Privatization in Russia

Table 1

Pledge Auction

Data

Company

whose

stock

Stock

in

Pledge

had been

put

into

pledge

amount

pledge

Industry

%

$ mln

Pledgee

Surgutneflegaz

oil extraction

88

SNG + Oneximbank

& processing

40.12

(SNG)

sea

North-West

&

river

steamship

line

transport

25.5

6.05

Oneximbank

Nafta-Moscow

+

oildistribution

15

20.1

Nafta-Moscow

Oneximbank

Mechel

metallurgy

15

13.3

Glancore

International

35.1

oil extraction &

+ R500

LUKoil

processing

5

billion

LUKoil

Novolipetsk

metallurgic

14.84

31

Oneximbank

complex

metallurgy

Murmansk

shipping

line

sea

23.5

4.125

transport

Menatepbank

oil extraction

130

SIDANKO

& processing

51

Oneximbank

oil extraction

45

159

UKOS, Menatep bank

Novorossiisk

UKOS

&

processing

shipping

20

22.65

NSC

sea

company

(NSC)

transport

oil extraction

51

100.3

Oil financialcompany

Sibneft

&

processing

The budget has received about $1 billion

from thepledge

auctions.

However,

hopes

for

the arrival

of new

owners

and

for

increased

effectiveness

of company

management

are

not usually

realized.

Even

the largest

banks,

in terms of

staff, are

ten

times smaller

than

the

companies

that are bought;

bank managers

do

not have

experience

in

managing

large, complex

nonfinancial

organizations.

They

cannot

es

tablish good

contacts

with managers

who have

been working

at

these

companies

formany years. Apparently,

the progressive

impact of new

market

structures

on

state enterprises

cannot be immediate;

the adap

tation process

and

the acceptance

of new managerial

ideas will

take

years.

At present,

the

issue

of pledge

auctions

is very

important: either

to

preserve

pledge

auctions

as

themajor

form of

large companies'

priva

tization

or

to remove

or

loosen

a

few

restrictions

and move

toward

40 RUSSIANAND EAST EUROPEANFINANCE AND TRADE

totally open

auctions,

even

for foreigners.

In this respect we

can

raise

two questions:

can

Russian

banks

and

enterprises

swallow

the new

portion

of privatized

companies,

and

towhat

extent

should we wait

for

a foreign

investor's

interest?

enter

There

is no

simple

answer.

Even

large banks,

not

tomention

prises, have

a

strong

investment potential.

This

will

inevitably

lead

to

understating

the budget

receipts

from privatization.

On

the other hand,

following

the example

of

the past

pledge

auctions,

we

see

that banks

and

investment companies

need

great

efforts tokeep

control

over

giant

companies

(Norilskii Nickel

has

130,000

personnel,

LUKoil?around

100,000,

UKOS?84,000,

etc.),

not

tomention

managing

them. The

biggest banks and investment companies

do

not have

the possibility

of

managing

several

giants

at

the same

time; therefore,

theyparticipate

in

an auction

only for speculative

reasons,

which

contradicts

the goal

of

an effective

owner.

It is hard

tofind

a

strategic

investor among

foreign

banks

and

companies.

Among

twelve

companies

that passed

through

pledge

auctions,

only

one?the

metallurgic

plant Mechel?was

sold

to

a strategic

investor from

Switzerland.

Furthermore,

finding

a strategic

investor

requires many

months

and

even

years. Many

companies

are

considerably

undervalued.

For

example,

market

capitalization

of

the

largest oil

company,

LUKoil,

is S6.5

billion.

The

equity markets

of

the

remaining

companies

are

less developed.

For

instance,

oil

stocks and

production

capacities

of

Surgutneftegaz

make

up

70

percent

of

the

same

characteristics

of LUKoil,

but

Surgut's

capitalization

is 3.5

times

lower.

If the pledge

payments

are analyzed

in comparison

with

the compa

nies'

market value,

we

can

conclude

that according

to budget

revenue

maximization

criteria,

the pledge auction

scheme

has

no clear

advan

tage over

direct

sale. The

only possible

advantage

is creating

a pause

between

real and

formal

(complete)

property

rights

transfer from gov

ernment

to private

owner. During

this time federal

authorities

had

an

opportunity

to analyze

the new

owner's

activity,

including

investment

activity,

tax debt

decrease,

and

company

restructuring.

If new

owner

had

no

success,

the government

would

get

the stock

share

back.

In a

case

of

including tax debt

payments

and

incremental

future tax reve

nues

into budget

privatization

income,

the pledge

auction

scheme

is

more

satisfactory

than direct

sale

of

stock

share. Moreover,

budget

interestshave

fewer contradictions

with

the goal

of seeking

an efficient

1997.

The

Search

forNew Ways

ofGoverning

the Privatization

Process

In the next

stages

of privatization,

the search

for an

effective

owner

should be a higher priority than

short-term budget

receipts,

since

an

effective

owner

can

ensure

future budget

revenues. Most

effective

is

privatization

by open

auction

sale, but

the state should

increase

compa

nies'

market

capitalization

to the highest

level

(by

forming a market

out of their equity, providing market

transparency,

and

so

on)

and,

finally,

to

take

active measures

to

secure

ownership

rights legally.

Paying

debts

to the budget

and

nonbudgetary

funds was

one

of

the

issues at pledge

auctions.

Paying

these debts was

eithermade

a

condi

tion at

the auctions,

or the state was

supposed

to cover

these debts

in

futurewhen

an

enterprise

stabilized

itswork

due

to the new

owner's

policy.

The

only

enterprise

thatdid not have

considerable

debts

before

the auction was

the oil company

Surgutneftegas.

to the

Since

the end

of the auction,

the situation with

nonpayments

budget

has not changed greatly;

ifanything,

ithas worsened.

The

debts

of oil

companies

(except

Surgutneftegas),

metallurgic

complexes,

Norilskii

Nickel,

and

all

three steamship

lines have

been

growing.

By

the beginning

of

1997

the payment

of

taxes became

so

complicated

that the government had

toundertake drastic measures.

One

such measure

is theResolution

of theGovernment

of theRus

sian

Federation

signed

inMarch

1997

[8] which

introduces

two new

forms (in addition

to bankruptcy)

of solving

the problem

with

nonpay

ers. At

the

enterprise's

option,

it could

either make

a

new

issue

of

shares or issue bonds worth

a

sum owed

to the budget. The

firstway

is

relatively

cheaper

for a

company

(bonds

assume

payment

of

interest)

but require

thatmajor

shareholders

share

their rights of company man

agement. That iswhy themajority of

enterprises

thatwere

choosing

between

shares

and

bonds

preferred

bonds.

Shares

versus

bonds

was

also

an

issue

at

companies

that had

had

pledge

auctions

in the past

42 RUSSIANAND EAST EUROPEANFINANCE AND TRADE

Funds aimed

at paying

taxes

and

executing payments

to nonbudge

tary fundswere

often

invested

into the ambitious investment programs

of the enterprise. The

oil

company

LUKoil that has

been

carrying

out

investment programs

outside Russia

(in Kazakhstan,

Azerbaijan,

and

powerful mines and mastering

processing

production.

Thus

the com

pany permits considerable debts

to the state deliberately

for the sake of

itsown

development.

The

situation with

theNovolipetsk

metallurgic

complex

is also

sig

nificant. According

to topmanagers

of

the complex,

its debt to

the

regionalbudgetby the end ofAugust

1996was

1.8 billion rubles.

1997

the debt was

paid

off. The most

probable

reason

for such

a quick

payoff

is financial

assistance

from

large traders of the company

(Trans

World Group, inparticular).

only wors

However, the position

of

the other metallurgic

complex

ened.At

theend of 1996and in 1997 the taxpolice sequesteredthe

company's

assets

and

sold itpartly from

the auctions.

There

was

some

delays

of goods being

exported.

of

debts

to

the budget

Generally,

solving

the problem

companies'

often depends

on how

firm is the position

of the government

toward

its

debtors

and measures

taken against

them.

Individual

Models

of Company

Development.

Pledgee

Actions

inManagement

According

to the financial

state analysis

and after studying

other avail

able

information about

companies,

where

shares were

put

into pledge,

we can

assume

that new

owners

(where

they actually

appeared)

could

not much

affect the situation

at companies

in such a

short period. We

actually witnessed

many

large

institutional

reforms

(transfer

of

ac

counts

to other banks,

resubordination

of

sales

system,

replacement

of

management,

to be

considered

below),

but

the development

of any

large company

has

an

inertia.Major

directions

of company develop

JULY-AUGUST

1999

43

ment

established

at the state enterprises where

they originated

may

affect

the current conditions

more

than new

owners who

appeared

as a

result

of pledge

auctions. We

can

speak with

some reservation

about

individual models

of company

development

thatare difficult

to change

and

are

impossible

to break

without

creating

various

conflicts

(Noril

skiiNickel

as an

example).

Factors

defining

the individual model

of

company

development

could

include:

?Management

staff at

the creation

of a joint-stock

company

and

in

the early

years

of

its existence.

Top

managers

could

be

conditionally

divided

into those focusing

on development

(LUKoil,

Surgutneftegas)

and

those

focusing

on preserving

the status quo

(theNovolipetsk

met

allurgic

complex,

Mechel).

Management

staff had

a greater

effect both

on

the structure of

rights and

on

the following

organizational

changes

in the joint-stock

company.

the com

?The

state of the company's

production

and

technology,

petitiveness

of goods.

The

privileges

were

given

to companies

with

a

level of

technology

higher

than average

in the

industry and

close

to the

world

level

(the Novolipetsk

metallurgic

complex),

as well

as

those

companies

able

to improve

the technology

of production

very quickly

and

keep

their goods

competitive.

This

factor

is combined

with

the

structure of

the joint-stock

company.

Sibneft

included

one

of

themost

modern

plants

inRussia?the

Omsk

oil

processing

plant and LUKoil

were

relatively

successful

Perm

and Volgograd

plants.

?The

internal and

theworld

market

of a

company's

goods

(serv

ices). Metallurgic

enterprises

suffered

greatly

as

the

internal demand

for theirgoods

subsided

and

they had

to shift to export production.

For

a number

of enterprises

such

as

theNorth-Western

Steamship

Line

the

internalmarket

is predominant

and

a

shift to export production

is

im

possible.

the difference

between

It

is precisely

these

factors

that determine

individual

models

of

company

development

and

their state

in

1995?

96.

Nonpayments

and

introduction

of

the "currency

corridor"

often

mentioned

by managers

of

companies

in distress

influenced

all

ana

lyzed

companies

but

cannot

give

a

satisfactory explanation

of

the dif

ference

in theircondition,

for example,

LUKoil

and Norilskii

Nickel.

Now

let us

proceed

to an

analysis

of pledgees'

actions

inmanage

ment

and

structural reform

in companies.

We

should

note,

first of all,

that

these are

actual

and not

nominal

pledgees,

and

they

should be

divided

into two groups.

The

first group

includes

enterprises

thathave

taken

their own

shares

into pledge

(LUKoil,

Surgutneftegas, Nafta

Moscow,

Novorossiisk

Steamship

Line,

and UKOS

in some way),

the

second?pledgees

are

outside

investors.

The

first group

of companies

is characterized

by running

develop

ment

programs

and structural reforms before

even holding pledge

auc

tions.After the auctions

these enterprises followed

their own

line.

There were

essential

changes

at

enterprises,

shares

of which

had

been

taken into pledge

by outside

investors,

changes

inmanagement

financial

and

goods

flows

to

structures controlled

by

the pledgee

(North-Western

Steamship Line,

Norilskii

Nickel,

Sidanko).

We

should also mention

a difference

in the behavior of

the

two

largest

outside

investors?Oneximbank/MFK

and Menatep.

Typically,

On

eximbank/MFK

was

more

active

inmanagement

replacement

and

company

restructuring.Menatep,

however,

followed

a

smooth

strategy

of changes.

shares were

carry out

Companies

whose

put up for pledge

auctions

the following

steps in structural reform and management

change:

?consolidation

of affiliate structures with a transfer to a

common

?continuation

of vertical

integration: expansion

of

the network

of

retail oil

product sale

by

all

oil

companies,

purchasing

shares

of

raw

material suppliersandproductprocessors(NorilskiiNickel);

?setting

up

large operational

structures on

thebasis

of

independent

enterprises,

changing

economic

relations

and

distribution

of functions

between

these

structures (LUKoil,

Sibneft);

?overcoming

atomism

of financial

responsibility

centers,

decen

tralization

of operative

decisions

with

strengthening

the financial

cen

tralization,

creation

of common

budgetary-financial

systems within

a

holding(NorilskiiNickel,UKOS,

LUKoil);

?introduction

of

outside management

at affiliate

companies

from

the side of a holding,

transfer of managers

to contract-based

system

(UKOS);

the main

from

?separating

production

nonproducing

supporting

departments, transfer of social

sphere entities

tomunicipal

bodies;

?reducing

the number

of personnel

to decrease

exceeding working

JULY-AUGUST

1999

45

Conclusion

Since

1992 Russia

has

been

carrying

out

a profound

transformation

of the economy

and

society.

Russian

experience

of

large-scale

pri

vatization

proves

that

transfer

of state-owned

assets

to

the private

sector and

changes

in property

rights

structure

do

not

automatically

ensure

increased

economic

efficiency

of privatized

firms or

even

presumptions

for such

a

growth

with

an

"efficient

owner."

Stocks

undervalued

in the process

of privatization

are

often more

attractive

for speculators

than for real

investors.

Poor

economic

performance,

high

agency

costs

at privatized

firms

caused

by

poor

protection

of

stockholders'

rights

and

a weakly

developed

capital

market,

and

high

political

risks

have

created

additional

barriers

for potential

in

vestors.

Political

objectives

in privatization

decisions

often

pre

vailed

under

budget

interests and

social

goals,

which

did

not make

it

possible

to use

a cash

flow

from privatization

of

state-owned

assets

formacroeconomic

stabilization.

It is quite

obvious

now

that the transfer of

state-owned

assets

and

control

rights from officials

to the private

sector

does

not mean

that

the government

should

abandon

regulation, but

this activity must

be

transferred

to carrying

out

an active

economic

policy

and

forming a

model

of

corporate

governance.

The

weakest

element

of corporate

governance

in present-day

Russia

is the enforcement

of

law, as well

as contradictions

between

legal

acts.

The

idea

of

strengthening

state

regulation

of

the

economy

was

brought

up

in President

Yeltsin's

speech

on 24

September

1997 and is treatedindifferent

his

theOrder

ways by

political

opponents.

Regulation

N254

"On

of Restructuring

Federal

Budget

Debts

..."

[8] was

the first attempt

to

strengthen

state

control

of privatized

enterprises

that did

not

obey

the

law. A

new

law

"On

Privatization

of

the State

Property

and

Fundamentals

of PrivatizationofMunicipal

Property in theRF,"

adopted by the

State

Duma

on

24

June

1997,

stresses

the

rights

of

state

repre

sentatives

inprivatized

firms, where

the state has

control

of block

of

stocks

or

"gold

stock." Another

new

law

is

strengthening

control

for fulfillment

of

investment

tenders

requirements

by

bodies

of

authority.

It

is

to be

hoped

that a

new

privatization

program

will

find an

optimal

balance

between

economic

independence

of firms and

Group,

Moscow,

1995).

2.

Jackson,

Peter

J., and Price, Catherine

M.,

eds. Privatization

and

Regulation:

A Review

of

the Issues.

London:

Longman,

1994.

3. Vickers,

J., and Yarrow,

G. Privatization:

An

Economic

Analysis.

London:

MIT

Press,

1988.

4.

Patokina,

O.

"Privatization

and

Company

Valuation

inRussia."

EMERGO,

Spring

1995,

vol.

2, no.

2, pp.

37-60.

5. Patokina,

O.,

and Kolari,

J. "Joint-Stock

Company

Clinozem:

A

Case

Study

of

Privatization

and Valuation."

Russian

and East

European

Finance

and

Trade,

vol.

32, no. 4 (July-August

1996),

pp. 74-92.

6. Boycko,

M.;

Shleifer, A.;

and Vishny,

R. Privatizing

Russia.

Cambridge: MIT

Press,

1995.

7.

"GKI podvodit itogi"(inRussian). Izvestiia, 6April 1997.

8.

Regulation

of

theGovernment

of theRussian

Federation

3May

1997 N254

"On

theOrder

of Restructuring

Federal

Budget

Debts

of Enterprises

and Organiza

tions."

9. The

Law

"On

Privatization

of the State

property and Fundamentals

of Privatiza

tionofMunicipal PropertyintheRF"

(adoptedby theStateDuma

24 June1997).