The Ivey Business Journal Interview: Aldo Musacchio

Aldo Musacchio is an associate professor in the Business, Government and International Economy unit and a Marvin Bower Fellow at Harvard Business School. He is the co-author of the forthcoming book, Leviathan Evolving: New Varieties of State Capitalism in Brazil and Beyond with Sergio G. Lazzarini, a professor of Strategy at Insper Institute of Education and Research, Sao Paulo.

They may not be discussed at the water cooler, like last night’s game, for example, but in many management and board meetings, State-Owned Enterprises (SOEs) and their motives are becoming a regular topic. And while the discussion of SOEs usually begins – and ends — with today’s Chinese variety, SOEs have a long and interesting history. IBJ recently discussed the history and other aspects of SOEs with a B-school academic who has done extensive research and writing on the phenomenon.

IBJ: Why did you write the book?

Aldo Musacchio: I realized that the current debate on state capitalism and the efficiency or inefficiency of State-Owned Enterprises was outdated. I have always been interested in corporate governance and I realized that flagship SOEs in emerging and developing countries were copying the governance arrangements of private companies. Moreover, the rise of China, Brazil, and Russia to center stage in global markets made me realize we needed to study their firms, state-owned or not, from a different perspective.


What is the commonly understood definition of state capitalism and why do some people fear it?

State capitalism is the widespread influence of a government in the economy, either through owning majority or minority equity positions in companies or by providing subsidized credit and/or other privileges to private companies.

Part of the fear and misunderstanding of state capitalism in the post-Berlin Wall era stems from the fact that most observers compare today’s SOEs to SOEs in the Soviet era. They are similar. However, this confusion of state capitalism with command economies leads to misunderstandings of the actual strategies governments now use to intervene in companies and the effects of those interventions on a company’s efficiency. The Soviets never made their SOEs comply with international financial standards nor had them audited by international accounting firms. Profitability was not a major concern for them.


Can you trace the history of SOEs?

The rise of SOEs began in the nineteenth century, when governments tried to solve basic market failures. Around the world, governments stepped in to provide public services such as mail, water and sewage, and later on electricity, telephone and railways. Governments acted as insurers against failure. This changed with the instability that prevailed widely in the 1920s and later, during the slowdown of the depression. Governments had to step in and take over the operation of these services. The policy of bailing out ailing industries became a more integral part of government policies in Europe and Latin America after the depression. The prototypical example is the Italian government’s Institute for Italian Reconstruction, which was formed in 1933 to bail out the county’s three-largest banks, which controlled a variety of companies.

This move essentially ushered in the second stage of state capitalism, from the 1930s to 1980s. It was characterized by the state venturing into firms across many industries, sometimes by design and sometimes by accident. This was largely a consequence of the nationalization of foreign companies. As some have contended, governments in the non-socialist world had become emboldened by their success as economic managers during World War 2. They leveraged that confidence to venture into major industries such as coal and steel, which the UK’s Labour government nationalized after the war. At the same time, governments in developing countries began to nationalize and operate companies at an accelerating pace.

There was a third stage in the evolution of state capitalism which was precipitated by the global liquidity crisis of the early 1980s. The crisis was a wake-up call for governments as it underlined two glaring weaknesses in the way they used SOEs. First, governments realized that they had to have stronger control over how SOEs were being run. For example, numerous SOEs, left to manage themselves, had more workers than they really needed. Secondly, the crisis revealed the folly of using SOEs to achieve political or social goals during the crisis, for example, by having SOEs issue debt on behalf of the government. SOEs had essentially gone from being a tool of development to being a drag on development and a burden on the government’s balance sheet. (One of the important results of the failure of the SOE model is that it led the IMF to call on governments to report net profits or net changes in SOE assets as part of a government’s financials). As governments in emerging markets restructured their debts to banks in the developed world and began to convert their debts into sovereign bonds, they realized that they had to eliminate burdensome, money-losing SOEs.

The changes in the third stage, at least in the largest emerging markets, resulted in a new mode of state capitalism, one in which governments retained some SOEs but changed the way they were run.  One approach was to corporatize, that is restructure, them so that they looked like a private corporation, with a board of directors and professional management, but without necessarily listing them on a stock exchange. In effect, the government became a majority owner in a variety of firms, such as oil companies Sinopec and Petrobras, or aeronatutics firm EADS, or the VTB bank in Russia. Governments also retained minority equity stakes in some of the privatized firms, which led to the rise in use of sovereign wealth funds to acquire minority positions in private firms they considered strategic.


Why should the Western world care about how SOEs operate?

Well, it turns out that many of us invest in SOEs, mostly through mutual funds, but also through other vehicles. Moreover, some of the largest firms in the world are SOEs. They are also multinationals, so either there is a Chinese or Brazilian SOE buying a local firm around the corner or there will be one soon. For instance, I just met someone who worked for Pilgrim’s Pride in the U.S., which was acquired recently by a Brazilian firm called JBS. What this person didn’t know is that the government of Brazil is the second-largest shareholder of JBS, with 29 percent of the voting equity.


“Opaque” is the word that is generally used to describe the state of SOE governance. What will it take to make those practices more transparent?

We want SOEs to be publicly listed, to report (audited) financials regularly, and to play by the rules of the World Trade Organization.  We also want them to act independently of the development banks of their home countries.  And, we want them to be in the spotlight, we want active NGOs and institutional investors exposing shady deals and corrupt practices. When Sinopec gets awarded a contract to exploit an oil field in Angola, we want to make sure that the government of Angola is not getting soft loans on the side. We all want SOEs to play by the rules.


Does a degree of managerial autonomy prevail in SOEs, especially compared to public firms in America?

Nothing compares to the degree of autonomy in American publicly listed firms; nothing. But in recent years, large SOEs in developed and developing countries have gained more autonomy from their governments, especially financial autonomy. In a survey I did of 30 national oil companies, I found that about half of them are publicly listed and have financial autonomy. That is, these 15 firms can make their investment decisions without having to ask for government approval. This is quite impressive, especially if we keep in mind that governments want to keep a grip on what is happening in the oil industry.


Is the contemporary model of state capitalism, as exemplified by Chinese SOEs, different than the model that prevailed in the latter half of the twentieth century?

Yes. State involvement in enterprises in the 20th century took the form of common economies or mixed economies in which governments owned a large number of enterprises and directly controlled the allocation of strategic resources. More recently – perhaps paradoxically – the privatization and liberalization waves of the 1980s and 1990s helped create two new forms of capitalism – both hybrid – in which the government influences investment decisions of private companies through majority ownership in publicly traded corporations and through either minority equity investments or loans from government banks.

So you have a marked distinction between the old form of Leviathan as an owner and manager, and today’s forms of state capitalism: through majority control in publicly traded corporations, or in a more hybrid fashion, through minority investments by developed banks, pension funds, sovereign wealth funds and the government itself. One is the Leviathan as a majority investor, the other the Leviathan as a minority investor. Many national oil companies (NOCs) are typical examples of the Leviathan as a majority shareholder. Governments have either full ownership, Aramco in Saudi Arabia and Pemex in Mexico, or at least control, Sinopec in China and Gazprom in Russia. These days, it’s fair to say that the Leviathan as a minority investor has become a dominant feature of state capitalism.


It seems to me that SOEs today are generally more interested in running an ideology-free, profitable business than they are in pushing the interests of the state.

Yes and no. I think governments (at least in middle to high income countries) have realized that if their SOEs are run following mostly political or social objectives, they end up being extremely inefficient and a financial burden. In other words, profitable SOEs make states stronger. Therefore, in the last 10 to 15 years we have seen a move towards more separation of ownership and control in SOEs.

In some of the largest SOEs in emerging markets, the most common agency problems found before 1980, such as weak incentives for managers or weak monitoring of managers by government agencies, have been tackled. SOEs in many countries have become profitable and voracious global players. For instance, the  Fortune Global 500 did not have any SOEs among the top ten firms in 2005, but today it has four. The number of SOEs among the top 100 global firms in 2005 was 11. Today there are 25 SOEs among the largest firms in the world (by revenues). This is why it is no longer valid to judge state capitalism in terms of the pre-a980’s command and control economy. We need to understand better how SOEs are run today. We especially need to understand new motivations of SOEs, their new corporate governance arrangements and their sources of competitiveness.


Many observers in the West see Chinese SOEs as proxies for the Chinese government/Communist Party, with hidden, ulterior motives. Is there any reason to be apprehensive about their motives?

Maybe. Recent research is starting to show that Chinese SOEs are aggressive in buying controlling stakes in companies in the natural resource sector in developed and developing countries. Perhaps they are acting as rational firms trying to secure inputs, just like Japanese firms did in the 1970s. But perhaps they are acting as proxies for the Chinese government. We know, for instance, that Chinese SOEs are aggressive when it comes to securing concessions for mining sites or oil fields abroad. They are also merging and acquiring a variety of natural resource firms around the world. That, for me, indicates they are trying to secure access to inputs they need at home. They are doing it because they need the inputs but also because it is a matter of national security.


In your observation, do SOEs – Chinese or others – promote their government’s foreign policies?

Yes, in many instances. But what is interesting is that it is hard to know. That is, SOEs go abroad and look for profitable opportunities. For example, some Chine SOEs seek opportunities in, say, oil fields in Africa that benefit China. So in a way you could say they are promoting Chinese foreign policy. Yet Sinopec also benefits from having access to cheap Angolan oil, so securing those resources is also of interest to the company.  In essence, diplomatic and financial objectives in these firms often overlap. Now, does China Development Bank need to give loans to Venezuela while it enjoys record-high oil prices? Not really, but they probably do it because they want to keep the country as an ally and because they can open the door to other Latin American countries such as Ecuador, Bolivia, Nicaragua, and Cuba.


The Canadian government recently approved CNOOC’s takeover of Nexen. Was the government’s very deliberate approach to the approval warranted?

I think so, and I think that even CNOOC knew this. CNOOC has a long history of being scrutinized for its intentions, especially when it came to  buying Western oil firms. Remember the UNOCAL deal (failed purchase, 2005). I think that in Canada, CNOOC went in knowing that it would be a slow process with lots of hurdles. But in the end they knew they would get it if they offered a good price.

Now, think about this deal. Is it a deal that benefits China? Yes, because it gives CNOOC access to oil in Canada, the U.S., and Africa. But it is also a deal that benefits the shareholders of CNOOC and Nexen. That is, here you have something that years ago would have been considered high imperialism. But today it is done by following the rules of the market, with investment bankers as advisors, with lawyers drafting contracts, with CNOOC paying a premium to Nexen shareholders, etc. This is really the new phase of state capitalism.


From your vantage point, do Chinese SOEs behave any differently than other, major foreign investors?  

They behave like aggressive multinational enterprises that are trying to secure inputs and markets for their products on a large scale and in a rapidly changing environment. Remember the 1970s and early 1980s when we were all afraid of Japanese multinationals, and they were private firms. Chinese SOEs (and private firms) are doing the same thing today.


How would you characterize the management style of SOEs, i.e., professional, sophisticated, lagging the management style, etc.?

My research shows that it is hard to generalize. There are SOEs with professional management, with incentive contracts for CEOs, with boards that have professionals and independent directors, etc. Other firms are connected to the government, have politically-appointed CEOs who have no experience in the industry, with no boards and which are not publicly traded. I would say that flagship SOEs in large countries are moving more and more to a model in which management is relatively sophisticated.


Are their management and operating styles relatively transparent?

Again, there is a lot of variation, making it hard for me to generalize. I did a study of 30 national oil companies (NOCs) and I found that only about 10 have financial reporting that follows GAAP or IFRS (international) reporting standards, with results audited by reputable firms. Among those ten NOCs, there are some really amazing firms that have transformed into firms with good governance, which are extremely transparent, and are seen as investor-friendly. Think for instance of Statoil (Norway) or Ecopetrol (Colombia).


SOE’s, whether Russian, Chinese or others, have traditionally been characterized as slow-moving, bureaucratic behemoths? Is this still the case?

I think this is a typical criticism that applies to the SOEs of extremely poor countries or SOEs of the past. Flagship SOEs in mid-income to high-income countries have been transformed into publicly-traded corporations in the last 20 years and their decision-making pace and execution lead times have shortened. These firms now respond to markets just like GM, GE or Google do. Obviously, I cannot generalize, but that is the trend.


To the extent that one can generalize, why would a western-trained manager go to work for a CNOOC, for example?

Imagine you are an extremely smart oil engineer with experience in exploration. Where is the cutting edge of exploration going to be right now? Well, in the CNOOC or Rosneft platforms doing deep sea drilling in inhospitable places (e.g., in the Arctic Circle). Moreover, some of these SOEs are now following the market, so they pay competitive salaries.


Are the managers of Chinese SOE’s professional managers or members of the party’s bureaucracy or both?

Well, both. There are many professors and Chinese Ph.D. students working on this right now, looking at the careers of these Chinese executives who work in SOEs. From my limited research on national oil companies it seems like the Chinese government likes to have members of the Communist Party with good technical backgrounds working in these firms. They have long careers in the oil industry and they may rotate among the three oil firms in China. There is a system of rewards that incentivizes these members of the Party to do a good job in their executive positions, mainly because promotions are based on performance. It is hard to see underperforming executives climbing through the ranks. So, these executives are not your typical run-of-the-mill bureaucrats.


The number of SOEs has been decreasing, whether in China or the EU. Why?

Governments have realized that SOEs can be a burden on their budgets, so since the 1980s most governments have been getting rid of unnecessary SOEs or those in which there was no reason for the government to be an owner.


Should private companies adopt certain characteristics/operating styles of SOEs?

Well, this is a tough question. Supposedly governments in some SOEs act as institutional investors with very long-term views. Thus they may incentivize firms to invest in R&D, especially in riskier projects, projects with long maturities, or projects that have high spillovers. Think for instance of Petrobras, the Brazilian oil company. They invest very aggressively in the development of biofuels and have done so for decades. They have also developed state-of-the-art technologies to drill for oil in ultra-deep waters (e.g., 7kms). These investments required big investments (lower dividends for shareholders) for decades. But the firm is now a leader both in biofuels and deepwater exploration.


Recalling Congress’s decision to reject Dubai Ports’ application several years ago, will the time come when America will approve either the takeover or management of an American asset by an SOE?

This is a good question. I don’t know. It will depend on how the acquisition plays in the American political system. Remember that in the Dubai Ports case the problem started when American senators used the deal as a campaign platform. But the Nexen deal is perhaps evidence that times have changed. After long deliberation, the Committee on Foreign Investment in the United States approved the deal, giving CNOOC ownership over Nexen’s assets in the Gulf of Mexico.