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On paper Russia has almost the best corporate governance laws of any former communist economy, but in practice the country's Wild West style of capitalism lives on. The battle for control remains paramount and the laws are no match for managers determined to hold sway over shareholders. Both foreign and domestic investors have suffered losses after being outmanoeuvred by unscrupulous managers.
At the same time, shareholders have promised capital spending in return for cheap equity only to renege on the deals. Analysts say the situation will not improve until companies develop a capital thirst that can only be satisfied by respecting shareholders' rights.
"Control is everything," says Christopher Granville, head of research at United City Bank. "Managers behave like owners now because that was how they behaved and were expected to behave in Soviet times. It is important to have an historical perspective."
Legislation has so far failed to have any real impact on their conduct. A new law on joint stock companies came into effect on January 1 and laid down standards for company organization; the rights and obligations of shareholders, directors and managers; and disclosure rules during takeovers.
In particular, the law sets requirements for licensed independent registrars which are precluded from other activities. This is to prevent conflicts of interest if they engage in broking or provide custody services. It also reaffirms the use of cumulative voting for elections to the board of directors. This erases an anomaly in Russia's existing securities legislation, drafted at the start of the decade, in which the principle of "one share, one vote" was replaced with "one shareholder, one vote" by a young lawyer hoping to prevent the concentration of power in companies. If Russian laws were effective, this piece of creative drafting might have aborted capitalism right at the outset. But since they were largely ignored, the freebooting model got off the ground.
"Since then, people have blasted through all the charters, but it has taken five years for the laws to be redrafted," says Peter Derby, president of Moscow-based Dialog Bank.
The new corporate governance framework is held in high esteem, the work of a plethora of western consultants and top Russian lawyers. Whether it can be put into practice is another matter. So far, the signs are not good. Although the EBRD rates Russia's joint stock law second only to the Czech Republic's corporate governance laws among transition economies, it places it at the bottom for effectiveness.
James Baillieu, director of corporate finance at CentreInvest, is also sceptical. He says the law has not been properly put into practice because there is no enforcement mechanism. The decrees for setting-up independent registrars look good on paper, for example, but in reality they are often subsidiaries of the companies whose registers they hold, says Baillieu.
Even the establishment of a watchdog the Securities Commission (SC), which gained legal status this spring has not prevented major abuses or convinced financial players that doing things in a transparent way is worthwhile. Last year, for example, there were two takeover attempts in the confectionary sector. One, the purchase of Babayev, was done the old "Russian way" and was successful. The other, Alliance-Menatep's bid for Red October, was conducted to the satisfaction of the SC's resource secretariat director Dmitry Subbotin, but failed. This shows the shortcomings of doing things the official way. "The Russians are very creative financially, because in the past they had to be," comments Tim Frost, president of fund manager Pioneer First Voucher.
Subbotin is not disheartened by such setbacks and promises more decrees and documents governing market regulation, corporate finance and investment management to come into effect this winter. "We cannot afford stagnation," he says. "It is important to maintain the dynamics that will create a proper legal framework and ensure the institutionalization of the commission."
Political battle
A tightening of Russia's criminal and administrative codes, which the country's parliament, the Duma, is currently considering, should also help. But even here the pervasive battle for corporate control in Russia has reared its ugly head. Dmitry Vasiliev, chairman of the Federal Commission for the Securities Market, who has lobbied hard for this legislation, has come out worse in a political battle over the controversial loans-for-shares scheme. Vasiliev opposed these transfers which were designed to put shares of major Russian companies in the hands of banks. The former president of Uneximbank, a major beneficiary of the scheme, was appointed first deputy prime minister for the economy in the summer cabinet reshuffle. And, in what appears to be a case of tit-for-tat politics, Vasiliev's chairmanship lost its cabinet status this month. He now reports to the new first deputy prime minister for finance, Alexander Livshits.
The problem of enforcement is compounded by the lack of precedent, particularly for regional courts, and the lack of resources of the SC. But whatever happens on the legal front and whatever funds are provided for bodies like the SC, some observers believe the need for capital will be the real driver of change in Russia.
According to Subbotin the pressures are already building up. Two-thirds of enterprises spoken to by the SC's resource secretariat want to raise cash in the Russian stock market or internationally. But the quid pro quo is exposure to international accounting standards' audits and transparent share dealings and only about 10% of enterprises are prepared to concede this.
Corporate governance can evolve only if budget constraints are real, says United City's Granville. "The struggle for control will then lead to a struggle for survival" and in the heartlands, Granville thinks that only 50% of enterprises in heavy industries, such as metallurgy, machine tools and chemicals, will survive. In effect, corporate governance and restructuring will arrive together.
Tyrant bosses
In the meantime, the abuses will continue. Many managers' first assault is against employees who gained stock in the mass privatization programme. Their usual approach is to siphon off profits into shell companies and then use the cash to buy the employees' shares. This method is extremely effective because it makes the companies look weak so employees are eager to sell and reduces the wages and taxes that the companies must pay. "As well as paralyzing government finances, there are humanitarian and social costs," says Pioneer's Frost.
The attitude of Russian managers to employee shareholders is that their rights are diminished because they acquired their interests through a mass privatization scheme and so have not injected capital into an enterprise. Strangely, this view has found sympathy with American officials on a USAID project working with the SC. "Why should a company's management treat shareholders differently from anyone else when they have brought no money to the table?" says one official.
But this is not the case with western and domestic investors in Russian companies who have also been on the receiving end of the Russian manager as corporate godfather. Russian managers under siege have perfected the art of sabotage such that it's difficult to tell whether there was a hidden agenda or whether the company was simply inefficient.
In August, Manezhnaya Ploshchad, which is building an underground shopping mall near the Kremlin Square, announced that it would float 30% of its shares to finance the rest of the mall's construction. The company, which is owned by the Moscow city government, aimed to raise $35.4 million by offering 15 million shares at Rb12,500 each ($2.37), preferably to a long-term foreign strategic investor. A week later the share offering was postponed when Olma, the brokerage handling the flotation, announced that a key company official was "out of town". Was this really the case or had someone changed his mind about diluting control?
In another instance, the Moscow city administration, headed by mayor Yury Luzhkov, recently moved to end the long-running fight for control of truck manufacturer Zik. In early 1995, Mikrodin (backed by Uneximbank) bought a 30% controlling stake in Zik for just $5 million, but both management and workers refused to accept them, and finally ousted them in January this year at a shareholders' council meeting. After Mikrodin failed to regain control in April, Uneximbank negotiated the sale of the majority holding to the Moscow government, which was acceptable to managers and workers.
Battles for control can also involve managers manipulating the very rules that were designed to protect investors. A British company, Illingworth Morris, bought a 49% stake in the Bolshevik Textile Factory, only for a Moscow court to decide that it had failed to follow the correct procedure. United City Bank's Granville thinks it likely that the Russian company's management manoeuvered Illingworth Morris to breach the investment code, so the court had no choice in its ruling.
A report for the Securities Commission, prepared by professor Joseph Blasi of Rutgers University, New Brunswick, gave a corporate governance rating to Russian companies. Points were given for the percentage of outsiders on the board of directors, the proportion of outside shareholders on the board, the use of cumulative voting for board appointments and the employment of independent share registrars. Points were deducted for dilutive stock buy-backs or new share issues and for secret voting to elect directors. Half the companies rated "poor" and none received the top rating. Even those rated "good" (39%) engaged in some bad practices which would put off investors, said the report entitled Corporate Ownership and Corporate Governance in the Russian Federation. The study concluded that although outside ownership had increased since privatization, it had now stalled while management ownership was continuing to rise.
But sometimes it is the actions of shareholders that cause concern. In the takeover of confectioner Babayev by Inkom-Capital (part of Inkombank), the purchaser promised to make substantial investments. In return the State Property Committee (GKI) allowed Inkom-Capital to acquire a cheap initial stake. But instead of putting money in, the bank used its stake as a base to make further purchases until it had gained control of the company.
Similarly, Menatep Bank promised to invest $182 million in Ust Ilimsk a timber company experiencing huge losses when it acquired a stake in an investment tender earlier this year. The funds never arrived and instead a classic shareholder-management bust-up ensued. At an extraordinary general meeting in June, Menatep sacked the top management who retaliated a few weeks later by refusing to recognize the bank's representatives as shareholders.
GKI has had its frustrations with managers as well as shareholders. Chairman Alexander Kazakov has explained that companies selling shares through investment tenders are expected to sign an agreement with the GKI vowing to protect shareholders' rights. These include putting tender winners in the share registers and opening an account where all funds from the tender and cash from the subsequent investment programme (if one materializes) must be kept.
Russia has a long way to go before its standards of corporate governance meet the requirements of Pioneer's Frost for, "clarity, certainty and consistency". But as Jane Holt, deputy director of the World Bank mission in Moscow points out, Russia's tradition of the corporate godfather will take a good while to break. Investors will need to be both cautious and patient for some time to come.
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