An inconvenient reality: State-owned corporations

Perhaps it is time for international standard setters to consider the anomalies that emerge when law that originates from the West is juxtaposed with a different variety of capitalism more commonly found in the East.

If capitalism is largely concerned with privately-owned profit-seeking enterprises, the notion of ‘state capitalism’ appears to be somewhat anomalous. Although state-owned corporations are commonly found in various parts of the world, their governance norms and the manner in which politics and business interact may seem ‘opaque, and even menacing’[1] to outsiders more familiar with predominant forms of corporate ownership in the Anglo-American context. Contrary to the presumption of private ownership, the ultimate beneficiaries of state-owned corporations are, or ought to be, the citizenry. Further, the entities’ aims extend beyond profit-seeking to supporting state interests including economic development. State-owned corporations are also thought to be more susceptible to corruption and may at times be used to further the political interests of powerful individuals.

Despite their increasing prominence in recent times, agency conflicts and risks arising in state-owned corporations are not adequately addressed by the core international prescriptions for responsible corporate governance. International prescriptions commonly seek to mitigate risks from agency conflicts ordinarily arising between shareholders and managers, and between controlling shareholders and minority shareholders. The mechanisms designed to guard against fraudulent behaviour and expropriation of corporate assets in these situations are ill-suited to a context where the state maintains both ownership and control of the corporate entity. Shareholders’ voting rights and accountability within the confines of a corporate entity afford little protection to the citizenry when vast amounts of public funds are used and abused in relative secrecy behind a corporate veil.

State-owned corporations are also thought to be more susceptible to corruption and may at times be used to further the political interests of powerful individuals.

The loss ensuing from the misuse of state-owned corporations as conduits for corruption is illustrated by the 1Malaysia Development Berhad (1MDB) scandal. Described by the US Attorney-General as ‘kleptocracy at its worst’,[2] 1MDB, a Malaysian state-owned company purportedly established for the benefit of the Malaysian people, was a vehicle for theft of over USD4.5 billion by former Prime Minister Najib Razak.  1MDB was incorporated as an unlisted public company, with minimal disclosure requirements.  The company was wholly-owned by the government through its investment arm, the Minister of Finance Incorporated. Najib, who was also the Minister of Finance, was able to exert control over the board of 1MDB and its subsidiary without effective requirements of accountability to the public.

The scandal precipitated investigations, and civil and criminal proceedings relating to money laundering in at least six countries. In Malaysia, Najib obstructed domestic investigations and used repressive laws to silence critics. Enforcement proceedings in Malaysia only commenced after the Najib administration fell in the May 2018 general elections. 

Significantly, these measurements are based primarily on law in the books, and indices such as the Doing Business rankings fail to capture the relatively weak enforcement of these laws in practice.

The scandal raises the question of why Malaysian corporate law failed to effectively safeguard against fraud of such magnitude despite approximating benchmarks of international standards.  The strength of Malaysian law is reflected in its ranking as second highest in the world for minority shareholder protection on the Doing Business 2020 index. Likewise, an empirical study using the Leximetric method revealed the strength of Malaysian shareholder protection law to be comparable to the US.

Significantly, these measurements are based primarily on law in the books, and indices such as the Doing Business rankings fail to capture the relatively weak enforcement of these laws in practice. The governance of state-owned companies is the subject of separate, less prescriptive OECD guidelines and, importantly, the high-profile international rankings do not hold countries accountable for these governance practices.

Although Malaysian corporate law has been modelled on Anglo-Australian law, Malaysia has distinctly different corporate ownership structures and political economy. The state’s extensive ownership and control of corporations is estimated at 42 per cent of the total market capitalisation on Bursa Malaysia. When unlisted corporations are included, the total value of state-owned corporations is even larger and the actual amount of assets held by state-owned corporations is not publicly known. Studies have revealed politics and business to be inextricably related in Malaysia where redistribution policies have resulted in widespread political patronage, and political influence is further strengthened through state-controlled institutional investors.

Concerns over potential corruption through state-owned corporations extend beyond Malaysia. Political and economic interests are often intertwined in Asian developmental states, and state ownership of corporations is found in various countries. Where corporations law permits such public funds to be managed behind a veil of secrecy, the risks of such corporate entities providing a cover for fraudulent transactions remain. 

Perhaps it is time for international standard setters to consider the anomalies that emerge when law that originates from the West is juxtaposed with a different variety of capitalism more commonly found in the East and other parts of the non-Western world. To avoid a recurrence of corruption such as that of the 1MDB scandal, there is need for more transparency especially where public monies are managed by state-owned corporations.