State-owned enterprises can learn from family businesses

State-owned enterprises (SOEs) are controlled subsidiaries of a government which undertake commercial activities. SOEs are globally common and are involved in a wide variety of activities such as mail services, telecommunications, airlines, airports, railroads, natural resources, broadcasting and healthcare.

Sometimes it is easy to forget that SOEs form an important component of the economy. Just think of the UK’s BBC, Manchester airport, London Underground and London Rail. SOEs are usually connected to natural monopolies and infrastructure thus giving them an even greater influence over the economy.

Since SOEs are expected to act with their commercial interests as their main goal they can learn a lot from the private sector. There is one area though that does not crossover well from the private sector to the SOEs and that is corporate governance. Being a fully owned subsidiary of a government creates unique challenges not least because a government does not hold commercial interest as its overriding goal.

Looking at a few examples from the private sector will help explain the issues. At the management level SOEs would be expected to look similar to their counterparts in the private sector. It is at the board level where things diverge. The board of a company has as one of its main aims to act in the collective interest of its shareholders. When there is a single shareholder it is sometimes not clear why it is necessary for a board to sit between the shareholder and management.

Consider a large conglomerate such as GE which has many fully owned subsidiaries. Does it make sense for the executives in GE to install a board in each fully owned subsidiary who then oversee the management in the subsidiary? Would it not make more sense for the management and the subsidiary to report directly to the responsible manager or management committee in the parent? Even in scenarios where a board is necessary due to regulations or preparation for sale a full blown board might not necessarily make sense, as opposed to, say, a smaller three man board.

Does the above argument mean that governments should dispense with the boards of SOEs? No, but it does indicate that the role of the board of a SOE is markedly different from that of the board of a private company. The difference comes in the type of the shareholder. In the GE example the executives found in the parent are just that, business executives. The parent therefore has the requisite skills and experience to oversee the commercial business of the subsidiary.

In the case of SOEs the parent is the government and usually the employees of a government will be technocrats and not businessmen, far more experienced in crafting public policy than in running a business. Furthermore the SOE’s existence is due to a divergence in goals and skills, for if the role of the SOE could have been effected directly by the government, then it would have been deployed in a government ministry or department.

So if a conglomerate is not the right comparison, what is? The answer is family companies. Usually owned by the founder, family companies exhibit a key feature of SOEs: although the company is expected to behave with a primary commercial aim, it is nonetheless expected to take care of the family’s needs.

The normal structure of a board of directors did not fully resolve this issue. What evolved though was the concept of a two-tiered board, a family council and a commercial board. This idea is not novel, in fact in Germany all corporates are required to have a two tiered board. This solution allows for the management of the family needs as well as commercial goals in an effective manner.

Consider SOEs having a commercial board and a separate government council. The commercial board might decide that it makes commercial sense to leverage the company eight times. The government council might decide that the burden to the government due to the implied sovereign guarantee would be too high, and limit borrowings to a more sensible one times leverage, thus avoiding an inadvertent debt burden.

There are many other issues where there would be a natural trade-off between commercial goals and public policy. A two tier board system might be the natural way to resolve these issues in an effective manner.

This article was originally published in The National