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International Journal of Information Technology and Business Management th

29 March 2013. Vol.11 No.1 © 2012 JITBM & ARF. All rights reserved

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THE INFLUENCE OF INSTITUTION ON STRATEGY AND ITS RELATIONSHIP WITH THE PERFORMANCE OF INDONESIAN STATE-OWNED ENTERPRISES Bambang Siswaji Students of Management and Business Doctoral Program, Bogor Agricultural Institute Nunung Nuryartono First Supervisor, Lecturer of Bogor Agricultural Institute Bustanul Arifin Second Supervisor, Lecturer of Bogor Agricultural Institute Muhammad Said Didu Third Supervisor, Lecturer of Bogor Agricultural Institute

ABSTRACT Institution influences strategy that leads to performance of enterprise. If the relationships hold for stateowned enterprise, the improvement of institutional environment will have the positive impact on the improvement of state-owned enterprise’s performance. The aim of this research is to investigate the causal relationship of institution-strategy and strategy-performance in state-owned enterprise environment, and to further elaborate the relationship to institution-performance of state-owned enterprise. Likert-scaled data have been collected from expert’s opinion survey. Structural equation modelling (SEM) analysis found: 1) institution significantly influences strategy; 2) strategy does not influence performance significantly; and 3) institution directly affects performance of state-owned enterprise. This research showed the importance of favorable institutional environment as prerequisite for improving state-owned enterprise’s performance. Keywords: state-owned enterprise, institution-based strategy, structural equation modelling

1.

INTRODUCTION

owned Enterprises had also been implementing right-sizing program, including consolidation and formation of Holding Companies for several SOEs alike.

The State-owned Enterprise (SOE) plays important roles in the Indonesian economy. Performance of SOE affects the growth of national economy (Yasin, 2012; Sugiharto, 2007). The SOE’s reformed program has so far been implemented through 3 steps (Nugroho and Siahaan, 2005:4), namely restructuring, profit-maximization and privatization. In order to improve the governance aspect of SOE, the Indonesian Government has enacted a law for State-owned Enterprises through Law Number 19, 2003, regarding State-owned Enterprises. As of 2012, the Ministry of State-

The performance of Indonesian SOEs in general shows positive trends, although in some aspects there are still rooms for improvement. The need for further improvement is validated by the presence of SOEs with negative profit. During the period of 2008 to 2011, there were 16 percent of SOEs that recorded losses in their financial statements. In 2011 alone, there were 23 SOEs at loss, 23 SOEs recorded accumulated losses and 24

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SOEs in despair (Antara, 29 March 2012). From 2007 to 2011, there were 50 SOEs that suffered financial loss, 45 of which are “Persero”, and this reflects 35.46% of total SOEs or 35.43% of total Persero SOEs.

is still relatively new (Hassard et al., 2007). This is unfortunate, since direct role of the institution that determines corporate strategic choices and performance has gaining popularity in the strategic management literature (Ingram & Silverman, 2002; Peng et al. 2009).

State-owned Enterprises with unsatisfactory performance are facing many obstacles, including: (1) Low capital which hardly support the company to achieve business economic scale and stable performance; (2) Management issues, both caused by (a) poor corporate governance, and/or (b) management team, especially in the aspect of strategic and managerial competencies or individual integrity; (3) competition dynamics which is poorly anticipated and responded; and (4) institutional factors that require further improvement. The last obstacles can be further described as the legal, polotical and social aspects that constrain the enterprise to pursue appropriate corporate strategies needed to achieve its goals.

The research question are: 1) whether institution influences SOE strategy and how? 2) whether strategy influences SOE performance and how? 3) whether institution influences SOE performance and how? The research is intended to investigate the causal relationship between institution variable and performance variable, strategy variable and performance variable, and institution variable and performance variable within SOEs, as shown in Figure 1. The research will be conducted with some limitations, namely: (a) only for SOE Persero; (b) the SOE strategy and performance will not be evaluated based on specific condition linked to SOE resources and capability, and industry competition where the SOE operates.

Based on literatures, the improvement of SOE’s performance can be achieved through 4 ways: (a) change of ownership (privatization); (b) reformed external business environment; (c) reformed SOE’s governance; and (d) reformed SOE’s internal affairs. Privatization is done by selling partial or total ownership of SOE to private sectors (Chang, 2007; Konings, et al. 2005; Kennedy and Jones, 2002). Reformed external business environment is achieved through stimulating competitive atmosphere and improving business environment (Chang, 2007; Konings, et al. 2005; Kennedy and Jones, 2002). Reformed SOE governance improves SOE management from government perspective as shareholder, followed by the implementation of hard-budget constraint and political and administrative reform (Chang, 2007; Kennedy and Jones, 2002; Li and Wu, 2002). Reformed SOE internal affair is done through SOE restructurization (Kennedy and Jones, 2002).

Figure 1 Research Framework

2.

THEORY

According to North (1991), institutions are the humanly devised constraints that structure political, economic and social interaction. They consist of both informal constraints (sanctions, taboos, customs, traditions, and codes of conduct), and formal rules (constitutions, laws, property rights). In short, institutions are reules of the game, while organization is player of the game (North, 1990; Peng, 2009). Institution defines sets of choices/opportunity and determine transaction and production costs, which in turn influence

Contrary to the shareholder and market competition approach, which had yielded many literatures, intuition-based management approach

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profitability and feasibility of involvement in the economic activity (North, 1991). Rationally, managers and the company would act on their interest and make strategic choices within formal and informal constrain in existing institution framework (Peng et al., 2009). Institution may determine opportunity, risk and associated costs related to strategic choices taken by the company (Zhu et al. 2011).

entrance strategy to developping country (Meyer et al. 2009), multinational corporation location selection (Damirbeg et al. 2010), and venture capital investment pattern (Fuller, 2010). Institutios also influence buyer-supplier relationship (Li et al. 2010), organization change strategy (O’Connor et al. 2006; Washington & Ventresca, 2004), and firm innovation (Zhu et al. 2011).

Strategy is flow of activities that are consistent and coherent conducted by the firm to achieve its goal (Burnes, 2004). Strategy determination is done by the management by considering internal condition such as company’s resources and capability (Barney et al. 2001); and company’s external condition (Pearce & Robinson, 2009; Johnson & Scholes, 2002; Porter, 1994) including institution condition (Peng et al. 2009; Ingram & Silverman, 2002). Company’s performance can be at maximum level if the strategy is in line with the task environment and institutional surrounding (Volberda et al. 2011). According to strategic choice concept (Child, 1997; Macmillan & Tampoe, 2000; Burnes, 2004), the strategy is a selection process to sets of alternatives or strategic option that is done in accordance with strategic intent and strategic assessment result.

Strategy is one of the most frequently discussed topic in literatures as a way to achieve organization objective (Porter, 1980, 1994; Barney, 1991; Barney et al. 2001; Peng et al., 2009). Research shows that strategy influences organization performance (Volberda et al. 2011; Brouther et al. 2007; Davies & Walters, 2004; Child et al. 2003; Heracleous, 2001a), including manufacturing comapny (Nandakumar et al. 2011). Strategy of relationship with stakeholder influences company performance (Tipuric & Lovrincevic, 2011). Non-market strategy also influences firm performance (He et al. 2007; Lux, 2008). Strategic content influences public organisation performance (Andrews et al. 2006; Boyne & Walker, 2004; 2010; Meier et al. 2007a, 2007b). Organisation performance is a result of strategy chosen by its management (Burnes, 2004; Macmillan & Tampoe, 2000; Child, 1997).

Performance is output or actual outcome of organization measured based on its goals and objectives (Richard, 2009). Organization performance can be measured by accounting based, market based, or hybrid measurment.

Relationship between institution and organization performance is implied by North (1990, 1991), Scott (2004), and Peng et al. (2009). A number of researchs show that organization performance is influenced by institution, including regulation and goverment policy (Rassier & Earnhart, 2010; Shariff et al. 2010; Hyder & Abraha, 2008; Berg et al. 2005; Heracleous, 2001a), regulation on product, financial and labor market (Chacar et al. 2010); goverment and political intervention (Agundu & Kiabel, 2010; Fuller, 2010), politician or poilitical control (Xu et al. 2005; Chang & Wong, 2004; Davies & Walters 2004), and political and social opennes (Dhanaraj & Beamish, 2009). Organization performance is also influenced by business institutional environment (Child et al.

Relationship between institution and firm strategy is rooted from institution theory (North 1990, 1991; Scott, 2004); Peng et al. 2009) and is stated by Ingram & Silverman (2002). Empirically, institutional factors signifinactly influence firm strategic choice (Farasahi & Hafsi, 2009; Roxas et al. 2008; Zhou, 2006; Zhou & Li, 2007; Peng, 2003; Heracleous, 2001a). Institution influences firm export behaviour (Gao et al. 2010), internationalisation strategy (Voss et al. 2011),

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2003), institutional sructure, management selection and incentive system (Aivazian, 2005); management compensation system (Pan et al. 2009), corporate governance (Filatotchev, 2005), control mode (Li et al. 2012), performance measurement system (Ittner et al. 2003); culture and financial institution (Hyder & Abraha, 2008), and also ethical culture (Tan, 2009). Institutional alignment, beside contingent alignment, also significantly influences firm performance (Volberda et al. 2011).

3.

state’s assets; 3) rules and procedures regarding financial and assest management, including its auditing and compliance; 4) rules regarding scope of business activities (market, product/services, price/tariff, business ventures) including auditing and compliance; 5) Status of Board of Commissioner, Directors and employees; 6) rules and norms/common practices in employee affairs settlements including auditing and its legal compliance; 7) political and/or related government agency interventions; 8) shareholder intervention, and strategic bureaucratic decision making; 9) procedures and selection practices of the management; 10) mechanism and practices of performance contract, compensation, reward/incentives and punishment, 11) support for GCG implementation; and 12) regulation and sectoral standard sufficiency, including supervision and compliance. The measurement for the institution variable uses method developed by Zhu et al. (2011) framework. Each institution indicator is valued based on its impact on change of opportunity, effectiveness, risk, and costs associated with activities done by the company.

METHODOLOGY

The research is constructed with quantitative approach using expert survey method. The expert’s judgment data will be examined to investigate the causal relationship among institution, strategy and performance variables of SOEs. 3.1. Variable Indicator and the Measurement Based on Law number 19/2003 regarding State-owned Enterprises (SOEs), SOE is business entity that is wholly or majority owned by the Government through direct capital insertion using specifically-allocated state’s capital. Persero SOE is a profit-motive limited liability SOE with at least 51% government share’s ownership.

The establishment of SOE strategy variable indicator follows Meier et al. (2007), and Andrew et al. (2006), whereby strategy consists of two elements, strategic stance and strategic actions. Strategic stance is categorized as Miles & Snow (1978) typology; strategic actions is formulized according to Porter (1994), combined with the strategic concept by Macmillan & Tampoe (2000), and performance improvement strategy by Pearce & Robbins (2008). In whole, strategy indicators are: 1) strategic stance as prospector; 2) strategic stance as analyzer; 3) strategic stance as defender; 4) strategic stance as reactor; 5) product/services change actions (launching/termination); 6) market change actions (entry/exit); 7) pricing change action (increase/decrease); 8) asset, technology, business portfolio change actions (add/reduce); 9) business venture change action (new venture/termination); 10) organization and employment change action (expansion/ streamlining); 11) business growth-related action;

SOE institution is defined in accordance with North (1990, 1991) as sets of rules, formal or informal, which constrain SOE activities in governing organizational components, interacting with other parties and achieving its business goals. SOE institution variable indicators is established based on textual analysis and in-depth interviews with SOE’s stakeholders regarding issues related to SOE institutional condition, and assessment on previous relevant researches. In this research, institution variable indicators consist of: 1) the company’s status as SOE, which frequently perceived as government agency; 2) SOE’s assets/wealth status that can be catogerized as

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12) business efficiency-related action. The measurement of strategy variables are done based on the company’s action frequency on related strategy indicators. This will ensure that only realized actions are taken into account (realized strategy), as implied by Heracleous (2001).

model specification to series of equation, which cover (a) equation for model measurement and (b) structural equation; (4) input matrix selection and estimation technique; (5) identification problem measurement; (6) goodness of fit criteria evaluation, which covers: (a) Chi-Square statistics 2 (χ ); (b) normed Chi-Square; (c) Root Mean Square Error of Approximation (RMSEA); (d) Goodness-ofFit index (GFI); and (e) Comparative Fit Index (CFI); (6) Model interpretation; and (7) hypothetical test, using prerequisite statistical measurement of critical ratio (CR) above 1.96 and probability (P) below 0.05.

The SOE performance is measured based on accounting-wise performance that represent the interest of the Government as shareholder (Le & Buck 2011). The selection of indicators is in line with the Ministry of SOE Regulation Number PER04/MBUMN/2011: 1) return on equity, calculated on ratio of earning to equity; 2) efficiency ratio, the ratio of operating expenses to operating income. Performance indicators of SOE are calculated by comparing them with private companies’ average performance during 2010-211 in similar sector.

4.

RESULTS

One hundred and forty eight responses were obtained from 200 questionaires distributed to sample respondents of predetermined SOE. From the collected responses, one hundred and forty responses were then analysed using SEM.

3.2. Data Collection and Analysis Data was collected using quesionaire instruments with five intervals Likert-scale model. The population in this research is group of experts with adequate knowledge about SOE institution, strategy and performance, including managers, directors, commissioners and SOE superintendents. Samples will be randomly selected using purposive sampling method. Sample of the research will be selected from predetermined Persero SOE, in order to obtain adequate representatives based on current SOE issues, which include: (a) as much as possible services sector (finance, non-finance, including infrastructure); (b) go-public SOE and non-public SOE; (c) SOE entitles for public service obligation from the government. As per Hair (in Wijanto, 2008), the minimum sample number for this research is 130 respondents.

Two-step approach was employed in this research model, as suggested by Wijanto (2008), the first step is measurement of model specification as Confirmatory Factor analysis (CFA) model, and the second step is adding structural model to CFA model to create hybrid model. Efforts on model adjustment were done to produce six models, and one model was selected with the best goodness of fit to the remaining models. The result of the whole model fitting is shown in Tabel 1 4.1. Measurement Model Analysis Measurement model is estimated using maximum likelihood (ML) method that creates institution latent variable with 12 observed indicators, strategy latent variable with nine observed indicators and performance latent variable with two observed indicators. The nine strategy variables were the end result from previously 12 indicators formulation, three were removed to obtain better validity, reliability and

Data was analysed using Structural Equation Modelling (SEM) method, complemented by validity test, reliability test and normality test. The sequence for SEM analysis will be as follow: (1) theoretical model development; (2) path diagram development for causal relationship; (3) converting

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goodness of fit. The validity test (based on t-table) and reliability test (based on construct reliability and variance extracted values) on this good measurement model are shown in Tabel 2 and Tabel 3.

other parties to achieved their goals; the same goes on up to ninth indicator, asset technology, and business portfolio change action. Three indicators previously nominated for the research were found to be invalid (have SLF < 0.5), they are strategic stance as reactor (in earlier model is stated as y4), pricing change action (in earlier model stated as y7); and action related to business efficiency (in earlier model stated as y12). The removal of these three indicators leads to improved reliability (VE value) of strategy latent variable (Y) and increases goodness of fit of measurement model. This indicates that SOE seldom implement strategy in the field of strategic intent as reactor, pricing change action and action related to business efficiency.

Validity indicator is determined not just based on t-value of loading factor, but also based on standardized loading factor (SLF), with critical value criteria of SLF bigger than 0.5 (Igbaria, et al. 1997 in Wijanto, 2008). The estimation result of standardized loading factor that shows the effect of each indicator on institution, strategy and performance latent variables of SOE can bee seen in Tabel 4, 5 and 6. Tabel 4 shows 12 institution latent variable indicators that have SLF above 0.5, indicating indicator validity. The highest SLF (0.88) is observed in x10, mechanism and practice of performance contract indicator. This means that mechanism and practice of performance contract has significant influence on institution latent variable. The next highest SLF, 0.86, is observed in x7 variable, which means that politics/government agency intervention is also significantly affecting institution latent variable; and so on. On the other hand, the lowest SLF, 0.64, is observed in x5 indicator, the status of board of commissioner, directors and employee, which means that this indicator has little effect on instituton latent variable.

Low SLF value on strategic action related to business efficiency indicator can be linked to high SLF value on business development action indicator; showing that the company tends to put development ahead and avoid efficiency strategy. Development strategy is measured by the frequency of SOEs to: 1) launch new product/services; 2) entering new market; 3) asset, technology, and business line acquisition or new subsidiary establishment; and 4) recruiting new employee and organization expansion; while efficiency strategy is measured from the frequency of SOEs in taking actions opposite those included in the previous development strategy.

Table 5 shows nine strategy latent variable indicators that have SLF above 0.5, which suggests valid indicators. The highest SLF, 0.98, is observed in y9 indicator (in earlier model is stated as y11), action on business development. This suggests action on business development indicator significantly influence strategy variable, in other words, business development strategy is the most frequent strategy used by SOE. The next highest SLF, 0.78, is observed in y3 (in earlier model is stated as y3) and y7 (in earlier model is stated as y9), which indicate that many SOEs employ defender as strategy, and have ventured with

Low SLF value on strtegic action related to business efficiency indicator can also be linked to low SLF on pricing change action, which is measured by the frequency of SOE in decreasing/increasing price or setting price below/above competitors. This is because the action of decreasing price and setting price below the competitors require efficient company’s operation, which is resulted from efficiency strategy (cost leadership). Tabel 6 shows that ROE and OEOI (ratio of Operating Expenses to Operating Income) are valid

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performance variable indicators. ROE and OEOI indicators have strong influence on performance, and with a mere 0.02 difference in value, ROE is found to have a slightly more influence.

The research result that shows the effect of institution on strategy is in line with the theory (Peng, et al. 2009); nevertheless, this research had enriched the existing theory by establishing direct relationship between institutuion and performance of SOE. On the other hand, research result showing that strategy variable does not significantly affect performance is not in line with the existing theory. This happens since the research uses cross-section data, and hence becomes less sensitive to measure performance change phenomena across the time that is caused by the strategy implemented by the SOE.

4.2. Structural Model Analysis On the second stage of data analysis, structural model analysis was done on three latent variables, institution (I), strategy (S) and performance (K). The relationship among these three variables can be seen in Picture 2. The above picture shows that t-value is bigger than 1.96, showing that institution significantly affects strategy (SLF is 0.55) and performance (SLF 0.89); while strategy does not significantly affect performance based on its t-value that is lower than 1.96. The structural equation model is as follow: S = 0.55 I + ε; P = - 0.02 S + 0.89 I + ε; P = 0.87 I + ε; where is: S = Strategy I = Institution P = Performance

The above equation also shows that institution explains 30% variance of strategy, which 2 is indicated by coefficient of determination (R = 0.3); the rest (70%) is explained by other variables (Error). The reduced form equation shows that institution explains 76% variance from 2 performance (R = 0.76); the rest (24%) is explained by variables outside the model (Error). This result shows the significance influence of institution on performance of SOE.

2

Error = 070; R = 0,3. 2 Error = 0,24; R = 0,76. 2 Error = 0,24; R = 0,76.

5.

Conclusion

The research result shows that institution variable significantly influences SOE’s strategy; institution variable also directly influences SOE’s performance; on the other hand, strategy variable does not have significant influence on SOE’s performance. The research also confirms twelve SOE’s institution indicators, nine strategy indicators and two performance indicators that were previously formulated in early stage of the research. Three strategy indicators were not confirmed, they are strategic stance as reactor, pricing change action and action related to business efficiency. The failure to confirm these three indicators shows that SOE does not implement strategic stance as reactor, pricing change action and action related to business efficiency, and this is caused by the current

Figure 2 Structural model: SLF value (above) and t-value (below).

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condition that does not support these three actions.

influence, and to neutralize its negative effect on performance. The result also shows the need for further research with approach that takes into account the change in SOE performance across the period (longitudinal) in order to accurately evaluate the impact of strategy on the SOE performance.

The policy implication emerges from this research is the need for institutional condition improvement in order to increase SOE performance. On managerial level, SOE’s management needs to improve its governance and strategy to benefit from positive institution

6.

Tables Table 1 Parameters and the whole model goodness of fit Criteria* Estimation Small values P≥0,05 0,00000 Lower cap (1) – 1,74 Upper cap (3) SNCP The smaller the better 0,61 RMSEA RMSEA ≤ 0,08 0,066 NFI NFI ≥ 0,90 0,96 NNFI NNFI ≥ 0,90 0,98 CFI CFI ≥ 0,90 0,98 IFI IFI ≥ 0,90 0,98 RFI RFI > 0,90 0,94 GFI GFI ≥ 0,90 0,84 RMR RMR < 0,05 0,015 *Parameters and criteria according to Wijanto (2008). Parameters* Chi-Square P Normed chi-square

-

Indicator variabel Institution: x1 x2 x3 x4 x5 x6 x7 x8 x9 x10 x11 x12

t-value 11.07 11.55 10.11 12.40 8.36 12.35 12.93 11.54 11.12 13.13 11.70 12.83

Table 2 Measurement model validity + Validity Indicator (t-value > 1,96) variabel Strategy: Good y1 Good y2 Good y3 Good y4 Good y5 Good y6 Good y7 Good y8 Good y9 Good Performance: Good z1 Good z2

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Fitting Level Marginal fit Good fit Good fit Good fit Good fit Good fit Good fit Good fit Good fit Marginal fit Good fit

+

t-value

Validity (t-value > 1,96)

*** 6.91 6.74 9.06 7.20 7.12 8.24 5.81 8.69

Good Good Good Good Good Good Good Good Good

*** 10.96

Good Good



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Validity criteria based on Ridgon and Ferguson in Wijanto (2008).

Variabel Institution Strategy Performance

Indicator x10 x7 x12 x4 x6 x2 x11 x8 x1 x9 x3 x5

Indicator y9 (y11) y3 (y3) y7 (y9) y2 (y2) y1 (y1) y4 (y5) y8 (y10) y5 (y6) y6 (y8)

Indicator z1 z2

Table 3 Measurement model reliability Reliability criteria CR ≥ 0.7 VE ≥ 0.50 0,96 ≥ 0.7 0.65 > 0.50 0.89 ≥ 0.7 0.50 > 0.50 0.82 ≥ 0.7 0.70 > 0.50

Reliability Good Good Good

Table 4 Standardized loading factor (SLF) of institution indicator Institution indicators description Mechanism and practice of performance contract Politics/government agency intervention Regulation and sectoral standardization sufficiency Regulation on business scope/activity Regulation and norm/common practices on internal dispute settlement Asset/wealth status as state’s wealth Support on GCG implementation Shareholder and bureaucratic decision making intervention Company’s status as SOE Procedures and practices for directors commissioner selection Rules and procedures on financial management Status on Board of Commissioner, Directors and employees

Table 5 Standardized loading factors (SLF) values for strategy indicators Strategy indicators description Business expansion action Strategic stance asi defender Business venture change action Strategic stance as analyzer Strategic chance as prospector Product/services change action Organization and employment change action Market change action Asset, technology and business portfolio change action

Table 6 Standardized loading factor value on performance indicator Performance indicator description Return on earning (ROE, ratio of earning to equity) Efficiency (OEOI, ratio of operating expenses to operating income)

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SLF values 0,88 0,86 0.86 0,84 0,84 0,81 0,81 0,80 0.79 0,78 0,74 0.64

SLF Values 0.98 0.78 0.78 0.71 0.61 0.61 0.54 0.51 0.51

SLF values 0.80 0.78



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