Flawed SOE model to blame

By Mike Ross

Friday 19th May 2000

The Airways Corporation diversification into British air-traffic control is not an insider-trading problem but a principal-versus-agent problem.

Insider trading complaints arise when company shares are listed on the Stock Exchange. Airways Corporation is a state-owned enterprise and is not listed.

While SOEs are expected to operate commercially, at "arm's length" from shareholding ministers, politicians cannot resist interfering.

As far back as 1989, a government advisory unit recognised that any diversification by SOEs would cause political problems. A 1989 report for the SOE advisory unit prepared by economist Brent Wheeler predicted public sector monitoring tools would struggle to contain the conflict between politicians as principal and SOE executives as agents.

Executives are required to run their SOE as a commercial operation. Though they are state trading organisations, SOEs operate in a commercial environment where diversification is commonly used to diversify risk.

The Wheeler report points out SOEs lose valuable opportunities to add value and improve the return to shareholding ministers if they stick to self-imposed or politically-imposed core business activities.

New Zealand Post has demonstrated the value of expanding offshore, restructuring and operating offshore postal services.

Appointments to SOE boards usually come from the private sector, mainly highly motivated entrepreneurs who see diversification as an obvious business strategy. Where an SOE enjoys a monopoly position, strong cashflows are available to fund new projects.

Statements of corporate intent negotiated between SOE executives and shareholding ministers can impose policy constraints on SOE boards. As happened in the case of Timberlands and West Coast logging, statements of corporate intent can change on a political whim.

The Wheeler report recommends privatisation as the best remedy, since it brings private sector disciplines to bear on over-enthusiastic managers.

In the private sector, managers are encouraged to take risks, but if they fail, they lose their jobs - kicked out by shareholders or sunk by the business going into bankruptcy. The same disciplines do not apply in the public sector.

State-ownership creates an implicit state guarantee for SOE debts. Taxpayers wind up absorbing losses. Managers are free to spend SOE money, knowing they face no personal risk, as long as they do not offend their political masters.

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