In a situation common to many emerging markets, in 1998 equity shares in Ukrainian firms were priced low relative to potential earnings. There was reason for greater pessimism about Ukraine than about other emerging economies in Eastern Europe, both those formerly part of the Soviet Union and those part of the outer empire COMECON states. From the Soviet collapse in 1991 through 1998, Ukraine suffered more than did other East European nations from political uncertainty arising from the internal east-west split; Ukrainian political and economic reforms came more slowly than they did in other emerging economies of the region; and a period of hyperinflation made long-term planning difficult for Ukrainian managers. But by 1998 Ukraine seemed to be on a path to growth and stability. President Kuchma, a man widely believed to have solid reformist credentials, had presented a reformist economic policy, though implementation remained a concern. The country had issued a new currency, the hryvna (Hr.), to replace the karbovonets (a stop-gap currency also known as the "coupon"). GDP had increased for several years in a row, and brokerage operations emerged for the nascent equities markets in this strategically placed country of 49 million people, sharing borders with growing markets in Russia and Poland. Particularly interesting to investors were firms in which Ukraine's agricultural endowment, large industrial infrastructure and workforce, and its position astride trade and transport routes between Russia and Western Europe provided advantages unique in the region.
Before the events of August 1998, Ukraine, like Russia, was a favorite choice of investors interested in emerging markets. If the risks were large, so were the potential returns. And the risks in Ukraine were very large indeed. Some markets are categorized as "emerging" for long periods because of systemic flaws; an especially important systemic flaw in the NIS was (and often still is) the absence of institutions for the protection of ownership rights, or a lack of integrity or authority in those institutions that have been created to protect them. Even where ownership rights are recognized in principle, the rights of shareholders, and especially minority shareholders, are often neglected. Ukraine was no exception. An illustration of this point is the case of the Dniproshyna Tire Plant, which took place in the heady days of 1997-98.
Ukrainian tire plants had been profitable in the 1990s, not unexpected given the country's supporting industrial infrastructure and access through established customer relationships to large markets in Russia, Eastern Europe, and parts of Asia. In November 1997, when the company's shares were trading at 60-65 Hr ($30-32), Dniproshyna's management decided to issue new shares at a price equal to their nominal value of 9.16 Hr per share, and to restrict purchase of these new shares to management and employees. Foreign investors owned 35% of the company's shares before the new issue, but the emission of new shares diluted their ownership share to 27%. Firms representing the foreign shareholders had been active in Ukraine for several years and challenged the move, but the Ukrainian Securities and Stock Market Commission stated that no laws had been violated. The Commission ruled that, according to the company's charter, management could make decisions about share emission without a general meeting of shareholders. In the wake of these actions the market price of Dniproshyna's shares fell by a greater percentage than the percentage increase in ownership share of management and employees, thus decreasing the value of these insiders' stock holdings. However, this price decrease hurt the foreign shareholders more, and the new ownership proportions remained in place.
Another problem for equities traders in Ukraine was the lack of coordination among registrars. (1) There were 270 registrars in Ukraine in 1998, some of which were controlled by the companies that used them. …