iDUSTY 5AND FRNAMCE SER1ESVOLUNY`_ E IAF17 Public IndustrialEnterprises July 1986 Determinants of Performance Public Disclosure Authorized Mahmood Ali Ayub and Sven Olaf Hegstad Public Disclosure Authorized Public Disclosure Authorized F,~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~1 Public Disclosure Authorized Public Industrial Enterprises Determinants of Performance - ii - Industry and Finance Series Volume 17 This series is produced by the Industry Department of the World Bank to disseminate ongoing work done by the department and to stimulate further discussions on the issues. The series will include reports on individual sectors in industry, as well as studies on global aspects of world industry, problems of industrial strategy and policy, and issues in industrial finance and financial development. Already published are the following: *Volume 1. Structural Changes in World Industry: A Quantitative Analysis of Recent Developments *Volume 2. Energy Efficiency and Fuel Substitution in the Cement Industry with Emphasis on Developing Countries *Volume 3. Industrial Restructuring: Issues and Experiences in Selected Developed Economies *Volume 4. Energy Efficiency in the Steel Industry with Emphasis on Developing Countries *Volume 5. World Sulphur Survey *Volume 6. Industrialization in Sub-Saharan Africa: Strategies and Performance *Volume 7. Small Enterprise Development: Economic Issues from African Experience *Volume 8. World Refinery Industry: Need for Restructuring *Volume 9. Guidelines for Calculating Financial and Economic Rates of Return for DFC Projects (also in French and Spanish) Volume 10. A Framework for Export Policy and Administration: Lessons from the East Asian Experience (also in Spanish) Volume 11. Fertilizer Producer Pricing in Developing Countries: Issues and Approaches Volume 12. Iron Ore: Global Prospects for the Industry, 1985-95 Volume 13. Tax Policy and Tax Reform in Semi-Industrial Countries Volume 14. Interest Rate Policies in Selected Developing Countries 1970-82 Volume 15. Mobilizing Small-Scale Savings: Approaches, Costs, and Benefits 'Volume16. World Bank Lending to Small Enterprises * Published as World Bank Technical Papers. INDUSTRYAND FINANCE SERIES VOLUME 17 PublicIndustrial Enterprises Determinants of Performance Mahmood Ali Ayub and Sven Olaf Hegstad The World Bank Washington, D.C., U.S.A. Copyright (© 1986 The International Bank for Reconstruction and Development/THE WORLD BANK 1818 H Street, N.W Washington, D.C. 20433, U.S.A. All rights reserved Manufactured in the United States of America First printing July 1986 This is a document published informally by the World Bank. In order that the information contained in it can be presented with the least possible delay, the typescript has not been prepared in accordance with the procedures appropriate to formal printed texts, and the World Bank accepts no responsibility for errors. The publication is supplied at a token charge to defray part of the cost of manufacture and distribution. The World Bank does not accept responsibility for the views expressed herein, which are those of the author(s) and should not be attributed to the World Bank or to its affiliated organizations. The findings, interpretations, and conclusions are the results of research supported by the Bank; they do not necessarily represent official policy of the Bank. The designations employed, the presentation of material, and any maps used in this document are solely for the convenience of the reader and do not imply the expression of any opinion whatsoever on the part of the World Bank or its affiliates conceming the legal status of any country, territory, city, area, or of its authorities, or conceming the delimitation of its boundaries or national affiliation. The most recent World Bank publications are described in the annual spring and fall lists; the continuing research program is described in the annual Abstracts of Current Studies. The latest edition of each is available free of charge from the Publications Sales Unit, Department T, The World Bank, 1818 H Street, NW., Washington, D.C. 20433, U.S.A., or from the European Office of the Bank, 66 avenue d'lina, 75116 Paris, France. Mahmood Ali Ayub is senior industry economist, and Sven Olaf Hegstad is senior industry specialist, in the Industry Department of the World Bank. Libraryof Congress Cataloging-in-PublicationData Ayub, MahmoodAli, 1948- Public Industrial enterprises. (Industry and finance series, ISSN 0256-2235 ; v. 17) Bibliography:p. 1. Government business enterprises. 2. Organizational effectiveness. I. Hegetad, Sven Olaf, 1945- II. Title. III. Series. HD3850.A98 1986 350.009'2 86-15825 ISBN 0-8213-0815-7 -v- ABSTRACT The main purpose of this study is to identify the factors, separate and apart from ownership, which influence the performanceof public industrial enterprises. Based on a review of performanceof state- owned enterprises in 13 countries, the authors isolate three main factors relating to the business and managerial environment that distinguish successful public enterprises from the poorly performing ones. These include: (i) the degree of competition that public enterprisesare exposed to; (ii) the degree of financial autonomy and accountabilityunder which public enterprisesoperate; and (iii) the extent and manner in which managerial autonomy and accountabilityare ensured. It is impossible,and perhaps misleading, to assess statistic- ally the individual importance of each of these factors. What is clear from the analysis is that, where these three factors exist as a package, the performance of public enterprises is significantlybetter than in those cases where most or all of these factors are non-existent. - vii - TABLE OF CONTENTS CHAPTER 1. INTRODUCTION AND SUMMARY..................... 1 Objectives and Scope of This Study .............. 1 Why Study Public Enterprises? ................... 2 Key Determinants of Performance ......... ....... 4 CHAPTER 2. THE ROLE AND PERFORMANCE OF PUBLIC INDUSTRIAL ENTERPRISES .... ***..***........................ 9 The Role of Public Industrial Enterprises ....... 9 Performance of Public Industrial Enterprises .... 12 Variations in Performance ........ ............. 13 Comparing Public and Private Enterprise Performance ................................. 14 Conclusion ... ...... .... .... ...... * .. *..*...........***** 17 CHAPTER 3. A COMPETITIVE ENVIRONMENT AS A DETERMINANT OF P°ERFORMANCE .........................................18 CHAPTER 4. FINANCIAL AUTONOMY AND ACCOUNTABILITY ............... 21 Overall Financial Framework ..................... 22 Greater Market Discipline.o-. ................. 23 Financial Objectives and Dividend Policies .... 23 Clarification of Social Objectives ............ 24 Elimination of Government Subsidies ...... o..... 26 Supportive Financial Policies ................... 27 Appropriate Capital Structure Policies ........ 27 Greater Discipline and Transparency in Financial Relations too .... * ................ 28 Performance Measurement and Incentives Systems ........ ............................ 29 Conclusion .............................................. 30 CHAPTER 5. MANAGERIAL AUTONOMY AND ACCOUNTABILITY .............. 31 Three Roles in Enterprise Management ............ 31 Evolution of Public Enterprise Management Models .................................... 33 Factors Affecting Organizational Designs ........ 39 Conclusion .................................... 41 - viii - TABLE OF CONTENTS (continued) CHAPTER 6. MANAGERIAL SKILLS AND MORALE ........................ 42 Managerial Skills .... * ............... .... 42 The Issue of Morale ............................. 43 CHAPTER 7. COORDINATION WITHIN THE GOVERNMENT .................. 45 Holding Companies ............................... 46 Focal Points ............... ........................ 48 Lessons from Experience ......................... 51 Options for Organizational Design ............... 53 Abolition of Special Public Enterprise Regimes ... **. **. *.*..*... .................. 53 Organizationof Public Enterprisesas Ordinary Stock CorporationUnder Corporate Law ...................... *..... 53 Reduction of Ministerial Control .............. 53 Creation of a Public Enterprise Intersectoral Board and Secretariat (Focal Point) ......... 54 Strengtheningof the Role of the Board of Directors ........ .. ... ... ..... 54 Strengtheningof the Role of the Chief Executive Officer and Top Management ........ 54 Decentralizationof Managerial Autonomy and Accountabilityto the Plant/Subsidiary Level ...*............................. **. 55 ANNEX I ORIGINS OF PUBLIC INDUSTRIAL ENTERPRISES ............ 56 Political and Ideological Considerations ....... 56 Takeover of Ailing Private Companies 58 Unwillingness or Inability of the Private Sector 59 Strategic Industries 59 Internal Growth and Diversification ......... 59 Creating Competition for the Private Sector 60 ANNEX II MANAGEMENTOF PUBLIC ENTERPRISES AND THE BOARD OF DIRECTORS .. ...... 61 The Role of the Board of Directors .......... 61 Policy-Making and Strategic Role 62 The Performance Evaluation Role 62 Appointment and Dismissal of the CEO ..... 62 Why Some Boards of Directors.AreNot Effective . 62 An Approach to Effective Board Operations *..... 63 Conclusion .......... .... 65 - ix - TABLE OF CONTENTS (continued) ANNEX III THE USE OF HOLDING COMPANIES ........................ 67 Purpose . ................. ...... .. ...... *. ... 67 Performance .................... ................ .... 69 Strengths ................ ..................