Opal''''s Site Organization and Development of Russian Business_4 ppt

aver-Table 2.5 Ownership and control in JSCs at different ownership and control concen-trations % of the number of JSCs Indicators of control types Controlling owner is present Concent

54 Organization and Development of Russian Business

legal and even helps shareholders to become accustomed to the use of corporate tools

intra-As estimated by respondents, the board of directors was the most ential of corporate bodies (Table 2.6), having a heavier clout than the meeting of shareholders Almost one half of the respondents reported that shareholder meetings had a strong influence, whereas 18% expressed the opposite Assessments of the influence of shareholder meetings were not linked to the extent of concentration as they were in the case of the board

influ-of directors With regards to board influ-of directors, companies with the age ownership concentration earned the highest ratings Apparently, a high concentration was also associated with other means of corporate control, since the subgroup with a counterbalancing shareholder did not result in a significantly different outcome

aver-Table 2.5 Ownership and control in JSCs at different ownership and control

concen-trations (% of the number of JSCs)

Indicators of

control types

Controlling owner is present

Concentration of ownership:

Yes No Low Medium High Presence of

counterbalance

Absence of counterbalance

Source: Author’s calculations based on survey data.

Table 2.6 Influence of board of directors on corporate decision-making at different

levels of ownership concentration (% of the number of JSCs)

Ranks of influence Sample Low Medium High Presence of

counterbalance

Absence of counterbalance

Stock Ownership and Corporate Control 55

With regard to the composition of the board of directors, corporate managers, who might also be shareholders, prevailed, and representatives

of large external shareholders ranked second As a result, these insiders held more than 78% of the votes, while independent directors and minor-ity shareholders held 11% (Table 2.7) As the ownership concentration increased, the shares of managers and rank-and-file employees declined, and those of representatives of large external shareholders grew At com-panies with low and average levels of concentration, the management, together with the employees, had the majority of votes Moreover, JSCs with/without a counterbalancing interest demonstrated a similar struc-ture of their boards

Another control tool is the possibility of dismissal of the management staff (or threat of dismissal), which comes easy in the case of stock domina-tion Personalities may cause problems in these cases In addition, oppor-tunistic behavior on the part of the new managers may also contribute This mechanism of control is well studied: a series of works were dedicated

to the analysis of change of managers, especially due to ineffectiveness of companies, and empirical studies produced different results (see Chapter 5 for details)

Another possibility for gaining control is related to having additional links

to the company’s executive management by establishing head companies or

by including special supervisory managers into the procedure for nation of decision-making; often, these are not staff members of a given company, or they may have a title that is not true to their real functions (“commissioners”) Such links are normally governed by in-house business management regulations and operated beyond the scope of intra-corporate procedures

coordi-Finally, another possibility is the use of informal schemes of control directly through the owners on a regular or case-by-case basis In fact, such

a possibility means a permanent, direct intervention of principal owners into the management procedures (which can be done without any agree-ment or taking into account other shareholders’ or stakeholders’ interests)

or a constant threat of such intervention

Either one or more of the methods of control indicated above can be implemented Corporate governance procedures must be followed despite the cost entailed in complying with laws and instructions Building addi-tional regulated and/or informal schemes for managerial control will bring the additional costs of duplicating corporate governance and management procedures Additional control in the organizational chain can be used as

a temporary tool (Dolgopyatova 2001) When principal shareholders act as executive managers, there is no need for additional supervision; however, the costs of intra-corporate procedures will be incurred nonetheless

The combination of having one individual be the manager and the owner does not resolve all of the issues related to efficient management Two issues

Stock Ownership and Corporate Control 57

that businesses face are described in the following First is the unity of agers, shareholders, and hired managers within a single management team

man-In such a case, the coordination of interests and differentiation of incentive mechanisms are needed.12 The second issue pertains to the efficiency and quality of self-management from the point of view of a company’s develop-ment, in which case market mechanisms for the selection of skilled manag-ers fail to work

The second issue took a significant amount of time to be added to the agenda because, in the 1990s, Russian manager-owners were considered professionals They were either representative of the pre-reform managerial corps or founders of new firms, and their skills were considered adequate to serve in the transition environment At the present time, most top managers have received additional advanced training Most significantly, they have gained experience in the market-based environment, and many former communist-era directors have been eventually assimilated into the new environment and become as good business promoters as new entrepreneurs (Yakovlev 2004) However, weak institutions for the protection of property rights would give no assurance that opportunistic behavior of managers would be checked through implementation of formal corporate governance standards; therefore, control by a combination of management and owner-ship became the most widespread practice

be presumed that this shareholder did not have full power of the second control center and formed a coalition with dominating owners

A vast majority of Russian JSCs demonstrated control through a ing owner or a consolidated group of owners, but they showed preference for combining the ownership and control functions for direct involvement in daily operations as the top managers of companies This formal institution

dominat-is not the only opportunity of control, as there are other widely used ments, including informal ones, which take company decision- making out-side of the scope of corporate governance procedures

instru-The hypothesis of a positive effect of high stock ownership tration in corporate operations was mainly confirmed While it was not

concen-58 Organization and Development of Russian Business

always associated with the best-performing companies, companies with dispersed ownership in Russian terms would lose to other companies in indicators of performance and intensity of restructuring At the average level of concentration, these companies would clearly take the lead in terms of better performance and the introduction of new products Where there was a controlling interest, companies demonstrated higher current labor productivity, although respondents were more conservative in their assessment of the economic condition of their companies Thus, in the given institutional environment, the shortcomings of dispersed owner-ship found certain empirical confirmation The findings in this chapter could be interpreted as a lack of incentives to develop business in a sit-uation of low concentration of ownership At the same time, it cannot

be ruled out that potential owners did not show interest in the assets of these companies, precisely because of the weak prospects of their business development

Acknowledgments

The chapter was prepared with financial support of the Program for Fundamental Studies of SU-HSE granted by the Ministry of Economic Development and Trade of the Russian Federation in 2006–2008 and a research grant from the Moscow Science Public Foundation sponsored by the U.S Agency on International Development in 2005–2006 I would like to thank Svetlana Avdasheva, Ichiro Iwasaki, Xavier Richet, Andrei Shastitko, and Yurii Simachyev for their useful comments and suggestions and Olga Uvarova for her assistance in data processing

is problematic to evaluate the expansion of these practices of indirect ownership Companies with federal government participation have become major players in M&A markets OECD experts believe that these activities were not always initiated

by the government but reflected their own corporate strategies, which could be contrary to government purposes (OECD 2006)

Stock Ownership and Corporate Control 59

4 A closed JSC is a legal form of a joint-stock company in Russia (see detailed nation of the peculiarities of this form in Chapter 3) In particular, a closed form

expla-of incorporation has limitations for the turnover expla-of shares, giving advantages

to existing shareholders In the course of privatization, closed companies were established as those owned by employees (reorganized from Soviet-type “leasing enterprises”); that is, in the 1990s, top managers received control over sales of shares and placement of new emissions This form gave them the potential for quick accumulation of shares

5 The issues of stockholding were formulated separately in the form of a range scale for each type of shareholder; thus, the sums of average shares calculated by range medians are considerably less than 100% This fact has to be taken into account in evaluating the results, which should be adjusted upwards by a factor of at least 1.12 For a comparative analysis, the derived data can be used without adjustment

6 We used the binary variable of increase/decline in labor productivity

7 The indicator was calculated as a ratio of sales in 2004 to the number of ees at the beginning of 2005

8 Specific features of management were not considered, as they may be enous and depend on ownership peculiarities In addition, the effects of man-agement on restructuring are discussed in Chapter 6

9 The Poisson model indicated that practically all our hypotheses concerning other factors were confirmed All industrial dummies were significant at the 1% level A positive effect was observed for the size of a company, its start-up his-tory, and affiliation to company groups (significant at the 1% level), competition with manufacturers from developed market economies (at the 5% level), and severe competition with Russian companies (at the 10% level) Other types of competition (with foreign companies located in Russia or with manufacturers from the CIS countries or market countries including Turkey and China) were not significant The results of the ordinal regression model are close to the ones presented

10 The structure of investment sources was evaluated on an aggregated scale

11 These abbreviations are used in the tables and figures presented in this chapter

12 In practice, this issue can be resolved by uniting top managers and owners within a single team by offering the former high wages, bonuses, and options,

as well as a unique corporate culture At the same time, research points to a gap that often occurs between this small group and other managers in perceiving the company’s goals and objectives as well as attitudes toward cultural standards (Kabalina 2005)

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in the Russian economy is already a thing of the past In addition, in recent years, there have been a growing number of new market entries by private firms against the background of a remarkable economic recovery, and new small and medium-sized companies led by entrepreneurs of the new genera-tion have been popping up one after another, tapping new markets by fill-ing every niche in the national economy.

However, the fact is that Russia’s business sector is mainly composed of former socialist enterprises that underwent corporatization as a result of the mass-privatization policy in the early 1990s followed by the monetary pri-vatization of the largest companies To achieve the political goal of redistri-bution of state assets to the general public in an equal manner, these former state-owned enterprises were compelled by law to transform themselves into joint-stock companies (JSCs) Most of their shares were transferred for free

or at extremely low prices to citizens, especially to the worker collectives and managers of the enterprises (Blasi et al 1997) This means that leading Russian business firms were founded in a completely different way from those in the US and other industrialized countries In addition, considering the underdeveloped financial sector and the premature markets for capital and managers in this country, which has only a short history as a capitalist state, Russian enterprises are in a very peculiar business environment com-pared to their Western counterparts

The preponderance of closed JSCs in comparison to open JSCs is one

of the most distinguishing features of the Russian corporate sector This

Legal Form of Incorporation 63

phenomenon may be revealed under the special circumstances ing Russian enterprises mentioned above Both open and closed JSCs are statutory legal forms of incorporation, as defined in the Federal Law on Joint-Stock Companies (hereinafter, the Law on JSCs) As we will later detail, these two corporate forms refer to the legal names of the two types of JSCs that are decisively different from each other in terms of share transferability

surround-to a third party All JSCs established in Russia must choose either of the two company types as their statutory organizational form As of January 1, 2005, there were only 58,400 open JSCs registered in Russia compared with as many as 389,200 closed JSCs.2 Regarding large-scale companies that require raising funds from outside sources, the number of open JSCs exceeds that

of closed JSCs, with the latter number still being fairly significant In fact, a survey conducted in 2003 by the Federal State Statistics Service found that,

of the 32,266 JSCs surveyed, excluding micro- and small enterprises, 19,407 were open companies, and the remaining 12,859 were closed ones (Rosstat 2004) In other words, four of every ten medium-sized and large Russian cor-porations were operating under a governance mechanism that put rigorous restrictions on the liquidity of their own shares

In many developed countries, JSCs are allowed to achieve “virtual”

organ-izational closedness by, for instance, making a special resolution at their general shareholder meeting that bans, in principle, the transfer of their shares to a third party, or by adding a provision to this effect in their corpo-rate charter For example, in Japan, JSCs intending to make it mandatory for their shareholders to seek their approval for the transfer of their shares must provide a provision to that effect in their corporate charter in accordance with Article 107 of the Company Law, and companies with such a provision are generally called “closed companies.” This practice is common among smaller companies There is no formal closed JSC as a legal corporate form

in the continental European countries either In the UK, on the other hand, business firms are formally classified according to Company Law into public companies and private companies depending on how they raise funds, and private companies have similar statutory characteristics to those of closed JSCs in Russia Furthermore, several states in the US have a Company Law that allows closed corporations to impose restrictions on the issuance and transfer of common stock in accordance with a shareholder agreement,

in contrast to general corporations In most of these states, the number of shareholders for closed corporations is strictly limited (e.g., to 30 in Nevada and Delaware and to 50 in Georgia and Wisconsin), as in Russia.3 This sug-gests that the Russian company law had broken away from the tradition of continental law and boldly incorporated some elements of common law However, in Russia, there are clear distinctions between closed and open JSCs in terms of not only the restrictions on the number of shareholders but also the modes of securities issuance, the required levels of minimum capi-tal, and disclosure obligations From this viewpoint, Russia has an extremely

64 Organization and Development of Russian Business

unique legal framework in comparison with the UK and US Moreover, as reported above, even though almost all of the Russian leading companies are former state-owned firms, about 40% of them are still operated as closed JSCs after more than 10 years of mass privatization This highlights the sharp contrast with the situation of closed corporations in the UK and US, most of which are family-run or privately held companies.4

Inspired by the economic theory on internal organization that has been developed from suggestions made by Coase (1937), a large number

of empirical studies have been conducted with regard to the determinants

of organizational choice and the relationship between organizational form and behavior, including corporate performance (Brickley & Dark 1987; Denning & Shastri 1993; Weir 1996; Harhhoff et al 1998; Blass & Carlton 2001; Deli & Varma 2002; Arruñada et al 2004; Damodaran et al 2005) Surprisingly, however, except for a valuable case study by Karpoff & Rice (1989), there is little empirical work investigating organizational choices

by JSCs and their possible impacts on corporate governance and firm formance Thus, the corporate forms of Russian JSCs are a very important research subject to be explored from the viewpoint of the study of law and economics

per-Furthermore, this topic is of great significance to understanding the Russian economic system As long as the primary nature of a public com-pany can be defined as a modern economic mechanism that attracts capital from a wide range of private investors and multiplies their wealth in the most effective way possible, an open company, which guarantees free share transferability, is the basic form of a stock company In this sense, a closed JSC is one that distances itself from the fundamental purpose of a modern corporation In addition, agency theory suggests that an open organiza-tional architecture is quite effective in inhibiting the opportunistic behav-iors of company managers and disciplining them toward the maximization

of shareholder equity under the separation of ownership and management (Fama & Jensen 1983a, 1983b) This can also be said of the modern Russian economy still in transition to a market economy Nevertheless, as previously reported, the reality in Russia is that not only small corporations but also large enterprises are still being organized and operated as closed JSCs It is quite possible that the high degree of orientation towards closed organiza-tion in the Russian business sector is inseparably linked to its poor corporate governance practices and its investment behavior, which remains inactive regardless of significant economic recovery in recent years In other words,

it is highly likely that there are severe agency problems within these Russian closed companies which prevent the enhancement of their corporate value

In order to redress this situation, it is critical to empirically investigate what factors drive many Russian firms to choose to become closed companies and how much harm is done to corporate management and maximization

of shareholder wealth by this choice Therefore, particular attention should