Corporate governance mechanisms in Russia are interesting because they are the result of a large-scale institutional experiment performed by the Russian government in the early 1990s with vigorous support from international financial institutions. The purpose of this experiment was to introduce a certain model of interaction between enterprises and investors, owners and managers, into the Russian environment. The logic of law making--from defining a general privatisation framework to specific activities to develop stock market infrastructure--was strongly influenced by the idea of creating this model. Multi-billion dollar loans were extended to the Russian government by the World Bank and IMF to pursue these objectives. Leading Russian reformers and many foreign consultants were involved in practical implementation of this model. And until the middle of the 1990s, despite all the inconsistency of the Russian government's economic policy in other areas, its activities in terms of institutional reform, especially the launch and implementation of the mass privatisation, were very highly regarded (see for example Åslund, 1995; Radygin, 1995).Then, however, as corporate conflicts spread and shareholders' rights were massively violated, the optimism with regard to the outputs of institutional reforms in Russia characteristic of the early and middle 1990s was replaced by profound scepticism. This scepticism (together with doubts that Russia had chosen the right privatisation model) was expressed in a sufficiently comprehensive manner in the well-known report by Stiglitz (1999).The obvious rejection of external investors and violation of laws had a negative impact on the reputation of Russia and Russian business. This trend reached its peak during the 1998 financial crisis, when the major Russian banks that were close to the government and owed a lot of money to their Western partners preferred to transfer all their liquid assets to their affiliated structures and to file for bankruptcy.1 And despite the significant changes that have occurred in Russia in recent years, most investors still have a sceptical and negative attitude to Russian business and Russian corporations. The following short phrase from the April 2003 issue of the US--Russia Business Council monthly report is very characteristic in this respect: 'Corporate governance in Russia is awful’. (It should be noted, however, that in making this point the authors in fact refer to corporate conflicts in 1997--99.)In this connection it would be logical to ask the reasons for such radical discrepancies between the reformers' expectations and the actual behaviour of Russian companies. It should be underlined that this question is not new for researchers studying the Russian transition economy. To experts, the weakness and inefficiency of corporate governance in Russia in the 1990s has been a generally recognised fact for a long time.The forms and methods of violating shareholders' and investors' rights are described in detail in many papers (see for example Radygin & Sidorov, 2000; Black, Kraakman & Tarassova, 2000). Most experts believe, however, that the unfavourable conditions for attracting investors to Russia are not the result of poor quality legislation.Formally, Russian corporate legislation is well developed. Practically, however, it is applied very badly or not applied at all (Vasil'ev, 2000; Berglöf & von Thadden, 2000). In this connection a traditional corporate governance recommendation to the Russian government is to strengthen enforcement mechanisms and toughen requirements for protecting shareholders' rights, for disclosing information on joint-stock companies' operations etc.Such recommendations suggest developing the stock market regulation and corporate governance model that was created in Russia in the second half of the 1990s and was based, ideologically, on US and UK experience. It is this area where the Russian Federal Commission on the Securities Market (FCSM) has been especially active recently. In 2000--01 the FCSM drafted amendments to the law on joint-stock companies and to the law on the securities market. The new edition of the joint-stock company law was made effective on 1 January 2002. Amendments to the securities market law were introduced by the government to the State Duma at the beginning of 2002. The government has also passed the Code of Corporate Governance, the development of which was initiated by the FCSM.However, recent empirical studies show that the current 'rules of the game’ very often do not encourage owners to restructure their enterprises, regardless of law enforcement practice (see Dolgopyatova, 2002). More general theoretical papers also reveal the strong objective nature of developing and transition economies (see Berglöf & von Thadden, 2000), which limits the application of traditional corporate governance mechanisms created in countries with developed market economies.In the context of these discussions we will try to identify the reasons for corporate governance failures in Russia in the 1990s and explain what caused the recent positive changes in this area. Our analysis will be broadly based on identifying changes in economic agents' motivation at different stages of development of Russian corporate structures.In the first section of the article we will look at the logic of creation and practical aspects of functioning of the Russian corporate governance model, including data on the scale of the corporate sector and the system of regulation of corporate activities in the Russian Federation. Then we will conduct a detailed analysis of incentives to attract investment through the stock market and motivation of open joint-stock companies' shareholders and managers, depending on the performance of the business they control. Finally, we will address the reasons for recent improvements in corporate governance in Russia and will outline possible directions of further evolution of Russian companies' relations with their shareholders and investors. On this basis general conclusions will be presented along with policy recommendations aimed to support positive changes in the behaviour of economic agents.The Russian Model of Corporate Governance in the 1990s: Theory and PracticeThe logic of the Russian corporate legislation in the 1990s was based on massive imports of institutions, with an orientation towards the Anglo-Saxon stock market and corporate governance model. To implement this model in Russian conditions the government took the following practical steps: Voucher privatisation with forced reorganisation of former state-owned enterprises into public companies and distribution of their shares among a great number of small-scale shareholders.Forced development of the stock market and its infrastructure (exchanges, brokers, depositaries and registrars).Creation of collective investment institutions (voucher investment funds, mutual funds, non-governmental pension funds etc).It was expected that dispersing shares among a large number of small shareholders would result in high liquidity of the stock market and give outside investors access to shares in privatised enterprises (through transactions on the secondary market). A developed stock market infrastructure would, in turn, reduce transaction costs and give small shareholders the opportunity 'to vote with their feet’ if they did not agree with the policy pursued by the company's management. The possibility of free purchase and sale of shares was also expected to encourage the creation of a corporate control market where big shareholders could replace the existing management and take control over the company by increasing their holdings when shares were 'dumped’ by small shareholders. Finally, investment institutions would be able to accumulate shares of small shareholders and protect their interests more effectively by supervising the management of enterprises.In practice, however, as we can see from the conditions and structure of the Russian corporate sector, and from the evolution of corporate governance legislation (see Boxes 1 and 2), these assumptions were implemented only partially.Box 1. Conditions and Structure of the Russian Corporate Sector(Based on Dolgopyatova, 2003)Types of JSCs. Under Russian legislation there are two main types of joint-stock companies (JSC) in the Russian economy--open joint-stock company (OAO) and closed joint-stock company (ZAO). The main difference of the ZAO is restriction of free circulation of shares. If one of the owners wants to sell his stock the other shareholders have a preferential right to buy it. In addition, the Joint-Stock Company Law effective since 1 January 1996 introduced the following limitations for ZAOs: 1) the number of ZAO founders (shareholders) can not exceed 50; 2) joint-stock companies where the state (federal and regional governments as well as municipalities) have a holding can only be created in the form of open joint-stock companies. These limitations do not cover ZAO created before the restrictions were introduced. There is another type of joint-stock companies--the workers' ZAO (or people's enterprise). However, it remains rather an 'exception’ which has no influence on the development of the corporate sector. For instance, there were not more than 100 ZAO of this type in industry at the end of 2002.Number of joint-stock companies. Evaluation of the size of the corporate sector in Russia involves certain difficulties. Official statistics provide information only on the number of registered enterprises, including the joint-stock companies in the Unified State Registry of Enterprises and Organisations. The number of joint-stock companies in the registry was over 51,000 at the beginning of 1996 and as many as 426,600 at the beginning of 2001. The latest data from the registry (1 January 2003) show 445,600 registered joint-stock companies.These data, however, are not accurate because they do not take into account transformation and reorganisation of enterprises, except for their official liquidation. According to estimations by Goskomstat and some independent experts, the registry contains from 30% to 50% of enterprises that stopped operations a long time ago. So we can look at approximately 200,000--250,000 joint-stock companies operating in Russia today.Goskomstat data do not provide any information on the proportion of ZAO and OAO among the registered joint-stock companies. However, some insight on this can be obtained from the end-2001 data of the regional division of the Federal Commission on the Securities Market in the Central Federal District (see http://www.mosfund.ru/resultes/otchet%20.pdf, p. 12).According to these data, there were 202,224 joint-stock companies registered in the CFD, which includes Moscow and a number of adjacent regions, at the end of the year. In 1997--2002 the department of registration of the regional FCSM division considered applications for the registration of securities issues from 37,007 joint-stock companies, of which 5,577 were open and 23,430 closed joint-stock companies. Taking into account the concentration of business activity in the CFD, we can assume that there is an average of six ZAO per one open joint-stock company in Russia.Role of joint-stock companies in the economy. Although Goskomstat collects information from enterprises on their organisational and legal types, consolidated economic data for them are not calculated. The role of joint-stock companies in the economy can be estimated indirectly on the basis of a survey of joint-stock companies created during privatisation. The survey covered over 23,000 joint-stock companies out of 26,000 and was done by Goskomstat as at 1 January 1996. At that time they accounted for over 20% of all employees (in industry--over 62% of employees). The share of joint-stock companies created during privatisation in total products (services) was already almost &unknown1; in industry, over ½ in construction, 26% in transport and less than 5% in retail and catering (see ISARP, 1997). Taking into account the newly created joint-stock companies mainly in retailing, services and the financial sector, we can argue that the corporate sector is dominant in the Russian economy.Structure of ownership and control. Since in 1993--94 approximately &unknown1; of all privatised enterprises chose the so-called second privatisation model (under which 51% of all shares passed to the workers), employees and managers initially prevailed in the structure of JSC owners. However, as early as in the late 1990s, according to the annual structural survey by Goskomstat covering nearly 27,000 large and medium-size enterprises (see Goskomstat, 2002), the share of individuals in the charter capital of the companies surveyed shrank to 15--20%. At the same time, in the period from 1999 to 2001 alone the share of non-financial commercial organisations in the charter capital of industrial enterprises grew from 42% to 65%. To be fair, it should be remembered that the data are weighted by size of charter capital and therefore to a larger degree reflect the ownership structure of the largest companies. It can also be pointed out that contributions by foreign legal entities and individuals to the charter capital of Russian companies in the period at issue did not exceed 10% on average. However, when only companies with foreign participation are examined the indicator rises to 40--47%.A number of empirical studies conducted in 1999--2001 by the Higher School of Economics (HSE), the Bureau for Economic Analysis (BEA), the Russian Economic Barometer (REB) and the Institute for the Economy in Transition (IET) demonstrate that the average share of the largest shareholder, depending on the samples, varied from 28% to 42%. That indicator showed a rising trend. At the same time, according to some surveys by HSE and REB, from one-quarter up to one-third of the responding companies already had a dominant owner controlling 50% of its shares or more.The structure of investment sources and scale and liquidity of the stock market. Equity remains the major source of investment for industrial enterprises, although its share showed a downward trend--from 77% in 1998 to 68% in 2001. The capacity of bank financing has been significantly expanded over recent years and the corporate bonds market has also shown dynamic development. As an example, MICEX, the leading stock exchange, had about 112 billion rubles or nearly $4bln worth of initial placement of corporate bonds in 1999--2002.The stock market has shown a positive trend over recent years. The RTS index (the leading stock index in Russia) had risen to 500 points in June 2003, which exceeds the late 2000 level fourfold. However, the scale and liquidity of the stock market are rather low. In 2002 the MICEX average daily turnover in the secondary equity market totaled about $150mln, while for the secondary corporate bonds market the figure was about $10mln. Average daily volumes of trading in equity in the RTS system (the second largest trading place) were ranging within the levels of $20--25mln. For the purposes of comparison it is worth pointing out that the market capitalisation of such companies as Gazprom and Yukos exceeded $20bln in 2002 in every case.Box 2. Evolution of Corporate Governance Legislation in Russia(based on Redkin, 2003)Stage 1: late 1980s--1994. This period was characterised by the development of legal institutions connected with the consolidation and redistribution of rights to private property assets. Legislation on privatisation featuring separate elements of corporate law was enacted within a very short time frame. However, it was of low regulatory potential and was rather designed to create an effect of serving as a legal foundation for the appropriation of state property by individuals and private institutions. That was the reason for the regulations' short life and high changeability: the bulk of the regulations issued were either abolished or radically amended during the 1990s. At the same time the privatisation of state-owned enterprises appeared to be the key factor for growth of demand, calling for introduction of corporate law as well as legal institutions relating to securities.In that period corporate law was represented by a rather brief Provision on Joint Stock Companies approved by Resolution No. 601 of the RSFSR Council of Ministers on 25 December 1990. There were also several instructions issued by Russia's Ministry of Finance and the Central Bank governing corporate relationships.The insufficiency of legislation and regulations complicated the conduct of corporate activities and triggered acute conflicts. There was a major conflict, which became internationally known in 1993--94, between foreign shareholders and the top management of Komineft. The essence of the conflict had to do with the issuance of additional shares by the company in relation to the revaluation of its fixed assets. Instead of pro rata distribution among shareholders the company distributed the shares free among its employees. The conflict, which lasted for nearly two years, could not be resolved on the basis of existing legislation and regulations and investors lost their money owing to the imperfections of corporate law. There were numerous cases of the same kind at that time. However, such heated rows in the stock market contributed to the growth of demand for legal regulation of corporate relationships.Stage 2: 1995--2000. This period was characterised by significant improvement in the quality of legal regulation of corporate relationships. It resulted from the introduction of a legislative basis for regulating relationships with shareholders in joint stock companies, the establishment of a state system for stock market regulation (Federal Commission for the Securities Market), the consolidation of the system for registering rights to equity and the introduction of procedures calling for the protection of investors in the securities market.In 1994 the first part of the RF Civil Code was adopted, followed by the passage of the second part in 1996. In the wake of privatisation and large-scale redistribution of property the demand for the securing of property rights--laws on fixed property registration and notaries--came high on the agenda. Concurrently, new institutions for the registration of rights came into being (chambers of registration, private notary services). Registrars and depositaries came to the stock market in numbers.During that period corporate law and the legislation on securities underwent meaningful development. The legal regulation of such relationships was elevated to the level of law for the first time. In 1995 the Federal Law on Joint Stock Companies (for the JSC law's basic provisions see Iwasaki, 2003) was passed, in 1996 the Federal Law on the Securities Market followed suit (prior to that such relationships were subject to regulatory acts only). The practice of the laws' application in court began taking shape (for particulars refer to Joint Resolution No. 4/8 of 2 April 1997 of the RF Supreme Court Plenary Meeting and the RF Higher Arbitration Court Plenary Meeting 'On Some Issues Related to Application of the Federal Law on Joint Stock Companies’).It was the FCSM-issued regulations that played an important role in the development of corporate law in Russia, notably the standards for securities and bonds issuance (the first edition was adopted in 1996). The problems of diluting charter capital and illegal activities by 'pocket’ registrars made the FCSM introduce more stringent requirements for securities issuance as well as regulate in every detail activities by securities rights registering institutions.But by and large the measures introduced were clearly not sufficient. The corporate legislation in the late 1990s was primarily of a regulatory nature and was not reinforced by adequate legal sanctions in the case of violation.Stage 3: 2000 -- present time. This period is characterised by a more integrated approach to the regulation of corporate relationships and further improvement of enforcement mechanisms.The RF Code on Administrative Violations as well as the RF Arbitration and Procedural Code saw new editions come into force in 2002. Supplements were added to the RF Criminal Code to deal with crimes in the securities market. Owing to their broad functional purposes the legal acts to a certain extent address corporate relationships in terms of protective mechanisms. The new Labor Code has been in force since February 2002 and, despite being not perfect, is based on market realities and is more in line with the law on joint stock companies than its Soviet counterpart.Amendments were introduced in the Federal Law on Joint Stock Companies (the nature of the amendments is examined in Medvedeva & Timofeev, 2003) and the Federal Law on the Securities Market in 2002 reflecting the lessons learned over the previous years in applying this legislation. A new version of the Federal Law on Bankruptcy came into effect.At the same time there is still a lack of effective and efficient protective mechanisms in place to counter fraud on the part of companies' CEOs, insider deals and other kinds of swindling by top managers. Procedures to raise claims against companies' CEOs for damages to the company (so-called indirect claims) do not work as a consequence of their legal deficiency incorporated in Article 71 of the Federal Law on Joint Stock Companies. The category of 'affiliated persons’ has to be better identified while the protection of an economic entity's interests within the framework of deals arousing interest needs to be better secured.The extensive imports of corporate legislation institutions and the 'dispersal’ of property in the course of the mass privatisation could not neutralise the apparent demand for the 'insider’ privatisation model promoted by managers of former state-owned companies. As a result, two trends could be clearly observed in the corporate sector in the mid-1990s: A tendency towards concentration of ownership and control--purchasing up to 75% of the shares (see Kuznetsov, 2002).A tendency towards minimum transparency in joint-stock company operations--creating sophisticated systems of corporate control over big enterprises through multiple affiliated firms and off-shore companies (see Yakovlev, Kuznetsov & Fominykh, 2002).The most important and special characteristic of the Russian corporate governance model based on these two trends is the obtaining of revenues from stock ownership not through profits (which is characteristic of the Anglo-Saxon model) but through control exercised by the dominant owner over the enterprise's cash flow. Using transfer pricing mechanisms profits of the head enterprise can be systematically transferred to companies affiliated either with the dominant shareholder or with top managers of the head enterprise (see Rozinsky, 2002). In doing so the interests of minority shareholders (including the employees) who do not participate in the decision-making process can obviously be ignored (for more on systematic violations of shareholders' rights in Russia see Radygin & Sidorov, 2000; and Black, Kraakman & Tarassova, 2000). It should be emphasised that such schemes for obtaining revenue were used not only by old-style 'red’ directors but also by new big private shareholders.Logically, this system of obtaining ownership revenue meant almost no dividends were paid in the 1990s. When combined with the total indifference of dominant owners and managers to creating a market for the shares of enterprises they controlled, this caused low capitalisation and very low liquidity of the stock market. Even during the peak times of the Russian stock market (1996--97) less than 1,000 out of 30,000 registered open joint-stock companies could meet the moderate requirements for listing with Russian stock exchanges; transactions were conducted in the shares of only 200--300 companies and there was regular trading in only a few dozen blue chips.In fact, the rapid development of the stock market in the mid-1990s and its decline afterwards were caused, to a large extent, by the demand for the stock market as a mechanism of shareholding consolidation. Once such shareholdings had been formed, the demand disappeared in a natural way.Obviously, there were systematic discrepancies between the rules stipulated in the legislation and business practices. In a certain sense we can say that the Russianmodel of corporate governance was created in the 1990s against government policy and functioned on the basis of systematic violation of formal rules. In our view the reasons for that lie in the way corporate governance institutions were formed. These reasons will be more thoroughly addressed in the next section.Development of Joint-stock Companies in Russia and Motivation of Owners and Managers of EnterprisesCritically analysing the existing approaches to the problem in economic literature, Berglöf & von Thadden (2000) propose a classification of corporate governance models characteristic of developing economies, economies in transition as well as developed market economies. Within this classification they identify key issues of corporate governance.For transition economies and especially for Russia significant differences are connected with the division into 'new’ and 'old’ (former state-owned) enterprises. Berglöf & von Thadden believe that the problem scarcely exists in the de novo sector because these enterprises have not yet reached a stage when it is necessary to differentiate between ownership and management. The former state-owned sector, on the other hand, is a source of serious problems.Privatised enterprises need serious restructuring and, theoretically, should generate demand for external sources of finance. In reality, however, they do not generate this demand, which, according to Berglöf & von Thadden, is caused by soft budget constraints, which reduce this need for restructuring. When outside investors themselves want to move into large Russian businesses the weak and imperfect judicial system bequeathed by the Soviet era is unable to ensure sound protection of outsiders' rights.The main recommendations resulting from this analysis come down to developing enforcement mechanisms and hardening budget constraints. This will create the necessary pressure on insiders and conditions for attracting new outside owners (including foreign ones) who can attract finance and initiate restructuring of enterprises.In our opinion these recommendations are right on the whole; however, they are a bit one-sided and formulated from the outsiders' perspective. The phenomena and processes analysed could also be viewed from the insiders' perspective. This angle could be useful because it allows better understanding of the actual costs and benefits of turning a business into a joint-stock company.In the course of natural development of a business its reorganisation into a public company requires at least two conditions to be met: The business is efficient enough. This makes it attractive for investors, secures the positions of the previous managers/owners at the initial stages of the privatisation process, and creates proportions for exchanging property for investment acceptable to the previous managers/owners.The previous managers/owners of the company are interested in attracting additional funds for business development purposes in exchange for part of their stake in the company. In practice this means readiness to co-operate with investors, including adequate disclosure of information, payment of dividends etc.As an example of companies developing in accordance with this pattern we could mention AO Vympelkom, which was created in the early 1990s as a co-operative, was then reorganised into a closed joint-stock company and then became the first Russian company to trade its shares on the NY Stock Exchange in 1996. Another example is AO Wimm-Bill-Dann Produkty Pitaniya, which successfully placed 25% of its shares in February 2002, attracting over $130 million in investment.However, for the vast majority of big Russian enterprises the privatisation process was not natural. During privatisation they were forced to become public companies. These enterprises had been created during the Soviet period and were oriented towards absolutely different, non-market values. That is why in most cases they proved inefficient in the new economic conditions and needed drastic restructuring. This had several important logical consequences: Before the consolidation of ownership and control in the hands of enterprise managers their positions remained quite unstable. On one hand this caused hostility on the part of the previous management towards potential outsiders; on the other hand it encouraged the transfer of liquid assets of the base enterprise to affiliated structures controlled by the managers.Consolidation of ownership and control in the hands of managers was performed by using some of the working capital of the enterprise, which only further weakened the enterprise, made it less attractive for investors and made the restructuring process more complicated.After consolidation of ownership and control and before restructuring, enterprises' opportunities for access to outside finance remained very limited. Low business efficiency made it unprofitable for managers to exchange shares for investment while the poor performance and old non-liquid fixed assets did not allow credit to be obtained. As a result, privatised enterprises had to use their own funds for development purposes.To complete the picture we can add that during the reorganisation and privatisation under 'voucher’ schemes enterprises themselves did not get any investment at all. It is not surprising, therefore, that from the point of view of managers and ordinary employees loyal to them all outsiders looked like spongers who claimed some of the profits of the enterprise without any apparent reason.This forced privatisation that did not take account of objective stages of enterprises' life cycles caused deformation of the public company institution and creation of a number of 'quasi open’ joint-stock companies that did not need outside shareholders at all and, for this reason, provoked corporate conflicts. In a broader theoretical context this institutional mutation process in transition economies is analysed by Kapelyushnikov (2001). It is noteworthy, though, that the interests and motivation of insiders did change as ownership and control were concentrated in their hands.At the initial stage insiders who did not have complete control over enterprises and were involved in a struggle against outsiders were not at all interested in any restructuring and usually tried to strip assets as quickly as possible. Once they became dominant owners again and regained legal control over enterprises, insiders still did not need minority shareholders and continued to violate their rights. As regards restructuring and transfer of assets, however, their policies were completely different. They controlled businesses and were interested in making them more efficient by restricting theft (including that by medium-level managers), by reducing unproductive costs, by implementing new technologies etc.Obviously, this evolution of interests depended on many factors (for example, onmanagers' qualifications). At present, Russian enterprises are at very different stages of their corporate development. Nevertheless, all of them, including a few newly created efficient private companies like AO Vympelkom, have the same organisational and legal framework of an open joint-stock company and must comply with corporate legislation requirements.In fact, most big Russian enterprises show discrepancies between their legal framework and the economic content of their activity. The costs of such discrepancies have been compensated by loose observance of rules and laws, which has gone on for a long time. At this stage, however, big enterprises will more often face real additional costs without getting any compensating benefits since most of them are still unprepared for opening their businesses to outside investors.We believe, therefore, that resolving corporate governance issues in Russia requires not only putting more pressure on insiders, strengthening budget constraints, protecting shareholders' rights and developing enforcement. Creating 'the right motivation’, a system of indirect positive incentives for insiders, and measures aimed at reducing the costs caused by the legislation can also play an important role here.Recent Changes in the Behaviour of Russian Corporations and Options for Corporate Governance Evolution in RussiaIn our opinion the change in the status of insiders, the fact that they acquired legal control over enterprises,2 created an enabling framework to improve corporate governance in Russian companies. To support this point the following recent trends can be highlighted: significant improvement of shareholder relations, improved transparency and regular payment of dividends, which have already increased the market capitalisation of some major companies (YUKOS is considered one of first movers here);real implementation of International Accounting Standards (IAS), which is especially visible against the collapse of the corresponding programme approved by a special government resolution in the spring of 1998;vigorous issuing of corporate bonds3 and the precedents of IPOs (Wimm-Bill-Dann, RosBusinessConsulting, 36&6 Pharmacies).At the same time, we believe, a number of other factors (apart from consolidation of ownership and control) had an effect on the behaviour of Russian companies.The August 1998 devaluation of the ruble resulted in increased competitiveness of Russian exports along with a dramatic rise in prices for imported products and their withdrawal from the domestic market. Growing sales improved the performance of Russian business. As a result, the new owners had an opportunity to recoup their investments in blocks of shares not only by withdrawing liquid assets from their enterprises but also by generating revenue from actually doing business. This created incentives to invest in the development of enterprises, which did not exist in the 1990s. One of the consequences of the new investment opportunities in Russia was a noticeable reduction in capital outflow. While in 1997--98 annual capital outflow from Russia was estimated at $20--25 billion, by 2001 this figure was reduced to $17 billion and by 2002 to $11 billion. According to the Central Bank and the Russian Ministry of Finance, the second quarter of 2003 was the first time capital inflow had exceeded capital outflow (see interview with Minister of Finance Alexei Kudrin in Financial Times, 23 June 2003).A new bankruptcy law went into effect at the beginning of 1998. It triggered a new wave of ownership redistribution and acute corporate conflicts, since the law, contrary to its original purpose, was used against well-performing and relatively efficient enterprises. However, such opportunistic use of any overdue debt, however small, to 'intercept’ control at successful enterprises cleared out the arrears accumulated in the 1990s.Apart from the devaluation effect that improved the competitiveness of Russian products and ensured an inflow of liquidity to more efficient enterprises, a more adequate government tax policy also contributed to reducing the non-payment problem. For instance, in 1999--2000 the government wrote off a significant amount of fines and penalties on overdue tax payments and provided a debt restructuring opportunity for enterprises which had made current tax payments on a regular basis over a certain period of time. By 2001 industrial arrears were concentrated in inefficient, failing enterprises, unlike in the mid-1990s, when they were typical of almost all major industrial enterprises.The end of mass privatisation also extended the time horizon of Russian business. This reduced the size of potential rents as well as the capacity and efficiency of rent-seeking strategies which were popular in the 1990s.Among other factors influencing business behaviour, the effect of the 1998 crisis should be highlighted. Together with the devaluation and default the crisis caused the government to be replaced. For the first time since 1991 the government included active representatives of the Communist party: Deputy Prime Minister Yu. Maslyukov, a prominent Communist party deputy and leader of a State Duma Committee, was in charge of economic issues in the Primakov government.Although the crisis mainly affected the middle class in big cities, it outlined for the 'oligarchs’ the possibility of losing their capital and property--if the rules of the game did not begin to change, if they continued to enable some individuals to make huge profits without creating conditions for economic and social development. On the whole, completion of the primary division of state property and realisation of the political risks related to rent-seeking behaviour encouraged business (primarily big business) to act more vigorously in the legal field, which nonetheless remains highly inadequate.It is noteworthy that there were serious problems with the legal framework in the 1990s as well. At that time, however, they were resolved by creating semi-legal and illegal asset redistribution schemes within the framework of informal business groups (see Yakovlev, Kuznetsov & Fominykh, 2002), since the efforts to change the legal environment in the short term proved initially inefficient. All this caused a rapid development of the shadow economy and an active outflow of capital.4In recent years the increased investment activity and the need to guarantee the protection of the existing ownership rights have encouraged business to seek more civilised and legal ways to interact with the state. Unlike in the 1990s, when 'investment’ in relationships with specific officials or policy makers paid back fairly quickly, legal interaction with the state could only be effective for individual companies under certain conditions. Such interaction is effective if it is based on collective interests and coordinated collective activities of the entrepreneurial community. The realisation of such collective interests helped create demand for law on the part of business,5 and the readiness for collective activities strengthened the role of entrepreneurial associations as representatives of collective business interests. This applies not only to the 'renewed’ Russian Union of Industrialists and Entrepreneurs but also to a number of industrial associations of entrepreneurs (for theinteraction between the Russian Association of Household Electronics (RATEK) and the State Customs Committee see Radaev, 2002).The above factors created conditions for positive change in Russian companies' attitude to outside shareholders and potential investors. In general, speaking about the evolution of the Russian corporate governance model within a certain simplified reference system, we can point out the following features (see Figure 1).Corporate governance policy in Russia and response of business in the 1990s.Initially, Russian reformers tried to implement an Anglo-Saxon experience-oriented corporate governance model. However, diffusion of ownership objectively contradicted the need to restructure enterprises. To emerge from crisis and develop their business, they needed one owner capable of making and implementing hard decisions and of taking responsibility in negotiations with potential outside investors. As a result, during the process of objective ownership consolidation Russian companies quickly moved from the upper left hand to the upper right hand corner in Figure 1.The evolution, however, will hardly stop at this point. As we mentioned earlier, consolidation of ownership has occurred in most major Russian companies and we can see discrepancies between their legal structure and the economic content of their activity. While they function as open joint-stock companies and incur costs typical of this organisational and legal form, they do not enjoy any compensating benefits (e.g. access to cheaper investment resources through the stock market) because they are not yet ready to really open themselves to outside investors.We believe the regulation system is likely to change partially in the next few years to become closer to the Continental European model. In the future, a certain reduction in ownership concentration is possible, as Russian companies (primarily medium-sized ones) really become open to attract investment. A key factor in thisprocess will be Russian investors' behaviour, because we know from other countries' experience that an abundant inflow of foreign investment normally starts when domestic investors really begin to invest in their country's economic development.It is noteworthy that similar changes in the corporate governance system have occurred in other countries as well. Despite the attempts by the American occupation authorities to radically transform Japan's corporate mechanisms in the first post-war years (see Aoki, 1988), they remained close to the Continental European model. It is believed that one of the reasons for that is dominance of Romano--Germanic traditions in the Japanese judicial system and its rejection of innovation characteristic of common law and creation of the basis for the Anglo-Saxon corporate governance model (see Johnson et al., 2000).Similar things took place in Russia in the 1990s. In Russia, as in Japan, civil law traditions still prevail. And one can rejoice that the experts who participated in the development of the original Russian corporate governance model are beginning to admit the role of the 'institutional landscape’ in analysing the transplant effect (see Shleifer et al., 2003).Conclusions and Policy ImplicationsWe have tried to demonstrate in this article that inefficiency of corporate governance in Russia and blunt violations of investors' and shareholders' rights in the 1990s were related not only to the insider structure of ownership but also to insufficient preconditions for implementing the Anglo-Saxon corporate governance model, which the reformers tried to transplant to the Russian environment. In our opinion, at least two requirements need to be met to make such an institutional experiment successful: availability of an existing legal framework that can support the functioning of sophisticated intermediary institutions (stock market, professional investors etc.) characteristic of the Anglo-Saxon model;a level of business efficiency at which managers are not afraid of losing their positions if the owner is changed and the original owners can obtain sufficient compensation for their shares.Neither requirement was met in Russia in the 1990s. Recent studies, however, have been focused on the imperfections of legal institutions followed by the traditional recommendations to improve enforcement. These recommendations are correct but not sufficient.It must be admitted that insiders play a key role in corporate processes in Russia and this is why government policy in this sphere cannot ignore their interests (which has been the case so far). This said, the interests of insiders themselves may differ significantly depending on the level of concentration of ownership and control. It is only consolidated owners that can have sufficient incentives to restructure and improve their business in the current Russian conditions. This category might be potentially interested in attracting investors and improving corporate governance. And it is for this reason that policy making needs to take into account the interests of various groups of insiders.The above means that the government--unlike in the 1990s--should not be looking at this or that pre-defined corporate governance model. Legal regulation should become more flexible. It should create conditions for the development of various corporate governance mechanisms and take into account the interests ofmarket players, their evolution and differentiation. We need a transition from the model of 'political modernisation’ of the institutional environment, with institutional supply being generated by the government, to the 'market modernisation’ model where demand for institutions is generated by market players themselves (see Cadwell & Polishchuk, 2001).In the field of corporate governance business, in our view, is ready for constructive cooperation with the government based on collective interests of the entrepreneurial community. However, for this cooperation to produce positive results, it is important that the government--and, in a broader context, the state--pursue public rather than some other interests. Unfortunately, the situation is still unclear.Almost immediately after taking office President Putin announced his policy of strengthening 'the vertical line of power’. Since there was no real political competition, however, this policy resulted in consolidation of the state machinery. While it remained out of control of both society and the supreme political power, the state machinery, guided by standard bureaucratic aspirations, began to play a more and more important role in the economy. As a result, the model of state capture or informal privatisation of power in the interests of business typical of the 1990s is gradually being replaced with that of informal capture of business to subordinate it to departmental interests.The above is indirectly confirmed by data from managers of Russian enterprises who were surveyed on the efficiency of court procedures used to resolve conflicts with private counterparties and government agencies (see Frye, 2002; and Golikova et al., 2003). Contrary to popular scepticism, arbitration courts are sufficiently effective in resolving disputes between enterprises while the probability of winning the case and having the court decision enforced in a conflict with government agencies is estimated by the respondents as significantly lower.This means that today the threat of ownership rights violation in Russia comes from the state machinery pursuing its bureaucratic or political goals rather than from company insiders.6 It is for this reason that the future of corporate governance in Russia depends not only on the strengthening of the judicial system but also on whether the government pursues the interests of society in its interaction with business or whether its policies are defined by the interests of individual agencies and political groups.Notes1These banks include ONEXIMBank, Rossiisky Kredit, SBS-Agro and others. However some papers (see Pappe, 2002) consider this asset stripping instead of debt repayment as a positive step which enabled Russian business to retain control over the largest national enterprises.2It should be noted that this process was pursued both by the management (e.g. AO Severstal) and by new investors, outsiders vis-à-vis the old management (e.g. Norilsk Nickel). However, regardless of the starting point, the emerging consolidated owner continued to act like the classical insider.3We should point out that in some cases the main purpose of corporate bond issues was not to raise funds but to improve the company's image in the market. This is characteristic, for instance, of natural resource-based industries that have had no major problems with liquidity in recent years.4According to World Bank experts, the share of the shadow economy in Russia was up to 40% in the mid-1990s (see Kaufman & Kaliberda, 1996). For more detailed analysis of the influence of the shadow economy on the development of economies in transition see Johnson, Kaufman & Shleifer (1997).5For more information on the development of demand for law in Russia see Hendley, 1999; Pistor, 1999; as well as Yakovlev, 2003; Medvedeva & Timofeev, 2003; and Simachev, 2003, on creating demand for legal institutions in the field of corporate governance.6It is in this context that most observers viewed the events that took place at the beginning of July 2003 when Platon Lebedev, a major YUKOS shareholder, was arrested on charges of breaking the law when pursuing a privatisation transaction in 1993--94 (see 'Presidential Ambiguity Undermines’, Moscow Times, 14 July 2003, p. 8; 'Power Struggle in the Kremlin’, Economist, 12 July 2003).
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Volume (Year): 16 (2004) Issue (Month): 4 (December) Pages: 387-403 Download reference. The following formats are available: HTML
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