Dzarasov R. Eichnerian theory of the business enterprise in the case of Russian corporations
Ruslan Dzarasov
PhD, Senior Research Fellow,
Central Economics and MathematicsInstitute,
Russian Academy of Sciences, Moscow
EICHNERIAN THEORY OF THE BUSINESS ENTERPRISE IN THE CASE OF RUSSIAN CORPORATIONS
Buffalo State College
Heterodox Microeconomics Workshop
02 March 2012
Contents
1. The Conundrum of Russian Capitalism
2. The Eichnerian Megacorp
3. Russian Model of Corporate Governance
4. Insider Rent and Investment Behaviour
5. Insider Rent and Conditions of Growth
6. The War of Big Insiders: a Case-Study
7. Russian Capitalism as a Social System
REFERENCES
Dear colleagues,
The paper submitted to your consideration offers an alternative vision of the modern Russian capitalism from standpoint of corporate governance and investment behaviour of its big business. Significance of this topic can be seen from the fact that even in the 2000s despite the unprecedentedly favorable external conditions for economic development of Russia, investments of her companies appeared insufficient in scale and inferior in quality to secure modernization of the country’s productive apparatus, overcome the raw extracting bias of industrial structure, achieve sound international competitiveness and reasonable living standards. This determined the main aim of the paper – to identify the internal, institutional obstacles impeding sustainable, innovative growth of the national economy.
1. TheConundrumofRussianCapitalism
TheindependentexpertsdonotshareratheroptimisticpictureoftherobustgrowthofinvestmentsinRussia, providedby the official statistics. In 2007, at the very eve of the world crisis, the scrapped capital stock in Russia exceeded the grossinvestmentasaproportionoftotalcapitalstock by a factor of 2.24 (Khanin and Fomin, 2007, p. 46). Annual residualvalueofthefixedcapitalstockmeasuredin prices of renovation declined in the pre-crisis 2000sby 2.75% (ibid.).Somesurveysoftheenterprises’ managerstestifythatatthebeginningof 2010 42% ofrespondentsdidnotcarry out any investments at all (Kuvalin and Moiseyev, 2010b, p. 131). Qualitativeindicesofinvestmentsareofnolessimportance. Inthemiddleof 2009 only 20% ofthesurveyedenterprisesdidnotneed modernization of their productive capacities. Therestwereinneedofpartialorfull-scalerenovation of their fixed assets.Inthesameperiodonly 6% oftheenterprisesinquestionundertookinvestmentsallowing them to achieve sound modernization (Kuvalin and Moiseyev, 2010a, p. 151). ThemajorityofRussianenterprises(63%)purchasenewandmany (15%) – second-handequipmentproducedinRussia, both of which managers consider being of low quality in comparison with the imported counterparts (Kuvalin and Moiseyev, 2010b, p. 129-30).
Kornevprovidesacluetothisproblemdemonstratingthatengineering hasadjustedtodeclineofdemandforitsproductionsimplifyingtheproducedequipment, moving to more primitive technologies, supplying cheaper but less productive machines and so forth. SuchstrategyallowsRussianfirmstodiminishtheir investment costs (Kornev, 2005, p. 68). Accordingtosomestudiesthe ‘cheap’ variantsdemandtwo-threetimeslessexpendituresperunitofinvestmentfunds, thanthestrategies assuming new construction and expansion of productive capacities of Russian enterprises (Gladyshevsky A.et al., 2002, p. 16). InresultoftheinferiorinvestmentstrategiesofRussiancompaniesthe country’s fixed capital stock arrived at a miserable state.
According to Kornev and Lavrenev (2011, p. 67) the average longevity length of machines and equipment of industrial assets amounts to 21 year, while in 1990 (in the last, but not the best year of the Soviet Union) it was only 10.8 years. (Normative period of equipment renovation in the USSR was 12 years.) The share of equipment with life longevity less than 5 years in the production apparatus of the machine-tool construction is 3.5% of the total stock and in engineering as a whole – 14.5%, while the share of equipment of less than 10 years longevity – 5.2% and 18.5% accordingly (Borisov and Pochukayeva, 2011, p. 59).
Thus, it is an empirical fact that in twenty years of market reforms investments of Russian companies are insufficient neither to arrest the shrinking of the fixed capital stock, nor to stop its technological degeneration. The main conundrum of Russian capitalism is the following: why it prefers inferior investments to the detriment of innovations and modernization of the national economy?
2. The Eichnerian Megacorp
One of possible ways to find an answer to this question is comparative analysis of the institutional nature and investment behavior of Russian and US-American big business. From my standpoint the Megacorp model of US-American Post-Keynesian Alfred Eichner (1938-1988) has a great heuristic potential for such a study.
EichnerianMegacorpisthetypical, representativecorporationofUSmanufacturing sector in the so-called “Golden age of capitalism” (the late 1940s – early 1970s). Itsdefiningfeaturesare: (a) separationofownershipandcontrolthelatterfunctionresidingwiththe managers; (b) fixed coefficients of production; and (c) oligopolistic industry structure. EichnerbelievedthatseparationofownershipfrommanagementextendstheMegacorp’s time horizon in the long run, making her prime objective maximization of long-term growth rather than short-term profit. Thishappens, becausewelfareofmanagersdependsnotonthesizeofdividends, but on long-term market position of a firm, determining salaries and non-pecuniary privileges. AsaresultinvestmentstrategystartsunderlyingMegacorp’spricing. LetusconsiderFig. 1.[1]
Fig. 1. The demand for and the supply of investment funds of a Megacorp.
The vertical axis measures the implicit (internal) interest rate (R), external (bank) interest rate (i) and expected investment profitability (r). The horizontal axis – additional, internally generated funds accumulated in the pricing (planned) period (ΔF/p). The curve SI reflects the supply of investment funds function. Its ascending part corresponds to internal generation of funds in result of price increase, while the straight part – to external borrowing. The curve DIreflects the demand for investment funds.
Thismodelestablishesthelinkbetweeninvestmentsandpricing in the corporate sector. Price increaseincurssomelosses of expectedprofitduetomarketlimitationsonpriceincrease (customerscanmovetosubstitutes, competitorsmayenterthemarket, thestatemayintervene). Implicit interest rate (R) reflects the discounted value of these expected losses of profit per unit of additional funds obtained due to price increase. Thesupplyofinvestmentfundsfunction(SI)growswithpriceincreaseandthecorresponding implicit interest rate (R) increase. Whenthelatterequalsexplicitinterestrate (i),theMegacorpstopsinternal generation of funds and starts external borrowing. Thedemandforinvestmentfunds (DI) isaninvestmentprojects portfolio ordered according to diminishing expected profitability(r). OneofthemostimportantcharacteristicsofEichnerianmodelisthataccordingtoitwage rate, investment and pricing are determined simultaneously.
As was said above, Eichnerian model reflected the realities of the post-World War II “Golden Age of Capitalism.” In last three decades (the 1980s-2000s) financialization had led to significant changes in the fundamental processes which determine development of capitalism. Arrighi (2010) defined financialization as a particular type of accumulation of capital when profit is increasingly appropriated through investing money at financial markets, rather than in productive capacities. This can be seen at the corporate level. Lazonick and O’Sullivan (2000) show that while in the 1970s US corporations tended to reinvest profits in firms’ growth (Eichnerian Megacorp), in the next two decades they increasingly started downsizing their labor and distributing the retained earnings to shareholders. Krippner (2005) finds that the share of profits accruing to FIRE (finance, insurance and real estate) surpassed the share of manufacturing profits. Even more importantis the fact, that non-financial corporations themselves had sharply increased their investment in financial assets in this period. This is consistent with the results of Milberg and Winkler (2010) presented at the Fig. 2.
As can be seen from the figure,combinednet dividends and share buybacksas percentage of internally generated funds in the US non-farmnon-financial corporate business oscillated below 30% until 1980s, then suddenly going through the roof and nearly reaching absurd 160% in 2007. This undoubtedly reflectsthe radical change in the distribution of the relative stakeholder power from managers to shareholders. In correspondence with this Zorn (2004) acknowledges ascendancy of the Chief Financial Officer among the corporate top-managers in USA. According to the “inflation of the capital assets” approach (Toporowski, 2005, see especially ‘Introduction’) an inflow of speculative financial resources at securities markets put such a powerful upward pressure on share prices, that they had completely broke away from corporate profits and the real assets value. This affected corporate governance drastically deteriorating its quality. As a result managerial fraud became widespread as the cases of Enron, WorldCom and the like testify.
Fig. 2. Net dividends plus share buybacks as percentage of internal funds in the US non-farmnon-financial corporate business, 1960–2008.
Source: Milberg and Winkler, 2010, p. 288.
All this is consistent with Veblenian treatment of the capitalist firm as a dual phenomenon, contradictory unity of pecuniary and technical business logic (Veblen, 1978). Veblenian approach assumes, that if the two sides of a business enterprise are in balance, then a firm is a long-term growth maximizer (like the Eichnerian Megacorp), but if it is otherwise – a financier overwhelms an engineer. Such a perspective is very consistent with duality of labor approach to accumulation of capital expounded in Marxian Das Kapital. Indeed, it assumes that the prime aim of the capitalist production is value, use value being only a means to obtain the former (monetary production economy in Keynes’ parlance). From this and the idea of ‘commodity fetishism’ the theory of fictitious capital is derived. The latter represented by ‘paper wealth’ is only a shadow of the real (productive) capital, which can temporarily exceed its source creating a fetishist illusion. Thus, Marx anticipates financialization with its bubbles, tracing it to the very foundations of the capitalist economy. To be sure, Arrighi (2010) demonstrates that this phenomenon is a recurring event in the history of the world capitalism.
In the perspective of the above results, the Eichnerian notion of Megacorp-long term growth maximizer needs updating.While that may be true, I believe that the model in question is still appropriate for analyzing the institutional obstacles for growth in Russia, because it corresponds to realities of a growing corporate economy.
3. RussianModelofCorporateGovernance
The roots of the current Russian model of corporate governance can be traced to the Soviet system, which was formed by Stalinist degeneration of the Russian revolution. Trotsky considered the Soviet regime as only a transitional, i.e. preparatory for a transition from capitalism to socialism, and in this sense being neither the former, nor the latter. The bureaucracy being the prime distributer of material commodities is by definition a privileged stratum of such a society. Departing from the transitional nature of the USSR, being neither capitalism, nor socialism, but including elements of both in a contradictory blend, Trotsky hypothesized that in the absence of a new tide of workers revolution bureaucracy itself can overthrow the Soviet system to restore capitalism. In a masterstroke of historical materialism he had written: “Privileges have only half their worth, if they cannot be transmitted to one’s children. But the right of testament is inseparable from the right of property. It is not enough to be the director of a trust; it is necessary to be a stockholder. The victory of the bureaucracy in this decisive sphere would mean its conversion into a new possessing class. … In reality a backslide to capitalism is wholly possible” (Trotsky, 2004 (1936), pp. 191-192).
The rapid economic growth and cultural development of the Soviet Union in the 20th century produced radical changes in the social structure of society, making it more complex and potentially unstable, since it gave rise to diverse and often contradictory social interests. Lane (2011, p. 38) identifies two broad social groups which were destined to become the driving forces of the move from central planning to capitalism. The first is comprised of state functionaries controlling over economy, cultural life, law enforcement agencies and military apparatus. This he calls ‘administrative class.’ It is complemented by ‘acquisition class’ formed by individuals from intelligentsia with personal skills which can be profitably realized through markets. Large fractions of the both big social groups were increasingly dissatisfied with the egalitarian practices which prevailed in the Soviet society. One should note that behind the ostensibly monolithic façade of the USSR the private appropriation of incomes on the bases of state property was gradually increasing. It was carried out in forms of privileges and informal control over resources. Eventually, in course of Gorbachev’s reforms a powerful block of pro-capitalist social forces was formed, led by bureaucracy, which was destined to overthrow the Soviet system and change it to capitalism (Kotz and Weir, 2007,pp. 107-111).
After collapse of the Soviet system at the beginning of the 1990s this tendency stemming from rotting of Stalinist bureaucracy was greatly encouraged and supported by Western influence in general and by US-American advisorsof the reformist Yeltsin’s government in particular. Eventually informal control over the assets exercised by bureaucracy and ‘acquisition’ class was entrenched and legalized by privatization.[2] The rationale was provided by the notorious principles of Washington consensus which underlay Russian reforms. Originally it was devised to promote neoliberal agenda of economic reforms – cutting state expenditures, deregulation of the capital markets, price liberalization, privatization – for Latin American countries. Scholars of the Washington consensus see it more as a vehicle of globalization than as a way to achieve sustainable growth and development (Serra, Spiegel, and Stiglitz 2008, p. 6). They note that the consensus “called for opening of countries to the outside world. As a result, the fortunes of developing countries have increasingly depended on what happens outside their boundaries” (ibid.).Russian ‘shock therapy’ was only a slavish replica of the abovementioned principles. Privatization was a pivotal element of reforms.
Privileges of bureaucracy and its informal control over resources, being strengthened by Gorbachev’s and legalized by Yeltsin’s reforms, became the prime preconditions of the Russian model of corporate governance.
Literature on corporate governance in modern Russia widely acknowledges that in this country it is impossible to implement the formal property rights if they are not backed by informal control over assets (Papper, 2002a, 2002b; Dolgopyatova, 2005;Ustyuzhanina et al., 2010).Ownership can generate revenue only if it gives“control over the cash-flows of an enterprise” (Dolgopyatova, 2005, p. 4).Studies of the internal control in Russian corporations show that ownership concentration became the salient feature of the Russian model of corporate governance, since the dominant shareholder either himself occupies the top-managerial position, or strictly monitors activities of the latter (Abe et al., 2007). Individuals who influence corporate governance are often referred to in literature as ‘insiders.’ I call ‘big insiders’ such stakeholders who control the key decision-making, especially concerning the firm’s finance, and outsiders – those, who are deprived of contributing to these decisions.Introduction of the new term is conditioned by the fact that members of a dominant group in a Russian corporation formally may not be its owners, if it is a state enterprise or if they exercise their control through proxies.
The defining feature of the Russian model of corporate governance is the reliance of big insiders on the infrastructure of control over enterprises. The former is a set of sometimes formal, but predominantly informal institutions securing personal control of the dominant group (big insiders) over the assets. One may distinguish between its external and internal elements (Fig. 3).
Fig. 3. Infrastructure of Insider Control over Assets
Source: Ruslan Dzarasov, Insider Control and Investment Behaviour of Russian Corporations. PhD Thesis in Economics, Stoke-on-Trent, UK, 2007, p. 78.
The external elements embrace: the sophisticated scheme of assets ownership through chains of offshore firms (‘offshore cloud’ in Papper’s parlance); connections with corrupted state functionaries and so-called ‘roofs’ or informal protection provided by the law enforcement agencies, private security agencies and criminal structures. The prime objective of the external elements of infrastructure of control – protection of the dominant position of big insiders from trespasses of their rivals. The internal elements of infrastructure of control are comprised of: high centralization of the managerial decision-making process greatly exceeding the standards of the developed countries; inflated controlling and monitoring departments; internal security departments. The prime objective of these institutions is to suppress opportunism of the hired labor and workers protest; and to secure a solid control of big insiders over the firms’ financial flows.
Infrastructure of control of big insiders reflects specifics of the Russian model of corporate governance characterized by inseparability or fusion of ownership and control (contrary to Eichnerian Megacorp). Infrastructure of control is a kit of tools securing subsumption of hired labor under capital by force. Hence, Russian big business is characterized by reliance on extra-economic coercion.
Primarily informal character of control over assets in Russia engenders fundamental instability of the dominant position of big insiders. To be sure, informal ‘property rights’ cannot be legalized and bequeathed to inheritors, but they always can be challenged. Waves of redistribution of the ‘property rights’ regularly sweep over the Russian economy. Their prime instrument is hostile takeovers, including wide application of raiding or qwasi-nationalisation (according to Ustyuzhanina’s expression). The great majority of these takeovers are hostile in nature, and are carried out with the help of coercion from state organs or involve criminal violence. From the 1990s, corporate raiding became a distinct sector of the national economy, with its own market for services and an enormous annual capital turnover.[3] Those who are threatened by hostile takeovers are above all big insiders who have not created an infrastructure of control powerful enough to defend their dominant positions. This means that ownership and control in Russian business are fundamentally unstable.Instability of the big insiders’ position conditions short-termism of their time horizon.
This short-termism, in turn, determines the dominant type of income most common in Russian business. It can be defined as insider rent, i.e. an income appropriated by big insiders due to their control over the firm’s financial flows. Insider rent can thus be measured asFree Cash Flow (FCF), minus various forms of interest payments on loans and also dividends paid to non-controlling shareholders. As a rule, the mechanism for obtaining rent involves figure-head trading companies registered in offshore sites. Big insiders sell the products of the companies they control to the trading houses, which they also control, at less than market prices. The proceeds from the subsequent resale of goods under market conditions finish up in private accounts which the large insiders hold in the offshore sites. Another, no less popular method of extracting rent has the big insiders setting up their own firms for the supplying of raw materials. In this case, shipments to businesses under the insiders’ control are made at elevated prices. Or, fly-by-night firms may be used to provide expensive fictitious services, rental of premises or equipment, and so forth.
Insider rent should be distinguished from the profit of the Eichnerian Megacorp which depends on the excess of proceeds over outlays. By contrast, big insiders in Russia deriveincome from their control over the financial flows of enterprises. Insider rent can be extracted at the expense both of the sources of profit and of some articles of costs. It can be augmented through cutting of the wages of workers and salaries of managers, reducing investments, appropriating depreciation fund, abstaining from paying for deliveries, squandering loans and so on. A firm may run at a loss, but continue to enrich the dominant group.Obviously, insider rent is appropriation of the results of unpaid labor and, hence, expresses the relations of exploitation of hired labor.