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Corporate Governance, Privatisation, and Financial Performance of

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168 Int. J. Revenue Management, Vol. 10, No. 2, 2018

Corporate governance, privatisation, and financial

performance of Indonesian state-owned enterprises

Nurharjanto, Tulus Haryono

and Djoko Suhardjanto
Universitas Sebelas Maret,
Jl. Ir. Sutami No. 36A,
Surakarta, 57126, Indonesia
Email: nurharjanto17@yahoo.com
Email: tulus_fe_uns@yahoo.com
Email: djoko.suhardjanto@yahoo.com
Email: djokosuhardjanto.feb@staff.uns.ac.id

Niki Lukviarman
Jl. Universitas Andalas,
Limau Manis, Pauh, Padang, 25163, Indonesia
Email: lukviarman@gmail.com
Email: nikilukviarman@eb.unand.ac.id

Erna Setiany*
Universitas Mercu Buana,
Jl. Meruya Selatan No. 1,
Jakarta, 11650, Indonesia
Email: setiany1189@gmail.com
Email: erna.setiany@mercubuana.ac.id
*Corresponding author

Abstract: This study aimed to investigate the effect of corporate

governance (CG) to state-owned enterprises (SOEs) performance before and
after privatisation. The data consisted of primary data obtained through
questionnaires, followed by focus group, and secondary data sourced from
published annual reports of SOEs. This research gathered 94 observations of
firm-year of SOEs listed in Indonesia. Multiple linear regression was employed
to analyse the effect of the CG index on the financial performance, and paired
sample t-test to test the performance before and after privatisation. The result
shows that the CG index has a positive effect on the financial performance of
SOEs. Furthermore, SOEs exhibited improved financial performance after
privatisation. Accordingly, the government of Indonesia should selectively
choose SOEs for privatisation to achieve the optimum results of privatisation in
accordance with the priorities imposed by the government as the primary
owner.

Keywords: corporate governance; financial performance; privatisation; state

owned enterprises.

Copyright © 2018 Inderscience Enterprises Ltd.

Corporate governance, privatisation, and financial performance 169

Reference to this paper should be made as follows: Nurharjanto, Haryono, T.,

Suhardjanto, D., Lukviarman, N. and Setiany, E. (2018) ‘Corporate
governance, privatisation, and financial performance of Indonesian state-owned
enterprises’, Int. J. Revenue Management, Vol. 10, No. 2, pp.168–188.

Biographical notes: Nurharjanto is a financial businessman and entrepreneur.

He received his Doctorate in Financial Management from Universitas Sebelas
Maret, Surakarta, Indonesia. He has published his research in various journals
or conferences, both nationally and internationally. His research interests
include corporate governance, privatisation, and financial management.

Tulus Haryono is a Professor of Marketing at Universitas Sebelas Maret,

Surakarta, Indonesia. He received his Doctorate in Marketing from Universitas
Brawijaya, Malang, Indonesia. He is currently serves as the Head of Doctoral
Program of Economics at Universitas Sebelas Maret, Surakarta, Indonesia.
He has published his research in various journals or conferences, both
nationally and internationally. His research interests include marketing and
consumer behaviour.

Djoko Suhardjanto is a Professor of Accounting at Universitas Sebelas Maret,

Surakarta, Indonesia. He received his Doctorate in Accounting from Curtin
University of Technology, Perth-Australia. Currently serve as the Chairman of
Accounting Association in Surakarta region in Indonesia. He has published his
research in various journals or conferences, both nationally and internationally.
His research interests include corporate governance, disclosure, corporate
social responsibility, and financial accounting.

Niki Lukviarman is a Professor of Corporate Governance at Universitas

Andalas Padang, Indonesia. He is an adjunct senior research fellows
of the Governance and Corporate Social Responsibility Centre (GCSR),
Curtin University of Technology, Perth-Australia (2004–2009). He is Visiting
Professor at various universities, NHL University of Applied Sciences
at Leeuwarden-the Netherlands (2013); Saxion university of Applied Sciences
at Deventer-The Netherlands (2017); Universitas Islam Indonesia (UII)
Yogyakarta-Indonesia; Universitas Sebelas Maret (UNS) Surakarta, Indonesia;
Universitas Islam Sumatera Utara (UISU), Medan Indonesia. His research
interests include corporate governance (particularly related to the issue of
ownership structure, business group, board of directors, corporate social
responsibility).

Erna Setiany is a Lecturer of Accounting at Universitas Mercu Buana, Jakarta,

Indonesia. She received her Doctorate in Accounting from Universitas Sebelas
Maret, Surakarta, Indonesia.. She has published her research in various journals
or conferences, both nationally and internationally. Her research interests
include corporate governance, disclosure, corporate social responsibility, and
financial accounting.

This paper is a revised and expanded version of a paper entitled ‘The

performance of state owned enterprices (SOE) in Indonesia’ presented at the
2nd Comparative Asia Africa Govenmental Accounting Conference (Caaga)
2017, Subang Jaya, Malaysia, 1–2 November, 2017.
170 Nurharjanto et al.

1 Introduction

This study aims to test whether a difference exists in the financial performance of
state-owned enterprises (SOEs) before and after privatisation. Furthermore, this study
investigates the effect of corporate governance (CG) implementation on the financial
performance of SOEs. The level of CG implementation is measured using the CG index
that fits the Indonesian SOEs. The financial performance of SOEs as the dependent
variable was measured using return on equity (ROE).
In the contexts of Indonesia, SOEs play an important role in the country’s economy.
Data from the Indonesian Central Bank (2010) show that the contribution of SOEs in the
economy of Indonesia in 2009 is 12.7% of GDP, which increased to 14.2% in 2010. In
2009, Indonesia had 141 SOEs with Rp 2,234 trillion total assets, Rp 574 trillion total
equity, Rp 986 billion amount of sales, and Rp 154 trillion operating income. However,
not all SOEs can generate profits because only 117 out of the 141 SOEs successfully
generated profit. One SOE can earn a net profit of Rp 88 trillion, whereas the other 24
SOEs suffered a loss of Rp 1.72 trillion. In 2010, the contribution of SOEs to the state
reached Rp 132.9 trillion, with the largest percentage in the form of tax payments
amounting to Rp 100.7 trillion (Indonesian Ministry of Finance, 2010). The preceding
explanation shows the importance of the role of SOEs in the economy of the country.
Megginson et al. (1994) and Wei et al. (2003) proved that after privatisation, SOEs in
various countries showed an increase in sales, capital investment, operating efficiency,
dividend payments, and leverage. By contrast, Gupta (2005) analysed the effect of the
partial privatisation of SOEs in India and proved that privatisation had a significant
positive impact on sales, profits, and labour productivity. A few other studies support the
research results of Gupta (2005), including Megginson and Netter (2001), Bortolotti et al.
(2002) and Aydin et al. (2007).
Several studies on the effect of privatisation on the financial performance of SOEs in
Indonesia have been previously conducted. Astami et al. (2010) determined that partially
privatised SOEs have better financial performance compared with fully government-
owned SOEs. Nahadi and Suzuki (2012) determined that the partial privatisation of SOEs
in Indonesia positively affects a company’s short- and long-term performance. SOEs will
experience a short-term increase in efficiency and productivity, but privatisation will
affect their long-term profitability, efficiency, and productivity. Several research results
on SOEs in Indonesia conclude that privatisation can improve the financial performance
of these enterprises. Thus, a study on SOEs in Indonesia should be conducted by
differentiating their performances before and after privatisation.
The development of CG-related issues in Indonesia was first identified in 1998, when
the economic crisis hit the country (Suhardjanto and Anggitarani, 2010). In addition,
various financial scandals in public companies were reported in Indonesia 2001,
particularly related to the manipulation of financial statements in PT Lippo Tbk and on
the issue of CG in PT Kimia Farma Tbk. For example, PT. Lippo Tbk allegedly engaged
in cheating by preparing multiple financial statements, while PT. Kimia Farma Tbk was
convicted of earnings management. Similar cases strengthen the indications that the
application of CG in Indonesia remains extremely weak (Boediono, 2005). The
encouragement of good CG implementation becomes important with the discovery that
the economic crisis in mid-1997 and 2008 experienced by many companies in several
countries were caused by the non-optimal CG infrastructure in the country. This finding
 Corporate governance, privatisation, and financial performance 171

is supported by the occurrence of massive financial scandals in the US, such as Enron,
Tyco, and Worldcom.
Christensen et al. (2010) analysed the effect of the presence of the Board of
Commissioners on the performance of financial companies listed on the Australian
Securities Exchange (ASX). The aforementioned study investigated the number of
commissioners and board meetings, proportion of independent commissioners, presence
of the Audit Committee, and effect of the Nomination and Remuneration Committee on
the financial performance of companies listed on the stock exchanges. The results
showed that the number of commissioners, proportion of independent commissioners,
and independence of the CEO negatively affect the financial performance as measured
using the return on assets (ROA).
Yermack’s (1996) research in the US tested the effect of the size of the board of
commissioners, composition of the board, compensation and turnover, and ownership of
a financial performance-based market. The aforementioned study determined that the size
of the board of commissioners negatively affects the company’s performance.
Furthermore, Eisenberg et al. (1998) determined that the size of the board of
commissioners in various companies in Finland negatively affects financial performance
as measured using ROA.
Privatisation has been extensively analysed and most previous studies have adopted a
macroeconomic or political perspective (Zahra et al., 2000). A few of these studies
focused on the role of performance evaluation systems and incentive management during
privatisation (Cragg and Dyck, 2000; Schröder, 2003; Giancreco and Peccei, 2005;
Okpara and Wynn, 2008). Other studies focused on the potential changes in strategy after
the privatisation of companies (Zahra and Hansen, 2000; Cuervo and Villalonga, 2000).
A few comprehensive studies combine all the variables, such as corporate governance,
strategy, control, and performance evaluation (Cuevas-Rodríguez et al., 2016).
Several previous studies related to the implementation of CG in different countries
use various measurements and variables. Klapper and Love (2004) and Brown and
Caylor (2004) used the CG index and determined that CG has a positive effect on
company performance. In Indonesia, Larcker et al. (2007) studied the influence of the
quality implementation of corporate governance proxied by a score of the corporate
governance perception index (CGPI) on the performance of non-banking companies from
2003 to 2005. The results showed that the application of CG measured using the index
has no effect on the performance of the company.
The application of CG is required in the structure of modern business management
and economics that are supported by the presence of the capital and money markets
(Witherell, 2000; Oman, 2001). In addition, the application of the optimal CG is expected
to improve efficiency to reduce transaction costs (Oman, 2001; Klapper and Love, 2004).
The preceding opinions confirm that CG has an important role for the organisation to
direct and control the various organisation elements to achieve the predetermined goals.
However, the implementation of the non-optimal CG can impact the decrease in a
company’s financial performance.
The current study analyses the effect of CG on the performance of SOEs in Indonesia.
The issue in this research is interesting because of its connection with the privatisation
program that has become a government policy in an effort to improve financial
performance and contribution of SOEs to the national economy. In the current study, CG
is also measured using the CG index. This index is important because it contains a
comprehensive assessment of the various principles of CG in SOE that will affect
172 Nurharjanto et al.

financial performance. The CG index is used by considering that in mid-2012, the SOE
Ministry issued the assessment indicators of CG in SOEs. The index is compiled
internally by the Ministry of State Enterprises for scrutiny to obtain an optimal and valid
result. Given these reasons, this research utilises the CG index developed by the author,
based on the input from numerous practitioners and academics who are experts in their
respective fields. This procedure is commonly used as practiced by Wallace and Cooke
(1990), Marston and Shrives (1991), Suhardjanto (2008), and Hassan and Marston
(2010).
The present study differs from previous studies in the following areas:
we analyse the financial performance of SOEs before and after privatisation
develop and use the index CG for SOE and its influence on the financial performance of
SOEs.
Accordingly, testing the aforementioned problems is expected to provide an overview of
the implementation of CG in the SOEs in Indonesia. Thus, this research is expected to
contribute to the field with scientific and practical implications of the implementation of
CG, thereby enabling the policy of privatisation in Indonesia to become substantially
comprehensive.
The other importance of this study is the novelty in attempting to collect the needed
data and information to achieve the research goals from numerous SOEs in Indonesia.
Moreover, given that this study aimed to compare the performances of SOEs before and
after privatisation, the number of samples used in this research is limited. This study
adequately collected various information, thereby prolonging the time needed to collect
the data. Among the hallmarks of this research are its complete and comprehensive data
and information compared with those of previous studies.
Based on the preceding discussion, this research formulates the research questions as
what is the difference in the financial performance of SOEs before and after
privatisation? And whether there is an effect of CG index on the financial performance of
SOEs in Indonesia?

2 Literature review and hypothesis development

2.1 Agency theory

In the organisational structure of SOEs, the parties that act as principal shareholders are
the government, non-government organisations (Setyowati, 2011), and the public
(Frederick, 2011). The government is the owner (acts as shareholder) because it acts as a
capital provider. The community categorised is the ultimate owner (ultimate
shareholders) because it provides investment funds for the government through tax
payments as taxpayers (Kamal, 2011). The agent in the SOEs’ organisational structure is
the management or the manager (Jusmaliani, 2003; Peng, 2012) with a mandate to run the
company’s operational activities. In accordance with the Company Law Nos. 40/2007 on
Corporation, the presence of the board in a company acts as an extension of the owner’s
hands in carrying out supervisory functions and providing advice to a corporation in
Indonesia.
Almasyari (2015) determined four types of agency relationships in SOEs the context
of CG. These relationships are as follows:
 Corporate governance, privatisation, and financial performance 173

• between the ultimate owner (community) and actual shareholders (government)

(ultimate principal–actual principal relationship problems)
• government and BOC (actual principal–board relationship problems)
• government and board of directors (actual principal–management relationship
problems)
• board of commissioners and board of directors (board–management relationship
problems).
The actual principal–board relationship occurs because the board of commissioners are
appointed and dismissed by the shareholders through the annual general meeting (AGM).
Furthermore, the actual principal–management relationship problem occurs because
members of the board of directors are appointed and dismissed directly by the
government. In addition, board–management relationship problems occur because the
monitoring and provision of advice to the board of directors become a full responsibility
of the board of commissioners.
Apart from the aforementioned agency problem, conflict of interest also exists in the
context of SOE because these enterprises have two main paradoxical objectives (Wilcox
et al., 2012). Although the main objective is profit from business activities (primarily
economic), SOEs have to serve the public interest (social character) (Almasyari, 2015).
In the objective course of business (economics), SOEs manage various strategic business
sectors to prevent the latter from being controlled by certain parties. These business
sectors include a wide range of business fields related to the people’s livelihood, such as
power companies, oil, and natural gas (Purwoko, 2002). Purwoko (2002) explained that
to serve public interest (social purpose), SOEs are intended to create jobs, create added
value, and particularly increase state revenues to boost the national economy. These two
paradoxical objectives place SOEs in an unfavourable situation in terms of competing
with private companies that primarily aim to generate profits (Almasyari, 2015).
Accordingly, CG in SOEs differs substantively with CG in private companies.
Monitoring is performed through a mechanism included in CG. Ettredge et al. (2010)
stated that the supervising role of the board of commissioners can address the agency
problem that occurs between management and shareholders. In this regard, agency theory
is a commonly used theory to describe CG (Lukviarman, 2005b). That is, CG is a control
mechanism to ensure the implementation of good business practices that considers the
right of any interested party because various interested parties have different purposes
(Lukviarman, 2005a).
The current study analysed the performance of SOEs by using agency theory as a
research base. The three basic assumptions of agency theory are as follows:
• people are opportunistic
• human beings have limited rationality
• people avoid risks (Eisenhardt, 1989).
These assumptions indicate that management, as an agent of the owner of the company,
should be supervised. The monitoring function is needed to reduce opportunistic
behaviour of management, cope with the limited rationality of the principal, and
minimise the possible risks faced by the principal. The monitoring is expected to improve
174 Nurharjanto et al.

management performance and ultimately boost a company’s financial performance.

Given these basic assumptions, this study investigates the role of CG in SOEs in
Indonesia by using agency theory, thereby expecting improvement in the financial
performance of SOEs.

2.2 Corporate governance (CG)

SOEs in Indonesia are under the Ministry of State Enterprises as representatives of the
government, thereby ensuring the application of CG on state-owned institutions in
accordance with regulations. To ensure that SOEs implement CG, a state company is
required to conduct internal audits and CG assessment as a form of accountability.
The implementation of CG is part of the effort to improve efficiency and competitiveness
and maximise the performance of a company in accordance with the predetermined
objectives.
The main issue that is crucial for current state-owned institutions is privatisation. The
main objective of privatisation is to enhance efficiency and increase the value added of
SOEs. A privatisation program is expected to improve the performance of state
enterprises. Related to the issue of privatisation is the importance of optimally
implementing good CG in SOEs to make the privatisation of a state company appealing.
A company with substantial state ownership may adopt certain corporate governance
mechanisms that will constrain state involvement in the corporate governance process
and protect the interests of other shareholders (Grosman et al., 2016)
The CG index is commonly used as a weighting of the various indicators of the
implementation of the company’s CG (e.g., Klapper and Love, 2004; Brown and Caylor,
2004). In general, the two methods of measuring CG by using indexes are the unweighted
and weighted indexes (Firth, 1979). In the unweighted index, each item has the same
weight (importance) because they are perceived as having the same quality and level of
importance. By contrast, the weighted method of each item has a different level of
importance in assessing the effectiveness of the implementation of CG. Thus, the latter is
considered a more valid method than the former. The current study uses the CG index as
a predictor or independent variable. Several previous studies within this group utilise the
CG index as well, among others: Gompers et al. (2003), Klapper and Love (2004),
Bebchuk et al. (2004), Black et al. (2006), Larcker et al. (2007), Bhagat and Bolton
(2008), Sivaramakrishnan and Yu (2008) and Yaghoobnezhad et al. (2012).
Kostyuk et al. (2011) stated that the measurement of the CG implementation quality
can be evaluated by focusing on the CG items that are considered substantially dominant.
These researchers measured the impact of the CG implementation on corporate
performance using Gompers et al. (2003) index also known as GIM index. The GIM
indices used a state, in which a high score indicates a strong management authority or
weak protection of shareholders and vice versa. The aforementioned study concluded that
the GIM index is negatively related to company performance, thereby implying that the
higher the GIM score, the lower the performance of the company. The CG index
compiled in previous studies (e.g., Klapper and Love, 2004; Brown and Caylor, 2004;
Gompers et al., 2003) showed that the BOC characteristics are deemed a major element
in the CG index and has the highest weight value. The CG index is arranged in such a
way to accommodate the importance and weight of the CG elements. Accordingly, the
weight of the CG elements is arranged based on the level of interest in the CG index that
is used to measure the effect of CG on company performance.
 Corporate governance, privatisation, and financial performance 175

The CG index in this study is used to test the strength of the relationship between the
principles of CG and financial performance of SOEs.
The CG index in the current study is prepared through the following series of stages.
1 Conducting a review of the CG index items in Indonesia. This process begins with
the identification of regulations concerning the existing CG practices in Indonesia
and considers the preparation of indexes based on these regulations.
2 Compiling the items of the CG SOE index in Indonesia. This compilation is based on
the CG principles and regulations on CG in Indonesia. The existing CG indexes are
simultaneously compiled from several previous studies, such as Singhvi and Desai
(1971), using 34 items of information; and Chow and Wong-Boren (1987), using 89
items. Susanto (1992) referred to the regulation of the Indonesian capital market
regulator (BAPEPAM) number SE-24/PM/1987 with 80 items.
3 Conducted focus group discussions with 11 scholars to evaluate the compiled items
of the CG SOE index and obtain an input from the discussion activities in stage 3.
This evaluation activity aims to ensure that the compilation results are in accordance
with the characteristics of CG of the BUMN companies in Indonesia and to ensure
that the index is relevant to the implementation of CG in SOE companies in
Indonesia.
4 The results of the evaluation activities are used thereafter as the basis for preparing
the questionnaire (Likert scale 1–7) for the respondents on the CG index of SOEs in
Indonesia. The respondents comprised 10 practitioners and 10 academics.
5 The weighting process includes
a summarising the responses obtained from the respondents per questionnaire
item,
b compiling all responses obtained from the respondents, and
c predicting the response value per item with the total response value as the
weight per item (index attached).
Thereafter, the weight obtained is used to construct this CG index.
6 The next stage is to select non-applicable items. Non-applicable items show
irrelevant items applied in Indonesia and are excluded in this research.
7 Thereafter, the applicable index item is used to review the company’s annual report
to obtain the CG scores of SOEs in Indonesia.

2.3 SOEs and privatisation in Indonesia

Privatisation has two viewpoints (Dwijowijoto and Wrihatnolo, 2008). In the narrow
sense, privatisation is the denationalisation of or sale of assets or shares to private
organisations of publicly owned companies. Such action has consequences in terms of
company management and operations of the transfer. In the broad sense, privatisation
covers all methods or policies implemented to improve the market’s role in the national
economy.
176 Nurharjanto et al.

From a different point of view, Sun et al. (2002) suggested two types of privatisation:
control privatisation, which is conducted on the shares of at least 51% owned by the
government; and revenue privatisation, which is conducted on the shares of a maximum
of 49% owned by the government, thereby enabling the government to maintain its right
to vote as a controlling shareholder. If this dichotomy is associated with the privatization
of SOEs in Indonesia, then no restrictions are expected on the percentage of shares that
can be privatised on SOEs in Indonesia. However, provisions related to the massive
privatisation sale of shares refer to the criteria of SOEs in accordance with Act 19 of
2003, which stipulates that a minimum of 51% shares of state companies are owned by
the state.

2.4 Financial performance of SOEs before and after privatisation

The crucial issue for state-owned institutions today is privatisation. Savas (1987)
explained that privatisation is the act of reducing the role of government or the increased
role of the private sector in the SOE asset ownership. The main objective of privatisation
is to increase the efficiency and value added of SOEs. A privatisation program is
expected to improve the performance of state enterprises. Related to the issue of
privatisation is the importance of properly and optimally implementing CG in SOEs to
encourage the privatisation of these enterprises. Moreover, the privatisation objectives
can be achieved optimally.
Privatisation provides an opportunity for the public to own the assets of SOEs,
thereby enabling the people to gain substantial control of these enterprises. Privatisation
is also expected to encourage an improved implementation of CG in SOEs through an
enhanced control mechanism from the public shareholders. Hence, the company’s
performance is expected to improve.
Megginson et al. (1994) concluded that privatisation has led to increased sales,
profits, and investments and enhanced efficient operations and the ability of employees,
thereby prompting the burden of corporate debt to decrease and increase dividends.
Gupta (2005) conducted research on the privatisation of state enterprises in India and
proved that privatisation had a positive impact on profitability, productivity, and
investment. Sun et al. (2002) and Sun and Tong (2003) also obtained a similar result in
china. Moreover, Mangaran (2003) conducted research on the privatisation of state banks
in the Philippines and proved that privatisation can improve the operational and financial
performance of banks. Tiemann and Schreyögg (2012) arrived at a similar conclusion,
that is, converting hospitals to private-for-profit status may be an effective method to
ensure the efficient use of the scarce resources in the hospital sector. The results of these
studies lead us to conclude that privatisation tends to improve the performance of a
company. Thus, the first hypothesis (H1) of this study is as follows:
H1: Differences exist in the SOEs’ financial performances (measured using ROE)
before and after privatisation.

2.5 Influence of the CG index on SOEs’ financial performance

Previous studies (Klapper and Love, 2004; Brown and Caylor, 2004; Gompers et al.,
2003) convincingly used the index approach as a CG measurement in analysing the
influence of CG on financial performance. However, previous research also used the CG
 Corporate governance, privatisation, and financial performance 177

characteristics as proxy of the CG implementation (Zabri et al., 2016; Bansal and

Sharma, 2016; Arora and Sharma, 2016). However, Bebchuk et al. (2004) and Black et
al. (2006) argued that the CG index is an ideal measurement to explain the various
elements of CG.
Bhagat and Bolton (2008) conducted a study on CG measured by a CG index and
concluded that CG has a positive effect on a company’s financial performance. By
contrast, Larcker et al. (2007) used the CG index measured the financial performance of
companies and eventually obtained mixed results (mixed result). Sivaramakrishnan and
Yu (2008) and Yaghoobnezhad et al. (2012) determined that CG index has no effect on a
company’s financial performance. Larcker et al. (2007) explained that the inconsistent
results from numerous previous studies may be caused by the difficulty of producing a
valid and reliable measure to construct a complex CG and using CG models that vary
between countries.
Although previous research showed mixed result(s), the current research argued that
corporate governance has a positive effect on the financial performance of SOEs
(measured using ROE). This argument is based on the statement that the application of
the optimal CG is expected to improve efficiency (Oman, 2001; Klapper and Love,
2004). Therefore, the second hypothesis (H2) of this study is as follows:
H2: CG, as measured using the CG index, has a positive effect on the financial
performance of SOEs.

3 Research design

The number of SOEs that have been listed on IDX until this study was conducted
(December 31, 2014) is 15 companies, which comprised 11 non-financial companies and
4 financial companies. The entire company will be sampled in this study because of the
limited population required for the current research. Therefore, this study consciously
combines financial and non-financial SOEs based on the preceding explanation.
Another aspect that requires attention is the different timing of the privatisation of
SOEs, including the sample in this study. Such conditions are beyond the control of the
researchers because of the difficulty in setting the time of privatisation of state
enterprises. Nonetheless, we should use the data of financial performance before and after
the privatisation of SOEs in accordance with the current research purpose. To maintain
the objectivity of this study despite the different privatisation dates among the companies,
we set a consistent observation window of three years before and after the privatisation
for every existing SOE in the sample.

3.1 Data and data collection methods

This research aims to compare the performances of SOEs before and after privatisation.
Accordingly, we set the observation period of three years prior to and after privatisation.
Thus, this study uses panel data for a six-year observation period. However, the three-
year window period with the privatisation year as the starting point means that the three
years prior to privatisation and three years after privatisation will vary for each SOE
studied.
178 Nurharjanto et al.

3.2 Data analysis

This research accepts the hypothesis if its significant value (p-value) is below 5% and
rejects if the hypothesis’ significant value (p-value) is above 5%. The regression model
for this research is as follows:
ROEit = αit + β1 Index CGit + β2TYPEit + eit.
where
ROE: SOEs’ financial performance measured using ROE
INDEX: Corporate governance index, measured using an index developed specifically
for Indonesian SOEs.
TYPE: Industry type, measured by a dummy and assigned a value of 2 if the type of
company is non-financial or 1 if the type of company is financial.
α: Constant
β: Coefficient
i: Observation (SOEs)
t: Year
e: Errors.

4 Data analysis and discussion

4.1 Difference in financial performance before and after privatisation

This study performed a t-test to assess the difference in the financial performances of
SOEs before and after privatisation. Table 1 shows that ROA and the mean net income
(NI) before the privatisation of SOEs are 6.48 and 1.39, respectively; whereas ROA and
NI after privatisation are 8.22 and 3.30, respectively. These values indicate that in
absolute terms, ROA and NI for SOE before privatisation differ from those after
privatisation. Thus, no difference exists in the financial performance (ROE) of SOEs
before and after privatisation.

Table 1 t-test on the differences in SOEs’ financial performance before and after
privatisation-1

Financial performance Notation N Mean

ROE 1 42 21.946
2 42 19.711
ROA 1 42 6.482
2 42 8.219
NI 1 42 1.393
2 42 3.304
1: before privatisation; 2: after privatisation.
 Corporate governance, privatisation, and financial performance 179

Table 2 shows that ROA and NI have t values of –1.68 and –3.18, respectively, with
significance values of 0.099 (<0.1%) and 0.003 (<0.05%), respectively. Thus, SOEs’
financial performances (ROA and NI) before and after privatisation are different from
each other. However, no difference exists when measured using ROE.

Table 2 t-test on the difference in SOEs’ financial performance before and after
privatisation-2

Paired differences
Explanation Mean Std. dev. T Sig. (2-tailed)
ROE_1 – ROE_2 2.235 2.983 0.749 0.458
ROA_1 – ROA_2 –1.737 6.678 –1.686 0.099 *
NI_1 – NI_2 –1.911 3.891 –3.182 0.003 **
*,**,***significant at 0.10, 0.05, and 0.01, respectively.

The first hypothesis of this research intends to test whether differences exist in SOEs’
financial performances measured using ROE before and after privatisation. The outcome
shows a split result, that is, differences exist in SOEs’ financial performances before and
after privatisation as measured using ROA and NI. However, no differences exist in
SOEs’ financial performances before and after privatisation when measured using ROE.
Therefore, the H1 is not supported.
The results of the t-tests in Tables 1 and 2 show that the mean values of SOEs’ ROA
and NI after privatisation are higher than those before privatisation, with a significance
level of 0.099 (10%) and 0.003 (5%), respectively. This finding indicates that the
financial performances of SOEs after privatisation is better than those before
privatisation. This condition implies the success of the privatisation program and boosts
the financial performance of SOEs.

4.2 Regression analysis of corporate governance index

This study uses regression test to analyse the effect of CG on SOEs’ financial
performances after privatisation. Table 3 shows the adjusted R2 value of 0.21, thereby
indicating that 21% of the variation in financial performance can be explained by the CG
index and the remaining 79% can be explained by other variables outside the model. The
ANOVA test results with an F value of 11.95 and a significance of 0.00 suggest that the
significance level is below 0.05. The regression model can be used to estimate the
financial performance of SOEs.
The significance value in this study is 0.00. That is, each independent variable
significantly influences the dependent variable. If the significance value is less than
the t-value, then the independent variable has a significant effect on the dependent
variable; otherwise, if the significance value is higher than the t-value, then the
independent variable has no significant effect on the dependent variable (Ghozali, 2013).
The t-values in the current study are computed using a significance level of 5%. The test
results show that the CG index positively affects financial performance. Therefore, H2 is
supported.
180 Nurharjanto et al.

Table 3 Regression analysis

Variable Coefficient Sig

Constant –35.765 0.004
INDEX 95.630 0.000 ***
TIPE –7.367 0.089 *
R Square 0.456
Adjusted R Square 0.208
F 11.948
Sig 0.000

5 Discussion

5.1 Financial performance of SOEs before and after privatisation

Privatisation is a crucial issue of state enterprises worldwide, including SOEs in
Indonesia. The main objective of privatisation is to enhance the efficiency and value
added of SOEs. Privatisation is part of a planned program to improve the performance of
state enterprises. Related to the issue of privatisation is the importance of proper and
optimal implementation of CG in SOEs to encourage the privatisation of these enterprises
the latter. Thus, the purpose of privatisation is expected to be achieved optimally.
Privatisation provides an opportunity for the public to own assets of SOEs, thereby
enabling the people to establish an optimum control role on SOEs. Privatisation is also
expected to encourage an improved implementation of CG of SOEs through enhanced
control mechanisms from public shareholders. Thus, the company’s performance is
expected to improve.
The results of this research support the idea of Megginson et al. (1994) that
privatisation has led to increased sales, profits, investment, efficient operation, and
human resource capacity, thereby prompting the burden of corporate debt to decrease and
increase dividends. This result is consistent with the research of Tomic (2006) on
privatisation in Brazil. Furthermore, these results confirm the findings of Gupta (2005)
that privatisation had a positive impact on profitability, productivity, and investment.
Given that SOEs in the current study also include financial SOE, our findings likewise
confirm the results of Mangaran (2003), that is, privatisation can improve the operational
and financial performance of the banking industry in the Philippines.
The results of the current research indicate that SOEs in Indonesia after privatisation
have better financial performance compared with those prior to privatisation. This finding
implies that the processes of privatisation of certain SOEs have been consistent with the
objectives of privatisation in general, as well as those set by the Indonesian government
through the Minister of SOEs. Therefore, the spirit of privatisation should be possessed
by all organs (i.e., shareholders, board of commissioners, board of directors, and
management team) of SOEs based on the predetermined objectives.
Although the characteristics (firm level) and contexts (country level) of SOEs in
China and Indonesia are different from one another, the enterprises from the two
countries are relatively similar as well. Yuan (2011) explained that in terms of ideology,
the government still controls most of the ownership shares in the privatised SOEs. The
 Corporate governance, privatisation, and financial performance 181

retained majority ownership raises the probability of government interference in SOEs.

This pattern is consistent with Shleifer and Vishny (1996), who stated that the majority
ownership in the state government aims to pursue social and political roles through CG
activities.
Cheung et al. (2005) conducted research on the influence of political connections on
the shareholders of SOEs in China that have gone public and determined that the interests
of the minority shareholders are affected. Furthermore, researchers have learned that the
ownership of SOEs by the state (state ownership) cannot protect the abuse of power by
private owners. Thus, Cheung et al. (2005) study proves the absence of direct
intervention from the state as the majority shareholder of SOEs, although SOEs in China
experienced a conflict of interest between the government ownership (the majority) with
public ownership (minority). The results of the current study are consistent with the
opinion of Shleifer and Vishny (1996), who introduced ‘the grabbing hand’ of the
government model.
The preceding description clarifies that despite being privatised through the sale of
shares to the public, the majority ownership in SOEs generally remains in state hand. The
same case is also suspected to occur in Indonesia, although the interests of the state as the
owner of SOEs have been left entirely to the Ministry of SOEs. This study did not
investigate the role of the government as the majority owner, including the study of
political intervention. Consequently, this research cannot prove that the existence of
SOEs in Indonesia marked with majority ownership by the government will affect its
decision-making.

5.2 Influence of the CG index on SOEs’ financial performance

We assess if CG plays a role on company performance. We assess if CG influenced the
organisation’s ability to determine the relevant approaches to facilitate the achievement
of organisational goals. Gompers et al. (2003) used the CG index and determined that
companies with a strong dominance of shareholder have substantial value, profit, sales
growth, and spending behaviours. Bebchuk et al. (2004) also used the CG index and
determined that the increased levels of this index can facilitate the valuation of
companies, particularly in assessing the rate of return. Black et al. (2006) also proved that
the CG index is an important factor that is applied in explaining the aspects that affect a
company’s market value. Furthermore, Klapper and Love (2004) used the CG index and
determined that implementing a good CG has a strong correlation with improved
operational activities and market valuation.
A few of the results of these studies enable us to conclude that the CG index is
needed to conduct a valuation of the CG implementation in the company. Thus, we can
determine the extent by which CG influences a company’s financial performance.
Moreover, testing using the CG index is expected to provide evidence on the general role
of CG as viewed from various aspects. The use of the CG index is expected to strengthen
the testing of previous hypotheses that use the CG characteristics as a proxy. The results
of testing with this CG index proved our claim that CG has an effect on companies’
financial performance.
Bebchuk et al. (2004) argued that the use of the CG indexes enables companies to
assess the return on investment. Black et al. (2006) determined that the CG index is an
important factor applied to explain the various aspects that influence the market value of
a company. Gompers et al. (2003) used the CG index and determined that companies
182 Nurharjanto et al.

with a strong dominance of shareholder have a substantial value, profit, sales growth, and
spending behaviours.
Bhagat and Bolton (2008) concluded that CG has a positive effect on a company’s
financial performance. By contrast, Larcker et al. (2007) used the CG index and a
measure of financial performance of companies and obtained mixed results.
Sivaramakrishnan and Yu (2008) and Yaghoobnezhad et al. (2012) determined that the
CG index does not affect companies’ financial performance. Larcker et al. (2007)
reported that the inconsistent results from several previous studies may be caused by the
difficulty of producing a valid and reliable measure for a complex CG construct and
using the CG models that vary between countries.

6 Conclusion

6.1 Conclusion
• The results of this study show improved financial performances of Indonesian SOEs
after privatisation. These results imply that SOEs in Indonesia should be selectively
encouraged toward privatisation based on government priority. Thus, these outcomes
confirm the conclusions of previous studies that privatisation leads to increased
efficiency, profits, and growth of enterprises and encourages managers to adopt
policies tailored to market forces. Accordingly, SOEs that have not been privatised
can be encouraged to pursue privatisation in accordance with government priorities.
• The results of this study also showed the effect of the CG index on Indonesian SOEs’
financial performance. The test results with the CG index developed based on the
CG principles strengthen the claim that CG has an effect on a company’s financial
performance. Thus, CG should be optimised.

6.2 Limitation
This study has several limitations as follows.
• Each SOE privatisation was implemented in various years (not simultaneously),
thereby leading to differences in the number of observations for each company.
Consequently, the research data are unbalanced.
• This research combined financial and non-financial SOEs in the same test. Hence,
this method can lead to bias because the financial sector is a highly regulated sector,
whereas the non-financial sector is not faced with strict regulation.
• This study used ROE to measure the accounting performance in the financial
performance of SOEs and did not use market performance. Evidently, market
performance can substantially reflect the market perceptions of each company’s
application of CG. However, the use of accounting performance in the current study
is based on the opinion of Lukviarman (2004), that is, accounting performance is
considerably suitable, because of the inefficient market conditions in developing
countries. However, future research may use the market performance of SOEs
because the current study used ROE to measure the financial performances of these
 Corporate governance, privatisation, and financial performance 183

enterprises. The use of market performance may also indicate investors’ perception
of privatisation.
• This study did not consider the political intervention of government as another factor
that may affect SOEs. This proposition can lead to difficulties in proving the
effectiveness of the board of commissioners under the intervention. Therefore, future
research could address this issue using qualitative methods.
• This study did not control for the Indonesian economic growth. Therefore, the result
of the current research remains biased because of the absence of Indonesian
economics as control variable.

6.3 Implication
The results of this study are expected to suppress concerns on state losses caused by
privatisation. The issue of privatisation is a crucial issue in SOEs in various countries,
including in Indonesia. The main objective of privatisation is to improve the efficiency
and value added of SOEs. Moreover, obtaining potential funding is expected to be
achieved optimally. The positive result of this research provide an affirmative force on
the issues of privatisation, CG implementation, and SOEs’ financial performances.

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 Corporate governance, privatisation, and financial performance 187

Appendix 1

Corporate Governance Index

No. Item Weight
1 Number of Board of Commissioners 0.0173
2 Proportion of Independent Commissioners 0.0185
3 The average age of the Board of Commissioners 0.0154
4 Proportion of women in the Board of Commissioners 0.0107
5 Education level of members of the Board of Commissioners 0.0177
6 The average experience of the Board of Commissioners 0.0189
7 Background of ethnic members of the Board of Commissioners 0.0117
8 Work experience of members of the Board of Commissioners 0.0187
9 The period of membership of the Board of Commissioners 0.0169
10 Commissioner’s Salary 0.0179
11 Outside of salary or facilities 0.0177
12 Number of Audit Committees 0.0177
13 Proportion of independent Audit Committee members 0.0181
14 Proportion of members of the Women’s Audit Committee 0.0117
15 Audit’s accounting education background 0.0173
16 The average experience/financial expertise of the Audit Committee 0.0187
17 The period of the Audit Committee’s membership 0.0165
18 Audit Committee meeting attendance 0.0181
19 Number of Audit Committee meetings in one year 0.0183
20 Share ownership of Commissioners 0.0167
21 Commissioner awarded ESOP (Employee Stock Option Plan) 0.0167
22 Percentage of public ownership in SOEs 0.0171
23 Foreign Ownership in BUMN 0.015
24 Involvement of foreign owners in the management of SOEs 0.0154
25 Restrictions on foreign ownership 0.0159
26 Rules of protection of minority ownership 0.0167
27 Rules of public and/or foreign ownership in the articles of association 0.0179
28 Limits of the term of office of the Board of Commissioners 0.0167
29 Rules on nomination of Commissioners 0.0183
30 Risk Committee at the Board of Commissioners 0.0183
31 Remuneration Committee in the Board of Commissioners 0.0185
32 Nomination Committee in Board of Commissioners 0.0187
33 Joint Committee 0.0175
34 Rules for Committee recruitment 0.0187
35 Committee charters 0.0177
Evaluation of the charter of the Committee in accordance with the
36 0.0179
development of industrial conditions
 188 Nurharjanto et al.

Appendix 1 (continued)

Corporate Governance Index

No. Item Weight
37 Regular evaluation of Board performance 0.0185
38 Education or training of Commissioners 0.0177
39 The frequency of training attended by the Commissioner 0.0173
Training (financial/strategy/risk management/corporate governance/other)
40 0.019
followed by the Board of Commissioners
41 Relevance of training in accordance with the functions and responsibilities 0.0187
Rules of reimbursement of the members of the Board of Commissioners
42 0.0171
during the term of office
Number of joint meetings of the Board of Commissioners and Board of
43 0.0189
Directors
44 Delivery of meeting invitations before the meeting 0.0171
45 Availability of meeting summary 0.0181
46 Result document or meeting decision 0.0181
47 Archiving 0.0185
48 Evaluate the follow up of the result of the meeting decision 0.0202
Commencement of the Board of Commissioners to the Board of Directors
49 0.0202
on the decision of the meeting that has not been followed up
50 Availability Rules of transparency of SOEs 0.0196
51 Mandatory disclosure compliance 0.02
52 Availability of Voluntary disclosure 0.0179
53 Rules of appointment and selection of KAP (Public Accounting Firm) 0.0196
54 Selection of Public Auditor conducted by the Audit Committee 0.0192
55 Using the service of Big Four Public Auditor 0.0183
56 Auditor opinion over the last three years 0.0187
57 The deed of incorporation relating to minority shareholders is influential 0.0165

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