Hybrid organisations: the ambiguous boundary between public and private activity

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S e e h t t p://o r c a .cf. a c. u k/ p olici e s. h t ml fo r u s a g e p olici e s.Co py ri g h t a n d m o r al ri g h t s fo r p u blic a tio n s m a d e a v ail a bl e in ORCA a r e r e t ai n e d by t h e c o py ri g h t h ol d e r s .All of these organisations finance their activities through charges made to various categories of user; all of them are subject to strong state engagement because all are perceived as serving a wider public purpose.This diverse list of organisations may be described as hybridsneither branches of government, nor commercial organisations, but with some of the characteristics of each.The term 'UK Government Investments' is misleading because the government financial involvement in these activities is not substantially based on an investment motive and any change to that involvement would rightly be the subject of public interest and scrutiny.
There are also many hybrid organisations outside the remit of UKGI: the BBC; museums and galleries; the Royal Parks; NHS hospital trusts; Heathrow Airport; the Bank of England; universities; the Corporation of London; privatised water and rail companies; newly created academies in secondary education; etc.That is before noting the many private businesses which derive much of their revenue from public sector activities: care home providers; companies with extensive outsourcing businesses; defence contractors.Then there is a wide range of public buildings and infrastructure assets are owned through special purpose vehicles; for example, the iconic Treasury building is leased to and from a private company which undertook and financed an extensive refurbishment.
For each hybrid, a related group of issues arises.What is the governance structure, and how does it reflect the wider public interest in these businesses?What is the capital structure, and in particular how is the equity obtained?What is the administrative procedure which takes control of these organisations if they fail, either financially or in terms of their wider societal objectives?It is evident simply from posing these questions that there are no common answers to them.Indeed in several cases it is not at all clear what the answers to these questions are.Even within UKGI, there appears to be little read across on these matters between organisations -no systematic analysis of what works well and what does not.This paper is a preliminary attempt to raise these issues.Such hybrids account for at least one quarter of all economic activity in the UK, and, given the structure of the Welsh economy, it is likely that this proportion is even higher in Wales.

Why hybrids?
A century ago, Max Weber famously identified the defining characteristic of the state as the monopoly of legitimate coercion within a territory (Weber (2015) pp.135-6).In the 19th century, the principal functions of the state were essentially coercive.
Although the modern state continues to exercise these functions, it is primarily engaged in the delivery of services.We look to it to provide health and education, and these are the principal items in the budgets of most such states.Government provides transport infrastructure, and collects the rubbish; it ensures that taps flow with water and that electricity sockets are live.There is even an expectation that the state, or its agencies, provide entertainment on television and ensure fast internet connections.
The principal criterion for assessing performance in coercive activity is the legitimacy of the process.Judges and police officers are expected to adhere to the dictates of the law: if someone goes to prison it should be because they have committed a specified offence, not because they are thought to be a bad person.
Likewise tax inspectors and benefit clerks are expected to collect and disburse according to the rules, not by reference to what they think is fair.However when the state delivers services, the principal concern is with the quality of the services.For example, we are not interested in how rubbish is collected: we just want it taken away.A good school is one which provides a good education for our children.We want comfortable and reliable trains, and the question of who provides the train is relevant only to the extent that it bears on these outcomes.proud cooperative grocery stores went into decline under the supervision of people whose primary concerns were ideological rather than in ensuring that the shelves were stocked with the things its customers wanted to buy (Myners, 2014).Nationalised industries suffered, and schools and hospitals still do, from the infiltration of producer interest groups into the supposed mechanisms of democratic control.
For many services, such as water supply or commuter trains, there is no competitive market, or plausible likelihood of one.For other public services, such as the Land Registry and universities, the public interest in, and value of, their activities extends well beyond the revenues they earn.In addition there are businesses, such as Royal Bank of Scotland and Carillion, which did provide services in a competitive market, but whose failure to do so successfully raised issues of public interest which government could not ignore.That is why we have, and will continue to have, many hybrids, and why the attempt to draw clear boundaries between public and private sector will necessarily fail.

Forms of commercial organisation
Any trading organisationone which has multiple sources of revenue and expenditure, requires access to reserves, to allow medium to long-term planning of its activities, which will inevitably imply uneven cash flows, and to provide for the unexpected, both losses and opportunities.The general answer to this problem in the private sector has been shareholder-provided equity.Payments to equity investors can be varied from year to year, depending on the profitability and cash flow requirements of the business, and by virtue of their contribution shareholders hold a residual claim on the assets of the business in any voluntary or involuntary liquidation.
In return, shareholders enjoy a primary role in governance.This is the reality in smaller companies.In larger ones, whose share ownership is inevitably dispersed, shareholder accountability is largely theoretical, although it has regained strength from the innovation of the hostile takeover and the ideological promotion of shareholder value which went with the financialisation of the British and American economies.Duty to promote the success of the company (1) A director of a company must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole, and in doing so have regard (amongst other matters) to-(a) the likely consequences of any decision in the long term, (b) the interests of the company's employees, (c) the need to foster the company's business relationships with suppliers, customers and others, (d) the impact of the company's operations on the community and the environment, (e) the desirability of the company maintaining a reputation for high standards of business conduct, and (f) the need to act fairly as between members of the company.

This
formulation is intentionally ambiguous.It cannot be interpreted as 'the purpose of the companies to maximise profits': the duty of the board of a company is to promote the success of the company, not the interests of its shareholders.However, the statute acknowledges that since the shareholders are residual claimants on the revenues and assets of the company it is likely that promoting the success of the company will benefit the members.Thus section 172 appears to give shareholders priority, while requiring the board to have regard to the interests of the stakeholder groups employees, suppliers, customers and the communityand to sustain the corporate reputation.Squeezed between the interference of ministers and the tinkering of civil servants on one side, and insatiable demands of employees and customers on the other, potential high custodians found opportunities for public service elsewhere.
The executive management of hybrid institutions must be accountable for the financial performance and social performance.
The Morrisonian answer was a single board which was responsible for both.This is not an arrangement which, as described above, is widely regarded as having proved successful.An  In water and railways, there are special administration procedures under the specific legislation governing these industries, which recognise the imperative need to keep taps flowing and trains running.An industry-specific resolution procedure is now in place for banks, including a complex requirement for living wills, in which the institution is required to make and file with its regulator a plan for asset disposals and financial reconstruction to avoid insolvency.
The special administration procedure for the rail industry came into operation during the collapse of Railtrack, the network operator, but in other rail cases such as the Virgin East Coast collapse this year, franchises have been returned to the state or franchisees replaced.
Before the bankruptcy of Enron, the water regulator had required that its subsidiary, Wessex Water, was ringfenced, so that the creditors of the American parent had no recourse to the assets of the subsidiary, and the company was sold as a going concern without any consequence for water supply.Ringfencing of retail banks is also due to come into effect next year.There are no provisions for special administration in electricity analogous to those in rail and water; Enron also owned a power station in Teesside and it appeared likely for a time that the facility would shut down, although a management buyout restored a viable financial structure.
The vast majority of hybrids have cushions of equity inadequate to deal with financial stress, so the liability for losses, when there are any, fall largely on debt holders.The normal pattern has been that debt during a construction phase is wholly or mainly provided by contractors, and then sold on to investors when the completed project is refinanced.John Laing was responsible for building the new National Physical Laboratory under a PFI arrangement, but was also the main provider of debt to the project, and the massive cost overruns on the project crippled the parent.from other public sector functions.That is not say that the delegation of authority and outcome is not relevant to other public sector activities -the central and difficult management skill of the police chief or army commander is to give juniors authority to act quickly within a highly disciplined framework -but the balance of emphasis is different.
Third, while both day-to-day and strategic management is the responsibility of an executive team, such development is within the context of an overarching framework which reflects the variety of legitimate public and private interests in the activities of the organisation.For the public limited company, that overarching framework is provided by the board, and to some degree by the asset manager in major institutional investors.It is also the board which has responsibility for the appointment of executive management.That raises the question of who appoints the board.In the context of a large public limited company, the board is effectively selfperpetuating; for smaller companies with concentrated shareholdings, responsibility for board appointment lies with these shareholders.
In the case of more or less every hybrid described in this paper, the answers to the questions of accountability and responsibility are complex.This may reflect a genuine difficulty of assimilating a variety of stakeholder interests, but in many cases the answers are simply opaque and obscure.
Fourth, whatever the mechanisms of responsibility and accountability, they should be robust against interest group capture.In the private sector, the mantra of shareholder value has often recently been cover for capture by senior executives as an interest group, most evidently seen in explosion of their remuneration.Before the global financial crisis, some financial companies were plainly run more or less entirely for the benefit of senior employees.
Capture by a broader group of employees, mostly through the activities of trade unions, was a major problem in British nationalised industries.Indeed one of the drivers of privatisation was the Thatcher government's attack on union power in these sectors.The refocusing of union organisation toward public sector professional workers has transferred the locus of this issue to other areas of hybrid activity such as schools and hospitals, while universities have always been employee-dominated organisations.While the interests of private-sector managers and low-skilled public-sector workers were primarily financial, these white-collar groups have broader concerns, with a particular emphasis on personal autonomy.
The emphasis above on the commonality of issues and problems in the corporate and hybrid sectors invites the question 'what are the differences?' The best answer to that is that corporate organisation works best when the value of corporate output is reasonably well measured by the revenue derived from customers.
Hybrids are mostly found in activities where revenue is not a good measure of the value of output.
That observation prompts the question of whether better metrics could be derived for the hybrid sector.When Gavyn Davies was chairman of the BBC, he promoted the idea that the BBC should be judged by the 'public value' that it created (Davies 2004)

Assessment
Two issues need to be dealt with at the outset.The first is that a large part of policy towards hybrids, indeed the very extent of the hybrid sector, is concerned with the structure of the government balance sheet.The capacity of global markets to absorb long-term sterling denominated debt is not materially affected by whether such paper is explicitly guaranteed by the government, backed by longterm contracts with that government or its agencies, or secured on revenues from regulated monopolies such as water and electricity.In all these cases the underlying covenant is fundamentally the same: the willingness of UK taxpayers and consumers to pay.1993).Such markets are certainly often irrational and ill-informed, but the likelihood that the British government will default on its debts in the foreseeable future is, for practical purposes, zero.As the radically different cases of the United States and Venezuela illustrate, default is more likely to arise as a result of political dysfunction than an assessment of the underlying position in terms of national assets and liabilities, the matters which are in the minds of the rating agencies.
The second preliminary issue is that parts of the hybrid sector today suffer from one of the central problems which reduced the effectiveness of British nationalised industries.Civil servants, and many of their political masters, seek to avoid responsibility for outcomes in an activity while being reluctant to relinquish control of that activity.Perhaps the most acute manifestation of this is in energy, where a laudable but perhaps unrealistic desire to create a competitive energy market conflicts with strong, and not necessarily consistent, views about what the outcomes of that market should be.Rail franchising raises similar issues.Perhaps evolution of mechanisms of greater autonomy in schools and hospitals is still at too early a stage for this criticism to be fairly levelled, but the tension between power without responsibility and its corollary of responsibility without power is already evident.

Futures
The range of functions undertaken by hybrids is diverse and it is reasonable to conclude that there is no 'one size fits all' structure.Any review of the composition of hybrid boards reveals that their composition is unimpressive by the standards of boards of major public companies.Hybrid boards should not be captured by interest groups, while nevertheless the objectives of the organisation must reflect the reasonable expectations of different stakeholder groups; this outcome will generally be better achieved by honest brokers than through the conflicting assertive voices of delegates advocating the importance of the interests they represent.While there is importance to achieving diversity of gender, ethnicity, etc. it is difficult to avoid the impression the board composition of hybrids is currently constructed with greater reference to genuflecting to the needs of varied constituencies than in achieving effectiveness of supervisory function.However in the absence of an effective board, it is not possible to achieve either proper accountability for executive management or secure balance between the social and financial objectives of hybrids.

But
That balance is key to their performance.Just as the different needs of different stakeholders are not well resolved by representatives competing for their respective interests, the relative importance of financial and social objectives of hybrids are better matched against each other by a single body than subject to conflict between different bodies proclaiming the supremacy of either the social or the financial.Perhaps the central difficulty of managing services in health and education is to persuade practitioners to assume responsibility for using available resources to achieve the best possible health and educational outcomes, rather than simply to act as advocates the needs of patients of students and demand, insatiably and unsuccessfully, that whatever resources they believe to be necessary are made available.
One would need to have extreme, and unjustifiable, faith in the role of a board populated by high custodians of the public interest to believe that hybrids could be left free of broader regulatory oversight.Such oversight may be undertaken by a regulatory agency such as OFWAT or OFGEM or, as seems more appropriate for agencies such as Companies House and the Land Registry, directly by the responsible government department.As with the boards of hybrids, there is no merit and significant disadvantage in separating the regulation of finance from the regulation of social functions.
UKGI is staffed principally by people with experience in corporate finance and investment banking.This is plainly useful when the government's objective is to sell shares in the hybrid.However only in a small number even of the hybrids in which UKGI is involved is this appropriate.Shares in, for example, Companies House would simply represent a stake in future revenues from Companies House, necessarily controlled by governmenteffectively a convoluted form of government borrowing.While the sale of securities would facilitate the application of a Companies Act structure, principally in relation to membership of the board, that in turn raises the question of who the members of such a company would be.This question does not appear to have a satisfactory answer in the case, for example, of privatised water companies which have complex ownership structures based on elaborate financial engineering.Whatever the right answer to the question of who should be the ultimate controlling party in the provision of important public services in the UK, the answer cannot possibly be 'a company located in a tax and regulatory haven with unknown beneficial owners'.
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