Control Mechanism and Value of Firm : Empirical Evidence from Indonesia Capital Market

Control Mechanism and Value of Firm: Empirical Evidence from Indonesia Capital Market Christian Herdinata*, Eduardus Tandelilin**, Hermeindito*** * Universitas Katolik Widya Mandala Surabaya, Indonesia ** Universitas Gadjah Mada, Indonesia *** Universitas Katolik Widya Mandala Surabaya, Indonesia


INTRODUCTION
Majority shareholders can conduct expropriation using corporate policy.However, this may lead to an agency conflict with minority shareholders.Shleifer and Vishny (1986) stated that majority shareholders can use their authority to obtain personal benefits by various means; among them, tunneling.Johnson et al., (2000) defined tunneling as an outgoing resources transfer from corporates for the benefit of controlling shareholders.Related party transactions, as indicated by tunneling, include: cash payment, asset purchases, asset sales, and asset exhcanges (Cheung, Rau, and Stouraitis, 2006;Cheung, Qi, and Rau, 2009).Based on this issue, it is important to prove if tunneling occurs in Indonesian companies.It is also necessary to know how to use control mechanism to reduce expropriation through tunneling in order to decrease agency conflict.Therefore, the primary focus of this study is to improve corporate performance via control mechanism on agency conflict that happens as a result of tunneling-indicated asset utilization.
Several empirical research studies related to control mechanism over agency conflict such as one taken by Jensen and Meckling (1976) show that leverage can reduce agency conflict between managers and shareholders.Furthermore, Jensen (1986) proved that leverage mechanism can reduce agency conflicts caused by overinvestment.Additionally, Kim and Sorensen (1986) and Friend and Lang (1988) found that the decision to increase leverage was consistest with the reduction of agency conflict.This statement is supported by Jensen, Solberg and Zorn (1992) who tested three financial decisions namely leverage, dividens, and insider ownership using a simultaneous equation model.They discovered that leverage and dividens were simultaneously used to reduce agency cost.On the other hand, Bathala, Moon and Rao (1994), examined the case using simultaneous equation system of insider ownership, leverage, and institutional ownership as independent variables.They found out that insitutional ownership acted as a substitute for managerial ownership and leverage in controlling agency conflict.Additionally, Chen and Steiner (1999) suggest that institutional ownership and managerial ownership had a substitutional effect on agency conflict control.Based on the empirical research, this study will use institutional ownership and leverage as control mechanism over agency conflict that happens as a result of asset utilization.
This study specifically examines the asset utilization managed by corporates.Several studies suggest a decline in company value during the announcement of tunneling-indicated related party transactions (Cheung, Rau, andStouraitis, 2006 andCheung, Qi, andRau, 2009).Jian and Wong (2010) discovered that corporates performed tunneling by making receivables transaction with related parties to transfer the companies' outgoing resources.Furthermore, Cheung, Jing, Lu, and Rau (2009) found an empirical evidence that sales transactions and asset purchases from related parties were used to perform tunneling.On the other hand, Aharony et al., (2005) discovered that receivables transaction against related parties indicated tunneling after IPO (Initial Public Offering).Therefore, the objectives of this study are to examine: (1) institutional ownership as control mechanism over asset utilization, (2) leverage as control mechanism over asset utilization, (3) interdependence relationship between institutional ownership and leverage in performing control mechanism towards asset utilization, (4) the influence of asset utilization on corporate performance, (5) institutional ownership as control mechanism over corporate performance, and (6) leverage as control mechanism over corporate performance.

Institutional Ownership and Asset Utilization
The ability to exercise control can be different for different levels of ownership.Unlike lower institutional ownership level, higher level of institutional ownership means a more effective managerial control.Bukart, Gromb, and Panunzi (1997) reinforced this with a suggestion that ownership level provides incentives for owners to monitor managerial behaviours in a more effective way.On the other hand, Iskandar et al., (2012) suggest that concentrated ownership can effectively increase the efficiency of asset utilization.A study conducted by Iturriaga and Crisostomo (2010) suggests a bell-shaped relationship between majority shareholders and corporate value.The active monitoring process conducted by the majority shareholders brings a positive result on corporate value.However, due to the increase in ownership level, majority shareholders tend to perform expropriation on minority shareholders.This action then affects corporate value negatively.
Based on this empirical evidence, there is a tradeoff between monitoring effect through institutional ownership and asset utilization.It can also be said that the effect of expropriation through tunneling over asset utilization is a result of the behavioral change of institutional shareholders on different ownership levels.Based on that explanation, the research hypothesis can be formulated as follows: H1: The influence of institutional ownership on asset utilization is positive when institutional ownership level is low and negative when institutional ownership level is high.

Leverage and Asset Utilization
Leverage works as an alternative way of transferring monitoring expenses from owners to lenders.Leverage should also encourage managers to be more disciplined in order to avoid bankruptcy.A research conducted by Maloney, McCormick and Mitchell (1993) suggests that leverage increases the decision making ability of the management.Additionally, Friend and Lang (1988) discovered that leverage could be used to reduce agency conflict by using external parties to oversee the management.Ade (2008) found a positive relationship between the external monitoring process conducted by banks as lenders towards total asset turnover.Based on that empirical evidence, it can be concluded that when leverage is low, the effect of control mechanism on asset utilization is low, whereas when leverage is high, the effect of control mechanism on asset utilization becomes stronger.The reason for this is because leverage is used to control the behaviour of institutional shareholders who perform expropriation through tunneling towards asset utilization.Th said action can bring loss to banks or lenders which lend money to the company.Based on this explanation, the hypothesis of this research can be formulated as follows: H2: The influence of leverage on asset utilization is negative when leverage level is low and positive when leverage level is high.

Institutional Ownership and Leverage
Jensen, Solberg and Zorn (1992) discovered that leverage and dividends were complementarily used to reduce agency costs but failed to prove that insider ownership was a substitution for leverage and dividends in controlling agency costs.Bathala, Moon and Rao (1994) also examined the simultaneous equation model based on insider ownership, leverage, and institutional ownership variables.They concluded that institutional ownership acted as a substitute for managerial ownership and leverage.On the other hand, Chen and Steiner (1999) found substitutional relationships between leverage, managerial ownership, dividends, and risks as well as between institutional ownership and managerial ownership.Finally, Crutchley et al., (1999) found a substitutional relationship between ownership structure and leverage or dividends.This empirical evidence suggests that institutional ownership and leverage can be effectively used as control mechanism on agency conflict.When the control mechanism performed through institutional ownership or leverage is weak, then the control mechanism performed by the company can be categorized as having a complementary relationship (positive relationship).On the other hand, when the institutional ownership or leverage is strong, then the control mechanism performed by the company has a substitutional relationship (negative relationship).Based on the above explanation, the hypothesis for this research can be formulated as follows: H3: Linear institutional ownership and leverage show a positive (complementary) relationship, whereas non-linear insitutional ownership and leverage show a negative relationship (substitutional).

Asset Utilization and Corporate Performance
The effect of asset utilization on corporate performance is influenced by tunneling-indicated related party transactions.Tunneling may occur through cash flow tunneling and asset tunneling (Atasanov et al., 2007).Jian and Wong (2010) found that corporates used receivables transactions with related parties via tunneling to transfer the corporates' outgoing resources.Aharony et al., (2005) also suggest that loan transactions to related parties are used as means of tunneling after IPO.On the other hand, Cheung, Jing, Lu, and Rau (2009) discovered an empiracal evidence which suggested that public companies in Hongkong performed asset tunneling through related party transactions.This happened because public companies were trading with related parties at higher price than independent parties.Therefore, asset sales to related parties under reasonable price (tunneling out) would indirectly affect the financial performance through the loss of potential synergy between assets affected by tunneling and the remaining assets (Atasanov et al., 2007).Meanwhile, asset purchases from related parties at higher value than reasonable price (tunneling in) would result in a decrease in corporate profitability (Atasanov et al., 2007).
Therefore, the increase in asset utilization will go in line with the increase in corporate performance as a result of the implementation of control mechanism through institutional ownership and leverage.Some research studies, including Wang, (2010) and Pouraghajan et al., (2013) suggest that asset utilization has a positive effect on corporate performance.Based on the explanation, the hypothesis for this research can be formulated as follows: H4: Asset utilization has a positive influence on corporate performance.

Ownership and Corporate
Performance Duggal and Millar (1999) suggest that institutional ownership play several important roles in improving the efficiency of capital markets.Firstly, institutional investors are considered as having better and more sophisticated research abilities in performing investment analysis.Secondly, high institutional ownership acts as an incentive for managerial supervision.Crutchley et al., (1999) reveal that institutional owners possess a more superior ability in management control than individual owners.Furthermore, Thomsen (2004) suggests that a concentrated ownership structure from majority shareholders has a non-linear correlation with corporate value.This means that when concentrated ownership structure is low, corporate value decreases.On the other hand, when the concentrated ownership structure is high, shareholders will hold internalization to protect their investments in the company.Kapopoulos and Lazaretou (2007) and Perrini et al, (2008) found that more concentrated ownership structure has a positive effect on the profitability of the company.Hu and Izumida (2008)  Leverage and Corporate Performance Jensen (1986) found that the use of leverage encourages managers to be more disciplined in response to the increase in corporate financial risk.On the other hand, the use of leverage also prevents managers from taking excessive actions (over-investment) regarding internal capital which can lead to agency costs (residual loss) increase that the owners must bear (Hermeindito, 2012).
Jensen (1986) argued that leverage helped prevent over-investment of free cash flow that managers do for their own benefits.Furthermore, Iturriaga and Crisostomo (2010) believed that leverage book value has a positive correlation with company value when investment opportunity is low.This shows that leverage can minimize the problem of over-investment.On the other hand, Beiner et al., (2006) found a positive relationship between leverage and corporate value and suggested using leverage as corporate governance mechanism in disciplining managers.In addition, some researchers have found a non-linear relationship between leverage and corporate performance.Kim and Sorensen (1996) and Hermeindito

Institutional Ownership and Asset Utilization
The test result of simultaneous equation model The applied leverage can also serve as a control system for the company by using banks or creditors to optimize asset utilization and improve corporate performance.Ade (2008) suggested a positive relationship between external monitoring by banks and total asset turnover.This shows that leverage can be used to control asset utilization.
When leverage is high, banks or creditors will be more strict with their monitoring function.As a result, asset utilization will increase.Therefore, it can be concluded that there is a trade-off between control mechanism effects via asset utilization monitoring and agency conflict effects via asset utilization tunneling at high leverage level.This condition can be seen in Picture 3.

Institutional Ownership and Leverage
The test result of simultaneous equation model  Bathala, Moon, and Rao (1994) believe that institutional ownership can be used as a substitute for managerial ownership and leverage.Likewise, Chen and Steiner (1999) also suggest that leverage, managerial ownership, dividends, and risks have substitutional effects.In addition, they also found out that institutional ownership and managerial ownership had a substitutional relationship.
Finally, Crutchley et al., (1999) also discovered a substitutional relationship between ownership structure and leverages or dividends.

Asset Utilization and Corporate Performance
The test result of simultaneous equation model  Finally, this research also provides an implication for capital market regulation and suggests that it should improve the monitoring on information related to related-party transactions (tunneling) investors need to prevent loss.

CONCLUSION
Control mechanism via institutional ownership on asset utilization is more dominant at higher levels.
Therefore, it brings positive and significant effects.
However, an overly-high institutional ownership level may lead to expropriation through tunneling which results in a negative and significant impact on asset utilization.On the other hand, control mechanism via leverage is more dominant at higher levels and brings a positive and significant effect on asset utilization, whereas lower leverage level leads to expropriation and gives a negative and significant effect on asset utilization.In the context of non-linear relationship, the correlation between institutional ownership and leverage is negative and significant.This shows that institutional ownership and leverage have a substitutional relationship in non-linear context.
In addition, the effect of asset utilization on corporate performance is positive and significant.
This suggests that asset utilization can be properly controlled to improve corporate performance.The influence of institutional ownership on corporate performance at institutional shareholder ownership level is still low.This results in expropriation which affects corporate performance negatively and significantly.This happens because negative impact of the decline in corporate performance as a result of expropriation only slightly affects the related parties.
On the other hand, when institutional shareholder ownership level is high, there will be a positive and significant influence on corporate performance.
also found a non-linear U-shaped effect between ownership concentration and corporate performance.This suggests a trade-off between expropriation effects and monitoring effects as a result of the behavioral changes within the majority shareholders at different levels of ownership concentration.It shows that higher ownership concentration leads to smaller acts of expropriation by majority shareholders, because they have to bear the increasing negative impacts of the expropriation.Cui and Mak (2002);Meca and Ballesta (2009); and Wellalage and Locke (2011) also found a nonlinear relationship between institutional ownership and corporate performance.They suggest that low institutional ownership leads to negative effects and high institutional ownership brings positive effects.Based on the above explanation, the hypothesis for this research can be formulated as follows:

( 2009 )
argued that the influence of leverage on corporate performance had a non-linear effect which showed positive signs in the beginning but indicated a negative effect when the leverage rose.This shows that higher leverage can lead to financial distress or even bankruptcy.Based on the explanation, the hypothesis for this research can be formulated as follows: H6: The effect of leverage on corporate performance is positive when leverage level is low and negative when leverage level is high.Based on the literature review and reseach hypothesis, a conceptual framework which consists of institutional ownership and leverage as part of control mechanism can be made.The framework will also include asset utilization and corporate performance as part of agency conflict.Below is the conceptual framework of this researchNon-linear variables in cubic relationship indicate negative relationship at lower levels, positive relationship at higher levels, and negative relationship at even higher levels +|-|+ Non-linear variables in cubic relationship indicate positive relationship at lower levels, negative relationship at higher levels, and positive relationship at Lin, and Huang (2011) KS : Kouki and Said (2011) IBS : Iskandar, Bukit, and Sanusi (2012) FK : Firdaus and Kusumastuti (20013) PTME : Pouraghajan et al., (2013) METHODS The research data come in the form of panel data obtained from Indonesian companies between 2001 and 2012.The company sample selection criteria include: (1) companies audited between 2001 and 2012, amounting to 177 companies, (2) companies which provided complete information on financial statement data for all research periods with the exception of 17 companies which failed to do so, (3) companies that were not undergoing any acquisition, merger, or delisting process, because the financial data needed for the research cannot be obtained from companies which undergo the delisting process (a total of 3 companies fall under this category), and (4) companies which provided complete information on stock market data with the exception of 21 companies which failed to provide the required information.The final sample amount is 136 companies.Financial data were obtained from the Indonesian Capital Market Directory (ICMD) from 2001 to 2012.A second examination was then conducted by comparing the data from ICMD and the annual financial statement from each company.Data were also obtained from Indonesian Securities Market Database (ISMD) published by the Faculty of Economics of Gadjah Mada University in Indonesia.Meanwhile, stock market data were obtained from the reports of Indonesia Stock Exchange (IDX).
book value; RISK_ROA = deviation standard of net income / total assets; DOM_OWN = percentage of domestic institutional ownership; OCF = operating cash flow / total assets; ROA = net income / total assets; SA = total fixed assets / total assets; ROIC = (NOPAT-paid dividends) / (long-term debt + total equity -retained earnings balance); FORG_DUM = dummy variable with the value of 1 for companies with foreign ownership and 0 for the rest; BLOCK_ DUM = dummy variable with the value of 1 for companies with an ownership rate higher than or equal to 5% and 0 for the rest; FDISS = dummy variable with the value of 1 for companies which do not experience financial distress and 0 for the rest; MGR_OWN_DUM = dummy variable with the value of 1 for companies with managerial ownership and 0 for the rest.
using the Three Stage Least Square estimation technique in Table6shows that the variable coefficient of institutional ownership is at a low level (β 21 = 2.1845) with a positive sign and a significance level of 10%, whereas at a higher level (γ 21 = -2.1195), it shows a negative sign with a significance level of 10%.As a result, Hypothesis 1 is proven.When institutional stockholders perform a control mechanism over asset utilization, they also take an active monitoring function in the company.This action brings a positive influence towards asset utilization.However, when institutional ownership concentration is high, they obtain almost all controls within the company and increase the moral hazard to conduct expropriation through related party transactions.Majority shareholders use this condition to conduct tunneling which brings a disadvantage to minority shareholders and results in the decline of asset utilization.This non-linear effect is an evidence that there is a conflict between majority shareholders and minority shareholders.This research is supported by Iturriaga and Crisostomo (2010) who applied a squared regression model to test the correlation between ownership concentration and corporate value and discovered a bell-shaped relationship between the two variables.They also suggested that ownership concentration increased corporate value in the beginning, but when the concentration level reached certain threshold, the majority shareholders conducted an active monitoring role towards the company management which resulted in a positive impact on corporate value.Nonetheless, with the rise of concentrated ownership after certain threshold, majority shareholders will possess enough power to conduct expropriation towards minority shareholders and this will bring a negative impact to corporate value.Therefore, there is a tradeoff between control mechanism effects on asset utilization monitoring via institutional ownership and agency conflict effects on asset utilization tunneling at high level of concentrated insitutional ownership.This condition can be seen in Picture 2 below: Picture 2. The Effect of Institutional Ownership on Asset Utilization at Higher Levels of Ownership Concentration Leverage and Asset Utilization The test result of simultaneous equation model using the Three Stage Least Square estimation technique in Table 6 shows that the variable coefficient of leverage is at a low level (β 22 = -0.3989)with a negative sign and a significance level of 1%, whereas at a higher level (γ 22 = 0.0238), it shows a positive sign and a significance level of 10%.Therefore, Hypothesis 2 is proven.When leverage is low, creditors or banks perform a relatively low monitoring function in the company.This brings a negative effect towards asset utilization because institutional shareholders can conduct expropriation through tunneling on creditors or banks which will lead to the decline in asset utilization.However, when leverage is high, creditors or banks obtain almost all control in asset utilization and this condition may result in the reduction in expropriation by means of tunneling.Friend and Lang (1988) discovered that leverage could be used to reduce agency conflict by inviting external parties to supervise the management.
evaluate and restructure the company's assets by considering an efficient business portfolio concept.This is evident with a proper control mechanism on asset utilization to improve corporate performance.Investors also need to perform an evaluation towards the behaviors of the managers in making policies related to the utilization of company assets.On the other hand, investors also need to consider the creditors' behaviour in monitoring the funding that the company receives, as well as observing the corporates' ability to pay due loan principals and interests.Additionally, decision makings made by business owners to change the ownership composition which involves institutional shareholders nees to be precise.This should be done so that the trade-off between expropriation effect and monitoring effect which comes as a result of the change in majority shareholders' behaviors will not bring a loss to investors despite tunneling.This study also gives an implication to creditors and banks in terms of lending decisions and control functions they set for the companies.
This happens because the parties involved reduce the act of expropriation since they suffer the most in the negative impact of the decline in corporate performance.Corporate control mechanism through leverage on corporate performance is a way to control the efficiency of monitoring cost.However, this proves to be insignificant in this study.Some recommendations for future research include the threshold borderline issue which shows that institutional ownership and leverage can be used as control mechanism as well as the issue of companies inside and outside the affiliation group which can show the tunneling-indicated related party transactions.The limitation in this study is that the available ultimate shareholder data have not been well-documented in Indonesia.Therefore, there is an insufficient amount of data to classify the ultimate shareholders into managerial ownership or independent groups.The difference in the classification may lead to different conclusions.The testing in this study is limited to non-linear context in the form of squared calculation.To study the influence pattern of control mechanism on institutional ownership and leverage towards asset utilization and corporate

Table 2 .
The next stage is to calculate the issued pre-determined variables and the endogenous variables entered with K value as the number of pre-determined variables in the model, k value as the number of predetermined variables in every equation in the model, and m value as the number of endogenous variables in every equation in the model.Based on the identification result of the simultaneous equation model as shown in Table3it can be seen that all equations are identified as

Table 5 .
Descriptive Statistics of Variables

Table 6 .
Test Results of Simultaneous Equation Model