Facm01-Bank Loan and the Agency Costs of Debt in Indonesia_

8/2/2019 Facm01-Bank Loan and the Agency Costs of Debt in Indonesia_

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The1stAccountingConference

FacultyofEconomicsUniversitasIndonesia

Depok,79November2007

BANK LOAN AND THE AGENCY COSTS OF DEBT IN INDONESIA; FREE

CASH FLOWS AND MANAGERIAL PERKS PERSPECTIVE

RANDI MILZA

NIKI LUKVIARMAN

Universitas Andalas

Abstract

This research provides a survey to examine the recent conditions on the agency

costs of debt problems in the Indonesian listed firms. Researcher structure the

existing research around two perspectives: (1) What are the impact of bank loan to

the firms free cash flows? 2) Are the firms managers consumed perks from the

bank loan? The evidence constituted that the amount of free cash flows and perks

are increase significantly as the addition of the loans. This study assumed that firms

managers in Indonesia, up to now, are still having a tendency to do overinvestment

but do not rely on firms size to do it. It is different as what some literature stated.

The firms manager also consumed perks, but the consuming of perks itself does not

rely on the age, assets structure, and the size of the firms. Those findings indicated

the existence of agency costs of debt within firms, which bear all the costs to the

creditors (banks). With the lack monitoring function performed mostly by

Indonesian banks, make those findings also suggest that debt governance practices

adopted in Indonesia is still weak in nature.

Keywords:bank loan, agency costs of debt, free cash flows, and managerial perks

1. Introduction

At the year of 1988, the Indonesian government was established some

liberalisation and deregulation law in banking industry where the restriction to open

new bank was reduced significantly (Hall and Mustika, 2003). The effect of this

policy was the increased in the total amount of bank rapidly in the industry. But the

other side, this financial sector reforms was not accompanied by strict

implementation of rules and regulations (Nasution, 1999). According to Nasution

BridgingtheGapbetweenTheory,Research,andPractice 1


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(1999), the regulators and bank managers also did not have sufficient personnel to

supervise and examine the fast-growing number and expanding powers of financial

institutions. As such, the drawbacks of this policy was also harmfulBy early 1998 in Indonesia, it was beginning to become clear either that the

banking system was in much worse condition than originally thought, or it had

deteriorated much more than anticipated. Many banks were closed, and all of the

large private banks were taken over by the government (some maintaining a minority

shareholding on the part of the original owners). McLeod (2002) convinced that the

total cost to the government of reimbursing Bank Indonesia for its liquidity support,

covering the guarantee of banks liabilities, and restoring capital adequacy ratios to

8% was estimated at 15% of GDP. These banking problems come from the bad loans

and suggest that the governance role of debt doesnt function in Indonesia.

In the term of debt financing, bank may actually obtain private information

about the firms during the process of negotiating the lending arrangements. Because

of banks lend funds with the full expectation of being repaid by the debtors, a

significant loan commitment represents an implied audit of the firm about its

creditworthiness; hence, a banker serves as an external auditor, passing judgment on

the firm's present condition and future prospects for loan repayment. The more

exclusive lender-borrower relationship increases the bargaining power of the bank

(Diamond, 1984; James, 1987; Lummer and McConnel, 1989; Boot and Thakor,

2000).

The cases of bad governance on the bank loan in Indonesia then arising so

many question marks for several people. Financial intermediaries are supposed to

mitigate some deleterious effects of debt financing by monitoring their borrowers

(Lookman, 2005). However, Kurniawan and Indriantoro (2000) constituted that in

the Indonesian banking industry, for example, loans were channelled with little

consideration for creditworthiness, and later prove to be uncollectible. Some lending

was given to politically connected firms and many loans were secured with assets

that turned out to be worth much less than their originally assessed amounts and

many others were not secured at all.

Chiu and Joh (2004) convinced that there are three reasons for financial

institutions giving loans to financially troubled firms. Loans could be given because



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of crony lending (government protections), related lending (firms affiliations with the

bank), and because of poor governance of financial institutions itself. Previously,

Rajan and Zingales (1998) argue that much of the collapse of the Asian tigers in1997 and 1998 was due to connected lending where lenders continuing to extend

credit to distressed borrowers rather than cutting of bad credits early and forcing

restructuring before problems grew out of control. It might be that there are no

differences for those conditions in Indonesia.

Pattrick (2001) stressed that all growing companies in Indonesia, large and

small, listed and unlisted, private sector and state owned enterprises, borrow from

banks to the extent possible, arising the problem of bank monitoring function become

the important issue. These findings also suggest that the implementation of a sound

corporate governance practice is at least as important for state-owned enterprises and

private listed firms.

Much of the previous literature that investigates the effect of various

corporate governance mechanism focuses only on equity financing (McConnell and

Serves, 1990; Yermack 1996; Karpoff, Malatesta and Walkling, 1996; Gompers,

Ishii and Metrick, 2003). However, the debt financing is also have the same

interesting and challenges of problems to make a research. Fulghieri and Suominen

(2006) show that corporate governance problem in the equity market interacts in an

essential way with the moral hazard problem in the debt market.

This research is then developed on the basis of previous research by Tian

(2003) which study about the managerial agency cost of debt between banks and

firms in the context of dual government ownership in China. The present study

expand that research without limits its scope on the dual government ownership

context, but the governance of debt as a whole including private listed firms. With

the same method, and by using managerial perks and free cash flows as proxies to

measured the managerial agency cost of debt, the researcher test those findings in the

Indonesian evidence.

This research then continued with the questions, Is the condition of the

managerial agency costs of debt still exists within companies in Indonesia?

Researcher then studies the associations of leverage especially bank loan and its

impact on managerial agency costs of debt that proxies by managerial perks and free



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cash flows. Some previous literature proposed that this problem is highly related to

the agency costs theory between firms, which as the party who need financing, and

financial institution (bank) as the party who gives financing.The purposes of this research is to find out the recent conditions of the

agency costs of debt problems, whether still exists or not, in the firms managerial-

perks and free cash flows perspective. Researcher then defined this objective in the

scope of its debt governance. Thus this study then becomes a positive reference to

firms and banks in posing a judgment of a sound corporate governance practices

recently, especially on the bank loan cases in Indonesia.

The remainder of the paper is structured as follows. Section 2 lays out main

theories and hypothesis. Section 3 describes the sample and the variables used.

Section 4 describes the research results. Sections 5 report conclusion, implications,

also limitation and suggestion of this research.

2. Theories and Hypothesis

2.1 Corporate Governance on Financial Context

There has been reasonable consensus among practitioners and academicians

about the importance of a sound corporate governance concept in the economy. In

Indonesia, many people known that the concept for corporate governance is become

popular when economic crises hit the country in 1997/98. Some arguments to be

considered that the main reason of this crises was because of the bad governance in

many aspects on the nation-side. The reason is, many economic activity and policy

has offsetting the rule of conduct in their implementation compared to which it have

been settled before.

In Indonesia, bank loan has become the major sources of external financing

almost for all companies, although the development of stock and bond markets is

also a high long term priority (Pattrick, 2001). Accordingly, banks will be in a

position to play a significant corporate governance role by monitoring business client

performance and management behaviours.

Research conducted by Facio, Lang, and Young (2001), for European cases,

confirms that capital market institutions are effective, make the external suppliers of

capital (i) dominate decisions on leverage amongst tightly-affiliated corporations,



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and (ii) anticipate that debt will facilitate expropriation. Otherwise for Asia, they

confirms that capital market institutions are ineffective, so that controlling

shareholders (i) dominate decisions on leverage, amongst loosely-affiliatedcorporations, and (ii) exploit this to increase the leverage of corporations more

vulnerable to expropriation, presumably to acquire more resources to expropriate.

Shleifer and Vishny (1997) define corporate governance as the ways through

which suppliers of capital to corporations assure themselves of getting a return on

their investment. In a more investment related definition, corporate governance is to

a certain extent set of mechanism through which outside investor protect themselves

against expropriation by the insiders, which are both managers and shareholders (La

Porta et al., 2000).

2.2 Agency Costs of Debt

Previously, Jensen & Meckling (1976) define agency relationship and

identify the agency costs. Agency relationship is a contract under which one or

more persons (principal) engage another person (agent) to perform some service on

their behalf, which involves delegating some decision-making authority to the

agent. The principle then take the risk after delegating their authority to the agent

since some agents interests may not in conform to the principle. This agency costs

then include monitoring expenditures by the principal such as auditing, budgeting,

control and compensation systems, bonding expenditures by the agent and residual

loss due to divergence of interests between the principal and the agent.

Past research, including Grossman and Hart (1982), Jensen (1986), Stulz

(1990), Hart and Moore (1995), Rajan and Winton (1995), and Stulz (2000), has

suggested leverage and debt maturity structure as effective ways to mitigate the

agency problem between shareholders and managers. The intuition is that leverage,

and particularly short-term debt, can reduce discretionary funds and subject

managers to the scrutiny of the financial market and the threat of default, effectively

curbing self-serving behaviour by managers (Harford, Li, and Zhao 2006).

However, as the firms raise an external financing as a way to discipline their

managers, another type of problems arise. Insider of firms, that are managers and

shareholders, cannot convinced the outsiders, that is the creditors (debtholders)



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easily, since there also an information asymmetery exists between those parties. It is

because creditors do not know the exact and true conditions about the firm within

now and future. This problems then make the creditors doubt about the debtgovernance of their loans by the firms, thus moral hazard also arise.

In the firms internal perspective, managers are not the perfect agent for

shareholders because they may adopt a non-value-maximizing behaviour and engage

in self-serving activities such as empire building and perquisite consumption at the

expense of shareholders. Since they contribute through their human capital,

managers have a tendency to avoid less risky project which in turn would give a

higher return to the firm. Moreover, Facio, Lang, and Young (2001) also stated that

default on corporate debt might not affect the professional managers net worth, but

would certainly devastate his reputation and career. This would not be a concern for

the controlling shareholder of a corporate group, who employs himself as top

manager and can borrow through a group affiliate from a group bank. According to

Boubakri and Ghouma (2006), managers also favour to engage in short term projects

rather than projects that ensure a continuity of the firm in the long run. Thus from the

creditors point of view this type of conflict would probably lead to default of their

principle and interest payment, and that is another rationality encourages creditors to

charge larger yields (costs) for firms with less disciplined managers.

Beyond the managers opportunistic behaviour, creditors also need to worry

about being expropriated by the owner (shareholders). Still with Boubakri and

Ghouma (2006), stockholders, especially controlling shareholders, could be induced

to operate wealth transfers from debt holders in their favour, especially by

undertaking riskier projects that are rewarding to shareholders but costly to debt

holders. According to the option theory, shareholders possess a call option on the

assets of the firm. The riskier are these assets, the more valuable is their option.

Obviously, debt claimants will bear all the cost, while shareholders capture most of

the gain if the investment does well. Such situation cannot be completely tackled by

the contract provision, thus arising the term we known as agency cost of debt.

Based on the research conducted by Tian (2003) about the agency cost of

debt between banks and firms in China in the context of dual government ownership,



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this study expand that research without limits its scope on the dual government

context, but the governance of debt as a whole including private firms.

The 1998s monetary crises showed that there is no differences on reality inIndonesia, which is from State Owned Enterprises (SOE) or private listed firms, that

have the best governance on bank loan. The two of them showed the same lack of

governance on bank debt. Both of them was hit worsely by the crises, each have

received loans not only from government bank but also from private bank, each have

failed on their project investment, and each have great amount of liability to paid that

loan.

2.3 Hypothesis Development

Previously, Kim and Sorensen (1986) suggest that the agency cost of debt is

more significant for those firms whose managers own a small portion of equity than

for those firms whose managers own a significant portion of equity because the

former group is more likely to make suboptimal investment decisions than the latter

group. Largely apart from this shareholder-focused corporate governance literature,

several finance scholars have pursued another line of research exploring financial

intermediation and its externalities that might affect other financial claimants (see

Datta, Iskandar-Datta, and Patel 1999, and Klock, Mansi, and Maxwell 2005).

Durnev and Kim (2003) also provide another theoretical model, and

empirically test the relationship between the financial characteristics of a firm and

corporate governance. They show that firms with good investment opportunity,

higher sales growth rates and higher dependency on external financing would

maintain a better corporate governance not to lose those good investment

opportunities.

2.3.1 Free Cash Flows

There are three parties that have interest on free cash flows. The first party

are managers. According to Tian (2003), the way some managers to spend free cash

for their own benefit is through over expanding corporate operations or empire-

building, fits the interest of managers at the cost of shareholders. Not only

managers, the shareholders also have interest in this cash flow in term of dividend

paid. Shepherd, Tung, and Yoon (2007) confirms that bank is another party who



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have the same interest about free cash flow. The importance of free cash flows to

bank is in maintaining the sustainability payment of their interest and loan principle.

Since the main focus of this research is on firms managers, then this researchjust look at the impact of free cash flows on managerial agency costs cluster.

Previously, some literature including Tian (2003), found that an increase of bank

loans increases the size of free cash flows that will lead firms to overinvestment

problems because of managers expropriations.

Dittmar and Smith (2005) then studied how good governance improves the

value of cash reserves. They find that a well governed firm has its excess resources

better fenced in, and that firms with poor corporate governance dissipate excess

cash reserves more quickly on less profitable investments than those with good

governance.

Grossman and Hart (1980) also Cheng and Lin (2006) proposed that debt is a

disciplinary device that may be used to reduce the agency costs of free cash flow.

Sheperd, Tung, and Yoon (2007) found there are some ways for creditors (bank) in

monitoring the firms. First, mandatory regular interest and principal payments on the

loan reduce the amount of free cash. Second, bank loans often contain an excess cash

covenant, which explicitly limits the borrower firms cash on hand by requiring that

any excess be used to pay down the bank debt. Third, the lender typically requires

the borrower firm to maintain its deposit accounts with the lender. This enables the

lender to monitor continuously the firms cash levels and uses of cash.

We can conclude that the above condition will only operated significantly if

bank monitoring is acceptable, exactly the same as Sheperd, Tung, and Yoon (2007)

stated. However, since the bank monitoring is not so well in Indonesia (conclude

from Nasution, 1999), then the function of debt to reduces the agency costs of free

cash flows would not be the same.

H1= there is significant associations between leverage and free cash flows

2.3.2 The Perks

In the process of searching the literatures for this research, no many bases to

get supporting findings about managerial perks can be found. Many people observe



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perks, but very few of them observe the associations between leverages and

managerial perks.

From all of the view findings, this recent study agreed with Tian (2003), thatproposed perks will increase respectively in the firms if having more leverage by the

addition of the bank loan on the weak governance system.

Another supportive finding also suggest by Jensen and Meckling (1976) long

time ago, constitute that managers of growing firms that was financed from outside

are less careful with peoples money. Indirectly, it indicated the sensitivity of

associations between leverage (bank loan) and managerial perks.

Different perspective was given by some people. (Grossman and Hart, 1982)

constitute that the use of debt increases the probability of bankruptcy and job loss.

This additional risk may further motivate managers to decrease their consumption of

perks and increase their efficiency. Laura, Lin, and Shift(1993) also proposed that if

bank monitoring were effective then managerial perks could be reduce because debt

constraints the action of managers, instead the creditors itself do not play an active

role in the governance of the corporations.

H2= there is significant associations between bank loan and perks

3. Data and Summary Statistic

3.1 Data Collection Method

The data used in this research are secondary data, collected from several

sources included Indonesian Capital Market Directory (ICMD), Company Audited

Financial Report, and www.jsx.com. Since there are some data that can not be

collected because of some reasons, then the choice of firms selected was based on the

most efficient data available.

The method of data collection is done by using pooling data method and

research sample is done by purposive sampling method based on some given criteria.

The data then merged to construct my final sample, consists of operating income,

interest expense on bank loan, current tax, dividends, book value of firms assets,

administration costs, sales, long-term bank loan, short-term bank loan, and total

assets.

http://www.jsx.com/http://www.jsx.com/


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3.2 Data Construction

The population of this research is all of the firms listed in Jakarta Stock

Exchange (JSX) in a period of 2003 to 2005, excluded firms operated in Banking,Credit Agencies Other Than Bank, and Security Insurances. Researcher assumes that

these type of firms are regulated and also because their levarage cannot be

interpreted in the same manner as for industrial firms.

The sample of this research is all the firms listed continually from 2003 until

2005 in JSX, after excluded firms operated in Banking, Credit Agencies Other Than

Bank, and Security Insurances. The sample then selected based on some following

criteria: (i) Firms must be listed in JSX continually in a period of 2003 to 2005 with a

complete summary of financial report and published it in Indonesia Capital Market

Directory (ICMD), (ii) The firms must also published its annual report in a period of

2003 and 2005 which is audited by independent auditor, (iii) The firms audited

annual report must clearly defined interest expense on bank loan explicitely. In my

opinion, it is important to get this account clearly defined to avoid some biases since

the some lack of informations given in the annual report if the data are calculated

mannually (some of this account is totaled with other kinds of interest expenses in a

annual report with no clear information about each rate)

3.3. Research Model

The statistical analysis of this research is divided into two parts; classical

assumption testing and hyphotesis testing. Researcher then have to changes the

regression model into natural logarithm form to get proper sufficiency in classical

assumption tests but in reading the results researcher have to change the results into

exponential forms. This research is also conduct a test to make sure that there is no

correlation between the two dependent variable to prevent some statistical biases.

3.3.1 Dependent variable

3.3.1.1 Managerial Perks

There are some definitions of perks. Tian (2003) stated that managerial perks

are the hidden income of management team. Bebchuk and Jackson (2005) stated that

hidden compensation takes an inefficient form that management would not choose to



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pursue out of their own pockets if they were compensated directly with cash. Thus

the abuse of perks imposes costs on the firm and ultimately its owners.

Rajan and Wulf (2007) defined perks as form of non-monetary compensationoffered to selected employees and also pointed out that perks is not strictly necessary

for the accomplishment of the employees duties. The examples of perks are first-

class air travel, club membership, company car, executive dining room, home

security systems, physical examination, telephone and fax, also seminary tickets, and

many more.

In the company point of view, perks actually could be treated in a positive

and negative manner. Perks in the negative manners is proposed by Jansen and

Meckling (1976), Grossman and Hart (1980), and Jensen (1986). They stated that

there a way for manages to misappropriate the firms surplus that firms generated.

Managers can do so because perks are difficult to observe by investor and investor

itself are usually not in physical contact with management, so they cannot see the

extent of perks consumption for themselves.

While perks is generally term in the negative manners, there are also some

positive outcome of the given perks. Still with Rajan and Wulf (2007), perks in

someway help managers in performing their duties, indirectly they aid productivity

of the managers even not as a critical parts of jobs duty being done. For example,

firms will benefit in negotiation if their managers in fresh condition after travelling in

first-class air travel than arriving tired and jaded with the economic-class air travel.

In this research, following Tian (2003), I measured perks as;

Equation 1

Perks =Adm.cost

Sales

Most perquisites for managers are not explicitly reported in the annual

reports, but they inflate the accounting item of administration costs. Administration

costs records the administration expenditures in organizing and managing corporate

operation. It includes the expense of the management team and the costs that should

be born by the company as a whole, such as corporate cars, travelling expenses,

entertainment expenses and other services bills (concluded from Tian, 2003).



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3.3.1.2 Free Cash Flows

Free Cash Flows terms were firstly proposed by Jensen (1986). Free cash

flows is the cash flows that are at the disposal of managers after valuable/efficientinvestment. According to Jensen (1986), managers could maximize objectives which

are not common in the stakeholders interest; through increasing the firms size that

will boosts his status, pay, and power in the company. Later on, managers then may

still take on more investment projects at the expense of shareholders, increasing firm

size but at the cost of lower net present value. However, according to Tian (2003),

with the legal bidding of repayment of interest and loan principle, debt function will

force out free cash flows by imposing rules and restriction on management.

Consequently, this will explain why free cash flows and investment is highly related.

In some estimation, Shepherd, Tung, and Yoon (2007) also include a measure

of free cash flows as a proxy for managerial agency costs. Jensen (1986) asserts that

free cash flow is the best measure of the discretionary funds and thus the best proxy

for agency conflicts

In this research, following Shepherd, Tung, and Yoon (2007), the researcher

measured these free cash flows (FCF) as:

Equation 2

FCF = oprt. income-(interest exp. on bank loan+(income taxes-changes in deffered taxes)+dividends)

BV. of firms assets

3.3.2 Independent Variable

Financial leverage is the liabilities of the firm and indicated the probabiltity

of financial distress, which may influences the governance role of debt by the firms.

Since the purposes of this research is to find out about the condition of managerial

agency costs of debt, esepecially bank loan in Indonesia, then following the criteria

the formula of leverage used is the debt from bank loan.

Equation 3

Leverage =Total Bank Loan

Total Assets



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3.3.3 Control Variable

This study use three items defined as control variable, that is firms size, firms

age, and assets structure. These three items must be controlled to minimize its effecton statistical results between indepedent variable and dependent variable.

1. Firms SizeIn this concepts, firms will tend to increase their debt level since the rapid

growth of the firms press more sources of financing. Bigger firms will easy access

the capital market because they have flexibility and ability to get sources of financing

(in term of symmetric information). Bernanke et al. (1994) present strong empirical

evidence that the severity of the agency cost problem faced by firms depends on firm

size. Firm size is measured by taking the logarithm of total assets of each year. This

study tends to use total assets in order to reduces the multicolineriality from this ratio

with administration costs per sales (perks).

2. Firms AgeFirm age relates to changes caused by the firm life cycle changes (Smith,

Mitchel, and Summer, 1985). Berger and Udell (1995) argue that firm age is

associated with the degree of information asymmetry. The degree of information

asymmetry is likely to be more severe in younger firms since they have limited

financial records. Firm age is measured by the number of years between the

observation year and firms founding year.

3. Assets StructureThe assets structure or the assets tangibility influences firms growth and

corporate valuation (Vilasuso and Minkler, 2001). The scales of managerial agency

costs probably systematically vary with the structure of corporate assets. Rajan and

Zingales (1995), argue that fixed assets are easier to collateralize, and so reduce the

agency costs of debt. The assets tangibility is measured as total fixed assets divided

by total assets.

Examining the relations between financial leverage and mangerial agency

costs of debt, the basic model to estimates is (Tian 2003):

Equation 4

Managerial Agency Costs of Debt = C+*Debt+ *Firms Characters +



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Figure 1. Model of Variable Definiton

Independent Variable

Dependent VariableLeverage

Control Variable

4. Results

The most important thing before conducting the statistical test for this

research is to convinces that there is no correlation between the two dependent

variables to prevent the statistical results bias.

Researcher then observed the relationship between free cash flows and perks

( Jensen and Meckling (1976) previously proposed that free cash flows caused

perks). From table 1, the Pearson Correlation value for free cash flows and perks

each is 0,30 which is > than (0,05). For that reason, this study assumed that there

is no correlation between the two dependent variables.

My findings was in line with Rajan and Wulf (2007), constituted that there is

no causal relationship between free cash flow and perks. In my opinion, supported

also by some previous literature, free cash flows is higly related with overinvestment

made by the managers, instead of with perks.

4.1 Results for Free Cash Fows

Some previous literature proposed that managers, shareholders, and creditors

have the same interest on the free cash flows. Shareholders want this free cash flow

in terms of dividend payment, managers could miss-use this free cash flow through

overinvestment to build their empire-building, and creditors want these free cash

flows to sustain the payment of interest and principle on their loans.

Grossman and Hart (1980) also Chen and Lin (2006) suggest that indirectly

in nature, more debt given by bank, will increase the total amount of free cash flows

that could be miss-used by the firms. However, Sheperd, Tung, and Yoon (2007)

Assets Structre

Firms Size

Firms Age

Perks

Free Cash Flows Managerial

Agency Costs ofDebt



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constituted that if banks can monitor continuously the firms cash level and uses of

cash, then the amount of free cash flows can be reduced. Reducing the amount of

free cash flows make the agency problems arising by it would not be a matter.Using statistical F-test, this research found a significant positive association

between leverage, tangibility, and firms age, if act as a group, to the free cash flows

amounts. From table 14, the F value is 7,784, and the Sig value is 0,000, which is <

(0,05). It means that the influence of independent variables (leverage, age,

tangibility, and LN assets), if act as a groups, is significant towards the dependent

variables (LN_Free Cash Flows).

Focusing more on leverage through statistical t-test, from table 16, after

analysing the result, statistical equation model that can be made is:

Equation 5

LN_FCF = -2,062 -1,761 Leverage 0,702 Tangibility + 0,018 Age +

Table 16 reports a positive influence between the leverage and free cash

flows after changing the results model into exponential forms.

A 0,1 increases in firms leverage increases the free cash flows amounts up to

0,172. Other things being equal (that are assets tangibility and firms age), a firm

which given more bank loan tends to have more free cash flows, thus increasing the

tendency to do overinvestment. This findings was in line with Jensen (1986),

Grossman and Hart (1980), Tian (2003), and also Chen and Lin (2006), suggesting

that more debt given by bank, will increase the total amount of fee cash flows that

could be misused by the firms.

The increased of free cash flows amount from debt financing also suggesting

a bad monitoring function performed by the banks in Indonesia, at least in the same

period of my sample. It is because; bank through their monitoring function in nature

should reduce the amount of free cash flows raised from their loans (Sheperd, Tung,

and Yoon, 2007). Again this condition doesnt happen in Indonesia.

Dittmar and Smith (2005) previously suggest that a good governance firms

better fenced their free cash flows compare to weak governance firms which have

more excess cash reserves. This research found that many Indonesian firms have



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more free cash flows if added more leverage through bank loan, thus based on

Dittmar and Smith (2005), suggesting the researcher to concludes, that many

Indonesian firms itself do not have proper governance on their debt.From table 1, this recent study also found that firms with sufficient period in

their operation (long age firms), still have amount of free cash flows increased by the

bank loan addition. Others thing being equal, an increases of 0,1 firms leverage

increases the total amount of free cash flows up to 0,498. This research then

assumed long age firms still tend to do overinvestment, indicating weak governance,

especially on bank loan. These findings suggest that firms in Indonesia, although

have a long period in their operation, can not reduce the managerial agency costs of

debt.

From table 1 also, researcher founds free cash flows are influenced positively

by the structure of the firms assets. Other things being equal, an increases 0,1 of

assets tangibility, make the firms free cash flows amount increases up to 1,018.

These findings indicated that firms with a large proportion of intangible assets also

tend to do overinvestment. But this research can not judge that the governance of

debt in this type of firms is weak or not. It is because my sample do not differentiated

certain business sector. For instances, the information technology sector, which have

more intangible assets, requires intensive investment, thus keeping more on their free

cash flows amount.

But my findings do not constituted any influence of firms size to the free

cash flows. No influence of firms size to free cash flows is an interesting finding.

Some previous literature including Jensen (1986), proposed that a manager, due to

the imperfect incentive alignment between shareholders and managers, managers

would seek private benefits proportional to the sizes of their firms, but share the

investment and operating costs with outside shareholders. Thus consequently, these

managers tend to over invest. My research indicated a different finding. The

association between firms size and free cash flows is insignificant in Indonesia. The

researcher can conclude, the amount of free cash flows do not influence by the firms

size in nature. It indicated the size of the firms is not a matter to the possibility of

debt governance in Indonesia. There is also no differentiation between bigger firm

and small firms in the implementation of debt governances make the overinvestment

problems do not rely on the size of that firms.



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4.2 Results of Perks

Some literature on perks proposed that perks could be in positive or negative

associations within the addition of leverage. The first point of view was proposed byJensen and Meckling (1976) and Tian (2003). Jensen and Meckling (1976) stated that

managers of firms that financed from outside will less careful about peoples money.

In his research, Tian (2003) also found that perks is highly associated with leverage

(bank loan) in China evidence. More leverage (bank loan) will make managerial

perks more increase.

In the other side, the negative associations findings were proposed by

Grossman and Hart, (1982) and Laura Lin, Shift (1993). Grossman and Hart

constitute that, since the use of debt increase the possibility of bankruptcy and job

loss, then managers will motivated to decrease their consumption as perks and

increase efficiency. Laura, Lin, and Shift (1993) also proposed that if bank

monitoring were effective then managerial perks could be reduce because debt

constraints the action of managers, instead the creditors itself did not play an active

role in the governance of the corporations.

Using statistical F Test, this research found a significant positive association

between leverage, tangibility, and firms age, if act as a group, to the perks amounts

From table 15, the F value is 1,951, and the Sig value is 0,104, which is > (0,05). It

means that the influence of independent variables (leverage, age, tangibility, and LN

assets), if act as a groups, is insignificant towards the dependent variables

(LN_Perks).

Focusing more on perks through statistical t-test, from table 17, after

analysing the result, statistical equation model that can be made is:

Equation 6

LN_Perks = -3,079 0,437 Leverage +

Table 16 reports a positive influence between the leverage and free cash

flows after changing the results model into exponential forms.



18/31




Based on statistical t-test, my finding in Indonesian evidence is the same as

Jensen and Meckling (1976) and Tian (2003), proposed that leverage is have

significant positive associations with managerial perks. From table 2, if other thingsbeing equal, researcher founds a 0,1 increases in the firms leverage make an

increases in managerial perks up to 0,646. The changes of 0,1 to 0,646 actually is an

interesting finding since it was a significant changes actually. It can assume that the

firms spend a huge portion on administration costs in every unit of sales with

increasing borrowings from the banks. That is, bank lending increase the firms

resources under the management control and bring about high administration

expenditure. With ineffective bank monitoring in Indonesia (Nasution, 1999), it

proposed a failed in the function of debt, as suggested by (Harford, Li, and Zhao,

2006).

My research also founds that the tendency of managerial perks on bank loan

given, didnt belong to the size of the firms, the structure of firms assets, and the

period of firms since it was established. It indicated, in consuming perks, managers

of these types of firms are in the same manners as the others firms. Perhaps it will

answer the questions why big firms, long age firms, and firms with better assets

structure in Indonesia were also failed in the implementation of corporate governance

practices, especially at the crises hit the country.

This research then concluded, in the weak of bank monitoring function in

Indonesia (Nasution, 1999), an increase of bank loans increase the amount of free

cash flows and managerial perks of the firms. The addition of bank loans, make firms

with sufficient assets structure and have long period in the operation, tend to miss-

used free cash flows in term of overinvestment projects. But in Indonesia, different

from Jensen (1986) findings, the firms managers do not rely on firms size to do

overinvestment. Firms managers in Indonesia also spend huge amount of this bank

loans to the administration expense, so, indirectly this firms managers have control

all the resources, thus increasing the consuming those debt as perks. However, perks

consuming do not rely on the size of the firms, its age, and its assets structure.

Based on these findings, my research then concluded that, up to now, the condition

of managerial agency costs of debt still exists within companies in Indonesia, and

suggesting a failed in the bank monitoring function.



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5.1 Conclusion, Implications, and Limitations and Suggestion

5.1 Conclusion

Through a statistical test, this research regressed the bank loan to get itsimpact on free cash flows and managerial perks of the firms. In the results, the

researcher founds that; (1) bank loan have a positive significant influence towards

the firms free cash flows, increasing the tendency of overinvestment by the firms

managers, (2) bank loans have a positive influence to managerial perks, but the

consuming of perks itself do not rely on the age, assets structure, and the size of the

firms.

From that findings and relying it on previous literature, this study can

assumed in Indonesian evidence the managerial agency costs of debt is still exists

within the company in Indonesia. It suggests that many improvement that have been

made by the regulator on the implementation of debt governance had not earned

significant results. It indicates that both the firms, as the party who needs financing,

and financial institution (bank), as the party who give financing, have not implement

a sound corporate governance practices.

5.2 Implications

The weak of debt governance practices in Indonesia suggests that a good

monitoring function performed by domestic bank should be increased indefinitely. It

is because bank monitoring is an essentials factors in implementing a sound debt

governance. Thus this can become a positive reference, especially for regulators, in

posing a judgment about points that should be considered in debt governance

practices within companies in Indonesia.

5.3 Limitations and Suggestions

There are some limitations, if encourage, will increase the acceptability of

this study. The research limitations are;

Only two proxies used to described the managerial agency costs of debt inIndonesian evidence. In fact, there are many proxies to described the

managerial agency costs of debt. We can observed it on many aspects

actually.

The used of administration costs to compute the managerial perks, may notdecribed the perks definitly since not directly to the real value of perks

samples.



20/31




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Appendixes

Table 1

Code Industry Name

AIMS wholesale PT. Akbar Indo Makmur Stimec Tbk.

AISA manufacture PT. Tiga Pilar Sejahtera Food Tbk.

AKRA wholesale PT. Aneka Kimia Raya

ALFA wholesale PT. Alfa Retailindo Tbk.

ALKA holding PT. Alakasa Industrindo

ALMI logam PT. Alumindo Light Metal Industry Tbk.

ANTA hotel PT. Anta Express Tour & Travel Service Tbk.

AQUA manufacture PT. Aqua Golden Mississippi Tbk.

BATA apparel PT. Sepatu Bata Tbk.

BLTA transportasi PT. Berlian Laju Tanker Tbk.

BMSR real estate PT. Bintang Mitra Semestaraya Tbk

BRNA plastic PT. Berlina Tbk.

BTON logam PT. Betonjaya Manunggal

BUDI kimia PT. Budi Acid Jaya Tbk.

CENT komputer PT. Centrin Online Tbk.

CKRA real estate PT. Ciptojaya Kontrindoreksa Tbk.

DAVO manufacture PT. Davomas Abadi Tbk.

EKAD kimia PT. Ekadharma Tape Industry Tbk.

ELTY real estate PT. Bakrieland Development Tbk.

EPMT wholesale PT. Enseval Putera Megatrading Tbk.

FMII real estate PT. Fortune Mate Indonesia Tbk.

FPNI plastic PT. Fatrapolindo Nusa Industri Tbk.

HEXA wholesale PT. Hexindo Adiperkasa Tbk.

HMSP manufacture PT. Hanjaya Mandala Sampoerna Tbk.

IKBI kabel PT. Sumi Indo Kabel Tbk.

INAF manufacture PT. Indofarma (Persero) Tbk.

INAI logam PT. Indal Alumunium Industry



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Code Industry Name

INCO mining PT. International Nickel Ind.

INDX tekstil PT. Indoexchange Dotcom

INTA wholesale PT. Intraco Penta Tbk.

INTD wholesale PT. INTER DELTA TBK.

JPFA pakan ternak PT. Japfa Comfeed Indonesia Tbk.

KAEF manufacture PT. Kimia Farma (Persero) Tbk.

KICI manufacture PT. Kedaung Indah Can Tbk.

KLBF manufacture PT. Kalbe Farma

KONI wholesale PT. Perdana Bangun Pusaka

KPIG keramik PT. Kridaperdana Indahgraha

LION logam PT. Lion Metal Works Tbk.

LMSH logam PT. Lionmesh Prima Tbk

LPLI others PT. Lippo E-Net

LSIP agro PT. PP London Sumatra Indonesia Tbk.

MDLN real estate PT. Modernland Realty Tbk.

MERK manufacture PT. Merck Tbk.

MLBI manufacture PT. Multi Bintang Indonesia Tbk.

MLIA keramik PT. Mulia Industrindo

MLND real estate PT. Mulialand

MTDL komputer PT. Metrodata Electronics Tbk.

MYOR manufacture PT. Mayora Indah Tbk.

MYTX tekstil PT. Apac Citra Centertex Tbk.

NIPS otomotif PT. Nipress Tbk.

PLAS holding PT. Palm Asia Corpora, Tbk

PTRO others PT. Petrosea Tbk.

RALS wholesale PT. Ramayana Lestari Sentosa Tbk.

RIGS transportasi PT. Rig Tenders Indonesia Tbk.

RIMO wholesale PT. Rimo Catur Lestari Tbk.

SAFE transportasi PT. Steady Safe Tbk.



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Code Industry Name

SDPC wholesale PT. Millenium Pharmacon International Tbk.

SHDA manufacture PT. Sari Husada

SIMA plastic PT Siwani Makmur

SMAR manufacture PT. SMART Corporation Tbk.

SMPL plastic PT. Summitplast Tbk.

SMRA real estate PT. Summarecon Agung Tbk.

SMSM otomotif PT. Selamat Sempurna Tbk.

SONA wholesale PT. Sona Topas Tourism Industry Tbk.

SSIA konstruksi PT. SURYA SEMESTA INTERNUSA Tbk.

STTP manufacture PT. Siantar Top Tbk.

SUBA manufacture PT. Suba Indah

TBLA manufacture PT. Tunas Baru Lampung Tbk.

TBMS manufacture PT. Tembaga Mulia Semanan

TCID manufacture PT. Mandom Indonesia Tbk.

TEJA tekstil PT. Texmaco Jaya

TGKA wholesale PT. Tigaraksa Satria Tbk.

TMPO media PT. Tempo Inti Media

ULTJ manufacture PT. Ultrajaya Milk Industry & Trading Company Tbk.

UNTR wholesale PT. United Tractors

UNVR manufacture PT. Unilever Indonesia

WICO wholesale PT. Wicaksana Overseas International Tbk.

Table 2

The effect of increasing + 0,1 independent variables to dependent variables

Variable If LN_FCF FCF

Leverage + 0,1 - 1,761 + 0,172

Tangibility + 0,1 - 0,702 + 0,496

Age + 0,1 + 0,018 + 1,018



26/31




Table 3

The effect of increasing + 0,1 independent variables to dependent variables

Variable If LN_Perks Perks

Leverage + 0,1 - 0,437 + 0,646

Pearson Correlation for Dependent Variable

Table 4

Correlations

CASHFLOW PERKS

CASHFLOW Pearson Correlation 1 -.030

Sig. (2-tailed) . .656

N 231 230

PERKS Pearson Correlation -.030 1

Sig. (2-tailed) .656 .

N 230 230

Classical Assumptions Testing

1. Normality Testsa. Normality Test for Original Data

Table 5

Tests of Normality

Kolmogorov-Smirnov

Statistic df Sig.

CASHFLOW .321 230 .000

PERKS .466 230 .000

b. Normality Tests for Free Cash FlowsTable 6

Tests of Normality

Kolmogorov-Smirnov

Statistic df Sig.

LN_CF .067 155 .084



27/31




Figure

Normal P-P Plot of Regression Stand

Dependent Variable: LN_CF

Observed Cum Prob

1.00.75.50.250.00ExpectedCumProb

1.00

.75

.50

.25

0.00

2

c. Normality Tests for Perks ModelTable 7

Tests of Normality

Kolmogorov-Smirnov

Statistic df Sig.

LN_PERKS .057 190 .200

This is a lower bound of the true significanceFigure 3

Normal P-P Plot of Regression Stand

Dependent Variable: LN_PERKS

Observed Cum Prob

1.00.75.50.250.00ExpectedCumProb

1.00

.75

.50

.25

0.00

2. Multicollineriality Testsa. Multicolineriality Tests for Free Cash Flows

Table 8

Coefficients

Collinearity Statistics

Tolerance VIF

(Constant)

LEVERAGE .950 1.053

LN_ASSET .909 1.101

TANGBLTY .956 1.046

AGE .972 1.028a Dependent Variable: LN_CF



28/31




b. Multicolineriality for PerksTable 9

CoefficientsCollinearity Statistics

Tolerance VIF

(Constant)

LEVERAGE .980 1.020

LN_ASSET .908 1.102

TANGBLTY .955 1.047

AGE .948 1.055a Dependent Variable: LN_PERKS

3. Heteroskedasticitya. Heteroskedasticity Tests for Free Cash Flows

Figure 4

Scatterplot

Dependent Variable: LN_CF

Regression Standardized Predicted Value

3210-1-2-3-4-5RegressionStandardizedR

esidual

3

2

1

0

-1

-2

-3

b. Heteroskedasticity Tests for PerksFigure 5

Scatterplot

Dependent Variable: LN_PERKS

Regression Standardized Predicted Value

20-2-4-6-8RegressionStandardizedResidual

3

2

1

0

-1

-2

-3



29/31




4. Autocorrelationsa. Autocorrelations for Free Cash Flows

Table 10Model Summary

R R Square Durbin-Watson

.415 .172 2.150

a Predictors: (Constant), AGE, TANGBLTY, LEVERAGE, LN_ASSET

b Dependent Variable: LN_CF

b.

Autocorrelations for PerksTable 11

Model Summary

R R Square Adjusted R Square Std. Error of the EstimateDurbin-

Watson

.201 .040 .020 .7026956 1,995


b Dependent Variable: LN_PERKS

R Square Tests

a. R Square Test for Free Cash Flows

Table 12

Model Summary

Change Statistics

R R SquareAdjusted

R Square

Std. Error

of the

Estimate

R Square

ChangeF Change df1 df2

Sig. F

Change

.415 .172 .1501.167884

8.172 7.784 4 150 .000





30/31




b. R Square Tests for Perks

Table 13

Model SummaryChange Statistics

R R SquareAdjusted

R Square

Std. Error

of the

Estimate

R Square

ChangeF Change df1 df2

Sig. F

Change

.201 .040 .020 .7026956 .040 1.951 4 185 .104



Statistical F-Testsa. Statistical F-Tests for Free Cash Flows

Table 14

ANOVA

Sum of

Squaresdf

Mean

SquareF Sig.

Regression 42.471 4 10.618 7.784 .000

Residual 204.593 150 1.364

Total 247.064 154



a. Statistical F-Tests for Perks

Table 15

ANOVA

Sum of

Squaresdf

Mean

SquareF Sig.

Regression 3.852 4 .963 1.951 .104

Residual 91.350 185 .494

Total 95.202 189





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Statistical T-Test

a. Statistical T-Test for Free Cash Flows Model

Table 16Coefficients

Unstandardized

Coefficients

Standardized

Coefficientst Sig.

95% Confidence

Interval for B

BStd.

ErrorBeta

Lower

Bound

Upper

Bound

(Constant) -2.062 .785 -2.626 .010 -3.614 -.511

LEVERAGE -1.761 .614 -.219 -2.870 .005 -2.974 -.548

LN_ASSET 2.450E-02 .059 .032 .414 .680 -.093 .142

TANGBLTY -.702 .181 -.295 -3.877 .000 -1.060 -.344

AGE 1.788E-02 .007 .188 2.501 .013 .004 .032

a Dependent Variable: LN_CF

b. Statistical T-Test for Perks Model

Table 17

Coefficients

Unstandardized

Coefficients

Standardized

Coefficientst Sig.

95% Confidence

Interval for B

BStd.

ErrorBeta

Lower

Bound

Upper

Bound

(Constant) -3.079 .436 -7.060 .000 -3.939 -2.218

LEVERAG

E-.437 .173 -.183 -2.521 .013 -.779 -.095

LN_ASSET 2.696E-02 .033 .062 .815 .416 -.038 .092

TANGBLT

Y-3.255E-02 .107 -.022 -.303 .762 -.244 .179

AGE 2.220E-03 .004 .044 .589 .557 -.005 .010

a Dependent Variable: LN_PERKS

Documents

Facm01-Bank Loan and the Agency Costs of Debt in Indonesia_