Part 2: Governance arrangements for Crown-owned companies

2.1
In this Part, we describe the governance arrangements for Crown-owned companies and our previous reporting on these arrangements.

2.2
The 1980s reforms that created the first Crown-owned companies were designed to make public entities and the public sector as a whole more effective and efficient. That task included transforming some public entities into Crown-owned companies run by Boards appointed from the private sector.

2.3
In the decades since, it has been increasingly recognised that Crown-owned companies, especially natural monopolies or providers of strategic services, might have "public good" purposes.

Governance arrangements in the commercial model

2.4
Among others, a company includes three groups of people:

• Shareholders are the owners of the company. They have the right to hire and dismiss directors, but it is not their job to run the company. If the company is incorporated with limited liability, the shareholders will not usually be liable (beyond the limit of their shareholding) for the company's debts or other obligations for example, unpaid creditors or breaches of the law.
• Directors are legally responsible for running the company. They share ultimate accountability for the company's well-being and, in some instances, may be held personally liable for the company's debts and obligations. Directors collectively form the company's Board. In general, a decision of the Board is a collective decision that all directors are individually accountable for. This might be the case even if a director has disagreed with the decision.
• Managers put the decisions of the Board into practice. They follow the directions set by the Board. The chief executive of the company is the only person directly accountable to the Board. All other employees are accountable to the chief executive.³

2.5
In considering public sector management and accountability arrangements, it is not uncommon to refer to two parts of the public interest: an ownership interest and a purchase interest.

2.6
An ownership interest is an interest in ensuring that the resources of the entity are used efficiently and that the value of the entity is being maintained in line with the owners' objectives.

2.7
A purchase interest is the interest a purchaser has in the goods or services that an entity provides. The purchaser is concerned with specifying and receiving the desired quantity and quality of goods or services.

2.8
The commercial model concerns the ownership interest. It can also achieve purchase interest aims. The rationale for public ownership might be in part financial gain and in part operational performance – such as the pursuit of a public policy objective. Public policy objectives include strategic national interest, the need to have public sector capability in a particular part of the economy, or the need to maintain democratic oversight of particular services.

2.9
As the owner of Crown-owned companies on behalf of the public, the Government manages investments for the benefit of all New Zealanders. Shareholding Ministers must account to Parliament for how Crown-owned companies perform and for their spending and use of other resources. Shareholding Ministers need relevant and timely information about these companies' performance to do that.

2.10
Figure 2 sets out governance arrangements and reporting relationships for Crown-owned companies.

What the commercial model provides

2.11
The commercial model provides two main formal mechanisms to allow shareholding Ministers to hold Crown-owned companies to account and to influence their performance and direction.

2.12
The shareholding Minister appoints Boards, whose members are accountable and responsible for the company's performance and for reporting on that performance to the shareholding Minister.

2.13
The Minister(s) (with varying degrees of regulation, formality, and the involvement of other parties) can comment on, and sometimes direct changes to, the accountability statements of Crown-owned companies. These accountability statements include the statement of corporate intent for SOEs, the statement of corporate intent and statement of core purpose for CRIs, and the statement of intent for other Crown companies (we refer to these statements collectively as "accountability statements").

Figure 2 Formal governance arrangements for Crown-owned companies

Key:
Solid lines: Legislative and Cabinet-mandated governance and reporting relationships.
Dashed lines: Less formal governance and reporting relationships.

2.14
The accountability statements and the annual reports of each Crown-owned company are presented to Parliament and provide information about the company's objectives and performance. These documents are the company's statement to the public about how it has performed and how it intends to manage publicly funded capital investment and, in some instances, revenue.

2.15
The shareholding Minister sends an annual letter of expectation to the chairperson of the Board of each Crown-owned company. The amount of detail about the nature and number of expectations in these letters varies.

Our previous reporting about commercial model governance arrangements

2.16
We first reported on the accountability requirements of the commercial model in a report about SOE accountability statements in 1990.⁴ We raised concern that the accountability statements presented to the House did not provide adequate information about SOEs' objectives, scope of activity, performance measures, and reporting obligations.

2.17
Our assessment was that the accountability statements did not provide enough information to meet the legislative requirements and that the SOEs were not meeting their accountability obligations to Parliament and the wider public.

2.18
In 1990, many SOEs expressed dissatisfaction with, and were reluctant to put significant effort into, preparing their accountability statements. Instead, they put effort into preparing their business plans. However, at the same time, several SOEs indicated that the accountability statement was an important document in setting overall operating targets. The business plan, unlike the accountability statement, is not a public document. We observed that the accountability statement should not require significant extra effort to produce because it is mainly a summary of the business plan.

2.19
In 1998, we noted that the requirement to prepare accountability statements had been applied, with slight modifications, to other entities, such as local authority trading enterprises, port companies, energy companies, and CRIs.⁵

2.20
In 1998, we reported that we had reviewed the accountability statements of selected SOEs, local authority trading enterprises, port companies, and energy companies. In doing so, we found a lack of compliance with the relevant legislative requirements. We concluded that not all of these entities were adequately preparing their accountability statements or adequately reporting against them. We considered that this situation reflected weaknesses in the legislative requirements, and poor entity and shareholder performance in preparing and reporting against the accountability statements.

2.21
We noted that the accountability statements are intended to be an important part of the framework for managing the ownership interest. They are intended to provide a public statement of how the Crown-owned company will manage and protect the owners' interest for the medium term, by requiring the entity to explicitly state its objectives and how it will measure its performance against those objectives.

2.22
The accountability statements provide an opportunity for shareholding Ministers, the public, and other interested parties to see that the Crown-owned company has plans that are consistent with the Minister's expectations as owners. Also, by requiring entities to report in their annual reports against the performance measures and standards set out in the accountability statements, the requirements provide a useful accountability mechanism to judge a Crown-owned company's performance.

2.23
In 1998, we reported that the accountability statements should:

• as a public document, inform the public of the activities and intentions of the Crown-owned company as ultimate owner of these companies, it is critical that the public should be informed about the direction of these companies;
• as part of the accountability process, specify the objectives and related performance measures and standards against which the Crown-owned company can provide a public account in its annual report;
• as a planning document in its draft form, provide a valuable means for the Crown-owned company to get input from the shareholding Ministers into the direction of its business – especially when the company's business is required to take account of non-commercial objectives that the shareholding Ministers might be responsible for; and
• as a relationship management document, play an important role in providing assurance that the Crown-owned company will be directed in line with the expectations of the shareholding Ministers, and that the Board and management know the criteria that the shareholding Ministers will evaluate their performance with.

2.24
In a 2007 performance audit of 54 public entities, we found improved compliance with legislative requirements for performance reporting. These 54 entities covered CRIs and SOEs, as well as energy and port companies.⁶

2.25
However, we were still concerned that only a little more than one-third of the entities linked their performance reporting to their stated objectives. We were also concerned about how useful and understandable the performance reporting was. For example, although SOEs are required by law to be good employers and to exhibit social responsibility, there was no performance information about these objectives. One-third of the sample had at least some performance targets that could not be measured. Several entities used internal deliverables, such as producing business plans, as measures or targets. The accountability statements of 45% of the entities were unlikely to be easily understood.

2.26
In March 2013, we drew attention to the new performance framework for CRIs, including the new statement of core purpose. We also drew attention to new requirements for CRIs to report their performance against that statement.⁷

2.27
Overall, we found that the reported performance in CRIs' annual reports is not strongly linked to the outcomes in their statements of core purpose. CRIs receive core funding to allow them to address the outcomes sought in their accountability statements. Each CRI's Board is responsible for deciding how to invest that core funding. The Board is also accountable for the CRI's success in fulfilling its core purpose, carrying out strategy, and achieving accountability statement outcomes. We noted that this is an essential part of CRIs' accountability to the Government and stakeholders.

3: Westlake, R. (2013), Guidance for the Directors of Banks, International Finance Corporation Global Corporate Governance Forum, available at www.ifc.org.

4: Controller and Auditor-General (1990), Report of the Controller and Auditor-General on Statements of Corporate Intent, pages 5-6.

5: Controller and Auditor-General (1998), Third Report for 1998, pages 101-108.

6: Controller and Auditor-General (2007), Statements of corporate intent: Legislative compliance and performance reporting.

7: Controller and Auditor-General (2013), Crown research institutes: Results of the 2011/12 audits.