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It’s obvious that any single law on the companies simply can’t cover the whole spectrum of corporate problems. Correspondingly the sole governmental regulatory body which will have the possibility to efficiently and legally intervene in case of disputes arising in connection with the relationships between the subjects of the corporate governance and control should become the most important element of the law enforcement system. Of course the role of such a factor as political will is also quite obvious.

3.3. The corporate securities market

The importance of the securities market for shaping the model of corporate governance doesn’t require comments. As it was already pointed out in the introduction under the conditions when the developing market is non-liquid, when the major objects of trading are the securities by 10-15 issuers, the mechanism of exit (sale of stocks) as an element of the corporate governance in the absolute majority of cases simply doesn’t work. The market of shares of a specific issuer may be liquid only for a short period of time and it works one way only: small shareholders may only exit and only during the periods of the consolidation of controlling interest or deepening of corporate conflicts between large shareholders and managers. In many cases this simply doesn’t occur at all (if the absolute control is established an/or this enterprise simply can’t be of interest for anybody).

Correspondingly, there is practically no alternative to the corporate governance model which is being formed: if the mechanisms of exit do not work (you can’t sell your shares) than the natural tendency of development would be to strengthen the mechanism of vote. If there are any problems in this connection as well (resulting) from the ideology of a principle still supported by the managers) than the only thing left would be the intervention of the state executive and judiciary authorities. Some inter-country comparisons are presented in Table 5.

But the opposite type of relationship also exists. According to many existing estimates violations of the corporate governance rules in the Russian corporations became one of the major factors leading to the withdrawal of investors and collapse of the securities market in 1998.1

147 The prime example in this respect is the adoption of federal law No 74-FZ of May 7, 1998 On the specific aspects of disposal of the shares of the Russian joint-stock company in the field of energy and electrification Unified Energy System of Russia and the shares of the other joint-stock companies in the power sector under the federal ownership.

In accordance with Article 3 it was established that foreign states, international organizations, foreign legal persons as well as their affiliated Russian legal persons and foreign individuals may own up to 25% of all types of the RAO’s shares. At the time when the law was adopted 30% of RAO’s shares were already owned by foreigners.1

158 The adoption of this quota which hypothetically meant a demand for nationalization of a certain shareholding became one of the key factors in the Russian stock market crash of 1998.

The Russian market of corporate securities was developing especially intensively during 1996-1997. The global financial crisis that began in 1997 dealt an especially severe blow to the emerging markets including Russia (the overall decrease of capitalization was 90% between October of 1997 and September of 1998). Nevertheless, even taking into account the sharp drop in the stock indices in 1997 Russia at that time still remained the absolute global leader in the growth of its stock index (which by the end of 1997 increased by 88% as compared with 1996). To a considerable degree it was explained by the significant legislative progress, development of the securities market infrastructure, growth of investment attractiveness of the Russian corporate securities against the background of decreasing yield of other financial instruments in 1995-1997.

Nevertheless, the Asian crisis and the lower world prices of raw commodities were just the external reasons of the financial crisis in Russia that has its own specific features. The catastrophic crash of the Russian stock market in 1998 is impossible to explain just by the unfavorable global financial situation. The latter only aggravated the accumulated internal negative trends in the Russian economy. It was exactly these internal trends which became fatal for the development of the situation in 1998. Unquestionably such a significant drop of the stock prices and liquidity between the autumn of 1997 and autumn of 1998 was linked to a whole range of different macroeconomic and institutional factors. 2



In medium-term perspective the securities market would probably be characterized by the following main tendencies:

- decrease of the number, larger size (mergers) and sharper competition between the professional securities market players;

- the post-crisis redistribution of ownership in financial groups and corporations which (together with the low prices at the weak stock market) would result in mass-scale abuses and violations of the shareholders rights;

- low probability of the increasing interest towards the Russian market on the part of foreign investors both because of the still remaining internal taxation problems and in connection with the possible deepening crisis of the global monetary and financial system;

- appearance of the instruments not typical of the Russian market due to the attempts of the real sector enterprises to find alternative sources of funding (corporate bonds, warehouse receipts, mortgages);

- development of the new forms of collective investment (closed mutual funds in real estate business etc.);

- more active role of the self-regulatory organizations of the professional participants of the securities market and investors (shareholders).

In general the securities market under the conditions of the transition economy can perform four major functions: attraction of investment, speculative portfolio investments, post-privatization redistribution of ownership rights in corporations, mechanism of the outside corporate governance (or pressure on the managers).

Attraction of investment into enterprises throughout 1990s remained the weak link in the market model which was shaped during this time. The speculative portfolio investments which were the market locomotive in 1996-1997 can hardly be expected to continue on the same scale, at least not until the presidential elections of the year 2000. The possibilities of the efficient start-up of the market mechanisms of corporate governance are definitely limited.

Probably in 1999-2000 the major function of the market which was also typical for all the previous years would remain the redistribution of ownership in Russian corporations but taking into account the specifics of the post-crisis situation. Correspondingly, the problem of the shareholders rights protection and strengthening of the government regulation in this field become especially urgent.

3.4. Bankruptcy procedures

The role of bankruptcy as the means to put pressure on the corporation managers in the market economy is well known and described in the abundant literature on this subject in all its aspects (both positive and negative). The threat of corporation’s bankruptcy if the managers choose the wrong market policy (and, in the most severe case, transfer of control to the creditors) is usually regarded as a major external instrument of the corporate governance. Apparently, as the outcome of the application of this mechanism (notwithstanding the advantages and disadvantages of the specific country models, whether they favor the creditors or the debtors) the financial situation of the corporation which underwent this procedure should be alleviated and its operation should become efficient.

At the same time we know well those specific objective limitations which exist under the transitional economy conditions as regards the efficient and mass-scale application of this mechanism (in respect of Russia, some inter-country comparisons are presented in Table 6):

- traditions of the soft budget restrictions;

- continued existence of many corporations with the state shareholding;

- need for the adequate and qualified executive and judicial infrastructure;

- social and political obstacles for conducting the real bankruptcy procedures in case of loss-making corporations, especially as regards the largest corporations or one-company towns;

- numerous technical difficulties connected with the objective evaluation of the financial situation of potential bankrupts;

- corruption and other criminal aspects of the problem including those connected with the redistribution of ownership.

Under these conditions the institution of bankruptcy in Russia since the moment of its appearance and during 1990s performed the two major functions:

- method of redistribution (obtaining, retaining, privatization) of property;

- method of permanent pressure and threat on the part of the state (both political and economical) which was used extremely rarely and very selectively.

The number of such cases during the period of 1993-1997 when the law On insolvency (bankruptcy) of enterprises (adopted by the RSFSR Supreme Soviet on November 19, 1992 and entered into force on March 1, 1993) was valid was very insignificant.2

173 Since 1993 and until March 1, 1998 the arbitration courts tried altogether 4.5 thousand of cases. As of March 1, 1998 the courts were engaged in proceedings involving 2.900 cases (Table 6).

The new law On insolvency (bankruptcy) No 6-FZ of January 8, 1998 entered into force on March 1, 1998. In this study we do not endeavor to evaluate its innovations and contents (see, for example Commentary.., 1998). We would only point out that this law is more detailed and progressive as compared to the previous one.

We believe that the essence of the problem is as follows: first, all the political and social and economic limitations for the mass-scale application of this law still remain (and are becoming even more relevant after the crisis of 1998). According to the RF Goskomstat figures in 1998 55.2% of small and medium Russian enterprises were loss-makers.

Second, under the conditions of high level of corruption and continuing redistribution of ownership the alternative solutions envisaged by the law and the procedure of their adoption become a convenient tool of manipulation and pressure in the interests of different participants of this process (of course, this is not the problem of the quality of the law as such). First of all it’s the issue of the type of arbitration manager to be appointed and objective criteria of choice between liquidation and rehabilitation.

In this connection, any significant simplification of the bankruptcy procedure initiation (at the level of arrears equal to 500 minimum wages for legal persons) also means that it would be much easier to put into operation this procedure for the alienation of property. From the Russian experience we know well that an appointment of a friendly arbitration manager (whether temporary or liquidation or external) practically automatically means that your problems would be resolved in your favor whether it’s protection against aggression or aggression.2


Third, if we compare the number of applications with the total number of Russian enterprises and number of debtor-companies these figures, instead of impressing us, would rather put us on an alert. Apparently, the overwhelming majority of the private creditors are not exactly in a hurry to use the legal schemes offered by the new law but traditionally prefer private enforcement. The bankruptcy as an institution so far has not yet gained wide recognition and become a universal and uniform system but mostly still remains the tool of selective pressure on debtors quite often motivated by political preferences of the federal and regional authorities.

Fourth, the problem of legal and practical support of the protection of rights and interests of all types of shareholders within the framework of the bankruptcy procedure still remains unresolved. In particular, the threat of enforced bankruptcy of many large corporations in arrears to the federal budget in 1998 became one of the factors of the rapid withdrawal of portfolio investors from the market of corporate securities.

Thus today it’s hardly possible to regard the institution of bankruptcy in Russia as a stable and efficient external mechanism to alleviate the management and finances of a company. The increase of the number of applications which was mentioned above so far, apparently, doesn’t indicate the enthusiastic response of creditors to the new legal perspectives opened to them but simply a trial run of the new methods of privatization of property, protection of managers against the hostile takeovers or, on the contrary, takeover of the objects (assets) of interest. It’s not accidental that this process coincided with the general stepping up of the ownership redistribution under the conditions of 1998 crisis.

3.5. Market of corporate control (takeovers)

The market of corporate control (threat of the hostile takeover and change of managers) as well as the threat of bankruptcy is considered to be one of the key external mechanisms of corporate governance. Many researchers believe that the takeover market is the only means of protecting the shareholders from the arbitrary actions of managers. It’s pointed out that this method is the most efficient when it’s necessary to break the opposition of the conservative board of directors not interested in rationalization (splitting up) or the company, especially, if it’s a highly diversified company (Coffee, 1988). In the numerous theoretical writings on the subject there is also an in-depth analysis of the interrelationship between takeovers accompanied by the private (special) benefit of large shareholders and improvement of the economic efficiency after control’s transition to a new owner.

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