Corporate Governance in Government Corporations

Michael J. Whincop

• Publisher: Routledge
• Year: 2017
• ISBN:
  9781351948494
• Edition: 1
• Topic: Business
• Subtopic: Corporate Governance
• Index: Business

Many governments across the world have responded to the need for greater efficiency in the delivery of government services by the reorganization of these bureaucracies along the lines of for-profit business corporations. In doing so, governments have relied on the capacity for governance practices to overcome the weaker incentives created by the attenuated 'property rights' that are created in public enterprise.

Chapter 1
Introduction

In the 1980s and 1990s, governments across the world sought to roll back the borders of the state, and to pursue, to the extent possible, the satisfaction of demands for essential services and utilities by way of competitive markets. It is common to analyse this transition in terms of the economic theory of public choice. In this theory, the behaviour of governments is best explained by the idea that political actors selfishly seek to maximise their own welfare, rather than selflessly furthering the public interest (e.g., Buchanan and Tullock 1965; Niskanen 1968, 1971). Because of the different parameters of markets to those of governments, the selfishness that is a virtue in the former becomes a vice in the latter. The normative thrust of most public choice theory is the desirability of smaller government. Public choice theory therefore provided a theoretical pedigree for the roll-back of the modern state over the last two decades, even though it was hard-pushed to explain why selfish politicians would behave in this uncharacteristic welfare-increasing manner.

Although the public choice explanation is important, particularly in its emphasis on comparative efficiency of public and private provision, there is something incomplete about it. Greater attention to history beyond the last two decades suggests that the questions of which services governments should provide, and the means by which it provides them, are only ever answered provisionally and are revisited at turns of political and economic cycles. The enthusiasm demonstrated in the 1980s and 1990s for neoliberal economic reform was not a permanent move away from public provision. Rather, it was a step best comprehended (without the distraction of its ideology) as a response, in part, to budgetary pressures, political agendas, and organisational crises within bureaucracies. Similar explanations apply to the signs of retreat from these principles at turn of the twenty-first century. Consider two examples. One is the quasi-nationalisation inherent in a number of government bailouts of airlines, such as Air New Zealand and Swissair (see generally Dirmeyer et al. 2002), and of the $15 billion bailout of the airline industry in the US.¹ The other occurs in the wake of the chaotic conditions of the electricity market in the United States, especially in California (Business Week 2001). Here, there is a move towards 'community choice' in the provision of electricity, which involves municipal governments becoming buyers of electricity on behalf of communities.² These developments need to be understood by reference to distributional concerns, politics, and the insolvency of private firms providing essential services. Historical evidence confirms that this is not merely a one-off cycle.

In an environment that behaves cyclically, there is a risk that even the more public-regarding policy aspirations that guide restructuring and reform will fall by the wayside. For one example, the price regulation that accompanies privatisation may be used to advance the interests of incumbent firms, rather than consumers. For another, governments may refuse to allow privatised firms providing essential services or infrastructure to face the full wrath of the marketplace. They may willingly bail them out, or subsidise others to do so. Finally, governments may renege on their commitments to free public bureaucracies from political micromanagement. Thus, these forms of restructuring simply shift the boundaries, and alter the forms, of the opportunism that economists call 'rent-seeking' in the political process.³

This scenario suggests that the governance arrangements of private firms and public bureaucracies supplying essential services, infrastructure and utilities are of prime importance. These governance arrangements determine the extent to which these hierarchies are protected against rent-seeking and political opportunism, and reflect the commitment of the government, now and in the future, to the goals declared at the time of its reform program.

This may appear to be self-evident. The study of governance in economics, law and public administration is of course well-established. However, the literature on governance of arrangements for service provision in the modern state is only beginning to emerge. Much of the analysis of privatisation consists of comparative static analysis of the economic efficiency of firms in public and private ownership (Megginson and Netter [2001] reviews these studies in detail). Many of these comparisons, however, tell us relatively little. It is doubtful that the managers of private and public owners both seek to maximise the same objective functions, or that the function that one maximises is more closely aligned with social welfare than the other.

In this context, the difficulty of equating the objectives that motivate governance structures complicates the extrapolation of the apparently concrete conclusions of much economic analysis of governance in corporations. The economic literature generally assumes that the goal of governance is to maximise the value of the firm's assets. The entitlements of parties with claims on those assets are restricted to the extent that they are likely to induce post-contractual opportunism, such as moral hazard or hold-out behaviour (Jensen and Meckling 1976; Williamson 1985). By contrast, where the state continues to have some involvement in the provision of goods and services, the efficiency objective must compete with a 'representational' objective. That is, the governance process must be capable of allowing community concerns to be brought to bear upon the provision of services that are thought to be integral to community welfare. The difficulty associated with trading off these different objectives makes the governance of these processes more complex, and complicates the extrapolation of normative conclusions reached regarding private firms.

Despite these problems, a literature on the governance issues associated with privatisation and partial privatisation is emerging, which focuses microanalytically on institutions and their limitations (e.g., Graham and Prosser 1991; D'Souza et al. 2000; Boubakri et al. 2001). By contrast, what is almost entirely absent is a sustained, general analysis of the governance of public firms organised and expected to be managed as business corporations (cf. Prichard 1983; Stevens 1993), except in the sui generis context of transitional economies (e.g., Shirley 1999). Even after the wave of privatisations and divestments of the 1980s and 1990s, government corporations (GCs) continue to serve vital functions in many economies throughout the world. In Western economies, GCs continue to have a pervasive role in markets that tend towards natural monopoly. In emerging economies, where markets lack equivalent sophistication, GCs will serve even more important roles, especially since privatisation has had limited success in some parts of the world (e.g., Kuznetsov and Kuznetsova 1999; McCarthy et al. 2000; Pagoulatos 2001).

To be sure, the GC has attracted its share of attention — in particular, the process of corporatisation, by which a government department is transformed into a substantially autonomous entity embracing the praxis and disciplines of a business corporation (see generally Collier and Pitkin 1999). However, much of that literature suffers from three serious flaws. The first is that the literature explicitly or implicitly proceeds from the premise that corporatisation is a process lacking 'closure'. That is, the corporatised entity awaits privatisation, the ultimate coup de grâce; or that corporatisation is somehow the 'wimp's' privatisation, awaiting a government of stronger will and conviction. That premise is unhelpful. In the first instance, its factual merit is debatable. There are a sufficiently large number of GCs that have not been privatised that the GC has every right to be analysed in its own terms. Further, analysis that begins by asserting the superiority of privatisation is unlikely to be helpful.

The second flaw is that where the literature analyses governance issues, it starts with the claim that the closer the parameters of the governance environment are to those of the business corporation, the better for all concerned. This, however, is overgeneralised. To see this fallacy, we may briefly turn our attention to the general theory of the second best in welfare economics (Lipsey and Lancaster 1956). There are a number of market imperfections which cause market equilibria to diverge from the social optimum. The theory asserts that the serial correction of these imperfections is just as likely to move an economy away from the optimum as it is to move it in the opposite and presumably desired direction. In much the same way, one cannot assert that emulating aspects of a governance institution that may be useful to business corporations will necessarily be desirable in a GC. The governance environment is different in a number of important respects, so the ideal governance equilibrium may look different as well (Stevens 1993).

The third flaw is that, despite its normative gravity, the literature is based on relatively little empirical evidence of governance institutions in corporatised organisations. Normative claims are usually based on intuition, experience in business corporations, and comparative public-private efficiency analyses. We lack solid evidence of governance processes in GCs, and in particular the role served by the government in its place as the shareholder. Because governments differ from the normal shareholding body of a business corporation in regards both to objectives and powers, the analysis of the behaviour of government shareholders is a subject of particular interest. It presents an opportunity for us to examine economic theories of political behaviour, and to gauge their application in particular institutional conditions.

In light of this hiatus in the literature, and the analytical flaws in most considerations of GCs, this book has several objectives. The first is to develop a more general theorisation of the governance of these entities, which does not begin with any presuppositions regarding the desirability of privatising the GC. In order to do that, we need to begin from the bottom and work up. Specifically, rather than being misled by the corporate form of the GC, which might narrow our inquiry undesirably, we must start by identifying each of the constituencies associated with GCs and analyse the interests that each has which might appropriately be protected by the governance process.

My second objective is to examine empirical evidence associated with governance processes in the GC. As noted above, the empirical analysis of corporatisation is often tendentious in its assumptions regarding the objective function that GC managers are supposed to be maximising. To compensate for these deficiencies, it is necessary to examine these issues microanalytically at the level of the relation between the various constituencies that governance processes supposedly protect.

Although my theoretical analysis is general, the empirical evidence is much more specific. More fully described below, it arises from a consideration of GCs in a specific jurisdiction, namely the Government Owned Corporations of the State of Queensland, Australia. Obviously, that evidence is only susceptible of imperfect generalisation to other systems. However, taken as a case study, its contribution outweighs its limitations. It shows some of the dilemmas developed in the theoretical analysis, and it illustrates a fundamental governance problem of commitment. That is, how is it possible for a government to commit to a governance environment in which managers attempt to pursue efficiency, even to the extent of enforcing that commitment against itself? I consider various answers to this question in the final chapter of this book.

My third objective is to make some tentative suggestions regarding the means of improving governance processes in GCs. Particularly if civil society is turning away from the dogmatic commitment to markets that characterised the 1980s and 1990s, it is necessary that public provision be accompanied by a strong commitment to governance. Otherwise, one simply sows the seeds for future cycling, with its attendant instability, waste, and rent-seeking. Weak governance will, at the margin, empower constituencies that advocate radical change, either towards or away from markets. There seems to be anecdotal evidence for the proposition that the weaker the economy of a state, the more its state-owned enterprises and GCs will be used for non-commercial, political objectives, especially employment creation (e.g., Stevens [1993], comparing the experience in Manitoba and Alberta, Canada). This in turn exacerbates the case for privatisation further along the political cycle. For that reason, at least, the strength of the commitment to governance is imperative.

Even if the perception that there is a move away from markets is a false or overstated one, substantial and important assets remain in the ownership of GCs and similar state-owned monopolies. It is important to ensure that those assets are subject to appropriate governance, however 'appropriateness' in either representation or efficiency is defined.

The remainder of this chapter is devoted to the following tasks. The first task is to develop the basic framework used in this book to analyse the principal governance problems that GCs experience. Whereas the business corporation (BC) essentially needs only to solve a single governance problem – how to align the interests of investors and managers – there are at least three distinct problems in the GC. These are, first, and as in a BC, the alignment of the interests of the GC's managers with those of its ultimate owners. Unlike the BC, however, the interests of the ultimate owners of the GC are much more heterogeneous than those in the BC, which can be described without distortion in terms of the desire for wealth maximisation. Next, there is the problem associated with the alignment of the interests of those wielding delegated governance power over managers with those of its ultimate owners. Governance powers will often be delegated to members of the executive government. As actors in the political process, questions arise regarding the extent to which these persons are inclined to use those governance powers for political advantage. The final governance problem is the reduction of social costs associated with anti-competitive behaviour by the GC. This links back to the first governance problem, since it is an aspect of the relation between managerial behaviour and the interests of the ultimate owners. However, the first governance problem relates to the 'agency costs' of management (Jensen and Meckling 1976), and the moral hazard problems arising from delegated power; whereas this governance problem involves the social costs associated with monopoly.

Second, a brief description of the governance structure of a GC is provided. The representative model is taken from the Queensland corporatisation regime. This provides a primer on organisational form, a point of departure for the GCs in other jurisdictions, and a reference to understand the empirical analysis. In chapter 2, this sketch is placed in perspective by evaluating both its historical antecedents and modern comparisons in other jurisdictions. Third, I outline the remaining chapters of the book.

Governance Problems in GCs

It is useful first to examine the logic of governance in a BC, in order to understand the necessary points of departure in the GC. The essential governance problem experienced in a private firm is associated with the arrangement between an investing principal and a managerial agent. The principal must find the optimal contract (defining that term widely to include all the incentives and governance processes applying to that contract) to encourage the agent to maximise the value of the principal's investment in the firm. The principal's incentives in choosing the contract, and the governance ...