Business Strategy Series

Corporate governance and dividend policy in Indonesia

Doddy Setiawan Lian Kee Phua
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 Corporate governance and dividend policy
in Indonesia
Doddy Setiawan and Lian Kee Phua
Doddy Setiawan is based at
the Faculty of Economics
and Business, Universitas
Sebelas Maret, Surakarta,
Indonesia. Lian Kee Phua is
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based at the School of
Management, Universiti
Sains Malaysia, Penang,
Malaysia.
The first author acknowledges
financial support from the
Faculty of Economics,
Universitas Sebelas Maret.
DOI 10.1108/BSS-01-2013-0003
1. Introduction
This research aims at examining the impact of corporate governance on dividend policy in
Indonesia. Mitton (2004) argues that dividend is an important issue for investors, especially
among low ranking corporate governance practice countries. Based on agency theory
(Jensen and Meckling, 1976) there are conflicts between principal and agents because they
act on self-interest. However, agency conflict in emerging market happened between the
majority and minority shareholders (Claessens et al., 2000; La Porta et al., 2000; Tabalujan,
2001). The majority shareholders tend to expropriate minority shareholders. One of the
mechanisms to protect minority shareholders is good corporate governance practice.
La Porta et al. (2000) explain the relationship between agency theory, dividend policy and
corporate governance. La Porta et al. (2000) and Mitton (2004) argue that minority
shareholders prefer dividend than reinvestment earnings. There are two theories regarding
the relationship between corporate governance and dividend policy: outcome and
substitution (La Porta et al., 2000). Outcome theory argues that there is a positive relation
between corporate governance and dividend policy. La Porta et al. (2000), Mitton (2004),
Kowalewski et al. (2008) confirms this theory. On the other hand, substitution theory shows
contrasting arguments. In order to give good impression, the weaker corporate governance
practice firms will give higher dividend. Jiraporn and Ning (2006) and Renneboog and
Szilagyi (2008) confirms substitution theory.
Previous researches mostly focus on developed countries, such as the US. Therefore, it is
important to investigate the effect of corporate governance on dividend policy in other
settings. Brown et al. (2011) and Claessens and Yurtoglu (2013) call for more research
based on local contexts to gain more understanding on how corporate governance functions
in different settings. This research examines the Indonesian context because as noted by
Baker and Powell (2012), dividend plays an important role on Indonesian companies.
Indonesian managers believe that dividend has significant effect on firm value. However,
research on dividend in Indonesia is rare except Ang et al. (1997), Baker and Powell (2012)
and Mahadwartha (2003). Previous researches investigate the effect of corporate
governance on dividend policy using cross countries data such as Mitton (2004) and
Sawicki (2009). Sawicki (2009) investigate the effect of corporate governance quality on
dividend policy among the South-East Asian countries. She finds that before the monetary
crisis that happened during 1997-1998, poor corporate governance firms pay higher
dividend. But the practice changes after the monetary crises, firms with better corporate
governance pay higher dividend. These studies do not examine specific characteristics
which are unique to individual countries. Therefore, the present study investigates the
impact of corporate governance on dividend policy of an individual country: Indonesia.
Poor corporate governance practice in Indonesia is one of the causes of the monetary crisis
in Indonesia (Capulong et al., 2001; Nam and Nam, 2004), therefore Indonesian government
introduced new regulations to direct Indonesian firms to adopt good corporate governance
VOL. 14 NO. 5/6 2013, pp. 135-143, Q Emerald Group Publishing Limited, ISSN 1751-5637 j BUSINESS STRATEGY SERIES j PAGE 135
 practice. Sawicki (2009) finds that corporate governance reforms in Southeast Asia changes
the relationship between corporate governance and dividend policy. After monetary crises
outcome theory is applicable instead of substitution theory. As pointed out by Claessens and
Yurtoglu (2013), it is important to analyse individual country because contextual settings
may have significant effect. Sawicki (2009) finds that corporate governance practice in
Indonesia obtained the lowest score after the monetary crisis. Thus, this paper focuses on
after the monetary crisis period to investigate the effect of corporate governance on
dividend policy. Mahadwartha (2003) investigates the impact of corporate governance on
the dividend policy by examining the relationship between dividend policy and managerial
ownership in the following year. He finds a negative relationship. The lower dividend paid by
the firms, the higher managerial ownership in the following year. We use the transparency
and disclosure index (TDI), develop by Kowalewski et al. (2008), as a proxy of corporate
governance practice. This research also examines other fundamental variables such as:
size, growth, and profitability.

2. Literature review and hypothesis development

One of important rights for investors is dividend. Jensen and Meckling (1976) argue that
managements tend to pursue self-interest on firms management. This behaviour will of
course harm investors. There is a conflict of interests between the management and
investors. However, in emerging markets, agency conflicts also happen between the
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majority and minority shareholders (Claessens et al., 2000; La Porta et al., 2000; Nam and
Nam, 2004; Tabalujan, 2001, 2002a, b). To protect minority shareholders’ rights, i.e. dividend,
good corporate governance mechanism is important. Kumar (2006) shows that corporate
governance mechanism influences dividend policy.
Minority shareholders prefer dividend than reinvesting firm earnings to ensure their rights on
dividend payment. There are two competing theories about corporate governance and
dividend policy: outcome theory and substitution theory (La Porta et al., 2000). Outcome
theory argues that good corporate governance firms give more protects on investors’ rights.
Good corporate governance firms pay higher dividend as compared to poor corporate
governance firm. There is a positive relation between corporate governance practice and
dividend policy. On the other hand, substitution theory argues that poor corporate
governance will give higher dividend in order to increase their profile among investors. They
try to attract investors using dividend as a mechanism. There is a negative relation between
corporate governance practice and dividend policy.
Research in this area shows inconclusive results. La Porta et al. (2000), Mitton (2004),
Kowalewski et al. (2008) find that firms with better corporate governance give higher dividend,
therefore they supported outcome theory. On the other hand, Gugler (2003), Gugler and
Yurtoglu (2003), Mahadwartha (2003), Jiraporn and Ning (2006), Renneboog and Szilagyi
(2008) find that firms with poor corporate governance give higher dividend. Poor corporate
governance compensates their weaknesses with higher dividend in order to attract investors.
There is a negative relationship between corporate governance and dividend policy, therefore
they confirm substitution theory. The sample of his research comprises manufacturing firms in
Indonesian Stock Exchange for 1993-2001 periods, consist of 80 firms. The result of his
research shows that lower dividend yield increases the probability of managerial ownership in
the following year. This result shows a negative relationship between dividend and managerial
ownership, thus he confirms substitution theory.
Gugler (2003) examines the impact of corporate governance on dividend policy using
Austrian firms as sample. Gugler (2003) examines the impact of ownership structure, either
government dominated firms or family dominated firms, on the non-financial dividend policy
for 1991-1999 periods. One of the important characteristic of the Austrian firms is
family-control. His result shows that the state-owned firms tend to manage their dividend, but
family-owned firms do not. However, dividend payment is low especially among family
owned firms. Gugler and Yurtoglu (2003) investigate the impact of corporate governance on
the dividend policy in Germany during 1992-1998 periods. They focus on the conflict
between majority and minority shareholders. The result on this research shows that the

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PAGE 136 BUSINESS STRATEGY SERIES VOL. 14 NO. 5/6 2013
 majority shareholders in Germany expropriate minority shareholders. Thus, Gugler and
Yurtoglu (2003) call for better protection of minority shareholders and to increase
transparency among public firms.
Jiraporn and Ning (2006) examine the impact of corporate governance, shareholder’ rights as
a proxy for corporate governance on dividend policy using the US sample firms. Their sample
consists of 1,500 firms from the NYSE, AMEX and NASDAQ. The result reveals a negative
correlation between shareholder’ rights and dividend policy, therefore they confirm substitution
theory. Knyazeva (2007) examines the impact of corporate governance on the firm’s dividend
payment behaviour. The result shows that investors will push harder on firms with poor
corporate governance to pay dividend. Firms with lower corporate governance score index
give higher dividend payment to investors. This result confirms negative relationship between
corporate governance and dividend policy, thus Knyazeva (2007) confirms substitution theory.
Renneboog and Szilagyi (2008) investigate dividend policy in country with poor corporate
governance protection. They are using The Netherlands as their sample because The
Netherlands have weak investor protection rules. The result shows that dividend payment is
low in The Netherlands and it is not responsive to earnings change.
On the other hand, Kowalewski et al. (2008), La Porta et al. (2000), Mitton (2004), and
Sawicki (2009) show a positive relationship between corporate governance and dividend
policy. La Porta et al. (2000), Mitton (2004) and Sawicki (2009) investigate cross country
samples; La Porta et al. (2000) examine developed countries, while Mitton (2004) and
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Sawicki (2009) investigate developing countries. The results of their samples show
conclusive result, firms with better corporate governance practice give higher dividend to
investors. Kowalewski et al. (2008) investigates the relationship between corporate
governance practice and dividend policy in Poland. They use listing firms at Warsaw Stock
Exchange during 1998-2004 periods. Using transparency and disclosure index (TDI) as a
proxy of corporate governance, their results show that increase of corporate governance
score is associated with increased dividend payment by the firms. Thus, better corporate
governance practice gives more protection to investor.
Based on the literature review, the first hypothesis is:
H1. Corporate governance affects dividend policy.

Denis and Osobov (2008) shows that firm size is positively related to dividend policy. They
use samples from 6 developed countries: the US, Canada, Japan, the UK, France and
Germany for 1998-2002 periods. Their result shows that bigger firms tend to give higher
dividend than smaller firms. Denis and Osobov (2008) argue that firm size is a proxy of life
cycle theory. Bigger firm size indicates the firm is more mature. Firms in the earlier life cycle
tend to allocate their earnings to reinvesting activities to enhance their growth. On the other
hand, mature firms tend to pay back their earnings to investors as dividend.
Mitton (2004) also supports Denis and Osobov (2008) findings. Mitton’s (2004) conducts his
study on developed countries. The result of Mitton (2004) shows that firm size has a positive
impact on dividend payment. The bigger the firm size, the higher the dividend payment.
Therefore, Denis and Osobov (2008) and Mitton (2004) show a positive relation between firm
size and dividend policy based on cross country samples.
Jiraporn and Ning (2006) also find positive influence of firm size on dividend payment based
on the US sample. Leal and Carvarhal-dal-silva (2007) also find positive impact of firm size
on dividend policy among Brazilian firms. Leal and Carvarhal-dal-silva (2007) also analyse
their samples based on ownership structures: top one majority shareholder, top three
majority shareholders, and top five majority shareholders, and they find positive impact of
firm size on dividend policy.
Kowalewski et al. (2008) also find positive impact of firm size on dividend policy at a
transition economic country, Poland. Renneboog and Szilagyi (2008) use Belgian samples,
Gugler (2003) and Gugler and Yurtoglu (2003) using Austrian and Germany samples,
respectively, also find a positive relation between firm size and dividend policy. Even though,

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VOL. 14 NO. 5/6 2013 BUSINESS STRATEGY SERIES PAGE 137
 the result on firm size is consistent from prior studies, it is worthwhile to test this variable in
Indonesia as this variable may proxy for some unique characteristics of Indonesian
companies.
Based on the literature review, the second hypothesis is:
H2. Firm size affects dividend policy.

Prior studies presented conclusive result on the affect of firm profitability on dividend policy,
which is a positive impact of firm profitability on dividend policy. This result is consistent
based on cross country (Denis and Osobov, 2008; Mitton, 2004) and single country sample
(Gugler, 2003; Gugler and Yurtoglu, 2003; Jiraporn and Ning, 2006; Kowalewski et al., 2008;
Leal and Carvarhal-dal-silva, 2007; Renneboog and Szilagyi, 2008). The firms that enjoy
higher earnings will pay higher dividend to investors, while firms with lower earning will pay
lower dividends to investors. We also test for firm profitability to examine whether Indonesian
companies react in the same manner.
Based on the literature review, the third hypothesis is:
H3. Firm profitability affects dividend policy.

Higher growth firms prefer to reinvest their earnings rather than to distribute it to
shareholders. The higher the growth rate of a firm, the higher the firm needs fund to
reinvest. Therefore, they will use their earnings to fund their investments rather than to pay
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dividend to shareholders. Gugler (2003) find clear evidence that family-owned firms
prefer to hold their earnings than to distribute it. The results of the relationship between
growth firms and dividend policy show conclusive result, i.e. a negative effect of growth
on dividend policy (Gugler, 2003; Gugler and Yurtoglu, 2003; Jiraporn and Ning, 2006;
Kowalewski et al., 2008; Leal and Carvarhal-dal-silva, 2007; Renneboog and Szilagyi,
2008). We also test for firm growth to confirm whether Indonesian firms react in similar
manner.
Based on the literature review, the fourth hypothesis is:
H4. Firm growth affects dividend policy.

3. Research methods
We select our sample from firms listed at Indonesian Stock Exchange that announce
dividend from 2004-2006 periods. In order to measure corporate governance practice, we
use the transparency and disclosure index (TDI) developed by Kowalewski et al. (2008).
This index is divided into three sub-indexes:
1. TDI-board, discloses the structure and procedure of the board of commissioners.
2. TDI-disclosure, disclose the disclosure practice of the firms.
3. TDI-shareholder, disclose the shareholder right of the firms.
The TDI index contains 32 questions that are divided into: 13 items for TDI-board, 13 items
for TDI-disclosure, and six items for TDI-disclosure. Since Indonesian uses a two-layer board
system: the board of directors and board of commissioners. We refer to the board of
commissioners for the TDI-board. We apply content analysis for data collection, if we find
relevant information, we give a score of 1 on that item and if we do not find relevant
information we give score 0 on that item. The authors use annual report, firm website and
information from Kompas daily as the sources for scoring the TDI index.
To test the hypothesis, the author applies regression analysis:

Div ¼ a þ b1TDI þ b2FS þ b3ROA þ b4Growth þ e ð1Þ

Div ¼ a þ b1TDI 2 board þ b2TDI disclosure þ b3TDI-shareholders þ b4FS

ð2Þ
þ b5ROA þ b6Growth þ e

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PAGE 138 BUSINESS STRATEGY SERIES VOL. 14 NO. 5/6 2013
 B Div ¼ dividend yield.
B TDI ¼ total score for TDI.
B TDI-board ¼ score for TDI board.
B TDI-disclosure ¼ score for TDI disclosure.
B TDI-shareholders ¼ score for TDI shareholder.
B FS ¼ firm size (using total asset as a proxy for firm size).
B ROA ¼ return on asset.
B Growth ¼ growth (using the market value of equity/book value of equity as a proxy for firm
growth).
The first equation tests the impact of corporate governance to dividend yield using the total
score of TDI, while the second equation observes the impact of each sub-index on dividend
policy.

4. Analysis
4.1 Descriptive statistics
The sample of this research comprises 248 firms/year that announces dividend payment
during observation period: 74, 111, and 63 dividend announcement for year 2004, 2005, and
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2006 respectively. The following table presents the descriptive statistics of this research.
From Table I, the descriptive statistics for total TDI score show that the actual range is 1 to 19,
with a mean of 10.48. The theoretical maximal score for TDI total is 32, thus the average
score for the TDI index Indonesian firm is only 32.75 per cent. This score is low, therefore
corporate governance practice in Indonesia is still poor. The highest score for sub-indexes
TDI is TDI-disclosure (5.29 or 40.69 per cent), next ranking is TDI-shareholder (1.68 or 28 per
cent) and the last is TDI-board (3.65 or 27.08 per cent). These data confirm Tabalujan (2001)
and Setiawan (2007) that found poor corporate governance in Indonesia as compared to
other countries in the ASEAN.

4.2 Hypothesis testing

The result of hypothesis testing discuss in this part. We begin the discussion for regression
based on the total score of TDI and followed by the sub-indexes of TDI.
From Table II, TDI is negatively related to dividend policy in Indonesia at 1 per cent level. This
result shows that poor corporate governance practice in Indonesia push Indonesian firms to
pay more dividends to investors in order to attract or retain the investors. This result confirms
Mahadwartha (2003) who found a negative correlation between dividend policy and
corporate governance. This result shows that substitution theory applies in Indonesia. This
result confirms Gugler (2003), Gugler and Yurtoglu (2003), Jiraporn and Ning (2006),
Knyazeva (2007), Renneboog and Szilagyi (2008) that substitution theory applies to explain
the correlation between corporate governance and dividend policy. Since corporate
governance is poor in Indonesia, Indonesian firms try to get attention or retain the investors
by offering higher dividend. From the investors’ point-of-view, since they bear higher risk due
to poor corporate governance practices, they thus ask for premium (high) dividend to

Table I Descriptive statistics

Theoretical range Minimum Maximum Mean

TDI 0-32 1.00 19.00 10.48

TDI-board 0-13 0.00 9.00 3.65
TDI-disclosure 0-13 1.00 8.00 5.29
TDI-shareholder 0-6 0.00 5.00 1.68

Notes: TDI ¼ transparency and disclosure index; n ¼ 248

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VOL. 14 NO. 5/6 2013 BUSINESS STRATEGY SERIES PAGE 139
 Table II Regression analysis for total TDI score
Variable Coefficient Tvalue Sig

TDI 21.243 23.131 0.002*

FS 0.010 0.156 0.876
ROA 0.679 12.084 0.000*
G 0.249 5.733 0.000*

Notes: *Significant 1 per cent; n ¼ 248; Div ¼ dividend yield; TDI ¼ total score for Transparency and
Disclosure Index, FS ¼ firm size (using total asset as a proxy for firm size); ROA ¼ return on asset;
G ¼ growth (using market value of equity/book value of equity as a proxy for firm growth)

compensate the higher risk. In the case of Indonesia, there are some doubts regarding the
implementation of corporate governance regulations. Even though the regulation is
excellent, the implementation is found to be poor. As a result, it will not lead to better
performance in Indonesia. Tabalujan (2002a) argues that the implementation of corporate
governance in Indonesia is not working well due to legal culture in Indonesia. Sato (2004)
also doubts about the success of corporate governance reform in Indonesia due to
ownership structure in Indonesia that are mostly controlled by the ultimate ownerships and
the collusion with government. As pointed out by Sawicki (2009), the corporate governance
score Indonesia has increased after the monetary crises. However, when compared to other
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countries, Indonesia is still getting the lowest scores. CLSA (2007, 2010, 2012) also shows
that the corporate governance practice in Indonesia among the weakest in Asia. Therefore,
investors bear higher risks due to poor corporate governance practice in Indonesia.
Investors thus expect higher dividend from their investments.
The other variables show diverse results. Firm size does not affect dividend policy, there is
no difference between big and small firm on dividend payment. This result does not confirm
Gugler (2003), Mitton (2004), Jiraporn and Ning (2006), Leal and Carvarhal-dal-silva (2007),
Denis and Osobov (2008), Gugler and Yurtoglu (2003), Kowalewski et al. (2008) and
Renneboog and Szilagyi (2008). Firm profitability is positively associated with dividend
policy at 1 per cent level. The higher the profitability, the higher the dividend distributed to
investors. Firms which enjoy high earnings pay more dividends to investors. This result
confirms Gugler (2003), Mitton (2004), Jiraporn and Ning (2006), Leal and
Carvarhal-dal-silva (2007), Denis and Osobov (2008), Gugler and Yurtoglu (2003),
Kowalewski et al. (2008) and Renneboog and Szilagyi (2008) that show positive influence of
firm profitability on dividend payments. Growth variables affect dividend policy positively.
Firms which have higher growth rates give higher dividend to investors. This result is in
contrast to other researches’ result (Gugler, 2003; Gugler and Yurtoglu, 2003; Jiraporn and
Ning, 2006; Kowalewski et al., 2008; Leal and Carvarhal-dal-silva, 2007; Renneboog and
Szilagyi, 2008). This phenomenon is interesting because since other researches show that
high growth firms prefer to reinvest their earnings onto their operations, this research shows
opposite result. Since high growth firm need fund to expand their operation they need more
capital, but at the same time they have to gain the trust from their investors. Dividend
payment is a signal from firms that they believe they have a good prospect in the future.
Another argument for why higher growth firms pay higher dividend is presented by Gul
(1999). Gul (1999) argues that higher dividends may be associated with higher growth
opportunity based on signalling theory (Miller and Rock, 1985). Firms that pay higher
dividend are sending a signal that they have higher growth opportunities. Therefore, firms
that have higher growth opportunities are paying more dividends. The following table
describes the effect of each sub-indexes on the dividend policy.
From Table III, TDI-board affects dividend policy negatively at 10 per cent level. Firms with
poor structure and procedures at board commissioners compensate this through higher
dividend payment to investors. TDI-shareholder also shows consistent result, that is a
negative effect on dividend policy at 5 per cent level. Firms will pay higher dividend because
they have poor disclosure practice. These investigations of two sub-indexes result
consistent with the total scores of TDI. Therefore these two sub-indexes shows substitution

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PAGE 140 BUSINESS STRATEGY SERIES VOL. 14 NO. 5/6 2013
 Table III Regression analysis for sub-indexes TDI score
Variable Coefficient Tvalue Sig

TDI-board 20.554 21.797 0.074***

TDI-disclosure 21.116 22.244 0.026**
TDI-shareholder 20.462 21.537 0.126
FS 0.073 1.084 0.280
ROA 0.656 11.169 0.000*
G 0.251 5.689 0.000*

Notes: *, **, *** ¼ sign at 1, 5, 10 per cent; n ¼ 248; Div ¼ dividend yield; TDI ¼ Transparency and
Disclosure Index; TDI-board ¼ Transparency and Disclosure Index for board;
TDI-disclosure ¼ Transparency and Disclosure Index for disclosure; TDI-shareholder ¼ Transparency
and Disclosure Index for shareholder; F ¼ firm size (using total asset as a proxy for firm size);
ROA ¼ return on asset; G ¼ growth (using market value of equity/book value of equity as a proxy for firm
growth)

theory applies in Indonesia. But, the TDI-shareholder does not affect dividend policy. This
result does not confirm other sub-indexes result and total score of TDI. Therefore
shareholders right practice does not affect dividend policy. The results of three other
independent are consistent with the first equation testing, which is firm size does not affect
dividend policy while firm profitability and growth are positively related to dividend policy.
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5. Conclusion
The result of this research shows that corporate governance practice in Indonesia is still low.
The TDI score is only 32.75 per cent of the maximum points. Indonesian firms tend to
compensate their poor corporate governance through higher dividend payment. There is a
negative effect of corporate governance on dividend payment. Therefore this research
confirms the application of substitution theory in Indonesia rather than outcome theory.
Subsequent analysis shows that: poor structure and procedures in the board of
commissioners, and poor disclosure practices are negatively related to dividend policy,
while shareholder rights does not. From the fundamental factor test, growth and firm
profitability are positively associated with the dividend policy while firm size is not.
Since this research focuses on the manufacturing industries, future research may consider
looking into other industries such as the banking industry. The banking industry, differs from
manufacture industry, have a tight regulation, therefore it is interesting to investigate how
banking policy on the corporate governance and dividend policy. Nasution and Setiawan
(2007) show that corporate governance mechanism mitigates earnings management. Thus,
does corporate governance have a positive or negative impact of the dividend on the
Indonesian banking industry?
Another promising area for research is a cross country comparison in ASEAN for corporate
governance and dividend policy. One of the reasons why financial crisis 1997 happened in
Asia is poor corporate governance. Therefore ASEAN countries, such as: Indonesia,
Malaysia, Singapore and Thailand react to this through establishing regulations on good
corporate governance. Thus, it is interesting to investigate the comparative transparency
and disclosure among ASEAN countries and how they affect dividend policy.

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Corresponding author
Doddy Setiawan can be contacted at: doddy.setiawan@gmail.com
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