Center for European Studies Central and Eastern Europe Working Paper No.

63

Western Capital versus the Russian State: Towards an Explanation of Recent Trends in Russias Corporate Governance
by

Stanislav Markus
Ph.D. Candidate, Department of Government, Harvard University Email: smarkus@fas.harvard.edu

Abstract

The literature on corporate governance in Russia stresses the abuse of shareholder rights in the face of various assetdiversion tactics by the management. Attributing this fiasco to a number of structural obstacles and the privatization legacy, the orthodox account fails to incorporatelet alone explainthe recent data demonstrating a qualitative improvement of corporate governance in crucial segments of the Russian economy. This paper disaggregates corporate governance into specific institutions and examines their quality at the firm level as well as by sector. The data supporting the analysis is drawn from recent studies by the OECD, UBS Warburg, CEFIR, and other organizations. The causal inference presented in this paper critically evaluates the impact of foreign capital on the improved corporate governance in Russias blue-chip firms. The paper presents two alternative state-centered scenarios to explain the implementation of internationally accepted standards of corporate governance by Russias big business.

Introduction Scholars, policymakers, and investors alike increasingly view corporate governance1 as the new benchmark of competitiveness. The focus on corporate decision making and control pertains especially to transition economies (Guy et al., 2000). Corporations as fundamental economic units pooling capital and maximizing profits were absent in the socialist economies, and the ensuing cognitive shift on the part of all stakeholders should not be underestimated. Domestic shareholders having received their shares virtually for free during mass privatizationneed to recognize their roles as owners and principals, while managershaving engaged in asset diversion during privatization and accustomed to running the corporations as their personal fiefdomsneed to realize their responsibilities as agents of the shareholders. Todays transition economies are often caught in a vicious circle of absent rule of law, ineffective government, and mismanaged opaque corporations. Hence, more accountable and transparent corporations can be expected to have spill-over effects on society. Good corporate governance is also imperative for the development of equity markets and the efficient allocation of scarce domestic savings: the value of shares depends in part on the investor protection, and unless the shares are expected to generate adequate returns, equity markets are likely to remain rudimentary. Finally, sound corporate governance is associated with larger foreign investment that, in addition to the badly needed capital inflow, can assure technology transfer via FDI and the effective monitoring of management via institutional investors participation in portfolio acquisitions. This paper examines corporate governance in Russia since the end of the 1990s. Ample literature has been generated on the failure to establish effective mechanisms of corporate governance in Russia due to botched privatization, the inadequacy of the legal framework and enforcement, and the insiders hostility towards corporate control by firm outsiders. Using the recent data from OECD, CEFIR and other studies, I provide a more nuanced account which disaggregates corporate governance into specific institutions, and outlines their prevalence in various economic sectors and company types. The crucial puzzle emerging from the paper concerns the adoption of international corporate governance measures by the managers of blue-chip corporations that provide the bulk of Russias GDP. My argument is that the conventional attribution of this phenomenon to the firms need for investment is insufficient. Instead, this paper offers a political state-centered explanation which links the corporate governance fashion among Russias top firms to Kremlins assumption of a more active role in the economy. 1. Corporate governance in Russia orthodox pessimism Two models of corporate governance have figured prominently in the literature (Aguilera and Jackson, 2003), neither of which has taken root in Russia. The outsider model prevalent in Anglo-Saxon countries with dispersed ownership stresses liquid capital markets as the disciplinary mechanism for managers: owners can easily sell their shares which could prompt a hostile takeover and replacement of the incumbent management.2 For Russia, the outsider model is rendered irrelevant by the illiquidity of capital markets, unenforced property rights, prohibitions against transfers of assets such as land, as well as the discretionary enforcement of bankruptcy legislature (Sprenger 2002, 19-20). Conversely, the insider model typical of continental Europe and Japan where share ownership is more concentrated emphasizes relational monitoring via company-internal mechanisms, e.g. via the presence of large stakeholders on corporate boards, such as banks that rely on private information
governance is usually defined as mechanisms for actual repatriation of profits to the providers of finance (Shleifer and Vishny, 1997). I adopt a slightly broader definition: corporate governance reflects the ability to control decisions and cash flows through formal or informal channels in a given corporation. 2This ideal-typical definition is qualified empirically by the rise of institutional investors in Anglo-Saxon countries which pool capital from dispersed owners and exert considerable control over management, especially in the case of private equity firms.
1
1Corporate

and voice rather than the arms-length transactions and exit in the outsider model. In Russia, the application of the insider model is thwarted by the opportunistic approach to asset management by Russias corporate stakeholders, who generally do not take a long-term interest in the firm as a community, undermining trust on which relational monitoring is based (Buck, 2003). A long list of causes has been suggested for the fiasco of Russias corporate governance, with privatization as top culprit. The engineers of the 1992-94 voucher privatization of circa 15,800 enterprises (Boycko et al. 1995, 106) coopted the insiders, i.e., managers and workers, by allowing them to purchase 51 percent of shares in their respective companies (Shleifer and Treisman, 2000). This option, chosen by 73 percent of privatized firms, pitted managers against workers in the internal voucher auctions, undermining trust among firm stakeholders (Woodruff, 2004), and led to the ownership of 22 percent by senior management in addition to 44 percent owned by other employees in 1994 (Buck et al. 1998, 93). In the process, managers used their discretion to consolidate both de jure ownership and de facto control: they determined the book value of assets, diverted enterprise and state funds for buying up shares from employees while usurping the voting power of workers shares by pooling them in manager-controlled trusts or by instituting proxy voting schemes (Blasi and Shleifer 1996, 101; Black et al. 2000, 1740-1). Given massive systemic uncertainty, managers used their control to expropriate shareholders through transfer pricing, asset stripping, and other techniques.3 The 1995-96 shares for loans privatization that handed over a dozen of leading oil and metals companies to Moscow-based banks was similarly problematic: the right to manage the auctions for government shares was allocated among well-connected financial powerhouses such as Oneximbank or Menatep, which colluded to win the auctions at infinitesimal prices. Instead of being converted into relational blockholders la Germany or Japan, these Russian banks constituted the result of an adverse selection mechanism in which any company adopting good corporate governance in the overall dishonest corporate sector is driven out of the market (Guy et al. 2000, 3-4; Gaddy and Ickes 2001, 107). In 2000, 62 percent of joint-stock companies did not have a single shareholder with a stake larger than 25 percent, while only 13 percent had a shareholder with a 50+ percent stake (OECD 2002, 80). Such fragmented ownership structure effectively precludes the possibility of relational monitoring since small shareholders cannot be expected to surmount collective action problems and information asymmetries vis--vis management in a corporate environment lacking transparency. The inadequacy of the legal framework and its poor enforcement critically compounded the above problems. Notably, until 1996 no legislation existed to regulate corporate affairs. Thereafter, the legal environment for corporate governance in Russia was largely shaped by three laws: On Joint-Stock Companies, effective since January 1996; On the Securities Market, effective since April 1996; and the law called On Protection of Investor Rights, effective since March 1999. Critical loopholes present in this legislation (somewhat remedied by recent amendments) included the absence of a clear definition of interested party transactions, the lack of personal managerial liability to prevent asset stripping, the opaque formula for net profit calculation allowing managers to use lower estimates which cost the investors $100 million per year in preferred dividends, the insufficient requirements on disclosing ownership and formal agreements, the unduly narrow definition of stipulated independence with respect to board members thwarting effective monitoring by shareholders and auditors, and many others (Sprenger 2002, 12-3; OECD 2002, 9-29; UBS 2002, 19). Finally, historically contingent cultural influences are cited as an impediment to effective corporate governance (McCarthy and Puffer, 2002). Buck (2003) argues that the traditional intrusive3Transfer pricing involves purchasing inputs from management-controlled trading companies at inflated prices, or selling to these companies at below-market prices. Asset stripping is often done by transferring company assets to management-owned holdings and bankrupting the value-stripped firm. For more details, see Fox and Heller (1999).

ness of the Russian/Soviet state in the economy, its authoritarian management style, and the historically speculative short-term approach of foreign investors to Russian business have generated defensive attitudes on the part of labor with respect to firm outsiders; such adversarial relations among stakeholders have allegedly entrenched opportunism as the operating principle of Russian firms. The verdict on corporate governance in Russia continues to be starkly negative. An EBRD working paper (Sprenger 2002, 1) contends that while the official stake owned by managers has been reduced to 15 percent,4 [m]anagers are the most powerful group of corporate owners in Russia. As Figure 1 shows, while corporate stakes owned by outsiders have steadily increased since 1994, the share owned by the insiders (managers plus workers) and that owned by the state was still very considerable on average in year 2000. An OECD study (2002, 82) suggests that the decrease in managers nominal stake reflects the transfer of shares to manager-affiliated companies and has been, in fact, accompanied by higher informal managerial control. The figures on managerial turnover, an indicator of market discipline on corporate governance, also seem worrisome; while the general manager had been replaced in 26 percent of the larger non-agricultural firms during 1999-2001, only in 20 percent of the cases was this due to poor performance (Springer 2002, 7). Figure 1: Ownership structure of Russian medium and large joint-stock companies 1994-2000 as % of the charter capital

Source: OECD 2002, 81 While the flak of corporate governance in Russia continues unabated in the academic literature (Black, et. al, 2000; La Porta, et al., 2000; Buck, 2003; Woodruff 2000; ibid, 2004), a new look at the evidence is warranted by the need to transcend the theoretical focus on structural obstacles and legacies, as well as the empirical necessity to disaggregate the corporate governance phenomenon. 2. Corporate governance disaggregated blue chips vs. the rest Given the radically disparate conditions facing Russias leading blue-chip firms in energy and telecommunications sectors and the large mass of capital-starved manufacturing firms, aggregate indicators of corporate governance are often misleading. To examine the overall trend among the blue chips in 2000-02, I use the UBS Warburg analysis, which covers twenty leading Russian corporations. The UBS rankings reflect the risk to investors present in eight categories of corporate governance such as transparency level, share dilution probability, transfer pricing risk, etc. Appendix 1 explains
to other estimates, this stake is much lower at 7.2 percent; for an overview of data on Russian corporate ownership, see OECD (2002, 88).
3
4According

and disaggregates these rankings by specific corporate governance institutions. Higher rankings reflect higher risk and lower quality of corporate governance. As Figure 2 demonstrates, corporate governance has clearly improved on average for this subset of Russian corporations. Figure 2: Change in average corporate governance risk for twenty blue-chip companies between 2000 and 2002
26

25

24

23

22

21

20

May

00

Nov 00

April

01

March

02

Note: Vertical axis represents corporate governance risk: lower bar height means better corporate governance. Companies that receive more than 35 penalty points are extremely risky, while those with a rating below 17 are relatively safe. Please see Appendix 1 for details. Source: UBS Warburg 2002, 5

A word is necessary on the methodological choice of UBS data. While no corporate governance ranking should be taken at face value, UBS relies on tangible criteria for its eight ranking components; the only serious exception is the bankruptcy component, reflecting the analysts understanding of corporate governance risk connected with a companys indebtednessin an environment where most companies have overdue payables and bankruptcy proceedings are highly politicized, this component is inevitably subjective. This caveat notwithstanding, triangulation confirms the positive trend apparent in UBS data. The rankings by the Institute of Corporate Law and Governance correlate strongly with the UBS rankings, stating a clear improvement between 2000 and 2002 (ICLG, 2002). The recent Standard & Poor report takes this conclusion even further by demonstrating that the positive trend has continued throughout 2003 and 2004.5 Table 1 disaggregates the four periods in Figure 2 into the specific firm rankings. The companies are listed in the order of their average quality of corporate governance across four periods with VimpelCom as a clear winner.
A

5The

S&P study relies on in-depth surveys of Russias fifty largest companies, analyzing their level of disclosure on eighty-nine items relating to ownership structure, investor relations, financial and operational information, as well as board and management structure and processes. See S&P (2004) for details.

Table 1: Company-specific change in corporate governance rankings for Twenty-two blue-chip companies between 2000 and 2002 13.03 2002 10.5 16.3 13 14 17.5 19.5 16.5 21.5 23.5 21 19 22 24 30.5 27 28 25 22 31.5 35.8 26.04 2001 10.5 14 16.5 16 19.5 18 19 18 20 20 25 24.5 26.5 25 16.5 29.5 27.5 33 32.5 42.5 37.8 17.11 2000 10.5 14 16 20.5 18 19 19 20 23 25 23.5 24 19 31 33.5 40 32.5 34.5 37.75 17.05 2000 12.5 13.5

Rank 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22

VimpelKom Lenenergo UralMash-Izhora

MTS

Lukoil Baltika SUN Interbrew Mosenergo

PTS

17 19.5 23 23 19 26 22 24 16 44.5 26 34 35.5 36.5 26.5 37

Severstal Tatneft Rostelecom Sibneft Irkutskenergo Aeroflot

YUKOS UES

Surgutneftegaz Norilsky Nikel Gazprom GAZ*

MGTS

Source: UBS Warburg in Black and Rachinsky (2003). Notes: Ranking numbers reflect corporate governance risk; higher numbers imply lower quality of corporate governance. For ranking methodology, see Appendix 1. Missing rankings mean that UBS has not yet started or stopped covering the corporation in that period (GAZ, for example, was dropped in 2001 since the company was essentially taken private).

Are the improvements in specific companies rankings mere window dressing by the incumbent management, or do they capture a more transparent modus operandi with increased shareholder leverage vis--vis management? Most of the measures underlying the rankings (Appendix 1) are based on the presence of specific institutions rather than subjective perceptions of market analysts. Sibneft is a case in point. In June 2001, the company stripped the Board of Directors of the right to increase charter capital, and annulled a large bulk of its authorized shares. Both moves were made in response to the audit and signaled substantially decreased risk of share dilution (Kommersant, 2001). Concurrently, Sibneft elected three independent directors, including the head of the Naufor brokers association Ivan Trishkin, to its nine-member board. Even more impressively, the corporation announced a record dividend of $612 million in August, paying out 90 percent of its 2000 profits and announcing a long-term dividend policy vouching to maintain an average payout ratio of circa 50 percent (Vedomosti, 2001). The anti-dilution stipulations, the presence of independent board members, and a credible dividend policy are all captured in the rankings, implying a significant improvement in corporate governance. Such verdict, however, was undercut in October 2001 when Sibneft announced that it had purchased its own 27-percent stake from the core shareholders in December 2000, only to
5

transfer it back to them in the summer of 2001: de facto, this transaction amounted to an interestfree loan to the core shareholders controlled by governance. Such a verdict, however, was undercut in October 2001, when Sibneft announced that it had purchased its own 27-percent stake from the core shareholders in December 2000, only to buy it back from them in the summer of 2001: de facto this transaction amounted to an interest-free loan controlled by Roman Abramovich, a high-profile oligarch, raised questions about Sibnefts transparency as the deal proceeded without timely notice to the minority shareholders (Vremya Novostei, 2001). On balance, the companys ranking improved only slightly between 2001 and 2002 (from 24.5 to 24 risk points) as the penalty points in transparency and asset transfers categories offset the gains in potential dilution, corporate governance initiatives, and dividend policy groups (UBS 2002, 8; Appendix 1). In other companies, the gains in corporate governance quality were less ambivalent: in particular, Yukos, Norilsk Nickel, and Tatneft steadily and substantially improved their rankings between 2000 and 2002. Norilsk Nickel, for example, proceeded as planned with corporate restructuring involving the cancellation of cross-held shares, installed preemptive rights in its charter (protecting against dilution), and listed its depositary receipts in the U.S. (UBS 2002, 6); not coincidentally, the company saw its reputation in Eksperts annual ranking rise from place 18 in 1997 to rank 6 in 2001 (Ekspert, 2002). Overall, the positive trend noted in Figure 2 reflects unmistakable improvement in concrete indicators of corporate governance across many of Russias blue-chip firms. While being the chief GDP contributors, these companies are by no means representative of the Russian corporate landscape. To assess how the rest of the economy fares, I use the data from the 2003 large-scale survey of 1,000 industrial enterprises, conducted jointly by Eurostat and Russias Center for Economic and Financial Research, which explicitly focuses on companies that do not have an RTS quotation of first or even second tier: this sample is representative of Russian industry, where access to equity markets is still an exception rather than the rule. Using questions on the implementation of six specific corporate governance standards (Figure 3), the study shows that only 1.3 percent of companies implemented all six measures while the average level of corporate governance adoption (represented by the aggregate portion of positively answered questions) was 42 percent (Guriev et al. 2003, 39). Of further interest are the aggregate sectoral rankings for non-blue-chip companies in which food-processing (rank 8), light industry (7) and construction materials (6) perform significantly worse than power and fuel (1), iron and steel (2), and chemicals (3), with machinery (4) and forestry/paper (5) occupying the middle of the spectrum (ibid, 23). 3. Corporate governance disaggregatedby specific institutions Which observable components does corporate governance comprise, and how are they implemented across firms and sectors? Figure 3 illustrates the results for non-blue-chip companies. Notably, there has been considerably more progress on the representation of minority shareholders and independent directors on corporate boards than on the implementation of international accounting standards such as U.S. GAAP or IAS. Sixty percent of the industrial firms (as compared with 25 percent of the blue chips) still do not have an independent share registrar, which evokes the manipulations of the 1990s, when cases involving the refusal to transfer shares, changing the share registration from common to preferred, illegally striking off shares from registers, or accidentally losing records were widespread (Guriev et al. 2003, 41; OECD 2002, 10; UBS 2002, 4)it is obvious that this state of affairs impedes the liquidity of shares needed for efficient asset reallocation. The Agenda for GSMs column captures whether the companies distribute an agenda in advance of general shareholder meetings, thus allowing shareholders to raise their concerns effectively. The presence of a shareholder affairs department reflects the existence of an institutional vehicle for conflict resolution.

Figure 3: Implementation of specific corporate governance institutions in non-blue-chip companies in 2003: survey data of 1,033 companies

90 80 70 60 50 40 30 20 10 0
INTERNATIONAL AGENDA for GSMs ACCOUNTING INDEPENDENT REGISTRAR SHAREHOLDER AFFAIRS DEPARTMENT INDEPENDENT DIRECTORS MINORITY SHAREHOLDERS REPRESENTED

Yes
Note: Vertical axis represents percentage of responses. Source: CEFIR study (Guriev et al. 2003, 41)

No

Not all six institutions reflected in Figure 3 are required by law to be implemented (Guriev et al. 2003, 15). The distribution of a shareholder meeting agenda to all shareholders is required of all companies while the international accounting standards are only imperative for listed companies in the first tier. An independent registrar is a legal requirement for companies with more than 500 security holders. Table 2 presents information for blue-chip companies: the data are disaggregated by company and by corporate governance category (see Appendix 1 for methodology). It is apparent that while correlated for each company, corporate governance institutions are implemented very selectively. VimpelCom (overall rank 1), for example, is a paragon of transparency and unrestricted ownership for minority shareholders and foreigners, but scores clearly worse on stipulations preventing share dilution than Tatneft or Mosenergo (overall ranks 7 and 10 respectively), and also scores worse on board independence, corporate governance charter and dividend policy (as represented by corporate governance initiatives) than Lenenergo or Sibneft (overall ranks 4 and 14, respectively). As for the differential quality of corporate governance standards across companies, the most severe risks are related to the manipulation of assets and dubious pricing techniques (Asset Transfers column), to the lack of minority shareholders and independent experts on corporate boards as well as to erratic dividend policy (Corp.Gov. Initiatives column). Much better, on the other hand, is the situation with respect to financial transparency and information disclosure, dilution of stakes, and restrictions on ownership and voting (first, second, and sixth columns respectively).

Table 2: Implementation of specific corporate governance institutions in twenty blue-chip companies in 2002
Rank (prev.) MAX AVERAGE 1 (1) 2 (4) 3 (3) 4 (2) 5 (7) 6 (8) 7 (9) 8 (5) 9 (-) 10 (5) 11 (12) 11 (18) 13 (9) 14 (11) 15 (15) 16 (12) 17 (16) 18 (14) 19 (17) 20 (19) VimpelCom UralMash
MTS

Low Transparency 14 3.5 0.0 0.5 0.0 3.3 4.0 3.5 2.0 4.0 2.0 3.5 2.0 3.5 6.5 5.5 6.5 0.5 2.5 3.5 4.0 10.3

Dilution 13 3.1 3.0 3.0 3.0 0.0 3.0 1.0 0.0 4.5 3.0 0.0 6.0 4.0 1.0 6.0 6.0 11.5 3.0 6.0 3.0 3.0

Asset Transfers 10 5.3 2.0 2.0 5.0 3.0 3.5 7.0 6.0 2.0 6.0 6.0 3.0 5.0 7.0 10.0 3.0 6.0 6.0 5.0 8.0 9.0

Mergers/ Restruct. 10 2.7 0.0 4.0 0.0 6.0 0.0 1.0 0.0 3.0 1.0 6.0 4.0 1.0 3.0 1.0 0.0 0.0 7.0 7.0 5.0 4.0

Bankruptcy 12 1.5 0.5 1.5 1.0 2.5 0.0 1.0 1.0 0.0 1.0 1.5 2.0 1.0 2.0 0.0 1.0 2.0 3.0 1.5 6.0 4.0

Ownership Restrictions 3 0.5 0.0 0.0 0.0 0.0 3.0 0.0 2.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 2.0 0.0 2.0 0.0

Corp.Gov. Initiatives 9 4.4 5.0 2.0 5.0 1.5 3.0 4.0 7.5 5.0 7.0 4.0 4.0 7.5 4.0 1.5 7.5 7.0 4.5 7.5 2.5 4.5

Registrar 1 0.4 0.0 0.0 0.0 0.0 0.0 0.0 0.5 1.0 1.0 0.5 1.0 0.0 0.0 0.0 1.0 1.0 0.0 0.0 1.0 1.0

Lenenergo
SUN Interbrew

Lukoil Tatneft Baltika Severstal Mosenergo Rostelekom Norilsk Nickel

PTS

Sibneft Surgutneftegaz Aeroflot

UES

Irkutskenergo Gazprom
MGTS

Note: Ranking numbers reflect corporate governance risk; higher numbers imply lower quality of corporate governance. Numbers in parentheses refer to the previous period. For methodology, see Appendix 1. Source: UBS Warburg 2002, 4.

4. Corporate governance disaggregated international dimension Two aspects of international finance are particularly relevant with respect to the governance of Russian corporations: the stakes in Russian corporations owned by Western institutional investors, and the listings of Russian shares on foreign stock exchanges. The blocks held by institutional investors, such as pension or mutual funds, are typically large and more likely to impact boards and shareholder meetings than minority shareholders at home or abroad. Until recently, the presence of such investors in Russia was minimal. In 2002, the largest U.S. pension fund CalPERS announced in a precedent-setting move that it would exclude emerging markets whose states do not respect human rights from its portfolio, explicitly dropping Russia from the list of permissible nations (San Francisco Chronicle, 2002). In a possible reversion of this trend, Fidelity Investments became the third-largest owner of VimpelCom in February 2004 by purchasing an 8 percent stake in the corporation (Vedomosti, Feb. 18, 2004). More pertinent for the time being is the propensity among Russias companies to list their papers on foreign exchanges. Theoretically, this trend has been linked to the desire of companies operating in investor-hostile environments to signal their goodwill to potential foreign owners via compliance with the corporate governance requirements of Western stock exchanges; effectively,

companies opt into investor-friendlier regimes and break through the ceiling of country risk perceptions (Doidge et al., 2004; La Porta et al., 2000). Practically, the listing on NYSE usually involves the issue of American Depositary Receipts (ADRs). ADRs provide U.S. investors with a convenient way to invest in foreign securities, circumventing the complexity of cross-border transactions and offering the same benefits enjoyed by the domestic shareholders of the foreign corporation.6 The UBS corporate governance rankings used in tables 1 and 2 assign two penalty points if a company has no plans to issue ADRs. One must beware using ADR issues per se as a corporate governance indicator, however, since the requisite corporate governance standards vary by ADR level: Level 1 ADRs barely require any disclosure and are inexpensiveless than $25,000 for a given company (Smirnova 2004, 8)but can only be traded in the over-the-counter market chiefly intended to assess the interest of the U.S. investors. Level 2 ADRs involve detailed financial disclosure including the reconciliation of financial statements to the US GAAP, and the timely submission to the SEC of all annual reports and interim financial statements: these ADRs can be listed and traded on one of the U.S. exchanges including NYSE, AMEX, etc.the issue costs range from $200,000 to $700,000 (ibid). Neither level 1 nor level 2 ADRs can be used to raise new equity capital which is reserved for level 3 ADRsthe most prestigious category providing the issuer with the ability to float a public offering in the U.S. and to list the ADRs on Nasdaq or one of the U.S. exchanges. The greatest market visibility inherent in Level 3 ADRs requires compliance with a panoply of SEC rules, including the full registration and reporting requirements of the SECs Exchange Act (which entail, e.g., the obligation to inform investors of the risks inherent in the corporations businesses).7 The fourth issue category comprises the so-called privately placed DRs (SEC Rule 144a ) which do not require SEC registration, and can raise capital through private placement with large institutional investors. While the disclosure requirements here are lower than in any of the three ADR levels mentioned above, private placement under Rule 144a suffers from limited liquidity and market visibility and is also pricey: $250,00$500,000 per issue (ibid). The UBS governance rankings take into account the different impact of ADR levels by only rewarding corporations with level 2 or 3 ADRs. Appendix 2 presents a comprehensive listing of foreign issues in the U.S. by Russian entities categorized by issue type. With the exception of VimpelCom, which floated ADRs in 1996 (the first Russian company since 1903 to list its stock on the NYSE), all other Russian corporations with level 3 ADRs MTS, Wimm-Bill-Dann, and the newcomer Mechel Steel Groupfloated their issues after 2000. Interestingly, none of the elite level-3 ADR issuers is in the energy sector, and only one fuel company, Tatneft, has issued level 2 ADRs (in March 1998). Energy, electric utilities, and metals firms (including Yukos, Lukoil, and Norilsk Nickel) are more prominent in the level-1 ADRs list (seventeen out of thirty-seven corporations) where the corporate governance requirements are significantly lower. Overall, only six Russian corporations have been able to issue level 3 or level 2 ADRs, as compared with forty-seven entities which have successfully sought level 1 ADRs and privately placed receipts. The impact of ADR floats on corporate governance so far appears mixed given that the overwhelming number of corporations have issued ADR types which do not involve significant governance adjustments. Yet companies with level 2 and 3 ADRs certainly had to absorb the new game rules. While the U.S. market remains hard to penetrate for capital-raising purposes, Russian corporations are discovering the London Stock Exchange as a less stringent alternative. Currently, the following Russian companies are listed on the LSE: Tatneft, Gazprom, LUKOIL, United Heavy Machineries, with AvtoVAZ undergoing the listing process (Vedomosti, Feb. 05, 2004). A full LSE listing requires three years of audited accounts using international standards and the quotation of shares in Moscow for at least six months. (Technically, companies can also list on Aim, Londons junior exchange, and obviate many disclosure requirements.) The truly relevant difference to the American
represent physical certificates of ownership in foreign corporation(s) while the actual shares of the foreign company are held on deposit by a custodian bank in the company's home country. ADRs carry the corporate and economic rights of the foreign shares, subject to the terms specified on the ADR certificate. 7For more details on ADR requirements, see http://www.adr.com/research/about_def.html
9
6ADRs

market, however, is the daunting Sarbanes-Oxley Act, adopted in the wake of the Enron scandal, which requires CEOs and finance directors to vouch personally for the accuracy of financial data, and which treats false statements as a criminal offence: the specter of such potential criminal liability can make Russian managers think twice about a listing in New York, says the head of equities at Alfa Bank, Russias biggest private bank (Ekspert, 2004). The stringency of requirements for raising capital in the U.S. is demonstrated by Wimm-Bill-Danns embarrassing admission, ahead of the companys NYSE listing in February 2002, that its largest shareholder is an ex-convict formerly imprisoned for violent crime, and that some of its owners and directors run the Trinity automobile and casino concern that, as Wimm-Bill-Dann carefully put, has been the subject of speculation in the Russian press, including possible links with organized crime. (Wall Street Journal, 2002) Yet, despite the very real limitations on managerial discretion accompanying many foreign listings, Russias top companies continue to seek IPOs en masse. Analysts mention twenty to thirty corporations with potential foreign IPOs in 2004-07, including Russias second-largest gas company Novatek, Rosbank, and others (see Euromoney (2004) for a full list). Says a London Stock Exchange expert, Russian companies [are] taking the steps necessary prior to an international listingundertaking restructurings, consulting with S&Ps corporate governance department,to make themselves more attractive. (ibid). Crucially, even companies whose financial and ownership attributes do not warrant hopes of capital inflows seek to list abroad and improve corporate governance. In October 2004, Russia's fifth-largest steel producer Mechel startled analysts by issuing level 3 ADRs on the New York Stock Exchange. For the first time, the company released its IAS financial statements and filed ownership-revealing documents with the U.S. Securities and Exchange Commission. The results raised eyebrows: companys operating profitability was only 9 percent in 2003 as compared to 25 percent and 40 percent for its competitors Severstal and Novolipetsk respectively, while its two senior managers (chairman Igor Zyuzin and general director Vladimir Iorikh) each controlled, directly or indirectly, roughly 47 percent of the company (Moscow Times, 2004). The international dimension of corporate governance seems to confirm the trend towards better corporate governance among the blue-chip firms. While not all listings abroad require tangible restructuring of corporate control, many do, and multiple heavyweight corporations seem eager to play by the rules and gain international exposure. 5. Finance as the driver of corporate governance fashion? Think again. Corporate governance has become a concern for many, though by no means all, blue-chip firms in Russia since the end of the 1990s. Multiple corporations have adopted measures that restrict managerial discretion through higher transparency, exacting share listings abroad, the presence of independent board members, and so forth. How do we explain this trend? The most intuitive explanation points to the need for investment as the key driving force: [s]ince the Russian market is relatively small, companies seek funding abroad, where rather stringent requirements are applied Good reputation allows raising funds through share issues or borrowing at more favorable conditions (Kaznadeeva, 2001). This explanation fits the evolutionary theory of economic change according to which, in the long run, product market competition forces firms to minimize costincluding the cost of capital, which in this case is minimized through the selfimposition of corporate governance standards. Likewise, the contemporary theory of corporate governance links greater expropriation of outside shareholders with worse terms for external finance. The theory posits a J-curve representing the firm value to corporate insiders after the introduction of investor protection: as long as the insiders discount the future value of the firm appropriately, and the macro-level uncertainty is kept within bounds, they can be expected to impose stricter governance measures upon themselves and suffer a decline in their rent streams that will be compensated by future capital inflows and rising profitability (La Porta et al., 2000).

10

I will argue that this finance-related explanation at best underdetermines the rush of Russias blue chips to corporate governance, and at worst distorts the reality by neglecting the role of the Russian government. In this section, I will mention several factors undermining the plausibility of the investment-related theory in the Russian context, and will then suggest an alternative angle. First, an up-to-date rigorous study of ADRs issued by Russian corporations shows no connection between a companys listing abroad and its stock returns: while the increased market visibility does lead to larger trade volume both in Russia and in the U.S., and hence to larger stock price variance, the average returns do not increase appreciably (Smirnova, 2004). The stock returns in the wake of an ADR flotation do not explain the willingness of Russian managers to undergo the painful process of compliance with the U.S. regulations on corporate governance. The evidence on investment flows and corporate governance is also mixed. The 2003 CEFIR survey of 1,000 industrial enterprises shows that improved corporate governance per se has no impact on investment (Guriev et al. 2003, 24-8), although this may be due to the exclusion of blue chips from the sample. Second, as already shown, companies sometimes can raisecapital abroad without major adjustments of their corporate governance practices, e.g. through private placements under the 144a SEC Rule in the U.S., or by listing on the Aim market in London. Third, according to the 2001 survey of corporate governance in RTS-listed companies, conducted by the Association of Russian Managers, the top managers of a hundred Russian companies were prepared to adopt the measures recommended by the government-endorsed Corporate Conduct Code even if they were not sure it would help them to attract investment (AMR/ RID, 2001). Fourth, the idiosyncrasies of Russias corporate landscape raise doubts about the suggestion that concerns with investment or market capitalization are forcing the top corporate managerial elites into accepting meaningful constraints on their own discretion. The defining trend in Russian big business today is its ongoing consolidation in a ruthless process of empire-building (Barnes, 2003; Hellman, 2002). Unlike the loose coupling of the financial-industrial groups of the 1990s, the current consolidation involves real technological, economic and financial integration[with] considerably higher level of corporate control over affiliated companies[and] effective organizational and legal transformation (OECD 2002, 83). The oligarchs of the 1990s were politically powerful yet economically fragmented; today, the opposite is true, as the politically marginalized tycoons expand and integrate their business empires. A ninety-page, in-depth OECD study concludes that explicit or disguised consolidation of ownership and control in Russian corporations remains a keytrend[that] has resulted in numerous conflicts with minority shareholders (ibid, 83). This consolidation often proceeds via illegitimate takeovers and set-up bankruptcies (Volkov, forthcoming).8 It should be apparent that attracting foreign capital is hardly the main headache of Russian managers. Yet the trend towards and the publicity around corporate governance is unambiguous among Russias corporate leadership, begging for an explanation. The next section briefly sketches out two possible roles the Russian state may have played in the process. 6. The Russian state: bell cow or scarecrow of corporate governance? Two related empirical points about the Russian governments involvement in the economy since the end of the 1990s pertain directly to our discussion. First, there has been a major shift in economic policy towards the reassertion of state capacity, with a concurrent speed-up of structural economic reforms (Nesterenko, 2000; Volkov, forthcoming). Dissatisfied with the Washington Consensus which prioritizes (sequentially if not substantively) stabilization and liberalization over admin8Due to the incomplete bankruptcy legislature, it is now possible to bankrupt legally virtually any company by buying up its debts and filing a legal suit against the debtor. The numbers are telling: in 1998, 4,747 companies were judged bankrupt; in 1999: 8,299; in 2000: 15,143; in 2001: circa 30,000; about one-third of these cases involved bankruptcy po zakazu [on demand] (Peregudov, 2003, p. 71).

11

istrative reform, the enforcement of property rights, and a long-term economic strategy, Putins government is much more receptive to the ideas of soft dirigisme, i.e. the state-administered creation of market infrastructure, despite the prominence of outspoken economic liberals such as Illarionov in Putins entourage. In 2003, the Ministry of Economic Development and Trade announced that in order to decrease Russias dependence on natural resources, the government will stimulate the agriculturalmanufacturing complex, the defense industry, and small businesses (sectors that must become the locomotives of the economy), while pushing for the de-monopolization and the debureaucratization of business environment (Strana.Ru, 2003). Concurrent with the official policy shift away from monetarism, the Kremlin has encouraged big business to contribute financially to the welfare system while politically exploiting corporate wrongdoing to keep the oligarchs in check. Second, and much less appreciated in the literature, is the role of the Russian state qua shareholder. An EBRD working paper (Sprenger 2002, 5) puts the stake owned by the Russian state in the hundred largest Russian enterprises at 14 percent, i.e., higher than at any point since 1995. The OECD estimates (Figure 1) suggest a 50 percent rise (!) in state ownership in medium and large joint-stock companies (from 8 to 12 percent) between 1998 and 2000. Surveys conducted by Radygin show a more conservative 30 percent growth in the average state-owned stake (from 10 to 12.8 percent) between 1996 and 2000 (cited in OECD 2002, 88). According to the Russian government, in 1999, the state had a share in more than 3,800 companies, including a 25-50 percent stake in 1,636 companies, a 50-100 percent stake in 489 companies, and a 100 percent stake in 364 companies; the government held a golden share (veto rights disproportionate to ownership) in 586 of these companies (Molozhaviy 1999, 2).9 Importantly, while the Russian state was legally precluded from buying shares during privatization, the law does not bar the purchase of shares by the state on secondary markets which amounts to (partial) re-nationalization (Pistor and Turkewitz 1996, 207). The growth in the states equity stakes is assessed by the OECD (2002, 82) as mid-term in nature and[likely to] continue in the next few years, attributable to the fact that private companies in arrears with mandatory payments have been declared bankrupt and taken over by the state, especially in the regions during 19982000. (Colorful examples of governors from Pskov, Kursk and Bashkiriya unleashing tax authorities on corporations and distributing the shares to their family members [Barnes 2003, 176] suggest that nepotism and personal enrichment were as much an issue as the lacunae in budget revenues.) For our purposes, however, the more institutionalized dynamic among the blue-chip firms is crucial: the years 1998-2000 werecharacterized by attempts to strengthen and tighten state control over companies in key sectors of the economyby redistributing state ownership in some major Russian corporations[through] consolidating the government-owned blocks of shares under the aegis of holding companies (OECD 2002, 82). A move towards state activism as far as the management of government-owned equity is concerned crystallized by the end of the 1990s. In 1999, the Deputy Minister of the State Property Ministry announced that the Russian Federation remains a major owner of property andplans to expand its regulatory function (Molozhaviy 1999, 2). These dynamics contrast sharply with states apathetic approach towards governmental equity management throughout the 1990s (Pistor and Turkewitz, 1996). Related to the second trend has been the increase in the number of state unitary enterprises: The past few years have been witnessing the emergence of more and more state unitary enterprises (so-called GUPs, state-owned entities with the right to carry out commercial activity, and, on paper, accountable to the Labor Ministry) that oftentimes effectively turn into the private companies of particular federal officials... [T]here are approximately 10,000 GUPs in Russia now and their number continues to grow. This means that state business is expanding. (Moskovskie Novosti, 2004)

9These

figures do not include more than 14,000 federal unity enterprises owned by the state at the time.
12

In the orthodox finance-related explanation of corporate governance, the concurrent increase of state pressure on firms and the companies adoption of better governance practices presents an anomaly. As S&P concludes in its 2004 report, [The] 2004 Transparency and Disclosure Survey of Russian companies indicates a[n] improvement in disclosure standards since the 2003 survey. This is particularly intriguing given the increased tension between the business community and the state bureaucracy brought on by the Yukos affair. This year's actions against Russias largest oil company could have potentially negatively affected the inclination of individuals and firms to disclose their ownership structures and otherwise decreased their standards of disclosure. Yet, the opposite pressure on the part of investors and the broader business community prevailed. Overall, S&Ps Governance Services index of transparency among the largest Russian companies has increased to 46% from 40% in 2003, and from 34% in 2002. (S&P, 2004, 2; my emphasis) The orthodox account juxtaposes the positive pressure of foreign investors with the negative impact of the Russian state on corporate practices. Yet, as already shown, the impact of foreign capital per se is highly questionable in the Russian context. Conversely, I argue that the outlined shifts in state policynamely, towards (a) more dirigisme in the economy with explicit pressure on big business, and (b) increased and more actively managed state equity in corporationshave positively influenced the trajectory of corporate governance in Russia. Of course, the impact of the Russian state and that of foreign capital are not mutually exclusive. Yet while the literature has exclusively focused on the latter, I present two scenarios according to which the state may have greatly (and positively) affected how Russias corporate behemoths are run. The bell cow scenario The Russian state may have endorsed the corporate governance agenda directly by playing the role of a bell cow with corporations following the lead. To begin with, as is the case with any owner, the Russian government cannot be uninterested in the returns its stake generates. The returns on investment in partially state-owned corporations had been dramatically undercut by the abuses of corporate governance throughout the 1990s. As of 1997, only 7 percent of partly state-owned corporations paid any dividends to the government; in 1999, the Ministry of State Property put the return on states investments at paltry 0.016 percent (Molozhaviy 1999, 3). Ironically, firms which had the governments share between 5 and 51 percent performed even worse than fully state-owned corporatized entities, because no effective monitoring of management could take place (Sprenger 2002, 8-9). Of course, the official budget-destined return on state-owned equity should not be confused with the cash pocketed by state representatives on corporate boards. By 1999, circa 2,000 state officers were delegated as state representatives in corporate decision-making bodies; 90 percent among them were employees of industrial ministries and local governments, and 10 percent came from the federal ministries10 on economic policy and public property (Molozhaviy 1999, 4). Given that these latter federal units are perceived as more committed to economic reform and less open to collusion with the incumbent management than the industrial ministries or local governments (Peregudov 2003), such division of responsibilities must have seemed unfortunate to the federal ministries officials. In any event, severe principal-agent problems between Moscows ministries and the local government officials on corporate boards included the failure of delegated state representatives to respect federal instructions on how to vote on company governance bodies, the representatives

10These include: the Russian Ministry for the Management of Public Property, the Russian Federal Property Fund, the Russian Finance Ministry, the Ministry of the Russian Federation for Anti-Monopoly Policy and Support of Business.

13

lackluster commitment to company affairs (sitting on corporate boards is a part-time job), and their sheer incompetence (Pistor and Turkewitz 1996; Molozhaviy 1999, 4). The concern with state equity returns, the loss of control over government representatives on corporate boards, and the broader shift towards more hands-on economic reforms are plausible reasons that have promptedat least according to governments official stance (ibid, 5)the federal organs to endorse professional outside auditors, stricter monitoring procedures, and a harder line on dividend payments. In February of 2004, for example, the Ministry on Trade and Development officially supported Vadim Kleiner from Hermitage Capital Management, known for his activist stance on corporate governance and transparence, in his bid for election to Gazproms board of directors (Vedomosti, Feb. 03, 2004). At Svyazinvest in the same year, five federal ministries pooled their efforts to establish a committee on corporate governance with one representative from each ministry, along with representatives of other investors and the Investor Protection Association (Vedomosti, Feb. 16, 2004). In a less benign trend, the federal ministries have clashed over whose representatives will sit on corporate boards of partially state-owned companies. As Russian analysts observe, Shortly before his dismissal, ex-prime minister Kasyanov ordered some Kremlin officials to be removed from the boards of directors in several large firms. In particular, ministers German Gref, Alexei Kudrin, and Ilya Yuzhanov had to cut down the number of their positions on corporate boards. Yet Kasyanovs plan added up to little more than a personnel reshuffle: While the Ministries of Trade and of Antimonopoly Policy lost some of their positions, other government agencies and departments, including the Energy Ministry, strengthened their flanks. Today Category-A officials are still calling the shots on boards of directors at statecontrolled companies: government ministers, deputy ministers, and Presidential Staff functionaries. All the indications are that the state is not going to let go of such an important element of regulating property and financial flows. Besides, the Ministry of Economic Development and Trade is currently drafting amendments to a law providing for state representatives on corporate boards of directors to be replaced automatically, without the need to call a shareholders meeting. (Moskovskie Novosti, June 04, 2004) The quoted report somewhat ominously concludes that the controlling stake in the Russian economyis still held by the state that [now] manages it through its representatives on corporate boards of directors (ibid). The most prominent example consistent with the bell cow scenario is the creation and promotion of the Corporate Conduct Code [Kodeks Korporativnogo Povedeniya] by the Russian government. The Code affirms the protection of interests of all shareholders, regardless of their stake size as its purpose, noting that better corporate conduct will increase investment inflow to all sectors of the Russian economy, from domestic sources and foreign investors alike (FCSM 2002, 3). Work on the Code began in mid-2000 in the context of new governments ambitious reform plan, and was completed in 2001, as requested by the ex-Prime Minister Kasyanov (UBS 2002, 13). Substantively, the Code is formulated as a set of legally non-binding recommendationsthough the government said it may make it enforceable at a later stagewhich chiefly reflect the outsider (shareholder value) model of corporate governance common in Anglo-Saxon countries, with some provisions common to the insider (relational monitoring) model.11 Given the non-binding nature of the

11The outsider model is reflected in the equal rights of shareholders at annual meetings (nota bene: these are, ironically, violated by the Russian states possession of golden shares), the significant information disclosure requirements to all current and potential shareholders, and the stress on maintaining share liquidity. The insider model is reflected in the preference for a collegial executive body (rather than a single CEO) and the emphasis

14

Code, could the corporations have been reasonably expected to comply? As UBS Warburg perceptibly observed, most large companies will be forced to comply from the start. First, this relates to companies where the state has majority controlGazprom, UES and Sberbankgiven the governments support for the initiative. Secondly, large companies that are still heavily dependent on political decisions are unlikely to risk the governments wrath. (ibid, 13). It is, indeed, plausible that the Code was written as not-so-tacit dictate of the new game rules for business elites in strategic sectors rather than as an economy-wide educational initiative. The CEFIR 2003 survey of non-blue-chip firms indicates that two years after the Codes pompous initiation, less than a third of executive managers in manufacturing know about the Codes existence, and only four percent are familiar with the Code in detail (Guriev et al. 2003, 29): the government, it seems, has made little effort to preach the Code in sectors where corporate governance abuses are worst. But the oligarchs did get the message. The scarecrow scenario More speculative in nature, this scenario posits that big business has endorsed corporate governance voluntarilybut not in order to attract foreign investment per se. Instead, corporate governance measures were intended by managerial elites as an anti-state insurance. The shift towards soft dirigisme in the economy was apparent before Putins tenure, and the not-so-soft intimidation of big business after 2000 left no doubt that conducting business as usual was no longer an option. In the 1990s, corporate elites could expropriate minority shareholders and tunnel assets out of the country while pushing the state for various concessions. With the shift in state policies and equity management style, the Russian government sent a credible signal that the elites ongoing rent streams could be imminently and permanently terminated. Faced with a dilemma (play by the rules and forego rents, or conduct business as usual and risk Kremlin scrutiny), big business may have found a third option. By adopting minimal corporate governance standards necessary to attract Western investors and broad international legitimacy among governments, think-tanks, media, etc.the corporations gain potentially powerful allies against interventionism by state authorities. The adoption of shareholder-oriented corporate governance, hence, is by no means a knee-jerk reaction to financial distress that supposedly forces managers to limit their own discretion. Managerial elites are willing to give the Western minority shareholders some control (easily abrogated when need be) when faced with a domestic rivalthe statecapable of appropriating much greater and more irreversible control rights. Opportunistic uses of legality by economic elites have been barely investigated in the literature.12 The scarecrow scenario effectively presents a case of agents (managers) trying to play off several principals (corporate stakeholders) against each other by using institutions (corporate governance) that have acquired broad international support. Empirically, the support for this scenario is not easily quantifiable. One interesting possibility concerns the previously discussed wave of level 1 ADR issues (see also Appendix 2) steadily rising since the end of the 1990s. Since these issues generate international visibility without new equity capital, the motivation behind them could be precisely that: to be visible and legitimate abroad in the hope of international support should the war on oligarchs at home be extended to more than a handful of showcases. The underlying logic of the scarecrow scenario is rather intuitive. In a poor country such as Russia, being extravagantly rich is immoral; any potential witch-hunt would be popularly supported, and the top magnates have become conscious of their political vulnerabilityhence the oligarchs philanthropy at home, and network-building abroad. Yukos provides a fascinating case-study for both of these strategies. With charitable donations exceeding $50 million annually across a broad range of causes (New York Times, 2003; ibid for this paragraph), the Yukos ex-CEO Khodorkovsky could teach Dale Carnegie a thing or two about
on company-internal monitoring including with a control and revision commission reporting to the annual shareholder meeting. (FCSM 2002; McCarty and Puffer, 2002) 12For one important exception, see Woodruff (2004).
15

how to win friends and influence people. Khodorkovsky sought a meeting with the national security adviser, Condoleezza Rice, as soon as George W. Bushs administration moved into the White House in early 2001part of the tycoons efforts to secure approval from the American establishment. Khodorkovsky did not meet Ms. Ricehaving failed a security background checkbut his steady efforts to win access to other influential Americans paid off. Just before his arrest, Khodorkovsky met with Energy Secretary Spencer Abraham to discuss America's oil policy. The Carlyle Group, an investment bank with the ex-president Mr. Bush senior as an adviser, maintained close business ties with Khodorkovsky. In summer 2002, Khodorkovsky attended a business summit in Idaho as a guest of a former senator, Bill Bradley, a New Jersey Democrat. The New York Times reports that Mr. Khodorkovsky spent heavily in Washington to court the Capitols inner circle. The Open Russia Foundation based in London and bankrolled by Khodorkovsky is advised by Mr. Bradley as well as Henry Kissinger, with whom Khodorkovsky had met twice. Since foreigners are barred from donating money to American politicians or political parties, Khodorkovsky focused on the U.S. thinktanks and organizations, including a $1 million donation to the Library of Congress and a $500,000 pledge to the Carnegie Endowment for International Peace. Both the Carnegie Endowment and the American Enterprise Institute (which declined to disclose its financial connection with Yukos) have backed Mr. Khodorkovsky in his ongoing stand-off with the Russian government. Could the improvement in corporate governance have similarly played the role of political insurance for top Russian magnates facing potential state persecution or marginalization through the states increasing economic dirigisme? Fiona Hill, a Russia analyst at the Brookings Institution, noted that the [American] think tanks were all joking about who wanted to take money to fund the Mikhail Khodorkovsky chair of good corporate governance (ibid). Jokes aside, the strategy worked. As Khodorkovskys conflict with the Russian government escalated, the tycoon enjoyed the firm (albeit futile) support of Western interests. Arguably, the improvement in corporate governance was crucial to subdue Western memories of the egregiously criminal abuses of law by the company throughout the 1990s. Tellingly, the Economist lashed out against Putins overall record by stating that the attack on Yukos, the best-run and most western-looking of Russian companies, was the worst of all (Economist, 2004, p. 9, my emphasis). Of course, if corporate governance measures were, indeed, intended as anti-state insurance by big business, the Yukos case has starkly demonstrated the limits of coverage. Conclusion This paper has investigated the quality of corporate governance in Russia in the initial, formative stage of Putins administration. The UBS Warburg data show a clear improvement across a set of specific corporate governance indicators for twenty leading corporations between 2000 and 2002. At the end of the period, there was substantial progress with respect to financial transparency and information disclosure, the risk of share dilution, as well as restrictions on ownership and voting. The companies VimpelKom, Lenenergo, and UralMash-Izhora scored best in the covered time frame, while Gazprom, GAZ, and MGTS received lowest rankings. The positive development of corporate governance among blue-chip firms was confirmed for the years 2003 and 2004 by the S&P study of Russias fifty largest companies, as well as by the annually conducted studies at the Institute of Corporate Law and Governance. The condition of corporate governance among the rest of the industrial sector appears worse, as demonstrated by the 2003 study of 1,000 industrial enterprises by Russias Center for Economic and Financial Research; but here, too, there are important sectoral and institutional variationsnatural resources and chemicals performed significantly better than other sectors (with food-processing and light industry being worst), while the representation of minority shareholders and independent directors on corporate boards is much more widespread than the implementation of international accounting standards.

16

To analyze the international dimension of corporate governance, this paper employed a dataset of Russian entities that have floated depositary receipts in the U.S. market. The listings increasingly involve high-level ADRs that necessitate substantial reforms of corporate governance. The number of IPOs is growing even for firms whose underlying fundamentals are too questionable to attract large capital inflow; this trend is particularly relevant for the London Stock Exchange, where three years of audited accounts according to international accounting standards are required. In explaining the improvement of corporate governance among big businesses, this paper has shifted attention from the lure of foreign investment to the role played by the Russian state. This perspective is particularly cogent in Russia given the recent serious changes in state policy towards economic dirigisme with explicit pressure on big business, and governments increased and more actively managed equity stake in partially state-owned corporations. As to the question of how these shiftspace the orthodox interpretationcould have positively influenced the quality of corporate governance, the paper offered two scenarios. First, the Russian state may have endorsed the corporate governance agenda to enhance the returns on state equity, to regain control over government representatives on corporate boards, or as a by-product of inter-agency struggle for asset control among federal ministries. Second, corporate governance may have been initiated by the big business elites themselves as anti-state insurance: politically unpopular and criminally liable tycoons may have sought international legitimacy, trying to play off Western investors and other foreign interests against the Russian state. These scenarios are not mutually exclusive. Most likely both efficiency and control-related incentives drive the corporate policy of the Russian state elites which comprise economic liberals, but the power-hungry siloviki are also largely thought to be behind the Yukos assault. The empirical dynamics addressed by the scenarios harbor great theoretical promise: effectively, corporate governance is an institutional toolkit from which state and managerial elites borrow selectively to further their agendas. While the state seeks financial transparency and managerial accountability in order to increase tax revenues but also to streamline control of the oligarchs, the executive managers seek to make their often illegally assembled empires more legitimateand hence more politically immuneextending their networks abroad and deepening the acceptance at home. The analysis of Russias corporate governance along these lines will yield qualitatively better insights than references to foreign investment as a perpetum mobile of corporate governance reform or a panacea for economic inefficiencies. While it is not difficult to bring the Russian state back in, an empirically and theoretically satisfying analysis of governmental involvement in corporate affairs remains to be conducted. This paper has sought to make a step in that direction.

17

Appendix 1 Methodology behind UBS Warburg corporate governance ratings (Source: UBS 2002, 20-2) Real and perceived corporate governance risks are divided into eight categories and twenty subcategories, each with a clearly defined risk weighting and guidelines for their allocation. Penalty points are assigned, thus the higher a companys rating, the higher the risks associated with it. This model produces results largely consistent with market perceptions of the corporate governance risks companies that receive more than 35 penalty points are extremely risky, while those with a rating below 17 are relatively safe. Main categories for calculating corporate governance risks (maximum possible sum of risk points = 72) 1. Transparency: Max = 14
US GAAP / IAS accounts: Max = 6 Ranges from 6 for companies that are allergic to international accounting standards (usually with good reason), to 0 for those with several years of US GAAP or IAS accounts.

Reputation for openness: Max = 4 Estimated by the relevant analyst, taking into account the presence and quality of a companys investor relations department, the openness of management, and the availability of the operating data necessary to construct accurate earnings models.
ADR program: Max = 2 Two penalty points for no intention to issue ADRs, 0 for an existing Level 2 or 3 program.

Annual General Meeting notifications: Max = 2 Companies unable to deliver AGM agendas to shareholders receive 2, those with irregular or delayed notifications get 1.5. 2. Dilution: Max = 13 The threat of possible unfair or economically unjustified dilution is perceived as one of the largest risks for shareholders. The presence of a large number of authorized shareswhich could be issued at the boards discretionoften indicates a higher probability that a dilutive issue may be upcoming. Reasonable and abusive share issues can be distinguished by whether a placement has clearly stated goals, whether a companys Charter contains protection against dilution, and whether minority investors can block board decisions over new issues. Authorized but unissued shares: Max = 7 The number of penalty points depends on the amount of shares authorized relative to those outstanding and the level of certainty investors have regarding the purposes of a planned issue. Portfolio investors hold 25 percent blocking stake: Max = 3 Companies are assigned 3 penalty points if outside shareholders are unable to block any unfavorable issue. Charter protection: Max = 3 The absence of Charter provisions granting preemptive rights or other measures protecting against dilution result in 3 penalty points. 3. Asset transfers / transfer pricing: Max = 10 Manipulation of assets and dubious pricing techniques are often hard to prove, but are sometimes possible to identify from close examination of financial statements and the trading techniques used by a company. Evidence shows that these practices, while sometimes invisible to investors, create the most serious drain on shareholder value.

18

Controlling shareholders: Max = 5 Companies are given 5 penalty points for having a controlling shareholder with a poor track record on corporate governance. If this shareholder happens to be the Russian government, meaning the company may operate for the benefit of the state rather than other shareholders, it receives 3 points. Transfer pricing: Max = 5 An unclear trading environment or extensive use of offshore and/or affiliated trading companies leads to an increased risk of transfer pricing, and is penalized by 15 points. 4. Mergers / restructuring: Max = 10 If a company in on the verge of merger or serious restructuring this creates the risk that assets may be lost or merger terms unfair, increasing short-term uncertainty. Mergers: Max = 5 Companies with no upcoming merger are given 0, those with announced merger terms 2, while those with uncertain terms, where the mergers are perceived to have a likely negative effect on investors, get the maximum 5 penalty points. Restructuring: Max = 5 This is measured based on the public availability and feasibility of a planned restructuring program and the actual steps management has already taken towards implementation. 5. Bankruptcy: Max = 12 A flexible approach towards measuring bankruptcy risk is adopted which reflects the understanding of the situation by UBS Warburg analysts. Overdue accounts payable or problems with tax arrears: Max = 5 Attempts to initiate bankruptcy, third parties actively buying a companys debt on the market, and large tax or payable arrears contribute to this risk measure. Indebtedness: Max = 5 Penalty points are assigned on the basis of a companys perceived ability to service its financial debt. The maximum 5 points are allocated to companies that have defaulted on their debt obligations. Financial management: Max = 2 The quality of a companys financial management significantly contributes to its ability to extricate itself from complex debt situations and bankruptcy threats. 6. Ownership and voting restrictions: Max = 3 Occasionally, companies have introduced restrictions on minority or foreign ownership or voting. Such companies are penalized since the inability to influence a companys decisions increases the threat that minority investors rights could be violated.
AGM

7. Corporate governance initiatives: Max = 9 A broadly defined measure of managements willingnessindicated by formally taken steps to share profits with outside shareholders and treat them fairly, as well as investors ability to channel their concerns to the board.

19

Board composition: Max = 3 Representatives of minority shareholders or well-known independent industry experts serving on the board usually helps to instill confidence that minority shareholders will at least be informed of the boards activities and have their concerns heard. Corporate governance charter: Max = 2 If company takes the initiative and introduces a corporate governance charter explicitly stating its policy towards outside shareholders, this is generally received positively by the market and reflected by 0 penalty points. Foreign strategic partnership: Max = 1 The presence of a foreign strategic investor working closely with management increases the chances of more civilized policies. Dividend policy: Max = 3 This indicator assesses not only the existence of a clearly stated dividend policy, but also the adequacy of the dividends paid and timeliness of these payments. 8. Registrar quality: Max = 1 Companies are penalized for using captive registrars instead of the services of larger, professional companies.

20

Appendix 2 Issues of Depositary Receipts by Russian entities until Nov. 2004 (Sources: Ekspert Group, http://www.gateway2russia.com/; Bank of New York database, http://www.adrbny.com/dr_directory.jsp; corporations websites) The list is comprehensive to authors best knowledge. If there are multiple issues per entity in a given category, only the earliest issue is recorded. The four categories (Level I-III ADRs and Private Placement under Rule 144a) are described in the main part of the paper, section 6. LEVEL III ADRs (NYSE) COMPANY MECHEL STEEL GROUP MOBILE TELESYSTEMS VIMPEL COMMUNICATIONS WIMM-BILL-DANN FOODS INDUSTRY Mining & Metals Wireless Comm. Wireless Comm. Food DATE Oct. 29, 2004 July 06, 2000 Nov. 01, 1996 Feb. 08, 2002

LEVEL II ADRs (NYSE) COMPANY ROSTELECOM TATNEFT INDUSTRY Fixed Line Comm. Energy DATE Dec. 30, 2002 March 25, 1998

21

LEVEL I ADRs (over-the-counter) COMPANY BANK VOZROZHDENIYE BASHINFORMSVYAZ BURYATZOLOTO CENTRAL TELECOMMUNICATION ELECTROSVYAZ OF PRIMORSKY REGION GUM (TORGOVY DOM) INKOMBANK IRKUTSKENERGO KAZAN CITY TELEPHONE NETWORK KAZANORGSINTEZ KUZBASSENERGO LUKOIL LENENERGO MOSENERGO MOSCOW CITY TELEPHONE NETWORK NIZHNEKAMSKNEFTEKHIM NIZHNEKAMSKSHINA NORILSK NICKEL NOVOGORODTELECOM PETERSBURG TELEPHONE NETWORK ROSNEFTEGAZSTROY ROSTOVELECTROSVYAZ PRIMORSKY SHIPPING ROSTOVENERGO SEVERSKY TUBE WORKS SIBNEFT SURGUTNEFTEGAZ SAMARAENERGO SOUTHERN TELECOMMUNICATIONS TRADING HOUSE TSUM UNITED HEAVY MACHINERY (URALMASH) UNIFIED ENERGY SYSTEMS URALSVYAZINFORM UT AIR VOLGATELECOM YUKOS INDUSTRY Banks Communications Tech. Mining & Metals Fixed Line Comm. Fixed Line Comm. Retail Banks Electric Utilities Fixed Line Comm. Energy Energy Energy Electric Utilities Electric Utilities Fixed Line Comm. Chemicals Auto Parts & Tires Mining & Metals Fixed Line Comm. Fixed Line Comm. Energy Electric Utilities Industrial Transport Electric Utilities Mining & Metals Energy Energy Electric Utilities Fixed Line Comm. Retail Industrial Equip. Electric Utilities Fixed Line Comm. Airlines Fixed Line Comm. Energy DATE July 03, 1996 Nov. 02, 1998 Oct. 27, 1997 Sept. 04, 2001 Sept. 04, 2001 Junr 07, 1996 May 28, 1996 Jan. 23, 1997 March 19, 1998 April 27, 1999 Oct. 23, 1997 Dec. 01, 1995 June 13, 2001 July 17, 1997 June 21, 1999 Dec. 18, 1998 Nov. 02, 1998 June 15, 2001 April 24, 2002 Sept. 04, 2001 Aug. 07, 1997 April 24, 2002 March 25, 1998 Sept. 22, 1998 Feb. 01, 1996 April 20, 1999 Dec. 30, 1996 Feb. 09, 1998 April 24, 2002 July 03, 1997 Jan. 16, 2001 Dec. 10, 2001 April 24, 2002 May 26, 1998 April 24, 2002 Dec. 22, 2000

22

PRIVATELY PLACED DRs (Rule 144a) COMPANY AEROFLOT AKRIKHIN GAZPROM LUKOIL MINFIN MOBILE TELESYSTEMS NTV SUN INTERBREW TNT-TELESET UNITED HEAVY MACHINERY (URALMASH) INDUSTRY Airlines Pharmaceutical Energy Energy Diversified Finan. Wireless Comm. Broadcasting Beverage Entertainment Industrial Equip. DATE Dec. 22, 2000 May 28, 1998 Oct. 01, 1996 March 01, 1996 Feb. 01, 1996 April 22, 2003 Jan. 28, 2000 Dec. 01, 1994 Jan. 28, 2000 Jan. 15, 1998

23

Bibliography Aguilera, Ruth and Gregory Jackson. The Cross-National Diversity of Corporate Governance: Dimensions and Determinants, Academy of Mana.ement Review 28 (2003): 447-465. AMR/RID. Issledovanie gotovnosti rossiiskikh predpriyatiy k vnedreniyu Kodeksa Korporativnogo Povedeniya (analiticheskiy otchet), analysis by the Association of Managers of Russia and the Russian Institute of Directors (2001). Barnes, Andrew. Russias New Business Groups and State Power, Post-Soviet Affairs 19 (2003): 154186. Black, Bernard, Reiner Kraakman and Anna Tarassova. Russian Privatization and Corporate Governance: What Went Wrong? Stanford Law Review 52 (2000): 1731-1808. Blasi J. and A. Shleifer (1996). Corporate Governance in RussiaAn Initial Look, in R. Frydman, C. W. Gray and A. Rapaczynski, eds., Corporate Governance in Central Europe and Russia, Vol. 2: Insiders and the State, Budapest/London/New York, pp.78-108. Boycko, M., A. Shleifer, and R. Vishny. Privatizing Russia (Cambridge: The MIT Press, 1995). Buck, Trevor Modern Russian Corporate Governance: Convergent Forces or Product of Russian History? Journal of World Business 38 (2003): 299-313. Buck, Trevor, Igor Filatotchev and Mike Wright. Agents, Stakeholders and Corporate Governance in Russian Firms, Journal of Management Studies 35,1 (January 1998): 81-104. Doidge, Craig, Andrew Karolyi, and Ren M. Stulz. Why do countries matter so much for corporate governance? Working Paper, Ohio State University and NBER (August 2004) http://www.cob.ohio-state.edu/fin/faculty/stulz/ Economist. The Challenger: Vladimir Putin takes on democracy, the West and all-comers. Dec. 11, 2004. Ekspert. 25 kompanii s nailuchshei reputatsiei, Feb. 18, 2002. Ekspert (Gateway to Russia edition). Russian executives become hooked on lure of London, by Astrid Wednlandt. Feb. 4, 2004. Euromoney. Russian IPOs set to boom, by Julian Evans. Nov. 23, 2004. FCSM (Federal Commission for Securities Markets), Kodeks Korporativnogo Povedeniya (2001): http://www.rid.ru/uploads/db2file_ru/Final%20Code%20in%20Russian%20Self.pdf Fox, Merritt and Michael Heller. Lessons from Fiascos in Russian Corporate Governance, William Davidson Institute Working Paper No. 282 (October 1999). Gaddy, Cliff and Barry Ickes. Stability and Disorder: An Evolutionary Analysis of Russias Virtual Economy, Russia in the New Century by V. Bonnell, G.Breslauer, eds. Boulder: Westview Press, 2001. Guriev, Sergei, Olga Lazareva, Andrei Rachinsky and Sergei Tsukhlo. Corporate Governance In Russian Industry, CEFIR study (2003) http://www.cefir.org/Papers/corp3_2.pdf Guy, Marie-Laurence, Stilpon Nestor, and Takahiro Yasui. The Relevance of Corporate Governance to Eurasian Transition Economies, paper presented at the Eurasia Corporate Governance Roundtable (October 2000). ICLG. Corporate Governance Ratings of 40 Russian businesses since 2000 (Moscow, 2002) http://www.iclg.ru/enrating1 Joel Hellman. Russias Transition to a Market Economy: A Permanent Redistribution? in Andrew Kuchins, ed., Russia after the Fall (Washington DC: Carnegie Endowment, 2002). Kaznadeeva, Yanina. Corporate Governance Codethere are more questions than answers, analysis by Corporate Governance in Russia at www.corp-gov.org (December 21, 2001). Kommersant. Sibneft pozabotilas o minoritarnykh aktsionerakh, by Petr Sapozhnikov. June 30, 2001. McCarthy, D. and S. Puffer. Corporate Governance in Russia: Towards a European, U.S., or Russian Model? European Management Journal 20 (2002): 630-640.

24

Molozhaviy, Sergey (Deputy Minister, Ministry of State Property). Role of the State in Shaping Corporate Governance Environment, report presented at the OECD Conference on Corporate Governance in Russia (Moscow, June 1999). Moskovskie Novosti. Gosudarstvoeto sovet direktorov, by N. Alyakrinskaya and D. Dokuchaev. June 4, 2004. Moscow Times. Mechel Plans New York IPO, Reveals Owners, by Simon Ostrovsky. Oct. 6, 2004. Nesterenko, Andrei. The Modernization Challenge Facing President Putin, Finance and Development 37 (September 2000). The New York Times. How Russian Oil Tycoon Courted Friends in U.S., by Timothy OBrien. Nov. 5, 2003. OECD, White Paper on Corporate Governance in Russia (2002). Peregudov, Sergey. Korporatsii, Obshchestvo, Gosudarstvo: Evolyutsiya Otnosheniy (Moscow: Nauka, 2003). Pistor, Katharina, and Joel Turkewitz. Coping with Hydra-State Ownership After Privatization, in Corporate Governance in Central Europe and Russia, Frydman, Gray and Rapaczynski, eds. (Budapest, London, New York: CEU Press, 1996) 2: pp. 192-246. A. Shleifer, and D. Treisman. Without a Map (Cambridge: The MIT Press, 2000). Shleifer, Andrei and Robert Vishny. A Survey of Corporate Governance, The Journal of Finance 52 (June 1997): 737-783. Smirnova, Elena. Impact of Cross-listing on Local Stock Returns: Case of Russian ADRs, William Davidson Institute Working Paper Number 691 (May 2004). Sprenger, Carsten. Ownership and Coporate Governance in Russian Industry: A Survey, EBRD Working paper No. 70 (January 2002). UBS Warburg, Russian Equity Research: Coporate Governance Analyzer (March 2002). Strana.Ru. Gosudarstvo mozhet prostimulirovat' oboronku, selo i malyi biznes, by Konstantin Ugodnikov. Oct. 24, 2003. http://www.strana.ru/stories/02/02/06/2462/197538.html Vedomosti. Sibneft snova radayot milliony, by Aleksandr Tutushkin. Oct. 31, 2001. Vedomosti. Vybory nachalis, by Irina Reznik. Feb. 03, 2004. Vedomosti. AvtoVAZ rasskazhet o sebe, by Yulia Fedorinova. Feb. 5, 2004. Vedomosti. Fidelity dokupil ADR VympelKoma, by Yuriy Granovsky. Feb. 18, 2004. Vedomosti. Aktsionery MRK prismotryat za Svyazinvestom, by Svetlana Vitkovskaya. Feb. 16, 2004. Volkov, Vadim. The Selective Use of State Capacity in Russias Economy: Property Disputes and Enterprise Takeovers After 2000, in Janos Kornai, Bo Rothstein, and Susan RoseAckerman, eds., Creating Social Trust in Post-Socialist Transition (New York: Palgrave MacMillan, forthcoming). San Francisco Chronicle. Human rights now a factor in CalPERS investments Fund wont support repressive regimes, by Bruce Wallace. Feb. 20, 2002. Vremya Novostei. Tuda-syuda i obratno. Oct. 30, 2001. Wall Street Journal. Russian IPO Discloses Its Shady Ties Ahead of Fridays Listing on NYSE, by Jeanne Whalen. Feb. 6, 2002. Woodruff, David. Rules for Followers: Institutional Theory and the New Politics of Economic Backwardness in Russia, Politics & Society 28,4 (2000): 437-482. Woodruff, David. Property Rights in Context: Privatizations Legacy for Corporate Legality in Poland and Russia, Studies in Comparative International Development 38,4 (2004): 82-108.

25