Transaction costs and corporate governance of sugar mills in Indonesia

Abstract

The sugar industry remains a priority for development in the Indonesian agricultural sector, especially in East Java. However, the performance of the sugar industry in East Java during the two last decades has declined, which is shown in the decreasing volume of production. This study utilized the analysis of transaction cost economics to identify the problems of the sugar mills in East Java - Indonesia. This research compares the transaction costs between state-owned (Ngadiredjo) and privately-owned (Kebon Agung) sugar mills. The study shows that in Kebon Agung Sugar Mill transaction costs are higher than production costs, while in Ngadiredjo Sugar Mill the reverse is true. However, the high transaction costs in Kebon Agung Sugar Mill cannot be attributed directly to inefficient institutions, because Ngadiredjo Sugar Mill incurred high costs for plants, land preparation, and fertilizer, which decreased the proportion of transaction costs. If analyzed in detail, the following facts are revealed: (i) market transaction costs in Kebon Agung Sugar Mill are higher than in Ngadiredjo Sugar Mill. This is because Kebon Agung Sugar Mill has established cooperation with sugarcane farmers in the form of extensions and transport subsidies; and (ii) the political transaction costs proportion in Ngadiredjo Sugar Mill is higher than in Kebon Agung Sugar Mill because of the imposition of many 'illegal' fees. There should be management (corporate) reform of sugar mills, both internal and external. Internally, sugar mill management must apply good corporate governance that guarantees the transparency and control of every activity. Nowadays, there is no controlling unit in sugar mill management that supervises corporate activity, so that it is susceptible to manipulation and mark-up. Externally, the relationship between sugar mill management (CEO) and the Board of Directors should be reformulated so that sugar mill management has wide authority to make corporate strategy decisions. Centralization of authority in holding firm (PTPN/PT. RNI) has caused high transaction costs as a result of the long hierarchy in decision-making.