Corporate Governance Cycles during Transition: Theory and Evidence from the Baltics

We begin by identifying a typical governance life-cycle, defined as changes in ownership structure, and including both the identity of the major owner and ownership concentration. The cycle is marked by key events and phases including start-up, initial growth, mature growth, and possibly a crisis and restructuring stage or exit stage. The governance cycle for transitional countries reflects some specific characteristics – e.g. often privatization produces specific initial ownership structures, with an unusually high proportion of insider, especially, employee ownership. Subsequently pressures for restructuring produce strong impulses for ownership changes. There is limited possibility for external finance because of the embryonic development of the banking system and the capital markets during early transition. The governance cycle is also influenced by specific features of the institutional, cultural and economic environment in a country. The varying importance of these factors is expected to produce differences in key features of ownership cycles such as the speed at which particular ownership changes occur. To provide simple hypothesis tests, we use new and rich enterprise panel data sets for the three Baltic countries. The data enable various measures of ownership to be constructed (including the identity of major owners and ownership concentration). The empirical analysis covers the ownership cycle with emphasis on initial ownership and subsequent changes. Our key method is to assemble a series of transition matrices showing both starting and final ownership configurations for sample enterprises and to simultaneously provide information on changes in concentration for the largest single owner. For Estonia this is supplemented with an analysis of the frequencies of different ownership-cycles including intermediary stages of ownership. In spite of important differences in institutional development, especially concerning the privatization process, we find that governance cycles are broadly similar in all countries. Employee ownership is rapidly fading and mainly being succeeded by managerial ownership. There are changes back and forth between manager and domestic external ownership, while foreign ownership is quite stable. Ownership concentration is mostly increasing after privatization, which included diversification both to employees and external owners. Since ownership diversification did not sit well with the slow development of the institutional framework, as expected we see a subsequent concentration of ownership on both managers, external domestic and foreign owners. However, variation in institutions, there are also important differences across countries. The adjustment of ownership structures is faster in Estonia and this can be explained by the relatively fast pace of institutional change and evolution of important governance institutions, including tough bankruptcy legislation and advances in the financial system.