Organization and Development of Russian Business A Firm-Level Analysis_2 pdf

The Emergence of Russian Corporations 31 part in the division of public assets, a strategy which some firms deliberately chose. Such firms have survived more hardships in the 1990s, but they could have learned more. Furthermore, it was they who created that potential for future economic growth which was first noticed by the McKinsey Co. in their report titled “Unlocking Economic Growth in Russia” and announced in Moscow in October 1999 (Palmeda & Lewis 2003). In general, describing the model of the Russian firm in the 2000s, we can point out that a significant part of Russian firms have assumed standard market incentives to develop business, such as making long-term profits, having higher company capitalization, and expanding their market share. In addition, majority shareholders, who, as a rule, maintain operational management in their hands and effectively control the activities of other managers, have become the key figures in most Russian firms. At the same time, the internal restructuring of Russian firms is far from completion. In terms of efficiency, Russian companies are still far behind the firms of other developing and emerging economies. For example, World Bank data show that, in 2004, labor productivity in the Russian industry was just slightly above the level of that in China but about a third of that in the South African Republic, less than half of that in Poland, and two thirds of that in Brazil (Desai & Goldberg 2007). However, these average figures conceal very large actual gaps in terms of added value between firms in the same industries. For instance, in 2004, the labor productivity gap between the best 20% and the worst 20% of firms was 11 times in transportation machinery, 16 times in light industry, and 24 times in the woodworking and food industries (Golikova et al. 2007). In actual practice, this means the coexistence of efficient and absolutely inefficient firms among Russian industries in the 2000s. This was possible because of an extensively growing domestic demand, which allowed inefficient firms to keep afloat. In this context, the global financial crisis, which started in 2007, may play an important role. It is clear that this crisis will test the durability of leading companies, and, on the other hand, it will help eliminate inefficient firms and eventually contrib- ute to a more efficient economy. Now, by comparing the evolution of the transition firm in Russia with the trends in Eastern Europe at the present stage, the following key points can be identified. A shift of the government to responsible macroeconomic and fiscal poli- cies, supported with substantial consolidation of public institutions, was very important for the change in firm behavior in Russia. It was a political result of the 1998 crisis, but, in Russia, strengthening of the government fol- lowed a different trajectory from that in the countries of Eastern Europe. In Eastern Europe, the state, oriented toward EU standards, was more inclined toward setting up the rules of the game and acting as an arbitrator. In Russia, however, the stronger government turned to active expansion of 978023_0217287_03_cha01. dd 31 5/12/2009 5:19:15 PM 32 Organization and Development of Russian Business its presence in the economy by using investment programs, policy-based institutions of development, and state-owned companies (see Table 1.1). This could be defined as an attempt to repeat the experience of South-East Asian countries from 1960 through the 1980s through the building of a similar pattern of relations between the state and big business under state leadership. One of the reasons for following this path is the illegitimacy of the results of privatization. In the public opinion, the privatization of the 1990s is con- sidered unjust (Denisova et al. 2007), and the representatives of the busi- ness community themselves acknowledge the legality of revising its results (Frye 2006). This lowers the degree of protection of property rights and gives the state an additional lever for keeping the largest companies under informal pressure, particularly those that received their assets at loans-for- shares auctions. Being closed for foreign investors is Russia’s another major distinction. In Eastern Europe, the model of corporation was shaped under very strong influence of foreign shareholders, who gained control over most large com- panies (Andreff 2005; Stark & Vedres 2006). In Russia, in the 1990s, although the government more than once pledged support to foreign investments, company managers were typically hostile to foreign shareholders. In the 2000s, the government and businesses reversed their roles, but the real situ- ation changed little. The companies that are controlled by Russian private owners are more inclined to cooperation with foreign investors, but, at the government level, foreign investments are truly welcome only in certain sectors. In a number of large-scale raw material projects, the government helped to oust foreign investors, and, in general, foreign shareholders in big business were assigned, under government pressure, to junior-partner positions. It is not by chance that here, in contrast to preceding sections of this chap- ter, we have made comparisons only with Eastern Europe. Although pack- ages of reforms at the enterprise level were originally quite similar in Russia and in Eastern Europe in the 2000s, the East European and Russian models of a firm were divergent in their development, and Russia was inclined to an orientation more comparable to that of China. The differences that we have reported above confirm this thesis. As a consequence, in the future, we expect that Russian companies will be divided into two sectors: the largest firms will remain directly or indi- rectly controlled by the state, and mid-sized firms, by the standards of the global market, will be more independent and open to foreign participation (Yakovlev & Danilov 2007). The largest firms share similarities with the model of the development firm as defined by Berglöf & von Thadden (2000); they have informal relations with the state and investors, which are typical of this model. On the other hand, mid-sized firms will evolve toward the model of a closely held firm with the predominance of large shareholders 978023_0217287_03_cha01. dd 32 5/12/2009 5:19:15 PM The Emergence of Russian Corporations 33 in governance and a limited presence in the stock market. In this context, the gradual disappearance of the concept of the transition firm is a distinct possibility. Notes 1. According to the data given by Qian (1999), in 1940, the annual plan in the USSR was compiled for 500 commodity items; however, in the late 1950s, the product mix of Gosplan had more than 2,000 items, and, by the end of the 1970s, plans on the level of USSR ministries had about 60,000 items. On the other hand, in China, in 1957, the plan of the central government included 532 items, and, by 1973, their number increased to only 617. This had been the result of several campaigns of administrative decentralization conducted by Mao Zedong, and, later, it was related to the consequences of the Cultural Revolution, when, in 1967–1968, no annual plans were compiled at the level of the central government. 2. This policy was a logical outcome from the Soviet model of organization of central- ized planning by industry, which implied the management of all enterprises from a single center, and the mere scale of the country required to reduce the number of managed objects to a minimum and to streamline their structure. On the con- trary, the government of China, based on the idea of regional self- sufficiency in case of American or Soviet aggression, designed a regional system of centralized planning and deliberately supported the development of the same types of pro- ductive facilities in different regions. In the literature, these differences in eco- nomic organization in the USSR and China were labeled U-Form and M-Form, by analogy with the linear-and-functional and matrix structures of management in corporations (Qian & Xu 1993; Maskin, Qian, & Xu 2000). 3. For instance, according to data given by Sinelnikov et al. 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(2006) The evolution of business–state interaction in Russia: From state capture to business capture? Europe–Asia Studies, 58: 1033–1056. Yakovlev, A. & Danilov, Yu. (2007) Russian corporation development in the next 20 years: Ownership structure, the role of state, and corporate finance, unpub- lished working paper. Moscow: Higher School of Economics. 978023_0217287_03_cha01. dd 35 5/12/2009 5:19:16 PM This page intentionally left blank Part I Ownership, Internal Control, and Management System 9780230_217287_04_cha02. dd 37 5/14/2009 3:42:31 PM This page intentionally left blank 39 2 Stock Ownership and Corporate Control Tatiana G. Dolgopyatova Introduction Researchers of the Russian economy have unanimously identified the most important features of stock ownership and control. First, the concentration of capital in the corporate sector resulting from its aggressive redistribu- tion for more than 15 years tends to be high. Second, the high concentration of ownership affected the development of corporate control and evolution of the mechanisms of corporate governance (Natsional’nyi Doklad 2008). This high concentration provides the basis for control by the majority share- holder or a consolidated group of such shareholders exercised by various formal and informal means (Dolgopyatova 2003, chapter 2). Majority share- holders are constrained only by the need to comply with the formal legal provisions and often imitate the activities of intra-corporate tools (bodies) (Razvitie Sprosa 2003). Third, the prevailing model of corporate control is that in which majority shareholders participate directly in management as top managers of companies (Insiders and Outsiders 2004; Stiglitz 1999). A combination of ownership and control has become a formal institution of Russian corporate practices, which restrict the demand for “outside” man- agers who do not own company shares. This institution has become wide- spread not only as a result of privatization (“red directors” becoming owners of enterprises) but also as a tool intentionally chosen by owners who estab- lished their businesses from scratch. In a situation of underdeveloped mar- kets for managerial staff and institutions for protection of property rights, this arrangement was preferred as compared to high costs of preventing opportunistic behavior of hired managers. 1 At the time of economic tran- sition, this behavior would take the extreme form of asset stripping and business raiding. This resulted in the elimination of the agency problem of corporate governance. On the basis on quantitative data obtained from our representative sur- vey and qualitative information of in-depth interviews with company own- ers and managers, in this chapter, we will discuss the relevance of simple 9780230_217287_04_cha02. dd 39 5/14/2009 3:42:31 PM 40 Organization and Development of Russian Business hypotheses regarding the role of high concentration of capital in the evolu- tion of intra-corporate control forms and business performance. We pre- sume that a high concentration of ownership is linked with its hidden structure and that it affects intra-corporate relationships. The vast major- ity of Russian JSCs combine ownership and control despite the current trend to separate executive management from ownership. Concentrated ownership will encourage owners to restructure and develop their businesses. The second section contains a description of the structure of stock own- ership that emerged in Russian companies in 2005 and the types of share- holders they include. The third section discusses the correlations between the level of ownership concentration and business performance, and the fourth section contains a description of the corporate control tools used by the majority shareholders. The results of the analysis are summarized in the fifth section. Ownership composition Since the mid-1990s, empirical studies performed by many Russian and international institutions have focused on corporate ownership and the con- trol mechanisms of Russian companies. These studies (e.g., Radygin & Entov 2001; Dolgopyatova 2003; Guriev et al. 2003; Yasin 2004; Kapelyushnikov & Dyomina 2005; Aukutsionek et al. 2007) suggested that, for many years, the economy underwent an extensive redistribution of stock ownership that was accompanied by entry of new shareholders. The Russian Economic Barometer (REB), the Center for Economic Conjuncture, and State University – Higher School of Economics (SU-HSE) have reported that the entry of new large owners affected from 5–7% of JSCs each year from the 1990s to the early 2000s. 2 Quantification of ownership concentration Russian companies have a characteristically high level of stock owner- ship concentration that increases annually. Aggressive ownership redis- tribution in the wake of privatization resulted in the rapid emergence of large shareholders. According to various surveys, in the beginning of the 2000s, the largest shareholder would own, on average, 40–50% of the assets; JSCs including a blockholder accounted for 40–65% of the total sample, while those with a controlling stakeholder accounted for up to 45% of the sample. Respondents also suggested (Razvitie Sprosa 2003) that at least two-thirds of open JSCs had an owner in control of the company. Qualitative surveys (e.g., interviews and case studies) generally suggested a higher level of concentration of real control, as opposed to formal ownership, in one person and practically the universal presence of a controlling shareholder. 9780230_217287_04_cha02. dd 40 5/14/2009 3:42:31 PM [...]... Dolgopyatova 2001) found that a higher concentration of capital was characteristic of smaller companies and businesses in relatively better-off industries, whose shares were attractive for their management and potential outside investors, 9780230_217287_04_cha02 dd 41 5/14/2009 3:42:32 PM 42 Organization and Development of Russian Business Less than 25% of shares 13% More than 50% of shares + absence of a counterbalance... concentration was approximately the same in manufacturing and communications and was not dependent on company size, type of incorporation, corporate background, and lack of international or domestic tradability of stock As the only significant (at the 1% level) difference, new companies had the second-largest shareholder twice as often as privatized and reorganized ones A very high level of concentration... administrations Minor individual shareholders Banks Investment funds and companies Russian nonfinancial enterprises Major external shareholders – individuals Foreign investors (individuals and legal entities) Type of shareholder Table 2.2 Average percentage of ordinary shares owned by type of shareholder at different levels of ownership concentration (% of charter capital) 46 Organization and Development of. .. Ownership and Corporate Control 41 Other important trends in the evolution of the structure of stock capital were reduced to a growth of holdings of company managers, with a noticeable decrease of holdings of all employees and a higher participation of external owners, primarily Russian legal entities, against the background of corporate integration Moreover, the role of public authorities at all levels against... Source: Author’s calculations based on survey data Stock ownership structure As reported by Dolgopyatova (2007), an important fact of corporate reality is the non-transparency and complexity of ownership rights and the concealment of true owners behind a multilevel chain (5–8 levels) of affiliated individuals and companies, offshore firms, nominal holders, and multistage company management systems This was... concentration was also characteristic of large public companies According to a survey by Standard & Poor’s of 80 Russian companies with most liquid shares, about 71% of them had shareholders with more than 50% stock in 2007, and only 8% of companies did not have a blockholder (S&P 200 7a) At 75 public companies accounting for 90% of the capitalization of the Russian stock market (S&P 2007b), the largest shareholder... survey gave two variables of the inseparability/separation of ownership and management The first variable is the question of whether large shareholders work as company managers; the second, that of whether a company CEO holds company shares Without considering those who indicated that it was difficult to answer, large shareholders were managers of 48% of the surveyed companies, and the CEOs were shareholders... (Aukutsionek et al 2007) Federal authorities hold 2.5 times more shares than regional and municipal authorities do In companies in which public agencies are among shareholders, federal agencies hold an average of approximately 40% of shares, while regional and local authorities hold less than one-fourth The share of small investors is naturally lower at high-concentration companies, while, at the same time,... formal and informal tools, to achieve corporate control The Russian practice includes the entire range of control procedures Combination of ownership and management Control through direct participation of the principal shareholder in corporate management in the capacity of top manager (CEO and/ or other top managers) has been widely practiced, thereby resolving the agent problem In this case, the data of. .. result of the general institutional environment of the Russian economy, in which the use of illegal finances and not always legitimate ways of property acquisition was common The Standard & Poor study of transparency cited above (S&P 200 7a) revealed that less than a quarter of the large public companies reported shareholders who owned 10 and more percent of stock The situation in other companies was much . management and potential outside investors, 978 023 0 _21 728 7_04_cha 02. dd 41 5/14 /20 09 3: 42: 32 PM 42 Organization and Development of Russian Business as well as of closed JSCs, in which it was. 3 42 365. Black, B., Kraakman, R., & Tarassova, A. (20 00) Russian privatization and corporate governance: What went wrong? Stanford Law Review, 52: 1731–1808. 978 023 _ 021 728 7_03_cha01. dd 33 5/ 12/ 2009 5:19:16. use of illegal finances and not always legitimate ways of property acquisition was com- mon. The Standard & Poor study of transparency cited above (S&P 20 0 7a) revealed that less than a