A desire to raise capital abroad is forcing Russian firms to improve corporate governance levels, says Alex Foreman-Peck.
Lack of good corporate governance is a problem worldwide for investors, but the risks in Russia are very different from those experienced in the US and Europe post-Enron.
While in the US, accounts were manipulated to boost share prices in order that executives could cash in their stock options, such accounting manipulation in Russia is unheard of. The Russian Accounting Standards (RAS) are not representative of a company's performance in the same way as US Generally Accepted Accounting Principles (GAAP) and are therefore divorced from share price behaviour. Manipulation to boost profits would not be credible and the share price would be unlikely to be affected. Companies are far more likely to use the RAS to understate their profits to reduce their heavy tax burden.
While this may save investors money, it deprives the government of revenue to provide public services to employees and domestic shareholders – hardly good corporate "citizenship" which is integral to good governance. One also has to remember understated profits will lead to smaller dividends, and without an increased share price, investors will suffer.
Governance standards
Small wonder that today the emphasis in Russia is very much on governance standards and this month The Banker publishes a chart (overleaf), drawn from Troika Dialog research, listing leading Russian corporates according to governance standards.
Loose accounting standards are not necessarily a problem if companies are audited professionally and with rigor. However this is often not the case in Russia. While the Ministry of Finance is now sole supervisor of the audit industry, it is estimated that only 40% of audit firms follow a clear set of audit procedures and nothing has been done as yet to prevent "single client" firms who are so dependent on one large client that their independence must be questioned. Nearly 10% of the RAS audit market is run by "single client" firms – the firm with the largest market share within this has Surgutneftegaz (ranked 27 in our table) to thank for this.
Using auditors for consultancy services and the use of off-balance sheet liabilities is common practice in Russia as in the US. While stock options are not, they can be simulated by "phantom shares" to circumnavigate legislation. Loans to directors are unheard of, partly because a director's remuneration is large and confidential. Recently LUKoil, (ranked nine) in a run up to an aborted American Depositary Receipt (ADR) placement, revealed its CEO's annual salary to be $1.5m, while the newly elected non-executive directors would be paid nothing.
In fact the strongest driver for reform of Russian governance has not been the state regulatory system, but the market itself. In a desire to raise capital abroad, firms are switching to International Accounting Standards (IAS). A total of 39 of the top 57 companies now use IAS, 33 of which have ADRs outstanding. Ten new firms switched to these or GAAP standards in the 2001 reporting year (Bashinformsvyaz ranked 23, Lenenergo ranked two, Magnitogorsk Metal ranked 35, to mention a few).
Additionally, large firms seeking listings abroad (YUKOS ranked four and LUKoil ranked nine) are revealing their beneficiary owners, who normally would hide behind nominees.
Securing foreign ownership may encourage transparency and greater financial discipline, but is still open to abuse. Many ADR holders do not realise they have voting rights and so do not ask their custodian to exercise them. Russian directors often have an agreement with the custodians that they may use unexercised votes themselves – known as "discretionary voting". They can therefore push through proposals that may not be in the best interests of shareholders.
Future's bright
Despite all this it seems that corporate governance has improved in Russia and is likely to improve in the future. There has been more shareholder representation on boards of directors such as Central Telecom (ranked 10) and Lenenergo (ranked 2). Charters have been revised to give independent non-executives approval over major decisions, as in the case of Norilsk Nickel (ranked 44), or limit the CEO's powers to approve deals in the company's assets, as in the case of Aeroflot (ranked 25).