Reports & Papers
from
Lawrence Livermore National Laboratory
Russian Corporate Governance: Reality, Perception, Risk, and Reward
May 7, 2001
Strengthening Democratic Institutions Project, Harvard University
Ruben Vardanian, President and CEO of Troika Dialog.
Chair: Dr. Graham Allison, Director of the Belfer Center for Science and International Affairs.
Summary by David Rekhviashvili, SDI Researcher
On May 7, 2001 at the John F. Kennedy School of Government Ruben Vardanian, President and CEO of Troika Dialog, one of Russia''s largest investment banks, discussed his recent report, "Russian Corporate Governance: Reality, Perception, Risk, and Reward," and his ongoing efforts at Troika Dialog to promote good corporate governance practices in Russia. Harvard students and professors attended the seminar, held by the Strengthening Democratic Institutions Project (SDI) and chaired by Graham Allison, Director of the Belfer Center for Science and International Affairs and of the Strengthening Democratic Institutions Project.
Mr. Vardanian began with the point that a broad discussion on the importance of developing corporate governance is currently underway in Russia. The fact that the issue of corporate governance has been identified by the Russian government and business elite as a problem worth paying attention to marks, according to Mr. Vardanian, headway that the country''s leadership has made on its way toward understanding the importance of conforming to established international business practices. Besides signaling changes happening in the attitudes of Russian elites toward a more "civilized" approach toward doing business, corporate governance is also one of the key factors influencing relative performance of the Russian economy. In order of importance, corporate governance comes right after economic predictability, political stability and peer group asset class factors.
However, for the time being, most Russian businesses have just begun to consider the pros and cons of establishing good corporate governance. Only a few companies have taken real steps to adhere to international standards in this realm and therefore Russian corporate governance continues to have very bad image abroad. According to Mr.Vardanian, having such a bad image greatly increases the volatility of the Russian market and downgrades its liquidity and valuation. It also damages the credibility of Russian businesses among their Western partners. The scale of the problem is revealed by a Troika Dialog study, showing that the poor image of corporate governance is currently downgrading the value of quoted shares in Russia by approximately $50 bln on a simple valuation model. That means a two-fold downgrading of the Russian market, as the total value of the country''s capital market is $47 bln.
One of the specific factors negatively impacting the image of Russian corporate governance is the absence of timely and accurate disclosure of information about Russian firms'' market capitalization, ownership structures, finances, and business practices. For instance, a major Russian aluminum producer, SUAL Holdings, declared a market capitalization of only $35 mln, had sales of $1 bln just in the year 2000. This example of a firm deliberately providing incorrect information about its market capitalization is very typical in today''s Russia. (Gazprom, Severstal and many others may serve as examples.)
Why didn''t corporate governance develop in Russia? In Mr. Vardanian''s opinion, the main reason is not because Russian businessmen did not understand the importance of establishing civilized management practice. That businessmen were not interested in managing their companies effectively and had almost no interest in the position of their companies on the global capital market had much greater impact. As the result of privatization of the state enterprises, Russian businesses overnight became owners of enormous assets. However, their interest was not in the long-term development of their companies. On the contrary, their goal was to extract as much money from company assets as possible, as quickly as possible without reinvesting the profits into the business. In fact, Russian businessmen were managing their companies as if they still belonged to the state or could be at any moment expropriated by the government.
Now the business priorities of Russian corporate elite are changing, Vardanian remarked: a more responsible approach, oriented to managing company assets in the most effective way is beginning to take precedence over the old practices. This process results in CEOs starting to care more about capital markets and, consequently, to attach a lot of importance to the capital evaluation of their companies. The crucial reason for this change is the emergence among the Russian business elite of an interest in long-term business development, in attracting capital investments and developing partnership with foreign companies. Another explanation for why Russian entrepreneurs have begun to adjust management practices in their companies to established international standards is that they want to become respectable members of the international business community. This change in management priorities became visible when some companies started revealing their real revenues. One of the examples is Surgutneftegas that published its $2 bln profit made in 1999 (although it should be noted that this company while making certain positive steps, still cannot qualify as transparent.) And now more and more Russian companies are revealing their real profits. It should be noted that a very important role in promoting this trend is being played by the current government and by the president. Vladimir Putin has discussed the issue of accurate disclosure of business information in meetings with Russian entrepreneurs. His statements have produced some positive results, stirring business people to improve transparency in their companies.
Mr. Vardanian outlined eight principles that constitute corporate governance.
Performance. A company should focus on long term financial returns to all shareholders, using peer group performance benchmarks.
Financial Discipline. Companies should disclose accurate, complete, timely financial information, using international accounting principles, verified by independent qualified audit.
Transparent Ownership Structure. Companies should provide information about all groups holding more than 5% of its shares, including executive officers, board directors, and other co-owners.
Voting Rights. Each ordinary share should qualify for one vote, shareholders'' voting rights should be ensured by the corporation.
Director Accountability. The board of directors of the corporation should be elected by and be accountable to the shareowners and should include independent non-executive directors.
Remuneration. Corporate remuneration policy should be consistent with shareholders'' interests.
Rule of Law. Corporations should abide by all laws regulating their operations.
Dialogue with Lawmakers. Government officials and corporations should engage in dialogue to improve correspondence between corporate governance principles and legislation.
Mr. Vardanian emphasized that releasing accurate information remains a major problem in the Russian corporate sector, but he indicated that more and more managers begin to understand that providing accurate information is important for the companies themselves, not just for controlling bodies. He also noted that recently dialogue between government and corporate structures has been developing actively and debate on restructuring of RAO UES may serve as an illustration of that.
In conclusion, Mr. Vardanian presented possible solutions to the problem of improving the Russian corporate governance system.
Corporate view. Controlling shareholders will realize that current government and economic changes represent the end of the epoch when the most profitable way of doing business was through illegal, abusive methods. They also will understand that adopting better management standards will improve the rating and will broaden business opportunities for their companies.
Government action. It is expected that in the next several months, the government will introduce legislation that will regulate corporate activities in a more effective way and will help to reduce the level of abusive management practices.
External pressure. Recent adoption of international corporate governance standards by the World Economic Forum in association with CalPERS company provides the government and business community with effective guidelines for exposing bad management practices. This and other similar initiatives will increase pressure on Russian corporations for change.
Questions and comments.
Q. In the West there is a well-established system of arbitration courts that resolve commercial disputes and whose decisions are binding. Is there such a system in Russia and if there is, is it working well or not working?
A. Such a system exists in Russia and it is working. However, problems with resolving commercial disputes are numerous because individual shareholders have a right to appeal to civil courts declaring that their civil rights are abused by companies and this procedure is very often used in the fights between corporations. But the arbitration system itself is working fairly well. The only major flaw in this system, in my opinion, is the existing procedure of appealing for revision of the court decision.
Q. Given that modern Russian businessmen are extremely good at finding their a way round every rule, presumably, managers interested in getting a good rating for their companies from your firm must try to play the system by pressuring you, by paying you, etc. Has anything like that happened when your firm was preparing this report evaluating Russian corporations?
A. Unfortunately nothing like that happened. I say unfortunately because this is a good indicator that most companies still do not attach due importance to corporate ratings. However, some firms expressed their concern over the low ratings and partly that concern comes from the firms'' awareness of the government monitoring and control, which has intensified recently; partly it comes from their desire to improve their image.
Q. When you started out your scenario of the lost capitalization of Russian firms because of poor corporate governance, many of the firms you listed in your report have substantial government holding and the government has been the primary seller of the stocks. Is it not within the power of the government and in their own best interest to force establishment of good corporate governance principles?
A. I absolutely agree with you, it certainly is in government''s interest. But the Russian government only recently began to realize that it is also a shareholder. For instance, until recently, with regard to natural monopolies, the government cared solely about the social aspects, energy supplies and tax collection problems and it never thought that it also was interested in maximizing the profits of these companies. Now the government has finally realized that it has to play an active role in optimizing companies'' performance, but it does not possess good management skills for doing so. This is why it will be a long and complicated process.