8 Organization and Development of Russian Business that, for JSCs not affiliated with company groups or parent companies of the groups, the influence was identified for ownership and governance features supporting the protection of property rights and for the pressure of com- petition with manufacturers from developed countries as an incentive for improving management quality. In Chapter 8, we test a competing hypothesis on the nature of Russian business groups and possible tools for disciplining the executive managers in the subsidiaries of those groups. Our empirical results show that busi- ness groups act as integrated companies rather than a network of companies and that hierarchical coordination prevails inside the groups. We also con- firmed that the most important way to resolve the agency problem in the groups is through the participation of the ultimate owners by themselves or represented by the parent company in the management. Corporate govern- ance instruments are important, mostly in subsidiaries acting in regulating industries or in state-owned companies. However, one in three subsidiaries that is a private company in nonregulated industry also develops internal corporate governance. Corporate governance as a disciplinary tool is neces- sary in state-owned as well as new private companies. Chapter 9 examines the impact of business integration on enterprise restructuring and financial and operating performance of group subsidi- aries in Russia. Directors of affiliated enterprises and, especially, of those merged after mass privatization acknowledge the impact of groups on the market competitiveness of the enterprises. A comparison of subsidiaries and independent enterprises supports the positive attitude of directors toward group membership. Our survey results indicate, as many other studies in Russia have shown, that group subsidiaries outperform independent enter- prises in terms of corporate restructuring and financial and operative per- formance. However, it is not clear whether the comparative advantages of group enterprises are explained by higher productivity alone. The results of our comparison of total factor productivity in affiliated and independent enterprises are mixed. The higher productivity of affiliated enterprises is mostly due to companies that joined the groups before 1995. The advan- tages of affiliated enterprises over independent ones provide an additional explanation of the stability of a business group as an organizational form in Russian industry. Better firm performance helps to solve agency problems in subsidiary companies. The chapters in Part III, “The Role of External Players in Corporate Governance,” present the outcomes of our research on the relationship among industrial and communications companies and commercial banks, business associations, and the government. It is controversial whether the latter three economic entities have a specific influence on corporate govern- ance and the performance of nonfinancial enterprises. Chapters 10, 11, and 12 present empirical evidence of these issues from a careful examination of the results of the enterprise survey. 978023_0217287_02_ . dd 8 5/12/2009 5:18:01 PM Introduction 9 The focus of Chapter 10 is on the banking sector. With the objective of clarifying the emerging role of commercial banks in corporate finance in economically buoyant Russia, we reveal the results of an analysis in this chap- ter conducted from a macro and micro standpoint. Macro-economically, the share of the banking sector in the overall corporate investment finance has been rising. The results from our joint survey reveal that about one-third of medium-to-large scale enterprises have no external borrowings, suggesting that there is still a large capacity for the banking sector to increase its role. These firms tended to be smaller, with a closely held ownership structure, and were not active in new investments. In this chapter, the role played by Sberbank, the largest Russian saving bank, is also examined; it is by far the largest major bank that has served as a main supplier of funds since the financial crisis of 1998. The enterprises that showed Sberbank as the larg- est financer were mostly large ones and had export records. They tended to have special relationships with the government, implying that the corpo- rate financing mechanism had been evolving in close cooperation between the government and enterprises. Chapter 11 scrutinizes the relationship between the business associations and their member firms. Empirical literature on the membership of Russian firms in business associations provides no clear explanation of the main incentives of the firms to participate in collective action. In this chapter, we explore whether these incentives are inspired by market pressure, or, on the contrary, whether rent-seeking and a desire to establish personal relation- ships with authorities influence major decisions within a firm. To clarify these issues, we empirically examine the determinants of membership in associations and explore the reasons for simultaneous membership in dif- ferent types of associations, that is, the phenomenon of multiple member- ship. Our estimation results reveal that the larger and better-performing enterprises are more interested in joining associations in situations of competitive pressure from the Baltic countries, Turkey, and China. We also confirmed that enterprises with general directors who are large owners sig- nificantly more often become members of associations than do firms headed by hired CEOs. The main benefits from joining these business associations are related to the close interactions with state authorities. We argue that this feature may help to overcome information asymmetry in the fragile institu- tional environment of Russian business. In addition, multiple membership significantly increases the chances to obtain financial and organizational support from the state and, thus, is a rational strategy of market players. In Chapter 12, we analyze the influence of the state on the improvement of corporate governance in Russia of the early 2000s. Taking into account the low quality of market institutions in the 1990s (i.e., the market failure phenomenon), we assume that state intervention as the second-best solu- tion had a positive impact in this case. Using a firm-level dataset obtained from our enterprise survey, we test this hypothesis in two types of corporate 978023_0217287_02_ . dd 9 5/12/2009 5:18:01 PM 10 Organization and Development of Russian Business models: state-owned or mixed firms and politically connected firms. The first model confirmed a strong positive influence of state ownership on the corporate governance in Russia in 2001–2004. The estimation results are sta- tistically robust in different model specifications. We connect this empirical evidence with attempts of the Russian government to use standard mecha- nisms and procedures of corporate governance to defend its property rights in its relationships with state-owned and mixed enterprises. The concluding chapter summarizes the major findings in this study and discusses the remaining issues and agenda for future research. We are hopeful that this volume will provide an insight into firm organi- zation and management in Russian business and stimulate further discus- sion and research on this topic. Notes 1. Many experts point out, however, that a large part of this remarkable growth of FDI inflow in recent years can be explained by active repatriation of offshore Russian capital. Nevertheless, it is also a fact that many Western companies, including several world-famous multinational enterprises, embarked or decided to embark on the Russian market, which also boosts direct capital investment into Russia. 2. We describe the details of the joint survey in the Appendix of this book. 3. Chapter outlines have been prepared by their individual authors. Bibliography Avdasheva, S. (2007) Russian holding groups: New empirical evidence, Problems of Economic Transition, 50/5: 24–43. Dolgopiatova, T. (2007) Ownership concentration and Russian company develop- ment: Empirical evidence, Problems of Economic Transition, 50/5: 7–23. Dolgopyatova, T. (ed.) (2006) Integratsionnye Protsessy, Korporativnoe Unpravleniye i Menedzhment v Rossiiskikh Kompaniyakh. Seriya “Nauchnye doklady: Nezavisimyi Ekonomicheskii Analiz,” No. 180. (Moscow: Moskovskii obshchestvennyi nauch- nyi fond i Proekty dlya budushchego). Dolgopyatova, T. G., Iwasaki, I., & Yakovlev, A. A. (eds.) (2007) Rossiiskaya Korporatsiya: Vnutrennyaya Organizatsiya, Vneshnie Vzaimodeistviya, Perspektivy Razvitiya (Moscow: Izdateliskii dom GU-VSHE). European Bank for Reconstruction and Development (EBRD), Transition Report (vari- ous issues) (London: EBRD). Federal State Statistics Service (Rosstat), Rossiiskii Statisticheskii Ezhegodnik (various issues) (Moscow: Rosstat). International Monetary Fund (IMF), World Economic Outlook Database (available at: http://www.imf.org/external/data.htm). Iwasaki, I. (2006) Korporativnoe pravo i organizatsionnyi vybor: Otkrytye i zakrytye aktsionernye obshchestva v Rossii, Rossiiskii Zhurnal Menedzhmenta, 4: 55–76. Iwasaki, I. (2007) Legal forms of joint stock companies and corporate behavior in Russia, Problems of Economic Transition, 50/5: 73–86. 978023_0217287_02_ . dd 10 5/12/2009 5:18:01 PM Introduction 11 Iwasaki, I. (2008) The determinants of board composition in a transforming econ- omy: Evidence from Russia, Journal of Corporate Finance, 14: 532–549. Sugiura, F. (2007) Rosia kigyo no shikin choutatsu koudou: Kigyo chousa deta ni motozuku bunseki, Keizai Kenkyu, 58: 151–162. Yakovlev, A. (2007) Rossiiskaya korporatsiya i regionalinye vlasti: Modeli vzaimoot- noshenii i ikh evoliutsiya, Voprosy Ekonomiki, 1: 124–139. 978023_0217287_02_ . dd 11 5/12/2009 5:18:01 PM 12 1 The Emergence of Russian Corporations: From the Soviet Enterprise to a Market Firm Tatiana G. Dolgopyatova, Ichiro Iwasaki, and Andrei A. Yakovlev Introduction In this chapter, the evolution of an enterprise model in the Russian economy is examined using two key events that predetermined major changes in enterprise behavior as division lines. The first was the disintegration of the Soviet Union, the swift dismantling of central planning, and the shock ther- apy of price liberalization in 1991–1992. The second event was the financial crisis of August 1998 and the political crisis that followed, which served as starting points for radical improvement in macroeconomic policy and strengthening of the role of the state. Prior to 1991, one could speak about socialist enterprise of the type that many researchers, from Josef Berliner to Janos Kornai, had been studying for several decades. The period from 1992 to 1998 in Russia was the time of classical transition firm, which disagreed with the forecasts of mainstream economists and led to serious challenges to the prevailing economic theory. These challenges were met by studies of economic transition and company behavior in transition economies, with the participation of leading econ- omists of the world, including Andrei Shleifer, Gerard Roland, and Josef Stiglitz. Finally, after 1998, the specific features of the transition firm started to erode and, the patterns became more in agreement with the standard models established in developing and developed economies. Our research focuses on this transitional period in Russia. However, to clarify the con- temporary trends, we focus on the features of the socialist enterprise and the transition firm and compare their Russian prototypes with counterparts in Eastern Europe and China. The remainder of this chapter is organized as follows: The first section is a discussion of the Soviet model of the socialist enterprise and its character- istics. The second section is an examination of Russian enterprise reforms in the initial stage of systemic transformation to a market economy. The 978023_0217287_03_cha01. dd 12 5/12/2009 5:19:12 PM The Emergence of Russian Corporations 13 third section traces the evolutionary process of Russian corporations after the 1998 financial crisis. The Soviet socialist enterprise The classical ideal model of a planned socialist economy implied that each enterprise was included in the system of central planning. This means that higher-ranking agencies of the state established output and input plans for an enterprise, identified suppliers and customers, and made decisions regarding capital investments and appointments of top managers. In this system, the main function of the enterprise was to achieve the target plan that had been set by the authorities. In this sense, the socialist enterprise has never been a firm. Rather, it was a production division or a shop in the gigantic “single factory,” as it had been described by Vladimir Lenin. In formal terms, the enterprise was considered a national property. However, in reality, the chief representative of the enterprise who protected the interests of the enterprise and its employees was the general manager – enterprise director. Physical resources were the main incentive for the socialist enterprise. They were the decisive factor, taking precedence over money. Decisions on the reallocation of resources for the next planning period were gener- ally dependent on successfully meeting the targets of the preceding period. Product demand was insignificant to the socialist enterprise because the right to acquire products was not based on customer solvency but, rather, on the customers identified in the procurement plans. Physical demand was also a matter of certain importance. This demand was taken into account in the compilation of a plan for the next term, but the compilation was also affected by many other matters, such as the achieved volume of output by certain item. After the plan was adopted, the target received from higher authorities became the primary task, and the enterprise produced the prod- ucts specified in the plan. However, product demand usually changed as the plans were being compiled, and some of the production then appeared to be unwanted by customers. At the same time, the products in high demand were always in short supply because changes in plans regularly lagged behind changes in demand. This process and its implications as a base for chronic shortages of resources in a planned economy are discussed in detail by Kornai (1980). The priority right to acquire products in short supply was given to the cus- tomers whose needs had been considered in procurement plans. However, suppliers had also some room for maneuvers in their relations with these customers. This was because each plan was initially compiled in physical terms (units of production). Prices were regarded as an auxiliary account- ing instrument, which could be used for the aggregation of plan targets for individual enterprises into integrated plans for industrial sectors and the 978023_0217287_03_cha01. dd 13 5/12/2009 5:19:13 PM 14 Organization and Development of Russian Business economy as a whole. However, total plan targets (excluding key designated items) were approved in value terms, as so-called “plans of gross output.” This enabled suppliers to operate on changes in assortment, producing (and imposing on customers) those products that were easier to make under regu- lar shortage of key inputs. This enabled suppliers to operate with changes in product type and customer demand, and to produce products that were easier to manufacture in consideration of the regular shortages of key components. Simultaneously, enterprise managers were constantly involved in negotia- tions with their suppliers about the procurement of key resources; they were also involved with their superior agencies about getting their plans of gross output either considered as fulfilled despite deviations from the planned assortment or corrected for shortages of resources. Managerial success in this informal interaction, which was first described by Berliner (1952) and later analyzed in a series of Duke–Berkeley Occasional Papers on the Second Economy in the USSR, was one of the main factors in the fulfillment of the target plans of an individual enterprise. In turn, failure to fulfill a plan was a cause for superior agencies to penalize the enterprise to the point of dismiss- ing its top manager from office. The role and functions of the socialist enterprise in the centrally planned economy led to a number of important consequences, which determined typical managerial behavior. Among them are the following: (a) attention was given to production and technology (typically, the absolute majority of enterprise directors in the USSR and other socialist countries were educated engineers and technicians); (b) the focus was on day-to-day operations of an enterprise with a short planning horizon (the management could make decisions within their approved annual plans, while decisions for more prolonged horizons that were related to the compilation and approval of five-year plans and implementation of investment projects came within the competence of higher levels of government); and (c) managers were involved in systematic informal negotiations with superior agencies about planned target volumes and resources allocated to the enterprise and with suppliers and customers on product mix and other terms of supply. This pattern of behavior was typical of enterprises in all socialist econo- mies. However, a substantial number of national features were related to the planning system in the USSR as well as to ideological approaches to organization of the Soviet planned economy. There are five features prima- rily responsible for the transformation of the Soviet enterprise, and they are described in detail below. First, Soviet enterprises had a very low degree of independence, prede- termined by the scale and detailed elaboration of central planning in the USSR. 1 T he y had no acce s s to rea l e c onom ic i n for mat ion, wh ic h wa s colle c ted by the central economic agencies. Their experience in horizontal interac- tion with other enterprises was limited to mutual adjustment of terms of 978023_0217287_03_cha01. dd 14 5/12/2009 5:19:13 PM The Emergence of Russian Corporations 15 production and supply in the framework of adopted plans. Production out- side of state plans in the USSR was regarded as criminal until the late 1980s. Outside of centralized planning, the only legal activity was food production on private plots in rural areas, whereas, in most of Eastern Europe, small private ownership was permitted. Economically and ideologically, the USSR was quite closed. Soviet enterprises had practically no contact with Western firms, and their managers had no knowledge of the operations of the mod- ern market economy. In the best cases, they based their understanding on information gleaned from Das Kapital by Karl Marx. Second, deliberate industrial policy for higher concentration of output and product specialization, which was the strongest in the 1960s and 1970s in the Soviet Union, 2 was the cause for the establishment of a noncompeti- tive industrial structure in which each enterprise had very limited numbers of suppliers and customers. As a result, enterprise directors knew each other well, and the whole managerial corps was a cohesive informal corporation. Readiness of the members of this corporation to help each other was one of the factors responsible for the survival of Russian enterprises and for the setup of barter networks under the crisis of arrears in the 1990s. However, the productive assets of Russian enterprises, which had been established under the industrial policy of preceding decades, were so specific that the enterprises were highly dependent on their partners. For this reason, after the launch of reforms, the activity of Russian enterprises became more disor- ganized than that of East European economies (Blanchard & Kremer 1997). Third, price disparities were greater in the USSR because the planning system lived longer and isolation from the world market was more complete. The disparities resulted from the desire of enterprises to overprice their prod- ucts in order to fulfill their “plans of gross output” (Kornai 1980). Central economic agencies used administered prices to prevent this tendency, but price control produced sufficient effects only in mono-product extract- ing and primary processing industries. In industries with more differenti- ated products, producers bypassed this obstacle by operating on changes in assortment when modified old products were passed for new ones with higher costs. This enabled the enterprises to demonstrate higher volumes of “gross output” at unchanged volumes of output in physical terms. As a result, in the course of time, prices of primary materials became under- stated, and prices of products with high level of processing grew overstated in comparison with international prices. This historically established rela- tive overstatement of costs and prices in some industries determined, to a large extent, the scale of competitive weakness of enterprises in these indus- tries in Russia after prices in foreign trade were liberalized. Fourth, the Soviet Union was considered the heart of world socialism. It resisted the United States and what it referred to as “imperialist aggression” while emphasizing the expansion of its military industrial complex (MIC). As a result, the share of enterprises belonging to the MIC and dependent on 978023_0217287_03_cha01. dd 15 5/12/2009 5:19:13 PM 16 Organization and Development of Russian Business military procurement orders was much higher in the USSR than in other socialist countries. For this reason, a sharp reduction in military spending in the age of reform had a stronger effect on the enterprises. Since many of these enterprises had been making technologically complex products and had been key customers of their suppliers, this reduction was an additional factor responsible for higher disorganization and a deeper slump in output (Blanchard & Kremer 1997). Finally, the Soviet model of a planned economy was very conservative, and Soviet enterprises had no experience of operation under reform. Eastern Europe started to reform its planning system and to introduce some ele- ments of market economy as early as at the end of the 1960s. China began a similar process in 1979, but, until that time, enterprises had gone through several waves of centralization and decentralization and had also survived the Cultural Revolution. Against this background, the Soviet Union limited all experiments in the late 1970s and early 1980s to various schemes of dis- tribution of final enterprise income and never touched upon the issues of industrial organization and planning. In general, a planned economy used quite different criteria for the assess- ment of enterprise performance and incentive mechanisms than those used in a market economy. As the Soviet economy reached a crisis level in the mid-1980s, changes in economic policy began to emerge. On the micro level, the logic of changes was focused on the transformation of incentives of economic agents. The formation of new incentive mechanisms took two directions. On the one hand, private initiative was allowed for the first time in serv- ices and supply of consumer goods. In 1986–1988, laws on personal labor and cooperative enterprises were enacted, and small private businesses were allowed. State-owned enterprises were permitted to launch joint ventures with foreign partners. Output prices for products and services of individual and cooperative, small-scale and joint ventures were unregulated. However, until 1992, the share of this private segment in the economy was too small to affect the behavior of state-owned enterprises. On the other hand, state-owned enterprises were given a greater extent of independence. This was regarded as a fundamental line of economic trans- formation aimed at the enhancement of efficiency of the Soviet socialist economy. Enterprise directors, willing to escape from the control of superior agencies, supported this line in every possible way. The Law on the State- Owned Enterprise, which was enacted in 1987 and came into effect in 1988, was an important step in this direction. This law provided for the creation of councils of labor collectives and the introduction of elected directors, which, indeed, made top managers independent from supervisory agencies. The law permitted labor collectives in agreement with a supervisory min- istry to lease assets of a state-owned enterprise and, later, to buy out the leased property with profits (this was one of the displays of “nomenklatura 978023_0217287_03_cha01. dd 16 5/12/2009 5:19:13 PM The Emergence of Russian Corporations 17 Table 1.1 Chronology of enterprise reforms and related events in the USSR and Russia, 1986–2007 Period Year Month Events a Category b The perestroika period and collapse of the Soviet Union 1986 Nov USSR law on individual labor activities enacted A 1987 Jan Resolution on joint enterprises adopted by the USSR cabinet of ministers C Jun USSR law on state enterprises enacted C 1988 May USSR law on cooperatives enacted C 1989 Nov USSR leasing law enacted E 1990 Mar USSR ownership law enacted C Jun USSR enterprise law enacted C Jun USSR law on corporate tax enacted F Aug 500-day plan announced A Dec USSR law on trade union enacted H Dec USSR law on investment activities enacted G Dec USSR banking law enacted E Dec RSFSR banking law enacted E Dec RSFSR law on ownership enacted C Dec RSFSR law on enterprises enacted C 1991 Mar RSFSR law on competition and limitation of monopoly enacted D Jun RSFSR law on investment enacted G Jul USSR law on denationalization and privatization enacted B Jul USSR law on foreign investment enacted G Jul USSR anti-monopoly law enacted D Jul RSFSR law on privatization enacted B Aug Soviet coup d’état attempt Dec RSFSR law on corporate tax enacted F Dec RSFSR law on value-added tax enacted F Dec Collapse of the Soviet Union The Yeltsin administration and initial enterprise reforms 1992 Jan Liberalization of price and foreign trade A May Mortgage law adopted E Jun Mass-privatization program adopted B Jun Law on consumer cooperatives adopted C Sep Law on monetary system adopted E Oct Law on foreign exchange regulation adopted E Oct Voucher privatization begins B Nov Law on bankruptcy adopted B 1993 May Treasure bills market initiated E Jun Customs code adopted F Jul New Russian ruble introduced E Aug Law on labor protection adopted H Sep– Oct Constitutional crisis Continued 978023_0217287_03_cha01. dd 17 5/12/2009 5:19:13 PM [...]... denotes a law of the Russian Soviet Federative Socialist Republic All laws adopted or enacted in 1992 onward are laws of the Russian Federation b A: Market and trade liberalization, B: Privatization and bankruptcy measures, C: Organization and corporate governance reform, D: Competition and industrial policies, E: Financial and monetary reform and corporate finance, F: Tax reform, G: SME and investment... this scheme, bringing a total of 5.1 trillion rubles of revenue (or about 1 billion US dollars in current prices) to the federal government 978023_0217287_03_cha01 dd 21 5/12/2009 5:19:14 PM 22 Organization and Development of Russian Business With loans-for-shares auctions, the Russian government drove a handful of commercial banks to snap up a large amount of shares of the biggest corporations This... opportunities for the development of companies in the industrial sector The August 1998 devaluation of the ruble resulted in increased competitiveness of Russian exports along with dramatic growth of prices and fall of demand for imported products Growing sales improved the performance of Russian business As a result, the new owners of enterprises (both old “red directors” and new private investors) had... increase of the RTS index in this period; therefore, at the end of 2007, the RTS index was 16 times higher than that in 2000 (see Table I.1 for details) Municipal enterprisesa 21,905 42,924 1994 Total number of privatized enterprises 1993 Table 1.2 Privatization of state-owned enterprises and privatization revenue in Russia, 1993–2007 24 Organization and Development of Russian Business not offer potential... on the payroll of the enterprises that had paid no wages for many months), people found jobs in the informal 978023_0217287_03_cha01 dd 25 5/12/2009 5:19:15 PM 26 Organization and Development of Russian Business sector However, this rapid development of private businesses in legal and semi-legal forms had contradicting results On the one hand, indeed, social problems were alleviated, and new jobs were... weaker and exposed to different pressure groups, and reforms were carried out partially (Hellman 1998) with the preservation of the sources of rent for these pressure groups Another important difference was a much larger amount of accumulated wealth under the command of the state and the availability of rich natural resources On the one hand, this enabled the state to postpone the necessary reforms and. .. consolidated power and a strong state As shown in Table 1.1, in the period of 1999–2003, the Russian government adopted a large set of new important legislation in such areas as taxation and customs regulation, corporate governance and bankruptcy, and labor regulation For the firms, from the point of view of the choice of strategic behavior, these changes on the government side meant that the scope of state... Organization and Development of Russian Business However, the quality of this new legislation was very low With the adoption of new laws, both governments tried to secure support from enterprise managers and the population rather than provide the conditions for sustainable market development This inter-government competition resulted in extremely populist policy3 and, in 1991, dramatic escalation of. .. together with the withdrawal of liquid assets from industrial enterprises This occurred to the detriment of interests of minority shareholders and the state Since the beginning of the 2000s, new ways of appropriation of corporate income became widespread, such as the payment of dividends and increase in the market value of shareholdings, which better corresponded to the principles of a market economy In... establishment of a tax system, the introduction of antimonopoly legislation, and the creation of a system of financial institutions On the micro level, all of these large-scale changes resulted in great uncertainty on the activity of enterprises At the same time, important features of the transition period were structural imbalances and price disparities, which were inherited from the planned economy and allowed . 1993 20 07 1993 1994 1995 1996 1997 1998 1999 20 00 20 01 20 02 2003 20 04 20 05 20 06 20 07 Total number of privatized enterprises 42, 924 21 ,905 10,1 52 4,997 2, 743 2, 129 1,536 2, 274 2, 287 2, 557 434 5 02. 3 02 Federally owned enterprises a 7,063 5,685 1,875 928 374 26 4 104 170 125 86 161 121 1 12 98 73 Regionally owned enterprises a 9, 521 5,1 12 1,317 715 548 321 29 8 27 4 23 1 22 6 1 52 246 22 6 25 4. hypothesis in two types of corporate 978 023 _ 021 728 7_ 02_ . dd 9 5/ 12/ 2009 5:18:01 PM 10 Organization and Development of Russian Business models: state-owned or mixed firms and politically connected