Reforming State-Owned Enterprises in Asia: Challenges and Solutions 9789811585739, 9789811585746

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ADB Institute Series on Development Economics

Farhad Taghizadeh-Hesary Naoyuki Yoshino · Chul Ju Kim Kunmin Kim Editors

Reforming StateOwned Enterprises in Asia Challenges and Solutions

ADB Institute Series on Development Economics Series Editor Tetsushi Sonobe

, Asian Development Bank Institute, Tokyo, Tokyo, Japan

Asia and the Pacific has been advancing in many aspects of its development, but the potential for growth is vast. The Asian Development Bank Institute Series on Development Economics aims to identify and propose solutions using a multidisciplinary approach to important development issues facing economies in the Asia and Pacific region. Through edited volumes and monographs, the series showcases the research output of the Asian Development Bank Institute as well as its collaboration with other leading think tanks and institutions worldwide. The current focus of the series is infrastructure development; financial inclusion, regulation, and education; housing policy; central and local government relations; macroeconomic policy; and governance. The series also examines the major bottlenecks to greater stability and integration in Asia and the Pacific, while addressing timely issues including trends in microfinance, fiscal policy stability, and ways of tackling income inequality. The publications in the series are relevant for scholars, policymakers, and students of economics, and provide recommendations for economic policy enhancement and a greater understanding of the implications of further capacity building and development reform in Asia and the Pacific.

More information about this series at http://www.springer.com/series/13512

Farhad Taghizadeh-Hesary • Naoyuki Yoshino • Chul Ju Kim • Kunmin Kim Editors

Reforming State-Owned Enterprises in Asia Challenges and Solutions

Editors Farhad Taghizadeh-Hesary Social Science Research Institute Tokai University Hiratsuka, Kanagawa, Japan Chul Ju Kim Asian Development Bank Institute Chiyoda-ku, Tokyo, Japan

Naoyuki Yoshino Keio University Minato-ku, Tokyo, Japan Kunmin Kim Public Institutions Reform Division Ministry of Strategy and Finance Sejong, Korea (Republic of)

The views in this publication do not necessarily reflect the views and policies of the Asian Development Bank Institute (ADBI), its Advisory Council, ADB’s Board or Governors, or the governments of ADB members.ADBI does not guarantee the accuracy of the data included in this publication and accepts no responsibility for any consequence of their use. ADBI uses proper ADB member names and abbreviations throughout and any variation or inaccuracy, including in citations and references, should be read as referring to the correct name.By making any designation of or reference to a particular territory or geographic area, or by using the term “recognize”, “country”, or other geographical names in this publication, ADBI does not intend to make any judgments as to the legal or other status of any territory or area.Asian Development Bank Institute Kasumigaseki Building 8F3-2-5, Kasumigaseki, ChiyodakuTokyo 100-6008, Japan www.adbi.orgADB recognizes “China” as the People’s Republic of China. Note: In this publication, “$” refers to US dollars. ISSN 2363-9032 ISSN 2363-9040 (electronic) ADB Institute Series on Development Economics ISBN 978-981-15-8573-9 ISBN 978-981-15-8574-6 (eBook) https://doi.org/10.1007/978-981-15-8574-6 © Asian Development Bank Institute 2021 This work is subject to copyright. All rights are reserved by the Publisher, whether the whole or part of the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microfilms or in any other physical way, and transmission or information storage and retrieval, electronic adaptation, computer software, or by similar or dissimilar methodology now known or hereafter developed. The use of general descriptive names, registered names, trademarks, service marks, etc. in this publication does not imply, even in the absence of a specific statement, that such names are exempt from the relevant protective laws and regulations and therefore free for general use. The publisher, the authors, and the editors are safe to assume that the advice and information in this book are believed to be true and accurate at the date of publication. Neither the publisher nor the authors or the editors give a warranty, expressed or implied, with respect to the material contained herein or for any errors or omissions that may have been made. The publisher remains neutral with regard to jurisdictional claims in published maps and institutional affiliations. This Springer imprint is published by the registered company Springer Nature Singapore Pte Ltd. The registered company address is: 152 Beach Road, #21-01/04 Gateway East, Singapore 189721, Singapore

Preface

Across developing countries in Asia, state-owned enterprises (SOEs) are important players in their economies, often the dominant in key sectors such as utilities, telecommunication, resources, and finance, making their performance essential for economic growth. State ownership of enterprises has been deemed as a method by which governments can regulate natural monopolies, supply essential public goods, promote social policies such as regional development and employment, as well as reduce market failures. However, state ownership can suffer from its inherent weakness in its governance such as the principal-agent problem and is prone to interferences from the ruling elite and bureaucrats in its operations, negatively affecting the performance of SOEs. Over the last few decades, low performance of SOEs has been a major concern globally. SOEs have tended to be less profitable than private-owned enterprises, more dependent on debt for their financial needs, and more labor-intensive with higher labor costs. These factors result in lower growth and lower dynamic markets especially for developing countries in Asia, which hinders foreign investment and home-grown innovation. However, SOEs attempting to satisfy multiple and often conflicting objectives makes it difficult to accurately assess their performance. Low profitability of SOEs can be a result of pursuing other social objectives even though social objectives often tend to be a convenient excuse for its low performance. As such, SOEs face a very different set of challenges than their private counterparts, requiring unique and carefully constructed mechanisms in governance, monitoring, and performance evaluation. Developing countries must reconsider why they establish SOEs, how they manage and monitor them, and how they improve their performance to liberate or liquidate unproductive sectors of the economy. Whether this means allowing for more competition, greater scrutiny, accountability, or other metrics such as privatization – reforming SOEs is an essential topic. Best practices, policies, and lessons from other countries can help shed light on potential and practical solutions for developing countries in Asia that aspire improved performance of SOEs and vibrant private sectors in their economies.

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Split into three parts consisting of 16 chapters on SOEs, this book first delves into corporate governance, strategy, and the legal framework of SOEs; then challenges and solutions in privatization; and finally, evaluation of SOE performance via country studies. The first part begins with a chapter by Henrique Schneider on New Public Management, emphasizing the organizational and behavioral aspects of SOEs. The primary assumption is: if an SOE acts as market enterprises, and if their management is allowed to follow the logic of the market, SOE will become more productive, innovative, and customer-oriented. Next, we find Chap. 2 by Chung-a Park on national practices for improving the accountability and performance of SOEs by examining relevant legislation, policies, and practices in Asian and other economies. The chapter assesses these against internationally agreed good practices exemplified by the OECD Guidelines on Corporate Governance of State-Owned Enterprises. Nine Asian countries reviewed in this study demonstrate varying degrees of efforts and progress. Pornchai Wisuttisak and Bin Abdul Rahman reviewed the experience of regulatory reform on SOEs in Chap. 3. The study explores the trends of regulatory reforms relating to privatization, liberalization, and competition, focusing on airlines, energy, and telecommunication in Thailand and Malaysia. India is a substantial country in Asia for SOE development, having moved from a command and control economy to a free market one. The new competition law introduced the tenet of competitive neutrality for SOEs engaged in economic activity. In Chap. 4, Vijay Kumar Singh examined the impact of competition law and policy on reforming SOEs in India. The state is a significant owner of industrial and commercial enterprises in Uzbekistan. SOEs dominate and have a significant influence on the performance of most economic sectors. In Chap. 5, Umidjon Abdullaev analyzed in detail the governance mechanisms currently employed to manage the portfolio of commercial SOEs. The second part begins with a focus on the relationship between corporate governance and corporate performance by Initial Public Offerings (IPO) of Kazakhstani SOEs. Keun Jung Lee in this chapter argued that privatization, an IPO, has different effects depending on the types of owners to whom it gives control in corporate governance. Privatization of Japanese National Railways and Japan Post is next and have been one of the most significant reforms for SOEs. Since the beginning of privatization processes, the outcomes of these reforms have reflected in productivity, quality of service, as well as the interdisciplinary diversification. In Chap. 7, Chul Ju Kim and Michael C. Huang aimed to illustrate the rationale, process, and consequences for these two important privatization cases in the history of SOE reforms. In Chap. 8, we find the economic reforms in India for the development of private enterprises, which are unfettered from functionary public sector management. In this chapter, Kunmin Kim and N. Panchanatham analyzed reform, partial privatization,

Preface

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and restructuring of Indian SOEs and emphasized the need to shape more effective policies to encourage continued and diverse economic development. In the final chapter of Part II, we find Iranian SOEs struggling with low productivity and low transparency of budget spending leading to a high budget deficit. In Chap. 9, Mohsen Fazelian, Hooman Peimani, and Farhad Taghizadeh-Hesary reviewed the possibility of privatizing the SOEs in Iran as the enterprises are vital in managing the country in the mid-term and long-term. Part III is on performance evaluation of SOEs and country studies, beginning with an empirical study by Taghizadeh-Hesary et al. that developed a comprehensive model for assessment of SOEs’ performance. Utilizing principal component analysis technique and the data of 1148 SOEs, this study aims at delivering a more comprehensive framework for assessing SOE performance across five factors: profitability, per capita productivity, per capita costs, debt due days, and solvency. Chapter 11 by Jhungsoo Park, Jina Kim, and Chul Ju Kim emphasizes the need to have balance between autonomy and accountability in the management model of public institutions. The overall structure for better performance of SOEs requires a smart evaluation system, and here we look at the Korean SOEs evaluation system with a history of 35 years providing various insights for other countries. Then we have a closer look at Viet Nam, which is a former centrally planned economy – notwithstaing bold reform and opening, it is still home to a substantial state-owned sector. In Chap. 12, Le Ngoc Dang, Dinh Dung Nguyen, and Farhad Taghizadeh-Hesary examined the existing challenges in the progress of reforming the SOE sector in Viet Nam to reduce their number while increasing their production capacity. The core of Chap. 13 is on the role of the Bangladesh Small and Cottage Industries Corporations as an SOE in the cluster-based development of small and medium-sized enterprises. In this chapter, Monzur Hossain looked at firm-level survey data over time and critically examined the institutional impact on the industrialization process in Bangladesh. In Chap. 14, Dawn Chow Yi Lin and Youngho Chang looked at the Temasek Holdings, an investment holding company for Singapore with a net portfolio value of S$313 billion, that has helped the Singaporean economy grow, excel, and prosper since its inception in 1974. The chapter looks at whether the Singaporean model for the management of SOEs can be replicated or adopted along with key challenges for an SOE to deliver sustainable value over the long term amid growing trade and geopolitical tensions. In Chap. 15, Thai-Ha Le, Farhad Taghizadeh-Hesary, and Canh Phuc Nguyen compared the significant obstacles to doing business for SOEs and their private counterparts in selected emerging Asian economies using data from the World Bank’s Enterprise Surveys. The conclusions of this study have connotations for policymakers to address the relevant obstacles in order to enhance the business climate in their countries. The final chapter (Chap. 16) by Serik Orazgaliyev looked at SOEs in the oil and gas industry, where they continue to secure leading positions in the majority of the oil-producing countries. This chapter explores a case of nationalization policies in Kazakhstan’s oil and gas industry in the post-Soviet period and the challenges of

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improving technological capabilities, access to capital and financial independence, as well as strategic human resource management. Hiratsuka, Kanagawa, Japan Minato-ku, Tokyo, Japan Chiyoda-ku, Tokyo, Japan Sejong, Republic of Korea

Farhad Taghizadeh-Hesary Naoyuki Yoshino Chul Ju Kim Kunmin Kim

Acknowledgments

We are grateful to Yong Beom Cho for his support in this project, Alan Myrold for editorial assistance, Adam Majoe for publication management, Grant Stillman for legal affairs management, and Masae Ikeda for secretarial support. We also thank Juno Kawakami of Springer Nature for her help and efforts in the book publishing process. We are exceedingly grateful to all the contributors to this book. Without their valuable contributions, we would not have been able to finalize this book.

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Contents

Part I 1

2

3

4

5

Corporate Governance, Strategy and the Legal Framework

Strategy, Independence, and Governance of State-Owned Enterprises in Asia . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Henrique Schneider

3

Enhancing the Transparency and Accountability of State-Owned Enterprises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Chung-a Park

21

Regulatory Frameworks for Reforms of State-Owned Enterprises in Thailand and Malaysia . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Pornchai Wisuttisak and Nasarudin Bin Abdul Rahman

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Reforming SOEs in Asia: Lessons from Competition Law and Policy in India . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Vijay Kumar Singh

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State-Owned Enterprises in Uzbekistan: Taking Stock and Some Reform Priorities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Umidjon Abdullaev

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Part II

Privatization: Challenges and Solutions

6

The Effects of Privatization and Corporate Governance of SOEs in Transition Economies: The Case of Kazakhstan . . . . . . . . . . . . . 113 Keun Jung Lee

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The Privatization of Japan Railways and Japan Post: Why, How, and Now . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 133 Chul Ju Kim and Michael C. Huang

8

Reform and Privatization of State-Owned Enterprises in India . . . . 157 Kunmin Kim and N. Panchanatham xi

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Contents

Privatization of Iranian State-Owned Enterprises: Barriers and Policy Recommendations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 169 Mohsen Fazelian, Hooman Peimani, and Farhad Taghizadeh-Hesary

Part III

Evaluation of Performance and Country Studies

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Necessity of Developing a Comprehensive Evaluation Framework for State-owned enterprises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 185 Farhad Taghizadeh-Hesary, Naoyuki Yoshino, Chul Ju Kim, and Aline Mortha

11

Is the Management Evaluation System of State-Owned Enterprises in the Republic of Korea a Good Tool for Better Performance? . . . 203 Jhungsoo Park, Jina Kim, and Chul Ju Kim

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State-Owned Enterprise Reform in Viet Nam: Progress and Challenges . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 231 Le Ngoc Dang, Dinh Dung Nguyen, and Farhad Taghizadeh-Hesary

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State-Owned Enterprises and Cluster-Based Industrialization: Evidence from Bangladesh . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 255 Monzur Hossain

14

State-Owned Enterprises in Singapore: Performance and Policy Recommendations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 275 Dawn Chow Yi Lin and Youngho Chang

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Obstacles to Doing Business in Asia: Cross-Country Analysis for State-Owned Enterprises and Private Firms . . . . . . . . . . . . . . . . . . 297 Thai-Ha Le, Farhad Taghizadeh-Hesary, and Canh Phuc Nguyen

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Nationalization and the Role of National Oil Companies: The Case of Kazakhstan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 323 Serik Orazgaliyev

About the Editors

Farhad Taghizadeh-Hesary is an associate professor of economics at Tokai University in Japan and a visiting professor at Keio University, Japan. He completed his master’s degree in energy economics from Tehran University, Iran, in 2011. Dr. Taghizadeh-Hesary subsequently obtained a Ph.D. in energy economics from Keio University in 2015 with a scholarship from the government of Japan (MEXT). He taught as an assistant professor at Keio, following the completion of his Ph.D., until March 2018 and is teaching as an assistant professor in the faculty of political science and economics at Waseda University, 2018–2020. He is a grantee of the Excellent Young Researcher (LEADER) status from the Ministry of Education, Culture, Sports, Science, and Technology (MEXT) of Japan with a 5 years’ competitive research grant (2019–2024). Dr. Taghizadeh-Hesary was visiting scholar, visiting professor, and visiting fellow at several institutions and universities such as the Institute of Energy Economics of Japan (IEEJ) (2013–2015); the Credit Risk Database (CRD) association of Japan (2014–2015); Graduate School of Economics of the University of Tokyo (2016–2017), Griffith University, Australia (2019); the University of Tasmania, Australia (2019). Dr. Taghizadeh-Hesary has published on a wide range of topics, including energy economics, energy policy, green finance, small and medium-sized enterprises finance, monetary policy, and banking. Currently, he is serving as associate editor of Finance Research Letters (SSCI). He has guest-edited special issues for prestigious journals, including Energy Policy, Energy Economics, Finance Research Letters, The Singapore Economic Review, International Review of Economics and Finance, Economic Analysis and Policy, Journal of Economic Integration, and Frontiers in Energy Research. His research credits include authoring more than 130 academic journal papers and book chapters and the editing ten books by major publishers (Springer Nature, Routledge: Taylor and Francis, World Scientific). Naoyuki Yoshino is professor emeritus at Keio University in Tokyo, Japan, and director of Financial Research Center (FSA Institute, Government of Japan). He obtained a Ph.D. in economics from Johns Hopkins University in 1979 (where his thesis supervisor was Sir Alan Walters (UK Prime Minister Margaret Thatcher’s xiii

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About the Editors

Economic Adviser)). Dr. Yoshino taught as assistant professor at the State University of New York at Buffalo. He was a visiting scholar at MIT (USA), visiting scholar at the Central Bank of Japan, and visiting professor at the University of New South Wales (Australia) and Fondation Nationale des Sciences Politiques (France). He received honorary doctorates from the University of Gothenburg (Sweden) and Martin Luther University of Halle-Wittenberg (Germany). Dr. Yoshino was also conferred with the Fukuzawa award from Keio University for his contribution to research. He was the dean/CEO of the Asian Development Bank Institute (ADBI) in Tokyo (2014–2020). Chul Ju Kim is deputy dean at the Asian Development Bank Institute (ADBI) overseeing the Institute’s capacity building and training activities. A national of the Republic of Korea, Chul Ju Kim had been a key policy maker in the Korean bureaucracy for more than 30 years. His expertise in policy-making covers areas in the design and implementation of macroeconomic policies, financial policy and supervision, industrial policy, international finance, social policies including labor market, social protection, and education. Before joining the ADBI, he was a secretary to the country’s president for economic and financial affairs, coordinating core policies in this arena among key ministries and agencies. From 2014 to 2016, Mr. Kim served as a deputy minister for planning and coordination at the Ministry of Finance and Strategy, contributing to the Ministry’s effective strategy setting and its smooth consultation with the parliament, ministries, and other stakeholders. From 2013 to 2014, he was director general of the Economic Policy Bureau –- in this capacity, he spearheaded the Republic of Korea’s overall economic policy directions in macroeconomics as well as structural reforms in key areas. Before this, he worked as a director general of the Public Institutional Policy Bureau where he played an integral role in establishing and implementing the SOEs policy leading to improved performance of SOEs. He also has had extensive experience in international finance institutions. In 2009, he served as a senior economist at the Poverty Reduction and Economic Management Department, East Asia and the Pacific Vice Presidency of the World Bank. From 2001 to 2005, he also worked at the Asian Development Bank in Manila, significantly contributing to the development the Central Asia Regional Economic Cooperation Program, one of the bank’s flagship regional cooperation platform. He holds a BA in economics from Seoul National University, Republic of Korea, and an MS in finance from Georgia State University, USA. Kunmin Kim is senior deputy director at the Ministry of Economy and Finance, Republic of Korea. Dr. Kunmin Kim has policy-making experience in fields of economic innovation, state-owned enterprise, large industrial conglomerate (chaebol; zaibatsu), small and medium-sized enterprises, and regulatory reform. He also has served Asian Development Bank Institute as a Capacity Building and Training (CBT) task manager. He studied at the National Graduate Institute for Policy Studies (master’s degree) and Waseda University (Ph.D. course) in Japan. His academic research topic also includes food and agricultural cooperation among Asian countries.

Contributors

Umidjon Abdullaev European Bank for Reconstruction and Development (EBRD), London, England Youngho Chang Singapore University of Social Sciences, Singapore, Singapore Le Ngoc Dang Academy of Finance, Ministry of Finance, Hanoi, Viet Nam Mohsen Fazelian Bank Maskan, Tehran, Iran Monzur Hossain Bangladesh Institute of Development Studies, Dhaka, Bangladesh Michael C. Huang SciREX Center, National Graduate Institute for Policy Studies, Tokyo, Japan Chul Ju Kim Asian Development Bank Institute, Chiyoda-ku, Tokyo, Japan Jina Kim Department of Public Administration, Ewha Woman’s University, Seoul, Republic of Korea Kunmin Kim Public Institutions Reform Division, Ministry of Economy and Finance, Sejong, Republic of Korea Thai-Ha Le Fulbright School of Public Policy and Management, Fulbright University Vietnam, Ho Chi Minh City, Viet Nam University of Economics Ho Chi Minh City, Ho Chi Minh City, Viet Nam Keun Jung Lee Bang College Business, KIMEP University, Almaty, Kazakhstan Aline Mortha Graduate School of Economics, Waseda University, Tokyo, Japan Canh Phuc Nguyen University of Economics Ho Chi Minh City, Ho Chi Minh City, Viet Nam Dinh Dung Nguyen Academy of Finance, Ministry of Finance, Hanoi, Viet Nam

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Contributors

Serik Orazgaliyev Nazarbayev University, Nur-Sultan, Kazakhstan N. Panchanatham Annamalai University, Chidambaram, India Chung-a Park Organisation for Economic Co-operation and Development (OECD), Paris, France Jhungsoo Park Ewha Womans University, Seoul, Republic of Korea Hooman Peimani Independent Senior Consultant, Burnaby, Canada Nasarudin Bin Abdul Rahman Malaysia Competition Commission, Kuala Lumpur, Malaysia International Islamic University, Gombak, Selangor, Malaysia Henrique Schneider Nordkademie University of Applied Sciences, Elmshorn, Germany Swiss Federation of SME, Bern, Switzerland Vijay Kumar Singh School of Law, University of Petroleum and Energy Studies (UPES), Dehradun, Uttarakhand, India Farhad Taghizadeh-Hesary Social Science Research Institute, Tokai University, Hiratsuka, Kanagawa, Japan Pornchai Wisuttisak Chiang Mai University, Chiang Mai, Thailand Naoyuki Yoshino Keio University, Minato-ku, Tokyo, Japan

Part I

Corporate Governance, Strategy and the Legal Framework

Chapter 1

Strategy, Independence, and Governance of State-Owned Enterprises in Asia Henrique Schneider

1.1

Introduction

State-owned enterprises (SOEs)—refer to Sect. 1.2.1 below for a definition—are important, especially in an Asian context. According to Fortune Magazine’s (2018) 500 list, three out of the world’s top-10 largest companies by revenues were Chinese SOEs: State Grid (rank 2), Sinopec (rank 3), and China National Petroleum (rank 4). Depending on the degree of direct and indirect government support, the next five ranks contain at least a group of near-state enterprises—near-state meaning companies in which the state either is a minor shareholder or has an institutionalized stake: Royal Dutch Shell, Toyota Motor, Volkswagen, BP, and Exxon Mobil. This only leaves two of the world’s ten largest companies neither belonging to nor being backed by the state, Walmart (rank 1) and Berkshire Hathaway (rank 10). Adopting an even more restrictive understanding, SOEs—companies of which the state is the majority shareholder—account for around 25% of the Fortune 500 entries by number of companies. Around 15% of them are in the People’s Republic of China (PRC), 5% are in other Asian countries, and 5% are in the rest of the world. Following the same criterion, in the list for the year 2005, SOEs constituted only about 6% of the total. SOEs not only seem to be important as an economic phenomenon; they also seem to be especially relevant to economies in Asia. Some SOEs are not only economically important but also play other, non-economic roles, like attracting, fomenting, and diffusing knowledge and education or securing the political interest of the state.

H. Schneider (*) Nordkademie University of Applied Sciences, Elmshorn, Germany Swiss Federation of Small and Medium Sized Enterprises, Bern, Switzerland e-mail: [email protected] © Asian Development Bank Institute 2021 F. Taghizadeh-Hesary et al. (eds.), Reforming State-Owned Enterprises in Asia, ADB Institute Series on Development Economics, https://doi.org/10.1007/978-981-15-8574-6_1

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H. Schneider

In recent years, successful SOEs have served as symbols of the (re-)emergence of many Asian economies. On the other hand, there are concerns about SOEs’ governance structures. The Organisation for Economic Co-operation and Development (OECD) published its Guidelines on Corporate Governance of State-Owned Enterprises as early as 2005, most recently updating them in 2015 (OECD 2015). In a 2016 report, the same organization cautioned governments to strengthen their governance standards in SOEs (OECD 2016a). In 2017, the OECD again reminded governments that SOEs could lead to remarkable distortions and to unfair competition (OECD 2017). In 2018, the OECD compared different practices on the governance of SOEs around the globe. It insisted on the need to strengthen monitoring and reporting mechanisms (OECD 2018a). In another report, it identified the independence of boards as success factors in the performance of SOEs (OECD 2018b), and, in yet another, it highlighted risk management as elemental (OECD 2016b). However, not only international organizations but also state agencies are paying attention to the governance structure of SOEs. An example of national evaluation— in the “East” and the “West”—is the PRC’s State-owned Assets Supervision and Administration Commission (SASAC), which is advancing an agenda on the reform of SOEs to strengthen their governance, focusing especially on the independence of the institutions and their board members as well as on the economic desiderata that the SOEs must fulfill (SASAC 2018). India is considering restructuring and privatization (Khanna 2012; Mishra 2014). On a regional level, the Asian Development Bank (ADB) has published many reports on SOE reform, the most recent being its thematic evaluation State-Owned Enterprise Engagement and Reform (ADB 2018), in which it states that “SOE reform is challenging, but critical” (xxii). This reform, according to the evaluation, should focus on government oversight and the political independence of SOEs, because they tend to improve the governance and performance of those entities (xxv). This paper is interested in the governance of SOEs. With insights gained from institutional economics, it answers the following question: How can countries reform SOEs to strengthen their governance? Here, this paper claims that, although the guidelines and lessons learned that the above-mentioned authors have identified are necessary for SOE reform, they are not sufficient. This paper asserts that, in a setting based on new public management (NPM), the ownership strategy and independence are building blocks for the good governance, and for the reform, of SOEs. As important as this answer is, it comes with a limitation of scope. Why does the state set up a company under its control or of which it is the main shareholder? The answer is either to secure strategic sectors or operations or to produce goods in a productive, innovative, and customer-oriented way. While the first part of the last sentence follows a political paradigm, the second follows an institutional paradigm, in this case NPM. In answering the question about how to govern SOEs, this paper limits its scope to the latter, deliberately leaving questions about politics and political economy aside. In reality, however, the two paradigms come together. The last

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section of the main body of this text briefly addresses this limitation of scope. Other papers deal in more detail with the interaction of politics and institutions regarding SOEs. The remainder of this text proceeds as follows. After defining state-owned enterprises and new public management, the paper develops a framework for ownership strategy and independence. An examination of how the three factors— new public management, strategy, and independence—enhance the governance of SOEs leads to its conclusion (reviewing its limitations) and to policy recommendations.

1.2

Setting the Stage: SOESs and NPM

This section defines SOEs and NPM, thus setting the stage for analyzing them as economic institutions. Economic institutions are well-established arrangements that are part of the culture or society in which economic interaction takes place. Institutions are the “rules of the game” when describing economic interactions, that is, social exchanges and the relevant “games.” Institutions that become formal administrations are called organizations. In this sense, the state and SOEs are institutionscum-organizations, while NPM, as a theory with normative implications, is an institution.

1.2.1

State-Owned Enterprises

Government corporations, government business enterprises, government-linked companies, parastatals, public enterprises, public sector units, and enterprises are some of the names for state-owned enterprises (SOEs). The name and the definition of SOEs vary depending on factors such as: the level of government that owns the enterprise (central/federal, state/regional, or local); the way in which the enterprise was founded; the position in the public administration hierarchy; the purpose of the SOE; the status of the SOE (held by the state, held by a state-led or sponsored cooperative, or in the process of privatization); full, majority, or minority ownership of the government; listing (or not) on a stock exchange; government shareholdings through vehicles such as government pension funds, asset management funds, restructuring corporations, and development lenders; or state-enabled (for example enterprises that the state has granted exclusive rights). ADB’s report summarized “there is no common definition of SOE” (ADB 2018, xii). This paper defines SOEs as enterprises of which the state has significant control through full, majority, or significant minority ownership. This control can be direct or indirect, and the company can operate at the central, federal, regional, or local level. This text also uses the terms “state” and “government” synonymously to describe all levels and manners of the formal organization of the political body.

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State refers, thus, to all branches of government, agencies, bodies, or official functions. These varying names and forms of SOEs do not only occur at the conceptual level. On the practical level, this differentiation provides governments with flexibility. They can set up SOEs according to their needs and the specifications of the markets in which they operate or adapt them to other constraints. On the other hand, these multiple forms may complicate the ownership policy, making SOEs less transparent and eventually insulating them from the legal framework applicable to other companies, including competition laws, bankruptcy provisions, or securities laws. These unintended negative consequences have led to different calls for reforming SOEs, as the introduction described. Before delving into the reform as such, it is advantageous to survey briefly the economic mechanism that makes SOEs attractive for governments and at the same time problematic. There are several rationales for setting up and running an SOE, constituting two groups. The rationales that belong to the first group are: providing public goods (e.g., national defense and public parks) and merit goods (e.g., public health and education), both of which benefit all the individuals within a society and for which collective payment through tax may be preferable to users paying individually; increasing access to public services, whereby the state could enforce SOEs to sell certain goods and services at reduced prices to targeted groups as a means of making certain services more affordable for the public good through cross-subsidization; launching new and emerging industries by channeling capital into SOEs that are, or can become, large enough to achieve economies of scale in sectors in which the startup costs are otherwise significant; or generating public funds. The rationales in the second group are: improving labor relations, particularly in “strategic” sectors; limiting private and foreign control in the domestic economy; encouraging economic development and industrialization; sustaining sectors of special interest for the economy, particularly to preserve employment; or controlling the decline of sunset industries, with the state receiving ownership stakes as part of the enterprise restructuring. The rationales belonging to the first group are typical outcomes of NPM. The ones belonging to the second group are political. Since this paper focuses on the first group, a greater understanding of NPM becomes necessary.

1.2.2

New Public Management

Most OECD countries have introduced new public management (NPM) policies since the 1980s. Policy makers and scholars have argued that NPM techniques will increase the efficiency in the state sector by introducing criteria from private sector management into traditional methods of public administration (Christensen and Lægreid 2016). NPM is an approach in public administration that employs the knowledge and experiences acquired in business management and other disciplines

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to improve the efficiency, effectiveness, and general performance of public services in the administration of the state and its bureaucratic apparatus. NPM encompasses a variety of concepts. These range from the general idea of “modernization of the public sector” to the narrower meaning of rationalization of the public administration. Although universal on a principle level, it is necessary to operationalize the different tenets of NPM. Its instantiation, therefore, ranges from complete openness to market forces and privatization, as is the case in Taipei, China, to the radical replanning of the public sector, as in New Zealand, the Republic of Korea, or Viet Nam. It can also indicate a spectrum from cases of rapid advance toward managerial running to cases of coexistence with residual links with more traditional forms of bureaucratic government in accordance with predefined rules, as for example in Japan, the PRC, or Malaysia (OECD 2018a). This differentiation notwithstanding, it is possible to synthesize the basic features of NPM into three fundamental elements (Christensen and Lægreid 2016): 1. Redefinition of the boundaries between state and market through privatization and externalization. 2. Reformulation of the macro-structure of the public sector by delegating state functions (at the lower organizational level) within it. 3. Redefinition of the operational rules characterizing the way in which the public sector carries out its functions and achieves its goals. This point consists of seven sub-components: (a) Toning down of the ties conditioning the public sector as compared with the private sector—this phenomenon includes the transformation of state economic bodies into limited companies; (b) Restructuring of activities/businesses in the public administration so that they operate “on a commercial basis,” that is, in a state of equilibrium between costs and revenue (corporatization); (c) Creation of a market with competition or simulated competition for public and merit goods; (d) Devolution of functions and competences from the center toward the outermost units or the lowest organizational levels within every entity in the public sector; (e) Redefinition of the administrative machinery replacing the bureaucratic model with the managerial one, shifting from formally structured and law-oriented organization to management and efficient breakdown of public resources according to the new economic role of the state’s functions; (f) Deregulation of the functioning of economic and social systems; and (g) Redefinition of citizens’ roles and rights. NPM is not without controversy. Indeed, the body of criticism is growing. For example, Hood and Dixon (2015) claimed that NPM brings little more than higher costs and more complaints. In a cautious evaluation, Dan and Pollitt (2015) asserted that NPM can work under clear conditions. In their words: “An adequate degree of administrative capacity, sustained reform over time and a ‘fitting context’ are the

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main factors that can tip the scale for the success of these management instruments.” Pollitt and Bouckaert (2017) examined the institutional arrangements under which NPM can work. Hyndman and Lapsley (2016) claimed that NPM’s “story continues,” especially in the management of state-owned enterprises.

1.2.3

Applying NPM to SOEs

Independent from its conceptual and empirical merits or shortcomings, NPM as an institution, or as a set of normative principles, relates to SOEs and their management. Institutional economics analyzes the role of normative principles in shaping economic behavior. As public choice, it also explains how institutions themselves behave as rational agents maximizing their own goals. The connection of agents in institutions and institutions as agents is a vast area of work, which Buchanan (2003) especially described. Regarding SOEs, Buchanan (1968) had already suggested how they might act if confronted with a dual mandate, that of providing public or merit goods and that of being entrepreneurial and making profits. NPM is a normative basis for the rules of the game; the state, however, decides which game to play. In other words, while NPM is an approach to how the state produces and distributes goods or organizes its processes as if they were productive and distributive processes, NPM cannot stipulate which goods, in what amount, or who receives them nor which processes and structure the state should have. The answer to the “which” question is a result of political deliberation. NPM addresses the “how” aspect. This seems straightforward, but it has an important consequence from the point of view of institutional, public choice economics. The state sets political goals—which goods to provide—and NPM leads to an additional goal—efficiency in the achievement of these goals. Note that efficiency is not a constraint under which the enterprises provide these goods; it is a goal in itself. NPM wants state agents to maximize their efficiency, instituting a continuous process for increasing it and measuring the output of processes in terms of input. NPM measures and manages the efficiency of the state structure and of the individuals working in that organization. In most cases, increasing the efficiency of the individuals working in the structure increases the efficiency of the organization. A system following NPM also rewards the individuals’ enhanced performance. NPM, therefore, operates on and influences two levels, the level of the organization and the level of the individuals working in the organization. Policies and instruments should thus address both of these levels to be effective. How do NPM and SOEs interact conceptually? In markets and the theory of the firm, make-or-buy decisions are a standard way of increasing efficiency. Make-orbuy decisions concern whether to produce a good in house or to buy it from external sources. Typically, make-or-buy decisions weigh the costs of in-house production against the costs of external source commission and integration of the product. In applying NPM, governments take make-or-buy decisions regarding the provision of public and merit goods. Either they provide the goods themselves or they externalize

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the provision to state-owned but run-as-private enterprises. They suppose that the provision of the predetermined good via the organization of a run-as-private enterprise will bring down the political and coordination costs of production as well as opening new perspectives on the provision of the good. The set-up of an independent company with the sole task of providing the predetermined good thus promises to increase efficiency while delivering on the goal that the state has set, the provision of goods. NPM, paralleling the make-or-buy decision and creating the SOE, fulfills both goals, the one related to the political desiderata and the one related to efficiency. The set-up of SOEs is not only a tool for combining these two goals. The very form of the SOE as such produces a further desideratum. SOEs, as companies, should be financially self-sustaining and produce profits. Even if they are not (yet), their set-up, per se, presupposes that they are or should become financially selfsustaining. This triangle of different goals poses a problem. If the state is to provide public or merit goods via SOEs, and if SOEs are to make a profit, then the SOEs would price their profits into those goods. This, in turn, would mean that the goods in question are not public or merit but in reality marketable and, consequently, non-state agents could provide them at an even lower price. The incidence of gain would at least stipulate the lowering of the pricing practices of the SOEs, which in turn would contradict the goal of operating at a profit. This is more than conceptual tension; it is a challenge for the management of SOEs. Often, the response is two-pronged. In their core activities, SOEs provide the goods that the state stipulates at the cost level. In addition to providing the assigned public or merit goods, SOEs seek new business opportunities, for example entering new markets, offering non-public/merit goods, or expanding their field of activities. In their core activities, SOEs maximize efficiency, and, in the additional opportunities, they maximize profits. To ease the conceptual and managerial tension of their goals, SOEs become hybrid organizations. They are at the same time a state agent and a market agent (Bruton et al. 2015). While this approach eases the tensions of SOEs under NPM, from the point of view of institutional or public choice economics, it creates problematic incentives. These perverse incentives have recently become an object of research (for example Cuervo-Cazurra et al. 2014; Bruton et al. 2015; Liang et al. 2015; Schneider 2016; Daiser et al. 2017; Guo et al. 2017; Li et al. 2018). It is possible to cluster them into two groups. The first cluster consists of perverse incentives affecting the SOE as an organization: • Whether they are too big to fail or not, SOEs enjoy a state guarantee; in some cases, it is an explicit and in others an implicit guarantee. Regardless, it is extremely unlikely that the state as the owner of the SOE would allow its liquidation. This state guarantee is comparable to insurance; the owner, however, externalizes its premium. This leads SOEs to expand their activities in riskier markets or to invest in less secure investments, relying on the guarantee in the case of failure. At least, most SOEs do not fully internalize the value of the state guarantee in their internal accounting.

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• As entities enjoying a state guarantee, with a sovereign equity holder and often with exclusivity if not a monopoly over their core activities, SOEs also aim to become financially self-sustainable. This makes them more appealing to non-state investors. Because of this implied stability, SOEs can raise money from debt at below-average market rates. This gives them an advantage over their private competition, which ironically leads to market competition challenging SOEs less, incentivizing them to be less efficient. • SOEs often cross-subsidize their activities. Under NPM, SOEs have the incentive to cross-subsidize from their core activities—from which they cannot make profits but can enjoy exclusivity and monopoly and therefore have little incentive to be efficient—to their pursuit of additional business opportunities. If they have no means for cross-subsidizing or if the law forbids them to do so, this still occurs, albeit indirectly, for example through adjusting their overhead costs or cost of capital. This, again, leads to the distortion of the competitive markets in which not only SOEs but also private companies operate. An example of these incentives materializing in Asian economies is the situation in which Chinese SOEs have easier access to capital and the capital that they access is cheaper. This is the result not only of pushing banks to lend money to other SOEs but also of the fact that, in the banks’ risk management systems, they usually rank SOEs as less risky than other investments and therefore lend means at a lower price. In Japan, the postal system uses its monopoly to cross-subsidize its banking branch (ADB 2018). The second cluster consists of those perverse incentives affecting the people who work in an SOE—this is the cluster that arises from NPM influencing not only the organizational level but also the personal level: • People working in SOEs have an incentive to show entrepreneurialism—or at least management performance—since the SOEs employ them not only to provide goods but also to run a company according to management benchmarks. Showing entrepreneurialism in an organization that makes it possible to underestimate costs or to externalize risks rationally entails acting on the incentives shown above. This means that there are not only incentives for the organization but also an incentive within the organization for management agents to act on those incentives. This, in turn, accelerates the imbalances discussed above. • SOEs are near-state entities. The state is not only the owner but also the lawmaker and regulator. People change their roles easily, since many former state employees work in SOEs and vice versa. Agents within SOEs and agents within the state have incentives to use the double role of the owner to maintain a legal and regulatory environment that is favorable for SOEs. Furthermore, they are motivated, if an SOE becomes troubled, to change the legal or regulatory framework to maintain the troubled asset. This, again, accelerates the market imbalances, especially in relation to private entrepreneurs, but also expunges the agents’ personal responsibility for their decisions, which again, negatively affects efficiency.

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• People working in SOEs have incentives to act as entrepreneurs, but they are equally motivated to act as state agents. This could lead to the arbitrage of responsibility: when business progresses well, these agents understand themselves as entrepreneurs; when business proceeds badly, they see themselves as state agents. Rewarding managers for their entrepreneurialism but not holding them responsible for mistakes again provides disincentives for efficiency. Two examples make these incentives plausible. In Viet Nam, there is often a “revolving door” between institutions of the state and SOEs; this means that individuals often change their place of employment between these two. In India and the Republic of Korea, the state administration has often changed the regulatory rules to accommodate the needs of SOEs (ADB 2018). In sum, applying NPM to SOEs is not as straightforward as it seems. Compiled from the perspective of institutional, public choice economics, this brief list shows that applying NPM to SOEs sets perverse incentives for the organization and the individuals working for it. The many calls for reforming SOEs in the “East” and the “West” confirm this finding. The literature that the introductory section to this paper referred to indicates not only that supranational and regional organizations are concerned about the many wrong incentives on which SOEs act contemporarily but also that even national agencies and those holding SOEs are committed to a reform. This reform, however, needs neither the entire abandonment of the SOE model nor the replacement of NPM. Indeed, NPM itself can advance resources for the reform. It is the goal of the next section to explain how strengthening the institutional basis that NPM sets out can make SOE reform possible.

1.3

Developing a Framework: Strategy and Independence

The above-mentioned perverse incentives and imbalances occur because the “rules of the game” for SOE allow them. While committing to NPM, an ownership strategy and independence can complement these institutions on which the government runs SOEs.

1.3.1

Strategy

Strategic management involves the formulation and implementation of the major goals and initiatives that an organization’s top management adopts on behalf of owners, based on consideration of the resources and an assessment of the internal and external environments in which the organization operates (Nag et al. 2007; Hill et al. 2014). Porter (1996) identified three principles underlying strategy: creating a “unique and valuable market position”; making trade-offs by choosing “what not to

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do”; and creating “fit” by aligning company activities with one another to support the chosen strategy. Management theory and practice often make a distinction between strategic management and operational management, with operational management concerned primarily with improving efficiency and controlling costs within the boundaries that the organization’s strategy sets. Most studies consider strategic management from the perspective of the enterprise—most SOEs do have a strategy—it can also be an instrument for its owner (or owners), in which case they call it the ownership strategy. In this strategy, the owner answers two questions: what does the owner want to achieve with the enterprise and what does the owner want the enterprise to achieve. Formulating an ownership strategy is the task of the owner; for the enterprise that it addresses, the ownership strategy is an institution, part of the “rule of the game,” or a normative basis. This instrument is applicable to SOEs. When the state develops an ownership strategy for each SOE that it owns, it can mitigate the problems mentioned above while strengthening governance and even positively influencing performance. In the past, many state owners either did not devise a comprehensive ownership strategy for their SOEs or limited the strategy to setting strategic goals, for example profit expectations, annual growth, or annual efficiency increases. Formulating strategic goals does not suffice as an ownership strategy; indeed, they even intensify the perverse incentives discussed earlier. The ownership strategy is much more far reaching, and, as Porter (1996) stated, it is a balance between what to achieve and what not to achieve, stating clear outcomes for both. For any specific SOE, the ownership strategy should consist of the following elements (based on Schedler 2008; Schedler and Finger 2008; Sonderegger 2014, 2015; World Bank 2014): • A legal and regulatory basis, including a statement about how enterprises can adapt this basis, which drivers lead to their adaptation, and which body is responsible for adapting them; it is necessary specifically to exclude the concerned SOE itself from all activities relating to the adaptation of the legal and regulatory base for its running, except for providing information though planned and organized channels in a planned and organized rhythm. • Grounded on the legal and regulatory basis, a clear statement about which public or merit good(s) the government tasks the concerned SOE with providing. • An analysis of the market environment, especially addressing the question of whether non-state, non-SEO agents can provide the same good; the analysis of the market environment contains a scenario analysis about the development of markets and goods. • The positioning of the SOE regarding the provision of the good that the government has tasked it with providing as well as the market analysis; here, a clear statement about how the owner adapts its ownership strategy according to the development of the market scenarios, especially if the good becomes marketable, is necessary—for example, the owner could state that, in the case of a good becoming a marketable good, it will privatize the SOE that provides it.

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• The goals that the state owner wants to achieve with the SOE as well those that the SOE has to achieve for the state owner; these goals should be at least clear and ideally measurable. • The areas of activity of the SOE, consisting of guidance in at least two areas, one on the core activities of the SOE and another on those business opportunities that the SOE can pursue additionally; this guidance is a closed list—SOEs should not operate outside the activities stated here. • The boundaries of activities of the SOE concerned; this section enumerates the activities in which the SOE concerned cannot engage as well as the reasons for the boundaries—this is a deliberate repletion (in negative) of the point made previously: the concerned SOE can only engage in positively listed activities. • The weighted average cost of capital (WACC) that the SOE has to use in its internal and managerial accounting; in this step, the objective of treating the cost of capital as exogenous is to diminish the incentive for externalizing risk—by setting the WACC, the owner is forcing the SOE to internalize the state guarantee as well as its more secured capital structure. Even if the SOE finds financial means at a lower cost than the WACC, the obligation is still to calculate with the WACC that the ownership strategy sets. • Human resource-related matters, especially the obligations of managers and employees as well as their personal responsibility, including automatic career penalties for creating or accepting conflicts with the ownership strategy or for engaging with the state outside the channels and rhythms that this strategy establishes. • Risk management, especially communicating the state owner’s tolerance of risk; this section also includes the SOE’s obligation to set up a risk management system disclosing and communicating information related to risks and the measures that it takes to mitigate them. • Matters related to the acquisition of and cooperation with other SOEs and private enterprises; here, again, the concept is of a closed positive list of situations in which acquisition and cooperation are possible—situations that this list does not foresee do not constitute opportunities for acquisition or cooperation. • The establishment of two circles of reporting and controlling, one within the SEO—between its strategic and its operative management—and one between the SOE’s strategic management and the owner. • Provisions for conflict resolution, especially for conflicts arising between the ownership strategy and the SOE’s strategy. • Channels and rhythm for the SOE to provide information and engage in dialogue with the owner. • Channels and rhythm for the review of the ownership strategy.

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Independence

While the ownership strategy ties an SOE to its owner, independence aims to strengthen its organizational structure as non-state. The goal is to reduce or eliminate the political influence on the SOE and the influence of the SOE on politics and policies. Vernon (1984) was among the first to research the meaning of independence in the setting of SOEs. Under the title “Linking Managers with Ministers,” he showed that dependence is a two-way street. On the one hand, there is dependence of managers from the state, but, on the other hand, state agents seek SOEs as dependent organizations. Further research has narrowed this scope. Much of the subsequent work focused on the members of the SOEs’ executive and non-executive boards. The OECD (2018a, 30–31), after a global comparison, put forward four key takeaways with policy implications. These takeaways are broadly the same as those that the World Bank (2014) identified in its toolkit for SOE corporate governance. They are: • Defining the responsibilities of boards of directors through centralization and professionalization of the ownership function: An unclear distinction between the respective roles of the board and the ownership function can hinder the board from achieving the key functions of establishing a corporate strategy and overseeing the management. Good practice calls for a clear definition and founding in legislation of the role of the board, in line with general company law. Insofar as all SOEs have boards of directors, it is necessary to assign SOE boards a clear mandate and ultimate responsibility for the company’s performance. • Professionalizing board nomination frameworks: The nomination process should be rule-based and a state function should supervise it on a whole-of-government basis. This could involve seeking expertise from external recruitment consultants, establishing databases of pools of directors, and involving the incumbent board. When SOEs have minority non-state investors, formal legal arrangements should also ensure their adequate board representation through legal provisions or corporate bylaws that safeguard minority representation and the state’s active engagement with shareholder agreements. • Improving disclosure related to board nomination and election processes: Formal eligibility rules should ensure the recruitment of suitable and competent board members. These could include processes to advise or vet ministerial candidates for board appointment or actual or de facto nomination committees proposing candidates for the ultimate decision of ministers. • Strengthening the role of SOEs in improving board efficiency and performance, setting goals, and measuring and reporting outputs. While all these points are valid, from a perspective rooted in institutional, public choice economics, it is advisable to return to Vernon’s (1984) original research idea, looking at the two-way relationship of dependence. In addition, two different levels interact here. The first is the organizational independence of SOEs and the state. The second level concerns the people working for SOEs. As discussed in the previous

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section, NPM affects the economic behavior of organizations and of the individuals therein. While the ownership strategy includes provisions for the independence of the organization, these (and other) guidelines address the independence of the people working for an SOE. These guidelines and the literature that the introduction to this paper quoted, however, focus on the board of the company. While the board is important, so are other people who work for the SOE. Additionally, state employees can be pivotal for maintaining independence. Here, because of this broader view of the interrelation of SOEs and the state, the addressees of independence are, as the discussion of NPM asserts, the organizational as well as the individual level. On the organizational level, the following policies can help in maintaining not only the independence of the SOE from the state but also the independence of the state from the SOE: • With the exception of those channels and rhythms that the ownership strategy defines, the SOE should not maintain any contact—formal or informal—with the state and vice versa. • If contact occurs, it is necessary to document and report it in the two circles of controlling mentioned in the ownership strategy. • When in contact, for example through the channels and rhythms that the ownership strategy stipulates, the SOE and the state must follow a pre-established agenda; furthermore, an independent agent should audit the conformity of the contact with the legal and regulatory base as well as with the ownership strategy. • The SOE must abstain from public affairs and lobbying activities in general. • The SOE must abstain from marketing activities, at least in their core areas of operation. At the level of the individuals working for or in an SOE as well as for or in the state, the following policies should apply: • A change in employment from the state to an SOE and vice versa at any level can only occur after a cooling down period of at least 2 years. • Current or former government officials, including elected officials, cannot work for an SOE or be elected or appointed to an organ of an SOE. • Current or former members of organs of an SOE, especially executive and non-executive directors, cannot stand for election or be appointed to any function within the state. • Members of organs of an SOE, and the management in general, should be personally accountable for their decisions. • The government should also implement other policies maintaining or increasing professionalism, integrity, and efficiency in the SOE, as the World Bank and the OECD proposed. It should broaden their scope from non-executive boards to all levels of executives and managers.

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NPM + Strategy + Independence = A Framework for Governance

On an institutional level, NPM enables the pursuit of three goals: the provision of public or merit goods, the increase of efficiency in providing these goods, and the provision of these goods through an enterprise operating with profits. NPM, however, does not suffice. These three goals can lead to conceptual and managerial contradictions, setting perverse incentives for SOEs and the people working in them, leading to moral hazards, competitive failures, and other imbalances. This study claims that, while NPM can—or should—serve as an institutional basis, two other instruments should complement this basis to assure the balancing of these three goals. These instruments are an ownership strategy and independence on an organizational as well as a personal level. Different agents have already suggested these instruments. This paper, however, operationalizes them by broadening their scope: the elements of the ownership strategy flanked by the elements of independence applied to NPM create a framework that minimizes perverse incentives and maximizes the incentives for SOEs to pursue the three goals while balancing them.

1.4

Limitations and Challenges

Having developed the framework, it is useful to review the limitations of this model as well as the challenges that it might face in its implementation. While the framework for governance that Sect. 1.2 developed addresses and broadens all the desiderata that the relevant literature has mentioned, the scope of this paper still constrains it. As the introduction and Sect. 1.1 remarked, this paper concerned the institutional aspect of SOE reform. Next to this there is also a political aspect, which this paper did not address. It is important, however, to stress that only if the political aspect wishes and works for reform can the institutional aspect yield positive effects. Simply said, the framework presented above only works if politics backs and implements it. It is worthwhile noting that the main impediments to SOE reform that research has tackled to date arise not from the institutional set-up but from the political aspect. For example, Leutert (2016), studying the PRC, identified four impediments to SOE reform there. One was related to NPM, consolidating hybrid organizations, and three were related to political will, aligning mismatched management, untangling managerial and party roles, and overcoming political promises. Setting up the framework mentioned in this paper helps in reforming SOEs but not without the political will to match, untangle, and overcome politics itself. Similar concerns apply to India, where network roles—party, family, religion, and brotherhoods—are more important (Bruton et al. 2015). In the Republic of Korea, the Lao People’s Democratic Republic, and Viet Nam, SOEs have the additional task: helping to overcome past and present conflicts. While conflict-

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solving is an important aspect, it adds to the difficulties of governing SOEs. Conflictsolving is an explicitly political and not an entrepreneurial task. Assigning this task to SOEs leads to their further involvement with and in politics (Turner et al. 2017). While there is plenty of literature on reforming SOEs in Asia, there is considerably less output on Africa and South America and almost none regarding North America and Europe (with the notable exception of Vernon and Aharoni (2014), which is, however, an update of an older study that they published in 1981. This might be an indication either that SOEs are more important in an Asian context or that they are in particular need of reform there. On the other hand, it might also point out a blind spot in the research about SOE reform. While the framework developed here addresses the need for SOE reform in Asia and therefore relies on Asia-specific research, its formulation makes it applicable to other regions as well. While there is almost no argument against SOE reform, there is a wide variety of possible reforms. Defining which reform path to pursue might be as difficult on the conceptual level as implementing the reform on the practical one. However, the main limitation of the framework presented here is the question left open: what if the government itself does not want a reform of SOEs?

1.5

Conclusions and Policy Recommendations

The following 10 theses about SOEs, their governance, and their reform conclude this paper (based on Schedler and Finger 2008): 1. Governments create SOEs to provide public and merit goods in organizational autonomy. 2. The function of corporate governance in SOEs is to increase their effectiveness and efficiency, thus creating value, while maintaining their adherence to the law and regulations. 3. Increased effectiveness, greater efficiency, innovation, and customer orientation are the factors that give SOEs legitimacy, especially in comparison with administrative units of the state. These legitimize their set-up as enterprises. 4. The obligation to provide public or merit goods is a factor that gives SOEs legitimacy. This legitimizes their set-up as state-owned entities. 5. The state is in a conflict of interest: its interest as owner and its interest as provisioner of public and merit goods are never in full harmony. 6. NPM might exacerbate this conflict of interest by making SOEs balance three goals: the provision of the public or merit good, increased efficiency, and operating with a profit. 7. The state can minimize this conflict of interests by devising an ownership strategy for each SOE. The ownership strategy becomes part of the normative cadre for the SOE. 8. Controlling and reporting are necessary to maintain and operationalize the ownership strategy.

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9. The state can minimize this conflict of interest by developing a policy on independence with two elements, the organizational independence of the SOE and the personal independence of the people working in an SOE. 10. Independence also calls for the state to be independent from SOEs at the organizational as well as at the personal level. The policy recommendation that this paper makes is the following: while NPM serves as an institutional basis, two other instruments should complement this basis to assure good governance and the eradication of perverse incentives. These instruments are an ownership strategy that the state—as the owner—gives to SOEs and independence on an organizational as well as on a personal level—which the state should set as policies. The ownership strategy of an SOE should contain the following elements: • A legal and regulatory basis including a statement about how enterprises can adapt this basis, which drivers lead to adaptation, and which body is responsible for adapting it. • Basing on the legal and regulatory basis, a clear statement about which public or merit good(s) the government tasks the concerned SOE with providing. • An analysis of the market environment, especially addressing the question of whether non-state, non-SEO agents can provide the same good. • The positioning of the SOE regarding the provisions of the good that it must provide as well as the market analysis. • The goals that the state owner wants to achieve with the SOE as well those that the SOE has to achieve for the state owner. • The areas of activities of the SOE—the SOE should not operate outside the activities stated here. • The boundaries of the SOE’s activities. • The weighted average cost of capital (WACC) for the SOE concerned. • Human resource-related matters. • Risk management, especially communicating the state owner’s tolerance of risk. • Matters related to acquisitions of and cooperation with other SOEs and private enterprises. • The establishment of two circles of reporting and controlling, one within the SEO—between its strategic and its operative management—and one between the SOE’s strategic management and the owner. • Provisions for conflict resolution, especially for conflicts arising between the ownership strategy and the SOE’s strategy. • Channels and rhythm for the SOE to provide information and engage in dialogue with the owner. • Channels and rhythm for the review of the ownership strategy. Independence, the second addition to NPM, consists of the following elements on the organizational level: • The SOE and the state should not maintain any contact—formal or informal— except for the channels that the ownership strategy stipulates.

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• If contact occurs, it is necessary to document and report it in the two circles of controlling mentioned in the ownership strategy. • When in contact, there is a pre-established agenda and auditing. • SOEs must abstain from involvement in public affairs. • SOEs must abstain from engaging in marketing activities. At the individual level, independence consists of the following: • A change in employment from the state to an SOE and vice versa at any level can only occur after a cooling down period of at least 2 years. • Current or former government officials, including elected officials, cannot work for an SOE or be elected or appointed to an organ of an SOE. • Current or former members of organs of an SOE, especially executive and non-executive directors, cannot stand for election or be appointed to any function within the state. • Members of organs of an SOE, and the management in general, should be personally accountable for their decisions. • Guidelines on professionalism, integrity, and efficiency in SOEs should be applicable to all levels of executives and managers.

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Hyndman, N., & Lapsley, I. (2016). New public management: The story continues. Financial Accountability & Management, 32, 385–408. Khanna, S. (2012). State-owned enterprises in India: Restructuring and growth. Copenhagen Journal of Asian Studies, 30, 5–28. Leutert, W. (2016). Challenges ahead in China’s reform of state-owned enterprises. Asia Policy, 21, 83–99. Li, J., Xia, J., & Zajac, E. (2018). On the duality of political and economic stakeholder influence on firm innovation performance: Theory and evidence from Chinese firms. Strategic Management Journal, 39, 193–216. Liang, H., Ren, B., & Sun, S. L. (2015). An anatomy of state control in the globalization of stateowned enterprises. Journal of International Business Studies, 46, 223–240. Mishra, R. K. (2014). The role of state-owned enterprises in India’s economic. In OECD Workshop on State-Owned Enterprises in the Development Process, Paris, 4 April 2014. Nag, R., Hambrick, D. C., & Chen, M. J. (2007). What is strategic management, really? Inductive derivation of a consensus definition of the field. Strategic Management Journal, 28, 935–955. Organisation for Economic Co-operation and Development (OECD). (2015). OECD guidelines on corporate governance of state-owned enterprises. Paris: OECD Publishing. Organisation for Economic Co-operation and Development (OECD). (2016a). State-owned enterprises as global competitors: A challenge or an opportunity? Paris: OECD Publishing. Organisation for Economic Co-operation and Development (OECD). (2016b). State owned enterprises in Asia, national policies. Paris: OECD Publishing. Organisation for Economic Co-operation and Development (OECD). (2017). OECD business and finance outlook 2017. Paris: OECD Publishing. Organisation for Economic Co-operation and Development (OECD). (2018a). Ownership and governance of state-owned enterprises: A compendium of national practices. Paris: OECD Publishing. Organisation for Economic Co-operation and Development (OECD). (2018b). Professionalising boards of directors of state-owned enterprises: Stocktaking of national practices. Paris: OECD Publishing. Pollitt, C., & Bouckaert, G. (2017). Public management reform: A comparative analysis—Into the age of austerity. Oxford: Oxford University Press. Porter, M. E. (1996). What is strategy? Harvard Business Review, November–December, 15–17. Schedler, K. (2008). Eigentümerstrategie für öffentliche Unternehmen. IDT Blickpunkte, 19, 4–5. Schedler, K., & Finger, M. (2008). 10 Thesen zur Führung öffentlicher Unternehmen. IDT Blickpunkte, 18, 14–17. Schneider, H. (2016). Staat und Wirtschaft im Wettbewerb. Sic!, 12, 1–16. Sonderegger, R. W. (2014). Führung, Steuerung und Aufsicht in Schweizer Städten: Erkenntnisse der Studie zum Stand der Umsetzung von Public Corporate Governance in Städten und grösseren Gemeinden der Schweiz. https://www.alexandria.unisg.ch/231453/1/sonderegger_ pcg_st%C3%A4dte_studie_140429.pdf. Accessed 5 Jan 2019. Sonderegger, R. W. (2015). Eignerstrategie zur Klärung der Ausgliederung der Stadtwerke: Strategische und organisatorische Neupositionierung. IMPacts, 10, 25. State-owned Assets Supervision and Administration Commission (SASAC). (2018). News. http:// en.sasac.gov.cn/2018/12/20/c_729.htm. Accessed 5 Jan 2019. Turner, M., O’Donnell, M., & Kwon, S. H. (2017). The politics of state-owned enterprise reform in South Korea, Laos, and Vietnam. Asian Perspective, 41, 181–184. Vernon, R. (1984). Linking managers with ministers: Dilemmas of the state-owned enterprise. Journal of Policy Analysis and Management, 4, 39–55. Vernon, R., & Aharoni, Y. (2014). State-owned Enterprise in the western economies. New York: Routledge. World Bank. (2014). Corporate governance of state-owned enterprises. http://documents. worldbank.org/curated/en/228331468169750340/pdf/ 913470PUB097810B00PUBLIC00100602014.pdf. Accessed 5 Jan 2019.

Chapter 2

Enhancing the Transparency and Accountability of State-Owned Enterprises Chung-a Park

2.1

Introduction

The presence of state-owned enterprises (SOEs) in the global economy, undertaking cross-border investment and trade in competition with private enterprises, has become prominent in recent years. A simple illustration is that in 2003 only 34 of the world’s 500 largest companies were state owned. As of recently, this number had grown to 102. This mostly reflects the growing international presence of emerging market economies – particularly in Asia – where SOEs are more prevalent. Stateowned enterprises are found well beyond the major utility providers, often representing a significant portion of the financial and manufacturing sectors. They also account for a significant share of the total stock market capitalization in Asia (OECD 2018). As a result, the operations of SOEs have an important global economic impact, and higher standards of accountability and transparency are essential to maintain an open international investment climate and avoid unwarranted protectionism. In particular, the disclosure of both financial and nonfinancial information is critical for the government, which can therefore be an efficient owner; the Parliament, to assess the performance of the state as an owner; the media, to raise awareness of the effectiveness of SOEs; and taxpayers and the general public, to be informed about the performance of SOEs. At the same time, ownership entities should ensure that the additional reporting requirements imposed on SOEs, in addition to those imposed on private enterprises, do not place an undue burden on their economic activities.

C.-a. Park (*) Organisation for Economic Co-operation and Development (OECD), Paris, France e-mail: [email protected] © Asian Development Bank Institute 2021 F. Taghizadeh-Hesary et al. (eds.), Reforming State-Owned Enterprises in Asia, ADB Institute Series on Development Economics, https://doi.org/10.1007/978-981-15-8574-6_2

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In recent decades, many governments in Asia have made important progress regarding putting in place legal regulatory frameworks to improve the transparency and accountability of SOEs as part of the effort to align practices more with internationally recognized good practices. These include defining and clarifying the financial and nonfinancial objectives of SOEs, better coordination of ownership responsibilities within the public administration, measuring and assessing performance against quantifiable objectives, and undertaking regular reporting on the business activities and performance of SOEs. It is also worth noting that an increasing number of trade and investment agreements have been including chapters on enhancing the governance and transparency of SOEs. This paper presents an overview of national approaches to enhancing the performance and accountability of SOEs by reviewing relevant legislation, policies, and measures applied to SOEs in Asian economies. It is based on desktop research complemented by key findings from recent OECD publications published in the context of the ongoing OECD-Asia Network on Corporate Governance of StateOwned Enterprises, which provides a forum for corporate practitioners, experts, and policy makers from the Asian region to identify policy challenges regarding the ownership and governance of SOEs, share good practices, and come up with recommendations for policy reform. The Asian jurisdictions analyzed in this paper are India, Indonesia, Kazakhstan, the Republic of Korea, Malaysia, Pakistan, the Philippines, Thailand, and Viet Nam. The paper is structured as follows: It first briefly introduces internationally recommended practices for ownership entities in the area of SOE disclosure and performance management, introducing key relevant elements of the OECD Guidelines on Corporate Governance of StateOwned Enterprises (the “SOE Guidelines”). Then it takes stock of policy, legal, and regulatory measures for developing and implementing disclosure measures including aggregate reporting practices and performance management measures within the SOE sectors in the surveyed countries. It highlights related recent reform experiences and challenges and provides a stocktaking of relevant legal and regulatory frameworks including centralization of the state ownership function; SOE-specific obligations on disclosure and reporting; internal and external audit functions; aggregate reporting practices; performance evaluation systems; and financial and nonfinancial indicators used to measure SOE performance. Lastly, the paper provides a list of issues and recommendations for the consideration of policy makers.

2.2

Internationally Recommended Practices on SOE Transparency and Accountability

SOEs are subject to different degrees of implementation and enforcement depending on their legal regulatory environment and the sector in which they operate. Nevertheless, there are common lessons on SOE governance and transparency that countries can extract from internationally recognized standards, such as the SOE

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Guidelines and the Accountability and Transparency Guide. The latest SOE Guidelines were last revised in 2015, and a large number of emerging economies and developing countries, including those from Asia, made significant contributions to the revision process. The SOE Guidelines state that SOEs should be as transparent to the general public as a publicly traded company should be to its shareholders (see Box 2.1). The Guidelines posit that governments redouble their efforts to enhance transparency and accountability at both the corporate and state levels: on the state of the financial structure and conditions in order to contribute to the overall assessment of SOEs; and of activities that affect the economic performance of SOEs themselves as well as the national economy. With regard to financial information disclosure, the SOE Guidelines also require SOEs to maintain their accounts in accordance with internationally agreed accounting standards and submit their financial statements to an independent external audit based on relevant international auditing standards. Effective internal audit procedures should be established, and overseen by an audit committee within the board of directors or its functional equivalent. The Guidelines also provide specific recommendations for performance monitoring and management. In particular, Chapter II of the Guidelines indicates that the main responsibilities of the state include: • Setting and monitoring the implementation of broad mandates and objectives for SOEs, including financial targets, capital structure objectives, and risk tolerance levels; • Setting up reporting systems that allow the ownership entity to regularly monitor, audit, and assess the performance of SOEs, and oversee and monitor their compliance with applicable corporate governance standards; • Establishing a clear remuneration policy for SOE boards that fosters the long- and medium-term interest of the enterprise and can attract and motivate qualified professionals. While the first two points are at the center of the issue of performance management as they relate to the monitoring of operational (financial and nonfinancial) objectives, the last point directly concerns the motivation of boards of directors with regard to meeting performance criteria. The newly launched OECD Anti-Corruption and Integrity Guidelines for State-Owned Enterprises (ACI Guidelines) also provide specific recommendations for the state as an enterprise owner on enhancing transparency and disclosure measures at both state and enterprise level (OECD 2019).

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Box 2.1 Selected SOE Guidelines’ Provisions on SOE Transparency and Disclosure Measures Annotations relevant to recommendation from the Guidelines Chapter VI. A. Reporting high-quality financial and nonfinancial information on SOEs All SOEs should disclose financial and nonfinancial information, and large and listed ones should do so according to high-quality internationally recognized standards. This implies that SOE board members sign financial reports and that CEOs and CFOs certify that these reports in all material respects appropriately and fairly present the operations and financial condition of the SOE. To the greatest extent possible, the relevant authorities should carry out a cost-benefit analysis to determine which SOEs should be submitted to highquality internationally recognized standards. This analysis should consider that demanding disclosure requirements are both an incentive and a means for the board and management to perform their duties professionally. A high level of disclosure is also valuable for SOEs pursuing important public policy objectives. It is particularly important when they have a significant impact on the state budget, on the risks carried by the state, or when they have a more global societal impact. In the EU, for example, companies that are entitled to state subsidies for carrying out services of general economic interest are required to keep separate accounts for these activities. SOEs should face at least the same disclosure requirements as listed companies. Disclosure requirements should not compromise essential corporate confidentiality and should not put SOEs at a disadvantage in relation to private competitors. SOEs should report on their financial and operating results, nonfinancial information, remuneration policies, related party transactions, governance structures, and governance policies. SOEs should disclose whether they follow any code of corporate governance and, if so, indicate which one. In the disclosure of financial and nonfinancial performance, it is considered good practice to adhere to internationally accepted reporting standards. With regard to the disclosure of remuneration of board members and key executives, it is viewed as good practice to carry this out on an individual basis. The information should include termination and retirement provisions, as well as any specific benefits or in-kind remuneration provided to board members. Chapter VI. B. Ensuring independent external audit SOEs’ annual financial statements should be subject to an independent external audit based on high-quality standards. Specific state control procedures are not a substitute for an independent external audit. (continued)

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Box 2.1 (continued) In the interest of the general public, SOEs should be as transparent as publicly traded corporations. Regardless of their legal status and even if they are not listed, all SOEs should report according to best-practice accounting and auditing standards. In practice, SOEs are not necessarily required to be audited by external, independent auditors. This is often due to specific state audit and control systems that are sometimes considered sufficient to ensure the quality and comprehensiveness of accounting information. These financial controls are typically performed by specialized state or “supreme” audit entities, which may inspect both SOEs and the ownership entity. In many cases they also attend board meetings and often report directly to the legislature on the performance of SOEs. However, these specific controls are designed to monitor the use of public funds and budget resources, rather than the operations of the SOE as a whole. Chapter VI. C. Establishing consistent reporting systems to monitor SOE performance The ownership entity should develop aggregate reporting that covers all SOEs and make it a key disclosure tool directed at the general public, the legislature, and the media. This reporting should be developed in a way that allows all readers to obtain a clear view of the overall performance and evolution of the SOEs. In addition, aggregate reporting is also instrumental for the ownership entity in deepening its understanding of SOE performance and in clarifying its own policy. The aggregate reporting should result in an annual aggregate report issued by the state. This aggregate report should primarily focus on financial performance and the value of the SOEs, but should also include information on performance related to key nonfinancial indicators. It should at least provide an indication of the total value of the state’s portfolio. It should also include a general statement on the state’s ownership policy and information on how the state has implemented this policy. Information on the organization of the ownership function should also be provided, as well as an overview of the evolution of SOEs, aggregate financial information, and reporting on changes in SOEs’ boards. The aggregate report should provide key financial indicators including turnover, profit, cash flow from operating activities, gross investment, return on equity, equity/asset ratio, and dividends. The ownership entity should strengthen disclosure on stakeholder relations by both having a clear policy and developing aggregate disclosure to the general public. Information should also be provided on the methods used to aggregate data. Source: OECD (2015), Guidelines on Corporate Governance of StateOwned Enterprises, OECD, Paris.

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2.3 2.3.1

Legal and Regulatory Frameworks for Improving the Transparency and Accountability of SOEs Centralization of State Ownership Function

The SOE Guidelines call for the centralization of the ownership function or, if this is not feasible, coordination of the exercise of state ownership on a whole-of-government basis. This is primarily driven by the need to avoid conflicts of interest by separating the ownership from other government functions that may affect the operating environment of SOEs. The issue of ownership can also have significant implications for transparency and accountability. Centralization of the ownership function can be a powerful tool for developing corporate governance measures specific to SOEs. It can also help strengthen and mobilize competences related to transparency and accountability, as it necessitates the creation of pools of experts with relevant expertise in areas such as financial reporting, disclosure, performance evaluation, and management or appointment to the board. Centralization can also help to ensure coordination across relevant national government entities as well as with subnational government entities and authorities on cross-cutting issues relevant to the accountability and transparency of SOEs. Historically the most prevalent state ownership model in Asia was a decentralized model. The ownership of SOEs in Asia was predominantly exercised by a multitude of responsible line ministries without coordinating agency in place. Explanations on other kinds of government ownership models are included in Box 2.2. Box 2.2 Different Types of State Ownership Models State ownership models can be broadly categorized into five types: a centralized model; a coordinating agency model; a dual model; a twin-track model; and a decentralized model. The countries with a centralized model for state ownership have established a central holding company for a significant portfolio of SOEs, or have established a central coordinating body, often responsible for monitoring performance or coordinating governance practices across the SOE sector. The coordinating agency model indicates countries where specialized government units operate in an advisory capacity to other shareholding ministries on operational and technical issues, and their policy priority is often to monitor SOE performance. Dual ownership occurs where two ministries (or equivalent state institutions) both exercise ownership functions such as objectives setting and board nominations. The features of the twin-track model can be considered functionally equivalent to the centralized model, but with two individual portfolios of SOEs overseen by two different government bodies. Source: OECD (2016a, 2017, 2018).

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A number of Asian governments have begun to implement some degree of policy coordination to further centralize the state ownership function by creating a central coordinating body or a holding company to oversee a portfolio of large SOEs. In late 2018, Viet Nam set up a special coordinating body called the Committee for State Capital Management (CMSC) to exercise the state’s ownership role in 19 of the country’s largest SOEs and state corporate groups; and the Philippines passed the Government-Owned and Controlled Corporations (GOCCs) Governance Act in 2011, which led to the creation of a commission to monitor the performance of GOCCs. The Republic of Korea consolidated a major part of all commercially important SOEs in the hands of one ownership unit – the Ministry of Economy and Finance – according to the 2007 Act on the Management of Public Institutions. Some examples of the reviewed countries with different ownership patterns are included in Table 2.1.

2.3.2

SOE-Specific Obligations on Disclosure and Reporting

Internationally recognized good practices call for the establishment of a comprehensive policy framework to ensure accountability and transparency in the SOE sector. All the countries studied except Malaysia have put in place SOE-specific reporting and disclosure guidelines or requirements while institutional features differ across countries (see Table 2.2).

2.3.3

Internal and External Audit Functions

Internationally recommended practices state that governments are encouraged to require their SOEs to follow the same auditing and accounting standards as listed companies. However, in general, the surveyed Asian jurisdictions lack comprehensive internal audit and control functions and do not have strong guidance on SOE corporate disclosure due to a relatively lower degree of corporatization. In most of the Asian countries reviewed in this paper, auditing of financial statements of SOEs is often undertaken by the comptroller general or the supreme audit institution, rather than by an external auditor who is independent. With the exception of the Republic of Korea and Viet Nam, the surveyed countries request their SOEs to submit their financial statements to an independent external audit on an ad hoc basis. Moreover, less than half of the surveyed countries have put in place requirements for SOEs to respect International Financial Reporting Standards (IFRS). SOEs in India, Malaysia, the Philippines, and Viet Nam are required to follow national accounting standards. In Kazakhstan, Pakistan, and Thailand, the majority of SOEs should keep their accounts aligned with IFRS, while in the Republic of Korea the largest SOEs are required to do so. In the Republic of Korea, financial

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Table 2.1 National approaches to exercising the ownership function

India

Ownership model Decentralized with coordinating agency

Indonesia

Dual

Kazakhstan

Centralized with exceptions (holding company model)

Institution(s) responsible for ownership function The Department of Public Enterprises (DPE) operates as the “nodal” agency for all SOEs. The DPE formulates all policies regarding performance improvement and evaluation, financial accounting, personnel management, and other relevant areas. However, its ownership model is different from a centralized model. The department is required to coordinate with a multitude of other government ministries and organizations in order to fulfill the tasks of the ownership function. The institutions that exercise state ownership rights in SOEs are the Ministry of Finance based on its authority given by Law No. 1 Year 2004 and the Ministry of State-Owned Enterprises based on its authority given by Government Regulation No. 41 Year 2003. As for the Ministry of SOEs, it currently supervises 114 SOEs where the government of Indonesia owns more than 50% of the companies’ shares. There are three separate holding companies in Kazakhstan that account for almost all of the SOE sector. SamrukKazyna is one of them and is also nominally referred to as a “sovereign wealth fund.” It is the largest joint-stock national holding company 100% owned by the government of the Republic of Kazakhstan. It governs the equity stakes of national companies and other legal entities and subsidiaries owned by those companies.

Objectives set by whole of government, or by individual ministry SOEs’ vision, mission, and long/short-term objectives developed by line ministry and SOE in a “consultative manner,” keeping in view the overall federal policy direction of the government.

The objectives for state ownership are articulated in the 2004 Law No. 1, the 2003 Government Regulation No. 41 and the 2003 Law No. 19 on State-Owned Enterprises.

The general objectives for a state’s enterprise ownership are presented in Article 192 of the Entrepreneurial Code of the Republic of Kazakhstan.

(continued)

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Table 2.1 (continued)

Republic of Korea

Ownership model Centralized under one ministry

Malaysia

Centralized with exceptions (holding company model)

Pakistan

Decentralized

Philippines

Decentralized with coordinating agency

Institution(s) responsible for ownership function The Ministry of Economy and Finance (MOEF) exercises the ownership rights over all public institutions, including SOEs, under the Act on the Management of Public Institutions, with the Ownership Steering Committee serving as its executive agent. At the same time, each line ministry controls a portfolio of businesses and related policies regarding SOEs under its jurisdiction. The Ownership Steering Committee makes decisions on the key policy issues regarding the oversight of SOEs. The Committee, led by the Minister of Economy and Finance, is composed of government representatives and no more than 11 civilian members with acknowledged expertise. Malaysia has placed a nontrivial portfolio of Government-Linked Companies (GLCs) under the purview of Kazanah Nasional Berhad, a sovereign wealth fund of the government, and several other large holding companies. State ownership is exercised only by the line ministries charged with sectoral regulation in the relevant markets.

The Philippines has adopted some degree of policy coordination through the creation of the Governance Commission for Government-Owned and Controlled Corporations (GCG) for monitoring the performance of SOEs.

Objectives set by whole of government, or by individual ministry The MOEF is in charge of defining and promulgating managerial guidelines for public institutions, including SOEs, monitoring and assessing their enforcement and performance. The performance goals of SOEs are established taking into consideration government policies. By law, each SOE is required to develop mediumand long-term management goals and then submit them to the MOEF and the related line ministries.

A reform programme titled Silver Book (2015) was introduced to facilitate policy coordination targeting the GLCs.

There is no explicit state ownership policy in place. Depending on their categorization and legal form, SOEs are subject to different regulations. The 2011 GOCC Governance Act states that the President of the Philippines is the primary representative of the state as the owner of GOCCs and reinforces the capacity of the GCG, on behalf of the state, to: supervise SOE board selection and nomination (continued)

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Table 2.1 (continued) Ownership model

Thailand

Centralized under one ministry

Viet Nam

Decentralized with coordinating agency

Institution(s) responsible for ownership function

The State Enterprise Policy Office (SEPO) under the Ministry of Finance exercises the state ownership rights in all SOEs. The SEPO is also secretariat to the committees that are responsible for monitoring and overseeing SOEs. Viet Nam set up a special coordinating body named the Committee for State Capital Management in 2018 to exercise the state’s ownership role in 19 of the country’s largest SOEs and state corporate groups. However, state ownership is still exercised by the line ministries, provincial committees, and State Capital Investment Corporation (SCIC) charged with sectoral regulation and policy in the relevant markets.

Objectives set by whole of government, or by individual ministry processes; and evaluate and assess SOEs’ performance. The GCG oversees 104 SOEs. The 2002 Act on Reorganization of Ministries, Ministerial Bureaus, and Departments (B.E. 2545, 2002) stipulates the institutional arrangements for SOE ownership, oversight, and regulation. The Viet Nam National Assembly promulgated the Law on State Capital Investment and Management in 2014, which plays a key role in exercising the state ownership function.

Source: OECD questionnaire responses from national authorities; OECD (2016a, 2017, 2018)

statements of SOEs are subject to both a state audit conducted by the Board of Audit and Inspection Committee and an external audit. With respect to internal audit measures, large Korean SOEs with asset values of at least 2 trillion Korean won should set up an audit committee. The Indonesian government has shown some progress by requiring their SOEs to have an internal audit function, and the function to report directly to the CEO and Audit Committee under Law No. 192003. They are also required to have regular meetings with the Board of Commissioners (BOC). However, for unlisted or small SOEs, the standard of information transparency or disclosures varies, as the IT infrastructure differs across SOEs and not all information can be easily collected. Especially for some restricted industries related to defense, the data might be categorized as sensitive information in the country. In India, SOEs’ financial statements are required to be audited by the Supreme Audit Institution (CAG) and be subject to legal controls by an external auditor. The audits are undertaken according to the standards established by the Institute of

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Table 2.2 SOE-specific reporting requirements or guidelines India

Indonesia

Kazakhstan

Republic of Korea

Under the Companies Act 2013, companies are required to publish annual reports that include a separate section on Corporate Governance with information on compliance. All SOEs are subject to the disclosure norms put forward by the government. SOEs should hand in a quarterly compliance report to their administrative ministries. It requires disclosures regarding board reports, prospectuses, AGM notices, annual returns, director’s responsibility statement, audit committee constitution, vigil mechanism etc. Central SOEs (CPSEs) are mandated to obtain a certificate from auditors/the company secretary with respect to compliance with these guidelines. CPSEs have a Central Vigilance Officer reporting to the Central Vigilance Commission of the central government. They are monitored and assessed following negotiation of a performance agreement between the SOE and its administrative ministry. Under Law No. 14/2008 (Article 14), the Minister of SOEs’ Regulation No. 9/2012 on Good Corporate Governance, SOEs are required to disclose some data and information to the general public. The Ministry of Finance and/or the Ministry of SOEs should have a communication and a hearing with the Parliament on a regular basis to discuss issues relevant to SOEs and their performance. Those ministries, as well as SOEs themselves, should also publish financial reports on their main activities and relevant information about their board of directors and board of commissioners and provide website links for inquiries. The information can be acquired through SOEs’ individual websites as well as the website of the Ministry of SOEs. SOEs are required to respect reporting requirements stated in the Law on Accounting and Financial Reporting and the Ministry of National Economy is required to undertake performance evaluation and monitoring of SOEs. SOEs are also required to abide by disclosure-related provisions of Kazakhstan’s sovereign wealth fund Samruk-Kazyna’s Corporate Governance Code dated 2015, which can be applied to all state-owned joint-stock companies in the portfolio of the holding company. The Code has a chapter specific to accountability and transparency. The Code also requires disclosure of these issues in the annual reports of the Fund and its subsidiaries. The information that follows is about the performance evaluation of Samruk-Kazyna, the state holding company that has shares in a significant portfolio of SOEs. Under the Official Information Disclosure Act dated 1998, information on the activities of government bodies, public institutions, and SOEs should be disclosed. The Act mandates that all public institutions, including all SOEs, disclose and report corporate information to the general public through the Internet-based portal called ALIO (All Public Information in One) inventory system (see www.alio.go.kr). The information covered includes the number of executives, employees, financial statement, income and expense statement, audit report, tax, internal and external evaluation reports undertaken by the National Assembly, the Board of Audit and Inspection, and the Ministry of Economy and Finance (MOEF), among many others. With respect to board qualifications and selection processes, a new clause was added to the Act in 2016 to make meeting minutes of the Committee for Recommending SOE CEOs publicly available for inspection by the public unless the case is judged to be exceptional according to the Official Information Disclosure Act. Also, the Committee is mandated to disclose eligibility criteria for CEOs taking into account specialities and requirements of the corresponding corporation or institution. Another Article was newly added to the Act in 2018 to require the Minister of Economy and Finance or the minister of the competent agency to (continued)

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Table 2.2 (continued)

Malaysia

Pakistan

Philippines

Thailand

Viet Nam

subject an executive of an SOE or public institution to an aggravated punishment and public scrutiny through resolution by the Steering Committee if she/he is found guilty in connection with employment fraud or employment irregularities. As part of the efforts to address the issue of the gender pay gap in the SOE sector, an amendment of the “Act on the Management of Public Institutions” was made on 31 December 2018 to require all SOEs and public institutions to disclose the status of the gender wage gap. A disclosure that is intentionally false or noncompliance with the disclosure system results in heavy penalties for the relevant SOEs. In terms of the SOEs that are publicly listed, they are subject to the listing requirements of Bursa Malaysia Securities Berhad. Examples of nonfinancial disclosures under this listing requirement include instances of change in management, borrowing of funds, and the making of a tender offer for another corporation’s securities, among others. Fully corporatized SOEs should abide by relevant provisions of the companies act, and statutory SOEs are subject to individual reporting requirements. Public Sector Companies (Corporate Governance) Rules 2013 require SOEs to disclose financial information in line with the International Financial Reporting Standards and outline rules for SOE board composition and independence. SOEs in the country are subject to disclosure requirements put forward by the ownership coordination entity (Governance Commission for GOCCs, or GCG). Section 25 of R.A. 10149 and specifically in GCG Memorandum Circular 201107 provides disclosure requirements of the GOCCs under GCG’s jurisdiction. It states that all GOCCs shall develop a website and upload both financial and nonfinancial information about the GOCC for public disclosure. Other provisions are Section 43 of GCG M.C. 2012-07, Section 45 on Mandatory Reports and Section 46 on other periodical requirements. The Securities and Exchange Commission (SEC) of the Philippines also passed the Revised Corporation Code into law in 2019 in order to strengthen corporate governance and issue guidelines for GOCCs. In this respect, the SEC issued Memorandum Circular No. 15 Series of 2019, under which companies, including GOCCs, are required to disclose their beneficial owners. A Cabinet decision dated 2011 requires all nonlisted companies to be subject to the same disclosure requirements as listed companies. Nonlisted SOEs are governed by disclosure requirements placed upon them by the State Enterprise Policy Office (SEPO). SEPO publishes annual reports whose functions can be considered to be similar or equivalent to an aggregate report on the SOE sector. The reports are entitled State Enterprise Reviews and contain information and data on the status of the implementation of state policies by SOEs, financial ratios, and key performance indicators (KPIs). The degree of compliance with SEPO’s disclosure requirements can be taken into account in the evaluation of the performance of SOEs. The disclosure requirements specific to SOEs are specified in Decree 81/2015/ ND-CP (dated 18 September 2015), which mandates SOEs to publish: annual and bi-annual financial reports; five-year business strategies; annual plans for business operations; annual reports on management, salary, and income. SOEs should also produce audited financial statements on their websites, before sending them to the responsible line ministry and the Ministry of Planning and Investment. However, in practice, SOEs’ compliance with the state’s disclosure requirements is not consistent.

Sources: OECD (2016a, 2017, 2018).

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Chartered Accountants of India. However, like Malaysia and Pakistan, Indian SOEs are not systematically required to set up an internal audit function. In the Philippines, the internal audit function is governed by a circular from the Budget and Management Department, which requires that the internal audit function in GOCCs report to their boards of directors. In Kazakhstan, the corporate governance code of Samruk-Kazyna encourages its portfolio companies to set up both an external audit and an internal audit function. Compliance with the Code is voluntary. The Law on Joint Stock Companies also empowers SOEs with such a legal form to set up an internal audit function. The companies in Samruk-Kazyna’s portfolio are required to be audited by the Accounts Committee for Control over Execution of the State Budget, which is a state controller charged with evaluating the use and the impact of public funds. In Malaysia, only SOEs with the Government-Linked Company (GLC) status that are listed on the national stock exchange are required to set up an internal audit function as indicated by the Securities Commission and Bursa Malaysia (stock exchange). Auditing and accounting measures and information disclosure measures by unlisted SOEs differ according to the requirements of the relevant majority stakeholder. In Thailand, financial statements of SOEs are audited by the Auditor General, who is required to directly report to the Prime Minister. All SOEs are mandated to set up an internal audit function that reports to the audit committee, in accordance with the regulations of the Ministry of Finance. In Viet Nam, under the 2005 Enterprise Law, SOEs are mandated to establish an internal audit function. It should report directly to the Management Board (CEO) and Supervisory Board designated by state ownership authorities.

2.3.4

Aggregate Reporting Practices

The SOE Guidelines encourage the state as an owner of commercial enterprises to develop and undertake regular reporting on SOEs and publish an aggregate report on SOEs on an annual basis. They also promote web-based communications in order to ensure smooth access for the general public. At the same time, policy makers need to ensure that aggregate reporting creates an added value to existing reporting requirements like annual reports to the legislature. Some ownership entities could produce limited aggregate reports by only covering SOEs that are active in comparable sectors. The SOE Guidelines further state that this aggregate report should focus on financial performance and the value of the SOEs, and should also provide information on performance related to key nonfinancial indicators. Aggregate reporting could cover information items including the state ownership policy and information on the status of the implementation of this policy; the value of the state’s portfolio (i.e. information about the size, value, and performance of the state sector); aggregate financial information and reporting on changes in SOEs’

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boards; key financial indicators (i.e. profit, turnover, cash flow from operating activities, return on equity, gross investment, dividends, and equity/asset ratio; the methods used to aggregate data; information on individual reporting on the most important SOEs; voting structures and stakeholder relations where there are nongovernment shareholders; related party transactions and risks (OECD 2015). According to a recent OECD study (OECD 2018), to facilitate disclosure and transparency, more than half of the 52 countries studied around the world produce and publish online some form of aggregate reporting on SOEs. Most of them contain all or the majority of SOEs in the reports. It should also be noted that these countries have relatively more centralized (or coordinated) state ownership, which generally facilitates the overall reporting process. Of the countries with aggregate reporting, all SOEs in commercial operation regularly publish financial information, but the degree of disclosure of nonfinancial information (e.g. nonfinancial corporate objectives, risks, and corporate guarantees) varies considerably from country to country. Aggregate reporting practices are less prevalent in Asian jurisdictions, which tend to have a more decentralized state ownership structure, where the relevant several line ministries exercise SOE ownership within their concerned sector, while other institutions play a coordinating role regarding governance of SOEs. Among the countries studied in this paper, India, the Philippines, and Thailand produce a comprehensive aggregate report on the entire SOE sector, which is made public. In India, the Department of Public Enterprises (DPE) is responsible for publishing an Annual Survey of SOEs that allows for a comprehensive landscape on the financial situation, operations, and performance of all SOEs. It also contains information on some individual SOEs. The report is disclosed online and is reviewed by the Parliament every year. In the Philippines, the GCG produces an annual report on the performance and activities of GOCCs, which is presented to the President and to Congress and is disclosed online. In Thailand, the SEPO publishes several annual reports that are equivalent to an aggregate report on the SOE sector in terms of its functions. The reports are entitled “State Enterprise Reviews” and include information on the implementation of state policies by SOEs, financial ratios, and key performance indicators. Malaysia, Pakistan, and Viet Nam do not produce any form of aggregate information on SOEs nor periodical reporting to the public on SOEs on a yearly basis. Disclosure of both financial and nonfinancial information by SOEs is implemented on an ad hoc basis and often public information is outdated and fragmented except for a few large equitized SOEs. The quality and volume of information (both financial and nonfinancial) differ depending on the responsible line ministry or controlling stakeholder. Achieving a better public disclosure system – in terms of quality and amount – could bring significant benefits. In the Republic of Korea, although the government does not actually publish an annual aggregate report on SOEs per se in the entire SOE sector or for a large portfolio of SOEs, the government’s approach – the system of ALIO disclosure – can be viewed as functionally equivalent. All the individual SOEs have been mandated to disclose company-level information, including their performance, on the ALIO

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website since 2005. Kazakhstan does not yet provide an aggregate report, but the annual report is prepared by the state holding company Samruk-Kazyna, which reflects the performance of the companies in its portfolio.

2.3.5

Formalizing Performance Evaluation Systems

Almost all the countries surveyed have implemented some kind of performance appraisal system for SOEs, aligning their practices more with the SOE Guidelines. In a majority of cases, the performance evaluation is annually conducted by the ownership entity or coordinating entity. Performance contracts and performance indicators are the main methods used to establish the performance evaluation process (OECD 2016). However, the professionalization of boards of directors and the management capacity of supervisors are critical to ensure the efficiency of the performance evaluation process (Kim and Ali 2017). At the same time, considering that the nature of many SOEs is to generate social welfare rather than profit, it is important to put in place a comprehensive evaluation system that takes into account different aspects of the performance of SOEs, including social and public policy objectives. While it is important for SOEs to make profits, having profitability as the only criterion can potentially mislead decision-makers (Taghizadeh-Hesary et al. 2019). Performance Contracts India, the Republic of Korea, and the Philippines have established performance assessment systems through performance contracts or their functionally equivalent tools, such as memorandums or agreements. Generally, these are documents that include annual performance objectives agreed and signed by the ownership entity and the executive management. It can be argued that this approach has helped governments delineate goals, improve the accountability of SOE executives and managers for corporate performance, and enhance their ability to oversee day-to-day operations. Performance Indicators Defining the state’s objectives through concrete performance indicators – including those related to financial performance, and also nonfinancial performance related to public policy objectives – is in line with good international practices for achieving greater transparency of the process of performance evaluation of SOEs. India, Indonesia, the Republic of Korea, and the Philippines conduct performance appraisals against quantitative indicators in order to measure both financial and nonfinancial performance (Table 2.3). Examples include standard financial performance indicators, numerical indicators of customer satisfaction, and the number of beneficiaries served. These countries have also introduced qualitative indicators to assess financial and nonfinancial performance related to corporate governance practices or risk management. For instance, in Indonesia, the Ministry of State-Owned

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Table 2.3 Examples of performance evaluation indicators used in Asia Financial

Nonfinancial

Quantitative Net profit (India) Financial ratios (Indonesia) Labour productivity (Republic of Korea) Return on investment (Philippines) Project cost overrun (India) Number of corporate events (India) Achievement of “core business targets” (Republic of Korea) Percentage of beneficiaries served (Philippines)

Qualitative Quality of risk management (Indonesia) Transparency of budgetary practices (Republic of Korea)

Commitment to corporate social responsibility (India) Timely submission of reports to regulators (Indonesia) Development of a gender equality policy, human rights, ethical management, safety, environment conservation, social integration, and job creation (Republic of Korea) Certifications indicating compliance with international standards (Philippines)

Source: State-Owned Enterprises in Asia: National Practices for Performance Evaluation and Management, OECD Publishing, Paris, https://www.oecd.org/corporate/SOEs-Asia-PerformanceEvaluation-Management.pdf

Enterprises has put in place an evaluation manual with quantitative indicators against which to undertake SOE performance appraisals, which are then mostly conducted by assessors from SOE boards of directors before being ultimately reviewed by the Ministry of State-Owned Enterprises. As part of efforts to enable “public institutions and SOEs to maximize their social values under the new administration, the Korean government established in 2018 a group of indicators to monitor the performance of SOEs and new public institutions, with respect to human rights, ethical management, safety, environment conservation, social integration, and job creation. In the Philippines, the state ownership entity established the Corporate Governance Scorecard (CGS) for SOEs in 2015 through the issuance of Memorandum Circular No. 2015-07. The CGS assesses the SOEs’ governance practices and their level of compliance with the standards in the areas relevant to the responsibilities of the board, disclosure and transparency, and stakeholder relationships. The CGS was first implemented in 2015, assessing the 2014 data of the SOEs to establish baseline data. Evaluating the effectiveness of individual indicators and performance measurement methods is beyond the scope of this paper. In Kazakhstan, performance evaluation systems are applied to only a limited portfolio of SOEs under the purview of the country’s state holding companies. Pakistan, which is characterized by a decentralized ownership structure, does not yet have a formal performance appraisal system for SOEs. Line ministries undertake SOE performance evaluation on an ad hoc basis.

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Conclusions and Key Policy Recommendations

It is encouraging to note that a majority of the Asian countries reviewed in this report have made important progress regarding putting in place legal regulatory frameworks to improve the accountability and performance of SOEs, bringing their national practices more in line with internationally recognized good practices. To begin with, most of the reviewed countries have implemented some degree of policy coordination to further centralize the state ownership function through the creation of a central coordinating body or a holding company to oversee a portfolio of large SOEs. They have established some forms of SOE-specific disclosure and requirements and some form of performance evaluation system for SOEs, by developing performance contracts or performance indicators. However, common governance-related challenges to the SOEs include a lack of comprehensive legal and regulatory frameworks for public disclosure of information. It is notable that, while reporting standards of individual SOEs and some categories of SOEs have improved, half of the surveyed countries still lag behind when it comes to aggregate reporting on a whole-of-government basis. The autonomy of corporate boards and executive managers is also considered a common weak point. Policy makers could consider following issues in order to enhance accountability and transparency in the SOE sector. Centralization of the Ownership Function International good practices hold that a centralization of the ownership function can be a useful tool for, and strong driver in, the development of aggregate reporting on SOEs. Centralization of the ownership function can help strengthen and mobilize relevant competencies as it necessitates creating pools of experts on key policy issues, such as board appointment and nomination or financial reporting. Clarification of SOEs’ Financial and Nonfinancial Performance Objectives Governments should set clear financial and nonfinancial performance targets for all state-owned companies through a state ownership entity or coordination unit in consultation with responsible line ministries and agencies. Objectives could be defined based on a classification of SOEs according to the nature of their main function – whether they aim at achieving a public policy function, a commercial function, or a combination of both. A comprehensive monitoring and performance evaluation mechanism should be implemented to define and follow up these company-specific performance objectives. Good Practices for Aggregate Reporting Governments can ameliorate the quality of financial and nonfinancial reporting by SOEs through annual publication of an aggregate report covering all SOEs. In addition, good practice calls for the introduction of web-based communications to ease access for the general public. This reporting system could be developed in such a way as to provide the general public and the media with a comprehensive picture of the overall financial performance and evolution of the SOEs, including turnover,

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profit, cash flow from operating activities, dividends and changes in SOE boards, gross investment, equity/asset ratio, and return on equity. Robust and Comprehensive Audit System Often, the credibility and quality of SOE corporate reporting is affected by the lack of comprehensive internal control systems, which are important for effectively monitoring compliance with regulations and laws, and reporting any irregularities or discrepancies to the board of directors. Sometimes, SOEs’ financial statements are not subject to an independent external audit, which is another essential tool for the detection of irregular transactions. Only a few place importance on the role of the audit committee and the board of directors in approving related party transactions to prevent the abusive nature of such transactions. Moreover, when SOEs are subject to various audits, including state audits and external audits, respective roles of these audits are not always clearly delineated, and in some cases duplicate each other. The establishment of a robust audit system may necessitate a review and appraisal of the respective focus and roles of internal, state, and external audits for SOEs, as well as the degree of corporatization of SOEs and their independence from the general government. Recurrent related party transactions may also be taken to the shareholders for approval. Professionalizing Boards of Directors of SOEs The nomination and appointment framework should be rule based and overseen by a state function on a whole-of-government basis. This could involve various efforts, such as seeking expertise from external recruitment consultants, creating databases for pools of directors, and involving the incumbent board. The recruitment of competent and suitable board members should be based on formal eligibility rules and publicly advertised. This could include establishing formal processes to advise or validate ministerial candidates for appointment to the board or actual or de facto nomination committees proposing candidates for final ministerial decision. Strengthening requirements for the independence of outside directors and ameliorating public disclosure related to board nomination and election processes could be useful. In addition, requiring disclosure of information on the identity and the number of board candidates, and/or requiring disclosure of voting percentage results at the AGM, may improve the transparency of board practices.

References Kim, C. J., & Ali, Z. (2017). Policy brief, efficient management of state-owned enterprises: Challenges and opportunities. ADB Institute. https://www.adb.org/sites/default/files/publica tion/390251/adbi-pb2017-4.pdf OECD. (2015). SOE guidelines on corporate governance of state-owned enterprises. Paris: OECD Publishing. https://doi.org/10.1787/9789264244160-en. OECD. (2016a). Transparency and disclosure measures for state-owned enterprises (SOEs): Stocktaking of national practices. In Issues paper prepared for the meeting of the Global Knowledge Sharing Network on Corporate Governance of State-Owned Enterprises

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(7 8 June 2016, Mexico City). https://www.oecd.org/daf/ca/2016-SOEs-issues%20paperTransparency-and-disclosure-measures.pdf OECD. (2016b). State-owned enterprises in Asia: National practices for performance evaluation and management. https://www.oecd.org/corporate/SOEs-Asia-Performance-Evaluation-Man agement.pdf OECD. (2017). Disclosure and transparency in the state-owned enterprise sector in Asia: Stocktaking of national practices. https://www.oecd.org/countries/bhutan/Disclosure-and-Transpar ency-in-SOE-Sector-in-Asia.pdf OECD. (2018). Ownership and governance of state-owned enterprises: A compendium of national practices. http://www.oecd.org/corporate/ca/Ownership-and-Governance-of-State-OwnedEnterprises-A-Compendium-of-National-Practices.pdf OECD. (2019). OECD anti-corruption and integrity guidelines for state-owned enterprises. http:// www.oecd.org/daf/ca/Guidelines-Anti-Corruption-Integrity-State-Owned-Enterprises.pdf Taghizadeh-Hesary, F., Yoshino, N., Kim, C. J., & Mortha, A. (2019). A comprehensive evaluation framework on the economic performance of state-owned enterprises (ADBI working paper 949). Tokyo: Asian Development Bank Institute. https://www.adb.org/publications/comprehen sive-evaluation-framework-economic-performance-state-owned-enterprises

Chapter 3

Regulatory Frameworks for Reforms of State-Owned Enterprises in Thailand and Malaysia Pornchai Wisuttisak and Nasarudin Bin Abdul Rahman

3.1

Introduction

State-owned enterprises (SOEs) play a significant role in providing public goods and services such as utilities and infrastructures. They also play a considerable role in promoting a country’s national agenda, such as providing employment opportunities, promoting national corporates and implementing socioeconomic and industrial policy. Since the state is a significant owner of SOEs, the latter enjoy a monopolistic position in the market and have a competitive advantage vis-à-vis other private enterprises. This creates many unintended market consequences such as inefficiency, nontransparency, and weak governance. Various regulatory and institutional frameworks for reforming SOEs have been adopted by countries around the world in order to stimulate competition, increase efficiency, and improve the level of their performance. However, the outcomes of these reforms are rather mixed. In Asia, for example, many SOEs are still operating less efficiently due to their complacent position in the market leading to poor performance. Against this backdrop, this paper aims to explore the experience of regulatory reform of SOEs in Thailand and Malaysia and the challenges that the countries are or have been facing in undertaking such reform. The paper will be divided into five main parts. The second part explores the international perspective of regulatory frameworks, designed to incentivize

P. Wisuttisak (*) Chiang Mai University, Chiang Mai, Thailand e-mail: [email protected] N. B. A. Rahman Malaysia Competition Commission, Kuala Lumpur, Malaysia International Islamic University, Gombak, Selangor, Malaysia e-mail: [email protected] © Asian Development Bank Institute 2021 F. Taghizadeh-Hesary et al. (eds.), Reforming State-Owned Enterprises in Asia, ADB Institute Series on Development Economics, https://doi.org/10.1007/978-981-15-8574-6_3

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reforms of SOEs. The third part explores the experience of Thailand and Malaysia in constituting their regulatory frameworks for the reform of SOEs. The fourth part discusses and analyzes the approach of Thailand and Malaysia toward the reform of SOEs as well as issues and challenges associated with such reform. The fifth part concludes the paper and provides some recommendations regarding better regulatory frameworks for the reform of SOEs.

3.2 3.2.1

International Perspective of Regulatory Frameworks and Design for Reforms Privatization, Liberalization, and Competition

State-owned enterprises (SOEs) are considered to be a main driver of economic development and are involved in pivotal national sectors such as energy, mining, infrastructure utilities, and financial services. The reasons for SOEs maintaining their status in these sectors include: supporting national economic and strategic interests; maintaining the national security of ownership control; serving specific public goods or services where the market cannot deliver; performing the role of natural monopoly; and maintaining a state-owned monopoly in cases where market regulation is inefficient (OECD 2018). However, during the period between 1980 and the present day there have been waves of SOE reform aimed at ensuring that SOEs can perform in an efficient manner. These waves can be seen in periods of privatization, liberalization, and market competition. In the initial stage of reform, countries paid more attention to the word “privatization” or “corporatization” with the objective of increasing the efficiency of SOEs. The UK government policy on privatization embarked on the important step of privatizing infrastructure utilities (Beasly 1997; Young 1987), which then contributed to the international movement directing countries to set their privatization policy in order to reform their SOEs between 1980 and 2000 (Card et al. 2007). In the UK, the government carried out a privatization program on major utility entities such as British Telecom (BT) in 1984 and British Gas in 1986, and the program later expanded to various SOEs in all economic sectors (Rhodes et al. 2014). Many of the privatizations contributed to market creation where before the nationalized SOEs had operated as an actual or near monopoly (Rhodes et al. 2014). In the international privatization arena, many countries adopted a policy following the UK’s footsteps. The EU countries adopted a privatization policy with similar aims of making their SOEs more efficient and building up a market, previously monopolized by SOEs (Clifton et al. 2006). The EU privatization paradigm was slightly different from the British model of privatization in that the privatization matched the development of EU members and the EU economy (Bortolotti and Milella 2006; Clifton et al. 2006). The privatization policy later spread globally with the objectives of improving

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inefficient SOEs and raising government budgets (Boutchkova and Megginson 2000; Debab 2011). However, the policy on privatization was later transformed to liberalization. The aim of the adoption of liberalization was to ensure that new enterprises were able to enter the market, which had previously been monopolized by the SOEs. The trend of liberalization tended to mix with privatization during the period 1990–2010, but the liberalization was the preferred policy in countries implementing reforms on SOEs. According to Newbery (1997), privatization of the infrastructure of SOEs is a policy dealing with ownership rather than control. In contrast, the liberalization policy aims to facilitate further improvements in performance compared to privatization alone (Newbery 1997). The privatization and liberalization policies are closely linked but they adopt a different approach. Privatization permitted strategic investors to purchase control over national SOEs and such privatization may lead to a change from public monopoly to private monopoly when new market entrants are under tight control (Pisciotta 2001). Privatization thus differs from liberalization in that the latter commonly focuses on competitive entry under market orientation (Pisciotta 2001). Examples in the United States include the adoption of liberalization to open access to gas pipelines and the dismantling of AT&T, thereby making long-distance calls a more competitive market (Newbery 1997). The UK also liberalized its telecommunication networks by permitting a new company, Mercury, to enter the market and compete with the privatized British Telecom (Moon et al. 2006). Similar liberalization policies were adopted to increase the number of market entrants and enhance efficiency in various infrastructure sectors in both developed and developing countries. Pollitt (2009), in his study on electricity liberalization in Southeast Europe, showed that there was a separation of transmission and distribution infrastructures in order to establish market competition for all customers (Pollitt 2009). Hulsink (1999), in his research on privatization and liberalization in European telecommunications, presents the general view of the telecom reform in the UK, the Netherlands, and France that after privatization, liberalization was a vital policy aimed at ensuring market creation and market entry in the telecom sectors (Hulsink 1999). Bowen (2000), in his research relating to the airline industry in Southeast Asia, shows that Singapore, Malaysia, Thailand, and the Philippines did implement privatization of their national airline carriers and these countries later adopted the international liberalization route with new entrant airlines (Bowen 2000). What can be seen is that liberalization is the later stage of the plan after the initial step of privatization and liberalization impacted the main characteristic of politicaleconomic changes in the last two decades between 1990 and 2010 (Keune et al. 2008; Newbery 1999). The reform phenomenon moved toward a focus on market competition purporting to create an efficient and competitive dynamic of economic sectors. From 2000 up to the present day, reforms of SOEs maintained their path of liberalization directed at a restructuring toward market competition. The 2001 OECD report on restructuring SOE utilities for competition shows that the implementation of liberalization concentrated on the restructuring of infrastructure industries by a structural separation of the competitive and noncompetitive components of

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Fig. 3.1 Trends and overlap policy on reform of SOEs under privatization, liberalization, and competition. (Sources: Authors)

industries (OECD 2001). An example of the structural separation of energy utilities is that the government required a separation of electricity generation, distribution, transmission, and retail sectors (Kirby et al. 1995). In the EU, energy separation was adopted through the liberalization of unbundling toward market competition (EU Commission 2006; Pollitt 2007). Based on the EU liberalization policy, many countries have followed a similar liberalization path of energy separation. The countries concerned are Belgium, Ireland, Italy, the Netherlands, New Zealand, Norway, Portugal, Spain, Finland, England and Wales, Australia, and Brazil (OECD 2001). Liberalization is also applied to other infrastructure services, namely telecommunications, airlines, and postal services, in these countries (OECD 2016b). Through liberalization that creates competition in infrastructure utilities, consumers can choose the infrastructure suppliers offering the best conditions and can achieve higher efficiency under consumer-friendly competition (EU Commission 2018a). What can be seen at this point is that there is a connection between liberalization and competition. Liberalization aims to facilitate the restructure of infrastructure utilities in order to generate market competition. The reform trends of liberalization and competition thus differ from those of privatization. Privatization mainly focuses on the change of public ownership to private ownership with the objective of achieving SOE efficiency, while liberalization is aimed at restructuring infrastructure utilities to competitive market conditions. The current global reform trends then pay more attention to maintaining market competition rather than creating competition through liberalization. The following Fig. 3.1 presents an overview of reform trends in infrastructure utilities based on privatization, liberalization, and competition.

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Regulatory Frameworks for Reforms

Regulatory frameworks are important factors, establishing and directing the reform of SOEs in various sectors. Although there are slight differences in meaning, the paper defines law and regulation with a similar meaning in terms of governmental rules, obligating and controlling reform. With reform based on privatization, liberalization, and market competition, there are three aspects of regulatory frameworks: (1) regulatory framework for privatization; (2) regulatory framework for competition; and (3) regulatory framework of competition. Regulatory framework for privatization refers to the changes in laws that obligate the sales of SOEs and make SOEs take on the form of corporates in the market economy. The changes in law are generally aimed at reducing the burden of government budgets from inefficient SOEs and ensuring that privatized or corporatized SOEs operate in an effective manner. At this point the difference between the words “privatization” and “corporatization” has to be clarified. The word “privatization” means obligating or changing SOEs to become private enterprises. The word “corporatization” means obligating or changing SOEs to become a form of entrepreneurial entity but government may hold some portion of the shares of SOEs. Nevertheless, it should be noted that in this paper the words “privatization” and “corporatization” are considered to be similar ideas in that the reform by governments aim to make SOEs become private corporates in order to ensure organizational efficiency. One example of this is that British Telecom (BT) had been privatized by the passing of the Telecommunications Act 1984. The Telecommunications Act 1984 compelled BT privatization by removing BT’s monopoly over telephone services and by setting up the telecom regulator – the Office of Telecommunications (Oftel) (Parker 2004; Rhodes et al. 2014). Through the Telecommunications Act, BT was privatized by an initial public offering (IPO) during between 1984 and 1993 (Rhodes et al. 2014). In Germany, the Treuhandgesetz 1990 (Law on Privatization) established the Treuhandanstalt, a public trust that was positioned as the main agency directing the privatization of public enterprises in Germany (Beijer 2018; Schmidt 1995). The Treuhandgesetz (Law on Privatization) listed the transformation of ownership and required the creation of many business entities with the ability to compete in the market. What can be seen is that the legal and regulatory changes contributed to the implementation of privatization and corporatization of public enterprises. The changes led to a significant transformation of public entities to become private companies. The changes also altered the utility sectors from public monopoly toward liberalization. Regulatory framework for competition refers to the passing of laws that constitute a restructuring and a market open to liberalization objectives. According to Levi-Faur, “regulation for competition” occurs when governments aim to reform economic sectors toward market competition (Levi-Faur 2003). The regulation for competition generally obligates structural changes and incentivizes new entrants to join the liberalized market. Thus, regulation for competition is a procedure to obligate sectoral regulators to implement sectoral restructuring toward liberalization

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with a unified regulatory regime (Jordana and Levi-Faur 2005). The regulation for competition can be classified as ex ante rules that transform a monopoly utility market to market competition. In the EU, the EU Commission adopted directive 2002/21/EC on the telecoms regulatory framework, which contributed to the removal of market restrictions and an open-access regime for interconnection arrangements among companies in EU telecommunications (EU Commission 2018b; Levi-Faur 2004). To restructure and liberalize telecommunications, the EU Commission later adopted a package of five directives and two regulations (EU Commission 2018b). The directives and regulations were purported to progress restructuring telecommunication toward market competition. In the Republic of Korea, the government adopted the Telecommunication Business Act 1983 and the Information and Telecommunication Construction Business Act 1997 in order to restructure telecommunication sectors by reducing the dominant position of the Republic of Korea’s public enterprise, Korea Telecom, and open licensing for new market entries (Kim 2016). The adoption was the result of the government’s intention to restructure the telecom sector to market competition by moving away from being a state-run monopoly and opening up the market to the new entrants of SK Telecom and LG U+ (Kim 2016; Tcha et al. 2000). The Republic of Korea’s energy sector has also followed a similar restructuring with the adoption of legislation obligating changes to SOEs and opting for competition in both electricity and gas (Lee 2011). Regulatory framework of competition refers to making sure that laws and regulations facilitating restructuring do not hamper the dynamic of market competition. Laws and regulations for restructuring SOEs may at some point become a competition hindrance rather than a competition creator. The situation where laws and regulations become a competition hindrance occurs when the laws and regulations create market barriers and interference to market competition. The laws and regulations for competition would then have to be changed to “laws and regulations of market competition.” Levi-Faur (1999) states that regulation for competition differs from regulation of competition in the degree of market intervention by state authorities (Levi-Faur 1999). The regulation of competition relies on market competition and gives authoritative power to competition agency, while regulation for competition relies primarily on a sectoral regulator to reform and restructure the infrastructure sectors (Jordana and Levi-Faur 2005). The regulation of competition is a light-handed approach to regulation, used when there is mature market competition and the regulation will focus only on preventing anti-competitive behaviors in the market (Bertram and Twaddle 2005; Levi-Faur 1998). An example from the UK is that the regulation for the energy sector is changed to a light-handed approach regulation and letting the market competition be the sector controller (OFGEM 2008). Black et al. (2009) show that transferring energy regulation from an intervention approach to a light-handed approach would yield effective sectoral development through competitive efficiency (Black et al. 2009). The regulation of competition has also been utilized in the Australian airport sector. The aim of adopting the regulation of competition under a light-handed approach in the Australian airport sector is to avoid regulation that directly controls the pricing of

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Fig. 3.2 Regulatory frameworks for reforms. (Sources: Authors)

airport services and allows the benefits of facilitating greater negotiation between airports and users (Arblaster 2017). What can be derived from Sects. 3.2.1 and 3.2.2 of this paper is that within the reform of SOEs through privatization, liberalization, and competition there are always changes of regulatory frameworks that obligate all of those reforms. Figure 3.2 shows the correlation between the reforms and the changes of laws and regulations described above.

3.3

Regulatory Frameworks of SOEs in Thailand and Malaysia Regulatory Frameworks of SOEs in Malaysia

The Government of Malaysia announced its policy to reform SOEs through privatization with the adoption of “Privatization Guidelines 1985.” The guidelines were followed by the passing in 1991 of the Privatization Master Plan (PMP), whose objectives were to reduce government budget burdens, increase economic efficiency, and facilitate economic growth (Nambiar 2009). The Master Plan identified 234 privatization proposals and 109 privatization projects were implemented (Tan 2008). Most of the SOEs in Malaysia have been set to be under the reforms through privatization and liberalization. In order to comply with the research limitations, this paper focuses on the reforms of SOEs in the telecommunication, energy, and airline sectors. The reason for focusing on these sectors is that the Malaysian

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government sees these sectors as reform pioneers and these sectors are critical economic sectors that have been controlled by Malaysian SOEs.

3.3.1

Malaysia Telecommunication Regulatory Reform

The Government of Malaysia passed the Telecommunications Service (Successor Company) Act 1985, which led to a change of corporate name from JTM to Syarikat Telekom Malaysia Berhad (STM) in 1987 (Nambiar 2009). STM was directed toward a privatization program in 1990 by an initial public offering (IPO) and was listed as the corporate name Telekom Malaysia on the Kuala Lumpur Stock Exchange (Partridge et al. 1995). The IPO was the result of the government’s legal obligation to initiate a privatization project in telecommunications. After the IPO on the stock exchange, the Telekom Malaysia (TM) was able to raise significant investment funds. After the privatization, the telecommunication sectors were restructured with permission for new entrants. Later, the passing of the Communications and Multimedia Act 1998 contributed to the establishment of a telecom regulator and to creating innovative competition in the telecommunication sector. With the passing of the act, the Malaysian Communication and Multimedia Commission (MCMC) has broad regulatory authority to shape the telecom market toward liberalization and competition (Cheong 2011). With the rapid technological advancement of spectrum and mobile telecommunication, Malaysia’s telecommunication has been liberalized with the introduction of market competition under regulatory governance of the Malaysian Communication and Multimedia Commission. The government introduced the National Telecommunication Policy 1994–2020, which focuses on the initiatives for competition within industry and the R&D activities in telecommunication technologies (Ramlan et al. 2013). An overview of the current telecommunication market in Malaysia shows that it comprises: the Axiata Group as regional cellular operator; Digi.Com as a Malaysia-focused cellular operator; Maxis Bhd as the largest Malaysian cellular operator according to subscribers; Telekom Malaysia (TM) as the dominant fixedline operator in Malaysia; and TIME dot Com Bhd as a data-centric, fixed-line telephone telecommunication (DBS Group Research 2016). It can be seen that the regulatory reforms following privatization and the passing of the new communication act led to the situation where the monopoly position of SOE-Telecom Malaysia was diluted and the market was reshaped into a competition. However, TM continues to have a virtual monopoly in the fixed-line services market given its scale and scope, vertical integration, and limited prospects for further market evolution by competing operators (MCMC 2008). TM also continues to be the monopoly provider in the provision of the broadcasting transmission service. Entry into this service is difficult due to physical and technical barriers (Lee 2002). The proposal to introduce preselection, which allows customers to select their long-distance carrier in advance and access codes, has also been dropped. One of the reasons for this is to protect the interests of TM (International Telecommunications Union

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2002). The government’s tender for high-speed broadband was not open to the public, and since it is considered an important service to the nation it was awarded exclusively to Telekom Malaysia based on a public private partnership (PPP) agreement between TM and the government. TM currently controls more than 90% of the local loop and there is no obligation on TM to unbundle its local loop to competitors. The MCMC as the regulator aims to introduce rules for accounting separation among vertically integrated operators. The rules will then facilitate more market competition by reducing cross-subsidies and potential abuse of market power (MCMC 2012).

3.3.2

Malaysia Energy Regulatory Reform

The Malaysian government initiated reform in the energy sector by establishing a privatization program with the aim of opening the sector to liberalization. In the electricity sector, the Malaysian National Electricity Board (NEB), the monopoly SOE in the supply of electricity during the 1980s, was put under a privatization program. In 1990, the Electricity Supply (Successor Company) Act 1990 (Act 448) was passed. The act established the corporation of Tenaga Nasional Berhad (TNB) to replace the NEB and floated the shares of the TNB on the Kuala Lumpur Stock Exchange (Tenaga Nasional Berhad 2018). However, the government still owns the majority of shares at 70%. The privatization program contributed to the establishment of three interconnected electricity companies. The regulatory reform was followed by the government’s decision to allow a new independence power producer (IPP) in 1992 (Singh 2018). The participation of the IPP in the electricity sector helped alleviate the sole responsibility of power generation from the TNB and created a sharing electricity power pool that prevented any further blackouts in Malaysia. The increase of independent power producers (IPPs) in the market reduced the dominant roles of the TNB and led the way to electricity liberalization and competition (Wisuttisak and Rahim 2018). Later, the government passed the Energy Commission Act 2001, establishing the Energy Commission, and the Malaysian government ceased its policy of electricity liberalization due to the experience of the electricity crisis in California (US) in 2000 (ERIA 2017). Thus, the current electricity structure in Malaysia is still mainly under the control of three vertically integrated SOEs – Tenaga Nasional Berhad (TNB), Sabah Electricity Sdn. Bhd., and Syarikat SESCO Berhad (ERIA 2017). The TNB remains the largest electricity generator in Malaysia. It still holds a monopoly in the transmission and distribution markets, thereby limiting competition at the wholesale and retail levels. By this, Malaysia still maintains SOEs’ monopoly position by utilizing the Single Buyer Market Model in managing the electricity supply in the country. A single buyer entity is established to manage the procurement of electricity and related services in Peninsular Malaysia (Malaysia Energy Commission 2018) One of the functions of the single buyer is to facilitate competition in the generation market and “ensure that it negotiates the

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terms and conditions of generator contracts in a fair and balanced manner that does not unreasonably discriminate against any party and ensures fair and reasonable terms and conditions for participation in the generation sector for all parties” (Malaysia Energy Commission 2018). In the oil and gas sector, Petroleum Nasional Berhad (PETRONAS) was established with the enactment of the Petroleum Development Act 1974. PETRONAS is a sole national corporation with exclusive legal rights, powers, liberties, and privileges of exploring, exploiting, winning, and obtaining petroleum whether onshore or offshore in Malaysia (MPC 2016). PETRONAS has a privilege as an SOE and is able to report directly to the Prime Minister. In other words, PERTRONAS acts as both a market player and a regulator in the oil and gas sector (Mehden and Troner 2007; PETRONAS 2018). While government aimed to implement the policy of liberalization in the oil and gas sectors, the policy was not conducted according to the aim. PETRONAS is still a monopoly SOE in oil and gas businesses. Nevertheless, the government has embarked on a gas business liberalization plan under the Gas Supply Act 1993 (Act 501). Malaysia had amended its Gas Supply Act (Gas Supply Act [Amendment] 2016), setting up third-party access to the gasification, transmission, and distribution system infrastructure. The amendment increases competition further, which strengthens the effectiveness and efficiency of the Malaysian gas sector (Hashim 2016).

3.3.3

Malaysia Airlines Regulatory Reform

With the privatization policy in 1985, Malaysian Airlines was privatized by way of an initial public offering (IPO) (ICAO Secretariat 2007). Some 40% of the shares of Malaysian Airlines were sold to the public and the government remained the majority shareholder (ICAO Secretariat 2007). After privatization, Malaysian Airlines transformed its operation to a business orientation but there was still political interference in the newly privatized Malaysian Airlines (Jomo and Syn 2005). In 2005, the Malaysian government had to buy back all of Malaysian Airlines’ shares due to it being on the brink of bankruptcy as a result of the financial crisis (Doraisami 2005). Malaysian Airlines had kept operating with financial losses for years from 2007 to 2014 with large government subsidies. The government passed the 2014 Malaysian Airlines System Berhad (Administration) Act (MAS Act) purporting to replace Malaysian Airlines with a new entity, Malaysia Airlines Berhad. The act required the airline to implement a new business model so as to create an effective, efficient, and seamless transition from Malaysian Airlines. Section 5 of the act appoints a professional administrator to manage MAB toward a profitable level. Importantly, Sections 11 and 12 of the act provide moratorium privilege to MAB for 12 months with a possible extension of another 12 months. Nevertheless, MAS could not make an upturn from its financial losses and the government, via the Kasana National Bhd, had to give significant financial support to MAS. The Kasana National Bhd is the strategic investment fund of the Malaysian government and it

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takes control over most SOEs in Malaysia (Khazanah Nasional Berhad 2018). Malaysian Airlines seems to have faced financial difficulty for years due to its inefficient operation and to the increasing aviation competition under the ASEAN open sky policy (Das 2018; Forsyth et al. 2006). As a result of the implementation of the open sky policy there are increase of market competition and many carriers, the premium and low-cost airlines entering the airline market in Malaysia. However, the competition led to financial trouble for Malaysian Airlines and the Malaysian government had to take action by providing significant financial subsidy.

3.3.4

Regulatory Frameworks of SOEs in Thailand

In 1957, Thailand was under the control of the military government under American advisory economic policies with the aim of reducing state intervention by relying on SOEs’ monopoly and encouraging private investment (Unger 1998). The government then directed its policy industrialization and private investment by passing the Investment Promotion Act in 1960 and 1962 (Unger 1998), while there was clear evidence of market openness with the government’s law supporting private participation, market concentration, and collusive business conduct (Paopongsakorn 2002). The SOEs controlled the Thai economy with their political relationships and performed the roles of both market regulators and market operators. The Thai economic crisis in 1997 downgraded Thailand from an economic tiger to a poor country with high international debt. The government had to adopt reform policy in 1998 so as to deal with public debt and to fundamentally reform SOEs. In 1998, the government announced the Master Plans for Privatization of SOEs laying down strategies for SOEs to stay partially or wholly under state control (Dempsey 2000). Thailand’s privatization strategy primarily involved the divestment of public enterprises for private investments and transferring ownership from the public to the private sector (Dempsey 2000). In the privatization policy all regulatory reforms were set to facilitate the implementation of privatization. The government enacted the State Enterprises Corporatization Act 2542 (1999), obligating various SOEs to join the privatization program. The focus of the reform will be on sectors similar to those in Malaysia, namely telecommunications, energy, and airlines. These are critical economic sectors and the Thai government initiated its regulatory reforms of those sectors as the pioneer sectors for privatization and commercialization.

3.3.4.1

Thailand Telecommunication Regulatory Reform

Before 1998, the telecommunication sector in Thailand was under duopoly control by the Telecommunication Organization of Thailand (TOT) and the Communication Authority of Thailand (CAT) (World Bank 2008). The TOT and the CAT acted both as service operators and regulators supervising their concessionaires (World Bank 2008). In 1998, the Telecommunication Master Plan was adopted to create

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privatization and liberalization. In 2000, the Thai government implemented privatization of both the TOT and the CAT by IPO on the Thai stock exchanges but the privatization was put on hold as there was political uncertainty as a result of the change of government in 2006. Due to the political uncertainty, the Thai government adopted corporatization of the TOT and the CAT without trading their shares to the public. The corporatization of both entities was carried out by establishing both of them as private companies but all the company shares were under government control. Within the period of reform of the telecommunication sector, the government carried out a significant liberalization process by approving various mobile service providers to compete in the telecommunication market. The mobile providers then competed fiercely with the SOEs. Additionally, a vital reform of the telecommunication sector occurred in 2004 with the establishment of the National Telecommunications Commission (NTC) by the 1997 Constitution. The National Broadcasting and Telecommunications Commission (NBTC) was established with the power and duties to regulate the frequency, broadcasting, and telecommunications businesses (NBTC 2018). As a result of the establishment of the NBTC, there regulations passed that contribute to the liberalization and competition in the telecommunication sector. The regulation leads to interconnection of services among telecom companies and they can compete in providing cheaper prices with a more efficient service for consumer choices. The current mobile service providers with market shares are the following: AIS company (43.7%), TRUE Company (29.4%), DTAC Company (24.07%), CAT (1.91%), and TOT (0.08%) (NBTC 2017). The Internet broadband providers with a market share are the following: TRUE Internet Company (38.4%), TOT (16.7%), 3BB company (33.2%), and AIS wireless network company (6.3%) (NBTC 2017). Thus, the Thai SOEs after their corporatization and sectoral liberalization reduced their market power and became smaller market players under market competition.

3.3.4.2

Thailand Energy Regulatory Reform

In 1998, the Thai government established the National Energy Policy Office (NEPO), which had duties as a planning agency for energy liberalization, including oil, gas, and electricity (Greacen and Greacen 2004). The NEPO proposed a plan to conduct structural reform of the oil and gas sector by unbundling gas transmission and distribution functions under the control of the SOE-Petroleum Authority of Thailand (PTT). With reference to the plan, the government adopted the Royal Decree Stipulating Time Clause for Repealing the Law Governing PTT, BE 2543 (2010). This royal decree was to remove the government-owned status of the PTT. The government also passed the Royal Decree Stipulating Powers, Rights, and Benefits of PTT PCL, BE 2543 (2001), which contributed to privatization via IPO of the PTT on the Thai stock exchanges. However, the privatization reform of the PTT did not adhere to the NEPO plan in that the government did not adopt structural separation of the gas sector and the establishment of access to essential gas pipeline facilities. The government only implemented privatization of the PTT by initial

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public offering of PTT’s shares on the Thai stock exchange without the structural separation (Wisuttisak 2012a). Although there were some market participants, the privatized PTT PCL maintained its dominant position. Currently, PTT PLC is considered a national energy champion and has become the largest listed company on the Thai stock exchanges. With regard to electricity, the Thai government through the NEPO later adopted the privatization plan of SOE electricity in 1999 (Wisuttisak 2012b). The privatization contained a step plan of privatization and liberalization of the electricity sector toward competition. The plan was to create entity separation in the electricity generation, transmission, distribution, and retail so as to ensure that vertical connection would not affect the liberalization process in the sector (Wisuttisak 2012b). However, the Thai government revised the plan to implement privatization by adhering to an “Enhanced Single Buyer” that would confer the monopoly power of electricity purchasing in Thailand to the privatized EGAT. Nevertheless, in 2006 some activists challenged the privatization plan in the Thai administrative court with the argument that the decrees were unconstitutional and could create a private monopoly in the electricity sector (Wisuttisak 2012b). The administrative court decided that privatization was unconstitutional. The court contended that the liberalization of electricity should be implemented under the establishment of the energy regulatory commission (ERC). Later, in 2008, the Energy Industry Act, B.E. 2550 (2007) was passed to establish the Energy Regulatory Commission (ERC 2018). However, since the establishment of the ERC, there has been a lack of progress in the privatization and liberalization of SOEs.

3.3.4.3

Thailand Airline Regulatory Reform

The reform of Thai airline sectors initiated by the Cabinet decision to privatize Thai Airways in June 1991 led to the initial public offering of Thai Airways’ shares on the Thai stock exchange. With the IPO listing, Thai Airways was renamed Thai Airways International Public Company Limited. Nevertheless, the Ministry of Finance still controls more than 50% of the share. The privatization of Thai Airways contributed to the increase in organizational efficiency as the company was released from the red tape system under Thai bureaucratic procedures. Thai Airways enjoyed a prosperous period from 1995 to 2008 and started to encounter a downturn by facing financial difficulty (Aumeboonsuke 2015). This was because the privatization came with stepping toward airline liberalization and the Thai government started to open up for new entrant airlines (Oum et al. 2010). The liberalization seemed to be an external factor that created structural reform of the Thai airline industry. More airline companies entered the Thai airline market. The liberalization is also similar to the Malaysian airline industry with the ASEAN regional policy of ASEAN open sky (Tan 2013). The policy led to openness among airline industries with the increase of airline companies in both low-cost and standard services (ASEAN 2018). With its huge organizational operation, Thai Airways was not able to speedily accommodate greater competition from other airlines. The overall reforms of the Thai airline

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industry are that the government adopted regulations for privatization with the advent of liberalization in the ASEAN region. What can be seen is that airline SOEs are reformed toward greater liberalization with market competition. This section has shown that Malaysia and Thailand have established their privatization and reform of SOEs program as a result of the changes to the regulatory framework. An overview of the SOEs’ reform implementation can be found in Table 3.1 below.

Table 3.1 Regulatory framework and SOE reform in Malaysia and Thailand Telecommunication

Airline sector

Energy sector

Thailand SOEs have been corporatized and market competition has been established. This is due to the rapid technological changes in mobile and Internet services. SOEs become small market players. Private companies enter and compete in the market. The regulatory framework for this sector can be considered as the step of “Regulatory for market competition.” The SOE Thai Airways has been privatized but is faced with financial loss due to the politically inefficient management and fierce competition from the ASEAN open sky policy. The regulatory frameworks for this sector can be considered as the step of “Regulatory for market competition.” The SOEs are faced with a competitive market system with many airlines competing in the market. The SOE -PTT in oil and gas has been privatized and listed on the stock market but the PTT still maintains its near monopoly position in oil and gas. The SOEs in electricity have not been privatized due to the political uncertainty and the court decision to overturn the implementation of privatization. The regulatory framework for this sector can be considered “Regulatory for privatization” with the lack of market competition.

Malaysia SOEs have been privatized. The SOEs still have a dominant position over landlines. But the sector has transformed to competition due to the rapid technological changes in mobile and Internet services. Private companies enter and compete in the market. The regulatory framework for this sector can be considered as the step of “Regulatory for market competition.” The SOE Malaysia Airlines has been privatized but has to deal with financial loss due to inefficient management and fierce competition from the ASEAN open sky policy. The regulatory frameworks for the sector are considered as the step of “Regulatory for market competition.” The SOEs are faced with a competitive market system with many airlines competing in the market. The SOE PETRONAS has not been privatized and has a privilege as a monopoly SOE. But the government has opened third-party access for the gas market. The SOE TNB in electricity has been privatized but the government owns the majority of shares at 70%. The TNB still vertically oligopolizes the market with other SOEs. The regulatory framework for this sector can be considered as “Regulatory for privatization” with the lack of market competition.

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Challenges of Regulatory Reform of SOEs in Thailand and Malaysia

This paper reviews the international perspectives on regulatory frameworks for the reform of SOEs. The second part discusses regulatory reforms of SOEs in the energy, telecommunication, and airline sectors. This part of the paper analyzes Thailand’s and Malaysia’s approach to regulatory reform as well as issues and challenges associated with the reform.

3.4.1

Regulatory Frameworks for Privatization and SOEs’ Influence over Political Economy

The experience from Thailand and Malaysia shows that governments use SOEs as a key economic and political driver. The governments resort to SOEs for operating infrastructure utilities such as the energy, telecommunication, and airline sectors. The governments can mandate SOEs to satisfy people’s demand for mass infrastructure utilities. The governments also use the SOEs to ensure infrastructure certainty, which is a key factor for their economic development (Nikomborirak 2017). In utilizing SOEs for economic purposes, the governments rely on SOEs’ operations in order to sustain their economic growth. The reliance relationship between governments and SOEs becomes a main feature for government policy on economic development. Similarly, in terms of political consideration, the Thai and Malaysian governments also employ their SOEs to ensure that their political positions are recognized by the wider public (Zanuddin 2007). One example is that the governments use the SOEs to provide low energy tariffs to ensure political recognition, whether the low prices would cause a business loss to the SOEs or not. Governments always proclaim that SOEs are political organizations and posit the idea of political acceptance among people. Thus, under reliance relationships, SOEs can gain important bargaining power over political economy. This is why the regulatory frameworks for privatization in Thailand and Malaysia were designed and implemented by maintaining the majority of shares for government control. The regulatory framework for privatization in Malaysia and Thailand might look successful in changing the status of state agencies toward a private enterprise. Nevertheless, the regulatory frameworks for privatization to some extent safeguard the government controls under the shadow of privatization. The reform based on the changes of regulation so as to implement the privatization of SOEs was not purely aimed at creating efficiency but mixed government and SOEs’ political and economic influences. The regulatory frameworks for privatization in this sense may be under a political connection among government, SOEs, and business groups (Acharya 2018). The regulations for privatization were too centralized under interest groups having patron-client networks with the governments (Neumann 2002; Tan 2008). The worst situation happens where the

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government designed the regulatory frameworks for privatization by giving favors to some businesses groups (Estrin and Pelletier 2018). The situation happens in the initial stage of adopting regulatory frameworks of privatization in the energy sector in Thailand (Wisuttisak 2012b). The example from Malaysia is where there is a situation of cronyism in privatized enterprises. Some groups of Malay Bumiputeras were given priority to shares of privatized enterprises and were able to access capital and subsidies to buy the shares (Johnson and Mitton 2003). In addition, the regulatory framework for privatization was also affected by the political economy in setting up boards or management levels of the privatized SOEs. Thailand and Malaysia face similar problems in appointing politically affiliated individuals, including former high-ranking politicians, on the boards of SOEs, which contributed to an important source of conflict of interest and heightened corruption risks (Banchanon 2017; OECD 2016a). What can be seen is that the regulatory frameworks for privatization did not contribute to the SOE’s efficiency gain because the frameworks were designed to benefit some private interest groups. Nevertheless, the paper notes that the regulatory frameworks for privatization are an important initial step in both Thailand and Malaysia for building up possible changes in the energy, telecommunication, and airlines sectors.

3.4.2

Regulatory Frameworks for Competition and SOEs

Thailand and Malaysia had similar paths of regulatory reforms by aiming to open up the infrastructure sectors, which were previously under monopoly control by SOEs. The regulatory frameworks for market competition were established in the energy, telecommunication, and airline sectors in Thailand and Malaysia. The frameworks were to enable additional market entries and obligate structural changes by removing entry barriers and restriction where SOEs were previously dominated in all infrastructure sectors. Nevertheless, in practice, regulatory frameworks do not establish liberalization and competition because the SOEs, after their privatization, remain the dominant firms. The examples from Thailand and Malaysia are in energy sectors where privatized SOEs still occupy the dominant position with the support of governments (Quiggin 2007). With regard to oil and gas markets, while having a plan on regulatory frameworks for privatization, regulatory frameworks for competition have not been established. The SOEs in Thailand and Malaysia dominate the markets. This is because the Thai and Malaysian governments prefer to build up a national energy champion but pay less attention to market competition in their national oil and gas markets. The privatized PTT PCL as a national champion has enormous support from the Thai government to control the oil and gas market in Thailand (Wannathepsakul 2015; Wisuttisak 2012b). In Malaysia, PETRONAS is still the national firm controlling upstream and downstream oil and gas production, transportation, and retail (Rahim and Liwan 2012). Thus, the challenges are that the regulatory framework for competition does not meet competition objectives due to the governments’

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preference to maintain the dominant position of the SOEs with a view to crafting their national champions. The regulatory frameworks for competition at this point face a limbo situation where governments cannot differentiate the SOEs’ interest from the national interest. In other words, the regulatory frameworks for competition conceal state intervention by a national champion in the name of competitiveness and marketization (Cerny 1997). In a different situation where the SOEs’ dominant positions were removed by liberalization, the regulatory frameworks for competition also face an issue with government subsidies. The subsidies are to make sure that the SOEs survive after privatization and liberalization. Nevertheless, the subsidies can become an unfair budgetary support to SOEs in competing with other market participants (Capobianco and Christiansen 2011). Both Thailand and Malaysia can be classified as being in a comparable position where their privatized SOEs in airlines face financial losses but the governments keep providing budget support to the airlines. Therefore, the regulatory framework for reform of SOEs in Thailand and Malaysia seems to face potential challenges. The design and implementation of the frameworks were not able to constitute the transformation of SOEs toward efficient operation. There is an issue regarding the dominant SOEs in the energy market and there is also the issue of governments having to inject financial support into inefficient privatized SOEs.

3.4.3

Regulatory Framework of Market Competition and SOEs

The regulatory framework of market competition still cannot be established in either Thailand or Malaysia. The regulatory frameworks for SOE reform in Thailand and Malaysia are still at the stage of “regulatory framework for competition” and find difficulty in being transformed toward “regulatory framework of competition.” Governments in both countries still rely on an interventionism approach for their regulation over energy sectors with less room for market competition. An example is from the energy sector where SOEs enjoy their dominant position with few small competitors in the energy sector. In the energy sectors, the experience from Thailand and Malaysia shows that the regulatory framework for competition is rarely implemented for building up liberalization and competition in the sectors. The SOEs with high political influence are able to bargain with the government and retain their dominant control over the infrastructure sector both in Thailand and Malaysia. Furthermore, the regulatory frameworks of market competition normally require a light-handed approach to regulation under competitive neutrality. The concept of competitive neutrality is that governments should not act or regulate any economic sectors with favors or preference for any enterprises, especially SOEs (Capobianco and Christiansen 2011). The governments, in stepping toward the regulatory frameworks of market competition, have to refrain from a role of regulatory intervention or

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from providing subsidies to SOEs. However, the experience from Thailand and Malaysia, as reflected in Sect. 3.3 of this paper, shows that governments are not aware that they should facilitate the system of competition in the reformed sectors such as telecommunications and airlines. Both Thai and Malaysian governments provide a significant amount of support while knowing that the privatized SOEs are inefficient in competing with other market participants. The regulatory frameworks of competition can be readily established but the governments seem to confuse their role in supporting competition with their role in supporting SOEs. Thus, the reform of SOEs in Thailand and Malaysia does not reach the step of regulatory framework of market competition. The governments are at the halfway point in their thinking in supporting liberalized competition or championing their SOEs (Painter and Wong 2005). The Thai and Malaysian governments seem to consider the words “too big to fail” in giving support to their SOEs.

3.5

Conclusion and Policy Recommendations

The paper reviews international perspectives on regulatory reforms of SOEs. The paper shows that privatization, liberalization, and competition are the main factors in driving the reform of SOEs. Privatization is to improve SOEs’ efficiency. Liberalization is needed for restructuring and opening markets for new entrants. Competition is important to ensure that the SOEs and new entrants adopt an efficient business approach. According to international experience, the government usually passed laws and regulations in order to establish these three factors. The governments have to adopt laws and regulations for privatization leading to changing the status of SOEs to private ones. After privatization, governments normally pass regulation for competition. The regulation would be implemented for restructuring and opening markets previously monopolized by the SOEs. The regulation for competition should be transformed later to regulation of market competition, which is a lighthanded approach to regulatory frameworks. The light-handed approach is to ensure that governmental laws and regulations do not hamper the process of competition in the markets. The paper also explores the experience of the reform of SOEs in Thailand and Malaysia. The wave of reform in energy, telecommunication, and airlines looks similar with small differences. The similarity is that their energy sectors are still under the control of SOEs with less room for market competition. While there was a set plan to liberalize the energy sector, the plan was not successfully implemented. In the telecommunication sector, the regulations for privatization were adopted in Thailand and Malaysia. The regulations led to changes in SOEs and to competition from many private participants. The privatized SOEs in telecommunication sectors have to face rapid technological changes and the swift rise of competition. A similar situation can be found in the regulatory reform of national airlines. Thai Airways and Malaysia Airlines encountered a similar position of having to face fierce airline competition under the ASEAN air liberalization policy.

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The paper also discusses the experience of regulatory reforms in Thailand and Malaysia. The regulatory frameworks in Thailand and Malaysia were successfully implemented but the political economy of the reliance relationships between the governments and SOEs persists. In Thailand and Malaysia, the regulatory frameworks for privatization were implemented without transparency and benefited some interest groups. The regulatory frameworks for competition in Thailand and Malaysia also face issues of favoring the dominant position of SOEs and the issue of government subsidies for inefficient SOEs. The issues lead to the lack of a step to establish a regulatory framework of market competition under light-handed governance. In light of the details above, the paper proposes some recommendations aimed at facilitating the regulatory framework for the reform of SOEs in Thailand and Malaysia. The recommendations are as follows: Establishing Regulatory Frameworks with the Objective of Building Up Market Competition In establishing regulatory frameworks for reform, it has to make sure that regulatory frameworks are to create a national economic interest that is largely different from SOEs’ interest. Governments in developing countries with political concerns tend to adhere to the idea that the development of SOEs is a national economic development. However, the important point of long-term reform is to create competitive efficiency rather than SOE efficiency. This is due to the fact that competitive efficiency can generate better results SOEs’ monopoly efficiency. The privatized SOEs that yield profits are normally able to maintain their dominant status in controlling infrastructure sectors. The profits seem to represent efficient development of privatized SOEs, but in another aspect, the profits are conferred from their dominant position. Thus, this paper recommends that all regulatory frameworks for the reform of SOEs must focus on market competition and refrain from giving regulatory support to SOEs. Issuing Regulatory Frameworks Expediting the Performance of SOEs The important factors for improving SOEs’ performance are the removal of corruption, and the reduction of mismanagement and incompetent staff; the appointment of competent management bodies without political interference; the encouragement of a competitive work culture by hiring and retaining talented individuals (Kim and Zulfiqar Ali 2017). Therefore, it is important to transform regulatory frameworks that can derive the factors above. An example is that the Thai and Malaysian governments should focus on crafting a regulatory framework under “performance-based regulation,” which connects goals, targets, and measures to utility performance or executive compensation (Littell et al. 2017; Albon 2000). Building Transparency of Regulatory Framework for Reform The regulatory frameworks should be implemented with transparency. The regulatory process from drafting, passing, and implementing should be under public scrutiny. There should also be the use of regulatory impact assessments (RIAs) for regulating the reform of SOEs. These RIAs can be an important mechanism for creating effective regulation that is widely accepted by the public. The RIAs require government to

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discuss with all stakeholders who will be impacted by a regulation and it can lead to clarity and transparency of the regulation. The use of RIAs also helps avoid regulatory failure arising from unnecessary regulation, or failing to regulate when regulation is needed (OECD 2017). With clarity and transparency, the regulatory framework for the reform will be recognized and accepted by the wider public. Adopting Regulatory Framework with Competitive Neutrality The regulatory framework must ensure that there is a fair level playing field for all market participants. According to the World Bank’s “Toolkit on Corporate Governance of State-Owned Enterprises,” the regulatory framework should be passed in order to eliminate differences between the rules governing SOEs and other companies and to ensure that SOEs operate on the same level of competition as private participants (World Bank 2014). The regulatory frameworks for reform should be drafted with adherence to the competitive neutrality principle (Capobianco and Christiansen 2011). The principle is to ensure that the government with its ownership over SOEs does not subsidize the SOEs, resulting in unfair market conditions. One example is that the regulatory framework should be drafted so as to institute the state’s ownership, which is separate from government activities that could obstruct market competition (Kim and Zulfiqar Ali 2017). In conclusion, the experience from Thailand and Malaysia shows that SOEs remain vital economic entities under socioeconomic development. However, the SOEs also undermine economic efficiency with their uncompetitive circumstances. The regulatory reforms should focus on building up market competition, which indirectly forces SOEs to improve their operation toward efficiency. The governments should neglect regulations that create anti-competitive support for SOEs and give more attention to regulations that build free and fair competition in all economic sectors.

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Chapter 4

Reforming SOEs in Asia: Lessons from Competition Law and Policy in India Vijay Kumar Singh

4.1

Introduction

State-owned enterprises (SOEs) or public sector enterprises/undertakings (PSE/Us) form an inherent part of the growth story of countries around the world. As the name suggests, these entities are owned and/or controlled by the state and the very nature of their ownership structure differentiates them from private enterprises. Backing from the government gives them a unique positioning in the market, both on the demand side and on the supply side. While, on the one hand, these entities enjoy a special advantage in terms of confidence/trust from the consumers, on the other hand, being publicly owned, expectations are also high from these SOEs. For example, in India, the Life Insurance Corporation (LIC) enjoys dominance in the life insurance sector and is perceived as the preferred insurer, particularly in rural areas, over the private players. While this is good for the LIC, the Supreme Court of India has declared it as ‘state’ under the Constitution and hence subject to the writ jurisdiction of the country with stricter scrutiny than private enterprises. The philosophy behind this approach is that the government or its instrumentalities may not be allowed to act arbitrarily and have to confer benefits/largesse in accordance with the established norms and policies, which is primarily driven by the ‘socialistic’ approach of the Constitution. Generally, we find that the SOEs in Asia, predominantly in India, have emerged from the colonial past, and the experiences of the East India Company are reflected in the policy making post-independence. The crucial economic and industrial activities were reserved for the public sector until liberalization when the markets were

V. K. Singh (*) School of Law, University of Petroleum and Energy Studies (UPES), Dehradun, Uttarakhand, India e-mail: [email protected] © Asian Development Bank Institute 2021 F. Taghizadeh-Hesary et al. (eds.), Reforming State-Owned Enterprises in Asia, ADB Institute Series on Development Economics, https://doi.org/10.1007/978-981-15-8574-6_4

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opened up under the requirements of the WTO. A review of literature on this subject clearly demarcates the virtues of reforming SOEs and the need to expand privatization, and promote good corporate governance and competitive neutrality. There is no doubt about the utility of these reform measures by the states in Asia, as is often reflected in their policy documents, but in actual practice some resistance to reforms is witnessed owing to the conditions of apartheid, the concerns of domestic industries, and sociopolitical pressures. Article 19 of the Constitution guarantees to the citizens of India the six freedoms to be enjoyed by them in all parts of the territory of India, including the freedom to practice any profession, occupation, or trade or business. However, this right is not absolute or uncontrolled, as Clauses (2) to (6) of Article 19 recognize the power of the state to make laws imposing reasonable restrictions on these freedoms for the reasons to be provided in those laws. Broad powers have been conferred on the administrative authorities through statutes, rules, and regulations that operate via the techniques of licensing, price-fixing (administered pricing), requisitioning of stocks (e.g., the concept of a levy on sugar), regulating the movement of commodities (Essential Commodities Act). It is a general rule under the Constitution that trade, commerce, and intercourse throughout the territory of India shall be free (Article 301). The idea of this provision is to have no barriers between the borders of the constituent state governments and to make the entire country one unit. This freedom applies to intra-state trade and commerce as well as inter-state trade and commerce. However, this freedom is subject to Articles 302–307, which impose some reasonable restrictions. The impact of these ‘reasonable restrictions’ on the freedom to trade is the subject matter of Article 19(6) and Article 304. Parliament is empowered to impose restrictions on the freedom of trade, commerce, and intercourse between one state and another or within any part of the territory of India, as may be necessary in the public interest (Article 302). However, no law can be made to give preference to one state over another except in cases of famine or scarcity of goods in any part of India – Article 303(1). In India, a state is empowered to confer some benefit on a government enterprise over and above what it confers on private undertakings. This was recognized by the Supreme Court in D.R. Venkatachalam v. Deputy Transport Commissioner (AIR 1977 SC 842. Special status to Govt. Owned Transport Undertaking). However, a distinction between the monopoly created by a state in its own favor and in favor of a third party has to be made. While the former may be allowed, the latter would be subject to judicial review on the grounds of arbitrariness. India’s industrial policy experiences a serious impact from its colonial past and thus preferred state-owned enterprises in the majority of sectors initially. There was a strict regime of licensing and market regulation. Due to some studies conducted by the Government of India (Hazari Committee, Mahalonobis Committee, KC Dasgupta Committee, etc.) it became evident that the licensing regime was playing into the hands of a few industrial houses and the wealth was becoming concentrated in a few hands. Thus, bearing in mind the constitutional aspirations to strike upon the ‘concentration of wealth leading to common detriment,’ the Monopolies and Restrictive Trade Practices Act (MRTP) was passed in 1969. This was the first formal

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competition legislation in the country dealing with monopolies and restrictive trade practices. In 1984, unfair trade practices (UTPs) were also brought under the purview of the MRTP. The scenario changed in 1991 with liberalized industrial policy and subsequent developments at the WTO necessitated reforms, including the competition law. The Competition Act 2002 in India was a watershed development, though it was resisted by a few on the grounds that Indian markets were not yet ready for a complete free-market system. The competition law brought the state-owned enterprises on a par with the private players in terms of the applicability of the competition law. The rules of the game were now the same for both. However, it took some time for this law to actually be enforced due to resistance to the legislation from some quarters and a challenge to its constitutionality, which was only settled in 2009 when the working provisions of the Competition Act in India (Section 3 dealing with anti-competitive agreements and Section 4 dealing with the abuse of dominance) were notified. It still took another 2 years, i.e. until 2011, before the regulation of combinations (merger regulations) was notified. In a decade of its enforcement, however, the competition law in India has not spared the state-owned enterprises from its application, just because it has state affiliation. Nevertheless, a softer approach toward SOEs is evident from analyzing the decisions of the Commission. This paper will try to test this hypothesis by examining cases decided by the CCI against SOEs and its approach in handling them. This paper will begin by introducing the concept of state-owned enterprises and the need for competitive neutrality. The main part of this paper will discuss important cases concerning state-owned enterprises in India under competition law and takeaways from the treatment meted out to these. In the conclusion and recommendations section, a summary of the key findings from the analysis carried out in the paper will be provided, along with some policy recommendations.

4.2

The Concept of “State-Owned Enterprises” in India

State-owned enterprises (SOEs)/public sector undertakings (PSUs) in India are widespread at all three levels of administration, i.e. central, state, and local, influencing the lives of millions of people across the length and breadth of the country. Be it public transport, railways, health, education, the public distribution system, banking, or insurance, to name but a few, SOEs/PSUs are at the nerve center. However, discussions on SOEs in India primarily revolve around central public sector undertakings (CPSEs) as there is a department at the central level that looks into them. At the state level, PSUs comprise primarily transport undertakings, tourism development corporations, developmental authorities, universities/schools, electricity corporations, water undertakings, agriculture processing units, mining units, financial enterprises, etc. and operate within the jurisdiction of each state. The references to SOEs in this chapter relate primarily to CPSEs.

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SOEs take different forms in India, depending upon their structure and sponsor/ promoter. Some of the main forms may be categorized as follows (Ram 2009): • Government companies – based on the ownership structure, and they are companies formed under the Companies Act with 51% of the share capital being held by the central or state government, e.g., the Gas Authority of India Limited (GAIL). • Public corporations – statutory corporations set up under a specific enactment by the central or state government, e.g., the Food Corporation of India Limited. • Departmental enterprises – (quasi-corporations) set up by the central or state government to carry out an economic activity controlled by the ministry itself, e.g., railways. • Public sector banks/financial institutions – dealt with under a separate framework in India, e.g., the State Bank of India and the Small Industries Development Bank of India (SIDBI). • Cooperative societies – entities established pursuant to some policy objective and involved in business in India, e.g., the National Cooperative Consumers’ Federation of India Limited (NCCF) under the Department of Consumer Affairs. • Autonomous bodies – set up as societies under various ministries to promote designated objectives, e.g., the Indian Institute of Corporate Affairs (IICA). • Trusts – an SOE holding assets of the central or state government in public trusts, e.g., the Indian Port Trusts Act 1908 covers many major and minor ports. While we may have provided for the aforementioned major types of SOEs, there are many economic entities that do not come under a strict definition of SOEs but are part of the public sector, involved in commercial activities, and impact on competition (Gouri 2010). We also see a number of innovations in terms of the structure of these SOEs: for example, the Goods and Service Tax Network (GSTN) was a special-purpose vehicle where the central and the state government held only 24.5% of equity shares with strategic control; however, later it was converted into a fully owned government company. It is interesting to note that the reversal from private governance to a fully owned government company was made by the GST Council on the grounds of the nature of a ‘state’ function being performed by the GSTN and its strategic role. The overall reforms scenario in India is toward introducing corporatization in functions of the government with clear accountability and a result-oriented approach. This is quite evident from the performance/outcome-based policies being attempted and practiced in all spheres of governance, including SOEs.

4.2.1

Reforms in ‘State-Owned Enterprises’

In the 1990s, as the policy of liberalization and deregulation gathered pace, along with policies to promote increasing integration of the Indian economy with the global economy, SOEs took a back seat (Khanna 2012). The new industrial policy

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of 1991 opened up the doors for private investment, which was previously reserved for the public enterprises. With the shift in the public policy toward liberalization and deregulation, the business environment of Indian SOEs underwent a radical change. There was a general perception that SOEs were ‘inefficient,’ and thus bringing in private control and management would change the way the public sector operated. At the root of this thinking was the essence of ‘competition,’ which would create pressure on SOEs to ‘perform or perish.’ The performance of SOEs was initiated with the French performance contracting system adopted on the basis of the Arjun Sengupta Committee Report (1984), which recommended a memorandum of understanding (MOU) between administrative (line) ministries and SOE managers. This system has seen a lot of transformation over the years, particularly in the last 5 years during which the concept of ‘cooperative fiscal federalism’ has driven the reforms. NITI Aayog has now replaced the Planning Commission. It has no role in allocating finances to states but has three primary tasks to perform, i.e., promoting cooperative, competitive federalism; assisting the central government in policy making; and serving as the government’s think tank.

4.2.2

Change in Governance – Toward Autonomy

The reforms in 1991 brought a focus on cutting the flab and complacency in the governance of SOEs. The Department of Public Enterprises (DPE) under the Ministry of Heavy Industries and Public Enterprises (known as the Bureau of Public Enterprises before 1991) is the nodal department for all central public sector enterprises (CPSEs) and formulates policy pertaining to CPSEs. These policies also serve as a reference point for the SOEs in states, i.e., state-level public enterprises, especially in light of the drive on ‘ease of doing business rankings’ for states since 2015. In 1997, the government recognized the comparative advantage of CPSEs by granting them more autonomy by declaring some of them as nav ratnas (new jewels) and ‘mini ratnas.’ In 2009, ‘Maha Ratna’ status was introduced. One of the prime goals of this categorization was to give these entities greater autonomy to compete in the global market and also to support them in becoming global giants. The categorization of CPSEs is based upon a rating obtained by each one on their performance under the MOU system in the last three out of 5 years. A composite score is arrived at to rate them as excellent, very good, good, etc. taking into consideration six factors, namely net profit, net worth, manpower cost, production cost, earning per share, and intersectoral performance (DPE 2011). For example, a CPSE has to fulfill the following criteria to obtain Maha Ratna status: • Must have Nav Ratna status • Average annual turnover during the last 3 years must be more than Rs. 25,000 crore ($3 billion $515 million) • Average annual net profit after tax during the last 3 years must be more than Rs. 5000 crore ($751 million)

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• Average annual net worth during the last 3 years must be more than Rs. 15,000 crore ($2 billion 108 million) • Must be listed on an Indian Stock Exchange as per Securities and Exchange Board of India (SEBI) regulations • Must have significant presence globally The progress of CPSEs from one category to another creates an incentive to compete and introduce best practices available globally. Based on their performance, as of June 2019, the following is the categorization of performing CPSEs in India: • • • •

Maha Ratna – 8 Nav Ratna – 16 Mini Ratna Category I – 61 Mini Ratna Category II – 12

CPSEs are also categorized into four schedules, i.e. schedule A (65), schedule B (66), schedule C (44), and schedule D (5). This categorization impacts the organizational structure and board-level salary of respective CPSEs. The categorization is proposed by the administrative department/ministry to the DPE, which examines it in consultation with the Public Enterprises Selection Board. The proposal contains the performance of the CPSEs on parameters like investment, capital employed, capacity addition, profits, etc. from the last 5 years. The proposal for categorization also includes information on complexities of problems being faced by the company, its national importance, its level of technology, its prospects of diversification, and competition from other sectors. The result of this exercise has a financial implication and hence the financial exchequer needs to be kept in the loop (Ministry of Heavy Industries and Public Enterprises 2012). According to the DPE, there are 339 CPSEs as of 31 March 2018. Out of these 339 CPSEs, 257 were in operation and 82 were nonoperational during the period 2017–18. Out of the operating 257 CPSEs, 184 were profit making, 71 loss making and two CPSEs made no profit no loss. The major sectors in which the CPSEs operate are defense, oil production and exploration, oil refineries, power equipment, steel, and fertilizers (Economic Survey 2018–2019).

4.2.3

The Disinvestment Phase

The government is focused on strategic disinvestment of its equity in SOEs through the Department (2004)/Ministry (2009) of Disinvestment. In April 2016, the Ministry of Disinvestment was christened the Department of Investment and Public Asset Management (DIPAM). The major disinvestments in CPSEs were carried out between 1999 and 2004. The government is reviewing the role of SOEs in economic development. As a result, a significant disinvestment can be seen in the hotels maintained by the government-owned Indian Tourism Development Corporation

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(ITDC). The government is of the view that “running and managing hotels on professional lines is not the work of the government or its entities.” The Present Status Despite raucous demands from many economists and multilateral institutions, the Indian government has found it difficult to carry out any further privatization or strategic sale of SOEs (Khanna 2012). Bringing reforms into SOEs is sometimes a politically aligned decision, and despite its economic reasoning, decisions have to be taken to the contrary. The present status of reforms in India indicates an indirect approach of pushing SOEs to compete with the private players, which is possible based on pure ‘competitive neutrality’ principles rather than protectionist measures. Divestment of Air India The government of India has been questioned regarding its support in bailing out the national flag carrier airline Air India on the grounds of competitive neutrality. In March 2018, the government offered to strategically divest 76% of its share in Air India; however, it could not get a buyer, allegedly due to proposed rights to be retained by the government with a 24% stake in the carrier, along with other reasons such as high debt, a track record of losses, and changes in the airline sector. The government has now changed its stance by offering to sell its full stake in Air India. Privatization of Airports and Railway Stations Delhi and Mumbai airports in India were privatized in 2006 under a public–private partnership (PPP) model with the majority stake held by private players (GVK and GMR). Twelve years after that development, the government has now decided to privatize another six airports, with private players holding more than a 75% stake. This development is being replicated with other transport, including railways, which has not yet seen divestment. However, it should be noted that several services, such as sanitation, vendors, etc., are already being dealt with by private agencies.

4.3

Introducing “Competitive Neutrality”

Competitive neutrality implies that no business entity is advantaged (or disadvantaged) solely because of its ownership (Capobianco and Christiansen 2011). Competitive neutrality requires governments not to use their legislative or fiscal powers to advantage their own businesses over the private sector. If this occurred, it would distort the competitive process and reduce efficiency. Efficiency is related more to the degree of competition rather than to ownership (Jones et al. 1999). The modern competition law in India is an outcome of the SVS Raghavan Committee Report in 2000, which observed: “It is well accepted that competition is a key to improving the performance of state monopolies and public enterprises.” The oft-noted inefficiency of government enterprises stems from their isolation from effective competition (Aharoni 1986).

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Taking cues from the global framework and pushing toward reforming SOEs, the Government of India went ahead to include a broad definition of ‘enterprise’ under Section 2(h) of the Competition Act, 2002 so as to include government departments engaged in commercial activities, with the exception of government activity related to sovereign functions (all activities carried out by departments of the central government dealing with atomic energy, currency, defense, and space). This definition provided a formal introduction to ‘competitive neutrality’ in India (Gaur 2012). The aggrieved private enterprises could now approach the Competition Commission of India (CCI) – an expert body established with the objective of promoting and sustaining competition in markets in India. However, the question still remains as to whether this introduction to ‘competitive neutrality’ has created the required ‘competitive neutrality framework (CNF).’ A CNF focuses on reforming the environment that public and private entities compete in. Introducing a CNF involves a systematic review of the legislative and administrative landscape in which SOEs operate, and a reform of that landscape so that the conditions in which SOEs operate are as closely matched to those faced by private sector competitors as possible (Capobianco and Christiansen 2011). The adoption of competitive neutrality principles in domestic legislations has not been uniform, and broadly we may categorize the jurisdictions into two groups, i.e., one, which has a precise definition of SOEs according to their legislation establishing clear ‘competitive neutrality’ principles and another in which this precision is lacking (Moroccan ICN 2014). Further, in terms of reforms in SOEs, there are jurisdictions that are pretty aggressive while others explore softer ways and means to introduce reforms giving priority to their SOEs. Convergence in the application of competitive neutrality principles for reforming SOEs is very important, and in this world, with more than 130 competition law jurisdictions, the nurturing of common norms is an essential step in the process of nudging the world toward greater economic coherence (Fox and Healey 2014). India has witnessed a significant transformation in its economy due to liberalization, privatization, and globalization, including its efforts in reforming the SOEs. There is a significant change from ‘regulation to management,’ ‘License Raj to open markets,’ ‘multiple approvals to single-window clearances,’ and many more (Ram 2014). Charting out reforms in each of the sectors in which SOEs operate in India may not be possible in this paper; however, discussion on some of these will provide us with a policy framework and direction of reforms for SOEs in India.

4.4

Energy Sector Reforms

One of the major sectors that have been catered to by the SOEs has been the energy sector, and naturally so, bearing in mind its strategic importance in terms of energy security and linkages with all forms of economic development. Post liberalization, there have been several efforts made by the government to resolve the underlying policy, institutional, and regulatory impediments in the energy sector, but private

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participation and investment did not foresee the expected results (TERI 2007). The energy sector in India primarily comprises coal, oil and gas, and electricity. Renewable energy is a new entrant in terms of focus. Each of these subsectors has its own competition issues and challenges in reforming the SOEs dealing with them.

4.4.1

Coal

As a fossil fuel, coal contributes towards the majority share in the energy mix. The coal sector in India was nationalized in 1973 with a view to checking the issues relating to unscientific mining, labor exploitation, and the need for energy security. Coal India Limited (CIL), with its seven subsidiaries, emerged as a natural monopoly in the coal sector with more than an 84% market share in the production of coal in India. However, in the absence of a coal regulator and ‘competition,’ over a period inefficiencies crept into the system, resulting in coal-block allocation issues (Supreme Court 2014) and alleged abuse of dominance by CIL. The tide changed and a need was felt to bring private participation into coal production, and accordingly the Government of India came up with the Coal Mines (Special Provisions) Act, 2015. Opening up the coal sector to encourage commercial mining and move toward market-determined prices can only succeed if decision-making is at arm’s length. This makes the need for an independent statutory coal regulator even more acute. The NITI Aayog think tank stated that the government must appoint an independent coal regulator for healthy and comprehensive development of this sector as soon as possible (NITI Aayog 2017).

4.4.1.1

Coal India Case

Competitive neutrality issues emerged in a batch of cases against Coal India and its group subsidiaries regarding alleged abuse of dominance in imposing discriminatory conditions in Fuel Supply Agreements (FSAs). The informants, namely power sector companies (some of them being SOEs themselves), approached the CCI against CIL and its subsidiaries. On finding that CIL had abused its dominant position, the CCI imposed a penalty of Rs. 1773 crores on CIL (later revised on remand from COMPAT to Rs. 591 crores). While concluding this order, CCI echoed the various anti-competitive factors identified in the coal sector, which creates a systemic risk, and emphasized “an imperative need to carry forward this reform momentum further by restructuring the sector by introducing more players so that it can reduce the dominance of any one player and can facilitate competition. Bringing the coal sector under the independent regulatory oversight would only help if there are enough players in the market” (Coal India Case 2013, 2017). In its subsequent order, while considering the penalties, the CCI noted that CIL is constrained in its autonomy, being subject to instructions from different government ministries/departments, but still “it has sufficient flexibility and

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functional independence in carrying out its commercial and contractual affairs and such factors do not detract from CIL and its subsidiaries operating independently of market forces and enjoying undisputed dominance in the relevant market.”

4.4.2

Oil and Gas

The oil and gas sector is increasing its share in the energy mix in India. Also referred to as the hydrocarbon sector, it is broadly divided into (i) Exploration and Production (E&P), (ii) Oil Refining and Marketing, (iii) Gas Transportation and Marketing, and (iv) Crude Oil and Petroleum Product Pipelines (TERI 2007). It may also be categorized into upstream, midstream, and downstream activities. Six national oil and gas companies (two upstream, one midstream, and three downstream) dominate the three segments of the Indian oil and gas industry in market sales. With the introduction of the New Exploration Licensing Policy (NELP) in 1999, the oil and gas exploration sector saw the entry of private domestic and foreign firms. However, the oil and gas sector is still dominated by public sector companies. There is no independent regulatory oversight in the upstream segment. The government has progressively dismantled the Administered Pricing Mechanism completely over a period, including the public distribution system outlays, which are now being dealt with through direct benefit transfers (DBTs). Currently, the Petroleum and Natural Gas Regulatory Board (PNGRB) regulates some aspects of downstream business in oil and gas. The Directorate General of Hydrocarbons (DGH) is the technical arm of the Ministry of Petroleum and Natural Gas and manages petroleum resources as well as monitoring production sharing contracts. The government is of the view that the sector still requires government support and thus has ruled out any independent statutory regulator as of now.

4.4.2.1

Oil PSU Cartel

The CCI received its first case from the oil and gas sector for alleged cartelization between the three state oil marketing companies – the Indian Oil Corporation (IOC), the Bharat Petroleum Corporation (BPCL), and the Hindustan Petroleum Corporation (HPCL), collectively referred to as Oil Marketing Companies (OMCs) – on an information filed by Reliance concerning the supply of aviation turbine fuel (ATF). The CCI had ordered an investigation into this matter; however, the Delhi High Court stayed the investigation by the CCI on the grounds of a lack of jurisdiction and the matter being within the purview of the PNGRB. In a subsequent suo motu case taken up by the CCI, it questioned the conduct of OMCs in simultaneously increasing petrol prices even when there was no administered price mechanism in vogue. This case was also stayed by the Delhi High Court. The matters are still pending before the High Court; however, in a subsequent information received against the OMCs for jointly floating a tender and engaging in a ‘buyers’ cartel,’ the CCI

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rejected the contention that the PNGRB had exclusive jurisdiction in this case to the exclusion of the commission (XYZ 2018).

4.4.2.2

Gas Supply Agreements

Similarly to CIL cases, in a batch of cases, gas sale agreement (GSA) clauses produced by the publicly owned GAIL (India) Ltd. were challenged before the CCI for being anti-competitive. It was alleged that due to its dominant position in the relevant market, GAIL was able to impose onerous conditions on consumers leading to abuse of its dominant position. The cases are under investigation by the Director General of the CCI (GAIL Case 2016). In a similar set of facts, a private player, Adani Gas, has been penalized for abuse of its dominant position in prescribing abusive GSA clauses. It would be interesting to track the developments in this matter for a comparative perspective.

4.4.2.3

Exemption from Merger Regulations

The government of India exempted all the CPSEs in the oil and gas sector from applying combination provisions of the Competition Act to allow smooth consolidation and stake purchases among state-owned oil and gas companies. The government wants to create a big energy company to compete globally. While this step is lauded for creating a national champion, it dilutes the government’s push toward ‘competitive neutrality,’ a balance that is always difficult to establish.

4.4.3

Electricity

Also referred to as the power sector, the electricity sector has seen a significant transformation over the years, in particular since the Electricity Act, 2003, which brought about far-reaching reforms in the electricity sector, including the unpacking of erstwhile electricity boards into generation, transmission, and distribution companies and the advent of the Central Electricity Regulatory Commission (CERC) at the central level and SERC at the state level (NITI Aayog 2017). Thus, power sector reform has usually involved some combination of product market competition, privatization, and regulation. However, private participation has largely been confined to generation. Delhi and Mumbai have seen some privatization in the distribution segment and needs more reforms. One of the critical issues in distribution has been the sharing of bottleneck facilities, i.e., transmission lines other than the issue of statutory market allocation.

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Discoms and Competition

The CCI had its first brush with interaction in this sector with the transferred pending cases under the old Monopolies and Restrictive Practices (MRTP) Law (the suo motu case taken up by the Director General – Investigation and Regulation (DGIR) under the MRTP Act), wherein the power Discoms of Delhi (Discoms) were alleged to have engaged in anti-competitive practices. This was supplemented by an information under the Competition Act against the three Discoms concerning engaging in abuse of their dominant position by selling ‘fast-running meters.’ The matter was referred to the DG-CCI for investigation, which found that the Discoms were abusing their dominant position. However, the Commission held that the issue of ‘fast-running meters’ has no bearing on competition in this sector and such issues may be looked at by the consumer forum or ombudsman established under the Electricity Act (Discoms Case 2011).

4.4.3.2

Interoperability

Interoperability issues in the electricity distribution sector in India were brought before the CCI by one of the consumers from Mumbai wherein the actions of the state electricity utility, the Brihanmumbai Electric Supply & Transport Undertaking (BEST), in not allowing changeover to another supplier, Tata Power, were challenged. As the informant had also preferred another case before the State Electricity Regulator (MERC), the CCI closed the case to wait for the outcome of the decision from the MERC. The matter went to the Supreme Court and it was found that there was no obligation on the state utility to grant open access in view of the exemption granted under the Electricity Act (BEST Undertaking Case 2010, 2014). Along similar lines to the CIL and GAIL cases, Tata Power filed an information alleging abuse of dominance by the National Thermal Power Corporation (NTPC) in imposing onerous conditions in power purchase agreements (PPAs), including the absence of an exit clause in very long-term contracts. The CCI closed this case on the grounds that the informant had the option of going to the Ministry of Power to get the reallocation done to some other party (NTPC 2017).

4.4.3.3

Sectoral Overlap

Just like the oil and gas sector, the electricity sector also saw a tussle between the electricity regulator CERC and the CCI when CERC came up with its own draft regulations in 2012 to tackle the adverse effect on competition in the energy sector (CERC 2012). The CCI objected to this regulation as usurping its jurisdiction and later the draft regulations were not implemented. On the issue of sectoral overlap, there is also a case pending in the Madras High Court challenging the jurisdiction of the CCI to deal with cases in the electricity

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sector. However, in 2014, the Delhi High Court left it to the CCI to decide that the Maharashtra State Power Generation Co. (Mahagenco) had abused its dominance by refusing to provide open access to the other independent power producers. Recently, the CCI has clarified its position on exercising jurisdiction in the electricity sector in a matter relating to abuse of their dominant position by the state electricity utilities in restricting open access (HPCL-Mittal 2018).

4.5

Telecommunication Sector

The telecommunication sector has witnessed the fastest reform measures, beginning even before liberalization, i.e. in the 1980s. The telecommunication sector includes primarily telephony (landline and mobile), the Internet and broadband services, and radio/television broadcasting. Reforms in this sector have been witnessed to a great extent by the common consumer with modern handsets, cheaper call rates, and the Internet and broadband. From 1997, the Telecom Regulatory Authority of India (TRAI) played a very significant role in regulating and giving direction to these reforms by way of robust policies and timely tariff interventions whenever required. In 2000, the constitution of the Telecom Dispute Settlement and Appellate Tribunal (TDSAT) further liberalized the sector by providing a separate body for adjudication and dispute settlement. While there are no issues as regards the operation of SOEs in this sector, there have been conflicts between the telecom regulator and the CCI on certain issues, in particular the following: • The TRAI’s recommendation on Intra Circle merger and acquisitions guidelines in the telecom sector (2012) • Consultation paper on monopoly/market dominance in cable TV services (2013) • Consultation paper on net neutrality (2017) • Predatory pricing tariff rule – barring telecom operators with over 30% of the market share from offering services at a price that is below the average cost of the service with the intention of reducing competition or eliminating competitors (2018). The Telecom Appellate Authority has dismissed some clauses of this rule and the TRAI has approached the Supreme Court on this. While the CCI has been writing to the TRAI about its jurisdiction in matters exclusively relating to competition concerns, the TRAI has not acceded to this argument and continues to argue for its jurisdiction to deal with matters on competition in the telecom sector. The Supreme Court of India has recently clarified the position of the CCI vis-à-vis the TRAI in a matter involving alleged cartelization by Airtel, Vodafone, and Idea (collectively called IDOs) and the Cellular Operators Association of India (COAI). In the case of an information filed by Reliance Jio, the CCI ordered an investigation into the alleged cartelization. This order was challenged by IDOs before the Bombay High Court wherein the order of the CCI was stayed and the matter went to the Supreme Court. The Supreme Court settled a

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long-pending issue regarding the jurisdictional conflict and held that the order by the CCI was premature in terms of the absence of adjudication on the technical issue of interconnection by the TRAI (Telecom Cartel Case – SC 2018).

4.6

General Insurance Sector

The insurance sector in India has experienced a 360-degree journey over a period of more than a hundred years. Its transition from an open competitive sector to nationalization (life insurance in 1956 and general insurance in 1973) and then back to a liberalized market in the 90s characterizes this phenomenon (Bhattacharya and Rane 2003). The Insurance Regulatory and Development Authority (IRDA) has changed the way the insurance sector used to work, bringing in significant reforms. Foreign investment in the insurance industry in India is limited to 49% under the automatic route and hence there exists a potential for reform in this sector. Publicly owned general insurance companies (collectively referred to as Public Sector General Insurance Companies [PSGICs]) hold about 60% of the market share in the health insurance business.

4.6.1

Bid Rigging

The insurance sector in India got the attention of the CCI through a case of a bid-rigging cartel entered into between the four Public Sector General Insurance Companies (PSGICs). The cartel was to bid for a tender floated by the state government of Kerala to select insurance service providers to run a governmentsponsored general insurance scheme. The CCI received an anonymous information and investigated this matter on its own, finding that the senior officials of the four PSGICs had met “to discuss about sharing of business and submission of a quotation for the above business” and recorded the minutes signed by its officials “to share the business among the four PSUs with United India as the leader with 70% and other companies with 10% each. . .” The CCI imposed a penalty on the PSGICs, which was also upheld by the appellate authority – the Competition Appellate Tribunal (Cartelization by PSGIC 2015).

4.6.2

Third Party Administrators Case

In a subsequent case, the conduct by the PSGICs again came under the scrutiny of the CCI wherein the informants alleged that the PSGICs were conducting their activities in an anti-competitive manner under the banner of the General Insurers (Public Sector) Association of India (GIPSA). The informant in this case alleged that

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the formation of Health Insurance TPA India Ltd. (HITPA) by PSGICs was an attempt to foreclose the market to prevent both existing and potential TPAs from entering the TPA market. TPAs generally handle the claims management process and act as a conduit between the insured and the insurer. While the formation of HITPA per se could not have been a serious concern in view of the “efficiency of JV” defense available in Section 3 of the Competition Act, the following direction from the administrative department of the public general insurance companies raised eyebrows: No Public Sector General Insurance Company shall obtain the business of standalone group health insurance from any of the other public sector companies without the prior written and explicit ‘No Objection’ from the concerned CMD of the other company. All PSU insurers shall necessarily share the data concerning premium, claims etc. with regard to major accounts and ensure that there is no competition between them in any corporate/group account. Any deviation from this instruction will be viewed seriously (DFS Circular 2012). In an overall analysis of this case, the Commission was of the opinion that the formation of HITPA would bring efficiency and is not anti-competitive, especially in view of the fact that HITPA was not engaged in any commercial activity as such. The Commission disapproved the issuance of the aforesaid directions by any person, body, or government department that may hinder fair play in the market. This case is important as the CCI distinguished the role of ministries/departments in issuing policy directions as a ‘sovereign function’ and not qualifying as an ‘entrepreneurial act’ to trigger competition law. In this case, the DFS was considered to be an extension of the government and acting on behalf of the President of India to monitor the overall performance and functioning of PSGICs to achieve their objectives (ATPA and GIPSA 2016). The aforementioned two cases brought forward a significant concern regarding fair play among the SOEs. Their common parent being the government, there is a natural affinity to favor and collude rather than compete. This is further strengthened by the absence of a ‘competition culture’ amongst the SOEs. What is required is a top-down approach in these situations. The aforementioned two cases in this sector definitely impacted the way these companies used to function toward better governance and a competitive spirit.

4.7

Transport Sector

The movement of goods and people plays a very important role in the development of a country. Sustained competition in the transport sector contributes to consumer welfare by reducing prices and the quality of goods. In India, transport is mainly covered by railways, road, air, and water. We have already dealt with the air transport sector. Water transport is not very well developed in India; however, new policies are making rapid strides toward its development. Strong competition

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may be seen in the road transport sector. With the promulgation of e-waybills under the Goods and Services Tax (GST), things have improved.

4.7.1

Railways

Indian Railways (IR) is the fourth-largest network in the world and plays a significant role in the development and growth of the country. It operates directly under the Ministry of Railways and importantly has its own central budget. However, from the budget year 2017–2018, in continuation of the reforms, the railway budget was merged with the union budget. Indian Railways came under the examination of the CCI in cases brought by the private container operators Arshiya Rail and KRIBHCO challenging the abuse of dominance by IR and the publicly owned Container Corporation of India (CONCOR). This case is important as the Delhi High Court in this case clearly distinguished between the ‘sovereign functions’ and ‘commercial activities’ performed by the railways and held railways to be subject to the jurisdiction of the CCI (Arshiya Rail Case 2010). Railways are up for a number of reforms, including reforming the functioning of SOEs and establishing a railway regulator (Debroy 2015); however, privatization of the railways seems to be a distant agenda for the government, bearing in mind its strategic and political importance.

4.7.2

Road Transport

While goods transport is primarily dominated by private truck operators, passenger transport is generally dominated by public transport departments. Every state has its own state transport undertakings and they enjoy some monopoly rights as to the routes, timings, and services they operate (CIRC-CUTS n.a). The CCI dismissed a case filed against the North West Karnataka Road Transport Corporation (NWKRTC) for alleged abuse of its dominant position, observing that the “Motor Vehicles Act, 1988 empowers the state governments to regulate the road transport services in their respective states. . . In the public interest, a state government may not allow private players to operate on certain routes.” However, the CCI asked the Karnataka government to take a fresh view on the flexible rates charged by the transport corporation. Interpretation of the term “public interest” is crucial in this case, and this was not carried out as such in the prima facie closure of the case.

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Real Estate Sector

In India, there are many public authorities under the state governments that are involved in the development of real estate. The CCI, in one of its first cases, made headlines by penalizing DLF Ltd., one of the prominent private builders in India for abuse of its dominant position by imposing unfair conditions on consumers. This case revolutionized the consumer protection regime in the real estate sector in India. In fact, the evolution of the Real Estate Regulatory Authority Act (RERA) in India may be attributed to this decision. The CCI has given equal treatment to state authorities like the Delhi Development Authority (DDA) and the Ghaziabad Development Authority (GDA) by imposing a penalty on them for anti-competitive conduct in unilaterally raising prices and imposing onerous conditions on lockedin consumers.

4.9

Public Procurement and SOEs

Public procurement refers to the procurement of goods and services by the public sector and becomes crucial because of the public money involved. The objective of public procurement is to achieve maximum economic efficiency through the competitive process of bidding. However, despite the economic transformation that the various countries in Asia have undergone, serious weaknesses have persisted in the area of public procurement. These include fragmented procurement procedures; the lack of professional procurement expertise; the absence of open, competitive tendering, especially for foreign suppliers; widespread corruption; and the lack of transparency (Jones 2007). The participation of SOEs in the tendering process further complicates the issues, especially in view of the perceived transparency and fairness issues in ensuring a level playing field between SOEs and private bidders. These issues emerge from three main factors: (i) privileged access to information; (ii) potential conflict of interest through the state’s direct/indirect control of ownership; and (iii) SOEs’ enjoyment of grants, subsidies, relief, etc. (ADBI 2018). In India, the public procurements have always been under the scrutiny of the Supreme Court of the country in view of Article 299 of the Constitution of India, which deals with government contracts. Through its several decisions, the Supreme Court of India has laid down the principle of public procurement that the government should be fair in its dealing, on the one hand, and with freedom of choice for the procurer as a consumer, on the other. In a number of the cases before the CCI, it has clearly recognized the ‘freedom of choice’ of the procurer to frame the terms and conditions of the tender document (Mahagenco Case 2017). In order to detect and prevent anti-competitive practices in public procurement, it is necessary to evaluate the market structure upfront and have robust tender conditions. Red flags arising out of these assessments would help the procurement

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agencies to increase the effectiveness of procurement competitively. In terms of process, India has made several changes to public procurement norms, one of the significant ones being the practice of performing e-procurement. This has plugged a lot of loopholes in the system. Though beyond the scope of this paper, another important element that comes up in public procurement issues coupled with the anticompetitive setup is ‘corruption,’ which has come to the forefront in a number of bid-rigging cases before the CCI. Moreover, pro-competitive procurement rules in SOEs and competitive neutrality principles can reduce the risk of corruption as the competitors would be watchful of any such behavior. In terms of public procurement, the CCI has got plenty of cases of bid-rigging, beginning with the first case against Indian Railways and SAIL. Preference in the procurement of rails for Steel Authority of India Limited (SAIL) by Indian Railways was challenged by Jindal Steels in one of the first cases before the CCI, which went to the Supreme Court on jurisdictional issues. However, the CCI did not find any anti-competitive issue in this procurement, respecting the ‘choice of the buyer’ and the flexibility available in the contract not leading to any foreclosure (CCI-SAIL Case 2010). However, there have been other cases in relation to bid-rigging in railways tendering wherein the CCI has made an observation on the entry barriers being created due to unreasonable conditions in the tender document. The CCI observed that a lower number of vendors approved by the standard-setting authority – the Research Designs & Standards Organization (RDSO) – creates a sort of entry barrier and restricts competition. Similarly, in the Sugar Mills case (2011), the CCI was of the view that the sugar industry is not free from control and is at present highly controlled and regulated. The CCI advised the government to consider framing a policy in this sector that allows the market and competitive forces to play a bigger role in the sector and ultimately benefit the consumers. MSEs and Public Procurement In India, there is a requirement for the PSUs to procure 20% of their requirements from micro and small enterprises (MSEs) (2012 order). There are 358 items that are exclusively reserved to be procured from MSEs. While this policy is to promote MSEs, the policy rests on the core principle of competitiveness, and procurement is done through transparent procurement norms.

4.10

Conclusion and Policy Recommendations

‘Competition’ as an agenda was formally dropped from the WTO working group agenda, and the movement of ‘divergence to convergence’ on basic principles of competition law and policy is now being taken care of by the bilateral, multilateral, and regional framework (Singh 2014). Internationally, UNCTAD, the OECD and

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the World Bank have highlighted the need to promote a ‘competitive neutrality’ framework so as to provide a level playing field for enterprises. Governments have entered into free trade agreements in which negotiation on a ‘competition’ chapter has been one of the important issues. A multilateral negotiation took pace for the Trans-Pacific Partnership (TPP) among 12 Asia-Pacific regions. One of the chapters of the TPP specifically dealt with SOEs, as the issue of SOEs was considered problematic in the international trade context for several reasons, the most prominent one being the issue of competitive neutrality (Kim 2017). While the ‘competitive neutrality’ argument has been made to usher in reforms in SOEs, creating a climate for them to compete with the private players, the drive has not been out of criticism. Many of these SOEs have been champions of addressing various social and political roles and also facing ‘reverse competitive neutrality,’ a term used to refer to the onerous conditions SOEs face because of their position as publicly funded bodies. Further, one cannot lose sight of the fact that SOEs have become tools for some countries to better position themselves for the future in the global economy, given the increased global competition for finances, talent, and resources (PWC 2015). Thus, a balance needs to be made between privatization and progressive reforms of SOEs, with one of the solutions being maintaining a clear distinction between the social and commercial functions of SOEs. A smudging of roles leads to inefficiencies in their operation and free-riding issues. The Indian experience of reforms carried out for SOEs has been remarkable so far, the prominent one being the applicability of Competition Law to SOEs, making no distinction from a private enterprise. The competition regulator in India has been bold enough to bring actions against some big SOEs and suggest measures for ensuring competitive neutrality, including ‘competition impact assessments’ of sectors and changes in legislations and policies. Although the advisory functions of the CCI are recommendatory in nature and government is not bound to follow the same, the CCI has been pretty active in its advocacy function in bringing in a ‘competition culture’ among SOEs through workshops, seminars, and conferences. Examples from the different sectors in India wherein these SOEs operate clearly show a pattern of functioning: for example, both the dominant SOEs in the coal sector and the oil and gas sector have been alleged to abuse their dominant position while negotiating fuel supply agreements with their clients, even when, in some cases, the clients themselves were another SOE. One of the reasons for such abuse could be the perceived notion of being close to the government. A comparative analysis of the functioning of SOEs in some prominent countries of Asia demonstrates that competition law forms an important element in bringing reforms to SOEs. Bringing changes to the corporate governance framework of these SOEs to increase their accountability, efficiency, and competitive spirit to a level similar to private enterprises is another important element. Governments are focusing on consolidating the smaller SOEs into bigger ones to compete globally. In India, we are seeing this trend in the financial sector involving the merger of banks, and in the oil and gas sector. Interestingly, India has exempted these sectors from the applicability of combination regulations so as to remove any scrutiny from the

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competition regulator. This contrasts with the focus on promoting ‘competitive neutrality’ principles under the competition law and brings forward the question of whether a competition regulator is the right body to deal with the issue or whether one should follow the Australian model in which a separate body (Productivity Commission) handles the matter. In India, one of the greatest challenges for enforcement of the competition law against SOEs has been the regulatory overlap between the sectoral regulators and the generic competition regulator. There have been jurisdictional challenges pending in the various constitutional courts of the country. While recently the Supreme Court of India has clarified the position in the telecom case, there are still cases pending in courts. This issue needs to be addressed as a priority, and it is suggested that in cases involving the interpretation of key provisions of the competition law, specifically involving jurisdictional overlaps, the courts should accord priority and interpret the final principles of engagement. A lot of other cases are dependent on these interpretations. While the competition law of India provides for consultation between regulators (Sections 21 and 21A), the outcome is not mandatory. It was advocated that these provisions should be made mandatory; however, the attempt did not succeed. A good coordination between the competition regulator and sectoral regulators would help greatly in establishing a competitive neutrality framework. Moreover, politicization of these issues in India creates several concerns and impedes reforms: for example, recently the performance of Hindustan Aeronautics Limited (HAL) – a defense sector SOE – has been receiving sharp criticism from parliamentary standing committees and it has been projected by the opposition as favoring private players over the national champion. In conclusion, one can raise the following points of reference for reforming SOEs through effective competition law and policy: • A definition of ‘enterprise,’ including government departments except those departments engaged in sovereign functions, provides clarity for SOEs that they are subject to enforcement of competition law. • The aforesaid definition, however, does not set the ‘competition culture’ amongst SOEs. This is attempted to be instilled by way of focused advocacy efforts on the part of competition agencies and the government. • In terms of enforcement, the competition regulator has fined many SOEs; however, at times it has appeared to give leeway due to existing policies and practices with some suggestions for improving their way of functioning (e.g., the Coal India case). • The government is making efforts to withdraw itself from less important sectors like running hotels; however, it has found it difficult to convince itself to lose complete control of important sectors like ‘commercial airlines,’ railways, etc. • Differentiating between ‘commercial activities’ and ‘social obligations’ of SOEs requires attention. In certain situations, de jure differentiation doesn’t help de facto reforms.

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• Collaboration between the competition regulator and sectoral regulators is very important. A mandatory consultation mechanism under the competition law may help. • Corporatization of the functioning of SOEs would help reform SOEs. There are incentives for performing SOEs in different parameters, including ‘good corporate governance’; including ‘competition compliance’ as a parameter may prove useful. • The judiciary shall accord priority to cases that require the setting of ground rules for operation of these SOEs. A delay in resolution may be harmful to the markets and the economy, and ultimately the citizens of the country. • Political perceptions and interventions shall be minimized in dealing with the issue of reforms. Education and advocacy in these matters would be very useful. India’s competition law and policy plays an important role in reforming SOEs by keeping a check and balance and providing operational ground rules. Anticompetitive behavior is reprimanded and advocacy efforts are carried out to instill a competition culture. India may not be a perfect example to follow, due to differences in national markets and its priorities, but its experiences could be a good learning point for Asian economies. While significant work has been done in terms of reforming SOEs, a lot still remains to be done in keeping this subject alive for discussion in the coming years with a focus on international convergence, beginning with convergence in principles and practices for reforming SOEs in Asia.

References ADBI. (2018). State-owned enterprises: Guidance note on procurement. Available via Asian Development Bank. https://doi.org/10.22617/TIM189429-2. Accessed 5 Jan 2019. Aharoni, Y. (1986). Political economy
The evolution and management of state-owned enterprises. Cambridge, MA: Ballinger. xvi, 411p. Arshiya Rail Case. (2010). Arshiya rail infrastructure limited against ministry of railways and CONCOR. CCI Case No. 64 of 2010 and 12 of 2011 and Case No. 02 of 2011 (KRIBHCO) decided on 09.08.2012. Association of Third Party Administrators and General Insurers’ (Public Sector) Association of India (GIPSA) – CCI Case 107 of 2013 order dated 04.01.2016. (2016). Best Undertaking Case. (2010\2014). Anila Gupta and Best Undertaking. CCI Case No. 6 of 2010 and Case 43 of 2014 decided on 11.01.2012 and 12.09.2014. Bhattacharya, A., & Rane, O. (2003). Nationalisation of insurance in India. In: Centre for civil society
The indian economy. https://ccs.in/internship_papers/2003/chap32.pdf. Accessed 23 Nov 2018. Capobianco, A., & Christiansen, H. (2011). Competitive neutrality and state-owned enterprises: Challenges and policy options (Available via OECD Corporate Governance Working Papers, No. 1, OECD Publishing). https://doi.org/10.1787/5kg9xfgjdhg6-en. Accessed 5 Oct 2018. CCI-SAIL Case. (2010). Competition commission of India v. SAIL, (2010) 10 SCC 744. CERC. (2012). Explanatory memorandum to the draft central electricity regulatory commission (Prevention of Adverse Effect on Competition) Regulations, 2012. CIRC-CUTS. (n.a.). Research study of the road transport sector in India. https://www.circ.in/pdf/ Road_Transport_Sector.pdf. Accessed 5 Dec 2018.

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Coal India Case. (2013\2017). Maharashtra state power generation company limited against Mahanadi coalfields limited and coal India Limited. . . – CCI Cases 3, 11 and 59 of 2012 decided on 09.12.2013 and revised order dated 24.03.2017. Debroy, B. (2015). Report of the committee for mobilization of resources for major railway projects and restructuring of railway ministry and railway board. Ministry of Railways, Government of India. DFS Circular. (2012). F.No.G 14017/115/2011- Ins.II) dated 24.05.2012 addressed to the CMDs of the PSGICs. Discoms Case. (2011). Neeraj Malhotra and North Delhi Power Limited, BSES Rajdhani Power Limited and BSES Yamuna Power Limited, CCI Case 06 of 2009 decided on 11.05.2011. DPE. (2011). Criteria/parameters for initial Categorization of Public Sector Enterprises (CPSEs). https://dpe.gov.in/guidelines/guidelines/chapters/2641. Accessed 18 Aug 2019. Economic Survey. (2018–2019). Government of India, Ministry of Finance. https://www. indiabudget.gov.in/economicsurvey/. Accessed 18 Aug 2019. Fox, E. M., & Healey, D. (2014). When the state harms competition – The role of competition law. 79. Antitrust Law Journal, 79(3), 769–820. GAIL Cases – Cases 16-20 of 2016. (2016). Case 45 of 2016 and Case 2 of 2017 (prima facie orders dated 03.10.2016, 17.07.2017 and 14.07.2017 respectively) – under investigation by DG-CCI. Gaur, S. (2012). Competitive neutrality. Available via UNCTAD. https://unctad.org/meetings/en/ Presentation/ciclp2012_RPP_SGaur_en.pdf. Accessed 15 Oct 2018. Gouri, G. (2010). The Application of Antitrust Law to State Run Enterprises (SOEs) in India. Available via CCI. https://www.cci.gov.in/sites/default/files/presentation_document/ CLandSOE_20100401142732.pdf. Accessed 25 Dec 2018. HPCL-Mittal. (2018). In Re: HPCL-Mittal Pipelines Limited and Gujarat Energy Transmission Corporation Limited & Ors. CCI Case No. 39 of 2017, decided on 31 January 2018. In Re: Cartelization by public sector insurance companies in rigging the bids submitted in response to the tenders floated by the Government of Kerala for selecting insurance service provider for Rashtriya Swasthya Bima Yojna, CCI Suo Moto Case No. 02 of 2014. Order dated 10.07.2015. https://www.cci.gov.in/sites/default/files/022014S.pdf. Accessed 23 Nov 2018. Jones, D. (2007). Public procurement in Southeast Asia: Challenge and reform. Journal of Public Procurement, 7(1), 3–33. Jones, S. L., Megginson, W. L., Nash, R. C., & Netter, J. M. (1999). Share issue privatizations as financial means to political and economic ends. Journal of Financial Economics, 53, 217–253. Khanna, S. (2012). State-owned enterprises in India: Restructuring and growth. The Copenhagen Journal of Asian Studies, 30(2), 5–28. Kim, M. (2017). Regulating the visible hands: Development of rules on state-owned enterprises in trade agreements, 58(1, winter), 225–272. Ministry of Heavy Industries & Public Enterprises. (2012). Criteria for categorization of CPSEs. http://pib.gov.in/newsite/PrintRelease.aspx?relid¼79714. Accessed 23 Nov 2018. Moroccan Conseil de la Concurrence. (2014). State-owned enterprises and competition (Special Report presented at International Competition Network (ICN) Annual Conference, Marrakech, 23–25 April 2014). NITI Aayog, Government of India. (2017). Draft national energy policy. Version as on 27.06.2017. Available via niti.gov.in. Accessed 5 Jan 2018. NTPC. (2017). Tata power Delhi distribution limited and NTPC Limited. CCI Case No. 20 of 2017 order dated 12.10.2017. PWC. (2015). State-owned enterprises catalysts for public value creation? Available via PWC. https://www.pwc.com/gx/en/psrc/publications/assets/pwc-state-owned-enterprise-psrc.pdf. Accessed 5 Jan 2019. Ram, K. (2009). State owned enterprises in India: Reviewing the evidence (OECD Working Group on Privatization and Corporate Governance of State Owned Assets). Ram, K. (2014). Role of state-owned enterprises in India’s economic development. In Paper presented at the OECD Workshop on State-Owned Enterprises in the Development Process.

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Available via OECD. https://www.oecd.org/daf/ca/Workshop_ SOEsDevelopmentProcess_India.pdf. Accessed 10 Nov 2018. Singh, V. K. (2011). Competition law and policy in India: The journey in a decade. 4 NUJS Law Review, 523, 523–566. Singh, V. K. (2014). Failed WTO platform for competition law convergence: Evolving alternate regime of MOUs on internationalization of competition law. Indian Journal of International Law, 54, 247–272. Supreme Court. (2014). Manohar Lal Sharma vs. Principal Secretary (2014) 9 SCC 516 and (2014) 9 SCC 614 decided on 24 September 2014. Telecom Cartel Case – SC. (2018). Competition Commission of India v. Bharati Airtel and Ors, 2018 SCC OnLine SC 2678, decided on 05.12.2018. TERI. (2007). Competition in India’s energy sector. New Delhi: The Energy and Resource Institute. [Project Report No. 2005RP30]. XYZ. (2018). XYZ and IOCL, BPCL and HPCL, CCI Case No. 05 of 2018 order dated 04.07.2018. Matter also refers to the two orders of the commission in Case No. 26 of 2010 and Suo Motu Case No. 03 of 2013 which has been stayed by Delhi High Court.

Chapter 5

State-Owned Enterprises in Uzbekistan: Taking Stock and Some Reform Priorities Umidjon Abdullaev

5.1

Introduction

Starting from end-2016, Uzbekistan embarked on a wide set of comprehensive structural reforms aimed at revitalizing key sectors, liberalizing its markets, and introducing market mechanisms in the economy. Given the still important role of state-owned enterprises (SOEs) across a number of sectors in the country, any package of economic reforms will necessarily have to take into account the high dominance of these enterprises across multiple sectors and address issues specifically related to, or stemming from, the dominance of SOEs in the economy. State-owned enterprises (SOEs) in Uzbekistan dominate and have significant influence on the performance of many sectors in the economy, including natural resources, energy, manufacturing, telecommunications, transport, and agriculture. Given that Uzbekistan is currently reinvigorating its reform efforts, particularly in terms of increasing the role of the private sector, strengthening the economy’s export potential and increasing its efficiency, detailed analysis of its SOE sector is of utmost importance. The SOE sector in Uzbekistan has been the key driver of its industrial development during the last few decades and will likely remain so in the coming years. In this respect, understanding better the SOE sector and identifying some of its critical issues and bottlenecks should help design effective reform initiatives in the future. The purpose of this study is to review the economic weight and degree of presence of SOEs in the economy of Uzbekistan, discuss the evolution of the scope of its privatization initiatives, and analyze in detail the governance mechanisms used by the Uzbek government to manage its portfolio of commercial

U. Abdullaev (*) European Bank for Reconstruction and Development, London, UK e-mail: [email protected] © Asian Development Bank Institute 2021 F. Taghizadeh-Hesary et al. (eds.), Reforming State-Owned Enterprises in Asia, ADB Institute Series on Development Economics, https://doi.org/10.1007/978-981-15-8574-6_5

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enterprises. The study is based on publicly available information on Uzbekistan’s SOE sector, including data available from the State Committee for Statistics, a number of state agencies, and a public repository of Uzbek legislation. In this respect, a major limitation of the study is the lack of analysis of operational performance of SOEs due to limited availability of consolidated and complete data on their financial and operational performance.1 The sector of state-owned enterprises and the need for governance reforms, particularly in the transition region, have been analyzed by a number of authors. Dewenter and Malatesta (2001) analyze the performance of SOEs in a number of countries and confirm their subpar performance relative to private firms. In a recent study, Richmond et al. (2019) analyze the performance and footprint of SOEs across central, eastern, and southeastern Europe and provide policy recommendations for addressing a number of governance and efficiency issues. In a similar study, Böwer (2017) looks into the performance of SOEs in a number of emerging economies. The analysis contained in this chapter complements a number of earlier related studies carried out primarily by international financial institutions (IFIs) by identifying the scope of the SOE sector in the economy of Uzbekistan, providing detailed analysis of a number of issues concerning the governance structure of SOEs, and by evaluating the government’s past privatization initiatives (for earlier studies, see Broadman (2000), Conrad and Lin (2005), and Conrad (2008)).

5.2

Economic Weight and Role of SOEs in the Economy

SOEs in Uzbekistan have traditionally been viewed as a key tool for achieving the country’s industrial policy objectives. During the past two decades Uzbekistan has implemented various activist industrial policies aimed at supporting existing, and developing new, industrial capacities in the country. SOEs have been an integral part of this strategy and the state’s production, export, and import substitution objectives over a wide range of goods have commonly translated into specific targets for major SOEs. SOEs in a number of sectors are also explicitly indicated in the legislation to be of strategic importance for the economic development of the country. Major SOEs overseeing sectors of the economy trace their history to sector ministries. Historically, the management of enterprises in Soviet-type economies had been carried out through sector-specific ministries (also referred to as “line ministries”), which was the common method of organizing the work of enterprises around state development plans and policies. Following the breakup of the Soviet Union, such ministries in many former Soviet economies were dismantled. In 1

Analysis in this chapter is based on data, structure of government agencies and related legislation known, valid and available as of end-2018. The Government of Uzbekistan has initiated a number of reforms in the area of the governance of SOEs throughout 2019 and 2020. Thus, some of the observations made in this study may be subject to revisions as ongoing reforms efforts in this area materialize.

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Uzbekistan, sector ministries were in many cases converted to holding companies, associations, or so-called “concerns,” which largely retained the functions of original sector ministries in terms of management of sector enterprises, their supervision, and overall implementation of industrial development policies. During the past two decades, sector associations and concerns have been corporatized and transformed into sector-specific joint-stock or holding companies, but many major SOEs retained their original multiple mandates and responsibilities. This largely translated into the current structure of industrial sectors in Uzbekistan, which are commonly characterized by a major sector-specific holding or joint-stock SOE with a mandate of managing the portfolio of SOEs operating in the sector, monitoring or supervising the performance of private enterprises, and implementing the state’s sector development policies. The state’s portfolio of industrial and commercial enterprises is large and spans most economic sectors. Complete and up-to-date data on the number and sectoral distribution of enterprises owned or controlled by the state are not publicly available. Despite constraints related to the availability of such data, existing evidence suggests that SOEs are present in most sectors of the economy, including energy, mining, oil and gas, light and heavy manufacturing, telecommunications, and transport (Table 5.1). Uzbek legislation does not formally identify the term “state-owned enterprise,” and thus no specific ownership thresholds designating an enterprise as “state-owned” exist. At the same time, the legislation allows for the establishment of a special type of entity called a “state unitary enterprise,” which is by definition fully owned by the state and is commonly created as a special entity for managing stateowned property.2 But the majority of large SOEs in the country are incorporated as joint-stock companies, commonly majority to fully state-owned. Thus, analyzing only the set of “state unitary enterprises” will omit the large set of enterprises that are de facto also state-owned, though they do explicitly bear such designation. Thus, in this chapter the term “state-owned enterprise” is used to refer to enterprises with different degrees of state ownership. Complete and up-to-date data on the size of state ownership in each SOE are not publicly available. Major SOEs, including those listed in Table 5.1, are commonly fully or majority owned by the state. Until early 2019, the Centre for Management of State Assets (CMSA), a unit within with the former State Committee for Assistance to Privatized Enterprises and Support of Competition (also referred to as the State Committee on Competition (SCC)), had been the government agency responsible for the ownership, management and monitoring of the state’s portfolio of industrial and commercial enterprises.3 The CMSA listed a little over 1400 enterprises in its 2016 report on the performance of enterprises it monitors, which likely includes core commercial and 2

Legally, state unitary enterprises do not own state-owned property and they are only in a position to use the property assigned to them. 3 The Centre for Management for State Assets (CMSA) and its parent agency (State Committee for Assistance to Privatized Enterprises and Support of Competition) were reorganized in early 2019 into several agencies with functions of ownership and management of the portfolio of state-owned enterprises being transferred to a newly created State Assets Management Agency (SAMA). The

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Table 5.1 Examples of major state-owned enterprises in Uzbekistan and their key markets (as of end-2018) Sector Agriculture

Enterprise Uzpakhtasanoateksport Holding Company Uzdonmahsulot JSC

Mining, metals

Almalyk Mining and Metallurgy Complex JSC Navoi Mining and Metallurgy State Company Uzmetkombinat JSC Uzbekneftegas Holding Company Uzbekenergo JSC

Oil and gas Electricity supply

Uzbekhydroenergo JSC Manufacturing

Uzagrotehsanoatholding Holding Company Uzavtosanoat JSC Uzbekengilsanoat JSC Uzeltekhsanoat JSC Uzbekoziqovqatholding Holding Company Uzkimyosanoat JSC Uzstroymaterialy JSC Uzsharobsanoat JSC

Transport

Uzbekiston Havo Yollari National Air Company Uzbekrailways JSC

Key products/Services Purchase, storage, processing, and export of cotton Grain storage, production of flour, bread products Mining, metals (copper, silver, gold, and others) Mining, metals (gold, uranium, and others) Ferrous metals Oil and gas exploration and production Production, distribution, and sale of electricity Operation and management of hydro power plants Production, servicing of agricultural machinery Production of automobiles, trucks, and buses Production of textile products Consumer and industrial electronic products Production and export of food products Production of chemical products, fertilizers Production of construction materials Production of alcoholic and other beverages Air transportation, management of airports Rail transportation

Source: Author’s elaboration

revenue-generating SOEs operating in Uzbekistan. The sector affiliation of enterprises in the CMSA reports shows that SOEs are present in most sectors of the economy, including the provision of various professional and technical services (engineering, standardization, testing, veterinary services), construction, information and communication (telecommunications and newspaper publishing), real estate (including ownership and management of markets), and various manufacturing

study will, nevertheless, refer to CMSA in the text, where relevant, given it was the key legal ownership entity for SOEs in the country until end-2018.

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Table 5.2 Sectoral distribution of enterprises monitored by the Centre for Management of State Assets (CMSA) (based on the 2016 Performance Report) Sector Professional, scientific, and technical activities Construction Information and communication Real estate activities Manufacturing Transportation and storage Wholesale and retail trade; repair of motor vehicles and motorcycles Administrative and support service activities Agriculture, forestry, and fishing Electricity, gas, steam, and air conditioning supply Water supply; sewerage, waste management, and remediation activities Human health and social work activities Other Total

Share (%) 25.4 18.1 7.9 7.8 6.1 5.9 5.4 5.1 3.9 2.6 2.1 2.0 7.7

Count 356 254 111 109 85 83 76 71 54 37 29 28 108 1401

Source: 2016 list of enterprises monitored by the Centre for Management of State Assets and the enterprises registry of the State Committee of the Republic of Uzbekistan on Statistics

activities (metals and metal products, fertilizers, food products, chemicals, and various machinery) (Table 5.2). Comprehensive and reliable data on the share of SOEs in GDP, sectoral and regional value-added, employment, and exports are not available. Official statistical sources provide information on the contribution to the economy of a group of enterprises that are classified as being in the “state sector.” However, this classification category includes only enterprises that are fully owned by the state, making it too restrictive and of limited scope. The definition of a “state enterprise” defined in the legislation includes only so-called “state unitary enterprises” and thus excludes companies of other legal forms with a state ownership share (e.g., joint-stock or limited liability companies). Despite a lack of reliable estimates of the contribution of SOEs to GDP, authorities report information on the contribution of enterprises with majority state ownership to industrial output. In particular, enterprises with majority state ownership accounted for 47% of the total industrial output in 2017 (State Committee for Statistics 2018). The contribution of such enterprises to industrial output varies considerably across regions, ranging from 26% in the Namangan region (Southeast Uzbekistan) to up to 80% in Navoi and Karakalpakstan (Northwest Uzbekistan). Alternative sources of data on economic weight and the contribution of SOEs to the economy are lacking. The lack of household or nationally representative firm survey data in Uzbekistan also limits other indirect sources of information, which could facilitate better assessment of the role of SOEs in the economy. Little available survey data provides evidence of the more important role of SOEs in employment (than suggested by official estimates based on a restrictive definition of SOEs). For example, according to the Uzbekistan Jobs, Skills, and Migration Survey undertaken

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by the World Bank in 2013, 37% of the employed worked in SOEs. The survey’s results also indicated that about 34% of the employed were self-employed, which suggests that employment in SOEs accounted for more than half of the total wage employment in the country (Ajwad et al. 2014). Many SOEs are monopolies or dominant producers of goods and services in their sectors. Information on the market position of many SOEs in a number of markets also points to their importance and significant market power. This is evident from the registry of companies with dominant positions in different product and service markets, which is published by the Uzbekistan’s competition authority (this registry does not include enterprises classified as natural monopolies). The early 2018 version of the registry lists over 120 goods and services along with 500 enterprises that provide them at either country level or within regional markets (the registry includes a large number of regional subsidiaries of major SOEs resulting in the quantity of enterprises exceeding the number of goods and services they provide across specific regional markets). Analysis of the list suggests that more than 90% of enterprises included in the registry are either state-owned or the state has some degree of control in them (e.g., joint ventures). SOEs hold a dominant market position in vehicle manufacturing; chemicals; supply of seeds, fertilizers, and fodder to the agricultural sector; supply of coal and gas; production of construction material (e.g., cement, asphalt, and others); provision of access to international data networks; various certification and engineering services; processing of cotton; and others.4 State ownership also appears to be specifically prominent among joint-stock companies. In particular, as of end-2016, out of 659 existing JSCs the state had a direct ownership share in 158 enterprises (24% of all JSCs), while shares of a further 329 JSCs were owned indirectly through other state-owned SOEs (49% of all JSCs). In other words, 73% of existing JSCs in Uzbekistan are either majority state-owned or the state has some degree of control and ownership in them. In terms of the volume of JSC share capital owned by the state, as of end-2016, 84% of the existing share capital of JSCs was directly or indirectly owned by the state (State Committee for Support of Privatized Enterprises 2017). Major SOEs continue to perform sector supervision and, in some cases, regulatory functions, which conflicts with their simultaneous role of enterprise owners and managers. In addition to being key economic players in different sectors of economy, major SOEs carry out various supervisory and regulatory functions over companies operating in a sector, both private and state-owned, which expands their economic weight beyond their actual market share. As noted earlier, the role of major SOEs in sector supervision and, in some cases, regulation is the outcome of them being successors of now defunct sector ministries. In addition, this role

4

An enterprise is classified as a dominant one in a given good or service market if its market share exceeds 50% of the total market size (including imports). Under certain conditions a 35% market share or above is already sufficient to classify the enterprise as one with a dominant position (Government of the Republic of Uzbekistan 2012).

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continued to be reinforced during the last few decades due to SOEs being viewed by the government as a key tool for achieving its industrial policy objectives. Supervisory and regulatory functions may range from the development, monitoring, and implementation of sector development programs to very specific control functions such as issuance of permissions to other companies in a sector, participation in the decision to issue licenses to new sector entrants, implementation of systems of quality control, development and approval of sector-specific regulation, and enforcement of technical and other standards. This arrangement creates significant conflict between the responsibilities of some major SOEs related to developing and enforcing sector regulation, ensuring efficient performance of their operational subsidiaries, supervision of existing private sector competitors, if any, and regulation of the entry of new players. The government recently has started to transfer some of these supervisory and regulatory functions from SOEs to ministries or state agencies, though further work by the authorities on reducing such conflicts of interest and functions remains necessary. Thus, despite a lack of data permitting more adequate analysis of the economic weight of SOEs in Uzbekistan, available evidence suggests that SOEs continue to play an important role in the country’s economic performance. SOEs are present in most sectors of the economy, many SOEs are dominant producers of goods and services in their markets, and major SOEs continue to perform sector supervision and, in some cases, the regulatory role they inherited from their predecessor institutions.

5.3

Scope and Progress of Privatization Programs

Privatization has traditionally been indicated as one of the main tools for reducing the role of the state in the economy. The Uzbek government has on numerous occasions stated its willingness to reduce the degree of state presence in the economy, particularly by using privatization as one of the main tools for achieving this objective. Privatization in Uzbekistan has had two distinct stages. The first stage started in 1992 and involved large-scale divestment of state shares in small enterprises in agriculture, construction, transport, communications, and various retail and other service sectors. This stage was also characterized by a large-scale privatization of state-owned housing stock. Unlike early-stage privatization efforts, programs initiated from the late 1990s and onwards were carried out on a case-by-case basis and focused not only on small to medium-size SOEs but also on partial privatization of large SOEs (Lieberman et al. 1997; Conrad and Lin 2005). Key privatization programs of the late 1990s and 2000s had a wide scope and ambition, though efforts to privatize large SOEs were not successful. Analysis of decrees initiating large privatization programs in the late 1990s and 2000s indicates that the government did consider partial divestment of its shares in strategic SOEs in mining, oil and gas, energy, transport, and manufacturing but those attempts largely did not succeed. Data on the number of privatized entities do indicate that the

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Table 5.3 Privatization in Uzbekistan, selected years Privatized enterprises Privatization proceeds, mln USDa

2005 980 68.2

2009 135 23.6

2010 96 14.0

2011 95 21.8

2015 848 36.7

2016 609 51.0

2017 542 28.1

a

At end-of-the-year official exchange rate Source: State Committee for Statistics of the Republic of Uzbekistan

government has continued to sell its assets in recent years but efforts have been focused on small and auxiliary enterprises and often on unused real estate property (Table 5.3). Major SOEs have commonly been indicated to be not subject to privatization. The overall scope of Uzbekistan’s privatization programs is defined in the “Law on denationalization and privatization” approved shortly following the breakup of the Soviet Union in November 1991 (Government of the Republic of Uzbekistan 1991). The law indicates that SOEs in a wide range of sectors, including in mining, oil and gas, chemicals, cotton processing, energy, manufacturing, information technologies, transportation, postal services, and others, may potentially be offered for privatization. However, one specific clause in the law specifies that SOEs included in a dedicated government-approved list will remain in state ownership and not be offered for privatization. The law does not prescribe a specific method of privatization of state property and allows for auctions, share sale (initial or secondary public offering), or direct sale to a strategic investor. The recent version of the list includes over 50 SOEs that are explicitly excluded from future privatization efforts (Government of the Republic of Uzbekistan 2017a). These include major SOEs in mining (Navoi and Almaly Mining and Metallurgy Complexes), telecommunications (Uzbektelecom JSC), oil and gas (core enterprises within Uzbekneftegas Holding Company), energy (Uzbekenergo JSC, Uzbekgidroenergo JSC), agriculture (Uzpakhtasanoateksport JSC, Uzdonmahsulot JSC), transport (Uzbekistan Airways, Uzbekistan Railways, airports), manufacturing (major SOEs in vehicle manufacturing, textiles, light manufacturing, construction materials, and food processing), and two commercial banks (the Halq Bank and the National Bank of Uzbekistan). A range of auxiliary SOEs are regularly offered for privatization but the willingness of the state to retain the controlling stake in many of them is evident. Before 2019, privatization efforts of the government were defined by a 2015 presidential decree, which offered a large set of SOEs for privatization (Government of the Republic of Uzbekistan 2015c). The decree in particular lists 68 SOEs offered to strategic investors and 342 SOEs that are to be privatized through public auctions. SOEs offered for privatization operate in different sectors, including chemicals, oil and gas, textiles, construction, food and other manufacturing, and real estate. The decree further lists over 800 real estate assets of the government to be offered to the private sector (either through auctions or at zero cost). Despite its seemingly wide scope, both in terms of the number of SOEs and sector coverage, the decree did not envisage the privatization of major SOEs currently

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responsible for overseeing sectors of the economy and those that account for the bulk of their output. Many enterprises in the decree are auxiliary or small companies operating in a sector and those providing very specific technical and related services to other key enterprises (e.g., construction, transport, and repair and maintenance services). More importantly, the decree clearly suggested that for many enterprises, effective transfer from state to private ownership was not envisaged. In particular, the state intended to retain a controlling 51% stake in 40 out of 68 SOEs offered to strategic investors (either through direct state ownership or ownership through a different SOE). The same applies to 95 out of 342 SOEs offered to privatization through public auctions. Majority state ownership was intended to be retained, particularly in enterprises in the chemicals sector, grain processing, cotton processing, and in ownership of city markets. The government appears to be reviving its privatization efforts, though proposed recent initiatives focus primarily on simplification of the privatization process itself. In particular, in January 2017 a presidential decree allowed the approval of privatization of small nonstrategic SOEs and the sale of state-owned real estate property at zero cost by local authorities (Government of the Republic of Uzbekistan 2017b). The decree also allowed for the privatization process to proceed in the case of a single bidder and deferral of payment of privatization proceeds for up to 3 years. While introducing simplification to the privatization process is laudatory, the potential economic impact of this initiative will likely remain limited. For instance, a little over 340 out of 1400 SOEs listed in the 2016 performance report of the Centre for Monitoring of State Assets (CMSA) are directly subordinate to local authorities and these primarily constitute local city markets, regional newspapers, and publishing houses, as well as enterprises in transportation, retail trade, construction, and municipal and various other technical services. Overall, the available information suggests that the scope of the privatization programs issued before 2019 remained largely limited and this constrained their ability to significantly promote the expansion of the private sector in key sectors of the economy. As noted above, the legislation clearly ruled out the privatization of major enterprises in such sectors as energy, natural resources, chemicals, vehicle manufacturing, transportation, agriculture, two dominant state-owned banks, and others. Many such enterprises are either monopolies or dominant players in their sectors. This suggests that the significant presence of SOEs in key sectors of the economy is likely to continue in the near future. Recent privatization programs focused on noncore and relatively small regional enterprises, which limited the potential of these programs to spur the development of a vibrant private sector through the privatization of state assets.

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Governance and Management of SOEs Formal Corporate Governance Framework

Most large SOEs have been corporatized and basic elements of the governance structure of joint-stock companies are in place. SOEs are commonly incorporated in the following three forms: (i) a joint-stock company (JSC); (ii) a limited liability company (LLC); or (iii) a state unitary enterprise. JSCs are the primary form used to incorporate major SOEs overseeing sectors of the economy, while their subsidiaries are commonly incorporated as JSCs, LLCs, or unitary enterprises. Nevertheless, the discussion in this section will focus on the governance practices of state-owned JSCs as the primary legal form used to incorporate large SOEs. The operation of joint-stock companies, including state-owned ones, is governed by the “Law on joint-stock companies and protection of shareholder rights” approved in 1996 and amended further on numerous occasions afterwards (Government of the Republic of Uzbekistan 1996). A typical state-owned JSC is governed by the general meeting of shareholders, the supervisory board, and the management. The latter can either be a single individual or a management board consisting of multiple directors. The law allows for the delegation of operational management of an enterprise (at the management level) to a third-party management company or to an individual (Government of the Republic of Uzbekistan 2006b). Supervisory boards of major SOEs commonly include high-level government officials and representatives of relevant ministries. For instance, according to a government resolution, the Prime Minister chairs the supervisory board of Uzbekistan Railways JSC, while various deputy ministers make up its members. Deputy prime ministers chair supervisory boards of Uzbekenergo JSC, Uzavtosanoat JSC, and Uzbekneftegas Holding Company, while a number of ministers, deputy prime ministers, or heads of government agencies are members of their supervisory boards (Government of the Republic of Uzbekistan 2006a). The legislation explicitly indicates that members of the supervisory board cannot at the same time be employed by the enterprise. No requirement or possibility for board committees except for the audit committee is specified (for instance, on remuneration, nomination, strategic planning, risk, or other issues). An audit committee reporting directly to the supervisory board is mandated to review the performance of an enterprise on an annual basis. The concept of an independent board director was recently introduced but compliance with a recommendation to introduce independent board directors is voluntary. The law on joint-stock companies does not introduce or mention the concept of an independent director within the supervisory board. On the other hand, the corporate governance code does mention the possibility of introducing an independent director to the supervisory board. Specifically, the code prescribes that at least 15% of the supervisory board should consist of independent directors. At the same time, compliance with the code is not mandatory and selective and it is not readily clear to what extent enterprises follow this specific recommendation.

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Supervisory boards of major SOEs do not appear to have full legal autonomy in appointing members of the management board and the company CEO. Members of the management board, excluding its chairman, are appointed by the supervisory board (after this right is explicitly granted to the supervisory board by the meeting of the shareholders). The chairman of the management board (i.e., the CEO) is appointed by the shareholders’ meeting, though legislation allows for appointment and dismissal of the CEO by the supervisory board if this right is explicitly granted to it in the enterprise statute. Regulation related to specific large SOEs commonly indicates further that the supervisory board appoints the CEO following the approval of the candidate by the Cabinet of Ministers and, in some cases, also by the President’s Office. For example, candidates for the position of CEO of Uzavtosanoat JSC, Uzbekenergo JSC, and Uzagroteksanoatholding JSC are additionally approved by the President’s Office (Government of the Republic of Uzbekistan 2001, 2004a, 2016a). A management contract with a CEO is signed for a year and the shareholders’ meeting (or the supervisory board if it is explicitly granted the right) decides whether to extend the management contract with the appointed CEO on an annual basis. State ownership rights are formally exercised by delegating the management of the state’s share in an enterprise to an individual or legal entity. Formally, management of state JSCs is carried out through delegation of the management of state shares in an enterprise to either (i) an individual, (ii) another SOE, or (iii) an asset management company. For the purpose of management of state assets, state trustees and SOEs are appointed directly, while asset management companies are indicated to be selected on a competitive basis (Government of the Republic of Uzbekistan 2006a, 2013). Individuals and legal entities delegated to manage the state’s share in enterprises are selected and appointed by a dedicated commission after the candidates for these roles are proposed by the ownership entity and approved by the Cabinet of Ministers (Government of the Republic of Uzbekistan 2003a, 2007). Individuals entrusted with the management of state assets may carry one of the two different legal titles: state trustee or state representative. State trustees are appointed in enterprises where the direct state ownership share exceeds 25% and they are indicated to have voting and other management rights commensurate with the size of the state’s shareholding (Government of the Republic of Uzbekistan 2003a). On the other hand, in enterprises where the state share is below or equal to 25% (including cases where a state share is nonexistent), the state has the right to appoint a state representative through exercising its right for a “golden share.” Legislation indicates that state trustees or representatives can be selected from the rank of government officials as well. Disclosure standards and requirements have recently improved. The law on the securities market imposes a set of disclosure and transparency requirements on listed JSCs (Government of the Republic of Uzbekistan 2015a). A separate government resolution imposes further disclosure requirements on official websites of JSCs (Government of the Republic of Uzbekistan 2014). A corporate governance code applicable to all JSCs was approved in early 2016 and its application is voluntary, which may likely result in differing degrees of compliance with its prescriptions. The

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code covers such issues as disclosure of information and transparency, internal audit, protection of shareholder rights, monitoring of compliance with code recommendations, and others. The code specifies that assessment of compliance with its recommendations should be carried out by a third-party organization on an annual basis. Joint-stock companies, including SOEs, are expected to publish the result of these assessments on their websites. Analysis of these assessments conducted by the CMSA suggests that the degree of compliance with the code and corporate governance standards is not complete and uniform, and further improvements in implementing recommended practices and standards are necessary.5 The SOE performance measurement system, as prescribed by the legislation, has notably improved in recent years. The system of monitoring the performance of SOEs evolved significantly in 2015, when a detailed and elaborate set of key performance indicators (KPIs) were introduced with an obligation for SOEs to start implementing the new set of KPIs from January 2016 (Government of the Republic of Uzbekistan 2015b). The new system of monitoring covers a wide range of KPIs, including indicators related to earnings, costs, rate of return, liquidity, indebtedness, ability to service debt, and others. In total, the set includes 13 mandatory performance indicators and an additional 13 supplementary ones. The performance of an enterprise is measured using the so-called “integrated efficiency indicator,” which is computed as a weighted average aggregate of primary performance data. One of the main uses of this recently introduced measure appears to be its application in the computation of the final remuneration of an SOE’s management. In particular, the variable part of the management compensation is indicated to be adjusted to the performance of an SOE as measured by the integrated efficiency indicator. Moreover, a weak performance by an SOE (as confirmed by low values of the efficiency indicator) for two quarters in a row may initiate the process of dismissal of a CEO (Government of the Republic of Uzbekistan 2015b). A business plan is another key document that lays out the performance targets of an enterprise and provides a framework for further monitoring of SOEs by the government. In terms of key performance metrics, according to legislation the business plan of a JSC is expected to include targets related to production, profitability, and dividend payouts and the document is approved by the shareholders’ meeting. CEOs report on the performance of an enterprise against business plan targets to the supervisory board on a quarterly basis (Government of the Republic of Uzbekistan 2003b). In addition, on an annual basis CEOs of large SOEs and chairmen of their supervisory boards report to the Cabinet of Ministers on the performance of their SOEs (Government of the Republic of Uzbekistan 2006c). Despite progress in the SOE performance measurement system, disclosure practices of key performance metrics need to improve. The SOE performance reports published by the CMSA on its website include the value of the integrated efficiency indicator for the monitored SOEs but neither each component of this indicator nor

5

A summary of the analysis is available via http://www.csam.uz/Default.aspx?id¼643

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further details (like weights employed by each SOE in the computation) are available. The lack of details about this measure and the absence of a comparable measure for private sector companies prevent a more comprehensive and meaningful analysis being provided. To summarize, key elements of the formal governance structure of SOEs appear to be in place, though more work on their further improvement is needed. Building blocks of the governance structure of SOEs, including a law on joint-stock companies, corporate governance code, and disclosure requirements, exist and basic formal accountability lines between enterprise management, supervisory board, and shareholders appear to be sufficiently determined. With few exceptions, major SOEs have already been incorporated as JSCs. Despite these improvements, further work on improving the efficiency of the formal governance structure is necessary, particularly in terms of increasing the degree of board autonomy, strengthening its professionalism (e.g., by introducing independent board directors), and ensuring full compliance with standards and practices prescribed by the legislation.

5.4.2

Further Governance Mechanisms and Policies

Despite significant progress in introducing a formal SOE governance structure, there exist multiple further governance mechanisms and policies that significantly influence the performance and day-to-day operations of SOEs. Beyond the formal governance structure prescribed by the legislation on joint-stock companies (including state-owned JSCs), there appear to be multiple other mechanisms that allow the government to exert significant direct control over the day-to-day operations of SOEs. These mechanisms influence the production and pricing decisions of SOEs as well as the incentive structure SOE management faces weakening the role of formal corporate governance mechanisms. The bureaucratic rank of CEOs of major SOEs points to the high political weight of these positions and blurred accountability and reporting lines to the supervisory board. Despite the law on joint-stock companies suggesting the status of CEOs or directors as executive managers of an enterprise, the actual role and position of CEOs of particularly large SOEs appear to be more extensive. For instance, the position of a CEO in a number of major SOEs, including Uzavtosanoat JSC, Uzbekneftegas JSC (and its major subsidiaries), Uzbekenergo JSC, Uzagroteksanoatholding JSC, and Uzbekoziqovqatholding Holding Company, is formally indicated to be equivalent to the rank of either a minister or first deputy minister. The position of a deputy CEO in these enterprises has the rank of a deputy minister (Government of the Republic of Uzbekistan 2004a, 2006d; 2001; 2016a, b). This suggests that many large SOEs, despite corporatization and the introduction of modern corporate governance mechanisms and structures, continue to play a role equivalent to that of sector ministries or associations. The assignment of the rank of a minister or a deputy minister to executive management and the resulting blurring of accountability and reporting lines also undermines the role of supervisory boards in

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these enterprises. The government has recently indicated its plan to discontinue this practice, which, when fully implemented, should contribute to improving the accountability and reporting lines of CEOs of major SOEs. The degree of autonomy of SOEs and their supervisory boards, especially in large SOEs, in determining strategic and operational decisions appears to be constrained. This is primarily due to the fact that key aspects of SOE operations, including capital investments, production, pricing, purchase of inputs, and exporting, appear to be significantly shaped by government decrees and resolutions. One of the state documents that strongly influences the operations of major SOEs is a state investment program. State investment programs are important planning documents that are used to coordinate the work of ministries, state agencies, and SOEs around major capital investment projects, specify sources of their financing, indicate specific targets set for each agency or organization carrying out the project, and provide a framework for monitoring the delivery and performance. When it comes to large SOEs, investment programs include investment projects SOEs are expected to carry out (including projects that are financed using internal funds), sources of their financing, and target outcomes. Related bylaws commonly specify additional targeted benefits, tax breaks, and other support measures provided specifically to an investment project to facilitate its implementation. Investment programs are approved on an annual basis and commonly cover projects intended to be implemented during the following 3 years. This investment monitoring and control system has undergone some revision in 2018 but core components of the framework appear to have remained the same (Government of the Republic of Uzbekistan 2017c). Many SOEs have also been strongly affected by the degree of government intervention in pricing decisions of goods they produce. These interventions have commonly been carried out through subjecting certain goods and services to price and distribution controls due to them being classified as being of strategic importance or the producer of these goods and services being designated as having a significant market power. In particular, the list of enterprises that are, or have recently been, subject to some form of price regulation appears significant. For instance, the list of enterprises that have been subject to price regulation (either due to being involved in the production of strategic goods and services or due to having a dominant position in a market) includes 280 joint-stock companies and other enterprises, including those that are subsidiaries of over 15 major industrial SOEs (Government of the Republic of Uzbekistan 2016c). A number of goods themselves are separately indicated as being of strategic importance, which makes them subject to price control regulation. In addition to goods that have traditionally been subject to some form of government control (e.g., electricity), the list of goods of strategic importance has commonly included natural gas, petrol and other fuels, coal, fertilizers, cotton, metals, construction materials (roof slates), and others. The Ministry of Finance is a key authority responsible for setting or approving prices, though legislation explicitly allows for the possibility that prices can also be regulated and set by other government agencies and regional authorities (Government of the Republic of Uzbekistan 2004b, 2017d). The government has recently

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started to gradually dismantle this system by introducing market-based pricing mechanisms and reducing the number of goods designated as strategic. Government influence on SOEs has been prominent not only through pricing decisions but also through its practice of allocation of key goods across different types of consumers. The allocation of a number of goods produced by major SOEs has traditionally been subject to strict government control and allocation requirements as well. In particular, the Ministry of Economy, with input from relevant SOEs and ministries, annually produces so-called “material balances” (supply-anduse balances) to forecast the supply of certain types of goods for the following year and to determine how these goods will be redistributed across key types of consumers (government, SOEs, private sector, export, and others) (Government of the Republic of Uzbekistan 2004b). Material balances have commonly prepared for a number of goods, including natural gas, oil and other fuels, electricity, coal, metals and certain metal products, fertilizers, wheat, cotton, and others (Government of the Republic of Uzbekistan 2006e). Goods for public sector needs (including for SOEs) are commonly supplied at regulated prices, while the price of the share of goods made available through the commodity exchange is determined as a result of exchange trades. The lack of publicly available information on approved material balances prevents estimation of the share of the annual supply of such regulated goods allocated through government-directed channels and, equivalently, the share made available through market mechanisms. The net effect of this policy on SOEs is also hard to estimate. On the one hand, many SOEs benefit from guaranteed access to key inputs at regulated prices, but on the other hand, the policy likely significantly restricts the opportunities for suppliers of these goods to exploit market opportunities, either in domestic or foreign markets, and compresses their profitability. Practices related to government-directed allocation of key goods and control of their prices started to undergo significant changes in 2018. A decree approved in November 2017 has introduced several important changes to these systems of price controls and allocation of goods in the economy (Government of the Republic of Uzbekistan 2017d). In particular, the decree indicated that starting from January 2018, over 20 types of goods, including fuel, metal products, cement, fertilizers, agricultural seeds, and others, were to be allocated by their suppliers through commodity exchange only. These reform initiatives suggest that many SOEs in the coming years will gradually start being exposed to prices for key inputs that more adequately reflect their scarcity and latent demand from competing consumers (e.g., the private sector). Some SOEs are additionally subject to significant control of their finances. Mechanisms of direct control of financial flows have been in use in a number of SOEs as well. For instance, the Ministry of Finance uses a specialized unit of financial inspectors, who are commonly deployed on-site within selected subsidiaries of Uzbekneftegaz JSC, an oil and gas company, and Uzpakhtayog JSC, an edible oil producer, as well as state-owned and private sector producers of alcoholic products. The primary responsibility of financial inspectors within these enterprises is day-to-day monitoring of their operations and finances to ensure correct

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computation and timely payment of taxes, compliance with contract obligations, and prevention of fraud (Government of the Republic of Uzbekistan 1996b, 1998, 2004c, 2017e). A specific mechanism of allocation of revenues may be explicitly prescribed for some SOEs too. For example, uses of revenues by a number of subsidiaries of Uzbekenergo JSC, and Uztransgaz JSC (revenues from the sale of electricity and natural gas, respectively) are explicitly prescribed by government resolutions (Government of the Republic of Uzbekistan 2017f). Direct governance mechanisms employed by the government provide tools for channeling SOE operations towards achieving its industrial policy objectives but likely at the expense of the efficiency of SOEs and their ability to respond to market signals. Moreover, these measures weaken the role of recently introduced formal corporate governance mechanisms (dual board structure following corporatization, disclosure requirements, use of performance KPIs), which, in essence, prioritize clear accountability lines and enterprise efficiency. The existence of a range of governance mechanisms beyond those prescribed by the formal governance structure likely restricts the ability of SOEs to flexibly use their resources and effectively react to market signals, including price movements or changes in the composition of demand. Strengthening the role of supervisory boards will require further reforms aimed at increasing their autonomy, phasing out direct control mechanisms, and clarifying better accountability lines of CEOs of major SOEs. The latter, in particular, will require prioritization of accountability lines of the management to the supervisory board and not, for instance, directly to the executive branch of the government. Such reforms should also be supported by efforts to improve board professionalism, including by considering the introduction of independent board directors to major SOEs.

5.5

Conclusions and Recommendations

There appear to be a number of overarching issues related to economic weight and the governance of SOEs in Uzbekistan, including: (i) determining the optimal degree of presence of SOEs in the economy and reducing the degree of interference of the government in their day-to-day operations; (ii) improving the overall governance structure of the SOE sector including by separating regulatory from ownership and management functions observed in major SOEs; (iii) strengthening the corporate governance mechanisms to create clear accountability lines of SOE management to the board and improve board autonomy and effectiveness; and (iv) exposing SOEs to competitive pressure from domestic and foreign private sector players and creating a level playing field between SOEs and private sector enterprises. Nevertheless, due to the Uzbek government’s view of SOEs as being a key tool for implementing its industrial policy objectives, it will likely resort to a gradual and cautious approach to reforming the SOE sector. The degree of presence of the state and SOEs in the economy needs to be critically assessed. The scope of sectors indicated to be of strategic importance

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appears very wide and covers almost all industrial sectors. In this respect, a review of the degree of presence of SOEs in sectors of the economy should be initiated and a strategy for material reduction of their footprint should be developed, especially if there is sufficient evidence that the industrial policy objectives of the government can also be achieved under private ownership of enterprises and effective sector regulation. This primarily concerns SOEs operating in potentially competitive sectors. In addition, the government’s portfolio includes a large number of enterprises and consolidating its portfolio will help concentrate its efforts specifically on those sectors, where market failures are large and there is no feasible alternative to dominant state ownership. The introduction of effective monitoring frameworks as well as improvements of the quality and quantity of available data on SOEs are equally important. Related to the issue above is the pervasiveness of direct control mechanisms and limited use of regulatory mechanisms to govern sectors. Thus, effective regulatory mechanisms need to be introduced and regulators that are independent from major SOEs need to be created. The practice of granting supervisory and regulatory functions to existing SOEs should be re-examined and phased out (and recent efforts to achieve this should be continued). A number of large SOEs are also members of commissions responsible for the issuance of licenses to new sector entrants. This practice should be re-examined too in view of a significant conflict this arrangement generates. An appropriate regulatory framework independent from large SOEs is necessary and vital for the successful performance of privatized enterprises and other private sector companies. Accountability lines of SOE management require clarity. The accountability lines for some CEOs, especially those of large SOEs, are not clear-cut. As discussed earlier, positions on management boards of large SOEs have been commonly equalized to the rank of ministers or deputy ministers, which makes them also directly accountable to, and part of, the Cabinet of Ministers. This technically weakens the role of supervisory boards, albeit currently formal, in terms of their ability to hold CEOs accountable and perform efficiently. Recent efforts to reform such arrangements should be completed. Board autonomy should be strengthened. The existence of highly prescriptive and closely monitored state investment and development programs limits boards’ potential ability to fully define companies’ investment and development strategy. The existence of government-determined and highly prescriptive resource allocation and price control mechanisms (though being phased out gradually) with respect to a number of goods also restricts the ability of some boards to influence marketing, sales, and export strategies. Board autonomy is likely curtailed further due to the fact that SOE boards commonly consist of only acting public officials and the institution of independent directors is in nascent stage. Most of these practices need to be re-examined to strengthen the professionalism of boards and to introduce a sufficient degree of autonomy in their decision-making. Phasing out direct SOE control mechanisms is critical. A related issue is the presence of an array of direct control mechanisms over day-to-day operations of SOEs. These range from the deployment of full-time financial inspectors within

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selected enterprises and directives on specific allocation of revenues in a number of sectors (oil and gas, energy) to detailed SOE-specific directives on reducing the intensity of use of various resources. The use of such mechanisms by the government not only contributes to further uncertainty over formal accountability lines of SOE management to its board but also limits its ability to efficiently respond to changes in external conditions and exert effective control over its assets. The SOE performance-monitoring system should prioritize SOE efficiency and its degree of transparency should be improved. The presence of a number of recurring government decrees and programs influencing SOE operations and performance (state investment and sector development programs, annual production and supply targets, localization programs, and recurring cost-cutting initiatives) appears to result in a wide range of quantitative targets imposed on SOEs. In such an environment, the new system of monitoring the performance of SOEs introduced in 2015 will likely not be able to fully shift the set of incentives SOE management faces, in particular from the traditional objective of achieving quantitative production targets to the goal of increasing and maintaining the economic efficiency of an enterprise. Comprehensive SOE evaluation methods, along the lines of the approach discussed in Taghizadeh-Hesary et al. (2019), should be considered as well. A level playing field with the private sector should be created. The degree of influence of market forces and market signals on SOEs has likely been significantly muted. This is mainly the result of SOEs commonly having preferential access to key resources, including foreign exchange (at a significantly appreciated rate until 2017), energy, and other key inputs and subsidized financing. The fact that investment and sector development programs are commonly supported by an extensive set of narrowly targeted tax breaks, custom duty reliefs, and similar measures puts SOEs involved in these programs in a significantly better competitive position than other private sector players. Creating a vibrant private sector and providing it with opportunities to expand will require elimination of such distortive practices and effective exposure of SOEs to competitive pressure from the private sector. The scope of future privatization programs should be gradually expanded as this appears to have substantially narrowed during the past decade. The government should reconsider its approach to privatization and consider expanding the scope of future programs. Analysis of the reasons for the failure of past ambitious privatization initiatives should also help adequately design future programs and increase the likelihood of their success. In this respect, recent simplifications of the privatization process introduced by the government, including granting the power to authorize small-scale privatizations to local authorities, are commendable.

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resources, strengthening the payment discipline, reduction of account receivables and payables”. Available via http://lex.uz/pages/getpage.aspx?lact_id¼3409606 Government of the Republic of Uzbekistan. (2017e). Decree of the Cabinet of Ministers No. 870 “On approval of the statute of Department of Financial Control of the Ministry of Finance”. Available via http://www.lex.uz/pages/getpage.aspx?lact_id¼3392654 Government of the Republic of Uzbekistan. (2017f). Resolution of the Ministry of Finance No. 2017-33. Available at http://lex.uz/pages/getpage.aspx?lact_id¼3278445 Lieberman, I. W., Nestor, S. S., & Desai, R. M. (1997). Between state and market: Mass privatization in transition economies. Washington, DC: The World Bank. Richmond, C., Benedek, D., Cabezon, E., Cegar, B., Dohlman, P., Hassine, M., Jajko, B., Kopyrski, P., Markevych, M., Miniane, J., & Parodi, F. (2019). Reassessing the role of state-owned enterprises in central, eastern and southeastern Europe (IMF Departmental Papers/Policy Papers19/11). Washington, DC: International Monetary Fund. State Committee for Statistics. (2018). Statistical review of the Republic of Uzbekistan, January– December 2017. The State Committee for Statistics of the Republic of Uzbekistan. State Committee for Support of Privatized Enterprises. (2017). Concept of the development of the secondary stock market in Uzbekistan in 2017–2018. Available via http://www.research-center. uz/info/concept/. Taghizadeh-Hesary, F., Yoshino, N., Kim, C. J., & Mortha, A. (2019) A comprehensive evaluation framework on the economic performance of state-owned enterprises (ADBI Working Paper 949). Tokyo: Asian Development Bank Institute. Available: https://www.adb.org/publications/ comprehensive-evaluation-framework-economic-performance-state-owned-enterprises.

Part II

Privatization: Challenges and Solutions

Chapter 6

The Effects of Privatization and Corporate Governance of SOEs in Transition Economies: The Case of Kazakhstan Keun Jung Lee

6.1

Introduction

This paper focuses on the relationship between corporate governance structure and privatized state-owned enterprises (SOEs) as a way to reform SOEs in a transition economy, using the experience of Central Asia as a case study. Companies around the world conduct initial public offerings (IPOs) to reform SOEs and to improve the liquidity of private companies. However, going public is an expensive process. In addition, public companies are always in the public eye and have to comply with certain regulatory requirements. Mourdoukoutas and Stefanidis (2009) argue that “sharing ownership with outside investors through an IPO has advantages and disadvantages that create dilemmas for company founders” (p. 125). However, the advantages of listing on the stock exchange are usually so great that they outweigh any disadvantages. First, the company gets more access to funds because it is getting the right to raise additional capital and to use alternative financing on favorable terms provided by private investors. Second, it increases the liquidity and diversification of equity and currency (IPO leaders of EY 2018). Moreover, the company’s prestige, brand awareness, reputation, and trust from customers also increase. Typically, the image of public companies is more favourable in comparison to private firms, which is particularly important for those industries that need reliable long-term collaboration between customers and suppliers. Furthermore, the public disclosure and circulation of securities on the stock markets creates national channels for marketing the company and its trademarks. Therefore, IPOs increase the value of the business and investors are willing to pay a premium for liquidity, that is, the ability to buy or sell shares easily. In contrast to

K. J. Lee (*) Bang College Business, KIMEP University, Almaty, Kazakhstan e-mail: [email protected] © Asian Development Bank Institute 2021 F. Taghizadeh-Hesary et al. (eds.), Reforming State-Owned Enterprises in Asia, ADB Institute Series on Development Economics, https://doi.org/10.1007/978-981-15-8574-6_6

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public firms, private companies have limited liquidity or do not have it at all (Brigham and Ehrhardt 2010). The main advantage of the IPO is that the company is not obliged to return capital which was raised from investors. However, Brzeszczynski (2012) emphasizes the major drawbacks of this type of investment. One of these disadvantages is that the new shareholders have a right to a portion of future profits as dividends. Furthermore, new participants dilute the ownership structure of the company. Thus, there is a risk of losing control over the firm (Mourdoukoutas and Stefanidis 2009). Governments in transition and emerging economies have been concerned with whether the privatization of SOEs can improve firm performance through different types of transactions (e.g., direct sale, share issue, restitution, and mass voucher; (Megginson and Netter 2001). Currently in Kazakhstan, within the framework of a forced industrial and innovative development of the economy, the problems of increasing and making effective use of the domestic financial resources are becoming more urgent. The former President of Kazakhstan, Nursultan Nazarbayev, addressed the reform of SOEs as follows: (primeminister.kz, 31 January 2017). 1. The reform of SOEs involves their transfer to the private sector or the elimination of all state-owned enterprises and organizations that do not conform to these principles by 2020. And this involves several thousand enterprises. It is critical to ensure privatization’s transparency and efficiency. There is also a need to reconsider the role of state holdings. 2. The government is tasked to provide a qualitative transformation of “SamrukKazyna” holding. It is necessary to conduct a thorough audit and optimization of both managerial and production business processes. As a result, it shall become a highly efficient, compact, and professional business/enterprise. Management and corporate governance need to be improved to international level. Therefore, this research examines the effects of privatization (i.e., IPO) and corporate governance of SOEs on firm performance in Kazakhstan corporations. In the case of Kazakhstan, the government has the dilemma of deciding what percentage of government ownership or sovereign wealth fund ownership will remain in the privatization of SOEs in order to improve social welfare and firm performance. This is the method they want to use another type of privatization conducted through the selling of controlling shares of publicly listed SOEs to private enterprises. Control privatization empowers the new controlling shareholders to influence the privatized firms and allow us to delve deeper into the mechanisms (e.g., reducing large shareholder expropriation, enhancing management incentives, and controlling employment levels) through which privatization may affect firm performance. It is important to mention that although privatization is a possible policy measure, SOE reforms without privatization and with control privatization are also possible, depending on the specific situation. Thus, the main objective of this study is to analyze perspectives of the IPO program to reform SOEs through privatization in Kazakhstan. In particular, this paper investigates the relationship between corporate governance and financial performance after privatization to determine whether privatization as a method of

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reforming SOEs is successful. The analysis helps to answer the main question: is the IPO program of interest to the public, finance institutions and policy makers and does it meet its objectives assigned to it?

6.2 6.2.1

SOEs, IPOs, and the Financial Market in Kazakhstan Sovereign Wealth Fund (SWF) for SOEs Samruk-Kazyna

Kazyna Holding or their affiliates Samruk-Kazyna is a national welfare fund for the management of the state assets of Kazakhstan. It is under the control of the government, established to improve the competitiveness and sustainability of the Kazakhstan economy and in anticipation of negative factors that may influence changes in world markets and economic growth in Kazakhstan. The key purpose of Samruk-Kazyna is to manage shares (interests) of national development institutions, national companies, and other legal entities it owns in order to maximize their long-term value and competitiveness in the world markets.1 To achieve this goal, the Sovereign Wealth Fund (SWF) supports the modernization and diversification of the economy as one of the three strategic directions, by active investments, particularly in the following segments. Given the main strategy of the SWF and its activities, it can be suggested that SWF Samruk-Kazyna is dedicated to stabilizing and diversifying the economy, with considerable domestic portfolio investments. In 2016, Samruk-Kazyna comprised 50–80% of Kazakhstan’s GDP. Additionally, oil and gas production was 25% of Kazakhstan’s GDP, export was 72% and the national budget was equal to 40%. The national fund of Kazakhstan gets high percentages from saving fund portfolio which is 75% and 25% from stability fund. Samruk-Kazyna is one of the youngest SWFs, ranking in 15th place of total assets all over the world ($77.5 billion assets) (Fig. 6.1).

6.2.2

Overview of IPOs and the Financial Market

An IPO is intended to raise long-term funds for the real sector of the economy, especially in the industrial sector. Another important function of IPOs is to develop

The National Welfare Fund “Samruk -Kazyna” was established by merging the joint stock companies of the Sustainable Development Fund “Kazyna” and the Kazakhstan Holding for Management of State Assets “Samruk” in accordance with the decree of the President of Kazakhstan, Nursultan Nazarbayev on 13 October 2008. From 2012, in connection with changes in the legislation of Kazakhstan, the name was changed to JSC “Samruk
Kazyna” (http://www.sk.kz). 1

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Fig. 6.1 Structure of the SWF in Kazakhstan. (Source: Samruk-Kazyna, http://www.sk.kz)

and increase the capitalization of the stock market. Conducting IPOs is the main condition of financial market development, increasing its liquidity and capitalization, stock trading volume; and the number of traded instruments. IPOs and privatization are also methods of redistributing capital within the economy, which stimulates the economy (Ritter 1998). The growing activity of Kazakh issuers on national and international financial markets is quite natural. Traditional sources of financing such as debt, equity, and budget have been depleted in recent years. Domestic companies are still undervalued and interested in getting an adequate valuation by the market. Moreover, the growth of the economy of Kazakhstan, the qualitatively new level of development of more than 7% of the annual growth of GDP, and corporate earnings allow them to use the IPO as an effective mechanism to attract investment more actively The development of the market can be divided into six main stages. Stage 1 2 The Beginning of Privatization (1991–1994) This stage can be characterized by a lack of conceptual approaches to the issue and the conversion and issuance of securities on the basis of established rules, as well as by mass privatization (Azhikhanov 2010). First, there were joint-stock companies with Kazakhstan’s first securities in history which wereon the wave of the social upswing caused by the process of democratization in 1991. In 1991, a law titled “On the conversion of securities and the stock exchange in the Kazakh SSR” was enacted, and the government introduced the “Regulations of the securities market” developed by the Ministry of Finance. Registration, issuance and circulation of securities were regulated by the first provisional rules in 1992 and then by the “Regulations on the rules of issuing and registration of securities of the companies and investment funds.”

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Stage 2 2 Formation (1995–1998) During this stage, several changes were implemented: improvement of the legal framework and market infrastructure; termination of mutual funds; growth of the stock market; the creation of infrastructure organizations; approval and implementation of the state program of development of the securities market in the years 1996–1998; and the beginning of pension reform. The government began to understand the important role of the securities market in the economy, but the process of privatization did not provide the expected budget revenues. The government, being the largest owner, prepared a plan to enter the securities market. Stage 3 – Development of Financial Market (1999–2004) In this stage, we can see further improvements to the legal framework, the emergence of new investors in the form of private pension funds, insurance companies and mutual funds; a growing number of types of securities,; issuance of municipal bonds; and activation of the segment of nongovernment corporate securities. The stock exchange market of corporate bonds was started in 1999, with the first listed on the Exchange on 1 February. Exchange sector repo transactions on government securities were also started in the same year, along with an organized secondary market of sovereign Eurobonds of Kazakhstan formed by the National Commission of Kazakhstan on securities. The first auction on these Eurobonds was held in the KASE on 19 October 1998. The law on the Securities Market, which regulates the activity of KASE, was put into force. There was a significant increase in the capacity of Kazakhstan’s securities market for the period from 2000 to 2004 (Azhikhanov 2010). Stage 4 2 The Starting of IPOs (2005–2007) The practice of initial public offerings for Kazakhstan firms was at its most popular in this period (Appendix 1). Large local companies and banks, such as the ENRC, KazMunaiGas, Kazakhmys, Alliance Bank, Halyk Bank, KazakhAltyn, and Kazkommertsbank entered the stock market from 2005 until 2008. The increasing activity of Kazakh issuers on national and international financial markets makes sense. As a result of ongoing economic reforms in Kazakhstan, a certain legal, economic, and organizational basis for the development of the domestic market for the IPOs has developed. At the same time the formation and development of the IPO market in Kazakhstan took place gradually with growing volume of transactions, new market participants and improvements in the legislation (Waters n.d.). Stage 5 2 The People’s IPO (2008–2014) This stage can be characterized by the development of the stock market during the financial crisis. The creation of the “Joint Action Plan of the Government, the National Bank of Kazakhstan and the Agency” to stabilize the economy and financial system for 2009–2010 included actions and procedures to develop the securities market. Under this policy, at the XIII Congress of the People’s Democratic Party, “Nur Otan” in February 2011, President Nursultan Nazarbaev announced “The People’s IPO” program—the offering of shares of the largest Kazakh companies to the population—which it was hoped would have a powerful impact on the

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development of the economy. The IPO mechanism (to be more precise, state-owned enterprises [SOEs] to the public) was introduced. In particular, as an official statement of the government, the People’s IPO was adopted in February 2011. It was intended to provide citizens with the chance to buy shares in the country’s major enterprises; to create a new tool for investing and augmenting personal savings, further developing the stock market; and to increase/improve businesses by offering additional funding in their pursuit of successful investment plans. The People’s IPO involved offering the public stakes in some of the companies of Samruk-Kazyna Holding. The People’s IPO campaign was planned to continue until 2015, and KazTransOil was the first company to float its shares when it was listed in autumn 2012. Stage 6 2 The Reform of SOEs through IPO (2015–2020) By 2020, the share of state ownership should be reduced to the level of other OECD countries (i.e., 15% of GDP). This reduction should give a new impetus to economic growth. By 2020, the private sector will be the main generator of economic growth and the share of state participation in the economy will be no more than 15% in gross value added. On 3 March 2016, during the session of the State Commission on the issues of modernizing the economy, the decision was taken to create the Delivery Offices under the Ministry of Finance of Kazakhstan, the joint-stock companies (JSC) Samruk-Kazyna, Baiterek, and KazAgro. There were eight sessions of the State Commission on the Issues of Modernization of the Economy concerning Privatization. The Privatization Plan for 2016–2020 (the Resolution of the Government of Kazakhstan of 30 December 2015 No. 1141) was to develop the draft concept of the law “On the Introduction of Changes and Amendments to Certain Legislative Acts on the Issues of Reforming the Structure of State Ownership.” The national welfare fund, which is the sole shareholder of the Samruk-Kazyna company, offered to acquire 15% of the total number of shares issued by the company. According to the current legislation, at least 20% of the total securities offer should be offered in Kazakhstan. The Astana International Exchange (AIX) of the Astana International Financial Center will be offered both common shares and global depository receipts (GDRs) in accordance with the rules and regulations. Nevertheless, for the Samruck-Kazyna Fund and government, an important aspect is getting the highest possible selling price, which, in fact, requires a double listing in both London and Astana. To achieve this goal without the help of the international capital markets is impossible. In 2018, Kazaktomprom, the world’s largest uranium producer, was floated in the first listing of a large Kazakh state company in more than a decade. However, Kazakhstan has deferred an IPO of the national oil firm KazmunayGaz to beyond 2019, partly due to a tepid investor appetite for stock offerings, uncertainty about Brexit, political tensions, and a global economic slowdown, topped off by the trade war between the United States (US) and the People’s Republic of China and sanctions against Iran and the Russian Federation (8 Feb 2019, Reuters).

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6.3

119

Literature Review

Phi et al. (2019) examine whether ownership identity is related to firm performance in terms of profitability and solvency. Public firms are less efficient than private firms, at least in terms of profitability. Cross-sectional comparisons also show that government firms tend to be more labor-intensive and have a higher labor cost than nongovernment ones. They suggest that privatization could be considered a driver for firm efficiency. Privatization as a policy could motivate private and public firms to cope with future changes in economic systems and encourage SOEs to shift their management toward maximizing profitability and efficiency in order to survive. Taghizadeh-Hesary et al. (2019) show that solvency, per capita costs, and per employee productivity have more deterministic power over the success or failure of SOEs than profitability. While profit making is important for SOEs, focusing on profitability as the sole assessment criterion will mislead policy makers, bearing in mind that the nature of many SOEs is to generate social welfare and not profit. In addition, it is widely argued that companies with a good corporate governance system have better financial performance in comparison to other firms. Several studies have been conducted in different economically developed and emerging countries (Wang 2005; Wu 2010) to examine the relationship between corporate governance and firm performance. Previous studies have mainly concentrated on share issue privatization. The evolution of ownership concentration after privatization and its antecedents are also documented in prior studies. Boubakri et al. (2011) show that private ownership concentration grows over time after privatization, as does firm performance. This is particularly the case in countries with weaker investor protection. They also find that cross-section differences in ownership concentration can be accounted for by firm size and growth, industry affiliation, privatization method, and level of institutional development. Although there are some studies on control privatization published in the People’s Republic of China (Zeng 2004; Fang et al. 2006; Dai 2007), they mainly focus on pre-and post-privatization performance comparison, use small and mixed samples (including three types of control transfer), and have little involvement with changes in incentives. Firm performance improvement after privatization is better in fully rather than partially privatized firms (Fang et al. 2006; Dai 2007). The board of directors is an important internal corporate governance mechanism. Changes in ownership structure, for example after going public, are usually accompanied by changes in the composition of the board of directors. These changes play a significant role for the Chinese firms because any changes in ownership structure lead to a reduction of the government’s influence on the corporate governance of the company (Li et al. 2011). The empirical studies of large public companies have shown a negative correlation between the size of the board and company performance (O’Connell and Cramer 2010). Since a small board size (BS) is documented in the literature as being more effective in monitoring corporate decisions (Yermack 1996), we expect a positive relationship between BS and overinvestment.

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According to Yu (2008), the CEO plays an important role in the corporate governance system. However, empirical tests show that CEO duality has not only a positive but also a negative impact on firms’ performance. So, by using multiple theories, we examine the relations of leadership structure, ownership structure, agency control mechanisms and agency problems with firm performance (Al-Matari et al. 2012). Board independence is reflected by the percentage of independent directors serving on the board. A higher percentage of independent directors reduces the agency problem stemming from the conflict of interest between shareholders and board members who are also insiders. Unfortunately, underdevelopment of the domestic market and a lack of the necessary financial resources do not allow for large company and lead to the fact that most national issuers prefer to be placed abroad. Most of Kazakhstan’s largest companies choose to list on the LSE rather than the KASE because they seek access to international investors in the fields of banking, natural resources, and real estate. The largest proportion of IPOs come to resource industries such as metals and mining and oil and gas. For Kazakhstan, this is an explainable trend as the economy of the country is based on importing and exporting in the natural resources industry. As Appendix 1 shows, 9 IPOs traded on the LSE in GDRs,2 9 IPOs on the alternative investment market (AIM)3 and 3 in the US and the Russian Federation. This brief literature review has shown that, although progress has been made in our understanding of how firm age, firm size, board size, CEO duality, leverage, IPO, and ownership concentration affect financial performance (return of asset (ROA) and return of equity (ROE)), there are still many opportunities to improve our perception of how a firm’s behavior changes under the influence of these factors (List of definitions of the variables is available in Table 6.1). The hypotheses below are suggested based on the review of the literature: H1: H2: H3: H4: H5:

There is a significant relationship between IPO and financial performance. There is a significant relationship between ownership concentration and financial performance. There is a significant relationship between board size and financial performance. There is a significant relationship between CEO duality and financial performance. There is a significant relationship between independent directors and the financial performance.

2 Global Depository Receipts (GDRs) are negotiable certificates issued by depository banks, which represent ownership of a given number of a company’s shares, which can be listed and traded independently from the underlying shares. 3 AIM is a submarket that allows smaller firms to float shares with a more flexible regulatory system than is applicable to the main market.

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Table 6.1 List of definitions of variables Variable definition Board size

Variable abbreviation BS

Independent directors CEO duality

ID

Institutional ownership Government ownership Managerial ownership Firm age Firm size Return on equity Return on assets

DUAL IN GO

Variable measurement The total number of directors sitting on the board at the shareholders’ annual meeting The total number of nonexecutive directors or independent directors A dummy variable that takes on 1 if the CEO is also the chairman of the board and 0 otherwise Percentage of equity owned by institutions

MO

Percentage of equity owned by government or sovereign wealth fund Percentage of equity owned by CEO and executive directors

AGE SIZE ROE

Years since establishment Total assets Net income divided by total equity

ROA

Net income divided by total assets

Source: Compiled by author

6.4 6.4.1

Sample and Methodology Sample

This study uses a sample of 21 IPOs of Kazakhstan SOEs listed on the AIM Markets and the LSE in the United Kingdom during the period from 2004 to 2017. Corporate governance and most variables used for this study have been manually collected from the annual reports of the firms. The data contain 536 observations of a listed non-financial companies on the KASE and LSE, including board size, proportion of nonexecutive directors (or independent directors), CEO/chair duality, institution ownership, government shareholding, and managerial ownership.

6.4.2

Methodology

This study investigates the performance of SOEs after IPO on the international financial market (i.e., LSE) to analyze the structure of ownership structure, corporate governance, and factors affecting companies’ performance in comparison to non-financial firms in KASE. The statistical analysis used fixed effects methods to investigate within the dummy variables industry and year. The use of fixed effects is

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to capture the unobservable variables and the correlation between unobservables and observables. ROAit ¼ α0 þ α1 ðBSÞit þ α2 ðIDÞit þ α3 ðDUALÞit þ α4 ðIN Þit þ α5 ðGOÞit þ α6 ðMOÞit þ α7 ðYear Þ þ α7 ðSIZEÞ þ εt ,

ð6:1Þ

ROE it ¼ α0 þ α1 ðBSÞit þ α2 ðIDÞit þ α3 ðDUALÞit þ α4 ðIN Þit þ α5 ðGOÞit þ α6 ðMOÞit þ α7 ðYear Þ þ α7 ðSIZE Þ þ εt ,

ð6:2Þ

The corporate governance variables are board size (BS), proportion of nonexecutive directors or independent directors (ID), CEO/chair duality (DUAL). Institutional ownership (IN) and government ownership (GO). Managerial ownership (MO). The results will be controlled for firm years (YEAR), firm size (SIZE), year dummy and industry dummy. Table 6.1 presents the variables with their abbreviations and definitions.

6.5

Analysis and Findings

The first result of the investigation into this model is the descriptive statistics of the IPOs of Kazakhstani SOEs on the LSE shown in Table 6.2. The second result is the descriptive statistics of the Kazakhstani companies listed on the KASE in Table 6.3, and the third result is the multivariate regression analysis, shown in Table 6.4. Table 6.2 shows the descriptive statistics of the main variables in the IPO of Kazakhstani SOEs listed on the LSE. The mean ROA is
7% while the mean ROE is 45.6%. The corporate of governance of variables show that board size (BS) the largest number of board members is 15, with a mean BS of 6.6. The mean of independent directors (IDs) is 1.9. Managerial ownership (MO) is approximately 48%; government ownership (GO) is more than 25%; and institutional ownership (IN) is 35%. Table 6.3 reports the descriptive statistics of the main variables in Kazakhstani companies listed on the KASE. The mean ROA is 11.4% while the mean ROE is 13.4%. The corporate of governance of variables show that the BS in Kazakh listed companies has a maximum of 11 board members awhile the smallest BS is 2 (which is the statutory lower limit for a public company). Independent directors (ID) constitute an average of 25% of boards, which is a fairly good representation for Kazakh companies. Managerial ownership (MO) is approximately 45%, which is significantly high in the companies that represent retail business and significantly low in the oil and gas sectors and communication industries. Government ownership (GO) is more than 50% and institutional ownership (IN) is 35%. Multivariate regression analysis was used to investigate the relationship between corporate governance and company’s financial performance measurements. The results indicate that there is a strongly statistically significant relationship in the

ROA
0.071 0.503 0.003
3.025 3.026 96

ROE 0.456 4.776 0.0410
5.350 45.250 96

IN 0.350 2.015 0.290 0.17 0.460 96

GO 0.253 2.147 0.203 0.170 0.350 96

MO 0.485 0.434 0.350 0.000 0.690 96

ID 1.93 0.2335 1.000 1.000 3.000 96

DUAL 0.190 0.450 0.000 0.000 1.000 96

BS 6.630 2.175 7.000 3.000 15.000 96

SIZE 2168.30 3590.42 160.00 13.000 12,410 96

AGE 11.854 5.353 12.000 5.000 21.000 96

Source: Compiled by author AGE age of the company, BS board size, DUAL CEO duality, GO government ownership, ID independent directors, IN institutional ownership, MO managerial ownership, ROA return on assets, ROE return on equity, SIZE total assets

Variables Mean SD Median Min. Max. No. firms

Table 6.2 The descriptive statistics of Kazakhstani companies listed on the LSE

6 The Effects of Privatization and Corporate Governance of SOEs in Transition. . . 123

ROA 0.114 0.350 0.030
0.380 11.680 440

ROE 0.134 0.208 0.090 0.024 9.770 440

IN 0.353 0.450 0.209 0.024 5.007 440

GO 0.503 0.354 0.580 0.000 1.000 440

MO 0.452 0.650 0.394 0.000 1.000 440

ID 2.350 0.530 3.000 1.000 3.000 440

DUAL 0.2990 0.220 0.250 0.000 6.000 440

BS 6.450 0 7.034 2.000 11.000 440

SIZE 18.20 1.80 18.200 14.810 21.660 440

AGE 15.28 1.520 14.520 1.000 22.000 440

Source: Compiled by author AGE age of the company, BS board size, DUAL CEO duality, GO government ownership, ID independent directors, IN institutional ownership, MO managerial ownership, ROA return on assets, ROE return on equity, SIZE total assets

Variables Mean Std.D Median Min. Max. No. firms

Table 6.3 The descriptive statistic of Kazakhstani companies listed on KASE

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Table 6.4 The corporate performance and corporate governance after IPO Variables GO IN MO ID DUAL BS SIZE AGE Industry dummy Year dummy R-squared Observations

IPO-LSE (1) ROA 0.005 (0.251) 0.255** (1.503) 0.605*** (5.357)
0.034 (
0.187)
0.131 (
1.065)
0.035 (
1.394) 0.001 (0.065) 0.023* (0.666) Yes Yes 0.37 96

IPO-LSE (2) ROE 0.045 (1.005) 0.450*** (2.054) 1.795* (1.664)
0.138 (
0.071)
1.428 (
1.055) 0.039 (0.014)
0.006 (
0.325) 0.004 (0.033) Yes Yes 0.41 96

IPO-KASE (3) ROA 0.020 (0.137) 0.085 (0.460) 0.011 (0.152) 0.020 (0.350) 0.014 (0.219)
0.035 (
0.468) 0.040 (0.598) 0.026** (0.450) Yes Yes 0.37 440

IPO-KASE (4) ROE 0.203 (1.040) 0.343** (1.953) 0.214* (1.975) 0.090 (0.201) 0.094 (1.509)
0.099 (
1.377) 0.048 (0.743) 0.054* (0.045) Yes Yes 0.45 440

Source: Compiled by author AGE age of the company, BS board size, DUAL CEO duality, GO government ownership, ID independent directors, IN institutional ownership, IPO-KASE initial public offering on the Kazakhstani Stock Exchange, IPO-LSE initial public offering on the London Stock Exchange, MO managerial ownership, ROA return on assets, ROE return on equity, SIZE amount of assets Note: ***, **, and * indicate the significance level at the 0.01, 0.05, and 0.1, respectively, based on two-tailed tests

case of ownership structure and no significant relationship between corporate governance variables and firm performance. In Table 6.4 (Model 2), ROE is significantly affected by ownership structure in the relationship between corporate performance and institutional ownership (IN) in the listed Kazakhstani firms on the LSE. This result in Model 2 also indicates a significantly positive relationship between firm performance and managerial ownership (MO). In Table 6.4 (Model 4), ROE is significantly affected by ownership structure in the relationship between corporate performance and corporate governance in the listed Kazakhstani firms on KASE. A 1% increase in institutional ownership will lead to a 34.3% increase in ROE. This may be due to the fact that institutional ownership provides more tangible assets on the balance sheet, meaning more overall assets and thus higher ROE.

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Robust Test

For the H1 test: There is a significant relationship between IPO and financial performance, the event-time approach is used because it measures the post-listing share price behavior. Event-time returns are more important than calendar-time returns due to the following reasons. First, calendar-time returns do not measure investor experience (Barber and Lyon 1997); second, calendar-time returns are generally not correctly specified in random samples (Lyon et al. 1999) and third, calendar-time returns have low power (Loughran and Ritter 2002). In the event-time approach, the buy and hold return (BHR) is used to measure the long-term market performance after IPO. The advantages of BHR over other performance measures are as follows. Firstly, the monthly portfolio rebalancing assumption may establish a downward bias in the long term in other measurements; and secondly, this may lead to cross-sectional correlation problems. BHR was used to reduce the statistical bias in the measurement of cumulative performance (Conrad and Kaul 1993). Fama (1998) has also argued that BHRs accurately measure long-term returns. BHR is defined as the geometrically compounded return. Geometric mean return is considered better than arithmetic mean return because it avoids negative return problems in long-term returns (Ljungqvist 1997). The return measures were calculated under equally weighted schemes up to 3 years after going public. Therefore, the long-term market performance measures were calculated for three post-listing time periods: year one (12 months); year two (24 months); and year three (36 months). Following Loughran and Ritter (1995) and Nazgul Kondybayeva (2015, the BHR was calculated as follows: Ln½BHRit ¼ α0 þ α1 ðMRÞit þ α2 ðPRIV Þit þ α3 ðINTLRÞit þ α4 ðROE Þit þ α5 ðSIZE Þit þ α6 ðAGE Þit þ εt The explanatory determinants in this study are market return (MR), corporate condition of the company (PRIV), initial return (INTLR), return of equity (ROE), size of the company (SIZE) and age of the company (AGE). These are presented in Table 6.5. The results show that most companies have a negative sign, which means that they underperform in the long term. A few, like Orsu Metals, KazMunaiGas, Nostrun Oil & Gas, and Central Asia Metals, have a positive performance in the long-term market, with both short-term (first 3 trading days cumulative abnormal returns) and long-term returns. The short-term performance was evaluated with the initial returns as the independent variable. Table 6.6 shows how the long-term performance can be analyzed by industry. Two companies from the mineral resources sector—Orsu Metals and Central Asia Metals—performed positively in 3 years after going IPO, while Frontier Mining and Kaz Minerals underperformed in the long run. In the oil and gas industry, KazMunaiGas and Nostrum Oil & Gas performed positively, but Max Petroleum

6 The Effects of Privatization and Corporate Governance of SOEs in Transition. . .

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Table 6.5 Summary of independent variables Independent variables Market return

Variable in the model MR

Corporate condition Initial return

PRIV

Return on equity Company size

ROE

Company age

AGE

INTLR

SIZE

Variable measure Post-day market return calculated based on FTSE 100 index for the same sample period Takes the value 1 if partially or fully owned by the state before IPO, value 0 if fully private company Calculated using the cumulative abnormal return (CAR) for the first trading day Shows the operational profitability of the company. Calculated from the financial reports of the companies The size of the IPO company calculated as the logarithm of total assets at the end of the year preceding the IPO issuance Number of years between the year of creation and listing

Source: Compiled by author

and Roxi Petroleum had a negative performance. Companies in other industries— Steppe Cement, Chagala Group, Kazakhstan Kagazy—also underperform in the long-term market. The whole picture shows that the most underperforming and overperforming companies were both from the oil and gas industry. In addition, it can be said that metal and mining and oil and gas sector companies are good in longterm market performance. Table 6.7 shows that there is a statistically significant positive association between BHR with market return and ROE. In addition, the empirical results confirm a significant negative association between BHR and initial return. The regression results for the model are discussed in the methodology, where BHR is the dependent variable. The MR affects BHR positively. The MR beta coefficient is 0.439, which means that one unit increase in MR increases BHR by 0.439 units, while other determinants held constant. The statistical significance of MR on BHR is 0.001, which is less than 0.05. This means that MR predicts the effect on ROE with almost 99.9% probability. Last, INTLR affects the BHR negatively. Its beta coefficient is
0.039. This means that a one unit increase in INTLR results in a 0.039 unit decrease in BHR. The statistical significance is quite high. In conclusion, the analysis of the relationship between BHR and independent variables MR and ROE affects the BHR positively for IPO companies. The results show that INTLR has a negative relationship with BHR.

6.6

Conclusion and Recommendation

This study investigated the long-term stock performance of Kazakhstani companies listed on the London Stock Exchange (LSE) and the Kazakhstan Stock Exchange (KASE) in order to determine whether the IPOs of SOEs are underperforming or overperforming in the long term and to identify their determinants of their

Source: Compiled by author

12 13

1 2 3 4 5 6 7 8 9 10 11

IPO Name ORSU, METALS FRONTIER, MINING STEPPE, CEMENT KAZ, MINERALS MAX, PETROLEUM KAZMUNAIGAS KAZKOMMERTSBANK HALYK, BANK CHAGALA, GROUP ROXI, PETROLEUM KAZAKHSTAN, KAGAZY NOSTRUM, OIL&, GAS CENTRALASIA, METALS

Oil and gas Copper and gold

Industry Metal and mining Gold and diamonds Construction material Metal and mining Oil and gas Oil and gas Financial services Financial services Real estate and property development Oil and gas Paper and cardboard

Table 6.6 Buy-and-hold returns for Three Years

LSE LSE’s AIM

Trading Floor LSE’s AIM LSE’s AIM LSE’s AIM LSE LSE’s AIM LSE LSE LSE LSE LSE’s AIM LSE 100 60

Placement Volume (Min. USD) 103 6 21 1365 46 2255 846 748 120 77 273 2008 2010

Year of Placement 2004 2004 2005 2005 2005 2006 2006 2006 2007 2007 2007

0.0389 0.0065

BHR 0.0292
0.0187
0.0112
0.0233 0.0023 0.0135
0.0243
0.0092
0.0210 0.0203
0.0659

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Table 6.7 The long-run performance of Kazakhstani IPOs listed on the LSE

MR AGE PRIV SIZE ROE INTLR R-squared Adjusted R-square

BHR Coefficient (beta) 0.439*** 0.364
0.769 0.356 0.019***
0.039** 0.751 0.701

Std. Error 0.574 0.001 0.009 0.005 0.001 0.016

t-Statistic 3.034 0.124
0.136 1.033 5.232
1.985

Prob. (p- value) 0,001 0,913 0,897 0,329 0,000 0,084

Source: Compiled by author Note: ***, **, and * indicate the significance level at the 0.01, 0.05, and 0.1, respectively, based on two-tailed tests

performance. The results show that return on equity (ROE) is significantly affected by the ownership structure (institutional ownership and managerial ownership) of Kazakhstani firms listed on the LSE. The metals and mining and oil and gas industries show a strong relationship of buy and hold return (BHR) with market return, firm size, ROE, and initial return on long-term performance. Corporate governance structure (board size, independent directors, and CEO duality) do not affect the financial performance (ROA and ROE). The successful implementation of the IPO program also implies broad outreach of the possibilities and modalities of the IPO and the potential risks of corporate governance structure. Efforts should be made to improve the financial literacy of the population, explaining the benefits of investing in stocks. Of particular importance are the issues regarding analyzing and predicting the financial market, as well as transparency of the companies that put their shares up for sale. Companies should provide transparent accountability and clear reporting mechanisms for disclosure of information, including on the results of financial/economic activities. Informational transparency of companies participating in a national IPO should be much higher than that of other firms. The government needs to make policies related to privatization that will help the corporate governance system mature from its current situation of having a lack of standard practices, distorted or inaccurate stock markets information, a lack of qualified corporate governance professionals, etc. Developing corporate governance practices will improve the transparency and accountability of board members and top executives and ultimately help to improve organizational performance. It will also enable potential investors to trust companies while thinking of investing in them. This will help Kazakhstan’s capital market to flourish as people will buy shares in local companies. Better governance practices will improve the reputation of Kazakhstan as a country that runs businesses in fair way as well as being a good governance indicator.

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Appendix 1 IPO market in Kazakhstan

IPO name Alliance Bank Caspian holdings

Industry Financial services Oil and gas

Chagala

Real estate and property development Technologies, telecommunications, and media Metal and mining, power industry, transport and logistics Gold, diamonds and gemstones mining Financial services Gold, diamonds and gemstones mining Gold, diamonds and gemstones mining Metal and mining Financial services Oil and gas

EPAM systems Eurasian natural resources Frontier mining Halyk Bank Hambledon mining KazakhGold Kazakhmys Kazkommertsbank KazMunaiGas KazTransOil Kcell Max Petroleum

Oil and gas Technologies, telecommunications, and media Oil and gas

Orsu metals

Metal and mining

Roxi petroleum

Oil and gas

Russian navigation technologies Shalkiya zinc Steppe cement

Technologies, telecommunications, and media Metal and mining Construction materials

Sunkar resources

Chemicals and petrochemicals Financial services

Tau capital Victoria oil and gas

Oil and gas

Trading floor LSE LSE’s AIM LSE NYSE LSE

LSE’s AIM LSE LSE’s AIM LSE LSE LSE KASE, LSE LSE KASE, LSE LSE’s AIM LSE’s AIM LSE’s AIM MICEX LSE LSE’s AIM LSE’s AIM LSE’s AIM LSE’s AIM

Placement volume (USD million) 704 7

Year of placement 2007 2004

120

2007

72

2012

3037

2007

6

2004

748 5

2006 2004

197

2005

1365 846 2255

2005 2006 2006

186 525

2012 2012

46

2005 2004

77

2007

9,694,000

2010

105

2006 2005

67

2008

250

2007

18

2004 (continued)

6 The Effects of Privatization and Corporate Governance of SOEs in Transition. . .

IPO name Yandex Zhaikmunai

Industry Technologies, telecommunications, and media Oil and gas

Trading floor NASDAQ LSE

Placement volume (USD million) 1435 100

131

Year of placement 2011 2008

Source: www.preqveca.ru

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Nazgul Kondybayeva. (2015). Long-run performance of Kazakhstan Initial Public offerings and its determents in London Stock Exchange (LSE). MBA Thesis, KIMEP University, Kazakhstan. O’Connell, V., & Cramer, N. (2010). The relationship between firm performance and board characteristics in Ireland. European Management Journal, 28(5), 387–399. Phi, N. T. M., Taghizadeh-Hesary, F., Tu, C. A., Yoshino, N., & Kim, C. J. (2019). Performance differential between private and state-owned enterprises: An analysis of profitability and leverage. In ADBI Working Paper 950. Tokyo: Asian Development Bank Institute. Ritter, J. R. (1998). Initial public offerings. Contemporary Finance Digest, 2(1), 5–30. Taghizadeh-Hesary, F., Yoshino, N., Kim, C. J., & Mortha, A. (2019). A comprehensive evaluation framework on the economic performance of state-owned enterprises. ADBI Working Paper 949. Tokyo: Asian Development Bank Institute. Wang, C. (2005). Ownership and operating performance of Chinese IPOs. Journal of Banking and Finance, 29(7), 1835–1856. Waters, A. (n.d.). IPOs come to Kazakhstan: Kazakh public to invest in nation’s prosperity. Edge Magazine, Retrieved from http://www.edgekz.com/ipos-come-kazakhstan-kazakh-publicinvest-nations-prosperity/ Wu, H.-L. (2010). Can minority state ownership influence firm value? Universal and contingency views of its governance effects. Journal of Business Research, 1–7. Yermack, D. (1996). High market valuation of companies with a small board of directors. Journal of Financial Economics, 40, 185–211. Yu, M. (2008). CEO duality and firm performance for Chinese shareholding companies. 19th Chinese Economic Association (UK) annual conference: 1–28. Zeng, Q. S. (2004). Large shareholder privatization and firm performance in listed firms. Economic Management (In Chinese), 10, 75–83.

Chapter 7

The Privatization of Japan Railways and Japan Post: Why, How, and Now Chul Ju Kim and Michael C. Huang

7.1

Introduction

Privatization of state-owned enterprises (SOEs) has been globally prevalent since the 1980s with a primary objective of improving their performance in profitability and provision of better service through the ownership change. Privatization led the transition to a market economy in the Soviet socialist countries, and became a critical aspect of reform packages to enhance public sector management in the 1990s both in developed and developing countries (Tamamura 2004). However, privatization has different nuances depending on the specific country circumstances. In the case of Japan, it was closely related to the process whereby entities called “special public corporations” were converted into regular joint stock companies so that their shares could be offered to the public, while they were still used to deliver government services or operate a monopoly in certain cases like post networks. Milhaupt and Pargendler (2017) indicates that privatization of special public corporations in Japan has come in two waves influenced by the UK’s Thatcher Revolution. The first reforms were taken by Prime Minister Yasuhiro Nakasone in the 1980s in response to a national debt crisis. Large-scale privatizations of three special public corporations were implemented in this era: Nippon Telegraph and Telephone Public Corporation (NTT), Japan Tobacco & Salt Public Corporation, and Japan National Railways (JNR). The second major privatization included financial institutions affiliated with Japan Post, which was initiated by Prime

C. J. Kim Asian Development Bank Institute, Chiyoda-ku, Tokyo, Japan e-mail: [email protected] M. C. Huang (*) SciREX Center, National Graduate Institute for Policy Studies, Tokyo, Japan e-mail: [email protected] © Asian Development Bank Institute 2021 F. Taghizadeh-Hesary et al. (eds.), Reforming State-Owned Enterprises in Asia, ADB Institute Series on Development Economics, https://doi.org/10.1007/978-981-15-8574-6_7

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Minister Junichiro Koizumi in 2005 and its shares were offered to the public as a listed company in 2015. A detailed exploration of these privatizations provides a window onto some distinctive features of Japan’s approach to privatization and the post-privatization governance of enterprises still partially owned by the government. Strong pressures and demand for the JNR reform led to a series of privatization measures since 1987 that divided the JNR into eight Japan Railway (JR) companies based on the geography and functions. Quite different from the railway privatization experiences in Europe, no separation of infrastructure and operation has enabled the JRs to handle and use their real assets for the diversification of its business lines. This privatization of the JNR was recognized as the first case of reform of a nationwide state-owned railway in the modern history (Kurosaki 2016). Up to date as of 2019, six over eight JR companies have obtained net profits and even become exporters of its technology and operating system. As for Japan Post (JP) system, demands to activate world’s biggest deposit of 260 trillion JPY in 1999, for financial mobility and to reduce long lasting operational underperformance have been urgent calling for structural reforms (Yoshino et al. 2018). Within a decade since its kick-off in 2005, the listing of JP Bank and JP Insurance in 2015 at the stock exchange was a milestone accomplishment, while the JP Service and JP Networks remain state-owned because of their non-excludability to the public interests. The JRs had three decades since the start of privatization, and Japan Post had more than a decade since its launch of reform in 2007. The socio-economy of Japan has undergone drastic changes with population aging and shrinking. Had not been for privatizations and resultant diversification and transformation of business models, they would have not been profitable and dynamic as today. The consequences from privatization of JP and JR are still evolving and could serve important references for developing countries on how to reforms of major SOEs could be done with structural reform and technology development. Building on detailed accounts of their privatization process illustrated in East Japan Railway Company (1995), Kasai (2004), Fink (2016), and Robinson (2017), the chapter aims to provide a timely and comprehensive review of Japan’s experience by looking into key factors for the privatization so as to deepen understanding of such complicated process in reconstructing, deregulation and technology implementation. It would provide valuable lessons for developing countries in which SOE reforms are integral to their economic and social development, and as such should be designed and implemented in a coherent, transparent, and consistent manner.

7 The Privatization of Japan Railways and Japan Post: Why, How, and Now

7.2 7.2.1

135

Japan Railway Why: Looming Threat and Urgent Reasons for Railway Privatization

Since the end of the Second World War, JNR enjoyed its monopolistic position with sizable operating profits in the domestic transport market until the mid-1960s. Key contributing factors were increasing transport demand stemming from high economic growth during that time and less competition with other modes of transportation, such as motor and air transport which still struggled with post-war recovery. However, high economic growth also made it possible for other modes of transport to rapidly develop in the late 1960s, and coupled with the inefficient management of JNR, political interference to extend railway network in unprofitable rural areas and strong trade union, it started losing its competitiveness and predominance in the rapidly changing market. The huge organization of JNR spanned the entire country with a large number of employees, resulting in inflexible budget formulation, and a lag in satisfying customer needs. In particular, a lack of a clear understanding of the actual management conditions by region or division made it difficult to implement strong corporate strategies including cross-subsidization, fostering cost awareness and profit targets in each region and business sector, thereby hindering an efficient operation. The large organization could not respond flexibly to and satisfy customers’ changing needs. Competition with other transport modes had become intense, but the top management was not oriented to compete with them through efficient and reasonable management. As a result, JNR faced severe public criticism for ineffective management, but the necessary operational reforms could be not pursued mainly due to strong opposition from politicized labor unions (Mizutani and Nakamura 2004). The inability to cope with major change, combined with increasing competition from other modes of transport eventually led to massive financial failures for JNR. It accumulated long-term debt each year. Konno (1997) indicates that this costly transportation company with a low rate of return had recorded a deficit of 37.1 trillion JPY, equivalent to $237.8 billion in 1987 at the time of reform, which was roughly equivalent to the combined national debts of several developing countries (Kurosaki 2016). It became evident that JNR had to enhance its operational efficiency, to transform it into a competitive entity, thereby to reduce the huge government subsidies. A comprehensive reform of JNR was called for to solve these pressing problems. Such SOE reform is not just for better financial performance but more importantly, for enhanced consumer satisfaction and social welfare (Taghizadeh-Hesary et al. 2019). Accordingly, “privatization” was proposed as a way to solve problems perceived to be attributable to its public enterprise status, and its breaking up into several companies was planned as a way to address problems attributable to the nationwide, monolithic nature of the organization.

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C. J. Kim and M. C. Huang

How: From Japan National Railway to Japan Railway Company

The main problem with JNR was two-fold: (i) the company was too large an organization to be managed properly and (ii) it had to operate under political influence as evidenced by its operation of even unprofitable lines built only for political purposes. Thus, it was decided that the company would be spilt into smaller companies with enough independence for managerial decisions including the rights on operation. After consideration of several options for separation, regional subdivision according to geographical demand was decided upon. This decision created quite a dilemma for smaller JR companies such as Kyushu, Shikoku, and Hokkaido as they would have to meet their customers’ local needs and compete to improve their performance. The process of JR privatization was long and painful, as Mizutani and Nakamura (2004) indicate, such reform could not be accomplished all at once, but rather in a step-by-step manner. It started in 1987 with the establishment of the Japan National Railway Settlement Corporation (JNRSC) – a temporary holding company. The reason why the government established such a company was its deep concern about the JNR’s dismal reputation as deficit-laden and inefficient, which could not attract enough interest from investors, negatively affecting the stock prices of newly created railway companies. In a first step, government control was reduced substantially to the level of regulations equivalent to those for private railways (Table 7.1). This framework was expected to eliminate unnecessary outside interference, establish management autonomy, and clarify management responsibility. Management would be given full capacity and responsibility over managerial decisions, including the labormanagement relationship that is envisaged to be resolved independently between trade unions and management. Equally important, railway companies would be able to diversify and expand into other fields of business aimed at increasing their corporate revenues. The aims of splitting up and privatizing JNR included: • • • • • • • •

Eliminate external interference Clarify management responsibility Normalize labor-management relations Diversify business fields Create manageable scales Strengthen regionalized management and collaboration Remove irrational interdependence Promote incentives for competition and marketization

The JR companies were formed as the JNRSC’s wholly owned joint-stock subsidiaries. Assets and liabilities of JNR were restructured in a way to ensure the competitiveness of the new companies. JNR ceded liabilities to the new companies only to the extent that they would not hinder sound management in the future. Remaining liabilities were assumed and disposed of by the JNRSC. JNR also ceded

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Table 7.1 Regulation changes for JR

Business fields

JNR Railway only

JR Free in principle (new business require the approval of the minister of transport) None

Investment restrictions Budget filing procedures

By law, approval of the minister of transport Diet resolution

Borrowing and bonds issuance

Approved of the minister of transport (by diet resolutions)

Appointment of executive officers

President: Appointed by the cabinet; members of the board of auditors and other executives: Appointed and approved by the minister of transport Determined in principle by the legal total salary system

Negotiations between labor and management

In principle by open bids

Decided autonomously

In principle, by diet resolution (reformed in 1977)

Approval of the minister of transporta

Salaries

Contract methods Fares

Approval of the business plan (revenue and expenditure budget must be presented as attached materials) Long-term borrowing and issue of debentures require the approval of the minister of transport General meeting of shareholders (representative directors and auditors require the approval of the minister of transport)

Private railways Free

None None

No restrictions

General meeting of shareholders

Negotiation between labor and management Decided autonomously Approval of the minister of transporta

Source: East Japan Railway Company (1995) a The Ministry of Transport merged into the Ministry of Land, Infrastructure, Transport, and Tourism in January 2001. After the JR privatization, fare amendments were made three times for the passenger railway (1989, 1996, 1997), and twice for freight (1989, 1997)

the minimum assets necessary to make the new companies viable as railway operators. Assets not ceded to the new companies were sold to the public by JNRSC to repay the liabilities left to the JNRSC (Fig. 7.1). The JNRSC began to sell its shares in JR companies in the early 1990s. In 1998, it was dissolved and the Japan Railway Construction Public Corporation was formed to settle the remaining obligations of the JNRSC (Milhaupt and Pargendler 2017). The splitting up of the JNR according to geography and functions led to the restructuring as follows. • • • •

Hokkaido Railway Company (JR Hokkaido) East Japan Railway Company (JR East) West Japan Railway Company (JR West) Central Japan Railway Company (JR Tokai)

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Fig. 7.1 Outlines of the JNR restructuring. (Source: Revised by authors from East Japan Railway Company (1995))

• • • • • • • •

Shikoku Railway Company (JR Shikoku) Kyushu Railway Company (JR Kyushu) Japan Freight Railway Company (JR Freight) Shinkansen (High speed rail)1 Holding Corporation Railway Communication Company2 Rail Information Systems Company Railway Technical Research Institute Japanese National Railways Settlement Corporation (JNRSC)

How to deal with surplus employees as a result of restructuring was a critical issue. As of April 1986, JNR’s employees totaled 277,000 of which 93,000 were estimated to be in excess by the Supervisory Committee. Kopicki and Thompson (2010) point out that as a partial way to address the issue, the new JR companies were required to hire 20% more employees than deemed necessary for their railway operations. The JNRSC then conducted measures for a three-year period for employees not hired by the new companies to help these employees find new jobs. The restructuring plan made specific provisions for the 93,000 employees deemed surplus: (i) transferring 32,000 to other railway companies; (ii) establishing a special fund for the voluntary early retirement of 20,000; and (iii) assigning the remaining 41,000 to the Settlement Corporation for relocation. After splitting up the JNR, a simplified organization structure in each company enabled management to make managerial decisions in a way that responded quickly

1 The infrastructure would be owned by a state-owned company and leased to JR East, JR Central, and JR West. 2 Railway Communication Company was for trunk line communications; Rail Information Systems Company for operations of nationwide railway information; Railway Technical Research Institute for research and development of the railway; JNRSC for liquidation of JNR’s historical debts.

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and appropriately to changes in the environment and customers’ needs. Management could clearly understand the actual status of each business sector and region, foster cost awareness, and thus vigorously pursue profit targets within the company. This also fostered a mutual sense of competition among the new railway companies. Another important key to success was the new form of rail management system. Compared to the European way of rail privatization, the so-called “Up and Down Separation Method” or “Vertical Separation” under which train operations are separated from infrastructure ownership, Japan has adopted a system of “Horizontal Separation.” This form of railway system allows competition and is expected to reduce operation costs, but this is still inconclusive. Mizutani and Uranishi (2013) find that using a total cost function of a railway organization, horizontal separation reduces railway costs, whereas Nash et al. (2014) find no evidence that vertical separation leads to more competition, or that such an increase in competition reduces costs. As such, the issue of railway operation after privatization continues to be an open question requiring further work to better measure the extent and effects of competition in different markets. In the Japanese context, horizontal separation that sets a good yardstick of competition among regional subdivisions has improved the overall performance of JR companies. Regional needs have increasingly been met, particularly with improvements in train frequency. The integration of railway services into different regional organizations has been relatively smooth, although the number of interregional rail services has decreased. Each JR company took responsibility for both train operation and infrastructure management within its territory. This means drivers can only drive trains on their own company’s track, therefore at the border station, there should be a change of drivers. As such, a fundamental characteristic in the Japanese passenger railway operation has been this clear separation of operational responsibilities at the border station, which is believed to have contributed to smooth, efficient, and safe passenger train operation. Vertical integration, namely integration of operation and infrastructure, implies that railway companies also manage the stations, depots, and often commercial zones around the stations. For example, Tokyo Station is shared between JR East and JR Central, though their tracks and platforms are completely separated. This vertical integration has increased the productivity of privatized JR companies comparable to large private railways, which are considered the most efficient railway operation in Japan. For instance, Mizutani and Nakamura (2005) estimate, through empirical tests, the effect of privatization on productivity growth amounting to about 29%. However, privatization does not mean that is free of any negative effects. For instance, in April 2005, about a year after the full privatization of JR West, a fatal accident occurred on the Fukuchiyama Line in Hyogo Prefecture. The accident was caused a commuter train (a seven-carriage train) entering a curve at too high a speed, leading to 107 deaths and 562 injuries (Transportation Analysis 2014). This accident was a sharp reminder that continuous improvement in railway management is critically required after privatization.

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Fig. 7.2 The Performance of JRs from 2008 to 2018 (¥ billion). (Source: JTTRI 2019)

7.2.3

Now: Service Diversification and Extension

While the reform of the Japanese railway has been regarded as largely successful, there remain a number of problems to be solved (Mizutani and Nakamura 2004). Privatization per se should not result in a simple transfer of monopolistic power from a public corporation to the private sector; the government should create a conducive environment to promote actual and potential competition in the market through regulatory changes and to foster such competition even within the organization itself through appropriate incentive mechanisms. In this regard, privatization of JNR deserves its own share of the credit. According to Japan Transport and Tourism Research Institute (JTTRI) (2019), the mileage share for railways is more than 75% in Japan, compared to US (1%), UK (10%), France (11%), and Germany (8%). Overviewing the consequences of JR reforms in the past 30 years, the results have been satisfactory regarding service provision following the global financial crisis in 2009 (Fig. 7.2) except for JR Hokkaido and JR Shikoku. The newly established JRs focused on their own markets and provided transport services appropriate for each region as well as JR Freight. Based on JTTRI statistics, the transport volume (passenger-km) decreased 6% in the decade prior to the JNR reform, but the trend changed course, substantially increasing to 27% in the decade after the reform. As for the passenger sector, since the termination of the cross-subsidy to the freight sector, it has become possible to re-invest the profit to improve passenger services such as high-speed railway (Fig. 7.3). Key indicators for JRs’ operation also demonstrate the healthy condition for the major JRs (Table 7.2). Furthermore, following the business model of other private railways, the JRs also commenced affiliated businesses, actively utilizing and developing the space in and around the stations. Nowadays, especially around large

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Fig. 7.3 Increasing Shinkansen (high speed rail) business. (Source: JTTRI 2019) Table 7.2 Key indicators for JRs’ operation as of March 2018 Operation length (km) Employees (persons) Revenue (billion JPY) Revenue other than railway (billion JPY) Net profit (billion JPY) Fund Customers per day (thousand persons) Revenue per mileage/ passenger (JPY) Net profit per passenger (JPY)

Hokkaido 2552 6904 84 6

East 7457 47,246 1991 83

Central 1971 19,619 1414 13

West 5007 28,326 948 28

53 682 371

359 0 17,565

625 0 1526

144 0 5179

537

283

2363

391

56

1122

Shikoku 855 2055 28 3

Kyushu 2273 6129 171 48

Freight 7959 5406 141 17

12 208 126

47 3887 908

11 0 n.a.

449

514

442

n.a.

76

261

142

n.a.

Source: Adapted by authors from the JTTRI (2019)

stations, it has become common for group firms of JR companies to promote various kinds of affiliated businesses such as tourism, and the revenue from these business activities has been increasing. Local rail services in small communities have been maintained for the past ten years but there are no guarantees that these will survive any serious financial slump the JRs might someday experience. Privatizations of the three JRs (East, Central, and West) have achieved positive balance sheets despite bearing the cost of infrastructure and the burden of the allocated JNR liabilities (Kurosaki 2016). As scheduled, the listings on the Tokyo Stock Exchange of JR East (2002), JR West (2004), JR Central (2006), and JR Kyushu (2016) set out the pathway to privatization with more flexible management

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and investments that paved the way for the diversification of their businesses.3 It was expected to be even more crucial to ensure the profitability of the JR firms given that a significant increase in passenger transport revenue is not expected in the future given the nation’s population decline (Japan Times 2017). Contributing factors to such favorable outcomes would include well-clarified management targets that could speed up faster decision-making through a simplified organizational structure. Meanwhile, the restructuring has improved productivity by stabilizing labor-management relations and reshaping employee attitudes, as well as enhancing services through regionalized management. The improved earning ability through different fields of business has been important for the cross-subsidies in the restructuring process. In addition, the strong commitment of the management team was essential to the successful transition. One important aspect of the JR privatization was its spill-over effects to other business sectors and the economy as a whole. According to a recent study (Huang et al. Forthcoming), the JR reforms have led to an improvement in social welfare and substantial growth of the shipping sector with increased diversification, deregulation, and improved connectivity. Based on such factors, the key lessons emerging from the JNR restructuring experience that have relevance for rail reform in other countries are summarized: • Strong political support is essential to successful restructuring. • Practical reorganization plans should be developed by experts with full knowledge and expertise on the sector, rather than politicians and bureaucrats. • For a railway in JNR’s condition, restructuring should precede privatization to increase the probability of success. • Short-term issues requiring immediate attention should be prioritized before tackling long-term problems. • Restructuring should have clear market-focused operating components. • There should be enough management incentives set early in the reform process to facilitate the reform process (Fig. 7.4). The reforms to the Japanese railway, characterized by breaking up into smaller companies and their privatization, can be said to be successful given the improved productivity, decreased overall operating deficits, decreasing fares, better services to customers, and the spill-over effects to other sectors. Milhaupt and Pargendler (2017) point out that the management of JR companies has been sustainable so far based on the original scheme planned at the time of the reform with better performance and public satisfaction. However, there have been wide variations in performance and challenges among JR companies given the rapid social-economic changes in the railway sector. For instance, JR Hokkaido and JR Shikoku, situated in low population density areas,

3

JR Hokkaido, JR Shikoku, and JR Freight are still governed by the Act for the Passenger Railway Companies and Japan Freight Railway Company and are under the control of the Japan Railway Construction, Transport, and Technology Agency, an Independent Administrative Institution.

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Fig. 7.4 The Key Indicators for Company Operation (2018). (Source: Adapted by authors from the JRs’ annual reports)

have suffered from operational disparity. It will be even more challenging to turn these two deficit JRs into profitable entities considering population aging and shrinking in Japan. The companies should take further innovations and decisive actions on service diversification following the successful case of JR Kyushu. In addition to diversification, the railway sector as a whole should act urgently to maintain its competitive position, such as to benefit from inbound tourists and collaboration with other transportation services by improving connectivity. While a decision was made to sustain local lines with declining passenger number, certain measures, such as vertical separation, should be introduced to gain financial support from local governments. Finally, while political intervention, one of the main culprits for the sluggish JR, has considerably lessened after the reform and privatization, a better and more sophisticated regulatory framework for JR companies would be required to cope with the drastic change in the social economy.

7.3 7.3.1

From Japan Post to JP Holdings Why Privatization

Since its establishment during the Meiji period in 1875, JP grew with the expansion of its business areas that covered postal delivery services, savings bank, and insurance. Currently, Japan’s postal system consists of the mail and a huge bank deposit network, simple banking and financial transactions, and insurance purchase. Such a system had contributed to the rapid economic development of the country after the World War II but raised important issues that required fundamental reform and privatization. Broadly speaking, JP was situated as a core institution representing old

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systems that served well in the past, but hindered further development with inefficiency, corruption, and lack of transparency (Duggan 2017). There was an urgent need for more efficient use of its huge assets, given that postal savings and postal life insurance together accounted for a quarter of Japan’s personal financial assets in the early 2000s. According to the 2010 annual report of JP Bank, it was the biggest deposit holder in the world with 175 trillion JPY ($1.9 trillion) in 2008, which was about 25% of Japan’s total deposits. Indeed, JP played a critical role in the development of the Japanese economy by collecting savings from customers in almost all areas of the country and channeling such savings into investments in SMEs, infrastructure, and housing through the government’s Fiscal Investment and Loan Program. However, as the economy advanced, there has been strong criticism that these investments led to wasteful spending often tied to political motives (Yoshino et al. 2018). Even after this system was finally abolished as part of the 2001 reform, the money, approximately 75% of JP’s 177 trillion JPY ($2.2 trillion) in deposits, has been invested in Japanese government bonds with no substantial role in creating new industries. Many, including Takeda and Mizuoka (2003), argue that it is critically important to encourage the birth and growth of new industries for the upgrading of industries and economies for further development through more efficient use of accumulated funds. More importantly, there have been deep concerns about fair competition and a level playing field. Indeed, JP had been very successful in its business because it was close, convenient, and reliable for its customers and very cost-effective through its nationwide network of around 24,000 branches. At the same time, it enjoyed a number of privileges and immunities, including state guarantees, premiums for postal deposits, and the remission of property tax. These unfair advantages have created distortions for market functions and saving incentives, leading to further hinder the development of well-functioning financial systems along with a changing environment. JP exercised strong political power using its branch network especially in rural areas, which prevented genuine reforms. Furthermore, there has been increasing criticism from major training partners that advantages enjoyed by Japan’s postal service in banking and insurance represent a clear violation of Japan’s obligations under the General Agreement on Trade in Service (GATS). In this sense, it was argued that indefinitely maintaining JP as a governmentcontrolled entity without fundamental reforms would result in potentially increasing system risks in the financial sector of Japan. Porges and Leong (2006) pointed out that the privatization of JP would make it possible to remobilize such assets to the development of private sectors, and to remove distortions to competition in the banking and insurance sectors. Thus, the need to reform this rigid financial system became the most important belief of Junichiro Koizumi when he became the Minister for Post and subsequently Prime Minister, initiating structural reform for the Japan postal system.

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7.3.2

How: From Government Agency to a Privatized Company

7.3.2.1

Ups and Downs of Privatization

145

The postal system in Japan started its services in 1871 with the addition of postal savings in 1875 and life insurance in 1916. In early 2001, as part of the reorganization of national bureaucracy by Prime Minister Mori, the Postal Service Agency was established under the then Ministry of Public Management, Home Affairs, Posts, and Telecommunications. Later in 2001, when Koizumi became Japan’s Premier, he was determined to pursue the privatization of JP similar to NTT as a holding company system. As a first step, in July 2002, the Postal Service Structural Reform Law was passed through the National Diet and the Postal Service Agency was converted into a public corporation, Japan Post Inc. with the state as a sole shareholder in April 2003. Premier Koizumi went on further with a bold plan for the JP privatization with a package of six privatization bills that finally passed the lower house, but to everyone’s surprise, was rejected in the upper house, reflecting the strong opposition to the postal privatization. Premier Koizumi went on to dissolve the Diet calling a snap election, a form of referendum on the postal privatization (Porges and Leong 2006) and received a landslide victory in the lower house in 2005. The decision-making on the privatization voting was also complex because of the strong power restoration within the ruling party. Imai (2009) examines the political incentives of Japan’s politicians from their voting behavior, finding that politicians with an inclination for large interventionist government had a tendency to oppose postal privatization. Empirical results show a robust positive correlation between politicians’ resistance to postal privatization and the prevalence of post offices whose workers and postmasters were anticipated to be adversely affected by the planned privatization. Most interestingly, the factional conflicts played an important role in the eventual votes on the privatization bills. The postal privatization referendum was a major political shock therapy, but its implementation was much delayed. The resultant reform package included: (1) The Financial Instruments and Exchange Law; (2) New Companies Law; and (3) Postal Privatization Law intended to achieve: • Market-opening (greater cross-border investment, particularly inward investment) • Better corporate governance through capital market opening • A move “from savings to investment” – diversification of household balance sheets The design of the legislation for privatization represented an attempt to achieve structural separation between the postal delivery and network businesses and financial services businesses. However, privatization of JP was challenging in the sense that the privatized companies had to be viable in the face of fair competition with private players in the market segments, and at the same time, postal delivery, to a

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Fig. 7.5 The restructuring and process of Japan post privatization. (Source: Revised by authors based on Japan Post)

certain degree, should meet the requirement of universal service obligations (Maruyama 2006). The Postal Privatization Law passed in October 2005 envisioned three phases of the privatization, namely a preparation phase, a ten-year transition phase starting on the privatization date of 1 April 2007, and a final phase of post-privatization configuration of companies (Fig. 7.5). From the beginning of the privatization procedure, JP Holdings became the shareholder of four to-be-privatized companies, including JP Bank, JP Insurance, JP Network, and JP Service. In the new framework, JP Holdings was initially stateowned but with the commitment that shares should be gradually sold off by 2017. The legislation also established a Cabinet-level Postal Privatization Headquarters, advised by a five-person Postal Privatization Commission (PPC), both of which would be dissolved by October 2017. The succession plan would be developed to resolve key issues such as how the assets, liabilities, and employees of Japan Post would be divided between the successor companies. The final privatization of the bank and insurance company would complete that process, but only after a ten-year transition. However, in the political transition in 2009, the reforms came under attack with the victory of the Democratic Party of Japan (DPJ) supported by trade unions. DPJ and its coalition partner, the People’s New Party (PNP), initiated a moratorium on share sales of JP companies. They further passed a revised bill in 2012 that (i) allowed the government to maintain a one-third interest in JP Holdings (and indefinite de facto control of the company); (ii) removed binding targets for the share

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sales of the two financial companies; (iii) installed a provision on universal financial services; and (iv) eased the constraints for entry into new business. The main argument was that the original plan ignored the needs of consumers focusing too much on profits and having already led to the closures of local post offices. Under the new plan, the government would retain more than one-third of the shares of JP Holdings, enough to allow the government to veto any major changes in the company. Such intervention again implied that Japan scaled back the plan to privatize the world’s biggest financial conglomerate to keep control of the stateowned group, which allowed the purchase of more government bonds and underscored the considerable political obstacles to badly needed economic reform in Japan (Sano 2010; CSIS 2012). In December 2012, the Abe administration took office recognizing privatization of the JP as an important part of its economic strategy called “Abenomics.” It featured a set of policies intended to revive the economy through monetary policy, fiscal consolidation, and a growth strategy against the long-lasting deflation and the continued conservative investment habits that accompanied rapid population aging (Robinson 2017). In particular, the Abe administration had to scale up the Tohoku earthquake reconstruction efforts that required mobilizing funds including share sales of JP companies. While the administration was still bound by the 2012 revised plan, it expedited the IPO process, eventually leading to the listing of three JP companies, JP Holdings, JP Bank, and JP Insurance in 2015 on the Tokyo Stock Exchange. It can be said that the long-lasting reform of Japan’s postal system was completed with such listings, while thereafter the government continued to sell shares of the companies.4

7.3.2.2

Decompositions and Impacts

Restructuring and privatization had a wide-ranging impact on the ways of doing business by the privatized companies. Above all, the cross-subsidy system, under which more profitable banking and insurance branches provided subsidies to the postal delivery branch to keep its prices below cost, was dismantled. In addition, the delivery company is also required to pay the network company for counter and other services that the network company supplies in a private company-based transaction. Therefore, the delivery company would have a strong incentive to take dramatic steps to compensate for the loss of subsidies by entering into new lines of business, increasing its mail volumes, and cutting costs. One such step, already articulated by the JP groups, would be to enter the logistics industry. This is a growing but complex industry, one which may require JP to partner with an established logistics provider at the outset.

4 As of the end of July 2019, the state owns 57% of JP Holdings; JP Holdings owns 100% of JP Service, 74.1% of JP Bank, and 64.4% of JP Insurance (Source: Nikkei Asian Review).

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One important feature of the postal reform in Japan was enhancing competition. To enable vibrant competition in the postal services, preferential treatment of JP Service should not be allowed even to keep the universal postal service. To the extent that the privatized postal delivery business receives preferential treatment that discriminates against its competitors, the playing field would be tilted toward JP Service, with negative effects on fair competition. However, given JP’s long history as an SOE and the government’s high interests in JP Holdings, many private sector competitors in financial services and insurance remained skeptical of the benefits of privatization. Competitors were apprehensive that in the absence of regulatory harmonization, privatization might merely transform an explicit government guarantee to the largest, government-protected players in financial services and insurance. The postal privatization, as Koizumi’s signature reform, was of both practical and symbolic value moving from the public to the private sectors concretizing its policy slogan—“from savings to investment.” The postal savings balance sheets remained inflated by deposits and cash that had flowed in from households when Japan’s “lost decade” was in full swing and sentiment was at its worst (Fink 2016). Some of the same concerns voiced by foreign competitors in the late 2000s have been repeated again under the Abe administration. Porges and Leong (2006) question whether Japan’s policymakers would create a strong postal service, with so much preferential treatment and so many subsidies that it overpowers its competitors and threatens competition in the industry, or a weak postal service that struggles to meet its universal service obligations and its deferred liabilities, ultimately needing a government bailout.5 Japanese banks benefitted from massive shifts of deposits out of JP Bank, but at the same time it formed a new competitive threat as JP Bank needed to expand into new business areas to survive as a private company as well as for insurance. An implicitly protected JP Bank and JP Insurance, if awarded a more extensive mandate than before, might dampen rather than promote competition in the financial sector. As pointed out, postal reform in Japan together with the New Company Law attempted to break down barriers to regional competition in financial services. It was expected to bring fundamental changes to Japan’s financial system. When JP Holdings was established in January 2006 according to the law, the Asia-Pacific Economic Cooperation (APEC) aptly lauded it as a “major achievement” (Fink 2016). However, mainly due to the partial nature of the postal reform, implementation delay, and subsequent political pressure combined to make the legislation much less revolutionary than initially anticipated, leading only to muted improvement in financial sector competition. Indeed, JP is not yet fully privatized partly because of its huge networking capability that could remain important in providing non-exclusive benefits to the public in general.

5 After the heated debate, Article one of the Postal Law in 2005 stipulated that Japan Post should deliver to all addresses at a uniform cost as fairly and cheaply as possible.

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149

Now: Still Evolving Process

The reform and privatization of JP is far from finished and still evolving. Indeed, the original reform measures, that if rightly implemented could have reshaped the financial sector entirely, have fallen far short of their ambitious goal. From this experience, important but tentative lessons could be derived and categorized into: (1) elements of its successful legislation; (2) characteristics of its much delayed and scaled-back implementation; and (3) the necessity for ongoing reform following privatization. Here, we would like to focus on the further reform process envisaged in the future to ensure the viability of the company in a changing environment. By 2019, the remaining employees, assets, and liabilities were divided among the successor entities. The next steps in the reform process where further developments are expected are: • Continuing sell-off of cross-held shares and reform of corporate boards, alongside the restructuring of the main bank relationships, • Ongoing efforts to diversify the Japanese household balance sheet “from savings to investment,” • Ongoing adaptation of the Financial Instruments and Exchange Law (FIEL) and Corporations Law to reflect new products and technological development with new measures, and • Using multilateral agreements and regional initiatives as levers to speed domestic reforms (e.g. the Trans-Pacific Partnership (TPP) and Asia Regional Funds Passport). To face future challenges, Japan Post Group (2018) advocates bolstering the earning power of the three core businesses, namely the logistics industry, financial industry, and technology, and strengthening the Group’s business foundation for total lifestyle support. This will serve its customers through the post office network to create a corporate group with the provision of a variety of products and services tailored to diverse lifestyles and the life stages of customers and support them in realizing safe, secure, comfortable, and enriched lives and lifestyles (Table 7.3). To achieve these objectives, it is indispensable to fulfill JP’s obligation to provide universal services to local communities. According to Ministry of Internal Affairs and Communications (2019a), the popularity of internet accessibility has increased from 46.3% in 2001 to 80.9% in 2017, smart phone from 1.1% in 2008 and 47.2% in 2016, respectively. Despite the domestic postal demand shows an annual decrease of 2.5%, the share of parcels has gradually increased (Fig. 7.6). Among all competitors in delivery service providers, the JP Network has dominated the letter pack market; on the other hand, the parcel market shows healthier competition. Initiatives for revenue growth including the domestic logistics business and international operations business by improving services such as EMS and international parcel deliveries are being initiated. With the boom in Internet commerce and the value-added

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Table 7.3 The matrix of JP group development Logistics industry

Financial industry

Socioeconomic Technology

Main external environment Continuation of declining trend in mail Continued expansion of the EC market Enduring historically low interest rate Environment Consideration of strengthening international financial regulations Principle of customer-oriented operation of business Diversification of settlement methods

Advent of declining population and ultra-low childbirth and aging society (decline in productive age population) Increase in personnel expenses and social security-related expense burden Emergence of new technologies (AI, RPA, automatic driving, drones, Fintech, etc.)

Response policies Strengthening of logistics functions Development of comprehensive logistics business in Japan and overseas Advancement and diversification of asset management and insurance sales activities focusing on protection needs Securing of appropriate financial soundness Promotion of fiduciary duty throughout the company Measures and improvement in quality of insurance solicitation Provision of new transfer settlement services (smartphone settlement, account overdraft, and debit cards) Improvements in administrative efficiency through use of new technologies and systems Working style reforms Use of new technologies aimed at future business development Enhancement of non-face-to-face channel

Source: Japan Post Group (2018)

Fig. 7.6 The transition of letter and parcel numbers (million). (Source: Ministry of Internal Affairs and Communications 2019b)

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network, the trade volume has risen substantially. According to the annual report in 2019, the revenue share was 20% and expected to reach 50% in 2030. With this aim, it will be important to enhance its corporate value as an organic combination of the post office network and two financial companies, and to pursue this organic combination with banking and insurance services to build a new network. JP remains a huge organization continuously redefining its position. It has strived for service diversification by utilizing its networking system, not just delivery of letters and parcels but also a reliable nearby service provider. With Japan being a super-aged society, mail carriers now have a new mission to provide regular visits to senior citizens for communication and safety checks. The monthly greeting service became more popular in rural areas and provided another spillover effect to civil society. One strong factor pushing for the reform is rapid technological development in ICT and Internet-based platforms. The JP group has set an agenda for IT reform to establish market positions in major industries such as energy, retail, and engineering through the aggregation of IT distributed in each business division. Countries with advanced data analysis technology such as Australia, Singapore, and the US have been expanding these emerging fields. Strengthening of synergy and developing new business would contribute to the creation of products and services that are necessary for every stage of the lives of customers through the use of the huge post office network as an important infrastructure for society. Such provision of universal services through the post office network would contribute to securing a prosperous society where everyone can live a safe and healthy life. The provision of reliable financial services in Japan through the largest network requires improving the Internet service and call center creating an “Organic integration” of post offices (client base/information) with better functions “through the eyes of customers.” However, the mismanagement of insurance sales was observed in the making of double premiums. Other private insurance providers also criticized the binding “insurance retail” between JP Insurance and JP Networks. This incident of miscalculation would significantly affect the reliable image of the insurance provision at JP Networks (The Nippon.com 2019). Having said this, it should be pointed out that JP faces historic challenges in rapidly changing social and technological environment. As a partially privatized SOE, there is always a risk that the actions of politicians and government officials would serve their own interest in enhancing power and wealth, rather than the interests of citizens. Listed SOEs may face different problems depending on how the state behaves as a shareholder. If it acts as a passive or absentee owner, managerial agency problems will prevail, so SOEs may suffer from managerial slack and managerial tunneling (i.e., the theft of corporate assets). More broadly, JP will have to take active steps to further redefine and adjust its business models to align with rapid socioeconomic structural changes including population aging and the increasing trend of the cyber lifestyle in the twenty-first century (Kuroda et al. 2018). JP’s huge networking capacity could provide an important platform for this transformation through a wiser use of its post office network and the diversification of its services.

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In this vein, the privatization of JP is not simply the reform of one single company, but of the society as a whole because its spillover effect could also contribute to creating a platform for addressing the structural changes faced. The brand value of JP strengthened by a series of reforms and privatization and reliability still rooted in the society could enable it to be a promising system provider with advanced technology and extensive experience in quality services in the twenty-first century.

7.4

Concluding Remarks

The still evolving privatization of JR and JP is fertile ground to provide important lessons for SOE reforms, not just because of the size involved, but because of the process, influences, and spillover effect toward socioeconomic changes. The process has never been easy or peaceful, rather characterized as full of pain, struggle, and with an information gap. It took more time than planned to overcome such obstacles and fluctuations. Most notably during the privatization process of the two giant companies, the reform took place at the turning point of Japan’s transition from periods of high economic growth to ones of falling economic vitality with an aging and shrinking population. Such reforms also had to cope with deteriorating government finances. The evolving process of the privatization also contained significant elements of rapid technological development. For JR, the split of the company led to more freedom and incentives for R&D activities, especially towards the high-speed railway system. As of 2019, JR Central, JR West, JR East, JR Kyushu, and JR Hokkaido all maintain capacity for high-speed rail technology, featuring resilience toward weather conditions, high speed, even artistic design, and most of all, safety devices. The Shinkansen is still the pride of R&D for export, as well as a vital attraction for inbound tourists. According to the Japan National Tourism Organization, the number of tourists has increased from five million in 2002 to 30 million in 2018, implying the continuous demand for a convenient public transportation system and other businesses such as hotels, shopping areas, and recreation services. In addition, the implementation of the IC card system since the 2000s has now spread all over Japan, contributing to efficient commuting and cashless payment. Regarding JP, the integrated system created by privatization combining postdelivery, banking, and insurance will be an even more influential platform supporting better lifestyles. That is to say, the information collected in various services could contribute to big data analysis to further enable the service provision through the JP network in a smarter facility while reducing the knowledge gap. The privatization of JR and JP could gradually provide solutions for the concept of the so-called Society 5.0, which is capable of providing the necessary goods and services to the people who need them at the required time and in just the right amount.

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To conclude, we integrate three key policy implementations from JR and JP privatization as follows: • Strong commitment and clear strategy for structural reform: To help the stakeholders work toward a clear target and time horizon for reforms. • Deregulation: To provide incentives for innovative solutions and involvement for more stakeholders to contribute to market efficiency and social welfare. • Promote technology: To apply advanced technology for effective information management in order to capture the development and adjust the change for further reform. The most important lesson from the reforms of JR and JP is that privatization, deregulation, and decentralization could create a powerful platform not only for the company but for the society as a whole. The privatization of JR and JP was not just the privatization of two giant SOEs, releasing their capacity to make more profit. Rather, it was the process to bring social welfare improvement by encouraging innovative services and creating more value-added public interests to facilitate sustainable development for the society. While the process of full privatization is still ongoing and evolving, these experiences will serve as good reference points for other countries in the twenty-first century.

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Japan Times. (2017). Privatization of JNR, 30 years on. https://www.japantimes.co.jp/opinion/ 2017/04/04/editorials/privatization-jnr-30-years/#.XIG-Zij7RPY. Accessed 5 Jan 2019. Japan Transport and Tourism Research Institute (JTTRI). (2019). Railway 2019 from numerical perspectives. Tokyo: JTTRI (In Japanese). Kasai, Y. (2004). Japanese National Railways: Its break-up and privatization. London: Global Oriental. Konno, S. (1997). JNR privatization-JR’s first 10 years and future perspectives. Japan Railway and Transport Review, 13, 34–38. Kopicki, R., & Thompson, L. (2010). Best methods of railway restructuring and privatization. CFS discussion paper series 111, World Bank, DC. http://siteresources.worldbank.org/ INTRAILWAYS/Resources/b35.pdf. Accessed 5 Jan 2019. Kuroda, M., Ikeuchi, K., Ikeuchi, H., & Huang, M. (2018). Assessments of ICT policy options: The framework of input-output table linked with intangible knowledge stock. In K. Mukhopadhyay (Ed.), Applications of input-output model (pp. 65–110). Springer. Kurosaki, F. (2016). Reform of the Japanese national railways (JNR). Network Industries Newsletter, 18(4), 8–11. Maruyama, S. (2006). Competition structure and future postal reform in Japan. In M. Crew & P. Kleindorfer (Eds.), Progress toward liberalization of the postal and delivery sector (pp. 369–384). Boston: Springer. Milhaupt, C., & Pargendler, M. (2017). Governance challenges of listed state-owned enterprises around the world: National experiences and a framework for reform. Cornell International Law Journal, 50(3). Ministry of Internal Affairs and Communications. (2019a). Review and perspectives of post service (in Japanese). http://www.soumu.go.jp/main_content/000637335.pdf. Accessed 28 Oct 2019. Ministry of Internal Affairs and Communications. (2019b). White paper information and communication in Japan. www.soumu.go.jp/johotsusintokei/whitepaper/ja/r01/html/nd234130.html. Accessed 28 Oct 2019. Mizutani, F., & Nakamura, K. (2004). The Japanese experience with railway restructuring. In T. Ito & A. Krueger (Eds.), The Japanese experience with railway restructuring in governance, regulation, and privatization in the Asia-pacific region (pp. 305–342). New York: University of Chicago Press. Mizutani, F., & Nakamura, K. (2005). Effects of Japan national railways’ privatization on labor productivity. Regional Science, 75(2), 177–199. Mizutani, F., & Uraishi, S. (2013). Does vertical separation reduce cost? An empirical analysis of the rail industry in European and east Asian OECD countries. Journal of Regulatory Economics, 43(1), 31–59. Nash, A., Smith, A., De Velde, D., Mizutani, F., & Uranishi, S. (2014). Structural reforms in the railways: Incentive misalignment and cost implications. Research in Transportation Economics, 48, 16–23. Porges, A., & Leong, J. (2006). The privatization of Japan post. In M. Crew & P. Kleindorfer (Eds.), Progress toward liberalization of the postal and delivery sector (pp. 385–400). Boston: Springer. Robinson, G. (2017). Pragmatic financialisation: The role of the Japanese post office. New Political Economy, 22(1), 61–75. Sano, H. (2010). Japan scales back Japan post privatization. Reuters. https://www.reuters.com/ article/us-japan-markets-japanpost-idUSTRE62N1TX20100324. Accessed 5 Jan 2019. Taghizadeh-Hesary, F., Yoshino, N., Kim, C.J., & Mortha, A. (2019). A comprehensive evaluation framework on the economic performance of state-owned enterprises. ADBI working paper 949. Tokyo: Asian Development Bank Institute. Takeda, I., & Mizuoka, F. (2003). The privatization of the Japan national railways: The myth of neo-liberal reform and spatial configurations of the rail network in Japan – A view from critical geography. In N. Low & B. Gleeson (Eds.), Making urban transport sustainable (pp. 149–164). London: Palgrave Macmillan.

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Tamamura, H. (2004). The actual state and effect of privatization. East Asia competition policy forum. https://www.jftc.go.jp/eacpf/03/privatization.pdf. Accessed 5 Jan 2019. The Nippon.com. (2019). Japan post mulling halt to commissioned insurance sales. 28 Jul 2019. https://www.nippon.com/en/news/yjj2019072700459/japan-post-mulling-halt-to-commis sioned-insurance-sales.html. Accessed 30 Jul 2019. Yoshino, N., Helble, M., Takeda, A., & Shimazaki, S. (2018). Postal savings and financial inclusion in Japan. In N. Yoshino, J. Ansón, & M. Helble (Eds.), Postal savings: Reaching everyone in Asia (pp. 268–285). Tokyo: ADBI Press.

Chapter 8

Reform and Privatization of State-Owned Enterprises in India Kunmin Kim and N. Panchanatham

8.1

Introduction

Privatization is a broad concept in economics. It comprises various operations, such as the introduction of private capital, the selling of government-owned assets, and transition to a private economy. Consequently, three major attributes of privatization are as follows: (1) ownership measures, (2) organizational measures, and (3) operational measures. Ownership measures refer to the transformation of the ownership of public enterprises to private owners. Organizational measures relate to the limitation of the state control in public companies. These involve the employment of methods for the leasing and restructuring of the enterprises. Operational measures concern the way to improve the profitability and efficiency of public enterprises. Nations throughout the world have their own enterprises. Even though the term state-owned enterprise (SOE) has mixed meanings, in general it means that the state has significant control over the ownership of a business enterprise. Indeed, every state has a bound responsibility to have active and professional ownership to create value. Such value can include economic value, social value, sustainability value, livelihood value, and so on. These SOEs have legal bindings to achieve the state’s vision and mission. It is also the responsibility of the SOEs to work following a strategic method befitting a business to support themselves, achieve continued development, fulfill the purpose of their existence, and enhance the income of the state without incurring losses. SOEs need to improve the monitoring of the

K. Kim (*) Public Institutions Reform Division, Ministry of Strategy and Finance, Sejong, Republic of Korea e-mail: [email protected] N. Panchanatham Department of Business Administration, Annamalai University, Chidambaram, India © Asian Development Bank Institute 2021 F. Taghizadeh-Hesary et al. (eds.), Reforming State-Owned Enterprises in Asia, ADB Institute Series on Development Economics, https://doi.org/10.1007/978-981-15-8574-6_8

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performance of public policy assignments within the scope of their corporate business administration. People of any nation expect SOEs to act in a commendable way in their chosen area of business. Many managers report that their organizations have achieved sustainable development in the past and expect them to do so in the future. For instance, this brings both tangible and intangible benefits not only to the companies themselves but also to the society. Specifically, tangible benefits arise from reducing the costs and risks of engaging in business, while intangible benefits can increase firms’ brand reputation, attractiveness to talent, and competitiveness (UN Global Compact and Accenture 2010, 2013; Haanaes et al. 2011, 2012; Kron et al. 2013). However, evidence and case studies have shown that many SOEs do not contribute in accordance with the expectation of the population or the government policies. Therefore, it is necessary to assess the performance of SOEs, and SOEs in India are no exception. For example, research has identified low performance levels and systematic variations in performance as major weaknesses of India’s SOEs (Ahuja and Majumdar 1998). In addition, the labor laws almost entirely ignore the privatization of public enterprises and therefore are unable to support the economic growth of this country (Bharti and Ganesh 2016). The objective of this paper is to identify and discuss the reforms that India has carried out, including the privatization of stateowned enterprises. The structure of the rest of this paper is as follows. Section 8.2 presents the historical background of SOEs in India. Section 8.3 describes Indian SOEs in central and state governments. Section 8.4 analyzes the role of SOEs in India’s economic development. Section 8.5 discusses the privatization of SOEs in India. Lastly, Sect. 8.6 concludes.

8.2

Historical Background of SOEs in India

India became independent in 1947 and has had to deal with several obstacles, such as massive poverty, high illiteracy and unemployment levels, a low GDP, and disease. As necessity is reportedly the mother of invention, India’s necessity prompted the establishment of SOEs in independent India. The challenges including economic, social, developmental, and industrial problems caused India’s government to adopt appropriate industrial policies and launch SOEs, which was a major step toward becoming a developed country. In India, the main purpose of the five-year plan1 is to construct a socialistic model for the society, concentrating on economic growth, selfreliance, social justice, poverty alleviation and the eradication of all its developmental barriers. Hence, the five-year plan led to a mixed economy with due respect and

India’s first Prime Minister, Jawaharlal Nehru, presented the First Five-Year Plan to the Parliament of India, and it needed urgent attention. The First Five-Year Plan, which the government launched in 1951, mainly focused on the development of the primary sector. 1

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provision for both public sector and private sector entities. The government manages nationalized industries, such as public utilities, railways and communications, because these generate a revenue source. In contrast, due to the high risk and low returns, information shortage, and reluctance on the part of a number of private enterprises, the country has established state capitalist enterprises from imperfect product and factor markets (Gillis 1980). The Government of India has founded hundreds of SOEs covering various manufacturing and service sectors. Similarly, the state (province) governments of various states have founded hundreds of public enterprises since independence. There are reasons why the Government of India has shown more interest in SOEs since the country became independent. The previous industrial policy in India in the British regime resulted in the slow growth of industries; it appeared that the British rulers were not serious about developing Indian industries but aimed to retain India as a permanent market for British products. Therefore, there was a need for the state to intervene in the economic activities. The then Indian National Congress recommended and its committee emphasized the need for state intervention in all the economic activities of the country, including the establishment of SOEs (Gupta 1978). Dhar (1987) reported that a noteworthy record in the public enterprise history was the Burma Oil Company’s2 establishment of the first oil refinery under the British Government initiative in 1921 at Digboi (Chattopadhyay 1987). Similarly, tea plantations and coal mining3 were important industries in Assam during the contemporary period.

8.3

Indian SOEs of Central and State Governments

India has its own model for SOEs, taking into consideration unity in diversity. The central government owns enterprises with a partial funding arrangement from the private sector or equity market, but it controls the enterprises. This arrangement refers to the SOEs of the central government of India. The state governments of different states of India follow the same model. Both the central and the state governments in India own wholly funded and controlled enterprises, like Indian 2

David Sime Cargill founded the company as the Rangoon Oil Company in Glasgow in 1886 to develop oil fields on the Indian subcontinent. In the late 1890s, it passed into the ownership of Sir Campbell Kirkman Finlay, whose family already possessed vast colonial interests through their trading vehicle James Finlay and Co. It played a major role in the oil industry on the Indian subcontinent for about a century through its subsidiaries and in the discovery of oil in the Middle East through its significant influence over British Petroleum. It marketed itself under the BOC brand in Myanmar, Bangladesh (formerly East Pakistan), and Assam (in India) and through a joint venture, Burmah–Shell, with Shell in the rest of India. 3 The tea industry in Assam is about 172 years old. It occupies an important position and plays a very useful part in the national economy. Robert Bruce, in 1823, discovered tea plants growing wild in the upper Brahmaputra Valley. In 1859, the second most important tea company, the Jorhat Tea Company began operation.

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Railways. In these enterprises, the business model involves 100% government decision making, and the governments earn revenues or profits for their exchequer. Yet another truth in the SOE scenario of India is that, at times, the terms SOE, public sector, and so on are used interchangeably, as the difference is marginal. Indeed, both central and state governments of India need to enhance their value in the economy and society; hence, SOEs have acted strategically to position themselves in the competitive world. Evidence has indicated that the role of SOEs has increased in India for the first decade since independence. According to the source of public sector enterprises of the Government of India Department (2018), there are 257 operating central public sector enterprises that are profit making. However, there are some loss-making public sector enterprises. Furthermore, there are public sector undertakings that the state governments of various states of India own and control. According to the Public Enterprises (PE) Survey, Government of India 20114 in India, more than 80% of PSEs operate in five sectors, consisting of agriculture, mining, manufacturing, electricity, and services. The Central Exchequer receives the contributions of central public sector enterprises (CPSEs) through dividend payments, interest on government loans, and the payment of taxes and duties (Government of India 2005). Many plants in the public sector operate in backward parts of the county, which lack basic industrial and civic facilities, such as electricity, water supply, townships, and workforce. Therefore, by providing these facilities and founding public sector enterprises, both central and state governments can achieve balanced regional development.

8.4

Role of SOEs in India’s Economic Development

To understand the importance of Indian SOEs, it is necessary to review the industrialization strategy of this country since the 1950s. Moreover, the Commercial Policy Resolution (1956) sets out the scope of the economy for SOEs. Although the Constitution protects the private sector and private property, the room for investment is still a limitation. After the country gained independence in 1947, Indian enterprises in utilities and infrastructure, such as railways, ports, airports, and telecommunication and power units, were largely in the public sector. The existing private enterprises in several basic and capital good sectors only operated with the state’s permission. By contrast, the trade goods sector and intermediate production goods, such as cement, were open to the private sector (Mohanty and Reddy 2010). It is true that Indian SOEs have assisted this country in achieving economic selfreliance. The main purposes of enterprises include building infrastructure for economic development and promoting industrialization; promoting employment and balancing regional development; creating a self-reliant economy through import

4

Government of India. 2011. Public Enterprises Survey 2009–10. New Delhi.

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substitution and developing the capacity to export; generating surpluses for development by earning suitable returns; and preventing the concentration of private economic power (Seabright 1993). There were only five SOEs with total investment of 290 million rupees (Rs) (equivalent to $60 million at the 1955 exchange rate) in the initial period of the First Five-Year Plan (1952).Since the Second Five-Year Plan, with the implementation of the Industrial Policy in 1956, the government established a number of new SOEs in core and basic industries. It set up units producing steel, heavy engineering, fertilizer, electricity generation equipment, and machine tools, the majority of which obtained technological and financial support from the Russian Federation and other Eastern European countries. By the 1970s, the government had decided to nationalize the coal industry, large commercial banks, and all insurance companies. As a consequence, state (provincial) governments established a large number of enterprises (SOEs), of which many firms operated in the joint sector and private partners held up to49% of the shares. When the Indian government launched the program on deregulation and liberalization5 heading the Seventh Five-Year Plan, the number of CSOEs significantly increased by 244 (excluding commercial banks and insurance companies). By 2005–2006, these had declined to 239 because of the withdrawal and privatization of some leading CSOEs. The early 1990s witnessed the development of Indian SOEs, since mature public enterprises dominated key sectors; these had successfully expanded their production, opened up new areas of technology, and substituted imports in an array of capital goods sectors, with technical competence, which aided India’s ranking in terms of industrialization, and with a large pool of trained workers with technical skills, especially in the chemical and manufacturing industries. There is a changing scenario in which SOEs or public sector enterprises are passing through difficult times. Their challenges concern poor management, misuse of resources, poor accountability, and often huge losses. Therefore, governments across the world have been active in selling off these huge behemoths in the last few decades to improve the efficiency of the assets invested and to halt the huge drain on resources. India is no exception. Rama (1999) argued that public sector downsizing is necessary because it assists in reforming SOEs in developing countries. He stated that the reform may improve economic efficiency; however, it is necessary to consider the risks. Chakrabarti et al. (2017) claimed that it is very difficult to achieve this with full privatization, while it is possible to improve SOEs’ performance through corporate governance reforms. Therefore, policy makers should carefully consider massive privatization when restructuring SOEs. Likewise, Joshi (1999) emphasized the role of privatization in reducing social costs and dislocations. He concluded that privatization in South Asian countries cannot enhance the confidence in the private sector and that this leads to large-scale worker retrenchment. Consequently, the Indian government released a new industrial policy on 24 July 1991,

5

Liberalization is any process whereby a state lifts restrictions on some private individual activities.

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which many viewed as a framework for the privatization of many sectors. The restructuring process included entry to the private sector in the place of SOEs, disinvestment, listing SOEs on the stock exchange, withdrawing budgetary support for loss-making SOEs, more professionalism and corporate culture and so on. SOEs make important contributions to India’s economic development. Although the liberalized economic regime and globalization have transformed the role and functioning of SOEs, these enterprises still play a significant role in the socioeconomic development of this country (Mishra 2014).

8.5 8.5.1

Privatization of SOEs in India Conceptualization of Privatization in India

The conceptualization of privatization in India consists of the following: 1. Delegation: The government manages the ownership and responsibility of an enterprise. However, private enterprises can deliver the products or services while the state actively participates in this process. Delegation occurs via a contract, franchise, lease, or grant. 2. Divestment: The government sells the majority stake of the enterprise to one or more private enterprises. Therefore, the state manages some ownership and a minority stakeholder 3. Displacement: Deregulation is the first step. This process allows private stakeholders to enter the market and then private companies will displace the public enterprise step by step. 4. Disinvestment: In this case, the government sells a partial or entire public enterprise directly to private parties. In India, privatization is linked to the economic reforms issued in 1991. Generally, privatization means encouraging private sector participation in the management and ownership of public sector enterprises or SOEs. Reviews have shown that, in the late 1980s and early 1990s, it was a global trend to reform loss-making public sector enterprises through the process of privatization. Not only developing countries like India but also certain Western European countries initiated this practice and brought it into force. India is a mixed economy that includes both public and private sector enterprises. Private participation in SOEs accounts for 49%, and the new industrial policy considers this carefully. The need to privatize public enterprises arises because of their poor financial and operating performance. There are many advantages of the privatization of SOEs. They include a considerable amount of reduction in the burden on the government, strengthening of the professional competition, improving of the public finance, funding of infrastructure development, responsibility and accountability to shareholders, reduction of unwanted interference, a committed labor force, and so on. Figure 8.1 shows the growth of public sector undertakings and performance contracts in India.

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Fig. 8.1 Growth of Public Sector Undertakings and Performance Contracts. (Source: Public Enterprise Survey, 1988–89 to 2015–16)

Ahuja and Majumdar (1998) assessed the factors affecting the performance of 68 Indian SOEs in the manufacturing sector between 1987 and 1991. They found that both low performance and systematic variations in the performance parameters influenced the performance of Indian SOEs. Size has a positive relationship with efficiency, while age negatively affects efficiency. In addition, the results indicated that economic liberalization and reforms may improve the performance of SOEs. State-owned firms in the manufacturing sector, which are smaller in size, are the prominent candidates for privatization. These firms are also easily transferable to private investors. This result helps policy makers to make pragmatic policies and guidelines concerning state-owned enterprises and their privatization issues. Another interesting research work has offered an understanding of privatization. Mandiratta and Bhalla (2017) claimed that SOEs have lower proficiency than privately owned firms. Thus, the main objective of disinvestment6 is to decrease the participation of the public sector in the economic actions of the country to support the private sector. The study investigated the performance of 15 central public sector enterprises (CPSEs) in the manufacturing, mining, electricity, and service sectors of India through the public share offering mode over the period 2003–12. It employed indicators to conduct a ratio analysis, including the computation of the return on assets, return on equity, sales efficiency, net income efficiency, debt equity, dividend payouts, real sales, and employment levels. The results showed that the public offering mode entails performance changes in CPSEs disinvested

6 Government of India. 1993. Report of the Committee on the Disinvestment of Shares in PSEs (Rangarajan Committee), April. New Delhi.

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Table 8.1 Privatization versus Nationalization Factors Ownership

Privatization Firms owned by the private sector

Incentives

The profit motive acts as an incentive for owners and managers Private firms may ignore external costs (pollution) and external benefits Incentive to introduce new technology and increase labor productivity Private firms employ managers with the best skills Private monopolies, e.g., water/trains, may charge high prices Worked well for BT and BA

Externalities Efficiency Knowledge Natural monopolies Depends on industry

Nationalization Firms owned and managed by the government Workers may feel motivated if they feel that the company belongs to them The government can put social benefits above the profit motive Nationalized firms may find it hard to sack surplus workers Politicians may interfere based on political motives The government can set prices based on social factors Natural monopolies, like trains/water; non-profit services like health care

Source: Economic Times, 12 May 2017

through the involvement of retail investors. Besides, the research interpreted the achievement and failure of privatization in the Indian context. According to Kikeri and Nellis (2002), it is necessary to consider four determinants, namely commitment, competition, transparency, and mitigation, because these affect the privatization yield in India. Specifically, in the Indian context, the competition and transparency factors have high scores, while commitment and mitigation obtain poor scores. To overcome the issues of privatization, the government should implement options such as partial privatization, the streamlining of objectives, increased autonomy, and managerial accountability (Kay and Thompson 1986; Yarrow 1986; Vickers and Yarrow 1991). India’s privatization of SOEs has many advantages and disadvantages. One can always argue for and against privatization. According to Tejvan Pettinger (2017), privatization involves selling state-owned assets to the private sector. There is a belief that the private sector can run a business more efficiently, as it places more emphasis on profit maximization. However, critics have argued that private hands can exert their monopoly power in the market at the cost of the wider social costs. Table 8.1 provides points for this argument. Air India7 is currently burdened with a debt of about 52,000 crores and has salary arrears of approximately Rs 1200 crores, accrued since 2012. The salary for 27,000 pilots and crews of Air India is pending. As a result, the Government of India

Air India is the flag carrier airline of India with headquarters in New Delhi. It is owned by Air India Limited, a government-owned enterprise, and operates a fleet of Airbus and Boeing aircraft serving 94 domestic and international destinations. The airline has its hub at Indira Gandhi International Airport, New Delhi, alongside several focus cities across India.

7

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decided to undertake disinvestment8 and privatization. Policy makers and policy implementers always remember the key points of the solutions to ensure that the privatization process runs smoothly. Creative actions of privatization in India include: (1) deregulating—reducing regulations (often a defining characteristic of privatization); (2) contracting with the private sector to purchase a service (road construction); (3) establishing incentives to encourage the private sector to provide a service; (4) abandoning or shedding services; (5) reducing the demand for a service; (6) establishing quasi-public organizations (government enterprises or charters); (7) establishing separate corporations—profit and non-profit (authority); (8) supplying temporary help on the part of the private sector; (9) issuing vouchers (K-12 education); (10) issuing waivers; (11) selling or giving away government-owned assets; (12) establishing franchises; (13) leasing; (14) subsidizing or making grants available to the private sector; (15) relying on user fees rather than tax dollars to fund a service (hunting licenses); (16) discontinuing subsidies to public entities providing joint funding; (17) establishing public/private partnerships; and (18) setting up consumer selfhelp processes or using volunteers.

8.5.2

Advantage of Privatization

There are some advantages of privatization. First, the incentive in private companies is always higher than that in public enterprises. The managers and officials of a private company usually take care in the game, because their income is associated with the performance of the company, while this incentive is not present in public organizations. Consequently, privatization generates greater efficiency of the firm. Second, there is a considerable amount of political interference in a public enterprise, and this interrupts the company in terms of taking economically beneficial decisions. In contrast, private companies do not usually allow political factors to influence their performance. Third, all the goals in the process may be short term, because the government often expects to obtain more votes from the public and therefore is often interested in the upcoming elections. The long-term goals of the company are often based on political decisions. Finally, privatization may enhance the competitive capacity of the firm in the market and consequently benefits consumers.

8 Government of India. 2007. White Paper on Disinvestment of Central Public Sector Enterprises. New Delhi: Department of Disinvestment.

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Disadvantages of Privatization

However, privatization has some disadvantages. For instance, this process concentrates more on the target in profit maximization, while India is the second-largest democratic country in the world. The social responsibility activities are minimal when compared with those of SOEs. Private sector enterprises do not give much importance to transparency and keep their stakeholders in the dark. To achieve their goals, private enterprises make every effort, such as encouraging corruption, unlawful ways of accomplishing objectives, lobbying, and so on. A review of the privatized status has indicated that privatization results in high employee turnover, retrenchment, low salaries, and so on, causing a certain imbalance in the society. Privatization and price inflation go hand in hand. Many more inconveniences, disadvantages, difficulties, setbacks, and troubles have continued during and after the privatization of SOEs in India.

8.6

Conclusion

Reforms are mandatory in every sector of a society, particularly in developing countries of Asia, as nothing is permanent except change. Policy-making bodies need to discuss the changing environment of the business world and provide policy guidelines for them, inclusive of SOEs. One of the measures of reforms is the privatization of SOEs. The process of privatization has both advantages and disadvantages for a developing nation like India. This paper has presented the salient features of privatization. If public enterprises function like private sector organizations, very efficiently without actually privatizing the enterprises, they can satisfy both the agenda of profit making and the social responsibility. The process of reforms, including full and partial privatization, has to continue day by day to enhance the efficiency of SOEs in India. It is inevitable that social justice is necessary in the process of introducing reforms. Involving members of the public as shareholders of SOEs will certainly improve their performance and accountability. Granting funds and concessions should avoid loss-making and problematic public enterprises. Despite implementing product mix diversification, Indian manufacturing companies present poor performance, especially financial performance, because of the lack of modernization of machinery and upgrading of people’s skills. These firms make positive contributions to the operating margin before direct labor, but most of them lose at the earnings before interest, tax, depreciation, and amortization (EBITDA) level. There are two solutions to this issue, consisting of restructuring and disinvestments (Bose 2011). To improve the performance of Indian SOEs, the government agreed to allow them greater autonomy and improve corporate governance by adjusting the boards and enhancing the powers of these boards to make investment and strategic decisions

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(Khanna 2012). Further, it should adopt the following suggestions to reform Indian SOEs: first, enhance the power of SOE boards to undertake decisions after considering all the relevant interests; second, improve the independence of SOE boards; third, reduce the government interventions in the functioning of SOEs; fourth, simplify the ownership of SOEs by consolidating ownership in a single entity, like the State-owned Assets Supervision and Administration Commission (SASAC) in the People’s Republic of China, Temasek in Singapore, or Khazanah in Malaysia; fifth, provide greater recognition and protection of minority shareholder interests; and, finally, implement appropriate balancing of the interests of shareholders and other stakeholders (Varottil 2015).

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Kikeri, S., & Nellis, J. (2002). Privatization in competitive sectors: The record to date (Policy Research Working Paper Series 2860). Washington, DC: The World Bank. Kron, D., Kruschwitz, N., Haanaes, K., Reeves, M., & Goh, E. (2013). The innovation bottom line (MIT Sloan management review and BCG research report). Boston, MA: Boston Consulting Group. Mandiratta, P., & Bhalla, G. S. (2017). Pre and post disinvestment performance evaluation of Indian CPSEs. Management and Labour Studies, 42(2), 120–134. Mishra, R. K. (2014). Role of state-owned enterprises in India’s economic development. Workshop on state-owned enterprises in the development process, Paris, 4 April 2014. Mohanty, M., & Reddy, N. (2010). Some explorations into India’s post-independence growth process, 1950/51–2002/03: The demand side. Economic and Political Weekly, 45(41), 47–58. Pettinger, T. (2017). Advantages and problems of privatization. Economics, 12 May. Rama, M. (1999). Public sector downsizing: An introduction. World Bank Economic Review, 13(1), 1–22. Seabright, P. (1993). Infrastructure and industrial policy in South Asia: Achieving the transition to a new regulatory environment. Washington, DC: World Bank. UN Global Compact and Accenture. (2010). A new era of sustainability. UN global compact— Accenture CEO study 2010. http://www.accenture.com/SiteCollectionDocuments/PDF/ Accenture_A_New_Era_of_Sustainability_CEO_Study.pdf UN Global Compact and Accenture. (2013). Architects of a better world. The UN global compact— Accenture CEO study on sustainability 2013. http://www.accenture.com/Microsites/ungcceostudy/Documents/pdf/13-1739_UNGC%20report_Final_FSC3.pdf Varottil, U. (2015). Corporate governance in state-owned enterprises. Quarterly Briefing. NSE, 9 (April), 1–6. Vickers, J., & Yarrow, G. (1991). Privatization: An economic analysis. Cambridge, MA: MIT Press. Yarrow, G. (1986). Privatization in theory and practice. Economic Policy, 2, 324–364.

Chapter 9

Privatization of Iranian State-Owned Enterprises: Barriers and Policy Recommendations Mohsen Fazelian, Hooman Peimani, and Farhad Taghizadeh-Hesary

9.1

Introduction and Background

In today’s world full of complexity and rapid changes, economic organizations and governments are forced to change their plans more than ever due to their operational conditions, given the speed of operational changes is much faster than that of implementation of long-term programs. The global environment in which governmental and non-governmental organizations operate has become increasingly turbulent in recent years. Therefore, economic organizations must strategically change their approaches and perceptions of their economic operation into effective strategies to adapt to their changing operational environments while providing the appropriate and logical framework in order to implement their strategies wisely and thoughtfully. Within this context, strategic planning approaches developed in the private sector can help them deal more efficiently with operational environments that are undergoing dramatic changes. According to Jamshidian (2005), the extensive governmental control over the Iranian industrial and service sectors could not overcome the barriers to economic activities especially the increasing misuse of public resources, growing public debts, lack of any improvement in operational efficiency and mismanagement of the public sector.

M. Fazelian Bank Maskan, Tehran, Iran H. Peimani Independent Senior Consultant, Burnaby, Canada F. Taghizadeh-Hesary (*) Social Science Research Institute, Tokai University, Hiratsuka, Kanagawa, Japan Keio University, Minato-ku, Tokyo, Japan e-mail: [email protected] © Asian Development Bank Institute 2021 F. Taghizadeh-Hesary et al. (eds.), Reforming State-Owned Enterprises in Asia, ADB Institute Series on Development Economics, https://doi.org/10.1007/978-981-15-8574-6_9

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Privatization in appearance is a process whereby the public sector facilities and functions are transferred to the private sector. According to D’Souza et al. (2007), other firms for customers and market shares may provide the pressure required to stimulate greater efficiency and profitability, and identify competition as a major determinant of post privatization performance improvements. The authors suggest that while privatization should stimulate efficiency gains in competitive environments, there is no advantage to private ownership when market power exists. In fact, privatization stimulates greater competition in the goods market. If privatization involves splitting an industry into competing parts, the resulting competition may drive costs and prices down and cause greater competition for financing. After privatizing, a company has to finance investment through the market and thus must issue shares or borrow from financial institutions. When it does so, it will be competing for funds with other companies and thus must be seen capable of using these funds profitably. Since privatization is a strategy, it should always be applied to reach certain goals towards a balance between political and economic issues. It is true that, in many instances, the private sector is more efficient and that some countries have corrected their inefficient economic structure through privatization. However, these facts, by themselves, should not be the reason for countries with large public sectors to privatize them with the assumption that privatization will address all their economic problems. Rather, each country should identify the specific reasons for its economic problems to opt for the solutions appropriate for the specific needs and realities of the country. In short, there is no one single magic economic solution for all countries with public-sector dominant economies suffering from various economic problems. Against this background, Iran’s experience with privatizing its state-dominated economy is examined. In particular, this chapter investigates the effects of privatization on the performance of the privatized corporations in Iran The chapter concentrates on experiences of privatizations in Iran and challenges between Securities & Exchange Organization (SEO) performances and plans. Reviewing the experience of Iran as an emerging economy will provide valuable policy implications for other developing and emerging economies as well.

9.2

Privatization of Iranian SOEs

In general, the basic goal for privatization in developed and developing countries is economic growth through ending the role of big government in their economies credited with poor management and inefficiency, although the stated emphasis in each case could be more on one or the other depending on its specific conditions. Yet, the motivating goals of privatization for countries can make a much longer list, although some of them common strategic nature such as reducing government’s activities and expenses, stimulating competition in the market, increasing efficiency and effectiveness of state agencies and transferring ownership of public entities to generate income for cash-starving governments or investment for financing in public

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Fig. 9.1 Privatization progress in Iran (2001–2018). (Note: dates are based on Iranian calendar dates (Iranian calendar starts on March 21). Source: Iranian Privatization Organization, https://en. ipo.ir/uploads/ipo-21062019-5.pdf (accessed: Oct 29, 2019))

projects. Other goals are of secondary importance such as encouraging/expanding private sector’s participation, decreasing budget deficits, reducing public debts and subsidies; downsizing public sector and public servants and expanding the basis for corporate taxation and increasing government tax revenues. Against this general background, the privatization of Iran’s state-owned enterprises (SOEs) began in the post-Iran – Iraq war era leading to the transfer of a large number of public firms to the private sector beginning 1991 (Alipour 2013). The initiative gained momentum in the following decade as a result of certain developments, including the establishment of the Privatization Organization in 2002 and, particularly, the promulgation of the general policies of Article 44 of the Constitution in (2006). Iran’s privatization strategy and its associated policies have been affected by a variety of factors, but, above all, its governments’ policies towards the very concept of privatization and its expected outcomes for Iran. Within this context, the fluctuations in the governments’ revenue have also influenced their enthusiasm for privatizing SOEs to speed up or slow down the process. As evident in Fig. 9.1, the pace of the privatization of SOEs have fluctuated since 2001, when the initiative started in earnest. The phenomenal expansion of the Iranian public sector was not due to a strategic decision, but because of the necessities of the early years of the Islamic Revolution of 1979. Hence, according to Saebi (1999), the newly-established Iranian government after the revolution had no choice but to nationalize certain industries and build a semi-centralized economy. It had to do so to overcome the chaotic economic situation and revive the Iranian economy, which was on free fall following the

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Revolution. However, the deficiencies of the revived economy necessitated decreasing the government share of the economy for which the privatization of SOEs was a necessity. Furthermore, privatization was part of the economic adjustment policy in Iran’s First Development Plan of 1989–19941 (Taghavi 1994). At the beginning years of the First and also Second (from 1995 to 20002) Development Plans, privatization and government withdrawal from economic activities were known as one of the required solutions to end the financial crises and increase of the economic growth rate. The two five-year plans assumed that privatization could make fundamental positive transformation in the direction and nature of the country’s economic growth. Moreover, earning financial resources was an additional reason for the government’s privatization initiative. For this purpose, the valuation of the public unit subject to privatization has high importance. Yet, as discussed latter in this chapter, the valuation process has proven to be problematic with the effect of not helping the achievement of the privatization process’s objectives. Privatization, according to Sloman and Wride (2009), will expose the country’s industries to market forces from which will flow the benefits of greater efficiency, faster growth and greater responsiveness to the wishes of the consumer. The private firm is interested in making profit, and so it is more likely to cut costs and be efficient. However, privatizing SOEs has not achieved its main objectives in Iran for a variety of reasons as discussed below.

9.3

Reasons Behind the Unsuccessful Privatization in Iran

Here we brought six reasons behind the unsuccessful privatization in Iran and other developing countries; namely unrealistic goals setting, lack of comprehensive plan and existence of rush, privatization without renovation, absence of a suitable information system, insufficient expertise and finally capital market bugs.

9.3.1

Unrealistic Goals Setting

Experiences reveal that implementation of a large privatization plan in a short period of time is not realistic. The privatization plan in Iran started by a ministerial decree in 1991. According to a survey done by the Iranian government, until mid- March 1992 (end of Iranian year 1370), 1875 public companies were identified and audited for privatization whose total nominal assets valued at about 28 trillion Iranian Rials (IRR) while their market value were more than 400 trillion IRR (1 USD ¼ 180 1 2

1368–1372 (Persian calendar years). 1374–1378 (Persian calendar years).

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IRR as of 1992). However, in March 1991, the total liquidity of the private sector of Iran was estimated at about 28.6 trillion IRR. Therefore, due to the vast liquidity gap, privatization of such huge amount of public assets was not possible in a short period of time. Consequently, the government’s privatization decision was unrealistic, which became one of the important reasons for the unsuccessfulness bid for privatization.

9.3.2

Lack of Comprehensive Plan and Existence of an Unjustified Rush

Unlike several successful experiences in Asia, Iran’s privatization initiative has suffered from a lack of comprehensive plan and an unjustified rush to privatize SOEs. For example, Turkey initiated its ambitious privatization process in 1980s (Onis 1991). In its privatization plan, the main goals and the associated necessary legal changes to the Turkish law were determined. The plan also set a realistic objective to begin the major undertaking by identifying 32 public entities for privatization in the first phase with clear spelled out steps for privatizing five of them to kick start the process. Likewise, Malaysia devised a comprehensive plan for privatization, which considered 236 public entities for privatization. However, in the Iranian case, not only has the privatization initiative lacked a realistic plan for privatizing a manageable number of public entities supported by the required legal frameworks, it has also lacked even any devised guiding principles for privatizing SOEs. According to Saebi (1999), the large number of identified SOEs for privatization were supposed to handle their privatization by themselves.

9.3.3

Absence of Suitable Information System

Another main problem which has slowed the privatization initiative in Iran is that buying companies’ shares is not well-publicized and thus known means for investment in Iran. According to Razmi (2007), about 90% of Iranian people did not know this type of investment opportunity or at least were not aware of its advantages. While the situation has improved over time and, today, more Iranians are aware of it and/or active in the financial market as shareholders thanks to the marketing initiatives of investment firms and the expansion of private banking, for example. However, even today, the linkage between the capital market and the privatization process is still not strong enough to facilitate the process by availing the stray capitals to SOEs in need of private funds.

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Insufficient Expertise in Privatization Process

Hiring public sector managers as private sector executives, which has been widelypracticed since the privatization bid started in Iran, is one of the obstacles to a meaningful privatization. Despite the expectation that the privatized entities will not return to their inefficient and counter-productive practices of their previous public sector era, evidence suggests that they have continued such practices thanks to their public sector managers who influence their shareholders’ decisions. Therefore, it can be said that beyond the ownership issue, the most important principle in privatization is that of management.

9.3.5

Capital Market Bugs

Underdevelopment of the capital market in Iran is a main reason for the failure of the privatization plan in Iran especially during the First and Second Development Plans. This is not a problem specific to Iran, but a prevailing one in most of the developing countries suffering from the absence of a coordinated mechanism for the operation of their capital markets with maximum efficiency. Thus, to address this problem, these countries’ SEO must operate as the sole active financial institute in their respective financial market ensuring the availability and a steady flow of capital. Reflecting on the Iranian case, Taiebnia and Mohamadi (2004) state that the privatization process through selling shares extends private ownership and expands to the availability of liquidity and private sector savings, capital investment, and nation’ participation in economic affairs. As a result of the expansion of share ownership, transactions in the Iranian capital market have increased and new and diverse financial institutions have also emerged. This positive development must be strengthened by putting in place a mechanism to ensure that this capital market be controlled by the Iranian SEO to prevent the supply of stocks beyond the market’s handling capacity. The lack of this requirement became apparent as the Tehran stock exchange market acting as the main Iranian stock exchange market did not operate as the leading capital authority, but just as a driver of the private capital. Such role was not even considered until 1997 when the Iranian stock exchange faced a recession and the validity of the privatization policy was questioned. Reflecting the malaise of other developing countries, the capital market in Iran has not had an important role in Iranian financial market for which the main culprit is the domination of the Iranian financial market by bank loans to leave a small share for the capital market, which is the case in many other developing Asian countries.

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Other Reasons Behind the Unsuccessfulness of the Privatization Plans

In addition to the aforementioned major reasons, there are additional reasons for the unsuccessful result of the Iranian privatization plan, which continued through Iran’s Third and Fourth Development Plans ending in 20103 as briefly discussed below: (i) Failure to transfer the effective ownership share to the private sector whether natural or legal persons. The available statistics reveal that during the Second Development Plan, privatized shares of the companies were sold to a large number of individuals each with a small amount of shares and thus insignificant say in the management of their respective companies to practically exclude them from influencing. People in such privatization plan act as retail investors waiting for their shares’ dividend or an increase in their prices to sell them. As the Iranian government has adopted a view toward repaying its debts through transferring the shares of some SOEs to any buyer regardless of whether or not such transaction will help achieve the other objectives of their privatization, increasing their productivity has not been considered in the privatization approach. (ii) Some Iranian public organizations such as the Social Security Organization and National Pension Fund were in priority for privatization because of their important responsibilities and the high level of liquidity or debt of public corporations to them. Consequently, in reality, the main transfer of funds as a result of privatization happened between different public sector entities buying each other and the share of real private sector in this privatization case was little. At the end, the government did not receive a significant amount of funds from the private sector, which betrayed a major objective of the privatization plan. (iii) The Iranian privatization plan has mainly targeted the manufacturing companies with the effect of excluding the bulk of the public service providers also in need of privatization, by and large. (iv) In absence of a clear comprehensive bill covering the entire privatization plan and providing for means to deal with its challenges, the unorganized passage of individual privatization bills have caused confusion and create distrust of the government policies for the private sector. (v) The absence of separation of the social goals from financial ones in the implementation of the SOEs’ privatization is another hindrance to their successful privatization. For instance, the law of assignment of public shares to veterans and workers has used the privatization as a tool for supportive social policies for the vulnerable social groups. This is due to mixing the Iranian government’s plans for redistribution of wealth with privatizing the SOEs, 3

1388 (Persian calendar year).

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which are contradictory and damaging for both purposes, in the long-term as not sustainable policies. Thus, since many of the covered social groups for the redistributive objectives who received the priority for the SOEs’ share transfer, are not financially capable to afford their shares, their shares have been undervalued or they have given financially unjustifiable special bank credits to enable them buy the shares.

9.4

General Challenges Facing Privatization in Iran

This section identifies the six major categories of challenges to the successful privatization of SOEs in Iran.

9.4.1

Cultural Challenges

The main cultural hurdles to achieving the privatization goals are as follows: (a) A prevailing negative view about privatization, especially due to the justified public concern about an increase of unemployment caused by privatization, and even about the private sector. It is therefore important to make change in the country’s economic culture to make clear the necessity of a vibrant private sector as the main driver of a dynamic and effective economy. In addition, it must become clear that without private sector investments, the creation of new work opportunities and thus reducing unemployment are not possible. (b) The weakness of the culture of entrepreneurship is a factor, which can be considered as the barrier to the mobility of the Iranian economy. Entrepreneurs could help grow the Iranian economy by their new creative ideas, through identifying the relative advantages of the economy and with their skills for the mobilization of the required financial and human resources to achieve economic development.

9.4.2

Human Resources

In order to have effective privatization, training and preparation of skillful human resources to advance privatization is required. The latter is in shortage in Iran. In addition, the human resources of the SOEs to be privatized are the most significant available assets to be kept. The existing rules and regulations of the country are not supportive enough for the redundant workers caused by privatization. In some cases, such people have not been sufficiently compensated for their lost jobs.

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Economic Challenges

In some privatized SOEs, even if the performance of the new management is acceptable, they still face a slowdown in their performance, because of inappropriate economic, industrial and commercial macro-environment prevailed in Iran. In this regard, the following issues are outstanding: (a) (b) (c) (d) (e)

The absence of a strong financial urgency for privatization. The absence of necessary liquidity. Control of stock exchange by competitors. Distortions in investment decisions. Inconsistency of the development plan’s targets with the privatization plan’s objectives.

9.4.4

Pricing Barriers

Lack of an appropriate pricing system for the subjected units for privatization is another issue. Failure to do comprehensive, fair and accurate stock evaluation and pricing of the selected SOEs for privatization will result in the failure of the privatization plan. While some concerned entities expect to evaluate the value of SOEs based on their assets, others preferred the pricing based on profitability. The difference in the above two views raised a lot of debates in Iran due to the problems associated with either of these methods, given valuating SOEs based on their assets, which do not generate revenues makes their pricing unrealistic, while SOE prices in capital market reflect their profitability without regard to their assets’ value. Public companies usually cannot use their assets properly resulting in their profits becoming far lower than their assets’ profitability. Moreover, since they enjoy financial perks enabling them to use foreign currencies at a cheaper rate of those available to the private sector, the book value of their machinery, their depreciation rate and the balance of their assets in financial statements are substantially different from the realities. In consequence, their profitability in their financial statements are not matched with their real performance. Additionally, the dependency of the pricing commission for the deal brokers to the value of the SOEs to be privatized has prompted a tendency for the evaluators benefiting from such deals to price these SOEs higher than their real prices. This tendency is reinforced by the Iranian government’s objective of financing the budget deficit through privatization.

9.4.5

Political Barriers

Political barriers are yet another challenges to privatization in Iran with various manifestations such as the following:

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(a) Lack of a national political consensus about privatization to prompt opposition within the Iranian political system affecting the implementation of the privatization plan. (b) Concerns among the ruling elite about the creation of economic power for the private sector enabling them eventually to create their power block while expanding their control to the strategic industries, mines and infrastructure.

9.4.6

Legal Barriers

Legislative unpredictability with the effect of creating uncertainties about the economic direction of the country and its impact on the private sector is another major challenge to the privatization plan. Controversial, contradictory, short-lived, changing and partisan legislations have made the economic situation unsafe and unpredictable for the Iranian private sector. Within this context, certain issues are noteworthy as follows: (a) Lack of a comprehensive law applicable to the privatization procedure, although, in recent years, the policies of the Iranian constitution’s Clause 44 have covered this gap to some extent. (b) Absence of a set of comprehensive and practical investment protection rules. (c) Overdue necessary reforms in basic labor, commerce, export and import, taxes and social insurance laws. (d) Lack of a strong social security (insurance) system to reduce the effects of unemployment due to privatization. (e) Lack of equal treatment of the private sector and the public sector vis-à-vis the tax laws.

9.5

Results of Implementation of General Policies in Privatizations

After over 18 years of implementation, it is obvious that the main privatization goals have not been achieved and the privatization practice has deviated from the plan. Examples include the creation of a new economic sector not defined in the privatization plan (public, cooperative/semi-govermental and private). The new sector and it's comprising businesses have out-grown their public sector counterparts. This sector uses the public capacities in all fields (e.g., financial, insurance, transportation and export/import) while not accepting almost any government oversight and the country’s laws. The cooperative/semi-govermental sector's share in the Iranian economy is significant, the public sector is in the shambles and the private sector is in a deep recession despite its initial boost.

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Betraying a very basic objective of the privatization plan, namely downsizing the public sector in favor of the private and cooperative sectors, the creation of new public companies has never stopped thanks to government directors with various excuses creating them to keep expanding the public sector. In short, real privatization has never happened, the real private sector, not the public sector entities now owning many privatized SOEs acting as private companies, has never been empowered. Azar et al. (2011) hold that the experience of privatization in Iran has not proved to be a good solution for the governments’ problems and Iran’s economic growth. Their empirical comparison of a number of the privatized large corporations’ performance over 2–3 year periods before and after their privatization, shows no improvement in their performance in comparison to their pre-privatization.

9.6

Conclusion and Recommendations

Privatization, if conducted properly, could be beneficial to their respective countries in many ways. They include decreasing the financial pressure of SOEs on countries’ budgets, improving their efficiency, improving distribution of incomes, minimizing the public sector, empowering the private one, extending the capital market, promoting competition and providing consumers with options Phi et al. (2020). Privatization cannot lead to economic growth by itself unless it is accompanied and supported by a range of reforms in many other fields such as the mentioned legal one. Assessing the legal aspects of privatization programs in developing countries indicates that privatization rights in these countries have a fixed status and, thus, is not dynamic to meet the realities of different economic sectors and their forming components. Certainly, success in the full implementation of privatization plans to ensure achieving all their objectives, requires the development of a comprehensive legal framework for privatization. In Iran, legal obstacles have surely paralyzed the privatization plan as a major factor. Evidence suggests that contrary to the expectations, the Iranian privatization plan has not been able to reduce the size of the government and the role of SOEs in the Iranian economy. Moreover, the trend of public corporations’ debt to the banking system has been increasing, indicating that the privatization policy has not improved the financial position of the government either. Although the effects of privatization on employment are generally ambiguous, the privatization method can play an important role in this regard, which is yet to be realized in Iran now suffering from a two-digit unemployment rate (ILO 2020). Policy Recommendations Drawing on the Iranian experience, the following policy recommendations are worth mentioning both for Iran and also similar countries going through or planning for privatizing their SOEs:

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Small-Scale Privatization Program Should Come First As the Iranian government started privatization with large companies with high price tags, the private sector could not afford buying their shares. The process should have been started with small and less expensive companies’ shares to help the private sector gradually generate the required capital for buying those of the larger companies, while the economy is growing. The merit of this approach is evident in the case of Central and Eastern European countries. They have adopted separate programs for privatizing small-scale enterprises, usually in the early phase of transition. Examples include the Czech Republic, Estonia, Hungary, Latvia and Poland, each of which has used a different method, for example, auctions in the case of the Czech Republic and concessions to insiders in that of Poland. Keeping these experiences in mind, Uvlaic (2003) concludes that by distinguishing between small-scale and large-scale privatization, the problems that delayed privatization of larger firms have been avoided, including high capital requirements, major restructuring needs, and regulatory weaknesses. Small firms proved much easier to privatize than larger ones, because most small firms in transition economies were in sectors such as trade and services, and therefore carried out activities with simpler technology, easy entry and rapid returns (that help to reduce both uncertainty and risk for generally risk-averse post-transition investors). Sufficient Authority for Iranian Privatization Organization (IPO) Inadequate authority has been granted to IPO in the Iranian process of privatization only to serve as another obstacle slowing down the privatization process. IPO does not have adequate authorities in this regard and sometimes when the shares of a company are divested there are so much pressure from the officials and the Parliament on this organization that it seems that its role and mission are ignored. Therefore having enough authority in the privatization process is important and recommended. Required Managerial Reforms in Privatization Process Resistance in the SOEs against privatization is another obstacle in the way of privatization. Such resistance always exists as the SOEs’ directors fear losing their positions and benefits. The main advantage of the private sector over SOEs is that due to the competitive environment, for continuing their activity the private companies have no choice but to promote the quality of their products and services, which is achievable through modifying their management structure. However, one of the main problems in the process of privatization in Iran is that the SOE’s shares are transferred without transferring the authorities and thus managerial power, which will lead to no change in the structure of the companies necessary for elevating their productivity. Other Practical Recommendations for Effective Privatization Privatization in Iran and similar transitional economies can be made more effective by the following ways: (i) Transparency of policies to the public; (ii) Stabilizing the macroeconomic status of the country;

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(iii) Considering the local and national economic culture and not just the dictated policies from international organizations; (iv) Reviewing the experiences of previous attempts at privatization in Iran and similar countries; (v) Liquidating non-productive enterprises and using their properties in more profitable ways, instead of privatizing them; and, (vi) Establishing a fully independent advisory committee for privatization of SOEs.

References Alipour, M. (2013). Has privatization of state-owned enterprises in Iran led to improved performance? International Journal of Commerce and Management. https://doi.org/10.1108/ IJCoMA-03-2012-0019. Azar, A., Lashgari, Z., & Amraee, H. (2011). The comparative survey of the performance of the privatized its challenges and solutions. Journal of Financial Economics, 5(16), 9–25. D’Souza, J., Megginson, W., & Nash, R. (2007). The effects of changes in corporate governance and restructurings on operating performance: Evidence from privatizations. Global Finance Journal, 18(2), 157–184. ILO. (2020). ILOSTAT database. Geneva: International Labour Organization. Data retrieved in June 21, 2020. Jamshidian, M. (2005). Productivity improvement and strategies for state owned enterprises. Iranian Economic Review, 10(2), 39–55. Onis, Z. (1991). The evolution of privatization in Turkey: The institutional context of publicenterprise reform. International Journal of Middle East Studies, 23(2), 163–176. Phi, N. T. M., Taghizadeh-Hesary, F., Tu, Ch. A., Yoshino, N., & Kim, C. J. (2020). Performance differential between private and state-owned enterprises: An analysis of profitability and solvency. Emerging Markets Finance and Trade. https://doi.org/10.1080/1540496X.2020. 1809375. Razmi, S. A. (2007). Privatization in Iran reasons and performance. Mashhad: Mashhad University. Saebi, M. (1999). Privatization in the Islamic Republic of Iran. Asian Review of Public Administration, 6(2), 156–160. Sloman, J., & Wride, A. (2009). Economics (7th ed.). Upper Saddle River: Prentice Hall. Taghavi. (1994). Privatization in the first development plan of the Islamic Republic of Iran (in Persian). Tahghighate Mali, 1(4), 35–71. Taiebnia, A., & Mohamadi, H. (2004). Comparing the efficiency of investments in Irans private and governmental sectors: An approach to privatization. The Journal of Planning and Budgeting, 9(4), 3–36. Uvalic, M. (2003). Privatization approaches: Effects on SME creation and performance. In R. J. McIntyre & B. Dallago (Eds.), Small and medium enterprises in transitional economies (pp. 171–184). Houndmills/New York: Palgrave Macmillan in association with the UN University/WIDER.

Part III

Evaluation of Performance and Country Studies

Chapter 10

Necessity of Developing a Comprehensive Evaluation Framework for State-owned enterprises Farhad Taghizadeh-Hesary, Naoyuki Yoshino, Chul Ju Kim, and Aline Mortha

10.1

Introduction

State-owned enterprises (SOEs) are important players in many economies, particularly in developing Asia. According to a 2017 study by the Organisation for Economic Co-operation and Development (OECD), central governments of 40 countries, excluding the People’s Republic of China (PRC), owned 2467 commercially oriented enterprises, accounting for around $2.4 trillion and employing 9.2 million people in 2015. The PRC itself has by far the biggest portfolio, owning 51,000 enterprises, valued around $29.2 trillion and employing 20.2 million people (OECD 2017). SOEs often dominate key sectors in the economy, as significant borrowers and trade controllers of major exports and goods. They also command a sizable share of public resources in many countries. In current and/or former socialist economies, for example, their SOEs represent a significant share in the economy. These types of enterprises also actively provide social services (Forfas 2010) and preserve social stability (Huang et al. 2010). They thus often dominate sectors such as finance and networks. In 2015, 51% of global SOE activity (with the exception of Chinese ones) concentrated on electricity, gas, transportation, telecom, and other utilities,

F. Taghizadeh-Hesary (*) Social Science Research Institute, Tokai University, Hiratsuka, Kanagawa, Japan e-mail: [email protected]; [email protected] N. Yoshino Keio University, Minato-ku, Tokyo, Japan C. J. Kim Asian Development Bank Institute, Chiyoda-ku, Tokyo, Japan A. Mortha Graduate School of Economics, Waseda University, Shinjuku-ku, Tokyo, Japan © Asian Development Bank Institute 2021 F. Taghizadeh-Hesary et al. (eds.), Reforming State-Owned Enterprises in Asia, ADB Institute Series on Development Economics, https://doi.org/10.1007/978-981-15-8574-6_10

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13% 5%

500

SOEs' operating revenue as % sum of top 180 companies’ operating revenue

25%

4,500

0%

0 PRC

Rest of the World

2016

2017

Total SOE's operating revenue

PRC = People’s Republic of China, SOE = state-owned enterprise. Notes: An SOE is defined as at least 50.01% of the capital owned by the government. Figures are based on 180 companies with the highest operating revenue. Source: Authors’ analytics based on Bureau van Dijk’s Orbis database. Fig. 10.1 Share of Operating Revenue of State-Owned Enterprises among Top Companies, 2009–2017. PRC People’s Republic of China, SOE state-owned enterprise. Notes: An SOE is defined as at least 50.01% of the capital owned by the government. Figures are based on 180 companies with the highest operating revenue. (Source: Authors’ analytics based on Bureau van Dijk’s Orbis database)

representing around 70% of total employment in these firms (OECD 2017); the finance sector represented 26% of SOE activity. In the PRC, in particular, financial firms hold over half of the SOEs’ value. Manufacturing, electricity, gas, transportation, and the primary sector each accounted for at least 5% of the value. Figure 10.1 shows the share of SOEs’ operating revenue in the top 180 companies with the highest operating revenue according to the Orbis database of Bureau van Dijk. In 2017, SOEs represented 22% of the firms with the highest revenue, of which 13% were from the PRC. In addition, the share of SOEs within this category has been almost constant since 2009. Attempting to fulfill multiple and conflicting roles such as providing social services while operating commercially can negatively affect SOEs’ performance (Forfas 2010). The issue of an absence of clear objectives, even among SOE managers, was raised as early as 1981 by Aharoni (1981) and remains a problem nowadays (Song 2018). Moreover, SOEs face different issues than their private counterparts. Despite questionable efficiency, few SOEs are ever liquidated. They usually operate in relatively noncompetitive markets and have their autonomy limited by government interventions. Managerial techniques in SOEs have proved inadequate for commercially operated firms, especially under the profit-sharing

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system in the PRC (Fu et al. 2008). While SOEs play a recognized role in providing social services, economists tend to look down on the overall economic performance of SOEs (Perkins 1996; Arocena and Oliveros 2012). At the same time, consensus is lacking on how to evaluate their performance, leading to differing conclusions from one study to another (Huang et al. 2010; Elliott and Zhou 2013). As enterprises receiving direct financing from governments, SOEs are expected to produce economic results—and crucially to evaluate these results in an exhaustive manner. Knowing which aspects of SOEs’ performance to target for improvement is a potentially useful tool for policy makers. It could also contribute to increasing the economic output of a country, especially where SOEs represent a significant share of the economy. In this research, we attempt to develop a comprehensive framework for evaluating the economic performance of SOEs by including indicators such as profitability, operation, structure, and per capita variables. Using principal component analysis (PCA) our statistical analysis aims at providing tools to assess the performance of SOEs that will enable central governments to increase the productivity of SOEs— and thus public capital—and to boost economic growth. In this analysis, we define SOEs as companies with at least 50.01% of their shares owned by a central or local government. We do not consider SOEs in which a government has indirect ownership, nor do we take into account firms where a government does not hold a majority of the shares.

10.2

Literature Review

The literature review introduces studies assessing the performance of SOEs. While evaluation methods vary from one study to another, the assessments favor looking at efficiency, productivity, and profitability. Studies especially focused on socialist economies, including former ones. In particular, researchers have analyzed SOEs in the PRC, where such firms feature in large numbers. Although many studies have assessed the economic performance of SOEs, they use different estimation methods depending on their analysis. Some authors evaluate performance based on profitability and other financial indicators, while others explored the difference in productivity and efficiency between SOEs and privately owned firms. Academics concur that SOEs generally exhibit lower efficiency than their private counterparts. Perkins (1996) showed that private firms in the PRC surpassed SOEs in terms of their total factor productivity (TFP) and that firms located in the Shanghai area had a lower TFP than those in the Shenzhen and Guangzhou areas. In general, the study showed that export-oriented SOEs have a higher TFP. Arocena and Oliveros (2012) used a double bootstrap data envelopment analysis model to compare pre- and post-privatization efficiency in Spanish SOEs and their closest private competitors. Their results revealed no significant difference in efficiency between SOEs and their private counterparts before privatization, but the efficiency

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of newly privatized firms significantly increased while that of their private competitors did not. Elliott and Zhou (2013) showed that non-exporting SOEs in the PRC have the lowest productivity, behind private domestic and international firms. When taking into account export status, however, SOEs become the most productive, even ahead of foreign exporters. Generally speaking, efficiency or productivity variables are broadly used indicators in evaluating performances of SOEs. In an attempt at assessing the performances of managers in Chinese SOEs, Zhuang et al. (2012) used costs, as well as efficiency indicators (management, technology and talents) as indicators. Moreover, there are studies concluding that reforms could improve efficiency. For example, the 1998 reform in the PRC1 in particular helped increase the productivity and efficiency of SOEs (Fu et al. 2008). Reform of profit-sharing and bonus payments also increased the productivity of Chinese SOEs by creating incentives for better performance and nurturing a more competitive market (Yao 1997). In Viet Nam as well, following the Doi Moi economic reforms, the TFP of SOEs grew at a rate of around 3%, accounting for 40% of the change in output of the firms (Ngu 2003). By comparing the performance of public and private firms in a Bertrand competition setting in which firms compete on prices rather than quantities, Nguyen (2015) provided a theoretical framework that explains why SOEs’ profitability dropped: the trade-off between profits and social welfare enhancement—as SOEs prioritize the latter, their profits are relatively low. In a recent study, Song (2018) analyzed the effect of the SOE reform in the PRC, and concluded that, although the reforms led to indubitable improvements in productivity, SOEs are still lagging behind their private counterparts. Another way to evaluate the performance of SOEs is to analyze more diverse factors such as profitability and financial indicators. Profitability has been a popular indicator of the success of SOEs among managers for a long time, as proved by Ramamurti (1987). When asked about weights to put on various indicators of success of SOEs, such as employment creation, export promotion, growth in sales, import substitution, good employee relations, technological independence, regional development, Indian managers were shown to consistently put a larger weight on profitability, regardless of the type of SOEs or their positions in the firm (Ramamurti 1987). Aivazian et al. (2005) used profitability indicators such as return on assets and return on sales, efficiency indicators such as output and sales per employee, and

1 In 1998–2003 alone, the number of SOEs in the PRC decreased by about 23,600 and their labor force by 13 million people. This process, promoted under the gaizhi policy for ideological and political reasons, took place at a large scale only after the central government adopted its policy of “grasping the large, letting go of the small” (zhuada fangxiao) in 1995 (Song 2018). A group of state-controlled holding firms emerged in the SOE sector as a result of the ownership reform. Importantly, gaizhi created an essential channel for transferring state production assets to the non-state sector, which can be viewed as a reallocation of resources to more productive uses, which contributed to the rapid growth of this sector. Moreover, ownership transformation helps both local and central governments to reduce the financial burden caused by nonperforming SOEs—a win–win situation (Garnaut et al. 2006).

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investment indicators in the PRC, while other authors (e.g., Lin and Rowe 2006) tend to base their assessment solely on profitability, which can be measured by return on assets (ROA), defined as net profits over total assets (Astami et al. 2010; Song 2018). Other studies even use a more comprehensive framework by using various financial indicators such as revenue per employee (gross margin), return on equity (ROE), profit margin, and debt burden (e.g., Abramov et al. 2017; Song 2018) or profit margin, ROE, current ratio (current assets over current liabilities), and solvency ratio (shareholder funds over total assets; e.g., Szarzec and Nowara 2017). Finally, leverage, gross profit, operating and non-operating revenue, costs, expenses and income as well as income before tax were used by Ho and Tsai (2018) to evaluate the performance of SOEs in Taipei, China. A nonconventional framework of evaluation can also be used to capture SOE performance in a more comprehensive manner. Some researchers have attempted to assess whether SOEs’ economic behavior was in line with profit maximization, and therefore were operating as commercial firms. Xu and Birch (1999) concluded that this was the case for SOEs in the energy and electricity sectors in Argentina, while firms in service-oriented sectors focused on employment maximization. Similarly, Zhuang et al. (2012) used the X-inefficiency evaluation framework to evaluate SOEs in competitive markets, through a comparison with their private counter-parts. Kloviene and Gimzauskiene (2016) highlighted that using typical profitability and financial indicators as performance indicators for SOEs was not appropriate as these firms exhibit special features. Instead, they advise that accountability and performance regulators be evaluated using qualitative methods. Overall, there is no academic consensus on how to evaluate the performance of SOEs. Some studies prefer productivity and efficiency criteria, while others make extensive use of financial and profitability indicators. While profit making is important, focusing solely on this criterion when analyzing SOEs will mislead the policy makers. In addition, because many SOEs focus on improving social welfare rather than making profit, such objectives should be duly taken into account when evaluating their performance. Due to the lack of data, however, our analysis will not look at SOEs’ social impact. The aim of this study is to provide a comprehensive framework for evaluating performance, combining various indicators instead of relying solely on profitability. Our approach most resembles that described by Ahuja and Majumdar (1998), in which the authors used data envelopment analysis, a nonparametric method, to create an overall performance measure of Indian SOEs by computing a score from gross fixed assets, value added, number of employees, and profitability ratio. The approach is unique in that we study various indicators— not only profitability or efficiency—and combine them into a comprehensive performance evaluation framework using a PCA methodology.

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Statistical Analysis

The following section introduces the data and variables. It also presents the statistical method and the transformation of the data.

10.3.1 Data and Variables Variables necessary for the study were carefully selected from the literature review in line with the theoretical model. As demonstrated in equation (19), the optimal objective function of an SOE involves three groups of variables: per employee profit, per employee costs, and liquidity. In addition, we reviewed the literature to find that, first, one way to evaluate the performance of firms is to consider their profitability indicators, as many authors highlighted. For this reason, we selected four variables to represent profitability: ROE (Var 1), ROA (Var 2), profit margin (Var 3), and cash flow over operating revenue (Var 4). ROE and ROA are obtained using firms’ profit–loss statements before tax. As using ROE and ROA is the most traditional way of evaluating how a firm manages the capital it is entrusted with, they are key elements for the assessment of the profitability of SOEs. Positive profit margin and positive cash flow reflect the profitability of a firm. Unlike Astami et al. (2010), for example, we chose several indicators of profitability, rather than only one, to provide a more comprehensive framework of evaluation. The second type of indicators used in this study is operational ones. In this category, we include two variables: debt due days (Var 5) and ratio of export revenue over operating revenue (Var 6). Debt due days are understood as a default variable in this study—the variable embodies the delay in repayment of installment and interest fees owed by an SOE to a banking institution. If this delay is over 90 days, then the company is considered as defaulting. There might be some concerns about using debt due days as an indicator of default, as few SOEs ever end up in bankruptcy thanks to heavy government support. However, based on the literature, this indicator appears to be rather popular in assessing the success or failure of SOEs. In addition, our theoretical model shows that the liquidity, solvency, or power of paying debt (in order to have less due debt) is one of the components of the optimal objective function of an SOE. The rationale behind the inclusion of Var 6 is detailed in studies by Perkins (1996) and Elliott and Zhou (2013). Given the difference in performance between export-oriented firms and domestic-oriented firms, the ratio of export revenue over operating revenue reflects the internationalization of SOEs; exportoriented SOEs tend to perform better and have greater efficiency. The third type of indicators is structural ones. It is crucial to evaluate the financial structure of SOEs as part of their performance, not solely their profitability. For this reason, we selected three variables to capture this aspect: liquidity ratio (Var 7), solvency ratio based on assets (Var 8), and solvency ratio based on liabilities (Var 9).

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Table 10.1 Model variables Notation Var 1 Var 2 Var 3 Var 4 Var 5 Var 6 Var 7 Var 8 Var 9 Var 10 Var 11 Var 12 Var 13 Var 14 Var 15

Definition Return on equity using P/L before tax Return on assets using P/L before tax Profit margin Cash flow/operating revenue Debt due days Export revenue/operating revenue Liquidity ratio Solvency ratio (asset based) Solvency ratio (liability based) Profit per employee Operating revenue per employee Costs of employees/operating revenue Average cost of employee Working capital per employee Total assets per employee

Unit %

Group Profitability

Days % %

Operational

$ $ % $ $ $

Structure

Per employee

Source: Authors’ compilation P/L profit–loss statement

Solvency ratio allows assessing a firm’s ability to meet its debt obligations. A low solvency ratio attests of a higher risk of insolvency and therefore potential bankruptcy. The liquidity ratio also plays a key role in evaluating solvency, as it captures the ability of a company to pay off its debts without raising external funds. Solvency is an important factor in a firm’s performance, though previous studies often have overlooked it, possibly because SOEs tend to enjoy “soft budget constraints” not subject to market liquidation. Finally, the last category of variables is related to per employee indicators. When assessing the performance of SOEs, per employee variables are essential as some firms reportedly have low productivity and are focused on employee maximization rather than profit maximization. In addition, SOEs are often overemploying (Putterman and Dong 2000) workers. In this study, six variables were selected: profit per employee (Var 10), operating revenue per employee (Var 11), costs of employee divided by operating revenue (Var 12), average cost of employee (Var 13), working capital per employee (Var 14), and total assets per employee (Var 15). Var 10–12 and Var 15 assess the profitability per employee and therefore productivity, which is a factor in SOE performance evaluation that has been abundantly tackled. Average cost of employee is a way to evaluate the weight employees have on a firm, through wages, social security requirements, unemployment insurance, or employment subsidies for laid-off SOE workers. As shown by Huang et al. (2010), these can sometimes be a burden for SOEs. Working capital per employee (Var 14) is a standard key performance indicator and represents the operating liquidity of a business. Thus, it is useful in assessing the economic performance of a firm. All 15 variables are summarized in Table 10.1.

192 Fig. 10.2 Data breakdown by sector. (Source: Authors’ compilation)

F. Taghizadeh-Hesary et al. Construction 5%

Other 15.13%

Other Services 39.11%

Gas, Water, Electricity 7.40%

Transport 33.36%

Source: Authors’ compilation.

We retrieved the data used in our analysis from the Orbis database of the Bureau van Dijk. They encompass 1148 SOEs, primarily from Europe: Bosnia and Herzegovina, Croatia, Estonia, France, Germany, Hungary, the United Kingdom, and others. French SOEs represent the majority of the data, followed by Croatian ones. Countries were selected based on their available datasets in a global sample; for each company, the latest data were used. As shown in Fig. 10.2, most SOEs studied are service providers: a third being transportation companies, 7% energy sector companies, and 5% construction companies. Only 15% of the total sample represents companies that are not service providers. To conclude this section on descriptive statistics, Table 10.2 represents the correlation matrix between the 15 variables in the analysis. Because of the use of different variables to assess profitability or productivity, it is not abnormal to witness a high correlation between the variables. In particular, there is a high correlation (shown in bold) between profitability variables: ROE with ROA (Var 1 and Var 2), ROA with profit margin (Var 2 and Var 3), and profit margin with cash flow over operating revenue (Var 3 and Var 4). In addition, per employee indicators are also strongly correlated: profit per employee (Var 10) and operating revenue per employee (Var 11) are both strongly correlated with total assets per employee (Var 15). Due to the high correlation between variables, a regression analysis using these 15 variables is not possible. For this reason, the study introduces PCA, a statistical method that allows converting a set of observations into linearly uncorrelated variables. This method is further detailed in the next part.

Var 1 1.000 .421 .321 .129
.039 .013 .007 .001 .024 .110 .020
.051 .069 .004 .043

Var 2 .421 1.000 .570 .337
.097 .017 .062 .371 .123 .114 .002
.118
.007
.007 .001

Var 3 .321 .570 1.000 .645
.150
.009 .139 .334 .080 .216
.009
.160
.051
.022 .128

Var 4 .129 .337 .645 1.000
.166
.038 .124 .316 .154 .160
.032
.151
.109
.031 .214

Source: Authors’ compilation Note: Correlations over 40% are shown in bold

Var 1 Var 2 Var 3 Var 4 Var 5 Var 6 Var 7 Var 8 Var 9 Var 10 Var 11 Var 12 Var 13 Var 14 Var 15

Var 5
.039
.097
.150
.166 1.000
.057
.089
.191
.079
.026
.038
.077
.022
.022
.024

Table 10.2 Correlation matrix between variables Var 6 .013 .017
.009
.038
.057 1.000 .055
.038
.095 .141 .201
.127 .153 .022 .194

Var 7 .007 .062 .139 .124
.089 .055 1.000 .264
.076 .071 .138
.084
.001
.022
.017

Var 8 .001 .371 .334 .316
.191
.038 .264 1.000 .117 .074
.018
.030
.073
.093
.033

Var 9 .024 .123 .080 .154
.079
.095
.076 .117 1.000
.046
.062 .075
.008
.058
.043

Var 10 .110 .114 .216 .160
.026 .141 .071 .074
.046 1.000 .237
.129 .094 .175 .580

Var 11 .020 .002
.009
.032
.038 .201 .138
.018
.062 .237 1.000
.168 .097 .192 .482

Var 12
.051
.118
.160
.151
.077
.127
.084
.030 .075
.129
.168 1.000 .186
.163
.195

Var 13 .069
.007
.051
.109
.022 .153
.001
.073
.008 .094 .097 .186 1.000 .242 .073

Var 14 .004
.007
.022
.031
.022 .022
.022
.093
.058 .175 .192
.163 .242 1.000 .265

Var 15 .043 .001 .128 .214
.024 .194
.017
.033
.043 .580 .482
.195 .073 .265 1.000

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10.3.2 Principal Component Analysis PCA is a data-reduction technique that extracts data, removes redundant information, highlights hidden features, and visualizes the main relationships that exist between observations (e.g., as used in Yoshino and Taghizadeh-Hesary 2014, 2015). PCA simplifies a dataset and creates a set of new variables, emphasizing latent features present in the dataset. PCA, unlike many other transformations methods, does not have a fixed set of vectors and adapts its basic vectors depending on the dataset. An additional advantage lies in the fact that the analysis indicates the similarities and differences between the various models created (Ho and Wu Ho and Desheng Dash 2009). Using this method, we reduce the 15 variables listed in Table 10.1 to determine the minimum number of components that can account for the correlated variance. Before proceeding, we test the suitability of the data for factor analysis. To do so, we perform two tests: the Kaiser–Meyer–Olkin (KMO) test and Bartlett’s test of sphericity. KMO is a measure of sampling adequacy that indicates the proportion of common variance that might be caused by underlying factors (e.g., Yoshino and Taghizadeh-Hesary 2014, 2015). A KMO value higher than 0.6 generally indicates that factor analysis may be useful, as is the case in our study with a value of 0.64. Bartlett’s test of sphericity shows whether the correlation matrix is an identity matrix, indicating that variables are unrelated (e.g., Yoshino and Taghizadeh-Hesary 2014, 2015). A significance level less than 0.05 indicates that there are significant relationships among the variables, as is the case in our study with less than 0.001. We can thus proceed with the PCA.

Table 10.3 Total variance explained

Component Z1 Z2 Z3 Z4 Z5 Z6 Z7 Z8 Z9 Z10 Z11 Z12 Z13 Z14 Z15

Initial eigenvalues Total % of Variance 2.782 18.549 2.164 14.430 1.284 8.563 1.227 8.178 1.114 7.428 .964 6.425 .902 6.015 .865 5.767 .821 5.475 .696 4.641 .653 4.351 .524 3.496 .433 2.888 .314 2.093 .255 1.702

Source: Authors’ compilation

Cumulative % 18.549 32.979 41.542 49.720 57.147 63.572 69.587 75.355 80.829 85.470 89.821 93.317 96.205 98.298 100.000

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Table 10.4 Matrix of factor loading Var 1 Var 2 Var 3 Var 4 Var 5 Var 6 Var 7 Var 8 Var 9 Var 10 Var 11 Var 12 Var 13 Var 14 Var 15

Component Z1 Z2 0.597
0.096 0.680
0.304 0.805
0.263 0.707
0.233
0.262 0.107 0.122 0.399 0.271
0.019 0.502
0.348 0.129
0.280 0.473 0.520 0.237 0.631
0.318
0.244
0.024 0.307 0.108 0.501 0.423 0.704

Z3 0.424 0.254 0.060
0.115
0.080
0.006
0.400
0.218 0.231 0.023
0.128 0.449 0.649 0.242
0.054

Z4
0.313
0.134
0.120
0.051 20.559 0.213 0.487 0.391 0.072
0.035 0.151 0.415 0.372
0.021
0.074

195

Z5 0.393 0.233 0.027
0.259 0.165 0.372 0.377
0.017 20.576
0.198 0.014
0.169 0.156
0.090
0.312

Source: Authors’ compilation Notes: The extraction method is principal component analysis, and the rotation method is direct oblimin with Kaiser normalization. Variables with large loadings (absolute value greater than 0.5) for a given factor are in bold P/L profit–loss statement

The next step is to determine how many factors should be used. Table 10.3 lists the estimated factors and their eigenvalues. We retain only those factors accounting for more than 10% of the variance (eigenvalues >1) in the final analysis—that is, the first five factors. Altogether, Z1 through Z5 explain 57% of the total variance of the performance indicators. In running the PCA, we use the direct oblimin rotation method. Direct oblimin is the standard method to obtain a non-orthogonal (oblique) solution, allowing factors to be correlated (Yoshino and Taghizadeh-Hesary 2015). Interpreting the revealed PCA information requires studying the pattern matrix. Table 10.4 presents the pattern matrix of factor loadings obtained using direct oblimin rotation. The first component, Z1, has five variables with an absolute value neatly over 0.5 (large loadings). We exclude asset-based solvency ratio (Var 8) as a component of Z1, however, to simplify the interpretation of the component. Indeed, all variables representing profitability (ROE, ROA, profit margin, and cash flow over operating revenue) have a value of over 0.5 and show positive signs. Therefore, we choose to interpret Z1 as the component representing profitability in the analysis. The second component, Z2, has four variables over 0.5: profit per employee (Var 10), operating revenue per employee (Var 11), working capital per employee (Var 14), and total assets per employee (Var 15). Given that all the variables explaining the variance of the component pertaining to the category of per capita profitability, Z2 can be understood as a reflection of productivity per employee. The next component, Z3,

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Table 10.5 Component correlation matrix

Component 1 2 3 4 5

1 1.000 .124
.102 .161
.069

2 .124 1.000 .041 .041 .144

3
.102 .041 1.000
.076 .014

4 .161 .041
.076 1.000
.074

5
.069 .144 .014
.074 1.000

Source: Authors’ compilation Note: The extraction method is principal component analysis, and the rotation method is direct oblimin with Kaiser normalization

is composed of two variables: cost of employee over operating revenue (Var 12) and average cost of employee (Var 13). Exceptionally, we decided to include Var 12 despite its value being below 0.5 to simplify the interpretation of Z3 as a reflection of per employee costs inside SOEs. The fourth component, Z4, only presents one variable with a value over 0.5. Z4 can hence be understood as showing debt due and default. Finally, the fifth variable represents “solvency” of SOEs, since the only variable that represents at least 0.5 of the factor loadings is the liabilitybased solvency ratio (Var 9). Because the use of PCA was partially motivated by the high correlation between variables, Table 10.5 shows a correlation matrix between the components. There appears to be no correlation between the components. This also means that we could have used a regular orthogonal rotation method, which does not allow correlation between components. Using an oblique rotation method provided the same result as using an orthogonal rotation. In this section, we detailed the methodology that allows us to assess the performance of SOEs. Using PCA, we established four components representing profitability, per employee productivity, per employee costs, and solvency. The results of this evaluation are presented in the next part.

10.4

Empirical Results

10.4.1 Regression Results We now present the results of a regression conducted using the components derived from the PCA as variables. Given the lack of correlation between the components, we use ordinary least squares (OLS) as the estimation method for the regression. The objective of this regression is to estimate the determinants behind the success or failure of SOEs through the performance indicators that we defined in the previous section. For this purpose, we chose debt due days (Z4) as the dependent variable in this study, interpreting it as a label of success or failure of an SOE. What this variable means is that a company with a delay of over 90 is considered as defaulting. As mentioned earlier, the variable represents the delay in the repayment of credit and

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Table 10.6 Regression results Variables C constant Z1 profitability Z2 per employee productivity Z3 per employee costs Z5 solvency

Coefficient 19.19

t-statistic 9.59

Std. error 2.00

Probability 0.00


0.14


10.34

0.01

0.00


0.22


48.40

0.004

0.00

0.26

31.49

0.008

0.00


0.60


71.41

0.008

0.00

Source: Authors’ compilation Notes: The dependent variable is Z4, and the estimation method is ordinary least squares (OLS) Observations ¼ 1137; R-squared ¼ 0.994; Adjusted R-squared ¼ 0.994; Durbin–Watson statistics ¼ 1.98

even defaults after a certain threshold. Defaulting is considered a failure for an SOE; thus, the higher Z4, the lower the success of the company. The results of the regression are shown in Table 10.6. All variables in the regression are statistically significant. In addition, indicators of goodness of fit are very high: both R-squared and adjusted R-squared are close to 99%, meaning that the model fits the data. Out of all variables, only the estimated coefficients for per employee costs (Z3) show a positive sign. It should not come as a surprise that higher costs per employee negatively affect SOEs’ performance, and empirical results confirm this fact. Higher costs per employee are shown to increase the days for repayment of credit, and therefore increase the chances of defaulting. On the other hand, the estimated coefficients for profitability, productivity per employee, and solvency all display a negative sign. Being a profitable firm (Z1) or a firm with high productivity per employee (Z2) decreases the number of days needed for a firm to pay back its loan to be a more successful firm. This derives from the fact that highly productive firms have higher revenues per employee and can pay back their debt with more ease. The same reasoning applies to firms with higher profitability. Solvency (Z5) is even more straightforward as the component captures the ability of a firm to pay off its debt. Having a higher solvency in the first place will definitely decrease the likelihood of a firm defaulting. In addition, the size of the estimators and thus the magnitude of each indicator on the performance of SOEs significantly differ. As shown in Table 10.6, the solvency component possesses the highest coefficient in absolute terms, 0.60. Solvency (Z5) hence appears to have a more decisive role in explaining why some companies default. Second, per capita variables such as productivity (Z2) and costs (Z3) have a medium-sized effect on a firm’s performance with their respective coefficients being 0.22 and 0.26 in absolute terms. It appears that per capita variables have a relatively significant influence on the success or failure of companies. Finally, the size of the estimator for profitability is the smallest, with an absolute value of 0.14. According

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to the empirical results, profitability proves to have the least deterministic power over the success or failure of SOEs, contrary to common perception. Overall, solvency, per employee costs, and per employee productivity are key components in explaining why some SOEs have due debt and why some fail to repay their outstanding debt in the given time. While profitability explains this effect as well, it does not have as much deterministic power as the previously mentioned variables. In analyzing the performance of SOEs, solvency, per employee costs, and per employee productivity should thus be prioritized as indicators, rather than traditionally used profitability variables.

10.4.2 Variable Movements This section explores the movements of each variable against Z4, the variable representing default in this analysis. Figure 10.3 shows the movements of solvency (Z5) associated with those of long due debts and therefore default (Z4). The graph shows that positive movements from debt due days are associated with strongly negative ones from solvency. Firms that have longer debt due days, or even default, do not usually have high solvency ratios, which is unsurprising as solvency ratios are a key indicator of the ability of a company to pay back its loans. Figure 10.4 displays the movements of per employee costs (Z3) associated with the default variable (Z4). This variable’s coefficient had the second highest coefficient in absolute value terms, and was the only one to feature a positive sign. As shown in the graph, positive movements of debt due days come with positive movements from costs per employee, although not as large in terms of size as the previous solvency variable. Firms with higher costs per employee are likely to also 15000 10000 5000 0 -5000 -10000 -15000 -20000 -25000 -30000

Z4

Z5

Z4 = debt due days (default variable), Z5 = solvency. Source: Authors’ compilation. Fig. 10.3 Movements of Solvency against Debt Due Days. Z4 ¼ debt due days (default variable), Z5 ¼ solvency. (Source: Authors’ compilation)

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20000 15000 10000

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Fig. 10.4 Movements of Per Capita Costs against Debt Due Days. Z3 ¼ per employee costs, Z4 ¼ debt due days (default). (Source: Authors’ compilation)

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Fig. 10.5 Movements of Per Capita Productivity against Debt Due Days. Z2 ¼ per employee productivity, Z4 ¼ debt due days (default). (Source: Authors’ compilation)

take longer to pay their accumulated debt and have long due dates, and some might even default. Figure 10.5 illustrates the movements of productivity per capita (Z2) against the default variable (Z4). Productivity per employee showed a negative sign in the regression and had a relatively large coefficient in absolute value terms. These features are clearly visible on the graph: when the default variable is positive, productivity per employee is largely negative. According to these empirical results, highly productive firms will not be likely to default or fail to pay back their loans on time.

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Fig. 10.6 Movements of Profitability against Debt Due Days. Z1 ¼ profitability, Z4 ¼ debt due days (default). (Source: Authors’ compilation)

Finally, Fig. 10.6 represents the movements of profitability (Z1), the variable usually used in assessing SOEs’ performance, against debt due days, the dependent variable of the regression (Z4). The regression results showed that, out of all variables, profitability had the smallest impact on the success or failure of SOEs. The graph shows a clear pattern of negative movements of profitability with debt due days. Firms with lower profitability will more often find themselves unable to pay back their debt in time and therefore default. Firms with lower profit margins are likely to have less capital available to pay back their loans, and therefore default.

10.5

Conclusion and Policy Implications

SOEs play a key role in the economy of many countries, especially in developing Asia, including the PRC and Central Asian countries where they represent a large share of the economy. Because SOEs use public funding, these types of firms are usually thought to be charged with increasing social welfare. At the same time, SOEs’ economic performance is generally seen as rather mediocre, as their priority remains social welfare enhancement. Such poor performance may slow down economic growth and even negatively affect other private firms, making it harder for them to access credit. This effect is especially pronounced in countries where SOEs figure largely in the economy. Therefore, it is crucial for central governments to implement a comprehensive evaluation method to assess the performance of such firms. Previous studies have offered many frameworks to analyze the performance of SOEs. Most focus on profitability and financial factors as indicators of success of SOEs. Yet, none offered a comprehensive framework of evaluation, capturing all

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aspects of their performance. By employing PCA, a statistical analysis technique, our study aims at providing such a comprehensive framework, incorporating various factors explaining SOE performance such as profitability, operational, structural, and per employee indicators. We applied 15 financial variables of 1148 SOEs mostly located in Europe and subjected them to PCA. This methodology reduced the number of variables to five components: Z1 (profitability), Z2 (per employee productivity), Z3 (per employee costs), Z4 (debt due days), and Z5 (solvency). In order to assess which of these variables had the most impact on the performance of SOEs, we ran a regression using the components obtained through the PCA. We used the component representing default and debt due days as the dependent variable. The results of the empirical study show that, contrary to common belief, solvency and per employee variables (costs and productivity) have more deterministic power over the success or failure of SOEs, compared to profitability. While higher per employee costs are associated with a higher likelihood of default among SOEs, higher profitability, productivity, and solvency are usually correlated with lower risks of default—and hence successful SOEs. As regards policy implication of this research, PCA is an efficient method to provide a comprehensive evaluation framework, capturing various performance elements that are usually highly correlated in one study. In addition, the regression offers a glance at the performance factors with the highest deterministic power on the success or failure of SOEs. While profitability is usually the favored indicator of many studies assessing SOE performance, our study showed that solvency, per employee costs, and per employee productivity are more decisive in evaluating their performance. Finally, it is important to mention that we used financial statements as the base of assessing the performance of SOEs and that the proposed evaluation framework does not evaluate their social welfare objectives. From the point of view of governments, it might be important to evaluate the social impact—in addition to financial performance. That will be the next recommended step for researchers.

References Abramov, A., Radygin, A., Entov, R., & Chernova, M. (2017). State ownership and efficiency characteristics. Russian Journal of Economics, 3, 129–157. Aharoni, Y. (1981). Evaluation of state-owned enterprises: A process perspective. Management Science, 27(11), 1340–1347. Ahuja, G., & Majumdar, S. K. (1998). An assessment of the performance of Indian state-owned enterprises. Journal of Productivity Analysis, 9(2), 113–132. Aivazian, V. A., Ge, Y., & Qiu, J. (2005). Can corporatization improve the performance of stateowned enterprises even without privatization? Journal of Corporate Finance, 11(5), 791–808. Arocena, P., & Oliveros, D. (2012). The efficiency of state-owned and privatized firms: Does ownership make a difference? International Journal of Production Economics, 140(1), 457–465. Astami, E. W., Tower, G., Rusmin, R., & Neilson, J. (2010). The effect of privatisation on performance of state-owned-Enterprises in Indonesia. Asian Review of Accounting, 18(1), 5–19.

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Elliott, R., & Zhou, Y. (2013). State-owned enterprises, exporting and productivity in China: A stochastic dominance approach. The World Economy, 36(8), 1000–1028. Forfas. (2010). The role of state-owned enterprises: Providing infrastructure and supporting economic recovery. Dublin: Forfas. Fu, F.-C., Vijverberg, C.-P. C., & Chen, Y.-S. (2008). Productivity and efficiency of state-owned Enterprises in China. Journal of Productivity Analysis, 29(3), 249–259. Garnaut, R., Song, L., & Yao, Y. (2006). Impact and significance of state-owned Enterprise restructuring in China. The China Journal, 55, 35–63. Ho, B. C.-T., & Desheng Dash, W. (2009). Online banking performance evaluation using data envelopment analysis and principal component analysis. Computers & Operations Research, 36 (6), 1835–1842. Ho, L.-H., & Tsai, C.-C. (2018). A model constructed to evaluate sustainable operation and development of state-owned enterprises after restructuring. Sustainability, 10(7), 1–11. Huang, X., Li, P., & Lotspeich, R. (2010). Economic growth and multi-tasking by state-owned enterprises: An analytic framework and empirical study based on Chinese provincial data. Economic Systems, 34(2), 160–177. Kloviene, R., & Gimzauskiene, E. (2016). Pecularities of performance measurement in state-owned enterprises – The case of Lithuania. Zeitschrift für Öffentliche und Gemeinwirtschaftliche Unternehmen, 39(1–2), 188–199. Lin, S., & Rowe, W. (2006). Determinants of the profitability of China’s regional SOEs. China Economic Review, 17(2), 120–141. Ngu, V. Q. (2003). Total factor productivity growth of industrial state-owned Enterprises in Vietnam, 1976–98. ASEAN Economic Bulletin, 20(2), 158–173. Nguyen, X. (2015). On the efficiency of private and state-owned Enterprises in Mixed Markets. Economic Modelling, 50, 130–137. Organisation for Economic Co-operation and Development (OECD). (2017). The size and Sectoral distribution of state-owned enterprises. Paris: OECD Publishing. https://doi.org/10.1787/ 9789264280663-en. Perkins, F. C. (1996). Productivity performance and priorities for the reform of China’s state-owned enterprises. Journal of Development Studies, 32(3), 414–444. Putterman, L., & Dong, X.-Y. (2000). China’s state-owned enterprises: Their role, job creation, and efficiency in long-term perspective. Modern China, 26(4), 403–447. Ramamurti, R. (1987). Performance evaluation of state-owned enterprises in theory and practice. Management Science, 33(7), 876–893. Song, L. (2018). State-owned Enterprise reform in China: Past, present and prospects. In L. Song, R. Garnaut, & C. Fang (Eds.), China’s 40 years of reform and development: 1978–2018 (pp. 345–374). Acton: ANU Press. Szarzec, K., & Nowara, W. (2017). The economic performance of state-owned Enterprises in Central and Eastern Europe. Post-Communist Economies, 29(3), 375–391. Xu, Z., & Birch, M. H. (1999). The economic performance of state-owned Enterprises in Argentina an empirical assessment. Review of Industrial Organization, 14(4), 355–375. Yao, S. (1997). Profit sharing, Bonus payment, and productivity: A case study of Chinese stateowned enterprises. Journal of Comparative Economics, 24(3), 281–296. Yoshino, N., & Taghizadeh-Hesary, F. (2014). Analytical framework on credit risks for financing small and medium-sized Enterprises in Asia. Asia-Pacific Development Journal, 21(2), 1–21. Yoshino, N., & Taghizadeh-Hesary, F. (2015). Analysis of credit ratings for small and mediumsized enterprises: Evidence from Asia. Asian Development Review, 32(2), 18–37. Zhuang, S., Yuan, X., & Wang, D. (2012). An evaluation of (X) inefficiency of state owned Enterprise in Market Competition Based on DEA. Management & Engineering, 7, 22–27.

Chapter 11

Is the Management Evaluation System of State-Owned Enterprises in the Republic of Korea a Good Tool for Better Performance? Jhungsoo Park, Jina Kim, and Chul Ju Kim

11.1

Introduction

State-owned enterprises (SOEs) in the Republic of Korea played a leading role in the post-war economic development process, but their role has been gradually reduced as the role of the government in the economic development process is replaced by the private sector (Park 2009). In the early 1960s, government-led development resulted in the government directly substituting the private sector to manage SOEs and organize private enterprises by effectively directing large-scale labor and capital. From the 1980s to the 1997 pre-International Monetary Fund (IMF) period, this method of government intervention in economic development became more indirect. As the industry and the private sector grew, various businesses were created outside government control, and the role of the government in economic development was gradually diminished as concerns over excessive government intervention and government failures were raised. From 1999 to 2017, after the economic crisis, restructuring and reforms took place throughout the entire government structure and the economy due to the global trend of neoliberalism and growing concerns about government failure. During the period from 1998 to 2003, large-scale privatization of public enterprises led to significant development of the market economy. In 2007,

J. Park Ewha Woman’s University, Seoul, Republic of Korea e-mail: [email protected] J. Kim (*) Department of Public Administration, Ewha Woman’s University, Seoul, Republic of Korea e-mail: [email protected] C. J. Kim Asian Development Bank Institute, Chiyoda-ku, Tokyo, Japan e-mail: [email protected] © Asian Development Bank Institute 2021 F. Taghizadeh-Hesary et al. (eds.), Reforming State-Owned Enterprises in Asia, ADB Institute Series on Development Economics, https://doi.org/10.1007/978-981-15-8574-6_11

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the law on the operation of public institutions was introduced to organize the governance structure for public institutions. As a result, the government’s role in the economy as a whole has become smaller, and various private sectors, including financial and network businesses, have grown significantly. In the process, the role of public enterprises in the Republic of Korea has also changed. In the early stage of economic development, the government did not have sufficient resources for the private sector, and it operated a public corporation to carry out large-scale social overhead capital (SOC) and investment projects centered on public corporations and to prevent monopolization of electricity, gas, communications, and networks. However, as the economy grew and matured, most of these public enterprises were privatized, and the role of public corporations as a major policy tool for economic development was reduced. Nonetheless, Korean public enterprises still play a major role in public administration by serving as a proxy organization for carrying out government policy, as well as providing public services on behalf of the government. This can be confirmed by the government budget, the size of the projects of all public institutions, and the size of the budget supported by the government. As of the end of 2018, the gross value of public sector projects was W647.4 trillion, 1.6 times the government’s total expenditure of W406.6 trillion (Korea Institute of Public Finance [KIPF] 2019). As of 2019, the budget for government support for public institutions is W74.4 trillion, accounting for 15.8% of the total government budget of W470.5 trillion (National Assembly Budget Office 2019). In the end, if public institutions fail to achieve their management outcomes due to inefficient operations, the government’s fiscal soundness may deteriorate. In order to manage public enterprises efficiently, the Korean government enacted the Basic Act on Management of Government-Invested Institutions in 1984 to institutionalize the management evaluation system for government-invested institutions. Since 2007, the law on the operation of public institutions has been enacted, thereby making it possible to unify existing evaluation systems, which are divided into government-invested institutions and affiliated institutions, and to manage public enterprises and public institutions more efficiently (performance evaluation system for SOEs). Since then, public institution management evaluation system in the Republic of Korea has improved performance by solving management inefficiency resulting from principal-agent problems and information asymmetry problems caused by the nature of public corporations. Despite the 20 years since the introduction of the management evaluation system for public institutions, the problems of public trust due to the high debt ratio of public institutions, poor management, and hiring and bidding irregularities have continued. In particular, as the evaluation index of the current performance evaluation, which was introduced in 2007 and has been implemented for 12 years, has been continually changed in accordance with the changes in government policy, the performance indicators of management performance evaluation play a role in improving the actual management performance of the public institution. The constant debate in previous studies related to public agency management evaluation also provides different arguments for the effectiveness of the

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management evaluation system. Some suggest that management evaluation has contributed to management performance by improving the service quality of public institutions and improving management efficiency (Abramov et al. 2017; Aivazian et al. 2005). On the other hand, others argue against whether management performance evaluation has substantially improved the management performance of public institutions (Aharoni 1981; Behn 2010; Brewer and Selden 2000; Ellwood 2000). This is because the management evaluation system is limited in its effectiveness due to operational flaws, and there is no significant improvement in the application of performance indicators and weights. The results of previous studies are different because the performance of public institutions is difficult to measure and there is uncertainty about the effectiveness of performance evaluation. Based on recent discussions about the effectiveness of the management evaluation system, this paper, through literature analysis, case study, and empirical analysis, examines whether the Korean government’s management performance evaluation system contributed to improvement of the productivity and profitability of public corporations. In particular, it is difficult to measure the performance of a business: each public institution has its unique characteristics, and the performance measure should consider both profitability and publicness. The main structure and contents of this paper are as follows. In Sect. 11.2, we review recent discussions and previous researches related to the management evaluation system. Sections 11.3 and 11.4 describe the status of the public corporation and public agency management performance evaluation system in the Republic of Korea. Finally, Sect. 11.5 provides conclusions and policy recommendations.

11.2

Literature Review

11.2.1 Performance Evaluation System for the Formation of Desirable Corporate Governance for SOEs Discussion on the performance evaluation (PE) of SOEs is based on public sector reforms such as New Public Management (NPM), public sector reform (PSR), and government reform. PE systems aimed at improving the performance of the public sector can be broadly divided into restructuring, securing autonomy and accountability, and performance monitoring and evaluation, among which the PE plays an integral role in improving performance. The PE system clarifies the relationship between the government and public institutions through performance contracts between the government and heads of institutions (Park 2014), and contributes to efficient domestic and external market operation through the creation of desirable corporate governance structures (Organization for Economic Cooperation and Development [OECD] 2015). It is difficult for SOEs to achieve a long-term performance orientation due to their innate characteristics, such as owner-agent problems and transaction costs arising

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from information asymmetry. Thus, they require a balance between administrative autonomy and government control (Park 2014). Securing a balance between autonomy and control is a key issue that penetrates the corporate governance and overall management system of SOEs. The government, which is responsible for supervising and monitoring the performance of SOEs, needs to manage SOEs (Ring and Perry 1985; Shirley and Nellis 1991). The government measures and evaluates the performance of public institutions in order to enhance and control their management efficiency (Bruns 1993). Effective performance management systems can also improve the quality of public services by mitigating owner-agent problems and securing efficiency (Wholey and Hatry 1992). However, in the process, there may be excessive government intervention in SOEs according to political considerations, which can lead to a reduction in accountability and capacity in the operation of SOEs (OECD 2015). This is because the various controls set by the government for efficient management of SOEs can rather constrain their autonomy and make it difficult to adapt to economic changes (Ra and Yun 2013). In this regard, the performance of SOEs may be improved when the management autonomy of an SOE is at a level similar to that of a private corporation (Aharoni 2000). After all, the PE system should be able to secure a balance between government control to maintain publicness and autonomy to pursue corporate profitability. Recently, researches have analyzed whether the management evaluation system is properly performed according to its original purpose and the nature of the public institution (Gray and Jenkins 1993; Jang and Park 2015). Gray and Jenkins (1993) analyzed the impact of the PE system on the management performance and decisionmaking of financial management, organizational management, etc., and verified the effectiveness, then presented direction for improvement for the PE system.

11.2.2 Theoretical and Empirical Debates Related to Measuring the Performance of SOEs While it is difficult to define the concept of performance because of its complex nature (Brewer and Selden 2000), the definition and measurement of performance for a public institution are more difficult. This is because public institutions are a mixed form of private and public organization. A company’s performance is generally measured by its profitability indicators, such as gross return on assets (ROA), return on equity (ROE), total sales, net assets, or labor productivity (Abramov et al. 2017; Aivazian et al. 2005). This is an appropriate method for measuring and assessing the performance of a private company that can clearly measure ownership, financial structure, and output. Profit maximization is widely regarded as the appropriate goal of private firms, yet in the case of SOEs, profitability is only one of several goals, and often not the most important (Aharoni 1981). Financial profitability cannot be the sole criterion for judging performance, because SOEs were created to achieve social or strategic objectives, and reported profits often depend critically

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on the prices of both inputs and outputs by the government (Aharoni 2000). SOEs may be expected to create employment, help develop laggardly regions, make unprofitable products in uneconomic plants, develop national technological capabilities, hold down prices, or earn foreign exchanges, even if pursuing those goals hurts their financial performance (Ramamurti 1987). If public corporations simultaneously act to pursue profitability and provide public services, there may be a negative impact on their performance measured around profitability (Forfas 2010; Nguyen et al. 2015). This can also be seen through the results of prior studies showing that SOEs are less capable and inefficient compared to private firms in the same industrial group (Kikeri et al. 1992; Likierman 1983; Ram et al. 1976). Furthermore, SOEs usually operate in relatively non-competitive markets and have their autonomy limited by government interventions (Taghizadeh-Hesary et al. 2019). In particular, if the government uses SOEs as a management tool for achieving a policy purpose, the performance of SOEs can be distorted (Behn 2010; Ra and Yun 2013). Thus, the multitude of goals, the contradictory directions from government, and the perverse incentives make measurement of performance by financial result inadequate (Aharoni 2000). After all, performance evaluation for SOEs is fundamentally different from the evaluation of performance for private companies. This is because measurement and evaluation of the performance of SOEs should take into account both political considerations and the complexity of the business project. As a result, some scholars have argued that it is difficult to assess the performance of SOEs unless they are run for profitability (Likierman 1983; Robson 1962). Thus, measures of performance for SOEs range from hard measures such as profitability, productivity, or growth rate to softer behavioral measures such as employee satisfaction, legitimacy, or managerial incentive or adaptability (Aharoni 2000). In addition to profitability indicators, methods of measuring performance have also been suggested recently in consideration of institutional and national characteristics such as operating conditions, financial structure, size and HRM status, leadership, market structure, government policies, etc. (Brewer and Selden 2000; De Castro and Uhlenbruck 1997; Ingraham et al. 2003; Murtha and Lenway 1994; Li and Tang 2009; Rainey and Steinbauer 1999; Taghizadeh-Hesary et al. 2019). After all, it is necessary to consider the various factors comprehensively in order to measure the performance of SOEs (Aharoni 1981).

11.3

SOEs in the Republic of Korea

11.3.1 Historical Overview of SOEs in the Republic of Korea SOEs in the Republic of Korea have been used as policy tools for government market intervention while being responsible for the production and supply of public services (Kwak 2003). This is a result of the government replacing the private sector and leading economic development in a situation where the private economy has become extremely vulnerable after the Korean War. This is very similar to the

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phenomenon in Western countries such as Europe, the United States, and Canada, where public corporations’ policies were expanded to address natural monopolies and to address imbalances among industrial sectors after World War II (Toninelli 2000). Due to this historical and environmental peculiarity, SOE policies in the Republic of Korea are relatively poor in terms of separating commercial and policy functions, and tend to be regarded as direct policy tools. This is a phenomenon that occurs in most developing Asian countries (Kim et al. 2010). The ownership structure of SOEs in the Republic of Korea is also a centralized model in which a single government department or government agency acts as proprietor in all aspects of finance, operations, audits, and performance management (KIPF 2017). In the Republic of Korea, however, the Act on the Management of Public Institutions (AMPI) was enacted in 2007, and the performance evaluation system for public institutions was formulated. Related systems were continually improved for the purpose of systematizing the governance structure of SOEs and balancing the government’s control and autonomy of management. In the 1980s and 1990s, before the IMF economic crisis in 1997, the economic fundamentals were established in accordance with the development of key industries and rapid economic growth, which led the government to take an indirect approach to economic development. During this period, as the private economy grew sufficiently, various business outcomes were created outside of government control, and the government’s role in economic growth was also reduced due to the emergence of NPM theories around the world and concerns over excessive government intervention. The expansion of neo-liberalism and NPM theory from 1998 until recently after the economic crisis led to reforms in government structure and the economy as a whole. After the economic crisis, the market economy was greatly expanded, with the restructuring of inefficient governments and firms, and the privatization of largescale public corporations. In 2007, the AMPI was enacted and the corporate governance structure of public institutions was organized. Through the enactment of the law, the governance structure of SOEs was standardized by institutional type, and a governance structure and PE system were implemented for SOEs. As a result, the role of the government is more restricted, and the private sector, including various industrial groups, has grown significantly. In the process, Korean public enterprises were also largely privatized, and their role as a means of implementing government policies shrank.

11.3.2 Current Status of SOEs in the Republic of Korea As of January 2019, 339 institutions have been designated public institutions under the AMPI to provide basic goods and services needed for people’s daily lives, including electricity, gas, roads, airports, ports, finance, medical and social welfare services, four major insurance policies, safety-related public inspections, and R&D; these play a pivotal role in the people’s lives. Table 11.1 shows the list of SOEs and Quasi-government organizations (QGOs) that have been designated through the

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Table 11.1 Designated SOEs and QGOs (2018–2019) Type of institution SOEs Market-type Quasi-market-type QGOs Fund management-type Commissioned service-type Non-classified public organization

Number of designated institutions 2018 2019 35 36 15 16 20 20 93 93 16 14 77 79 338 339

Source: Ministry of Economy and Finance (2019)

Fig. 11.1 Institutional Units Comprising the Central Government’s Public Sector and the Private Sector. (Source: KIPF 2019)

deliberation and resolution of the Ownership Steering Committee. As of 2019, there is a total of 36 SOEs, divided into 16 market-type and 20 quasi-market-type SOEs. QGO comprise a total of 93 institutions, classified by 14 fund management-type institutions and 79 commissioned service-type institutions. The classification system for the institutional components of the public and private sectors within the national economy is defined differently by country. The institutional components of the public and private sectors of the Korean central government can be classified as shown in Fig. 11.1. Whether a particular institutional unit belongs to the public or private sector depends on whether the institutional unit is owned or controlled by the government or the private sector. In addition, the types and characteristics of individual institutional units that constitute the public and private sectors may be classified according to the relative extent to which certain institutional units serve public or private interests (or profitability). Another criterion for classifying the types and characteristics of the institutional units that make up the public sector is the degree of separation from the government, or the degree of autonomy of those institutional units. The institutional units that form the public sector naturally tend to be more public and less autonomous, because

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Fig. 11.2 Relationship between the General Government and SOEs and QGOs in the Public Sector. (Source: KIPF 2019)

the public sector has a closer relationship with the government. On the other hand, as the relationship with the government grows more distant, the units have a less public nature and more autonomy. As seen in Fig. 11.1, SOE, QGO, government-funded research institutes, and corporate-type organizations are the key agents that make up the public sector. At the same time, they are located at the boundary between the public and private sectors. SOEs and QGOs are the basic institutional units that make up the public sector. Under the current AMPI, SOEs (market-type and quasi-markettype SOEs) and QGOs (commissioned service-type and fund management-type QGOs) are defined as the institutional units that make up the public sector. Thus, from a systematic perspective, defining SOEs and QGOs accurately is an important policy task. As shown in Fig. 11.2, the types of institution in the public sector of the Korean central government are government sector institutions (such as government organizations, executive bodies, etc.), general government institutions (government sector and QGOs), and SOEs and QGOs (QGOs, corporate-type agencies, government enterprises, and SOEs). Of these, the scope and type of SOE and QGO under the AMPI can be divided into QGOs (commissioned-service type and fund management-type QGOs), corporate-type agencies (special accounts organizations of executive agencies), government enterprises, and market-type and quasi-markettype SOEs. Among SOEs, those within the scope of the national SOEs are

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Table 11.2 Criteria for the classification of types of SOE and QGO Year SOE Market-type Quasi-market-type QGO Fund management-type Commissioned service-type Non-classified public organization

Major changes Self-generating revenue 50% Institutions whose self-generating revenue 85% (and asset size > W2 trillion) Self-generating revenue of 50–85% Self-generating revenue