Demand for Law and the Security of Property Rights: The ...faculty.wcas.northwestern.edu/~jlg562/documents/8... · Jordan Gans-Morse as well as a survey of 301 ﬁrms from eight Russian

American Political Science Review (2017) 111 2 338ndash359

doi101017S0003055416000691 ccopy American Political Science Association 2017

Demand for Law and the Security of Property Rights The Case ofPost-Soviet RussiaJORDAN GANS-MORSE Northwestern University

Studies of property rights overwhelmingly focus on whether states expropriate or protect propertyoverlooking the crucial issue of whether private sector actors will use state institutions By contrastI argue that the ldquosupplyrdquo of formal legal institutions often fails to ensure firms will rely on the

state for property rights protection Instead firms frequently avoid formal legal institutions and turnto illegal strategies based on violence or corruption Whether firms adopt legal strategies depends on(1) firm-level practices and beliefs that impede the use of law (2) the effectiveness of illegal strategiesand (3) coordination problems resulting from firmsrsquo expectations about each otherrsquos strategies Drawingon interviews with firms lawyers and private security agencies as well as an original survey of Russianenterprises I illustrate how ldquodemand-siderdquo factors led to a surprising increase in Russian firmsrsquo reliance onformal legal institutions over the past two decades The findings suggest that comprehensive understandingof property rights and the rule of law requires not only attention to state institutionsrsquo effectiveness butalso to private actorsrsquo strategies

R ecognizing the importance of secure propertyrights for economic development social scien-tists for decades have sought to explain why

certain states expropriate property while others de-velop institutions that allow property rights to flourish(eg Acemoglu and Robinson 2006 North 1981 Olson1993) Much less attention has been devoted to thequestion of the extent to which firms and other privatesector actors will use state institutions should rulerschoose to provide them1

That private sector actors will use state institutionscannot be taken for granted Since Macaulayrsquos (1963)seminal work scholars widely have accepted that firmsfrequently turn to litigation or law enforcement offi-cials only as a last resort preferring instead to resolveconflicts on the basis of personal relationships andinformal norms Moreover under certain conditionsfirms employ strategies that are not merely informalbut rather outright illegal For instance unregistered

Jordan Gans-Morse is Assistant Professor Department of PoliticalScience Northwestern University 601 University Place EvanstonIL 60208 (jordangans-morsenorthwesternedu)

The author thanks Neil Abrams Karen Alter Marc BerensonJose Cheibub Georgy Egorov M Steven Fish Timothy Frye ScottGehlbach Anna Grzymala-Busse Kathryn Hendley Alisha Hol-land Sarah Hummel William Hurst PJ Lamberson Benjamin Less-ing Pauline Jones Luong James Mahoney Stanislav Markus IsraelMarques Evgeniia Mikriukova Stephen Nelson Simeon NichterRobert Orttung Andrew Roberts Jason Seawright David SzakonyiKateryna Vago Steven Vogel Jeffrey Winters Matthew WintersAndrei Yakovlev Dong Zhang and John Zysman This researchhas received support from an NSF DDIG grant (SES-0921635) theFulbright-Hays DDRA program the SSRC Eurasia program theAmerican Bar Foundation and the Kellogg School of ManagementDispute Resolution Research Center

Received June 26 2015 revised May 24 2016 accepted July 192016 First published online February 20 2017

1 A handful of economists have developed models of institutionaldemand analyzing private sector lobbying for or against the rule oflaw (Hoff and Stiglitz 2004 Polishchuk and Savvateev 2004 Sonin2003) and there is a sizable literature on how firms secure propertyand contracts in the absence of effective state institutions (eg Greif1993 Haber et al 2003 Markus 2012 McMillan and Woodruff 1999)These studies offer valuable insights but do not address the questionof why firms do or do not use formal legal institutions

firms in Peru rely on ldquothe protection that local bulliesor mafias are willing to sell themrdquo (de Soto 2003 155)while in Indonesia some private security companiesoffer services that include ldquothe intimidation of aclientrsquos business rivalsrdquo (Wilson 2010 255) In additionto violence firms frequently exploit corruption withinthe state In China there is evidence that ldquoentire[government] bureaus support private firms inways of varying legalityrdquo (Wank 2004 113) while inKyrgyzstan according to one Bishkek-based journalistldquoconflicts about property are impossible to resolveif you do not have contacts with the president or withhigh-ranking officialsrdquo (cited in Spector 2008 163) InRussia following the Soviet Unionrsquos collapse firmsrsquouse of violence and corruption became particularlyextreme In the mid-1990s two out of five enterprisemanagers reported facing physical coercion in thecourse of doing business (Radaev 1999 36ndash40) whilewell into the 2000s law enforcement officials continuedto intervene ldquoinformally as private enforcersrdquo on behalfof firms engaged in business disputes (Volkov 2002 xii)

When do firms use violence and corruption suchas private protection rackets and illicit governmentconnections to protect property rights And whendo firms instead use formal legal institutions such ascourts and law enforcement agencies The temptinganswer would be that firms turn to law when state ca-pacity is high and resort to illegal strategies when thestate is weak Indeed to the extent that the prominentproperty rights studies cited above consider firmsrsquo useof state institutions they assume that private actorsrsquowillingness to turn to the state depends primarily onformal institutionsrsquo effectiveness By contrast this arti-cle recognizes the statersquos important role in maintainingproperty security but also contends that state ldquosupplyrdquoof institutions is a necessary but frequently insufficientcondition for firms to rely on law Instead three fac-tors other than state capacity often determine whetherfirms utilize violence and corruption or whether firmsemploy legal strategies These factors are (1) firm-levelpractices and beliefs that lead firms to avoid legal strate-gies (ie ldquodemand-siderdquo barriers) (2) the effective-ness of illegal strategies for securing property and (3)

Demand for Law and the Security of Property Rights

coordination problems resulting from firmsrsquo expecta-tions about other firmsrsquo willingness to use law2

This article illustrates the importance of demand-side factors for understanding firmsrsquo reliance on legalinstitutions through a detailed study of firm strategiesfor securing property in Russia over the two decadesfollowing the Soviet Unionrsquos collapse The case of post-Soviet Russia is noteworthy for two reasons First onemight expect that once economies become mired in vio-lence or corruption these circumstances persist indefi-nitely or at best evolve toward legality over many yearsAnd indeed disproportionate attention to high-profileclashes involving owners of Russiarsquos largest conglom-erates frequently referred to as ldquooligarchsrdquo has per-petuated Russian capitalismrsquos lawless image (see egBarnes 2003 Hoffman 2002) But analysis of Russiarsquosunderstudied nonoligarchic firms many of which aresmall or medium enterprises reveals that these firmsrsquostrategies have evolved dramatically Between 1994and 2010 the number of annual court cases initiatedby Russian firms quintupled increasing from around200000 to over one million (VAS 2011) More broadlybased on in-depth interviews with firms lawyers andprivate security agencies as well as an original survey ofenterprises from eight cities I demonstrate that manyRussian firms replaced violence and corruption withreliance on formal legal institutions beginning in thelate 1990s

Second given Russiarsquos long history of state-led de-velopment one might expect that increasing use oflegal strategies can be attributed to changes in theeffectiveness of state institutions However a state-centric explanation can at best partially account forRussian firmsrsquo evolving strategies During the periodin which firms increasingly utilized law the effective-ness of Russiarsquos formal legal institutions improved onlymodestly and in many ways the Russian state becamemore corrupt and predatory By contrast analysis ofdemand-side factors offers significant insights into Rus-sian firmsrsquo adoption of legal strategies In particularfirmsrsquo partial emergence from the shadow economyreduced a major demand-side barrier to the use oflaw by mitigating firmsrsquo concerns that turning to le-gal institutions might expose illicit practices relatedto tax evasion Similarly the consolidation of own-ership in privatized firms reduced ownersrsquo readinessto incur risks associated with violence and corrup-tion undermining illegal strategiesrsquo effectiveness Inturn declining demand-side barriers and effectivenessof illegal strategies altered firmsrsquo expectations abouteach otherrsquos strategies helping overcome coordinationproblems that had impeded willingness to use law

Beyond offering insights into firm strategies andtheir evolution in post-Soviet Russia the broader con-tribution of this article is to shed light on why institu-tional reforms implemented without consideration of

2 These arguments build on Pistor (1996) and Hendley (1997 1999)but whereas the primary concern of these earlier works was to un-derstand why firms in countries such as Russia were not using formallegal institutions my focus is on conditions under which firms do turnto legal strategies

firmsrsquo and citizensrsquo everyday practices frequently failAs prominent legal scholars have emphasized firmsrsquouse of violence and corruption undermines formal in-stitutions whereas firmsrsquo use of courts and law en-forcement reinforces formal institutionsrsquo effectivenessand relevance (Hendley 1997 Pistor 1996) It followsthat comprehensive understanding of the rule of lawand the security of property requires more than at-tention to top-down institutional reforms Instead thedemand-side approach to property security advocatedhere provides a novel perspective on the developmentof state capacity suggesting along the lines of Migdalrsquos(2001) ldquostate-in-societyrdquo approach that effective state-building depends not only on rulersrsquo policies but alsoon societal actorsrsquo strategies

The remainder of this article is divided into four sec-tions The following section provides an overview ofRussian firmsrsquo evolving strategies for securing prop-erty throughout the post-Soviet period The secondsection then offers a theory of institutional demandand formalizes the argument with a simple model Thethird section illustrates the theory using qualitative andquantitative evidence drawn from the Russian case Fi-nally the concluding section considers the argumentrsquosgeneralizability and emphasizes broader implicationsof a demand-side approach to property security

EVOLVING PROPERTY SECURITYSTRATEGIES IN POST-SOVIET RUSSIA

This article examines variation over time in Russianfirmsrsquo property security strategies firmsrsquo efforts to re-solve conflicts related to acquiring assets protectingproperty and enforcing contracts The concept of prop-erty security employed here is broader than the conceptof property rights which frequently are defined as therights to use derive income from and transfer an assetto another owner (Barzel 1997 3) Throughout his-tory force has been wielded to accumulate and protectclaims to property By contrast the concept of ldquorightsrdquopresupposes the existence of the modern state whichpublicly codifies the law identifies citizensrsquo privilegesand obligations and establishes the distinction betweenlegitimate and illegitimate ownership (Winters 20117) In modern societies relying on formal legal institu-tions to enforce property rights is one possible strategyfor securing property But as noted above firms inmany societies also continue to employ violence andcorruption to protect property claims without refer-ence to law Property security therefore encompassesstrategies both for protecting property claims and forenforcing property rights3

Drawing on 90 interviews conducted throughout2009 with firms lawyers and private security agencies

3 To be clear this article does not evaluate arguments about the valueof property rights per se but rather focuses on how firms secureproperty with a particular emphasis on whether firms use formallegal institutions Nevertheless firmsrsquo confidence in legal institutionsis strongly correlated with important indicators of property rightsrsquovalue such as firmsrsquo rates of investment (see eg Frye 2004 Johnsonet al 2002)

Jordan Gans-Morse

as well as a survey of 301 firms from eight Russiancities carried out in 2010 this section details Rus-sian firmsrsquo reduced reliance on illegal and increaseduse of legal property security strategies over the pasttwo decades4 In the late 1980s and early 1990s vio-lence played an extraordinary role in Russian firmsrsquoeconomic relations Criminal protection rackets origi-nally formed to extort kiosks in open-air markets butsoon evolved into more complex operations Crimi-nal gangs offered entrepreneursmdashparticularly smallerbusinessesmdashservices including protection against otherextortionists enforcement of contracts collection ofdebt and intelligence gathering on prospective busi-ness partners (Volkov 2002) Along with criminal rack-ets private security agencies multiplied rapidly whilelarger firms created internal security services describedby the journalist David Hoffman (1997) as ldquoprivatearmies of security agents bodyguards and commer-cial spiesrdquo By 1993 there were already approximately5000 registered private security agencies by the late2000s this figure was estimated to be 30000 (Gans-Morse 2012 267 Volkov 2002 138)5

From the mid-1990s onward however violence inthe Russian business world declined Matveeva (200786) analyzed business conflicts in Russiarsquos Central Fed-eral District between 1997 and 2005 and recorded a sig-nificant drop in annual businesspeople murdered from213 to 33 Businesspeople corroborate this decline inviolence A survey conducted by Radaev (1999) of 221firms across 21 Russian regions in 1997 revealed thatapproximately two out of five respondents reportedpersonally experiencing violent extortion or threats ofphysical coercion ldquosometimesrdquo or ldquooftenrdquo By contrastin my 2010 survey of 301 firms from eight Russian citiesless than five percent of respondents reported a similarfrequency of threats or coercion Surveys also provideevidence of criminal racketsrsquo decline Frye and Zhu-ravskaya (2000) found in a 1996 survey of 230 smallretail shops in Moscow Ulyanovsk and Smolensk thatover 40 percent of respondents reported having contactwith criminal groups in the previous six months6 My2010 survey found that less than 8 percent of 105 smallbusinesses in the sample (and less than 4 percent of the301 firms in the overall sample) reported contact withrackets at any point in the previous three years7

4 The survey was conducted in Moscow St Petersburg Ekaterin-burg Nizhniy Novgorod Samara Novosibirsk Rostov-on-Don andKazan For additional information see Section 2 of the Online Ap-pendix5 Although some private security agencies and internal security ser-vices operated legally many others did not as noted by Volkov (2002143) ldquoThe use of force and intimidation to recover debts and settledisputes among businessmen is one of the major activities of criminalgroups Many PPCs [private protection companies] are also involvedin this business using purely criminal methodsrdquo6 Other survey studies documenting the extensiveness of protectionpayments include Johnson et al (2002) and Radaev (1999) For adissenting view suggesting that criminal rackets were less pervasiveat least among larger firms see Hendley et al (2000)7 Comparison of nonpanel surveys across time periods warrants cau-tion (see Frye 2010 85ndash6) but the magnitude of the shiftsmdashoften30 or more percentage pointsmdashas well as the fact that nonsurveydata point to similar conclusions indicate that claims concerning thedecline in violence are well founded

The extent of criminal protection racketsrsquo declineis best summarized by the cofounder of a prominentMoscow private security agency In the early 1990she explained the majority of his firmrsquos work involvedhelping clients deal with rackets By 1995 a noticeableshift was occurring ldquo criminal groups were disap-pearing to such an extent that they were becomingsimply something exotic If a client came to us andsaid that some thugs from the street had tried to extorthim well this was for us something exciting [It gaveus a] sort of nostalgia for the old daysrdquo (Security Firm5 interview 18 September 2009) The shift away fromviolence is also apparent in the private security sec-tor By the late 2000s security agencies differed littlefrom their Western counterparts with experts estimat-ing that provision of basic physical security of build-ings cargo and business executives accounted for 70percent of the sectorrsquos revenues the rest consisting ofinformation security legal services and installment ofcameras and alarms8

As reliance on violence waned Russian firms turnedto two types of strategies for securing property On theone hand they increasingly utilized strategies relyingon the corrupt appropriation of state resources suchas protection rackets offered by law enforcement offi-cials At the same time however firms began to utilizeformal legal institutions in earnest

Law enforcement rackets offered many of the ser-vices previously provided by criminal organizationsincluding debt collection contract enforcement andadjudication of disputes By the early 2000s observersestimated that criminal rackets maintained control ofaround 10ndash20 percent of the private security marketwhile law enforcement protection services divided upthe remaining clients (Khodorych 2002 Volkov 2002169ndash70) One journalist summarized the situation asfollows ldquoBy the end of the 1990s the majority ofentrepreneurs capable of making money were lsquovolun-tarilyrsquo providing support to the law enforcement au-thorities It could be said that the country had beendivided into zones of lsquopolice patronagersquo [militseiskoyotvetstvennosti]rdquo (Sborov 2003) Many of these prac-tices have persisted In the 2010 survey I conductedapproximately 20 and 17 percent of firms reportedusing bureaucrats and law enforcement agencies re-spectively in an ldquounofficial capacityrdquo to address a se-curity issue in the previous three years while nearly 14percent of respondents admitted relying on ldquoinformalconnectionsrdquo in the commercial courts

Yet a focus on corruptionrsquos persistence and subver-sive uses of formal legal institutions overlooks broaderchanges in Russian firmsrsquo strategies over the last twodecades From a low point of around 200000 in 1994the number of cases initiated by firms in Russiarsquos com-mercial courts approximately quintupled to over amillion by 2010 (VAS 2011)9 While rising caseloads

8 Aleksandr Ivanchenko Director of Russian Security Industry As-sociation Interviewed on June 8 20099 Russiarsquos commercial courts (arbitrazhnye sudy) are specializedcourts within the state judicial system that hear civil disputes amongfirms and civil or administrative cases between firms and the state

can reflect increased legal violations rather than in-creased willingness to use law between 2000 and 2007the number of violations reported by firms in fact de-clined (Yakovlev 2008 231) In further support of agenuine strategy shift 54 percent of respondents in the2010 survey I conducted reported being more willingto turn to courts as compared to 10 years ago Only 6percent reported being less willing (Thirty-three per-cent reported their willingness remained unchangedand 7 percent answered ldquodonrsquot knowrdquo) Overall nu-merous surveys conducted since the late 1990s havedocumented firmsrsquo extensive use of legal institutionswith about one-third of smaller and two-thirds of largerfirms having utilized the commercial courts (eg Hend-ley et al 2000 Yakovlev 2008 Yakovlev et al 2004)

Litigation rates reflect of course only a fraction offirmsrsquo reliance on legal strategies For every dispute incourt countless others are negotiated in ldquothe shadowof the lawrdquo where the threat of litigation shapes ne-gotiations (Mnookin and Kornhauser 1978) But thereis broader evidence that law plays an increasingly im-portant role in Russian business One indicator is thegrowing population of lawyers which more than dou-bled between 1996 and 2010 (Gans-Morse 2012 274ndash5)Lawyers themselves moreover see significant changesin their professionrsquos role As one of Russiarsquos top taxlawyers recalled today there is booming demand forhis services whereas in the 1990s his ldquo main problemwas not winning but convincing businesspeople thatit is worth going to courtrdquo (Lawyer 21 interview 5November 2009) Nor is firmsrsquo increasing reliance onformal legal institutions limited to Moscow as indi-cated by the observation of a lawyer from the Siberiantown of Barnaul that ldquo people more or less havecome to resolve disputes in a civilized way by going tocourtrdquo According to this lawyer courts are so packedwith litigants that ldquo to move through the corridors ofa courthouse is now impossiblerdquo (Lawyer 22 interview30 September 2009)

The most striking evidence of lawrsquos role in contem-porary Russia is how firms evaluate their use of lawyersand courts relative to other property security strategiesAs seen in Table 1 when respondents were asked torank on a 1 to 7 scale how likely a firm like theirs wouldbe to utilize various strategies to resolve a propertydispute (with 7 meaning ldquovery likelyrdquo and 1 meaningldquovery unlikelyrdquo) the highest ranking strategies werethe use of lawyers to resolve the conflict out of court(average ranking 60) and filing a claim in the commer-cial courts (57) By contrast the average rankings forthe likelihood of turning to a private security firm orcriminal racket were 23 and 19 respectively while theuse of strategies relying on corruption fell somewherein between A similar question examining preferredstrategies for collecting a debt produced nearly identi-cal results

Before considering explanations for Russian firmsrsquoevolving strategies several issues warrant discussion

Criminal cases are heard separately in the courts of general jurisdic-tion (sudy obshchey yurisdiktsii)

First while social desirability bias or respondentsrsquo im-perfect recall are inherent concerns when researchingsensitive topics the fact that quantitative survey dataqualitative interview data and objective data such ascaseloads all point to similar conclusions should inpart mitigate such concerns10 Moreover the magni-tude of trends in question is noteworthy For instanceapproximately 40 percent of firms openly reported con-tact with criminal rackets in the 1990s while fewerthan 10 percent report contact in recent surveys11

There is no evidence that respondentsrsquo trustworthinesschanged dramatically enough over time to account forsuch sizable shifts Meanwhile it should not be as-sumed that businesspeople have an incentive to over-report their use of the legal system To the contraryMacaulayrsquos (1963) classic study suggests that litigationagainst business partners breaches social norms whichmight encourage respondents to understate relianceon law

A second possible concern is that firmsrsquo use of legalinstitutions primarily reflects increased bribery and ex-ploitation of judicial corruption rather than increasedreliance on law But scholars such as Hendley (2006351) have found that although ldquocases that attract theinterest of those in power can be manipulated to servetheir interestsrdquo such concerns do not apply to thebulk of disputes ldquomundane cases are handled in ac-cordance with the prevailing lawrdquo Similarly the part-ner of a Moscow law firm explained that ldquoConnectionsare probably needed if the case is high-profile big orpolitical or if the opponent is a large company Butfor middle-sized cases they are not necessary andthe majority of cases are rather small rdquo (Lawyer 6interview 6 March 2009) Finally while there has been ageneral trend toward legal strategies over time it is im-portant to recognize that this trend occurred unevenlyacross different types of firms Indeed cross-firm varia-tion should be expected according to the demand-sideapproach developed below for key explanatory fac-tors such tax compliance or ownership consolidationthemselves occur unevenly across firm types

In summary whereas firms extensively utilized vi-olence in the early-to-mid 1990s such strategies havebecome a rarity And while reliance on protection rack-ets offered by government officials and other corruptstrategies persists firmsrsquo widespread use of legal insti-tutions cannot be attributed to exploitation of a corruptjudicial system Rather Russian firms have come torely extensively on law and lawyers to protect propertyand enforce contracts

EXPLAINING DEMAND FOR LAW ATHEORY AND MODEL

What accounts for the evolution of firmsrsquo property se-curity strategies in Russia and beyond The focus onrulers and states in Acemoglu and Robinson (2006)

10 See Section 3 of the Online Appendix for additional discussion ofdata collection concerns11 These figures refer to Frye and Zhuravskayarsquos 1996 survey and tomy 2010 survey cited on the previous page

Jordan Gans-Morse

TABLE 1 Russian Firmsrsquo Preferred Property Security Strategies

Respondents were asked the following questionsDebt Dispute Letrsquos say that another company owes your firm a significant sum of money for products purchased orservices rendered and has not made the payment even though the agreed upon deadline has passed To recover themoney owed how likely would a firm like yours be to use each of the followingProperty Dispute Letrsquos say that a competitor is trying to gain control of some significant physical asset owned by yourfirm (eg office space or a factory) To defend its assets how likely would a firm like yours be to do each of thefollowing

Average responses on a scale of 1 to 7 where 1 is ldquovery unlikelyrdquo and 7 is ldquovery likelyrdquo

Legal Strategies Debt PropertyRely on lawyers to resolve the dispute out of court 631

(301 007)604

(297 009)

Turn to the commercial courts 586(292 009)

569(293 010)

Seek the help of law enforcement officials acting in their formal capacity 483(298 013)

518(295 012)

Seek the help of government bureaucrats acting in their formal capacity 399(294 013)

457(290 012)

Illegal Strategies (corruption)Turn to the commercial courts using informal connections 419

(268 014)432

(268 014)

Seek the help of law enforcement officials acting in an informal capacity 365(288 013)

378(280 013)

Seek the help of government bureaucrats acting in an informal capacity 337(286 013)

363(281 013)

Illegal Strategies (violence)Rely on an internal security service 322

(274 014)329

(272 014)

Seek the help of a private security agency 209(278 010)

221(278 011)

Seek the help of criminal or mafia groups 175(277 008)

187(272 010)

Note The number of observations and standard errors are in parentheses

North (1981) Olson (1993) and other prominent prop-erty rights studies directs attention to rising state ca-pacity as a probable explanation for firmsrsquo increaseduse of law or decreased use of violence and corruptionThis article by contrast emphasizes the key role offirmsrsquo demand for institutions Before developing myargument the following section highlights why state-centric approaches frequently provide only a partialexplanation for why firms adopt legal strategies

Supply-Side Approaches

It is tempting to assume that the effectiveness of for-mal legal institutions explains whether firms are willingto use legal strategies12 And to be sure where statelegal capacity is altogether lacking firms are unlikelyto rely on law13 However the inverse is not necessar-ily true supplying effective institutions does not guar-

12 I define formal legal institutions as both the formal rules (eg lawsand government decrees) that shape economic relations and alsothe state organizations charged with enforcing these rules Althoughcourts may be the most obvious institution in this category law en-forcement and specialized regulatory agencies also play essentialroles in securing property13 For example McMillan and Woodruff (1999 652ndash3) found that90 percent of Vietnamese firms they surveyed believe ldquocourts are ofno use in enforcing contracts or resolving disputesrdquo and conse-quently these firms not only avoid courts but more broadly ldquocontractwithout the shadow of the lawrdquo

antee firms will use them For instance Pistor et al(1999 17) emphasize that courts in fast-growing EastAsian countriesmdashcountries renowned for high statecapacitymdashfor decades figured prominently in criminalcases but ldquoplayed a less important role in settling com-mercial disputesrdquo Furthermore firms not only eschewlegal strategies in some societies with relatively effec-tive legal institutions but firms also turn to law in othersocieties where legal institutionsrsquo weaknesses are well-known For example Whiting (2010 183) documentsa 20-fold increase between 1983 and 2001 in economicdisputes heard by Chinarsquos courts despite the fact thatldquoCourts in the PRC are subordinate to the party lackcompetent judges and have weak enforcement pow-ersrdquo Thus without denying the importance of statelegal capacity existing evidence indicates that the cor-relation between legal institutionsrsquo effectiveness andfirm strategies is far from determinative

Beyond the effectiveness of formal legal institutionsstate capacity might be expected to influence firmstrategies in other ways States capable of providingeconomic growth and political stability arguably cre-ate a business environment conducive to legal strate-gies Yet prominent counterexamples raise questionsabout the explanatory power of such macrostructuralarguments Milhaupt and West (2000) find that despitedecades of growth and stability Japanese firms haverelied persistently and extensively on criminal racketsfor services ranging from debt collection to resolution

of shareholder conflicts Meanwhile Japanese firmshistorically have shown an even lower propensity toutilize legal strategies than their counterparts in lesserdeveloped East Asian countries such as South Koreaand Taiwan (Pistor et al 1999 215) Macrostructuralarguments also leave important questions unansweredFor example they fail to illuminate the heterogeneityin strategies across different types of firms noted inthe preceding section For these and related reasonslater sections of this article make clear that neither in-creased effectiveness of legal institutions nor improvedstate capacity more broadly adequately explain Rus-sian firmsrsquo evolving property security strategies

Overall supply-side explanations offer valuable in-sights yet remain incomplete They struggle to explaincases in which state legal capacity is relatively highyet firms circumvent formal legal institutions as wellas cases in which shifts in firm strategies occur in theabsence of heightened state legal capacity They alsofall short in explaining variation in strategies acrossdifferent types of firms A key contribution of this arti-cle is thus to integrate existing supply-side approacheswith a complementary demand-side approach therebyoffering a framework for more comprehensive under-standing of property security

A Demand-Side Approach

The shortcomings of supply-side approaches makeclear that effective state institutions are necessary butfrequently insufficient to induce firmsrsquo use of legalinstitutions Instead firmsrsquo willingness to adopt legalstrategies depends on three factors unrelated to stateldquosupplyrdquo of effective institutions (1) the prevalence ofdemand-side barriers to the use of formal institutions(2) the effectiveness of illegal strategies and (3) theextent of coordination problems resulting from expec-tations about other firmsrsquo strategies This section elab-orates on each of these factors the following sectionformalizes the argument with a simple model

Demand-side barriers are practices and beliefs thatinhibit firmsrsquo willingness to use formal legal institu-tions They can result from cultural factors which ac-cording to some scholars account for low reliance onlegal institutions in many East Asian countries (seethe discussion in Ginsburg and Hoetker 2006 33ndash4)But perhaps the most prominent demand-side barrierin many countries and the barrier on which I focusbelow pertains to firmsrsquo operations in the unofficialeconomy As Hay and Shleifer (1998 399) explainfirms in the shadow economy are nearly always ldquoinviolation of some tax customs foreign-exchange orregulatory rulesrdquo and consequently cannot ldquouse theofficial legal system for fear of exposurerdquo While it hasbeen rare for Russian firms to operate without registra-tion (ie fully in the informal economy) throughoutthe 1990s firms frequently hid revenue from the taxauthorities Consequently a key factor contributing tofirmsrsquo increasing reliance on legal strategies has beenimproved levels of tax compliance

Second as with any competing set of services firmsrsquowillingness to use formal legal institutions depends onthe effectiveness of illegal strategies which depends inturn on at least two factors transaction costs and therisk of sanctions There is a rich body of literature ana-lyzing transaction costs and the relative effectiveness ofalternatives to formal legal institutions (eg Macaulay1963 Williamson 1985) But what sets the use of illegalstrategies apart from the use of informal strategies (iestrategies that do not directly rely on formal legal insti-tutions yet do not inherently violate the law) is the riskof sanctions including physical harm criminal prose-cution or the loss of funding from investors wary of afirmrsquos unsavory reputation An increase in state legalcapacity is one possible source of such sanctions Butin the Russian case a number of demand-side factorshave affected the risk of using illegal strategies In latersections I analyze the impact of evolving ownershipstructures on Russian ownersrsquo willingness to employviolence and corruption Whereas dispersed ownershipand minimal minority shareholder protections createdincentives for owners in the 1990s to use any meanspossible to acquire assets in ongoing ownership battlesthe ownership consolidation that occurred by the 2000schanged ownersrsquo calculus of risk Seeking longer-termprofits through productive investments owners recog-nized that illegal strategies could undermine firmsrsquo rep-utations and destabilize the overall business climate Asa result illegal strategiesrsquo effectiveness relative to legalstrategies declined

Third because of the unique nature of law coor-dination problems affect property security strategiesSpecifically law matters most when a sufficient pro-portion of a society perceives that other members ofsociety also believe law matters and act accordingly(Hendley 1999 92ndash3) Consequently firmsrsquo concernsabout other firmsrsquo persistent use of violence and cor-ruption hinder the adoption of legal strategies anda shift toward law requires a shift in firmsrsquo expecta-tions These coordination problems create a dynamicresembling the tipping point models scholars have usedto analyze revolutions neighborhood segregation andthe adoption of national languages (Kuran 1989 Laitin1998 Schelling 1971) As in such models the valueto using legal strategies remains lower than the valueto using illegal strategies until a critical mass of firmscomes to use legal strategies at which point the econ-omy ldquotipsrdquo toward a new equilibrium in which the valueof using legal strategies surpasses the value of usingillegal strategies One of the key implications of suchdynamics is that the vicious and virtuous cycles result-ing from firmsrsquo expectations about each other amplifythe effects of other trends When demand-side barri-ers or illegal strategiesrsquo effectiveness declines thesechanges directly lead some firms to use legal strategiesmore extensively If the proportion of firms initiallyadopting legal strategies is sufficiently large to ldquotiprdquoan economy toward a more lawful equilibrium thenthe initial reduction in demand-side barriers will alsoindirectly affect firm strategies as firmsrsquo expectationsthat other firms are increasingly turning to law becomes

Jordan Gans-Morse

an independent factor encouraging adoption of legalstrategies14

As a heuristic device for the empirical analyses thatfollow the model below formalizes the theory dis-cussed thus far It elucidates (1) why state legal capacityis a necessary but frequently insufficient condition forfirms to use legal strategies (2) why firms frequentlyadopt legal strategies even without improvements inlegal capacity due to declining demand-side barriersor the decreasing effectiveness of illegal strategies

Formalizing the Argument

Consider a game in which a conflict arises between twofirms drawn randomly from a large population of iden-tical firms over an asset with value V Each firm i hasa pure strategy space si = L I where L representslegal and I represents illegal strategies An endogenousproportion λ of firms rely on legal strategies while aproportion 1 minus λ rely on illegal strategies When theconflict begins the two firms choose their strategiessimultaneously representing firmsrsquo inability to observethe preferred strategies of other individual firms Afterboth firms choose a strategy payoffs are realized andthe game ends The payoffs are as follows

Legal vs legal strategies The loser receives nothingwhile the winner receives (α minus γ)V where α isin (0 1) is ameasure of the effectiveness of formal legal institutionsand γ isin (0 α) is a measure of demand-side barriersBecause identical firms using the same strategy havean equal chance of winning the expected payoff foreither firm is (α minus γ) V

2 Illegal vs illegal strategies The loser receives nothing

while the winner receives βV where β isin (0 1) is a mea-sure of illegal strategiesrsquo effectiveness The state detectsillegal strategies with probability q and confiscates allassets a payoff of 0 Because identical firms using thesame strategy have an equal chance of winning theexpected payoff for either firm is (1 minus q)βV

2 Legal vs illegal strategies The firm using the illegal

strategy wins the conflict and acquires the asset ofvalue V but with probability q the state detects theillegal activity confiscates the assets and returns themto the lawful firm Accordingly the expected payofffor the firm using a legal strategy is q(α minus γ)V where αagain represents the effectiveness of the legal institu-tions used for restitution and γ captures demand-sidebarriers Correspondingly the expected payoff for thefirm using an illegal strategy is (1 minus q)βV15

14 Another potential explanatory factor that complements thedemand-side variables introduced here pertains to experiential learn-ing If market-supporting legal institutions are conceptualized asa new technology then average costs of employing legal strate-gies might be expected to decrease over time through a processof ldquolearning-by-doingrdquo (see eg Arrow 1962) However regressionanalyses presented in Section 6 of the Online Appendix do not pro-duce robust evidence in favor of an experiential learning hypothesisAll regressions in the article nevertheless control for key variablesrelated to the learning hypothesis including firm age and previouslitigation experience15 Assuming illegal beat legal strategies simplifies analysis but doesnot qualitatively change results I make one additional technical

A Nash equilibrium (NE) in this game will be a pro-file of strategies such that each firmrsquos strategy is a bestresponse to all other firmsrsquo strategies More formally aNE is a strategy profile (slowast

i slowastminusi) for all firms i isin I such

that slowasti isin BRi(slowast

minusi)To examine the effects of state legal capacity on firm

strategies first consider an economy in which legalinstitutions (α) are ineffective to such a degree thata firmrsquos expected payoff to using illegal strategies isgreater than the payoff to using legal strategies re-gardless of other firmsrsquo strategies In this low-capacityeconomy the unique NE is for all firms to utilize il-legal strategies Consequently a necessary conditionfor firmsrsquo use of legal strategies is that legal capacitymust be high enough that the equilibrium in which allfirms use illegal strategies is no longer unique Nowconsider an economy in which formal legal institutionsare effective enough that a firmrsquos expected payoff tousing legal strategies is at least as great as the payoffto using illegal strategies but only if a sufficient num-ber of other firms also employ legal strategies In suchintermediate-capacity economies multiple equilibriaexist including equilibria in which some or all firmsuse legal strategies (as discussed below) but also anequilibrium in which all firms use illegal strategies Inother words an intermediate level of legal capacity isinsufficient to guarantee firmsrsquo use of legal strategiesThe following proposition formalizes these intuitions

Proposition 1 Let α = 2β(1 minus q) + γ and α = β2q(1 minus

q) + γ Then16

1 For any α lt α the unique NE for the game isslowast

i = I for all firms i isin I2 For any α isin [α α) there exists a NE in which

slowasti = I for all firms i isin I

Proposition 1 states that α ge α is a necessary but in-sufficient condition for the use of legal strategies Con-sequently state legal capacity plays a central role ininducing firms to rely on law but explanations relyingon state capacity alone remain incomplete

Complete explanations require further consid-eration of demand-side factors particularly inintermediate-capacity states (ie in states where α isin[α α))17 For this region of the parameter space ille-gal strategies yield higher payoffs than legal strategieswhen all firms use illegal strategies (ie when λ = 0)and legal strategies yield higher payoffs than illegal

assumption that q lt 14 This assumption rules out regions of the

parameter space that result in a game of chicken in which illegalstrategies are a best response to legal strategies and vice versa for itis difficult to conceive of real-world scenarios represented by such agame16 Formal proofs for all propositions are included in Section 4 of theOnline Appendix17 A sufficient condition for a unique NE in which all firms use legalstrategies is α ge α Substantively this corresponds to high-capacitystates such as the advanced industrialized countries However thisarticlersquos focus is on intermediate-capacity states in which legal ca-pacity is sufficient to make legal strategies viable but insufficient toensure a unique lawful equilibrium

strategies when all firms use legal strategies (ie whenλ = 1) Consequently when all firms use the samestrategy no firm can increase its expected payoffs byadopting an alternative strategy Meanwhile a thirdequilibrium exists in which λ = λlowast where λlowast is theproportion of firms using legal strategies such that themarginal firm is indifferent between legal and illegalstrategies Although such an equilibrium is ldquounstablerdquoin the sense that a small perturbation of parametervalues leads all firms to adopt either legal or illegalstrategies no firm has an incentive to alter its strategygiven the distribution of strategies in the economy

The proportion of firms using legal strategies λlowast rep-resents a tipping point To analyze demand-side factorsrsquoimpact the marginal firmrsquos indifference condition canbe written

λlowast[

(α minus γ)2

minus (1 minus q)β]

= (1 minus λlowast)[

(1 minus q)β

2minus q(α minus γ)

When the left-hand side of Equation (1) increasesan economy ldquotipsrdquo toward an equilibrium in whichall firms use legal strategies when the righthand sideincreases the opposite occurs The equation offers in-sights into parameter shifts that make tips more likelyAll else equal Equation (1) indicates that it becomeseasier to a tip an economy toward a lawful equilib-rium as state legal capacity (α) increases But in manydeveloping countries legal reforms are politically ortechnically infeasible Fortunately Equation (1) alsomakes clear that even if legal capacity remains stagnantor marginally deteriorates sufficiently large declines indemand-side barriers (γ) or the effectiveness of illegalstrategies (β) for a sufficiently large group of firms canfacilitate a tip toward a lawful equilibrium The theoryrsquossecond key proposition formalizes these intuitions

Proposition 2 Given q β and γ let α isin [α α) where αand α are as defined in Proposition 1 Suppose initiallythat λ = 0 Then

1 For any α isin [α α] and γ le γ there exists a β

such that if β declines to β for a portion offirms ω ge λlowast then λ = λlowast or λ = 1 will be anequilibrium

2 For any α isin [α α] and β le β there exists a γsuch that if γ declines to γ for a portion offirms ω ge λlowast then λ = λlowast or λ = 1 will be anequilibrium18

Proposition 2 states that given a necessary level ofstate legal capacity α ge α falling demand-side barriersandor declining effectiveness of illegal strategies can

18 Part 2 requires the assumption γ gt ( 12q minus 2)(1 minus q)β Substan-

tively this ensures that demand-side barriers (γ) play a sufficientlylarge role in firmsrsquo initial reluctance to use legal strategies such thata reduction in barriers can induce a strategy shift even holding illegalstrategiesrsquo effectiveness (β) constant

be sufficient conditions for firms to use legal strate-gies even if legal capacity is unchanged or decreasingConsequently demand-side factors frequently are de-terminative of firm strategies

The simple model reveals the logic underlying thetheory presented above It elucidates (1) why state legalcapacity is a necessary but frequently insufficient con-dition for firms to use legal strategies and (2) why firmsfrequently adopt legal strategies even without height-ened legal capacity The model furthermore demon-strates how reducing demand-side barriers or illegalstrategiesrsquo effectiveness has both a direct effect on firmstrategies as well as an indirect effect as other firmsadapt to the initial wave of strategy shifts The followingsection examines these points in greater detail throughanalysis of the Russian case

SUPPLY AND DEMAND FOR LAW INPOST-SOVIET RUSSIA

Post-Soviet Russia illustrates the theoryrsquos two mainpropositions In accordance with Proposition 1 theRussian case makes evident how effective legal insti-tutions are necessary but often insufficient to inducefirmsrsquo use of law In accordance with Proposition 2 theRussian case makes evident conditions under whichdemand-side factors determine firm strategies Evenwhen improvements in state legal capacity are mod-est shifts in demand-side barriers the effectiveness ofillegal strategies and expectations about other firmsrsquostrategies can induce firms to turn from violence andcorruption toward law

The current section first examines the role of statecapacity in the Russian case It then analyzes the im-pact on firm strategies of reduced demand-side barriersresulting from improved tax compliance declining ef-fectiveness of illegal strategies resulting from changesin privatized firmsrsquo ownership structures and the mit-igation of coordination problems resulting from firmsrsquoexpectations about each otherrsquos willingness to adoptlegal strategies

The Role of State Capacity

The key tenet of Proposition 1mdashthat rising effective-ness of formal legal institutions frequently is insuf-ficient to induce firmsrsquo use of lawmdashbecame rapidlyapparent in post-Soviet Russia During the chaos fol-lowing the Soviet Unionrsquos collapse formal institutionswere in such disarray that firms often had few choicesbut to rely on corrupt state officials or violence suppliedby private actors Yet by the mid-1990s significant insti-tutional development had occurred including new leg-islation on joint-stock companies securities marketsand bankruptcy a new Civil Code and the formation ofa new system of commercial courts Surveying Russiarsquoslegal institutions Hendley (1999 90) concluded thatldquoComparing snapshots of the legal landscape in 1985and 1998 would make immediately apparent the fun-damental and far-reaching nature of recent reformsrdquoHowever she also emphasized how legal reformersrsquo

Jordan Gans-Morse

expectations that increased effectiveness of legal insti-tutions would be followed by increased private sectorreliance on law remained unfulfilled ldquoAlthough thisconnection between supply of and demand for lawmay have seemed self-evident it has proven elusivein practicerdquo (Hendley 1999 89) Pistor (1996 87) cameto similar conclusions noting that ldquoIn Russia the earlyinstitutional changes aimed at providing a court systemfor handling commercial disputes have so far provedto be largely ineffective The main reasons for this ap-pear to lie less in the inefficiency of the system thanin the lack of demand for the services that it offersrdquoIn short a handful of legal scholars clearly recognizedthat heightened state legal capacity in the Russian casewas insufficient to induce the use of legal institutions

Often overlooked however is what came next Inline with the key tenets of Proposition 2mdashthat firmsoften may increase their reliance on law even with-out heightened state legal capacitymdashfirms turned tolegal strategies throughout the late 1990s and 2000sdespite significant reservations about the effectivenessof Russiarsquos formal legal institutions Indeed Russianfirms continued to adopt legal strategies throughoutthe 2000s despite rising corruption and predation bystate officials

Vladimir Putin came to power first as Prime Ministerin 1999 and then as President in 2000 with a man-date to rebuild the Russian state which had reachedthe brink of financial collapse (Hill and Gaddy 2013chap 3) As Putin recentralized power state revenuesaided by economic growth and skyrocketing oil pricesclimbed steadily Law enforcement courts and regula-tory agencies began to reestablish a role in enforcingthe rules governing Russiarsquos economy The probabilitythat strategies based on violence or corruption wouldresult in sanctions rose and strategies relying on le-gal institutions became a potentially viable option Yetthese improvements should not be overstated As Tay-lor (2011 111) notes

The achievements of [Putinrsquos] state-building project weremodest and partial with the greatest gains in capacity tak-ing place in rebuilding a regime of repression Muchless progress was made in coping with core routinetasks Repressing opposition figures and ldquobadrdquo oli-garchs certainly came much more naturally to Russianlaw enforcement officials than establishing a stable privateproperty rights regime

Buttressing this perspective is Russiarsquos consistent rank-ings in the bottom quartile of international rankingssuch as the World Bankrsquos Rule of Law Index through-out the 2000s19

That firms perceived minimal improvements in Rus-sian legal institutionsrsquo effectiveness can be seen inFigure 1 which shows firmsrsquo assessments of the court

19 See World Governance Indicators ldquoCountry Data Report forRussiardquo at wwwgovindicatorsorg Similarly reversal rates of lowercourtsrsquo decisionsmdasha common measure of judicial quality (eg Pos-ner 2000 Shvets 2012)mdashremained steady or increased from the late1990s onward with the exception of a brief decline in 2004 and 2005(VAS Osnovye pokazateli arbitrazhnykh sudov RF various years)

system drawing on data from the World Bank-EBRDBusiness Environment and Enterprise PerformanceSurvey (BEEPS) With respect to impartiality corrup-tion efficiency and affordability assessments of thecourts improved marginally and in the case of afford-ability fell between 1999 and 2005 Only with respectto courtsrsquo ability to enforce decisions did firmsrsquo evalua-tions improve but it is not clear that a lack of enforce-ment was ever a primary barrier to firmsrsquo use of le-gal institutions Even in the mid-1990s Hendley (1997242) found that ldquorarely do managers cite problems withcollection as a reason for bypassing courtsrdquo (see alsoHendley 2001 39) Likewise in a survey conductedin 2000 Yakovlev (2008 234) found that among firmswhich faced a legal violation but chose not to go tocourt fewer than one in eight indicated that enforce-ment concerns motivated their decision20 Ultimatelywhat warrants emphasis is the small percentage of firmsthroughout this period associating positive traits withcourts

Firmsrsquo evaluations of other types of formal legalinstitutions were even more dire than assessments ofcourts Yakovlev (2008 222) compared surveys of firmsconducted in the same eight regions in 2000 and 2007Firmsrsquo overall assessment of the commercial courts im-proved slightly But evaluations of the police whichwere already negative in 2000 remained unchangedwhile evaluations of local regulators and inspectors felldramatically

Beyond state legal capacity there is little evidencethat rising state capacity in a broader sense can accountfor the evolution of Russian firmsrsquo strategies The Rus-sian economy did grow at a robust annual rate of 7 per-cent between Putinrsquos rise to power in 2000 and the 2009financial crisis in part due to the statersquos sound macroe-conomic policies But the effect of economic growthand stability on firm strategies was highly ambiguousFirmsrsquo use of legal institutions rose throughout Russiarsquoseconomic boommdashand then rose at an even faster rateas firms turned to the courts to resolve nonpaymentconflicts during the 2009 crisis Not only did use oflegal strategies proceed apace across a boom and bustbut firm strategies diverged sharply during the 2009crisis as compared to firmsrsquo reaction to the financialcrisis Russia endured in 1998 Between 2008 and 2009the number of annual interfirm cases spiked by nearly80 percent Between 1997 and 1998 annual interfirmcases increased by less than 10 percent indicating thatfirms resolved their nonpayment conflicts during thisearlier period outside of the formal legal system (VAS2011) That firms responded differently to similar eco-nomic circumstances casts doubt on claims that Putinrsquosmacroeconomic policy or economic stability in generalcan explain firmsrsquo increasing reliance on legal strate-gies

20 While a new bailiff system created in the late 1990s aimed toimprove enforcement of court decisions Kahnrsquos (2002) comprehen-sive analysis of these reforms found them highly ineffective Amongother problems in the early 2000s bailiffs continued to face over 100new cases per month a workload that would have required them toenforce a case every two hours in order to keep pace (Kahn 2002159)

FIGURE 1 Russian Firmsrsquo Assessment of CourtsPercent of firms agreeing that the following descriptions are associated with the court system

Source World Bank-EBRD BEEPS survey These percentages refer to respondents who ldquofrequentlyrdquo ldquousuallyrdquo or ldquoalwaysrdquo associatethe descriptions with the court system

In addition to economic growth the early years ofPutinrsquos regime are often associated with political sta-bility and the reassertion of law and order While thereis some truth to this perspective it overlooks impor-tant trends As McFaul and Stoner-Weiss (2008 74ndash6) have noted the frequency of terrorist attacks andthe murder rate actually increased during Putinrsquos firsttwo presidential terms World Bank ratings of Russiarsquospolitical stability regulatory quality and governmenteffectiveness similarly either plateaued or temporarilyimproved in the early 2000s before again declining21

Moreover from the vantage point of firms corruptstate officialsrsquo increasing predation soon offset what-ever initial stability was provided by Putinrsquos rise topower By the late 2000s businesspeople regularly re-ferred to bureaucrats as the primary threat to propertysecurity In the words of a consultant to small busi-nesses in Moscow ldquoWho cares about criminals In-spectors can close you in a matter of seconds This is initself a kind of mafia systemrdquo (Firm 25 interview 3 June2009) Corrupt law enforcement officials meanwhilethreatened entrepreneurs with criminal prosecution inorder to force firms to pay bribes or sell assets at belowmarket prices The most high-profile attack by Russianofficials was the 2003 arrest of Mikhail KhodorkovskyRussiarsquos richest tycoon at the time but the Khodor-kovsky Affair was not an isolated incident and mayhave instigated copycat behavior among lower-level

21 See World Governance Indicators ldquoCountry Data Report for Rus-siardquo at wwwgovindicatorsorg

officials (Gans-Morse 2012) As of 2013 by some esti-mates approximately 110000 businesspeople were in-carcerated for what in Russia are known as ldquoeconomiccrimesrdquo (Kramer 2013) Indeed a major puzzle regard-ing property security strategies in Russia is that firmsbecame increasingly reliant on law not only while theeffectiveness of legal institutions remained in doubtmdashbut also while state officials themselves were becominga fundamental cause of political and economic insta-bility

In short although Putin substantially increased fund-ing for legal institutions and expanded governmentagenciesrsquo authority firms did not perceive a signifi-cant improvement in legal institutionsrsquo effectivenessMoreover by empowering state officials Putin not onlyfailed to improve the competence of those staffing le-gal institutions but also created potent new threatsto firmsrsquo property rights Ultimately while efforts toimprove state capacity may have made legal strate-gies viable rising institutional effectiveness at best canprovide a partial explanation for Russian firmsrsquo evolv-ing strategies A comprehensive explanation requiresattention to demand-side factors affecting firmsrsquochoices of how to secure property

Demand-Side Barriers Exiting the UnofficialEconomy

Proposition 2 of the theory presented above makesclear that firms frequently adopt legal strategies evenin the absence of improvements in state legal capacity

Jordan Gans-Morse

The proposition furthermore emphasizes factors otherthan rising legal capacity that can heighten firmsrsquo will-ingness to use law including the decline of demand-side barriersmdashthe practices and beliefs that lead firmsto avoid formal institutions A prominent example offalling demand-side barriers in the Russian case per-tains to improved tax compliance which alleviatedfirmsrsquo concerns that turning to legal institutions coulddraw attention to illicit tax practices

Following the Soviet collapse a large unofficial sec-tor of the economy formed in part as a result of firmsrsquoefforts to avoid taxation Firms developed numerousschemes to reduce their tax burden including barterand under-reporting of sales and wages (Shleifer andTreisman 2001 chaps 5ndash6) Legal scholars soon recog-nized tax evasion as a significant demand-side barrier tothe use of law Solomon (1997 54) for instance notedthat ldquoThe realities of the tax system and the ways thatmany firms chose to cope with it (operating partly inthe gray economy with two sets of financial records)had the added effect of discouraging those firms fromusing the courts to resolve disputesrdquo One reason firmsavoided courts he concluded was because they wereldquoloathe to risk exposing their own illegal practicesrdquoMoreover criminals and corrupt officials sought outfirms that violated laws knowing they could be coercedinto using illegal protection services As a Moscowlawyer explained ldquoIn terms of which businesses faceproblems with bureaucrats and criminal groups themost vulnerable are those using lsquoblack cashrsquo22 Theycanrsquot turn to the courts or police for help and everyoneknows thatrdquo (Lawyer 8 interview 6 February 2009)

Russiarsquos 1998 financial crisis provided impetus forfirms to exit the informal sector In particular a sharpfall in the rublersquos value stimulated unexpectedly robusteconomic growth in the year following the crisis en-couraging firms to formalize their operations in orderto take advantage of emerging economic opportunities(Dyufi 2005 127 Valitova and Tambovtsev 2001 9)Meanwhile the crisis instilled a sense of mutual vulner-ability among business tycoons and Russiarsquos leaderswho then engaged in a cooperative policymaking effortresulting in tax reforms (Jones Luong and Weinthal2004)23 These reforms formalized taxpayersrsquo rightsand obligations streamlined tax collection for socialfunds and reduced tax rates (Anisimova et al 2008a2008b) Throughout the early 2000s tax complianceimproved significantly albeit unevenly across different

22 The phrase ldquoblack cashrdquo (chernye nalichnye) refers to revenueshidden from state authorities23 I make no claim about the crisisrsquos direct impact on firmsrsquo prop-erty security strategies Rather the crisis (and postcrisis recovery)reduced demand-side barriers which in turn influenced firm strate-gies I also do not offer an argument about the crisisrsquos impactacross the former Soviet Union Of the 12 non-Baltic former re-publics only fourmdashRussia Ukraine Kazakhstan and Moldovamdashexperienced negative GDP growth in 1998 (World DevelopmentIndicators accessed 422016) Moreover it was the unique featuresof Russiarsquos crisismdashdebt default exchange rate devaluation postcrisisimport-substitution growthmdashthat linked the crisis to firmsrsquo exit fromthe informal economy (see Section 7 of the Online Appendix)

types of firms24 According to the World Bank-EBRDBEEPS surveys the percentage of respondents claim-ing that typical Russian firms report 90 percent or moreof sales revenue for tax purposes rose from 42 percentin 1999 to 65 percent in 2005 a 23 percentage pointincrease The change was even greater with respectto the percentage of respondents claiming that typicalfirms report 100 percent of revenuemdasha 32 percentagepoint increase rising from 28 to 60 percent25

Improved tax compliance had a profound effect onfirm strategies As one respondent explained in refer-ence to addressing employee theft a widespread con-cern in Russia firms ldquohave to operate legally becausewhen they catch a dishonest accountant in the act ofstealing they explain Listen fellow I pay my taxes soletrsquos go to court And they will not be afraid to go tocourt because they know that their books are cleanrdquo(Firm 15 interview 26 March 2009 emphasis added)A founding partner of a Moscow law firm confirmedthese observations offering a similar logic ldquoThere are[now] more commercial disputes between legal entitiesThat is companies have switched well are switching toa legal tax regime system Accordingly they turn tolaw firms conclude civil contracts and find protectionfor their contracts in the courts Previously everythingwas decided with a handshake Now itrsquos not likethis rdquo (Lawyer 20 interview 28 October 2008 em-phasis added)

Survey data provide further evidence of the rela-tionship between tax compliance and property secu-rity strategies In an ideal world panel data wouldfacilitate the tracking of individual firms over timeallowing analysis of how changes in a firmrsquos tax com-pliance affect its strategies Panel data measuring therelevant variables do not exist but it is nonetheless pos-sible cautiously to draw inferences from cross-sectionaldata If levels of tax compliance influence strategiesthen firms that evade taxes should be less likely to uselegal institutions and more likely to rely on violenceor corruption To this end firms in the survey I con-ducted were asked ldquoApproximately what percentageof total annual sales would you estimate the typicalfirm in your line of business reports for tax purposesrdquoSixty-eight percent of those responding stated thata typical firm reports more than 90 percent of salesrevenues26

24 I conceptualize firmsrsquo decisions regarding operations in the unoffi-cial economy as a demand-side variable because these are firm-levelchoices that reflect numerous factors other than state capacity Statepolicies such as tax reform undeniably influence tax complianceBut even within a given tax and regulatory regime studies revealconsiderable heterogeneity by sector firm size ownership type prof-itability growth and other firm-level variables with respect to payingtaxes and formally registering firms (Easter 2012 105ndash123 Kanburand Keen 2015 McPherson and Liedholm 1996)25 Authorrsquos calculations based on data from the BEEPS surveysDifference-in-means tests show that all differences between the 1999and 2005 averages are statistically significant at the 99 percent confi-dence level26 Respondents were given six choices less than 10 10 to 2425 to 49 50 to 74 75 to 89 more than 90 and ldquonotsureunwilling to answerrdquo

FIGURE 2 Tax Compliance and Propensity to Use StrategiesThe figure below shows the difference between the average responses of firms that report less than 90 of sales revenue fortax purposes (ie ldquotax violatorsrdquo) and of firms that report more than 90 (ie ldquotax compliersrdquo) on a 1 to 7 scale where 1 isldquovery unlikelyrdquo and 7 is ldquovery likelyrdquo holding other factors constant

Notes N = 301 Circles indicate point estimates from OLS regressions Horizontal lines represent 95 confidence intervals Controlvariables include the firmrsquos age number of employees financial health sector city of location and ownership structure (ie whetheror not the firm has foreign or government shareholders) the respondentrsquos age gender job description and education and dummyvariables for recent disputes and litigation experience All regressions also control for the two other variables of interest ownershipconsolidation and expectations about other firmsrsquo willingness to use legal strategies Missing data are multiply imputed See Table 1above for exact wording of the property and debt dispute scenarios

I then reconsidered firmsrsquo preferred strategies forresponding to the hypothetical property and debt dis-putes introduced in Table 1 above in which respon-dents rated on a 1 to 7 scale their likeliness of usingvarious strategies The ratings of firmsrsquo propensity touse strategies serve as dependent variables for theanalyses in Figure 2 which utilize OLS regressions toexamine the hypothesis that firms with low levels oftax compliance are less likely to utilize legal and morelikely to utilize illegal strategies27 The strategies arearrayed along the vertical axis to the left of Figure 2The circles represent point estimates of the regressioncoefficients of a ldquotax violatorrdquo dummy variable thatequals one for firms reporting less than 90 percent of

27 Missing data for all analyses were multiply imputed using theAMELIA II package for R (Honaker et al 2011) but the results aresimilar with listwise deletion as shown in Section 55 in the OnlineAppendix

revenues and zero otherwise The horizontal lines rep-resent 95 percent confidence intervals As can be seenin the regression tables in the Appendix all modelspecifications control for the wide range of variableslisted in the note to Figure 2 Analyses also control forconsolidation of ownership in privatized firms and forexpectations about other firmsrsquo strategies

Point estimates to the left of the dotted line indicatethat firms reporting less than 90 percent of revenue(ie ldquotax violatorsrdquo) rate their likeliness of using agiven strategy lower than firms reporting more than90 percent (ie ldquotax compliersrdquo) Point estimates tothe right of the dotted line indicate that ldquotax violatorsrdquoare more likely to use a given strategy In accordancewith the hypothesis that tax evading firms are lesslikely to utilize formal legal institutions ldquotax violatorsrdquorate their likeliness of turning to courts to address aproperty dispute around 055 points lower (t = 191p lt 010) than ldquotax compliersrdquo and their likeliness of

Jordan Gans-Morse

turning to lawyers to resolve the dispute out of court042 points lower (t = 171 p lt 010) holding otherfactors constant28 Tax violators additionally rate theirlikeliness of using illegal strategies much higher thantax compliers In the case of turning to law enforcementin an unofficial capacity to help resolve a property dis-pute the point estimate is 098 (t = 272 p lt 001) thepoint estimate for turning to bureaucrats in an unoffi-cial capacity is 110 (t = 310 p lt 001) Tax violatorsalso rate their likeliness of resorting to the services ofcriminal rackets 074 points higher (t = 293 p lt 001)The results pertaining to debt disputes are similar asshown in Figure 2 and the regression tables in the Ap-pendix Analyses in Section 53 of the Online Appendixshow that all results are also robust when using orderedlogit regressions in place of OLS Results additionallyare robust when a threshold of 75 percent of sales rev-enue reported to tax authorities is used to separate ldquotaxviolatorsrdquo and ldquotax compliersrdquo instead of a 90 percentthreshold (see Section 54 of the Online Appendix)29

To be sure the results of cross-sectional regressionsshould be interpreted with caution Rather than im-proved tax compliance inducing greater use of legalstrategies it is plausible that heightened effectivenessof legal institutions draws firms out of the unofficialeconomy But evidence from surveys probing why firmsleave the unofficial economy suggests that endogene-ity concerns should not be overstated For instancein a survey of Peruvian apparel firms that recentlyemerged from the informal sector only six percent ofrespondents suggested that a motivating factor was tobe able to ldquouse the justice system to demand contractexecutionrdquo The top reasons for reducing activities inthe shadow economy were access to more suppliersand customers the need to obtain credit from formalsources and the desire to avoid payment of fines (Bruceet al 2007 46) In the specific case of Russia moreoverthe preceding section demonstrated that there has notbeen a significant increase in state legal capacity Itfollows that it is much more likely that increased taxcompliance stimulated firmsrsquo greater use of formal legalinstitutions rather than the other way around

In summary substantial evidence both from quan-titative and qualitative sources of data indicates thatlow tax compliance levels create significant demand-side barriers to the use of law Accordingly as tax com-pliance in Russia improved a significant impedimentto legal strategies was removed and firms came to relyincreasingly on formal legal institutions

28 Analyses reveal no relationship however between complianceand turning to law enforcement or bureaucrats in an official capacityArguably respondents struggled to imagine relying on these actorsin an official capacity given firmsrsquo perceptions discussed above thatlaw enforcement agencies are highly corrupt29 Section 56 of the Online Appendix shows that results also arerobust using an alternative econometric approach that accounts forcorrelations across firmsrsquo willingness to use different types of strate-gies The alternative approach first employs k-means cluster analysisto group firms with similar profiles into distinct clusters Firmsrsquo clusterassignments then serve as dependent variables in a set of multinomiallogit regressions Section 57 additionally demonstrates that resultsare robust across firms of different sizes

Effectiveness of Illegal Strategies TheImpact of Ownership Consolidation

Just as Proposition 2 in the model above emphasizesthat falling demand-side barriers can contribute tofirmsrsquo increased reliance on legal institutions illegalstrategiesrsquo declining effectiveness can have a similareffect In post-Soviet Russia one factor that signif-icantly contributed to illegal strategiesrsquo declining ef-fectiveness pertained to ownership consolidation inprivatized firms which reduced ownersrsquo willingness toincur risks associated with violence or corruption Be-tween 1992 and the end of 1995 Russia privatized over100000 small enterprises and nearly 18000 mediumand large firms (Blasi et al 1997 189) Due to politicsand practicality the majority of medium and large firmswere privatized via a program in which citizens andworkers received vouchers exchangeable for sharesin privatizing enterprises Privatization consequentlyresulted in fractured ownership spread across work-ers managers investment funds wealthy individualsand firms with cross-holdings With minimal minorityshareholder protection limited oversight of managersand few dominant owners all parties with control overcash flows or physical assets faced perverse incentivesTransferring resources to front companies or embez-zling proceeds from the sale of company assets pro-vided a surer path to enrichment than long-term in-vestment

The financial crisis of 1998 initiated a significanttransformation in ownership structures dislodgingSoviet-era managers and allowing firms which weath-ered the crisis to acquire failing enterprisesrsquo assets(Androsov 2010 13 Radygin and Arkhipov 2001 16)Meanwhile the rublersquos depreciation made the man-ufacturing sector competitive for the first time sincecommunismrsquos collapse increasing the value of invest-ment in productive assets (Yakovlev et al 2004 16)30

Following a turbulent period of corporate conflictsdominant owners appeared In 1995 less than 15 per-cent of industrial firms had a shareholder with a ma-jority stake (Dolgopyatova 2005 7) By the mid-2000sapproximately three-fourths of firms had such a share-holder (Dolgopyatova 2010 85ndash6)

Concentration of ownership decreased ownersrsquo will-ingness to risk sanctions that could result from using il-legal strategies With undisputed control of enterprisesowners could reap gains from long-term investmentswithout fear that competing owners or asset-strippingmanagers would dilute their profits (Yakovlev et al

30 See Section 7 of the Online Appendix for further details aboutthe links between the 1998 crisis and ownership consolidation Itdeserves emphasis that the effects of the crisis on property redis-tribution were particularly acute in Russia given the pace and formof Russiarsquos privatization By 1998 Russiarsquos private sector share ofGDP reached 70 the highest among the non-Baltic former Sovietrepublics Russia also relied more extensively than its neighbors onvoucher privatization as opposed to cash privatization or manager-employee buyouts which created unusually severe problems withdispersed ownership (EBRD 1999) Nor did ownership consolidationresult from rising state capacity To the contrary corporate gover-nance studies emphasize that ownership concentration is indicativeof state weakness (Lazareva et al 2009 323 325)

2004 chap 3) Longer-term investment required sta-bility and predictability and owners perceived thatviolence and corruption could undermine both AsRadaev (2002 44) found in his study of the Russianconsumer electronics industry in the early 2000s ldquoTo-day a definitive reevaluation of risk is occurring amongleading players in the marketmdashrisk is beginning to beperceived as more painful The reason is not only pos-sible losses as a consequence of fines and confiscationof goods The fact of the matter is that reducingcertain types of risks is necessary in order to increasethe successful promotion of a companyrsquos brandrdquoVladimir Potanin a prominent Russian tycoon ex-pressed similar logic in 2003 when he declared

The ldquocorporate warsrdquo had shown that the damage causedby dubious methods in competition exceeded the potentialbenefits even for the ldquowinnersrdquo The positive devel-opments were achieved after most large business groupscompleted the consolidation of their assets and the ownersbecame interested in improving the quality of managementand raising external financing Effective Russian com-panies are interested in having a new business climate inthe country based on civilized rules of business and newethics of relations (Potanin 2003)

In short ownership consolidation in privatized firmscreated incentives for owners to engage in long-terminvestment rather than rapid acquisition of assets Un-der these conditions illegal strategiesrsquo effectiveness de-clined

Survey data provide further evidence of the rela-tionships between ownership consolidation and firmstrategies In the survey I conducted respondents wereasked ldquoDoes your firm have a single owner or an ownerwith a controlling packet of sharesrdquo Of the 301 respon-dent firms 78 were privatized firms Of these 40mdashapproximately 51 percentmdashreport consolidated own-ership As in previous analyses firmsrsquo ratings of theirlikeliness to use a given strategy to resolve a propertyor debt dispute serve as the dependent variables inthe OLS regression analyses in Figure 3 To assess theeffect of consolidated ownership on privatized firmsrsquostrategies I interacted a dummy variable measuringconsolidation (with a value of one for consolidatedownership and zero otherwise) with a dummy variablefor privatization (one if privatized zero if the firm wascreated de novo) The point estimates represented bycircles in Figure 3 present the marginal effects of con-solidated ownership in privatized firms calculated asthe sum of the coefficients on the consolidation variableand the interaction term

Figure 3 shows results consistent with the claim thatownership consolidation in privatized firms providesincentives to avoid illegal strategies even controllingfor the wide range of variables listed in the note toFigure 2 as well as for levels of tax compliance andexpectations about other firmsrsquo strategies Point esti-mates to the left of the vertical dotted line indicatethat privatized firms with consolidated ownership areless likely to use a given strategy than privatized firmswithout consolidated ownership Firms with consoli-

dated ownership rate their likeliness of using informalconnections in court to resolve a property dispute 115points lower (t = 207 p lt 005) than those withoutconsolidated ownership of turning to law enforcementin an unofficial capacity 121 points lower (t = 229p lt 005) and of turning to bureaucrats in an unofficialcapacity 102 points lower (t = 207 p lt 005) Theyalso rate their likeliness of using an internal securityservice 096 points lower31 Once again analyses usingthe debt dispute scenario produce similar results andall results are robust when using ordered logit in placeof OLS

In summary as owners reoriented toward longer-term investment strategies that require a respectablebusiness reputation and stable business environmentthey became less inclined to incur risks entailed inusing violence and corruption Consequently illegalproperty security strategiesrsquo relative effectiveness de-clined Both qualitative and quantitative evidence in-dicate that this decline contributed to firmsrsquo shift awayfrom illegal strategies

Coordination Dilemmas

The model introduced above emphasizes that demand-side factors not only have a direct effect on firm strate-gies but also an indirect effect as firmsrsquo expectationsabout each otherrsquos strategies shift When a substan-tial number of firms rely on violence and corruptionthis hesitancy to use legal institutions may serve asa barrier to other firmsrsquo adoption of legal strategiesSuch coordination dilemmas were apparent in Rus-sia during the early post-Soviet period Neverthelesssignificant changes in Russian firmsrsquo expectations oc-curred Moreover the mechanisms underlying this shiftare consistent with the tipping point model developedabove Managers and owners were acutely aware ofeach otherrsquos strategies and as declines in demand-side barriers or illegal strategiesrsquo effectiveness inducedsome firms to adopt legal strategies this shift providedincentives for others to follow suit

Russian businesspeople explicitly refer to coordina-tion problems For example as a Siberian brick factoryowner noted he would like to operate legally but fearsthat following the law while others do not means hiscompetitor ldquohas an advantage he gets ahead morequicklyrdquo (Firm 51 interview 18 September 2009) Asmall businessman who opened an import businesssoon after the Soviet Unionrsquos collapse described thisconundrum in detail

I am in general an adherent to living by the law payingtaxes doing business legally When [we started] weimported goods and we tried to pay all taxes But as

31 The analyses reveal no relationship between consolidation andthe use of private security agencies or criminal protection racketsPresumably this is because private security agencies and criminalrackets as opposed to internal security services are more frequentlyemployed by smaller firms whereas privatized firms tend to be large(The average size of privatized firms in the survey sample is 664employees compared to a sample average of 390)

Jordan Gans-Morse

FIGURE 3 Ownership Consolidation and Propensity to Use StrategiesThe figure below shows the difference between the average responses of privatized firms with consolidated ownership andprivatized firms without consolidated ownership on a 1 to 7 scale where 1 is ldquovery unlikelyrdquo and 7 is ldquovery likelyrdquo holdingother factors constant

Notes N = 301 Circles indicate the marginal effect of ownership consolidation in privatized firms estimated using OLS regressions(see text for further details) Horizontal lines represent 95 confidence intervals Missing data are multiply imputed See Table 1 abovefor exact wording of the property and debt dispute scenarios and the note to Figure 2 for a list of control variables All regressions alsocontrol for the two other variables of interest tax compliance and expectations about other firmsrsquo willingness to use legal strategies

a result the cost of our goods turned out to be higherthan of those goods our competitors were selling on thestreet [This was] because the so-called ldquoblackrdquo importsldquogreyrdquo imports shuttle traders and so on were flourish-ing Therefore in order to survive we were forced toalso switch to these schemes (Firm 21 interview 3 April2009)

This downward cost-cutting spiral has significant impli-cations when firms seek to switch from illegal to legalbusiness practices A manager of a Moscow consumerelectronics company interviewed by Radaev (2002 47)in the early 2000s captured this logic perfectly ex-plaining ldquoItrsquos not possible to legalize onersquos businessby oneself Itrsquos necessary that the rest of the marketand maybe even the whole market is legalized Be-cause if 90 percent work legally and 10 percent illegallythen we canrsquot do anything Everyone [ie consumers]will eventually run to the 10 percentrdquo Beyond cost-cutting businesspeople note that illegal strategiesrsquo useelicits responses in kind creating a vicious cycle An

expatriate with experience in the Russian steel indus-try recalled the blunt assessment of his firmrsquos generaldirector regarding the use of violence ldquoWe donrsquot sendin guys with guns because we donrsquot want guys with gunscoming to see usrdquo (Firm 10 interview 14 March 2009)Radaevrsquos (2002 50) study of the consumer electronicssector again came to similar conclusions finding thatldquoAny rough use of force [by one firm against another]signifies the beginning of a lsquowarrsquo rdquo

Survey data once more provide the opportunity toexamine relationships between coordination problemsand property security strategies In the 2010 survey Iconducted respondents were asked about the extent towhich they agreed with the statement ldquoThe majorityof firms with whom I conduct business do their bestto follow the lawrdquo Sixty-six percent of respondentsagreed with the statement 34 percent did not32 As

32 Agreement refers to respondents who stated they ldquostrongly agreerdquoor ldquoagreerdquo with the statement

FIGURE 4 Coordination Problems and Propensity to Use StrategiesThe figure below shows the difference between the average responses of firms which disagree that the majority of otherfirms are law-abiding (ie ldquopessimistsrdquo) compared to those which agree (ie ldquooptimistsrdquo) on a 1 to 7 scale where 1 is ldquoveryunlikelyrdquo to use a given strategy and 7 is ldquovery likelyrdquo holding other factors constant

Notes N = 301 Circles indicate point estimates from OLS regressions Horizontal lines represent 95 confidence intervals Missingdata are multiply imputed See Table 1 above for exact wording of the property and debt dispute scenarios and the note to Figure 2 for alist of control variables All regressions also control for the two other variables of interest tax compliance and ownership consolidation

above firmsrsquo ratings of their propensity to use distinctstrategies serve as the dependent variables for the OLSregression analyses in Figure 4 Strategies are arrayedalong the vertical axis to the left of the figure Circlesrepresent point estimates of the coefficient on a dummyvariable that equals one if respondents disagree withthe statement that the majority of other firms are law-abiding and zero otherwise The horizontal lines rep-resent 95 percent confidence intervals

Point estimates to the left of the vertical dotted lineindicate that respondents perceiving the majority offirms with whom they do business to be lawbreak-ers (ie ldquopessimistsrdquo) are less likely to use a givenstrategy than those perceiving the majority of theirbusiness partners to be law-abiding (ie ldquooptimistsrdquo)Point estimates to the right of the line indicate theopposite Controlling for the variables listed in thenote to Figure 2 as well as for tax compliance andownership consolidation ldquopessimistsrdquo on average ratetheir likeliness of using courts to address a propertydispute about 042 points lower (t = 185 p lt 010)

than ldquooptimistsrdquo and rate their likeliness of turning tolawyers out of court about 039 points lower (t = 195p lt 010) Similarly ldquopessimistsrdquo rate their likelinessof turning to bureaucrats in an official capacity 068points lower (t = 245 p lt 005) ldquoPessimistrdquo firmsthat perceive others to be lawbreakers also display agreater propensity to use illegal strategies Their aver-age ratings for using informal connections in court are064 points higher (t = 221 p lt 005) Similarly theyrate their likeliness of turning to law enforcement inan unofficial capacity 067 points (t = 250 p lt 005)and of seeking the services of a criminal protectionracket 049 points higher (t = 237 p lt 005) Resultsrelated to debt disputes suggest a similar pattern andare again robust when using ordered logit in placeof OLS

As in previous sections the results of cross-sectionalanalyses should be interpreted cautiously Firms over-estimating othersrsquo lawfulness may also overestimatetheir own use of legal strategies which could producespurious correlations Yet while such concerns deserve

Jordan Gans-Morse

attention the fact that both quantitative and quali-tative data point to similar conclusions supports thecontention that coordination problems significantly af-fect firmsrsquo strategies

Further evidence of the role of coordination prob-lems emerges from analysis of how firmsrsquo expectationsshifted over time Whereas 66 percent of respondents inthe 2010 survey I conducted agreed with the statementldquoThe majority of firms with whom I conduct business dotheir best to follow the lawrdquo only 31 percent of respon-dents agreed that ldquoTen years ago the majority of firmswith whom I conducted business did their best to followthe lawrdquo How did such a shift in expectations occurEvidence from in-depth interviews as well as sectoralstudies conducted by Russian researchers is consistentwith the tipping point interpretation of evolving firmstrategies As some firms adopted legal strategies inresponse to a decline in demand-side barriers or illegalstrategiesrsquo effectiveness other firms recognized peersrsquochanging practices and reevaluated their own strate-gies

The case of the small business owner of a long-running import operation discussed above provides anillustrative example of how corruptionrsquos relative costsaffect firm strategies As noted this owner fell preyto competitive pressures in the 1990s to adopt illicitpractices But over time the rising costs of briberydecreased illegal strategiesrsquo effectiveness and alteredhis willingness to rely on corruption ldquo the costs ofthese lsquograyrsquo [ie semilegal] schemes grew maybe notso much that it became economically profitable but atleast that it was not so harmful to work legally Whensuch an opportunity arose we switched a large part[of our business] to legal schemesrdquo (Firm 21 interview3 April 2009) Meanwhile Radaevrsquos (2002) study of theRussian consumer electronics sector also cited aboveprovides evidence of how initial shifts in strategies gainmomentum As discussed consumer electronic firmsexpressed unwillingness to legalize operations unlessa large segment of their sector abandoned illicit prac-tices simultaneously When Radaev probed further tounderstand how a widespread shift was occurring de-spite such barriers he found that once the process oflegalization was underway firms were acutely awareof changing tendencies and consistently reconsideredtheir strategies in response ldquoDirectors [of firms] knoweach other they have followed the activities of theirlsquoneighborsrsquo for many years and accordingly they havea good conception of what to expect from themand what is better to not count onrdquo (Radaev 200248)

In summary firmsrsquo expectations about each otherrsquoswillingness to use law independently affect the likeli-ness that firms will adopt legal strategies These coor-dination problems can lead to vicious cycles that lockeconomies in unlawful equilibria But when a decline indemand-side barriers or illegal strategiesrsquo effectivenessleads a vanguard of firms to abandon illegal strategiesthe potential arises for a shift from vicious to virtu-ous cycles in which positive expectations encouragefurther reliance on formal legal institutions

DISCUSSION

This article has offered a theory of institutional de-mand that provides insights into the conditions underwhich firms utilize formal legal institutions The theoryproposes that state legal capacity is a necessary butinsufficient condition for firms to turn to law Ratherfirms frequently adopt legal strategies in response tofalling demand-side barriers or declining effectivenessof illegal strategies the influence of which is amplifiedby the effects of firmsrsquo expectations about each otherrsquoswillingness to use law

This articlersquos aim is theory building with the case ofRussia serving to illustrate the theoryrsquos key tenets Butthe theory of institutional demand developed here of-fers insights into property security strategies in a broadrange of countries with intermediate levels of state le-gal capacitymdashthat is in countries where (1) a modicumof state legal capacity exists yet (2) formal legal insti-tutions are not sufficiently effective to ensure a uniqueequilibrium in which all firms use legal strategies Inother words scope conditions encompass all countriesother than failed states and the subset of OECD coun-tries in which the vast majority of firms already shunstrategies involving violence or corruption Moreoveralthough the specific types of demand-side barriers inintermediate-capacity states may vary from country tocountry the theory suggests that these barriers willlargely fall into the categories of firmsrsquo operations inthe unofficial economy collective action problems orcultural norms Likewise the factors influencing illegalstrategiesrsquo effectiveness may be context-specific butthese factors are likely to relate to transaction costs orthe risk of sanctions

To be sure firmsrsquo reliance on legal institutions shouldnot be equated with the emergence of the rule of law asystem in which laws equally constrain all actors bothstate and private But a focus on firmsrsquo property securitystrategies forces scholars to recognize understudiedchallenges that firmsrsquo use of violence or corruption posefor rule-of-law development A focus on firm strategiesalso forces rule-of-law advocates to look beyond formallegal institutions with the aim of alleviating demand-side barriers These lessons hold relevance for much ofthe developing world

Turning attention from rulers to firms additionallyencourages new perspectives on state building AsMigdal (2001) notes advocating what he refers to asa ldquostate-in-societyrdquo approach state-buildingrsquos successdepends on societal actorsrsquo strategies State building isnot only a top-down process of implementing institu-tional blueprints but also a bottom-up process involv-ing the daily role of numerous ldquoordinaryrdquo actors in ldquotheongoing struggles among shifting coalitions over therules for daily behaviorrdquo (Migdal 2001 10) Strategiesutilizing violence or corruptionmdashnot only on the partof firms but also on the part of political parties citizensor lower-level bureaucratsmdashintrinsically undermine orsubvert formal institutions By undermining state in-stitutions such strategies contribute to a fundamentaldivergence between on-the-ground practices and for-mal rules Even more nefariously by subverting state

institutions illegal strategies imbue state policies withthe logic of private gain rather than public interest Bycontrast legal strategies reinforce formal institutionsas citizensrsquo and firmsrsquo reliance on formal institutionsinfuses these institutions with authority

Ultimately by utilizing state institutions societalactors contribute on a micro-level to state buildingby circumventing or subverting state institutions theycontribute to institutional breakdown Consequentlythe implications of the demand-side approach to prop-

erty security advocated here are wide-ranging Re-moving demand-side barriers to the use of formalinstitutions or mitigating illegal alternativesrsquo effective-ness may be essential not only for developing the rule oflaw but also for improving state capacity more broadly

SUPPLEMENTARY MATERIALS

To view supplementary material for this article pleasevisit httpsdoiorg101017S0003055416000691

Jordan Gans-Morse

APPENDIX

TABLE A1 Regression ResultsmdashProperty Dispute Scenario

Law Gov Law Gov PrivateCourts Enf Officials Courts Enf Officials Criminal Sec Internal

Lawyers (formal) (formal) (formal) (informal) (informal) (informal) Rackets Agency Security

(1)Tax violator minus 042dagger minus 055dagger minus 027 minus 020 057 098lowastlowast 110lowastlowast 074lowastlowast 045 007(025) (029) (034) (034) (035) (036) (036) (025) (029) (035)

(3)Privatizedlowast 029 042 minus 026 034 minus 115lowast minus 121lowast minus 102lowast 005 minus 006 minus 095consolidated

(marginal effects) (040) (037) (050) (052) (055) (053) (049) (026) (030) (062)(5)Others unlawful minus 039dagger minus 042dagger minus 031 minus 068lowast 064lowast 067lowast 034 049lowast 025 037

(020) (023) (026) (028) (029) (027) (026) (021) (022) (028)

Privatized minus 029 minus 021 minus 113lowast minus 025 041 minus 028 008 minus 048 minus 094lowast 051(040) (042) (052) (054) (057) (059) (056) (036) (038) (059)

Consolidated 034 012 minus 055 007 006 minus 077dagger minus 044 009 minus 020 minus 018(031) (034) (037) (040) (042) (042) (042) (027) (032) (038)

Privatizedlowast minus 005 030 029 027 minus 120dagger minus 044 minus 058 minus 004 014 minus 077consolidated

(047) (048) (062) (063) (068) (066) (063) (035) (041) (071)Firm age 010 024lowast 012 012 000 007 minus 006 006 011 004

(008) (010) (010) (011) (013) (012) (012) (008) (009) (012)Foreign owned 017 076lowast minus 026 minus 060 033 012 minus 001 050 034 020

(027) (031) (040) (044) (043) (043) (043) (034) (041) (044)Gov owned 005 036 000 031 minus 009 minus 071 minus 044 005 minus 007 minus 027

(033) (035) (039) (044) (046) (045) (049) (033) (036) (051)Bus assoc 014 minus 002 071lowastlowast 089lowastlowast 062lowast 031 034 007 005 060dagger

(021) (022) (025) (027) (031) (026) (028) (024) (024) (031)Rights violated 001 030 027 029 034 057dagger 039 018 022 037

(022) (028) (029) (031) (032) (033) (031) (022) (027) (032)Litigated 045 028 064lowast minus 027 021 002 minus 017 minus 028 minus 044dagger minus 007

(028) (030) (031) (032) (035) (033) (033) (022) (025) (036)Legal ed minus 016 026 021 042 019 026 075dagger 065lowast 019 039

(027) (032) (039) (039) (044) (038) (041) (031) (029) (038)Age 000 003lowast minus 002dagger minus 002dagger 001 minus 001 000 minus 003lowastlowastlowast minus 002dagger minus 001

(001) (001) (001) (001) (002) (001) (001) (001) (001) (001)Male 028 024 009 001 043 008 028 minus 024 026 minus 010

(020) (023) (026) (026) (030) (028) (028) (021) (024) (029)(Intercept) 557lowastlowastlowast 321lowastlowast 803lowastlowastlowast 684lowastlowastlowast 104 329lowastlowast 286lowast 342lowastlowastlowast 377lowastlowastlowast 432lowastlowastlowast

(100) (110) (111) (122) (128) (125) (122) (080) (105) (119)City dummies yes yes yes yes yes yes yes yes yes yesSector dummies yes yes yes yes yes yes yes yes yes yesFirm size dummies yes yes yes yes yes yes yes yes yes yesFirm finances yes yes yes yes yes yes yes yes yes yes

dummiesJob title dummies yes yes yes yes yes yes yes yes yes yesN 301 301 301 301 301 301 301 301 301 301R sq 025 030 026 027 027 032 031 036 030 030Adj R sq 014 019 015 016 016 021 020 027 019 019

Notes Row (1) shows the OLS regression coefficients displayed in Figure 2 Row (3) shows the marginal effects displayed in Figure 3which are the sum of the coefficients for the consolidation dummy and consolidationlowastprivatization interaction variables Row (5) showsthe coefficients displayed in Figure 4daggerSignificant at p lt 010 lowastp lt 005 lowastlowastp lt 001 lowastlowastlowast p lt 0001 Robust standard errors in parentheses

TABLE A2 Regression ResultsmdashDebt Dispute Scenario

Lawyers (formal) (formal) (formal) (informal)(informal)(informal) Rackets Agency Security

(1)Tax violator 000 minus 052lowast 006 012 073lowast 109lowastlowast 131lowastlowastlowast 063lowastlowast 053dagger 019(021) (024) (035) (034) (034) (037) (034) (021) (028) (035)

(3)Privatizedlowast 027 008 minus 036 minus 025 minus 107dagger minus 122lowast minus 115lowast minus 010 minus 020 minus 059consolidated

(marginal effects) (037) (032) (055) (051) (056) (052) (050) (020) (029) (061)(5)Others unlawful minus 020 minus 022 011 minus 059lowast 061lowast 051dagger 013 038lowast 039dagger 038

(017) (019) (028) (029) (029) (027) (026) (017) (021) (028)

Privatized minus 028 minus 032 001 minus 005 016 029 036 minus 064lowast minus 082lowast 026(033) (034) (058) (055) (058) (057) (056) (032) (037) (055)

Consolidated minus 009 minus 038 minus 025 minus 012 minus 035 minus 083lowast minus 036 minus 009 minus 045 minus 026(024) (026) (042) (042) (039) (042) (038) (026) (031) (034)

Privatizedlowast 035 046 minus 011 minus 013 minus 073 minus 039 minus 079 000 025 minus 033consolidated

(042) (040) (069) (064) (069) (066) (061) (031) (039) (067)Firm age 007 013 012 014 minus 003 minus 003 minus 004 011 003 012

(008) (010) (011) (011) (013) (012) (012) (008) (009) (012)Foreign owned 004 040 minus 033 000 034 minus 015 001 032 022 017

(024) (029) (044) (043) (043) (045) (041) (028) (033) (042)Gov owned 002 020 004 043 minus 031 minus 070 minus 045 001 000 018

(033) (036) (047) (044) (049) (049) (047) (025) (027) (051)Bus assoc minus 020 minus 001 015 minus 006 047 018 008 minus 002 024 057dagger

(016) (019) (029) (029) (032) (027) (026) (019) (022) (032)Rights violated minus 001 039dagger 061dagger 008 033 minus 005 007 027 038 025

(019) (023) (032) (033) (033) (033) (031) (021) (026) (032)Litigated 015 minus 019 minus 020 minus 018 009 002 010 minus 008 minus 033 minus 031

(019) (024) (035) (034) (035) (035) (031) (020) (023) (036)Legal ed 006 038 069 011 017 071dagger 059 053dagger 039 102lowastlowast

(026) (025) (045) (040) (046) (039) (038) (027) (026) (037)Age 000 001 minus 003dagger minus 001 001 minus 001 minus 001 minus 002lowast minus 001 minus 001

(001) (001) (001) (001) (002) (001) (001) (001) (001) (001)Male 003 036dagger minus 024 minus 022 048 minus 021 minus 007 minus 021 minus 018 minus 038

(018) (020) (029) (029) (030) (027) (027) (018) (021) (029)(Intercept) 590lowastlowastlowast 444lowastlowastlowast 677lowastlowastlowast 616lowastlowastlowast 102 435lowastlowastlowast 363lowastlowast 343lowastlowastlowast 479lowastlowastlowast 426lowastlowastlowast

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Androsov Ivan V 2010 ldquoOsobennosti Transformatsii OtnosheniiSobstvennosti v Usloviyakh Krisisnykh Etapov TsiklichnostiRazvitiya Rynochnoy Ekonomiki [Transforming Property Rela-tions under Crisis Conditions of the Cyclical Stages of MarketEconomy Development]rdquo Vestnik TGU 3 (83) 9ndash17

Anisimova Lyudmila Pavel Kadochnikov Tatiana A MalininaVladimir Nazarov Sergei Germanovich Sinelnikov-Murylev andIlya Trunin 2008a Reforma Nalogoblazheniya Dokhodov Nase-leniya v Rossii [Reform of the Personal Income Taxationin Russia] Moscow Russia Gaidar Institute for EconomicPolicy

Anisimova Lyudmila Tatiana A Malinina and Elena V Shkrebela(2008b) Nalog na Pribyl Organizatisii [The Corporate IncomeTax] xpn Moscow Russia Gaidar Institute for Economic Policy

Arrow Kenneth J 1962 ldquoThe Economic Implications of Learningby Doingrdquo The Review of Economic Studies 29 (3) 155ndash73

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Barnes Andrew 2003 ldquoRussiarsquos New Business Groups and StatePowerrdquo Post-Soviet Affairs 19 (2) 154ndash86

Barzel Yoram 1997 Economic Analysis of Property Rights NewYork Cambridge University Press

Blasi Joseph R Maya Kroumova and Douglas Kruse 1997 Krem-lin Capitalism Privatizing the Russian Economy Ithaca NY Cor-nell University Press

Bruce John W Omar Garcia-Bolivar Michael Roth Anna Knoxand Jon Schmid 2007 Land and Business Formalization for LegalEmpowerment of the Poor Strategic Overview Paper USAIDIthaca NY

de Soto Hernando 2003 The Mystery of Capital Why CapitalismTriumphs in the West and Fails Everywhere Else New York NYBasic Books

Dolgopyatova Tatiana 2005 Evolution of Corporate Control Mod-els in Russian Companies New Trends and Factors Higher Schoolof Economics Working Paper

Dolgopyatova Tatiana 2010 ldquoKontsentratsiya Sobstvennosti vRossiiskoi Promyshlennosti Evolyutsionnye Izmeneniya naMikrourovne [Concentration of Ownership in Russian IndustryEvolutionary Change on the Micro-level]rdquo Dzhurnal Novoi Eko-nomicheskoi Assotsiatsii (8) 80ndash100

Dyufi Karolina 2005 ldquoBarter i Sdelki Mezhdu Kompaniyami KNormalizatsii Raschetov Posle Krizisa 1998 [Barter and Inter-enterprise Transactions Toward the Normalization of Accountsafter the 1998 Crisis]rdquo Problemy Prognozirovaniya (1) 121ndash30

Easter Gerald M 2012 Capital Coercion and PostcommunistStates Ithaca NY Cornell University Press

European Bank for Reconstruction and Development (EBRD)1999 Transition Report 1999 Ten Years of Transition

Frye Timothy 2004 ldquoCredible Commitment and Property RightsEvidence from Russiardquo American Political Science Review 98 (3)453ndash66

Frye Timothy 2010 ldquoCorruption and the Rule of Lawrdquo In Russia af-ter the Global Economic Crisis eds Anders Aslund Sergei Gurievand Andrew Kuchins eds Washington DC Peter G PetersonInstitute for International Economics 79ndash94

Frye Timothy and Ekaterina Zhuravskaya 2000 ldquoRackets Reg-ulation and the Rule of Lawrdquo Journal of Law Economics andOrganization 16 (2) 478ndash502

Gans-Morse Jordan 2012 ldquoThreats to Property Rights in RussiaFrom Private Coercion to State Aggressionrdquo Post-Soviet Affairs28 (3) 263ndash95

Ginsburg Tom and Glenn Hoetker 2006 ldquoThe Unreluctant Liti-gant An Empirical Analysis of Japanrsquos Turn to Litigationrdquo TheJournal of Legal Studies 35 (1) 31ndash59

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Hendley Kathryn 1997 ldquoLegal Development in Post-Soviet Rus-siardquo Post-Soviet Affairs 13 (3) 228ndash51

Hendley Kathryn 1999 ldquoRewriting the Rules of the Game in Rus-sia The Neglected Issue of Demand for Lawrdquo East EuropeanConstitutional Review 8 (4) 89ndash95

Hendley Kathryn 2001 ldquoBeyond the Tip of the Iceberg BusinessDisputes in Russiardquo In Assessing the Value of Law in Transi-tion Economies ed Peter Murrell Ann Arbor MI University ofMichigan Press pp 20ndash55

Hendley Kathryn 2006 ldquoAssessing the Rule of Law in RussiardquoCardozo Journal of International and Comparative Law 14 (2)347ndash91

Hendley Kathryn Peter Murrell and Randi Ryterman 2000 ldquoLawRelationships and Private Enforcement Transactional Strategiesof Russian Enterprisesrdquo Europe-Asia Studies 52 (4) 627ndash56

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Hoff Karla and Joseph E Stiglitz 2004 ldquoAfter the Big Bang Ob-stacles to the Emergence of the Rule of Law in Post-CommunistSocietiesrdquo American Economic Review 94 (3) 753ndash63

Hoffman David E 2002 The Oligarchs Wealth and Power in theNew Russia New York NY Public Affairs

Hoffman David 1997 Banditry Threatens the New Russia TheWashington Post (May 12) httpswwwwashingtonpostcomarchivepolitics19970512banditry-threatens-the-new-russiae46ef158-bd84-4ca9-870f-612817fe5854

Honaker James Gary King and Matthew Blackwell 2011 ldquoAmeliaII A Program for Missing Datardquo Journal of Statistical Software 45(7) 1ndash47

Johnson Simon John McMillan and Christopher Woodruff 2002ldquoProperty Rights and Financerdquo American Economic Review 92(5) 1335ndash56

Jones Luong Pauline and Erika Weinthal 2004 ldquoContra CoercionRussian Tax Reform Exogenous Shocks and Negotiated Institu-tional Changerdquo American Political Science Review 98 (1) 139ndash52

Kahn Peter L 2002 ldquoThe Russian Bailiffs Service and the Enforce-ment of Civil Judgmentsrdquo Post-Soviet Affairs 18 (2) 148ndash81

Kanbur Ravi and Michael Keen 2015 ldquoReducing InformalityrdquoFinance amp Development 52 (1) 52ndash4

Khodorych Aleksei 2002 ldquoPoslednii Dovod Zashchity [The De-fensersquos Last Argument]rdquo Dengi (April 17)

Kramer Andrew E 2013 ldquoRussiarsquos Stimulus Plan Open the GulagGatesrdquo New York Times (August 8)

Kuran Timur 1989 ldquoSparks and Prairie Fires A Theory of Unan-ticipated Political Revolutionrdquo Public Choice 61 (1) 41ndash74

Laitin David D 1998 Identity in Formation The Russian-SpeakingPopulations in the Near Abroad Ithaca NY Cornell UniversityPress

Lazareva Olga Andrei Rachinsky and Sergey Stepanov 2009 ldquoASurvey of Corporate Governance in Russiardquo In Corporate Gover-nance in Transition Economies ed Robert W McGee New YorkNY Springer 315ndash49

Macaulay Stewart 1963 ldquoNon-Contractual Relations in BusinessA Preliminary Studyrdquo American Sociological Review 28 55ndash67

Markus Stanislav 2012 ldquoSecure Property as a Bottom-Up ProcessFirms Stakeholders and Predators in Weak Statesrdquo World Politics64 (2) 242ndash77

Matveeva N 2007 ldquoKriminologicheskiy analiz sostoyaniya za-shchishchennosti predprinimatelei ot tyazhkogo nasiliya v Tsen-tralnom Federalnom okruge [Criminological analysis of the en-trepreneursrsquo degree of protection from harmful violence in theCentral Federal District]rdquo In Kriminalnaya ekonimika i organizo-vannaya prestupnost [The criminal economy and organized crime]ed A Dolgova Moscow The Russian Criminological Associationand the Nizhgovorod Academy of the MVD

McFaul Michael and Kathryn Stoner-Weiss 2008 ldquoThe Myth ofthe Authoritarian Model How Putinrsquos Crackdown Holds RussiaBackrdquo Foreign Affairs 87 (1) 68ndash84

McMillan John and Christopher Woodruff 1999 ldquoDispute Preven-tion without Courts in Vietnamrdquo Journal of Law Economics ampOrganization 15 (3) 637ndash58

McPherson Michael A and Carl Liedholm 1996 ldquoDeterminants ofSmall and Micro Enterprise Registration Results from Surveys inNiger and Swazilandrdquo World Development 24 (3) 481ndash7

Migdal Joel S 2001 State in Society Studying how States and So-cieties Transform and Constitute One Another New York Cam-bridge University Press

Milhaupt Curtis J and Mark D West 2000 ldquoThe Dark Side ofPrivate Ordering An Institutional and Empirical Analysis of Or-ganized Crimerdquo The University of Chicago Law Review 67 (1)41ndash98

Mnookin Robert H and Lewis Kornhauser 1978 ldquoBargaining inthe Shadow of the Law The Case of Divorcerdquo Yale Law Journal88 (5) 950ndash97

North Douglass C 1981 Structure and Change in Economic HistoryNew York NY Norton

Olson Mancur 1993 ldquoDictatorship Democracy and Develop-mentrdquo American Political Science Review 87 (3) 567ndash76

Pistor Katharina 1996 ldquoSupply and Demand for Contract Enforce-ment in Russia Courts Arbitration and Private EnforcementrdquoReview of Central and East European Law 22 (1) 55ndash87

Pistor Katharina Philip Wellons and Jeffrey Sachs 1999 The Roleof Law and Legal Institutions in Asian Economic Development1960ndash1995 Oxford Oxford University Press

Polishchuk Leonid and Alexi Savvateev 2004 ldquoSpontaneous(Non) Emergence of Property Rightsrdquo The Economics of Transi-tion 12 (1) 103ndash27

Posner Richard A 2000 ldquoIs the Ninth Circuit too Large A Statisti-cal Study of Judicial Qualityrdquo The Journal of Legal Studies 29 (2)711ndash9

Potanin Vladimir 2003 ldquoCorporate Governance ldquoRussian Modelrdquoin Progressrdquo Journal on Foreign Affairs and International Rela-tions Available at httpengglobalaffairsrunumbern 1724

Radaev Vadim 1999 ldquoThe Role of Violence in Russian BusinessRelationsrdquo Problems of Economic Transition 41 (12) 34ndash61

Radaev Vadim 2002 Institutsionalnaya Dinamika Rynkov iFormirovanie Novych Konseptsii Kontrolya [Institutional MarketDynamics and the Formation of New Concepts of Control] HigherSchool of Economics working paper

Radygin Alexander and Sergei Arkhipov 2001 Tendentsii v Struc-ture Sobstvennosti Intensivnost Korporativnykh Konfliktov i Fi-nansovoe Sostoyanie Predpriyatii [Trends in Ownership Structurethe Intensity of Corporate Conflicts and the Financial Conditionof Enterprises] Russian-European Centre for Economic Policyreport

Sborov Afanasiy 2003 Oborotni v pogonakh [Werewolves inEpaulets] Vlast (July 21)

Schelling Thomas C 1971 ldquoDynamic Models of Segregationrdquo TheJournal of Mathematical Sociology 1 (2) 143ndash86

Shleifer Andrei and Daniel Treisman 2001 Without a Map PoliticalTactics and Economic Reform in Russia Cambridge MA MITPress

Shvets Julia 2012 ldquoJudicial Institutions and Firmsrsquo External Fi-nance Evidence from Russiardquo Journal of Law Economics ampOrganization 29 (4) 735ndash64

Solomon Peter H 1997 ldquoThe Persistence of Judicial Reform inContemporary Russiardquo East European Constitutional Review 650ndash6

Sonin Konstantin 2003 ldquoWhy the Rich may Favor Poor Protectionof Property Rightsrdquo Journal of Comparative Economics 31 (4)715ndash31

Spector Regine 2008 ldquoSecuring Property in Contemporary Kyr-gyzstanrdquo Post-Soviet Affairs 24 (2) 149ndash76

Taylor Brian D 2011 State Building in Putinrsquos Russia Policing andCoercion After Communism New York Cambridge UniversityPress

Valitova Lilia and Vitaly Tambovtsev 2001 ldquoRossiiskii Barter v1992-2000 Godakh [Russian Barter during 1992ndash2000s]rdquo RussianEconomic Barometer (1) 8ndash12

Volkov Vadim 2002 Violent Entrepreneurs The Use of Force inthe making of Russian Capitalism Ithaca NY Cornell UniversityPress

Vysshyi Arbitrazhnyi Sud (VAS) 2011 Osnovnye Pokazateli RabotyArbitrazhniykh Sudov RF [Basic Indicators of the Work of the theCommercial Courts of the RF] Vysshyi arbitrazhnyi sud [SupremeArbitrazh Court] in Moscow

Wank David 2004 ldquoBusiness-State Clientelism in China Declineor Evolutionrdquo In Social Connections in China Institutions Cul-ture and the Changing Nature of Guanxi eds Thomas GoldDoug Guthrie and David Wank New York Cambridge UniversityPress 97ndash116

Whiting Susan H 2010 ldquoContracting and Dispute Resolutionamong Chinese Firms Law and Its Substitutesrdquo In Dynamicsof Local Governance in China During the Reform Era edsTse-Kang Leng and Yun-Han Chu Lanham MD LexingtonBooks pp 181ndash224

Williamson Oliver E 1985 The Economic Institutions of CapitalismNew York NY Macmillan

Wilson Ian 2010 ldquoReconfiguring Rackets Racket Regimes Pro-tection and the State in Post-New Order Jakartardquo In The Stateand Illegality in Indonesia eds Edward Aspinall and Gerry vanKlinken Lanham MD Lexington Books 239ndash60

Winters Jeffrey A 2011 Oligarchy New York Cambridge Univer-sity Press

Yakovlev Andrei 2008 Pravo i Pravoprimenenie v Rossii GlazamiBiznesa Chto Izmenilos za Sem Let [Law and Law Enforce-ment in Russia through the Eyes of Business What Changedin the Last Seven Years] In Pravoprimenenie Teoriya i Prak-tika ed Yury Tikhomirov Moscow Formula Prava 214ndash39

Yakovlev Andrei Victoria Golovanova Tatiana G DolgopyatovaBoris Kuznetsov and Yuri Simachev 2004 Spros na Pravov Sfere Korporativnogo Upravleniya [Demand for Law in theSphere of Corporate Governance] Moscow Higher School ofEconomics

EVOLVING PROPERTY SECURITY STRATEGIES IN POST-SOVIET RUSSIA

EXPLAINING DEMAND FOR LAW A THEORY AND MODEL




SUPPLY AND DEMAND FOR LAW IN POST-SOVIET RUSSIA


Demand-Side Barriers Exiting the Unofficial Economy

Effectiveness of Illegal Strategies The Impact of Ownership Consolidation


DISCUSSION


REFERENCES

coordination problems resulting from firmsrsquo expecta-tions about other firmsrsquo willingness to use law2

This article illustrates the importance of demand-side factors for understanding firmsrsquo reliance on legalinstitutions through a detailed study of firm strategiesfor securing property in Russia over the two decadesfollowing the Soviet Unionrsquos collapse The case of post-Soviet Russia is noteworthy for two reasons First onemight expect that once economies become mired in vio-lence or corruption these circumstances persist indefi-nitely or at best evolve toward legality over many yearsAnd indeed disproportionate attention to high-profileclashes involving owners of Russiarsquos largest conglom-erates frequently referred to as ldquooligarchsrdquo has per-petuated Russian capitalismrsquos lawless image (see egBarnes 2003 Hoffman 2002) But analysis of Russiarsquosunderstudied nonoligarchic firms many of which aresmall or medium enterprises reveals that these firmsrsquostrategies have evolved dramatically Between 1994and 2010 the number of annual court cases initiatedby Russian firms quintupled increasing from around200000 to over one million (VAS 2011) More broadlybased on in-depth interviews with firms lawyers andprivate security agencies as well as an original survey ofenterprises from eight cities I demonstrate that manyRussian firms replaced violence and corruption withreliance on formal legal institutions beginning in thelate 1990s

Second given Russiarsquos long history of state-led de-velopment one might expect that increasing use oflegal strategies can be attributed to changes in theeffectiveness of state institutions However a state-centric explanation can at best partially account forRussian firmsrsquo evolving strategies During the periodin which firms increasingly utilized law the effective-ness of Russiarsquos formal legal institutions improved onlymodestly and in many ways the Russian state becamemore corrupt and predatory By contrast analysis ofdemand-side factors offers significant insights into Rus-sian firmsrsquo adoption of legal strategies In particularfirmsrsquo partial emergence from the shadow economyreduced a major demand-side barrier to the use oflaw by mitigating firmsrsquo concerns that turning to le-gal institutions might expose illicit practices relatedto tax evasion Similarly the consolidation of own-ership in privatized firms reduced ownersrsquo readinessto incur risks associated with violence and corrup-tion undermining illegal strategiesrsquo effectiveness Inturn declining demand-side barriers and effectivenessof illegal strategies altered firmsrsquo expectations abouteach otherrsquos strategies helping overcome coordinationproblems that had impeded willingness to use law

Beyond offering insights into firm strategies andtheir evolution in post-Soviet Russia the broader con-tribution of this article is to shed light on why institu-tional reforms implemented without consideration of

2 These arguments build on Pistor (1996) and Hendley (1997 1999)but whereas the primary concern of these earlier works was to un-derstand why firms in countries such as Russia were not using formallegal institutions my focus is on conditions under which firms do turnto legal strategies

firmsrsquo and citizensrsquo everyday practices frequently failAs prominent legal scholars have emphasized firmsrsquouse of violence and corruption undermines formal in-stitutions whereas firmsrsquo use of courts and law en-forcement reinforces formal institutionsrsquo effectivenessand relevance (Hendley 1997 Pistor 1996) It followsthat comprehensive understanding of the rule of lawand the security of property requires more than at-tention to top-down institutional reforms Instead thedemand-side approach to property security advocatedhere provides a novel perspective on the developmentof state capacity suggesting along the lines of Migdalrsquos(2001) ldquostate-in-societyrdquo approach that effective state-building depends not only on rulersrsquo policies but alsoon societal actorsrsquo strategies

The remainder of this article is divided into four sec-tions The following section provides an overview ofRussian firmsrsquo evolving strategies for securing prop-erty throughout the post-Soviet period The secondsection then offers a theory of institutional demandand formalizes the argument with a simple model Thethird section illustrates the theory using qualitative andquantitative evidence drawn from the Russian case Fi-nally the concluding section considers the argumentrsquosgeneralizability and emphasizes broader implicationsof a demand-side approach to property security

EVOLVING PROPERTY SECURITYSTRATEGIES IN POST-SOVIET RUSSIA

This article examines variation over time in Russianfirmsrsquo property security strategies firmsrsquo efforts to re-solve conflicts related to acquiring assets protectingproperty and enforcing contracts The concept of prop-erty security employed here is broader than the conceptof property rights which frequently are defined as therights to use derive income from and transfer an assetto another owner (Barzel 1997 3) Throughout his-tory force has been wielded to accumulate and protectclaims to property By contrast the concept of ldquorightsrdquopresupposes the existence of the modern state whichpublicly codifies the law identifies citizensrsquo privilegesand obligations and establishes the distinction betweenlegitimate and illegitimate ownership (Winters 20117) In modern societies relying on formal legal institu-tions to enforce property rights is one possible strategyfor securing property But as noted above firms inmany societies also continue to employ violence andcorruption to protect property claims without refer-ence to law Property security therefore encompassesstrategies both for protecting property claims and forenforcing property rights3

Drawing on 90 interviews conducted throughout2009 with firms lawyers and private security agencies

3 To be clear this article does not evaluate arguments about the valueof property rights per se but rather focuses on how firms secureproperty with a particular emphasis on whether firms use formallegal institutions Nevertheless firmsrsquo confidence in legal institutionsis strongly correlated with important indicators of property rightsrsquovalue such as firmsrsquo rates of investment (see eg Frye 2004 Johnsonet al 2002)

Jordan Gans-Morse

(301 007)604

(297 009)

569(293 010)

518(295 012)

457(290 012)

(268 014)432

(268 014)

378(280 013)

363(281 013)

(274 014)329

(272 014)

221(278 011)

187(272 010)

Jordan Gans-Morse

q) + γ Then16

λlowast[

(α minus γ)2

(1 minus q)β

Jordan Gans-Morse

DISCUSSION

Jordan Gans-Morse

APPENDIX

(020) (023) (026) (028) (029) (027) (026) (021) (022) (028)

(001) (001) (001) (001) (002) (001) (001) (001) (001) (001)Male 028 024 009 001 043 008 028 minus 024 026 minus 010

(017) (019) (028) (029) (029) (027) (026) (017) (021) (028)

REFERENCES

Jordan Gans-Morse









DISCUSSION


REFERENCES

Jordan Gans-Morse

(301 007)604

(297 009)

569(293 010)

518(295 012)

457(290 012)

(268 014)432

(268 014)

378(280 013)

363(281 013)

(274 014)329

(272 014)

221(278 011)

187(272 010)

Jordan Gans-Morse

q) + γ Then16

λlowast[

(α minus γ)2

(1 minus q)β

Jordan Gans-Morse

DISCUSSION

Jordan Gans-Morse

APPENDIX

(020) (023) (026) (028) (029) (027) (026) (021) (022) (028)

(001) (001) (001) (001) (002) (001) (001) (001) (001) (001)Male 028 024 009 001 043 008 028 minus 024 026 minus 010

(017) (019) (028) (029) (029) (027) (026) (017) (021) (028)

REFERENCES

Jordan Gans-Morse









DISCUSSION


REFERENCES

Jordan Gans-Morse

(301 007)604

(297 009)

569(293 010)

518(295 012)

457(290 012)

(268 014)432

(268 014)

378(280 013)

363(281 013)

(274 014)329

(272 014)

221(278 011)

187(272 010)

Jordan Gans-Morse

q) + γ Then16

λlowast[

(α minus γ)2

(1 minus q)β

Jordan Gans-Morse

DISCUSSION

Jordan Gans-Morse

APPENDIX

(020) (023) (026) (028) (029) (027) (026) (021) (022) (028)

(001) (001) (001) (001) (002) (001) (001) (001) (001) (001)Male 028 024 009 001 043 008 028 minus 024 026 minus 010

(017) (019) (028) (029) (029) (027) (026) (017) (021) (028)

REFERENCES

Jordan Gans-Morse









DISCUSSION


REFERENCES

Jordan Gans-Morse

(301 007)604

(297 009)

569(293 010)

518(295 012)

457(290 012)

(268 014)432

(268 014)

378(280 013)

363(281 013)

(274 014)329

(272 014)

221(278 011)

187(272 010)

Jordan Gans-Morse

q) + γ Then16

λlowast[

(α minus γ)2

(1 minus q)β

Jordan Gans-Morse

DISCUSSION

Jordan Gans-Morse

APPENDIX

(020) (023) (026) (028) (029) (027) (026) (021) (022) (028)

(001) (001) (001) (001) (002) (001) (001) (001) (001) (001)Male 028 024 009 001 043 008 028 minus 024 026 minus 010

(017) (019) (028) (029) (029) (027) (026) (017) (021) (028)

REFERENCES

Jordan Gans-Morse









DISCUSSION


REFERENCES

Jordan Gans-Morse

q) + γ Then16

λlowast[

(α minus γ)2

(1 minus q)β

Jordan Gans-Morse

DISCUSSION

Jordan Gans-Morse

APPENDIX

(020) (023) (026) (028) (029) (027) (026) (021) (022) (028)

(001) (001) (001) (001) (002) (001) (001) (001) (001) (001)Male 028 024 009 001 043 008 028 minus 024 026 minus 010

(017) (019) (028) (029) (029) (027) (026) (017) (021) (028)

REFERENCES

Jordan Gans-Morse









DISCUSSION


REFERENCES

Jordan Gans-Morse

q) + γ Then16

λlowast[

(α minus γ)2

(1 minus q)β

Jordan Gans-Morse

DISCUSSION

Jordan Gans-Morse

APPENDIX

(020) (023) (026) (028) (029) (027) (026) (021) (022) (028)

(001) (001) (001) (001) (002) (001) (001) (001) (001) (001)Male 028 024 009 001 043 008 028 minus 024 026 minus 010

(017) (019) (028) (029) (029) (027) (026) (017) (021) (028)

REFERENCES

Jordan Gans-Morse









DISCUSSION


REFERENCES

λlowast[

(α minus γ)2

(1 minus q)β

Jordan Gans-Morse

DISCUSSION

Jordan Gans-Morse

APPENDIX

(020) (023) (026) (028) (029) (027) (026) (021) (022) (028)

(001) (001) (001) (001) (002) (001) (001) (001) (001) (001)Male 028 024 009 001 043 008 028 minus 024 026 minus 010

(017) (019) (028) (029) (029) (027) (026) (017) (021) (028)

REFERENCES

Jordan Gans-Morse









DISCUSSION


REFERENCES

Jordan Gans-Morse

DISCUSSION

Jordan Gans-Morse

APPENDIX

(020) (023) (026) (028) (029) (027) (026) (021) (022) (028)

(001) (001) (001) (001) (002) (001) (001) (001) (001) (001)Male 028 024 009 001 043 008 028 minus 024 026 minus 010

(017) (019) (028) (029) (029) (027) (026) (017) (021) (028)

REFERENCES

Jordan Gans-Morse









DISCUSSION


REFERENCES

Jordan Gans-Morse

DISCUSSION

Jordan Gans-Morse

APPENDIX

(020) (023) (026) (028) (029) (027) (026) (021) (022) (028)

(001) (001) (001) (001) (002) (001) (001) (001) (001) (001)Male 028 024 009 001 043 008 028 minus 024 026 minus 010

(017) (019) (028) (029) (029) (027) (026) (017) (021) (028)

REFERENCES

Jordan Gans-Morse









DISCUSSION


REFERENCES

Jordan Gans-Morse

DISCUSSION

Jordan Gans-Morse

APPENDIX

(020) (023) (026) (028) (029) (027) (026) (021) (022) (028)

(001) (001) (001) (001) (002) (001) (001) (001) (001) (001)Male 028 024 009 001 043 008 028 minus 024 026 minus 010

(017) (019) (028) (029) (029) (027) (026) (017) (021) (028)

REFERENCES

Jordan Gans-Morse









DISCUSSION


REFERENCES

Jordan Gans-Morse

DISCUSSION

Jordan Gans-Morse

APPENDIX

(020) (023) (026) (028) (029) (027) (026) (021) (022) (028)

(001) (001) (001) (001) (002) (001) (001) (001) (001) (001)Male 028 024 009 001 043 008 028 minus 024 026 minus 010

(017) (019) (028) (029) (029) (027) (026) (017) (021) (028)

REFERENCES

Jordan Gans-Morse









DISCUSSION


REFERENCES

Jordan Gans-Morse

DISCUSSION

Jordan Gans-Morse

APPENDIX

(020) (023) (026) (028) (029) (027) (026) (021) (022) (028)

(001) (001) (001) (001) (002) (001) (001) (001) (001) (001)Male 028 024 009 001 043 008 028 minus 024 026 minus 010

(017) (019) (028) (029) (029) (027) (026) (017) (021) (028)

REFERENCES

Jordan Gans-Morse









DISCUSSION


REFERENCES

Jordan Gans-Morse

DISCUSSION

Jordan Gans-Morse

APPENDIX

(020) (023) (026) (028) (029) (027) (026) (021) (022) (028)

(001) (001) (001) (001) (002) (001) (001) (001) (001) (001)Male 028 024 009 001 043 008 028 minus 024 026 minus 010

(017) (019) (028) (029) (029) (027) (026) (017) (021) (028)

REFERENCES

Jordan Gans-Morse









DISCUSSION


REFERENCES

Jordan Gans-Morse

DISCUSSION

Jordan Gans-Morse

APPENDIX

(020) (023) (026) (028) (029) (027) (026) (021) (022) (028)

(001) (001) (001) (001) (002) (001) (001) (001) (001) (001)Male 028 024 009 001 043 008 028 minus 024 026 minus 010

(017) (019) (028) (029) (029) (027) (026) (017) (021) (028)

REFERENCES

Jordan Gans-Morse









DISCUSSION


REFERENCES

Jordan Gans-Morse

DISCUSSION

Jordan Gans-Morse

APPENDIX

(020) (023) (026) (028) (029) (027) (026) (021) (022) (028)

(001) (001) (001) (001) (002) (001) (001) (001) (001) (001)Male 028 024 009 001 043 008 028 minus 024 026 minus 010

(017) (019) (028) (029) (029) (027) (026) (017) (021) (028)

REFERENCES

Jordan Gans-Morse









DISCUSSION


REFERENCES

Jordan Gans-Morse

DISCUSSION

Jordan Gans-Morse

APPENDIX

(020) (023) (026) (028) (029) (027) (026) (021) (022) (028)

(001) (001) (001) (001) (002) (001) (001) (001) (001) (001)Male 028 024 009 001 043 008 028 minus 024 026 minus 010

(017) (019) (028) (029) (029) (027) (026) (017) (021) (028)

REFERENCES

Jordan Gans-Morse









DISCUSSION


REFERENCES

Jordan Gans-Morse

APPENDIX

(020) (023) (026) (028) (029) (027) (026) (021) (022) (028)

(001) (001) (001) (001) (002) (001) (001) (001) (001) (001)Male 028 024 009 001 043 008 028 minus 024 026 minus 010

(017) (019) (028) (029) (029) (027) (026) (017) (021) (028)

REFERENCES

Jordan Gans-Morse









DISCUSSION


REFERENCES

Jordan Gans-Morse

APPENDIX

(020) (023) (026) (028) (029) (027) (026) (021) (022) (028)

(001) (001) (001) (001) (002) (001) (001) (001) (001) (001)Male 028 024 009 001 043 008 028 minus 024 026 minus 010

(017) (019) (028) (029) (029) (027) (026) (017) (021) (028)

REFERENCES

Jordan Gans-Morse









DISCUSSION


REFERENCES

(017) (019) (028) (029) (029) (027) (026) (017) (021) (028)

REFERENCES

Jordan Gans-Morse









DISCUSSION


REFERENCES

Jordan Gans-Morse









DISCUSSION


REFERENCES

Documents

Demand for Law and the Security of Property Rights: The ...faculty.wcas.northwestern.edu/~jlg562/documents/8... · Jordan Gans-Morse as well as a survey of 301 ﬁrms from eight Russian