Thursday, August 25, 2011

Ernst & Young on the State-Owned Enterprises (SOE) Debate

A Question of Corporate Governance

In this private study, the international consultancy Ernst & Young outlines its moderated and nuanced position with regard to SOEs.

The main thrust of Ernst & Young’s argument is that SOEs can indeed be important pillars of the economy. In fact, towards the future SOEs will remain a key bulwark defending strategic industries and guaranteeing the adequacy of infrastructure, such as electricity, power and communication grids, basic networks and transport. However, Traditional governance structures and vague missions have tended to make it difficult for SOEs to do perform well.

This position is reminiscent of the quote for Barrack Obama: “We have so much time debating the size of government that we have neglected to consider the more serious question of how well our government actually works

Contrary to the established theoretical view which permeated through academia and later throughout society in the last 25 years, reflecting the view of state-run enterprises as lethargic, inefficient, and bureaucratic does not hold. These traits were found to be neither particular nor specific to SOEs. This should of course to no surprise to anyone who has ever read a Dilbert comic, to say nothing of the commonly held opinion about corporate America.

Rather, this paper focuses on improving and maximizing the quality of SOE governance. All too often, inefficiencies within specific SOEs have been used as a justification for their dismantling, ultimately leading to a reduction in welfare as employment levels are reduced, and the business cycle deepens as yet another firm takes pro-cyclical rather than counter-cyclical action. This is roughly akin to using the fact that your puppy has soiled the carpet as a justification to having him euthanized. This paper seeks instead to train best behavior.
In particular the goals of SOE policy should be:

1. Protect the interests of all the stakeholders (including customers, minority shareholders, society, etc.) and guarantee the autonomous economic development of the firm.
2. Appoint competent and skillful board members in a transparent, skill-based nomination process.
3. Guarantee the autonomy of the boards but still allow governments to exert authority at a strategic level through regular board evaluation mechanisms.
4. Create other processes that promote accountability and transparency.

Table 1: Key Sectors of SOE Operation

Ernst & Young outline that SOEs are mainly concentrated in key strategic sectors of the economy, where the hand of the state is seen as a key part of the continued stability and governance of the economy. Accordingly, public support of the presence of SOEs varies by sector, with some sectors drawing widespread SOE skepticism while others sectors draw widespread SOE support. 

SOEs can have a vital role in forcing market discipline in otherwise difficult regulate markets. The paper goes on to outline the torch-bearing role that SOEs have in Chinese reforms and the buttressing effect that Indian SOEs have on economic growth.

Figure 1: Support for State Ownership of the Sector

Government and enterprise is a series of studies and initiatives examining various facets and aspects of governments’ relationships with enterprise. We open the series with this study which focuses on state-owned enterprises, where the aim is to delve deeper into the issue of government ownership, understanding how the state operates in this particular role. 

Upcoming initiatives in the series will continue to develop the government and enterprise theme, delving deeper into what governments (national and local) own, what they co-deliver in partnership with the private sector, and where they regulate provision from the market.
About the Authors:
-Philippe Peuch-Lestrade is the Global Government & Public Sector Leader at Ernst & Young
-Alessandro Cenderello  is the Global Government & Public Sector Markets Leader at Ernst & Young


  1. I don't think there is anything inherently wrong with SOEs per se. Many countries had or still have successful SOEs (Renault, Volkswagen, Singapore Airlines, Samsung, Nokia, Toyota,... come to mind right now) and as you said, the question is not whether we should have private or public companies, the REAL question is how to make them work. Aurelio

    Said this, I am more inclined to think that, all things being equal, a private company will be more likely to be more cost-effective than a SOE, but not everything is life has to be decided based on the bottom line.

    Another condition under which I strongly favor SOE is in case of underdeveloped industries but with huge potential for growth. Think of oil at the beginning of the century. It was such a risky endeavour that very few capitalists would risk their money in that industry and that, coupled with the fact that it was so capital intensive, required the government's involvement. Once there is enough knowledge and capital around to operate them sucessfully, there is no real need for the government to have a 100% control.

    I think the same is happening now with renewable energies. They are still underdeveloped but they have huge potential to benefit society and mankind as a whole. Is it time for the governments to step in and collaborate with the private sector? I think so (too bad most of them are broke)

  2. I personally think that there are place in the economy where SOEs can play a pivotal role.That is because:

    1: Their potential for counter-cyclical effect
    2: Their potential for providing an accelerator effect for other sectors
    3: Their potential ability to provide market discipline, especially in difficult to regulate sectors.

    As for cost-effective, I'm not sure that this is always what we need. Especially since cost-effectiveness is pro-cyclical behavior that can come at the expense of R&D budgets.

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  4. I believe that an SOE can be very successful given the political environment is similar to the necessary business environment of the time.

    For example, a Chinese or Saudi SOE can be very successful due to the political autocracy and the top people being cronies of the political leaders paying large taxes to the their relevant central government. (either via bribes or taxes)

    However, in the United States, we have representation without taxation. Since 50% of our population pays no taxes, they are not truly vested in the success of anything the government does. So, in our democratic environment, the private sector is where individuals and institutions put their money where their mouth is.

    (previous post deleted due to typo)

  5. I would not say that the private sector is the only place where that happens. You have to consider that an SOE set up in any democratic country presumably represents the will of the voters. According to this report that is especially the case in the Transport and Energy sectors.