A Sourcebook - UN-Water

surrounding area, to small schemes serving new housing development areas, like CanCara Environment
in Jamaica.
Private ownership tends to reduce corruption in the areas for which the provider is responsible—the
provider level—but may create new areas of corruption risk at the sector level.
Corruption at a provider level is not generally an issue when the provider is privately owned, simply
because if company funds are misappropriated, this is a cost to the shareholders, not the public. If
the funds are not public, their misappropriation is not corruption. This is not a semantic distinction.
Theft and misuse of provider funds is a cost to the public when the provider is public. However, when
the provider is private, theft and misuse of provider funds is a cost to the shareholders of the company.
The shareholders own and collectively control the company, so they have the incentives and
ability to ensure that the control systems outlined in Section 9 are applied, to stop leakage of company
resources.
Private ownership usually needs to be complemented with a well designed regulatory system, if its potential
to increase efficiency at the provider level is to be realized. If the provider is able to pass on all
its costs to customers, the owner’s incentives to reduce costs by curbing misuse of company funds will
diminish.
A number of regulatory options are possible here. Unregulated provision—generally only used with
small providers—may work, because the provider will generally set the tariff at the maximum consumers
are willing and able to pay. In this situation, any cost saving or revenue increase translates directly
into additional profits for the owners. 28 So in an unregulated situation, the owner will be highly motivated
to ensure that its staff do not take kickbacks from suppliers, or illicitly reduce customers’ bills.
A potential problem arises where the tariff is limited, but set equal to the provider’s costs. In this case,
an increase in costs as a result, say, of staff taking kickbacks in exchange for rigging supply contracts,
will simply be passed on to the customers. The owners’ profit remains unchanged, giving them little
incentive to prevent such kickbacks. It follows that where tariffs are regulated, it will be desirable for
the regulatory system to preserve incentives on the utility to reduce costs and increase revenues—as
price caps do, for example. It will also be desirable to ensure that, where prices are set with reference
to the cost of service, the price reflects a reasonable cost of service—which should exclude costs from
staff misusing company resources—not simply the actual cost of service. Standard regulatory scrutiny,
benchmarking and cost study techniques can be used to do this.
Remaining with regulatory issues, there may be issues with approval of capital projects, or contracts
with related parties. Sometimes regulated private utilities transfer profits out of the business by paying
above market rates to related companies for management services, equipment and other inputs (see
discussion in Section 7). These issues are best dealt with as part of regulation. Good practice techniques
include ensuring that contracts with related parties are done on an arms-length basis, and that
only reasonable costs may be passed on in tariffs.
At the sector level, private ownership can have considerable advantages in increasing provider autonomy,
and in making it easier to give the provider incentives to do well. Penalties for failure to provide
service are often not effective when applied to a public company, since often the net effect is
that the public suffers (from the increased losses in the utility the government owns) while the managers
of the utility remain unperturbed. Penalties applied to a private company can be more effective,
since it is the shareholders who suffer, not the general public. To avoid the reduction in profits that penalties
entail, shareholders are motivated to make sure that managers deliver the required service.
28
Brook Cowen, P. and Cowen, T. (1998). “Deregulated Private Water Supply”. Cato Journal 18 (1).
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