PROPOSAL FOR STRENGTHENING THE GOVERNANCE AND …

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69693

Zambia:

PROPOSAL FOR STRENGTHENING THE GOVERNANCE AND PERFORMANCE MONITORING OF ZAMBIA'S STATE OWNED ENTERPRISES

September 2008

Corporate Governance Policy Practice Financial and Private Sector Development Vice Presidency

The World Bank

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Table of Contents

Table of Contents..................................................................................................................... 2

I. Introduction ........................................................................................................................... 1

II. Why reform the ownership and governance of SOEs? ..................................................... 2 The important role of SOEs..................................................................................................... 2 The Poor Performance of some SOEs .................................................................................... 2 Poor SOE Governance Practices............................................................................................ 3 The Benefits of Reform ........................................................................................................... 4

III. Strategy for Reform ............................................................................................................ 6 1. Strengthening the ownership function and creating a strong "Ownership Unit".................... 7

The role of the shareholding Minister (Minister of Finance) .................................................................. 8 The Role of the Ownership Unit............................................................................................................. 9 The role of the board............................................................................................................................ 12 The role of Management...................................................................................................................... 12 The Role of Line Ministries .................................................................................................................. 12

2. Introducing performance monitoring regime for SOE boards and management .................13

The Statement of Intent (SOI).............................................................................................................. 14 Reports and Key Performance Indicators............................................................................................ 15

3. Developing an Ownership Policy........................................................................................15

The development of a code of corporate governance for SOEs ......................................................... 16 Board Composition .............................................................................................................................. 16 Board Appointments ............................................................................................................................ 16 Board Fees .......................................................................................................................................... 18

4. Enacting legislation to implement the new framework ........................................................18

Basic Implementation Plan.....................................................................................................19

ANNEX 1: State Owned Enterprises in Zambia.....................................................................21

ANNEX 2: Sample Charter for the Guidance of Government-Owned Companies ..............23

ANNEX 3: Example of a Statement of Corporate Intent........................................................25

ANNEX 4: Note on Monitoring Government Companies ......................................................26

I. Introduction

In August 2006, the Ministry of Finance and National Planning requested the World Bank to carry out a review of corporate governance practices in the state-owned enterprise / parastatal sector, with the goal of benchmarking the experience in Zambia against international good practice. This report was submitted to the authorities in April 2007, and a workshop was held in November to discuss the report. At this workshop the World Bank was requested to work with the Ministry to draft a strategy for improving the corporate governance of state-owned enterprises in Zambia. A series of meetings was held in Lusaka between the World Bank team and the Ministry staff, resulting in the outline of a strategy and next steps. This document is designed to be a brief and focused summary of the rationale for reform, and a blueprint that lays out an initial strategy.. The goal is for this document to form the basis of further discussions between the MOFNP and the other stakeholders. The proposals are the based on the Bank's 2007 diagnostic report, and on the discussions between members of the Zambian Ministry of Finance and the World Bank team in March 2008. This proposal is organized into the following sections: A review of the arguments for reform of the ownership and governance of SOEs in Zambia The presentation of a strategy for reform:

o Strengthen the ownership function and creating a strong "Ownership Unit" o Introduce performance monitoring regime for SOE boards and management o Develop a code of corporate governance for SOEs o Pass legislation to implement the new framework Basic implementation plan The report was drafted by Mr. Ronald Hamilton1, consultant, and Mr. Alex Berg, of the World Bank's Corporate Governance Policy Practice. This report forms one element of the corporate governance action plan developed by the Global Corporate Governance Forum, and Alison Dillon Kibirige (project manager) provided useful advice, comments and support. The report was then peer-reviewed by World Bank experts. Peer review comments were received from Mazen Bouri, Olivier Fr?mond, William Mako, and John Speakman. The authors wish to express their appreciation of the support, comments and contribution of the Officials from the Ministry of Finance.

1 In addition to Mr. Hamilton's experience with New Zealand's and other jurisdictions' corporatization programs (national and local), the team has drawn upon the Owner's Expectation Manual prepared by the Crown Company Monitoring Advisory Unit (New Zealand) and papers Mr. Hamilton has written for the Commonwealth Association for Corporate Governance.

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II. Why reform the ownership and governance of SOEs?

The past thirty years have seen several changes in how policymakers in Zambia have viewed the development contributions of SOEs. Throughout the 1950s and 60s SOEs were seen as key institutions: useful tools to resolve market failure, and engines of development. But beginning in the 1980s the poor performance of state enterprises led to more and more calls for private-sector-led growth, and privatization. Public enterprise reform became gradually discredited.

Today, SOE reform is again on the agenda in Zambia. This interest is driven by a variety of factors:

A realization of the significant on-going role played by SOEs in the economy, and the importance of

many of these companies for poverty reduction and overall economic growth;

The continued poor performance of many SOEs

The recognition that improvements can be made to SOE governance.

The important role of SOEs

Over time, the role of the State in the Zambian economy has been significantly reduced. As the result of a significant privatization program, 240 entities were privatized or liquidated since 1991. However, as in many countries, the past several years have seen changing political support for privatization in many countries. This was largely the result of several trends, including some very public privatization problems, particularly in the mining sector, and a drop in number of easy-to-privatize companies. The remaining portfolio consists of companies that are either "strategic" (i.e. considered off-limits to the privatization process), or companies that have a variety of issues or problems that make them unattractive to private investors.2 Today, SOEs3 continue to play an important role in the Zambian economy (see Annex 1 for a complete list). SOEs in Zambia operate in a range of industries and include some of the largest formal sector employers. They dominate key sectors, including energy, communications, transportation, and media. SOEs also play a major role in finance and mining. Significant SOEs include Zambia Electricity Supply Corporation (ZESCO), Zambia Telecommunications Corporation (ZAMTEL), Zambia Postal Services Corporation (ZAMPOST), Zambia Railways (ZR), Zambian National Commercial Bank (Zanaco), Development Bank of Zambia (DBZ), Zambia National Broadcasting Corporation (ZNBC), and Zambia Consolidated Copper Mines-Investment Holdings (ZCCM-IH). The government is the sole owner of 26 companies, with 25 held at the national level. The government shares ownership in 14 SOEs (with a minority stake in 7). Under current plans most of these companies will remain under state ownership for the indefinite future.

The Poor Performance of some SOEs

In the past, SOEs in Zambia were unprofitable and a significant drain on the national budget. This situation has improved but SOEs continue to perform poorly. There is little information available about the financial performance (and fiscal drain) of SOEs, but anecdotal evidence continues to raise concerns.4

2 A review of the SOE portfolio with a view to privatization was not carried out for this study or the background assessments of SOE governance. This opinion is based on conversations with various market participants. 3 This report used the term "state-owned enterprise" to refer to a all enterprises in Zambia that engage in commercial activity, and that are owned by the government. It includes companies organized under the Companies Act, and statutory companies organized under their own founding legislation. There is the possibility that the latter may be incorporated as SOEs but there no firm government policy as yet. However, most of the proposals in this report can be applied to the statutory companies as well as the SOEs. For simplicity, this memorandum will refer only to SOEs. 4 This information was current as of September 2007.

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Nitrogen Chemicals, for example, has been consistently loss making and requires ongoing subsidies. Indeni Refinery, jointly owned with Total, has been performing below capacity and shut down entirely for two months in 2005. ZCCM-IH has also performed below expectations.

More important than financial performance is the ability of the key SOEs to deliver essential services to the public. Many of the companies that remain in the portfolio (ZESCO, ZAMTEL, ZAMPOST, ZR) do provide crucial infrastructure services. Improved governance and company performance would also potentially increase access to electricity, telecom, and transport services.5 Achieving the full potential from these companies will of course require reforms to policy-setting and regulatory functions.

Poor SOE Governance Practices

SOE governance in Zambia follows some aspects of international good practice, as reflected in the OECD Guidelines on the Corporate Governance of State-Owned Enterprises (a full review is presented in Corporate Governance of State Owned Enterprise in Zambia):

Zambia is a common law country whose legislation and legal system have been strongly influenced by the United Kingdom, and whose practices have been influenced by South Africa. Zambia has taken important steps to improve corporate governance over the past few years, including the issuance of a Code of Corporate Governance. Awareness of the importance of good corporate governance is relatively high in the private sector, and many institutions important for good governance are in place (including an Institute of Directors).

SOEs have two basic legal forms. There is no overarching law or regulation specifically for SOEs or SOE governance. The "ownership policy" of the government, to the extent that there is one, depends on various laws and polices and practices at the ministerial and SOE level. Most SOEs are legally founded under the Companies Act (CA), and are required to follow the same rules and procedures as other companies. Eleven SOEs are "statutory corporations" and established by an act of parliament. The statutory corporations do not fall under the CA, and are governed by their own founding legislation.6

Zambia has a variation of what is usually called the "dual model" of ownership and control, with ownership functions in most SOEs shared between the Ministry of Finance and National Planning (MFNP), and an "administrative" ministry assigned to the SOE based on sector. The Minister of Finance holds 99 percent of the states shares in SOEs ex officio; the ST the other 1 percent. Most SOEs have the Secretary of the Treasury (ST), the Permanent Secretary (PS), or other Ministry officials on their board. The MFNP also vets other board candidates, together with the administrative ministry. It gathers SOE annual reports and passes them onto parliament. The Ministry monitors SOEs in liquidation and receivership. The Ministry also provides credit to SOEs, by "on-lending" funds borrowed from international financial institutions. Under the PFA, the ST has additional powers and responsibilities regarding statutory corporations. The Investment and Debt Management Department (IDM) of the MFNP carries out or supports many of the Ministry's governance and finance functions related to SOEs. A variety of control bodies act as watchdogs or regulators.7

These arrangements follow some aspects of international good practice.

The government has worked to separate the ownership and regulatory functions for SOEs.

Most SOEs are corporatized and fall under the provisions of the CA. Those that are not generally

5

6 The Public Finance Act 2004 (PFA) includes a chapter on statutory corporations. It empowers the Secretary of the Treasury (ST) to receive information, set conditions for providing grants, oversee valuation of assets, ensure efficient management, protect the interest of the government during privatization, and oversee the winding up of statutory corporations. It requires statutory corporations to have audit committees. 7 These include the Auditor General, the Anti-Corruption Commission, Patents and Companies Registration Office, the Bank of Zambia (over financial institutions), the Zambian Institute of Chartered Accountants (over auditors), and the Securities and Exchange Commission (over listed SOEs).

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follow similar governance procedures. Recent reform has reduced exceptions for SOEs in other laws.

The State is not generally involved in the day-to-day management of SOEs.

Many SOE boards include qualified, independent members, including the chairman.

SOE boards sometimes play a meaningful role in oversight and developing strategy.

However, the government and the companies face a number of challenges:

The participants in the current system have confusing roles and accountabilities. At the government level, there is no focus on SOE ownership and governance. Units that oversee SOEs are focused on policy and regulation, not on being an effective shareholder or ensuring the state derives the most benefit from its assets.

Information on SOEs available to the owners is relatively limited. Company monitoring is carried out through board attendance, and little information is centrally available. While some SOEs regularly produce annual reports available to the public, much of the state-owned sector is opaque, even to its nominal owners. SOEs generally do not have explicit objectives, targets, or performance monitoring for their boards or management. Government owners cannot say that they are getting the best return for their investment. Opacity is probably concealing poor performance in some companies. More generally, the government does not know how the overall portfolio is performing, and citizens cannot make judgments about the performance of the companies or of the owners.

In spite of recent reforms, significant political interference remains in the system. The CEO of many important companies is still effectively appointed by the President, reducing the accountability of management to the board. The presence of government officials on boards can weaken their ability to act effectively. While boards have improved in the past few years, some companies suffer from specific problems, such as the absence of a board or CEO for extended periods.

The Benefits of Reform

The drive to reform the corporate governance of SOEs should be driven by the desire of the shareholding Minister to be able to act as an effective owner of some of the most important institutions in Zambia. The interlocking goals of reform in Zambia are to:

Improve company performance by setting explicit goals, injecting private sector business disciplines into the companies and empowering their owners to monitor performance and take action when necessary. Confused accountabilities and underperforming boards obfuscate such outcomes.

Reduce political interference in companies by insulating companies with more professional owners.

Reduce risks and costs to the government budget. Under-performing SOEs place the Government at risk ? reputational, political and fiscal. Many SOEs have been expensive drains on national budgets. Governance reform should help impose hard budget constraints on companies, increase their autonomy, and eventually allow companies to borrow directly from the private sector rather than from government. SOEs which do not maximize their revenue potential (and, consequentially, dividends) or which depend on government funding to survive are an expense against government revenues. The Government's revenues can be better applied to the delivery of basic social needs ? health, education and welfare.

Increase trust between management, boards, owners, Parliaments, and citizens, by increasing transparency and building a business culture in the companies and the ownership entities.

Reduce risks to government officials. Another albeit lesser benefit in advancing the reform process is for officials. Being directly responsible for poor performing commercial assets may have personal remuneration advantages but can be damaging to an official's career.

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 Do all this in a cost-effective manner. Governance reform should be seen as a cost effective approach that is distinct from past forms of public enterprise reform that required large amounts of investments and "restructuring' of the company.

SOE governance reform is a continuation of the corporatization and other reform efforts that have already been undertaken. Zambia has already embraced the private sector model of companies led by boards of directors. In many cases, the regulatory function of the state has been separated from the ownership function. The strategy outlined in this paper will take corporatization to the next level. An ownership strategy and regime that sets SOE targets, monitors the SOEs in their striving to achieve these targets and makes the tough decision in regard to those which fall short, will provide fiscal and social benefits to the Zambian taxpayer and consumer. Removing government involvement in operational decision-making will allow Ministers to devote more of their time to their main roles. It will also place the responsibility for running the SOEs squarely on persons appointed for their commercial competence and relevant industry skills. Last but not least, improvements to SOE governance will have important demonstration effects for other companies in Zambia. Companies within Zambia look to the corporate governance standards set by large SOEs. If corporate governance is improved in these companies then it will be improved for the country as a whole. In short, SOE governance reform that strengthens the powers of boards to act commercially and in the uncluttered interests of the companies, while better defining the government ownership structures, will have fiscal, political and social benefits for the Government and the Zambian consumers.

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III. Strategy for Reform

Corporate governance concerns the structures and processes for the direction and control of companies, including the relationships among the management, board of directors, owners, and other stakeholders. Good corporate governance contributes to sustainable economic development by enhancing the company performance and increasing access to external finance. SOEs face significant corporate governance challenges, driven by a wide separation of ownership (by government on behalf of the citizens of a country) from control (by the directors and managers that run the company). Many government bodies can influence SOEs (one or more ministries, cabinet, an ownership entity specifically created to oversee SOEs, the Parliament), but each may potentially use the companies to achieve short-term political goals, and undermining their efficiency.

Current thinking on SOE corporate governance reform incorporates lessons on how to improve corporate governance from the private sector, and the international consensus that has developed regarding corporate governance reform. It also builds on reforms to SOE administration and management in the 1970s and 1980s, and later efforts to prepare SOEs for privatization. Better corporate governance should result in companies operating on a more commercial basis, with improved profitability, increased transparency, more accountable boards and management, improved internal controls, and sustainable employment. Overall, corporate governance provides a coherent and tested framework for addressing key weaknesses of SOEs. The objective of this paper is to develop an ownership strategy that leads to the adoption of sound governance practices, robust performance monitoring strategies and the formation of an agency to assist the government shareholder to achieve positive outcomes from its remaining commercial ventures.

The strategy focuses on the need for:

Strong, sound accountability structures

Defined roles for Ministers, boards and officials.

A robust performance monitoring regime for boards and SOEs

Strong monitoring processes

Focused, skilled, and relevant boards

Robust board appointment processes

Codes and charter to guide boards in their corporate governance.

The formation of a dedicated, business-focused Ownership Unit.

Capacity building in the SOEs (board and senior management) and in the Ownership Unit.

Appropriate board fees.

A new legal framework that enshrines the powers of the shareholders in regard to, inter alia, appointing and removing directors, setting each SOE's strategic direction, and the information requirements for monitoring SOE performance.

Good corporate governance is much more than adopting sound boardroom practices ? although these are important. It also includes sound board appointments, improved lines of accountabilities and delegations and the use of modern measures of investment performance.

For SOEs, it has additional implications for Ministers and officials. In some countries, this model places certain institutional and behavioral expectations on people who have previously been accustomed to direct involvement in the operational aspects of the business. In the absence of appropriate disciplines there is frequently confusion between an official's/agency's regulatory and purchase roles and their ownership roles. Line Ministers and officials are often the most significant perpetrators of this confusion.

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