Asian Development Bank 2001 All rights reserved This publication was prepared under the Asian Development Bank s regional Technical Assistance 5802: A

Transcription

1 Corporate Governance and Finance in East Asia A Study of Indonesia, Republic of Korea, Malaysia, Philippines, and Thailand VOLUME TWO Country Studies Edited by: Juzhong Zhuang Senior Economist Regional Economic Monitoring Unit Asian Development Bank David Edwards Assistant Chief Economist Project Economic Evaluation Division Asian Development Bank Ma Virginita A Capulong Senior Sector Analyst Agriculture and Social Sectors Department (West) Asian Development Bank

2 Asian Development Bank 2001 All rights reserved This publication was prepared under the Asian Development Bank s regional Technical Assistance 5802: A Study on Corporate Governance and Financing in Selected DMCs The views expressed in this book are those of the authors and do not necessarily reflect the views and policies of the Asian Development Bank, or its Board of Directors or the governments they represent The Asian Development Bank does not guarantee the accuracy of the data included in this publication and accepts no responsibility for any consequences for their use Use of the term country does not imply any judgment by the authors or the Asian Development Bank as to the legal or other status of any territorial entity ISBN Publication Stock No Published and printed by the Asian Development Bank P O Box 789, 0980 Manila, Philippines

3 iii Contents List of Tables List of Figures Foreword Preface Abbreviations vi ix x xi xii 1 Indonesia Introduction 1 1 2Overview of the Corporate Sector Historical Development The Capital Market The Banking Sector Foreign Capital Growth and Financial Performance Legal and Regulatory Framework Corporate Ownership and Control Corporate Ownership Structure Management and Internal Control External Control Corporate Financing Financial Market Instruments Patterns of Corporate Financing Corporate Financing and Ownership Concentration The Corporate Sector in the Financial Crisis Causes of the Financial Crisis Impact of the Financial Crisis on the Corporate and Banking Sectors Responses to the Crisis Summary, Conclusions, and Recommendations Summary and Conclusions Policy Recommendations 48 References 51 2 Republic of Korea Introduction Overview of the Corporate Sector Historical Development Rise of the Large Business Groups (Chaebols) Role of the Capital Market and Foreign Capital Growth and Financial Performance 65

4 iv 2 3 Corporate Ownership and Control Patterns of Corporate Ownership Internal Management and Control Shareholder Rights Control by Creditors The Market for Corporate Control Control by the Government Employee Participation in Corporate Governance Corporate Financing Overview of the Financial System Patterns of Corporate Financing Financial Structure, Diversification, and Corporate Performance The Corporate Sector in the Financial Crisis Weaknesses in Corporate Governance The Role of Government Intervention Manifestations of Weak Corporate Governance and Government Intervention Shortcomings in Macroeconomic Policy Responses to the Crisis and Policy Recommendations Corporate Restructuring Activities Policy Measures for Corporate Reform Policy Recommendations 148 References The Philippines Introduction Overview of the Corporate Sector Historical Development Growth and Financial Performance Legal and Regulatory Framework Corporate Ownership and Control Patterns of Corporate Ownership Corporate Management and Shareholder Control The Role of Creditors in Corporate Control Corporate Financing The Financial Market and Instruments Patterns of Corporate Financing Ownership Concentration, Financial Leverage, and Performance The Corporate Sector in the Financial Crisis The Financial Crisis: Causes and Manifestations Impact of the Crisis on the Corporate Sector Responses to the Crisis 214

5 v 3 6 Summary, Conclusions, and Recommendations Summary and Conclusions Policy Recommendations 219 References Thailand Introduction Overview of the Corporate Sector Historical Development Development of Capital Markets Growth and Financial Performance Legal and Regulatory Framework Corporate Ownership and Control Patterns of Corporate Ownership Corporate Management and Control External Control Corporate Financing Overview of the Financial Sector Patterns of Corporate Financing The Corporate Sector during the Financial Crisis Impact of the Financial Crisis on the Corporate Sector Responses to the Crisis Summary, Conclusions, and Recommendations Summary and Conclusions Policy Recommendations 273 References 277

6 vi List of Tables 1 Indonesia Table 1 1 Growth of the Banking Sector, Table 1 2 Foreign Capital Flows, Table 1 3 Growth and Financial Performance of Publicly Listed Companies, Table 1 4 Growth Performance of Publicly Listed Companies by Sector, Table 1 5 Financial Performance of Publicly Listed Companies by Sector, Table 1 6 Growth and Financial Performance of State-Owned Companies, Table 1 7 Growth Performance of the Top 300 Conglomerates, Table 1 8 Ownership Concentration of Publicly Listed Companies, Table 1 9 Ownership Concentration of Publicly Listed Companies Table 1 10 by Sector, Anatomy of the Top 300 Indonesian Conglomerates, Table 1 11 Characteristics of the Board of Commissioners 26 Table 1 12 Characteristics of the Board of Directors 27 Table 1 13 Presence of Board Committees in Listed Companies 28 Table 1 14 Banking Sector Outstanding Loans, Table 1 15 Value of Stocks Issued and Stock Market Capitalization, Table 1 16 Financing Patterns of Publicly Listed Nonfinancial Companies, Table 1 17 DER of Listed Companies by Degree of Ownership Concentration 36 Table 1 18 GDP Growth by Sector, Table 1 19 DER and ROE of Publicly Listed Companies by Sector, Table 1 20 ROE of the Banking Sector, Table 1 21 Nonperforming Loans by Type of Bank, Republic of Korea Table 2 1 Listed Firms with Positive Economic Value Added, Table 2 2 Key Macroeconomic Indicators 56 Table 2 3 Subsidiaries of the 30 Largest Chaebols 61 Table 2 4 Development of the Stock Market,

7 vii Table 2 5 Private Capital Flows to Korea, Table 2 6 Growth and Financial Performance of the Nonfinancial Corporate Sector, Table 2 7 International Comparison of Ratios of Ordinary Income to Sales in Manufacturing 66 Table 2 8 Growth and Financial Performance of Selected Industries 68 Table 2 9 Growth and Financial Performance of Listed Companies, Table 2 10 Growth and Financial Performance of Listed Companies by Size, Table 2 11 Features of the 30 Largest Chaebols 72 Table 2 12 Growth and Financial Performance of the 30 Largest Chaebols, Table 2 13 The Top 30 Chaebols Debt-to-Equity Ratio, Table 2 14 Ownership Composition of Listed Companies, Table 2 15 Ownership Composition of Listed Nonfinancial Firms by Industry, 1990 and Table 2 16 Ownership Composition of Listed Nonfinancial Firms by Size, Table 2 17 Ownership Composition of Listed Nonfinancial Firms by Control Type, Table 2 18 Ownership Composition of Listed Firms in Selected Countries, Table 2 19 Ownership Concentration of All Listed Firms, Table 2 20 Ownership Concentration of Listed Nonfinancial Firms, Table 2 21 Ownership Concentration of Listed Nonfinancial Firms by Industry, Table 2 22 Ownership Concentration of Listed Nonfinancial Firms by Firm Size, Table 2 23 Ownership Concentration of the Survey Sample of 81 Listed Firms, Table 2 24 Internal Shareholdings of the 30 Largest Chaebols, Table 2 25 Flow of Funds of the Nonfinancial Corporate Sector, Table 2 26 Financing Patterns of the Nonfinancial Corporate Sector, Table 2 27 Financing Patterns of the Nonfinancial Corporate Sector by Industry 122 Table 2 28 Financing Patterns of Listed Companies, Table 2 29 Financing Patterns of the Top 30 Chaebols, Table 2 30 Cross-Payment Guarantees of the Top 30 Chaebols,

8 viii Table 2 31 Net Profit Margins of Chaebols, Table 2 32 Number of Firms with Dishonored Checks, Table 2 33 Nonperforming Loans of General Banks, The Philippines Table 3 1 GDP Growth of Southeast Asian Countries, Table 3 2Growth and Financial Performance of the Top 1,000 Companies, Table 3 3 The Corporate Sector and Gross Domestic Product, Table 3 4 Growth and Financial Performance of the Corporate Sector by Ownership Type, Table 3 5 Growth and Financial Performance of the Corporate Sector by Control Structure, Table 3 6 Growth and Financial Performance of the Corporate Sector by Firm Size, Table 3 7 Growth and Financial Performance of the Corporate Sector by Industry, Table 3 8 Ownership Composition of Philippine Publicly Listed Companies by Sector, Table 3 9 Ownership Concentration at Critical Levels of Control Over Publicly Listed Companies, Table 3 10 Composition of Top Five Shareholders of Philippine Table 3 11 Publicly Listed Companies by Sector, Total and Per Company Sales, Sector Orientation, Flagship Company, and Affiliated Banks of Selected Business Groups, Table 3 12 Control Structure of the Top 50 Corporate Entities, Table 3 13 ADB Survey Results on Shareholder Rights 191 Table 3 14 Philippine Stock Market Performance, Table 3 15 Financing Patterns of the Corporate Sector, Table 3 16 Corporate Financing Patterns by Ownership Type, Table 3 17 Composition of Assets and Financing of the Publicly Listed Sector, Table 3 18 Financing Patterns by Control Structure, Table 3 19 Financing Patterns by Firm Size, Table 3 20 Financing Patterns by Industry, Table 3 21 Ownership Concentration, Profitability, and Financial Leverage 209 Table 3 22 Foreign Investment Flows, Thailand Table 4 1 Public Companies Registered, Table 4 2 Public Offerings of Securities,

9 ix Table 4 3 Statistical Highlights of the Stock Exchange of Thailand, Table 4 4 Key Financial Ratios of Publicly Listed Companies, Table 4 5 Average Key Financial Ratios by Company Size, Table 4 6 Top-Five Ownership Concentration of Publicly Listed Companies in Thailand, Table 4 7 Statistical Relationships between Corporate Profitability, Leverage, Ownership Concentration, and Company Size 242 Table 4 8 Top-Five Shareholder Composition of Publicly Listed Companies in Thailand, Table 4 9 Merger and Acquisition Activities, Table 4 10 Size and Composition of the Thai Financial Sector, Table 4 11 Offerings of Debt Securities, Table 4 12 Common-Size Statements for Companies Listed in SET, Table 4 13 Common-Size Statements of Public Companies by Ownership Concentration, Table 4 14 Financial Ratios of All Listed Firms, Table 4 15 Financial Ratios of Listed Companies by Ownership Concentration, Table 4 16 External Debt, Table 4 17 Number of Newly Registered and Bankrupted/Closed Companies, List of Figures Figure 1 1 The Suharto Group 24 Figure 1 2Typical Internal Organizational Structure of a Publicly Listed Company in Indonesia 25 Figure 3 1 Corporate Control Structure: The Case of Ayala Corporation 195 Figure 3 2 Corporate Control Structure: the Case of Lopez Group 197

10 x Foreword Corporate governance has become a major policy concern in the wake of the Asian financial crisis Weak governance structure, poor investment, and risky financing practices of the corporate sector in the affected countries contributed to their sharp economic recession in The weaknesses in corporate governance and finance undermined the capacity of these countries to withstand the combined shocks of depreciated currencies, massive capital outflows, increased interest rates, and large contraction in domestic demand To help understand corporate governance issues and their impact, as well as to identify needs for interventions in addressing policy and institutional weaknesses, the Economics and Development Resource Center of the Asian Development Bank (ADB) undertook a regional study on corporate governance and finance in selected developing member countries The countries covered are Indonesia, Republic of Korea, Malaysia, Philippines, and Thailand This book presents the major findings of the study The policy recommendations will support ADB s financial sector work in its developing member countries Arvind Panagariya Chief Economist

11 xi Preface Corporate Governance and Finance in East Asia presents the findings of a regional study of corporate governance and finance in selected developing member countries of the Asian Development Bank (ADB) The study attempts to identify the weaknesses in corporate governance and finance in countries most affected by the 1997 Asian financial crisis, and recommends policy and reform measures to address the weaknesses The study covers Indonesia, Republic of Korea, Malaysia, Philippines, and Thailand The findings of the study are presented in two volumes Volume One, A Consolidated Report, presents a framework for analyzing corporate governance and finance, summarizes the major findings of the five country studies, and provides key policy recommendations for strengthening corporate governance and improving the efficiency of corporate finance in ADB member countries Volume Two, Country Studies, collects four country reports We would like to thank country experts Saud Husnan of Gadsab Mada University, Indonesia; Kwang S Chung and Yen Kyun Wang of Chung-Ang University, Republic of Korea; Fazilah Abdul Samad of University of Malaya, Malaysia; Cesar G Saldaña of PSR Consulting, Inc, the Philippines; and Piman Limpaphayom of Asian University of Science and Technology, Thailand, for their efforts and cooperation in conducting the country studies Cesar G Saldaña also provided useful inputs to the preparation of the consolidated report The volumes benefited extensively from constructive comments from ADB staff and officials of the ministries of finance, central banks, securities and exchange commissions, stock exchanges, and corporate restructuring agencies of the eight ADB member countries that participated in the study s finalization workshop in Manila, on November 1999 Our deep appreciation goes to Jungsoo Lee, former Chief Economist, and S Ghon Rhee, former Resident Scholar, for their strong support at various stages of the study; Manabu Fujimura, for his efforts in organizing the finalization workshop; Marcelia Garcia, Marinie Baguisa, Ma Regina Sibal, and Rosanna Benavidez, for their administrative support and assistance; and Josef Yap, Leah Sumulong, Graham James Dwyer, Judith Banning, and Lynette Mallery, for their editorial assistance and advice

12 xii Abbreviations ADB AGM AGSM AMU APEC B BDC BIBF BIS BOC BOD BSDC BSP BUN CB CDRAC CEO CP CRA DER ESOP EVA FDI FSC GAAP GATT GDP GNP HCI IBRA IDFR IEFR IFS IMF IPO IPP JSX NBFI NEFR NPL OECD OTC Asian Development Bank annual general meeting annual general shareholders meeting asset management unit Asia-Pacific Economic Cooperation baht Bond Dealers Club Bangkok International Banking Facility Bank for International Settlements board of commissioners board of directors Bangkok Stock Dealing Center Bangko Sentral ng Pilipinas (Central Bank) Bank Umum Nasional convertible bond Corporate Debt Restructuring Advisory Committee chief executive officer commercial paper Corporate Restructuring Agreement debt-to-equity ratio employee stock ownership plan economic value added foreign direct investment Financial Supervisory Commission generally accepted accounting principles General Agreement on Tariffs and Trade gross domestic product gross national product heavy and chemical industries Indonesian Bank Restructuring Agency incremental debt financing ratio incremental equity financing ratio International Financial Statistics International Monetary Fund initial public offering investment priorities plan Jakarta Stock Exchange nonbank financial institution new equity financing ratio nonperforming loan Organisation for Economic Co-operation and Development over-the-counter

13 xiii P PCO PD PICPA PLDT PSE PTB ROA ROE Rp RSA SBL SCS SEA SEC SET SFR SMC SSS SOC TIE TQ W US peso planning and coordination office Presidential Decree Philippine Institute of Certified Public Accountants Philippine Long Distance Telephone Co Philippine Stock Exchange principal transactions bank return on assets return on equity rupiah Revised Securities Act single borrower limit share of a controlling shareholder Securities and Exchange Act Securities and Exchange Commission Stock Exchange of Thailand self-financing ratio San Miguel Corporation Social Security System State-owned company times interest earned Tobin s Q won United States Note: In this volume, $ refers to US dollars, unless otherwise stated

14 1 Indonesia Saud Husnan Introduction The currency crisis that began in mid-1997 in Thailand spread quickly to Indonesia and the rest of Southeast Asia. Initially, Indonesia s monetary authority tried to defend the domestic currency, the rupiah, by widening the intervention band, while maintaining its managed floating system. From 5 to 8 percent in June 1997, when the currency crisis hit Thailand, the band was widened to 12 percent on 11 July 1997 when the crisis started spilling over to Indonesia. After resisting pressure for a short period, the rupiah fell by 6 percent against the dollar on 21 July 1997, the biggest one-day fall in five years. Finally, the Indonesian monetary authority realized that the system could not cope with the continuing pressure on the currency, as the risk of losing all foreign exchange reserves to prop up the rupiah was too high. On 14 August 1997, the monetary authority decided to adopt a free floating exchange rate system. The currency fell further because of strong demand for dollars. As the rupiah weakened, nervous lenders refused to refinance maturing loans, investors cut down and then reversed the flow of funds, borrowers tried to obtain dollars before the rupiah fell further, and individuals joined the chase for dollars. At that time, several banks ran out of dollar notes. From Rp4,950 to the dollar at the end of December 1997, the exchange rate fell to more than Rp15,000 at the height of the crisis in June 1998, although it later stabilized at about Rp9,000. At that exchange rate, it is estimated that half of Indonesian corporations became technically insolvent. The crisis also exacerbated an already deepening political turmoil. The financial crisis devastated the Indonesian economy. In 1998, gross domestic product (GDP) contracted by 13 percent and the inflation 1 Associate Professor, Faculty of Economics, Gadsab Mada University, Yogyakarta, Indonesia. The author wishes to thank Juzhong Zhuang, David Edwards, both of ADB, and David Webb of the London School of Economics for their guidance and supervision in conducting the study, the Jarkata Stock Exchange for its help and support in conducting company surveys, and Lea Sumulong and Graham Dwyer for their editorial assistance.

15 2 Corporate Governance and Finance in East Asia, Vol. II rate reached 58.5 percent. All sectors, except utilities, posted negative growth. The construction sector was the worst hit, contracting by 36.5 percent, followed by finance (-26.6 percent) and trade (-18 percent). The scale of the financial crisis exposed weaknesses of the country s corporate sector. The highly concentrated and family-based ownership structure of corporate groups and companies resulted in a governance structure where corporate decisions lie in the hands of controlling families. In many instances, these controlling families had political connections that allowed their companies to enjoy special privileges. Foreign creditors, no doubt, placed a high premium on these political connections in assessing the chances of being repaid. To facilitate even easier access to credit, the controlling families of corporate groups often established banks to provide funds to affiliated nonfinancial companies. These banks were allowed to operate even if they violated minimum capital adequacy requirements. In this setup, short-term loans were used to finance long-term investments. Lending activities of affiliate banks that were not sufficiently backed by owners equity and the reliance by foreign lenders on the strength of political connections paved the way for risky investments. These were already contributing to high levels of nonperforming loans (NPLs) in the Indonesian banking sector several years before the 1997 crisis erupted. On the other hand, prior to the financial crisis, the Indonesian economy seemed to be in generally good shape. Economic growth reached more than 7 percent per year and the inflation rate was kept at single digit levels. However, the currency composition and term structure of corporate foreign indebtedness were causes for concern. Foreign debt reached more than $100 billion. Although as a percent of GDP the stock of outstanding foreign debt owed directly by the private sector was smaller than that of the Republic of Korea, Malaysia, or Thailand, this left the Indonesian economy extremely vulnerable. When the crisis hit the country, highly leveraged companies, particularly those with large foreign loans, were the ones most affected. This study reviews the Indonesian corporate sector s historical development, regulatory framework, patterns of ownership and control, patterns of financing, and responses to the financial crisis. It analyzes the weaknesses of corporate governance in Indonesia, how it has affected corporate financial performance and financing, and how it contributed to the crisis. The study also identifies family-based companies and corporate groups, and analyzes their importance to the corporate sector in Indonesia. Section 1.2 presents an overview of the Indonesian corporate sector. Section 1.3 looks at patterns of corporate ownership and control, and

16 Chapter 1: Indonesia 3 profiles the corporate sector s governance characteristics. This section reports the results of an Asian Development Bank (ADB) survey on corporate management and control practices in Indonesian publicly listed companies. 2 Section 1.4 analyzes corporate financing patterns. It also examines the statistical relationship between corporate performance and corporate governance characteristics. Section 1.5 examines the corporate sector during the financial crisis in terms of its role, how it was affected by the crisis, and its response. Section 1.6 summarizes the major findings of the study and suggests recommendations to improve governance in the Indonesian corporate sector. 1.2 Overview of the Corporate Sector Historical Development The marked permeability between the State and business in Indonesia goes back to the country s struggle for independence. The Government became directly involved in industry as a result of the nationalization of Dutchowned shipping firms and oil companies, in the course of the fight for nationhood from 1942 to Up until the mid-1960s, while Chinese and indigenous entrepreneurs ran some large businesses in trading, textiles, and tobacco industries, medium- and large-scale companies were dominated by state-run industrial concerns. With the relatively liberal laws governing foreign and domestic private investments introduced by the New Order Government in 1967 and 1968, a gradual shift in public investment away from manufacturing took place. Subsequently, substantial volumes of private investment entered the scene. In the early 1970s, the windfall from oil and gas revenues was an important factor that allowed the Government to promote industrial development via import substitution. The industries that emerged were highly import-dependent and reliant on tariff protection. Despite the oil revenues, 2 Survey questionnaires were sent to 280 companies listed in the Jakarta Stock Exchange. However, only 40 companies replied 39 are private companies and one state-owned company (Bank BNI). Not all items in the questionnaires were answered by the respondents.

17 4 Corporate Governance and Finance in East Asia, Vol. II the currency needed to be devalued periodically under a managed floating exchange rate system to avoid large current account deficits. During this period, a distinct industrial elite started to emerge. These were families with strong links to the political elite of the New Order. In the 1980s, the Government shifted its industrial policy toward the promotion of labor-intensive exports. Export credits with low interest rates were granted to industries that were intensive in the use of local labor and raw materials. By 1987, exports of nonoil products (particularly textiles and footwear, wood, and related products) had shares in total exports that were rapidly increasing. In 1992, the value of manufactured exports overtook the value of oil and gas exports for the first time. Partly as a result of various government policies, the Indonesian industrial sector was quite diverse. While most of the companies were small, produced consumer goods, and employed the bulk of the industrial labor force, there were also many rapidly growing large-scale companies and business groups or conglomerates, which dominated their respective sectoral outputs and markets The Capital Market The Government reactivated the stock exchange in A number of underwriters emerged, mostly nonbank financial institutions and stockbrokers. But until the end of 1988, the number of firms quoted in the stock market was only 24. The equity market remained largely unappealing due to a number of factors. First, many founding owners of companies were reluctant to go public and dilute their corporate ownership. Generally speaking, the dilution of corporate ownership, even when new shareholders do not threaten the control exercised by the original owners, potentially subjects companies to greater regulatory scrutiny. Second, the stock exchange was also unattractive to companies trying to raise capital as they could borrow from state banks at very low interest rates. Third, investors were reluctant to supply funds to the stock market because they did not know whom to trust and the mechanisms that could protect small investors and shareholders against expropriation by controlling shareholders were underdeveloped. Regulations in the banking sector led to equities having higher risk but lower returns than bank deposits. Last, the Capital Market Executive Agency and National Investment Trust tried to attract small investors to the stock market by setting prices and preferring small orders in initial public offerings (IPOs). But these proved counterproductive because they limited the potential for capital gains to prospective investors.

18 Chapter 1: Indonesia 5 At the end of 1988, the liberalization of the banking industry allowed banks to determine lending rates for nonpriority loans. Thus, companies could no longer enjoy low-interest credit from state banks. The Government also abolished the practice of setting prices for IPOs and removed restrictions on price movements in the secondary market, which were previously constrained to 4 percent per day. The Government also allowed foreign investors to buy up to 49 percent of listed shares. Consequently, the number of listed companies in the stock exchange increased substantially, from 24 in 1988 to more than 300 in During this period, the capital market played an increasing role in raising long-term funds needed by the corporate sector. Conglomerates carried out 210 out of 257 IPOs, with a total value of Rp16.5 trillion. The development of the Indonesian stock market also provided a vehicle for the privatization of state-owned companies (SOCs). Since 1977, six SOCs had issued equities in the market, with a total value of more than Rp8 trillion. However, to date, the controlling shareholder of these SOCs is still the State The Banking Sector Despite the development of the stock market, the banking sector has been and still is the major source of credit for the corporate sector. Through the years, the banking sector has undergone many reforms. However, the legal infrastructure that was supposed to guide the evolution of the banking sector was not backed by effective enforcement. The initial banking sector reform was introduced in Interest rate regulations on state banks and credit ceilings in general were removed. The banking sector, which up to then was channeling oil revenues to priority sectors, began to face competition. The dominance of state banks started to erode. However, priority credits still enjoyed subsidized interest rates and funding from the Central Bank. In 1988, more significant reforms were introduced. These included the opening of the banking industry to new entrants, reduced restrictions on foreign exchange transactions, and increased access of domestic banks to international financial markets. Further reforms along the same direction and affecting state-controlled banks came in the 1990s. Partly as a result of these reforms, the number of private domestic banks increased. Table 1.1 shows that from 1994 to 1998, private domestic banks dominated the sector in terms of number and total assets. But in terms of assets per bank, state-owned banks were still among the biggest.

19 6 Corporate Governance and Finance in East Asia, Vol. II Table 1.1 Growth of the Banking Sector, Type of Bank State-Owned Banks Assets (Rp trillion) Number of Banks Foreign Banks Assets (Rp trillion) Number of Banks Joint Venture Banks Assets (Rp trillion) Number of Banks Regional Government Banks Assets (Rp trillion) Number of Banks Private National Banks Assets (Rp trillion) Number of Banks Total Assets (Rp trillion) Number of Banks Source: Bank Indonesia. Assets and liabilities were concentrated in the top 10 banks. In terms of assets, private domestic banks among the top 10 in 1997 included Bank Central Asia (BCA) (ranked first and linked to the Salim group), Bank Danamon (ranked 7 th ), and Bank International Indonesia (ranked 9 th ). The other banks among the top 10 were state banks. Among private domestic banks, the 10 largest were all affiliated with major business groups. Of these, BCA, Bank Danamon, and Bank Umum Nasional (BUN) have failed and the first two are now under management of the Indonesian Bank Restructuring Agency (IBRA), while BUN has been closed down by the Government. Both BCA and BUN have shareholders linked to the former President Suharto. The deregulation of the banking industry and the liberalization of the capital account created a variety of new sources of financing for the corporate sector. But the banking system proved incapable of performing its intermediation function. Because regulation was weak, banks could earn profits even when they did not gather and process information about risk.

20 Chapter 1: Indonesia 7 Foreign and domestic banks defaulted on their responsibility of deciding where capital should go and ensuring that it was used in the most effective way. In effect, there was an explosion of credit for which the probability of repayment was based on little but blind faith in the sustainability of rapid growth and on the presumption that political connections were as good as government guarantees against bankruptcy of borrowers Foreign Capital The years of rapid industrial growth attracted a large amount of foreign direct investments (FDIs), initially from Japan and the Republic of Korea. But FDIs were only one form of foreign capital inflows to Indonesia. In the 1990s, there was a phenomenal growth in direct borrowings by Indonesian corporations. Until the onset of the crisis, foreign creditors were eager to provide financing to Indonesia, especially through bank loans. Between 1990 and 1996, Indonesia received capital inflows averaging about 4 percent of GDP. Although these inflows were not nearly as large as those received by Thailand (10 percent of GDP) and Malaysia (9 percent of GDP), they still amounted to a large sum for the economy to absorb. From the mid-1980s until July 1997, when the financial crisis hit Indonesia, FDI flows were strong. Most FDIs came in through joint ventures with business groups having strong political connections. Net FDI flows increased to $5.59 billion in 1996, as shown in Table 1.2. Successive policy deregulation facilitated FDIs in various light manufacturing industries, such as metal goods, textiles, and footwear. Increasingly, foreign investment also had a strong presence in the services and infrastructure sectors. In 1994, the Government allowed foreign investors to own 100 percent of an Indonesian company, except in certain strategic sectors. Table 1.2 Foreign Capital Flows, ($ billion) Type of Flows Net FDI (0.40) Net Portfolio Investment (0.09) (0.01) (0.09) (2.63) (1.88) Foreign Bank Loans (13.15) = not available. Source: IFS CD-ROM, IMF, September 2000; Joint BIS-IMF-OECD-World Bank Statistics on External Debt, November 2000.

21 8 Corporate Governance and Finance in East Asia, Vol. II Up until the late 1980s, participation in the Indonesian stock market was exclusive to domestic investors. The Government relaxed this restriction in 1988, allowing foreign investors to buy up to 49 percent of stocks of a publicly listed company. Consequently, foreign investors began to dominate daily trading, increasing the total trading value from Rp8 trillion in 1992 to Rp120.4 trillion in In September 1997, with the onset of the Asian crisis, the limit on foreign portfolio investment was removed and foreign investors were allowed to buy up to 100 percent of shares of a listed Indonesian company. Between 1989 and 1992, the average foreign ownership of listed companies was 21 percent. This increased to 30 percent by the end of 1993, but declined to an average of 25 percent during In the 1990s, foreign banks became a significant source of financing for the corporate sector. By the end of 1997, more than 50 percent of total Indonesian private debt and 60 percent of total foreign exchange debt were owed to 175 foreign banks and other foreign financial institutions. Capital account liberalization permitted the inflow of foreign capital that fueled the credit boom in the country. Private borrowers preferred foreign loans since these were relatively cheaper, especially the short-term ones. From 1987 to 1996, the average borrowing rate for dollar loans was 9 percent, plus 4 percent for the depreciation of the rupiah. This is lower than the average borrowing rate of 18 percent for loans in domestic currency. The private sector left foreign loans unhedged because the depreciation of the rupiah had never reached more than 4 percent annually since the 1986 devaluation under the managed floating system. In November 1998, total corporate debt reached nearly $118 billion. Domestic corporate debt was about $50 billion equivalent, of which two thirds were rupiah-denominated. The external corporate debt owed to foreign commercial banks was $67 billion. The excessive dollar borrowings made the corporate sector vulnerable to sudden currency fluctuations Growth and Financial Performance While it was obvious that the term structure and currency composition of debt suggested problems in the run-up to the crisis, an interesting question is whether standard measures of corporate profitability and performance also indicated the same. The following section looks at the growth and financial performance of the corporate sector. Due to data constraints, the analysis focuses only on publicly listed companies, state-owned companies (SOCs), and conglomerates.

22 Chapter 1: Indonesia 9 Publicly Listed Companies Table 1.3 shows the growth and financial performance of Indonesian publicly listed companies. During , total sales of listed companies grew at an annual average rate of 31 percent, while total assets grew at 43 percent. Despite such rapid growth, publicly listed companies as a group contributed less than 10 percent to GDP, although the contribution increased over time. Net profits grew at an annual rate of more than 20 percent from 1992 to 1996, but turned negative in The growth of listed companies was sustained by continuing investments. Table 1.3 Growth and Financial Performance of Publicly Listed Companies, (percent) Item Growth Indicators Sales Growth Share of Value Added in GDP a Asset Growth Financial Indicators Debt-to-Equity Ratio Return on Equity Return on Assets Asset Turnover b = not available. Note: The number of firms is not identical for each year. In 1997, there were 204 firms; 1996, 248 firms; 1995, 246 firms; 1994, 250 firms; 1993, 226 firms, and 1992, 174 firms. a Value added was assumed to be 30 percent of total sales. b Asset turnover is defined as sales over assets. Source: JSX Monthly (several publications). Average return on equity (ROE) of listed firms was 11.8 percent between 1992 and 1996, but dropped to 1.1 percent in 1997 when the crisis began to buffet Indonesia. Return on assets (ROA) was also relatively stable during , averaging 3.4 percent, but declined to 0.6 percent in Asset turnover was above 30 percent until 1996, but fell to 24.7 percent in The debt-to-equity ratio (DER) was high compared to those of listed companies in Malaysia and the Philippines, ranging from 220 to 250 percent between 1992 and When the crisis battered Indonesia in 1997, the average DER increased to 310 percent from 230 percent the

23 10 Corporate Governance and Finance in East Asia, Vol. II previous year. This indicates that a substantial part of corporate debt was denominated in dollars and unhedged. Overall, it appeared that the performance of listed companies was quite satisfactory prior to the crisis, although asset turnover was slow. The ROE levels suggest that high leverage enabled listed companies to achieve high returns on equity. The Jakarta Stock Exchange (JSX) classified listed companies into nine sectors: agriculture; mining; basic industry and chemicals; miscellaneous industry; consumer goods; property, real estate, and building construction; infrastructure; finance; and trade, investment, and services. In terms of sales and asset levels in 1997, the dominant sector was the finance sector. However, in terms of growth of sales and assets, the mining sector ranked first, followed by agriculture (Table 1.4). In terms of share of value added to GDP, only two sectors (mining and finance) showed a consistently increasing trend from The finance sector s contribution to GDP, meanwhile, increased from 0.73 percent in 1992 to 1.64 percent in Table 1.5 presents the financial performance of listed companies by sector. From 1995, the mining sector had the lowest DER, indicating its reliance on equity to support growth. The finance; trade, investment, and services; and property, real estate, and building construction sectors had the highest DERs because companies in these sectors found it easy to obtain credit from banks. For instance, when the property sector was booming during , the banks eagerly provided credit to property development companies. The same applied to the trade sector. Before the crisis, the mining sector had the highest ROE, averaging 21.3 percent between 1992 and But the sector s ROE fluctuated a lot, due mainly to the domination of the International Nickel Company of Canada, which operated in nickel and copper mining in 1992 and During those years, the fluctuation in nickel and copper prices contributed to the oscillation of ROE. The consumer goods sector ranked second in terms of ROE, averaging 17.7 percent during This sector was less affected by the crisis, still posting a positive but lower ROE, helped in part by the relatively strong demand for consumer goods. Also, the companies in the sector did not operate with a high leverage. Meanwhile, the property sector was severely affected by the crisis, with ROE falling to in When interest rates increased, ROE fell drastically because the sector had one of the highest DERs. Most companies in the sector that had unhedged dollar-denominated loans suffered exchange rate losses when the rupiah weakened. ROA of all sectors dropped in Four sectors (basic industry and chemicals, miscellaneous industry, property, and trade) even posted

24 Table 1.4 Growth Performance of Publicly Listed Companies by Sector, (percent) Indicator/Sector Sales Growth Agriculture (75.3) Mining Basic Industry and Chemicals (11.4) Misc. Industry Consumer Goods Industry (8.4) Prop., Real Estate, and Bldg. Constn. (76.7) (20.5) Infrastructure Finance Trade, Investment, and Services (0.6) Asset Growth Agriculture Mining Basic Industry and Chemicals Misc. Industry Consumer Goods Industry Prop., Real Estate, and Bldg. Constn Infrastructure Finance Trade, Investment, and Services Net Profit Growth Agriculture Mining (28.6) (7.7) (27.8) Basic Industry and Chemicals (12.7) (113.5) Misc. Industry (149.5) Consumer Goods Industry (41.6) Prop., Real Estate, and Bldg. Constn (192.0) Infrastructure (11.3) Finance (41.7) Trade, Investment, and Services 90.0 (82.8) (203.2) Share of Value Added in GDP Agriculture Mining Basic Industry and Chemicals Misc. Industry Consumer Goods Industry Prop., Real Estate, and Bldg. Constn Infrastructure Finance Trade, Investment, and Services = not available. Source: JSX Monthly (several publications).

25 Table 1.5 Financial Performance of Publicly Listed Companies by Sector, (percent) Indicator/Sector Debt-to-Equity Agriculture Mining Basic Industry and Chemicals Misc. Industry Consumer Goods Industry Prop., Real Estate, and Bldg. Constn Infrastructure Finance Trade, Investment, and Services Return on Equity Agriculture Mining (5.8) Basic Industry and Chemicals (4.0) Misc. Industry (3.6) Consumer Goods Industry Prop., Real Estate, and Bldg. Constn (11.2) Infrastructure Finance Trade, Investment, and Services Return on Assets Agriculture Mining Basic Industry and Chemicals (0.4) Misc. Industry (1.3) Consumer Goods Industry Prop., Real Estate, and Bldg. Constn (3.2) Infrastructure Finance Trade, Investment, and Services (2.6) Asset Turnover Agriculture Mining Basic Industry and Chemicals Misc. Industry Consumer Goods Industry Prop., Real Estate, and Bldg. Constn Infrastructure Finance Trade, Investment, and Services Source: JSX Monthly (several publications).

26 Chapter 1: Indonesia 13 negative ROA. Trade had the highest ROA of 39.1 percent in 1993, but dropped dramatically to 4.4 percent the following year. The finance and miscellaneous industry, and basic industry and chemicals sectors had relatively stable ROA before the crisis. Only the agriculture sector showed an increase in ROA in the couple of years before State-Owned Companies At the end of 1995, there were 165 state-owned companies (SOCs) 3 in Indonesia. SOCs actively operated in various sectors 4 under the supervision of technical departments. For instance, the Department of Finance supervised 30 SOCs, which collectively had the largest assets. The Department of Mining and Energy ranked first in terms of sales of SOCs under its control. This was due to large sales by the National Oil Company (Pertamina). Just like private companies, SOCs diversified into many businesses. By 1995, there were 58 SOCs with subsidiaries and affiliates. Taken together, the subsidiaries and affiliates number 459 with total assets of Rp343.3 trillion. SOCs sales growth fluctuated during , registering an average annual rate of 10 percent. Similarly, growth of net profits and assets was erratic, averaging 24 and 31 percent, respectively, between 1993 and These growth rates were low compared to those for listed companies during the same period. Assuming a fixed ratio of value added to sales, the SOCs value added as a percentage of GDP ranged from 6 to 8.7 percent. This was relatively high compared to the 3.7 to 7 percent for publicly listed companies. However, the ratio decreased from 8.7 percent in 1990 to 6 percent in 1996, indicating SOCs declining contribution to GDP. SOCs ROE ranged from 6.6 to 8.8 percent between 1992 and 1995 (Table 1.6), much lower than that of companies listed in the stock exchange. The DER was slightly higher than for listed companies, but it continuously declined from 370 percent in 1992 to 250 percent in ROA had been at high levels from 1992 to 1995, increasing from 21.1 percent in 1992 to 28.3 percent in Asset turnover rates were lower relative to those of publicly listed companies. While asset turnover rates of publicly listed 3 4 SOCs are those in which the State has at least a 51 percent equity interest. Six SOCs were listed in the Jakarta Stock Exchange. The sectoral distribution of 165 SOCs is as follows: nonfinancial (143 companies); banks (seven companies); insurance (11 companies); and finance company (four companies).

27 14 Corporate Governance and Finance in East Asia, Vol. II companies consistently declined over time, SOCs asset turnover rates showed a downward trend from 32.4 percent in 1992 to 28.6 percent in 1994, but climbed to 30.5 percent in Table 1.6 Growth and Financial Performance of State-Owned Companies, (percent) Indicator Growth Indicators Sales Growth 16.4 (9.1) 25.1 Share of Value Added in GDP a Assets Growth 23.1 (2.6) 17.3 Financial Indicators Debt-to-Equity Ratio Return on Equity Return on Assets Asset Turnover b = not available. a Value added was assumed to be 30 percent of total sales. b Asset turnover is defined as sales over assets. Source: Indonesian Data Business Center. Conglomerates This study used available data on the top 300 conglomerates in Indonesia. In 1997, these conglomerates owned 9,766 business units, mostly private companies. Their total sales increased from Rp90.1 trillion in 1990 to Rp234 trillion in Assuming a constant ratio of value added to sales, the contribution of conglomerates to GDP increased from 12.8 percent in 1990 to 13.4 percent in 1994, but dropped to 11.2 percent in 1997 (Table 1.7). Table 1.7 Growth Performance of the Top 300 Conglomerates, (percent) Item Sales Growth Share of Value Added in GDP a = not available. a Value added was assumed to be 30 percent of total sales. Source: Indonesian Data Business Center.