Gradual steps to understanding sound corporate governance
<p>Gradual steps to understanding sound corporate governance</p><p>By George S. Tahija</p><p> The following article is an excerpt from a paper presented at
the APEC Symposium in Sydney on Nov. 3, 1998.</p><p> SYDNEY: Indonesia is undergoing many changes. Major
transitions are taking place in the sociopolitical and industrial
structure. To look at corporate governance in perspective, it is
necessary to understand the nature and magnitude of these
changes.</p><p>First, our society is emerging from a period of feudalistic
and paternalistic government. We are desperately searching for
some form of democratic government that will allow all
Indonesians to feel fairly represented. We must also ensure
prosperity, and above all, on-going unity of the nation.</p><p>Second, as the technological revolution sweeps the world, we
are beginning to depart from being a traditional agricultural and
industrial society. Indonesia's public and political institutions
find themselves becoming vehicles catering to the past. They are
unable to cope with present needs and certainly unable to
anticipate future demands.</p><p>Indonesia's recent troubles reflect the dire consequences of
failure to manage the transition. In the short term, political
parties and public institutions responsible for governance of
finance and banking will be the focus of attention. In the medium
term, education, health and the environment must surely become
the focus of reform.</p><p>Most companies on the Jakarta Stock Exchange are only one step
removed from their origins. Most started as family run businesses
or government business units where the owners had free reign.
These companies are still grappling with the transition, and the
majority probably view corporate governance as a hindrance rather
than an important support to corporate development.</p><p>Managing these changes is a challenge under any circumstances,
let alone during this period of unprecedented and severe economic
crisis.</p><p>Corporate governance is a relatively recent phenomenon in its
current form. Until the late 1980s, and subject to the
constraints of Company Law and Stock Exchange Listing Procedures,
self-regulation of companies was the norm. This self-regulation,
in practice, was limited to the presence of a few nonexecutive
directors, probably selected by management. Audit committees and
remuneration committees were the exception rather than the rule,
certainly in countries such as the UK, Australia and Singapore.</p><p>In many developed economies, standards of corporate governance
were subjected to scrutiny after the financial scandals of the
1980s. The aftermath of these scandals and the resultant
financial turmoil changed attitudes toward corporate governance
in virtually every developed economy.</p><p>Developed economies have the advantage of being able to build
corporate governance on a foundation of political stability, a
solid body of law and impartial implementation of that law,
professional services, including accountants and lawyers, and a
sound banking system. There must also be a cadre of people
prepared to accept positions as nonexecutive directors who
understand their fiduciary duties, and most importantly, have the
courage to meet their obligations. Of course, none of this should
be static. Regulatory frameworks and institutions, including
those in the banking system, must constantly evolve to meet
changing needs.</p><p>Until the mid 1980s, economic growth was driven by the
government and funded mainly by oil and gas exports. When oil and
gas revenues declined in the mid 1980s, the government wisely
embarked on a liberalization program to diversify its sources of
income. It also began to share its role in development with the
private sector.</p><p>First, in 1986, the government initiated extensive
deregulation of trade and business to boost non-oil and gas
exports. It encouraged larger and broader participation of both
foreign and local capital in industries that were traditionally
government owned, such as powers, telecommunications and
transportation.</p><p>Second, the deregulation of the banking sector in 1988 was
initiated to increase the availability of credit to fuel further
growth.</p><p>These efforts were successful. Non-oil exports grew from 30
percent to 70 percent of total export revenues. In less than
eight years, the private sector replaced the government as the
main engine of growth and employment. This in itself was a major
achievement. Unfortunately, much of this impressive growth by the
private sector was supported by equally impressive amounts of
debt, which would eventually put the entire country in a
vulnerable position.</p><p>Strategically, the government had taken the right steps. What
remained unaddressed were a weak legal system, a weak audit
regime and breaches of the banking regulations on a massive
scale. This was a major mistake because it encouraged
unsustainable business practices to flourish unabatedly.</p><p>It was commonly known that we had a high-cost economy caused
by collusion, corruption and favoritism. Political and economic
observers had for years warned of the dangers of these practices
and urged reform.</p><p>Few in the government and private sector paid attention to
those warnings while economic growth continued. Frankly, the
international investment and financial community continued to
provide financing to the private sector in increasingly large
amounts. International investment banks competed with each other
for advisory and lead underwriting roles to the very cronies they
are now complaining about. The World Bank and the IMF, until
1996, gave rave reviews on Indonesia's economic achievements and
portrayed us as a model developing country.</p><p>So it is not surprising that there was little, if any,
incentive for reform. Greed, arrogance and complacency on all
sides (from within and without) overruled ethics and good
judgment.</p><p>Globalization and liberalization were the trigger rather than
the cause of Indonesia's financial collapse. Internal weakness
and irresponsible capitalism were the root cause.</p><p>What can we do to achieve better corporate governance?</p><p>The stage needs to be set before corporate governance can
happen. Above all else, we must have a political system with
transparent checks and balances. Until there is a more democratic
political system, concentrations of power and influence will
occur in society. This concentration of influence will inevitably
encourage collusion and corruption. Regulation and enforcement
cannot function equitably in this environment. In the past, this
has led to directed lending to preferred parties, rigged stock
markets, politically favored companies and many regulatory
"exceptions".</p><p>In Indonesia, the salary of civil servants must be increased
for two reasons. First, it is unfair and unrealistic to expect
regulators and enforcers to act impartially when their salaries
don't even cover basic needs. Second, we must improve salaries in
order to attract capable young people into government service.</p><p>Business leaders must set the example for responsible
capitalism. We are part of a much larger society, without which
we will not survive. When the interests of a few outweigh the
interest of many, sustainable development becomes impossible.
Every one looses. This has become painfully apparent in
Indonesia. Business leaders need to focus on:</p><p>* improving productivity and quality of assets rather than just
going for asset growth</p><p>* building competitive businesses rather than just trading assets</p><p>* viewing good corporate governance as a competitive advantage
rather than a regulatory burden</p><p>* rethinking the viability of the so-called diversified
conglomerate.</p><p>Until the financial crisis began last year, international
financial institutions such as banks, securities companies and
fund managers were actively raising money for Asian corporates
that were clearly engaged in less than transparent practices. In
pursuit of fee income, financial institutions have basically been
rewarding the very type of behavior that erodes the fabric of
society and the foundation on which good corporate governance is
built. I believe these financial institutions have behaved
irresponsibly, and in so doing have contributed to the crisis.
They need to take a good hard look at the kind of people they
were supporting and why they were supporting them.</p><p>The task ahead is a difficult one but certainly not
insurmountable. This is not a time for gimmicks or short-term
solutions. We must put the long-term economic development of the
country ahead of short-term political interest. Progress toward
better governance is actually being made, particularly in the
financial sector. We must remember that it is a process rather
than an event and it will take time to get there but I am
confident that we will.</p><p>Indonesia is still a country with an abundance of natural and
human resources and a huge potential market. If we do the right
things, local and foreign investment will return to Indonesia and
develop these resources.</p>
the APEC Symposium in Sydney on Nov. 3, 1998.</p><p> SYDNEY: Indonesia is undergoing many changes. Major
transitions are taking place in the sociopolitical and industrial
structure. To look at corporate governance in perspective, it is
necessary to understand the nature and magnitude of these
changes.</p><p>First, our society is emerging from a period of feudalistic
and paternalistic government. We are desperately searching for
some form of democratic government that will allow all
Indonesians to feel fairly represented. We must also ensure
prosperity, and above all, on-going unity of the nation.</p><p>Second, as the technological revolution sweeps the world, we
are beginning to depart from being a traditional agricultural and
industrial society. Indonesia's public and political institutions
find themselves becoming vehicles catering to the past. They are
unable to cope with present needs and certainly unable to
anticipate future demands.</p><p>Indonesia's recent troubles reflect the dire consequences of
failure to manage the transition. In the short term, political
parties and public institutions responsible for governance of
finance and banking will be the focus of attention. In the medium
term, education, health and the environment must surely become
the focus of reform.</p><p>Most companies on the Jakarta Stock Exchange are only one step
removed from their origins. Most started as family run businesses
or government business units where the owners had free reign.
These companies are still grappling with the transition, and the
majority probably view corporate governance as a hindrance rather
than an important support to corporate development.</p><p>Managing these changes is a challenge under any circumstances,
let alone during this period of unprecedented and severe economic
crisis.</p><p>Corporate governance is a relatively recent phenomenon in its
current form. Until the late 1980s, and subject to the
constraints of Company Law and Stock Exchange Listing Procedures,
self-regulation of companies was the norm. This self-regulation,
in practice, was limited to the presence of a few nonexecutive
directors, probably selected by management. Audit committees and
remuneration committees were the exception rather than the rule,
certainly in countries such as the UK, Australia and Singapore.</p><p>In many developed economies, standards of corporate governance
were subjected to scrutiny after the financial scandals of the
1980s. The aftermath of these scandals and the resultant
financial turmoil changed attitudes toward corporate governance
in virtually every developed economy.</p><p>Developed economies have the advantage of being able to build
corporate governance on a foundation of political stability, a
solid body of law and impartial implementation of that law,
professional services, including accountants and lawyers, and a
sound banking system. There must also be a cadre of people
prepared to accept positions as nonexecutive directors who
understand their fiduciary duties, and most importantly, have the
courage to meet their obligations. Of course, none of this should
be static. Regulatory frameworks and institutions, including
those in the banking system, must constantly evolve to meet
changing needs.</p><p>Until the mid 1980s, economic growth was driven by the
government and funded mainly by oil and gas exports. When oil and
gas revenues declined in the mid 1980s, the government wisely
embarked on a liberalization program to diversify its sources of
income. It also began to share its role in development with the
private sector.</p><p>First, in 1986, the government initiated extensive
deregulation of trade and business to boost non-oil and gas
exports. It encouraged larger and broader participation of both
foreign and local capital in industries that were traditionally
government owned, such as powers, telecommunications and
transportation.</p><p>Second, the deregulation of the banking sector in 1988 was
initiated to increase the availability of credit to fuel further
growth.</p><p>These efforts were successful. Non-oil exports grew from 30
percent to 70 percent of total export revenues. In less than
eight years, the private sector replaced the government as the
main engine of growth and employment. This in itself was a major
achievement. Unfortunately, much of this impressive growth by the
private sector was supported by equally impressive amounts of
debt, which would eventually put the entire country in a
vulnerable position.</p><p>Strategically, the government had taken the right steps. What
remained unaddressed were a weak legal system, a weak audit
regime and breaches of the banking regulations on a massive
scale. This was a major mistake because it encouraged
unsustainable business practices to flourish unabatedly.</p><p>It was commonly known that we had a high-cost economy caused
by collusion, corruption and favoritism. Political and economic
observers had for years warned of the dangers of these practices
and urged reform.</p><p>Few in the government and private sector paid attention to
those warnings while economic growth continued. Frankly, the
international investment and financial community continued to
provide financing to the private sector in increasingly large
amounts. International investment banks competed with each other
for advisory and lead underwriting roles to the very cronies they
are now complaining about. The World Bank and the IMF, until
1996, gave rave reviews on Indonesia's economic achievements and
portrayed us as a model developing country.</p><p>So it is not surprising that there was little, if any,
incentive for reform. Greed, arrogance and complacency on all
sides (from within and without) overruled ethics and good
judgment.</p><p>Globalization and liberalization were the trigger rather than
the cause of Indonesia's financial collapse. Internal weakness
and irresponsible capitalism were the root cause.</p><p>What can we do to achieve better corporate governance?</p><p>The stage needs to be set before corporate governance can
happen. Above all else, we must have a political system with
transparent checks and balances. Until there is a more democratic
political system, concentrations of power and influence will
occur in society. This concentration of influence will inevitably
encourage collusion and corruption. Regulation and enforcement
cannot function equitably in this environment. In the past, this
has led to directed lending to preferred parties, rigged stock
markets, politically favored companies and many regulatory
"exceptions".</p><p>In Indonesia, the salary of civil servants must be increased
for two reasons. First, it is unfair and unrealistic to expect
regulators and enforcers to act impartially when their salaries
don't even cover basic needs. Second, we must improve salaries in
order to attract capable young people into government service.</p><p>Business leaders must set the example for responsible
capitalism. We are part of a much larger society, without which
we will not survive. When the interests of a few outweigh the
interest of many, sustainable development becomes impossible.
Every one looses. This has become painfully apparent in
Indonesia. Business leaders need to focus on:</p><p>* improving productivity and quality of assets rather than just
going for asset growth</p><p>* building competitive businesses rather than just trading assets</p><p>* viewing good corporate governance as a competitive advantage
rather than a regulatory burden</p><p>* rethinking the viability of the so-called diversified
conglomerate.</p><p>Until the financial crisis began last year, international
financial institutions such as banks, securities companies and
fund managers were actively raising money for Asian corporates
that were clearly engaged in less than transparent practices. In
pursuit of fee income, financial institutions have basically been
rewarding the very type of behavior that erodes the fabric of
society and the foundation on which good corporate governance is
built. I believe these financial institutions have behaved
irresponsibly, and in so doing have contributed to the crisis.
They need to take a good hard look at the kind of people they
were supporting and why they were supporting them.</p><p>The task ahead is a difficult one but certainly not
insurmountable. This is not a time for gimmicks or short-term
solutions. We must put the long-term economic development of the
country ahead of short-term political interest. Progress toward
better governance is actually being made, particularly in the
financial sector. We must remember that it is a process rather
than an event and it will take time to get there but I am
confident that we will.</p><p>Indonesia is still a country with an abundance of natural and
human resources and a huge potential market. If we do the right
things, local and foreign investment will return to Indonesia and
develop these resources.</p>