In this article, Priya Agrawal discusses Corporate governance in State-owned enterprises.

Introduction

Corporations, whether they are family firms or State enterprises, work within boundaries set by law, by regulations, by those who own and fund them and by the expectations of those they serve. The natures of these boundaries vary country to country and undergo fundamental changes through time. That is why there can be no single generally applicable corporate governance model.

Good corporate management means using the physical resources, financial resources, and human resources to get the best results in terms of profitability, productivity, and market capitalization. Corporate governance depends on two factors, namely, the attitudes and the values cherished by the management of the business enterprise, and the external environment in which the company operates. The external environment in which the business operates would include the legislation relating to the functioning of business enterprises covering the entire spectrum from registration of companies, structure, settlement of disputes, laws relating to capital market and so on. As regards the governance of State-owned enterprises, the Government has throughout maintained a tight rein on them.

What are State-owned enterprises?

State-owned enterprises(hereinafter referred to as SOEs) are enterprises that carry out commercial activities on behalf of the State, its owner. They are government-controlled companies or statutory corporations set up by an Act of Parliament, or departmental enterprises of the government like in the defense sector, railways, or telecommunications.

The SOEs enjoy characteristics such as distinct legal personality, the appointment of Board by the Government and audit through the Comptroller and Auditor General. The SOEs are controlled by several agencies such as the following:

• Department of Expenditure (Ministry of Finance)
• Department of Public Enterprises (Ministry of Industries)
• Planning Commission
• Comptroller and Auditor General
• Secretariat for Industrial Approvals (Ministry of Industries)
• Director General of Technical Development (Ministry of Industries)
• Director General of Foreign Trade (Ministry of Commerce)
• Ministry of Company Affairs in case of SOEs registered as companies under the Companies Act
• Parliamentary Committee on Public Undertakings (COPUs)
• The Members of Parliament
• Consultative Committee

The SOEs can be in the form of a company registered under the Companies Act, or it can be a Public Sector Undertaking (PSU). The various terminologies often used synonymously with SOEs are PSUs, State-owned Company, Government-owned Corporation, State privatized- industry.

The SOEs is a global phenomenon, and such organizations exist in Australia, New Zealand, the United States of America, China and South Africa, such as Freddie Mac and Fannie Mae in the United States of America.

Role of SOEs

State-owned enterprises play a significant role in national and international economic activity.

First, in many developing economies, SOEs are the sole providers of public services (e.g., water and electricity provision, telecommunications and postal services). Secondly, bearing in mind that many developing economies have largely agrarian economies, SOEs regularly account for between 25% and 50% of the urban economy. Thirdly, in economies with less developed private sectors, SOEs can be a major source of employment and job training for the local population.

In developed economies, a more restricted economic role is played by the SOEs. A recent study of Organisation for Economic Co-operation and Development (OECD) -area SOEs shows that they account for as much as 10% of economic activity, but in general their share of the economy is much lower, with SOEs accounting for 2.5% of national employment on average. SOEs are, however, highly concentrated in infrastructure and other network industries and in some cases also the financial sector (OECD, 2014b).

Together, the network industries (telecoms, electricity and gas, transportation and other utilities, including postal services) account for about half of all OECD SOEs by value and 60% by employment share.

Need for corporate governance in SOEs

State-owned enterprises (SOEs) are assets that the government manages on behalf of citizens. Thus, it is essential to ensure that these assets are handled with utmost care and professionalism. For economic growth and development, it is critical that the SOEs perform efficiently. One must understand the fact that the resources utilized by the SOEs are ultimately the public resources. So, when the SOEs are not managed properly, public resources are wasted, funds are channelled away from the productive activities, and the development is ultimately hindered. But when they are governed transparently and efficiently, they can correct market failures, improve public service delivery and play a role in creating fairer and more competitive markets.

Governance of SOEs

Through the SOEs, the Government plays the role of an entrepreneur, planner, investor, regulator and so on. The SOEs are required to function within the framework of national planning and are expected to work as key instruments for the realization of plan objectives. The governance of SOEs is done by the Government by making enabling provisions in the Articles of Association. These provisions cover the following aspects:

1. Check on composition of the Board of Directors
2. Nomination of Government officials on the Board
3. Restrictions on the Board powers
4. Making governmental approval mandatory in some cases
5. Vesting the power to issue directives with the Government

The control of the SOEs vests in the Administrative Ministry/Department which oversees the functioning of the enterprise undertakes periodical reviews of performance, sanctions capital schemes and issues formal and informal instructions.

Issues of governance in SOEs

SOEs face some particular governance challenges that can impair/reduce their ability to perform efficiently, create value, and contribute to economic development. One of the main reasons is the unclear accountability of the SOEs. Their accountability is often dispersed among various State bodies with inherently different policy interests. SOEs might serve various political masters who may have different interests. There is no clear line of accountability of the SOEs. This may lead to an excess political influence on the working of the SOEs; or it may leave a vacuum, with passive ownership and limited oversight, increasing the risk that corporate insiders will advance their personal interests rather than those of the enterprise and the general public. Bribery can also be a major issue in the SOEs. Their employees are particularly at a high risk of soliciting and receiving bribes.

The contrariant policies of the SOEs such as procuring profits with private companies while dispensing public services add to the complexity of the issue. Creating a balance between performance of multiple objectives intensively and falsifying competition can be a challenging situation. In the current scenario, it is of prime importance to prevent the market collapse by establishing equal application of the market regulation to SOEs and private competitors, such as guidelines relating to competition and procurement. It is also important to make sure that any subsidies to SOEs are calibrated to the actual costs of fulfilling clear public policy objectives, to avoid market distorting cross-subsidization of SOEs’ commercial activities.

Recommendations of DCA Committee on Listed Public Sector Corporations

With increasing privatization, more and more companies in the public sector would function as listed corporations with institutional and retail shareholdings in addition to the Government’s own. The Committee gave the following recommendations:

• The foremost need would be to protect the needs of vast stakeholder clientele in the public sector enterprises.
• To the extent companies’ legislation governs such corporations, it is necessary to clarify governance requirements and the mutually complementary roles of different legislative, monitoring and assurance agencies that bear upon their functioning.
• The effort should be to usher governance practices to the highest standards while offering them enough elbow room to function and respond in a businesslike
• The internal audit function is an important instrument for Board surveillance and executive-control. These arrangements should continue on lines similar to those applicable to private sector companies.
• The Audit Committees of the Boards of respective companies should be entrusted with the tasks similar to their counterparts in the private sector listed companies and ensure that the independence of internal audit function, its resources and expertise, and other such matters are duly taken care
• The concepts of vigilance and ethical conduct in business operations are valid, and every effort should be made to ensure that the deviant behavior is detected and dealt with and in fact to the extent possible, pre-empted.
• Organizational control systems should be designed to root out unacceptable behavior through more transparent processes and vastly reduced discretionary authorities.

The Committee has specifically eulogized the work done by the Committee set up in the United Kingdom in the 1990s under the chairmanship of Lord Nolan which published a document setting out standards of behavior in public service. This body has now been converted into a permanent committee with full-time members researching and offering guidance in this field. A draft code of ethics for Public Sector Enterprises and concerned administrative ministries had been prepared by the then Chairman of Public Sector Enterprises Selection Board.

It may be appropriate to constitute a Committee to consider and prescribe a code of behavior and ethics applicable to SOEs in India which can be adopted by company boards for enforcement within the organization.

The Draft code of conduct and ethics for the PSEs and Administrative Ministries

The objective of the Code is to prescribe standards of integrity and conduct that are to apply to all executives and employees in the PSEs and the officials and employees of the Administrative Ministries concerned with them.

The principles stated below underlie and supplement the rules and laws regulating the public and private conduct of the executives/officers and employees of both PSEs and Administrative Ministers.

Objectives of the PSEs

• The role of the executives/officers is to assist the PSEs to achieve its objectives as spelt out in the charter constituting the setting up of the enterprise.
• It is the obligation of every executive/officer and employee of the PSE/Administrative Ministry to hold the Rule of Law and respect for human rights solely in the public interest while making recommendations or exercising administrative authority. He/she must maintain the highest standards of probity and
• The religion, region, caste, language of the executive will have no influence on his official capacity to work.

Conflict of interest and peer pressure

• Executives, officers, and employees of the PSEs/Administrative Ministries should refrain from decisions in respect of which they have reason to believe that they are calculated to benefit any particular person or party at the expense of the public interest.
• Every executive, officer, and employee in the PSE/Administrative Ministry shall disclose any clash of interest when there is a conflict between public and private interest, or he/she is likely to benefit from any act of omission or commission while discharging his/her functions.
• Executives, officers, and employees of the PSEs/Administrative Ministries should be alert to any actual or potential conflict of interest, financial or otherwise and should disclose this to their superiors about whether the conflict covers them and their family members

Accountability and responsiveness to the public

• Executives, officers and employees in the PSEs/Administrative Ministries should be consistent, equitable and honest in their treatment of the members of the public, with particular care for the weaker sections of society and should not be or appear to be unfair or discriminatory. The decision in pursuit of discretionary powers should be justifiable on the basis of non-arbitrary and objective criteria.
• Executives, officers, and employees in the PSEs/Administrative Ministries should accept the obligation to recognize and enforce customer’s right for speedy redress of grievances and be committed to provide services of declared quality and standard to customers.

Concern for the value of public assets and funds

• The employees in PSE/Administrative Ministry should avoid wastage and extravagance and ensure effective and efficient use of public money within their control. No unlawful stoppage or disruption of work or damage to the assets of the PSEs should be resorted

Continuous improvement in professionalism and teamwork

• It shall be the duty of every employee of the PSE/ Administrative Ministry to upgrade his/her skills and knowledge continuously, strive for creativity and innovation, and nurture the values of the team working and

SCOPE’s suggestions on SOEs

The Standing Conference on Public Enterprises (SCOPE) has indicated the need for availability of resources, both for revamping and retaining a competitive edge for the SOEs in a market-driven economy. In its view, whatever resources the SOEs had, were being taken away. The need is to plow back a part of the disinvestment proceeds to the SOEs for the purpose of their development. This is particularly essential due to diminishing budgetary support to these enterprises.

OECD Guidelines for SOE corporate governance

The OECD’s guidelines for corporate governance of SOEs can be summarized as follows:

Ensuring an adequate legal and regulatory framework for SOEs

The legal and regulatory framework for SOEs should ensure a level playing field in markets where SOEs and private sector companies compete in order to avoid market distortions. The framework should build on, and be fully compatible with, the OECD Principles of Corporate Governance.

The state acting as an owner

The State should act as an informed and active owner and establish a clear and consistent ownership policy, ensuring that the governance of SOEs is carried out in a transparent and accountable manner, with the necessary degree of professionalism and effectiveness.

Equitable treatment of shareholders

The state and its SOEs should recognize the rights of all shareholders and, in accordance with the OECD Principles of Corporate Governance, ensure their equitable treatment and equal access to corporate information.

Relations with stakeholders

The state ownership policy should fully recognize the SOEs’ responsibilities towards stakeholders and request that they report on their relationships with stakeholders.

Transparency and disclosure

SOEs should observe high standards of transparency, in accordance with the OECD Principles of Corporate Governance.

The responsibilities of the boards of SOEs

The boards of SOEs should have the necessary authority, competences, and objectivity to carry out their functions of strategic guidance and monitoring of management. They should act with integrity and be held accountable for their actions.

Conclusion

Owing to the role that the SOEs play in the development of an economy, it is imperative that they function efficiently. Adoption of sound governance policies in SOEs is the need of the day!