WP/17/221

State-Owned Enterprises in Emerging Europe:

The Good, the Bad, and the Ugly

by Uwe Böwer

IMF Working Papers describe research in progress by the author(s) and are published
to elicit comments and to encourage debate. The views expressed in IMF Working Papers
are those of the author(s) and do not necessarily represent the views of the IMF, its
Executive Board, or IMF management.
 2

© 2017 International Monetary Fund WP/17/221

IMF Working Paper

European Department

State-Owned Enterprises in Emerging Europe:

The Good, the Bad, and the Ugly

Prepared by Uwe Böwer1

Authorized for distribution by Reza Baqir

October 2017

IMF Working Papers describe research in progress by the author(s) and are published to
elicit comments and to encourage debate. The views expressed in IMF Working Papers are
those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board,
or IMF management.

Abstract

State-owned enterprises (SOEs) play an important role in Emerging Europe’s economies,

notably in the energy and transport sectors. Based on a new firm-level dataset, this paper
reviews the SOE landscape, assesses SOE performance across countries and vis-à-vis
private firms, and evaluates recent SOE governance reform experience in 11 Emerging
European countries, as well as Sweden as a benchmark. Profitability and efficiency of
resource allocation of SOEs lag those of private firms in most sectors, with substantial
cross-country variation. Poor SOE performance raises three main risks: large and risky
contingent liabilities could stretch public finances; sizeable state ownership of banks
coupled with poor governance could threaten financial stability; and negative productivity
spillovers could affect the economy at large. SOE governance frameworks are partly weak
and should be strengthened along three lines: fleshing out a consistent ownership policy;
giving teeth to financial oversight; and making SOE boards more professional.

JEL Classification Numbers: G38, H63, L33

Keywords: State-Owned Enterprises, Emerging Europe
Author’s E-Mail Address: UBoewer@imf.org

1I thank Reza Baqir, Brian Olden, and seminar participants in the IMF’s European Department and Fiscal Affairs
Department for providing helpful comments.
 3

CONTENTS

Abstract .....................................................................................................................................2

I. Introduction ..........................................................................................................................4

II. Stylized Facts .......................................................................................................................5

A. The Dataset ...............................................................................................................5
B. The Role of SOEs in the Economy ...........................................................................7

III. SOE Performance and Economic Risks ..........................................................................8

A. Profits/Losses and Liabilities ....................................................................................9
B. Profitability..............................................................................................................10
C. Efficiency ................................................................................................................11
D. Output Quality.........................................................................................................14
E. Economic Risks of Poor SOE Performance ............................................................15

IV. SOE Governance .............................................................................................................16

A. An Ideal SOE Governance Framework ..................................................................16
B. SOE Governance Performance and Reforms in Emerging Europe.........................17

V. Conclusion..........................................................................................................................21

VI. Annex ................................................................................................................................23

VII. References .......................................................................................................................25

BOXES
1. OECD Guidelines on Corporate Governance of SOEs........................................................17

FIGURES
1. The SOE Dataset ....................................................................................................................6
2. Share of SOEs in the Economy..............................................................................................7
3. Share of SOEs in Economic Sectors ......................................................................................8
4. Profits/Losses .........................................................................................................................9
5. Liabilities .............................................................................................................................10
6. Profitability ..........................................................................................................................11
7. Capital Efficiency ................................................................................................................12
8. Labor Efficiency ..................................................................................................................13
9. Output Quality .....................................................................................................................14
10. Contingent Liabilities.........................................................................................................15
11. SOE Governance Performance ..........................................................................................17
12. SOE Governance Challenges in Emerging Europe ...........................................................18
 4

I. INTRODUCTION

State-owned enterprises (SOEs) play an important role in the economies of Emerging

Europe. Poorly exercised state ownership can carry substantive macroeconomic risks on
fiscal policy, financial stability and, via productivity spillovers, on economic growth.
Emerging European economies are particularly susceptible to these risks as, in some cases,
legacy issues with SOEs prevail as a result of inconsistent privatization during the transition
process. Varying degrees of institutional quality aggravate the risks of suboptimal SOE
governance.

The objective of this paper is twofold. The first objective is to review the SOE landscape in
Emerging Europe and assess SOE performance across countries and vis-à-vis private firms.
A new firm-level dataset is constructed, covering 11 Emerging European countries and
Sweden as a benchmark country. The second objective is to gauge the underlying SOE
governance frameworks in these countries by identifying shortcomings, evaluating recent
reform experiences, and drawing overall lessons for policy implications.

The analysis finds large variation in SOE performance and governance reforms across
countries — “good, bad, and ugly”. SOEs make up significant shares of employment and
output in several countries. They are especially important in network sectors, such as energy,
transportation, and water management. In some countries and sectors, SOE are heavily loss-
making. Large amounts of debt have been piled up in the energy and transport sectors, but
partly also in telecoms, financial services and real estate. SOE profitability and the efficiency
of resource allocation in SOEs largely lags those in private firms, and the gaps are
particularly large in some of the Southeast European and Baltic countries. Risks arise where
contingent liabilities are sizeable, poorly regulated state ownership of banks amplify financial
instability, and negative productivity spillovers affect the larger economy. Underlying SOE
governance reforms have advanced in Slovenia, Lithuania and Latvia but have remained
rudimentary so far in Bulgaria.

The emerging lessons call for decisive SOE governance reform. First, a well-defined
ownership policy is needed at the highest level, clarifying the rationale for state ownership
and reviewing it case-by-case every year. Centralizing the ownership function, rather than
leaving it with line ministries, is particularly advisable if the overall institutional quality is
weak. Second, financial oversight teams need to have teeth to implement and monitor
financial performance targets. Dividend policies should be balanced and predictable. Third,
firm-level governance needs to ensure professionalized SOE boards. Appointments should be
determined by skill and experience, not political affiliation. Remuneration needs to strike a
healthy balance of remaining competitive while being transparent and merit-based.

The paper is organized as follows. Section II presents the dataset and sets the scene by
reviewing the broader SOE landscape in Emerging Europe. Section III assesses SOE
performance including indebtedness, profitability, efficiency and output quality. It also
discusses risks of poor SOE performance on fiscal, financial, and macroeconomic stability.
Section IV addresses SOE governance by setting out the ideal framework, identifying major
challenges in Emerging Europe and, based on a country-by-country review, draws
overarching lessons for policy implications. Section V concludes.
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II. STYLIZED FACTS

This section presents the SOE dataset and discusses the role of SOEs in Emerging
Europe’s economies. First, the presentation includes the overall number of SOEs across
countries, as well as a disaggregation of SOEs into eight relevant economic sectors by
country, highlighting the distribution by number of SOEs, employment, and output. Second,
the output and employment shares of SOEs are presented by country, and then by sector and
country, pointing to a dominant role of SOEs mainly in the network sectors of several
countries.

A. The Dataset

The analysis of SOEs is based on a rich firm-level dataset. The dataset was constructed for
this study and is based on the Orbis database provided by Bureau Van Dijk. It covers the
years 2012-2014. Annual averages aim at smoothening the data. After cleaning for inactive
companies, outliers and double entries, the total number of SOEs amounts 6,282.2 Although
the coverage of the Orbis database is extensive, it cannot be regarded as fully exhaustive, so
the presented aggregate figures of SOE activity should be understood as indicative.3

The dataset comprises eleven new European Union member states, 4 as well as Sweden.
The country choice is not only motivated by data limitations but also by comparability of
countries which operate in the homogeneous economic and legal environment of the EU, e.g.
regarding market access and state-aid scrutiny. Sweden is added as a benchmark country,
representing an advanced economy which operates are large SOE portfolio with a very sound
governance framework.

The number of SOEs varies across countries. While the dataset records 2097 SOEs for
Poland, 1699 for Sweden, and around 800 each for Bulgaria and Romania, the numbers in
other countries are far smaller. Beyond data coverage, this variation is likely due to different
privatization strategies since the beginning of economic transition, as well as different
organizational forms of municipal entities.

The SOE landscape is characterized by a large variety of firms. SOEs vary in size, from
small local entities with only a few employees to large-scale companies, notably in the
network industries. Breaking the dataset down into eight economic sectors which are most

2
State ownership is defined as a minimum stake of 50.1 percent. The indicated numbers refer to the maximum
available firm data. For several indicators reported in this paper, the actual availability of data varies by country
and sector.

3
This paper adopts a wide definition of the term “SOE”, including firms owned by the central government as
well as sub-national government levels, classified within and outside of general government accounts.
4
Bulgaria, Croatia, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, Slovakia, and
Slovenia.
 6

relevant for SOE activity5 reveals differences between the relative shares in the firm
numbers, employment, and output by sector.6 The number of SOEs is dominated by firms in
healthcare, water utilities, services, and other industries. In terms of SOE employment,
healthcare, transport, and postal services feature prominently in the dataset. However, output
shares are more strongly dominated by the energy sector, alongside transport and other
services.7

Figure 1. The SOE Dataset

Number of SOEs by sector Energy Healthcare Mining
Number of SOEs (Percent of total, 2012-14)
Other ind. & agri. Other services Postal services
Transport Water utilities
100
Poland 2097
Sweden 1699 80
Bulgaria 799
Romania 798 60
Croatia 184
40
Slovenia 174
Latvia 151 20
Czech Rep. 142
Hungary 98 0
Estonia 54
Lithuania 47
Slovakia 39

0 500 1000 1500 2000 2500

SOE employent by sector Energy Healthcare Mining SOE output by sector Energy Healthcare Mining
Other ind. & agri. Other services Postal services Other ind. & agri. Other services Postal services
(Percent of total, 2012-14) Transport Water utilities
(Percent of total, 2012-14) Transport Water utilities
100 100

80 80

60 60

40 40

20 20

0 0

Sources: Orbis; and IMF staff calculations.

5
Sectors are defined in line with NACE-2 sections as follows: Mining (B – mining & quarrying), other
industries & agriculture (A – agriculture, C – manufacturing, F – construction), energy (D – electricity, gas,
steam and air conditioning supply), water utilities (E – water supply, sewerage, waste management and
remediation activities), transport (H49-H52 - land, water and air transport and warehousing/support activities
for transportation), postal services (H53 – postal and courier services), healthcare (Q – human health and social
work activities), other services (G – wholesale and retail trade, I – accommodation, J – ICT services, K –
financial services, L – real estate services, M – professional activities, N – administrative and support services,
P – education, R – arts & entertainment, S – other service activities).

6
In addition to firm number, employment, and output, it was attempted to include value-added in this
presentation, recognizing that output data tends to be biased by varying degrees of intermediate good inputs.
However, data scarcity as well as the prevalence of negative values for value-added, on the back of negative
profits, led to the exclusion of the constructed value-added indicator.

7
Hospitals and medical centers account for around half of SOEs in Bulgaria as they are set up as trade
companies since a healthcare reform in 2000. In other countries, the healthcare sector plays a far smaller role, or
is completely absent from the SOE dataset. Given the atypical role of healthcare for SOE analysis, this sector is
excluded from the remainder of the paper. The same applies for postal services which, despite partly sizable
employment, contributes very little to the number of SOEs and SOE output.
 7

B. The Role of SOEs in the Economy

SOEs have an important economic role in

several countries. Aggregating across all Figure 2. Share of SOEs in the Economy
sectors, SOEs contribute between around 1 Share of SOEs in the economy
and 12 percent to total economic output, and (Percent of total)

between around 0.5 and 8 percent of total Output Employment

employment. Slovenia, Poland and Sweden Slovenia

Poland
Sweden
exhibit the largest SOE output shares while Bulgaria
Croatia
large shares of SOE employment are found Hungary
Estonia
in Sweden, Bulgaria and Slovenia. The Czech Republic
Latvia

differences between output and employment Romania

Slovakia
Lithuania
shares suggest that some countries operate
0 5 10
more capital-intensive production in SOE Sources: Orbis, Eurostat; and IMF staff calculations.
Note: Annual average in 2012-2014. The healthcare sector is excluded.

sectors while in other countries, labor-

intensive production is more prominent.

In the network industries of several countries, SOEs play a dominating role. Breaking
down the output and employment shares of SOEs by sectors shows that the energy sector is
most strongly dominated by SOEs. In Slovenia, Hungary, Poland, and Bulgaria, more than 60
percent of energy-sector output is generated by SOEs. The SOE employment shares are
largely below the output shares, pointing to capital intensive production and the use of
intermediate product inputs. The mining sectors of Sweden and Estonia are also clearly
dominated by SOEs, with output shares exceeding 50 percent. In the water utility sector,
SOEs are responsible for around 30 percent of output in Poland, Bulgaria, and Slovenia. The
transport sector is most clearly influenced by SOEs in Hungary, with output and employment
shares above 20 percent, and in Bulgaria with an employment share of around 26 percent,
albeit with a lower output share. In other services, only Sweden and Slovenia exhibit SOE
output shares of above 5 percent while in other industries, the influence of SOEs remains
below 5 percent in all countries.
 8

Figure 3. Share of SOEs in Economic Sectors

Share of SOEs in economic sectors, energy

(Percent of sector total)
Output Employment

Slovenia
Hungary
Poland
Bulgaria
Sweden
Estonia
Croatia
Czech Republic
Slovakia
Lithuania
Romania
Latvia

0 20 40 60 80 100
Sources: Orbis, Eurostat; and IMF staff calculations.
Note: Annual average in 2012-2014.

III. SOE PERFORMANCE AND ECONOMIC RISKS

This section addresses to SOEs’ financial performance and ensuing risks. It first presents
aggregate profits/losses, liabilities, profitability, as well as efficiency of capital and labor
allocations. It then addresses output quality and discusses fiscal, financial and
macroeconomic risks stemming from poor SOE performance.
 9

A. Profits/Losses and Liabilities

In some sectors, SOEs are heavily loss-making. Profits and losses before tax are
aggregated across firms and by sectors, averaged over the period 2012-2014 and expressed in
percent of GDP. In Southeastern Europe (SEE), large losses are recorded in the Bulgarian
energy sector which are mainly due to the National Electricity Company and its structural
tariff deficit. In Croatia, the transport sector stands out with significant losses. The state-
owned automotive company is behind the losses in other industries in Slovenia. In Latvia, the
losses in other services are caused by the bad bank which was established during the
resolution of the country’s financial crisis. In contrast, several sectors in other countries
exhibit significant profits, for instance in the energy sectors of the Central and Eastern
European (CEE) countries as well as Croatia and Estonia, and in Estonia’s and Slovakia’s
transport sectors. In Sweden, the large profits in the services sector are mainly due to the
gaming industry and public real estate companies.

Figure 4. Profits/Losses
CEE: Aggregated profits/losses of SOEs
(Percent of GDP)
Czech Republic Hungary Poland
Slovakia Slovenia

Energy

Mining

Other industries & agriculture

Other services

Transport

Water utilities

-.4 -.2 0 .2 .4 .6
Sources: Orbis, IMF WEO; and IMF staff calculations.
Note: Annual average in 2012-2014.

The accumulated liabilities of SOEs are partly very sizeable. The energy sectors in
Bulgaria, Croatia, Estonia, and Slovenia show SOE debt ranging between 5 and 7 percent of
GDP. The transport sector—largely the public railways—holds debt of around 9 percent of
GDP in Slovenia and around 6 percent in Slovakia. The large liabilities of Croatia’s other
industries are due to the public motorway company. SOE debt in other services stands out in
Latvia, again on account of the bad bank, and in Sweden where the telecom company and the
real estate sector hold very large amounts of debt.
 10

Figure 5. Liabilities

CEE: Aggregated liabilities of SOEs

(Percent of GDP)
Czech Republic Hungary Poland
Slovakia Slovenia

Energy

Mining

Other industries & agriculture

Other services

Transport

Water utilities

0 2 4 6 8 10
Sources: Orbis, IMF WEO; and IMF staff calculations.
Note: Annual average in 2012-2014.

B. Profitability

In most sectors, SOEs are less profitable than private firms. Firm profitability is
measured by the return on equity (ROE), defined as the profits and losses before tax as a
percentage of shareholders’ equity. It hence indicates the ability of a company to generate
profits with the money that shareholders have invested. In the vast majority of cases, SOEs
are lagging behind private firms’ profitability, with the notable exceptions of the Swedish
and Estonian mining sectors as well as the Slovak services and industries. Across countries,
Bulgaria, Romania and Poland tend to be among the lower-ranking countries, both in terms
of ranked SOE profitability, and in terms of the gap between private-sector and SOE
profitability, i.e. the difference between the blue and red bars in the charts. The comparison
needs to be interpreted with some caution, as the profitability of certain SOEs might suffer
from insufficient compensation for public service obligations and from regulated prices
which, in the energy sector, can lead to structural tariff deficits. Moreover, caution is
warranted given the averaging of very large numbers of private firms. However, the
emerging big picture appears rather clear-cut, and resulting implications for policy and
regulation are addressed in the section on SOE governance below.
 11

Figure 6. Profitability

C. Efficiency

Allocative efficiency of capital of SOEs lags behind in many sectors. Efficiency of capital
allocation is approximated by the return on capital employed (ROCE) which is the operating
profit or loss before tax as a share of capital employed. This measure indicates the efficiency
by which the sum of shareholders’ equity and debt are deployed to generate profits. The
 12

transport sectors as well as other services display the largest gaps between the ROCE of
SOEs and private firms in most countries, pointing to comparably inefficient capital
allocation in SOEs of those sectors. In the energy and mining sectors, as well as in other
industries, the picture is more nuanced, with some countries showing more capital efficient
SOEs than private firms, such as the Czech Republic, Bulgaria (mining) and Slovakia (other
industries).

Figure 7. Capital Efficiency

Return on capital employed (ROCE), other ind. & agric.

(Percent)
SOEs private firms

Estonia
Croatia
Slovakia
Latvia
Czech Republic
Sweden
Romania
Poland
Hungary
Lithuania
Bulgaria
Slovenia

-10 0 10 20 30
Sources: Orbis; and IMF staff calculations.
Note: Annual average in 2012-2014.
 13

Allocative efficiency of labor scores relatively unfavorably in SOEs compared to private

firms. This difference appears in higher average cost of labor per capita in SOEs than in
private firms. In most countries and sectors, SOEs incur larger labor costs than private firms,
partly substantially so. Cases of roughly equal labor cost in SOEs and private firms include
the energy and transport sectors in Sweden, other services in Hungary and Poland, as well as
other industries in Lithuania and Poland. Some extreme cases can be explained by small
samples with notable outliers for this indicator, including the transport sector in Latvia which
is driven by the national airline.

Figure 8. Labor Efficiency

 14

D. Output Quality

SOE-dominated infrastructure sectors deliver partly poor output quality. While no

specific data for SOE output quality are available, the World Economic Forum’s Global
Competitiveness Indicators for infrastructure provide some inside in cross-country
performance of those sectors which are partly heavily dominated by SOEs. Bulgaria and
Romania exhibit particularly poor output quality, ranking at the bottom of the Emerging
Europe sample in overall infrastructure, electricity supply and, when abstracting from the
land-locked countries Czech Republic, Hungary, and Slovakia, also in port infrastructure.
Next to Sweden, better performance is indicated for the Baltic countries, the Czech Republic,
Slovakia and Slovenia.

Figure 9. Output Quality

Overall infrastructure Electricity supply
(better quality on top) (better quality on top)
Sweden Sweden
Estonia
Czech Republic
Lithuania
Slovenia
Czech Republic
Slovak Republic
Slovenia
Croatia
Latvia
Estonia
Hungary
Lithuania
Croatia
Poland
Slovak Republic
Latvia
Poland
Hungary
Bulgaria
Romania
Romania
Bulgaria
0 1 2 3 4 5 6 7
0 1 2 3 4 5 6 7
Note: Composite indicator of energy, transport, and Note: Reliability of electricity supply, i.e. lack of
ICT infrastructure. Source: WEF Global interruptions and lack of voltage fluctuations, from
Competitiveness Indicators (2016-2017).
1=extremely unreliable, to 7=extremely reliable. Source:
WEF GCI (2016-2017).

Railroad infrastructure Port infrastructure

(better quality on top) (better quality on top)

Czech Republic Sweden

Slovak Republic Estonia
Lithuania Slovenia
Sweden Latvia
Latvia Lithuania
Estonia Croatia
Hungary Poland
Poland Bulgaria
Bulgaria Czech Republic
Slovenia Romania
Croatia Hungary
Romania Slovak Republic

0 1 2 3 4 5 6 7 0 1 2 3 4 5 6 7

Note: Quality of the railroad system, from Note: Extensiveness and condition of seaports, or
1=extremely underdeveloped, to 7=extensive and access to seaports, from 1=extremely poor, to
efficient. Source: WEF GCI (2016-2017). 7=extremely good. Source: WEF GCI (2016-2017).
 15

E. Economic Risks of Poor SOE Performance

Weak performance of SOEs carries macroeconomic risks. High indebtedness, feeble

profitability, poor efficiency, and wanting output quality as shown in the preceding
subsections can give rise to risks at the macro level. These risks can emerge via three main
channels, namely (i) risks to public finances, mainly via contingent liabilities, (ii) risks to
financial sector stability via state-owned banks, and (iii) risks to productivity and growth via
spillovers from SOEs to other firms.

Fiscal risks arise with contingent

Figure 10. Contingent Liabilities
liabilities on the back of excessive SOE (Percent of GDP)
indebtedness. Aggregate debt of SOEs
classified outside of general government Slovenia
accounts represents contingent liabilities Sweden
which might aggravate the risk profile of the Poland
public debt position. The degree of risk may Latvia
Hungary
either stem from the size of the contingent
Bulgaria
liabilities—as in the cases of Slovenia, Czech Rep.
Sweden and Poland—or from an elevated Croatia 2015

likelihood of materialization of even modest Romania 2014

contingent liabilities. The latter might Estonia
2013
become relevant in cases where SOEs are Lithuania
Slovakia
largely exempt from insolvency regulations,
0 20 40 60 80 100
such as in Bulgaria. Note: Total outstanding liabilities of government-controlled
entities classified outside general government. Source: Eurostat.
Risks to financial sector stability may
emanate from regulatory failures in the
face of sizeable state ownership of banks. In Slovenia, the state owned not only a sizeable
portfolio of non-financial companies but also the three largest domestic banks and holds
around 63 percent of the total banking sector’s equity (IMF, 2016d; IMF, 2016e). After the
first hit of the global financial crisis, Slovenia experienced another banking crisis in 2012-13
when the mostly state-owned banking system came under pressure and led the sovereign to
lose market access. Cross-enterprise ownership structures with SOEs at their heart, and
pervasive connected lending was believed to have amplified the crises. As a result,
bankruptcies were wide-spread and mounting NPLs ate up bank capital (IMF, 2017b).
Progress with privatization of Slovenian SOEs has been mixed so far, and the Slovenian
experience highlights that corporate governance failures coupled with excessive state control
of banks can result in interference with their lending, potentially leading to serious financial
and macro stability risks.

Risks to productivity and growth emerge when SOE performance affects productivity
also in other sectors of the economy. Recent World Bank analysis based on Bulgarian firm-
level data suggests that performance in SOE-dominated network service sectors has
significant effects on firm productivity also in manufacturing and other downstream service-
sector firms which rely on network service sector inputs (World Bank, 2015). The study
measures network service sector performance by using EBRD Structural Change indicators,
gauging reform progress in transition economies against the standards of advanced
 16

economies. The authors also test the impact of the presence of foreign service firms, the level
of competition, and the extent to which service providers are also exporters on downstream
firm productivity. Improvements in network service sector performance turns out to enhance
downstream firm productivity particularly in the electricity sector, and also likely in the
transport sector, although the analysis of the latter suffers from data shortages. Both sectors
are typically dominated by SOEs in many Emerging European countries. Opening these
sectors up to foreign investors, increasing competition and, to a lesser extent, promoting
export activity among network sector firms, also leads to improved firm-level total factor
productivity in downstream firms. In sum, the evidence suggests that the performance of
SOE-dominated service sectors such as energy generates spillovers—positive or negative—
on downstream firm productivity. Poor SOE performance hence carries risks to economy-
wide productivity and growth, while tangible improvements in SOE performance has the
potential to boost productivity across the economy as a whole.

IV. SOE GOVERNANCE

This section turns to SOE governance as the foundation of SOE performance. It first
presents the best-case SOE governance set-up as sketched by OECD guidelines. It then
highlights the main shortcomings of SOE governance in Emerging Europe and summarizes
three major lessons emerging from a comprehensive country-by-country review of recent
SOE reforms.

A. An Ideal SOE Governance Framework

Good corporate governance is at the heart of healthy SOEs. Given their special role as
providers of key public services, the effectiveness of SOEs has a strong impact on the
welfare of citizens and on the competitiveness of the economy at large. As SOEs often
operate with dual goals of economic market activity and public policy obligations, a
functioning governance environment for SOEs is crucial. Well-designed governance
structures are also needed to address the frequent challenge of undue hands-on and politically
motivated ownership interference in SOEs.

The OECD guidelines on SOE governance provide an international benchmark of best

practices. Agreed between OECD member states in 2005 and further developed in 2015, the
guidelines are recommendations to governments towards efficient, transparent and
accountable operation of SOEs. They aim at professionalizing the state as an owner, making
SOEs operate with similar good practices as private enterprises, and ensuring competition
between public and private firms at level playing field. Box 1 presents the overall guidelines
in brief (OECD, 2015a). Due to their general relevance, these SOE guidelines constitute
useful yardsticks also for those Emerging European countries which are currently not
members of the OECD.
 17

Box 1. OECD Guidelines on Corporate Governance of SOEs

Rationales for state ownership: The state exercises the ownership of SOEs in the interest of the general public. It
should carefully evaluate and disclose the objectives that justify state ownership and subject these to a recurrent
review.
The state’s role as an owner: The state should act as an informed and active owner, ensuring that the governance of
SOEs is carried out in a transparent and accountable manner, with a high degree of professionalism and effectiveness.
SOES in the marketplace: Consistent with the rationale for state ownership, the legal and regulatory framework for
SOEs should ensure a level playing field and fair competition in the marketplace when SOEs undertake economic
activities.
Equitable treatment of shareholders: Where SOEs are listed or otherwise include non-state investors among their
owners, the state and the enterprises should recognize the rights of all shareholders and ensure shareholders’ equitable
treatment and equal access to corporate information.
Stakeholder relations and responsible business: The state ownership policy should fully recognize SOEs’
responsibilities towards stakeholders and request that SOEs report on their relations with stakeholders. It should make
clear any expectations the state has in respect of responsible business conduct by SOEs.
Disclosure and transparency: SOEs should observe high standards of transparency and be subject to the same high
quality accounting, disclosure, compliance and auditing standards as listed companies.
The responsibilities of boards: The boards of SOEs should have the necessary authority, competencies and
objectivity to carry out their functions of strategic guidance and monitoring of management. They should act with
integrity and be held accountable for their actions.

B. SOE Governance Performance and Reforms in Emerging Europe

Qualitative governance
indicators point to Figure 11. SOE Governance Performance
considerable variation Governance of SOEs Governance and enterprise restructuring
across countries. The (least restrictive on top) (better progress on top)

OECD’s state control Slovenia

Slovak Republic
indicators for Emerging Estonia
Poland
European countries gauges Latvia
Hungary
Croatia
the insulation of SOEs from
Hungary Latvia
market discipline and the Slovak Republic Croatia
political interference in the Czech Republic
Slovenia
management of SOEs. Poland
Lithuania
Bulgaria and Lithuania Romania
Romania
display the worst-possible Lithuania

Bulgaria Bulgaria
ratings. The EBRD transition
0 1 2 3 4 5 6 0 1 2 3 4
indicator on governance and Note: Degree of hard budget constraints,
Note: Degree of insulation of SOEs from market
enterprise restructuring discipline and degree of political interference in the enforcement of bankruptcy legislation, competition
management of SOEs. Source: OECD Product Market and corporate governance. Source: EBRD Transition
measures the degree of hard Regulation Indicators (2013). Indicators (2014).

budget constraints,
enforcement of bankruptcy legislation, competition and corporate governance. Again,
Bulgaria scores worst among available countries, followed by Romania. However, these
 18

indicators should be interpreted with caution as they reflect only selected dimension of SOE
governance, and in both cases, the latest vintages are already slightly dated.

Country-specific SOE governance challenges emerge in ownership policy, financial

oversight, and board appointments. An extensive review of SOE governance challenges
and reform efforts in Emerging European countries included in this study points to three
main areas of concern. Figure 12 shows these challenges and the resulting risks in overview.
• Ownership policy. At the strategic level, the rationale for state ownership is rarely
specified clearly, partly as a legacy of inconsistent post-transition privatization
procedures. The objectives of SOEs are often not unequivocally defined and spelt out.
Legal provisions concerning SOEs tend to be unclear and opaque. As a result, the
responsibilities for SOEs are typically fragmented and without clear reporting lines
among government ministries and agencies.
• Financial oversight. At the more specific level of financial oversight, there are either
no dedicated oversight teams in place, or they tend to be understaffed and not
endowed with a sufficiently rigorous mandate. Effective financial oversight is often
hampered by the absence or vagueness of SOE performance targets. Even if such
targets are in place, compliance is often not monitored with adequate scrutiny, or
failure to comply is not sanctioned with deterring consequences. Dividend policies
are in many cases erratic and lack predictability.
• Board appointments. Zooming into corporate governance at firm level, many SOEs
suffer from political board appointments without transparent and competitive
selection procedures. Frequent replacements hamper efficient board functioning.
Private-sector expertise, international experience, and independent board members
are often absent. In many cases, remuneration is not fully transparent nor
performance-based.

Figure 12. SOE Governance Challenges in Emerging Europe

 19

Several countries have undertaken SOE reform while others are lagging behind. The
country-specific review of reform experiences is detailed in the Annex. Three major lessons
emerge.

Lesson #1: Flesh out a consistent ownership policy

A clear institutional basis is the foundation of a strong ownership policy. This could be a
dedicated SOE framework law, or a high-level political document referencing and
synthesizing the elements of policies, laws, and regulations applicable to SOEs. It should
specify the rationale for state ownership, outline well-defined policy objectives, and lay out a
coherent strategy for exercising the state’s SOE ownership function. Transparent ownership
structures and clear privatization strategies, notably for the banking sector, can reduce
financial stability risks. Latvia’s State Administration Structure Law stipulates the rationale
in cases of market failure, natural monopoly, strategically important sectors and overriding
public interest (OECD 2015b). Lithuania’s Ownership Guidelines indicate profit
maximization, national strategic interests as well as social purposes as key SOE policy
objectives (OECD 2015c). A regular review of state ownership should make the case for
divestment of state assets if deemed no longer in line with state ownership objectives.
Estonia and Sweden carry out such a review on an annual basis (OECD, 2011;
Regeringskansliet, 2015).

The roles and responsibilities of various government bodies should be clearly specified
and ring-fenced to avoid inconsistency and overlap. Notably, the choice between a
centralized vs. decentralized or hybrid ownership models must be made on solid grounds.
The OECD recommends to exercise SOE ownership rights in one dedicated, accountable
entity within the government, rather than keeping SOE responsibility primarily at the level of
line ministries or other agencies. The benefit of the central approach is to ensure consistency
and allow for concentrating relevant experts on key issues in one place. Experience in
Bulgaria and Romania suggests that countries with weaker institutional environments are at
greater risk of losses to welfare, productivity and growth due to cronyism if they operate a
decentralized governance model that leaves SOE management in the hands of line ministries
with little coordination across government entities (IMF 2016b). These countries are likely to
fare better with a centralized model, provided the central ownership entity is subject to
effective accountability. Slovenia has established a centralized holding company in charge of
managing and divesting state assets (European Commission, 2015c). However, the example
of Sweden shows that a robust institutional environment also allows for well-functioning
decentralized or hybrid models (European Commission, 2016a; Regeringskansliet, 2015).

Ownership and policy functions should be clearly separated. Ownership functions, e.g. to
pursue value maximization, should be kept distinct from policy functions, such as sectoral
regulation, to avoid conflict of interest and political patronage and hence reduce the risk of
fiscal excess and efficiency loss. This separation is generally facilitated by adopting the
centralized ownership model. Slovenia has incorporated this separation in its new corporate
governance code for SOEs (European Commission, 2015c). Also Romania has made efforts
towards this end but their effectiveness remains limited as long as the ownership set-up
continues to be fragmented (Marrez, 2015).
 20

The competition authority needs a strong mandate to ensure a level playing field.
Putting SOEs on equal footing with private firms would benefit cross-sector productivity
and, by abolishing insolvency exemptions, reduce also fiscal risks. The competition authority
should be empowered to reach also the municipal level. Sweden’s competition authority can
take municipalities to court in cases where the set-up of SOEs is believed to constitute an
unwarranted constraint to competitive markets in relation to private firms (European
Commission, 2016a).

Lesson #2: Give teeth to financial oversight

A well-powered SOE oversight unit should be established or upgraded. Financial
oversight focuses on specific SOE performance monitoring and is hence distinct from the
general ownership policy. As a first step, a dedicated financial oversight unit should collect
and synthesize SOE financial information on a regular basis and build a publicly-accessible
database which also includes SOEs at sub-national levels. As a second step, the oversight
unit should analyze risks to fiscal, financial, and macro stability emanating from potential
SOE underperformance. It should also develop strategies for mitigating these risks and
publish its findings in regular reports which ensure public accountability and feed these
proposals into the political process to inform any potential fiscal implications beyond party
lines. The oversight units are often best-placed in the Ministry of Finance, but depending on
a country’s institutional structure, they can also reside in other government entities with the
respective skill resources. In Estonia, an oversight unit within the Ministry of Finance
monitors financial accounts and publishes a consolidated annual report (OECD, 2011). In
Sweden, this role is assigned to a unit within the Ministry for Enterprise and Innovation;
however, only central-government SOEs are covered (Regeringskansliet, 2015). Lithuania
operates a coordination unit in its State Property Fund (European Commission, 2015b).

Clearly defined performance targets should be put in place and effectively monitored.
These targets are preferably based on rates of return or capital structures, as is the case in
Sweden, Latvia, Lithuania and Slovenia (Regeringskansliet, 2015; OECD, 2015b; OECD,
2015c; European Commission, 2017f). On the contrary, performance targets that relate to
sales volumes or employment, like in Bulgaria, can have counter-productive effects as they
tend to serve industrial or labor market policy goals, rather than value maximization (IMF,
2016b). Performance benchmarking with private and foreign companies can further inform
the monitoring process towards better resource allocation efficiency. Compliance with the
performance targets should be closely monitored by the oversight unit or in delegated
entities. Non-compliance should be followed by sanctions of varying severity, ranging from
additional reporting requirements to administrative measures imposed on SOE boards (IMF,
2016a). Among OECD countries, Korea applies a particularly informative and rigorous SOE
monitoring system, including customer satisfaction surveys and index-based evaluations
which are seen as key factors for the exemplary efficiency and performance of Korea’s SOEs
(Park et al. 2016).

Dividend policies should be predictable and balanced. They should facilitate a stable
planning framework for the company’s long-term investment while ensuring an adequate
capital return for the state as an owner. In Bulgaria, the Czech Republic, Estonia and
 21

Hungary, dividend requirements are determined on an ad-hoc basis, partly taking into
account the financial state of companies, and are sometimes guided more by government
budget needs than SOE profitability. Poland applies broad guidelines stipulating that annual
dividend decisions should be guided by the need to recover prior losses, long-term
investment strategies, privatization, and firm indebtedness. The dividend levels are
determined in relation to rate-of-return indicators and liquidity ratios. In Lithuania, explicit
dividend ratios apply, amounting to at least 7 percent of equity and at most 80 percent of
company profits for limited liability firms while statutory corporations are expected to pay
out 50 percent of annual profits. Slovenia’s general dividend policy foresees an annual pay-
out of at least one third of net profits. In other countries, including Australia and the
Netherlands, dividend payments are explicitly linked to achieving a desired capital structure,
reflected by a certain target credit rating (OECD 2014b). While that level of sophistication
might be excessive for Emerging European countries, it seems advisable to adopt an
intermediate degree of formalization to make dividend policies work better for SOEs and the
state.

Lesson #3: Make SOE boards more professional

The role of SOE boards should be unequivocally defined and founded in legislation.
Endowed with a clear mandate, boards should be enabled to exercise their operational
functions independently and without undue state intervention. Transparency measures, such
as reporting requirements, should promote accountability. Board performance should be
evaluated on an annual basis, as is the case in the Czech Republic and Sweden (OECD, 2013;
Regeringskansliet, 2015).

The nomination process for board members should be transparent and skill-based.
Appointments should rely on competitive selection procedures based on competence, not on
political affiliation, and include independent board members. Croatia and Romania have
made efforts to depoliticize SOE boards by improving transparency of selection procedures,
sharpening qualification requirements and involving external contractors (European
Commission, 2016a; Marrez, 2015). However, the independence of external staffing agencies
is cannot always be guaranteed if they depend on government funding. Candidates should
ideally possess private-sector expertise and international experience. Estonia requires board
members to come equally from the private and public sectors to secure more private-sector
expertise (OECD, 2013). Excessively frequent changes, as report in Bulgaria, should be
avoided (Park et al., 2016).

Remuneration policies should be clear and balanced. The trade-off between attracting
qualified professionals and ensuring long-term company interests needs to be addressed
Avoiding excessive remuneration helps to reduce fiscal risks. Remuneration should ideally
be linked to performance. Sweden applies guidelines for reasonable and competitive
remuneration of senior executives in agreement with shareholders. In Hungary, remuneration
limits in relation to the minimum wage are in place (OECD, 2013).
 22

V. CONCLUSION

SOE performance in Emerging Europe shows a mixed picture. SOEs play an important
role in the economies of Emerging Europe, notably in network sectors. Compared to private
firms, the profitability and efficiency of resource allocation in SOEs largely lag behind, as
evidenced by sizeable gaps in return on equity and return on capital employed, as well as
unfavorable relative cost of employees. Large cross-country variation shows that some
countries exhibit worse SOE performance than others.

Poor SOE performance creates risks to fiscal, financial, and macro stability. In cases of
sizeable contingent liabilities, or when moderate contingent liabilities are more likely to
materialize on the back of insolvency exemptions, public finances can come under pressure.
Financial instability can be accelerated in case of large-scale state ownership of banks
coupled with opaque cross-ownership structures and regulatory failures. Spillover of weak
productivity to downstream firms reflects the wider macro risk of poor SOE performance.

SOE governance challenges should be addressed by comprehensive reforms. Reviewing

SOE governance challenges and recent reform experiences country-by-country reveals a
mixed bag of “good, bad and ugly” practices. While some countries, such as Slovenia and
Lithuania, have advanced their SOE governance frameworks in recent years, others are still
at the early stage of SOE reform, such as Bulgaria. The emerging lessons point to a need to
(i) clearly define the high-level ownership policy by specifying and regularly reviewing the
case of state ownership case-by-case, assigning distinct responsibilities to government
entities, and ideally exercising the ownership function in a centralized manner as long as
overall institutional quality remains weak; (ii) give teeth to financial oversight teams to
effectively implement and monitor financial performance targets; and (iii) professionalize
SOE boards by ensuring competitive selection procedures based on skill and experience, as
well as transparent and merit-based remuneration. Overall, SOE reform efforts show that the
devil is in the details, and even strong de jure frameworks are challenged by implementation
failures. Achieving a sustainable and healthy SOE landscape will require perseverance and
stamina over time.
 23

VI. ANNEX

Table A1. Recent SOE Reform Experience in Emerging Europe and Sweden
Ownership policy Financial oversight SOE boards
• No clear rationale nor • Publication of quarterly SOE • Competitive selections
strategy for state ownership statements but no possible but unusual
• Fragmented framework: line systematic risk assessment • Absence of value-
ministries in charge, no • Targets and monitoring with maximizing remuneration
Bulgaria
effective coordination line ministries, falling short • Frequent change and
• SOE framework law failed in of international practices political intervention leading
2013, new draft underway • No clear lines of to inappropriate
accountability for fiscal risk qualification and experience
• Definition of strategic SOEs • Attempts to strengthen • New selection framework to
vs. SOEs for privatization monitoring framework improve qualifications and
• Ownership decentralized • Limited supervision, no to allow for private-sector
Croatia
• Privatizations advanced at medium-term performance candidates
slow pace and partly failed benchmarks • Even external recruitment
firms not fully independent
• Social, strategic and public • Financial performance • Adoption of principles for
beneficial objectives supervised by MoF remuneration structures
• Ownership role transferred • New transparency and
from privatization agency to accountability mechanisms
Czech Republic
MoF while line ministries • Nominations require
keep operational control professional qualifications
• External audit assessments
of board performance
• Objectives: public purpose • MoF coordination unit to • Direct instructions from
and earning revenue monitor financial accounts ministers to SOE directors
• Ownership and regulation and publish a consolidated abolished
Estonia
functions separated but no annual report • Board members equally
formal ownership policy • Internal audit functions only from private and public
document beyond a certain size sectors
• State assets act regulates • Inter-ministerial council • Qualification requirements
management of SOEs established to oversee for supervisory boards
• Objectives: long-term holding company and SOE • Public and independent
Hungary management, value creation management representatives but no
• State holding company explicit policy preference
under Min. of Development • Remuneration limits in
but also other govt. bodies relation to minimum wage
• New SOE law • Coordination institution • Reintroduction of boards of
• Rationales for ownership: monitoring and assessing directors with appropriate
market failure, natural SOE performance based on professional background
Latvia monopoly, strategic sectors rate-of-return criteria • Nomination/appointment
• Initial ambition for central • Municipal SOEs not included process unclear
holding structure watered • Remuneration regulations
down set by the Cabinet
• Ownership guideline: profit- • Performance targets based • Criteria for nomination and
maximization, strategic on return on equity appointment
interest, social goals • Monitoring mechanism in • Database of potential board
• Specified responsibilities of place members
Lithuania
state ownership entities • Dividend policy specified by • At least 1/3 of board
• Separation of ownership and firm statute members to be independent
policy functions • Coordination unit in the • Implementation and
• Failed to set up holding firm State Property Fund autonomy to be improved
 24

• Legislation to separate • Oversight delegated by • Possibility of open

ownership from regulation Prime Minister’s Office to competition and
and to promote value line ministries recruitment consultants but
creation and competition • Dividends determined in direct appointments remain
Poland while keeping state control relation to rate-of-return possible
in strategic cases indicators and liquidity • Appointment subject to
• Privatizations but limited ratios opinion by special council in
shift of control; recent push PM Office
to increase role of SOEs
• Specified public service • MoF unit tasked with • Amended legislation for
obligations oversight but underpowered more transparent and
• Separation of ownership and • Strengthened performance professional selections to
policy functions monitoring at MoF de-politicize boards
Romania
• Ownership set-up remains • Enhanced transparency on • Contracting of selection
fragmented financial information and process to external advisor
related-party transactions in case of large companies
• Implementation challenging
• Separation of ownership and • Overall profitability target: • Improved transparency of
policy functions 8% return-on-equity by 2020 remuneration and bonuses
• Consolidation of ownership • Individual performance • Commitment to assessing
and management by holding indicators for each SOE SOE management
Slovenia
company and bad bank • Dividend policy: annual pay- performance based on
• Long-term strategy for state out of at least 1/3 of net objective criteria
assets and divestment profits
classification
• Detailed ownership policy • Annual aggregate SOE • Nomination: committees
• Value generation and public report (central government) establish needs-based
service assignment • Firm-specific targets and recruitment profiles
• Case for public ownership performance tracking • Collective govt. decision
Sweden
reviewed annually • Same reporting • Guidelines for reasonable,
• Competition authority can transparency as listed firms competitive remuneration
take municipalities to court • Dividend policy linked to • Annual evaluations and self-
optimal capital structure evaluation
 25

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