Paper Assignment 

For 
Corporate Governance subject
2021

Corporate governance system

Governance as a system

The point of view of the organization as an open system is based on the functionalist paradigm
which is the philosophical foundation of the concept of governance (Lukviarman, 2001). If it is related to
the definition of CG, it will emphasize the need for efforts to maintain balance and stability in social life.
Which is where the functionalist paradigm implies that each individual or group with an interest in the
corporation carries out its "function" and maintains a relationship in accordance with the "structure"
regulated in legislation in a system or environment where the organization is located. This is due to
cultural differences, the opposite aspect of the Universalist approach.

The basic problems of corporate governance since the time of Adam Smith are caused by the
separation between ownership and control of the company. This condition creates a "conflict of
interest" that can affect efforts to achieve company goals. For this reason, a system as a discipline force
is needed so that this conflict of interest will not harm the company or stakeholders. The phenomenon
of CG can be observed through understanding a system consisting of a subsystem, such as companies or
corporations and other institutions. Adam Smith likens that each piece in a chess game has a different
function, role and motion and forms a system that makes the game run well. Conversely, if there is one
piece that is played that is not in accordance with its function, there will be a disorder that makes the
game chaotic and cannot achieve its goal. Corporate governance is also the same as the analogy, so that
various instruments / institutions as well as a code of conduct and laws are needed to maintain balance
through a mechanism of checks and balances so that the system can work optimally.

Corporate Governance: Systems and models

 Governance model is a framework and process, including activities and various tools and
methodologies that can be described, documented, studied, and operated in an organization (Shaw,
2003, p. 76). Governance model is also a decision-making process that is designed so that the
corporation is able to grow and survive in its environment. However, the governance model will become
'inanimate objects' without being supported by a dynamic corporate governance system and vice versa.
System governance is associated with a set of logical subsystems and related feedback loops that will
influence every strategic decision-making process in a corporation.

The diversity of corporate governance systems

In general, the benefits of implementing CG are efforts to increase value for various interested
parties involved in an organization (Corporation) in interacting with their environment. The variation in
the practice and application of CG systems across countries can be considered an important
phenomenon (Mayer, 1997). Positively, this variation is expected to refer to search efforts through the
development of a system with an increasingly efficient governance structure and mechanism. This
development is expected to lead to efforts to maximize the welfare of society as a whole.

Governance and financial systems

Capital structure can be considered as a pattern that describes how risk and control are
allocated by various investors in a corporation. So the capital structure of a company is not only related
and limited to the composition or structure of financing using debt and equity owned by the company.
In an economy, there is a financial system that can be divided into two, namely a Bank-oriented and
Market-oriented financial system. In general, the difference between the two lies in the dominant use of
financing sources carried out by each company in an economic system. In a banking-oriented system,
corporate financing is usually dominated by the use of sources of financing from commercial,
commercial and investment banking institutions. Meanwhile, the market-oriented system, corporate
financing is dominated by funds originating from the financial market, especially the capital market.

Indonesia is one of the countries that is in a developing phase and the financial system
mechanism adopted by all companies with different levels of industrial competition really needs a
financial system that is able to meet the sources of funding and company financing. The company's
preference for the capital structure to be managed has an impact on the expectations of achieving the
company's goals, both in the short and long term. The orientation of companies towards the financial
system adopted in Indonesia shows that the majority of companies have financial systems that are
oriented towards financial institutions. This condition has an interpretation that the company's ability
and confidence to use the capital market as a source of funding is not optimal in contributing to the
company's financing sources.

The capital structure mechanism applied by the company, with the approach used to use
financing sources in general, aims to maximize the value of the company and the welfare of
shareholders through the ability to increase the value of the company at the expense of the costs
generated by sources of financing that will be received in the future. The capital structure management
mechanism implemented by go-public companies with the characteristics of a financial system
orientation in banking institutions is very common in Indonesia. This is because go-public companies do
not only use financing sources from banking-oriented financial institutions, but also other sources of
financing from the financial market. By obtaining market-based funding, it is hoped that the go-public
companies will be able to better direct their ability to face business competition.

The understanding of relationship between financial system orientation and capital structure
will influence to corporate behavior in obtaining funding sources. Financing patterns will affect the
corporate capital structure at the micro level, but will affect the financial system of a macro economy.
Then the financial system will affect various governance mechanisms that are able to maintain the
balance of stakeholders' interests, in order to reduce the agency costs that will arise.

Governance: Separation of ownership and control

The separation between ownership and control is at the root of the problem in the conception
of CG and has been recognized through a long-lived tradition from Adam Smith, to Berle and Means to
Jensen and Meckling. However, the dispersed corporate holdings expressed in the Berle and Means
(1932) model are increasingly uncommon in the world. This claim is supported by a study conducted by
La Porta, Lopez-de-Silanez and Schleifer which found that 64% of large companies in the 27 richest
countries in the world have controlling shareholders with control usually centered on the family.
Concentrated corporate ownership has received criticism from Schleifer and VIshny (1997); La porta,
Lopez-de Silanes, and Shleifer and Bebchuk, Kraakman, and Triantis (2000) as a systematic attempt to
give excessive power to controlling shareholders in using corporate resources for the group's goals to
detriment the interests of other stakeholders.

The existence of majority shareholders on the other hand is also argued to be able to provide
benefits to the corporation, and in the end these benefits will be obtained by all shareholders. The
incentive effect of this ownership pattern will reduce the need for supervision and supervision from
other parties outside the company, thus reducing monitoring costs as a component of agency costs.
Other benefits through the existence of controlling shareholders will be obtained for companies
affiliated with the business group.

Ownership structure and control mechanisms

Agency theory has two types of governance tools in an effort to reduce the impact of agency problems;
external and internal control mechanisms. External control mechanism refers to the possibility of the
company's external environment reacting in disciplining companies that have low company
performance. Meanwhile, the internal control mechanism entrusts the effectiveness of control to the
internal devices contained in the company, such as the existence of the board of commissioners.

Governance; Characteristics and comparisons

Market-oriented governance systems are commonly found in various countries such as America
and Britain which are characterized by the dominant role of the capital market in the country's
economy. In this system, the control mechanism for market-based companies is at the core of the
corporate control system. Several previous studies have shown that Indonesia uses the CG system
following the Continental European model and is not included in the market dominated system
category. Such claims are based on the following characteristics:
a. Indonesia adopted the French civil-law tradition as found and used by several other countries

b. Using a two-tier board system, namely the board of directors and the board of commissioners as
stated in law number 40 of 2007

C. companies in Indonesia, even those that have gone public, are dominated by a concentrated
ownership structure

D. using corporate financing sources that predominantly come from external financing, such as through
banking institutions.

Governance System Elements

A governance system consists of three main components: a. governance structure, b. governance

process, and c. the results obtained from the implementation of governance

A. Governance structure

The governance structure is important in supporting the effective functioning of CG in a

corporation, so it must be clear and understandable for various elements of the organization. Until now,
there has not been found an appropriate and applicable cross-organization CG structure characterized
by the organizational environment. However, in practice the most important thing is how individuals or
organizational members place the CG structure so that it can work optimally. There are 3 hierarchical
governance structures: 1) annual General meetings of shareholders or GMS, 2) The board of director 3)
the executive managers

B. Governance Mechanism
 Governance mechanisms can be broadly categorized based on their characteristics as an internal
or external part of a corporation. The main concern for the internal mechanism of a governance system
is the existence and role of the Board of Directors and the availability of managerial incentives schemes.
Meanwhile, external governance mechanisms are based on the effectiveness of market mechanisms in
disciplining companies and the reliability of a country's legal and regulatory systems.

The purpose of Internal Controlling mechanism is an early warning system to set the
organization back on track before facing the concern challenges. In this case, Board of director will be
top management on this system control and have responsibility to re-function the company back to
normal. While the External controlling mechanism control the function that operates through market
competition and being part of governance tools in disciplining management behavior.

C. Governance Outcomes

According to MacMillan and Downing (1999), good application of corporate governance will
increase the ability of companies to access international capital markets. Based on this opinion, it can be
concluded that governance outcomes through governance implementation are expected to increase the
competitiveness and access of companies to financing sources at the global level. Optimization of the
governance process will be achieved only if it is supported by a regulatory environment that is
appropriate and supportive for the operation of control mechanisms in a governance system. So the
dynamics of environmental change require organizations to make adjustments in such a way that they
can survive.

References
Prof.Niki Lukviarman, M. (2016). Corporate Governance. Solo: Pt. Era Adicitra Intermedia.