Opal''''s Site Organization and Development of Russian Business_5 potx

Table 3.4 Comparison between open and closed joint-stock companies regarding the ownership structure, capital demand and sup-
ply constraints, relationship with business groups, past policies on company start-ups, and company size
Variables
a
Open JSCs Closed JSCs
b
N
Mean/
proportion
Median N
Mean/
proportion
c
Median
d
Outsider ownership share (OWNOUT) 448 2.21 2.00 223 1.18
***
0.00
###
State ownership share (OWNSTA) 473 0.66 0.00 236 0.12
***
0.00
###
Federal government agencies (OWNFED) 480 0.49 0.00 238 0.09
***
0.00
###
Regional and local government agencies (OWNREG) 478 0.23 0.00 237 0.05
***
0.00
###

Private ownership share (OWNPRI) 449 1.72 0.00 223 1.06
***
0.00
###
Commercial banks (OWNBAN) 470 0.19 0.00 231 0.07
**
0.00
###
Investment funds and other financial institutions (OWNFIN) 465 0.31 0.00 233 0.09
***
0.00
###
Non-financial corporations (OWNCOR) 463 1.06 0.00 237 0.69
***
0.00
###
Foreign investors (OWNFOR) 469 0.37 0.00 234 0.31 0.00
##
Proportion of firms with a large managerial shareholder
(shareholder group) (MANSHA) 527 0.43 0.00 255 0.58
†††
1.00
###
Proportion of firms planning to issue securities in the near future
(SECPLA) 449 0.12 0.00 256 0.08 0.00
Proportion of firms with a long-term credit relationship with a
certain commercial bank (RELBAN) 529 0.85 1.00 256 0.76
†††
1.00
###

Proportion of member companies of a business group (GROFIR) 553 0.41 0.00 269 0.36 0.00
Proportion of core corporations of a business group (GROCOR) 553 0.05 0.00 269 0.06 0.00
Proportion of affiliated companies of a business group (GROAFF) 553 0.35 0.00 269 0.31 0.00
Continued
9780230_217287_05_cha03. dd 77 5/14/2009 3:44:52 PM
Table 3.4 Continued
Variables
a
Open JSCs Closed JSCs
b
N
Mean/
proportion
Median N
Mean/
proportion
c
Median
d
Total number of member companies of a business group that
a company belongs to (GROSIZ) 536 7.67 0.00 261 9.98 0.00
Proportion of former state-owned or ex-municipal privatized firms
(PRICOM)
553 0.78 1.00 269 0.51
†††
1.00
###
Proportion of firms that separated from a state or privatized
company (SPIOFF) 553 0.09 0.00 269 0.11 0.00
Average number of employees (COMSIZ) 553 2414.77 600.00 269 794.19

***
300.00
###
Notes:
a
“Ownership share” means an ownership share rated on the following 6-point scale: 0: 0%; 1: 10.0% or less; 2: 10.1 to 25.0%; 3: 25.1 to 50.0%; 4: 50.1
to 75.0%; 5: 75.1 to 100.0%. OWNOUT and OWNPRI exclude ownership by domestic individual shareholders. MANSHA, SECPLA, RELBAN, GROFIR,
GROCOR, GROAFF, PRICOM and SPIOFF are dichotomous variables, which take a value of 1 to corresponding firms.
b
Workers’ joint-stock companies (people’s enterprises) are excluded from observations.
c

***
: The difference of the means in comparison with open JSCs is significant at the 1% level according to the t-test (the Welch test was performed instead
of the t-test when the null-hypothesis that the two samples have the same population variance was rejected by F-test for homoscedasticity),
**
: at the 5%
level;
†††
: The difference of the proportions in comparison with open JSCs is significant at the 1% level according to the ␹
2
test.
###
: The difference in comparison with open JSCs is significant at the 1% level according to the Wilcoxon rank-sum test,
##
: at the 5% level
Source: The joint enterprise survey.
9780230_217287_05_cha03. dd 78 5/14/2009 3:44:52 PM
Legal Form of Incorporation 79
Furthermore, the differences between open and closed JSCs regarding the

proportion of companies having a long-term credit relationship with a spe-
cific commercial bank, the proportion of privatized firms, and the average
number of employees are also statistically significant and consistent with
our theoretical hypotheses. The remaining variables need to be reexamined
using a regression analysis technique, since their statistical significance was
not detected by simply comparing the descriptive statistics.
Multivariate regression analysis
The basic sample for our estimation consists of 557 observations, excluding
all stock companies that have already issued securities in the past (Sample
type I). In order to validate the robustness of the estimation results, a sup-
plementary estimation is performed using the following three cases: Sample
type II, which is made up of the firms included in Sample type I exclud-
ing all communications firms; Sample type III, which excludes firms whose
number of employees exceeds the mean of the number of employees of the
closed JSCs plus/minus 1 standard deviation from the basic sample set; and
Sample type IV, which consists of firms with a stable ownership structure
that did not experience changes in major shareholders from 2001 to 2004.
An estimation using the former two cases focuses on the estimation bias
arising from the characteristics of newly emerged telecommunication busi-
nesses and those of mega corporations. On the other hand, the estimation
using Sample type IV deals with the possible endogeneity relating to cor-
porate forms and ownership structures. As an alternative way to deal with
the endogeneity of two elements, we also conducted a two-stage probit esti-
mation
16
by introducing the following four variables to be utilized as addi-
tional instruments together with all exogenous variables in the right-hand
side on the first stage of regression: a dummy variable of shareholding by an
incumbent CEO (or president) (CEOSHA); a dummy variable that is assigned
a value of 1 if there is a shareholder or a shareholder group that substantially

controls corporate management (DOMSHA); the age level of the CEO or com-
pany president (CEOAGE); and a three-point-scale assessment of the inten-
sity of competition with domestic firms in a product market (COMDOM).
17

The White’s estimator of heteroskedasticity-consistent standard errors is
used for various statistical tests.
The following is the basic equation of our regression, and the marks in
parentheses stand for the expected signs:
Pr[CLOCOM = 1] = F(constant, OUTOWN(-), MANSHA(?), SECPLA(-),
RELBAN(-), NUMFIN(-), GROFIR(-), GROSIZ(+), PRICOM(-), SPIOFF(-),
COMSIZ(-), industry dummies)
Table 3.5 shows the estimation results.
18
The coefficients of the independent
variables represent their marginal effects.
9780230_217287_05_cha03. dd 79 5/14/2009 3:44:52 PM
Table 3.5 Probit regression analysis of the corporate-form choice model
Dependent variable
CLOCOM
Sample constraints
a
Type I Type I Type I Type I Type II Type III Type IV Type I
Model [1] [2] [3] [4] [5] [6] [7] [8]
OWNOUT Ϫ0.055
***
Ϫ0.056
***
Ϫ0.058
***

Ϫ0.058
***
Ϫ0.050
***
Ϫ0.169
**
(0.01) (0.01) (0.01) (0.01) (0.01) (0.07)
OWNSTA Ϫ0.120
***
(0.03)
OWNFED Ϫ0.106
***
(0.03)
OWNREG Ϫ0.143
***
(0.04)
OWNPRI Ϫ0.041
***
(0.01)
OWNBAN Ϫ0.023
(0.05)
OWNFIN Ϫ0.071
(0.04)
OWNCOR Ϫ0.057
***
(0.01)
OWNFOR 0.019
(0.03)
MANSHA 0.100
**

0.093
**
0.099
**
0.102
**
0.104
**
0.105
**
0.110
**
0.210
*
(0.05) (0.05) (0.05) (0.05) (0.04) (0.05) (0.05) (0.11)
SECPLA Ϫ0.131
*
Ϫ0.124
*
Ϫ0.129
*
Ϫ0.133
**
Ϫ0.113 Ϫ0.116 Ϫ0.175
*
Ϫ0.124
**
(0.07) (0.07) (0.07) (0.07) (0.08) (0.08) (0.10) (0.06)
9780230_217287_05_cha03. dd 80 5/14/2009 3:44:53 PM
RELBAN Ϫ0.148 Ϫ0.153

**
Ϫ0.146
**
Ϫ0.149
**
Ϫ0.138
**
Ϫ0.158
**
Ϫ0.134
*
Ϫ0.143
**
(0.06) (0.06) (0.06) (0.06) (0.06) (0.06) (0.07) (0.07)
NUMFIN Ϫ0.188
**
Ϫ0.191
***
Ϫ0.194
***
Ϫ0.192
***
Ϫ0.164
**
Ϫ0.185
***
Ϫ0.142 Ϫ0.146
**
(0.06) (0.07) (0.07) (0.06) (0.07) (0.07) (0.08) (0.07)
GROFIR Ϫ0.217

**
Ϫ0.216
**
Ϫ0.209
**
Ϫ0.179
*
Ϫ0.253
***
Ϫ0.169 Ϫ0.225
**
(0.10) (0.09) (0.09) (0.10) (0.09) (0.14) (0.09)
GROCOR
Ϫ0.232
***
(0.08)
GROAFF
Ϫ0.196
**
(0.10)
GROSIZ 0.098
**
0.088
*
0.085
*
0.094
**
0.084
*

0.115
**
0.067 0.122
**
(0.05) (0.05) (0.04) (0.05) (0.05) (0.05) (0.07) (0.05)
PRICOM Ϫ0.390
***
Ϫ0.383
***
Ϫ0.403
***
Ϫ0.394
***
Ϫ0.376
***
Ϫ0.388
***
Ϫ0.423
***
Ϫ0.392
***
(0.06) (0.06) (0.06) (0.06) (0.06) (0.06) (0.07) (0.06)
SPIOFF Ϫ0.173
***
Ϫ0.162
**
Ϫ0.166
***
Ϫ0.178
***

Ϫ0.160
***
Ϫ0.168
**
Ϫ0.200
***
Ϫ0.180
***
(0.06) (0.06) (0.06) (0.06) (0.06) (0.07) (0.07) (0.06)
COMSIZ Ϫ0.062
**
Ϫ0.058
**
Ϫ0.060
**
Ϫ0.064
**
Ϫ0.049
*
Ϫ0.070
**
Ϫ0.068
**
Ϫ0.037
(0.03) (0.03) (0.03) (0.03) (0.03) (0.03) (0.03) (0.03)
Industry dummies Yes Yes Yes Yes Yes Yes Yes Yes
N 557 555 555 557 525 534 389 527
Pseudo R
2
0.19 0.20 0.21 0.19 0.16 0.19 0.17 0.17

Log likelihood Ϫ295.70 Ϫ290.69 Ϫ286.06 Ϫ295.44 Ϫ283.83 Ϫ284.18 Ϫ211.91 Ϫ282.43
Notes:
a
Type I: basic sample (available observations without firms that already issued securities in the past); Type II: excluding communications firms from the
basic sample; Type III: excluding those with the total number of employees exceeding the mean of number of employees of closed JSCs (794.19 person)
plus/minus 1 standard deviation (3,149.14) from the basic sample; Type IV: excluding those that experienced a change in the major shareholders from
2001 to 2004 from the basic sample.
***
: significant at the 1% level,
**
: at the 5% level,
*
: at the 10% level.
Source: Author’s estimation. The number of financial institutions per 1,000 firms in the location (NUMFIN) was calculated by the author based on
Rosstat (2005) and CBR (2005). Other variables are based on the results of the joint enterprise survey.
9780230_217287_05_cha03. dd 81 5/14/2009 3:44:53 PM
82 Organization and Development of Russian Business
Except for the variables representing ownership by financial institutions
including commercial banks and foreign ownership, all of the explanatory
variables for Models 1 through 4 estimated using the basic sample have the
predicted signs with high statistical significance.
19
The presence of non-
managerial shareholders diminishes the probability that an investment-
target firm will become a closed JSC. Another interesting aspect is that the
marginal effect of state involvement is much stronger than the influence of
private owners. The impact of capital demand and the development of local
financial institutions also reduce the probability of the choice of closed
JSCs. Companies linked with a business group through ownership tend to
choose to become open JSCs. However, the larger a business group becomes,

the higher the number of closed companies that are included among its
member firms. Privatized firms are more likely to be open companies, as
are JSCs spun off from state-owned or municipal enterprises or from other
privatized companies. In addition, as the size of a company grows, the likeli-
hood of the company operating as a closed JSC significantly decreases.
On the other hand, the result that a large management shareholder
dummy (MANSHA) is significant and positive illustrates a special character-
istic of the Russian economy. This implies that Russian managers place far
more importance on maintaining effective control of their company than
on obtaining capital gains by having stock in their companies. Furthermore,
it suggests that they have a strong desire to prevent outside intervention
by their company management and discipline by shareholders, even at the
cost of a somewhat reduced value and lowered transferability of their own
shares.
20
In other words, as suggested by agency theorists who elucidate
the behavioral pattern of company executives in the developed countries,
the inclination toward managerial entrenchment is also significant among
Russian managers. Furthermore, this result clearly demonstrates that the
most attractive reason for Russian managers to operate their firms as closed
JSCs is the variety of fringe benefits they obtain by doing so. Even at the time
of the joint survey, which was 14 years after the systemic transformation to
a market economy, it was highly likely that many corporate executives still
held such perceptions, given the underdeveloped capital and managerial
markets in the Russian economy.
It is logical that the SECPLA for Models 5 and 6 is slightly less significant
than that for the other models since the sample set does not include any
communications companies,
21
which represent the emerging industry in

Russia, or the largest corporations, which have substantial financial needs
and are highly motivated to raise equity capital. It is not surprising that
the GROFIR and GROSIZ for Model 7 are insignificant, considering that an
impressive 46.4% of the surveyed firms (110 of 237) that experienced a sub-
stantial change in their ownership structure from 2001 to 2004 were almost
group firms. What is more important from the viewpoint of the statisti-
cal robustness of the estimation results is that the explanatory power and
9780230_217287_05_cha03. dd 82 5/14/2009 3:44:53 PM
Legal Form of Incorporation 83
significance of the ownership variables in Model 7 are almost at the same
level as those of the estimates for Model 1.
22
In addition, the result of a two-
stage probit estimation of Model 8 also strongly suggests that there is an
empirical relation between the corporate form and the ownership structure
even if we assume that both of them are determined endogenously.
Concluding remarks
In Russia, an overwhelming number of JSCs choose to become closed com-
panies despite the fact that this corporate form strays far from the primary
nature of stock companies, that is, an economic mechanism intended to
raise capital from a wide range of private investors and increase share-
holder wealth as effectively as possible. This trend is equally obvious for
medium-sized and large enterprises in the manufacturing and communi-
cations sectors. In this chapter, we attempted to conduct theoretical and
empirical examinations on this quite interesting economic phenomenon
using the results of the Japan–Russia large-scale joint enterprise survey.
We illustrated the mechanism behind the organizational choice between
two alternative corporate forms and identified the following four fac-
tors that encourage many Russian firms to be closed: (a) a widespread
insider-dominating corporate ownership structure emerging as a result of

the mass-privatization policy; (b) a strong orientation among managers
toward closed corporate organization due to the underdeveloped capital and
managerial markets; (c) slumping needs for corporate finance; and (d) insuf-
ficient financial support from local financial institutions. The empirical
relation between ownership structure and corporate form does exist even if
the endogeneity of the two elements is assumed.
The fact that the above four factors still have a significant impact on the
behavioral patterns of Russian corporations even after well over a decade
since the collapse of the Soviet Union is a reminder of the difficult and time-
consuming transition process from a centrally planned to a market-based
economic system. We also found that, in addition to the four determinates
outlined above, the historical path-dependency of the enterprise privatiza-
tion in the early 1990s and the intense formation of business groups, both
of which represent peculiarities of the transforming Russian economy, have
a significant impact on the choice of corporate form by Russian firms.
Acknowledgments
The research was financially supported by the Japan Securities Scholarship
Foundation (JSSF), the Foundation of Japan Legislation Society, and
grants-in-aid for scientific research from the Ministry of Education and
Science of Japan (Nos. 16530149 and 17203019) in FY2004–8. I also thank
Naohito Abe, Tatiana G. Dolgopyatova, Martin Gilman, Satoshi Mizobata,
9780230_217287_05_cha03. dd 83 5/14/2009 3:44:53 PM
84 Organization and Development of Russian Business
Andrei A. Yakovlev for their valuable comments and suggestions. Needless
to say, all remaining errors are mine.
Notes
1. Including companies of mixed ownership.
2. According to unpublished official statistics.
3. For more details, see the studies on comparative law by Kraakman et al. (2004)
and McCahery et al. (2004). Concerning closed corporations in the US, Allen &

Kraakman (2003), Pinto & Branson (2004), and Mitchell & Mitchell (2006) pro-
vide detailed descriptions and useful case studies.
4. For instance, an overwhelming majority of US closed corporations are family-
owned firms that represent 95% of all American businesses and are responsible
for about 50% of US employment (Bauman et al. 2007: 339).
5. These provisions refer to the Civil Code, Part I, chapter 4, Articles 96 to 104, and
to the Law on JSCs. This section was written taking into account the laws and
regulations that were effective in Russia during the period in which the enter-
prise survey was conducted and which was used as the base material for this
empirical study.
6. Article 7 of the Regulations for Joint-Stock Companies approved by the
Resolution of the RSFSR Cabinet of Ministers No. 601 of December 25, 1990,
which was later replaced by the current Law on JSCs, provided that the share-
holders of a closed JSC were prohibited from transferring their shares without
the approval of the majority of all the shareholders of that closed JSC. The share
transfer restriction provided in the Law on JSCs now in effect is less severe than
that in the Regulations for Joint-Stock Companies that was in force until the
end of 1995.
7. Refer to Article 1 of the amended Federal Law on Minimum Wages of December 29,
2004.
8. Refer to the Presidential Decree on Measures to Protect the Rights of Shareholders
and to Ensure the Interests of the State as an Owner and Shareholder of August 18,
1996. This decree lost its effect in February 2005 with the amendment of the
Bankruptcy Law.
9. After the Russian government adopted International Accounting Standards (IAS)
in 1997, the nation’s accounting system saw some improvements every year in
compliance with the Generally Accepted Accounting Principles (GAAP) for
industrialized countries. However, there are still some problems in terms of the
accuracy and transparency of disclosed company information because of the
failure to enforce the IAS at all enterprises as well as because of the insufficient

number of auditing firms and accountants (Saito 2003; Iwasaki 2007a).
10. In the US, a company with an “S corporation” status granted by the Internal
Revenue Service (IRS) may file a composite tax return of corporate income and
loss together with stakeholder’s personal income in order to prevent double taxa-
tion of corporate profits for general corporations and personal income tax for
dividends.
11. Refer to Article 3 of Part I of the Tax Code. Although it is not reported in Article 3,
it is widely recognized that the principle of equal taxation is construed to be
applicable to both open and closed JSCs (Abrosimov et al. 2005: 10). In fact, in
Russia, joint-stock companies are treated in the same way as limited and other
types of companies in terms of taxation.
9780230_217287_05_cha03. dd 84 5/14/2009 3:44:53 PM
Legal Form of Incorporation 85
12. In fact, experts at the Levada Center Social Research Institution who assisted
with the enterprise survey, drawing upon their experience with panel surveys
conducted before and after 2005, confirmed that only about 600 to 700 of 1,000
firms could claim that their company profile was nearly unchanged for a period
of 3 years after being surveyed. The remaining 300 to 400 firms were excluded
from the panel surveys because they had already closed, changed their business,
or made significant organizational changes.
13. See Johnson (1997), Perotti & Gelfer (2001), Hoffman (2002), Klepach & Yakovlev
(2004), and Guriev & Rachinsky (2005) for details on the financial-industrial
groups and oligarchs in Russia.
14. In other words, domestic individual shareholders, including employee share-
holders, are treated as a reference category. The experience of our joint research
team and that of other researchers indicates that many Russian top managers
do not have sufficient data on company ownership by employees, ownership
by other managers, or ownership by the relatives, families, or acquaintances
of employees, all of whom are categorized as outside individual shareholders.
Therefore, their answers to our questions about their insider ownership may con-

tain substantive measurement errors. In addition, the reason that we used a large
management shareholder dummy variable that represents the position of man-
agers as corporate owners is that it is quite difficult to ask managers to submit
accurate data on their own shareholding rate; making such a request of managers
is very likely to result in their refusal to participate in the survey.
15. Hence, newly established private firms after the collapse of the Soviet Union are
treated as the reference in our estimation.
16. The two-stage procedure would be to estimate the reduced forms for ownership
variables by probit or ordered probit maximum likelihood and estimate the
corporate-form choice model by probit after substituting the predicted values for
ownership variables. For more details regarding the two-stage estimation meth-
ods, see Maddala (1983), Newey (1987), and Rivers & Vuong (1988).
17. The correlation coefficients for CLOCOM and each of the newly introduced
4 variables range between Ϫ0.032 and 0.019 and are statistically insignificant.
18. The correlation coefficients for the independent variables used in each model are
well below a threshold of 0.70 for possible multicollinearity in all combinations
(Lind et al. 2004).
19. The non-significance of ownership by financial institutions and foreign own-
ership is consistent with the statements pointed out by many researchers per-
taining to the passive attitude of commercial banks and investment funds as
institutional investors, the weak presence of foreign shareholders, and the wide-
spread share purchases by managers and their affiliates through offshore compa-
nies (Iwasaki 2007b).
20. This is closely associated with the fact that the sample firms used for the empiri-
cal analysis in this section as well as the overwhelming majority of Russian com-
panies are unlisted and have stock prices that are not particularly sensitive to
management performance, which leads to an extremely low incentive effect of
stock ownership by managers.
21. In fact, the Russian communication sector, which has been developing in recent
years at a breathtaking speed, driven by cellular phone and Internet service busi-

nesses, saw an average annual real growth rate of 22.4% between 2001 and 2004.
This growth is much higher than the 4.2% for the eight manufacturing sectors
covered by our enterprise survey and is the reason that the telecommunication
sector is regarded as the new economy in Russia.
9780230_217287_05_cha03. dd 85 5/14/2009 3:44:53 PM
86 Organization and Development of Russian Business
22. On the other hand, all models were re-estimated by logit, and the results were
found to be almost the same as those indicated in Table 3.5.
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89
4
The Structure of Corporate Boards
Ichiro Iwasaki
Introduction
Despite the fact that a general shareholder meeting is a supreme
decision-making organ within a corporation, few challenge the argument
by Jensen (1993) that a board of directors plays the most important role
in an internal control system. In a modern corporate system separating
management from ownership, “boards are the overlap between the small,
powerful group that runs the company and huge, diffuse, and relatively
powerless group that simply wishes to see the company run well” (Monks &
Minow 1996: 167). Accordingly, the primary mission of the directors is to
supervise the corporate management on behalf of shareholders by adhering
to their duties of due care and loyalty. In other words, if the responsibil-
ity of senior managers is to make decisions at their own discretion regard-
ing business operations, that of the board of directors is to exercise control
over such management decisions. Only this division of power prevents the
management from being the sole evaluator of the business performance as
well as ensuring the safeguard of invested shareholder capital (Baysinger &
Hoskisson 1990).
In Russia, competition in product markets is not weak in many indus-
tries (Broadman 2000). The capital market and the market of corporate

control also remain underdeveloped (Sugiura 2007). Under such circum-
stances, Russia is expected to establish internal controls that are as strong
and functional as those of developed countries in order to effectively pro-
mote discipline in corporate management. Meanwhile, the role of a board
of directors cannot be limited to the monitoring of management even in a
broad sense that would include CEO appointment and turnover, the assess-
ment of financial performance, and the determination of managerial remu-
neration. A board of directors is hierarchically superior to management. In
fact, it provides strategic management expertise, advice, and recommenda-
tions regarding management activities (Baysinger & Butler 1985). In addi-
tion, as suggested by Hermalin and Weisbach (1988), a corporate board is
9780230_217287_06_cha04. dd 89 5/14/2009 3:46:31 PM
90 Organization and Development of Russian Business
a competitive training site for CEO candidates. Accordingly, a corporate
board is not necessarily comprised of persons whose roles are limited to
managerial supervision. Moreover, as Bathala and Rao (1995) argue, outsider
directors do not always account for the majority of board members because
corporations naturally use other governance mechanisms when alleviat-
ing a conflict between owners and managers in order to optimize board
functions. In fact, board structure differs depending on the region, country,
economic system, industrial sector, market, corporate form, and business
activity of the company.
To understand this organizational diversity, scholars have turned to agency
theory (Jensen & Meckling 1976; Fama 1980; Fama & Jensen 1983), the the-
ory of property rights (Demsetz 1967; Alchian & Demsetz 1972) and other
management theories, such as the resource-dependent theory (Pfeffer &
Salancik 1978) and the stewardship theory (Muth & Donaldson 1998). In
addition, the development of empirical tools has continued through inter-
action mainly with research works on American and European companies,
which share the set of standards that is now applicable to postcommunist

economies as well. Nevertheless, to the best of our knowledge, there has
never been any thorough study on the determinants of board structure in
Russia and other transitional countries.
To deepen our understanding of transition economies, this study repre-
sents an attempt to identify the economically and statistically significant
factors determining the formation of a board of directors in Russian com-
panies through a comprehensive reexamination of the theoretical and
empirical implications of board structure in developed countries. This is
the primary objective of this chapter. In this research field, Hermalin and
Weisbach (1998) propose a bargaining hypothesis in which the structure of
a corporate board is determined through a bargaining process between the
CEO and outside board members, presenting a different theoretical model
from the traditional agency theory, which implicitly assumes a preestab-
lished harmony in the self-organization of the firm. As is discussed later,
the bargaining hypothesis and the agency theory assume different positions
regarding the manner in which the bargaining power of corporate manag-
ers and their countervailing parties affects their company’s board structure.
Judging the applicability of these two approaches to Russian firms from this
viewpoint is a matter of great importance for understanding the organiza-
tional behavior of business firms in a transition period and is the second
objective of this chapter.
These two objectives raise the question of which dimension of a firm’s
organization and which business activities are essential for the empirical
analysis of Russian corporations. To address this issue, the potential deter-
minants of board structure are classified into two categories. The first is gov-
ernance variables in a narrow sense, which include those relating to a firm’s
organization, such as ownership structure and company size. The second is
9780230_217287_06_cha04. dd 90 5/14/2009 3:46:31 PM
The Structure of Corporate Boards 91
business-activity variables, consisting of those relating to business type, com-

petition environment, fund-raising activities, and financial performance.
Furthermore, the governance variables are divided into bargaining variables,
which reflect the bargaining power of managers and that of interested par-
ties who are in conflict with the managers, and other governance variables
for the examination of the second objective of this research. In this chapter,
the impacts of the three variable groups are empirically compared within
the structure of corporate boards.
As a third objective, we propose and empirically validate several theo-
retical hypotheses concerning the interrelation of board structure with
the special features of corporate law and the transition economy in Russia.
While Russian corporate law adopts the Anglo-American type of corporate
model in general, it introduces several unique regulations regarding the
governance mechanism in joint-stock companies, including placing a lower
limit on board size, prohibiting the vesting of the two titles of company
top manager and board chairman in one person, and not allowing other
executive directors to concurrently assume one quarter or more of the board
membership (Black & Kraakman 1996; Iwasaki 2007a). An investigation of
the impact of these legal arrangements on board structure would definitely
be worthwhile. In addition, for researchers of transition economies, it is
an intriguing subject to study how influential the succession of the “com-
mon properties of the working class” in the socialist era is over the internal
organization and management system in former state-owned enterprises
in comparison to newly established private firms in the transition period
(Djankov & Murrell 2002). Furthermore, the potential impact of integration
with so-called business groups on corporate governance in their affiliate
companies cannot be overlooked. An empirical study of the above specific
features in the Russian economy in terms of their effects on board structure
will contribute valuable findings and theoretical viewpoints to the study of
transition economies as well as to the field of financial and organizational
economics.

To investigate three objectives stated above, we conduct an empirical anal-
ysis of the determinants of (a) board size, (b) proportion of outsider directors
(board composition), and (c) appointment of board chairmen (board leader-
ship structure) dealing with their endogeneity. We assume that these three
board components are interrelated and simultaneously determined. This
is called endogenous board formation. Recent theoretical and empirical work
gives considerable attention to this structural aspect in corporate boards
(Lehn et al. 2005; Adams & Ferreira 2007; Boone et al. 2007; Coles et al.
2008; Linck et al. 2008).
As the basis for the empirical analysis in this chapter, we utilize the results
of the Japan–Russia large-scale enterprise survey conducted in 2005. The sur-
vey results include information on the size of the boards, basic attributes of
board directors, and methods used for the appointment of board chairmen,
9780230_217287_06_cha04. dd 91 5/14/2009 3:46:31 PM
92 Organization and Development of Russian Business
which made it possible to carry out a detailed investigation of 741 board
chairmen and 4,818 directors. In addition, databases belonging to SKRIN
and SPARK Co., both of which are major company information agencies in
Russia, were used in this study to obtain data on the financial performance,
the industrial classification, and the percentage of ownership shares held by
the managers and board members of our sample firms.
The remainder of this chapter is organized as follows. The next section
describes the legal framework of the board structure in Russian joint-stock
companies. The third section reports the general characteristics of board
structure based on the results of the joint enterprise survey. The fourth sec-
tion presents testable hypotheses. The fifth section conducts empirical anal-
ysis of the determinants of board formation. Concluding remarks follow.
Legal framework of the board structure in
Russian joint-stock companies
In Russia, the legal basis for joint-stock companies is provided by the pro-

visions of the Civil Code and the Federal Law on Joint-Stock Companies
(Law on JSCs) and supplemented by the Corporate Governance (CG) Code.
1

According to corporate law, not all joint-stock companies founded in Russia
are required to establish a board of directors. Article 64 of the Law on JSCs
provides that the general shareholder meeting of a joint-stock company
whose voting shares are held by fewer than 50 persons may perform the
same functions as those of the board of directors. This measure is construed
as a legal device for enabling comparatively small companies directly man-
aged by their shareholders to avoid establishing an unnecessary corporate
organ and reduce management costs (Tsepov 2006).
The number and appointment of board members are determined exclu-
sively by an ordinary resolution of a shareholder meeting (Law on JSCs,
Art. 48(1), Para. 4). Nevertheless, there are strict legal requirements as to the
minimum number of directors. They provide that companies with 10,000
or more voting shareholders must have no fewer than 9 directors; those
with 1,000 or more but fewer than 10,000 voting shareholders must have no
fewer than 7 directors; and those with fewer than 1,000 voting shareholders
must have no fewer than 5 directors (Art. 66(3)). On the other hand, there is
no statutory upper limit. The term of office for directors is one year (defined
as the date of appointment to the date of the next year’s shareholder meet-
ing), and all of their seats must be contested at a regular shareholder meeting
to be held no earlier than two months and no later than six months from
the commencement of the fiscal year (Art. 47(1)). In other words, a staggered
board is not allowed in Russia, in contrast to the cases of the US and France,
where such a system is quite common. All directors must be elected through
cumulative voting, a system that aims to protect the interests of minority
shareholders (Art. 66(4)).
2

Every shareholder who holds one-fiftieth or more
9780230_217287_06_cha04. dd 92 5/14/2009 3:46:32 PM
The Structure of Corporate Boards 93
of the total issued shares (2% or more voting equity) has a right to nomi-
nate directors (Art. 53(1)). Shareholders with one-tenth or more of the total
issued shares also have the right to convene an extraordinary shareholder
meeting and file a motion seeking the replacement of incumbent directors
(Art. 55(1)).
A board chairman is elected among the directors approved at a share-
holder meeting by a simple majority. Directors may replace their chairman
at any time by a resolution adopted by the majority of their votes unless oth-
erwise stipulated in the articles of incorporation (Law on JSCs, Art. 67(1)).
The most distinctive feature of the management and supervisory bod-
ies of Russian joint-stock companies lies in comparatively strict restrictions
regarding managers assuming board memberships. The Law on JSCs prohib-
its the top manager (single executive organ) from serving as his company
board chairman. It also prevents members of the collective executive organ
(the management/administration division), consisting of senior managers,
from accounting for one-quarter or more of the board membership (Law on
JSCs, Art. 66(2)).
3
In addition, members of the audit committee established
as a subordinate organ to the general shareholder meetings for the purpose
of investigating financial and management activities may not become board
members (Art. 85(6)).
The Law on JSCs, however, includes no provision preventing the board
chairman from being elected from among insider directors; moreover, it
allows joint-stock companies to determine at their own discretion whether
to establish a collective executive organ (Art. 69(1)). Soon after the enact-
ment of the Law on JSCs in 1996, it became clear that joint-stock companies

might easily evade the restrictions on managers assuming board mem-
berships by not establishing a collective executive organ. As explained in
another paper (Iwasaki 2007a), the adoption of a collective executive organ
requires an amendment of the articles of incorporation and is determined
by a supermajority resolution at a general shareholder meeting (passed by a
majority of not less than three-quarters of the votes of present shareholders
owning a majority of voting shares); this makes it highly possible for man-
agers to attempt to reject requests from outside shareholders to increase the
level of managerial monitoring in collusion with affiliated companies and
employees. It is also likely that a top manager with significant ownership
could appoint an individual under his influence to a board chairmanship.
The CG Code is a kind of government decree issued by the Federal
Commission for Securities Market (FCSM) in April 2002. The CG Code stip-
ulates rules to be followed by all joint-stock companies operating in Russia
with regard to matters pertaining to corporate management, basic princi-
ples of corporate governance (chapter 1), and the settlement of internal dis-
putes (chapter 10). The CG Code devotes much space to matters regarding
the board of directors setting forth detailed rules on board structure as well
as the appointment of board members (chapter 3, section 2). The CG Code,
9780230_217287_06_cha04. dd 93 5/14/2009 3:46:32 PM
94 Organization and Development of Russian Business
however, contains very few numerical targets of board composition; one
of those mandates that joint-stock companies include in their articles of
incorporation is the provision that they have at least three “independent
directors”
4
who account for no less than one-quarter of the board mem-
bership (section 2.2.3). The CG Code has not had a significant effect yet
because it is a relatively new government decree with no legal binding force.
Nevertheless, it is also a fact that some securities exchanges closely examine

whether domestic corporations that have applied for listing their stock or
issuing their bonds are compliant with the code, in accordance with admin-
istrative directions issued by the FCSM. Therefore, the CG Code possibly has
some influence on Russian companies seeking to raise funds from capital
markets.
The structure of Russian corporate boards:
A statistical overview
As already mentioned, in Russia, joint-stock companies with fewer than
50 voting shareholders may determine at their discretion whether or not to
set up a board of directors. Of the 298 surveyed firms whose total number of
shareholders immediately before the survey was known to us, 46 (15.4%) had
fewer than 50 shareholders, including 3 (1.0%) without a board of directors.
The average (median) number of shareholders for these three firms was only
1.3 (1), much smaller than 18.1 (14) for the other 43 enterprises.
5
This differ-
ence is statistically significant (t ϭ Ϫ1.665, p ϭ 0.051 (one-sided); Wilcoxon
Z ϭ Ϫ2.356, p ϭ 0.019). Hence, there are only a few companies with an
extremely small shareholder base that do not have a corporate board despite
the institutional consideration allowing small firms not to set one up.
Of the 822 surveyed firms, 730 (88.8%) responded to our questions
regarding their board size and the basic attributes of their board members.
As Table 4.1 demonstrates, as of the first half of 2005, joint-stock com-
panies in Russia had an average number of 6.6 board members (standard
deviation: 2.4, median: 7), of which only 76 firms or 10.4% had 10 or more
board members. These figures have been stable throughout the transition
period and are consistent with the results of past surveys by Blasi and
Shleifer (1996), Dolgopyatova (2003), and Yasin (2004). Compared with
approximately 18,600 enterprises in 19 countries throughout the world
surveyed in 22 prior studies, the average board size of Russian companies

is smaller than that of large listed firms in the US and other major devel-
oped countries but almost the same as that of initial public offering (IPO)
firms in those large nations and that of listed companies in small coun-
tries (Table 4.2). Considering that most of the enterprises covered by the
joint survey were unlisted companies, Russian corporations are expanding
the scale of their internal organs, following the path of major Western
countries.
9780230_217287_06_cha04. dd 94 5/14/2009 3:46:32 PM
95
Table 4.1 Descriptive statistics on board size and number of directors by their attributes of 730 surveyed firms
Mean S. D. Median Min. Max. 25 percentile 75 percentile Total Share (%)
Board size 6.64 2.40 7 3 23 5 7 4,818 100.0
Insider directors 3.22 2.43 3 0 21 1 5 2,352 48.8
Managers 2.90 2.21 3 0 15 1 5 2,117 43.9
Representatives of
employees and labor
unions
0.32 1.15 0 0 21 0 0 235 4.9
Outsider directors 3.42 2.94 3 0 17 1 5 2,466 51.2
Representatives of
nonemployee private
shareholders
2.55 2.59 2 0 17 0 4 1,865 38.7
Independent directors 0.43 1.13 0 0 10 0 0 314 6.5
Representatives of federal
government agencies
0.18 0.77 0 0 8 0 0 135 2.8
Representatives of local
governments
0.21 0.75 0 0 6 0 0 152 3.2

Source: The joint enterprise survey.
9780230_217287_06_cha04. dd 95 5/14/2009 3:46:32 PM
96
Table 4.2 International comparison of board size and proportion of outsider directors

Analysis
period
Sample
size
Board size
(no. of directors)
Proportion of outsider
directors (%)
Mean S. D. Median Mean S. D. Median
North America
U.S. IPO firms
1
1978–87 1,116 6.07 1.87 6
U.S. IPO firms
2
1988–92 1,019 6.21 62
U.S. listed firms
3
1989–95 508 11.88 2.95 12 55.3 17.1 56.2
U.S. large industrial firms
4
1999 100 11.79 2.94 12 71.8 12.1 73.0
U.S. large commercial banks
4
1999 100 16.37 5.01 16 81.3 6.9 83.1

U.S. large public firms
4
1999 100 11.46 2.74 11 80.5 11.7 83.3
U.S. listed firms
5, a
1990–2003 9,436 8 7 65.2 70.0
Canadian listed firms
6
1996 79 12.34 12 74 79
Canadian public firms
7
2000 38 10.81 3.07 11 89.4 10.6 90.0
Europe
U.K. listed firms
8
1993–96 1,271 8.01 2.64 8 42.7 14.4 42.9
U.K. listed firms
9
1994 250 8.07 2.84 8 39
U.K. listed firms
6
1996 66 12.03 12 48 50
French IPO firms
10
1993–99 299 5.30 2.32 5 53.1
French listed firms
6
1996 42 12.93 13 81 82
German listed firms
6

1996 33 15.06 16 60 58
Italian listed firms
6
1996 56 9.23 9 74 81
Spanish listed firms
6
1996 28 12.29 11 75 80
9780230_217287_06_cha04. dd 96 5/14/2009 3:46:33 PM
97
Swiss listed firms
6
1996 17 9.12 9 90 90
Swiss listed firms
11, b
2001 165 6.59 2.33 6 87 15 89
Dutch listed firms
6
1996 37 6.84 7
Dutch listed firms
12
1996 94 4.95 1.83 5 84.3 19.9 100
Belgian listed firms
6
1996 12 13.17 11.5 76 81
Swedish listed firms
13
1996–98 98 8.18 2.01 84 13
Finnish small and medium-scale
firm
14

1992–94 879 3.71 1.52 3
Russian joint-stock companies
15
2005 730 6.64 2.40 7 48.9 35.3 55.6
Asia-Pacific
Japanese listed firms
16
1990–2001 1,280 13.97 6.55 13 20.0 19.7 14.3
Chinese IPO firms
17, c
1996 113 10.13 3.18 30 24
Chinese listed firms
18
1996 530 9.8 41
Taiwanese listed firms
19
1998 251 8.19 4.18 7
Korean listed firms
20
1990–99 199 10.51 8.36
Australian listed firms
21, c
1989 135 5.56 2.03 5 62 27 67
Singapore listed firms
22
1995 147 8.04 2.08 8 57 21 57
New Zealand listed firms
23
1991–95 63–105 6.60 2.15 6 55.7 25.7 60.0
Notes:

a
The proportion of outsider directors is calculated by the author using the data of the percentage of executive directors.
b
Board of auditors.
c
The proportion of outsider directors covers only independent directors.
Sources: 1: Baker & Gompers (2003); 2: Boone et al. (2007); 3: Fich & Shivdasani (2006); 4: Booth et al. (2002); 5: Linck et al. (2008); 6: de Andres et al.
(2005); 7: Bozec (2005); 8: Peasnell et al. (2005); 9: Vefeas & Theodorov (1998); 10: Roosenboom (2005); 11: Beiner et al. (2004); 12: van Ees et al. (2003);
13: Randøy & Jenssen (2004); 14: Eisenberg et al. (1998); 15: This study; 16: Abe (2003); 17: Tian & Lau (2001); 18: Peng (2004); 19: Yeh & Woidtke (2005);
20: Kim (2005); 21: Arthur (2001); 22: Mak & Li (2001); 23: Prevost et al. (2002).
9780230_217287_06_cha04. dd 97 5/14/2009 3:46:33 PM
98 Organization and Development of Russian Business
Figure 4.1 demonstrates that the board sizes of Russian enterprises are
influenced by the abovementioned legal restrictions as to the minimum
required number of board members according to the number of sharehold-
ers. In fact, of the 730 joint-stock companies, as many as 520 firms, or 71.2%,
have a total of 5, 7, or 9 board members.
Table 4.1 also shows the breakdown of 4,818 board members from the
730 surveyed firms by classifying them into six groups with basic statistics
of specific attributes. From this point forward, a director appointed from
among company managers, rank-and-file employees, and representatives of
a labor union is referred to as an “insider director,” and a director identified
by other circumstances is referred to as an “outsider director.”
6
According to the survey results, the board of directors in a typi-
cal joint-stock company consists of an average of 3.2 insider directors
and 3.4 outsider directors. Contrary to general belief, Russian corporate
boards do not appear to be insider-dominated. A significant percentage
(90.0%) of insider directors is appointed from among senior managers.
Insider directors of this type account for 43.9% of all directors, and they

hold positions on the board in 640 (87.7%) of the 730 surveyed enter-
prises. However, 152, or 23.8%, of these 730 companies have only one
insider director with a managerial background (probably, a top man-
ager). Companies with (an) insider director(s) representing the interests
Figure 4.1 Board size of 730 joint-stock companies (frequency distribution)
Source: The joint enterprise survey.
40
27
245
44
208
23
67
20
38
2
8
4
1111
0
25
50
75
100
125
150
175
200
225
250

275
01234567891011121314151617181920212223
Board size (total number of directors)
No. of companies
9780230_217287_06_cha04. dd 98 5/14/2009 3:46:33 PM
The Structure of Corporate Boards 99
of workers or of a labor union account only for 16.0% (117 companies) of
all our samples.
On the other hand, of outsider directors, 75.6% represent private outsider
owners. Of those, 240, or 12.9%, assume directorships for the interest of
minority shareholders. This outcome could be considered a positive effect of
mandatory cumulative voting. Of the 730 surveyed firms, 481 (65.9%) have
an average number of 3.9 (standard deviation: 2.3; median: 4) directors rep-
resenting private outside shareholders. As for independent directors,
7
they
account for 6.5% of all directors and 12.7% of all outsider directors. However,
only 138 (18.9%), or nearly one-fifth, of the 730 surveyed enterprises have
(an) independent director(s). Despite active efforts by the FCSM, independ-
ent directors are still not common in Russia. As in the case of independent
directors, the number of state representatives is quite small, accounting for
6.0% of all directors and 11.7% of all outsider directors. Although no sta-
tistical background is provided here due to space limitations, we confirmed
that state representatives were sent in large numbers to large-scale formerly
state-owned enterprises operating in strictly regulated industries.
The results of struggles among these interested parties reflect the extent
of outsider representation on the board. Among the 730 responding enter-
prises, the average proportion of outsider directors was 48.9% (median:
55.6%). As shown in Table 4.2, this level is nearly the same as that for listed
firms in the UK, US, China, and the Asia-Pacific region, much lower than

that for companies in Europe, and much higher than that for Japanese com-
panies. Since most of the surveyed firms are unlisted, it appears that the
typical Russian company has the same level of openness as its counterpart
in industrialized countries despite the commonly held opinion that they
are insider-dominated. On the other hand, as shown in Figure 4.2, most
of our sample firms do not have the typical board structure. Rather, the
majority of Russian companies are either governed by a board of directors
with an extremely high proportion of outsider representation on the board
or completely dominated by insider directors. As reported by Barnhart et al.
(1994), Peasnell et al. (2005), and Roosenboom (2005), the extent of outsider
representation of listed and unlisted companies in developed countries has
a bell-shaped distribution in general. Moreover, Table 4.2 indicates that the
standard deviation of the outsider directorship ratio in our samples (35.3%)
is much higher than those in other studies. Therefore, it would be quite
appropriate to perceive the reality of Russian enterprises from the viewpoint
of polarization in terms of the proportion of outsider directors.
As reported earlier, Russian law prohibits a top manager from assuming
the formal leadership of his company’s board; however, that does not pre-
vent an insider director from becoming a board chairman. Furthermore, in
Russia, vertical or horizontal business integrations, including participation
in holding companies or other company groups through stock ownership,
are becoming more prevalent in a dynamic context, prompting corporate
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