Corporate Governance Problems in Kazakhstan

Synergy Partners Law Firm LLC | View firm profile

By Alzhan Stamkulov, partner, Synergy Partners Law Firm. In the course of our (Synergy Partners Law Firm) corporate law practice, we conducted legal due diligence in relation to more than 15 different Kazakhstani companies of different sectors, both large and medium-sized. Our experience helped us to identify some common problems in corporate governance. These problems can be observed by financiers, accountants and managers, but we would like to share these observations as professional corporate lawyers.

Management: loyalty or competence?

Fraud is the biggest damage to the Kazakhstani business. Every business and every company will face this issue from time to time. The fraud may appear as a commercial bribery in company procurements, in overpricing or profit stealing, insider leaks, the theft and sale of customers’ database and valuable business information to competitors. The roots of these problems lie in the lack of a competent management team in a company. And, vice versa, fraud should be considered as proof of the existence of incompetent top management in a company.

Many business owners in Kazakhstan prefer loyalty of the top management rather than its competence. Thus, they often hire their relatives, friends, or "trusted people" in order to have loyalty. Sometimes it is driven by confidentiality whenever the methods and business practices may be unethical or illegal.

Foreign multinational companies usually have stronger management teams. Foreign managers are very costly for a business, but there is a perception, that they are more competent and more loyal. As for the fraud, they solve this problem successfully. Some do it through the procedures, controls, through corporate governance, high-quality selection of staff combined with high salaries and support of a corporate culture. Other managers do it through certain business processes and HR-marketing. Some foreign companies use software solutions, for example, the ERM-systems, CRM-systems, eliminating human factor by automation of as many business processes as possible. In general, foreign companies consider fraud elimination as a challenge, and eliminate fraud successfully.

Clearly, it raises a question: why not hire foreign managers? Indeed, some foreign managers in Kazakhstan demonstrate excellent results. However, regardless of whether it is foreign or local top managers, the management team must be competent and able to defend their vision, solutions and strategic plans to beneficiaries and stakeholders. To summarize, the competence of management team comes first, and then the integration of software solutions through the optimization of business processes in a company.

Company’s value: assets or corporate governance?

Modern aggressive hedge funds in USA acquire some equity, quickly increase the company’s value with the aim to resell it later for a margin. Usually, such company later suffers from losses due to the lack of long-term plans and strategies. Essentially, the same phenomenon happens in Kazakhstan. Investors acquire a controlling stake or the whole company, appoint a management team, conduct a few changes in the company. The owners do not require management team effectiveness. In their opinion, the company's assets and management loyalty are more important than corporate governance, since in any case such company would be sold.

The basic strategy is focused on the acquisition of undervalued assets. The following M&A transaction will have a speculative nature. Investment decisions are based on the asset valuation, that is, based on the availability of the undervalued property. For example, the value of a mining company will be based on its mineral resources. In their opinion, corporate governance and management competence, as well as the business processes will not increase the company’s value. Similar situation in the companies that have assets such as business centres, hotels, warehouse, factories, agricultural land, gas stations, railway cars and tanks. Evaluation of these companies is based on the valuation of its assets and cash flows generated by these assets.

As someone observed in foreign mass media, Kazakhstan has a low corporate governance culture. We believe that most Kazakhstani business owners are mistaken about aims of corporate governance. They do not believe that proper corporate governance may increase a company’s value. In fact, corporate governance can improve the business and increase the company’s value by several times.

Here is an example. Air Astana started out with the capital of approximately US$ 10 mln in 2001. Now the company has 30 aeroplanes. Sales amounted to about $ 1 bln in 2014, while net income reached US$ 20 mln. All data about the company is available on the corporate website, in the form of annual report. The company competes successfully with foreign and local air carriers. Unlike the Russian Aeroflot, Air Astana does not receive any government subsidies. The company has increased its assets by several times through good corporate governance, and raised ten times the company value, bringing profits annually.

Companies without material assets

The phenomenon of companies with no material assets is surprising. For example, the largest and leading global taxi carrier Uber has no cars. These companies have outstanding management teams that conduct their core business with innovative technology. Innovations in corporate history have always taken place, but successful companies created an outstanding management team and thereafter focused on marketing and the development of best-selling products or services.

Now products are becoming outdated very quickly under the onslaught of technological revolutions. Video tapes, fax machines and diskettes no longer exist. The list could go further. Therefore, companies create strong management teams, introduce corporate governance, make the company transparent. In the new economy, a classic property becomes a bottleneck due to capital expenditures and operating expenses. But the main point is that new technologies will always appear and some businesses will become obsolete. The management team shall quickly identify these upcoming drastic changes and find new business opportunities. For example, a local retailer Meloman was transformed into Marvin. The economic environment does not matter, what matters is the competence of a management team.

Decisions making process: debates

In Kazakhstan there is a perception that corporate governance is the bureaucracy that slows down decision-making process, creates rigmarole, and ties the hands and opportunities for leadership and management. Kazakhstani companies try to do everything very quickly. The decision-making process is more emotional, rather than rational that requires a good judgment. In some companies, CEOs make decisions independently. But the logic of CEOs’ reasoning and justification is undocumented. Even some boards also do not record their ideas and judgments, the reasons why they have postponed or took certain actions, decisions or business opportunities.

What’s worse, collegium bodies like boards of directors have so-called “alfa” leaders that are trying to prevent a common judgment and members’ discussion, so that in most cases the company decision-making is dominated by a single person’s judgment rule. How is that bad? The management team is forced to consider and discuss an “alfa” leader’s proposal, while alternative views and offerings are not taken into account. That creates a tunnel vision for the top management team, thereby decreasing mental abilities to find solutions at management board, a board of directors, or supervisory board levels. Kazakhstan has yet to adopt the corporate culture of expressing different opinions and views. And when expressed, they are viewed as confrontation inside the top management.

To avoid an influence of a single person, OECD Guidelines offer to introduce independent directors, who must not be influenced by the shareholders or by the management board. Certain stock exchanges require that at least half of members of the board of directors are independent directors. Some business owners in Kazakhstan have distorted understanding of the role of independent directors. Large shareholders facilitate the appointment of independent directors strongly loyal to them, doing themselves a disservice. As we have seen in practice, such independent directors did not do their work. In most cases they are very passive in Kazakh companies, they do not make any contribution to the company’s business.

German co-determination laws require that in major German companies the supervisory board shall consist of employees’ representatives, so that they can influence decisions made by the supervisory board. In practice, employees are interested in stability and profitability of the company. Such employees’ representatives may be considered an opposition, whose interests and vision may not coincide with loyal members of the supervisory board appointed by shareholders.

The composition of a supervisory board or a board of directors shall lead to open and effective discussions on the most important agenda. Moreover, a simply open debate itself is not sufficient for finding appropriate solutions. We have seen the management decision of Kazakhstan companies taken in debates among 2-3 top managers or shareholders. Such decisions are taken in a truly open discussion. But in practice, such decisions were wrong. Later, important decisions would be taken in open discussions among at least 5-6 people. That increased the quality of generated decisions. The firm documented the decisions that were conducted without the pressure from shareholders or management members. The minutes of meetings mentioned the reasons and judgments for certain decisions being taken or deferred.

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