## IMF Working Paper: The Nexus Between Public Enterprise Governance, Financial Performance, and Macroeconomic Vulnerabilities: An Application to Moldova

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### I. Background, context, and motivation
- Public enterprises deliver key public goods and services and operate in systemically important sectors such as utilities, infrastructure, and energy.
- Drivers of weak governance:
  - Poorly defined state ownership rationale (objective).
  - Weak legal (regulatory) umbrella.
  - Poor institutional setup and frail checks and balances.
  - Undue state intervention (ad-hoc political interference or vested interests).
  - Unclear/forced policy mandates, complex financial interlinkages with government, and overly complicated lines of authority.
- Consequences of weak governance:
  - Lost growth potential via hampered economy-wide activity.
  - Significant fiscal and quasi-fiscal risks and elevated fiscal costs from continued government support.
  - Corruption, mismanagement of public sector assets, misallocation of resources, and weakened market competitiveness.
- International best practice emphasis: strengthen corporate governance of public enterprises to reduce fiscal risks, support macroeconomic stability, and create a level playing field for private sector development.

### II. Public corporate governance frameworks and links to performance and fiscal risks
- A strong governance framework defines ownership structure, mandate/objective, management structure and Board composition, legal framework and governing regulations, oversight and supervision (financial reporting, financial audits), and transparency/public disclosure.
- Governance frameworks shape:
  - Nature of activity (fiscal/quasi-fiscal; commercial/non-commercial; financial/non-financial).
  - Size and dominance (assets/liabilities; employment; sectoral share & systemic importance; market share).
  - Corporate finances and operational performance (key revenue resources; own resources vs. government loans, guarantees, grants, subsidies).
- Two-way financial risk channels between public corporations and the state:
  - Public corporations often rely on government grants, loans, subsidies, sovereign guarantees and other transfers, creating contingent fiscal liabilities.
  - Fiscal policy actions by the state (e.g., cuts in capital allocations) can worsen firm-level profitability, liquidity, or solvency risks.
  - Poor corporate performance can feed back to the state via lower tax, dividend, and other transfers, potentially precipitating adverse feedback loops and systemic sector risks.
- Elevated and persistent firm-level risks can spill over to sector-wide and macro-fiscal vulnerabilities; risks are costlier when companies are part of chains or have horizontal/vertical financial/operational linkages.

### III. Moldova — corporate vulnerabilities, financial flows, and two-way state linkages (highlights)
- Aggregate figures and concentration:
  - Total debt and arrears outstanding on companies for which data is available amounted to 7.3 percent and 3.3 percent of GDP, respectively, as of end-2018.
  - A sizable amount of debt is concentrated in a handful of large firms in energy, public works, telecommunications, and transportation.
- Examples of two-way financial flows:
  - Termoelectrica (recipient of on-lent loans).
  - State Road Administration (large recipient of state subsidies).
  - Milesti Mici (recipient of state guaranteed debt).
  - Orhei water and sanitation company (recipient of both on-lent loans and subsidies).
- On-lending and net flows:
  - On-lending to public enterprises appears to have added little value to their performance (based on data for Termoelectrica, Moldelectrica, Moldovan Railways, CET-NORD).
  - Net financial flows from government to public enterprises can be large; lack of comprehensive Moldova-wide data prevents full quantification. Example cited: Georgia — net flows added 6 percent of GDP to general government expenditures over 2014–18.
- Governance deficiencies noted:
  - High perceptions of corruption from mismanagement of corporate portfolios.
  - Poor transparency and disclosure.
  - Political interference and forced mandates.
  - Inadequate supervision and opaque lines of authority.
  - Monopolistic/oligopolistic practices and unclear state ownership policy.

### IV. Overview of Moldova’s state-owned enterprise sector: size, scope, coverage, structure, and liabilities
- Sector footprint and employment:
  - Over 900 companies.
  - One-third operate at the central government level; the remainder at sub-national (municipal/local) level.
  - Combined assets valued at about 21 percent of GDP (US$2.5 billion), concentrated in public works, energy, telecom, and transportation.
  - In 90 percent of enterprises operating at the central level, the controlling share of the state was 100 percent; only 44 companies had state participation below 50 percent.
  - Companies at the central level hired almost 40 employees (as of 2018—about 4 percent of total national employment).
  - 15 companies reportedly listed on the stock exchange (as of 2016).
- Concentration and liabilities:
  - The largest five enterprises (State road administration, Termoelectrica, Moldtelecom, Moldova Railways, Red-Nord) operate at the central government level.
  - Their assets (and outstanding liabilities) constituted roughly 6–7 percent of total assets and total liabilities out of the 326 companies for which data is available.
  - Sub-national enterprises are much smaller; only three had liabilities exceeding MDL 100 million, and the largest municipal liability was below MDL 500 million.
- Net worth and equity:
  - Total net worth improved in 2019 driven by growth in equity in most central-government sectors, despite a slight drop as a share of GDP from 2018 to 2019.
  - One-fifth of all companies had negative equity; the majority of these are at the local level.
  - Sustained net losses eroded retained earnings in many companies, shrinking overall equity positions.
- Statutory capital breaches:
  - Five enterprises had the value of net assets lower than their statutory capital—besides another 28 state-owned enterprises all at the central government level.
  - Additionally, 92 other enterprises operating at the sub-national government level breached minimum net asset position requirements relative to statutory capital.

### V. Organization, legal framework, and institutional arrangements (overview and Box 2)
- Legal forms and oversight:
  - Companies incorporated as SOEs, JSCs, and LLCs.
  - State ownership follows a centralized model founded and supervised by the Public Property Agency (PPA), subordinated to the Government.
  - Three key laws: Law 246 (2017) on state owned enterprises and municipal enterprises; Law 1134 (1997) on joint stock companies; Decision 902 (2017) on the organization and functioning of the PPA.
  - Other legislation: Law 149 (2012) on Insolvency, Law 183 (2012) on Competition, Moldova’s Civil Code 1107–XV (2002).
  - JSC sub-national interests represented by the Congress of Local Authorities from Moldova.
- Corporate governance bodies and PPA powers:
  - PPA approves statutes; regulates BoDs; appoints BoAs; appoints and revokes BoD chair and members; establishes monthly remuneration for senior management; members of BoDs appointed for 2 years (eligible for reappointment); decides annual deductions from net profits; can raise/lower share capital and agree to pledge state assets; presents to MoF the auditor’s report on SOEs.
- Board of Directors (SOE) responsibilities and meetings:
  - Approve business plans; set performance indicators and evaluation criteria; approve annual finances including personnel and salary fund; ensure procurement transparency; select the administrator by competition and the audit entity; present management proposals to PPA; convene meetings at least once a quarter; members may sit on boards of up to three other enterprises; decisions by majority vote.
- Administrator (SOE executive) obligations:
  - In charge of daily operations; responsible for integrity and efficient use of assets; alerts BoD of deficiencies; presents quarterly financial reports; annual financial statements and audit reports to PPA and BoD; submits profit distribution proposals; appointed for up to five years.
- Board of Auditors (BoA) features:
  - May include PPA and central authority representatives (at least three people); undertake bi-annual audits and unannounced audits; chairman presents audit report to administrator and BoD; audit includes evaluation relative to preceding year; members may participate in BoD meetings with advisory vote; members qualified in accounting, finance, or economics/jurisprudence; appointed for up to 2 years.
- JSC-specific rules (Law 1134, 1997):
  - BoD members elected for up to 4 years with unlimited renewal; can serve on no more than 5 boards; ordinary board meetings held quarterly.
  - Auditing commission appointed for 2–5 years, accountable to the general meeting; members must be qualified in accounting, finance, or economics; audits can be initiated by commission, shareholders with 10 percent voting shares, or general meeting/BoD; prohibitions on auditing firms being affiliates or concluding other contracts with the enterprise.

### VI. Drivers of profitability and financial performance (Box 3: ROE decomposition and financial indicators)
- DuPont decomposition drivers:
  - ROE = financial leverage × asset efficiency × operating efficiency.
  - Financial leverage (equity multiplier) is high in many public enterprises and a key contributor to ROE.
  - Asset efficiency (asset turnover) is a strong profitability driver in education, mining, construction, medicine, and retail.
  - Operating efficiency (net profit margin) is hampered by loss-making enterprises; six sectors show negative impacts on ROE from operating inefficiencies, especially the water sector.
- Cost recovery and sector performance:
  - Cost recovery ratio hovered only mildly above “1” in 10 sectors; six sectors had poor cost recovery ratios; agriculture and water activities were significantly below 1.
  - More sectors at the local level struggled to achieve cost recovery relative to the central level.
- Labor costs and impact:
  - Of the 326 enterprises:
    - A third pay salaries that exceed 75 percent of their total expenses.
    - 47 enterprises pay salaries comprising over 90 percent of their total expenses.
    - Labor costs absorb almost 15 percent on average of total enterprise revenue.
    - 14 companies have salary costs that exceed their revenue intake.
  - Salary burden by government level:
    - Sub-national level: share of salaries to expenses and to revenue are over 60 percent and over 40 percent, respectively.
    - Central government level: share of salaries to expenses and to revenue are 36 percent and 15 percent, respectively.
- Direct state subsidies:
  - Total subsidies to four central-government public enterprises reached 1.5 percent of GDP, with the overwhelming amount granted to one state company managing roads (the state roads administration).
  - The road administration subsidy exceeded the enterprise’s operating revenue by 20 percent.
  - Two of the other subsidized companies realized losses despite state support.
- Depreciation, amortization, and tax effects:
  - Sizeable depreciation and amortization costs in key sectors dampen profitability; three sectors face depressed profit margins due to significant debt amortization and depreciation.
  - Corporate taxes paid are not identified as inhibiting profitability.
- Liquidity indicators:
  - Net liquid assets broadly adequate overall; telecommunications and water faced liquidity shortfalls.
  - Net liquid assets at sub-national level were negative and much weaker than central level.
  - Current liquidity ratio: all but four sectors had current ratios above “1” on average; some sectors exceeded “2” (transportation, construction, industry, trade).
  - Insufficient liquidity in telecommunications, agriculture, tourism, and water.
  - Receivable turnover averaged 2 months; creditor turnover averaged over 4 months.
  - Forty-six enterprises recorded debtor or creditor turnover exceeding 1,000 days.
- Solvency measures:
  - Debt-to-assets: manageable (less than 0.5) for most sectors, but higher in water services, agro-industry, electricity, and agriculture at the central level; construction and telecommunications at the sub-national level were also higher.
  - Nine companies had debt exceeding their assets; among these, two companies had debts three-to-four times the size of their assets.
  - Debt-to-equity ratios: elevated in many sectors (double digit in agro-industries, water sector, retail, agriculture, construction), worse at the sub-national level.
  - Debt-to-profits (debt-to-EBITDA): indebtedness in five sectors was 20-to-50 times the size of their earnings.
- Financial risk assessment (326 enterprises):
  - Overall assessment: “High” overall level of financial risk at both central and sub-national levels.
  - Profitability risk: “Moderate” overall, but “High” at the sub-national level. 200 enterprises faced “high” or “very high” risks to profitability; three-quarters of those were sub-national.
  - Liquidity risk: “High” overall, but “Very high” at the sub-national level. 102 enterprises suffered “high” or “very high” liquidity risks; two-thirds were sub-national.
  - Solvency risk: “High” overall and at all government levels. 128 enterprises faced “high” or “very high” solvency risks; three-quarters operated at the sub-national level.
  - Combined/multiple risks: 250 companies (over three-quarters of the sample) face combined or multiple financial risks.
  - Core vulnerable group: 44 companies face “high” or “very high” risks across profitability, liquidity, and solvency:
    - Includes 14 companies at the central level (including three energy-sector companies).
    - Sub-national core group includes 30 companies (including one water and sanitation company).
    - The core group’s liabilities make up over 13 percent of the 326 public companies’ liabilities, or 1 percent of GDP.
  - Pre-pandemic trend: Over 15 percent of public enterprises had worsening risk profiles prior to COVID-19. 40 companies reduced overall financial risk in 2019 relative to 2018; 50 companies saw risk rise in 2019.

### VII. Stress testing the 15 enterprises with the largest liabilities (method and results)
- Group characteristics:
  - 15 companies’ liabilities amount to over 6 percent of GDP and 88 percent of the liabilities of all enterprises covered.
  - All had at least one “high” or “very high” risk except the largest company (state road administration, liabilities equivalent to 2.1 percent of GDP).
- Stress test assumptions:
  - Shock 1 (economy-wide growth shock): 1.5 percentage points weaker economic growth recovery from the pandemic in 2021 (relative to the baseline) plus a 10 percent weaker leu.
  - Shock 2 (combined macro + liquidity shock): the growth shock plus a liquidity constraint defined as a 30 percent share of receivables potentially materializing.
- Stress test outcomes:
  - Immediate deterioration in profitability indicators (e.g., Return on Assets declines under shocks).
  - Weaker liquidity positions and debt indicators in the years ahead for this group.
  - Worst-case modeled scenario where the government assumes the liability burden of the 15 companies:
    - Add about 8 percentage points of GDP to public debt in the year of the shock (2021).
    - Add 16 percentage points of GDP to debt over the next 5 years.
    - Impose additional costs from absorbing their economic losses estimated at 0.7 percent of GDP in 2021 and 1.4 percent of GDP cumulatively over the medium term.
  - Estimates exclude other forgone financial flows to the state (e.g., tax and dividend transfers or tariff collections) and are therefore conservative.

### VIII. Case study: State Roads Administration (Box 4) — “Too Big to Fail?”
- Description and scale:
  - Manages state assets worth almost 6 percent of GDP and employs about 170 staff.
  - Receives government subsidies amounting to 1.4 percent of GDP.
  - Financial statements for 2019 reported a net income of MDL 0.8 million, inclusive of the state’s direct subsidies.
- Findings when direct state support removed:
  - The company would have faced a huge loss hampering cash flow and potentially triggering defaults on payments.
  - Possible coping responses: fire asset sales; borrow from the local market at prohibitively high cost; tap reserves (which would have depleted/wiped out 40 percent of its equity).
  - Likely eventual requirement: costly capital injection through state intervention.
- Fiscal risk implications:
  - Stress test exposes severe hidden fiscal costs and risks for both the company and the state.
  - Cross-country experience points to large fiscal costs of resolving failing SOEs.
- Key policy questions flagged:
  - Rationale for continuous state subsidies where market alternatives exist?
  - Opportunity cost of providing large public funds (especially to one company) and financing mechanisms (including external funding with high debt burden).
  - Efficiency and effectiveness of state management over public assets.
  - Market efficiency and level playing field considerations for competitiveness.
  - Adequacy of managerial oversight.
- Recommended analytical and governance actions:
  - Undertake a deeper cost-benefit analysis and examination of the rationale behind such public enterprises.
  - Revisit and strengthen governance frameworks to mitigate fiscal risks and improve operational performance.

### IX. Annex II — How Moldova’s governance framework compares to international best practices and reform implications
- State ownership and liquidation rules:
  - Authorities developing a strategy document on ownership policy; alignment to best practices is under discussion.
  - Reorganization/dissolution governed by Articles 12-15 of Law 246; JSCs by chapters 19 and 20.
  - Liquidation requirements: liquidator commission minimum 3 people appointed by PPA; reorganization/dissolution by government decision; forced dissolution by court in some cases (e.g., no assets or no financial reports for three years).
  - For JSCs, dissolution grounds include non-convening of general meeting for 2 consecutive years; shareholders can apply for dissolution.
  - Assessment alignment summary: “Adopt an explicit ownership policy (define objective of state ownership)” — Partially aligned; “Rationale for establishing and terminating SOEs” — Partially aligned.
- Aggregate reporting, audits, and disclosure:
  - Law mandates disclosure of annual financial reports and audit reports on enterprise webpages and PPA website.
  - Practice concerns: unclear compliance; media reports suggest many companies do not meet disclosure mandates.
  - Audit arrangements:
    - Article 7: BoD selects audit entity; suggestion to delegate to PPA to strengthen oversight.
    - Article 8 (5): exemption from compensation for BoD member acting per written instructions of the founder — flagged for review.
    - Article 10: audit report evaluates performance relative to preceding year—recommendation to assess relative to pre-set targets.
    - Article 11: audited-by-Court-of-Accounts enterprises exempt from mandatory audit—identified as weakening audit objectivity.
  - JSC law gaps: audits obligatory only where state share exceeds 50 percent, not mandatory for all companies.
- Separation of ownership and regulation; unclear areas:
  - Involvement of PPA, MoF, and line ministries blurs ownership vs. regulation.
  - Areas unclear/unknown from legislation: separation of competitive/non-competitive activities; fiscal/regulatory parity with private firms; clear financing decision basis; non-preferential market debt access; calibration of direct state support to public policy costs; separate accounting of commercial/non-commercial activities; executive remuneration criteria; regular board evaluations; application of prudent financial risk management systems.
- Boards, qualifications, conflicts of interest:
  - Minimum qualifications required for Boards of Auditors but not for BoD members in SOE and JSC laws.
  - Conflict of interest provisions present in both laws; JSC law includes personal liability clauses and disclosure requirements for large transactions.
  - Gaps: no minimum qualifications for BoD members and no explicit legal clarity on regular board evaluations or professionalization steps.
- Asset management and operational aspects:
  - Law on SOEs addresses state asset management but leaves operational specifics to other legislation.
  - Law on JSCs references assets but lacks specifics on prudent management of state assets.
  - Both laws do not explicitly clarify application of financial and operational risk management tools/systems.
- Cross-country reform lessons and relevance to Moldova:
  - Common reform priorities: adopt an ownership policy; separate management from supervision; strengthen oversight, audit, reporting, and monitoring; reduce state interference; strengthen Board independence and internal controls; enhance commercial viability via revenue and cost measures; improve asset management; strengthen competition frameworks and encourage private participation.
  - Country reform examples cited (selected): Morocco, Barbados, Uzbekistan, Poland, North Macedonia, Serbia, Belarus, Georgia, South Africa.
  - Relevance: governance strengthening is important given systemic underperformance, elevated financial risks, dominance across government levels and sectors, and magnitude of state-managed assets.
  - Empirical note: governance reforms can enhance SOE performance (example: Lithuania’s corporate governance reform during 2012-13).

*Source: PPA and author’s calculations. (Content extracted from the IMF working paper chapter section.)*

### References .............................................................................................................

### wpiea2022050-print-pdf - References .............................................................................................................

### I. Background, context, and motivation
- Public enterprises play a central role in many economies, delivering key public goods and services and operating in systemically important sectors such as utilities, infrastructure, and energy.
- Weak governance in public enterprises can arise from:
  - Poorly defined state ownership rationale (objective).
  - Weak legal (regulatory) umbrella.
  - Poor institutional setup and frail checks and balances.
  - Undue state intervention (ad-hoc political interference or vested interests).
  - Unclear/forced policy mandates, complex financial interlinkages with government, and overly complicated lines of authority.
- Consequences of weak governance include:
  - Lost growth potential via hampered economy-wide activity.
  - Significant fiscal and quasi-fiscal risks and elevated fiscal costs from continued government support.
  - Corruption, mismanagement of public sector assets, misallocation of resources, and weakened market competitiveness.
- International best practices emphasize strengthening corporate governance of public enterprises to reduce fiscal risks, support macroeconomic stability, and create a level playing field for private sector development.

### II. Public corporate governance frameworks and the nexus with corporate performance, fiscal costs, and macro-vulnerabilities
- A strong governance framework defines:
  - Ownership structure (public / private—including foreign).
  - Mandate; Objective.
  - Management structure; Board composition.
  - Legal framework; Governing regulations.
  - Oversight and supervision (financial reporting, financial audits).
  - Transparency; public disclosure.
- Governance frameworks shape:
  - Nature of activity (fiscal/quasi-fiscal; commercial/non-commercial; financial/non-financial).
  - Size and dominance (assets/liabilities; employment; sectoral share & systemic importance; market share).
  - Corporate finances and operational performance (key revenue resources and funding; own resources vs. other resources such as government loans, guarantees, grants, subsidies).
- Financial interlinkages with the state create two-way channels of risk:
  - Public corporations often rely on government grants, loans, subsidies, sovereign guarantees and other transfers, creating contingent fiscal liabilities.
  - Fiscal policy actions by the state (e.g., cuts in capital allocations) can worsen firm-level profitability, liquidity, or solvency risks.
  - Poor corporate performance can feed back to the state via lower tax, dividend, and other transfers, potentially precipitating adverse feedback loops and systemic sector risks.
- Elevated and persistent firm-level risks can spill over to sector-wide and macro-fiscal vulnerabilities; risks are costlier when companies are part of chains or have horizontal/vertical financial/operational linkages.

### III. Moldova—corporate vulnerabilities, financial flows, and two-way state linkages (Box 1 highlights)
- Key figures and observations:
  - Total debt and arrears outstanding on companies for which data is available amounted to 7.3 percent and 3.3 percent of GDP, respectively, as of end-2018.
  - A sizable amount of debt is concentrated in a handful of large firms in energy, public works, telecommunications, and transportation.
  - Examples of firms exhibiting two-way financial flows with the state include:
    - Termoelectrica (recipient of on-lent loans).
    - State Road Administration (large recipient of state subsidies).
    - Milesti Mici (recipient of state guaranteed debt).
    - Orhei water and sanitation company (recipient of both on-lent loans and subsidies).
  - On-lending to public enterprises appears to have added little value to their performance, based on available data for four key companies in strategic sectors (Termoelectrica, Moldelectrica, Moldovan Railways, CET-NORD).
  - Net financial flows from government to public enterprises can be large; the lack of comprehensive Moldova-wide data prevents full quantification. Example cited for Georgia: net flows added 6 percent of GDP to general government expenditures over 2014–18.
- Governance deficiencies contributing to weak performance:
  - High perceptions of corruption due to mismanagement of corporate portfolios.
  - Poor transparency and disclosure practices.
  - Political interference in company decisions and forced policy mandates.
  - Inadequate supervision and opaque lines of authority.
  - Prevalence of monopolistic/oligopolistic practices that distort markets.
  - Lack of clarity on the state’s overall ownership policy and weak control over corporate adherence to institutional, legal, and operational requirements.

### IV. Overview of Moldova’s state-owned enterprise sector: size, scope, coverage, and structure
- Size and scope:
  - Sector footprint: over 900 companies.
  - One-third operate at the central government level; the remainder at sub-national (municipal/local) level.
  - Combined assets valued at about 21 percent of GDP (US$2.5 billion), concentrated in public works, energy, telecom, and transportation.
  - In 90 percent of enterprises operating at the central level, the controlling share of the state was 100 percent (full control/ownership); only 44 companies had state participation below 50 percent.
  - Companies at the central level hired almost 40 employees (as of 2018—about 4 percent of total national employment).
  - 15 companies reportedly listed on the stock exchange (as of 2016).
- Concentration and liabilities:
  - The largest five enterprises (State road administration, Termoelectrica, Moldtelecom, Moldova Railways, Red-Nord) operate at the central government level.
  - Their assets (and outstanding liabilities) constituted roughly 6–7 percent of total assets and total liabilities out of the 326 companies for which data is available.
  - Sub-national enterprises are much smaller; only three had liabilities exceeding MDL 100 million, and the largest municipal liability was below MDL 500 million.
- Net worth and equity:
  - Total net worth improved in 2019 driven by growth in equity in most central-government sectors, despite a slight drop as a share of GDP from 2018 to 2019.
  - One-fifth of all companies had negative equity; the majority of these are at the local level.
  - Sustained net losses eroded retained earnings in many companies, shrinking overall equity positions.
- Statutory capital breaches:
  - Five enterprises had the value of net assets lower than their statutory capital—besides another 28 state-owned enterprises all at the central government level.
  - Additionally, 92 other enterprises operating at the sub-national government level breached minimum net asset position requirements relative to statutory capital.

### V. Organization, legal framework, and institutional arrangements
- Legal forms and oversight:
  - Companies are incorporated as state-owned enterprises (SOEs), joint-stock companies (JSCs), and limited liability companies (LLCs).
  - State ownership follows a centralized model founded and supervised by the Public Property Agency (PPA), subordinated to the Government.
  - Three key laws governing public enterprises:
    - Law 246 (2017) on state owned enterprises and municipal enterprises.
    - Law 1134 (1997) on joint stock companies.
    - Decision 902 (2017) on the organization and functioning of the PPA.
  - Other relevant legislation includes Law 149 (2012) on Insolvency, Law 183 (2012) on Competition, and Moldova’s Civil Code 1107–XV (2002).
  - Interests of JSCs at sub-national/municipal level are represented by the Congress of Local Authorities from Moldova (a non-governmental organization).
- Corporate governance bodies:
  - Four management bodies jointly govern public enterprises: the founder (PPA), the board of directors (BoD) of each company, the administrator (executive body), and the board of auditors (BoA, or commission of censors).

*IMF Working Paper: The Nexus Between Public Enterprise Governance, Financial Performance, and Macroeconomic Vulnerabilities: An Application to Moldova*

### Box 2. Institutional Set-up of Public Enterprises

### Box 2. Institutional Set-up of Public Enterprises

### Public Property Agency (PPA): mandate and powers
- Approves statutes of enterprises.
- Regulates the Board of Directors (BoD) and appoints the Board of Auditors (BoA).
- Appoints and revokes the chairman and the members of the BoD and members of the BoA.
- Establishes monthly remuneration for senior management.
- Members of BoDs are appointed by the PPA for 2 years, with eligibility for reappointment.
- Decides on the annual deductions from net profits to be transferred to state/local budgets and approves the distribution of annual net profits.
- Authority to raise or lower the share capital of companies, and to agree to pledge state assets as collateral for bank loans.
- Presents to MoF the auditor’s report on SOEs.

### For state-owned enterprises (SOEs): Board of Directors (BoD)
- Approves business plans.
- Sets performance indicators of the enterprise and evaluation criteria.
- Approves annual finances including personnel and salary fund.
- Ensures transparency of procurement related procedures.
- Selects the administrator (by competition) as well as the audit entity.
- Presents to the founder (PPA):
  - proposals to improve management;
  - proposals to modify share capital;
  - proposals to streamline the enterprise’s activity;
  - its annual performance report.
- Meetings:
  - Convened by its president and/or at the request of at least 1/3 of its members.
  - Held not less than once in a quarter.
- Members:
  - May sit on boards of other enterprises (not exceeding three).
  - BoD decisions are adopted by majority vote.

### Administrator (SOE executive)
- In charge of daily operations, executing and implementing decisions by the PPA and BoDs.
- Responsible for the “integrity, efficient use and development of the enterprise's assets” and for alerting the BoD of deficiencies and proposing remedies.
- Presents quarterly financial reports to the BoD and annual financial statements and the audit report to the PPA and BoD.
- Submits for approval to the BoD the proposal on the distribution of annual profits.
- Administrators are appointed for a term of up to five years.

### Board of Auditors (BoA)
- May comprise representatives of the PPA and of the central public administration authorities (at least three people).
- Undertakes bi-annual audits and may undertake unannounced audits.
- The chairman of the BoA presents the audit report to the administrator and to the BoD.
- The audit report includes an evaluation/assessment of activity/performance relative to the preceding year.
- Members of the BoA can participate in the meetings of the BoD and have an advisory vote.
- Members must be qualified in accounting, finance, or economics/jurisprudence.
- Members are appointed for up to 2 years.

### For joint stock companies (JSCs) under Law 1134 (1997)
- Law 1134 (1997) establishes the framework governing registration procedures, aims and activities, statutory capital requirements, and obligations and rights of shareholders (e.g., owning 5, 10, or 25 percent of company shares).
- Members of the BoD:
  - Elected for a term not exceeding 4 years (but with unlimited renewal).
  - Can hold position of a member of a board in no more than 5 different companies at any time.
  - Ordinary board meetings are held quarterly (to examine quarterly performance reports presented by the administration of the enterprise).
- Auditing commission:
  - Appointed for 2–5 years and is accountable to the general meeting of shareholders.
  - Members must have qualification criteria in accounting, finance, or economics.
  - Audits are performed at the commission’s own initiative, at the request of shareholders holding 10 percent of voting shares, or by a decision by the general meeting of shareholders or by the BoD.
  - Audit safeguards include a prohibition on an auditing firm to be an affiliate of the enterprise or its management, as well as to conclude any other contracts apart from the audit with the enterprise.

*Sources: Law No. 246 regarding the state enterprise and the municipal enterprise, and Law No. 1134 on joint stock companies.*

### Box 3. Breakdown of ROE

### Box 3. Breakdown of ROE

### DuPont decomposition and drivers of ROE
- ROE is decomposed into the product of three elements: financial leverage; asset efficiency; and operating efficiency.
- Financial leverage (equity multiplier: assets to equity) is high in many public enterprises and a key contributor to overall ROE. High equity multipliers indicate larger balance sheet gaps between assets and own capital (greater liabilities such as long- and short-term debt).
- Asset efficiency (asset turnover: sales revenue to assets) is a strong driver of profitability in many sectors, notably education, mining, construction, medicine, and retail activities.
- Operating efficiency (net profit margin: net profit to total revenue) is hampered by loss-making enterprises; six sectors show negative impacts on ROE from operating inefficiencies, especially the water sector.

### Cost recovery and sector performance
- The cost recovery ratio (ability to generate revenue to cover operating expenses) hovered only mildly above “1” in 10 sectors, indicating limited ability to maintain assets and operate sustainably without supplementary funding.
- Six sectors had poor cost recovery ratios; agriculture and water activities were significantly below 1.
- More sectors at the local (sub-national) level struggled to achieve cost recovery relative to the central level.

### Labor costs and their impact on profitability
- Of the 326 enterprises:
  - A third pay salaries that exceed 75 percent of their total expenses.
  - 47 enterprises pay salaries comprising over 90 percent of their total expenses.
  - Labor costs absorb almost 15 percent on average of total enterprise revenue.
  - 14 companies have salary costs that exceed their revenue intake.
- Labor costs are particularly high in transportation, electricity and gas, telecommunications, and other services.
- Salary burden by government level:
  - Sub-national level: share of salaries to expenses and to revenue are over 60 percent and over 40 percent, respectively.
  - Central government level: share of salaries to expenses and to revenue are 36 percent and 15 percent, respectively.

### Direct state subsidies and masking of financial performance
- Total subsidies to four central-government public enterprises reached 1.5 percent of GDP, with the overwhelming amount granted to one state company managing roads (the state roads administration).
- The road administration subsidy exceeded the enterprise’s operating revenue by 20 percent, implying the company would have otherwise incurred sizeable losses.
- Two of the other subsidized companies realized losses despite state support, indicating severe operational weaknesses.

### Depreciation, amortization, and tax effects
- Sizeable depreciation and amortization costs in key sectors dampen profitability prospects; three sectors face depressed profit margins due to significant debt amortization and depreciation.
- Corporate taxes paid are not identified as inhibiting profitability.

### Liquidity
- Net liquid assets (liquid assets to liquid liabilities) were broadly adequate overall, but:
  - Two sectors (telecommunications and water) faced liquidity shortfalls.
  - Net liquid assets at the sub-national level were negative and much weaker than at the central government level.
- Current liquidity ratio (current assets to current liabilities):
  - All but four sectors had current ratios above “1” on average.
  - Some sectors exceeded “2” (transportation, construction, industry, trade).
  - Insufficient liquidity in telecommunications, agriculture, tourism, and water.
- Receivables and payables turnover:
  - Debtor turnover averaged 2 months (for enterprises with available data).
  - Creditor turnover averaged over 4 months, indicating slow supplier repayment.
  - Forty-six enterprises recorded debtor or creditor turnover exceeding 1,000 days.

### Solvency
- Solvency is a major weakness across all levels of government due to loss-making companies and negative equity positions.
- Debt-to-assets:
  - Manageable (less than 0.5) for most sectors, but higher in water services, agro-industry, electricity, and agriculture at the central level; construction and telecommunications at the sub-national level were also higher.
  - Nine companies had debt exceeding their assets; among these, two companies had debts three-to-four times the size of their assets.
- Debt-to-equity ratios:
  - Elevated in many sectors (double digit in agro-industries, water sector, retail, agriculture, construction), with worse positions at the sub-national level.
  - Negative equity in many enterprises indicates overleveraging and/or undercapitalization.
- Debt-to-profits (debt-to-EBITDA):
  - Extremely high and particularly worrying for loss-making enterprises.
  - Indebtedness in five sectors was 20-to-50 times the size of their earnings, indicating potential insolvency.

### Financial risk assessment (326 public enterprises)
- Overall assessment: “High” overall level of financial risk at both central and sub-national levels.
- Profitability risk:
  - “Moderate” overall, but “High” at the sub-national level.
  - 200 enterprises faced “high” or “very high” risks to profitability.
  - Three-quarters of those were at the sub-national level.
- Liquidity risk:
  - “High” overall, but “Very high” at the sub-national level.
  - 102 enterprises suffered “high” or “very high” liquidity risks; two-thirds of these were at the sub-national level.
- Solvency risk:
  - “High” overall and at all government levels.
  - 128 enterprises faced “high” or “very high” solvency risks; three-quarters operated at the sub-national level.
- Combined/multiple risks:
  - 250 companies (over three-quarters of the sample) face combined or multiple financial risks.
  - 44 companies form a core vulnerable group confronting “high” or “very high” risks across profitability, liquidity, and solvency.
    - This core group includes 14 companies at the central level (including three energy-sector companies).
    - The sub-national core group includes 30 companies (including one water and sanitation company).
    - The core group’s liabilities make up over 13 percent of the 326 public companies’ liabilities, or 1 percent of GDP.
- Pre-pandemic trend:
  - Over 15 percent of public enterprises had worsening risk profiles prior to COVID-19.
  - 40 companies reduced overall financial risk in 2019 relative to 2018; 50 companies saw risk rise in 2019.

### Stress testing the 15 enterprises with the largest liabilities
- Group characteristics:
  - 15 companies’ liabilities amount to over 6 percent of GDP and 88 percent of the liabilities of all enterprises covered.
  - All had at least one “high” or “very high” risk except the largest company (state road administration, liabilities equivalent to 2.1 percent of GDP).
- Stress test assumptions:
  - Shock 1 (economy-wide growth shock): 1.5 percentage points weaker economic growth recovery from the pandemic in 2021 (relative to the baseline) plus a 10 percent weaker leu.
  - Shock 2 (combined macro + liquidity shock): the growth shock plus a liquidity constraint defined as a 30 percent share of receivables potentially materializing.
- Stress test results and projections:
  - Immediate deterioration in profitability indicators (e.g., Return on Assets declines under shocks).
  - Weaker liquidity positions and debt indicators in the years ahead for this group.
  - A worst-case modeled scenario where the government assumes the liability burden of the 15 companies would:
    - Add about 8 percentage points of GDP to public debt in the year of the shock (2021).
    - Add 16 percentage points of GDP to debt over the next 5 years.
    - Impose additional costs from absorbing their economic losses estimated at 0.7 percent of GDP in 2021 and 1.4 percent of GDP cumulatively over the medium term.
  - Estimates exclude other forgone financial flows to the state (e.g., tax and dividend transfers or tariff collections) and are therefore conservative.

*Source: PPA and author’s calculations. (Content extracted from the IMF working paper chapter section.)*

### Box 4. Too Big to Fail? Pulling the Plug on the Government’s Direct Support Schemes for Public

### Box 4. Too Big to Fail? Pulling the Plug on the Government’s Direct Support Schemes for Public Enterprises: Moldova’s State Roads Administration (Public Works)

### Description and scale
- The State Roads Administration company is Moldova’s largest SOE, managing state assets worth almost 6 percent of GDP and employing about 170 staff.
- It receives government subsidies amounting to 1.4 percent of GDP.
- The company’s financial statements for 2019 reported a net income of MDL 0.8 million, inclusive of the state’s direct subsidies to support its operations.

### Stress-test findings and financial vulnerabilities
- Removing direct state support reveals underlying operational weaknesses that mask seemingly profitable, liquid and solvent positions.
- In the absence of direct support:
  - The company would have faced a huge loss hampering its cash flow operations and impacting its performance, potentially precluding it from meeting existing and future obligations (triggering possible defaults on its current and other payments).
  - The company may have been forced to resort to:
    - fire asset sales;
    - borrow from the local market at a prohibitively high cost; or
    - tap into its reserves (which would have depleted/wiped out 40 percent of the its equity).
  - Ultimately, the company would likely require a costly capital injection through state intervention.

### Fiscal risk implications
- The stress test exposes severe hidden fiscal costs and risks that could materialize for both the company and the state.
- Experience in other countries points to large fiscal costs of resolving failing SOEs.

### Key policy questions for deeper analysis
- Why does the state need to subsidize otherwise failing companies through a continuous lifeline of direct government support (i.e. the rationale for state ownership), especially where alternate market structures exist?
- What is the opportunity cost related to provision of such large public funds (especially to one single company), and what mechanisms underlie its financing (including via external funding channels that may carry a high debt burden for the state)?
- To what extent is the state efficiently and effectively managing a large share of its public assets?
- Are market efficiency and level playing field considerations for competitiveness of public enterprises adequately addressed?
- What is the degree and aptitude of managerial oversight over the company’s operations?

### Recommended analytical and governance actions
- Undertake a deeper cost-benefit analysis and examination of the rationale behind the existence of this and similar public enterprises in Moldova.
- Revisit and strengthen governance frameworks within which this and similar companies operate to mitigate fiscal risks and improve operational performance.

*Source: PPA and author’s calculations based on the IMF’s Fiscal Affairs Department SOE Fiscal Risks and Stress Test tool.*

### Annex II. How Does Moldova's Existing Governance Framework

### Annex II. How Does Moldova's Existing Governance Framework Compare to International Best Practices?

### State ownership: ownership policy and rationale for establishing/terminating SOEs
- Authorities are developing a strategy document to look into ownership policy; it is under discussion and its alignment to best practices is yet to be fully determined (see IMF, March 2021 report).
- Legal framework:
  - Reorganization or dissolution of SOEs: governed by Articles 12-15 of Law 246; JSCs by chapters 19 and 20 for JSCs (voluntarily or forced dissolution) and distribution of company assets at liquidation stage.
  - For SOEs, liquidations require a liquidator (liquidation commission of minimum 3 people appointed by the PPA). The decision to liquidate by the commission is adopted by majority vote. Reorganization or dissolution is by government decision.
  - Based on the PPA’s request, in some instances an enterprise can be subject to forced dissolution by a court decision (e.g. an enterprise has no assets or has not operated or reported financial statements for three years).
  - For JSCs, reorganization includes mergers, split up of enterprises, transforming legal form, and dissolution/liquidation; decision follows the general meeting of shareholders and is grounded in the Charter. Special provisions apply in case of privatization (Article 100 of JSC law).
  - Dissolution possible if “the entity's equity reported in the yearly balance sheet, for three years in a row, is lower than its share capital, in which case the PPA shall take action under the law (cut the share capital, contribute funds to share capital, close down the company, etc.).”
  - Circumstances under which a JSC can be dissolved (Article 53): “The non-convening by the company for 2 consecutive years of the general meeting of shareholders constitutes a ground for dissolution of the company based on the decision of the court...”. Also, “Any shareholder has the right to apply to the court for the dissolution of the company”.
- Alignment status summary in table: “Adopt an explicit ownership policy (define objective of state ownership)” — Partially aligned; “Rationale for establishing and terminating SOEs” — Partially aligned.

### Aggregate reporting, audits, and disclosure (transparency)
- Law on SOEs mandates disclosure of annual financial reports and the audit report to be published both on the enterprises’ webpage and on the website of the PPA (chapter VI, and Article 18).
- Practice concerns:
  - It is unclear if all companies abide by disclosure mandates or if legal requirements on financial and non-financial disclosures are met in practice (according to a media article many companies do not; see IMF, March 2021 report).
- Audit arrangements and legal provisions:
  - Article 7: BoD selects the audit entity; this responsibility could be strengthened by delegating it to the PPA as the oversight body.
  - Article 8 (5): “the member of the board of directors shall be exempt from compensation for damage caused during the performance of his duties if he has acted in accordance with the written instructions of the founder” — flagged for review to mitigate top-down corruption risk.
  - Article 10: Audit report includes an evaluation/assessment of activity/performance relative to the preceding year; recommendation that assessments be conducted relative to pre-set targets/objectives.
  - Article 11: “The annual financial statements of the state / municipal enterprises that have been subject to the audit of the Court of Accounts of the Republic of Moldova shall not be subject to the mandatory audit provided in paragraph (1) for the audited year” — identified as weakening audit objectivity.
- JSC law:
  - Chapters 16 to 18; Article 87: assigns responsibility to the company and its officers for negligence in keeping accounting records and/or preparation and submission of financial and other reports, inclusive of any unauthentic or erroneous data, and publication of untrue information.
  - JSC law does not specify regular intervals for performing audits.
  - Audits are obligatory only in companies where the share of the state exceeds 50 percent of capital, rather than mandatory for all companies regardless of state share.

### Separation of ownership and regulation; financial/governance best-practice principles
- Institutional clarity:
  - The involvement of—and role playing among—the PPA, the MoF, and line ministries blurs lines of responsibility between ownership and regulation, fragmenting the overall institutional arrangement (see IMF, March 2021 report).
- Areas with unclear legal alignment (listed as “Unknown / unclear from relevant legislation”):
  - Separate competitive from non-competitive activity.
  - Fiscal (tax) and regulatory treatment akin to private companies.
  - Clear basis for financing decisions.
  - Access to debt financing from the market is non-preferential.
  - Direct state support calibrated to the cost of fulfilling public policy objectives.
  - Separate accounts of commercial and non-commercial activities.
  - Establish criteria for executive remuneration (mark-to-market, limits, etc).
  - Regular board evaluations.
  - Adopt and apply prudent financial and operational risk management systems (tools) and internal controls.
- Performance targets and dividends:
  - Law on SOEs mandates BoDs to establish performance indicators (Article 8, sub-bullet 7b) and regulates post-operational management of bottom line results (Article 2, sub bullet 4j).
  - Law on JSCs is less clear on setting performance targets and both laws are vague on alignment of expected rates of return with the private sector.
  - Dividend payout:
    - Not mentioned in the Law on SOEs.
    - Law on JSCs outlines dividend payouts in several articles (Articles 15, 25, 35, 48, 49) but does not require alignment with private sector levels.
    - Dividend payout practice: Negotiated.

### Board composition, qualifications, and professionalization
- Qualifications and committees:
  - Law on SOEs sets minimum qualifications for members of Boards of Auditors (audit committee—Article 10), but not for members of companies’ BoDs.
  - Law on JSCs provides minimum qualifications for members of companies’ audit committees (Article 71), but not for members of BoDs.
- Conflict of interest and anti-corruption provisions:
  - Law on SOEs: contains several articles dealing with resolving conflicts of interests (Chapter One, Article 2 sub-bullet 4k; Chapter Five, Articles 16-17).
  - Law on JSCs (Article 74) addresses conflict of interest via personal liability for damage caused by premeditated actions leading to bankruptcy, willfully distorting or concealing information, contravention of regulations (e.g., payment or failure to pay dividends/interest), over-pricing of securities purchased, (mis)abuse of company assets, and willful violation of procedures (e.g., concluding large transactions that exceed 25 percent of company assets in value — Article 83 and Chapters 15 and 18).
  - Safeguards: protection of whistleblowers who vote against violation of procedures; prevalence of joint liability where joint decisions violate charters; no release of liability in delegation of decision-making power.
  - Disclosure requirement: Law mandates financial reports to include information on large transactions and others where there is a conflict of interest (Article 91).
- Gaps:
  - Both SOE and JSC laws do not set minimum qualifications for BoD members, and do not explicitly provide clarity on regular board evaluations or formal professionalization steps for BoDs.

### Asset management and other operational aspects
- Asset management:
  - Law on SOEs provides articles dealing with management of state assets but leaves operational aspects to be established by other undefined legislation (e.g., Chapter Two, Article 3 (3): “possession, use and disposition over the assets of the state / municipal enterprise shall be established by the legislation”; Article 3 (5): “transmission, commercialization, leasing / leasing or loaning and scrapping of the state / municipal enterprise assets shall be carried out in the manner established by the Government”.)
  - Law on JSCs references assets in operational definitions and dividend contexts but lacks specifics on prudent management of state assets.
- Risk management and internal controls:
  - The Law on SOEs and the Law on JSCs do not explicitly provide clarity on application of relevant financial and operational risk management tools or systems in public enterprises.

### Cross-country reform experiences and implications for Moldova
- Common reform priorities observed across countries:
  - Adopt an ownership policy and clarify rationale for state ownership following comprehensive SOE reviews.
  - Separate management from supervision; strengthen oversight, audit functions, financial reporting, and continuous monitoring.
  - Reduce state interference, strengthen independence of company boards, improve internal controls and disclosure requirements.
  - Tackle commercial viability via revenue enhancements and cost-effectiveness measures, including structural expenditure reductions and better monitoring of fiscal risks and liabilities.
  - Improve asset management to put state assets to better productive use and earn higher returns.
  - Strengthen competition frameworks and encourage private sector participation via mergers, divestments, and privatizations.
- Country examples of reform actions (selected highlights):
  - Morocco, Barbados, Uzbekistan, Poland, North Macedonia, Serbia, Belarus, Georgia, South Africa — reforms ranged from restructuring SOEs, creating monitoring agencies, strengthening anti-corruption and competition roles, implementing management-by-objective frameworks, selling assets, to labor and tariff reforms.
- Relevance to Moldova:
  - Strengthening governance is particularly relevant given systemic underperformance of the majority of enterprises, elevated financial risk profiles, dominance across government levels and sectors, and the magnitude of assets invested in and managed by the state.
- Empirical note:
  - Experiences show improvements in corporate governance can enhance SOE performance operationally and institutionally (example: Lithuania’s corporate governance reform during 2012-13).

*Source: Annex II and related sections of the IMF Working Paper "The Nexus Between Public Enterprise Governance, Financial Performance, and Macroeconomic Vulnerabilities: An Application to Moldova" (Working Paper No. WP/22/50).*

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_Source: https://www.imf.org/-/media/files/publications/wp/2022/english/wpiea2022050-print-pdf.pdf_