What is a State Owned Enterprise?
A State Owned Enterprise (SOE) is a body formed by the government through legal means so that it can take part in activities of a commercial nature. Essentially, SOEs are created to undertake commercial activities on behalf of the government.
The government may assume full or partial ownership of a state owned enterprise, which is usually allowed to take part in specific activities. There are many SOEs around the world and examples include Fannie Mae and Freddie Mac, which are sponsored by the US Government.
Role of the SOE
In most countries with an abundant supply of resources, the state usually owns a stake in minerals, oil, and gas produced locally. The resources are accrued because a state owned enterprise owns or operates shares through what is known as an operating license.
The license allows an SOE to enter into a production-sharing contract with other entities on behalf of the government and generate revenue. In addition, revenue can be generated when entities with which an SOE is transacting make payments through royalties rather than actual currencies.
Apart from representing the government in commercial activities, a state owned enterprise also sells physical resources, mostly to trading bodies and companies. In many countries, the management of state resources such as oil and gas is a preserve of SOEs, because it provides an avenue through which the government can be held accountable on matters involving extractive resources.
State owned enterprises are also called government-owned corporations; they can easily be confused with what most people know as listed companies whose stock is partly owned by a government entity. Although both bodies have a government body that owns a portion of the shares, listed companies are owned and operated by private individuals.
SOEs are a common feature around the world, and they can be found predominantly in China, the US, New Zealand, and South Africa. From a legal point of view, many SOEs can be considered business entities in their own right, which provides them with rights that come with being a business enterprise. For that reason, they are required to abide by all the regulations and laws governing their operation and conduct. Otherwise, the law will hold them liable for any irresponsible actions.
State Owned Enterprise Examples
In the US, mortgage companies like Fannie Mae and Freddie Mac are among the most notable state owned enterprises, although they are not restricted to lending only. In other countries such as China, there are many SOEs that receive state support, include the Jin Jiang Hotel, a Shanghai-based entity that is fully owned and operated by the government.
In Africa, South Africa’s Eskom, a utility company, is one of the biggest entities in terms of its power generation capacity, and it is owned and operated by the government of South Africa. Most public utility and transport services are SOEs, and so are mining corporations and postal services.
Corporatization of an SOE
Sometimes, state owned enterprises are formed out of urgency on the part of the government through what is known as corporatization, which allows the entity to act as a for-profit body. In many cases, such SOEs work to meet the goals the government had in mind, however, technically speaking, they operate as commercial bodies.
Often, governments in developing countries create state-owned enterprises in areas of the economy they wish to grow and encourage economic development. This is the case in Brazil and Argentina, which have seen good growth in oil exploration and telecommunication, respectively.
Profits in a State Owned Enterprise
Although state owned enterprises are for-profit entities, not all of them make profits. For instance, the US Postal Service has incurred losses for a considerable number of years at a time. While many SOEs are allowed to operate under similar circumstances, those that are vital to the operation of government business receive bailouts to keep them going, particularly those that are important in infrastructural development. In this case, such SOEs cost the government a lot of money to run and do not generate revenue in return.
SOEs and Economic Development
State owned enterprises are the backbone of many countries, especially in the developing world, and if used properly, they can help spur growth. However, it is still not clear whether the other types of SOEs offer the same benefit to the economy. Nevertheless, there are success stories around the world such as in Norway.
However, South Africa’s not been that lucky, failing to achieve the same level of success compared to Norway. Government control is not entirely the problem. Rather, success is based on the extent of autonomy and level of managerial skills. For example, Norway makes use of the board model and all shareholders are equal.
SOEs are a global phenomenon. Through them, the government is able to venture into commercial activities such as explorative resources. Unfortunately, SOEs can incur a negative reputation by being exploited through corrupt dealings in several countries. When put to good use and managed well, SOEs can help spur economic growth and development.
Thank you for reading CFI’s guide to a State Owned Enterprise. CFI is the official provider of the global Financial Modeling & Valuation Analyst (FMVA)™ certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional resources below will be useful: