Do political connections affect a firm’s performance?

Amiruddin

This thesis is presented for the degree of

Doctor of Business Administration of

The University of Western Australia

UWA Business School

Accounting and Finance

2016

i

Abstract

Previous studies have indicated that political connection can be a source of value to a

firm, and may affect firm performance.

This study has examined the links between political connection and firm performance in

Indonesia after the Soeharto era, when politically connected firms enjoyed favourable

benefits such as exclusive import licences, bail-outs and favourable financings.

The study used a mixed method approach: interviews with 34 bankers, analysts, fund

managers, academics, lawyers and business owners on their perception regarding the

need for political connection for business to be competitive in Indonesia, and a

regression analysis on panel data of listed non-financial companies in the Indonesia

Stock Exchange (IDX).

To define politically connected firms, this study used a measure whether a firm has any

member of the board of directors or the board of commissioners a politically exposed

person (PEP) or not. As measures of firm performance, return on assets (ROA) was

used for accounting-based firm performance and Tobin’s Q and market-adjusted returns

were used for market-based firm performance.

The findings from the interviews indicated that political connections were still needed

in the post-Soeharto era for ‘political protection’, as well as for access to information

and to regulators. The findings from examining the financial performance of the listed

companies in the IDX have corroborated the findings from the interviews. More than

one-third (36%) of Indonesian listed companies had political connectedness: 91%. The

concentration of politically connected firms was in the agricultural, mining,

property/real estate and miscellaneous industries (e.g., auto and auto parts). Not only

were they prevalent, the politically connected firms were some of the largest in the

country, where the mean and median value were higher in terms of market

capitalisation, total assets, total revenue and net profits.

The degree of political connection depended on the industry, the scale of the business

and the stage of the business. The dispersion of power structures necessitated businesses

to obtain wider political connections, especially in more regulated industries such as

ii

mining, oil and gas, plantations and property/real estate. However, the perception of the

interviewees was that political connection was just one of the factors required for

success; the key factor for a company’s success is its management. The results of the

regression showed that political connection had significant effects on market-based firm

performance, but not accounting-based firm performance. The effects on Tobin’s Q

were significant and positive, while the effects on returns were significant and negative.

Various robustness tests were conducted, such as including the top 40 business groups

in the definition of PEP, the addition of industry dummies, and matched pair tests on the

means of ROA and the change in ROA. Robustness tests confirmed Tobin’s Q

maintained significant and positive effects, with no difference in the means of ROA or

the change in ROA using a matched pair tests. The consumer industry had a positive

significant effect on Tobin’s Q. The number of the PEP board members did not have

any effect on ROA or market-adjusted returns, except on Tobin’s Q; however, the

number of PEP board members had significant and positive effects on the ROA within

the sample of PEP companies that experienced changes in their boards.

The findings of a relationship between political connection and market-based firm

performance have corroborated previous findings. This study has contributed to the

research on political connection, firm performance, institutions and how business is

conducted in emerging markets.

iii

Contents

Abstract ........................................................................................................................ i

Contents .................................................................................................................... iii

List of Figures ............................................................................................................ vi

List of Tables ............................................................................................................ vii

List of Abbreviations ............................................................................................. viii

Declaration of Originality.......................................................................................... x

Acknowledgements .................................................................................................... xi

Chapter 1: Research Rationale ................................................................................. 1 1.1 Introduction ........................................................................................................ 1 1.2 Research Background ......................................................................................... 1 1.3 Research Purpose and Key Questions ................................................................ 3 1.4 Research Significance ........................................................................................ 3 1.5 Research Scope .................................................................................................. 4 1.6 Thesis Structure .................................................................................................. 4

Chapter 2: Background & Literature Review ........................................................ 5 2.1 Introduction ........................................................................................................ 5 2.2 Overview of the Indonesian Economy ............................................................... 6

2.2.1 Recent Developments ................................................................................. 6 2.2.2 Capital Market Development ...................................................................... 7 2.2.3 Business Landscape .................................................................................... 8

2.3 Overview of Indonesia’s Political System ....................................................... 12 2.3.1 Recent Developments ............................................................................... 12 2.3.2 Brief History of the Political System ........................................................ 14

2.3.2.1 The Soekarno Era ............................................................................... 14 2.3.2.2 The Soeharto Era ............................................................................... 15 2.3.2.3 The Reformation Era .......................................................................... 18

2.4 Politics and Business in Indonesia ................................................................... 20 2.4.1 Introduction ............................................................................................... 20 2.4.2 The State and Rent-Seeking ...................................................................... 21 2.4.3 Oligarchy ................................................................................................... 22 2.4.4 Culture ....................................................................................................... 23 2.4.5 Government Intervention .......................................................................... 26 2.4.6 Case Study: The Salim Group ................................................................... 30

2.5 The Theoretical Foundations of Earlier Research ............................................ 32 2.5.1 Determinants of Firm Performance ........................................................... 32 2.5.2 Institutional Voids ..................................................................................... 33 2.5.3 The Effects of Having Political Connections on Firm Performance......... 35

Chapter 3: Perceptions of Business and Politics in Indonesia ............................. 40 3.1 Introduction ...................................................................................................... 40 3.2 Research Design ............................................................................................... 41

3.2.1 Rationale for Interview Method ................................................................ 41 3.2.2 Selection of Interview Participants ........................................................... 41 3.2.3 Data Analysis ............................................................................................ 42

iv

3.3 Findings ............................................................................................................ 42 3.3.1 Interviewee Characteristics ....................................................................... 42 3.3.2 Data Analysis—Manual Coding ............................................................... 45

3.3.2.1 What Factors are Important to Compete Effectively in Indonesia? .. 45 3.3.2.2 Why the Need for Political Connection? ............................................ 51 3.3.2.3 Need for Political Connection During and After the Suharto Era .... 53 3.3.2.4 Variation in Political Connection by Sectors of Industry .................. 55 3.3.2.5 Mechanism of Political Connection ................................................... 58

3.3.3 Data Analysis Using Leximancer ............................................................. 62 3.4 Summary .......................................................................................................... 65

3.4.1 Interviewees’ Characteristics .................................................................... 65 3.4.2 Does Political Connection Matter? ........................................................... 66 3.4.3 Why the Need for Political Connection? .................................................. 67 3.4.4 Conditions During and After the Soeharto Era ......................................... 67 3.4.5 Variation of Political Connection by Sectors of Industry ......................... 67 3.4.6 Mechanisms of Political Connection ........................................................ 68 3.4.7 Summary Data Analysis Using Leximancer ............................................. 68

3.5 Discussion and Implications ............................................................................ 69

Chapter 4: Political Connection and Firm Performance in Indonesia ............... 72 4.1 Introduction ...................................................................................................... 72 4.2 Background and Hypotheses ............................................................................ 72

4.2.1 Research Background ............................................................................... 72 4.2.2 Research Hypotheses ................................................................................ 73

4.3 Research Design ............................................................................................... 75 4.3.1 Sample and Time Period ........................................................................... 75 4.3.2 Research Data ........................................................................................... 75

4.3.2.1 Data Collection Method ..................................................................... 75 4.3.2.2 Independent Variables ....................................................................... 76

4.3.3 Research Models ....................................................................................... 77 4.3.3.1 Dependent Variables .......................................................................... 77 4.3.3.2 Control Variables ............................................................................... 78 4.3.3.3 Ordinary Least Squares ..................................................................... 78 4.3.3.4 Research Model.................................................................................. 79

4.4 Results .............................................................................................................. 80 4.4.1 Overview of Sample.................................................................................. 80 4.4.2 Descriptive Statistics and Correlation ....................................................... 81 4.4.3 Comparison of PEP and Non-PEP Companies ......................................... 82 4.4.4 Regression Model Results ......................................................................... 88

4.5 Robustness Tests .............................................................................................. 92 4.5.1 Robustness Test 1 ..................................................................................... 92 4.5.2 Robustness Test 2 ..................................................................................... 95 4.5.3 Robustness Test 3 ..................................................................................... 97

4.6 Discussion ........................................................................................................ 97

Chapter 5: Conclusions ......................................................................................... 100 5.1 Introduction .................................................................................................... 100 5.2 Theoretical and Empirical Findings and Contributions ................................. 100 Research Limitations ........................................................................................... 104 5.3 104 5.4 Implication of Findings .................................................................................. 106

v

References ............................................................................................................... 107

Appendix A ............................................................................................................. 120

Appendix B ............................................................................................................. 123

Appendix C ............................................................................................................. 125

vi

List of Figures

Figure 3.1: Key Success Factors Viewed as Necessary for Competitiveness ........... 49

Figure 3.2: Perceptions of Variation in Political Connectedness by Industry Sector 58

Figure 3.3: Concept Map of Political Connectedness ................................................ 64

vii

List of Tables

Table 2.1: Top 80 Business Groups in Indonesia ........................................................ 9

Table 3.1: Characteristics of Interviewees Based on Their Professions .................... 43

Table 3.2: Characteristics of Interviewees Based on Their Positions ........................ 43

Table 3.3: The Cross-Tabulation of Interviewees’ Jobs and Education .................... 44

Table 3.4: Interviewees’ Perceptions of the Necessity of Political Connections ....... 46

Table 3.5: Reasons for Answering ‘Depends On’ ..................................................... 46

Table 3.6: Main Themes and Concepts ...................................................................... 65

Table 4.1: Number of Companies with PEP and the Number of PEPs ..................... 81

Table 4.2: Descriptive Statistics of Variables ............................................................ 81

Table 4.3: Correlation between Variables .................................................................. 82

Table 4.4: Politically Connected Firms and Sectors of the Industry.......................... 83

Table 4.5: Ranking of Companies with a PEP in the Industry................................... 84

Table 4.6: Mean Value of Variables for PEP Companies and Non-PEP Companies 85

Table 4.7: Regression Results .................................................................................... 88

Table 4.8: Regression Results for NUM as Dependent Variables ............................. 90

Table 4.9: Regression Results for Changing NUM ................................................... 91

Table 4.10: Regression Results with Top 40 Business Groups ................................. 93

Table 4.11: T-test of ROA between All Companies and Top 40 Business Group .... 94

Table 4.12: Regression Results with Industry Dummies ........................................... 95

Table 4.13: T-test Result for ROA of Matched Pair Companies ............................... 97

viii

List of Abbreviations

AFC Asian Financial Crisis

AMDAL Analisa Mengenai Dampak Lingkungan

APINDO Asosiasi Pengusaha Indonesia

ASEAN Association of South East Asian Nations

BAPPENAS Badan Perencanaan Nasional

BCA Bank of Central Asia

BI Bank Indonesia

BODCOM Board Composition

BPOM Badan Pengawas Obat & Makanan

BUMN Badan Usaha Milik Negara

CONTR Concentrated Ownership

EPS Earnings Per Share

FDI Foreign Direct Investment

Golkar Golongan Karya

GFC Global Financial Crisis

IBRA Indonesian Banking Restructuring Agency

ICBP Indofood Consumer Brand Products

IDR Indonesian Rupiah

IMF International Monetary Fund

JCRA Japan Credit Rating Agency

KADIN Kamar Dagang & Industri Indonesia

KIP Kartu Indonesia Pintar

KIS Kartu Indonesia Sehat

KKP Kartu Keluarga Sejahtera

KPK Komisi Pemberantasan Korupsi

KPU Komisi Pemilihan Umum

KSO Kerja Sama Operasi

MAC Middle Class and Affluent Consumers

MNC Media Nusantara Citra

MOF Ministry of Finance

MP Member of Parliament

MPR Majelis Permusyawaratan Rakyat

NPL Non-Performing Loans

NUM Number of PEPs

OJK Otoritas Jasa Keuangan

OLS Ordinary Least Squares

ix

PAN Partai Amanat Nasional

PDIP Partai Demokrasi Indonesia Perjuangan

PEP Politically Exposed Person/s

PERDA Peraturan Daerah

PKI Partai Komunis Indonesia

PSC Production sharing contract

R&D Research & Development

ROA Return on Assets

ROE Returns of Equity

ROS Return on Sales

RUP Rencana Urgensi Perekonomian

SBY Susilo Bambang Yudhoyono

SOE State-Owned Enterprise

TI Transparency International

UBO Ultimate Beneficiary Owners

US United States of America

USD US Dollar

x

Declaration of Originality

I certify that this thesis does not incorporate without acknowledgement any material

previously submitted for a degree or diploma in any university; and that to the best of

my knowledge and belief it does not contain any material previously published or

written by another person except where due reference is made in the text.

Signed: On: 4 July 2016

xi

Acknowledgements

When I started out on the journey of the DBA programme, I was warned that the

journey of a Doctorate programme would be a long and lonely journey. It was indeed

so. However, the journey was very rewarding. Without the help and support of

countless individuals whom I cannot mention each and everyone of them, I would not

be able to complete this journey.

First and foremost, I would like to thank my mother - Khatijah and my late father -

Husin Ibrahim. Though my mother cannot even read and write and my father never

finished primary school, they instilled in me the importance of education in life and a

passion for a lifelong learning.

I would like to thank my wife - Rosalin Devi and my sons - Alif, Bing and Faridz. They

have been my constant supporters, inspirations, critics and encouragement even when I

had to take some time off my career to complete this journey.

I would like to thank Winthrop Professor Raymond da Silva Rosa and Associate

Professor Marvin Wee, my co-supervisors. Without their advice, guidance, and

patience, I would have been lost in the journey. Also my sincere thanks to Winthrop

Professor Geoffrey Soutar, DBA Programme Director and all staff at the UWA

Business School Research Office.

My thanks and sincere gratitude to the 34 interviewees who took time and efforts to

share their views despite their busy schedules. And to all friends, family, colleagues that

have supported me in this process, I am forever indebted for the exchanges of ideas,

words of encouragement, and any help extended to me.

Last, I would also like to thank and acknowledge the editing works by Elite Editing

(Australia). All editorial works were restricted to Standards D and E of the Australian

Standards for Editing Practice.

1

Chapter 1: Research Rationale

1.1 Introduction

The background to this research provides the rationale for and description of why I am

interested in examining the relationship between business, politics and firm (or

company)1 performance. Further, I will describe the research purpose and key questions.

I will then explain the thesis structure and contents.

1.2 Research Background

I worked in Indonesia for over 20 years. During the first four years, I worked in the

corporate world; for the last 16 of those years I worked as a senior banker. I observed

the phenomenon of a close relationship between business and politics both during and

after the post-Soeharto era. This prompted my idea to study the correlation between

business, politics and company performance in Indonesia.

In an emerging market such as that of Indonesia, the lack of institutional settings—a

situation called ‘institutional voids’—has been nominated as a reason for the emergence

of business groups concentrated in the hands of a few families (Khanna & Yafeh 2007;

Sato 2004). The majority of big family firms in Indonesia are owned by the descendants

of Chinese business people. They did not have the option of a political career, or joining

the bureaucracy or military during Soeharto’s time; hence, some perceive this is why the

Indonesian business world has been dominated by the Chinese (Muhaimin 1991;

Yoshihara 1988). However, as discussed in the literature review, the Chinese have

participated in business since the Dutch colonial period. Chinese cultural traits have

been perceived as the reason for this phenomenon (Yoshihara 1988). The Chinese have

been ‘subjugated’ and ‘co-opted’ by the political powers in a neo-patrimonialist regime

during Soeharto’s time (Chua 2008).

In the post-Soeharto era, Chinese dominance in business has not abated, although some

business groups have suffered major losses or have even disappeared completely in the

aftermath of the 1988 Asian financial crisis (AFC) (Chua 2008). Chua (2008) has

1 The terms company and firm are used interchangeably throughout this thesis.

2

argued that they are now more assertive and have better leverage due to their

indispensable capital. Since regional autonomy was established in 2001, power has been

dispersed regionally. In a democratic Indonesia, elections at the regional and central

levels require a huge amount of funding. Business people have become the source of

capital (Chua 2008).

Has the existence of politically connected firms translated into better firm performance

for these companies in Indonesia recently? This thesis will attempt to provide answers

through empirical evidence regarding the potential correlation between politics and

businesses in recent times (2009–2013); specifically, whether ‘politically connected’

firms perform better or not than other firms.

For this study, politically connected firms are defined as firms that have a Politically

Exposed Person (PEP) in the board of directors or commissioners. A more detailed

description of politically connected firms and PEP is available on page 78 (section

4.3.2.2 Chapter 4).

First, interviews with senior professionals, business owners, lawyers and academics

were conducted to obtain perceptions of business and politics in Indonesia’s post-

Soeharto era. These interviews will provide the background and further insight into the

quantitative analysis. Quantitative analysis will apply ordinary least square (OLS)

regression to the panel data of listed companies’ performance and their political

connectedness in subsequent chapters.

Business focuses on profit maximisation and firms tend to use all means to seize

opportunities and mitigate risk, including using political connections. This phenomenon

has been observed in Indonesia in previous studies such as those described in Chapter 2

(‘Literature Review’). Politics and business have been intimately intertwined to the

point that some of the largest business groups in Indonesia were born and flourished

under ‘political protection’ during Soeharto’s regime.

Since 1998, democracy has replaced Soeharto’s authoritarian regime. Have conditions

changed post-Soeharto? This thesis will explore the need for political connections to

compete in business in the post-Soeharto era, and whether political connections have

added value to Indonesian listed companies in recent times.

3

1.3 Research Purpose and Key Questions

This research examines the existence of political connections when conducting business

in Indonesia. An attempt was made to investigate the necessity of political connections

in doing business: how a different political era could result in different political

connection mechanisms and whether different company characteristics would affect

performance. To develop this research, the following questions were analysed and

discussed:

1. Are political connections necessary to be competitive in Indonesia? If so, why?

2. Has the situation become better or worse post-Soeharto?

3. Do political connections vary across industry sectors? How?

4. What mechanisms for political connections are used by firms?

5. Do political connections affect a firm’s performance in Indonesia?

6. Does the number of politically exposed persons (PEPs) on a board affect a

firm’s performance in Indonesia?

This research has used a mixed methods approach to answer the key research questions.

A qualitative method was used for interviews with 34 senior executives, business

owners, lawyers and academics in Indonesia regarding their perceptions of key research

questions 1 to 4; a quantitative method using OLS regression analysis on the

performance of listed companies that are politically connected or not in Indonesia was

conducted for research questions 5 and 6.

1.4 Research Significance

Previous studies have examined the correlation between politics and business in

Indonesia from the perspective of sociology, history or political economics and have

largely focused on the Soeharto era. This study has also examined the correlation

between politics and business in Indonesia, but has focused on business and

management perspectives in the post-Soeharto era. In addition, this study has examined

the correlation between political connection and a firm’s performance using the OLS

regression method on panel data. Moreover, using both qualitative and quantitative

approaches will provide enriched findings.

4

1.5 Research Scope

This research has used financial data from the audited financial statements of listed

companies in the Indonesian Stock Exchange (IDX) from 2009 to 2013. The

measurement of political connections has been based on previous studies (Faccio 2006)

that have examined whether board members, directors or commissioners are or have

been senior officials in the government, military and judiciary. Moreover, in-depth

interviews were conducted with 34 senior executives, business owners, lawyers and

academics. This will provide some important data to support the whole range of

arguments presented in this research.

1.6 Thesis Structure

The thesis will begin by discussing the institutional settings and providing a literature

review in Chapter 2. This chapter will review Indonesia’s recent economy and its

political system.

Chapter 3 describes the perceptions of respondents regarding politics and business in

Indonesia. It begins with a brief outline of the previous studies, followed by a main

section analysing the interview data using manual coding. To enrich this manual coding,

the analysis has used Leximancer software to code the interview results. Leximancer

coding produces a concept map. This map will indicate the closeness of the various

themes emerging from the Leximancer coding. These sections are constructed based on

the key research questions. A short summary is followed by discussion and

implications.

Chapter 4 describes the analysis of the key research questions using a quantitative

approach. Panel data regression was employed to answer whether politically connected

firms have better accounting performance using the measure return of assets (ROA),

and market-based performance using Tobin’s Q and market-adjusted returns. The

results and their implications are described at the close of Chapter 4.

Chapter 5 consists of a conclusion and some directions for future research. This chapter

will finish with a discussion on the implications of the findings for managers and policy

makers.

5

Chapter 2: Background & Literature Review

2.1 Introduction

Since its independence in 1945, Indonesia has experienced different political regimes.

Different regimes have resulted in different governmental dynamics, including policies,

priorities and expenditure, depending on the respective needs and allocations of the

regime’s period (Permana & Wika 2014).

During the Soeharto era, business and politics were intertwined intensely (Borsuk &

Chng 2014). Power was concentrated in one person—President Soeharto. In post-

Soeharto authoritarian regimes, reformation resulted in a democracy with more

transparency, better supervisory systems and an open trade regime (Basri 2013).

However, the intertwining of business and politics has not subsided in the post-Soeharto

era (Chua 2008).

Indonesia has the fourth largest population in the world, with a growing middle class

and increasing numbers of middle class and affluent consumers (MAC). Rastogi et al.

(2013) from Boston Consulting Group have predicted that Indonesia’s MAC population

could double in size, reaching 141 million people by 2020. Oberman et al. (2012) from

McKinsey have estimated that Indonesia could become the seventh largest economy in

the world in 2030; in terms of gross domestic product (GDP), Indonesia was ranked

sixteenth in the world in 2012.

I will start the literature review by reviewing institutional settings. In Section 2.2, I will

review the Indonesian economy, focusing on the business landscape concentrated in the

hands of a few families. In Section 2.3, I will review Indonesia’s political systems

during the different regimes: the Soekarno, Soeharto and post-Soeharto eras. The links

between politics and business in Indonesia are outlined in Section 2.4. I will focus on

oligarchy, the state and rent-seeking, and culture and government intervention as

possible explanations for this intertwining of politics and business. I will discuss a brief

case study of the Salim Group. Finally, I will review the earlier research on

‘institutional voids’, political connectedness and firm performance, and the potential

mechanisms to explain why political connectedness can add value or be detrimental to a

firm’s performance, in Section 2.5.

6

2.2 Overview of the Indonesian Economy

2.2.1 Recent Developments

Indonesia is a member of the G20 countries and the Association of South East Asian

Nations (ASEAN). Indonesia was ranked third among the G20 countries—after China

and India—for its GDP growth of 5.36% (year-on-year) as of April 2014 (International

Monetary Fund [IMF] 2014). In the past four years (2010-2013), Indonesia has

sustained a GDP growth of 4 to 6%.

Indonesia has the largest population of the ASEAN countries, numbering 253.6 million.

However, Indonesia’s GDP per capita of USD 3,420 ranks fifth after Singapore, Brunei

Darussalam, Malaysia and Thailand (IMF 2014). Indonesia’s biggest sector with respect

to its GDP is the manufacturing industry (21.02%) followed by trade, hotel, and

restaurants (16.52%), agriculture, farming (13.38%), and construction (12.67%) (Biro

Pusat Statistik [BPS] 2014).

Indonesia was affected less severely by the 2008 GFC compared to other countries; this

is because Indonesia had a strong base of domestic consumption, which accounted for

56.51% of GDP in 2010. This remained stable until 2014 (55.71% of GDP), and

Indonesia’s share of exports as part of its GDP was relatively small at around 17% of

GDP (Tambunan 2010; Wie 2012).

Exports and imports amounted to USD 13.5 billion and USD 13.1 billion respectively

for November 2014 (BPS 2014). The most significant contributor to exports is the

manufacturing industry, with 68.15% of the total export value (Bank Indonesia [BI]

2015). The manufacturing industry also received the largest portion of foreign direct

investment (FDI) in the third quarter of 2014 (Q3-2014), 32.67% of the total FDI in Q3-

2014 (BI 2015). The next largest recipients were agriculture and forestry (15.38%),

mining and quarrying (12.63%), transportation, storage and communication (12.43%).

FDI accounted for 68% of total investment in Q1-2014, while domestic direct

investment was only 32% of the total investment (Badan Koordinasi Penanaman Modal

[BKPM] 2014).

Actual full year inflation was 4%, 8.38% and 8.36% for 2012, 2013 and 2014,

respectively. BI’s rate was maintained at 7.5% as of February 2015. The BI rate, which

7

is a policy rate, has been maintained in the range of 7.50 to 7.75% since December

2013. This reflects BI’s stance to maintain a loose monetary policy.

Regarding the exchange rate policy, Indonesia has adopted a flexible exchange rate. The

exchange rate’s assumption for the 2014 government budget was around IDR

(Indonesian rupiah) 12,000/USD; however, as of 24 August 2015, the rupiah had

surpassed IDR 13,800/USD.

Indonesia has an increasing absolute value of debt from year to year amounting to IDR

2,576 trillion for 2014, of which the higher portion comes from the private sector

(Ministry of Finance [MOF] 2015). For the government debt, there is an upper limit of

3% of budget deficit as per Act No. 17/2003 on Public Finance. The reserve as of

September 2014 was relatively high (historically) at USD 111.16 billion. However, it

was the lowest compared to Japan, China, India, Malaysia, Thailand and Singapore; that

is only 2.86% from China’s reserves (BI (2015). As for the Indonesian rating, in 2011,

Standard & Poors (S&P) – a rating agency - increased Indonesia’s rating from BB to

BB+2. Other rating agencies, such as Japan Credit Rating Agency (JCRA), Fitch and

Moody’s have classified Indonesia into an investment grade rating category (i.e., BBB

[MOF 2015]).

Eradicating corruption has been one of the main agendas of President Susilo Bambang

Yudhoyono (SBY) and President Joko Widodo (Jokowi) (Dodd 2014). However,

perceptions of a high level of corruption still exist; for example in the Transparency

International (TI) index, Indonesia ranked 107 out of 175 countries in 2014 on the TI

Corruption Perception Index (TI 2014). Nevertheless, this is an improvement from the

ranking of 133 out of 145 countries in 2004, and being classified as the world’s third

most corrupt country in 2001.

2.2.2 Capital Market Development

Indonesia’s stock exchange was established in Jakarta in 1912 by the Dutch East Indies

government (Jakarta was then known as Batavia). It was closed several times during

both World War One (WWI) and Two (WWII). In 1977, President Soeharto re-activated

2 S&P use a rating scale from the highest to the lowest as follows: AAA, AA, A, BBB, BB, B,

CCC, CC, C and D for default. The ratings maybe noted with ‘+’ or “-‘ to show relative

standing within the categories.

8

the stock exchange. It was supervised by the Capital Market Supervisory Agency

(Badan Pengawas Pasar Modal). In 1989, the Surabaya Stock Exchange began to

operate, merging with the Jakarta Stock Exchange in 2007 to become the IDX. As of

February 2015, there were 506 companies listed in the market; the value of Jakarta

Composite Index was 5,223.29 on 7 April 2015 which was a historic high (Otoritas

Jasa Keuangan [OJK] 2015).

In the first week of 2015, Indonesian market capitalisation accounted for USD 414.26

billion, with a transaction volume of 42.70 billion shares (OJK 2015). The highest

market capitalisation was from the financial sector (19.54%), followed by the consumer

goods sector (19.54%), the infrastructure sector (14.10%) and the trade sector (11.91%).

The lowest value of market capitalisation occurred in the agricultural sector, with

3.10%.

The value of bonds outstanding was IDR 1,436.48 trillion, of which 84.23% of the total

value consisted of government bonds. For mutual funds, the net asset under

management was IDR 242.25 trillion in January 2015 (or approximately 5% of the total

assets of the banking sector). The highest valued mutual fund was the shares type, with

a value of IDR 103.31 trillion. This was followed by protected mutual funds (IDR 43.01

trillion), fixed income mutual funds (IDR 36.05 trillion), with lowest being syariah-

index mutual funds (IDR 0.14 trillion).

2.2.3 Business Landscape

In Indonesia, concentrated ownership of the largest companies in the hands of a few

families has been observed by Claessens, Djankov, & Klingebiel (1999). Claessens,

Djankov & Klingebiel (1999) note that the top 15 families in Indonesia owned 67.3% of

corporations prior to the 1997 AFC—a much higher figure compared to Thailand and

Malaysia (between 30–40%) and Korea (between 15–25%). This figure would be 82.5%

if state ownership were included. Djiwandono (2005) attributes this concentration to the

high use of non-performing loans (NPL) and the violation of legal lending limits during

the AFC. He further states that the situation is linked to corruption resulting from

institutional weaknesses such as ineffective corporate governance, legal and judiciary

systems.

9

This finding has been corroborated by Khanna and Yafeh (2007) and Sato (2004).

Khanna and Yafeh (2007) state that Indonesia has the largest fraction of firms classified

as a business group (two-thirds) among the various emerging countries for which data

were available for the period 1993 to 1995.3 Sato (2004) corroborates Khanna and

Yafeh (2007) and states that in 1996, of the top 100 listed companies, 58 were group-

affiliated, accounting for 70% of aggregate sales and 73% of aggregate assets. By 2000,

the number of group-affiliated companies in the top 100 listed companies had decreased

to 44, their shares had fallen to 56% and their shares in assets had fallen to 36% (Sato

2004). However, they have remained relatively significant up to the present date, as

indicated in the following table.

Table 2.1: Top 80 Business Groups in Indonesia

Rank Groups

Rev

($b) Rank Groups

Rev

($b)

1. Salim Group 13.2 41. Berca Group 0.85

2. Sinarmas Group 8.9 42.

Kompas Gramedia

Group 0.85

3. Djarum Group 8.5 43. Harita Group 0.83

4. Lippo Group 6 44. Sungai Budi Group 0.82

5. Gudang Garam Group 5 45. Sugar Group 0.78

6. Royal Golden Eagle 4.2 46. ABM Investama Group 0.75

7. Bakrie Group 3.5 47. Medco Energi 0.75

8. Adaro Energy 3.2 48. Musim Mas 0.7

9. Alfamart Group 3.1 49. Tempo Scan 0.67

10. CT Corpora 3.1 50. Harum Energi 0.65

11. Tiphone Mobile 3 51. Ramayana Lestari 0.65

12. Wings Group 2.4 52. Rekso Group 0.6

13 Triputra Group 2.3 53. Mayapada Group 0.6

14. Barito Pacific 2.3 54. Mulia Group 0.6

15. Charoen Phokpand 2.2 55. Sritex Group 0.59

16. AKR Corporindo 2.1 56. First Resources Group 0.57

17. Gadjah Tunggal Group 1.9 57. Modern Group 0.57

3 Business groups are defined as a set of legally-separate firms with stable relationship in multiple

strategically-unrelated activities and under common ownership and control by Cuervo-Cazurra (2006).

10

Rank Groups

Rev

($b) Rank Groups

Rev

($b)

18. Japfa Comfeed 1.9 58. Hadji Kalla Group 0.56

19. Kalbe Farma 1.84 59. Bank Bukopin 0.55

20. Gobel Group 1.8 60. Garuda Food 0.52

21. Panin Group 1.53 61. Rodamas group 0.52

22. Indorama Synthetics 1.52 62. Emtek Group 0.5

23. Argo Manunggal 1.5 63. Santini Group 0.5

24. Mayora Indah 1.2 64. Supreme Cable 0.49

25. ABC Group 1.2 65. Toba Bara Group 0.48

26. Wilmar Group 1.1 66. Samudera Indonesia 0.48

27. Indika Energy Group 1.1 67. Fajar Paper 0.45

28. Bosowa Group 1 68. Lautan Luas 0.42

29. TNT Group 1 69. Agung Podomoro 0.41

30. MNC Group 1 70. Summarecon 0.41

31. Tunas Ridean 0.99 71. Sriwijaya Air 0.42

32. Lion Air Group 0.99 72. Maspion Group 0.36

33. Arsari Group 0.99 73. Kawan Lama (ACE) 0.35

34. Persada Capital Group 0.98 74. Pan Brothers 0.34

35. Trikomsel Group 0.93 75. Fast Food Indonesia 0.32

36. FKS Multi Agro 0.9 76. OSO Group 0.3

37. Gunung Sewu Group 0.89 77. Rajawali Group 0.28

38. Sintesa Group 0.88 78. Artha Graha Group 0.28

39 Darmex Agro Group 0.86 79. Sumi Indo Kabel 0.27

40. Ciputra Group 0.86 80. Total Bangun Persada 0.16

The table above is modified from the 100 top groups published by the Globe Asia

magazine August 2015 edition, using revenue in USD billion for 2015. I have excluded

foreign-owned business groups such as Astra/Jardine, Sampoerna/Philip Morris,

Danamon/Temasek, CIMB Niaga/Khazanah and Indosat/Qatar Telecom, as the focus of

this study is on locally owned business groups.

The largest business group in Indonesia prior to the AFC was the Salim Group. The

Salim Group remains one of the largest groups today. According to Globe Asia, it

ranked second after Astra in the top 100 groups, with a combined revenue of USD13.2

billion as of August 2015. It is still ranked number one. The Astra Group has been

11

excluded, as it is owned by the Jardine C&C Group of Hong Kong (as seen in the above

table). This ranking may change over time as some of the business groups’ fortunes are

linked to the commodities cycle; nevertheless, these business groups represent some of

the largest and most prominent business groups in Indonesia.

The AFC formed a watershed period that brought the IMF to Indonesia, where it

implemented various measures of austerity that affected business groups. Through

IBRA (Indonesian Banking Restructuring Agency), many business groups de-

concentrated and focused on their core competencies (Basri & van der Eng 2005). Salim

Group chose to maintain their core businesses (i.e., food and beverage businesses

[Indofood and Bogasari]). They devolved their ownership of virtually every other

business to IBRA, including stakes in leading automotive, cement and coal companies

and the Bank of Central Asia (BCA). Sinarmas Group remained relatively intact during

the AFC, as did Lippo group. However, Sinarmas Group had to declare the largest

private sector debt default in 2001. Bakrie Group had owned businesses ranging from

steel pipe, plantation, real estate and financial services such as banks, securities and

insurance. They lost almost all their financial services companies. The other companies

remain part of the Bakrie Group, but are now much smaller relative to their thermal-coal

businesses acquired from BHP Billiton after the AFC. Some business groups did not

survive the AFC at all, such as the Dharmala and Nusamba/Bob Hasan groups.

Yuri Sato has studied various business groups in Indonesia, along with their origins and

strategies. Sato (1993) has examined Salim Group’s expansion and transformation

processes. This group is one of the largest business groups in Indonesia. Sato (1996) has

also examined the Astra Group, emphasising how they have developed their

management system, and are now considered the pioneer of management modernisation

in Indonesia. Sato (2004) has found that business group affiliation and borrowing

behaviour resulted in performance differences among companies. Group-affiliated

companies had higher leverage before the AFC and suffered heavily during this crisis.

Firms affiliated with established groups had higher indebtedness, but also higher returns

of equities (ROE) before the crisis and were likely to survive the crisis. In contrast,

firms affiliated with rapid-growth groups had the lowest profitability and suffered most

from the AFC.

12

Lukviawarman (2004) has studied the relationship between ownership structures,

monitoring and firm performance in Indonesia using the agency theory of contractual

relationship among various parties. He found that the existence of controlling

shareholders in the hands of a family was a source of corporate governance problems.

Using the same agency theory, Prabowo (2010) studied the composition of boards of

directors on firm performance in Indonesia. Independent leadership was found to have a

positive relationship with firm performance. Prabowo (2010) also found that

shareholding by controlling owners had negative associations with firm performance.

Corporate diversification has many causes. Claessens et al. (1999) have argued that

firms diversify to create internal factor markets that are most cost-effective in allocating

resources when compared to external markets. One stream of research views business

groups as responses to market failures and associated transaction costs (Leff 1978). This

has been supported by Khanna (1999, 2000). These researchers have argued that

business groups can serve as functional substitutes to fill the ‘institutional voids’ in

emerging economies. Khanna and Yafeh (2007) have argued that as groups arise for

different reasons and in different environments, their effect on social welfare is

unambiguous; groups may sometimes play a positive role by making up for

underdeveloped economic institutions (Khanna 1999, 2000). However, they can also be

detrimental for social welfare due to rent-seeking or monopoly power (Fisman 2001;

Mobarak & Purbasari 2005).

2.3 Overview of Indonesia’s Political System

2.3.1 Recent Developments

After President Soeharto stepped down in 1998, there was a significant improvement in

Indonesia’s democratic system including free elections and freedom of expressions in

the media.

In 2004, SBY and Jusuf Kalla were elected as president and vice president through

direct election. This was Indonesia’s first direct election of a president. In addition, the

military’s power was diminished: they no longer had seats in parliament and separation

between the police and military forces was established.

13

President SBY was again elected in the next presidential general election in 2009, with

Budiono as vice president. According to Marcus Mitzer (of the Lowy Institute in

Sydney, Australia), President SBY’s popularity resulted from several factors. These

include the distribution of massive cash programs for the poor and a strong perception

by Indonesian society that the national economic condition had improved compared to

the preceding year.

Notwithstanding SBY’s popularity, public support for him decreased during his second

term in office. This lack of support was indicated by his reduced approval rating: from

85% after his election to 66% by October 2010. This posed little problem for SBY, as

the constitution barred the president from entering a third round of elections. This

decline in popularity was due to the controversial Bank Century bail out, which ended

with the departure of the Minister of Finance, Sri Mulyani Indrawati. Some have argued

that Indrawati’s departure was beneficial for Aburizal Bakrie from Golkar (a key

coalition party of SBY’s Democratic Party), since this might have strengthened Bakrie’s

position for the 2014 presidential election (Vaughn 2011). However, as we will see

below, Bakrie did not make the final round of the 2014 presidential elections.

In 2014, Indonesia held a general election to elect legislative members, the president

and vice president. The legislative election was first held on April 2014; for this, the

party with largest number of supporters would propose the presidential and vice

presidential candidates for the election in July 2014. The result from the legislative

election was as follows: Partai Demokrasi Indonesia Perjuangan (PDIP) party was the

first winner with 23, 681, 471 supporters, Golkar party held second place with 18, 432,

312 supporters and Gerindra party had 14, 760, 371 supporters (Komisi Pemilihan

Umum [KPU] 2014).

The last presidential election in 2014 saw the popular former governor of Jakarta—Joko

Widodo (Jokowi)—and Jusuf Kalla (both proposed by PDIP Party’s coalition) winning

the election by 53.15% against Gerindra’s chairperson Prabowo Subianto and his

running mate from Partai Amanat Nasional (PAN) Hatta Rajasa, who obtained 46.85%

of the votes (KPU 2014).

There are 34 ministers under President Jokowi’s cabinet, the so-called ‘working cabinet’

(Parlina & Widiarto 2014). During his 100 days in government, Jokowi was criticised

14

for some of his policies, such as those that increased fuel prices. This was accompanied

by the distribution of the Kartu Indonesia Sehat (KIS or Indonesia Health Cards), Kartu

Keluarga Sejahtera (KKS or Prosperous Family Cards) and Kartu Indonesia Pintar (KIP

(KIP or Indonesia Smart Cards) as compensation to low-income people. More recently,

there have also been critiques about the president’s ability and commitment to

combating corruption in Indonesia in relation to the conflict between the police and the

Corruption Eradication Commission (Sidjabat 2015).

2.3.2 Brief History of the Political System

2.3.2.1 The Soekarno Era

The influences of Hinduism, Buddhism, Islam, Dutch colonial rule and powerful

nationalistic independence movements—along with other cultural and external

influences—have shaped Indonesia’s political system. Indonesia was occupied by the

Dutch for three-and-a-half centuries. Dutch colonial rule shaped the current

geographical make-up of contemporary Indonesia. The Dutch colonial period ended

when the Japanese arrived in 1942. During WWII, making the most of the momentum

of Japanese surrender in 1945, Indonesia proclaimed her independence on 17 August

1945. Two central figures in this proclamation were Soekarno and Mohammad Hatta,

who became Indonesia’s first president and vice president (respectively). In its early

period of independence, as stipulated in Indonesia’s 1945 Constitution, the country

practiced a presidential system of government. This system was characterised by a clear

separation between the executive and legislative functions. In addition, this system

provided checks and balances to safeguard the government. At the same time, the

legislative body possessed the right to dismiss the president. According to Noor (2008),

Indonesia practiced a pure presidential system of government characterised by: (1) the

president as head of government; (2) the president having a fixed tenure of five years;

(3) the president not being accountable to the legislative body; and (4) the president

having no mandate to dismiss the legislative body. Further, Noor (2008) has asserted

that Indonesia implemented a hybrid system of government in that period, which

incorporated both a presidential and a parliamentary system. The evidence supporting

this argument is that the president was accountable to Majelis Permusyawaratan Rakyat

(MPR or People’s Consultative Assembly) as legislative body in which MPR had the

authority to enact laws.

15

Indonesia experienced a parliamentary system by enacting legislations on 14 November

1945 and a federal system by enacting legislations on 27 December 1949. A substantial

instability existed in the government and political system during this period, which was

characterised by the rise and fall of cabinets in the parliament within short periods;

hence, the parliamentary system was not successful in contributing to Indonesia’s

political stability. President Soekarno then embarked upon Guided Democracy from

1959; this lasted until 1965, with a coalition of mutually hostile nationalists,

communists and religious groups. This period was marked by high levels of government

intervention in the economy, excessive debt, high inflation and low growth. Political

groups competed fiercely and the threat of disintegration was always present (Cassing

2000).

2.3.2.2 The Soeharto Era

President Soekarno was forced to step down when Indonesia was threatened by the

military rebellions of Partai Komunis Indonesia (PKI or the Communist Party of

Indonesia. These rebellions forced President Soekarno to be eased out of power and

gave Soeharto the opportunity to consolidate his own position as Indonesia’s ruler over

the next 32 years. As the ruler, Soeharto had exceptional power and authority over

almost every aspect of life, including politics, the economy and the military. The Golkar

party was the consistent winner of general elections. Cassing (2000) has maintained that

Soeharto gained full support from the military and the broad backing of society. Further,

Cassing (2000) explains that Soeharto’s strategy was to compete with the executive

office for a power that created limitations on political discourse and isolation for the

political opposition. Soeharto did not believe in political competition and openness. The

function of cabinet ministers was to execute the policies of the president with no

political power of their own. As Cassing (2000, p.160) argues:

[S]oeharto eliminated political competition and that this in particular allowed for the

creation of a mercantilistic economic environment akin to 16th century England and

France.

Seda (2005) has asserted that pervasive patrimonalism was an embedded characteristic

of Soeharto’s regime, in which Soeharto gained his exceptionally strong political power

through his efforts to ensure the loyalty of key sections of the political elite. This was

16

done by satisfying the political elite’s interests, mainly material interests. The finances

for servicing this aspiration and interest were derived from the country’s oil boom

revenue in 1973, which gave the country abundant prosperity. This abundant prosperity

had allowed Soeharto to patronise his supporters and simultaneously threaten his

opponents. This gave him the opportunity to maintain his power and transform the

bureaucracy into an instrument of presidential power. As a consequence, there was a

high concentration of power in Soeharto’s hands.

As part of a strategy to patronise his supporters, Soeharto also allowed key government

officers to grant licences for certain economic activities. These officers were thus

enabled to extract financial resources from private parties. It was not only the

government officers who gained substantial benefits from Soeharto’s strategy.

Soeharto’s associates, including Chinese businessman Liem Sioe Liong, along with Bob

Hasan and his children, also obtained facility in the form of monopolies over the import

and distribution of major commodities. These associates and their families were given

the facility to become involved in projects: they won several large government projects

financed by state-owned banks with low interest rates. Unfortunately, some of these

loans defaulted, forcing the banks to collect payments (Schwarz 2004). Soeharto’s

pervasive patrimonialist strategy resulted in the elimination of political competition and

increased the concentration of power to a small group of people; in addition, it resulted

in a set of rent-seeking incentives,4

which ultimately shaped regulation in the

Indonesian economy (Cassing 2000).

In terms of economic policy, as per Seda (2005), Soeharto’s strategy was influenced

considerably by two groups: technocrats (market-oriented), most of whom were in the

Badan Perencanaan Nasional (BAPPENAS or Central Planning Bureau) and MOF, and

the nationalists (government planning-oriented), most of whom were in the Ministry of

Trade and Industry and the State Ministry of Research and Technology. The

technocrats, led by Prof. Widjojo Nitisastro emphasised market mechanisms when

overseeing the national economy. Policies included market deregulation and

privatisation of state assets to foster economic growth. In contrast, the nationalists

emphasised the role of government in conducting the national economy. Their policies

4 Rent-seeking is defined as ‘the activities whereby individuals seek return from state-sanctioned

monopoly rights’ (Ekelund & Tollison 1981).

17

encouraged the maximisation of state resources to build and strengthen domestic

markets. The nationalist group argued that the government should implement import

substitution policies and allocate more resources to high-tech state enterprises.

Generally, the direction of development strategies in Soeharto’s era was dependent on

the state of the economy. In periods of economic boom, the nationalists’ strategies were

implemented, while in times of economic stagnation, the technocrats’ strategies were

preferred.

In terms of natural resources management, Soeharto attracted foreign companies to

participate in extracting Indonesia’s natural resources, ascribing this approach to

Indonesia’s insufficient technology and capital (Seda 2005). To facilitate foreign

companies’ participation in the extraction of Indonesia’s natural resources, Soeharto

initiated important laws pertaining to foreign investment. These laws include: (1) Law

1/1967 on foreign investment, which stipulates clear procedures for foreign operations

in Indonesia; (2) Law 5/1967 on forestry, which stipulates that all forests fall under the

control of the state, and (3) Law 11/1967 on mining, stating that all lands within the

Republic of Indonesia could be used for mining. As a result of enacting the laws, a large

number of multinational companies have participated in natural resources extraction in

Indonesia (Seda 2005).

During the 1970s, oil became Indonesia’s main export and the primary source of

government revenue. However, this changed with the collapse of oil prices in the 1980s,

leading to budget deficits for Indonesia. The international oil price decreased from USD

38 per barrel to USD 12. This decline reduced the portion of oil and gas exports from

USD 18.4 billion (82% of total exports in 1982) to USD 8.3 billion (56% of total

exports in 1986). On the fiscal side, the decrease in oil prices resulted in decreased

government revenue from the oil and gas sectors: from IDR 8.6 trillion to IDR 6.3

trillion, or from 70% to 39% of total revenue (Robison & Rosser 1998).

This budget deficit required corrective action. One proposed action was trade

liberalisation to allow for a more diversified, manufacturing-based economy. However,

this proposal raised new problems for Soeharto, as trade liberalisation would have

required the relaxation of some trade barriers; in turn, this would have reduced the

monopoly power of Soeharto’s associates through import substitution. This dilemma

resulted in some misguided and crucial policies such as policies of granting monopolies

18

of car imports and toll roads to the family member of Soeharto (Cassing 2000).

However, economic structural adjustment appeared to be the only choice. To reduce the

Indonesian budgetary reliance on oil and gas and to encourage labour intensiveness, the

government deregulated trade, finance and investment. This corrective action was

effective, shown in the increase of non-oil and gas exports exceeding oil and gas

exports. Indonesia’s national economy had started to recover by the beginning of the

1990s.

Another economic shock came in the late 1990s, as a result of insufficient regulation

and prudence and the control mechanisms necessary to conduct liberalisation policies.

Although most macroeconomic variables signalled a healthy economy, corruption and

favouritism in the industrial and financial sectors meant that the economy was not as

strong and stable as it seemed. For instance, banking deregulation made it much easier

to establish new banks by lowering capital requirements substantially and opened up

new licenses and branches. This relaxation stimulated banks to expand their credit,

increasing the money supply by up to two-and-a-half times in three years. This

condition worsened when banks began lending large sums of public money to the

banks’ owners or to their associates for unfeasible projects (Cassing 2000). This

banking sector deregulation has been considered a fundamental policy mistake. In

addition, the decision to implement the nationalists’ idea to give government support for

large state enterprises was inefficient as only few of these state enterprises performed

well. In the absence of strong economic performance, the Indonesian economy

collapsed when the AFC struck in 1997, when Soeharto was forced to step down.

2.3.2.3 The Reformation Era

Soeharto’s fall was followed by a major transformation in all aspects of Indonesia’s

politics and economy. This period of reform (known as reformasi) involved the

economy, political sphere, bureaucracy and government regulations. Confidence

improved regarding the opportunities to foster democracy in Indonesia. Soeharto was

succeeded by President BJ Habibie (1998–1999), Abdurrahman Wahid (1999–2001),

Megawati Soekarno Putri (2001–2004), SBY (2004–2014), and Joko Widodo (2014-

2019).

19

A number of key reforms have been designed to enhance good government practices

and to increase the quality of Indonesia’s democracy. For example, in the political

system, the power divided between the president (as the executive body) and the

parliament (as the legislative body) has been balanced through the acknowledgement of

new political parties and their right to participate in general elections, prescribed by

Law 2/1999 and 31/2002. With regard to fiscal policy, the enactment of Law 22/1999

on local government and Law 25/1999 has allowed a more balanced budget allocation

between the central and regional governments (Resosudarmo 2005). Based on these

laws, the central government is mandated to transfer increased authority to provincial

and district level governments (Vaughn 2011). Along with the expectation that this

transformation will enable Indonesia to achieve long term development, this radical

change also raises negative effects such as political uncertainty, inconsistent laws and

regulations, weak law enforcement and a weak governmental system (Vaughn 2011).

The Abdulrahman Wahid presidency, which was followed by that of Megawati, did not

produce many reforms; the main party that supported Wahid held a minority in the

parliament. In fact, all governments post-Soeharto, including SBY’s (2004–2014)

government, have been based on the so-called ‘rainbow coalition’: SBY’s Democrat

Party also did not win a majority of seats. SBY’s government post-2009 consisted of six

out of the nine parties in parliament. This created a dominant among perception within

Indonesia’s mainstream literature regarding ‘cartelisation’ tendencies, borrowing from

the work of Katz and Mair (1995), and as elaborated here by Mietzner (2013, p.3):

[c]ontemporary political parties no longer compete with each other but form collusive

alliances to jointly exploit state resources.

Despite this, Mietzner (2013) argues there is little evidence that cartelisation was indeed

the main feature of post-Soeharto era politics.

Resosudarmo (2005) has noted the immediate effects of reformasi and the

implementation of the decentralisation policy. First, there was an increase in conflict

between central and local governments due to a lack of harmony among various levels

of government. There was a sense of competition regarding the dominance of both

central and regional governments. Second, a number of local conflicts involved both

disputes between local communities and the state, along with disputes among local

20

communities themselves. These types of conflicts had increased in particular due to

competition over obtaining the rights to exploit natural resources. Third, a change in the

nature of corruption existed, in which a centralised corruption was replaced by a more

fragmented and widespread bribe-collection system. Fourth, there was tendency of the

regional governments to raise revenue through nuisance taxes such as regional taxes

levied on the consumers payable to the local government on top of central government

taxes and resource licences.

2.4 Politics and Business in Indonesia

2.4.1 Introduction

The Indonesian business landscape has been characterised as ‘ersatz capitalism’

(Yoshihara 1988), ‘crony capitalism’ or ‘patron-client’ (Muhaimin 1991). Yoshihara

(1988) has defined Indonesia’s economy as ‘ersatz’ since the Indonesian economy has

been dominated by foreign capital, Chinese capitalists, rent-seekers, crony capitalists

and bureaucratic capitalists. The patron-client concept resulted from ‘neo-

patrimonialism’, a concept that originated in Max Weber’s patrimonialism (Muhaimin

1991). Muhaimin (1991) used this patron-client framework in his thesis on politics and

business in Indonesia.

Soeharto, Indonesia’s second and longest serving president (1968–1998) did not begin

the patron-client system. During Sukarno’s regime (1945–1968), business people also

enjoyed special favours. However, during Soeharto’s regime, politics and business

became much more closely intertwined (Borsuk & Chng 2014). Such links between

politics and business—especially during Soeharto’s regime—were well documented by

the ground-breaking works of Muhaimin (1991), Shin (1989), Yoshihara (1988),

Robison (1986) and a biography on Liem Sioe Liong’s Salim Group by Borsuk and

Chng (2014).

After the Soeharto era, exclusive import licences and monopolies for certain companies

or business groups were dismantled by the IMF. An era of democracy had begun. The

regime adopted civilian rule under Habibie (1998–1999), Abdurrahman Wahid (1999–

2002), Megawati (2002–2004) and SBY (2004–2014). Having political connections no

longer had the same effect. The excess and easy profits from exclusive import licences

21

and monopolies that had resulted from political connections in the past were no longer

the modus operandi. The manifestations of these relationships were less blatant.

Nonetheless, the links between business and politics in Indonesia post-Soeharto

continue and even flourish, despite democratisation, decentralisation and deregulation

(Chua 2008).

Previous studies examining the links between politics and business in Indonesia can be

categorised in general as examinations from the perspective of political economists,

such as works by Shin (1989) and Robison (1986) or socio-historical-cultural works,

such as those by Borsuk and Chng (2014), Backman (2001), Muhaimin (1991) and

Yoshihara (1988). In the following sections, I will first examine the mechanisms of how

the state apparatus can take advantage of its position for rent-seeking. I will then discuss

the possible causes of this intertwining of politics and business in Indonesia: oligarchy,

culture and government intervention.

2.4.2 The State and Rent-Seeking

Despite a decline in its power, the presidency remains the most contested position in

Indonesia, due its central role in the budgeting, law-making and economic planning

(Mietzner 2013). Accordingly:

[t]ycoons have continued to seek the president’s favour by offering financial

inducement (Mietzner 2013, p.75).

The second most coveted position is that of a minister. Besides a ministerial budget and

the managerial autonomy that comes with it, a ministry has the power to implement

policies such as determining quotas for imports of certain commodity. This has

provided ample opportunity for patronage from the Soekarno era to the present day

(Mietzner 2013).

Being a member of parliament (MP), especially in the post-Soeharto era, is a lucrative

position that is contested heavily. The ability to draft laws and influence any proposed

legislation can encourage MPs to use their institutional powers to advantage (Mietzner

2013). For example, the parliament has to approve government-proposed budgets.

‘Budget scalping’—the insertion and or approval of certain projects in exchange for

kickbacks from businesspeople—has been observed and identified as a very serious

22

phenomenon (Mietzner 2013). MPs have also been accused of accepting kickbacks to

block or approve certain points in proposed legislation (Mietzner 2013). For example,

Mietzner (2013) mentions a certain paragraph that was disadvantageous to the tobacco

industry that suddenly disappeared from proposed legislation on the tobacco industry.

Yoshihara (1988, p.87), as far back as the late 1980s, has argued that:

[d]emocracy has not necessarily done better than dictatorship; it too has created many

rent-seekers, although the use of government connections for business is not as

blatant as under dictatorship.

One major problem with democracy is that politicians need funds to run for office and

they turn to business people as their main source of capital.

2.4.3 Oligarchy

Winters (2014) mentions that Indonesia has followed a typical capitalist development,

whereby ‘a small number of ultra-wealthy citizens at the top are rapidly pulling away

from the rest’ (Winters 2014, p.11). He further notes that extreme inequality in wealth

brings with it extreme inequality in politics. Oligarchy theory captures this relationship

best, as wealth is the most potent of power resources. Oligarchs are ‘actors empowered

by wealth’ (Winters 2014, p.14). Winters’ theory was derived from power resources

theory, and wealth as one of the powers.

Winters (2011) further typifies four ideal oligarchies according to whether oligarchs are

armed or disarmed: warring, ruling, sultanistic or civil. Indonesia has been classified ‘as

a classic example of ‘sultanistic oligarchy’ under Soeharto’ (Winters 2014, p.15). The

emergence of a wealthy stratum in Indonesia began mostly during Soeharto’s time in

office. To maintain one’s wealth, one had to be in the proximity of and aligned with

Soeharto. Since 1998, Indonesia had been ruled by an electorally chosen oligarch. In

concluding his analysis, Winters (2014) was not optimistic regarding the potential of the

law to constrain oligarchs in Indonesia as they will not impose punitive legal constraints

on themselves. The core of oligarchy is the politics of defending wealth. Post-Soeharto,

Indonesian oligarchs have used their ‘material power for wealth and property defence in

a political economy overflowing with threats and uncertainties’ (Winters 2011, p.192).

Another seminal work on oligarchy in Indonesia is a study by Robison and Hadiz

23

(2004). Robison and Hadiz approached the oligarchs as a class and examined the

collective nature of their behaviour in pursuit of authority; hence, this is more of a neo-

Marxist approach. However, both works note that democratisation has changed

Indonesian politics but has not eliminating oligarchic rule (Ford & Pepinsky 2014).

Hadiz and Robison (2014) argue that up to the current era, over a decade after Soeharto

resigned, a close proximity to public officials is still how the private sector accumulates

its wealth. Social and economic power has been reorganised but largely remains the

same. The same names continue to dominate politics and business in contemporary

Indonesia.

2.4.4 Culture

Some scholars try to identify culture as a reason for the intertwining of politics and

business in Indonesia. Indonesian culture, dominated by Javanese culture, inhibits risk

taking; hence the indigenous population aspires to become civil servants, bureaucrats or

to join the military. In contrast, Chinese Indonesians have little choice but to go into

business. During Soeharto’s era, no Chinese Indonesians became ministers (except for

Bob Hasan; Soeharto’s ‘crony’ was appointed to a ministerial role for a brief period at

the end of his reign), top bureaucrats or top military officers. This fact aligns well with

the culture and nature of the Chinese who are perceived as hardworking, and who have

business networks within and beyond Indonesia for sources of capital (Yoshihara 1988).

A mutual relationship has evolved to a point where patron-client relations (as per

Weber’s concept) have developed and where Chinese businesspeople ‘were co-opted

and subjugated during Soeharto era’ (Chua 2008).

Indonesia’s economic performance has been attributed to Chinese minorities (Yoshihara

1988). Yoshihara (1995) attributes the success of the rent-seeking Chinese ‘ersatz

capitalists’ to culture of a lack of strong work ethics. By a lack of strong work ethics

Yoshihara means that the value orientation of the indigenous population emphasised

leisure and adaptation to nature. Moreover, he claims that indigenous Indonesians have

a built-in bias against plain money-making and towards the non-materialistic aspects of

life (Yoshihara 1995).

‘Chineseness’ has been compared with Protestantism and European capitalism, in that

they hold similar values regarding materialism, an emphasis on education, obedience,

24

handwork and thrift (Mackie 1998). Mackie (1999) claims that the Chinese have the

capabilities as well as incentives for commercial success due to their values and culture

cause the Chinese. Mackie (1989, p.99) cites their ‘strong motivation to succeed’, or

even ‘the widespread Chinese propensity towards gambling’ as the traits that enabled

them to flourish in business.

Culturally based premises, such as trust (xin yong) and connection (guanxi) have been

cited to explain the widespread influence of Chinese businesspeople in South East Asia

(see Backman 2001; Menkhoff & Gerke 2002; Tan 2000; Wu 2000); however, typically

they take guanxi (connections) as just another characteristic trait of ethnic Chinese

(Backman 2001; Wu 2000).

Soon after Soeharto came into power, Chinese capital was welcomed and was treated

more and more as domestic capital. As a result, the Chinese expanded into various

fields the new economic policy had opened up (Yoshihara 1988). During Soeharto’s

New Order regime, the interests of the rulers and Chinese capitalists were aligned; links

to state officials as patrons were critical for the emergence of business groups and

crucial for further capital accumulation (Chua 2008).

During the Soeharto era, Soeharto had virtual power, maintaining that power through

authoritarianism, centralism and collusion (Chua 2008). Chua (2008) has claimed that

the Soeharto regime’s key component was the subjugation of capitalists, who were

mostly of Chinese descent. They were ‘outcast’ from politics, and ‘thus [became]

appropriate partners to be raised and co-opted as compliant partners’ (Chua 2008).

Muhaimin (1991) argues that the intense involvement of Indonesian officials (inside and

outside the government and parliament) in business during Soeharto’s era was derived

from patrimonial relations in the Indonesian political system and the attitude of the

bureaucratic political elite who upheld traditional values. Traditionally, the ‘surplus’

from important economic sectors was distributed to civilian and military officials. This

tradition forced business people to take patronage from the elite.

The other factor in the involvement of Indonesian officials in business was the pattern

of personal relationships. This aspect was deeply rooted in Javanese culture. In

Indonesian society, the patron-client relationship (paternalism) was very dominant, with

needs and dependence always present. As noted in Muhaimin (1991), Indonesian

25

cultural values (unlike those of the Chinese) inhibit economic behaviour that is crucial

in the private sector, such as risk taking. Indonesians prefer to work as bureaucrats or

civil servants: as the patrons. Muhaimin (1991) has even concluded that the patron-

client structure will probably still be characteristic of Indonesian business in the future.

However, some scholars have rebutted this cultural interpretation of Chinese business

success and have instead offered a structuralist interpretation. These scholars include

political scientists such as Shin (1989), Macintyre (1990), Winters (1996) and Rosser

(2002). According to these scholars, analysing the structure of Indonesia’s political

economy will give insights into state-capital power relations. They focus on state-

business relations, patron-client relationships, political partnerships and the composition

of certain conglomerates and business groups.

Robison (1986) has offered a class analysis based on the assumption that modern

societies are characterised by class divisions, with capitalism as their main driving

force. Chinese business people form just such a capitalist class. In the same vein, Shin

(1989) has attempted to identify and characterise the new capitalists who are largely of

Chinese descent, with some being pribumi (indigenous Indonesian), emerging from

Soeharto’s era. However, Shin (1989) maintains that these capitalists have failed to

form a capitalist class due to factional politics and bureaucratic interests. He proposes

that they will mature to form a new capitalist class, as they have been subjugated and

subordinated to state managers thus far.

Chua (2008) has described Soeharto’s New Order as bureaucratic capitalism, in which

the state elite has managed to preserve both its autonomous appropriation of the state

apparatus and its hegemony over the capitalist class. Chua (2008) goes on to argue that

the post-Soeharto Indonesian state is moving towards a plutocratic capitalist regime,

where capital finally has the best opportunity to exercise structural and even

instrumental control over the state.

In the past, politicians have treated Chinese business people ‘like minor wives—

enjoyed but not recognized’ (Wanandi 2013, p.127)). However, after Soeharto era, Chua

(2008) has argued that Chinese tycoons have benefitted most from the democratisation,

decentralisation and deregulation efforts. The new regime could not do without Chinese

capitalists as they are economically indispensable to an Indonesian economy that is

26

emerging from a deep crisis. The major business groups have survived, and have even

helped determine the course of post-Soeharto Indonesia; perhaps they will rise to a more

overtly dominant position within the ruling alliance (Chua 2008). The capitalists in

post-Soeharto Indonesia have become more assertive (Chua 2008). Some of them have

even set up their own political parties. The link between politics and business does not

appear to have weakened in the post-Soeharto era. As Eklof (2001, p.243) states:

[t]he relationship is symbiotic, as business has much to gain from influencing the

political process and politicians often desperately need funds for their political

activities.

2.4.5 Government Intervention

In East Asian Miracle (Page 1993), the success of East Asian countries (including

Indonesia) was attributed to accumulation of physical and human capital and a free

market economy with selective intervention policies. However, The World Bank has

acknowledged that such interventionist policies have created rent-seekers (Page 1994).

Government intervention has resulted in some inefficiency and rent-seekers, particularly

as in Indonesia the intervention was low quality (Yoshihara 1988). A nationalistic pro-

pribumi policy has created many rent-seekers among the pribumi, while the Chinese

have had to seek protective patrons among political power holders (Yoshihara 1988).

Jomo (2001) has said that in Indonesia, government intervention seems to have been

influenced by rent-seeking considerations, and this has undermined industrial policy

initiatives. Some examples of this include:

high-tech investment in developing an aircraft industry in the 1990s,

spearheaded by Habibie, then Minister of Research

a so called “national car policy” that was awarded to Soeharto’s son so that he

could import cars and their components at very favourable import taxes

a monopoly in the trading and importation of cloves to Soeharto’s son.

Besides the close family and supporters of Soeharto, various family business groups

linked to Chinese businessmen have enjoyed various interventions. The most notable of

these is the Salim Group. These interventions included a ‘bail out’ of the Salim Group’s

27

cement company—Indocement—when it faced financial difficulties (Borsuk & Chng

2014).

Various governments under Sukarno paid considerable attention to assisting indigenous

business people, to reduce the perceived dominance of the Chinese in business,

introducing policies that discriminated against the Chinese (Borsuk & Chng 2014).

Indonesia’s economic structure was dominated by foreign companies and Chinese

traders at the outset of the country’s 1945 independence, following 344 years of Dutch

colonial rule (Muhaimin 1991). Western capital first moved into South East Asia mainly

to produce primary commodities. The first major export of the period was sugar

(Yoshihara 1988).

Government intervention had begun as early as one year after the Dutch officially

sanctioned Indonesia as an independent country. A nationalistic policy called the

Rencana Urgensi Perekonomian (RUP or Economics Urgency Plan) was established to

change the colonial economic structure (Muhaimin 1991).

RUP was followed by the Benteng program in 1955. This program was clearly aimed at

protecting and fostering middle class pribumi business people from the perceived

dominance of foreign and Chinese capital in the economy. It did this by reserving

import licences for their (that is, the non-Chinese) exclusive use, along with giving them

loans and facilities. The government provided import licences for certain easily

distributable items, such as cloves for kretek cigarettes, loincloth for batik, the

allocation of foreign exchange; the government also gave aid in the form of credit that

was only for pribumi business people (Muhaimin 1991).

The Benteng program granted licences to pribumi business people who enjoyed close

ties with power holders and the military, but were unable to benefit from this due to a

lack of capital and expertise. Indonesian economic historian Wie (2012, p.8) has

commented that:

[t]hus Indonesia’s experience with its first affirmative programme to promote a strong

and self-reliant indigenous business class proved to a failure.

Further discrimination against Chinese business people came with the adoption of

government regulation PP10 1959 (Peraturan Pemerintah No. 10 of 1959). This

28

regulation banned ‘alien Chinese’ from retail trade in rural areas. This resulted in an

estimated movement of 120,000 Chinese people back to China (Borsuk & Chng 2014).

The RUP and the Benteng program have been accused of abuses. As Muhaimin (1991,

p.85) has said:

[a]ll cabinets which started from 1950 until March 1955 were accused had given

favoritism basic import licenses’ (p.82). So, ‘in this context, an official became

valuable patronage source that could be used to gather political support’.

The patron-client phenomenon has been observable in Indonesia’s contemporary

politics and business dealings since this time.

Soekarno’s Guided Economic Period (1957–1965) welcomed neither foreign capital nor

traditional Chinese small traders in rural areas (Muhaimin 1991). During this time, more

focus was placed on developing state-owned enterprises (SOEs) in an Indonesian

version of socialism. The government prioritised state enterprises over private ones.

Another consequence of this Guided Democracy was the emergence of business people

who enjoyed patronage (Muhaimin 1991). The nationalisation of Dutch companies

following confrontations with the Dutch in West Papua (Irian Jaya) formed the basis of

future SOEs in Indonesia. During this period, capital, contracts, concessions and credit

from the state, were first given directly to SOEs; and certain national private

businessmen could also claim them (Muhaimin 1991).

Foreign capital was encouraged after the Guided Democracy system. The patron-client

phenomena was exacerbated during Soeharto’s New Order government when it

established the Foreign Investment Act 1967 and the Domestic Investment Act 1968

(Muhaimin 1991). These gave the state and its bureaucrats a powerful authority over

allocating capital, credits, concessions and licences for their clients.

The discretion of economic protection in Indonesia, at least until 1974, was largely

limited to the import sector (Muhaimin 1991). Towards 1970 however, political

pressures forced the government to give special aid and protection once again to

pribumi business people (Muhaimin 1991). However, inefficiencies in its

implementation created a repeat of the situation in the 1950s. A proliferation of so-

called ‘Ali-Baba arrangements’ created a situation in which the pribumi with political

29

connections provided fronts to obtain licences which they then sold or used in

cooperation with the Chinese, who provided capital and expertise (Muhaimin 1991).

The discretion to give protection had produced a patron-client system that benefitted the

pribumi. However, Muhaimin (1991) concluded that the system was not able to develop

strong pribumi entrepreneurs, as they lacked entrepreneurial skills, capital and

organisation.

The patron-client system is very sensitive to changes in the power structure. During the

early years following independence (1945–1959), the key to success for entrepreneurs

lay in their ability to be close to a political party and cabinet figures (Muhaimin 1991).

In the Guided Democracy period (1959–1965), the power to control the bureaucracy

shifted to the Presidential Palace.

In the New Order, the key to understanding decision-making in relation to Indonesia’s

economy was to recognise President Soeharto’s position as the most senior decision

maker (Muhaimin 1991). The outcome of changes in regime was the rise of other

business people who had relationships with the New Order elite. In 1968, a company

belonging to Probosutedjo (a family related to Soeharto) obtained a lucrative monopoly

over clove importation—cloves being essential for the kretek cigarette industry—from

the Minister of Trade, Dr Soemitro Djojohadikusumo (Muhaimin 1991). Probosutedjo

denied he had received the licence because of his link to Soeharto (Muhaimin 1991).

As mentioned by Emil Salim, in the introduction of a book edited by Resosudarmo

(2005), Indonesia in the 1980s and 1990s (under Soeharto’s rule) followed the

‘Washington consensus’: that countries should adopt a market paradigm and that the

private sector should dominate the market. The government undertook privatisations

and de-regulated various sectors, including the financial sector. The turning point

happened after the 1997 AFC, when it became apparent that the development policies

were flawed. In 1988, the ‘Santiago consensus’ recognised these market failures and the

need for government to correct the market.

Many current business people and their business groups emerged during the Soeharto

era, including as many as 17 of the 30 largest business groups in existence in 2008, with

all of the 30 largest business groups but one owned by the Chinese (Chua 2008). It

would have been reasonable to suppose that the 1988 AFC would have obliterated most

30

of these business groups. However, many have survived and have been included in the

top 80 business groups (as mentioned previously) and have grown even bigger.

2.4.6 Case Study: The Salim Group

The most widely cited case study on the links between political patronage and business

in Indonesia is that of the Salim Group. Soeharto and the Salim Group’s founder Liem

Sioe Liong (Liem) had a classic patron-client relationship. The president ‘protected’

Liem and ensured that his formative ventures succeeded by allowing him to hold

monopolies and giving him preferential treatment (Borsuk & Chng 2014).

After migrating to Indonesia from China in the 1930s, Liem was able to build a simple

trading business into a conglomerate in Indonesia. In the early stages, the Salim Group

was able to capitalise on government ‘[p]olicies designed to protect and nurture

domestic capitalists, particularly in import substitution, because of its capacity to secure

monopolies and access to the financial and organisational resources of international

capital’ (Robison 1986, p.297). Sato (1993, p.437) has also stated that ‘[p]ursuing

monopolistic and oligopolistic market positions became a cornerstone of the group’s

corporate behavior’.

The Salim Group was on a growth fast track, benefitting from this positioning. Liem—

and Suharto’s half-brother—obtained exclusive rights for many years to import cloves

from Zanzibar and Madagascar (Borsuk & Chng 2014). For many people, the Salim

Group has become so large due to its monopolies; these are the sources of cash flow

that allow the group to invest in many other businesses (Borsuk & Chng 2014).

Liem understood there was a price to pay for being so close to Soeharto. As noted by

Borsuk and Chng (2014), he offered shares readily to the president’s family members;

for example, a 30% stake in his bank, then the Bank BCA. He was also called upon to

rescue the troubled Bank Duta, which was owned by foundations linked to Soeharto

(Borsuk & Chng 2014).

Once Anthony Salim – Liem’s youngest son and heir apparent – returned from

England in 1971, the Salim Group consciously pursued geographic expansion beyond

Indonesia as a way of diversifying (Borsuk & Chng 2014). After Suharto fell in 1998,

31

Salim’s investments outside Indonesia proved very useful to settle his debts and

maintain his control of Indofood, a food and beverage business (Borsuk & Chng 2014).

Borsuk and Chng (2014) have attributed Salim’s success to his close ties to the late

President Soeharto, both before and during Soeharto’s 32-year rule, which ended in

1998 (after the AFC in the same year). The two had become friends when General

Soeharto was Commander of Central Java. When General Soeharto took control of the

country in the 1960s and was looking for ways to develop the economy, he often turned

to Liem, who effectively gave him control of key profitable businesses in clove imports,

flourmills and cement. He was viewed as Indonesia’s first industrialist, taking the lead

in building some of the first flourmills and cement plants in the country (Borsuk &

Chng 2014).

The group has struggled with huge debts and was forced to sell some of its prime assets

following the AFC, including its flagship BCA. Anthony Salim (the third son) has been

running the company since the 1990s. The Salim Group has bounced back, despite

Soeharto losing power in 1998, due to its strong market share, internationalisation and

professionalism, combined with Anthony’s business acumen (Borsuk & Chng 2014;

Dieleman 2007). The group’s managers have been able to clean up their debt and focus

on expanding their core enterprises, including food and agricultural businesses. Liem

left Indonesia for Singapore after the AFC, where he died in June 2012 at the age of 95.

Today, the Salim Group is still one of the most prominent family business groups in

Indonesia, as shown in the previous table of top business groups in Indonesia. Borsuk

and Chng (2014, p.517) quote Anthony who said:

[S]alim had moved far from its origins, from “connections to non-connections”.

Salim Group currently operates in many areas of business, much like the Astra Group.

However, unlike the Astra Group they do not have one listed holding company. Salim

Group is best known for its presence in the consumer sector, with products such as

instant noodles (Indomie) through Indofood and Indofood Consumer Brand Products

(ICBP). They have also businesses involved in flour milling (Bogasari), palm-oil

plantations (Salim Ivomas, Lonsum Plantation, Indoagri), an automotive distributorship

(Indomobil). They have continued to expand outside Indonesia through First Pacific,

which is listed in Hong Kong.

32

As far back as 1986, Robison (1986, p.297) had observed that:

[T]he Liem group can no longer be regarded as a client or comprador group

hanging onto the coat-tails of Indonesian generals and foreign bankers; it is a major

regional and international financial and industrial group with a substantial capital

base’.

One of the most comprehensive academic studies on the Salim Group is that by

Dieleman (2007). She conducted an in-depth, longitudinal study focused on unravelling

the Salim Group’s business strategy. She found that indeed Salim’s strategy oscillated

over time from a relationship-based strategy to a more market-based one.

2.5 The Theoretical Foundations of Earlier Research

This section will examine the theoretical foundations of earlier research on political

connection and firm performance. It consists of three parts: the determinants of firm

performance, an explanation of ‘institutional void’ as a theoretical foundation to analyse

the phenomenon of business groups in emerging markets, and an analysis of previous

empirical research on the effects of political connections on a firm’s performance.

2.5.1 Determinants of Firm Performance

Firms exist to achieve profit maximisation. In the process of maximising profits, firms

interact with agents and markets in a constant cycle of interactions. Strategic choices

made by firms can affect outputs, outputs can affect market prices, market prices can

affect agents’ budget sets and utilities, utilities can affect incentives within firms,

ultimately returning to affect the strategic choices within firms (Zame 2007).

Previous studies have reached few conclusions on the determinants of firm

performance. Previous studies are divided into two streams: those focusing on external

factors as the major influences and those looking at internal factors believed to have

major effects. Many researchers have argued that external factors, such as industry

forces, have played a major role in influencing firm performance (Hawawini,

Subramanian & Verdin 2003). The external factors for a firm’s performance are well-

explained theoretically by industrial organisation economics. The major determinants

include characteristics of the industry, the companies’ position relative to their

competitors, and the quality and quantity of the firm’s resources (Hansen & Wirnerfelt

33

1989). Conversely, some researchers have argued that internal factors are the major

determinants of firm performance, determining competitive advantages and successes or

failures during economic downturns (Opler & Titman 1994). The empirical evidence for

both streams of thoughts is inconclusive (Hatem 2014).

Company performance can be measured by profit margins or increased turnover

(Elizabeth & Baines 1998). This includes ROA, ROE and return on sales (ROS) (Hatem

2014). Firm performance can also be measured using market measures like earnings per

share (EPS) (Hatem 2014), Tobin’s Q (Morck, Shleifer & Vishny 1988; Niessen &

Ruenzi 2009) or market-adjusted returns (Braun & Sharma 2007). One method of

calculating Tobin’s Q has been suggested by Schlingemann, Stulz and Walkling (2002)

as the ratio of the book value of assets minus the book value of equity plus the market

value of equity to the book value of assets. Market-adjusted returns can be calculated by

subtracting the share price return of the particular stock with the relevant composite

index.

Firms tend to optimise all means to achieve better performance, even by rent-seeking.

‘Rent-seeking’ is a term coined by Anne Krueger (1974). She has said that rent-seeking

occurs when a firm uses its resources for economic gain without having to deliver any

benefits back to society through the creation of wealth (Krueger 1974). One example of

rent-seeking is when a firm tries to persuade government to provide lower tariffs,

subsidies and grants to the firm. These regulations would not provide any benefits for

society; instead, they would just circulate the wealth from taxpayers to the special

interest group. As such, the theory of rent-seeking leads to the argument that those firms

with political connections to the government tend to reap economic benefits, leading to

better performance for those firms.

2.5.2 Institutional Voids

Emerging markets lack transparency, and ambiguity as well as uncertainty of regulation

(Dhanaraj & Khanna 2011). Indonesia is considered an emerging market. Hence, doing

business in Indonesia requires consideration of such conditions. This complexity is

studied by examining the fundamental arrangements that support market functions. The

absence of such arrangements or institutions is coined as an ‘institutional void’ by

Khanna and Palepu (2010).

34

North (1991) has described institutions as constraints established by humans when

structuring interaction between politics, economics and social factors. Institutions

consist of formal and informal institutions. Formal institutions include formal rules such

as constitutions, laws and property rights. Conversely, informal institutions include

sanctions, customs, taboos, traditions and codes of conduct. Institutions are created to

reduce uncertainty as they provide direction for people undertaking activities.

Neoclassical economics assumes that information in markets flows perfectly; however,

this is difficult to implement, even in developed countries. Further, violation of

neoclassical assumptions is more pronounced in emerging markets.

Five institutional dimensions can be examined for their relationships with political

needs (Khanna & Palepu 2010). These five dimensions are: (1) capital markets, (2)

labour markets, (3) product markets, (4) government regulations and (5) contract

enforcement.

Regarding capital markets, investors feel safe investing in developed countries as these

countries have clear regulations for the capital market. However, investors are reluctant

to invest their money in companies, especially new enterprises, in emerging markets. As

a result, well-established business groups or conglomerates have the advantage in

obtaining capital from investors.

In terms of labour markets, emerging markets lack well-trained and qualified

employees. Again, well-established business groups have advantages regarding the

labour market. This is because these groups could have internal management

development programs and training established to develop their employees’ skills.

Another way they manage their human resources is to transfer employees from a

company facing a downturn to another, more stable company, as a government in an

emerging market may not provide unemployment benefits.

Government in emerging markets often intervenes extensively in business. In addition,

it is difficult for companies to predict what regulations will be established in the future.

Again, business groups or conglomerates have certain advantages as they can act as

intermediaries, providing a ‘bridge’ for investors or their partners to communicate with

the government. The costs of acting as an intermediary could be spread among the

several companies within a group. Further, is also important to maintain relations with

35

government bureaucrats. For example, major Malaysian political parties have

affiliations with business groups, and large companies in Indonesia have access to

government officials. Another way to establish a relationship with government is by

educating regulators on how business and projects are conducted.

Finally, if there are any disputes between parties, contract enforcement is clear in

developed markets. However, it is less clear in emerging markets. Business groups have

the advantage here, as they could have had some track records in solving contract

enforcement issues in the past. If there is no history of misconduct, then companies in

the group will be able to gain credibility from the investors or other business parties.

In summary, conglomerates or business groups might be advantaged in emerging

markets as they may be able to leverage their assets and capital to obtain trust from

investors and other business parties. Moreover in emerging markets, where formal

institutions are absent, informal institutions become important in conducting business.

2.5.3 The Effects of Having Political Connections on Firm Performance

Much empirical research has examined the effects of having political connections on a

firm’s performance. This section begins with a discussion on how and why companies

may link themselves with politics, and whether such links offer positive or negative

effects on the firm’s performance. It will also examine some other aspects concerning

the company policies regarding political connections.

There are many ways for companies to be politically connected. In the United States of

America (US), firms can appoint directors with a political background to accommodate

their business with bureaucrats (Agrawal & Knoeber 2001). Moreover, having

politicians or government officials on the board of directors, would result in higher

performance compared to a close relationship or knowing certain politicians (Boubakri,

Cosset & Saffar 2009). Stronger connections, such as owners having close relationships

rather than directors, and having close relationships with ministers rather than MPs, lead

to a greater difference in the performance of connected and non-connected firms (Faccio

2010).

A country’s legal environment also influences whether political connections can be

established. Countries with a higher level of corruption tend to have greater differences

36

in performance between politically connected and non-connected firms. A symbiotic

relationship exists between politicians and capital in which capital groups distribute

their wealth to politicians in exchange for receiving monopolies, concessions, licences,

quotas, construction projects and permits (Pathmanand 2006). However, if capital

groups form their own political party, then this wealth distribution decreases.

The existence of political connections could result in companies having better

performance compared to non-connected companies. In Germany, firms with political

connections to the Nazi party outperformed the market (Ferguson & Voth 2008).

Brazilian firms that provided contributions to federal elections experienced higher stock

returns around the time of the 1998 and 2002 elections (Claessens, Lang & Fan 2006).

Using the measure of geographical connections in Pakistan and Zimbabwe, political

connections are, on average, worth over 10% of a firm’s value, though unexpected

losses would lead to a 1.7% decline in a firm’s value for those politically connected

firms (Faccio & Parsley 2009). Using a data set on the political connections of board

members of S&P 500 companies, Goldman, Rocholl and So (2009) have determined

that companies experienced positive abnormal stock returns following the appointment

(and the announcement of this) of politically connected people as board members of

those companies. Moreover, companies supporting the US Republican Party increased

in value after the 2000 election; companies connected to the Democratic Party

decreased in value (Goldman, Rocholl and So 2009). Examining the post-merger

performance of companies, Brockman, Rui and Zou (2013) have found that well-

connected firms outperformed others by more than 20% in terms of abnormal stock

returns; however, this only happens in countries with weak legal systems or high levels

of corruption. For well-connected firms in countries with strong legal systems, they

underperform their counterparts in terms of abnormal stock returns. The difference is

higher for domestic mergers compared to cross-border mergers as politicians have a

greater incentive to influence the merger.

In Thailand, large companies’ values increase when the owners enter politics;

politicians will create policies that are favourable for their companies, resulting in a

higher market share (Bunkanwanicha & Wiwattanakantang 2008). Connected firms

have lower tax rate payments and higher market power (Faccio 2007, 2010). In

Germany, firms with political connections have higher valued assets and better sales,

37

market capitalisation, accounting performance and stock returns (Niessen & Ruenzi

2009). However, they also have less risk, market valuation and growth opportunities.

This could indicate that MPs in Germany prefer to work with large and stable firms to

maintain their reputations, as new transparency laws enacted in 2007 stated that any

additional income of parliament members should be publicly available information

(Niessen & Ruenzi 2009).

The mechanisms through which political connections could add value to companies

varies. In Indonesia, the relatives of President Soeharto were easily granted licences to

import, while others were given a restricted licence, resulting in a higher industry

concentration for political connected firms (Mobarak & Purbasari 2005). In Malaysia,

firms that have close relationship with the former Prime Minister Mahathir lost

subsidies in the first phase of the AFC; however, they were more likely to get subsidies

after capital controls were imposed (Johnson & Mitton 2003).

In addition to these mechanisms, politically linked companies have a higher probability

of being bailed out when facing financial distress; the probability is even higher when

the IMF or World Bank provides financial assistance (Faccio 2006). Moreover, Faccio

(2006) found that in some countries, political connections influence the allocation of

capital through financial assistance. Duchin and Sosyura (2012) found that connections

to US congressmen on finance committees and representation at the Federal Reserve via

board members increased a bank’s likelihood of receiving funds from the Troubled

Asset Relief Program (TARF). Companies that had politicians on their board of

directors could receive long-term debt from state-owned banks, with lower interest rates

and less collateral (Charumilind, Kali & Wiwattanakantang 2006; Claessens, Lang &

Fan 2006; Cull & Xu 2005; Faccio 2007, 2010; Khwaja & Mian 2005; Sapienza 2004).

This has also been supported by Boubakri, Cosset and Saffar (2009), using the data of

234 firms from 23 countries to determine that firms with political connections had

higher debt to total assets and current liabilities as they had more ability to obtain debt.

Conversely, political connections could be detrimental for companies. In Canada, heir-

controlled Canadian firms had lower industry-adjusted financial performance, labour

capital ratios, research and development (R&D) spending and a decreased share price

after the US-Canada free trade agreement was announced (Morck, Strangeland &

Yeung 1998). In Indonesia, news about President Soeharto’s health in 1995 to 1997

38

resulted in lower market prices that were even more pronounced for politically

connected firms (Fisman 2001). Having political connections without good managerial

skills could harm a firm’s performance (Fan, Wong & Zhang 2007). This is supported

by Boubakri, Cosset and Saffar (2009), who found that firms with political connections

had lower ROA; this was potentially due to the lower managerial skills connected to the

ease of business that resulted from having better connections. In France, firms with

politically connected CEOs tend to have lower profits as they have to pay higher wage

bills (Bertrand, Schoar & Thesmar 2007). In addition, firms with political connections

can have higher leverage and market shares, but a lower accounting performance

compared to their competitors. Differences between connected and non-connected firms

become particularly pronounced when political links are stronger, and when connected

firms operate in countries with higher levels of corruption (Faccio 2007). Examining

corporate donations to political candidates for federal offices in the US from 1991 to

2004, Agrawal, Meschke and Wang (2012) found that firms who donated had free cash

problems, lower returns and lower corporate governance.

The existence of political connections does not result in only having a higher or lower

performance, but can also affect companies in relation to business policies, such as

dividend payments and financing options. Investors in loosely affiliated companies

tended to be less concerned about dividend rates; dividends could be used to allay

concerns for investors in tightly affiliated companies, which results in higher dividend

rates for the latter type of companies (Faccio 2010). However, multiple large

shareholders in Europe help protect minority shareholders from controlling

shareholders; in Asia, they tend to collude. Well-connected firms are less likely to trade

foreign securities compared to non-connected firms as they have greater access to state-

owned banks, making foreign securities less attractive. Foreign securities require greater

transparency; less transparency could mean they could extract economics benefits (Leuz

& Oberholzer Gee 2006).

This section shows that the results of various empirical evidences on the effects of

political connection on firm performance are mixed. However, the majority of the

findings tend to support the notion of the positive effects of having political connection

to firm performance especially in countries where “institutional voids” exist and weak

legal environment prevail. This fits the description of Indonesia. Therefore, this forms

39

the basis of the hypotheses of potential link between politically connection firms and

firm performance in Indonesia.

40

Chapter 3: Perceptions of Business and Politics in Indonesia

3.1 Introduction

This chapter will present the results from the interviews of a convenient sample of 34

professionals in Indonesia regarding their perceptions of the need for political

connections to compete in business in Indonesia. Prior research has shown that firms

with political connections could have some advantages in conducting their business.

Khwaja and Mian (2005) found that firms with politicians on their board of directors

could have easier access to long-term debt from state-owned banks with lower interest

rates. However, Fan, Wong and Zhang (2007) have explained that political connections

without good managerial skills could harm a firm’s performance. For a better

understanding of the need for political connection in running a business in Indonesia,

this study will document, via a series of interviews, the perceptions of Indonesian

professionals with extensive business experience.

The key hypothesis is that political connections are necessary to be competitive in

Indonesia. Sub-hypotheses are threefold: the situation has become worse post- Soeharto,

political connections vary across industry and politically connected board member is

used to gain political connections.

The interviewees hail from a variety of professions, such as the banking and finance

industries, business sectors and academia. They have worked and dealt with Indonesian

businesses for a considerable amount of time. They have, on average, more than 16

years of professional experience in Indonesia.

The interviews sought evidence to answer the following first four key research

questions as mentioned in Chapter 1 page 3:

1. Are political connections necessary to be competitive in Indonesia? If so, why?

2. Has the situation become better or worse post-Soeharto?

3. Do political connections vary across industry sectors? How?

4. What mechanisms for political connections are used by firms?

41

3.2 Research Design

3.2.1 Rationale for Interview Method

Interviews were used for this part of the study as they allowed a more interactive

process to extract in-depth and often-unstructured views from the interviewees;

interviews also enable follow up on questions (Flick 2014; Wisker 2008). This method

is preferred over questionnaires or surveys, as it allows the researcher to probe into

further perceptions from interviewees related to the topics. The researcher conducted the

interviews during August 2014, and each interview lasted from between 30 minutes to

one hour. The interviews were held in Jakarta and Singapore.

Typical questions during the interviews were:

1. What is your educational background and professional experience?

2. Which companies do you perceive are most competitive in Indonesia?

3. What are the factors that are important to competing effectively in

Indonesia?

4. Do you believe companies need to be politically connected to be competitive

in Indonesia? If so, why?

5. Has it changed before and after Soeharto? How?

6. Does politically connectedness vary across industries? If so, why?

7. How else might you define political connectedness?

3.2.2 Selection of Interview Participants

To garner the perceptions of business and politics in Indonesia, interviewees included in

the study needed to have been involved first-hand with, or have observed the Indonesian

market at a senior level, defined as a minimum of 10 years work experience either in the

business world or in academia. The interviewees have worked in public or private

companies, as entrepreneurs or in academia. Various professional backgrounds were

beneficial to achieve a variety of views on whether different conditions related to

political connections existed in different industry sectors.

42

An invite list of interviewees was developed based on the list of contacts that the

researcher had access to in his role as a senior banker in Indonesia. Of the 50 invitations

extended, 34 responded and participated in the interviews5

. Of the 16 potential

interviewees who did not participate at the end, there were mainly two reasons: they did

not respond at all or they declined as they viewed the topic was too sensitive.

3.2.3 Data Analysis

The data analysis was conducted using a manual coding process, where the interview

transcripts were analysed and categorised. This provided insights into the common

themes that emerged from the interviews to shed light on the key research questions.

Relevant quotations from the interviewees have been provided to strengthen the

particular themes.

To examine the robustness of the manual coding, the interview transcripts were also

analysed using Leximancer software. This software is particularly useful for the

unstructured or in-depth interview method used in this study. The key feature of the

software is that it does not require the researcher to pre-define any concepts or themes.

The software uses algorithms that are statistically based, employing linear dynamics and

machine learning (Smith & Humphreys 2006). Hence, the software allows an unbiased

method of analysing textual data that improves the reliability and decreases the

researcher’s possible subjectivity in data analysis (Kivunja 2013; Penn-Edwards 2010).

The software produces a concept map, which reveals the links between themes and

concepts.

3.3 Findings

3.3.1 Interviewee Characteristics

The sample included 34 participants in senior level positions. Tables 3.1, 3.2 and 3.3

provide a breakdown of the participants’ characteristics based on their current

profession, job position and educational background, respectively.

5 A sample of Invitation Letter and Consent Form for the interviews are in the Appendix.

43

Table 3.1: Characteristics of Interviewees Based on Their Professions

Jobs Number Percentage

Academics 5 14.7

Bankers 12 35.3

Business Executives 5 14.7

Fund Managers 4 11.8

Lawyers 4 11.8

Research Analysts 4 11.8

Total 34 100.0

Source: interviews, August 2014

Table 3.1 shows that the sample comprised of bankers (35.5%), academics and business

executives (14.7% each), fund managers, research analysts and lawyers (11.8%

respectively). Based on their professional experience, all interviewees had more than 10

years working experience.

Table 3.2: Characteristics of Interviewees Based on Their Positions

Position Percentage

CEO 5.9%

COO 2.9%

Director 17.6%

Commissioner 5.9%

Chairman 5.9%

Business Owner 8.8%

Managing Director 11.8%

Managing Partner 5.9%

Partner 5.9%

Senior Research Analyst 2.9%

Head of Research 8.8%

Fund Manager 5.9%

Professor/Assistant Professors 11.8%

Source: interviews, August 2014

44

Table 3.2 shows that 38.2% held senior C-level positions (CEO, COO, director,

commissioner & chairman), 8.8% were business owners, 11.8% held the position of

managing director, 11.8% were either managing partner or partner, 5.9% were fund

managers, 11.8% were professors/assistant professors in academia, 11.8% held the

position of head of research or senior research analyst.

With regard to their educational background, Table 3.3 shows that the majority of the

interviewees held a master’s degree (50%), followed by those holding a bachelor degree

(38.2%) and doctorates (11.8%). Moreover, 75.8% of interviewees were college

graduates from abroad, 44.4% interviewees were working or had worked abroad, and

29.4% interviewees had studied and worked or had worked abroad. Educational

background has been used widely in the past as a variable to predict organisational

performance, the degree of innovation and the acceptability of new ideas (Bourantas &

Papadakis 1998) in a company. Thus, a higher educational background could suggest

that people had a high capacity to process information and were also open to change in

the business environment. In this study, the educational background could augment the

years of experience to explain the level of expertise of interviewees.

Table 3.3: The Cross-Tabulation of Interviewees’ Jobs and Education

Experience

Total

10–15

Years

16–20

Years

21–25

Years

26–30

Years

> 30

Years

Education

level

Bachelor Count 2 5 4 1 1 13

% within

Education 15.4% 38.5% 30.8% 7.7% 7.7% 100.0%

Masters Count 6 6 3 1 0 16

% within

Education 37.5% 37.5% 18.8% 6.3% 0% 100.0%

Doctorates Count 0 3 0 1 0 4

% within

Education 0% 75.0% 0% 25.0% 0% 100.0%

Total Count 8 14 7 3 1 33

% within

Education 24.2% 42.4% 21.2% 9.1% 3.0% 100.0%

Source: interviews, August 2014

45

Based on their educational background and working experience, the majority of

bachelor’s and master’s degree holders had more than 16 years working experience

(84.6% and 62.5%, respectively). Meanwhile, all the doctorate holders had more than

16 years working experience. This indicates that the interviewees had been selected

according to their expertise.

3.3.2 Data Analysis—Manual Coding

3.3.2.1 What Factors are Important to Compete Effectively in Indonesia?

Whether political connection adds value to companies in Indonesia is the key question

for this research. The answers from our interviewees were mixed, although most

interviewees thought it was necessary or that it depended on the industry, company size,

and whether the business was in its early stages or not:

[i]n emerging markets, in my opinion yes, if you want to be honest, political

connection is needed. For companies to grow, besides strong management, they are

supported by good political connectedness (Banker).

Government policies are important to watch out. Take for example if we sell instant

noodle. If in a locality, selling instant noodle is forbidden, suddenly you are out of

business. So, understanding political networking is important (Business Executive).

The distribution of perceptions of necessity for political connection is provided in Table

3.4. Additionally, Table 3.5 shows the detailed reasons for the answer that the need for

political connections depends on certain factors.

46

Table 3.4: Interviewees’ Perceptions of the Necessity of Political Connections

Professions Political Connectedness and Being Competitive

Total N Necessary No Need Depend On Not Sure

Academics 5 80% 20% 100.0%

Bankers 12 33.3% 8.3% 58.3% 100.0%

Business Executives 5 20% 80% 100.0%

Fund Managers 4 50% 25% 25% 100.0%

Lawyers 4 50% 50% 100.0%

Research Analyst 4 50% 50% 100.0%

Source: interviews, August 2014

Table 3.5: Reasons for Answering ‘Depends On’

Reasons for Answering ‘Depends On’ Percentage

Important in the early days 18.8%

It help, but it is not a criteria 18.8%

Scale of business 18.8%

Sectors of the industry 43.8%

Total 100.0%

Source: interviews, August 2014

As shown in Table 3.5 above, a significant majority of interviewees perceived that the

industry sector was important regarding whether the need, or not, for political

connection. A more detailed discussion on variations among the various sectors of

industry follows shortly. However, a few relevant quotations are provided here:

[w]hen they were start-up companies, most of them basically were politically

connected. If you look at sectors of the industries, there are certain sectors that are

considered sensitive to politics for example mining industry. As you can see, even if

the owner is not politically connected, they tend to employ ex-government officials,

or retirees from the government and the public sector (Banker).

It depends on the sectors of the industry. I think for companies in the consumer

sector, no need really. Maybe you still need some political connection to get some

minor licenses (Business Executive).

47

It depends on the sectors. If you are a SOE, say a SOE building contractor companies

doing government projects-infrastructure such as roads, ports, infrastructure projects,

having political connectedness is very important (Banker).

If your business however is involving the state expenditure then whether you like it or

not, yes you have to have political connection. When we talk about government

routine spending, such as writing utensils, computers etc., if you want that business

then you must have political connectedness in Indonesia (Academic).

Some interviewees’ viewed that the need for political connection was dependent on the

company’s size. While a small company may not need political connections, the need

for political connection arose as a business scaled upwards. This is because competition

increases and political connection can be used as a tool by others to compete against

you. Being politically connected may be necessary to protect the business. Size can be

aligned to the size of revenue or assets, and also by how strategic the sector is. For

example, oil, gas and mining companies are important and strategic to the government,

as the sector is an important source of taxes and royalties. The more government

involvement in the business sector, the more important political connection is:

[i]f you start from zero and you are less than 300 or 200 billion rupiah, in terms of

sales, I think political connectedness is not needed generally, regardless of the

industry (Fund Manager).

But once you are bigger and you need to “move a mountain”, then you need political

connectedness. For example, you need to win businesses in heavily regulated sectors,

then off course you need political connection. Or if you want to change the

competition landscape by stopping foreign competition, you set up new

acts/regulations, you need political connection (Lawyer).

The big business groups have more access than others to politics, government and

power. These big groups have been established a long time and hence have a longer

history (Lawyer).

The interviewees suggested that being politically connected did not necessarily ensure a

company’s competitiveness. By having political connections, a company may obtain

government projects more easily. However, having strong management, capital and

48

distribution networks were also necessary for a company to survive and flourish. The

view from the interviewees suggested that political connection was just one of the many

key success factors:

[w]hat I want so say, political connectedness is important if there are other qualities

within the company to make it useful meaning they have good product, good

management, good planning, and then if they have political connectedness, they can

capitalise on it. If not, they cannot (Academic).

I would say that yes, being politically connected would definitely help in terms of

your day-to-day business activities. But being politically connected alone will not get

you very far. You can look at the previous Soeharto’s family businesses. They were

supremely politically connected. But without good human resources, good

management, those businesses would flounder. They would not do well in the long

run (Banker).

Political connection will give you an advantage in the beginning of your business. But

at the end of the day once the operation is up and running, it is still up to you, up to

operation to actually be able to deliver the results. We have seen it in the past, when

Indonesia tried to have national cars programme with Kia to take the tax advantages

using political connection. Kia didn’t have the ‘right’ products for Indonesia,

therefore they still failed, despite [having] the tax incentives (Banker).

Figure 3.1 presents the key success factors, as discussed during the interviews, for

companies to compete successfully in Indonesia.

49

Source: interviews, August 2014

Figure 3.1: Key Success Factors Viewed as Necessary for Competitiveness

For analytical simplicity, the key success factors in Figure 3.1 above can be divided into

internal and external key success factors. Internal factors are those within the firm’s

control. External factors are those beyond the firm’s realm and control, such as the

wider industry, economics and environment. These distinctions align with the

discussion on the determinants of firm performance in Section 2.5.1.

While political connection is one of the key success factors for competitiveness in

Indonesia, the interviewees noted overwhelmingly that management is the key and most

important factor. Good managers will need to be visionary, shrewd with operating costs,

be able to adapt to changes in the business environment and be willing to invest in R&D

innovation:

[l]ike any business in the world, I think good management is critical. Ultimately it is

what drives the business. I know that it does sound like cliché, the biggest asset of a

company is human resources. It is probably pretty much underlying the successful

businesses in Indonesia. You would not be surprised that most people consider that

Astra is the breeding ground of top management for a lot of Indonesian corporates

(Banker).

The management[’s] capabilities in becoming competitive to know where the

business is going is very important. How they actually maintain the margins. This

relates to the shrewdness of the management (Fund Manager).

Internal key success factors

•Management

•Product and services

•Distribution network

•Good corporate governance

•R&D innovation

External key success factors

•Business sector & market share

• First mover advantage

•Ability to adapt

•Cultural understanding

•Political connection

50

The most important quality of the management capabilities is the ability to adapt to

market situation be they domestic or offshore market[s] (Banker).

One of the key success factors is understanding the cultural background of the

society. When we talk about cultural background, it is not only about ways of doing

business, but also understanding the institutions that exist in the society (Fund

Manager).

Management is very important. Their management must be willing to do research on

new products, and enhance existing products. They have to have management who

are willing to understand that people may change, industry landscape of the business

changes, and they have to be ready to spend R&D to prepare to anticipate changes

that may happen in order for them to sustain growth (Fund Manager).

Good products and services, supported by wide distribution networks, are key success

factors, especially for retail, pharmaceuticals and the banking sector. Of these factors, a

wide distribution network was cited often by the interviewees as vital, as Indonesia has

a poor infrastructure:

[t]hey must have good distribution networks for the sales. Because as we know

infrastructure is an issue in Indonesia, hence distribution can be a big problem.

Therefore those that have good distribution from the beginning or that have built the

distribution channels better than their competitors, they have the advantages. If they

want to sell new products, it could be distributed quickly to the consumers (Fund

Manager).

As we have a huge area, distribution is very important. In normal circumstances,

distribution is important. But with our geography, distribution is even more

important. There are no companies that can grow fast without strong distribution

capabilities (Academic).

Having said that, a business group that has the ability to ride this is the one that would

be able to tap into the various regions in Indonesia. Meaning that those that have the

distribution networks. For example, Astra. They are able to maintain the market

shares. You see every New Year they come out with new products of cars. You see

new players into the car markets rely on technological advancement in their products.

51

But unless you have the distribution network that sells the products across Indonesia,

you will not be able to reach the kind of level where Astra is (Research Analyst).

3.3.2.2 Why the Need for Political Connection?

Political connectedness in Indonesian business is considered necessary for several

reasons: (1) to obtain necessary licencing, (2) to obtain access to information, (3) to

have access to regulators and bureaucracy due to issues of regulation, transparency and

enforcement, and (4) first and foremost as ‘a form of protection’:

[j]ust for an illustration, our second president, Mr Soeharto, whenever there were

good businesses, and if you don’t have any relationship with him and his family, it is

very easy for them to “occupy” your business. They stopped you from every angle in

order for your business not to progress (Fund Manager).

Everything we need has to involve dealing with the government, for example you

require certain licenses, so your competitors may use their link with the government

through their political link to stop you to get the licenses (Lawyer).

Political connection is not to obtain favours, but more for protection against

blackmail. When a company is becoming big, there are always nuisances against

them (Academics).

Apart from ‘political protection’, it was important to access information about the

business environment, competitive landscape and any policies from government that

might affect their business:

[f]rom time to time you do need help from the government in order [to] establish

business with acceptable business scale for the business to survive. It is important to

have the connectivity so you are aware of the market development. There could be

global events or regional events on the economic sides, the government need to take

certain actions. And in order to take the actions, they need to ask private sectors what

the implications would be, and if you don’t know these people, you can be caught on

the wrong side and your opinion will not be heard (Banker).

52

In order for the companies to get more information about their business, and to

expand in line with the government’s program of the government, it is easier to get

such information from (ex) government officials (Banker).

Such political connection helps in terms knowing what next regulations would be in

the business sectors by knowing them ahead of time, be them deregulation or

regulation (Business Executive).

Political connectedness would help as it could expedite the process in the licenses.

And also you may obtain some useful information that is not public (Banker).

It was essential to have access to regulators/bureaucrats so that the right communication

channels could be established if the business encountered any issues with bureaucracy.

Some interviewees viewed such access as crucial for the survival of their business:

[y]ou should be connected to the goals of the Governor or the Regent, as well the

Minister. But supporting these and well-connected does not mean you have to bribe

them or give gratification or give them some facilities (Banker).

Some of the officials after they retire they become member of the board of

commissioners in one of the companies. Although they have retired, they still have

influence in their connected ministries or state government offices. Even though they

don’t have legal positions anymore, per Indonesian culture, an ex-General for

example still has influence in the military, as well as ex-high officials still have

influence in their ministries have (Lawyer).

You have to know the governor in the head office and branches. You have to know

who the minister is, even by knowing means a lot. If you get to know them

personally, you have the relationship and then you can contact them. You understand

where things are going, where regulations are going. When you do positive impact to

the society, politician benefits also from the development (Business Executive).

For example, we need to go to the districts and then to the central government, but it

cannot be decided at the central government only. So political connectedness is

important [at] all the various levels and stages. So we need good relationship at the

local level and central government (Business Executive).

53

The need for political connectedness could be the result of a lack of clarity and

enforcement regarding laws. The more unclear the regulations and the weaker the

enforcement was, the more a company needed to have political connectedness:

[i]t is too clear and too rigid. So people translate them word by words. So the

situation is forms over substance. Actually it should be substance over forms. They

make it too rigid, so it becomes forms over substance (Fund Manager).

3.3.2.3 Need for Political Connection During and After the Suharto Era

Most interviewees felt there were significant differences in the periods during and after

the 32-year rule of President Suharto. Some interviewees said the need for political

connection used to be stronger in the period during Soeharto’s rule, but the need was no

longer present:

[s]o long you understand the regulations and you are doing it right, and thanks to

Indonesia has gotten more democratic, you can actually argue with the government

that you are actually doing the right things along with government regulations. So

that’s why I said the need for political connection used to be but no more thanks to

the democratisation and the impact of 1998 AFC (Research Analyst).

The interviewees perceived that democracy had provided a more transparent

environment since the media and the press were liberalised. The increased transparency

provided some kind of social control:

[i] feel now it is better. For example if it relates to something new and concerns a lot

of people, they tend not to make things difficult as they can become the focus of the

media, publicity, people tend to hold themselves out (Lawyer).

Democracy makes things a lot more transparent and therefore there is now level

playing field in terms of regulatory access. That means the ability or the advantage

that you get from being well connected to the power become diluted (Research

Analyst).

Everybody is watching. However, once they know everyone is watching everyone, at

the end they cooperate with each other. I get something you get something too

(Business Executive).

54

The above quotations reveal that some interviewees perceived that from 1998, the

media had more freedom in circulating news, which made every action more

transparent. However, political connections still existed but were transformed. During

the Soeharto period the situation was clearer, as power was concentrated in one hand:

that of President Soeharto and his family. However, after Indonesia had become a full

democracy, power sharing was established among the various political parties and

subsequent presidents, along with the regional and local governments. As the power

was shared, business people needed to connect with various parties, which could result

in higher costs when conducting their business. An explanation of this phenomenon is

provided in the following participant quotations:

[s]oeharto, during his New Order era, had split the resources basically into two: for

the Chinese, you can easily go the banks, and if you are pribumi (indigenous), you

can go the Pertamina if they want to start up a business. So in the Soeharto era, you

needed to be politically connected to be able to get the money from the system and

started a business with Pertamina (Fund Manager).

When so many political parties were set up in the Reformation era (post-Soeharto

era), this created various power bases in the society. They can decide how the money

circulated among the SOEs, for example projects to be given to those close to them

(Fund Manager).

If we talk about Soeharto era, friends of Soeharto were safe, others not. Today, you

know, there are yellow, red, blue, or green.6 If the Komisi Pemberantasan Korupsi

(KPK or Corruption Eradication Agency) is calling you, at the end even if you are

close to the yellow, red, blue, green, it doesn’t matter. But you need to be close to

everybody anyway for your business-sake (Fund Manager).

In the past it was clear: yes you are politically connected or no, you are not. If you

don’t have the political connection then you could not get big deals. Now however it

is unclear and uncertain. Sometimes they said yes it is possible when you request for

something, then the results at the end turn out to be not possible. Sometime they said

certain permits can be extended for example, then they said no. The Regent wants this

and that, yet it is not clear if the Regent’s requests were fulfilled, the permits will be

6 The colour refers to the various colours of the political party banners. Yellow refers to the Golkar party,

red refers to the PDIP party, blue refers to the Democrat party, and green refers to the islamists parties.

55

issued for example. So it is more chaotic. The power is not concentrated into one

hand (Business Executive).

Post-Soeharto, in 2001, Indonesia enacted a law that gave much more autonomy to the

regions, especially the regencies (Kabupaten). This created a dispersion of power to the

regencies, in particular as the Regent (Bupati) could now issue licences and permits for

certain parts of the mining and minerals extraction sector. Most interviewees felt that

the situation was worse and the need for political connectedness had increased for those

involved in the mining, mineral extraction, oil and gas and property sectors:

[a] lot of Peraturan Daerah (PERDA or local regulations) are not really conducive to

business, but making it more difficult for businesses (Banker).

Indeed, due to regional autonomy, the need for political connectedness in negative

sense is getting worse. The power is now spread out everywhere and these regional

heads are inexperienced people (Academic).

From the nominal value it is going to get more costly because it is decentralised, you

got to entertain various Regents from many areas (Research Analyst).

3.3.2.4 Variation in Political Connection by Sectors of Industry

As discussed in the previous section, most interviewees felt that the need for political

connectedness was dependent on the industry sectors in which the company operated.

Businesses in sectors that were highly regulated usually required more political

connectedness, as they depended on the local and/or central government for licencing,

permits, contracts and the awarding of projects:

[a]t the end of the days, sectors that have high degree of regulations require more

political connectedness (Banker).

Basically whatever the government deemed as strategic, whether it is staple food or

cooking oil. The lower class masses use a lot of cooking oil. If you operate in a sector

deemed as strategic, there would be more need for political connectedness (Banker).

Yes. It would definitely need to vary. And the reason is that for different industry, the

nature of the industry is different. For example, if you deal directly with the

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consumers, you deal less with the government. But if you deal with something

strategic or deemed to be strategic by the government of the country then there would

be a lot more political relationship that you have to deal with. For example, the oil

and gas, mining or even companies like in the cement-it is still being considered as

strategic, then there has got to be a lot more interrelations with the political issues

compared for example you are selling candies. So different industry will have

different levels of exposure to political interference (Research Analyst).

The sectors that needed strong political connectedness included: (1) oil and gas, (2)

mining and energy, (3) plantations, (4) property, (5) telecommunication and (6)

banking. The oil and gas and mining sectors were viewed as the two sectors that

required the most political connectedness. This was due to the magnitude of the

government’s role in the business processes of these industries being bigger than that of

other sectors. The oil and gas and mining sectors were perceived by interviewees to

have a high necessity of political connection, as these are natural resources owned by

the state. They are considered strategic sectors important for the state budget in relation

to taxes, royalties and duties:

[f]or certain sectors that deal a lot with government such as infrastructure, ports,

airports, and mining, political connection or political connectedness would be more

important (Banker).

I think the sector that is really huge in terms of their growth and income, for example

oil and gas, and mining, you have to be politically connected to operate in these

sectors (Lawyer).

In my opinion, mining and oil and gas need political connection because it involves

licenses and permits, and taxes/royalties. So if those companies have board members

that have strong political connections, it will be beneficial for the processing of

licenses etc., as they may need 30-40 various licenses and permits (Banker).

[t]o operate in the oil and gas sector, you have to be very well connected politically.

For you to be awarded for the Kerja Sama Operasi (KSO or joint operation) or PSC

(production sharing contract), you need to be very politically connected (Lawyer).

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You need to get the Analisa Mengenai Dampak Lingkungan (AMDAL or

environmental assessment) from the environmental department; you need to get an

approval from the Ministry of Energy etc. And when you start production, you need

to have good relationship with the local government, partly because there are a lot of

employees on site-local people. Hence, you need political connection (Business

Executive).

On the other hand, the interviewees perceived that consumer goods, consumer finance

and retail were sectors that required the least political connectedness. Government did

not dominate the business process and did not regulate a company’s inputs and outputs;

therefore, a company could buy from the market and sell to the market without

government intervention. Moreover, the licencing process in this sector was considered

relatively well-established and transparent:

[c]onsumer goods are not highly regulated. Sometimes they are free competition.

Hence, the need for political connectedness is less compared to highly regulated

industry (Research Analyst).

Consumer sector companies only deal with the government at Badan Pengawas Obat

& Makanan (BPOM or Food and Drugs Administration) for food and health permits

for their products. How about if you have a wrong product number? Then how to

escalate? If you are a small company, you just sort it out quietly with the regulator.

But if you are a big company, and your competitors may know about it, they can

‘blow it up’ and impact your sales. Hence you still need some connectivity to ‘calm it

down’ (Fund Manager).

Retail sector requires less political connectedness. You need location permits

(SIUP/TDP) or be aware of changes in regulations for example now you cannot build

new malls or prohibition of FDI in the sector. This sector is less regulated (Fund

Manager).

I think for the least influence of politics is probably consumer goods companies. Why

is that? The government does not control the input and output. They can buy raw

material from the free market, sell to the market, price to the market, without

intervention from the government that controls the inputs, outputs and price (Business

Executive).

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Figure 3.2 summarises the degree of political connectedness that correlates with the

degree of government regulation for various sectors, based on the views of the

interviewees regarding the need for political connectedness by industry sector.

Source: interviews, August 2014; figure is not to scale

Figure 3.2: Perceptions of Variation in Political Connectedness by Industry Sector

Figure 3.2 shows that as government regulation increases, the need for political

connection increases. The oil and gas and mining sectors have the highest need for

political connectedness as they are highly regulated. The property, plantation,

telecommunication and banking sectors were viewed as requiring moderate political

connectedness. The consumer and retail sectors had the least need for political

connectedness.

3.3.2.5 Mechanism of Political Connection

Most interviewees felt that political connectedness could be indicated by having a

member of the board of directors, or the board of commissioners in the company who

was connected with the government, parliament, judiciary and military:

[p]olitical connection could be for example if ex-officials sit in the board. They may

be close to the current decision-makers within the Agency or Regulators. In short,

they still have good relationship within the power holders within the government

(Business Executive).

Most interviewees viewed that this connection could also be obtained through the

company owners. However, operating this variable would be problematic as the data for

ultimate beneficiary owners (UBO) were not readily and publicly available.

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I will discuss further the various mechanisms for political connection in the following

sub-sections.

3.3.2.5.1 Connection Through the Owners

A political connection could be built through the owner’s connections. It could be that

the owner had a close relationship with government officials when those officials were

still in power, or even after they had retired from their positions. The perception was

that such a connection was stronger compared to one obtained through the board of

directors or commissioners:

[if] they consider the need to connect politically, businessmen can use government or

ex-government official that have political connectedness to government in board. So

this could be a form of goodwill. For the owner, probably the ex-official has assisted

throughout the growth period. You see that our Chief of Police-Bimantoro-when he

retired he was recruited by Charoen Phokpand for example as board member. That

may be a reflection of the relationship made or built during the period when

Bimantoro was acting as the Chief of Police with the company or with the owner of

the company (Lawyer).

Yes either the controlling shareholders are connected, or they use people to get this

connectedness (Business Executive).

Sometimes the political connection is conducted through the owners, sometimes

through the management as well. If the management has very good connection with

power, it can also somehow help the company. But the biggest leverage will be if the

owner is a good friend of the power holder himself (Research Analyst).

3.3.2.5.2 Owners Entering Politics

Owners could enter into and become functionaries of political parties or government,

some acting as a presidential advisor, ministers or even making a run as a presidential

candidate. The most recent trend was for business people to establish political parties

themselves, such as Partai Nasional Demokrat (Nasdem), which was set up by Surya

Paloh, the owner of the Metro TV business group and Partai Perindo, which was set up

by Hary Tanoesoedibjo, the owner of MNC business group. The perception of the

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interviewees on the motives for why these owners entered politics is that it was to

sustain and protect their business interests:

[a]ctually in Indonesia context, one form of politically connection happens when the

business people enter political parties. This is quite unique because they are easily

observable like the Bakrie business group where Aburizal Bakrie became the chief of

Golkar party, and MNC, chairman of MNC became the vice chief of a party (Hanura

Party). The chairman of Nasdem Party is also a businessman. And to some extent,

Gerindra Party as well. Those are political parties, which can be considered driven by

the business, so the business is politically connected (Academic).

You can say for example the owners claimed they are already retired and then they

want to be involved in politics. But most of the times, I see basically they do that in

order to protect whatever the interests of the family business as a form of family

interests protection (Banker).

There are cases like if I were a businessman and then I left my business to become an

MP. I tried to enter a certain Commission in the Parliament, which relates to my

business. There, political connectedness happened (Academic).

3.3.2.5.3 Campaign Donations

One way to be actively connected politically was by contributing to campaign

donations. The perception from the interviewees was that this occurred during the

previous presidential elections in 2014. To hedge their bets, owners typically

contributed to more than one political party or presidential candidate:7

[i]n the beginning, in order to establish political connectedness, companies actively

donate to the political parties. So they don’t have connection through the boards. But

they donate actively (Academic).

To establish the connection, they may become a contributor to the political party.

They don’t really use the company’s money but through individual shareholders or

through vehicles. In our law, there is a limitation on donation amount, so you may

have to split out the amount. For political parties, normally they need to disclose the

details of campaign donations. But for the listed companies themselves, the donations

7 The donations are funded from the company’s budget or, more often, from the owners’ own resources.

Research on the campaign donations is difficult due to the lack of data.

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may be intermingled with other expenses. Normally in Indonesia it is called informal

discussion, but we know exactly what it is (Lawyer).

It usually starts from donations at the level of shareholders or owners (Banker).

3.3.2.5.4 Industry Associations

Joining and being active in an industry association was perceived as a way to connect

politically. These associations, such as Kamar Dagang & Industri Indonesia (KADIN or

Indonesia Chamber of Commerce) and Asosiasi Pengusaha Indonesia (APINDO or

Indonesia Employers’ Associations), championed the causes of the industry. These

associations were often consulted by the government when issuing new regulations. The

members of the associations often accompanied the President on official visits to

foreign countries to build business ties:

[t]he company becomes part of an association (industry association) such as KADIN,

or APINDO. If you become a member of an association like KADIN, you can ask

your chairman to help your companies (Banker).

In Indonesia, you have the Association of Emiten Indonesia (AEI-Indonesian Issuers

Association), and then you have KADIN, APINDO, that is also the place they can get

good network, business network as well as government network because there are

intensive interaction with the government (Academic).

Say if I were a businessman, and I need to import strategic raw material such as

sugar, then I need to get active in an association. This association is also active in the

parliament. And if the businessman also sits in the parliament, it is easy for him/her to

pressurize the government as the counter-party of the parliament (Academic).

3.3.2.5.5 Advisors/Consultants

Hiring well-connected people as advisors or consultants requires less disclosure.

Interviewees viewed this as another way to become politically connected. These people

are not necessarily on the board of directors or commissioners but are still in the

company’s payroll. They act as the ‘door-opener’, or someone who has the necessary

access and influences:

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[t]he question is how many PEP in your payrolls? It is difficult to measures but they

exist. They are not formally in the company say as advisors. But they don’t want to

disclose it openly (Fund Manager).

Outside the political circles but they have experienced dealing with the government

for example they were advisors to the World Bank. Maybe we can use that as an

indirect measure (Research Analyst).

If they don’t have strong member of board of commissioners, like in mining sector,

maybe they can use other channels. I think they use management consultants or

advisors. It can be packaged as such (Banker).

I think they use advisors, as now people are becoming smarter not to get involved

directly, through a third party which seems to be independent (Lawyer).

3.3.3 Data Analysis Using Leximancer

Leximancer was used to examine the robustness of results from manual coding.

Leximancer is software that transforms lexical co-occurrence information from natural

language into semantic patterns in an unsupervised manner; hence, it minimises any

bias. Leximancer extracts the main concepts; it illustrates them and the

interrelationships between concepts in a ‘concept map’. This map also shows the themes

within which the concept is grouped and helps with the visualisation.

The map’s coloured circles represent the themes and the concepts deemed similar, are

shown close to each other and are enclosed within the same coloured circle. The

concept map also shows the absolute and relative frequencies of concepts and the co-

occurrences of concepts. The intensity of colour in the concept map represents

frequency, with red being the most intense, and cool colours such as blue as the least

intense. The size of the concept points indicates ‘connectedness’, while similar themes

are surrounded by circles. The strength of association between concepts is represented

by their proximity, and by the brightness of links (Galea & Loosemore 2008).8

The steps to generate the concept map are as follows:

8 For further information on Leximancer, its use and advantages see Smith (2000), Smith (2003), Martin

and Rice (2007) and Kivunja (2013).

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1. The transcripts of interviews (in Word) are uploaded to Leximancer.

2. Concept seeds are generated. This is a pre-processing step followed by

automatic concepts identification. For the text processing settings, the default

setting for the software is two sentences per block, as a standard recommended

by the software.

3. Thesaurus is generated. This step defines the concept by extracting the data

according to their relational meaning (Kivunja 2013). Words that were

frequently mentioned but that were less relevant, such as ‘able’, ‘called’,

‘certain’, ‘different’ and important’ were removed. In addition, words in singular

and plural forms were merged into one concept.

The following concept map resulted from analysis of the transcribed interviews.

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Source:

interviews, August 2014—coding using Leximancer

Figure 3.3: Concept Map of Political Connectedness

The theme with the highest frequency in the concept map was ‘political’. This theme is

located in the largest circle and is red. This indicates that ‘political’ was the most

important theme among the interviewees. Within the political theme, considering that

‘political’ had the largest black circle in the red circle, our interviewees perceived a

strong link between the concepts ‘political’, ‘government’, ‘connected’, ‘board’ and

‘commissioner’. The theme with the second highest frequency was ‘companies’, which

has ‘companies’, ‘business’ and ‘listed’ as concepts with strong links between them.

Table 3.6 provides the list of main themes and concepts.

Our interviewees perceived a close proximity between the themes ‘political’ and

‘company’ and the close relationship between these themes was expressed specifically

through the concept of ‘commissioner’, preceded by the concepts of ‘government’ and

‘company’.

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The close proximity of the political and company themes to the themes ‘Indonesia’,

‘resources’ and ‘sector’ indicated that our interviewees viewed the five themes as

having strong relationships among the high frequency themes. Among the sector theme,

the closest proximity to political was ‘resources’, a theme with two interlinked concepts

of ‘mining’ and ‘resources’. This has corroborated the results from the manual coding in

which the interviewees perceived that political connections went through

‘commissioner’, ‘government’ and were closely related to certain sectors: mining and

resources.

Table 3.6: Main Themes and Concepts

Main Themes (Connectivity) Concepts

Political (100%) Political

Government

Connected

Board

Commissioners

Companies (71%) Companies

Business

Listed

Sector (32%) Sector

Industry

Market (29%) Market

Competitive

Resources (24%) Resources

Indonesia (22%) Indonesia

Source: interviews, August 2014—coding using Leximancer

3.4 Summary

This section will summarise the overall findings in this chapter that relate to the key

research questions.

3.4.1 Interviewees’ Characteristics

The most common interviewee occupation was that of banker (35.5%), followed by

academics and business executives (14.7% each), fund managers, research analysts and

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lawyers (11.8% each). They all had working experience of more than 10 years, with an

average of 16 years. Majority of the interviewees had a master’s degree (50.0%),

followed by those with a bachelor degree (38.2%) and doctorates (11.8%). Based on

their education and work experience, the percentage of those who had master’s and

bachelor’s degrees with more than 16 years working experience were 84.6% and 62.5%,

respectively Those with doctorates had more than 16 years of professional experience.

These results indicate that the interviewees are well-experienced professionals in

Indonesia. The sample of interviewees are drawn from the researcher’s network as a

senior banker and come from various background of professions. It is hard to get the

responses and time of these people as evident from the fact some of them declined to

take part partly due to the sensitive nature of the research topic in Indonesia. There is no

reason to believe they should be biased.

3.4.2 Does Political Connection Matter?

The majority of interviewees perceived that political connection was needed to compete

in Indonesian business. The level of political connectedness depended on the sector of

the industry, the size of the company, and whether the company was in its early stage or

not.

The majority of interviewees mentioned that the effect of the relationship depended on

which sector the company operated within. A few qualified the scale of the company

(smaller companies required less political connection), and at which stage was company

in (political connectedness being mostly needed for the early stages), the complexity of

the business and whether there were dependencies with the government (the more

dependent they were, the more political connection was needed)

Political connection was not the most important factor for companies to succeed.

Management was the most important factor according to the perceptions of our

interviewees. Management capabilities also needed to be supported by good products

and services, a wide distribution network, good corporate governance, human resources

and R&D innovation. Regarding the external factors required for companies to succeed,

these included access to capital, the choice and growth of the sector, the ability to adapt

and local knowledge.

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3.4.3 Why the Need for Political Connection?

The results of the in-depth interviews have shown that almost all the interviewees said

there was a need for political connection, citing the following reasons:

to ensure licences and permits were obtained and extended as needed

to access information about new regulations or changes in regulations

to gain access to regulators and bureaucracy

to act as a form of protection.

The most important reason for political connectedness cited by our interviewees was for

‘political protection’. This was due to the uncertainty of regulations and a competition

landscape that could use political connectedness to attack a competitor.

3.4.4 Conditions During and After the Soeharto Era

It is clear from our interviewees that during the Soeharto era, political connection to

Soeharto was critical. Post-Soeharto, changes to democracy did not negate the need for

political connection in business. In fact, some perceived that the need for these links

was even more pronounced, due to power dispersion to local governments. This was

especially true for the oil and gas and mining sectors, where there were many

interactions relating to permits and licences from local governments.

3.4.5 Variation of Political Connection by Sectors of Industry

Most interviewees said that the need for political connectedness varied according to

which sectors of the industry they were in. The majority of interviewees believed that

the mining industry and the oil and gas industry were the two sectors that required the

most political connectedness, as they needed various licences and permits from the

central government level, and more at the regional level since regional autonomy was

established in 2001. Other sectors that required more political connectedness included

the plantation industry and the property, telecommunication and banking sectors. Most

interviewees mentioned that the consumer goods and retail sectors required the least

political connectedness.

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3.4.6 Mechanisms of Political Connection

Most interviewees viewed the measure used (i.e., whether the board member and their

family members were or were not senior officials in the government, parliament,

judiciary or military) was an appropriate indication of political connectedness.

Other measures to obtain political connections included: through the controlling owner

or majority owner/s (not necessarily through board members); whether the owners had

entered politics; the amount of campaign contributions; the number of projects won

from the government; activities in the industry association; trade group or industry

lobbying groups; and rendering the services of consultants/advisors. The first two

mechanisms—connection through the owners and owners entering politics—were the

most important.

3.4.7 Summary Data Analysis Using Leximancer

To test the robustness of the manual coding, Leximancer was used. Leximancer is data

analysis software for qualitative research, and is particularly useful for the interview

method used in this research. The software can produce an unbiased machine-driven

analysis of data that is then translated into a concept map.

The highest frequency theme in the concept map was ‘political’; this indicates that

‘political’ was the most important theme among the interviewees. The second highest

frequency theme was ‘companies’. Within the political theme, our interviewees

perceived a strong link between the concepts ‘political’, ‘government’, ‘connected’,

‘board’ and ‘commissioners’. Within ‘companies’, they perceived a strong link between

‘companies’, ‘business’ and ‘listed’.

The close proximity of ‘political’ and ‘companies’ indicates a strong relationship,

according to the interviewees’ perceptions. Besides the close proximity, the line

indicates a close relationship between ‘political’ and ‘company’, specifically through

the concepts of ‘commissioner’ and ‘company’. Additionally, the close proximity of the

political and company themes to three other themes—‘Indonesia’, ‘resources’ and

‘sector’—indicates that our interviewees’ viewed the five themes as having a strong

relationship with the high frequency themes. Regarding the sector theme, the theme

with the closest proximity to ‘political’ was ‘resources’, with the two interlinked

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concepts of ‘mining’ and ‘resources’. This again indicates a stronger relationship

between the political and resources and mining themes.

3.5 Discussion and Implications

Chua (2008) interviewed 51 people: politicians, journalists, economists, academics,

executives and business people. This significant study has provided an interesting

insight into the perceptions of professionals regarding politics and business in Indonesia

in the post-Soeharto era. Chua (2008) used sociological analysis to examine the

relationship between the state and capital in the post-Soeharto era, focusing on Chinese

‘big businesses’ in Indonesia. My approach is based on business and management

strategy and has used a mixed method approach of interviews, as well as regression

analysis. This research has contributed to the body of literature on political connection,

business and firm performance. Using interviews was not easy as the subject matter is

still sensitive for many Indonesians, let alone professionals and business people.

Ethically we kept the interviewees anonymous throughout the study, to maintain as

much openness and frankness from the interview results as possible.

Chua (2008) found that in the post-Soeharto era, capitalists were even more entrenched

after the unravelling of the New Order (of the Soeharto era), to the point that they were

more independent and dominant and had more direct access to power. From the results

of my interviews, political connectedness was indeed still viewed as necessary to

operate a business in Indonesia. However, the need was more for ‘political protection’.

The overwhelming view was that other factors existed that were more important to the

success and competitiveness of a business in Indonesia. Most important among these

was management capability.

Having political connections without good managerial skills could harm a firm’s

performance (Fan, Wong & Zhang 2007). This is supported by Boubakri, Cosset and

Saffar (2009), who found that companies with political connections had lower ROA,

which might be because lower managerial skills result from having political

connections.

Risk is inherent in any business. Hence, as mentioned by van der Eng (2004, p.5),

‘[f]irms explore[d] and found various ways to minimise risks, including political

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patronage’. In the past, political patronage was concentrated in the hands of President

Soeharto and his family. In the post-Soeharto era, the dispersion of power and the

uncertainty of the political situation in the early years of reformation made it more

difficult to seek political protection. As Chua (2008) has mentioned, business people

soon found ways to mitigate their risks and operate within the new environment. In fact,

their capital was needed even more by politicians as a source of finance to run for

office.

Exploitation of Indonesia’s natural resources has occurred since the Soeharto era.

Exploitation rights were given to Soeharto’s close friends and were viewed as a way to

strengthen his regime (Gellert 2005; Seda 2005). Despite the natural resources sector

being replaced by manufacturing as the main engine of growth since the 1980s, this

sector remains important. Fairer revenue sharing between central and local governments

from natural resources followed the establishment of regional autonomy (Alisyahbana

2005). However, this also created issues such as unclear land tenure, weak law

enforcement and inconsistent law and regulations (Fox, Adjuri & Pradnja 2005). In

addition, this also changed the corruption and political patronage patterns, whereby a

centralised system now became a diffused system (Seda 2005). This was observed and

clearly voiced by our interviewees when comparing conditions during and after the

Soeharto era.

As mentioned in the literature review, there are various ways for businesses to connect

with politics. In the US, having directors with a political background is a way to

accommodate business with bureaucrats (Agrawal & Knoeber 2001). Stronger

connections, for example with owners having close relationships, rather than directors,

and having close relationships with ministers rather than members of parliament, seem

to be beneficial to firm performance (Faccio 2007, 2010). In Thailand, when owners

enter politics this will typically increase their firm’s value (Bunkanwanicha &

Wiwattanakantang 2008). Whether political connections add value to a firm’s

performance in Indonesia will be the key research question in Chapter 4.

Similarly, our interviewees viewed that connections through owners or through the

owners entering politics were other mechanisms to connect business and politics,

perhaps in even more effective and pervasive ways.

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Chapter 4: Political Connection and Firm Performance in

Indonesia

4.1 Introduction

In this chapter, the correlation between political connection and firm performance has

been analysed to determine whether political connection could enhance a firm’s

performance. The analysis has focused on two of the last six research questions on page

3 of Chapter 1:

1. Do political connections affect a firm’s performance in Indonesia?

2. Does the number of politically exposed persons (PEPs) on a board affect a

firm’s performance in Indonesia?

4.2 Background and Hypotheses

4.2.1 Research Background

During the Soeharto regime, politically well-connected firms were provided with

substantial economic benefits in the form of exclusive import licences, bail-outs and

favourable financing (Borsuk & Chng 2014; Muhaimin 1991; Shin 1989; Yoshihara

1988). One of the many advantages of being politically connected in business is easier

access to the debt market (Khwaja & Mian, 2005). Backman (2001) has noted that

Tommy Soeharto (President Soeharto’s son) was able to obtain easy debt financing for

his corporations, by virtue of his father’s intervention.

Fisman (2001) has studied the movement of company stock prices for those connected

to President Soeharto with news about the President’s health to estimate the value of

political connection in Indonesia. Johnson and Mitton (2003) have examined the effects

of political connectedness in Malaysia by analysing changes in the market value of

connected firms in the wake of the AFC. Faccio (2007) has studied whether political

connections affected firm performance across the Asia Pacific. Overall, these studies

support the notion that political connections affect a firm’s market value.

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Bunkanwanicha and Wiwattanakantang (2008) have approached the matter of politics

and business differently. They investigated the effect of business owners seeking the top

office in Thailand. They found that the market valuation of firms increased significantly

when the business owners were connected with the Prime Minister of Thailand. There

was no significant effect of political power on financing; rather, the person with the

power used policy regulations as a mechanism to grant state favours to politically

connected firms. Such policies hindered domestic and foreign competitors. As a result,

these politically connected firms were able to capture a greater market share.

Other researchers have found that political connection without good management could

be potentially harmful to a firm’s performance (Fan, Wong & Zhang 2007). Their

results have suggested that firms with political connection had lower ROA. Fan, Wong

and Zhang’s (2007) paper has suggested that other factors were more dominant in

affecting a firm’s value, notably managerial skills.

Costs are incurred through having political connections; for example, the distribution of

the company’s wealth to politicians in exchange for (1) the rights to establish

monopolies, (2) the granting of concessions, licences, quotas and permits, and (3)

preferential treatment in the tendering of construction projects (Pathmanand 2006).

Hence, empirical quantitative analysis is needed to check if political connections have

any value to a firm’s performance.

4.2.2 Research Hypotheses

North (1991) has explained that formal and informal institutions must exist in a country

for that country’s economy and market to function. Formal institutions consist of formal

rules and regulations, laws and statutes, property rights, policies and procedures, and

govern the socio-economic and political aspects of society. Informal institutions can

include sanctions, customs, traditions and unwritten codes of conduct.

Neoclassical economics assumes that information flow between buyers and sellers is

perfect, transactions are frictionless, and that an unconstrained market access exists for

both buyers and sellers (Coase 1937). However, it is well known that these assumptions

are not realised, even in developed markets, and the violation of these ‘rules’ is even

more pronounced in emerging markets (Khanna & Palepu 2010). Thus, Khanna and

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Palepu (2010) have argued that for emerging markets, the institutional approach helps to

build a more realistic model than does the approach of neoclassical economics.

The existence of transactional costs and the asymmetry of information cause market

imperfection. This results in the non-existence or lack of market intermediaries in

emerging markets, known as ‘institutional voids’ (Khanna & Palepu 2010). Khanna and

Palepu (2010) have expanded the research from previous studies on institutional

economics by Coase (1937), Williamson (1985) and North (1991).

Informal institutions are more pertinent in emerging market economies where the

contract implementation is more fragile due to deficient legal frameworks (Khanna &

Palepu 2010). As such, informal institutions are important to minimise uncertainty and

enhance reliability (Khanna & Palepu 1997; Peng & Jiang 2002). Relational ties,

networks and government contacts have been prevalent and are assigned an enabler and

extra role in business functioning. Peng and Jiang (2002) have argued that two reasons

exist to explain why informal institutions are important: formal institutions are not able

to provide a credible legal framework, and the volatility of political setups could affect

the function of government and market operations.

Informal institutions and personal ties in Asian markets are vital to accomplish

corporate targets and govern corporate and business issues (Peng & Jiang 2002;

Studwell 2008). This is because emerging Asian economies have weak corporate

governance (La Porta, Lopez-de-Silanes & Shleifer 1999). The types of informal

structures relied upon by Asian family firms are networks that are based on trust and

loyalty with family, close friends and governmental officials (Peng & Jiang 2002).

Being politically connected can therefore be considered as a way of using those

informal institutions to maintain competitiveness.

Having political connections could result in better firm performance. This is because

firms can obtain some benefits, such as easier access to debt financing (Khwaja & Mian

2005); in addition, more favourable regulations for politically connected companies can

be achieved (Bunkanwanicha & Wiwattanakantang 2008).

Therefore, the hypotheses of this study can be stated as follows:

hypothesis 1: politically connected firms have better firm performance

75

hypothesis 2: firm performance is associated with the number of board members

who are politically connected.

The analysis focuses on the last two research questions on page 3 of Chapter 1 and has

been re-iterated on section 4.1 Chapter 4.

4.3 Research Design

4.3.1 Sample and Time Period

The research sample consists of companies listed on the IDX. Annual data have been

used in the analysis; the financial year-end date is 31 December in Indonesia. For

comparability, listed companies in the financial sector have been excluded. This was

done as the financial and market ratios calculated for companies in the financial sector

are different to those for companies in the non-financial sector.

The sample period ran from 2009 to 2013. The sample period began in 2009 to avoid

any confounding effects of the GFC that began in 2008.9 The choice of a five-year

observation was to obtain enough data for running the regression. The number of

observations totalled 2,196. This decreased to 1,989 observations due to the exclusion

of ROA missing data.

4.3.2 Research Data

4.3.2.1 Data Collection Method

The secondary data of all companies listed on the IDX were collected from a number of

sources, as described below:

1. Financial statements: the balance sheets, income statements, cash flows,

financial and operating ratios, as well as market data (market capitalisation,

enterprise values, dividends and share prices) of all listed Indonesian companies

(i.e., 485 companies) were sourced from Bloomberg and IDX for five years.

2. Announcements about changes to the boards of commissioners or boards of

directors made by the listed companies. These announcements are required by

9 The majority of the Indonesian companies were not significantly affected by the GFC (Tambunan, 2010;

Wie 2012).

76

IDX regulation and were released to the general public and published in

newspapers.

3. Lists of directors and commissioners of all listed companies in Indonesia. These

were collected from annual reports, company websites and IDX website.

To compile a dataset of politically connected listed companies, each director or

commissioner had to have their PEP status verified. This involved manual checking of

their resumes from annual reports and company websites.

4.3.2.2 Independent Variables

This study has adapted Faccio’s (2006, 2010) definition of politically connected firms.

Faccio has defined a company as being politically connected if one of its top directors

(CEO, president, vice president or secretary) is a MP, or a minister, or has been closely

related to a top politician or party.10

In contrast, I classify a company as being politically

connected if any members of the board of directors or commissioners are:

1. Presidents, former presidents, families and aides to presidents.

2. Ministers, former ministers or in a position at a similar level to ministers (e.g.,

police chief, army chief, attorney general chief judge).

3. Director-generals or secretary-generals or deputy ministers (a position one level

below a minister) and directors (two positions below the ministerial level) and

former officials of the above.

4. Public officials or former public officials in a regulator body such as the

Financial Services Authority (OJK), the Central Bank (BI) or the MOF.

5. An immediate family member of individuals mentioned in numbers 1–5, such as

spouse, parents, siblings, children and spouse’s parents or siblings.

6. Any individuals publicly known (or actually known) to be a close personal or

professional associate.

Firm performance has been measured by ROA, Tobin’s Q and market-adjusted returns.

Calculation of ROA uses data from financial statements and the calculation of Tobin Q

uses data from financial statements and market data from IDX. The calculation of

10

However, unlike Faccio (2006, 2010), I do not define a company as being politically connected if at

least one of its large shareholders (i.e., a shareholder controlling at least 10% of voting shares) due to the

lack of readily and publicly available data on the UBOs of the listed companies in Indonesia.

77

market-adjusted return uses the data of companies’ share prices and the price of the

Index Harga Saham Gabungan (IHSG or Jakarta Composite Index) as the market price.

The data of a company’s establishment, which will be used as measurement of the age

variable, have been compiled from annual reports and company websites. The exchange

rates of IDR to USD have been obtained from Bloomberg.

4.3.3 Research Models

4.3.3.1 Dependent Variables

I have followed Faccio (2006, 2010), using ROA as a measure of accounting operating

firm performance. I have also followed Morck, Shleifer and Vishny (1988) and have

used Tobin’s Q as a proxy for a firm’s market valuation. To compute Tobin’s Q, I used

the method suggested by Schlingemann, Stulz & Walkling (2002). Tobin’s Q is defined

as the ratio of the book value of assets minus the book value of equity plus the market

value of equity to the book value of assets. Further, following Braun and Sharma

(2007), market-adjusted return has been applied as another measure of market-based

firm performance. The market-adjusted return has been calculated by subtracting the

share price return with market return; in this case, I used the IDX composite price index

(IHSG).

Differences exist between accounting operating firm performance and market-based

firm performance. Demsetz and Villalonga (2001) have noted that while accounting

firm performance is backward looking, Tobin’s Q and market-adjusted returns are more

forward looking. Accounting firm performance measures what management has

achieved. The achievement is measured by accountants following a set of accounting

standards. In contrast, Tobin’s Q reflects the value assigned by investors on a firm’s

intangible assets, based on predicted future revenue streams. Hence, it could be seen as

assigning a value on what the management may achieve. Tobin’s Q is therefore

determined by investors’ perceptions (i.e., optimism, pessimism) (Demsetz &

Villalonga 2001). Similar to Tobin’s Q, market-adjusted returns reflect the perceptions

of investors regarding the value of companies relative to the overall market (Braun &

Sharma 2007).

78

4.3.3.2 Control Variables

I have used the following control variables:

Size = log normal of total asset for each company.

Leverage = proportion of total debt to total assets for each company.

Age = length of company’s establishment.

deltaExchange Rate = percentage change of IDR to USD exchange rates from

the previous year.

Majumdar (1997) and Braun and Sharma (2007) have examined size and age, and their

effect on firm performance. Size has also been used by Helwina and Lukviawarman

(2007), as total assets are the resources within firms used to run the business and

generate returns.

Dogan (2013) has examined the effect of leverage on ROA using firms in Turkey.

Braun and Sharma (2007) have also used leverage as a control variable as it could

provide a mechanism to check agency cost. In addition, Bartov and Bodnar (1994) have

applied change in currency as control variable for examining a firm’s performance as

companies with transactions in foreign exchanges would be exposed to exchange rate

movements. Companies with net short economic positions would suffer if depreciation

occurred, but they could benefit from appreciation. Conversely, companies with a net

long economic position could benefit from appreciation depreciation.

4.3.3.3 Ordinary Least Squares

This study aims to examine the effects of board members with political affiliations and

connections on firm performance, using control variables such as size, age, leverage and

changes in exchange rates as a macroeconomic indicator. Firm performances are

measured by their ROA, Tobin Q and market-adjusted returns. Political connection may

not be the only variable determining firm performance.

This research has used data from many companies over many years. Thus, panel data is

appropriate for this study. If the companies had the same number of time series data,

this was known as balanced panel data. However, the number of observations within

79

companies had different numbers of time series data, so the data used were unbalanced

panel data.

4.3.3.4 Research Model

The research model has been adapted from a similar study by Helwina and

Lukviawarman (2007) in corporate governance. The difference in the model is that this

study has applied PEP and the number of PEP (NUM) instead of board composition

(BODCOM) and concentrated ownership (CONTR),11

whereas size and leverage have

remained as control variables.

This research model has also followed an empirical study by Faccio (2007), who used

accounting performances such as ROA and market-to-book ratios as the dependent

variables and political connection as the independent variable.

Thus, the research model used in this study is as follows:

yi,t = α + β1PEPi,t + β2NUMi,t + β3SIZEi,t + β4LEVi,t + β5AGEi,t + β6deltaExchRatei,t +

Ei,t (1)

yi,t = ROA, Tobin’s Q, and market-adjusted return for every i company in year t

ROAi,t = net incomei,t/total assetsi,t

Tobin’s Q = (total assetsi,t - total equityi,t + market capi,t)/total assetsi,t

Market-adjusted return = (pricei,t – pricei,t-1) – (pricem,t – pricem,t-1)

PEPii,t = Dummy variable of politically connected firms for every i company in

year t, which takes the value of 0 for company that does not have political

connection and a value of 1 otherwise

NUMi,t = Number of politically connected people for company i in year t

SIZEi,t = ln (log normal) of total assets for company i in year t

LEVi,t = proportion of total debt to total assets for company i in year t

AGEi,t = length of company i establishment until year t

deltaExchRatet = percentage change of IDR/USD for year t

Ei,t = error term for company i in year t

a = constant

11

BODCOM is defined as the proportion of Independent Commissioners to total number of

commissioners and CONTR is defined as individual or institutional owning 50% or more shares.

80

b = coefficient of variables.

A panel regression with fixed effect was used, as the sample of observations did not

show any significant change throughout the years. The sample has remained relatively

stable. Fixed effects are an alternative to random effects and the pooled least square

method. The fixed effect approach provides an intercept for each individual (company)

and/or time.

4.4 Results

4.4.1 Overview of Sample

Table 4.1 shows the number of companies with PEPs increased during the sample

period 2009 to 2013. This number was around 23 to 27% of the total companies listed in

IDX and 29 to 34% of the total non-financial companies in the IDX. Moreover, the

highest number of PEP in one company was seven. Most companies had one or two

PEPs on their boards.

81

Table 4.1: Number of Companies with PEP and the Number of PEPs

Number of PEPs Number of Companies

2009 2010 2011 2012 2013

Total Companies Listed on IDX 497 520 546 571 603

Total Non-Financial Companies 394 415 439 462 486

Total PEP Companies 115 137 148 156 158

Number of PEPs in Companies

1 66 81 86 91 91

2 31 33 34 34 30

3 9 13 17 16 21

4 5 4 3 5 6

5 2 4 5 5 4

6 1 1 1 3 3

7 1 1 2 2 3

Total PEP Companies 115 137 148 156 158

Source: regression results

4.4.2 Descriptive Statistics and Correlation

Before examining the regression results, the descriptive statistics of the data are given in

the following table.

Table 4.2: Descriptive Statistics of Variables

Variable Observations Mean Std Dev Minimum Maximum

PEP 1,989 0.3589 0.4798 0 1

NUM 1,989 0.6415 1.1351 0 7

ROA 1,989 6.1629 30.771 -135.8 890.2

Tobin’s Q 1,989 0.9252 1.5458 0 20.1991

Return 1,940 -1.4489 5.0385 -52.9087 18.685

Age 1,989 25.182 15.9574 -4 108

DeltaExchangeRate 1,989 0.0139 0.0844 -0.0990 0.1009

TD/TE 1,989 0.6668 4.2499

-

110.5789 65.2232

Source: regression results

82

Table 4.2 shows there were 1,989 observations in this study; except for the market-

adjusted return (return), only 1,940 have been included, as incomplete data were derived

from few companies. Value was the most diverse of the variables as it had the highest

value of standard deviation. The mean value of PEP showed that 36% of companies in

the observations through the sample period had PEP on their boards.

Table 4.3: Correlation between Variables

PEP NUM ROA

Tobin’

s Q Return SIZE LEV AGE

delta

Exch

Rate

PEP 1

NUM 0.7454 1

ROA -0.0129 0.0138 1

Tobin’s Q 0.0831 0.088 0.0888 1

Market-

Adjusted 0.0515 0.0418 0.1291 0.1291 1

SIZE 0.403 0.3895 -0.0683 0.0735 0.0958 1

LEV

(TD/TE) -0.0161 -0.0128 0.0439 0.0314 0.1235 0.1778 1

AGE 0.221 0.2681 0.0137

-

0.0274 0.3869 0.0208 0.0051 1

deltaExch

Rate -0.0022 0.0062 -0.0247

-

0.0402 -0.016 -0.0167 0.0168 -0.0392 1

Source: regression results

The correlation table shows no perfect multicollinearity existed between variables. As

the correlation value was closer to 1, this meant that the variables had a higher

relationship in moving to the same direction. Conversely, if the value was closer to -1,

this meant that the variables had a higher relationship in moving to a different direction.

4.4.3 Comparison of PEP and Non-PEP Companies

Based on the sectors of industry classification as per IDX, Table 4.4 provides the details

of PEP companies in each industry (sectors and industry are used interchangeably).

83

Table 4.4: Politically Connected Firms and Sectors of the Industry

Industry

% of Companies-PEP to Total Companies in the

Industry

2009 2010 2011

No % No % No %

Agriculture 4 28.57% 5 29.41% 7 38.89%

Basic Industry & Chemicals 9 15.79% 15 25.00% 14 23.73%

Consumer Goods 10 33.33% 12 37.50% 14 43.75%

Infrastructure, Utilities &

Transportation 12 29.27% 15 35.71% 16 33.33%

Mining 13 37.14% 16 41.03% 17 42.50%

Miscellaneous Industry 16 43.24% 17 44.74% 19 48.72%

Property, Real Estate & Building

Construction 24 47.06% 24 43.64% 25 46.30%

Trade, Service & Investment 27 29.35% 32 33.68% 34 34.34%

Industry 2012 2013 Average

No % No % No %

Agriculture 8 44.44% 10 58.82% 7 40.03%

Basic Industry & Chemicals 16 25.40% 17 27.42% 14 23.47%

Consumer Goods 14 45.16% 13 41.94% 13 40.34%

Infrastructure, Utilities &

Transportation 18 36.00% 18 36.73% 16 34.21%

Mining 19 46.34% 22 55.00% 17 44.40%

Miscellaneous Industry 18 46.15% 18 46.15% 18 45.80%

Property, Real Estate & Building

Construction 25 44.64% 26 46.43% 25 45.61%

Trade, Service & Investment 36 35.64% 35 35.71% 33 33.75%

Table 4.4 shows the number of PEP companies in every industry and the percentage of

this compared to total companies in the industry. It shows that property, real estate and

building construction are the top three industries, with the highest number of companies

with PEP compared to other industries in 2009 to 2012. However, in 2013, property,

real estate and building construction became the fourth and agriculture had the highest

number of companies with PEP. Conversely, basic industry and chemicals had the

lowest percentage of PEP companies compared to other industries from 2009 to 2013.

84

This indicates that different industries have different political connection needs

characteristics.

On average, the category miscellaneous industry had the highest number of PEPs. The

second was property and infrastructure. The third was the construction and mining

industries.

The following table shows the ranking of PEP concentration in the industry.

Table 4.5: Ranking of Companies with a PEP in the Industry

Rank

% of Companies with a PEP in the Industry

2009 2010 2011 2012 2013

Ind % Ind % Ind % Ind % Ind %

1 2 15.79% 2 25.00% 2 23.73% 2 25.40% 2 27.42%

2 1 28.57% 1 29.41% 4 33.33% 8 35.64% 8 35.71%

3 4 29.27% 8 33.68% 8 34.34% 4 36.00% 4 36.73%

4 8 29.35% 4 35.71% 1 38.89% 1 44.44% 3 41.94%

5 3 33.33% 3 37.50% 5 42.50% 7 44.64% 6 46.15%

6 5 37.14% 5 41.03% 3 43.75% 3 45.16% 7 46.43%

7 6 43.24% 7 43.64% 7 46.30% 6 46.15% 5 55.00%

8 7 47.06% 6 44.74% 6 48.72% 5 46.34% 1 58.82%

Ind=industry

Table 4.5 above shows the ranking of sectors of industry based on the number of a

company’s PEP ratio to total companies in the particular industry. The sectors of

industry notation refers to the industry classification by IDX:

industry no. 1: agriculture

industry no. 2: basic industry and chemical

industry no. 3: consumer goods

industry no. 4: infrastructure, utilities and transportation

industry no. 5: mining

industry no. 6: miscellaneous

industry no. 7: property, real estate and building construction

industry no. 8: trade, service and investment.

85

The highest ratio was ranked for no. 8; the system calculated as the higher the order, the

higher the rank. For example for the year 2013, the highest ratio of PEP concentration in

the industry was in agriculture (58.82% of all companies in agriculture had PEP on their

boards), followed by mining (55.00%) and property, real estate and building

construction (46.43%).

Finally, Table 4.6 provides a statistical explanation as to whether PEP and non-PEP

companies had different financial characteristics.

Table 4.6: Mean Value of Variables for PEP Companies and Non-PEP Companies

Variables 2009 2010 2011 2012 2013 Average

Market Capitalisation

Mean Value of PEP Companies (in

Trillion IDR) 2.4512 3.1651 3.1665 3.4258 3.5018 3.1421

Mean Value of Non-PEP Companies

(in Trillion IDR) 10.5652 13.8799 14.2285 14.7823 14.5375 13.5987

Mean Value of PEP to Non-PEP 4.31 4.39 4.49 4.32 4.15 4.332

P-Value 0.0056 0.0003 0.0004 0.0003 0.0003

Median Value of PEP Companies (in

Trillion IDR) 0.3508 0.4542 0.6319 0.7655 1.0117 0.6428

Median Value of Non-PEP

Companies (in Trillion IDR) 1.481 3.2364 3.4794 3.3276 3.4287 2.9906

Median Value of PEP to Non-PEP 4.22 7.12 5.51 4.35 3.39 4.918

P-Value 0.3817 0.0003 0.0006 0 0

Sales

Mean Value of PEP Companies (in

Trillion IDR) 1.6756 1.6447 1.781 2.0175 2.3301 1.8898

Mean Value of Non-PEP Companies

(in Trillion IDR) 5.8928 6.2015 7.5381 8.2046 8.8124 7.3299

Mean Value of PEP to Non-PEP 3.52 3.77 4.23 4.07 3.78 3.874

P-Value 0.0005 0.0002 0 0 0

Median Value of PEP Companies (in

Trillion IDR) 0.3872 0.4289 0.543 0.6819 0.8594 0.5801

Median Value of Non-PEP

Companies (in Trillion IDR) 1.7306 1.7902 2.1282 2.6165 3.0646 2.266

Median Value of PEP to Non-PEP 4.47 4.17 3.92 3.84 3.57 3.994

P-Value 0 0 0 0 0

Total Assets

Mean Value of PEP Companies (in

Trillion IDR) 2.005 1.9744 2.1113 2.596 3.2694 2.3912

Mean Value of Non-PEP Companies 8.106 8.5192 9.8442 10.7604 12.9298 10.0319

86

Variables 2009 2010 2011 2012 2013 Average

(in Trillion IDR)

Mean Value of PEP to Non-PEP 4.04 4.31 4.66 4.15 3.95 4.222

P-Value 0 0 0 0 0

Median Value of PEP Companies (in

Trillion IDR) 0.5427 0.6008 0.8414 1.059 1.367 0.8822

Median Value of Non-PEP

Companies (in Trillion IDR) 2.8302 3.5896 4.0038 4.186 5.5536 4.0326

Median Value of PEP to Non-PEP 5.22 5.97 4.76 3.95 4.06 4.792

P-Value 0 0 0 0 0

Profits

Mean Value of PEP Companies

(in Trillion IDR) 55.2691 70.5697 84.9267 72.5038 57.1912 68.0921

Mean Value of Non-PEP Companies

(in Trillion IDR) 15.2987 13.3925 16.9407 13.2619 13.0585 14.3904

Mean Value of PEP to Non-PEP 3.6127 5.2693 5.0132 5.4671 4.3796 4.7484

P-Value 0.0244 0.0031 0.0005 0.0047 0.0588

Median Value of PEP Companies (in

Trillion IDR) 10.9402 19.2589 15.2988 12.8254 10.8141 13.8275

Median Value of Non-PEP

Companies (in Trillion IDR) 1.221 2.1692 3.1416 4.1591 4.2942 2.997

Median Value of PEP to Non-PEP 8.9602 8.8781 4.8698 3.0837 2.5183 5.662

P-Value 0.0001 0.0002 0 0.0144 0.0389

ROA

Mean Value of PEP Companies

(in Trillion IDR) 5.6824 5.5303 4.4524 5.474 5.7418 5.5661

Mean Value of Non-PEP Companies

(in Trillion IDR) 6.8540 7.6789 9.7412 5.2875 4.5244 6.5369

Mean Value of PEP to Non-PEP 1.2062 1.3885 2.1879 0.9659 0.7880 1.1744

P-Value 0.2038 0.2985 0.0904 0.4335 0.1477 0.2056

Median Value of PEP Companies (in

Trillion IDR) 4.2 4.6 4.1 5.25 4.15 4.3

Median Value of Non-PEP

Companies (in Trillion IDR) 4.1 5.1 4.55 4.3 4 4.5

Median Value of PEP to Non-PEP 0.9762 1.1087 1.1098 0.8190 0.9639 1.0465

P-Value 0.6084 0.1705 0.8149 0.3692 0.8115 0.717

TDTE

Mean Value of PEP Companies

(in Trillion IDR) 1.4078 0.0141 0.5259 0.5541 0.8117 0.6425

Mean Value of Non-PEP Companies

(in Trillion IDR) 0.9233 0.8253 0.4077 0.7454 0.518 0.6819

Mean Value of PEP to Non-PEP 0.6558 58.5319 0.7752 1.3452 0.6382 1.0613

P-Value 0.1986 0.1615 0.3831 0.1949 0.0575 0.4287

87

Variables 2009 2010 2011 2012 2013 Average

Median Value of PEP Companies (in

Trillion IDR) 0.4513 0.3661 0.4127 0.3769 0.4166 0.4047

Median Value of Non-PEP

Companies (in Trillion IDR) 0.3692 0.4084 0.3025 0.3654 0.3599 0.3612

Median Value of PEP to Non-PEP 0.8181 1.1155 0.7330 0.9695 0.8638 0.8925

P-Value 0.1619 0.8078 0.8138 0.3659 0.6300 0.6611

Number of Observations

Non-PEP Companies 259 259 260 263 254 259

PEP Companies 111 133 144 152 154 139

*p-value is significant when the value is smaller than 1%

Table 4.6 provides the average value of market capitalisation, sales, total assets, profits,

ROA and leverage (total debt/total equity) for PEP companies and non-PEP companies.

It also illustrates by how many times the value of financial characteristics of PEP

companies outweigh the non-PEP companies. The probability value (p-value) was

included to examine whether a significant difference existed between both groups of

companies.

The results have revealed that PEP companies have a higher average (mean) value of

market capitalisation, sales and total assets. The mean value of market capitalisation for

PEP to non-PEP companies was 4.31 times in 2009; this means that PEP companies in

2009 had 4.31 times the average market capitalisation when compared to non-PEP

companies. Further, the p-values indicate the obvious differences in average values of

the financial characteristics between PEP and non-PEP companies, as the hypothesis is

that there is no difference between these values.

In addition, PEP companies had a higher median value of market capitalisation, sales,

total assets and profits when compared to non-PEP companies. The p-values indicate

the obvious difference in the median value of financial characteristics between PEP and

non-PEP companies, as the hypothesis is that there is no difference between these

values.

The mean and median value of PEP and non-PEP companies did not differ in value.

This means that the ROA and leverage values between PEP and non-PEP companies

were relatively similar, even though non-PEP companies always had a higher value

across time.

88

4.4.4 Regression Model Results

The regression was conducted three times for each dependent variable: ROA, Tobin’s Q

and Return (market-adjusted return) with the same specifications of independent

variables as in Model 1. Table 4.6 shows the regression results.

Table 4.7: Regression Results

Variables Panel

ROA Tobin’s Q Return

Constant 23.0766*** 0.1289 -7.1305***

(5.8726) (0.2946) (0.8923)

PEP 0.1026 0.1773** -0.5711**

(1.5395) (0.0772) (0.2325)

Size -1.3987*** 0.0491** 0.4117***

(0.4293) (0.0215) (0.0651)

TDTE -0.1923 -0.0144* 0.0021

(0.1625) (0.0081) (0.0244)

Age 0.1127** 0.0019 -0.0113*

(0.0444) (0.0022) (0.0067)

deltaExchange 4.9642 -0.3417 22.9969***

(8.1869) (0.4106) (1.2499)

Observations 1984 1984 1935

Prob(F) 0.0041 0.0003 0.0000

Adj R-squared 0.0062 0.0090 0.1653

*,**,*** means significant in 10%, 5% & 1% respectively

Numbers in parentheses are standard errors for each coefficient

Source: regression results

Table 4.7 reveals that all the models are valid as the value of F-statistics was significant:

as shown, the value is less than 1%. The R-squared values are 0.62%, 0.90% and

16.53% respectively. This means the independent variables could explain 0.62%,

0.90% and 16.53% of the dependent variable respectively.

89

The results indicate that PEPs have a significant effect on Tobin’s Q and market-

adjusted returns, but not on ROA. PEPs have positive effects on Tobin’s Q. This implies

that companies with PEPs have higher Tobin’s Q compared to companies without PEPs,

and vice versa for market-adjusted returns.

Size has a significant effect on ROA, Tobin’s Q and market-adjusted returns. The

effects are positive on Tobin’s Q and Return, but negative on ROA. This means that

higher total assets would increase Tobin’s Q and Return, but would decrease ROA.

Moreover, leverage only has an effect on Tobin’s Q, with a negative sign. This implies

that higher leverages would decrease the value of Tobin’s Q. In contrast, changes in

exchange rates only have an effect on market-adjusted returns with positive signs. The

higher the change in exchange rates, the higher the value of market-adjusted returns.

Finally, variable age has significant effects on ROA and market-adjusted returns, with

different signs. The older companies would have a higher value of ROA, but a lower

value of market-adjusted return.

To answer the second hypothesis, an investigation into the effects of the number of

board members was conducted. The regression results of NUM to ROA, Tobin’s Q, and

market-adjusted returns are as follows.

90

Table 4.8: Regression Results for NUM as Dependent Variables

Variables Panel

ROA Tobin’s Q Return

Constant 198.1467*** 0.1780 25.9962***

(16.0815) (0.2995) (2.4927)

NUM 0.2609 0.0814** 0.0932

(1.7206) (0.0337) (0.2561)

Size -18.5997*** 0.0475** 0.6392***

(1.2653) (0.0216) (0.1982)

TDTE 0.0000 -0.0143* 0.0000**

(0.0000) (0.0081) (0.0000)

Age 2.7798*** 0.0016 -1.4523***

(0.5414) (0.0023) (0.0810)

deltaExchange 0.0013 -0.3504 27.5344***

(7.6799) (0.4105) (1.1539)

Observations 1984 1984 1935

Prob(F) 0.0000 0.0003 0.0000

Adj R-squared 0.1252 0.0093 0.3572

*,**,*** means significant in 10%, 5%, 1% respectively.

Numbers in parentheses are standard errors for each coefficient

Source: regression results

These results indicate that the numbers of politically connected people (NUM) have a

significant effect on Tobin’s Q only, but do not have any significant effect on ROA and

market-adjusted returns.

Finally, an investigation of the effects of NUM on ROA, Tobin Q and returns within the

sample of companies that had changed their PEP numbers was conducted. The results

are as follows.

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Table 4.9: Regression Results for Changing NUM

Variables Panel

ROA Tobin’s Q Return

Constant -12.2521*** -0.7666 -8.5579***

(4.3128) (0.5270) (1.5463)

NUM 0.7407* 0.0136 0.1866

(0.3855) (0.0491) (0.1382)

Size 1.0361*** 0.1122*** 0.4445***

(0.2957) (0.0366) (0.1060)

TDTE -0.0000 -0.0140 0.0000**

(0.000) (0.0108) (0.0000)

Age 0.0355 0.0059* -0.0103

(0.0254) (0.0033) (0.0091)

deltaExchange -18.5487*** -0.9873 20.9548***

(5.7303) (0.7119) (2.0568)

Observations 712 764 711

Prob(F) 0.0000 0.0010 0.0000

Adj R-squared 0.0378 0.0202 0.1572

*,**,*** means significant in 10%, 5%, 1% respectively.

Numbers in parentheses are standard errors for each coefficient

Source: regression results

The results indicate a significant and positive relationship between NUM and ROA,

signifying that a higher number of politically connected persons in a company will

result in a higher value of ROA.

Size had a significant effect on the three dependent variables with positive signs.

Leverage had a significant positive effect on market-adjusted returns, although with a

relatively low value. Age had a significant effect on Tobin’s Q with a positive sign,

implying that older companies would have a higher value of Tobin’s Q. Finally,

changes in exchange rates had a significant effect on ROA and market-adjusted returns

with different signs. Greater changes in exchange rates would decrease the value of

ROA, but would increase the value of market-adjusted returns.

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4.5 Robustness Tests

Robustness and further explorations have been conducted:

1. the addition of companies within the top 40 business groups to the definition of

PEP

2. the addition of industry dummies to Model 1

3. a matched pair test of the ROA means.

4.5.1 Robustness Test 1

Data from the top 40 non-financial listed companies were added to the definition of PEP

to obtain a deeper analysis. The reason for including these top 40 business groups is that

Indonesian business groups have dominated Indonesia’s business landscape. They have

harnessed political links since Soeharto’s regime, and these links remain prevalent even

in the post-Soeharto era. Their inclusion can be considered a ‘proxy’ of the owners’

links with politics. The cut off for including only the top 40 business groups was

considered sufficient for a convenient sample. These groups represent three times

(triple) the total revenue of the next top 40 business groups, as modified from the

Forbes Indonesia Publication. The regression results from including these top 40

business groups are as follows.

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Table 4.10: Regression Results with Top 40 Business Groups

Variables Panel

ROA Tobin’s Q Market

Constant 22.6221*** 0.0716 -6.6762***

(5.7676) (0.2893) (0.8785)

PEP+TOP 40 -0.4179 0.1594** -0.1952

(1.4688) (0.0737) (0.2231)

Size -1.3534*** 0.0525** 0.3738***

(0.4223) (0.0212) (0.0642)

TDTE -0.1927 -0.0143* 0.0020

(0.1625) (0.0082) (0.0244)

Age 0.1145** 0.0022 -0.0129*

(0.0442) (0.0022) (0.0067)

deltaExchange 4.8997 -0.3446 23.0673***

(8.1864) (0.4107) (1.2515)

Observations 1984 1984 1935

Prob(F) 0.0040 0.0004 0.0000

Adj R-squared 0.0062 0.0087 0.1630

*,**,*** means significant in 10%, 5%, 1% respectively

Numbers in parentheses are standard errors for each coefficient

Source: regression results

Table 4.10 shows that all the models are valid. The value of F-statistics is significant, as

revealed by the value being less than 1%. The R-squared values are 0.62%, 0.87% and

16.30% respectively. The results show that PEPs have significant and positive effects

on Tobin’s Q, but PEPs have neither any significant effect on ROA nor one on market-

adjusted returns.

The main change from previous results is that PEPs no longer have a significant effect

on market-adjusted returns. The control variables results have remained the same.

Further, t-tests were conducted at first for all companies, including the top 40 business

groups, to check the result’s robustness. Second, all companies compared with SOE,

and the third all companies compared with Badan Usaha Milik Negara (BUMN or

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State-owned Enterprises), Bakrie and MNC groups (BBM). The reason for the various

levels of tests was to check whether there would be any difference if the level of

political connectedness were different. The assumption is that SOE have a very high

level of state ownership. Bakrie and MNC groups have controlling shareholder(s) who

have been chairman of political parties.

Table 4.11: T-test of ROA between All Companies and Top 40 Business Group

ROA All Companies SOE Companies

Mean 6.1016 7.6667

Variance 973.0071 308.1059

Observations 1911 78

P-Value 0.2302

ROA All Companies SOE+Bakrie+MNC

Mean 6.2368 5.3019

Variance 1008.967 223.1153

Observations 1832 157

P-Value 0.2530

ROA All Companies Top 40 + SOE

Mean 6.2780 5.5051

Variance 1086.109 150.8597

Observations 1693 296

P-Value 0.2357

*p-value is significant when the value is smaller than 1%

The t-test results indicate no difference in ROA between all companies and SOE, all

companies and BBM, and also all companies and the top 40 business groups.

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4.5.2 Robustness Test 2

Industry dummies were entered to Model 1 to check the robustness. The industry

classification is based on IDX and derived also from the interviews. The rationale for

including industry dummies was to check whether the more regulated industries

required more political connectedness, and the subsequent effect on firm performance.

I add the following industry dummies to Model 1, whereby:

D1 = dummy variable; value 1 for basic industry and chemicals

D2 = dummy variable; value 1 for consumer goods industry

D3 = dummy variable; value 1 for infrastructure, utilities and transportation

industry

D4 = dummy variable; value 1 for mining industry

D5 = dummy variable; value 1 for miscellaneous industry

D6 = dummy variable; value 1 for property, real estate and building construction

industry

D7 = dummy variable; value 1 for trade, service and investment industry.

The regression results are as follows.

Table 4.12: Regression Results with Industry Dummies

Variables Panel

ROA Tobin’s Q Market

Constant 21.1787*** 0.9309*** -7.1119***

(7.0460) (0.3441) (1.0724)

PEP 0.0405 0.2001*** -0.5734**

(1.5591) (0.0761) (0.2354)

Size -1.2868*** 0.0414* 0.4197***

(0.4410) (0.0215) (0.0669)

TDTE -0.1864 -0.0135* 0.0038

(0.1625) (0.0079) (0.0244)

Age 0.1181** 0.0029 -0.0152**

(0.0459) (0.0022) (0.0069)

deltaExchange 4.9856 -0.3032 23.0156***

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Variables Panel

ROA Tobin’s Q Market

(8.1772) (0.3993) (1.2475)

D1 -1.1145 -0.9492*** -0.1221

(3.6415) (0.1778) (0.5559)

D2 5.7760 0.0377 1.1642*

(3.9510) (0.1929) (0.6026)

D3 -2.4605 -0.9101*** -0.2417

(3.7765) (0.1844) (0.5778)

D4 0.0163 -0.4318** -0.0627

(3.8479) (0.1879) (0.5881)

D5 -3.3799 -1.2479*** 0.3236

(3.8852) (0.1897) (0.5920)

D6 -0.1289 -1.0402*** -0.2599

(3.6865) (0.1800) (0.5627)

D7 1.8979 -0.6586*** -0.2599

(3.4847) (0.1702) (0.5328)

Observations 1984 1984 1935

Prob(F) 0.0035 0.0000 0.0000

Adj R-squared 0.0087 0.0631 0.1686

*,**,*** means significant in 10%, 5%, 1% respectively.

Numbers in parentheses are standard errors for each coefficient

Source: regression results

Using industry dummies as control variables, the results show that PEPs did not have

any significant effect on ROA. PEPs still had significant effects on Tobin’s Q and

market-adjusted returns.

All dummy industries, except industry 2 (consumer goods), had significant, negative

signs on Tobin’s Q. This means that industries 1 and 3 to 7 have a lower value of

Tobin’s Q compared to other industries. Industry 2 had a significant positive sign on

market-adjusted returns, implying that Industry 2 had a higher value of market-adjusted

returns compared to other industries.

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4.5.3 Robustness Test 3

The last robustness was a t-test check on ROA and a change of ROA to a matched pair

sample. Sixty-four companies had changed their number of PEPs. To conduct the

matched pair tests, a list of similar companies needed to be defined by looking into

similar sized companies within the same industry. I used total assets as the measurement

of size and a difference of a maximum 30% cut off between two companies. First,

similar sized companies within the sub-industry (as per IDX categories) were identified.

The list of matched pair companies is provided in the appendix. The t-test results are as

follows.

Table 4.13: T-test Result for ROA of Matched Pair Companies

ROA Changes in PEP Without Changes in PEP

Mean 1.2616 0.3957

Variance 228.3466 38.1352

Observations 64 64

P-Value 0.3429

*p-value is significant when the value is smaller than 1%

Table 4.13 reveals that no significance difference exists in the means of ROA, as well as

in the change of ROA for both PEP companies and non-PEP companies. T-tests were

also conducted for the ROE, gross margins, operating margins, net income margins,

operating profits/total assets and gross profits/total assets. The results remained the

same; that is, no significance difference existed in the means of the two groups.

4.6 Discussion

The combined method of interviews and regressions were used to analyse the

correlation between political connection, business and a firm’s performance in

Indonesia after the Suharto era. This combined method has not been conducted

previously. Thus, my research contribution has given new insights into this area.

A relatively high prevalence of PEP exists in Indonesia. This situation supports the

argument of ‘institutional voids’ in emerging markets as propagated by Khanna and

Palepu (2010). Firms use their political connections to mitigate the risks of operating in

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emerging markets like Indonesia, due to the asymmetry of information, a weak legal

enforcement environment, and a weak institutional framework in Indonesia generally.

Developing or emerging Asian economies have weak corporate governance (La Porta,

Lopez-de-Silanes & Shleifer 1999). As a result, personalised and relational aspects

govern corporate governance in Asian business (Carney & Gedajlovic 2001). In my

view, besides personalised and relational aspects, the needs of political connection have

become important for doing business in Indonesia due to this weak corporate

governance.

Political connections are vital to gain access to information, new government

regulations and ‘political protection’. Political connectedness is still needed to operate

businesses in Indonesia. Apparently, political connection access seems to be more

widespread in the current era (22% during Soeharto’s era as per Faccio [2006], with this

research finding 36%). Ninety-one per cent (or a vast majority) of PEP sit on the boards

of commissioners. They may be asked to solve particular issues as necessary. This

might be useful for gaining political access and ‘political protection’.

The regression results indicate that PEPs have significant effects on Tobin’s Q and

market-adjusted returns. However, PEPs have no effects on ROA. This indicates that

PEPs add value to market-based firm performance but not to accounting firm

performance. The number of PEPs on boards does not have any effect on ROA, Tobin’s

Q or market-adjusted returns. However, when the sample was limited to companies that

had experienced changes in their PEP, the number of the board members had a positive

and significant effect on ROA.

Political connections have significant and positive effects on market firm performance

as measured by market-adjusted returns; these results are in line with previous studies

by Bunkanwanicha and Wiwattanakantang (2008), Niessen and Ruenzi (2009),

Ferguson and Voth (2008), Claessens, Lang and Fan (2006), Faccio and Parsley (2009),

Goldman, Rocholl and So (2009), Fisman (2001) and Brockman, Rui and Zou (2013).

Claessens, Lang and Fan (2006) found that politically connected firms had higher stock

returns, as the market has expectations regarding firm-specific political favours. This

implies that the market itself values political favours more than being non-politically

connected. Moreover, Niessen and Ruenzi (2009) found that firms with political

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connections had higher stock prices as politically connected people preferred to work

with large and stable firms to maintain their reputation. In other words, politically

connected people would join companies with a good reputation. People would have in

mind that the good companies that were able to hire politically connected people could

generate political benefits in the future, as found by Goldman, Rocholl and So (2009).

According to Claessens, Lang, & Fan (2006), Niessen and Ruenzi (2009) and Goldman,

Rocholl and So (2009), it could be said that investors expected firms with political

connection to have higher stock returns as the investors might perceive that having

politically connected PEP on their boards might give those firms certain competitive

advantages. In accordance with institutional voids, Brockman, Rui and Zou (2013) have

found that politically well-connected firms outperformed others by more than 20% in

countries with weak legal systems. As Indonesia is an emerging market, it is still

considered to have a weak legal system, as shown by the high level of corruption;

Indonesia raked 107 out of 175 countries on the TI Corruption Perception Index 2014.

The effects of PEPs on ROA, even after t-tests, indicate no significant relationship

between the two. This may imply that being politically connected did not necessarily

mean better or worse outcomes in accounting-based firm performance.

Other factors may exist that are far more important to enhance operating firm

performance, such as managerial skills (Boubakri, Cosset & Saffar 2009; Faccio 2007;

Fan et al. 2007). These results also align with our results on the perceptions about

political connection and business. Professionals thought that a myriad of factors were

important for a business to be competitive. One of these could be political connections,

but the most important factor was management capability. However, it is interesting to

note that having more than one PEP on the board may improve the Tobin’s Q and ROA.

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Chapter 5: Conclusions

5.1 Introduction

This chapter will summarise the findings and discussions of this study regarding the

study’s hypotheses. These will be discussed further in Section 5.2 below. Following this

is the section on research limitations. I will conclude this chapter with the implications

of the results for managers and policy makers.

5.2 Theoretical and Empirical Findings and Contributions

This research has used two methods to determine comprehensive answers to the six key

research questions: a qualitative method using in-depth interviews to answer the first

four research questions and a quantitative method using regressions to answer the last

two research questions.

To reiterate, the six key research questions are:

1. Are political connections necessary to be competitive in Indonesia? If so, why?

2. Has the situation become better or worse post-Soeharto?

3. Do political connections vary across industry sectors? How?

4. What mechanisms for political connections are used by firms?

5. Do political connections affect a firm’s performance in Indonesia?

6. Does the number of politically exposed persons (PEPs) on a board affect a

firm’s performance in Indonesia?

From the interviews analysis, political connections were viewed as necessary to

compete in Indonesian business. This relates to the key hypotheses in Chapter 3 and the

first research question above.

The findings regarding the characteristics of the PEP vs. non-PEP companies in Chapter

4 have shown that more than one-third (36%) of non-financial listed companies in

Indonesia had political connectedness through their board members. Of this connection,

91% were connected through their board of commissioners. This high prevalence of

political connectedness after the Soeharto era indicates that political connections are

still viewed as necessary; this was also indicated by the findings of the interviews.

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Again, this answers the key hypothesis regarding whether political connections were

still needed or not.

As to the follow up research question to why the need for such political connections, the

need for such political connectedness may depend on a few factors: the industry, the

stage of the business, and the scale of the business. The foremost reason why political

connection is needed to do business in Indonesia is that it operates as ‘political

protection’. This is followed by the ability to access information and

regulators/bureaucrats to ensure the necessary licences/permits can be obtained; this

may be due to the opaqueness of regulations and law enforcement in Indonesia. This is

clearly indicated by the interviewees in Chapter 3. However, the salient point noted by

the interviewees was that political connections were just one of the key success factors

among many for doing business in Indonesia: political connection alone cannot make a

company successful. The main key success factor was having a strong management,

followed by good products and services, good corporate governance, a wide distribution

network, the ability to adapt and change and R&D innovation, as discussed in Chapter

3.

With regards to the second research question whether political connections vary across

the sectors of the industry, the interviews’ results in Chapter 3 indicate political

connections do indeed vary across the sectors of the industry. The more regulated the

industry is such as oil & gas, mining, property for example, the more political

connectedness is needed.

The review of PEPs and the industry that each company operated in Chapter 4 has

revealed that the largest number of politically connected companies operated in the

property (12.5%), coal mining (8.33%) and transportation (5.95) sectors. This again

corroborates the findings from the interviews in Chapter 3 that the more regulated

industries, such as mining and property, required more political connectedness.

With regards to the third research question whether the situation has worsened post

Soeharto, this study found that conditions have changed since the Soeharto era, as

power is now shared by the regions and among various political parties. The fact that

there is no concentration of power in the hands of one person like Soeharto may have

contributed to the view that the current situation is worse; now business people may

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need to have wider political connections with various parties at the central level or

regional level. The presidency remains the key position that politicians seek, followed

by ministerial appointments and MPs.

With regards to the fourth research question on mechanism of political connections,

board member who are PEPs can be considered as a mechanism to have connection to

politics as indicated in Chapter 3. However, political connections may not necessarily

be made through board members only. Often, owners connect directly to politics and in

some cases, owners enter active politics to gain political connections to protect or

enhance their business interests.

Regarding the quantitative method in Chapter 4, an OLS regression method with panel

data was applied. The regression results have shown that political connections did have

significant effects on Tobin’s Q and market-adjusted returns, but not on ROA. In other

words, political connections affected market-based firm performance but not accounting

operating performance. These answer the fifth research question whether political

connections affect a firm performance in Indonesia. However, for Tobin’s Q and

returns, the model only explained 0.90 and 16.53% respectively between the

independent variables and the dependent variable.

When robustness tests were conducted by including the top 40 business groups in the

definition of PEP, or the addition of industry factors, the findings remained the same.

There was no relationship between PEP and ROA. The matched pair tests also

confirmed no difference existed in the means of ROA or the means of the change in

ROA. The results of the link between PEP and Tobin’s Q remained through the

robustness tests.

The findings regarding NUM also confirmed no relationship existed between NUM and

ROA. However, NUM had a positive and significant relationship with Tobin’s Q, but

no relationship with market-adjusted returns. A further investigation into the

relationship between NUM and firm performance measures within the sample of 64

companies that experienced changes in their PEP showed that NUM had a positive and

significant relationship with ROA. These answer the last research question whether the

number of board member (NUM) affect a firm’s performance.

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The lack of any association between political connections and accounting performance

is contrary to earlier findings by Faccio (2007, 2010) and Niessen & Ruenzi (2009).

This could reflect either the weak power of the tests used in this research to pick up any

associated performance, or a weakening of relationship between political connections

and accounting performance. Political connections may be needed in a highly regulated

industry such as oil and gas, mining and property, but even in those industries, having

political connections may just level the playing field, as most companies have political

connection to a degree. Another possibility therefore performance isn’t a function of

political connection but rather competence. Hence it may indicate that political

connection may be necessary but not sufficient.

Based on the perception of the interviewees in Chapter 3, a company’s performance

depended more on the management, the products and services suites, the ability to adapt

and change, while political connection is but one of a myriad of factors but not the

paramount factor. As revealed in the findings of Fan et al. (2007), Faccio (2007, 2010),

Boubakri, Cosset and Saffar (2009), managerial skills are crucial, not merely political

connection. This has again been emphasised strongly by the findings from our

interviewees that revealed management was paramount to a firm’s success.

Investors in the capital market do seem to attribute value to a firm’s political

connectedness, as indicated by the significant relationships with Tobin’s Q and market-

adjusted returns. The negative relationship between political connectedness and returns

corroborates the findings from Fisman (2001).

The reason for business to have political connectedness, as mentioned by our

respondents, was mainly for ‘political protection’. By that they mean that political

protection is more for ‘defensive’ than ‘offensive’ reasons. Costs are associated with

such connections. Political connection can be viewed as risk mitigation. In emerging

markets like Indonesia, the uncertainty of laws and patchy law enforcement track

records (which have been highlighted by our respondents) and the lack of institutional

settings ensure that firms must acquire political connectedness to sustain business in a

fiercely competitive market. Rival companies may use all available means to compete,

including using their political connections to edge out other companies. Hence, political

connection can be a source of value to a firm.

104

One of the motivations for conducting this research is examine whether the trend

towards a more participatory democracy in the political system from a dictatorial system

would be accompanied by equal trend towards democratisation and participation in the

economic system. The answer from this research seems to indicate ”yes but

imperfectly”.

While the more participatory democratisation in Indonesia post Soeharto-era brought

the opening of the market and a more level playing field, which resulted in increased

competitive forces, it was hard for new entrants to break into business and gain market

shares. The results of the research indicated the reasons for that. In other words,

political connections still matter to an extent, but to a larger extent because the

incumbents which largely consist of Chinese dominated business groups posses most of

the competencies, resources, and skills to succeed in a more competitive environment.

Opening up of the economy as a result of democratisation seems to benefits most the

group of businessmen that were doing well and got their start under the old system of

political patronage during Soeharto-era. However, it might be too early to see their

dominance decrease.

5.3 Research Limitations

I believe the sample of 34 bankers, fund managers, academics, lawyers and business

owners are representative enough. They chose to participate voluntarily despite their

busy schedule due to their seniority and the sensitivity of the research topic. This is a

result of a professional network out of my 20 years working experience in Indonesia.

After all, having such sample is indeed better than having none at all. Furthermore, I did

not rely merely on the interviews data, but I also used accounting data, shares price data,

and also prior research.

The dataset used included listed companies in the IDX. Non-listed private companies

were excluded not because they were insignificant, but because their data were not

readily and publicly available.

The empirical testing relied on the financial ratios derived from the audited financial

statements of Indonesian listed companies that had obtained a clean record from the

105

auditors. The base assumption here was that they were accurate and truly reflected the

operating performances of companies in the dataset.

The Tobin’s Q and market-adjusted returns rely on the end of year stock price. The

stock price is assumed to truly reflect the market valuation of companies in the dataset.

We did not consider the company’s liquidity, amount of shares floated to the public and

stock volatility.

To operate the variable political connectedness, we used the measure of whether board

members were politically connected or not. There was some feedback from our

respondents concerning whether owners who connected to politics directly or owners

who entered into active politics provided better measures of political connectedness.

This measurement was still problematic at this stage, due to a lack of readily and

publicly available data. Additionally, it is yet to be proven that when owners enter

active politics this will benefit their businesses groups. However, this could be an area

of further research into politics, business and firm performance.

Two levels of board members exist in the Indonesian corporate system: a board of

commissioners that acts more as a supervisory board and a board of directors that acts

as day-to-day management. Ninety-one per cent of PEPs sit on the board of

commissioners, with the rest on the board of directors. However, when we split the

PEPs into the two boards, the findings of the OLS regression did not indicate any

significant changes to the ROAs.

The time period chosen was also limited to 2009 to 2013. The availability of data

prevented us from using a longer time horizon. Further research with a longer time

horizon and higher frequency than annual data may provide further insights into the

research questions.

As the findings have indicated a relationship with Tobin’s Q and market-adjusted

returns, further extension of this research may include interviewing a wider range of

fund managers about their perceptions regarding the value of political connections in

Indonesia. This research has not focused on the causality and direction of the

relationship; that is, whether firms with political connections become competitive or

whether politicians who observe competitive companies then choose to sit on the boards

of such companies.

106

5.4 Implication of Findings

The findings of this study could be important for people in the business sector. First,

political connections are not the only factor in determining a company’s success.

Political connections might help, but ultimately other factors such as management and

other competitive advantages could determine the firm performance. Using PEPs seem

to be motivated more by risk mitigation, to gain ‘political protection’. The prevalence of

such politically connected companies in Indonesia has affirmed the view that the

benefits may outweigh the costs.

As for the government and regulators, they may establish a policy regarding the criteria

of people who can sit on the boards of listed companies, or at least on the transparency

of information regarding whether someone is PEP or not. According to the findings of

this study, some industries required political connections to operate. In some cases, in

the view of our respondents, the appointment of certain PEPs to a board can be a return

for favours done previously when they had been active as regulators. The appointment

of a direct supervisor or regulator to a board (as soon as they have retired) may create a

conflict of interest. Perhaps a certain ‘cooling off’ period can be considered before such

appointments to mitigate the perception of such conflicts of interest.

Further transparency requirements, such as to disclose the UBO of listed companies

may be necessary to enhance the transparency of who really controls the said listed

companies. Additionally, a requirement to detail any campaign contribution, such as

those that have been implemented in other countries like Brazil (Claessens, Feijen &

Laeven 2008) might help increase transparency. When and if such data become

available in the future, further research may be able to examine the relationship between

politics and business at an even deeper level.

107

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Appendix A

List of Companies in the Matched-Pair Test

Change in PEP No Change

Code Industry TA Code Industry TA

SSMS 1 3,701,917.49 PALM 1 3,990,894.83

SGRO 1 4,512,655.53 ANJT 1 4,835,837.89

BWPT 1 6,200,427.31 TBLA 1 6,212,359.00

CPRO 1 7,179,387.00 LSIP 1 7,974,876.00

SIMA 2 65,314.18 INCI 2 136,142.06

IGAR 2 314,746.64 APLI 2 303,594.49

KBRI 2 788,749.19 INAI 2 765,881.41

NIKL 2 1,514,191.40 IMPC 2 1,644,814.29

UNIC 2 3,277,014.46 TRST 2 3,260,919.51

MLIA 2 7,189,899.45 FASW 2 5,692,060.41

SMCB 2 14,894,990.00 TPIA 2 23,213,520.46

JPFA 2 14,917,590.00 BRPT 2 28,247,421.90

CPIN 2 15,722,197.00 KRAS 2 28,958,563.68

INTP 2 26,607,241.00 SMGR 2 30,792,884.09

SQBB 3 421,187.98 SQBI 3 421,187.98

CEKA 3 1,069,627.30 DVLA 3 1,190,054.29

AISA 3 5,020,824.00 TSPC 3 5,407,957.92

RMBA 3 9,232,016.00 MYOR 3 9,709,838.25

ICBP 3 21,267,470.00 UNVR 3 13,348,188.00

SAFE 4 14,395.38 ZBRA 4 39,645.20

INDX 4 147,417.71 LRNA 4 239,668.00

MIRA 4 491,868.24 WEHA 4 515,509.83

HITS 4 1,940,272.82 BBRM 4 1,999,157.31

APOL 4 2,577,573.88 TRUB 4 2,710,182.10

TRAM 4 3,885,235.70 MBSS 4 4,293,359.61

FREN 4 15,866,493.43 TOWR 4 15,534,076.00

TBIG 4 18,719,211.00 JSMR 4 28,058,581.78

EXCL 4 40,277,626.00 GIAA 4 35,947,562.87

118

Change in PEP No Change

SMMT 5 626,650.33 MBAP 5 880,197.53

GTBO 5 1,076,575.60 RUIS 5 1,277,942.89

ATPK 5 1,489,339.95 ESSA 5 1,439,439.91

BSSR 5 1,937,956.78 MYOH 5 1,815,818.26

TOBA 5 3,792,755.42 CITA 5 3,773,605.65

DEWA 5 4,451,275.21 ELSA 5 4,370,964.00

HRUM 5 5,849,159.24 PTRO 5 6,197,475.14

TKGA 5 6,046,016.14 TINS 5 7,883,294.00

BIPI 5 16,053,486.27 ITMG 5 16,146,620.52

BRMS 5 22,966,472.67 ANTM 5 21,865,117.39

ENRG 5 28,217,941.71 INCO 5 27,761,218.23

ADRO 5 81,489,723.67 BUMI 5 72,387,177.74

BATA 6 680,685.06 KBLM 6 654,296.26

SRIL 6 5,590,981.80 ADMG 6 6,824,159.96

AUTO 6 12,617,678.00 INDR 6 8,943,987.17

IMAS 6 22,315,022.51 GJTL 6 15,350,754.00

LCGP 7 1,652,514.52 NRCA 7 1,625,318.98

COWL 7 1,944,913.75 GWSA 7 2,045,701.78

TOTL 7 2,226,418.48 DGIK 7 2,100,802.67

PWON 7 9,298,245.41 MDLN 7 9,647,813.08

BKSL 7 10,665,713.36 ADHI 7 9,720,961.76

APLN 7 19,679,908.99 CTRA 7 20,114,871.38

AIMS 8 24,648.96 GMCW 8 20,617.64

CMPP 8 59,996.77 INTD 8 53,413.14

ICON 8 73,912.75 PGLI 8 65,733.45

TRIL 8 185,933.39 WICO 8 169,324.43

HOME 8 260,422.40 FORU 8 263,517.56

GEMA 8 377,603.94 SAME 8 377,654.88

MICE 8 628,738.17 GREN 8 615,900.48

MIDI 8 2,108,897.00 SRAJ 8 2,052,080.88

TGKA 8 2,471,998.08 ACES 8 2,478,918.58

FISH 8 3,190,225.74 CSAP 8 3,107,895.43

JSPT 8 3,428,702.49 JKON 8 3,417,012.22

119

Change in PEP No Change

CNKO 8 5,516,122.34 EPMT 8 5,528,067.70

AMRT 8 10,962,227.00 MPMX 8 11,220,245.00

DSSA 8 14,586,639.26 AKRA 8 14,633,141.38

120

Appendix B

Sample of Invitation Letter

Our ref: Information Letter

1 July 2014

An Investigation of Politically Connectedness and Company Performance in Indonesia

Dear Sir/Madam

We are seeking your participation in a research study on the relationship between political

connectedness and company performance in Indonesia.

There are two phases to the study. The first involves the investigation, through interviews, of market

professionals’ perceptions of political connectedness in Indonesia and its effect on the value of the firm. The second phase involves analysing political connectedness and operating performance using data

from financial statements of listed companies in Indonesia.

Political connectedness of a company can be measured by examining whether members of the board of directors or commissioners are current or former senior officials in the executive, legislative,

administrative and military.

We welcome your participation in the study by taking part in an interview that should take no longer than

60 minutes. Questions in the interview include the following:

1. What%is your educational background and professional experience?

2. Which companies do you perceive are most competitive in Indonesia?

3. What are the factors that are important to competing effectively in Indonesia? 4. Do you believe companies need to be politically connected to be competitive in Indonesia? If so,

why? 5. Does politically connectedness vary across industries? If so, why?

6. How else might you define political connectedness?

By completing the Participant Consent Form attached, you are indicating your consent to participate in

this study. While we would greatly value your input, participation in this study is voluntary. You may withdraw your written consent at any time during the data collection period of this research project. Your participation in this study does not prejudice any right to compensation, which you may have under statute or common law.

All of your responses will be anonymous and confidential, and data will be reported in a way that will ensure that you will not be identified. No reference will be made to the companies you work for. For the

analysis and discussion, comments may be aggregate or discussed with reference to your position or professions, e.g., comments from lawyers or consensus from research analysts. It is our intention to not

store any identifying information, nor to collect identifying information with the interviews.

Business School

M250 35 Stirling Highway

Crawley

WA 6009

Australia

T +618 6488 2974 E ray.dasilvarosa@uwa.edu.au www.business.uwa.edu.au

CRICOS Provider Code: 00126G

121

The audio of the individual interviews will be recorded and transcribed to ensure that all responses are captured. Recordings and anonymous transcriptions of the discussion will be stored securely in a

database on the computer of the researcher at the UWA Business School until the completion of the research when the audio files will be destroyed.

Should you have further questions regarding this study or would like to receive the summarized results of this study, please do not hesitate to contact Amiruddin (aamiruddin@yahoo.com).

Yours sincerely,

W/Prof Raymond Da Silva Rosa A/Prof Marvin Wee

UWA Business School UWA Business School

Amiruddin DBA Student, UWA Business School

Approval to conduct this research has been provided by The University of Western Australia, in

accordance with its ethics review and approval procedures. Any person considering participation in this research project, or agreeing to participate, may raise any questions or issues with the researchers at any

time.

In addition, any person not satisfied with the response of researchers may raise ethics issues or

concerns, and may make any complaints about this research project by contacting the Human Research Ethics Office at The University of Western Australia on (08) 6488 3703 or by emailing to hreo-

research@uwa.edu.au

All research participants are entitled to retain a copy of any Participant Information Letter and/or

Participant Consent Form relating to this research project.

122

Appendix C

Sample of Consent Letter

Our ref: Participant Consent Form (PCF)

1 July 2014

An Investigation of Politically Connectedness and Company Performance in Indonesia

I (the participant) have read the information provided and any questions I have asked have been answered to my

satisfaction. I agree to participate in this activity, realising that I may withdraw at any time without reason and without prejudice.

I understand that all identifiable (attributable) information that I provide is treated as strictly confidential and will not be released by the investigator in any form that may identify me. The only exception to this principle of confidentiality is if documents are required by law.

I have been advised as to what data is being collected, the purpose for collecting the data, and what will be done with the data upon completion of the research.

I agree that research data gathered for the study may be published provided my name or other identifying information is not used.

________________ _______________ Participant Date

(Please note that, as the PCF is not a contract between parties, it is not necessary that the researcher

counter-sign the form. Nor is it necessary to have a witness to the participant's signature. There may be some exceptions to this generalisation in cases where researchers feel that there would be practical,

rather than purely legal, benefit in being able to more clearly verify a participant's consent.)

Approval to conduct this research has been provided by The University of Western Australia, in accordance with its ethics review and approval procedures. Any person considering participation in this research project, or agreeing to participate, may raise any questions or issues with the researchers at

any time.

In addition, any person not satisfied with the response of researchers may raise ethics issues or

concerns, and may make any complaints about this research project by contacting the Human Research Ethics Office at The University of Western Australia on (08) 6488 3703 or by emailing to hreo-research@uwa.edu.au

All research participants are entitled to retain a copy of any Participant Information Letter and/or Participant Consent Form relating to this research project.

UWA Business School

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Australia

T +618 6488 2974 E Ray.dasilvarosa@uwa.edu.au www.business.uwa.edu.au

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