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There have been a number of problems in ordinary corporate governance in recent decades.
Boards of directors are charged with supervising management of market corporations. Boards establish performance standards for managers and set their pay levels. They also are responsible for appointing auditors who scrutinize the books of the company, to ensure that the revenues, costs, assets and liabilities are all accurately reported in its financial statements.
Yet, despite the discipline of the marketplace and the twitchy financial markets, they have fallen down again and again. Take for example Bre-X, Sino-Forest, Enron, Home Capital, and the sub-prime mortgage meltdown that began 10 years ago, slowly accelerating into the devastating global financial crisis.
There’s supposed to a shareholder democracy, where ordinary investors can nominate directors and advance corporate bylaws to improve management accountability and rein in compensation that can have little correlation with corporate financial or operational results.
There have been substantial advances in these efforts in the past several years, led by activist investors such as aggressive hedge fund and private equity players. Also involved are some motivated institutional investors, such as pension funds, that recognize that simply selling out from an underperforming company may leave them with fewer investment options in the future.
Ultimately, corporate takeovers can wrest control from recalcitrant and lacklustre managers. That brings some disruption when restructuring occurs, but it also can reallocate corporate assets to their most profitable use.
Yet, there are no such remedies in the Crown corporation world.
Directors of Crown corporations are political appointees. Their interests and strategies are aligned with the provincial or federal regime of the day. Some may have technical, managerial, directorial or financial expertise, but the main criterion for consideration for board appointment is loyalty to the political party that put them on that board.
Executive compensation can’t be based on stock options or share price performance, since no shares can be publicly traded in Crown corporations or they lose their non-tax status. These managers also have other goals besides maximizing current or future profits or profit margins, so those targets can’t be used to evaluate and reward managerial performance.
Being non-taxable, and having access to lower-cost provincial or federal debt funding, their cost of capital is much lower than for private-sector companies. That’s especially true since their equity capital (contributed directly by government) is erroneously viewed as cost-free. So a very low rate of return on assets is the bar they may or may not hurdle, guaranteeing a low-to-mediocre rate of return.
The result is that Crown corporation managers have little risk of being terminated for poor performance. (Although the best managers may not wish to work in such mediocre and low-reward circumstances.)
Provincial and federal 10-year bonds yield around two per cent annually. That should not be the measure of an adequate corporate rate of return. It certainly wouldn’t be acceptable to individual or institutional investors, with the array of stock market and other opportunities available. Taxpayers deserve better.
Crown directors also have little vulnerability. So such dismal returns can be perpetuated indefinitely, with taxpayer money being locked into investments that abysmally underperform those in open markets.
Even worse, politicians and their bureaucratic underlings often actively meddle in Crown strategy, further reducing profitability as a priority.
Crown corporations are inherently backward-looking, seeking to protect industries and sectors that are in flux. Even businesses such as telecoms and power utilities must cope with technological, legal, regulatory and political risk and change.
It’s not clear that taxpayers should be exposed to such risk when the entire investment could be lost, either gradually as Crown corporations hesitate to adapt (perhaps by shedding staff), or more swiftly and savagely.
The only thing worse than not-so-benign neglect is the sort of empire building and social-political goal-seeking that provincial politicians have tried to do with the various provincial power companies, or the federal government has done in a number of specialty firms (especially in import-export and business development loans).
It’s almost impossible to have effective Crown corporate governance, which inevitably leads to disastrous, costly new investments.
But there is hope: use the discipline of the open marketplace to reform and redirect these flailing and insufficiently accountable Crown corporations.
Ian Madsen is a senior policy analyst for the think-tank Frontier Centre for Public Policy.
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