From Bureaucracy to Business Enterprise

Legal and Policy Issues in the Transformation of Government Services

Michael J. Whincop

• Publisher: Routledge
• Year: 2017
• ISBN:
  9781351765688
• Edition: 1
• Topic: Derecho
• Subtopic: Teoría y práctica del derecho

This title was first published in 2003.This book analyzes the policy initiatives used in Australia, New Zealand, the United Kingdom, and the United States to improve the efficiency of government service delivery, such as commercialization, privatization, and, in particular, corporatization. The book looks at how markets, corporate governance processes, and judicial and administrative reviews affect the efficiency and ethics of service delivery. The book crosses a number of academic disciplines - corporate law and governance, law and economics, public choice theory, ethics and public law and administration. It will also be of value to a range of professional constituencies - to those involved in governance functions in government and privatized corporations, to professionals servicing these organizations, and to officials administering government services. These issues are also highly pertinent to emerging economies where governance of public services is crucial to the transition to market democracy.

Chapter 1
Introduction

Michael J. Whincop

During the 1980s and 1990s, governments around the world critically examined their role in the delivery of services. A series of radical policy shifts occurred. In the liberal democracies of the Western world, there was a backlash against the idea of 'big government', culminating in privatisation programs and the reorganisation of government programs. In former Eastern bloc economies, the industrial organisation of production was restructured by substituting property rights and market transactions for central planning. At a global level, all of these programs were seen as the ascendancy of markets over government provision. Below the surface, however, the aims, methods, and extent of these programs diverged. Although economic ideology played an important role, specific factors in local economic and political equilibria influenced the translation of ideology into policy. For example, the fervour for privatisation was shaped by the fervour for nationalisation in previous generations and the extent of the malaise in nationalised industries. The devil was, as always, in the detail.

In the 1990s and the early years of the new millennium, there has been a backlash against this ideology of markets and competition. Cracks have begun to show in various places. Various anecdotal experiences are in point. In New Zealand and California, crippling failures in electricity supply in private, regulated industries have shaken popular faith in competition. In Australia, the microeconomic reform processes inspired by National Competition Policy have only served to ignite a wick of opposition to 'economic rationalism' by a loose alliance of malcontents (such as rural industries and the urban poor) and populists. In the United Kingdom, the spectacle of appalling rail crashes has put nationalisation back on the policy table, at a time when Baroness Thatcher remains a significant figure in British public life. Helping to unify these local experiences are international trends, such as the literally violent opposition to the globalisation of trade and the bodies sponsoring it. Even those defending the existing economic institutions have conceded that the entities delivering essential services, privatised or not, must be accountable in the public interest, not just to their shareholders.

Whether or not there is merit in these policy trends, they suggest that moves from markets to government provision occur within a larger cycle. This suggestion is confirmed by experiences in previous generations-concerns regarding efficiency, accountability, and the public interest have recurred constantly in policy debate (Brown, this volume).

The cyclical oscillation between public provision and market procurement, and between efficiency and accountability, focuses scholarly attention on the governance of the firms and enterprises delivering essential services. A study of governance is important because it demonstrates first how, in practice, public interest considerations, efficiency, and private interest group concerns are reconciled. Second, it illustrates how credibly a government has committed to a particular balance between these considerations. Luigi Zingales (1998) states that corporate governance is the set of constraints on how parties to a contract divide its economic surplus, and on the capacity of parties to renegotiate the allocation of surplus. By analogy, a study of governance in the provision of essential services shows the constraints on the government in attempting to alter, in a different political environment, a balance between efficiency and other considerations.

This book examines governance in government business enterprises (GBEs) and, in particular, government owned corporations (GOCs). The GBE is an organisational arrangement internal to government which organises the delivery of essential services, utilities, infrastructure, and other business services as a discrete operational unit, separate from regulatory or policy-making functions. As a discrete unit, it becomes possible to examine the extent to which the GBE is recovering its costs, and the magnitude of any implicit subsidy its operations afford. GOCs are a subset of GBEs which are given a mandate to operate commercially and to maximise the value of the firm while remaining in government ownership. The process of creating a GOC-dubbed corporatisation- usually aims to emulate some of the governance processes applying to corporations with exchange-traded stock. These processes include the autonomy of the board of directors and management, subject to explicitly defined governance entitlements of the executive government.

The study of GBEs and GOCs is important for two reasons. First, much less has been written about governance in GOCs than the other organisational and contractual devices used in modern service delivery, such as privatisation and competitive tendering (for example, Graham and Prosser 1991; Rimmer 1994). Most economic analysis examines the productive efficiency of GOCs (MacAvoy et al. 1989), rather than taking a microanalytical approach to their governance, despite the many fascinating comparisons that could be made with the governance of privately owned corporations. There is almost no law and economics literature on the GOC, and most legal scholarship is restricted to doctrinal analysis.

Second, the current political environment suggests that the GOC may be an important locus for service delivery. In the 1980s and early 1990s, the GOC was seen as a transitionary stage between bureaucracy and privatisation. In the current environment, however, public interest concerns suggest that the trade-off between efficiency and the public interest inherent in the GOC may be a more feasible political equilibrium than either a regulated, privatised firm, or to a bureaucracy situated within a government department.

To recognise the existence of a trade-off between efficiency and the public interest implies that it will rarely be possible to examine GOCs solely in terms of a narrow economic efficiency calculus. Demands will be placed on the GOC that are not just hard to measure, but sometimes hard to articulate formally. The chapters in this book bring wide-ranging theoretical material to bear on GOC governance. The principal discipline is economics, but the contributors to this volume also make use of management theory, ethics, public choice theory, and public administration-moreover, the economic analysis often reveals how different modeling assumptions lead to contrasting conclusions. Nonetheless, these diverse perspectives sound a surprisingly unanimous note of caution. To attempt to govern GOCs in a manner that emulates, as much as possible, the behaviour and regulation of private corporations is only occasionally optimal. The idiosyncratic properties of GOC governance require specific identification and analysis; analogical solutions are rarely appealing.

A Theoretical Model of the GOC

We need to understand the differences in the stakeholders associated with private corporations and GOCs, and how these impact on the proper objectives of a system of corporate governance. The 'classical' private firm is a bilateral arrangement between a principal and an agent. The principal must find the optimal contract to encourage the agent to maximise the value of the principal's investment in the firm. The principal's incentives in choosing the contract, and the governance mechanisms it requires, correspond closely to social welfare. The principal bears the residual wealth effects of the contract chosen, and by maximising his wealth he should maximise social welfare (Jensen and Meckling 1976). Since the historic work of Berle and Means (1932), it has been recognised that, where the principal is a highly diffuse body of shareholders, the incentive to choose an optimal contract and take actions when required may be distorted by the effects of collective action problems. Various market effects, however-such as the capital market and the market for corporate control-limit the scope for self-interested behaviour by managers. The government assists this process by providing standard form contracts that decrease the transaction costs associated with selecting contracting and corporate governance processes (Easterbrook and Fischel 1991). Every corporation has a range of nonequity stakeholders (such as employees and creditors), but their interests rarely figure in corporate governance processes. Stakeholders with low transaction costs are better off relying on explicit contracts than the collective processes of the board, and those with high transaction costs can rely on tort law and other legislation.

Shareholders vary in their involvement in corporate governance (Roe 1994). Institutional shareholders holding substantial blocks of equity, such as pension funds and other financial institutions, are less likely to act passively. They are more willing to vote, to interact personally with directors, to make governance proposals and so on. Axe the interests of institutions perfectly aligned with those of the other shareholders? Possibly not; the most active institutions in the United States have been managers of public pension funds. These managers act at times more like politicians-in-the-making (Gillan and Starks 1998; Romano 1999). However, there are limits on institutional self-interest-they rely on the support of other shareholders to be effective, and their own performance will be gauged on financial criteria

The governance milieu of the GOC is different in fundamental respects. First, the GOC's business often partakes of elements of natural monopoly-the sort of consideration that caused it to be publicly owned in the first place. In this respect, the government experiences an inescapable conflict of interest between its interest as shareholder to maximise the value of the corporation (which requires the firm to maximise its monopoly rents) and its duty as guardian of the public interest to maximise social welfare (by setting marginal revenue equal to marginal cost).¹

Second, many enterprises are located in the public sector in order to permit the pursuit of goals thought socially desirable. An example is providing essential services to rural areas, such as postal services. A firm maximising its value would rarely choose to perform these services. Various devices can be used to address this problem, of which a specifically funded government directive (called a 'community service obligation' (CSO) in Australia and New Zealand) is common. Although this desirably reveals the cost of such social subsidies, it suffers from three problems. Governments may use their power over the GOC to circumvent the need to use the CSO mechanism. They may do this either to conceal the full magnitude of the subsidy for policy reasons or to use the funding in areas with a higher political payoff. In addition, the funding of the CSO is complicated by the monopsonistic aspect of the demand for such services-establishing the opportunity cost of devoting GOC resources to the problem can be difficult. Finally, there is the risk, given both monopsonistic demand and monopolistic supply, that the subsidy provided for the activity funds anti-competitive behaviour by the GOC in other, more contestable market segments. For example, Sidak and Spulber (1996) propose limiting the business of the United States Postal Service to its statutory monopoly over letter mail. This is in order to prevent the use of its monopoly rents to subsidise actions that would undermine competition in other markets (such as express post).

Third, shareholdings in the GOC are economically unique. In the classical firm, the shareholder is the principal, who owns the firm's residual income. In the modern exchange-traded corporation, the rights of institutional investors may be exercised by agents with self-serving motives. In the GOC, the ultimate owners, the public, must also be represented, typically by a member of the executive government-a Minister of State in the Westminster system. Despite the 'agents watching agents' analogy, the difference between an institutional investor and a Ministerial shareholding in a GOC is profound. An institutional investor will always be monitored on portfolio returns, and competes with other institutions on that basis, whereas maximising the value of GOCs will rarely win many votes in the electorate given free-rider problems. Ministers, by contrast, are likely to seek to maximise electoral support, by responding to the demands of well-organised interest groups (Buchanan and Tullock 1965; Peltzman 1976). Interest group politics may affect governance.

It is even unclear what objective function a 'public-regarding' government should maximise in governing the GOC. In private corporations, the contractual nature of investment necessarily selects value maximisation as the objective for managers. But the nature of citizenship in a polity does not carry that implication for GOCs, especially when citizens are consumers of GOC services. Just as citizens are both consumers and investors in GOCs, so too Ministers shoehorn responsibilities as governance agents, regulators, and customers. Those varying responsibilities complicate accountability relations and are apt to enable the governance parameters established for the GOC to be exceeded, either for political gain or public interest.

The government department that a Ministerial shareholder administers also complicates matters. A department bureaucracy will have its own unique interests, such as maximising its budget, or maximising its role in the determination of policy and the application of discretionary funding (Niskanen 1971; Dunleavy 1991). Strategic planning in GOCs may often be distorted by the need to form (or to counter) issue-based coalitions designed to further self-interested aims between the Minister and the department, the GOC and the department, or the Minister and the GOC.

Based on this analysis, we may identify three goals that might desirably be furthered in the GOC. First, the agency costs of management need to be minimised. This is true of all corporations. Overreaching and expropriation continue to be undesirable in GOCs-although the proximity of interest groups to GOCs creates a new category of 'political' conflicts of interest that challenges traditional fiduciary norms (Whincop 2001). Unlike listed business corporations, the GOC lacks market mechanisms that signal its success in reducing these costs.

Second, it is desirable to minimise the agency costs of governance. Ministerial shareholders or other members of the executive government exercise governance powers in GOCs. Although objectives in the GOC are more confused than in private firms, Ministerial shareholders should exercise their power for public-regarding purposes, not for political gain. There is no analogous norm limiting the shareholder's governance power in private corporations (cf. Romano 1999).

Third, GOCs should be constrained from acting anti-competitively, particularly where they operate a natural monopoly. There may be cases where it is desirable for the GOC to expand into new areas of business, but at the least the subsidisation of new operations should be apparent.

It seems likely that there will be relatively few governance mechanisms that serve all three purposes simultaneously. This is especially true for the first and second principles, since strengthening governance entitlements is likely to trade off lower agency costs of management with higher agency costs of governance. For these reasons, the practice of corporate governance in private firms can only be applied...

Table of contents

• Cover
• Half Title
• Dedication
• Title
• Copyright
• Contents
• List of Figures and Tables
• List of Contributors
• Preface
• List of Cases
• 1 Introduction
• 2 Halfway House or Revolving Door? Corporatisation and Political Cycles in Western Democracy
• 3 Governance of Public Corporations: Profits and the Public Benefit
• 4 Corporatisation and the Behaviour of Government Owned Corporations
• 5 Comments on Quiggin and King
• 6 The Role of Ministerial Shareholders in the Governance of Government Owned Corporations
• 7 Virtual Privatisation: Governance Reforms for Government Owned Firms
• 8 Comments on Whincop and Skeel
• 9 A Private-Rights Standing Model to Promote Public-Regarding Behaviour by Government Owned Corporations
• 10 Governance, Liability and Immunity of Government Business Enterprises and Their Boards
• 11 Complaint Resolution in Government Owned Corporations and Privatised Utilities: Some Legal and Constitutional Conundrums
• 12 Comments on Stearns, Horrigan and Zifcak
• Index