In many countries, state-owned enterprises (SOEs) play a key economic role, either as providers of fundamental public services or generating fiscal revenues by controlling strategic assets. To better achieve the objectives for which they were created, SOEs need to use their resources efficiently and effectively. As a result, how governments monitor and govern these institutions is an important element for their success.
Until a decade ago, most countries in the world monitored their state-owned enterprises using what is called the dual model, which combines internal and external monitoring mechanisms. Internal monitoring typically involves a board of directors, management, and other internal stakeholders who are responsible for ensuring that the SOE is operating effectively and efficiently. External monitoring, on the other hand, is usually conducted by government agencies, independent auditors, or other external stakeholders who are tasked with assessing the SOE’s performance and ensuring that it is meeting its objectives[1].
The Inter-American Development Bank (IDB) has highlighted over the years issues with the dual model of monitoring. One of the main issues is the potential for conflicts of interest between the internal and external monitoring mechanisms.
For example, if an SOE’s board of directors has close ties to the government, it may be hesitant to provide negative feedback on the SOE’s performance. Alternatively, if external monitors have a close relationship with the government, they may be reluctant to criticize the SOE’s performance, fearing repercussions from the government[2].
Main Challenges Faced by Latin and the Caribbean to Monitor State-Owned Enterprises
A common issue we have discovered in missions to countries in the Latin America and the Caribbean (LAC) region is that a lot of these external boards were integrated by representatives of different ministries, who either had little time to prepare for the meetings or did not really act as “checks and balances” for the management.
One of the reasons for this is the “multiple principals problem,” where no one does the full job of monitoring because they assume others will do it or that the ministry of finance is actually doing the job. Another reason is the “busy boards problem,” where those appointed to the boards must monitor too many firms and do their ministerial work, thus have no time to do the job of directors properly.
As a result, boards of directors of SOEs oftentimes became rubberstamping boards. This is a problem because the internal monitoring component is lost and the fiscal costs can be significant as board member compensation can be very high, like in the case of Mexico or Paraguay.
Finally, another complication is that boards of directors that have outside professionals and independent members can be easily politicized. This means that boards that on paper should be stacked with professionals can turn into patronage tools (e.g., with political parties appointing board members from within their ranks) and do not serve the purpose of internal monitoring.
Issues Related to External Monitoring of State-Owned Enterprises
In terms of external monitoring, having a line ministry act as “owner” of the SOE, is also problematic as it often does not coordinate with the ministry of finance or other agencies to exercise this role. Worse still, ministries assume the ministry of finance is doing the hard monitoring and therefore are happy to give direction and social objectives to the SOE, without paying attention to the bottom line. The coordination problem also extends to ministries and boards and, without effective coordination, there may be duplication of effort, with both internal and external monitors assessing the same aspects of the SOE’s performance[3].
Finally, there are resource constraints associated with maintaining both internal and external monitoring mechanisms. The costs of running both sets of monitors can be high, and some SOEs may not have the resources to support both.
Efforts to Professionalize SOE Boards: The Cases of Chile and Peru
It is important to note that not all efforts to professionalize boards of SOEs have been problematic. Boards have been very effective when they are integrated by professionals (and independent members) nominated by SOE monitoring agencies and not by politicians—or when boards are not collections of representatives of ministries. Take the case of Chile and Peru, where their SOE centralized agencies have nominated professionals and independents to boards and exercise tight monitoring of their actions. In Peru, since most SOEs operate following private law, directors are liable for their decisions.
The introduction of such model of professionalized SOE boards, recommended by the OECD and the World Bank[4], can be problematic in LAC for two reasons. First, in some countries the fiscal savings of eliminating professional boards of directors may be significant. Second, as Tamira LaCruz has identified for small economies in the Caribbean, in less developed nations there may not even be a pool of experienced professionals large enough to have truly independent directors of SOEs with expertise in an industry[5].
New Model for Monitoring State-Owned Enterprises
Taking all these issues into account and the experience and knowledge we have gathered from the field, the authors of this post propose an alternative policy recommendation. The solution relies on intensifying monitoring by the ministry of finance through a General Directorate of Public Enterprises that can play the role of owner and has the legal tools to monitor and evaluate the performance of SOEs and their managers.
The idea is as follows: the boards of directors can be eliminated if necessary, and the role of owner of the company is given to a General Directorate of Public Enterprises (GDPE). That is, the monitoring role that in the OECD model is held by the boards of directors should be transferred to a body of professionals in the DPE. Ideally, the GDPE would have some professionals with operational experience in public enterprises and have sufficient personnel to monitor the companies under the purview of the DGEP.
A GDPE needs to have the following characteristics:
- Firstly, it must operate as the almost sole intermediary between public enterprises and the ministry of finance and the executive power. This means SOE managers must answer to the GDPE and not request resources directly from the president or other departments within the ministry of finance.
- Secondly, the GDPE must have qualified and sufficient personnel to monitor existing public enterprises.
- Thirdly, it centralizes the role of monitoring, with strict timelines, of budget execution, financial performance, and goal execution. Goals can be agreed between the GDPE and the SOE management in consultation with relevant parties (e.g., the energy ministry for an electricity company).
- Fourthly, the GDPE is responsible for the centralized collection of financial and budgetary execution information.
- Fifthly, it maintains a timely information dashboard shared within the ministry of finance (especially with the directorates of planning, public investment, and public credit) to monitor SOEs.
- Finally, the GDPE, together with the budget evaluation department, exercises strict monitoring of annual operational plans (POAs) and physical-financial goals of public enterprises. In fact, in some countries there are experiments with more ambitious annual goals, following the Korean Performance Evaluation Model.
Conclusion
Creating and empowering the GDPE is a challenge especially because politicians prefer to keep the direct link and control of state-owned enterprises.
However, if our countries really want to unlock the development potential of such entities, they must rethink their governance. This will be key to improve their operations. More importantly, governments will be able to generate fiscal revenues that can be used to reduce debt or finance much-needed public investments.
What to know more about this topic? Check out our studies:
Smoldering Embers: Do State-Owned Enterprises Threaten Fiscal Stability in the Caribbean?
Fixing State-Owned Enterprises: New policy solutions to old problems
State-Owned Enterprise Reform in Latin America
Related blog:
How to manage fiscal risks from state-owned enterprises
Learn more about what the IDB does on fiscal management.
[1] Corporate Governance of State-Owned Enterprises in Southeast Asia,” OECD Corporate Governance Working Papers, No. 17, OECD Publishing, Paris. DOI: https://doi.org/10.1787/98a7efdb-en
[2] Corporate Governance of State-Owned Enterprises in Southeast Asia,” OECD Corporate Governance Working Papers, No. 17, OECD Publishing, Paris. DOI: https://doi.org/10.1787/98a7efdb-en
[3] Pineda Ayerbe, Emilio and Musacchio, Aldo (eds.) (2019). Fixing State-Owned Enterprises: New policy solutions to old problems. Inter-American Development Bank
[4] OECD (2011), Corporate Governance of State-Owned Enterprises: A Survey of OECD Countries, OECD Publishing, Paris.
OECD (2015), “Governance of State-Owned Enterprises in Brazil: Strengthening Transparency and Accountability to Implement the OECD Guidelines on Corporate Governance of State-Owned Enterprises,” OECD Corporate Governance Working Papers, No. 9, OECD Publishing, Paris.
Corporate Governance of State-Owned Enterprises in Southeast Asia,” OECD Corporate Governance Working Papers, No. 17, OECD Publishing, Paris. DOI: https://doi.org/10.1787/98a7efdb-en
World Bank (2014), “SOE Monitoring and Evaluation Toolkit”, World Bank, Washington, DC. Available at: https://openknowledge.worldbank.org/handle/10986/20417
[5] Reyes-Tagle, G., Hosein, R., Musacchio, A., Wagner, R., Pan, C., Yu, F., … & Rosso, L. (2022). Smoldering Embers: Do State-Owned Enterprises Threaten Fiscal Stability in the Caribbean?.
Discussion on SOEs should be encouraged in the LAC region. Political economy considerations should be not part of such discussion, but key/central aspects for any institutional design. SOEs vary a lot not only in magnitude on its financial/political role in countries, but also to which sector belong. The idea of the GDPE or DGEP (same meaning in this article?) for political insulation is troubling in the way that there should be a political control, but in terms of public/political/electoral accountability of SOEs. There must be an external device (outside the MoF, outside the Federal/state/local government which oversees SOEs. Some countries in the past had tried to control/monitor/evaluate oversee SOEs though a ministry of planning, or a cabinet/level institution dedicated to such goal. This, is, in my opinion, the best of both technical and political worlds. The IFS in the UK and the NAO are both examples and models the LAC region can gain insights from.
Been there, done that in Curacao. Thrown out of the window, by the same politicians that created the structure. The inability the exercise both internal and external undue influence, ultimately is the main reason why things don’t work. Regardless if what structures are created.