Municipal companies need a goal

Toomas Mattson | 7/7/2010 | 9:52 AM

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TALLINN, 7 July 2010 - According to the National Audit Office (NAO), local authorities have not always established goals for participating in companies and foundations. There are serious shortcomings in the organisation of management of companies and the NAO finds that public interests are not well protected in companies where local authorities have a shareholding.

The NAO audited the use of funds arising from law with the aim of exercising owner’s or founder’s rights in 17 companies and foundations controlled by local authorities and identified the goals of participating in companies.

The audit showed that in the local authorities under observation it had usually not been determined as to why participating in the company is important for the local authority and how it contributes to the performance of the local authority’s functions. Therefore, the motive of participating in companies often remained unclear. In various instances the important argument seemed to be the desire to take a loan without increasing the loan burden of the local authority.

The audit also showed that the duties of the directing bodies of companies are often not followed and the rights granted to local authorities by law for directing and controlling the activities of the company are exercised passively. The division of roles of the directing body of the company and those of the rural municipality or city government is often considered a formality that is not overly important upon management of the company. This is colourfully illustrated by the desire of local authority leaders to interfere with the activities of municipal companies using means that are appropriate for coordinating the activities of local authorities. This is neither in line with the principles of management of companies, nor does it make up for the shortcomings in the activities of the directing bodies. If the directing bodies do not perform their functions, there is a real risk that important changes in the financial position of the company will not receive the required attention and the company may run into economic difficulties. Such examples were indeed found in the course of the audit.

Above all, supervisory boards are the directing bodies that should live up to their role in municipal companies. After all, in essence, their duty is to exercise supervision over the lawfulness of the activities of the company and fulfilment of the objectives established for the management board. Unfortunately, supervisory boards are often formed on political grounds and their members do not possess sufficient professional skills.

Based on the audit, the NAO made recommendations to the local authorities, directing bodies of companies as well as to the Minister of Regional Affairs and to the Minister of Finance.
In connection with the fact that the draft Financial Management of Local Authorities Act has been stuck in the Riigikogu since October 2008, Airi Mikli, the Audit Director of the Local Authorities Audit Department of the NAO, noted the following:
“The purpose of the draft act under discussion is to update the requirements related to budgeting and budget implementation in local authorities, but also to establish additional measures for ensuring the financial discipline of local authorities and their related companies. The act should help to control excessive spending and borrowing in local authorities and lay the foundations for making decisions relying on long-term and transparent financial planning in local authorities. If the act enters into force, the restrictions established on the budget deficit must be followed, among others, by companies and foundations operating under the dominant influence of the local authority. This would put an end to the rather widespread financing scheme whereby a loan is taken by a company for the purposes of preventing an increase of the local authority’s debt burden, while the local authority allocates the funds required for repayment of the loan from its own budget.

The NAO finds that adoption of the act would be an important step in improving financial control over rural municipalities and cities. It is worrying that the drafting of the act is moving down a long and winding road in the Riigikogu. Although this year the second reading was reached, it has been suspended for the time being.

It is also known that the legislature is planning amendments that will weaken the measures planned for controlling the financial activities of local authorities. According to the amendments, budget deficit and debt restrictions would be applicable only to some municipal companies, i.e. only to companies that depend on transactions made with other public entities, in other words, companies that earn over a half of their revenue from transactions with such entities or receive support or rental income from the local authority to the extent that amounts to one-tenth of their total revenue. The NAO finds that before making such an exception it should be carefully considered whether the act has the desired impact on the financial discipline of local authorities in such an event and helps to break the former habit of evading restrictions. And even if the exception is established by the act, it should be considered more thoroughly how to prevent intentional disregard for requirements of law – the company can be financially dependent on the local authority in a way other than revenue obtained via sales, lease or support (e.g. periodical contributions to the share capital of the company).”

This spring there were approx. 380 companies and foundations controlled by local authorities. Thereby municipal companies are usually engaged in providing public utility services and foundations are engaged in the field of health care.

Since some service important for the local community is usually provided via such companies, the interest of local residents calls for sustainable management. Moreover, cases were the activities of the company are financed largely from the rural municipality or city budget, that is, where the tax revenue is used for management of the company, are not rare.
In 2009 the revenues of municipal companies and foundations amounted to approx. 7.3 billion Estonian kroons.

The opportunity of rural municipality and city leaders to interfere with the activities of the companies or foundations is much more limited that the possibility to organise the work of the local authority. A company is an independent economic entity whose management is subject to its own rules that have to be followed. Local authority leaders have to understand this in order to achieve control over the activities of the company using lawful means and hedge risks threatening the public interests related to the company in the best possible manner.

At the end of 2009 52% of the companies and foundations controlled by local authorities were so-called micro-enterprises (up to 9 employees), 37% were small enterprises (10-49 employees), 7% medium-sized enterprises (50-249 employees) and 4% were large enterprises (250 or more employees).

Toomas Mattson
Head of the Communication Service of the National Audit Office
+372 640 0777
+372 513 4900
[email protected]

  • Posted: 7/7/2010 9:52 AM
  • Last Update: 11/10/2015 6:04 PM
  • Last Review: 11/10/2015 6:04 PM

Siim Valmar Kiisler, the Minister of Regional Affairs, found that the legislation is force gives local authorities sufficient means for exercising their interests in various companies.

Pärnu Postimees/Scanpix Baltics

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