Asia Pulp and Paper: a business rationale based on debt entrenchment and financial expropriation

The paper analyses the rise and fall of the Indonesian conglomerate Asia Pulp & Paper, which became the largest pulp and paper producer in Asia outside Japan, then faced in March 2001 the largest default for a private group in an emerging country ($13 billion). Our analysis is based on financial data and field work in Indonesia, and includes knowledge about the forestry operations of the group that are key to understand its corporate governance with the alleged use of transfer pricing. It helps understand a specific economic rationality for the ultimate owners (Widjaja family) in a context of poor corporate and public governance. The pyramid structure of the group allows the ultimate owners to dilute their direct investment along a chain of intermediaries, while keeping control of the decisions and accounts. The main use of debts to finance the expansion of the group was also remarkable because it allowed the ultimate owners to prioritize short term profits in a sector where long term strategies are the rule. This short term horizon could be prioritized owing to a low cost access to natural forests in Indonesia for fiber supply to the giant pulp mills, and because 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 detailed case study is a contribution to the theories of debt entrenchment and financial expropriation, which are key to understand the East Asian business models. It also illustrates how politics interfered in the ability of the group to survive, as the Indonesian government held back claims on domestic debts and influenced the debt restructuring process.