Cash Flow Diversion and Corporate Governance: Evidence from Russia

Abstract

Using a unique set of data that contains 236 million banking transactions of 1.7 million Russian firms over the 2003 to 2004 period, I examine the use of "spacemen", short-lived special purpose entities created for cash flow diversion purposes. I first estimate diversion in Russia to be 11.3% of GDP in 2003 and 13.1% of GDP in 2004, which corresponds to tax evasion of 4.6%-5.0% and 5.4%-5.8% of GDP, accordingly. Next, based on transfers to spacemen, I construct a direct measure of cash flow diversion for 180 public companies. I find that on average, firms divert 18% (2.6%) of their real profits (revenue) to spacemen per year, although large corporations evade 50%-70% less than small ones. Finally, I document that neither government ownership nor commonly advocated good corporate governance practices such as audit by a reputable accounting firm or the presence of a foreign director on the board help to curb diversion activities.

Keywords: diversion, private benefits of control, corporate governance

JEL Classification: F30, G30, M41