Comment: Governance imbalances in SOEs are bad news for Brazil’s financial ecosystem

Moves to roll back governance reforms introduced in the wake of the Car Wash scandal are bad news for Brazilian investors, says Fabio Coelho.

Fabio Coelho, Brazilian Institutional Investors Association (Amec)

Listed state-owned enterprises (SOEs) are known for being a complex corporate governance ecosystem all over the world. The mixed capital ownership structure makes them subject to the agenda of a given government, but as publicly-listed companies they should also abide by the principles of transparency and equitable treatment of shareholders.

In Brazil, this delicate balance is being disturbed, a move that historically caused systemic ripple effects in the economic growth, financial landscape, and political sphere of Latin America’s biggest economy.

The most notorious move in this scenario was Congress’s attempt to revamp the 2016 SOEs Law, followed by an injunction granted in March this year by the Supreme Court declaring it unconstitutional – made by a single Justice.

That means the referred bill is no longer effectively enforced until the court reaches a final ruling. The legal uncertainty is leading to corporate conflicts, with potential harm to minority shareholders.

Such a situation echoes the reasons why the bill was enacted in the first place, in the aftermath of a riotous era in the country. A few years before, the Car Wash taskforce police uncovered a series of corruption scandals involving high-level federal administration members and prominent SOEs’ senior executives.

The cases led to massive value destruction in financial markets, causing extensive losses to shareholders in Brazil and abroad. Eventually, even the oil maker felt the financial impacts, with compensation paid from class actions in the US (around $3 billion) surpassing the amounts illegally siphoned and later recovered by authorities.

Overall, the law was an attempt to learn from past mistakes and prevent them happening again by establishing a clear separation between the political and the business worlds.

Taking inspiration from other levels of public administration, such as regulators, the law set new criteria for board and C-level nominations. These range from demanding proven work experience and higher academic qualifications to, more importantly, banning professionals who have engaged in political activities in the past three years.

Over time, the rules led to significant performance gains in those mixed-capital companies. According to data from the Federal administration, SOEs’ corporate governance improved significantly, as the index that evaluates such criteria nearly doubled from 4.15 to 8.07 (out of 10) in 2016-21.

At the same time, companies like Petrobras – which once was the most indebted oil maker in the world – turned losses into record profits. Of course, this particular oil producer benefitted from a new commodities cycle. Still, the governance improvements brought by professional management and the adoption of best practices were essential to ensure continuing success.

Recovery measures

However, those businesses flourished at a difficult time. As the covid-19 pandemic and the following inflation crisis worsened the economic conditions, political actors increasingly demanded that state-owned companies took a more active role in recovery measures.

While it seems a reasonable idea, considering they do have a social function, such pressure came at the expense of corporate governance. In the past few years, the federal administration has treated them like cabinets, sometimes by frequently replacing CEOs arbitrarily or publishing relevant information outside adequate channels and time for disclosure.

Petrobras suffered the most from such interferences, a process that only intensified in 2023.

Despite the best corporate governance practices recommended by the company’s own experts, the Brazilian government, as the main shareholder, elected board members who currently hold positions in the federal administration – a move that would have been perceived as a major conflict of interest in any other jurisdiction.

Moreover, Petrobras recently announced plans to amend its bylaws to end restrictions on nominees for management positions, in accordance with the current and temporary Supreme Court’s view of the law, as well as to create a fund to retain profits.

Although the decisions still need shareholders’ approval, the sloppy communication rattled the market, which obviously fears another round of political interference in the company’s governance.

As a result of the disturbances, not only Petrobras’s stocks faced steep losses, but the Brazilian market as a whole. Eventually, as higher interest rates reduce the appetite for equities, the increased risk perception in the relationship with the government leads investors to apply severe discounts on SOEs’ valuation.

As they are hugely relevant for the local stock exchange, that poses a drain on the benchmark index Ibovespa as well.

Overturning the nomination requirements, thus favouring political choices, is the most recent attack on SOEs’ corporate governance, but probably not the last. Unfortunately, every controversy involving such companies also weakens Brazil’s credibility in an era in which the market strives for respect toward all stakeholders and strong governance measures.

Fabio Coelho is CEO of the Brazilian Institutional Investors Association (Amec)