The Reach of Law into the Enterprise in Transition
Ref. no. 680-90
As early as July 1988 Mikhail Gorbachev used the notion of the rule of law as a rallying cry for legal reform in the Soviet Union. Establishment of the rule of law was similarly espoused as a fundamental goal during the Eastern European revolutions of 1989. It has ranked as high as stabilization and privatization among the priorities of the leading reformers and their foreign advisers, but it is typically more elusive.
In a market setting the rule of law is important to governments because it enhances the credibility of policymakers by placing restraints on their ability to arbitrarily reformulate policies. It is also critical to firms. Laws provide standards of conduct that can coordinate behavior and reduce transaction costs.
The purpose of this research is to understand the part that the rule of law plays in economic relationships in Russia and, by implication, in other reforming socialist economies. Using original survey research, it is examining the usefulness of laws and legal institutions to firms in organizing themselves and their relationships with other firms. This work focuses primarily on three bodies of law--contract law (including law on secured instruments), antitrust law, and company law.
Collection of data from 1,200 managers and legal experts in 300 firms in six regions of Russia should be completed by September 1997. In a pretest of the survey instruments, completed in the spring of 1996, 60 managers and legal experts in 15 firms in Yekaterinburg and Moscow were interviewed. Evidence from this pretest suggests several interesting preliminary conclusions.
Firms appear to have fairly good access to information about new laws and to legal institutions in both Yekaterinburg and Moscow. All the enterprises visited have in-house legal expertise. Half have relationships with external lawyers, typically in connection with foreign activities. All subscribe to the standard printed sources of legal information, and 75 percent subscribe to computerized databases that are updated regularly.
The willingness of enterprise managers to maintain a legal department and to purchase a database suggests that they attach importance to obtaining up-to-date information about law. Yet although the legal departments serve as the main conduit for information about laws and legal institutions, they are not well integrated into the business life of enterprises. Representatives of legal departments do not regularly advise management about the consequences of proposed actions. Lawyers, whether in-house or external, do not play an active part in negotiating contracts, in restructuring relationships, or in corporate governance. Their functions are more technical, such as producing standard form contracts or verifying the legality of contracts negotiated by others.
Firms routinely use courts to settle disputes, apparently without large cost to their business relationships. But legal institutions do not appear to provide an adequate foundation for relationships. Court decisions often are not enforced, and norms necessary to increase contract compliance and reduce enforcement costs appear to be inadequate. Firms' routine use of courts appears to be a consequence of historical practice rather than of a deliberate strategy to use law and legal institutions to further their interests.
Despite the availability of legal information, managers and legal experts in firms are unfamiliar with important aspects of contract, antitrust, and company law; in most cases their knowledge of the law cannot be distinguished from random guesses. Respondents are more familiar with historical laws than current ones and often confuse the two.
Moreover, many of the economic institutions commonly thought of as ensuring compliance--cross-ownership, common membership on boards of directors, common membership in business associations, and common banks--appear to be absent or unimportant. Market power appears to be diminishing. So mutual economic dependence no longer appears to be an adequate mechanism for ensuring contractual performance. Social institutions commonly thought of as facilitating relationships between managers of different firms--common university affiliation, religion, national or ethnic group, or membership in a civic association--also are either absent or unimportant.
In the absence of legal and related institutions to support transactions, most contractual relationships appear to be based on historical relationships. Many relationships, particularly newer ones, are supported by the use of payment terms, such as prepayment, generally viewed as costly. Private security firms are widely used for enforcement.
What is the apparent consequence of these institutional problems? No complex transactions were observed, despite an attempt to do so. Thus the absence of social, economic, and legal institutions to support transactions appears to undermine the ability of firms to undertake certain potentially important transactions.
Responsibility: Policy Research Department, Finance and Private Sector Development Division--Randi Ryterman (rryterman@worldbank.org). With Peter Murrell, University of Maryland; Barry Ickes, Pennsylvania State University; Kathryn Hendley, University of Wisconsin; Barbara Weber, Harvard University; Alla Mozgovaya, Institute of Sociology, Moscow; and Valery Makarov and other economists at the Central Economics and Mathematics Institute, Moscow. The National Council for Soviet and East European Research is providing funding for the research.
Completion date: June 1998.
Report:
Hendley, Kathryn, Barry W. Ickes, Peter Murrell, and Randi Ryterman. 1997. "Observations on the Use of Law by Russian Enterprises." Post-Soviet Affairs 13(1):1941.
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