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Public Industrial Enterprises July 1986Determinants of Performance

Mahmood Ali Ayub and Sven Olaf Hegstad

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Public Industrial Enterprises

Determinants of Performance

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Industry and Finance Series

Volume 17

This series is produced by the Industry Department of the WorldBank to disseminate ongoing work done by the department and to stimulatefurther discussions on the issues. The series will include reports onindividual sectors in industry, as well as studies on global aspects ofworld industry, problems of industrial strategy and policy, and issues inindustrial finance and financial development.

Already published are the following:

*Volume 1. Structural Changes in World Industry: A Quantitative Analysisof Recent Developments

*Volume 2. Energy Efficiency and Fuel Substitution in the Cement Industrywith Emphasis on Developing Countries

*Volume 3. Industrial Restructuring: Issues and Experiences in SelectedDeveloped Economies

*Volume 4. Energy Efficiency in the Steel Industry with Emphasis onDeveloping Countries

*Volume 5. World Sulphur Survey

*Volume 6. Industrialization in Sub-Saharan Africa: Strategies andPerformance

*Volume 7. Small Enterprise Development: Economic Issues from AfricanExperience

*Volume 8. World Refinery Industry: Need for Restructuring

*Volume 9. Guidelines for Calculating Financial and Economic Rates ofReturn for DFC Projects (also in French and Spanish)

Volume 10. A Framework for Export Policy and Administration: Lessons fromthe East Asian Experience (also in Spanish)

Volume 11. Fertilizer Producer Pricing in Developing Countries: Issuesand Approaches

Volume 12. Iron Ore: Global Prospects for the Industry, 1985-95

Volume 13. Tax Policy and Tax Reform in Semi-Industrial Countries

Volume 14. Interest Rate Policies in Selected Developing Countries 1970-82

Volume 15. Mobilizing Small-Scale Savings: Approaches, Costs, andBenefits

'Volume 16. World Bank Lending to Small Enterprises

* Published as World Bank Technical Papers.

INDUSTRY AND FINANCE SERIES VOLUME 17

Public Industrial EnterprisesDeterminants of Performance

Mahmood Ali Ayub and Sven Olaf Hegstad

The World BankWashington, D.C., U.S.A.

Copyright (© 1986The International Bank for Reconstructionand Development/THE WORLD BANK

1818 H Street, N.WWashington, D.C. 20433, U.S.A.

All rights reservedManufactured in the United States of AmericaFirst printing July 1986

This is a document published informally by the World Bank. In order that theinformation contained in it can be presented with the least possible delay, thetypescript has not been prepared in accordance with the procedures appropriate toformal printed texts, and the World Bank accepts no responsibility for errors. Thepublication is supplied at a token charge to defray part of the cost of manufacture anddistribution.

The World Bank does not accept responsibility for the views expressed herein, whichare those of the author(s) and should not be attributed to the World Bank or to itsaffiliated organizations. The findings, interpretations, and conclusions are the resultsof research supported by the Bank; they do not necessarily represent official policy ofthe Bank. The designations employed, the presentation of material, and any maps usedin this document are solely for the convenience of the reader and do not imply theexpression of any opinion whatsoever on the part of the World Bank or its affiliatesconceming the legal status of any country, territory, city, area, or of its authorities, orconceming the delimitation of its boundaries or national affiliation.

The most recent World Bank publications are described in the annual spring and falllists; the continuing research program is described in the annual Abstracts of CurrentStudies. The latest edition of each is available free of charge from the Publications SalesUnit, Department T, The World Bank, 1818 H Street, NW., Washington, D.C. 20433,U.S.A., or from the European Office of the Bank, 66 avenue d'lina, 75116 Paris, France.

Mahmood Ali Ayub is senior industry economist, and Sven Olaf Hegstad is seniorindustry specialist, in the Industry Department of the World Bank.

Library of Congress Cataloging-in-Publication Data

Ayub, Mahmood Ali, 1948-Public Industrial enterprises.

(Industry and finance series, ISSN 0256-2235 ; v. 17)Bibliography: p.1. Government business enterprises. 2. Organizational

effectiveness. I. Hegetad, Sven Olaf, 1945-II. Title. III. Series.HD3850.A98 1986 350.009'2 86-15825ISBN 0-8213-0815-7

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ABSTRACT

The main purpose of this study is to identify the factors,separate and apart from ownership, which influence the performance ofpublic industrial enterprises. Based on a review of performance of state-owned enterprises in 13 countries, the authors isolate three main factorsrelating to the business and managerial environment that distinguishsuccessful public enterprises from the poorly performing ones. Theseinclude: (i) the degree of competition that public enterprises are exposedto; (ii) the degree of financial autonomy and accountability under whichpublic enterprises operate; and (iii) the extent and manner in whichmanagerial autonomy and accountability are ensured.

It is impossible, and perhaps misleading, to assess statistic-ally the individual importance of each of these factors. What is clearfrom the analysis is that, where these three factors exist as a package,the performance of public enterprises is significantly better than in thosecases where most or all of these factors are non-existent.

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TABLE OF CONTENTS

CHAPTER 1. INTRODUCTION AND SUMMARY ..................... 1

Objectives and Scope of This Study .............. 1Why Study Public Enterprises? ................... 2Key Determinants of Performance ......... ....... 4

CHAPTER 2. THE ROLE AND PERFORMANCE OF PUBLIC INDUSTRIALENTERPRISES .... ***..***........................ 9

The Role of Public Industrial Enterprises ....... 9Performance of Public Industrial Enterprises .... 12Variations in Performance ........ ............. 13Comparing Public and Private EnterprisePerformance ................................. 14

Conclusion ... ...... .... ... . ..... . . * .. *.. *...........***** 17

CHAPTER 3. A COMPETITIVE ENVIRONMENT AS A DETERMINANT OFP°ERFORMANCE ......................................... 18

CHAPTER 4. FINANCIAL AUTONOMY AND ACCOUNTABILITY ............... . 21

Overall Financial Framework ..................... 22Greater Market Discipline.o-. ................. 23Financial Objectives and Dividend Policies .... 23Clarification of Social Objectives ............ 24Elimination of Government Subsidies ...... o..... 26

Supportive Financial Policies ................... 27Appropriate Capital Structure Policies ........ 27Greater Discipline and Transparency inFinancial Relations too .... * ................ 28

Performance Measurement and IncentivesSystems ........ ............................ 29

Conclusion ........................................ ...... 30

CHAPTER 5. MANAGERIAL AUTONOMY AND ACCOUNTABILITY .............. 31

Three Roles in Enterprise Management ............ 31Evolution of Public Enterprise Management

Models .................................... 33Factors Affecting Organizational Designs ........ 39Conclusion .................................... 41

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TABLE OF CONTENTS (continued)

CHAPTER 6. MANAGERIAL SKILLS AND MORALE ........................ 42

Managerial Skills .... * ............... .... 42The Issue of Morale ............................. 43

CHAPTER 7. COORDINATION WITHIN THE GOVERNMENT .................. 45

Holding Companies ............................... 46

Focal Points ......... ...... ........................ 48Lessons from Experience ......................... 51Options for Organizational Design ............... 53Abolition of Special Public EnterpriseRegimes ... **. **. *.*..*... .................. 53

Organization of Public Enterprises asOrdinary Stock Corporation UnderCorporate Law ...................... *..... 53

Reduction of Ministerial Control .............. 53Creation of a Public Enterprise IntersectoralBoard and Secretariat (Focal Point) ......... 54

Strengthening of the Role of the Boardof Directors ........ .. ... ... ..... . 54

Strengthening of the Role of the ChiefExecutive Officer and Top Management ........ 54

Decentralization of Managerial Autonomyand Accountability to the Plant/SubsidiaryLevel ...*... .......................... **. 55

ANNEX I ORIGINS OF PUBLIC INDUSTRIAL ENTERPRISES ............ 56

Political and Ideological Considerations ....... 56Takeover of Ailing Private Companies 58Unwillingness or Inability of the Private Sector 59Strategic Industries 59Internal Growth and Diversification ......... 59Creating Competition for the Private Sector 60

ANNEX II MANAGEMENT OF PUBLIC ENTERPRISES AND THE BOARD OFDIRECTORS .. ...... 61

The Role of the Board of Directors .......... 61Policy-Making and Strategic Role 62The Performance Evaluation Role 62Appointment and Dismissal of the CEO ..... 62Why Some Boards of Directors.Are Not Effective . 62An Approach to Effective Board Operations *..... 63Conclusion .......... .... 65

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TABLE OF CONTENTS (continued)

ANNEX III THE USE OF HOLDING COMPANIES ........................ 67

Purpose . ................. ...... .. ...... *. ... 67Performance .................... ................ .... 69

Strengths ................ . ................... 69Buffer Against Excessive Political Interference 69Professional Management of the Ownership Role 70Leveraging Scarce Management Skills .......... 70

Benefits from Cooperation (Synergy) ...... .... 70Weaknesses ........ ,....... *.,.* .............. 71

Effective Tool for Political Interference .... 71Excessive Layers of Management and Slow

Decision-Making ......... . ........................... * . 71

Lower Motivation and Quality of Managers ...... 72

Excessive Financial Powers ................... 72Lack of Appropriate Role ...................... 72

When to Use Holding Companies .................. 73

STATISTICAL ANNEX ......................................... o................ 75

LIST OF TABLES

Summary Table - Factors Affecting Public EnterprisePerformance ... ................... . ....... . 8

Table 1 - Share of Public Enterprises in Non-U.S.Fortune 500 Companies ........... o 9

Table 2 - Profitability of Public IndustrialEnterprises by Subsector, 1984 15

Table 3 - Comparison of Financial Profitability, 1984 16

Table 4 - Levels of Financial Control 30Table 5 - Conventional Roles in Corporate Management 32Table 6 - Management Models for Public Industrial

Enterprises in Thirteen Countries .34

Table 7 - Establishment of Multisectoral HoldingCompanies . .... . .- - .... ".-.-. . 46

Table 8 - Focal Point Organizations .49

TABLE OF CONTENTS (continued)

LIST OF FIGURES

Figure 1 - Public Ownership of Selected IndustrialSubsectors, 1984 . .0 .... ..... ...... .......... 11

Figure 2 - Vicious Circle of Public Enterprise SectorManagement .......... ........................ 22

Figure 3 - Life Cycle of Public Enterprise SectorOrganizations. ... ...... ..... ..... ... 38

Figure 4 - Public Enterprises in Italy ................... 47

LIST OF ANNEX TABLES

Table A-1 - Establishment of Holding Companies .......... 67Table A-2 - Summary of Strengths and Weaknesses ....... 73Table A-3 - Use of Holding Companies ................. ... 74Table SA-1 - Key Indicators of Major Public Industrial

Enterprises, 1984 .. ... .-.. ... .... .. ... ....... . .. . 75Table SA-2 - Shares of Public Industrial Enterprises

in Selected Indicators, 1983 ................ 77

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FOREWORD AND ACKNOWLEDGEMENTS

This study was undertaken with a view to fulfilling the growingneed in the World Bank as well as its member countries for understandingthe underlying factors that influence the performance of public industrialenterprises. To fulfill this need, country case studies of such enter-prises were undertaken for thirteen countries, using a common information-gathering and analytical approach. The authors of these country studieswere as follows:

Austria : Anne MilneBrazil : Mahmood AyubFrance : Gilles MichelGhana : Ebenezer NyakoteyIndia : Jayant KalotraIsrael : David KochavItaly Sergio RistucciaNorway : Bo CarlssonPakistan : Istiqbal MehdiPortugal : Sven HegstadSweden : Bo CarlssonTunisia : Jan SvejnarZambia : Charles Becker

The above country studies were used as background material forthe present study. Where necessary, those studies were complemented byother sources of information and the experiences of other countries.

The authors are greatly indebted to Kemal Dervis, Harinder Kohliand Anil Sood for their support and guidance at all stages of preparation.We are grateful to Dennis Flannery and Ira Lieberman for their support inwriting the annex on the board of directors and to Sujin Hur and RebeccaSekse for their assistance with the statistical work, to Whitney Watrissfor editorial suggestions and to Wilson Peiris and Tony Tenorio for theirpatient help in typing various drafts of this study. Finally, the authorswish to acknowledge the helpful comments of Jean Grosdidier de Matons,Leroy Jones, Gobind Nankani, Roy Pepper, Alejandro Schwedhelm, EdilbertoSegura, Mary Shirley, Charles Vuylsteke and George Zaidan.

CHAPTER 1

INTRODUCTION AND SUMMARY

1.01 Why do some public industrial enterprises perform better thanothers? Why is it, for example, that public enterprises in Brazil achievegenerally better financial and economic results than do their counterpartsin Ghana or Pakistan? Within Brazil, what is it that makes the nationaliron ore company (CVRD) and the national petroleum company (PETROBRAS) muchmore successful than, say, the copper company (Caraiba Metais) or, at theextreme, the railroad company (RFFSA)? Why does India's Hindustan MachineTools (HMT) remain dynamic and well-performing, whereas other public enter-prises in the same country and even in the same subsector are far lesssuccessful?

1.02 There are two sets of factors. The first consists of country-specific cultural, social, political, macroeconomic and institutionalcharacteristics, that explain inter-country differences in enterpriseperformance. The other comprises more enterprise-specific matters, such asthe degree of autonomy, extent of both domestic and foreign competition,and the corporate and managerial environment. This set explains intra-country differences in enterprise performance. Clearly, there is overlapbetween the two sets of factors.

Objectives and Scope of This Study

1.03 This study addresses only those factors in the two sets that arepeculiar to public firms and that can be influenced by policy-makers.Thus, although cultural and social factors can be of critical importance indetermining the degree of success of public enterprises, they are outsidethe purview of this report. Similarly, the quality of individual chiefexecutive officers has an important effect on the performance of publicenterprises, but the same is equally true for private firms. Likewise, acrucial determinant of performance of both public and private enterprisesis the appropriateness of the macropolicy and institutional environment.Sound industrial, trade and financial policies, an institutional environ-ment that is not too encumbered by regulations, absence of severe rigidi-ties in product and factor markets, the existence of domestic competition,well-articulated fiscal reforms and realistic restructuring plans are allextremely important determinants of performance. While these policy issuesare outside the purview of the present study, it is assumed throughout thisstudy that governments would put in place at least the minimum package ofsuch policy measures as a mutually complementary and reinforcing element toother more specific public enterprise management measures discussed in thisreport.

1.04 The background material for this study comprises 13 country casestudies of public industrial enterprise sectors, which are available onrequest. These studies were complemented by interviews with seniormanagers of successful and not-so-successful public enterprises. Thecountries included are Austria, Brazil, France, Ghana, India, Israel,

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Italy, Norway, Pakistan, Portugal, Sweden, Tunisia and Zambia. The casestudies contain detailed information on the genesis, role, performance,control mechanisms, organizational structures and key performanceconstraints of public industrial enterprises in each country. To ensuremaximum consistency and comparability, a common questionnaire was used forinterviews with enterprise managers and government officials and forpreparing the country reports. Where relevant, this report also draws onthe authors' experiences with other countries, especially Bolivia, Turkeyand Uganda.

1.05 This study deals primarily with public industrial enterprises.Since these entities generally produce tradable goods in markets with vary-ing degrees of competition, they are distinct from some other public enter-prises such as utilities and transport companies, which often are naturalmonopolies. However, most of the organizational and management issuesfacing public industrial enterprises are also relevant to other publiccompanies even though the remedies may differ.

Why Study Public Enterprises?

1.06 In many countries, particularly those in which a robust privatesector did not exist, public industrial enterprises have played a crucialrole in the development of the industrial sector. They have been the mainsources of growth in several industrial sectors in countries such asBrazil, Egypt, Ghana, India, Pakistan, Turkey and Zambia, to name a few.They have also frequently played an important role in the fulfillment ofcertain social objectives that probably the state or the private sectorwould have found difficult to undertake. Unfortunately, however, the highgrowth rate and the fulfillment of social objectives were not achieved inmany cases in a cost-effective way. So long as countries experienced rapidindustrial growth and resources were relatively abundant, these inefficien-cies were tolerated and even ignored. However, the severe resourceconstraints and curtailment of growth in many countries during the lastseveral years has made many governments realize that public enterprises canbecome obstacles to the resolution of macroeconomic problems such as highinflation rates, large budgetary deficits, excessive foreign debt and thelike.

1.07 Furthermore, the business environment for public industrialenterprises changed dramatically between the 1950s and the 1980s. Thefifties and early sixties were characterized by strong and predictablegrowth. The main concern of producers was to solve production problemsso as to be able to satisfy demand. Starting in the sixties, the marketplace gradually shifted to consumer-driven markets. At the same time,developing countries became a significant factor in the world market formanufactured goods and a globalization of the market place evolvedrapidly. The increased speed of technological change further fueledcompetitive pressures. Response to customer preferences and enhancedmotivation became increasingly important, and rigidity in long-termplanning was replaced with flexibility, creativity and planning for stra-tegic options. Public enterprises frequently characterized by bureaucraticorganizational structures and relatively slow decision-making processeswere often ill-suited to respond effectively to the changing environment.

At the same time, especially in the more developed countries, many of theoriginal reasons for the creation of public industrial enterprises dis-appeared or were diluted, such as being engines of growth for industriali-zation and fulfilling a lack of private sector initiative. Regardless oftheir size, stage of development and political preferences, many countriesare, therefore, currently undertaking careful assessments of the role,performance and raison d'etre of public enterprises.

1.08 The response of several developing countries to their mountingeconomic problems has been to impose restrictive monetary policies. In theabsence of greater emphasis on fiscal constraints and with somewhat morelax controls on public sector expansion and easier access to domestic andforeign credit, there has been some "crowding out" of private sectoractivities even in countries such as Brazil and Turkey (in the late 1970s)that have assigned priority to private sector development. At the sametime, the result has been excessively high real interest rates and severefinancial distress. A more appropriate policy response may be to givegreater priority to reducing the public sector deficit in general, andreducing the financial subsidies to public enterprises in particular. Thiswould help in relaxing somewhat the constraints on credit to privateproducers. Such a policy mix can elicit a greater supply response from theeconomy.

1.09 Another response of several governments to the relatively poorperformance of public industrial enterprises has been to restructure themas a complement to policy and institutional reforms. Such restructuringhas involved consideration of a wide variety of measures, including break-ing up large units, merging small ones, selling assets, spinning units off,liquidating them completely, opening up a sector to private investors, andprivatizing existing units partially or entirely. While privatization isgenerally desirable, the extent, nature and speed with which it can bepursued varies from country to country. Even in countries such as Braziland Turkey, whose governments have publicly endorsed privatization, theprocess has been slow in view of the need to build a broad political con-sensus, to change entrenched positions, to inculcate a new approach and toovercome certain inherent economic constraints. Thus, in Brazil, evenafter six years of a widely publicized divestiture program, the assets ofprivatized public industrial enterprises have so far reached only 2-3 per-cent of the total assets of all public industrial enterprises, and only oneof the 17 privatized firms or groups has more than 1,000 employees. Insome countries, particularly in Africa, the thinness of the domesticcapital markets, scarcity of experienced entrepreneurs and reluctance ofthe private sector to acquire inefficient and loss-making state assets atmutually acceptable prices are inherent economic structural constraints onprivatization. Even in higher income countries such as Chile, financialsector weaknesses can greatly complicate privatization. It is thereforerealistic to assume that large portions of industry will remain in publicownership for considerable time, even in countries committed to privatiza-tion. Given the substantial weight of public enterprises in most countries(see Chapter 2), the efficient management of their operations is thereforelikely to continue to have a crucial impact on industrial growth and macro-economic prosperity in many countries.

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Key Determinants of Performance

1.10 No country, developed or developing, has devised a perfect way tomanage public industrial enterprises. Even if one were found, social andcultural differences would make its blind replication almost meaningless.But there are clearly better and worse ways of managing public enter-prises.

1.11 Attempts at achieving a more efficient public enterprise sectormust begin with an understanding of the factors inhibiting adequateperformance. Are they purely inherent, arising from public ownership perse? Or, are there other important determinants of performance, separateand apart from ownership, that can be influenced by governments?

1.12 To some extent, the poor performance of public industrial enter-prises relative to their private counterparts (discussed in Chapter 2) canbe explained by some inherent differences relating to ownership. Theseinclude: lack of a significant financial stake on the part of the putativeowners of public enterprises (government officials representing the state);limited threat of bankruptcy and reorganization because of easy recourse togovernment funds and political inertia in terms of lay-offs of largenumbers of employees; the circuitous chain of decision-making devised toensure public accountability; and the generally close political tiesbetween trade unions and government officials and board members. However,while these inherent factors are important, they are only part of theexplanation. Evidence from our study indicates that factors not strictlyrelated to ownership per se are equally important, and this study attemptsto identify these.

1.13 Our review of the performance of state-owned enterprises in 13countries has highlighted three factors relating to the business andmanagerial environment that distinguish successful public enterprises fromthe poorly performing ones: the degree of competition that public enter-prises are exposed to; the degree of financial autonomy and accountabilityunder which public enterprises operate; and the extent and manner in whichmanagerial autonomy and accountability are ensured. If these factors canbe managed appropriately, the performance gap between public and privateenterprises can be reduced significantly, and to levels that in many casescan be justified by the infrastructural, strategic or social reasons thatmotivated the creation of many public enterprises in the first place.

1.14 The first component of a framework for the management of publicindustrial enterprises is the degree of competition that these entities areexposed to. Our study discovered numerous cases in which public industrialenterprises subjected to a more demanding, competitive environment tendedto perform better. Inappropriate macroeconomic, trade and industrialpolicies (maintenance of an overvalued exchange rate, excessive reliance onquantitative import restrictions, high tariff protection, price controls,restrictive procurement policies, localization programs, investment licens-ing, regulations on entry and exit and other regulatory constraints) arethe most potent constraints on competition for both public and privatefirms. While it was not the purpose of this study to examine comprehen-sively the above policies, it is worth repeating that without a set of

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rational and consistent policies that engender a competitive environment,specific measures for better management of public enterprises cannot helpmuch. In addition, some specific ways of fostering competition amongpublic enterprises are discussed in Chapter 3.

1.15 The second component is the degree of financial autonomy andaccountability of public enterprises. This entails giving firms sufficientfinancial autonomy, holding public enterprise managers accountable andensuring that they pay the government (and any other shareholders) an ade-quate return on capital in much the same way as private firms do. Manywell-intentioned governments assume that financial profitability is not ahigh priority for public enterprises. If public managers are freed ofdomination by profit motives, it is argued, they will automatically concen-trate on achieving broad social goals rather than narrowly defined finan-cial targets. Generations of public managers have been taught that thereis a stigma attached to financial profitability.

1.16 The problem with this view is that freedom from concern withprofits frequently degenerates into a lack of concern for wasteful use ofresources without a guarantee that social objectives are being fulfilledadequately. While it does encourage public investment, it is often withpoor timing and feasibility: the innumerable "white elephants" in publicinvestments in many countries are ample testimony to this outcome. Publicenterprises in certain social infrastructure sectors set up specifically toachieve certain non-financial objectives perhaps can afford to ignorefinancial objectives. But public industrial enterprises that produce trad-able goods that face (or potentially face) domestic and foreign competitioncan only do so at great cost. All the above argues for strict financialdiscipline, including elimination of subsidies and enforcement of dividendpolicies for those enterprises that are financially viable, and a programof action toward such an end for those that are currently loss-makers.Such a program would include (i) a clear identification of the sources ofpoor financial performance and (ii) establishment of a time-bound programfor eliminating losses. Some guidelines for appropriate financial policiesare provided in Chapter 4.

1.17 The third crucial factor that distinguishes successful publicenterprises from poorly performing ones is managerial autonomy and account-ability. Experience indicates that excessive control of, and interferencewith, the operational decisions of public managers (in investment, productmix, pricing, hiring and firing of staff, wage-setting, procurementpolicies, etc.) can suffocate managerial initiative and result in a loss ofaccountability and costly operational inefficiencies. The problem ofexcessive operational control is not only that the process is time-consum-ing for an already over-stretched bureaucracy, but also that governmentofficials lack the necessary information, business perspective and confi-dence to make correct and expeditious decisions. Excessive politicalinterference in the operational matters of public enterprises can bereduced by demarcating clearly the roles and responsibilities of thegovernment (ownership role), the board of directors (strategic role) andthe management of enterprises (operational role); by appointing profes-sional directors with experience relevant to their tasks; by decentralizing

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appropriate powers to the board of directors; and by introducing a manage-ment philosophy that is less control-oriented and procedure-bound and more

concerned with judging managers on the basis of enterprise viability and alimited set of indicators of performance. This decentralized structure canbe applied to most countries and enterprises. Naturally, the types of

powers granted and services provided by central units, and the mix betweenmarket and government control, will vary between countries such as Swedenand Zambia. However, these differing levels of powers and functions couldbe exercised within the same decentralized organizational structure. Theseissues are discussed in Chapter 5.

1.18 A related set of factors, examined in Chapter 6, affecting theautonomy and accountability of public enterprise managers is the ability ofthese managers to influence quality and availability of managerial skills,and to maintain morale in a situation where many of the frustrations of thework force may be the result of powers outside of the public enterprise.Problems arise because of the inability of public enterprises to attract orretain highly qualified staff; high turnover rates of managers resultingfrom political changes or civil service rotation policies; and politicalconsiderations in filling vacancies. While budgetary constraints preventgovernments from offering more competitive salaries to public managers,there are many other ways to increase motivation (delegating greaterresponsibility) and reducing the severe shortages of skills (well-focusedtraining programs). The second factor--high morale--can affect performancebut it is generally the result, not the cause, of good performance inpublic enterprises. However, this study has provided several exampleswhere public managers have adroitly used small, well-publicized successesto turn sagging morale and discipline around and thereby improve perform-ance further.

1.19 Once the government has decided how much decision-making power todelegate, the next issue is how to organize its various components,(ministries, specialized agencies, etc.) to ensure effective decision-making. The multiplicity of government agencies involved in decisionsrelating to public enterprises has frequently led to confusion, duplicationand excessive control. Superimposed on this diffusion of responsibility isthe propensity of public enterprises to become lightning rods for excessivepolitical interference and discontinuity in decision-making with everychange in government.

1.20 To improve coordination and reduce interference, governments haveexperimented with various institutional arrangements. Two approaches,reviewed in Chapter 7, are the use of holding companies and central super-visory agencies (or focal points). Evidence from both developed and devel-oping countries suggests that large-scale state-owned multisectoral holdingcompanies have been a negative factor. Instead of being a buffer againstexcessive political interference, they have: become an effective tool forpolitical domination and interference; created excessive layers of manage-ment; reduced the transparency of performance; and resulted in slow andbureaucratic decision-making. State-owned holding companies are likely to

be somewhat more effective when they are used to manage small- and medium-sized enterprises. Central supervisory agencies can play an important role

if: their functions include, and are limited to, the execution of theownership role; their functions and size are carefully defined and circums-cribed; they are inhibited from interfering in the day-to-day operations ofthe enterprises; and if they are staffed with highly qualified persons withrelevant industrial and managerial experience. While one main character-istic of public enterprise sector management is excessive government inter-ference, it is equally common to find a lack of effective control, a situa-tion that creates uncertainty, lack of understanding and sometimes distrustand that frequently ends up in excessive interference. The dual purpose ofeffective central supervisory agencies is, on the one hand, to protect thepowers of the board of directors and management from undue politicalmaneuvering, and, on the other, to exercise effective control of a limitednumber of performance factors.

1.21 The following summary table enumerates some of the key componentsof the three factors, indicated earlier, that influence the performance ofpublic industrial enterprises. Details on these are provided in thefollowing chapters. It is impossible, and perhaps misleading, to assessstatistically the individual importance of each of these factors. What isclear from our analysis is that, where these factors exist as a package,the performance of public enterprises is significantly better than in thosecases where most or all of these factors are non-existent.

SUMMARY TABIE: FACTORS AFFETING PUBLIC ENTERPRISE PERFORKANCE

PERFORMANCE ENHANC ING FACTORS PERFORMAJCE RETARDING FACTORS

Competitive Environment Competitive Environment

1. Exposure of public enterprises to domestic and foreign competi- 1. Excessive protection from domestic and foreign competition.tion via more outward-oriented trade and industrial policies andless regulation. 2. Assignment of monopoly powers or consolidation of several

enterprises into a single one without any perceivedeconomies of scale.

2. Encouragement of public enterprises to compete among themselvesand with private companies in the same lines of business.

3. Wide publicity in meetings and in the national press of thecomparative performance of different public enterprises.

4. Breaking uip of overly centralized and monolithic companies intosmaller ones, where economies of scale are not important.

Financial Autonomy and Accountability Financial Autonomy and Accountability

5. Reliance on capital markets as the primary source of financing. 3. Disregard by government and/or puiblic managers for financialprofitabtlity.

6. Where government debt financing ts used, market interest ratesare charged. 4. Excessive reliance on government funds, frequently at subsidized

rates.7. Strict enforcement by government of return on capital criteria,

including dividend payments. 5. No pressure on enterprises to make dtvidend payments or to earnan adequate return on capital.

8. Enterprises not overburdened with too many social objectives and,where necessary, are compensated for performance of social 6. Confitcts between social and financial objectives, and the pre-

functLons. dominance of social objectives.

9. Reducition of operating subsidies, if necessary in a phased way, 7. Excessive reliance on debt rather than equity financtng.with ithe objective of their total elimination (except for item 8)

8. Complicated maze of transfers between enterprises acnd central

10. A proper debt/equity ratio consistent with the business risks. budgetary authorities.

11. Greater transparency in enterprise-governnent flows to ensure 9. Poor quality and/or delayed financial accounts.betteir financial accountability.

10. No accountability for financial performance.12. Use of generally accepted accounting standards, timely publica-

tion of financial statements, audited by independent private 11. No financial stake of managers in company's financial performauditors. Also, setting up of a simple financial performance ance.measurement system.

13. Linking of performance to a system of rewards and penalties formanagers and key staff.

Managerial Autonomy and Accountability. and Coordination Managerial Autonomy and Accountability, and Coordination

14. Clear demarcation of the ownership, strategic and operating 12. Excessive control of, and tnterference with, the operations of

roles,. public enterprises.

15. Appointment of professional directors, with relevant experience, 13. Politicized board of directors.and delegation to them of strategic decisions.

14. Little autonomy for public managers in daily operations.

16. Delegation of substantial managerial autonomy in day-to-dayoperations to public enterprise managers. 15. Multiplicity of agencies involved in coordination, control and

supervision of public enterprises.

17. Delinking of enterprise recruitment, promotion and salaryadministration from public service regulations. 16. Existence of bureaucratic, over-centralized multisector holding

companies.

18. Where necessary, establishment of well-focused sector holdingcompanies with well-defined functions.

19. Strengthening of oversight agencies for better supervision, andsetting up of public enterprise focal points for policy-makingand execution.

20. Organization of public enterprises as ordinary stock corporationsunder corporate law.

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CHAPTER 2

THE ROLE AND PERFORMANCE OF PUBLIC INDUSTRIAL ENTERPRISES

2.01 The purpose of this chapter is to place the role and performanceof public industrial enterprises in perspective. Section A deals with theweight of these entities in the economies of the sample countries.Section B assesses the performance of public industrial enterprises, bothin absolute terms and in relation to that of private firms.

The Role of Public Industrial Enterprises

2.02 Public industrial enterprises hold an important position in theeconomies of the sample countries, although there are differences ofmagnitude. Of the 500 largest non-U.S. industrial corporations on theFortune list for 1985, some 71 are public (see Table 1, Statistical Annex,for the list, which also includes petroleum companies). More signi-ficantly, public industrial enterprises account for 19 percent, 21 percentand 21.4 percent of the total sales, assets and employment, respectively,of the 500 firms. Equally important, over the last decade theirimportance, in terms of the number of public enterprises on the Fortunelist and the share of employment, has increased, as indicated by Table 1.

Table 1: SHARE OF PUBLIC ENTERPRISES IN NON-U.S. FORTUNE 500 COMPANIES

1975 (X of total) 1984a/ (X of total)

Number of Enterprises 54 (10.8) 71 (14.2)Total Sales (US$ billion) 162 (19.7) 359 (19.0)Total Assets (US$ billion) 156 (20.5) 339 (21.0)Total Employees (million) 3.0 (17.5) 3.8 (21.4)

a/ A significant portion of the increase in the number of public enter-prises, their sales and assets is explained by the nationalization ofmany industrial enterprises in France since 1981.

Source: Fortune, August 1976 and August 1985.

2.03 Based on data for the sample countries (the shares of all theirpublic industrial enterprises in value added, gross fixed investment andemployment are provided in Table 2 in the Statistical Annex), there is noindication that the average share of public ownership of industrial valueadded is related to the level of development of a country (as measured by

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GDP per capita).1/ There were various economic, political, social andhistorical factors (such as the nationalization of Renault in France forcollaborating with the Nazis during World War II and the more recentnationalizations of many industrial companies since 1981 after the instal-lation of the socialist government in that country) that have determinedthe size of the public sector, regardless of the stage of economicdevelopment.2/ On the other hand, there appears to be a discerniblepattern in the relative share of public ownership between various sub-sectors, regardless of whether a country is developed or developing. Thispattern which is shown in Figure 1, can be largely explained by suchfactors as the perception of some subsectors as strategic or as character-ized by economies of scale (such as steel, aerospace, telecommunications,etc.).

2.04 Much more important than the share of public industrial enter-prises in total value added is their share in total investment. Put dif-ferently, the public enterprise sector in the sample countries, with theexception of Austria, is much more capital-intensive than the privateenterprise sector. For the sample countries, the average share of publicindustrial enterprises in capital formation was 26 percent, more than twicethe share in GDP of about 11 percent. As Sheahan indicated, "in Brazil andin India it is almost as if industries were divided between private andpublic enterprise according to their capital intensity."3/ To a largeextent, this situation reflects the fact that some public enterprises wereset up precisely because of the large-scale capital requirements of somesubsectors (such as steel, oil refining, etc.) that the private sector wasunable to finance. However, it may also reflect differences in the rela-tive factor prices faced by public and private enterprises. In a number ofthe sample countries, the cost of capital to public industrial enterprisesis lower than that to their private counterparts, and the availability of

1/ The correlation coefficients of per capita GDP with the shares ofpublic industrial enterprises in industrial and total GDP were only0.05 and 0.03, respectively. Kendall's rank coefficients were,respectively, 0.14 and 0.39 (a zero value signifies a random patternand 1.00 indicates exactly similar rank orders), results that are onlysignificant at 1 percent and 10 percent levels of confidence,respectively.

2/ For some details on the origins and development of public industrialenterprises in the sample countries, see Annex I.

3/ John B. Sheahan, "Public Enterprise in Developing Countries," inWilliam G. Shepherd, Public Enterprise: Economic Analysis of Theoryand Practice (Lexington, Ky.: Lexington Books, 1976).

Figure 1:Public Ownership of Selected Industrial Subsectors,

1984

PETRO CEET MOTOR MNN MZR TE EEO

TEXTILES ELECTRONICS CHEMICALS CNNICSCO

AUSTMIA 0 0 N.A. 0 * _**

BRAZIL 0 G 0 0 _ 6 6FRANCE ___ Q _Q_

GHANA N.A. Q Q N.A. N.A.

INDIA _ _ _ _ _ _

ISRAEL 0 ___ 0 QN.A Q __

ITALY _.A 0 NA ._ . . _

SWEDEN 0 _° _ _ __ * __ _ A _ __ _ _ _ _ 6 _ _

TUNISIA Q O N.A. GJ6 N.A.

ZAMBIA N.A. N.A. N.A.

Q I^U' OY 251 rPUBUC SOX PUSUC &75X PUSUC * MARC

NOTES:(i) In a number of countries, developed and developing, some public companies have substantial

(but less than 50%) ownership in private hands. However, for the purpose of this report,

these are considered as fully public.(ii) Fertilizers refers to nitrogenous fertilizers only.(iii) Telecommunications refers to services, not manufacturing.(iv) The entry for India's motor vehicles takes into account the recently established, publicly

owned Maruthi plant.(v) The entries for Israel's motor vehicles and steel indicate majority ownership not by the

private sector but by the General Federation of Labor Trade Unions (Histradut).(vi) N.A. indicates not available or negligible production.

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subsidized lending from domestic monetary authorities or aid agenciesencourages relatively capital-intensive techniques.4/

Performance of Public Industrial Enterprises

2.05 Assessing the performance of public industrial enterprises ismade difficult by a lack of data for roughly the same time periods,problems of cross-country comparison and the choice of indicatorsavailable. Given these problems, the approach taken here was the "weightof evidence" one used by historians and jurists rather than one of testinghypotheses statistically. For the purpose of this study, it was deemedsufficient to rely on a set of conventional indicators that together shedlight on performance. These indicators include financial profitability,self-financing ratios, productivity growth and the share of theseenterprises in the overall budgetary deficit and external debt.

2.06 Financial profitability, as an indicator of public industrialenterprise performance, is far from perfect. Good financial performancemay measure efficiency but may also result from market distortions andpricing policies. For example, some of the more profitable public indus-trial enterprises in Ghana (including the distillery and cocoa factorieslocated in Accra and Takoradi, respectively) owe their financial successalmost wholly to monopolistic positions and to very high levels of protec-tion from foreign competition, and they have negative value added at inter-national prices. Until recently, some 90 percent of the total sales ofpublic industrial enterprises in Pakistan were subject to price controls,and this constraint affected the financial profitability of enterprises insuch subsectors as fertilizers, cement, automobile assembly and petroleum.However, financial profitability does indicate whether the public enter-prise generates revenue or not and therefore whether (and how much) itdepends on the national treasury for its operations. As will be indicatedlater, the degree of managerial autonomy of public industrial enterprises,an important determinant of performance, depends to a large extent on thedegree of independence from treasury financing.

2.07 The data for the sample countries indicate generally low finan-cial rates of return for public industrial enterprises. For example, overthe period 1977-83, the 15 largest Portuguese public enterprises achievedan average rate of return on capital employed of about 10 percent, comparedto an average rate of inflation of about 21 percent. In Ghana, the compar-able rate of return was about 18 percent, compared to an average rate ofinflation of 96 percent. Similarly, in Pakistan, the return on capitalemployed averaged about 2 percent during the 1970s and slightly over 4

4/ While high capital intensity is characteristic of the publicenterprise sectors in most sample countries, it is particularly markedin Ghana. Two sugar factories and a state footwear factory installedconveyors to undertake tasks that are not even mechanized in the U.S.See Tony Killick, "The Role and Performance of the Public Sector inthe Industrialization of Some African Developing Countries: AnIn-Depth Assessment," in The Changing Role of the Public IndustrialSector in Development, (Vienna: UNIDO, 1983).

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percent during 1980-83, compared to an average rate of inflation over thewhole period of about 12 percent.5! Consolidated financial accounts for140 Indian public enterprises indicate an average pre-tax return on capitalemployed for 1978-83 of about 11 percent in current terms. However, over90 percent of these profits were in the petroleum sector. Among industrialcountries, Austrian public industrial enterprises (in the OIAG Group)registered an average return on capital employed of about 3 percent during1975-80, and since 1980 many of the firms have encountered losses. InSweden, the Statsforetag enterprises kept fairly even pace with the rest ofSwedish industry during 1970-76 in terms of both sales per employee andprofitability, even though their return on invested capital as a groupreached the 10 percent target only once (in 1974). However, losses wereincurred as a group in all subsequent years until 1983.

2.08 Performance in terms of real value added growth has been somewhatbetter. For example, Brazilian public enterprises registered a generallystrong performance during 1966-75, both in absolute terms and in comparisonwith industry as a whole. Real value added in large Brazilian publicenterprises increased 3.7 times over the period, compared to 2.4 times inindustry as a whole. Data are, however, not available to measure theextent to which this reflects a greater level of investment by publicenterprises and the degree to which it represents an increase in totalfactor productivity. Since 1975, such value added increases have beensignificantly lower for both public enterprises and industry in general.Similarly in Portugal, real value added per employee increased by 83percent during 1976-79 for the largest 13 public industrial enterprises.In subsequent years the increase was only 2 percent.

Variations in Performance

2.09 Financial performance varies considerably among public enter-prises in the same country and between subsectors across countries. InIsrael, within the Israel Chemicals Limited (ICL) group, the most profit-able subsidiary--the Dead Sea Works--had an average annual return onrevalued capital of 12 percent in 1980-83 and 18 percent in 1984, ratesthat are considered high for the heavy chemical industry. In contrast,another subsidiary in the same group--Fertilizers and Chemicals--has beenbarely profitable, to some extent because it has concentrated on thedomestic market in which fertilizer prices are controlled. In Zambia, somesubsidiaries of Indeco (such as Zambia Breweries, Zambia Oxygen, NationalBreweries, Zamefa, Supa Baking and Chilanga Cement) are profitable, whereasLuangwa Industries, Zambezi Sawmills, Nitrogen Chemicals and LivingstoneMotors have been loss-makers. In Ghana, the best performers have beenGIHOC's cocoa processing factory, a liquor distillery and a fruit cannery,whereas its two sugar factories have been big loss-makers. In Brazil,PETROBRAS and CVRD have been consistently profitable, together with a fewsmaller public enterprises (Mafersa, Celma, Tasa, etc.), whereas the ironand steel companies (Siderbras, Acesita and Siderama) have been substantial

5/ The data refer to the public industrial enterprises under the juris-diction of the Ministry of Production, which account for most ofpublic industrial value added and employment.

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loss-makers. In India, gross profits (before tax and interest charges) forpublic industrial enterprises during the early to mid-1970s averaged about19 percent for the petroleum industry, 11 percent for medium and lightengineering, 2 percent for steel and -3 percent for minerals and metals.

2.10 The same variation in performance is visible in the industrial-ized countries in our sample. In Austria, OMV and SGP have been the onlyconsistently profitable public industrial enterprises. On the other hand,the largest contributors to losses have been the two large steel companies,Voest-Alpine and VEW. In France, public industrial enterprises can beclassified into three groups based on their profitability: the heavyloss-makers (the two steel firms, Usinor and Sacilor, and, since 1983,Renault); those enterprises that break even or have light losses (mainlyThomson, the electronics and telecommunications company, and EMC, thechemical company); and the profitable firms (such as Dassault, Matra,Saint-Gobain and Roussel).

2.11 Looking at the data across subsectors, variation in profitabilitycan be perceived significant (Table 2). The most profitable subsectors in1984 for the largest public enterprises in the world (not just in thesample countries) were mining and petroleum, the least profitable ones,steel and automobiles. Almost without exception, steel companies have beenthe largest contributors to public sector deficits. Excess global capacityand low world prices have resulted in huge losses in many countries,including France, Italy, Sweden, Brazil, Austria, India and Pakistan. Thefact that this subsector is considered strategic and is generally dominatedby strong trade unions has made cost reduction difficult.

Comparing Public and Private Enterprise Performance

2.12 How does the performance of public industrial enterprises comparewith their private counterparts in the sample countries? This questionneeds to be addressed with caution. Public industrial enterprises areoften expected to fulfill at least some social objectives in addition toprofit-making ones, and this role can affect their financial performance.Moreover, the public enterprise sector in many countries includes loss-making companies that the governments acquired for non-economic reasons.Also, the public enterprises' portfolio is frequently dominated by slow-growth basic industries even in countries such as France and the UnitedKingdom. Further problems can arise when too static a view is taken, thatis, when, for example, comparison is made between a new inexperiencedpublic enterprise and a well-established private one, or vice-versa. Inthis sense, comparisons of public and private firms' performance in thisstudy (and most other studies) are not rigorous enough and should beconsidered as only indicative and illustrative.

2.13 With these caveats, the evidence collected in this study suggeststhat within the sample countries, and sometimes within the same industrialsubsectors, public enterprises have generally performed worse than privateones in terms of financial profitability. Thus, in Israel, a study of asample of 25 public industrial enterprises and 37 private companies (inwhich 14 public and 24 private ones were in the same industrial subsectors)

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Table 2: FITABILM (F PlEL INXETRIAL HImS BY SUBS I, 1984

Number of (kGss Net Net IncmaSubsector Number of Loss-Mkdrg Assets Incae as % of

Firns Firm (US$ billion) (US$ billio) (kces Assets

yirg a/ 5 1 14,808 1,097 7.4Petrolenm b/ 26 2 183,356 7,029 3.8Tobacco 2 0 874 16 1.8Chiencals 5 2 17,895 293 1.6Aerospace 3 0 7,751 73 0.9Electronics 2 1 16,657 66 0.4Steel ard Metal Mafacturirg 15 7 49,234 -1,853 -3.8Motor Vehicles 4 2 25,949 -1,467 -5.7

Total/Average for Above 62 14 316,524 5,254 1.7

Source: Based on Table 1 of the Statistical Annex.

a/ Average profitability mm substantially affectel by CVRD of Brazil. Without it, the average falls to2.9 percent.

b/ Not included is YPF of Argentina, whose large losses distort the picture considerably. If YPF vereinclided, average profitability would decline to 1.8 percent.

showed considerably lower financial profitability for the former than forthe later. 6 / Before-tax profits for public enterprises averaged 1.6 per-cent of sales in 1976-78, compared to 11.6 percent in private companies. Acomparison of the profitability of large public and private Brazilian firmsfor 1974 and 1978 indicates that the rate of return on equity for publicenterprises was on the order of one-half the return earned by the privatesector.

2.14 In India, which has one of the largest and most diversifiedpublic industrial sectors among the developing countries, the financialperformance of public enterprises has been significantly worse than that ofprivate enterprises in the same industry (though not necessarily in thesame product line).7/ A recent study of public and private enterprises inIndia's fertilizer industry concluded that, while productivity performancein the most efficient public enterprises was comparable to that achieved bythe best private enterprises, productivity in the public sector as a whole

6/ See Ehud Diskin, "Attitude toward Risk in Israeli Private and PublicEnterprises," Ph.D. thesis, Hebrew University of Jerusalem, 1980

(unpublished).

7/ See V. Sri Ram, N. Sharma and K.K.P. Nair, Performance of PublicSector Undertakings (New Delhi: Economic and Scientific Researchfoundation, 1976).

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was lower than in the private sector.8/ In this case, the differences inperformance were partly explained by the higher input costs in the publicenterprises that resulted from their obligation to use indigenous feed-stocks, and because of the older, outmoded technology employed in parts ofthe public sector (public fertilizer plants were established as "pioneer"enterprises in the 1950s, whereas the first private firm came into exist-ence in 1968). To the extent that in most of these countries public enter-prises have access to more preferential rates of interest in borrowing andfrequently do not pay interest at all, the difference in performancebetween public and private firms is even greater.

2.15 In the case of France, the publicly owned Renault more than heldits own with the private automobile companies in that country until 1983.However, information prepared for this study indicates that French publiccompanies were more severely affected by the recession of 1980-82 thantheir private counterparts and that the private sector recovered fasterthan the public sector. Finally, an analysis of the data for the 500largest non-U.S. companies on the Fortune list for 1985 demonstrates thehigher profitability of private firms (Table 3).

Table 3: COMPARISON OF FINANCIAL PROFITABILITY, 1984(net income as % of gross assets)

Public PrivateSubsector Industrial Industrial

Enterprises Enterprises

Mining 7.4 15.5Petroleum 3.8 4.4Tobacco 1.8 8.5Chemicals 1.6 3.5Aerospace 0.9 2.9Electronics 0.4 3.6Steel and Metal Manufacturing -3.8 0.7Motor Vehicles -5.7 3.3

Weighted Average for Above 1.7 4.0

Source: "The Largest Non-U.S. Corporation," Fortune, August 19, 1985.

8/ See M. Gupta, "Productivity Performance of the Public and the PrivateSectors in India: A Case Study of the Fertilizer Industry," IndianEconomic Review, Vol. 19 (1982).

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Conclusion

2.16 A portion of the relatively poor performance of public industrialenterprises can be explained by their continued concentration in productlines and basic industries (such as steel, automobiles and fertilizers)that have experienced little growth in recent years, or in developing newindustries (such as aerospace) that are still in their infancy, and by thetakeover of ailing private sector firms. However, it is still true thatthese enterprises have contributed significantly to the macroeconomicproblems of many countries. For example, in Brazil during 1980-82, themajor federal public enterprises accounted for close to 50 percent of theoverall deficit of the consolidated federal government. In India, the nettransfers (current and capital) from the central government to publicindustrial enterprises increased from about US$890 million in 1978 toUS$2,320 million in 1983. The public enterprise sector has also beenresponsible for a significant portion of the external debt in a number ofcountries.9/ Most notably, Brazil's public enterprises account for overtwo-thirds of the country's external public debt. In Zambia, theinternational debt of ZIMCO alone accounts for over half of the totalexternal public debt. At the end of 1982, public enterprises accounted forabout 60 percent of Portugal's external public debt of US$13.5 billion andsome 90 percent of the country's short-term external liabilities of US$4billion.

2.17 The response of several developing countries to their mountingeconomic problems has been to impose restrictive monetary policies. In theabsence of greater emphasis on fiscal constraints and with somewhat morelax controls on public sector expansion and easier access to domestic andforeign credit, there has been some "crowding out" of private sectoractivities even in countries such as Brazil and Turkey (in the late 1970s)that attach great importance to private sector development. At the sametime, the result has been excessively high real interest rates and severefinancial distress. A more appropriate policy response may be to givegreater priority to reducing the public sector deficit in general, andreducing the financial support to public enterprises in particular. Thiswould help in relaxing somewhat the constraints on credit to privateproducers. This policy mix can elicit a greater supply response from theeconomy.

2.18 Since public industrial enterprises are such a significant partof the industrial sector in most countries, efforts at making them moreefficient have become imperative. In the following chapters, issuesrelated to improving the performance of public industrial enterprises areexamined, using evidence gathered in this study.

9/ In some cases, of course, the external borrowing of public enterpriseswas not voluntary but forced on them by governments that used thecreditworthiness of these enterprises to contract external loans.

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CHAPTER 3

A COMPETITIVE ENVIRONMENT AS A DETERMINANT OF PERFORMANCE

3.01 In view of the many determinants, mostly non-quantifiable, of theperformance of public industrial enterprises, no rigorous statisticalanalysis exists of the correlation between the degree of competition towhich public enterprises are exposed and their performance. The presentstudy is no exception. However, evidence from the sample countriesstrongly indicates that public industrial enterprises subject to a moredemanding, competitive environment, whether domestic or foreign, tend toperform better.

3.02 The post-World War II experience of French and Italian publicienterprises, particularly of Finsider in the Italian steel industry, ofRenault in the French automobile industry and, to a lesser extent, of SNIASin the French aviation industry, indicates that more open trade policiesand substantial domestic competition have kept public firms in industryunder pressure to control costs, limit economic waste and rationalize theuse of resources for non-commercial goals. In Brazil, the success of CVRDis explained in large part by the fact that it has had to survive in thefiercely competitive international markets for iron ore. The same is truefor some of the petrochemical subsidiaries of PETROBRAS in that country,and for OCP (phosphates) of Morocco. Israel Chemicals Ltd (ICL) is anothergood example where foreign competition has engendered superior perfor-mance. ICL would probably not have been significantly more profitable hadits ownership been private. In India, the publicly owned Richardson andCruddas has faced severe competition in structurals and industrial machin-ery from the private company, Testeels. The results are evident, despite,problems during the late 1970s owing to the repercussions of the then newlyacquired Muland plant and the disturbed industrial relations. In Zambia,three of the seven best financially performing public industrial firms areexporters (Zambia Oxygen, Zamefa and Chilanga Cement), while two of thefive moderate performers (Kafue Textiles and Zambia Sugar) are smallexporters. None of the poor performers are exporters.

3.03 The outstanding performance of Hindustan Machine Tools (HMT) ofIndia can be explained in large measure by the fact that, since the reces-sion of 1966-69 it has placed greater emphasis on exporting, marketing andprofitability.16/ It has also encountered fierce domestic competition inwatches, machine tools, tractors and lamps. Thus, even though the enter-prise was established initially for import substitution in the machinetools subsector, and even though it was forced by the government to goreluctantly into watch, tractor and lamp production, it has performed

10/ For details, see Pradip Khandwalla: The Performance Determinants ofIndian Public Enterprises, a study prepared for the World Bank, 1981.

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remarkably well. Why? Admittedly it has enjoyed significant operationalautonomy and substantial ministerial support, but so have the other lesssuccessful public enterprises, BPCL and BHPV, in the same (engineering)subsector. Domestic and foreign competition, which leave no room forcomplacency, appears to have been an important factor.

3.04 Of course, this is not to say that the response to the competi-tive environment is any less important than the environment itself. Publiccompanies in the same competitive environment have reacted differently,depending on their management. Occasionally, changes in leadership in thesame enterprise have led to better use of the environment. Within the IRIcomplex of Italy, the weaker performance of the engineering companies inthe early post-war years compared to that of the steel firms can beexplained almost completely in terms of differences in the quality ofmanagement which IRI failed to rectify. The point is not, therefore, thatcompetitive pressures are the determining factor in all cases, but ratherthat, given other factors, competitive pressures tend to bring out the bestin public enterprise management. An environment where challenges arenon-existent can suffocate the initiative of the best managers, public orprivate.

Fostering a Competitive Environment

3.05 Inappropriate macroeconomic, trade and industrial policies arethe most potent constraints on competition for both public and privatefirms. These policies include the maintenance of an overvalued exchangerate, reliance on quantitative restrictions and bans, high tariff protec-tion, price controls, domestic content legislation (especially in theautomobiles and electronics subsectors), investment licensing, regulationson entry and exit and other regulatory constraints.

3.06 The rationalization of these policies can improve the competitiveenvironment considerably, but there are also other ways that are morespecific to public enterprises. First, governments can make explicitattempts to nurture competition among public industrial enterprises andbetween public and private firms. Evidence indicates that such competitioncan occur even among public enterprises that are considered strategic. Agood example is the Heavy Mechanical Complex (HMC) at Taxila in Pakistan.The company faces competition in the production of road rollers and sugarmills from the privatized firm Ittefaq Foundry. It has to compete in theconstruction of cement plants not only with imports (allowed in with a dutyof 20 percent), but also with another public enterprise, Karachi Shipyard.It also faces competition in its production of electrical towers, boilersand overhead travelling cranes not only from private firms but also fromthe publicly owned Pakistan Engineering Company (PECO). Similar competi-tion, but on a much more intensive scale, exists among the variouspetrochemical subsidiaries of PETROBRAS in Brazil.

3.07 There is every reason to believe that Leon Festinger's *"socialcomparison theory" (which states that "people most strenuously seek toevaluate their performance by comparing themselves to others, not by using

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absolute standards") 'V applies as well to public enterprises. Centralmonitoring agencies should therefore make information on comparativeperformance widely available. In countries where performance targets arereviewed by such agencies, at least some of the meetings should be devotedto a comparative analysis of performance with public managers under thesame roof. The results could be widely publicized in the national press.It is surprising how many public enterprise managers interviewed in Braziland Pakistan (two countries where legislative and pressure group controlshave been virtually non-existent during most.of the last two decades)stressed their fear of unfavorable coverage in the national press.

3.08 Another way to subject public enterprises to competitive pres-sures is to encourage them to seek export markets. Of course, no amount ofencouragement or cajoling can make them export if the policy framework hasa strong anti-export bias built into it, or if the institutional, infra-structural and marketing constraints are severe. Where these biases andconstraints are surmountable, a small shift of the products to exportmarkets can have a sizable impact on the quality of management and competi-itiveness, even if the impact on the balance of payments is minimal. Afterall, only about 8 percent of the total sales of India's HMT are exported,blut this level appears to be sufficient to give the company access to newmanagement techniques and new technologies.

3.09 In industries in which economies of scale are not important,competition can also be enhanced by breaking up overly centralized andmonolithic holding companies or even large industrial enterprises. Thelbreak-up of Statsforetag in Sweden into smaller sectoral holding companieshas definitely increased competition and made public enterprises more,zonscious of efficiency considerations. The proposal of the new Boliviangovernment to break up the Bolivian Mining Corporation (COMIBOL) intoseveral competing mining enterprises could be a useful experiment.Occasionally, the break-up of large enterprises may be necessary but notsufficient for better performance. For example, the breaking up of FCI inthe early 1970s in India resulted in improvement in performance to acertain point only, mainly because the regulatory environment that hamperedoperations remained unchanged. This result stresses, once again, theimportance of a favorable regulatory and policy environment within whichenterprise-specific changes can 'be effected.

:3.10 In short, public enterprises should, to the largest extent possi-ible, be subjected to competitive pressures. Toward this end, considerationshould be given to introducing public enterprises on stock exchanges,establishing joint ventures with the private sector, stimulating exportinitiatives, breaking up monopoly firms, allowing competition among publicenterprises, and breaking up or reorganizing rigid conglomerates into moreflexible and dynamic bodies.

11/ Quoted by Peters and Waterman, In Search of Excellence (New York:Harper and Row, 1982).

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CHAPTER 4

FINANCIAL AUTONOMY AND ACCOUNTABILITY

4.01 One of the major causes of the financial and economic problemsthat most large public enterprise sectors around the world currently faceis the lack of a clear separation between the management and operations ofenterprises on the one hand and political considerations and processes onthe other. In many cases, this results in diffuse and conflicting objec-tives, limitations on managerial autonomy and accountability required forefficient commercial operations, and a civil service culture where chiefexecutive officers (CEOs) are more administrators than entrepreneurialbusinessmen. In such an environment, employment, investment and pricingdecisions are frequently made without due consideration to the financialconsequences.

4.02 These roots of public enterprise sector problems are in manycases only the starting point of a vicious circle that reinforces itselfuntil a crisis is precipitated. Poor investment choices, low productivityand highly leveraged capital structures create losses, reduce a firm'sability to raise resources from regular capital markets and banks anddrives managers to justify poor results with reference to a multitude ofsocial objectives. As a result, employee morale and financial disciplineare further eroded. For example, in Portugal it was found, among the 15largest public enterprises visited, that the loss-making ones on averagehad increased salaries significantly more than the profit-making ones. Asthe financial problems accelerate, the government finds itself forced tocentralize decision-making and controls further. Massive amounts ofcapital are injected into the public enterprise sector in desperate rescueoperations; special financial measures have included the "ParticipateBonds" in France, "Endowment Funds" in Italy, "Public Enterprise-Bonds" tobe serviced by the government in Austria, conversion of government debt toequity in Turkey, and cancellation of interest payments in India. However,financial support alone gives only temporary relief, unless it is combinedwith comprehensive physical and managerial restructuring measures. Unfor-tunately, in many cases a series of costly crises has to take place beforeeffective corrective actions are taken. This vicious circle is illustratedin Figure 2.

4.03 A fundamental prerequisite for improving public enterprise sectorperformance is to delegate more decision-making power to enterprisemanagers. Among the elements of autonomy that managers interviewed forthis study cherished most was financial autonomy, in the sense of substan-tial freedom from reliance on treasury financing. The two French steelcompanies (Usinor and Sacilor) have been chronic loss-makers, and as aresult all major decisions are subject to prior approval by their tutelleauthorities. By contrast, Saint-Gobain and Roussel, essentially profit-able, have enjoyed the greatest possible managerial autonomy. Similarly inSweden, the profitable Tobacco Company has experienced significantly morefreedom than the loss-making NJA (steel) company, even though both are sub-sidiaries of the same holding company, Statsforetag. The same conditionslargely explain the greater autonomy of PETROBRAS and CVRD in Brazil

- 22-

Figure 2:Vicious Circle of Public Enterprise Sector Management

STARTING POINT

1. Lack of managerialautonomy &accountablltty

2. Weak financial B. Further strsngtheningdiscipline of central controls

and deciston making

3. Poor Investment choices, 7. Less managerlallow productivity5 autonomy andexcessive leverage accountabilfty

~~~~/

4. Flnancial losses 6. Flnonciallustifled wlth crisissocial objectives

Deterioratingmorale.further reducedfinanctaldlsclpllne

as compared with the steel companies and the railroad company (RFFSA).Israel Chemicals Limited (ICL), one of the most autonomous public enter-prises, has had no major government contributions since it was establishedin 1967, depending instead on the retention of profits over the years.

4.04 What constitutes financial autonomy? What are the major finan-cial elements of an environment conducive to good performance? How canfinancial discipline be improved, and how can public enterprises be madefinancially more accountable? Experience indicates two major components:(i) an overall financial framework in which to manage the public enterprisesector; and (ii) supportive financial policies. The overall financialframework is the driving force behind the establishment of a productivemanagerial environment. The supportive policies and organization need tobe designed to support and reinforce the framework.

Overall Financial Framework

4.05 The success of government officials in managing public enter-prises depends crucially on a number of financial issues. These include:(i) the extent to which the enterprises are exposed to greater marketdiscipline; (ii) the importance of financial objectives, including paymentof dividends; (iii) the clarity of social objectives; and (iv) the degreeof restriction on access to subsidies from the state.

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Greater Market Discipline

4.06 Subjecting public enterprises to greater market discipline can bea potent way of improving financial performance. A combination of moreautonomy in financial matters and greater exposure to, and control by,markets normally creates among public enterprise managers a stronger senseof responsibility and a more genuine interest in the financial viability ofthe enterprise.

4.07 Access of public enterprises to capital markets is an importantway of institutionalizing financial discipline. Independent bankersscrutinize investment and financing decisions before they extend funds.The use of bond markets, equity markets and joint ventures open the publicenterprise to public scrutiny and to special audits and reportingrequirements. Interviews with public industrial enterprise managers inIsrael suggested that in enterprises whose minority shares are traded onthe Tel Aviv Stock Exchange (such as Dead Sea Works, Chemicals andFertilizers, and Cables of Zion), financial performance and discipline havebeen improved because of the greater transparency resulting from thepublication of semi-annual financial statements and their potentialexposure to legal suits by minority shareholders for non-businesslikemanagement.

4.08 Public enterprises should be encouraged to raise, to the extentpossible, all their debt financing outside the government and the centralbank. Whenever government debt financing is used, market interest ratesshould be charged; and joint ventures and floating of minority equitypositions on stock exchanges should be encouraged.

Financial Objectives and Dividend Policies

4.09 Sound financial management is a prerequisite for exposure ofpublic enterprises to the discipline and control of financial markets.Sound financial management entails specifying of financial objectives,establishing a mechanism to monitor these indicators, and holding managersaccountable for the outcome. The main measures to be used include: returnon assets or capital employed, return on equity, dividend pay-out ratio,maximum debt equity ratio and a pre-specified level of internal financingof large investment projects. The ratios are to a varying degree beingused by public enterprise managers in the sample countries. One exceptionis Austria, where enterprise financial objectives are not specifiedexplicitly but are couched in terms of "satisfactory" (undefined) profit-ability and cash flow. Officials of the public industrial enterpriseoverseeing unit in Sweden underlined that, in an effort to increase finan-cial discipline and performance among public enterprises, the establishmentof broad financial objectives and enforcement of a clear dividend policyare even more important in state-owned enterprises than in private firms,because of the former's inherent bias toward giving excessive priority tonon-financial objectives. They further stressed that even though thedividends in many cases may be small, frequently the principle of payingthem is more important than the amount. The enforcement of dividend policyis a highly visible and substantive action demonstrating that the govern-ment gives high priority to financial management and that state equity is

- 24 -

not considered free goods. It also forces management to rethink its growthstrategies and ideally to focus on productivity and profitability improve-ments as ways to finance the "new" financial obligations created by thedividend requirement.

4.10 In most countries in this study, dividend payments were eitherinsignificant or non-existent. This pattern does not mean that dividendpolicy has been unimportant, but rather that it has been neglected forsocial reasons or because of the inability of public enterprises to pay.

4.11 What amount of dividends should an enterprise pay, and how shoulddividend policies be formulated? The policies will vary among enterprisesdepending on factors such as risk, growth potential, asset structure andinflation rates. As a starting point, the government should determine foreach enterprise the required rate of after-tax return on equity capital.Countries with significant inflation will have to include revaluation ofassets in the calculation of return. Total target return on equity, directand indirect, normally is somewhat higher than the cost of debt and varieswith the levels of financial and business risk. A portion of this return,limited in some countries by law to the direct return, can then be set asthe dividend pay-out target. Typically, enterprises with low growth andlow investments pay out a majority of their after-tax profits. Conversely,enterprises with high growth and high investment requirements have rela-tively low dividend pay-out ratios. Generally, dividends vary between 25percent and 75 percent of after-tax profits. While profits may vary signi-ficantly between years, enterprises typically strive to pay stable divid-ends that grow at a steady rate at or above the inflation rate. Thisobjective means that dividend pay-outs can be more than 100 percent ofafter-tax profits in bad years and a much smaller percentage in boom years.

Clarification of Social Objectives

4.12 Public enterprises are frequently expected to pursue a variety ofsocial objectives, which can include such diverse g ls as redistributingincome, subsidizing particular regions of a countryid creating or main-taining employment. The fulfillment of at least some social objectives bypublic enterprises may be necessary and, in some cases, even advisable.

4.13 The problem is not the fulfillment of these objectives. Evenprivate enterprises have some social objectives, such as maintaining excessemployment during certain periods and providing adequate housing, educationand health facilities to their employees. The problem is that the multi-plicity of objectives and the absence of priorities among them lead to asituation where social objectives become an excuse for poor financial per-formance. In contrast, the watchword of Texas Instruments of the U.S.is "more than two objectives is no objectives." In other cases, socialobjectives become so predominant that they overwhelm the main objective ofthe public enterprise as a productive unit. Many examples of such situa-tions exist in both developing and developed countries. Perhaps the bestexamples in our sa!mple of countries are the bicycle plant at Chipata inZambia, the Aboso Glass Factory and the Bolgatanga Meat Factory in Ghana

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and the Bolan and Shahdadkot textile mills in Pakistan. Among the devel-oped countries, a good example is the state-owned aluminum company (ASV) inNorway, whose operations are substantially constrained by the need toprovide employment in a region where few alternative employment opportuni-ties exist. Social objectives have also been extremely important forCDF-Chimie (heavy chemicals) and EMC (chemicals) in France. In the case ofEMC, it has been estimated that the cost of rendering specific socialservices exceeded its overall deficit in 1984.

4.14 In using public industrial enterprises for social purposes,governments need to address two relevant issues. First, are the socialobjectives truly being fulfilled? Second, are there no better alternativesfor achieving them?

4.15 There is evidence that the pursuit of social objectives by publicenterprises can lead to inadvertent and perverse results. The case ofZambia's publicly owned agro-based industries (largely producing vegetableoil products, detergents and soap) is illustrative. Stringent pricecontrols on refined oil and fats (only recently lifted) have led not onlyto large financial losses but also to low morale and a shift in the productmix away from the production of oils and fats. This result was preciselythe opposite of the government's social priorities. Price controls areintended to benefit the poor, but end up subsidizing large industrialusers, wholesalers or the upper middle class in urban areas. The StateCement Corporation of Pakistan (SCCP) has in the past sold cement in Lahoreat Rs.2 per bag below the cost of production plus freight charges (from itsZeal Pak plant at Hyderabad, some 700 miles away) essentially to appeasethe urban elite in the city where the head office is located. Similarlyexcessive efforts to maintain or expand employment generally result incostly losses of efficiency and low morale.12/

4.16 In many instances, there may be preferred alternatives to the useof public enterprises as agents of social change. The objective of region-ally balanced economic growth is better achieved through an investmentencouragement scheme that consists not only of income and corporate taxcredits but also of direct cash grants from the treasury. The impressiveindustrial growth of the economically depressed North East region of Brazilover the last two decades was achieved with hardly any public investment.Often it is better to allow public enterprises to operate on commercial,profit-seeking lines and then use their profits to achieve social goalssuch as income redistribution and employment creation.

12/ For further examples of such unintended results, see Mary Shirley,Managing State-Owned Enterprises, World Bank Staff Working PaperNo. 577 (Washington, D.C., 1983).

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4.17 Even in cases where investment decisions have been taken onsocial grounds, the operational decisions need not be.13/ For example, ina number of the sample countries, governments have established large inte-grated iron and steel plants for strategic and national security reasons.These non-commercial objectives are achieved once the plant is set up andinitiates operations. However, the plant can nonetheless be operated alongcommercial lines. It may well earn a lower financial return as a result ofpoor location or absence of comparative advantage, but society stands togain by allowing the plant to earn as high a return as possible.

4.18 In a number of countries, especially France, Italy and Sweden,public enterprises are compensated explicitly on a contractual basisthrough the budget for undertaking social objectives.14/ This approach isfeasible in terms of preventing public enterprises from being saddled withexcessive social burdens and, at the same time, avoiding random departuresfrom efficiency criteria. However, such compensatory payments for under-taking non-commercial objectives should be viewed as second-best or eventhird-best solutions and should be used sparingly. Moreover, if thecontracts'become too frequent and large'in relation to a public enter-prise s normal activities, management may lose sight of its primaryobjective. Once such attitudes become entrenched, it is costly and time-consuming to change them. It is for these reasons that in Sweden, wherethe system of "contract offers" has been in existence for a considerablelength of time, has limited its application to only a handful of cases.Even in those few cases, the contracts have been for a restricted time andsubject to ex-post evaluation. The potential problems explain why Norwayhas shied away from such mechanisms.

Elimination of Government Subsidies

4.19 Public enterprises must learn to be financially autonomous. Easyrecourse to government subsidies for operating purposes in most casesreduces the pressure on public managers to close non-viable operations,divest non-strategic businesses to free up capital and initiate tough costcutting programs, all actions that normally are necessary for long-termsurvival in the private sector.

4.20 In cases where the enterprises are heavily dependent on subsi-dies, the government and management should agree on a plan for phasing themout over a limited period. This action may have to be matched with acomplementary program of physical and financial restructuring.

13/ This argument is developed by Leroy Jones, "The Linkage betweenObjectives and Control Mechanisms in the Public Manufacturing Sector,"in The Changing Role of the Public Industrial Sector in Development(UNIDO, Vienna, 1983).

14/ This approach was recommended by the 1968 Nora Report in France. SeeGroupe de Travail de Comite Interministerial des Enterprises Publi-ques, Rapport sur les Enterprises Publiques (Paris: La DocumentationFrancaise, 1969).

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4.21 In principle, public enterprises should receive government fundsonly under the following circumstances: (i) increases in equity capital tofinance viable expansion projects; (ii) increases in equity capital as partof restructuring operations aimed at creating viable operations; and(iii) subsidies for performing non-economic social functions, as explicitlyagreed between the government and an enterprise. The latter type ofagreement should be used only in rare cases where the economic impact ofthe social functions is substantial.

4.22 Elimination of subsidies is one of the strongest actions that agovernment can take to substantiate a reorientation in financial policiesand to force more economically oriented behavior on public managers.

Supportive Financial Policies

4.23 To support the decentralized management model described above,governments would need to establish and enforce clear capital structurepolicies and exercise greater discipline and transparency in financialrelations.

Appropriate Capital Structure Policies

4.24 Several major benefits arise from using a proper mix of debt andequity, as opposed to using mostly or only debt in financing public enter-prises. Such a mix: (i) increases the enterprises' ability to borrow infinancial markets; (ii) serves as a check against overexpansion;(iii) stimulates a profit orientation; and (iv) reduces financial risk andstrengthens the ability to survive downturns in the economy.

4.25 (i) Increased Ability to Borrow in Financial Markets. With anappropriate level of equity capital in their balance sheets, publicmanagers will be in a better position to negotiate financing with banksbased on the strength of those balance sheets and the quality of their cashflow. Where investment and financing decisions can be implemented withoutgovernment support, the board of directors should be given full authorityto approve. Naturally, a state-owned enterprise can seldom functionprecisely the same way that a private enterprise can, partly because of theinherent difference between the two types of ownership and partly becauseof "imperfections" in the banking system, i.e., both state and privatelyowned banks may tend to lend to state enterprises based on implied govern-ment guarantees. Many countries have, in spite of market imperfections, ahigh degree of market dynamism, that can contribute importantly toefficient market-oriented behavior.

4.26 (ii) Check against Overexpansion. A debt/equity target serves asa check against overexpansion by relating an expansion of assets to therate of profitability and the growth of retained earnings. If the debt/equity ratio deteriorates below a certain point, banks will normally not bewilling to provide further financing without government guarantees.Equally important, the commitment to proper debt/equity financing can alsoserve as an efficient check against overexpansionary investment decisionsby public officials, as it ties the investment decision directly to theequity financing decision.

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4.27 (iii) Stimulating Profit Orientation. With a proper debt/equityratio and satisfactory profitability, public enterprises will be able toborrow from banks and expand their operations based on their own capacityto generate retained earnings. This possibility gives management anincentive to focus on profitability, since it provides the base forexpanding enterprise operations.

4.28 (iv) Reduced Financial Risk. A further argument for using aproper mix of debt and equity financing, as opposed to only debt financing,is that it reduces the enterprises' financial risk. During downturns inthe economy, enterprises financed with equity will have lower debt serviceobligations and will therefore be less likely to encounter acute liquidityproblems. In many enterprises, the lack of a capital structure policy hasresulted in overexpansion. Debt has been allowed to finance expansions andlosses to such an extent that in many cases the enterprises have negativeequity capital. At the same time, many governments have expanded theiroverall financial commitments to such an extent that they have very limitedresources available for assisting these enterprises. In this situation,enterprise managements tend, for prolonged periods, to be preoccupied withday-to-day liability management, with consequent reductions in operationalefficiency and often losses of market shares and competitiveness. With aproper debt/equity policy, public enterprises will be better equipped toavoid the above type of solvency and liquidity crisis.

Greater Discipline and Transparency in Financial Relations

4.29 A review of the accounts of the major public enterprises in oursample indicated a complicated maze of transfers between central budgetaryauthorities and public enterprises. To improve financial discipline andtransparency in financial relations, and to be able to record "true"financial results, governments should demand tax, duty, interest, dividendand amortization payments from public enterprises the same way they do fromprivate enterprises. Losses and negative cash flow would then have to befinanced explicitly in a more transparent way through new equity, loans,etc. It is important that the "true" financial situation of enterprisesbe reflected in the dialogue between public enterprise managers and thegovernment about the enterprises' future development.

4.30 If governments are to require sharp financial discipline frompublic enterprises, they must demonstrate discipline and effectiveness intheir own internal financial management. Some guidelines to this end are:(i) governments' commitments to pay in new equity capital as part of largeinvestment projects should duly consider the risks involved and their owncapacity to finance these commitments; (ii) governments' payments to publicenterprises approved by appropriate ministry(ies) should not be questionedand delayed by other ministries; (iii) the semi-annual issuance of approvedpayments should be more or less automatic without further bureaucraticdelays; and (iv) public enterprises should not be used to finance govern-ment deficits.

4.31 Other factors key to financial autonomy and accountability arethe disposition of profits after taxes and the disposition of liquid

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assets. Under normal circumstances, public enterprises should be allowedto transfer to retained earnings all profits after taxes and payment ofdividends. In inflationary environments, many public enterprises, eventhose with zero real growth, need significant amounts of retained earningsjust to maintain their debt/equity ratio. Public enterprises with realgrowth potential should be given the freedom to exploit these opportunitieswith internally generated funds. A similar argument applies to the dis-position of excess cash/liquid assets. Viable enterprises should beallowed to decide how to redeploy excess cash generated from operationsand/or by divestiture. The rationale is that public enterprise managerswho have successfully generated a positive cash balance normally are in abetter position to decide upon its productive use than are governmentofficials more distant from the market place.

Performance Measurement and Incentives Systems

4.32 An effective system for performance measurement and controlshould be established. It can serve the government in establishing manage-rial accountability in a number of ways. It reveals whether, and theextent to which, the boards of directors of the public enterprises aremeeting their financial commitments. It emphasizes to the board andmanagement the importance placed on financial objectives, performance anddiscipline. It is a basis for rewards and punishments. And it providesthe government a tool to control overall credit expansion in parts or allof the public enterprises sector.

4.33 The level of detail entering a financial system will vary fromcountry to country and between enterprises within countries. In general,the more an enterprise is controlled by competitive market forces and theless it is dependent on government financial support, the less detailedwill the centralized data requirements be (see Table 4). In countries suchas France, Norway and Sweden, it may be sufficient to collect the enter-prises' formal annual reports. On the other hand in countries such asGhana and Zambia, the governments may need to request quarterly financialstatements and production and personnel data, and may publish an annualsummary of the performance of all public enterprises at the end of theyear.

4.34 The performance monitoring system would need to be linked to anincentive system with different levels of rewards including promotions,financial bonuses, fringe benefits, official and non-official recognitionof achievement and publication of annual results. These incentives aremost effective when they are used in a relatively competitive environmentand where a high degree of financial and managerial autonomy is granted tomanagement, the latter factor being a substantial incentive in itself. Inhighly protected economies, such bonuses would need to be used with cautionsince they may well increase the incentive for non-optimal and inefficientexpansion of operations.

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Table 4: LEVELS OF FINANCIAL CONTROL

Financially Public Enter-Financially Independent prisesIndependent Public Enter- Dependent onPublic prises in Mono- Government

Financial Control Tools Enterprises poly Markets Finance

Strategic Plan * * *Annual Operating Budget *Capital Investment Plan * *Quarterly Financial Reports * *Report on Capital Projects *Audited Financial Statements * * *Management Audits *Price/Tariff Assessments *

Conclusion

4.35 To summarize, public enterprises should be allowed, to the extentpossible, to operate freely within the confines of their business chartersand the capacity of their balance sheets. Under these conditions, thegovernment should concentrate its decision-making and control functions onissues related to its ownership role, while decisions related to strategyand operations should be delegated to the board of directors and manage-ment. Governments should establish a minimum rate of dividend paymentsfrom all companies. For loss-making firms, a coherent and time-boundprogram should be established to eliminate the causes of financial loss sothat, at the end of the period, such entities will be able to distributedividends. The program would include the elimination of subsidies andlprice controls, more emphasis on performance relative to financial objec-tives, more appropriate debt/equity policies, loosening of the borrowingconstraints on public enterprises, and more transparency in the financialrelationship between the government, public enterprises and state-ownedfinancial institutions.

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CHAPTER 5

MANAGERIAL AUTONOMY AND ACCOUNTABILITY

5.01 Two key determinants of the performance of public industrialenterprises are the extent to which the government decentralizes decision-making to enterprise managers, and how it manages the organizational inter-face between it and enterprises. This chapter and the next one address thecrucial issue of how much decision-making power should be delegated andwhat managerial environment can facilitate this process. Once the govern-ment has decided on the magnitude of its role in controlling public enter-prises, the other issue is how it organizes its various components(ministries, specialized agencies, etc.) to enable it to exercise effectivecontrol, the subject of Chapter 7.

Three Roles in Enterprise Management

5.02 In private enterprises, there are three distinct roles pertainingto owners and managers: ownership, strategic and operating. The ownershiprole, performed by the owner(s), involves defining the business charter,setting the overall objectives of the enterprise, appointing and dismissingthe board of directors, and approving annual accounts and dividendpayments. These powers are formally executed through an annual share-holders' meeting. The strategic role is the responsibility of the board ofdirectors. Its major functions, discussed in detail in Annex II, are todecide upon strategic plans, monitor performance against targets, andappoint, advise and dismiss the chief executive officer. Typically, theboard is part-time, meeting four to eight times a year, and is composed ofpersons with high stature and professional experience relevant to thebusiness of the firm. The operating role is performed by the chief execu-tive officer (CEO) and his top management. Their major responsibility isto manage and develop the enterprise in accordance with agreed objectives(Table 5).

5.03 This separation of the three distinct roles, which came aboutbecause of more widespread ownership and because owners found it difficultto manage an increasing number of diverse enterprises, has stood the testof decades of industrial development and is prevalent in the privatesectors of western industrialized countries and increasingly in mostdeveloping countries with "mixed" economies.

5.04 How do public enterprise organizational structures deviate fromthis prototype? The relatively short experience of many governments withthe management of public enterprises, the excessive lines of control, themultitudinous (and occasionally conflicting) objectives and tasks they areassigned, and the lack of adequate information flows between public enter-prises and government, invariably lead to encroachment by governments (asowners) on the strategic and operational functions of public enterprises.This breakdown in the demarcation of the major functions is the source ofmuch of the poor performance of public enterprises.

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Table 5: CONVENTIONAL ROLES IN CORPORATE MANAGEMENT

Roles and Functions Basic Characteristics

o Ownership Role (Owners)- Define enterprise charter - Long-term view- Appoint and dismiss the - Broad objectives

Board of Directors - Broad, non-involved,- Approve annual accounts monitoring of performance

ex posto Strategic Role (Board of

Directors)- Provide strategic guidance - Medium-term view- Control performance - Specific strategies and- Appoint, advise, reward operational targets

and dismiss the chief - Close periodic monitoring ofexecutive officer (CEO) performance vis-a-vis

strategic objectives ando Operating Role (Management) operational targets

- Develop and manage theenterprise according to - Shorter-term viewagreed upon objectives - Development of alternative

strategies, plans andprograms

- Management of resources- Detailed day-to-day decision-

making and control ofoperational performance

5.05 A simple example will illustrate this breakdown. In a number ofthe sample countries, boards of directors are obliged to seek ministerialapproval for relatively small investments, hiring and firing of staff,wage-setting, working capital decision-making, procurement policies,foreign travel, and much else. In a private enterprise, the power toapprove these actions is almost always delegated by the shareholders to theboard of directors and further to the CEO. The logic is that the board ofdirectors and the CEO will be judged on the basis of the financial perform-ance of their decisions. The board can, therefore, exercise its controlfunction by discussing and approving strategic choices, setting broadfinancial objectives and examining performance rather than the processes bywhich the outcomes are generated. The private sector control philosophycenters on control of viability, while the public administration's philo-sophy, in many instances, is characterized more by compliance with rulesand regulations. Given that the strategic role is mostly exercised byministries, public enterprise boards tend to be more involved in operatingdecisions, which impinge on the normal operating role of the CEO as exe-cuted in the private sector. In certain cases, it may be justified forgovernments to involve themselves in certain decisions that private sectorfirms would handle at the board level. For example, governments may getinvolved in the investment decision because of its macroeconomic impact onthe overall fiscal deficit and concern about the quality of projects. As aresult, high government officials in countries such as Ghana, India,

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Pakistan and Zambia are extensively involved in detailed investment deci-sions. There are several problems with this process: it is time-consumingfor an already over-stretched bureaucracy; the ministries lack the informa-tion and the business perspective to make the correct decisions; and, mostimportant, it absolves the management of its responsibility and account-ability for enterprise performance.

5.06 When performance cannot be quantified and when an effectivecontrol structure does not exist, it becomes impossible to exercise effec-tive control of performance. When governments cannot control performance,they attempt to control processes. And ineffective control frequentlyleads to excessive interference.

Evolution of Public Enterprise Management Models

5.07 The sample countries included in this study provide a richvariety of organizational structures. The most highly decentralized struc-tures are those in Sweden and Norway. Intermediate ones occur in France,Austria, Italy, Brazil, Portugal and Israel, while highly centralized onesare found in Ghana, India, Pakistan and Tunisia (Table 6).

5.08 A comparison of the two polar cases--Sweden and Norway on the onehand and Ghana on the other--is instructive. In Sweden, the Cabinet, theformal owner of public enterprises, has delegated this responsibility tothe Minister of Industry. Within the ministry, a Unit for State Participa-tions (Unit 5), staffed by eight professionals, actually execute the owner-ship role for the public industrial enterprises, which employ some 90,000people. A similar number of staff within the Ministry of Industry inNorway perform the ownership role for public industrial enterprises there,which employ some 50,000 people.

5.09 In both countries, the ownership role is to define the charter,including broad objectives/purpose, of individual enterprises, to hire andfire members of the board of directors, to establish dividend objectives,to assure that strategic and financial plans are developed by the board ofdirectors, to approve annual accounts and the allocation of profits, and tomonitor performance. All major decision-making regarding multi-annualplans, annual budgets, investments, financing, personnel policies, etc.,are decentralized to the board of directors of individual enterprises. TheUnit for State Participations does not intervene in the boards' decision-making, does not maintain a data bank of financial and/or operationalenterprise data, does not keep a roster of management candidates and doesnot perform any management services. Executives of Unit 5 participate asdirectors only on a limited number of boards. They stress that in theirrole as board members they take special care to act only in the bestinterests of the enterprise and not to overpower the board with theirownership role. Only in times of crisis and when state financial supportis required by an enterprise does the Unit for State Participations step upits participation in decision-making. Most public enterprises are organ-ized as limited liability stock corporations and are regulated by corporatelaw. The CEOs of Swedish public enterprises have the same responsibilityfor development and operations as do their counterparts in the private

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- 35 -

sector: they hire and fire top management, set salaries, set prices,select suppliers, negotiate loans, etc., and are also responsible for thefinancial performance of their firms. They are exposed to the same marketforces that confront private corporations. Where a firm also has privateshareholders, the board reflects it.15/

5.10 While during the last 15 years Sweden had most of her industrialenterprises organized under one superholding company, recently this companywas broken down into one holding company for medium-sized enterprises and anumber of branch oriented corporations, each owned directly by the Ministryof Industry. This decision was in line with the government's belief indecentralized decision-making.

5.11 By contrast, public enterprise managers in Ghana have littleautonomy and are subject to excessive multiple controls. Ghana's expe-rience with public industrial enterprises started in the 1960s as a part ofthe program of the first republic (1957-66). During the period 1975 to1981 public industrial enterprises contributed about 60 percent of totalindustrial production in the country. Concern with extreme ministerialinterference in public enterprise management and poor performance have ledto a number of organizational changes during the 25-year lifespan of theenterprises.

5.12 The Ghana Industrial Rolding Company (GIHOC) was established in1967. A central government body named the State Enterprise Commission(SEC), with varying responsibilities for development and control of publicenterprises,has been established and reestablished three times: 1965, 1976and in 1981. In its current incarnation, its role is to advise the govern-ment on issues related to performance, strategy, finance and personnel andto monitor and evaluate performance. The formal structure of controlplaces the ownership role with the sectoral minister. Lines of responsi-bility then flow through the holding company's board and management down tothe board and management of the operating companies. In practice, exces-sive powers and control remain firmly placed in the ministries based on asystem of multiple controls, with the sectoral ministers having the mostimportant positions. For example, prices are set by the Prices and IncomesBoard, a unit under the Ministry of Finance and Economic Planning. Thedismissal of five or more workers must be authorized by the Ministry ofLabor (except in cases of proven criminal offenses). Import licenses areallocated by the Ministries of Trade and Finance, while letters of creditfor approved import licenses are the responsibility of the Bank of Ghanaand the commercial banks. Approval of immigrant quotas for non-Ghanaianpersonnel is handled by the Ghana Investment Center and the Ministry ofInterior. Wage contracts negotiated between workers and management needthe recommendation of the Prices and Incomes Board and the approval of theMinistry of Finance. These examples illustrate the web of bureaucraticcontrols, all of which are centralized in the government.

15/ While it is difficult to observe a causal relationship between privateparticipation in public companies and their performance, many obser-vers believe that the professional competence of the experiencedprivate sector individuals on the board of the Swedish steel holdingcompany, SSAB, has contributed significantly to its successfulrestructuring to date.

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5.13 Between these two extremes lie important examples of varyingdegrees of decentralization. For example, the French model until 1982 wasone of double tutelage, with sectoral ministers in charge of approvingoperating methods and the Minister of Finance responsible for financialissues. After the nationalization of the larger industrial groups, theprinciple of unity of tutelage was introduced to classify and rationalizethe relationship between the state and the firms. Today the French organi-zational model is essentially similar to the Swedish and Norwegian ones inthat no holding companies dominate the industrial sector, and direct linesof responsibility flowing from the sectoral ministries to the board ofdirectors and to enterprise management.

5.14 There are, however, two important differences exist between theFrench and Scandinavian models. First, the French system has a largenumber of control mechanisms centralized in the state bureaucracy. Theseinclude: financial controllers working in the public enterprises andreporting to the Ministry of Finance; parliamentary control of publicenterprise activities; a Court of Accounts that keeps a check on annualstatements and the use of state funds; and an Inspectorate of Finances,within the Ministry of Finance, that intervenes in specific financialissues. In Sweden and Norway, no such institutionalized controls exist,reliance being placed instead on independent auditors who analyze theannual accounts of the public enterprises in the same way as those ofprivate firms. Second, the role of the board of directors is less powerfuland substantial in France than in the Scandinavian countries. The Frenchboard makes some formal decisions, such as delegation of signature andapproval of documents such as budgets and important loan applications, butwithout being able to modify them. Important management decisions relatingto investment and financing are to a large extent made by the ChiefExecutive Officer without prior advice of the board.

5.15 The Italian model for managing public enterprises includes asuperholding company, Instituto per la Ricostruzione Industriale (IRI) tomanage the state-owned industrial enterprises. This superholding companyembodies some 600,000 employees and hundreds of enterprises from telecom-munications, airlines, TV and radio to steel, shipbuilding and automobiles,all organized under several subholding companies. The most obvious differ-ence, compared to the Scandinavian countries, is that the unit within thegovernment responsible for state enterprises in Italy is organized as aseparate ministry (Ministry of State Participations), is much larger (withsome 300 employees) and has more bureaucratic and political responsibili-ties. Higher level public enterprise officials interviewed felt that oneof the major weaknesses of the Italian organizational model was the far-reaching, strongly political, influence of the Ministry of State Participa-tions.

5.16 When governments take over the strategic role traditionally play-ed by the board of directors and get entangled in operating decisions,problems surface quickly. The board's principal functions of providingstrategic guidance and effective control are generally replaced by poor orno guidance, weak or no controls, and slow and politicized decision-making

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Political relations become more important than productivity and financialperformance. Enterprise morale declines, and recruitment and motivation ofqualified managers become difficult at best.

5.17 Many government officials involved with public enterprise manage-ment totally underestimate the complexities involved in managing industrialfirms and the importance of management. An enterprise is not only input,production functions, systems and output; foremost it is people and abusiness. The success of an enterprise depends on creativity, flexibility,dedication, perseverance and hard work, particularly of top management,who, by their example, set the culture, direction and spirit for the restof the employees. Government planning officials and civil servantsappointed as directors and CEOs of public enterprises (in many cases) lackboth the relevant knowledge, experience and motivation to orchestrate thehuman and financial resources and myriad decisions to be made in creatingand maintaining effective and viable enterprises.

5.18 It has become increasingly evident that an important factor inthe differences in productivity among companies and among countries is themanagement and its effect on the motivation, culture and spirit of theenterprise. It follows, that to stimulate successful public enterpriseoperations, governments must hire top quality professional entrepreneurs/managers and by organizational design shield these people from unduepolitical and bureaucratic interference.

5.19 Recognition of the inefficiency of large centrally plannedbureaucracies and increasing understanding of the importance of the indivi-dual manager are two complementary forces currently moving many governmentsto take steps toward more decentralization, and in many cases to the mostdecentralized organizational mode for managing public enterprises, thetransfer of ownership to the private sector.

5.20 As countries move from industrial infancy through growth andmaturity into the post-industrial era, there is a pattern as to whichorganizational structures dominate in different periods. At the risk ofoversimplification, Figure 3 illustrates how public enterprise sectororganizations have tended to move through five increasingly decentralizedstages as the economy grows and matures. This evolution toward increas-ingly decentralized management models can be explained by some of thecharacteristics of the process of industrialization. As industrializationincreases, the complexities and competitiveness of the market place as wellas the speed of change all accelerate. Rigid and bureaucratic managementmodels that are appropriate at earlier stages become obsolete, and moredecentralized management structures become a necessity for survival.

5.21 Naturally, any one country does not necessarily implement allfive types of organizations, instead most countries tend to move fromhighly centralized to more decentralized organizations. For example, Indianever used holding companies as a dominant organizational solution, but attimes its ministries functioned like holding companies. Further, somecountries may temporarily move parts or all of their public enterprise

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Figure 3: LIFE CYCLE OF PE SECTOR ORGANIZATIONS

LEML (W OUSTRIAL iVxmPimi

IIWAIIC! GRO!H MAlUITII RENEWAL I RENEWAL 171

PE SCTOR IN Holdin \RKLATION- and Super- DirectlySHIP TO GW PIEs, holding Owned by Joint

Regulated by Companies Govt., Ventures/Government Regulated Introduction

PEs as Civil by on StockDept. of Service Commercial ExchangesMinistry Codes Code

STAGE 1 STAGE 2 STAGE 3 ! STAGE 4 STAGE 5

1W.ANIZATIOtiAL MOM.DIVISION (N FOIERS

OWNERSHIP ROLE Govt. Govt. Govt. Govt. Govt./Priv.STRATHGIC ROLE Govt. Govt./Mgt. Holding Co. Board BoardOPERATII ROLE Govt. Mgt./Govt. Mgt. Mgt. Mgt.

sector in the opposite direction, e.g., toward more centralized organiza-tional structures. Public enterprises in Brazil during the sixties andmuch of the seventies, for example, had a level of autonomy envied bycounterpart managers in most developing countries. They were already usingthe Stage 5 model. Many public enterprises were minority-owned by privatepartners and their shares were traded on Brazilian stock exchanges.However, because of overexpansion during the seventies, government controlmechanisms were significantly strengthened after 1980. Similarly, publicenterprises in Italy experienced a much higher degree of autonomy in thefifties and the early sixties than later. This shift to increasing controlwas caused by an ideological shift toward a more socially-oriented economicpolicy, with increasing emphasis on centralized planning. As a result,most public enterprises became organized under a huge superholding company,and a separate ministry for public enterprises was established. Theseperiods of centralization are relatively few and do not represent a

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counter-argument to the long-term trend of increasing decentralization.Recently, the Italian superholding company IRI has adopted a divestiturestrategy of selling part of the equity capital of major subsidiaries to theprivate sector.

5.22 It may be speculated that the importance of the public industrialenterprise sector in the overall economy will diminish in the post-industrial era. Most of the circumstances that motivated the creation ofpublic enterprises in the first place, such as the lack of industrialinfrastructure, nonexistence of equity markets and a limited privatesector, have diminished over time. The new emerging high technology andservice-related industries are typically not capital-intensive, but ratherare entrepreneurial in character and ill-suited for exploitation by thebureaucratic organizational cultures frequently found in public enter-prises. The public enterprise sector is likely to decrease in relationshipto GNP, and in some countries even in actual terms. A significant numberof enterprises are likely to leave the public sector in the future.Privatization efforts, including joint ventures, are currently underway ina large number of countries, both developed and developing, such as theUnited Kingdom, Norway, Sweden, Italy, Spain, the Federal Republic ofGermany, Japan, Turkey, Uganda, Togo, Cameroon, Brazil and Argentina, tomention a few.

5.23 The attraction and success of large superholding companies arealso passe. Increasingly they are likely to be broken up into moredecentralized and flexible bodies better able to adapt to market changes.The Swedish experience is of particular interest. Statsforetag, theSwedish industrial holding company, after having been cut down in sizeduring 1983/84, now seems to be moving toward an investment company mode ofoperations, that is, it is introducing its subsidiaries on the stockexchanges and buying and selling companies to enhance the value andviability of its portfolio.

Factors Affecting Organizational Designs

5.24 The above examples illustrate the substantial differences in thecentralization and decentralization of powers among governments and publicenterprises. What accounts for these differences in organizationaldesigns?

5.25 Evidence from the country case studies suggests that, in additionto the perceived role and objectives of public enterprises, there are twomain factors important to the degree of decentralization. They are:(i) the level of economic development in terms of the availability ofindustrial infrastructure, institutions, human skills, private sectorresources, etc; and (ii) the degree of the market orientation of theproduct and factor (labor and capital) markets.

5.26 Level of Economic Development. Countries with low levels ofindustrial development and a limited private sector have opted to establishpublic enterprises in industries such as steel, cement, petrochemicals,etc. (For details, see Annex I.) In view of the large amounts of capital

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required, complexity of the technology to be used and scarcity ofmanagerial resources, governments have justified the centralization of anumber of functions for planning, implementing and controlling the overalldevelopment process. Countries such as Ghana, India, Pakistan and Zambiaall experienced this pattern in the 1950s and 1960s. Under these circums-tances, an appropriate role for governments would be to define the majorinvestment priorities in terms of industrial subsectors; to resolve theIssues related to appropriate technology; to set targets for publicenterprises and monitor performance against these targets; and to promote,advise on and monitor the implementation of major training programs inmanagement, production and new technology.

5.27 A word of caution is necessary, however. A centralized approachcan compensate to only a limited extent for a lack of managerial skills andtechnological know-how at the enterprise level. While a central ministrymay be able to choose the appropriate type of engine to be produced, itcannot, by "long distance phone calls," advise plant managers and workerson how to solve a production problem. When the technology and processesare manageable, it may be possible to leverage the competence of a centralmanagement group and compensate partially for the limited skills of plantmanagers in order to develop and, for some time, manage a significantnumber of plants. However, as these plants mature and move into morecomplex technologies and businesses, and as new products and markets aredeveloped, new managerial resources and technological skills have to bedeveloped at the enterprise level. At such a point, decisions ought to begradually decentralized to the public enterprises.

5.28 Degree of Market Orientation. Where relatively robust productand factor markets exist, as in the European countries in the sample, theneed for a centralized approach to enterprise management is far less. Insuch situations, financial performance, while not a perfect indicator ofenterprise performance, is highly relevant. Public managers will be'controlled" by employees, peers, the media, the financial sector, thecommercial code, generally accepted accounting principles and the owners'long-term objectives.

5.29 Where markets are underdeveloped, it may be necessary to insti-tute, for a limited period, some organizational and systems controls in theareas of financing, labor policy, pricing, production quantities, operatingcosts, marketing and performance measurement. Since there are risks andinherent costs involved in such controls, governments should abolish themas market controls become more effective.

5.30 It is interesting to note that, of all the countries in oursample, Austria, Sweden and Norway have had the most success during thelast four decades in fulfilling ambitious social objectives such as freeschools and universities, free child care and health programs, comprehen-sive retirement programs, equalization of pay structures and redistributionof wealth. Yet these countries did not choose an ideological strategy butrather a more pragmatic one of active industrial and/or private sectorsupport strategy. For example, the Swedish Social Democrats, in poweruninterruptedly between the early 1930s and 1976, emphasized the dynamism

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and productivity of the private sector, whereas the government's role wasseen as setting a supportive incentives environment. By building a highlycompetitive and strong private sector, the country was able to develop thenecessary tax base for implementing social reforms.

Conclusion

5.31 How can governments avoid, or at least ameliorate, problems aris-ing from excessive centralization? To some extent, as indicated, the in-creasing complexity of industrial activities is itself ensuring that publicenterprises are delegated powers hitherto withheld from them. A good exam-ple is India, where the government has increasingly come to appreciate thatthe excessively centralized structure of public enterprise control may havebeen appropriate in the 1950s and 1960s, but is hopelessly anachronistic ata time when many Indian enterprises have to compete in fiercely competitiveforeign markets.

5.32 While the public enterprise sector may give governments fewerheadaches in the post-industrial era, this prognosis is no comfort for mostcountries today. The important point of this discussion is that strategiesfor public enterprise organizational design should take into considerationlong-term trends and needs. Governments should try to avoid large, rigid,special-purpose solutions with high political exit barriers. Instead, theemphasis should be on creating flexible and market oriented mechanisms,partly in the interest of efficiency and partly to make it easier for thegovernment to adapt the sector to changing circumstances.

5.33 There is no reason for developing countries to wait until thepost-industrial area to move into some of the more decentralized forms oforganization. Naturally, the types of powers granted and services providedby central units, and the mix between market and government controls, willvary significantly between countries like Sweden on the one hand and Zambiaon the other. However, these varying levels of powers, services andcontrols could basically be exercised within the same type of decentralizedorganizational structure.

5.34 The experience of public industrial enterprises, as well as oflarge private enterprises, indicates that the worst repercussions of a poororganizational structure can be avoided through scrupulous adherence to thefollowing principles: (i) clear demarcation of the major roles and respon-sibilities among the three parties indicated above, namely, the government,the board of directors and the management of public enterprises; (ii) fulldelegation of authority in line with delegated responsibility; (iii) theappointment of professional directors and managing directors withexperience directly relevant to their tasks; and (iv) introducing a manage-ment philosophy that is less control-oriented and less procedure-bound andmore concerned with judging managers on the basis of enterprise viabilityand a limited set of indicators of performance. Adequate decentralizationis not, by itself, sufficient for satisfactory performance. However, itsabsence can confound the most meticulously worked out organizationalstructure.

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CHAPTER 6

MANAGERIAL SKILLS AND MORALE

6.01 In the previous chapter, the degree of managerial autonomy andaccountability was identified as an important determinant of publicenterprise performance. The main factors influencing the degree of suchdelegation of autonomy were examined. As indicated, there is a host ofsuch factors that together determine how much decision-making power isactually decentralized by governments to enterprise managers. This chapterhighlights two such factors of particular relevance to public enterprises.They are the quality of managerial skills in public enterprises, and theability of public enterprise managers to maintain morale. Together, thesetwo factors facilitate government efforts to decentralize and to enablepublic enterprise managers to create an environment conducive to greaterproductivity and innovation.

Managerial Skills

6.02 The quality of managerial staff of public enterprises in develop-ing countries varies considerably across countries and even across enter-prises in the same country. At one extreme are Brazil and Israel, wherepublic enterprise managers are generally well-educated in their fields, aredisdainful of government bureaucracy and are knowledgeable of privateenterprise methods. At the other extreme are Ghana, India, Pakistan andZambia, where many public managers are closer in their attitudes to bureau-crats than to private entrepreneurs.

6.03 A number of factors explain the variations in the quantity andquality of managerial skills in developing countries. First, with fewexceptions (such as Brazil until the late 1970s) public enterprise managersare paid substantially less than their counterparts in the private sector.For example, in Zambia, public enterprise salary ceilings are still setwith reference to civil service levels. In mid-1984, a managing directorof a modern private sector Zambian firm earned on average Kwacha(K) 35,000-40,000 per year. The comparable salary at an enterprise underthe publicly owned Indeco was only K 15,000 (about US$10,000). Thedifference was sufficiently vast that even the impressive perks given inthe parastatal sector (automobile, housing allowance, and free electricity,water and telephone) did not come close to bridging the gap. In somecountries, it is not only difficult to maintain managers within the publicsector, but there may also be an exodus abroad. India and Pakistan inparticular have suffered a substantial brain-drain to the Middle East overthe last decade. One of the most severely affected has been NationalRefinery Limited of Pakistan, the demand for whose technical and managerialstaff in the Middle East has been considerable.

6.04 Second, public enterprises in developing countries typicallyexperience high rates of turnover of managerial staff either because ofpolitical changes or because of the rotation involved in the civilservice. In India and Pakistan, for example, the chairman and managingdirectors are appointed for five-year terms but rarely stay more than

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three. HMT of India, earlier identified as one of the most successfulIndian public industrial enterprises, was also one of the few corporationsin India to have the same chief executive for almost 15 years. Equallydamaging to public enterprise performance is procrastination in filling topmanagement vacancies. The brief period in the late 1970s during which BHPVof India was without a chief executives proved very costly to theenterprise.

6.05 Third, in a number of developing countries, public enterprisesare considered dumping grounds for politicians and retired generals. Theirlack of technical and managerial know-how becomes a formidable handicap anda source of poor performance.

6.06 Fourth, there have been severe shortages of managerial skills insome sample countries, particularly Zambia and Ghana. This problem has notonly created bottlenecks but has also caused excessive dependence on thechief executive officers and a few managers. To some extent, the problemhas become even more acute, at least in the short run, in such countries asZambia that encourage through regulation the increasing participation ofnationals in the place of expatriates.

6.07 How can governments reduce this constraint? One of the mosteffective ways of nurturing a motivated and more dynamic public enterprisemanagement is to depoliticize, to the extent possible, its hiring andfiring. Sufficient managerial autonomy and accountability would ensure aless bureaucratic response. Another interesting solution is illustrated byICL of Israel. Senior management staff are employed under specialcontracts, have no tenure and can be dismissed at any time, but are alsopaid higher salaries than in other public enterprises.

6.08 Given the tight budgetary situations in many developing coun-tries, raising the salaries of public managers closer to their counterpartsin the private sector may not feasible. There are even those who believethat raising public managers' salaries may make the positions even moreattractive for political appointments. However, if the governmentenvisions a more dynamic and decentralized role for public enterprises, itwould need to attract highly qualified and experienced managers. To dothis, it would need to make the salaries of public managers much morecompetitive with those of their counterparts in the private sector.

6.09 While there are numerous training programs for technical skillsin the public enterprises examined, there are far fewer for managerialones. To gain from economies of scales in training, some countries havecreated training centers for groups of enterprises. For example, thePortuguese holding company for manufacturing enterprises, IPE, providestraining to managers of its subsidiaries. Similarly, the Austrian holdingcompany, OIAG, sponsors in management training for its subsidiaries. Bothholding companies arrange for trainees to participate in programs abroad.

The Issue of Morale

6.10 High morale is generally the result, not the cause, of goodperformance in public enterprises. However, these entities would have a

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far better chance of success within a given environment if they were notsaddled with an understandably widespread (but not always fair) opinionthat they are a locus of corruption, special privilege and irremediableperformance. Projecting a more positive image of public enterprises couldinfluence performance at the margin. In private U.S. companies, "thevolume of contrived opportunities for showering pins, buttons, badges andmedals on people is staggering at McDonald's, Tupperware, IBM and manyothers. They actively seek out and pursue endless excuses to give outrewards."16/

6.11 A demoralized organization needs success to keep up itsmomentum. Without it, disillusionment can set in rapidly. No spectacularincidents of success are needed; sometimes even minor gains rebuild confi-dence and restore morale. The chief executive officer needs to identifyareas of activity where proper planning and determined effort can result inquick results. A number of examples from India's public engineering firmsin the late 1970s illustrate this point.17/ In the case of BHPV, thecompany won a large morale-boosting order for paper-converting machinery inthe face of stiff international competition, and its top management lost noopportunity in publicizing this achievement within the enterprise andoutside. In the case of Richardson and Cruddas, reducing the share oflow-value structurals, increasing scrap sales and raising sales of pointsand crossings to railways were quick-return tasks whose intrinsic returnswere more than just the value of the sales. The secret of success in theearly stages of turnarounds may well lie more in such seemingly minor butwell-publicized incidents of success that shore up confidence than ingrand, long-term strategies.

6.12 The successful peformance of some Israeli companies after theirprivatization (Tadiran, Elbit and Haifa Chemicals) was at least to someextent the result of an improved image and the increase in staff morale.Obviously, there were other factors, such as new technology and marketing.By contrast, the sale of the government's minority shares in ZIM (Israel'snational shipping company) to Israel Corporation has not been successfulbecause of personal rivalries and financial irregularities that haveseverely affected company morale.

6.13 Finally, governments, as owners of public enterprises, have everyright to investigate charges of irregularities and to ensure honest manage-ment. However, this action should be done in as non-political away aspossible. A major source of concern among Zambian public enterprisemanagers in 1984 was the formation of an Anti-Corruption Commission (ACC)empowered to investigate charges of corruption. It appears to have been todemoralized public managers, especially lower level ones, and to have madethem even more reluctant to make decisions individually. Such legalinvestigations need to be specific and to be completed rapidly to enduncertainties about the future of enterprise leadership.

16/ Peters and Waterman, In Search of Excellence.

17/ See Khandwalla, Performance Determinants.

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CHAPTER 7

COORDINATION WITHIN THE GOVERNMENT

7.01 The greater the centralization of powers relating to the manage-ment of public enterprises, the greater is the need for attention to theorganization of decision-making within the government. Lack ofcoordination among the various government entities responsible for publicenterprises frequently contributes to dysfunctional policy dialogue betweenthe government and the enterprises, and this weakness in turn culminates inexcessive interference. Such a lack of coordination assumes variousforms. There may be inadequate coordination between investment decisions(ministries of industry and planning) and financing decisions (ministry offinance). There may be inconsistencies between pricing decisions (ministryof industry and/or commerce) and subsidy decisions (ministry of finance).In addition, conflicts may arise (and frequently do arise) between thefinancial objectives as stated by the ministry of finance and the socialobjectives enunciated by the sectoral ministries. This is but a smallsample of the innumerable problems that arise in practice. Superimposed onthese problems is, first, the propensity of public enterprises to becomelightning rods for excessive political interference and for discontinuityin decision-making with every change in government, and, second, the lackof technical, financial and managerial skills required to run increasinglycomplex industrial enterprises.

7.02 For these reasons--namely, the need for coordination, for reducedpolitical interference, and for greater industrial experience governmentshave attempted to devise organizational arrangements that place governmentat arm's length from public enterprises. One solution has been to decen-tralize the ownership role of public enterprises to a holding company.Another has been to establish public enterprise oversight agencies andspecialized government bureaus, broadly referred to here as focal points.

Holding Companies

7.03 Of the thirteen countries covered in this study, six rely, orhave relied on large multi-sectoral holding companies (sometimes referredto as superholding companies) to manage a significant part of the publicenterprise sector. Italy established IRI in 1933 to manage the industrialportfolio of several large banks that were rescued by the government duringthe Depression. In the other five countries, the use of holding companiesis a more recent phenomenon. In the case of Pakistan, the experiment wasshort-lived, between 1972 and 1978. Table 7 summarizes this information.

7.04 The rationale for setting up a holding or multi-sector holdingcompany is that it can: (i) act as an effective buffer against excessivepolitical interference; (ii) provide effective coordination of decision-making, clear strategic guidance and improved financial discipline;

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Table 7: ESTABLISHMENT OF MULTISECTORAL HOLDING COMPANIES

Year No. ofCreated Country Holding Company Employees

1933 Italy Istituto per la Ricostuzione Industriale(IRI), Superholding 600,000

1965 Zambia Zambia Industrial and Mining Corp. Ltd.(ZIMCO), SuperholdingIndustrial Development Corporation(INDECO), Subholding 20,000

1967 Ghana Ghana Industrial Holding Corp. (GIHOC) 15,000

1970 Sweden Statsforetag 48,000 a/

1970 Austria Osterreichische IndustrieverwaltungsAktiengesellscheft (OIAG) 150,000

1972-78 Pakistan Board of Industrial Management 80,000

a/ Prior to the break-up of Statsforetag.

(iii) assist in pooling scarce managerial talents, thereby infusingindustrial and enterprise-level experience into the enterprises; and(iv) lead to benefits of synergy, such as economies of scale in largeprocurement contracts as well as in establishing foreign marketing outlets,lower cost financing, etc.18/

7.05 These arguments are all very valid, and some state-owned holdingcompanies have indeed performed adequately. However, the overall expe-rience with large state-owned multi-sectoral holding companies has beennegative. The drawbacks (and strengths) of these entities are examinedin detail in Annex III. To summarize here, instead of being buffersagainst excessive political interference, they can become powerful tools

18/ From the point of view of the holding company, there is also a taxadvantage, in that losses in one public enterprise can be used toreduce income tax payments in profitable enterprises in the samesubsector and, depending on local tax laws, even in public enterprisesin other subsectors.

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for political domination, interference and control. In some cases, thesheer size of the multi-sectoral companies creates unnecessary layers ofmanagement and results in slow and bureaucratic decision-making. Thelayers of enterprises and government bodies governing public enterprises inItaly is a case in point (Figure 4).

Figure 4: PUBLIC ENTERPRISES IN ITALY

PARLIAMENT(Approval of long-termplans and use of endow-

ment funds)

InterministerialCommittee for

Public Enterprises

IMinistry of StateParticipations

.IIRI

Superholding

I

8 Large SectoralHolding Companies

Subsidiaries/SometimesHolding Company's

IOperatingCompanies

| CONSUMERS l

7.06 Holding companies can sometimes also lead to lower motivation andquality of public enterprise managers when important operational decisionsbecome centralized at the level of the holding company. For instance, anumber of frustrated senior public enterprise managers in Pakistan com-plained that the government's efforts to decentralize decision-making totheir enterprises ended up "getting stuck" at the holding company level.Even more serious is the excessive financial power that becomes vested in

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the holding companies. Their ability to transfer funds between subsidia-ries can result in inefficient resource allocation, the starving of viablefirms with strong long-term growth potential and the costly sustenance ofnon-viable enterprises.

7.07 Sweden's experience with a superholding company is instructive.The state holding company, Statsforetag AB, was established in 1970. Givenits rather disappointing performance, two government inquiries wereinitiated in 1977 and 1982. They concluded that the Statsforetag hadsimply become too large and too complex to be managed effectively as asingle entity. It was felt that the major subsidiaries of the holdingcompany, such as LKAB (mining), SSAB (steel) and Svenska Petroleum, were solarge that their financial needs were jeopardizing the existence not onlyof the other relatively smaller companies but also of the entire holdingcompany. Moreover, excessive involvement of top management with the largercompanies left insufficient time for the smaller subsidiaries. At the sametime, the sheer size of the financial transactions and the social implica-tions of plant closures were, in many cases, such that all negotiationstook place directly between the subsidiaries and the Swedish government.The management of the holding company was left with limited, if any,effective role in decision-making. As a result, Sweden has moved from theconcept of a single superholding company to several sectoral ones inshipbuilding, steel, textiles, apparel and the like.

7.08 Unfortunately, the experience of developing countries in thesample of countries suggests that superholding companies invariably lead togreater, rather than less, politicization, to excessive centralization ofdecision-making and, therefore, to poor overall performance. In Pakistan,after the nationalization of industries in 1972, a Board of IndustrialManagement (BIM) was set up as a superholding company along the lines ofIRI of Italy. In view of the poor record of the Board, and upon the recom-mendations of two high-powered commissions (Uquaili and Uttra), it wasdissolved in 1978. Separate sectoral holding companies were set up in itsplace in the chemicals, fertilizer, automobile, cement, engineering,petroleum refining, steel and textile subsectors.

7.09 State-owned holding companies are likely to be most effectivewhen they are used to manage small- and medium-sized enterprises and whenthey are not allowed to grow beyond a certain size. Further, they can alsobe effective when they are established along sectoral lines to function asa mother company for a group of operating companies. The Israeli chemicalgroup, ICL, is a good example of a relatively successful sectoral holdingcompany. (Further details on the advantages and drawbacks of holdingcompanies, and when and how they are most effective, are provided inAnnex III.)

Focal Points

7.10 The use of holding companies is one way to coordinate decision-making 8nd to cope with excessive political interference and lack ofindustrial experience. Another form, prevalent in some of the samplecountries, consists of public enterprise oversight agencies and specialized

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government bureaus. Broadly speaking, these entities, also called focalpoints, are of two types: those that perform the full ownership role andthose that have a more limited ownership role in the sense of beingsupervisory or advisory. The functions of these units and examples areprovided in Table 8.

7.11 Among the focal points playing an ownership role are those inNorway, Sweden and Austria, all of which are very small, each employingless than 10 people. They concentrate, in accordance with the decentral-ized management philosophy of their governments, on their limited but

Table 8: FOCAL POINT ORGANIZATIONS

A. Focal Points with an Ownership Role

Responsibilities

o To establish and amend the charter of the enterpriseo To hire and fire the board of directorso To approve annual accounts and dividend paymentso To hire auditorso To monitor performance

Examples

1. Norway: Public Enterprise Unit in Ministry of Industry2. Sweden: Unit Five in Ministry of Industry3. Austria: Ministry of Public Enterprises4. Italy: Ministry of State Participations5. Canada: Overseeing Agency for Crown Corporations

B. Focal Points with a Supervisory/Advisory Role

Responsibilities

o To define financial and operational objectiveso To review multi-annual plans and budgetso To monitor performance on a monthly or quarterly basiso To provide technical assistance and training

Examples

1. Brazil : Special Secretariat for the Control of StateEnterprises (SEST) within Ministry of Planning

2. India : Bureau of Public Enterprises (BPE)3. Pakistan : Experts Advisory Cell (EAC) within the Ministry of

Production4. Israel : The Government Company Authority (GCA) within the

Ministry of Finance5. Ghana : The State Enterprise Commission (SEC)

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important ownership role. Italy's Ministry of State Participations, on theother hand, with some 300 employees, has been criticized for beingexcessively large, bureaucratic and political.

7.12 Focal points with supervisory functions can play a valuable rolein obtaining timely and relevant information on public industrial enter-prises, a prerequisite for effectively assessing performance.19/ Arelatively successful focal point with supervisory responsibility has beenSEST in Brazil. Its experience has shown that clarity in the role andobjectives of such entities can make them useful agents of change in thedirection of greater efficiency for public enterprises. In its six yearsof existence, SEST has been able to bring greater accountability to publicenterprises without getting involved in day-to-day operations, even thoughsome of its operational functions (such as the recommending of ceilings andtargets for certain categories of expenditures) have the potential forleading to excessive interference in the operational functions of publicenterprises. Through its continuous monitoring of the key economicvariables, and with the full political support of the government, it hasbeen able to bring the priorities of even powerful enterprises such asPETROBRAS and CVRD more in line with the exigencies of the overalleconomy. And yet these results were achieved by focusing mainly on broadaggregates and ensuring compliance. SEST's small but professionally verycompetent staff of less than 50 professionals, deliberately kept to thatlevel by the government, inhibited it from excessive interference in theday-to-day affairs of the enterprises.

7.13 Strong political support and real operational powers are thecornerstones of a successful supervisory focal point. Some of the keyoperational powers of SEST are:

(i) To recommend ceilings and targets for all major categories ofrevenues and expenditures, foreign debt, imports and fuelconsumption of public enterprises;

(ii) To recommend distribution of public enterprise profits anddividends;

(iii) To recommend new equity capital increases for public enterprises;and

(iv) To recommend creation and acquisition of new entities as well asthe liquidation and divestiture of old ones.

Last, but not least, its recommendations are made directly to the Presidentof the Republic for final approval.

7.14 The contrast of SEST with SEC of Ghana is instructive. Theprecise role of SEC has never been very clear, and its political support

19/ For example, prior to the establishment of SEST in Brazil in 1979,even information on the number of public enterprises in existence wasnot readily available.

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has wavered. The agency's work is frustrated by delayed reporting by thepublic enterprises; sometimes the reports are so late as to be virtuallyuseless. On the other hand, public enterprise managers interviewed considerthe agency an unnecessary bottleneck in their operations.

7.15 In terms of effectiveness, Israel's Government Company Authoritylies between SEST of Brazil and SEC of Ghana. The Authority, a unit withinthe Ministry of Finance, does not have any real powers beyond reviewingbudgets and reports. The influence of the Authority has, therefore,depended mainly on the extent to which the Minister of Finance has wishedto use it as a professional unit, and on the caliber and qualifications ofthe director of the unit. The Authority was fairly effective in the 1960sand early 1970s when it was headed by an energetic director. In lateryears, the Authority lost some of its influence because of less supportfrom the Ministers of Finance, who appointed either weaker directors orpolitically motivated ones. The Barak Commission, appointed by theMinisters of Finance and Justice in 1968 to prepare a draft law for publicenterprises, made a number of recommendations to strengthen the powers ofthe Authority. These recommendations, which were not implemented, were:vi) to attach the Authority to the chairman of the Committee of EconomicMinisters (rather than making it a unit within the Ministry of Finance);and (ii) to give the Authority the power to nominate one director on theboard of each public enterprise. In retrospect, these were reasonableproposals in the right direction. However, they may not have been enoughto elevate the Authority's effectiveness and importance to the level ofSEST. To achieve that position, some of the financial powers normallybelonging to the Ministry of Finance would have to have been transferred tothe Authority.

Lessons from Experience

7.16 The experience of both developing and developed countriessuggests that superholding companies are generally unwieldy, unresponsiveto the rapid changes that typify industrial sector activity, and excessive-ly prone to political interference. A somewhat more attractive organiza-tional arrangement, though still a second-best solution, is a well-focusedsectoral holding company. Such a sectoral entity can have several advan-tages in addition to acting as a buffer against excessive political inter-ference. Research and development expenditures too large for individualenterprises can be shared among several of them. Economies of scale canarise in negotiating large-scale procurement contracts, in establishingforeign market outlets and in pooling scarce managerial talents. They havealso been useful in arranging domestic and external financing that indivi-dual enterprises could not have obtained on their own. Restructuring of anindustrial subsector is also easier in some cases if the ownership ofparticipating firms is under the same umbrella. The establishment of thesteel holding company, SSAB, in Sweden in 1977 has been a key to thesuccessful restructuring there. However, it needs to be emphasized thatholding companies should be sectoral to achieve the synergies enumerated.The performance of holding companies that cut across sectors (such as thePIDC in Pakistan) is generally poor. It also needs to be stressed that theperformance of even sectoral holding companies depends to a considerableextent on the existence of active domestic and foreign competition,well-developed financial markets and freedom of entry for new firms.

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7.17 The main objectives of focal points would be to: (i) lead thepublic enterprise sector reform process; (ii) develop and maintain highquality board of directors for public enterprises; (iii) coordinategovernment decision-making and protect public enterprise boards fromexcessive government interference; and (iv) monitor public enterpriseperformance. The establishment of an ill-conceived and poorly constitutedfocal point can become an additional layer of bureaucracy that worksagainst a more decentralized management structure. However, it can be aneffective catalytic agent for change and a promoter of more effectiveoperations if it adheres to the above mentioned objectives.

7.18 Evidence from the sample countries also indicates that it isdesirable to strengthen oversight agencies with some elements of the owner-ship role in addition to their supervisory functions. This is done inNorway, Sweden, Austria and Italy. Also, the success of SEST depends, tosome extent, on the fact that it has been granted several powers thatnormally belong to the ownership role. Second, particularly in the case ofdeveloping countries, there are strong reasons for elevating the ownershiprole of oversight agencies beyond the realm of one individual ministry,'that is, to have it report to an intersectoral committee, to organize it asa quasi-governmental unit, and/or to attach it to the Prime Minister's/President's Office. This type of solution has several advantages:

(i) it increases the status and importance of the unit to levelscommensurate with the size, importance and complexities attachedto the public enterprise sector;

(ii) it creates a unit with a direct link to the country's politicalleadership and which can concentrate all its attention on publicenterprise issues without being distracted by other ministerialtasks;

(iii) it will be easier to create a less political and more enter-prise/industry-oriented culture in a unit operating "halfoutside" the normal ministries.

(iv) it may, in certain situations, be a more politically acceptablesolution, since no existing functional ministry will gain powerover the others.

(v) it avoids undue concentration of power in one functionalministry.

7.19 Naturally, what is a good solution for Brazil may not be a goodsolution for Ghana, India or Sweden and above conclusions will not apply toall situations. For example, in the case of Sweden and Norway, the owner-ship and supervisory roles are merged into one unit. However, owing to thevery decentralized management structure used in these countries, mostsupervisory functions are performed by the market place and by boards ofdirectors. This reduces the importance of the issue of where to organizethe focal point. Further, some countries may choose to establish two ormore focal points for different types of public enterprises, for example,one for manufacturing enterprises and one for public utilities.

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Options for Organizational Design

7.20 Establishment of an institutional and policy environment condu-cive to good public enterprise performance is a challenging task. Under-standably, solutions will vary among countries depending on factors such asthe level of economic development, availability of free markets, politicalorientation and ideological currents. However, there is a set of optionsand a basic organizational structure, the general thrust and direction ofwhich applies to most countries. Basically what is proposed is an institu-tional and policy framework which stresses the decentralization ofdecision-making powers and responsibility to the board of directors andmanagement, and the strengthening of the capabilities of these two bodies.Naturally, the types of powers granted and services provided by centralgovernment units, the mix between market and government controls, and therole, composition and location of focal points will vary significantlyacross countries. However, these variations could be exercised within thesame organizational structure and policy framework as suggested below.

7.21 (i) Abolition of Special Public Enterprise Regimes: Specialpublic enterprise laws and regulation, including personnel regimes, shouldbe eliminated or limited to essential provisions outlining the generalframework for the organization and management of public enterprises. Thisapproach avoids unnecessary details that unduly tie the hands of govern-ments and enterprise management. Employees of the enterprises should begoverned by the laws and contracts applicable to private sectorenterprises.

7.22 (ii) Organization of Public Enterprises as Ordinary Stock Cor-porations under Corporate Law: Most public enterprises are of a differentnature and have different histories. For this reason, the government asshareholder should have the flexibility to adjust the charter of each oneaccording to its nature, task and even managerial ability. However, thereneeds to be a consistent decentralized organizational logic, as describedby commercial law. That is, the shareholders will appoint the board ofdirectors by voting according to their respective shareholdings. The boardwill, in turn, choose among its members a chairman of the board and willappoint and dismiss the general manager and assistant general managers.All employees will be hired and fired by management.

7.23 (iii) Reduction of Ministerial Control: One logical and indis-pensable corollary to restoring the normal function of the various parts ofthe corporate mechanism (shareholders, board, management) as provided bycorporate law is to separate the ownership role from the sectoral role andto make sure that sectoral ministries concern themselves only with theanalysis, formulation and implementation of macroeconomic and sectoralpolicy matters. This system excludes direct operational ties with owner-ship and its undue involvement in both business policies and day-to-daymanagement. In many countries, the sectoral ministries need to strengthentheir capabilities to manage sectoral policies and operational responsi-bilities. Thus, in most cases, the "*loss" of direct authority over publicenterprises is not likely to create any severe employment problem.

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7.24 (iv) Creation of a Public Enterprise Intersectoral Board andSecretariat (Focal Point): The ownership role of the government could bedelegated to a Public Enterprise Intersectoral Board (PEIB) or similarbody. In addition, the PEIB could be charged with taking a leadership rolein improving the institutional and managerial environment of public'enterprises. The PEIB would ideally be composed of representatives fromthe leading ministries, as well as a number of industry leaders fromprivate and public enterprises. The PEIB would typically meet only four tosix times a year and would operate only as a decision-making body. One ofthe board's first tasks would be to constitute its own administrative arm,e.g., a permanent Public Enterprise Secretariat.

7.25 Whereas the board's role would be policy-making, the secretariatwould act as administrator, coordinator and executing agency of the board.The secretariat could be organized as a quasi-governmental unit that wouldallow management to compete through market-level salaries for highlyqualified employees. While the secretariat would report to its board, itLs important that it have access to the prime minister's or president'soffice or to a ministry, either formally or informally. It should have asmall and highly qualified staff, The general manager of the secretariatshould have substantial experience as a senior manager of a large privateenterprise and preferably similar experience of a public one. The successof the secretariat will depend on its ability to create and maintain a highquality board of directors and strong financial discipline, while at thesame time avoiding excessive reporting systems and interference in theday-to-day operations of public enterprises.

7.26 (v) Strengthening of the Role of the Board of Directors: Becausethe government frequently lacks the time or the capacity to provide a largenumber of very different and complex public enterprises with strategicguidance and effective performance evaluation, this task must be delegatedone level below the government, that is, to the board of directors.

7.27 The government as shareholder should confer to the board ofdirectors all the powers and responsibilities that such boards have in anyregular commercial corporation. The board will represent the government'sinterest so far as it maximizes the health and long-term viability of theenterprise. Board members should be composed of leaders from industry,trade, academia and government. (See Annex II for further details on theeffective use of boards.) While care must be taken to select highly quali-fied board members and to grant a high degree of autonomy, it is equallyimportant that the board delegate full operating responsibility to manage-ment, not interfere in day-to-day operations and concentrate its energieson the more limited but equally important strategic role, i.e., on theprovision of guidance and the monitoring of performance.

7.28 (vi) Strengthening of the Role of the Chief Executive Officer(CEO) and Top Management: The government should create an environment forCEOs that: (i) rewards initiative and monitors performance (output) ratherthan regulates actions and control costs (input); (ii) states explicitfinancial objectives and rewards financial discipline; (iii) eliminatessubsidies to cover operating losses; and (iv) delegates full operational

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authority to the CEO. For example, the CEO should, within budgetarylimits, have the power to appoint the top management team, subject only toboard approval; to hire and fire employees and to make investment andexpenditure decisions.

7.29 (vii) Decentralization of Managerial Autonomy and Accountabilityto the Plant/Subsidiary Level: When the government decides to decentralizemore autonomy and accountability to public enterprise management, care mustbe taken to assure that this process spreads throughout each one. Forexample, should there be sectoral holding companies, the government shouldensure that the decentralization process does not stop at the level of theholding company board, but that the board and management of operatingenterprises also benefit from the process. Organizational cultures resistchange, and special attention must therefore be given to the management ofdecentralization.

7.30 The above list of recommendations for organizational and institu-tional changes, by no means exhaustive, indicates the type of measureswhich if adopted can, at the very least, alleviate some of the glaringinefficiencies of public industrial enterprises. These measures, comple-mented by the nurturing of a competitive environment, an appropriate indus-trial, trade, financial and regulatory policy framework and the existenceof substantial managerial and financial autonomy and accountability,constitute a package of reforms that can improve the performance of publicindustrial enterprises considerably.

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ANNEX I

ORIGINS OF PUBLIC INDUSTRIAL ENTERPRISES

Since public industrial enterprises produce items that can bemanufactured by private enterprises, which in some countries and sectorsare the predominant producers, the question arises: what led to the birthand development of public enterprises in such activities? Were the factorspurely political and ideological, or were they primarily economic?

Based on evidence from the sample of countries, the most impor-tant factors in the genesis and development of public industrial enter-prises have been: political/ideological considerations; the takeover ofailing private companies; an unwillingness or inability of privatecompanies to undertake certain large industrial investments; the mainte-nance of control over strategic sectors; internal growth and diversifica-tion; and efforts to foster greater competition.

Political and Ideological Considerations

While purely political and/or ideological factors are far lessimportant in the creation of public industrial enterprises than for publicenterprises in general, there have been specific examples of thisrationale, for various periods, in France, Austria, Portugal, India,Pakistan, Zambia and Ghana.

Although a dirigiste tradition has existed in France ever sincethe days of Colbert in the seventeenth century, it was only after WorldWar II that genuine political considerations became important in setting uppublic industrial enterprises. The turning point was General Charles deGaulle's major speech on October IL, 1944, at Lille, when he announced thetakeover by the state of the management of all large wealth. A "morality"argument subsequently led to the public appropriation of firms whose ownershad collaborated with the Nazis during the war. This was the case withRenault and the two companies that today comprise SNIAS. Similarly inAustria, the Western European natiLon with the largest state-owned sector,most of the nationalizations in the immediate post-war period werepolitical, with enterprises being taken over from their Nazi owners. Anexample is the nationalization of the Hermann Goering steel plant estab-lished in Linz, which is now part of the largest industrial enterprise inthe country, Voest-Alpine AG. Other political nationalizations in post-warAustria were the takeover of nearly all mining operations (iron ore,lignite, lead, zinc and oil), steel, aluminum, non-ferrous metals, fertil-izers and oil refining products, as well as some of the larger machineryand electrical equipment industries.

More recent examples of ideological factors leading to thesetting up of public industrial enterprises in Western Europe can be foundin Portugal since 1974 and in France since 1981. In Portugal, the DecreeLaw of 1976--the legal framework for statutory public enterprises--was aproduct of the revolution of 1974 that overthrew Europe's oldest dictator-ship. In France, the role of the public sector in industry has increased

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dramatically since the election in 1981 of the Socialist Party (with theCommunist Party as a junior coalition partner). Most of the bankingsector, two major financial companies and the five largest industrialgroups were fully nationalized. The government also acquired majorityownership in five other industrial groups (three of which were foreign-controlled) and two main steel groups. These nationalizations were clearparts of an overall political program, rather than the result of economic,financial or technical considerations.

Among the developing countries in the sample, there have beenperiods when political and/or ideological factors were predominant. Thepost-independence leadership of India believed that socialist developmentnecessitated the creation of strong and viable public enterprises. Even inPakistan, where economic development has traditionally been more private-oriented, there was a period (1972-77) of rapid increase in the size of thepublic industrial enterprise sector on purely ideological grounds. InGhana, particularly during the First Republic (1957-66), an importantpolitical consideration was the breaking up of the economic power offoreign companies. In Zambia, the unilateral declaration of independenceby Rhodesia (now Zimbabwe) in 1965 and the subsequent border clashes withthat country contributed to a strong sense of urgency for industrializa-tion, which led to the setting up of a number of public industrial enter-prises under Indeco's management. Subsequently, the Mulungushi Declarationof 1968 marked a watershed in the growth of the country's public industrialenterprises.1/ The Zambezi Sawmills were taken over in 1968, and twolarge copper companies were nationalized in 1969-70.

While political and ideological considerations were important insome countries at some points, nationalization should not be confused withthe creation of public industrial enterprises. Indeed, in many cases,public industrial enterprises were set up precisely to loosen somewhat thedirect control of the state over certain industrial activities in thepublic sector. Thus, in Brazil, administrative reforms under Decree-Law200 of 1967 made it attractive for units within the general government tobe restructured as public enterprises.2 / This option explains, to a largeextent, the fact that the most spectacular growth of public industrialenterprises in Brazil occurred after a conservative, market-orientedmilitary regime came to power in 1964. No less than about one-third ofBrazil's federal public enterprises were established during 1970-75.Similarly, in Israel, the Government Companies Law (Section 4a) requirespublic enterprises to behave in the same way as any private firm. Thisrequirement explains why, although the Labor Government has been theleading force in successive Israeli coalition governments (1948-77 andagain since 1984), the establishment and management of public industrial

1/ The Declaration refers to a speech delivered by President KennethKaunda to the National Council of the United National IndependenceParty (UNIP); it has formed the basis of the economic philosophy ofZambia.

2/ For details on these reforms, see Helio Beltrao, "A RevolucaoSilenciosa," Visao, August 31, 1976.

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enterprises have always reflected pragmatic considerations. Likewise, inFrance and Sweden, governments have explicitly stated that public enter-prises should operate in business-like fashion.3/

Takeover of Ailing Private Companies

In a number of cases, governments have decided to bail out largeprivate industrial firms (and sometimes whole industries) particularly inthe automobile, steel, textiles and shipbuilding subsectors to preserveemployment or for some similar reason. Much European industry nationalizedduring the 1930s was in response to such considerations. However, thereare also more recent examples in the sample countries. In France, thegovernment's massive rescue operations of the two largest steel companies,Usinor and Sacilor in 1978 and Renault's acquisition of Berliet (Citroen'sailing truck subsidiary), are good examples. In Italy, EGAM, the stateholding company set up for mining and metallurgy, acquired over 40previously private companies in such diverse fields as shipping, insuranceand textiles machinery.4 / State-owned commercial banks in Italy havefrequently complained about being saddled with large rescue operations suchas those of the two major chemical groups, SIR and Liquid-chemica. How-ever, sometimes they have had no choice: Credit Italiano, BancoCommerciale Italiana and Banco di Roma, the three large banks, are allcontrolled by IRI. Similar rescues of failing firms also occurred inAustria: in 1980, Landberbank took over Eumig, the camera and projectormanufacturer.

Sweden's shipbuilding industry, among the world's largest, cameinto state hands piece by piece for similar reasons, with the culminationin the establishment of the state-owned Svenska Varv in 1977, and the take-over of the last shipyard to remain in private hands, Kockums, in 1978.Similarly, the steel industry, traditionally one of Sweden's most competi-tive, came under state control in 1977 with the establishment of SwedishSteel, into which the loss-making steel companies were merged. Other take-overs involved Sweden's two large clothing and textile concerns and the twolargest pulp and paper manufacturers. What is ironic about such expansionof state-ownership in Sweden is that it occurred when the non-socialistparties were in power, parties that were elected on a platform of rollingback Swedish socialism. Faced with a widespread economic crisis inindustry, the Swedish conservatives nationalized more property in 4 yearsthan the Social Democrats had in 44 years.

Cases of takeover of ailing companies among the developingcountries also exist, although they have been less dramatic. Several smallcompanies have been nationalized in India and Pakistan for this reason. InBrazil, where until the last five years the economy has been expanding

3/ For example, in France, the introduction to the Law on Nationalizationsof February 11, 1982 (Official Gazette) states: "Nationalizationshould in no case mean statism."

4/ EGAM was later liquidated and its assets passed on to IRI and ENI.

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rapidly, the only major takeover was in the mid-1950s; it involved threesteel plants (Usiminas, Cofavi and Cosipa). In Ghana, a number of privatecompanies were taken over in 1978-79 (such as the Dutch Company R.T.Briscoe), but the reasons were mainly alleged business malpractice such astax evasion and violation of current regulations.

Unwillingness or Inability of the Private Sector

Many large-scale, capital-intensive and resource-based projectsrequire investment and technology beyond the capability or willingness ofexisting national private industrialists. The extent of the risk involvedin such projects and their long gestation periods sometimes exclude domes-tic private participation, and many countries have restrictions on foreigninvestment. The state therefore emerges as the sole entrepreneur. Theemergence of public industrial enterprises for such reasons has been commonin most developing countries, especially India, Pakistan, Ghana andZambia. In Brazil as well, the setting up of the giant PETROBRAS and CVRDcompanies was dictated primarily by the need for capital on a scale toolarge for the domestic private sector, especially when foreign investmentin these subsectors had been rejected on political grounds. In Israel, thesetting up of Dead Sea Works, which extracts and processes potash, andIsrael Chemicals Limited (ICL) was the result of the large investmentrequirements. Even in developed countries, governments have set up publicindustrial enterprises where the risks were perceived as too high by theprivate sector. Examples exist in such high technology industries aselectronics, microprocessors, biotechnology, robotics, energy-savingequipment and telecommunications.

Strategic Industries

Many governments prefer to exercise control over certain keyindustrial subsectors they want to use to direct the economic and socialdevelopment of the country. Such "commanding heights" arguments have beenimportant in India and also in Pakistan, Ghana and Zambia in certainperiods. Evidence from the sample countries indicates that, regardless ofthe size and stage of development of a country, state ownership is muchhigher in such strategic subsectors as steel and telecommunications ascompared, for example, to textiles. In the same category are those publicindustrial enterprises with links to defense, such as the Israel AircraftIndustries and Brazil's state-owned producer of small aircraft (Embraer)and the Brazilian nuclear company (Nuclebras).

Internal Growth and Diversification

This reason for increasing the role of public industrial enter-prises has been termed "creeping nationalization" by Edouard Bonnefous, theformer president of the French Senatets finance commission. From a politi-cal point of view, internal growth and diversification have been lessvisible and less controversial reasons for expanding state ownership. For

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example, while the number of French state-owned companies actually declinedfrom 170 to 130 over the 1970s, their subsidiaries multiplied from 266 to650. In particular, Elf-Aquitaine, the French state oil company, has usedits oil profits to acquire companies (such as the U.S. natural resourcesgiant, Texas Gulf) and to diversify into chemicals, biotechnology, pharma-ceuticals, metals, plastics, solar energy and other fields.5/ In the caseof Italy, a state company, GEPI, was set up in 1971 to develop a nationalcapacity in electronics, aerospace and nuclear energy. Within four years,it had 54 operating firms for a total of 25,000 employees. In Austria,Chemie Linz, the chemical arm of OIAG, similarly moved increasingly out offertilizers and into synthetics and basic chemicals during the 1970s.

Among developing countries, the best examples of growth throughdiversification are found in Brazil. The vast majority of public indus-trial enterprises set up in that country after 1967 in the mining and manu-facturing sectors owe their existence to the creation of subsidiaries,occasionally third- and fourth-generation ones. The experience ofPETROBRAS and CVRD are instructive. In the mid-1960s, PETROBRAS was asingle domestic company whose primary activity was exploration. Today, itcontrols, or is a dominant partner in, over 70 other companies. Similarly,in the case of CVRD, the enterprise began its operations primarily in themining and shipping of iron ore.. Then in the 1970s, it moved aggressivelythrough its subsidiaries and minority-owned affiliates into bauxite,alumina, aluminum, manganese, phosphates, fertilizer, pulp and paper andtitanium.6/

Creating Competition for the Private Sector

In a very few cases, public enterprises have been set up to prodthe private sector through greater competition. One such example was theIsraeli government's launching of a state-owned insurance company tocompete with private insurance firms.7/ Another example was the settingup of the Ghana National Trading Corporation to compete with foreigntrading firms and thus break their oligopolistic power. While few publicfirms have been established for this motive, the degree of competitionbetween public and private enterprises, and even of public industrialenterprises among themselves, can be an important factor in the performanceof public enterprises.

5/ See Edouard Bonnefous, "Senat Rapport d'Information sur le Controle desEnterprises Publiques en 1977," (Filiales et prises de participationdes enterprises publiques), No. 379 (Paris: Senate of France, 1977).

6/ In its diversification efforts, the enterprise overextended itself.For that reason, together with a decline in international iron-oreprices in 1977, it was forced by its financial crisis to sell itssubsidiaries in bauxite, aluminum, cellulose and manganese to theprivate sector.

7/ See "Yuval Israel Insurance Company," Tel Aviv University, Faculty ofManagement case study.

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ANNEX II

MANAGEMENT OF PUBLIC ENTERPRISES AND THE BOARD OF DIRECTORS

The board of directors is one of the three organizational pillarsof effective management of public enterprises. In one capacity, it servesas a crucial "buffer" between the ownership role of the government and theoperating role of the chief executive officer (CEO) and senior executivesof the enterprise. The ownership role, performed by the owner(s), involvesdefining the business charter, setting the objectives of the enterprise,appointing and dismissing the board of directors, and approving annualaccounts and dividend payments. These powers are formally executed throughthe annual shareholders' meeting. The operating role is performed by theCEO and the top management. Their major responsibility is to manage anddevelop the enterprise in accordance with agreed objectives. The strategicrole is the responsibility of the board of directors. Its major functionsare to decide upon strategic plans, to monitor performance against targets,and to appoint and dismiss the CEO. Typically the board is part-time,meeting 6-12 times a year, and is composed of persons with high stature andprofessional experience relevant to the business of the firm.

The role of the board is examined here from the perspective ofideology, autonomy and accountability, roles and responsibilities, respon-siveness to market forces, problems common to existing boards of publicenterprises, pitfalls to avoid, and ways to constitute an effective board.

The Role of the Board of Directors

The board has three important roles vis-a-vis management:(1) approval of policy and strategy; (2) performance evaluation; and(3) appointment and dismissal of the chief executive officer.

Policy-Making and Strategic Role

The board's function here is to provide strategic guidance to theCEO and management by participating in the formulation and evaluation theenterprise's strategic plan and by critically examining the enterprise'sfuture direction. Major policy decisions taken by the board are normallylogical extensions of the strategic plan. These include, inter alia,dividend policy, medium- and long-term borrowing over and above statedamounts, short-term borrowing in excess of normal trade requirements, majorcapital expenditures exceeding certain defined limits, issuance of shares,closure or sale of business units or major assets of the business,acquisitions, joint ventures or major technical licensing agreements, newor revised compensation and pension programs, and salary increases andbonuses for the CEO and senior executives. In making major policydecisions, the board serves as a check on the operating power of the CEO.Generally, however, these policy decisions are based on the recommendationsof management, for which the board should receive adequate documentationand analysis in advance of the board meeting at which the decision is to bemade.

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Given the complexity of large-scale public enterprises and thenumber of diverse policy areas upon which the board must make policy deci-sions, it is not surprising that, increasingly, the boards have delegatedtheir authority to committees ander them, such as, for example, audit,finance and strategic planning committees. Perhaps of greatest importanceis the executive committee, which meets with the CEO to deal with relevantboard matters in the interim between Board meetings. The committees allowthe board to divide their responsibilities and work effectively, to call onmembers of management responsible for a specific area under board reviewand to call on outside expertise as required.

The Performance Evaluation Role

By conducting regularly scheduled, periodic meetings, the boardcan evaluate management's ability to develop and implement strategic plansas well as scrutinize its performance relative to stated objectives.Normally, it does so by a review and approval of strategic plans and annualbudgets, and analysis and discussion of regular and special reportssubmitted by management prior to board meetings. Moreover, the board, asan independent verifier of management's performance, should also review theaudited financial statements of the enterprise as well as other auditfindings, as prepared by independent public accountants, who are normallyappointed or reappointed by the shareholders' meeting on an annual basis.The board's evaluator's role is, therefore, primarily oriented to a reviewof management's effectiveness in running the day-to-day business. Thisrole clearly implies that management is to run the enterprise on anongoing basis and that the board should abstain from intervention inday-to-day matters.

Appointment and Dismissal of the CEO

The board should normally be empowered to hire and fire the CEOas well as approve the appointment of key executives of the enterprise asrecommended by the CEO. This power should take the appointment of the CEOout of the realm of pure politics and ensure selection based on merit andprior qualifications. Moreover, this power is the major leverage the Boardhas to deal with poor operating performance by a CEO and other management.

Why Some Boards of Directors Are Not Effective

The cause of ineffective boards is usually problems of designand/or implementation. The concept is a sound one that has stood the testof time and which, if properly employed, seems to be the best method ofguiding a commercial enterprise. Difficulties arise when the role of theboard is misunderstood or abuses are permitted in its operations. If theconvening authority of the board expects it to approve the most detailedactions of management, it will fail. On the other hand, if the Board mustseek approval of the convening authority before taking action, it willfail. The owner of the enterprise must be certain that the Board has fullauthority to carry out its role and that the board will, in return, permitmanagement to have the requisite authority to carry out its role.

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The single most damaging abuse of these principles is theappointment of board members who are improperly motivated or incompetent.In the private sector, we note cases in which family members or socialacquaintances of the controlling shareholder are placed on a board or casesin which members are selected because they are certain to vote along withthe majority. In the public enterprise sector, we find Board membershipsdispensed as political favors or given to individuals who can be counted onto maintain the status quo.

When governments take over the strategic role traditionallyplayed by the board of directors and get entangled in operating decisions,problems surface quickly. The board's principal functions of providingstrategic guidance and effective control are generally replaced by inade-quate guidance, weak or no controls, and slow and politicized decision-making. Political relations become more important than productivity andfinancial performance. Enterprise morale declines, and recruitment andmotivation of qualified managers becomes difficult at best. The overlap ofthe political and commercial spheres has had disastrous results in thepublic industrial enterprises of many developing countries.

Too often, boards are regarded as a necessary evil by enterprisemanagement. On the one hand, the board may intervene in day-to-day opera-tions, usurping management's power and perogatives. In addition, ministe-rial representatives on the board may hamper the operating effectiveness ofthe enterprise by imposing political demands on management. On the otherhand, with a politically powerful CEO, the board may collectively become a'rubber stamp" for management action. Neither extreme is desirable.Perhaps the most desirable situation is a state of creative tension betweenmanagement and the board, with the balance of power roughly inequilibrium.

An Approach to Effective Board Operations

As public enterprises have grown in size and complexity and theexternal environment surrounding them has grown more uncertain, the ideo-logy of socially oriented state ownership that has led to appointment ofrepresentatives of government ministries as board members, together withthe political appointment of management representatives, is beingincreasingly reappraised in light of the need to orient the enterprisestoward the market. While the board must be representative of the owner,the government, it can be staffed with members from outside government whooffer a diversity of skills, independent viewpoints and experiences thatcan increase the effectiveness of the Board. Moreover, the appointment ofindependent, outside directors, with fixed renewable tenures, can offer theenterprise continuity of representation beyond transient changes ingovernment and, thereby, depoliticize the board to a certain extent. Thatis not to imply, however, that the board should not be responsive to theoverall requirements of the government and the dictates of the law, orregulations governing public enterprises. To the contrary, these mattersare one of the primary fiduciary responsibilities of board members. Butthe role should be objectively responsive, based on defined criteria andnot on the changing whims or dictates of the government or the ministries

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represented on the board. In other words, in order to operate efficientlyand effectively, the Board must be able to buffer or shelter the publicenterprise from the political expediency of the moment.

Moreover, board members should be protective of the larger socialgood as well as the wider interests of the enterprise with respect to suchissues as, for example, environmental impact, service to consumers, marketresponsiveness to customers who may be in the private sector and dependenton the enterprise for goods and services, and avoidance of corruptpractices.

As such, the board of a public enterprise should be accountableto its owner, the government, based to the fullest extent possible onobjective standards, which may include quantitative goals, i.e., financialperformance targets, and qualitative ones, normally related to its largersocial role in society, as well as on compliance with clearly establishedlaws, rules and regulations. In this context, what constitutes aneffective board? It should contain the following elements:

o Size: 6-15 members, depending on the size and complexity of theenterprise.

o Board Representation. The board should comprise members withprofessional experience relevant to the business of theenterprise. Chief eiecutive officers of industrial firms wouldbe ideal candidates for the board of a public firm. Othersuitable candidates would be distinguished senior members of thebanking, legal, accounting or educational worlds. The profes-sional standing of board members should be higher than or atleast equal to that of the CEO of the enterprise. Normally,government officials, who directly represent the owner should notbe on the board in order to avoid undue interference of the ownerin the strategic role of the board and to avoid reducing theaccountability of the board. Exceptions to this rule shouldcertainly be permitted in the case of highly qualified governmentofficials whose ability to make important contributions to theboard is unquestioned. The chairman of the board shouldpreferably be distinct from the CEO except in those cases wherethe CEO is the best suited candidate for the chairmanship. Aboveall, appointments to the board should be based on merit and thepotential contribution of the member to the effective operationof the enterprise. Board members should have fixed, renewabletenures on a staggered basis so to provide continuity and avoidreplacement of board 'members with changes in government.

o Board Committees. Some of the policy work of the board should beassigned to appropriate committees, with the assistance ofmembers of management and outside specialists as necessary.Board committees avoid overloading the board with too manydetailed matters.

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o Subsidiary Boards. Boards of subsidiary firms should activelyparticipate in providing direction and regional sensitivity tomain operating subsidiaries, affiliates and joint ventures.Subsidiary boards will enhance the process of decentralization inlarge public enterprises and further attune the enterprise tomarket conditions.

o Frequency of Meetings. The board should normally meet 6-10 timesa year, with a calendaT or notice of planned meetings providedwell in advance. Ideally the meetings should be rotated amongthe primary operating locations of the enterprise so that theBoard is able to visit operational sites and have occasion tomeet with line management.

O Board Agenda. A clearly defined agenda should be prepared foreach board meeting, which normally should consider such items asapproval of previous board minutes, review of the financialresults for the period as compared to the budget, analysis ofreports on operating performance, decision-making on key policyissues, and handling of other items, including committee reportsand specific problems.

o Board Materials. All documents to be discussed by the boardshould normally be posted to members one week in advance ofmeetings. Board members should not be expected to make decisionsat meetings without supporting analysis that is, the say so ofmanagement is not a sufficient basis, nor should they be expectedto digest critical material at the meeting.

O Minutes. Minutes of board meetings should be prepared and mailedout within a set period following the meetings.

O Compensation of Board Members. To attract experienced, capable,board participation, directors' fees should be paid to publicenterprise board members commensurate with the fees paid toprivate sector board members in the country. Normally, boardmembers should be expected to commit 1-2 additional days permeeting to the enterprise over and above the actual day of themeeting.

Conclusion

The exact design of the role and functions of the board ofdirector will clearly vary from country to country depending on thecultural and business environment. However, in most countries, the boardcan be an effective instrument for change in, and development of, publicenterprises. All too often, however, it is treated in a proforma way bymanagement, or else it is a politically charged vehicle for governmentintervention in key public sector enterprises. Neither approach isdesirable, particularly in light of the uncertain and difficult worldeconomic conditions. Public enterprises must be held accountable for thesame level of efficiency as the private sector. This standard can only be

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achieved with a professional board able to evaluate management'sperformance, make key policy decisions in a timely manner and guide theenterprise strategically. As such, the board must be accountable to theowner, the government, for results according to defined objectives, but notbe controlled by government's political whims. The board is an importantbuffer between government and management, but, more importantly, it mustfunction in its own right as one of the three organizational pillars of apublic enterprise.

A board of directors is made up of highly charged, usuallyegotistical, human beings. Therefore, it is subject to all of the short-comings that befall any human endeavor. The board cannot be expected tosolve all the problems faced by an enterprise, but when properly designedand constituted, it is the best arrangement for guiding a firm toward itsmandated goals. Conversely, when a board is ill-conceived or poorlyconstituted, it will be inadequate at best and obstructionist at worst.

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ANNEX III

THE USE OF HOLDING COMPANIES

Purpose

Of the 13 countries covered in this study, 6 rely on largemulti-sectoral holding companies to manage a significant part of the publicenterprise sector. Italy established IRI in 1933 to manage the industrialportfolio of several large banks that were rescued by the government afterthe economic crash. In the other five countries, the use of holdingcompanies is a more recent phenomenon: it was only in the late sixties andearly seventies that strong holding companies started to play a dominantrole (see Annex Table A-1).

Some of the purposes behind the establishment of holding com-panies were: (i) to protect operating companies from undue politicalinterference; (ii) to establish a professional body that on behalf of thegovernment, could exercise the ownership role, e.g., provide effectivestrategic guidance and constructive control; and (iii) coordinatedecision-making within the government as it relates to public enterprises.These are the more clearly stated objectives for establishing holdingcompanies.

Table A-1: ESTABLISHMENT OF HOLDING COMPANIES

Year of No. ofEstab. Country Holding Company Employees

1933 Italy Istituto per la Ricostuzione Industriale(IRI), superholding 600,000

1965 Zambia Zambia Industrial and Mining Corp. Ltd.(ZIMCO), superholdingIndustrial Development Corporation(INDECO), subholding 20,000

1967 Ghana Ghana Industrial Holding Corp. (GIHOC)

1970 Sweden Statsforetag 48,000a/

1970 Austria Osterreichische IndustrieverwaltungsAktiengesellscheft (OIAG) 150,000

1972 Pakistan Board of Industrial Management 80,000

a/ Prior to the break-up of Statsforetag.

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It is probable that the choice of a holding company to serve theabove purposes was heavily influenced by a number of broad global trendsthat took place during the sixties and early seventies:

(i) Industrial organization and economic thinking were characterizedby technology, long-term planning and economies of scale,influenced by the peaking of the industrial era and demand-drivenmarkets after World War II.

(ii) European countries encouraged by rapid economic growth during thefifties and early sixties impatiently wanted to move further withaggressive social and economic reforms. With increased knowledgeof technology, economics and advanced planning, the belief wasthat economic growth could be further enhanced by increasingstate intervention in the market place. "Why should we acceptdownturns in the business cycle that do not exist in East-bloccountries?" was a commonly asked question. Many European coun-tries therefore embarked upon a more "activitist" industrialpolicy to promote direct and indirect investments in targetindustries and geographic locations, to bail out large, sickprivate firms, to reduce unemployment, to manage the businesscycle, to further build social reform programs, etc.

(iii) African countries, once liberalized from their capitalisticcolonial masters, naturally looked for somewhat less capitalisticsolutions in choosing an economic strategy. The planned economyapproach to economic development, which included a large elementof state-owned enterprises, seemed to be a viable alternative orcomplement, given the Soviet Union's relatively sharp economicprogress during the two first decades after World War II.

With all these trends taking place the creation of large holdingor superholding companies to tackle the management problems of publicenterprises surely looked like an effective solution to many countries.

Unfortunately, most of the underlying forces that supported thoseabove trends changed dramatically during the late sixties and early seven-ties. For example, the demand-driven markets created by the rebuilding ofEurope and Japan leveled out for the first time in the sixties; at the sametime, developing countries became a significant factor in the world marketfor manufactured goods; the increased speed of technological change furtherfueled competitive pressures; the oil shocks put downward pressure onglobal growth; the western world entered the post-industrial area;economies of scale became less of a competitive factor; exploitation ofhuman knowledge and motivation became increasingly important; rigidity inlong-term planning was replaced with flexibility, creativity and strategicoptions; the centralistic strategy to planned economic development provedbankrupt; and decentralized, pluralistic and market-oriented approaches toeconomic development took a lead role. Given all these new trends changeshow have the holding companies performed?

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Performance

The financial performance of the holding companies has been verypoor. Huge losses and extreme accumulation of debt have caused most ofthem into severe financial problems, with serious macro-economic conse-quences for the country in question. The only exception is Pakistan'sholding company, whose performance is more difficult to judge because some90 percent of its production is sold in markets with cost-plus pricecontrols.

The reason for the poor financial performance cannot be blamedonly on the holding company structure as such, but more importantly on thehost of decisions taken during the seventies that flew in the face ofchanging trends and market realities. On average, public enterprises haveperformed poorly whether they have been managed by holding companies ornot (see Chapter 2). To compare the performance of public enterprise withor without holding companies is impossible, given the many factors influ-encing performance. However, it is equally clear that holding companieshave not been able to improve the performance of public enterprise sectorsin comparison with how they would have faired without holding companies.Of course, there is always the exception to the general rules. ENI, theItalian petroleum holding company, experienced very successful growth andprofitability during the fifties and early sixties. However, todaycircumstances have changed. ENI is much bigger and more bureaucratic,while the market place is more complex and competitive forces are strongerand faster.

What, then, are the strengths and weaknesses of the holding com-panies? These are discussed next.

Strengths

The major strengths of the holding company concept for managementof public enterprises can be grouped into four broad categories:

Buffer against Excessive Political Interference

The creation of a holding company between public enterprises andsectoral ministries can be one effective way of delinking the political andthe commercial spheres. To achieve this objective, care must be taken to:(i) depoliticize the selection of board members and managers of both theholding company and its subsidiaries; (ii) hire directors and managers withprofessional and relevant experience; and (iii) duly decentralize theownership role of the holding company with respect to subsidiaries.Countries such as Austria and Norway have written into their publicenterprise laws that certain government officials, such as ministers,secretaries of state and employees of the sectoral ministry cannot serve onthe board of directors of public enterprises. However, in most countrieseven in Austria, the selection process is still heavily politicized. InZambia the president of the country was the chairman of the board of thesuperholding company, Zimco, for many years. In Austria, all the fourmajor political parties get their proportionate share of board members in

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the superholding as well as in the eight subholding companies. Thus,depolitization of the management structure of a holding company is at bestdifficult. Another important way to buffer against undue political[nterference can be to organize the subsidiaries of the holding companyunder private commercial law and to avoid any special statutory laws thatextend the civil service culture of government to public enterprises.

Professional Management of the Ownership Role

Holding companies should be established outside the civil serviceculture of the government and be staffed with people with professionalmanagerial skills. This approach puts them in a much better position, ascompared with the ministries, to provide effective strategic guidance andconstructive performance evaluation. This structure normally willfacilitate a more rational dialogue about social and financial objectivesand improved financial discipline and systems. In fact, most of theholding companies have relatively sophisticated financial planning andcontrol systems. Unfortunately, enterprises are run not by systems butrather by people, and skills and motivational factors in most cases faroutweigh the importance of systems.

Leveraging Scarce Management Skills

Especially in developing countries in the early phases ofdevelopment, there may be situations where public enterprises can benefitfrom the pooling of certain scarce managerial talents into a centralholding company. This central resource then guides and monitors projectdesign and development, organization, staffing and performance. Scarcecentral skills can be leveraged to a large extent where plant levelcomplexity is low. However, one has to be very cautious about how far thiscentral resource can be leveraged. As markets and plant level complexitygradually increase and plant managers acquire appropriate skills, thecentral holding company resources must be decentralized, a transition thatis frequently difficult because of vested interests and resistance tochange.

Benefits from Cooperation (Synergy)

The benefits of cooperation are likely to be the greates betweenenterprises within the same subsector, as for example, petrochemicals andchemicals, iron ore and steel, forestry and pulp and paper. Research anddevelopment projects and upstream production processes too large forindividual public enterprises can be shared among several of them.Economies of scale can be an advantage in negotiating large-scaleprocurement contracts as well in establishing foreign marketing outlets.Restructuring of an industrial subsector is in some cases easier ifparticipating firms are under the same ownership umbrella. For example,the sectoral steel holding company, Swedish Steel AB, established in themid-seventies, has been very successful in restructuring and increasing thecompetitiveness of the Swedish commercial steel business. Lower costfinancing is another benefit frequently claimed by holding companymanagers. This result is likely when the holding company portfolio

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consists primarily of small- and medium-sized enterprises. With largerones, the freedom and responsibility to arrange their own financing is apowerful incentive to find new, creative, efficient and low-cost sources offinancing in ways a central holding company frequently would not identifybecause it is further removed from the action. Last, the tax advantageoffered by a holding company from of organization can be substantial.Losses in one public enterprise can be used to reduce income taxes inprofitable ones in the same subsector and, depending on local tax laws,even in those in other subsectors.

With so many factors in favor of holding companies, why is ittheir performance record is so weak? Following is a discussion of some ofthe weaknesses of the holding company concept.

Weaknesses

Effective Tool for Political Interference

In a political environment, holding companies can be turned bypoliticians into effective tools. If the boards of directors andmanagement of superholding and sectoral holding companies are selectedprimarily along political lines there is a great risk that decision-makingwill become excessively politicized. Similarly, when large amounts ofstate financing are provided to the public enterprise sector through theholding company for expansionary and/or "bail-out" purposes, resourceallocation tends to be politicized and ineffective, e.g., investmentchoices are poor, non-viable firms are bailed out, excessive employment inthe face of mounting losses, etc. In these situations, the superholdingcompany is an effective tool only for carrying out political wills.

Clearly, if IRI, the Italian superholding company, employing some600,000 people, had been organized into, say, 30 independent firms, itwould have been more difficult for the government to exercise excessivepolitical influence in their affairs. The Norwegian government contemp-lated establishing a state holding company in 1977, but after a studyrejected the idea. It appears the main reason was that a holding companywould give the politicians too powerful an instrument.

Excessive Layers of Management, and Slow Decision-Making

With the accelerating pace of change in markets, products andtechnology, enterprises must have the resources and power to make quick, inmany cases instant, decisions, if they are to compete effectively andsurvive in the market place. Superholding and holding companies representin most cases unnecessary layers of management whose negative effects onenterprise performance by far exceed the positive ones. Clearly, a privatecompany whose major policy decisions must be approved only by its board ofdirectors will have a decisive competitive advantage compared with theoperating companies at the bottom of the IRI hierarchy. However, theproblem here is not only the speed of decision-making but, equallyimportant, the cost of bureaucratic policies and the motivational factorsdetermining the quality of decision-making.

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Lower Motivation and Quality of Managers

Enterprises that have independence and demonstrated effectivenessare normally better able to recruit and keep high-caliber managers than areenterprises more dependent on others for their decision-making. Independ-ent public enterprises are fully responsible for all major business func-tions, such as obtaining financing from the banking system, maintainingtheir own international sales organization and developing personnel poli-cies. There is no holding company to bail them out if things go wrong.These enterprises become masters of their own future. Such characteristicsappeal to and attract higher quality managers. Since the long-term successor failure of most enterprises is closely linked to the quality ofmanagement motivational factors attracting and maintaining high-qualityleaders are imperative for success.

Excessive Financial Powers.

The financial policies of holding companies can be more or lesscentralized. The most dangerous approach is a highly centralized set offinancial policies according to which subsidiaries are required to transferall profits and cash balances to the holding company's accounts and wherethe holding company management has full power to allocate these funds. Inthis situation, profits and cash balances of viable firms are likely tosubsidize non-viable operations. Some of the major problems of thisapproach are: (i) resource allocation is inefficient, as the holdingcompany management, being removed from the market place, is less qualifiedto put excess cash balances into productive uses than are managers ofsuccessful firms; (ii) most viable firms must retain most of theirafter-tax earnings if they are to sustain long-term growth; (iii)non-viable enterprises are maintaiLned at great cost long after they reachtheir terminal stage; and (iv) a Lack of financial autonomy at theenterprise level has a negative effect on the motivation and quality ofmanagers. A much more decentralized approach is desirable in most cases.Direct lending and borrowing between the holding company and itssubsidiaries should be handled at arms-length.

Lack of Appropriate Role.

The circumstances that influence the design of organizationsclhange over time, and organizations need to changed accordingly. However,b,ecause of vested interests, resistance to change and rigidity in systems,it frequently takes a crisis to force needed organizational reform. Thiswas the case with the Swedish holding company, Statsforetag, and some ofits major subsidiaries in steel, pulp and paper, and shipbuilding. In thelate seventies, Statsforetag's subsidiaries in these subsectors had to gothrough a major restructuring affecting the employment of thousands ofpeople and costing several billion dollars. The size of the relatedfinancial requirements and the social implications of plant closures weresuch that all communication and negotiation soon took place directlybetween the management and boards of directors of the subsidiaries and theMinistry of Industry. Holding company management had a very limited, if

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any, role to play in the decision-making. In a country more formalisticthan Sweden, all decision-making would probably have been slowed or could,in some cases, have even been stopped by holding company executivesclinging to their formal powers.

In the end, the Swedish government decided to transfer thelargest enterprises in Statsforetag's portfolio to the Ministry ofIndustry. Further motive behind this action was to avoid having holdingcompany management allocate 90 percent of its time to a few large money-losing firms and neglecting its responsibilities toward the medium- andsmall-sized firms where it would be more able to play an effective role.

When to Use Holding Companies

In trying to decide when and how to use holding companies eachsituation must be evaluated on its own merit. The relevance of thedifferent strengths and weaknesses discussed above will vary with eachsituation. There are, however, a number of more general lesson that can bedrawn.

The popularity of large holding/superholding companies to managepublic enterprises has long since reached its peak and is now at a lowebb. The major reasons are that: (i) the broad trends that motivated theestablishment of large holding structures have changed dramatically and nowfavor more decentralized and flexible management structures; (ii) theperformance of most large holding companies has been weak, and most are incrisis; and (iii) when weighing the strengths and weaknesses of largeholding structures (see Annex Table A-2), the negative factors tend tooutweigh the positive ones by far.

Table A-2: SUMMARY OF STRENGTHS AND WEAKNESSES

Strengths Weaknesses

o Initial Buffer Against Excessive o Lack of Appropriate RolePolitical Interference o Excessive Financial

o Coordination and Professional PowersManagement of the Ownership Role o Effect Tool for Political

o Leveraging Scarce InterferenceManagement Skills o Excessive Layers of

o Benefits from Cooperation Management, Bureaucratic and(Synergy) Slow Decision-making

o Negative Effect onMotivation and Qualityof Managers

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The major reasons for establishing a holding company were in manycases to create a "buffer against excessive political interference" and toestablish "professional management of the ownership role." Theseobjectives can, in most cases, be better achieved by establishing a smallpublic enterprise unit to exercise the ownership role, by decentralizingthe financial and strategic powers to a board of directors of theenterprise, and by legally organizing the public enterprises under thecommercial code and eliminating the statutory codes promoting a civilservice culture (see the recommendations in Chapter 3).

"Leveraging scarce management skills" and "benefits from coopera-tion (synergy)" are the two main objectives that will continue to motivatethe use of holding companies also in the future. However, the scope ofthese holding companies is likely to be more limited and focused. It isprimarily in the case of medium-sized enterprises that both developing anddeveloped countries can get the most "value added" from holding companies.In this instance, the holding company can provide certain technical andmanagerial skills, improve financial discipline, stimulate beneficialcooperation among enterprises and provide broader opportunities for manage-ment development and career planning. Large enterprises should normallyhave all the required managerial and technical skills within themselves, inwhich case the holding company has very little if any positive value tocontribute; rather, its "value added" is likely to be negative. Smallenterprises should be privatized, since they require an entrepreneurialmanagement style rarely found in the public enterprises. The abovediscussion is summarized in Annex Table A-3.

Large enterprises within certain sectors, such as petrochemicals,steel and manufacturing, may benefit from being organized under a sectoralholding company. However, in these circumstances, the holding companytakes on the character of corporate management for a group of operatingcompanies. This type of "operating" holding company is not considered inTable 4.

Table A-3: USE OF HOLDING COMPANIES

MARKET SITUATION

COMPETITIVE MONOPOLY

PrivateSIZE SMALL Privatize Holding

OF MEDIUM Holding Holding

PEs Directly Owned Directly OwnedLARGE by Government by Government

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STATISTICAL ANNEX

Table S&-1: Key Indicators for Major Public In&strial Enterprises, 1984

SAME ASSEIS Mr INIUOEEfRRSE aWIXY - DDM SUBSFclcR

(US $ millim)

A. Public Ehterprises frmm Sanple Coxtries

1. Eati Nazionale Idrocaburi(EI) Italy 25,798 23,989 (50) 130,897 Petroletn2. IRI Italy 23,354 NA NA 504,915 Metal mfg;shipbldg,etc.3. ElfA4quitaine France 20,662 16,895 743 76,219 Petroleam4. Ccompa.ie Francaise des Petroles France 18,159 11,011 149 44,981 Petroleem5. Petrobras Brazil 17,087 13,797 633 58,507 Petrolemt6. Rimilt France 12,227 10,727 (1,436) 213,725 mbtor vehicles & parts7. Indian Oil India 8,856 2,594 80 29,757 Petroleem8. Copapie Gererale d-Electricite France 8,480 9,372 68 161,900 Electromic, appliances9. Montedison Italy 7,044 6,098 (47) 71,215 Chanicals

10. Saint-Gobain France 7,015 5,903 59 125,228 [a] B1t. mtls;netal prod.11. Tthoen France 6,620 7,285 (2) 111,900 [a] Electrunic, appliances12. Rlune-oulenc France 5,856 4,487 227 79,230 [a] lumicals13. Sacilor France 4,334 4,433 (920) 63,583 Metal mfg-steel14. Pechiney France 4,064 3,884 62 48,230 Metal mfg-aliunin,steel15. V1M-Alpine Austria 3,780 5,329 27 69,988 Metal mfg-steel;etc.16. Oil & Natural Gas Cmissiom India 3,367 5,931 781 37,016 Petroleam17. Steel Authority of India India 3,013 6,892 (208) 205,236 Metal mfg-steel18. Aerospatiale France 2,875 4,627 38 35,000 Aerospace19. cmV Austria 2,834 1,463 12 7,297 Petrolemi20. EFl4 Italy 2,547 1,941 (324) 40,400 Metal mfg-steel21. Zambia Industrial & Mining (ZI}CO) Zaibia 2,272 3,593 (12) 131,390 Mining-copper22. Petroleos de PErtugal (PEIEROGAL) Portugal 2,160 2,722 4 6,910 Petrolen23. Ctenie Linz Austria 1,822 402 7 7,847 Chenicals24. Canlhia Vale do Rio Doce (CVRD) Brazil 1,685 4,863 915 20,299 Mining-irmn ore25. Charbonnages de France France 1,677 2,990 (24) 50,978 C'bmicals/inining26. SNBXXA France 1,628 2,345 7 25,475 Aircraft engines27. Matra France 1,571 1,829 8 28,000 Aerospace28. Enterprise Miniere et (:iimique France 1,570 780 7 12,761 Mining-copper29. Bull France 1,555 651 56 26,453 Cacuters,office equip.30. SSAB (Svnskt Stal) Sweden 1,445 1,247 24 15,202 Metal mfg-steel31. Statsforetag Crkxp 9weden 1,428 1,349 7 24,901 Industrial,trans. equip32. Bharat Heavy Electricals India 1,191 2,096 36 73,180 Industrial,trans. equip33. UI5MAS Brazil 960 1,920 59 14,606 Metal mfg-steel34. Austria Tabakwerke Austria 925 319 9 2,217 Tobacco35. Pakistan State Oil Pakistan 912 119 8 1,972 Petroleum36. Siderurgica Nacional Brazil 897 3,805 (166) 27,208 Metal ifg-steel

Subtotal 211,670 177,688 837 2,584,623

[a] Also includes certain subsidiaries oined 50% or less, either fully or on a prorated basis.

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Tble SA-1: Key Indicators for YMjor Public ltAtrial Ehterprises, 1984 (citinued)

MS ASSS NEr UCOIINTEVUSE omum -4?mrl - - fslBG

(US $ million)

B. Other Public- hterprise

1. Pb (Petroles M icms) !mico 19,405 37,433 7 175,420 Petroleun2. VolknagI GerMy 16,035 10,438 86 238,353 Notor vehicles3. Kwait Petrolem Kuwit 14,997 16,692 958 14,640 Petrolem4. Petrolsos de V1emzela Venezuela 13,598 17,109 2,239 43,553 Petrolau5. Yaciaientos Petamliferas (YI) Argentina 6,880 9,110 (3,593) 33,728 Petrolem6. Chinese Petrolem Taini 5,943 4,323 531 21,702 Petrolan7. Neste Finland 5,364 2,434 12 8,422 Petrolen8. British Steel Britain 5,008 5,221 (382) 78,750 Metal mfg-steel9. Britibh leylard Britain 4,543 2,581 108 80,478 Meter vehicles

10. Statoil NPrWy 4,364 5,057 144 4,855 Petrolem11. NDrsk Hydro NM-Way 4,354 3,918 130 19,825 Chemicals12. E tWE Spain 4,305 1,649 20 5,422 Petroleum;chemicals13. lsrkiye Petrolleri Thrkey 4,180 3,182 354 16,504 Petroleun14. Petro-Csada Cmada 3,626 6,851 194 6,697 Petrolan15. Saigitter Germmy 3,423 2,615 (153) 45,920 Metal mfg;shipbldg16. Cockerill Sare Belgiun 2,991 2,392 73 19,159 Metal mfg-steel17. Saarberg,rke Germany 2,455 1,560 (29) 31,030 Petroleu;mining-coal18. berizh Oil Britain 2,298 1,182 56 21,474 Petrolem;auto parts19. Isoor S. Africa 2,262 3,137 59 62,600 Metal mfg-steel20. VWAG Gerniny 2,097 1,897 38 20,979 Metal mfg-steel21. Bipresa Combhiana de Petrol Colcibia 1,907 1,540 28 10,403 Petroleum22. Rolls-Royce Britain 1,882 1,295 27 40,900 Aerospace23. Tabacalera Spain 1,658 555 7 8,614 Tobacco24. caUlnw-QRuz Chile 1,535 3,570 144 25,339 Mining-copper25. EIresa Nacional del Petroleo Chile 1,416 995 60 3,531 Petroleum26. British Shipbuilers Britain 1,323 882 (346) 48,500 Shipbldg;trans. equip27. Petroperu Peru 1,310 783 9 9,821 Petrolazn28. Philippe Nstional Oil Philippines 1,240 1,447 42 9,316 Petrolam29. Eiso,-Qtzeit Finland 1,149 1,629 12 13,402 Paper & Vood products30. ENBSID Spain 1,115 1,852 (153) 21,012 Metal mfg-steel31. SEAT Spain 1,087 2,203 (225) 23,610 MDtor vehicles32. Chxna Steel Taiim 1,026 2,669 111 7,620 Metal mfg-steel33. Valmet Finland 1,000 756 15 16,258 Indh,trial,transp equip34. Hispanoil Spain 997 253 37 262 Petrolem35. GCAMINES Zaire 971 2,002 43 35,846 Mining-copper

Subtotal (Other Public Baterprises) 147,744 161,212 663 1,223,945Subtotal (Ssple Contries) 211,670 177,688 837 2,584,623

Orsnd Total 359,414 338,900 1,500 3,808,568

Source: "Ibe largest NI-U.S. Corporatioms Ranked by Sales." Fortume (August 19, 1985)

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Table SA-2: Shares of Public Inistrial Enterprises in Selected Indicators, 1982(percentaes)

Share ofIrKiustrial Total Inrdustrial Total Irkdustrial Total Industry

CDP GDP Investiurnt Investnent Emplyment EaplWnent in GDP

Austria 29 11 19 14 25 9 39

Brazil 31 11 33 20 14 3 35

France a/ 22 7 22 16 16 8 32

Ghana b/ 48 3 85 55 63 13 7

India 35 9 75 22 23 3 26

Israel 33 9 50 12 13 4 27

Italy 13 5 22 12 15 6 40

Pakistan 26 7 50 13 22 3 27

Portugal 28 11 70 18 14 5 40

Sweden 26 8 46 16 17 5 31

Tunisia 56 20 69 36 55 25 36

Zanbia 80 30 95 80 85 10 38

Average for allcountries 35.6 10.9 53.0 26.2 30.2 7.8 31.5

Average fordevelopedcountries c/ 22.5 7.7 27.2 14.5 18.2 7.0 35.5

Average fordevelopixgcountries 42.1 12.5 65.9 32.0 36.1 8.2 29.5

Source: Staff estimates; World Bank, World Development Report 1985, (New York: OxfordUniversity Press, MNUDD)

a/ Includirg enterprises nationalized in 1982.x xlnirg joint ventures.

c/ Austria, France, Italy and Sweden.

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