their decision-making.
    • Sustainable practices contribute to the long-term viability and success of SOEs.

Recent developments

  • The UK government has introduced the Corporate Governance Code for State-Owned Companies, which sets out a series of principles and guidelines for the governance of SOEs. The Code aims to ensure that SOEs are managed in a transparent and accountable manner, and that they operate in the best interests of the public.
  • Independent scrutiny and reporting mechanisms have been established to enhance oversight of SOEs. These mechanisms include the National Audit Office, which is responsible for auditing the financial statements of SOEs, and the Public Accounts Committee, which is a parliamentary committee that scrutinises the performance of SOEs.
  • The government has also introduced a number of reforms to the way in which SOEs are privatised. These reforms are designed to ensure that privatisation is carried out in a fair and transparent manner, and that the proceeds of privatisation are used to benefit the public.
  • In addition to the UK government, a number of other countries have also introduced reforms to the governance of SOEs. These reforms reflect a growing recognition of the importance of ensuring that SOEs are managed in a transparent and accountable manner.
  • The reforms to the governance of SOEs are a positive development. They will help to ensure that SOEs are managed in a way that is in the best interests of the public.

Challenges faced by SOEs

Here are some of the key challenges facing SOEs in the U.K.:

  • Political interference: SOEs are often subject to political interference, which can lead to inefficient decision-making and a lack of accountability. For example, a government may pressure an SOE to hire unqualified workers or to make investments that are not in the best interests of the company.
  • Lack of competition: SOEs often operate in markets where they have little or no competition. This can lead to complacency and a lack of innovation. 
  • High costs: SOEs often have higher costs than private-sector companies. This is due to a number of factors, including political interference, a lack of competition, and inefficient management.
  • Lack of accountability: SOEs are often not held accountable for their performance. This is because they are not subject to the same market forces as private-sector companies. For example, if an SOE makes a loss, it can simply ask the government for more money.
  • Corruption: Corruption is a major problem in many SOEs. This is because SOEs are often seen as a source of patronage for politicians and their cronies. For example, a study by the World Bank found that corruption costs the global economy trillions of dollars each year.
  • Inflexibility: Inflexibility is another major challenge facing SOEs. This is because SOEs are often bound by a number of regulations and rules that make it difficult for them to adapt to changing market conditions.
  • Lack of investment: SOEs often lack the investment capital needed to stay competitive. This is because governments are often reluctant to provide funding for SOEs, especially when they are running at a loss.
  • Low productivity: SOEs often have lower productivity than private-sector companies. This is due to a number of factors, including political interference, a lack of competition, and inefficient management.

Despite these challenges, SOEs can play an important role in the U.K. economy. SOEs can provide essential services that may not be provided by the private sector, such as infrastructure and utilities. SOEs can also help to promote economic development in underserved areas.

The competence of corporate governance for SOEs in the U.K. is a complex issue. There are a number of challenges facing SOEs, but they can also play an important role in the economy. It is important to find a balance between the need for efficiency and accountability and the need for essential services.

Case studies

Exemplary Governance Practices: Showcasing SOEs with effective governance structures and successful practice/ profit making in the UK.

One example of an SOE with effective governance structures and practices in the UK is the BBC, the British Broadcasting Corporation. The BBC is a television broadcaster that operates under the Royal Charter, i.e., with the allowance of the King in the year 1927. The BBC has also entered into a framework agreement with the UK government for the broadcasting services which it provides. It is governed by a board of directors, which sets the strategic directions, ensures compliance with legal and regulatory obligations and oversees the delivery of the public service. The board reflects diversity in parlance with the UK’s population and the members participating are appointed through a very fair and open procedure. 

The board is seconded by many committees, such as the Audit and Risk Committee, the Editorial Guidelines and Standards Committee, and the Nominations Committee. The BBC’s management is structured unitarily and is led by a Director-General, who is the chief executive officer and editor-in-chief. The Director General is responsible for the operational management of the BBC and is backed by a senior leadership team. An annual report is published by the BBC, which provides information in relation to its performance, governance and impact. It also publishes its accounts to the general public and believes in maintaining standards of high integrity and editorial independence. The BBC is subject to external oversight by Ofcom, the UK’s communications regulator, which monitors its compliance with broadcasting rules and licence conditions. 

Deficient Governance Instances: Analysing SOEs in the UK that failed to maintain and sustain governance failures and their repercussions.

The most prominent of the lot as an example of deficient governance would be UK Network Rail, which operates and owns the railway network primarily in Great Britain. Network Rail was established in 2002 as a not-for-profit company and limited by guarantee, having members instead of shareholders. However, in 2014, the Office for National Statistics reclassified Network Rail as a central government body due to its high level of public debt and dependence on government funding.

This reclassification had significant implications for governance and accountability arrangements with respect to Network Rail, as it came under the radar for more direct governmental control and scrutiny. The SEO has been dealing with several governance challenges over the years, such as cost overruns, delayed projects, below standard performances, safety issues, and low shareholder involvement. Some of the factors that fuelled these challenges include: unclear arrangements between Network Rail and other rail operators, which brought confusion in roles to be played; lack of regulatory actions by the Office of Rail and Road; inadequate board composition and lack of skills of the board members to handle situations; inefficient risk management and low internal control; low transparency and disclosure; and cultural issues such as complacency, stocking of data not to be published in public, and lack of adaptive mentality. These governance failures have resulted in negative consequences for Network Rail’s reputation, finances, operations, and public trust.

Conclusion

The assessment of the competence of corporate governance for a SOE within the UK revealed several strengths and weaknesses. The strengths are a clear vision and social welfare-driven mission, a diverse and inclusive board that possesses qualifications, a responsive and fast track risk management system, and a respectable level of transparency and accountability. On the other side, the weaknesses include low stakeholder involvement, frail and flawed performance evaluation system, lack of adaptive mindset for innovation and digitalisation of procedures, and discordance with ESG principles and climate goals. These findings are supported by various reports and academic papers, such as the OECD Guidelines on Corporate Governance of SOEs, the CIPD factsheet on corporate governance, and the ICAEW insights on SOE sustainability.

The assessment of the competence of corporate governance for a state-owned enterprise within the UK is not a one-time evaluation but rather an ongoing process that requires progressive evaluation and adaptation. The economic and social landscapes are changing exponentially, generating new challenges and opportunities for SOEs to deal with. Therefore, it is necessary that SOEs move along with the latest trends and developments in their respective sectors, markets, and society at large, and that they adjust their governance compellability accordingly. 

This can be achieved by benchmarking against best practices adopted globally or by leading SOEs, by seeking feedback from external experts and auditors, and by anticipating future scenarios and risks.

References

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