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. Last Updated: 07/27/2016

Firms Need More Than Just a Code

The Cabinet has asked the Federal Securities Commission to compile a corporate governance code and to take steps toward implementing it by March. The code will only be a small step toward forming effective businesses in this country.

Don’t believe the myth that corporations are governed like investor democracies. Corporations are run by managers who have usually negotiated away some of their powers of control in return for capital. The myth goes back to the days of sailing ships when merchants would get together to share the risk of a dangerous voyage, and vote for a board of directors that would appoint a manager — a sea captain — for the venture. Shares of the votes and profits were divided according to the amount of capital or labor invested.

Nowadays, instead of the shareholders forming a board of directors that hires management, it is the other way around. Future managers hire the necessary directors and give them some power in order to borrow from banks, raise venture capital or sell shares. Usually firms go through stages of financing where managers negotiate away some of their control at each stage. Despite its mythical democracy, the corporate form thrives in the West because of the enforceable laws that have grown up around it and its effectiveness in raising capital.

The new corporate governance code in Russia will help raise capital only after other institutions are in place. A banking system needs to be able to make loans to small businesses. Venture capitalists need to provide both know-how and capital to high-tech firms. A domestic market in newly issued shares is needed for medium-sized firms. Without these institutions, only very large firms are able to raise capital abroad. Often these firms have no experience in exchanging control for capital.

Well-governed corporations are so rare here because of the lack of clear and enforceable laws. Corporate governance in this country is based on personal relationships with bureaucrats — inviting corruption and nontransparent regulation. Small and medium-sized businesses cannot survive unless they have a relationship with some low- or medium-level bureaucrat because almost every business activity violates some regulation. Large businesses cannot survive without a relationship with a high-level member of the government.

In this environment outside shareholders have little chance of getting a fair return even with a well- written corporate code. Corporations that publish all the information needed for investors to monitor managers are only letting bureaucrats know how much they can be squeezed. Managers who treat shareholders fairly are likely to have them take over the firm in unfair administrative or court proceedings.

The need for secrecy from bureaucrats means that the most effective form of business organization would be single-owner firms financed by bank loans, if there were real banks. The next most efficient system may be a robber-baron oligarchy — large single-owner firms financed by the government. Western-style corporations will be limited to a few rapidly growing sectors that need more capital than the government can provide, and even then only to firms that figure out how to keep the bureaucrats at bay.

As business conditions evolve, the different forms of business will also evolve. The corporate governance code is part of this evolution. A very small part.

Peter Ekman is a financial educator based in Moscow. He welcomes e-mail.