Stakeholders, Governance, and the Russian Enterprise Dilemma

1. Introduction
Russian problems
§ Continuing lack of investment and restructuring in the corporate sector
o Russian’s firms output, profitability, and cost efficiency is very low
o Domestic investment in Russian fall
o Russian receive the least foreign direct investment
§ “Virtual” Economy
o Wages left unpaid, fiscal obligations unfulfilled, barter based transaction
o Lack of credible investor protection

“Why the construction of the institutional apparatus required to ensure payments and investor protection in Russian has proved to be such an intractable problem for so long, despite the country’s having received the best available advice and millions of dollars in foreign aid.

2. What happens when manager are owners
No external monitoring should be needed in an enterprise wholly owned by those who:
§ Initiate and implement decision
§ Provide the financing
§ Bear the residual risks

Problem of corporate Governance in Russia
§ Not limited in protecting minority shareholders ↔ insufficient incentives
o Owner-managers → with the short time horizon → expected gain from increasing firm’s value and share application less than what they can obtain by stripping asset
o Maximizing value → reasonable objective → if that value can be analyzed through the sale of the ownership rights in enterprises
o Owners have been more inclined to withdraw cash (illegally)

3. Regional governments exert influence
§ Regional governments → exert a strong influence → key enterprises (whether they have been formally privatized
§ Cash-flow diversion → taxable revenues reduce → regional governments collect revenues and control it

4. Barter and arrears as tools of control
Barter → nonpayment and non cash settlement
§ Preferential tax treatment
§ “discount” on utility bills
§ preferences in public procurement

5. Need for selective ownership transformation
Three critical problems in relying upon bankruptcy procedures to initiate ownership transformation:
§ Creditor coordination is difficult to sustain
§ The capacity of the judicial system is limited
§ Bankruptcy is disruptive

Any transaction aimed at restructuring ownership must apply with two requirements:
§ Acquired equity must be simultaneously sold to external investors
§ Resulting shareholdings must be sold in a way that involves some degree of competition among prospective investors

Dilemmas on ownership mechanism
§ Simultaneous conversion of debt to shares and the sale of the resulting shares can be accomplished only if there is only a priori investor interest in the share purchase
§ If the investor interest is needed before a conversion can take place, this will preclude a competitive auction

Ownership transformation would accomplish three necessary reforms:
§ It would transfer a cash payment to the regional authorities
§ It would allow coalitions of outside investors to dilute the ownership of insiders
§ It followed up with a coherent program of supporting social reforms

Objection
§ Ownership transformation is an easy exit for managers, but it is not
§ Ownership transformation would be applied only to steps debt