Bahan KuliaBahan Kuliah Genap 13 - 14h Genap 13 - 14 Revisi

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Corporate Governance
An Introduction
(Konsep dan Kerangka)*
Purwatiningsih Lisdiono
*diambil dari berbagai sumber
www.themegallery.com
When a business goes wrong, look only to
the people who are running it

-Michael Dell
-CEO Dell Corporation

Definition of CG (1)
Definisi menurut OECD (1999)
Definisi menurut KNKG cari dan bandingkan
Definisi menurut IICG cari dan bandingkan
Definisi menurut Kepmen BUMN tentang Tata Kelola
Perusahaan cari dan bandingkan
Secara singkat, CG adalah Processes and structure by
which business and affairs of corporate sector is directed
and controlled (Cadbury Committee , 1992)

Corporate Governance is the system by which business
operations are directed and controlled.

The corporate governance structure specifies the
distribution of rights and responsibilities among different
participants in the corporation, such as, board, managers,
shareholders and other stakeholders, and spells out the
rules and procedures for making decisions on corporate
affairs.

By doing this, it also provides the structure through which
the company objectives are set, and the means of attaining
those objectives and monitoring performance,

OECD April 1999.
World Bank Define corporate governance in
international context as that blend of law,
regulation and appropriate voluntary private sector
practices which enable a corporation to attract
financial and human capital, perform efficiently, and
thereby perpetuate itself by generating long-term
economic value for its shareholders and society as a
whole

Shleifer and Vishny (1997) : Corporate governance
deals with the ways in which suppliers of finance to
corporations assure themselves of getting a return
on their investment
This definition can be expanded to define corporate
governance as being concerned with the resolution
of collective action problems among dispersed
investors and the reconciliation of conflicts of interest
between various corporate claimholders.
For Tuanakotta (1999), corporate governance is
essentially about best business practice, aiming to
enhance organizational performance and wellbeing
and to create shareholder and stakeholder value.
He stated that corporate governance is beyond
structure and compliance.
It has to be directed towards process and
effectiveness. It is also beyond compliance and
disclosure.
It has to be directed toward positive performance. In
conclusion, good corporate governance is good
business. Good governance is not separate project, or
simply an add on to running your business. Its running
and managing your business as usual.


It is about check and balance between all organ of
organization.

The most important : it is about changing the way of
thinking to run the business, Changing the mindset.
Making the companies accountable to their
stakeholders.

The key issue :TRANPARENCY and ACCOUNTABILITY

Corporate Governance Theories
Agency Theory (Jensen & Meckling, 1976)
Transaction-cost Economics (Williamson, 1996)
Stewardship Theory (Davis, Schoorman, Donaldson,
1997)
Stakeholder Theory (Mitchell, Agle, Wood, 1997)
Others theories that are relevant

Some Background Information
Adolf Berle and Gardiner Means The Modern
Corporation and Private Property (1932)
After US Stock market crash
Concerned with performance of modern corporations and
efficient use of resources
Issues associated with separation of ownership and
control. How do you hold managers accountable?
What are the potential problems?
How can you address those problems?
Pemegang Saham
RUPS
Dewan Komisaris
Dewan Direksi
Stakeholders

Employees
Customers
Suppliers
Creditors
Society
Standards
(IAI- accounting
standards)

Laws

Regulations
Internal External
Private Regulatory
Bank
Markets
Product Markets
Labor Market
Capital Market
Corporate Governance Mechanism :
The Internal and External Architecture
Reputational agents

Accountants
Lawyers
Credit rating
Investment bankers
Financial media
Investment advisors
Research
analyst
Internal Auditor
Accounting
Management
Source : Modification from Cadbury (1999) Corporate Governance: A Framework for Implementation, Kim and Nofsinger ( 2004)
Corporate Governance.
L/O/G/O
Source: The World Bank Group
Emphasis on Market Institutions
OECD Principles of Corporate Governance
1. Ensuring the Basis for an Effective Corporate
Governance Framework*
2. The Rights of Shareholders and Key Ownership
Structures*
3. The Equitable Treatment of Shareholders
4. The Role of Stakeholders in Corporate
Governance
5. Disclosure and Transparency
6. The Responsibilities of the Board

Corporate governance intersect with many
disciplines include micro-economics,
organizational theory, information theory, law,
accounting, finance, management, psychology,
sociology and politics.
Each may view corporate governance in a
different way.
Corporate Governance is multi - discipline
Why is it important?
Proliferation of financial scandals and crisis
Loss of trust of investors
Globalization lead to increasing cross-border
investment opportunities but investors may not
have knowledge about the regulatory
framework of overseas investees investors
need security or safety guarantee that are
common and can be applied everywhere with
some adaptation one of that guarantee is
good corporate governance practice

Why is it important (continued)
Search for investment (FDI trends) : Investors are
not willing to invest in countries / companies that are corrupt, prone to
fraud, poorly managed and lacking sufficient protection for investors
rights one of the solution is GCG
Competition push companies to search for
lower / cheaper Cost of capital
Privatization
SOE / BUMN reform
Competitiveness pressures
Sustainability

Again, Why GCG? Main Reason
Corporation interacts with various parties in
conducting its business:
Directors / Management
Stockholders
Majority
Minority
Creditors
Government
Employees
Public

Why CG?
Those relations could cause conflict of interest
To control/manage that possible conflict of
interests among parties , one of the solution is
to apply CG
CG is also needed to protect the interests of
principals from opportunistic behavior of
agent
Ultimate Objective: enhancing shareholder
value, whilst taking into account the interests
of other stakeholders.

Drivers of Corporate Governance Dealing with
Failures and Scandals
Chile Financial Crisis 1970s
Asian Financial Crisis 1997
Russian Financial Crisis 1998
Impact of governance failures
on:
Companies
Societies
Economies
Challenges today: Who is next
to fail? Who wants to fail?
Questions remain in regards to Chinas
underlying financial health despite
impressive growth figures
Corporate Governance and Competitiveness
Stronger Shareholder Protection=Larger Stock Markets
Stronger Corporate Governance=Lower Cost of Capital
Higher Equity Rights=Higher Returns on Investment
Business Ethics
CORE VALUES of CG
Transparency
Fairness
Accountability
Responsibility
Guide for behavior Structure of decision-making
Ethical Behavior Matters
Why does it matter?
Ethical business practices = ability to retain
existing customers, gain new ones
Positive impact on employees - management
Supply chains, global market opportunities
Corporate citizenship and the role of business in
society if succeed could win the peoples
heart become competitive advantage
Applying ethics
Bright lines vs. values
Ethics as a set of evolving guidelines
Ethics and responsible decision-making by the
Board
Board of Directors
Fundamentals:
Duty of care
Duty of loyalty
Business judgment rule
Institutions Matter!
Functioning Markets
Better Environment for Doing Business
Rule of
Law
Good
Governance
Property
Rights
Access to
Information
Market
Entry
Objective of Corporate Governance
Build up an environment of trust and confidence amongst those
that having competing and conflicting interest
Enhance shareholders value and protect the interest of other
stakeholders by enhancing the corporate performance and
accountability
Promote the efficient use of scarce resources
Promote the trust of investors
Good corporate governance has a positive link to economic
development and good corporate performance
Funds will flow to entities which are seen to have internationally
accepted standards of corporate governance
Corporate Governance also plays an important role in maintaining
corporate integrity and managing the risk of corporate fraud,
combating against management misconduct and corruption


What can good corporate governance
bring to a corporation?

Creation and enhancement of a corporations
competitive advantage
Enabling a corporation to perform efficiently and
preventing fraud and malpractice
Providing protection to shareholders interest
Increasing the valuation of an enterprise
Ensuring compliance with laws and regulations
Alleviating poverty by enhancing social
responsibilitiese
Increase trust of shareholders and creditors
lower cost of capital

Corporate governance at the heart of investment
decisions
75% ready to pay premium for high governance
standards
Premium range:
1214% North America, Western Europe
20-25% Asia, Latin America
30%+ Eastern Europe, Africa
Investor surveys: McKinsey 2002
Today, the importance of good governance
is widely appreciated (even in Asia).
Good governance is a very easy phrase to
say, but much harder to understand and
to appreciate.
It is not only for companies, but also for
public institutions (Public Sector
Governance)
The Core Values of CG
Transparency
Accountability
Fairness
Responsibility

Organs CG
General Meeting of Shareholders (RUPS)
Board of Commissioners (Dewan Komisaris)
Independent commissioners
Remuneration Committee
Nomination Committee
Audit Committee
CG Committee
Risk Management Committee
Board of Directors (Direksi)
Internal Audit
Risk Management Team
MANAGEMENT
Vs
CORPORATE GOVERNANCE
Agency
Relationship
Risk Bearing Specialist
(Principal)
Managers
(Agents)
Decision
Makers
which creates
Managerial Decision-
Making Specialist
(Agent)
Hire
An agency relationship exists when:
Shareholder
(Principals)
Firm
Owners
Agency Theory (Jensen and Meckling)
Conflict of Interests
Insiders have an information advantage over
other parties (i.e. outsiders).
Insiders: Management, Majority Stockholders
Outsiders: Creditors, Minority Stockholders,
Government, Employees, Public
These parties pursue their own interests
(i.e.,self-interest), which can be conflicting
As a result, the parties whose action is
unobservable tend to shirk (i.e., insiders),
which is detrimental to the other parties

Shareholder Manager Conflict
The self-interested behavior of managers may
be at conflict with the interest of
shareholders.
Managers may favor growth and larger size of
the firm, for the reason of:
Greater job security
Larger compensation
Greater prestige
Larger discretionary expense accounts

Principal Agent Relationship
An agent has decision making authority that
affects the well-being of the principal.

Examples of principal-agent relationship:
Shareholders - Manager
Creditors - Firm
Majority Stockholders Minority Stockholders
Government Firm
Employees Firm
Public/society - Firm
The Agency problem occurs when:
The desires or goals of the principal & agent conflict
and it is difficult or expensive for the principal to verify
that the agent has behaved appropriately.

Agency problem in Indonesia :
Majority interest / shareholders Vs.
Minority interest
Agency Theory
L/O/G/O
- Agency Theory-
Beyza Oba
Spring 2004

Corporate governance:
an old problem a new solution
Seperation of ownership and control in joint-stock company (Berle
and Means 1932) allows the firms behaviour to diverge from the
profit maximizing, cost minimizing ideal

The principal problem rests in the abuse of power by corporate
elites; status quo leaves excess power in the hands of senior
management, some of whom abuse this in the service of their own
interest (Hutton, 1995), the result is damaging for shareholders

Corporate governance includes the structures, process, cultures
and systems that engender the successfull operation of
organisations (Keasey and Wright 1993) and mechanisms to cope
with these elements

Agency Theory
In economics, the principal-agent problem treats the difficulties that arise
under conditions of incomplete and asymmetric information when a
principal hires an agent.
Various mechanisms may be used to try to align the interests of the agent
with those of the principal, such as commissions, profit sharing, or fear of
firing. The principal-agent problem is found in most employer/employee
relationships, for example, when shareholders hire top executives of
corporations.
Assumptions of agency Theory:
Bounded rationality
Opportunism
Information asymmetry
AT focuses on the relationship and goal incongruance between managers and
shareholders
Agency relationships occur when one partner in a transaction (the principal)
delegates authority to another (the agent) and the welfare of the principal is
affected by the choices of the agent
Agency Theory
The delegation of decision-making authority from principal to
agent is problematic :
The interests of principal and agent ussualy will diverge
The principal cannot perfectly and costlessly monitor the
actions of the agent
The principal cannot perfectly and costlessly monitor and
acquire the information available to or possesed by the agent

These create the agency problem that is the possibility of
opportunistic behaviour on the part of the agent that works
against the welfare of the principal
Agency costs
Agency costs; incur to protect principals interests and to reduce the
possibility that agents will misbehave
Monitoring expenditures by principals
Bonding expenditures by agents
Residual loss of the principal

Essential sources of agency problems:
Moral hazard; more of the agents actions are hidden from the principal
or are costly to observe

In economic theory, a moral hazard is a situation where a party will
have a tendency to take risks because the costs that could incur will not
be felt by the party taking the risk. In other words, it is a tendency to be
more willing to take a risk, knowing that the potential costs or burdens
of taking such risk will be borne, in whole or in part, by others. A moral
hazard may occur where the actions of one party may change to the
detriment of another after a financial transaction has taken place.

44
Economists explain moral hazard as a special case of information
asymmetry, a situation in which one party in a transaction has more
information than another. In particular, moral hazard may occur if a party
that is insulated from risk has more information about its actions and
intentions than the party paying for the negative consequences of the
risk. More broadly, moral hazard occurs when the party with more
information about its actions or intentions has a tendency or incentive
to behave inappropriately from the perspective of the party with less
information.
Moral hazard also arises in a principalagent problem, where one party,
called an agent, acts on behalf of another party, called the principal. The
agent usually has more information about his or her actions or intentions
than the principal does, because the principal usually cannot completely
monitor the agent. The agent may have an incentive to act inappropriately
(from the viewpoint of the principal) if the interests of the agent and the
principal are not aligned.

Agency costs
Essential sources of agency problems:

Adverse selection; the agent posseses information that is, for the principal
unobservable or costly to obtain

Adverse selection, anti-selection, or negative selection is a term used in
economics, insurance, risk management, and statistics. It refers to a market
process in which undesired results occur when buyers and sellers have
asymmetric information (access to different information); the "bad" products
or services are more likely to be selected. For example, a bank that sets one
price for all of its chequing account customers runs the risk of being adversely
selected against by its low-balance, high-activity (and hence least profitable)
customers.

Risk aversion; as organisations grow managers become risk averse (they
would like to protect their position, managers would like to max. chance of
success by projects that have already brought success, managers build
structures to increase their chances of control)

46
Resolving agency problems
Principals and agents resolve agency problems through;
Monitoring; observing the behaviour and performance of
agents

Bonding; arrangements that penalise agents for acting in
ways that violate the interests of principals or reward them
for achieving principals goals

Contracts between agents and principals specify the monitoring
and bonding arrangements

47
Why do principals delegate authority to
agents?
Size
Simplicity of business operations (conceiving
opportunity, funding, making and implementing
decisions)
Decision making situation can overhelm the
cognitive capacity of a single individual, decison
quality can be improved by assigning different parts
of the decision to different individuals
48
What monitoring mechanisms can principals put to
minimize agency costs?
Owners seek maximum effort from employees at minimal cost while employees seek
to minimise effort and maximise remuneration (i.e. pay and benefits)

Monitoring mechanisms;
A. Contracts

Principals can monitor agents by collecting information about their behaviour
(decisions and actions)
behavioural contracts; specify the activities workers should engage in
e.g. institutional investors monitor the decisions of of senior managers, board of
directors monitor top management...

Principals can monitor consequences of (only partially obseved) agent behaviour
outcome based contracts; compensation, rewards, piece rate production,
commissions..

When tasks are not highly programmable monitoring performance (output) is
more efficient

Performance monitoring is problematic in relation to teams, free rider problems

49
What monitoring mechanisms can principals put to
minimize agency costs?
B. Board of directors
board is charged with fiduciary responsibility (i.e. legal
trustee) of safeguarding the stockholders investment Inside
and outside board members
The outside board membersprovide objectivity as the board
ratifies and monitors the decisions of managers
responsibilities of the board of directors;
establish policies and objectives for the firm
elect, monitor, evaluate and compensate top managers
monitor, approve the financial condition of the firm
ensure that regulations are enforced

50
The role of market discipline
Managerial labour market views the previous associations of managers
with success and failure as information about their talents .
Managers of failing firms may not see a reduction in wages , but will be
disciplines as the managerial labour market attaches less value to their
services
Managers in more sucessful markets may not receive any immediate gain
in wages but the success of their firm may increase their value in
managerial labour market

Capital market and corporate control
If managers (agents) of a firm take actions that are viewed by the market
as adversly affecting the value of the firms assets, then the price of the
assets (i.e. stock price) will likely to drop. Managers in other firms,
believing that they can profitably manage the assets of the failing firm,
may be engaged in a takeover battle. The managers of the troubled firm
will loose control of their firm and old high agency cost managers will be
replaced by low (?) agency cost managers

51
Assumptions of CG
The effective CG practice are often associated with:
1. A sound legal and regulatory framework and
rules of law in addition to incentive structures.
2. The ethical and transparent operations of
enterprises and their management.
Ethical Conduct :
Ethic is the background color of Corporate
Governance.
Ethical conduct is putting into place the
mind-set do unto others you would have
done unto you.
Ethical approach is about reasonable
standard of behavior, both individually and
corporately. It is not the perfection.

GCG and Its Impacts : CG as a Risk Factor

Country Level:
Market Infrastructure
Regulatory & Legal Environment
Informational Infrastructure

Common Problem : Form over Substance

Source: Standard and Poors
GCG and Its Impacts : CG as a Risk Factor
Company Level:

1. Ownership Structure & Concentration
2. Financial Stakeholder Relations
3. Financial Transparency and Information
Disclosure.
4. Board and Management Structure and Process

Common Problem : Form over Substance

Source: Standard and Poors
Corporate Governance Dilemma
56
Business costs of too
much corporate
governance regulation
Benefits of having
corporate governance
mechanisms in place
Strategy for Corporate Governance Reform
1. Initial Assessment
2. Outreach and Education
3. Develop and Institute Corporate Governance
Mechanisms
4. Capacity-Building, Enforcement, and Follow-
up
57
1. Initial Assessment
Assess corporate governance failures,
challenges, opportunities, etc.
Rate country standards vs. international best
practices
OECD principles/guidelines and local realities
58
2. Outreach and Education
Identify stakeholders
Build awareness: business leaders,
policymakers, society
Create broader public demand for reform
Public education campaigns

59
3. Develop and Institute
Corporate Governance Mechanisms
Develop corporate governance codes and
internal control mechanisms
Foster shareholder activism
Improve regulatory and enforcement
frameworks
Create corporate governance networks
including regulatory bodies, business
leaders and organizations, and other civil
society groups

60
4. Capacity-Building, Enforcement, and Follow-up
Training and certification programs for
managers and directors
Establishment of Institutes of Directors
Create corporate governance ratings systems
for investors
Training for financial intermediaries
Broader legal and institutional enforcement:
ex. Judicial systems

61
Institutions and Corporate Governance
What does it mean for countries?
Initial conditions matter
Need to recognize that there is a cross-section of
countries, approaches, and capacities
Set own reform goals and priorities
Strike the right balance between international best
practices and local needs, priorities, and experiences
Share lessons learned knowledge management
Focus on processes rather than outcomes
How you develop CG mechanisms and how they function vs. what you are
trying to develop
62
L/O/G/O
Terima kasih
Thank you
Merci
Gracias

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