Preventing Predation: Oligarchs, Obfuscation, and Political Connections

Preventing Predation: Oligarchs, Obfuscation,
and Political Connections
John S. Earle*, Scott Gehlbach**, Anton Shirikov***,
and Solomiya Shpak*
*George Mason University
**University of Chicago and Sciences Po
***University of Wisconsin–Madison

Protection from predation
I Protection of property rights (from expropriation, arbitrary
taxation) widely understood as a necessary condition for
investment and growth (North, 1981; Olson, 1993; Acemoglu
and Johnson, 2005)

and Johnson, 2005)
I Traditional understanding: state provides such protection as a
public good (Bueno de Mesquita and Root, 2000; North,
Wallis and Weingast, 2009)

and Johnson, 2005)
I Traditional understanding: state provides such protection as a
public good (Bueno de Mesquita and Root, 2000; North,
Wallis and Weingast, 2009)
I Lesson from postcommunist experience: ﬁrm owners can take
private actions to protect property from competitors and state
- Form alliances with politicians (Markus and Charnysh, 2017)
and stakeholders (Markus, 2015)
- Seek political o ce (Gehlbach, Sonin and Zhuravskaya, 2010;
Szakonyi, 2018)
- Accept protection of mob and other “violent entepreneurs”
(Frye and Zhuravskaya, 2000; Volkov, 2002)
- Perform “good works” to increase perceived legitimacy of
property rights (Frye, 2006, 2017)
,,

Obfuscating ownership
Another strategy: obfuscate ownership
I Panama, Paradise Papers: beneﬁcial ownership often obscured
behind proxy owners, shell companies, o↵shore ﬁrms

I Goals of obfuscation
- Politicians: hide corrupt earnings
- Businesspeople: protect property from expropriation, arbitrary
taxation (our focus)

I Goals of obfuscation
- Politicians: hide corrupt earnings
- Businesspeople: protect property from expropriation, arbitrary
taxation (our focus)
I Mechanisms of protection
- Create obscure target for legal assault (raiderstvo), even when
identify of owner common knowledge
Adding numerous layers of ownership between an asset and the
beneﬁcial owner in di↵erent jurisdictions, and using di↵erent types
of legal structures, can prevent detection and frustrate
investigations. (FATF and Egmont Group, 2018)
- Transfer proﬁts and liquid assets abroad
- Involve multiple jurisdictions

Rinat Akhmetov (System
Capital Management)
I Before 2004
- Relative transparency, short
ownership chains ending in
Akhmetov himself
- Quintessential “Blue” oligarch, chief
sponsor of Viktor Yanukovych

Rinat Akhmetov (System
Capital Management)
I Before 2004
- Relative transparency, short
ownership chains ending in
Akhmetov himself
- Quintessential “Blue” oligarch, chief
sponsor of Viktor Yanukovych
I After 2004
- Criminal investigation, threats of
“reprivatization”
- SCM restructured to obscure
ownership behind o↵shore ﬁrms,
increase di culty of seizing assets

Petro Poroshenko
(UkrPromInvest)
I “Chocolate king” (later president) of
Ukraine
I Complicated ownership chains, lots of
o↵shores
I “Orange” oligarch: supported Viktor
Yuschchenko during 2004 presidential
campaign
I Little change in ownership structure
after Orange Revolution (though
Panama Papers. . . )

Obfuscation and political connections
I Obfuscation can help to protect assets but plausibly less
valuable for politically connected owners

I Obfuscation costly
- Direct costs: lawyers, bankers, etc. (fees, rents)
- Foregone restructuring, reduced access to ﬁnance
- Legal exposure, reputational risk
- Plausibly cheaper for politically connected owners

I Obfuscation costly
- Direct costs: lawyers, bankers, etc. (fees, rents)
- Foregone restructuring, reduced access to ﬁnance
- Legal exposure, reputational risk
- Plausibly cheaper for politically connected owners
I Ex ante ambiguous relationship between obfuscation and
political connections: depends on substitutability,
complementarity of obfuscation and connections
(formal argument)

This paper
I We study ownership patterns of Ukrainian “oligarchs” just
before and after Orange Revolution

This paper
I Using data from investigative journalists and ﬁrm registries,
we
- identify and characterize ownership chains of > 300 key
enterprises
- compare ownership patterns of oligarchs more (“Blue”) or less
(“Orange”) connected to incumbent regime in 2004
- examine changes in ownership patterns after unexpected
political turnover of Orange Revolution

This paper
I Using data from investigative journalists and ﬁrm registries,
we
- identify and characterize ownership chains of > 300 key
enterprises
- compare ownership patterns of oligarchs more (“Blue”) or less
(“Orange”) connected to incumbent regime in 2004
- examine changes in ownership patterns after unexpected
political turnover of Orange Revolution
I We ﬁnd:
- Orange oligarchs more likely to obfuscate ownership before
Orange Revolution
- Blue oligarchs turn to o↵shore entities to obfuscate ownership
after Orange Revolution
- Similar patterns in much larger sample of JSCs

Contributions
I Political connections (Fisman, 2001; Faccio, 2006)
- Oligarchs in postcommunist countries (Earle and Gehlbach,
2015; Treisman, 2016; Lamberova and Sonin, 2018; Guriev and
Rachinsky, 2005; Gorodnichenko and Grygorenko, 2008)
- This paper: ownership chains before/after political shock,
relationship between obfuscation and connections
I Economics of property rights
- Incentives within ﬁrms (Coase, 1937; Williamson, 1985;
Grossman and Hart, 1986; Hart and Moore, 1990), bargaining
between ﬁrms and state (Shleifer and Vishny, 1994)
- Little work on how rights are held (pyramids: La Porta,
Lopez-de Silanes and Shleifer, 1999)
I Inequality and o↵shore wealth
- Journalistic (Obermayer and Obermaier, 2016), and academic
(Findley, Nielson and Sharman, 2014, 2015; Zucman, 2013,
2014, 2015; Findley, Nielson and Sharman, 2013) accounts
- Tax avoidance/evasion (e.g., Zucman, 2014; Tørsløv, Wier and
Zucman, 2018; Alstadsæter, Johannesen and Zucman, 2019);
our work: arbitrary taxation =) role for political connections

Identifying ownership chains
Lists of oligarch-controlled ﬁrms circa 2004 (just prior to Orange
Revolution)
I Delo (InvestGazeta): annual lists of oligarch holdings
I Ukra¨ıns’ka Pravda: “Who Owns What in Ukraine”
I Together, 442 ﬁrms from 34 oligarch groups (376/28 with
ownership data, 329/26 with various covariates)

Data sources on ﬁrm ownership
I Joint Stock Company Registry (JSCReg)
- Owners with 10% stake
- Individual owners not identiﬁed
- Essentially voluntary reporting, so data missing for some JSCs
- Restrict to owners as of April 2004 (November 2006)
I Single Registry (SReg)
- Records of “all” ownership changes
- Many obvious errors and omissions
- Ownership structure di cult to infer
- Restrict to owners from January 1999 through April 2004
(November 2006)

Basic algorithm: beginning with Delo/Ukra¨ıns’ka Pravda firms,
and then again for any subsequently identified Ukrainian corporate
owners,
1. Ukrainian firm?
Yes Go to (2)
No Stop
2. Present in JSCReg?
Yes Extract corporate owners, go to (3)
No Extract corporate and individual owners from SReg, go to (4)
3. Individual owners in JSCReg?
Yes Extract individual owners from SReg, go to (4)
No Go to (4)
4. Owner identified in (2) or (3) state agency, charity, etc.?
Yes Remove owner
No Stop

Result of algorithm: ownership chains for 376 firms, comprising
I 1003 Ukrainian firms (including “root” firms)
I 349 foreign firms
I 1107 Ukrainian individuals (including oligarchs, their relatives,
and known associates)
I 20 foreign individuals

Delo/UP firm Other Ukrainian firm Foreign firm Oligarch Other individual
Ownership leading to oligarch Other ownership link
Ownership networks in 2004 for UkrPromInvest (Petro Poroshenko)
and System Capital Management (Rinat Akhmetov), respectively.

Chacterizing ownership chains
Share Number
No oligarch in chain 0.708 233
Oligarch in chain 0.292 96
Oligarch in chain, 1 step 0.040 13
Oligarch in chain,  2 steps 0.173 57
Foreign in chain 0.571 188
O↵shore in chain 0.383 126
Notes: Shares based on regression sample of 329 ﬁrms.
Distance to oligarch (1 1/steps): mean 0.855, standard
deviation 0.254.

Political connections
I Orange (97 firms): Aval, Brinkford (David Zhvania),
Finansy i Kredyt (Kostyantyn Zhevago), Orlan, Pryvat (Ihor
Kolomoyskyy), Oleksandr Tretiakov, UkrPromInvest (Petro
Poroshenko)
I Blue (165 firms): Andriy Derkach, Energo (Victor
Nusenkis), Anatoliy and Igor Franchuk, Interpipe (Viktor
Pinchuk), Vasyl Khmelnytskyi, Andriy and Serhiy Kliuev, Kyiv
Seven, “Old Donetsk,” Radon, System Capital Management
(Rinat Akhmetov), Dmytro Tabachnyk, TAS (Serhiy Tihipko),
Ukrinterproduct (Oleksandr Leshchinskyi)
I Gray (67 firms): Basis, Oleksandr Feldman, Intercontact,
ISD (Serhiy Taruta), UkrSotsBank (Valeriy Khoroshkovskyi),
UkrSybBank (Oleksandr Yaroslavsky)

Empirical strategy
Obfuscation = f (Political connections)

Empirical strategy
Identiﬁcation (measurement error, joint determination of
obfuscation and political connections)

Empirical strategy
1. Sector ﬁxed e↵ects, controls for employment, TFP, privatized
(Frye, 2006; Denisova et al., 2009; Frye, 2017)
2. Instrument political connections (Color 2 {0, 1, 2}) on
oblast-level vote for Yushchenko in 2004 (regional
concentration of oligarch groups and political parties;
composition e↵ects, selection of governors)
3. Compare change in obfuscation among Blue and Orange ﬁrms
after 2004 (unanticipated turnover, frictions in establishing
and breaking connections; identifying ownership changes in
SReg =) foreign/o↵shore only)

Empirical strategy
On a two-period panel,
Oit = 1ORANGEi + 11ORANGEi · t + 2GRAYi + 21GRAYi · t
+ 3SIZEi + 31SIZEi · t + 4TFPi + 41TFPi · t
+ 5PRIVATIZEDi + 51PRIVATIZEDi · t
+ SECTORi + SECTORi 1 · t + ↵i + uit,
where i indexes ﬁrms; t 2 {0, 1} indexes periods, with all variables
measured at t = 0; and Oit is a measure of obfuscation.
Di↵erencing the equation for t = 0 from that for t = 1 gives
Oi = 11ORANGEi + 21GRAYi + 31SIZEi + 41TFPi +
51PRIVATIZEDi + SECTORi 1 + ✏i ,
where Oi is change in obfuscation from t = 0 to t = 1 and
✏i ⌘ ui1 ui0.

Empirical strategy
1. Sector ﬁxed e↵ects, controls for employment, TFP, privatized
2. Instrument political connections (Color 2 {0, 1, 2}) on
oblast-level vote for Yushchenko in 2004 (regional
concentration of oligarch groups and political parties;
composition e↵ects, selection of governors)
3. Compare change in obfuscation among Blue and Orange ﬁrms
after 2004 (unanticipated turnover, frictions in establishing
and breaking connections; identifying ownership changes in
SReg =) foreign/o↵shore only)

Political connections and obfuscated ownership
Oligarch in ownership chain, 2004
(1) (2) (3) (4) (5) (6)
No oligarch in chain Distance to oligarch (-1/steps)
OLS OLS IV OLS OLS IV
Orange 0.290⇤⇤⇤
0.134⇤⇤
(0.095) (0.054)
Gray 0.170 0.095
(0.129) (0.060)
Color 0.147⇤⇤⇤
0.268⇤⇤
0.068⇤⇤
0.098
(0.050) (0.131) (0.028) (0.061)
Sector FEs Yes Yes Yes Yes Yes Yes
Observations 329 329 329 329 329 329
Notes: Linear regressions. Color = 0 if Blue, 1 if Gray, 2 if Orange. Controls:
employment, TFP, privatized. First-stage F-statistic: 6.89. In parentheses,
heteroskedasticity-robust standard errors that correct for clustering at oligarch
level. [ﬁrst-stage results]

Foreign/o↵shore owners, 2004
(1) (2) (3) (4) (5) (6)
Foreign in chain O↵shore in chain
Orange 0.081 0.123
(0.135) (0.113)
Gray 0.177 0.223⇤⇤
(0.130) (0.095)
Color 0.029 0.254 0.047 0.184
(0.069) (0.162) (0.061) (0.161)
Observations 329 329 329 329 329 329
level. [ﬁrst-stage results]

Foreign/o↵shore ownership by “color,” 2004 and 2006
2004 2006
Foreign 188 221
Blue 99 119
Orange 63 69
Gray 26 33
O↵shore 126 180
Blue 65 98
Orange 50 53
Gray 11 29

DO, NOFF
DO ! FO ! OFF DO ! OFF NOFF ! OFF FO ! DO
All 0.326 0.338 0.277 0.470 0.069
Blue 0.409 0.400 0.333 0.529 0.071
Orange 0.265 0.234 0.206 0.308 0.048
Gray 0.244 0.339 0.244 0.600 0.115
Notes: Proportion of ﬁrms transitioning to/from:
- Domestic ownership only (DO)
- Foreign ownership (FO)
- Foreign but only non-o↵shore ownership (NOFF)
- Foreign o↵shore ownership (OFF).

Change in foreign/o↵shore owners, 2004 to 2006
(1) (2) (3) (4) (5) (6)
Change in foreign Change in o↵shore
Orange 0.076 0.180⇤⇤⇤
(0.080) (0.053)
Gray 0.019 0.078
(0.088) (0.082)
Color 0.037 0.160⇤
0.081⇤⇤⇤
0.125
(0.042) (0.093) (0.027) (0.119)
Observations 327 327 327 327 327 327
level. [ﬁrst-stage results] [placebo regressions]

Alternative explanations
I Di↵erential ease in matching names of Blue/Orange oligarchs
- False negatives: check against various [mis]spellings
- False positives: examine postal addresses, patterns of
cross-ownership
I Use of legal services in o↵shore jurisdictions (Sharafutdinova
and Dawisha, 2017)
- Unconnected owners more at risk (e.g., of breach of contract)
=) o↵shore ownership
- Ownership vs. contract, oligarch in chain
I Alliances with foreign investors to prevent expropriation
(Markus, 2015)
- In Cyrprus, BVI?

Inferring connections from political geography
I All firms in JSCReg: 14,543 firms (12,040 with covariates)
I Beneficial owner (“oligarch”) not observed for vast majority
I Infer connections from location of firm ! “reduced form”
regressions
Oi = 1YUSHCHENKOi + 2SIZEi + 3TFPi
+ 4PRIVATIZEDi + SECTORi + ui .
and
Oi = 11YUSHCHENKOi + 21SIZEi + 31TFPi +
41PRIVATIZEDi + SECTORi 1 + ✏i ,
I Caveat: Not all firms a↵ected by national politics

Foreign/o↵shore owners, 2004, all ﬁrms in JSCReg
(1) (2) (3) (4)
Vote for Yushchenko 0.023 0.025 0.012 0.013
(0.034) (0.023) (0.016) (0.013)
Employment 0.039⇤⇤⇤
0.019⇤⇤⇤
(0.003) (0.002)
TFP 0.027⇤⇤⇤
0.007⇤⇤⇤
(0.004) (0.002)
Privatized 0.013 0.010
(0.010) (0.008)
Sector FEs Yes Yes Yes Yes
Observations 14,543 12,040 14,543 12,040
Notes: Linear regressions. In parentheses, heteroskedasticity-robust standard
errors that correct for correlation of error terms at provincial level.

Change in foreign/o↵shore owners, 2004 to 2006, all ﬁrms in JSCReg
(1) (2) (3) (4)
Vote for Yushchenko 0.022⇤⇤
0.018⇤⇤
0.012 0.007
(0.008) (0.008) (0.010) (0.009)
Employment 0.008⇤⇤⇤
0.009⇤⇤⇤
(0.002) (0.002)
TFP 0.002 0.004
(0.003) (0.003)
Privatized 0.005 0.002
(0.006) (0.006)
Sector FEs Yes Yes Yes Yes
Observations 12,708 11,014 12,708 11,014
Notes: Linear regressions. In parentheses, heteroskedasticity-robust standard
errors that correct for correlation of error terms at provincial level.

Summary
I Importance of obfuscated ownership as strategy to prevent
predation in environment of poor protection of property rights
I Incentive to obfuscate ownership depends on political
connections of asset owners
- Orange oligarchs more likely to obfuscate before Orange
Revolution
- Blue oligarchs use o↵shore entities to obfuscate after Orange
Revolution
- Similar patterns in much larger sample of JSCs
I Relationship to theoretical framework: political connections
reduce threat of predation more than they reduce cost of
obfuscation

Discussion
I Di↵erent results in countries with stronger property rights and
more regular political turnover (Koch brothers, Bezos,
Bloomberg)?
I Relationship between obfuscated ownership and other
strategies to prevent predation?
I Why not collective action to improve property rights and save
cost of obfuscation (North and Weingast, 1989; North, 1990;
Ansell and Samuels, 2014)? If anything, property rights less
secure after Orange Revolution (Markus, 2016)
- Di cult to inﬂuence design of institutions when regime change
sudden (Albertus and Menaldo, 2018)
- Beneﬁts to rich of weak property rights (Sonin, 2003; Ho↵ and
Stiglitz, 2004), with costs o↵set by strategies such as
obfuscation

Preventing Predation: Oligarchs, Obfuscation, and Political Connections

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