Opal''''s Site Organization and Development of Russian Business_10 pptx

192 Organization and Development of Russian Business
In general, a number of characteristics regarding the peculiarities of cor-
porate management were relevant and significant. Irrespective of the JSC
involvement in integration, we observed an adverse effect of restructuring
on the chances of selection in favor of hired managers. Globalization (exist-
ence of competition with foreign manufacturers that aggravates operating
conditions for companies) encouraged the engagement of hired managers.
No steady effect of the size of enterprise on the setup of corporate control
was revealed.
10
Severe competition with Russian manufacturers remains a mystery. The
adverse effect on selection in favor of hired management is typical of all
companies and JSCs classified as independent businesses. The existence of
such competition may reflect restructuring in progress at enterprises, but it
also demonstrates operation in relatively competitive markets requiring no
special competences.
Privatization promoted a combination of functions, but its influence is
not stable. As for the management labor market, its limited role may be
defined by the quality of a selected proxy variable.
The question of how Russian companies will advance is worthy of con-
sideration. Whether owners will remain as managers or rely on the labor
market for hiring top managers will be of interest. It is safe to predict that
restructuring of the legacy of the state-planning economy will be up for
completion and competition in globalizing markets will improve against
the smoothing of the effect of privatization and the inevitable resignation
of the “red directors” generation, thereby enhancing the intention to hire
professional management and search for better candidates. It remains to
be seen whether costs from “self-administration” will outweigh company
benefits from minimizing the risks of managers’ opportunistic behavior.
From all appearances, the existence of an alternative mechanism of control
through integration has already made these values comparable. The risks

of the violation of shareholders’ rights and poor corporate governance are
as important for independent businesses as they were before. It is far more
difficult to forecast the situation with property rights protection. However,
a certain improvement in corporate governance in the 2000s was evident
(Korporativnoe Upravleniye 2007, Natsional’nyi Doklad 2008), and this
tendency is expected to remain in perspective. Incentives for improving
intra-corporate practice are derived from the growing demand for invest-
ments under increasing competition, and the transition to the engagement
of hired managers pushes companies to arrange for standard intra-corporate
procedures promoting corporate governance development.
Acknowledgments
This research was conducted with financial support of SU-HSE (individual
academic grant of the Scientific Foundation No.06-01-0050 and funds from
9780230_217287_09_cha07. dd 192 5/14/2009 3:50:20 PM
Corporate Control and Business Integration 193
the Program for Fundamental Studies granted by the Ministry of Economic
Development and Trade of the Russian Federation in 2007–2008). I would
like to thank Heiko Pleines, Andrei Shastitko, and Yurii Simachyev for their
useful comments and suggestions. Special thanks are given to Olga Uvarova
for her assistance in data processing.
Notes
1. The explanations of abbreviations reflecting configurations of ownership and
management used in tables and graphs of this chapter were made in Chapter 2.
2. Records of in-depth interviews show that board activities are often a tribute paid
to formal legal regulations and that their titular nature tends to correlate with
both the fusion of the board with executive management and the stability of its
membership (Dolgopyatova 2004).
3. Although such ownership indicates, to some degree, an enterprise’s participation
in the holding company group, it may have an individual value as a signal of
nontransparency.

4. The existence of a foreign or quasi-foreign investor will have no effect on the
formulation of a quantitative hypothesis.
5. Management turnover is certainly encouraged by inefficient management, but a
single survey is insufficient to offer adequate indicators of its measurement.
6. Restructuring was required for the overwhelming majority of Russian compa-
nies, both privatized ones whose assets were collected under the state-planned
economy and new ones, because they emerged in the real sector from what
was left from old Soviet enterprises by accumulating their assets. Corporate
integration became one of the main forms of business restructuring (Radygin
2004).
7. It should be emphasized that, although the point is the company’s external fac-
tor of competition in the market of its products, we in fact have only a subjective
respondent assessment of the level of competition that can be developed though
a set of conditions.
8. A series of signals is available in the survey, namely, the educational background
of the CEO as well as his/her “history” (external manager or incumbent, i.e.,
staff member of a given enterprise) and management experience at foreign busi-
nesses or government bodies. However, such characteristics are unlikely to be
independent factors of choice; thus, they may be useful at the stage of looking
for a suitable candidate (or be its effect) rather than for a shareholder’s critical
decision with regard to withdrawal from management.
9. Labor market supply can also differ depending on the size and the status of
populated areas (capital city, town, and village). However, the situation is not
exactly straightforward. On the one hand, a more important status and popula-
tion will offer a wider choice of labor, while, on the other hand, small villages are
unattractive to business owners as a place of principal residence. When a busi-
ness includes divisions located elsewhere, especially in small towns and villages,
shareholders will be more inclined to look for local candidates for managerial
positions, while they themselves could manage companies located in Moscow or
other large cities.

10. The number of employees is closely correlated with the company’s form of incor-
poration, and the last indicator includes the effect of size.
9780230_217287_09_cha07. dd 193 5/14/2009 3:50:20 PM
194 Organization and Development of Russian Business
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195
8
Corporate Governance and
Decision-Making in Business Groups
Svetlana B. Avdasheva
Introduction
This chapter and the following one are devoted to independent legal entities
that constitute united companies and are known as business groups (BGs) or
holding company groups. In modern economic literature, BGs are defined
as “a set of firms which, though legally independent, are bound together by
a constellation of formal and informal ties and are accustomed to taking
coordinated action” (Khanna & Rivkin 2001: 47–48). Russian law defines
a parent company and its subsidiary, which together constitute a holding
company group, as a pair of agents, one of which, namely, the parent com-
pany, has sufficient authority to determine the decisions of another based
on ownership rights or any other type of control rights.
1
In this respect,
both terms, BGs and holding company groups, are synonymous.
In Russia, the term “business group” usually applies to legally independent
entities under the same control that were historically independent businesses
and have experience acting independently. BGs are sometimes considered
to be newly established integrations that occurred after privatization.
In this book, a business group is defined as a set of legally independ-

ent entities joined by ownership rights. The set of entities (enterprises) is
under control of the ultimate owner (or small groups of interrelated ultimate
owners) or parent company. No distinction is generally made between BGs
founded during the Soviet times and those established in mergers during
the economic upturn that started in 1999 after the completion of a mass
movement of privatization.
Competing hypotheses of corporate governance in
Russian business groups
In contemporary studies, considerable attention is given to Russian BGs as
a form of concentration of capital and assets and, at the same time, as a
way to restructure privatized enterprises. Mergers are also among the most
9780230_217287_10_cha08. dd 195 5/14/2009 3:51:15 PM
196 Organization and Development of Russian Business
important events changing the organization of markets in Russia. During
the economic upturn, the ratio of merger value to GDP increased from 4%
in 2001 to about 8% in 2005–2007.
2
The largest groups control almost one-
half of the relevant industrial markets in Russia (Guriev & Rachinsky 2005)
and the great majority of companies listed on stock exchanges (Boone &
Rodionov 2002). After the acquisition of undervalued assets or their takeo-
ver via the use of various informal instruments during the 1990s, BGs have
been making substantial efforts to restructure their constituent companies.
“Oligarchs” are not only the largest shareholders but also more efficient
owners in comparison to the owners of nonaffiliated enterprises (Guriev &
Rachinsky 2005).
However, the rapid development of BGs contradicts common knowledge
about the prominent features of the Russian national model of corporate
governance (see Chapters 1 and 7 for details). BGs are supposed to be based
on the separation of ownership and management. However, in recent sur-

veys, it has been demonstrated that, in most Russian companies, ownership
and management converge. Given a weak institutional environment, the
most successful way to resolve agency problems in a typical Russian com-
pany is the “do-it-yourself” option. That is the reason that many executive
managers of privatized firms became the controlling owners, and new own-
ers of companies (both privatized and newly established) became execu-
tive managers (in reality, if not formally) or hired managers that were so
closely affiliated that the agency problem could be considered to be nonex-
istent. Therefore, an important problem in the study of transition in Russia
is explaining the model of corporate governance in Russian BGs. Thus, it is
necessary to understand which specific tools are used to prevent losses from
the agency problem in Russian BGs.
It is worthwhile to discuss five hypotheses regarding the instruments of
corporate governance in BGs:
Hypothesis H1: There is no agency problem in Russian BGs, since they are
not companies. The formation of BGs is a completely artificial process moti-
vated by political considerations. From this point of view, the support provided
by the Russian government to large company alliances thoroughly explains the
incentives for typical privatized enterprises to join BGs.
If the JSCs in the group are integrated in the company, that is, if they are
organized into a hierarchical system, then four hypotheses are possible:
Hypothesis H2: The principal-agent problem is solved by the convergence of
ownership and management, as is traditional in Russia. BGs have the same
system of corporate control as do independent or autonomous enterprises. This
means that management is not separated from ownership and ultimate owners
manage the enterprises in the BGs.
9780230_217287_10_cha08. dd 196 5/14/2009 3:51:15 PM
Corporate Governance and Decision-Making 197
If the BGs are organized as hierarchies but management is separated from
ownership, then,

Hypothesis H3: The principal-agent problem is solved by the development
of internal corporate governance tools, which include boards, independent
directors, and internal audit units. This should be extremely important in the
Russian context of weak external instruments to uphold the discipline of execu-
tive management.
Hypothesis H4: The principal-agent problem is solved by the owner having
additional bargaining power. One example is the state as a dominant owner.
Hypothesis H5: The executive management in BGs is disciplined by the ben-
efits of joining the group. For instance, BGs can be supported by relational-type
contracts (Goldberg 1980) between an owner who is an outsider not participat-
ing in management and an executive manager. In this case, the outside owner
does not need to spend resources to control executive management. Discipline
within the group of enterprises is upheld by mutual interests.
Not all of the hypotheses are mutually exclusive. This is especially true
for H3–H5. Improvement of subsidiary performance can complement the
impact of corporate governance bodies as a disciplinary device. The poten-
tial opportunism of executive management can be prevented by direct
supervision of a parent company and by increasing the performance of
the enterprise within a BG. The objective in this chapter is to examine the
hypotheses, from H1 to H4, using the results of the Japan–Russia joint sur-
vey conducted in 2005. The next chapter is devoted to the impact of BG
membership on the performance of subsidiaries, and the analysis will pro-
vide evidence in favor of H5.
Organization of Russian business groups
The ratio of enterprises that are members of BGs and their share in the
overall employment in the relevant industry are presented in Figure 8.1.
Communications, fuel and energy, and metallurgy lead in the percentage
of industry employment in the BGs, while light industry and construction
materials are comparative outsiders. The larger companies are involved in
group membership. Of 323 enterprises that identified themselves as affili-

ated to a BG, 44 respondents declared themselves to be parent companies;
the others are subsidiaries. Almost one-third of the subsidiary companies in
the sample are in regulated industries that include the generation and trans-
mission of electric power and regional telecommunication companies. The
share of JSCs affiliated with BGs is very close to the alternative estimates of
the share of BGs in economic activity in Russia (see, for instance, Guriev &
Rachinsky 2005).
9780230_217287_10_cha08. dd 197 5/14/2009 3:51:16 PM
198 Organization and Development of Russian Business
Although BGs are primarily of interest as a form of ownership realloca-
tion following privatization, not all the enterprises in the sample joined the
groups after privatization and liberalization. In the fuel and power indus-
tries, the largest groups emerged before 1992. In all other industries, most of
the groups were founded after privatization. Mergers intensified during the
economic recovery after 1999; most of the deals for the sample took place in
2002. During this year, 50 enterprises, or slightly less than one-sixth of the
whole subsample of affiliated companies, joined their groups. About half
of the BGs are horizontal; they include enterprises in the same industry.
Slightly more than a quarter are vertical; they contain producers along the
same technological chain. The rest are conglomerate. Most groups include
numerous auxiliary units as separate legal entities in addition to the basic
production facilities; half of the groups include trade enterprises, and about
one-fifth include banks and/or financial/insurance companies.
Therefore, the firms in the groups represented in the survey are very het-
erogeneous by the origin, industry, and experience of being autonomous as
a business unit. However, by considering such diverse companies, we can
collect evidence to support several of the hypotheses presented in this study
on the nature of corporate governance in the subsidiaries.
Before discussing the various alternative hypotheses, it is necessary
to analyze the allocation of responsibilities and the decision-making

0 10203040
(%)
50 60 70 80 90
Total
Communications
Construction materials
Food industry
Light industry
Wood, paper, and wood products
Chemicals and petrochemicals
Machine building and metal working
Metallurgy
Fuel and energy
Percent of enterprises affiliated to BGs by industry
Percent of workers employed in BGs by industry
Figure 8.1 Share of business groups (BGs) in number of companies and in employment (%)
Source: Author’s illustration based on survey data.
9780230_217287_10_cha08. dd 198 5/14/2009 3:51:16 PM
Corporate Governance and Decision-Making 199
process within the BGs. The goal here is to make sure that coordination
and decision-making within the groups comply with a hierarchical system,
which gives rise to the agency problem. If, according to the classification of
the new institutional economics (Williamson 1985), coordination within
BGs is more of a hybrid-type coordination between legally and economi-
cally independent units, then the stability of these companies should be
analyzed solely in the framework of relational contracting and not in the
framework of corporate governance and corporate control.
If subsidiaries are part of companies but not independent businesses and
the disciplinary devices within the groups are to be considered it is neces-
sary to evaluate corporate governance as disciplinary device. In order to

do that it is necessary to compare the corporate governance, including the
convergence of ownership and management in companies that are either
affiliated or nonaffiliated with a BG, as well as the role of internal corpo-
rate governance instruments, such as the board of directors and shareholder
meetings. In Chapter 7, it was demonstrated that corporate governance in
subsidiaries in holding company groups differs substantially from corporate
governance in JSCs representing autonomous business. In this chapter, the
different types of subsidiaries are investigated. Special attention is given to
the comparison of corporate governance in companies in regulated indus-
tries, such as energy and telecommunications, and nonregulated industries.
In regulated industries, the agency problem can be prevented, since the state
can uphold the discipline of executive management with a broad range of
supplementary instruments. Correspondingly, we can expect more effective
internal corporate governance in the holding company groups in regulated
industries.
The remainder of the chapter is organized as follows. The second sec-
tion is devoted to decision-making in BGs. The scope of centralization and
the involvement of stakeholders in strategic planning are under analysis
in order to support or reject H1. The third section is a comparison of the
internal instruments of corporate governance in the JSCs in regulated and
nonregulated industries in order to discuss H2–H4. The fourth section is
an attempt to quantify the role of different instruments used to discipline
executive management in Russian BGs.
Decision-making in the holding company groups:
Centralization or networking with stakeholders?
During the last decade, among Russian economists, there were a number
of competing opinions about decision-making within BGs. Ten years ago,
most experts considered BGs as completely artificial alliances without com-
mon group decisions and without a special system of decision-making.
In the course of time, most researchers concluded that the nontranspar-

ency of the ownership structure and decision-making prevents identifying
9780230_217287_10_cha08. dd 199 5/14/2009 3:51:17 PM
200 Organization and Development of Russian Business
the type of coordination that occurs within a group and even the group
boundaries. It spite of nontransparency, centralized decision-making takes
place (Pappe 2000). The ownership structure within the groups, as well as
the group boundaries, became more transparent over a 10-year period, and
the same was true for the decision-making within the groups. However, the
results of the comparison of the decision-making and management in the
BGs with those in a large company are still debatable. In some studies, it was
reported that both strategic and daily management decisions in the groups
are extremely centralized (Dolgopyatova 2004). Others observed the cen-
tralization of only strategic management decisions, as daily management
decisions are decentralized (Radygin 2004). However, in almost all studies,
there was agreement that BGs are a specific type of firm with hierarchi-
cal governance of transactions and not a network of enterprises that are
equal partners. Moreover, with the course of time, Russian BGs restructured
the system of decision-making toward further separation of strategic and
daily management decisions and the centralization of strategic decisions
(Pappe & Galukhina 2006).
According to the results of sample surveys of enterprises in the project
Structural Changes in the Russian Industry (Yasin 2004), there is evidence
that authority is divided between parent companies and subsidiaries in a
rather irregular way: the parent company makes all financial, marketing,
and investment decisions, which include not only strategic but also daily
decisions, along the traditional lines of this division, and subsidiaries make
production management decisions only.
There were 30 respondents, representing both affiliated and nonaffiliated
enterprises. All the respondents were top managers of their firms: 14 were
general directors, and 11 were deputy directors. Most of the companies were

established in the Soviet period and then privatized (60% were open JSCs,
and 30% were closed JSCs); 37% of the respondents were in light indus-
try, 30% were in the food industry, and 33% were in the machine-building
industry. As reported above, interviews were conducted in medium-size
companies: 13 of the companies had 100 to 500 employees, 12 had 501 to
1,000 employees, and only 5 had more than 1,000 employees. The typical
firm in the sample had relatively stable financial performance, while there
were some firms in bankruptcy, including those that were under exter-
nal management at the moment of the interview. Firms interviewed had
demonstrated a very large increase of output since 1998. Of the 30 firms
included in the interview, 16 were part of various BGs, which are outside
owners of the enterprises. Only one respondent said that his enterprise was
part of a BG that did not participate in authorized capital and, in spite of
that, performed the functions of executive management.
In most cases, the responsibility for decision-making was allocated so that
the parent company was the marketing center of the group and all market-
ing and financial decisions were centralized; the affiliated enterprise was a
9780230_217287_10_cha08. dd 200 5/14/2009 3:51:17 PM
Corporate Governance and Decision-Making 201
production facility only but enjoyed significant autonomy in production
decisions and labor management. The following quotations from the inter-
view are typical:
“Key decisions are made at the enterprise level; the group was formed only for mar-
keting.” This respondent was the general director of a machine- building
enterprise with 300 employees. The strong opinion expressed by the
respondent that marketing decisions were of secondary importance to
him is crucial here.
“The holding company (parent company in this context) controls all the
finances, buys all the inputs for production, and provides us with the
technologies, including all of the documentation We supply the final

products in exchange for that.” This respondent was the general director
of a machine-building firm with 1,800 employees. The director of the
enterprise considers the management and decision-making within the
group as internal markets but not as hierarchical coordination.
“The enterprise is freed from unusual and unnecessary decisions. The par-
ent company performs the functions of the Soviet Glavk (industrial plan-
ning body under socialism). We don’t care about what and how much to
produce The holding (parent) company supplies the raw materials, sells
our products, and takes care of all the accounting, taxes, and finances.
The director shouldn’t think about taxes and wages The holding com-
pany (parent company) is a buffer that saves us from the market ” This
respondent was the general director of a machine-building enterprise
with 1,100 employees. The notion of enterprise as a production unit of
broader company is typical here.
“(The parent company) deals with the marketing for the most part. I do not
care any more to whom the product is sold or at what price it is sold.” The
respondent was the general director of a food processing enterprise with
430 employees.
The results of the interview lead us to the conclusion that, first, decision-
making in the BGs has changed significantly from that in the period when
enterprises functioned as independent entities; yet, secondly, the main
trend of these changes is not to modify the decision-making process at the
enterprise level but to strip the enterprises of all marketing decisions; the
enterprises then become pure production facilities. It is symptomatic that
the top managers of the enterprises stress the use of Soviet-type planning
inside the BGs as the main advantage of this form of organization. The con-
clusion is that holding companies are a very Soviet form of capitalism, and
this important explanation of the rise of this organizational form in Russian
industries has been suggested by others, for example, Clarke (2004).
The level of centralization of decision-making in BGs needs to be assessed

to verify the hypotheses on the corporate governance of BGs given above. A
9780230_217287_10_cha08. dd 201 5/14/2009 3:51:17 PM
202 Organization and Development of Russian Business
high degree of centralization of decision-making would mean that owner-
ship and management are not separated, and, thus, the agency problem is
resolved (H2). If the parent company concentrates all important decisions
at the level of headquarters, or, as is typical for Russian JSCs, at the level of
a small group of ultimate owners, there is no specific agency problem in
the BGs other than the typical agency problem faced by all big companies.
However, if the top management of affiliated companies enjoys substantial
autonomy, then the agency problem between parent and subsidiary intensi-
fies, and specific instruments are needed to resolve it.
Our survey results are ambiguous as to whether decision-making is cen-
tralized or decentralized. The degree of centralization does not seem to be
very high if we look at the decisions made exclusively by the parent com-
pany without participation of the enterprise. Strategic decisions are made
by the parent company alone in 40% of the groups, while daily manage-
ment decisions are completely centralized in only 5%. However, in slightly
more than half of the enterprises, parent companies participate or coordi-
nate strategic and daily management decisions, although subsidiaries retain
an influence on them. Important evidence is that the degree of centraliza-
tion of daily management decisions significantly increases over time. From
enterprises that became subsidiaries in the groups before 1995, the last year
of mass privatization, 55% consider themselves as fully autonomous in daily
management decisions. Among the enterprises that became subsidiaries
after 1995, the ratio falls substantially to 37%. Therefore, recent BGs employ
more centralized decision-making.
This evidence is in favor of H2: even if ownership and management at
the level of subsidiaries are formally separated and the ultimate owner does
not own the shares of subsidiaries, the role of the parent company reflects

the participation of the owner in management. By taking part in daily
management decisions in subsidiaries, which is the case for more than half
of the enterprises, parent companies and the ultimate owners correspond-
ingly prevent the soundest manifestations of agency problems at the level
of subsidiaries.
The participation of stakeholders in the planning and management of the
enterprises is important for both analyzing the process of decision- making
in BGs and qualifying them as companies rather than as networks of compa-
nies. Networking and corresponding relational rents are traditionally seen
as an important source of advantages for BGs, especially in Korea, Taiwan,
India, and Malaysia (see Khanna & Yafeh 2005, for a survey). The high
importance of networks, which may have been inherited from the Soviet
period in some cases, is also often attributed to Russian enterprises. The
influence of networks on decision-making, management, and performance
in enterprises was evaluated by researchers of Russian enterprises either pos-
itively or very negatively. According to the first point of view, contacts with
stakeholders suggest relational rents in the networks of traditional suppliers
9780230_217287_10_cha08. dd 202 5/14/2009 3:51:17 PM
Corporate Governance and Decision-Making 203
and customers (Moers 2000) and then improve the economic performance
of the enterprise, while, according to the second point of view, support-
ing relationships in traditional networks is the alternative to a market-
oriented restructuring that prevents upgrading of the enterprise (Gaddy &
Ickes 1998). At the same time, both groups agree that Russian enterprises are
active participants of networking, both formal and informal.
However, our findings contradict this notion as far as members in BGs
are concerned (Table 8.1). Although group member companies more often
coordinate their strategic decisions with different types of stakeholders, this
coordination is quite limited. A large part of the respondents, 69% of inde-
pendent enterprises and 57% of group member companies, reported that

they do not coordinate their strategic management decisions with any type
of outside stakeholders. Horizontal coordination between firms is imple-
mented by less than one-third of BG members.
Even this modest difference between affiliated and nonaffiliated com-
panies can be easily explained, both by the size of the companies and by
the specifics of regulated industries. First, the importance of stakeholders
and the scale of networking generally increase with the size of the com-
pany and the specificity of the deals, and BGs are substantially larger than
nonaffiliated enterprises. Second, companies in regulated industries, where
affiliated enterprises prevail, are involved in more intensive networking in
order to bargain over regulated tariffs and investment plans that need to be
approved by regulatory bodies and/or parliament. As is evident in Table 8.1,
federal and regional administrations are important stakeholders for JSCs in
regulated industries, both as regulators and as representatives of the state as
shareholders. This evidence indirectly refutes H1.
In conclusion, our survey results show that it is a hierarchical coordina-
tion rather than networking that prevails in Russian BGs. Group firms (first
Table 8.1 Enterprises coordinating strategic decisions with outside stakeholders (%)
Affiliated JSCs Non-
affiliated
JSCs
In
regulated
industries
(N = 79–82)
In
nonregulated
industries
(N = 97–100)
Overall

Federal administrations 40.00 14.60 21.90 9.60
Regional administrations 52.20 28.20 35.20 22.70
Workers and trade unions 47.80 30.80 35.70 27.00
Banks (not group members) 22.30 17.50 18.90 12.10
Suppliers and customers
(not group members)
21.10 20.80 20.90 13.40
Members of a BG 30.20 31.80 30.80 —
Source: Author’s calculations based on survey data.
9780230_217287_10_cha08. dd 203 5/14/2009 3:51:17 PM
204 Organization and Development of Russian Business
of all, “old” group members) retain autonomy in daily management deci-
sions at most. The specific tools for resolving the agency problem lie in the
relations between the parent company and the subsidiaries.
Corporate governance in BGs: The state’s presence matters
Group firms, particularly subsidiaries, differ from independent companies by
their patterns of ownership and control (Table 8.2). Many group member JSCs
are under unilateral influence of the dominant owner. Control in the groups is
largely based on shareholding: two-thirds of independent enterprises reported
that they had a shareholder or a group of shareholders with a controlling stake,
but almost four-fifths of the group member companies already had such own-
ers. The smaller number of firms in which there is an owner with a blocking
package in addition to another owner with a controlling stake among subsidi-
aries is an additional indicator of the higher concentration of control in sub-
sidiaries. In contrast, parent companies of BGs more often have an owner with
a controlling stake along with an owner holding a blocking package.
Table 8.2 Ownership and management in JSCs depending on their affiliation with
BGs (%)
Indicators Not
affiliated

(1)
Affiliated
(2)
In BGs Differences
significant
at the 5%
level
Parent
(3)
Subsidiaries
(4)
A controlling owner or
a controlling group of
owners is present
85.25
(461)
90.68
(311)
90.70
(43)
90.68
(268)
Among (1)
and (2)
An owner (consolidated
group of owners) of
a controlling stake
(50%+1 share) is present
66.30
(460)

78.11
(297)
66.67
(42)
79.22
(255)
Among (1)
and (4)
Apart from the owner
of a controlling stake,
an owner of a blocking
package is present
32.66
(294)
27.23
(224)
50.00
(28)
23.98
(196)
Among (1),
(3) and (4)
Large shareholders act
as enterprise managers
56.24
(473)
34.95
(309)
53.50
(43)

31.95
(266)
Among (1),
(3) and (4)
The CEO (chairman of
the board of directors)
holds enterprise shares
70.23
(477)
50.66
(304)
68.29
(41)
47.91
(263)
Among (1),
(3) and (4)
Notes:
The number of respondents is given in brackets. The significance of the difference is estimated
using the Tamhane T2 test.
Source: Author’s calculations based on survey data.
9780230_217287_10_cha08. dd 204 5/14/2009 3:51:18 PM
Corporate Governance and Decision-Making 205
As reported in Chapter 7, affiliate companies of a BGs, especially subsidi-
aries, demonstrate a lower level of convergence of ownership and manage-
ment than independent companies. This is especially true for the largest
diversified groups with many subsidiaries and an all-Russian and/or inter-
national scope of activities. Under management separated from ownership,
the ultimate owner should rely on the internal system of corporate govern-
ance in order to prevent the exertion of an agency problem. Therefore, in

subsidiaries, as in other JSCs with management separated from ownership,
the structure and role of corporate governance bodies are expected to reflect
the increasing demand for disciplining executive management. Our survey
data comply with these expectations. The average share of managers on the
boards of directors in affiliated companies is 32%, which is notably lower
than the 54% in nonaffiliated companies. The share of external owners on
the boards is much higher in affiliated companies, especially in subsidiaries
(47% of the board members in subsidiaries, 28% in parent companies, and
24% in nonaffiliated companies). Finally, the percentage of the boards of
directors, which include independent directors, is twice higher among group
firms than among independent JSCs (27% as opposed to 14%). Respondents
representing group members more frequently report that shareholder meet-
ings play an important role in decision-making (58% in subsidiaries in con-
trast to 45–46% in parent and nonaffiliated companies). The same is true for
the board of directors: 71% of companies in BGs considered the board to be
extremely important, in contrast to 63% of nonaffiliated companies.
Corporate governance implies a strong reliance on both the market of
control and the market of managers, which should be more important for
group firms because of management separated from ownership. At the
enterprise level, this reliance must be reflected in a higher frequency of
change of owners, top managers, and members of the boards of directors.
During 2001–2004, when the process of corporate integration was experi-
encing its most intensive period, every third enterprise belonging to a BG
changed owners, while the percentage for nonaffiliated enterprises was only
a quarter. The same is true for the change of general directors: 49% of the
general directors in affiliated companies were replaced during the period
under analysis, in contrast to 32% in nonaffiliated enterprises.
As is clear, the results of our joint survey provide supporting evidence
for H3. Instruments of corporate governance are more important in group
firms. At the same time, we cannot fully refute H2, which states that the

agency problem is solved in BGs in the same way as in nonaffiliated JSCs:
by the convergence of management and ownership. Top managers own
shares, and controlling shareholders act as managers in, at the very least,
one-third of the BG subsidiaries. However, the data on corporate govern-
ance presented allow different interpretation. In many Russian companies,
corporate bodies do not play an important role in decision-making in spite
of the fact that, formally, corporate procedures comply with the standards
9780230_217287_10_cha08. dd 205 5/14/2009 3:51:18 PM
206 Organization and Development of Russian Business
of good corporate governance (Yakovlev 2004). Therefore, it is necessary to
look closer at the subsidiaries in which corporate governance is relatively
developed. It is possible that the functioning of corporate governance is
supported by supplementary instruments.
The range of these instruments is extremely broad: from relational con-
tracting based on mutual interest of the parties involved to asymmetric
position of the parties. The latter is a case in which, for instance, a parent
company is the only or dominant supplier of important input for the subsid-
iary. Another example is when an ultimate owner is closely related with an
influential political power or special interest group. Our survey, of course,
does not provide evidence on all the possible advantages of parent compa-
nies that allow for effective control of decision-making in a subsidiary.
One special case is when a state is an owner and/or regulator. The author-
ity of the state as a regulator and/or owner can provide additional support
for corporate governance (H4), especially in the modern Russian context,
when the state, especially, federal authority, is of growing importance. If
a state supports corporate governance in the subsidiaries, it will be more
developed in the subgroup of subsidiaries in regulated industries and/or
subsidiaries with state shareholding. The state at the level of the federal
and/or regional authority is a shareholder (major or minor) in many JSCs in
regulated industries. For comparison, in nonregulated industries, only every

tenth JSC affiliated to a BG has shares belonging to the federal authori-
ties, and every sixteenth has shares belonging to regional authorities or to
municipalities. In regulated industries, federal authorities are a shareholder
in about 40% of affiliated JSCs, and regional authorities or municipalities
are shareholders in about 20% of affiliated JSCs.
Our survey data show significant differences in the structure of the board
of directors and its role in corporate governance in regulated and nonregu-
lated industries. In group firms in regulated industries, the composition of
the corporate board complies with good corporate governance standards
better than in nonregulated industries (Table 8.3). While the executive
management in regulated industries is represented in the same proportion
of JSCs, the share of this group in the number of board seats is significantly
lower in regulated industries. Worker representatives who are mostly passive
on Russian boards are almost unrepresented in this group of companies. It
is necessary to stress the significantly higher ratio of boards in regulated
industries that include independent directors. Important conclusions on
the ability of the board members to influence the managerial decisions can
be drawn. Participants of the corporate board with no additional control
rights, such as independent directors and small outside owners, are more
often represented in regulated industries, but their shares are not always
higher in comparison to those of nonregulated industries. In fact, they are
lower for independent directors. Apparently, this can be considered to be
evidence that the very presence of the state among shareholders protects
9780230_217287_10_cha08. dd 206 5/14/2009 3:51:18 PM
Table 8.3 Boards of directors in subsidiaries of BGs in regulated and nonregulated industries
Share of the boards in which a given group is represented,
% of respondents
a
Share of a given group in the board (only for boards
in which a given group is represented), %

a
Nonregulated
industries (N = 195)
Regulated
industries (N = 88)
Overall affiliated
companies (N = 283)
Nonregulated
industries
Regulated
industries
Overall affiliated
companies
Number of board
members
6.80*** 8.00*** 7.20
Managers of JSC 83.08 76.14 80.92 42.87*** 31.30*** 39.48
Workers and
representatives of
trade unions
12.82** 3.41** 9.89 29.06 18.84 27.96
State 14.87** 32.95** 20.49 31.43 41.14 37.26
Large outside
shareholders
74.87 75.0 0 74.91 60.12 57.38 59.27
Small outside
shareholders
9.74*** 27.27*** 15.19 18.61*** 31.32*** 25.65
Independent
directors

18.97*** 43.18*** 26.50 42.97*** 28.55*** 35.65
Notes:
a
Comparison of frequencies by ␹
2
test; comparison of means by F-test for number of board members and Kruskal Wallis test for the shares of the group
in the board. ***: significant at the 1% level, **: at the 5% level, *: at the 10% level.
Source: Author’s calculations based on survey data.

9780230_217287_10_cha08. dd 207 5/14/2009 3:51:18 PM
208 Organization and Development of Russian Business
property rights for all the groups of owners and provide board members
with the power in decision-making. The state serves as a guarantee for non-
controlling outside owners to influence corporate governance through their
seats on the board.
Again, the different board structure in regulated and nonregulated
industries does not allow higher assessment of corporate governance in
companies with state ownership. The difference itself could be explained
by the fact that the standards of good corporate governance in regulated
industries are applied under pressure of the state, and these standards are
very often applied quite formally, without significant impact on decision-
making (Yakovlev 2004). However, the respondents themselves were very
appreciative of the influence of corporate governance instruments, includ-
ing shareholder meetings and the board of directors, most of all in regulated
industries. In fact, among the top managers of affiliated JSCs in regulated
industries, 67% assessed the role of shareholder meetings as high in contrast
to 56% of top managers in nonregulated industries and 46% in nonaffiliated
enterprises. The same is true for the board of directors: 86% of respondents
in affiliated JSCs in regulated industries agree that it has a strong influence
on decision-making in the enterprise, in contrast to 65% in affiliated JSCs

in nonregulated industries and 63% in nonaffiliated JSCs. Regular dividend
payments are additional evidence that affiliated JSCs in regulated industries
try to follow good standards of corporate governance. During the three years
before the survey was conducted, even fewer affiliated JSCs in nonregulated
industries (29%) than nonaffiliated JSCs (40%) paid dividends. In regulated
industries, two-thirds of JSCs paid dividends during this period.
The assumption that the state as a shareholder has a positive impact on
the effectiveness of corporate governance is indirectly confirmed by the
respondents’ assessment of the concentration of ownership. In nonregu-
lated industries, 68% of respondents see the current ratio of concentration
as optimal for the companies, 12% see an increase of concentration neces-
sary, and only 8% believe that a lowering of concentration is possible. The
opinions in regulated industries are different: about one-half of the respond-
ents consider the concentration ratio to be optimal, but, at the same time,
30% of the respondents think a decrease of concentration could be useful.
Nine percent believe that an increase of concentration is necessary. It seems
that the respondents in affiliated enterprises in regulated industries do not
consider the agency problem to be so acute. That is the reason that they do
not seek further concentration of ownership, which is the main instrument
to protect ownership’s rights in Russia (see Chapter 7).
The evidence of more developed corporate governance in regulated indus-
tries contributes to an extremely important question about the role of the
state in securing and protecting property rights in Russia. The impact of
the state on ownership rights at the level of the economy as a whole and
that of one given company is different. It is common knowledge that, in
9780230_217287_10_cha08. dd 208 5/14/2009 3:51:19 PM
Corporate Governance and Decision-Making 209
contemporary Russia, the state is the main threat to property rights and the
owners of industrial assets are not exempt. At the same time, in a given
company, the very presence of state shareholding can protect the property

rights not only of the state as an owner but also of private shareholders. That
is the reason that corporate governance in the companies under influence of
the state as a shareholder and/or regulator is associated with lower cost and
protects the interests of owners better than in private companies without
state presence. Additional protection is important, in the first place, for com-
panies with complicated internal organization and structure, such as BGs.
In summary, the survey data are insufficient to refute H2–H4. About one-
third of the BG members apply a model of corporate control in which man-
agement is not separated from ownership, and this fact supports H2. Affiliated
JSCs evidently surpass the nonaffiliated enterprises in the development of cor-
porate governance, and this does not allow us to refute H3. In their turn, JSCs
in regulated industries outperformed those in nonregulated sectors in follow-
ing good corporate governance standards. Protection of property rights by the
state as a shareholder and/or regulator weakens the incentives for ownership
concentration and for the owner participating in management. Therefore, H4,
regarding the additional instruments that allow the owner to discipline execu-
tive management in affiliated enterprises, cannot be denied either.
Conclusions
BGs represent a significant proportion of enterprises in Russian industries.
Thus far, during the last decade, mergers and corporate integration have
been among the most typical forms of business restructuring in Russia.
The primary objective in this chapter was to explain the development of
the organizational form apparently based on the separation of ownership
and management, such as BG, in a country in which a national model of
corporate governance is based on the convergence of ownership and man-
agement. In this context, the central issue is identifying the main instru-
ments employed to solve the agency problem under separated management
and ownership. Several explanations are likely, from the possibility that
there is no additional agency problem because ownership and management
in the Russian groups are in fact not separated to the possibility that the

agency problem is resolved using the instruments of corporate governance,
including monitoring and specific types of incentive contracts with execu-
tive management. Our survey results demonstrate that the agency problem
should exist in Russian BGs, since a hierarchical type of coordination pre-
vails in them. In spite of the heterogeneity of BGs, most of them are organ-
ized as companies and not as networks of independent businesses.
There is no simple way to determine what the main instrument is for solving
the agency problem in Russian BGs, as they are very heterogeneous. In some
of them, ownership and management are not separated, and, in this case, the
9780230_217287_10_cha08. dd 209 5/14/2009 3:51:19 PM
210 Organization and Development of Russian Business
model of corporate governance does not differ much from that of a typical
nonaffiliated company. Convergence of management and ownership prevents
potential losses from the agency problem. At the same time, Russian BGs apply
internal mechanisms of corporate governance, a board of directors in the first
instance, as controlling devices more actively than nonaffiliated enterprises.
However, the instruments of internal corporate governance seem to be most
effective in companies in which the state has enough bargaining power against
top managers (as regulator and/or owner) to protect property rights and to
force subsidiaries to apply good corporate governance standards.
Figure 8.2 gives a rough estimation of the role that various instruments dis-
cussed in this chapter play in solving the agency problem in the subsidiaries
of BGs based on the data on subsidiaries in which respondents answered all
the relevant questions on ownership, control, and decision-making. These
tools are not mutually exclusive, as reported above. The ranking of possible
instruments to support managerial discipline is arbitrary to a great extent. It
is interesting, however, to assess the spread of different discipline devices in
Russian BGs, at least approximately. The classification follows the common
knowledge that to protect the interests of the ultimate owner in the very
imperfect institutional environment, a do-it-yourself option is applied as

the best one. A special form of this option is the participation of the parent
company, rather than the ultimate owner by himself, in the daily manage-
ment of the group firm.
Management separated from
ownership, participation
of parent company in daily
management
decisions 16%
Others 13%
Owners directly
participate in
management
32%
Management separated
from ownership,
internal CG, regulated
industries 12%
Management separated
from ownership,
state ownership or
regulated industry 10%
Management separated
from ownership, internal CG,
nonregulated industries,
no state ownership
17%
Figure 8.2 Instruments to solve the agency problem in Russian BG subsidiaries
(N = 258)
Source: Author’s illustration based on survey data.
9780230_217287_10_cha08. dd 210 5/14/2009 3:51:19 PM

Corporate Governance and Decision-Making 211
The alternative to direct participation in decision-making is the develop-
ment of a corporate governance system as a tool for owners to subordinate
executive management. About 30% of the JSCs developed an internal system
of corporate governance. The respondents consider shareholder meetings
and the board of directors as “extremely important in decision-making.”
Corporate governance bodies are especially important in the subsidiaries
of BGs in regulated industries. This could be considered to be evidence that
the state supports corporate governance and that the internal instruments
of corporate governance could be most efficient under the protection of the
state. Moreover, state ownership or regulation can discipline executive man-
agement even in the absence of internal corporate governance. Ten percent
of the subsidiaries in the sample fall into this group.
In conclusion, our survey data make the widespread existence of holding
company groups in Russian industries less unexplainable. The discipline of
executive management is not a mystery in about one-half of subsidiaries, since
owners themselves or represented by parent companies directly participate in
management. Neither is it mysterious in about one-fourth of the subsidiaries
in regulated industries and/or those with state shareholding. A not very large
but noticeable share of subsidiaries, 17%, supports the view that internal cor-
porate governance itself, without any supplementary support, allows private
owners of industrial assets in Russia to control executive management and to
prevent the acute manifestation of the agency problem. Only a small part of
subsidiaries, 13%, does not fit any of the explanations presented.
By discussing various ways to prevent losses from agency problems, it has
been demonstrated that there are no severe inconsistencies between the
development of BGs and the Russian institutional environment as a source
of serious agency problems under management separated from ownership.
Ultimate owners and/or parent companies find specific devices to prevent
losses from the agency problem in their groups.

Acknowledgments
This research was prepared with financial support of SU-HSE (individual
academic grant of Scientific Foundation No. 06-01-0063 and funds from
the Program of Fundamental Studies granted by the Ministry of Economic
Development and Trade of the Russian Federation in 2007–2008). I am grate-
ful to Tatiana Dolgopyatova, Ichiro Iwasaki, Victoria Golikova, Konstantin
Sonin, Fumikazu Sugiura, and Andrei Yakovlev, as well as to Bruno Dallago,
John Litwack, and other participants in the ninth EACES conference in
Brighton, UK, in September 2006, for their comments and suggestions.
Notes
1. See, for instance, article 105 of the Civil Code of the Russian Federation: “The
economic company shall be recognized as subsidiary, if the other (the parent)
9780230_217287_10_cha08. dd 211 5/14/2009 3:51:20 PM
212 Organization and Development of Russian Business
economic company can exert a decisive impact on the decisions, adopted by such
a company on account of its prevalent participation in its authorized capital, or
in conformity with the agreement, signed between them, or in any other way.”
2. Data of Mergers & Acquisitions informational and analytical project (available at:
www.merger.ru).
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9780230_217287_10_cha08. dd 212 5/14/2009 3:51:20 PM

213
9
Impact of Business Integration
on Corporate Restructuring and
Performance
Svetlana B. Avdasheva
Introduction
The impact of business groups (BGs) on the restructuring and business
performance of subsidiaries has been an important feature of studies of
Russian companies. The characteristic of this impact provides answers to
two questions. The first is why BGs formed during the past decade remain
an important part of the Russian industry and why their share continues to
grow. An effort should be made to explain the emergence of major diversi-
fied amalgamations in an unstable institutional environment, which should
aggravate an agency problem and cause the group performance to deterio-
rate. The second question is threefold and involves the following: first, the
role that BGs played in Russian corporate restructuring during the past dec-
ade; second, whether they contributed to the increase of competitiveness by
corporate restructuring or enabled enterprises to survive without profound
restructuring; and finally, in the case of the success of BG member enter-
prises, whether this success was due to enhanced competitiveness of the
companies or support from the authorities.
Recent studies of the impact of mergers on
the conduct and performance of enterprises
Russian economic and business literature expresses various points of view
on the impact of BGs on enterprise activity. In the literature devoted to the
Russian transition, all forms of enterprise mergers, from voluntary affilia-
tions to new companies controlled by a single owner, are often considered as
a means of overcoming problems of disorganization within Russian indus-
try (Blanchard & Kremer 1997) that are caused by privatization of enter-

prises within their legal boundaries formed under socialism. The role of the
driving force of growth was consecutively claimed by officially registered
9780230_217287_11_cha09. dd 213 5/14/2009 11:06:13 AM
214 Organization and Development of Russian Business
financial-industrial groups (Dementiev 2000), by new “oligarchic” associa-
tions controlled by private owners (Dynkin & Sokolov 2002), and, recently
(at least, in the official rhetoric), by integrations of state-owned enterprises
(SOE) headed by state-developed institutions.
In most Russian studies, BGs were evaluated on the basis of quantitative
indicators, such as output, growth ratio, profit, and investments (Dynkin &
Sokolov 2002; Dolgopyatova 2003). The possibility of making major invest-
ments was regarded as the main advantage of Russian BGs (Klepach &
Yakovlev 2004). The focus of this analysis of the restructuring of BG mem-
ber enterprises was primarily restricted to quantitative indicators. Most of
the sampling surveys (Yasin 2004) showed that the share of enterprises
undergoing restructuring efforts was higher among group members than
among independent companies. The share of companies implementing
investment projects in 1999–2001 was twice as high among BG members
as among independent enterprises, and BG members have shown a ratio
of investments to sales that is twice higher than that of independent firms
(Dolgopyatova 2005). Membership in BGs increases an enterprise’s chances
of successful implementation of various types of investment projects (Frye
2004, 2006).
A comparison of the total factor productivity (TFP) of independent
enterprises and members of “oligarchic integrations” (major BGs) made by
Guriev and Rachinsky (2005) produced mixed results. Enterprises pooled
into groups demonstrated higher ratios of total factor productivity growth
during the reporting year, but, in static terms, the productivity of group
participants was not significantly different from the productivity of inde-
pendent enterprises. The question of whether oligarchs are more efficient

owners remains open.
Monographic research conducted by Pappe (2000, 2002a, 2002b) explains
the origins of the BGs’ advantages. The formation of BGs controlled by pri-
vate owners is equivalent to the transformation of a Soviet enterprise into a
company adapted to a market. Therefore, entrepreneurship meets labor and
capital. In this case, the creation of a marketing system within the frame-
works of the amalgamation eliminates the need for the market adaptation of
each given enterprise. This is the reason that the competitiveness of BGs can
be combined with the preservation at the enterprise level of a management
system maximally close to the old Soviet pattern (Clarke 2004).
An additional factor stimulating restructuring inside a BG is the presence
of additional property right protection tools (Frye 2004, 2006). The proba-
bility of an illegal raider capture of property is lower inside larger amalgama-
tions. Equivalently, larger groups enjoy the positive scale effect of protecting
property rights, which are extremely important in the Russian institutional
environment. Consequently, the motives for restructuring group member
enterprises are higher. There is a point of view according to which enter-
prises that are members of major BGs experience a lesser danger of capture
9780230_217287_11_cha09. dd 214 5/14/2009 11:06:13 AM