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New study reveals what happens when public services and market forces collide

Research shows that when a government agency becomes a state-owned company, responsibilities for decision-making get less clear, and risk-taking and salaries can go up
Muistio vuodelta 1988
Memo on management salaries from 1988.

Researchers looked at how transitioning from a government agency to a state-owned company affects management decision-making and strategy. The result they found suggests that governance voids that form after they become a limited liability company allow management more discretion to increase their power, and salaries.

Using novel digital historical research, the researchers analysed over 50,000 pages of internal archive material from Telecom Finland between 1987 and 1998. From 1990 Telecom Finland operated as Posti-Tele, in 1998 it was renamed Sonera and is now part of Telia Corporation.

In the early 1990s, Telecom Finland underwent market-orientated organisational changes, the most significant being the incorporation of Posti and Tele. As the government stepped away from running the agency’s day-to-day operations, a partial governance void formed within the new company. The company's corporate governance system had blind spots, which enabled management to increase their governing power.

'In the private sector, objectives and decision-making is clearer. The top management strives to create value for shareholders. Management’s decision-making is supervised and assisted by the company's Board of Directors,’ said Eero Aalto, PhD candidate at Aalto University.

‘‘In a government agency, the state has strict resource control, but when it transitions into a state-owned company changes this to management-by-results: allowing for more operational freedom and the opportunity to radically change strategy for things like internationalisation. In state-owned companies, senior management gained power and used it to push its own remuneration to similar levels of other private sector executives, among other things,’ PhD candidate Zeerim Cheung from Aalto University said.

The management of a state-owned company tries to make decisions that help the company to succeed in the market. These decisions may conflict with political objectives and the public interest. Excessive rewards, which are frequently debated in public, are part of this development.

In addition to financial incentives, management in state-owned companies also seeks to advance their career and reputation.

‘Because company survival in an open market is dependent on their competitiveness, management have to make market-based decisions, such as changes in cost structure and offerings. However, these actions may conflict with what the political leadership expects of the public operator and service provider,’ Eero Aalto said.

Governance voids can encourage excessive risk-taking

Governance voids and the resulting conflict between management and owner expectations are also apparent in state-owned companies’ risk taking.

‘In the study we found that Tele's move to a more market-oriented direction dramatically increased the risks in international investment in relation to the size of the Finnish business operations. Company management and the owner may have an asymmetric view of the risk-return profile of the investment. In a best-case scenario, taking big risks can lead to success and the management being widely praised. At worst, when the risk materialises, the state and ultimately the taxpayer must come to the company’s rescue. An example of this is the infamous Sonera 3G deal in the early 2000s,’ said Zeerim Cheung.

“Risk-taking” is somewhat of a misnomer in state-backed companies because government resources are always there as a back up. Therefore, incentives should be weighed against actual risk.

‘State-owned companies have changed their structures over time, and in recent decades the focus of their activities has become increasingly market-driven. However, in the public sphere, their business is predominantly seen as providing public services. For example, Posti operates in the middle ground between public services and market forces,’ researcher Pasi Nevalainen from the University of Jyväskylä said.

And while a state-owned company is a business, its existence often stems from social reasons.

‘If political goals conflict with the state-owned company's goals, it can lead to loss of company performance and the situation becoming sensationalised,’ Zeerim Cheung said.

This summer, the study was selected as one of the best at the Academy of Management Conference and as a finalist for the Douglas Nigh award for junior scholars, and as a finalist for the Research Methods award at the Academy of International Business.

Further information:

Zeerim Cheung
PhD candidate
Aalto University, Department of Industrial Engineering and Management
[email protected]
0503372610

Article: State control, internal legitimacy, and the internalization process of a state-owned enterprise

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