Privatization In Russia Essay Research Paper For

Privatization In Russia Essay, Research Paper For some, the privatization of Russian industry has been one of the great success stories of Russia?s painful economic transition: quick, firm and radical action was taken to shift the great bulk of Russian industry out of state hands, thereby laying the basis for a radical restructuring of enterprises and improvements in their performance.

Privatization In Russia Essay, Research Paper

For some, the privatization of Russian industry has been one of the great success stories of Russia?s painful economic transition: quick, firm and radical action was taken to shift the great bulk of Russian industry out of state hands, thereby laying the basis for a radical restructuring of enterprises and improvements in their performance. Others see privatization as a best a failure, at worst a catastrophe. Not surprisingly those opposed to the market and economic reform as a whole share this view. But many commentators who see themselves as supporters of reform find plenty in Russian privatization to criticize: the process led to the transfer of ownership to inappropriate people and as a consequence no beneficial restructuring of enterprises or the economy can be expected.

While this paper will attempt to cover the three key facets of privatization: that enterprises be transferred to private ownership; that the new owners be able de jure and de facto to exercise ownership rights; and, finally and ultimately most importantly, that the new owners exercise their ownership rights in such a way as to bring about improvements in enterprise performance. The key issues to be surveyed, therefore, are: who as a result of privatization obtained ownership of Russian industrial assets, and are they appropriate owners; can new owners, particularly if they are appropriate owners, exercise their ownership rights; and has privatization led to improvements in enterprise performance? The paper will deal with privatization only within the industrial sector; thereby ignoring the highly controversial privatization?s of the last twelve months or so in the energy and utility sectors.

Who are the new owners?

Global data showing about 70% of GNP being produced in the private sector reflects the high levels of privatization of industrial enterprises, with the great bulk of enterprises having been privatized by mid-1994. However privatization does not necessarily mean the complete removal of the state from an equity involvement in enterprises.

State ownership. The state retains shareholdings in a significant number of privatized enterprises on the basis of government decrees declaring the ?strategic significance for national security? of the enterprise. Shareholdings range from 20 to 51 per cent or a Golden Share (a single share giving veto rights over certain strategic issues of corporate development) retained by the state for up to three years. In late 1997 the state had shareholdings in 2900 enterprises. The shareholding consisted of a Golden Share in 1351 cases, of over 50% of shares in 128, of 25-50%, in 1037, of 20-25% in 228, and less than 20% in 303 of cases. By far the largest numbers of state holdings are in the energy sector (860). Not surprisingly the defense industry sector has a significant number (260). The rest are scattered across the economy.

This is a not insignificant state equity interest in Russian industry. There appears to be no particular trend towards either the strengthening or weakening of the state?s holdings, primarily because there are very differing views within government over which direction any trend should take. There is a continuing dribble of disposals, but decrees extending the period for which the state can retain parcels of shares in particular enterprises are also not rare. The number of enterprises deemed to require a ?strategic? state interest increased from the original 2700 set in the government?s 1995 decree, to over 3200 in early 1997, but had declined to 2900 by the end of 1997. It seems likely that a rump state presence will remain for some time to come, but not at a level that represents the basis for a significant rolling back of privatization.

Majority workforce shareholdings are seen as leading to two possible outcomes: collective ownership, in which the enterprise is owned and managed in a collective way by a workforce with common interests; or management ownership, in which management in various ways gains de facto if not de jure ownership rights over workforce shares and thereby gains effective ownership of the enterprise.

Collective ownership derives either from a natural alliance between managers and rank-and-file employees, probably based on Soviet traditions of paternalism and the ?social contract?, or from the need of managers to pander to workers who control a majority of voting rights at shareholder meetings. Although some observers might find a collective ownership outcome desirable, on the grounds that it provides for workplace democracy and high-incentive work habits, reform-oriented commentators generally find it a form of ownership likely to lead to the maintenance of excessively high levels of underemployed staff and an over concentration on consumption at the expense of investment.

The management ownership outcome derives from the ability of management to totally dominate divided, demoralized or indifferent rank-and-file employees. The argument that they do so by bribing employees with promises of secure employment and the maintenance of social welfare provisions is essentially the same as that presented in the previous paragraph on collective ownership. However, there is an increasing awareness among commentators that any Soviet paternalism and coincidence of management-worker interests that might have once existed have not survived the rigors of the transition and the self-interest of managers. As A.S. Bim puts it:

"Given serious ?positional differences? between managers and other employees, it seemed reasonable as early as 1993 to draw attention to the quite peculiar nature of insider ownership in Russia and to argue against simplifications such as the statements common in 1993-1994 that privatization in Russia had proceeded de facto in favor of workers (employees) or insiders as a homogeneous group."

The rigors of the transition, difficult market conditions and something close to a hard budget constraint, have made it impossible for managers to maintain employment and social welfare provision. The managers? self-interest, whether it be reflected in asset stripping or building up a profitable enterprise, pushes them in a similar direction. They then have two options. Once is to rely on coercion and manipulation, rather than bribery, to get worker owners to support them; the other is to get the workers to sell their shares to them.

Coercion and manipulation have been much in evidence. The crudest approach is the threat of dismissal of those who vote against management. Another popular approach at least requires the initial support of a majority of workforce shareholders. Management sets up a holding company type structure, the paid-in capital of which consists of all the workforce shares (or all those for which the management can get approval). The articles of association of the new structure are written in such a way that management controls it and through it the enterprise.15 Gurkov writes of individual managers building up their own ?cultivated plot? of workers over whom they have most direct work-based control and influence, and the managers then forming alliances and bringing their workers? shares with them into the alliance.16

But such arrangements cannot bring complete security of control. The greatest security comes when managers own in their own right a controlling shareholding. Management appears to have had greater opportunities than rank-and-file workers and staff to obtain shares in the privatization process itself. If Option 1 were chosen top management was entitled under the privatization legislation to purchase up to 5 per cent of shares. There is evidence that under Option 2 management obtained more than a proportionate distribution of shares in the internal tenders which allocated workforce shares among individual staff. Usually this was because they had greater financial resources, including access to credit.

Since privatization some managers have continued to build up holdings by buying shares from workers, often again by applying various forms of coercion. One approach is to engineer high levels of labor turnover, in the expectation that departing workers will sell their shares. Even those who remain, often not being paid for months, are forced to sell through financial exigency. It is implied that wages arrears are a deliberate ploy by managers to bring about such an outcome.

Outside owners: Privatization procedures were designed to give outsiders significant access to Russian industrial assets. As we have already seen, the workforce and management could obtain major holdings, indeed controlling holdings, if they so desired. The rest, however, were disposed of through a combination of voucher auctions (since the vouchers distributed to the entire population were freely negotiable, voucher auctions attracted the participation of insiders, outside speculators and outside strategic investors) and investment tenders and auctions (in which fixed parcels of shares, usually ranging from 15-30%, were sold to a single highest bidder, whose bid would have contained an investment plan including cash injections into the enterprise).

The procedures made it very difficult for a single outsider to build up a controlling shareholding. The voucher auctions distributed shares among many bidders; the parcels sold through investment auctions were too small. However it is possible, if not easy, to build up controlling shareholdings through post-privatization purchases of shares.

Shareholder?s

Such turnover can take place only if shareholders are able to exercise their ownership rights. It is not hard to find evidence of managers making it very difficult to exercise those rights. Their misdeeds include sacking or otherwise discriminating against workers who sell their shares; putting barriers in the way of outsiders purchasing shares or refusing to register purchases that are made; and discriminating against minority shareholders in terms of dividend policy. To these can be added the refusal to allow representatives of minority shareholders onto the board of directors, diluting the holdings of existing shareholders by issuing new shares and allocating them to management cronies, refusing to call shareholder meetings, manipulating the agendas of such meetings, concealing information on enterprise performance from shareholders, and making strategic decisions without consulting shareholders.

And some of the provisions of the Civil Code dealt with these abuses. The basic principles of shareholder rights and corporate governance were then set out in a consolidated piece of legislation, the Law ?On Joint-Stock Companies? (aktsionernye obshchestva, AOs), which after a long passage through parliament was passed by the Duma (the lower house) on 24 November 1995 and signed by Yeltsin on 26 December 1995, to come into legal force as of 1 January 1996.

The Law clearly responds to most of the abuses of shareholders? rights, which littered the initial years of post-communist corporate governance. A summary of the legislation, especially the clauses most related to the protection of shareholders? rights follows.

Some of the examples of management behavior outlined above make it clear how important the rules on notification of meetings and quorums are. Regulations on notification are contained in Article 52. It is not essential that shareholders be informed directly and personally of shareholders? meeting, although if a simple advertisement is to suffice the publication in which it is to appear must be specified in the Articles of Association. For larger AOs at least 30 days notice must be given of a meeting, with the Law containing a considerable degree of specification of the information that must be included in the notification.

The board of directors of an AO with over 1,000 shareholders must have at least seven members; nine members are required for AOs with over 10,000 shareholders. Members of the management committee must be in a minority on the board, and the general director cannot simultaneously chair the board (Art.66). Although the Law makes no provisions for the representation of minority shareholders on boards of directors, the requirement that ?cumulative voting? be used in elections to boards is presumably designed to provide some protection (Art.59). The Federal Commission on the Capital Market reports an increase in outsider representation on boards since the first half of 1994, but also those outsiders are still underrepresented.

One would be unwise to underestimate the ingenuity of Russian managers in finding ways around the Law, or their willingness to simply disobey it.61 Nevertheless the most obvious sources of abuse of shareholders? rights have been dealt with. The fact that the Law – one passed after all by a communist-dominated parliament – has a pro-shareholder orientation is in itself worthy of note. As Dmitrii Vasil?ev, the head of the Federal Commission on the Capital Market, put it after the passage of the Law: As a result, we can say most violations of shareholders? rights are now illegal in Russia

Conclusion

I am prepared nevertheless to venture, albeit tentatively, that the score card is not obviously against privatization. The suggestion that the designers of privatization were somehow conned into handing ownership over to managers does not stand up. The indications are that they knew what they were doing and judged that outside owners would eventually assert themselves.

Gradually they are doing so, and gradually they are improving their ability to exercise and enforce their ownership rights. Sometimes they are doing so in ways that are no less reprehensible than the methods of the manager-owners. There are also reasons to be concerned about the long-term consequences of the sort of bank-dominated and highly integrated ownership that many of the outsiders have brought. The best that can be said at this stage is that all modern economies have at their peak a corporate sector dominated by large integrated institutions.

Clearly the private sector, and thereby privatization, has to bear some responsibility for an economy in which it has a 70% share but which is unable to provide in anything like adequate proportions growth or welfare. But in this there are other factors also at work. Indeed there are some small indications, at both macro- and micro-levels, of a positive correlation between private ownership and good performance. With time that correlation could well become stronger and more evident.