Who to Trust with the Management of Government Companies

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What does the CEO of a government company need for success, and how does this differ from the portrait of a private business manager? INSEAD Business School Professor and Ward Howell Senior Partner Stanislav Shekshnia and Ward Howell Talent Equity Institute Project Manager Veronika Zagieva share the results of their research with Forbes.

Original article: Forbes

One of the consequences of the 2008-2009 crisis was the government’s active return to the economic sphere. The most recent recession strengthened this position, which will continue at least until the end of President Vladimir Putin’s term. Over the past six years, the government has increased not only its level of economic regulation, but also the extent to which it is directly involved in business. Today, government companies control about half of the banking and insurance sectors, 40-45% of the oil and gas industry, and 73% of the transportation industry. In addition, about one-quarter of the economically active population works for them. 

The public sector became not just present, but significant. Russia is somewhere in between emerging market economies in which government participates in certain areas and China, in which government companies are the base of the economy. Though the country’s leadership has not made any announcements regarding program development in this arena, it is logical to assume that it has high hopes for the development of government companies, seeing them as potential drivers of future economic growth. Unfortunately, at the moment, the Russian public sector cannot provide intense growth. Why not?

Traditionally, economists and corporate governance specialists have asserted that government is a chronically ineffective business owner. Unlike private investors, who are focused on profits, government, by means of the bureaucrats acting in its name, does not have a definitive goal; managers are unmotivated to add value and are inclined to use their authority for their own interests (corruption). Despite this, over the last few years research has shown that under certain circumstances, government companies can stably deliver high financial results – the share of government companies in the Fortune 500 list grew from 9% in 2005 to 23% in 2014.

Our own observations have shown that in the case of government companies (as in cases of public companies without a controlling shareholder) ownership and the owner are secondary factors in performance. What is most important is leadership.

The success of an enterprise is determined by those that manage it and how they do it.

Accordingly, effective leadership in a government company markedly differs from leadership in a private business, though it does share some fundamental aspects.

In 2015, the Harvard Business Review published its global list of the most effective company managers, which included the CEOs of three government companies. One of them, Djalma Bastos de Morais, became the CEO of Brazilian energy company Cemig when he was 62 years old. In the years he led the company (from 1999 to 2015), its capitalization grew by $19 bln, and total shareholder return increased by more than 1,000%. Before assuming this role, Bastos de Morais successfully worked in major Brazilian oil and telecommunications companies, and was also the head of the ministry of telecommunications in Brazil. Despite the fact that he lacked several attributes CEOs of private companies often have – industry experience, a degree from a leading university, an MBA – Djalma achieved impressive results.

What does the CEO of a government company need for success, and how does this portrait differ from the head of a private business? Our research on 250 CEOs of major companies in Russia provides several answers to this question.

First we identified the most effective CEOs, and then evaluated them through four indicators on a scale of 1 to 7.

  • Work experience in the industry — Industry experience gives a CEO a quicker and deeper understanding of the essence of the business and enables him to more quickly establish authority and gain the trust of his employees.
  • Company knowledge  One of the advantages CEOs who worked at the company before their appointment have is a knowledge of the culture, personal connections and an ability to easily access resources and enact decisions.
  • Relationship with the owner — СЕОs that have worked with the owner and have, logically, gained his trust, remain in their position longer, even amid unsatisfactory results. In the case of government companies in which the owner is not an actual person, we replaced this indicator with GR resources – the ability to build relationships with regulators and other governing bodies that have a substantial effect on the company’s business.   
  • Visibility — This characteristic describes how well-known a CEO is in the external environment in which he acts as the face of the company and an active proponent of its goals, strategy, and values.

CEOs in private businesses are balanced between three main indicators: work experience in the industry, company knowledge, and relationship with the owner: 70% of effective CEOs have more than eight years of work experience in the industry, 80% worked in the company for more than three years, and only one CEO in our selection did not know the owner prior to his appointment. The fourth indicator – level of visibility – was decidedly weaker (more than half of effective CEOs were completely unnoticed by the media, and the rest extremely rarely agreed to interviews or press announcements).

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Fig. 1 Effective CEOs in private and public companies

On the other hand, CEOs in government companies strongly reflect only two indicators – significant GR resources and visibility. As far as company knowledge and work experience in the industry goes, 70% of effective government company CEOs had no work experience in the industry and only one worked at the company for more than two years. It turns out that there is a negative correlation for CEOs of Russian companies between industry experience/company knowledge and leadership/performance.

Those that had industry experience and worked in the company before being appointed chief executive were less effective.

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Fig. 2 Effective CEOs in government companies

How can this correlation be explained? Surely, new CEOs without a social network in the organization or responsibilities to its influential members have an easier time making radical, organizational changes, including replacing non-performing managers. To some extent, this could also be explained by the CEO’s lack of industry experience – without a team from the industry, they are freer to choose their teammates and can attract the best of the best from the market. In four of nine cases, that is exactly what happened: a new CEO hired the industry’s best professionals; another two brought in their own trusted teams from outside the industry. Another possible explanation is that external candidates have high social status and extensive social networks, which help them gain access to additional resources unavailable to internal candidates.

Effective CEOs of government companies have significant GR resources (6 of 9 CEOs previously held high posts in federal or regional government) and are very present in the public eye. It is possible that this is all done to one end – to build trust with the owner (the government). The owner-government and representatives acting on its behalf are far more removed from the CEO than shareholders of a private company. Crafting an image of effective management in the public sphere can strengthen the government’s, as well as its representatives’, trust in a concrete CEO.

In private companies, where, in the best cases, the owner is at arm’s length, but more frequently is directly involved in the business, being in the media spotlight can actually generate frustration and distrust for a CEO. Most effective CEOs are able to create productive relationships with owners because they have managed to achieve results without overshadowing the owner. Meanwhile, business owners typically take on a large share of the responsibility for a company’s GR and PR needs.

Herman Gref became chairman of the board at Sberbank without having any work experience in the business or specialized (financial) education, and with a fairly limited knowledge of the company – only through membership on the board of directors. However, he brought with him a reputation as an efficient bureaucrat, high visibility and direct contact with key figures in the government, which is the bank’s main shareholder. Gref’s reputation, social network and constant interaction with important stakeholders has ensured him autonomy in strategic and operational management. He has visibility, popularity, and loyalty from external and internal stakeholders, who reacted positively to his program. Gref quite quickly formed a team of specialists to compensate for his lack of industry experience and knowledge and, at the same time, started to actively study banking and modern management, which allowed him to at first catch up and then outpace many other banker heads of the bank’s competitors.

The history of Vitaly Savelyev, under whose leadership Aeroflot went from being a loss-making airline to a dynamic, profitable, and attractive option for customers, is similar to that of Gref. Savelyev’s GR resources and reputation ensured a high level of autonomy for Aeroflot’s management. Careful attention to talent that already worked in the company and intense immersion in the industry’s best global practices through the help of consultants and colleagues provided necessary industry knowledge. The management experience of Savelyev and the leaders that came with him decisively improved and, eventually, fundamentally restructured the company.  

However, a leader’s powerful GR resources and visibility does not always guarantee a government company’s success (there have been several recent high-profile departures of government company executives). The presence of a social network on the government level and visibility on the national level is a necessary, but not sufficient factor for the success of a government company CEO.

Furthermore, as in the private sector, results are achieved by leaders with ambition, intellectual curiosity and drive.

All heads of government companies, having become leaders, are setting out to achieve the large, complicated dreams they have for their organizations. They see it as a business and want that business to not just be successful, but outstanding. Savelyev created the most profitable airline in Europe, and Gref a world-class financial institution. They have benchmarks and indicators that must be reached and the passion to do so. Intellectual curiosity helps leaders learn (about the industry, best management practices, modern technologies) and teach their organizations. Heads of other major government companies certainly have strong ambitions for leadership, but they are not so closely tied to the future of the institutions they had as commercial organizations, the dynamics of global business competition do not drive them the way they do the heads of Sberbank and Aeroflot.

As statistics show that the most successful government companies are those whose managements have high levels of autonomy, the government’s best strategy of corporate governance is one in which it selects and assigns the “right” managers and creates the “right” working conditions for them. If such an approach is adopted, then the following pieces of practical advice will be helpful for government representatives.

Who should the government look for?

The profile of a candidate for the general director position of a state company should contain the necessary and desired elements. Among the first we include contacts in government bodies (a network), the ability to interact with government representatives, external visibility or the potential to quickly build it, business ambition, intellectual curiosity and drive, the ability to evaluate and attract talent, and strong health. As far as desirable qualities go, we include business intellect, social intellect, industry knowledge, knowledge of general management, and experience leading a business.

How should they be compensated?

Not long ago, Forbes published a list of the highest-paid company leaders. The first three were general directors of state-owned companies, which in fact comprised about half of the entire list. We do not believe that the size or form of compensation has a decisive influence on the behavior of managers in their role. A modern CEO’s incentives for action are much more complicated and are determined, first and foremost, by internal factors. Unfortunately, the same thing can be said about the role of compensation as an anticorruption instrument – neither the size nor form of remuneration can prevent criminal actions by top managers. However, compensation plays a significant, if not decisive, role in the acceptance or decline of a new offer. Therefore, a CEO’s compensation should be enough to be attractive when compared with other similar positions on the market.

If a board of directors wants to run a first-class business, it should pay its head a first-class salary.

If the board is focused on compensating the general director with the salary of a government bureaucrat, then it runs the risk of getting a more bureaucrat-oriented candidate, instead of an entrepreneurial leader, which could add to corruption.

The creation of a first-class business requires a long-term perspective. Therefore, boards of directors could consider creating a variable remuneration system, in which a CEO’s material compensation is linked to a company’s long-term financial results. These systems come in various forms, from bonuses or substantial portions of bonuses deferred five years or more to phantom or real stock options, which can be put into effect after five years or more, regardless of continued work in the company.

What needs to be done to create optimal conditions?

Boards of directors and general directors should negotiate the division of authority and responsibilities, as the more authority management has, the more likely its success will be, provided that the board complied with its first task of choosing the right leader. At an early stage, the board should make sure that the CEO has clearly articulated leadership ambitions that are linked to the business of the company and can be directed toward strategy and quantitative indicators; in fact, strategic development should be delegated to that leader.

In any case, the board should maintain its ability to dismiss a CEO, evaluate his work and determine compensation. Monitoring is best done by specialists – an auditing committee or internal audit.

Practice shows that public announcements about a newly appointed manager’s intentions for a company positively influence the likelihood that they will happen. Publicity increases the legitimacy of a CEO and his programs, creates additional external interest in the company and encourages its employees to change.