GAAMA metaphysics.

Introduction

Five years ago, I began a project to assist in the development of the Ukrainian Capital Market. My initial assignment was to develop back-office procedures for the Ukrainian securities self-regulatory organization, PFTS. As first flight approached Kiev's Borispol Airport, I began to read the Kiev Post. Of particular interest was an opinion poll inquiring, "What should be done with Chernobyl's damaged nuclear reactors?" Virtually all respondents thought that government experts should resolve this issue. Since markets are about opinions, I began to appreciate the sensitivity to the initial condition and the related difficulty in changing a command economy.

Today there is a greater diversity of opinion in the Ukraine. Kiev has a vibrant consumer market and a developing durable goods market. The biggest difference between 1997 and today is convenience. Then, money and my driver could obtain whatever I needed. Now, Kiev offers not only the products but also many of the conveniences that Americans have come to take for granted.

Yet progress in the consumer and durable goods economic sectors has not extended into the capital market. I have been privileged to be part of two separate projects that were led by two very dedicated and capable project managers in Geoffrey Elkind of KPMG and Nancy Gordillo of Financial Markets International. Nevertheless, despite our hard work and delivery of professional products, Ukraine's capital market exists today more in form than in substance.

WHY? ... Because the cart was placed before the horse. If one thinks of the Soviet economy as a giant distribution system, donor agencies built airports before renovating roads and railroads. It is this paper's thesis that slower-than-expected capital market development in some Newly Independent States ("NIS") is attributable to a misperception of the former Soviet Union's governance structure. "Soviet Inc.," was an unprofitable firm, NOT an inefficient market. Its CEO, Joseph Stalin, was a "Robber Baron" of an industrial monopoly. Its politburo was a compliant Board of Directors. "Soviet Inc." was a hierarchical structure complete with an organizational chart and procedures manual for the production of goods and services. The marketing department set prices through a command-and-control process rather than through buyer-and-seller negotiation. Instead of a corporate town (i.e., Akron, Ohio), "Soviet Inc." was a corporate continent, a conglomerate that employed approximately 200,000,000 workers and encompassed 13 time zones.

Having diagnosed the former Soviet Union as an inefficient market, donor agencies provided market infrastructure and regulations. In some instances, this constrained entrepreneurial initiative by adding complexity to the pre-existing Byzantine bureaucracy. A financial shopping mall was built without providing desirable enterprises to stock the shelves. If consumers were unenthusiastic to purchase the goods and services of post-Soviet successor enterprises, why would investors want to acquire the securities of these enterprises?

Sensitivity to initial condition

In August 1991, the Soviet Union was "atomized." Thousands of enterprises were hurtled across its socio-economic universe. But what was the commercial DNA bequeathed to the economic enterprises of the post-Soviet successor states?

To understand why the Soviet Union is defined, as an "unprofitable firm" requires differentiating among the various governance structures. The following 2x2-governance matrix illustrates the process by which economies organize their normative commercial activity.

The model combines binary benchmarks that analyze ranges of economic activity relative to transparency and profitability. The transparency construct addresses the treatment of information. Markets tend to be "open" (Soros, 2000) and develop disclosure regimes for information requirements (i.e., NASDAQ's advertising budget), whereas firms are inclined to be "closed" and guard trade secrets through intellectual property protection (i.e., patents, trademarks, and copyrights). The profitability construct analyzes whether NIS economies can evolve beyond self-sustainability (rewarding the enterprise's employees and management) to commercial viability (rewarding the enterprise's employees, management, and risk-capital contributors). Commercially viable enterprises tend to be in the private sector and employ a marginal-cost model (profits are maximized where marginal revenues equal the marginal cost of the nth product sold). Self-sustainable entities, on the other hand, tend to be affiliated with the public sector. They are inclined to use an average-cost model (e.g., an industrial policy enterprise such as the post office delivers a letter for the same rate, irrespective of whether the letter is to be delivered across the street or across the country). Then these constructs are combined to design a robust model for understanding. Given the paper's thesis, the focus of the discussion will be the reflexive development of markets and firms.

When post-Soviet successor states became independent, economic policy makers had to determine what end-condition they desired. This required knowing whether the "Soviet Inc." governance structure was that of a "firm" or a "market." Turning around "Soviet, Inc." required an operational restructuring to increase efficiencies and a financial reorganization to lower the cost of capital. The independent variables of market development are infrastructure and regulations, whereas the independent variables of enterprise turnarounds are products and people. A firm turnaround begins by redesigning its products and retraining its people. The old corporate culture must be replaced. Otherwise the "iron law of oligarchy will centralize power, ossify operational components, and stagnate the thought processes in an attempt to retain control.

To this point, it is instructive to compare the restructuring experiences of the post-Soviet successor states with IBM. IBM was the flagship of American industry during the 1970s. Many thought IBM represented the best of American technology. IBM's primary product was not technology, but "job insurance" for the Chief Information Officer (CIO). Marketing representatives would "close" sales with the statement that "nobody ever lost their job by buying IBM." Translation: should a problem arise, IBM would put its corporate muscle to work to solve your problem. This worked well until mini-computers replaced mainframe computers at the start of the Information Age. To maintain their corporate dominance, IBM made a big bet on the O[S.sub.2] operating system. They lost. IBM's stock, which had peaked at $200 per share in the mid-1980s, began a prolonged ten-year slide to $50 per share. During this retrenchment, IBM was restructured numerous times. Each time, unfortunately, the new Chief Executive Officer (CEO) was promoted from within IBM's management. He owed his allegiance to IBM O[S.sub.2] operating system and corporate cronyism. When the stock bottomed at $50 per share, the institutional investors asserted themselves and selected a non-technician, Louis Gerstner, to be the new CEO. Gerstner barely knew how to operate a computer--he was a retailer, but he knew how to operate a company. He broke IBM's corporate culture, redesigned their products, and turned around the company. The stock recently traded as high as $100 per share. IBM totally redesigned its product line and...