Crown Entities: Balancing Independence and Risk

Major functions of New Zealand government, particularly in the health and education sectors but also in transport, economic development, and scientific research, are carried out by Crown entities rather than by departments. In contrast to departments, which are directly responsible to Ministers, Crown entities are owned by the Crown but are legally separate. The status of each entity is spelled out in legislation that specifies its functions and governance. The typical arrangement provides for a board (appointed by the Responsible Minister) that appoints the chief executive and has powers similar to those held by the boards of private enterprises.

The Public Finance Act (PFA) defines the minimum level of reporting that each Crown entity must provide to Parliament. All Crown entities (listed on the 4th schedule of the PFA) must provide a set of audited annual financial statements. Those Crown entities from which the Minister also purchases services (listed on the 5th schedule) must also provide a statement of service performance that sets out the services actually supplied as compared with specifications established at the start of the year. Those Crown entities presenting a significant ownership interest or purchase contracting risk (listed on the 6th schedule), must prepare a statement of intent at the start of each financial year that includes information on the objectives of the Crown entity, the nature and scope of activities, performance targets and measures against which the entity can be judged, accounting policies, and other matters as appropriate. Additional reporting or accountability requirements may be outlined in each entity's enabling legislation, or trust deed if it is a trust. Each Crown entity must also submit an audited annual report including financial statements and comparisons of financial and service performance against the targets set in the statement of intent.

There are presently more than 2,700 Crown entities, including 2,600 school boards of trustees, 23 Crown health enterprises, 4 regional health authorities, 21 business development boards, and various other bodies. Collectively, Crown entities spend approximately two-thirds of the resources budgeted for the operation of New Zealand government and one-third of total Crown expenses. These monies are made available to Crown entities through funding agreements or similar arrangements negotiated with the Vote Minister. Some Crown entities also derive substantial revenue from user charges or commercial activities.

The Crown entities are a diverse lot and have been established for a variety of reasons. Some (such as those in transport) were established pursuant to the separation of operations from policy; some (such as the school boards) were established to give parents and other stakeholders a stronger voice in deciding the services to be provided; some (such as the regional health authorities) serve as purchasing agents for the government; some (such as the Crown health enterprises) are suppliers of services. At least one (the Law Commission) provides independent policy advice; another (the Lotteries Grants Board) is a transfer agent. These examples show that Crown entities are a catch-all category for the many institutions that are neither departments nor State-owned enterprises. Although they share a common label, the Crown entities are not homogeneous in either form or function.

Thoughtful consideration has been given by Treasury and others to the possibility of developing principles to determine whether a particular institution should be accorded Crown entity status. What is lacking, some have argued, is a theory of organisational design that would promote consistency in structuring public institutions. But in view of the variety of Crown entities, it is unlikely that available theoretical tools would provide a sufficient basis for selecting among alternative institutional arrangements. A report commissioned by SSC has recommended a number of criteria for designing Crown entities (Crown Entities: Categories and Principles; McKinlay Douglas Limited, 1994). The primary recommendation is that each entity be single purpose: regulatory, policy, and purchase functions should not be commingled. The report also suggested that an institution would be suitable for Crown entity status to the extent that (1) the output to be contracted for could be specified and measured; (2) giving the entity independence would diminish the risk held by the government; (3) independence and objectivity were important; (4) the government needed specialised expertise; (5) it wanted to enhance stakeholder input; (6) outputs or services were contestable; and (7) the cost of transitioning to Crown entity status was modest.

In view of the wide disparities in the types and functions of these entities, it may be of little value to seek consistency in design. A more productive approach may be to examine, on a case by case basis, the effects rather than the causes of conferring Crown entity status. The most important effect is that public risk and public expenditure are separated. The government holds the risk, and Crown entities spend much of the money. In designing institutions, the government must balance its financial and political risk against the value of giving the entity legal independence. Even when the entity is independent, the government still may be liable in case of negligence or default, and it may bear political onus for perceived inadequacies in services. When the government owns the Crown entity, supplies all or most of its capital and operating funds, and makes most of the key policies, it cannot escape responsibility by claiming that the entity is independent.

I previously argued that in separating policy from operations, it should not be presumed that the new agency will be a Crown entity. The government may be best served by a variety of organisational forms including Crown-owned companies that operate in contestable markets, Crown entities that are financed by public funds, and other types of non-departmental bodies and executive agencies that have operating flexibility but not legal independence. The last is the route favoured in the United Kingdom's Next Steps initiative. If the United Kingdom system were adopted, the chief executive of each such agency would be appointed by the Responsible Minister or the government, not by a governing board. The Minister would negotiate an understanding with the chief executive, setting forth the managerial flexibilities that the agency would be given. The Minister would take the initiative in establishing financial and service targets for the agency and would assess its performance against the targets. This assessment would enable the Minister to fine tune the agency's operating discretion to its managerial capability. The Minister and the agency would negotiate an annual funding agreement that would specify the resources to be provided and work to be done. Each agency would prepare an annual report including financial statements.

Executive agencies would give the government an additional option in designing institutions. In some cases, it may opt for the independence afforded Crown entities, but in others it may prefer the executive agency model or some other arrangement.

Balancing risk and independence also entails review of the accountability framework within which Crown entities operate. Although they are not subject to the same requirements as are imposed on departments, Crown entities are accountable for their finances and performance. In addition to the statement of intent and annual report which are tabled in Parliament, some Crown entities negotiate funding or purchasing agreements with the Minister setting forth the performance expectations and conditions under which it will operate during the year. The Cabinet decided in 1992 that each Crown entity must enter into a purchase agreement with the Minister, but this was not applied until recently. All non-departmental suppliers, including private sector suppliers, must how have a purchase agreement with the Minister. Some Ministers issue formal policy guidelines announcing the priorities to be followed by the Crown entities under their purview. Some Crown entities are closely monitored by the relevant department to ensure that public funds are well spent and that the government's policies and objectives are carried out. Monitoring is especially rigorous in health and education, the two largest sectors in which Crown entities operate. The Education Review Office audits the management and service performance of community schools, the Ministry of Health monitors the performance of the regional health authorities, and the Crown Company Monitoring Advisory Unit and the Treasury monitor the performance of Crown health enterprises. The extensive accountability requirements arise out of the need to manage risk while giving the entities legal and operational independence. Striking this balance entails substantially higher transaction costs than would be incurred by comparable entities operating within departments.

Despite the vast accountability apparatus, the operations and finances of Crown entities are not as transparent as they should be. In the course of the year, an enormous amount of data is generated on the past performance of Crown entities and expectations for the future. However, very little of the data is reported in the budget and related documents. These documents contain estimates of appropriations for each output class, but they do not indicate the volume of services to be provided or priorities to be emphasised in the financial year to which they pertain. The inadequacy of performance information affects the entire budget, but the problem may be even more severe when Crown entities are the end spenders of public funds.

The format and contents of the Estimates have been revised almost every year since the reforms were introduced. The overall trend has been to make the Estimates more accessible and the cost of government programmes more transparent. The clumsy and confusing POBOCS (Payments on Behalf of the Crown) category has been discarded, and the Estimates now distinguish between departmental and non-departmental output classes. But in the case of Crown entities, the current format still fails to provide a clear and comprehensive account of where the money is going and what it will buy. Crown health enterprises (CHEs) illustrate the deficiencies in the budgetary treatment of Crown entities. Reading the budget documents, one would not know that almost all hospital services used by New Zealanders are provided by the CHEs. The Estimates do have a separate Vote for the CHEs, but it only covers capital contributions to these enterprises and the cost of providing policy advice by a specialised unit in Treasury. No mention is made in the explanation of this Vote that the bulk of financial resources are provided via the Health Vote. The estimates pertaining to this Vote do not even mention the CHEs, but they do indicate that approximately $4 billion is to be provided to the regional health authorities.

Transparency is one of the values promoted by the reforms enacted during the past decade. By this measure, the estimates and other budget documents fall far short of the mark with respect to some Crown entities. It is just about impossible to get a full picture of what particular Crown entities are doing or spending. The budget documents should be formatted to provide more information on those Crown entities that are the end users of public funds.

But the issue of Crown entities goes beyond the form of the budget to the substance of Government policy. Crown entities lengthen the chain of accountability from policies made by Government at one end of the chain to the delivery of services at the other end. The longer the chain - it has more links in the Health Sector than in any other - the weaker the Government's confidence that the priorities it establishes will be fully reflected in the services provided. Solving this problem may require fundamental changes in the status, funding, and management of some Crown entities.

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