Vladimir Sidorovich
Corporate Governance in the Russian Companies with State Participation1.
The corporate governance has become a key area in economic relations at the beginning of new millennium. Since the government is a major economic agent in many countries, the issues of corporate governance impact enterprises with state participation. Supporting this logic, the Organization for Economic Cooperation and Development, which is a principal “trend setter” in the area of corporate governance, published a document entitled “Guidelines on Corporate Governance of State-owned Enterprises” in 2005.
Evidently, the role of the Russian government as an economic agent and corporate owner has increased in the course of the last few years. This trend is taken by the society in two ways. On the one hand, many see it as a triumph of justice, perceived as the recovery of the unlawfully alienated property by the “legal owner”, or at least something that resembles the early phase of such a triumph. On the other hand, criticism regarding abandoning of the market economy, encroachment on the rights and even the establishment of a new class of oligarchic civil servants is heard quite often. Both these assessments include rightful accusations of the, to put it mildly, lack of transparency in the process of the ownership rights changing hands.
All of this adds particular importance to the corporate governance issues in the Russian state-owned companies.
Certainly, enhancement of the corporate governance, including the economic and legal relationships between the shareholders, executive bodies and other stakeholders in the company, is important of itself, without connection to the above “political” issues. However, in countries other than Russia , the organization and economic reasons are often quite enough to substantiate the need for the corporate governance enhancement in the companies with state participation, whereas in Russia the unsustainable property relations and the “transition nature” of the current historical period add political overtones to the issue under review.
Actions (or inaction) by the government regarding the corporate governance issues in the companies with state participation are a more unbiased indicator than the televised statements or printed proclamations, clearly showing which goals the government and its representatives acting as economic agents are really after.
The current status of the corporate governance in the Russian companies with state participation cannot be deemed satisfactory.
Despite the fact that the Corporate Governance Code, which is a document containing recommendations on organizing the corporate governance at the Russian companies, has been adopted on the initiative of the state in the person of the Federal Financial Markets Service (FFMS) and approved in the Minutes by the Russian Government, most of the companies with state participation do not use the recommendations therein.
The progress made by major (public) joint stock companies with state participation in furtherance of the corporate governance is accounted for by “own understanding” by senior enterprise management (however, generally not the Board of Directors!) of the importance of the institute and the need to comply with the mandatory requirements for admission of the securities to trading on the Russian and foreign exchanges.
There is no single and clear-cut government policy regarding the development of the corporate governance institute available at the “subordinate enterprises”.
Here are the specific shortfalls of the corporate governance in the Russian companies with state participation.
1) Lack of clear objectives for SOEs.
In private business, the shareholders and executive authorities have a clear idea of the goals pursued by their enterprise. Having substantiated the advantages of changes and their compliance with the business goals, it is relatively easy to motivate the above stakeholders to perform actions aimed at further improvement of the corporate governance system.
The enterprises with state participation typically have hazy and inconsistent owner's objectives in combination with contradicting group interests inside the government, which hamper the opportunities for making such changes. This is acknowledged by the government itself. Its Concept of Property Management and Privatization in the Russian Federation says the following: “since the state's goals and interests implemented by way of participation in the economic partnerships and companies are not always evident to not only management, but also the government authorities that secure the services of the former, the activities of the representatives of the Russian Federation and other governors are based on their own understanding of these goals and interests”.
Transforming “state interests” into cleat-cut goals of the enterprise activities is a challenging managerial task. Nevertheless, the government, being a governing body, should not limit itself to the declaration of its complexity, but manage the issue and resolve it.
2) Boards of Directors
2.1.) Ministers and Political Influence
The Boards of Directors in the companies with state participation are “formal” executive bodies. They do not do much other than secure formal compliance with the Law on Joint Stock Companies. All major decisions regarding the company operations, such as appointments of managers, setting main lines of business are actually made in circumvention of the boards of directors. The former only approve those decisions, if the law requires them to do so. The rule is to vote on major issues by surveys, i.e. without conducting meetings or holding discussions.
The political influence, and sometimes political intervention, are obvious shortfalls within the corporate governance system at the Russian enterprises with state participation.
It is noteworthy, that certain specifics related to the involvement of politicians and public servants into the decision-making processes within the state companies exist in all countries. This practice is described in the quarterly review named Independent Director (winter 2006), published by the Independent Directors Association.
However, many countries “try to restrict the political formation of the boards of directors at enterprises with state participation, which is often seen as a serious impediment to the board's professionalism.2
Similar situation with “formal” boards of directors has historically been typical for the Russian private companies, too, which are traditionally notable for high concentration of property. Nevertheless, the evolution of corporate relations and economic environment make the owners realize the need to make the boards of directors more professional, which will enhance the companies' level of manageability and provide additional competitive advantages through involvement of additional intellectual resources into the management process.
This trend is not typical for the Russian companies with state participation.
A typical board of directors in a company with state participation is “a private party” including ministers and lower ranking bureaucrats, who view their membership on the board as another “community service”, not at all as a “workplace”.
Certainly, ministers have a large staff of subordinate experts at their “main jobs”, who are knowledgeable in many areas and can be assigned corresponding tasks. Such a “collective mind” is quite useful for developing decisions by a board member. The question is whether this situation is really being capitalized on, and to which extent this process has been formalized and, therefore, is legitimate, and whether such an approach is expedient from the perspective of the state efficiency.
There are apprehensions that the third-party directors, who do not belong to the government authorities, will tend to make decisions that may contradict the owner's interests, i.e. “state interests”. First, history lessons come handy here (both ancient and modern), which tell us that ministers do not always act in the best interests of the state. Second, national interests are infrequently mixed up with the interests pursued by certain groups of people within the government. Moreover, as the above-quoted Concept of Property Management states, the actions by the managing bureaucrats are often based on their own, i.e. subjective understanding of the national goals and interests.
The issues of protection of the owner interests can be resolved to a significant extent by clear-cut goal-setting and efficient organization of the corporate governance, which is achieved by way of introduction of existing “appropriate practices” (among which is the Russian Code of Corporate Conduct and the above-mentioned OECD recommendations). These practices promote, among other things, introduction of independent directors into the boards.
2.2.) Independent Directors
The approach by the state toward the institute of independent directors is set forth in the Project for the Development of Corporate Legislation until 2008 published by the Ministry of Economic Development and Commerce: “The analysis of domestic and foreign practice shows that when comparing successful companies without independent directors to similar businesses with independent directors, there was no indication to the beneficial role of independent directors. More than that, independence in the Russian environment normally bears a formal nature”.
The OECD Guidelines outline a different point of view: “ A central requirement to enhance the objectivity of SOE boards is to nominate a sufficient number of competent non-executive board members who are capable of independent judgement. These board members should have the relevant competence and experience and it is advisable that they be recruited from the private sector”.
I share the second point of view. No doubt, inviting experts in the field of finance, law, corporate governance and audit, who have experience of corporate work, have special knowledge and good business standing, who have an opportunity to “carve out” enough time to work on the board of directors, will have a beneficial effect on improving efficiency of operation of the executive bodies and enterprise in its entirety.
2.3.) Board Committees
“ When necessary, SOE boards should set up specialized committees to support the full board in performing its functions, particularly in respect to audit, risk management and remuneration ”, say the OECD Guidelines.
“The establishment of the board committees is a pre-condition for efficient functioning of the board of directors”, says the FFMS Code of Corporate Conduct, which recommends the companies to set up three types of committees “on strategic planning, audit, personnel and remunerations”.
The establishment of committees is a step toward establishment of professional boards of directors. The committee members shall specialize in a certain set of issues and look deeper into them. The responsibility of the board members for a particular area of business becomes more tangible. Certainly, the functionality of such committees depends on their individual composition. The establishment of committees made up entirely of government bureaucrats can hardly be justified.
The board of directors should focus particularly on monitoring of the management activities. In many countries, the public companies must set up board audit committees by law (the best known example is the Sarbanes-Oxley Act in the US ). In accordance with the FFSM-approved Regulations on Organizing the Securities Trading, the companies whose stocks are on the A Lists of the Russian exchanges should set up audit committees headed by independent directors.
Objections regarding the use of audit committees draw on the fact that the Russian corporate law provides for a unique corporate control body, which is the inspection commission. These objections are quite legitimate. The law vests the inspection commission with huge powers, that is provides it with the right to audit all activities of a company, including the board of directors. The audit committees can't even dream about such authority.
However, this right remains unclaimed in real life. “The inspection commission is a body that remains in a state of deep lethargy in the majority of companies during almost their entire reporting year. Prior to the annual shareholders' meeting, the board of directors brings it back to memory with great difficulty and annoyance. The commission members have approximately the same feelings about the fact of their membership”.3
The reasons for the absence of demand for the inspection commission go back to the specifics of the practice and the legal imperfections, when the majority owner is “categorically disinterested in checking his own corporation business management and the law…actively encourages him to do so”.4
Oftentimes, a company employee elected to the inspection commission, such as the deputy senior accountant, “audits” his bosses.
Today, public companies in Russia have to establish two bodies with similar audit functions: one, the inspection commission, under the Law on Joint Stock Companies, the other, the audit committee, in accordance with the Code of Corporate Conduct and the above FFSM Regulations. The worst thing about it is not the “overlapping functions”, but the fact that both these bodies (especially in the companies with state participation) sometimes perform on an exclusively formal basis.
On the one hand, the inspection commission should not include the company employees to prevent the conflict of interest and avoid making audits a pure formality. On the other hand, a limited number of external experts (a regular inspection commission includes 3 to 5 members) even the very skilled ones, are unlikely to be able to conduct thorough audits in a large joint stock company.
Therefore, the lawmakers need to develop the formats that will enhance the real capabilities of inspection commissions. Its members must conform to the established qualification requirements and bear specific legal responsibility. The inspection commission must work on a regular basis, not limiting itself to confirmation of the annual report, which is essentially a nonsensical activity.
Otherwise, this institute should be cancelled altogether given is uselessness, and the internal corporate control should be relegated in its entirety to the internal audit bodies and corresponding board committees that are answerable to the board of directors.
2.4.) Liability of a Board Member.
Some researchers believe that in Russia the board members bear no real responsibility, and the level of their responsibility is referred to as “nominal”. This is not quite so. “Despite the fact that the bulk of the types of responsibility established by the law regarding the joint stock company officials is applicable exclusively to the members of executive bodies, certain regulations providing for civil, criminal and administrative responsibility have direct bearing on the board members or can be applied to them”.5
One other thing is that “currently the law and judicial practice lack clear-cut criteria for assessing the factors that hold directors and managers of the companies harmless (loyalty, proper care of the company business, prudence). The bona fide and prudence principles governing the work of a board member or a manager set forth in Article 71 of the Law on Joint Stock Companies are not filled with specific content through judicial practice”.6
Accordingly, time is ripe to make legal criteria for liability of the directors more specific. In addition to that, “it would be useful to significantly increase the economic component when establishing the punishment for economic breaches of law, including the criminal sanctions”. 7
3) Disclosure and Transparency
The analysis of practice of the companies with state participation shows low level of the information disclosure standards and insufficiency of its scope, which does not allow to make conclusions about the company status.
What is transparency and information openness, and why are they important? Transparency does not imply disclosure of a “nuclear bomb recipe” or of any other strategically important state secret, which the companies with state participation may be privy to. The issue is about honesty and morality in economic relations. We the taxpayers are the stakeholders in the state companies, their “end beneficiaries” and are entitled to the full and truthful information about the way our enterprises are run, about their successes and shortfalls.
4) Compensation of the Board Members and Top-management.
The adequate level of the information transparency should provide for disclosure of information about the remuneration of the board members and managers. Unlike Western companies, where compensation levels can be found in the openly published annual reports, precisely the lack of transparency precludes, with a few reservations, obtaining corresponding official information about the Russian companies with state participation.
The available information makes it clear that the amount of remuneration received by the board members in a number of Russian companies with state participation exceeds the numbers in Western companies that are similar in size, or even larger that their Russian counterparts. The Gazprombank board members were paid bonuses running into millions of US dollars as of the end of 2004. Compare this to “60,000 euros a year averaged by a European bank director”.8
Such situation looks abnormal and unsubstantiated. Operational efficiency of the Russian state companies does not consistently exceed similar indicator in the Western companies. Even when the efficiency is high,9 it is achieved mostly through significantly lower personnel costs as compared to the Western companies, including salary and related social benefits. Given this situation, the compensations received by the Russian board members that exceed the Western level are just immoral. These amounts are not function of the “work contribution” of these directors to the work and success of the company.
The OECD corporate governance guidelines recommends bringing closer the remuneration level of the board members at state enterprises and in private sector. On the other hand, it is evident that zealous fulfillment of the OECD recommendations on that score does not rank as a priority task in improvement of the corporate governance in the Russian companies with state participation.
Certainly, board members of the companies with state participation should be compensated accordingly. Otherwise, their will just keep their seats warm, but not actually work. However, in Russia 's circumstances the amount of such compensations should be pegged to some real values, such as the average salary in the state economy sector, salaries of civil servants or, if using comparable Western companies as a benchmark, adjustments should be made to the GDP per capita.
Given the formal nature of most boards of directors in companies with state participation, it is unlikely that the performance-based bonus systems could be currently used with any chance of success. As a last resort, their max value should be set with due account taken of the above restrictions.
The following essential steps to improve the corporate governance in the companies with state participation should serve well to overcome the drawbacks outlined in the article.
The issues of enhancement of the corporate governance in the companies with state participation go beyond the narrow limits of economic relations and do not boil down to increased efficiency of the state-controlled business. The state must set the example of appropriate organization of the corporate governance and conform to the principles and standards established by itself. Disregard for such principles and standards reduces motivation for improvement of the corporate governance of the private companies, and affects the overall economic development. In addition to that, excessive closeness and lack of transparency in the organization of state business results in increased public mistrust, whereas, according to certain historians, the lack of trust in the state caused all the political turmoils in Russia during the 20 th century.
1 1 For the purpose of this paper, the companies with state participation are the joint stock companies where the state owns a share in the capital that exceeds 50%, and their subsidiaries (enterprises with indirect state participation).
2 Independent Director, Quarterly Review, winter 2006, p. 24
For example, in Norway , members of the parliament, ministers or state secretaries are not allowed to be on the boards of directors.
3 Osipenko, O.V., Institutes of Corporate Governance and Shareholder Conflicts in Russia , Moscow , Eksmos Publishers, 2004, page 294.
5 Maksimov, Pyotr, Liability of Board Members under Russian Law http://lawfirm.ru/article/index.php?id=94
6 Concept for Development of the Corporate Law until 2008, Ministry of Economic Development and Commerce.
9 Efficiency is always a conventional value to a certain extent, as in the short-term perspective in can be attained, for instance, through the company failing to renew its fixed assets, which may run counter to its long-term interests.