Background of the study

The objectives of the study were explored in the first chapter: the first objective was to discover the budget changes in local governments in Indonesia. The issue of budget changes in local government is relevant since Indonesia has entered an era of fiscal decentralisation; in this system, local governments are mandated to allocate resources. However, as the local budget authorities (parliament members and local leaders) have particular interests, to obtain both political and welfare benefits, there are possibilities of budget optimisation by those authorities in order to address their interests. The second objective was to find the determinant factors of the parts of budget changes that were indicated as rent-seeking. The third objective was to find the factors that influence an increase in rent-seeking and the impact of audits in limiting the possibility of rent-seeking. As rent-seeking tends to produce wastage in local government budgets, there is needed a monitoring system that can limit the existence of this behaviour. Audits are widely believed to be an important instrument to prevent the possibility of rent- seeking.

The first chapter of this study contained the background to the study. It focused on the significance of the greater authority given to local budget authorities in Indonesia in deciding on budget allocations during the implementation of fiscal decentralisation. A short review in this chapter identified the possibility that certain budget sectors might be optimised to accomplish the diverse interests of the budget authorities, both in maintaining their positions and in obtaining self-prosperity.

The implementation of decentralisation in Indonesia has led to the possible existence of rent- seeking behaviour by certain individuals or groups in local governments that have the power in the local government budget process. Both local parliament members and local leaders have the opportunity to optimise the budget as they have similar interests: first to accomplish their constituents' expectations, because they are both elected by the public through general

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elections. In this context, the optimisation will support them to maintain their positions, particularly if they decide to be incumbents in the next election.

However, budget optimisation may not relate only to the continuation of political positions (as parliament members or local leaders) but also correspond to the intention to make a return on their political investment. This leads to the research question of how the budget changes reflect the possibility of the existence of these rent-seeking behaviours.

Related to the second objective of this study, budget changes should ideally be caused only by rational factors, which consist of local economic factors, the density of the population and also local government financial capability. However, from the results of regression analysis, there is a certain amount of the budget that does not reflect these determinants. There are unidentified factors that influence the changes, one of which is the motive of rent-seeking. This brief description leads to the next research question regarding the certain amount of the budget that is possibly being optimised for certain interests.

The last objective of this study relates to the importance of audits in preventing the occurrence of deviations in budget usage. This is a continuation of the previous research question related to the amount of the budget that is not affected by the determinant rational factors. The remaining part of the budget is indicated to be subject to the motivation of rent-seeking (Park 2008). Some scholars advised that rent-seeking tends to result in budget wastage, so it will be harmful to local productivity (Katz and Rosenberg 1989, Katz et al. 1990). Therefore, the audit mechanism will play a significant role in protecting the larger part of the budget from this motivation (Adams 1994, Dye and Stapenhurst 1997, Ferraz and Finan 2007a, Khan 2006).

Chapter 2 presented the literature review. The chapter began with a theory that supports the possibility of using the budget for particular interests. The budget optimisation in local governments can be viewed in the context of the agency relationship theory, in which the local budget authorities (which consist of the local parliament members and local leaders) play the agents, while the public and the central government play the principal. Based on this theory, the agents have more information than the principal, particularly related to the strategic decisions in using local resources. This advantage may be optimised by the local authorities for various reasons, including political or personal welfare motives.

This chapter also explored previous studies related to the objectives of the research. Based on the objectives of the study, previous studies were classified into three groups: first, the research that investigated budget changes; second, the research that related to the factors

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that influence budget allocation; and third, the research related to the importance of audits in minimising the opportunity for using the budget for rent-seeking motives.

Chapter 3 explored the methodology applied to address the research questions. The chapter presented the sample data and the resources used to obtain the data, the developed hypotheses and also the statistical analysis used to answer the research questions.

Chapters 4, and 5 are the chapters that provided the results of the study. Chapter 4 explored budget changes not only chronologically, but also from the perspective of the years before general elections, for both legislative members and local leaders. Looking at the changes from these perspectives resulted in the discovery of certain budget sectors that are possibly being optimised by certain groups in local government for particular interests. This chapter also provided the determinant factors in relation to budget allocation. The factors that are considered the determinants are rational ones; the regression did not only generate the factors that significantly influence budget allocation, but also the remainder of the budget that is not affected by these rational factors. This leads to the likelihood of the presence of rent-seeking behaviour. Using the resulted residual value, the indicated of rent-seeking is then determined by employing the Park (2008) approach. Chapter 5 presented the results of the regression in order to find the factors that stimulate higher amounts of the budget being dissipated, and also the impact of audits in preventing the increase of rent-seeking behaviour in local government budgets.

Chapter 6 discussed the results of the study from the perspectives of the theory applied and also in consistency with previous research. The important finding of this chapter is related to the significant role of audits in limiting the possibility of rent-seeking.