Privatization in Russia

Russian

and East European

Finance

and Trade, vol. 35, no. 4, July-August

1999,

The

last

two decades

revealed

a

strong

tendency to economic

liberali

zation

and

deregulation

inmany

countries around theworld. This gen

eral

tendency was

caused

by growing

public

sector inefficiency and

public

debt

increase. According

to theWorld

Bank

information

[1], at

least 83 countries

have

been

conducting

privatization

as a part of com

plex

policy

aimed

at

improving

public

and

private

enterprises

activi

ties, reducing

budget deficit, and

creating incentives

for private

sector

development.

Privatization

has

become

the core

of transition reform in

Russia

and Central

and Eastern

European

countries.

Since

1992

Russia

has been

carrying out large-scale

privatization

program.

For

the

last five years

property rights

structure

inRussia

has

undergone

radical

changes.

The

statistical

data

of privatization

proc

esses

[7] shows that in 1993 43,000 companieswere

privatized, in

January 1997 are as follows:

?privatized:

126,793

entities

(55 percent

of former state-owned),

?federal

government-owned:

approximately

30,500

enterprises.

This

paper

was

presented

at

the

53d Congress

of

the International

Institute

of

Public

Finance,

Kyoto,

August

25-28,

1997.

Olga

A.

Patokina,

Ph.D.

in Economics,

is associate

professor

in theDepartment

of

Public

Administration,

St. Petersburg

State University.

Igor N.

Baranov,

M.Sc.

in

Economics,

is

assistant

professor

in

the Department

of Public

Administration,

St.

Petersburg

State University.

30

JULY-AUGUST

1999

31

Nowadays

private

and mixed

companies

produce

about

two-thirds

of industrial output

and

their share

in total

investments

ismore

then 80

percent.

But

the process

of

redistribution

of property

rights and

re

structuring of

industrial

enterprises

is not

finished. According

to

the

plans

of

the new government

of

theRussian

Federation

announced

in

April

1997,

all

state-owned

enterprises

that have

a

free hand

in doing

business

almost

without

state

control

should

be

transformed

by

1999

into:

?private

enterprises,

with

100 percent

state capital,

?self-financing

companies

?treasury

companies

funded

from the budget.

There

are

some

disputes

concerning

the number

of existing

treasury

federal

enterprises?it

varies

between

100 and

700.

But whatever

it is,

it is obvious

that the government

has

to privatize

a few

thousand

enter

prises

during

the next

few

years.

Besides,

most

enterprises

are big

industrial companies

whose

stock

is owned

by

the federal

government.

These

data

illustrate quantitative

results

of

a large-scale privatization

program. What

kind

of qualitative

results

have

been

obtained?

One

way

to answer

this question

is to compare

outcomes

with

initial goals.

The

analysis

of privatization

programs

carried

out

indifferent coun

tries reveals

themain

objectives

stated

in these programs. Without

a

debt,

the primary

objective

of privatization,

especially

in

the former

centrally planned

economies,

is improving

economic

efficiency

of pri

vatized

state enterprises

and

the overall

economic

performance

of

the

economy.

The

problem

of efficiency

is often connected

or even

identi

fied with

the search

for an

"efficient

owner"

or

"core

stockholders."

The

second motivation

driving

privatization

inmany

countries

is

its

contribution

tomacroeconomic

stabilization.

The

sale

of

state assets

is

seen as a means

of reducing

state budget

shortage,

either by generating

additional

revenues

from assets

sales

or by

reducing

subsidies

to ineffi

cient

state-owned

firms. A

number

of objectives

such

as

development

of

securities market,

increasing

the number

of

investors, and

redistri

bution

of property

rights are mentioned

as

incentives

for privatization

of

state-owned

firms. As

far as

changes

of property

rights

structure

affect

economic

and

political

interests of different groups

of people,

the technical

implementation

of privatization

program

should

take into

account

the attitude

of

stakeholders

of privatized

firms

and

public

to

the idea

of privatization

to provide

privatization

process with

political

support.

So

there are

always

political

goals,

often hidden,

inprivatiza

32 RUSSIANAND EAST EUROPEANFINANCE AND TRADE

tion programs;

they could

prevail

under

economic

objectives

and

de

fine

themost

important features of the privatization

program: methods

used

and

economic

and

social

consequences.

However,

as

a number

of

studies say [2, 3],

in spite of common

goals

and

privatization

methods

it is not

possible

to

give

privatization

results

a

simple

and

unique

interpretation. These

results

depend

on

combinations

of government

goals

pursued,

political

environment,

extent of financial markets

devel

opment,

economic

performance

of privatized

enterprises,

attitude

to

ward

privatization,

redistribution of theproperty rights.

Based

on an analysis

of theoretical

background

and political motiva

tion

inherent

in the foundation

of Russian Privatization

Program

pre

sented by Boycko,

Shleifer,

and Vishny

[6],

the authors'

previous

case

studies

[4, 5], and

new

research,

this paper

highlights

a

conflict

be

tween different privatization

objectives:

budget

incomes

and

seeking

efficient owners

indifferent

stages of theprivatization

process

inRus

sia. Confining

ourselves

to a

brief

survey

of

results

and

lessons

of

"spontaneous"

and

"vouchers"

privatization,

we

focus

our attention

on

issues and first results

of a

new

approach

to privatization,

connected

with so-called "pledge auctions."

1986-91.

The

First Attempt

at Seeking

Efficient

Owners

Privatization

as

a process

ofmass

transfer of

state-owned

assets

to the

was

launched

by

thepresident's

February

decree

N66.

Actually,

priva

tization as

a process

of deregulation

and

transforming property rights

structure began

earlier,

during

1986-90.

At

that time, Gorbachev's

government

adopted

a number

of

legislative

acts

thatwere

to stimulate

the establishment

of more

effective

forms

of organization

of produc

tive and scientific activity, such as

scientific-technical

youth

associa

tions

(1986),

productive

cooperatives

(1987),

so-called

"small

enterprises"

(1989),

and

joint ventures.

Itwas

the first attempt

to seek

or

to create

efficient owners, which

failed. The

above-mentioned

legis

lative acts

togetherwith

the law "On

State-Owned

Enterprise"

affected

serious

reallocation

of control

rights for state-owned

firms, frommin

istry officials

to

themanagers

of

firms

and

to

the organizations of

workers

and

employees.

Detailed

analysis

of

this period

and

its out

comes

can

be found in

[4]. Unprecedented

tax and

other economic

JULY-AUGUST

1999

33

advantages

granted

to

these

new

nonstate

organizations

legally

and

lack of any

regulation of relations

with state-owned firms resulted in

large-scale

stealing

of

state-owned

assets and an overflow

of budget

money and material

resources

of state firms

to the private sector, with

out return. This process,

termed spontaneous

or wild

privatization,

led

to the poor

performance

of privatized firms in the

future, reinforced

1992-94.

"Vouchers"

Privatization:

Goals

and Outcomes

Objectives

and

general

ideas.

The

primary

objective

of privatization

was

stated by

key

participants

of development

and

implementation

of

the privatization

program

as

depoliticization

of state-owned

firms,

that

is, freeing

them from

the control

of

traditional

(nonreformist)

politi

cians.

(See

[6].)

The

inefficiency

of

state-owned

enterprises

under

socialism

was

attributed

to

the split

of

control

and

cashflow

rights.

The

idea

of

the

authors

of

the first privatization

program

was

to

concentrate

control and

cashflow

rights

in the hands

of managers

and

outside

investors.

The

design

of

the first privatization

program

was

to ensure

a balance

of

interests of different groups

of

stakehold

ers of state-owned

firms and

provide

the privatization

process

with

public

support.

Taking

into account

this disposition

of interest, the strategy of priva

tization was

as

follows

[see

6]:

1. To

eliminate

theparticipation

in theprivatization

process

ofmin

istries and other officials who

had

controlled

state enterprises

before.

2.

To

provide

significant

benefits

for insiders?managers,

workers,

and

employees?to

guarantee

their support.

3.

To

involve

the public

as

participants,

providing

every

citizen

with

opportunities

topurchase

a part of state-owned

assets.

The

privatization

program

and

numerous

governmental

resolutions,

regulations,

and

instructions

defining

privatization

procedures

pre

sumed

different procedures

for privatization

of "small"

and

"large"

state-owned

enterprises.

"Small

privatization"

was

connected

with

small firms in such sectors

as

retail, public

catering, and

consumer

services. Itwas conducted by

local

authorities

and was

mainly

com

pleted

in 1993.

These

firms were

privatized

as

a proprietorships.

Pri

vatization

provided

the

stimulus

for rapid

development

of

sectors of

34 RUSSIANAND EAST EUROPEANFINANCE AND TRADE

economy

underdeveloped

under

socialism. We

will

not go

into amore

detailed

analysis

of

the

results

of

"small

privatization,"

as

revenues

were

accumulated

by

local

governments

and were

insignificant

due

to

unprecedented

benefits

granted

toworkers

and

employees

participating

in privatization

of their firms;

the cashflow

from

privatization

could

not provide

a

significant

contribution

to the federal

or

even

the local

budget. Now

we

turn to "large

privatization"

issues,

connected

with

obtaining

the objectives

mentioned

above.

There

were

four

essential

elements

in this program

that defined

its success:

corporatization

and

fixed

order

of

the sale

of newly

founded

companies'

shares;

insiders'

benefits

(three

options

of

benefits

for managers

and

employees);

vouchers

and vouchers'

auction

as

an

instrument ofmass

privatization;

vouchers'

market

as a

segment of security market.

In Russia

privatization

of

large enterprises was

fulfilled by

creating

stock

companies

on

the basis

of

state

enterprises

and

then by

the sale

of stock

shares

step

by

step. The

president's

decree

N756

and

the

regulation

"On

theCommercialization

of State-Owned

Enterprises

and

their Transformation

intoOpen

Joint-Stock

Companies"

of July 1992

obligated

themanagers

of

all

large

enterprises

(those

not exempted

from privatization)

to transform

them

into joint-stock

companies.

At

that time

100 percent

of issued

stocks were

state-owned.

From

this

moment

the firm

left the guardianship

of

theministries

and

became

subordinated

to the State

Property

Fund,

a

new

authority, formed

for

the control

of

state-owned

assets.

This

fund was

obligated

to

start

stocks sale within

a short time.

Numerous

governmental

resolutions

and

regulations

followed

this

edict

and

defined

the structure and

order

of presentation

of theprivati

zation

plan,

the order

of

carrying

out

closed

subscription

for

shares,

shares pricing, and so forth.

In accordance

with

the instructions elaborated by

the State Committee

on State

Property Management,

the value

of privatized

firms was

esti

mated

as

a net book value

of

itsassets

at a fixed date

in 1992,

the initial

data being

taken from

the balance

sheet. This

figure usually was

too

low

because:

(1)

this estimation

did

not

include

the value

of

such

important

assets

as

land

or

the rights

to explore mineral

resources,

(2)

the book

value

of fixed assets was

many

times lower

than theirmarket

price due

to

the extremely high

rate of

inflation.We

next

show

how

the preliminary

company

value

influenced

themarket

price

of

enterprise

shares

and

cash budget

inflow at different stages

of

theprivatization

process.

At

the first stage,

stock was

closely

held?it

was

partly

distributed

(up

to 51

percent)

at privileged

price

between

employees

and

com

pany's

management.

This

price

depended

on

the category

of benefits

chosen

by

the employees

before

starting closed

subscription,

but

the

maximum

price was

only

1.7 times more

than its book

value.

In

line

with

legislation,

employees'

stocks

could

be paid

both with money

and

with

vouchers.

To give

all

citizens

inRussia

a chance

toparticipate

in the

privatization process and toprovide

a demand

for shares under

large-scale

privatization,

150 million

special privatization

checks

(vouchers)

were

given

to citizens

free

of charge. Up

to 80 percent

of payment

could

be

covered with vouchers,

so budget

incomes were

not significant at thefirst

stage of privatization. Analysis

of

results of

the closed

subscription

re

vealed

that about

70 percent

of enterprises had

chosen

so-called

the sec

ond

variant of privileges?acquisition

of 51

percent

share

capital

by

employees

and managers.

The

real control was

kept by managers.

At

the

second

stage

of privatization,

a

block

of

stocks

(up

to 29

percent)

were

offered

to insiders and

outsiders

to be

bought

for vouch

ers. The

voucher

auctions

revealed

a

group

of

companies

thatwere

attractive

to institutional

investors. The

real competition

took place

for

these companies'

shares,

but

therewas

no

(or

little) demand

for shares

of

themajority

of

companies.

An

acquisition

of

51

percent

of share

capital

by

employees

and managers

through

closed

subscription

en

abled managers

tomaintain

their control. Managers

also were

inter

ested

in seeking

an appropriate

buyer

(investor)

for

their companies

before

itwas

sold at auction

so

they could keep control.

In fact, during

these

stages real owners

and managers

were

changed

rarely. The main

result

of

the voucher

stage

was

quick

and

broad

denationalization,

creating

a

private

sector

in Russian

economy.

Earning money

from

state property

sale was

not

themain

goal

of the government.

Investment

and monetary

auctions

followed

by vouchers

had

to at

tractadditional

capital

and

decrease

budget

subsidies

to loss-run

enter

prises.

In fact,

the

investment

auctions'

outcomes

were

not as

optimistic

as

theywere

supposed

to be. Most

of

the companies

were

not prepared

for sale

and many

were

close

to bankruptcy. Weak

pro

tection

of outsiders'

rights

and

political

and

economic

instability

also

did

not

stimulate

investment

in privatized

companies.

Large

stock

shares

thatwere

not sold at that time

are

now

held

mainly

by

the

federal

government

and will

be

sold

at auction

in the next few years.

36 RUSSIANAND EAST EUROPEANFINANCE AND TRADE

1994-95.

Changes

in the Property-Rights

Structure

in "Post-voucher"

Privatization

First we

should

analyze

the structure of ownership

thathas

taken shape

as a

result

of

the previous

privatization

stages

and

its effect on

the

Russian

economy.

According

to

the

1994

results

of

theWorld

Bank's

two

surveys

regarding

the structure of share

capital

(143

industrial enterprises

have

been

questioned

in 32

regions of Russia)

insiders

owned

65 percent

of

stock,

outsiders

22

percent,

and

the state

13 percent. The

1995 figures

were

almost

the same

for state ownership;

the insiders'

share fell to 57

percent

a

and

the outsiders'

rose

to 30

percent. While

average

figures

reveal

tendency,

real ownership

structure varies

greatly

in different

cases,

as

do

developing

relations

between

managers

and outsiders

and

their claims

for control

rights.

as

Although

the outsiders'

share

grows,

the survey

results

above

indicate,

one

of

themain

trends

of

recent

years might

be

considered

the formation

of capital

closed

to an outside

investor. This

is associ

ated with

the above-mentioned

privileges

received

by workers

and

management

in

the period

of

privatization,

as

well

as

new

issue

underwriting

by

closed

subscription

or

through

closed

auctions.

Moreover,

outsiders'

rights

are weakly

protected

by

law, which

al

ways

gives

rise to conflicts

between

management

and

outside

inves

tors. Boards

of directors

often

represent

interests of not

all

investors

but

only

of management

and

are

influenced

by

a

general

director.

We

could

name

themost

common

violations

of outside

investors'

rights:

share

capital

increase

by

new

issues

(which

decreases

the

share of

outsiders),

keeping

secret

the dates

of

shareholder

meetings

and

agendas,

paying

dividends

only

to

staff. There

were

also

cases

when

outside

investors were

not allowed

to attend

a

general

share

holders'

meeting.

Another

trend is that themajority

of stock

is dispersed

among many

of the company's

workers,

not

linked

tomanagement.

When

such a

capital

structure exists,

a

company

is actually

run by

old management,

but not by formal owners. Management

and workers

create

a private

agreement

when

the former ensures

stable

employment.

Management

is not

certain

of

their position's

long-term

stability,

especially

ifa

considerable

portion

of

their stock

belongs

to the gov

ernment, which

could

sell

it eventually.

As

a

result, many

managers

JULY-AUGUST

1999

37

perceive

only

short-term goals,

often

striving

tomaximize

their per

sonal

benefits.

As

a consequence

of

the above

trends, the existing

ownership

struc

ture

inRussia

hampers

the structural

reforms

in the economy;

even

with a significant reduction of inflation

there is no

rise

in investment.

Strikes

and manifestos

by workers

who

are not paid

for several months

(and

also

those who

have

not worked

for several months or who

are

employed

only

two

to three days

a week)

are

common,

as are so-called

nonpayments

(when

enterprises

do not

have

enough

working

capital

theyuse

chains

of offset payments

formutual

settlements).

The

problem

of choosing a form of privatization

for the near

future

is closely

connected

with

collecting

debts on taxes and social

insurance

from enterprises

(themain

debtors

are big industrial companies

whose

majority

of

stock

is

in the hands

of

the federal government).

At

the

moment

the government

could use

threemethods

forbudget

receipts:

?a

company's

bankruptcy;

?the

1 vote,

additional

issue of shares

of 50 percent

plus

putting

the

controlling block

of shares

intoa pledge

until

thefinal debt

settlement;

?covered

bond

issue with

succeeding

transfer of

receipts

to

the

budget.

The

first two methods

provide

for redistribution

of ownership. The

same

time

it is

trying to find

an effective owner

for a

company. An

effective owner

should

ensure

the stability of a company

so that itwill

be able

to pay

taxes and social

insurance.

1995-97.

Pledge

Auctions

Pledge

auctions

became

one

of

the new

forms of privatization.

To

get

cash,

the federal

government

put

intopledge

its stocks

of

industrial and

transport companies.

If, after a

certain period

of

time,

the government

does

not pay this off,

the stock becomes

the property

of

the pledgee.

We

should

note

that

the government

did not have

the

intention

of

taking

the

stock

out

of pledge;

in fact

the

intention was

to

sell

it,

and

belatedly.Pledge

auctionsmade

it

for

althoughindirectly

possible

the government

to:

?circumnavigate

the conservative

parliament's

opposition

to put

thestockof

to

ting

leadingenterprises

privatehands;

38 RUSSIANAND EAST EUROPEANFINANCE AND TRADE

?attract

funds

to

the budget at

the most

pressing

moments

of

budget

crisis on

the eve of

thepresident

elections;

?analyze

actions

of

the new

stock owners and ifnecessary

to take

itout of pledge

before

the term ends.

In addition,

since

only Russian

organizations

(large banks

and

com

panies)

could

take part

in auctions,

the

latter assisted

in establishing

a

link between

banks

and

big

industrial

enterprises.

Itwas

obvious

that

only

the arrival

of new

owners

could

improve

themanagement

of a

company

whose

stock had

been

put

intopledge.

In fact pledge

auctions

were

the

idea of a group

of banks

(the president

of

themost powerful

of them,Oneximbank,

later became

vice

president

of the government).

The

government

created

new

centers

of influence

in the economy

ca

pable

of

with the

and

others)

competing

biggestmonopolies (Gazprom

to influence

economic

policy.

Seventeen

enterprises

were

put up

for auction;

therewere

no

bids

for five;

therefore, only

twelve

enterprises

actually

participated

in the

auction.

There

was

competition

for five

and

the remaining

seven were

sold

at a

price

close

to the starting price

set by the government.

The

largest

deal

was

on

38

percent

of

shares

of Norilskii

Nickel,

which

produces

more

than 40

percent

of

theworld

platinum

output and

20

percent

of theworld

nickel

output. This

stock was

sold

toOneximbank

for SI70.1

million

(foreign participation

was

not allowed

at

this auc

tion). The

data

on

the other auctions

is presented

inTable

1.

As

the table

shows, most

companies

were

buying

themselves,

that

is,

themanagement

saved

and

even

strengthened

its positions.

It is

interesting

that all

these companies

have

tax debts

and

paid

for

the

stock

either

from

the payroll

fund

of

their own

employees

or from

affiliate

banks

where

they keep

an

account. This showed once again

that companies

can potentially

settle

theirbudget

debts.

The

auctions

were

accompanied

by many

conflicts between

thepar

ticipants. After

the auctions, many

new

owners

had

problems

in com

municating with management.

For

example,

Oneximbank

managed

to

get on theboard ofdirectorsofNorilskiiNickel onlyhalfa yearafter

the auction,

then replaced

the general

director and

begin

restructuring

the company's

business.

Before

the auction

took place,

thebudget

and

social insurancedebt ofNorilskiiNickel

attained$700 million. Thus

themain

revenues were

available

for the budget

not during

the auction

but

only

after

the new

owners

repaid

current

debts

in full. At

some