Organization and Development of Russian Business A Firm-Level Analysis_10 docx

We will verify the hypothesis that membership in BGs has a favorable impact on the activeness of enterprises in restructuring H1 and on the financial and operative performance H2 of ente

by the state, although Russia’s modern history shows that, even if this rule

is true, frequent and significant exceptions to it are allowed

There are two alternative concepts of the BG impact on subsidiaries One

is that of the BG as a means of protection of a subsidiary against the external environment (Yakovlev & Danilov 2007), and the other is that of the BG

as an initiator of active restructuring aimed at increasing competitiveness (Pappe & Galukhina 2006) The difference between these concepts lacks depth because the subsidiaries in both cases increase their competitiveness due to

BG membership Therefore, the two concepts provide a basis for different hypotheses concerning the comparative efficiency of BG members and non-

members In the former case, BG member enterprises may not display higher productivity than independent enterprises The main role of amalgamations

is to give independent enterprises a boost in reaching the level of

compara-ble companies The results of Guriev and Rachinsky confirm precisely this concept of BG impact on comparative productivity and competitiveness of enterprises incorporated in groups In the latter case, a BG member can be expected to demonstrate higher productivity; the role of amalgamation is to enable members to gain leadership in relevant industries

Testable hypotheses and data

Our goal in this chapter is to examine the hypothesis that Russian BGs have

a positive impact on subsidiary enterprises and to evaluate the correctness

of the existing ideas about the impact of the Russian BGs on the conduct and performance of their member enterprises According to these concepts, subsidiaries in BGs are relatively large enterprises1 that experience, possibly because of their size, greater difficulties in a market-oriented restructuring Membership in groups promotes the sales of enterprises and more active restructuring More active restructuring can compensate for a later start of transformations but does not guarantee that a merged enterprise achieves leadership in the market This is the reason that subsidiaries within groups may not display higher productivity

The analysis of the impact of a BG on competitiveness is seriously

com-plicated by the nonhomogeneity of the groups and group members In the previous chapter, it was reported that participants of merger processes2 after privatization refer to themselves as BGs, as do enterprises that have belonged

to major companies from the moment of their creation, for instance,

power-generating units and local communication networks The impact of parent companies on the conduct and performance of these two types of subsidiar-

ies can vary substantially In the latter case, it is difficult to determine the impact because the BG is a natural form of the asset’s allocation, organiza-

tion, and subordination

Our study compares the activity of group members and independent enterprises Subsidiaries representing only part of the business rather than

216 Organization and Development of Russian Business

the business as a whole are selected for survey purposes from the entire ple of BG members To show the impact of transactions concluded after an enterprise is privatized, group member subsidiaries are classified according

sam-to the time of the merger deals that occurred before or after 1995, which was the last year of mass privatization

In some cases, industries will be categorized as regulated and lated in order to reflect the specifics of the impact of head companies on the conduct of subsidiaries in groups The performance results are influenced

nonregu-by state tariffs and returns on investment regulations On the whole, the impact of membership in holdings in regulated industries on the finan-cial and operative performance of subsidiaries can be expected to be not as strong as it would be in nonregulated industries

We will verify the hypothesis that membership in BGs has a favorable impact on the activeness of enterprises in restructuring (H1) and on the financial and operative performance (H2) of enterprises At the same time, members of holdings merged after privatization do not demonstrate sustain-able resource productivity advantages over independent companies (H3)

The chapter is organized as follows: the next paragraph is an assessment

of the role of a BG by directors of the affiliated enterprises In the following section, the impact of group membership on the restructuring activity of subsidiary enterprises is analyzed The third paragraph is a consideration

of the performance indicators of subsidiary companies vis-à-vis ent enterprises Finally, the fourth paragraph introduces a comparison of the TFP in affiliated companies with independent ones A summary of the results of the empirical analysis is presented in the Conclusion

independ-Managers of subsidiaries on the advantages of

being members of BGs

In our survey, the gains from an affiliation with a BG for the directors of the enterprises can be assessed by two indicators The first is which party initiated the affiliation with the group, and the second is what advantages the enterprise obtained from operating as a member of the group The key role in initiating the merger of an enterprise was played by the owners of the parent company by more than 40% of the respondents However, in a third of all cases, the initiative came from the private owners of other com-panies as well The answers give the impression that, in Russian industry, the role of friendly takeovers is comparable to that of hostile takeovers The impact of state administrations on the federal or regional level as initiators

of corporate integration is relatively modest and is negligible for mergers in nonregulated industries It is important to emphasize that most BGs are the result of private and not state decisions

Responses to the question about the advantages gained by their companies

by belonging to BGs confirm the notion that, for directors, competitiveness

on the market on the whole is more important than relations with the state

In accordance with the two alternative concepts of the role of Russian BGs, that is, as a tool to protect against the external environment and as the driving force of restructuring, a subsidiary’s advantages can be classified as protective or active gains Protective gains include the strengthening of bar-

gaining positions in relationships with the state and protection against

hos-tile takeover Active gains involve the improvement of competitiveness in the market and the enhancement of investment availability Protective gains are more important for group participants that merged before privatization

and during initial property distribution (Figure 9.1) BG participants that

merged after 1995, on the contrary, associate greater value with the gains connected with the companies’ market competitiveness, that is, stronger positions on the domestic and world market and access to investments and new technologies Support in relationships with the state is more important for subsidiaries that lack independent experience in a market economy On the whole, the evaluations of the gains from participation in BGs made by enterprise directors support the H1 and H2 hypotheses

An important source of additional advantages for subsidiaries from group membership is internal financing This could be important, especially in view of Russia’s underdeveloped financial markets Until now, evidence on internal financial markets in Russian BGs has been controversial Earlier stud-

ies (Perotti & Gelfer 2001) confirmed the hypothesis about their existence,3

but later studies did not (Shumilov & Volchkova 2005) According to our survey, in companies affiliated with groups, the second and third most important financial sources of investment are shared by bank borrowings and group funds (15–20%) About one-third of the respondents reported that they do not use group funds for financing their investment The size of

Protected from hostile takeover

Strengthened bargaining position

in relation with state

No gains

Merged before 1995 Merged since 1996

Figure 9.1 Gains from joining business groups (BGs) according to directors of

enter-prises by time of merger (% of respondents)

Source: Author’s illustration based on survey data.

218 Organization and Development of Russian Business

this share differs significantly depending on the industry The highest share

of such enterprises is in electric power (about 60%) and construction rials (50%), with lower shares in the chemical and petrochemical indus-try (22%) and light industry (17%) At the same time, about one-quarter of affiliated firms consider internal financial markets to be important, with the share of group funding in overall investments being more than 20%.4The use of an additional source of funding of restructuring should also sup-port hypothesis H1

mate-To sum up, top managers of group companies acknowledge the positive impact of affiliation with a BG on competitiveness and firm performance However, their statements need to be verified The question of whether enterprises use additional sources of financing for restructuring and not for compensation to make up for shortfalls will be answered Another issue that will be examined is whether higher restructuring activity improved their financial and operative performance and led to higher productivity

Impact of business integration on corporate restructuring

A comparison of the intensity with which independent companies and group subsidiaries engaged in restructuring demonstrates that the latter applied measures aimed at the increase of competitiveness more often dur-ing 2001–2004 (Figure 9.2) The superiority of BG participants is particularly clear in the area of restructuring involving production expansion, namely, successfully introducing new technologies and making significant capital investments However, a considerable number of respondents had joined

0 20 40 60 80

Successful introduction of essentially new products and services

Introduction of new production facilities

Increasing of expenditures on marketing and advertising

Successful introduction of new technologies Successful certification according

to international strandards

Making of significant capital investments Increasing R&D expenditures

Long-term (over one year)

credit Increasing volume of export

Independent enterprises Merged before 2000 Merged since 2001

Figure 9.2 Restructuring activity in subsidiaries of BG vis-à-vis independent companies

Source: Author’s illustration based on survey data.

groups in the same period when restructuring had become more active It

is noteworthy that new subsidiaries that merged after 2001 displayed the highest degree of activity aimed at the restructuring of all other groups of enterprises In this case, we could not distinguish between the two compet-

ing hypotheses, that is, that group membership had a favorable impact on the restructuring intensity and that BGs were acquiring enterprises which were more active in restructuring This is the reason that the analysis was conducted only for the old group participants that merged before 2000

To test the hypothesis that the intensity of restructuring displayed by

sub-sidiaries is higher than that of independent companies, we used the index

of intensity of restructuring (INDRES).5 This index is calculated as the total

number of restructuring measures, including the successful introduction

of essentially new products and services, the introduction of new

produc-tion facilities, the increase of expenditures on marketing and advertising, the successful introduction of new technologies, successful certification according to international standards, significant capital investments, and

an increase of R&D expenditures.6

Presumably, the intensity of restructuring in nonregulated industries is influenced by company size, corporate governance organization, and mar-

ket competition as well as by membership in BGs In regulated industries, competition as such is restricted by the model of regulation, and, in many cases, it is completely impossible This is the reason that the set of explana-

tory variables is different for nonregulated and regulated industries: for both types of industries, the set includes attribution to subsidiaries merged before

2000, the GROAF1 variable, the company size COMSIZ variable measured by

the logarithm of the number of employees, the property and management

convergence indicator, MANSHA, which equals 1 if large owners participate

in management of the firm and 0 otherwise, and variables for individual industries and types of settlement (capital city, regional center, town, urban settlement, or village) The comparison of the impact of BG membership and corporate governance organization on the scope of restructuring is con-

nected with the problem raised in a previous chapter, namely, the reason for the widespread practice of the BG organizational form resorting to the separation of management from ownership in the Russian economy when it has been amply demonstrated that the opposite model, in which ownership converges with management, is much more advantageous The investiga-

tion also examines the advantages of BGs compensating for a more acute agency problem caused by the separation of property from management

In addition, the explanatory competition variables COMPRU and COMPFO are used for nonregulated industries The COMPRU variable equals 1 if the

enterprise experiences tough competition and 0 in all other cases The

COMPFO variable equals 1 if the enterprise experiences competition with

suppliers from developed Western countries and 0 in other cases The

intro-duction of two different competition indicators is justified by previous

220 Organization and Development of Russian Business

experience of an empirical analysis of Russian companies’ performance (Avdasheva et al 2007) A positive response to the question of tough compe-tition with Russian manufacturers may not necessarily reflect competition intensity proper The choice of this answer often reflects not the market competition but the low competitiveness of the enterprise in comparison with other domestic suppliers At the same time, a positive response to the question about the existence of competition with foreign suppliers usually means that the company’s production is indeed involved in competition in the global market This is the reason that a number of empirical studies have failed to reveal a favorable impact of competition with domestic suppliers on the intensity of Russian companies’ restructuring, in contrast to the case of competition with foreign manufacturers Our survey has demonstrated that the impact of competition with domestic and foreign manufacturers on the behavior of enterprises, e.g., on the choice of the company organizational model, is not just different but clearly opposite (see Chapter 7 for details)

Judging by the results of our survey and contrary to the existing ion about a considerable decline in competition within the framework

opin-of Russian groups, subsidiaries experience as much competition as pendent firms Considering nonregulated industries alone,7 every 20th enterprise among independent firms and subsidiaries experiences no com-petition with domestic or foreign suppliers; approximately one-quarter of the enterprises have to cope with tough competition with domestic and/or foreign suppliers; and the overwhelming majority of respondents evaluate the competition as moderate.8 A number of surveys of Russian enterprises have confirmed the favorable, although not always monotonic, impact of competition on restructuring (see Avdasheva et al 2007 for survey) In our case, the impact of competition may amplify the effect of the enterprises’ affiliation with BGs

inde-Regression analysis denies the null hypothesis that the intensity of turing of group subsidiaries did not differ statistically from the intensity of restructuring of independent companies (Table 9.1).9 This pattern is true for both regulated and nonregulated industries As expected, for the reasons presented in Chapter 7, the convergence of ownership and management, which is demonstrated by the participation of large shareholders in com-pany management, has a statistically significant favorable impact on the intensity of restructuring only in nonregulated industries Among the two competition indicators, it is competition with foreign manufacturers that has a statistically significant favorable impact on the intensity of restructur-ing in nonregulated industries

restruc-The impact of the industry in most regression specifications was cally significant The impact of location is also significant with the expected sign: enterprises located in regional centers and the capital city took more restructuring measures in 2001–2004 than enterprises located in urban set-tlements and villages In some specifications, enterprises located in towns

statisti-also demonstrated advantages over companies located in urban settlements and villages.

Therefore, hypothesis H1 is confirmed: group subsidiaries were more actively involved in restructuring in 2001–2004 than independent enter-

prises Participation in competition and access to additional financial and business resources within the framework of a BG has a favorable impact

on the quantity of enterprise restructuring measures Additional resources available to enterprises inside a BG, in turn, substitute the solution of the agency problem by the use of the do-it-yourself option

Impact of affiliation with a business group on

financial and operative performance

The second type of hypotheses tested in this chapter is that BG subsidiaries demonstrate better financial and operative performance indicators The con-

firmation of this hypothesis would lead to two important conclusions First,

Table 9.1 Impact of membership in business groups on restructuring activity

Dependent variable INDRES (intensity of firm restructuring)

Estimator Ordinal logit Ordinal logit Poisson Poisson

0.100***

(7.177)

0.048(0.112)

a Sample I: enterprises in nonregulated industries; Sample II: enterprises in regulated industries.

Wald statistics (Wald Chi-square for Poisson model) are reported in parentheses.

Only subsidiaries merged before 2000 are included.

***: significant at the 1% level, **: at the 5% level, *: at the 10% level.

Source: Author’s estimation.

222 Organization and Development of Russian Business

a wider program of subsidiary restructuring during the four previous years yields fruit Second, we can once again confirm the assumption expressed

in the previous chapter that better financial performance of group member enterprises may provide the basis for maintaining corporate discipline and preventing conflicts between ultimate owners and executive management

The common lack of reliability and distortion in financial data gests that use of different financial and operational performance indica-tors would provide for greater accuracy Survey results and annual reports together might be better sources of information The first indicator is the response to the question about companies’ output increase during the

sug-four-year period preceding the survey The INCOUT variable is based on

responses from directors to the question about the change of output ing the four years preceding the survey The value of this variable is 1 if the enterprise reduced its output, 0 if the output has not changed, 1 if the output increased less then 50%, 3 if the output grew more than 50%, and

dur-4 if the output more than doubled The higher the INCOUT variable is, the

more successful and competitive the enterprise is The second indicator is the self-assessments of financial performance, both direct and in response

to the question about the need to finance a shortfall in cash The FINPER

indicator reflects the sufficiency of cash inflows for the financing of current activity and equals 1 if the enterprise did not experience a serious shortfall

in cash flow during 2001–2004 and 0 in other cases The FINSELF indicator

value ranges from 2 to 2 depending on respondents’ self-assessment of the company’s financial performance (including the responses bad/ likely bad/ satisfactory/ likely good/ good) The third indicator is the profitability (ratio of profit to sale) and returns on asset (ROA) indicators obtained on the basis of companies’ book reports from SKRIN and SPARK databases.10

The AVEPRO and ROAAVE indicators represent the average profitability and

returns on asset values in the period of 2002–2005

According to the assessments of company directors, the share of prises that increased their output in 2001–2004 was higher among affiliated firms: 42% of subsidiaries more than doubled their output in comparison

enter-to 27% among auenter-tonomous enterprises It is noteworthy that 40% of group members that increased their output simultaneously cut employment A similar indicator for independent enterprises was less than 30% Subsidiaries are not only stepping up output but also enhancing labor productivity The superiority of subsidiaries in increasing output and simultaneously reducing employment is manifested both in the regulated and nonregulated indus-tries An employment reduction with a simultaneous increase in output is slightly more frequent among enterprises merged before 2000 and, even more often, among those merged before 1995 Group members also dem-onstrate better financial performance and experience difficulties with the financing of their current activities less frequently (Figure 9.3) However, the advantages of subsidiaries can be explained by a favorable impact of

the parent companies and by the industrial structure of the groups It was reported in the previous chapter that the distribution of the group enter-

prises gravitates, first, toward industries with higher profitability and,

sec-ond, toward larger enterprises displaying better financial stability This is the reason that the effect of membership in BGs should be distinguished from the effect of size and industry classification

Nevertheless, our regression analysis showed that this is not connected with the size and industry classification of the enterprises only (Table 9.2)

In nonregulated industries,11 participants in BGs displayed higher

probabil-ity of output increase, better financial performance self-assessment, lower probability to encounter shortfalls in cash flows, and significantly higher profitability and ROA indicators Besides group membership, significant fac-

tors explaining all indicators were the enterprises’ industry classification and location Enterprises located in the capital city, regional centers, and towns demonstrated better financial and operative performance than enterprises located in villages Interestingly, although all group participants had better indicators, for example, higher financial performance self-assessment, this effect was higher and statistically more significant for old subsidiaries that had merged before 2000 At the same time, neither the competition char-

acteristics that were measured by the COMPRU and COMPFO indicators nor

corporate governance organizations represented by the indicator of large

owner participation in management MANSHA had a noticeable impact on

company financial performance results

Therefore, hypothesis H2 is also confirmed as true The higher activity of enterprises in groups with better financial performance creates the image

of Russian groups as quite normal companies and, at the same time, refutes the opinion that the development of connections between enterprises replaces corporate restructuring (Gaddy & Ickes 1998) Regardless of the

Parent companies Subsidiaries

Bad Likely bad Satisfatory

Self-assessment of financial performance of the

enterpriseat time of survey

Serious shortfall in cash flow between

2001 and 2004

Figure 9.3 Financial performance of different types of enterprises

Source: Author’s illustration based on survey data.

cause-and-effect relationship between corporate restructuring and

finan-cial performance (i.e., whether restructuring ensures an increase of profit or better financial performance allows for restructuring), both phenomena are observable in Russian BGs

Impact of business integration on total factor productivity

The data of enterprises’ annual balance sheets allow a comparison of the TFP on the basis of the Cobb–Douglas production function in independ-

ent enterprises on the one hand and subsidiaries of BGs on the other The analysis is aimed at establishing the extent to which the advantages of sub-

sidiaries, primarily, more stable financial performance and better financial indicators, are due to higher productivity On the other hand, a comparative analysis of productivity will determine the gains of corporate restructuring within BGs Higher resource productivity would provide an unambiguous favorable assessment of the impact of BGs on the development of Russian enterprises

On the basis of other results of TFP analysis (Guriev & Rachinsky 2005)

of enterprises merged with major integrations, we assume that

subsidiar-ies have higher productivity than independent firms The TFP comparison

is based on the Cobb–Douglas production function evaluation Company proceeds are used as the output indicator, the average number of employed

individuals (the LABOR variable), as the indicator of labor use, and the book value of fixed assets, CAPITA, as the indicator of capital use volume The

source of data on employment and the value of fixed assets for subsidiaries

in industries, which includes all industries surveyed, except

telecommuni-cations, is the SPARK database

In addition to the industry and settlement-type variables characterizing the enterprise, the regression analysis was also based on the factor of retain-

ing a state package of shares at the respondent enterprise The value of the

OWNSTA variable is 1 if the stake of the state on the federal or local level

in the company equity capital exceeds 10% and 0 in other cases Retaining

a significant share in state property is expected to result in the lowering

of company productivity This can happen in the contemporary Russian economy for two reasons The first is associated with the traditional disad-

vantage of the state as the principal in comparison with the private owner Representatives of the state have fewer personal incentives toward raising the productivity of the assets administered by them and fewer opportuni-

ties to control the executive management as compared to private owners The second is connected with the specific role of small state-owned stakes

in Russian joint-stock companies Retaining such stakes is an effective tool

to prevent a change of owners This is the reason that the managers and owners of enterprises with lower productivity and the worst corporate gov-

ernance are interested in retaining a state-owned stake, usually in the form