Crown Corporations, All State-Owned Firms, Have No Innate Independence or Authentic Profitability

Commentary, Crown Corporations, Ian Madsen

In recent days, reports, studies and analyses have implicitly shown that the essential character of state-owned enterprises, including Canadian Crown corporations, makes it impossible for these entities to have true independence of mission, strategy, governance or even on-the-ground operations. They also have goals inherent in their establishment that are counter to the normal private sector primary one of profit maximization in either the short or long term; i.e., a return on the investment that shareholders have made commensurate with the risk and opportunity cost involved in that investment.

The first thing to note is that state-owned enterprises are founded for specific public policy reasons, whether they are created organically, from a small office and then force-fed, or, which is much more often the case, built up by buying or, frequently, expropriating existing firms or assets of firms. 

Thus, it also follows that they either fulfil a function which no other private sector firms are doing, which is seldom the case, or are an aggregation and accumulation of commercial enterprises which were not performing well or profitably. Finally, they may be single firms or the synthesis of several profitable firms, perhaps even lavishly profitable—which may be why politicians or other government functionaries, or inside or outside activists, covet their cash flow, assets or power and influence.

In the case of creating a firm filling a role that no private sector firms have seen fit to do, it would appear unlikely to be profitable unless it receives important legal waivers, favourable regulations, concessional financing, such as non-taxability (as in Canada), monopoly status— forcing customers to buy its goods or services—or a combination of any or all of the aforementioned conditions. If such firms are profitable at all, it is only through contrived means. So, even a meagre sort of profitability would be inauthentic and unsustainable without the aid received.

Let’s look at the case of a firm that combines one or more zombie or underperforming companies, or an agglomeration of similarly unattractive corporate assets, if it is barely profitable, actually losing money, or, even worse, hemorrhaging cash. While this entity or its forebears have been struggling and attempting to compete on a purely commercial basis, it does not seem likely that simply installing new managers, technicians or other specialists at or near the top will put the revamped entity on a new, dynamic trajectory where positive cash flow, while not imminent, has a faint glimmer of visibility.  

Generally, the market for corporate control is quite vigorous, evident by the abundant, multifarious mergers, acquisitions and bankruptcies which are constantly in flux; any such replacement of managers and restructuring of the firm or its precursors would have already occurred. Indeed, it is often the case that existing managers at firms that governments take over are replaced, and it rarely seems to help the firm become any more truly economically viable, let alone abundantly profitable and replete with cash.

In the final case, of lucrative firms that governments take over, several different scenarios can play out. The firm can stay much the same, but incentives to management and directors decline, as they cannot be compensated by share awards or stock options which are no longer possible. The government sucks the firm dry by withdrawing dividends, royalties or taxes to subsidize the rest of its activities or favoured groups. Or profitability—short-, medium- or long-term—is subordinated to other missions, goals or targets that politically influential individuals or groups suggest are more important. Hence, in this case too, the state firm’s economic viability and profitability will be in jeopardy, and likely decline, once it is controlled by state actors who are not profit-motivated, interested or conversant in those terms, concepts or principles.

In all these situations, the governance of the state firm may seem to be key. If only the directors on their boards are knowledgeable of commercial, technical, logistical, industrial, financial and other key matters, perhaps by virtue of being accomplished corporate executives, investors, financiers (not the same thing) or otherwise prudent professionals, then the firms will be, if not highly profitable, then at least effective, efficient and sufficiently profitable. Then, they will not require cash injections from taxpayers and will also earn more than the government’s cost of funds.

However, such hope is nearly always in vain. It is hard for these firms to attract high-performance professionals and business people. First, the remuneration is not usually at the same high level as the directors receive at other comparable firms in the public sector. There would be an outcry if directors received far more than the median salary for just part-time work (monthly or quarterly board meetings), which they usually do; just as top executives in the private sector receive millions of dollars a year in salary, bonuses, benefits and stock options.  There is an effective ceiling of under $1 million, generally, at state-owned firms, narrowing the potential talent pool of managers and directors.

The other issue mentioned earlier is that directors, top managers and other employees at Crown corporations and other wholly-owned firms cannot be rewarded or motivated by stock options or phantom stock options or the equivalent since there are no shares in the firm being traded. (However, in most other nations, there is often a substantial float of shares in majority state-owned firms that trade on public exchanges). This not only reduces the pool of interested highly qualified top managers and directors who could effectively manage and steer the firm, but reduces the interest in the ones installed in such firms in improving profitability, which is the primary upward driver of share prices.

Finally, it is often not in the interest of the politicians who are ultimately responsible for state-owned firms to put in place effective, imaginative and dynamic managers and directors, because such positions are often used to reward favoured supporters, donors, former politicians, bureaucrats or activists. They may not truly want to improve the performance of these firms anyway, or just to the extent that they are no longer conspicuously bleeding red ink. For that, competent but mediocre seat-fillers may do. 

Change of governance standards to require better profitability, higher return on capital invested, evaluation of performance and more appropriate and remunerative rewards to managers and directors could improve financial conditions in some special cases, but the essential problem remains. State ownership means subservience of profitability to public policy aims and political ideology; the taxpayers who are supposedly the ultimate shareholders will have no real influence, and rarely the return on investment that publicly traded shareholder-controlled corporations enjoy, and the risk of failure all too many government-owned firms evade. 

Managers and directors will always be beholden to their government masters and not truly independent. The only real way to improve performance is to sell the firms to investors who have a vital stake in their success. Any other seemingly ameliorative measures will fall far short. 

There will be much more on this topic to come: there are over 100 reasons why Crown corporations, and state-owned enterprises more generally, are a bad idea, irredeemable, unreformable and should be sold off.

Ian Madsen is senior policy analyst at the Frontier Centre for Public Policy.

Photo by Sean Pollock on Unsplash.