## _howtonote1605

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### Introduction and fiscal risk magnitude
- Episodes in which contingent liabilities materialized over 1990–2014:
  - Maximum cost of episodes involving public corporations was 15.1 percent of GDP.
  - Average cost was 3 percent of GDP.
- Public corporations were the second-largest category of fiscal risk after the financial sector.
- The number of episodes involving public corporations and their average fiscal cost doubled between the 1990s and the 2000s.
- Market value of public corporations accounts for over 11 percent of the market capitalization of listed companies worldwide; country examples: Brazil, 18 percent; India, 22 percent; China, 44 percent.
- Share of public corporations among Fortune Global 500 companies grew from 9 percent in 2005 to 23 percent in 2014, driven primarily by Chinese public corporations.
- Even where the public corporation sector is smaller (for example, sub-Saharan Africa), substantial fiscal risks may arise.

### Why financial supervision and oversight matter
- Public corporations often account for a significant share of economic activity and, in many countries, the bulk of public sector assets and liabilities.
- Inefficient or poorly managed public corporations can:
  - Produce at high costs, overcharge customers, and under-provide essential services such as power, water, and telecommunications.
  - Impose substantial economic and fiscal costs.
- Loss-making public corporations can create persistent fiscal drag through government guarantees, subsidies, loans, or capital injections; liabilities are often assumed by government even if not explicitly guaranteed.
- Public corporations are often used to pursue political objectives and engage in quasi-fiscal activities (for example, public service obligations below cost-recovery, price regulations implying cross-subsidies, ancillary operations outside the core mandate, or excessive employment) without budget compensation.
- Public corporations can be mechanisms to circumvent fiscal controls or channels for financial corruption, conducting fiscal operations off-budget or channeling political favors and patronage.

### Changing character of public corporations
- Many traditional natural monopolies have disappeared due to technological change (examples: electricity distribution, telecommunications).
- Many large public corporations now operate in oil, gas, copper, and other mineral sectors; some are legal monopolies rather than natural monopolies.

### Essential building blocks of an effective financial oversight framework
- Comprehensive definitions and classifications conforming with international standards.
- Mechanism for periodic government review of the status and viability of public corporations to ensure commercial and economic viability.
- Policy framework determining ownership, legal and institutional status.
- Robust system of financial controls and approvals.
- Arrangements for measuring and monitoring financial performance and quasi-fiscal activities.
- Measures to enhance government capacity for overseeing public corporations, with guidance on sequencing reforms.

### Definition and classification guidance
- Public corporations take diverse legal and organizational forms and include many names (state-owned enterprises, parastatals, government business enterprises, crown corporations, nonprofit organizations).
- Clear, transparent definitions and classifications should align with international standards.
- GFSM 2014 definition: corporations are “entities that are capable of generating a profit or other financial gain for their owners, are recognized by law as separate legal entities from their owners, and are set up for purposes of engaging in market production” (paragraph 2.31).
- A corporation is classified as a public corporation if it is controlled by the government (paragraph 2.107).
- Public corporations can be classified as nonfinancial or financial corporations depending on primary activity (paragraphs 2.113–2.116).
- Control may be assessed using eight indicators proposed in Box 2.2 of GFSM 2014.
- Market test for classifying a unit as a market producer: value of sales (excluding taxes and subsidies not directly linked to output) should average at least half of production costs (compensation of employees, use of goods and services, consumption of fixed capital, and a return on capital) over a period of at least three years.
- Classification challenges arise where prices are difficult to determine (for example, utilities, nuclear energy production, weapons production).
- Special purpose vehicles (SPVs) used for fiscal or quasi-fiscal activities are subject to the same classification criteria; GFSM 2014 paragraphs 2.136–2.138 provide further guidance.

### Reviewing the status and optimal treatment of public corporations
- Governments should assess alternatives before establishing new public corporations (for example, tax and regulatory frameworks or targeted subsidies may achieve policy goals more efficiently).
- Legislation should require full assessment of costs and benefits before creating a new public corporation.
- Governments should periodically review the status and viability of existing public corporations using a framework that considers:
  - Economic performance (for example, actual or potential profitability and market conditions).
  - Strategic or national security relevance.
  - Political orientation regarding the role of market and state ownership.
  - Social context (for example, income distribution impacts of corporatization or privatization and potential short-term employment losses).
- Even when privatization is not viable, partial listing can expose public corporations to market discipline.
- Stylized decision matrix for review outcomes (Policy or Strategic Relevance vs. Commercial Viability):
  - Low relevance, Low viability: Close down.
  - Low relevance, High viability: Privatize.
  - High relevance, Low viability: Convert into a noncommercial government entity.
  - High relevance, High viability: Retain as a public corporation, monitor closely operations and finances.

### Policy, legal, and institutional frameworks: ownership policy
- Governments should develop and publish a comprehensive ownership policy that:
  - States the state’s policy and financial objectives as shareholder for each company or group of companies (which may mix financial, economic, and social objectives).
  - Explains how the government will exercise ownership rights and the main functions carried out as owner.
  - Specifies the objectives and mandate of each public corporation.
  - Describes the organization of the ownership function and the relationship between financial and nonfinancial oversight.
  - Sets principles and policies such as ensuring a level playing field between public corporations and the private sector.
  - Refers to constitution, laws, regulations, codes, and other documents defining ownership rights.
- On financial oversight, the ownership policy should explicitly address:
  - Planning or budgeting requirements.
  - Reporting requirements.
  - Pricing and tariffs.
  - Dividend policy.
  - Financial assistance from the government, including guarantees.
  - Contractual commitments.
- The ownership policy should ensure these elements are included in the government’s financial monitoring and reporting framework.

### Legal framework and oversight arrangements
- Many countries use a framework law on public corporations (self-standing or as part of public finance law) to clarify roles of government and corporations in financial management.
- The legal framework should define whether public corporations are incorporated under a special legal form or under commercial law, and clarify whether commercial law applies in its entirety or with special provisions for public corporations.
- The legal framework should define the financial oversight function and specify whether it is carried out by the Ministry of Finance, a sector ministry in consultation with the Ministry of Finance, or an independent agency.
- Laws should state the government's powers to receive, comment on, and approve:
  - financial plans,
  - financial targets,
  - annual financial statements of public corporations;
  - set financial performance targets;
  - respond to requests by public corporations for compensation of public sector obligations, capital injections, borrowing, or government guarantees.
- Public reporting requirements: require full annual financial statements containing a statement of operations, a cash flow statement, and a balance sheet, prepared in accordance with national or international accounting standards.
- Require the government to publish an annual report on whether public corporations are achieving their policy and financial objectives and complying with obligations to prepare regular and timely financial reports.
- Require annual accounts to be audited by a reputable, independent auditing body recognized internationally, and to publish the audit report.
- Include sanctions in the legal framework to ensure enforceability, including measures such as:
  - additional reporting requirements (for example, monthly rather than quarterly reports),
  - imposition of additional controls (for example, over staff recruitment, pay, or major investment decisions),
  - administrative measures (for example, steps to dismiss or suspend members of the management board),
  - government imposition of direct control over day-to-day operations in extreme cases,
  - sanctions applied to members of the management board or government officials charged with oversight.

### Roles, governance, and the arm’s-length principle
- Clarify the role of the sector ministry and the public corporation’s management board in law.
- Assign the sector ministry responsibility for policy issues related to the sector, but the sector ministry should not be involved in the strategic planning of individual public corporations, especially where private sector competitors exist under the same policy framework.
- Adopt the “arm’s length” principle distinguishing ownership functions from management; management boards should operate without interference or pressure from line ministries.
- Where board independence cannot be guaranteed, the Ministry of Finance may need to provide stronger oversight of financial performance.
- Require all public corporations to establish an audit committee and a well-functioning internal audit regime.
- Provide guidance for boards on assuring management autonomy, developing and sustaining management skills, selecting and remunerating board members, and avoiding pressures to exempt certain public corporations from good governance principles.

### Institutional frameworks and ownership/oversight models
- Ownership and financial oversight functions may overlap; options include:
  - Centralized model: locate both ownership and financial oversight in a central agency (Ministry of Finance, Treasury, or Presidency). Examples cited: Brazil and Sweden.
  - Holding company/autonomous agency model: shares held by an autonomous agency, holding company, or investment company (examples: Austria (Österreichische Industrieholding AG), China (SASAC), Finland (Solidium Oy), France (APE), Kenya (Government Investment Corporation, GIC), Malaysia (Khazanah), Peru (FONAFE), Singapore (Temasek), Spain (SEPI)). Advantages: professional asset managers, insulation from political interference. Prerequisites: harmonized legal frameworks and a published comprehensive corporate governance framework.
  - Decentralized or mixed models: line ministries hold shares under a framework established and supervised by the Ministry of Finance or another central agency. Examples: Mexico, South Africa, Thailand.
- Monitoring units are frequently located in the Ministry of Finance, Prime Minister’s Office, or Ministry of Planning; they need expertise in financial analysis, corporate governance, corporate finance, and law, and often publish annual monitoring reports on sector performance and fiscal risks.
- Examples of institutional practices and controls include: requirements for strategic plans, financial plans, risk management plans; Shareholder Compacts; multiyear budgets submitted in advance; limits on borrowing, guarantees, and contingent liabilities; and advisory committees on contingent liabilities.

### Central financial control and approvals (elements)
- Government should state clear, operational financial and policy objectives for each public corporation (e.g., dividend, profit, return on equity).
- Financial plans: government ownership gives veto power on major corporate policy and financial plan decisions; assessments should ensure:
  - financial targets, prices and tariffs, capital levels, and dividend targets are appropriate;
  - balance between commercial objectives and public service obligations is adequate;
  - investment plans reflect government priorities;
  - financial and operational risks are actively managed;
  - public corporations do not create subsidiaries to transfer control of public assets to private interests.
- Borrowing: governments may establish ceilings on borrowing for public corporations to limit contingent liabilities.
- Guarantees: governments may prohibit or strictly control issuance of guarantees by public corporations to third parties.
- Sale/pledging of assets: governments may restrict sale or use as collateral of nonfinancial assets provided by the government, and may restrict pledging or securitization of future revenue streams.
- Mergers/acquisitions: governments typically require approval for mergers or acquisitions that affect operations, finances, or competition.
- Corporate governance: the government selects board members, but CEO and key personnel selection should be performed by the board without government interference.

### Monitoring financial performance, reporting standards, and consolidation
- Encourage adoption of International Financial Reporting Standards (IFRS) and International Standards on Auditing to enhance reliability, comparability, and quality of financial data.
- In less-advanced economies, require IFRS and international audit standards only for the largest public corporations or those with substantial exposure to fiscal risk if costs are prohibitive.
- Under IFRS, government support to public corporations should reflect the economic nature of transactions rather than legal form; this is consistent with IPSAS and GFSM 2014 and aids consolidation.
- Pay particular attention to financial transactions such as capital injections, loans, and debt assumptions to determine whether they are purchases of financial assets or capital transfers, following GFSM 2014 decision trees.
- Public corporation monitoring reports should typically include five main sections:
  - An overview of the sector and highlights of public corporation activities during the year, including material policy decisions or transactions;
  - A full list of companies owned by the government, broken down by industry, size, and type of ownership (for example, majority- or minority-owned companies, strategic companies, or candidates for privatization);
  - An overview of how the government has exercised its ownership policy, including appointment of board members, dividend policy, organizational and governance arrangements, and announcement of financial and public policy targets;
  - Financial performance analysis and risk disclosure consistent with best practice in monitoring reports.

### Key components of an annual report on public corporations
- Events in brief.
- Ownership issues, including ownership model, company cases, nominations to company boards, financial targets, sustainability business models, public policy targets, remuneration and terms of employment, company portfolio and valuation, and effect of company divestments and dividends in government finances.
- Individual company data, including description of mandate and operations, summary of activities in 2014, targets, performance review, summary financial information (abridged income statement and balance sheet, key ratios), and panel charts.
- General information, including state’s ownership policy, accounting principles and definitions, legislation, summary of changes in executive boards, assessment of reporting practices, guidelines for reporting, guidelines for terms of employments for senior executives, and management responsibility for companies.
- Special topics may include ownership policy, remuneration policy, valuation of companies, organization and management issues, and impact of public corporations on government finances and the economy.

### Indicators of public corporations’ financial health and risk
- Financial performance indicators:
  - Profit margin (earnings/revenue).
  - Return on equity (earnings/equity).
  - Return on assets (earnings/assets).
- Financial risk indicators:
  - Liquidity (current assets/current liabilities).
  - Leverage (assets/equity).
  - Solvency (liabilities/revenue).
  - Probability of default (e.g., Altman Z-Score, Ohlson O-Score, Black-Scholes-Merton default probabilities).
- Transactions with the government:
  - Dividends, taxes, grants, compensation for quasi-fiscal activities, other subsidies.
  - Changes in government equity holdings in the public corporation.
  - Guarantees given or called.
- Foreign linkages:
  - Relative weight of debt to foreign creditors.
  - Currency composition of debt.
  - Hedging of currency risk.
- Recommendation: comprehensive information on transactions with government should be included in the government’s annual financial statements and other fiscal reports.

### Examples of specific indicators monitored (Australia)
- Financial performance examples (formulas preserved):
  - Profit before tax = Revenue – Total expenses (excluding income tax).
  - Operating profit margin = Earnings before interest and tax from operation / Operating revenue.
  - Cost Recovery = (Operating revenue / Operating expenses) x 100.
  - Return on operating assets = (Earnings before interest and tax / Average operating assets) x 100.
  - Return on total equity = (Operating profit after tax / Average total equity) x 100.
  - Operating cash flow to sales = (Operating cash flow / Operating revenue) x 100.
- Financial risk examples (formulas preserved):
  - Debt to equity = (Debt / Equity based on operating assets and liabilities) x 100.
  - Debt to operating assets = (Debt / Average operating assets) x 100.
  - Total liabilities to equity = (Total liabilities / Total equity) x 100.
  - Interest Coverage = Earnings before interest and tax / Gross interest expense.
  - Current ratio = (Current operating assets / Current operating liabilities) x 100.
  - Leverage ratio = (Total operating assets / Equity based on operating assets and liabilities) x 100.
  - Short term debt coverage = (Operating cash flow / Current liabilities) x 100.
- Transactions with government examples (formulas preserved):
  - Dividend to equity = (Dividend paid or provided for / Average equity based on operating assets and liabilities) x 100.
  - Divident payout ratio = (Dividends paid or provided for / Operating profit after tax) x 100.
  - Income tax expense = the value of income tax or income tax-equivalent expenses payable to government.
  - Grants revenue ratio = (Grants to cover deficits in operations / Revenue) x 100.
  - Public service obligations = sum of payments by governments to public corporations for specific noncommercial activities they direct public corporations to undertake.

### Segmentation, oversight intensity, and special challenges
- Segmentation methods:
  - Composite indicator (linear combination of business ratios, weighted by coefficients).
  - Simple count of the number of indicators exceeding established (safe) thresholds.
  - Designation as high-risk if a particular indicator reaches an unacceptable fiscal risk level.
- Oversight implications:
  - Higher-risk enterprises should face stricter oversight (more frequent reporting, stricter targets, tighter controls) and be required to implement risk-mitigating measures.
  - Larger public corporations should be subject to stricter oversight regimes even if measured risk is low; size indicators include level of sales, assets or liabilities, or income tax paid.
- Special challenges arise when a public corporation has a complex corporate structure with many subsidiaries or shell corporations and unreliable or nontransparent parent-company information.

### Recommendations to mitigate fiscal risks from public corporations
- Direct controls to limit fiscal exposure:
  - Reduce size of public corporation sector.
  - Impose caps on liabilities that public corporations can accumulate.
- Regulations and charges to reduce risky activities:
  - Hold public corporation boards accountable for financial performance.
- Transfer or sharing of risks:
  - Introduce explicit no-bailout clauses.
- Provisioning for unmitigated risks:
  - Expense expected subsidies (e.g., compensation for quasi-fiscal activities) in the budget.
  - Set aside financial assets to meet potential restructuring costs of public corporations.
- Fiscal risk reporting:
  - Include a summary of fiscal risks from the public corporation sector in the wider fiscal risk statement.

### Quasi-fiscal activities (QFAs): definitions, measurement, and treatment
- Definition: operations carried out by public corporations to further a public policy objective that worsen their financial position relative to a strictly commercial profit-maximizing level.
- Common forms:
  - Public service obligations: charging less than commercial cost prices for goods and services (implicit subsidy to consumers).
  - Noncore functions: obligations to provide goods/services or undertake capital investments unrelated to core functions.
  - Subsidized purchases: paying above commercial prices to particular suppliers.
  - “Super-dividends”: withdrawal of own funds in excess of distributable income of the accounting year, normally from sales of assets or accumulated reserves.
  - Pricing for short-term budget revenue purposes: setting higher prices to increase short-term profits and dividends at the expense of medium-term market position.
- Recommended treatment:
  - Cost of public service obligations and subsidized purchases should be fully funded through the budget and disclosed separately in the financial statements of both the government and the public corporation.
  - Disclosure should include type of activity, rationale for delivery via the public corporation, the opportunity cost, and the compensation mechanism if applicable.
  - Disclosure increases transparency, holds government accountable, prevents hiding fiscal activities within public corporations, and enables comparisons with private-sector competitors.

### Methods and illustrative numerical examples for estimating QFA costs
- Methods:
  - For targeted reduced-tariff regimes or above-market-price payments: estimate as the difference between sales of output at observable market prices and the prices specified by the government for the target groups.
  - For obligations where market prices are not observable (e.g., low-density transport services): estimate using indirect methods, such as the actual cost of providing the service.
- Box 4 illustrative examples (numerical):
  - Example A: Reduced rail tariff for students
    - Government requests transport at a quarter of the regular fare ($1 per trip).
    - In 2015, the Railway Corporation sold 23,000 student fare tickets.
    - Cost of 2015 quasi-fiscal activity = $17,250 = 23,000 × $0.75 (assumes a price elasticity equal to zero)
  - Example B: Subsidized bus route to a rural community
    - Loss-making route details in 2015: operating costs, $56 million; interest paid, $4 million; ticket sales, $20 million.
    - The average surplus obtained on other routes was 10 percent of ticket sales.
    - Estimated economic cost of 2015 quasi-fiscal activity (millions) = $40 = $56 + $4 – $20
    - Compensation paid in 2015 (millions) = $46 = ($56 + $4) × 1.1 -– $20
  - Example C: Super-dividend from national energy company
    - Board determined distribution of $100 million in dividends for 2015.
    - $100 million resulted from distributable income of $60 million, sale of land of $30 million, and draw down on accumulated reserves of $10 million.
    - Cost of 2015 quasi-fiscal activity (millions): $40 = $30 + $10
    - Government accounts should record this amount as a financial transaction (exchange of equity for cash), rather than as revenue.

### Capacity building, sequencing, and priority actions
- Building an oversight system takes time and resources; advanced economies have spent many years developing systems.
- In low-capacity countries:
  - Adopt a risk-based and sequenced approach to building an oversight regime.
  - Prioritize intensive monitoring on a relatively small number of public corporations where inefficiencies and fiscal risks are concentrated.
  - Short-term (up to one year) priority: ensure a full inventory of public sector entities with commercial or quasi-commercial functions and classify entities according to the latest international standards.

### Implementation of an oversight regime (Table 3 structure and priorities)
- System elements and suggested prioritization are organized into Short Term, Medium Term, and Long Term.
- Major categories preserved:
  - 1. Definition/classification/status of public corporations (including inventory and GFSM 2001/2014 classification).
  - 2. Broad ownership policy (objectives, organization, mandate, principles, disclosure, dividend policy, modalities for financial assistance, policy on quasi-fiscal activities).
  - 3. Disclosure of mandate for each public corporation.
  - 4. Legal framework for public corporations.
  - 5. Public corporation oversight unit in Ministry of Finance with functions including advice on financial support, analysis of financial health, estimation of fiscal impact, advice on board appointments and dividends, central controls, monitoring, drafting annual reports, and estimation of QFA costs.
  - 6. Central financial control and approvals (review/approval of financial plans, approval of new borrowing and guarantees, approval of asset sales/pledging, approval of mergers/acquisitions, review of staffing and remuneration policies).
  - 7. Publication of annual Public Corporation Monitoring Report (sector overview, list of companies, financial performance, how ownership policy was exercised, financial impact of transactions).
- Timing priorities:
  - Short Term:
    - Establish a basic reporting framework for public corporations that are high risk or have a large fiscal or budgetary impact.
    - Determine the role and responsibilities of the President’s Office, the Ministry of Finance, and line ministries participating in oversight.
  - Medium Term (up to three years):
    - Establish (or revise) the legal framework relating to public corporations.
    - Provide the Ministry of Finance (or another approved entity) with the required powers to review financial plans of public corporations and monitor their performance.
    - Develop a public corporation ownership policy.
    - Strengthen Ministry of Finance capacity to supervise public corporations.
    - Financial oversight unit could start to publish a consolidated annual report on public corporations.
  - Long Term (more than three years):
    - Develop a more elaborate set of performance indicators and targets for monitoring financial performance.
    - Ensure the cost of delivering public service obligations and other quasi-fiscal activities is fully funded in the budget and disclosed in financial reports prepared by the government and the public corporations.
    - Carry out a review of the economic and financial status of business enterprises and whether they should continue to be classified as public corporations.

### Institutional arrangements and operational controls relevant to QFA cost estimation
- Create a public corporation oversight unit with explicit mandate to estimate costs of current and future quasi-fiscal activities.
- Routinely estimate fiscal and budgetary impact of public corporations and include a policy on quasi-fiscal activities within a broad ownership policy.
- Publish an annual Public Corporation Monitoring Report that discloses financial impact of transactions between public corporations and government and information on public service obligations.
- Operational controls to mitigate fiscal risks from QFAs include central financial control and approvals for new borrowing, concession of guarantees, sales or pledging of assets, and mergers or acquisitions; central review and approval of financial plans to ensure QFA costs are identified and funded; and monitoring of financial reports and performance indicators to track QFA-related flows.

*Source: HOW TO IMPROVE THE FINANCIAL OVERSIGHT OF PUBLIC CORPORATIONS — Introduction (IMF Fiscal Affairs Department How-to notes, November 2016).*

### Introduction

### _howtonote1605 - Introduction

### Fiscal risks from public corporations: evidence and magnitude
- Episodes in which contingent liabilities materialized over 1990–2014: maximum cost of episodes involving public corporations was 15.1 percent of GDP; average cost was 3 percent of GDP.
- Public corporations were the second-largest category of fiscal risk after the financial sector.
- The number of episodes involving public corporations and their average fiscal cost doubled between the 1990s and the 2000s.
- Market value of public corporations accounts for over 11 percent of the market capitalization of listed companies worldwide; country examples: Brazil, 18 percent; India, 22 percent; China, 44 percent.
- Share of public corporations among Fortune Global 500 companies grew from 9 percent in 2005 to 23 percent in 2014, driven primarily by Chinese public corporations.
- Even where the public corporation sector is smaller (for example, sub-Saharan Africa), substantial fiscal risks may arise.

### Why effective financial supervision and oversight is important
- Public corporations continue to account for a significant share of economic activity and, in many countries, the bulk of public sector assets and liabilities.
- Inefficient or poorly managed public corporations can:
  - Produce at high costs, overcharge customers, and under-provide essential services such as power, water, and telecommunications.
  - Impose substantial economic and fiscal costs.
- Loss-making public corporations can create persistent fiscal drag through government guarantees, subsidies, loans, or capital injections; liabilities are often assumed by government even if not explicitly guaranteed.
- Public corporations are often used to pursue political objectives and engage in quasi-fiscal activities (for example, public service obligations below cost-recovery, price regulations implying cross-subsidies, ancillary operations outside the core mandate, or excessive employment) without budget compensation.
- Public corporations can be mechanisms to circumvent fiscal controls or channels for financial corruption, conducting fiscal operations off-budget or channeling political favors and patronage.

### Changing character of public corporations
- Many traditional natural monopolies have disappeared due to technological change (examples: electricity distribution, telecommunications).
- Many large public corporations now operate in oil, gas, copper, and other mineral sectors; some are legal monopolies rather than natural monopolies.

### Essential building blocks of an effective financial oversight framework
- Comprehensive definitions and classifications conforming with international standards.
- Mechanism for periodic government review of the status and viability of public corporations to ensure commercial and economic viability.
- Policy framework determining ownership, legal and institutional status.
- Robust system of financial controls and approvals.
- Arrangements for measuring and monitoring financial performance and quasi-fiscal activities.
- Measures to enhance government capacity for overseeing public corporations, with guidance on sequencing reforms.

### Definition and classification guidance
- Public corporations take diverse legal and organizational forms and include many names (state-owned enterprises, parastatals, government business enterprises, crown corporations, nonprofit organizations).
- Clear, transparent definitions and classifications should align with international standards.
- GFSM 2014 definition: corporations are “entities that are capable of generating a profit or other financial gain for their owners, are recognized by law as separate legal entities from their owners, and are set up for purposes of engaging in market production” (paragraph 2.31).
- A corporation is classified as a public corporation if it is controlled by the government (paragraph 2.107).
- Public corporations can be classified as nonfinancial or financial corporations depending on primary activity (paragraphs 2.113–2.116).
- Control may be assessed using eight indicators proposed in Box 2.2 of GFSM 2014.
- Market test for classifying a unit as a market producer: value of sales (excluding taxes and subsidies not directly linked to output) should average at least half of production costs (compensation of employees, use of goods and services, consumption of fixed capital, and a return on capital) over a period of at least three years.
- Classification challenges arise where prices are difficult to determine (for example, utilities, nuclear energy production, weapons production).
- Special purpose vehicles (SPVs) used for fiscal or quasi-fiscal activities are subject to the same classification criteria; GFSM 2014 paragraphs 2.136–2.138 provide further guidance.

### Reviewing the status of public corporations
- Governments should assess alternatives before establishing new public corporations (for example, tax and regulatory frameworks or targeted subsidies may achieve policy goals more efficiently).
- Legislation should require full assessment of costs and benefits before creating a new public corporation.
- Governments should periodically review the status and viability of existing public corporations using a framework that considers:
  - Economic performance (for example, actual or potential profitability and market conditions).
  - Strategic or national security relevance.
  - Political orientation regarding the role of market and state ownership.
  - Social context (for example, income distribution impacts of corporatization or privatization and potential short-term employment losses).
- Even when privatization is not viable, partial listing can expose public corporations to market discipline.
- Stylized decision matrix for review outcomes (Policy or Strategic Relevance vs. Commercial Viability):
  - Low relevance, Low viability: Close down.
  - Low relevance, High viability: Privatize.
  - High relevance, Low viability: Convert into a noncommercial government entity.
  - High relevance, High viability: Retain as a public corporation, monitor closely operations and finances.

### Policy, legal, and institutional frameworks
- Effective financial oversight requires a clearly defined ownership policy backed by strong legal and institutional arrangements.
- Business laws governing enterprise structure, board powers, financial reporting, and independent audit are necessary but should be supplemented by a public sector–specific oversight framework that defines goals, powers, and responsibilities of the corporation, the Ministry of Finance, and line ministries.
- The institutional and legal framework should account for interactions with financial institutions (for example, domino effects from a public corporation’s financial collapse) and foreign shareholding.

Ownership policy (key elements)
- Governments should develop and publish a comprehensive ownership policy that:
  - States the state’s policy and financial objectives as shareholder for each company or group of companies (which may mix financial, economic, and social objectives).
  - Explains how the government will exercise ownership rights and the main functions carried out as owner.
  - Specifies the objectives and mandate of each public corporation.
  - Describes the organization of the ownership function and the relationship between financial and nonfinancial oversight.
  - Sets principles and policies such as ensuring a level playing field between public corporations and the private sector.
  - Refers to constitution, laws, regulations, codes, and other documents defining ownership rights.
- On financial oversight, the ownership policy should explicitly address:
  - Planning or budgeting requirements.
  - Reporting requirements.
  - Pricing and tariffs.
  - Dividend policy.
  - Financial assistance from the government, including guarantees.
  - Contractual commitments.
- The ownership policy should ensure these elements are included in the government’s financial monitoring and reporting framework.

Legal framework (overview)
- Many countries use a framework law on public corporations (self-standing or as part of public finance law) to clarify roles of government and corporations in financial management.
- The legal framework should include elements that define financial management responsibilities and oversight arrangements.

*Source: HOW TO IMPROVE THE FINANCIAL OVERSIGHT OF PUBLIC CORPORATIONS — Introduction (IMF Fiscal Affairs Department How-to notes, November 2016).*

### 1. A clear definition of a public corporation. If there

### 1. A clear definition of a public corporation. If there is a special legal form of incorporation only applied to public corporations, then the law should define the parameters of this legal form.

### Legal framework: definitions, oversight, reporting, and sanctions
- Define whether public corporations are incorporated under a special legal form or under commercial law, and clarify whether commercial law applies in its entirety or with special provisions for public corporations.
- Define the financial oversight function and specify whether it is carried out by the Ministry of Finance, a sector ministry in consultation with the Ministry of Finance, or an independent agency (as in the Swedish model).
- State the government's powers to receive, comment on, and approve:
  - financial plans,
  - financial targets,
  - annual financial statements of public corporations;
  - set financial performance targets;
  - respond to requests by public corporations for compensation of public sector obligations, capital injections, borrowing, or government guarantees.
- Public reporting requirements: require full annual financial statements
  - containing a statement of operations, a cash flow statement, and a balance sheet,
  - prepared in accordance with national or international accounting standards.12
- Require the government to publish an annual report on whether public corporations are achieving their policy and financial objectives and complying with obligations to prepare regular and timely financial reports.
- Require annual accounts to be audited by a reputable, independent auditing body recognized internationally, and to publish the audit report.13
- Include sanctions in the legal framework to ensure enforceability, including measures such as:
  - additional reporting requirements (for example, monthly rather than quarterly reports),
  - imposition of additional controls (for example, over staff recruitment, pay, or major investment decisions),
  - administrative measures (for example, steps to dismiss or suspend members of the management board),
  - government imposition of direct control over day-to-day operations in extreme cases,
  - sanctions applied to members of the management board or government officials charged with oversight.

### Roles, governance, and the arm’s-length principle
- Clarify the role of the sector ministry and the public corporation’s management board in law (OECD 2015).14
- Assign the sector ministry responsibility for policy issues related to the sector, but:
  - the sector ministry should not be involved in the strategic planning of individual public corporations, especially where private sector competitors exist under the same policy framework.
- Adopt the “arm’s length” principle distinguishing ownership functions from management; management boards should operate without interference or pressure from line ministries.
- Where board independence cannot be guaranteed, the Ministry of Finance may need to provide stronger oversight of financial performance.
- Guidance for boards may be needed on issues such as:
  - assuring management autonomy,
  - developing and sustaining management skills,
  - selecting and remunerating board members,
  - avoiding pressures to exempt certain public corporations from good governance principles.19
- Require all public corporations to establish an audit committee and a well-functioning internal audit regime.

### Institutional framework and models for ownership and oversight
- Ownership and financial oversight functions may overlap; options include:
  - Centralized model: locate both ownership and financial oversight in a central agency (Ministry of Finance, Treasury, or Presidency). Examples cited: Brazil and Sweden.
  - Holding company/autonomous agency model: shares held by an autonomous agency, holding company, or investment company (examples: Austria (Österreichische Industrieholding AG), China (SASAC), Finland (Solidium Oy), France (APE), Kenya (Government Investment Corporation, GIC), Malaysia (Khazanah), Peru (FONAFE), Singapore (Temasek), Spain (SEPI)). Advantages: professional asset managers, insulation from political interference. Prerequisites: harmonized legal frameworks and a published comprehensive corporate governance framework.
  - Decentralized or mixed models: line ministries hold shares under a framework established and supervised by the Ministry of Finance or another central agency. Examples: Mexico, South Africa, Thailand. These require close coordination between the Ministry of Finance and the share-holding ministry/agency.
- Monitoring units: many countries locate a dedicated oversight/monitoring unit in:
  - Ministry of Finance (examples: Chile, France, New Zealand, South Africa, Sweden),
  - Prime Minister’s Office (example: Finland),
  - Ministry of Planning (example: Brazil).
- In less-advanced economies lacking corporate finance expertise, centralizing resources in the Ministry of Finance is often appropriate.
- Monitoring units need expertise in financial analysis, corporate governance, corporate finance, and law; they may support government representatives on boards.
- Monitoring units frequently publish annual monitoring reports on sector performance and fiscal risks.16
- Example institutional practices (South Africa, Turkey, etc.), and specifics:
  - The Public Finance Management Act of 1999 and Treasury regulations require public enterprises to submit on an annual basis: (1) strategic plans, (2) financial plans, and (3) risk management plans.
  - The Department of Public Enterprises (DPE) enters into a Shareholder Compact with six of the largest commercial state enterprises, formalizing key performance indicators and other performance data. The DPE approves significant transactions and the Minister nominates board members who must be approved by Cabinet.
  - Public enterprises must submit multiyear budgets to the DPE at least one month before the start of their financial year. The National Treasury imposes annual limits on borrowing, guarantees, and other contingent liabilities.
  - The Fiscal Liability Committee in the National Treasury advises the Minister on short- and medium-term contingent liabilities and guarantees related to public enterprises.
  - Public enterprises must prepare annual financial statements in line with generally accepted accounting practices within five months of the end of each year and submit quarterly financial reports to the DPE or supervising ministry when not under DPE oversight.

### Central financial control and approvals (elements of control)
- Financial and policy objectives: the government should state clear, operational financial and policy objectives for each public corporation (e.g., dividend, profit, return on equity).
- Financial plans: government ownership gives veto power on major corporate policy and financial plan decisions. When assessing plans, governments should ensure:
  - financial targets, prices and tariffs, capital levels, and dividend targets are appropriate;
  - balance between commercial objectives and public service obligations is adequate;
  - investment plans reflect government priorities;
  - financial and operational risks are actively managed;
  - public corporations do not create subsidiaries to transfer control of public assets to private interests.
- Borrowing: governments may establish ceilings on borrowing for public corporations to limit contingent liabilities.
- Guarantees: governments may prohibit or strictly control issuance of guarantees by public corporations to third parties.
- Sale/pledging of assets: governments may restrict sale or use as collateral of nonfinancial assets provided by the government, and may restrict pledging or securitization of future revenue streams.
- Mergers/acquisitions: governments typically require approval for mergers or acquisitions that affect operations, finances, or competition.
- Corporate governance: public corporations should establish professional management and governance frameworks that operate effectively without government interference, in line with international standards (OECD 2015). The government selects board members, but CEO and key personnel selection should be performed by the board without government interference.

### Monitoring financial performance, reporting standards, and consolidation
- Financial reporting and auditing:
  - Encourage adoption of International Financial Reporting Standards (IFRS) and International Standards on Auditing to enhance reliability, comparability, and quality of financial data.20
  - In less-advanced economies, require IFRS and international audit standards only for the largest public corporations or those with substantial exposure to fiscal risk if costs are prohibitive.
  - Under IFRS, government support to public corporations should reflect the economic nature of transactions rather than legal form; this is consistent with IPSAS and GFSM 2014 and aids consolidation.
  - Pay particular attention to financial transactions such as capital injections, loans, and debt assumptions to determine whether they are purchases of financial assets or capital transfers, following GFSM 2014 decision trees (Figures A3.1 and A3.2).
- Public corporation monitoring reports should typically include five main sections:
  - An overview of the sector and highlights of public corporation activities during the year, including material policy decisions or transactions;
  - A full list of companies owned by the government, broken down by industry, size, and type of ownership (for example, majority- or minority-owned companies, strategic companies, or candidates for privatization);
  - An overview of how the government has exercised its ownership policy, including appointment of board members, dividend policy, organizational and governance arrangements, and announcement of financial and public policy targets;21
  - (Additional sections implied by the source include financial performance analysis and risk disclosure consistent with best practice in monitoring reports.)

*International Monetary Fund | November 2016*

### 1. Financial overview

### 1. Financial overview

### Key components of an annual report on public corporations
- The report should cover:
  - Events in brief.
  - Ownership issues, including:
    - Ownership model.
    - Company cases.
    - Nominations to company boards.
    - Financial targets.
    - Sustainability business models.
    - Public policy targets.
    - Remuneration and terms of employment.
    - Company portfolio, including its valuation.
    - Effect of company divestments and dividends in government finances.
  - Individual company data, including:
    - Description of company’s mandate and operations (Source: Department for Innovation and State-Owned Companies (2015)).
    - Summary of activities in 2014.
    - Targets (financial, sustainability, and public policy).
    - Performance review.
    - Summary financial information (abridged income statement and balance sheet, key ratios, reporting performance).
    - Panel charts (state ownership, gender distribution, and one performance indicator).
  - General information, including:
    - State’s ownership policy.
    - Accounting principles and definitions.
    - Legislation.
    - Summary of changes in executive boards.
    - Assessment of reporting practices.
    - Guidelines for reporting.
    - Guidelines for terms of employments for senior executives.
    - Management responsibility for companies.
- Special topics: more thorough explanation of ownership policy, remuneration policy, valuation of companies, organization and management issues, and impact of public corporations on government finances and the economy.

### Indicators of public corporations’ financial health
- Governments typically focus surveillance on:
  - Financial performance indicators:
    - Profit margin (earnings/revenue).
    - Return on equity (earnings/equity).
    - Return on assets (earnings/assets).
  - Financial risk indicators:
    - Liquidity (current assets/current liabilities).
    - Leverage (assets/equity).
    - Solvency (liabilities/revenue).
    - Probability of default (e.g., Altman Z-Score, Ohlson O-Score, Black-Scholes-Merton default probabilities).
  - Transactions with the government:
    - Dividends, taxes, grants, compensation for quasi-fiscal activities, other subsidies.
    - Changes in government equity holdings in the public corporation.
    - Guarantees given or called.
  - Foreign linkages:
    - Relative weight of debt to foreign creditors.
    - Currency composition of debt.
    - Hedging of currency risk.
- Recommendation: comprehensive information on transactions with government should be included in the government’s annual financial statements and other fiscal reports.

### Examples of specific indicators monitored (Australia)
- Financial performance (indication of commercial viability), examples:
  - Profit before tax = Revenue – Total expenses (excluding income tax).
  - Operating profit margin = Earnings before interest and tax from operation / Operating revenue.
  - Cost Recovery = (Operating revenue / Operating expenses) x 100.
  - Return on operating assets = (Earnings before interest and tax / Average operating assets) x 100.
  - Return on total equity = (Operating profit after tax / Average total equity) x 100.
  - Operating cash flow to sales = (Operating cash flow / Operating revenue) x 100.
- Financial risk examples:
  - Debt to equity = (Debt / Equity based on operating assets and liabilities) x 100.
  - Debt to operating assets = (Debt / Average operating assets) x 100.
  - Total liabilities to equity = (Total liabilities / Total equity) x 100.
  - Interest Coverage = Earnings before interest and tax / Gross interest expense.
  - Current ratio = (Current operating assets / Current operating liabilities) x 100.
  - Leverage ratio = (Total operating assets / Equity based on operating assets and liabilities) x 100.
  - Short term debt coverage = (Operating cash flow / Current liabilities) x 100.
- Transactions with government examples:
  - Dividend to equity = (Dividend paid or provided for / Average equity based on operating assets and liabilities) x 100.
  - Divident payout ratio = (Dividends paid or provided for / Operating profit after tax) x 100.
  - Income tax expense = the value of income tax or income tax-equivalent expenses payable to government.
  - Grants revenue ratio = (Grants to cover deficits in operations / Revenue) x 100.
  - Public service obligations = sum of payments by governments to public corporations for specific noncommercial activities they direct public corporations to undertake.

### Segmentation and monitoring of public corporations by risk
- Segmentation methods:
  - Composite indicator (linear combination of business ratios, weighted by coefficients).
  - Simple count of the number of indicators exceeding established (safe) thresholds.
  - Designation as high-risk if a particular indicator reaches an unacceptable fiscal risk level.
- Oversight implications:
  - Higher-risk enterprises should face stricter oversight (more frequent reporting, stricter targets, tighter controls) and be required to implement risk-mitigating measures.
  - Larger public corporations should be subject to stricter oversight regimes even if measured risk is low; size indicators include level of sales, assets or liabilities, or income tax paid.
  - Special challenges arise when a public corporation has a complex corporate structure with many subsidiaries or shell corporations and unreliable or nontransparent parent-company information.

### Recommendations to mitigate risks from public corporations (IMF summary)
- Direct controls to limit fiscal exposure:
  - Reduce size of public corporation sector.
  - Impose caps on liabilities that public corporations can accumulate.
- Regulations and charges to reduce risky activities:
  - Hold public corporation boards accountable for financial performance.
- Transfer or sharing of risks:
  - Introduce explicit no-bailout clauses.
- Provisioning for unmitigated risks:
  - Expense expected subsidies (e.g., compensation for quasi-fiscal activities) in the budget.
  - Set aside financial assets to meet potential restructuring costs of public corporations.
- Fiscal risk reporting:
  - Include a summary of fiscal risks from the public corporation sector in the wider fiscal risk statement.

### Quasi-fiscal activities: definitions and policy treatment
- Definition: operations carried out by public corporations to further a public policy objective that worsen their financial position relative to a strictly commercial profit-maximizing level.
- Common forms:
  - Public service obligations: charging less than commercial cost prices for goods and services (implicit subsidy to consumers).
  - Noncore functions: obligations to provide goods/services or undertake capital investments unrelated to core functions.
  - Subsidized purchases: paying above commercial prices to particular suppliers.
  - “Super-dividends”: withdrawal of own funds in excess of distributable income of the accounting year, normally from sales of assets or accumulated reserves.
  - Pricing for short-term budget revenue purposes: setting higher prices to increase short-term profits and dividends at the expense of medium-term market position.
- Recommended treatment:
  - Cost of public service obligations and subsidized purchases should be fully funded through the budget and disclosed separately in the financial statements of both the government and the public corporation.
  - Disclosure should include type of activity, rationale for delivery via the public corporation, the opportunity cost, and the compensation mechanism if applicable.
  - Disclosure increases transparency, holds government accountable, prevents hiding fiscal activities within public corporations, and enables comparisons with private-sector competitors.

### Methods for estimating costs of quasi-fiscal activities
- For targeted reduced-tariff regimes or above-market-price payments: estimate as the difference between sales of output at observable market prices and the prices specified by the government for the target groups.
- For obligations where market prices are not observable (e.g., low-density transport services): estimate using indirect methods, such as the actual cost of providing the service.

### Illustrative numerical examples of quasi-fiscal activity costs (Box 4 examples)
- Example A: Reduced rail tariff for students
  - Government requests transport at a quarter of the regular fare ($1 per trip).
  - In 2015, the Railway Corporation sold 23,000 student fare tickets.
  - Cost of 2015 quasi-fiscal activity = $17,250 = 23,000 × $0.75 (assumes a price elasticity equal to zero)
- Example B: Subsidized bus route to a rural community
  - Loss-making route details in 2015: operating costs, $56 million; interest paid, $4 million; ticket sales, $20 million.
  - The average surplus obtained on other routes was 10 percent of ticket sales.
  - Estimated economic cost of 2015 quasi-fiscal activity (millions) = $40 = $56 + $4 – $20
  - Compensation paid in 2015 (millions) = $46 = ($56 + $4) × 1.1 -– $20
- Example C: Super-dividend from national energy company
  - Board determined distribution of $100 million in dividends for 2015.
  - $100 million resulted from distributable income of $60 million, sale of land of $30 million, and draw down on accumulated reserves of $10 million.
  - Cost of 2015 quasi-fiscal activity (millions): $40 = $30 + $10
  - Government accounts should record this amount as a financial transaction (exchange of equity for cash), rather than as revenue.

### Capacity building and sequencing of reforms
- Building an oversight system takes time and resources; advanced economies have spent many years developing systems.
- In low-capacity countries:
  - Adopt a risk-based and sequenced approach to building an oversight regime.
  - Prioritize intensive monitoring on a relatively small number of public corporations where inefficiencies and fiscal risks are concentrated.
  - Short-term (up to one year) priority: ensure a full inventory of public sector entities with commercial or quasi-commercial functions and classify entities according to the latest international standards.

*Source: How to IMprove tHe FInancIal oversIgHt oF publIc corporatIons, International Monetary Fund | November 2016.*

### Box 5. Illustrative Examples of Quasi-Fiscal Activity Cost Estimation

### Box 5. Illustrative Examples of Quasi-Fiscal Activity Cost Estimation

### Implementation of an Oversight Regime for Public Corporations (Table 3 structure)
- System elements and suggested prioritization are organized into Short Term, Medium Term, and Long Term.
- Major categories (preserved numbering and subitems):
  - 1. Definition/classification/status of public corporations
    - 1.1 Inventory of public corporations
    - 1.2 Classification of public corporations in line with GFSM 2001/2014
    - 1.3 Periodic review of classification and optimal status of public corporations
  - 2. Broad ownership policy, comprising:
    - 2.1 Government’s objectives as owner of public corporations
    - 2.2 Organization of ownership function
    - 2.3 Mandate of entities exercising ownership role
    - 2.4 Main principles and policies to be followed
    - 2.5 Information disclosure requirements
    - 2.6 Dividend policy
    - 2.7 Modalities for financial assistance from the state
    - 2.8 Policy on quasi-fiscal activities
  - 3. Disclosure of mandate for each public corporation
  - 4. Legal framework for public corporations
  - 5. Public corporation oversight unit in Ministry of Finance, with the following functions:
    - 5.1 Advice on financial support to public corporations
    - 5.2 Analysis of financial health of public corporations
    - 5.3 Estimation of fiscal and budgetary impact of public corporations
    - 5.4 Advice on appointment of board members
    - 5.5 Advice on annual dividends
    - 5.6 Central financial controls and approvals
    - 5.7 Monitoring of financial reports and performance indicators
    - 5.8 Drafting of annual public corporation monitoring reports
    - 5.9 Estimation of costs of current and future quasi-fiscal activities
  - 6. Central financial control and approvals, comprising:
    - 6.1 Review and approval of financial plans
    - 6.2 Approval of new borrowing and of concession of guarantees
    - 6.3 Approval of sales or pledging of assets
    - 6.4 Approval of mergers or acquisitions
    - 6.5 Review staffing and remuneration policies
  - 7. Publication of annual Public Corporation Monitoring Report, comprising:
    - 7.1 An overview of the sector and highlights of activities
    - 7.2 A full list of companies owned by government
    - 7.3 Information on individual public corporations’ financial performance, public service obligations, fiscal risks, etc.
    - 7.4 An overview of how the government exercised its ownership policy
    - 7.5 Financial impact of transactions between public corporations and government

### Short-term, Medium-term, and Long-term Priorities (timing preserved)
- Short Term:
  - Establish a basic reporting framework for public corporations that are high risk or have a large fiscal or budgetary impact (alignment with GFSM 2001/2014 implied).
  - Determine the role and responsibilities of the President’s Office, the Ministry of Finance, and line ministries participating in oversight.
- Medium Term (up to three years):
  - Establish (or revise) the legal framework relating to public corporations.
  - Provide the Ministry of Finance (or another approved entity) with the required powers to review financial plans of public corporations and monitor their performance.
  - Develop a public corporation ownership policy.
  - Strengthen Ministry of Finance capacity to supervise public corporations.
  - Financial oversight unit could start to publish a consolidated annual report on public corporations.
- Long Term (more than three years):
  - Develop a more elaborate set of performance indicators and targets for monitoring financial performance.
  - Ensure the cost of delivering public service obligations and other quasi-fiscal activities is fully funded in the budget and disclosed in financial reports prepared by the government and the public corporations.
  - Carry out a review of the economic and financial status of business enterprises and whether they should continue to be classified as public corporations.

### Functions and Practices Relevant to Quasi-Fiscal Activity (QFA) Cost Estimation
- Institutional arrangements supporting QFA cost estimation:
  - Creation of a public corporation oversight unit with explicit mandate to estimate costs of current and future quasi-fiscal activities (see 5.9).
  - Routine estimation of fiscal and budgetary impact of public corporations (see 5.3).
  - Inclusion of policy on quasi-fiscal activities within a broad ownership policy (see 2.8).
  - Publication of an annual Public Corporation Monitoring Report that discloses financial impact of transactions between public corporations and government and information on public service obligations (see 7.3 and 7.5).
- Operational controls that mitigate fiscal risks from QFAs:
  - Central financial control and approvals for new borrowing, concession of guarantees, sales or pledging of assets, and mergers or acquisitions (see 6.1–6.4).
  - Central review and approval of financial plans (see 6.1) to ensure QFA costs are identified and funded.
  - Monitoring of financial reports and performance indicators to track QFA-related flows (see 5.7).

### Policy and Governance Considerations
- Legal and reporting frameworks:
  - Clarify mandates and disclosure requirements so QFA costs are transparent (see 2.3, 2.5, 3, 4).
  - Require the cost of public service obligations and QFAs to be fully funded in the budget and disclosed in government and public corporation financial reports (long-term priority).
- Capacity and communication:
  - Strengthen Ministry of Finance capacity and establish an oversight unit to provide advice on financial support, analyze financial health, and estimate fiscal impacts (see 5.1–5.3).
  - Build support among stakeholders and the public; develop an effective communication strategy and a change management plan to reduce opposition to reform.
- Reporting and accountability:
  - Publish consolidated annual monitoring reports covering sector overview, lists of companies, financial performance, public service obligations, fiscal risks, and government ownership policy execution (see 7.1–7.5).

*International Monetary Fund, How to Improve the Financial Oversight of Public Corporations (Box 5).*

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