Yukos and the Wild, Wild East: Can Putin Win the Showdown?

The arrest of Russian oil tycoon Mikhail Khodorkovsky on tax-evasion and fraud charges – with the apparent approval of President Vladimir Putin, if not by his direct order – is one of those stories of intrigue and high-level maneuvering reminiscent of the days when trying to discern what went on behind the Iron Curtain was raised to an art form.

 

Wharton faculty and others offer different interpretations of the reasons for Khodorkovsky’s jailing and the potential fallout for Russian businesses and foreign investors. Should the arrest unnerve investors, or should investors be savvy enough to realize that the murky world of Russian business is anything but genteel? And what about the main players in this drama: Is Khodorkovsky, Russia’s richest man, a lawless individual who needs to be reined in by a tough leader like Putin? Or is Khodorkovsky a talented capitalist being singled out by an authoritarian regime that feels threatened by his foray into politics and bankrolling of prominent people opposed to Putin?

 

Khodorkovsky, 40, was picked up on Oct. 25 by armed authorities aboard a plane at an airport in Siberia. He was jailed on charges that include fraud, forgery, and personal and corporate tax evasion amounting to more than $1 billion. The charges against Khodorkovsky followed the July 2 arrest of another Yukos official, Platon Lebedev, on fraud charges stemming from a privatization in the 1990s. Prosecutors have frozen Khodorkovsy’s large holding of Yukos shares, leading some to fear that authorities may want to roll back gains made through privatization and democracy.

 

Following his arrest, Khodorkovsky denied the charges and resigned as CEO. A day after the resignation, Yukos named its chairman, Simon Kukes, a U.S. citizen of Russian descent, to replace Khodorkovsky.

 

The controversy is only the latest incident in a longstanding battle between Putin and Russia’s super-rich executives. In 2000, Putin reportedly met with a group of oligarchs and told them that if they meddled in politics they would risk losing their assets, but that if they stayed out of politics any sins committed in the past would be forgiven and they would be allowed to keep their wealth. Over the next few years, Khodorkovsky became a symbol of improving Russian business practices. But he also made statements critical of the government, hinted that he might retire from Yukos and run for office, and had Yukos’s lobbyists work to persuade the Russian parliament to block some changes to tax laws affecting oil companies.

 

Philip Nichols, a professor of legal studies at Wharton who visits Russia regularly to conduct research on emerging economies, believes that prosecutors are doing a necessary and important job in investigating an allegedly corrupt businessman. When Yukos went private, Khodorkovsky was said to be part of a plan to defraud the Russian government of billions of dollars, says Nichols, referring to a notorious “loans for shares” scheme in the 1990s. Banks loaned money to the Russian government in exchange for the go-ahead to manage large state-owned corporations. When the companies went private, Khodorkovsky and other well-connected figures managed the privatizations and bought shares in the firms at rock-bottom prices.

 

“Virtually without exception, they ended up selling shares in the companies to themselves,” Nichols states. “Yukos was bought for $300 million and was valued at $6 billion.” Nichols says the fact that Russian authorities are investigating Khodorkovsy and have frozen his stake in Yukos should be no more alarming than U.S. prosecutors investigating Enron or Tyco. “The U.S. busted trusts,” Nichols adds. “Teddy Roosevelt is one of the heroes of the country.”

 

Poster Boy

In more recent years, Khodorkovsky had taken steps to manage Yukos like a Western firm, adopting certain U.S.-style accounting practices and making the company more transparent. In doing so, he grew to be admired by many business people in Russia and elsewhere. But the average Russian remains contemptuous of Khodorkovsky and other oligarchs who are seen to have illegally lined their pockets with massive fortunes at the expense of the state. Nichols says Khodorkovsky became the “the golden boy of the West,” but remembers the days when Khodorkovsky was not seen as “a wonderful guy with a white hat.”

 

Northeastern University professor Daniel J. McCarthy, a leading scholar of Russian management practices and corporate governance, disagrees with Nichols on the reason for Khodorkovsky’s arrest.

 

McCarthy says a more plausible explanation is that authorities are using the investigation as a tool to clamp down on a powerful figure who poses a significant political threat to Putin and his supporters. Parliamentary elections are set for December and Putin himself faces reelection in March 2004. While Putin is not expected to lose, he nonetheless feels that it is in his best interest to clip the wings of a rival for power, according to this view. Moreover, Putin knows that many Russian voters are by no means unhappy to see one of the rich and famous behind bars. “The oligarchs are not popular at all in Russia,” says McCarthy. “They are despised.”

 

Dmitry Kulish, a Wharton alumnus who is director of business development for a Moscow industrial holding company called The Bioprocess Group, says Khodorkovsky invited investigation by his behavior. “I always was and still am very much pro-Putin,” says Kulish. “He has a tough job to do – I mean cleaning the ugly mess which we have in Russia today – and as far as I understand he does it as well as humanly possible. The Khodorkovsky situation is complex, and anyone who tries to simplify it by claiming that it is a sure start of repression and authoritative rule is either naive or an instigator. We have to keep watching further events. Only after we see what Putin does next can we make any inference.”

 

Kulish believes that Khodorkovsky is being prosecuted because Putin wants to keep anyone who is super-wealthy from holding high office in Russia, especially the presidency. “Khodorkovsky was arrested because he became politically active,” he says. “However, the true reason for his arrest is not Putin’s fear of his losing his job; it is that Putin doesn’t want Khodorkovsky to become president of Russia on general principle. If you lived in Russia, you would understand what I mean. Corruption in Russia is high, and people are politically uneducated. If you have a lot of money, you can manipulate people … You can buy newspapers and TV stations and convince people of anything. Putin is not afraid of his job. He’s afraid that Khodorkovsky might become president because of his money.”

 

Kulish says Kukes, the new CEO of Yukos, is “a leader strong and experienced enough to bring the company through this disaster,” adding that his own company has not made any changes in strategy or tactics as a result of Khodorkovsky’s detention.

 

Rattling Some Nerves

McCarthy, Nichols and Kulish say the Khodorkovsky case has rattled the nerves of many, but not all, investors. Passive investors who had little idea of the level of business corruption that exists in Russia may find themselves more worried than direct investors on the ground who have witnessed wrongdoing first-hand and took it into account before investing a dime.

 

Passive investors who own shares in Yukos may be the most vulnerable because they do not have much control. “It’s unclear how you protect yourself from risk like this,” Kulish notes. “If you live in New York and you buy Yukos, it’s difficult for you to judge if the CEO will be jailed tomorrow. These people may be scared, and they may limit their investment in Russian companies in the future. But for others the story is different. People who came to Russia already have seen the way things go on here. They can really distinguish what company is reckless and will be in conflict with the authorities and which ones are moderate and will have peace with authorities.”

 

Wharton’s Nichols says astute investors should welcome Khodorkovsky’s prosecution. “If I’m a smart business person, the arrest encourages me. It can be interpreted as a sign that Russia is moving further toward the rule of law. That will make it easier for investors to effectuate honest relationships in Russia.”

Indeed, says Dmitri Ivanov, a Wharton alumnus and native of the Ukraine, while Khodorkovsky’s arrest “has a negative impact in the short-term, it is hard to see actual investment damage in the longer run. First, Russia‘s long-term economic fundamentals remain strong – 7% annual GDP growth, a healthy trade surplus, a strong fiscal base, a soaring stock market, and more FDI in the past nine months than in the previous 12 years put together. Even after Khodorkovsky’s arrest, new investments have continued to pour into Russia’s booming economy, with Ikea committing $300 million for construction of new retail outlets, Deutsche Bank acquiring a local investment bank for $70 million, General Motors investing $60 million in production facilities and several other companies announcing new investments.” Also, he says, “investors tend to have short memories. BP and Royal Dutch, for example, were burned badly in Russian crises in 1998 only to come back now, committing 15% of their capital to projects in Russia.”

In the short run, according to Northeastern’s McCarthy, the Khodorkovsky case is going to scare off foreign investors, who in many cases were already reluctant to put money into Russia for a lot of other reasons, including a lack of corporate transparency and a legal system where some judges can be readily bribed.

 

Putin has tried to allay concerns that Khodorkovsky’s arrest portends a return to the bad old days before democracy and privatization. In remarks on Nov. 14 to a group of industrialists, Putin did not mention Khodorkovsky by name. But, according to a Reuters dispatch, Putin earned applause when he said: “A question arises whether there may be a return to the past. There will not be.”

 

Sonja Schlegel-Breemen, who runs a consulting firm specializing in cross cultural training for investors in Russia and other emerging economies, agrees. “Khodorkovsky’s arrest was not an attack on capitalism within Russia, but rather an attempt to show Yukos’s former CEO his place for political reasons. Looking at it from a cross-cultural perspective, this move was to ensure Putin’s standing as the leader of the country, and not to undermine FDI into Russia.”

 

Ivanov suggests that foreign observers who “shuddered … at the repercussions of Yukos’ stock seizure” failed to realize what the repercussions would have been if the authorities hadn’t acted. “More than 80% of Yukos stock is held by insiders. [After the investigations began], Yukos’ board announced an extraordinary dividend of $3 billion – a four fold increase in a year. The authorities took possession of the stock to avoid seeing the company’s cash being siphoned abroad … Imposing market regulation and having the stomach to challenge perpetrators is a welcome sign of market surety,” Ivanov says.

 

How will the Khodorkovsky affair play out?

 

Sheila M. Puffer is professor of international business at Northeastern and co-author with McCarthy of the forthcoming book, Corporate Governance in Russia. In a telephone interview from Boston during a break at a Nov. 14 symposium on Russian business, she noted that some attendees thought Khodorkovsky would be imprisoned at least until the end of the year and possibly through the presidential election in March.

 

“I wouldn’t be surprised if Khodorkovsky didn’t declare his run for the presidency from his cell,” says Puffer. “That would be a way for him to keep himself in the press. He doesn’t stand a chance of being elected, of course, but the main reason he was imprisoned is the oligarchs weren’t supposed to challenge Putin’s political leadership. It’s not about fraud and tax evasion.”

 

As far as Yukos itself is concerned, those interviewed say Kukes is a seasoned leader who will have to use all of his talents to keep the company on track in the months to come as important strategic issues for the company are decided. Khodorkovsky had been negotiating with ExxonMobil and ChevronTexaco to sell as much as 40% of Yukos. What’s more, Yukos has expressed support for additional Russian oil exports to the United States, which has long wanted to become less dependent on petroleum from the Middle East. Russia’s oil is increasingly vital to the world economy. Saudi Arabia remains the world’s biggest exporter of oil, but Russia recently eclipsed Saudi Arabia to become the world’s top oil producer.

 

“My immediate reaction [to the arrest] was that this isn’t going to affect the day-to-day management of Yukos,” Puffer says. “In terms of its strategic plans, Yukos wants to team up with a Western partner, but I don’t know how that’s going to play out. Russian companies are highly centralized and delegation [of authority] is not [one of their] strong suits. And it may be that this detention could deal a blow to the company’s strategic initiatives.”

 

Memos from Jail

McCarthy says it is quite possible that Khodorkovsky will, through a Yukos attorney, continue to exert some control over Yukos from his jail cell. But he thinks that Yukos will largely remain in a “holding pattern” until Kukes and other executives see how the Khodorkovsky matter unwinds. “I don’t think we’ll see any strategic moves being made,” says McCarthy. “But I can’t imagine Khodorkovsky would be … unable to at least communicate a general direction for Yukos.”

 

Kulish, the Moscow businessman, says the worst-case scenario would be if authorities launched widespread prosecutions of more business people as a method of blackmail and intimidation. “That would indeed destroy the current business growth and optimism in Russia. It would be really bad. I would probably hate Putin for that. But so far it is not happening. It is Putin’s job to make sure it does not happen. I and my company as well as many Russians and foreigners hope that he does this job.”

 

For his part, Nichols says Putin will be vindicated in the end because the prosecution of Khodorkovsky is a legitimate attempt to crack down on corporate corruption. Nichols points to recent comments in the Russian press by former Soviet premier Mikhail Gorbachev, who expressed surprise that some in the Western news media would interpret the investigation of an oligarch with a history of shady business practices as an attack on Russia’s nascent democracy.

 

“According to surveys,” says Nichols, “most Russian people think this is a prosecution of a guy who did some pretty heinous stuff.”

Citing Knowledge@Wharton

Close


For Personal use:

Please use the following citations to quote for personal use:

MLA

"Yukos and the Wild, Wild East: Can Putin Win the Showdown?." Knowledge@Wharton. The Wharton School, University of Pennsylvania, 03 December, 2003. Web. 23 November, 2017 <http://knowledge.wharton.upenn.edu/article/yukos-and-the-wild-wild-east-can-putin-win-the-showdown/>

APA

Yukos and the Wild, Wild East: Can Putin Win the Showdown?. Knowledge@Wharton (2003, December 03). Retrieved from http://knowledge.wharton.upenn.edu/article/yukos-and-the-wild-wild-east-can-putin-win-the-showdown/

Chicago

"Yukos and the Wild, Wild East: Can Putin Win the Showdown?" Knowledge@Wharton, December 03, 2003,
accessed November 23, 2017. http://knowledge.wharton.upenn.edu/article/yukos-and-the-wild-wild-east-can-putin-win-the-showdown/


For Educational/Business use:

Please contact us for repurposing articles, podcasts, or videos using our content licensing contact form.