The Role of Governance in the Economic Performance of Small to Medium Sized Family Enterprises in Indonesia

This study aims to investigate factors that encourage family firms to adopt either formal or relational governance in Indonesian context. Formal governance associated with the application of a formal contract and administrative control. Meanwhile, relational governance relating to the application of social control was examined. Even though family firms frequently employ relational governance there is little information about when family firms should adopt formal rather than relational governance. There is also a lack of evidence in the literature about the factors influencing the application of governance mechanisms in family owned SMEs and their appropriateness in the context of family SMEs. This thesis addresses two research questions: what are the influencing factors that determine governance mechanisms in family SMEs in Indonesia? Which is the most appropriate governance mechanism in the context of family SMEs in Indonesia? The study is based on primary data collected through questionnaires administered to the owner-managers of 350 family firms in Indonesia. This study uses factor analysis to validate the construct and hierarchichal regression to examine the hypothesis. This study used family SMEs in the manufacturing and service industries. These sectors involve close relationships with stakeholders including suppliers, producers, and consumers. The results showed that uncertainty is a determining factor for intra-firm relationships as family SMEs tends to formalize their control by using objective assessments and formal procedures such as strategic planning, budgeting and formal evaluation in times of uncertainty. Asset specificity, however, since it has a significant impact on both formal and relational governances, it may be excluded as a determinant of governance mechanism. The findings also supported a view that family firms' objectives did not have an effect on governance mechanism. With reference to inter-firm relationships, two factors - asset specificity and uncertainty - influenced both formal and relational governance. Asset specificity refers to the assets which are dedicated for particular purposes and their value will decrease when utilized for other purposes. Meanwhile, uncertainty refers to unpredictable changes surrounding exchanges. This study confirms that formal governance was more favourable than relational governance for anticipating asset specificity and uncertainty transaction. In the case of inter-firm relationships, there was no such preference as both formal and relational governance were preferred equally likely for responding to transaction of asset specificity and uncertainty. By addressing governance issues related to family SMEs, this study contributes to an understanding of the connections between the characteristics of family SMEs, economic business activities, environmental factors, and governance mechanisms in the Indonesian context