How to overcome inefficiency of municipal enterprises?

2 October 2020
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There are about 14,000 municipal enterprises[1] in Ukraine (ME). The efficiency of their work as well as of state-owned enterprises (ca. 3.7 thousand) in Ukraine suffers from political interference. In this research, we focus exclusively on municipal enterprises and companies that are located in oblast centres[2] of Ukraine and are subordinated to the city councils (706 enterprises).

The object of this study is unitary municipal companies in oblast centres; the subject is the quality of governance of these MEs by local authorities. We do not aim to provide comprehensive recommendations that would improve the operational performance of each of the existing municipal enterprise. Instead, our goal is to determine how cities should change their approach to managing citizens’ assets.

Earlier, the Centre for Economic Strategy reported that state-owned enterprises were 2.9 percentage points less profitable than private ones[3], and municipal enterprises are even less profitable (median profitability of MEs tends to zero).[4] Notably, the monopoly status has almost no effect on the profitability of MEs.[5]

Municipal enterprises tend to have a negative return on equity and assets. This is especially true for companies that provide services of general economic interest (water, heat and gas, house management, municipal waste management) and public transport. Most companies in these areas are in municipal ownership. They provide housing and utility services at regulated rates and have a high degree of depreciation of fixed assets. The unsatisfactory condition of many MEs is a consequence of the problems related to the functioning of the whole industry.

The average rate of return on assets (ROA) for MEs in oblast centres for the last ten years has been 0.03%; the return on equity (ROE) averages at 0.05%. At the same time, for the suppliers of water, electricity and gas and public transport, these figures are negative and range from -1% to -5% over a three-year horizon.

MEs are financed from public funds. In 2019, 68% of the MEs that we analysed in oblast centres received UAH 14.4 billion of budget funds (excluding MEs in the field of education and healthcare) – approximately 8.2% of budget expenditures of the respective cities. MEs’ taxes to the city budgets do not even compensate the replenishments of the authorized capital, let alone the value of assets and taxes on land and real estate at the disposal of the MEs that the community is not receiving.

The following problems are common for all municipal enterprises:

  • unclear ownership policy;
  • excessive political influence;
  • inefficient asset management.

The key aspect for improving the efficiency of management of municipal property is its liberation from the political influence at the local level.

The absence of real implementation of corporate governance reform at MEs is explained both by the unwillingness to reduce rent-seeking opportunities from MEs’ activities and by the risk of losing operational control over the entity for which the government is politically responsible.

To solve the problems mentioned above, we recommend implementing the following steps:

Depending on their role for the local councils, we recommend different approaches to different MEs.

  • In particular, for MEs that provide services of general economic interest (SGEI, ensure the viability of the city) the aim should be to use public-private partnership (PPP) tools to attract strategic investors, with the prospective privatisation of companies that are not natural monopolies.
  • Natural monopolies and transport MEs should become appealing for investment through corporate governance reform. The main aspects of the reform should be the appointment of supervisory boards with independent members at MEs with more than 500 employees, with more than UAH 200 million asset worth or a net income of more than UAH 100 million. Such MEs should also be subject to an annual independent audit.
  • Various agencies in the form of MEs that perform functions of the local councils may not be of interest for privatisation. They may be reorganised or liquidated, and the respective functions should be transferred to the executive bodies of the councils, other organisational and legal forms or these services could be purchased on the market.
  • As for other municipal enterprises operating in competitive markets (markets, pharmacies, office buildings, hotels among others), privatisation or liquidation of MEs and sale of assets should be carried out.

Local authorities can improve the management of ME by implementing corporate governance reform at the largest of them – with an asset worth of about UAH 118 billion.

It is possible to attract investments and increase the level of competition in the cities by privatising about a quarter of MEs with a book value of about UAH 12 billion.

We also recommend several quick steps to reduce political influence on MEs.

On the state level:

  • Remove restrictions for setting salaries for directors of MEs.
  • Forbid members of city councils from working at MEs.
  • Establish mandatory supervisory boards on natural monopolies and the largest MEs.
  • Strengthen the power of supervisory boards legislatively.
  • Enhance the AMCU’s control over the creation of MEs.

On the local level:

  • Create effective supervisory boards at the largest MEs.
  • Privatise and liquidate municipal enterprises that do not serve the public interest.
  • Conduct an annual independent audit with a public presentation of the results.

 

[1] Ukrainian: Комунальне підприємство

[2] Oblast (Ukrainian: область), refers to one of Ukraine’s 24 primary administrative units (regions)

[3] Are state-owned enterprises less profitable than private ones? https://ces.org.ua/chy-ye-derzhavni-pidpryyemstva-mensh-prybutkovymy-za-pryvatni/

[4] Public Utility Companies: to sell or to keep? https://voxukraine.org/uk/komunalni-pidpriyemstva-prodati-chi-zalishiti/

[5] Ibid.

[6] Triage is a military and medical term of French origin that refers to the process of determining the priority of patients’ treatments based on the severity of their condition. In the context of the reform of state and municipal enterprises, it refers to the sorting of entities into groups, including those to remain publicly owned, objects to be privatised and enterprises to be liquidated.

[7] Ukrainian: Класифікація видів економічної діяльності (КВЕД)

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