The authors thank
Prof. John Eichenseher, Prof. Terry Warfield, Prof. Mark Covaleski,
University of Wisconsin -
Madison for the valuable comments on this paper.
INTRODUCTION.
The current economic transformation of the former Soviet economy is qualitatively different from other historical or current examples of major changes in the structure of economic institutions. The initial conditions, the scope and desired speed of the undertaking, and the initial passiveness of the general population all distinguish this process from economic change elsewhere.
The Russian privatization program so far has been considered as the focal point of the transition to the market. It has challenged the former organization of property rights and has been viewed as the government's most effective tool for implementing radical economic reform. Unfortunately, the privatization program did not fully account for its actual effects for microeconomic characteristics and parameters due to the desire to make it fast and irreversible. Following the logic of a command economy, it was assumed that a well-developed deterministic approach (where full credit was given to the market as the sole economic regulator) would bring immediate positive changes in the economy. This approach was not successful because the starting point was quite distinguishable from the situation in which a market can regulate the state without any purposive intervention. Moreover, the underdeveloped market forces have been growing mature based on a system inherited from the Soviet era which relies on a vertically integrated organization of production. This system does not suit the market. Despite the formal economic changes, the market today is still far from being fully developed.
It depends on numerous objective factors related to the traditional branch structure of the Russian economy, commodity availability, lack of competition, geography of the state, heavy dependence on the raw material extraction industry, and the distinctive socioeconomic situation in Russia.
Privatization aimed the major economic changes in the Russian economy such as the evolution of the ownership, the decentralization of the governance functions, and the formation of a new control mechanism. It has changed the power claim relations by converting state owned and managed enterprises into joint stock companies. In this context, we were able to identify several problems related to changes in ownership and governance. First, the control system is essentially new and managers face greater freedom in decision making. The problem here is due to the fact that the new managers' functions are largely filled by individuals trained to work in the realities of the command economy, a situation which often precludes the enterprises' active adaptation to the market environment. Therefore, the issue of the managers' attitudes toward privatization and ownership redistribution, as well as their influence on the firm's behavior became immediately important.
Second, the changes in the firms' ownership in combination with an insufficient framework of corporate law had facilitated entrenchment by the management of the former state enterprises and had enabled them to reinforce their position in the corporation. Under such circumstances managers became the key players of the transition process. Yet, because the initial design of privatization did not account for this situation, today we can witness the collision of interests between the managers who are trying to survive and remain on the top of the situation and the government which is displaying the desire to speed up the transformation process. Therefore, an analysis of the managers' influence on the ownership structure and corporate governance of Russian enterprises after privatization is providing a crucial piece of knowledge, which can never be considered as complete. The managers' behavior is investigated in terms of its influence on the formation of the enterprises' main objectives and strategies.
In at least two ways this study distinguishes itself from many other studies on privatization, corporate ownership and governance in successor states. (Kokh, 1998, Blasi, 1996, Aslund, 1995, Sachs, 1995, Bergstrom, 1995, Vasiliev, 1994, Abalkin, 1993, etc.) First, this study does not consider the presence of outsiders in an ownership structure as the effective devise, which can change managers' behavior. It does not follow the common wisdom among scholars that the reason for the poor performance of the Russian enterprises is the failure of outside owners to gain a foothold in privatized Russian firms. This paper is more an attempt to proclaim that corporate behavior will not necessarily vary with changes in the structure of corporate ownership in transition economies, due to the specific socio-economic environment and peculiar characteristics of the relationship between inside and outside owners. The rationality of Russian managers' behavior will be examined in light of the "agency problem" which is the result of conflicting interests among the various parties such as managers, employees, capital contributors, suppliers and buyers (adjacent firms), and government officials that influence corporate behavior. Second, to explore managers' behavior we took an historical perspective and used theories developed in the United States fifty and more years ago. The main reason for this strategy is our belief in the regularity of socioeconomic processes, even though they take place in different countries and distant in time. In the late 1920's the American economy experienced the development of new business institutions such as multiunit enterprises administered by sets of salaried managers. Economists at the time witnessed the ways in which managers wrested control from other groups of stockholders and used resources in contradiction with the stockholders' interests. The similarities in both past American and current Russian experiences support the legitimacy of this approach.
The paper consists of seven sections. Sections one and two provide the reader with the background for the issues addressed. They include a brief overview of the privatization process and the phenomenon of managers' power in Russia in some detail. Section three characterizes the sample. Section four describes the economy, industry and region related factors that affect the ownership structure. Section five explores the influence of the managers' behavior on the formation of the firms' strategies. In particular, it analyzes both the managers' attitude toward control and ownership redistribution and the ways in which managers affect the firms' behavior by adopting various modes of action. Section six deals with the peculiarities of outside ownership by discussing beneficial interest owners and state ownership. Section seven provides conclusions on the addressed issues.
The Russian economy in its present state is an imperfect and inefficient market. It is imperfect because of the high degree of monopolization and inefficient because of the lack of development of the infrastructure (banks, investment funds, etc.), the underdeveloped entrepreneurial culture, the impossibility of information flow, and a very approximate reaction of market agents to the changing conditions of commercial activity.
The socioeconomic system has an enormous amount of inertia. The economy is still a conglomerate of state capitalism, deformed socialism, extra-economic compulsion, and very specific private property relations, which have grown out of black market relations and the privatization process. Moreover, it is not a mixed economy, but something very specific, because all named components are present in almost every economic entity. Therefore, the rational economic agent and the atmosphere for rational decision-making have quite different characteristics from what Western scholars are accustomed to.
In such a setting, the reform of property rights in Russia became an important element in the transition from an administrative to a market economy. Privatization aimed to "rationalize"
the use of resources and the size of the enterprise (huge conglomerates were to be broken into several entities), thereby maximizing the overall productive capacity of the economy.
Unfortunately, in the process of formulating a privatization policy, the social reference points were not included in the initial aims and the various interests of different social groups were not defined. There was no pilot study done on the managers' attitudes toward privatization prior to its formulation, the draft of Privatization Law was not properly discussed publicly. Thus, the government in the process of formulating privatization policy did very little to define the social interest groups that would serve as the socio-political base. Many problems later on stemmed from the fact that the government did not fully account for the interests of two very powerful social forces: the management of state enterprises and the new entrepreneurs.
At first, the process of privatization was supposed to separate management from ownership to expose managers to the discipline of markets. Presidential Decree "On Organization Measures To Transform State Enterprises and Voluntary Associations Of State Enterprises Into Joint Stock Companies" from July 1, 1992 initially prohibited privatization in the form of closed joint stock companies and was supposed to force enterprises to accept outside ownership. Later on, changes in the law allowed the privatization in the form of closed joint stock companies (Appendix 1). Those changes caused a high level of inside ownership in Russian companies, which further hindered the outside owners' already poor control abilities. (Zaostrovtsev, 1994)
The Russian privatization program was based on voucher distribution, and the "labor
collectives" (managers and workers) became the main owners of the enterprises for which they had been working ( Kokh, 1998, Aslund, 1995, Sachs, 1995, Chubais & Vishnevkaya, 1994). The whole process therefore turned into the privatization of insiders and the managers retain the power over the enterprise. So, it is very important to understand that the level of the managers' ownership does not really reflect an accurate picture of their control capabilities, because managers have rigid control over the workers' ownership and can also heavily influence certain groups of outsiders. The managers' privilege to exercise the power inherited from past economic relationships seems important enough to be analyzed in detail.
2.THE OVERVIEW OF MANAGERS'POWER.
Even though the ideology of management is undergoing significant changes in Russia, managers can still keep their power and control their firms. What is the justification for the managers' superiority and the workers' obedience in Russia? Currently managers can keep their power, to a large extent simply by virtue of their positions. Their power is legitimized by the workers and the key role executives are supposed to play is to inculcate in them the main purpose of an organization - surviving. So far, employees have been predominantly cooperative in Russian firms. They have a common goal: to get through the transition with the least loss possible. This goal results from the hardship of the economic environment and cannot be achieved without cooperative endeavors. But even though the goal of surviving is common for all participants of a firm, different groups of owners have divergent interests and priorities. Thus, there are different forces within an organization, which are generated by different groups acting in concert to achieve a common goal (Cyert & March, 1992). The best people to lead the process are managers, due to their specific position within the firm in relation to the intellectual and institutional powers. Managers set the firms' objectives, using propaganda and indoctrination to make their aims understandable and acceptable to all employees. Ultimately, by influencing the workers -stockholders' power, managers attempt through the solid goal of surviving to create the illusion of a community.
Thus, the problem of human relations in an authoritarian setting of hierarchical organization becomes immediately important. Russian managers, for the most part, do not include workers within their purview and workers are considered simply another source of production (Berle & Means, 1933) for several reasons. First, workers do not oppose the managers' power. Second, workers do not force themselves on the management's consciousness by developing unions. Third, there is no scarcity of labor. Forth, the unstable economic environment gives managers the ability to justify the "privilege of voluntary action and association for themselves, while imposing upon all subordinates the duty of obedience." (Bendrix, 1956, Barzel, 1989). Therefore, the socioeconomic condition so far seems favorable for managers to keep their power over the workers' will, and managers remain in a powerful position relative to corporate control.
On a micro-level, Russian enterprises exhibit a peculiar social alliance. Because of Soviet inheritance, Russian enterprises have a specific "director-employees" relationship. It is mostly authoritarian (as opposed to the democratic), production centered, and concerned with bureaucratic rules. Yet top management always wants to appear as the protector and benefactor
of employees. Although the new economic rules destroyed the old maxims, the traditional managers' behavior, attributable to the Soviet era, remains prevalent. For example, even though there is no lack of available labor on the market, nor restrictions on recruiting or layoffs, but preservation of the labor force remains the key priority among the managers' activities. With the significant decrease in industry output (about 50%), Russia since 1992 has not experienced mass unemployment. It is commonly known that managers have found some very specific ways to avoid layoffs such as part time work, long delays with the paychecks, payroll payments made in units of output, etc.
The explanation for these phenomena may lie in Knight's (1921) analysis of the distribution of risk among cooperative parties within the firm. He sees the process of redistributing risk between owners-managers and employees as the main rationale of a firm's existence. The profit and loss consequences of fluctuations in business outcomes are absorbed by the owners-managers, who contract to pay relatively stable wages to employees. Employees are thus at least partially insulated from those fluctuations, and the greater proportion of risk is reallocated to the party that more willing to bear it. In return, the owners-managers require employees to allow their activities within the firm to be supervised. To accept this supervision, employees require relatively fixed contracts, which are in a sense insurance that attenuates risk. Therefore, the whole logic should be interpreted as reduction in risk cost through risk reallocation rather than risk redistribution.
For the Russian situation, Knight's rationalization makes sense because the employees view the paternalistic role of the management as a way to reduce risk rather than merely redistributing it. Reduction of risk is obviously in the interest of owners-managers, given that
they have taken on a large share of the risk inherent in business transactions. (Demsetz, 1995)
The study suggests that the most evident paternalistic approaches to the organization of production can be observed in places where managers have failed to find new strategies to survive and still rely on old methods. The working collectives in these settings usually remain under the heavy influence of managers, and represent the long-term basis for the managers' control over the economic entities. Thus, the inheritance of the managers' functions is preserved. Those functions include mediating and defending of the enterprises' interests and establishing connections with bureaucratic administration. In this sense, the managers' control is taken as that which ensures stability and smooth business relations. Thus, the body of managers formed in the past remains the crucial participant in the ownership distribution and control process. The managers are elite employees with their own set of interests and unique capabilities, which enable them to find the solutions to peculiar problems.
Another reason that they are able to keep their power is that workers in Russia are trained to accept "wage slavery" (Perrow, 1986). Most of them never attempt to go into business and become self-employed. The idea of working for somebody else without any discretion regarding the job is still dominant. Therefore, already existing perceptions made possible the existence of managers' superiority.
While the managers' ability to control is contingent on their relatively powerful position, the precondition for the concentration of the ownership resides in the peculiar economic situation. Russian firms operate in a market characterized by a high level of political and
economic instability. So, as the theory suggests (Demsetz & Lehn, 1985), managerial performance in Russia can be monitored only at very high cost. The unpredictable and unstable environment requires timely managerial decisions concerning redeployment of corporate assets and personnel. In addition, it is necessary to run a company using extraordinary approaches (informal relationships, barter, etc.), which gives additional privileges to managers and contributes to an information asymmetry between managers and stockholders. Thus, a firm's control potential is directly associated with the noisiness of the environment in which it operates and this environment gives rise to a more concentrated ownership structure. Russian voucher privatization facilitated this process further. The concentration of the ownership by insiders, accompanied by the managers' powerful position, leads to the managers' near complete control over the enterprises. Managers by themselves are aware of the importance of this control, and they intend to figure out all possible ways to maintain the status quo.
Basically, they use three approaches to gain and keep corporate control: 1) they use their charismatic leadership and current paternalistic power in order to strengthen their position; 2) they redeem stock from the workers (3 1 % of the sampled managers have already redeemed stocks from the workers, and 38% of them are planning to do the same in a short run future); and 3) they represent workers-stockholders in decision making processes. It is especially important for managers when the portion of outside ownership is large enough so that they cannot fully exercise their power. In this case they use the workers-stockholders' voting power in order to outweigh the voting capabilities of outsiders.
Along with these tactics, managers have designed a peculiar way to preserve their control over the enterprises. They prevent the undesirable redistribution of the ownership by creating
internal trust funds. According to the internal rule (usually launched by the board of directors) workers-stockholders are supposed to put their stocks in the trust fund, with no rights to redeem or withhold stocks from it. Commonly those funds give their voting proxies to the managers. The managers' right to control and keep their authority is unquestioned by workers in most cases.
The study was done on the basis of questionnaires distributed in 1996 to the CEO's of Russian firms and uses ownership structure data available on the sample firms. The questionnaires were designed and administered by native Russian speakers and then both the responses and questionnaires were translated into English for the purposes of this research. Data were collected in four geographical areas (oblast) of the Russian Federation: Moscow (M), St. Petersburg (SP), Nizhnii Novgorod (NN), and Ural (U) regions. The choice of the geographical areas was predetermined by three different factors. First, substantial blocks of within-region observations were sought due to the claim that the activities of regional administrations coupled
with increased transport costs serve to break up the national market into a series of regional markets with regional differentiation in costs, performance, behavior, etc. (Mau & Stupin, 1997, Kirkow, 1997, Hanson, 1997). Second, predominantly industrial, as opposed to agricultural areas, were chosen. And third, regions containing various industries rather then one predominant industry were chosen. The desire to study multi-industrial regions was based on the assumption that the process of firms’ adaptation to market conditions varies across industries. The population from which the sample was drawn is based on a list of all privatized firms provided by the Oblast (Region) Property Funds. In each region the list for the Mass Privatization Program (MPP) was obtained with full information as to the names of firms, their managers, their addresses, and partial information as to firms’ sectors and number of employees.
To be included in the sample, firms had to meet the following selection criteria: 1) They must belong to manufacturing or extraction industries. 2) They had to be either companies privatized under the State Privatization Program or Privatized Leasehold Companies (PLC), newly created companies cannot be included. 3) Firms with fewer than 500 workers were excluded from the sample. 4) They had to be finished with the privatization process at least six month prior to the survey. The latter requirement is due to the fact that data collected close to the time of privatization point is likely to contain little sign of change in firm behavior due to privatization. The six-month period should be long enough for managers to choose their specific mode of adaptive behavior. Ownership structure and the variant of privatization data (1995-1996) were drawn from the privatization papers available on the enterprises. These criteria initially yielded 350 enterprises in total and the number of enterprises for each geographical area was approximately the same. The final sample consists of 312 firms, due to response rate of 89% from twelve different industries.
EXHIBIT 1. The sample structure by industries, (%).
Industries |
#of the firms |
% |
Fuel (F) |
8 |
2.6 |
Consumer goods (CG) |
50 |
16.9 |
Timber (T) |
13 |
4.2 |
Machinery & metal production (MP) |
115 |
36.0 |
Chemical (Ch) |
21 |
6.7 |
Food processing (FP) |
48 |
15.4 |
Publishing (P) |
2 |
0.6 |
Construction materials (CM) |
17 |
5.4 |
Communication systems (CS) |
1 |
0.3 |
Building construction (BC) |
22 |
7.1 |
Metallurgical (M) |
8 |
2.6 |
Electric power (EP) |
7 |
2.2 |
Total |
312 |
100 |
The final sample includes open type joint stock companies (variant 1 -20.5% of the sample), closed type joint stock companies (variant 2 -54.2% of the sample), family or solely owned enterprises (variant 3 - 4.2% of the sample), long term lease (10. 3 % of the sample) direct purchase (3.8% of the sample), and special cases (7. 0 % of the sample).
EXHIBIT 2. The sample structure by the legal form and the size of the firm.
Variant of privatization |
% |
# of employees (mean) |
Variant 1 |
20.5 |
3051 |
Variant 2 |
54.2 |
1374 |
Variant 3 |
4.2 |
546 |
Long term lease |
10.3 |
786 |
Direct purchase |
3.8 |
646 |
Special cases |
7.0 |
1356 |
Total |
100.0 |
The sample includes different size companies with the number of workers varies from the 500 workers (41% of the sample), to 500 -1000 workers (25%); to 1000-3000 workers (24%); to more than 3 000 workers (10% of the sample respectively). The choice to investigate different size firms was predetermined by substantial variation in ownership structure in terms of size. The large open joint-stock companies appear to be more attractive and accessible for outside investors. Thus, insiders in the largest firms have the smallest portion of equity, which presumably led to the weaker managers' control. Therefore, the differences in managers' behavior can intuitively be dependent on the size of the firm.
LIMITATIONS:
There are two problems related to the sample. One disadvantage of the data set for describing ownership structure is that it presumably is dynamic. For instance, as the state privatizes its remaining holdings and as employees begin to sell their shares, the ownership structure is likely to change. Other sources indicate, however, that few such sales have taken place. Employees have not been very active selling their shares to outsiders. The results reported by Blasi, Kroumova, et al. (1997) suggest that inside ownership might actually be rising slightly in 1997 compared to the previous year.
State ownership in most companies has changed little in the recent past . So-called "investment actions" have been very slow and the "loans-for-shares" program focuses on the mining industry, which is not included in the sample (Kokh, 1998), Blasi & Shleifer (1996) suggest that the median for inside ownership sale across all the firms was 0%, with the mean for managers’ and workers’ ownership sale at 4% and 1% for the trust funds. This implies that ownership structure has not changed at all in more than half of companies, and that changes are somewhat minimal in the other firms.
Therefore, the analysis of the owbership structure in 1996 can provide relatively accurate picture of the current condition. It also seems very useful to analyze the 1996 situation as the result of mass privatization and as the starting point for future changes related to the new Law on Joint Stock Companies. In addition to the ownership structure problem, this study (as well as all other existing studies we are aware of) lacks information about the composition of voting and non-voting stocks. The data available so far show that state holdings are predominantly non-voting shares and that a large percentage of the stake owned by workers is also non-voting stock. Therefore, it is quite complicated to capture outsiders’ influence on companies’ behavior, and all we can use so far is the level of outside ownership, assuming that this variable correlates with outside effect on firms' governance.
Finally, this survey does not use any accounting numbers from financial statements for several reasons: 1. Many accountants in Russia still use old Soviet accounting standards, which were not designed for a market economy. Thus, financial results computed according to the old standards cannot be compared to those based on new approaches. 2. High levels of barter off-book transactions render current financial statements, even under new (international) accounting standards, quite incomplete. 3. Endemic non-payment of debts and taxes further complicate the analysis of current financial statements. All three reasons tend to make Russian financial statements unreliable and useless for analysis purposes. Hence, the only clearly intervally-scaled and verifiable data being used in this paper is the size of the firm (# of workers) and the ownership structure (% of total ownership). All other measures derive from management perceptions or estimates as reported in the survey.
Before starting the analysis the ownership structure in Russia some distinctive characteristics related to the country’s economic and cultural features should be examined foremost. First, Russia represents an expansive economic domain, with traditionally branch structure of its economy. Thus, it is feasable that different regions and industries exhibit distinctive characteristics of there ownership structure. Second, informal relationships in Russia have always been an important part of any institutional structure. Therefore, privatization presumably did not escape the influence of this eccentricity, which will be reflected in specific composition of the outside ownership. And third, with the state being a major owner in the recent past it is important to examine its role in shaping firms’ behavior.
4.THE AGGREGATED FACTORS AFFECTING THE OWNERSHIP STRUCTURE.
A. Economic factors affecting the dynamic of the property relations.
The very peculiar economic environment in Russia heavily influences the success of property rights reform. The evolution of the governance system took place in the specific environment of the transition period, which can be characterized by the following:
Under such conditions, the process of formatting the new corporate governance structure is a challenge for most economic entities. Managers of newly privatized firms face all the problems, which accompany the evolution of property rights such as the creation of new supply and demand relationships, the search for new markets, the lack of funding from the state budget, and the development of new economic strategy. The degree of success during the transition period thus very heavily depends on managers, i.e. on the degree of their control over the enterprises, their ability to analyze all consequences of their decisions, and their ability to develop a suitable long-term strategy.
B. The regional and industrial peculiarities of the ownership structure.
The main peculiarities of the Russian industry are its branch structure and vast size. Analysis of the ownership structure in the regional dimension shows that different regions have distinctive characteristics.
EXHIBIT 3. The regions differences in ownership structure (%, means)
Ownership |
Moscow |
St. Ptrsburg |
Ural |
Nizhny Nvgrd |
Inside owners(IO) |
60.8 |
52.3 |
51.1 |
65.4 |
Workers (W) |
47.8 |
36.5 |
38.3 |
48.2 |
Trust Fund (TF) |
.5 |
3.7 |
1.1 |
5.3 |
Managers (M) |
12.5 |
12.1 |
11.7 |
11.9 |
Outside owners(OO) |
39.2 |
47.7 |
48.9 |
34.6 |
Individual owners(IO) |
5.9 |
10.3 |
10.1 |
6.5 |
State (S) |
10.5 |
7.3 |
12.3 |
6.9 |
Investment Funds(IF) |
1.6 |
6.4 |
6.2 |
5.4 |
Adjacent Firms (AF) |
1.0 |
3.4 |
5.1 |
2.8 |
Banks (B) |
1.6 |
4.2 |
0.1 |
1.4 |
Holdings (H) |
4.5 |
2.2 |
3.5 |
3.5 |
Foreign Investors(FI) |
1.3 |
3.3 |
1.0 |
.2 |
Others (o) |
12.8 |
10.6 |
10.6 |
7.9 |
TOTAL |
100 |
100 |
100 |
100 |
The Moscow and the Nizhny Novgorod regions have relatively similar ownership structure with high level of inside ownership (60,8% in M and 65.4% in NN) and an insignificant presence of outsiders among the stockholders. The industries of the Ural region have a very specific composition. Most of the military related, mineral extractive and metallurgical enterprises historically were located in this area. All of these industries play a strategically important part in the Russian economy. The state remains the main owner of such enterprises, and workers-stockholders' ownership is relatively low there. In the metallurgical industry adjacent firms (suppliers and buyers) play a significant role in the production process and therefore make up the important group of owners in those firms. They own a significant portion of stocks at the expense of other outsiders (8% is the adjacent firms' ownership in metallurgical industry vs. 0% in power and fuel industries, 1.3% in timber industry, 2.8% in machine building industry, 1.3% in chemical industry, etc).
The St. Petersburg region has highly qualified professionals and well-developed economic connections with Scandinavian countries. The ownership structure of the St. Petersburg region contains a large amount of foreign investors, banks, and individual investors, which are on average 15% higher than for other areas, and the portion of workers-stockholders is relatively lower than in the Moscow and Nizhny Novgorod regions.
EXHIBIT 4. Industrial differences in ownership structure (%, means)
Ch. |
F |
MP |
M |
EP |
CG |
T |
FP |
CM |
CB |
|
I0: |
56.4 |
34.0 |
49.1 |
62.3 |
65.8 |
68.5 |
78.2 |
53.2 |
59.5 |
70.4 |
W |
40.7 |
21.9 |
35.0 |
53.0 |
59.3 |
46.4 |
67.4 |
41.2 |
48.4 |
55.1 |
TF |
4.5 |
0.4 |
2.6 |
0.0 |
0.0 |
4.6 |
1.3 |
2.6 |
0.0 |
4.5 |
M |
14.4 |
11.7 |
11.5 |
9.3 |
6.5 |
17.5 |
9.5 |
9.4 |
11.1 |
10.8 |
00: |
43.6 |
66.0 |
50.9 |
37.7 |
34.2 |
31.5 |
21.8 |
46.8 |
40.5 |
29.6 |
In.0 |
8.3 |
10.4 |
9.9 |
9.9 |
8.0 |
7.3 |
4.4 |
5.9 |
11.5 |
6.0 |
S |
15.9 |
24.0 |
10.7 |
5.5 |
24.5 |
4.9 |
6. 1 |
12.2 |
10.0 |
2.5 |
IF |
5.9 |
9.1 |
6.6 |
2.5 |
0.1 |
3.8 |
4.8 |
4.6 |
3.6 |
1.4 |
AF |
1.3 |
0.0 |
2.8 |
8.0 |
0.0 |
2.6 |
1.3 |
4.9 |
3.1 |
5.4 |
B |
1.9 |
0.0 |
2.4 |
2.3 |
0.0 |
1.0 |
0.0 |
2.8 |
4.1 |
0.0 |
H |
6.0 |
1.9 |
4.4 |
5.6 |
0.0 |
1.6 |
1.1 |
4.1 |
2.5 |
3.4 |
F1 |
0.0 |
2.1 |
2.0 |
0.0 |
1.6 |
0.5 |
0.1 |
3.5 |
2.1 |
0.0 |
0 |
4.3 |
18.5 |
12.1 |
3.9 |
0.0 |
9.8 |
4.0 |
8.8 |
3.6 |
10.9 |
Total |
100 |
100 |
100 |
100 |
100 |
100 |
100 |
100 |
100 |
100 |
An analysis of the industrial peculiarities of the ownership structure show that the timber (forestry) industry has the highest level of inside ownership (78.2%, within which 67.4% and 9.5% of the equity is owned by workers and managers respectively). Banks, on the another hand, have zero ownership there, and both phenomena are due to the fact that the timber industry has a strong internal and external market share. Therefore, financial resources (including convertible currency) are not an issue for those firms, and insiders can own and control their entities without having any need to share those fanctions.
Other industries also show a high level of inside ownership, especially if they adopted the second variant of privatization, which contains considerable privilege for the insiders. The Russian economy historically has had a highly monopolized production sphere, which helps insiders to keep their power by owning not just a firm but a market share and ownership of rights associated with it (Alchian & Demsetz, 1972), and there is no short term means to change this situation. For instance, in the construction-building industry, the level of inside ownership has reached 70.4%, where 55.1%, 10.8%, and 4.5% of equity belong respectively to workers, managers, and internal trust fund; in electric-power and consumer goods industries those figures are 65.8%, 59.3%, 6.5%,0%, and 68.5%, 46.4%, 17.5%, 4.6%, respectively.
EXHIBIT 5. Differences in firms' ownership structure due to their size and legal form (%, means)
Number of employees
<500 500>1000 1000-3000 >3000 Type of the firm Open
type Closed type
10: |
62.8 |
61.5 |
56.5 |
34.5 |
54.3 |
85.2 |
W |
43.5 |
48.0 |
45.1 |
23.6 |
36.8 |
68.0 |
TF |
4.3 |
0.3 |
2.0 |
3.9 |
2.8 |
3.3 |
M |
15.0 |
13.2 |
9.4 |
7.0 |
14.7 |
13.9 |
00: |
37.2 |
38.5 |
43.5 |
65.5 |
45.7 |
14.8 |
In. 0 |
6.9 |
6.9 |
9.4 |
11.9 |
8.9 |
4.4 |
S |
9.4 |
5.7 |
9.3 |
18.0 |
10.9 |
1.4 |
IF |
4.5 |
5.2 |
4.6 |
6.2 |
5.1 |
3.9 |
AF |
2.0 |
4.3 |
2.6 |
4.5 |
3.5 |
0.3 |
B |
1.2 |
1.6 |
2.3 |
2.6 |
2.0 |
0.6 |
H |
3.2 |
4.1 |
3.4 |
3.0 |
2.0 |
0.5 |
FI |
2.1 |
1.4 |
0.4 |
2.6 |
1.7 |
0.5 |
0 |
7.9 |
9.3 |
11.5 |
16.7 |
11.6 |
3.2 |
Total |
100 |
100 |
100 |
100 |
100 |
100 |
The most significant variations in ownership structure are represented by the differently sized enterprises with a distinct legal form. The large open joint stock companies appear to be the most attractive and accessible for outside investors. The workers and managers there have the smallest portion of the equity (23.6% and 7% respectively). The very large firms (more than
3,000 employees) show the highest state ownership level (18%), due to the large portion of strategically important enterprises among them. The managers' rigid control over the enterprises is usually weaker in open joint stock companies, and there are more opportunities for outsiders to invest in these companies.
5. MANAGERS' INFLUENCE ON FIRMS' BEHAVIOR.
A. The modes of business adaptation to a new economic environment
A major result of the transition to the new property relations was the transfer of all decision making and control functions from the state to the firm level. During the transition period, managers were given unprecedented freedom to act and make their own decisions, and also to obtain the major part of former state ownership in a highly uncertain economic environment. This situation is the logical result of the transition from the pre-reform economic period, when the state was no longer capable of carrying out its routine functions. But the opportunities for the managers to make their own decisions did not come without other consequences, such as the high costs of adaptation to a new economic system which forced the managers to compromise. They attempted to find a way to adopt the new economic system while still using traditional methods. In our study, CEO's have identified their emphasis on developing short-term tactics. They concentrated predominantly on everyday survival policy, pursuing short -term goals such as current monthly income.
The methods of adapting and surviving in a new economic environment are heavily dependent on managers' priorities and the availability of financial resources. After the state cut its subsidies to the enterprises, the lack of financial resources became the most important problem for the firms. In the questionnaire we have asked CEOs 1) to identify all approaches they have been using to find financial resources after privatization; 2) to assess the importance of different financial sources for their firms during the same period, using the scale from 1 to 7 (1 means "not important", 7 means "very important").
EXHIBIT 6. Managers' assessment of different financial resources.
|
Total |
|||||||||||||||||||||
% |
% |
% |
% |
% |
% |
% |
# |
|||||||||||||||
Sale of equipment, buildings, inventories |
56.8 |
10.3 |
11.3 |
5.8 |
5.8 |
1.3 |
8.7 |
310 |
||||||||||||||
Lease |
40.0 |
20.3 |
12.3 |
7.7 |
7.1 |
3.5 |
9.1 |
310 |
||||||||||||||
Income from "old"production |
35.3 |
9.3 |
10.7 |
7.8 |
8.4 |
5.2 |
23.3 |
309 |
||||||||||||||
Income from "new" Production |
33.3 |
12.1 |
12.3 |
8.4 |
9.7 |
6.1 |
18.1 |
309 |
||||||||||||||
Banks' credits |
48.4 |
8.4 |
7.2 |
9.1 |
9.7 |
6.2 |
11.0 |
308 |
||||||||||||||
Debts |
41.4 |
7.9 |
6.9 |
9.2 |
8.6 |
8.2 |
17.8 |
304 |
The results of this part of the study identified income from the production of an "old" and "new" output as the most used source of financial resources. The fact that more than one third of the CEO's assessed the income from "new production" as a non- important financial source (vs. 18. 1 % responders who estimated it as a very important financial source) is proof that Russian firms are not aggressive in new markets. This phenomenon along with the fact that firms do not use bank credits very actively (48.4% of CEO's have scaled credit as non-important financial source vs. 11 % of responders who estimated it as a very important source) suggests the firms' weak interest in implementing new technologies and new products. At the same time, all firms actively used the sale of equipment, buildings and inventories (diminishing the value of the firm), lease, and accrued liabilities (tax debt, accumulated accounts payables, and overdue payroll payments) as financial sources.
Our other finding relates to the managers' concern about current income. Theory suggests that the short-term horizon approach is common for managers. (Watts & Zimmerman, 1990) But Russian CEO's emphasis on current monthly income cannot be explained by the availability of contractual constraints (which incorporate accounting-based restrictions on managers' actions, e.g., debt covenants, corporate charters, and bylaws) because they are underdeveloped in Russia. Thus, corporate management is not required to adjust reported accounting numbers to relieve these (potential) constraints. Moreover, neither managers nor standard makers expressed much concern about the information content of accounting numbers, which might be due to both the absence of motivations to encourage value maximizing actions and the underdeveloped system of information in Russia.
We think that the most logical explanation for the managers' concern about current income is very high uncertainty (economic instability, inflation, dynamic law, etc.) and scarcity of financial resources. In addition, as our study shows, managers are simply confused by the highly unstable and uncertain economic environment, and they cannot determine their current priorities. Thus, the analysis of the data suggests that Russian managers have developed a predominantly short run survival approach as opposed to developing any long-term strategy.
B. Managers' attitude toward control and ownership redistribution.
Because managers are a professional group with a distinctive set of interests, their priorities are more set than those of the workers-stockholders, which are not yet distinct. This study has identified that managers have well-articulated claims, such as the control over the firm, and a very skeptical attitude toward the workers-stockholders' involvement in the decision making process. In our study, 21 % of CEO's think that the delegation of the voting
rights to the managers and their full discretion to exert corporate control are the best solutions for the corporate governance problems; 19% of the respondents think that only the strategic and the most important issues should be discussed in the stockholders meetings, while the rest of the decisions should be made by management in an executive manner.
EXHIBIT 7. Managers' attitudes toward the outsiders participation in firms' governance.
Activity |
% |
Didn’t answer % |
|||||||||||||||||||||||||
Budgeting |
37.1 |
4.5 |
2.5 |
5.8 |
1.9 |
5.8 |
6.4 |
36.0 |
|||||||||||||||||||
Seeking new internal markets |
39.1 |
4.2 |
5.4 |
3.8 |
4.8 |
2.2 |
3.8 |
36.7 |
|||||||||||||||||||
Seeking new foreign markets |
43.2 |
5.1 |
4.2 |
3.2 |
1.9 |
1.3 |
3.8 |
37.3 |
|||||||||||||||||||
Research and development |
39.1 |
4.5 |
5.4 |
3.8 |
2.8 |
2.6 |
4.5 |
37.3 |
|||||||||||||||||||
Support in technological development |
42.0 |
6.7 |
3.8 |
3.5 |
3.2 |
0.9 |
2.6 |
37.3 |
|||||||||||||||||||
Auditing and control |
21.4 |
5.4 |
6.7 |
5.1 |
6.4 |
5.1 |
12.2 |
37.7 |
|||||||||||||||||||
Structural changes in organization |
36.8 |
4.2 |
4.8 |
5.1 |
3.2 |
2.8 |
5.8 |
37.3 |
|||||||||||||||||||
Participation in boards of directors |
44.9 |
4.8 |
2.9 |
2.2 |
2.8 |
2.2 |
2.2 |
38.0 |
Along with the skeptical attitude toward the workers-stockholders' involvement in the decision making process, managers also display predominantly negative attitudes toward outsiders. The CEO's place a very low value on the outside owners' participation in the firms' governance. Just 6.4% and 12.2% of the responders admitted outsiders' extremely important role in the budgeting and the control respectively, and most of them expressed skepticism about the outsiders' participation in the board of directors (44.9 %) and their support of technological development (42%), marketing (43.2%), and R&D (39.1%). CEO's have identified the concentration of the ownership by outsiders as the most undesirable outcome from the redistribution of property.
EXHIBIT 8. Managers attitude toward the different groups of owners.
Negative |
Positive |
Refused to answer |
Total |
|
% |
% |
% |
% |
|
Workers |
17.3 |
62.5 |
20.2 |
100 |
Banks |
50.3 |
29.1 |
20.6 |
100 |
InvestmentFunds |
48.4 |
30.4 |
21.2 |
100 |
Adjacent Firms |
38.1 |
40.1 |
21.8 |
100 |
ForeignInvestors |
36.6 |
46.7 |
16.7 |
100 |
Most unwelcome among outsiders are banks (50.3%) and investment funds (48.4%). Managers consider suppliers and buyers (40.1 % of responders) and foreign investors (46.7% of responders) as the "least dangerous" group of outside investors because 1) they cannot gain real power over the firm., and 2) certain groups of outside investors (adjacent firms) display predominantly collaborative attitude, which will be discussed later in this paper.
Because managers are so concerned about property redistribution, they have conducted various steps toward precluding it. Yet, one third of CEO's feel secure enough not to take certain steps because: 1) the control package belongs to the state (40.7%), 2) managers' powerful position gives them the ability "to employ some peculiar factors, which will make the firm unattractive to the outside investors," (51 %); 3) they have control over the entity and do not plan to give it up (16.3 %).
EXHIBIT 9. Managers' assessment on the possibility of ownership accumulation by outsiders. (%)
Reasons |
No |
Yes |
Didn't answer |
The situation is under |
50.6 |
29.8 |
19.6 |
The firm is unattractive |
17.3 |
32.3 |
50.4 |
Insiders are major owners |
35.2 |
16.3 |
48.5 |
State is the major owner |
8.3 |
40.7 |
51.0 |
Managers can make |
10.9 |
51.0 |
38.1 |
Therefore, managers are willing to use any available opportunity to gain and keep control over the enterprises. In their responses, CEO's have identified several situations in which their major interest would be satisfied: 1) the control package of shares belongs to the state; 2) the control package is held by insiders; 3) the control package is held by outsiders if and only if outsiders are a) are trusted stockholders which the managers have a long term business relationship with; or b) they will not claim control and monitoring functions.
Thus, first Russian managers will do whatever it takes to control their enterprises, which reflects the immature entrepreneurial behavior. We think it can be explained by the tremendous inertia in the socioeconomic mentality of Russian agents due to the lack of market education and experience, an underdeveloped infrastructure (banks, investment funds, communication system, etc.), and the very peculiar state of the Russian economy. Second, the outside ownership per se will not necessarily change the corporate behavior (as due to the diminishing managers' control), because some groups of outsiders show very collaborative attitude and no inclination to compress managers monitoring ambitions.
6. THE PECULIARITIES OF OUTSIDERS OWNERSHIP.
A."Non-accidental" outsiders.
Beneficial interest owners consist of two parties. The first party includes individual ("non-accidental") stockholders such as relatives, friends, managers and directors of firms somehow (formally or informally) related to the given enterprise. The second group includes corporate investors (suppliers and buyers). Both groups usually have a long- term business (or other) relationship with the firms' managers. Because they have known each other for a long period of time, "non-accidental" investors support the managers' decisions and this informal relationship creates the potential for the managers to keep control over the firm during the transition period. There are at least two indirect evidences of this relationship. First, we observed the association between the changes in managers' ownership and outside ownership. For instance, when the ownership of "non-accidental" individual stockholders increased from 5% up to 12% in various firms of the construction materials industry, the managers' ownership diminished from 15% to 7%. Second, the individual outsiders are the only group (besides the state), with an ownership higher than 10% in such efficient and hard to access industries as fuel, building-construction materials, etc. It was almost impossible to make such efficient investments without any support from powerful insiders.
Adjacent firms do not account for high corporate ownership (2.8% on average, with the highest level in metallurgy, 8%). But they have high governance potential due to the adjacent firms' strong presence in the boards of directors. The overall existence of very close relationships, both formal and informal, between the suppliers and buyers is due to the very inflexible system of business relations that existed during the Soviet era. Firms still cannot find the solution for the high monopolization and strong non-rational vertical integration of the economy, which leads to the inflation of non-payments and non-stable situations in the economy.
Adjacent firms are the parties most interested in the stabilization of money and business relations. Being generally interested in effective business coordination, enterprises nevertheless did not show a big concern for the consolidation of the ownership by intertwining the equities of adjacent firms (the "keiretsu" system in Japan). (Aoki, 1988) Managers in their responses expressed a very skeptical attitude toward the consolidation and acquisition of other firms. They consider consolidation as a threat to their control over the firms, even though they understand the importance of consolidation and mergers in the long run. On an everyday basis managers have to deal with the problems of mutual credits, bartering, non-payments, etc. It might seem that firms would be very interested in strengthening their position on the market by changing their partners, technologies, and different price policies in the future. Intuitively, it is hardly attainable in the current information vacuum and system of business relations inherited from the past.
Thus, adjacent firms as the "non-accidental" individual investors are the very specific categories of outside stockholders because according to our survey, they represent one of the most acceptable by managers groups of outsiders. Therefore, it is plausible to predict that if the level of outside ownership will grow due to the enlarging the stake of "non-accidental" investors the change in corporate behavior become questionable. The governing power of managers can intuitively be languished by introducing the dispersed ownership rather than just increasing the level of outside ownership.
The state as an outside owner.
The state being de jure the most significant outside owner, de facto plays a trivial role in the control and monitoring of the enterprises' activities. The passiveness of the state is due to several circumstances: the state has not yet developed a consistent strategy for how to improve the organization of production or how to influence the managers' destructive behavior by enforcing contracts. Moreover, the state does not have a special body to achieve those goals.
Following the law, the state holds the majority of the stocks in strategically important industries such as fuel, electric power, military related ones, etc (Appendix 2). Overall 7.1 % of the sample have state ownership, which exceeds 40%, and 9.6% of the sample has a state ownership, which exceeds 30%. The state also controls many enterprises by holding the "veto" right, the so-called "golden stock." This right means that if the decision made by the managers or the board of directors is somehow contradictory to the state's interests, such a decision can be canceled by the state. However, this right has not been exercised yet.
It is difficult now to predict the future state strategy. In the meantime, the managers do not feel a strong state presence on firm's administrative body because the state does not exercise its power. So, the managers do not express any negative attitudes toward the state since it is only a nominal major owner of a significant portion of Russian enterprises.
7. CONCLUSIONS AND FUTURE RESARCH.
In this study we investigated the managers' attitudes toward changes in corporate ownership and governance in Russia during the transition period, when the economic and legislative environment is unstable and the market is underdeveloped.
Our analysis was primarily concentrated on corporate ownership structure as the derivative of the managers' primary interest in corporate control, on the approaches the managers employ in order to satisfy their primary interests, and on the sources of the managers' power. Attention was then directed to the relationship between the ownership structure and governance potentials of different groups of investors. The study incorporates the analyses of managers' responses regarding their primary incentives and interests related to addressed topics. The major results are summarized below:
1) Currently the distinctive socioeconomic environment in Russia provides enough incentives to ensure that the managers' behavior remains consistent with their desire to keep control of the corporate leadership. In this context, the managers' priorities include control and survival issues, conditional on the transition period. The transfer of control from state to managers has not been accompanied by an increase in output or greater efficiency. The consequences of this transfer will probably become more prominent as market forces grow mature.
2) The initial attempt to separate ownership and control in order to increase managers’ incentives to be concerned about accounting numbers has not been successful. The noisy economic environment, distinctive design of the privatization law, and the managers’ additional efforts to control the firms they are governing, has led to a high level of inside ownership among the Russian firms. Currently managers have negative attitudes toward any actions which could be considered a threat to their powerful position (disperse ownership, consolidation, merger, etc.)
While the reshaping of authority structures and changes in managers’ decision making rights illustrate profound organizational change, possible strategic change appears limited to relatively minor alterations in production and marketing activities. The main factor limiting consistent strategic changes is the inadequate control structure of Russian firms, which stems from the inherent contradictions between ownership rights and managerial power. With respect to the current poor economic situation, the absence of clear and stable accounting rules, which would help new owners to construct and monitor a clear strategic agenda, and strong managerial interest in preserving the status quo, indicate that the rapid recovery of Russian industry appears doubtful. Nevertheless, this situation cannot continue forever. This study shows that managers in Russia remain economically rational, because they have very good economic reasons to behave the way they do, i.e. their rationality is bounded by the peculiarities of transition period. Therefore, in the long run, their needs for new investments and their desire not just to survive, but also to prosper, will lead to more visible manifestations of profit maximization
3) The analysis of the outside owners' attributes suggest that meantime certain groups of stockhoders display very collaborative attitude. They compose the party of so called "trusted stockholders", and managers did not mind them to be involved in the governing process. Therefore, changes in governing system toward giving the greater power to the outsiders cannot emphasize only the issue of the failure of outside owners to gain a foothold in privatized Russian firms, and thus, explore the potentials to shift the ownership structure toward the expanding the outside ownership. Intuitevely, it should rather underline the possibilities to introduce the dispersed ownership, because it can diminish the control and monitoring managers' abilities.
Evidence of the managers' attitudes toward dispersed ownership and control, the firms' strategy, and the managers' incentives are limited. While we document, based on our questionnaire, certain types of managers' behavior such as their concern about current income, control over the firm, short term surviving policy, etc., much about those topics is still unknown. Therefore, we see the opportunity for an empirical test of the relations between managerial ownership and corporate performance measures as one extension of this research. This test would require additional financial data gathering. Another extension is to explore the hypotheses on managers' incentives in the selection and application of different models of business adaptation to a new economic environment. Finally, the third possible future study is the investigation of the corporate governance's effect (e.g., takeovers, buyouts, and board of directors) on the ownership structure and managers' incentives in corporate performance.
APPENDIX 1 .
In 1992, the Privatization Law and subsequent amending acts specified the stages of privatization procedures for all state enterprises subject to mandatory privatization. Initially, the Privatization Law had foreseen a rather traditional program of sale for state-owned enterprises, involving their valuation according to the discounted future cash flow method, their transformation into joint stock companies, and the sale of shares "on the securities market" over an extended period of time. The procedures specified by the Privatization Law were later modified by the Interim Regulations for Privatization Commissions, issued as supplement 7 to the Acceleration Decree, Decree 721 and the Commercialization Statute. This presidential enactment altered the initially chosen ad hoc mode of initiation for the privatization process and replaced it with obligatory transformation procedures within a rigid timetable (to be complete by November 1, 1992), accompanied by the preparation of full – fledged privatization plans. Workers collectives of each enterprise had to create privatization commissions (usually composed of 5 persons) by October1. 1992. Only if the workers collective failed to do so, was a commission then established by the appropriate property committee in conformity with the Interim Regulations of the Acceleration Decree. Guidelines for the Valuation of Properties Targeted for Privatization, issued as Supplement 2 to the Acceleration Decree, specified the book value method of valuation without adjustment for inflation as obligatory. Because the Privatization Law entitled employees of new joint stock companies to a 30% discount on their purchase of shares and installment purchases by employees (with up to 3-year terms and minimum 20% down- payments), the change in favor of book- value pricing and the decision not to adjust for inflation greatly increased the value of any preferential discounts for insiders. Indeed, given the rate of inflation in Russia (2,610% in 1992, 900% in 1993, 300% in 1994, etc.), it became quite possible that all sales at nominal prices, even without preferential terms, would amount to giveaways. But the preferential terms themselves were also changed significantly in favor of insiders by June 1992, when the State Program was enacted. Both direct subsidies granted to insiders and their ability to acquire large (often controlling) stakes in privatization changed the way privatization ensued. Finally, the voucher program announced in August 1992 gave each citizen a direct Rb. 10,000 subsidy which insiders could use to buy the shares of their enterprises at extremely depressed prices.
Three options (variants) of privatization were proposed. Variant 1 was essentially taken directly from the Basic Provision. Under this variant, employees (workers and managers) were given 25% of equity without payment in the form of preferred non-voting stocks. In addition, workers were entitled to buy for cash or vouchers another 10% of voting stocks (full voting rights) in closed subscription. These shares were sold at a 30% discount from January 1992 book value and could be paid in installments over more than three years. 5% shares were sold to the top managers (CEO, his deputy, head engineer, head accountant) on a regular basis for the nominal (book value) price, 10% were given to employees' shareholder funds.
The rest of the equity shares were sold to outsiders through voucher auctions and tenders. This variant of privatization mostly created open type join-stock companies with a significant level of outside ownership.
Under Variant 2 workers and managers could buy up to 51% of voting shares at 1.7 times the book value of the enterprise on July1, 1992. These sales could be made for vouchers and/or cash and did not involve any preferential terms. 5% of voting stock was given to the employees' shareholders fund, 29% was sold through voucher auctions, and 15% was sold through tender. When enterprise managers and workers bought shares, they were primarily motivated by the desire to own at least a controlling block of shares, maximizing their interests to the extent possible. Generally they sought to use majority control to ensure that profits go to employees and to prevent layoffs that might be imposed by outsider proprietors. This variant of privatization mostly created closed type joint-stock companies with significant levels of inside ownership.
Privatization option three mostly applied to medium size enterprises with more than 200 employees, and provided special privileges for a small group of insiders
In order to elect variant 2 or 3 the workers collective had to vote for it with at least a two-thirds majority. In all other cases, the "default" meant variant 1.
According to privatization rules, enterprise governance should be removed from workers' councils and managers and given to a supervisory board (or board of directors) controlled by the owners of the enterprise.
APPENDIX 2.
The Russian privatization program
identified a number of enterprises not subject to mandatory privatization. First,
enterprises involved with mineral resources, military facilities, nuclear reactors,
rail and water transport will not be privatized and remain under control of
the former branch industries. Second, various enterprises belonging to "strategic"
industries (defense, mineral and precious stone extraction, energy, etc.) can
be privatized at the discretion of the government or GKI. In these enterprises,
the government typically retains a considerable shareholding (from one-third
to one-half), or keeps the "golden share" through which authorities can veto
any changes in the charter capital or the strategy of the enterprise. OECD estimates
suggest that as many as 30% of all enterprises have been excluded from the normal
privatization process.
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