Ethical Commitment Index, Corporate Governance and Financial Performance

in Listed Company Indonesia.

Medina Amanda S.Mn, QWP.

Institut Teknologi Bandung

School of Business and Management, Institut Teknologi Bandung, Jl. Ganesha No. 10

Bandung, 40132.

medinamndaa@gmail.com

Yunieta Anny NainggolanPh.D.

Institut Teknologi Bandung

School of Business and Management, Institut Teknologi Bandung, Jl. Ganesha No. 10

Bandung, 40132.

yunieta@sbm-itb.ac.id

ABSTRACT

Recently, Corporate Governance (CG) and Business Ethics become a major

consideration in corporate strategies, especially in emerging market where the

application of both issues are not executed well (Peters, Miller, & Kusyk, 2011).

Indonesia as emerging market has experienced both issues seen from lowest ranking

in CG Quality ASEAN and dropped two ranked 90 th in Free Corruption Country

regarding ethics. By entering the globalization era with borderless business activities,

Indonesian companies face more milestones in theglobal marketplace. This era is in

line with the advancement to both issues since the application of these two will lead

companies to the financial performances dipped, revenue losses, bad reputation, and

even bankruptcy (Mascarenhas, 2015). Furthermore, in investment strategies, a

variety of investors would consider those factors in making a decision. In fact, the

prior studies regarding ethical commitment index have never been conducted in

Indonesia. This research examines the relationship of corporate governance, ethical

commitment index and company financial performance in listed company in

Indonesia. Ethical commitment index will be used to measure business ethics, while

corporate governance is going to be assessed from local, foreign, managerial

ownership, board size, independent managerial, and audit committee. In generating

the result, the execution of multi-linear regression is conducted. This research finds

that ethical commitment index has no relation toward financial performance. While

the increasing of manager ownership concentration and concentration of audit

committee will decrease a financial performance in Indonesia. Moreover, the higher

managerial ownership tends to have a less concern of ethics in a company. This

research suggests the company to pay more to their ownership structure and

effectiveness of audit committee besides support government intention to enhance

those issues. Besides, the managerial ownership and audit committee of a company

can be a consideration for aninvestorbefore making an investment decision.

Keywords: corporate governance, ethics, ethical commitment index, financial

performance.ownership concentration, board size, independent managerial, and

audit committee.

INTRODUCTION

Understanding factors that affect financial performance are one of the goals in

corporate management. Knowing those factors, the company expects to achieve good

financial performance and minimize the risks that will affect financial performance in

the future. For few decades, corporate governance and ethics become an issue that

noticed by the company. With good corporate governance and ethics application, it is

expected thecompany will gain trust both from investor and consumer.

Entering globalization era, theborderless area makes companies face more risks,

challenges, and competitions in global market place. This era also increases the

importance of corporate governance because it will help companies to minimize the

risk in liberalization and walk on the right path. Additionally, corporate governance

becomes more important due to the increase of corporate failure caused by bad

governance application. It can be seen from the collapse of Barings Empire, Daiwa

Bank debacle, and Maxwell Affair. One of the main reasons for their collapse is the

lack of corporate governance (Shahid, 2001). Bad corporate governance is also

related to bad ethics. For instance, one of the biggest companies’ bankruptcy in the

United States, Enron in 2001. They are proven to be doing collusion, corruption,

nepotism and also their manager was arrested (Smith, 2004). This shows that bad

ethics and corporate governance will lead companies to company performances

dipped.

Researchers have started to study the relationship of corporate governance and ethics

to corporate financial performance, especially in developed countries such as the US,

Spain, and South Korea. The result shows different findings, especially in emerging

market where the applications of corporate governance were not executed well

(Peters, Miller, & Kusyk, 2011). In Indonesia, as an emerging market has the lowest

score in Ranking Asian Market on CG Quality (Asian Corporate Governance

Association (ACGA), 2014). Besides corporate governance, Indonesia also has got a

problem related to ethics. It is proven by the fact that Indonesia declined 2 rankings,

from the 88th to the 90th free corruption country in ASEAN (Mazrieva, 2017).

To resolved the issues, many intentions have already been done by Indonesian

Government such as Indonesia’s Code of Good Corporate Governance in 2006 and

Law No. 40 of 2007 Article 74 which obligated the listed company to do Corporate

Social Responsibility (CSR). Those actions show a positive intention from the

government in improving the applications of both issues in Indonesian companies. It

also expects the improvement of corporate governance and business ethics in the

company in Indonesia.

In Indonesia, the studies related to ethics already done by different measurement such

as Islamic ethics questionnaire, but ethical commitment index and relate the data to

the financial performance in Indonesian company never been executed. Therefore,

based on the factors mentioned and knowing that this study has not been executed

before in Indonesia, this study needs to be executed.

In this study, business ethics measurement result is collected from ethical

commitment index by Nainggolan et, al (2017) in their working paper. Ethical

Commitment Index (ECI) method has also used by Choi & Jung (2008) and Pae and

Choi (2011) in South Korea. This study aims to analyze the relationship between

ethical commitment index, corporate governance toward corporate financial

performances. By knowing the relationship between those variables, it will help

investors and individuals, who have aconcern about corporate governance and

business ethics, make decisions in the portfolio investment.

LITERATURE REVIEW

Ethics is one of the branch studies in philosophy that has core value in arranging,

maintaining, and recommending the right and wrong action(Jenning, 2005). Ethics

that applies in a business context is called business ethics. According to Epstein

(1989), business ethics focuses on general principles and analytical approaches in an

ethical path based on aparticular field in business activity. It also examines theethical

problem that appears in abusiness environment (Solomon, 1991). The role of ethics is

essentialfor the business effectiveness of a company(Singhapakdi, 1991). If there is

no any implementation of business ethics, ethical and agency problems will easily

arise in an organization. Furthermore, the companies with high ethical values will

have a competitive advantage such as improved employee morale, better reputation,

more trusted investor relations, and lower cost of capital. All of the competitive

advantages will lead companies better financial performance in the long run.

In order to institutionalize the business ethics application in corporate, it requires a

guideline called code of ethics. According to Business Dictionary, code of ethics is a

set of guideline to help management within the corporation in conducting their action

which in line with the ethical standard. In other literature, Kaptein & Schwartz (2008)

explained that code of ethics consists of set principles that develop by the company to

be a guideline issue for at least manager, employee, company, toward stakeholders

and society in general. Although there is no warranty, the institutionalization of ethics

is important due to increased occurrence of unethical behaviour within

theorganization(Chua & Rahman, 2011).

One of the ways to improve and monitor ethics is from corporate governance.

According to Organization for Economic Cooperation and Development (OECD)

(2004), corporate governance is set of structures that relate to a relationship among a

company’s management, directors, its shareholders, and other stakeholders. All of the

stakeholders from corporate governance are expected to control all the activities by a

certain right that existing in legal framework on corporate (John & Senbet, 1998).

Corporate governance represents institutional arrangements, decision-making

mechanisms, and organizational design(Lu & Zhang, 2016). Based on previous

literature, application of corporate governance and their effects on companies

performances showing different findings. Gompers, et al (2003) find that’s firm with

highest corporate governance will have higher performance related to firm value,

profit, and sales growth. Contrarily, Maka&Kusnadi (2005) indicates inversely

relationship between corporate governance and firm value in countries.

In Indonesia, the government released the first Code of Good Corporate Governance

by The National Committee on Corporate Governance (NCCG) in 1999. Low

corporate governance rating and a multi-dimensional crisis in Indonesia is one of the

reasons that pushed thegovernment to improve the code. Continuously improving

from 2001, 2004, In 2006 National Committee of Governance released The Code of

Good Corporate Governance Indonesia as guideline code for companies to implement

Good Corporate Governance (GCG) in Indonesia.GCG has 5 principles values which

ensure the companies to achieve sustainability and consider the interest of

stakeholders. These values are transparency, accountability, responsibility,

independency, and fairness.

PREVIOUS STUDIES

Corporate governance becomes an interesting topic to discussed and examines by

many researchers. Past studies have found different findings regarding the issue. In

term of the relationship between corporate governance and financial performance, the

findings show a mixed result. Some of the studies find the positive relationship such

as Abdallah & Ismail ( 2006) which explain a positive relationship between corporate

governance and firm value. This research conducted in 2008-2012 to all firms listed

in GCC (The Gulf Country) countries. The same result also shows in Gompers, et al

(2003). Contrarily, the other studies found anegative relationship between corporate

governance toward financial performances (Maka&Kusnadi, 2005). Maka & Kusnadi

(2005) found that large board related to theless efficient use of assets and effect to

lower profitability. Furthermore, Morck et al. (1988) also findnegative relationship

between corporate governance specifically managerial ownership toward financial

performance. Whileinsignificant relationship between corporate governance and

financial performance also shows in literature Ghazali (2010). A negative relationship

is due to time conducted the research was too early. All those research shows mixed

finding regarding corporate governance and financial performance.

Furthermore, many researchers also already started to studies business ethics or

ethical commitment index toward corporate financial performance especially

inadevelopedcountries such as South Korea, Spain, and US. Most of the studies have

shown positive significanteffect of ethics toward corporate financial performance.

Mascarenhas (2015) stated that unethical behaviour in conducting business will lead

to revenue losses. These findings means ethical commitment index has positive

relationship toward financial performances. Supporting this, Verschoor (1998) also

finds apositive relationship between ethical commitment and company financial

performance. He finds that the companies that include their ethical behavior in annual

reports show favorable corporate financial performance compared to those that do

not. On the side notes, there are another finding regarding thepositive relationship of

ethical commitment of company toward financial performance in (Elayan et al.,

2014) and ( Rodriguez and Fernandez,2015).

However, in Pae and Choi (2011) finds an insignificant relationship between ethical

commitment index and corporate financial performances. According to Pae and Choi

(2011), this research is consistent with previous studies which stated relationship

between business ethics is not clear enough to short-term measurement financial

performances. The more robust relationship for business ethics and financial

performance is applied for long-term effect (Choi and Jung, 2008; Preston &

O'Bannon, 1997).

Despite many studies regarding corporate governance and ethical commitment index

toward corporate financial performance, the relationship between ethical commitment

index and corporate governance also becomes an interesting topic. At a glance,

ethical commitment index and corporate governance seem identical, but actually,both

of the issues represent thedifferent area. According to Pae and Choi (2011), corporate

governance represents governance mechanism, while business ethics represent ethical

decision making from corporate. Past studies found that corporate governance is

positively significant toward ethical commitment index (Pae and Choi, 2011;

Brickley, Smith Jr., &Jerold,2002).

DATA

The sample of this research use 30 companies from respondent of questionnaire

Ethical Commitment Index from Nainggolan et al. (2017). Those 30 companies, will

be used to analyze ethical commitment index, the corporate governance and financial

performance in Indonesia. Furthermore, data for corporate governance and control

variables are gathered from Indonesia Stock Exchange (IDX) over period 2012-2016.

For the corporate governance, data obtained from theannual report of analyzed listed

companies. This report will identify the variables needed for measuring corporate

governance listed companies. The variables used for corporate governance are local,

foreign and managerial ownership, board size, independent managerial, and audit

committee of a company.

METHODOLOGY

This study aims to analyze the relationship among ethical commitment index,

corporate governance and financial performance. To analyze those issues, this

research used multi linear regression analysis. The first equation model used to test

therelationship of ethical commitment index toward financial performance as follow: CFP=β0+β1 ECI+Control+e

where ECI is ethical commitment index, and CFP is corporate financial performances

measurement which are ROE, NPM, ROA, and Tobin’s Q. Ethical Commitment

Index is expected to have a positive relationship toward company financial

performance since most of the studies show a positive relationship between ethics

toward company financial performances.

This research used 4 control variables. The four variables are Beta(b), Total Asset

(ta), Change of Sales (cs), and Financial Leverage (flv). Beta expects to have a

positive relationship toward corporate financial performance since the higher the risk,

the more return that company will get. Beta used for control a systematic risk of a

company. Furthermore, total asset expected to have a negative relationship toward

corporate financial performance (Dang & Li, 2013). The better financial

performance, the more asset used by the company to increase their financial

performance. Change of sales expects to have a positive relationship toward

corporate financial performance since the higher sales growth will have higher value

in a capital market (Dechow et al., 2004). The company that rely on debt financing

tend to have a good business ethics, therefore it will increase the return to the

company (Pae and Choi, 2011). Hence, this research expects a positive relationship

toward company financial performance.

The second equation model used to test the relationship between both Ethical

Commitment Index and Corporate Governance toward financial performance. The

equation as follows:

CFP=β 0+β 1 ECI+β 2CorporateGovernance+Control+e

where :

β 0 = Constant

β 1−β 7 = Correlation of Coefficient

e = Residual error of regression model

The dependent of this research is acorporate financial performance which divided

into 4 model which is ROA, NPM, ROE, and Tobin’s Q. The independent for this

research are ethical commitment index and corporate governance which will be

assessed from local, foreign, and managerial ownership, Independent Managerial,

Audit Committee, and Board size. Ownership of local shareholders is measured

aportion of share that own by anindividual, corporate, and also government in

Indonesia to a total number of shares.When a company have more dispersed

ownership, it will face higher agency cost and will decrease a financial performance

of a company (Ng'ang'a et al., 2016). Hence, this research expects a negative

relationship toward financial performance. Furthermore, ownership of foreign

shareholders is calculated from aportion of foreign shareholders in a company. This

research expects a positive relationship between foreign shareholders towards

corporate financial performances because foreign ownership used as aproactive

legitimate action to ensure continued inflows(Haniffa & Cooke, 2005) which will

increase a financial performance of a company.

Ownership of managerial shareholders is a portion of share ownership by board

directors and commissioners inside the company to a total number of shares

(Wahihdahwati, 2002 cited from Irawan& Nainggolan, 2016). Agency problem arises

when a manager inside the corporation owns a little stock of a company. They did not

have asense of ownership and lead to opportunistic behavior(Jensen & Meckling,

1976). While, if the manager owns more stock of a company it will reduce agency

cost and improve manager effectiveness in conducting business. Hence, this research

expects a positive relationship between managerial shareholders toward financial

performances.

Board size measures the total number of directors and commissioners in the

company. Indonesia applies two-tier board structure where the board of

commissioners are separated from the board of directors (Hermawan, 2011).Board

size expects to have negative relationship toward corporate financial performances

since the higher board size will lead thecompany to ineffective communication,

control and decision making and will lead to decreasing performances(Jensen, 1993).

Moreover, independent managerialis the proportion of independent directors plus

independent commissioners to total managerial (directors and commissioners).

Independent managerial will help board director to control the business activities and

increase theeffectiveness of theboard of directors (Said et al., 2009). The more

effective board of directors will lead to better financial performance. Hence, a

positive relationship between independent directors toward corporate financial

performances is expected.

Audit committee function as monitoring committee to ensure internal control system,

internal and external audit, good corporate governance is going well. They also have

to monitor and review company’s compliance based on Indonesia law and existed

regulation. The audit committee is expected to have a positive relationship toward

financial performance since it can reduce agency cost and increase internal control of

a company. So, it will increase the performance of a company. Moreover, this

research equation used 4 control variables. The four variables are Beta, Total Asset,

Change of Sales, and Financial Leverage.

The third equation model aims to analyze the relationship between corporate

governance toward ethical commitment index. The equation model as follows: ECI=β 0+β 1Corporate Governance+Controls+e

The dependent variable for this equation is Ethical Commitment Index (ECI).

Furthermore, independent variables use corporate governance measurement which

are local, foreign and managerial ownership, board size, independent managerial, and

audit committee.

Corporate governance expects to have a positive relationship toward ethical

commitment index since the more comprehensive corporate governance tend to have

a strong business ethics (Pae and Choi, 2011). While for control variables are use

beta (5-year rolling beta from the CAPM), Total asset, change of sales and financial

leverage.

RESULT AND ANALYSISTable 1 Descriptive Statistics for 5-years Average

Mean SD Minimum Maximum

Dependent Variable

Return on Equity (ROE) 0.135 0.511 -1.440 2.266

Net Profit Margin (NPM) -0.153 1.197 -6.470 0.253

Return on Asset (ROA) 0.282 0.452 -0.040 1.826

Tobin's Q 1.20 2.082 0.044 10.597

Independent Variables

ECI 9.000 2.150 4.000 11.000

Local Ownership 0.749 0.287 0.065 1.000

Foreign Ownership 0.231 0.276 0.000 0.928

Managerial Ownership 0.020 0.077 0.000 0.414

Board Size 8.433 3.380 3.000 18.000

Independent Managerial 0.283 0.165 0.000 0.750

Audit Committee 0.133 0.115 0.000 0.400

Control Variables

Total Asset 928847121699 45 117960455 226161395566678

Financial Leverage 2.236 1.665 -1.164 8.441

Change of Sales 0.125 0.435 -0.408 2.233

Beta 0.575 1.611 -7.322 2.516

This table presents the mean, standard deviation (SD), minimum value, and themaximum value of all regression

variables. It is calculated from 30 companies in Indonesia Listed Companies for 5-year averages.

Table 1 shows descriptive statistics for 5-year average. From the descriptive statistic

above, the average net profit margin of this research is -15.2%. It is abad indicator for

their financial performance. However, theinvestordoes not pay attention to it since the

market value is still higher than its true asset value. It is shown by the average

Tobin’s Q of these company is higher than 1. The justification of this anomaly may

come from its good ROA and ROE of these companies which are 28.1% and 13.5%

respectively. Furthermore, descriptive statistic data shows that the application of

ethics in Indonesia is quite good, it is shown in the mean average ethical commitment

index is 9 out of 11. Indonesia is dominated by local ownership which has around

average 75% of share, foreign own 23% of the share, while manager just owns 2% of

share in Indonesia company.

For the last five years, acompany in Indonesia already fulfilled the regulation which

obligated the company to have at least 4 board of directors and commissioners. From

the data, we can see mostly the Indonesian company exceed the government order by

has more board managerial. Some companies in Indonesia did not use independent

managerial, while they already applied and fulfilled minimum requirement for audit

committee which is at least 2 people

Table 2 Descriptive Statistics for End Year of 2016

Mean SD Minimum Maximum

Dependent Variable

Return on Equity (ROE) 0.208 0.630 -0.419 3.399

Net Profit Margin (NPM) -0.321 1.963 -10.659 0.330

Return on Asset (ROA) 0.400 0.685 -0.115 2.881

Tobin's Q 1.302 2.102 0.041 10.480

Independent Variables

ECI 9.000 2.150 4.000 11.000

Local Ownership 0.743 0.274 0.084 1.000

Foreign Ownership 0.235 0.260 0.000 0.916

Managerial Ownership 0.022 0.101 0.000 0.550

Board Size 8.200 3.438 3.000 18.000

Independent Managerial 0.298 0.185 0.000 0.750

Audit Committee 0.779 0.409 0.333 1.667

Control Variables

Total Asset13538858755

3 40 119640264

26190422515096

5

Financial Leverage 2.105 1.275 -0.618 6.435

Change of Sales -0.067 0.249 -0.862 0.196

Beta 0.575 1.611 -7.322 2.516

The table presents the mean, standard deviation (SD), minimum value, and maximum value of all

regression variables. It is calculated from 30 companies in Indonesia Listed Companies for end year of

2016

From the descriptive statistics data for end year of 2016, the average net profit margin

shows -32,12%. The decreasing performance is higher than the 5-years average

descriptive statistic data. Although the NPM show anegative result, it not affects the

ROA and ROE, because the return is increasing compare to 5-years average data.

Hence, this increasing of both indicators make the market value higher than its true

asset value and increase from the 5-years average.

Ethical commitment index assumed not change for the past 5 years. Hence, in the

endyear of 2016, the descriptive statistics show that some companies in Indonesia

have highest commitment value toward ethics. It can be seen from the maximum

value of the variable ECI (11) which is the highest score of ECI measurement.

Furthermore, application of ethics in Indonesia is quite various, seen by the range of

ECI is quite high with 7 point differences.

Ownership of share in Indonesian company is still dominated by local shareholders.

Foreign ownership owns about 20 percent of share in Indonesia, while managerial

ownership just owns 2.2% in end year of 2016. The is no significant differences of

ownership for the last five years and end of year 2016.

Correlation between independent variables is important because high correlation will

lead to bias conclusion. The high correlation between independent occur when the

correlation value is above 0.5. For average 5 years, table 4.5 shows that most of

variables did not have high correlation between each other, so they can use in one

model regression. However, there is one independent variables that has high

correlation which is local ownership(lo) and foreign ownership(fo). In order to solve

the high correlation problem, this research need to separate local ownership and

foreign ownership into different regression model.

For Independent variables in the end of year 2016, the correlation matrix on table 6

shows ahigh correlation between some variables. The variables are between local

ownership(lo) and foreign ownership(fo), independent managerial(im) and audit

committee (ac), board size and audit committee(ac), and between financial leverage

(flv) – change of sales (cs). Those variables need to be separated into various

regression model to overcome the correlation problem.

Regression ResultTable 5 Regression Result for 5-years Average The Relationship between ethical commitment index, corporate

governance and financial performances

Model (1)-(4) aims to test the relationship between ethical commitment index toward

corporate financial performance for average 5 years. The result is expected to show a

positive relationship between ethical commitment index toward corporate financial

performances. From Model (1)-(4), all the regression result shows that ethical

commitment index is statistically insignificant toward company financial

performance. Hence, there is no evidence to support thehypothesis for therelationship

between ethical commitment index and company financial performances. It means

that there is no robust effect between ethical commitment index toward financial

performances. The insignificant result due to different political and environmental

both for investor and market in Indonesia. An investor in Indonesia tends to see the

corporate governance of a company not the ethics of a company. One of the reason is

anethical commitment of a company is hard to measure and time-consuming, whereas

investor should decide stock on their portfolio in limited time.

However, the finding is consistent with theprevious result which stated that ethical

commitment index shows insignificant differences to short-term measurement

financial ratio such as ROA, NPM, ROE (Pae and Choi, 2011 and Preston &

O'Bannon, 1997). It can be concluded that research is same with Indonesia cases,

which has more ethics problem compare to develop countries. Moreover, the result

might also because of the time in conducting the research is not too long so it cannot

interpret the long-term effect of this issue.

Model (5) to Model (12) examine therelationship between both corporate governance

and ethical commitment index toward financial performance for average 5 years.

Model 5-8 will assess corporate governance from local, board size, independent

managerial, and audit committee. While model 9-12 will assess corporate governance

from foreign and managerial ownership. From the regression result, it shows different

findings with the hypothesis which expect apositive relationship between ethical

commitment index and corporate governance toward financial performances.

Evidently, the result only shows a negative significant relationship between corporate

governance through managerial ownership toward corporate financial performances.

While ECI, local ownership, foreign ownership, board size, independent managerial

and theaudit committee has no evidence to related toward corporate financial

performances. The significant and negative relationship between managerial

ownership to corporate financial performance is documented at model (11) in table 5

for 5-years average (-0.75). Interestingly, the result in Indonesia shows a conflicting

with the agency theory where managerial ownership will increase the manager

performance and increase financial performance.

The result also demonstrates that financial performances tend to decrease at a higher

level of managerial ownership. It is consistent with Morck et al. (1988) and Bebchuk

& Fried, (2003) where managerial ownership has negative related to financial

performance. Furthermore, Bebchuk et al., (2010) also find evidence that higher CEO

salary compares to other board directors will effect lower corporate value. The result

from this research might be occurring because of the higher managerial ownership

will lead manager to have agency conflict, when the dominant manager has

atendency to do more exploitation in the company. This action will lead to decreasing

performance of a company.

For control variables, in table 9 model (4) and model (12) total asset shows positive

and significantly related to Tobin’s Q. Table 6 Regression Result The Relationship between ethical commitment index, corporate governance and financial

performancesfor End Year of 2016.

For end year of 2016, the relationship between ethical commitment index and

financial performance result is consistent with the 5-years average. It can be seen

from themodel (1)-(4) which show there is no evidence between ethical commitment

index and financial performance. The author finds no evidence to support the

research hypothesis which expects a positive relationship between ethical

commitment index toward financial performances. Furthermore, it also means that

ethical commitment index not strong tendency related to financial performance for

both long-term and short-term periods

However, the finding is consistent with theprevious result which stated that ethical

commitment index shows insignificant differences to short-term measurement

financial ratio such as ROA, NPM, ROE (Pae and Choi, 2011 and Preston &

O'Bannon, 1997). It can be concluded those research is same with Indonesia cases,

which has more ethics problem compare to develop countries

Model (5) to Model (12) on Table 6 examine therelationship between both corporate

governance and ethical commitment index toward financial performance for end year

of 2016, respectively. Model 5-8 will assess corporate governance from local, board

size, and independent managerial. While, model 9-12 will assess corporate

governance from foreign, managerial ownership, and audit committee. The corporate

governance regression model is separated due to existing high correlation among

independent variables. The regression result shows a consistent result with the result

for 5-years average. This documented a negative significant relationship between

corporate governance through managerial ownership (-0.85). It means that both for

short-term and long-term shows tendency that the higher level managerial ownership

will decrease financial performances of a company and conflict with agency theory

where the higher managerial ownership will decrease agency problem. This is an

interesting topic to deeply focused more on the further research. This might be

occurring because of the higher managerial ownership will lead to extraction by

dominant ownership at expense of minor shareholder. This event will lead to agency

problem between minor shareholder toward company and in the end, will lead to

decreasing performance of a company.

Furthermore, for end year of 2016, the regression result also shows a negative

significant relationship between audit committee and ROA in model (11) in Table 6

Audit committee has p-value 0.031 and coefficient -0.735. This finding is not

occurred in model (11) for average 5 years. This might due to the variables has more

tendency to short-term effect than long-term effect. Based on the result, the

hypothesis is rejected. It might be due to higher audit committee make the company

cannot do fraud or the regulation is stricter. So, the profit cannot be higher and have

tendency in decreasing profit than the company with less audit committee.

For control variables, there is insignificant result between total asset toward Tobin’s

Q in model (4) and model (12) in table 6 for end year of 2016 compare to 5-years

average regression result. Furthermore, the regression model (2), (3), and (6) shows

positive and significant relationship between change of sales to corporate financial

performance. While, beta shows negative and significant relationship toward return

on equity in model (9).Table 7 Regression Result The Relationship between Ethical Commitment Index (ECI) and Corporate Governance for

5-years Average

Model (1) (2)ECI ECI

 Constant 5.356 6.0281(0.064) (0.021)

Independent VariablesECI

Local ownership 0.489(0.746)

Foreign ownership 0.6618(0.717)

Managerial ownership -1.3264(0.57)

Board Size 0.2221(0.325)

Independent Managerial 0.5902(0.88)

Audit Committee -2.1068(0.618)

Control VariablesTotal Asset 0.0292 0.0849

(0.781) (0.316)Financial Leverage 0.4051 0.2621

(0.091)* (0.187)Change of Sales -0.5297 -0.1578

(0.427) (0.87)Beta -0.1999 -0.1176

(0.272) (0.391)R-squared 0.1814 0.0629Note: This table shows the coefficient and p-value. in the bracket () is p-value. *p<0.1;**p<0.05; ***p<0.01

ROE: Return on Equity; NPM: Net Profit Margin; ROA: Return on Asset; Tobin’s Q:Market Capitalization

Total asset;

ECI: Ethical Commitment Index; Table represent regression result for average 5 years

Table 7 examines relationship between ethical commitment index and corporate

governance for 5- years average in listed company Indonesia. Model (1) assessed

corporate governance from local ownership, board size, independent managerial and

audit committee. While model (2) assessed corporate governance from foreign and

managerial ownership.

Regression result show there is no evidence that corporate governance is significant

toward Ethical Commitment Index for 5-years average. This result is different with

ahypothesis which expects a positive relationship between corporate governance

toward ethical commitment index. It might be because corporate governance has

aninsignificant effect or tendency to explain the ethical commitment index in the

long-run. Furthermore, it can also occur because the ethical commitment index used

for this study is not calculated consecutively every year.For control variables,

financial leverage shows positive significant relationship toward ethical commitment

index.

Table 8 Regression Result The Relationship between Ethical Commitment Index (ECI) and Corporate Governance

Model (1)* (2)*

ECI ECI

Constant 6.2487 6.0252

(0.07) (0.008)

Independent Variables

ECI

Local ownership -0.2293

(0.901)

Foreign ownership 1.7831

(0.23)

Managerial ownership -2.701

(0.089)*

Board Size 0.1634

(0.336)

Independent Managerial 2.7042

(0.371)

Audit Committee -1.571

(0.245)

Control Variables

Total Asset 0.0376 0.1078

(0.647) (0.071)*

Financial Leverage 0.464

(0.063)*

Change of Sales 2.0289

(0.463)

Beta -0.2457 -0.227

(0.117) (0.085)*

R-squared 0.1613 0.2073

Note : This table shows the coefficient and p-value, in the bracket () is p-value. *p<0.1;**p<0.05;

***p<0.01

ROE: Return on Equity; NPM: Net Profit Margin; ROA: Return on Asset ; Tobin’s Q:

Market CapitalizationTotal asset ; ECI: Ethical Commitment Index; Table represent regression result for end year

of 2016

Table 8 examines corporate governance toward ethical commitment index for end

year 2016. Model (1) assessed corporate governance from local ownership, board

size, and independent managerial and model (2) from foreign ownership, managerial

ownership and audit committee. Regression shows there is negative and significant

relationship between managerial ownership toward ethical commitment index. The

result is different with ahypothesis which expects a positive relationship between

managerial ownership toward ECI. Managerial ownership has p-value 0.089 and

coefficient -2.701. It is different with the hypothesis which expectspositive

relationship between corporate governance to ECI. This might occur due to high

managerial ownership will lead to high agency problem because manager feels like

they own the company. High possibility of agency problem will lead to unethical

behavior of thecompany. For short-time managerial ownership will have significant

effect toward ECI, however, for long-time, the effect of managerial ownership will

fade. It can be seen from the regression result in 4.11 which documented there is no

significant result between corporate governance toward ethical commitment index for

average 5 years. Furthermore, it also might happen because the manager not paying

attention to ethics, the ethics more like symbol not an application. Hence, the higher

managerial ownership will lead to less concern toward ethics. For control variables,

total asset and financial leverage show positive and significant relationship toward

ethical commitment index.

CONCLUSION AND RECOMMENDATION

Globalization makes competition fiercer and need high speed of change. This era also

confronts with trust issue where right and wrong fall in between. In a competitive

market, thebehavior of a company is monitored by themarket and will affect directly

to financial performance as well as stock price. Started from decreasing financial

performance even bankruptcy of many companies in the world due to lack of ethics

and corporate governance. Both issuesbecomes important to be considered.

Furthermore, theinvestor also tends to see both indicators before decided their

investment. Many researchers, especially in developed market, already study and

confirm mixed findings of ethics and corporate governance. Although Indonesia has

alow ranking of corporate governance index and more problem regarding ethics,

thegovernment already shows some intentions to enhance the issue in business

activities in Indonesia. Furthermore, there are none of thestudies in Indonesia that

examines about ethical commitment index toward financial performance. This

research aims to give the perspective of ethical commitment application in Indonesian

company as well to fill the gap and contributes to the literature on corporate

governance, ethics and corporate financial performance.

This study aims to know the relationship between ethical commitment index and

corporate governance toward corporate financial performances in Indonesia listed

company. The sample data for this research obtained from anethical commitment

index respondent questionnaire of Nainggolan et al. (2017) which are 30 companies

from liquid listed company in Indonesia Stock Exchange. Multi-linear regression is

conducted between independent and dependent variables. Dependent variables of

this research are corporate financial performance and ethical commitment index.

Corporate financial performance measured by ROA, ROE, NPM, and Tobin’s Q.

While independent variables are ethical commitment index, local ownership, foreign

ownership, managerial ownership, board size, independent managerial, and audit

committee.

This result of this research are as follow:

1. There is no evidence that Ethical Commitment Index has relationship toward

financial performances. The result shows ethical commitment index has

insignificant result toward corporate financial performance. This might happen

because ethical commitment index will have long term effect to increase the

financial performance. Besides, this supports a statement that ethical commitment

index has no clear relation toward short-term financial performances and has

themore robust effect on long-term performances.

2. Between ethical commitment index and corporate governance, only corporate

governance through managerial ownership that has a negative significant

relationship toward corporate financial performances. Interestingly, it conflicting

with the agency theories and attractive to deeply discussed for further research.

The result for average 5 years is consistent with the result for the end year of

2016 which means the variables have atendency both for short-time and long-

term effect. This might be occurring because of the higher managerial ownership

will lead to sources extraction by dominant ownership at expense of minor

shareholder. This event will lead to agency problem between minor shareholder

toward thecompany and in the end, will lead to decreasing performance of a

company. This finding indicates that in Indonesia, high managerial ownership in

company Indonesia will have lower efficiency for business operation and

decrease financial performances.

3. Corporate Governance through audit committee has also negative significant

relationship toward corporate financial performances for end year of 2016. It

might be due to higher audit committee make the company cannot do fraud or the

regulation is stricter. So, the profit cannot be higher and have atendency in

decreasing profit than the company with less audit committee.

4. This research suggests the company to pay more to their ownership structure and

effectiveness of audit committee besides support government intentions to

enhance corporate governance and ethics. So, the existing of managerial

ownership and audit committee can increase financial performance rather than

degrade performances.

5. This research also highlights the relationship between ethics and corporate

governance. The empirical result documented a negative and significant

relationship between managerial ownership toward ethical commitment index.

This might be due to higher managerial ownership will lead to higher agency

problem since the dominant manager will exploit more at expense of minor

shareholder and lead. Higher agency problem will lead to dipped commitment

toward ethics such as corruption, political motives, and expropriate for

theindividual benefit (Wright et al., 2002). High possibility of agency problem

will lead to unethical behavior of thecompany. For short-time managerial

ownership will have significant effect toward ECI, however, for long-time, the

effect of managerial ownership will fade. It is also might happen because

manager tends to see ethical commitment as a symbol not an application. This

result suggests the company to ensure manager objective who own share is in line

with company objective to prevent agency problem and unethical behavior.

Furthermore, it is better for themanager to change theperspective of ethical

commitment as asymbol into theapplication of ethics, so higher managerial will

lead to better company commitment toward ethics.

The scope of this research has limited sample and time conducted. Time to do this

research is only one year and ethical commitment index respondent just 30 out of 305

listed company in Indonesia. Least number of respondent ethical commitment index

questionnaire can also be an indication that companies in Indonesia do not really pay

attention to theethical commitment of a company. This research use data from ethical

commitment index respond result from Nainggolan et al. (2017) working paper,

company annual report data, and financial report from Indonesia Stock exchange

(IDX). Further research can extend the number of thesample through more sample

from respondent ethical commitment index questionnaire and the time conducted the

research. Furthermore, to find amore comprehensive representation of corporate

financial performance toward ethical commitment index and corporate governance,

further research can use ECI changes over ayear or add another measurement into

ECI. It can also add another dependent and independent variable in order to get more

exact and robust result regarding ethics, corporate governance, and financial

performance.

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