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Owner's Expectations Manual

7 Financial Governance

  • All SOEs are expected to enhance shareholder value in their operations over the longer term, while managing risk to an appropriate level. The following sections set out shareholding Ministers' specific expectations around related financial governance matters.

7.1 Financial targets

  • All SOEs are expected to add to shareholder value in their operations over the longer term and to meet short-term financial targets specified in their SCI (refer to Chapter 5).
  • The setting of appropriate financial targets aims to ensure that SOEs:
    • are focused on earning appropriate risk-adjusted rates of return over the business planning period
    • replicate the disciplines exerted over private sector companies that result from share market trading and the threat of takeover, and
    • operate in an environment that is competitively neutral with the private sector.
  • This does not mean that a target in excess of the cost of capital needs to be achieved consistently every year as long as an appropriate average return is achieved over time.

7.2 Performance against targets

  • COMU has established a standardised set of financial performance measures to measure shareholder return, profitability and solvency for SOEs. The aim is to promote transparency and consistency. The financial performance measures and the related definitions are set out at Annex 5. SOEs are encouraged to include these measures in their SCI, where relevant, and adopt the proposed calculation. COMU intends to incorporate the final set of measures in its reports to the Ministers on the financial performance of SOEs.
  • If an SOE anticipates that it will not achieve its stated performance targets, shareholding Ministers expect advice from the board, including detail of the reasons for the expected shortfall and the actions to remedy the situation in the future. In general, this can be achieved through the quarterly reporting process. Where performance shortfalls are significant, however, shareholding Ministers expect more direct notification, including any remedial action proposed, and to be made aware of progress. In this instance, officials may interact more frequently with the board, depending on the circumstances at the time.
  • In cases of serious underperformance or financial distress by an SOE, shareholding Ministers have a number of options, including:
    • seeking more detailed information from the SOE (eg, monthly accounts and cash flow forecasts)
    • working with the board with a view to improving its performance
    • reviewing the membership of the board
    • appointing a special advisor to the board, and
    • liquidating or re-capitalising the SOE.
  • Such measures, particularly the latter, would only be taken in extreme circumstances, and shareholding Ministers would consult with the board before taking such steps. Boards should not, in the absence of an express agreement to this effect from shareholding Ministers, assume that additional financial support will be provided by the Crown to an SOE.

7.3 Managing for value – value-based reporting

  • A core expectation for SOE boards is that there is a continual focus on managing for value. As outlined in Section 5.5.3, boards should understand the company's value drivers and monitor enterprise value constantly.
  • To support this, in addition to reporting under the requirements of generally accepted accounting practice (GAAP), Ministers also encourage the use of value-based reporting methods such as Economic Value Added (EVA[7]).
  • While each SOE is required to be as profitable and efficient as comparable companies not owned by the Crown, a number of SOEs have a few companies with which to compare their performance. EVA is a useful benchmarking tool in such cases. Put more simply, EVA is net operating profit minus an appropriate charge for the opportunity cost of all capital (debt + equity) invested in an enterprise. The resulting EVA is therefore the profit (or loss) in excess of (or below) an investor's required return.

7.4 Managing risks

  • Boards are responsible for managing risks, and should establish processes and practices within the SOE to manage all risks associated with its operations.
  • Boards should also keep shareholding Ministers informed of risk management strategies through their business plans and other reports, when necessary and as per the “no surprises” policy.

7.5 Foreign exchange risk management

  • SOEs with exposure to foreign exchange risks should have policies and procedures for managing these risks and, if requested, report against these policies and procedures to shareholding Ministers.

Notes

  • [7]EVA is a registered trademark of Stern Stewart.
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