JULY 10, 2001
MALCOLM S. SALTER
OAO YUKOS Oil Company
As Mikhail Khodorkovsky, CEO of Russia‘s second largest oil company, seated himself at the
head of the conference table, the sprawling map of the Russian Federation framed just above his head
lent an air of magnitude to the occasion. He greeted the team of YUKOS‘s senior executives in front of
I want to thank everyone here for the tremendous progress that we have made over the
past 12 months. We have just announced over $2.5 billion in net profit for 2000, our stock price
is up over 1,000%, and the State of Wisconsin just bought 1% of our stock. Our recent
corporate governance program aimed at winning back investors is unprecedented in Russia.
It is only February 2001—less than a year since we introduced our comprehensive new corporate governance program—and our work is far from done. Our stock price remains at a steep discount to not only the Western majors and other emerging markets oil companies, but
even to our Russian oil competitors. The major question before us today is to determine what
additional corporate governance measures need to be taken in order to get the market to value
As the executives assembled it was apparent that, despite their pride in what had been
accomplished over the last year, there was a distinct feeling of frustration. So much had been done to
sell the YUKOS story to the market, and now the company‘s stock price appeared to have hit a bit of
1Meanwhile, just across downtown Moscow, Dave Neill, head of equity research for the oil and
gas sector at a leading Russian investment bank, was pondering much the same questions. YUKOS
had been his prize holding for 2000, but after so much price appreciation, was it time to sell? Or,
should he increase his YUKOS position? After all, it was still trading at a sizable discount to its
Russian oil peers.
In general, Dave had always had a difficult time evaluating YUKOS. Based purely on its oil
reserves, EBITDA and production costs, it was a clear winner. But, conventional valuation analysis
ignored the company‘s corporate governance risks. Here, Dave was torn:
1 Disguised name.
________________________________________________________________________________________________________________ Joshua N. Rosenbaum (MBA ‗01) prepared this case under the supervision of Professor Malcolm S. Salter. HBS cases are developed solely as the basis for class discussion. Cases are not intended to serve as endorsements, sources of primary data, or illustrations of effective or ineffective management. Copyright ? 2001 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-7685, write Harvard Business School Publishing, Boston, MA 02163, or go to http://www.hbsp.harvard.edu. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of Harvard Business School.
On the one hand, I respect YUKOS‘s progress on the corporate governance front and I
believe that Khodorkovsky is trying to build an internationally recognized and respected oil 901-021 OAO Yukos Oil Company company. But, the company‘s ownership structure, which is dominated by a core shareholder
group, is still an issue for me.
Like the YUKOS team, Dave reflected on what corporate governance changes he would need to
see before he could recommend a significantly higher target stock price.
Corporate Governance in Russia
The Magnitude of the Problem
Russia largely caused the creation of the phrase „corporate governance abuse‟ and acquired a reputation for 2being an especially high-risk place in which to do business.
Russia ranked dead last in a [November 2000] survey of corporate governance practices in 25 emerging 3markets—well below places like Indonesia and Thailand.
For equity analysts covering Russian stocks, the quality of a company‘s corporate governance was
a top priority. It was examined and rated with the same depth as production costs, financial
projections, and the management team. Most Russian investment banks featured a proprietary
methodology for rating the corporate governance of those stocks within their coverage. (See
In emerging markets in general, where information flows were less efficient, regulatory controls
and enforcement were weaker, and shareholder rights were less respected, potential investors were
subject to significant corporate governance risks. In post-soviet Russia, however, corporate
governance abuses were taken to a new level, plaguing even the highest-profile blue chip companies.
Investors—many of whom had experience in frontier markets—were left powerless as large
blockholders diluted their shares, denied them access to shareholder meetings, and engaged in
myriad forms of self-dealing such as asset-stripping and transfer-pricing that destroyed the value of
4their holdings. Appeals to local courts and authorities exacerbated rather than eased their problems:
―[There is] a fundamental weakness in Russia—the rule of law is not universally respected and applied. All are not equal before the law and all too often the courts get lost in the detail of a case and 5then are guided by vested interests rather than any sense of justice.‖
Over the long-term, however, the Russian economy in aggregate had endured much greater losses
than those of spurned investors. Russia‘s foreign direct investment (FDI) lagged far behind that of its
2 Troika Dialogue: Russian Oil and Gas Sector, February 2001, p. 2.
3 Bernard Black, ―Does Corporate Governance Matter? A Crude Test Using Russian Data,‖ Stanford Law School Working Paper No. 209, December 2000, p. 4.
4 According to Bernard Black in ―Russian Privatization and Corporate Governance: What Went Wrong?‖ (Stanford Law Review, Working Paper No. 178 , August 1999 draft, p. 3), self-dealing refers to ―transactions between insiders and the company, in which the insiders profit at the company‘s expense.‖
5 Yevgeniya Borisova, ―Squabbles for Control Shaking Up Investors,‖ The Moscow Times, November 2, 1999, p. 2. 2
much smaller Central European neighbors such as Hungary and Poland—in 1998, its gross FDI as a 6 The country‘s percentage of GDP was 0.4% as opposed to 2.3% and 2.5% for Hungary and Poland.OAO Yukos Oil Company 901-021 market capitalization also traded at a huge discount. Valued at roughly $50 billion in early 2001, the
entire Russian stock market—which included some of the world‘s largest oil and gas producers—was
worth roughly half of Nokia‘s market capitalization. This was particularly poignant for Russians
because Nokia is located in neighboring Finland, which was once under the dominion of the Russian
empire. Looked at from a different angle, Belgium‘s market capitalization per capita was 54 times
that in Russia (see Exhibit 2). In short, as one Russian bank noted:
Corporate governance violations have a detrimental effect that extends well beyond the
corporation itself. Corporate governance enforcement, or the lack of it, is a dominant indicator
of real productive investment. Without such investment, an economy will collapse. Russia‘s
7current economic [trouble] is partially the result of its appalling corporate governance record‖
Sources of Russia‟s Corporate Governance Problem
Explanations as to why the corporate governance problem was so acute in Russia vary widely
from the historical to the sociological to the legalistic. Nearly all critics, however, placed much of the
blame on the country‘s privatization program. Designed to be quick and transformational, the
Russian mass privatization program certainly met these criteria. From 1992-1993 the vast majority of 8Russia‘s industrial base (roughly 15,000 enterprises) moved from state to private ownership.
Mass privatization problemsThe speed and magnitude of this privatization effort, however,
spawned two major systemic problems. First, in order to gain the rapid consent of soviet directors
and employees, the state was forced to give them enormous incentives—namely majority blocks of shares. Therefore, a new class of owner-managers was created from the sea of old directors. A
typical ownership structure for a Russian company that underwent the mass privatization process 9included a greater than 60% share for management and employees. These large share blocks were essentially controlled by the managers because Russian employees were historically deferential to
their enterprise directors and were generally uninformed about corporate rights and processes. This
was problematic because the former soviet directors were hardly the cadre of managers who could be
expected to turn around Russia‘s ailing industrial base. Furthermore, even assuming that these
managers were talented enough to create globally competitive firms, how many of them would
choose the longer-term, uncertain restructuring path? As Bernard Black, legal expert on Russian
corporate legislation and behavior, wrote:
[W]e don‘t doubt that privatization gave managers incentives to make profits. The harder
question . . . was how many managers would choose, or were capable of, profiting by
improving their business; versus how many would devote their efforts to stealing the value
10that the business still had.
6 World Bank website, World Development Indicators database.
7 Troika Dialog:Corporate Governance in Russia, May 1999, p. 1.
8 Bernard Black, ―Russian Privatization and Corporate Governance: What Went Wrong?‖ p. 14. 9 Joseph Blasi, ―Corporate Ownership and Corporate Governance in the Russian Federation (Rutgers University, 1996), pp. 1-2.
10 Bernard Black, ―Russian Privatization and Corporate Governance: What Went Wrong?,‖ p. 16.
Second, in order to capitalize on the political leverage of the early post-soviet years, the mass
privatization program was rushed into operation before the creation of a solid regulatory and legal
framework. This vacuum fed the temptation for the new class of owner-managers to expropriate 901-021 OAO Yukos Oil Company
company value for themselves. Fundamental laws governing corporations and capital markets, as 11well as a Russian Federal Commission for Securities Markets (FCSM), were not established until 1994 and beyond. Similarly, the court system was woefully corrupted and inexperienced in
adjudicating corporate matters. By the time these institutional issues began to be addressed, abusive
corporate behavior had already brought financial payoffs to company managers, thereby reinforcing
Loans-for-Shares: Auctioning off Russia’s crown jewelsThis backdrop of powerful owner-manager groups, self-dealing, and poor transparency set the stage for the most controversial
episode in Russia‘s transformation to a market economy—the so-called ―Loans-for-Shares‖ program in late 1995. By the end of this program, Russia‘s most coveted assets—those companies that had been kept out of mass privatization for ―strategic‖ reasons—were under private ownership. Furthermore, they were sold off for prices at fractions of their market value at closed auctions, in
which foreigners were prevented from participating. While the state‘s motivation for Loans-for-
Shares continued to prompt great debate, the process was clear.
During the summer of 1995, Russia‘s most powerful and well-connected businessmen were involved in intense negotiations with the Russian Prime Minister and the State Privatization
Committee regarding the privatization of Russia‘s bluest chip companies. These talks culminated on
August 31 when Yeltsin signed Presidential Decree 889, thereby creating the legal basis for a Loans-
For-Shares program. In accordance with this decree, the Russian government would auction off the
rights to manage the state‘s shares in select companies in the oil, metals, and telecoms sectors. In
return for the right to manage these shares, the state would receive loans for which the companies‘
shares were pledged as collateral. These loans were low interest and came due in September 1996, at
12which time the state would either have to repay them in full or forfeit its shares in the companies.
With the government‘s coffers empty, it was well understood at the time that the government had
little chance of repaying these loans. Therefore, winning the right to manage the shares was
tantamount to securing ownership.
Another key aspect of Loans-for-Shares was the fact that those banks chosen to auction off the
rights to manage the blue chips‘ shares were controlled by the same businessmen who had been
negotiating with the Russian government to buy these companies. Unsurprisingly, these banks
proceeded to sell the management rights to, and effectively, the companies to themselves and affiliate
companies at bargain basement prices. A 38 % stake in Norilsk Nickel, the world‘s leading producer
of nickel and platinum, changed hands for $170.1 million. A majority stake in a Siberian oil company
called Sidanco was sold off for $130 million. To put this in perspective, two years later British
13Petroleum paid roughly $550 million for a 10% stake in this same company.
It was under these circumstances that YUKOS, a Siberian oil company with huge proven reserves
and considered to be the second biggest prize on the block (behind Norilsk Nickel), passed into
private ownership. On December 8, 45% of YUKOS was sold to a company controlled by Menatep
Bank for $159 million. The same company received another 33% of the oil company in return for the
11 Designed to be the functional equivalent of the U.S. Securities and Exchange Commission.
12 Chrystia Freeland, Sale of the Century (New York: Crown Publishers, 2000), p. 180.
13 Ibid, p. 183.
14 This investment commitment to invest an additional $150 million in the company in the future.obligation was eventually increased, bringing the entire YUKOS purchase price to roughly $350-$400
OAO Yukos Oil Company 901-021 million. Menatep Bank was owned and run by Mikhail Khodorkovsky.
Despite the fire-sale prices, there were strong advocates for the Loans-for-Shares program,
especially from among Yeltsin‘s reform elite—the party of power in the mid-1990s. Throughout 1995,
the country was reeling from a bloody, unpopular war in Chechnya, economic conditions were poor,
and the state was in dire need of money. With parliamentary elections approaching in late
December and presidential elections to follow in June 1996, the resurgent Russian Communist Party
and right-wing nationalist parties were at historic highs in the polls. There was a sense of urgency in
Yeltsin‘s administration as he solicited campaign support from Russia‘s business elite, which had
much-needed cash as well as control over the nation‘s leading nonstate television stations and
newspapers. Yegor Gaidar, former prime minister of Russia in 1992 and architect of Russia‘s first free
market reforms, said in 1998: ―I understood the Loans-for-Shares program perfectly well. The Loans-for-Shares created a political pact. They helped to ensure that [the Communist Party] did not come to
15the Kremlin. It was a necessary pact.‖
Loans-for-Shares solved three additional tricky political problems for Yeltsin‘s team. First, it
enabled the state to get these large assets—which were piling up debt, draining the state budget, and
being run into the ground—off its books quickly. As Khodorkovsky said regarding his purchase of
YUKOS: ―Yes, the price was low - $400 million—but I was taking on $3 billion of debt. In East 1617Germany [the Treuhand] sold such companies for one dollar.‖
Second, in a time of nationalistic uproar and budget deficits, the program provided a way for the
state to get a quick cash infusion from domestic sources—that is, without having to give up ownership of the country‘s prime assets to foreigners. And, third, Loans-for-Shares served to get these companies out of the hands of the old soviet directors and under the management of Russia‘s
most accomplished businessmen, where they were more likely to be successfully restructured.
By 2001, YUKOS had become not only a giant of the Russian oil industry but was among the top
nonstate-owned oil producers in the world, turning out 1.1 million barrels per day. Furthermore,
YUKOS‘s proven reserves of 11.4 billions of barrels of oil put it on a par with Exxon Mobil and 18significantly ahead of Shell and BP Amoco. (See Exhibits 3a and 3b.) Within Russia—the world‘s
third leading oil-producing country in 1999 (see Exhibit 4)—YUKOS was the second largest oil 19company in terms of proven reserves and annual oil production, and number one in refining. By
most accounts, it was the best-managed oil company in Russia, with lower extraction and production
14 Ibid, p. 186.
15Ibid, p. 171.
16 The German privatization agency charged with selling off East German assets after reunification.
17 Simon Pirani, ―Oligarch? No, I‘m Just an Oil Magnate . . .,‖ The Guardian, June 6, 2000. 18 From YUKOS company documents.
19 Dean Gaddy, ―Fresh Opportunities Arise in Russia as Country‘s Oil Majors Respond to Lessons Learned from the 1990s,‖ Oil & Gas Journal, February 28, 2000.
20costs than those of its chief domestic rivals. YUKOS‘s prospects were bolstered by the fact that independent experts believed that the company had an additional 5.1 billion barrels of oil reserves
901-021 OAO Yukos Oil Company (for the time being, categorized as ―probable‖). Furthermore, due to its 2000 production growth rate 2122of 11.4%—the highest among all Russian oil companies—and projected 2001 growth rate of 14%,
YUKOS was closing in on the Russian number one oil producer Lukoil.
YUKOS was structured as a holding company comprised of numerous subsidiaries, including
four primary oil-producing companies, four refineries and a string of sales and marketing companies.
(See Exhibit 5.) Of these subsidiaries, its most valuable were the three oil production units
Yuganskneftegaz, Samaraneftegaz, and Tomskneft—which combined had over 11 billion barrels of oil reserves. Prior to 1999, each of these three subsidiaries featured sizable minority (i.e., non-YUKOS)
stakes due to the fact that they were partially privatized in 1994 before controlling share packets were
sold to Menatep during Loans-for-Shares. By the end of 1999, YUKOS had increased its ownership in
23these subsidiaries to 90%.
Mikhail Khodorkovsky and MenatepIn order to understand YUKOS, one must start with its founder and current CEO, Mikhail Khodorkovsky, who was born in Russia in 1963. An intelligent,
hard-working man, Khodorkovsky graduated first in his class of engineers at the prestigious
Mendeleev Institute in Moscow. Refused a plum posting at a top defense plant, Khodorkovsky
founded one of the first private banks in Russia in the late 1980s. With Khodorkovsky at the helm,
this bank—named Menatep in 1989—flourished during the chaotic market transition period of the 24late Gorbachev years.
By 1992, Menatep was well positioned to pick and choose among the more attractive enterprises
offered under the mass privatization program. Gradually, Menatep developed into a broad
industrial conglomerate that provided financial services to its holdings. In late 1995, Menatep
capitalized on the enormous opportunity offered by Loans-for-Shares and then set about growing 25YUKOS, accumulating 90% of the parent company‘s shares by 1997.
Later in 1997, Menatep raised $236 million in loans from German, Japanese, and South African
banks—West Merchant Bank, Daiwa, and Standard Bank, respectively—pledging shares in YUKOS
as collateral. This debt proved ill-timed when in August 1998 Menatep was shaken by Russia‘s
financial crisis. Shortly thereafter, Menatep was forced to default and the three banks immediately
claimed their aggregate 32% share of YUKOS.
The corporate governance controversyIn early 1999, with Russia‘s domestic finances in disarray and oil prices reaching a low of $10 per barrel, YUKOS set out upon a strategy of rapid
consolidation of its subsidiaries—in particular its prime oil production units Yuganskneftegaz,
20 Emerging Markets Investor, November 9, 2000.
21 As presented by Mikhail Khodorkovsky on May 15, 2001 in Moscow. (Note: Surgut was second with an 8% 2000 production growth rate, while Lukoil had a modest 1.4% production growth rate in 2000.)
22 Renaissance Capital Russia Research: YUKOS, March 2001, p. 35.
23 Troika Dialog Research: YUKOS Company Report, November 15, 2000, p. 3.
24 Pirani, The Guardian, June 4, 2000.
25 Brunswick UBS Warburg: The Russian Oil Industry, November 16, 2000, p. 31.
Samaraneftegaz, and Tomskneft. The strategy was as complex as it was brazen. At a round of
extraordinary shareholder meetings (EGMs) in March 1999, YUKOS approved massive share OAO Yukos Oil Company 901-021 issuances of its subsidiaries‘ stock to a variety of offshore companies in Cyprus, the Isle of Man, the
Virgin Islands, the Bahamas and the Marshall Islands. All of these companies were widely believed
by the financial community to be owned by YUKOS. While YUKOS denied control over them, a
senior manager suggested that they were ―business partners‖ that shared YUKOS‘s strategic vision
for the company. By the end of March 1999, minority shareholders saw their holdings in the 26 Many minority shareholders expressed their subsidiaries reduced from 37%-49% to 14%-17%.frustrations, as follows:
You might ask why minority shareholders didn‘t simply vote down [these share issuances]
at the EGMs. After all, their collective stake in each of the companies exceeds the 25% needed
to block such unfavorable actions under Russian law. Well…the minority shareholders were
barred at the door by YUKOS security personnel and a local court marshal who were
purportedly carrying out the order of a judge in an action to which the minority shareholders 27were not a party, nor even advised of. . . .
Similarly, at the Tomskneft EGM, some shareholders alleged that YUKOS changed the event‘s 28location without notice so that unwanted shareholders physically could not attend.
YUKOS countered that these moves were necessary because minority shareholders refused to
cooperate with YUKOS‘s planned consolidation and restructuring—a strategy that YUKOS felt was critical at the time in order to ensure long-term competitiveness. In fact, low oil prices during 1998
and early 1999 sparked a flurry of merger and restructuring activity in the global oil industry as the
oil majors scrambled to cut costs. This period spawned two mega-mergers, namely BP‘s acquisition of Amoco and Exxon‘s union with Mobil.
YUKOS further defended its share issuances by claiming that one western minority shareholder
(with 10%+ holdings in each of the subsidiaries) was intentionally refusing to cooperate with the
parent company in order to force it to buy him out at an inflated price—thereby committing a form of
29―greenmail.‖ Khodorkovsky alleged that this shareholder was demanding $700 million for his 30stakes and was threatening to obstruct management unless his price was met. A YUKOS
spokesman said at the time, ―The essence of this conflict is, the [western minority shareholder] has 31resorted to greenmail tactics toward YUKOS.‖
Meanwhile, minority shareholders learned about two additional objectionable resolutions that
were approved at the March EGMs. First, shareholders found that the new stock was sold not for
cash, but for promissory notes (IOUs) from other YUKOS subsidiaries, with a maturation date in 2003.
26 This data comes from two sources: 1) Troika Dialog: YUKOS Company Report, November 15, 2000, p. 16; 2) David Hoffman, ―Out of Step with Russia?,‖ The Washington Post, April 18, 1999.
27 Excerpt from remarks by Michael Hunter, President of Dart Management, June 1, 1999.
28 Troika Dialog: YUKOS Company Report, November 15, 2000, p. 16.
29 Technically speaking, this was not actually greenmail, which involves a minority shareholder who is seeking to take over the company. The Dictionary of Finance and Investment Terms defines greenmail as ―payment of a premium to a raider trying to take over a company through a proxy contest or other means.‖ (Note: All YUKOS comments referring to ―greenmail‖ were made prior to December 1999.)
30 Jim Landers, ―Russian Roulette,‖ The Dallas Morning New, May 21, 2000.
31 David Hoffman, The Washington Post, April 18, 1999.
Therefore, the subsidiaries would not receive any cash or working capital from the issuances. Second,
YUKOS had approved a measure authorizing its subsidiaries to sell oil for $1.50 a barrel over the next
three years (the current price was $13 per barrel), presumably to offshore oil trading companies 901-021 OAO Yukos Oil Company
controlled by the YUKOS parent. These trading houses would then resell the oil at world market
prices for a huge profit.
YUKOS defended the above moves—which many denounced as blatant acts of share dilution and transfer-pricing—as necessary in order to avoid the smothering and arbitrary Russian tax
32authorities. By minimizing up-front cash income and moving profits offshore, YUKOS argued that
it had actually mitigated the subsidiaries‘ tax burden by tens of million of dollars, thereby creating
significant shareholder value. As CEO Khodorkovsky said, ―As long as the tax regime is unjust, I will 33try to find a way around it.‖
Unconvinced by the above arguments, the foreign minority shareholders in the three YUKOS
subsidiaries appealed to the Russian Federal Commission for Securities Markets, the country‘s
market regulator, to refuse to register the new share issuances. Simultaneously, they launched a
massive PR campaign against YUKOS in the international and Russian press. During the spring and
summer of 1999, full-length articles condemning YUKOS for its poor corporate governance practices
appeared in The Wall Street Journal, The New York Times, and the Washington Post. The investors
appealed to the United States Government, the World Bank, the OECD, and the EBRD for assistance.
They also sent letters condemning YUKOS‘s treatment of shareholders‘ rights to major western
institutional investors, funds, and banks with interests in emerging markets.
In June 1999, YUKOS shares were trading at 15? apiece, down 98% from their high of $6 just two
34years earlier. In overall value terms, YUKOS‘s market capitalization fell to $335 million from as 35high as $13.5 billion in late 1997. By contrast, BP Amoco had a 1999 market capitalization of over 36$180 billion, while Exxon Mobil‘s 1999 market capitalization was roughly $250 billion. In terms of
P/E ratios, YUKOS‘s 1.3 ratio in June 1999 was extremely low even in comparison with the 6.8 ratio 37that its liquid Russian oil sector peers had at the time. BP Amoco‘s average 1999 P/E ratio was 27.9 38and Exxon Mobil‘s was 31.8.
The turning pointIn the latter half of 1999, YUKOS was at a crossroads. Consolidation,
though still contested, was complete and the company‘s business prospects were looking up as oil
prices rose sharply—by 2000, the price per barrel of oil had doubled to nearly $30. (See Exhibit 6 on
world oil prices.) With its shares priced so cheaply, many financial advisers recommended that
32 At the time, Russian taxes were often taken as a percentage of revenue. Furthermore, it was technically possible for the corporate tax rate in Russia to exceed 100% of revenues under certain circumstances. A crude example: suppose that for a given company, the tax code requires that 50% of revenues goes to the federal government, 25% goes to a special war veteran fund, 20% goes to pensioners and 15% goes to a social protection fund. The resulting composite tax rate would be 110% of revenues.
33 Pirani, The Guardian, June 4, 2000.
34 Alan Cullison, ―Vanishing Act: How Oil Giant YUKOS Came to Resemble an Empty Cupboard,‖ The Wall Street Journal Europe, July 15, 1999.
35 Troika Dialog: The Perception and Cost of Corporate Governance Risk, February 2001, Section 4 (7). 36 Wall Street Journal Online, www.interactive.wsj.com.
37 Jeanne Whalen, ―Russia‘s YUKOS Posts a Strong ‘99 Profit,‖ The Wall Street Journal, July 15, 2000. 38 Brunswick UBS Warburg Russia Equity Research: The Russian Oil Industry, January 19, 2001, p. 9. 8
YUKOS‘s core shareholders take the company private in order to reap the cash windfalls that were
pouring into the company. OAO Yukos Oil Company 901-021
YUKOS‘s core shareholders, however, decided to keep the company public. CEO
An oil company has a special responsibility to society because its output is essential to the
country‘s people and industry on a daily basis. Therefore, we felt the need to remain a
transparent, open, and predictable entity. This is especially important for YUKOS because its
oil fields in Siberia and Southern Russia are dependent on the workers who live in the
surrounding company towns. A public company, which is more transparent and predictable,
helps give them a measure of assurance. In addition, as a public entity, we are able to
compensate the residents of these towns with company shares, which help align interests and
share the company‘s upside. Finally, we at YUKOS are interested in becoming major global
players in the oil industry. In order to do so and to maintain the option of attracting capital
going forward, we need to be public. But, it must be said that, in choosing to remain public,
YUKOS‘s core shareholders chose the more difficult, less certain path, and the path of greater 39. transparency
As owners of a public company, YUKOS‘s core shareholders had large incentives to boost the 40company‘s depressed share price. With the help of McKinsey and Co., management turned its attention to improving operations, accelerating the completion of an internal reorganization program.
By the end of 1999, YUKOS, which was previously managed by geographical region, had been
restructured into three entities: upstream (YUKOS Exploration and Production); downstream
(YUKOS Refining and Marketing); and corporate headquarters (YUKOS-Moscow), which was 41responsible for strategic planning, finances, and administration. YUKOS also embarked on an
ambitious cost-cutting program, including significant employee layoffs. At the same time, YUKOS
formed an alliance with French oil-services firm Schlumberger in order to increase its production and
technological efficiencies in the oil fields. Both programs paid off as YUKOS‘s production costs 42decreased by 60%, an accomplishment that was facilitated by the ruble‘s August 1998 devaluation.
The above management decisions were considered bold and groundbreaking for a Russian
company, especially one in the notoriously opaque oil sector. As 1999 came to a close, YUKOS raised
even more eyebrows when Khodorkovsky hired several western oil executives from companies such
as BP Amoco, Schlumberger, Elf Aquitane SA, and Kvaemer AS. (See Exhibit 7 for a listing of
YUKOS‘s international executives.)
39 Interview with Mikhail Khodorkovsky, March 11, 2001.
40 The motives behind this are simple. Since shares trade at a multiple of earnings, in any given year it is more profitable for the controlling shareholders to boost the multiple on their stock price than to expropriate that year‘s cash flows. A stock price with a P/E ratio of 10, for example, affords the rough equivalent of ten years of cash flows, while expropriation gives shareholders only one year‘s cash flows.
41 Kate LeBlanc and Pierre Terzian, ―Khodorkovsky Battles to Burnish Image of Both Russia and YUKOS,‖ Petrostrategies, May 22, 2000.
42 Jason Bush, ―Prodigal Son: Are Russia‘s Oilgarchs Going Straight?,‖ Business Central Europe, May 31, 2000. (Note: For a Russian company such as YUKOS, with revenues in dollars and production/operating costs in rubles, the devalued ruble improved margins.)
43Despite these management and operational improvements, YUKOS‘s stock price remained flat.
Sergei Drobizhev, Deputy Director of Corporate Finance, remarked:
901-021 OAO Yukos Oil Company
We realized in the winter of 1999-2000 that unless we took specific steps to address the
market‘s concern about our corporate governance, our stock would continue to be punished.
At this point, we set out to create a true global public company with full transparency and
western-style investor relations. Our first big step in this direction was to bring in Michel 44Soublin, a former Schlumberger executive, as CFO in order to oversee many of these reforms.
YUKOS’s Corporate Governance Awakening
In December 1999, YUKOS settled its long-standing dispute with its most vocal minority
shareholder. While, the exact sum of the out of court settlement was undisclosed, it was thought to 45be in the area of $120-$160 million—enough for the U.S. investor to recoup his initial investment.
With this settlement, all sizable minority shareholders had been bought out by the core shareholders.
In firm control of its subsidiaries, YUKOS proceeded to retroactively cancel the dilutive share
issuances that were approved at the March 1999 EGMs.
Throughout early 2000, YUKOS continued to send strong signals that it was serious about
strengthening its corporate governance. The company announced that it would pay a dividend for
461999 (its first ever) of roughly $110 million, representing a payout ratio of 8.8%. (See Exhibit 8 for
dividend payout ratios of western oil majors.) YUKOS also announced that later in the year it would
publish its 1998 and 1999 financial statements in accordance with GAAP (Generally Accepted
Accounting Principles). At the same time, analysts received information that YUKOS‘s core shareholders planned to elect a majority of nonexecutive directors, including foreigners, to its board
at the upcoming June AGM (annual shareholders meeting).
Still, YUKOS‘s stock price stayed flat as investors remained wary of past governance abuses. In March 2000, Hugo Eriksen, YUKOS‘s Director of International Information said: ―We have a terrible
reputation, I know. But we want to tap international markets, to list our shares in the west, to be as
47western as any other international company. To do this, there are rules that you must abide by.‖
He added: ―We don‘t want to fool anyone into buying our shares. We are not constructing a mirage. 48We are building long term value for the company.‖
A “Corporate Governance Charter”
At its June 2000 AGM, YUKOS codified its promises by approving a special corporate governance
charter ―committing YUKOS to adhere to principles widely observed in member countries of the
43 Troika Dialog: YUKOS Company Report, November 15, 2000, p. 1.
44 Interview with Sergei Drobizhev, March 6, 2001.
45 LeBlanc and Terzian, op. cit., May 22, 2000.
46 Troika Dialog Research: Russian Oil and Gas Sector, February 2001, p. 64.
47 Ben Aris, ―YUKOS on the Mend,‖ EuroMoney, March 3, 2000.