10.1108@ARA-01-2018-0020

Asian Review of Accounting
Budget implementation in a risky environment: evidence from the Indonesian
public sector
Fuad Rakhman,
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Budget implementation in a risky
environment: evidence from the
Indonesian public sector
Budget
implementation
in a risky
environment
Fuad Rakhman
Faculty of Economics and Business,
Universitas Gadjah Mada, Yogyakarta, Indonesia
Received 24 January 2018
Revised 9 June 2018
30 December 2018
Accepted 2 March 2019
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Abstract
Purpose – The purpose of this paper is to investigate factors affecting budget implementation among local
governments in Indonesia, where rules are relatively strict and risks of facing corruption charges are high.
Design/methodology/approach – This study employs regression analyses using a sample of 1,151 local
government-years.
Findings – This study finds that the level of budget implementation is affected by the leadership factors (i.e.
mayors’ term, tenure and age) and the proportion of capital expenditures. The level of budget implementation
is relatively lower when the mayor is in the second term, is in the early years of the five-year tenure and is
over 60 years old. Higher proportion of capital expenditures also reduces the level of budget implementation.
Originality/value – This study contributes to the literature by presenting empirical evidence as to what
factors explain the variations in the level of budget implementation among local governments especially
under strict rules and a risky environment.
Keywords Local government, Budget implementation
Paper type Research paper
1. Introduction
Budget implementation or budget execution is an important mechanism of the budgeting
process (Hackbart and Ramsey, 1999). Budget implementation among governmental
institutions is a major concern for central governments (Albulescu and Goyeau, 2014;
Oliewo, 2015; Paliova and Lybek, 2014) as government spending usually accounts for a
significant proportion of economic activities. However, most studies focus on budget
preparation while not enough attention paid to budget implementation (McCaffery and
Mutty, 1999). This study explores the determinants of the level of budget implementation
among local governments in Indonesia, where rules on budget implementation are made
very strict and risks of governmental leaders facing corruption charges are relatively high.
Agency theory assumes that managers are risk and effort averse (Baiman, 1990; Jensen
and Meckling, 1976). Under a strict and risky environment, risk- and effort-averse managers
often opt to act cautiously in executing strategies, leading to slower budget implementation
and poor strategy execution, especially when the increased risks are not associated with
greater rewards as is common in governmental institutions. Evidence suggests that
managers who take on risks without being adequately compensated for these risks will
suffer poor performance (Sheehan, 2010). Poor budget implementation by mayors of local
governments potentially impedes the development of the local governments in particular
and has negative impacts on the economy of the country in general.
Despite the critical impacts of budget implementation on national economies, studies
investigating the factors affecting budget implementation among governmental institutions
The author would like to thank two anonymous reviewers and the editor, the participants of the 2016
European Accounting Association annual meeting in Maastricht, the Netherland and of the research
workshop at the Department of Accounting, UGM for comments. The author thanks the Faculty of
Economics and Business, UGM for the research grant.
Asian Review of Accounting
© Emerald Publishing Limited
1321-7348
DOI 10.1108/ARA-01-2018-0020
Downloaded by Stockholm University Library At 00:08 25 April 2019 (PT)
ARA
remain scarce. An examination of budget implementation in the context of Indonesian local
governments is important for the following reasons. First, Indonesia provides a unique
setting where rules on budget implementation by local governments are arranged in a
relatively strict manner to minimize the possibility of corruption. For example, existing rules
require that any governmental project or procurement involving funds of at least 200m
rupiahs (around $15,385, with $1 ¼ Rp13,000) be completed through bidding instead of a
direct appointment. If the project fails to attract more than one bidder, the bidding process
has to be restarted over again. Many believe that such rules have become a source of slow
and frustrating budget implementation among governmental institutions[1].
Second, with the strong efforts by the Corruption Eradication Commission in Indonesia to
track down corruption among governmental officials, implementing budgets through program
executions becomes riskier for governmental executives. As of early 2014, in the course of the
10 years since the era of the direct election of governmental leaders (presidents, governors and
mayors) began, 318 governmental leaders (including governors and mayors) had been charged
with being suspects of corruption ( Jawa Pos, 2014). Interestingly, some of them were charged
merely because they did not follow the correct procedures instead of the intention to steal
public money. This statistic creates concerns and leads to overly cautious behavior on the part
of mayors to minimize the possibility of facing corruption charges, resulting in slow and weak
budget implementation[2]. In 2015, for example, by the end of June, the budget realization
among provincial and local governments only reached 25.9 and 24.6 percent, respectively
(Republika, 2015), indicating slow program implementation at the national level[3]. Even
though each local government is required to prepare a balanced budget, this study shows that
on average local governments only spent 90 percent of the overall budget (and only 83 percent
of the capital budget), leaving a large chunk of the remaining funds unused by the end of year.
In light of the relatively strict environment and under a higher risk associated with
implementing budgets, it is interesting to explore what factors would affect the extent of
budget implementation among local governments in Indonesia.
This study mainly examines whether managerial factors (i.e. mayors’ ages, tenure, term and
gender) affect budget implementation. This study finds that budget implementation is higher:
when mayors are still reelection eligible, the closer to the election year and when mayors’ age is
below 60 (i.e. a typical retirement age). This study controls for institutional factors and for the
budget composition. This study further reveals that budget implementation is negatively
associated with the size of the government, the status of a local government as a city
(metropolitan area) and the proportion of capital expenditures out of the total budget.
This study contributes to the literature by presenting empirical evidence as to what factors
explain the variations in the level of budget implementation among local governments
especially under strict rules and a risky environment. This study differs from other studies
examining the issue of budget implementation in Indonesia at the subnational level by
employing an empirical/archival approach. Some other studies have examined this issue using
a descriptive (e.g. Putra et al., 2011) and a survey approach (such as Harryanto et al., 2014). This
study sheds some light on the causes of low budget implementation, and some alternatives to
improve the implementation of local governments’ budgets, and thus help the country maintain
and support its economic growth. For example, one policy implication is that since the
Indonesian central government has been very concerned about low budget implementation
among local governments, more monitoring by the central government may be needed.
The findings of this study suggest that monitoring should be more emphasized on mayors in
the second term whose motivation is relatively low. The finding is consistent with Antia et al.
(2010) stating that a shorter decision horizon is associated with greater agency costs.
The research findings potentially provide constituents with the knowledge on the
characteristics of governmental leaders who would better promote the development of their
local government, through better program implementation. The public tendency is to reelect
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a mayor, who performed well the first time around, to serve a second term. However, this
study shows that budget implementation is usually weaker when mayors serve a second
term, most probably because they are legally banned from running for a third term, and this
lowers their incentive to implement programs.
Further, there have been disagreements in the public discourse in Indonesia as to
whether an age limit (both upper and lower) is necessary for governmental leadership
positions. This study provides support for setting an upper age limit for candidates running
for mayors, as the local governments whose mayors are over 60 years old tend to have
relatively poor program implementation (e.g. due to higher risk aversion), as reflected by
their lower budget realization. This is consistent with Roger and Suarez (1983) that risk
aversion is increasing with age.
2. Institutional setting and hypotheses development
The level of a budget implementation in governmental institutions is a concern for many
countries. For example, budget absorption has been a big issue in many African countries
(e.g. Oliewo, 2015). In the European Union, many studies have been conducted to address
the absorption of the structural and cohesion funds in the EU (Albulescu and Goyeau, 2014;
Paliova and Lybek, 2014). In Indonesia, slow budget implementation has been a concern
since the application of the new budgeting systems where local governments cannot use
funds for activities or projects other than those which were approved in the budget.
2.1 Public budgeting and budget implementation in Indonesia
Indonesia currently has 34 provinces (each led by a governor). Under the provinces, there are
over 500 regencies (kabupaten) and cities (kota), which are led by mayors[4]. Every single local
government has to go through the budgeting process annually. The process of preparing a
budget for the next fiscal year usually starts in early June and is initiated by the executive
branch, who sets general guidelines for the budget preparation. The budgeting process is
relatively participative, in that the various agencies propose their budgets to be discussed and
negotiated with mayors. The budget is expected to be ready, and made formal and binding, by
the end of December with the approval of the local parliament. As soon as the budget becomes
effective, throughout the fiscal year, the central government monitors the implementation of
the budget by all governmental sectors, including local governments. Periodically, local
governments submit reports on the realization of their budget to the Ministry of Finance.
Since 2003, the Indonesian Government has adopted performance-based budgeting
systems, which is a prominent reform around the world (Andrews, 2003, 2004). The new
budgeting system is designed to improve the efficiency, effectiveness and control of public
expenditures by linking the funding to the key performance indicators. One of the
consequences of this adoption is that at the end of the year, unabsorbed funds cannot be used
for activities or programs beyond those already outlined in the budget. Instead, the unabsorbed
funds will be recognized as “excess funds” and roll over into the next fiscal period and may be
used as an additional source of financing. Crain and O’Roark (2004) provided evidence that
performance-based budgeting reduces state spending per capita by at least 2 percent.
Previously, the government implemented a “use it or lose it” policy. Under this policy,
there were huge incentives to spend funds especially near the fiscal year’s end to avoid fund
expirations and to reduce the probability of the central government cutting their budget in
the following fiscal year (Fichtner and Michel, 2016). On the one hand, the “use it or lose it”
policy improves budget realization. On the other hand, however, it potentially creates
irresponsible behavior by the local governments and agencies near the end of the fiscal year,
as they would spend any remaining funds on items or projects that would benefit neither the
institutions nor the people. Thus, local governments spend a huge amount of money just for
the sake of avoiding fund expiration and face zero opportunity costs, hurting the local
Budget
implementation
in a risky
environment
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ARA
governments’ budget efficiency. Liebman and Mahoney (2017) documented evidence that
year-end spending sprees among US governmental agencies (where the “use it or lose it”
policy applied) is associated with lower quality projects.
The central government has an interest in making sure that the limited resources
appropriated in the budgets are utilized in the most effective and efficient way. With
the approval of the parliament, the central government abolished the “use it or lose it”
policy in 2003 and let unabsorbed funds to roll over into the next period. However, a persistent
problem in the budget realization is that local governments are usually slow in implementing
their programs in the first semester of the fiscal year. The central government has observed that
most of the time, large proportions of the available funds are spent near the end of the fiscal
year. Unfortunately, by the end of the fiscal year, under the new system, most local governments
are not able to absorb the entire funds appropriated in the budget for many reasons.
A report by the Indonesian National Development Planning Body identified several
factors causing the slow and low implementation of governments’ budgets. One factor is
related to the bureaucracy. When budget users failed to show the supporting documents for
accountability purposes, the Ministry of Finance froze the budget account until they
submitted all the necessary documents, which might take them some time to furnish.
Another factor is related to capital expenditures, which can involve a lengthy tender
process. When such projects involve building infrastructure which requires the purchase
and clearance of land, the process can be slowed down due to disputes between the local
government and the owners of the land (usually concerning land prices), creating
unnecessary delays to the projects’ initiation and completion.
Another alleged source of slow and weak budget implementation is the country’s war
against corruption. Indonesia established the Corruption Eradication Commission in 2002 to
minimize corruption especially in governmental institutions. The definition of corruption in
Indonesia is very broad that many governmental leaders were charged with corruption even
in the absence of the intention to steal public money; some of them failed to follow the proper
procedures correctly, and then corruption cases were built against them when there were
state losses involved. This introduces more risks associated with budget implementation
among mayors of local governments, and the increased risks have been blamed for the
weaker budget implementation in the country.
2.2 Hypotheses development
The agency theory assumes that the interest of principals and agents are not necessarily
aligned (Eisenhardt, 1989; Jensen and Meckling, 1976). The issue of conflict of interest arises
from the assumption that agents are opportunistic and effort averse (Baiman, 1990). Other
critical issues in the agency theory are performance measurement and incentive systems
(Lambert, 2001, 2006). In light of the agency theory, if mayors perceive reelection as rewards
for exerting costly efforts, it is predicted that mayors will behave differently when they are
still eligible for reelection and when they are not. More specifically, when term limit binds
and mayors are legally banned to run for reelection, the incentives are taken away from the
equation, effectively reducing their motivation to exert efforts and to act in the best interest
of the principal. In this case, agents are more likely to commit political shirking (Lott, 1990).
Further, agency theory assumes that agents are risk averse ( Jensen and Meckling, 1976). In
the context of Indonesian local governments where implementing budgets are associated
with risks (e.g. of facing corruption charges and project failures), the effect of eliminating
rewards on the level of mayors’ efforts is expected to be more profound. When agents face
greater risks without being reasonably compensated, the performance would decline
(Sheehan, 2010).
2.2.1 Horizon problem. Studies have found that managers nearing the end of their
service (i.e. resignation or retirement) suffer from horizon problems. Managers do not have
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strong enough incentives to invest in projects whose outcome will materialize beyond their
service horizon. For example, managers with a shorter horizon tend to avoid projects with a
longer payback period (Antia et al., 2010). Managers in their final year in office reduce R&D
spending to maximize profits, while R&D expenditure is necessary to maintain firms’ longterm growth (Cheng, 2004; Dechow and Sloan, 1991; Murphy, 1999). In the governmental
setting, Alt et al. (2011) documented that US states with reelection eligible governors enjoy
higher economic growth compared to those whose governors already reach the end of term
limit and are legally banned from running for reelection. In their first terms, mayors have a
strong desire to implement programs more extensively as they perceive that implementing
programs is an “investment” that will improve their chances of getting reelected. This is
because governmental leaders eligible for reelection care about reputation buildings (Besley
and Case, 1995). Mayors in their second term, however, are not likely to be reelected and
thus have lower incentives to implement programs in the budget. Thus, the weak budget
implementation could be attributed more to a lack of incentives rather than a lack of
capacity to implement programs by the leadership teams. It is expected that budget
implementation is weaker when mayors are in their second term than in the first term:
H1. The level of budget implementation is higher under first-term mayors than that
under second-term mayors.
2.2.2 Political budget cycles. Mayors observe reelection as a reward for their performance in
implementing programs. The literature on political budget cycles (Rogoff, 1990) suggests that
politicians become more opportunistic as elections draw nearer and take actions that would
increase their chances of getting reelected. Klein and Sakurai (2015) found that first-term
mayors in Brazil reduce revenues from taxes and switch operational expenditure into capital
expenditures in the last year before elections. During the five-year tenure of a mayor’s first
term, it is expected that budget implementation is higher in the years nearing the election
(Years 4 and 5) compared to the early years during the five-year tenure (Years 1–3):
H2. The level of budget implementation is higher when closer to the election year.
2.2.3 Upper Echelon theory. The upper echelon theory (Hambrick and Mason, 1984) suggests
that the strategies and outcomes of an organization reflect the characteristics and
backgrounds of its top managers such as age, experience, education and socioeconomic
backgrounds, and financial positions. In other words, leadership effectiveness, as reflected by
organizational performance, is influenced by the characteristics of the top managers. Extant
studies confirm that top managers do matter when it comes to strategy implementation
and organizational performance (Chaganti and Sambharya, 1987; Díaz-Fernández et al., 2015;
Norburn and Birley, 1988). The theory, for example, predicts that firms with younger
managers are inclined to take risky strategies and enjoy greater growth than those with older
ones. In light of this theory, in the context of local government, younger mayors are less risk
averse and are more likely to implement their programs intensively and thus improve the
budget realization of their local governments. It is expected that the mayors’ age is negatively
associated with the level of budget implementation:
H3. The level of budget implementation is negatively associated with the age of
the mayor.
3. Methods
3.1 Research model
This study examines the determinants of budget implementation among local governments
in Indonesia. Several managerial factors that potentially affect budget implementation
Budget
implementation
in a risky
environment
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ARA
are identified. The managerial factors incorporate the characteristics and details of mayors
such as their term, tenure, gender and age. The model also incorporates institutional factors
such as local governments’ size, their geographic location and their status as a regency or a
city (e.g. metropolitan area). Finally, the model includes the budget composition, which is
measured as the proportion of capital expenditures out of the total budget. The central
government commonly uses the level of budget realization as a measure of budget
implementation, with the assumption that a higher budget realization indicates that more
programs are being implemented. Even though budget realization reflects the amount of
input (efforts) rather than output (results) of budget implementation, it is a critical indicator
for the central government in Indonesia to use to evaluate the effectiveness of local
governments. Accordingly, this study uses budget realization as a proxy for budget
implementation. The model is presented as follows:
Realizationit ¼ m0 þm1 TERM it þm2 TENRit þm3 GN DRit þm4 AGE it þm5 SI Z E it
þm6 CAPEX it þm7 J AV Ai þm8 M ETROi þFixed ef f ect þe;
(1)
where Realizationit is the budget realization ratio as measured by the actual spending
divided by the total budget of local government i at year t[5]; TERMit a dummy variable set
to 1 if the mayor of a local government i in year t serves a second term, and 0 otherwise;
TENRit a dummy variable set to 1 if the mayor of a local government i in year t is in the
fourth or fifth year of his/her tenure, and 0 otherwise; GNDRit a dummy variable set to 1 if
the mayor of a local government i in year t is a male, and 0 if a female; AGEit a dummy
variable set to 1 if the age of the mayor of a local government i in year t is 60 years or older,
and 0 otherwise[6]; SIZEit a natural log of the total assets of a local government i in year t;
CAPEXit the capital expenditure ratio as measured by the amount of the capital expenditure
budget divided by the total budget of a local government i in year t; JAVAi a dummy
variable set to 1 if the local government i is situated in the islands of Java or Bali, and 0
otherwise; METROi a dummy variable set to 1 if the local government is located in a
metropolitan area; Fixed effect the year fixed effect; and e the error term.
I control for gender as gender affects managers’ risk preference (Khan and Vieito, 2013)
and potentially affects organizational performance. The model also control for institutional
factors such as the size of the institution (Aggarwal et al., 2012; McClelland et al., 2012),
whether the local government is located in a metropolitan area where people are more
politically active (Rosenstone and Hansen, 1993) and more involved in government’s
decision making (Yang and Callahan, 2007), the proportion of its capital expenditure budget
with respect to its total budget, and the geographic location whether it is situated in Java or
Bali[7] as regions in these islands are known to be relatively more developed than others.
Additionally, the model incorporates the year fixed effect to control for countrywide effects
as the budget implementation of local governments was likely to move together across
years. For example, when the economy was sluggish in a certain year, it is expected that in
general the budget implementation would decline in all local governments.
3.2 Sample and data
The sample of this study includes local governments from all the provinces in Indonesia[8].
This study uses financial reports released by the local governments during the periods from
2008 through 2011, during which the central government was still under the same president
to control for possible variations in budget realization between presidents. The financial
reports provide financial data (e.g. total budget, actual spending, total assets and capital
expenditures) and institutional data (e.g. the size and location of governments, whether the
local government is located in a metropolitan area). The names of mayors are mentioned on
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the signing page of the financial reports, while the rest of mayors’ details (e.g. age, term,
tenure and gender) were manually collected from various sources and websites.
Local governments are required to submit financial reports on an annual basis
containing a balance sheet, a budget and realization report, a cash flow statement and notes
relevant to the statements. The Supreme Audit Board audits the reports and delivers an
audit opinion on each individual report. The audit opinions accompanying the financial
reports are diverse, ranging from unqualified to disclaimer. To increase the reliability of the
financial data for this study, this study excludes observations whose financial reports
received an adverse opinion or a disclaimer from the Supreme Audit Board. Thus, this study
includes only those reports receiving unqualified and qualified opinions, which presumably
have more reliable and accurate accounting information. The elimination of reports with
an adverse or a disclaimer of opinion reduces the sample size by 496 observations.
Observations with incomplete information and those with extreme and questionable values
are excluded, resulting in a sample size of 1,151 local government-years. The sample
selection procedure is described in Table I.
Table II presents the distribution of the total budget realization and capital budget
realization by year. The table shows that the capital budget realization is always lower than
the total budget realization. This implies that lower budget realization is relatively more
associated with the capital budget instead of the operational budget. The mean (median)
capital budget realization is 82.9 percent (85 percent) during the four-year periods.
The lowest capital budget realization occurred in the year 2011 with the overall average
being 78.8 percent, while the highest was in 2009 with an average of 88.6 percent. The table
further shows that budget realization was the lowest in 2008 where the mean (median)
realization was only 89.03 percent (90 percent). In the other three years, the average budget
realization was relatively similar at around 90 percent. The highest budget realization in the
sample was 99 percent.
Budget
implementation
in a risky
environment
4. Results and discussions
4.1 Descriptive analysis
This study uses 1,151 local government-years as the sample from the 2008 through 2011 fiscal
years. Table III shows the descriptive statistics of the variables examined in this study. The
average (median) budget realization during the period was 90.13 percent (91.46 percent).
Initial number of observations
Financial reports with an adverse opinion or disclaimer
Observations with insufficient information
Observations with extreme values
Final sample size
Year
n
Mean
Total budget realization
Min.
Med.
Max.
1,760
(496)
(85)
(28)
1,151
SD
Mean
Capital budget realization
Min.
Med.
Max.
Table I.
Sample selection
procedure
SD
2008
260
0.890
0.53
0.90
0.99
0.068
0.859
0.48
0.89
0.99
0.110
2009
267
0.907
0.60
0.92
0.99
0.062
0.886
0.45
0.92
0.99
0.103
2010
298
0.903
0.68
0.91
0.99
0.052
0.795
0.44
0.81
0.98
0.112
2011
326
0.903
0.63
0.91
0.98
0.051
0.788
0.42
0.80
0.99
0.113
All
1,151
0.901
0.53
0.91
0.99
0.058
0.829
0.42
0.85
0.99
0.117
Notes: Total budget ¼ operational budget + capital budget. The total budget realization is then the weighted
average realization of the operational budget and the capital budget
Table II.
Total budget and
capital budget
realization by year
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Table III.
Descriptive statistics
of the variables
Variables
n
Mean
Min.
Q1
Med.
Q3
Max.
SD
TREAL (%)
1,151
90.13
52.84
87.88
91.46
94.02
99.07
5.80
TERM
1,151
0.38
0
0
0
1.00
1.00
0.49
TENR (years)
1,151
2.81
1.00
2.00
3.00
4.00
5.00
1.42
AGE (years)
1,151
51.35
30.00
46.00
52.00
57.00
75.00
8.14
GNDR
1,151
0.97
0
1.00
1.00
1.00
1.00
0.17
CAPEX (%)
1,151
24.30
5.35
16.98
22.89
29.60
61.07
9.64
SIZE (billion rupiahs)
1,151
2,004
12
1,056
1,512
2,193
36,556
2,293
JAVA
1,151
0.35
0
0
0
1.00
1.00
0.48
CITY
1,151
0.22
0
0
0
0
1.00
0.41
Notes: TREAL ¼ the total budget realization ratio as measured by the total actual spending divided by the
total budget of local government i at year t. TERM ¼ a dummy variable set to 1 if the mayor of the local
government i in year t serves in the second term, and 0 otherwise. TENR ¼ a dummy variable set to 1 if the
mayor of the local government i in year t is in the fourth or fifth year in his/her tenure, and 0 otherwise.
GNDR ¼ a dummy variable set to 1 if the mayor of the local government i in year t is a male, and 0 if a female.
AGE ¼ a dummy variable set to 1 if the age of the mayor of the local government i in year t is 60 years or
older, and 0 otherwise. CAPEX ¼ the capital expenditure ratio as measured by the amount of the capital
expenditure budget divided by the total budget of local government i in year t. JAVA ¼ a dummy variable set
to 1 if the local government i is situated in Java or Bali, and 0 otherwise. CITY ¼ a dummy variable set to 1
if the local government is in a metropolitan area (kota), and 0 if it is a regency (kabupaten)
This means that on average, every year the local governments failed to absorb nearly
10 percent of the funds in their budget. The lowest budget realization in the sample is
52.84 percent, while the largest is 99.07 percent. Around 62 percent (38 percent) of the financial
reports in the sample were signed by mayors serving in their first (second) term. The average
(median) age of the mayors is 51.35 years (52 years), with the youngest mayor being only
30 years old, and the oldest 75 years old. The vast majority (97 percent) of observations has a
male mayor. The average (median) proportion of capital expenditures with respect to the total
budget is 24.30 percent (22.89 percent), ranging from the smallest proportion of 5.35 percent to
the largest proportion of 61.07 percent. The average total assets in the sample are 2 trillion
rupiahs (or $148m, $1 ¼ Rp13,500), with the smallest having 12bn and the largest 36.6 trillion
rupiah. Around 35 percent of the local governments in the sample are situated in Java or Bali,
and 22 percent are in metropolitan areas.
4.2 Correlation analysis
Table IV presents the Pearson’s correlation coefficients among variables used in this study.
The coefficients in the table suggest that there is no multicollinearity issue. The strongest
correlation seems to be between CAPEX and JAVA (r ¼ −0.532), indicating that the capital
Variables
Table IV.
Correlations analysis
REAL
TERM
TENR
GNDR
AGE
CAPEX
SIZE
REAL
1
−0.046
0.033 −0.018 −0.079** −0.384**
0.022
TERM
1
−0.025
0.023
0.103** −0.058
0.090**
TENR
1
0.05
0.044
0.134**
0.004
GNDR
1
0.024
0.091** −0.105**
AGE
1
0.070*
0.044
CAPEX
1
−0.207**
SIZE
1
JAVA
CITY
Notes: *,**Correlation is significant at 5 and 1 percent levels, respectively
JAVA
CITY
0.189**
0.088**
−0.068*
−0.190**
0
−0.532**
0.366**
1
−0.111**
0.054
−0.025
0.007
0.060*
−0.032
0.045
0.013
1
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budget proportion is relatively higher in local governments outside the island of Java.
This is consistent with the governmental policy created in 2008 to promote acceleration of
development in less developed regions. Therefore, local governments outside the island of
Java would allocate a higher percentage of funds on capital expenditures. The second
largest correlation is between CAPEX and REAL (r ¼ −0.384), showing that the local
governments with the higher level of capital expenditures have relatively lower program
implementation. The next strongest correlation is between JAVA and SIZE, indicating that
local governments situated in the island of Java tend to be larger (i.e. have more assets).
Budget
implementation
in a risky
environment
4.3 Regression results
Table V presents the results of two separate regression analyses exploring the determinants of
local governments’ budget implementation when the dependent variable is: the total budget
implementation (TREAL) and the capital budget implementation (CREAL). The table shows
that the variable TERM reduces budget implementation. This basically means that budget
implementation is generally weaker when mayors are serving their second term than when
serving a first term. The variable tenure (TENR) increases budget implementation, indicating
that during the five-year tenure in a single term, budget implementation improves when
the mayors are in their fourth and fifth years, compared to that in their first three years.
Dependent variable
Variables
Constant
TERM
TENR
GNDR
AGE
CAPEX
SIZE
JAVA
CITY
F-statistics
Adjusted R2 (%)
n
Notes: Model:
Exp. signs
−
+
?
−
−
?
?
?
TREAL
CREAL
1.024***
−0.050*
0.089***
0.017
−0.055**
−0.465***
−0.056**
0.021
−0.099***
32.1
22.90
1,151
0.983***
−0.047*
0.051*
0.005
−0.060**
−0.109***
−0.036
−0.107***
−0.006
18.2
14.10
1,151
Realizationit ¼ m0 þ m1 TERM it þm2 TEN Rit þ m3 GNDRit þ m4 AGE it
þ m5 SI Z E it þm6 CAPEX it þ m7 J AV Ai þ m8 CI TY i þ Fixed ef f ect þ e:
TREALit ¼ the budget realization ratio as measured by the actual total spending divided by the total budget
of the local government i at year t. CREALit ¼ capital budget realization ratio as measured by the actual
capital expenditure divided by the total capital expenditure budget of the local government i at year t.
TERM ¼ a dummy variable set to 1 if the mayor of the local government i in year t serves in the second term,
and 0 otherwise. TENR ¼ a dummy variable set to 1 if the mayor of the local government i in year t is in
the fourth or fifth year in his/her tenure, and 0 otherwise. GNDR ¼ a dummy variable set to 1 if the mayor of
the local government i in year t is a male, and 0 if a female. AGE ¼ a dummy variable set to 1 if the age of the
mayor of the local government i in year t is more than 60 years old, and 0 otherwise. SIZE ¼ a natural log of
the total assets of the local government i in year t. CAPEX ¼ the capital expenditure ratio as measured by the
amount of the capital expenditure budget divided by the total budget of the local government i in year t.
JAVA ¼ a dummy variable set to 1 if the local government i is situated in Java or Bali islands, and 0 otherwise.
CITY ¼ a dummy variable set to 1 if the local government is a metropolitan area (city), and 0 if it is a regency
(kabupaten). The result on the year fixed effect is not reported for brevity. *,**,***Significant at the 10, 5 and
1 percent levels, respectively
Table V.
Regression results
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ARA
This might be interpreted as the mayors speeding up their program implementation as
elections draw nearer to increase the chances of them getting reelected.
The results further show that the mayors’ age (AGE) negatively affects budget
implementation. More specifically, this study finds that budget implementation is significantly
weaker when a mayor who is older than 60 years controls the local government[9]. Research
suggests that young managers are more willing to take risky strategies (Hambrick and Mason,
1984) than older managers. This finding is consistent with the view that older managers are
more risk averse and conservative. Since implementing programs especially those associated
with capital expenditures in local governments are risky (e.g. risk of project failures, risk of
facing corruption charges), mayors who are older than 60 are relatively more reluctant to
implement planned programs, thus reducing budget realization.
The results in Table V further suggest that a high proportion of capital expenditures
(CAPEX) in the budget is a major source of low budget implementation. On average, a
1-percent increase in capital expenditures in the budget will reduce total budget realization
(TREAL) by 0.46 percent in that year, and the result is significant at the 1 percent level.
The size of the government (SIZE) is negatively associated with budget implementation.
The larger the amount of total assets that a local government has, the weaker the budget
implementation is. Further, budget implementation tends to be weaker among local
government in metropolitan areas. Since cities (metropolitan areas) are relatively more
developed, there is relatively less room for program implementation, especially those
associated with infrastructure. Further, implementing programs in larger local governments
is more complicated and time consuming than in smaller governments.
Additionally, the results show that the capital budget implementation (CREAL) is
significantly affected by the geographical location of the local governments. This study
finds that when the regencies or cities are located in Java or Bali, the capital budget
realization is lower. This implies that implementing programs associated with a capital
budget (such as building new roads) in highly populated Java/Bali is more complex and
might be constrained by the availability of land than in regencies or cities outside these
two islands.
4.4 Additional analysis
The results in Table V show that the mayors’ ages are a significant determinant of the local
governments’ budget implementation. The results suggest that budget implementation is
weaker when a mayor who is older than 60 leads a local government. As an additional
analysis, Table VI presents the budget implementation by the mayors’ age groups.
The table shows that total budget realization is consistently above 90 percent for age groups
I through III where the mayors’ ages are 60 years or below. However, for age group IV
(61–65 years), the average budget realization significantly declines to 86.5 percent. Further,
for the mayors in age group V (above 65 years old), the budget realization gets even worse,
down to an average of 85.3 percent. A similar pattern is observed for the capital budget
realization where age 60 seems to be the critical turning point for the realization level.
Age group
Mayors’ age (years)
Table VI.
Average budget
realization by
mayors’ age
Total
Number of observations
1,151
Total budget realization
0.901
Capital budget realization
0.829
Note: ***Significant at 1 percent level
I
o41
II
41–50
III
51–60
IV
61–65
V
W65
χ2 value
113
0.901
0.816
386
0.907
0.832
502
0.901
0.836
125
0.865
0.812
25
0.853
0.766
299.3***
331.5***
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5. Conclusions and limitations
5.1 Conclusions
This study explores the determinants of budget implementation among local
governments in Indonesia. This study investigates if managerial factors affect the
level of local governments’ budget implementation by controlling for institutional factors
and the budget composition. With respect to managerial factors, this study finds that
budget implementation is weaker when mayors serve the second term, increasing the
agency costs (Antia et al., 2010). Due to the election laws on governmental leaderships,
mayors serving their second term are not eligible for reelection ( for a third term)
regardless of their performance. This apparently reduces the incentives for a mayor to
implement programs when the mayor is serving his/her second term, which apparently
hurt the budget implementation. Further, during mayors’ five-year tenure, the budget
implementation tends to be weaker in the first three years than in the last two years of the
term of their service, consistent with the political budget cycle (Rogoff, 1990). The higher
budget implementation in the fourth/fifth years could be due to the approaching
reelection time. Mayors have strong incentives to implement programs in the years close
to the campaign periods to boost their reputation, and thus improve their budget
implementation (Shi and Svensson, 2006). This study also finds that budget
implementation is affected by mayors’ age. Specifically, budget implementation is
significantly weaker when a mayor over 60 years old leads the local government. This is
consistent with the view that managers in or nearing their retirement age are more
conservative and risk averse (Roger and Suarez, 1983), which hinder organizational
long-term performance (Hambrick and Mason, 1984). This study does not find any
association between the gender of the mayors and the level of budget implementation.
With respect to the budget composition, this study finds that the amount of the capital
expenditures as a proportion of the total budget is negatively associated with the budget
implementation. The higher the proportion of capital expenditures is, the weaker the
budget implementation is. Implementing programs associated with capital expenditures
definitely need more efforts (e.g. through a lengthy bidding process) and is exposed to
higher risks (e.g. the risk of the project’s failure, the risk of facing corruption charges)
compared to implementing programs associated with routine activities using operational
budgets. It is expected that budget implementation would be low when a local
government allocate more resources to its capital expenditure programs. This study finds
that the proportion of the capital expenditure budget is the most significant factor among
all the variables in the model, which hinder the local government in achieving its
maximum budget implementation. For institutional factors, this study finds that budget
implementation is negatively associated with the size of the local government (proxied by
its total assets). The larger the government’s size, the weaker the budget implementation.
Budget implementation tends to be weaker in metropolitan areas. However, this study
does not find any association between the local government’s geographic location and the
budget implementation.
5.2 Limitations and further research
This study uses budget realization as a proxy for budget implementation. Weaker budget
implementation could be caused by two contrasting reasons: ineffective program
implementation where mayors fail to implement programs or efficient program
implementation where mayors use less fund to implement their programs: both will
result in lower budget realization at the end of the fiscal year. This study assumes that low
budget realization reflects the former, instead of the latter reason due to the fact that the
central government is generally not happy with low budget realization among local
governments. However, there must be to some extent some efficient local governments that
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ARA
are successful in implementing programs with less financial resources, leading to lower
budget realization. Therefore, a limitation of this study is the inability to trace the
origin of low realizations that leaves some funds unused. This is especially because the local
governments’ current financial and performance reporting systems fail to provide
information to help identify whether low budget realization is actually associated
with a favorable, or an unfavorable variance. Another limitation is that this study
does not incorporate factors such as government policies, economic conditions and
political matters, which vary across local governments and potentially affect the budget
implementation behavior.
Further studies could incorporate other possible determinants of budget implementation
not yet incorporated into the model. One possible determinant would be the presence
of corruption charges in the years leading to the budget period. If a mayor of a local
government is forced to steps down due to a corruption charge, the succeeding mayor is
expected to be more conservative in implementing the government’s programs, lowering
budget realization. Another determinant would be the risk preferences of the governmental
leaders. A more conservative mayor is expected to be more cautious in spending the
government’s funds especially those associated with capital expenditures, potentially
weakening budget implementation.
Notes
1. Another example of strict rules would be that in many governmental institutions, a person
traveling paid for by the government has to submit ticket invoices, the boarding passes and a
signature on an official travel document of the counter parties she/he visits, all to confirm that the
travel actually happens and all costs are accounted for.
2. To relieve fears among governmental leaders, in early 2015, President Joko Widodo told the
Attorney General to avoid criminalizing governmental leaders of corruption when the cause was
administrative, rather than the intention to steal public money.
3. On August 24, 2015, President Joko Widodo gathered all the governors and mayors together to
express his concerns regarding the low level of budget realization among the provincial and local
governments and that it hampered the economic growth. The governors and mayors were urged to
step up spending by implementing their programs using the appropriated funds in the local
governments’ budgets.
4. In Indonesia, a regency is a local government area under a province and is led by a mayor, with a
population ranging from tens of thousands to millions of people. A city is a local government
(usually in metropolitan areas) characterized by having a higher population both in number and
density, being more industrialized, and having better infrastructure compared to a regency.
Since 2005, virtually all the mayors of regencies and cities have been elected directly by the people.
Only mayors in the capital city areas of Jakarta are selected by the governor.
5. The calculation of budget realization follows the formula suggested by the Ministry of Finance in
Rule No. 249/PMK.02/2011.
6. The age cut off in this model is set at 60 to reflect the retirement age. In Indonesia, the retirement
age for governmental officers varies depending on the institution, ranging from 55 for those in
military institutions to 65 in higher education institutions.
7. Java is an island in Indonesia where the capital city ( Jakarta) is located and is significantly more
developed than other islands. Until recently, national development had been too focused on Java,
leaving wide economic and infrastructure gaps between Java and the other islands. The island
covers an area of less than seven percent of the country’s total land area, but it is occupied by more
than half of the total population. This study also includes Bali in the category of relatively
developed islands.
8. Due to the central government’s efforts to promote regional growth, the number of local
governments kept increasing. As of mid-2015, there were 514 local governments (416 regencies
(kapubaten) and 98 cities (kota)) in the 34 different provinces in Indonesia.
9. The variable AGE is significant at the 5 percent level when the partition is at 60 years old.
However, the significance level improves to 1 percent when the partition is changed to 65 years old.
For a further analysis, see Table VI.
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Corresponding author
Fuad Rakhman can be contacted at: frakhman@ugm.ac.id
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Budget
implementation
in a risky
environment