The Vicious Circles of Control: Regional Governments and Insiders in Privatized Russian Enterprises

24 Pages Posted: 6 Mar 2000

See all articles by Raj M. Desai

Raj M. Desai

Georgetown University - Edmund A. Walsh School of Foreign Service (SFS); The Brookings Institution

Itzhak Goldberg

CASE - Center for Social and Economic Research; Fraunhofer Center for Central and Eastern Europe

Date Written: February 2000

Abstract

In Russia and other transition economies that have implemented voucher privatization programs, how can one account for the puzzling behavior of insider-managers who, in stripping assets from the very firms they own, appear to be stealing from one pocket to fill the other?

How can one account for the puzzling behavior of insider-managers who, in stripping assets from the very firms they own, appear to be stealing from one pocket to fill the other?

Desai and Goldberg suggest that such asset-stripping and failure to restructure are the consequences of interactions between insiders (manager-owners) and regional governments in a particular property rights regime. In this regime, the ability to realize value is limited by uncertainty and illiquidity, so managers have little incentive to increase value. As the central institutions that rule Russia have ceded their powers to the regions, regional governments have imposed various distortions on enterprises to protect local employment.

Prospective outsider-investors doubt they can acquire the control rights they need for restructuring firms and doubt they can avoid the distortions regional governments impose on the firms in which they might invest. The result: little restructuring and little new investment. And regional governments, knowing the firms' taxable cash flows will have been reduced through cash flow diversion, have responded by collecting revenues in kind.

To disentangle these vicious circles of control, Desai and Goldberg propose a pilot for transforming ownership in insider-dominated firms through a system of simultaneous tax-debt-for-equity conversion and resale through competitive auctions.

The objective: to show regional governments, by example, that a more sustainable way to protect employment is to give managers incentives to increase enterprises' value by transferring effective control to investors.

The proposed mechanism would provide cash benefits to insiders who agree to sell control to outside investors. The increased cash revenue (rather than in-kind or money surrogates) would enable regional governments to finance safety nets for the unemployed and to promote other regional initiatives.

This paper - a product of the Private and Financial Sectors Development Unit, Europe and Central Asia Region - is part of a larger effort in the region to address growth, governance, and poverty in the former Soviet Union. The authors may be contacted at desair@gunet.georgetown.edu or igoldberg@worldbank.org.

JEL Classification: G34, P21

Suggested Citation

Desai, Raj M. and Goldberg, Itzhak, The Vicious Circles of Control: Regional Governments and Insiders in Privatized Russian Enterprises (February 2000). Available at SSRN: https://ssrn.com/abstract=190570

Raj M. Desai (Contact Author)

Georgetown University - Edmund A. Walsh School of Foreign Service (SFS) ( email )

Washington, DC 20057
United States

The Brookings Institution ( email )

1775 Massachusetts Ave., NW
Washington, DC 20036
United States

Itzhak Goldberg

CASE - Center for Social and Economic Research ( email )

Al. Jana Pawła II 61/212
Warsaw, 01-031
Poland

Fraunhofer Center for Central and Eastern Europe ( email )

Germany

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