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EASTERN TRANSITION TRAJECTORIES

Measurement, typologies, differentiation, interpretations

International Conference GTD Grenoble

December 10-11, 1999

POST-PRIVATIZATION CORPORATE GOVERNANCE IN RUSSIA:

Singular Path or Typical Transition Trajectory

by

Dr. Alexander Radygin,

Member of the Board, Institute for the Economy in Transition (Moscow)

CONTENTS

1. Introduction. Preliminary methodological notes

2. Tendency toward ownership concentration and myth of an efficient owner

2.1. Privatization models

2.2. Ownership structure in transition economies: main trends

2.3. Interrelationship between ownership concentration and effective corporate governance

3. Major mechanisms of the corporate governance and their specific features in Russia

3.1. Internal mechanisms

3.2.The general legislative situation.

3.3. The corporate securities market

3.4. Bankruptcy procedures

3.5. Market of corporate control (takeovers)

4. Conclusions

Sources

Tables

Draft - For discussion only

1. Introduction. Preliminary methodological notes

In the present day economic literature the well–defined property rights (clarity, stability and predictability of the property rights) are regarded as one of the major factors of the economic growth and are closely linked to the successful economic development (Coase, 1960; Demsetz, 1967; North, 1981). Nevertheless, the role of the clearly defined property rights may vary depending upon the size of entities, whether they are public or private, the access to information etc. (Arrow, 1974; Stiglitz, 1994; World bank, 1998).

The importance of this element of the institutional environment for the transitional model of the corporate governance and the respective government regulation can’t be overrated. Thus, under the socialist economic system there was a system of legal sanctions and enforcement for the protection of the public property. In the transitional Russian economy the zone of uncertainty in the field of the property rights has become wider since the system of protection of the public property is eroded and a new clear system of the private ownership rights is yet non-existent.1

The erosion of the property rights also leads to the paralysis of the corporations’ investment activity because the better defined are the property rights the less are the risks at the capital market (Grossman, Hart, 1986; Hart, Moore, 1990). At the same time there are still no clear economic and legal boundaries between the public and private property with all the resultant problems (including the protracted absence of the bankruptcies as the mechanism of the corporate control). The problems in the field of ownership relations stemming from the imperfect information are also apparent.

If we interpret a firm as an institution, organization or network of contracts (Alchian, Demsetz, 1972; North, Thomas, 1973; Williamson, 1985, and others) and apply a corresponding approach to the corporate governance we can also make broad practical conclusions for the transitional economy. In particular, the absence of the developed system, long-standing culture and clear standardized mechanism of contract implementation as the channels for the transfer of the authority (property rights) clusters leads to the mass-scale violations of the shareholders’ rights, a single case-tailored enforcement for the political purposes, development of the non-market relationships between the economic players, growth of the rent-oriented activity, corruption (see for details Radygin, Entov, 1999).

Conflicts between the managers and outside shareholders (both large and small) within the framework of the principal-agent relationship become very sharp. Problems related to the monitoring of managers by the shareholders2, and consequences thereof, are aggravated by the fact that the managers, either directly or through proxy, are acting both as insiders and outsiders of the corporation in accordance with all possible interpretations of these terms.3 The problem of the issuer’s transparency becomes a crucial one not only for the potential investors but also for the de-facto outside shareholders of the corporation.

The corporate governance problem is no less important from the standpoint of the financial system which is understood as the certain institutional arrangements providing for the transformation of savings into investments and allocating resources among alternative users within the industrial sector (Tobin, 1984). Under the conditions of the transition economy it’s the development of an efficient system of financial institutions, primarily banks, within the overall framework of the financial system that becomes especially important for the shaping of the national model of the corporate governance and financing of industrial corporations.

Their weakness in Russia became especially apparent during the financial crisis of 1998 and the theoretical discussion about the principal character of the national model of the corporate governance (the American model versus the German one) became groundless. Correspondingly, the potential role of banks as an alternative mechanism of the corporate control under the conditions when the other mechanism which may force the managers to act not only in their own interests are of limited use (discussed in Stiglitz, 1994, pp. 77-78, 189-190) also turns out to be of little relevance.

From the standpoint of the applied analysis of the corporate control issues the situation in the transitional economy is ambiguous. On the one hand, according to the tradition of the manager’s revolution’ concept known since 1930s (Berle, Means, 1932) there are reasons to put the formal owners outside the framework of the real authority relationships involving control and management in the Russian joint stock companies. This is especially typical for the first post-privatization years before the law On joint-stock companies was enacted. On the other hand, there are also reasons to claim that there is such a link as ownership – corporate control – corporate governance. The latter makes sense in the cases when it’s possible to identify different types of the hard cores of the shareholders excersizing the direct control or by mean of the affiliated entities (coalitions in the terms of the organizations theory). In this connection the key problem is to identify the hubs of real control (Aghion, Tirole, 1996) in a corporation under the formally dispersed ownership structure.

It should also be pointed out under the conditions of the non-liquid market the problem of choice between the mechanism of vote and the mechanism of exit loses its dichotomic nature (Hirschman, 1970, pp. 15-54) since in essence there is no alternative: if it’s impossible to sell one’s shares than it’s necessary to upgrade the role of the vote mechanism. One of the potential ways of this mechanism’s implementation in the transition economy is offered by the self-enforcing model of the corporate governance (Black, Kraakman, Tarasova, 1997; Black, Kraakman, Hay, 1996).

In the end it’s necessary to make several methodological conclusions of a more general nature. The term institutional changes is usually applied to the specific institutional arrangements (institutions) but, as a rule, never to the whole institutional structure as the totality of the institutional arrangements (Lin, Nugent, 1995, p. 2307).

The specific character of the transitional economy is such that the institutional changes, as opposed to the generally accepted approach, not only can but should be analyzed comprehensively, i.e. within the framework of the overall institutional structure of the economy. Such an approach to the same extent also applies to the problem of the emergence of the corporate governance model and control in the transition economy.

The specifics of the emerging model of the corporate governance and control as an independent institutional arrangement may be understood only within the framework of the whole totality of the institutional changes in the transition economy. At the same time the problem is that it’s impossible to analyze globally all the institutions (in one study) even in respect of a relatively narrow issue of the corporate governance and control development.4

It’s obvious that the two above-mentioned conclusions to some extent contradict each other. It was exactly due to this reason that the author on purpose limited the analysis to the singling out of the key aspects taking into consideration the Russian specifics. Below we would attempt to review two major blocks of the problems in their interrelationship.

First, the evaluation of the major trends in the property rights redistribution in Russia as the basis for the understanding of the emerging national model of the corporate governance. Second, assessments of the>

2. Tendency toward ownership concentration and myth of an efficient owner

2.1. Privatization models

The major trends in the property rights redistribution within and after privatization are the institutional basis for the understanding of the emerging national models of the corporate governance.

There is a rather extensive literature on problems of privatization in transitional economies 5, and in the present work there is no sense to conduct the in-depth comparative analysis of the models. Let's consider briefly only most general tendencies. Now in transitional economies three main models of privatization are known: the program of mass privatization (MP), insider’s model (MEBO), model of initial majority shareholdings (for details see also tab. 1). The special place (practically in all countries) takes a model of mixed (private-state) ownership. There are also models, specific to separate countries, such as a model of "social - oriented" ownership and model " case-by-case ". 6

Mass privatization (MP). The principle of charge-free distribution of state ownership has not become general in East Europe, therefore significance of the MP for consequent corporate governance of privatized enterprises was unequal in the various countries. This model was widely applied in Russia and Czechoslovakia (after disintegration of the uniform state - in Czech Republic), Latvia, Lithuania, Mongolia. In many other countries MP (as the base model) was conducted later (Armenia, Azerbaijan, Georgia, Kazakhstan, Kirgizstan, Moldova, Ukraine). In other countries this model was stipulated as additional to other methods of privatization or for a very small part of the shares of a narrow circle of the enterprises (Albania, Bulgaria, Poland, Slovenia, Tadjikistan, Estonia). In a number of countries, nevertheless, its realization has stayed at the stage of acceptance of the appropriate legislation (Romania) or in connection with crisis of a 1997 (Albania).

In some countries such schemes were not used (former GDR, Hungary, Macedonia). Nevertheless Hungarian project, for example, provided a possibility of deriving by each full age citizen of the interest-free credit in 100 thousand forints for 5 years by analogy to the acting system of crediting of employees. In some countries of former Yugoslavia there was a transfer of a part of the shares to various social funds as the special variant of MP.

Within the framework of the program it was supposed, that the distribution of the vouchers (bonds, checks, points etc.) simultaneously would result in emerging of small shareholders and/or large outsiders (investment funds). It will give a push to development of the capital market, to the consequent concentration of ownership by active investors and - in the total - to efficiency of corporations. As a whole it is accepted to consider, that the role of the MP for the future corporate governance initially (originally) remains uncertain, probably to a great extent negative, though in the medium-run period all depends on a practical solution of a dilemma " diffusion of the vouchers - ownership concentration".

Insider’s model (MEBO). This model is based on purchase of the enterprise (assets of the enterprise) or of controlling block of shares by the employees and managers (jointly or separately) with the formal right of a consequent sale/purchase. Such practice has been rather widely applied in Albania, Belarus, Poland, Romania, Slovakia, Tadjikistan, Turkmenistan, Uzbekistan. In Russia and Georgia this model as a matter of fact has become official "submodel" (with large legal privileges to the employees) in frameworks of MP. In Lithuania and Mongolia the situation was similar, however developed spontaneously (employees and the members of their families used the vouchers for purchasing of the shares of the enterprises on " open " the market, i.e. without closed subscription).

Specific insiders’ models have developed also in Slovenia, Croatia and Macedonia, however they can be considered separately within the context of general Yugoslavian "inheritance" and use the submodels of different social funds (as a peculiar model of "social - oriented" ownership).

The evaluations of actual participation of the employees and managers of the enterprises in their privatization in various countries rather hardly differ from each other. Nevertheless findings of many researches show, that the employees ownership has taken the certain niche within the framework of transitional economy. Influence of this model to corporate governance, as a rule, is relatively negative, though some contributors consider higher information possibilities of insiders to monitor activity of the managers. Obviously, that the last thesis in specific conditions of transitional economy is solvent only only theoretically (especially taking into account the fact that managers are the most influential insiders).

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