Corporate Ownership, Financial Transparency, and Access to Finance

Introduction

The private ownership of productive assets that characterizes capitalism relies on an institutional foundation nonexistent in the immediate post-communist systems. In particular, capitalist systems provide for legal protections that allow the pooling of capital with controlled risk for investors and a potentially important new source of financing for productive entities. Building those systems, however, requires reforms much deeper than stroke-of-the-pen passage of laws. Investor confidence-indeed fundamental fairness-requires corporate transparency and accountability. In the West, systems that have been in existence for centuries are yet to be perfected, a fact made clear by the wave of governance and accounting scandals that have occupied the headlines in recent years. The relative infancy of the systems in transition countries poses an even greater challenge.

This chapter uses the case studies of firms that were undertaken in each of the SEE8 (the eight countries that are the subject of this study) in the summer of 2002 and the data from the 2002 EBRD and World Bank Business Environment and Enterprise Performance Survey (BEEPS2) to examine the elements of the basic paradigm of corporate governance and access to finance, as well as the impact that both have on investment and growth in the region.1 Certain core aspects of corporate governance have been the subject of a great deal of attention since the early days of the transition-namely, the basic questions of company law, legal forms of organization, and maintenance of minority shareholder rights (see Mesnard 2001). The essence of how legal provisions influence the incentives of managers and owners in the postsocialist world is much better understood now than a decade ago. This chapter will, for this reason, not dwell on these aspects of corporate governance but will focus instead on issues of financial transparency and accountability.

As described in chapter 2, in many countries of South Eastern Europe (SEE), the principal method of privatizing firms was the management-employee buyout (MEBO), a system that left ownership primarily in the hands of insiders. The reliance on insider-centered privatization schemes left a legacy of fragmented ownership, limited incentives to restructure, and in most cases no new infusion of capital for the enterprises. In some instances, the resulting ownership structures led to fundamental conflicts of interest. In the former Yugoslav Republic of Macedonia, inter-locking ownership between banks and enterprises is reported to lead to misuse of available credit. In the countries of the former Yugoslavia, the tradition of self-management similarly led to powerful domination by employees, an effect that persists today, making fundamental restructuring and retrenchment of the enterprises more difficult. In some cases, privatization to insiders also facilitated the nontransparent award of state assets to the well connected. The informal ties between politicians and the new enterprise owners presented the fundamental conflict of interest-politicians had an incentive to use their powers for the benefit of certain enterprises, rather than for the whole of society, whereas enterprises tended to make decisions based on political, rather than profit-maximizing, criteria. Although insider privatizations are no longer the norm in some of the countries of SEE, the legacy of past decisions lingers.

The disposition of the bloated state-owned enterprises that epitomized central planning has coincided with the emergence of new firms that have provided the engine for employment, income generation, and growth in many countries. New firms and revitalized old firms alike require financing for their activities. Although the public trading of shares of corporatized enterprises potentially provides an avenue for the largest firms to raise equity capital, such firms still require day-to-day working capital. For medium-size and small companies, financing options are even more limited, and providers of debt financing require some assurances that their funds will be repaid. Systems that support financial transparency and accountability help provide peace of mind for creditors.

At first blush, the relationship between financial transparency and performance seems straightforward: Firms with more transparent finances should hav...

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