In our paper, we consider how the legal and policy challenges associated with related-party transactions (RPTs) in state-owned enterprises (SOEs) differ from those associated with privately owned enterprises (POEs). Our analysis reveals two key differences: first, RPTs in SOEs may decrease social welfare not only when they cause harm to a given SOE by extracting wealth from minority (non-state) investors (the common problem known as ‘tunneling’ potentially found in any firm with a controlling shareholder), but also when the state provides the SOE with benefits (such as a subsidy) not available on the same terms to a POE. This form of RPT is sometimes referred to as ‘propping.’ While governments can and do occasionally prop up POEs (especially in times of crisis), propping is more prevalent and pervasive in SOEs.

The second, and from our perspective more interesting, difference, is that the state does not need to engage in a ‘transaction’ in order to extract something of value from an SOE at the expense of minority (non-state) shareholders. Rather, the state can extract private benefits of control by engaging in what we call ‘policy channeling’ – the government’s use of partial ownership of an SOE to achieve social or industrial policy objectives. Operating an SOE not to maximize shareholder wealth but to achieve a government policy objective may be appealing to a state in its capacity as controlling shareholder for a variety of reasons: it may be a lower cost substitute for regulation in weak institutional environments, minority investors implicitly bear at least some of the cost of the policy’s implementation, and the SOE shields the policy from public participation and accountability.

Interestingly, not all states engaged in extensive ownership of business enterprise pursue policy channeling. In Singapore, Temasek, the state holding company, pursues a strategy of operating SOEs in a completely commercial, profit-maximizing fashion. The government then uses its share of the profits from the SOEs to pursue its social policies. Thus, although state ownership of business enterprises is used as a means of pursuing policy objectives, management of the enterprises is not. 

After mapping the nature of these issues in SOEs, our paper examines the potential for different legal strategies to address them. Interventions could in theory occur at the level of the controlling shareholder – the state – or at the level of the SOE. At the controlling shareholder level, measures can be taken to insulate the state’s role as a shareholder from its role as a regulator and policy maker, such as fully centralizing the ownership function in a separate state holding company. This is one of the key recommendations of the influential OECD Guidelines on the Corporate Governance of State-Owned Enterprises. We discuss the limitations of this approach. At the SOE level, most countries have sought to improve their governance by subjecting SOEs to the same corporate law that applies to POEs. We again discuss the limitations of this approach. Finally, we consider a novel approach to SOE governance in Brazil, where the stock exchange has created a voluntary accreditation program for SOEs seeking to comply with corporate governance best practices.

Still, most policy initiatives concerning SOEs have a general focus and are not tailored specifically to related-party transactions. Policy channeling raises interesting issues of legal strategy that have not been addressed in depth in the literature. While corporate law is generally ill-equipped to police the merits of corporate decisions in the absence of a conflict of interest, it is possible that strategies drawn from corporate law might be adapted to address policy channeling. We outline one such adaptation in our paper, involving minority (non-state) shareholder approval of the policy objective being pursued by an SOE.


Curtis J. Milhaupt is Professor of Law at Stanford University.

Mariana Pargendler is the Florence Rogatz Visiting Professor of Law at Yale Law School.