Corporate governance and state governments

Corporate governance aims to maximize its shareholders' value. But can state governments apply the same concept with their peoples?
By Amr Hussein Elalfy, MBA, CFA

6/15/19 10:04 PM

Most investors realize well that corporate governance - especially in the stock market - is essential in preserving their rights as shareholders. Following the rules of governance helps avoid conflicts of interest that usually come about between shareholders on the one hand and management on the other, hence the importance of corporate governance. But what if we apply the corporate governance system in some way to states?

If we were to consider that the state is a joint stock company and that the people is the largest shareholder in that company and that the political administration is the board of directors of the company and therefore the goal of the people will be the same goal of shareholders, which is to maximize the return on their investment. This may be summed up in the money invested in the case of the company, but in the case of the state what are the people’s investments to be maximized? Capital is undoubtedly one of those investments, but other factors, such as human resources, include effort, time, and knowledge.

In the case of the company, the board of directors weighs the various projects to maximize the return on their shareholders' investments as part of their fiduciary duty - whether implicit or stated – that is granted by these shareholders through voting in the general assemblies when selecting the board of directors. Similarly, in the case of the state, the political administration, through various governments manages the country's affairs towards a general strategy whose main objective is to maximize the return to the people by raising their standard of living and welfare while reducing unemployment and looking after health care and education.

This underlines the importance of the political decisions made by the governments to diversify state investments and diversify their sources of funding. Some countries that are financially strong may not borrow and use their assets as a major component of their investments, while some other countries borrow heavily and can only continue to refinance their investments by borrowing even more to stimulate high economic growth rates. But this situation is unsustainable, which can create headwinds for the state if the investment environment changes or growth rates begin to falter. This could eventually pressure the state badly.

Therefore, it is best to diversify the sources of finance by means of "moderation" between the use of the state's financial resources on the one hand and borrowing (locally or internationally) on the other hand. It is what companies’ board of directors really want: the best combination of shareholders’ equity and debt, or the so-called optimal capital structure, where corporate values are highest. The political administration of a state must determine this mix between the people's ownership rights and borrowing to maximize return on investment and thus see their state flourish.

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