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 contribute 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 policies, 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 followed 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 considered unjust (Denisova et al 2007), and the representatives of the business 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-forshares 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 companies (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 situation 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 chapter, we have made comparisons only with Eastern Europe Although packages 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 indirectly 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 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 This policy was a logical outcome from the Soviet model of organization of centralized 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 contrary, 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 productive facilities in different regions In the literature, these differences in economic 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) For instance, according to data given by Sinelnikov et al (1998), by the end of 1991, expenditures of the Union budget were three times as large as its revenue Bibliography Andreff, W (2005) Corporate governance structures in postsocialist economies: Toward a Central Eastern European model of corporate control? EACES Working paper No (available at: http://www.eaces.net/news/WP-4-05.pdf) Avdasheva, S (ed.) (2000) Analiz Roli Integrirovannykh Struktur na Rossiiskikh Tovarnykh Rynkakh (Moscow: TEIS) Berglöf, E & Pajuste, A (2003) Emerging owners, eclipsing markets? Corporate governance in Central and Eastern Europe In: Cornelius, P K & Kogut, B (eds), Corporate Governance and Capital Flows in a Global Economy (New York and Tokyo: Oxford University Press) Berglöf, E & von Thadden, E L (2000) The changing corporate governance paradigm: Implications for transitional and developing countries In: Cohen, S S & Boyds, G (eds), Corporate Governance and Globalization: Long-Range Planning Issues (Cheltenham: E Elgar) Berliner, J S (1952) The informal organization of the soviet firm, Quarterly Journal of Economics, 66: 342–365 Black, B., Kraakman, R., & Tarassova, A (2000) Russian privatization and corporate governance: What went wrong? Stanford Law Review, 52: 1731–1808 978023_0217287_03_cha01 dd 33 5/12/2009 5:19:16 PM 34 Organization and Development of Russian Business Blanchard, O & Kremer, M (1997) Disorganization, Quarterly Journal of Economics, 112: 1091–1126 Blasi, J., Kroumova, M., & Kruse, D (1997) Kremlin Capitalism: The Privatization of the Russian Economy (Ithaca, NY and London: Cornell University Press) Boycko, M., Shleifer, A., & Vishny, R W (1995) Privatizing Russia (Cambridge, MA: MIT Press) Denisova, I., Eller, M., Frye, T., & Zhuravskaya, E (2007) Who wants to revise privatization and why? Evidence from 28 post-communist countries Working paper No 105 Moscow: Center for Economic and Financial Research and New Economic School Desai, R M & Goldberg, I (eds) (2007) Enhancing Russia’s Competitiveness and Innovative Capacity (Washington, DC: World Bank) Dolgopyatova, T (2002) Corporate control in the Russian industry: Actors and mechanisms, East–West Journal of Economics and Business, 5: 197–215 Ericson, R E & Ickes, B W (2000) A model of Russia’s virtual economy Discussion paper No 10 Helsinki: Bank of Finland Institute for Economies in Transition (BOFIT) Federal State Statistical Service (Rosstat) Rossiya v Tsifrakh (Moscow: Rosstat) (various issues) Frye, T (2006) Original sin, good works, and property rights in Russia, World Politics, 58: 479–504 Gaddy, C & Ickes, B W (1998) Russia’s virtual economy, Foreign Affairs, 77: 53–67 Golikova, V., Gonchar, K., Kuznetsov, B., & Yakovlev, A (2007) Russian Manufacturing at the Crossroads: What Prevents Firms from Becoming Competitive? (Moscow: Higher School of Economics) Hellman, J S (1998) Winners take all: The politics of partial reform in postcommunist transitions, World Politics, 50: 203–234 Hellman J S., Jones, G., & Kaufman, D (2003) Seize the state, seize the day: State capture and influence in transition economies, Journal of Comparative Economics, 31: 751–773 Iwasaki, I (2007) Enterprise reform and corporate governance in Russia: A quantitative survey, Journal of Economic Surveys, 21: 849–902 Iwasaki, I & Suzuki, T (2007) Transition strategy, corporate exploitation, and state capture: An empirical analysis of the former Soviet states, Communist and PostCommunist Studies, 40: 393–422 Johnson, S., Kaufman, D., & Shleifer, A (1997) The unofficial economy in transition, Brooking Papers on Economic Activity, 2: 159–239 Johnson, S., La Porta, R., Lopez de Silanes, F., & Shleifer, A (2000) Tunneling Working paper No 7523 Cambridge, MA: National Bureau of Economic Research Kolodko, G W (2002) From Shock to Therapy: The Political Economy of Post-Socialist Transformation (Oxford and Tokyo: Oxford University Press) Kornai, J (1980) Economics of Shortage (Amsterdam: North Holland) Kornai, J (1992) The Socialist System: The Political Economy of Communism (Princeton, NJ: Princeton University Press) Maskin, E., Qian, Y., & Xu, C (2000) Incentives, information and organizational form, Review of Economic Studies, 67: 359–378 Palmeda, V & Lewis, B (2003) Unlocking economic growth in Russia In: Hardt, J P (ed.) Russia’s Uncertain Economic Future (Armonk and New York: M.E Sharpe) Pappe, Ya (2000) Oligarkhi: Ekonomicheskaya Khronika 1992–2000 (Moscow: SU-HSE) 978023_0217287_03_cha01 dd 34 5/12/2009 5:19:16 PM The Emergence of Russian Corporations 35 Polterovich, V M (2001) Institutional traps In: Klein, L R & Pomer, M (eds) The New Russia: Transition Gone Awry (Stanford: Stanford University Press), pp 93–116 Qian, Y (1999) The process of China’s market transition (1978–1998): Evolutionary, historical and institutional perspectives Paper prepared for the Journal of Institutional and Theoretical Economics symposium on “Big-Bang Transformation of Economic Systems as a Challenge to New Institutional Economics,” Wallerfangen/ Saar Qian, Y & Xu, C (1993) Why China’s economic reforms differ: The M-form hierarchy and entry/expansion of the non-state sector, Economics of Transition, 1: 135–170 Razvitie Sprosa na Pravovoe Regulirovanie Korporativnogo Upravleniya v Chastnom Sektore Seriya “Nauchnye doklady: nezavisimyi economicheskii analiz,” No 148, Moskovskii obshchestvennyi nauchnyi fond, 2003 (Moscow: Moskovskii obshchestvennyi nauchnyi fond & “Proyekty dlya budushchego”) (available at: http:// www.mpsf.org/lib.html) Roland, G (2000) Transition and Economics: Politics, Markets, and Firms (Cambridge, MA: MIT Press) Simachyev, Yu (2003) Institut nesostoyatel’nosti v Russii: spros, osnovnye tendertsii i problemy razvitiya, Voprosy Ekonimiki 4: 62–82 Sinelnikov, S., Anisimova, L., Batkibekov, S., Medoev, V., Reznikov, K., & Shkrebela, E (1998) Problemy Nalogovoi Sistemy Rossii: Analiz Situatsii i Perspektivy Razvitiya (Moscow: Evraziya) Stark, D & Vedres, B (2006) Social times of network spaces: Network sequences and foreign investment in Hungary, American Journal of Sociology, 111: 1367–1411 Vahtra, P & Liuhto, K (2004) Expansion or exodus? Foreign operations of Russia’s largest corporations, Turku School of Economics and Business Administration, Electronic Publications of Pan-European Institute, (available at: http://www tukkk.fi/pei) Woodruff, D M (2004) Property rights in context: Privatization’s legacy for corporate legality in Poland and Russia, Studies in Comparative International Development, 38: 82–108 Yakovlev, A (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, unpublished 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 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 redistribution 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 shareholder or a consolidated group of such shareholders exercised by various formal and informal means (Dolgopyatova 2003, chapter 2) Majority shareholders 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” managers who not own company shares This institution has become widespread not only as a result of privatization (“red directors” becoming owners of enterprises) but also as a tool intentionally chosen by owners who established their businesses from scratch In a situation of underdeveloped markets 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 transition, 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 survey and qualitative information of in-depth interviews with company owners and managers, in this chapter, we will discuss the relevance of simple 39 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 evolution of intra-corporate control forms and business performance We presume that a high concentration of ownership is linked with its hidden structure and that it affects intra-corporate relationships The vast majority 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 ownership that emerged in Russian companies in 2005 and the types of shareholders 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 control 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 ownership concentration that increases annually Aggressive ownership redistribution 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 Stock 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 the background of ongoing privatization and the emergence of new businesses showed a decreasing trend almost up to the mid-2000s Currently, the last trend is being reversed as the position of public authorities, primarily federal agencies, becomes stronger In the area of nationalization, the federal government has demonstrated an active stance Today, federal authorities hold a predominant interest with major Russian companies in the real economy and financial sector Through these agencies, the government not only controls the production of a sizeable portion of GDP but has also become a major stock market investor, the government’s share in capitalization of the Russian stock market being more than one-third in 2006 (Panov & Borissov 2006) By estimates of Troika Dialog (2008), the state controlled about 40% of capitalization at the end of 2007 Our studies have confirmed a very high degree of ownership concentration (more than 50% of shares owned by one shareholder) in the sample, which was observed in almost 70% of surveyed companies Companies with the average level of concentration (25–50% of shares owned by the largest shareholder) were approximately 18% of the total, while those with a low level of ownership concentration (in Russian terms) with the blockholder (owner of more than 25% of total stock) yet not to emerge accounted for only 13% of the sample High-concentration companies included two subgroups depending on whether there was the second large shareholder with at least a blocking minority ownership (counterbalance) Almost one-half of the companies had a dominant shareholder not contained by the stake of the second shareholder (Figure 2.1) A desirable level of concentration was achieved to a large extent, which almost 70% of respondents considered optimal for business development, with about 18% wanting an increase and only 13% wanting a decrease A vast majority of respondents (over 87%) asserted that their company already had an owner (coalition of owners) in control of corporate operations The area of real control turned out to be considerably wider than the ownership structure would suggest, and more in line with the evidence collected in in-depth interviews Curiously, companies with a controlling owner included 50% of low-concentration companies and more than 86% of average-concentration companies Studies dating back primarily to the late 1990s (for example, 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 48% From 25% to 50% of shares 18% More than 50% of shares + presence of a counterbalance 21% Figure 2.1 Classification of surveyed joint-stock companies by level of ownership concentration Source: Author’s illustration based on survey data as well as of closed JSCs, in which it was easier for managers to reach capital consolidation.4 Unlike privatized enterprises, in which privatization by vouchers formed a still existing class of minority shareholders, new businesses may demonstrate a higher degree of concentration It could be also presumed that concentration of the stock could be lower in those companies whose shares are tradable at stock markets and attractive to small investors Our survey produced contradicting results The pattern of distribution of businesses by the degree of ownership 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 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 2007a) At 75 public companies accounting for 90% of the capitalization of the Russian stock market (S&P 2007b), the largest shareholder would own, on average, 58% of shares Moreover, in internationally tradable companies, this share was almost 50% (56% in companies listed with LSE, and 34% in companies listed with NYSE/NASDAQ) A high concentration of ownership and control became an intrinsic feature of Russian companies and, at the same time, demonstrated a significant 9780230_217287_04_cha02 dd 42 5/14/2009 3:42:32 PM Stock Ownership and Corporate Control 43 Independent jointstock companies Affiliated companies of company groups Parent companies of company groups 20 40 60 80 100 Concentration of ownership (%) Low Medium High with a counterbalance High, absence of a counterbalance Figure 2.2 Concentration of ownership in independent and integrated companies Source: Author’s illustration based on survey data link with corporate integration (Figure 2.2), which confirmed the ideas expressed by Deryabina (2001) and Radygin (2001) regarding the role of emerging market structures in the redistribution of property A higher concentration is characteristic of subsidiary companies in a holding company group, while parent companies would more often include the second-largest shareholder In 2001–2004, a change of the main owner was characteristic of 30% of companies covered by surveys (7–8% of companies each year, on average) The higher the concentration was, the more often it was foreshadowed by a change of owners; this change happened twice as often with a high concentration of capital than with a low one (33% compared to 16%) This change would most frequently happen in companies with the second control center and affected over 39% of companies In onethird of companies, consolidation of control in one person was preceded by a change of the main owner, while the reverse was true for 13% of companies Ownership concentration developed against the background of intracorporate disputes, which demonstrated a significant link with the change of owners taking place in this period: in the event of the change, disputes were characteristic of 41% of companies, as compared to 22% of the rest In 2005, the extent of stock concentration correlated positively with internal disputes in 2001–2004, which peaked in the event of the second control center (Table 2.1) In JSCs with a controlling shareholder, the frequency of disputes was almost 30%, against 13% at those companies without a controlling owner 9780230_217287_04_cha02 dd 43 5/14/2009 3:42:32 PM 44 Organization and Development of Russian Business Table 2.1 Intra-corporate disputes in 2001–2004 at different levels of ownership concentration (% of the number of JSCs) Disputes: Sample Low Were Were not Number of JSCs 26 73.2 768 17.8 82.2 90 Medium 25.2 74.8 127 High Presence of counterbalance 30.2 69.8 514 41.7 58.3 347 Absence of counterbalance 24.2 75.8 151 Significance of differences by three groups of JSCs, 0.042; by four groups, Ϫ0.000a Note: a ␹2 test 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 the 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 2007a) 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 worse Recently, Chernykh (2008) conducted in-depth research on this issue based on formal and informal data of public companies and demonstrated that companies are controlled by anonymous insiders masking their holdings through nominee and foreign offshore arrangements In fact, some of these owners (beneficiaries) are well known by the public and the media Survey results based on voluntary estimates of respondents show an aggregated structure of ownership that sometimes differs from a formal structure The studies cited above suggest a minor role of financial investors and foreign shareholders in the capital of a company; the core owners are company employees (mostly managers) and outside shareholders (legal entities) Normally, employees will account for 30–45% of shares, with managers accounting for 10–20% (as a matter of exception, REB data suggest almost one-third of total capital), but ownership of the management is always hidden External holders, primarily Russian nonfinancial entities, will account for 50–60% In a situation of ownership concentration, the predominant role in ordinary stock holding5 is played by large shareholders (individuals), paralleled by a meaningful total holding of minority shareholders, the third largest group of owners being Russian nonfinancial entities (Table 2.2) 9780230_217287_04_cha02 dd 44 5/14/2009 3:42:33 PM 9780230_217287_04_cha02 dd 45 5/14/2009 3:42:33 PM 7.2 1.3 40.5 1.0 1.9 7.1 26.3 2.8 24.9 1.5 2.7 13.7 34.8 4.6 Low 4.7 1.9 Samplea 3.0 35.4 9.4 31.1 0.6 1.5 5.5 1.7 Medium 5.3 35.8 16.0 20.5 1.8 3.2 4.2 2.3 High 5.1 37.5 15.9 19.1 1.5 3.9 4.5 3.2 Presence of counterbalance 0.107/0.195 0.207/0.299 5.6 0.002/0.004 0.000/0.000 0.681/0.524 0.547/0.736 0.034/0.094 0.136/0.157 Significance of differencesb 34.8 16.6 20.9 2.0 2.8 4.1 2.0 Absence of counterbalance Source: Author’s calculations based on survey data Notes: a The number of respondents varies from 698 to 720 b Kruscal Wallis test was used The numerator presents significance of differences by three groups of JSCs, and the denominator presents significance by four groups Federal administration Regional and/or local 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 Russian Business Public authorities ranked fourth by holding more than 7% of ordinary shares In each fifth company, the government was among the shareholders, with federal agencies holding a stake in each ninth company, while regional and municipal governments held a stake in each thirteenth company REB data also suggest that state holding amounted to 7% in 2005, and increased to 9% in 2007 (Aukutsionek et al 2007) Federal authorities hold 2.5 times more shares than regional and municipal authorities 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, the share of Russian nonfinancial entities is at its highest The share of federal agencies turned out to be the highest at low-concentration companies In identified companies with/without the counterbalance, the formal ownership structures were practically identical Interestingly, the differences in terms of shares held by large external shareholders were negligible It is noteworthy that, at a high concentration of equity, almost one-fifth was held by different Russian financial and nonfinancial entities, which apparently represented the interests of the largest owners Holdings of foreign investors (in the form of companies incorporated elsewhere) could also act as a shield The ownership composition of ordinary stock confirmed the high concentration of capital along with the continued existence of sizeable dispersed holdings and the prevalence of large shareholders from among individuals and nonfinancial entities Moreover, legal entities were used to cover up the holdings of the largest individual owners Shares of banks and other financial investors were minor, only to reflect the weak role of financial intermediation and banking sector The shares of foreign investors were still small Ownership concentration and business development Qualitative studies would repeatedly suggest that business incentives of large holders changed from asset stripping to development of the business Owners became interested in developing their businesses, and the difference between former directors and owners and new holders gradually diminished (Yakovlev 2003; Yakovlev et al 2006) When a company was purchased with the purpose of corporate integration, its prospects were originally underpinned by the development of the whole business Meanwhile, attempts to measure statistically how ownership concentration affected the performance of Russian companies (which was normally done on current profitability indicators) did not produce clear results While some researchers reported a positive impact (Radygin & Entov 2001), others found a negative influence (Kuznetsov & Muravyov 2000), and some reported no linkage at all (Yasin 2004) Some studies revealed a nonlinear dependence 9780230_217287_04_cha02 dd 46 5/14/2009 3:42:33 PM Stock Ownership and Corporate Control 47 According to studies of the major Russian companies (Kuznetsov & Muravyov 2000), concentration and profitability had a U-shaped linkage, the minimum being reached with 52% owned by the largest shareholder According to a 2001 REB survey, the average level of concentration (10–50% of equity) proved to be the most efficient (Kapelyushnikov 2001) In a later REB survey based on 2003 data (Kapelyushnikov & Dyomina 2005), the concentration of ownership had a negative effect, resulting in lack of capacity, lower wages and profitability, and a higher risk of loss Moreover, the authors produced evidence (in a small sample of companies) of the positive role of the size of shareholding owned by the second-largest owner The analysis of quality of corporate governance in Russian companies identified a reversed U-shape linkage with ownership concentration The concentration would improve corporate governance up to a certain threshold, but any further increase of the largest shareholding would no longer have a positive impact (Guriev et al 2003) Golikova et al (2003) demonstrated that, when there was a controlling owner, the company tended to use the best practices of corporate governance Incidentally, econometric studies performed in other transition economies also reported conflicting findings For example, Earle and Telegdy (2001) demonstrated with an example of Romanian firms that the concentration of ownership correlated positively with labor productivity A positive effect (with a foreign investor as the owner) was also demonstrated in a study performed in the Czech Republic (Hanousek, Kocenda, & Svejnar 2004); on the other hand, another study reported a positive effect of dispersed ownership on the profitability of companies under the survey (Kocenda & Svejnar 2002) For Polish companies, the concentration was U-linked to performance, with competition being a complementing factor to improve the quality of corporate governance (Grosfeld & Tressel 2002) Interviews conducted at individual companies normally suggested a positive effect of stock ownership concentration by private shareholders on business restructuring and strategic development but an absence of a linear link to performance (the best performers were companies with the average level of concentration, and the worst, those with a low level) The project (Yasin 2004) also demonstrated, on the basis of nearly 40 interviews, that high-concentration companies were more active investors and had easier access to bank loans to finance their investments A test of these assumptions based on a sample of more than 500 companies (Dolgopyatova & Uvarova 2006) did not produce any evidence in favor of better performance, investment, and restructuring preferences of highconcentration businesses However, when there was a controlling interest, companies could more actively seek outside funds, bank loans, and funds of Russian partners and other private investors A comparison of ownership structures and intensity of corporate restructuring performed by the Bureau of Economic Analysis as part of the survey of about 430 companies 9780230_217287_04_cha02 dd 47 5/14/2009 3:42:34 PM 48 Organization and Development of Russian Business revealed a positive role of concentration by foreign investors for restructuring (Simachyev 2001) Based on this evidence, we speculated that the high concentration of ownership positively affected the long-term aspects of corporate operations to be paralleled by higher investment activities and a tendency for restructuring Through our survey, we evaluated the linkages between the extent of the concentration and business performance/development indicators (Table 2.3) The best operating performance was demonstrated by entities with average levels of concentration, and the worst, by those with lower levels Similar findings were produced when we compared companies by dynamics (adjusted for inflation) of sales and labor productivity for the period of 2001–2004.6 A comparison of companies by level of labor productivity in 20047 showed that, in terms of the average value of this indicator, the best companies were high-concentration companies, but no significant difference was found for medians Moreover, the presence of the second control center, while not affecting a vast majority of ratings, impaired the dynamics of sales and labor productivity in the high-concentration group, which was contrary to the above findings reported by the REB The survey revealed a positive correlation between ownership concentration and restructuring and business development policies (Figure 2.3) In Successful introduction of essentially new products and services 70% Increasing volume of exports 50% Introduction of new production facilities 30% Increasing R&D expenditures Increase inexpenditures on marketing and advertising 10% Horizon of planning is more than years Successful introduction of new technologies Making of significant capital investments Successful certification by international standards Less than 25% of shares More than 50% of shares From 25 to 50% of shares Figure 2.3 Modernization activities of companies at different levels of ownership concentration Source: Author’s illustration based on survey data 9780230_217287_04_cha02 dd 48 5/14/2009 3:42:34 PM 9780230_217287_04_cha02 dd 49 5/14/2009 3:42:35 PM Medium 65.7 45.8 49.6 4.6 61.4 0.71 (0.36) 39.6 26.8 56.7 16.5 44.4 0.61 (0.29) 4.11 (0.40) 55.6 57.9 36.7 50.9 12.4 High 2.56 (0.38) 47.7 54.1 38.2 49.0 12.8 Presence of counterbalance 4.89 (0.40) 58.0 59.7 36.3 51.7 12.0 Absence of counterbalance 0.015 (0.330)/ 0.027 (0.438) 0.071/0.028 0.005/0.023 0.001/0.005 Significance of differencesa, b Source: Author’s calculations based on survey data Notes: a Comparison of frequencies was based on ␹2 test, comparison of means used Krukcal Wallis test, and comparison of medians was based on median test b The numerator presents significance of differences by three groups of JSCs, and the denominator presents significance by four groups c Median or median test in parentheses JSCs increased gross sales in 2004 (% of the number of JSCs) JSCs increased labor productivity during 2001–2004 (% of the number of JSCs) Labor productivity in 2004 (mln rubles per employee)c Business performance Good or quite good Fair Rather poor or poor Financial and economic state (% of the number of JSCs) Low Current economic situation of enterprises at different levels of ownership concentration Indicators of business performance Table 2.3 50 Organization and Development of Russian Business production upgrading (production capacities commissioned, principally new products introduced), the best performers were companies with an average level of concentration, and, in higher exports, those with a high concentration Similarly, companies with the second-largest shareholder were more active in the introduction of new products and in the expansion of capacity, and there were no significant differences in the other indicators observed All companies with a blockholder would behave similarly, while those with dispersed ownership were the least prone to restructuring in any respect (except R&D expenditures) Some advantages of companies with an average concentration were explained by the fact that they normally started restructuring later than those in which the process of ownership consolidation was completed for the most part In 2001–2004, investment activities were characterized by the fact that almost one fourth of the sample did not invest while 40% of respondents estimated the amount of investments as considerable The higher the concentration of ownership, the more frequent the assessment of investments In companies without a counterbalance, enterprises with considerable investments accounted for almost 47% of the total At the same time, the decision-making horizon, which indirectly characterized the development of strategic planning, was invariable to capital consolidation profiles To check these revealed correlations, we conducted multivariate regression analysis controlling for size (number of employees) and industrial affiliation of companies with various levels of ownership concentration (high, medium, and low) In the list of independent variables, we also included other characteristics important for business modernization, such as the indicators of competition with different market players (this external factor may increase propensity for restructuring activities); a dummy for being a new company established after 1992 (these companies are more flexible and adjusted to market environment); and company affiliation to holding company groups (we assume that independent companies are less involved in restructuring).8 First, we constructed nine binary logistic regression models for each modernization action illustrated by Figure 2.3 (the dependent variable was equal to “1” in the case of implementing of the action and “0” otherwise) For the second step, we applied an ordinal probit regression and a Poisson model for a special count-dependent variable INDRES, constructing it as a sum of values of the seven partial variables (excluding increasing exports and strategic planning for more than years as events, as those are not considered modernization activities) This measure of the intensity of restructuring assumes values from zero up to seven Selected results of calculations are presented in Table 2.4 Logistic models demonstrated that, in a majority of cases, dispersed ownership had negative influence on the choice of a modernization action, 9780230_217287_04_cha02 dd 50 5/14/2009 3:42:35 PM Stock Ownership and Corporate Control Table 2.4 modelsa 51 Coefficients for the variable “concentration of ownership” in regression Dependent variables Horizon of planning is more than yearsb Significant capital investmentsb Introduction of new production capacitiesb Increasing of exportsb Increasing of marketing and advertising expendituresb Increasing R&D expendituresb Successful introduction of new productsb Successful introduction of new technologiesb Successful certification by international standardsb INDRES (intensity of restructuring)c INDRES (intensity of restructuring)d Medium concentration Pseudo R 0.407 0.19 Ϫ0.232 0.24 Ϫ0.555** 0.308 0.18 Ϫ0.719** Ϫ0.671** Ϫ0.421 0.001 0.29 0.15 Ϫ0.591* 0.047 Ϫ0.122 0.455* 0.20 0.15 Ϫ0.138 0.248 0.11 Ϫ0.422 0.208 0.28 Ϫ0.386*** 0.077 0.22 Ϫ0.227*** 0.040 ⌵〈 Low concentration Ϫ0.104 Ϫ0.933*** Notes: a Basic category is high concentration of ownership b Binary logistic model c Ordinal probit model d Poisson model ***: significant at the 1% level, **: at the 5% level, *: at the 10% level Source: Author’s estimation but medium- and high-concentration JSCs had no significant differences Medium concentration was positively correlated with the introduction of essentially new products In addition, an empirical study reported that dispersed ownership had a significantly negative effect on the intensity of restructuring.9 Russian companies demonstrated a dominating trend for self-financing, although it could be assumed that high-concentration entities would use external funds more actively Simultaneously, informal and personalized relationships in economic operations specific to Russia could, on the contrary, encourage creditors to cooperate with the “Master” of the enterprise they know As a result, we did not reveal any differences in terms of funds and their percentage in the structure of investments between companies with varying levels of ownership concentration.10 9780230_217287_04_cha02 dd 51 5/14/2009 3:42:35 PM 52 Organization and Development of Russian Business Corporate control under concentrated ownership The existence of controlling shareholders brings to another level the solution of the key problem of corporate governance, i.e coping with opportunistic behavior of the management (Stiglitz 1999) On the one hand, the free-rider problem copes with principal shareholders with incentives to develop and provide control of the business On the other hand, there are various opportunities, including 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 interviews demonstrate (Insiders and Outsiders 2004) that the combination of ownership and management usually charges managers with the responsibilities of the boards Shareholders, executives, and nonexecutive directors make a unified group that represents itself across all corporate bodies and places intra-corporate procedures under its control Then, it becomes futile to try to define good corporate governance Our 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 in 63% of them As anticipated, these indicators are significantly correlated Joint consideration of these questions makes it possible to divide the surveyed JSCs into a number of groups (Figure 2.4) We can define JSCs in which large shareholders are managers as a group with a combination of ownership and management This group includes two unequal subgroups One group, called M&D_S,11 has a large group of shareholders who are managers, and, at the same time, the CEO is a shareholder (as a rule, large) This subgroup is identified as having “complete inseparability.” In the small subgroup, large shareholders are company’s managers, but the CEO is not a shareholder (M_S) Such situations occur infrequently; they are usually temporary or related to the geographical isolation of an enterprise from its major owners However, a number of such cases were revealed during the in-depth interviews (Yasin 2004) In JSCs in which respondents gave negative answers to both questions, the ownership was formally separated from management There is a substantial subgroup in which only the CEO is a small or medium shareholder (D_S) The CEO’s stake may be the result of privatization because “red directors” were still preserved or new owners tend 9780230_217287_04_cha02 dd 52 5/14/2009 3:42:35 PM Stock Ownership and Corporate Control Large shareholders are not managers, and the CEO is not a shareholder 29% Large shareholders are not managers, but the CEO is a shareholder 23% 53 Large shareholders are managers, and the CEO is a shareholder 40% Large shareholders are managers, but the CEO is not a shareholder 8% Figure 2.4 Classification of surveyed companies by participation of shareholders in their management Source: Author’s illustration based on survey data to appoint CEOs from the ranks of former managers who were minority shareholders or because the owners endowed him with some shares Even a modest stake in the hands of a top manager gives him additional control, especially in situations in which working teams or public administration has a stake in the capital and in cases involving dispersed property There were clear differences in the organization of governance at entities with various levels of stock ownership concentration (Table 2.5) A combination of functions was found to be more characteristic of the average level of concentration and companies with a counterbalancing large shareholder In division of functions, a high concentration was characteristic of 78% of companies, while the controlling owner was found in 85% However, when the managers or directors were large shareholders, high-concentration companies accounted for only 68 and 64% of the total, while a controlling owner was found in 91 and 82%, respectively This finding confirms the possibility to combine executive management and ownership in strengthening the control of shareholders Other control tools of large shareholders Along with the practice of inseparable functions, large shareholders have other ways of gaining control over companies One of them is to capture the corporate boards Through domination, principal shareholders can legally adopt basic decisions at the meeting of shareholders, including the formation of the board of directors and management boards while ignoring the interests of minority shareholders Although such a method allows a jointstock company to be virtually controlled as a private company, it remains 9780230_217287_04_cha02 dd 53 5/14/2009 3:42:35 PM ... PM 42 Organization and Development of Russian Business Less than 25% of shares 13% More than 50% of shares + absence of a counterbalance 48% From 25% to 50% of shares 18% More than 50% of shares... 3:42:31 PM 40 Organization and Development of Russian Business hypotheses regarding the role of high concentration of capital in the evolution of intra-corporate control forms and business performance... in lack of capacity, lower wages and profitability, and a higher risk of loss Moreover, the authors produced evidence (in a small sample of companies) of the positive role of the size of shareholding