Edi and Jessica 2020
Edi and Jessica 2020
Edi and Jessica 2020
009
Keywords Abstract
Earning Management, Purpose: This research is carried out to investigate the
Discretionary accruals, influence of firm characteristics and good governance
Firm Characteristics, characteristics to earnings management behavior.
Good Corporate Furthermore, the research is expanded to determine the
Governance. predictive discretionary accruals models in Indonesia.
The author utilizing firm listed in Indonesia Stock
Jel Classification Exchange during 2014 – 2018 as research object.
M10. Design/methodology/approach: The research samples
is selected by utilizing the purposive sampling method. In
Received addition, the data analyze is conducted through E-Views
15.02.2020 version 10. Three discretionary accruals models is used
to define earnings management behavior. The research
Reviewed assumed firm characteristics factors such as financial
12.03.2020 performance, firm size, leverage, and share issuance
activity and good governance characteristics such as
Accepted board of directors’ size and auditor’s size.
20.03.2020 Findings: The research discovers that firm
characteristics can accentuate the earnings management
behavior significantly. In other hand, in good corporate
governance characteristics only big four auditor is
significant. The research also find that discretionary
accruals model of Jones, Dechow, and Kothari are
predictive in Indonesia.
Practical implications: The discoveries of this research
provide understanding for investors that enforcement on
both governance and monitoring mechanism are
essential approach to reduce earnings management
behavior.
Originality/value: The research investigated three
models of discretionary accruals’ capability in predicting
earnings management behavior, and found out all
discretionary accruals model are still relevant to be use
in predictive to define earnings management behavior in
Indonesia.
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1. Introduction
Firm valuation is yielded through the performance of firm in the short run and long run which
is indicated by firm earnings. Therefore, firm earnings is closely associated with firm
valuation. Release of concurrent information around earnings announcement show that
there’s an increase in market response to earnings announcements (Beaver, McNichols, &
Wang, 2019). Consistent with the theory of fraud triangle, financial targets served as a
rationalization to commit manipulation (Sukirman & Sari, 2013). Study also found out that
managers’ ability would increase firm efficiency and decrease the possibility of earnings
restatement, which will increase earnings quality eventually (Edi & Suyadi, 2018). Moreover,
managers are found to perform aggressive accounting choice and risk taking behavior in
financial reporting (Kim, 2015). Managers intentionally exploit the loopholes in financial
regulations and accounting choice to obtain inappropriate benefits (Bhasin, 2016). Firm
characteristics have strong impact on earnings management behavior. Some of them will
accentuate the earnings management behavior, while others will attenuate it. Firm size, firm
leverage, and firm financial performance are all found to have significant impact on earnings
management (Charfeddine, Riahi, & Omri, 2013). Furthermore, effective good governance
mechanism is also believed to constraint earnings management behavior (Salim & Hn, 2019).
In early 2019, PT Garuda Indonesia is discovered to have earnings manipulation during the
accounting period of 2018. The state owned company is found to manipulate earnings by
recognizing unearned revenue of $239.94 million. The manipulation is deliberately conducted
by managers disregard the opposition of the commissioners to make the performance looks
better than the prior year. Earnings management is a phenomenon around the world.
Recently in August 2019, US’s financial watchdog – the SEC conduct investigation towards
General Electric. General Electric was suspected to commit bigger fraud than Enron, the
accounting fraud it committed is worth for $38 billion which is over 40% of the firm’s market
capitalization. Again, with the similar manner, the General Electric’s managers concealed an
approximately $29 billion of losses from the public and is heading to bankruptcy. Accounting
fraud is also involving start-up firms in Silicon Valley. In early 2019, WeWork, the unicorn
start-up firm whose public offerings is the most expected event is burst out. WeWork suffered
substantial losses over years. In 2016, it suffered $429 million of $436 million in revenue, and
continually to suffer loss. In 2019, the firm reported loss of $690 million of $1.5 billion in
revenue. Poor corporate governance is pointed as the reason behind the problems faced by
We Work.
The act of earnings management of course have caused the financial instrument cannot
perform as guidelines in making decision (Walker, 2013). Therefore, the research is
conducted to provide empirical evidence showing how to recognize earnings management,
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statements users (Francis, Huang, Rajgopal, & Zang, 2008). By conducting earnings
management, managers turned earnings as the report of their enthusiasm instead of as the
result of firm financial performance (Levitt, 1998). The definition of earnings management
have led us to think about the subjectivity in accounting process and how earnings
management is committed.
2.2.1 Accrual Based Earning Management
Accruals based earnings management is interpreted as involvement of managers’ choices and
discretions in preparing financial statements and constructing transaction, to provide
misleading information regarding the financial condition of the firm (Healy & Wahlen, 1999).
Accruals based earnings management might not essential to have impact on the cash flow
(Cupertino, Martinez, & da Costa, 2015). Compared to real earnings management, accrual
based earnings management is more prone to be discovered and less costly (Kothari, Mizik, &
Roychowdhury, 2016). Therefore, manager is predicted to commit accruals based earnings
management prior to commit real earnings management. That is, a lot of researches
(including this paper) are focused on accruals based earnings management to explain the
activity of earnings management (Dechow, Sloan, & Sweeney, 1995; Healy, 1985; Jones, 1991;
Kothari, Leone, & Wasley, 2005).
2.2.2 Earning Management Measurement
The research employed cash flow approach to acquire the value of total accruals which the
equation is as follows:
The equation above reflects the value of net operating accruals, which is the amount of short-
term accruals obtained from operating activities. Even so, the total value of accruals alone
cannot be compared directly with other companies. This is because the value of accruals will
be influenced by firm growth factor (DeAngelo, 1986). Therefore, total accruals must be
scaled to the average of total assets to be comparable:
Where:
: Total accruals of firm i on t period.
: Total assets of firm i at the end of t period.
: Net income of firm i on t period.
: Operating cash flow of firm i on t period.
Accruals consist of discretionary accruals and non-discretionary accruals. Therefore, the value
of discretionary accruals can be obtained by subtracting the value of non-discretionary
accruals from total accruals.
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Where:
: Discretionary accruals of firm i on t period.
: Non-discretionary accruals of firm i on t period.
The difference between the models of discretionary accruals that will be used reposed
in the measurement approach of non-discretionary accruals. In this research, the
discretionary accruals measurement model that will be used are as follows:
1. Model of Jones (1991)
Where:
: Change in revenue, which is calculated by subtracting revenue of
firm i on t period with revenue on t – 1 period.
: Value of property, plant, and equipment of firm i at the end of t
period.
2. Model of Dechow et al. (1995)
Where:
: Change in receivables, which is calculated by subtracting receivables
of firm i on t period with receivables on t – 1 period.
3. Model of Kothari et al. (2005)
Where:
: Return on asset of firm i on period of t – 1.
2.3 Firm Characteristics and Good Corporate Governance Characteristics
Firm characteristics is described as organization internal factors that emerged within the
internal environment of the organization itself and can be controlled which encompasses
management influences and firm competencies (Zou & Stan, 1998). Furthermore, firm
characteristics is categorized into seven classes: valuation, investment, prior returns,
earnings, financial distress, external financing, and other class (Kogan & Tian, 2012). In this
research, firm characteristics included are firm size to reflect valuation, firm performance to
reflect earnings, leverage to reflect financial distress, and stock issuance activity to reflect
external financing.
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Mechanism of ownership and control to protect minority rights, legal inhibition against
management self-benefit behavior is called corporate governance (Shleifer & Vishny, 1997).
Therefore, good governance characteristics is reasoned as attentive oversight characteristics
that reflected best practice to prohibit management discretion and restrict their ability to
respond to the potentials of a financial crisis which is believed would bring detrimental effect
towards a firm (Van Essen, Engelen, & Carney, 2013). The studies encompassed board of
director’s size to reflect board characteristics and auditor’s size to reflect audit quality.
2.3.1 Financial Perfomance
Financial performance indicate the capability of a firm in utilizing assets to generate earnings.
Return on assets provides an overview to see how much earnings after tax is obtained after
investing in assets. Based on this definition, then in measuring the company's performance,
the ratio of return on assets can be used (Alexander & Hengky, 2017; Dewi & Prasetiono,
2012).
2.3.2 Firm Size
Firm size indicate the scale of a firm. Numerous of approaches are used to measure firm size,
including total assets, market value of equity, and revenues. However, every approach of firm
size only measure certain area of implication. The use of market capitalization is more
suitable for market oriented and progressive implication, total assets is fit for the
measurement of firm resources but not firm performance, and total revenue is an appropriate
measurement for product market and non-progressive implication (C. Dang, (Frank) Li, &
Yang, 2018). Earnings management engagement is associated with firm performance and is
past oriented. Consistent with the argument, this research used the natural logarithm of total
revenue approach to measure firm size (N. H. Dang et al., 2017).
2.3.3 Leverage
Leverage shows how a company utilizes debt to obtain economic benefits. In other words,
leverage also can be used to measure the capital structure of a firm. Leverage can be obtained
by comparing the level of a firm’s total debt to the total book value of the firm's assets (Azlina,
2010; Mahawyahrti & Budiasih, 2017).
2.3.4 Board of Director’s Size
Board of directors is a group of people that are appointed to supervise, take charge of firm’s
operational, and act in accordance to firm’s objective. An effective board of directors is an
implication of good governance mechanism. Board characteristics can be measured in various
ways. Board characteristics are identified through the composition of the board, such as:
board of directors’ size, existence of independent directors, the dual role of Chief Executive
Officer, and board tenure (Nugroho & Eko, 2011). Consistent with prior researches, this
research use board of directors’ size by calculating the number of directors in the board as a
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proxy of board characteristics (Neifar, Halioui, & Abdelaziz, 2016; Xie, Davidson, & DaDalt,
2003).
2.3.5 Auditor’s Size
The size of firm’s independent auditor can be used as a benchmark for audit quality.
Numerous of researchers argued that auditors that are associated with big four can provide
higher audit quality compared to non-big four auditors (Hussainey, 2009; Rusmin, 2010).
Based on this reason, numerous of researches measure the audit quality by categorizing
auditor whether it is big four or non-big four auditors (Ahmad, Suhara, & Ilyas, 2016; Alves,
2013).
2.3.6 Share Issuance Activity
Shares issuance is a way for firms to raise funds from external parties. Share issuance
activities are believed to be a motivation for earnings management (Cohen & Zarowin, 2010;
Yang, Hsu, & Yang, 2013). Therefore, the presence or absence of share issuance activities by
firms in a period have an influence on earnings management behavior (N. H. Dang et al.,
2017).
2.4 Firm Characteristics, Good Corporate Governance Characteristics and Earning
Management Behavior.
2.4.1 Financial Perfomance and Earning Management
The possibility to engage earnings management become higher when executives’
compensation are based on firm financial performance (Sun, 2014).
Managers have a tendency to engage earnings management to satisfy financial thresholds in
three conditions:
1. To avoid negative earnings in current performance (Charoenwong & Jiraporn, 2009).
2. To sustain firm financial performance (Amar & Abaoub, 2010).
3. To fulfil analyst’s prognosis (Doyle, Jennings, & Soliman, 2013).
By comparing firm that missing analyst’s prognosis and firm that meeting analyst’s prognosis,
the research suggested firm that meeting analyst’s prognosis by manage accruals expense
downwardly will gain short run share price benefit (Bhojraj, Hribar, Picconi, & McInnis, 2009).
That is, by mean of earnings management behavior, reported financial performance is
expected to be higher. Build upon the exposition above, therefore the first hypotheses in this
research is
H1: Financial performance has positive and significant influence on earnings management.
2.4.2 Firm Size and Earning Management
Insistence to have a better financial performance, larger possession of assets, and negotiation
power to bargain with auditors provided large firms opportunity and motivation to engage
more earnings management (Ali, Noor, Khurshid, & Mahmood, 2015). According to the
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political cost assumption, large firms might have higher political cost and under more public
attention, therefore large firms will engage more earnings management behavior (Rusmin,
Scully, & Tower, 2013). Auditors will probably impede earnings management behavior
engaged by small firm than large firm. Audit partners in non-big four are found to
compromise audit independence for financially significant clients (W. Chi, Douthett, & Lisic,
2012). The predictability of earnings is found lower is large firm due to the higher probability
of earnings manipulation to elude negative earnings and government intervention (Ahmed
AL-Dhamari & Nor Izah Ku Ismail, 2014). Moreover as firm size increase, family firms will
more possible to engage in earnings management behavior (Martin, Campbell, & Gomez-Mejia,
2016). Large firms have more complicated and complex transaction compared to small firm,
thus large firm is more prompt to engage earnings management (N. H. Dang et al., 2017). The
higher information and agency risk faced by large firm are believed to enable managers to
conduct earnings management (Nalarreason, T, & Mardiati, 2019). Other study revealed that
large firm prompt to utilize discretionary accruals in placing their seasonal share issuance
(Shu & Chiang, 2014). Based on explanation above, therefore the second hypotheses in this
research is
H2: Firm size has positive and significant influence on earnings management.
2.4.3 Leverage and Earning Management
Creditors and investors are argued to monitor firms that they funded in. Study found out that
short term liability is positively associated with earnings management behavior only strong
for low creditworthiness firms (Fung & Goodwin, 2013). Firms’ earnings management
behavior is found decreasing when bank monitoring mechanism’s efficiency increased (Ahn &
Choi, 2009). The level of leverage is found low in pre-merger and acquisition firms which
engage in upward earnings management behavior (Alsharairi & Salama, 2012). Additionally,
another study also find that distressed firms are actually less possible to commit earnings
management because those firms will used up all means for engaging earnings management
(Ghazali, Shafie, & Sanusi, 2015). When level of debt comparatively low, the regression of debt
on earnings management is found negative. In contrast, when debt is high, the regression is
found positive (Alzoubi, 2018). Debt is found to incline positive earnings management in low
transparency and high diversified firms (Rodríguez-Pérez & van Hemmen, 2010). Intensified
leverage limiting manager’s opportunistic behavior due to strict monitoring therefore
alleviate accrual-based earnings management however exacerbate real earnings management
(Vakilifard & Mortazavi, 2016). According to the elucidation above, therefore the third
hypotheses in this research is
H3: Leverage has negative and significant influence on earnings management.
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behavior in effective legal system audit environment (Memiş & Çetenak, 2012). Posit on the
description above, therefore the fifth hypotheses in this research is
H5: Auditor’s size has negative and significant influence on earnings management.
2.4.5 Share Issuance Activity and Earning Management
Earnings management is engaged in order to meet financial threshold and analysts’ forecast
so that firm’s share price will soar up in the short run (Bhojraj et al., 2009). Income increasing
earnings management resulted in equity overvaluation (J. (Daniel) Chi & Gupta, 2009).
Research discovered that firms which issue multiple seasoned equity offerings will
continuously manage discretionary accruals to raise earnings (Chang & Lin, 2018). Moreover,
firms are found to engage in both real and accrual-based earnings management during
seasoned equity offerings (Cohen & Zarowin, 2010). By analyzing long run performance, the
study revealed that firms that managed earnings aggressively during initial public offerings
suffered poor share returns after several periods (Yang et al., 2013). Furthermore,
researchers documented three movements of discretionary accruals during share issuance
(Miloud, 2014):
1. Grow before share issuance period
2. Reach the peak on the share issuance period, and
3. Decline after share issuance period.
Earnings management around seasoned equity offerings engaged by large firm is positively
associated with short term performance and negatively associated with long term
performance (Shu & Chiang, 2014). Postulate on the findings above, therefore the last
hypotheses in this research is
H6: Share issuance activity has positive and significant influence on earnings management.
3. Research Methodology
The research employed firms listed on the Indonesia Stock Exchange (IDX) during 2014 -
2018 as research objects. The research samples are obtained through purposive sampling
method, a non-random techniques that are based on distinctive quality of the samples (Etikan,
Musa, & Alkassim, 2016). Furthermore, the audited financial statements is obtained from the
sample firm official websites and IDX website. The multiple linear regression, the panel
regression, the Spearman, data analyze was employed through is the E-Views program
version 10.
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4. Research Finding
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The research discovered that financial performance, firm size, and share issuance activity can
accentuate the earnings management behavior significantly on firms listed in Indonesia Stock
Exchange (IDX). In other hand, big four auditors can attenuate the earnings management
behavior significantly. Leverage can decrease earnings management behavior however is
partially significant. Board of directors’ size have negative influence on earnings management
behavior, however the influence is insignificant. Moreover, the result show that the
hypotheses test of Jones’ model is different from Dechow and Kothari’s model. Therefore, the
Spearman’s Rank correlation analyze is carried out to investigate the predictive capability of
Jones’ model.
Table 4.4 The Spearman’s Rank Correlation Analyze
The Spearman’s Rank correlation test show that all discretionary accruals are strongly
correlated. The correlation between Dechow model and Kothari model is higher compared to
the correlation towards Jones model. In the discretionary accruals of Jones model, it was
assumed that revenue cannot be influenced by managers’ discretion or is non-discretionary
(Dechow et al., 1995). However, earnings management could have been managed through
revenue. Managers use strategic revenue recognition by utilizing both deferral sales account
and accrual sales account to avert earnings uncertainty (Caylor, 2010). Therefore, although all
discretionary accruals are strongly correlated, the hypotheses result of Jones model is
different from the other models. But the jones model, dechow and Kothari are still relevant as
a measurement for earning management.
5. Conclusion
Managers might engage earnings management to obtain short run stock benefit (Bhojraj et al.,
2009). Larger firms possesses more incentives and opportunities to conduct earnings
management (Ali et al., 2015; N. H. Dang et al., 2017). This phenomenon signify that
governance practice and earnings quality in large firm might not better than small firms. In
other hand, big four auditors can attenuate the earnings management behavior significantly.
This suggest Indonesia have an efficient audit environment that enable the big four auditors to
perform effectively. As studies suggested big four auditors might limit earnings management
behavior under enforced legal environment (Memiş & Çetenak, 2012; Yasar, 2013). Leverage
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can decrease earnings management behavior however is partially significant. This indicate
that creditors such as bank could serve as external monitor mechanism on firms, however
needs more enforcement from the internal monitor mechanism from firm itself. Board of
directors’ size have negative influence on earnings management behavior, however the
influence is insignificant.
Due to the different hypotheses result among Jones’ model and the other two models, the
Spearman’s Rank correlation is carried out. The findings in the research show that all
discretionary accruals model are predictive in Indonesia. However, correlation between
Dechow and Kothari’s model are slightly higher than Jones’ model.
The findings suggest that enforcement on legal system should not only be applied on audit
environment but also firm corporate governance policy. Moreover, as bank efficiency
increased, debt firms’ earnings management behavior could be decreased (Ahn & Choi, 2009).
That is, monitor and control mechanism to protect investor should be relied on both internal
mechanism (through corporate governance) and external mechanism (through independent
auditors and banks). For investors and creditors, discoveries of this research provide novel
understanding that firm valuation should not only based on financial figures such as firm
performance and firm size. Qualitative measure such as managerial ability and corporate
governance practice and characteristics should also be emphasized (Edi & Suyadi, 2018; Salim
& Hn, 2019). Further research might concentrated on variables that constraint earnings
management behavior such as leverage and board structures. The extend of leverage in
distressed firm that would attenuate earnings management behavior could be focused on
(Alzoubi, 2018). In addition, further research could also focused on the quality of boards
rather than only focused on boards’ size (Payal & Singh, 2017).
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