This is the presentation I made at the E3 Conference in Bhutan. The main theme was increasing efficiency in the SOEs specially in the energy sector. The presentation does not dwell upon privatization as that was not in the scope of this paper. Though I have separately written on Privatization. This is all about Corporate Governance ...

1. Making the SOEs better
By
Kashif Mateen Ansari

2. State Owned Entities
Many developing countries have used state-owned entities to
address a number of developmental issues. The developed world
has also used commercial state-owned entities for further
economic development of their respective countries.
There is a long held view, within the private sector that state-owned
entities are inherently inefficient and should be
privatised.
Can there be efficient State Owned Entities ???
despite of the popular belief it appears that there are many who
believe so.
In his article, “State owned Enterprise Reforms”, Ha Joon Chang
observes that state-owned entities can be efficient and well-run.

3. Successful SOEs
Indeed, there have been very successful state-owned enterprises,
as observed by Chang as follows:
The Singapore Airlines, often voted the best airline in the world,
is a state-owned entity, 57 per cent owned by the government
holding company, Temasek Holdings, whose sole shareholder is
the Singapore Ministry of Finance.
The highly respected Bombay Transport Authority of India is
also a state-owned entity.
World-class companies like the Brazilian regional jet
manufacturer Empresa Brasileira de Aeronáutica (EMBRAER),
the French carmaker Renault, and the Korean steel-maker
Pohang Steel Company (POSCO), all initially succeeded as state-owned
entities, with the state still exercising critical influence in
many of them.

4. The Power of the SOEs
From the analysis of major global companies, The Economist observed
the following companies in the world that are either state owned or
state backed:
Thirteen biggest oil firms, which between them they have a grip on
more than three quarters of the world’s oil reserves;
The world’s biggest natural gas company, Russia’s Gazprom;
China Mobile is a mobile phone company with six hundred million
customers;
Saudi Basic Industries Corporation is one of the world’s most profitable
chemical companies;
Russia’s Sberbank is Europe’s third largest bank by market
capitalisation;
Dubai Ports is the world’s third largest port operator; and
The Airline Emirates is growing at 20% annually.
The Economist report “The visible hand”

6. These are some of the many examples of state-owned
or backed entities that have done phenomenally well
and the number seems to be increasing. This is
contrary to the popular belief that state owned entities
are inherently inefficient.

7. Role of SOEs
The role of state-owned enterprises in Singapore is
outlined in the Temasek’s general investment strategy
and centres on the following five themes:
Transforming economies;
Growing middle class;
Pioneering innovative products and/or businesses;
Deepening comparative advantage; and
Focus on emerging champions.

8. Ireland
Provision of essential infrastructure and services that are critical to the
country’s economic development
Early SOEs played a key role in enhancing skills
SOEs are used to address broader national economic and social well-being
objectives of government;
They have traditionally played a key role in setting salary levels for certain
professionals across the economy;
The commercial SOEs are key investors in infrastructure provision and are
responsible for delivering a significant part of Ireland’s National Development
Plan;
The establishment of SOEs was driven by a desire to initiate strategically
important economic activities which private enterprise had either failed to
initiate or to operate on a sufficiently extensive scale;
More recently, State ownership in the financial sector has increased as the State
has taken large equity positions in a range of distressed banks. This is a direct
response to market failure.

9. India
the SOEs in India have also played a role of developing
small and medium enterprises by ensuring, among other
things, funding of entrepreneurship.
Recently the role has focused on internationalisation of
SOEs by granting autonomy to them to make investments
abroad and form joint ventures, for example Bharat Heavey
Electricals Limited (BEHL) expanded its international
operation through entering new markets and building up
on existing ones.
Another example is Oil and Natural Gas Corporation
Limited (ONGC) which is currently engaged in overseas
exploration and production in countries like China,
Columbia, Brazil, Nigeria, Cuba and Vietnam.

10. The Economist

11. Justification
Natural Monopoly: In industries where technological conditions dictate that there can
be only one supplier, the monopoly supplier may produce at less than socially optimal
level and appropriate monopoly rents. Examples: railways, water, and electricity. Under
such circumstances, there is a strong case for an SOE to be set up and regulated to
prevent abuse of such a natural monopoly;
Capital Market Failure: Private sector investors may refuse to invest in industries that
have high risk and/or long gestation period. Examples: capital-intensive, high technology
industries in developing countries, such as aircraft in Brazil or steel in the Republic of
Korea;
Externalities: Private sector investors do not have the incentive to invest in industries
which benefit other industries without being paid for the service. Examples: basic inputs
industries such as steel and chemicals;
Equity: Profit-seeking firms in industries that provide basic goods and services may
refuse to serve less profitable customers, such as poor people or people living in remote
areas. Examples: water, postal services, public transport, and basic education;
Security of Supply: Ensuring constant and reliable supply of commodities that are
critical to the functioning of the country and its people; and
Infrastructure: The need to build and maintain infrastructure that promotes economic
activities.

12. Inefficiency
Despite the theoretical justifications for establishment of SOEs and the
many examples of well performing SOEs, many SOEs are not well run
and are inefficient.
The Principal-Agent Problem: This principle recognises that SOEs
are not run by their owners like in private companies. Given the self-seeking
nature of humans, the argument goes; no SOE manager will
run the firm as efficiently as an owner-manager would run his own
firm.
The Free-Rider Problem: SOEs have numerous owners (all citizens).
No individual owner (citizen) has the incentive to monitor the SOE
managers as the benefits from monitoring will accrue to all owners
while the costs are borne by the individuals who do the monitoring.
The Soft Budget Constraint: Being part of the government, SOEs are
able to secure additional financial assistance if their performance lags.
This leeway makes the SOE managers lax in their management.
Chang, 2007

13. Why SOEs fail (particular reference
to Power Sector):
Ownership structure
Exercise of authority
Role of regulators
Tariff
Expense
Technical standards
Quality of service

14. Inefficiencies
Over staffing
Political interference
Misplaced/ No Incentive systems
Transparency issues

15. Customer Orientation
Management ability
Performance orientation
Low profitability
Limited innovation

16. Broader Strategies for improvement
Vital importance of electricity in any economy
Reliable electricity is vital for economic growth and
poverty reduction

17. Owner’s driven
performance
improving the
service
standards
serving the un-served
areas

18. Strengthening
competition

20. Corporate Governance
A crow was sitting on a tree, doing nothing all day. A
small rabbit saw the crow and asked him: "Can I also sit
like you and do nothing all day long?" The crow
answered: "Sure, why not." So, the rabbit sat on the
ground below the crow, and rested. All of a sudden, a fox
appeared, jumped on the rabbit and ate it.
Q: What can we learn from this?
A: To be sitting and doing nothing, you must be sitting
very high up.

21. First and the Foremost
Privatization

22. Short of privatization
Subjecting the SOE to Companies law
and other corporate regulations like
private companies
Additional public reporting for
more transparency
Introducing commercial
culture

23. Countries with SOEs under Company
Legislation
Corporatized SOEs operate under normal company legislation in many
countries and sometimes under both company law and SOE law:
• Bhutan, where SOEs operate under the company law and must also
abide by the SOE ownership policy that is in place.
• Chile, where company law applies to all SOEs except for nine large SOEs
that have their own separate laws.
• Ghana and Kenya, where SOEs are governed mainly by company law.
• India, where SOEs fall under company law but must also follow the
many different guidelines established for SOEs as well as a corporate
governance code for SOEs.
• Malaysia, where government-linked corporations (GLCs) are governed
by company law with the GLC Transformation Program and the GLC
Transformation Manual in place.

24. Pakistan, where SOEs are regulated by the Companies’
Ordinance and by recently issued Rules on Corporate
Governance for SOEs.
Peru, where SOEs fall under both company law and an SOE
law that creates the state ownership entity FONAFE, with a
corporate governance code in place for SOEs.
Serbia, where corporatized SOEs fall under the new company
law.
South Africa, where SOEs operate under company law with
the Protocol for Corporate Governance in place.
Zambia, where most SOEs are legally founded under the
Company law
World bank Tool Kit on CG for SOEs

25. Bringing independent directors
Partial/ Limited privatization of minority stake
Involvement of debt market
Reducing conflict of interest between
government and SOEs
Arm’s length relationship

26. The OECD
principles of
corporate
governance
Ensure the
Equitable
treatment of all
shareholders
Recognize the
rights of
stakeholders as
established by
law
Timely and
accurate
disclosure
Ensure the
strategic
guidance , the
effective
monitoring

27. The OECD principles of corporate
governance
The principles are that the corporate governance framework should
Protect shareholders’ rights.
• Ensure the equitable treatment of all shareholders, including
minority and foreign shareholders. All shareholders should have the
opportunity to obtain effective redress for violation of their rights.
• Recognize the rights of stakeholders as established by law and
encourage active cooperation between corporations and stakeholders in
creating wealth, jobs, and the sustainability of financially sound
enterprises.
• Ensure that timely and accurate disclosure is made on all material
matters regarding the corporation, including the financial situation,
performance, ownership, and governance of the company.
• Ensure the strategic guidance of the company, the effective monitoring
of management by the board, and the board’s accountability to the
company and the shareholders.
Source: OECD

28. Important highlights on Board’s Role in SOEs from
Companies Act, 2013, India
 Disclosures in the Directors’ Responsibility Statement by all companies
 The boards would now have to articulate their policy on directors’ appointment and
remuneration
 The boards would have to explain if there are any qualifications in the secretarial audit
report
 The boards would have to lay down its policies for regulatory compliance and risk
management and ensure these are operating effectively
 The boards would have to devise proper systems to ensure compliance with the
provisions of all applicable laws and that such systems were adequate and operating
effectively
 The boards have to make annual assessment of the internal financial controls and
may consider getting an independent expert assurance on such systems
 The boards would have to lay down the manner of formal evaluation of performance
of the board, its committees and individual directors for listed and public companies.
Source: Companies Act 2013, Ministry of Corporate Affairs, Government of India

29. Separating the SOEs and Regulators

31. The GOP is committed to pursue a far reaching reform
programme for the power sector and to help meet the
country's future power needs.
Implementation of the envisaged programme will
bring about a gradual transition of the power system
from integrated, state-owned utilities to a
decentralized system with separate generation,
transmission and distribution entities,
Having substantial private ownership and
management, reflecting and encouraging a
commercial and competitive operating environment.

32. Importance of hydropower SOEs and their
Financial Management
The predominance of the hydropower sector in the national economy is
expected to increase during the next 10 years.
Commissioning of Tala HPP (1,020 MW) in 2007 had a major impact on both
GDP and exports. The power export in 2008–2009 was 45% of total exports and
the power sector contributed over 40% of fiscal revenues.
Power sector-related debt consisted of 55% of external debt as of 2009.
The addition of debt from Tala HPP and the expected addition of further debt
from new hydropower projects to be commissioned during 2014–2019 will see a
substantial buildup in external debt. Hydropower-related debt will amount to
about 80% of GDP by 2017 and the debt service will increase to about 50% of
total exports by 2020.
Evaluation Study By ADB on “Bhutan Energy Sector”

33. The increased debt burden will be accompanied by an rise
in fiscal revenues from hydropower exports. After meeting
debt service obligations, the net cash surplus of the power
export sector in 2017 will be 22.5% of the projected GDP in
2017 and this will increase to 31% of projected GDP in 2020.
Instituting prudent and transparent financial management
practices to utilize the substantial financial surplus from
power exports to promote the overall economic growth and
socioeconomic well-being of Bhutan in a sustainable
manner will be a challenge for the government.

34. Training of Management
As per IFAC Financial managers in the public sector need to be competent and
proficient in the following areas to discharge their responsibilities effectively:
• Strategic management • Information systems
• Performance measurement • Economy
• Management Accounting • Presentation
• Financial Accounting • Analysis
• Operational Planning and Design • Negotiating
• Budgeting Writing
• Internal Control • Counseling
• Audit • Facilitation
• Governance • Conflict management
Study by IFAC public sector committee tilted “governance in the public sector”

35. The critical areas for financial management performance are:
• strategic planning;
• formulation of output objectives, performance measures and
operational plans;
• organization (people and structure, operational processes and
technology);
• performance measurement, financial and performance
reporting;
• management of funds, working capital and other assets;
• reliable and relevant accounting and information systems; and
• procurement and contracting for goods and services.
Study by IFAC public sector committee tilted “governance in the public sector”

36. Other measures
Other than improving the Corporate Governance other
measures can be undertaken:
Facilitate competition in the electricity industry
Improve regulation of functions that cannot be
competitive.
Improving the business environment for all firms , which
may include
Enforcement of Contracts,
Improving Employment Law,
Simplifying Tax Administration

37. Credits
Role of state-owned entities in the developmental state , South Africa courtesy
Presidency Office ,
The Economist, Special Report ; “The Visible Hand”
The World Bank Toolkit on Corporate Governance of SOEs
Some Options for Improving the Governance of State-Owned Electricity
Utilities, energy and mining sector board discussion paper, the World Bank
SRO_180_PublicSectorCompanies_CGRules_2013 pakistan
Evaluation Study, by ADB, “Bhutan : Energy Sector”
Tackling Investment Challenges in Energy Sector by IEA

38. Thank you

39. Bhutan energy sector- ADB
Key Issues,
Way forward
Key findings
recommendations

40. Institutional reforms and corporatization.
Prior to the establishment of BPC as a corporate entity in 2002, the power
sector in Bhutan was managed as part of the government under civil service
rules and regulations.
Issues were:
lack of flexibility,
managerial autonomy, and
financial independence.
flexibility introduced under the new corporate structure resulted in
a more enterprising corporate culture.
Use of private contractors
decentralization of project implementation, and
This has resulted into timely provision of counterpart funds would have been
difficult under the previous organizational structure.

41. Cost recovery. A cost-reflective tariff structure is essential, with due
consideration for the residential consumers consuming less than the
lifeline block (i.e., less than 80 kWh per month).
Financial sustainability. Rural electrification to be financially
sustainable. Hence, the power sector in Bhutan can continue to absorb
the high cost of rural electrification provided the government
continues to provide electricity for domestic supply at a discount to
export price.
Grid extension and off-grid renewable energy. There is scope for
judicious use of grid extension and off-grid renewable energy
applications for achieving 100% electrification. Bhutan has achieved an
electrification rate of around 60%, mostly with grid extensions, at an
average cost of connection per household of $1,500.

42. High voltage transmission network. Ensuring the development of
the high voltage (400 kV/220 kV) transmission network in parallel with
implementation of the 10,000 MW hydropower program remains a
challenging task.
Tala HPP and Chukka HPP had dedicated transmission lines to
evacuate power to India. However, with the development of over 10,000
MW of hydropower capacity consisting of over 10 separate projects
during the next 10–15 years, a holistic approach must be taken to
development of the transmission network.
This would enable Bhutan to minimize the investment requirement in
the transmission network while providing adequate redundancy in the
network to ensure network reliability while providing connectivity to
domestic load centers and collecting substations across the border in
India.
The adverse impacts on biodiversity corridors can also be reduced by
minimizing the transmission corridors through protected areas.

43. Seasonal variations. The availability of hydropower is seasonal and Bhutan is
experiencing difficulties in meeting its domestic power demand during winter. Hence, an
adequate level of firm power capacity must be developed through several hydropower
projects,with storage to minimize power shortages during winter.
Another option is to develop non-hydro forms of renewable energy (such as wind power)
to complement hydropower and diversify the country’s energy mix to reduce over-dependency
on hydropower and mitigate the hydrology risk.
However, development of the renewable energy in Bhutan is limited by lack of data and
feasibility studies on potential renewable energy projects, including small hydropower
projects (i.e., below 25 MW), transmission network connectivity constraints, and
financial constraints.
It is expected that some of the policy barriers to renewable energy development will be
addressed in the renewable energy policy under preparation with ADB assistance.

44. . Key Issues
Environmental and social issues. Environmental and social issues associated with the
large-scale development of hydropower must be addressed in the context of possible changes
to hydrology in the Himalayas as a result of climate change. The NEC, which has the primary
responsibility for monitoring and enforcing mitigating measures for the adverse environment
impacts of large hydropower projects, lacks the institutional capacity to discharge its
responsibilities effectively given the scale of proposed hydropower development in Bhutan.
There is also an absence of basin-wide studies to assess the cumulative impacts of the
development of hydropower projects in cascade along the same river basin, and a need for
environmental flows to ensure the ecological integrity of river basins. ADB has provided several
TA projects, including the ongoing TA 38 for institutional capacity building of the NEC, to
institutionalize mechanisms for climate change adaptation and developing CDM projects. The
NEC needs more focused capacity building on river basin management and monitoring, and
enforcement of environmental management of large-scale hydropower projects as Bhutan is
embarking on a large-scale hydropower development program.

45. Lessons Learned Bhutan
Continuity. Long-term continuity in supporting institutional building and sector
investments, such as rural electrification, has been highly effective. ADB has maintained
continuity in its support for institutional building and financial assistance for rural
electrification.
This has built up a high degree of trust and confidence in ADB by government
counterparts.
ADB’s record of financing a major share of the rural electrification target under each five
year
plan since 1995 has enabled the government to plan ahead with certainty over the
availability of
financing. The presence of ADB as the anchor financier for the rural electrification
program also
provided comfort to bilateral development partners to provide funding to complement
ADB
financing, and share project preparation and implementation arrangements with ADB-financed
larger rural electrification projects.

46. Socioeconomic and cultural context. Poverty and gender targeting should be based
on extensive understanding of the country’s socioeconomic and cultural context. ADB-financed
rural electrification projects in 1999 and 2003 attempted to target the rural electrification
benefits
to poor households by providing pre-designed household wiring kits to poor households.
ADB
also attempted to train female technicians to install and maintain solar panels in remote
areas to
increase the gender focus of the rural electrification program. Although these initiatives
were
designed based on socioeconomic surveys, they have not been effective as expected as
the
cultural context and social prejudices in the case of wiring kits, and institutional and
financial
sustainability in the case of village-based technicians, were not fully taken into account.

47. Ownership. Increased ownership of TA by the executing
agencies results in more
effective TA implementation and sustainable TA outcomes.
Executing agencies have shown a
high degree of ownership in identifying the need for TA,
defining the scope of the TA projects,
and in TA implementation. Selectively increasing their role in TA
management, based on their
record in TA implementation, could increase the effectiveness of
TA as it provides an increased
sense of ownership and responsibility. The IEM has noted that
several executing agencies in
the energy sector are highly competent and familiar with ADB
TA administration procedures.

48. Corporate-governance disclosure
requirements of the ASX—excerpt
The Australian stock exchange, ASX, requires listed companies to disclose whether they abide by the following
“best practice recommendations” for corporate governance and, if they do not abide by them, explain why
not. For brevity, we have excluded some recommendations about providing information. Original numbering
has been retained.
1.1 Formalize and disclose the functions reserved to the board and those delegated to management.
2.1 A majority of the board should be independent directors.
2.2 The chairperson should be an independent director.
2.3 The roles of chairperson and chief executive officer should not be exercised by the same individual.
2.4 The board should establish a nomination committee.
3.1 Establish a code of conduct to guide the directors, the chief executive officer (or equivalent), the chief
financial officer (or equivalent) and any other key executives as to: 3.1.1 the practices necessary to
maintain confidence in the company’s integrity and 3.1.2 the responsibility and accountability of
individuals for reporting and investigating reports of unethical practices.
3.2 Disclose the policy concerning trading in company securities by directors, officers and employees.
4.1 Require the chief executive officer (or equivalent) and the chief financial officer (or equivalent) to state
in writing to the board that the company’s financial reports present a true and fair view, in all material
respects, of the company’s financial condition and operational results and are in accordance with relevant
accounting standards.
4.2 The board should establish an audit committee.
4.3 Structure the audit committee so that it consists of: only non-executive directors; a majority of
independent directors; an independent chairperson, who is not chairperson of the board; at least three
members.

49. 4.4 The audit committee should have a formal charter.
5.1 Establish written policies and procedures designed to ensure compliance with ASX Listing Rule disclosure
requirements and to ensure accountability at a senior management level for that compliance.
6.1 Design and disclose a communications strategy to promote effective communication with shareholders
and encourage effective participation at general meetings.
6.2 Request the external auditor to attend the annual general meeting and be available to answer
shareholder questions about the conduct of the audit and the preparation and content of the auditor’s
report.
7.1 The board or appropriate board committee should establish policies on risk oversight and management.
7.2 The chief executive officer (or equivalent) and the chief financial officer (or equivalent) should state to the
board in writing that: 7.2.1 the statement given in accordance with best practice recommendation 4.1
(the integrity of financial statements) is founded on a sound system of risk management and internal
compliance and control which implements the policies adopted by the board; and 7.2.2 the company’s
risk management and internal compliance and control system is operating efficiently and effectively in all
material respects.

50. 8.1 Disclose the process for performance evaluation of the board, its committees and
individual directors,
and key executives.
9.1 Provide disclosure in relation to the company’s remuneration policies to enable
investors to understand
(i) the costs and benefits of those policies and (ii) the link between remuneration paid to
directors and
key executives and corporate performance.
9.2 The board should establish a remuneration committee.
9.3 Clearly distinguish the structure of non-executive directors’ remuneration from that
of executives.
9.4 Ensure that payment of equity-based executive remuneration is made in accordance
with thresholds
set in plans approved by shareholders.
10.1 Establish and disclose a code of conduct to guide compliance with legal and other
obligations
to legitimate stakeholders.
Source: ASX Corporate Governance Council, 2003.

51. Power sector
ENABLING INVESTMENT THROUGH
POLICY CLARITY AND REGULATORY
EFFICIENCY

52. Improving governance of State owned Utilities