Graham Stack in Moscow -

Gone are the bad old days of Russian oligarchs ousting minority shareholders from annual general meetings at the point of a gun. While corporate governance in Russia is still far from perfect, a study recently released by an investment bank shows that good corporate behaviour pays off: the shares of Russia's best-run companies have significantly outperformed those of companies which aren't transparent.

According to a study by Moscow-based Troika Dialog, corporate governance in Russia significantly improved in 2007, with the number of companies classified as low risk increasing by 8 percentage points to a total of 30% of listed companies. This, despite the sharp rise in state ownership since 2004.

The Troika Dialog study, entitled "Who Owns Russia?", found that since 2004 the ownership of listed companies shifted significantly, with the number of state-owned firms surging from 24% to 40%, making it the largest ownership group in Russia. This expansion has come at the cost of private owners, whose share has fallen from 50% to 33%. The amount of free float has grown by from 25% to 27%.

But, according to the study's author Elena Krasnitskaya, increased state ownership has not stopped corporate governance improving in 2007 - and to some extent it has even supported the improvement. "Before 2004, oligarchs ran most of Russian industry like a private fiefdom," says Krasnitskaya. "Their companies would set minority shareholders at naught and make a farce of disclosing beneficiaries. With the state now controlling more than 40% of traded companies' equity, the beneficiary is at least well known."

"Investors concerned with corporate governance risk may welcome the state's newfound dominance, as the ownership structure of Russian companies has become more transparent and their corporate governance practices more consistent," she rather surprisingly concludes in the report.

Renaissance Capital's oil and gas analyst Alexander Burgansky largely agrees. "I don't think increased state ownership has had any significant negative impact on corporate governance. In certain aspects we have seen some of the financial openness decline in Sibneft, after it became Gazpromneft, but the same cannot be said for Rosneft after acquiring Yukos, it has stayed as transparent as Yukos was as far as underlying financial data is concerned," he says. "I would say that on balance you cannot make any direct link between state ownership and corporate standards. If you look at some of the largest state-owned companies in Russia - Sberbank, Gazprom Rosneft, VTB - you will see a general improvement in corporate governance."

Burgansky also points to a knock-on effect from companies that IPO to their state peers. For example, he argues that the IPO of oil major Rosneft made a big difference to corporate governance at Gazprom, while the IPO of state-owned bank VTB had a big impact on corporate governance at Sberbank. "The state companies watch each other and mimic what is going on in their respective businesses," he says. "The flotation of state-owned enterprises has a positive trend on corporative governance not only on those companies but also on their state-owned peers."

In addition, the management of state-owned companies now have greater incentives with share options schemes to improve shareholder value. "A lot of what the Russian government now demands of companies implicitly leads to improved governance," says Burgansky. "But obviously with state-owned companies things take time, and there's a time lag with regard to some private companies. Rosneft is doing a very good job in terms of financial transparency. The level of openness is pretty good." Troika's list of top-five companies advancing the most in 2007 includes VTB and Rosneft.

Tatiana Dolgopiatova, an expert on corporate governance at Moscow's prestigious Higher School of Economics, agrees that state ownership can be "enlightened."

"It's curious, but companies' surveys show that in state-controlled companies, formal procedures are observed better and comply better with good corporative governance. This is also linked with fact that the state owns stakes primarily in large companies. Also, the state demands that its representatives always vote in favour of dividends at shareholder assemblies and in the supervisory board, so state-owned companies usually pay dividends more regularly. In fact, minority investors often prefer to purchase shares in companies where the state has a controlling stake, because they can count on receiving dividends."

"However," she notes, "comparing the very biggest, private companies are more likely to include independent directors on their supervisory board than state-owned companies."

Black marks and brownie points

Troika downgraded Gazprom's corporate governance rating in 2007 once it stopped reporting information on the owners of the 3.86% stake previously held by Gazfond and Gazprombank. "The stake is worth around $10bn at current prices, and this undermines transparency and damages the management's track record," says Krasnitskaya.

However, Troika points out that Gazprom's sins pale beside those of privately-owned oil major Surgutneftegaz, which is rated as one of Russia's least transparent companies. Surgutneftegaz management moved 42% of voting shares to an obscure company in 2003, and now no longer discloses the ownership of that stake but classes them as treasury shares. This has significantly increased the risk that these shares will be transferred to private owners without fair compensation to other shareholders.

Troika also blasts Surgutneftegaz for discontinuing GAAP reporting and disbanding its Moscow-based investor relations team. "Furthermore, facing a legal suit filed by the dissenting international shareholders, the company allegedly secured a political lobby to oust some of its most active opponents out of the country in 2006," writes Troika, referring to the notorious Surgutneftegaz-sponsored withdrawal of investor Bill Browder's Russian visa early in 2007. Browder, head of Hermitage Capital, is a vociferous, high-profile campaigner for minority shareholders' rights and improved corporate governance in Russia. "We maintain our opinion that Surgutneftegaz has the most opaque ownership structure on the market," is Troika's damning verdict.

State-owned oil pipeline operator Transneft also comes in for criticism - despite its recent change of management. "Transneft is one of the most investor-hostile companies on our list," says Krasnitskaya. "The core shareholder appears not to recognize that preferred shareholders have a claim to the company's cash flows. Until this is accepted, corporate governance risks are likely to remain high."

She is holding out hope that the company's new CEO to replace Semyon Vainshtok, who is heading up the committee in charge of the 2014 Olympics in Sochi, will improve the ailing corporate governance practices.

On the plus side, Troika is looking to improved corporate governance at state-owned Sberbank precisely because of increasing state involvement. The independent-minded and long-serving head, Andrei Kazmin, was replaced in the autumn by Putin ally and former economy minister German Gref. "The outgoing management had spoiled the track record by opposing minority shareholders' presence on the board and the initiation of a sponsored GDR program," says Troika. "While relaxed rules on foreign bank ownership have greatly increased foreign shareholder presence, the management has shown little desire to launch a GDR program until recently." Kranitskaya expects improvements in investor relations and the launch of a sponsored ADR programme to follow from Kazmin's departure.

Sins of the sector

Troika's survey finds that it's not the type of ownership that influences standards of corporate governance as much as the sector in which the company operates. All in all, nine of the 18 most investor-friendly companies in the Troika report are from the telecommunications industry, while industrial sectors like chemicals and oil remain quite closed toward outside shareholders and lack incentives to communicate openly with the investors.

Troika's top-five companies comprise the telecom firms Comstar-UTS and MTS, industrial conglomerate (and MTS holding company) Sistema, independent gas producer Novatek, and Vozrozhdenie Bank. The five worst companies - Silvinit, Surgutneftegaz, Bashkirenergo, Bashneft and Ufaneftekhim - are all, except for Bashkirenergo, in the chemicals and oil branches, and none are state owned.

The real estate sector is a prime example of the shift towards more public ownership leading to significant improvements in corporate governance in what was until recently one of Russia's murkiest industries.

With real estate prices soaring in Russia, developers have been desperate to raise cash to press on with building. The speed of growth has been such that many companies acquire development rights without having completed projects they could use as collateral to raise debt - forcing them to finance development through equity. As a result, Russian real estate equity raised $8bn in 2006-2007, and the number of listed companies in the sector exploded from two or three to 15 across the CIS. There were four IPOs and three secondary offerings from Russia-focused companies in 2007 alone. "The wave of IPOs in the real estate sector has definitely played a positive role in improving corporative governance standards in the sector and reduced the possibility of corruption," believes Renaissance Capital analyst Alexei Yazykov.

Dolgopiatova agrees: "Best corporate governance is observed among companies placing shares on Western exchanges."

It's no coincidence that the company which pioneered real estate IPOs back in 2004, Interros-owned Open Investments, is now rated by Troika as one of Russia's lowest-risk companies, and by Alfa Group as "one of the strongest investment cases in the market." Four out of nine directors are independent, two of them foreigners.

Whether the new openness demanded by equity financing is sustainable for the real estate sector remains to be seen. Alfa Bank's Martin Brady warns that many of the newly-floated development companies are "young" and "have limited operating histories overall and even less experience as public companies." As such, Brady anticipates that these companies will face a steep "learning curve" in terms of understanding how to act in the best interest of their new public shareholders.

But there are strong incentives to stay clean. Brady points out that Open Investments' share price has climbed six-fold since its IPO in 2004. This illustrates the morale of Troika's tale: corporate governance correlates with price performance. Better-governed companies generate superior shareholder returns. Of the 65 companies that Troika analyzed, 40 stocks had outperformed the market in the period and 25 underperformed. The share of well-governed companies is the highest in the outperforming group (40%), and lowest among underperforming stocks (16%). "80% of those companies identified as being in the 'low risk' group outperformed the index this year, and they outperformed those in the 'high risk' group by 67.3%," the report notes.

Even for state companies, the drive to boost share value and market capitalization should stimulate further improvements in corporate governance. "After all," says Renaissance's Burgansky, "Dmitry Medvedev as chairman of the Gazprom board set management the target of achieving a market capitalization of $1 trillion. That's going to demand a lot of improvements."

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