CAF - Guidelines for Good Corporate Governance of State-Owned Enterprises

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N° 37 / 2021

GUIDELINES

FOR GOOD

CORPORATE

GOVERNANCE

OF STATE-OWNED

ENTERPRISESCREDITS

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TRANSFORMATION SERIES Guidelines for Good Corporate Governance of State-Owned Enterprises 2 Guidelines for Good Corporate Governance of State-Owned Enterprises

PUBLIC POLICY AND PRODUCTIVE TRANSFORMATION SERIES

Editor CAF

Legal Deposit: DC2021000670

ISBN Complete Work: 978-980-6810-67-9

ISBN Volume: 978-980-422-227-6

Vice President Private Sector Jorge Arbache Authors Alfredo Ibarguen (R.I.P.) Andrés Oneto Jose Gómez-Zorrilla We would like to thank Andres Bernal and Catalina Rojas for their contributions and valuable comments. The ideas and proposals contained in this edition are the sole responsibility of their authors and do not necessarily reflect the official position of CAF. Graphic design Gatos Gemelos Assembly and diagramming Claudia Parra Gabaldón Translation Cecile Dunn The digital version of this publication can be found at: https://scioteca.caf.com/ © 2021 Corporación Andina de Fomento All rights reservedPUBLIC POLICY AND

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CONTENTS

BEST CORPORATE

GOVERNANCE

PRACTICES IN

STATE-OWNED

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REFORMS OF

STATE-OWNED

ENTERPRISES

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II IIIINTRODUCTION

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REGARDING THE

GUIDELINES FOR

GOOD CORPORATE

GOVERNANCE OF

STATE-OWNED

ENTERPRISES

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IV BEST PRACTICE

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TRANSFORMATION SERIES Guidelines for Good Corporate Governance of State-Owned Enterprises 4

REGARDING THE

GUIDELINES FOR

GOOD CORPORATE

GOVERNANCE OF

STATE-OWNED

ENTERPRISES

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IV BEST PRACTICE

GUIDELINES FOR

THE OPERATION OF

CORPORATE

GOVERNANCE IN

STATE-OWNED

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V

1. Need for an effective legal and regulatory framework

2. The role of state ownership

3. Equal rights and treatment of shareholders

4. General Assembly of Shareholders

5. Board of Directors

6. Control architecture

7. Transparency and financial and non-financial information

FINAL

REMARKS

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VI

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REFERENCE GUIDE TO

THE GUIDELINES

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VII APPENDICES

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TRANSFORMATION SERIES Guidelines for Good Corporate Governance of State-Owned Enterprises 6 PROLOGUE As a development bank, CAFs agenda is to seek regional integration and the sustainable development of its member countries. In this regard, corporate governance is one of the many instruments available to the institution to reinforce the business fabric while maintaining a long-term vision of inclusion and sustainability. Through the Corporate Governance Program, CAF seeks to contribute to responsible competitiveness both at the individual level of public and private companies and at the aggregate level with supervisory and regulatory bodies. To this end, the Program develops conceptual and practical tools and disseminates this knowledge in order to raise awareness of the importance this topic has for the development of the region.

competitiveness both at the individual level of public and private companies and at the aggregate level with supervisory and regulatory bodies. To this end, the Program develops conceptual and practical tools and disseminates this knowledge in order to raise awareness of the importance this topic has for the development of the region. Corporate governance should be understood as a mechanism for reinforcing companies’ institutional and managerial abilities as well as encouraging transparency, accountability, and effective management at the same time that it defines clear rules of the game for the main players: the owners, Board of Directors, and upper management as well as other stakeholders. In contrast, its absence in state-owned enterprises appears in many forms such as a lack of independence and integrity in audit processes, failures in risk management, and the hiring of personnel who are not qualified to carry out their duties, etc. These shortcomings do not allow for efficient management of resources, nor do they safeguard the assets of the organizations. CAF presents these Guidelines for Good Corporate Governance of State-Owned Enterprises as an update to the document published in 2010. The objective is to provide the state-owned enterprises, ownership representatives, regulators, and public policy makers in the region with a set of basic principles that constitute the foundations for good corporate governance. Through this publication, CAF seeks to continue to provide state-owned enterprises with solid support in the creation of a true culture of corporate governance. Even when this is a long-term task, the adoption of the guidelines could make a significant contribution to the sustainable development of the region and contribute to optimizing the relationships between the companies and the state as their owner and with the various stakeholders they interact with. Jorge Arbache Vice President Private SectorEXECUTIVE SUMMARY State-owned enterprises in Latin America continue to play an important role in the economies of almost all the countries in the region by providing various utilities and their participation in sectors identified by the different governments as priorities. In addition, in some cases, these companies actively participate in the local capital markets

State-owned enterprises in Latin America continue to play an important role in the economies of almost all the countries in the region by providing various utilities and their participation in sectors identified by the different governments as priorities. In addition, in some cases, these companies actively participate in the local capital markets whether this is through the issuance of debt securities or having their shares listed on stock exchanges. Considering the above, corporate governance reforms in Latin American state-owned enterprises are very relevant for the development policies in the region and critically important for improving the management and impact of these institutions that, historically and as a whole, have yielded poor results when measured against the objectives for which they were created.

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TRANSFORMATION SERIES Guidelines for Good Corporate Governance of State-Owned Enterprises 7 In this respect, all of the participants in a state-owned enterprise –government, ministry or management agency, Board of Directors, and managers– should ensure that the company is organized and functioning as a model of excellence in corporate governance, good environmental practices, and high ethical standards. These guidelines should be seen as recommendations that serve as a basis for orienting public policies as well as the management decisions that contribute to consolidating corporate governance of state-owned enterprises in the region and, therefore, improve their performance and transparency.

Key words: Corporate governance, state-owned enterprises, SOE, Latin America, Board of Directors, shareholders, control architecture, information transparency, state ownershipPUBLIC POLICY

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CHAPTE I

INTRODUCTION

Background In 2010, CAF - Latin American Development Bank - published the first version of the Guidelines for Good Corporate Governance of State-Owned Enterprises as a benchmark for corporate governance focused on the entire sector of state-owned businesses. This document was prepared by taking the CAF Guidelines for a Code of Corporate Governance (2004) that target private sector companies as well as the “OECD Guidelines on Corporate Governance of

Governance of State-Owned Enterprises as a benchmark for corporate governance focused on the entire sector of state-owned businesses. This document was prepared by taking the CAF Guidelines for a Code of Corporate Governance (2004) that target private sector companies as well as the “OECD Guidelines on Corporate Governance of State-Owned Enterprises “ (2005) as a starting point. Since their publication, and thanks to both their solid conceptual rigor and strong practical focus, the Guidelines have been the basis for implementing reforms in corporate governance practices in Latin American State-Owned Enterprises (SOEs) with the support of CAF in many cases and thus contributing to the effective advancement and reinforcement of corporate governance in the region. This initiative is another example of the importance that CAF has given to the dissemination and implementation of good corporate governance practices as a tool to increase companies’ competitiveness regardless of their size and type of ownership as well as to facilitate their sustainability since the first 2004 Guidelines for private sector companies.PUBLIC POLICY AND

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TRANSFORMATION SERIES Guidelines for Good Corporate Governance of State-Owned Enterprises 9 Rationale for the Revision From then until today, corporate governance as a discipline has experienced remarkable development, both globally and regionally, hence the importance of this update. The present Guidelines do not constitute a break with the Guidelines that were initially published in 2010, but rather a further development. This makes it possible to adapt them to the new advances experienced in corporate governance as well as to respond to the current challenges in this area. From a practical point of view, the content of the current Guidelines is also influenced by the significant and relevant practical experience acquired in their effective implementation in SOEs in the region. This makes it possible to ensure that they are applicable to the reality of this type of business. In this respect, significant contributions are made in this update, in particular the following: • A revision of the dynamics and operations of the Boards of Directors and their committees, as a key aspect for the proper exercise of their duties.

applicable to the reality of this type of business. In this respect, significant contributions are made in this update, in particular the following: • A revision of the dynamics and operations of the Boards of Directors and their committees, as a key aspect for the proper exercise of their duties. • The development of a completely new area related to control architecture in which risk management and internal control are addressed. • The inclusion of new corporate governance practices in all areas as well as the revision of those already outlined in the 2010 Guidelines. • The deepening of the pragmatic approach initially proposed in the 2010 Guidelines. From the implementation processes in which we have participated, multiple lessons have been derived about the relationship between SOEs and their ownership representatives, about the importance of the Board of Directors, the tools needed to reinforce their independence and operations as effective decision-making and supervisory bodies as well as the mechanisms needed to have sound oversight and accountability systems. However, in spite of the formal progress that has been made in different countries, the problems of adoption and, more specifically, of compliance with good corporate governance practices in SOEs are far from being resolved. Our vision with this new edition of the Guidelines for Good Corporate Governance of State-Owned Enterprises is for it to continue to be a reference document that meets the expectations of the SOE community, ownership representatives, public policy makers, regulators and supervisors as well as a tool that is significantly important for effectively enhancing and reinforcing corporate governance in the region’s state-owned enterprises. Importance of corporate governance in SOE The decision on whether a company should be in the hands of the private sector or the state is a question that still generates a lot of debate and controversy in the field of public policy in Latin America. This document is not intended to solve this dilemma. On the contrary, the intention is to leave it partially aside in order to tackle another question that we consider equally complex: once a company is owned by the state, regardless of the economic sector in which it operates, what principles of corporate governance

to solve this dilemma. On the contrary, the intention is to leave it partially aside in order to tackle another question that we consider equally complex: once a company is owned by the state, regardless of the economic sector in which it operates, what principles of corporate governance can make its management more effective and transparent? The framing of this question implies that state-owned enterprises can – under certain institutional conditions –PUBLIC POLICY AND

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TRANSFORMATION SERIES Guidelines for Good Corporate Governance of State-Owned Enterprises 10 resolve many of the dilemmas involved in public ownership and, in particular, the tensions that arise between upper management and the state and that often extend to the relationship between the company and the citizens. The incorporation of best practices into corporate governance for SOEs is geared towards helping public administration contribute to better performance for state institutions whether at the level of the central government or the sub-national one. Furthermore, if, in the future, the decision is made to evaluate the possibility of privatizing it, the fact that these practices have been implemented would improve the value of the SOE to the extent that the principles of transparency and accountability are applied. In this regard, it is important to emphasize that the adoption of corporate governance for SOEs is neutral in terms of the readiness or lack thereof to keep these companies in the hands of the state. It may be thought that corporate governance practices for SOEs should be the same as those commonly recommended for private companies, both those that are privately held and those listed on the stock exchange. However, although many of these guidelines can be harmonized, the characteristics of SOEs are distinctive in certain respects. One of the main distinctions is its relationship with the state as a shareholder or owner. In this respect, understanding the characteristics of SOEs is essential to identifying the types of risks they face as well as the types of business practices that should be encouraged to mitigate many of these problems. To this end, their characteristics are listed below: • The creation of SOEs is not always driven by commercial

SOEs is essential to identifying the types of risks they face as well as the types of business practices that should be encouraged to mitigate many of these problems. To this end, their characteristics are listed below: • The creation of SOEs is not always driven by commercial considerations but by mandates from different sources. Based on the models that are usually presented in Latin America and taking the study document “Corporate Governance in Latin America as a reference. Importance to State-Owned Enterprises (2012) the classification of these can placed in four not necessarily mutually exclusive categories: (i) the ones created to achieve public policy objectives; (ii) the ones involved in providing public services (e.g. Water, electricity, gas, etc.); (iii) those established as exclusive providers of goods or services needed by the state (for example, military suppliers) and; (iv) those responsible for producing income for the state and competing with the private sector on equal terms. Often, when certain economic sectors are reserved to the state for economic development or as a mechanism to guarantee greater equity in access to services, these mandates have constitutional status. The important thing in creating a SOE is that the mandate be as clear as possible so that the state can translate it into identifiable objectives and that there be a positive balance between the social benefits and costs associated with the stateowned enterprise. Thus, the expectations in terms of economic and social profitability would be better defined with respect to the management of the entities as would the definition of efficiency and accountability indicators. Similarly, once the classification of SOEs has been defined and communicated, their corporate governance can be structured and adjusted to serve the objectives of the state as the owner. • Due to the mere fact of its public nature, both the Board of Directors and the upper management of a SOE may perceive that it is feasible for the company to be the object of “bailouts” by the government in office, be it national, state, or municipal. This simple fact could generate lax restrictions that could encourage

Board of Directors and the upper management of a SOE may perceive that it is feasible for the company to be the object of “bailouts” by the government in office, be it national, state, or municipal. This simple fact could generate lax restrictions that could encourage unprofessional management behaviors and lead to thePUBLIC POLICY AND

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TRANSFORMATION SERIES Guidelines for Good Corporate Governance of State-Owned Enterprises 11 company not being oriented towards its true social and commercial purpose. In other words, to the extent that the Board of Directors and upper management of SOEs are not exposed to market discipline the same way that private companies are, they can – and often are – subject to capital injections by the government when they face financial problems caused by poor management performance or the granting of collateral benefits to access financial markets on a privileged basis by those who exercise property rights on behalf of the state. • In the absence of proper public controls, the state can use SOEs as an instrument of fiscal policy or, in extreme cases, as a clientelist political culture by the government in office involving itself in the daily operation of the company to fulfill electoral favors. It is in these types of situations that the upper management of the SOE is forced to deviate from its social, strategic, or commercial purpose, and this negatively affects their performance. For example, governments may try to use SOEs to increase current spending (e.g., hiring more staff than necessary) or investment spending (i.e., adopting investment projects that are not in their budget nor strictly necessary to improve the productivity of the business). Likewise, the government may extract resources, beyond the established dividend policy, directly from the company to finance the expansion of public spending to the detriment of the investments required by the company. All of the above limits the management capability of the company and, therefore, reduces its productivity. There is no escaping the fact that, since the very birth of democratic regimes, transparency and accountability have been understood to be their basis. “Along these lines,

detriment of the investments required by the company. All of the above limits the management capability of the company and, therefore, reduces its productivity. There is no escaping the fact that, since the very birth of democratic regimes, transparency and accountability have been understood to be their basis. “Along these lines, public affairs, including the management of state-owned enterprises, must be open to social scrutiny, and those who manage them must be held accountable in a timely and reliable manner. Transparency and accountability give legitimacy and credibility to the democratic political system, make it possible to ensure that it serves the common good, and help governors, legislators, and public officials to serve the general interest rather than their own particular interests.”1 Thus, SOEs – especially in the area of public services – maintain a direct relationship with not only the state, as the owner of the company, but also with the citizenry, who are not always properly represented by the state. This reality should force SOEs to develop information and accountability mechanisms geared to meeting both the needs of the shareholder or owner and those of the stakeholders linked to the company, particularly its users. This dual accountability creates different, but often complementary, obligations for both the Board of Directors and upper management. • SOEs are usually created under special legal systems which makes the regulations governing their operations different from those governing private companies. This distinct legal treatment usually results in market access requirements and conditions and particular tax obligations for this type of company. In addition, certain legal forms adopted by SOEs do not facilitate the structuring of advanced governance models or encourage transparency about the relationships between different levels of company governance, i.e., the level where property rights are exercised, the level from which the company is managed, and the level responsible for day-to-day operations.

1. Revista Polis. Gustavo Ernesto Emmerich Isaac “Transparencia, rendición de cuentas, responsabilidad gubernamental y participación ciudadana”

(Transparency, accountability, government responsibility,

and the level responsible for day-to-day operations.

1. Revista Polis. Gustavo Ernesto Emmerich Isaac “Transparencia, rendición de cuentas, responsabilidad gubernamental y participación ciudadana”

(Transparency, accountability, government responsibility, and citizen participation) (2004)• Considering the fact that the administrations in office last approximately four to six years – depending on the countries’ electoral cycle – it is not uncommon for there to be a perverse incentive to draw up short-term goals and strategies, which can also change diametrically with the change to a new administration. Some of these points can be mitigated with a proper application of corporate governance principles. These provide the organization with an institutional structure and sustainability, thus allowing it to better meet the objectives for which it was created. The recommendations on guidelines for adopting better corporate governance practices for SOEs should be oriented towards overcoming this particular reality they face as public institutions. In fact, when SOEs are mixed, that is, they include a minority participation on the part of the private sector, they must ensure that the majority shareholder (in this case, the state) does not succeed in extracting a bonus because of its control over the directors and management and its privileged political position as a state shareholder. In other words, due to its status as a state-owned enterprise, the SOE could abuse minority (private) shareholders, so it is necessary to generate mechanisms to protect the interests of these shareholders and those of the company. In this respect, it must be understood that the corporate governance of an SOE must be oriented towards ensuring that the state act as a responsible and proactive shareholder whose main interest is to maximize the value of the company in accordance with its mandate, be it social or economic, without getting directly involved with its daily operations. At the same time, it must seek to ensure that the Board of Directors and upper management do not take over the

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in accordance with its mandate, be it social or economic, without getting directly involved with its daily operations. At the same time, it must seek to ensure that the Board of Directors and upper management do not take over the

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TRANSFORMATION SERIES Guidelines for Good Corporate Governance of State-Owned Enterprises 12 company to the detriment of a potentially passive shareholder – as can sometimes be the case with a state that does not appropriately exercise its role as owner – and act in accordance with objectives that benefit them to the detriment of the state. They should also ensure that if there are minority shareholders, they receive equal treatment with access to the same information as the majority shareholder and that in public service companies, citizens are duly consulted and informed. Due to the characteristics mentioned above, their participation in sectors considered strategic by governments and the importance that SOEs have at the social and economic level, it is not surprising that they are the most visible in many emerging markets and, therefore, should play an active leadership role in the implementation of robust corporate governance models. To the extent that corporate governance principles are increasingly recognized globally as a starting point for healthy markets and business development, state-owned enterprises can help advance these initiatives within the markets in which they operate in order to raise awareness of how the adoption of advanced corporate governance models can yield important benefits for the SOE, such as:

1. Maintaining a long-term business perspective; and ii. Efficient achievement of the company’s objectives, through the following objectives, etc.: • Balance between economic results and the social objectives for which it may have been created. • Clear processes and structures for business-oriented decision making and compliance with organizational purposes.PUBLIC POLICY

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TRANSFORMATION SERIES Guidelines for Good Corporate Governance of State-Owned Enterprises 13 • More stable Board of Directors and upper management teams. • Transparency and accountability. • Stricter risk controls. • Management of conflicts of interest and selfcontracting.

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TRANSFORMATION SERIES Guidelines for Good Corporate Governance of State-Owned Enterprises 13 • More stable Board of Directors and upper management teams. • Transparency and accountability. • Stricter risk controls. • Management of conflicts of interest and selfcontracting. • Improved social and environmental practices. • Improved public relations with the media, and reinforced communication with stakeholders. • Reduced pressure from both the public interest and the supervisory bodies. • Better long-term economic performance. • Increased competitiveness by eliminating social losses. • Better access to capital markets and reduction in the cost of capital. • Attracting the types of investors that institutionally strengthen the company. • Compliance with regulations. • Improving relations with minority shareholders. In this document, SOEs will be defined as companies or institutions where the state exercises control over the property in its entirety, with a majority position, or through a significant minority. In the SOE, the shareholder or owner will be referred to as the public entity, be it a ministry, agency, sovereign fund, or mayor’s office, which has the power to exercise the state’s property rights over the company it controls. The Board of Directors refers to the Management Council or Advisory Board of the SOE, understood as the corporate body of direction and administration in charge of setting the company’s guidelines and strategy and supervising the management directly by mandate of the shareholder or owner. Likewise, reference will be made to the executive team, management or upper management as an instance in which a group of professionals – under the leadership of the chief executive – directly operates the business or service under the guidelines and strategy established by the Board of Directors. Finally, the corporate governance of SOEs will be defined as the formal and informal institutional arrangements that shape the company’s oversight, transparency, and leadership relationships and that govern the relationships between the shareholder or owner, the Board of Directors, the management, and the various groups of stakeholders in the company (employees, citizens, and consumers, etc.).CHAPTER II

REFORMS OF

shape the company’s oversight, transparency, and leadership relationships and that govern the relationships between the shareholder or owner, the Board of Directors, the management, and the various groups of stakeholders in the company (employees, citizens, and consumers, etc.).CHAPTER II

REFORMS OF

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TRANSFORMATION SERIES Guidelines for Good Corporate Governance of State-Owned Enterprises 14 The implementation of these corporate governance guidelines for SOEs implies a reform process in the public sector and in the performance of SOEs. The experience gained by CAF in the implementation processes it has led over the last few years shows that these reforms are not simple to carry out. In fact, they are extremely complex processes for reasons that go beyond the following:

1. Many SOEs are incorporated under special laws, and reforming them requires a high level of commitment from the political authority, something that does not always exist, since the various state representatives involved in SOEs may not have recognized the importance of this issue.

2. The resistance to change and the failure to recognize the underlying conflicts of interest that can be perceived in the different representatives of the state, ministries, controlling bodies, agencies, and other branches of public power that influence SOEs given the possibility of losing influence as a result of modernizing the SOEs through the implementation of good corporate governance practices.

3. When faced with corporate governance reform processes, the attitude of the management and employees of SOEs

(often referred to as public servants) can vary from enthusiastic support to lack of interest and even obstruction since the changes advocated involve higher stan