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Corporate governance in Russia: main trends and some prospects

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

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Content

1) Russian CG model: transplantation of

institutions and efficiency problem

2) New tendencies after 2000 and their pre-

conditions

3) New stage: post-Yukos development +

influence of the crisis 2008-2009 +

forecast for the future

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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

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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

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1 9 9 3 1 9 9 4 1 9 9 5 1 9 9 6 1 9 9 7 1 9 9 8 1 9 9 9 2 0 0 0 2 0 0 1 2 0 0 2 2 0 0 3 2 0 0 4 2 0 0 5 2 0 0 6 2 0 0 7

N u m b e r o f p r i v a t i z e d e n t e r p r i s e s i n R u s s i a ( 1 9 9 3 - 2 0 0 7 )

F e d e r a l - o w n e d e n t e r p r i s e s a R e g i o n - o w n e d e n t e r p r i s e s a M u n i c i p a l e n t e r p r i s e s a

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Some results of privatization in Russia in 1993-1999

1 9 9 3 - 1 9 9 9

T o t a l n u m b e r o f p r iv a t iz e d

e n t e r p r is e s 8 6 3 8 6

F e d e r a l- o w n e d e n t e r p r is e s 1 6 2 9 3

R e g io n - o w n e d e n t e r p r is e s 1 7 8 3 2

M u n ic ip a l e n t e r p r is e s 5 2 2 6 1

T o t a l r e v e n u e f r o m

p r iv a t iz a t io n ( M io U S D ) 9 1 3 6

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Loan-for-shares actions in 1995

C o m p a n y B u y e r S h a r e h o ld in g

s i z e

A u c t io n p r i c e in n o v . - d e c .

1 9 9 5

P r i c e o f t h i s s h a r e h o ld in g b y t h e e n d o f 2 0 0 4 ( b a s e d o n c u r r e n t c a p i t a l i z a t io n )

M in in g a n d m e ta llu r g ic a l c o m p a n y “ N o r ils k y n ic k e l”

O N E X I M b a n k ( V . P o ta n in ) 3 8 % $ 1 7 0 m l n . A b o u t $ 5 b l n .

O il c o m p a n y S u r g u tn e ft e g a s S u r g u tn e ft e g a s ( V . B o g d a n o v )

4 0 % $ 3 0 0 m l n . $ 1 2 , 5 b l n .

O il c o m p a n y S ib n e ft B . B e r e z o v s k y R . A b r a m o v ic h

5 1 % $ 1 0 0 m l n . $ 8 , 2 b l n .

O il c o m p a n y S id a n k o * * M F K a n d A lfa - G r o u p ( M . F r id m a n )

5 1 % $ 1 3 0 m l n . $ 5 , 1 b l n .

O il c o m p a n y L u k o il L u k o il ( V . A le k p e r o v ) 5 % $ 1 4 1 m l n . $ 2 , 4 b l n .

( * * ) I n 2 0 0 2 O C S id a n k o t o g e t h e r w it h t h e T u m e n O il C o m p a n y m e r g e d in t o a n e w c o m p a n y – T N K - B P , e s t a b lis h e d w it h 5 0 % p a r t ic ip a t io n o f B r it is h P e t r o le u m .

( * ) B y t h e e n d o f 2 0 0 4 O C Y u k o s s h a r e s f e ll a p p r o x im a t e ly 3 0 t im e s c o m p a r e d t o t h e ir le v e l b e f o r e t h e a r r e s t o f P . L e b e d e va n d M . K h o d o r k o v s k y . A s o f 3 0 . 0 6 . 2 0 0 3 , t h e 4 5 % s h a r e h o ld in g o f t h e c o m p a n y c o s t a b o u t $ 1 4 b ln .

O il c o m p a n y Y U K O S * 4 5 % $ 1 5 9 m l n . $ 4 5 0 m l n .M E N A T E P b a n k ( M . K h o d o r k o v s k y )

Increase of RTS index for the same time period = 7,4 times (83 to 614)

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Russian model of corporate governance: some results

• 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

For 30,000 open JSC founded in 1990s:

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)

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Russian ‘quasi-open’ JSC: influence on incentives of owners and managers

• 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 outsidersNon-transparency of

financeAssets stripping

Starting conditions: Inefficiency of SOE

Compulsory conversion of SOE to open JSC

‘CG in Russia is awful.’

(US-Russia Business Council monthly report, April 2003)

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CG in Russia after 2000: New tendencies

• 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)

I.2001 – VII.2003: fivefold increase of RTS index

Invitation of large foreign outsiders (Allianz/ROSNO 2001, BP/TNK 2002)

First steps: First results:

CBR/MinFin: Net capital inflow in first two quarters 2003

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Pre-conditions of positive shifts

• 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

• End of mass privatization, decrease of total rent volume and limits for rent-seeking strategies typical for 1990s

• Crisis 1998: the possibility to lose – limits of assets stripping

• Understanding of collective interests and readiness to collaboration (new RSPP)

Economic Political

Real control on assets and new long-term interests of insiders Bargaining with government about legal environment

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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

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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

Post-Yukos development: general framework

• 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

• 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

Economic sidePolitical side

Diversification of economy ?..

New empirical evidences: two surveys

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• Survey: 957 manufacturing firms from 8 sectors and 48 regions

• Time period: February – June 2009

• 1st 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

JSC with foreign participation by sectors (panel data), %

2005 2009Change over 4

years, p.p.

Total JSC sample 8,2 11,4 +3,2Food producers 4,9 6,0 +1,1Textiles and garments 3,0 3,8 +0,8Timber and woodworking 16,7 18,2 +1,5Chemicals 18,4 28,1 +9,7Metals and fabricated metal products 8,8 13,3 +4,5Electrical, electronic and optical equipment 10,0 13,9 +3,9Transport vehicles and equipment 10,5 17,6 +7,1Machines and equipment 1,6 2,0 +0,4

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Government participation in JSC equity (panel) and the role of stock market

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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

1 9 9 3 - 1 9 9 9 2 0 0 0 - 2 0 0 7

T o t a l n u m b e r o f p r iv a t iz e d

e n t e r p r is e s 8 6 3 8 6 9 2 9 1

F e d e r a l- o w n e d e n t e r p r is e s 1 6 2 9 3 9 4 6

R e g io n - o w n e d e n t e r p r is e s 1 7 8 3 2 1 7 2 4

M u n ic ip a l e n t e r p r is e s 5 2 2 6 1 6 6 2 1

T o t a l r e v e n u e f r o m

p r iv a t iz a t io n ( M io U S D ) 9 1 3 6 1 9 6 1 0

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R e v e n u e f r o m p r i v a t i z a t i o n i n R u s s i a ( M i o U S D ) a n d R T S i n d e x

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U S D r e ve n u e fr o m p r i va t i z a t i o n R T S i n d e x ( a ve r a g e fo r a y e a r )

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Foreign direct investment inflow into Russia, 1995-2007

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( M ill io n U S D )

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N e t F D I in f lo w ( E B R D )

G r o s s F D I in f lo w ( R o s s t a t )

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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

Rank Company name

Market capitalization (mln dollars)

State share (%) Rank Company name

Market capitalization (mln dollars)

State share (%)

1 Gazprom 46660 38.0 1 Gazprom 236187 50.1

7 RAO UES 10884 53.8 2 Rosneft 92968 84.6

9 Sberbank 7431 60.6 4 Sberbank 51058 60.6

15 Mosenergo 3220 95.3 9 Gazprom Neft 22787 73.7

21 Rostelekom 1469 50.7 12 Vneshtorgbank (VTB) 18823 77.5

22 Uralsvyazinform 1153 57.8 15 RusHydro 16738 60.4

23 Aeroflot 1142 51.2 22 Rostelekom 8349 50.7

25 Rosneft-Purneftegaz 1015 82.0 23 Unified National Electric Grid(FGC UES)

6377 77.7

33 Volga Telecom 679 51.0 26 Bank of Moscow 5531 44.0

34 Bashneft 664 63.7 32 Mosenergo 4043 60.5

Market capitalization of ten largest SOEs

74317 Market capitalization of ten largest SOEs

462861

Total market capitalization 237014 Total market capitalization 975098Share of ten largest SOEs (%) 31.4 Share of ten largest SOEs (%) 47.5

2004 (as of September 1) 2008 (as of September 1)

Source: Sprenger (2008)

Crisis 2008-2009 and firms behavior

• 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?

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Biggest companies

• 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

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Mid-size companies

• 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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During the crisis: Large companies

• 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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Last trends in Russian stock market

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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

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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

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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 non-stable 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

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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.

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Evolution of firm models

Family firm

Widely held firm

Closely held firm

Development firm

В

С

Transition firm

ML

А

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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

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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?