Business culture in Indonesia is based on relationships rather than rules, largely as a result of the high incidence of concentrated ownership, family-owned businesses, and controlling shareholders, as noted in the World Bank's 2004 Report on the Observance of Standards and Codes (ROSC) on Indonesia's compliance with the Organization for Economic Cooperation and Development (OECD) Corporate Governance Principles. The first Code of Good Corporate Governance was developed under the National Committee for Corporate Governance (CCG). The CCG was replaced in 2004 by the National Committee on Governance (NCG), which is responsible for strengthening, disseminating, and promoting good corporate governance principles in the private sector. In 2006, the NCG issued a new Code of Good Corporate Governance. While Indonesia has an elaborate system of corporate governance rules, corporate governance practices often fall short of the OECD's recommendations. In its 2004 ROSC, the World Bank recommended improving the effectiveness of implementation and enforcement of legislation and regulations to improve the corporate governance framework. It further advised establishing nomination committees and a cumulative voting system, ensuring disclosure and transparency in annual reports and financial statements, and improving the roles and responsibilities of the audit committees. The principal law governing stock corporations in Indonesia is the 2007 Company Law No. 40, whereas stock markets are mainly regulated under the 1995 Capital Market Law No. 8. The Jakarta Stock Exchange and the Surabaya Stock Exchange were integrated into the Indonesia Stock Exchange in December 2007.

General Overview

In the 2004 ROSC on Indonesia's compliance with the OECD Corporate Governance Principles, the World Bank came to the conclusion that while Indonesia had an elaborate system of corporate governance rules, corporate governance practices often fell short of the OECD's recommendations. In its 2006 report on the Role of Non-Bank Financial Institutions, the World Bank identified weaknesses in Indonesia's equity market regarding enforcement of transparency, information disclosure, and corporate governance. Moreover, citing its own 2004 ROSC on Indonesia's corporate governance framework, the World Bank stated that "Indonesia's business culture is based on relationships rather than rules, largely as a result of the high incidence of concentrated ownership, family-owned businesses, and controlling shareholders" (p. 53). The 2004 World Bank report recommended improving the effectiveness of implementation and enforcement of legislation and regulations to improve the corporate governance framework. It further advised establishing nomination committees and a cumulative voting system, ensuring disclosure and transparency in annual reports and financial statements, and improving the roles and responsibilities of the audit committees.

The first Code of Good Corporate Governance was developed under the National Committee for Corporate Governance, which was established in 1999 through a ministerial decree. The Committee was replaced in 2004 by the National Committee on Governance (Komite Nasional Kebijakan Governance, or NCG), and a new Code of Good Corporate Governance was issued in 2006. According to the World Bank's 2004 ROSC, the NCG is responsible for strengthening, disseminating, and promoting good corporate governance principles in the private sector. As part of its Financial Governance and Social Security Reform Program, the Asian Development Bank (ADB) identified Indonesia's poor governance and weak implementation of the legal and regulatory system for the financial system. It urged the country to amend its Capital Market Law and Company Law to strengthen supervision and regulation, and to incorporate international best practices and standards. The new Company Law No. 40 was implemented in 2007, and Indonesia adopted the new Investment Law No. 25 on May 2 of the same year. Stock markets are mainly regulated under the 1995 Capital Market Law No. 8.

Following the merger of the Capital Markets Supervisory Agency (Badan Pengawas Pasar Modal, or Bapepam) with the Financial Institution Directorate General (Direktorat Jenderal Lembaga Keuangan, or DJLK) into the Indonesian Capital Market and Nonbank Financial Service Supervisory Agency (Badan Pengawas Pasar Modal & Lembaga Keuangan, or Bapepam-LK) in 2004, the Financial Services Authority (Otoritas Jasa Keuangan, or OJK) was created in 2007 as an integrated supervisory authority for the financial sector in Indonesia. The OJK also has the authority to regulate capital market activities, and is expected to be operational before 2010. The Jakarta Stock Exchange and the Surabaya Stock Exchange were integrated into the Indonesia Stock Exchange (Bursa Efek Indonesia, or IDX) in December 2007. During the same year, market capitalization of the IDX, as noted on its website, amounted to USD 276.25 billion (IDR 2,539 trillion), of which 78 % came from equities, representing a 58.69% increase from the previous year. As of 2007, the IDX has 383 listed companies. In its 2006 Country Strategy and Program report, the ADB recommended developing Indonesia's bond and secondary market "to ensure transparency and efficiency of price discovery through an electronic platform" (p. 116-117). The 2006 World Bank report on the Role of Non-Bank Financial Institutions encouraged the participation of the Central Securities Depository in the Bank of Indonesia's Scripless Securities Settlement System.

In its 2008 Doing Business report, the World Bank rates investor protection in Indonesia in 2007 at slightly below the OECD average. The Investor Protection Index is a subcomponent of the World Bank's 2008 Doing Business Indicators, and consists of three dimensions of investor protection: transparency of transactions (Extent of Disclosure Index), liability for self-dealing (Extent of Director Liability Index) and shareholders' ability to sue officers and directors for misconduct (Ease of Shareholder Suits Index). The indexes range between 0 and 10, with higher values indicating greater disclosure, greater liability of directors, greater powers of shareholders to challenge the transaction, and better investor protection. Particularly noteworthy is Indonesia's score of 9.0 in the disclosure index against a regional average of 5.0 and an OECD average of 6.4. On the other hand, it only scores 3.0 in the Shareholder Suits Index against a regional average of 6.3 and an OECD average of 6.5. Indonesia also scores 5.0 in the Director Liability Index against a regional average of 4.4 and an OECD average of 5.1.

The Principles

Principle I: Ensuring the Basis for an Effective Corporate Governance Framework

II

The principal law governing stock corporations in Indonesia is the 2007 Company Law No. 40, whereas stock markets are mainly regulated under the 1995 Capital Market Law No. 8. On May 2, 2007, Indonesia adopted Investment Law No. 25. The first Code of Good Corporate Governance was developed under the National Committee for Corporate Governance, which was established in 1999 through a ministerial decree. The Committee was replaced in 2004 by the NCG, and a new Code of Good Corporate Governance was issued in 2006. According to the World Bank's 2004 ROSC, the NCG is responsible for strengthening, disseminating, and promoting good corporate governance principles in the private sector. The OJK was created in 2007 as an integrated supervisory authority for the financial sector, merging the DJLK with the Bapepam. The OJK also has the authority to regulate capital market activities, and is expected to be operational before 2010. The World Bank's 2004 ROSC reported that Indonesia had an elaborate system of corporate governance rules, but found that corporate governance practices often fell short of the OECD's recommendations. The World Bank report recommended strengthening the enforcement of laws and regulations, as well as administrative sanctions for violation of securities or disclosure rules. However, the World Bank ROSC did not directly addressed Indonesia's compliance with this principle, as it had not been added to the OECD principles at the time of the assessment.

Principle II: The Rights of Shareholders and Key Ownership Function

EN

In its 2004 ROSC, the World Bank rated Indonesia's observance with the sub-principles of Principle II as follows: "Rights to Participate in Fundamental Decisions" and "Shareholder's Annual General Meeting Rights" are rated as "Largely Observed," indicating that only minor shortcomings are observed, which do not raise questions about the authorities' ability and intent to achieve full observance in the short term. "Basic Shareholder Rights" is rated as "Partially Observed," indicating that while the legal and regulatory framework complies with the principle, practices and enforcement diverge. "Disproportionate Control Disclosure," "Functioning Control Arrangements," and "Cost/Benefit to Voting" are rated as "Materially Not Observed," indicating that, despite progress, shortcomings are sufficient to raise doubts about the authorities' ability to achieve observance. Per the same report, redress available to shareholders if their rights are violated remains limited.

In its 2004 ROSC, the World Bank recommended strengthening shareholder access to information related to general meetings, as well as their right to make proposals during the meeting. With regard to basic shareholder rights, the World Bank report advised improving the rights of minority shareholders by, inter alia, establishing a cumulative voting system, and requiring listed companies to set up nomination and remuneration committees. Further efforts, such as shareholder activism, should also be made to encourage compliance. Concerning the materially not observed sub-principles, the World Bank report recommended requiring institutional investors to disclose their voting policy. It further encouraged controlling shareholders to adequately disclose discrepancies between cash flow rights and voting rights, as well as cross ownership.

Principle III: The Equitable Treatment of Shareholders

EN

In its 2004 ROSC, the World Bank rated Indonesia's observance with all three sub-principles of Principle III as "Partially Observed," indicating that while the legal and regulatory framework complies with the principle, practices and enforcement diverge. While class action suits are allowed, according to the same report, they tend to be costly and are therefore limited. The World Bank report advised improving the framework for filing class action lawsuits by notably lowering the threshold for filing lawsuits against members of the Board of Directors or Board of Commissioners. Regarding insider trading, it encouraged the stock exchange and the Bapepam, prior to its integration into the OJK, to strengthen market surveillance, provide special training on insider trading rules, and further clarify definitions of related party transactions to minimize legal uncertainty. Conflicts of interest or related party transactions should also be fully disclosed to the company by the directors and related parties.

Principle IV: The Role of Stakeholders in Corporate Governance

EN

In its 2004 ROSC, the World Bank rated Indonesia's observance with all four sub-principles of Principle IV as "Partially Observed," indicating that while the legal and regulatory framework complies with the principle, practices and enforcement diverge. The World Bank report noted that stakeholders' access to company information was "not adequate" (p. 9). With regards to stakeholder rights, the World Bank report advised requiring the reporting and registration of pledged shares into the Company Share Register, and providing the same information to the Central Securities Depository. It further recommended publicly disclosing annual reports and company information on internet.

Principle V: Disclosure and Transparency

EN

In its 2004 ROSC, the World Bank rated Indonesia's observance with all four sub-principles of Principle V as "Partially Observed," indicating that while the legal and regulatory framework complies with the principle, practices and enforcement diverge. Regarding disclosure standards, the World Bank report recommended requiring listed companies to make annual reports available on the internet in a timely manner, and improving disclosure relating to the governance structure and internal control system. It further advised fully adopting the International Financial Reporting Standards (IFRSs) and International Auditing Standards (IASs), and strengthening accountants' legal liability. According to the OECD's 2006 Corporate Governance report, Indonesia introduced a wide range of reform measures to improve information disclosure to shareholders and the public, including the quarterly submission of financial reports.

The World Bank's 2005 report on accounting and auditing states that under the Capital Market Law, issuers, and public companies are required to file audited financial statements with the Bapepam on an annual and semi-annual basis. Furthermore, financial statements must be prepared in accordance with generally accepted accounting principles which refer to the Indonesian Financial Accounting Standards (PSAK) set by the Indonesian Institute of Accountants. Per the same report, capital markets may also be subject to accounting regulations established by the BAPEPAM when deemed necessary. However, the World Bank's 2004 ROSC noted that while the PSAK are largely consistent with international standards, there is a gap between those standards and actual practices. According to the ADB's 2006 Country Strategy and Program report, the IFRSs and IASs were expected to be fully introduced by 2008.

Principle VI: The Responsibilities of the Board

EN

In its 2004 ROSC, the World Bank rated Indonesia's observance with all six sub-principles of Principle VI as "Partially Observed," indicating that while the legal and regulatory framework complies with the principle, practices and enforcement diverge. Under Indonesia's dual board system, as noted in the OECD's 2006 Corporate Governance report, the Board of Commissioners has supervisory and advisory duties, whereas the Board of Directors performs the executive roles. Furthermore, Indonesia requires that independent commissioners account for at least 30 percent of the total number of board members. Per the same report, however, "Indonesia does not have any laws that specify the rules for shareholder approval of the appointment of directors or commissioners" (p. 23). In its 2004 ROSC, the World Bank advised regularly evaluating the effectiveness of the internal control system in line with international best practices. Regarding due diligence, it recommended further clarifying the responsibilities of independent commissioners, and improving the audit committee's duties and effectiveness. It also encouraged the separation of management from the owners, and appointment of professional managers. Per the same report, the Capital Market Law should be revised to require the Board of Directors and Board of Commissioners to treat all shareholders in a fair manner and expand the role and responsibilities of the Board of Commissioners by establishing a nomination committee for listed companies.