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The Hermitage Fund Media and Corporate Governance in Russia Case Solution
After the privatization and loan for share schemes by Russian government, managers and oligarchs acquired the control and enriched themselves. Russia did not have effective governance institutions, and there exist a need for effective accounting rules and regulations, and enforcement of these laws by the regulatory authorities. Hermitage Fund in Russia used an effective strategy of investing by focusing on the undervalued companies with corporate governance problems. Using an activism strategy, it limited the management’s miss-governance and hence stock prices increased. Such activism was responded by the active responses through the press and lawsuits. But it positively affected the governance decisions. Stock prices increased, and it benefitted the investors. New laws were introduced which benefited the companies and the country as a whole.
Following questions are answered in this case study solution
What are the various ways in which managers in Russia extract value out of their companies disproportionate to their equity stakes? Which of these methods seem to be peculiar to the Russian environment?
What institutions and mechanisms are normally important in decisions by insiders to divert resources and which of these are ineffective in Russia?
What is Browder’s strategy? How does this differ from traditional investing? Do you agree with Browder’s contention that media attention limit corporate governance abuses (in Russia, elsewhere)? How does the medium affect governance decisions?
As an investor in the Hermitage Fund, what would you advise Bill Browder do in Summer 2002?
What stands in the way of shareholder activism of this type more generally for investment funds? Is such activism good for fund investors? Is it good for the country?
Case Analysis for The Hermitage Fund Media and Corporate Governance in Russia
1. What are the various ways in which managers in Russia extract value out of their companies disproportionate to their equity stakes? Which of these methods seem to be peculiar to the Russian environment?
Macroeconomic policies and reforms related to the privatization of the firms caused many problems related to corporate governance. Workers and managers were able to buy shares through vouchers auction. Managers and individuals who came to the power neglected the regulations and controls by the government. Earlier, strategic industries of oil, gas and minerals deposits were not privatized but later on in 1995, they were also sold through loans for shares privatization. Government acquired loans from the banks and held the shares as collateral which lead to the increased control and presence of the oligarchs and financial leaders in the companies.
Managers acquired control through privatization and took advantage of the powerful position to enrich themselves. Laws and regulations were not followed by these managers and they took decisions without involving the minority shareholders. Shares were diluted without the knowledge and consent of the other shareholders. According to Exhibit 9, other issues were reported related to the asset stripping in case of sales of subsidiaries, capital expenditures and dilution of shares of subsidiaries. There was unequal treatment of the shareholders related to the financial information and corporate events. Related party transactions and other problems were present which indicate the weak accounting standards and the regulation structure in Russia. In Russia, as institutions like company laws, accounting rules and regulations were slow to develop; these managers took advantage of the lack of corporate government structure. They manipulated the judges and ignored the legal judgments. Hence overall, the companies in the Russia were facing issues related to the governance structure and were causing problems for the Russian economy.
2. What institutions and mechanisms are normally important in decisions by insiders to divert resources and which of these are ineffective in Russia?
Well-functioning corporate governance institutions are very important, and these institutions address the issues between investor of resources and insiders controlling these resources. Company laws, accounting standards, rules and regulations, financial intermediaries provide an effective corporate governance structure. Accounting standards and rules are very important to address issues related to the decision by insiders including related party transactions, asset stripping, profit skimming, and dilution of shares and provision of information to the shareholders. Hence, such rules and their effective enforcement by institutions like Securities and Exchange Commission’s and judicial systems create transparent governance systems where insiders are not allowed to enrich themselves and to divert the resources for their own benefit.
In Russia, these institutions were not very well developed. Securities and Exchange Commission did not have the ability to enforce the laws and rulings while judicial system was also very corrupt. In Russia, some laws were introduced but they were quite weak, and companies opted out of the standard shareholder protections. Russian accountings Standards also have some problems as these rules did not address the needs of financial investors. As the insiders had majority stakes in the organizations, governance mechanism weakened. These individuals and groups changed the Company charters, and board due to their votes. Laws and rules did not address this issue; minority shareholders were not informed about the decisions and their shares were diluted without their consent. In Russia, an overall governance system was not functioning because of the weak laws and effective enforcement.
3. What is Browder’s strategy? How does this differ from traditional investing? Do you agree with Browder’s contention that media attention limit corporate governance abuses (in Russia, elsewhere)? How do the media affect governance decisions?
Browder’s strategy is focused on corporate governance and shareholder activism. He buys the position in companies which are undervalued and have corporate governance problems and then he launches his own corporate governance initiatives to unlock the intrinsic value of the company. He limits the management’s ability to enrich themselves through effective activism strategy. Traditional investing is based on skills and effective decision makings in stock picking and then waiting for changes in the market and company.
Media Attention certainly limits the corporate governance abuses, and it helps in the new legislations to solve the issues related to the corporate governance. With stories in the newspapers, companies have to consider the issues and to improve their corporate governance as the regulators and board members are informed about the problems. Oligarchs in Russia were not concerned about their image in the country, but as they sought acceptance in the international community, they had to care about their image and reputation. International press coverage now could force these people and companies to focus on the governance decisions. Communication through media was quite effective which lead to the organization of the shareholders and created a pressure for changing the systems and laws. Even in cases where Browder’s could not win the lawsuits, but the international media coverage increased awareness and steps were taken for better governance decisions.
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