Corporate Governance and Firms Valuations: Case of Russia.

Natalia Kravchenko – professor of Novosibirsk State University, leading researcher of In-

stitute of Economics and Industrial Engineering Siberian Branch of Russian Science Academy,
Russia, 630090, Novosibirsk, Prospect Lavrientieva, 17, tel. 73832-30-09-77;
fax: 73832 30-25-80; nkrav@ieie.nsc.ru

Almira Yusupova – associate professor of Novosibirsk State University, senior researcher

of Institute of Economics and Industrial Engineering Siberian Branch of Russian Science Acad-
emy
Russia, 630090, Novosibirsk, Prospect Lavrientieva, 17, tel. 73832-30-25-69;
fax: 73832 30-25-80; yusupova@ieie.nsc.ru

Abstract
Paper deals with the analysis of relationship between corporate governance level and mar-
ket valuation of Russian firms. Our basic assumption is that these characteristics are related.
This relationship is especially important in developing countries where even small improvements
of corporate governance could influence greatly on financial indicators. Thus we try to examine
the links between the level of the corporate governance, measured in terms of national rating and
market valuation of the firms listed in the main national stock exchanges. P/E and P/S ratios
were used as indicators for investors preferences.
Research of international markets shows that investors are ready to pay more for stocks of
companies with good corporate governance system. This is not fully confirmed on Russian mar-
kets. It is necessary to take into account that information available for analysis is rather limited.
Russian case is very specific one; the aims of companies and managers in Russia are not
similar to western companies. We consider that in Russian P/S ratio indicates investors’ posi-
tions better. Our results show that P/S ratio demonstrates more clear tendencies than P/E. P/S
ratio slowly decreases with the decrease of corporate governance level. The variation of P/S is
much less than P/E.
Our analysis shows that investors tend to pay less for companies with lower level of corpo-
rate governance. In other words investors are ready to pay high price for good governed compa-
nies on western markets. While in Russia they are ready to pay lower price for companies with
low level of governance. Sometimes the price could be rather high under speculative demand.

1
 Corporate Governance and Firms Valuations: case of Russia.

Paper deals with the analysis of relationship between corporate governance level and mar-
ket valuation of Russian firms. The first part of the paper is devoted to literature review; special
emphasis is made on theoretical works and empirical surveys of Russian market. Then comes
description of data set; two national rating lists were used under research – national rating of
corporate governance and list of companies with highest market values. Main calculations and
results are described in the third part; they show dependence between market value and corporate
governance specific for Russian economic environment. Paper is concluded by several final re-
marks.

1. Literature review.
Recent research papers demonstrate that the better corporate governance is highly corre-
lated with better operating performance and market valuation.
R. La Porta, F. Lopez-De-Silanes, A. Shleifer (2002) using a sample of 539 large firms
from 27 wealthy economies find evidence of higher valuation of firms in countries with better
protection of minority shareholders and in firms with higher cashflow ownership by the control-
ling shareholder.
The corporate governance problem in developing and transition countries is quite distinct
from that of developed market economies. The different researchers concentrated on studying
of firm-level corporate governance practices across emerging markets and a greater understand-
ing of the environment in which corporate governance matters more.
E. Berglöf and S. Claessens (2004) show that when the general enforcement environment is
weak and specific enforcement mechanisms function poorly, as in many developing and transi-
tion countries, few of the traditional corporate governance mechanisms are effective.
F. Jesover (2001) examines corporate governance in the Russian firms according to the
OECD Principles of Corporate Governance on shareholder rights and their equitable treatment.
L. Klapper and I. Love (2002) find evidence that firm-level corporate governance provi-
sions matter more in countries with weak legal environments. Firms can partially compensate for
ineffective laws and enforcement typical for emerging markets by establishing good corporate
governance and providing credible investor protection.
B.Black (2001) examined the relationship between corporate governance behavior (on the
base of corporate governance rankings) and market value for a sample of 21 Russian firms and
finds statistically strong correlation between value ratio and governance ranking, which demon-
strates that corporate governance behavior has a powerful effect on market value in a country
where legal and cultural constraints on corporate behavior are weak.
2
 Coombes P., Watson M., Campos C. E., Newell R. E., Wilson G. demonstrate the high cor-
relation between the corporate governance and valuation of the firms for a number of developed
and emerging markets. The investors are ready to pay some premiums for stocks of companies
were system of corporate governance takes into account the interests of shareholders. This pre-
mium is more under unstable economic environment.
Some interesting reviews of Russian situation should be mentioned here also. Federal
Stock Commission, Institute of Stock Market and Management and TACIS conducted joint re-
search of corporate governance problems in Russia in 2001. They prepared Reports on Corporate
governance in Russia. 60 largest Russian companies were studied within this project. The re-
search showed that Boards of directors in Russian companies do not follow the best practices on
corporate governance and demonstrate very limited influence on the corporate performance. This
situation could be interpreted as the result of insider and executive directors’ dominance and lack
of time devoted to those activities.
The questions whether Russian companies are interested in corporate governance in gen-
eral could be formulated. High level of corporate governance limits the power of firm’s top man-
agers. It is not quite clear whether Russian directors are ready to reduce their control even in or-
der to attract additional investments.
One more empirical research related to this question should be mentioned here, (S.Guriev,
O. Lazareva, A. Rachinsky and S. Tsukhlo, 2003). 1000 industrial firms – joint stock compa-
nies – open and closed – were included to the review under this research. The main aim was to
decide whether firms use components of corporate governance in practice. It turned out that less
than one half of firms use elements of corporate governance. S.Guriev and others also analyzed
the relationship between the type of corporate governance and general characteristics of the firm.
This relationship was supposed to show the existence of general factors which determine firm’s
intention to implement standards of corporate governance. The results revealed that firm’s size is
one of such factors. The bigger the firm is the lower the relative costs of corporate governance
standards introduction are.
The ownership structure is another important factor. It was discovered that the higher the
shares of managers and big external owners are the better corporate governance is. This means
that consolidation of stock gives incentives to improve corporate governance.
Unexpected absence of relationship between corporate governance and investment attrac-
tiveness was found. Partly this could be explained by the type of firms and limited information.
Our research deals with that problem, and is aimed to find out the interdependence between
corporate governance and firm market valuation.

3
 Our basic assumption is that such dependence exists. This relationship is especially impor-
tant in developing countries where even small improvements of corporate governance could in-
fluence greatly on financial indicators. Thus we try to examine the links between the level of the
corporate governance, measured in terms of national rating and market valuation of the firms
listed in the main national stock exchanges (MICEX and RTS 1).

3. Sources of information

Our research is based on data on corporate governance rating lists developed for Russian
companies. Such ratings have very short history in Russia. Several rating agencies develop their
own scales, some of these ratings use alphabetical symbols (“Expert RA”, RID), some numbers
(Standard & Poor's (S&P) for companies ranks.
Our estimations are based on rating list developed by “Expert RA” agency (National Rat-
ing of Corporate Governance). Some information on these data comes below.
Rating Agency “Expert RA” and Russian Institute of Directors in 2003 created joint ven-
ture for preparing and publishing information on corporate governance in Russian firms.
Leading companies get ranks basing on public information and special reviews data.
Corporate Governance Rating is based on the estimations of the following elements:
1. Rights and obligations of the shareholders
2. Role of stakeholders and corporate governance
3. Transparency and disclosure of information and audit
4. Board of directors (executive and non-executive members of the board, their compensa-
tion and performance)
Each company listed in the rating list can get one of the following grades depending on the
level of corporate governance:
Grade A – companies with high level of corporate governance;
Grade B - companies with average level of corporate governance;
Grade C - companies with low level of corporate governance
Grade D - companies where level of corporate governance is unsatisfactory.
Each grade (except D) is divided to three sub grades, for example grade A includes sub grades
? ++, ? + and ? .
Almost all Russian companies included in rating list got grades B and C. Only “Centrtele-
kom” company was graded as A.

1
Moscow Interbank Currency Exchange and Russian Trading System are the main places for organized stock trad-
ing.
4
 We tried to find out the relationship between the level of corporate governance and market
valuation of the firm. For this purpose we compared the national rating of corporate governance
mentioned above with another rating list – list where companies are ranked according their mar-
ket value. Such rating was prepared by “Expert RA” agency. We managed to get necessary in-
formation on 137 Russian companies.
We would prefer to use numerical ranks for our analysis but such information was avail-
able for 13 companies only. So we had to use alphabetical symbols for ranks.
We’ve chosen ?/? (price/earning ratio) and ?/S (price/sales ratio) ratios as indicators of in-
vestment attractiveness.
P/E ratio is stock price divided to earnings during last 12 months. If P/E ratio is higher
than average market level investors have high expectations on the company’s growth.
P/E ratios are rather unstable for Russian companies and they should be used very care-
fully.
P/S ratio is stock price divided to company’s sales.
Our assumption is that P/S indicator is more stable because sales are less dependent on
speculative factors which managers use in order to manipulate with data on profit shown in fi-
nancial reports which is rather typical for Russian companies.
4. Main calculations and results.
As it was mentioned above the initial sample included companies from national rating; the
number of such companies was 137. Then we selected companies for which the comparison was
possible, i.e. companies with required information on ? /? and P/S indicators. This indicators
where calculated for similar time periods; all companies are listed in the stock exchange.
As a result we’ve got a list of 82 Russian companies from different industries. All this co-
mpanies had corporate governance rank and information on ? /? and P/S meanings.
For each grade of corporate governance we calculated maximum, minimum and average
meanings of our indicators.
The results are shown in table 1 below.
Table 1.
General characteristics of P/E and P/S ratios for selected companies.
Grade of
corporate
governance ? ?++ ?+ ? ? ++
?/?
Average ?/? for 400 big Russian companies = 10.95
Average 9,05 18,21 35,42 37,60 37,3
Minimum 5,44 5,3 4,01 1,92
Maximum 61,23 325,66 180,16 212,89

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 P/S
Average ?/S for 400 big Russian companies = 1.23
Average 0,65 1,54 1,11 0,85 0,45
Minimum 0,16 0,14 0,18 0,1
Maximum 4,9 3,84 3,15 0,97
Note: 400 big companies are 400 companies with the highest market value in October,
2004.
It should be pointed out that P/E meanings are in general less than average meanings for
western companies; basing on this indicator we could conclude that Russian companies are “un-
derestimated” by investors.
P/S indicator analysis leads to different conclusion. This difference could have several ex-
planations. The incentive of Russian managers to manipulate with profit is not the main explana-
tion here. The argument that Russian stock market is not developed well and consequently the
prices of Russian companies’ stocks are lower than in the western markets also doesn’t work
here. P/S and P/E indicators are based on the same level of prices but show different tendencies.
The explanation might be related to the fact that Russian industrial markets are less com-
petitive, firms have access to cheaper resources and this makes it possible to get higher profits on
the same level of sales (sales are more profitable) comparing with western firms. We are not able
yet to give full explanation to this fact, we plan to do it under our further research.
On the next step we excluded firms which had P/E ratio about ten times higher than group
average. There were 2 such firms and both had corporate governance grade B+. So we excluded
from the sample 2 firms: “NPK Irkut” with P/E equal to 229,46 and “Kostromskaya GRES”
with P/E equal to 325,66. Table 2 contains general characteristics of the sample with out these
two extremes.
Table 2.
General characteristics of P/E and P/S ratio without extreme cases.
Grade of
corporate
governance ? ?++ ?+ ? ? ++
?/?
Average 9,05 18,21 20,81 37,60 37,3
Minimum 5,44 5,3 4,01 1,92
Maximum 61,23 81,97 180,16 212,89
P/S
Average 0,65 1,54 1,04 0,85 0,45
Minimum 0,16 0,14 0,18 0,1
Maximum 4,9 3,84 3,15 0,97

These data show surprising relationship – as grade of corporate governance becomes lower
the P/E ratio increases. At the same time variation of P/E ratio is increasing, this is reflected in
table 3.

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 Table 3.
Standard deviation of ratios.
Grade of corpo-
rate governance ? ?++ ?+ ? ? ++
Standard P/S 18,47 61,59 46,21 65,18
Deviation P/E 1,45 0,99 0,87 0,24

Standard deviation indicates the homogeneous character of the sample. Our results show
that variation is very high. P/S ratio variations become less as the level of corporate governance
becomes lower. P/E variation in general is more significant, this means that firms with similar
level of corporate governance have different attractiveness for investors.
The results show that investors are ready to pay more for the stocks of companies with
lower level of corporate governance. Companies with lower level of corporate governance are
more attractive for investors than companies with high standards of corporate governance. This
could be explained partly by the fact that companies get low rank of corporate governance when
they have nontransparent structure and reporting. But usually demand on their stock is influ-
enced by decision of interested insiders, who can get profits form stock speculations. So such
companies are low valued by external invertors but are very attractive for insiders.
It is necessary to point out that companies from different industries are included to each
group. This leads to great differences of ratios. We tired to do the same simple calculations for
the set of firms from one industry. Electrical energy and oil and gas industries were chosen as
examples. The results are presented in tables 4 and 5.
From the group of energy firms we excluded two firms – (“Irkutsenergo” from group B+
and Kostromskaya GRES from group B) with extreme meanings of ratios.
It turned out that energy companies are very different. We could not manage to get more
homogeneous data when we took firms from this industry only. It is difficult to find out any ten-
dencies for this industry.

Table 4
P/E and P/S ratios for energy companies.

Grade Average Standard deviation Number of firms in the

of cor- P/E P/S P/E P/S sample
porate
gov-
ernanc
e
? ++ 61,23 0,5 1
?+ 25,52 1,06 16,28 1,19 22
? 87,896 0,318 68,66 0,15 4

7
? ?+ 35,2 0,6 47,07 0,45 2

Other industry example looks very different (table 5).

Table 5
P/E and P/S ratios for oil and gas companies

Grade of Average Standard deviation Number of

corporate P/E P/S P/E P/S firms in the
govern- sample
ance
? ++ 7,81 1,58 1,2 0,31 3
?+ 6,33 1,34 1,41 0,88 2
? 35,79 3,09 1
? ?+ 3,25 0,49 1

Companies in this sample are more homogeneous; standard deviation is less significant
here. Only one oil and gas company (“Surgutneftegas”) has grade of corporate governance B.
Ratios for this company are very different from the others. If we exclude this company from the
analysis (this line is marked in the table) data show clear relationship between level of corporate
governance and attractiveness for investors. The higher the level of corporate governance is the
more attractive is the firm for investors. This is true for both indicators.
We also tried to compare the level of corporate governance and market value of companies.
As it was mentioned earlier we used the list of top Russian companies ranked according to their
market value. The larger is the company’s value the lower grade it gets. For each grade of cor-
porate governance we calculated average rank of market value. The results are shown in table 6.
Table 6
Level of corporate governance and market value of company.
.
Grade of corporate governance Average rank
? 42 (only one company)
? ++ 49,27
?+ 80,12
? 96,48
?,?+ 97,27
Note: We used two rating lists of companies which where developed independently. Each group
of one corporate governance grade includes firms with different ranks of market value. Thus
group B++ includes Gasprom Company which has the biggest market value and rank 1. The
same group B++ also includes another companies for example “UTair” which has market value
rank 178. We calculated average rank for each group in order to eliminate individual differ-
ences. We realize that this average very conditional but to some extent it reflects general situa-

8
tion in the group. Definite relationship could be observed – the higher the level of corporate gov-
ernance is accompanied by the higher market value.
Usually for developed markets P/E ratio is more informative as it is based on profit which
is directly related to dividends. P/S ratio is less important from this sense as sales are not so in-
teresting for investors as profit.
Russian case is very specific one; the aims of companies and managers in Russia are not
similar to western companies. We consider that in Russian P/S ratio indicates investors’ posi-
tions better. Our results show that P/S ratio demonstrates more clear tendencies than P/E. P/S
ratio slowly decreases with the decrease of corporate governance level. The variation of P/S is
much less than P/E.
We analyzed the distribution of companies according to P/S ratio within the groups of cor-
porate governance grade. 5 intervals were selected (table 7).

Table 7
Share of companies in P/S ratio intervals, %.

Grade of corporate Intervals of P/S meanings Number of

governance 0 - 0,99 1,00 - 2,00 - 2,99 3,00 - 3,99 More companies
1,99 than
4,00
? 100 1
? ++ 33,3 50 0 8,3 8,3 12
?+ 68,4 10,5 13,2 7,9 0 38
? 76,2 14,2 0 9,5 0 21
? 100 10

It is necessary to stress that we are very limited in information data and therefore could not
formulate full complete conclusions.
Nevertheless it is possible to point out following observations:
1. As level of corporate governance decreases P/S meanings become lower. This
means that most investors value companies with low corporate governance lower.
2. High P/S (more than 4) ratio could be found only in grade B ++. This grade means
rather high level of corporate governance.
3. The higher the level of corporate governance is the lower is the share low P/S
meanings. This means that inverters are ready to pay more for the better corporate
governance.
4. The lower the level of corporate governance is the smaller the variation of P/S ra-
tio is. Companies with low level of corporate governance are understood by inves-
tors homogeneously and in general get low ratios.

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 5. Conclusions

Most Russian companies are not involved in development of corporate government sys-
tems yet. At the same time national leaders and companies who are interested in investors attrac-
tion try to form norms of corporate behavior. We consider that standards of corporate govern-
ance will be adopted first of all by the firms which tend to make the list of shareholders wider.
They try to attract both foreign and domestic investors.
Research of international markets shows that investors are ready to pay more for stocks of
companies with good corporate governance system. This is not fully confirmed on Russian mar-
kets. It is necessary to take into account that information available for analysis is rather limited.
Our analysis shows that investors tend to pay less for companies with lower level of corpo-
rate governance. In other words investors are ready to pay high price for good governed compa-
nies on western markets. While in Russia they are ready to pay lower price for companies with
low level of governance. Sometimes the price could be rather high under speculative demand.

References
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