Earning Management Theory Development 1. Agency Theory

13 Stiles and Taylor 2002 argue that fragmentation of these various perspectives has led to a lack of consensus regarding corporate governance and the actual role of the board of directors in the organization as the nature of board’s contribution and the expectations placed upon it depends heavily on which theoretical perspective used. However, these frameworks often overlap theoretically and do share significant commonalities Solomon and Solomon, 2004. 2.3.2 Definition of Corporate Governance According to Cadbury 2000 in Dima Jamali 2008, Corporate Governance CG defines as “the system by which companies are directed and controlled”. The control aspect of CG encompasses the notions of compliance, accountability, and transparency MacMillan, Money, Downing and Hillenbrad, 2004, and how managers exert their functions through compliance with the existing laws and regulations and codes of conduct Cadbury, 2000. The importance of CG lies in its quest at craftingcontinuously refining the laws, regulations, and contr acts that govern companies’ operations, and ensuring that shareholder rights are safeguarded, stakeholder and manager interests are reconciled, and that a transparent environment is maintained wherein each party is able to assume its responsibilities and c ontribute to the corporation’s growth and value creation Page, 2005. Governance thus sets the tone for the organization, defining how power is exerted and how decisions are reached. According to Macey 2008, p. 1, the purpose of corporate governance is to persuade, induce, compel, and otherwise motivate corporate managers to keep 14 the promise they make to investors. Another way to say this is that corporate governance is about reducing deviance by corporation where deviance is defined as any actions by management or directors that are at odds with the legitimate, investment-backed expectations of investors. Good corporate governance, then, is simply about keeping promises. Bad governance corporate deviance is defined as promise breaking behavior The OECD Principles of Corporate Governance, inter alia referred to in the EU Commission’s Action Plan on Company Law and Corporate Governance , take a slightly broader view: “Corporate governance involves a set of relationships between a company’s management, its board, its shareholders and other stakeholders. Corporate governance also provides the structure through which the objectives of the company are set, and the means of attaining those objectives and monitoring performance are determined. Good corporate governance should provide proper incentives for the board and management to pursue objectives that are in the interests of the company and its shareholders, and should facilitate effective monitoring.” This definition goes beyond the definitions cited above ma inly insofar as a company’s objectives and the mechanism for setting the objectives are treated as a corporate governance issue, not as endogenously given. Put succinctly, corporate governance “deals with the ways in which suppliers of finance to corporations assure themselves of getting a return on their investment.” Regarding to Ministry Of Finance Of The Republic Of Indonesia BAPEPAM, 2006 in Corporate Governance, Annual report must include a brief