The Abolition of Independent Directors in Indonesia: Rationally Autochthonous or Foolishly Idiosyncratic?

The independent director is the paradigmatic example of Anglo-America’s influence over global corporate governance. The concept of the independent director was created in the United States in the 1970s and quickly became a defining feature of American corporate governance.  In the 1990s, the United Kingdom made America’s concept of independent directors a hallmark of its inaugural code of corporate governance. Over the next decade, UK-style corporate governance codes, with independent directors at their core, proliferated around the world.  By the 2000s, the global ubiquity of independent directors transformed them into a universal litmus test for ‘good’ corporate governance. Following the 2008 Global Financial Crisis, some countries questioned the extent to which independent directors should be relied on to promote good corporate governance. However, despite some rethinking of their role and ambiguous empirical evidence of their effectiveness, today’s conventional wisdom suggests that no credible system of corporate governance can exist without independent directors. 

At first glance, Asia exemplifies the global adoption of the Anglo-American idea that independent directors are required for ‘good’ corporate governance. Prior to the 1997 Asian Financial Crisis, boards in Asia were dominated by corporate insiders, with independent directors being either non-existent or playing a marginal role on boards throughout Asia.  Legal reforms following the Asian Financial Crisis resulted in ‘many of the laws and regulations in Asia’s leading economies [appearing] to do more to promote or require ‘independent directors’ on the boards of listed companies than those in many leading Western economies’.  The past decade has even seen Japan and Taiwan, which traditionally have championed insider dominated boards, reform their laws to make independent directors mandatory in their listed companies.  As one of us concluded in a book on ‘Independent Directors in Asia’ published in 2017, ’it is now indisputable that the ‘independent director’ is a ubiquitous feature of corporate governance throughout Asia – and its rise appears to have no immediate end in sight’’. 

Then, in 2018, Indonesia did what most in the global corporate governance community would see as unthinkable: abolish the requirement (or even suggestion) for boards of listed companies to have independent directors – the culmination of a movement that began in 2006 resulting in the elimination of a feature of Indonesian corporate governance that existed for over a decade.  Despite Indonesia having the world’s fourth largest population, seventh largest economy (GDP PPP), and being on a trajectory of high economic growth, this surprising corporate governance development has received scant attention from comparative corporate law scholars.  To the best of our knowledge, there has been no in-depth analysis, either within Indonesia or internationally, of Indonesia’s abolition of the requirement for independent directors to be on the boards of its listed companies.

In our recent ECGI Working Paper we aim to fill this gap in the literature by undertaking a quantitative and qualitative analysis of this significant development in Indonesian corporate governance. Our empirical analysis of the annual reports of Indonesia’s 20 most valuable public companies reveals that in the year following the abolition of the requirement for independent directors, 81% of the companies that previously reported having independent directors had none.  By 2023, there was not a single independent director in any of Indonesia’s 20 largest listed companies – a fact that, to the best of our knowledge, was unknown prior to our research. This watershed development raises three questions which our Working Paper seeks to answer. 

First, despite conventional wisdom that independent directors are required for good corporate governance, why did Indonesia abolish its requirement for independent directors in its listed companies? It appears that the requirement for independent directors was abolished because it was seen as functionally redundant in the context of Indonesia’s ostensibly ‘two-tier board’ system – in which a supervisory board – called ‘the board of commissioners’ – was viewed as fulfilling the role of independent directors. Relatedly, the original implementation of the American concept of the independent director was done under extreme economic pressure from the International Monetary Fund (IMF), which was seen as an afront to Indonesia’s civil law ‘two-tier board’ tradition and its national sovereignty. Regardless of the rationale, this reform has made independent commissioners on the board of commissioners (rather than independent directors on the board of directors) the focal point for good corporate governance in Indonesia. 

Second, given that independent commissioners have become the focal point for good corporate governance in Indonesia, what impact is this likely to have on Indonesian corporate governance? To answer this question, we conducted semi-structured interviews with ten independent commissioners in several of Indonesia’s large and midsize listed companies involved in various industries.  Based on these interviews and an analysis of the corporate law, it appears that independent commissioners provide only a partial substitute for independent directors in promoting good corporate governance in listed companies in Indonesia. In addition, evidence based on these interviews suggests that the ability of independent commissioners to promote good corporate governance may be compromised by controlling shareholders’ influence, their limited legal authority, and potential pressure placed upon them from corrupt government practices. Moreover, it appears that there may be a risk of the independence of ‘independent’ commissioners being compromised by political interests – especially in Indonesia’s powerful state-owned enterprises. Ultimately, we conclude that Indonesia’s reliance on independent commissioners – rather than independent directors – may have some tenuous theoretical validity based on its ostensibly ‘two-tier board’ system; but even this rationale suffers from the fact that its so-called ‘two-tier board’ may not even qualify as a ‘two-tier board’ when viewed through a comparative lens. Given this legal impediment and the practical risks we have highlighted above, reforms to Indonesia’s independent commissioner system are required to ensure that independent commissioners in practice can fulfil the heavy responsibility that has been placed upon them.

Third, given Indonesia’s substantial reliance on independent commissioners and the weaknesses that exist in its current regulatory framework and controlling shareholder dominated  corporate governance context, what reforms could be made to ensure that independent commissioners provide an effective tool to address Indonesia’s corporate governance challenges? Based on our analysis, we suggest bespoke reforms to improve the effectiveness of Indonesia’s independent commissioner system that take account of Indonesia’s level of development, its concentrated shareholder landscape, the dominance of its state-controlled and family-controlled listed companies, and its ongoing battle with endemic corruption. These suggested reforms, which are another significant contribution of our research, aim to transform Indonesia’s current system of independent commissioners into an autochthonous corporate governance mechanism that ‘fits’ Indonesia’s local context and quells the corporate governance maladies that may jeopardize Indonesia achieving its enormous potential.

We conclude our Working Paper by illuminating what Indonesia’s idiosyncratic abolition of its requirement for independent directors may suggest about the global evolution of corporate law. The original transplant of Anglo-American-cum-global independent directors into Indonesia’s civil law, ‘two-tier’, corporate board system over a decade ago was unsurprising. It was part of a global trend, which was accentuated in Asia, of ‘legal misfits’ being imported into systems of corporate governance to demonstrate adherence to Anglo-American-cum-global norms of ‘good’ corporate governance.  However, as regionalization replaces globalization and Asia’s economic prowess continues to rise, green shoots of autochthonous solutions to corporate governance maladies have recently been sprouting across Asia.  In this new era of more bespoke local corporate governance solutions, Indonesia’s previously unthinkable break with a hallmark of Anglo-American-cum-global ‘good’ corporate governance – the independent director – perhaps portends the ‘new normal’ in what may be a more regional and autochthonous future for corporate governance globally.

The authors’ full article can be accessed here.

Royhan Akbar is Lecturer and Researcher at University Gadjah Mada Faculty of Law.

Nathaniel Mangunsong is a Doctoral Student at Universitas Indonesia Faculty of Law.

Dan W. Puchniak is Professor of Law at Singapore Management University Yong Pung How School of Law.