Corporate Governance of Public Enterprises in … · Corporate Governance of Public Enterprises ......

WORLD BANK TECHNICAL PAPER NUMBER 3 3 _ 9 Iqq1b

Corporate Governance of Public Enterprisesin Transitional Economies

Edited by Dominique Pannier

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WORLD BANK TECHNICAL PAPER NUMBER 323

Corporate Governance of Public Enterprisesin Transitional Economies

Edited by Dominique Pannier

The World BankWashington, D.C.

Copyright C) 1996The Intemational Bank for Reconstructionand Development/THE WORLD BANK1818 H Street, N.W.Washington, D.C. 20433, U.S.A.

All rights reservedManufactured in the United States of AmericaFirst printing May 1996

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ISSN: 0253-7494

Dominique Pannier is Senior Public Management Specialist on the Public Sector Management Team inthe Technical Department for Europe and Central Asia, Middle East and North Africa Regions, theWorld Bank.

Library of Congress Cataloging-in-Publication Data

Corporate govemance of public enterprises in transitional economies /edited by Dominique Pannier.

p. cm. - (World Bank technical paper, ISSN 0253-7494; no.323)

Includes bibliographical references.ISBN 0-8213-3636-31. Government business enterprises-Europe, Eastem-Management.

2. Corporate govemance-Europe, Eastem. 3. Government businessenterprises-Management-Case studies. I. Pannier, Dominique,1954- . II. Series.HD4140.7.C67 1996350.009'2'0947-dc2O 96-14997

CIP

Corporate Governance of Public Enterpries in Transitional Economies

CONTENTS

Foreword .............................................................. viiAbstract .............................................................. ixAcknowledgments ............... I ....................................... xiContributors .......................................................... xiii

I. Overview

Corporate Governance of Public Enterprises: The Comparative Experience(Dominique Pannier and Salvatore Schiavo-Campo) .............................. 3Public Enterprise Reform: The Context of Corporate Governance .................... 4

Privatization . .......................................................... 4Competition ........................................................... 4Hard Budgets .......................................................... 4Financial Sector Reforms .............. ................................... 4Restructuring .......................................................... 5

Elements of Corporate Govemance of PEs ...................................... 5Corporatization . ....................................................... 6Selection of an Agent to Represent the State .................................. 9Improving Management of PEs ........................................... 13The Role of Boards of Directors ........................................... 16Performance and Management Contracts ................................... 20Performance Contracts . ................................................. 20Management Contracts .............. ................................... 23

II. Country Studies

Hungary (Marc Stephens) ...................................................... 29Summary .............................................................. 29Ownership and Management Structure of Public Enterprises ...................... 30Organization of APV Rt . .................................................. 30Corporatization and Deregulation ........................................... 31Ownership and Management of Telecommunications, Energy, and Railways .... ...... 32Telecommunications and Postal Service ....................................... 33Lessons and Prospects . .................................................... 36

iii

Contents

Poland (Marion Leblanc-Wohrer) ...................... ......................... 37Summary . ............................................................. 37Organization of State-Owned Enterprises ..................................... 37Institutional Framework for Privatization ..................................... 38Corporate Govemance of State-Owned Enterprises .............................. 38Corporate Govemance of Commercialized Enterprises ........................... 39Corporate Govemance in Specific Sectors ..................................... 41

Romania (Marion Leblanc-Wohrer) ..................... ......................... 45Summary . ............................................................. 45Legal Framework . ....................................................... 45Organization of the State-Owned Enterprise Sector .............................. 46Institutional Framework for Privatization ..................................... 47Organization of Corporate Governance ...................................... 48Management Contract for Commercial Companies and "Regies Autonomes" ...... ....... 50Corporate Governance in the Energy Sector ................................... 52

Russia (Irina Starodubrovskaya) ...................... .......................... 57Summary . ............................................................. 57Background . ........................................................... 58Representation of the State's Ownership Interests ............................... 59Corporatized and Noncorporatized Sectors:

Types of State-Owned Enterprises and Forms of State Participation in Ownership .... 61Natural Monopolies and Crisis Sectors:

Practical Experience with Public Regulation ................................. 66Lessons and Prospects .................................................... 69

Ulaaine (Lev Freinkman and Arshad Sayed) .. 71Summary . ............................................................. 71Corporate Governance: Institutional Arrangements ............................. 72Recent Resolutions Concerning Corporate Governance of SOEs ..................... 72Corporatization and Privatization ........................................... 73Governance of Majority State-Owned Enterprises ............................... 74

III. Illustrations from Developed Market Economies

International Trends in Public Enterprise Policy (John Nellis) ......... .. .............. 83

Relationship between Owners and Management- Commercial Utilities ..... .. ........... 89The Case of the German Railway (Frank Matthias Ludwig) ....................... 90The Experience of France Telecom (Girard MAoine) .............................. 95The Experience of France in Gas and Electricity (Jean-Pierre Pery) ................. 101Corporatization of Public Enterprises in New Zealand (Richard William Prebble) ...... 104

iv

Corporate Governance of Public Enterprises in Transitional Economies

Relationship between Owners and Management Declining industries .................. 107The Case of British Steel (Ronald Halstead) ................................... 108The Experience of the French Coal Industry (Jean-Pierre Pery) .................... 113

Establishing Effective Oversight over Public Enterprises ............................. 119The Role of Boards: The Case of Canadian Railways (Brian R.D. Smith) .... ......... 120Selection and Removal of Managers:

The Experience of British Steel (Ronald Halstead) ............................ 127

ANNEX A - Corporate Governance of Public Enterprises in France(Marion Leblanc-Wohrer) ............ ............................. 133

ANNEX B - Holding Companies: The Case of Austria (Oskar Gruinwald) .... ......... 141

Bibliography . .............................................................. 145

Boxes

1. Performance Contracts in China ....................................... 152. Drafting Performance Contracts With State Enterprises: An Illustration .... ..... 223. Management Contracting in Poland and Romania .......................... 244. AV Rt's Structure and Function .315. Comercialization .406. Proposal by the Ministry of Privatization to Create a Ministry of Treasury .417. Special Supervisory Mechanisms .468. Are "Regies Autonomes" Necessary? .499. Necessary Steps to Turn the State Railways into a Public Limited Company .93

10. France Telecom Group in 1994 .9911. France Telecom Today: New Structures ........ ........................ 10012. British Steel (Industry) Ltd. BS(I) ........... ........................... 11213. The French Economics and Social Development Fund (FDES) ..... ........... 11414. Corporate Governance of State-Owned Enterprises in Canada .... ........... 126

v

Corporate Governance of Public Enterprises in Transitional Economics

Foreword

The reform of the public enterprise tered, corporate governance can help tosector is at the heart of structural implement financial discipline and improvetransformation in transitional economies. performance. As a monitoring andWhile the basic direction of reform is to controlling device it can help introducedivest the state of enterprise ownership, a transparency and accountability.number of enterprises are likely to remainin the public sector for an indefinite period This volume is an outcome of anor while awaiting privatization. With the international workshop on Corporatedisappearance of the former system of direct Governance of Public Enterprises, attendedcontrol from the center and the lack of by policy makers from transitionaladequate alternative systems suited to a economies and experts from developedmarket environment, the management and market economies, organized in Octobercontrol of enterprise assets - corporate 1994 in Prague by the Public Sectorgovernance - has emerged as a key issue. Management Team of this Department. TheA comprehensive strategy for public volume highlights the corporate governanceenterprise reform should include the five options available to governments and the"external" reform elements of divestiture, conditions for success in establishing thehard budgets, competition, distancing of the balance between shareholders' control andenterprise from the government, and managerial autonomy. It compares andfinancial sector restructuring. Corporate draws lessons from the varied experience ofgovemance is an important complementary transitional economies, includes exampleselement, particularly in the transitional from developed market economies and aimseconomies where other checks on the to provide practical policy recommendationsbehavior of enterprise managers are not yet to policy makers and enterprise reformadequately developed. If properly adminis- practitioners.

Anil SoodDirector, Technical Departmentfor Europe and Central Asia,Middle East and North Africa Regions

vii

Corporate Governance of Public Enterpries in Transiffonal Economies

Abstract

Privatization has been the basic transitional economies: the process ofdirection of reform in transitional corporatization; the choice of governanceeconomies. In implementing this process, structure; improving management; the rolehowever, policy makers overlooked the of boards of directors; and the advantagesproblems of the remaining public and limitations of performance andenterprises, mainly public utilities and management contracts. Chapter II describesnatural resource-based industries which the corporate governance regime in the fiveoften include declining industries. This countries of the sample: the extent andvolume draws lessons from the contrasting content of the residual public sector; theexperience of five large transitional legal and institutional framework foreconomies (Hungary, Poland, Romania, corporate governance; and illustrations fromRussia, Ukraine) in corporate governance of the power, railways, coal, telecom-public enterprises, i.e. their management and munications and postal sectors. Chapter IIIoversight. Relevant experiences of deve- contains relevant corporate governanceloped market economies are included. experiences from developed market

economies: state asset management inThe volume's first chapter provides an Austria and New Zealand; railways in

overview of the main dimensions of Canada and Germany; energy, coal andcorporate governance of public enterprises, telecommunications sectors in France; andwith reference to actual experience in steel in Britain.

ix


Acknowledgments

The editor is grateful for valuable Several of the papers were presented incomments provided by Wafik Grais, Russell preliminary form to the World BankMuir and John Nellis, and for the constant Seminar on Corporate Governance of Publicsupport of Salvatore Schiavo-Campo. I Enterprises in Transitional Economies,would like to thank Arshad Sayed and P.K. Prague, October 1994, organized by theSubramanian for their editorial assistance. Public Sector Management Team of the

Technical Department for Europe andThe country studies have been prepared Central Asia. All these papers were

under the editor's direct supervision. revised, partly benefitting from theAssistance was provided for Hungary, by discussions at the seminar, and updated asKrisztina Kiss, Tamas Markus, Ilham necessary to November 1995.Zurayk; for Poland, by RachidBenmessaoud, Christian Duvigneau, Yves Geoffrey Lamb supported theDuvivier, Mario Reyes-Vidal, Enn Vasur preparation of the 1994 seminar, Anil Sood(World Bank); for Romania, by Ileana chaired the seminar, and Lynette Alemar,Ionescu (Alternate Executive Director), Muriel Darlington, and JosephinePatrick Tardy, Maziar Minovi, Akin Onwuemene assisted in organizing it.Oduolowu (World Bank); for Russia, by Lynette Alemar, Celestine Collins andElvira Nabiulina (Ministry of Economy of Brigitte Franklin processed the variousthe Russian Federation); for Ukraine, by drafts of the volume.Veronique Bishop, Bernard Drum, AnaGoshko, Peter Kyle, Lazlo Lovei, ThomasTill, Jonathan Pavluk (World Bank).

xi

Corporate Govemance of Public Enterprises in Transitional Economies

Contributors*

Lev Freinkman, Economist, Russia Country Dominique Pannier, Senior Public SectorOperations, World Bank Management Specialist, EMTPM, World

BankOskar Grunwald, Member of the Board and

former Chairman, Austrian Public Jean-Pierre Pery, Deputy Director,Holding Company Directorate for Gas, Electricity and Coal,

French Ministry of IndustryRonald Halstead, former Deputy Chairman,

British Steel Richard William Prebble, former Minister ofState Owned Enterprises, New Zealand

Marion Leblanc-Wohrer, Consultant, PublicSector Management Team, Technical Arshad Sayed, Consultant, EMTPM, WorldDepartment for Europe and Central Asia Bank(EMTPM), World Bank

Salvatore Schiavo-Campo, PrincipalFrank Matthias Ludwig, Head of Transport Economnist, EMTPM, World Bank

and Company Policy, DeutscheBundesbahn Brian R.D. Smith, Chairman of the Board of

Directors, Canadian RailwaysGerard Moine, Director, Office of the

President, France Telecom Irina Staro d ubro vskaya, Economist, MoscowResident Mission, World Bank

John Nellis, Senior Manager, Private SectorDevelopment Department, World Bank Marc Stephens, Economist, EMTPM, World

Bank

* Titles and affiliations as of the time of writing.

xiii

I.

OVERVIEW


Corporate Governance of Public Enterprises:The Comparative Experience

Dominique Pannier and Salvatore Schiavo-Campo

This volume reviews the general issue comprehensive governance policy for PEsof corporate governance of public has rarely been adopted.enterprises (PEs), i.e., the framework formanagement and control, with particular A number of enterprises will remain inreference to transitional economies in public hands in the long run (the "residual"Eastern Europe and the former USSR. In public sector). The actual content of thethese economies, where the former structure residual public sector varies betweenof direct state controls on PEs collapsed but countries, and is expected in any case towhere indirect and market-based shrink over time. (Currently, the residualmechanisms are nascent, improving public sector includes some utilities, so-corporate governance is essential. called strategic industries and some natural

resource-based industries.) Other enter-In these economies, the basic direction prises, although slated for privatization, will

of reform has been to privatize quickly and still be in the public domain for years tobroadly. In doing so, policy makers come, because of the complexity of theoverlooked the problems of the PEs that process. Typical cases are the coal andwould remain in government hands, for four metal producers which underpin thereasons. First, there was an expectation that economy of entire towns or regions. Thismost enterprises would be privatized volume covers the corporate governance ofquickly. Second, the importance of PEs which will remain in public hands forimproved PE performance for the implemen- the foreseeable future. Public enterprisestation of the reform process was not well which are to be privatized in short order,understood. Third, when it was recognized those in the financial sector and the issues ofthat PEs would continue to remain a state minority shareholding are not coveredsubstantial and important part of the here. Minority private shareholding in PEseconomy, the state lacked the capacity to is rare in the transitional economies.foster better performance by PEs. Finally, itwas often considered that attention to better In order to provide a summary usefulmanagement of public enterprises would to readers unfamiliar with the issues, thisweaken the privatization effort. A first chapter compares across countries the

3

Corporate Governance of Public Enterprises: The Comparative Experience

key elements of corporate governance and by and large, the material presented in thisincludes some fairly basic considerations, volume was current as of November 1995.)well known to specialists in this area. The The final chapter provides illustrations fromsecond chapter consists of five case studies: the experience of developed marketHungary, Poland, Romania, Russia and economies, especially in the utilities andUkraine. (It must be noted that the situation declining sectors.is continuously evolving in many countries;

Public Enterprise Reform:The Context of Corporate Governance

PE reform comprises both "internal" and Competition not only compels better"external" measures. While corporate performance but also enables an assessmentgovernance consists of "internal" reforms of the enterprise's efficiency relative tothat directly affect the management and competitors.control of assets, for the sake ofcompleteness, we summarize below very Hard Budgetsbriefly the role of the "external" measures.The key consideration here is that This has been one of the most difficultimprovements in corporate governance are issues to tackle in the transitional economies.an essential complement to external reform Enterprise restructuring programs havemeasures, and a part of PE reform rather often stalled because PEs have had access tothan a substitute for it. subsidies and privileges, have been

permitted to accumulate tax arrears, or havePrivatization obtained other soft financing that enabled

them to survive without improvingBy privatizing public enterprises, efficiency. Recent successful reforms in this

economies can gain in many ways: reduced area have aimed at eliminating, or at leastpolitical influence on the management of the lowering, subsidies and transfers,enterprise, transfer of risk to the private particularly operating subsidies. Theowners providing powerful incentives for Central European countries in particularefficiency gains, reduced wastage, etc.' have taken important steps toward the

imposition of hard budget constraints. ForCompetition example, budgetary subsidies to SOEs were

sharply reduced in Poland after 1990 and inCompetition can be fostered through the Czech Republic after 1991, and both

the removal of price controls and entry countries (as well as Russia) have moved tobarriers, liberalization of foreign trade, curb access to soft credits.abolition of unnecessary regulation andbreak-up of monopoly structures. Financial Sector Reforms

Hard budget constraints cannot beimplemented unless banks stop providing

See the bibliography for references to divestiture subsidized credit or automatic rollovers.and the other external measures.

4


Financial sector reforms in the transitional Corporate governance is an enablingeconomies have included improving condition that can reinforce the externalsupervision and regulation, reducing reform measures summarized above. Itdirected-credit programs and direct helps enforce financial discipline; enables thegovernment control over financial injection of transparent rules and proceduresintermediaries, reducing interest rate instead of direct and personal interventions;controls, and similar measures designed to and protects public assets from unduestrengthen the capacity of the financial "appropriation" by insiders. Spontaneoussystem to allocate capital on an economic "appropriations" of state assets by groupsbasis. often dominated by the former

nomenklatura generate resentment whichRestructuring reduces the credibility of the entire reform

process. Improved corporate governance isDownsizing loss-making enterprises and particularly important in the transitional

restoring their viability is an important part economies because other measures thatof any sound PE reform program. This is a provide checks on the behavior of managers,complex task, particularly concerning the such as rating companies, brokers, financialneed to partition the social assets from the investors that assess the performance ofcommercial assets. Generally, the following enterprises, and the capital market are yet tomeasures have helped: develop.

* hiving off competitive businesses from Better corporate governance involvesthe public goods core; strengthening or developing institutions,

* privatizing and spinning off functions enacting regulations, building administrativenot central to operations (such as con- and monitoring capacity, and politicalstruction and equipment subsidiaries); support. All of these actions require efforts

* separating the policy and regulatory and direct costs. Good sense and thefunctions from operational functions; overwhelming weight of evidence indicateand that these costs are justified.

* breaking up monopolies into smallercompeting units.

Elements of Corporate Governance of PEs

As noted, "internal" improvements in the state; management improvements; thecorporate governance are an essential part of role of board of directors; and performancethe PE reform process and an adjunct to the and management contracts. Each section"external" reform measures. The principal contains a list of concrete conclusions.dimensions of corporate governance reform, Many of these conclusions rest on variousdiscussed below, are the process of corpora- considerations and experiences additional totization; selection of an agent to represent those summarized in the section in question.

5


Corporatization Deutsche Bahn AG, which operates undernormal corporation law (although the state

The General Issue remains the only shareholder). The changehas reduced the financial burden of the

In transitional economies, the state has railways on the federal budget. In France,inherited a situation where the distinction telecommunications were run by the Generalbetween the roles of owner (principal) and Directorate of Telecommunications in themanager (agent) was blurred, and this has Ministry of Post and Telecommunicationscontributed in large measure to the poor (PTT). The directorate was transformed inperformance of PEs. Therefore, separating July 1990 from an administrative departmentthe identity of the owner from the agent - within a ministry into a public, corporatizedcorporatization - is the first step in quasi-company functioning in a competitiveimproving corporate governance arrange- environment - France Telecom - with thements. financial autonomy essential to adjust to

changing economic conditions."Corporatization" is the setting up of an

independent legal entity for the enterprise, For the transitional economies, whereseparate from the identity of the state as the corporation as an ownership andowner. Corporatization usually involves management structure is quite new,commercialization of activities so that public corporatization of state enterprises offersenterprise operations are governed by even greater benefits. First, it can helpcornmercial law like private enterprises. clarify the ownership of enterprises,(Nevertheless, in many transitional establish clear title, and sort out the web ofeconomies, PEs are exempted from relationships among enterprises, theircommercial law.) Generally in transition subsidiaries and ministries - a necessaryeconomies, "joint-stock companies" have first step toward hardening the budgetemerged as a common form of corporate constraints. Clear title also gives the ownerorganization. power to dispose of assets, and initiate

partial or full privatization. As such,Both developed and transitional corporatization has often been used as a first

economy experience show that cor- step toward privatization.poratization carries important benefits. Invirtually all cases, the net result of the Furthermore, corporatization providescorporatization is an increase - sometimes different sets of opportunities in differentvery large - in the efficiency of allocation countries. In countries like Hungary, whereand utilization of the country's economic during the socialist period the state cededresources. In the developed market- many of its rights over the enterprises toeconomy countries, corporatization of public insiders, corporatization is being used toenterprises has been a major step in regain control from enterprise managers,improving corporate governance, as shown while in the former Czechoslovakia, wherein the cases of the Canadian Railways, the state managed during the socialistBritish Steel and New Zealand described in period to retain direct control,Chapter III. In Germany, for example, the corporatization is being used to providerailways which were historically managed enhanced autonomy and to defineby a federal authority were transformed by responsibilities for the management ofGovernment in 1994 into a company, enterprises.

6


Country Experiences and the 1988 Business Enterprises Act thatregulate the formation and operation of

As noted, and to be discussed in detail most business entities. In Hungary, thein Chapter II, the first step in transitional passage of the 1988 law resulted in a waveeconomies was to quickly corporatize public of manager-initiated restructuring ofenterprises. This, in turn, was supposed to enterprise assets. That law gave managersencourage privatization and the the right to reorganize all or part of theirparticipation of foreign investors. In most enterprise into a limited liability company.cases, corporatization has involved the As a result, managers often transferred thecreation of incorporated companies. best of the enterprise assets into commercialExceptions include the creation of bifurcated companies and proceeded to distributesystems of incorporated companies and non- shares in these companies. State officialscommercial entities, calledregies autonomes lost control of the process and were unable(autonomous holdings) in Romania and to keep track of the ownership structureskazenny in Russia. put in place by the managers. In March

1990, the Hungarian government created theIn Poland, in late 1990, the Government State Property Agency (AVU) to put a stop

embarked on a comprehensive corporatiza- to this chaotic period of company creationtion and privatization program. The Privati- and share shuffling. AVU took control ofzation Law of July 1990 created the Ministry about 1,900 of the roughly 2,000 mediumof Privatization (MOP) to represent the state and large PEs; the rest remained with thetreasury in exercising ownership. The MOP sector ministries and municipalities. By endwas responsible for transforming state 1995, almost all enterprises in which theenterprises into commercialized enterprises. state retains a share have been corporatized.In the newly established joint-stockcompanies, all shares were taken over by the In Romania, the process of enterprisestate treasury. This method, called capital reform started in 1990, soon after theprivatization, was aimed at large and viable revolution. By mid-1991, the corporati-enterprises, henceforth submitted to zation of state-owned enterprises wascommercial law, for which the Commercial complete, resulting in two types ofCode of 1934 was revived. Corporatization enterprises: the regies autonomes (RAs),in Poland was essentially viewed as a means which are natural monopolies or publicfor improving corporate governance before services deemed essential for nationalprivatization and to address the problem of security and welfare, and the commercial"spontaneous privatization." The virtual companies, which were supposed to beveto power given by the law to the privatized. While the new Company Lawemployees was overcome by tax savings and provides a regulatory framework for theother incentives offered by the government. establishment, management and liquidationAnd so, despite its other benefits, of commercial companies, it is not applicablecorporatization in Poland resulted in to the RAs. As of August 1994, there werepractice in softening the budget constraint of about 400 RAs. Of these, it is expected thatthe PEs. 44 RAs of national importance will remain

under direct central state supervision, whileHungarian PEs operate within a fairly supervision over the remaining RAs is

comprehensive, market-oriented legal being devolved to local authorities. Whileframework, including the Insolvency Act all RAs are assumed to remain in the public

7


sector, their commercial activities are being railway worker. In addition, the Railwaysspun off into commercial companies. Some offered generous redundancy payments to6,300 commercial companies were surplus workers - 90% of whom acceptedincorporated in 1990-91 and are now slated voluntary redundancy. These highfor privatization. redundancy payments overcame the

resistance of workers' councils; and once theIn Russia, enterprises in which the state workers themselves favored corporatization,

retains a stake fall inlto two main categories: the union's opposition ended. In fact, incorporatized and non-corporatized. The every single case, it was opposition byformer consists of joint-stock companies senior management which proved to be thewholly-owned by the state, as well as biggest barrier to corporatization.corporations in which the state retainsmajority shareholding or a controlling right Similarly, the changes in the French(golden share). In the latter, enterprises are telecommunication industry were at firstmostly controlled by line ministries. In perceived as a veritable cultural revolution.addition, a new legal form, the kazenny, or In view of the very close links between the"governmental plant," has been introduced French postal service and France Telecom, itfor a restricted range of the non- appeared impossible to change the status ofcorporatized sector. The kazenny maintains France Telecom without affecting the postalthe old governance pattern of multiple service. Reform of this sector, therefore,principals and thus provides openings for included not only the 150,000 employees inmanagement to resist privatization, sidestep telecommunications but a total of 500,000supervision and avoid a hard budget civil servants. Thus, it was necessary toconstraint. bring the public, customers and employees

together to discuss the problems of theOvercoming Resistance sector as a whole and to consider future

directions. A wide-ranging internal andIt is often thought that resistance to external debate took place within France

corporatization, particularly by workers, is a Telecom and society at large regarding themajor stumbling block. In practice, future of the postal and telecommunicationsexperience from developed market-economy services. Negotiations took place with thecountries suggests that internal resistance to unions, an intensive public informationcorporatization can be overcome by campaign was implemented, andappropriate "change management." The corporatization plans were modified toNew Zealand case, for example, shows the incorporate the ideas expressed. Ultimately,importance of direct and open the process resulted in the creation of acommunication with workers. Prior to state-owned quasi-corporation, and theevery corporatization, company manage- modification of the regulatory framework.ment invariably warned the government ofanticipated resistance from unions. The In the case of the transitionalresistance, however, never materialized economies, another major difficulty has beenbecause the government effectively the reluctance of the sector ministries. Sincecommunicated to workers the reasons and the enterprises were considered as anbenefits of the corporatization process. In appendage of the ministry, it has beenthe case of the corporatization of the New difficult to make the ministries acceptZealand railways, the Minister of State- corporatization, with an indirectOwned Enterprises wrote directly to every accountability relationship and protection

8


from interference, because of loss of power Also, governments should avoid sector-and influence over the enterprises. The specific schemes; corporatize alladoption of hybrid approaches to enterprises or commercial undertakingscorporatization such as the kazenny or the that remain in state hand; and setregies autonomes, is a manifestation of that mandatory guidelines for the wayresistance. To ensure smooth implemen- corporatization is prepared by thetation of the corporatization process, sector enterprises; andministries with a vested interest in blockingcorporatization have either been removed * ensure open communication andfrom the process (as in Ukraine), or the credibility. Disseminate informationprocess has been managed by an about corporatization and its benefits,independent body (as in Hungary). In particularly to the employees. MonitorUkraine, at first, corporatization was top- closely reluctant enterprise managers,down and initiated by the sector ministries. forcing them to join the process or toSince the ministries were also the founders resign.of the joint-stock companies, they couldeasily block or delay the process. Selection of an Agent to RepresentRecognizing this problem, a November 1994 the Statedecree abolished the Ministry of Economy'scorporatization program and entirely Establishing appropriate oversight hasremoved sector ministries from the been difficult for four reasons: (i) the endcorporatization process. result of corporatization was meant to be

quick privatization; (ii) the credibility andConclusions authority of the state was low; (iii) former

branch ministries have sought to keep theirThe experience reviewed in Chapters II influence over the enterprises; (iv) lack of

and III suggests, among other things, that experience in corporate legislation. Thesethe following measures can help ensure the are the main reasons for the hesitancybenefits of corporatization: observed in the transitional countries, and

explain the unclear mandate and overlap-submit the enterprise to commercial ping responsibilities of the agencies inlaw. Submission to commercial law charge of state property.will underline the business orientationof PEs. Commercial law should include The General Issueprovisions on bankruptcy wherepossible. The threat of bankruptcy will The state has basically two roles withsend the right signal to PEs, implying regard to PE, as "sovereign" and as "owner."that the government will not In its "sovereign" role the state has the sameautomatically bail them out; rights and obligations with respect to PEs as

it has vis-a-vis private enterprises. For* establish one corporate form. Govern- example, monetary and tax policies are

ments should avoid hybrid solutions equally applicable to public and privatesuch as the kazenny, which enterprises. However, as "owner," theundermine the key objective of government also has to ensure that society'scorporatization of distancing the welfare is maximized from the investmententerprise from politcal influence. and operations of the PEs. When the PE

9


takes the legal form of a corporation, the Commercial companies still in public handsfunctions of the state as owner are similar to are 70% owned by the State Ownershipthose exercised by shareholders acting Fund, established as a public body in 1992.collectively. The main choice that govern- This fund is required to divest itself of itsments have faced in exercising their owner- holdings over seven years. To prevent aship rights has been between a public concentration of ownership and encourageorganization and a private arrangement such privatization, the remaining 30% has beenas a management contract. divided among five private ownership funds

established as private organizations.Country Experiences

Some similarities are noticeable in theMost transitional economies have opted Russian case, where non-corporatized

for a public semi-autonomous agency to enterprises, including kazennys, are placedrepresent the state. under the authority of the relevant sector

ministry. By contrast, the Russian FederalUntil 1995, Hungary experienced the State Property Committee (GKI) holds the

coexistence of two organizations, a public enterprise shares, both those which are to beagency and a holding company. The sold and those which are to remain in publicrationale was to have one organization to hands. Although the GKI has a pivotal rolehold the shares of companies to be in privatization as well as in managingprivatized, and a separate organization to public enterprise assets, its powers aremanage the enterprises in which the state limited in the latter case by the competingwanted to retain full or partial ownership. responsibilities of sector ministries. ForThis division of responsibility failed, due example, GKI approves the standard charterlargely to the successive expansion of the of state-owned enterprises and the modeloverbroad definition of residual public contract with enterprise managers.sector ("enterprises with economic-strategic, However, specific charters and managerialnational economy or other important contracts are approved by sector ministriesinterest"). The privatization law of May 1995 which are also responsible for appointmentreduced the minimum public participation and dismissal of managers. In the case offrom 50% to 25%, and merged the two minority state shareholding, another agency,organizations. Accordingly, the focus of the the State Property Fund, acts as the owner.unified agency has shifted towards If a federal state-owned enterprise isprivatization, and the divestiture of assets considered insolvent, state representation isnow takes priority over conservation of transferred to the Federal Bankruptcyassets. Agency.

In the case of Romania, due to the fact The most significant innovation in thisthat two types of public enterprises have field occurred in 1995. Through abeen created (commercial companies and September decree, a loan-equity swapregies autonomes), a proliferation of undertaken to reduce the Russian federalinstitutions with oversight responsibilities budget deficit authorized banks and localhas emerged. Re'gies autono mes of "national and foreign investors to manage state sharesinterest" are directly overseen by the in certain enterprises in exchange for majorrelevant sector ministry, but other ministries loans to the state. This measure allows theare also involved, in particular the ministry state to retain ownership of the shares.of finance, blurring lines of accountability. However, ownership of the shares will be

10


transferred to the banks and the investors if routinely supported Air New Zealand'sthe state defaults on the loans. The right to expansion plans. Second, there was amanage the shares is to be allocated by shortage of business skills in thetender and the amount of the loans and the government and thus effective control wasconditions and guarantees are to be diluted. In response, the government set updetermined by the successful bidders. a single asset-management agency that was

close to, but separate from, the Treasury.In Poland, a centralized unified scheme The agency concentrated on the

was created in 1990, when the newly shareholders' role, and hired staff withestablished Ministry of Privatization took business skills who learned to identify earlyover the representation of the State Treasury signs of failure. Because the agency(the legal owner). Since then, the Ministry monitors many enterprises, it is able to takehas experienced difficulties in asserting a national overview of all the corporations,authority over enterprise managers who and has so far been very successful.have taken advantage of the persistentinvolvement of numerous government The Holding Company Alternative:departments. Thus, in 1994, the Ministry of Small Benefits and Large DrawbacksPrivatization proposed a draft law creatinga new agency, the Treasury, in order to Although envisaged by some countriesdistinguish regulatory functions from like Ukraine, Russia and Kazakhstan (see"operational" ownership functions. The below), the transitional economies have soMinistry would retain its regulatory and far avoided the holding company scheme.policy role. The Treasury would implement The model of Austria in the 1970s is thegovernment policy concerning management reference for the holding company. Itof public enterprise assets, as well as the consists of creating a corporation to hold thetransfer of ownership to private investors. state's shares in public enterprises andThe operational arm of the Treasury would manage the enterprises. The goals of thebe the specialized regional agencies which Austrian government were to:would manage assets on behalf of the StateTreasury, and directly supervise state owned * distance state-owned enterprises fromenterprises. These regional agencies would politics and increase continuity;have a board and a supervisory council. * establish a financial rationale;

* insure greater professionalism, andExperiences in Romania, Russia, * improve the controlling system.

Ukraine and elsewhere have proven that themain reason for opposing a uniform Among transitional economies,organizational arrangement has been the Kazakhstan has followed the holdingattempt to maintain old pattems of personal company route on a large scale. On therelationships with sector ministries. Among basis of June 1992 legislation, themarket-economy countries, New Zealand government created 83 state holdingtried giving the exercise of ownership rights companies between September 1993 andto ministries. However, this was a failure June 1994. These holding companies in turnfor two main reasons. First, the enterprises controlled 1,573 enterprises, most of themin effect captured the monitoring agency. sector-based and created from existingFor example, the Ministry of Civil Aviation structures such as branch ministries.

11


The holding companies were intended subsidies. It is doubtful whether combiningto address two major governance problems. the governance function, financial andFirst, they were intended to control commercial activities within the same entityperceived abuses by directors of state will promote efficient downsizing.enterprises, who in 1991 had been given theright to sell, lease and transfer assets of their The holding company does notcompanies. Second, they were intended to generally appear to be a satisfactory modelbe an intermediate layer between the for the organization of state assetsgovernment and the state enterprises, thus management, and certainly not inreducing operational interface with transitional economies, where thoseministries. However, in practice, the responsible for protecting the autonomy ofholding companies themselves were not the enterprises are closely related to thesubject to effective governance by the state, sector ministries that used to own theresulting in lack of accountability. enterprises. Furthermore, once created,

holding companies become very difficult toSupervisory boards did exist in most disband. Intemational experience points to

cases, but were composed of employees the longevity of both the holding companiesfrom governmental agencies and had little and their subsidiary enterprises, due to theirimpact on the management. Ministerial capacity to bargain and sustain the flow ofinterference in enterprises continued, as the govermment subsidies. The best knownholding companies executives were mostly example is the Italian state holdingformer ministry officials, and the line company, IRI. IRI had the statutoryministries used their allies on the boards of obligation to dismantle itself within fiveenterprises to interfere with operations. The years of its start in 1948. This statutoryholding companies did not govem the obligation did not prevent it from becomingsubsidiary companies on the basis of market one of the largest industrial conglomeratescriteria. Rather, their activities centered on in Italy over the next 40 years.controlling competition, and obtainingcapital and production inputs. Holding Conclusionscompanies were often used for providingcross-subsidies to enterprises that would The following conclusions emerge fromotherwise fail. The law has stipulated, that transitional economy experiences and thestate holding companies are to be practice in developed market economies.transitional structures (indeed, the Governments should "invest" in a centralprivatization in 1994 included many public agency mandated to manage state'ssubsidiaries of holding companies). residual ownership. This agency wouldHowever, there are pressures from various serve as the government's operational armstakeholders to prolong their existence. and specifically would:

In a variant of the holding company * be responsible for the oversight ofmodel, in the Russian coal sector, a state- every public enterprise;owned company (ROSUGOL) has beenestablished to manage state shares in coal * not take the form of a holdingmines and former production associations. company. However, it may be feasibleBut ROSUGOL also carries out various other to create holding structures foractivities such as consulting, diversifying in managing decline in specific sectors forother economic sectors and distributing a limited time with appropriate

12


accountability safeguards and an of PEs: (i) retrain existing managers;irrevocable sunset clause (following the (ii) increase the stock of managers;German example of the (iii) improve selection from existingTreuenhlandtstalt); managers; (iv) evaluate and reward or

penalize accordingly. Human resource* delegate as many operational tasks as development and training issues are outside

feasible to private contractors or the scope of this volume. We focus belowspecialized entities; on the latter two issues: selection and

performance evaluation.* not be in charge of regulatory activities

in order to avoid conflicts of interest. Selection of ManagersThe regulatory function should bevested in separate agencies; In selecting managers there are three

common problems: (i) entrenched relation-* preferably be separate from the ships leading to bias in selection; (ii) lack of

department which decides upon objective performance measurement; andfinancial transfers to public enterprises (iii) opaque selection processes. It is(e.g. Treasury or Ministry of Finance), essential to note that in all countriesalthough it must develop a close governments exert substantial influence inrelationship with that department. the appointment or removal of managers of

PEs. In the UK, for example, the Minister ofImproving Management of PEs Industry was directly responsible for

appointing the chief executive and executiveThe General Issue directors of British Steel, before its

privatization. In France, the government "deFor PEs, survival in the transition and facto" appoints the chief executives of Gas of

success in an emerging market economy will France and Electricity of France, bylargely be determined by how well and fast requiring Board members to vote for athe enterprises adapt to changing conditions. particular chief executive officer. While theIn turn, how well they adapt will depend governments should and will have some saygreatly on the skills of top managers. in the selection process, it is clear that theWhile some managers are indeed making more transparent and objective the process,the changes required to pursue new the better are the chances of matchingbusiness opportunities, many others are managers with the requirements of thecontent to hold on to their positions. enterprise.

The increased autonomy acquired by One way to distance the governmentmanagers of former socialist public from the enterprise and thereby "loosen" theenterprises, coupled with lack of market links between governments and managers isindicators or enforced accounting standards to create boards of directors and have theto measure enterprise outcomes, makes it boards select the managers (the role ofextremely difficult to judge their boards of directors is discussed next).performance. Arrangements vary. For example, in

Austria, the minister nominates theThere are essentially four non-exclusive supervisory board and participates in the

ways in which to improve the management selection of the state holding company

13

Corporate Governance of Public Enterprises: The Comparahve Experience

management. In Canada, the supervisory good practice is followed in Poland whereboards of the Federal State Holding the managers are selected through a biddingCompany are nominated by the ministries or process for commercialized enterprises inby Parliament, and participate in the sectors open to privatization. Once chosen,selection of the holding company managers are required to restructure themanagement which is appointed by the enterprise to prepare for privatization, andcabinet. A better example of distancing the to add value to the firm. They receive feesgovernment from the enterprise is Germany, and a percentage of the value added to thewhere the management of most public enterprise. This ensures that only capableenterprises is selected by the board, which is managers are chosen, who can take on theappointed by the government; the role of restructuring enterprises with a viewgovernment has the final say only in the to foster privatization.case of disputes over appointments ordismissals. Perfornance Evaluation and Incentives

The selection process of managers in In tackling the issue of performance ofPEs has never been fully transparent in managers three areas need to be addressed:Eastern Europe and the former USSR. (i) performance evaluation; (ii) performanceGovernments have recently begun to adopt information; and (iii) performance incentivemore "open" procedures. For example, in systems.Hungary, the board of directors is appointedby the Privatization Minister, but the Until recently, performance evaluationappointments are screened by a systems were largely non-existent inParliamentary Committee, and six out of the transitional economies. The lack of objectiveeight board members are nominated by measures of management performanceParliamentary groups. Among the inge- meant, obviously, that many non-performingnious ways to ensure a more open process is managers were overlooked and outstandingthe introduction of competition, as has been ones were unrewarded.done in Romania and Poland. In Romania,a law of October 1993 stipulates that, rather Performance information is standard inthan automatically renegotiating contracts most developed countries, and reduces thewith existing managers, contests are to be information asymmetry that exists betweenheld to select managers of commercial insiders and outsiders. Without informationcompanies in which the State holds over performance measurement is baseless.50% of share capital. Invitation for Managers are informed of the criteria byapplications and the selection criteria are which they will be evaluated at periodicpublished in leading newspapers. The rules intervals, either explicitly or implicitly.and eligibility criteria have been well Sometimes norms dictate what kind ofdefined. Nevertheless, many incumbent performance is expected without explicitmanagers have found ways to maintain their agreement. Performance evaluation systemspositions due to their personal connections. are now beginning to add to the quantitativeIn the case of the rigies autonomes, the so- aspects some qualitative aspects ofcalled management contracts are more performance such as employee satisfaction,similar to performance contracts: incumbent customer satisfaction, delivery time, etc. Inmanagers are favored and no formal the transitional economies, both thebidding process occurs in the selection, qualitative and quantitative aspects ofnegotiation and signing of the contract. A performance evaluation have yet to be

14


Box 1: Performance Cortracts in China

China was the first transitional economy to ing the rights to make production decisions,introduce performance contracts. Beginning in 1987, determine prices for outputs and inputs, purchasea variety of contracts were introduced under the goods and materials, make investment decisions, hire"Contract Responsibility System," all of which gave workers, and determine wages and bonuses.managers of industrial public enterprises greatercontrol over enterprise operations in return for Assessing the extent to which these contractsmeeting profit remittance targets. Many contracts have improved performance is difficult. In general,also gave the public enterprises greater autonomy enterprise performance improved, but increasingover sales and permitted managers to grant competition from the non-state sector may have beenemployee bonuses and hire contract workers. In the essential factor. Performance contracts in China,1992 a government directive stipulated that contracts moreover, while providing incentives for goodcould grant managers additional autonomy, includ- performance failed to penalize bad performance.

included in the information systems and of China (see box) is relevant to theprocedures need to be developed that will transitional economies of Eastern Europeallow the flow of information throughout and the former USSR.the organization and to outsiders.

In devising an incentive scheme for PEIn performance setting exercises, the management, the main issues are criteria for

targets and who sets the targets are both enterprise eligibility for the incentiveimportant. If targets are "soft" they will scheme; the categories of personnel thatdefeat the purpose of an evaluation system. should be covered by the scheme; the natureSimilarly, if the targets are set by sector of incentives to be provided; and the sourcesministries with a paternalistic approach, of funds. In Pakistan, the enterprises arethey are unlikely to be optimal. In Russia, graded on the basis of the performancewhere until 1994 relations between the agreement, ranging from excellent to poor.heads of non-corporatized PEs and the Those assessed as "excellent" are entitled tosectoral governing agencies were regulated a bonus of three months' wages,by labor contracts, bonuses were given on progressively decreasing to zero asthe basis of performance indicators almost performance falls to poor . Use should alsoidentical to those used under the socialist be made of non-monetary incentives such assystem. A presidential decree of July 1994 recognition by the government, individualimproved the situation by recognizing the upgrading to board level, integration ofrelations with managers under civil law, management in decisions regardingwith contracts allowing directors to share in remuneration and publicizing both successesthe enterprise's profits and, conversely, and failures.possible replacement of the manager in theevent of losses. Similarly, the so-called In summary, performance improvementmanagement contracts being developed in will require:Romania include performance criteria suchas turnover, profit, import-export balance, * specifying clear rules and enforcementinvestment, and productivity based on the mechlanisms for enterprise performance,previous year's financial performance. through explicit performance orAlthough outside the region, the experience management contracts; developing

15


transparent and publicized performance measures can be adopted in transitionalevaluation systems; conducting and economies:publicizing regular externalcomprehensive audits; and acting * Locate the authorityfor removal in onedecisively in the case of failure; institution, preferably the Board of

Directors;* contracting public managers on a fixed

term, as has been done recently in * Distance the government from theRussia, and evaluating their results managers, to ensure that the managersbefore renewing their contracts; and are unable to seek support from their

"patrons" in the ministries; thus,* improving reporting procedures by ministerial officials should not form the

making them part of the objectives set majority of the Board;for managers and boards or as part ofthe performance evaluation. A good * Improve the stahts of the removalexample is Romania, where under the authzor'ty by enhancing the pay andmanagement contract the manager has prestige of the positions. In Ukraine,to report quarterly to the shareholders there was an attempt to ensure thisthe financial statement and the situation but in the wrong direction.statement of investments. Resolution no. 47 of January 1993,

prohibits salaries of managers fromRemoval of Non-Performing Managers exceeding those of board members,

whereas the right approach would be toTransitional economies have generally raise the pay of board members

been unable to make significant changes in towards that of the managers.key management positions until recently.As will be discussed in Chapter II, in The Role of Boards of DirectorsPoland, the supervisory boards are tooweak; in Russia, many managers of The General Issueenterprise have functioned as if they werethe private owners; in Ukraine, the balance In both public and private enterprises ofof power between the sector ministries and market economies, the board of directorsthe management is tilted in favor of the (BOD) functions as the intermediarylatter; in Hungary, the incumbent managers between owners and managers. It ishave taken advantage of the confusion in responsible for protecting shareholderproperty rights, to appropriate enterprise investments by ensuring managementassets or strengthen their own positions. performance and accountability.

In addition to the obvious need for The state as owner is faced with a basicinformation on performance, it is important choice. It can delegate the control functionto hold managers accountable for their to the board, or, if it considers that boardsactions. Once it has been established that are an imperfect control of full-timemanagers are not performing, and managers, it can establish formal controlappropriate cautions (or, where useful, through performance contracts. Combiningtraining) have been given, the responsible boards and performance contracts isauthority should act decisively. In order to possible; however, the latter will decreaseovercome the problem of collusion, three the authority of the board since the owner

16


involvement will be much greater. In effectiveness of company boards in practicegeneral, the choice between performance depends not only on their structure, but alsocontracts or boards depends largely on the on other factors such as the authority givengovernment's capacity to prepare, monitor by the owner, personalities of the boardand enforce the performance contract, members, size of the boards, frequency ofcompared to its capacity to choose and meetings, and flow of information betweensupport effective boards. the board and the management. There are

no generally valid prescriptions concerningCorporate boards of directors are new these factors, and practices vary.

institutions in transitional countries. It isimportant therefore to see how boards have A number of different models of boardbeen used as governance instruments in the structure and composition have emerged orPE sector. are still emerging in the region. The

widespread adoption of the German modelCountry Experiences in Eastern Europe is explained largely by the

desire to involve workers in companyCountries such as Germany, Hungary, governance because the supervisory board

the Netherlands, Poland and the Ukraine includes members selected by the workers.have a two-tiered board structure. In In Russia, instead, PEs are eithercontrast, France, Italy, UK and the regie noncorporatized and directly overseen byautonoo2es in Romania have unitary board the sector ministry, or joint-stock companiesstructures. In the two-tier system, the in which the state owns a majority orsupervisory board is typically made up of controlling share. In the latter case, a boardnon-executive members appointed by the of directors is established via a standardowner, while the management board is an joint-stock company charter, and includesexecutive entity nominated by the the director general of the enterprise, thesupervisory board itself or jointly with the representatives of the GKI (State Propertyowner. In the unitary system the board Management Agency) and the workers'comprises both executive and non-executive collective and local authorities. The federalmembers. An advantage of the unitary government is prohibited from having asystem is its simplicity and clarity, and majority on the board even when it owns aavoiding conflicts between the two boards, controlling share.which places managers (or owners) in aposition of arbitration. The choice between Under the Polish scheme, most PEsa unitary or a two-tiered board structure have been corporatized as limited liabilitydepends on the characteristics of the country joint-stock companies with a two-tieredand government preferences. board. For each, the Ministry of

Privatization (MOP) appoints a supervisoryTo exercise their functions effectively, board, two-thirds of whom are nominated

all boards have to balance conflicting by the Ministry and one-third by thedemands: exercise their legal responsibility workers. Board members must pass an oralwithout stifling the initiative of the exam given by the MOP and have a higherexecutive; and represent the interests of education degree. This is an interestingshareholders, without being intimately feature of the Polish system which is worthinvolved in the affairs of the company or the considering in other countries. Reportsinternal allocation of responsibilities. The suggest that these supervisory boards are

17


still too weak to exercise real control over order to increase managerial responsiveness.management, as indicated among other In commercial companies boards arethings by the fact that few enterprise abolished once management contracts aredirectors have been replaced. signed; in RAs the boards continue to

function even after the signing of aHungary and Ukraine have also management contract.

adopted two-tiered board systems. InHungary, corporatized PEs have a board of A cursory examination of the waydirectors with the traditional responsibilities boards function in transitional economiesof a management board, and a supervisory reveals a number of common problems,board whose role is primarily advisory,. many of which are typical also of PEs inMembers of the board are appointed by the other parts of the world. The most generalshareholders, APV Rt., or the sector ministry issue concerns the difficulty of establishingin the case of enterprises entirely state- effective control over enterprise managers.owned. The supervisory board members areappointed by the shareholders and the Other factors contribute to the weaknessworkers. In Ukraine, enterprises which are of board control in transitional countries.at least 75% state-owned must form a First, governance structures are evolvingsupervisory council and a board of directors. (with the rules in many cases yet to beT'he council's membership is jointly defined), and capacity is limited.approved by the Ministries of Economy and Consequently, managers retain a great dealFinance, and may include representatives of of leeway within the existing rules, and thethese ministries, the State Property Fund, need to establish boards for thousands offounding agencies, banks serving the PEs has taxed the capacity of governments.company, and employees. The manager of In Romania, for example, only about 1,100the enterprise is the chairperson of the out of the more than 6,000 publicboard of directors. Other members are commercial companies had boards ofapproved by the supervisory council on the directors almost two years after launchingbasis of the chairperson's recommendations, the corporatization program.and are generally drawn from former StateProperty Fund executives. Second, there is a lack of experienced

board members. The legal framework doesRomania has established two different little more than provide a board with

govemance structures for commercial legitimacy to govem. Its real powercompanies and regies autonomes (RAs). depends on the knowledge that directorsCommercial companies have two-tiered possess and their ability to work as a team.board structures, along German lines; Many countries in the transitional economieswhereas RAs have a single board consisting appear to draw PE board members fromof 7-15 directors appointed by sector among current and former govermmentministries and consisting of representatives employees. This can be problematic: publicof the sector ministry, the Ministry of employees do not always have the businessFinance, other sector ministries with an expertise required and may rely on the PEinterest in the enterprise, and on occasion, for political patronage and/or a source ofindividuals with relevant expertise. The future employment.Romanian government has begun toexperiment with real management contracts Third, in many cases, the public ownerfor both commercial companies and RAs in does not provide sufficient incentives for

18


Examples of Board Empowerment in the U.S.

Company Innovation

Dayton Hudson Corporation Requires the outside directors to conduct an annual evaluation of theCEO.

Medtronic Solicits opinions on board procedures by requiring all directors tocomplete a questionnaire; then the full board reviews the results at anannual meeting and tries to make improvements.

Stanhome Developed a formal document that specifies the board's purpose, size,proportion of outside directors, annual calendar, and expectations ofdirectors and management.

Mallinckrodt Separated the roles of chair of the board and CEO.

Lukens Formed a committee of outside directors to study a major acquisitionproposal, hold discussions with management, and recommend actionto the full board.

Campbell Soup Company Designated a lead director with the title of vice chairman.

Monsanto Increased the proportion of the board's time that would be focused onstrategic direction and considered specific capital proposals withinthat framework.

General Motors Developed an explicit set of guidelines that outline how the board willfunction and be structured.

Note: The companies are listed in the chronological order in which they made significant moves towardempowerment. The innovation listed is only one of several changes each board has made. From J. W.Lorsch, "Empowering The Board," Harvard Business Review, January-February 1995.

board members to encourage good government. There is no single best way toperformance. In Russia until 1994, for structure a board. In practice, the situationexample, there were no provisions to in many transitional economies suggests thatcompensate board members for travel and a unitary board is probably preferable. Inother expenses. Moreover, the State any event, the following is needed:Property Management Agency tried todictate board members' positions on most * first, evaluate whether a board isissues, which made serving on PE boards, preferable to the alternatives ofvery unattractive. performance or management contracts,

based on three criteria: (i) the capacityConclusions of the government to set up boards

with real power and accountability;The key objective of creating a board of (ii) the availability of good potential

directors is to ensure an arm's-length board members and; (iii) the size andrelationship between the PE and the nature of the enterprises in question;

19

Corporate Governance of Public Enterpnses: The Comparative Experience

* clarify board objectives. The by-laws must be established to review boardshould establish mandatory responsi- members' performance.bilities for boards, without anyopportunity to delegate. These Performance and Management Contractsmandatory responsibilities shouldinclude among others: reporting on PE Although they are both referred to asperformance, approving budgets, "contracts," performance and managementinvestments, corporate plans, accounts, contracts respond to different needs andselecting or firing managers and have distinct requirements.deciding on compensation for topmanagement. In order to be effective Performance Contractsboard members must have full access toinformation about the enterprises. The General Issue

* give the board adequate authority; Performance contracts are agreementsbetween governments andpublic managers,

* ensure credibility of the board by whereby the government sets strategicpaying a great deal of attention to the objectives and the managers decide onselection process of board members. operational strategy to achieve thoseThe selection process should produce objectives. (Performance contract is usedindependent, competent board here in the generic sense, which includesmembers representing different contract plans, program contracts,constituencies,-predominantly from the performance agreements, memoranda ofprivate sector. In the special case of understanding, signalling systems,PEs belonging to declining sectors, statements of intent and public utilitybank's or creditor's representatives licenses.)should form the majority of boards;

The process of developing performance* help boards organize themselves and contracts is beneficial in itself: it leads to a

provide training wlh ere lacking. dialogue on facts and figures; forces use ofEffective board-functioning depends a common ground to view the problems ofalso on proper internal division of the enterprise; and helps both parties tolabor. This may include the creation of become familiar with the problems of thecommittees such as an audit committee, enterprises. A performance contract is onlysalary review committee (for top an opportunity: it is the proper design ofmanagement), capital investment the contract, an incentive system,committee. Board members may need improvement of information andspecial training in order to not only enforceability which make it an instrumentunderstand the company's financial for improving enterprise performance. Sinceresults, but also outside benchmarks; most contracts are indicative rather than

prescriptive, the probability of success* provide adequate incentives and depends more on the importance both sides

accountability systems. Board attach to delivering on major commitmentsmembers' remuneration must be than on the degree of detail with whichcompetitive with that of enterprises' their relationship is spelled out in advance.management. In addition, procedures

20


Country Experiences all PE's managers. Rewards were linked toperformance, as evaluated by independent

In Romania, performance contracts auditors. Performance indicators are used tohave been prepared in 1993 in collaboration measure results against the trend as well aswith the World Bank for the regies agreed upon targets. Set annually, 70% ofautonomes. The first 50 of these contracts the indicators are quantitative, and includerequire all public enterprises to design a profitability and productivity, as well assystem of accountability, and clearly specify sector-specific indicators. Qualitativethe objectives of the state enterprise and the indicators include corporate strategy,corresponding responsibilities of the research and development, improvements ingovernment as owner. It is too early to management information, and internalassess their success. control systems. Indicators are combined

into a single "public profitability measure"In France, performance contracts using a weighted average of performance

introduced in 1970, first with the French with respect to each indicator.National Railway (SNCF) and electricityutility (EDF) have been successful in Conclusionsclarifying responsibilities and establishing arational framework for the dialogue between Performance contracts are not a panaceaowners and management. The contract for the problems of the public sector, anddetermines the broad financial goals for the experience of countries that haveproductivity, tariffs, debt, profit, and successfully executed performance contractsdividends; the main objectives for shows that:commercial development and quality policy,international action, investment, and social * performance contracts should be usedpolicy; and provides for a mechanism of selectively, and only when there is acontract implementation. clear commitment on the part of

government to redefine the relationshipNew Zealand has been using a variation with the firm through a multi-year

of performance contracting since 1986, with contract;much success. The system includes a"statement of corporate intent" for each * when designing the contract, it isstate-owned corporation, which is redrafted crucial that the information upon whicheach year to define the goals, targets, and the performance targets of thesubsidies for any non-commercial goals. enterprise are set is made available toImprovements in productivity, profits, both parties;customer service and lower prices weredramatic. * a permanent, credible, independent and

small oversight body should beSouth Korea has had perhaps the most established, to act as an arbiter and

successful experience to date with conflict-resolution mechanism. Itsperformance contracts. As part of the 1983 assessments should be public;reform of public enterprises, contracts wereinstituted to permit comparative evaluation * the contract should specify as objectiveof the short and long-term performance of a set of measures of enterprise

performance as possible;

21


Box 2: Dkafting Performane Contracts with State Enterprises: An Mlustration*

At the beginning of the year the enterprise signs a performance agreement stipulating the followingtargets:

Performance Agreement Targets

.................................... .............ah. .s

Criterion Units Weight 1 2 3 4 5Very

Excellent Good Good Fair Poor

1. Gross Profit million .50 400 385 350 300 250

2. Exports million .30 80 70 65 60 55

3. ProjectImplementation month .20 6 8 12 14 16

At the end of the year the achievements of this enterprise are as follows:

* Gross Profit: 385 million* Exports: 65 million* Project Implementation: 6 months

Accordingly, the weighted score is 2.10, as shown below. (Excellent performance would be indicated bya score of 1.0 and poor performance by a score of 5.0.) The weighted result is the key concept of allperformance contracts, for it measures the ability of the enterprise to meet its commitments and allows theevaluation of management.

Calculation of Composite Score

Criterion Units Achievement Raw Score Weight WeightedRazv Score

Gross Profit million 385 2 .50 1

Exports million 65 3 .30 .90

Project Implementation months 5 1 .20 .20

Composite Score 2.10

* Adapted from an actual agreement prepared by Prajapati Trivedi of the World Bank for Thailand.

22

Corporate Governance of Public Enterprises in TransiHonal Economies

* performance indicators should be Management Contractsderived from an agreed 3-5 year plan.These indicators should be made part of The General Issuethe management information system,which will help ensure timely issuance Management contracts (MCs) areof financial results and audits; contractual arrangements between the

government and private managers.* performance targets should only be Consequently, MCs are closer to "external"

adjusted when major factors outside the reform measures and to privatization. Thecontrol of managers change; relationship between the government and

the private manager can also take the form* once performance targets have been set, of a lease (where the government receives a

managers should be left free to manage, fixed rent), concessions (where thesubject only to general government government is responsible for fixedpolicies and contractual guidelines. investments) and joint-ventures (where theHowever, the govemment must be private manager owns a share). The use ofprepared to face the case of failure and MCs is dependent on their suitability foract decisively to replace the manager, particular sectors. They are most often usedwhere needed; when governments find it particularly costly

to manage the enterprise directly; when* to the extent possible, employees of PEs enterprise technology is not changing

should receive a bonus or reward rapidly; when output is a homogenouslinked to their actual performance, so product; or when the supplier has anthat personal goals become congruent intemational reputation to protect andwith organizational goals as defined in quality is easily compared, as with hotels.the performance contract; Generally, management contracts are most

effective in restructuring operations, when3 a small bureau should be created at a an enterprise faces severe managerial

central location, responsible for difficulties, seeks to regain profitability,managing the performance contracting wants to rehabilitate a major part of itssystem. Preparatory work on strategic operations, or when a government wishes toplanning and contracting should be improve the financial performance of a state-done by an interministerial task force owned enterprise before privatizing it.for which the bureau would serve as atechnical secretariat; Country Experiences

* if government capacity is not sufficient A comparative review shows that noor if enforceability of performance government has systematically adopted MCscontracts is doubtful, govemments as an important instrument of publicshould consider empowering company enterprise reform, despite its potentialboards or using management contracts. advantages. Some countries, such as

23


Poland, Romania, Sri Lanka, as well as prises. Two illustrations of managementseveral African countries, have implemented contracts are described for Poland anda number of MCs, but nowhere do MCs Romania in Box 3 below.cover a large proportion of public enter-

Box 3: Managemnent Contracting in Poland and Romania

In Poland, MCs are used under the In the fall of 1993, as part of its nationalPrivatization Through Restructuring (PTR) program, strategy and under an IMF program, the Romanianwhich seeks to find a privatization path for those government introduced MCs as a method ofenterprises that appear difficult to sell in their improving corporate governance during thepresent state or that require some restructuring. The transition to privatization. According to the MCsprogram calls for restructuring and privatization to law, all commercial companies with over 50% statebe carried out by highly qualified management ownership, as well as all regies autonomes (RAs)groups. These management groups were invited to were obliged to conclude MCs. By early 1995,bid for one or more of the 27 companies involved in several hundred enterprises had signed contractsthe pilot project of PTR, as well as to submit with management groups, mainly the existingbusiness plans that outlined the changes needed to management. Among RAs, 11 contracts have beenprepare a company for privatization. A tender was signed and for 16 others management contractorsorganized for each company participating in the have been selected. The process adopted wasprogram, and the management group that submitted decentralized as the Boards were given the authoritythe highest bid, along with a viable restructuring to implement MCs and to agree on the performanceplan, was awarded a mandate to negotiate a requirements. At this stage it is difficult to judge theManagement Contract (MC) for the company with success or failure of the program. A mass priva-the Ministry of Privatization. Each bid reflected the tization program, proposed in mid-1994, causedmanagement group's estimate of the value of the uncertainty for the companies and may have createdcompany. Under PTR, the contractor's compensation uncertainty about the future of many MCs.takes three forms: a fixed fee, a success fee(percentage of the cumulative net profit), and an An interesting pilot program initiated by theequity fee (percentage of the capital gain upon the government of Romania with World Bank assistancesale of at least 51% of the company share). targets selected companies to be marketed through

an international tendering process intended to attractA key attraction of this program is the foreign contractors/investors using MCs with

relatively low initial capital outlay (as compared privatization features. The pilot program offerswith other privatization tracks). Upon signing the potential investors who are wary of the political andMC, each management group is required to pay into commercial risks of operating in Romania anthe company a sum equivalent to 5% of its bid value. instrument that would amount to an "extended dueThis money is then made available to the company diligence" period by offering them a combination ofto finance restructuring. As of early 1995, of the 27 management control plus such features as an optionenterprises in the PTR, 15 management groups had to buy/sell, a small equity stake, and the right tobeen selected and four contracts signed. match future offers.

Like performance contracts, manage- powers of hiring and firing, promotion andment contracts can be complex and time- lay-off; planning and design of capitalconsuming to design due to the broad range investments; control of productionof issues that must be addressed relating to schedules; procurement and maintenance;the precise scope of the manager's role and and preparation of annual work programsresponsibilities and allocation of authority and corresponding budgets. The MC shouldand control between the owner and clearly indicate how in practice the owner'smnanager. The manager is often given authority is to be exercised (by the board of

24


directors or by a governmental agency) and Conclusionsenforced. Provision should also be made forcompensation, duration of the MC, liability Successful MCs will require:of the manager, personnel issues, andremuneration of technology transfer. * a correct choice of incentives including

the use of success fees instead of orDesigning MCs as well as performance alongside fixed fees; minority share in

contracts requires increasing the availability equity for the contracted manager, andof information about the enterprise. Such tight links between incentives andinformation can be obtained through profit;competitive bidding. In order to maximize * full managerial autonomy;the information, the call for tenders should * emphasis on profit generation;be on a periodic basis. This information * an independent, permanent, crediblesystem should be part of the reward system oversight body which can supervise thefor managers. execution of MCs.

25

II.

COUNTRY STUDIES

These papers were written by World Bank staff specifically for the World Bank Seminar on Corporate Governance of PublicEnterprises in Transitional Economies, held in Prague in October 1994; they were updated as of November 1995. Whileevery effort has been made to ensure their accuracy, the World Bank cannot guarantee that the papers do not contain factualor other inaccuracies.


Hungary

Marc Stephens

Summary were owned by AV Rt, while MAV Rt, therailway company, and Magyar Posta Rt, the

Hungary has sought to improve the post office, are (partly or wholly) ownedcorporate governance of its state enterprises and operated by a ministry.through the twin strategy of gradualprivatization and the reassertion of Most residual state-owned enterprisesownership rights in the residual state sector. have been corporatized, although the state'sOver half of all medium size and large state stake in each enterprise varies. Eachenterprises have now been privatized. By enterprise has a board of directors and1993 the private sector was estimated to be supervisory board. However, responsibilityproducing about 50% of total GDP, a figure for appointing board members and the chiefthat has risen to 60% in 1994. executive officer varies across enterprises.

Recently, through the Privatization Act In keeping with the thrust ofof May 9,1995, the Government has decided privatization, Hungary is moving towardsto increase private equity participation in the greater private participation and increasingresidual public enterprise sector. Logically, foreign share ownership in its publicit has decided to merge the State Property enterprises. MATAV Rt was recentlyAgency AVU with the State Holding partially privatized through the sale of aCompany AV Rt to create the State 30% stake to a foreign consortium, in thePrivatization and Property Management largest such sale in Eastern Europe to date.Agency, APV Rt. The new body will be MVM Rt (Electricity Company) is also slatedresponsible for privatizing firms in its for privatization. Two major loss-makingcontrol as soon as possible. Before this, the industries, Railways and Coal are beingState Property Agency, AVU, owned more restructured, with a view to improving theirenterprises than the State Holding management. Many aspects of theCompany, AV Rt, and the line ministries. Hungarian experience are worthThe paper focuses on those enterprises in considering, and first of all to increasewhich the state has kept an equity stake. private equity participation in the residualMATAV Rt, the telecommunications com- public enterprise sector. The sophisticatedpany, and MVM Rt, the power company, combination of pressure from competition,

29

Hungary

sector or enterprise reorganization and purposes," or be capable of economiccreation of corporate governance operation "only in a unified system." Anmechanisms to distantiate public enterprises enterprise may also be included iffrom politics are of great interest. "preparation of the property ... for sale takes

a particularly long time."Ownership and Management Structureof Public Enterprises However, this structure has changed

with the adoption of the Privatization bill ofThe State Property Agency (known in May 1995. The new state agency APV Rt,

Hungarian as AVU), was created in March holds over 90% of total state shareholdings1990 to assume ownership of most medium in enterprises. It has the responsibility of-size and large state enterprises. The divesting at least 50% of the current Stateobjective was to transform them into equity holdings of AVU and AVRt over thecommercial companies and to prepare the 1995-1997 period. To facilitate this, the newprivatization process. This agency took over law sharply reduces the previouslymore than 1900 of the roughly 2000 mandated minimum shareholdings inmedium-size and large state enterprises and enterprises.the rest remained with the line ministriesand municipalities. The privatization process The new act stipulates that forcontinued to experience problems and companies, mainly public services, the statedelays during the early part of the agency's will retain control in the following threeexistence, although many of these problems ways: (i) ownership share not to be lowerhave been resolved. than 50+1%, (ii) in exceptional cases, the

lowest share that the state can hold toIn August 1992, in accordance with the guarantee its ownership will not be less than

Law on the Management of Enterprise 25+1% and/or (iii) a share akin to theProperty, 172 enterprises in which the state "golden share," that will guarantee the state'swished to retain full or partial ownership voting priority.were transferred from AVU to the newlycreated state holding company, AV Rt Organization of APV RI(originally called the State AssetManagement Company). The rest reverted to The Privatization Act of May 1995the line ministries and a few other small merges the AV Rt and the State Propertystate assets to management agencies. Agency (AVU), into a single State PropertyFollowing the August 1992 reallocation of Agency, the APV Rt. The shareholder'sstate enterprises portfolio, AV Rt had 46% of rights in APV Rt are exercised by thethe book value of the state portfolio, AVU Minister in charge of Privatization. Thehad 31%, and the line ministries 23%. company is governed by eleven members ofEnterprises that had to remain state-owned, the Board of Directors, appointed for aas a matter of law, were designated in the period of not more than three years. The1992 Law on the Management and Board of Directors will be appointed andUtilization of Entrepreneurial Assets relieved by the Government. ThePermanently Remaining in State Ownership. Privatization Minister, in consultation withTo be included under the law an enterprise the Finance Minister, shall makewould have to be of "economic-strategic, recommendations for appointing thenational economy, or other important Directors, whose appointments will beinterests;" serve "national public service screened by a Parliamentary Committee.

30

Corporate Governance of Public Enterpises in Transitional Economies

Box 4: AV Rt's Structure and Function

With the passage of the Privatization bill in established for asset-management, sales, financialJune 1995, AV Rt will cease to exist, its name will be affairs, legal affairs, and administration. AV Rttransformed to APV Rt and will be merged with employed about 170 people.AVU. Until this transformation, AV Rt was theagency primarily responsible for monitoring the According to AV Rt, primary responsibility forenterprises in which the state retained a majority the day-to-day management of enterprises in itsstake. AV Rt's stated objectives were to privatize the portfolio rested with the boards of the constituentcompanies it holds to the fullest extent allowed by corporations. The extent of AV Rt's involvement inlaw; to maximize the value of the assets in order to a company was defined by its share in the companypreserve certain (undefined) strategic activities; and and by the company's importance. For criticallyto pay a dividend to its owner, the Hungarian state. important companies, AV Rt was represented on theAV Rt's income was derived partly from the company's board. In addition, AV Rt nominatedprivatization of companies in its portfolio and partly other board members, usually in proportion to itsfrom borrowing internationally. AV Rt's goal was not ownership share. There were plans to create reviewto maximize its short-term revenue, but to improve boards to identify suitable candidates for companythe long-run prospects of the companies in its boards. Each review board would include aportfolio and thus of the state budget. It owned recognized industry authority, local representatives,between 95 and 100% of the shares of about two- and the AV Rt portfolio manager. Their nominationsthirds of the enterprises in its portfolio, although this would be subject to approval by the AV Rt board.proportion was to decrease over time. Foreigninvestors owned about 5.7% of AV Rt's total assets. In addition, AV Rt monitored these enterprises'Domestic investors were being encouraged through activities by reviewing acquisitions and divestituresa number of plans, such as employee share and requiring feasibility studies for all majorownership plans and the small investor share investments. It used risk-analysis to assesspurchase plan. investment decisions. AV Rt's Controller's Depart-

ment analyzed financial reports and marketAV Rt was managed by an eleven-member indicators on a monthly basis. The system of

board that was recommended by the privatization accounting control covered AV Rt's entire portfoliominister and appointed by the prime minister. and was intended to assist in making managementMembers served for four years and a minimum of decisions, including asset management andthree members would also be on the staff of AV Rt. privatization strategy. AV Rt also offered mana-The chairman of the board was also the Chief gement training to its enterprises.Executive Officer. Five larger directorates had been

The operation of APV Rt will be be appointed by the employers, and one bysupervised by a Supervisory Board the workers.consisting of eleven members. TheChairman and the members of the The day-to-day working of theSupervisory Board are appointed for at least organization will be the responsibility of thethree years. The chairman of the director general, acting as an employee ofSupervisory Board will be appointed and or the Company.recalled in accordance with therecommendation of the State Audit Office. Corporatization and DeregulationSix of the supervisory board members willbe nominated by Parliamentary groups. Short of outright sale, Hungary hasOne member of the Supervisory Board will experimented with a number of other ways

31

Hungary

to involve the private sector in the operation venture company formed by a stateand management of its infrastructure. enterprise and a private investor. HungaryAlmost all enterprises in which the state has also employed build-operate-transferretains a share, including those previously arrangements (or concessions), particularlyowned by AV Rt, have been corporatized. in transport (road construction) and mining.Corporations in Hungary operate within a However, it has rarely used affermagefairly comprehensive, market-oriented legal (leasing) or management contracts.framework. This includes the 1988 BusinessEnterprises Act that together with Involving the private sector in thesubsequent legislation, stipulates and management and operation of stateregulates the formation, organization, and enterprises has brought much-neededoperation of most business entities; the 1988 pricing discipline to these enterprises, whichForeign Investment Act (as amended); the have traditionally priced their services1991 Accounting Law; the 1992 Labor Code; substantially below economic cost. It hasthe 1992 Insolvency Act; and comprehensive also generated competitive discipline andtax legislation. Several of these laws, increased the enterprises' access to expertiseincluding the Insolvency Act, also apply to and much-needed finance. MATAV Rt, thenoncorporatized state enterprises. Hungarian telecommunications company, is

a prime example. In cases where com-Most corporatized state enterprises take petitive pressures have been considered

the form of public limited companies. The insufficient to generate a dynamic industry,Business Enterprises Act requires that public for example in the energy sector, Hungarylimited companies, designated by the has established regulatory systems. TheseHungarian abbreviation, Rt, appoint a board regulatory systems closely resemble those ofof directors of three to eleven members, a Germany in that ministries influencesupervisory board of at least three members, regulatory decisions, albeit indirectly,and a financial auditor. One-third of the through a regulatory agency under thesupervisory board's members must be ministry's authority.appointed by the workers. The supervisoryboard has the purely advisory, non- With the passage of the newexecutive role reviewing the company's privatization bill into law, the governmentbudget and ensuring that the company's seeks to involve the private sector further inactivities conform to the legal and regulatory the ownership of state-owned enterprises.framework. In general, the period ofappointment of the supervisory board is Ownership and Management ofdetermined by the company's general Telecommunications, Energy,meeting. and Railways

Hungary is also attempting to introduce MATAV Rt, the Hungarian Tele-market discipline into the state sector by communications Company, and MVM Rt,deregulating activities such as road the Hungarian Power Company, are ownedtransport, contracting out road construction, by APV Rt. However, with the newor proposing the establishment of private, privatizationbill, themajority shareholdingindependent power generation projects. In of MATAV Rt is to be in private hands.some cases, such as cellular telephonecommunications, responsibility for Within the energy sector, there are acompetitive activities was given to a joint- number of enterprises that are part-owned

32


by APV Rt, directly and part-owned by approving the annual business plan.MVM Rt, which is owned by APV Rt. These MATAV Rt also has a nine-memberinclude seven power plant companies, six supervisory board: four appointed by APVdistribution companies and a national grid Rt, three by MATAV Rt workers, and twooperating company. In each case, MVM Rt by Ameritech and Deutsche Telekom.owns 50%, APV Rt owns about 48% and themunicipalities the balance. Coal mines, The Hungarian government haswhich were previously owned by the retained a special "category B" ("golden")Ministry of Trade and Industry, are now preferential share in MATAV Rt, whichowned by power stations, which are, in gives it the right to be represented on theturn, owned by APV Rt, MVM, and the board, to cast the deciding vote at themunicipalities. Two enterprises are still general meeting, and to veto certainowned by ministries: MAV Rt, the decisions. These include whether toHungarian Railway Company and Magyar increase or decrease share capital, to changePosta Rt, the Hungarian Post Company, the corporate mission, to appoint andboth of which are owned by the Ministry of remunerate board members, to accept newTransport, Communications, and Water international loans, and to decide onManagement. mergers and acquisitions. Meanwhile, the

government is now keen to divest theTelecommunications and remaining state equity in MATAV to aboutPostal Service 35% or less.

Until 1990, postal services, broadcasting Although APV Rt retains shareholderand telecommunications were provided by control of MATAV Rt, the strategic investorsHungarian Post. Then in January 1990, have substantial management controlHungarian Post was split into three through their pre-eminent position on theenterprises including the telecom- operating committee, which manages themunications company MATAV and Magyar day-to-day operations of the company andPost. implements the annual business plan. Two

of the four committee members areTelecommunications nominated by APV Rt and two by the

investors. In the event of a tie, the castingIn December 1991, MATAV was vote rests with the investors.

converted into a (one-member) joint-stockcompany. In December 1993, a 30% stake in The 1992 Telecommunications LawMATAV Rt was sold to Magyar Com, a allows for several services, including publicDeutsche Telekom-Ameritech consortium. A telephone service and public mobile radiosmall number of shares are also owned by telephone service, to be granted bythe European Bank for Reconstruction and concession to a private company or to aDevelopment and the International Finance state-established agency. The law sets outCorporation. The Board of Directors has certain provisions to which the concessioneleven members: seven are appointed by must conform. The state's role in theAV Rt and four by Ameritech and Deutsche telecommunications sector includes:Telekom. The chairman of the board is development of a national policy, regulationelected by the board members and is also of the concession market, economic andthe CEO. The board is responsible for technical regulation, and supervision of the

33

Hungary

telecommunication networks. Although the formalized in annual contracts, replacing theregulatory regime includes a special previous system of arbitrary internal pricing.communications authority, the discretion toreview price caps (as is the case with MVM Rt's new organization andpower) is vested in a government ministry. management structure are defined in its

articles of association, which were approvedPostal Services by AVU as a founder of MVM Rt. Its board

of directors includes representatives fromMagyar Posta Rt became a joint stock the state (four directors), MVM Rt (one

company on December 31, 1993. It is wholly director, the CEO) outside companies (twostate-owned. The Ministry of Transport, directors), banks (one director), academicCommunications and Water Management institutions (one director) and Parliamentrepresents the state's interests. It appoints (one director). MVM Rt's supervisory boardthe seven members of the board of directors has six members, two of them appointed byand six of the nine members of the the employees and four by the owner.supervisory board. The remaining three are Supervisory board members serve for aappointed by the postal workers. The chief maximum of five years.executive officer, who was elected chairmanby the board of directors, is also appointed Responsibility for preparing priceby the same minister. Management is schedules was given to a newly establishedappointed by the CEO. Recently, cost-profit Energy Office in the Ministry of Industrycenters were established and an annual and Trade in accordance with the April 1994performance review system was introduced. Act on the Production, Transport and

Supply of Electric Energy. Final respon-Electricity & Gas sibility for prices, however, rests with the

Minister of Industry and Trade. The EnergyIn 1992, the state-owned power sector Office was also given the task of issuing

was re-organized into eight generating licenses for the production, transmission andcompanies, a national transmission distribution of electricity; monitoringcompany, and six regional distribution standards; and investigating consumercompanies, all under the umbrella of MVM complaints.Rt. The MVM Rt group has about 39,000employees: 58% of them in distribution, As long as it wholly owns the nuclear40% in power generation, and 2% in power station and the transmission system,administration. the government would have the currently

mandated minimum share in the electricityThe 1992 restructuring and corporati- sector as a whole. In addition, the

zation of the electricity sector was intended government plans to enlist privateto decentralize the operational decision- participation in the power generation sectormaking process, by replacing the central by allowing independent power generationplanning mechanism with contractual to proceed and by selling stakes in existingrelationships between the generation and non nuclear plants.distribution subsidiaries, and to improve theefficiency of operations. For example, Coalcommercial arrangements for purchases andsales between the generating companies, In 1990 there were about 60,000 peopleMVM Rt, and the distribution companies are working in the Hungarian coal industry and

34

Corporate Governance of Public Enterprtses in Transitional Economies

all mines were owned by the Ministry of RailwaysIndustry and Trade. Today there are about18,000 workers, employed primarily in six MAV Rt is one of the largest loss-mines that have come under the control of makers among Hungary's state enterprises.regional power generating companies owned To offset these losses, tariffs andby MVM Rt. Between 1991 and the year government subsidies have been increasing.2000, the share of coal in energy consump- Moreover, the 1993 Act permits thetion is expected to fall from 22% to 14%, establishment of private railways. Variouswhile the shares of oil and gas are expected subsidiary activities have been partially orto rise. Demand for coal is likely to fall majority privatized, including cateringbecause old coal-fired power stations are services, of which private investors ownbeing replaced by gas-fired units and 85%. Despite this, and despite staff layoffs,households are substituting gas for coal. MAV Rt's financial position continues toProduction of coal is projected to fall by 42% deteriorate.over this period.

MAV Rt was established as a publicDownsizing the Hungarian coal limited liability company under the July

industry was the responsibility of the Coal 1993 Railway Act. The government retainsMining Restructuring Center, a government complete ownership in MAV Rt, as is legallybody with a staff of five, reporting directly required (although this requirement mayto the Minister of Industry and Trade. The soon change). The Ministry of Transport,Center was responsible for liquidating coal Communications, and Water exercisesmines, which at the time belonged to the ownership and its duties include overseeingMinistry of Industry and Trade, and the following:ensuring that landscaping and recultivationwere carried out. The Center received funds * Changes in capital structure, mergersdirectly from the government's central and acquisitions, introduction of MAVbudget for these purposes. Rt components into the stock markets,

long-term debt contracts, asset sales,All six remaining mines have been and significant financialparticipation

corporatized: four have become joint-stock in other companies.companies and two, limited liability * Appointment, dismissal, and compen-companies. About 25% of the mines' assets sation of the CEO, members of theare owned by their creditors, while the rest board of directors, and members of theare shared by MVM Rt (about 37%), APV Rt supervisory board.(about 37%) and local governments (about * Appointment of the financial auditor.1%). APV Rt is effectively the owner andcontroller of the residual coal sector and is The board of directors has from five toresponsible for any privatization. nine members. The first appointment was

for two and a half years. The CEO andAccording to the 1993 Mining Act, deputy CEO are automatically members.

regulation of the industry is the primary Other members include a senior official ofresponsibility of the Minister of Industry the Ministry of Transport, two CEOs ofand Trade. The Act allows concessions to be other transportation companies, and agranted for periods of up to thirty five years university professor. The board of directors(renewable once) if a concession fee is paid. controls operations; makes one-year and

35

Hungary

long-term plans and investment decisions; commissioner and the CEO answers to thehandles long-term debt contracts, asset sales, latter.and small-scale financial participation inother companies; prepares balance sheets, In addition to the above bodies, aprofit and loss statements, and an annual "creditor's committee" advises MAV Rt oncompany report; and handles international financial matters such as loans, investmentrelations. plans, and liabilities. This ad hoc committee

was founded in September 1993 and itsIn addition to the board of directors, members include senior members of major

MAV Rt has a supervisory board. The Hungarian banks that lend to MAV Rt.supervisory board also has from five to ninemembers, two-thirds of whom are appointed Lessons and Prospectsby the Ministry of Transport, and the restare elected by the employees. Its members Hungary's approach to corporateinclude two Ministry of Transport officials, governance of the residual state sector wasone Ministry of Finance official, three trade shaped initially by the need for the state tounion officials, one senior official from a regain control of its assets from enterpriseHungarian bank, and one business managers. To this end AVU, later AV andexecutive. The supervisory board supervises now APV Rt were established as a means ofpolicymaking and other important centralizing the management andmanagement decisions, acts as an advisor to privatization of state assets.the Ministry of Transport on importantproposals made by the board of directors, Corporatization, the enactment ofand validates and approves annual financial market-oriented legislation, the existence ofstatements. The CEO is responsible for the a dynamic private sector, together withmanagement and control of MAV Rt's day- recent measures deregulating telecommuni-to-day operations, the execution of decisions cations, power, and other areas of the infra-made by the owner and the board of structure, have subjected state-owned enter-directors. prises to the discipline of market competi-

tion. In addition, during its existence AV RtCurrently there seems to be no active monitored the performance of the

board of directors. Instead the Ministry of enterprises in its portfolio and played anTransport has appointed a commissioner to active role in improving their management,run MAV Rt. A president answers to the performance and subsequent privatization.

36


Poland

Marion Leblatic-Wohrer

Summary pushing for the creation of an independentState Treasury Ministry.

From 1989 to 1993, the Polishgovernment emphasized privatization and Organization of State-Ownedneglected to address corporate governance Enterprisesin the public sector. Commercialization wasviewed as a means to improve enterprise Before 1989, Polish enterprises weregovernance while waiting for privatization. organized into socialized and nonsocializedFew special ownership control mechanisms units. Broadly speaking, socialized units

were created. Several projects sought to included state-owned enterprises,clarify the assignment of responsibilities cooperatives, and social organizationsamong government agencies for the (unions, and religious or political groups).ownership of public enterprises were Nonsocialized units mainly comprisedcontinuously delayed. individual businesses and joint ventures

with foreign investors. After 1989 theRecently, the government has become introduction of new legal organizational

concerned about the prospect of having to structures and new types of mixedoversee a vastly increased number of ownership blurred this classification. Incommercialized enterprises. The slow rate response, the authorities developed a newof privatization has required the Ministry of classification system based on public orPrivatization to develop workable private ownership. This system has been inarrangements to prevent enterprises force since January 1, 1991.awaiting privatization from failing.Commercialization is beginning to be During the 1980s power over stateviewed not only as a first step to enterprises shifted from the stateprivatization, but also as a means of administration to employees. The demise ofclarifying management responsibilities for communism further reduced the state'sthe firms that will remain in the public powers, making workers councils andsector at least for the medium term. To this general workers assemblies the dominantend, the Ministry of Privatization is stakeholders and supervisors of the

37

Poland

enterprises' activities. The rights of these Funds (NIFs), whose shares would bebodies resembled those typically held by the distributed to private citizens through aboard of directors and the general voucher scheme.shareholders meeting in a Western jointstock company. These rights include As a transitional step towardapproval of the enterprise's statutes, long privatization, the government programterm plans and objectives; annual review of envisioned a large scale commercializationthe activities of the enterprise and of the of state enterprises. Commercialization wasmanaging director; the power to determine viewed as a means to improve enterprisethe proportion of profits to be distributed to governance before privatization (commer-workers and to review appointments and cialized enterprises were supposed to bedismissals of the managing director and privatized within two years). According toother managerial personnel; approval of the Privatization Law, a state enterprise canmergers, transformations and assets. be transformed into a joint-stock or limited

hiabihity company fully owned by the stateState enterprises had no effective owner Treasury. When this takes place the state

and workers, represented by a workers' enterprise comes to be governed by the 1934council, had the power to oppose personnel commercial Code rather than by the 1981changes and restructuring activities. There State Owned Enterprises Act. A companywere no effective incentives to maximize the created by the transformation of a statevalue of the firm. In short, there was no enterprise remains wholly owned by theadvocate for capital formation, which led to state treasury until its shares are distributeddissipation of the firm's capital base and to third parties.wait-and-see attitudes rather than decisiverestructuring. As of December 1993 the public sector

included about 5,924 state enterprises andInstitutional Framework for about 527 commercialized state enterprisesPrivatization The bulk of public enterprises were in

industry (about 2,752), and constructionAs part of the Economic Transformation (about 988). The remainder operated in

Program, and, to address the issues of the trade and service sectors (about 641). By"spontaneous governance and spontaneous the end of December 1993, public enterprisesprivatization," the Government embarked in accounted for an estimated 60 to 70% of alllate 1990 on a comprehensive enterprises' gross sales and 1999 enterprisescorporatization and privatization program. had been privatized (602 in industry, 624 inFollowing enactment of the Law on construction and 130 in transportation).privatization of state enterprises in July1990, the government developed a multi- Corporate Governance oftrack approach to privatization that includes: State-Owned Enterprises(i) privatization through the dissolution ofstate enterprises, or "liquidation" (productive The Privatization Law of July 1990assets were sold or leased to new private created the Ministry of Privatization (MOP)companies); (ii) capital privatization, under to represent the state treasury in exercisingwhich shares were sold to private investors. ownership over commercialized enterprises.Later, mass privatization was envisaged as Under this law the Ministry, which definesa one-time transfer of the ownership of the company statute on behalf of the stateselected enterprises to National Investment treasury, is responsible for transforming

38

Corporate Governance of Public Enteiprises in Transitional Economies

state enterprises into commercialized general meeting. In addition, the ministryenterprises. The enterprise's funds become can take over a part or all of thethe company's capital at the time of company's debt and issue new shares totransition. In the newly established joint- increase the share capital. The minister isstock company, all shares are taken over by also formally in charge of preparing the firmthe state treasury represented by the for privatization.Ministry of Privatization.

Supervisory boards usually consist ofThe initiative for commercialization may six persons in the case of a joint-stock

come from a joint motion of the enterprise's company and three in the case of a limitedmanaging director and the workers council, liability company. The MOP appoints twofrom the enterprise's founding body with third of the seats. Eligible individuals mustthe support of the enterprise, or from the be over 25 years old, must have receivedCouncil of Ministers with the support of the higher education and pass an exam set byenterprise. In the last case, the consent of the MOP. In 1993, 3,000 people passed theboth the managing director and the workers exam, and 2,000 of them were appointed tocouncil is still required. In most cases, the board positions. The ministry also providesPrivatization Law ceded the power over the an intensive 100-hours training program forcorporatization decision to the enterprise those wishing to take the exam. Theemployees. Enterprise commercialization is supervisory board convenes once a monthconditional on enterprises having clarified to: examine company accounts and reports;the legal status of their assets. The ministry suspend, if necessary, Board members;has refused commercialization in one prepare report for the annual generalquarter of cases. At the end of 1993 there meeting and select and remunerate thewere 527 commercialized enterprises (less Board.than 10%). Most commercialized enterprisesare in the industry sector (83%) and are Beyond the training and the stipulationslarge. of the commercial code, the MOP does not

provide any guidelines about how theCorporate Governance of supervisory boards should perform theirConumercialized Enterprises duties. The performance of supervisory

boards and the board of directors is assessedCommercialization aims to change a annually at the general meeting.

firm's corporate governance. When an Supervisory board members do notenterprise's legal status changes, the participate in these meetings.workers' council is abolished and the MOPappoints a supervisory board. By law, two- Supervisory boards are generally toothirds of the supervisory board must be weak to exercise real control overnominated by the Minister of Privatization, management, as revealed by the relativelyand one-third must be composed of workers' small number of enterprise directors thatrepresentatives. The MOP appoints have been replaced. Furthermore, oncemembers of supervisory boards on the basis board members have been trained andof clearly specified eligibility criteria and tested, their involvement in managingrepresents the state treasury at the annual enterprises is largely unregulated.

39

Poland

Box 5: Commercialization

The notion of commercialization is usually settle legal questions, especially regarding owner-interpreted as simply a change in the legal status of ship of land and buildings.an economic entity from a state-owned enterprise toa company incorporated under commercial law. But The Polish commercialization program has beencommercialization primarily involves the rehabilita- heavily criticized by the press. One criticism con-tion of enterprise's business. This process affects all cerns the rapid pace of the program. Some doubtfacets of the enterprise's operations. that it will be possible to incorporate so many

enterprises under commercial law, and for them toThe change of legal status should strengthen begin overnight to operate according to commercial

the owners' supervision over state enterprises; rules. These critics hold that simply granting a newchange the organizational and legal structure of the legal status changes very little. Companies that haveenterprise to adjust to the new market economy; been commercialized and are still completely ownedcreate transparent decision making; generate at 100% by the treasury experience considerablepressure for market-oriented restructuring and problems. Critics are also afraid that commerciali-facilitate reorganization or liquidation of enterprises zation will delay privatization, claiming that, withoutunder the commercial law; and force enterprises to any clear prospect of privatization political pressures

will mount to retain the status quo.

Evidence indicates that insiders, Management contracts were introducedespecially management, have maintained in an attempt to strengthen the governancetheir privileged status in many enterprises. of commercialized enterprises. PotentialAs a rule, no significant changes are made enterprises managers are selected through ain the key management positions of the new bidding process. Once chosen, managers arecompanies. Although workers' councils are required to restructure the enterprise toeliminated when a company is corporatized, prepare for privatization, and to add valueworkers' representatives on supervisory to the firm. They receive fees and aboards often continue to play an important percentage of the value added to thedecision making role. Other informal enterprise. About 25 enterprises havereports indicate that the supervisory boards signed management contracts.are either passive or ignored by insiders.

The MOP intends to commercializeMoreover, effective control requires the about 1,000 medium-size state firms by 1995.

creation of a framework in which state By making the managers of these firmsenterprises managers are accountable to directly accountable to the state treasury, thesingle principals for meeting clear objectives government is hoping to tip the balance ofand are rewarded for their achievements. In power away from workers' councils andPoland, state enterprises are often required towards management. The government isto pursue non-commercial objectives such also trying to pass legislation that wouldas employment or regional development as allow commercialization to take placewell as profit maximization. Managers must without the consent of workers' councils.also answer to numerous governmentdepartments.

40


Box 6: Proposal by the Ministry of Privatization to Create a Ministr of Treasury

The current govemance system has been vatizing state firms, making stipulations for foreigncriticized because it combines regulatory and investments and supporting capital marketproperty management functions within the same development. The execution of the Ministry'sministry. This leads to joint formulation in the state ownership rights would be entrusted to specializedbudget of proceeds from managing property with regional agencies, the Agencies for State Treasuryproceeds obtained through fiscal policy instruments. Assets (ASTAs). The state treasury would beIn this way state property often finances immediate responsible for establishing the ASTAs; organizingbudget needs. As a result, short-term goals take and supervising them. Supervision would includepriority over long-term economic restructuring. The approving purchase and sale of equity; establishinggovemment must create an homogeneous institution companies; increasing or reducing equity into represent the state treasury and perform all the companies, transferring additional capital tofunctions conceming its properties. However, such companies; and merging, transforming oran institution should be created when the state sector liquidating companies.is no longer predominant in the economy, and whenthe economy is relatively stable. Meanwhile, this ASTAs would manage assets and revenues oninstitution must not be involved with the budget; behalf of the state treasury, supervise stateprocess which is the task of the MOF. enterprises, execute contracts for the use of assets

and the sale of enterprises.This analysis led the MOP to propose creating

an agency that would differentiate the regulatory According to the first proposal, an Agencyand ownership functions, both of which are currently would consist of a three- or five-member Board, aexecuted by the MOP. The law would create a council and an auditing Committee. The Minister ofMinistry of Treasury, as well as Agencies for State Treasury would appoint the president of the Board.Treasury Assets. The remaining members would be appointed by the

Ministry at the request of the president of theCommercialized firms would be directly Agency. The council would consist of 5 members

responsible to the Treasury rather than the ministries appointed by the Ministry , two of the candidatesor regional authorities. The Treasury would not being recommended by the Ministry of Finance andhave to seek approval from firms' management or one by the Ministry of Industry and Trade.workers' councils in deciding how firms shoulddevelop. The Ministry hopes that clarifying the lines The draft law has not yet been enacted as theof managerial authority will create an attractive Polish President opposed in July 1995 his veto to thebusiness climate. It also hopes that a clearer adopted legislation on commercialization andownership structure would strengthen managers' privatization of state owned firms. Both the law anddetermination to resist demand for excessive wage. the veto have been deferred to the Constitutional

Court. The decision of the Court did not take placeThe tasks of the Ministry of Treasury would before the November 1995 presidential elections. It

include implementing state policy conceming is not certain that the final version will resemble themanaging public assets, transforming property, pri- one described here.

Corporate Govermance in term. These are the energy, mining, steel,Specific Sectors and defense sectors, which include about

300 enterprises and account for about 20% ofThe government identified the sectors industrial output. In all other sectors,

over which it wanted to retain some control enterprises are eligible for privatization.(majority or golden share) in the medium

41

Poland

Corporate Governance Hard Coal. MOIT was the foundingin the Energy Sector agency in charge of the hard coal state

enterprises. In accordance with theThe energy sector is one of the largest February 1993 Law on Privatization of

sectors in the Polish economy. It consists of Strategic Industry (coal, power, defense)two energy producing subsectors (hard coal MOIT became solely responsible for theand lignite and oil and gas), two energy commercialization of these enterprises inconversion subsectors (electric power and recognition of its experience with the miningdistrict heating), and one energy processing industry. But it was not an ideal solutionsubsector (oil refining). Together, they since the Ministry sets policies in the energyaccounted for about 11% of the country's sector, and represents the owner (thetotal investments in 1990-92. In 1993 the treasury) of the newly formed joint stockenergy sector accounted for about 8% of companies. The regulating function will beGDP and directly employed 4% of the transferred to an independent agency onceworking population. the energy law is adopted by the legislature.

Among its other duties, this agency wouldThe energy sector was substantially regulate network energy prices.

restructured in October 1987. An act of theParliament dissolved the Ministry of Mines In 1989, as part of its strategy toand Energy and sector responsibility was improve the performance of the miningtransferred to a reorganized and downsized industry, reduce cost and improveMinistry of Industry and Trade (MOIT). At competition among the mines, thethe same time, the hard coal and power government abolished the Hard Coal Boardsector also were reorganized and further and created individual mining state-ownedcentralized in an effort to reduce companies that were established as legaladministrative overhead. All hard coal entities. Sixty coal mines were grouped intonining enterprises were brought under the seven multi-mine companies, each managing

control of a new state monopoly, the Hard between 7 and 12 mines; seven single-mineCoal Board. The lignite mines were companies were also created. The newtransferred from the coal to the power sector multi-mine and single-mine companies wereand were merged into the newly created established as joint stock companies. EachPower and Lignite Board. The gas sector company has a supervisory board, consistingwas not affected since the Polish Oil and of three members designated by MOIT,Gas Company had already been vertically three members chosen by the workers, andintegrated in 1983. All three centralized three members from outside institutions.entities had a 25-member supervisory The role of the supervisory board, thoughcouncil, representing government, still evolving, will need to be further definedemployees and consumers. MOIT appoin- and reinforced as the companies developted the general managers. commercial practices. The multi-mine

companies also have a board ofAs part of the World Bank's sector management, appointed by MOIT and a

assistance strategy and with the Energy supervisory board.Sector Adjustment loan - Heat SupplyRestructuring and Conservation Project, the In conjunction with the Economicgovernment set out to implement a Transformation Program and a majorcomprehensive energy sector restructuring review of the economy, the governmentprogram. placed seven mines on a Government

42


closure program in 1990. Subsequent the 33 distribution companies have beenanalyses concluded that about 15 mines commercialized. The 34 generationwould have to be closed or merged. enterprises will be commercialized after theyHowever action on this matter progressed are merged into a smaller number ofslowly. The outline of a full-fledged separate generating companies.restructuring program was not prepareduntil early 1993. The first phase consisted PPGC was created as a joint-stockmainly of the reorganization of the sector, company in August 1990, just before Powerand the commercialization and introduction and lignite Board monopoly was dissolved.of cost-cutting measures were carried out in All company shares are held by the1993. The crucial measures for mine Treasury, represented by the MOIT. PPGCclosures and mergers are expected to take has a supervisory council of 11 peopleplace in the second phase during 1994-1995. appointed for three years. The council is

chaired by the Vice-Minister of Industry andThe State Hard Coal Agency was Trade. PPGC has a two-tier structure,

created when the Hard Coal Board was consisting of a four-member board ofdissolved in 1989. Initially, it provided directors which is appointed by MOIT, andtechnical assistance to the mines and the management, consisting of theadvised MOIT, the industry, and the unions. departments heads.It currently oversees the industry's closureand merger program and provides technical Corporate Governance in theassistance on a competitive basis. Telecommunications Sector

Natural Gas. Natural gas is produced At the time of the historic politicalby the Polish Oil and Gas Company changes in Poland in the early 1990s, the(PGNiG), the last remaining monopoly. nation's telecommunications infrastructurePGNiG is expected to be broken up into was among the most rudimentary inmainstream and downstream operation and Europe. The Government was well awareservice companies. The divestiture of that the development of a telecommuni-service companies has already begun and cations network was critical to economicthe separation of exploration and growth and national development. Todistribution companies is scheduled to start rehabilitate the sector the Governmentin the spring of 1995. introduced a series of reform measures.

Electricity. The power sector under- Before 1990, the organization of thewent substantial demonopolization and telecommunications sector was simple. Adivestiture. Until September 1990 it limited range of services - telephone, telex,consisted of 106 enterprises consolidated and telegraph - was provided by the Polishunder the former Power and Lignite Board. Post, Telephone, and CommunicationWhen this Board was dissolved, all service (PPTT), which was a state enterprise underenterprises were spun off into joint-stock the direct control of the Ministry for Postcompanies. The sector now consists of 68 and Telecommunications (MPT). Theautonomous enterprises specialized in the enterprise was operated as a governmentgeneration, transmission and distribution of agency, with profits from telecommuni-electricity. The transmission company, the cations returned to the national treasury.Polish Power Grid Company (PPGC), and

43

Poland

The Post and Telecommunication Act networks. Deregulation has led to theof November 1990 aimed at demonopolizing creation of a cellular radio network in athe telecommunications sector and joint venture with France Telecom andsubstantially restructuring it. The Ministry Ameritech.of Posts and Telecommunications wasreorganized and assigned responsibilities The Post and Telecommunications Actfor: (i) issuing and rescinding licenses for does not give the MPT enough legalservice providers; (ii) issuing of authority to effectively regulate thehomologation certificates; (iii) defining the telecommunications sector and to respond topolicy for national frequency management the tremendous changes taking place. Tofor radio communications. The PPTT was resolve some of these issues, the governmenttransformed into a joint-stock company, is now drafting a new telecommunicationsTPSA, which had MPT as its founding law. This law is intended to bring Poland'sbody and had all 100% of its shares held by telecommunications in line with thethe state. Telecommunications services were telecommunications sector in the Europeanseparated from postal services, and the Union.postal responsibilities were assigned to thePolish Post Office. TPSA was given an Corporate Governanceexclusive monopoly power over inter- in the Railways Sectornational telecommunications services.

Polish Railways (PKP) is a state-ownedThe Polish telecommunications sector enterprise. The government appoints the

now consists of three segments: general director who appoints the deputygeneral directors and chief accountant with

• the MPT, which is both owner and the approval of the Minister of Transportregulator. The Ministry is formally and Maritime Economy. PKP is beingresponsible for regulating and restructured to reduce its excessive numbersupervising the sector. In addition, of employees and to spin off some of itssince the state treasury has full activities as separate supplementary entities.ownership of TPSA, the Ministry is PKP is reorganizing its monolithic railroadindirectly responsible for operating system along its principal lines of business:most telecommunications services; commercial freight, intercity passenger, and

* telecommunications services providers, international passenger. Eventually, it isof which Telekomunikacja Polska expected to have an infrastructure(TPSA) is the primary company, under department servicing institutionally distinctthe Ministry for Posts and Telecom- lines of business, with each paying suitable,munications; nondiscriminatory compensation for track

* the telecommunications manufacturing use. Suburban passenger activities will beindustry, under the jurisdiction of the spun off to local agencies or providedMinistry of industry, which is under "contracts" with national and localgradually being privatized. governments. PKP will transfer its liabilities

and nonrail assets (mainly urban real assets)The Post and Telecommunications Act to a new authority. It will also seek to

also introduced private sector participation transfer its nonrail activities to the privatein telecommunications services, and lifted sector. This reorganization will separaterestrictions on foreign ownership of local commercial services from public services.

44


Romania

Marion Leblanc-Wohrer

munmary accelerated in 1993-94. As of September1994, about 800 commercial companies

The process of enterprise reform started had been privatized. The Governmentin 1990, early after the revolution. By is presently launching a very ambitiousmid-1991, the commercialization of mass privatization program aiming atState-Owned Enterprises was complete, privatizing 3,000 commercial companiesresulting in two types of enterprises: in the coming months.

(i) The "Regies Autonomes" ("autonomous While the ownership and governance ofholdings"). These are either national the commercial companies have been sharedmonopolies or public services deemed among a State Ownership Fund and fiveessential for national security and Private Ownership Funds, the "regieswelfare. As of August 1994, there were autonomes" have remained under directabout 400 "regies autonomes" (RAS). control of either branch ministries (forOf these, it is expected that 44 of "regies autonomes" of national importance)national importance will remain under or local authorities. The Government isdirect State supervision, while the strengthening the governance mechanismsremaining ones are being devolved to of the first group through the nomination oflocal authorities. The "regies representatives on their board of directorsautonomes" are slated to remain in the and through management contracts. Apublic sector. However, many activities subset of five major "regies autonomes" haveof a commercial nature are being spun been placed in a special isolation program tooff and transformed into commercial force their management to cut downcompanies. payment arrears and, in some cases, their

losses.(ii) The Commercial Companies. Some

6,300 commercial companies were Legal Frameworkincorporated in 1990-91. Thesecommercial companies are slated for Most of the essential legal andprivatization. After a slow start, the regulatory framework for the enterpriseprivatization program was sharply sector is in place. Law No. 15 on State-

45

Romania

Box 7: Special Supervisory Mechanisms

The Romanian government in Decision 301 of served as committee president and the MOFJuly 1993 instituted a special isolation program for a representative served as the secretariat. Eachgroup of thirty commercial companies whose member of the committee had one vote, although thefinancial situation was critical. These commercial representative of the state-owned creditorcompanies were denied access to bank credits until commercial banks could only vote in matters thatthey had produced acceptable financial recovery concern their debtor commercial companies.plans (FRP). Likewise, representatives of POFs could only vote on

matters related to the commercial companies theyThe supervision was exercised by monitoring hold shares in.

commissions set up in each of the commercialcompanies, which included expert representatives FRPs were actually established with thefrom the Ministry of Finances (MOF), the Ministry of assistance of World Bank's consultants andIndustry (MOI), the State Ownership Fund and the subsequently approved by the Government TheNational Bank of Romania (NBR). These SOF was then instructed to monitor theircommissions were established and managed by a implementation.restructuring committee (RC) that voted the FRPs.The SOF implemented the program. As of August 1994:

The monitoring commission censured the strict * four commercial companies are in the process ofimplementation of the FRPs and reported every liquidation; 12 have "graduated" and, havingmonth to the RC. Several options were available: regained their financial health, have left the

program;* replace the management of the commercial * three have been privatized; and

company; * the remaining 11 are still being restructured.* withdraw further financial support;* declare a state of insolvency and propose Following this rather successful exercise, a new

liquidation. group of 32 commercial companies and eight "regiesautonomes," including the largest loss makers, will

The restructuring committee (RC) consisted of be included in a similar program under therepresentatives from MOI, SOF, POF, MOF, NBR, supervision of a newly created Agency forcreditors state-owned banks. The SOF representative Restructuring and the SOF.

Owned Enterprise Restructuring (August Organization of the State-Owned1990) converted all state-owned enterprises Enterprise Sectorinto Commercial Companies or "regies auto-nomes." Company Law No. 31 (November In 1989 Romania had about 6,000 state1990) provided a regulatory framework for enterprises. By mid-1991 their commer-the establishment, management and liquida- cialization had largely been completed,tion of commercial companies. Law No. 58 creating "regies autonomes" and commercial(August 1991) on privatization of companies.commercial companies provided the legaland institutional framework for the privati- (i) "Regies autonomes" are legal entities inzation program. In June 1994 Parliament which the capital is entirely stateapproved a law for the establishment and owned. The government hasoperation of the stock exchange and the established clear policies limiting theNational Securities Commission. range of activities appropriate to "regies

46


autonomes," as codified in Decision 266 the first auctioning of small assets.of June 10, 1993. This status is During the years 1992-93, it built up arestricted to state enterprises that are well-qualified management team and a"natural monopolies of public interest comprehensive network of regionalor essential for national defense and branches to ensure full coverage of thesecurity." The government limited the country. However, recently the role ofsphere of "regie autonomes" activity by the agency has been greatly reducedforcing many of them to reincorporate because its regional network and directas commercial companies or to spin off privatization activities have beenancillary operations as commercial transferred to the SOF. Its presidentcompanies. As of June 1994, there were left in September 1993 and had notabout 400 "regies autonomes," down been replaced by February 1994.from the nearly 900 that had been Further, most of the agency's best staffincorporated in 1990-91. Of these, 346 have left. The agency is now limited tohave regional importance (mainly in its policy-making, monitoring andwater distribution, public transportation control functions.and road maintenance). Ultimately,only forty four that have national (ii) The State Ownership Fund (SOF) wasimportance will remain in the public established as a public body in Junesector, at least in the near future. 1992 and began operating in OctoberBranch ministries are responsible for 1992. It is the majority shareholder ofthe governance of "regies autonomes" of all commercial companies, having anational importance while local 70% stake in each. According to Lawauthorities govern regional "regies No. 58, this fund is required to divestautonomes." itself of its holdings over seven years at

a rate of at least 10 percent of its(ii) Commercial Companies are the 6,300 original shareholding each year. Its

joint-stock companies that were board of directors is composed ofcorporatized in 1990-91. Their capital members appointed by the Romanianhas been split between the State president (5), Parliament (6), Cabinet ofOwnership Fund (SOF), which owns Ministries (5) and the president of the70%, and five Private Ownership Funds NAP. The board plays a major role in(POFs) under a scheme whereby each policy design as well as in day-to-dayPOF holds the remaining 30% in about decision making. The SOF hasone-fifth of the commercial companies. operated independently of the

government. However, it has beenInstitutional Framework for Privatization plagued by constant management

changes (four general directors within(i) The National Agency for Privatization one year) and various organizational

(NAP) was established in early 1991 as problems and has not successfullya public body to develop a privatization implemented its own privatizationstrategy and to monitor and control its program.implementation. Initially, the agencyplayed an active role in launching the (iii) Five Private Ownership Funds (POFs)privatization process. It initiated the were established in 1992 as privatefirst pilot privatization and organized organizations. Each fund was allocated

47

Romania

30% of the commercial companies' of commercial companies. Each board mustshares, either on a sectoral or on a have at least seven directors (the generalregional basis, on behalf of the manager of the firm is the chairman of thepopulation. These funds essentially board) and there must be at least threeperform like closed-end stock funds members in the General Assembly ofand, at the end of five years, are Shareholders (two for the SOF and one forexpected to be converted into mutual the POFs). The SOF has tended to choosefunds. Headquarters for each fund people from the public sector. The POFshave been established in five different tend to choose people from the privatecities. Even though the members of sector, or academics. Enterprise boards alsotheir boards of directors are nominated include representatives of local authoritiesby the government and approved by and other parties with limited experience inthe Parliament, the POFs have behaved corporate guidance. Apart from largeindependently and consider themselves enterprises where they are directlytruly private organizations. Presently represented, SOF and POFs choose theirthese are the most dynamic representatives from among local officials,organizations in the privatization such as prefects or mayors. In someframework. regions, board members receive a large flat

fee plus a commission on profits netted byOrganization of Corporate Govemance commercial companies beyond their

business plan target. These fees make theseCorporate Governance of Directors' positions quite attractive.Commercial Companies Moreover, since the business plan targets are

proposed by the general manager andThe Law No. 31 on Corporations approved by the directors, both members of

provided a regulatory framework for the the board of directors, there is a risk of theirestablishment and management of colluding to maximize commissions.commercial companies. It established atwo-tier governance structure comprised of: The corporate governance framework,

set out in Law No. 31 was introduced rather* thegeneral assembly of shareholders of quickly, but effective governance continued

each commercial company, which is a to be hampered by the lack of experienceCouncil of State Representatives as among board members. In practice, thelong as the state is the only majority of the commercial companies areshareholder; self-managed and enterprise managers act

* the board of directors, elected by the with considerable independence. Moreover,General Assembly of Shareholders; and not every enterprise has a board of directors.

* the management board, appointed by In 1992, only 1,080 had a board of directorsthe board of directors for operational of more than 6,000 enterprises. Themanagement of a company. management and governance of enterprises

are also affected by powerful TradeThe general assembly of shareholders Unions.

is composed of two representatives from theSOF and one from the POF for medium- Governing such a large number ofand large-scale enterprises and one from commercial companies is a problem. Botheither fund for small firms. These the POFs and the SOF must rely on outsiderepresentatives elect directors to the board representatives. Even if the pace of

48


Box 8: Are "Rtgies Autonomes" Necessary?

Separating "regies autonomes" and commercial sincerity of Romania's commitment to a marketcompanies in Romania and establishing enterprises economy. They continue to exert power overthat will not be subjected to privatization in strategic resource allocation hence frustrating the transition tosectors is criticized. reliance on market forces.

Critics emphasize that: In addition, the legal foundations andprovisions for the governance and accountability of

Firms have not been chosen to be "regies "regies autonomes" set out in Law No 15 seems veryautonomes" according to well-defined criteria, raising weak, especially concerning local "regies autonomes."doubts as to whether many "regies autonomes" are Since a "regie autonome" income benefits theengaged in activities that could be better handled by authority that created it, there is a danger that localcommercial companies and eventually the private governments will exploit "regies autonomes" purelysector. Neither legislation nor the constitution as revenue sources rather than allowing privateclearly specify what enterprises should be "regies businesses to develop and then taxing them.autonomes." On the other hand, economic criteria,such as if the enterprise is a natural monopoly, Because they are insulated from competitiveprovides a public good, or if there is a low demand forces, the "regie autonome" may be, or may become,elasticity for the product, are not always followed. inefficient. In fact, some inefficient firms were madeThe importance of "`rgies autonomes" in the "regies autonomes" precisely to shield them from theRomanian economy creates doubts among domestic market consequences of inefficiency.entrepreneurs and foreign investors about the

privatization is accelerating, the SOF and have a board of directors including betweenthe POFs do not have the internal capacity 7 to 15 Directors representing the sectorto effectively monitor so many commercial branch ministry, the MOF, other branchcompanies and management contracts. ministries with an interest in the activity ofTherefore, it is likely that the daunting tasks the "regie autonome." Some individualsof selecting and training representatives for would be appointed for their specialmore than 6,000 commercial companies and expertise.designing and monitoring managementcontracts wil preclude effective governance, Branch ministries carefully superviseat least in the short run. national "regies autonomes," commonly

interfering in their activities. It raises theCorporate Governance of concern that branch ministries may not be"Regies Autonomes" conferring the operational autonomy that the

management of the "regies autonomes"The governance of national "regies requires to strengthen managerial

autonomes" is the direct responsibility of the responsibility and accountability. Law No.relevant branch ministries, although other 15 stipulated that the "regies autonomes"ministries are involved, including the board of directors should comprise:Ministry of Finance (MOF). The directors of management board members (full-time"Regies autonomes" are appointed by employees of the company), ministerialrelevant branch ministries and by MOF. board members (employed by a ministry,"Regies autonomes" of national interest mainly in Ministry of Industry (MOI) and

49

Romania

MOF), and outside board members Management Contract for Commercial(appointed by MOI and MOF). Recent Companies and "R`ies Autonomes"experience has shown that the inclusion ofgovernment members on the board is To strengthen the governance mechan-clouding the issue of corporate governance: ism, Parliament enacted Law No. 66 on(i) these members have not been able to Management Contracts in October 1993. Itexercise judgment independent of their establishes a framework for managementministries; and (ii) all decisions are indirectly contracts for all commercial companies andbeing left to the ministries, sometimes to the "regies autonomes" in 1994.detriment of the company.

The basic problem of state enterprises isLocal governments are directly govern- that they are controlled by many players

ing local "regies autonomes." Public service with multiple conflicting objectives. Forenterprises provide most public services example, "regies autonomes" must deal with(water supply, solid waste collection and the branch ministry, which feels that it hasdisposal, urban heating, urban transport and the mandate to control them, with the MOFroad maintenance). These enterprises were and the Parliament, which may have othercreated following the break up of the state- goals. To resolve this problem, therun district services departments mandated Management Contract clearly specifies theby the Law on the Restructuring of State objectives of the state enterprise and theEconomic Units. The local "regies corresponding responsibilities of theautonomes" have a considerable advantage government as owner. Commercialover administrative bodies in delivering companies have less of a conflict because inservices, as they can more easily apply the most cases their ties with the ministries areprinciple of direct cost recovery through not as strong and they answer only to theuser charges. SOF.

The ownership of public service enter- According to article 1 of the Law No.prises was transferred to local governments 66, "The management contract is anand was then supposed to be assigned to agreement by which a legal person whoeither districts or municipalities depending carries out an economic activity, in theon the nature of the service. However, most capacity of owner, entrusts a manager toenterprises are in financial disarray. Tariff organize and manage its activity, on theand other income is, in many cases, basis of some measurable targets andinsufficient to cover minimal operating performance criteria, for a payment." Theexpenses. Investment is low or inexistent Romanians call contracts for the commercialand, as a result, the capital stock is companies and the "regies autonomes"depreciating rapidly. These enterprises used management contracts. But theto depend on government subsidies. By government's behavior suggests that thetransferring their ownership to local contracts are more like performancegovernments, the state hoped to end their contracts, at least for the 'regies autonomes."dependence. However, local governments The major difference between the two typesare reluctant to assume this responsibility of contracts is the contractor: governmentbecause they lack the resources to do so. employed managers in the case ofThe ownership situation is thus very performance contracts and privateunclear. In fact no one is actually contractors selected through a biddingcontrolling local "regies autonomes." process in the case of management contract.

50


Management Contract administrators of commercial companies."for Commercial Companies: The selection criteria include: demonstratedReal Management Contract decision-making skills; attending courses

given by the management institutions;The SOF and the POF to which the having management experience in a

commercial company is allocated, and the commercial company or "regie autonome;"other shareholders' representatives, after and making proposals for the commercialconsulting the branch ministries, draw up company's rehabilitation, recovery andthe management contract. The management privatization.contract is binding for a period of fouryears. The objectives and performance Though Romania has started to usecriteria include: turnover; profit or an other tests in selecting managers, incumbentsynthetic financial indicator; import-export managers usually retain their position, evenbalance; investment volume; and after testing. Because the representatives ofproductivity. The terms of reference are the SOF and POF are often localbased on the previous years' financial personalities, they are likely to haveperformance. Every quarter the manager personal connections with the incumbentmust present to the shareholders a statement manager.of the enterprise's economic and financialsituation, and the state of the investments. The role of the manager is of

importance. According to article 25 of LawThe parties to the contracts are the 66, "as soon as the management contract is

commercial company through the represen- concluded, the administrator or the board oftative appointed by the General Assembly of directors in office at that time will stepShareholders, and the manager. down." Thus, the only remaining body to

supervise the manager will be the GeneralLaw No. 66 stipulates that there should Meeting of Shareholders.

be a bidding process to select the managerrather than automatically negotiating with Management Contractthe existing state enterprise manager. The for "Regies Autonomes":Law establishes rules for selecting managers Performance Contractthrough contests for commercial companiesin which the SOF holds over 50% of share The provisions of Law No. 66 alsocapital. Such managers' competitions must apply to the "regies autonomes."be held within six months of the law's date Management contracts for "regiesof effectiveness. The manager is appointed autonomes" are closer to performanceby the unanimous vote of a commission contracts: incumbent managers are favoredappointed by the shareholders. Invitation and no formal bidding process occurs in thefor bids and selection criteria are published selection, negotiation and contract signing.in national and local newspapers. Other features are similar to those for the

commercial companies. The plan to abolishThe rules for and the eligibility criteria the board of directors was a major bone of

for selection have been well defined for the contention between the "regies autonomes"manager contest. A prospective manager and the government, and it has apparentlymust possess good professional references been decided to retain the board after the"from the latest job or from managers or signature of the management contract.

51

Romania

Management contracts have been Tourism which is also represented on thisprepared in collaboration with the World board; and the Ministry of Environment.Bank, especially with "regies autonomes,"and are currently being signed. To establish an effective transparent

regulatory framework that will reconcileCorporate Governance policy objectives (meeting oil and gasin the Energy Sector demand at lower costs) with ownership

objectives (maximizing profits), theThe energy sector accounted for 46% of Romanian government created an indepen-

industrial investment in 1990, and nearly dent regulatory authority: the National100% of public industrial investment in 1992 Agency for Mineral Resources (NAMR).because of the nuclear power development NAMR was established (decree No 417) inprogram. Following the 1989 revolution, the August 1993 as an independent agencyState Planning Agency was abolished and reporting directly to the cabinet. Theresponsibility for energy development was Agency represents the State in all relationsentrusted to the Ministry of Industry (MOI). with central and local government andThe "centrals," enterprise holding groups foreign entities. NAMR's main functionsthat coordinated and implemented annual include managing Romania's mineralplan decisions, were replaced by "regies resources, establishing fees for geologicalautonomes" for the production and supply exploration, and issuing regulationsof energy products, and by commercial concerning exploration, production andcompanies for support services and protection of the useful deposits of mineralactivities. This enabled the government to resources.separate policy and regulation fromoperational functions. NAMR is to be managed by a president

who will have the rank of secretary of State,The Ministry of Industry sets policies and is appointed by the Prime Minister. The

and regulates the energy sector. The agency's president will be supported by aministry is divided into 11 departments each board of administration whose sevenheaded by a secretary of state. The members are appointed by the PrimeSecretary of State for Energy has the Minister and will include experiencedprincipal role in setting energy policies, representatives from the Ministry of Finance,though other departments are also involved Ministry of Justice, Ministry of Industry, andat times (the Secretaries of State for Ministry of Environment. As a first step inRestructuring, Strategy and Reform; and the making the agency operational, theSecretary of State for Management, government has appointed the President ofLegislation, Human Resources and NAMR.Administration). The Secretary of State forEnergy has several divisions under him, Five "regies autonomes" have beeneach headed by a director general. Other established in the sector: (a) RENEL,ministries involved in policy formulation responsible for power generation,functions, sector regulation, and ownership transmission and distribution; (b) PETROM,functions are the Ministry of Economy and responsible for the production of oil andFinance which sets prices, and is represented associated gas; (c) ROMGAZ, responsibleon the board of directors of the "regies for the production, transmission andautonomes;" the Ministry of Commerce and distribution of non-associated gas; (d) RAL,

responsible for the mining and distribution

52


of lignite; and (e) RAH, responsible for the RENEL was reorganized in late 1992mining and distribution of hard coal. and given a corporate form. CorporateComplementing the work of the "regies policy-making is vested in a nine-memberautonomes" are 45 commercial companies, board of directors, which is chaired by theincluding CONPET which transports and president of RENEL. In addition, the boardstores all domestic and imported gas. of directors comprises representatives of the

government, financial institutions, fuelThese agencies seem to suffer from suppliers, and consumers. RENEL's

common systemic problems including: management, which includes the President(i) government micro-management ranging and five Vice-Presidents (one each for:from control over prices and profits to generation; transmission and distribution;interference in day-to-day affairs; (ii) lack of nuclear power group; strategy andcommercial orientation; (iii) lack of financial development, finance and human resources),accountability and the absence of sound handles day-to-day affairs.investment decision-making procedures;(iv) overlapping responsibilities of agencies The reorganization was intended toand departments within agencies; separate the corporate policy-making from(v) overemployment; and (vi) the absence of company management operations. How-a competitive environment that would foster ever, there is little separation in practiceoperational efficiency and flexibility. The since several vice-presidents are alsosector needs to be restructured in order to members of the board of directors.achieve efficiency, improve managementcapabilities, and promote private sector Gas Sectorinvestments essential to the efficientdevelopment of the sector. In pursuit of ROMGAZ is a vertically integratedthese objectives, the Government, with the "regie autonome" responsible for gasassistance of the World Bank, has developed exploration, production, transmission andan overall strategy for the energy sector. distribution. It is managed by a general

manager, who reports to the board ofElectricity Sector directors. Both the general manager and all

members of the Board are appointed by theRENEL is a "regie autonome" Ministry of Industry. The board consists of

responsible for electricity and heat seven members, including the Generalgeneration, transmission, and distribution. Manager and one representative each fromIt was created in 1990 from the former the Ministries of Industry, Finance andMinistry of Electrical Energy (MEE), which Commerce. The board of directors has thehad been responsible for the electricity power to approve budgets prepared byproduction and supply, detailed engineering. ROMGAZ's management and to approvedesign and construction, foreign trade, work and investment programs within theresearch and development, and nuclear guidelines set by the Ministry of Industry.power development. Some of theconstruction and foreign trade departments The 1994 World Bank financedwere spun off into independent commercial Petroleum Sector Rehabilitation projectcompanies. The staff of RENEL was includes a component for restructuringreduced from 200,000 in 1990 to 105,000 in ROMGAZ. This restructuring is designed1993. to correct the anomalies and inefficiencies

53

Romania

created by its involvement in service and country's geographically dispersed coalmaintenance-oriented activities and to mining activities into two companiesimprove its accounting and management allowed each company to control aninformation systems. Since ROMGAZ is a unusually large number of mines. While thevertically integrated group, its exploration, creation of two companies was a logical,production, gas transmission and practical and probably useful organizationaldistribution activities are the responsibility step at the beginning of the economicof a single headquarters management group. transformation, particularly given the needThe Corporate Development Program would to dissolve the ministerial lines ofconvert ROMGAZ into a holding company responsibility, there is now a need towith four subsidiaries. The program would review the sector's organizational structureinclude: to find ways to create viable economic

producers. The options considered by the* restructuring ROMGAZ as a company government and the World Bank would

that would coordinate the activities of include:four Strategic Business Units (SBUs):one for exploration/production, one for (i) breaking-up the existing "regiestransmission, and two for distribution autonomes" into smaller companies;of gas;

(ii) spinning off unprofitable mines by* reorganizing the functions of the SBUs placing them under new ownership and

and the headquarters group along lines management or phasing out theirmore closely related to their respective operation; andactivities and upgrading theirdepartments for accounting, financial (iii) transferring mines that supply a singlemanagement, corporate planning, and power plant to the power plant.human resources;

Management in both RAL and RAH has- establishing financial performance very good technical qualifications.

criteria for each SBU; and However, its ability to act is inhibited bystrong union and worker pressure and it

* developing options for privatizing the lacks financial and commercial expertise, asSBUs. well as institutionalized procedures for cost

accounting, auditing, and capital budgeting.Coal and Lignite Sector

Railways SectorTwo "regies autonomes" are operating

in this sector. RAL which manages all The situation of the Railways sectorlignite mining operations, and RAH which (SNCFR) has worsened dramatically sincemanages all hard coal mining operations. In the loss of the major part of the freightterms of output, profitability and future traffic in 1989. A thorough reorganization isdevelopment prospects, RAL is the more required to equip SNCFR to cope with theimportant of the two. changed economic and political environ-

ment. In 1990 SNCFR was reorganized andRAL operates about 35 surface mines is now a "regie autonome." It is divided

and 50 underground mines. RAH operates into eight regions and the area of the port ofonly underground mines. Consolidating the Constanza. Each region has three to five

54


sub-regional units to manage railway Ministry of Communications' efforts tooperations. The president of the board is commercialize the Communications sector,assisted by three vice-presidents Rom-Post-Telecom was split in January 1991(operational, technical and financial). The into the separate "regies autonomes." Rom-board is responsible for determining railway telecom (universal telecommunications), Postpolicy, including tariff policy, organization Regie Autonome (postal services), Radioand operations control. Regie Autonome (radio), General

Inspectorate (mobile telecommunication),A draft law was written by foreign and Bank Post (financial services).

consultants at the request of the SNCFR todefine it as a "regie autonome" operating on Each of these "regies autonomes" is acommercial principles (consultants proposed separate legal entity with its own profit andto transform SNCFR into a commercial loss statements. These enterprises are notcompany, but the government refused). expected to be privatized, because theSNCFR would be a "regie autonome" with a government considers the functions theyfifteen-member board of directors: the perform to be strategically important. Thechairman, appointed by the government and government has indicated, however, that itrecommended by the Minister of Transport; would consider changing the status of Rom-representatives of the Ministries of Telecom and General Inspectorate toTransport, Finance, Employment and Social facilitate their commercialization.Protection, Industry and Public Works;experts and economists. The chairman A board of directors in the Ministry ofwould serve as the president of SNCFR. A Communications provides guidance and"Holding Board" would be established to oversight to Rom-Telecom's management.advise the president on corporate policy, This board of directors has 15 members.controlling and guiding activities, and Five directors are representatives of thecoordinating. Performance contracts are also Ministries of Industry and Finance, thebeing written. districts units, the association of customer

protection, and educational institutions.Telecommunications Sector

The organizational structure of Rom-The Ministry of Communications is Telecom is hierarchical and rigid. It is

responsible for the telecommunications headed by a general director selected andsector. It sets national telecommunications appointed by the board of directors, subjectpolicy and performs regulatory functions to approval by the Ministry of Tele-including allocating frequencies, setting communications. The senior managementtariff and establishing technical standards. team is accountable to the Ministry ofIn 1990, as a first step in the restructuring. Communications for Rom-Telecom'sprocess, Rom-Post-Telecom was established technical, financial and managementto provide telecommunications, postal, radio performance.and television services. As part of the

55


Russia

Iinna Starodubrovskaya

Snmuary residual state sector: representation of thestate ownership rights has been distributed

Developing a corporate governance in a more clear way between the centralsystem for state-owned enterprises has not government, the State Property Cornmitteebeen a focus of reforms in Russia, which has (GKI) and sectoral agencies; rights andinstead emphasized their rapid privatization. responsibilities of the managers of state-Before the beginning of mass privatization owned enterprise have been clarified andall the state property was divided into four the procedure for making contracts withcategories: exclusive federal property, state-owned enterprise managersfederal property which might be transferred established; the general principles of stateto the subjects of the federation, property of representation in the governing bodies ofthe subjects of the federation, and municipal joint-stock companies partly owned by theproperty. By the middle of 1994, public state have been described; the rules on howsector enterprises (i.e., those wholly owned to deal with insolvent state-ownedby the state) employed about 48% of the enterprises have been established; and thetotal labor force and produced about 35% of legal basis for governmental (kazenny) plantthe nation's industrial output. However, the establishment and operation has beenregulatory basis for public sector control is formed. The reform of state-ownedembryonic. Sectors and types of enterprises enterprises is aimed primarily at overcomingto be totally owned by the state are defined the negative consequences of past policieson a "residual" basis, e.g., as entities granting the state-owned enterprise directorsprohibited for privatization under the State the "full right of economic management,"Privatization Program which is periodically, which has led to numerous cases of abuseupdated. This same document identifies and misuse.sectors where the state retains control overstrategic decision-making, as well as the In practice, noncorporatized sectors areforms of such a control. mainly governed under sector-specific

schemes whose principles are outlined inDuring 1994, a number of legal acts special presidential and governmental

have been enacted which are designed to resolutions for that sector. Joint-stockimprove the corporate governance of the companies, in which the state has a

57

Russia

controlling interest ("Golden Share") are privatization. By the middle of 1994, publicsubject to the general regulations for joint sector enterprises (enterprises completelystock company operation, with due regard owned by the state) employed about 48% offor sectoral peculiarities normally reflected the total labor force (down from 60% in thein presidential decrees. To manage the first quarter of 1993) and produced aboutblocks of shares held by the state, the GKI 35% of the nation's industrial output (almostuses different sector-specific schemes: there 75% in the first quarter of 1993).is no standard solution. This paper willpresent the corporate governance structure The table below summarizes theof the main residual public enterprises. For progress of corporatization.example, in the power sector, the state holdsa controlling interest in a joint stock Since early 1994, more attention hascompany, RAO EES Rossii, whereas in the been given to the issue of corporatecoal sector, a state-owned enterprise, governance in the public sector. A numberRosugol, has been established and contracts of government resolutions and presidentialwith GKI for the commercial management of decrees have been adopted that: allocatepublic shares. In contrast, in the public property management/responsibili-telecommunications sector there is no ties among the Russian government, theintermediary management structure; the State Property Committee (GKI) and sectorpublic interest is represented by the staff of governing agencies; specify the duties of thethe Ministry of Communications under director of a state-owned enterprise; regulateagreement with GKI. contracts with state-owned enterprise

managers; and establish ways to representBackground state interests in the enterprises' decision-

making bodies.In Russia, developing a corporate

governance system for state-owned The reform of the corporate governanceenterprises has not been a focus of reforms, of state-owned enterprises is primarilywhich have instead emphasized their rapid intended to change the responsibilities and

Privatization and Corporatization, 1993-94

In First Six Months1993 1994

Number of privatized enterprises 43,000 12,000

Corporatized enterprises as percent of all privatized 31 47enterprises

Enterprises whose controlling share is held by the state 3.2 11as a percent of all corporatized enterprises

Enterprises whose controlling share is held by the state 1.5 6as a percent of all corporatized enterprises

Source: Goskomstat

58


incentives of their directors. While workers Representation of the State'snever took a very active part in enterprise Ownership Interestsmanagement in Russia, the scope ofauthority of state-owned enterprise directors The redistribution of public propertyeven in the pre-reform period was among the federal, regional, and municipalcomparable to that of private owners. governments took place in December 1991,Legally, directors were granted the full right in preparation for mass privatization. Aof economic management, essentially giving resolution of the Supreme Soviet of thethem a free hand in enterprise property Russian Federation identified three types ofmanagement and creating the opportunity public property: exclusive federal property,for numerous cases of misuse. Decisions federal property that might be transferred totaken in 1994 have significantly restricted private citizens, and municipal property.the rights of state-owned enterprise Property that did not fall under any of themanagers, forcing them to manage three categories was considered to be ownedenterprise property in strict compliance with by private citizens. According to the aboveits purpose as defined in the transfer classification, federal property includeddocuments or enterprise charter, and mining enterprises (except for theprohibiting them from making real estate production of local raw materials); fuel andtransactions without the GKI's approval. energy enterprises; railway, air, pipeline,For example, state-owned enterprise inland water and marine transport;managers do not have the right to lease communications; most power and gasassets, or create subsidiaries without GKI's distribution enterprises; television and radioconsent. transmission facilities; and federal highways

and their respective servicing entities.However, mechanisms of manager s

responsibility to the state as an owner are Public property division does not implynot yet adequately enforced. Many of the that owners at different levels actinstruments and methods of governance independently. The managers of largetypical of the former state planning system federal property facilities take the interestsand many of personal relations established of regional authorities into account, notablythen (the so-called "telephone right") still when appointing directors. When aplay a significant role in governance today. fundamental decision is made on theAt the same time, organizations meant to corporate governance of federal state-ownedrepresent the state's interests often act as enterprises, the Federal government usuallyrepresentatives of the enterprises and lobby recommends that regional authoritiesfor them. This behavior is especially implement a similar policy with respect tocharacteristic of line ministries or bodies their own enterprises.which grew out of former ministries. Thesebodies still hold on to their old patterns of The distribution of responsibility fordealing with their former subordinate federal property management has not beenenterprises, despite the fact that their addressed for a long time and isownership may have changed radically. characterized by some uncertainties. At

59

Russia

present, the following bodies are in a held by the state, these shares are managedposition to implement the powers of by the Federal Property Fund. To manageownership: the GKI, the Russian Federal the shares held by the state, the GKI usesProperty Fund, the Federal Bankruptcy different sector-specific schemes, rather thanAgency under the GKI, and sectoral a standard solution. However, according togoverning agencies. governmental resolution No. 96 of

February 10, 1994, the Russian governmentWith respect to enterprises owned must decide which of the entities (GKI or

exclusively by the state, the powers are Property Fund) shall act as a founder ondistributed as follows. The GKI is in charge behalf of the state.of transferring public property to legalentities for economic and operational If a federal state-owned enterprise or amanagement, for lease or use under partially owned enterprise is consideredagreements, and to monitor targeted insolvent (according to insolvency criteriautilization. In addition, the GKI approves a legalized by governmental resolution No.standard charter of a state-owned enterprise 498 of May 20, 1994), state representation isand a model contract with a manager. transferred to the Federal Agency ofHowever, the approval of specific charters, Bankruptcy. This agency thus acquiresconclusion of managerial contracts, and extensive powers with respect to directorappointment and dismissal of managers are replacement, enterprise restructuring,the responsibility of sector governing ownership change, and a number of otheragencies. Sector agencies can also make operational issues.decisions on the establishment,reorganization, and liquidation of their Under presidential decree No. 2296 ofrespective subordinate enterprises if the December 24, 1993, on trust property, blocksdecisions can be implemented given of state shares (fixed as state property afteravailable budgetary allocations and labor privatization) can be transferred to a trust,requirements. All other decisions are the with the state budget being its exclusiveresponsibility of the Russian government beneficiary. However, this mechanism wasand the GKI. not widely used until the issuance of the

decree of September 1995 on loan equityThe GKI supervises the utilization of swaps, which represents a major innovation.

state property and realty transactions madeby federal state-owned enterprises, federal Through the September 1, 1995 decree,state organizations and federal governing the Russian loan-equity swap undertaken toagencies. There are very few exceptions: the reduce the federal budget deficit hasMinistry of Railways, for instance, has the authorized banks and local and foreignright to sell the rolling stock at its own investors to manage state shares in certaindiscretion. The GKI monitors other federal enterprises in exchange for major loans totransactions. the state. The measure allows the state to

retain ownership of the shares. However,With respect to partially state-owned the shares will be transferred to the banks

enterprises, on one hand the GKI acts as a and investors if the state defaults on therepresentative of the state if the state owns loans. The right to manage the sharesthe controlling share. On the other hand, if would be allocated by tender and thean enterprise is subject to unrestricted amount of the loans and the conditions andprivatization, and its shares are still partly

60

Corporate Govemance of Public Enterprises in Transitional Economies

guarantees would be determined by the and rare earth elements; nuclearsuccessful bidders. engineering r military; production and

utilization of virulent, toxic, and explosiveCorporatized and Noncorporatized materials; research institutions; wholesaleSectors: Types of State-Owned trade enterprises engaged in publicEnterprises and Forms of State procurement and export/import operationsParticipation in Ownership under international agreements; and foreign

trade enterprises. A decision to retain theLegal forms for the operation of a state- controlling share can be made for a three-

owned enterprise have not yet been year term, which can be renewed once. Atfinalized. The privatization program the same time, the Russian government oradopted in December 1993 recognized only the GKI can sell the controlling sharestwo types of state-owned enterprises: state before the end of the three-year period.organizations and joint-stock companies thatare entirely publicly-owned. Presidential The level of participation associateddecree No. 1003 of May 23, 1994, introduced with the controlling share is 51%, 36% (ina third type, a kazenny or governmental the case where non voting shares areplant (factory or farm). This new legal form present) or 25.5%, of the capital base.has yet to be tried in practice. A number of Alternatively, the state can decide to retaindraft laws describe other types of state- a "golden share." With a golden share, theowned enterprises, such as noncorporatized state reserves the right to veto the followingenterprises. Those enterprises that have not decisions made by a shareholder meeting:been corporatized are mainly governedunder sector-specific schemes whose * to amend a joint-stock company charter;principles are outlined in special presidential * to reorganize or liquidate a joint-stockand governmental resolutions. Examples of company;noncorporatized enterprises are mentioned * to participate in other enterprises andlater in the sector descriptions. enterprise associations; and

0 to manage the enterprise's property.

Joint-stock Companies When 25.5% of the shares are held as

Joint-stock companies in which the state property, the range of decisions left tostate has a controlling interest are subject to the discretion of public bodies is close tothe general regulations for joint-stock that associated with a golden share. Thesecompany operation, and presidential decrees include decisions which must be agreedthat account for sectoral exceptions. In with the holders of the remaining 75% of thepractice, joint-stock companies that are votes, as defined by the standard joint-stockowned exclusively by the state are company charter.uncommon and a special mechanism fortheir governance has not been developed. A controlling share equal to 51% or

25.5% of the voting stock allows the state toFor a number of sectors, the Federation influence any decision that could be made

can retain controlling shares, including: by the shareholders meeting. Under thecommunications; fuel and energy; water post-voucher privatization program, theand transport; production and processing of Russian government will decide on a case-precious metals and stones, and radioactive by-case basis whether to retain a controlling

61

Russia

share. Reserving controlling shares of were no real incentives for taking part inprivatized enterprises as state property has this work. The Decree did not clearlynot been widely implemented (see Table specify how representatives were to bepage 58). remunerated for their services. Moreover,

the issue of compensation for travel andBefore the first shareholders' meeting, other business expenses of people

which must be held within twelve months of responsible for public representation wasthe registration of a joint-stock company, the not addressed.board of directors, including those of joint-stock companies partially owned by the Presidential decree No. 1200 onstate, shall be determined by the standard Measures to Ensure State Control of thejoint-stock company charter. According to Economy, signed on June 10th, 1994,the charter, the board of directors consists of specifies the mechanism for representingthe general director; a representative of the state interests in joint-stock companies. TheGKI or a trust owner; a representative of the decree envisages that representatives canworking collective; and a representative of include civil servants or other Russianlocal authorities. Even when the Federation citizens, except members of the Parliamentowns controlling share, representatives of and local bodies. State representatives arefederal authorities cannot have a majority on to reach a written agreement with bodies onthe board. Theoretically, should a conflict whose behalf they act on draft decisions thatarise, they will be forced to convene a they will submit and support and on theirgeneral shareholders meeting to exercise position on draft decisions proposed bytheir ownership rights. Nevertheless, in other members of the joint-stock companypractice, public bodies are preserving the management. The issues covered includeabove membership structure of boards even changing and amending the company'safter the first shareholders' meeting. The statutory documents; changing thedirector of a joint-stock company in which company's authorized capital; appointingthe controlling share is owned by the state is (electing) members to joint-stock companyappointed by the sector governing agency or management and supervisory bodies; loansanother body representing the state. exceeding 10% of the company's net assets;

realty transactions; and participation of theBefore June 1994, representation of state company in establishing other enterprises

interests in joint-stock companies partially and financial and industrial groups.owned by the state was based on Representatives of the state are to alsopresidential decree No. 1392 of November submit to their respective governmental16, 1992. This decree stipulated that the bodies reports on the performance of thestate's interest could be represented at the joint-stock company at least twice a year.board of directors on a contractual basis by This decree includes promising provisions,people identified by the Russian government but the mechanism it foresees for decisionor the GKI, including officials from state- making is cumbersome.owned enterprise administrations or public-management bodies. Civil servants engaging This decree gives a more detailedin this activity were not subject to the description of the legal rights and duties ofrestrictions set out in the presidential decree representatives who are not civil servants.on the Prevention of Corruption in the Civil It establishes that the GKI or the PropertyService System, and were to be remunerated Fund are to enter into contracts with thesefor their service. In practice, however, there individuals to represent the interests of the

62


state. The contract is to be registered by have to travel all over the country to takejudicial bodies and specify: part in the management of a large number

of enterprises, which might be considered a* the duration of the contract and the waste of time and money. The Ministry of

procedure for its early termination; Communications, for example, is trying to* the rights and responsibilities of a state use the controlling share held by the state to

representative; maintain control over its former subordinate* remuneration; and enterprises (now joint-stock companies). To* the penalty for the violation of alleviate this problem, the GKI has proposed

contractual terms and conditions. retaining ministries to represent publicinterests only in the most important

For civil servants, the decree only states communications enterprises. For the otherthat if their voting is at variance with the enterprises, the ministry can contract with aagreed decisions of governmental bodies, local official to represent the interests of thethey are to be subject to disciplinary state or transfer the state's share to a trust.sanctions and, at most, to dismissal from thecivil service. The other issues related to the N-oncorporatized Sectormechanism of public interest representationby civil servants have not yet been formally A number of sectors and enterpriseestablished. categories cannot be privatized under the

State Privatization Program: they can beThese decrees do not clearly specify generally equated with the notion of a

which bodies can choose public "noncorporatized public sector." This sectorrepresentatives (especially in the case of civil includes inter alia: organizations more thanservants) and on behalf of which bodies the 50% funded directly from the Russianrepresentatives can act, although the most Federation's federal budget; railways; mints;frequently mentioned bodies are the Russian nuclear and toxic waste disposal enterprises;Federation government, the GKI, the nuclear power plants; enterprises producingProperty Fund, and federal executive nuclear and radioactive materials andauthorities (which usually include sectoral nuclear weapons; postal enterprises;agencies). However, it is established that if precious stone grading factories, gold andthe management body of a joint-stock silver refineries; radio and televisioncompany includes state representatives transmission facilities and radio centers; andselected by several governmental agencies, a number of research institutions, etc.they are to agree on their common positionprior to discussions. The idea of establishing entities in the

form of kazenny-government plantsIn practice, modifying relations between (factories or farms), as a way of primarily

ministries and their once subordinate reorganizing a part of the noncorporatizedenterprises when ownership changes is a public sector has recently been proposed. Incomplicated process. The ministries retain a compliance with presidential decree No.desire to exercise control as reflected, for 1003, these entities would be establishedinstance, in the appointment of federal from primarily noncorporatized state-ownedministerial staff only to represent public enterprises intended to be liquidated.interests in the management of joint-stock However, it is still unclear how widespreadcompanies. As a result, ministerial officials this type of entity can become and what role

63

Russia

it would play. (The postal services since performance. The manager's salary is paidtheir reorganization in 1992 bear some out of the plant's wage bill, according to theresemblance to the kazenny concept. The rules established for civil servants.problems that have arisen in that sector arediscussed at the end of this report.) The activities of kazenny are to be

financed by product sales and revenuesUnder the decree, kazenny can be from other authorized activities. If a plant

established from federal, industrial or lacks resources, it can obtain public funds toagricultural state-owned enterprises that implement its development plan, maintainmeet at least one of the following social infrastructure facilities, and coverrequirements: losses from the execution of the plan order.

The amount of funding is deterrnined* they carry out activities restricted to annually as part of the process of plan order

state-owned enterprises; and development plan approval. The* the state consumes at least 50% of their Ministry of Finance (MOF) provides

product; or budgetary allocations only after receiving* their privatization is prohibited by the information on the expenditures and general

state program. economic performance of the plant in thepreceding period.

This type of organization is a reactionto the misuse of budgetary appropriations or Property is transferred to a kazennyreal property by enterprise managers and/or based on the right of operationalto the lack of profits from activities carried management. As a rule, a plant sells itsout over the last two years. The reform is products independently. However, withoutthus perceived as a way of punishing the approval of the Russian government orenterprise managers. its authorized agency, a kazenny is not in a

position to establish subsidiaries, act as aRegulations for operating akazenny are founder of enterprises and organizations, or

set out in presidential decree No. 1003, make realty transactions and use real estateStandard Charter and Procedure for as collateral. A kazenny can only obtainPlanning and Financing the Activities of credits under guarantees from the RussianGovernment Plants (Factories or Farms) government.Established on the Basis of LiquidatedFederal State-Owned Enterprises. A Apart from kazenny, two other legalkazenny operates in compliance with an forms of noncorporatized enterprises areannual plan order and a development plan, anticipated in the Civil Code: "unitarian"and has the rights of an independent enterprises that would be state or municipaleconomic activity, as permitted by a state enterprises. Accountability and governanceagency authorized to govern the plant (this mechanisms for the operation of unitarianagency has not yet been identified). The enterprises have not yet been fullyplan order shall establish basic indices of developed.production and sales, including setting andestablishing conditions for changing prices System of Relations with Directorsand wages, setting the employment limit, of State-Owned Enterprisesand determining the procedure and timingfor obtaining funds. A kazenny plant As in joint-stock companies, the directormanager is responsible for the plant's of a noncorporatized state-owned enterprise

64


is appointed by the sector governing agency powers, and manage enterpriseor by another body that represents the state, property;in consultation with the local government. * reporting procedures;In some cases, special regulatory acts have * procedures for and terms of an earlyestablished rules for appointing heads of termination of contracts;noncorporatized state-owned enterprises. * responsibility of the enterprise managerFor example, the Russian government has regarding the economic performance ofpassed resolutions covering the appointment the enterprise and safety and properof heads of individual regional railways. In use of property, including liability forother cases, appointment is regulated by any damage to the enterprise integrityinformal mechanisms. For example, a as a result of action or inaction; andmoratorium on director replacement was * size of compensation in special casestemporarily instituted during the and social guarantees to an enterprisecorporatization and privatization of the manager and the manager's family.volatile coal sector to avoid destabilizing thissector. The decree specifies that contracts

should be made with newly appointedUntil 1994, relations between the state managers of state-owned enterprises, as well

and the heads of noncorporatized state- as with managers whose labor contractsowned enterprises were regulated by labor have expired. In addition, reviewing laborcontracts with sector governing agencies. contracts with the managers of state-ownedHowever, the incentive system was often enterprises in accordance with the decree isdetermined by other factors. In a number of a prerequisite for obtaining federal financialcases, directors received bonuses on the support (as stipulated in presidential decreebasis of performance indices practically No. 1484 of July 8, 1994). Existing laboridentical to those used under the socialist contracts with the managers of federal state-system. owned enterprises will not be renewed or

extended. Thus, managers are no longerAccording to presidential decree No. viewed as any other employee. Instead,

1200 (June 1994), the relations between relations with managers are governed bygovernmental bodies and heads of federal civil law.state-owned enterprises are to be regulatedunder contracts (that may resemble Implementation of the new regulatorymanagement contracts) made according to system is expected to have a significantthe civil law. The decree sets out the impact on the behavior of enterprisefollowing mandatory provisions: managers by eliminating or reducing the

negative implications of the previous "full* contract duration of at least three years; economic management system." The new* a guaranteed pay of no less than ten system enhances the incentives for profitably

minimum monthly salaries; operating an enterprise. Under the contract,* manager's share in enterprise's net a director shares the enterprise's profits. At

profit; the same time, if losses are incurred, an* rights and responsibilities of the enter- enterprise can be considered insolvent,

prise manager concerning enterprise leading to the intervention of themanagement, including the right to hire Bankruptcy Agency and possibly theand dismiss employees, delegate replacement of the manager.

65

Russia

Managers are unlikely to be swayed by problems will be addressed over the middle-the threat of transforming enterprises into term.kazenny. For one, only a limited range ofenterprises are eligible. For another, such a According to the draft law, naturaltransformation is viewed positively in many monopolies include pipeline transportationcases. On the one hand, a manager's rights of oil and gas; railway transportation and aare severely restricted, but on the other, a number of other segments and types ofmanager is largely relieved of responsibility transportation services; power productionfor the plant's financial performance and can and transmission; certain types ofbenefit from the contradictions in the telecommunications and postal services; andcentralized governance mechanism. Some local utilities. The law does not envisagedirectors have tried to obtain the status of a any limitations on ownership of naturalkazenny; numerous applications of this type monopolies and applies as well to privatizedhave been made for different ministries. facilities, even those without any public

shares. It calls for the establishment ofDespite these changes, it can be governing agencies to perform the following

assumed that a manager's position will be major functions:secure for a long period of time. There is asyet no "market" for managers, making the * compiling a list of natural monopolies;search for a qualified replacement very * regulating the activities of naturaldifficult. Further, governing agencies often monopolies, including the identifica-have a paternal attitude toward managers, tion of priority consumer groups andwhich prevents an objective assessment of various methods for price regulation;their performance. * monitoring diversification of natural

monopolies' activities, their investments,Natural Monopolies and Crisis Sectors: and realty transactions on a preliminaryPractical Experience with Public basis;Regulation * monitoring the movement of natural

monopolies' stock; andTlhe activities of natural monopolies * imposing sanctions if a natural

represent one of the most urgent issues of monopoly violates the law.the Russian economic reform. Low-qualityTservice provision, overshooting of prices and The draft law recognizes that reformingtariffs, and lack of responsiveness to the natural monopoly governance systemcustomers are typical of Russian natural will be a lengthy and gradual process. Untilmonopolies. The first attempts to solve the end of 1996, existing public governingthese problems are currently being made. In agencies will take on the role of regulatingearly 1994, a draft law on natural natural monopolies. Each sector will havemonopolies was prepared and submitted to its own reform implementation rate andthe state Duma. The development of methodology.possible approaches to sector-specificreforms has been initiated with the help of Railwaysforeign experts. However, the content of thedraft law and the current situation in The economic transition has not hadspecific sectors do not suggest immediate much of an effect on the governancereforms in this area. Most likely, these mechanism in the railway sector. The

Ministry of Railways, which has retained its

66


independence from other transport- construction industry enterprises workinggoverning agencies, still combines the for power sector for commercialfunctions of governing agency, owner and management (close to trust). The controllingeconomic agent. Only catering facilities in share of RAO EES (no less than 50%trains and at stations have been privatized, according to presidential decree No. 1334) isalthough, even there, the process has been held by the state, with 30% of the publictedious and slow. votes belonging to regions. RAO's board of

directors consists of 15 people, including tenA strictly vertical governance structure representatives of the state. Three of the ten

has been preserved: railways are represent regions and the rest are high-levelsubordinate to the Ministry of Railways, officials from core econornic public bodies,railway divisions to railways, and linear such as the GKI, the Ministry of Economy,units (such as stations and depots) to and the Ministry of Fuel and Energy.divisions. Unlike the "premarket" period,the Ministry of Railways does not dictate the The allocation of responsibilities in theamount of railway transportation to provide, sector is the responsibility of the Ministry ofbut coordinates transportation, redistributes Fuel and Energy (MOFE). The federal andfinancial resources, and influences railway regional energy commissions regulate tariffs.tariffs. Radical reforms in the sector will be It is intended that the public control overextremely difficult and are not likely to be RAO EES be executed through stateinitiated in the short term. The difficulty is representatives on the board of directors.largely a result of three major factors:

However, these mechanisms do not• the importance of Russian railway work efficiently enough. Experts believe

transport and impermissibility of any that RAO EES, which is a giant monopolydeviations from its normal operation, holding company, cannot be effectivelywhich, in the opinion of national externally regulated because the stateleaders, can occur during the process of representatives are totally dependent oninstitutional changes; company managers for information on the

* the lobbying capacity of the Ministry of company activities. In addition, companyRailways, which is interested in representatives were members of the Federalpreserving the existing status; and Energy Comnmission and largely controlled

i large-scale cross-subsidization of its decisions on prices and tariffs. Thevarious railways and freight and Commission, which consisted of less than 20passenger transportation. people who had other responsibilities and

were not paid for their service, lacked theElectricity required capacity and resources for real

control over tariffs.A joint-stock company, RAO EES Rossii

(RAO EES), was established in the power Presently, a number of measures aresector, with the state contributing to its being taken to change the situation. Thecharter capital (among other facilities) no status of the Federal Energy Conmmissionless than 49% of the shares of every regional has been enhanced and its rights expanded.power joint stock company and 51 to 100% It is now chaired by the First Deputyof the shares of large power plants. RAO Chairman of the Russian government, A.EES also received state shares of Chubais. The Ministry of Economy (MOE)

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Russia

is responsible for providing logistic support * Enterprises included in productionto the Commission. The Statute of the associations were transformed intoFederal Energy Commission, approved by subsidiaries of joint-stock companiesGovernmental Resolution No. 739 of established from these associations.June 19, 1994, has authorized the * Enterprises included in voluntaryCommission to obtain information from associations were corporatized asenterprises to better justify tariffs, improve independent joint-stock companies.the pricing mechanism in the energy sector, Holding structures were also formed byand study the efficiency of public regulation consolidating shares of theseand competitive market formation in the enterprises.sector.

In both cases, the controlling share ofIn principle, the revamped Federal the joint-stock companies was held by the

Energy Commission could serve as a state, with a regional share included in thestarting point for a body that would regulate state block. Some mines were privatizedthe electric power sector as a natural following the national privatization scheme.monopoly, although its form is that of aninteragency cornmission, consisting of The following bodies are involved inproducer, consumer and government coal-sector governance:representatives. However, the incorporatingof consumers is a step forward, since there * Rosugol: a state-owned holdingwere practically no consumers in the former established by the GKI under aproducer-dominated Commission. Further, presidential decree. Rosugol has amany experts believe that the successful contract with the GKI for theregulation and improvement of the sector's management of public shares of coalefficiency requires large-scale reforms aimed mines and associations (similar to aat the formation of a competitive power trust). Appointments of the generalmarket. director and members of the company's

management bodies must be approvedNuclear power stations remain 100% by the government. In addition to

state owned; there are no plans for managing public blocks of shares,privatization. The bulk of these stations are Rosugol carries out various activitiespart of the state concern RosEnergoAtom such as consulting, diversifying intowhich is subordinated to the Ministry of other sectors, and distributing subsidies.Nuclear Energy. Experts doubt that it is possible to

combine the public governance of coalCoal enterprises and commercial relations

within the same body.Corporate governance mechanisms in * The Ministry of Fuel and Energy is in

the coal sector were developed in response charge of implementing state policy into many factors, including a complicated this sector.social situation in many coal regions, a * Interagency Commission for themultilevel institutional structure, and Socioeconomic Problems of Coalallocation of large subsidies. They were not Production Regions: established todesigned to promote efficient downsizing. coordinate the interests of governmentalIn compliance with the Presidential Decree, bodies (the Ministry of Finance, thethere were two schemes for "privatization": Ministry of Economy, the Ministry of

68


Social Protection, the Ministry of Fuel the Federal Post Service Department, and doand Energy, and the Ministry of not require public support. According to aEnvironmental Protection and Natural high-level official in the Federal Post ServiceResources), trade unions, and admini- Department, the availability of such servicesstrations of coal producing regions, to is among the criteria used to assess theaddress problems in the coal industry. efficiency of postal service managers.The Commission is headed by the First Although the Russian postal services wereDeputy Prime Minister. It was set up reorganized prior to the emergence of thein response to increased social tension concept of the kazenny, the result bearsand intensified workers' movements some resemblance to thekazenny and pointsand strikes in coal-producing regions. to problems that may emerge with this

model.The current governance structure does

not promote the downsizing of inefficient Lessons and Prospectsenterprises; the coal industry has a complexmultilevel structure, in which financial flows During 1994, there have been a numbercan hardly be regulated by the state. At the of legislative reforms which appear tosame time, the need for coal sector down- recognize the need for an effective system ofsizing is widely recognized both within the monitoring and controlling state-ownedgovernment and by the general public. The enterprises, although Russia is still far fromWorld Bank's report on coal industry re- implementing such a system. These reformsstructuring has played a significant role in include a more rational distribution of stateattracting attention to the problem. There property governing functions amongare two approaches to downsizing: Rosugol different governrnental agencies, as well asproposes to solve the problem by making a reforms to improve the state's control over10-year agreement with the government, and the management staff of state-owned enter-the Bank calls for the creation of indepen- prises. In addition, a new legal form, thedent coal companies in each region. The kazenny, has been proposed to facilitate thecompletion of the restructuring program has liquidation of certain noncorporatized state-been entrusted to the Ministry of Economy, owned enterprises.and its outcome is difficult to predict.

It remains to be seen how these reformsPostal Services will improve the public sector corporate

governance system. In the case of theBased on Presidential Decree No. 1390 kazenny, the proposed reform has yet to be

of November 16, 1992, the postal service put into practice. The strengthening of theformerly integrated in the Federal Post public corporate governance system is likelyService Department, was separated from the to require several improvements, includingMinistry of Communications and its regional further development of the conceptual, legalbodies were transformed into state and institutional basis, together withorganizations. appropriate instruments for the corporate

governance of state-owned enterprises; andTo obtain additional funds, postal improvement in the regulation of natural

service offices have diversified into secon- monopolies to underpin reforms in thedary activities spheres, including trade and corporate regime.freight. These activities are encouraged by

69


Ukraine

Lev Freinkman and Arshad Sayed

Smniary SPF states that from early 1992 to mid-199514,856, or about 15% of the total number of

With the launching of the stabilization former state-owned small enterprises, andprogram of October 1994, the government is 3,781 or 20% of the total medium and largemaking a concerted effort towards privati- scale enterprises were privatized. Thezation and reducing state intervention in the majority of these enterprises were privatizedproductive sector. Yet, much of the by worker or lease buy-outs.enterprise sector remains in state hands.

In general, the corporate governanceDespite the early establishment of a regime of state-owned enterprises is

relatively progressive legal framework and characterized by elements of the old systemambitious privatization targets, complicated of socialist administrative control, withoutimplementation procedures and retrograde the basic mechanisms to implement thisleasing legislation blocked speedy progress control. There is yet to be a consistenton privatization. These obstacles reflect a coordinated policy on corporate governanceweak overall commitment to privatization across the sectors and so while the sectorsand the entrenched interests of the old such as Telecom and Coal are beingSoviet structure-enterprise directors, overhauled, corporate governance of theirworkers' collectives and branch ministries. enterprises is still unclear. Similarly in the

Rail sector, where a holding company isAccording to the SPF (State Property being set up, details are sketchy on who

Fund) about 2,200 small scale enterprises would control the company, what would beand 1,087 medium and large scale the relations between it and its subsidiariesenterprises were privatized in the first half and how its management would be heldof 1995. Some of these were repeat auctions accountable. Although there is a growingwith an average of 15% of the shares being awareness on the part of the government tosold through closed subscriptions to tackle such issues, its direction and intentionworkers and an additional 30% on average remain unclear.was retained for sale later. Additionally, the

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Ukraine

Corporate Governance: the SPF and the Ministry of DestatizationInstitutional Arrangements was abolished. City and oblast level

property funds were created to sell offIn the late 1980s, about 90% of locally owned or "communal" property,

Ukrainian large and medium-size enterprises (mainly small objects of retail trade, cateringreported directly to former Soviet branch and services). Because many localministries in Moscow. The collapse of the administrations opposed the privatizationSoviet Union required a rapid reorganization goals and blocked the execution of policy, aof the government. A parliamentary decree President's Decree on the Unification ofon August 30, 1991 transferred control over Privatization Organs was passed in earlythe enterprises that were formerly Soviet 1994. This decree mandates that all localproperty to the Ukrainian government. property funds be placed under the

authority of the SPF.Many government agencies were

unprepared for the sudden increase in their On the whole, branch ministrieswork load. Understaffed, they were not received more power with respect toable to effectively control the enterprises in corporate governance of state firms than didtheir subsectors. At present too, ministries the State Property Fund and the Ministry ofare still unable to maintain day-to-day the Economy. The Ministry of Economycontrol over enterprise activity, especially in was only given the right to advise on thethe areas of income and asset disposal. management of state property and toEnterprise managers act autonomously in monitor the activities of branch ministries.many areas, and they have developedefficient schemes to bypass government Historically, labor collectives neverregulations. With the drastic reduction in played an important role within thesubsidies, the old system of exercising corporate governance structure. Althoughgovernment control over enterprises through in the late 1980s, the Law on Statebudget transfers distributed by branch Enterprises enabled labor collectives to electministries is no longer possible. The managers of state-owned enterprises, thisspontaneous privatization that started served to strengthen managers'following the Gorbachev reforms, has independence from ministries rather thancontinued. The governance regime of most change the balance of power withinof the medium and large SOEs in Ukraine, enterprises. With respect to day-to-dayhas in practice, been in a state of limbo for management, state-owned enterprisesseveral years. continue to be management-controlled firms

with sector ministries exerting influenceSince the beginning of the privatization over some strategic issues. The balance of

process in Ukraine, there has been a power between management and ministriestendency to centralize authority in order to is, to a large extent, determined by theincrease the effectiveness of the process. personalities of the parties involved, ratherTwo central privatization organs were than by approved legislation.initially created in 1991, the Ministry ofDestatization and Demonopolization, which Recent Resolutions concerninghad responsibility for designing of the Corporate Governance of SOEsprivatization program, and the SPF, whichwas to execute the sale of state property. In In 1994 the Ukrainian government1993, both functions were consolidated in initiated far reaching measures to transform

72


sectoral structures. These changes, as in the An example of the power that wasTelecom, Electricity or Coal sectors were given to branch ministries was in theintended to introduce competition between appointment of chief executives of state-firms, private or state owned. However, a owned enterprises. According to govern-comprehensive, cross-sectoral legal ment resolution 360 of December 14, 1991,framework for corporate governance of the ministry hired the head of a state-ownedstate owned firms has still not been enterprise by signing a contract. Thedeveloped. A standard corporate contract would need to be signed even if agovernance model has not been approved. manager was elected to that position by aInstead, a few individual decisions creating labor collective. This resolution thus furthernew industrial structures and govemance diminished the role of labor collectives inmechanisms in separate sectors have been corporate governance. The contract wouldmade. These decisions were approved on a specify the enterprise's production andcase-by-case basis, and were typically commercial goals; the rights, obligations,initiated by the relevant branch ministry. and responsibilities of both parties; wagesThe changes continue to reflect the influence and other terms of employment; theof the old ministerial administrators. duration of the contract; and the grounds for

terminating the contract. In keeping withThe structure of corporate governance the former socialist tradition, the contract

of state-owned enterprises was set out in the was considered part of the common Laborgovernmental decree of December 1, 1992 on Code, but not part of the Civil Code.the Administration of Property Owned bythe State. According to this decree, branch Resolution 47 of January 26, 1993ministries were required to perform most of established the principles of salary controlthe functions of state property management. for state-owned enterprise managers. TheSpecifically, branch ministries were resolution stipulated that the salary levels ofdelegated power to: different positions and bonus schemes had

to be developed by the branch ministries in• decide on the creation, reorganization, coordination with the Ministry of Labor. In

and liquidation of state-owned general, managerial salaries were not toenterprises; exceed the salary levels of the chiefs of the

* adopt and enforce enterprise charters. branch ministry that oversee the enterprise* conclude and cancel contracts with and would depend on the volume of gross

enterprise executives; sales. Bonuses were to be granted as a* grant permission to the State Property percentage of the firm's net profits.

Fund to create joint ventures with stateproperty; and Corporatization and Privatization

* prepare proposals to divide stateproperty between the national and The Ukrainian privatization programmunicipal levels. included two processes for converting state

owned enterprises to joint stock companies:At the same time, the ministries were corporatization and privatization.

not permitted to directly intervene in the Privatization describes the bottom-upenterprises' day-to-day economic activities. process initiated by buyer associations,However, anecdotal evidence indicates that mainly workers' collectives. Corporatizationthis provision is not being followed. consisted of the top-to-bottom approach,

73

Ukraine

with the transformation initiated by the Recognizing this problem, thebranch ministry. In this case, the enterprise government in its November 1994 decree onwas transformed into a joint-stock company the functions of branch ministries, abolishedwith 100% state ownership. Corporatization the Ministry of Economy's corporatizationwas considered a necessary step to reform program and entirely removed branchstate owned enterprise governance and ministries from the corporatization processprepare enterprises tor mass privatization. for enterprises to be privatized, thusFor enterprise preparation, part of the strengthening the SPF's authority overenterprise pool was to be corporatized privatization.under the auspices of the SPF while anotherlist of 3,500 enterprises, in accordance with Governance of Majority State-Ownedthe June 1993 Presidential Decree "On the EnterprisesCorporatization of State-Owned Enterprises,"were to be corporatized under the Ministry The privatization program does notof Economy auspices with branch ministries provide much information on theinvolved as founders of the newly created management of corporatized enterprises thatjoint-stock companies. These ministries remain majority state-owned. However, thewere able to block or delay corporatization program proposes that the State Propertysince they acted as founders of the joint- Fund shall:stock companies.

transfer the shares of state property toAs per the June 1993 presidential decree trustee administrations; and

on corporatization, the branch ministries * appoint representatives to participate inwere responsible for overseeing the shareholder meetings and supervisorycorporatization process. In general, the boards of joint-stock companies.ministries had very little incentive to pushfor corporatization since the process reduced According to the presidential decree oftheir area of control. They were also June 15, 1993 and the Law on Economicresponsible for the forming of Societies, mixed enterprises whose capital iscorporatization commissions for individual at least 75% state-owned must form aenterprises to which they would appoint supervisory council and a board of directors.their own representatives. These ministries The supervisory council's membership mustused to approve the charter of joint-stock be jointly approved by the Ministries ofcompanies, propose supervisory boards for Economy and Finance. Representatives ofindividual companies and delegate their both of these ministries, the State Propertyrepresentatives to these boards. The time Fund, the company, the founders, banksschedule for corporatization was approved serving the company, and employees mayby the Ministry of Economy, and its serve on the supervisory council. Theimplementation was supervised by the salaries of supervisory council members areCabinet of Ministries. The role of the State set according to special governmentProperty Fund was much less important. It regulations. The manager of a corporatizedwas only once a ministry had completed the enterprise executes the duties of the boardprivatization plan and organized a joint- of directors' chairperson during the periodstock company that its shares were immediately following corporatization.transferred to the State Property Fund for Other members of the board of directorssale. must be approved by the supervisory

council on the basis of the chairperson's

74


proposals. Generally, they must be chosen The drafts of a presidential and afrom the former State Property Fund governmental decree to transform theexecutives. Ukrainian Railways into a national, joint-

stock holding company were prepared earlyIn May 1994 the "Provisions on Holding in spring of 1994. These decrees proposed

Companies created in the Course of that the Ukrainian Railways hold 51% of theCorporatization and Privatization" were shares of all major independent enterprisesapproved by a special presidential decree. in the sector, including regional railroads,The Provisions contain a general definition and 30% of the shares of auxiliaryof holding companies that own a controlling enterprises, such as those involved in trade,block of shares in another company. The construction, and equipment repair. Thedecree gives branch ministries many regional railroads would also beopportunities to form holding companies transformed into regional holdingfrom the corporatized enterprises that companies and obtain 51% of the shares ofpreviously reported to them. However, a all enterprises reporting to them, such asholding company may only be created with local transport enterprises, depots, railwaythe approval of the Antimonopoly stations, and warehouses. TheCommittee and the Ministry of the corporatization of all enterprises included inEconomy, which must establish application this holding was to have been completed byprocedures. Since May 1995, additional December 1, 1994, under the generalpresidential decrees have approved the supervision of the Ministry ofcreation of large holding companies (in Transportation, but has apparently not beennonconsumer goods distribution, in the oil completed as yet. The railroad property thatand gas sector, and most recently in the coal is not subject to privatization will besectors), and in other sectors (in railways devoted to the long-term use of theand telecom) such holding structures have Ukrainian Railways. All shares transferredbeen proposed. to the Ukrainian Railways, as well as its

own shares are to be in trust managementThe Railways Sector by the managers of the holding company

intil its assets are privatized.There are six separate railways in

Ukraine. Since 1992 they have operated According to the drafts, the Ukrainianunder a consolidated administration that Railways would be required to approve thereports directly to the Council of Ministries. charters of enterprises in the holding andThe railways' budget was set by the supervise their activities, sign and terminateMinistries of Economy and Finance. The contracts with enterprise heads (except withMinistry of Transport had a coordinating regional railroad heads, who will beand advisory role, although the division of appointed by the Cabinet of Ministries), andresponsibilities between the Ministry and the control enterprises use of state property.Ukrainian Railways were not fully defined. The Ukrainian Railways management mustRecent reforms have been adopted which develop the draft of its own charter incharge the Ministry with providing cooperation with the Ministries of Transportregulatory functions, including tariff control, and Economy, and the Antimonopolyand the Ukrainian Railways with overseeing Committee. The charter must then beoperations. approved by the government.

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Ukraine

It is proposed that the Ukrainian Four types of companies have beenRailways should have a two-tiered created to effect this restructuring:governance structure. The members of thesupervisory council, the controlling body, * The state enterprise, Energomarket,will be appointed by the government. The comprised of the central and regionalboard of directors will be the executive dispatch centers.body. The chairperson and vice chairman of a The national electric company,the board will also be appointed by the comprised of all high voltage networks.government, and the remaining four board * Seven joint-stock, electric-generationmembers will be appointed by the companies, which will unite all powersupervisory council. The chairperson will stations with high capacity. They willhave the same rank as the first deputy of the compete with each other. Theseminister of transportation. corporatized, state owned companies

will generate electricity to be sold intoElectricity a wholesale electricity "pool," or

Energomarket managed by the NationalDuring 1992-93, two line agencies Dispatch Center of Ukraine.

operated in the electricity sector: the * Regional electric distributionMinistry of Power and Electrification and companies, which are to be privatizedUkratomenergoprom, the concem managing in the short run.nuclear stations. These agencies reported tothe deputy prime minister responsible for Local distribution companies (LDCs)the energy sector. Both structures acted like will buy electricity in bulk from themonopolistic, vertically integrated concems Energomarket and sell the electricity on thehaving the dual function of a government retail market to local customers. The localregulating agency and a holding company. companies will receive two licenses, one forIn addition, they carried out most of the distribution and one for supply. The twofunctions connected with planning, activities will have separate accounts andinvestment, and supply for individual separate pricing arrangements, checked byenterprises. The presidential decree of May the regulator. Later the two businesses may21, 1994 called for an in-depth restructuring become two separate companies. Andof this subsector, and implementation began others will be allowed to start a supplyin the late summer. The reforms are business.designed to separate the governance andregulatory functions and to improve The National Electricity Regulatoryelectricity efficiency, service, and eventually Commission (NERC), an independentlower relative electricity prices. governmental regulatory agency funded

from the state budget, will watch over thisThe government has reorganized new system to protect the rights of

Ukraine's power sector into a number of consumers and to ensure that the powerseparate, state managed "businesses." industry is profitable. Thus, each newlySeparate corporate entities have been created created entity in the power system has itsto handle electricity generation, own set of special responsibilities.transmission, and distribution in a processknown as "unbundling." The Ukrainian government will play an

important role in the new power sector,acting as a watchdog over the industry

76


(through the NERC) and as the owner of the Communications in June 1993, and isnew companies in the unbundled power controlled by it. The association comprisessector. However, these corporatized 34 "republican" and regional telecommu-companies will have their own board of nication enterprises among them "Ukrtech."directors and executives who will be The aim of the association is to promoteresponsible for the day-to-day management extension of Ukraine's telecommunicationof these enterprises, removing the need for systems, to provide adherence to a uniformthe government to run the power sector as technical and technological policy in thein the past. subsector. Ukrtelecom is headed by a

Director General appointed on a contractSince this reorganization is recent not basis by the Minister of Communications

all corporate governance mechanisms are yet and is approved by the Cabinet;in place. The selection and appointment of Ukrtelecom's board of Directors consist ofstate representatives on companies' boards the Director General, deputy directors,and their behavior in encouraging or appointed by the Director General, as wellimpeding competition, will determine the as managers of the republican, regional andeffective functioning of this system. municipal communication enterprises.Sufficient care should therefore be devoted Regulation on the board and its compositionto this issue in order to unleash market is approved by the Ministry offorces. Communications of Ukraine.

Telecommunications An interesting addition to the Board ofDirectors is an "observation Board," which

The former largely monopolistic sector unlike the supervisory boards is nothas recently experienced a complete responsible for selection or firing ofoverhaul and has been restructured in the managers. This board which consists of 21following manner. At present, there are: persons, includes representatives of

communication enterprises nominated by* over 100 mainly local licensed telecom the Ukrtelecom Board, consumer

operators; representatives nominated by state and- licenses are non-exclusive; public organizations, and representatives of- many operators have private state bodies nomninated by the various

participation including two 49% ministries. The board is primarily expectedforeign-owned joint ventures which to oversee decisions on the administrationprovide mobile service and long and use of telecom development funds. Thedistance and international switching; board is expected to meet once every six

* a state-owned association, Ukrtelecom, months. The members are not paid a salaryholds the state's share in these and do not have the right to interfere inoperators; and Ukrtelecom board's operational activities.

* the Ministry of communicationsperforms the regulatory functions such Rather than privatizing existing telecomas issuing licenses and advising the providers, the Ukrainian Ministry ofMinistry of Economy on tariffs. communications has issued non-exclusive

licenses to new operators, which competeThe Ukrainian "Ukrtelecom" Association with the existing providers and in some

was formed by order of the Ministry of cases with each other. Concerns about

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Ukraine

whether these companies operate on a "level * Ukrtelecom is expected to beplaying field" with the existing providers are transformed to a holding company;mitigated by the fact that: (i) the * the SOEs are to be corporatized;government-owned companies do not * the Telecom Authority, established asreceive subsidies; (ii) in many cases the per the communications law passed byexisting providers are unable to meet new the Parliament in March 1995, willdemand - for example the wait for new function under the Cabinet of Ministerslines exceeds ten years; (iii) Ukrtelecom or to assume with the required indepen-the regional operators often own shares in dence some of the regulatorythe competitors as well as in the existing responsibilities of the Ministry ofproviders. Communications; and

* additional new operators offering newControl over enterprises in this sector services on commercial terms are

depends on the type of enterprise, which emerging.may be of the following three kinds:

Coal* national joint ventures (JVs): three joint-

stock companies for mobile The Ukrainian coal mining industry iscommunications, domestic and suffering from a deep crisis. Between 1990international switching and data and 1995, coal output decreased by aboutnetwork, are 51, 1% government owned 50%. Due to high material, energy andand 49% by private interests. The labor costs, the coal industry is unable tostate's share is held by Ukrtelecom. cover its production costs. In addition toThe private shares of the three producing coal, the mining companies alsocompanies are held by western telecom deliver social services adding further costsoperators. The general managers of the that reduce the competitiveness of the coalJVs are representatives of these mines. With payment arrears piling up andoperators; therefore, the private foreign the state unable to provide any furtherinvestor has the control over operations, subsidies, it has become clear that largeunder the oversight of the board. parts of the coal industry are not viable.Boards include representatives of bothUkrtelecom and JV partners; There are 383 enterprises in the coal

* local JVs: undertaken between state- industry. Out of these, 295 enterprises areowned regional phone companies and organized into 40 associations, the rest areprivate partners often western, to free-standing (or independent). Twenty-provide new types of service such as three associations are engaged in coalhigh-quality local service; local JVs are production, three in coal washing, and thesimilar to national JVs except that a rest are active in geological research, shaftrepresentative of a regional phone design, mine construction, minecompany sits on the board (rather than mechanization, and equipment repair.Ukrtelecom); and Concerning the legal status of the

* SOEs: these are not corporations and enterprises, only 28 are joint-stockas such they enjoy much less autonomy companies mostly engaged in machinein management from Ukrtelecom. building and construction. Only one of the

mines is a joint-stock company. The bulk ofIn the future the sector is to be further the enterprises in the sector have not been

transformed in the following way: corporatized yet.

78


In early 1995, the Ministry of Coal maker, the owner and the regulator for theIndustry (MCI) decided that the survival of coal sector.the viable core of coal mines required theclosure of at least 39 mines. The remaining While officially only a small portion ofmines were placed into two categories: the coal is distributed as "state order" with(i) 57 mines that have a secure future; and explicit payments from the state, more than(ii) 160 mines that, if given additional 80% of domestic coal production issupport, can survive and become com- distributed through "Uglesbyt" a "Coal Tradepetitive. Association." Earlier it used to have an

exclusive right to purchase and sell coal toUntil 1995, coal prices used to be customers. In early 1995, coal mrining

regulated by the Ministry of Economy. In enterprises were allowed to market 20% ofearly 1995, the regulatory function was their coal. For the remaining 80%, Uglesbytturned over to the MCI, with the exception is still responsible for purchasing and sellingof coal prices for household consumers. The coal. Uglesbyt is also the only authorizedMinistry of Economy still plays an important agency to export coal. While Uglesbyt isrole in the development of annual and long now called a "Coal Trade Association," itterm production and investment programs also continues (de facto) to be the executorand financing arrangements. In addition, it of "sector orders," based on a "sector plan."sets the margins the local retail outlets cancharge to household consumers over the The MCI has prepared a draftwholesale price of coal. The role of the Presidential Decree on the corporatization ofMinistry of Finance is focused on the the coal industry. According to this draft,approval of subsidies in connection with the 23 coal associations will be merged tothe annual budget cycle. Local form 15 geographically based coalgovernments, depending on their budgetary production businesses that will be convertedresources, establish the amount of coal that into joint-stock companies (JSCs). The targetcan be sold to each household at subsidized date for the completion of corporatization isprices. April 1, 1996. According to the plan, the

state will own 100% of the equity of theThe MCI, the key government agency JSCs initially. However, the intention is to

for the coal sector, was established in late sell this equity over time so as to achieve the1994, taking over the responsibilities of the full privatization of the industry. Theseformer State Coal Committee. The MCI is JSCs will contain only those activities thatresponsible for the development of are directly related to the core business ofgovernment polcy in the coal sector, coal production, including the localappointment and supervision of enterprise operational marketing activities of Uglesbyt.managers, approval of coal production and The central planning, coal distribution andmarketing plans, establishment of coal revenue transfer functions of Uglesbyt willprices, advising the government on the disappear. The management of the JSCsallocation of subsidies (and directed credit), (and independent mines) will be free toand decisions regarding the closure and negotiate and determine the prices of theirdevelopment of mines. In summary, the production. The directors of the JSCs willMCI represents at the same time the policy be appointed by the Ministry of Coal, under

79

Ukraine

short-term contracts of a maximum duration Improving the competitiveness of theof one year. The contracts will be based on coal industry will also require the reductionperformance-related pay. of overemployment, transition to a market

based system from the currently centrallyIn the future, the MCI will have a planned system, and reform of the

central role in and responsibility for the organizational and management structure ofreform of the Ukrainian coal industry. In the industry. The main building blocks ofparticular, the Ministry will be expected to: such a restructuring being:

(i) determine the composition of the new * liberalizing of coal markets;JSCs and manage the separation of non- * establishing of new corporatized entitiescore activities; by combining economically viable coal

mines, washing plants and marketing(ii) manage the transfer of social assets to organizations;

local authorities; * rapidly closing uneconomic mines; andfocusing budgetary support on the cost

(iii) represent the state as a shareholder in of mine closures, including social costs,the JSCs, and arrange and manage and the divestiture of assets.performance-related contracts for seniormanagement; While the reorganization of this sector

shows promise for improvement in(iv) administer the fund that provides management of this sector, the overhang of

compensation for the cost of the control structure of the branch ministrytransferring workers from mines which and its marketing arm in corporateare closed; and governance at every "level" (or in every

enterprise), leaves much room for(v) establish and supervise the activities of questioning the effectiveness of the changes.

"Ukrainian Coal Enterprise," thecompany entrusted with managingmine closures.

80

III.

ILLUSTRATIONS FROMDEVELOPED

MARKET ECONOMIES


International Trendsin Public Enterprise Policy

John Nellis

A key lesson leamed from the have a program for dealing with theseprivatization experience in non-socialist public enterprises prior to theircountries such as Argentina, Mexico, privatization. They thought that improvingMorocco, and those in Westem Europe, is performance in the many enterprises,that privatization has been a complicated, temporarily or indefinitely, which wereintensely political process that almost always likely to remain in the hands of the state,took longer to get going and to complete was not a problem, because:than anticipated by the designers of theprogram. For example, Mrs. Aquino, then * in a very short period of time therePresident of the Philippines, announced the would not be any public enterprises tosale of Philippines airlines in 1987 and said worry about, since the reformersthat it would be completed within 90 days; intended to move very quickly onsale was finally completed in 1992. privatization; and

even for those that would stay in statePrivatization: hands for a time, argued the reformers,A Slow Process in Transitional it would be better to do nothing andEconomies simply wait until privatization came

along, since they regarded bureaucratsIn Poland and the former as completely incapable of running

Czechoslovakia, early in the transition, enterprises in a competent manner.radical reforming govermments passionatelydedicated to free market economics in Many of the first wave of radicalgeneral, and to privatization of state owned reforming officials, at least in these twoenterprises in particular, came to power. countries, thus rejected the idea that theyThey believed, as the World Bank does, that should be devoting thought or resources tothe ultimate solution for poorly performing the problem of how to improve performancepublic enterprises is to privatize them. in remaining state firms. Equally, theyHowever, despite worldwide experience rejected the notion that the World Bank orrevealing that privatization of even a few extemal agents could or should help them inhundred enterprises can be a slow and any way with this question.complex process, these govermments did not

83

International Trends in Public Enterprise Policy

More than four years have passed since reasonable to estimate that the secondthe transition started, and privatization has phase of privatization - selling theindeed been very slow in most post- remaining enterprises for cash - willcommunist countries. be a much slower process.

In the countries that make up the* At present in Poland, of an estimated former Yugoslavia, privatization really

8,440 enterprises in 1990, some 2,517, or has not proceeded very far or very fast.about 30% have been privatized - but And in Romania and Hungarythat leaves 70%, close to 6,000 privatization has at best been modestcompanies unprivatized. As of mid- until mid-1994.1994, 24 enterprises had been soldthrough public offerings, and another That privatization took place at all was60 or so had been sold to foreign a major accomplishment in these countries,investors in negotiated sales, a very or any other post-communist country, givensmall total number when compared to the difficulty of the circumstances inheritedthe plans to sell hundreds of firms by and the many and major obstacles that blockthese means in 1990 alone. Most of the the path to privatization. To repeat,privatization in Poland that has privatization is the best and ultimate answeroccurred has been in medium-sized to the problem of poorly performing publiccompanies; it has come about through enterprises. Nonetheless, the fact has to bemanagement and employee buyouts faced that a large number of enterprisesfollowing the official liquidation of the have not yet been sold, and that they remaincompany. under the official ownership of the state.

Even if the mass privatization program in* In the Czech Republic and in Poland is successfully launched and

neighboring Slovakia, out of some 7,000 completed; even after the completion of themedium and large firms in 1990, about second wave of voucher privatization in the3,275, or 47%, have been privatized. Czech Republic and in Slovakia; even afterThis is an excellent record - but it still the commencement of the second wave ofleaves a fair number of enterprises in sales for cash in Russia - there will stillstate hands; and even in the Czech remain a substantial number of enterprisesRepublic, the state in many cases still owned by the public sector in these and allretains a portion of the shares in other post-communist countries. So there isenterprises that have been mainly a need for reforms of the public enterprisesprivatized. (PEs).

* In Russia, between 12 and 14,000 medium- Inproving Performance of PEs:and large-scale enterprises have been The Case of China

privatized through the voucher auctionmethod in the last 20 months alone. Experience in non-transition countriesThis is rightly seen as a tremendous shows that there are many state ownedaccomplishment - but there are enterprises which perform reasonably well,another 10,000 or so enterprises and some that perform very well, in termsremaining, and the voucher program, of profitability, productivity and economicwhich was the means by which the first efficiency. There are a number of highlywave of privatization took place so successful public enterprises in Westernquickly, has come to an end. It is Europe - particularly in Austria, Germany

84


and France - in Canada, and in New have few wage or bonus regulations,Zealand. There are also a number of success and few environmental restrictions.stories from Asia - For example, a public Commercial profitability is their mainsector fertilizer company in Indonesia, or the and over-riding goal, and non-electricity generating authority of Thailand. commercial objectives are not allowedEvery region offers examples of well run to take precedence over profits.public enterprises.

They operate under a hard budgetOne very interesting and revealing constraint, meaning that they receive no

example is the case of the Township and subsidies from government owners, andVillage Enterprises (TVEs) in China. There no subsidized credit from the state-are more than 1.3 million TVEs in China; owned banks; and they buy and sell atthey employ 90 million people. They market-determined prices. (The resultproduce more than 20% of China's industrial is that most of them finance theiroutput; they now account for about 25% of investments from retained earnings orChina's manufactured exports, and are from capital injected by private jointgrowing at roughly double the rate of the venture investors.)state-owned enterprises (SOEs). TVEs yielda return on capital two or three times that of * TVE managers have much greaterthe SOEs. They behave much like private autonomy than SOE managers; they cancompanies, but they are not privately hire who they want and pay themowned. As their name implies, they are according to their productivity, andowned by the sub-national governments of they can - and they do - fireChina, the regions and municipalities. Their employees who do not perform.performance contrasts very favorably with Managers can select what products toSOEs, of which at least a third (and produce, and the markets in which toprobably many more) are unprofitable. try to sell their products. They canThey outperform SOEs because: price their products according to

market principles; they make their own* TVEs are exposed to competition. They investment decisions and choose the

have to compete in markets with other technology they need. In sum,producers of similar products in their managers are allowed, indeedregion or elsewhere in the country. encouraged and even forced, toThere is just about unrestricted entry manage.into the ranks of TVEs, which meansany local government can create them. * Managers and workers have betterThere are few obstacles to exit, which incentives. Workers and, in particular,means TVEs can and do fail and go out. managers are paid according to howof business, and their local government well the enterprise performs - andowners do not rescue them when they they are fired if they consistentlypersistently lose money. perform poorly.

* TVEs operate with fewer policy This sort of behavior is definitely notconstraints. They have few if any the norm in most state-owned enterprises.requirements to provide social benefits TVEs are a stunning example of how(a major problem for the SOEs), they positive performance can be instilled in

85


enterprises which are not privately owned reasons of size, and especially for reasons- but are made to act as if they were. related to incentives, Chinese SOEs tend to

function more poorly than TVEs.For the hundreds of thousands of state

owned enterprises in China (not including SOE Reforms:TVEs) the question remains: why don't the Lessons from Other CountriesChinese authorities simply apply to SOEsthe successful arrangements they use for The Chinese SOE case illustrates manyTVEs? The answer to this question is very of the causes of poor public enterpriserevealing about the problems of state-owned performance. But, according to experts, thereenterprises in China, and indeed, around the are some necessary steps to take toworld. overcome and correct them, other than

privatization.In the first place, Chinese SOEs operate

in different sectors than TVEs - they tend A prime cause of poor performance isto be older, larger and working in the heavy that state owned enterprises have multipleindustrial sectors such as steel, machine and conflicting objectives. They are told totools, etc. In contrast, TVEs generally make money, and at the same time toproduce consumer goods. Industrial SOEs maintain existing levels of employment, ordominate the heavy industrial sectors and they are instructed to reduce costs to ause older technology; TVEs work in light rational minimum, but they must continueindustry, and their more recent creation to buy their inputs from a particularmeans their technology is more up to date. supplier, or they are instructed to keep openSOEs report to central officials who are not a plant that is uneconomically situated, etc.personally touched by the good or bad The imposition by government owners ofperformance of the enterprise. objectives other than commercial

profitability is commonplace in SOEs, andDespite persistent performance the cost to profitability and productivity

improvement measures and campaigns over imposed by non-commercial objectives isthe past decade, SOE aggregate performance one of the main reasons for deficient SOEhas not greatly improved. One of the main performance.reasons for this is that SOEs fulfill manysocial, non-commercial objectives. TVEs, on To overcome this problem, governmentsthe other hand, are supervised by local have to take a series of measures. First,officials who are dependent on the profits of some governments attempt to provide clearthe TVEs to finance their political programs and unambiguous objectives to their- and it has been argued that many local companies by means of performanceofficials get direct financial benefits from agreements that specify the obligations ofwell-performing TVEs. In these circum- both the owner and enterprise management.stances the local government "owners" of There are many different types of suchTVEs are more interested in making money agreements; they are used in countries asthan in protecting the jobs of incumbents or widespread as France, Gambia, India,fulfilling other, non-commercial objectives. Bolivia, Pakistan and Korea.So, for reasons of market structure - that is,exposure to competition - for reasons of Though they have been widely applied,the sectors in which they work, for reasons there is little solid evidence that the signingof their general outmoded technology, for of a performance agreement leads to

86


improved financial and economic meaning that many SOEs receive unjustifiedperformance. Indeed, a World Bank study and persistent subsidies or capital injectionson the subject of performance contracts from the state; or they get credit from thefound "little evidence" that they improved banking system at below market rates (whileperformance. There is some evidence to competitors, especially those in the privatesuggest they may have made performance sector, pay full price); or they are excusedworse. Where performance did improve, it from meeting their payments; or theywas because the management's contracts receive exemptions from dividends, taxes,gave credible signals that the rules had customs duties, overdue bills, etc. There arechanged, and provided managers with hundreds of ways for governments toconcrete incentives to do better. subsidize or soften the financial

requirements asked of SOEs, andAnother improvement mechanism often governments have used them all.

used is to reform an enterprise's board ofdirectors, staffing it with technical experts or Conclusionpeople in the line of business of theenterprise, giving it the responsibility and Many governments attack this problemthe power to supervise the company and by removing all or most of the guarantees tokeep it aimed at the commercial objectives banks and creditors they previously offeredassigned by the owner. Board reform has on enterprise debts and obligations, andbeen part of the SOE reform program in they require that in future borrowing, theirmany countries, including New Zealand and SOEs go to commercial capital markets, andKorea. Yet another method, used by itself or that their loan applications be treated noin conjunction with the previous approaches, differently from those of private sectorhas been to appoint strong and experienced applicants. Reforming governments try toleaders - sometimes with extensive private create a "level playing field" for allsector experience - and give them a free enterprises, public and private, andhand to run the business as Chief Executive eliminate the subsidies, bailouts and specialOfficer (CEO). treatments previously given to SOEs.

Experience shows that resisting theA second cause of poor performance is temptation to provide financial assistance to

lack of incentives for managers. In many troubled SOEs is one of the hardest steps forcountries, SOE managers earn more than governments to take.civil servants, but much less than CEOs ofprivate sector companies of equivalent size Many governments protect their SOEsor importance. If government owners want from competition, even though it ismanagers to take risks, make decisions - absolutely clear that exposure to competitionand make the right decisions - and suffer. is one of the most powerful causes ofthe consequences of mistakes, then they improved performance. Most of the SOEshave to reward these managers; they have to known for their efficiency and profitabilityprovide a salary and other incentives are those forced to operate in highlysufficient to attract and retain high quality competitive markets, in which their relativepeople. success or failure can be measured.

Reforming governments around the world,A third cause of SOE problems is what tired of continuing losses and the inability to

is called the "soft budget constraint," assess performance, are eliminating the

87


protected markets and regulatory barriers conflict, as, eventually, they inevitably do,which guard their SOEs. politics tends to outweigh economics, and

the non-commercial objectives win. StatesNo government finds it painless and may be rich enough for a time to tolerate the

easy to enforce these reforms. The over- losses and financial drain that are caused byriding problem of SOEs is that government the triumph of the non-commercial goals -

owners want them to fulfill both commercial but sooner or later the money runs out andand non-commercial objectives. When these fundamental reform is needed.

88


Relationship between Ownersand Management:

Commercial Utilities

Among all the vexatious issues in contract), enabling it to gain full autonomycorporate governance, none is more in a partially competitive environment, withtroublesome then the defining of the the gradual introduction of deregulation andrelationship between the owner and the separation of regulatory authority. Privatemanagers. The presentations in this section sector corporate governance mechanismsprovide a small spectrum of choices to deal have been adopted, but trade unions havewith owner-manager issues in the provision blocked full privatization.of commercial public services. FrankMatthias Ludwig presents the case of the Next, Jean-Pierre Pery elucidates theDeutsche Bundesbahn (Germany's railway key characteristics of the relationshipcompany). The case highlights the between the owner and managers in theimportance of corporatization, accompanied case of France's Gas and Electricityby the separation of commercial goals and companies. In so doing, he points out thepublic service obligations and by the usefulness of a strategic performancedistinction between the infrastructure (in contract in clarifying the situation betweenpublic hands) and its operation, to be several ministerial departments and theprivatized in future, so that the enterprise managers. The present situation, wherebycan face up to the competition. the state is both shareholder and regulator,

may not be sustainable.Gerard Moine argues that the key

transformation in the case of France Telecom Finally, Richard William Prebblecame about with the change in the outlines the principles and modalities of thecompany's relationship with the state, corporatization of New Zealand's publictransforming it from a hierarchical authority enterprises.to a contractual relationship (performance

89

Relationship between Owners and Management: Commercial Utilities

The Case of the German RailwayFrank Matthias Ludwig

Until 1994, the federal railways were reserves, and b) achieving an appropriatemanaged as a federal administrative return on the equity capital invested. In thisauthority. The fundamental decision on the context, the Deutsche Bundesbahn fulfilledstructural reform of the railways was made its public service obligations.by the federal government on July 15, 1992.The first step was to create a new company, There was a broad allocation of rightsDeutsche Bahn AG (DB AG), which is based to the Federal Minister of Transport whopurely on corporation law. The state is still had the right to approve, inter alia:the only shareholder at the moment. Next,two new state authorities in charge of * the business plan - and any significant"public tasks" to be fulfilled by the Railways alteration of said business plan -

were created. To this date, "state" tasks and during the business year, and theentrepreneurial tasks are clearly defined. annual financial statements. ApprovalThe third step will take place three to five also required the agreement of theyears from now. The DB AG will be turned Federal Minister of Finance;into a holding company. Under its * the construction of new lines, as well asumbrella, there will be at least four implementation of basic upgrading orindependent corporations (public limited modification of technical installations;companies) that will be opened to private * the permanent closure of a line,investments. One limitation to the full discontinuation of operations of a majorprivatization of DB AG will remain, in that station, the shutdown or relocation of aprivate shareholders will not be majority workshop or any other major facility;owners of infrastructure. According to the * the establishment, relocation, or anyConstitution, at least 51% of the fundamental reorganization of ainfrastructure ownership will remain in state regional head office or a central officehands. of the Deutsche Bundesbahn as well as

any alteration of its regional areas;Legal Situation before the Railway * the establishment or acquisition of otherReform of 1992 companies; and

* the approval of tariffs and proposalsPrinciples of Management with respect to timetables to "be takenand Supervision into consideration as far as possible."

Until 1992, The Deutsche Bundesbahn The Ministry also had rights ofwas managed as a federal agency with approval with respect to personnel matters,administrative autonomy. such as decisions with respect to

remuneration and promotion. Since staffIt was managed like an enterprise, with members of the Deutsche Bundesbahn were

the general goal of a) providing optimum public service employees, these decisionstransport services in accordance with required the agreement of the Federalcommercial principles, so that revenues Ministers of Transport, of the Interior and ofcovered expenditures including the liability Finance. The Federal Minister of Transport

90


was also responsible for decisions regulated the agreement of the Administrative Board,by public (service) law concerning personnel and if no agreement was reached, thematters of the members and deputy decision was made by the Federalmembers of the Board of Management. Government.

Organization of Corporate Supervision The Board of Management was boundunder the Two Tier Model by resolutions of the Administrative Board.

It conducted business with the due diligenceThe Administrative Board (comparable of a business-like and conscientious

to a supervisory board) was composed of manager.20 members, including four groups con-sisting of five members each, nominated by The Reform of 1992the federal government. The proposedmembers of the Administrative Board came Objectives of the Reformfrom (i) the Federal Council (Bundesrat); (ii)every sector of the economy; (iii) trade The objectives of the reform were tounions; and (iv) other members. The reduce the overall financial burden of themembers of the federal government had the railways as much as possible. Anotherright to participate in or send a repre- objective was to put the railways in thesentative to all meetings of the Adminis- position of playing a greater role on thetrative Board. The members had to perform future transport market, and to execute thetheir duties to the benefit of the German EC Council Directive on the Development ofpeople, the German economy and also to the the European Railways of July 29, 1991.Deutsche Bundesbahn, which was difficult This Directive demanded: (i) commercialto accomplish all at the same time. autonomy of the railways; (ii) financial

adjustment of the railways; (iii) separation ofThe role of the Administrative Board infrastructure and operations at least on

included the approval of the business plan, accountancy basis; (iv) public servicestaff plan, and annual financial statements; obligations performed on contractual basisthe right to propose the appointment/ with interested public bodies; and (v) freedismissal of members of the Board of access of third parties (internationalManagement and other executive employees groupings of national railways andof the Deutsche Bundesbahn. It also set the international combined transport operators)railway fares and other transport rates, to the national rail networks.which were vital to the financial situation ofthe Deutsche Bundesbahn. Prerequisites of Reform

The Board of Managemtent was com- The prerequisites were to place the rail-posed of one chairman and other members, ways on an equal footing with theirthe number of which was decided by the competitors regarding their entrepreneurialFederal Government. The official relation- scope for action - within the framework ofship between the board of management and an overall transport policy - and to releasethe Federal Government was governed by the railways of their legally imposed publicpublic law. Appointments were made with service obligations.

91


Main Features of the Reform Regime

Pre-Reform Post-ReformPublic Authority Company in AG Form (joint stock company)

1. Orientation in line with superior political 1. Entrepreneurial orientation.objectives.

2. Restricted by public civil service and 2. Integrated into general private and companybudgetary law. law.

3. The actions of each individual are restricted 3. The actions of each individual are orientedby provisions and regulations. towards the bottom-line results.

Current Status of the DB AG damages. Board members can be dismissedby the Supervisory Board, at the share-

The goals of the enterprise are as holders' meeting, for neglect of duties, or asfollows: (a) to provide and market rail traffic a result of withdrawal of confidence.services for the conveyance of goods andpassengers; (b) to operate and market the The Board of Management needs therailway infrastructure including, in consent of the Supervisory Board forparticular, the planning, construction, business activities including the following:maintenance and management of theoperations control and safety systems; and * initiation of new fundamental areas of(c) to support all business activities in areas activities within the scope of the articlesrelated to rail traffic. Furthermore, the of association or discontinuance ofcompany is entitled to engage in any existing activities;business activities required to achieve the * fundamental alterations in the companyabove goals. organization;

* acquisition or formation of otherThe company may establish or buy a companies, acquisition and disposal of

share in undertakings of a similar or related shareholdings in other companies andnature at home and abroad. It may divide participation in a capital increase withits operations totally or partially into such capital investments with the value ofundertakings and restrict itself to more than DM10 million;management functions. * investments not already provided for in

the budget planning, if the costs exceedThe New Corporate Governance DM20 million;Organization * acquisition and disposal of real estate

unless provided for in the budgetThe Board of Management is set up in planning, if the value exceeds DM10

accordance with the Company Act. The million; andcompany management is responsible for the * taking up loans, debentures or otherentire management policy. Board members credits with a term of more than oneare appointed by the Supervisory Board for year, if the amount exceeds DM500a maximum of five years, and are liable for million in each case.

92


Box 9: Necessary Steps to Turn the State Railways into a Public Limited Company

I-

entrepreneurIal area Federal Railway Property

entreprneurial aret pubik area Id laep

maintenance) - state tasks federal lawtas -administation of personnel., - transport ~~~~~~~- administration of debts

Federal Railway Office Federal Railway Property -chnef

at les 4 diiin - chneo

-. _ - (remaining special state property) constitution,E , E Q O e l state tasks especially

-administration of debts Art 87 GG

-cJ a b i | (unless Ministry -administration of personnel and

I; E . O S q G e tof Transport) -real estate management - federel law

.o TasoDB AG-Holding 3rd step

|=rI.I. legally forseen

company act ato = = , F NF =R the earliest3 years, at the

a l ll ll latest 5 yearsafter start of

.l, E ~ o g _ 11 _ DB AG

t~~~~~~~~~~~~~~~~~0~~~~~~ ~e.; .3 d 4th step

legally foreseen*° T a | | . | possibility to- I I I I I dissolve

DB AG(Holding)

to merge it with11 distance 11 11 11 11freight11 11infra-cIlindividual plc's

passenger passenger tra structure ~~~~~~~~~~~~~~~~or to split it uppassenger passenger traffic su e among othertrafric PCICPic's

Note: @3 special state property traditional authority 0 public limited company

93


The Supervisory Board is composed of it will pay back only part of the annual20 members. Ten members are the share- depreciations, or will receive directholders' representatives appointed by the construction cost grants. DB AG will presentgeneral assembly (of which three are contracts to the Federal Republic on thedelegated by the Federal German details of infrastructure construction andGovernment while still a shareholder), and financing. Maintenance and operating coststhe other ten members represent the staff, have to be borne by DB AG. Therefore,including three union representatives and 100% of the infrastructure costs remainingone representative of management staff. In with DB AG after reform have to be coveredaccordance with the Company Act, the role by the users of the infrastructure.of the General Assembly includes legalchanges introduced to clarify the duties of Conclusioneach category.

The first year of operating as a formallyThe reform has modified the financing privatized company has shown that

of infrastructure. Capital costs of infra- Deutsche Bundesbahn is able to run atstructure investment will be taken over by a profit and increase turnover withoutthe state. Infrastructure investment raising prices. After decades of heavyaccording to the National Master Plan has to losses, the board of management was able tobe fully paid back by DB AG at the level of present a net operating profit of DM 88annual depreciations. In the event that million for the year 1994. The Germancertain infrastructure investment projects are taxpayer had saved DM 3 billion in 1994, innot - or only partially - in the commer- comparison with continuing the status quo.cial and entrepreneurial interest of DB AG,

94


The Experience of France TelecomGirard Moine

Technological development, the telecommunications industry was in a veryevolution of ideas, globalization and the poor state for decades because, for manyincrease in competition that took place in years, telecommunications services werethe past fifteen years were all new and considered to be a privilege and not a publicimportant challenges faced by the French service, i.e. it was not conceived to delivertelecommunications industry. Yet, the its services to the public at large. At theconcept of public service which is in France beginning of the 1970s, however, theintrinsically linked to the telecom- government realized the importance ofmunications sector had, at the same time, to telecommunications and decided to movebe preserved. As a result, the telecom- toward a modern telecom network. Duringmunications agency in France was that time, some changes were suggestedtransformed from an administrative within the directorate. The department wasdepartment within a ministry into a public, modernized, with the implementation of acorporatized quasi-company functioning in new organizational structure and aa competitive environment. "management charter." However, a broader

reform failed because telecommunicationsThe Telecommunications Industry was were still viewed as a source of income forrun as a government agency until 1990 the state budget. As of 1990, telecom-

munications were still an instrument of stateUntil 1990, the telecommunications industrial and budgetary policy, used to

operations was run as a standard directorate support the development of the electronicswithin the Ministry of Post and industry and to subsidize the generalTelecommunications (PTT), called the budget.General Directorate for Telecommunications(Direction Generale des Telecommuni- France Telecom became a public sectorcations). The Minister was in fact the head company with the 1990 reformof this directorate. This department had noreal autonomy in terms of personnel, Reasons for Changefinancial, procurement or pricing policies.The Ministry was mainly regulated by three The last fifteen years have been markedbodies: the Parliament (which approved the by several profound changes that havebudget of PTT), the Ministry of Finance - compelled the telecommunications industrythe Treasury (which owned the Cogecom to adopt new structures. These include:holding company - see below), and theEuropean Community. Ex-post control was, * New technologies. Technologicaland still is, performed by the public Court of development supported by theAudit. development of microprocessors

brought telecommunications and dataThis department was restricted in its processing much closer. This

technical and budget choices. The French technological convergence opened the

95


way to a real boom in the Negotiating Changetelecommunications-based services market.Obviously, monopolies were not the most The proposed changes in the Frenchappropriate structures for the rapid telecommunication industry were perceivedexploitation of these new markets. as a veritable cultural revolution. In view of

the very close link between the French* Liberal ideology. Since the beginning postal service and France Telecom, it

of the eighties, deregulation and appeared impossible to deal with changes inprivatization appeared to many to be the status of France Telecom withoutthe solution to all problems resulting considering that of the postal service.from inefficiency. Reform of the sector, therefore, concerned

not only 150,000 employees in Telecommuni-* Globalization of markets. Large-scale cations but in fact a total of 500,000 civil

customers and, more particularly, servants. Thus it was necessary to bring themultinationals increased pressure on public, the customers, and all the employeesoperators for international services. together to discuss the problems of theThe telecommunications market was sector, and to engage in open discussions ondestined to break through national possible future directions. There was afrontiers and become globalized. wide-ranging internal and external debate

within France Telecom and within the civilThese three factors have resulted in the society regarding the future of the postal

opening of new markets to be capitalized. and telecommunications services.The decisive milestone in this development Negotiations took place with the unions; andwas the dismantling of AT&T in 1984 in the an intensive public information campaignUS. Another important factor was the move was implemented. The project was adaptedtowards a single European market. The to reflect the ideas expressed; in fact, theneed to create an inter-European telecommunication agency's transformationtelecommunications market led to the into a joint stock company with every laborpublication of the EC Commission's Green contract governed by private law had to bePaper on the Development of the Common postponed due to the opposition of the tradeMarket for Telecommunications and Services unions. Ultimately, the process resulted inin 1987. The overall objective was to the creation of state-owned quasi-companyprovide European users with the largest and the modification of the telecommuni-possible range of services under the most cations regulatory framework.favorable conditions possible, whilemaintaining coherence and uniformity Adapting to Changes:among the networks and services provided The New Organizational Structurein member countries. The EC Green paperestablished a general framework which took The new legislative and regulatoryinto account the unquestionable specificity framework for telecommunications in Franceof telecommunications and, in a sense, is based on two laws. One was approvedbrought it into the realm of the common law on July 2, 1990, defining a new statutoryregulating the exchange of services, while framework for the French postal andalso recognizing the globalization of the telecommunications services, and modifyingsector and putting an end to the the status of France Telecom, granting it theprotectionist context in which it had means to become a competitive publicdeveloped. service. A second law, approved on

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December 29, 1990, defined the regulatory account, and that concerns for defense,control over telecommunications in France security and research are maintained. Butby stipulating how networks and services France Telecom now has financialcould be established and operated. The new autonomy, which is essential to continue toorganizational form required substantive progress in times of rapid technologicalchanges in the legal system. According to development and to meet the increasinglythe new rules, France Telecom is no longer complex needs of clients. France Telecomsubject to administrative law, but rather, to is now the direct owner of its assets and ofcommercial law. The operation has lost its its stakes in its subsidiaries.monopolistic position and is now subject toregulated competition. France Telecom has The corporation's relationship with PI[retained its public service obligations; also reflects a duality and a balance. Inhowever these are specified and limited. areas where it does not have exclusive

rights, France Telecom is subject to the sameUnder the law of July 1990, France regulations that the "General Directorate for

Telecom severed its traditional ties with the Post and Telecommunications" (DGPT),French administration, and became an within the PTT has established for all otherindependently operating quasi-company telecommunications service providers. Forestablished as a public corporation. France areas open to competition, the corporationTelecom's charter is based on commercial as a public operating company is subject tolaw, and elects a chairman, a board, and the same regulations as its competitors. Thedirectorates. The Ministry of Posts and PTT ministry also has a supervisory roleTelecommunications is in charge of over the corporation which is characterizedoverseeing the public enterprise. The by proprietary functions (notably theParliament, acting through a committee, approval of its strategy) and by theexercises a lighter control than before, and protection of specific state interests.the European Union remains involvedthrough general regulation and direct The New Relationship with the Staterelations with the enterprises. The state isthe owner of France Telecom. It has also The key element of the change was thebecome a regulator of the telecom- institution of a new relationship with themunication industry, pursuing a policy state, transforming it from a hierarchicalintended to allow other actors to enter the authority to a contractual relationship.market and to compete with France France Telecom and the Ministry nowTelecom. interact through a contract, known as a

"contract-plan"; the Ministry of Finance isFrance Telecom must follow the also partner in this contract. A multi-year

guidelines set out by the Ministry of Posts contract is signed regularly between Franceand Telecommunications (PTT); however, it Telecom and the state, which defines theis no longer required to submit its budget strategic orientation for the company, itsfor parliament approval. The management concrete objectives, and proposed financialof France Telecom is responsible to its board indicators. France Telecom thus has gainedof directors, president, and chief executive the authority to define its own strategy.officer. Its status as a state-owned publiccorporation guarantees that its public service The "contract-plan" describes theresponsibilities will continue to be taken into economic and financial guiding principles.

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Degree of Competition According to Services Provided

System Discipline Objectives

Monopoly Public terrestrial infrastructure Public ServiceVoice Telephony Strategic Resource

Cost OrganizationCoherence of Basic Networks

Structured and Controlled Messenger Services To take advantage of a dynamicCompetition Radio Services market

Independent Networks Not harm public provision

Full Competition Value-added Services To create a dynamic force inTerminals multifarious markets

The current agreement - the first - covers a holding company called Cogecom.the period from 1991 to 1994. It stipulates Cogecom and its subsidiaries existed beforethat France Telecom prices can only increase the 1990-92 reform, when France Telecomby an amount which is 3% lower that the was still part of the public administration.yearly general increase of GNP prices; its Cogecom's scope of activities includesinvestment may reach an amount of FF150 networks for television and radiobillion. The level of its debt over the period transmission and multi-media, mobilemust be significantly reduced, and personnel telecommunications with French andproductivity should increase by at least 4.6% international subsidiaries, and softwarea year. The "contract-plan" also reflects the production. Cogecom represents 15% of thesupervisory role of the state as the owner, activities of the France Telecom group, 10%recognizing its role in exercising the of the staff, and 15% of the turnover.necessary control over France Telecom in allareas not regulated naturally by market France Telecom nowadays faces threeforces. At the same time, the contract major challenges, to which it has to adaptprotects the company's management very quickly. First, France Telecom faces aautonomy from the unavoidable and generalization of competition. It needs topowerful temptations of the state to interfere adapt its strategy, corporate culture, tariffin enterprise management, while ensuring structure and organization to this newthat the company continues to take into context. The European Union in particular,account the public service requirements and is planning to introduce general competitionspecific interests of the state with respect to in all telecommunication services in 1998,defense, civil security and research. eliminating all restrictions. Second, France

Telecom has to become a full-fledgedOutlook corporation with greater autonomy. The

capital stock has to be opened to otherAs a result of the reforms, France partners, and, in order to compete, France

Telecom has become a powerful economic Telecom has to define a strategic growthplayer. One of the specificities of the French project. Finally, France Telecom is facedexperience is that France Telecom is a with the globalization of the telecommu-company with subsidiaries, regrouped under nication sector; telecommunication services

98

Corporate Governance of Public Enterprtses in Transitional Economies

Box 10: France Telecom Group in 1994

Key FiguresFrance Telecom Cogecom

Revenues F 126.5 billion F 17.1 billionOperating Income F 30 billion F 1.6 billionNet Income F 4 billion F 285 million (France Telecom Group Share)Investments F 37 billion F 5.2 billionEmployees 153,100 persons 13,700 persons

($1=F 5.3)Plroducts and Services

6.5 million Minitel terminals installed400,000 mobile telephone subscribers600,000 Numerus/ISDN basic rate accesses106,000 Transpac data communications subscribers196,000 public phones, 123,000 of them card-operated

are now operating on a worldwide basis. politicians in charge, including the personalFrance Telecom needs to adapt its strategy, involvement of Minister Paul Quiles andorganization and financial structure to this then Prime Minister Michel Rocard. It isnew context, and to enter into partnerships. also due to the method adopted, whichFrance Telecom has already taken steps in consisted of negotiations with all thethis direction by entering into partnership stakeholders, which was subsequentlywith the German company, Deutsch adapted to the actual situation of France atTelekom, and the American long-distance that time. Yet the evolution of telecom incarrier, Sprnnt. the modem age is a continuous adaptation

to technical innovations, economic rules andConclusion the needs of different consumer groups in

society. These rapid changes will continueThe success of the reform of the to affect the sector and will undoubtedly

telecommunications sector in France is due require further reform and adaptations.first to the strong determination of the

99


Box 11: France Telecom Today: New Structures

Until 1990

|European Community

Pria3n_len .Ministry of PTT inistryIof Finance

Minister

ll Regional Om

Subsidiary Subsidiary

After 1990

European Union

HeParliamentary Ce P Mines|| Committee 1 inistry of PTT+

SubsidaryoSr

10irectorates0

Headquartr |Coem I b

Subsidiary S S

100


The Experience of France in Gas and ElectricityJean-Pierre Pe ry

In France, the gas and electricity At the same time, however, the state isutilities, Gaz de France (GDF) and Electricite the sole owner of EDF and GDF which are,de France (EDF), belong to a "network in turn, the dominant service providers insector" that is, a sector in which the service their sectors. As owner, the governmentor the product is delivered through a grid. appoints the president of the board of

directors and the general director. OneThe French experience on the third of the board of directors is formed by

relationship between owners and representatives of ministries, another thirdmanagement, elucidates three characteristics: by experts appointed by the government,(i) the government role as both owner and and the remaining third is elected by theregulator; (ii) the constitution of the workers. The government, especially theperformance contract, and (iii) the potential Ministry of Economy, is in charge of theimpact of increased competition. financial control of the utility through a

"financial inspector." Budget and accounts,The Role of the State as well as the investmnent plan and financial

capital investments of firms are subject toEDF and GDF being public companies, the owner's agreement. The Ministry of

the government plays both roles, that is, of Industry appoints a "commissaire dua shareholder and a public regulatory gouvernement," a governmental represen-authority. In 1946, the electricity and gas tative, who attends the board of directors'sectors were nationalized during a period of meetings in an advisory capacity, and whotransition characterized by lack of private is the administrative interlocutor of theinitiative and capital, huge reconstruction utility with which he is very familiar,needs and rapid development of the follows all its projects and activities, conveyseconomy. the government's instructions, but can also

represent the company's interest inAs a public authority, the state is government debates.

responsible for energy policy and for otherpublic interest policies (environmental The confusion of two roles hasregulations, regional planning) which can, in advantages and disadvantages. The state isturn, influence the activities of EDF and stronger in its relationship With veryGDF. The state is in charge of the pouwerful utilities. It is not easy to control adevelopment and implementation of the company like EDF, which is the leadingregulations. It is also the "conceding power" electricity company in the world, with a 20%which grants transmission or gas pipe share of the European market. As a result,concessions to the operators, and which the relationship sometimes looks like acontrols the distribution concessions granted power struggle. It also allows the state toby local authorities. Finally, the state is the mobilize the company in favor of generalregulator which ensures the optimal interest actions or orientations such asfunctioning of the market through tariffs, employment or environment, or regionalinvestment and competition control. planning.

101


On the other hand, the confusion of The core of the contract, the basis of allroles can be detrimental to the optimal the other provisions, is an agreementmanagement of the company. For example, between these three ministries and thethe state is not a rich shareholder. It does company's management regarding thenot bring sufficient capital to the company, financial objectives and the method tothus forcing the utility to borrow distribute profits among the company itselfexcessively. In the past, it also gave greater for its investments; the consumer, throughimportance to the price index than to the tariff programming - which must take intorational evolution of tariffs. account the productivity gains and not

increase at the same rate as inflation; theThe Function of the Program Contract future consumer, through the debt

reduction; and the public owner throughIn order to clarify the relationship dividends.

between owner and management, thegovernment has signed program contracts, From this point of view, the contractsimnilar to performance contracts, with EDF represents a major step towards making theand GDF. The basic philosophy of the relationship between the government andprogram contract is that the public owner the company more objective. In this context,has to guide the enterprise, and not manage it is interesting to note that, in the Unitedit. The company should be managed like Kingdom, the agency regulating theany other private company, with the same electricity industry (OFFER), has recentlymethods and responsibility sharing. The signed contractual tariff agreements with thecontract determines the broad financial goals public electric distribution utilities, whichregarding productivity, tariffs, debt, profit, basically follow the same principle.and dividends. Within this framework, itpresents the main objectives for commercial The Inpact of Competitiondevelopment, international action, invest-ment programs, social policy and quality Finally, it is important to consider howpolicy, and it provides for a control of the relationship between the owner and thecontract implementation. management will change in the future, as a

result of increased competition, if new actorsThe contract does not exhaust all in the gas and electricity sectors are

dimensions of the relationship between the introduced. Some experts agree that Francepublic owner and the company. Other will have to distinguish more clearlycontracts with various ministries have been between the different roles of the state: onsigned in the fields of environment, regional the one hand the shareholder, and on theplanning and employment. However, this other, the regulator, in order to avoid acontract is a strategic one, signed by the situation where the state would be boththree ministries in charge of the judge and interested party. This wouldshareholders' control of the company certainly require the creation of an(Ministries of Industry, Economy, Budget). independent public regulator. However,Above all, it is a contract among these the French Ministry of Economy andministries in order to reconcile the general Finance does not agree with this view.interests they represent, to coordinate thestrategic control, and to avoid disagreement Another question remains unanswered:between them. how will it be possible to keep such

102


powerful companies under control? For agency? The British experience in thisexample, EDF, which employs 120,000 respect is not very encouraging, because thepeople, is controlled by a team of 25 civil regulating agency has either acceptedservants in the Ministry of Industry, assisted market donination of the most powerfulby five or six people in the Ministries of companies, PG and NP, or has introducedEconomy and Budget. How will it be artificial market sharing, as in the case ofpossible to maintain a balanced relationship gas, reducing the market share of thebetween such companies and the regulating dominating company, BG.

103


Corporatization of Public Enterprises in New ZealandRichard William Prebble

Deciding on the scope of corporati- Help from independent consultants iszation is of major importance. The New necessary to assist in defining the scope ofZealand experience demonstrates that it is each corporation. In the New Zealand case,expensive if corporations have to be outside reports were done on eachrestructured repeatedly; it is, therefore, corporation as a basis for the government'simportant to establish the scope correctly the decision.first time.

Attitudes of Workers' CouncilsBasic Principles Applied toCorporatization in New Zealand In New Zealand, before every corporati-

zation, management warned the government* Corporations should not be their own that transformation would be very difficult

regulators, consequently it is necessary because of resistance from workers, councils,to split off the regulatory functions and and unions. However, in every case, seniorput them into a government and middle management themselves becamedepartment. For example, in New the biggest obstacle to corporatization;Zealand, the conservation forests were unions sometimes were an obstacle, butsplit from commercial forests, forestry workers' councils were not.mills were split from commercialforests. The solution to the workers' opposition

resided in communication. Communicating* Corporations should have a single to workers through middle management, or

commercial focus because conglomerate unions, or workers' councils is fatal, becausecorporations are not successful. New the message gets reinterpreted. Communi-Zealand, for example, split the "post cation must be direct. For example, in theoffice" into Telecoms, New Zealand case of corporatization of the New ZealandPost and Post Bank. Similarly, the set railways, the Minister of State-Ownedup of "Electrocorp" with the national Enterprises wrote directly to every railwaypower grid was not a success, whereas worker, setting out the facts. He wrote towith the split of the power workers' homes so their wives could learntransportation (the grid) from the the facts. In addition, the Railways offeredgenerators, both corporations generous redundancy payments to surplusperformed better. workers - 90% of whom accepted

voluntary redundancy despite the* Non-commercial functions should be historically high unemployment. These high

identified and split off. In New redundancy payments overcame theZealand, the National Engineering workers' councils' resistance.Company Works Corporation was alsothe inspector of lifts, cranes etc., a non- The New Zealand experience showscommercial function which had to be that once direct, honest and openseparated from the commercial one. communication with the workers was

104


established, there were no serious obstacles of Energy for the mines industry, theto corporatization. When workers were ministry of Forestry for forestry corporation,given a choice between working in a badly- and the Treasury for banks.run business or a well-run business, theyselected the well-run business every time. However, this policy was a failure forOnce the workers favored corporatization, two main reasons. First, the tradingthe unions and workers' councils' opposition corporations captured the monitoringto corporatization ended, provided that the agency - for example, the Ministry of Civilunions and councils were reassured that Aviation liked aeroplanes and supportedthey would still be recognized. The every one of Air New Zealand's expansiongovernment withheld recognition to use as plans. Second, there was a shortage ofa bargaining chip. In the end unions business skills in the government. Bybargained away everything in order to keep expanding the number of agencies,their power base as recognized bargaining management skills were spread too thinly.agents.

In response, the government moved inAftitude of Management the opposite direction, setting up a singletowards Corporatization asset management agency that was close to,

but separate from the Treasury, and thusIn many cases, management represented able to have some independent financial

a much more difficult obstacle. The New analysts. The agency concentrated on theZealand government was forced to say to shareholders role, and hired a staff withmanagement that, unless they strongly and business skills who learned to identify earlyefficiently supported corporatization, they signs of failure. They also have learned towould be replaced with managers who did. identify good boards and good boardMany senior managers had to be replaced. members. Because the agency is monitoringMiddle management opposition is under- so many businesses, it is able to take astandable because it is the most threatened national overview of all the corporations.by the reforms - but it still had to be dealt To date, this agency has been verywith. Just as modern corporations have successful. The success of the agencyrealized that with computers they do not depends in part on its ability to develop aneed an army of middle managers, so it is special relationship with the financewith state corporations. For example, in department and, in turn, with thesome state corporations, head offices were availability of an able and strong minister.reduced from 600 to 60.

Identification of the OwnerSelecting the Agentas Owner's Representative New Zealand never spent much time

considering the question of who acts asNew Zealand has tried a wide range of owner for the state, because it had a model

agents. The first choice was the logical one: in existence. For this past century, the statethe sectoral ministry. The Minister of Civil in New Zealand has owned some companiesAviation, for example, was the logical in the private sector. While the Minister ofshareholding minister and the Civil Aviation the Treasury normally used to hold theDepartment the logical monitoring ministry shares in Air New Zealand, the Minister offor the airline industry, as were the ministry Civil Aviation appointed the directors. So

105


New Zealand adopted the model of responsibility. In New Zealand, boards andMinisters as shareholders. The Minister of managers sign strategic plans.Finance holds half the shares in allcorporations, and another minister, The present government has, as aappointed by cabinet, holds the other 50%. matter of policy, stated that someAs it happens, the other minister has been government businesses in areas such as statethe Minister for State-Owned Enterprises, radio, electrical generation and nationalbut legally it could be any minister. transmission, and New Zealand's postal

service will not be sold. However, thePotentially, if the Minister of State government runs these businesses using the

Enterprises and the Finance Minister had a same model employed for businesses thatdisagreement, corporatization would be are to be privatized. All permanently orparalysed. In reality, this has never temporarily public businesses are set uphappened; the system works in New under the private sector Companies Act,Zealand because ministers have to cooperate with commercial balance sheets, commercialand are accountable to Parliament; there is objects and non-government boards; sociala special time put aside to debate the objectives are separate. In the case of thecorporations' past performance, and for the state radio, an agency funded by licensestatements of corporate intent. As the fees, called New Zealand-On-Air, contractscorporations work well, the debate is usually directly and transparently to promotefairly low key. cultural and ethnic radio and other

programmning considered to be non-Allowing agencies that are not commercial.

accountable to Parliament to be owners ofstate-owned enterprises is questionable. ConclusionScrutiny would be very difficult, asdemonstrated by the difficulties involved in Corporatization in New Zealand hasexamining subsidiary companies. If been a successful policy. Nevertheless, in aministers are responsible for the fast evolving environment, businesses havecorporations, then the ministers should to grow and adapt, or they die. Stateexercise ownership. ownership is not always compatible with

this principle. As an illustration, by owningAllocation of Responsibility Between a business like electrical generation theManagers and Govermnental government becomes involved in plans forDepartments the new generation. There is a significant

risk, because many power projects in NewDirect responsibility of managers seems Zealand have had significant cost overruns.

to be more effective. It is important that As the private sector is able and willing tomanagers have the power to make decisions, finance electrical generation, it is not a goodotherwise, they are not responsible, and use of the tax-payers resources.cannot be held accountable. If they havedirect responsibility for decisions concerning Appointing good boards, competentprices, wages, and capital expenditure, they managers and insisting on performance canthen have direct responsibility for outcomes. help improve state businesses - but theReal performance is dependent on this direct truth is that government is in the political

game, and is not good at business.

106


Relationship between Ownersand Management:

Declining Industries

In this discussion of how PEs can In the next presentation, using theovercome the challenges of operating in experience of the French coal industry, Jean-declining industries, Sir Ronald Halstead Pierre Pery argues that a public owner candiscusses how British Steel, a loss making rationally manage the decline of an industry,public company, tackled the threats to its provided agreement is reached with localsurvival by rationalizing dramatically its governments and trade unions, and thatproduction, downsizing its workforce, profitable activities are separated from losscancelling non-commercial objectives, and making ones.introducing performance-linked bonusesunder a strict regime of financial oversight. Evidence is presented to demonstrateThe cost borne by the national and that it is important that companies inEuropean budgets of this restructuring prior declining industries not be managed as ifto privatization has been high. In contrast, the company were in decline. In the case ofthe kind of conunitment and the "authority" France, the lack of proper corporaterequired by governments to enforce new organization in the form of one powerfulcorporate governance arrangements, as well organization in the coal sector, instead ofas the financial means to implement the separate entities that would be able tochanges, is very thin in the transition provide a long term orientation, has proveneconomies. adverse.

107

Relationship between Owner and Management: Declining Industies

The Case of British SteelRonald Halstead

British Steel: Plant Closures andFrom Losses To Viability Manpower Reductions

By the mid-1970s the British Steel During a five-year period (1977 toCorporation (BSC), like many producers 1982), there were 30 major plant closures.worldwide, was facing a number of threats The number of blast furnaces was reducedto survival: over-capacity in world steel; from 30 to 10, and production capacity wasintense competition; and escalating costs as reduced from 21.5 million to 15 milliona result of the oil crisis. Labor-related costs tonnes per annum. At the time of nation-reached a peak in 1978-79 of L1,100 million, alization (1967), the number of employeesequivalent to 35% of turnover. totalled 257,000. This was reduced to

170,000 by 1979 and to 53,000 by 1988. TheMoreover, a particular feature of the effects on manpower productivity were

Iron and Steel Nationalization Act of 1967 dramatic. In 1979 it took over 14 man-hours(and its replacement in 1975) was that it to produce a tonne of steel. By 1989 thatimposed on the Corporation a general duty figure had been reduced to 4.4 man-hoursto ensure that domestic demand for iron and per tonne and the proportion of labor costssteel products would be met by the to turnover had fallen from 35% in 1979 toCorporation. This undoubtedly constrained below 20%.the Corporation's ability to rationalize itsproduct range and, therefore, represented a Decentralization of Industrial Relationsconstraint on the Company's ability to"downsize" its operations. This duty was Central wage negotiations were devol-removed in the 1981 Iron and Steel Act. ved and linked to incentives. Labor cost

increases were largely met through self-In 1979 BSC lost Ll.5 billion and, at the financing deals from improved performance.

insistence of the newly elected Conservative Every three months, depending on the rategovernment, a plan was prepared by the of progress toward locally agreed perfor-management, under the close supervision of mance targets, a bonus was paid as a lumpthe chairman and non-executive directors, to sum to all employees at a plant, from thesubstantially reduce the losses and reach a plant manager to the laborer on the shop-break-even situation. Break-even was floor. This has had the effect of dramatizingachieved in 1985. In 1988, the year of the link between pay and performanceprivatization, the Corporation made a profit whilst emphasizing the interdependence ofof £561 million. all those working at a plant, irrespective of

status, union or occupation. ThisSteps Taken to Achieve Viability combination of policies allowed the

company to give higher rewards toThe following summarizes the steps employees, an increase of 19% in real terms

taken to achieve viability. over 11 years, whilst reducing the laborcosts per tonne of steel.

108


Improving Communications executive directors were appointed to theBoard by the Minister for Industry on the

Many of the policies and programs recommendation of the chairman and non-introduced would be unpalatable for the executive members of the Board.work forces of any corporation. Con-sequently, the third element of the strategy There were normally up to seven non-was designed to deal with this problem. executive directors; and the executiveTraditionally in the steel industry, many of directors consisted of divisional managingthe workers' managements had close directors, finance director, personnel/relationships with their employees. There industrial relations director, and the researchhad always been elaborate consultative and and development director. The companyparticipative systems, generally concentrated secretary also attended all meetings of theon representatives of employees. Under the Board and took the minutes.pressure of the changes needed at the time,however, the system needed improvement; The matters considered at the Boardand many techniques were used to included the rolling corporate plan, annualcommunicate the plans to the workforce, budget, monthly trading results and chiefincluding direct letters to employees' homes executives report, major capital investments,(involvement of families), works newspapers divestments and plant closures. Many ofand direct video messages to the workforce. these items were for submission to theThe Corporation twice polled its entire government (see below). A senior civilworkforce in order to test the strength of servant from each of the Trade and Industrysupport for its policies when these were and the Treasury attended the Boardchallenged. In both cases there was meetings by invitation; they were the mainoverwhelming support from the rank and links with the two government departmentsfile for the survival plans explained and concerned.proposed by the Corporation's management.

There were two sub-committees of theCorporate Governance Board - the Audit Committee and thebefore Privatization Compensation Committee - both com-

posed of non-executive directors. The AuditBefore the 1988 privatization, super- Committee was concerned with the financial

vision, reporting to government and funding controls of the Corporation; and theof restructuring were arrangements already Compensation Committee dealt within place. The following elements were directors' remuneration. The chairman ofcharacteristic of its governance structure. the Compensation Committee had direct

access to the Minister for Industry andBoard of Directors discussed with him the salaries of the

chairman, chief executive and executiveThe Board consisted of chairman, chief directors. The Minister for Industry then

executive, non-executive directors and full- had to clear salary increases with thetime executive directors who managed the Treasury. Invariably salaries were kept at abusiness. The chairman and non-executive low level so that there was an increasingdirectors were appointed by the Minister for disparity between nationalized industryIndustry for three-year terms which could salaries and those of equivalent executivebe renewed. The chief executive and jobs in the private sector. However, British

109

Relationship between Owner and Management: Declining Industries

Steel obtained approval for a bonus system Community, a quota system was applied tothat allowed executives to earn up to an both production and sales, with targetadditional 30% of salary, depending on capacity reductions subscribed to by eachperformance against budget. No other member nation. In addition, it was agreednationalized industry obtained this to phase out all state aids by Decemberconcession. 1985. As far as BSC was concerned, all

advances (made under Section 180) wereRelations with the Government regarded as state aid and before any

payments could be released, formalInformation concerning the operating approval was required from the EC.

results and cash requirements of the BritishSteel Corporation (BSC) was supplied to the If the Corporation required fundsgovernment on a regular basis in the 1980s. (within its external financial limits and itsNormally, contact was made through BSC's borrowing limits) that had not been releasedsponsoring government department, the by the EC, then it was necessary to borrowDepartment of Trade and Industry (DTI), short-term on the financial markets foralthough the Treasury also dealt directly which normal commercial rates of interestwith the Corporation. BSC was required to had to be paid.operate within the restraint of annualgovernment cash limits (external financing Annual Submissionslimits), which were made after jointdiscussion and review. The regime of cash The Corporation regularly submitted tolimits on nationalized industries was the government detailed plans, both for theintroduced by the government in 1976/77 as upcoming year and the medium-term.part of its measures to bring public These plans were generally on a corporateexpenditure under close control. Cash limits basis, although the operating budgets alsowere in tum applied within the Corporation showed details for each of the operatingto its individual businesses, where they divisions of the Corporation. The corporateformed an essential element of management plans were prepared to take into account thediscipline and control. The Corporation was objectives set for BSC by the govemment, asalso required to operate within borrowing well as internally set targets for performancelimits imposed by the appropriate Iron and improvements within BSC. Among otherSteel Act then currently in force, or relevant things, the plans contained projections ofBorrowings Orders laid before parliament. BSC funding needs for the following three

calendar years. The plans were the subjectBeginning April 1978 cash advances to of extended negotiations with government

the Corporation were made under Section representatives, during which the plans180) of the Iron and Steel Acts of 1975. In were modified as appropriate.principle, these advances were interest-free,although the Corporation was to be required Monthly Submissionsto pay dividends once financial viability hadbeen achieved. It was recognized in the Cash Advances. In order to receive theearly 1980s that a manifest crisis existed in funds from the government, a formalthe EC steel industry, with low steel request was submitted to the DTI, generallydemand, poor prices and a significant excess on a monthly basis. This request detailedcapacity. In order to proceed towards a the actual application of funds for theviable steel industry throughout the previous month, and included forecasts for

110


the next three months ahead. DTI and the been modifications to the original plan.Treasury could seek justification of the cash Inevitably, given the business back-requirement, and also review the previous ground, the planned redundancies weremonth's actual expenditures. This was implemented in most cases.normally done at a regular monthly review * A target notice period of one year.meeting attended by all interested parties. * Negotiation of severance payments with

the trade unions for each closure. Pay-Monthly Results. The monthly results ments were related to the employees'

for the Corporation and businesses were length of service; a typical severancereported to the BSC Board in the monthly payment would amount to 26 weeks'management accounts. Copies were sup- pay.plied to the DTI and the Treasury and theresults were subsequently discussed at the Steps taken with individual employeesjoint monitoring review meeting. Not only included:was actual cash expenditure shown for theprevious month, but comparisons were * Peercounselling. Existingemployeesatmade against the budget for each constituent different levels discuss various pro-element of application. In addition to the fessional options for laid-off workers.formalized nature of the meetings noted * Voluntary redundancy whenever pos-above, it was always open to the sible, but not in the case of full plantgovernment to request reviews and/or closures.meetings on specific subjects at any time, 0 Early retirement at 55 years of age, 10which were held as required at a years before UK statutory retirement.chairman/minister level and/or at a staff Some employees chose to embark on alevel. In particular, these meetings took second career at this stage. During theplace when it was necessary to review the period between 1977-84, 60,000Corporation's medium-term plans or employees took early retirement.strategies. The system of reporting and * Retraining. The Corporation providedmonitoring described above allowed the retraining benefits in terms of earningsgovernment to fully control the usage of protection and course fees to enablefunds and the rates of advance. employees to receive proper training for

an alternative career. These benefitsSocial Plan to Accompany would last for up to a year at 90% ofPlant Closures previous earnings.

Compensation. All employees who leftThe task of dealing with plant closures the Corporation as redundant received

was not an easy one. Successful efforts a sizeable cash award. In addition torequired three characteristics, namely,, the severance payments alreadycollective action, committed action and rapid mentioned, employees received anaction to ensure effectiveness. In general, enhanced redundancy payment of 90%the steps taken were: of past earnings covering between 90

and 150 weeks. The corporation* Consultations 7uith the trade unions received some assistance from the UK

and local gozvernment. These some- government and the EC to meet thetimes produced alternative solutions to costs of redundancy.full closure. In some cases there have

IZ1


Conclusion especially in the area of laborshedding:designing of redundancy packages

British Steel was able to successfully that would make it attractive for labor tomanage the transformation from a loss leave; providing counselling services to allaymaking to a viable enterprise, by allowing it fears of the new situation; consulting withthe autonomy to undertake managerial trade unions and employees about the plantdecisions, such as the designing of compen- closures; and ensuring that employees hadsation policies to match performance and opportunities for retraining and jobyet, at the same time extracting strict res- placement outside. One such innovation,ponsibility for performance, through the was the creation of BS(I), to help create jobsannual and monthly submissions. However, in areas affected by British Steel'ssuch dramatic changes would not have been restructuring. Its main features are outlinedpossible without some required innovation, below.

Box 12: British Steel (Industry) Ltd. BS(I)

The Organization BS(I) was set up in 1975 as a Finance. Despite the UK's well developed capitalwholly-owned subsidiary of Bntish Steel. Its sole mandate markets, small, growing businesses often have difficulty inwas to help to create jobs in geographic areas affected by raising relatively small amounts of risk capital often neededthe restructuring of the steel industry; currently, there are 19 because they are usually unable to offer adequate security.target areas. This mandate has remained largely BS(I) is one of the very few sources of risk capital to meetunchanged, except that today there is a greater emphasis on these needs; the company has invested between L10,000 andthe durability of the jobs and the diversification of the local L150,000 in the form of loan or equity capital in sucheconomy, and less on short-term job creation measures. The companies.company operates very much at arm's length from the restof British Steel. Over the years its board of directors has Premises Small businesses, particularly newincluded business people from the private sector and businesses, often have difficulty in finding suitable premisesnational officers of the trade unions as well as executives on affordable terms. bS(l) addressed this problem originallyfrom the British Steel group. It works in dose collaboration by converting redundant steelworks' ancillary buildings intowith central government and regional and local authorities. self-contained units and, more recently, by building modem

business centers.In 1981 the bS(I) Board proposed to invest most of the

foUlowing three years of funding in job creation assets, Indirect Assistance The indirect programs orprimarily business loans and property. The main objective assistance include several initiatives for encouragingof this plan was to make BS(I) financiaUy independent of entrepreneurial skills in young people and providingBritish Steel after March 1984. The transformation was financial support for other local economic regenerationsuccessful, and from April 1, 1984 BS(l)'s income has been initiatives, including the Local Enterprise Agencies whichderived from property rental and from the interest on loans provide business advice for new and existing businesses atto businesses, which created jobs in closure areas and, more the lower end of the size spectrum.recently, dividends from companies in which it has taken ashareholding. This income is now generally sufficient to Results Over 3,000 businesses have been directly andcover its normal operating costs. materiaUy assisted by BS(I), mainly with finance or premises

or both, with a three-year job creation potential of overActivities The company has always foUowed the 50,000 jobs. In addition, it has been estimated that at least

principle of filling gaps in the supply of the resources and a similar number of jobs have been created as a result ofservices which small, but growing businesses need. As the indirect British Steel (Industry) support.needs of small businesses have changed through time, sohave bS(I) programs.

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The Experience of the French Coal EndustryJean-Pierre Pery

The declining industries, such as steel situation where their production andor coal, pose specific problems, in addition markets continue to shrink along with ato the other difficulties that transition worsening financial position caused by theireconomies face. inability to compete in world markets.

The French Situation Ownership of the Minesin the Coal Sector

Under common law, mineral rightsThe Decline of Coal Mining in France belong to the owner of the surface land.

However, this is not the case in the FrenchThe coal industry in France has been in mining code: the owner of the surface has

decline since the Second World War. no mining rights. Mining rights are givenProduction has decreased from 50 million by the state to operators in the form of atons in 1947 to 9 million tons in 1994. The mining concession, with a maximumnumbers of workers decreased from 360,000 duration of 25 years. The concessionin 1947 to 17,000 at present. Consumption operator also needs a license from theof coal, currently at 25 million tons, is Administration.rapidly decreasing in all sectors (steelindustry, cement, residential). In other This system aims to be in conformityindustrial sectors the consumption remains with different principles, including:steady because of low coal prices, but at arather low level. In France, because of the * the idea that mineral resources are ofimportance of nuclear electricity generation, public interest and cannot bethe use of coal in the energy sector is very appropriated definitively by particularlimited; coal accounts for only 4.5% of the interests;electricity generation (using 8 million tons of * the need for a legal framework thatcoal). allows economically viable operations

by the mining company; andCoal prices in France are free and * the respect of public security and

determined with reference to international environmental obligations.prices, but production costs are muchhigher. For example, in 1992 the average Ownership of the Coal Miningproduction cost was FF543 while the price in Companiesthe international market was FF242, that isto say less than half the production cost. Coal mines were nationalized afterThis situation is due to bad geological World War I and their operation turnedconditions: French coal is of poor quality, over to newly created companies. In 1946,and difficult to rmine because deposits are France was in a situation not very differentcoming to an end. Thus, companies from that of countries currently in aengaged in coal production are faced with transition: weakness of private entrepre-the difficult challenge of managing a neurship, lack of capital, and the necessity

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for rapid recovery. Today, coal mines in (Ministries of Industry, Economy, BudgetFrance are operated by three public and Social Affairs), seven experts appointedcompanies owned by the French state. by the state and six union representativesThese include: elected by the workers. The president and

the managing director are appointed by the* two local operators: one in the coal government, upon proposal by the board of

basins of central and south of France, directors. A special representative of thethe other in the Lorraine basin in the government ("Conmnissaire du Gouverne-northeast; ment") attends the sessions of the board of

* a third operator, CDF (Charbonnage de directors in an advisory capacity. Generally,France), which controls and coordinates the representative is the director of gas,the other two, managing some common electricity and coal at the Ministry ofservices (especially financial services) Industry. He is in fact the administrativeand determining the global strategy. interlocutor of the company.There is no capital link among the threeoperators, which is a problem. The public coal companies, like all

public utilities and declining industries inThe state is both the owner of the France, are under the financial control of the

mining companies and the public regulatory Ministry of Finance which appoints aauthority. As owner, the state exerts its financial inspector ("Contr6leur d'Etat").control through the Ministries of Industry Budgets and financial statements have to beand of Finance. The board of directors of approved by the governrment. The annualeach company is composed of 18 members, investment plan is also approved by aincluding five representatives of the state specific body, the FDES.

Box 13: The French Economics and Social Development Fund (FDES)

During the expansion of the 1950s and 1960s, the The fund is financed by budgetary appropriations,Economics and Social Fund (FDES) proved to be a major special resources affected to its operations and theinstrument for channelng funds into long-term industrial reimbursement of former loans. The Ministry of Financeinvestment. Created in 1955 as a special account within the decides whether to subsidize interest rates on loans.French budget, FDES aimed at financing investment projectswhich followed Planner's guidelines or specific priorities FDES has a fundamental role in financing largepursued by the government such as industry conversion or infrastructure and equipment investments. Originally,decentralization. The FDES board of directors is composed funds were slated to finance investment projects of largeof representatives of various technical Ministries (such as enterprises, public transportation, local governments andthe Minaistries of Transportation, Equipment, Industry, etc.), tourismn Special concern was given to enterprises whosehigh level civil servants (Heads of central departments) and activities were fundamental within a spedfic area. As therepresentatives of financial institutions (such as the Banq ue French financial system became more independent from thede France, the Caisse des Depo4 etc.). The Minister of government in the early 1970s, FDES's role declined.Finance serves as the chairman and has the power of final Currently, FDES lending activity is now concentrated indecision on loans. Thus, FDES's board of directors is an troubled semi-pubhc and public sectors, such asessential institution of coordination for the government's transportation, mining sector and public investment. Itsfinancial policy, primarily towards public and secondarily, main role remains in the reaUocation of public investmentprivate enterprises. Its functions include: deciding on within various sectors. In particular in the energy sector,lending activities; scrutinizing public enterprises' investment the FDES board acts as a regulator of the investmentpolicy; and approving agreements with intermediary programs.financial institutions.

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Regulation of the Sector economic activities for the former coal-producing areas.

However, the government is also thepublic regulatory authority, not just the * Maintaining a free market with freeshareholder. As regulatory authority, it is in prices, based on the international coalcharge of the broad energy policy and other price, as well as free relationshipspublic policies that can affect coal mnining amnong collieries and electricity utilities.activity (such as environment, foreign trade, Indeed, the government refused to giveand social policies). For example, the choice any support to the coal sector marketof nuclear electricity generation has had through artificially high prices.great consequences on the coal sector.

*Promoting transparency. The decline ofIn addition, the government establishes the coal industry requires subsidies so

the niining code and all the administrative as to mnanage a socially acceptableproceedings. For example, when mining phasing out and avoiding any sudden,activity comes to an end on a site, it is mass redundancy. This requires timenecessary to engage in a very long and and costs a great deal, and must becomplicated procedure of relinquishing the transparent, which means that theconcessions that involves major problems of subsidies are given through the publicliability. The government also regulates budget to the collieries to help financecompetition in the energy sector, including the expenses inherited from the past -

the relationship between coal mines and the with no link with the present miningelectricity generation company, quality and activity (such as the former miners'import control. Finally, the government's pensions) - as well as to finance therole is to assure the proper functioning of re-industrialization work of the coalthe coal market. areas and, finally, to finance collieries

losses.Specific Features: Role of the Ownerin Declining Industries As long as it follows the above-

mentioned principles, state ownership helpsThe role of the owner in the case of reconcile a market approach with a social

declining industries is different from the role approach to the problem of the coalof the owner in the case of commercial industry's decline. In addition, the publicsectors, especially when this owner is a owner has a global perspective on thepublic entity. The French experience problem of the declining industry and candemonstrates that a public owner can implement other policies easing the phasingprovide an opportunity to rationally manage out of collieries, for example bythe decline based on the following. programming educational investments. Itprinciples: can also maintain reindustrialization activity

in the coal areas after the closure of the* Helping the declining sector and areas mine. In the north of France, where mnines

during this difficult phase in order to have been closed for two years, afind new jobs for the miners who are reindustrialization subsidiary is still at work.too young to retire and to promote new

115


Limitations Imposed The subsidies must be transparent andby the Nature of Ownership given through the public budget, not

hidden in artificial market prices. It isAlthough such principles are attractive, worth noting that it would have been

in reality, the public owner faces several better to distribute these subsidiesdifficulties in rationally managing the through regional budgets, as indecline of coal. It is not easy to be both the Belgium, because otherwise it is in theshareholder and the public authority subject interest of local authorities to maintainto political choices under pressure from mining activities even at a loss, in orderpublic opinion. Making decisions about the to receive as many national subsidiesschedule of mine closures, for example, is and infrastructure programs as possible.difficult and subject to delay andbacktracking. Closure decisions are difficult * Second, to negotiate an agreementto implement because of the state's global between the unions and the collieriesapproach as shareholder. As the on a global plan to manage the decline.government closes the mines in decreasing In France, the mining company CDForder of losses per ton and per miner, the and the unions have negotiated thedifficulties it meets on a small site with "coal pacts," the main impact of whichheavy losses block the entire procedure and will be the creation of social guaranteesprevent it from taking adequate steps for former miners and the acceptance ofregarding other and larger sites. the year 2005 as the end of coal mining

activity in France.Finally, it is also difficult for the public

owner to solve some of the major problems * Third, in order to maintain a rationalposed by the end of mnining activity, such as economic discipline in the relationshipthe responsibilities relating to the former between the public owner and themining operation or the future of real estate management, it is essential to createassets owned by the collieries. The state is specific subsidiaries in order to separatesensitive to the complaints of local the profitable activities (such asauthorities regarding closures, and in electricity generation) from the loss-recognizing that, the state encounters the making activities (such as coal mining)risk of asset-stripping of the company. and to avoid compensating these losses.

This separation helps the state to makeTo resolve these difficulties, the French appropriate investment and industrial

government found that the following steps strategy decisions.were critical:

Sectors in Decline versusFirst, to make all actors (management, Companies in Declineunions, local authorities) aware of theirresponsibilities and interests in the Managing the Declinerational management decline. This in the Coal Sectormeans not covering entirely theoperational losses in order to encourage Any company operating in a decliningthe company's management to increase industry has to guard itself from the dangerproductivity and to enforce self- of being managed as a declining company.discipline, and letting the citizens know It can face this challenge by:what the coals sector costs the nation.

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* managing the decline, closing sites, * developing new engineeringreducing production and at the same technologies as in the case of under-time becoming more competitive and ground coal mines and coal-operatedproductive on the sites that are stil power plants outside of France. Asviable. It may not be easy to reconcile CDF's mines in France are closing, onethese objectives. How to keep of the most interesting cases ofexperienced miners and executives on implementation by CDF of modemsuch sites, with a global policy leading mining techniques can be found into people reconversion? How to India; andfinance investments in a financiallydebased situation? The most * recognizing that sectoral changes haveproductive investments that can be implications for the organization of themade lead to an earlier closing date; company; a proper structuring of the

group is of major importance to* not letting viable activities be rationally manage the coal sector's

overshadowed by non-viable activities. decline and to ensure the developmentFor example, electricity generation by of viable new activities at the samethe collieries' power plants is profitable. time. The French experience showsIn the case of CDF, its future lies in that:electricity generation, which nowrepresents more than half of the - the French industrial organization inturnover, with nine power plants this sector, with separate companiestotalling 2600 MW; in the different coal basins, is not

efficient. It is better to gather all* considering the changes in the activities mining activities into one company

of the company. For example, the new or group, with a central powerfulresponsibilities of CDF, which ensure organization and long-term strategicthe future of CDF as a company, are no orientation, that can maintainlonger in the field of coal extraction in guidance and negotiate with localFrance, but in the field of reconversion authorities and unions;and reindustrialization, intemationalmining engineering and electricity - isolating viable activities into distinctgeneration; subsidiaries to avoid any

compensation of mining losses by* reconverting and reindustrializing profits from these activities would

declining areas through job creation, jeopardize their development.and infrastructure development. CDFhas created specific subsidiaries in this Privatization in Declining Sectorsfield of activity, which in turn requireparticular experience and skills. One of In France, the decline of the coal sectorthese subsidiaries, has helped the has been managed within the framework ofcreation of more than 49,000 jobs since a public company. The issue of whether1986; privatization is possible in a declining sector

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has not been addressed. Based on the energy supply, and is in violation ofEuropean experience, three experiences can European regulations. The second solutionbe distinguished: is efficient if the geological mining

conditions allow it and if there remains athe market support to coal mining, market for the coal. It requires that the newthrough artificial internal prices, privatized operators not be obliged toespecially in the relationship between support the costs incurred by other non-electricity utilities and coal mines, viable mines or closed mines, such aswhich can be private or public miners' pensions. This strategy also requires(Germany); a selection of the pits: only a few can be

privatized. Finally, the third solution is* the privatization of coal mines after adapted to the case of bad geological

separating the losses inherited from the conditions and sufficient reserves. It is apast, which have not been passed on to good way to reconcile the free market andthe new operators (UK); and the social management of the coal decline

for the population of coal-producing areas.* the management of decline by a public

agency in charge of progressively In conclusion, the French experienceclosing the mines under socially shows that the relationship between theacceptable conditions, and ensuring the owner and management has to be radicallyfuture of the company by the adapted in the case of declining industries.development of viable activities, in The management of a declining industry ispartnership if necessary with other costly and has major social dimensions.interests (France). Every decision is subject to questioning

because of local and national politicalThe first solution is very costly; in 1992, interests. However, it is desirable to

the subsidies per ton of coal amounted to 60 anticipate such problems and to put intoEcu in Germany, 21.5 in the UK, and 19.9 in place an adequate framework as soon asFrance. Moreover, it does not lead to the possible, based on the principles ofend of the activity, but rather prolongs it transparency, responsibility, social solidarityindefinitely, disturbing the energy market, and efficient structure of the company.undermining the competitiveness of the

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Establishing Effective Oversightover Public Enterprises

This section concludes the volume with development of the corporation on behalf oftwo cases of managerial issues of PEs. The the shareholder. A proper division offirst, by Brian R.D. Smith, deals with the responsibilities among the shareholders, theoversight responsibility of owners vis-a-vis board of directors and the management is atthe managers and describes the case of the the heart of establishing an appropriateCanadian Public Enterprises. Smith believes governance structure, according to Smith.that the system of checks and balances forcorporate governance embodied in a special The second paper, by Sir Ronaldlegislation, has served Canada well so far, Halstead, provides the specifics of personneland may have its merits in applicability management as undertaken at British Steel,elsewhere. Establishing clearly the oversight in order to prepare the assumption of futureresponsibility of the Board and provisions of management positions like the method forthe Board's performance evaluation, were identification of high potential or rewardsimportant measures taken to guide the policy for performing individuals.

119

Establishing Effective Oversight over Public Enterprises

The Role of Boards:The Case of Canadian Railways

Brian R.D. Smith

Introduction extensively, going back to the early years ofthis century. Entities called "Crown

Corporate governance has been defined corporations" were established to achieveas the process and structure used to direct public policy goals in instances where it wasand manage the business and affairs of the deemed necessary to distance governmentcorporation with the objective of enhancing from day-to-day management activities andshareholder value. A key aspect of where there was a need for the activity to becorporate governance is the manner in managed according to sound commercialwhich powers and responsibilities are practices. Today, there are close to 50shared among shareholders, the board of federal Crown corporations in Canada, withdirectors, and management. The expression assets totalling more than $53 billion. Many"oversight of management" sums up in a more exist at the various provincial levels.phrase the fundamental role of a Federal corporations today employ aboutcorporation's board of directors as 120,000 people, roughly as many asrepresentative of the owner or shareholders. Canada's public service, excluding theBut the mechanisms by which this armed forces and the Royal Canadianresponsibility is carried out in a public Mounted Police.enterprise necessarily differ from standardpractice in the private sector. Canadian public enterprises may be

divided into two groups: those that supportStructures and processes have evolved infrastructure - Canadian National

in Canada to permit effective oversight of Railways (CNR), for example - and thosemanagement in public enterprises. They that promote cultural identity, such as themay not always work as intended, but they Canadian Broadcasting Corporation.are essential to the balancing andreconciliation of public policy and corporate Crown corporations also vary in termsobjectives, which the shareholder and of financial viability and dependence onmanagement respectively represent. government funding. Some, like Canadian

National Railways, operate in a fullySelected statistics for Canadian PEs are commercial environment. They compete on

shown below, along with the market share an equal footing with private sector firmsof public enterprises in different sectors. and are subject to the same regulatoryThe Appendix summarizes the corporate regime as their competitors. They aregovernance regime in Canada. expected to be self-supporting and self-

financing, to be profitable, and to contributeBackground: dividends to their shareholder. Others,Public enterprises in Canada because of the nature of their mandate,

depend on state appropriations to fulfill theCanada has used public enterprises as public policy goals for which they were

an instrument of nation-building fairly established.

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Canadian State-wned Enterprises

1. Selected Statistics, 1991-1992(Canadian $)

SOE portfolio 55 parent enterprises

Total SOE assets $77 billionDecrease in SOE assets $6.1 billion (last 5 years)

Employment 121,148Decline in employment 32% (last 5 years)Net decline attributed to privatization 64% (last 5 years)

Efficiency gains 36% (last 5 years)

Decrease in loans, advances and investment 21% (last 5 years)Reduction in indebtedness 12%, or $1.9 billion (last 6 years)

Dissolutions/transfers 37 transactions (last 6 years)

Privatization 23 transactionsProceeds from privatization $4.7 billion

Z Mraket Sham of Fntel istes in the Public and Private Sectoms

Eomcoic Federal Provincial Pnvate Economic Federd Provincial Privake

Sector SOEs SOEs Enteaprises Sector SOEs SOEs Enterprises

Em-y Cdharailand gas x x X Television x x X

Power - X X Film x x Xcoal x - x Mueuns X x x

uranium - X x Tlwatres x x X

Transportation BanrUng/Fmnanctal

Railways Comnercial banks - - Xfreight X x X Developnrnt ban X x Xpassenger X x x Venture capital - x X

Mari freight - - X

Ferries x x x Construction x x XCanals X x

Ports X X x Agria4ltur/FishenesTrucking - - X Fish processing x x XAirlins - - X Marketing boards

wheat X -

TUeemunicahions saltfish x - X

Iltematioral - - X fresh fish x - Xbter-proinial - - X dairy products x x XIntra-provincial - x X livestock feed x - X

Pbst and Cowier X - x MAufactwing - - X

Jrte 'x' =partial ma*et share; X' =dcninant ma,ket share

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Over the years, Canada has continually Management's responsibility is to formulatereviewed the status of its various Crown and carry out strategies that achieve thatcorporations: Are they still needed for objective. In the normal course of events,policy reasons? Would they function better the interests of the shareholder and thein the private sector? As a result, some interests of the corporation closely coincide.corporations have been dissolved, others Shareholders are best served when theprivatized. Recently, the Minister of company is run primarily with a view toTransport has formed a parliamentary task mnaximizing profitability. So it can be saidforce to examine the future ownership and that directors should act with the bestoperation of Canadian National Railways, interests of the corporation itself in mindincluding possible privatization. Both the because that will bring the greatest benefitboard and the management of CNR have to shareholders.welcomed this initiative as a timely andpromising opportunity to review the However, the role of the board in aenterprise's mandate in the light of current public enterprise is more complex becauseand future economic demands. This the shareholder is not an investor seekingcoincides with attempts by the two maximum return on his or her investment,Canadian railways to rationalize and but a democratic institution with importantstreamline their eastern Canadian public policy goals to which the corporationoperations. Canadian Pacific Railway (a is expected to contribute. This is not to sayprivate sector company) has recently offered that the shareholder is not concerned withto buy the entire eastern operations of CNR the commercial viability of the corporation.- so the Canadian rail industry is currently After all, good performance in financialentering a period of major change and re- terms is vitally important to management ofexamination. the nation's accounts. But it does indicate

the often difficult balancing act that theCorporate Governance: board, as representative of the shareholderStructures and Processes and as the primary link between shareholder

and management, must perform inThe general characteristics of the attempting to reconcile the pursuit of profit

Canadian corporate governance system for and the pursuit of public policy objectives.SOEs are described in Annex 2. In addition,Canada has established specific structures A recently published guide for Crownand processes to facilitate oversight of public corporations directors summarizes theirenterprise management by boards of complex role this way: To "oversee thedirectors and to ensure accountability. corporation on the Crown's behalf by

holding management accountable for theRole of the Board company's performance, its long-termin Public versus Private Enterprises viability and the achievement of its

objectives." The structures whereby theAccording to the conventional corporate boards carry out this function are set out in

model, a company is operated first and legislation: theFinancialAdministrationAct,foremost for the benefit of its shareholders. which governs all Crown corporations, andThe owners entrust to the board of directors the specific legislation, if any, under whichthe responsibility for monitoring the individual corporation was established.management and ensuring that company Ten years ago, in the wake of perceivedactivities contribute to shareholder benefit. accountability failures in a number of Crown

122


corporations, the Financial Administration * Safeguarding the corporation'sAct was amended to improve and resources. In this respect, the boardstandardize the governance of these public acts as steward of the company'senterprises. The changes have strengthened financial and physical assets. It mustthe ability of the board to oversee review and pass judgment on operatingmanagement and guide the development of and capital budgets as well as newthe corporation on behalf of the shareholder. project proposals and borrowing

requests. It has to decide on the sale ofInstruments for Oversight corporation assets and on the methodof Management of sale. For example, CNR

management's proposal to spend $200Crown corporations are required to million on a new rail tunnel under the

present reporting and accountability St. Clair river at the Canada-U.S.documents on a regular basis. These border, was subject to board approval,documents include the corporate plan, as was the external borrowing thecapital and operating budgets, quarterly project required. The board assessedfinancial statements, and the annual report whether the tunnel proposal was in linewith audited financial statements. Each is with CNR's planned strategic directionprepared by management, with guidance and represented a valid use of companyfrom the board of directors. Each must be resources. The conclusion was that itapproved by the board before being would indeed contribute in a majorsubmitted to the shareholder through the way to greater competitiveness in theminister responsible for the corporation (in marketplace and increased revenuesCNR's case, the Minister of Transport). over the long term, both of which areOnce approved by the shareholder, these primary corporate objectives, anddocuments become the basis of management greatly enhance CNR's freight businessaccountability. They constitute the key between Chicago and Toronto.element in the board's oversight ofmanagement performance. * Monitoring the performance of the

corporation. This is a continuous taskBasic responsibilities of the board and the framework for the board's

include: oversight function. By studying reportson the company's performance, board

* Establishing the corporation's strategic members are able to assess thedirection. The focus of this function is appropriateness of the strategic planthe formulation of the corporate plan, and the means management haswhich originates with management. adopted to achieve the objectives.The board is intimately involved in the Occasionally, this review results inprocess and has a duty to ensure that changes both to strategy and tactics.the elements of the plan correspondwith the objectives the shareholder has * Reporting to the Crouwn. It is theset for the corporation. The approved board's responsibility to convey to theplan then serves as a basis for shareholder a complete picture of thesubsequent decisions as well as a functioning of the corporation inyardstick against which management relation to its established strategicperformance is measured. direction. Obviously, this is possible

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only if the board has exercised accounting policies, proposed capitalscrupulous oversight of management in expenditures, and the intemal auditthe formulation and implementation of function. The environmental and socialthe corporate plan. Of course, reporting policy committee verifies compliance withto the shareholder must go beyond the legal requirements, monitors social issues,prescribed submission of board- and ensures that the company hasapproved plans, reports, and budgets. established appropriate policies in the socialThe board, through the chairperson, and environmental fields. Theshould bring to the attention of the compensation committee monitors theminister any important matter that falls quality of management by reviewingoutside the regular reporting routine if executive appointments, managementthe directors feel that shareholder compensation and benefit plans, andinvolvement is warranted. management succession, training and

recruitment practices.Structure of Canadian Railways'Oversight Issues

The make-up of the board, the role of A number of important issues arethe directors and the conditions of office are associated with the setting up, staffing, andspelled out in the goveming legislation, the functioning of public enterprise boards.Canadian National Railways Act. CNR's They may be grouped as having to do withboard comprises a chairperson and 11 other the selection of directors, their development,directors, one of whom is the chief executive evaluation of their performance, andofficer (CEO) and the only "inside" or constraints on their activities.executive board member. The chair is fulltime but independent of management. Selection. In Canada, the CabinetApart from the chair and CEO, the directors (Governor in Council), selects Crownserve on a part-time basis. They are corporation directors - altogether, aboutappointed by the shareholders on the basis 600 positions. Finding receptiveof their ability to contribute effectively to individuals with the right mix of skillsCNR's govemance and collectively, they and knowledge to match the needs ofrepresent the various regions of the country each corporation can be an enormouswhere CNR has a presence. The majority of challenge and must be undertaken withthe directors have a background in business great care.or law and are also usually politicallyconnected. * Development. Even with the ideal

background, a new director has toThe board uses committees extensively undergo a rapid process of leaming

as a means of enhancing productivity and about the corporation and its businesscapitalizing on the individual skills of the environment if he or she is to performvarious directors. Currently, there are six effectively. Both management andcommittees: audit, environmental and social shareholder must providepolicy, compensation, investment, real comprehensive orientation materials toestate, and executive. Each committee has a bring new directors up to speed asrole to play in the oversight of management. quickly as possible. Once that has beenThe audit committee oversees the achieved, there should be an ongoingpreparation of financial statements, development process to form a career

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path involving conunittee assignments is to refrain from any partisan politicalof increasing complexity and activity that would reflect in a negativeresponsibility so that each director way on the impartiality of thecontributes to the best of his or her corporation. Another is to avoid anyability. potential conflict of interest by not

getting involved in board deliberationsEvaluation. Another necessity is a on a matter in which the director has amechanism for evaluating the personal interest.performance of the board as a wholeand that of individual directors. This is Conclusiona function best performed by the boarditself in collaboration with the Canada has had a long and largelyshareholder - but it must be based on successful experience with public enterprise.consistent and objective standards. The accountability framework and the

checks and balances established between* Constraints. Directors of Crown owner and management - embodied by the

corporations are subject to constraints board of directors have generally servednot usually applicable in the private Canadians well. But as national needssector. These constraints stem from the evolve, it must be ensured that theneed to maintain a distance between the institutions, both public and private, remainessentially commercial nature of the flexible and open to new concepts.political nature of the shareholder. One

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Box 14: Corporate Governance of State-Owned Enterprises in Canada

Role of the Govenmment He may propose the restructuring, acquisition, sale or

The Parliament, the Cabinet and its liquidation of enterprises.the Finance or Treasury minister and the line The line minister negotiates with the manage-ministries play an indirect role in the governance of ment of the enterprise to establish enterprise goals,SOEs. At the level of the enterprise, the board of and monitors performance. Together with thedirectors and management of the enterprise are Treasury, the minister negotiates dividends and maydirectly responsible for management and control. The call for special dividends if the enterprise has surplusspecific responsibilities of each of the governmental cash in hand, and receive those dividends which arebodies are described below (the role of the boards contributed to the consolidated revenue fund of theand management is covered in the preceding section). Treasury. If necessary, the minister can issue

The Parliament is responsible for approving all "directives" to an enterprise, instructions that may beasto SOEs. In addition, Parliament in the public interest but not necessarily in theappropriations toSE.I diin alaet commercial interest of the company.

exercises control over the proliferation of enterprises,given that the creation of SOEs requires a special act, A number of instruments are used to monitoras well as over the liquidation of SOEs. and evaluate SOE performance. All enterprises must

submit audited financial statements to theThe Cabinet must approve the purchase or goenetauirsreponedbthCbnt

divestiture of wholly or partially-held subsidiaries of government; auditors are appointed by the Cabineta parent SOE. The Cabinet also appoints the chair- for a three year period. In addition, comprehensiveman and boards of directors of SOEs, usually upon audits of systems and practices are conducted everyman~~~~~ ~~ an bors fdietrso SE,usalyuo five years by an outside management consultant orrecommendation of the prime minister or the line vebyear an eralminister. In general, candidates for chair-man have by the auditor general.experience at the highest level of the industry, or Furthermore, enterprises are subject to legalhave been involved in public service with political restrictions, including laws that are specific to stateaffiliations. Board members are selected to ensure owned enterprises, as well as laws that affect allappropriate professional skills on the board, and/or corporations. SOEs, in the first instance, are boundregional, ethnic, gender and linguistic representation. by their articles of incorporation and the corporateThe Cabinet also approves the appointment of CEOs by-laws. In addition, most SOEs are subject toas well as the salary scales and/or honoraria of the federal laws concerning competition policy, unfairCEOs, chairmen, and boards of directors. The chair- trading practices, environmental regulations, officialmen and directors serve at the pleasure of the languages, labor codes and property rights. SOEs,Cabinet, but in practice are rarely dismissed for like private corporations, are accountable to thepolitical reasons. courts which enforce these laws.

The Treasury Board must review and approve The responsibility for commercial performancecorporate plans, capital and operating budgets, rests with the enterprise. The role of the governmentannual reports and audited financial statements is limited to shareholder functions and to the usualwhich are prepared by the management of the enter- functions of the state. The separation of the roles ofprise and approved by the Board of Directors. In chairman and president means that the CEO isaddition, the Treasury Board must also approve accountable to the board of directors and theinterim borrowing requirements and major invest- chairman is accountable to the shareholder. The clearments not included in the enterprise's business plan. legal framework for the mandate for boardsFinally, the Board establishes ceilings on lines of diminishes political interference. The corporatecredit and borrowing from commercial banks and business plan prepared by enterprise managementother financial institutions, both nationally and and approved by the Board clarifies the enterprise'sinternationally. goals and objectives in terms of profitability and

The line minister is accountable to Parliament efficiency, and the quarterly financial reportingfor allaspets ofenterprisac be performanc, and f system enables both enterprise and government

for all aspects of enterprise performance, and for officials to monitor performance, identifyingintegrating the strategies of individual enterprises e . . 'into the plans for the sub-sector or sector as a whole. riorating operating results and over-runs in

capital investments promptly.

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Selection and Removal of Manugers:The Experience of British Steel

Ronald Halstead

Introduction Basic Training

At the time British Steel was a public The provision of basic training,owned company, the Minister for Industry including professional qualifications is thewas responsible for the appointment of the responsibility of the particular works/chief executive and executive directors after business unit, each of which has appropriateconsultation with the chairman and non- training facilities. British Steel also has aexecutive directors of the Board of the residential management training collegeCorporation. They were appointed on three- which provides a broad program ofyear contracts and subject to all other management training, designed to assistconditions of employment of employees of career progression from graduate entry levelthe Corporation. Senior managers were through to senior management. Some 1,400appointed by the chief executive after managers receive training at the college eachconsultation with the chairman and directors year.of the Corporation. The following are thebasic procedures used throughout the Corporate Resource DevelopmentCorporation with respect to the selection,appointment and removal of managers. British Steel has a company-wide

system of development for its managersRecruitment designed to meet individuals' aspirations for

continuous career development and theRecruitment into management ranks company's need for high-quality managers

was and still is focused largely on young with broad experience of a number ofgraduates leaving universities, of whom technologies, functions, markets, etc.approximately 150 were recruited each year. Information about the developmentContacts with universities and the requirements of managers is derived fromrecruitment process are coordinated two key sources:centrally, but initially graduates areappointed to particular works or businesses * A regular annual appraisal ofwhere they undertake basic training to fit performance of each manager,them for first management posts and to indicating the extent to which majormeet the requirement of professional objectives have been met, andqualifications. There is relatively little development and training needs.recruitment of mature managers from other * For those seen as of high potential, theemployers and those recruited tend to be formal assessment of that potential,specialists. leading to the creation of an

appropriate career development plan.

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Those seen as being of high potential those appointed. Recommendations to theare formally recorded as being members of committee are made by appointment panelsa corporate resource (currently totalling 250), of directors following formal interview ofwhich is seen as the seedstock for future those nominated from the corporatesenior management posts leading ultimately resource.to director level. Members of the corporateresource are interviewed regularly by careerpanels consisting of executive directors who Reward Structureoffer appropriate guidance on developmentand career opportunities. In order to sustain the corporate

resource approach, the terms and conditionsAccelerated Development of all British Steel senior managers are

administered centrally in accordance with aParticular programs have been created common corporate pattern. The rewards

to assist young managers who are members objective of the company is to provide anof the corporate resource in developing the opportunity of earnings at or above thebroad range of skills needed for senior appropriate market median where personalmanagement/director posts. For younger and business performance are good. Pay formanagers, the accelerated management performance is an important feature of thedevelopment program is run in conjunction reward policy, with general reviews beingwith a business school on a modular basis entirely discretionary and reflecting theand leads first to a certificate in performance and contributions of themanagement studies and thereafter through individual. Bonus is a significant feature ofa three-year distance learning program to an the package, providing up to 25% ofMBA. For more experienced managers, the earnings for senior managers and designedinternational management program, run in to reflect appropriate, successful businessconjunction with international business performance.schools, also on a modular basis, provides aparticularly international perspective to Terninationmanagement training. A significant numberof senior appointments in recent years have In order to create opportunities forbeen drawn from managers who have younger managers with potential to movesuccess-fully completed these programs. into more demanding jobs, attractive con-

tributory pension arrangements exist, whichAppointment provide an opportunity for senior managers

to retire at age 60 at two-third of final salaryIn order to reinforce the objectives of with long service. Particularly during the

the corporate resource concept, all senior decade of the 1980s, when British Steel wasmanagement appointments are subject to the closing a large number of plants, it was notapproval of an Appointments and Salaries possible to retain the original managementCommittee, a committee of executive stock, although redeployment provisionsdirectors chaired by the chief executive. An were made to encourage those with higherobjective of the committee is to ensure that skills to remain with the company. Duringeach appointment that is made draws this period it was necessary to declare aeffectively on the stock of high-potential large number of managers redundant, withmanagers that has been created and appropriate redundancy payments asprovides continuing career development to provided under national and European

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arrangements. Wherever possible, Managers could also be dismissed forvolunteers for redundancy were encouraged the following reasons: breach of the code ofto take advantage of these terms, which conduct under the terms of their contract ofwere particularly attractive to those employment; and inadequate performance.approaching retirement age.

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ANNEXES


Annex A

Corporate Governance of Public Enterprises in FranceMarion Leblanc-Wohrer

The French public enterprise system is company Aerospatiale, Renault, and Airnot based on a theoretical model, but was France. These groups employ one milliondesigned case by case. The state-owned people and their turnover is FF 1200 billion.sector came into existence after World War This program does not include enterprises inI and was rapidly expanded in 1936 (the the non-competitive sector, which requireperiod of the Popular Front), 1945-46 (as a change of status before they can bereaction to World War II), and 1981-82 privatized. Following implementation of the(following the election of the socialist program, the public sector will begovernment). As a result, the system of concentrated in the non-competitive sectorFrench state enterprises includes several (Electricite de France, Gaz de France,corporate governance systems. In the Charbonnages de France, SNCF, RATP, Lacompetitive sector, the state usually acts like Poste, and France Telecom for a shorta private shareholder. In the while).noncompetitive sector, the state has greatercontrol over the enterprises. In 1992 the public sector included 2,750

enterprises, employing 1.7 million peopleIn 1981-82 the government tripled the (9% of the employed population). The state

public sector's share in the French GDP by controlled directly 105 enterprises (in whichnationalizing eleven industrial groups, two it owned more than half of the sharefinancial companies and thirty-six banks. In capital), of which fifteen were large1986, the conservative government began industrial groups. These groups representedprivatizing enterprises in the competitive 90% of the energy sector and 80% of thesector. The reduction in the public sector's metallurgy sector. They controlled moreshare in the French economy will accelerate than 50% of the capital of 492 enterprises.with the implementation of the 1993privatization program. This program is In 1992, the public sector includeddesigned to privatize twenty-one of the enterprises in the energy sector (Electricitymajor public enterprises, including insurance of France, Gas of France, French Coal), incompanies, four banks, and fourteen the industrial sector, in the transportationindustrial groups, including the aerospace sector (railways, underground company,

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ANNEX A - Corporate Governance of Public Enterprises in France

aerospace company) and in the financial Structures of State Enterprisessector (banks, and some insurancecompanies). Public "establishments" comprise

industrial and commercial public "establish-Specificity of the French Model ments" and mixed public "establishments"

performing administrative and industrial orThere is no definition of state commercial activities, such as the Caisse

enterprises in French law. The legislature Nationale de Credit Agricole (a state-ownedhas provided only partial definitions bank operating in the agricultural sector) ordesigned to govern specific legal situations independent ports. Industrial andrather than establishing a general definition. commercial public "establishments" (EPIC)The distinctive nature of the public sector undertake industrial and commercialhas historical roots and its legal basis falls activities, but their activities are related towithin both public and private law. the general interest of the country. Most of

these are monopolies or oligopolies thatState enterprises have two main legal provide public services, to which the

forms, public "establishments" and Constitution guarantees the equality ofcommercial companies. Public "establish- access. Most large state enterprises withments" are enterprises whose activities are some monopoly power have this status,related to the general interest of the country including Electricity of France, Gas ofand which have not been corporatized. France, French Coal, and French Railways.They have an industrial and commercial Although certain aspects of their activitiesnature, although some of them also perform and operations remain subject toregulatory activities. They are usually in the administrative law because of their publicnon-competitive sector. Public commercial status, most of the acts they perform arecompanies (joint-stock companies) are subject to the rules of private law.usually in the competitive sector, and thestate controls the majority of the share EPIC can create subsidiaries in the formcapital. of joint-stock companies as long as the

parent enterprise retains at least 50%These two types of state enterprises ownership. This allows these "establish-

differ in structure and management ments" to diversify their activities. Thedepending on their purpose, the extent to decision to create subsidiaries is subject towhich the sector in which they operate is authorization by the line minister or bycompetitive, and the size of the state's share decree upon the advice of the Conseil d'Etat.capital holdings.

State enterprises in the competitiveState enterprises are also governed by sector usually take the form of joint-stock

two legal systems, public and private. companies, where the capital can bePublic law includes specific rules that apply partially or entirely state-owned. The sameto administrative activities undertaken by applied to nationalized enterprises whichstate enterprises, and disputes are settled by remained commercial companies. It is rarethe administrative courts. Private law to see the state creating commercialregulates industrial and commercial activity, companies unless they were subsidiaries ofand disputes are referred to the ordinary public "establishments."courts.

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State enterprises can be established as State enterprises are also subject tocommercial companies (societe d'eonomie European laws. The European Commissionmixte) with both public and private capital. is keen to enforce fair competition betweenThe capital composition of such companies the public and the private sectors. Forand the objectives they pursue (such as example, since 1980, a European directiveurban development) give rise to some compels the state to notify the Commissionexemptions from general laws governing when it plans to grant capital contributionscommercial companies. to public enterprises.

Legislation Governing Public Enterprises Finally, starting in 1983, specific lawsmodifying the status and governance of the

State enterprises are subject to public public sector were enacted. These includelaw with respect to their activities in laws on Democratization of the Public Sectorconnection with any public service, the use (1983), which determine the governanceof prerogatives of state power, and their structure of the enterprises, and laws onlegal form as a public establishment. privatization and the opening of companies'Regulatory decisions made by state capital to the private sector (1986). Decreeenterprises providing an industrial and No 91 (1991) allowed the private sector tocommercial public service or concerning acquire shares in the capital of major publicspecial prerogatives outside the bounds of enterprises. The opening of the capital togeneral law (such as the right of the private sector of public enterprises aimsexpropriation or the power to conclude at facilitating the modernization of thesecontracts that require the occupation of enterprises by bringing in new capital butpublic property) are administrative does not modify the status of the state as thedecisions; if challenged, they are referred to major shareholder.administrative courts. In certaincircumstances, these privileges are Prior State Control over the Public Sectorconcurrent with the submission of theseactivities to rules and regulations of public The power of the state as a shareholderlaw. depends on whether the enterprise is a

public establishment or a commercial com-Commercial law applies to all pany. In the competitive sector, the state

commercial activities, such as registration of acts as a private shareholder: it appointsthe company, participation in professional members of the board, approves theelections, application of accrual-basis company's strategic plan, its accounts, andaccounting rules, contracts entered into by the distribution of benefits. It expresses itsstate enterprises, and application of taxes. decisions through its representatives. In theThe distinctive nature of EPIC means that noncompetitive sector, the state exercises itsthey are not bound to the general powers more directly. The following tablecommercial law, including bankruptcy and shows the allocation of administrativejudiciary settlement. Enforcement measures powers and appointment of managementavailable under private law may not be used bodies.against such an enterprise.

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Allocation of Administrative Powers

Industrial and Commercial Commercial companies Commercial companiesPublic Establishment stae share >90% State share < 90%/o

BOARD OF DIRECTORS

* Members Parity between: Parity between:- state representatives; - state's representatives; - state and private- qualified personnel - qualified personnel shareholders' representatives,(experts); (experts); (number of state- employees' representatives. - employees' representatives depends on

representatives. the size of the state's sharecapital holdings);

- employees' representatives (athird of members).

* Powers Day-to-day activities. Need According toapprobation of line ministries Commercial law According tofor investments decisions, Commercial lawborrowing, tariff and wagepolicy.

MANAGEMENT Chairperson Chairperson ChairpersonBODES

General directors General directors General directors

GENERAL None None if state-owned at General Meeting according toMEETING 100% . A state commercial law

representative acts at thegeneral meeting.

Appointment of MNnagement Bodies

Industrial and Commercial Commercial companies Commercial companiesPublic Establishment state share >90% State share < 90%

PRESIDENT OF co-signs the appointment co-signs the appointment of co-signs the appointment of theTFE STATE of the Chairperson the Chairperson Chairperson

CABINET OF - appoints the Chairperson - appoints the Chairperson - appoints the Chairperson.MNISTERS and managing directors and managing directors - Managing director is

- appoints state - appoints state appointed by the Chairperson.representa-tives and representatives at the - appoints its representatives atexperts at the Board Board; the Board ( proportionally to

- appoints experts, at the its share capital). Privateboard's suggestion. shareholders representatives

are elected by the GeneralMeeting.

LINE MINISTRIES approves appointments by approves appointments by approves appointments byCabinet of Ministers Cabinet of Ministers Cabinet of Ministers

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Financial and Technical Supervision A body of state inspectors exerciseseconomic and financial supervision of public

The Ministry of Economy and Finance enterprises. They inform the minister of theexercises its controls through the Treasury, enterprise's decisions and inform theBudget, and Price departments. The enterprises of the minister's position. Theycoordination of these departments rests sit on the board of directors and can exercisemainly with the minister's office. a suspensory veto but have no voting

power.The Treasury department acts as the

enterprise's owner. It determines the Technical supervision is exercised byamount of debt that the state enterprise may the line ministries, generally the ministry ofissue on financial markets, and the increase Industry, Defence, or Transport. Thisin share capital and approves capital supervision is exercised by representativesinvestment decisions, mergers and acqui- appointed by the line ministries to the boardsitions. of directors. These government

commissioners (commissaires duThe Budget department handles the gouvemement) relate information regarding

budgetary assistance paid by the state, and the enterprise's decisions and ensure that thethe Price department controls prices in the ministerial instructions on the managementpublic sector in conjunction with the line of the enterprise are put into practice.ministries. In some industries it has onlythe power of approval, such as in the metro The Parliament must approvecompany (RATP). nationalization and privatization decisions

and private capital contributions that wouldThe Economics and Social Fund (FDES) cause the state to lose its majority share

is a special account within the state budget holdings, since this would result in thedesigned to coordinate the government's transfer of an enterprise from the publicfinancial policy toward public and private sector to the private sector. Parliament alsoenterprises. Its functions include deciding has to approve any increase in share capital.on lending activities and scrutinizing publicenterprises' investment policy. The Fund's A Posteriori State Controlboard of directors is composed of over the Public Sectorrepresentatives from various technicalministries (such as the Ministry of Despite attempts to take social needsTransportation, the Ministry of Equipment, into account, the control of state enterprisesand the Ministry of Industry), high-level remains guided by the logic of profit andcivil servants (heads of central departments), loss and financial equilibrium. Three bodiesand representatives of financial institutions are responsible for controlling state(such as the Bank of France and the Caisse enterprise: the Cour des Comptes (Court ofdes dep6ts). The minister of finances serves Accounts), statutory auditors, and theas the chairperson. Parliament.

137


The Court of Accounts audits accounts Several other factors have contributedof all industrial and commercial public to the relatively good performance of public"establishments" and commercial companies enterprises in the noncompetitive sector.in which the state owns the majority of the These include the depth of technical,share capital and assess their performances. financial and economic capabilities in the

sectoral ministries. In addition, theThe Commissaires aux Comptes continuity of personnel in the relevant

(Statutory Auditors) play a legal role in state ministries and stability of senior enterpriseenterprises formed as corporations and in management have facilitated long-termsome public "establishments" (such as planning, the relative transparency ofelectricity, gas, and coal). They are operations and the minimal interference ofappointed by the Ministry of Finance. politically-motivated decisions.

The government must provide the Sectoral Study: Electricity of FranceParliament with an annual list of state (EDF)enterprises and their balance sheets andoperating accounts. Parliamentary control of Enterprises in the electricity sector werethe management of state enterprises may be nationalized in 1946, and Electricity ofexercised through investigative and France (EDF) was created as an industrialcontrolling commissions, but this procedure and commercial public establishment. EDFhas rarely been used. acts as a monopoly in distribution and

production. In 1992 it had a staff of 120,000,Strengths of the Governance System and its turnover was FF 171 billion (around

US$34 billion). Its benefits amounted toPublic enterprises were designed on a FF 1.9 billion in 1991 (US$380 million).

case-by-case basis and, as a result, theirgovernance status is very flexible. The state controls EDF. It determinesFurthermore, the responsibility for energy policy and regulates the sector incommercial performance rests with the terms of security, health, and theenterprise. This autonomy has allowed environment. But it does not manage it.enterprises to expand their activities andmodermize. The Cabinet of Ministers appoints a

third of the board of directors (stateOne of the major success of the French representatives), and appoints the

system of public enterprises was the creation chairperson and the general directors.and implementation of "contracts plans"between the enterprises and the The Ministry of Finance, through FDES,government. Contract plans ensure state examines investment projects, controls thecontrol and respect of state objectives while budget, and authorizes borrowing. It alsoallowing autonomous management. They determines wage policy in conjunction withare negotiated agreements between the the line ministry.government, acting as the owner of the stateenterprise, and the enterprise itself, aimed Financial supervision is exercised by theat spelling out the rights and duties of both Mission of Financial and Economic Control,parties. Contract plans were signed with which consists of two state representativesmost of the largest EPIC and with placed within EDF.commercial companies after 1981.

138


The Ministry of Industry appoints one * to define economic and financialgovernment commissioner (commissaire du objectives, such as reducing the debtGouvemement) who relates information and increasing productivity;regarding enterprise decisions and ensuresthat the ministerial instructions on the * to assure coordination between themanagement of the enterprise are put into enterprise's medium-term objectivespractice. and the state's policy. The contract

determines the conditions under whichThe state does not manage EDF. To the EDF can diversify its activities

enforce this autonomy and delineate state without unfairly competing with theand EDF responsibilities, the state signed a private sector; andcontract plan with EDF in 1970. This planwas the first signed in France and was * to define social policy.considered to be the model contract plan. Itspelled out a system of more flexible The state's supervision of the EDF isgovernment supervision that reduced the tight in terms of determining energy policy,powers of the government's representatives but it gives the firm autonomy to manage itsand the Ministries of Finance and Energy. activities. There are no subventions fromSince the 1970s, EDF and the state have the state. As a result, EDF is an economicregularly signed new contracts. The success. The firm makes profits, andobjectives spelled out in the current contract electricity service is provided at a low costare: (one of the lowest in Europe).

139


Annex B

Holding Companies: The Case of AustriaOskar Gruinwald

Organization of the Nationalized policy of social partnership securedSector in Austria industrial peace and strong position of the

shop stewards led to a high degree ofidentification of the workers toward their

In Austria, nationalizations started after company.WWII. The First Nationalization Act (1946)comprised mining, heavy industry and Development in the Organization ofbanks and the Second Nationalization Act Nationalized Industries(1947) included electrical utilities. Themotivations behind nationalization were a Organization of the Public Sector in Austriamixture: politics and ideology on one side,and very pragmatic considerations on the 1945 - 50 Reconstructionother. Years later, enterprises would be 1950 - 60 Expansion & Stabilizationprivatized in the context of a similar 1960 - 70 Discussion of Reorganizationpr.iva.ized Issues of Mergerscombination of ideological and practical Ists epracat SepsFirst Privatization Stepsconsiderations. Structural Change

1970 - 85 Holding StructureMain Characteristics of MergersNationalization in Austria Steel Crisis

Decline of Heavy Industry

The success of nationalizations in the First CapitalInfusioififties and sixties depended on the following 1985 - 90 Major Reorganization &factors: the legal system remained State financial helpunchanged; companies were nationalized, New Strategy:but not entire sectors like in the UK; an Internationalization/experienced management was kept at the Privatizationhead of the nationalized companies; the MajorityPrivatizationunions played a very positive role: the

141

Annex B - Holding Companies: The Case of Austria

Initially the public enterprise sector was company for a period of time, and laterreorganized after every federal election. return to the private sector; andVarious ministries were in charge of * increase flexibility: It is much easier foradministering the ownership rights, which a holding company to privatize theirrendered the management of public assets subsidiaries than for ministries whichunclear. Finally, in 1970, the holding have more political responsibilities. Forcompany (OIAG) was established, example, the Austrian holdingcompanyrepresenting the first real solution to the was very successful in handling severalproblem of ownership of public enterprises. sales in 1993 and 1994, with the help of

investment banks. This was madeThe Austrian Holding Company possible because the companies kept the

negotiations secret.In 1970, the Austrian government made

the decision to establish a holding company Corporate Governancefor state-owned enterprises. The goals were in the Public Sectorto:

The minister of Public Economy and* distance state-owned enterprises from Transport currently controls 100% of the

politics: state-owned industries are holding company, which in turn ownsnever entirely free from political several industrial companies.influence, but a holding companystructure allows the reduction of party The Role of the Ministerinfluence;

• establish a financial rationale: a The formal rules require that theholding company is more profit- minister report to Parliament, makeoriented than a government agency, decisions on state subsidies and guarantees,because such a company has a balance nominate the Supervisory Board of thesheet, and is interested in dividends. holding company, and participate in theBy contrast, in the context of the federal selection of the holding companybudget, a few millions of dividends do management. He is also consulted on thenot make a big difference; appointment of the BOD. The strategy is

* improve the financial function: a also very often discussed with the minister.holding company can have a central The minister offers recommendations ontreasury function, and many other major reorganizations and mergers; in casecorporate functions that can not be of regional problems (such as plant closure),performed in the Ministries; it is the minister who approaches the

* increase continuity: a holding company holding company. The chief executive andis better able to survive elections and the president of the supervisory board are inchanges of government; permanent informal contact with the

* insure greater professionalism: there is minister. Although major decisions aremore industrial experience among the invariably made following consultation withstaff of a holding company than in the the minister, his recommendations are notministries. Staff can be hired from the necessarily followed.private sector to work in the holding

142


Role of the Holding Company decisions, financial policy (whether theyborrow or not, and the choice of the bank)

The holding company's functions and production, sales and price policies.include: The holding company and the ministries did

not interfere in these decisions.a nominating the supervisory board of

subsidiary companies; management Structure and Duties of Supervisoryand staff of the holding company sit on Boards on the Basis of Austrian &the supervisory board of the subsidiary German Company Lawcompanies. In most cases, they occupy (Two-tier System)the functions of either chairman or vice-chairman; The Austrian and the German systems

* duties dealing with the annual general are very similar but both are quite differentmeeting such as approval of accounts, from the Anglo-American system of a one-appointment of auditors; and tier board.

* duties dealing with the ExtraordinaryGeneral Meetings, including approval The responsibilities of the Supervisoryof capital increases, change of articles of Board are: to nominate executiveassociation and mergers. management for a maximum period of five

Before the privatization program of years (one to six members); to approve theRefore the hold mpanin Aprogram of acquisition and sale of companies, the

1993, the holding company in Austria also closure of plants, the real estate transactionsexercised addihonal functons that are not and capital expenditure, the borrowingtypical of all holding companies. These policy (bonds, credits and loans), the startfunctionsuincludedipreparationof guidelines and closure of businesses and productionfor the subsidiary companies with the lines, and the general principles of corporatepurpose of introducing a uniform controlLmg policy. The board must hold a minimum ofsystem, cost accounting system, three meetings annually (usually fourconsolidation guidelines, and treasury meetings). Two-thirds of the Supervisorycentralization. These guideltnes also Board are elected by shareholders for aregulated management remuneration and period of four years and can be removed atintroduced a system of investment projects any time; one third are nominated by theevaluation. The holding company also council of shop stewards.approved acquisitions and divestitures, theannual budget, the mid-term plan (3 to 5 Thus, the Supervisory Board is not justyears) and the corporation's strategy. a supervisor. The Supervisory Board

participates in, and must approve, importantRole of Operating Subsidiary management decisions involving investment,Companies acquisition and strategy. The Supervisory

Board also gives advice and supportsOperating companies have always kept business. The Supervisory Boards of most

important functions and sole power and major companies consist of managers ofresponsibility, in the following activities: major companies insist expers of

purchse poicy, ersonel an wage other companies, industrialists, experts inpurchase policy, personnel and wage law and natural science, representatives ofpolicies (although Supervisory boards are unions, and chambers of commerce, ofinvolved in this function), investment customers, bankers and suppliers that give

143

Annex B - Holding Companies: The Case of Austria

them access to a very good network of there are limits to a horizontal holding. Forcontacts. example, the public holding company of a

European country owned a refinery, andThe Supervisory Board can have several other companies such as a barber shop and

committees, including the Presidential a flower shop. This is too extreme: oneCommittee, the Audit Committee, the holding company cannot care for 20Finance Committee and the Special Purpose different industrial sectors. Three or four isConmmittee. These commnittees can either absolutely the maximum.prepare a board resolution or be authorizedto give final approval. There are also vertical limits. For

example, the Austrian state-holding had aIssues sectoral holding company which owned a

German sub-holding company for someThere are still a number of issues con- products; this German firm owned a Dutch

cerming the holding company structure and sub-holding company, for some financingthe relationship with the ministry which purposes, and the Dutch company hadhave to be decided on country-by-country subsidiaries that really produced. Problemsand case-by-case basis: should public occur in communication, information andcompanies, for example, be regulated by responsibility. When something goesspecial laws, or only common company wrong, the responsibility is blurred becauselaws? Austria used to have special laws, but of so many layers.most of them were abolished. One difficultylies in the applicability of bankruptcy law. Other issues involved are the extent toIf a public share-holding in a company is which competition is allowed within theover 51% in Austria, it will normally be holding group, the degree of autonomy ofbailed out, but not if it is less than 51%. To subsidiaries and the need for overallwhat extent should the Ministry get coordination.involved? This issue is linked to thedifficult question of political responsibility Conclusionand its limits: how can the minister beresponsible for commercial activities, and The holding model as a form ofwhat does that entail? management of state assets has performed

relatively well in Austria. However, theFurthermore, there are several types of same necessary conditions might not be

holding companies, and the choice of present in most transition economies;appropriate form is difficult. The prevalence of the rule of law, transparencygovernment must choose between a strategic of public decisions, respect for theholding or financial holding. A strategic company's autonomy, management to beholding is more involved in the strategic used in the corporate governance ofdecisions than a financial holding. (A subsidiaries and a competent bureaucracy.completely different type would be a Recent changes in economic conditions havemanagement holding.) called for privatization, and the Austrian

holding company has not resisted thisHolding companies exert their function change. Thus, the holding company model

along vertical and horizontal lines. The has been a transitional one for Austria.choice is of major importance. However,

144


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