Promoting the Public Interest
Comments from ACCA
January 2003
The Association of Chartered Certified Accountants (ACCA) is pleased to have this opportunity to comment on Promoting the Public Interest (the draft report). These comments have been prepared in consultation with members of the ACCA's Public Sector Technical Committee, a group of experienced accountants working in the public sector.
ACCA has mixed views on this report. We consider that the first section provides a useful back ground on the not-for-profit sector in the UK, the various legal forms which organisations in this sector can take and the existing regulatory framework. In contrast, we consider that the second section on Financing and Risk in Public Interest Companies is less useful as its assumptions are not explored or validated and it is over theoretical and technical.
Unjustified assumptions
As the draft report says (at the top of page 45), the second section "assumes that access to private sector finance is both practical, legal and desirable". These assumptions are not explored and the reasons for adopting them are not explained, beyond the Institute for Public Policy Research's (IPPR) argument that diversity in the provision of public services should be extended.
At several points in the second section of the draft report it is stated that equity finance has an important role as "shareholders ... will drive efficiency and seek to extract the last pound of value from the organisation" (for example, the top of page 47). This assumed causal relationship between the use of equity finance and improvements in efficiency is not adequately explained. In addition, the draft report makes no mention of the fact that institutional investors are often criticised for taking a very passive role with their shareholdings and do not often use these to influence the management of the companies concerned.
The draft report does state that "managers are seen as best incentivised with the search for real operating efficiencies if they can be sacked if they do not achieve these efficiencies and if their remuneration reflects their success in optimising performance" (page 46). The implication appears to be that performance related pay and, in the extreme, dismissal of managers for poor performance is linked to the use of some form of equity finance. Performance related pay is, however, widespread across the public sector and senior managers may be dismissed if their organisations are not performing at an acceptable level. Several NHS chief executives were, for example, recently dismissed after their trusts were given a 'no-star' rating.
At the top of page 48, the draft report states that "Government is not a particularly good shareholder and is not capable of providing incentives to managers". Again almost no explanation is provided to justify this assumption.
Crucially, the overall conclusion of the draft report, "that Public Interest Companies have a significant potential role to play in the delivery of public services" is given little or no justification within the text.
The role of risk
If, as the draft report states (page 44), the "management of risk is the sine qua non of business", it is strange that few private sector businesses had adopted formal risk management procedures before the 1990's. We consider that it is the making of profit that is central to any business rather than risk management, which is a supportive or enabling technique.
The obligation to provide an essential public service will remain with the government whatever the nature of the contract or partnership with the private on not-for-profit sector organisation concerned. The government cannot allow these services to fail and so, whenever their continued provision is called into question, the private sector provider will be supported by the tax-payer. The draft report recognises this on page 81 where it states that "Government will (in many cases) remain responsible for payments or large subsidies, and in many cases they will bear the ultimate risk for providing the essential service if the Public Interest Company goes bust" (page 81). Far from the private sector managing risks more effectively, time and again, private sector failures have demonstrated that the key risks remain with the public sector even when the services are provided by the private or not-for-profit sectors.
Formal risk management was only introduced in the UK public sector in the late 1990's after the PFI initiative was launched. Thus the search for efficient risk management cannot be claimed as a reason for partnerships between the private and public sectors. Risk transfer is, however, often the main financial justification for such partnerships. Most PFI schemes, for example, would not be considered to provide value for money without taking into account the value of risks which are assumed to have been transferred away from the public sector.
We believe that IPPR should give far more serious thought to the actual benefits of the effective and efficient provision of public services which may be achieved through partnerships with private sector or public interest companies, rather than placing so much emphasis on the role of risk. IPPR should also explain why incentivision of public sector managers through the introduction of equity finance, free market-like relationships and legal contracts is now considered to be so effective. This view is in contrast to the importance which was given, in the past, to the role of the public sector ethos in motivating all public sector employees (rather than just their managers) and thus helping to provide high quality services in a cost effective manner.
Foundation Hospitals and other NHS reforms
The second section of the draft report includes consideration of the arguments for and against the introduction of Foundation Hospitals and the proposed reforms to financial flows within the NHS. This is the most important aspect of the current debate on the subject of public interest companies, so it is strange that the draft report does not provide a more comprehensive consideration of these proposals.
This limited discussion is further undermined by a failure to provide adequate explanations for its assumptions and claims. Thus the draft report states that Foundation Hospitals may be able to "tackle the management bureaucracy that is endemic in the NHS" (page 58) without describing how this will be achieved. Further the draft report states that access to capital markets "might have the additional benefit of providing some private sector efficiency incentives" (page 59) without outlining how such incentives will actually lead to significantly greater improvements in efficiency than are currently achieved through budgetary pressure.
Whilst the draft report does not explain how the possible benefits of the current NHS reforms will be achieved, it does acknowledge that the reforms may lead to a large increase in transaction costs. Thus the draft report states (on page 60), that the proposed reforms to the system of financial flows across the NHS "largely recreates the Conservative Government's 'internal market' which the Labour Government of 1997 dismantled. There are concerns that such a system would lead to an explosion in bureaucracy, with many more accountants being employed to watch where money was flowing rather than doctors being employed to directly improve health outcomes".
Government borrowing
The draft report contains a useful discussion over the concern the Government has over the level of public sector borrowing in the UK, although the point is not made that the target of 40% of net debt to GDP is low by international and historical comparisons.
We agree with the draft report's dismissal of the argument for PFI in terms of access to additional finance and that "this 'off-balance sheet' justification for PFI is now discredited" (page 79). We would also support the IPPR view that the accounting treatment of a PFI scheme should be determined after it has been justified on value for money terms. We are concerned, however, that a suitable methodology for such a justification has yet to be developed and we do not believe that the recent revision to the Treasury's Green Book has achieved this goal.
The draft report does not explain why borrowing money from private markets will provide efficiency drivers (pages 56 and 59) whilst borrowing via the Treasury will not, despite acknowledging (on page 59) that the Treasury can borrow at lower rates than individual entities (whether in the public, private or not-for-profit sectors). This omission is particularly strange as the draft report quotes a report (page 28) which "shows that the presumed efficiencies of profit-maximising shareholder based organisations over Public Interest Companies are somewhat illusory".
Quality of public services
The draft report does not address the problems associated with the lack of clarity in the definition of the quality of public services. This is despite this being essential to the successful further extension of market type relationships in the provision of public services. There are two aspects to the provision of public services, the cost of provision and the quality of the services which are provided. Where only the financial aspect of a service can be defined with any degree of precision, it is almost inevitable that the financial cost of public services will take precedence with a consequent reduction to the quality of these services.