board duties - inggris

8/7/2019 Board Duties - Inggris

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CHAPTER 1

BASIC CONCEPTS



Board of Directors is a term used in the United States to collectively describe

a company’s supervisors and managers, consisting of majority shareholders, the

company’s founders, major creditors, and people employed by the company. The

model of American corporate structure is illustrated in figure 1-2. It is a one-tier

system. From among the members of the board of directors, at least two will be

elected to the positions of chief executive officer (CEO) and chief financial officer

(CFO). Often, a third is elected to the position of chief operating officer (COO).

Unlike the American model, the European model follows a two-board system (see

figures 1 and 2), such as is adopted in Indonesia. In this two-tier system, shareholders

appoint a group of managers to operate the company (management) and a group o

management supervisors and advisors, who are referred to as commissioners. This

concept of corporate supervision developed over time as companies and their

ownership expanded.

DEVELOPMENT OF CORPORATIONS

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Supervision and operation of companies started to get complicated with the

industrial revolution in Europe in the 18th century, and later that century in the United

States, with the introduction of public ownership (Hendriksen 1995, p 18). Prior to

that, most companies were owned and supervised by families. Management and

supervision in a family-owned company lay in the hands of one person: the owner.

This management-owner system was neither complex nor complicated.

Public ownership was introduced for the first time in Europe in the 16 th

century, with the establishment of a company called South Sea Limited Inc. This

company was involved in the slave trade, transporting slaves from Africa to be sold in

the slave markets in London. In need of substantial funds, the company began

offering shares to the royal family and to members of parliament. Public companies

meant public ownership, and a market was needed to operate trade in shares. So, the

world’s first stock market, the London Stock Exchange, was born in 1873.

With the export of the industrial revolution from Europe to America came the

first corporation, the Santa Fe railroad company. In need of massive funding, the

company's founders invited the public to own shares in the company by purchasing

stocks, which sparked the idea of setting up the world's second stock exchange. The

New York Stock Exchange began operations in 1892.

Following the introduction of corporations, both in America and in Europe,

supervision and operation of companies became increasingly complex

complicated. In America, the company’s founders and controlling or majority

shareholders, and the company’s major creditors would decide who would supervise

and decide on the company’s strategic direction. So, the company’s founders,

majority shareholders, major creditors and representatives of minority shareholders

formed a group of company supervisors and controllers, which was called the board

of directors. From among the members of the board of directors, two or three were

elected to hold the positions of chief executive officer (CEO), chief financial officer

(CFO), and, in many cases, chief operating officer (COO). The CEO in turn would

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choose several people as senior managers who would be part of a management team

under the command of the CEO. This is what is referred to as one tier management.

The European, two-tier management model divides corporate power between

two groups of managers. The first is called the board of commissioners, which is

chaired by a president commissioner or chief commissioner; and the second is the

board of management, which is chaired by a managing director. These two boards are

elected by a general meeting of shareholders. The board of commissioners has the job

of supervising and advising, and its members are appointed by the majority and

minority shareholders and management (the two-tier model is shown in figure 1-2).

Figure 1-1 shows the contractual relationship between the principals and

agents. The principals are the company’s owners and founders; the agents are

management. Under these conditions, the principal-agent contract is in fact between

the chief executive officer and the managers and employees, not between the board of

directors and the chief executive officer.

Conflict between agents and principals will lead to opportunistic behaviour at

the expense of the owners. Minority stockholder representation is very limited. To

protect the rights of stockholders requires a person with no direct association with

management and stockholders, an independent director.

Brown and Caylor (2006) analysed the relationship between good corporate

governance and company operating performance. Samples were taken from 1,757

firms. The presence of independent directors, audit committee and nomination

committee in a company were associated with high return on equity and return on

assets. This suggests that independent directors play a part in adding value to the

company. The greater the number of independent directors, the better one would

expect corporate governance to be in terms of protecting stakeholders’ interests.

Figure 1-1. A Contracting Schematic of The Modern Corporation (one tier system)

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`

Source: Fred R.Kaen, p. 18

CIVIC R EPUBLICANISM

Civic republican is a concept that is closely associated with propownership and the owners’ social responsibility as members of society. So, owners of

wealth in general will move into politics to protect their property from

opportunistic tendencies of others, because, it is argued, humans are inherently

opportunistic. Based on this assumption, expansion of ownership to the general

BOARD OF DIRECTORS

C E O

Creditors:Financial Institution

Bond HoldersManagers

and

Employees

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Common stockholdersPublic shareholders

Institutional InvestorsLarge Block Holders

Other Corporations

Suppliers Customers

Government:

• Local

• State

• National

• Foreign



public will create political protection for owners of wealth. And that means wider

ownership of wealth is one way of making humans less opportunistic.

Wider ownership of wealth will result in collective ownership, which in turn

will grow commitment to public welfare and a harmonious relationship with the

environment.

The civic republican also believes that wider ownership of wealth is the way

to achieve liberty and equality. Liberty in the sense of freedom from tyranny and

oligarchy, and the ability to determine one’s own fate in general and economic self-

reliance in particular, to avoid being dependent on a group of rule makers or those

with power. Under these conditions, the price of labour, and of other factors of

production, would be determined by market forces and not by an aristocracy or a

clique of investors. The market, here, is the media that sets optimum prices, freeing

individuals from dependency and oppression. In other words, the market is the media

that creates love of life, the freedom to choose one’s own values without having to

depend on others, and that, ultimately, creates welfare.

Figure 1-2 Typical Indonesian Contracting Schematic

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Source: Mas’ud Machfoedz

The market will determine a price that balances supply and demand for

economic resources. The market will also increase efficiency through arms length

transactions, a process of price determination that disregards social status and class.

The market will allow people to make transactions freely and responsibly, and in this

way all market players will hold equal positions and enjoy the same freedoms. This in

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Stockholders Meeting

Board of

Commissioners

Executive Directors:

• President Director

• Operating Directors

ManagersAnd

Employees

Suppliers Customers

CreditorsGovernment

Others



turn will create democracy, freedom, and social responsibility through market

mechanisms.

To create these ideal market conditions, ownership of wealth must be spread

wide, not concentrated in certain individuals or stakeholders. In addition, the market

itself must be efficient and free from manipulation by market players. If these

conditions are met, the market will be what is known as a perfect market; otherwise

there will be market failure, with monopolies doing the selling, oligopolies setting

prices, and monopsonies doing the buying, which would be harmful to civil freedoms

and liberties.

LIBERALISM

Another concept of business is liberalism. Unlike the civil republican, the

liberal does not believe that human nature can be changed by distributing wealth to

the public through property markets. Humans, they argue, are basically opportunistic

and self-seeking when it comes to property ownership, and because of this they

cannot be motivated to become socially responsible citizens. Liberalism focuses on

the creation of institutional-procedural structures, and management systems, to create

conditions that prevent concentration of economic and political power in the few. In

other words, liberalism does not seek to eliminate human’s opportunistic tendencies.

They seek only to control that human trait. This means that markets need to be

created to facilitate economic transactions because barter is no longer efficient, and

that property is used to create economic welfare and generate economic growth. For

liberals, economic growth is the goal, not changing human nature.

The key aspect of liberalism is how growth can be maintained through

efficient markets by controlling the opportunistic and self-seeking nature of humans.

AGENCY THEORY

Jensen and Meckling (1976) offered an explanation of the principal-agent

relationship. The principal is represented as stockholders and the agent is represented

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as management. The two parties, principal and agent, in normative and empirical

terms, share several characteristics: moral hazard, bounded rationality, and risk averse

or opportunistic. They are self seeking at the expense of others: shareholders want the

value of their shares to rise, thus increasing their wealth, by asking management to

maximise earnings per share (EPS), because EPS has a positive correlation with share

price (Machfoed and Sugiri 2002; Ou and Penman 1990). With the target of

maximizing EPS, management will implement earnings management (Machfoedz and

Fajrih 2005) to ensure high bottom line earnings and attractive incentives for

management.

These conditions pose problems for the agent. The principal, who wants share

price to rise continually, will pressure management to focus their efforts on

maximizing profits. Managers will retain their positions or receive attractive bonuses

or benefits, and so continue to try to maximise profits by seeking fit accounting

methods. Stockholders do not necessarily realise that adopting earnings management

can endanger the company’s sustainability, as in the case of Enron. This is what is

referred to as bounded rationality. Another problem concerning agency is information

asymmetry. The management operating a company has far more information than do

stockholders or other stakeholders. This will mean that stockholders do not receive

adequate information and adverse selection will be made as a result.

Figure 1-3 Agency Theory

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AGENCY THEORYAGENCY THEORY

•MORALE HAZARD

•BOUNDED RATIONALITY

•RISK AVERSE

INFORMATION

ASSIMETRY

ADVERSE

SELECTION

EVERY EFFORT TO REDUCE

THE INFORMATION ASSIMETRY

WILL INCREASE AGENCY COSTS

In the one-tier system adopted by America, the game of infor

asymmetry can be played by majority shareholders along with management, because

they are members of a group of corporate decision makers. If this happens, those that

suffer most are the minority shareholders, because they could make a

investment decisions and suffer investment losses as a result. So, a system of good

corporate governance is needed, such as increasing the number of outside directors or

independent commissioners. Information asymmetry is even worse in two-tier

systems, such as in Indonesia, where shareholders are outside management (though in

many cases majority shareholders sit on the board of commissioners). So, to ensure

good corporate governance, a company must have independent commissioners.

THE COMPLEXITY OF R ELATIONS IN A MODERN CORPORATION

Today we are all connected .

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Today is a time of shifting paradigm, in which corporations consist of relations

between management and owners, such as stockholders, but encompass wider

relations too. Extended enterprise includes relations between investors, customers,

suppliers, competitors, regulators and networks (stakeholders’ paradigm). From the

corporate governance perspective, understanding these relations is vital.

Good corporate governance begins by paying heed to the interests of the

company’s owners. Investor confidence is essential for the company to get the capital

it needs for corporate development. An understanding of the company’s consumers is

needed to make market strategies that will add value to the company for its

consumers. In the same vein, an understanding of suppliers is an integral part of

creating value for the company. Failure in selection of the company’s suppliers, for

example, could cause delays in the production process. Corporate governance is a

mechanism that understands and accommodates the interests of these stakeholders.

As an example, not having good relations with stakeholders may result in

substantial losses, or even ruin a company. Newmont, Freeport and Lapindo are

examples of companies that have failed to accommodate the interests of stakeholders.

Newmont ignored the environmental problems caused by its poor waste management,

and as a result received several claims, including from NGOs concerned with health

issues. Investor confidence in the company decreased because it was thought not to

have taken into account stakeholders’ interests. This suggests that today companies

have to be concerned not only with maximising profits for its investors, but must also

accommodate the interests of other stakeholders that have relations with

company, including the public, consumers and other stakeholders.

SUMMARY

Concepts of good corporate governance must take into consideration the

relationships between the organs of the company and its structure, whether two tier or

one tier. There are two models of business management, the United States adopts a

one-tier system, and the countries of Europe, a two-tier system. The one-tier system

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is a concept inspired by liberalism; the two-tier system by civic republicanism. The

civic republican believes that everyone who holds wealth has a pubic responsibility,

and for this reason ownership of corporations is shared with the public. This one-tier

system is concept inspired by liberalism. Liberalism says that responsibility for

ownership of wealth is not to the public, but to increasing welfare, so managers of

corporations must be able to enhance welfare. Indonesia adopts a two-tier system. As

a consequence of the country’s long experience of operating state enterprises during

Dutch colonial times, its statutes and social regulations tend towards Dutch law. In

some companies, such as PT Sampoerna, PT Gudang Garam and PT Polytron, where

the owner is also the company’s majority stockholders and founder, the positions of

company president and chief executive officer are found. Though this may seem

similar to the one-board system adopted in the United States, Indonesian corporate

law and regulations do not allow this. Under these circumstances, independent

directors are required to keep the opportunistic tendencies of the owners in check, and

to avoid moral hazard and information asymmetry in management. Independent

directors are a media for achieving good corporate governance. Today, corporations

focus not only on stockholders, but on stakeholders, too. Corporate governance is a

mechanism that understands and accommodates the interests of these various

stakeholders. Accommodating the interests of stakeholders will increase the value of

the firm.

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Boards must be able, using certain tools, to anticipate what will happen to a

company in the future. To do this, potential problems must analysed. Boards must

build appropriate corporate visions and missions, and be visionary. That done, boards

must actively participate in developing the company’s programmes.

Figure 2-1 Flowchart of Board of Directors’ and Board of Commissioners’ Duties

Source: Mas’ud Machfoedz

VISION, MISSION

and STRATEGY

PROGRAMMING

Supervising andadvising

BUDGETTING

Board’s

Responsibilityand Direction

VALUE COMPANY

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The processes involved in the operation and execution of a company’s vision and

mission in a management control system (Anthony and Govindarajan, 2005) are

illustrated in figure 2-1. At the highest level, the company must develop a vision and

mission. Strategies to execute the vision and mission must then be outlined. The

responsibility of boards is to determine the direction of the company and participate

directly in formulating strategies. At this stage, boards (not necessarily boards of

commissioners) will determine the direction of the company in the context of

achieving the company’s goals, which bottom line will be increasing the value of the

firm. In companies that sell shares to the public, the value of the firm is determined

by market capitalisation per share, that is, share price times number of shares issued.

Vision, mission and strategy can be well formulated if boards have the vision and

experience to anticipate what will happen to the company in the future.

For boards to be able to anticipate what will happen in the future, they need to

able to manage risk.

Many boards fall short when it comes to anticipating what might happen in

the future, leaving them powerless to deal with crises in the firm. This is where an

ideal composition of board members is an advantage. In particular, independent

members of boards should be selected for their competence in their field. To help

anticipate what might happen in the future, a board may be assisted by a risk

management committee, or form a team of experts that can perform analysis of the

industry in which the firm operates.

Empowering the directors of firms to focus on the bigger picture of what

management should be doing is another factor associated with the d

anticipation. Firms adopting a one-tier system are better able to supervise corporate

strategy than those employing a two-tier system. In the one-tier system, the positions

of chief executive officer and chief finance officers, and sometimes chief operations

officers, are held by members of the board. This dual function makes execution of

mission and strategy easier. In the two-tier system, because the boa

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commissioners cannot be directly involved in the operation of the company, board

members are not such an inspiration in the company’s vision, mission and strategy.

An example is the role of the board of directors in the collapse of Enron,

declared by the United States Senate’s Permanent Suborindatee on Investigation and

based on an in-depth review that found evidence of the board’s failure to monitor.

The board occasionally “chose to ignore” problems, and also allowed Enron to

engage in “risky” practices. This was a problem of corporate governance. The

problem originated from the company’s “progressive” organisational strategy, known

as “redesign corporation”. In a redesigned corporation, projects are implemented

bottom up, not top down. In some firms, executive monitoring means analysing risk

management reports. Power Report concludes that the Enron board was and should be

found guilty because it failed to request information and failed to review and analyse

information not given to board members. This indicates a failure on the part of the

Enron board to anticipate future events.

2.ADVOCACY:

Advocacy refers to individual support given by board members

stakeholders. Board members can communicate with stakeholders, shareholders and

the public in several ways. Board members can shape perceptions of the company,

public education and knowledge, and understanding of the company’s business. In

this way, board provide not only emotional and intellectual support, but also financial

management and investment policy support.

One way in which board members can influence perceptions of the company

is through disclosure policy on corporate social responsibility (CSR). Today, CSR is

a major trend. CSR is legally required action taken by the company in the interests of

the workforce, environment, and society. CSR can increase the value of the firm.

Rubin and Barnea (2006) analysed the relationship between CSR expenditure and the

value of the firm. When CSR expenditure is low, a positive contribution to the value

of the firm will be made by increasing the productivity of the workforce or avoiding

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costs and fines associated with reputation and pollution. But at the same time, each

increase in CSR expenditure will reduce the welfare of stockholders. If corporate

decisions are made to maximise the value of the firm, the level of CSR expenditure is

a significant decision for boards to make. Insider managers (corporate managers,

directors, blockholders) may want to increase CSR expenditure to level higher than

that which would maximise the value of the firm if there are personal gains to be

made from doing so. For example, if a certain level of CSR enhances their reputation

as individuals who care about the environment, society and workers. While high CSR

expenditure may be advantageous to the firm’s insiders (affiliated shareholders), non-

affiliated shareholders may not approve of high CSR expenditure if it reduces the

value of the firm. Thus, CSR can be a cause of conflict between shareholders. This

conflict can be seen from two normative perspectives. On the one hand, there is

evidence for choosing CSR expenditure higher than that which would maximise the

value of the firm. This has a negative connotation because it reduces shareholder

value. On the other hand, high CSR expenditure promotes a social agenda, which is

perceived as positive. Most would interpret the problem as action by managers

seeking to profit from share prices, and would be very surprised that CSR conflict has

implications for the balance between corporate goals and social goals. From the social

welfare perspective, whether this conflict will increase welfare depends on whether

the company stands to benefit from making a contribution to social welfare.

(what did the lapindo board do?). How did Lapindo’s CSR contribute to social

welfare? Was Lapindo transparent in its communication of the condition of the

company to stakeholders?

3.AUTONOMY:

Engaging boards in formulating and implementing corporate strategy is a

sensitive issue. Although boards also direct CEOs in formulating the corporate

structure and strategy, it is understandable if there is problem concerning the

“ownership” of strategies that are in the hands of CEOs and their management teams.

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To increase effectiveness, an organisation not only needs clear, unambiguous

strategy, but also the confidence that top management has the authority and capacity

to implement it. By their very nature, boards do not have the leadership needed to

manage products and markets, because the majority of their members do not have

specific experience and knowledge of industry, and more importantly, do not have the

capacity to translate corporate vision and strategy into concrete operations. Thus,

boards cannot make decisions alone, but need the help of competent CEOs.

To implement the company’s vision, mission and strategy, the board must

work with the CEO to run the company drawing on their individual expertise and

creating synergy. Although boards have the legal right to monitor and evaluate the

performance of CEOs, they must give CEOs the freedom to do their work properly.

Given this autonomy, CEOs feels they are trusted to manage the firm properly, and

will try not to abuse that trust. But without the autonomy and freedom to do their

jobs, CEOs will feel useless and increasingly frustrated. At the very least, it will

generate negative feeling.

4.ACCOUNTABILITY:

Autonomy must be balanced by accountability. Boards must ensure that while

giving autonomy to executives, in return they require accountability from the

executives. Given fiduciary, executives must be monitored to ensure that they are

able to maintain public trust, advance the company, and carry out and execute the

company's mission. To monitor the accountability of the executives, boards can form

several committees, such as an audit committee, risk monitoring committee, and a

remuneration and nomination committee. It should be noted that formation of these

committees can create tension in relations with the executives, and here the role of

boards is to alleviate such tension.

Independence will reduce agency cost by making boards responsible to

shareholders for the company's performance. Independence ensure that they evaluate

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management decisions objectively. The accountability function includes passive

monitoring. For independent boards, to reduce agency cost, they must actively grow a

culture of responding to shareholders' interests. Though independent boards cannot

and need not make the best decisions about a company's problems, this allows

managers to ensure the basic integrity of management actions.

In recent times, there has been more and more focus on c

accountability, largely as a consequence of economic crises, accounting

remuneration scandals, and suspicion surrounding firms' social and environmental

implications, and as a result, there is growing transparency regarding corporate

practices. This growing demand for transparency comes from two different angles,

which appear to overlap. On the one hand, accountability is required in the context of

corporate governance, and began by covering matters related to staffing and ethics.

On the other hand, separate from the traditional corporate governance framework, are

sustainability reports. Generally focusing solely on environmental issues, the scope of

these reports has begun to expand to include ethical and social issues, such as

problems related to society and company employees, which the corporate structure

must address, and to financial aspects.

Sustainability reporting is broadly defined to include environmenta

social/ethical, and financial aspects (or triple bottom line “people, plant, profit”

reporting). The number of constituents and potential readers of sustainability reports

has expanded to include internal and external stakeholders, including shareholders.

Sometimes referred to as CSR reporting, sustainability reporting is perceived as

fulfilling the company's CSR role, a concept seen as fulfilling a company’s economic,

legal, ethical and philanthropic responsibilities to stakeholders and the public in

general. On this basis, the implication is that accountability in the sustainability

reporting and corporate governance frameworks tends to converge. What

interesting is that the sustainability reporting framework raises questions about the

nature of accountability and the concept of transparency. Whether accountability

should be part of the annual report or a separate sustainability report needs to be

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made. Although an integrated reportan annual financial report including social and

ethical information, otherwise referred to as “sustainable stakeholder accounting”

has been recommended, it should be noted that attention must be given to ensuring

proper integration. Sustainability measures in the annual report in some cases are kept

separate, though incorporated into the corporate governance section related to

sustainability. When corporate governance and sustainability are properly integrated

and reported together, this provides an opportunity to adopt integrated accounting.

Also important is determining the level and detail of information provided, because

while parts of this information are provided voluntarily, other parts are required,

particularly information about risk and management control (including social, ethical

and environmental aspects), reputation and trademarks, and the ethical dimensions of

remuneration and auditing.

Sustainability reporting is a way for companies to meet the wants of a variety

of stakeholders. If it is integrated with corporate governance, the relationship between

the company and shareholders and between the company and society, will be

covered. How to give stakeholders (including shareholders) the information they

want, and at the same time accommodate the different interests (which can lead to

conflict)? The auditor verifying the report can act as liaison in identifying the areas

that need more attention.

5. ADVICE:

Boards have legal authority when it comes to decision making in a firm. This

means that boards must review and approve operations fundamentals, finances,

strategy, and other corporate plans. To reduce moral hazard, boards must participate

actively in decision making. In their role as advisor, boards must adopt a variety of

approaches. Boards use the expertise of their members to direct management, in

keeping with the direction of company strategy. When board members have full-time

jobs in other companies, they rely on the company’s CEO to provide the necessary

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information to evaluate, for example, whether the company should enter a new line of

business. The more information provided and the better managers synthesise the

information, the better advice will be given by the boards. When a board acts in its

advisory role, it is better for shareholders if the board’s preferences correspond to

those of the company’s managers. This means that other constituents

shareholders will not reduce the value of shareholdings by allowing the board’s

preferences to override those of management.

Board members are people who have expertise, experience and skills in a

variety of fields. With their expertise and experience, a board should be able to give

advice to management about operating the company efficiently and effectively.

Boards should comprise people of various backgrounds, notably finan

accountancy, the industry in which the company operates, and politics.

6.ASSISTANCE:

A more important duty of boards than giving advice is giving assistance.

There are interesting lessons to be learned from the game of football about the

importance of assistance. The aim of football is the same as that of business: to beat

the competition by scoring goals. In a World Cup match, the Brazilian eleven was

losing right up to the closing minutes. At this critical time, Ronaldinho, the ace

Brazilian striker took the ball into left field and carefully passed the ball to Ronaldo,

who was standing unmarked on the right of the English goal. Ronaldo took the pass

from Ronaldinho and kicked the ball into the net with ease – GOAL! The

commentator said, “Ronaldinho was assisting Ronaldo to create a spectacular goal”.

In other words, with the assistance of Ronaldinho, Ronaldo was able to score and win

the match for Brazil. Assistance for company executive is crucial, because executives

have to realise company strategy and the need the direction or assistance of the board

to really achieve what the board wants.

Summary

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In practice, the duties of boards vary widely from one country to another,

depending on the organisational structure adopted (one tier or two tier). Following is

a summary of boards’ duties in several countries:

First, boards must ensure that good corporate governance is implemented.

Second, they monitor the performance of management and of the company.

Boards have responsibilities related to control of management performance,

evaluation, and remuneration, management development, and personnel policy.

Boards should pay attention not only to current performance but to long-term

performance, too. Indicators used to evaluate management performance must befair and relevant, so that management is motivated to execute its functions

properly because its performance is fairly evaluated. Third , boards should pay

attention to financial reporting, the integrity of internal and external control

systems, management information systems and risk management. Boards should

understand corporate risk and monitor the balance between risk and return, ensure

that effective risk management systems are running properly. Appointment of

external accountants is another duty entrusted to boards as a way of exercising

control over the company’s financial reporting. Fourth is the board’s duties

related to corporate strategy. Boards should provide missions, strategic direction

and long-term goals. Without long-term goals, a company will lost its direction.

Boards must also evaluate implementation of strategy. Fifth is the board’s duties

related to allocation of financial resources. It is a duty of boards to monitor the

adequacy and allocation of financial resources and to approve business plans and

budgets. Finally, there is the communication role of boards. Along w

management, boards are responsible for the continuity of communication between

the company and the outside world, such as the press, consumer

shareholders. Last but not least , boards play a pivotal role in crisis and conflict

situations.

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CHAPTER 3

BOARDS’ RESPONSIBILITIES

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‘Too much emphasis on monitoring tends to create a rift between non-executive

and executive directors, whereas the more traditional job of forming strategy

requires close collaboration. In both activities, though, independent directors

face the same problem: they depend largely on the chief executive and the

company’s management for information.’ The Economist (February 10, 2001 p

68) describing a survey by PWC of British boards.



A characteristic of public companies in Indonesia is the separation of owners

and managers. This makes it difficult for owners to directly monitor all actions taken

by managers. The main problem is information asymmetry, or the difference in

information provided management as an internal organ of the company, and that held

by owners. Managers, as full-time company employees, have a great deal more

information about the company than the owners do. Management can behave

opportunistically, in their own interests, by not giving reliable information to owners,

for example about an accounting profit based bonus contract. Management could

manipulate profit figures, among others by changing accounting methods

manipulating receivables loss reserves, guarantee costs and other discretionary

expenditure. Profits are manipulated to achieve the targets required to receive a

bonus. Profit manipulation will diminish the reliability of accounting information,

and less than reliable information will result in adverse selection by information

users. What is needed to prevent this is an independent party, in this case the board of

commissioners. Boards are responsible for building build appropriate corporate

visions and missions, and ensuring the company is visionary. This done, the

commissioners must actively participate in developing company programmes and

ensuring that the company’s programmes are run properly (figure 2.1). In short, the

responsibility of the board of commissioners includes: accountability, information

transparency and shareholder voice function.

1. ACCOUNTABILITY

Corporate governance theory states that the function of the boar

commissioners is to identify mechanisms and reduce agency cost. Management has

information superiority that allows managers to distort information. In game theory,

the players in a game try to work out the strategy of each of the other players.

Likewise investors, having anticipated opportunistic behaviour by management, will

ask managers to use the services of an auditor to conduct a special purpose audit, for

example to improve information transparency. Employing the services of an auditor

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will incur a cost that will be deducted from company profits, thus reducing

shareholders’ dividends. The board of commissioners is responsible for developing

mechanisms to prevent management domination by reviewing corporate decisions

and reducing management misbehaviour to protect the interests of shareholders.

Boards of commissioners can reduce agency cost because they

accountable to shareholders for improving company performance. Boards

commissioners perform accountability by monitoring. A wide spread of shareholders

means that they are unable monitor and get close to managers to detect management

negligence, so delegation of monitoring is crucial.

Accountability is not only about passive monitoring. Boards of commissioners

must actively respond to shareholders interests. Although commissioners do not

always act as policy makers in a company, their closeness with managers should

guarantee integrity of management actions. In other words, boards of commissioners

are not only accountable after the fact, but are also involved in decision making. In

this way, boards of commissioners can assure investors, and regulation and law

makers that the company is being run in the interests of the company.

2. INFORMATION TRANSPARENCY

Boards of commissioners are responsible for improving the transparency of

information produced by management. The main problem with agency is information

asymmetry: investors need information to make investment decisions,

management tends to provide information that is less than accurate, for example by

manipulating profits. As an example, a company makes profits of 500 M by

capitalising a portion of costs (i.e. capital leasing), so expenditure will be lower and

profits inflated. Window dressing like this results in misleading information and

makes investors make inaccurate decisions. To address this problem, investors need a

mediator that can guarantee the quality of corporate information. This function can

be performed by boards of commissioners, because the closeness between boards and

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management allows boards to function as transformers of information

management to investors. In this function, the reputation of the boa

commissioners is a guarantee that its closeness with management does not undermine

its independence.

The reputation and competency of boards of commissioners ensures that

management will improve information transparency. There are two mutual conditions

to information transparency: information forcing and information validatio

Information forcing prevents management from distorting information, because

mandatory disclosure alone is not enough to ensure that investors get reliable

information. Here, boards of commissioners have a responsibility to a

information forcing, which means increasing the volume and quality of information

in the form of mandatory and voluntary disclosure. Competent boards will be able to

motivate management to provide reliable information so that management report

users have enough information to make economic decisions. To give an example

from the business world, if a company has high legal risk, it would help provide

investors with a picture from which they could predict the future condition of the

company if the board executed this responsibility by asking management to disclose

this legal risk. An example would be a company that could face legal charges because

of the nature of its business (such as a mining company producing waste that could

pollute the environment).

Information validation is the function of monitoring management to ensure

that accurate information is provided to stakeholders. In this position, boards are

responsible for monitoring the presentation of information before its publications, to

ensure that a high degree of accuracy and validity. Boards of commissioners not only

ask management to publish accurate information, but also ensure the reliability of

information. A very relevant example of information validation is when a board of

commissioners asks an audit committee to review the work of the internal auditor

who performed a particular audit to ensure that the information presented by

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management is valid and accurate. For firms that sell their shares to the public,

accurate and reliable information will help create efficient capital and real markets. If

the information presented by management is valid and accurate, transaction costs will

be more efficient because investors will not need to spend more to locate additional

information. Likewise in the real sector, valid and accurate information from

management will make creditor funding costs and covenants more efficient, and

attract more efficient production costs. It is here that boards help to create capital

markets and real sectors that are efficient and will create a value of the firm that is

reliable.

3. SHAREHOLDER VOICE FUNCTION

Shareholder voice function illustrates that boards are also responsible for

improving the value of the voice of investors in increasing the value of a firm. A

board’s responsibility in terms of voice function is to create equilibrium conditions by

minimising communication constraints between investors and managers. Boards must

be able to assure that optimal decisions about company operations will result in an

equal share of welfare between management and investors. Investor welfare, which is

measured from the value of the company’s shares, will be affected by the book value

of the company; when per share book value increases, it has been proven empirically

that share price will also rise, increasing investor welfare. On the other hand,

increasing investor welfare will cause investors to make decisions at meetings of

shareholders to retain management, and increase their remuneration, including in the

form of management stock ownership plans (MSOP) and employee stock ownership

plans (ESOP). If the board’s responsibility as the balancer of these two voices is wellexecuted, there will be a significant decrease in tension between management and

investors and an increase in investor value.

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EMPIRICAL STUDIES OF BOARDS’ R ESPONSIBILITIES

Accounting figures are used to assess the health and sustainability of acompany. Managers have an incentive to manipulate accounting figures using certain

accounting methods, and by making changes to receivables loss reserves, guarantee

costs and so on. From the creditor’s perspective, bond holders and creditors will

protect their investments. A key element in protection their investments is to look at

accounting figures. Creditors use accounting figures to assess management diligence

to loan contracts.

Boards have a responsibility to monitor the financial reporting process.

Boards meet regularly with accounting staff and external auditors to review financial

reports, audit procedures and internal control mechanisms. Investors see boards as a

key element in the process of presenting relevant and reliable financial reports.

Anderson et al. (2003) tested the relationship between boards’ characteristics,

integrity of financial reports, and cost of debt. The sample of 252 industrial firms was

taken from the Lehmnan Brothers Fixed Income and S&P 500 databases. The results

of the analysis indicated that cost of debt in firms with independent commissioners

tended to be lower than in companies that had fewer independent commissioners. The

researchers also found that there was a negative relationship between the size of the

board of commissioners and cost of debt. Overall, these research results indicated that

bond holders and creditors perceive auditor independency as a key element in

determining interest expense. Creditors believe that independent commissioners can

enhance the validity of financial reports.

Dalton et al. (1998) carried out a meta-analysis to review research on the

composition of boards, management structure, and financial performance. Meta-

analysis is an in-depth study of previous research to identify factors suspected of

influencing financial performance. This meta-analysis was carried out because there

inconsistencies in the results of previous research on the influence of the composition

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of boards and management structure on financial performance. A sample was taken

from 54 researches on the influence of the composition of boards and 31 researches

on the influence of management structure on corporate performance. According to

agency theory, separating the owners of a company from its management will cause

managers to behave in a morally hazardous way. Managers, with their knowledge of

the company and their expertise, can profit from the company at the expense of

investors. Independent board members play a key role in monitoring managers to

protect investors' interests. Stewardship theory, on the other hand, says that managers

will work in the interests of investors, and for this reason the control function is

delegated to management. According to this theory, insider directors executive the

supervisory function more effectively because they have good quality information,

thus better able to evaluate mangers' performance. Research findings indicated that

there is no relationship between the composition of boards (independent and internal

directors) and financial performance.

Corporate governance has to do with providing security for investors so they

receive the returns on investment that they expect. Investors use cor

governance mechanisms to minimize or eliminate financial and non-financial fraud in

companies. An example of financial fraud is using accounting methods to manipulate

profits or produce financial reports that do not reflect the true financial condition of

the company. Non-financial fraud includes not only fraud of shareholders, but also

fraud of consumers and government, and other crimes. Karposs and Lott (1993)

showed that there is a significant decrease in share price in companies that commit

fraud. Decreases in share price will have a significant effect on return on investment.

The main duty of boards is to protect investors’ long-term interests. Boards

assume responsibility for performing internal control and making decision for

shareholders. This responsibility is delegated because shareholders general

diversify the risk on their investments by investing in more than one company.

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Diversification gives rise to the problem of free-riders, shareholders have no way of

ensuring that management is acting in the shareholders' interest.

Persons (2006) identified characteristics of corporate government that help to

reduce the possibility of non-financial fraud occurring. The characteristics

corporate governance tested in this research were the level of independence and the

effectiveness of boards. Fama and Jensen (1983) note that boards h

responsibility to monitor the actions of management. The more independent boards

are, the better they execute their monitoring function. This research used four

variables to measure the independency of boards: (1) percentage of independent

commissioners, (2) whether the chief executive officer (CEO) was al

commissioner, (3) the period of office of managers and commissioners

percentage shares held by independent commissioners relative to total shares owned

by all directors. The independency of boards is low if the composition of independent

commissioners is low, if managers double as commissioners, if the period of office of

commissioners and manager sis low, and if the percentage of shares owned by

independent commissioners is small. The effectiveness of boards was measured from

the size of boards and the frequency of meetings. Effectiveness is low if the number

of commissioners is large and the number of meetings is few. This research also

incorporated other variables that could potentially affect non-financial fraud.

Non-financial data on reported fraud were taken from the Wall Street Journal

Index 1999-2002. The sample consisted of 83 firms listed on the New York Stock

Exchange. The results of the research indicated a relationship between low levels of

fraud and small sized boards, large percentage shareholdings by independ

commissioners, long periods of office of managers and commissioners,

profitability, and, notably, an a corporate code of ethics. This suggests that regulators

should not only ensure that companies have codes of ethics, but that they implement

them.

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Marciukaityte et al. (2006) examined whether, after fraud has occurred,

companies change their corporate governance structures, and whether these changes

in corporate governance affect company performance. Fraud data was taken from the

Wall Street Journal for the period 1978-2001. Three types of fraud were used: (1)

fraud of stakeholders, which happens when a firm implicitly or explicitly deceives in

contracts with suppliers, employees or consumers; (2) fraud of government, which

happens when firms contravene contracts with government; and (3) financi

reporting fraud, which happens when managers do not reveal the real financial

condition of the firm. The results of the research indicate that after fraud has

occurred, firms increase the number of independent commissioners on their boards,

audit committees, compensation committees, and nomination committees. Share

prices improve after changes have been made to corporate governance structure and

improvements are made to internal control systems.

The main function of board is to minimise costs arising from the separation of

owners and managers in a modern firm. Boards have a responsibility to exercise

internal control and make other decisions on behalf of shareholders. The composition

of the board is a key factor in making monitoring of the actions of managers more

effective. Fama and Jensen (1983) argue that the effectiveness of boards

monitoring management is a function of the mix of insider and outsider board

members. Boards are not an effective instrument of internal control of there is no

limit on the spread of management. Managers are better informed about the condition

of the firm than owners are, and boards could be used as a tool by management to

take action in their interests, to the detriment of shareholders. The solution to this

agency problem is to have independent directors. Independent commissioners have an

incentive to build their reputations as experts in decision control, so they will execute

their responsibilities properly, unless they want their reputations destroyed. Research

by Rosenstein and Wyatt (1990) indicates that investors react in a positive way to

input from independent commissioners on the board. This suggests that investors

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believe that the presence of independent commissioners will protect investors'

interests. Input from independent commissioners on the board will enhance the

company's internal control function and prevent fraud.

Beasly (1996) analysed the relationship between the composition of boards of

directors and financial reporting fraud. Data were taken from 150 public companies

for the period 1980-1999. The sample consisted of 75 firms that had committed fraud

and 75 companies that had not committed fraud. The cases of fraud covered

contraventions of the rules of the Stock Exchange Commission (SEC). The results of

the research indicated that there were differences in the composition of boards of

companies that had committed fraud and of those that had not. Boards of companies

that had committed fraud had fewer independent commissioners than the boards of

companies that had not committed fraud. Having independent commissioners will

enhance the effectiveness of boards in detecting and preventing fraud. This research

also indicated that having audit committees reduces the likelihood of managers

committing fraud.

Fama (1980) indicated that incentive for independent commissioners to

undertake monitoring also comes from the job market. Independent commissioners

perform their monitoring function well because they wish to maintain

reputations as experts in the job market. Corporate failure is the responsibility not

only of management but of boards, too. The reputation of commissioners in the job

market will be tarnished if commissioners failed to execute their responsibility to

work in the interests of the firm and increase the value of the firm.

Summary

The main responsibility of boards is assure stakeholders that management is

implementing the vision, mission and strategy of the company to optimise the value

of the firm. More specifically, the main responsibilities of boards are to ensure a high

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degree of management accountability, improve information transparency, and execute

the shareholders' voice function.

Accountability means that boards must assure stakeholders that management

are not taking moral risks that could harm stakeholders in general, and stockholders

in particular. Boards should be able to detect all actions by management that could

increase agency cost and immediately monitor these actions to minimise the increase

in agency cost.

As well as being responsible for ensuring management accountability, boards

also have a responsibility to assure stakeholders of the importance of information

transparency. Transparency of information from management will reduce information

asymmetry and minimise distortion of the quality of information so that management

information can be used to help information users make economic decisions, such as

investment and bond purchase decisions.

The third responsibility of board is to represent the voice of shareholders.

Shareholders are the owners of the company. They are limited in the extent to which

they can participate in controlling the company. Control and monitoring

shareholders is limited to shareholders' meetings. Under these conditio

commissioners must function as the shareholders' voice in increasing the value of the

firm.

In both normative and empirical terms, there is evidence that execution of the

three responsibilities of boards described above will make stakeholders,

particularly stockholders, trust management and boards more as a consequence of

increases in the value of the firm, indicated by increases in share price.

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CHAPTER 4

EMPOWERING THE BOARD

Ten or 15 years ago, if you were invited to sit on a

company’s board of directors, it meant that you had reached a certain level in the business world and were

being rewarded for your achievements. Today, being a

board member involves much more than just rewards: theboard member must now not only show a strong track

record, but must also bring to the table the proper skills

and competencies, a strong commitment to the firm, and a

willingness to share some of the risks-It’s still prestigiousto be a director; but now you’ve got to know your stuff

(Christian Bellavance, ca Magazine)

A managing director of a public company communicates with a minister to

ask the minister to make a public statement about plans with a high risk of loss, to the

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effect that this is not a result of negligence by the firm. The considerable influence

this director has over a minister lies in relationship previously nurtured by the

director by doing a great deal to help the minister with his job. This non business

related expenditure was incurred without the knowledge of the company's board of

commissioners. The board did not have a complete understanding of the expenditure

incurred as a consequence of the managing director having more power than the

board. This illustration indicates that a major weakness in corporate management

today lies in the concentration of authority in the hands of management. An

imbalance of power is one of the root causes of fraud, manipulation of financial

reports, and other improprieties. The systematic problems facing Enron were a

consequence of an imbalance of this kind.

To ensure a balance of power, boards need to be empowered. Empowering the

board means that the board has the capacity and independence to monitor the

performance of management and the company. An empowered board can also

influence management to change the direction of strategy if its performance does not

meet the board's expectations; and, in the extreme, replace the com

management.

Management and boards must have a synergetic relationship. A board as an

internal organ of the company must be empowered to carry its functions as supervisor

and advisor of management. A synergetic relationship between the board and

management will strengthen the position of the board, so that it is not simply

following the wishes of management which may well be influenced by the self

interests of the company managers. The job of management is to manage the firm,

while the function of boards is to implement control mechanisms to ensure that there

are checks and balances. Strengthening the board-management relationship will

strengthen the board’s ability to advise and to monitor company performance.

Without a balance of power, the check and balance function of boards will not

operate properly.

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DEMAND FOR EMPOWERMENT

There is a correlation between the weakness of the position of a board and the

level of misuse of authority by company managers. When a board has insufficient

power, this provides opportunities for management to take action that may be

detrimental to the company or that could trigger conflict between the board and

management, undermining company performance. There is pressure from various

quarters on companies to empower boards.

First, most investors do not want to participate directly in management of the

company, but prefer to encourage boards and the media to monitor management.

Second , with adequate power, boards have the power to replace managers who

perform poorly. Third, there is a correlation between good corporate governance that

places board in a strong position and the competitive success of a company.

INVALID ASSUMPTIONS ABOUT EMPOWERING DIRECTORS

In companies where directors are empowered, CEOs do not find their power

diminished

Managers often perceive empowering boards as a threat. Managers feel that boards

intervene where their behaviour is concerned and in the decisions they make

regarding management of the company. Managers feel that empowering boards will

diminish their power. But one can obtain power without the other losing it.

Management fears that empowering boards will diminish the management function in

the company need to be erased. The fact is that empowering boards will help

managers to run the company, provided that managers recognize that everyone in the

company shares a common vision and mission. Empowering boards must be seen as a

way of achieving the common goal of improving company performance. Balance of

power in The management-board relationship and synchronisation of vision and

mission are essential to achieving good corporate governance.

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The assumption that boards participate actively only if a company is in crisis

is mistaken. Boards that do not participate in monitoring company performance will

fail to detect problems facing the company in a timely fashion. Problems that are not

immediately addressed and allowed to pile up will turn into an iceberg, and when it

melts, it will submerge the company. Enron is a case in point: the downfall of this

company was not only the result of mismanagement, but also of the board's failure to

execute its functions.

The boards' role as monitor varies with the complexity of the duties facing

managers. There are at least three factors that influence the processes and procedures

used by boards to monitor management: first, the board's view of managers' ideas. If

boards do not like management's ideas, they will monitor management more

frequently and more carefully. Second , the problems and complexity of the company.

If the board feels that the company is having problems, it will make more of an effort

to understand management's decisions and way of thinking than it would if the

company were not having problems. Third, market and technology changes in the

company's line of business. Firms in the technology industry are of higher complexity

because of rapid changes in technology and rapidly changing markets. Boards must

have all the necessary information to determine the direction of the company and to

give useful advice. A board's ability to continually update its knowledge and

understanding of the company's business increases the power of the board.

The question is when and to what extent should boards intervene in corporate

strategy? A line has to be drawn between boards, which contribute ideas for corporate

strategy, and management, which manages the company. Boards have to approve

company strategy and review and evaluate its results. The extent of the board's

intervention depends on the specific environment of the company, for example, in

making decisions pertaining to acquisitions, takeovers, and so on, boards must be

actively involved because these will have a significant bearing on the company's

future performance.

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THE SOURCES AND LIMIT OF DIRECTORS’ POWER

The source of directors' power depends largely on: the directors' knowledge and the

solidarity of the board as a unit. Directors work part-time in a company, while

managers are full-time company employees. Seen in terms of hours worked, it is

hardly surprising that managers have a better understanding of the complexities of the

company than directors do. From the managers' perspective, meetings with boards are

generally seen as an instrument for boards to obtain information about the company

from management. Directors do need to have data about the company, but this data

needs to be translated into information that can be used for decision making.

Financial data and other data is only a small part of the real picture. The ability to

process data into useful information and knowledge depends largely on the directors'

knowledge of the company's business. Superior knowledge is a source of power for

boards.

The knowledge that directors have comes from written information, such as

financial reports, and from oral information that comes from discussions with

managers. The challenge for boards is how to process this information into useful

knowledge at the appropriate time. Directors must also be able to understand external

factors that affect company performance, such as changes in market conditions,

technology and the economy. To be able to carry out effective evaluations of

management and approve corporate strategy, directors need not only financial

information, which provides an indicator of historical performance, but

information about the company's progress in implementing strategy. Knowledge of

technological developments, new services and products, changes in consum

demand, and what the company's competitors are doing is crucial.

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The information that directors use must be a balance of financial data, which

focuses on the past, and strategic information, which focuses on the company's future

prospects.

Solidarity among board members is a source of power. Board consensus is a

powerful tool for controlling management; board consensus can replace

management of a company that is performing badly.

WHAT MAKES AN EMPOWERED BOARD?

The following can empower boards:

a. The majority of board members come from outside the company and have no

links with the company.

b. The number of board members is kept to a minimum to foster unity among the

group. Board members should understand goals and want to achieve them.

c. Board members have experience in leadership and business, and understand the

company's business.

d. Board members communicate freely with other board members, at committee

meetings with or without management.

e. Directors receive data on the company's finances and industry performance that

enables them to understand the relative performance of the company vis-à-vis its

competitors.

EFFECTIVE EMPOWERMENT

Routine management evaluation, through regular meetings and empowerment of

existing committees, is central to effective monitoring, because it is the first step

towards empowering boards. Evaluations of management will give a clear message to

directors about the company’s performance and enhance their understanding of the

3



company. A good understanding of the company will further empower boards. These

evaluations will be beneficial for management, too, because the direct communication

between managers and directors will flag areas of concern and ge

recommendations for making improvements. Managers will also be able to discuss

their reactions.

There are several criteria for effective evaluation:

a. Evaluation must be performed continuously, through mechanisms established by

the company’s articles of association.

b. Evaluate annual and long-term performance, and compare these with other

companies in the same industry

c. Evaluate the appropriateness of management goals to the goals of the company

d. Managers must have individual performance evaluations

e. Boards must evaluate management performance.

THEORY OF FRIENDLY BOARDS

Boards have the legal authority to make decisions in the company. Boards must

review and approve operations, financial and strategic plans. To reduce the moral

hazard that arises when managers select projects that do not maximise shareholder

value, managers must have approval from the board. Under these circumstances, the

boards participate actively in decision making and monitoring. But this does not

negate the responsibilities of directors, and management may not hide behind the

board. The remain responsible both institutionally and individually.

As well as being responsible for monitoring the firm, a board must also give

advice to managers about the direction of company strategy. Because directors do not

work full time in a company, they need to get financial and non-financial information

from managers. If managers provide reliable information, the directors will be able to

offer good advice.

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Boards assume the dual role of monitoring and giving advice to manages.

When boards implement the monitoring function intensively, managers are faced with

a trade off in sharing information. On the one hand, boards will provide better advice

if mangers provide them with reliable information. On the other hand, the information

the managers provide will help the board to better understand the condition of the

firm. And if the board knows that the company is slipping or is below the industry

average, it will intervene in managerial decision-making.

The board’s role as supervisor and advisor complement each other, because

boards use information from managers to make better recommendations

implement better policy. To motivate managers to provide information, shareholders

would be best off electing friendly directors who focus not only on the supervisory

function but on the advisory function, too.

Adams and Ferreira (2005) tested the theory of friendly boards. Emphasis on

the control function by independent directors will have adverse consequences,

because managers will tend to reduce the amount of information they provide, and in

turn, the advice they are given will not be the best. Thus, increasing the number of

independent directors will reduce shareholder value. Shareholders will benefit if

increasing the number of independent directors leads to better disclosure practices.

Adams and Ferreira showed that the model of management-friendly boards could be

optimal.

An interesting finding from the Adams and Ferreira study was

independent directs are not influenced by company performance. Contrary to research

by Ezzamel and Watson (1993), Pearce and Zara (1992), Rosenstein and Wyatt

(1990) showed that there is a positive correlation between the composition of boards

and company performance. The inconsistency in the results of research on the effect

of independent directors on corporate performance may be because definition of

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CHAPTER 5

NEW TOOLS FOR BOARDS

Today, the presence of institutional investors, regulatory bodies, the press, and

the fear of legal retribution has made the boards of directors of public companies

search more actively for practical steps for strategic management. There is a

difference in perspective between that of boards of directors and that of boards of

commissioners. Boards of directors/managers are expected to translate strategic

vision into actual operations. They must focus on the strategic path to maximising

4



corporate profitability. Therefore, optimal performance standards are needed to

motivate members of the organisation. Boards of commissioners, on the other hand,

are responsible for representing the investors’ perspective. Boards of commissioners

evaluate the validity of strategies that are implemented, by comparing current returns

on a particular strategy with possible returns on other feasible strategies. Although

they have different perspectives, the difference diminishes when boards of directors

and boards of commissioners build strategy.

STRATEGIC AUDIT

A strategic audit, which is designed to give credibility to management

leadership, is an effective strategy for anticipating problems and showin

shareholders that the board of directors is committed to and is implementing good

governance. A strategic audit must be directed by independent commissioners, and

the board of commissioners must set the key criteria for monitoring strategic results.

The elements of a strategic audit are:

1. Setting criteria

It is important that in setting criteria for a strategic audit, the criteria

are objective. The criteria must also be familiar and easily understood, and use

acceptable financial performance indicators. This is because; a)

responsibility of the board of commissioner is to understand the impacts of

strategies adopted in appraising shareholder value, and this require

financial-based performance evaluation; b) managers are familiar with the

product market and the company’s particular problems, and have access to a

phenomenal quantity and range of data, giving them an advantage over the

board of commissioners.

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These criteria must also focus on sustainable levels of shareholder

return and investment, and allow for income flow comparisons across

companies, and comparison of investment alternatives across firms in the

same industry and in other industries.

The criteria must also reflect fundamental economic realities, such as

shareholder loyalty depending on competitive ROI (return on investment).

Other criteria commonly used to evaluate alternative strategies are CFRIO

(cash flow return on investment), EVA (economic value added), and TSR

(total shareholder return). However, since each of these measures has its own

strengths and weaknesses, a board of commissioners must make the best

analysis possible and use only one.

2. Designing and maintaining databases

The process of identifying effective strategies requires boards of

commissioners to control not only the performance criteria but also to

maintain a database of these criteria. There are several options here. One is to

ask the CEO to employ staff to do this. But this could result in conflict of

interests arising from staff working with sensitive data. Another option is to

request the services of an external consultant to design a database and collect

data the board of commissioners wishes to monitor. The best solution is to

engage an external auditor, who will evaluate the design and data collection

carried out by the external consultant. This will ensure that there is

consistency in maintenance, documentation and reporting in the long term.

3. Strategic Audit Committee

The audit committee must select the criteria for auditing strategic

performance, including database design, and establish the audit process. This

will improve the integrity and continuity of data collection and reporting, and

identify problems to be discussed with the directors. The strategic audit

4



committee is the equivalent of the audit committee in Indonesian legislation

pertaining to organizational structure. The strategic audit committee focuses

on reviewing corporate strategy, which can also be done by an audit

committee.

4. Relations with directors

The review process aims to discuss strategic performance with the

CEO, in order to alleviate any hostile atmosphere within the organisation.

5. Readiness to do the task

The board of commissioner must watch out for signs of weaknesses in

the company’s strategic mission, and for events that indicate opportunities for

adjusting strategic direction. There are several events that may require special

meetings with the strategic audit committee include:

On this basis, the board of directors cannot work alone to operationalise corporate

strategy. Maximising performance requires evaluation of their performance by the

audit committee and independent commissioners.

Research results show that the size and composition of boards affects the

company activities. The size and composition of the boards of directors can affect the

effectiveness of monitoring. The size and composition of boards of directors also

affects the relationship between managerial and institutional investors and company

performance. According to Pfeffer (1973), expanding the size and diversity of

membership of the board of directors will be beneficial to the company because it

creates networks with external stakeholders and guarantees a supply of resources.

Hermalin and Weisbach (1988) stated that outside directors, as well as beingmore effective in monitoring management, are also tools for disciplining managers,

and minimizing inefficiencies and low levels of performance. Outside directors

contribute to the value of firm through evaluation and strategic decision making

(Brickley and James, 1987).

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Fama and Jensen (1983) claim that brining in outside directors will enhance

the performance of the board and reduce the likelihood of managers expropriating

shareholder wealth.

Beasly (1996) showed that firms that engage in fraud have a significantly

lower percentage of outside directors than firms that do not engage in fraud.

F ORENSIC ACCOUNTING

Several empirical studies have shown that bad corporate governance will undermine a

company’s performance. Sliding company performance will prompt management to

behave in an opportunistic way, by manipulating reported profits to ensure theyreceive their bonuses. As a consequence, the reliability of the financial reports will be

in doubt. Boards function to prevent opportunistic behaviour by management that

would be detrimental to investors.

Forensic accounting is expertise in financial and non-financial auditing

exercised to investigate problems that cannot be solved by conventional accounting or

auditing methods (Bologna and Lindquist, 1995). As a discipline, forensic accounting

requires financial expertise, knowledge of fraud, and an understanding of the realities

of business and of the prevailing system of law or legislation. This implies that

forensic accountants are equipped not only with expertise in financial accounting, but

in internal control systems and the law, as well as with investigat

interpersonal skills. Forensic accounting can be used as a tool to protect shareholders

from management's opportunistic behaviour. By helping the firm to prevent and

detect fraud, forensic accounting can help a firm adopt good corporate governance, as

follows:

First, corporate governance. Forensic accountants can help formulate and

develop governance policy, establish appropriate responsibilities for boards and audit

committees, ensure a fair allocation of power among management, boards and

investors, and ensure that there are codes of ethics for employees and managers.

Codes of ethics need to be enforced if managers display unacceptable behaviour.

4



Second, fraud prevention. Forensic accountants know that the best way to

prevent fraud is to set up efficient control systems, including a good environmental

control system that are based on management philosophy about ethical behaviour and

corporate governance policy, good accounting systems that guarantee the accuracy of

recording, classifying and reporting of relevant transactions, and strong control

procedures that provide security of assets, appropriate authority, and appropriate

audit mechanisms.

Third, creating a positive working environment. A fraud preventio

programme will also create a positive working environment. For example, highly

motivated employees will not be tempted to misuse their authority. Forensic

accountants can guarantee that governance policy is created to avoid high risk

environments.

Fourth, creating effective communication. Communication is a key element in

ensuring that employees and investors, management and boards have exercised their

rights and responsibilities. Effective communication must flow not only from the top

down, but also among employees. Forensic accountants can support the dissemination

of information on governance and ethics policy to the relevant people.

Fifth, vigilant oversight. For all systems to work properly, continuous

monitoring and evaluation is required to ensure that these systems are functioning

properly. Forensic accountants can monitor management commitment, management

procedures, and employee activity.

Sixth, establishing consequences. The possibility of punishment prevents a

person from committing fraud. Forensic accountants can hep prepare policy that

prevents criminal action.

Seventh, fraud investigation. Forensic accountants can ensure the integrity of

financial reports by actively investigating fraud, identifying areas of risk, and

investigating financial and accounting anomalies.

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Summary

In the second millennium, business is very different from business in the first

millennium. The use of advanced technology totally changes the strategy and

operation of firms in competition. As a consequence, there has also been a shift in

corporate fraud, from blue collar crime to white collar crime. Competition strategy

has changed too, with the shift in competition from the real world to the virtual

world.

Two new tools have been introduced to handle this condition. First is the

strategic audit. This is an audit to determine whether a company’s operations are in

keeping with strategy outlined by top management. The second is forensic auditing.

This is not the same as a normal financial audit. In a forensic audit, the auditor goes

beyond the scope of a normal audit to include the possible impacts of the audit

findings. Here, corporate risk may be analysed, which means that the auditor must

have knowledge of accounting, strategy and law. In a forensic audit, the auditor is an

audit team and the audit is carried out together by the members of the team.

Forensic audits are useful for: building good corporate governance, preventing

fraud before it happens, creating a positive work environment, building effective

communication between organs inside and outside the company, and ensuring that

systems within the company operate properly.

4



CHAPTER 6. THE AUDIT COMMITTEEAND OTHER SUPPORTING COMMITTEES

The audit committee has the separate task of helping the bo

commissioners to fulfil its responsibility to provide comprehensive supervision. The

audit committee helps the board of commissioners to monitor financial reporting by

management to enhance the credibility of financial reports. In undertaking its duties,

the audit committee sets up formal communication between the board, management,

external auditors and internal auditors (Bradbury et al., 2004). The audit committee

acts as liaison in the event of a difference of opinion between management and

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auditors concerning interpretation and application of the Generally Accep

Accounting Principles (Klien, 2002).

Members of the audit committee should be independent commissioners, who

are free from day-to-day managerial duties and whose main responsibility is to assist

the board of commissioners undertake its responsibilities, particularly with regard to

corporate accounting policy, internal supervision, and financial reporting systems. In

general, the audit committee has responsibilities in three areas (FCGI, Volume II, p

12):

a. Financial reporting

The responsibility of the audit committee in the area of financial reporting is

to ensure that financial reports prepared by management give a true picture of the

following: 1) financial condition, 2) business results, 3) long-term plans

commitments.

The scope of implementation in this area encompasses:

1. Giving recommendations to the external auditor

2. Examining matters pertaining to the external auditor:

a. Auditor’s letter of appointment

b. Audit cost estimate

c. Auditor’s visit schedule

d. Coordination with internal audit

e. Monitoring audit results

f. Evaluating implementation of the auditor’s work

3. Evaluating accounting policy and policy-related decisions

4. Examining financial reports, including:

a. Interim financial reports

b. Annual reports

c. Auditors’ opinions and management letters

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Evaluation of accounting policy and policy decisions can be effectively

performed by obtaining a brief summary from officers in the company’s accounting

department.

b. Corporate governance

The audit committee’s responsibility in the area of corporate governance is to

ensure that the firm has been run legally, carried out its business in an ethical way,

and performed effective monitoring of conflicts of interest and of fraud by company

employees.

The scope of implementation in this area encompasses:

1. Evaluating company policy relevant to compliance with laws and regulations,

ethics, conflicts of interest, and investigation of fraud and deception.

2. Monitoring ongoing and pending judicial processes pertaining to corporate

governance where the company is a party to the process.

3. Investigating major cases of conflict of interest, fraud and deception.

4. Requiring the internal auditor to report on corporate governance audit findings

and other key findings.

c. Corporate control

The audit committee’s responsibility in the area of corporate control includes

having an understanding of problems and potential risks and of internal control

systems, and monitoring control processes performed by the internal auditor. The

scope of the internal audit must include review and evaluation of the adequacy and

effectiveness of internal control systems.

d. A member of the audit committee:

• Has a high level of integrity, competence and knowledge, adequate experience

appropriate to their educational backgrounds, and good communication skills.

• Has an educational background in accountancy or finance

• Has sufficient knowledge to read and understand financial reports.

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• Has sufficient knowledge of capital market legislation and other relevant

legislation.

• Has not been employed in a public accountant's office, a legal consultant's

office, or by any organization that provides audit, non-audit, or consultancy

services to the listed or public company concerned, during the 6 (six) months

prior to being appointed by the board of commissioners.

• Has not been authorised or responsible for the planning, management, or

control the operations of the listed or public company in the 6 (six) months

prior to being appointed by the board of commissioners, expect as an

independent commissioner.

• Has no direct or indirect shareholding in the listed or public company. In this

event that a member of the audit committee obtains shares as the consequence

of peristiwa hokum amaka, the said member is required to have disposed of

these shares within 6 (six) months of their acquisition.

• Has no:

a. Family relations, by marriage or descent to the second degree, either

horizontal or vertical, with members of the board of commissioners or

board of directors or with shareholders of the listed or public company;

b. Direct or indirect business relations associated with the operations of the

listed or public company.

Pursuant to Decree of the Capital Market Supervisory Board No. 29/PM/2004,

which aims to reduce the lag in submission of the financial statements of listed

companies to the public and the Capital Market Supervisory Board as of the end of

the 2002 fiscal year, listed companies are required to make public financial reports as

follows: 1) annual reports, no later than three months after the date of the accountant's

opinion of the financial report, 2) mid year reports: (a) one month after the date of the

financial report, if unaudited, (b) two months after the date of the financial report, if

5



the audit is limited, (c) three months after the date of the financial report, if there is an

auditor's opinion. One task of the audit committee that lies within the scope of its

responsibility for corporate governance is to assess corporate policy with regard to its

compliance with the law. Thus, the presence of an audit committee as an institution

will have a bearing on the company's compliance with Capital Marketing Supervisory

Board regulations concerning the timely publication of financial reports. In other

words, the reporting lag for a company that has a audit committee will be shorter than

that of a company that does not have an audit committee.

A company that has an audit committee that comprises entirely of independent

members, at least one of whom has knowledge of accounting and finance, and that

holds meetings three times a year, will have few problems with its financial reporting

(McMulen and Ragahunandan, 1996).

One of the tasks of the audit committee is to recommend an external auditor to

audit the company's financial reports. According to De Angelo (1981), the quality of

an audit depends on the possibility of the auditor detecting fraud in the accounting

system and reporting fraud. Thus, a good quality audit can improve the quality of the

company's financial reporting and reduce the asymmetry of information between

management and shareholders. Verschoor (1993) states that supervision of an

external audit should enhance auditor independency, thus making the audit more

effective. The presence of an audit board correlates with fewer claims from

shareholders of fraud, fewer illegal acts, and fewer changes of auditor when there is a

difference of opinion between the company and the auditor (McMulen, 1996).

On improving the effectiveness of audit committees, the Blue Ribbo

Committee (BRC) says that an audit committee will improve financial reporting it the

committee comprises independent, financially literate, fully committed members and

convenes regular meetings. Bryan et al. (2004) tested whether the

recommendation will improve the quality of profit reporting by analysing profit

informativeness and transparency of reporting to determine whether these were better

in companies that had audit committees, as suggested by the BRC. ERC was used as

5



proxy for profit informativeness, and the level of accrual mispricing (overpricing) as

the proxy for transparency. The sample was 1,291 firms listed in 1996 Fortune 500

for the period 1996 – 2000. It was found that ERC was stronger when the audit

committee was independent and financially literate, and accrual overpricing was

smaller when the audit committee was independent and held regular meetings.

Overall, the results of the research indicated that independent and effective audit

committees will improve the quality of financial reporting; a finding that supports the

recommendations of the BRC and the 2002 Sarbanas-Oxley Act.

Qin (2006) analysed the impact of the financial expertise of the audit

committee on quality of profit as measured in terms of profit-return. The sample used

consisted of 92 firms from 43 public industries in the United States. The research

findings indicated that a company that had an audit committee with professional

accounting expertise had better quality of profit. There was a positive correlation

between accounting expertise on the audit committee and quality of profit.

The new NYSE regulations for corporate governance require au

committees to discuss and review assessments of corporate risk and hedging

strategies. They are also additional requirements regarding the composition and

financial knowledge of the directors on the board and the audit committee. Dionne

and Triki (2005) analysed these new regulations in terms of more profitable hedging

decisions for shareholders. They found that the requirements pertaining to the

composition and independency of audit committees benefited shareholders, but that

audit committee members having an accounting background was not particularly

important. Notably, they found that the directors with financial backgro

encouraged corporate hedging, and that active directors with an accou

background did not play active roles in many policies. The results of this research

also suggested that there was a positive correlation between hedging and company

performance, indicating that shareholders were better off with directors with financial

backgrounds sitting on the board and the audit committee. These findings support

5



empirical evidence in favour of having directors with a university education on the

board and audit committee

In compliance with the 2002 Sarbanas Oxley Act, the NYSE requires that

there be financial expertise on the audit committee. But the definition of financial

expertise is a controversial issue; one that reached a peak when the stock exchange

adopted a definition of financial expertise that was broad in scope. Dhaliwal et al.

(2006) analysed the relationship between three definitions of financial expertise

pertinent to the audit committee (accounting expertise, finance expertise,

supervisory expertise) and quality of accruals. The sample used in this research

consisted of firms on the Investor Responsibility Research Center (IRRC) board

practice database, from 1995-1998, which were 1,114 firms from 53 industries. The

research findings indicated a positive correlation between accounting expertise and

quality of accruals. This suggests that the current definition of financial expertise is

too broad, and in the future, the focus should be on the accounting expertise of the

audit committee.

OTHER SUPPORTING COMMITTEES

In a complex business environment, delegation of tasks to committees will

improve time effectiveness and efficiency. Formation of committees on boards will

increase the effectiveness of boards because specialisation allows board members to

carry out tasks suited to their expertise and education, thus producing better policy

and action. Specialisation will also improve time efficiency.

However, in practice, specialisation can result in unwelcome consequences,

for example: committees are often able to make proposals, but not decisions;

decisions are made by the board as a whole. Another unfavourable consequence is

that the feeling of fellowship among board members is upset because of the limited

participation of board members who do not sit on a particular committee. One way to

address the problems that arise from the formation of committees within boards is to

5



have clear instructions regarding the operationalisation of the committees and full

reports on the committees’ operations to the board.

Committees, other than the audit committee, that could be formed to lighten

the workload of boards include:

a. Nomination Committee

The duties of this committee are:

- selecting managers’ profiles

- selecting board members

- assessing the independency of directors

- evaluating management and boards

- management development as a part of human resource development

and recruitment policy

b. Remuneration Committee

The task of the remuneration committee is to monitor managers’ salaries,

including performance rewards for managers.

c. Risk management committee

One of the principles of transparency in corporate governance is adoption of

enterprise-wide risk management. The purpose of risk management is identify

risk, measure risk, and deal with risk above a certain level of tolerance. In

enterprise-wide risk management, risk is not only specific/unsystematic risk

such as financial risks including non payments, industrial action and third-

party claims, but also market/systematic risk. Examples of market/systematic

risk are inflation, recession and so on. A rise in world oil prices as the result

of a knock-on effect outside the control of the company will have an effect on

the firm’s performance. But can the company’s managers be blamed for

factors outside their control? The process of identifying risks and setting up

measures to minimise or manage risk are crucial. These measures are a

demonstration of the company’s responsibility to its stakeholders.

5



This committee aims to understand corporate risk and monitor the balance

between risk and returns, ensuring that an effective risk management system

is in place.

d. Corporate governance committee

This committee is responsible for monitoring implementation of corporate

governance and compliance with corporate governance standards.

e. Financial committee

Formation of committees should be flexible, that is, appropriate to the needs

of the firm and the type of firm.

According to Murphy (2004), sufficient compensation is enough to attract a person to

a good, promising career in corporate management. Recent changes have made it

difficult to make remuneration systems fair. This is very complex problem. There will

be conflict at the firm level, and many difficulties will ensue. But today’s wise and

forward-looking managers can gain a competitive advantage by making difficult

choices about remuneration, governance, and relations with the capital market.

Appropriate investment in the integrity of the organisation and systems will have

short-term and long-term advantages. Wise board members and CEOs will encourage

this type of investment because they understand that properly functioning monitoring

and governance systems will ensure not only the success of the organisation, but also

personal success. Damage to personal reputations and the reputations of organisations

make headlines in the USA and the world over.

Current scandals over the allowances and perquisites given to CEOs have

fuelled debate about limiting compensation for executives and improving

structure of corporate governance. Several things can be done to improve in this area:

require that compensation committees be more independent, require executives to

hold equity in the company, require improved disclosure of executive compensation,

increase the participation of institutional investors in corporate governance (including

executive compensation), and require firms to make stock options an expense in the

profit and loss statement (Matsumara and Shin, 2005)

5



Gore et al. (2005) analysed the relationship between the monit

environment and the level of equity incentives for CFOs (chief financial officers).

Data covered 3,628 firms with data on their CFOs in the ExecuComp database, from

1993 to 2001. The research found a negative correlation between the CFO’s portfolio

of options and the existence of a finance committee and CFOs with a financial

background. These research findings are consistent with financial expertise on the

board and in the CEO being a significant factor in the determination of equity

incentives for CEOs.

According to Ferrarini and Moloney (2005), there has been a divergence

among the countries in the European Union (EU) when it comes to establishing

structures for executive remuneration. There are marked differences in the adoption

of best practices in paysetting and disclosure of executive pay. This divergence is in

keeping with the predictions of agency theory. Although in 2004 the EU adopted two

key recommendations on executive pay, the results of this research indicate that

reforms in the EU should proceed with caution. Harmonisation should be limited, and

the sole focus should be on disclosure. Disclosure is central to adopting effective

incentive contracts that can manage the agency cost of executive pay between

countries where corporate governance systems of dispersed ownership

blockholding are adopted, without intervention in governance structure and options.

Other intervention in the payment process could give rise to divergent competitive

risk.

Calcagno and Renneboog (2004) demonstrated that equity seniority and

managerial compensation have important implications for the design of remuneration

contracts. Traditional literature assumes that equity takes priority over remuneration,

but this has been proven otherwise, notably in the case of bankruptcy regulations and

observed practice. Theoretically, including equity risk will change the incentive to

give managers higher performance-related incentives (the contract substitutio

effect). If managerial compensation is of higher priority than equity claims, the

greater the leverage the lesser the power of the incentive scheme, and the higher the

5



base wage. In the case of junior compensation, the focus is more on pay for

performance incentives. Empirical research suggests the remuneration seniority as the

base wage is significantly higher and performance bonuses lower in firms that are

financially distressed.

Summary

The adoption of good corporate governance requires that committees be set up

to help the board of commissioners perform its duties. These committees must be

independent and are responsible to the board of commissioners. One such committee,

which more than 90 percent of public companies in Indonesia now have, is the audit

committee, which helps the board of commissioners direct management to improve

the effectiveness and efficiency of the company. The audit committee is responsible

for performing reviews of internal audits and of work related to financial matters.

Committees that must adopt good corporate governance are the remuneration and

nomination committees. It is the job of the former to fact find and conduct analyses to

set appropriate remuneration for management and commissioners, while the latter is

responsible for helping the board of commissioners nominate people for strategic

positions in the company and whose names will be put forward at a general meeting

of shareholders.

Another key committee is the risk management committee. The Enron scandal

left stakeholders with no choice but to require that management anticipate risks that

could destroy the company. The risk management committee helps the board of

commissioners to assess and anticipate corporate risk and find solutions to avoid or

minimise this risk. Another committee gaining in importance is the investment

committee. Many firms are less then prudent in their investments and this could be

harmful to the company. Thus, the board of commissioners needs help to monitor and

advise on all major investments.

6



CASE STUDIES

CASE 1.

At a routine meeting between the board of commissioners and the board of

directors, the main agenda was to discuss three issues: the decline in the company’s

performance, a cooperation agreement with the Ministry of Agriculture, and the

findings of an internal audit on fraud in the regional office. Following are the minutes

of the meeting.

.

The meeting opened at 08.30, Monday, November 21, 2006, chaired by the President Commissioner and attended by all directors and members of the boa

commissioners.

President Commissioner (PC): The prognosis as of the end of 2006 for financialperformance shows that bottom line earnings did not achieve

the 2006 target.

Independent Commissioner /Chair of Audit Committee (IC): The audit committee’s

analysis indicates that the most significant deviations are a

20% increase in marketing costs and personnel costs of 15%higher than planned. These increases were not offset in any

way by an increase in revenue; in fact revenue was down 6

percent. This resulted in a decrease in bottom line earnings of Rp 48 billion or 8 percent.

Commissioner/Chair of Remuneration and Nomination Committee (Co): The increase

in personnel costs is accounted for largely by an increase innon-target related production bonuses, and by an increase in

directors’ salaries. This across the board allocation of

production bonuses should be reviewed. Directors’ salariesare still below the market average.

Managing Director (MD): From the start, I completely disagreed with these acrossthe board production bonuses; they must be based on

achievement of targets. But unions union oppose switching to

a merit system. If there has been a decrease in revenue this is

due to two things: first, a shift in consumption patterns

6



resulting in a drastic reduction in demand for ready-to-eat

foods; and second, the cancellation of a government contract

cut from the national budget.

Human Resources Director (HRD): To add to what the MD said, as far as I’m aware,

our employees are overpaid. Our competitors record far higher sales than we do, and their employees are on lower

wages than ours are.

PC : Could the board of directors not negotiate with the unions?

Discussion about financial performance and human resources continued for morethan an hour. Over the past two years the company’s performance has not been

satisfactory. The market has meted out its punishment, with a 10 percent fall in shareprice.

Discuss how the board of commissioners could intervene, both in its advisory and

supervisory functions, in this situation.

From 09.45, the meeting continued with a discussion of the cooperation agreement

with the Ministry of Agriculture.

PC: We, the board of commissioners, have just received an invitation to sign a

cooperation agreement between our company and the Ministry of Agriculture. We

have no idea how this came about; the first we knew of it was when we received thisinvitation.

IC: I’ve reviewed this cooperation agreement, which includes establishing a network

of distributors of agricultural commodities and fertiliser, at the company’s expense.As far as I’m concerned the outputs are not clear, and fertiliser distribution is not our

core business.

PC: Why were we, the board of commissioners, not involved in discussions about this

before now?

MD: The board of directors felt that this was a technical issue, so we regarded asbeing within the jurisdiction of the board of directors.

PC: This is a policy issue, which requires the approval of the board of commissioners.How did this happen?

6



Discussion of the cooperation agreement continued for 60 minutes and ended in

dispute. The secretary of the board of commissioners and the risk management

committee will discuss the issue and report the board of commissioners forthwith.

Discuss how the board of commissioners and board of directors should best

approach this relationship.

The meeting continued with discussion of fraud in the regional offices, which wasregarded as misuse of authority and corporate fraud. It was agreed that this would

be reported to the appropriate authorities. The meeting closed at 12.30.

CASE 2

PT ‘Transportasi Cepat Indonesia’ (PT TCI) is a publicly listed transport company,operating since 1953. Up until the 1980s, PT TCI was a profitable firm with growing

assets and revenue. At the end of the 1980s, the government issued a policyderegulating land, air and marine transportation. As a result of this policy,

competition in the transportation business became very tight. PT TCI was directly

affected by this policy and the ensuing business climate, and in the mid 1990s, began

suffering continuous losses and started having liquidity problems. In response to thisdeteriorating condition, management began running up significant debts to continue

operating the business. Early in 2000, shareholders replaced the board of directors

three times. The latest board of directors was appointed in early 2004.

The new board of directors adopted a new strategy of cost cutting and repairing the

company’s transportation equipment. In early 2006, the public accountant thataudited PT TCI published the audit findings, gave the financial report prepared by

management, which showed profits of Rp 38 billion, an unqualified opinion.

Following the publication of the accountant’s report, an independent commissioner who is also chair of the audit committee, asked the audit committee to perform a

review of the findings of the public accountant’s audit. The outcome was that the

independent commissioner believed the accountant’s report to be in error. According

to the independent commissioner, the profit and loss statement prepared bymanagement should have reported a loss of Rp 8 billion. The independent

commissioner stated this openly and his comments were published in the press.

This sparked internal dispute between management and the public accountant on the

one hand, and the independent commissioner on the other. The dispute continued and

affected the operations of the company.

Questions:

1. Did the independent commissioner do the right thing?

6



2. What should management have done?

3. How should this problem be resolved?

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