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INSTITUTIONAL TRANSITIONS AND STRATEGIC CHOICES:

IMPLICATIONS FOR CORPORATE SOCIAL RESPONSIBILITY

IN RUSSIA

Mike W. Peng Fisher College of Business The Ohio State University

2100 Neil Avenue Columbus, OH 43210

Tel: (614) 292-0311 / Fax: (614) 292-7062 Email: peng.51@osu.edu

http://fisher.osu.edu/mhr/faculty/peng

Yelena Ruban Fisher College of Business The Ohio State University

Email: ygruban@hotmail.com

A chapter commissioned by The World Bank for Corporate Social Responsibility and Sustainable Competitiveness in Russia

Washington, DC: The World Bank July 15, 2003

[Acknowledgment] This research was supported, in part, by a National Science Foundation CAREER grant (SES 0238820). It directly benefited from the World Bank/Wharton School Zicklin Center conference on corporate social responsibility and sustainable competitiveness in Russia held at the World Bank headquarters in Washington and via videoconference in Moscow and Philadelphia on December 6, 2002. While we thank all participants for lively discussions, we especially appreciate the stimulating conversations with the group in Washington, namely, James Baron, Robert Hisrich, Nien-he Hsieh, Dan Kaufman, William Laufer, Dan McCarthy, Aileen Nowlan, Djordjija Petkoski, Sheila Puffer, and Alisa Valderrama. //TransTimeRus0307.doc//07/12/13/15/2003//7,397 words//

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One of the leading themes in management and strategy research on emerging economies

such as Russia is how organizations make strategic choices during institutional transitions

(Hoskisson, Eden, Lau, and Wright, 2000; Peng, 2000). Since institutions are typically

conceptualized as �the rules of the game in a society� (North, 1990: 3), institutional transitions can

be defined as �fundamental and comprehensive changes introduced to the formal and informal rules

of the game that affect organizations as players� (Peng, 2003: 275). Drawing on research from a

wide variety of emerging economies, Peng (2003) has developed a two-phase model of market-

oriented institutional transitions, consisting of an early phase and a late phase. The early phase is

characterized by informal relationship-based institutional frameworks, which give rise to network-

centered strategies. The late phase is governed by formal rule-based institutional frameworks, which

call for more market-based strategies. It is argued that while the general direction is to move toward

the late phase, most emerging economies are still struggling to move away from the early phase,

and that these transitions are chaotic, turbulent, and not necessarily smooth (Peng, 2000, 2003).

Nevertheless, out of the chaos associated with the transitions, a clear movement has recently

emerged in countries such as Russia, namely, the corporate social responsibility (CSR) movement

(Puffer and McCarthy, 2003). CSR refers to �the firm�s consideration of, and response to, issues

beyond the narrow economic, technical, and legal requirements of the firm to accomplish social

benefits along with the traditional economic gains which the firm seeks� (Davis, 1973: 312;

Donaldson and Preston, 1995; Freeman, 1984; Jones, 1995; Mitchell, Agle, and Wood, 1997; Quinn

and Jones, 1995; Swanson, 1999; Wicks and Freeman, 1998; Wood, 1991). A theoretically

interesting and practically important question is: Why now? Specifically, why has the CSR

movement emerged as a major movement approximately one decade after the disappearance of the

former Soviet Union? Why did it not emerge earlier? What is the fuss about CSR now and in the

foreseeable future?

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Applying and extending the two-phase model of institutional transitions (Peng, 2003), this

chapter argues that the emergence of the CSR movement is indicative of the struggle that the

Russian economy is going through moving toward the late phase of transitions. We suggest that the

rise of CSR as an increasingly important part of mainstream public policy and business strategy

discussions is a clear signal that the Russian transitions may have reached the limits of the early

phase of transitions, and that the shift toward the late phase is underway. After briefly reviewing the

two-phase model, we provide a multilevel analysis, from the perspective of (1) public policy level

through the acceleration of corporate governance legislature, (2) firm level through the example of

the banking industry in preparation for Russia�s World Trade Organization (WTO) accession, and

(3) individual level through the transformation of a leading Russian businessman (oligarch). Finally,

we conclude the chapter with five forward-looking propositions predicting the dynamics of CSR

adoption, diffusion, and impact on firm performance in Russia.

THE TWO-PHASE MODEL OF INSTITUTIONAL TRANSITIONS1

The Role of Institutions and Institutional Transitions

Since the role of institutions is �to reduce uncertainty by establishing a stable (but not

necessarily efficient) structure to human interaction,� �institutions affect the performance of the

economy by their effect on the costs of exchange and production� (North, 1990: 5-6). Therefore,

market-oriented institutional transitions can be conceptualized as moving from one primary mode of

exchange to another mode in order to reduce uncertainty.

Although transaction structures vary tremendously around the world, researchers in

management (Peng, 2003), sociology (Fukuyama, 1995), economics (North, 1990), and

1 This section draws heavily from Peng (2003: 278-283), which has more complete references.

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international organizations (World Bank, 2002) generally agree that these structures can be broadly

grouped in two ways. The first is relationship-based, personalized exchange and the second is rule-

based, impersonal exchange. Each is supported by a distinctive set of institutions, the first being

more informal and the second being more formal. Each of them is introduced next.

Informal, Relationship-Based Exchange

Known as �relational contracting,� relationship-based, personalized exchange �has

characterized most of economic history� (North, 1990: 34). Initially, at time T1 in Figure 1, the

costs to engage in relational contracting are high (at point A) and benefits low (at point B), because

transaction parties need to build strong social networks through a time- and resource-consuming

process. When the scale, scope, and specificity of transactions expand, the costs per transaction

move down (from A to C and then to E) and benefits move up (from B to C and further to D), since

the threat of opportunism is limited by the extent to which informal sanctions may be imposed

against opportunists if necessary. There is little demand for costly, formal rule-based third-party

enforcement. Thus, between T2 and T3, the economy is likely to benefit from relational contracting.

[ Insert Figure 1 about here ]

Past time T3, however, the costs of such a mode may gradually outweigh its benefits,

because �the greater the variety and numbers of exchange, the more complex the kinds of

agreements that have to be made, and so the more difficult it is to do so� in the absence of formal

institutions (North, 1990: 34). Specifically, given the expansion of transactions in a complex

economy, there is a limit as to the number and strength of network ties an individual or organization

can possess. In other words, how many good friends can each person have? Nobody can claim to

have 100 (or more) good friends (regardless of how one defines �good friends�). Especially when

the informal enforcement regime is weak, trust can be easily exploited and abused. As a result, the

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limit of relational contracting is likely to be reached at time T3, when the cost and benefit curves

reach their points of inflection. Past T4, the costs are likely to gradually outweigh the benefits.

Formal, Rule-Based Exchange

Often termed �arm�s-length transaction,� the second transaction mode is rule-based,

impersonal exchange with third-party enforcement. As the economy expands, the scale, scope, and

specificity of transactions rise exponentially, calling for the emergence of third-party enforcement

through formal legal and regulatory regimes. These rules and regulations are different from

bureaucratic ones such as those found in many former Soviet-type economies which are hostile to

market competition. While bureaucratic rules may have certain benefits (e.g., accomplishing

priority goals in military and space programs), they tend to result in a massive market failure (Peng,

2000: 20-40). The new rules and regulations refer to market-supporting formal institutions designed

to facilitate more impersonal economic exchange (World Bank, 2002).

Shown in Figure 2, the initial costs per transaction are high, because of the high costs to

develop and implement formal institutions (e.g., courts). Over time, however, third-party

enforcement is likely to facilitate the widening of markets, because unfamiliar parties, who would

have been deterred to transact before, are now confident enough to trade with each other in order to

capture the gains from more complex exchanges. Thus, formal market-supporting institutions may

facilitate more new entries by lowering transaction costs, thereby stimulating more economic

expansion. Heralded as a key characteristic of the market economy, rule-based, impersonal

exchange has been regarded as �the critical underpinning of successful modern economies involved

in the complex contracting necessary for modern economic growth� (North, 1990: 35).

[ Insert Figure 2 about here ]

Transitioning From the Early Phase to the Late Phase

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Throughout emerging economies, despite the openly proclaimed objective of becoming

�market economies,� the transitions typically end up with a predominately relationship-based

transaction structure first and then may gradually move to a second, rule-based one. This two-phase

transition model is depicted in Figure 3, which merges Figures 1 and 2 (Peng, 2003).

The transitions start at T1, when the costs of relationship-based transactions begin to drop

and the benefits begin to rise. This is due to the emergence of new opportunities as the economic

landscape is being shaped. Historical practices associated with informal trading (such as blat in

Russia and guanxi in China) may also give legitimacy to this way of doing business (Peng, 2001a;

Peng and Heath, 1996). In the process (especially between T2 and T3), many firms survive and

grow by employing network-based strategies based on personal trust and informal agreements

among managers and officials in order to overcome the institutional uncertainties (Peng and Luo,

2000). However, past the points of inflection, D and E, the expanding scale and scope of

transactions gradually call for formal institutions to support the increasingly complex transaction

structure. But the process between T1 and T3 is long and the changes tend to be incremental.

[ Insert Figure 3 about here ]

At the critical T3, the accumulated momentum in favor of having more formal rules finally

starts to overcome the inertia in the deep structure of the previous mode of transaction. Sources of

such a momentum may include changes in political regimes (e.g., the Velvet Revolution in

Czechoslovakia), shifts in economic policies (e.g., the WTO accession in China), and pressures

from international interests (e.g., the reforms mandated by the International Monetary Fund in

South Korea). Sudden, revolutionary changes in institutional frameworks are likely to occur at this

point. Achieving an identifiable break with the past, the economy moves into a new, rule-based

phase. This phase is almost certain to require a long period of incremental evolution, because of (1)

the lack of a sufficient number of rules to govern all transactions; (2) the lack of credible

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enforcement of the rules that do exist; and (3) the tremendous inertia, resistance, and lack of

adaptation on the part of some organizations. Therefore, unless the economy reaches point G at T5,

the costs per transaction of relying on the new rules are still likely to outweigh their benefits, thus

creating incentives for some (but not all) firms to continue to rely on networks. Only past T5 will

the benefits of a rule-based transaction regime be appropriated.

Although there is a great deal of diversity across emerging economies, the transformation

toward more rule-based market transactions seems to have taken place � of course, with different

paces and setbacks � around the world. This does not necessarily mean that arm�s-length

transactions are inherently better, because �in many situations the demand for new and modern

institutions may not be evident� (World Bank, 2002: 177). Both forms of exchanges complement

each other. Relational contracting has an advantage over formal institutions in that participants may

have better information than any third party (e.g., courts), especially when the size of the economy

is limited � imagine a small village economy where everybody knows each other. Its disadvantage

is that it may cause firms to stick with established networks and relationships rather than working

with new, untried trading partners, thus creating barriers to entry. As transaction complexity

increases, informal information processing and enforcement within the group may become difficult

� imagine a city or national economy. This is because informal commitments are more difficult to

coordinate and deviations harder to punish. Arm�s-length transactions, on the other hand, help

overcome these barriers, by bringing together formerly distant groups (firms, communities, and

even countries) to enjoy the gains from complicated long-distance trade. These rule-based

transactions thus become increasingly attractive as more new players enter the game.

Policy and Strategy Implications

In the most abbreviated fashion, the implications of the two-phase model of institutional

transitions are twofold. First, from a public policy standpoint, formal rule-making is affected by the

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supply and demand for these �services.� When the demand for complex transactions is not

sufficiently strong, the benefits for formal rule-making may not outweigh the costs, thus reducing

the incentive on the part of policymakers to push for (supply) these rules (Keim, 2001). Second,

from a business strategy standpoint, strategies during the early phase center on networks and

relationships (such as blat in Russia), whereas strategies during the late phase capitalize on market-

based resources and capabilities (Peng, 2003).

For policymakers, managers, and scholars, the biggest challenge, of course, is how to

identify the points of inflection transitioning from the early phase to the late phase. Unfortunately,

Peng (2003: 293) writes that at present there is no clear answer to this important question yet and

that future researchers are urged to pay more attention to identify these theoretically important but

practically elusive points of inflection. In the remainder of this chapter, we will take up this

challenge, by arguing, through a multilevel analysis, that the recent CSR movement in Russia offers

a glimpse into these possible points of inflection.

PUBLIC POLICY LEVEL: CORPORATE GOVERNANCE LEGISLATURE

While �steady progress� would be a fair characterization of the improvement in corporate

governance in Russia since the beginning of the post-Soviet era (Perkins, 2003), it is evident that

the pace for corporate governance legislature has accelerated since the late 1990s (Jesover, 2001;

McCarthy and Puffer, this volume; Puffer and McCarthy, 2003). Notable examples include the Joint

Stock Company Law (1996), Securities Market Law (1996), Investor Protection Law (1999), Tax

Reform Law (2001), and Code of Corporate Conduct (2002). While the call for strengthening the

formal legal and regulatory frameworks governing corporate governance in areas such as

privatization has been heard from the beginning of the transitions, only since the late 1990s have we

seen more concrete (although still far from perfect) measures being first enacted and then gradually

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enforced. Why is there such a change in pace? Why have policymakers pushed corporate

governance to the forefront of the reform agenda more recently?

While there can be many answers to these intriguing questions, we suggest that the

transitions from an early phase to a late phase may hold a key to understanding such a change in

pace. It seems clear that during the early phase of transitions, informal, network- and relationship-

based strategies, in the absence of a clear, formal institutional framework, allowed for substantial

room for corporate growth (Peng and Heath, 1996). While the abuses and excesses associated with

privatization have been widely publicized, it is important to note that many managers have run their

enterprises in a legitimate way (Puffer and McCarthy, 2003). They essentially take advantage of the

region between T2 and T3 in Figure 3, whereby the benefits of relationship-based strategies

outweigh the costs. However, it seems clear that there are limits (T3 in Figure 3), beyond which

further leveraging of network-based strategies, without attempting to move toward a new mode of

transaction, may backfire.

While how to identify T3 in Figure 3 remains a subject of debate (Peng, 2003: 293), in

Russia, we argue that the 1998 financial collapse can be regarded as a T3 event. This crisis, perhaps

as a blessing in disguise, has served as a catalyst in bringing corporate governance problems to the

forefront of the public policy agenda. Despite some lip service being paid to corporate governance,

from a public policy standpoint, as long as privatization was reasonably progressing and foreign

investment starting to pour in Russia, there was little incentive to address corporate governance

problems. In short, when the demand was not there, supply did not emerge (Keim, 2001). Prior to

1998, policymakers had other high priority issues to deal with. However, the 1998 crisis exposed

the severity of some of the abuses and excesses associated with a largely informal system of

corporate governance (Filatotchev, Buck, and Zhukov, 2000). These abuses and excesses became

more severe in the aftermath of the crisis, as managers and majority shareholders increased their

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expropriation (asset stripping) activities in order to make up for their �losses� due to the crisis

(Young, Peng, Ahlstrom, and Bruton, 2002). Minority shareholders ended up being expropriated

more harshly, not only resulting in a total collapse of domestic investor confidence, but also a

virtual dissipation of foreign investor interest. Investors previously willing to overlook corporate

governance imperfections were now either quitting or at least paying more attention to the hazards

of investing in weakly governed markets � in 2000, Russia was ranked last among 25 emerging

economies in corporate governance (Puffer and McCarthy, 2003; see also Ladnyi, 2002).

Because attracting external equity finance is crucial, the timing for addressing corporate

governance issues � in particular, minority shareholder protection � is ripe in Russia (Jesover,

2001). It is apparent that if the economy is to be developed, external finance would have to come in.

However, without major corporate governance reforms, this is not likely to happen. For example,

FDI in Russia in 1998 was a mere $1.5 billion, less than the total sum of FDI in Hungary, and a tiny

fraction (little more than 2%) of the inflows moving into China (Jesover, 2001: 80). On the other

hand, Russia�s aspirations to join the WTO, an interest first expressed during the Yeltsin

administration to the WTO�s predecessor (GATT) in 1993 and renewed by President Putin since

1999, call for significant reforms in corporate governance.2 In this regard, Russia and other

emerging economies, although from a relatively low base, are not alone in the new interest in

strengthening corporate governance. Only in the 1990s did developed economies start to promulgate

more formalized �Principles of Corporate Governance,� as exemplified by the 1999 OECD

document with that title. OCED has been working with the Russian authorities, and helping with the

2 While the typical WTO accession procedure takes an average of 5-7 years, Russia, although not an �average� country, is in its 10th year of the process as of 2003. Of the four main stages of accession, it has completed the first and second stages (gathering information on trade policy regime and conducting bilateral negotiations with individual members, respectively). As of early 2003, its progress on the third stage (drafting documents) has slowed, and no clear date is in sight for the final stage (universal approval of the accession package) (Bush, 2003).

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drafting and enactment of the Code of Corporate Governance in 2002 in Russia (McCarthy and

Puffer, 2003; Perkins, 2003).

Overall, we may regard the interest to address the limits of the pre-1998 informal

governance framework as a push factor, and the lure of a higher set of standards which would result

in more external investment as a pull factor. A combination of the push and pull factors has resulted

in the acceleration of corporate governance legislature, which signifies the transitions toward the

late, rule-based phase. A hallmark of such a late phase is that people will have more trust in the

formal �system� as opposed to their informal networks and relationships (Fukuyama, 1995; Peng,

2000). The importance of trust can also be seen in our next, firm-level analysis.

FIRM LEVEL: BANKS� COPING STRATEGY

The banking industry in Russia serves as a case in point on the importance of trust embodied

in the CSR movement. After the overnight ruble devaluation in the early 1990s, when most of the

general public lost their savings that they had held in the state-owned, Soviet-era Sberbank, the only

official organization which provided financial services, trust in the state-owned bank diminished in

a direct proportion to ruble�s value. This explains why Russian people invested all the money they

had left in the newly emerged private banks in the mid 1990s. The reason for the belief that their

money would be safer there was the fact that new private owners had not yet engaged in any

wrongful actions against their customers. Also, a big part of it was a very extensive advertisement

of dividends, which was a completely new experience for the general public.

Unfortunately, most founders of the private banks active in the mid 1990s acted

opportunistically. The Soviet-era principle that it is permissible (although technically illegal) to

steal from the government became the new principle that it is allowable to steal from your neighbor

as long as you don�t get caught. During the late 1990s, most of the private banks either went

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bankrupt, or simply closed their offices without any explanation. Sadly, a majority of customers lost

their savings again. The social uproar was very similar to the recent Enron and WorldCom scandals

in United States, although on a larger scale (Goldman, 2003).

Since, in a short span of less than a decade, trust in the banking system was abused and

destroyed twice in the midst of great economic, social, and political difficulties and sacrifices, not

surprisingly the recovery process becomes exceedingly difficult. Right now Russians in general do

not trust any financial organizations, and prefer to keep their savings at home (under the mattress, as

they say) in the form of dollars or euros as the most stable currencies. There is a good reason to do

so, since a significant number of the 1,332 banks licensed for operation as of January 1, 2003 may

be �pocket banks,� whose main function is money laundering for their parent companies (Bush,

2003: 33). Our guess is that the next form of financial organizations that people would give their

trust to would be foreign banks� branches that have a chance to be established following Russia�s

eventual accession to the WTO (discussed above). This is dramatically different from the typical

�liability of foreignness� as documented by international business researchers (Zaheer, 1995). In

contrast, Russian banks may suffer from a �liability of domesticness.�

Although Russian customers clearly stand to gain from the emerging banking competition

brought by the eventual WTO accession, the outlook seems bleak for Russian banks. Facing such

dire straights, how do the Russian banks � especially legitimate ones � cope? CSR seems to be a

reasonable answer, in trying to project a more trustworthy image and combating the opportunistic

tendency on the part of some firms and managers. This is related to the corporate governance

reform discussed above. Given the failure of the informal norms to guard against opportunist

behavior, banking firms which subject themselves to a higher set of formal corporate governance

standards may stand a fighting chance to win back some (but probably not all) customer trust during

the late, rule-based phase of the transitions. While this is an uphill battle, CSR can become a

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potential source of differentiation (McWilliams and Siegel, 2001). That is why leveraging CSR as a

coping strategy has been brought to the forefront of strategy discussions in Russian banks and other

firms recently. However, having been burned twice, customers will more closely scrutinize the

deeds, as opposed to the mere words, of firms and their managers. In this connection, as shown

next, the transformation of individual managers becomes important.

INDIVIDUAL LEVEL: THE TRANSFORMATION OF KHODORKOVSKY

Organizations are made of people, and strategies are crafted and implemented by people.

Ultimately, transitions in strategic choices boil down to transformations in the outlook and behavior

of managers. Some conventional wisdom argues that the Russian culture, dating back to the Czarist

regime and reinforced by the communist system, is inherently opportunistic, corruptive, and not up

to the standards of modern market-based competition (e.g., Ledeneva, 1998). This line of reasoning

suggests an essentially hopeless outcome for the Russian economy, in the absence of significant

culture change, which is a long-term process. From an institutional perspective, we fundamentally

disagree. To the extent that individuals and organizations make rational choices according to the

institutional constraints they face (North, 1990), it is possible that managers and the firms they lead

can change, sometimes rapidly, given the right kind of institutional incentives (Peng, 2000, 2001a,

2003). In Russia, the best example we can find is the transformation of Mikhail Khodorkovsky,

currently the CEO and majority shareholder of Yukos Oil.

Khodorkovsky was one of the seven notorious oligarchs who divided up some of Russia�s

most valuable assets with very abusive, non-transparent, and hence widely criticized methods

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(Goldman, 2003: 1).3 Yet, he has become a most unlikely devotee of corporate governance, and has

been widely heralded as a new vanguard of CSR (Puffer and McCarthy, 2003; Shekshnia, 2003).

The reason is very simple: There is money to be made with good CSR attributes such as sound

corporate governance in the post-1998 era when financial markets became more discriminating. For

example, during 1999, among listed companies, there was a 700-fold increase in firm value between

the best governed firm (Vimpelcom, a telecom firm) and the worst governed ones (Tomskneft,

Samaraneftegaz, and Yuganskneftegaz, all of which are oil firms) (Black, 2001: 94).

Research in Russia (Puffer and McCarthy, 2001) and elsewhere (Peng, 2001a) suggests that

entrepreneurs learn much faster than the rest of the population, are more flexible to embrace new

mental models, and often deviate from the behavioral norms of the general population (most of

whom are not entrepreneurs). Although theoretically possible, the transformation of outlook and

behavior of Khodorkovsky is still remarkable, not only because it seems to correspond very well

with the two-phase model, but also because it takes place in such a short span of time. Although the

model is speculated to be played out for �a generation or more� (Peng, 2003: 293) for country-level

transitions, Khodorkovsky�s individual-level transitions have been observed in a few years.

As an entrepreneur, Khodorkovsky started in the late 1980s by buying and selling goods

with a mark-up. In the early 1990s, controlling corporate assets and diverting cash flows to himself

and other insiders, through largely informal networks and relationships, was the name of the game

he played. Yet, by the late 1990s, he clearly sensed the arrival of the new phase, recognizing that he

could do better by increasingly the per share value of his vast shareholdings in the increasingly rule-

based phase. At Yukos Oil, Khodorkovsky started to introduce modern governance practices after

3 In 1996, one of these oligarchs boasted that the seven oligarchs collectively controlled 50% of the country�s assets, which is �an exaggeration perhaps, but not too far from the truth� (Goldman, 2003: 2).

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1998, such as GAAP accounting and regular investor meetings. Probably the most prominent

change is the composition of the board, which has only one inside manager/owner, Khodorkovsky

himself. This is in radical contrast with the typical Russian board, whereby outside directors either

are non-existent or serve largely decorative purposes (Peng, Buck, and Filatotchev, 2003). Half of

the Yukos Oil directors are foreign executives. The board has sophisticated committee structures

and elaborated rules (Shekshnia, 2003). Yukos Oil sends a clear signal of being interested in raising

international capital. These new policies have been widely applauded, and Yukos� share price

increased 250% within a year of their implementation (Puffer and McCarthy, 2003). However,

many critics still have serious doubts on �whether or not he has truly reformed, or if he has simply

concluded that having stolen all he can within Russia he must now look overseas� (Goldman, 2003:

149). We believe that the story of Khodorkovsky indicates that instead of debating the abstract

ethical versus unethical nature of entrepreneurs and their business strategies (Jones, 1995; Quinn

and Jones, 1995), it probably is more useful to adopt a more pragmatic perspective when trying to

appreciate the great transitions which unfold in Russia and which these entrepreneurs are a major

part of (Peng, 2001a; Wicks and Freeman, 1998).

While Khodorkovsky is certainly not an average entrepreneur or manager and his firm is

probably on the leading edge of sound corporate governance practices in Russia, he is not alone in

experiencing such transformation. Having observed his success, an increasingly large number of

entrepreneurs, managers, and the firms they lead are following and imitating this example, slowly

but surely elevating the CSR level for the country�s businesses to some new heights. Writing about

the practical implications of the two-phase model, Peng (2003: 292) suggests:

The best managers expect strategy to shift over time by constantly deciphering the changes

in the �big picture� and by being willing to take advantage of new opportunities. As

emerging economies evolve, the best-performing firms seem to be those that convert the

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gains from the previous, relationship-based into the market-centered resources and

capabilities. Firm that fail to realize the passing of their time are likely to fall behind or go

out of business.

It seems that Khodorkovsky may be one of the best living examples of such a prediction,

although the author was totally unaware of such an example when the above arguments were made

(!).

LOOKING INTO THE FUTURE

Through our public policy-, firm-, and individual-level examples, we have argued that the

recent rise of the CSR movement in Russia is a great case study of the transitions moving from an

early phase featuring interpersonal networks and relationships to a late phase centered on market-

based resource and capabilities. Graphically, this movement indicates the trials and triumphs in the

region between T3 and T4 in Figure 3, whereby the limits of a previous, relationship-based phase

may have been reached at T3. While this process will not be smooth, the fact that Russia has

already embarked on this journey is encouraging. Given the tremendous challenges that lie ahead,

we continue to predict � to be on the safe side � that this process will take �a generation or more to

reach T5� (Peng, 2003: 293). However, the rapid transformation of individuals such as

Khodorkovsky reminds us that Russia has succeeded in compressing into a decade much of the

legislative, regulatory, and private initiatives governing the modern corporation that the United

States developed over two centuries. So we are also reasonably hopeful that our conservative

estimate above may be indeed too conservative � and we would be pleased if that is the case.

From a research perspective, this case of the CSR movement in Russia helps move ahead

the research agenda on the two-phase model of institutional transitions and their associated strategic

choices (Peng, 2003). Specifically, the rise of the CSR movement in an emerging economy allows

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for an empirical identification of the crucial but under-specified points of inflection during

institutional transitions. Stated more formally:

Proposition 1: The rise of the CSR movement in an emerging economy is an empirically

verifiable sign of institutional transitions which may have reached the limits of an early,

informal, relationship-based phase and which may have started to move to a late, formal,

rule-based phase (the region between T3 and T4 in Figure 3).

From a practical standpoint, it is important that CSR is not a panacea. For example, it is not

cheap to engage in CSR practices. Khodorkovsky, for example, admitted having to endure a much

slower decision-making process with more outsiders on the board (Shekshnia, 2003). Also, all these

outside directors have to be paid with reasonable compensation if the appointing firm expects them

to provide high-quality governance services. Hopefully, these higher costs associated with CSR will

be translated into higher quality decisions and better market performance. CSR is probably best

viewed as a source of differentiation or an investment to boost firms� competitive advantage, as

opposed to being viewed as social philanthropy, which may actually result in reduced firm

performance (Hillman and Keim, 2001). To the extent that consumers who value CSR are willing to

pay a higher price for a product with ideal CSR attributes (such as a higher share price), consumers

need to be made aware of the existence of these CSR attributes through product advertisements,

securities disclosures, and press announcements, all of which, again, add to firms� cost structure.

It is important to note that decades of systematic research in the West does not conclusively

suggest a positive link between CSR and firm performance (Griffin and Mahon, 1997; Harrison and

Freeman, 1984; Margolis and Walsh, 2003). While some studies indicate a positive relationship

(Berman, Wicks, Kotha, and Jones, 1999; Waddock and Graves, 1997), others report a negative

relationship (Wright and Ferris, 1997) or no relationship (Agle, Mitchell, and Sonnenfeld, 1999;

McWilliams and Siegel, 2000). Therefore, Russian companies joining the CSR �bandwagon� eager

18

to make a quick buck (or ruble) need to be reminded that the ideal level of CSR is best determined

by a cost-benefit analysis. To maximize profit, the firm should offer precisely the level of CSR for

which the increased revenue equals the higher cost (McWilliams and Siegel, 2001: 125).

Despite such caution, it seems likely that many Russian firms may join the CSR bandwagon.

Since organizations act to enhance or protect their legitimacy, copying other reputable organizations

� even in the absence of direct performance benefits of doing so � may simply be a low-cost

heuristic to gain legitimacy (Peng, 2004). New practices such as CSR are generally regarded as

state-of-the-art techniques. Therefore, jumping on such a bandwagon may be perceived as a form of

innovation when it is contrasted with the more passive act of ignoring such trends. While scholars

may interpret these actions as chasing fads (Abrahamson, 1996), practitioners are likely to view

them as a signaling device to keep up with competition � at least symbolically. When there is so

much ambiguity in attributing the causes of organizational outcome such as performance, outside

observers often rely on positively valued behavior as a signal in making their judgments of a firm�s

management, therefore gradually fueling firms� interest in engaging in certain desirable behavior

such as CSR (Peng, 2004).

While many firms face the rising normative expectations for having some CSR initiatives,

they are not likely to join such a bandwagon with the same pace. There may be at least two

organizational attributes that differentiate the early adopters from late adopters.4 First, poor prior

firm performance may prompt more CSR initiatives. In this manner, poor performance, such as that

affecting Russian banks discussed earlier, acts as a catalyst to trigger organizational changes (Peng,

2004). On the other hand, high-performance firms, some of which may still pay less attention to

CSR, are not under as much pressure to introduce CSR initiatives. Therefore:

4 Discussions leading to Propositions 2-4 draw heavily from Peng (2004).

19

Proposition 2: There is a positive relationship between poor prior performance of the firm

and the introduction of CSR initiatives in Russia.

Second, large firms are likely to be under greater pressure to maintain legitimacy by

responding to institutional demands. Because of their visibility, these firms tend to be scrutinized

more intensely by officials, scholars, and journalists. For example, while not every company is

required to be in compliance with the 2002 Code of Corporate Conduct, as of February 1, 2003,

Russia�s largest companies are legally required to do so (Perkins, 2003: 26). Overall, given the

increasingly vocal public opinion in Russia in favor of CSR, large firms may have incentives to

have some appearance of CSR, even if only for symbolic purposes (McWilliams and Siegel, 2001).

Therefore:

Proposition 3: There is a positive relationship between a large firm size and the

introduction of CSR initiatives in Russia.

Finally, it is possible that during the transitions, the more other firms engage in CSR

activities, the more likely that any given firm is to follow (Peng, 2004). Although the diffusion is

initially driven by the efficiency motives of early adopters (such as Russian banking firms with

performance problems), late adopters are likely to follow for symbolic legitimacy reasons. As the

practice diffuses to more firms, the two predictive factors identified above may become increasingly

less relevant to the adoption process. In other words:

Proposition 4: The strength of the relationship between (a) poor prior performance and

(b) large firm size on one hand and the introduction of CSR initiatives on the other hand

will decrease over time in Russia.

This probably explains the inconclusive findings on whether there is a positive link between

CSR and firm performance in the West (Agle et al., 1999; Berman et al., 1999; Griffin and Mahon,

1997; Harrison and Freeman, 1999; Margolis and Walsh, 2003; McWilliams and Siegel, 2000;

20

Waddock and Graves, 1997; Wright and Ferris, 1997). We suspect the same dynamics may play out

in Russia and other emerging economies. As a point of firm-specific differentiation, CSR may

initially boost the performance of early adopting firms, such as Vimpelcom and Yukos Oil

discussed earlier. However, over time, its value as a firm-specific resource (Peng, 2001b) may be

less emphasized and less beneficial as more firms join the CSR bandwagon. In other words, CSR,

while not losing its significance, may eventually become an equalizer as opposed to a differentiator

in the future. Therefore, we conclude this chapter with a prediction on the performance implications

of CSR, whose novelty value may eventually lose:

Proposition 5: The relationship between CSR and firm performance in Russia will be

positive initially, but neutral over time.

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Figure 1. The Costs and Benefits of Relationship-Based, Personalized Exchange

Costs/ benefits D Costs Costs A C F Benefits B Benefits E T1 T2 T3 T4 Time

[Source] Peng, M. W. 2003. Institutional transitions and strategic choices. Academy of Management Review, 28: 279.

Figure 2. The Costs and Benefits of Rule-Based, Impersonal Exchange

Costs/ Costs benefits A C Benefits B T1 T2 Time

[Source] Peng, M. W. 2003. Institutional transitions and strategic choices. Academy of Management Review, 28: 280.

25

Figure 3. A Two-Phase Model of Institutional Transitions

Costs/ Costs benefits (rule) D shift A Costs (relationship) C F G E Benefits B (relationship) shift Benefits (rule) T1 T2 T3 T4 T5 Time Early Late phase phase

[Source] Peng, M. W. 2003. Institutional transitions and strategic choices. Academy of Management Review, 28: 281.

26

About the Authors

Mike W. Peng is an assistant professor of management at the Fisher College of Business, The Ohio

State University, Columbus, Ohio, USA. He holds a PhD degree in strategy from the University of

Washington, Seattle. He has published over 25 articles in leading scholarly and professional

journals, covering organizations in Asia, Central and Eastern Europe, China, Hong Kong, Japan,

Russia, South Korea, Thailand, and the United States. He has also authored Business Strategies in

Transition Economies (Sage, 2000). His research has been supported by close to half a million

dollars in external funding from agencies such as the U.S. National Science Foundation and the

Hong Kong Research Grants Council. He has been quoted by Newsweek, Exporter Magazine, Radio

Free Asia, and Voice of America, and selected by London�s Financial Times as one of the �next

generation business thinkers.� At present, he is writing a new textbook, Global Strategy, and

working on a five-year (2003-08), NSF-sponsored research project on strategic choices during

institutional transitions, from which this chapter draws. Contact: peng.51@osu.edu.

Yelena Ruban is a former student of Professor Peng. She holds an MBA degree from the Fisher

College of Business, The Ohio State University and a Master of Science degree in civil engineering

from Rostov-on-Don State Building University, Russia. During her studies at Fisher, she became

interested in the area of global business strategy in transition economies. Her other interests include

construction management technology and environmental engineering research. She currently serves

as a civil environmental engineer at an engineering consulting company, Ribway Engineering

Group, Inc. Contact: ruban.1@osu.edu