corporate governance in russia:: towards a european, us, or russian model?

European Management Journal Vol. 20, No. 6, pp. 630–640, 2002 2002 Elsevier Science Ltd. All rights reserved.Pergamon

Printed in Great Britain0263-2373/02 $22.00 + 0.00PII: S0263-2373(02)00114-7

Corporate Governance inRussia:Towards a European, US,or Russian Model?DANIEL McCARTHY, Northeastern University, BostonSHEILA PUFFER, Northeastern University, Boston

This article analyzes Russia’s emerging corporategovernance system taking into account both foreignand domestic influences. It discusses influences onRussia’s corporate governance from other countries,particularly the US, Germany, and France. Aspectsof Russian culture and traditions are then examinedto see how they might influence the country’s evolv-ing corporate governance system. Although Russiawill continue to be influenced by international stan-dards and systems of other countries, the articleconcludes that Russian corporate governance willevolve into its own unique model reflecting thecountry’s traditions, values, and culture. Impli-cations for Western investors are discussed. 2002 Elsevier Science Ltd. All rights reserved.

Keywords: Russia, Corporate Governance, Com-parative Corporate Governance Systems, Businessand Management

Corporate Governance: Catalyst for theRussian Economy

Since Vladimir Putin was elected President of theRussian Federation in 2000, one of his major goals hasbeen to secure Russia’s place in the global economiccommunity. He has focused on pursuing Russia’smembership in the World Trade Organization as ameans of achieving economic stability, increasingeconomic growth, enhancing attractiveness forinvestment, and building confidence in the country’seconomic future. An important related initiative hasbeen to develop a corporate governance system that

European Management Journal Vol. 20, No. 6, pp. 630–640, December 2002630

would provide an environment conducive to achiev-ing these objectives. Substantial progress in this areais necessary because of the dismal treatment thatcountless minority shareholders and foreign inves-tors suffered during the first decade of the country’stransition to a market economy.

To put the evolving model of Russian corporategovernance in context, we first discuss the concept ofcorporate governance as an underpinning of a capi-talist system, with its theoretical foundations inagency theory, as well as in the theory of embeddednational cultures. A brief review is then presented ofthe abusive and destructive corporate practices thatcharacterized Russia’s first decade of ‘Wild West’capitalism, which led to serious efforts to redressthese abuses beginning in the late 1990s. This is fol-lowed by a discussion of the external influences thatshaped the country’s initial efforts to establish a legit-imate corporate governance system, including thecenterpiece of that effort, the government’s Code ofCorporate Conduct unveiled in 2001. In addition tointernational standards, features of corporate govern-ance systems of three countries that have had astrong influence on Russia are explored — the US,Germany, and France. Russia has long had Asianinfluences on its culture as well, but in this article wefocus on Western influences. A perspective is thendeveloped of an evolution to a unique Russian sys-tem that recognizes the country’s distinctive culture,history, and traditions, in addition to internationalinfluences on corporate governance. The article con-cludes with implications of the evolving system forWestern investors.

Seven decades of

communism and central

planning had provided little or

no experience in dealing with

issues of ownership and

shareholder rights

CORPORATE GOVERNANCE

Foundations of Corporate GovernanceCorporate governance has been defined as ‘the exer-cise of power over and responsibility for corporateentities’ (Mallin, 2002). It includes the perspective ofowners, or capital providers, in assessing their riskwith investments in a firm’s resources, in evaluatingcapital allocations to provide maximum returns, andmonitoring how capital is managed over time(Rubach and Sebora, 1998). Corporate governancesystems recognize the inherent conflict in objectivesbetween owner-shareholders and managers, and thusestablish institutions, policies, and procedures to pro-tect shareholders’ interests. Shareholders are pur-ported to seek the maximization of profit or theshareholder value of the firm, while managers areinclined to make decisions that perpetuate their ownpersonal rewards, positions, and longevity withintheir firms.

One model of corporate governance is based onagency theory, which has as its underpinning thisfundamental conflict betweenshareholders and managers(e.g., Buhner et al., 1997; Don-aldson, 1990; Jensen and Mec-kling, 1976; Shleifer andVishny, 1997). With the recentproliferation among manycountries of the concept ofshareholder value, which advo-cates the primacy of share-holder interest, some expertshave suggested that a conver-gence toward the agency theorymodel of corporate governanceis occurring. Russia’s developing corporate govern-ance system appears on the surface to validate thisview, since it has been strongly influenced by thismodel that prevails in the US and the UK.

While not in direct conflict with agency theory, thecultural embeddedness model takes a more expans-ive approach, noting that differences in corporategovernance exist among countries because of theirparticular institutional and cultural variations. Theseinclude influences such as the relative efficiency ofcapital markets and regulations, as well as socializ-ation experiences (Bird and Wiersema, 1996; Chark-ham, 1994; Lubatkin et al., 2001; Roe, 1993). Forinstance, an empirical study found that differentinstitutions accounted for variations in ownershipmodes of firms in 12 European countries (Thomsenand Pedersen, 1996; Pedersen and Thomsen, 1997).Another major study that documented differencesamong national systems of corporate governance alsorefutes the convergence view (Gedajlovic andShapiro, 2001). As Russia’s corporate governance sys-tem evolves, we believe that it will begin to reflectmore of the cultural embeddedness model, incorpor-ating additional influences from its own culture, his-tory, and traditions.

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Corporate Governance Abuses in the Decade of‘Wild West’ Capitalism

During Russia’s 70 years of communism and centralplanning, as well as during the early years of peres-troika and glasnost, there was no private ownershipof commercial or industrial enterprises. There wereno shareholders, since the State was the owner of allproductive assets and organizations, and thus, therewas no role for corporate governance in the sensethat it is generally understood in a market economy.Enterprise managers reported to industrial minis-tries, which allocated resources, established pro-duction plans, and set prices. Although enterprisemanagers were accountable to and received rewardsand punishments from the ministries, the relation-ship was not analogous to the manager-ownerrelationship in a market economy. However, once thegovernment’s privatization program began creatingpublicly owned stock companies in the early 1990s,corporate governance was needed to balance theinterests of shareholder-owners against those of

potentially opportunistic man-agers. Agency theory holds thatmanagers might well act intheir own self-interest by con-cealing or distorting infor-mation and other such actions(Jensen and Meckling, 1976).

Unfortunately, this assumptionproved to be too true duringRussia’s tumultuous decade ofthe 1990s as the countryattempted to establish a mar-ket-driven economy with pri-

vately owned enterprises. The confusion caused bythe new circumstances, as well as the disintegrationof old systems, created an environment where evenwell-intentioned managers, who tried to run theirenterprises in ethical ways, often found their effortsto be fruitless (Puffer et al., 1997). The lack of guide-lines and the extreme pressures for makingenterprises self-sufficient also led many managers tooperate as if the enterprises were their own, abusingthe rights of other shareholders in the process. Mostmanagers were the same individuals who had runthese enterprises prior to privatization, and somehad, in fact, gained extensive ownership of theirfirms, at extremely low cost. By the end of the privat-ization period, more than 70 per cent of enterpriseswere in the hands of enterprise managers (Economist,1994), defeating the government’s objective of disper-sing ownership among the Russian population.

At the same time, the infamous oligarchs, who hadcreated large financial and industrial conglomeratesor FIGS, exercised their growing economic power towrest even more ownership and control over thefledging market economy by negotiating lucrativedeals for themselves with the government. The mostnotorious of these was the 1996 loans-for-shares


scheme, in which some oligarchs financed PresidentYeltsin’s re-election campaign with loans to thegovernment. In return, they received shares thatincreased their ownership of even more keyenterprises. However, their wealth and power, likethose of many enterprise managers, were greatlydiminished by the country’s 1998 financial crisis, inwhich the government defaulted on its debts to oli-garch-owned banks and other creditors.

In fact, the oligarchs’ own excesses and abuseshelped cause the crisis, as did the abuses by otherenterprise managers that resulted in the trampling ofshareholder rights, including those of foreign compa-nies that had invested in, or partnered with, theseenterprises (McCarthy and Puffer, 1997). The abusesincluded asset stripping of their enterprises, settingup personally-owned shadow companies to whichthey funneled assets and funds, not announcingshareholder meetings, deleting names from share-holder registers, and minimal transparency of theiractions and financial statements. A clear indication ofRussia’s dire situation was the country’s ranking lastin responsible corporate governance in an inter-national study of 25 emerging countries (Karmin,2000). A major effect of these abuses, deficiencies,and dysfunctions was to discourage investment byboth foreign and domestic interests.

Awakening to Corporate Governance

These excesses and abuses created severe problemsfor the Russian economy, but also led governmentofficials and concerned business executives to realizethat serious reforms were required if the countrywere to emerge from chaos. It was clear that, withouta sound corporate governance system and support-ing institutions like capital markets, investor confi-dence could not be expected. Further attempts todevelop a market economy and attract domestic andforeign investment would be futile, and PresidentPutin also realized that integrating Russia into theWorld Trade Organization required the samereforms. In late 2001, the government issued a draftof a new Code of Corporate Conduct, which was tobe the foundation for a system of corporate govern-ance aimed at increasing transparency and disclos-ure, as well as initiating a supporting infrastructure.

International Influences on Russia’sCorporate Governance System

Just prior to the time Russia was about to develop itsown standards, a phenomenon of worldwide atten-tion to corporate governance had occurred, withmajor thrusts to develop and revise guidelines. Othercountries were also taking major steps to remedytheir own situations and curtail opportunities for


managers to engage in self-serving abuses. At least11 international groups had developed standards, aswell as 25 individual nations, most during the later1990s (Gedajlovic and Shapiro, 2001). Virtually all ofthese efforts sought to build trust in the systems onthe part of investors and potential investors. Changeswere intended to increase confidence that managerswould not be able to exploit their positions for theirown advantage to the detriment of shareholders andother stakeholders.

Not surprisingly, Russia’s legislators and businessleaders looked to international standards, such asthose developed by the OECD and the World Econ-omic Forum. With no tradition of corporate govern-ance, Russians had little internal precedent to use indeveloping their standards. Seven decades of com-munism and central planning had provided little orno experience in dealing with issues of ownershipand shareholder rights. Other countries, includingthose more advanced in corporate governance thanRussia, were still grappling with international press-ures such as globalization, as well as nationalchanges such as increasing freedom, privatization,and consolidation of industries. Russia, too, wasunder pressure from international agencies andinvestors to clean up what had been called ‘one ofthe murkiest corporate swamps’ (Rossant et al., 2002).It was clearly more expeditious for Russia to base itsdeveloping system of corporate governance on stan-dards and guidelines already established by othercountries and international agencies.

Russia’s Code of Corporate Conduct:Internationally Inspired

The combined efforts of many government organiza-tions and business leaders culminated in the draft ofa new Code of Corporate Conduct issued by the Fed-eral Securities Commission (FSC) in late 2001, andwas expected to be passed by the Duma as a set ofrecommendations for corporations by 2003. Keygovernment officials included Prime Minister Kasy-anov, Deputy Prime Minister and Finance MinisterKudrin, Deputy Head of the Presidential Adminis-tration Dmitry Kozak, and Igor Kostikov, Chairmanof the Federal Commission for the Russian SecuritiesMarket. Government officials worked in collabor-ation with private groups, including the CorporateGovernance Association, the Russian Institute ofDirectors, and Club 2015, an organization of far-sighted business people dedicated to ethical businesspractices in Russia.

The Russian code’s broad objective was to provide aframework for corporate governance in Russian cor-porations. It was based primarily on the OECD’sinternational guidelines for effective corporategovernance, but also reflected other internationalstandards, particularly those drafted by the WorldEconomic Forum. In substance, the standards


reflected strongly the shareholder-rights orientationof the US corporate governance system, but also con-tained aspects of the German system, which was alsoinfluenced by the OECD principles.

The development of a code was in contrast to the USmodel, which does not have a formal code. As insome other countries, the code was initiated as a setof recommendations, but was expected to bringabout major changes as Russian companies revisedtheir charters to conform with the code. The code ismore like Germany’s, whose two influential codesare voluntary: the Code of Best Practice/CorporateGovernance Principles, developed by the Germanpanel on corporate governance, and the GermanCode of Corporate Governance, created by theBerliner Initiativkreis.

As stated in its introduction: ‘The purpose of the codeis to enhance good governance rules in Russian com-panies, including effective protection of share-holders’ rights and interests, equitable treatment ofshareholders and transparency of decision-making:to underpin the professional and ethical responsi-bility of directors and other company officials andshareholders; to improve information disclosure; andto develop a comprehensive system of business eth-ics standards.’

Igor Kostikov, head of the Federal Securities Com-mission, stated: ‘We have produced a real frameworkfor the markets to make a decision’ (Bases, 2002, p.7). The idea was that investors would rely on disclos-ure and comparisons against standards such as thecode to reward or punish companies, and heexpected investors to punish companies that did notadhere to the code. He seemed to echo the view ofPeer Schatz, a member of the German government’sCromme Committee to reform that country’s corpor-ate governance with recommendations for voluntarycompany compliance. He stated: ‘To be in non-compliance when you said you would comply leadsto the worst punishment possible, loss of credibility’(Rossant et al., 2002, p. 81). In Germany, no govern-ment agencies are responsible for enforcement of cor-porate governance rules, but the major source ofrelated laws is the Stock Corporation Act or Aktien-gesetz (Wegen et al., 2002).

The Russian government’s Code of Corporate Con-duct, while drawing heavily upon international stan-dards for good corporate governance, is also consist-ent with existing Russian laws. The 68-page code isnot a new law, but a detailed set of recommendationsand procedures reflecting international best practices.The code consists of 10 chapters that cover the prin-ciples of corporate governance, the general share-holders’ meeting, boards of directors, executive bod-ies and the secretary of the company, major corporateactions, disclosure of company information, super-vision of financial and business operations, divid-ends, and conflict resolution.


To encourage compliance with the code, companieswith more than 1000 shareholders would be requiredto state in their annual reports any deviations fromthe code, thereby disclosing such noncompliance toshareholders, prospective investors, and others. Thevoluntary compliance approach also recognizes thepower of an informed market to exercise its ownjudgment. This is consistent with the views of a USexpert, who, in discussing voluntary complianceaccompanied by information to shareholders, notedthat ‘with disclosure, the market will render its ownjudgments’ (Garten, 2002).

Concurrent with the development of the code wasthe publication by the leading Russian investmentbank, Troika Dialog, of an annual ranking of the top70 Russian companies on various measures of cor-porate governance. The rankings were also based oninternational criteria, in this case those developed bythe World Economic Forum. The initial rankings pub-lished in 2000 were largely ignored by the enterpriseexecutives, but soon drew their corrective actions asthey noted that investors were paying close attentionto the rankings. Activities like this ranking wouldlikely hasten compliance by major companies withthe code.

Influences From the US, Germany, and France

Russia’s new code of corporate conduct appears tohave borrowed substantially from the US in specify-ing the standards for many areas of corporategovernance. In spite of recent scandals, the US hasbeen viewed as a world leader in effective corporategovernance practices and transparency, with stronglaws and tough enforcement, particularly by theSecurities and Exchange Commission. In addition tosuch legal requirements and restrictions, individualstock exchanges including the New York StockExchange and Nasdaq have their own standards andrequirements. In contrast, the listing rules of the Ger-man Neuer Markt do not mandate specific corporategovernance structures or practices (Wegen et al.,2002). Although the initial international influences onRussia’s corporate governance system came frominternational organizations and from the US, the sys-tem might well begin to show more signs of beinginfluenced by other countries. Germany and France,for instance, have had a strong influence on Russiain the past. Various characteristics of corporategovernance in these countries are now discussed.

Stock Exchanges and Financial Markets

Some Russian companies have listed or aspire to liston US exchanges and have adapted their own corpor-ate codes and standards to comply with theexchanges’ stringent requirements. Their reasons fordoing so were very pragmatic, and aimed to increasethe valuation of their companies. According to a 2001

Some Russian companies

have adopted two-tiered

boards, a practice likely

borrowed from France or

Germany


study of 21 Russian firms, corporate governancepractices were strongly related to a firm’s potentialmarket value. The author of the study concluded thatcorporate governance practices can have a powerfuleffect on market value in countries with weak legaland cultural constraints on corporate behavior (Black,2001). Other research conducted at the Yale Inter-national Institute of Corporate Governance hasshown that the quality of corporate governanceinfluences companies’ cost of capital, as well the sizeand vibrancy of a country’s capital markets(Garten, 2002).

Vimpelcom, the first Russian company to list on theNYSE had a P/E of 20 in early 2002, effectively quad-rupling the value of the company, while most Rus-sian companies still averaged a P/E of around 4 or5. To become listed, Vimpelcomhad to become a model of cor-porate disclosure and trans-parency in its corporategovernance system. Yukos Oilalso enjoyed such benefits ofstrengthening its corporategovernance standards andbehavior in anticipation of a USstock-exchange listing. Inves-tors rewarded the company’snew openness with a six-foldrun-up in its share price. Prior to that action, Yukos’sannual profitability of $3.5 billion had realized a mar-ket capitalization of merely $2 billion due to the lackof investor confidence in the company.

Thus, the financial markets in the US provide sub-stantial evaluation and discipline for companies asthey develop and demonstrate their corporategovernance standards. In contrast, the markets inother countries such as France, Germany, and Japan,provide far less influence in monitoring these factors.The fundamental reason is the lower level of disclos-ure and transparency in those countries, in whichcorporate governance systems are guided more byconstraints and mechanisms within the firm than byexternal requirements. Given the early stage of Rus-sia’s financial markets and regulatory institutions,many Russian companies may choose to mirror moreclosely those countries in their own codes, ratherthan the US with its stronger institutions and disclos-ure requirements. Russian companies might thus relymore upon internal corporate mechanisms such asmajor shareholder power and boards of directors tomonitor corporate activities.

Board Structure

Other aspects of corporate governance might also bedrawn from countries other than the US for a numberof reasons. Members of US boards of directors areelected representatives of the shareholders, and aresupposed to adhere to the premise of maximizing


shareholder value. This tenet of market capitalismplaces stockholders as the most important stake-holders in companies. Many Russian companies, incontrast, may well have other stakeholders, or share-holders with other objectives, who could be rep-resented on their boards. This is common in otherEuropean countries that have a tradition of socialcapitalism. For instance, the boards of directors inGermany and France represent more stakeholdersthan boards in the US, or even the UK. In Germanyand France, these include banks and other companiesthat own large blocks of stock, and companies inthese countries have traditionally cooperated withtheir governments in supporting social objectives.For instance, although CEOs in France typically serveon the boards of a number of major French compa-nies, commonly known as interlocking directorates,

their common educational andsocial backgrounds often leadthem to act as good servants ofthe State in representing theircompanies, as a way of main-taining their personal repu-tations and social status(Bauer, 1990).

The boards of most Russiancompanies have been insideboards, composed almost

exclusively of members of management. That prac-tice is changing, however, and will likely continue todo so as companies adopt the new code of conduct.And pressure from stockholder groups has alsoprompted companies to add outside directors to theirboards. For instance, the Russian government, witha 38 per cent ownership position in Gazprom, orches-trated the 2001 appointment to the board of an inde-pendent director, Boris Fyodorov, a respected mar-ket-reform economist. Also, the investment firm,Hermitage Capital Management, sought board seatsand various governance reforms in important Rus-sian firms in which it held shares. And contrary tothe nearly universal approach of US public compa-nies in which the CEO also serves as chairman of theboard, the new Russian code recommends separatingthe two functions, as is the case with German super-visory boards.

Some Russian companies have adopted two-tieredboards, a practice likely borrowed from France orGermany. Such systems attempt to balance the poweramong management and non-executive or supervis-ory directors, auditors, shareholders, and other stake-holders. Balance is considered important in good cor-porate governance systems and is sought by manymeans, including non-executive directors, as in Ger-many. ‘Within a corporate governance structure, non-executive directors occupy a prominent position:they are responsible for monitoring the managementor executive board members’ (Hooghiemstra andVan Manen, 2002). Large German companies mustutilize two-tiered boards including a supervisory


board of non-executive directors, and a managementboard of company executives. There is no overlap-ping membership between the two boards, since eachhas its own separate rights and responsibilities. Ger-man co-determination laws require that half thesupervisory board members be representatives of theemployees in AGs with more than 2000 workers. Thecorresponding proportion for AGs with 500–2000employees is one-third of the members. France, onthe other hand, allows two-tiered boards, withworker representatives allowed to attend boardmeetings but not to vote.

Russian law, as noted in the Russian code, while notprohibiting overlapping members between two-tiered boards, does restrict the percentage of manage-ment board members serving on the board of direc-tors to 25 per cent of total directors. This is possiblyan influence of the German system, in contrast to theless restrictive US policies on board composition.Additionally, German boards have no mandatorycommittees, in contrast to the US, as well as the rec-ommendations of the Russian code, which does man-date various committees.

Disclosure and Shareholder Rights

Regarding disclosure, German board practices neednot be disclosed, except for the composition of thesupervisory board, but financial results of some listedcompanies must be disclosed on a quarterly basis.However, minority shareholders may contest share-holder resolutions that violate the basic obligationsof board members such as promoting the basic pur-pose of the company, prohibiting damage to the firm,and exerting their influence in a responsible manner(Wegen et al., 2002). This lower disclosure require-ment might well appeal to executives of many Rus-sian companies, in spite of the code’s recommen-dations for higher levels of disclosure.

The overall situation in France regarding shareholderrights is not much different from Germany. Tra-ditionally, it was difficult for minority shareholdersto assert their rights against majority shareholders orthe board of directors. More recently, shareholderrights in French companies, although not terriblystrong, have been considered equal to those in theother continental European countries. But in contrastto the German system, entrenched French companymanagements can still resist a change in control withsuch techniques as double voting rights for someshareholders or a limitation on the maximum num-ber of votes that any shareholder can exercise(Feldman, 2002). Although Russia’s code does notexplicitly mandate one vote for each share, its callfor equal treatment of all shareholders implies thatprinciple. Further progress in France was the passageof legislation in 2001 requiring that the board ofdirectors’ annual report disclose the remunerationand benefits of top management, including that


received from entities controlled by the parent com-pany. The Russian code calls for the board of direc-tors to be very specific about its criteria for evaluatingand remunerating top management. However, thedisclosure of remuneration was typically secret dur-ing the country’s market economy transition, and isstill quite rare.

Thus, Russia’s system of corporate governance hasborrowed heavily from international organizations aswell as from other industrialized countries. Doing sowas eminently reasonable, since Russia lacked anyreal precedents in corporate governance. Addition-ally, the pressure from President Putin, as well as theflagrant abuses of the past, made it mandatory tomove swiftly in developing such a system. Numer-ous other countries had only recently been involvedin a similar process, and Russia made the choice notto be left behind in an area that was crucial to itseconomic development. And because of Asian influ-ences in Russia’s history, the country may also lookto Japan or Korea for guidelines in some areas suchas networking and keiretsu-like relationships amongdiversified groups like the FIGS. Most individualcompanies, however, are likely to continue takingtheir major signals from the US due to the lure ofrelatively high market capitalizations as a percent ofGDP, relative to other countries. However, theseother countries also have less disclosure and trans-parency in their corporate governance, which mightappeal to some Russian companies. As it evolves, webelieve that Russia’s system will continue to look toother countries for models, but will also introducemore of its own more culturally based initiatives.

The Evolving Russian Model

Pressures from the Changing Environment

Corporate governance systems are modified as cir-cumstances change, as evidenced by the responses tothe problems and pressures of the Enron scandal. TheUS, with its highly developed corporate governancesystem, had to extensively revise its rules and regu-lations in 2002. While the Enron scandal provided themain impetus, other mounting problems had madeit clear that the balance of power in many US cor-porations had shifted to management, often aided bysupportive boards of directors. Many such executivesand directors profited at the expense of most share-holders and employees. Harvey Pitt, chairman of theUS Securities and Exchange Commission, noted in2002 that the Enron crisis was a trigger for long-needed reforms in corporate governance, trans-parency, and required changes to laws. All aimed atprotecting shareholders, as well as increasing theintegrity of the entire system. The purpose was toaddress the abuses of private property rights andviolations of the sanctity of individual ownershipthat had clearly been committed by far too many


companies, auditors, and other institutions likeinvestment banks. So, even in highly developed cor-porate governance systems, change is periodicallyrequired, and the system will usually re-emphasizethe society’s basic cultural beliefs and values.

As noted earlier, the flagrant abuses of the 1990s, aswell as Putin’s objective of gaining entry to the WorldTrade Organization, provided the impetus for therapid development of a corporate governance sys-tem. According to the US Ambassador to Russia,Alexander Vershbow: ‘From the Russian leadership’spoint of view the WTO accession process is the lever-age needed to implement reforms’ (Russia BusinessWatch, 2002, p. 14). Additional pressures will inevi-tably arise, as the country gains experience, andencounters challenges in implementing its emergingcorporate governance system. In fact, the US Enroncrisis in 2002 was a catalyst for the Russian govern-ment to investigate and take strong action against theabuses of entrenched managers at companies likeGazprom, as well as against high-profile auditorsincluding PricewaterhouseCoopers. Such actionswere a clear signal of the increasing importance ofstrong corporate governance and a simultaneousdecrease in tolerance of flagrant abuses of share-holder rights.

The role of Culture in Corporate GovernanceSystems

The dominance of international influences in theearly stages of Russian corporate governance, webelieve, occurred because it was necessary for thecountry to rapidly put into place a system that wouldcorrect flagrant problems and capitalize on newopportunities. We contend, however, that the coun-try’s evolving system of corporate governance willover time increasingly reflect Russia’s own situation,including its institutions, as well as its culture, tra-ditions, and values. Culture refers to the set of beliefsshared by members of a society or group as to howthings ought to be (Schein, 1985). These shared beliefsemanate from institutions such as school systems andreligious organizations as well as family relation-ships. It is clear from the experience of the US, Ger-many, and France that these characteristics play a sig-nificant role in corporate governance systems. Andas problems and pressures for change occur, thechanges made will likely be influenced by the coun-try’s institutions, and reflect a return to the society’sbasic values and traditions. Pressures seem toawaken the instinct to cling to the basic traditionsand values imbued in the citizenry, and that havetraditionally provided the foundations of corporategovernance in countries with relatively well-developed systems.


The United States

The US corporate governance system, for instance,reflects the values of individualism, self-reliance, fairplay, accumulating private property, and sanctity ofownership rights. When problems, such as the Enronscandal, have threatened the country’s basic valueswhich had provided the underpinning of the corpor-ate governance system, proposed legal changes re-emphasized those values. These changes reflect thepredominant US approach to corporate governanceconstraints, and are in the main imposed andenforced by external agencies and regulators. Theygenerally aim to reaffirm and protect the ownershiprights of shareholders and protect their propertyfrom abuses on the part of managers and directors,as well as auditors and investment analysts. Theseremedies call for an increase in disclosure, as well asnew constraints upon the actions of senior managersand directors who might seek to enrich themselvesat the expense of employees and shareholders. Suchconstraints are intended to create a more level play-ing field for all stakeholders.

France

Core cultural values in France include egalitarianism,hierarchy, and respect for authority (Calori et al.,1997). The French system of corporate governancedepends primarily upon internal corporate mech-anisms, such as boards of directors and responsiblemanagement, rather than upon external constraints.Fundamental behaviors often reflect the values ofsocial capitalism, with its attendant responsibilities tosociety by the government and other large insti-tutions. There appears to be a shared understandingof such things among the CEOs and directors of largeFrench companies. They share basic French values,primarily because of their common educational back-grounds and socialization experiences as graduatesof the elite Grandes Ecoles (Crozier, 1995). This com-mon background is reinforced by subsequent social-ization as members of interlocking directorates, andsocial networks of major company executives andgovernment officials (Bauer and Bertin-Mourot, 1987;Crozier, 1995). Thus, fundamental French values aretypically reflected in the behaviors exhibited bymembers of these groups, and the same values aremanifested in the internal corporate mechanismsthey develop.

Germany

German cultural values, as exhibited by managers,emphasize performance orientation as the predomi-nant value, along with practices reflecting suchcharacteristics as low compassion, high autonomy,and high assertiveness (Brodbeck et al., 2002). Thevalue that managers place on performance, certaintyseeking, and logic, as opposed to human relation-

Later, under the

communist regime, enterprise

managers kept two sets of

books


ships, is likely reinforced by the technical education,which has been traditional for most German topmanagers. Like France, the primary constraints onmanagement behaviors found in the country’s cor-porate governance system are internal, rather thanimposed by external institutions. This internal con-straint approach seems to reflect the country’s cul-tural emphasis on autonomy. The German system,like the French, also incorporates the traditionalvalues of social capitalism such that large corpora-tions, as well as the government, are expected to usetheir power and resources to help provide a socialsafety net for citizens, as well as social benefits forworkers. However, those values, developed prim-arily during the last half-century, may be in the pro-cess of declining as the country has more recentlyshown less inclination to follow the tenets of socialcapitalism (Hahn, 1995). While powerful Germanlabor unions have resisted such a trend in changingvalues, some changes toward less social obligationcould yet be reflected in Germany’s corporategovernance system, accompanied by an increasingemphasis on shareholders’ objectives includingprofitability.

Russian Structural and Cultural Influences in anEvolving System

The corporate governance systems of the US, France,and Germany clearly reflect culturally embeddedcharacteristics of those societies, the resistance thesecharacteristics exhibit to change, and the propensityto revert to such values inresponse to problems andpressures. After the immediatepressures to quickly develop acredible corporate governancesystem, which led to relyingheavily upon internationalmodels, we expect that Russia’sexperience will increasinglymirror those countries. Its own cultural influenceswill become more and more important in the evol-ution of its corporate governance system. Of themany potential cultural values and traditions thatcould provide such influence (Fey et al., 2001; Pufferand McCarthy, 1995; Puffer et al., 1997), we discussthree interrelated cultural characteristics and some oftheir potential influences on an evolving Russian cor-porate governance system. These are: a tendency tocircumvent laws and directives, low trust in trans-actions outside personal relationships, and relianceon personal networks to achieve objectives.

Circumventing Laws and Directives

The Russian cultural tradition of circumventing lawsand directives has deep roots in the country’s historyand political structures. For instance, in nineteenth-century Russia, Count Benkendorf is reputed to have


said that laws were made for subordinates and notfor bosses (Shein and Zhuplev, 2002). Such attitudeshad led serfs to withhold agricultural productionfrom their landowners, circumventing the authoritythey saw as unreasonable. Later, under the commu-nist regime, enterprise managers kept two sets ofbooks. One set was used to report positive results,usually false, to the ministry in order to receivebonuses, while the other set contained the true datafor their own records. Circumventing laws was alsothe basis for a vast black-market economy that oper-ated during the communist period as well as duringthe transition to a market economy. Thus, Russianculture has long considered it acceptable to ignorelaws and rules that seem to make little sense, or aredifficult to comply with. These norms developed dur-ing times when individuals had to be resourceful insecuring their own survival and futures in environ-ments of extreme scarcity and harsh punishment.

Taking care of oneself was historically a predominantgoal in a very difficult environment, and led peopleto turn a blind eye to what they perceived asunrealistic laws and regulations under oppressiveconditions. This could be seen as a way of makingsense of a very difficult and confusing environment(Weick, 1995). This cultural value should be wellunderstood by Russian policy-makers and adminis-trators as they create external constraints to preventcorporate officials from circumventing governancerequirements. Policy-makers may well be able to cre-ate positive outcomes by developing clear and unam-biguous laws and guidelines that can be seen as

reasonable by corporateofficials and other stakeholders.Such legislation could followthe precedent of the country’ssimplified flat income tax intro-duced in 2001, which resultedin a dramatic increase in tax fil-ings and compliance with thelaw. Strong enforcement of

strict laws will be required to help ensure com-pliance, but some corporate officials and others willundoubtedly succumb to an inclination to circum-vent such externally imposed constraints. When suchbehavior occurs, it will emphasize the need to imposestronger measures.

Low Trust

A related cultural characteristic is the tendency forRussians to distrust individuals, groups, and organi-zations in transactions that fall outside their sphereof personal relationships. As noted by the nineteenth-century historian Kliuchevskii (1987), the extremecaution with which Russians engage in relationshipsis due primarily to their centuries of enduring a harshgeographic environment. The harsh political environ-ment was also a source of mistrust. The communistparty and the ruling elites that preceded it used sec-


ret police and citizen-informants to suppress dissent,create fear, and ensure obedience to authority. Penal-ties for dissent, disobedience, or unauthorizedbehavior were notoriously harsh and often arbitrarilyimposed. Factory managers during the communistperiod, for instance, were required to be party mem-bers and their political loyalty was more importantfor their careers than their managerial abilities. Man-agers were constantly monitored by the enterprise’sparty committee, which also approved majordecisions. Having low trust of such individuals, Rus-sians learned to closely guard information that couldbe used to harm or disadvantage them. In the contextof corporate governance, trust in the system and trustamong its stakeholders are essential underpinningsfor transparency and disclosure of corporate andshareholder information.

The cultural tradition of mistrust may cause stake-holders of all types to want to withhold informationthat is needed to make the system work fairly foreveryone. Such a culturally ingrained resistance tosharing information will require rigorous enforce-ment of disclosure requirements. And there can alsobe a positive aspect to low trust as it relates to corpor-ate governance. It can cause people to take a cautiousapproach to information provided, as well as to thepurported benefits of company decisions and actions.Such caution could lead to shareholders’ demandingmore complete explanations and support fordecisions. In a sense, the low trust characteristiccould emphasize the need for companies to be com-plete and transparent in the information they provideif they intend to attract investment from skepticalsources. The end result could be more pressure onRussian companies for better corporate governance.

Personal Networks

A third Russian cultural tradition is reliance on per-sonal networks of trusted friends and colleagues toget things done (Peng, 2001). Throughout the coun-try’s history, attempts at going through official chan-nels and procedures would too often result in frus-tration and failure, especially since the resources andopportunities sought after were typically in shortsupply. Such frustrating experiences, combined withthe traditions of circumventing rules and mistrustingindividuals in impersonal transactions, have led Rus-sians to develop personal networks to help oneanother obtain information, goods and services, jobs,admission to educational institutions and pro-fessional organizations, financing, and other suchobjectives. Such tightly knit networks can have animpact on the effectiveness of the corporate govern-ance system since network members trust oneanother and influence members’ attitudes andbehaviors. Groups such as Club 2015 and the RussianInstitute of Directors could take leadership roles byhaving their members agree to practice exemplarycorporate governance in their organizations, and


assist other organizations in developing similarlyhigh standards. Additionally, prestigious stockexchanges, with their strict disclosure rules, can pro-vide new networks for companies seeking to listthere. Such positive networks could create broadersupport for compliance with corporate governancemechanisms by demonstrating the positive benefitsof transparency, disclosure, and fair play. What alsomust be understood and guarded against is thepotential for other networks of tightly connectedindividuals to work against the corporate governancesystem and undermine it for their own gain.

Looking Ahead Toward a RussianModel

We conclude that Russia’s initial corporate govern-ance system will predominantly contain elements ofconvergence reflecting the fundamental principlesendorsed by international organizations. Addition-ally, convergence will be exhibited as some elementsare drawn directly from the systems of other coun-tries. For instance, some individual Russian compa-nies will be heavily influenced by the standards ofthe US and its stock exchanges. Many Russian execu-tives recognize listing as a way of greatly increasingthe value of their companies, and listing requires thatthe companies meet stock exchange standards fortransparency and disclosure. The evolving Russiansystem, however, will diverge from such inter-national influences as it becomes imprinted with thecountry’s unique cultural stamp. There are manyforces for convergence, but, as discussed above,countries’ cultural characteristics differ, and thesedifferences lead to divergence as they become incor-porated into a country’s corporate governance sys-tem.

We expect Russia’s unique culture and values toinfluence the country’s evolving corporate govern-ance system more strongly in the future. In the nearterm, Russia’s system will continue to look to inter-national models for the reasons stated earlier. As thecountry’s situation evolves, it will develop additionalinstitutions and structures like its Federal SecuritiesCommission to provide external constraints, or atleast guidelines, for companies to demonstrateresponsible corporate governance. Over time, thedirectives and guidelines of these institutions andstructures will likely reflect more of Russia’s uniquesituation, and will often be incorporated into Russianlaws. Additionally, company executives and direc-tors may well add their own voices to developinternal constraints and policies to their individualcorporate governance processes. As the content andprocesses of the country’s corporate governance sys-tem are tested by experience, both internal and exter-nal changes will undoubtedly be initiated. Given theexperience of other countries, we expect that these


changes will more and more reflect basic Russian cul-tural values.

As is evident from our discussion of three culturalcharacteristics, chosen from among many, there isstrong potential for such deep-seated cultural influ-ences to dilute and even undermine Russia’s corpor-ate governance efforts. This potential is also dis-cussed in a recent Russian publication (Shein andZhuplev, 2002). Negative practices would most likelyhappen in a time of uncertainty or problems, whencompany executives and directors, as well as publicofficials, might well revert to culturally ingrainedbehaviors. However, by understanding the potentialfor negative behaviors resulting from cultural influ-ences, stakeholders can take steps to not only preventsuch negative behaviors, but also encourage positivebehaviors, resulting in a stronger corporate govern-ance system.

Implications for Western Investors

What might both direct and indirect Western inves-tors expect if the country can develop a substantialsystem of corporate governance? The Russian stockmarket in 2001 produced returns among the highestin the world, yet the level of foreign investment hasremained low because of serious problems in Rus-sia’s corporate governance system, particularlyshareholder rights. The situation, however, has beenimproving somewhat, and the elements of thedeveloping system will initially be quite familiar toWestern investors. With political stability, the coun-try will likely continue to improve both the systemand its enforcement. Both are needed if Russia and itscompanies are to enjoy a promising economic future.Protection for shareholders will be critical to provideacceptable country risk for investors, particularlythose from the US and Germany, who have for a dec-ade been the major investors in Russia. An effectivesystem will be needed to attract the levels of directforeign investment the country requires to stimulateeconomic growth.

As Russia moves on the path toward responsible cor-porate governance, Western investors should watchthe progress and direction of developments. Mostimportantly, they should not necessarily expect thatcontinued refinements to the corporate governancesystem will mirror systems with which they are mostfamiliar. The evolving Russian system is likely toreflect increasingly the country’s cultural traditionsand values, some of which may cause changes thatmay not seem favorable to foreign investors. Stayingcurrent with the country’s corporate governance sys-tem will continue to be vitally important for makinginvestment decisions.


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McCarthy has numerous publications emphasizing ment in Russia, the former Soviet Union and EasternRussian management and was ranked as one of the Two Europe in a study of articles published from 1986 toTop Scholars in management in Russia, the former 2000 in 12 leading journals. Author of several books,Soviet Union and Eastern Europe in a study of articles her latest is the forthcoming, Corporate Governancepublished from 1986 to 2000 in 12 leading journals. A in Russia.forthcoming book is Corporate Governance in Rus-sia.


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corporate governance in russia:: towards a european, us, or russian model?

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