Enterprise Funds: Evolving Models for Private Sector Development in
Central and Eastern Europe (Chapter Report, 03/09/94, GAO/NSIAD-94-77).
Enterprise funds are an experimental way of delivering aid to the
private sectors in Central and Eastern European countries making the
transition from centrally planned to market-oriented economies. The
enterprise funds are private U.S. corporations authorized by Congress
and staffed by experienced business managers. Authorized funding for
the first four funds, which involve Poland, Hungary, the former Czech
and Slovak Republics, and Bulgaria, totals about $440 million. Federal
contributions to enterprise funds represented about 28 percent of all
budgeted U.S. assistance for the region between fiscal years 1990 and
1993. This report reviews the first four enterprise funds' (1)
investment and program strategies and plans for sustainability, (2)
overall performance, (3) management practices, and (4) oversight by U.S.
government agencies.
--------------------------- Indexing Terms -----------------------------
REPORTNUM: NSIAD-94-77
TITLE: Enterprise Funds: Evolving Models for Private Sector
Development in Central and Eastern Europe
DATE: 03/09/94
SUBJECT: Investments abroad
Developing countries
Foreign economic assistance
Non-government enterprises
Financial management
Capital
Accounting procedures
Technical assistance
Conflict of interest
Financial records
IDENTIFIER: Poland
Hungary
Czech Federal Republic
Czechoslovakia
Slovak Federal Republic
Bulgaria
Hungarian-American Enterprise Fund
Polish-American Enterprise Fund
Czech and Slovak-American Enterprise Fund
Bulgarian-American Enterprise Fund
Europe
Polish Private Equity Fund (Poland)
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Cover
================================================================ COVER
Report to the Chairman, Subcommittee on Foreign Operations, Export
Financing, and Related Programs, Committee on Appropriations, House
of Representatives
March 1994
ENTERPRISE FUNDS - EVOLVING MODELS
FOR PRIVATE SECTOR DEVELOPMENT IN
CENTRAL AND EASTERN EUROPE
GAO/NSIAD-94-77
Enterprise Funds
Abbreviations
=============================================================== ABBREV
AID - Agency for International Development
GAO - General Accounting Office
OMB - Office of Management and Budget
SEED - Support for East European Democracy
Letter
=============================================================== LETTER
B-253523
March 9, 1994
The Honorable David R. Obey
Chairman, Subcommittee on Foreign Operations,
Export Financing, and Related Programs
Committee on Appropriations
House of Representatives
Dear Mr. Chairman:
As you requested, this report provides information on the enterprise
funds created in four Central and Eastern European countries. We
reviewed the implementation of the section of the Support for East
European Democracy Act, which was the basis for the creation of
enterprise funds in Poland, Hungary, the former Czech and Slovak
Federal Republic, and Bulgaria. We make several observations
designed to improve the funds' operations.
Unless you publicly announce its contents earlier, we plan no further
distribution of this report until 30 days after its issue date. At
that time, we will send copies to the Director, Office of Management
and Budget; the Secretary of State; the Administrator, Agency for
International Development; and other interested congressional
committees. Copies will also be made available to other interested
parties upon request.
Please contact me at (202) 512-4128 if you or your staff have any
questions concerning this report. Major contributors to this report
are listed in appendix III.
Sincerely yours,
Harold J. Johnson, Director
International Affairs Issues
EXECUTIVE SUMMARY
============================================================ Chapter 0
PURPOSE
---------------------------------------------------------- Chapter 0:1
Enterprise funds are an experimental model of assistance delivery to
the developing private sectors in selected countries of Central and
Eastern Europe as they change from centrally planned to market-
oriented economies. The enterprise funds are private U.S.
corporations authorized by the Congress and staffed by experienced
business managers. They have operated for nearly 4 years in the
region. Authorized funding for the first four funds is $250 million
to the Polish-American Enterprise Fund, $70 million to the
Hungarian-American Enterprise Fund, $65 million to the Czech and
Slovak-American Enterprise Fund, and $55 million to the
Bulgarian-American Enterprise Fund. Federal contributions to
enterprise funds represented about 28 percent of all budgeted U.S.
assistance for the region between fiscal years 1990 and 1993.
Since plans for the creation of new enterprise funds in other Central
and Eastern European countries and the independent states of the
former Soviet Union are being finalized, the Chairman of the
Subcommittee on Foreign Operations, Export Financing, and Related
Programs, House Committee on Appropriations, asked GAO to review (1)
the first four enterprise funds' investment and program strategies
and plans for sustainability, (2) their overall performance, (3)
their management practices, and (4) oversight by U.S. government
agencies.
BACKGROUND
---------------------------------------------------------- Chapter 0:2
In November 1989, the Support for East European Democracy (SEED) Act
authorized the creation of the enterprise funds in Poland and Hungary
to help private sector development in those countries. Enterprise
funds for the former Czech and Slovak Federal Republic were created
in 1990 and Bulgaria in 1991. The enterprise funds primarily make
loans to, or investments in, small and medium businesses in which
other financial institutions are reluctant to invest. The enterprise
funds are also to provide technical assistance for private sector
development in the host country. According to the act, enterprise
funds are private corporations, not U.S. government agencies, and
their employees are not government officials or employees.
RESULTS IN BRIEF
---------------------------------------------------------- Chapter 0:3
The four enterprise funds have used a variety of investment
approaches to address the conditions they found in each country.
Although it is not possible to tell which of the many investments
will be ultimately successful, other lenders are beginning to follow
the small business loan programs created by the enterprise funds.
The enterprise funds have already, through their investments, created
jobs and increased business experience of nationals. Additionally,
they have become a resource other investors have turned to for
information on the business climate in the countries of operation.
The enterprise funds' strategies to dispose of investments include
sale to existing owners, private placement to other investors, or
sale to the general public through a stock exchange. The enterprise
funds have varied in their interpretation of how technical assistance
should be applied between investment and noninvestment related
projects.
The enterprise funds encountered problems operating in evolving
economies. Loan recipients and other companies in which the
enterprise funds invested did not always submit timely, complete, and
accurate financial statements to provide information to managers on
investment performance. Therefore, this source of information on how
well investments were performing was not consistently available to
fund managers.
In accordance with the SEED Act, the Agency for International
Development (AID) and the State Department gave the funds maximum
flexibility in developing their programs, but this approach limited
the agencies' ability to ensure that fund programs were in line with
U.S. government objectives.
PRINCIPAL FINDINGS
---------------------------------------------------------- Chapter 0:4
ENTERPRISE FUND INVESTMENT
AND TECHNICAL ASSISTANCE
STRATEGIES
-------------------------------------------------------- Chapter 0:4.1
Policies set by each enterprise fund varied regarding the level of
equity held, the mix of equity investments to loans, investment size,
and the kind of loan programs developed. Poland and Hungary had
taken some steps toward the creation of a private sector before the
collapse of communism, affecting the kinds of investments made by
these respective enterprise funds. They could invest in businesses
with some experience and were not limited to investing in a large
proportion of start-up business as were the Czech and Slovak and
Bulgarian funds.
The Polish Fund often obtained investment control through majority
equity investments, whereas the Hungarian and Czech and Slovak funds
generally made minority equity investments. Loan programs developed
by the funds addressed some of the previously unmet needs for
business loans with features such as longer terms, less stringent
collateral, and in some cases, more attractive interest rates.
All of the funds developed or planned small business loan programs
through affiliation with local banks, which handled some of the loan
programs' administration. Most of the enterprise funds granted
larger loans directly. According to the Hungarian Fund, it made few
direct loans because Hungarian law allows such loans only when an
equity ownership is present. As a result, most of the Hungarian
investments were in equity shares. The Polish Fund also responded to
a lack of a credit market by investing in a commercial bank and by
starting a mortgage bank.
The enterprise funds have identified a number of strategies to
sustain their operations once U.S. government funds have been
expended and to exit their investments; however, since the enterprise
funds' investments are to a great extent not readily convertible to
cash, the viability of these strategies remains to be proven.
Enterprise fund investment revenues covered only part of the funds'
expenses for fiscal year 1992. All of the funds have sought to
expand the amount of capital that they manage, which would provide
fees and help cover expenses. The Polish Fund was successful in
attracting $101 million of investment capital from outside investors.
Enterprise fund disbursal of technical assistance grants varied from
giving nearly all assistance to general private sector development
projects to restricting technical assistance to those companies in
which the funds either had planned to invest or had actually
invested, or a mixture of the two approaches. However, over time
officers of the Polish, Hungarian, and Czech and Slovak funds
concluded that the level of understanding of business practices at
the companies in which they had invested was lower than originally
thought. The officials also said that they planned to place greater
emphasis in the future on technical assistance to their investments.
ANALYSIS OF FUND INVESTMENTS
HINDERED BY INCONSISTENT AND
INCOMPLETE FINANCIAL
REPORTING
-------------------------------------------------------- Chapter 0:4.2
Analysis of fund investments was hindered by inconsistent and
inaccurate financial reporting. Recipients of assistance from the
enterprise funds did not consistently submit timely, accurate, and
complete financial statements. Inconsistent requirements in their
contracts and lack of training on how to prepare adequate financial
reports contribute to the problem. As a result, fund managers lacked
adequate information on investment performance.
GAO's analysis of the Polish Fund's investment portfolio revealed net
losses in 1991 and 1992 because of low revenues, low manufacturing
industry gross margins, high expenses, bad debts, and currency
exchange losses. According to the State Department and AID, these
conditions were not unexpected given the start-up nature of the
enterprise fund and the high-risk environment in Poland. Because of
a large number of missing reports and inconsistently applied
accounting principles, a financial analysis could not be done on the
investments of the Hungarian or the Czech and Slovak funds. The
Bulgarian Fund's first investments were made late in 1992 so
financial reports were not yet due at the time of GAO's review.
Despite the high-risk environment of the venture capital business in
these emerging markets, the Polish and Hungarian funds reported
having each experienced only two failed investments.
ENTERPRISE FUND INVESTMENTS
HAVE ENCOUNTERED PROBLEMS
-------------------------------------------------------- Chapter 0:4.3
Three enterprise funds reported that initial evaluations and
subsequent monitoring of investments were very difficult to conduct
because of the lack of comparable information and entrepreneurs'
business inexperience in the emerging markets of Central and Eastern
Europe. The enterprise funds have had to deal with some unethical
business practices, and some investments have faced financial and
organizational problems.
For example, an investment services company, EurAmerica, established
in April 1992, for which the Hungarian Fund provided about 99 percent
of the capital, was not organized following the Fund's policies
regarding size of investment and contribution by co-investors.
EurAmerica also had management problems that included (1) failure to
submit quarterly financial statements, (2) a 2-month delay in the
annual audit by the outside auditor, (3) disorganized financial
records, and (4) missing minutes of board of directors meetings. In
addition, two EurAmerica officials were being paid salaries that far
exceeded the salary limit of $150,000 for enterprise fund management
set by an informal agreement between the enterprise funds and State,
AID, and the House Appropriations Committee. In August 1993, the
contracts between the Hungarian Fund and EurAmerica were renegotiated
and included a $150,000 salary cap and a partial return of the
capital invested in EurAmerica by the Hungarian Fund.
GAO noted two cases of potential conflicts of interest in the
application of noninvestment related technical assistance. One case
involved paying the salary of a Hungarian government official, and
the other involved a Polish Fund Board member's affiliation with a
funded program. With the limited amount of technical assistance
funding provided to the enterprise funds and weaknesses found in
financial services infrastructure, assistance funds would be better
spent on making the funds' investments viable rather than on
noninvestment related activities.
GOVERNMENT OVERSIGHT OF
ENTERPRISE FUNDS
-------------------------------------------------------- Chapter 0:4.4
The SEED Act intended that federal oversight of the enterprise funds
should be limited. Congressional reports relating to the
appropriations bill for fiscal year 1991 called for a hands-off
policy for enterprise funds' oversight by the executive branch. The
State Department and AID provided limited oversight by the AID
Inspector General, the AID project officer, and the SEED Coordinator.
This model was chosen for the region in an effort to provide
assistance that would be delivered as rapidly as possible and so
there would be freedom for each enterprise fund to develop programs
customized to fit the needs of each country.
The State Department and AID oversight of the enterprise funds
consisted primarily of an annual review by the AID Inspector General
of audits performed by certified public accounting firms of the
enterprise funds; documentation of fund drawdowns and preparation of
a monthly report on the grant cash balance; review of summaries of
enterprise funds' investments; brief semiannual reviews in
Washington, D.C.; and brief visits to both the U.S. and overseas
fund offices.
In 1992, the House Appropriations Committee established requirements
for enterprise funds to provide it with more timely information about
their activities. In September 1993, the executive branch proposed
to the Congress new measures for increasing its oversight.
RECOMMENDATIONS
---------------------------------------------------------- Chapter 0:5
Because the funds are private enterprises, GAO is not making formal
recommendations to them. However, GAO makes a number of suggestions
designed to improve management and financial controls in the
enterprise funds. (See chs. 3 and 4.)
AGENCY COMMENTS
---------------------------------------------------------- Chapter 0:6
The State Department and AID provided joint comments on a draft of
this report. They generally agreed with the report's overall
conclusions and cited steps taken by the funds to improve the quality
of financial reporting by their investments. They further stated
that the executive branch is initiating actions designed to improve
its oversight of the enterprise funds. Their specific comments have
been incorporated into the report where appropriate. The joint
comments of State and AID are presented in their entirety in appendix
II.
GAO did not obtain official comments from the enterprise funds, but
it discussed a draft of the report with officials representing the
funds. These officials generally agreed with the report, but
provided some clarifying information that has been incorporated in
the report as appropriate. The funds emphasized that improvements,
particularly in financial reporting, were occurring during the period
covered by GAO's review and that these improvements are continuing.
INTRODUCTION
============================================================ Chapter 1
Enterprise funds were established as part of the Support for East
European Democracy (SEED) Act of 1989 (P.L. 101-179) program in
selected countries of Central and Eastern Europe.\1 The act responded
to the extraordinary transformations from communism to democracy and
the development of market-oriented economies and sought to nurture
reform efforts in the region. The enterprise funds are U.S.
government-financed, nonprofit private U.S. corporations modeled
after venture capital management companies. According to the act,
the purpose of enterprise funds was to promote the development of the
private sector. They did this primarily by identifying and
implementing mechanisms for timely investment where traditional
financial institutions chose not to invest.
--------------------
\1 The term "Central and Eastern Europe" refers to Albania, Bulgaria,
the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland,
Romania, Slovakia, and the former Yugoslavia.
ENTERPRISE FUNDS HAVE A BROAD
MANDATE
---------------------------------------------------------- Chapter 1:1
The SEED Act initially authorized an assistance program for Poland
and Hungary, countries that took the lead in the transformation from
communism to democracy and market-oriented economies. The creation
of enterprise funds was a large part of the act's provisions for
private sector development. The funds originally provided for Poland
and Hungary, and funds subsequently provided for all enterprise
funds, remain available until expended. In general, enterprise funds
receive funding from the Agency for International Development (AID)
as they develop proposals for investments. This included a fund's
estimate of cash needs for a given month plus an agreed upon cash
buffer. As of June 1993, none of the enterprise funds had received
their full authorization.
Using funds subsequently provided for SEED activities, enterprise
funds were announced for the former Czech and Slovak Federal
Republic\2 in November 1990, Bulgaria in July 1991, and the Baltic
States (Estonia, Latvia, and Lithuania) in June 1993. Pursuant to
the Freedom Support Act of 1992, similar funds were announced for
Russia in July 1993;\3 Romania and the Central Asian Republics
(Kazakhstan, the Krygyz Republic, Tajikistan, Turkmenistan, and
Uzbekistan) in December 1993; and Albania and the western New
Independent States (Belarus, Moldova, and Ukraine) in January 1994.
In this report, we reviewed the operations of the four funds
operating in November 1992--the Polish, Hungarian, Czech and Slovak,
and Bulgarian funds.
Enterprise funds accounted for about 28 percent of the SEED Act
assistance for the region between fiscal years 1990 and 1993.\4 The
original authorized funding for the Polish-American Enterprise Fund
was $240 million, Hungarian-American Enterprise Fund was $60 million,
Czech and Slovak-American Enterprise Fund was $60 million, and
Bulgarian-American Enterprise Fund was $50 million. In 1991 and
1992, the enterprise funds received additional authorizations, which
were provided for technical assistance, raising the total authorized
funding to $250 million for the Polish Fund, $70 million for the
Hungarian Fund, $65 million for the Czech and Slovak Fund, and $55
million for the Bulgarian Fund.
The enterprise funds are to assist in developing the private sector,
especially small-to-medium size businesses. In 1989, with few
precedents for this kind of economic assistance, it was difficult to
predict which measures would be the most effective, particularly
since the conditions found in each country would likely be different.
Consequently, the act indicated that joint ventures, loans, grants,
equity investments, feasibility studies, technical assistance,
training, insurance, and guarantees were all appropriate enterprise
fund activities. While the act provided an operating framework for
the enterprise funds, it allowed the organizations substantial
latitude in how the funds would actually operate.
According to the act, enterprise funds are private corporations and
not U.S. government agencies, and their officers, employees, or
members of the board of directors are not government officials or
employees. The act states that AID shall grant money to the
enterprise funds for their operating and administrative expenses and
that the Department of State would provide overall coordination. In
implementing the provisions of the act, a key objective set by the
executive branch, the Congress, and the enterprise funds was that the
funds would become self-sustaining through the reinvestment of
earnings and by obtaining outside capital for investments.
The act states that each enterprise fund would be governed by a board
of directors consisting of private citizens of the United States and
the host country who are experienced and knowledgeable in private
sector development. The President of the United States, in
consultation with the Congress, designated the initial U.S. board
members for each fund, who constituted the majority on each board.
Successor U.S. directors and host country board members are elected
by the boards after receiving the advice of the President. Host
country board members must be committed to respect for democracy and
a free market economy. Each board was responsible for establishing
its organization by appointing officers of the corporation, providing
overall management and direction of the enterprise fund, and
approving investment decisions. The boards meet for a day and half
each quarter to make decisions affecting an enterprise fund's
portfolio. U.S. board members, who donate their services, include
leaders in venture capital and investment banking industries and
senior officers of large companies. As the Department of State and
AID have pointed out in their comments on this report, "Each Fund
also has its own Board of Directors which must accept the
responsibility for the success or failure of these endeavors."
The management of enterprise fund equity and loan investments has
been modeled on investment management in the venture capital industry
in which venture capital is invested in primarily small, young
companies during early stages of their development with the investors
being significantly involved in monitoring, advising, and following
up on operation results. While the objective of most venture capital
firms is to maximize profits, the enterprise funds have multiple
objectives that are distinct from the venture capital model in
significant ways. These involve working for not only a return on
investment but also to benefit the investee and have an overall
effect on the host country.
The enterprise funds' professional staffs consist primarily of
investment managers\5 who are responsible for reviewing investment
proposals, preparing proposals of viable investments for board review
and approval, and monitoring the investment after loans are made or
equity is acquired. Investment managers also conduct an important
element of the investment process known as the "due diligence"
review. Such a review examines in detail the quality of a proposed
investment's management team, product characteristics, related
technologies and vulnerabilities, and market potential. Investment
managers may also seek out investments and negotiate investment
terms, sometimes assisted by financial analysts or outside
consultants.
--------------------
\2 In January 1993, following the division of the Czech and Slovak
Federal Republic, the original Czech and Slovak American-Enterprise
Fund created two country specific funds--the Czech- American
Enterprise Fund and the Slovak-American Enterprise Fund--under
separate management teams but sharing a common board of directors.
The Washington office acts as a holding company for the two funds.
During our fieldwork in November 1992, the Czech and Slovak funds
functioned as one fund; therefore, we report on its activities as one
organization.
\3 In addition to the enterprise fund for small and medium businesses
in Russia that is patterned after the enterprise funds in Central and
Eastern Europe, in January 1994 the United States established the
Fund for Large Enterprises in Russia that will offer comprehensive
financing packages for medium and large enterprises with between
1,000 and 10,000 employees. The latter fund is part of the U.S.
contribution for privatization and restructuring by the world's
leading seven industrialized nations and will be organized as a
private corporation run by a private sector board of directors,
appointed by the President of the United States.
\4 Enterprise funds were budgeted $395 million of the $1.4 billion of
assistance to the region, between fiscal years 1990 and 1993. Some
funds will still be drawing on their authorizations after fiscal year
1993. As of June 1993, $207 million of budgeted funding had been
disbursed to the funds.
\5 The title for this position varies by fund. Persons performing
these functions are known as investment managers at the Polish Fund,
investment associates at the Hungarian Fund, investment officers at
the Czech and Slovak Fund, and business development officers and
investment officers at the Bulgarian Fund. In this report, we refer
to these positions collectively as investment managers.
OBJECTIVES, SCOPE, AND
METHODOLOGY
---------------------------------------------------------- Chapter 1:2
Since plans for the creation of new enterprise funds in other Central
and Eastern European countries and the independent states of the
former Soviet Union are being finalized, the Chairman of the
Subcommittee on Foreign Operations, Export Financing, and Related
Programs, House Committee on Appropriations, requested that we review
the enterprise funds established for Central and Eastern European
countries. Specifically our objectives were to review (1) the first
four enterprise funds' investment and program strategies and plans
for sustainability, (2) their overall performance, (3) their
management practices, and (4) oversight by U.S. government agencies.
We performed our work at AID headquarters in Washington, D.C., and at
AID missions in Poland, Hungary, and the former Czech and Slovak
Federal Republic; at the U.S. headquarters of Polish, Hungarian,
Czech and Slovak, and Bulgarian funds; and enterprise fund offices
and sites of selected fund investments in Poland, Hungary, and the
former Czech and Slovak Federal Republic. We interviewed fund
management and staff and obtained documents from enterprise fund
offices; AID officials and nongovernment organization assistance
contractors; host country business people; officials from the
Department of State; and representatives of the host governments of
the countries where the funds operate. While we discussed the
potential for fraud and unethical business practices with enterprise
fund managers and the necessity for developing measures to guard
against such practices, we did not review all internal control
provisions at the enterprise funds or at the companies in which they
invested to determine the adequacy of the internal controls. We
spoke with officials of development banks and venture capital
companies for background information on investing in developing
markets. We did not visit Bulgaria because the Bulgarian Fund had
only signed agreements on its first investments, and there would have
been little to observe in site visits at the time of our fieldwork.
We conducted our review between July 1992 and September 1993 in
accordance with generally accepted government auditing standards.
The Department of State and AID provided joint comments on a draft of
this report. Their specific comments have been incorporated in the
report where appropriate, and the entire text of their comments is
reprinted in appendix II. We also discussed the report draft with
officials representing the funds and have incorporated their comments
as appropriate.
EACH ENTERPRISE FUND HAS ITS OWN
INVESTMENT AND TECHNICAL
ASSISTANCE STRATEGY
============================================================ Chapter 2
Each enterprise fund has followed a distinct investment approach and
implemented different types of programs to carry out their mandate to
invest in, and help develop, the private sector of their respective
countries. These differences were affected by economic conditions in
the countries as well as business opportunities for joint ventures,
start-up operations, and the privatization of former state-owned
enterprises. The policies set by the board of directors of each
enterprise fund resulted in unique approaches to small and medium
business investment. For example, each enterprise fund had distinct
policies on (1) the dollar value of investments, (2) whether the
enterprise fund would hold a majority or minority position in equity
investments, and (3) the mix of equity or loan investments.
Venture capital companies' investments in equity have provided a
model for a large share of the funds' investments. Following this
model, the Polish Fund had been successful in attracting $101 million
of outside investment capital as of November 1992. All of the funds
have incorporated loans into their programs to respond to the lack of
credit, and small business loan programs have been successful with
low default rates. The Polish Fund pioneered mortgage banking in
Poland to promote residential construction and home ownership. At
the time of our review, the enterprise funds were developing plans
for sustaining operations after AID grant funds are disbursed and
have identified several strategies for selling or otherwise disposing
of their investments, referred to in this report as an "exit
strategy."
Each enterprise fund also interpreted differently their mandate to
provide technical assistance to develop the private sector, and they
used technical assistance funds for a variety of investment and
noninvestment related activities.
ENTERPRISE FUND INVESTMENT
STRATEGIES
---------------------------------------------------------- Chapter 2:1
To help establish a suitable investment strategy, each enterprise
fund, as it began to organize, tried to identify and address the
unique opportunities and particular needs of its respective host
country. The funds identified industries and economic conditions
they desired to affect as the focus of their investment strategies,
and based their investment strategies on the business conditions
found in the country. The boards' and enterprise fund managements'
philosophy on how to best pursue investments was also a factor.
THE POLISH FUND
-------------------------------------------------------- Chapter 2:1.1
The Polish Fund's basic strategy was to invest in companies it
believed had economic viability and would grow to create profits and
jobs. About 51 percent of its investments were in banking and
finance (see fig. 2.1), since the Fund identified a lack of capital
and experience in small commercial and mortgage lending as a critical
area of need. The Fund's investments in services consisted of two
retail companies, a newspaper, and two printing companies. As of
April 1993, the Fund reported that nearly 6,500 employees were
working in businesses that received a small business loan, and over
2,900 were employed at businesses in which the Polish Fund had a
direct equity investment.
Figure 2.1: Distribution by
Industry of All Polish Fund
Investments as of January 31,
1993
(See figure in printed
edition.)
Note: Investments are presented at historical costs and total $106
million.
Source: Compiled by GAO from Polish Fund data.
Although all investments in Poland entail risk, the Polish Fund was
able to partially ameliorate its investment risk by investing in
private-sector companies that had been allowed to function prior to
the 1989 reforms and did not have to invest in many start-up
companies, which are inherently more risky than established
businesses. For 12 of 17 of its investments, the Polish Fund
invested in existing companies. The Polish Fund's investments in
start-up companies accounted for only 13 percent of the Polish Fund's
gross investment of $106 million.
Joint ventures with foreign partners are a means of bringing in
foreign capital, technical expertise, and management know-how, but
only 9 percent of its investments were in joint ventures with private
foreign investors, all of which were with U.S. partners. The Polish
Fund found that large U.S. investors preferred to develop and
formulate their own ventures, while small American investors had
little interest in Poland. The Polish Fund had only invested in one
former state-owned company that was privatized.
THE HUNGARIAN FUND
-------------------------------------------------------- Chapter 2:1.2
The Hungarian Fund had the largest proportion (48 percent) of its
investments in services. These investments included retail
businesses, a printing company, and information and telecommunication
companies (see fig. 2.2). In December 1992, the Hungarian Fund
reported that companies in which it had invested had a total of
10,726 employees.
Figure 2.2: Distribution by
Industry of All Hungarian Fund
Investments as of January 31,
1993
(See figure in printed
edition.)
Note: Investments are presented at historical cost and total $38
million.
Source: Compiled by GAO from Hungarian Fund data.
Compared with the other enterprise funds, the Hungarian Fund had the
largest number of joint ventures with foreign investors because of
the higher confidence and interest foreign investors had shown for
investment in Hungary. The Hungarian private sector had started to
develop before 1989. Joint ventures accounted for about 47 percent
of invested funds. About 79 percent\1 of these investments were with
U.S. joint venture partners. As of January 1993, the Hungarian Fund
had invested in six state-owned companies that had been privatized.
The Hungarian Fund's diverse portfolio included investments in two
large publicly traded companies, representing 12 percent of invested
capital. The Hungarian Fund's investment in companies that had
access to other sources of capital, raises a question of whether such
investments were consistent with the Fund's mandate to develop small-
and medium-size businesses. According to the Fund, its investments
in the publicly traded companies leveraged additional investment
capital by (1) encouraging other investors to invest and (2) helping
to stabilize the stock market, which was not very efficient in
pricing stock offerings. Hungarian Fund officials also stated that
the investments in public companies provided a balance for the
portfolio and enabled the Fund to invest in other riskier businesses.
--------------------
\1 Joint ventures with U.S. partners represented 37 percent of all
Hungarian Fund investments.
THE CZECH AND SLOVAK FUND
-------------------------------------------------------- Chapter 2:1.3
The Czech and Slovak Fund's strategy was to seek investments that
would create jobs, promote exports, improve the environment and
energy efficiency, and develop agriculture. The Czech and Slovak
Fund invested 58 percent of its portfolio in manufacturing
investments, a greater proportion than the other enterprise funds
(see fig. 2.3). The Czech and Slovak Fund also had 6 percent of its
portfolio invested in energy related investments. These investments
included several small hydroelectric generating systems for small
communities. The Czech and Slovak Fund estimated that in 1993 the
companies it invested in would employ approximately 1,180 people.\2
The Czech and Slovak Fund investments, on average, were smaller than
those made by the other enterprise funds. As of January 1993, the
Czech and Slovak Fund had invested about $9.5 million in 32
businesses.
Figure 2.3: Distribution by
Industry of All Czech and
Slovak Fund Investments as of
January 31, 1993
(See figure in printed
edition.)
Note: Investments are presented at historical cost and total $9.5
million.
Source: Compiled by GAO from Czech and Slovak Fund data.
The Czech and Slovak private sectors were slower to develop than the
private sectors in Poland and Hungary. Consequently, the Czech and
Slovak Fund did not have the option of investing in previously
existing companies with a long-track record. The Czech and Slovak
Fund has been successful in attracting joint venture investments,
which represent 26 percent of its portfolio, all with U.S. partners.
Its investments in start-up companies were 28 percent of the
portfolio.
The proportion of start-up investments and total investments in the
two republics of the former Czech and Slovak Federal Republic were
different. In Slovakia, start-up companies represented 56 percent of
the Czech and Slovak Fund's investments compared to 59 percent in the
Czech Republic. However, about 58 percent of the Czech and Slovak
Fund's total investments were in Slovakia even though the Slovak
Republic's gross domestic product was 38 percent of the Czech
Republic's. AID and State Department officials in the two republics
attributed this greater tendency for investments in Slovakia to the
efforts of the director of the Czech and Slovak Fund's Slovak
operations, based in Bratislava, Slovakia.
The Czech and Slovak Fund had invested in one former state-owned
enterprise that had been privatized. The Fund found that the process
of working with a company as it was being privatized very time
consuming and resource demanding and had diminished its efforts in
this area. The Czech and Slovak Fund decided that further
involvement in privatization would be limited to the purchase of
equity in the companies that had already been privatized.
--------------------
\2 Many of the Czech and Slovak Fund investments were in start-up
operations in 1992, and the 1992 employment figures understate the
impact these investments were projected to have on employment.
Therefore, the Czech and Slovak Fund presented their projected April
1993 employment figures, which we reported.
THE BULGARIAN FUND
-------------------------------------------------------- Chapter 2:1.4
The Bulgarian Fund's investment strategy emphasized agribusiness,
light industry, and tourism (see fig. 2.4). The Bulgarian Fund
selected industries where government approvals or permits were not
required or that had been given a higher priority for privatization
by the Bulgarian government. The largest of the Fund's three
investments was an agribusiness factory producing baked goods. The
Bulgarian Fund also made a related service sector investment in a
wholesale food and dry goods distribution enterprise.
Figure 2.4: Distribution by
Industry of All Bulgarian Fund
Investments as of January 31,
1993
(See figure in printed
edition.)
Note: Investments are presented at historical cost and total $2.3
million.
Source: Compiled by GAO from Bulgarian Fund data.
Like the Czech and Slovak Fund, the Bulgarian Fund expected its
investments would primarily be in joint ventures and start-up
businesses since Bulgaria's private sector was just beginning to
emerge, and there were few existing businesses in which to invest.
Two of the three investments were joint ventures, and the third was a
business small loan program.
The rate at which the Bulgarian Fund made investments varied
considerably from the other enterprise funds' results. During the
first
18 months of operation, the Polish Fund had invested 34 percent of
its originally authorized funding, the Hungarian Fund 27 percent, the
Czech and Slovak Fund 12 percent, while the Bulgarian Fund had
invested only 5 percent. A Bulgarian Fund officer attributed the
slow rate of investment to several factors, including stalled legal
reforms, complex privatization efforts, and little interest from
foreign investors. As of June 1993, the Bulgarian Fund had not
concluded any additional investments.
ENTERPRISE FUND STRATEGIES ON
EQUITY POSITIONS DIFFERED
---------------------------------------------------------- Chapter 2:2
In venture capital investments, the decisions about the percentage of
equity share that will be held affects the role the investor wants to
have and is capable of taking in the management of the business.
While having a majority equity position does not necessarily require
active participation on the boards of directors of the companies,
holding majority positions may make it more desirable to do so.
The Polish Fund held majority equity positions and exerted management
control in the businesses in which it invested. Limited available
capital from other sources was one of the reasons cited by the Fund
for its majority equity positions. The Polish Fund held a 50 percent
or greater share in 7 of 17 enterprises in which it held equity.
About 64 percent of the Polish Fund's portfolio was in equity
investments (see fig. 2.5). The remaining 36 percent of the Polish
Fund's portfolio consisted of loans repayable in U.S. dollars where
the borrower assumed the risk of currency fluctuations. Of the
Polish Fund's 17 direct investments, 15 companies received both
equity and loans, while 2 companies were exclusively loans.
Figure 2.5: Debt and Equity
Investments of Enterprise Funds
as of January 31, 1993
(See figure in printed
edition.)
Note: Enterprise fund's investments are presented at historical
cost.
Source: Compiled by GAO from enterprise fund data.
The Hungarian Fund invested 80 percent of its portfolio in equity
investment and only 20 percent in loans made through financial
intermediaries. The Fund preferred to take minority equity positions
and be a passive investor. The Hungarian Fund president stated that
the Fund had enough responsibilities of its own and could not assume
the responsibility of running companies. However, the Hungarian Fund
has made exceptions to this policy. The Fund had 50 percent or more
ownership in three investments, but provided for a buy-out provision
to encourage the minority share entrepreneurs to purchase some of the
Hungarian Fund's equity.
Approximately 28 percent of the Czech and Slovak Fund capital was
invested in equity investments and 72 percent in loans. The original
position of the Czech and Slovak Fund was to seek minority equity
positions and to make entrepreneurs responsible for day-to-day
operations of their firms, even though the Fund expected to serve as
a principal funding source. The Fund stated that it preferred to own
a range from 10 percent to 35 percent of the equity of businesses in
which it invests. In June 1992, the Fund's board of directors
reconsidered this position and decided that it would, in certain
cases, take a majority position for short-term holding with a plan to
sell off a portion to other investors.
The Bulgarian Fund's director of finance and administration said that
the Fund preferred that not more than half of its capital be in
equity investments. Of the Fund's first three investments, 4 percent
was invested in equity and 96 percent of the capital was invested in
debt.
ENTERPRISE FUND LOAN PROGRAMS
---------------------------------------------------------- Chapter 2:3
The enterprise funds' loans addressed a previously unmet need for
differently structured business loans with such features as longer
terms, less stringent collateral requirements, and in some cases,
more attractive interest rates. The Polish and Hungarian Funds
established small loan programs through local banks. The Czech and
Slovak and Bulgarian funds were planning small loan programs.\3
The Polish Fund's business loans were made directly by the Fund or
through a small loan "windows" program it had established through
state-commercial banks. Small business loans ranged from $5,000 to
$75,000, while the Polish Fund directly handled business loans above
$100,000. The Polish Fund offered loans that were generally dollar
denominated so the borrower assumed the foreign exchange risk.\4
In December 1990, the Polish Fund and nine regional Polish commercial
banks organized the windows program as a Polish Fund
subsidiary--Enterprise Credit Corporation. The program was developed
to handle small business loans. The South Shore Bank of Chicago,
which had experience in small business development lending, trained
the state-bank loan officers, who in turn worked on behalf of the
Enterprise Credit Corporation in evaluating credit risk and assisting
small businesses. By November 1992, the Polish Fund had invested $28
million in this program and had made over 1,500 loans in 49 of the 90
counties in Poland. The default rate has been low--about 3 percent
of the portfolio, that is, comparable to U.S. rates.
The windows program had been widely praised as well aligned with the
SEED mandate to fund small businesses. At the time we completed our
review, at least one Polish state bank subsequently established its
own program of small business loans after its positive experience
with the Polish Fund's windows program. Applicants of the program,
even those who did not obtain loans, said that the application
process increased their understanding of the fundamentals of
business.
The Polish Fund became a pioneer in mortgage banking in Poland, a
form of financing that was previously unavailable. The objective was
to promote residential construction and home ownership. The
Polish-American Mortgage Bank, which began operations in October
1992, represented a $6-million equity investment plus an additional
$4 million in Polish Fund loans, and was a 50-percent joint venture
with two Polish institutions. The Polish Fund's legal counsel
participated in rewriting Polish laws to provide a legal framework
for mortgage lending. The bank operates by first financing
residential multifamily construction projects and later provides
mortgage loans for the buyers of the units. The loans were dollar
denominated with developers being eligible for 1-year loans while
buyers of housing could obtain up to 15-year loans. Middle class
Poles who worked for western firms were the target market for the
mortgages.
According to the Hungarian Fund president, Hungarian law prohibits
the Fund from making direct loans to businesses in which it does not
have an equity investment; therefore, only 20 percent of the
Hungarian Fund's investment portfolio was in debt holdings. Four
loans totaling $2.6 million were issued through a Hungarian
intermediary financial institution under an arrangement that
prevented the Hungarian Fund from realizing a profit on these loans
because of the interest margin and administration expenses charged.
The Hungarian Fund's investment of $5 million\5 in a small loan
program was set up exclusively for developmental purposes using
Hungarian banks to administer the loans. This 5-year program was
structured to encourage small business loans by Hungarian banks and
was not expected to generate any profit for the Fund. These local
currency loans were equivalent to between $10,000 and $100,000,
although a few loans have exceeded this amount. By February 28,
1993, more than 100 loans had been made through the program, and the
program funds were nearly fully disbursed. At that date, about 4
percent of the loans were nonperforming. The Hungarian Fund did not
plan to invest any more money in this program but had tried to bring
in other investors to increase the program's capital base.
The Czech and Slovak Fund portfolio contained predominantly direct
loans. In January 1993, the direct loans ranged in size from about
$6,000 to $563,000 payable in local currency. The Fund set its loan
interest at the lower end of the range for market interest rates.
State banks required high collateral--up to 200-percent secured by
fixed assets--whereas the Fund was more flexible and accepted less
collateral depending on the applicant's resources. Also, the Fund
made loans to finance a business' cash flow and had 4- to 6-year
maturity dates. The Czech and Slovak Fund believed that debt serves
to establish discipline for a business. Loans were approved for a
set amount and paid out in phases as needed. Czech and Slovak Fund
managers monitored the extent of the progress made on the business'
development and required monthly loan payments to (1) reinforce the
notion that these were loans, not grants; (2) generate cash flow for
relending and to cover Fund operating expenses; and (3) focus
business management on its obligations.
The Czech and Slovak Fund plans to establish joint small-business
lending programs with local banks. The program will be capitalized
at $5 million in the Czech Republic and $3 million in Slovakia,
making this program the Fund's largest investment. The value of
individual loans will not generally exceed $125,000. The Czech and
Slovak Fund's investments are to be matched by the banks, for a total
of $16 million of available funding for business loans. The
president of the Fund emphasized the social and economic benefits of
this program.
--------------------
\3 In discussing a draft of this report, the Czech and Slovak Fund
indicated that joint lending programs were initiated in both the
Czech Republic and Slovakia in the third quarter of 1993.
\4 In September 1991, the Polish Fund received from the U.S.
Embassy, in zloty, the local currency, a $7.7 million equivalent
contribution of residual funds from 1990 agricultural donations. The
Polish Fund used these funds for loans to agricultural projects.
This money was in addition to the $240 million authorized by the SEED
Act.
\5 In September 1992, the Hungarian Fund revalued the $5 million
downward by 10 percent to $4.5 million.
ENTERPRISE FUNDS SEEK
ADDITIONAL VENTURE CAPITAL
---------------------------------------------------------- Chapter 2:4
The SEED Act provided that the enterprise funds could increase their
effectiveness by soliciting additional venture capital for
investments. In November 1992, the Polish Fund was the first
enterprise fund to interest outside financial institutions and large
investors in creating a limited partnership for investment in Poland,
with the goal of a high overall rate of return through capital
growth. The partnership known as the Polish Private Equity Fund was
capitalized at $151 million, of which $50 million was from the Polish
Fund, and the balance from outside investors, including the European
Bank for Reconstruction and Development. The Equity Fund was managed
by the Polish Fund's management team who would identify investment
opportunities and was required by contract to present the same
investments in the same proportions to independent investment
committees of the Equity Fund and the Polish Fund. The Polish Fund
could then choose to co-invest or make individual investment in any
proposed investment deal.
The Polish Fund estimated that the two funds could be managed at a
lesser combined cost than to operate the funds individually. Since
the Equity Fund will be charged a management fee, the Polish Fund
expected that proportionally expenses attributable to the Polish
Fund's business would decrease. Also, the creation of the Equity
Fund provided the management team with the opportunity of earning
incentive compensation that was calculated as a percentage of the net
realized gains on investment and was sought by the Polish Fund as a
mechanism to assure long-term management commitment. The incentive
compensation will be calculated on the performance of the capital
that was from private sources.
The Polish Fund and the Equity Fund had somewhat dissimilar
objectives. The SEED Act had set a broad goal of private sector
economic development for the Polish Fund, while the Equity Fund's
focus was on the profitability of projects with the objective of
seeking superior returns. The Equity Fund would make both equity and
loan investments but would not participate in the Polish Fund's small
loan program, make high-risk agricultural investments, or use its
funds for technical assistance. As of June 1993, the Polish Fund and
the Equity Fund had jointly concluded five investments.
The Hungarian and Czech and Slovak funds had expressed an intention
to seek outside investment capital. The Hungarian Fund had initiated
plans to start its first equity fund for outside investment capital
from Hungarian institutions.
In addition to the enterprise funds' activities to introduce outside
investment capital into the countries in which they operate, they are
turned to for advice by investors interested in exploring business
opportunities unrelated to the enterprise funds. The officers of the
enterprise funds said they shared their experiences and information
on the local investment climate with other potential investors.
ENTERPRISE FUND PLANS FOR
SUSTAINABILITY ARE BEING
DEVELOPED
---------------------------------------------------------- Chapter 2:5
The SEED Act funds are expected to be fully disbursed in several
years and according to the State Department Special Advisor for East
European Assistance, additional authorizations are not anticipated.
Each of the enterprise funds have set goals of sustaining their
operations beyond the congressional authorization. Although these
plans vary, they include investment revenues, management fees, and
the selling off of assets to keep the enterprise funds operational.
The enterprise funds have identified several strategies or methods of
disposing of investments.
In discussing this report with the enterprise funds, they said that
in view of the uncertainty of the investment business in these newly
created free markets, it is not practical to assume that a fully
developed plan for sustainability would have been able to be achieved
yet. However, as the enterprise funds make investments and are able
to build portfolios that can be recycled, they envisioned that each
fund will more fully develop such a plan.
1992 INVESTMENT REVENUES
COVERED ONLY PART OF THE
EXPENSES
-------------------------------------------------------- Chapter 2:5.1
The cost of operating offices in both the United States and abroad,
international communication and travel, professional fees, bad debts,
valuation, and currency losses are among the costs incurred by the
enterprise funds. As indicated in table 2.1, enterprise funds
investment revenues had not covered expenses for the year ended
September 30, 1992. For the three oldest enterprise funds--the
Polish, Hungarian, and the Czech and Slovak funds that had received
revenues from investments in enterprises--these revenues covered
between 16 to 39 percent of the expenses.
Table 2.1
Investment Revenues and Expenses of
Enterprise Funds for the Year Ended
September 30, 1992
(Dollars in millions)
Revenues/
Investment percent
Enterprise fund revenues Expenses Loss of expenses
--------------------------------- ---------- -------- ------ ---------------
Polish $3.95 $10.10 $6.15 39
Hungarian 0.85 2.80 1.95 30
Czech and Slovak 0.31 1.94 1.63 16
Bulgarian 0.02 0.73 0.71 3\a
--------------------------------------------------------------------------------
\a Since the Bulgarian Fund has not concluded any investments in the
enterprises as of the end of fiscal year 1992, only 3 percent of its
expenses were covered by Fund revenues such as interest income.
Source: Compiled by GAO from enterprise fund 1992 audited
consolidated financial statements.
As the balance of SEED appropriations are invested, they will have to
generate investment revenues at a higher rate than marginal increases
in expenses to avoid future losses. Table 2.2 provides a breakdown
of the expenses and losses for the enterprise funds in 1992.
Compensation and benefits represented the enterprise funds' largest
expenses.
Table 2.2
Expenses and Losses of Enterprise Funds
for 1992
(Dollars in millions)
Poli Hungaria Czech/ Bulgaria
Expenses and losses sh n Slovak n
-------------------------- ---- -------- ------ --------
Compensation and benefits $2.2 $1.11 $0.93 $0.43
1
Bad debts and net 4.30 0.04 0.20 0
valuation losses
General and administrative 1.05 0.56 0.19 0.15
Professional services 0.50 0.58 0.24 0.05
Occupancy 0.73 0.22 0.14 0.03
Exchange losses 0.86 0 0 0
Program development 0.22 0.19 0.17 0.03
Depreciation 0.23 0.10 0.07 0.04
============================================================
Total $10. $2.80 $1.94 $0.73
10
------------------------------------------------------------
Source: Compiled by GAO from enterprise fund 1992 audited
consolidated financial statements.
THE DEBT TO EQUITY RATIO
AFFECTS CASH REFLOWS
-------------------------------------------------------- Chapter 2:5.2
The enterprise funds have had to consider the costs and benefits of
the type of investments they make. The Polish Fund investments have
been approximately two-thirds equity and one-third debt. The Polish
Fund's president stated that the Fund prefers equity investments over
loans because the downside risk potential is about the same, in that
a business may fail and much of the investment may be lost, but that
equity investments have the possibility of larger profits compared to
more modest return on debt.
The Polish Fund's strategy in the short run is based on expanding the
amount of capital the Fund manages, since the market for its equity
investments is still developing. While the management fees paid by
the Equity Fund help reduce the Polish Fund's operating expenses, the
Fund may sell selected equity holdings. According to its president,
the Polish Fund plans to start, possibly in 3 years, another equity
fund of outside investment capital. When this additional fund is
created, the collection of management fees is anticipated to fully
cover all Polish Fund expenses.
The Hungarian Fund's portfolio was comprised of predominately equity
investments. The Hungarian Fund president could not predict with any
certainty when the Fund may become self-sufficient. The president
said the $60-million capital received from the U.S. government was
not enough to enable the Hungarian Fund to be self-sustaining, and
current dividend and other income received by the Fund has been
small. By June 1993, the Hungarian Fund had sold two investments and
expected to sell others later in the year. The Hungarian Fund has
initiated plans to seek outside investment capital on which it may
earn management fees through the creation of new equity funds. The
first equity fund is planned to raise between $12 million to $25
million through private placement of capital from Hungarian
institutions. Later, an equity fund for international investors in
Hungary is envisioned.
The Czech and Slovak Fund has devised a short-term strategy for
sustainability by holding about three-quarters of its portfolios in
debt investments and one-quarter in equity. This structure provided
some assurance that the Fund would be receiving reflows of a
predictable size at predictable times and served as a hedge against
the slowly developing market for their equity investments. Later,
the Fund expected to increase its holding of equity. The Czech and
Slovak Fund's strategy was devised so that once the Fund had $20
million invested in debt, the reflows would cover their expenses. By
March 1993, the chairman of the Fund said that it had become clear
that the goal of sustainability was not going to be reached by the
beginning of fiscal year 1994. Nonetheless, this continued to be a
financial target for the Fund. Raising outside investment capital
will probably be required for the Fund to be sustainable over time.
The president of the Bulgarian Fund said that a formal business plan
addressing the issues of investment exit strategies or sustainability
of the Fund had not yet been developed, but the Bulgarian Fund's
Board had communicated an overall philosophy to establish some broad
guidelines. The Fund's president anticipated that once the Fund had
invested $40 million, a 10-percent return on its mix of debt and
equity would generate sufficient revenues to cover its annual
operating costs.
THREE FUNDS HAVE IDENTIFIED
EXIT STRATEGIES
-------------------------------------------------------- Chapter 2:5.3
Debt is determined by the life of the loan, which to date the funds
have structured short term from 3 years to 8 years. Loans may also
be sold to other investors. Strategies for realizing proceeds from
equity investments are more varied and generally involve their sale
to existing owners, private placement to other investors, or sale to
the general public through a stock exchange. Since the fund's equity
investments have been structured primarily for capital appreciation
through reinvestment of earnings, they were not expected to produce
significant cash dividends in the short term.
As of June 1993, officers of the Polish, Hungarian, and Czech and
Slovak funds told us they believed that their portfolios were to a
great extent, not liquid as they had not developed sufficiently to
attract investor attention. Although in 1992, the Hungarian Fund
sold at a profit a major part of its equity shares in a record
company. The president of the Polish Fund told us that he expected
it would be another 5 years before the Fund would know which
investments were going to be successful.
The Polish Fund planned to partially or completely dispose of its
equity investments through private placements to buyers, including
sales to other investment funds. According to the president of the
Polish Fund, when the Fund is ready to sell its investment shares
there will generally be no right-of-first-refusal extended to
existing shareholders. The Fund expects existing shareholders to
compete with other buyers. The Fund is interested in maximizing the
Fund's profit and views the right-of-first-refusal as a mechanism
that sometimes can delay sale negotiations.
The Hungarian Fund has indicated that its preferred method of selling
equity investments was going to be through the stock market, once the
businesses in the portfolio have been developed so they would be
attractive to other investors. The Hungarian Fund's creation of an
investment services company was part of its plan to establish an
institution that could underwrite public offerings of companies of
the size the Hungarian Fund holds. The Polish and Czech and Slovak
funds viewed the sale of their holdings through stock exchanges as
options that may be possible for them in the future.\6
The Czech and Slovak Fund emphasized to its clients that the Fund is
not a long-term investor and that its basic strategy is for other
stockholders to buy its equity shares. The Fund expects to sell its
equity in a given business after about 5 years at a fair market value
of shares, and the existing owners will be given the
right-of-first-refusal. While the Czech and Slovak Fund's board
believes that it is necessary to invest in a manner that ensures the
future profitability of the Fund, the Fund may be willing to sell an
investment sooner at a reasonable profit rather than hold out for
greater gain in the future. According to Fund officials, they want
to be in position to reinvest and foster other businesses.
--------------------
\6 The Budapest Stock Exchange opened in June 1990; the Warsaw Stock
Exchange opened in July 1991; the Bratislava Stock Exchange opened in
April 1993; and the Prague Stock Exchange began trading securities in
June 1993.
TECHNICAL ASSISTANCE VARIES BY
ENTERPRISE FUND
---------------------------------------------------------- Chapter 2:6
The SEED Act listed grants and technical assistance as appropriate
uses for the monies authorized to the enterprise funds. However, at
first there was generally no incentive for the enterprise funds to
use the money that they have received from AID to provide technical
assistance since these activities do not directly generate profit.
The Hungarian Fund's board set a policy limiting the Fund's
activities to what they considered their primarily mandate, a focus
on securing the long-term viability of the organization by using all
monies for investments.
In June 1991, AID committed an additional $5 million each for the
Polish, Hungarian, and Czech and Slovak funds and in December 1992, a
similar commitment was made to the Bulgarian Fund.\7 These funds were
specifically provided for technical assistance. In notification
letters to the presidents of the Polish, Hungarian, and Czech and
Slovak funds,\8 AID indicated that the technical assistance funds
were to be used for providing grants to the private sector in the
countries of operation or to assist the governments of the countries
to make changes in their investment-related laws and practices that
would promote the growth of the private sector. AID did not provide
more detailed guidelines for how the technical assistance funds
should be used.
Over time, all four enterprise funds developed technical assistance
programs. The characteristics of these programs were determined by
fund policies that set the degree to which this assistance was tied
to investments and noninvestment-related projects. In October 1992,
after the Polish and Hungarian funds had disbursed over half and
obligated nearly all of their technical assistance funds, they were
notified by AID that they would each receive $5 million more for
technical assistance projects.
The Czech and Slovak Fund used its technical assistance funding at a
much slower rate and did not receive an additional authorization.
The Fund established a conservative policy that it would distribute
technical assistance monies in proportion to its disbursal of program
money, but in practice, disbursal of technical assistance money
lagged far behind investments. The Fund's investments as of January
31, 1993, amounted to nearly $9.5 million, or 16 percent of
authorized funding, while only 5 percent of technical assistance
funds was spent.
--------------------
\7 This added to the original authorization for each fund: the
Polish Fund's from $240 million to $245 million; the Hungarian Fund's
from $60 million to $65 million; the Czech and Slovak Fund's from $60
million to $65 million; and the Bulgarian Fund's from $50 million to
$55 million.
\8 The Bulgarian Fund's chairman was notified by the Secretary of
State of the increased authorization for technical assistance
activities.
ENTERPRISE FUNDS' TECHNICAL
ASSISTANCE PROJECTS
-------------------------------------------------------- Chapter 2:6.1
The enterprise funds had various interpretations of the broad mandate
to provide technical assistance to the private sector. The policies
set by each enterprise fund for use of technical assistance ranged
from almost exclusively using the grants for support of its direct
investments or investment-related projects, to a focus on general
assistance activities or noninvestment related projects, or a mixture
of the two approaches (see fig. 2.6).
Figure 2.6: Technical
Assistance Expenditures of
Enterprise Funds as of January
31, 1993
(See figure in printed
edition.)
Source: Compiled by GAO from enterprise fund data.
The Polish Fund had used about 57 percent of the $5.7 million spent
on technical assistance for projects related to its investments.
This assistance was frequently in the early stages of the investment
when the Fund perceived weaknesses in the skills of the investment's
management team. The Polish Fund's largest technical assistance
project was for training in the banking industry.
The majority of the Hungarian Fund's technical assistance programs
were not directly tied to the Fund's investments. Of the 23
technical assistance projects financed by the Hungarian Fund, only 7,
representing about
15 percent of the $2.9 million technical assistance funds disbursed,
were directly related to investments. The two broad criteria set by
the Hungarian Fund for technical assistance grants were that (1) the
projects further the development of private enterprise or market
economy infrastructure and (2) other sources of funding were not
readily available. An example of an investment-related project was
the funding of due diligence reviews on prospective investments in
the biomedical industry. Noninvestment-related projects included
funding of government advisers, studies of the economy, and the
development of a training program on business and entrepreneurship.
A Hungarian Fund official told us that the Fund did not emphasize
direct assistance to its investments because they did not want the
management of these companies to view the Hungarian Fund as anything
other than an investor.
The Czech and Slovak and the Bulgarian funds used nearly all of their
technical assistance funds on investment-related projects. Technical
assistance funds were used to hire experts to work with investors and
assist in business plan development. While the Czech and Slovak Fund
board of directors' position was that AID and other U.S. government
agencies were primarily responsible for economywide programs, the
Fund's 1992 annual report indicated an interest in expanding
technical assistance funds to the wider business community in the
countries of operation. The Bulgarian Fund had decided to use its
technical assistance to support operations of the companies in which
it invested, and expected to commit technical assistance funds to all
of the Fund's investments.
CONCLUSIONS
---------------------------------------------------------- Chapter 2:7
The enterprise funds have developed a wide variety of investments,
programs, and institutions, some of which will potentially be models
for private sector development in their host countries and in
countries where new enterprise funds will be established. Each fund
has developed its unique approach to respond to country conditions
and business opportunities. Although it is too early to determine
which of these will be the most successful, early indications are
that the small loan programs have been well received and have set an
example other financial institutions are beginning to follow. The
enterprise funds have already, through their investments, created
jobs and increased business experience of nationals. Additionally,
they have become a resource other investors have turned to for
information on the business climate in the countries of operation.
The enterprise funds have identified a number of strategies to
sustain their operations once U.S. government funds have been
expended and to exit their investments. However, since the
enterprise funds' investments are to a great extent not liquid, the
viability of these strategies remains to be proven.
ANALYSIS OF ENTERPRISE FUND
INVESTMENTS HINDERED BY
INCONSISTENT AND INCOMPLETE
FINANCIAL REPORTING
============================================================ Chapter 3
The enterprise funds need accurate and reliable financial information
about their investments on a regular and periodic basis in order to
assess the investments' performance and identify potential trends and
problem areas. This is particularly important in the business
environment in Central and Eastern Europe where accounting and
auditing standards have not been developed and basic accounting and
financial reporting has not been used as a management tool. We
found, however, that the enterprise funds did not consistently have
such information available to help them manage their portfolios.
The enterprise funds' investment agreements were inconsistent in
specifying the accounting principles to be used, the type of
financial statements to be submitted, and the time frame for their
submittal to fund managers. When investments did submit financial
statements, they were of limited use because of missing or incomplete
statements, particularly a statement of cash flow. In addition, some
of the submitted statements contained inaccuracies or lacked
sufficiently detailed information for analysis.
Investment agreements were inconsistent in specifying the auditing
standards to be used by independent auditors, and financial
statements of enterprise funds' investments we examined were audited
using either international or U.S. auditing standards. In addition,
the independent audits did not disclose to potential users of the
financial statements whether or not material weaknesses in internal
controls had been identified.
The Hungarian and the Czech and Slovak funds were unable to provide a
sufficient number of financial statements for us to perform a
meaningful analysis of their investments. After extensive efforts,
we obtained most of the financial statements for the investments of
the Polish Fund through September 30, 1992, to perform a portfolio
analysis, which is presented in appendix I. Our analysis of the
financial statements of investments of the Polish Fund showed a net
portfolio loss due to insufficient revenues, low gross margins, and
high expenses, particularly bad debts and currency exchange losses.
According to the State Department and AID, these conditions were not
unexpected given the start-up nature of the enterprise fund and the
high-risk environment in Poland.
By June 1993, after 3 years of operations, the Polish and Hungarian
funds reported a total of only four failed investments. These failed
investments represented about 3 percent of the funds invested by the
Polish Fund and 2 percent of the funds invested by the Hungarian
Fund.
INVESTMENTS WERE THE ENTERPRISE
FUNDS' LARGEST ASSET
---------------------------------------------------------- Chapter 3:1
Investments of debt and equity in private sector businesses
constituted 68 percent of the Polish, Hungarian, and Czech and Slovak
funds' total consolidated assets as of September 30, 1992 (see table
3.1). The Bulgarian Fund was incorporated in November 1991, and had
not yet disbursed funds to investments through September 30, 1992.
Table 3.1
Composition of Enterprise Fund
Consolidated Assets as of September 30,
1992
(Dollars in millions)
Net
investmen Other Total
Enterprise fund ts Cash assets assets
------------------------- --------- ------ ------ ======
Polish $75.9 $38.3 $2.4 $116.6
Hungarian 28.4 8.8 0.8 38.0
Czech/Slovak 6.9 2.2 0.4 9.5
------------------------------------------------------------
Source: Compiled by GAO from enterprise fund 1992 audited financial
statements.
Investments were carried by the enterprise funds at cost net of
allowances for bad debts and valuation gains and losses. Most of the
enterprise funds' investments were closely held and were not readily
marketable. Enterprise fund management conducted a valuation of
investments annually, or more often if circumstances warranted. The
valuation considered such factors as financial condition and
operating results, economic and marketing conditions affecting
operations, and other events. Enterprise fund officials told us that
most of the investments operated on a calendar year basis as the use
of fiscal year-ends was not prevalent or had not yet been permitted
by the laws in each country. Investments were also required by the
investment agreements to have an annual audit, which were performed
by various international certified public accounting firms in
accordance with either international or U.S. auditing standards.
ACCOUNTING AND REPORTING
REQUIREMENTS WERE NOT
CONSISTENT
---------------------------------------------------------- Chapter 3:2
Accounting and reporting requirements established in investment
agreements between the enterprise funds and the companies in which
they have invested were not consistent. The agreements varied in the
accounting principles to be used to maintain financial records and
did not require investments to prepare the same type of financial
statements. Investment agreements also did not require all
investments to submit their financial statements for the same
accounting periods and within a consistent time frame. Enterprise
fund presidents and chief financial officers stated that the
inconsistencies of accounting and reporting provisions arose during
negotiations over each agreement conducted by different individuals
at different times. However, the lack of consistent accounting and
reporting for investments created an inability to compare performance
and identify problems.
We examined all 17 of the Polish Fund investment agreements where we
received financial statements as of September 30, 1992, and examined
over half of the investment agreements for the Hungarian Fund and the
Czech and Slovak Fund. As indicated in table 3.2, the enterprise
funds' agreements specified a variety of accounting principles to
maintain accounting records, with 30 percent of the agreements we
examined having no provision.
Table 3.2
Accounting Principles of Enterprise
Funds
Poli Czech/
sh Hungari Slovak Tota
Accounting principles Fund an Fund Fund l
--------------------------- ---- ------- ---------- ====
United States 3 2 0 5
United States and local\a 9 3 0 12
United States, local,\a and 3 0 0 3
local law\b
United States and local 0 1 0 1
law\b
Local\a 0 0 3 3
Local law\b 0 0 1 1
International 0 6 0 6
No provision 2 0 11 13
============================================================
Total 17 12 15 44
------------------------------------------------------------
\a Local refers to the accounting principles in use or under
development within each country.
\b Local law refers to the basis of accounting prescribed for
statutory or tax reporting purposes.
Source: Compiled by GAO from enterprise fund investment agreements.
Commenting on a draft of this report, officials representing the
Polish Fund said they had other ways to obtain financial information
from the two investments whose contract do not specify reporting
requirements. The Fund has a 50-percent ownership interest, sits on
the supervisory boards of both companies, and can therefore obtain
financial information on the basis of accounting the board directs.
One of these companies, the mortgage bank, is also subject to
accounting principles and financial report requirements set by the
National Bank of Poland.
In discussing a draft of this report, officials representing the
Czech and Slovak Fund said they anticipated using financial
statements prepared in accordance with local accounting principles or
laws and thus had made no specific provisions in most of its
agreements.
Both U.S. and international accounting principles require
preparation of reports consisting of a balance sheet, statement of
income or loss, and statement of cash flow. However, as indicated in
table 3.3, 40 investment agreements we examined included differing
requirements on the type of financial statements to be prepared and
the other four agreements contained no provision at all on the type
of statements to be prepared.
Table 3.3
Financial Report Requirements of
Enterprise Funds
Poli Czech/
sh Hungari Slovak Tota
Financial statement type Fund an Fund Fund l
--------------------------- ---- ------- ---------- ====
Balance sheet, income and 12 1 7 20
cash flow statement
Balance sheet and income 2 7 5 14
statement only
Balance and cash flow 0 3 2 5
statement only
Income statement only 1 0 0 1
No provision 2 1 1 4
============================================================
Total 17 12 15 44
------------------------------------------------------------
Source: Compiled by GAO from enterprise fund investment agreements.
As indicated in table 3.4, the investment agreements we examined were
inconsistent in their time reporting requirements for the submittal
of both audited annual and unaudited interim financial statements to
fund managers. Interim financial statement reporting periods in the
investment agreements also varied from monthly to quarterly with 11
percent of the agreements examined having no provision at all.
Table 3.4
Reporting Times and Periods of
Enterprise Funds
Poli Czech/
sh Hungari Slovak Tota
Fund an Fund Fund l
--------------------------- ---- ------- ---------- ====
Annual reporting times
------------------------------------------------------------
Within 60 days of year-end 1 0 2 3
Within 90 days of year-end 9 2 0 11
Within 120 days of year- 1 7 0 8
end
No date specified 6 3 13 22
============================================================
Total 17 12 15 44
Interim reporting times
------------------------------------------------------------
Within 30 days of period 11 8 0 19
end
Within 45 days of period 0 0 7 7
end
Within 60 days of period 0 1 1 2
end
No date specified 6 3 7 16
============================================================
Total 17 12 15 44
Interim reporting periods
------------------------------------------------------------
Monthly 11 2 0 13
Quarterly 3 10 13 26
No period specified 3 0 2 5
============================================================
Total 17 12 15 44
------------------------------------------------------------
Source: Compiled by GAO from enterprise fund investment agreements.
Enterprise fund managers were generally aware of these
inconsistencies and have been working with the investments and their
financial reports in order to obtain better financial information.
The information taken from individual investment's financial reports
was being used to develop automated financial statements that report
the results of the investment operations in a more uniform manner.
In addition, several cash flow statements have been developed by fund
managers to help improve overall financial reporting.
SOME INVESTMENT FINANCIAL
STATEMENTS WERE MISSING OR
INCOMPLETE
---------------------------------------------------------- Chapter 3:3
Enterprise fund managers could not fully monitor the financial
performance of the investments because they did not receive all
required financial statements or received statements with incomplete
data. In addition, some statements were received months late, which
affected the ability to make timely management decisions. Summary
level data were often submitted without sufficient detail showing how
funds were used. As a result, we were unable to perform a meaningful
financial analysis of the Hungarian and the Czech and Slovak funds'
investment portfolios as of December 31, 1991, June 30, 1992, and
September 30, 1992. After extensive efforts, we obtained most of the
financial statements for the investments of the Polish Fund through
September 30, 1992, to perform a portfolio analysis. Table 3.5 shows
enterprise funds' missing or incomplete investment financial
statements we found for the three periods of our analysis.
Table 3.5
Missing or Incomplete Investment
Financial Statements of Enterprise Funds
Number of
investment Percen Percen Percen
Date and Fund s Number t Number t Number t
-------------------- ---------- ------ ------ ------ ------ ------ ------
Dec. 31, 1991
--------------------------------------------------------------------------------
Polish 17 0 0 0 0 0 0
Hungarian 14 1 7 3 21 12 86
Czech/Slovak 2 2 100 2 100 2 100
June 30, 1992
--------------------------------------------------------------------------------
Polish 19 0 0 4 21 13 68
Hungarian 19 3 16 5 26 16 84
Czech/Slovak 20 11 55 11 55 20 100
Sept. 30, 1992
--------------------------------------------------------------------------------
Polish 17 1 6 3 18 12 71
Hungarian 22 4 18 13 59 19 86
Czech/Slovak 28 12 43 11 39 28 100
--------------------------------------------------------------------------------
Source: Compiled by GAO from enterprise fund data.
Financial statements for 17 Polish Fund investments as of December
31, 1991, were obtained by the Fund during the period between March
28, 1992, and July 30, 1992. Fifteen of the 17 investments that had
activity were audited as of December 31, 1991. The reason for delays
was that auditors were completing their first audits of the
investments, and this took additional time. Interim financial
statements for June 30, 1992, were submitted by 19 investments in
July 1992. Most lacked cash flow statements and four provided only
summary revenue and expense data. Interim financial statements for
September 30, 1992, on 17 investments were not obtained by us until
April 1993. One investment--a newspaper publishing company--had
ceased operations in September 1992, and no financial statements were
prepared, although expenses were incurred and cash disbursed. Two
other investments provided only summary revenue and expense data and
again, most investments lacked cash flow statements.
According to the Hungarian Fund's chief financial officer, its
investments did not submit required financial statements for several
reasons. For example, two investments that received almost $1
million did not submit September 30, 1992, financial statements
because they were effectively bankrupt and were straightening out
their accounting records in an effort to produce reliable financial
statements. Also, a $4-million investment in an investment services
company did not submit audited financial statements on time. Audited
financial statements for the company as of December 31, 1992, were
finally received by the Hungarian Fund on May 31, 1993.
The Czech and Slovak Fund investments also did not submit complete
financial statements, and we found many cases where investments did
not submit any financial statements for more than one reporting
period. For example:
Four investments received about $400,000 as of June 30, 1992, and
did not submit any financial statements to the Fund. By
September 30, 1992, these four investments had received about
$897,000 and still had not submitted financial statements.
As of September 30, 1992, another five investments had received
funding with a carrying value of almost $440,000 and had not
submitted any financial statements for that period.
None of the investments submitted a cash flow statement for three
periods we analyzed.
Enterprise fund chief financial officers said that they have been
working with their investments to instill a discipline of preparing
financial statements that could be used as a management tool by both
the investments and the funds. However, local business personnel
generally were not trained in U.S. accounting methods and had never
had to prepare such financial reports under the former Communist
regime. Furthermore, businesses generally did not have appropriate
accounting systems and also had to keep books to conform with local
laws. According to the officers, everything had to be translated
from local languages to English and converted from local currency to
U.S. dollars, thus further compounding the financial reporting
problems. Although a cash flow statement is a basic financial report
required by both U.S. and international accounting principles, the
enterprise funds generally emphasized obtaining a balance sheet and
income statement from investments. The Czech and Slovak Fund
investment agreements did not require a cash flow statement.
SOME FINANCIAL STATEMENTS WERE
INSUFFICIENT OR INACCURATE
---------------------------------------------------------- Chapter 3:4
All three enterprise funds held investments that submitted financial
statements without sufficient detailed information to show how the
monies were used. While the Polish Fund improved its investment
reporting in 1992 by standardizing data to be submitted by all
investments, the reports lacked sufficient detail on revenues,
expenses, and cash flow. The lack of standardized and detailed
reporting was also noted for the Hungarian and Czech and Slovak
funds. Such data are essential to monitor key elements of interest
earnings, sales growth, gross margin fluctuations, overhead costs,
currency effect, interest costs, depreciation charges, and bad debts.
A cash flow statement is still only required for year-end reporting
purposes. The sources and uses of cash flow are key elements in
running a business.
In most cases, financial statements combined all sources of income or
all types of expenses, and then reported this information in summary
form. For example, investments did not identify and report the
different sources of income, such as normal business operations;
income from nonbusiness operations, like interest income; and income
or loss due to currency exchange. Separate categories of expenses
were also not always reported such as the cost of goods sold;
selling, general, and administrative expenses; interest expense; bad
debts; income taxes; and depreciation.
Investments' financial statements need sufficient detail so that
managers can conduct a meaningful analysis of the investment and
identify areas that need improvement. For example, interest income
may exceed a loss from normal business operations and thus mask the
need to improve normal business operations. Expense detail could be
used to compare investments against each other or to compare an
investment against industry statistics.
Although, we did not review the validity of the financial statements
submitted by investments, Hungarian Fund officials have questioned
the accuracy of some of the financial reports. For example, they
said:
Accounts receivable and inventory were inaccurately reported on the
balance sheet of a company that operated a consignment
warehouse.
An investment submitted its unaudited financial statements from
December 1991 that the Hungarian Fund used in its decision to
invest in the company in January 1992. When the company was
subsequently audited in November 1992, Fund officials concluded
that the data provided in December 1991 were not accurate.
Czech and Slovak Fund managers noted the following examples of
questionable reporting:
One investment's accounting system was seriously flawed by
incorrectly recording assets as expenses. Consequently, assets
were understated while expenses were overstated. The Fund had
required that the investment establish a new accounting system
and obtain a year-end audit to assure that expenses are fairly
presented.
Another investment reported depreciation expense on its income
statement; however, the balance sheet had no amount recorded for
accumulated depreciation.
Balance sheet information on two investments understated Fund loans
payable by over $336,000.
AUDITS OF INVESTMENTS WERE
INCONSISTENT AND DID NOT
DISCLOSE MATERIAL WEAKNESSES
---------------------------------------------------------- Chapter 3:5
Financial statements of enterprise fund investments were audited
using either international or U.S. auditing standards,\1 because
investment agreements were inconsistent in specifying the auditing
standards to be used by independent auditors and local auditing
standards are still evolving. In addition, the audit reports did not
disclose to potential financial statements users whether material
weaknesses had been identified in a firm's internal controls,
although such disclosure is not required by either U.S. or
international auditing standards.\2
Of the 15 Polish Fund investments that were audited as of December
31, 1991, 8 investments were audited in accordance with international
standards and 7 investments were audited in accordance with U.S.
standards. Audited financial statements were not available for
investments of the Hungarian Fund as of December 31, 1991; however,
the
December 31, 1992, financial statements of one Hungarian Fund
investment were audited in accordance with U.S. standards. Audited
statements were not available for investments of the Czech and Slovak
Fund, and the Bulgarian Fund had funded no investments through
September 30, 1992. The Polish Fund's chief financial officer stated
that the standards used by auditors for its various investments were
consistent with the accounting principles specified in the investment
agreements.
U.S. and international auditing standards require that the
independent auditor consider an entity's internal control structure
in determining the nature, timing, and extent of audit testing.
However, neither the U.S. nor international standards require that
the auditor report on internal controls, although commonly an auditor
will issue a management letter containing internal control and
operational issues requiring management's attention. These standards
also do not provide that if a separate internal control report or
management letter is prepared that they be issued together with the
auditor's opinion on the financial statements, or that a statement be
added to the auditor's opinion to indicate that any separate reports
have also been issued. The enterprise funds agreed that auditors'
internal control reports and management letters are useful for
improving operations, but they believe that such reports or letters
are costly to produce and that public disclosure of their contents
could be misunderstood.
--------------------
\1 As indicated earlier, the Czech and Slovak Fund officials followed
local auditing standards.
\2 Disclosure of material internal control weaknesses is required by
generally accepted government auditing standards issued by the
Comptroller General of the United States.
INVESTMENT FAILURES HAVE BEEN
FEW
---------------------------------------------------------- Chapter 3:6
As of June 1993, the Polish and Hungarian funds had recorded a total
of only four investments that had failed. When compared to the total
capital invested by each fund, the failed investments represented
about 3 percent of the Polish Fund's investments and 2 percent of the
Hungarian Fund's investments. The two Polish Fund investments that
failed were a newspaper and an agricultural investment. The
Hungarian Fund invested in an appliance manufacturing company and an
electronics firm, which subsequently declared bankruptcy. Other
investments that have not failed but are encountering financial and
organizational problems are discussed in the next chapter.
Allowances for partial losses at the Polish, Hungarian, and Czech and
Slovak funds had been recognized in the enterprise funds' financial
reports. The Bulgarian Fund's first investments were disbursed after
September 30, 1992, and no losses or allowances had been recognized
through June 1993.
CONCLUSIONS
---------------------------------------------------------- Chapter 3:7
The Polish, Hungarian, and Czech and Slovak funds did not have
complete, accurate, and timely financial information on their
investments. Among other things, this can be attributed to (1)
funding agreements with inconsistent requirements on the accounting
principles to be used, the types of financial statements to be
submitted, the period of time that the statements should cover, and
the dates that investments should submit their statements; (2)
nonstandardized financial reporting with an insufficient level of
detail for financial analysis; and (3) the limited capability of some
investments to prepare adequate financial statements.
Investment financial statements should complement other program
information and enable enterprise fund managers to be more effective
in monitoring the performance of each investment. These statements
are expected to provide a financial picture of the operations of the
enterprise funds' investments that cannot be obtained elsewhere.
However, because many of the investment's financial statements were
not complete, accurate, and sufficiently detailed the enterprise
funds had no assurance that they were sufficiently informed about the
financial health of each investment.
Inconsistencies in accounting principles and auditing standards to be
used also hindered the comparability of investment financial
statements, while the lack of disclosure of material weaknesses or
internal control conditions limited the amount of information
provided to current and potential investors. Since auditors are
already required by existing audit standards to assess internal
controls and report to management material weaknesses in internal
controls or other reportable conditions, providing this information
to all users of the financial reports could be done in a manner which
would not lead to misinterpretation and at a cost that would not be
prohibitive.
OBSERVATIONS
---------------------------------------------------------- Chapter 3:8
Because the funds are private enterprises, we do not make
recommendations to them. However, we believe the enterprise fund
managers could improve their operations by
developing and enforcing standard and consistent investment
agreement provisions that specify the (1) accounting principles
to be used, (2) types of financial statements that investments
are required to submit to the enterprise funds, (3) period of
time that statements should cover, (4) dates that investments
should submit their financial statements, and (5) level of
detailed financial information required;
modifying investment agreements where annual audits of investments
are required to include the issuance of a report on internal
controls or management letter as part of the audit and that the
companies make those documents available to potential users of
the financial statements; and
assessing the capability of each investment to prepare complete,
accurate, and timely financial statements with the minimum level
of required detailed financial information, prior to disbursing
funds, and provide technical assistance as necessary.
ENTERPRISE FUND INVESTMENTS HAVE
ENCOUNTERED PROBLEMS
============================================================ Chapter 4
While investing in unlisted companies\1 in the United States is
considered to be high risk, comparable investments in Central and
Eastern Europe face additional risk due to the countries' evolving
economies. All four of the enterprise funds reported that initial
evaluations and subsequent monitoring of investments were very
difficult to conduct because of the lack of comparable business
experience and information. On occasions, the funds have had to deal
with unethical business practices by individuals with whom they did
business. Several of the companies in which the enterprise funds
invested were encountering financial and organizational problems.
Potential conflicts of interest in the application of
noninvestment-related technical assistance were also noted.
--------------------
\1 An unlisted company is one not listed on a stock exchange.
INVESTMENTS FACED RISK IN
EVOLVING ECONOMIES
---------------------------------------------------------- Chapter 4:1
Business investments involve an inherent risk of loss or devaluation,
particularly in a start-up situation. The risk of failure for the
enterprise fund investments is heightened by the struggle to create a
private business sector from the ground up while the economies suffer
from economic depression. The business infrastructure, including the
emerging capital markets, lacked modern production, marketing, and
distribution networks, as well as a cadre of skilled managers.
The enterprise funds were under pressure to make investments because
of the high expectations raised by early publicity about the funds
and demand for their services. The enterprise funds found that they
had to invent procedures because the business experience and
information they would have relied on in a market economy were just
evolving in the countries of operation. Often the proposals
submitted to the enterprise funds lacked an appropriate business
plan, and the enterprise funds had to work with the applicants to
prepare one. Licensing and registration placed additional burdens on
the investment process. According to the Polish Fund's managing
director in Warsaw, analysis and development of the investment
constitutes the smaller portion of effort in the investment process
in Poland compared to the United States, and administrative matters
such as licensing and registrations require much more effort.
The president of the Hungarian Fund said that when the Fund started,
given the economic and political environment, it was exceedingly
difficult to perform a detailed evaluation of a potential
investment's management team and its business plan, a process known
in the industry as a "due diligence" review. Since Western-style
methods of review were unavailable in Hungary, it was hard to
determine the best evaluation methods to use. He said that even
after the Fund's personnel had become more knowledgeable, the process
continued to be difficult and time consuming.
The Polish Fund's experience with their first private bank investment
illustrates the problems that can occur when a due diligence review
is incomplete. In May 1991, the Polish Fund invested in a bank
created in 1989 by a group of businessmen. Along with this
investment, the Fund inherited many bad loans the co-investors had
made after the initial negotiations for the purchase of the bank were
concluded, but before the Polish Fund took control of the credit
committee. Polish Fund officials said that their review did not
follow up on the changes in the bank's lending activities after this
investment had been approved by the Fund's board. Despite the
inadequacies of the due diligence review, in June 1993 the president
of the Fund said that the performance of the bank's loan portfolio
had improved after a newly appointed, experienced bank president and
new bank directors, with the help of credit managers of the Fund's
small loan windows program, created a new credit committee to more
thoroughly review new loans and to salvage what they could from the
bad loans.
According to the Polish Fund's managing director in Warsaw, decisions
regarding investments had to be based on less information than would
be considered appropriate in the United States. For example, because
of the general absence of credit, there is no credit history
information to rely upon. Furthermore, in the U.S. investment
decisions would be based at least, in part, on audited financial
statements; however, such statements were frequently unavailable for
businesses in Central and Eastern Europe.
In the initial days of the enterprise fund operations, all of the
investment managers' efforts were focused on the investment process.
Subsequently, post-investment monitoring duties were added to the
work load of investment managers, most of whom had little experience
in this area. Monitoring was done primarily by reviewing financial
statements and periodic personal contacts by enterprise fund
investment managers. Representatives of the enterprise funds also
sat on the boards of directors of the principal investments. In
discussing a draft of this report with officials representing the
enterprise funds, they said that fund managers also reviewed
financial material such as financial forecasts and invoices; attended
meetings of supervisory boards and investee management; toured
investees' facilities; and met with clients and customers of the
investees, municipal authorities, and investees' creditors.
Nevertheless, officials from the Polish, Hungarian, and Czech and
Slovak funds acknowledged that investment monitoring needed
improvement. They found that some firms were reluctant to share
information with the enterprise funds' representatives. The funds
attributed this reluctance to the legacy of the Communist system.
The Polish Fund's chief financial officer said that the Fund's
investment managers try to obtain qualitative as well as quantitative
information on which to base their investment decisions. The officer
also said that reliable financial information was not easily obtained
and traditional financial analysis was difficult and time consuming.
The enterprise funds concluded that the business managers of
companies in which they invested often were less knowledgeable in
financial matters than earlier assessments had indicated.
While most of the enterprise funds continue to hold individual
investment managers responsible for monitoring their assigned
investments, the funds have begun to provide additional support and
oversight of the monitoring activities. We noted that the Polish,
Hungarian, and Czech and Slovak funds had begun to (1) assign
oversight responsibility for all investment monitoring to a
particular fund officer, (2) identify consultants who could work with
the firms to help them improve their financial information and
accounting systems, and (3) establish or plan computer tracking
monitoring systems.
ENTERPRISE FUNDS HAVE
ENCOUNTERED SOME UNETHICAL
BUSINESS PRACTICES
---------------------------------------------------------- Chapter 4:2
The enterprise funds were faced with business environments that at
times operated under different standards of ethics than were
acceptable for U.S.-funded assistance. The enterprise funds found
that they had to be vigilant about the business ethics of those they
dealt with, and in some instances, had encountered unethical business
practices.
The managing director of the Hungarian Fund acknowledged that a
representative of a Western European company had attempted to bribe
him to encourage a particular investment by the Fund, but he did not
consider bribery to be a significant problem for the Fund. In
another instance, the director suspected that a company in which the
Hungarian Fund had invested received a kickback when the entrepreneur
insisted on dealing with a particular supplier.
The Bulgarian Fund encountered a situation in which an individual
fraudulently represented himself as being affiliated with the
Enterprise Fund and claimed to be able to guarantee funding from the
Bulgarian Fund for a fee. The Bulgarian Fund obtained a retraction
from this person and published the retraction in a local newspaper.
During our review we also noted that in 1991, the Polish Fund had
heard allegations that some employees of the participating Polish
banks in the Fund's small loan windows program, were demanding bribes
in return for assuring bank loans. The Polish Fund and independent
parties investigated the allegations, and eventually one loan officer
was asked to resign for poor performance, but the Fund was not able
to confirm any impropriety. According to the Fund, it was just a
coincidence that this resignation was requested at the same time the
investigations were occurring.
While the Polish Fund reported that bribery and unethical business
practices were commonplace in Poland, the Fund also stated that in no
case did any officer of the Polish Fund report that any business
person or government official sought to influence the Fund through
unethical practices.
THE HUNGARIAN FUND'S INVESTMENT
IN AN INVESTMENT SERVICES
COMPANY HAS RAISED CONCERNS
---------------------------------------------------------- Chapter 4:3
In April 1992, the Hungarian Fund invested $4 million, about 99
percent of the paid-in capital, in an investment services company,
EurAmerica. This investment was atypical for Hungarian Fund
investments since it did not comply with Fund policies, which limited
investments to $3 million and required a significant capital
contribution by co-investors.
From its inception, the Hungarian Fund envisioned the need for an
investment services company in Hungary and considered this an
integral part of the Fund's strategy for its investments. According
to the management plan, the Fund believed that this company would (1)
assist in the Hungarian government's privatization program; (2) help
develop capital markets in Hungary and underwrite shares of the
Hungarian Fund's companies once they were marketable; (3) provide
training for Hungarians in financial services; and (4) interest other
investors to participate in projects the Fund undertakes. The
Hungarian Fund believed that Hungary had the potential of becoming a
financial center in Central and Eastern Europe, and this institution
was a step in that direction.
The president of the Hungarian Fund said that the size of the Fund's
investment of $4 million was determined by EurAmerica's need to hold
a substantial amount of capital to establish the organization's
credibility in financial markets. Except for the amount used for
operations, the president anticipated that the capital was not going
to be used for underwriting activities until the Hungarian Fund's
invested capital had been reimbursed. He said EurAmerica was
initially to focus on performing financial advisory services to prove
that it could support itself on its earnings.
According to the Hungarian Fund, a key problem in establishing the
company was to find and compensate experienced investment bankers who
were willing to work in Hungary. In April 1992, the Hungarian Fund
negotiated contracts with three investment bankers to manage
EurAmerica. The contracts called for first-year annual compensation
of approximately $400,000 for the company's chief executive officer,
$300,000 for the president, and $100,000 for a vice president to be
paid from money provided to the Hungarian Fund by the U.S.
government. The salaries were guaranteed and not tied to performance
during the first compensation period. Salaries were to be reduced by
50 percent if the company did not show a profit after 15 months. The
Hungarian Fund's president stated that this compensation was in line
with both the market rates for investment bank principals and the
salaries these individuals previously received in their prior
positions at a large U.S.-based investment bank. However, the Fund
could not provide documentation of these assertions.
After several contractual agreements with EurAmerica had not been
fulfilled, the Hungarian Fund chief financial officer conducted a
review of EurAmerica's financial management practices in April 1993.
The Hungarian Fund had not received any quarterly financial
statements from EurAmerica, as required by the EurAmerica joint
venture agreement, and the required annual audit by the outside
auditor was delayed.\2 The chief financial officer found that the
auditors could not have performed the annual audit at the time
designated in the joint venture agreement due to the disorganized
condition of EurAmerica's records. The chief financial officer found
that the entire EurAmerica administrative staff of four individuals,
who were responsible for maintaining the records, had recently
resigned. The reasons given for two resignations were personal, and
the officer did not learn the reasons for the other resignations.
Although he did not believe their resignations were in anticipation
of the annual audit, he found their work had been substandard. The
chief financial officer also found that EurAmerica had not kept
formal minutes recording the board of directors' meetings, and he had
to ask the company directors to reconstruct these minutes from their
notes.
On May 31, 1993, a certified public accounting firm, which conducted
the annual audit of EurAmerica, issued an unqualified opinion\3 on
its financial statements in accordance with U.S. auditing standards.
However, on June 10, 1993, the accounting firm also issued a separate
letter to EurAmerica management and shareholders, including the
Hungarian Fund that indicated a number of specific concerns regarding
the company's operations. While U.S. auditing standards do not
require that the management letter be provided to users of financial
statements, a danger exists that other users of the financial
statements, such as potential investors, who rely upon the
unqualified opinion may be misled if they are not also furnished with
the findings contained in the management letter.
On August 24, 1993, the Hungarian Fund announced that the EurAmerica
investment had been restructured in order to bring it into voluntary
compliance with the informal salary guidelines State, AID, and the
House Appropriations Committee set for the enterprise fund staff.
This was done even though the EurAmerica staff are not considered to
be employees of the Hungarian Fund. This salary cap of $150,000 will
be in effect until the Hungarian Fund is reimbursed its initial
$4-million investment along with interest, at which time EurAmerica
will become a completely independent entity. The Hungarian Fund will
continue to receive a percentage of EurAmerica's net profits for 5
years after the payback. Also, as part of the renegotiation
agreement, the principals of EurAmerica agreed to return immediately
a minimum of $1 million and on August 27, 1993, EurAmerica returned
$1.3 million to the Hungarian Fund.
--------------------
\2 The chief financial officer said that in October or November 1992,
EurAmerica management had requested and received approval from the
Hungarian Fund president for a postponement of the first annual audit
until June 30, 1993. This audit was to have occurred as of December
31, 1992, and reported by March 31, 1993. After EurAmerica was the
subject of unfavorable press, the Fund insisted that the audit be
completed by May 31, 1993.
\3 The American Institute of Certified Public Accountants definition
of an unqualified opinion or an auditor's standard report--"The
auditors's standard report states that the financial statements
present fairly, in all material respects, an entity's financial
position, results of operations, and cash flows in conformity with
generally accepted accounting principles."
SEVERAL INVESTMENTS HAVE
ENCOUNTERED DIFFICULTIES
---------------------------------------------------------- Chapter 4:4
THE POLISH FUND
-------------------------------------------------------- Chapter 4:4.1
The Polish Fund's investments in agriculture and a newspaper
demonstrate some of the difficulties confronting firms during the
transition from a centrally planned economy to a market system. For
example, an agricultural cooperative that was given a $2.4-million
loan from the Polish Fund for upgrading a food storage facility,
viewed the loan the same as the "loans" it had previously received
from the former Communist government. Borrowers were never expected
to repay these loans. The cooperative members also rejected the
business advice of an American consultant on food processing who
spent 10 months with the cooperative, and the members accused the
consultant of wanting to ruin the business so that Western investors
could buy it very cheaply. The consultant concluded that many people
in the cooperative did not want to work hard and did not consider
operating the business efficiently to be a high priority. The Polish
Fund did not have an equity position in this business and thus was
limited in its ability to influence the business' operations and
claim collateral.
In another case, the Polish Fund invested $2.2 million in debt and
equity in another agricultural cooperative, but in this instance the
Polish Fund managers acted on their prerogative as majority owners
and unilaterally decided to delay the start of operations of a
produce-sorting plant. This decision was made because a poor growing
season and construction delays would have caused the company to
operate at an estimated loss of $500,000 during the first season.
The Polish Fund was criticized by the cooperative for making the
decision for purely financial reasons. The members of the
cooperative, who wanted to use the sorting facility in which they had
also invested felt that their interests were being disregarded by the
Fund. Once the company started production the following year, some
members of the cooperative boycotted the operation and marketed their
produce through other distribution channels.
The Polish Fund also invested $3 million in a nationwide newspaper
that failed before publication began. The newspaper business was
considered a high-risk business, and a number of newspapers had
previously failed in Poland. According to the Polish Fund's
consultant for this investment, the publication, modeled after a USA
Today format, had a potential market. Nevertheless, there were
circumstances connected with this investment that increased its risk.
The Polish Fund's president told us that the Fund lost confidence in
this business because the newspaper's poor financial management and
the resignations of a number of key personnel. Also, the editor was
unclear about how much additional capital the paper needed to start
operations after experiencing delays in obtaining equipment. Faced
with the decision to invest additional funds or cut its losses, the
Polish Fund chose to close down the operation and sell or lease the
physical assets acquired. To recover at least part of its
investment, in December 1992, the Polish Fund signed a letter of
intent with a joint venture partner interested in co-investing in a
publishing business, possibly magazines and books, with control of
editorial policy to be in the hands of the joint venture partner.
THE HUNGARIAN FUND
-------------------------------------------------------- Chapter 4:4.2
The Hungarian Fund also experienced investment failures. For
example, the Fund's investment of $370,000 in a systems integrator
and process control company failed in September 1992, and a $600,000
loan to an appliance manufacturing company failed in March 1993. The
systems integrator company was managed by an American joint venture
partner. The company became bankrupt due to the general manager's
unauthorized creation of a subsidiary company for which he borrowed
funds guaranteed by the company in which the Hungarian Fund invested.
The Fund decided that the fees that might be expended in legal action
against their joint venture partner were not justified, considering
the small size of their investment. Concerning the appliance firm,
we noted that the due diligence review did not reveal sufficient
information about its financial position at the time of investment.
The financial officer of the appliance firm told us that his company
concealed information about the company's creditors and outstanding
law suits. The Hungarian Fund was, however, able to seize collateral
that backed the appliance firm's loan. In comments on a draft of
this report, officials representing the Fund, said that this seized
collateral was sold for a significant portion of the amount owed on
the loan.
THE CZECH AND SLOVAK FUND
-------------------------------------------------------- Chapter 4:4.3
The Czech and Slovak Fund had set up a reserve of $200,000 for
possible losses on four investments. Several of the Fund's loans
received extensions of grace periods, having fallen behind in
starting operations. The Czech and Slovak Fund's loans generally
received grace periods on interest and principal during their
projected start-up phase. Start-up businesses were the most likely
to experience delays due to construction delays or delays in
obtaining required permits and land titles. Other companies were
operating, but not able to meet their loan payments, which were past
due. Of the Fund's 28 investments in November 1992, 6 had been given
grace period extensions or were past due. According to its chief
financial officer, the Fund tried to hold businesses to the terms of
the loan, but considered the circumstances in each case. As of June
1993, the Czech and Slovak Fund had not had any failed investments.
CONFLICT OF INTEREST AND
POST-EMPLOYMENT ISSUES
---------------------------------------------------------- Chapter 4:5
During our review, we identified two cases of potential or appearance
of conflict of interest in the applications of noninvestment-related
technical assistance. One case involved paying the salary of a
Hungarian government official and the other involved a Polish Fund
Board member's affiliation with a funded program. We also noted that
the enterprise funds do not restrict employees from subsequently
working for companies related to the enterprise fund.
POTENTIAL CONFLICTS OF
INTEREST
-------------------------------------------------------- Chapter 4:5.1
In the fall of 1992, a senior Hungarian government official and the
U.S. Ambassador to Budapest requested that the Hungarian Fund pay
the salary of a U.S. citizen to head the Hungarian State Asset
Holding Company. The Hungarian Fund agreed to fund this position
from its technical assistance account. The individual in question
was an employee of the U.S. Department of the Interior who had
served from 1990 to 1992 as a senior government adviser to the
Hungarian government on energy policy under other sponsorship.
The Hungarian State Asset Holding Company was established as an
agency of the Hungarian government to assist the management of the
government's privatization program and was given a mandate to arrange
for the partial disposition of about 160 enterprises that the
Hungarian government had decided to privatize while retaining a
portion of the shares. In justifying this use of technical
assistance funds, the Hungarian Fund pointed to the notification
letter from AID that specified that technical assistance could be
used to assist the government of Hungary to make changes in its
investment-related laws and practices to promote the growth of the
private sector.
The president of the Hungarian Fund said that he did not believe that
there was a conflict of interest between the president of the holding
company and the interests of the Hungarian Fund because it was Fund
policy to limit its investments to a maximum $3 million.\4
The president said that consequently the Hungarian Fund would not be
a likely investor in any of the privatized companies because of their
size. Furthermore, he said that the salary support was similar to a
previous arrangement under which the Fund paid the salary of an
adviser from a U.S. private institute to the Hungarian government
Minister on Bank Privatization.
The individual's assignment from the U.S. Department of the Interior
to the Hungarian Fund was made under provisions of the
Intergovernmental Personnel Act which permit the assignment of U.S.
government employees to nonprofit organizations that offer
professional advisory and development services to governments.
However, placing this U.S. government employee with the Hungarian
government holding company raised a question concerning the U.S.
Constitution's prohibition against a U.S. government official
holding any office of a foreign state without congressional consent.
During June 1993, while the propriety of this transaction, and use of
technical assistance funds to pay for it, were under review by the
Office of Personnel Management and the Department of the Interior,
newspapers in the United States and Hungary publicized this matter,
causing the individual to resign. The case, however, never was
adjudicated.
The other situation with the appearance of a conflict of interest
involved an April 1991 technical assistance grant of $1 million by
the Polish Fund to the Educational Enterprise Foundation. This
Foundation is an organization affiliated with a Polish university
that sponsors education programs to promote entrepreneurship and
gives scholarships for study and training in the United States. The
Foundation also received a matching grant of an equivalent of $1
million in local currency from the Polish government. The idea for
the Foundation was suggested to the Polish Fund by an individual
serving in the Polish government who had previously served on the
Polish Fund's Board of Directors.
In May 1991, after the Polish Fund's Board of Directors unanimously
voted to make the technical assistance grant, a Fund director was
asked to serve as president of the Educational Enterprise Foundation.
In addition to receiving a salary for the position as Foundation
president and director's fees from the Polish Fund, he was also a
professor at the university where the foundation was established. As
of June 1993, this person continued to serve in all three capacities.
The Educational Enterprise Foundation has not received additional
funding from the Polish Fund.
The Polish Fund's general counsel stated that in his opinion a
conflict of interest did not exist since the Board member in question
did not assume the position of president of the Foundation until
after the vote of the Board of Directors approving the technical
assistance grant and that in the future he will recuse himself when
any matters regarding the Foundation are handled by the Board.
--------------------
\4 As previously noted, this policy was not followed in the case of
the $4-million investment in EurAmerica.
POST-EMPLOYMENT CONCERNS
-------------------------------------------------------- Chapter 4:5.2
The funds do not have a policy restricting employees from accepting
positions with investments they had previously managed or other
companies with which they were affiliated while employed by an
enterprise fund. For example, a former Hungarian Fund analyst
subsequently accepted a position with the Fund's co-investor in an
investment for which she had performed the due diligence review.
Since there are no restrictions preventing former staff from going to
work for companies with which they were associated while working for
an enterprise fund, there is a chance that staff would be able to
negotiate investments that may not be in an enterprise fund's best
interests and create advantageous employment opportunities for
themselves.
In commenting on a draft of this report, officials representing the
enterprise funds indicated that investment proposals are reviewed by
multiple levels of management in addition to the board of directors
before the board makes investment decisions. They thought that it
was unlikely that an investment manager could negotiate an agreement
that would be personally advantageous. They also questioned the
legal enforceability of employment restrictions in Central and
Eastern Europe.
The State Department and AID stated that while this kind of
prohibition is appropriate for government employees they believed it
less appropriate for private sector employees. They said that in
certain cases it may be beneficial for individuals who had been
employed with an enterprise fund to later accept positions at
fund-related companies. The enterprise funds believe that in certain
cases, this kind of move may be instrumental in providing the
companies with needed skilled personnel and thus help ensure that the
investment becomes successful.
CONCLUSIONS
---------------------------------------------------------- Chapter 4:6
The enterprise funds are operating in a high-risk environment and
some business failures can be expected to occur. This risky
environment is precisely the reason for creating enterprise funds to
establish successful models and encourage other investors to follow.
As the funds become more experienced in workable business procedures
in their host countries, problems are expected to decline.
With the limited amount of technical assistance funding provided to
the enterprise funds and weaknesses found in financial services
infrastructure, we believe that assistance funds would be better
spent on making the funds' investments more viable rather than on
noninvestment related activities. We recognize that the Polish,
Hungarian, and Czech and Slovak funds have identified weaknesses in
the business skills of the entrepreneurs of the companies in which
they have invested and have begun to shift additional assistance
resources into programs to improve these skills. State and AID
indicated that the executive branch's new oversight parameters for
the enterprise funds will require that a fund obtain prior written
approval from AID when it intends to provide technical assistance not
directly related to current or potential investment activities.
Enterprise funds' policies prescribing that directors, officers, and
employees guard against both actual conflict of interest and the
appearance of impropriety do not appear to have been strictly
enforced. The potential conflict of interest in the applications of
noninvestment related technical assistance indicated that closer
scrutiny and additional guidance may be needed in this area,
particularly since U.S. government funds are involved.
OBSERVATIONS
---------------------------------------------------------- Chapter 4:7
Because the funds are private enterprises, we do not make
recommendations to them. However, we believe the enterprise fund
managers could improve their operations by
focusing technical assistance resources on investment-related
projects and
enforcing the policies against both actual conflict of interest and
appearance of impropriety.
U.S. GOVERNMENT OVERSIGHT OF
ENTERPRISE FUNDS
============================================================ Chapter 5
The enterprise funds were designed to have limited U.S. government
oversight and to permit them to respond quickly to the needs of the
developing private sector in Central and Eastern Europe. This
structure permitted the funds to operate independently from the
traditional AID oversight structures, and AID's role in overseeing
this assistance program has been narrowly defined. AID played a more
limited advisory role in the implementation and programming of the
enterprise funds than they ordinarily do in their grantee programs.
The State Department and AID limited oversight of the enterprise
funds to (1) an annual review by the AID Inspector General of audits
performed by certified public accounting firms of the enterprise
funds but not those of the funds' investments; (2) documentation of
fund drawdowns and preparation of a monthly report on the grant cash
balance; (3) a review of summaries of enterprise funds' investments;
(4) brief semiannual reviews in Washington, D.C., on the status of
the programs; and (5) brief visits to both the U.S. and overseas
fund offices. According to AID officials, AID did not seek access to
the books and records of the enterprise funds' investments.
ENTERPRISE FUNDS WERE EXEMPT
FROM MOST ASSISTANCE
REGULATIONS
---------------------------------------------------------- Chapter 5:1
The SEED Act intended that the enterprise funds be private, nonprofit
corporations freeing them from many bureaucratic constraints.
Section 201(c) of the SEED Act states that funding for the enterprise
funds will "be made available to the Polish-American Enterprise Fund
and the Hungarian-American Enterprise Fund and used for the purposes
of this section notwithstanding any other provision of the law." The
SEED Coordinator, AID General Counsel, and AID Inspector General
interpreted this "notwithstanding" clause as exempting the funds from
customary U.S. assistance program regulations.
The SEED Act provided for a State Department coordinator to oversee
all SEED programs and activities. AID was charged to act as the
grantor of the funding. The act required the enterprise funds to
meet certain audit and financial record keeping requirements but did
not include specific provisions for program monitoring or oversight
by the executive branch agencies. The act required (1) the
enterprise funds to have an annual audit by independent auditors and
(2) each recipient of assistance to keep separate accounts of the
assistance and, for audit purposes, grant full access to enterprise
funds or their authorized representatives. The act, enterprise fund
certificates of incorporation, and corporate bylaws, all gave the
enterprise fund boards of directors authority to control the
direction and decisions of the funds and, along with fund management,
to design and implement programs.
An additional delineation of AID's oversight activities was made in
the grant agreements between AID and the funds in May 1990.\1
These agreements stated that the funds' independent auditors would
submit the required annual audits to the AID Inspector General for
review of "the quality of audit work and adequacy of audit coverage."
The agreements gave the AID Inspector General authority to have audit
access to the books and records maintained by the funds on
disbursements of grant or technical assistance, but did not provide
further access to the enterprise funds' investments. Additionally,
the grant agreements provided that AID could participate in
semiannual reviews concerning the funds progress in accomplishing the
purposes of the grant agreement.
In November 1990, the Foreign Operations, Export Financing, and
Related Programs Appropriations Act, 1991 (P.L. 101-513) required
that money made available for the Polish and Hungarian enterprise
funds be expended "at the minimum rate necessary to make timely
payment for projects and activities." The Senate Appropriations
Committee report\2 concerning this legislation indicated that AID
should limit its oversight, specifying that "AID's role is simply to
write the check on a periodic basis when the enterprise funds
determine that additional funding is necessary." The Conference
Report\3 on this legislation stipulated that the conferees strongly
emphasized that "AID is not to attempt to second-guess investment
decisions." These reports called for a hands-off policy for
enterprise funds' oversight by the executive branch. The SEED
Coordinator, AID General Counsel, and AID Inspector General said that
the reports reinforced that AID had limited oversight responsibility
of the enterprise funds.
Audit guidelines prepared by the AID Inspector General in November
1991 limited its annual reviews to compliance audits.\4
The Inspector General noted in the guidelines that oversight was
limited to the enterprise fund policies and procedures and are "not
as strict and specific as those applied to other AID grantees." AID
cited the grant agreements as the only binding documents for grantee
requirements and that the funds were not expected to comply with
standard Office of Management and Budget requirements for grant
recipients.\5 The compliance audit guidelines were subsequently
applied to all of the enterprise funds and the Inspector General has
routinely performed annual compliance audits of the funds.
A February 1992 draft protocol agreement between AID and the funds
specified how AID would carry out its responsibilities. The draft
agreement provided for (1) documentation of fund drawdowns and
preparation of a monthly report on the grant cash balance; (2) review
of summaries of enterprise funds' investments; (3) semiannual reviews
of the status of the programs; (4) visits to the funds by the AID
project officer; and (5) a final evaluation of the funds. The final
evaluation was projected to be conducted once the U.S. government
funds were sufficiently disbursed to determine the use of enterprise
funds as a means of delivering economic assistance. The draft
protocol, although never signed, established a basis for a review
process between AID and the enterprise funds.
The semiannual reviews, chaired by the State Department, focus on a
presentation by an enterprise fund's management of the overall
performance of the fund, the status of funding, and the resolution of
problems that arise through other monitoring efforts. Prior to a
semiannual review, an enterprise fund provides AID with a set of
documents summarizing its operations. We attended a semiannual
review of the Hungarian Fund in March 1993, which lasted 2 hours, and
consisted of an overview of its investments and operations presented
by the Fund's president, with limited time for questions. AID, with
State's concurrence, denied our request to attend subsequent
semiannual reviews. However, we obtained reports of these meetings,
and the structure of the other semiannual reviews appeared to be
similar to the perfunctory meeting we observed.
The draft protocol agreement provided for up to three visits annually
at enterprise funds by the AID project officer, but envisioned that
the time the project officer would spend with the enterprise funds
would be 3 hours for each fund's U.S. office and 1 day for each
fund's in-country office. Such time limitations significantly
restrict the project officer's access to information and ability to
conduct an in-depth assessment of the funds' performance.
In commenting on a draft of this report, enterprise fund officials
noted that some visits to in-country offices by the project officer
had lasted longer than the time foreseen by the protocol agreement,
included some site visits to investments, and meetings with company
management. Nevertheless, the AID project officer stated that there
had been inadequate time allotted for by the funds for his visits.
However, in discussing the funds' assertions with the project
officer, he said that during his more recent visits, there was a
marked change in his ability to complete his planned review that was
characterized by a greater degree of openness and cooperation from
the enterprise funds.
The Appropriations Act for fiscal year 1993 (P.L. 102-391)
transferred primary responsibility for the day-to-day implementation
of SEED programs from AID's headquarters staff in Washington to AID's
overseas offices. State and AID said that the overseas offices would
be responsible to the Coordinator and subject to the guidance of the
in-country Ambassador. AID's enterprise fund project officer in
Washington, D.C., told us that while he would still be the contact
person for enterprise funds, he was integrating AID field staff into
his visits at enterprise fund offices abroad. He was accompanied by
an AID field office staff member on his semiannual visits in the host
countries in June 1993. According to the Acting Assistant
Administrator of AID's Bureau for Europe, the change to field
oversight of all SEED programs, including the enterprise funds, was
part of a natural evolution from a quick start-up program in two
countries to a longer term sustainable program with operations in
over a dozen countries.
--------------------
\1 The Czech and Slovak and Bulgarian funds' grant agreements, in
April 1991 and November 1991 respectively, were nearly identical to
the Polish and Hungarian funds' grant agreements in May 1990.
\2 Senate Report 101-519.
\3 House Report 101-968.
\4 Compliance audits conducted by the Inspector General were to
determine the adequacy of an enterprise fund's audit report prepared
by nonfederal auditors engaged to perform audits of a fund's programs
and through this review determine the enterprise fund's compliance
with (1) the SEED Act; (2) the grant agreement; and (3) grantee
bylaws, articles of incorporation and policies and procedures.
\5 Office of Management and Budget Circulars A-110, A-122, A-128, and
A-133.
CONGRESS CHANGES MONITORING
---------------------------------------------------------- Chapter 5:2
In 1992, the Congress considered measures that would provide more
timely information about enterprise fund programs. In its June 1992
report on the fiscal year 1993 appropriations bill,\6 the House
Appropriations Committee stated the Committee's intent that "any new
relationships or structures which have not been justified to the
Congress, which these Funds may enter utilizing appropriated funds,
require notification."
In keeping with this notification directive, in the summer of 1992,
the Polish Fund was asked by the House Appropriations Committee to
provide additional information on the plans for the creation of the
Equity Fund.\7 The original plan for management incentive
compensation designed by the Polish Fund was to be calculated as a
percentage of the net realized gains on all monies invested by the
Equity Fund, including $50 million provided to the Polish Fund by the
U.S. government. This plan had the potential of creating a very
large compensation package for Fund management that would be based
partly on the investment of U.S. government funds. After
consultation with the Committee, the Fund changed the management
compensation plan to include profit share compensation on only funds
obtained from outside investors and not the U.S. government.
In another case, the House Appropriations Committee became concerned
that the executive branch had failed to negotiate adequate provisions
of the plan for eventual enterprise fund liquidation at the time of
the original grant documents and took measures to change them. In
December 1992, the Committee placed a hold on disbursal of enterprise
funds' 1993 appropriations pending a renegotiation with the
enterprise funds of provisions for eventual fund liquidation.
The Committee was concerned that the enterprise fund certificates of
incorporation had given the boards of directors all decision- making
authority regarding fund liquidation, with only the provisions that
any remaining proceeds would be reimbursed to either a nonprofit
organization or the U.S. government. The certificates of
incorporation did not give the U.S. government a role in the
liquidation decision.
In June 1993, AID officials presented the Committee with a revised
proposal for liquidation. This proposal included provisions for
greater U.S. government control of liquidation within certain time
frames,\8 but would allow the enterprise funds to manage the
liquidation.
The Committee also initiated its own inquiry of the Hungarian Fund's
EurAmerica investment. As a result of this inquiry, the Hungarian
Fund renegotiated its contract with the principal officers of the
investment services company; a condition the Fund had to meet before
it could receive further funding. Furthermore, the Committee
specified additional conditions relating to circumstances requiring
notification and salary limits for personnel of all the enterprise
funds in Central and Eastern Europe or their major investments that
it believed should be met before the enterprise funds received
further appropriated funds.
In September 1993, AID informed the Committee of new procedures it
would follow concerning executive branch oversight of enterprise fund
activities. These procedures include consultation with the cognizant
congressional committees on various matters related to the funds.
The new procedures call for written approval by AID of (1) enterprise
fund structural changes such as establishing a subsidiary or
affiliate with substantially the same personnel as the fund or (2)
most investments in companies primarily involved in financial
services. Also, a $150,000 cap on salaries of enterprise fund
employees or staff of companies in which an enterprise fund holds a
majority interest was established. AID said it would provide
semiannual briefings to the congressional committees on the progress
of each enterprise fund and that all noninvestment related technical
assistance will be subject to AID approval. These changes in AID's
relationship with the enterprise funds have been incorporated into
the grant agreement with the new Russian-American Enterprise Fund.
The executive branch will also include them in revised grant
agreements currently being negotiated with the existing funds.
AID said that these changes in procedures "would take the burden of
review and approval off the Congress and put that burden and the
accountability that goes with it squarely with AID (in coordination
with State)." It is unclear whether more stringent oversight will
include greater access to source documents.
--------------------
\6 House Report 102-585.
\7 In discussing a draft of this report, the Polish Fund noted that
since December 1991, acting on its own initiative, it had provided
information to the State Department and AID and sought their approval
of its plans for the creation of the Equity Fund. In February 1992,
Fund officials held several meetings with cognizant congressional
committees on this matter.
\8 The administration must inform each fund 1 year before the time
set for liquidation. This would not occur before 10 years or after
15 years of operation and would be upon mutual agreement.
CONCLUSIONS
---------------------------------------------------------- Chapter 5:3
While AID's new approach to dealing with the enterprise funds will
improve the executive branch's oversight of them, AID's oversight
will still be less than its oversight responsibilities for other
grantees. The enterprise funds will retain substantial autonomy in
planning and carrying out their investment decisions. State and AID
said that dealing with the funds in this manner will maintain the
independence of the enterprise funds while ensuring better
accountability. However, it is too early to know whether the
procedures and agreements outlined by AID will be adequate.
ANALYSIS OF THE POLISH FUND'S
INVESTMENT PORTFOLIO
=========================================================== Appendix I
We performed an analysis of individual companies in the Polish Fund's
investment portfolio on December 31, 1991, June 30, 1992, and
September 30, 1992. We selected December 31, 1991, as it was the
first year for which the investments were audited by independent
certified public accounting firms. June 30, 1992, represented 6
months of unaudited interim data, and September 30, 1992, was the
last quarter that we could obtain unaudited interim data on
investments, as well as it being the end of the Polish Fund's fiscal
year. Data were compiled from the financial statements of individual
companies in the Polish Fund's investment portfolio and converted
from Polish zloty to U.S. dollars at the official exchange rate on
the balance sheet dates.
Our analysis indicated that the Polish Fund's investments of equity
and debt leveraged additional Polish investments of equity, debt, and
vendor trade credit. As indicated in table I.1, every $1 of Polish
Fund investment is associated with another $0.50 to $0.61 of other
private investment in Poland, which in turn created a ripple effect
for additional private sector business activity to supply and finance
the investment's growth.
Table I.1
Leveraging Effect of the Polish Fund
Investments
(Dollars in millions)
Trade Leverage
Date Equity Debt Total Equity Debt credit Total percent
-------------- ------ ------ ====== ------ ------ ------ ====== --------
Dec. 31, 1991 $51 $31 $82 $18 $15 $13 $46 56
June 30, 1992 70 32 102 21 13 17 51 50
Sep. 30, 1992 60 33 93 21 14 22 57 61
--------------------------------------------------------------------------------
\a At original cost.
Source: Compiled by GAO from financial statements of individual
companies in the Polish Fund's investment portfolio.
While the Polish Fund's debt investments steadily increased over the
three reporting periods, equity investments decreased as of September
30, 1992, primarily due to a cash refund of $8 million from the
Polish Fund's joint venture subsidiary. Polish private investment
steadily increased from $46 million as of December 31, 1991, to $57
million as of September 30, 1992, primarily due to growing trade
credit as the investments developed their operations.
Other factors that affected the value of individual companies in the
Polish Fund's investment portfolio were currency exchange losses and
the impact of high inflation. The Polish Fund's equity position
ranged from 25-percent to 100-percent ownership of the investment and
was converted at the time of investment in Poland from U.S. dollars
to Polish zloty. Any subsequent currency fluctuations increase or
decrease the dollar equivalent of the original zloty investment, as
well as the related subsequent value of earnings or deficits. By
September 30, 1992, the Polish Fund's $30 million of zloty equity
investments\1 experienced a cumulative loss of $4.6 million or 15
percent of the cost of its original investment. Thus, equity
investors may be reluctant to invest where there is significant risk
of currency devaluation. However, currency exchange losses affecting
equity may be offset by an increase in zloty asset values due to
inflation in Poland of 70 percent in 1991 and 43 percent in 1992.
The extent of the offset, along with many other business performance
factors, will ultimately be reflected in the amount realized upon the
sale of the equity share.
The Polish Fund's debt holdings and interest thereon are repayable in
U.S. dollars, thus the investments and not the Polish Fund, bear the
loss or gain of any currency fluctuations. However, the Polish Fund
is also an equity owner in 15 of 17 investments in which it has
provided loans, and thus bears its share of currency exchange risk.
If currency devaluations become severe, the large quantity of local
currency needed to service the debt may threaten the viability of the
investment.
We analyzed the composition of investment assets by industry,
including the liquidity of cash to other assets and the extent of
investment in fixed assets, receivables, inventories, and other
assets. We also analyzed investment total revenues, total expenses,
and the resulting gain or loss to determine their changes. However,
we were precluded from a more detailed analysis because of a lack of
detailed revenue and expense information and missing cash flow
statements.
--------------------
\1 The Polish Fund had additional equity investments of $30 million
that were dollar denominated.
COMPOSITION OF THE POLISH
FUND'S INVESTMENT ASSETS BY
INDUSTRY
------------------------------------------------------- Appendix I:0.1
As indicated in table I.2, the Polish Fund and Polish private equity
and debt as of September 30, 1992, the last period of our analysis,
were invested in the assets of 17 investments in 5 industries.
Table I.2
Composition of the Polish Fund
Investment Assets by Industry as of
September 30, 1992
(Dollars in millions)
Fixed Receivable Inventor Other
Number Industry Cash assets s y assets Total
------ ------------------ ------ ------ ---------- -------- ------ ======
4 Banking 62 2 35 0 1 $64.7
4 Services 57 25 7 3 8 30.8
4 Manufacturing 22 22 14 21 21 24.3
4 Agribusiness 2 61 33 3 1 18.4
1 Residential 1 28 6 55 10 2.5
construction
17 Total 45 24 19 6 6 $140.7
--------------------------------------------------------------------------------
Source: Compiled by GAO from financial statements of individual
companies in the Polish Fund's investment portfolio.
Cash comprised the highest total percentage, or 45 percent of total
investment assets as of September 30, 1992, which is highly liquid.
The banking investments are the most liquid, with 62 percent of their
assets in cash which, after reserve requirements, were available for
small business loans and the start-up of the residential mortgage
loan program. While the services investments appeared to have
excessive cash, some liquidity is needed for working capital to meet
start-up and operating expenses primarily for the printing business,
and will be drawn down by fixed asset and inventory acquisitions. In
the meantime, cash not needed for immediate operating purposes has
been earning interest income in a U.S. bank as protection against
devaluation of the Polish zloty.
Fixed assets represent amounts invested in equipment, buildings, and
land, and comprise a total of 24 percent of total investment assets
as of September 30, 1992. Nonbanking industries, particularly
agribusiness with 61 percent of their fixed assets, required a
significant level of investment in physical plant and equipment.
Several facilities were under construction or renovation and most
investments required purchase or replacement of capital assets. When
placed in service fixed assets were depreciated primarily on a
straight line method over their estimated useful service life.
Receivables from customers for loans and trade receivables comprised
19 percent of total investment assets as of September 30, 1992.
Loans from banking investments to Polish small businesses represented
35 percent of their total assets and are generally repayable in U.S.
dollars at annual interest rates from 12 percent to 16 percent over a
period not to exceed
5 years. A few loans in Polish zloty are repayable at annual
interest rates from 36 percent to 50 percent over a period from 1
month to 36 months. With 43-percent annual inflation in Poland in
1992, zloty borrowers obtained benefit that offset the higher zloty
loan interest rate.
Inventory comprised 6 percent of total investment assets as of
September 30, 1992, and were concentrated in the residential
construction and manufacturing industries. Inventories comprised 55
percent of the residential construction industry as it starts
operations with completed houses purchased by borrowers from the
mortgage bank investment.
Other assets, which include prepaid expenses, comprised 6 percent of
total investment assets as of September 30, 1992. Other assets
consist primarily of goodwill, which is the excess amount of the
non-Polish Fund equity over the market value of the investment's
tangible fixed assets at the time of Polish Fund purchase. This
intangible asset represents the value of the investment's business
name, customers, product or service recognition, market area, and
established organizational structure. Goodwill is being amortized on
a straight-line basis over 5 years to
10 years from the date of Polish Fund purchase.
INVESTMENT TOTAL REVENUES,
TOTAL EXPENSES, AND
RESULTING PORTFOLIO LOSS
------------------------------------------------------- Appendix I:0.2
The Polish Fund's investments showed a net loss of $4.3 million on
$31.8 million of total revenues for the 9 months ended September 30,
1992, or 13.5 percent. Through the year ended December 31, 1991, the
portfolio experienced a net loss of $1.6 million on $22.7 million of
total revenue, or 7 percent. Financial data on over 21,000 large-
and medium-size Polish private sector and public businesses issued by
the government of Poland reported net losses of 1.3 percent for 1991
and 1.6 percent for 1992. Our analysis of the Fund's losses showed
that they were primarily due to insufficient revenues, low
manufacturing industry gross margins, and high expenses, particularly
bad debts and currency exchange losses. As indicated in table I.3,
the Polish Fund's investment revenue and expenses for the 9 months
ended September 30, 1992, were generated from
17 investments in 5 industry segments.
Table I.3
Composition of the Polish Fund
Investment Revenues and Expenses by
Industry for the 9 Months Ended
September 30, 1992
(Dollars in millions)
Total Total
Number Industry revenues expenses (Loss)
--------------- --------------- ======== ======== ------
4 Banking $4.8 $5.1 ($0.3)
4 Services 10.2 10.7 (0.5)
4 Manufacturing 11.5 13.3 (1.8)
4 Agribusiness 4.7 6.3 (1.6)
1 Residential 0.6 0.7 (0.1)
construction
17 Total $31.8 $36.1 ($4.3)
------------------------------------------------------------
Source: Compiled from financial statements of individual companies
in the Polish Fund's investment portfolio.
Revenues were low as many of the investments were still building
their administrative, marketing, supply, and distribution structures,
or were just starting operations, such as the warehouse business and
the mortgage bank. Polish Fund officials and company managers at the
investments stated that they lost many of their former markets.
Sales to both Polish state-owned companies and the former Soviet
Union have decreased because they could not afford to buy the
products. In some cases, barter transactions remain the only way to
conduct business. According to an officer at one company we visited,
its electronic circuit board products were sold to a former Soviet
state enterprise which in turn arranged for a quantity of electric
power as payment, which was subsequently brokered in Poland to
receive cash.
To increase sales in international markets, the Polish Fund's
investments found that they had to improve product quality, which
required investment in equipment, the restructuring of operations,
and the reorganization of personnel. Long neglected environmental
concerns also face the management of investments. For example:
The director of operations for an investment told us that they had
previously manufactured circuit boards for Soviet television
sets that had a high-product failure rate due to their lack of
testing equipment. Using capital from the Polish Fund, the
company purchased computer and testing equipment, which brought
the failure rate to zero as defective boards were either
reworked or scrapped, instead of shipped to the customer.
At the Polish Fund's investment of a former state-owned printing
plant that services 88 daily newspapers, we observed obsolete
line-o-type presses in use. The company president stated that
they are in the process of buying new equipment as breakdowns
are frequent due to the advanced age of its presses and the thin
paper available, which comes apart and clogs the equipment. The
president also stated that since parts for the presses are
difficult to obtain they must be repaired or made in their
machine shop.
We also observed at the printing plant that many manual operations
were being performed, from hand counting and tying bundles of
papers as they came off the press to loading the bundles onto
waiting trucks for distribution. The company president
explained that many workers had been guaranteed a job under the
former state system and thus positions were created to employ
them, however menial. The company was in the process of
reorganization, which included an assessment of staffing
requirements.
Finally, we noted a thick accumulation of black soot covering many
surfaces in the printing plant that reflected a lack of
environmental and health concerns. The company president stated
that they are trying to implement some health and safety
regulations and have recently changed from lead based to
vegetable based printing inks.
Gross margin is the profit generated from the difference between
product sales and the cost to manufacture the product, but before
expenses for selling, general, administrative, interest, and currency
exchange. From the audited financial statements for the year ended
December 31, 1991, the Polish Fund's four manufacturing investments
generated an overall gross margin of 16 percent of sales. For three
of the four manufacturing investments that reported unaudited
detailed information for the 9 months ended September 30, 1992,
overall gross margin was 19 percent, indicating some improvement
assuming consistent classification and accurate reporting. We were
unable to find industry statistics on overall gross margins for
Polish manufacturing companies. We recognize that comparison with
U.S. business statistics is problematic; however, we noted that U.S.
manufacturing businesses surveyed by the 1991 Almanac of Business and
Industrial Financial Ratios reported an overall gross margin of 30
percent of sales.
We noted that total expenses were high in relation to total revenue
due to start-up situations and the need to build sales. However,
expenses that significantly contributed to overall losses through
September 30, 1992, were bad debts and currency exchange.
For the year ended December 31, 1991, bad debt expense of $1.2
million for the banking industry and $0.5 million for the
manufacturing and services industries amounted to over 10 percent of
revenue, and exceeded the overall loss of $1.6 million for the
period. For the 9 months ended September 30, 1992, the banking
segment recorded $1.2 million of bad debt expense, or 49 percent of
interest income. Again, we were unable to find Polish industry
statistics; however, these bad debt expense ratios are considerably
more than the less than one-half of 1 percent of revenue for U.S.
manufacturers and service businesses and 2 percent of interest income
for financial institutions as surveyed by the 1991 Almanac of
Business and Industrial Financial Ratios. Due diligence failure was
a significant factor in the high bad debts in the banking segment.
Western management, training, changes in customer attitude, and
establishment of critical assessments of customer credit worthiness
are factors being implemented by the Polish Fund to reduce bad debts
expense in the future.
Currency exchange also contributed significantly to investment
losses. When the Polish Fund's investments conduct business in
currencies other than zloty, gains or losses result from fluctuations
in exchange rates. Normally, these gains or losses do not have a
significant effect on financial results when currencies remain fairly
stable. However, the Polish zloty has had severe devaluation against
the U.S. dollar and other major currencies. This devaluation
creates accounting losses due to foreign exchange, particularly since
most investment debt is repayable in U.S. dollars.
Figure I.1 charts the 46-percent devaluation of the Polish zloty
against the U.S. dollar from September 1990 when the Polish Fund
began investments through September 1992.
Figure I.1: Devaluation of the
Polish Zloty Against the U.S.
Dollar
(See figure in printed
edition.)
Source: International Monetary Fund, International Financial
Statistics.
For the year ended December 31, 1991, we identified $300,000 in net
losses due to currency exchange and $2.1 million of net losses for
the
9 months ended September 30, 1992. Financial data provided by the
Polish Fund's investments did not always identify currency exchange
gains or losses and some amounts may be classified in other revenue
or expense accounts.
(See figure in printed edition.)Appendix II
COMMENTS FROM THE DEPARTMENT OF
STATE AND THE AGENCY FOR
INTERNATIONAL DEVELOPMENT
=========================================================== Appendix I
(See figure in printed edition.)
(See figure in printed edition.)
(See figure in printed edition.)
The following are GAO's comments on the Department of State and the
Agency of International Development's letter dated December 23, 1993.
GAO COMMENTS
--------------------------------------------------------- Appendix I:1
1. We recognize the difficult business environments in which the
enterprise funds operate. It is precisely for this reason that the
enterprise funds have to standardize and enforce the agreements with
their investees regarding financial reporting.
2. We have deleted the observation regarding the creation of
training programs for investment managers.
3. We have included information on the executive branch's new
oversight parameters for technical assistance projects not directly
related to current or potential investments.
4. We have revised our report to include this information and have
deleted our suggestion that the funds restrict employees from
subsequently working for companies related to an enterprise fund.
MAJOR CONTRIBUTORS TO THIS REPORT
========================================================= Appendix III
NATIONAL SECURITY AND
INTERNATIONAL AFFAIRS DIVISION,
WASHINGTON, D.C.
------------------------------------------------------- Appendix III:1
Lee W. Richardson, Assistant Director
Maria Z. Oliver, Project Manager
Bruce L. Kutnick, Senior Economist
Anne Spitza, Evaluator
ACCOUNTING AND INFORMATION
MANAGEMENT DIVISION,
WASHINGTON, D.C.
------------------------------------------------------- Appendix III:2
Roger Stoltz, Assistant Director
John Riefsnyder, Assistant Director
Harold P. Santorelli, Senior Evaluator
Patrick R. Dugan, Senior Evaluator
OFFICE OF GENERAL COUNSEL,
WASHINGTON, D.C.
------------------------------------------------------- Appendix III:3
Jerold Cohen, Assistant General Counsel
Richard Seldin, Senior Attorney