indonesia interlocking directorship and vertical integration and conglomeration date: 20 august 2014...

INDONESIAInterlocking DIRECTORSHIP

and Vertical INTEGRATION and CONGLOMERATION

Date: 20 August 2014By: HMBC RIKRIK RIZKIYANA

Definitions …of conglomeration, vertical integration, and

interlocking directorate according to Indonesian Competition Law and other international institutions

UNCTAD

concentration of economic power that occurs through mergers, takeovers, joint venture and other acquisitions of control, such as interlocking directorates, which involving different kinds of business activities.

OECD

a firm or business enterprise having different economic activities in different unrelated industries. Conglomerate firms may emerge through mergers and acquisitions and/or investments across a diverse range of industries for a variety of reasons such as minimization of risk, increased access to financial and management resources, and more efficient allocation of resources.

CONGLOMERATION definition

OECDthe ownership or control by a firm of different stages of the production process. Vertical integration may be achieved through new investment and/or vertical mergers and acquisition of existing firms at different stages of production. An important motive for vertical integration is efficiencies and minimization of transaction costs.

ICLAn agreement between or among undertakings to control chain of production process of certain products or services of which each stage is the result of added value of further process, being it under a direct or indirect chain.

Vertical INTEGRATION meaning

OECD

The same person sits on the board of directors of two or more companies.

ICL

A person who serves as the director or commissioner of a company that is concurrently being the director or commissioner at other enterprises.

Interlocking DIRECTORATE definition

Purposes…of business and ICL..

Where do they intersect?

UNCTADTo control or eliminate restrictive agreements or arrangements among enterprises, or mergers and acquisitions or abuse of dominant positions of market power, which limit access to markets or otherwise unduly restrain competition, adversely affecting domestic or international trade or economic development.

ICL• To maintain public interest and increase national economic efficiency as one

of the methods to increase the people’s welfare; • to establish the conducive business environment by regulating fair

competition in order to guarantee equal opportunity to do business between small scale, medium scale and large scale businesses can be guaranteed;

• to prevent monopolistic practices and unfair competition as results of undertaking’s conducts, and

• to achieve effectiveness and efficiency in doing business.

Purposes of COMPETITION law

Theory of the firm:

The rational undertakings try maximizing profit.

Profit = Total Revenue – Total Cost

If cost is reducted by not sacrificing anything on product quality and quantity, ceteris paribus, thus higher profit can be achieved mainly through efficiency and effectiveness.

Purposes of BUSINESS

Business AND competition law

EFFICIENCY

EFFECTIVENESS

BUSINESS:-Lower cost-Better performance-Product innovation

FAIR COMPETITION:-Lower price to consumers-Better services-Better quality and more options

Regulations…as stipulated by Indonesian Competition Law

Relevant LEGISLATIONS in Indonesia

Law No. 5 of 1999 (Indonesian Competition Law/”ICL”):

• Article 14 regarding Vertical Integration and KPPU Regulation No. 5 of 2010 Article 14 regarding Vertical Integration and KPPU Regulation No. 5 of 2010 regarding Article 14 Guideline on Vertical Integration (Vertical Integration Guideline)regarding Article 14 Guideline on Vertical Integration (Vertical Integration Guideline)

• UUnder Chapter III of prohibited agreementsnder Chapter III of prohibited agreements

Article 14:Article 14:Undertakings are prohibited from making and entering into any agreement with other undertakings with the intention to control production of some products belonging to a chain of certain goods and/or services production in which each chain of production is a result of the manufacturing or continued process, either in direct or indirect chain, which can result in unfair business competition and/or damages to the public.

Relevant LEGISLATIONS in Indonesia (cont’d)

Law No. 5 of 1999 (Indonesian Competition Law/”ICL”):

• Article 26 regarding Interlocking Directorate and the Guidelines and KPPU Article 26 regarding Interlocking Directorate and the Guidelines and KPPU Regulation No. 7 of 2009 regarding Article 26 Guideline on Interlocking Directorate Regulation No. 7 of 2009 regarding Article 26 Guideline on Interlocking Directorate (Interlocking Directorate Guideline)(Interlocking Directorate Guideline);;

• Under Chapter of Under Chapter of ““Dominant PositionDominant Position””..

Article 26:Article 26:A person who serves as the director or commissioner of a company is prohibited from concurrently being the director or commissioner at other enterprises, if the said enterprises:

a. are in the same relevant market; or b. are closely related to the field and/or type of business; or c. can jointly control the market share of certain goods and/or services (“in dominant

position”), which could cause monopolistic practices and/or unfair business competition.

Article 14 of ICL

Vertical integration occurs when•several supporting businesses ‘going up the line of production’ support each other to produce a final, consumable product.

Pro-competitive impact of Vertical Integration:•increased efficiency via the technical efficiency, the transaction cost and the elimination of double marginalization; •the sustainability of the raw material supply and access to consumers.

Anti-competitive impact of Vertical Integration:•the access foreclosure in upstream or downstream market, facilitated price or output coordination as part of collusion effort in the relevant upstream/downstream market.

Article 26 of ICL

Arcticle 26Arcticle 26

ICL prohibits a person to hold a position as Director and/or Commissioner in two or more companies if the companies conduct business in the same relevant market, have close connection in the field or type of business, and can jointly control the specific goods or services, which may lead to monopolistic practice and unfair business competition.

Interlocking Directorate will potentially impede competition when involving undertakings having dominant position in their market share combination. In that regards, then interlocking directorate wil also impede competition once followed by abusive conduct from the dominant position.

Rationales…of undertaking performing interlocking directorates.

COMPANY’s perspectives

Interlocking directorate in a vertical integration is important for conglomerate companies.Interlocking directorate in a vertical integration is important for conglomerate companies.

A good corporate governance is required to maximize the benefit of interlocking A good corporate governance is required to maximize the benefit of interlocking directorate with a vertical integration, which leads to a strong and competitive directorate with a vertical integration, which leads to a strong and competitive conglomerate companies.conglomerate companies.

The importance of interlocking directorate in vertically integrated undertakings

BackgroundBackground

A defining characteristic of the current business environment is its dynamism. A defining characteristic of the current business environment is its dynamism. Uncertainty and interdependence pose serious challenges to management theory and Uncertainty and interdependence pose serious challenges to management theory and practice. Vertical integration and interlocking directorate are ways of dealing with practice. Vertical integration and interlocking directorate are ways of dealing with uncertainty and interdependence (Morgan, 1980).uncertainty and interdependence (Morgan, 1980).

Board interlocks can be used to cope with increasing levels of environmental Board interlocks can be used to cope with increasing levels of environmental uncertainty and particular types of resource dependencies (Lang and Lockhart, 1990). uncertainty and particular types of resource dependencies (Lang and Lockhart, 1990). They can also be used as control and co-ordination devices in the context of interThey can also be used as control and co-ordination devices in the context of inter--organiorganizzational networks (Maman, 1999)ational networks (Maman, 1999)..

Coordination

Coordination is required to achieve the missions and visions of the whole conglomerate Coordination is required to achieve the missions and visions of the whole conglomerate companies; the parent company and its subsidiaries. So are the coherent business companies; the parent company and its subsidiaries. So are the coherent business decisions and strategies among companies achieved through proper coordination.decisions and strategies among companies achieved through proper coordination.

AA network is created when network is created when directorsdirectors are elected to the boards of directors of other firms, are elected to the boards of directors of other firms, thus forming an interlock (Carpenter and Westphal 2001, Mizruchi 1996).thus forming an interlock (Carpenter and Westphal 2001, Mizruchi 1996). Directors may be Directors may be better able to make such decisions by relying on their social networks. Positive and better able to make such decisions by relying on their social networks. Positive and negative experiences from other firms can be used as indicators of the opportunities and negative experiences from other firms can be used as indicators of the opportunities and risks that are associated with strategic decisions. Directors may form a useful social risks that are associated with strategic decisions. Directors may form a useful social network for corporate decision makers because of their intimate knowledge of top-level network for corporate decision makers because of their intimate knowledge of top-level issues and their similar levels of discretion in decision making.issues and their similar levels of discretion in decision making.

Supply CHAIN

As stated before, by forming an interlocking directorate, conglomerate companies can As stated before, by forming an interlocking directorate, conglomerate companies can deal deal withwith the the increasing levels of environmental uncertainty and particular types of increasing levels of environmental uncertainty and particular types of resource dependenciesresource dependencies. In fact, the prime objective of conglomerate companies is to . In fact, the prime objective of conglomerate companies is to ensure the company’s supply chain and production continuity. ensure the company’s supply chain and production continuity.

EXAMPLE: CINEPLEX CASE (KPPU’S DECREE NO. 05/KPPU-L/2002)

Harris Lasmana and Suryo Suherman formed an interlocking directorate in strategic posts Harris Lasmana and Suryo Suherman formed an interlocking directorate in strategic posts in some film importer companies and or cinema companies that potentially cause a in some film importer companies and or cinema companies that potentially cause a monopolistic practice and unfair competition, according to ICL. However, until the end of monopolistic practice and unfair competition, according to ICL. However, until the end of investigation held by the Commission, the evidence of the abuse and disadvantage of investigation held by the Commission, the evidence of the abuse and disadvantage of interlocking directorate for fair competition is remain unfound. Thus, the Commission interlocking directorate for fair competition is remain unfound. Thus, the Commission determined that the interlocking directorate performed by Harris Lasmana and Suryo determined that the interlocking directorate performed by Harris Lasmana and Suryo Suherman did not cause monopolistic practice and unfair competition and therefore they Suherman did not cause monopolistic practice and unfair competition and therefore they did not violate Article 26 of ICL.did not violate Article 26 of ICL.

This case also shows us that (vertically) integrated companies, in this case are between This case also shows us that (vertically) integrated companies, in this case are between Swe Zhe Cinema and PT Swe Zhe Film (film importer company), is intentionally to fulfill the Swe Zhe Cinema and PT Swe Zhe Film (film importer company), is intentionally to fulfill the film supply that will be aired in Swe Zhe Cinema. These integrated companies were simply film supply that will be aired in Swe Zhe Cinema. These integrated companies were simply apply a business strategy to obtain an independent resource to reduce uncertainty of apply a business strategy to obtain an independent resource to reduce uncertainty of supply source, and that business strategy is performed by not harming the fair competition supply source, and that business strategy is performed by not harming the fair competition while it increases its efficiency. With a subsidiary company that ensure supply chain of its while it increases its efficiency. With a subsidiary company that ensure supply chain of its mother company, in the end the whole companies will achieve a sustainable growth.mother company, in the end the whole companies will achieve a sustainable growth.

Impact…of interlocking directorate in vertically integrated

undertakings

• Interlocking directorate and vertical integration will constitute an Single Economic Entity.

• Single Economic Entity Doctrine sees the relationship between Parent Company and its subsidiaries where the subsidiaries do not have independence to take its own decision as a single economic entity.

• KPPU advanced a single economic entity theory that would classify all foreign parties affiliated with Indonesian parties as undertakings, thus appearing to reduce the scope of this prohibition.

Definition of SINGLE ECONOMIC ENTITY

• Interlocking directorate and vertical integration among the undertakings will not raise the issue of cartel since it will constitute a single economic entity.

Competition Impacts

• Rather, Interlocking directorate and vertical integration among the undertakings of the same conglomerate parent company will impede competition when it is followed by abuse of dominant position in the form of exploitative and exclusionary conducts such as:• Discrimination;• Predatory behavior (price or non price)• Exclusive dealing;• Tying in / bundling; and• Boycott or Refusal to deal.

The ICL does not specify that its prohibitions are applicable to foreign entities. Rather, the KPPU developed the single economic entity doctrine to extend the law’s reach to foreign entities. This doctrine was first used in the Temasek case (2007), where Temasek, a Singapore holding company holding both directly and indirectly shares in two Indonesian mobile phone operators. The ICL prohibits cross-shareholding that creates monopolistic practices or unfair business competition. The question was whether Temasek, as a foreign entity, is subject to the cross-shareholding prohibition. KPPU held that Temasek constituted a single economic entity with two Indonesian companies because Temasek was allegedly:

•involved in the management of these companies •authorized to appoint directors or commissioners; and •authorized to have access to confidential information.

Therefore, the KPPU held that Temasek is liable to administrative sanction even though it is a foreign entity that does not operate in Indonesia.

PRECEDENTS of KPPU cases

In the Astro case (2008), KPPU held that Astro (a group of Malaysian companies) was subject to the ICL because it formed a single economic entity with PT. Direct Vision (an Indonesian pay-TV operator) because Astro:

•was in the process of investing in PT. Direct Vision •already had the authority to appoint directors of PT. Direct Vision; and •had licensed its brand name, IT services, and certain TV content to be used by PT. Direct Vision

PRECEDENTS of KPPU cases … (cont’d)

NEGATIVE impacts

Interlocking Directorate with Vertical Integration might give negative impact to conglomerates.

The development of private business during 1999 crisis, was marred by all kinds of inefficient government policies that caused market distortion. Meanwhile, the development of private business in reality occurred mostly due to the condition of unfair business competition. The above phenomena was developed by a close relationship between the decision makers and undertakings. Furthermore, these undertakings acquired excessive facilities that created a social gap. The emergence of conglomerate and a small group of strong undertakings without being supported by a spirit of true entrepreneurship was one of the factors that caused the economic stamina to become very fragile and unable to compete. Thus, the good corporate governance is the important key to achieve maximum benefit of interlocking directorate with vertical integration.

Action log…that undertakings should consider

Recommendation

As long as not followed by abuse of dominant position, interlocking As long as not followed by abuse of dominant position, interlocking directorate as well as vertical integration will not violating ICL. directorate as well as vertical integration will not violating ICL.

It is suggestedIt is suggested that the strategic role of directors, and especially interlocking that the strategic role of directors, and especially interlocking directors, would be more effectively fulfilled if directors consciously create and exploit directors, would be more effectively fulfilled if directors consciously create and exploit interlocks to ensure that networks deliver the highest possible strategic benefits to interlocks to ensure that networks deliver the highest possible strategic benefits to the firms and their partners. If (interlocking) directors carry out their informating roles the firms and their partners. If (interlocking) directors carry out their informating roles effectively, organizational efficiency will be increased due to higher timeliness, effectively, organizational efficiency will be increased due to higher timeliness, accuracy and use of relevant environmental informationaccuracy and use of relevant environmental information. Thus, in the end, the benefit . Thus, in the end, the benefit of interlocking directorate with vertical integration will significantly occurs to the whole of interlocking directorate with vertical integration will significantly occurs to the whole companies without violating the ICL. companies without violating the ICL.

According to ICL, Vertical Integration Guidelines, and UNCTAD, vertical integration is not prohibited, it even can be pro-competition provided that:1.There is always access for undertakings in affected upstream or downstream market (no foreclosure to essential facility or to main buyer); 2.There is no intention to coordinate collusion by, among others, controlling production/price/capacity/quality of certain product or services.

In such regard, it is important for conglomerate undertaking to have the internal alarm on the size of pie possessed by the subsidiaries, in any industries:•Too big Market Share beware for not abusing dominance over the supplying or distributing undertakings that are head to head competing with the subsidiaries!

•Mediocre market share in concentrated market beware in participating in any associations participated by the parent and subsidiaries.

Recommendation (cont’d)

indonesia interlocking directorship and vertical integration and conglomeration date: 20 august 2014...

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