Thursday, September 07, 2006

New CIFOR Research

Asia Pulp & Paper Indonesia: The business rationale that led to forest degradation and financial collapse

Asia Pulp & Paper (APP) has expanded impressively during the 1990s to become the largest pulp and paper producer in Asia outside Japan, and one of the top ten producers in the world. In March 2001, the group suddenly announced a debt standstill on $13 billion, after many years of high profits due to very low production costs. The group is controlled by the Widjaja family members, its ultimate owners, who have been able to finance most of the expansion in Indonesia through domestic and international debts (bank loans or bonds). This family also controls Sinar Mas, which is one of the top Indonesian conglomerates. The pyramid structure of APP allows the ultimate owners to dilute their direct investment along a chain of intermediaries, while keeping control of the decisions and accounts. Research in finance has proved that this well-known strategy of reducing the ownership rights relative to the voting rights, usually causes poor corporate governance and reduced business performance. This phenomenon was particularly true in the case of the Asian type corporate model with its highly concentrated ownership in the hands of families. We found numerous transactions between APP and Sinar Mas affiliated companies, and these appear to suggest the use of transfer pricing. In particular, we are concerned by the possible instrumental use of the companies in charge of wood supply (the main operational cost for the pulp industry), and which are presumably owned by the ultimate owners without any control by minority shareholders and creditors of APP. The rents resulting from the clearing of natural forests to supply mills, which we estimate, were unusually high. The main use of debts to finance the enormous investments of APP is also remarkable for two reasons: huge profits were made in the short term owing to a low cost access to natural forests in Indonesia; and the creditors’ rights could never be satisfied due to poor law enforcement and the absence of a cross-border insolvency regime in the Asia-Pacific region. This suggests that APP is a case of debt entrenchment, the theory of which says that conglomerates use debts to prioritize the ultimate owners’ interests to the detriment of minority shareholders and external creditors. Finally, some facts suggest that politics were also important in the ability of the group to survive, as the Indonesian government held back claims on domestic debts and influenced the debt restructuring process. More