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At the same time, during that initial stageof the sale of property (shares) the question of structural change in Russianenterprises, and the attraction of investment was not, as a rule, raised.At best, large outside investors have acquired a share of capital that does notrepresent a controlling interest, at least at the first stage of distributionof the shares. Under these circumstances, the prevailing structure ofproperty in Russia, its likely future evolution, the special significance itmay have for a potential investor, and the role of transactions on thesecondary market, as well as the changes in the ideology of privatisation inthe middle of 1994, will be crucial. We shall discuss all this in Chapter8 and Chapter 9.

Chapter8. A New Ownership Structure and a Secondary Market inShares

8.1. Formation and Evolution of the InitialOwnership Structure

In the process of the initial securing ofownership rights to the property being privatised one could clearly distinguishtwo trends: formation of the capital of Russian corporations closed tooutside investors and retention of regional and sectoralmonopolies.

The first trend was a result of the use ofoptions 1 and 2 (see Appendix 1). A package of vast privileges forenterprise workers (free shares and shares on beneficial terms, anincorporation fund and a privatisation fund formed from the profits of theenterprise) have made it possible, together with the reduction of prices(practised all around) of the property being privatised, for them to becomeowners of major national firms with the minimum of costs. That was donethrough keeping a controlling equity interest in the hands of the workcollective and administration, or through shares which belong to the stateplaced in trust. As a result of closed subscription for shares or theconduct of auctions with limited admission of institutional investors or thebroad masses of private investors, an original capital structure was formedwhich, while falling under the legal status of an open joint stock company, inmost cases was more reminiscent of a capital structure of the closedtype.

The second trend is the effect of thesectoral and regional monopolies, which under the new conditions set clearlydesignated borders for the effective movement of capital through the creationof financial flows which, while remaining closed would at the same time allowredistribution between less and more profitable units within the structureitself, without resort to a stock market. A preference for territorialand financially closed-type enterprises prevents free movement ofcapital. This trend is seen quite clearly in the attempts to form holdingcompanies and industrial groups incorporating (as a necessary element) acommercial bank, or sometimes an investment company. Given the continuoustechnological, production and business links, however, an even greaterincentive is an aspiration to re-create the old financial systems that wouldmobilise the local capital and erect a barrier in the way of penetration by`outside' trading and banking business (see IET, March 1994,pp.164-168).

These trends will affect the viability ofRussian corporations differently for they are far from being homogenous (seeShmeleva & Radygin, 1994; Radygin, 1994b). A supplementary brake onfurther transformation of the capital structure of the new joint stockcompanies is the policy of the property funds, which were in no hurry to sellthe reserved packets of shares which comprised 10-20% in the majority ofenterprises.

At the same time, despite the seemingcloseness of the capital structure of Russian privatised enterprises, what wesee is a rather intensive process of transition of the property rights obtainedin the course of the initial placement of shares, a transition in favour ofoutside investors as well as the managers of enterprises. In other words,the initial placement of shares in the privatised enterprises, with all therestriction on changes in the structure of their capital, is nevertheless arather short stage, which will inevitably be followed by a whole series ofsecondary transactions (the ideal result of which should be the appearance ofan `efficient owner').

Another important conclusion is that theprocess of concentration of the capital initially dispersed in the course ofthe voucher privatisation has already started.

The third important conclusion is thatwithin the context of the effective model of privatisation (that was in forcefrom 1992 to the first half of 1994), one of the most promising ways ofparticipation for any serious investor, whether foreign or domestic, in thecapital of the Russian enterprises being privatised was through acquisition ofa portion of capital on the basis of secondary transactions in the shares ofthe first issue or in the course of an additional issue.

To carry out a more detailed analysis it ismost important, first of all, to consider some typical versions and theevolution of the capital structure of new joint stock companies that appear inthe course of the initial placement of shares (see Tables 10-11).

First of all, what we witness here is aprocess of `erosion' of the initial block of shares received by the personnelof enterprises through a closed subscription. In practice, at mostenterprises the management is quite capable of getting some 15-25% of the stockby employing a mechanism of proportional distribution of shares by closedsubscription, rather than a single minimum for all, using an option right andthe buy-out of shares from the workforce after the closed subscription is over,as well as buying vouchers at auctions and using dummy firms.

As interviews with 426 representatives ofindustrial factories shows (the opinions were polled in January 1994 by theAll-Russia Centre for the Study of the Public Opinion), the share of directorsin the equity is higher at medium-size and small businesses. Of specialinterest is the fact that in December 1993, compared with 1992, the economicsituation improved at those enterprises where the share of directors in theequity was higher. The same is true of those enterprises where the shareof foreign investors is rather high, and where banks and shadow figures play apronounced role. Where the role of the work collective is higher,however, the trend of the economic situation was rather negative (Table12).

Another typical situation is whererepresentatives of the engineering groups and of `working aristocracy' are theholders of quite large blocks of shares (1-2%), while many rank and fileworkers sell their shares within 2-3 months. A contributing factor tothis may be the fact that only one-third of all privatised joint stockcompanies intended to pay dividends for 1993. In many cases the marketprice offered by intermediaries may be quite attractive for a worker. Forexample, in summer 1994 many workers at Mosenergo were selling the shares thatthey got through a closed subscription at a price of 120-200 rubles per share,a minimum price of 1000 rubles.

Naturally, the shares of most enterprisesare not very liquid and sale may be allowed only to an intermediary who isacting in accordance with a specific order (it may be an outside buyer or themanagement) or with the aim of reselling the packet accumulated at a betterprice on the market. New problems also cropped up: almost totaldiscrimination against outside shareholders by the management, unlawfulprohibition of employees to sell their shares to `outsiders' under threat ofdismissal, unlawful charter limitations on the upper limit of a holding ofshares and many other things (see also Chapter 9).

At voucher auctions big buyers werepredominant. The lion's share of the average 20% of stock put up forauction by a medium-size enterprise is usually bought by investment funds,intermediary firms which will resell the stock to an investment holder, andagain the management (see Chapter 7). So while originally the ratio ofmanagement to outside investment institutions as buyers of shares at voucherauctions was 4:1 (that was the situation in St. Petersburg, for example) (`Ontrends...', 1993), in the second half of 1993 and first half of 1994 thesituation changed in favour of outside investors. At the same time, thatdid not mean any antagonism between the two groups. Quite the contrary,one can speak of a trend toward a merger, because many voucher funds werecreated (in an indirect way) by the privatised enterprises themselves. Inthat case the voucher funds served to accumulate the means for a `self-buy-out'of enterprises and for purchase (through a power of attorney or other means) ofa portion of the capital of related agents and contractors. Anotherversion of voucher fund merger with management is joint control of certainblocks of shares held by the management and the shares acquired by voucherfunds.

Many big `outside' investors whoparticipated in the auctions took into account, first of all, such factors asthe size of the block of shares sold, the size of the state share, theavailability of preferred non-voting shares, the size of the authorisedcapital, which all shows that there is a priority orientation to establishingcontrol. The size of the enterprise's land is also a potential basis forobtaining credits.

In 1994 the major trend in this sphere wasa further reduction of small investors at the auctions in favour of the abovebuyers. While on average small private investors bought about 15% of theshares for auction (with half of them being the shares of the personnel of theenterprise), in 1994 that portion dropped to 5-10%.

The same trend - growing wholesale sellingof shares of the enterprises being privatised - was also characteristic of thefirst floatation of shares on the regional exchanges (eg. the South-UralsExchange, International Vladivostok Exchange, Perm Commodity Stock Exchange,Ekaterinburg Exchange) which, together with the local property funds, wereengaged in regular bidding.

As has been shown above, the investmenttender, while an extremely promising method of attraction of large investors,so far has not become a very significant phenomenon. The total nominalvalue of the shares that went to winners of investment tenders was not morethan 10 billion rubles by the middle of 1994. All the same, one canhardly call the winners of the tenders that were conducted smallinvestors.

Thus even the first wave of the initialfloatation of the shares of enterprises being privatised in Russia suggeststhat the equity ownership structure of the emerging joint stock companies has aclear trend not toward the dispersed-type Anglo-American model but rather thecontinental European model with a clear-cut majority controlling interest, thisgoing, naturally, together with the specific Russian features and the costs ofthe transition period. It is quite clear that this trend should intensifyafter 1 July 1994 as money privatisation proceeds. Estimates of the levelof participation in the process of privatisation in that period by citizens ofRussia range from 1.5% (the Veteran investment fund) up to 6% (GKI). Thisconclusion is supported by the results of the investigation of potentialinvestors in the money stage of privatisation carried out by the Association ofMarketing in March-April 1994 (see Appendix 2).

At the same time, it seems hardly possiblethat a capital structure will be formed in the near future which will markedlyinfluence the efficiency of the privatised enterprises. This is because aconsiderable part of the blocks of shares, though concentrated in the hands oflarge institutional holders, is still intended for resale at this stage.Because of this many current holders can hardly be interested in long-terminvestments that go hand in hand with reconstruction and development ofenterprises.

Because of the trend toward a majoritycontrolling interest even at the stage of the original sales, any outsideinvestor will have to deal with an institutional holder, whether it is aproperty fund, the management, some kind of middle man who has bought someshares for the purpose of resale, or a voucher fund. Taking into accountthe large volume of non-privatised property, the presence of nomenklatura `oases' (i.e. certainprofitable, export-led and other enterprises with an informally closed capitalstructure), and the present infrastructure of the securities market, it must besaid that in the long run there will need to be contacts between an investorand a holder of a block of shares. This in turn will underline the acutenature of the problems of information in the area of investment.

From a broader perspective we can concludethat in Russia all the necessary conditions exist for redistribution of theproperty initially formed in the course of privatisation on a scale that couldbe compatible with the scale of large privatisation at the first stage.The noticeably vigorous activity of the secondary equity market in privatisedenterprises' shares in 1994, though mainly speculative in its motives, is themost convincing proof for that conclusion.

8.2. The Secondary Market in the Shares ofPrivatised Enterprises

Usually in countries that have a wellestablished stock exchange the ratio of the volumes of the primary andsecondary markets ranges from 80:20 to 95:5 in favour of the secondarymarket. In Russia the situation is diametrically opposite (see Table 13),though compared with the moment of emergence of the stock market in Russia therole of the secondary market in the total volume of trading in securities isrising. In 1991 the share of the secondary market may be estimated at5-7%, in 1992 it was 10-12%, while in 1993 it rose to as much as 16-20% (INIOR,1994).

The secondary market in the shares ofprivatised enterprises was formed practically at the same time as privatisedjoint stock companies appeared. The volume of trading outside the stockexchange varies; such trading goes on in the shares of practically everyissuer, which is connected, in particular, with the formation of large blocksof shares before the first meetings of shareholders and re-election of theboards of directors (Mikhailov, 1993).

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