Andrei Yakovlev,
Institute for Industrial and Market Studies at State University – Higher School of Economics ayakovlev@hse.ru
Hanken School of Economics, October 21, 2010
1

Content
1) Russian CG model: transplantation of institutions and efficiency problem
2) New tendencies after 2000 and their preconditions
3) New stage: post-Yukos development + influence of the crisis 2008-2009 + forecast for the future
2

Russian model of corporate governance: basic ideas
• Transformation of state owned enterprises
(SOE) into open joint stock companies (JSC)
• Dispersed ownership structure resulted from mass voucher privatization
• Free circulation of JSC shares on stock market
• Professional intermediaries (investment funds, mutual funds etc) supported free circulation of
JSC shares
3

Russian model of corporate governance: implementation
• Mass privatization 1993-1995 and development of stock market institutions:
– 26,300 open JSC (compulsory conversion from SOE)
– about 400 voucher investment funds
– above 10,000 brokers in stock market
• Nov. 1994: Civil Code (part I), Dec. 1995:
Federal Law on JSC – legal regulation of shareholders / managers interactions
4

45 000
40 000
35 000
30 000
25 000
20 000
15 000
10 000
5 000
0
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
Federal-owned enterprises a Region-owned enterprises a Municipal enterprises a
5

Some results of privatization in Russia in 1993-1999
1993-1999
86386
16293
17832
52261
9136
6

Loan-for-shares actions in 1995
Company Buyer Share holding size
Auction price in nov.-dec.
1995
Price of this share holding by the end of 2004 (based on current capitalization)
38% $170 mln.
About $5 bln.
Mining and metallurgical company “Norilsky nickel”
Oil company YUKOS *
Oil company Surgutneftegas
Oil company Sibneft
ONEXIM bank (V.Potanin)
MENATEP bank (M.
Khodorkovsky)
Surgutneftegas
(V.Bogdanov)
B.Berezovsky
R.Abramovich
Oil company Sidanko ** MFK and Alfa-Group
(M.Fridman)
Oil company Lukoil Lukoil (V.Alekperov)
45%
40%
51%
51%
$159 mln.
$300 mln.
$100 mln.
$130 mln.
$450 mln.
$12,5 bln.
$8,2 bln.
$5,1 bln.
5% $141 mln.
$2,4 bln.
(*) By the end of 2004 OC Yukos shares fell approximately 30 times compared to their level before the arrest of P. Lebedev and M. Khodorkovsky. As of 30.06.2003, the 45% share holding of the company cost about $14 bln.
(**) In 2002 OC Sidanko together with the Tumen Oil Company merged into a new company – TNK-BP, established with
50% participation of British Petroleum.
Increase of RTS index for the same time period = 7,4 times (83 to 614)
7

Russian model of corporate governance: some results
For 30,000 open JSC founded in 1990s:
• Satisfy listing requirements of Russian stock exchanges
• Shares are traded on organized markets
• Stock market is liquid
Less than 1000 companies or approximately 3%
Less than 300 companies or approximately 1%
Less than 80 companies
Relevant research: no effect on productivity even 5 years after privatization (Brawn et al, 2006); huge violations of property rights (Black et al, 2000); state capture (Hellman et al, 2000)
8

Russian ‘quasi-open’ JSC: influence on incentives of owners and managers
Starting conditions : Inefficiency of SOE
Compulsory conversion of SOE to open JSC
• Demand for restructuring, however: absence of responsible owner under dispersed ownership structure
• Under-evaluation of enterprises – shares value vs. value of liquid assets: strong incentives for opportunistic behavior of managers and majority shareholders
Hostility to outsiders
Non-transparency of finance
Assets stripping
‘CG in Russia is awful.’
(US-Russia Business Council monthly report, April 2003)
9

CG in Russia after 2000: New tendencies
First steps:
• Biggest companies started to improve their corporate governance (YUKOS as first mover)
• Voluntary information disclosure on the base of IAS and GAAP
(opposite to failure of relevant program approved by government in 1998)
• Mass issues of corporate bonds
(> 5 billions USD in 1999-2003)
• New shares issues (Wimm-Bill-
Dann 2002 etc. at US market)
First results:
I.2001 – VII.2003: fivefold increase of
RTS index
Invitation of large foreign outsiders
(Allianz/ROSNO
2001, BP/TNK 2002)
CBR/MinFin: Net capital inflow in first two quarters 2003
10

Pre-conditions of positive shifts
Economic
• Strong concentration of ownership and control – as key instrument to protect property rights under weak institutional environment
• Ruble devaluation – increase of business profitability
• Implementation of new (1998)
Law on bankruptcy: new wave of ownership redistribution and
‘clearance’ of non-payments accumulated in 1990s
Political
• End of mass privatization, decrease of total rent volume and limits for rentseeking strategies typical for 1990s
• Crisis 1998: the possibility to lose – limits of assets stripping
• Understanding of collective interests and readiness to collaboration (new RSPP)

Real control on assets and new long-term interests of insiders

Bargaining with government about legal environment
11

Yukos case: its reasons and influence on CG
Reasons: mainly political – conflict between Putin’s administration and oligarchs of previous (El’tsin) period
First (short-term) consequences:
 New expectations of privatization results’ revision
 Additional costs of ‘social responsibility’

Strong disincentives for leading national companies to be large and open and to invest in Russia
– estimations of capital outflow for 2004 – about $17 billion;
– strong shift of stock market turnover after Oct. 2003 from Moscow to London
12

Post-Yukos development: general framework
Political side
• Policy of state control on
‘strategic assets’ (oil & gas, defense industry, infrastructure)
• Further pressure on old oligarchs (Alfa-group etc)
• Restrictions for foreigners in
‘strategic’ industries
Economic side
• Russia as growing market
• Investment ratings (Fitch,
Moody’s) and increase of foreign investment
•
WTO accession and globalization – strong pressure of competition and need for large national companies
Diversification of economy ?..

Transformation of large Russian companies to
MNC, direct investment abroad (CIS, East Europe)
 Need for capital and new IPO
 Improvement of CG in ‘second echelon’ of
Russian business
13

New empirical evidences: two surveys
• Survey: 957 manufacturing firms from 8 sectors and 48 regions
• Time period: February – June 2009
• 1 st round of survey – in 2005-2006, 499 firms in panel
• Some parameters of the sample:
1) The enterprises employed about 8% of the average payroll across the whole sample, and in 2007, they produced about
6% of the total output of manufacturing industries
2) the average surveyed enterprise had 587 employees (14% of firms above 1000 workers)
3) 73% of firms had been established before 1991 and 10% after
1998
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JSC with foreign participation by sectors
(panel data), %
Total JSC sample
Food producers
Textiles and garments
Timber and woodworking
Chemicals
Metals and fabricated metal products
Electrical, electronic and optical equipment
Transport vehicles and equipment
Machines and equipment
2005 2009
8,2 11,4
4,9
3,0
1,6
6,0
3,8
16,7 18,2
18,4 28,1
8,8 13,3
10,0 13,9
10,5 17,6
2,0
Change over 4 years, p.p.
+3,2
+1,1
+0,8
+1,5
+9,7
+4,5
+3,9
+7,1
+0,4
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Government participation in JSC equity (panel) and the role of stock market
One more interesting observation: the share of JSC publicly trading in their securities (shares and bonds) doubled over 4 years – from 4.8% to 9.6%
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The scale of privatization in Russia after 1999
1993-1999 2000-2007
86386 9 291
16293 946
17832 1 724
52261 6 621
9136 19 610
17

2500
2000
1500
1000
500
0
5000
4500
4000
3500
3000
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
0
2500
2000
1500
1000
500
USD revenue from privatization RTS index (average for a year)
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Foreign direct investment inflow into Russia, 1995-2007
(Million USD)
30 000
25 000
20 000
Net FDI inflow (EBRD)
Gross FDI inflow (Rosstat)
15 000
10 000
5 000
0
-5 000
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
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Other (mid-term) trends of post-Yukos development
• High economic growth (above 7% per year in 2004-2007)
• Booming on Russian stock market
• Further improvement of CG in Russia (about 70 IPOs in 2005-
2007; at the beginning 2008 - 57 companies traded in NY and
London)
• Strong increase of FDI in Russia + increase of Russian direct investment abroad
At the same time :
• Strong state intervention (direct and indirect control on
Gazprom, Sibneft, OMZ, Power Machines, AvtoVAZ etc)
• Active industrial policy (state holdings in aviation, shipbuilding, arms production; investment fund for co-financing of large infrastructure projects; state corporations in priority areas…)
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Ten largest SOEs and their market capitalization
2004 (as of September 1)
Rank
1 Gazprom
Company name
7 RAO UES
9 Sberbank
15 Mosenergo
21 Rostelekom
22 Uralsvyazinform
23 Aeroflot
25 Rosneft-Purneftegaz
33 Volga Telecom
34 Bashneft
2008 (as of September 1)
Market capitalization State share
(mln dollars)
46660
(%)
38.0
10884 53.8
7431
3220
1469
1153
1142
1015
60.6
95.3
50.7
57.8
51.2
82.0
679
664
51.0
63.7
Rank
1 Gazprom
Company name
2 Rosneft
4 Sberbank
9 Gazprom Neft
12 Vneshtorgbank (VTB)
15 RusHydro
22 Rostelekom
23 Unified National Electric Grid
(FGC UES)
Market capitalization State share
(mln dollars)
236187
(%)
50.1
92968 84.6
51058
22787
18823
16738
8349
6377
60.6
73.7
77.5
60.4
50.7
77.7
26 Bank of Moscow
32 Mosenergo
5531
4043
44.0
60.5
Market capitalization of ten largest SOEs
74317
Total market capitalization
Share of ten largest SOEs (%)
Source: Sprenger (2008)
237014
31.4
Market capitalization of ten largest SOEs
Total market capitalization
Share of ten largest SOEs (%)
462861
975098
47.5
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• Crash in stock market and troubles in financial sector
• Decrease of demand for metals, chemical products and wood in world market => strong decrease of industrial output and high unemployment
• Decrease of oil prices => decrease of hard currency inflow + capital outflow => attack on the ruble and strong devaluation
• Macroeconomic policy as a key, but: Who can survive and can be drivers of economy after crisis?
22

• Close informal relationships with the government
(especially after the YUKOS affaire) => the way for receiving “administrative rents” => trade-off with real investment in the business
• Proximity to the state produced an illusion that risks were lower => incentives for active borrowing (mostly abroad, because Russian financial system was underdeveloped), as well as for super-aggressive M&A
• The remaining uncertainty about ownership rights => special defense mechanism against corporate takeover: to take the profit away to foreign off-shore accounts and to finance company’s activity in Russia with borrowings
23

• Became an important part of the economy
(44% of total sales of LME in 2006)
• Strong non-homogeneity in terms of productivity and growth ( HSE/WB project: productivity gap; Expert magazine project: 38% of firms with 20% annual growth in 2000-2006; Both projects: successful firms are in all sectors )
• Different sources of growth: markets factors vs. (informal) administrative support
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• Their situation was more difficult as a result of excessively aggressive policies and underestimation of risks.
• More complicated management structure => their owners had no adequate information about the condition of their businesses => problems with prevention of managers from opportunistic behavior
• Proximity to the state enabled them to lobby for assistance, but upon receipt of assistance, as a rule, they got bound with additional “social obligations” => obstacle to restructuring
• Getting public loans against shares => uncertainty about future property rights => incentives, not only to managers but also to current owners, to strip assets.
• Close proximity to the state and common interest enabled these companies to blockade allocation of resources for public support to other, more efficient companies of the “second echelon”.
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Mid-size companies growing mainly on market factors
• Under the crisis conditions, were more ready for severe restructuring
• Could gain from incentives to increase exports and import substitution (if they could complete their investment projects)
• Tried to keep the expansion of their activities unnoticed, being concerned about imposition of additional “social obligations” and pressure to deal with inefficient partners.
• In cases of development and expansion, could collide, competing for resources, with companies relying mostly on the support from regional and local governments
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Midsize companies growing mainly on administrative factors
• Faced a dramatic drop of competitive power;
• Could choose the opportunistic strategies facing a danger of drastic layoffs – reckoning on provoking of “social tension” on the side of authorities and creating conditions for lobbying for public support;
• Used more actively their connections with government at different levels, limiting the scope for competition.
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Current stage of corporate governance in Russia
• Highly concentrated ownership structure
• Integrated business groups
• Merger and acquisition (extraction of profit from underestimated assets)
• Low transparency of business
• Limited (comparing to CEE) participation of foreign investors
• Mixt of public and private corporations in one legal form of „open joint-stock company“
But:
• Some differences for large and middle-sized firms
29

Large companies
• Increase of governmental shareholdings in the largest
‘strategic’ companies.
• But more important: informal influence on the politics of the largest private companies (both – before and during the crisis).
• Foreign strategic investors – only as ‘junior’ partner (in the best cases).
• Free float (mainly in Europe) – limited. Presence at stock market – not as source of corporate finance but as instrument of reputation and image improvement.
• External financial resources – mainly debt financing
30

Middle-sized companies
• Ownership structure - much less dependent on the politics of the government and will be mostly determined by external factors and shareholders’ interests.
• Key difference – bigger potential for growth and higher demand for finance => medium corporations will be more active in equity financing (mainly on Russian stock market).
• The absence of positive changes in the conditions for doing business => strategic investors will entering the market; business climate improvement => portfolio investors will be more important
• At the same time: risks of opportunistic behavior – some nonstable companies can use IPOs for transfer of their financial problems to unqualified investors
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Tendencies typical for both segments
• Business groups will stay important as an instrument of defense from imperfect business environment.
• Active direct investment abroad: both as instrument of expansion and partial withdraw of business from Russian jurisdiction
• Stock market: positive dynamics but limited role and influence
32

Midterm forecast: general

Disappearance of ‘ transition firm ’ model as substantive phenomenon - followed by orientation of Russian corporations on the model of ‘ closely held firms
’
(especially in the segment of medium corporations).

The segment of large corporations will be most probably characterized by orientation on ‘ development firm
’ model featuring informal relationship with the government and investors.
33

Evolution of firm models
А Widely held firm
С
Transition firm
Family firm
L
Development firm
M
В
Closely held firm
34

Long-term trends
• Increase of competition
• Enlargement of corporations
• Foreign investors participation
As a result :

Transformation of Russian companies into MNC

Transfer of knowledge from foreign investors as a factor of competitiveness

Incentives for management as instrument to increase the efficiency of business
35

Important long-term factors
• Global trends in CG development: competitions USA vs. UK standards
• Demography: in 15-20 years ‘pioneers’ generation
(current owners-managers) will leave business => demand for legal instrument of property rights transfer
+ opportunities for separation of management and ownership + for more dispersed ownership structure
• Governmental policy
─
Antitrust + SME
─
Reform of pension system and institutional investors
The share of ‘new’ big business?
The transparency of business?
The role of stock market?
36