54 Organization and Development of Russian Business legal and even helps shareholders to become accustomed to the use of intra- corporate tools. As estimated by respondents, the board of directors was the most influ- ential of corporate bodies (Table 2.6), having a heavier clout than the meeting of shareholders. Almost one half of the respondents reported that shareholder meetings had a strong influence, whereas 18% expressed the opposite. Assessments of the influence of shareholder meetings were not linked to the extent of concentration as they were in the case of the board of directors. With regards to board of directors, companies with the aver- age ownership concentration earned the highest ratings. Apparently, a high concentration was also associated with other means of corporate control, since the subgroup with a counterbalancing shareholder did not result in a significantly different outcome. Table 2.5 Ownership and control in JSCs at different ownership and control concen- trations (% of the number of JSCs) Indicators of control types Controlling owner is present Concentration of ownership: Ye s N o L o w M e di u m Hi g h Pre s e n c e o f counterbalance Absence of counterbalance M&D_S 41.6 28.7 29.2 53.7 37.7 40.4 36.8 M_S 8.4 4.3 5.6 4.1 9.6 9.9 9.3 D_S 22.2 33.0 38.2 23.6 20.9 21.2 20.9 Separation 27.8 34.0 27.0 18.7 31.8 28.5 33.0 Significance of differences by three group, 0.016, 0.000 by four groups of JSCs a Note: a ␹ 2 test. Source: Author’s calculations based on survey data. Table 2.6 Influence of board of directors on corporate decision-making at different levels of ownership concentration (% of the number of JSCs) Ranks of influence Sample Low Medium High Presence of counterbalance Absence of counterbalance Strong influence 66.3 66.3 79.6 62.0 57.2 64.2 Moderate influence 26.8 27.9 16.5 29.6 31.8 28.4 Practically no influence 6.9 5.8 3.9 8.4 11.0 7.3 Number of JSCs 772 86 127 513 154 341 Significance of differences by three groups of JSCs, 0.006; by four groups, Ϫ0.008 a Note: a ␹ 2 test. Source: Author’s calculations based on survey data. 9780230_217287_04_cha02. dd 54 5/14/2009 3:42:36 PM Stock Ownership and Corporate Control 55 With regard to the composition of the board of directors, corporate managers, who might also be shareholders, prevailed, and representatives of large external shareholders ranked second. As a result, these insiders held more than 78% of the votes, while independent directors and minor- ity shareholders held 11% (Table 2.7). As the ownership concentration increased, the shares of managers and rank-and-file employees declined, and those of representatives of large external shareholders grew. At com- panies with low and average levels of concentration, the management, together with the employees, had the majority of votes. Moreover, JSCs with/without a counterbalancing interest demonstrated a similar struc- ture of their boards. Another control tool is the possibility of dismissal of the management staff (or threat of dismissal), which comes easy in the case of stock domina- tion. Personalities may cause problems in these cases. In addition, oppor- tunistic behavior on the part of the new managers may also contribute. This mechanism of control is well studied: a series of works were dedicated to the analysis of change of managers, especially due to ineffectiveness of companies, and empirical studies produced different results (see Chapter 5 for details). Another possibility for gaining control is related to having additional links to the company’s executive management by establishing head companies or by including special supervisory managers into the procedure for coordi- nation of decision-making; often, these are not staff members of a given company, or they may have a title that is not true to their real functions (“commissioners”). Such links are normally governed by in-house business management regulations and operated beyond the scope of intra-corporate procedures. Finally, another possibility is the use of informal schemes of control directly through the owners on a regular or case-by-case basis. In fact, such a possibility means a permanent, direct intervention of principal owners into the management procedures (which can be done without any agree- ment or taking into account other shareholders’ or stakeholders’ interests) or a constant threat of such intervention. Either one or more of the methods of control indicated above can be implemented. Corporate governance procedures must be followed despite the cost entailed in complying with laws and instructions. Building addi- tional regulated and/or informal schemes for managerial control will bring the additional costs of duplicating corporate governance and management procedures. Additional control in the organizational chain can be used as a temporary tool (Dolgopyatova 2001). When principal shareholders act as executive managers, there is no need for additional supervision; however, the costs of intra-corporate procedures will be incurred nonetheless. The combination of having one individual be the manager and the owner does not resolve all of the issues related to efficient management. Two issues 9780230_217287_04_cha02. dd 55 5/14/2009 3:42:36 PM Table 2.7 Structure of board of directors at different levels of capital concentration (% of total membership) Representatives on the board Sample Low Medium High Presence of counterbalance Absence of counterbalance Significance of differences a, b Company managers 46.4 54.9 49.2 44.1 40.5 45.6 0.013/0.010 Rank-and-file workers, trade union 5.0 8.0 6.0 4.2 2.9 4.8 0.011/0.012 Federal, regional/local administrations 5.0 3.9 7.1 4.9 5.1 5.1 0.063/0.152 Major outside shareholders 32.0 22.2 25.0 35.5 39.7 33.3 0.000/0.000 Minority outside shareholders 4.7 5.4 5.5 4.0 3.7 4.0 0.183/0.208 Independent directors 6.2 4.0 7.1 6.6 7.1 6.6 0.925/0.914 Others 0.7 1.7 0.2 0.8 1.1 0.6 0.641/0.836 Total membership, in number of persons 6.7 6.6 6.7 6.7 6.7 6.7 0.877/0.912 Number of JSCs 736 88 121 487 143 329 — Notes: a Kruskal Wallis test. b The numerator presents significance of differences by three groups of JSCs, and the denominator presents significance by four groups. Source: Author’s calculations based on survey data. 9780230_217287_04_cha02. dd 56 5/14/2009 3:42:36 PM Stock Ownership and Corporate Control 57 that businesses face are described in the following. First is the unity of man- agers, shareholders, and hired managers within a single management team. In such a case, the coordination of interests and differentiation of incentive mechanisms are needed. 12 The second issue pertains to the efficiency and quality of self-management from the point of view of a company’s develop- ment, in which case market mechanisms for the selection of skilled manag- ers fail to work. The second issue took a significant amount of time to be added to the agenda because, in the 1990s, Russian manager-owners were considered professionals. They were either representative of the pre-reform managerial corps or founders of new firms, and their skills were considered adequate to serve in the transition environment. At the present time, most top managers have received additional advanced training. Most significantly, they have gained experience in the market-based environment, and many former communist-era directors have been eventually assimilated into the new environment and become as good business promoters as new entrepreneurs (Yakovlev 2004). However, weak institutions for the protection of property rights would give no assurance that opportunistic behavior of managers would be checked through implementation of formal corporate governance standards; therefore, control by a combination of management and owner- ship became the most widespread practice. Concluding remarks Russian companies demonstrated that a high level of equity concentration was an inherent feature of business. The highest concentration was observed at subsidiaries of holding company groups, in which it was used to keep them within the corporate orbit and partially hidden behind the holdings of legal entities. Redistribution of assets and corporate conflicts preceded the consolidation of equity, which resulted in the emergence of a domi- nating shareholder who would establish control over corporate governance. The presence of the second-largest shareholder at the company often did not affect either corporate activities or intra-corporate mechanisms. It could be presumed that this shareholder did not have full power of the second control center and formed a coalition with dominating owners. A vast majority of Russian JSCs demonstrated control through a dominat- ing owner or a consolidated group of owners, but they showed preference for combining the ownership and control functions for direct involvement in daily operations as the top managers of companies. This formal institution is not the only opportunity of control, as there are other widely used instru- ments, including informal ones, which take company decision- making out- side of the scope of corporate governance procedures. The hypothesis of a positive effect of high stock ownership concen- tration in corporate operations was mainly confirmed. While it was not 9780230_217287_04_cha02. dd 57 5/14/2009 3:42:37 PM 58 Organization and Development of Russian Business always associated with the best-performing companies, companies with dispersed ownership in Russian terms would lose to other companies in indicators of performance and intensity of restructuring. At the average level of concentration, these companies would clearly take the lead in terms of better performance and the introduction of new products. Where there was a controlling interest, companies demonstrated higher current labor productivity, although respondents were more conservative in their assessment of the economic condition of their companies. Thus, in the given institutional environment, the shortcomings of dispersed owner- ship found certain empirical confirmation. The findings in this chapter could be interpreted as a lack of incentives to develop business in a sit- uation of low concentration of ownership. At the same time, it cannot be ruled out that potential owners did not show interest in the assets of these companies, precisely because of the weak prospects of their business development. Acknowledgments The chapter was prepared with financial support of the Program for Fundamental Studies of SU-HSE granted by the Ministry of Economic Development and Trade of the Russian Federation in 2006–2008 and a research grant from the Moscow Science Public Foundation sponsored by the U.S. Agency on International Development in 2005–2006. I would like to thank Svetlana Avdasheva, Ichiro Iwasaki, Xavier Richet, Andrei Shastitko, and Yurii Simachyev for their useful comments and suggestions and Olga Uvarova for her assistance in data processing. Notes 1. The word “hired” is used to emphasize that these mangers either do not own com- pany shares or have small holdings. 2. See a detailed description of ownership redistribution trends in the 1990s–2000s in Dolgopyatova (2007). 3. Its stronger influence was manifested in an increase of government shares of large companies and the emergence of holding company groups that are predominantly state-owned. Along with a desire to establish public control over the most attrac- tive assets in the oil and gas industry, there is a trend for better supervision over the defense industry and other sectors (for example, aviation, automobile, and ship- building industries), which can count on government support, and also for the consolidation of enterprises to secure their market shares. In addition, large JSCs with state holdings increasingly purchase shares of other companies, although it is problematic to evaluate the expansion of these practices of indirect ownership. Companies with federal government participation have become major players in M&A markets. OECD experts believe that these activities were not always initiated by the government but reflected their own corporate strategies, which could be contrary to government purposes (OECD 2006). 9780230_217287_04_cha02. dd 58 5/14/2009 3:42:37 PM Stock Ownership and Corporate Control 59 4. A closed JSC is a legal form of a joint-stock company in Russia (see detailed expla- nation of the peculiarities of this form in Chapter 3). In particular, a closed form of incorporation has limitations for the turnover of shares, giving advantages to existing shareholders. In the course of privatization, closed companies were established as those owned by employees (reorganized from Soviet-type “leasing enterprises”); that is, in the 1990s, top managers received control over sales of shares and placement of new emissions. This form gave them the potential for quick accumulation of shares. 5. The issues of stockholding were formulated separately in the form of a range scale for each type of shareholder; thus, the sums of average shares calculated by range medians are considerably less than 100%. This fact has to be taken into account in evaluating the results, which should be adjusted upwards by a factor of at least 1.12. For a comparative analysis, the derived data can be used without adjustment. 6. We used the binary variable of increase/decline in labor productivity. 7. The indicator was calculated as a ratio of sales in 2004 to the number of employ- ees at the beginning of 2005. 8. Specific features of management were not considered, as they may be endog- enous and depend on ownership peculiarities. In addition, the effects of man- agement on restructuring are discussed in Chapter 6. 9. The Poisson model indicated that practically all our hypotheses concerning other factors were confirmed. All industrial dummies were significant at the 1% level. A positive effect was observed for the size of a company, its start-up his- tory, and affiliation to company groups (significant at the 1% level), competition with manufacturers from developed market economies (at the 5% level), and severe competition with Russian companies (at the 10% level). Other types of competition (with foreign companies located in Russia or with manufacturers from the CIS countries or market countries including Turkey and China) were not significant. The results of the ordinal regression model are close to the ones presented. 10. The structure of investment sources was evaluated on an aggregated scale. 11. These abbreviations are used in the tables and figures presented in this chapter. 12. In practice, this issue can be resolved by uniting top managers and owners within a single team by offering the former high wages, bonuses, and options, as well as a unique corporate culture. 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(2004) Structural Changes in the Russian Industry (Moscow: SU-HSE Publishing House). 9780230_217287_04_cha02. dd 61 5/14/2009 3:42:38 PM 62 3 Legal Form of Incorporation Ichiro Iwasaki Introduction The Russian corporate sector went through a fundamental transition to a capitalist economy triggered by the collapse of the Soviet Union. As of 2005, private corporations accounted for about 65% of the country’s GDP, nearly 88.6% of its industrial production, and about 91.5% of its total employment (EBRD 2005; Rosstat 2007). 1 Even though state control over “strategic indus- tries” continues, the overwhelming dominance of state-owned enterprises in the Russian economy is already a thing of the past. In addition, in recent years, there have been a growing number of new market entries by private firms against the background of a remarkable economic recovery, and new small and medium-sized companies led by entrepreneurs of the new genera- tion have been popping up one after another, tapping new markets by fill- ing every niche in the national economy. However, the fact is that Russia’s business sector is mainly composed of former socialist enterprises that underwent corporatization as a result of the mass-privatization policy in the early 1990s followed by the monetary pri- vatization of the largest companies. To achieve the political goal of redistri- bution of state assets to the general public in an equal manner, these former state-owned enterprises were compelled by law to transform themselves into joint-stock companies (JSCs). Most of their shares were transferred for free or at extremely low prices to citizens, especially to the worker collectives and managers of the enterprises (Blasi et al. 1997). This means that leading Russian business firms were founded in a completely different way from those in the US and other industrialized countries. In addition, considering the underdeveloped financial sector and the premature markets for capital and managers in this country, which has only a short history as a capitalist state, Russian enterprises are in a very peculiar business environment com- pared to their Western counterparts. The preponderance of closed JSCs in comparison to open JSCs is one of the most distinguishing features of the Russian corporate sector. This 9780230_217287_05_cha03. dd 62 5/14/2009 3:44:48 PM Legal Form of Incorporation 63 phenomenon may be revealed under the special circumstances surround- ing Russian enterprises mentioned above. Both open and closed JSCs are statutory legal forms of incorporation, as defined in the Federal Law on Joint-Stock Companies (hereinafter, the Law on JSCs). As we will later detail, these two corporate forms refer to the legal names of the two types of JSCs that are decisively different from each other in terms of share transferability to a third party. All JSCs established in Russia must choose either of the two company types as their statutory organizational form. As of January 1, 2005, there were only 58,400 open JSCs registered in Russia compared with as many as 389,200 closed JSCs. 2 Regarding large-scale companies that require raising funds from outside sources, the number of open JSCs exceeds that of closed JSCs, with the latter number still being fairly significant. In fact, a survey conducted in 2003 by the Federal State Statistics Service found that, of the 32,266 JSCs surveyed, excluding micro- and small enterprises, 19,407 were open companies, and the remaining 12,859 were closed ones (Rosstat 2004). In other words, four of every ten medium-sized and large Russian cor- porations were operating under a governance mechanism that put rigorous restrictions on the liquidity of their own shares. In many developed countries, JSCs are allowed to achieve “virtual” organ- izational closedness by, for instance, making a special resolution at their general shareholder meeting that bans, in principle, the transfer of their shares to a third party, or by adding a provision to this effect in their corpo- rate charter. For example, in Japan, JSCs intending to make it mandatory for their shareholders to seek their approval for the transfer of their shares must provide a provision to that effect in their corporate charter in accordance with Article 107 of the Company Law, and companies with such a provision are generally called “closed companies.” This practice is common among smaller companies. There is no formal closed JSC as a legal corporate form in the continental European countries either. In the UK, on the other hand, business firms are formally classified according to Company Law into public companies and private companies depending on how they raise funds, and private companies have similar statutory characteristics to those of closed JSCs in Russia. Furthermore, several states in the US have a Company Law that allows closed corporations to impose restrictions on the issuance and transfer of common stock in accordance with a shareholder agreement, in contrast to general corporations. In most of these states, the number of shareholders for closed corporations is strictly limited (e.g., to 30 in Nevada and Delaware and to 50 in Georgia and Wisconsin), as in Russia. 3 This sug- gests that the Russian company law had broken away from the tradition of continental law and boldly incorporated some elements of common law. However, in Russia, there are clear distinctions between closed and open JSCs in terms of not only the restrictions on the number of shareholders but also the modes of securities issuance, the required levels of minimum capi- tal, and disclosure obligations. From this viewpoint, Russia has an extremely 9780230_217287_05_cha03. dd 63 5/14/2009 3:44:48 PM [...]... second and the third mechanisms as to the organizational 9780230_217287_05_cha03 dd 73 5/14/2009 3:44:51 PM 74 Organization and Development of Russian Business choice of a corporate form can be summarized in the following hypothesis: the influence of nonmanagerial shareholders increases the possibility of firms becoming open JSCs as their organizational choices, while, on the other hand, the influence of. .. number of closed JSCs with 50 or more shareholders, many of which are either former state-owned enterprises and ex-municipal companies that were privatized in the process of the mass-privatization policy launched in the early 1990s or affiliates of private firms and brand-new companies opened in those days 9780230_217287_05_cha03 dd 67 5/14/2009 3:44:50 PM 68 Organization and Development of Russian. .. sector, and the development of these local financial institutions is an overriding factor affecting the fundraising abilities of local companies 9780230_217287_05_cha03 dd 75 5/14/2009 3:44:51 PM 76 Organization and Development of Russian Business The variables for the relationship between a company and the business group to which the company belongs are a group firm dummy (GROFIR) assigned a value of 1... swap between privatization vouchers distributed to the general public free of charge and the shares of state-owned and municipal enterprises On the other hand, in consideration of the fact that managers are still the dominant shareholders in many Russian firms and in light of the strong orientation of these company insiders toward organizational closedness, it is reasonable for them to favor a closed JSC... companies and how much harm is done to corporate management and maximization of shareholder wealth by this choice Therefore, particular attention should 9780230_217287_05_cha03 dd 64 5/14/2009 3:44:48 PM Legal Form of Incorporation 65 also be given to research on the legal forms of incorporation of Russian JSCs in the context of Russian economic studies To date, there have been only a handful of economic... representing the influence of shareholders and managers over organizational strategies, (b) variables concerning the constraints affecting capital demand and supply of the company; (c) variables regarding the linkage between a company with a business group and the organizational scale of that group; (d) variables concerning the impact of past policies on company start-ups; and (e) other control variables...64 Organization and Development of Russian Business unique legal framework in comparison with the UK and US Moreover, as reported above, even though almost all of the Russian leading companies are former state-owned firms, about 40% of them are still operated as closed JSCs after more than 10 years of mass privatization This highlights the sharp contrast with the situation of closed corporations... theory of the organization and the firm advocated and developed by Alchian & Demsetz (1972), Jensen & Meckling (1976), Mayers & Smith (1981), Williamson (1985, 1996), Milgrom & Roberts (1992), Jensen (2000), Furubotn & Richter (2005), and others, the differences between the institutional settings of open and closed JSCs would affect the incentives and decision-making processes of corporate managers and. .. managers and shareholders Lack of consensus among managers and shareholders 349 Mass-privatization policy for state-owned enterprises 93 No of affirmative respondents All companies Most important reason for being in the current corporate form Legal restrictions on the number of shareholders, minimum required capitalization (minimum share capital) Table 3.3 72 Organization and Development of Russian. .. company is a member of a certain holding company or another business group by owning stocks; and a core corporation dummy (GROCOR) and an affiliate firm dummy (GROAFF), both of which reflect the characteristics of the company’s group membership The organizational size of the business group is represented by the natural logarithm of the total number of its member firms (GROSIZ) The impact of past policies . enterprises 349 44 .1 291 54. 4 58 22.7 Judgment by the managers and shareholders 248 31 .4 133 24. 9 115 44 .9 Lack of consensus among managers and shareholders 7 0.9 3 0.6 4 1.6 Time and cost of changing. 5/ 14/ 2009 3 :44 :48 PM 64 Organization and Development of Russian Business unique legal framework in comparison with the UK and US. Moreover, as reported above, even though almost all of the Russian. Presence of counterbalance Absence of counterbalance Significance of differences a, b Company managers 46 .4 54. 9 49 .2 44 .1 40 .5 45 .6 0.013/0.010 Rank -and- file workers, trade union 5.0 8.0 6.0 4. 2