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Invention Journal of Research Technology in Engineering & Management (IJRTEM) ISSN: 2455-3689 www.ijrtem.com Volume 1 Issue 3 ǁ May. 2016 ǁ PP 12-19

State-Invested Enterprises (SIEs) in Mongolia and corporate governance: Implications for economic development and growth. Ernest Nweke(ACA, ACTI, CPA), Prof. Enkhtuya Bavuudorj(PhD) Royal International University (RIU), Ulaanbaatar, Mongolia. SoBAH, Mongolian University of Science & Technology, Ulaanbaatar, Mongolia. ABSTRACT: Globalization, the rapid development and expansion of the Mongolian economy has made the enhancement of corporate governance mechanisms in Mongolia’s state-invested companies imperative. Although Mongolian government has made giant strides in promoting private ownership, a good percentage of listed companies are still state owned having significant influence on the country’s GDP and total market capitalization. While it is a known fact that adherence to the basic principles of good corporate governance are essential for economic growth and development, they are not usually upheld in government owned enterprises. Transparency, accountability, rule of law and stable investment climate are vital in Mongolia’s quest for economic growth and transition to free market. Moreover, in today’s internationalized capital markets, only reputable local companies that meet high environmental, health, safety and corporate governance standards are able to attract foreign capital. This makes it even more of a necessity than choice for good corporate governance standards to be maintained in all Mongolian companies; state-invested or privately held. This paper is an attempt at x-raying the transformative efforts of Mongolian government in promoting economic development and growth through improved corporate governance in state-invested enterprises in Mongolia. Key words: Economic development, economic growth, corporate governance, enterprises, Mongolia.

1. Introduction State invested enterprises are companies or corporations in which the state has stakes either wholly or partially. State ownership has its merits and demerits. Merits of state ownership are not farfetched; inability of capital markets to provide financing for large firms to carry out socially beneficial projects, strategic industry argument, national pride, defense argument and unattractiveness of some sectors to private funding are all justifications for state ownership. Its unintended consequences include the potential for firm mismanagement, corruption, lax in control, supervisions and content of regulations. The most potent argument against state ownership arises out of the conflict of interest associated with duality of state’s role as shareholder and corporate governance regulator. Private ownership on the other hand implies the absence of state investment in companies. It is a proven harbinger of efficiency, good corporate governance, profitability and economic growth. It should be noted that good corporate governance practice fosters economic development through transparency, disclosure equitable treatment of stakeholder and improved investor confidence. What then is corporate governance? “Corporate governance involves a set of relationships between a company’s management, its board, its shareholders and other stakeholders” [1] Good corporate governance provides proper incentives for the boards of companies and management to pursue objectives that are in the best interests of the company and its shareholders and should facilitate effective monitoring. The International Finance Corporation (IFC), an arm of the World Bank agrees with these views; “….good corporate governance contributes to sustainable economic development by enhancing the performance of companies and increasing their access to outside capital” [2] The organization for economic cooperation and development (OECD) enunciated the linkage between good corporate practices and economic development in the following statement; “the presence of an effective corporate governance system, within an individual company and across an economy as a whole, helps to provide a degree of confidence that is necessary for the proper functioning of a market economy. As a result, the cost of capital is lower and firms are encouraged to use resources more efficiently, thereby underpinning growth” [3]. It is therefore clear that the degree to which companies adhere to fundamental principles of good corporate governance is an increasingly important element for investment decisions and has implications for economic growth. If countries are to reap the full benefits of the global capital market, and if they are to attract long-term “patient” capital, corporate governance mechanisms must be credible, well understood across borders and adhere to internationally accepted principles. Mongolia’s soviet era economy was dominated by state ownership, wide spread inefficiencies resulting in poor investor confidence. This is the reason why Mongolian government has placed serious emphasis on privatization to turn the economy around. This paper highlights the efforts of the government in strengthening corporate governance practices in SIEs through outright sale and in some cases reduction in state interests.

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State-Invested Enterprises (SIEs) in Mongolia and corporate governance: Implications for economic development and I (a) Problem Statement and Research Questions Mongolia is currently at the threshold of a major economic transformation driven by the exploitation of its enormous mineral resources. According to World Bank, “to ensure sustainable and inclusive growth, Mongolia will need to strengthen institutional capacity to manage public revenues efficiently...” [4]. Government has already implemented far-reaching economic and political reforms that have facilitated its transformation of Mongolia from state-controlled to a market-driven economy. However, inefficiency still persists in the economy on a massive scale especially in government invested enterprises. There is an urgent need to further improve governance position and encourage more private sector ownership in order to increase Mongolia’s global competitiveness the more. The Mongolia Economic Policy Reform and Competitiveness project designed to promote increased competitiveness of its economy to achieve broad and sustainable, private–sector–led economic growth is ongoing. The key questions are; what gains have been made? How has it impacted economic growth? What is the position of corporate governance in SIEs in Mongolia? I (b) Research objectives and Hypotheses The key objective of this study is to highlight the efforts of Mongolian government at improving the corporate governance (CG) practices in SIEs and the effect it has had on the economic growth and development. With the objectives in mind, the following hypotheses have been formulated; Ho1: Poor corporate governance practices in Mongolian SIEs do not result in inefficiency. Ho2: Increases in private ownership in Mongolia have not led to improved CG in SIEs Ho3: Improved private sector ownership has not contributed to Mongolia’s economic growth.

2. Theoretical Framework Agency theory and neoclassical economic theory provide a perfect explanation of the CG situation in SIEs. Agency theorists posit that an agency relationship subsists between shareholders and directors in their respective roles as principals and agents. According to Jensen and Meckling (1976, p. 308) agency relationship is "a contract under which one or more persons (the principal[s]) engage another person (the agent) to perform some service on their behalf which involves delegating some decision making authority to the agent” [5]. This is the scenario in private enterprises where managers (single agent) are the agents of the shareholders (single principal). In SIEs the scenario is different; a dual agency conflict situation exists. SIEs are governed by multiple agents; directors and elected state officials while voters who elect public officials are regarded as the principals. This multiple agency has been blamed for the poor performance of SIEs; “Inefficiency of the boards of SIEs arises because the agents (public officials) who have the powers to appoint board members and issue managerial directives do not always act in the best interest of SIEs, but in the interest of voters who can vote them out” [6]. Most SIEs were established in Mongolia in the Soviet era to provide key services. They control key sectors such as agricultural exports, transport and communications, manufacturing and agricultural trade and government exercises immense control over them appointing directors and issuing directives of a general nature. Furthermore, a good number of the SIEs were not set up to make profits and as such, profit maximization ought not to be the sole basis for measuring their efficiency. Neo-classical economic theorists believe that “the failure to measure performance by profitability is regarded as the main cause of the inefficiency of SIEs, as it deprives them of the incentive to increase gains, cut costs, and operate efficiently” [7]. The need for privatization is therefore attributable to “the failure of the State, as an owner of enterprises, to motivate the firms to realize competitive business standards” [8]. As a result, neo-classical economic theorists regard privatization as a requirement for achieving a free capitalist market economy and as the best way to enhance operational efficiency because “the need to increase individual gains or wealth maximization in a free market results in efficiency and therefore contributes to the general social welfare and economic benefits” [9] For them, the competition and efficiency arising from privatization is justified on the basis that it leads to the better provision of services at a lower cost and therefore enhances the enjoyment of socio-economic rights by all. In the light of the above, move by the Mongolian government to enhance the competitiveness of the national economy through improved private sector participation is a welcome development.

3. Methodology This paper is empirical in nature. It is factual; deriving information from both reliable secondary and primary sources. The paper begins with an introduction explaining the key concepts, highlights the need for good corporate governance and the linkage to economic growth and development, lays emphasis on government efforts to improve governance situation in Mongolian SIEs, dwells on the macroeconomic changes in GDP structure of Mongolia overtime and focuses on the challenges ahead. III (a) Collection and Analysis of secondary data Authoritative websites and government literatures were consulted for secondary data. Secondary data for the study was in respect of market capitalization of SIEs and Mongolia GDP data and was analyzed using charts, bars, percentages and regression analysis in excel.

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State-Invested Enterprises (SIEs) in Mongolia and corporate governance: Implications for economic development and III (b) Primary Data Collection and Analysis Personal interviews and surveys were held to collect primary data. Primary data was in respect of corporate governance practices in Mongolian SIEs and was collected using questionnaire. The questionnaire is structured in such a way that it covers four key governance areas; disclosure and transparency, board functioning and independence, shareholders rights and conflict of interest. There were a total of twenty (20) questions on the questionnaire; six (6) each pertaining to disclosure and board functioning and independence, four (4) each pertaining to shareholders rights and conflict of interest. Questionnaire responses were measured using Likert five point-scale; strongly agree to strongly disagree. III (c) Population and Sample Size Out of a population of thirty-six (36) SIEs listed on the Mongolian Stock Exchange, a sample size of fifteen (15) randomly selected companies was used for the study. Five (5) management level employees were surveyed in each selected company giving a total of seventy-five (75) respondents. This was to ensure that only knowledgeable and experienced staff were surveyed. Analyses of collected data test of hypotheses were carried out using Chi- square test. Conclusions were drawn and recommendations made to further improve corporate governance practices in Mongolian SIEs.

4. Mongolia – Change in macroeconomic structure Mongolia is a country very rich in natural resources with formidable growth prospects. Transitioning from a socialist to a democratic system of governance and free market economy in the early 90s, Mongolia is today one of the fastest growing economies with GDP growth rate for 2011 reaching an all time high of 17.50% and 12% for 2013 according to the World bank [10]. The current scenario is in sharp contrast with the situation in the early 1990s when the economy was in doldrums; state invested enterprises accounted for 96% of the economy with the bulk of the support for the economy coming in the form of Soviet aids. Soviet aids accounted for as much as two thirds of the GDP. This enormous level of aid disappeared with the fall of the Soviet Union between 1990 and 1992, pushing the country into deep recession. Government quickly responded with transition to democratic rule, establishing the Mongolian Stock Exchange (MSE) to facilitate the privatization of state owned enterprises. Government establishments were marred by large scale inefficiencies and corruption and privatization was a sure option to improve the competitiveness of the Mongolian economy. Table 1: Ownership of MSE listed companies as at March 2015 OWNERSHIP OF MSE LISTED COMPANIES AS AT MARCH 2015 100% State owned companies Partly state owned companies Non-state owned companies TOTAL Source: Author-prepared, using 2015 research data.

NUMBER OF COMPANIES 21 15 288 324

Table 1 above clearly illustrates how the ownership structure of listed enterprises has changed over time on the MSE. 96% of listed companies in the early stages of the MSE were state owned, as at March 2015, the picture has changed dramatically.

Figure 1: Ownership of MSE listed companies as at March 2015. Source: Author-prepared, using 2015 research data. Fig.1 above illustrates the sharp decline in state ownership of MSE listed companies. It is easily observable that the change in the ownership structure of Mongolian enterprises brought about massive improvement in economic performance and unparalleled contributions to GDP growth by the private sector. In terms of GDP | Volume 1| Issue 3 |

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State-Invested Enterprises (SIEs) in Mongolia and corporate governance: Implications for economic development and contribution, the private sector accounted for 56% in 1996, 71.8% in 1999, 75% in 2001 and over 80 percent as of today. Table 2 below further illustrates this transformation. Table 2: Change in Mongolia GDP structure CHANGE IN MONGOLIA GDP STRUCTURE YEAR STATE PRIVATE TOTAL 1990 96% 4% 100% 1996 44% 56% 100% 1999 38% 72% 100% 2000 37% 73% 100% 2001 25% 75% 100% 2004 22% 78% 100% 2007 18% 82% 100% 2010 15% 88% 100% 2011 13% 89% 100% 2014 10% 90% 100% Source: Author-prepared, using 2015 research data. Table 2 above shows that overtime, the structure of Mongolian economy has changed from state-driven to private-sectordriven. Fig. 2 below diagrammatically illustrates the change in Mongolia GDP structure from state driven to private- sector-driven.

Figure 2: Change in Mongolia’s GDP structure Source: Author-prepared, using 2015 research data from http://www.tradingeconomics.com/mongolia/gdp-growth-annual. Table 3: GDP growth rate and private ownership PRIVATE OWNERSHIP % OF YEAR NATIONAL ECONOMY(X) 1990 4% 1996 56% 1999 72% 2000 73% 2001 75% 2004 78% 2007 82% 2010 88% 2011 89% 2014 90% Source: Author-prepared, using 2015 research data.

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GDP GROWTH RATE % (Y) -8% 7% 4% 4% 3% 5% 10% 8% 18% 12%

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State-Invested Enterprises (SIEs) in Mongolia and corporate governance: Implications for economic development and Table 3 above shows that as state role in the economy declined with increase in private ownership, efficiency and profitability increased resulting in increased GDP growth rate overtime.

Figure 3: GDP growth rate and private ownership Source: Author-prepared, using 2015 research data Figure 3 above clearly shows that the current double digit growth rate of the Mongolian economy is attributable to increased private sector participation in the economy. Private sector participation in the economy increased as a result of government privatization program.

5. Brief insight into Corporate Governance practices in Mongolian SOEs In spite of the enormous change in GDP structure of Mongolia, the few SOEs left still are still a significant proportion of the economy. Although “SOEs can be operated according to similarly high standards of governance, transparency and efficiency as private companies, only some of the world’s most advanced economies have attained this point” [11]. Mongolian experience has shown that corporate governance in these SOEs is virtually non-existent. These companies are mainly in energy, mining, transportation and agric sectors. Many of these SIEs do not have formal mission and vision statements. Furthermore, in a good number of them and contrary to the provisions of the Mongolian company law that requires board membership of 9 or more, board membership is 8 or less. Majority of the boards are dominated by non executive members. Furthermore, a many do not have by-laws for board of directors. It is therefore not surprising that most of the boards do not function properly and some even do not hold meetings for upwards of one year. Bearing the above inefficiencies in mind, it is encouraging and a welcome development that Mongolian government is unrelenting in its efforts to further reduce government ownership in SIEs. Set out below is a list of state owned enterprises for full or partial privatization.

6. Current and ongoing reforms According to News.mn, the under listed companies are up for privatization. In most cases, the reasons for the privatization and the mode have been provided. VI (a) List of companies for complete privatization 1. [“Erdenet-Bulgan energy network” and “Baganuur, South-Eastern region energy network”. The purpose of privatization is to expand company, renew technology and equipment, cut the costs, and maintain reliability of service. Open tender will be used to privatize this state asset and national nominees will be allowed for bidding; 2. “Tsagaan Shonkhor” (White Falcon), state owned factory, will be privatized by open tender; 3. “Orgil Rashaan Suvilal” (Orgil Sanatorium Resort), a state owned share-holding company, will be privatized by open tender under the condition that it will not be allowed to change current business operations. 4. “University of Movie Art” LLC will be privatized by open tender in case if private shareholders refuses to buy the Government shares of this company; 5. “Auto Impex” company’s shares will be sold at Stock Exchange in case if private shareholders refuses to buy the Government shares of this company; 6. “Khutul Cement and Lime Factory”, a state owned share-holding company will be sold at Stock Exchange; 7. “Monsam” LLC, share owned by state will be privatized by open tender; 8. “Road Equipment Rental”, share owned by state will be privatized by open tender;

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State-Invested Enterprises (SIEs) in Mongolia and corporate governance: Implications for economic development and 9.

Union of Corporation of traditional medical science, technology, manufacturing, Erchim Corporation, Armono corporation and Agriculture technique, science, technology, manufacturing will be privatized by closed tender based on intellectual property valuation and under the condition that it will not be allowed to change current operations. Only scientist and researchers in the field will be allowed to attend in this tender.

VI (b) Companies, where the government shares will be decreased 1. “Mongolian Stock Exchange”, a state owned share-holding company, will be restructured as minimum of 34% of total shares are under government and up to 66% of total shares will be offered to strategic and financial investors in several phases. The shares will be sold open at Mongolian Stock Exchange and other international stock exchanges with good reputation; 2. “Agriculture foundation”, a state owned factory, will be gone as company structure. The minimum of 34% of the company will be under government and up to 66% of company will be privatized by several phases; 3. “Agriculture Exchange” LLC will be changed as share-holding company. The minimum of 34% of the company will be under government and up to 66% of company will be privatized by several phases at Mongolian Stock Exchange; 4. “Mongol Post”, a state owned share-holding company, will issue additional shares equivalent to its 34% of current total shares and will sell them at Mongolia Stock Exchange; 5. “MIAT” (Mongolia Airlines), a state owned share-holding company. The minimum of 51% of the company will be under government and up to 49% of company will be privatized by open tender; 6. “Telecom Mongolia” a state owned share-holding company, will issue additional shares under the condition that government shares have to be 34% as minimum. 7. “Mongolia Netcom” a state owned limited liability company’s minimum of 34% will remain under government and up to 66% will be privatized by several phases to other companies which have similar business operations; 8. “Shivee-Ovoo” share-holding company’s up to 20% of government shares will be sold at national and international stock exchanges with good reputation; 9. “Baganuur” share-holding company will issue additional shares under the condition that protect government’s share as minimum of 51% and the shares will be sold at Mongolian Stock Exchange”] [12] . VI (c) Key provisions of OECD Guidelines on CG of State-owned Enterprises OECD has made vital pronouncements on CG of SIEs/SOEs in the following areas; 1.State governance of SOEs - Effective Legal and Regulatory Framework for SOEs and State Acting as an Owner. 2. Corporate governance of SOEs - Key concepts– separation of responsibilities, Governance by the board of directors, Executive Management of day-to-day company affairs. These principles serve as guide for countries to benchmark their frameworks. Mongolian framework for governance of SIEs is closely related to the OECD principles. VI (d) Legal and Regulatory Framework for SIEs in Mongolia The following laws and agencies are relevant for the regulation and governance of SIEs in Mongolia. i) Law on Management and Financing of Budgetary Institutions (LMFBI) ii) Law on State and Local Property (LSLP) iii) Decree of State Property Committee iv) Department of State Property Management and Privatization v) Department of Monitoring, Registration, and Procurement

7. TEST OF HYPOTHESES AND RESULTS Questionnaire responses were analyzed and research hypotheses were tested using Chi-Square. The test results are a presented below; Hypothesis 1 Poor corporate governance practices in Mongolian SIEs do not result in inefficiency. Table1: Chi-Square for responses to questions relevant to Ho1 RESPONSE CATEGORY Fo Fe Fo - Fe (Fo - Fe)² Strongly agree 7 45 -38 1444 Agree 30 45 -15 225 Undecided 6 45 -39 1521 Disagree 17 45 -28 784 Strongly disagree 165 45 120 14400 TOTAL 225 Source: Author, 2015 survey.

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(Fo - Fe)²/Fe 32.09 5 33.8 17.42 320 408.31

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State-Invested Enterprises (SIEs) in Mongolia and corporate governance: Implications for economic development and Fo = Observed Frequency, Fe = Expected Frequency Test Statistics X²cal (Chi-Square Calculated) = 413.73 df = 4 α = 1% X²tab (Chi-Square Tabular, X² 0.01,4) =13.28 Test validity All Fe are > 5 Min. Fe = 45 Sample size is > 50 Each Class is > 5

The results above show that the X²cal = 408.31, X²tab = 13.28 at 4 degrees of freedom. X²cal is > X²tab therefore the null hypothesis Ho1 that Poor corporate governance practices in Mongolian SIEs do not result in inefficiency is rejected and the alternate hypothesis H1 that Poor corporate governance practices in Mongolian SIEs result in inefficiency is accepted. Hypothesis 2 Ho2: Increases in private ownership in Mongolian SIEs have not led to improved CG practices. Table2: Chi-Square for responses to questions relevant to Ho2 RESPONSE CATEGORY Fo Fe Fo - Fe (Fo - Fe)² Strongly agree 9 45 -36 1296 Agree 15 45 -30 900 Undecided 6 45 -39 1521 Disagree 15 45 -30 900 Strongly disagree 180 45 135 18225 TOTAL 225

(Fo - Fe)²/Fe 28.8 20 33.8 20 405 507.6

Source:Author,2015 survey. The test results show that the X²cal = 507.6, X²tab = 13.28 at 4 degrees of freedom. X²cal is > X²tab therefore the null hypothesis Ho2: Increases in private ownership in Mongolian SIEs have not led to improved CG practices is rejected and the alternate hypothesis H2: Increases in private ownership in Mongolian SIEs have led to improved CG practices is accepted. Hypothesis 3 Ho3: Improved private sector ownership has not contributed to Mongolia’s economic growth. To test this hypothesis, regression analysis in excel was utilized in analyzing the secondary data shown on table 3: GDP growth rate and private ownership. The result is presented below; Test Statistics X²cal (Chi-Square Calculated) = 507.6 df = 4 α = 1% X²tab (Chi-Square Tabular, X² 0.01,4) =13.28 Test validity All Fe are > 5 Min. Fe = 45 Sample size is > 50 Each Class is > 5

Regression Results Regression Statistics Multiple R R Square Adjusted R Square Standard Error | Volume 1| Issue 3 |

0.843572 0.711614 0.675566 0.038097

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State-Invested Enterprises (SIEs) in Mongolia and corporate governance: Implications for economic development and Decision rule: Accept Ho3 if P-value is > α (the significance level i.e. 1 – confidence level) Reject Ho if P-value is < α In this case, the P-value of 0.036 is < 0.05, so reject Ho3 and accept H3: Improved private sector ownership has contributed to Mongolia’s economic growth. Since the regression line explains 71% of the change in GDP, the relationship is significant.

8. CONCLUSION This paper highlights the efforts of Mongolian government in promoting economic development and growth through improved corporate governance in state-invested enterprises in Mongolia. Mongolian economy has undergone intense transformation that has resulted in double digit growth rate. Private sector is the key to economic progress, prosperity and economic development. All three null hypothesis formulated were rejected and their alternatives accepted. The paper concludes that poor corporate governance practices in Mongolian SIEs result in inefficiency, Increases in private ownership in Mongolia have led to improved CG in SIEs and improved private sector ownership has contributed to Mongolia’s economic growth. The tempo of government’s reform agenda should be maintained in order to further enhance economic growth and development through improved corporate governance practices in SIEs.

9.

RECOMMENDATIONS

Based on the outcomes of the research, the following recommendations are made; 1. Survey results showed that the problem is not the lack of laws and regulations but rather adherence to existing rules. Hence, awareness should be created; supervision and strict adherence to rules should be enforced in those enterprises that may not be fully privatized. 2. Public debate on the corporate governance of SIEs should be encouraged 3. All SIEs should have the required board membership 4. There should be well articulated and clear mission and vision statements for all SIEs 5. Corporate governance committees should be set up a s matter of necessity in all SIEs 6. Government, its agencies and officials should desist from interfering in management of SIEs. 7. The board nomination process for SIEs should be transparent 8. SIE performance should be benchmarked against achievable standards 9. All SIEs should be subjected to strict audit requirements 10. To improve competencies of SIE boards, certification training for board members and induction training should be a vital requirement.

References [1] [2] [3] [4] [5] [6] [7] [8] [9] [10] [11] [12]

OECD Principles of corporate governance, 2004 ed., Preamble. About Corporate Governance. Available from http://www.ifc.org/wps/wcm/connect/Topics_Ext_Content/IFC_External_ Corporate_Site/Corporate+Governance (Accessed September 28, 2014) http://acts.oecd.org/Instruments/ShowInstrumentView.aspx?InstrumentID=151&InstrumentPID=147&Lang=en&Book( Accessed March 12, 2015) http://www.worldbank.org/en/country/mongolia/overview(Accessed April 2nd, 2015) Jensen, M. C., & Meckling, W. H. 1976. Theory of the firm: Managerial behavior, agency costs and ownership structure. Journal of Financial Economics, 3(4): 305–360. Jim Brumby & Michael Hyndman, State Owned Enterprise Governance: Focus on Economic Efficiency, in corporate governance, state owned enterprises and privatization, supra note 15, at 33, 38-41. Danwood Mzikenge Chirwa, socio-economic rights and privatization of basic services in South Africa: a theoretical framework, 4 econ. soc. rights rev. 1, 3 (2003). Saul Estrin, State Ownership, Corporate Governance and Privatization, in corporate governance, state owned enterprises and privatization 11 (Org. Econ. Cooperation & Dev. ("OECD") ed., 1998). Gary Becker, the economic approach to human behavior 3-14 (1976); Richard Posner, the problems of jurisprudence 353 (1990). http://www.tradingeconomics.com/mongolia/gdp-growth-annual(Accessed April 10th, 2015) OECD Corporate Governance Working Papers No. 14, (2014). News.mn, quoted on http://mad-intelligence.com/mongolian-government-to-privatize-state-companies/ (Accessed March 12th , 2015)

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