Bahan Kuliah Genap CG Sesi 1 - Genap 17-18

L/O/G/O
Corporate Governance –
An Introduction
(Konsep dan Kerangka)*
Purwatiningsih Lisdiono
*diambil dari berbagai sumber

Corporate Governance
“When a business goes wrong, look only to

the people who are running it”
-Michael Dell
-CEO Dell Corporation
www.themegallery.com
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
• Tugas : cari penjelasan ringkas tentang teori di atas
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?
MANAGEMENT
Vs
CORPORATE GOVERNANCE
Agency Theory (Jensen and Meckling)
An agency relationship exists when:
Agency
Shareholder Relationship
(Principals) Risk Bearing Specialist
(Principal)
Firm Hire
Managerial Decision-
Owners Making Specialist
(Agent)
Managers
(Agents)
which creates
Decision
Makers
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
Agency Theory
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
Corporate Governance Mechanism :
The Internal and External Architecture
Internal External
Private Regulatory
Pemegang Saham Stakeholders
Standards
(IAI- accounting
•Employees standards)
RUPS •Customers
•Suppliers Laws
•Creditors
Regulations
•Society
Dewan Komisaris
Reputational agents Bank
Dewan Direksi • Accountants
• Lawyers
• Credit rating
• Investment bankers Markets
Management • Financial media • Product Markets
• Investment advisors
•Internal Auditor • Labor Market
• Research • Capital Market
•Accounting • Corporate Governance
analyst
Source : Modification from Cadbury (1999) “Corporate Governance: A Framework for Implementation”, Kim and Nofsinger ( 2004)
“Corporate Governance”.
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
*Cek OECD principles 2015
Corporate Governance is multi - discipline
▪ 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.
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.
Corporate Governance Business Ethics
Structure of decision-making Guide for behavior
CORE VALUES of CG
Transparency
Fairness
Accountability
Responsibility
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 people’s
heart”  become competitive advantage
Institutions Matter!
Functioning Markets
Better Environment for Doing Business
Property Good Market Rule of Access to

Rights Governance Entry Law Information
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 corporation’s

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
▪ 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”)
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
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 Poor’s
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 Poor’s
Corporate Governance Dilemma
Benefits of having
corporate governance
mechanisms in place
Business costs of too

much corporate
governance regulation
35
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 firm’s 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
▪ Agency Theory 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 principal’s interests and to reduce the
possibility that agents will misbehave
• Bonding expenditures by agents
• Monitoring expenditures by principals
• Residual loss of the principal
Essential sources of agency problems:

Moral hazard; more of the agent’s 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.
40
▪ 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 principal–agent 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)
42
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
43
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

44
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 stockholder’s 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
45
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 firm’s 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
46
L/O/G/O
Terima kasih
Thank you
Merci
Gracias

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L/O/G/O

*diambil dari berbagai sumber

“When a business goes wrong, look only to

▪ Definisi menurut OECD (1999)

The corporate governance structure specifies the

By doing this, it also provides the structure through which

OECD April 1999.

▪ The most important : it is about changing the way of

▪ The key issue :TRANPARENCY and ACCOUNTABILITY

• Agency Theory (Jensen & Meckling, 1976)

• Adolf Berle and Gardiner Means “The Modern

Examples of principal-agent relationship:

The Agency problem occurs when:

• Agency problem in Indonesia :

▪ Corporate governance intersect with many

Corporation interacts with various parties in

Structure of decision-making Guide for behavior

Property Good Market Rule of Access to

▪ Creation and enhancement of a corporation’s

▪ Ethic is the background color of Corporate

• Common Problem : Form over Substance

Source: Standard and Poor’s

1. Ownership Structure & Concentration

Common Problem : Form over Substance

Source: Standard and Poor’s

Business costs of too

The principal problem rests in the abuse of power by corporate

Corporate governance includes “the structures, process, cultures

These create the agency problem – that is the possibility of

Essential sources of agency problems:

In economic theory, a moral hazard is a situation where a party will

Adverse selection, anti-selection, or negative selection is a term used in

Risk aversion; as organisations grow managers become risk averse (they

• Principals can monitor agents by collecting information about their behaviour

• Principals can monitor consequences of (only partially obseved) agent behaviour

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

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

Capital market and corporate control

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