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Cronyism and the governance of state owned enterprises

By Ravi Ratnasabapathy

Some Government appointments to the boards of state owned enterprises have caused widespread dismay. The general public grumble that there seems to be a return to the bad old ways, with friends and relatives of politicians being appointed to plum posi­tions. It is therefore opportune to examine the desired governance structure of state enterprises.

Nepotism and cronyism are the practice of giving preferential treatment to relatives and friends in employment. The term nepotism is derived from the Italian word ‘nepotismo’, which is based on Latin root ‘nepos’ meaning nephew. Since the Middle Ages and until the late 17th century, some Catholic popes and bishops, who had no legitimate heirs, appointed their nephews positions of power in the church. The related issue of cronyism refers to partiality towards friends and associates, not blood relatives.

State enterprises are run for the benefit of the public and to be properly administered they require com­petent people. It is not that every relative or friend is incompetent or unsuitable but unfortunately it is often the case that it is the very people who lack skills to make a proper career elsewhere turn to politically influential people to “fix them up” in a job. This was a defining characteristic of the previous regime and it is important that the new Government breaks from the bad practice of the past.

As a matter of principle all appointments from the most junior to the level below the CEO should be based on merit and subject to a standard selection pro­cess, exams and interviews. (For appointments to the Board and the CEO refer the box on the Organisation for EconomicCo-operation and Development (OECD) guidelines. It would not matter if a relative or a friend is appointed, provided they go through the standard selection process and are selected purely on merit.

If the staff is appointed on the basis of merit there should be no requirement for a change of personnel when a Government changes, which will give some continuity to policy. The Ceylon Electricity Board (CEB) and the Colombo Stock Exchange (CSE) have main­tained a degree of independence in this regard.

We also need to frame this debate within the wider sphere of governance of state enterprises, and not simply focus on the appointment of directors. The OECD has published a set of guidelines that give con­crete advice to countries on how to more effectively manage their responsibilities as company owners, thus helping to make state-owned enterprises more competitive, efficient, and transparent.

These guidelines represent an ideal and implementing them in-toto overnight may not be practically possible due to political trade unions and entrenched political appointees.

The OECD Guide comprises six sections:

I. Ensuring an Effective Legal and Regulatory Framework for State-Owned Enterprises

II. The State Acting as an Owner

III. Equitable Treatment of Shareholders

IV. Relations with Stakeholders

V. Transparency and disclosure

VI. The Responsibilities of the Boards of State- Owned Enterprises

The most important points from this are discussed below. It is advisable that the Government adopt a comprehensive framework to SOE governance. It will undoubtedly improve performance and maintain the confidence of the public.

I. Ensuring an Effective Legal and Regulatory Frame­work for State-Owned Enterprises

The legal and regulatory framework for state-owned enterprises should ensure a level-playing field in markets where state-owned enterprises and private sector companies compete in order to avoid market distortions.

A. SOEs should not be exempt from the application of general laws and regulations. Stakeholders, including competitors, should have access to efficient redress and an even-handed ruling when they consider that their rights have been violated.

B. There should be a clear separation between the state’s ownership function and other state functions that may influence the conditions for state-owned enterprises, particularly with regard to market regula­tion. In simple terms, there should be no preferential treatment by regulators for state owned enterprises.

C. The legal form under which SOEs operate should be standardised and allow creditors to press their claims and to initiate insolvency procedures.

D. Any obligations that an SOE is required to undertake in terms of public services beyond the generally ac­cepted norm should be clearly mandated and should be disclosed to the public. Costs related to such activities should also be disclosed. This will prevent abuse such as the funding of election campaigns and tamshas for the minister.

E. SOEs should face competition in funding. Their rela­tions with state-owned banks, state-owned financial institutions and other state-owned companies should be based on purely commercial grounds. This will pre­vent the development of off-balance sheet black holes in public finances.

II. The State Acting as an Owner

The state should act as an informed and active owner. A clear and ownership policy should be present, which explains the objectives of ownership against which performance can be measured.

A. The government should issue an ownership policy that defines the overall objectives of state ownership. It must explain the state’s role in the corporate gov­ernance of SOEs, and how it will implement its owner­ship policy.

B. The government should not be involved in the day-to-day management of SOEs and allow them full op­erational autonomy to achieve their defined objectives.

C. The exercise of ownership rights should be clearly identified within the state administration. Ideally all shareholding by the state should be centralised under one specialised body which will oversee the invest­ments and be held responsible to parliament. This will ensure that proper attention is paid to the manage­ment of investments and consistent policies apply. The body should:

a. Ensure a well-structured and transparent board nomination processes and actively participating in the nomination of all SOEs’ boards. Board nomination should not be the prerogative of the minister alone.

b. Setting up reporting systems allowing regular mon­itoring and assessment of SOE performance. This will enable proper reporting to parliament.

III. Equitable Treatment of Shareholders

The state and state-owned enterprises should rec­ognise the rights of all shareholders and ensure their equitable treatment and equal access to corporate information. This is relevant where the state owns a partial shareholding and ensures that the concerns of minority shareholders are addressed.

An active policy of consultation with minority share­holders, transparency in dealings and facilitating minority participation at shareholders meetings is necessary.

IV. Relations with Stakeholders

The state ownership policy should fully recognise the state-owned enterprises’ responsibilities towards stakeholders and request that they report on their relations with stakeholders.

V. Transparency and disclosure

State-owned enterprises should observe high stan­dards of transparency in the conduct of their affairs. In particular:

A. The entity vested with the state shareholding should develop consistent and aggregate reporting on state-owned enterprises and publish annually an ag­gregate report on SOEs. In Sri Lanka’s case it may also be advisable, additionally, to list all SOEs on the stock exchange. Meeting the disclosure requirements of the Colombo Stock Exchange (CSE) will go a long way to improving transparency.

B. SOEs should be subject to an annual independent external audit based on international standards. The existence of specific state control procedures does not substitute for an independent external audit.

VI. The Responsibilities of the Boards of State- Owned Enterprises

A. The boards of SOEs should be assigned a clear mandate and ultimate responsibility for the company’s performance. The board should be fully accountable to the owners, act in the best interest of the company and treat all shareholders equitably.

B. SOE boards should carry out their functions of monitoring of management and strategic guidance, subject to the objectives set by the government and the ownership entity. They should have the power to appoint and remove the CEO. Note that the minister does not appoint the CEO, it is the board that appoints the CEO.

C. When necessary, SOE boards should set up special­ised committees to support the full board in perform­ing its functions, particularly in respect to audit, risk management and remuneration.

D. SOE boards should carry out an annual evaluation to appraise their performance.