NCPA - National Center for Policy Analysis

From Communism To Kleptocracy

April 5, 2002

The rapid privatization of Russian state-own enterprises after the Soviet Union collapsed in the late 1980s was intended to boost efficiency by giving control to managers as soon as possible. But this "shock therapy" had very negative unintended consequences. The enterprises were taken over by "kleptocrats" who managed to enrich themselves at the expense of minority shareholders and workers using various fraudulent strategies.

  • In "voucher auctions," for instance, 60 percent to 65 percent, on average, of state enterprises were sold to managers and employees at low prices.
  • But many managers then used company funds to buy additional shares from workers and bribe state officials into selling them other firms at a fraction of their worth.
  • One method managers used to drain enterprises was to sell commodities like oil to middle-men at a fraction of their market value; when the oil was sold to third parties at market prices, the conspirators split the profits.

According to three former advisers to the Russian government, the lack of enforceable corporate governance laws was the key factor. They say privatization might have been more successful if it had been done in stages, with the creation of adequate institutional and legal framework preceding the actual turnover of management responsibilities and ownership.

Another researcher, Bernard Black of Stanford University, estimates that while the potential value of Russian firms is around $3 trillion, the actual market value is only $30 billion. This huge difference is mostly due to inadequate corporate governance.

Source: "Corporate Looting in Russia," Economic Intuition, Summer 2001; based on Bernard S. Black, Reiner Kraakman and Anna Tarassova, "Russian Privatization and Corporate Governance: What Went Wrong?" Stanford Law Review, June 2001, and Bernard S. Black, "The corporate governance behavior and market value of Russian firms," Emerging Markets Review, June 2001.

 

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