PakistanPakistanCorporate Governance 

ofof State Owned Enterprises 

Dr.  Shamshad AkhtarInstitute of Chartered Accountants of Pakistan

KarachiKarachiMay 3, 2012

State owned Enterprise Sector• Over the years, privatization has helped scaled down the size of SOE sector and also helped

i th f f i d i t hiimprove the performance of companies under private ownership

– Case in point is banking sector & telecom

– Privatization is a preferred option and solution as SOEs governance in Pakistan will remaina challenge

– In any case about 40 odd federal SOEs operate in the manufacturing sector

• Size and significance of sector: over 140 companies are involved in commercial activities andb t 50 i t i t t i t h t t d fi i labout 50 or so companies operate in strategic sectors such as power, transport and financialsector

– Pakistan SOEs contribution to output is roughly 10% but it shoulders burden of employmentgeneration.

– 23 Pak‐SOEs listed on KSE but constitute one third of market capitalization

• Globally the SOE sector has been privatized

its size and valuation larger in a number of OECD countries (OECD SOEs combined value to– its size and valuation larger in a number of OECD countries (OECD‐SOEs combined value to$2 trillion) and economic weight significant

– most of the sector is corporatized even if not listed,

– at least half of companies listed on stock exchanges and State holds minority strategicstakes in companies

– Sector concentration is high in transportation, energy and telecommunication and in someinstances in financial institutions5/17/2012 2

Acknowledgement of Severity of Problem

• Budget for 2011/2012 acknowledged that SOEs are choking economy

– Public welfare losses have grown because of shortages of basic services– Public welfare losses have grown because of shortages of basic services

– Industry is facing hardships because of disruptions and lack of access toelectricity, gas and watery, g

– Financial losses growing – budget reported that• Government subsidized power sector losses of over Rs 1000 billionpin the last three years to ensure a lower tariff to consumers

• Steps were taken to reduce inter corporate circular debt includingpicking up of Rs 400 billion, improving PEPCO’s receivablesTh fi i l l h b th t k d fl di i P t• The financial losses have both a stock and flow dimension. Pastlosses have been deferred though issuance of bank guaranteedborrowings and special issuance of medium term securities andannually there has to be accommodation of emerging liabilities

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The Government’s Plans for SOE sector

• Some good initiatives but yet to yield visible results

– Cabinet Committee on Restructuring has developed restructuring plans for fewg p g psectors: Power and Railways sectors and PIA/PSM but implementation has been weak

– Policy pronouncements made to professionalize Boards of Directors and inductprofessional management from the marketprofessional management from the market

– A holding company of GENCOs formed and independent professionals inducted on itsBoard and policy intentions are to transform other boards

– SECP and industry efforts to work towards introduction of Code of CorporateGovernance commendable

These reforms are incomplete and partial and implementation weak

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Everywhere Corporate governance matters

• Over the years several studies confirm that there is 

– strong connection between board composition and market valuations of emerging marketcompanies.

– Companies with higher proportion of outsider/independent directors tend to reporthigher valuation. For e.g

• Korean firms with 50% outside directors had 40% higher share price

• Stronger board structures reduce the likelihood of fraud and expropriation throughStronger board structures reduce the likelihood of fraud and expropriation throughrelated party transactions

• Corporate governance practices changes are significant across a number of countries and has d lit ti diff i ibl imade a qualitative difference as visible in

– Firms performance improvements,  although in varying degrees

– convergence in corporate governance across companies and countries is slow

– GDP growth, productivity growth, and the ratio of investment to GDP andGDP growth, productivity growth, and the ratio of investment to GDP and 

– the growth effect is particularly pronounced for industries that are most dependent on external finance

• Recurring crisis has brought home further significance of corporate governance

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Can Fixing Code of Corporate Governance of SOEs do the Trick?

• This is a long debate but international evidence confirms that corporate governance policystrengthening necessary but not sufficient to ensure its effectivity and results. This islargely because

1. SOE corporate governance reforms cannot be effective without strong politicalcommitment nor implemented or sustained without an accommodative and supportiveoverall public sector governance environment and framework

2. SOEs reforms cannot take off unless there is a deeper recognition and consensuses thatthese firms are strategic state assets and it is incumbent on key stakeholders. i.e theGovernment and the legislature in particular to recognize that they serve as custodian ofth t d t bl t th N ti f li i li dthese assets and are accountable to the Nation for negligence in policy andimplementation.

3. Self regulation of corporate governance, as has proven in case of failure of self regulationmodel of financial industry (evident during the recurring episode of financial crisis'sincluding Asian/Russia/LTCM and housing bubble followed by subprime mortgage andnow Euro crisis) does serve industry well, but cannot control greed and cannot servepublic interest well.

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Can Fixing Code of Corporate Governance of SOEs do the Trick?

4. Level playing field for public and private sector critical

• public monopolies can be worse than private monopolies if poorlyperforming

• Competitiveness critical to drive performance

5. Internal Governance is a necessary, but not sufficient for SOEperformance that have to face a host of external adversities anddemands

6 Strengthening of transparency and accountability frameworks6. Strengthening of transparency and accountability frameworkswith special provisions for safeguarding state assets andpreserving/enhancing their marketability and valuation isimportantimportant

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Adopt SOE Corporate Governance Code

• Within the Code of Corporate Governance, ensure we placehigh priority on few provision to start off

1. Appointment of CEOs and BOD process and quality

2. Clarify roles and responsibility of the Board and CEOs

3. Separation of the role of Board and CEO

4. Form the technical Committee

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1. Appointment of CEOs, Board and its Composition

G d i i b b• Good provision but best to

• Insulate the process of appointment of CEOs and Board member from politics is to setup an independent Commission with high powered professionals to select theseprofessionals on competence and meritprofessionals on competence and merit

• Appointments to be based on agreed “fit and proper” criteria and a roaster ofprofessional candidate developed to select from

• CEO ought to be appointed by the Board based on defined “fit and proper criteria”based on an open and competitive process

– Scrutiny of conflict of interest provisions– Board should ensure due process for misconductBoard should ensure due process for misconduct

• The Board of Directors should include broad based and diverse skills includingindustry specialist, financial and human resource experts etc.

• If the Government is sole or controlling owner, it is undoubtedly in a uniqueposition to nominate and elect the board but there is often tendency to appointexcessive government representatives.

• If the government opts to nominate BOD it should perform effective due diligence• If the government opts to nominate BOD it should perform effective due diligencein identifying, nominating and electing board members.

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2. Role and responsibility of Board• Ensure the government and directors understand that the SOE Board is• Ensure the government and directors understand that the SOE Board is

accountable to shareholder as well as wider stakeholders and is responsible forSOE performance

• Board and shareholders should have a clear understanding of the SOE Boardroles and responsibility

• SOE Board, like private companies, have to be involved in the Mission andVision, strategy and oversight of the company, while delegating management toCEOCEO

• SOE Boards capacities need strengthening and Board has to have anf funderstanding of the public role and functions SOEs

• Directors need to develop a clear understanding of the risks and liabilitiescompany faces and ensure risk mitigation strategies are applied to safeguardpublic assets and resources.5/17/2012 10

3.   Separation of the role of Chairman and CEOs

• This is quite common in Europe with German and Dutch regulators requiring thissplit

• In the United Kingdom, over 80% of large companies have an independentchairman, and

• In US this proportion has steadily grown from a low of 16% to about 40% or so.

• There is also a rise in the share of companies with independent Chairman.

• Cleaving the CEO and chairman role makes senses as CEO is responsible fort d t li ti ll b t d t lf it dcompany management and cannot realistically be expected to self monitor and

evaluate own role and performance.

• Chairperson is responsible for driving the strategy and policy and for managing• Chairperson is responsible for driving the strategy and policy and for managingdynamic interaction among the Board and carrying greater compliance andreporting requirements.

• Success depends on how effectively the role of Chairman and CEOs is defined andp ysegregated.

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4. Form Committees to perform critical functions

• The guidelines recommend rightly for SOEs to constitute a range of Board committees: 

• audit, 

• risk• risk, 

• human resource, 

• procurement etc.

• These Committees to be assigned clear mandate and ensure their effective gaccountability

• Ensure Boards chaired by competent Board members

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Pakistan:  SOEs Policy Framework• Introduce a coherent and consistent policy framework to avoid each sector ministry manages,Introduce a coherent and consistent policy framework to avoid each sector ministry manages,

runs and operates companies on an ad hoc basis

– Reportedly, the mismanagement of SOEs by inexperienced people, vested interest,interference and misuse of funds based has grown

Whil i t d l k f d kill d fi i i i h b– While companies reported surplus work force and skill deficiencies companies have beendirected to retroactively absorb past laid off workers who had enjoyed VRS benefits

– Patronage and loyalty, rather than performance of company, is being rewarded

– No uniform policy of remuneration and wages of SOE sector nor is it linked to productivity

• Develop central management data & information system which could offer a comprehensiveperspective on operational and financial performance

• Ownership and oversight dispersed and fragmented being with Sector Ministries who do nothave a transparent policy framework or reporting on SOEs under their domain

• Quality of oversight varies as the Ministries lack capacities and understanding of the principlesof governing SOEs and regulators either weak or are being undermined

Limited reco nition of need for safe ardin the p blic assets and enhancin their market• Limited recognition of need for safeguarding the public assets and enhancing their marketvaluation

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Corporate Governance of SOEs• The draft Public Sector Companies (Corporate Governance) Regulations

– a first step and a necessary precondition for setting right the principles ofinternal governance at firm level.

– The code for SOEs is similar to the Code of Corporate Governance applicablet th li t d titito the listed entities

– 23 SOEs who are publicly listed and are likely to be following most of theRequirements of the Code

The proposed code offers to SOEs guidance consistent with the OECD– The proposed code offers to SOEs guidance consistent with the OECDGuidelines for Corporate Governance of State Owned Enterprises, 2005

• Add to Code elucidations to offer more deeper guidance on SOEsAdd to Code elucidations to offer more deeper guidance on SOEs

– SOEs need to be held to higher standards of accountability than privatecompanies as they are public assets and use tax payer money

– State ownership does not automatically guarantee Ministerial or any otherp y g yentities misplaced control over the mission and activities of an SOE

– Recognition that the goals of SOEs are typically a more complex mixture ofsocial, political, and commercial objectives.

– There has to be simultaneous resolution of a host of external factors thatadversely impact governance

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Fixing internal governance of companies is necessary but notsufficient for setting the governance right

Nurture a sound external governance framework1. Consider pros and cons of decentralized model of ownership and oversight of

Pakistan and centralize ownership model

2. Ensure competitive neutrality and contestability of markets in which SOEs operate –use the power of competition to introduce better results

3. Develop an objective and clear SOE policy

4. Convert SOEs to a proper legal structure

5. Develop a policy for public service obligations

6. Develop role and capacities of sector regulators

7. Develop a Watch dog and offer them tools such as corporate scorecard for ensuringtransparency and compliance with the Code

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No one size fit model for centralized ownership model• A survey of OECD and study of the World Bank suggests a growing trend among its members toA survey of OECD and study of the World Bank suggests a growing trend among its members to

move from decentralized to a centralized ownership model.

• Centralization, both in the developed and developing countries, means adopting the holdingt t d t f i th SOE t d it i ht d “ d fcompany structure and transferring the SOE assets and its oversight under “under one roof

structure.”

• Rationale for an umbrella framework stems from need for adoption of consistent approach topromote

– SOE strategy alignment and synergy creation

– allow SOEs of different sectors to operate under a one umbrella to manage strategy,operational or financial holdingoperational or financial holding.

– Achieve economies of scale and scope to pool resources, lower risk, and provide access tolower cost financing.

– a layer that shields the SOEs from politics and government intervention including multipleconflicting objectives, political intervention, and a lower degree of transparency.

– Transparency and accountability by opening access of ownership to the public.

• Re‐examination of ownership functions are also critical as a uniform approach has to be adopted• Re‐examination of ownership functions are also critical as a uniform approach has to be adoptedto nurture well SOEs for an eventual privatization that is often resisted by the relevant sectorministry whose interference in any case impacts the company performance and dilutes theaccountability.5/17/2012 16

Holding Company as a Governance Structure inManaging and Monitoring State‐Owned Enterprises

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Models of Centralized Ownership

• Different countries have adopted varying approaches suiting their requirements

• In the UK and Australia, the government’s set up constituted performs monitoring andmanagement functions, although the structure does not hold equity in the companies.

• In Poland, the bulk of SOEs are under the Ministry of the Treasury, which has specialunits for privatization and SOE governance.

• In Indonesia, the Ministry of State‐Owned Enterprises exercises the states ownershipi ht i SOE ith t titi f diff t trights in SOEs with separate entities for different sectors.

• In Jordan, the ownership function are vested with the Jordan Investment Corporation

• In Turkey, the Treasury and the Privatization Administration, are the legal owners ofSOEs.

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Singapore Temasek• Role model being quoted world wide is Singapore established Temasek – an old Malay names

“ t ” ( i il b di ith diff t h t i ti i th t i )“sea town” (or similar bodies with different characteristics in other countries)

• Temasek,, is registered under Company Act and serves as a national holding company for SOEsshares and 100% owned by MOF

– the President is custodial of the investments approves THL’s annual budget

– Under Singapore’s Constitution and laws, neither the President of Singapore nor theGovernment can be involved in THL investment, divestment or other business decisions

• Temasek has substantial authority over its subsidiary companies

• is responsible for appointment of Board and CEOs.

• Exercise good government internally in THL andExercise good government internally in THL and

• subscribes standards for its subsidiaries or independent statutory corporations

• Position of the Chairman and CEO separate and CEOs manage and run companies withwith full flexibility

• Strong and ethically sound civil service and statutory boards legislated by Parliament have fullautonomy but accountability is strong and this together contributes to smooth function ofTemasek

• To institutionalize its role, Temasek has recently became more transparent and sought creditrating to establish it long term role and be supportive of raising capital5/17/2012 19

Competitive Neutrality

• State ownership should not entitle competitive edge to SOE so create a level playingState ownership should not entitle competitive edge to SOE so create a level playingfield and nurture contestability in markets

• Competition forces firms to minimize costs and to search for new and better ways ofp ydoing business and will enhance economic efficiency and innovation.

• Enhance role and capacities of Regulators and Competition Commission to examinethe SOEs role in transport, power generation and public utilities which often operateas ‘natural monopolies’ (even if private entry allowed) and examine whether stateownership is ensuring an adequate level of service provision.

• Examine ways of generating competition within the market. For example, throughcompetitive tendering – i.e. competition for the market – as an option: for e.gcountries have allocated on a competitive tendering basis the public service obligationcountries have allocated on a competitive tendering basis the public service obligationsuch as the domestic transport routes (air and railways), particularly for social andregional access

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Other Factors

• Develop a clear SOE policy

– The Government as a shareholder needs to communicate what the objectives,role and mandate of SOEs ought to be and what is their expectation regardingg p g goperational and financial performance.

– The government to modernize the operating guidelines and rules.

– SOEs should be allowed to be run on commercial principles, and held accountableto ensure judicious use of public resources, while serving the demands of societyat an affordable price.

• Convert most SOEs to standard legal structures

– corporatize the departmental undertakings delivering services (such as PakistanRailways), bodies set up under special Acts/Statues (PIA) and joint ventures (suchas Development Financial Institutions)as Development Financial Institutions).

– Corporatization would contribute to overall transparency by requiring propercompilation of accounts and information, while bring companies under companyand other laws and insulating companies from political intrusion. Boards shouldg p pbe empowered with full powers to oversee the companies.

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Other factors

• Develop a policy for public service obligations.

– Given its broad based implications for public, SOEs should make full disclosure oftrade offs it faces, costs and quality of delivery etc.trade offs it faces, costs and quality of delivery etc.

– Legislature to approve the PSO policy and its cost implications

– The budget should annually provide for financing of the required subsidies in atransparent manner.p

• Develop the role and capacities of sector regulators

– Enhance the regulatory frameworks in accordance with the sector policiesg y p

– Check the compliance with sector policies, regulation and pricing regime

– Involve stakeholders in consultations

– Enhance advocacy of corporate governance beyond firm level andy p g y

– develop awareness of the legislature and executive branch so that these bodiesreinforce corporate governance.

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Conclusion

• The Government and private sector need to reflect on how to institutionalize monitoring• The Government and private sector need to reflect on how to institutionalize monitoringand reporting on compliance of Code in a sustainable manner

• For listed companies, SECP is the main hub that should now extend its ambit to unlistedSOEs too by being more proactive in scrutinizing compliance with the standard covenants ofcompany, securities and other key legislation and regulations.

• Examine the centralized ownership model and see what is suitable recognizing that “oldhabits die hard” but shielding the SOEs from political and bureaucratic interventions is in itsi d f b i f l i l d bi ld b i i linterest and upfront buy in from legislature and Cabinet would be critical

• Establish clear guidelines for subsidies and transfers: it should be rule based rather thanEstablish clear guidelines for subsidies and transfers: it should be rule based rather thandictated by individuals and ensure that separate accounting frames are adopted forcommercial versus social service obligation and there is a formulae based approach tocompensation for public service obligations

• These guidelines and regulations be approved by legislature so they recognize the implications, while ensuring accountability of finances offered to SOEs

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Conclusion

• Recommend setting up a focal unit – perhaps a public private partnership based oni i l b i d d i h f IFC C i i b d hi hinternational best practice and sponsored with support of IFC a Commission or body whichis empowered and mandated to

– Collate the operational and financial performance and service standards offered vis ap pvis the corporate strategy and benchmarks

– Develop a score card which both the listed and other SOE undertakings adopt andreport their compliance relative to the corporate governance codereport their compliance relative to the corporate governance code

– Offer online this information to public and the performance of comparativecompanies

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