General Overview
Proportionality principle, according to OECD Guidelines explains that any shareholder should have the same fraction of cash flow and voting rights, for the purpose to have proportional distributions of cash flow and control rights among investors in publicly traded corporations.[1] This principle regulates as well for the purpose of proportionality between ultimate economic risk and control, which means that share capital which has an unlimited right to participate in the profits of the company or in the residue on the liquidation, should normally carry control rights, in proportion to the risk carried. The holders of these rights to the residual profits and assets of the company are best equipped to decide on the affairs of the company as the ultimate effects of their decisions in which will be borne by them. [2] Proportionality principle, in this regard prohibit the use of several mechanisms to control corporations, for example the use of dual class shares, pyramidal ownership structures, cross ownership, golden shares and voting caps, in which in the end will create a wedge between the nominal income rights and the voting rights that the ultimate owners of a public corporation possess. [3] Therefore it can be concluded that under proportionality principle, a shareholder shall have one share for one vote, to have a power to control corporation and to prove that he or she has ownership in the corporation.
One share one vote is the basis of the right to vote according to proportionality principle. In this case, shareholders should have a right to vote in general meetings in proportion to issued shareholder capital. An one share one vote principle is used to control a group of firms rather than a single party. International Corporate Governance Network states that corporations’ ordinary shares should feature one share one vote for each, and if shareholders given a power to disproportionate to their equity ownership, the disproportionate structures should be disclosed and justified. Furthermore, one share one vote rules are superior to Controlling Enhancing Mechanisms (hereinafter “CEMs”) if there are gains from takeovers and weakening controlling shareholders. [4]
According to a journal wrote by Mike Burkart and Samuel Lee from Swedish Institute for Financial Research, the standard justification for one share one vote is based on two main points, in which the first one is that the residual control rights should rest with shareholders because they are the residual claimants and thus have the strongest interest in maximizing firm value, and the second one is that voting power should match economic incentives, in this case, shareholders should be able to voice their opinion in proportion to their owned risk-capital.[5] Moreover, it is true that shareholders, who supply equal amounts of capital should have equal opportunity to influence corporate decisions, however, in reality it is often violated, in which among the top 300 European companies, 35 percent deviated in 2005 from the one share one vote principle, and it appears as well in North America, which is less frequent than in Europe, but still common. [6]
Moreover, there are several mechanisms that deviate from one share one vote scheme and proportionality principle, which can be defined as disproportional ownership mechanism. Disproportional ownership principle means that the mechanism allow shareholders to control a proportion of votes that is larger than their proportion of rights to the firm’s cash flow, in this case is a deviation from one share one vote scheme.[7] In which under the disproportional ownership, there is a separation of voting and cash flow rights.
The separation of voting and cash flow rights may compromise the efficiency of markets of corporate ownership and control. [8] Moreover, mechanisms to separate voting rights from cash flow rights in listed companies are legally available in most OECD countries, and the leveraging voting rights, in most jurisdictions and market places allow multiple share classes and virtually all accept the reliance on pyramidal or cascading shareholdings. Separating ownership and cash flow may give benefit to seek private benefits at the cost of non-controlling shareholders.
Disproportionality principle has several mechanisms, for the purpose to allow the existing blockholders to enhance control leveraging voting power and lock-in control.[9] The mechanisms can be describe as follow; dual class shares, pyramidal ownership structures, cross ownership, golden shares, and voting caps, that create a wedge between the nominal income rights and voting rights that the ultimate owners possess. According to report from OECD, it has been proven that the control mechanisms in companies with controlling owners, and pyramidal structure is a preferred instrument in many OECD countries, especially in Belgium (79%) and Sweden (53%) and zero in in the United States and United Kingdom, while in fact referring to cross-holding structure, can be find in Germany (20%), and Austria (15%). [10]
According to OECD guidelines, there are two main types that OECD used to bolster the voting powers of individuals hence creating controlling shareholders, which is differentiate voting rights on company shares and multi-firm structures. These two mechanisms are[11]:
- Differentiated voting rights.
Under this mechanism, company under its corporate charter or bylaws leverage voting power to stipulate differential voting rights, and this can be done by structurize dual-class structures, and in common stock, by issuing non-voting shares or preference shares which have common characteristics with debt as well as equity and in most jurisdictions they assume voting rights if the issuers fail to honour their preference commitments.
- Multi-firm structures.
Voting rights can be separated from cash flow rights even with a single class of shares by creating a set of cascading shareholdings or a pyramidal hierarchy in which higher-tier companies own shares in lower-tier companies. Pyramids are complementary to dual class share structures insofar as almost any pyramidal control structure can be reproduced through dual share classes. However for complex control structures, the controlling shareholders may prefer pyramids since the underlying share tend to be more liquid than stocks split into several classes.
European companies rarely using one share one vote scheme. This can be happened on the ground that one share one vote scheme is not justified by economic efficiency.[12] One share one vote scheme, under some circumstances on take over, may become the optimal security-voting structure, with requirement that the management team has a significant private benefit. However, if both teams have a significant private benefit, a departure from one share - one vote may increase the total value of the company.3 Therefore, many of European Companies, use a multiple voting rights scheme as their controlling and voting mechanism in their corporations. Multiple voting rights structure according to ECGI has been accepted and available in several countries, such as Denmark, France, Ireland, Hungary, the Netherlands, Finland, Sweden, the United Kingdom, The United States, and Japan. [13] The application of multiple voting rights is not applicable in certain decisions, for example in Hungary, multiple voting rights are not applicable to decisions requiring qualified majority.[14] In applying multiple voting rights scheme, it should be noted to pay attention of equality principle, which means that the multiple voting rights must apply to all shares of a specified class.[15]
In South East Asia countries, control of corporation is enhanced through pyramid structures and cross holdings among firms. In Indonesia, Japan, and Singapore, voting rights consequently exceed formal cash-flow rights, and the top management of about 60% of firms that are not widely held is related to the family of the controlling shareholder. These can be concluded that the mechanism of ownership and control among South East Asian countries have ability and incentives of controlling shareholders to expropriate from minority shareholders.[16] Moreover, the separation of ownership and control is highest in Japan, Indonesia and Singapore, and lowest in the Philippines and Thailand. [17]
According to corporate governance point of view, the concentration of voting rights is crucial, since it enables owners to determine dividend, policies, investment, projects, personnel appointments, and many more. Concentration of control might give impacts to the evolution of the countries’ legal systems, for example, a concentrated control structure of the whole corporate sector could lead to the suppression of minority rights and hold back the institutional development of legal and regulatory channels to enforce these rights. Furthermore, the direct participation by government officials in the control of a large part of the corporate sector opens up the possibility of wide spread conflicts between public and private interests of some individuals, leading to crony capitalism as what has been happened in Indonesia and Philippines when the Suharto and Ferdinand Marcos became presidents for Indonesia and Phillipine. In conclusion, since wealth concentration might give negative impact for the evolution of the legal and other institutional frameworks for corporate governance and the manner in which economic activity is conducted, which might lead to be a barrier for policy reform in the future, therefore corporate governance especially in Indonesia as one of South East Asia countries should be re-arrange.
Indonesian companies’ structures are based on state control and family controlled.[18] As what has been stated on the previous statement above, it is common to find control by families or by limited number of shareholders. Estimation of 67.3% of publicly listed companies was family held, while only 6.6% was widely held. Asian Development Bank found out that in Indonesia , on average the top five largest shareholders control from 57% to over 65% of the company shares, which might create risks in corporate governance.
As one of the countries whom under its company law and capital market law hold a one share one vote scheme for its shareholders’ voting right, in which has been proven under Indonesian Company Law number 40 Year 2007 in article 53 in which states that Articles of Association may classifies 1 (one) classifications or more of shares.[19] Moreover, every share under the same clasiffication gives the same right to the shareholders.
Furthermore. Indonesia classifies shares in 5 forms, which are:[20]
- Share with or without voting rights.
- Share with special right to elect Board of Directors and/ or Board of Commissioners.
- Share, after in certain length of time can be take back and be replaced with another share.
- Share, which give right to the holder to accept dividend earlier than the other shareholders.
- Share, which give rights to the holder to accept earlier than the other shareholder the amount of money after company’s liquidation.
Under Indonesian Capital Market Law, there are two categories of shares, under claimed point of view, which are common stock, and preferred stock. While common stock limits its stockholder’s liability, where the liability of the stockholder is limited with the amount of stocks they held, preferred stock gives its stockholder a fixed income, with the same scheme like bonds, and can generate income, as wish by investor. [21] Moreover, regarding in trading working environment, categories of shares are divided into five, which are blue-chip stocks, income stocks, growth stocks, speculative stock, and counter cyclical stock .[22] Blue chip stocks can be defined as a stock which comes from a highly reputable company, has a stable income and consistent in paying dividend.[23] Moreover, income stocks can be described as stock which has capability to pay dividend higher than the average dividend paid on the previous year.[24] Growth stock can be divided into two categories to be defined. The first one is a well-known growth stock, which is a stock which has a higher growth income from an enterprise which is a leading company in its industry, and the last one is a lesser known growth stock which comes from an enterprise which is not a leader in its industry, however has a characteristic of growth stock. [25]
As what has been elaborated above, Indonesia regulates regarding ownership of shares under Company Law and Capital Market Law. However, the controlling scheme still based on one share one vote, with voting shares and non-voting shares. Furthermore, even if the ownership and control of the company in Indonesia seems proportional, indeed however the ownership and control in Indonesia work differently. First and foremost, the agency problem is not between the owners and the managers, but between “strong” shareholders and minority shareholders. This is because there is a strong degree of ownership concentration, owner involvement in supervisory / management board and the existence of family business group are big.
The majority of ownership and control from family business group might cause supremacy of controlling shareholders which might cause ineffectiveness of corporate governance implementation in Indonesia.
It is can be said that the law and management or finance approach to corporate governance have important role to protect investors especially for the development of an economy or a corporation. The value of ownership rights attached to corporate equity depends on the country’s legal system and the quality of its law enforcement. It therefore can be concluded that law and regulation serve as a guidance in allocating and enforcing the rights and obligations in one country, therefore, system of law and regulations are the most basic corporate governance mechanisms that govern the firm’s operations that exist.
In the end, in this dissertation will be further examined regarding reforming the legal framework of Indonesian law and regulations and reforming its corporate governance in which will be compared to legal framework in European countries as well as in South East Asia.
Thus, the key question of this dissertation can be formulated as follows:
“What is the relationship between proportionality principle and the reform of ownership and control of companies in Indonesia, based on comparison between separation of ownership and control on European Companies and South East Asian companies?”
Scope of Dissertation
Chapter I
Corporate Governance and Proportionality Principle
1.1 Corporate Governance According to OECD
1.2 Separation of Ownership and Control based on Proportionality Principle
1.3 Deviation of Separation of Ownership and Control from Proportionality Principle
1.4 Justification to Disproportionate the Ownership and Control of the Companies
Chapter 2
Separation of Ownership and Control in European and South East Asian Companies
2.1 Ownership and Control Mechanisms in European Companies
2.2Ownership and Control Mechanisms in South East Asian Companies
2.3 Ownership and Control Mechanisms in Indonesian Companies
2.3.1 Indonesian Corporation Law
2.3.2 Indonesian Capital Market Law
2.3.3 State Owned Companies
2.3.4 Families Controlled Companies
Chapter 3
The Impact of Ownership and Control Mechanisms in Indonesian Companies
3.1 The Impact of State Owned Controlled Companies and Families Controlled Companies in Indonesia for its Corporate Governance
3.2 Reforming Indonesian’s Legal Framework of its Corporate Governance
3.2.1 Indonesian Corporation Law
3.2.2 Indonesian Capital Market Law
Chapter 4
Conclusion
[1] OECD, “Lack of Proportionality Between Ownership and Control: Overview and Issues for Discussion”, OECD Steering Group on Corporate Governance, (2007) p.1
[2] European Commission, “Report on the Proportionality Principle in the European Union”, European Commission, p.5
[3] Morten Bennedsen, Kasper Meisner Nielsen, “The Principle of Proportionality: Separating the Impact of Dual Class Shares, Pyramid sand Cross-ownership on Firm Value Across Legal Regime in Western Europe,”
[4] Supra, note 2.at p.6
[5] Mike Burkart, and Samuel Lee, “One Share One Vote: The Theory”, Swedish Institute for Financial Research, page 4
[6] Ibid, page 1.
[7] Renee Adams and Daniel Ferreira, “One Share, One Vote: The Empirical Evidence”. Finance Working No.177/2007, ECGI.2007. p 3
[8] Supra, note 1.at p.7
[9] Ibid,.
[10] Supra, note 1 at.p.6
[11] Supra, note 1.at p.8
[12] Guido Ferrarini, “One Share One Vote : A European Rule,” Law Working Paper No.58/2008, ECGI, (2006) page 1
[13] Ibid.,
[14] Ibid.,
[15] Ibid.,
[16] Stijn Claessens, et al, “The Separation of Ownership and Control in East Asia Corporations”, Journal of Financial Economics, 58 (2000) 81-112
[17] Ibid
[18] Ibid
[19] Article 53 of Indonesian Company Law Number 40 Year 2007
[20] Ibid.,
[21] See Yanuar Palimo, Pengertian Saham dan Jenis-Jenis Saham, November 2007, at http://coki002.wordpress.com/pengertian-saham-dan-jenis-jenis-saham/, at.p.1
[22] Ibid.,
[23] Ibid
[24] Ibid
[25] Ibid
