Red barons or robber barons? Governance and investment in Russian financial-industrial groups

We study the governance role of Russian financial-industrial groups (FIG) a nd their impact on the allocation of capital. We compare member firms of gr oups with a control set of firms categorized by dispersed ownership or/and management and employee control. We distinguish between hierarchical FIGs, where a bank is in firm control, and industry groups, which are looser alli ances without a common control structure. We find that investment is sensit ive to internal finance for the non-group firms. Industry group firms are n ot different from the independent firms in that respect, while there is neg ative correlation in bank-led group firms, suggesting extensive financial r eallocation and the use of profitable firms as cash cows. These results sug gest either an internal capital market which redirects finance to firms wit h better investment opportunities or opportunistic value transfers by the c ontrolling banks. We further assess the quality of the investment process i n group and non-group firms by measuring the correlation of investment with a proxy for Tobin's Q. The result supports the notion that hierarchical gr oup firms allocate capital comparatively better than other firms, presumabl y because the controlling bank has a stronger profit motive and authority. However, the extent of redistribution is such that private appropriation of value by the controlling shareholders is a serious possibility. (C) 2001 E lsevier Science B.V. All rights reserved.