Business in Indonesia: New Challenges, Old Problems

11 TINKERING AROUND THE EDGES: INADEQUACY OF CORPORATE GOVERNANCE REFORM IN POST-CRISIS INDONESIA

178 Few would dispute that better corporate governance is important to Indonesia’s recovery from the economic crisis of 1997–98. With a significant number of major banks and corporations still under the control of the Indonesian Bank Restructuring Agency (IBRA), the process of divestment will succeed only if prospective investors are confident that their investments will be managed in their own best interests. Equally, with equity markets weak and bank financing likely to remain dominant, improving management and lending practices in the banking sector will be essential to both reducing the cost of capital and preventing future liquidity and capital account crises. What regulatory reforms, then, have been introduced since 1997 to improve corporate governance in Indonesia? The most significant are a National Code of Corporate Governance (‘the Corporate Governance Code’), Decree No. 117/ 2002 of the Minister for State Enterprises concerning good corporate governance in state-owned enterprises (SOEs) (‘the Ministerial Decree’), and Jakarta Stock Exchange (JSE) Regulation No. I-A (‘the JSE Regulation’).1 Other activities of note include the circulation of draft new company and capital market laws, the institution of ‘annual report awards’ for listed companies, and the creation of a number of NGOs and NGO-related programs to ‘socialise’ better corporate governance practices in Indonesia (ADB 2003). This chapter briefly considers how well these regulatory measures are likely to improve corporate governance in Indonesia. It will argue that they have some merit in themselves but ultimately will have little effect on the central problem, which is the interaction between institutional corruption and family-owned corporate conglomerates. First, I introduce this argument by canvassing the main characteristics of Indonesian corporate governance. Then I consider corporate governance-related reforms since 1997, including the Corporate Governance Code and the mandatory requirement for independent commissioners and audit 11 TINKERING AROUND THE EDGES: INADEQUACY OF CORPORATE GOVERNANCE REFORM IN POST-CRISIS INDONESIA Daniel Fitzpatrick INADEQUACY OF CORPORATE GOVERNANCE REFORM IN POST-CRISIS INDONESIA 179 committees in listed enterprises and SOEs. In particular, I argue that these reforms have not adequately addressed the question of conflicts of interest and related party dealings. I conclude with an overview of reforms that would better address this fundamental issue. THE NATURE OF THE PROBLEM: INDONESIAN CORPORATE GOVERNANCE BEFORE AND AFTER 1997 Corporate Governance before 1997 Before the 1997 crisis, corporate governance in Indonesia had three main characteristics . First, large corporations exhibited highly concentrated ownership patterns, often within the context of family control and a diversified conglomerate structure (Claessens, Djankov and Lang 1999; Husnan 2000: 19–23). This not only facilitated expropriation of corporate wealth at the expense of minority shareholders (Claessens, Djankov, Fan and Lang 1999a) but also negated many of the ‘shareholder-friendly’ aspects of the 1995 Company Law and 1995 Capital Markets Law. For example, the orthodox notion that boards of commissioners and directors monitor management on behalf of all shareholders proved irrelevant in the context of overwhelming management control by dominant shareholders (Fitzpatrick 2000). Similarly, the disciplining role traditionally played by threat of hostile takeover in the event of underperformance had little meaning in an environment where management and controlling shareholders were essentially indistinguishable (Capulong et al. 2000: Sections 2.4, 3.5; Bennett 1999: 19–26). Second, most conglomerates established their own banks after financial sector deregulation in the 1990s, and then borrowed heavily from them with little regard for prudential lending requirements or rules governing related party lending (Fitzpatrick 1998: 184–189; Husnan 2000: 22, 37). Thus the system of bank-centred corporate governance found in Germany and Japan, where the ‘insider’ role provides the opportunity to monitor corporate debtor management , did not evolve in Indonesia. Instead, banks and other financial institutions were subordinated to related party borrowers, which left their portfolios weak and highly vulnerable to external economic shocks. Third, most large corporations participated in patrimonial relationships with an often corrupt political and bureaucratic elite (Husnan 2000: 38). This phenomenon of ‘crony capitalism’ particularly affected issues of enforcement, whether through regulatory authorities such as the Capital Market Supervisory Agency (Bapepam) or the JSE, or through private litigation by disgruntled shareholders or creditors. Indeed, a striking feature of Indonesian corporate governance has been the low level of successful court enforcement proceedings relative to a high level of corporate abuses (Tabalujan 2000: Ch. 4). Without the threat of enforcement, corporate actors have few disincentives for misbehaviour ; without judicial rulings to give content to corporate rules and standards...