Theoretical Background and Development of Hypothesis
1734 corrective or repressive action. The release and applications of rules to contain fairness and
transparency principles are preventive actions to assure that the principles are implemented. Bapepam also conducts corrective actions such as punishment for public companies which
violate the regulation. Further, the punishment can be imposed to company leaders and
managers individually or collectively.
An example of regulation issued by the Bapepam is Rule No. X.K.1 on Information Disclosure. The regulation states that every public effectively registered company should report
the report to Bapepam and the public a decision or event that contain material information or that could possibly influence value of the stock or investor decision, as soon as possible no later
than the end of the 2
nd
day after the decision or the event occur. Theoretical framework that obliges management to disclose information about the condition
of the firm is explained in agency theory. Jensen and Meckling 1976 state that agency relationship exists if there is one or more individuals which called principal authorize the other
individual or organization, which called agent, to manage their wealth. The principal, then, will provide facilities to support the work of the agent. Principals also delegate to the agent
authorities to make decision with regard to the business and the wealth of the principals. An institution of monitoring and control is mandatory to assure that management acts on the
interest of principals, and for that reason a regulatory institution obliges publicly listed firms to file reports about their decisions and about the firm.
Fraud, Market Manipulation, and Conflict of Interest Fraud, market manipulation, and conflict of interest are typical unethical and unlawful acts
in business that benefit certain parties at the cost of others through unfair transaction. Regulation to prevent fraud, market manipulation, and conflict of interest transaction can be
explained using agency theory. Agency relationship is a contract between principals and agents Coase, 1937; Jensen and Meckling, 1976; and Fama and Jensen, 1983. The point from agency
relationship is segregation between ownership principal and control management. Principals have expectation that agents will provide a certain level of return for the money they invested.
Agency theory tries to answer the problems in agency relationship Eisenhardt, 1989: information asymmetry and different risk preferences, with effective contracting and effective
1735 regulation. Effective contracting and regulation facilitate principals and agents to reduce
agency problems. Principal may prevent the conflict of interest by using a good incentive and monitoring system Jensen and Meckling 1976. Agent can also spend a bonding cost at certain
circumstances to assure that there is no action against the principal‘s interest, or to assure that principal would give compensation to a beneficial action. However, agents still have a
possibility to make decisions that maximize their benefits. The value of money that equal to a reduction of principal‘s prosperity is also a cost for the agency relationship which usually called
as a residual loss. Effective contracting and regulation may stimulate other instruments to reduce agency
problems and agency costs Jensen and Meckling 1976: the work of market for managerial resources, the work of efficient capital market, and market for corporate control.
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A manager could be fired and replaced if he or she does not perform. Market for managers can also close
the opportunity for bad managers, either bad performers or bad attitudes. The work of efficient capital market can be used as measurement of manager‘s performance through the company
stock price, while market for corporate control may threaten weak corporate management by acquisition. In summary, an effective regulation will prevent fraud, market manipulation, and
conflict of interest transaction. Contracts and regulation are made to make the relationship capable to explain the items of
the tasks of the management in managing the fund from investor. Ideally, they should sign a detailed contract which capable to accommodate all possible situations in the future. However,
uncertainties of the future obstruct the making of perfect contract. Considering this situation, investors ought to give residual controlling rights to management, which is, rights to make
decisions on certain occasions which have not been accommodate by the contract. Manager has a discretionary right in managing investor‘s fund and managers could do an expropriation of the
fund. εanager‘s residual control right provide opportunities for embezzlement, that eventually
resulted in disadvantages for investors.
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Contract and regulation laws are similar in terms that both are agreed items by parties involved in the agreements. The difference is that contract is bound to limited signing parties while regulation is
bound to the community members involved in transaction being regulated. Thus regulation is broader laws that contracts.
1736 Expropriation could happen in many forms such as embezzling investor‘s fund, sell
compan y‘s product to manager‘s company an example of related party or conflict of interest
at lost, and selling other company‘s assets to manager‘s company. The worst form of expropriation is keeping the managerial position although there is lack or not enough
competence Shleifer dan Vishny, 1989. Jensen and Ruback 1983 contend that a fact of unqualified managers who defend their position is the most expensive agency problem.
Timely Submission of Financial Statement Financial reporting is a medium of communication for company and interested parties or the
stakeholders. It contains all information about the company especially company‘s economic resources and measurement of management achievement. The extent of benefit of financial
reporting is determined one other things by the timeliness of financial reporting Givoly and Palmon 1λ8β, Schwartz and Soo 1λλ6, and Na‘im β000. The benefit of the financial report
decreases as the time passes IAI 2002. Timely financial reporting decreases the asymmetric information Kim dan Verrechia 1994.
The timeliness of financial reporting contributes to improve capital market efficiency, it is one of evaluation and pricing tools, one of information resources to prevent insider trading and to
reduce leakage of information or rumor in stock market Owusu and Ansah 2000. In Indonesia, the timely financial reporting is regulated in Law no. 81995 about Capital Market and
Bapepam rule No.80PM1996 about Submission of Periodic Financial Reporting.
Compliance and Non-Compliance Hypotheses Issues about compliance and non-compliances have been examined in social science
especially in economics, psychology and sociology research. Compliance is personal, group or organizational behavior to do or not to do something in accordance with rules. Economics
studies focus more on rational decision made by individuals to comply or not to comply considering the economic utility Becker 1968. Psychology and sociology literature describe
that compliance behavior is determined by internal and external factors Tyler 1990a, 1990b. Internal factor is a will that emerges from nature of individuals, the strength of which would
1737 influence their way of thinking and could control their behavior. External factor is strength
from outside individuals which could influence their way of thinking and behavior. Tyler 1990a, 1990b also contends that there are two basic perspectives in sociology
literature about law compliances: instrumental and normative perspective. Instrumental perspective assumes that an individual is entirely pushed by self interests and responses toward
changes in tangible, incentive, and penalty that related to behavior. Normative perspective assumes that an individual is more oriented to moral values and against their personal interests.
Individual tends to obey law that they think it is in accordance and consistent with their internal norms. Normative commitment through morality means that an individual obeys the
law because it is thought it is good, whereas normative commitment through legitimacy means that an individual obeys the law because the regulation that constructs the law has the right to
control the behavior. This study extends the sociological perspectives of compliance behavior by looking at the
behaviors of firms in complying or not-complying the capital market regulation in Indonesia. We posit that financial conditions of the firms may drive the firms to comply or not to comply
the regulations. Firms may tend to hide or to delay the release of information due to financial difficulties the firms face.
We try to explore the association of financial positions i.e. total asset, total sales, financial distress, profitability, and liquidity with behavior of the firms in complying or not complying
to the capital market regulation i.e. the rule of timeliness of financial reporting, information openness, conflict of interest transaction, and fraud and market manipulation. The reason
behind this prediction is that management attempts to hinder financial difficulties by non- complying to the regulations. Another reason is that firms tend to comply with the regulation
when they are in good financial positions, and when they have effective contracting so that they do not need to violate the laws. This research extends previous studies that focus on
information regulation disclosures and timeliness of financial reporting to other regulation such as regulation against conflict of interest transaction and market manipulation. Thus, we
hypothesize that larger firm size, lower debt to equity ratio, higher profitability, and higher liquidity are negatively associated with non-complying behavior of the firms.
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