THE IMPACT OF CORPORATE GOVERNANCE ON EARNINGS MANAGEMENT: EVIDENCE FROM MALAYSIA
MANAGEMENT: EVIDENCE FROM MALAYSIA
SKRIPSI Submitted As Partial Fulfillment Of Requirement For The Degree of Sarjana Ekonomi (SE) at the Sebelas Maret University
By: MUHAMMAD ANDI D.H.B.A F0308067 FACULTY OF ECONOMICS SEBELAS MARET UNIVERSITY SURAKARTA
· “May the Force be with you” (Star Wars) · “When you do something for the right reasons, nothing can stop you”
(We Bought A Zoo)
· “Hope for the best, plan for the worst” (The Bourne Ultimatum) · “Life is made from the choices that we make” (Back To The Future) · “You have to do the best with what God give you” (Forrest Gump) · “Happiness only real when shared” (Into The Wild) · “Money is not the prime asset in life, time is” (Wall Street: Money
Never Sleeps)
· “Yesterday is history, tomorrow is mystery, today is a gift” (Kung Fu
Panda)
· “Man Jadda Wa Jadda” (Negeri 5 Menara)
This skripsi and whatsoever success
that I could achieve is dedicated to
MY LOVED FAMILY
There is no kindness love like your truly love
Thanks for all the support and pray all the time.
YOU ARE THE APPLE OF MY EYE
Assalamu’alaikum Wr. Wb. Researcher will be grateful to Allah SWT for all the mercy and bless so that I were able to finish this research well. This Skripsi is proposed to complete all the requirements of achieves the degree of Sarjana Ekonomi of Accounting
Department, Sebelas Maret University, Surakarta.
Researcher realizes that he could not have finished this skripsi without the supports and involvement of many parties both directly and indirectly. I owe a very great debt and thanks to:
1. Dr. Wisnu Untoro, M.S., as the Dean of Economics Department, Sebelas Maret University, Surakarta.
2. Drs. Santoso Tri Hananto M.Si., Ak., as the Head of Accounting Department, Sebelas Maret University, Surakarta.
3. Drs. Muh Agung Prabowo, M.Si., Ph.D, Ak., as my supervisor. I wish to express my deepest thanks to Mr. Agung for his considerable help to give advices and a very closely improved result.
4. Prof. Dr. Rachmawati, M.Si., Ak., as my academic advisor, thanks for all your support and advices.
5. My mother, my father, and all my sister. Ibu, all this perspiration is dedicated to you, the smartest, most beautiful and wisest woman i have ever known. Bapak, Karina, Sebrina and Dina thank you for the support in this great 5. My mother, my father, and all my sister. Ibu, all this perspiration is dedicated to you, the smartest, most beautiful and wisest woman i have ever known. Bapak, Karina, Sebrina and Dina thank you for the support in this great
7. My trusted friend Dion Librazky, thanks for your support all the time.
8. My friends Raras and Isnaeni thanks for all your support and valuable advice.
9. My partner in crime, Rahmah Fitriani, finally we finished this study!
10. All of my friends in Accounting Department, I am happy to have you all in the last four years. I wish that graduation is not the end of our friendship.
11. All of my friends in HMJ Akuntansi, keep on fire guys!
12. Member of GB who have gave happiness and pleasure. Andhika, Miko, Adrian, Krisnandi, Eja, Nanda, Alfin, Adhi Kur, Peka, Deddy, Rofi and Adhi Kur.
13. All my friends in KOMPAK Community. Thank you so much for the friendship in all four years. All Hail Kantin!
14. All of my friends in United Indonesia Chapter Solo.
15. All of my friends in Standup Comedy Solo.
16. My first love,Sukma Rani, thank you for teaching me love. You are the apple of my eye.
17. For all people that Researcher could not mention one by one, thanks for all your support in the last four years.
has a lot of constraint, thus any suggestions and critics are expected for the sake of improving this study.
As I close this acknowledgment, I expect that this writing will be useful to all parties. Wassalammu’alaikum Wr. Wb
Surakarta, June , 2012
Muhammad Andi D. H.B.A
1. Chairman Characteristics ............................................
2. Board Structures .........................................................
3. Independent Committees .............................................
4. Family Control ...........................................................
16 CHAPTER II RESEARCH METHODS .....................................
A. Research Design.............................................................
B. Population and Sample ...................................................
C. Source and Data Collecting Technique ............................
D. Operational Definition and Measurement of Variables .....
1. Independent Variables.................................................
2. Dependent Variable ....................................................
3. Control Variables........................................................
E. Data Analysis Methods ...................................................
1. Classic Assumption Test .............................................
2. Descriptive Statistics and Univariate............................
3. Multivariate ................................................................
26 CHAPTER IV DATA ANALYSIS.............................................
A. Total Data Collection .....................................................
B. Classic Assumption Analysis .........................................
C. Descriptive Statistics and Univariate ..............................
D. Multivariate ..................................................................
Earnings Management.................................................
33
2. The Interaction of Corporate Governance on Earnings Management.................................................
42 CHAPTER V CONCLUSION....................................................
46
A. Conclusion ....................................................................
46
B. Research Constraints .....................................................
48
C. Research Suggestions ....................................................
48 REFERENCES ............................................................................
49 APPENDIXES
TABLE PAGE
IV.1 Sample Selection ................................................................
28
IV.2 Variable Definition .............................................................
29
IV.3 Descriptive Statistics.......................... ..................................
30
IV.4 Pearson Correlation .............................................................
32
IV.5 Linear Regression (A) .........................................................
34
IV.6 Linear Regression (B) .........................................................
41
IV.7 Regression with Interaction Effect (A) .................................
43
IV.8 Regression with Interaction Effect (B) .................................
45
Appendix I
Previous Studies
Appendix II
List of Companies
Appendix III Corporate Governance and Discretionary Accrual Appendix IV
Descriptive Statistics
Appendix V
Pearson Correlation
Appendix VI
Classic Assumption Test
Appendix VII
Results of Linear Regression
ABSTRACT THE IMPACT OF CORPORATE GOVERNANCE ON EARNINGS MANAGEMENT: EVIDENCE FROM MALAYSIA
Muhammad Andi D.H.B.A
NIM F0308067
The objective in this research is to investigate the impact of corporate governance mechanisms on the earnings management in Malaysia. Specifically, this research examines the effect of chairman characteristics, board structure, independent committees, and family control on earnings management.
This research focuses on manufacture companies that listed in Bursa Malaysia Berhad for period 2010. The research data were collected from financial statements and annual reports which published by companies. Purposive sampling method was used to determine research sample and 200 samples were collected. Hypothesis was tested by Ordinary Least Square (OLS) regression model using SPSS 17.00 software
The results of this research show that corporate governance mechanism simultaneously effect on the earnings management. Only chairman financial background and size of board that partially and significantly had effect on earnings management. Additionally,the interaction between corporate governance variables and earnings management had insignificant effect.
Keywords: Corporate Governance, Chairman Characteristics, Board Structure, Independent Committees, Family Control, Earnings Management.
INTRODUCTION
A. Background
Agency relationship is a contract under which one or more persons to engage another person to perform some service on their behalf which involves delegating some decision making authority to the agent (Jensen and Meckling, 1976). In the context of the firm, the agent (manager) acts on behalf of the principal (shareholder). They also claim that separation of authority between the owner-manage and outside shareholders could cause conflict of interest as managers tendency to appropriate perquisites out of the firm’s resources for own consumption. The agency relationship will lead to information asymmetry problems. Information asymmetry between management (agent) and shareholder (principal) could cause managers to use it in preparing and reporting financial statements for their advantage. Richardson (1998) found that information asymmetry increase the level of earnings management.
Earnings management will reduce the quality of reported earnings and also reducing investor confidence in the financial reports. Earnings management occur in some corporate scandals of financial reporting, such as Enron, Global Crossings, Tyco, WorldCom, and others (Cornett et al., 2006). Because of that financial scandals, corporate governance now has already used by many entity in the bussiness world. The implementation of corporate governance mechanism Earnings management will reduce the quality of reported earnings and also reducing investor confidence in the financial reports. Earnings management occur in some corporate scandals of financial reporting, such as Enron, Global Crossings, Tyco, WorldCom, and others (Cornett et al., 2006). Because of that financial scandals, corporate governance now has already used by many entity in the bussiness world. The implementation of corporate governance mechanism
According to the statement by Bhattacharyay (2004), there are still a lot of problems associated with Asian countries in strengthening corporate governance. He claimed several main problems, such as:
1. Excessive government intervention.
2. Highly concentrated ownership structure.
3. Weak external discipline in the corporate sector.
4. Weak legal systems and regulatory
5. Lack of quality information.
6. Lack of investor’s protection
7. Lack of developed capital market Those conditions and problems make the importance of coporate governance mechanisme in Malaysia have possibly similar impact compared to other countries in Asia.
Corporate governance has become an important issue in Malaysia since the emergence of the Asia financial crisis in mid-1997. In order to improve the monitoring function of corporate governance mechanisms in Malaysia, the Code of Corporate Governance was drafted in1999 and subsequently approved in 2000 by the Ministry of Finance (Saleh et al., 2005). The Code made full effect to company requirement where public listed companies in Malaysia are now required to put in their annual report the statement of corporate governance,
(Hashim et al., 2000). Nowadays, Malaysia’s progress in strengthening its corporate governance framework has received international recognition. Malaysia has consistently been ranked 4 th for investor protection in the World Bank Doing Business Report during 2006–2010 (Malaysia Corporate Governance Blue Print 2011).
Previous studies in several country including in Malaysia has investigated the relationship between different corporate governance factors and earnings management and the results show many different evidence impacts (can be found in Appendix 1). The result could be different in Malaysia because each country has different regulation and culture on corporate govenance mechanism. It’s supported with statement by Abdullah (1992) that Malaysia has various cultures which play a significant role in determining the culture of an organization. Although previous studies have made attempts to reveal factors of corporate governance that affecting earnings management, there is limited empirical evidence that connecting family control and independent committees in company with earnings management. Therefore, the impact of corporate governance mechanism in Malaysia still be an empirical question.
Hence, the primary aim of this study is expected could give explanation and emprical evidence about effectiveness corporate governance in constraining earnings management. This study also investigate the effects of eleven explanatory variables which consists of chairman tenure, chairman financial Hence, the primary aim of this study is expected could give explanation and emprical evidence about effectiveness corporate governance in constraining earnings management. This study also investigate the effects of eleven explanatory variables which consists of chairman tenure, chairman financial
B. Problem Statements
The problem statements in this study consist of:
1. Do chairman characteristics (chairman tenure, chairman financial background and executive chairman) have impacts to earnings management?
2. Do board structures (independent board, size of board and board meeting) have impacts to earnings management?
3. Do independent committees (remuneration committee independence, audit committee independence, and nomination committee independence) have impacts to earnings management?
4. Does family control (family involvement and family ownership) have impacts to earnings management?
C. Research Objectives
Main objective in this study is to find empirical evidence about:
1. The impact of chairman tenure related to earnings management in Malaysia companies.
2. The impact of chairman financial background related to earnings management in Malaysia companies.
3. The impact of executive chairman related to earnings management in Malaysia companies.
management in Malaysia companies.
5. The impact of board meeting related to earnings management in Malaysia companies.
6. The impact of remuneration committee independence related to earnings management in Malaysia companies.
7. The impact of nomination committee independence related to earnings management in Malaysia companies.
8. The impact of audit committee independence related to earnings management in Malaysia companies.
9. The impact of family involvement related to earnings management in Malaysian companies.
10. The impact of family ownership related to earnings management in Malaysia companies.
D. Research Benefits
This study is expected to give considerable benefits to:
1. Investors, creditor, and stakeholder, this papers could enhance them to understand corporate governance mechanism in Malaysia, so that they can make a good quality assessment of certain companies before making an investing decision.
2. Development of literature about the impact of corporate governance on earnings management in Malaysia. This study is expected could explain 2. Development of literature about the impact of corporate governance on earnings management in Malaysia. This study is expected could explain
E. Organization of Skripsi
Chapter I
: Introduction
This chapter contains introduction, problem statement, research objectives, research benefits and organization of skripsi.
Chapter II
: Theoretical Framework
This chapter contains literature review which leads the way to hypotheses development and research model.
Chapter III
: Research Method
Population, sample, measurements of variables and data analysis method are discussed.
Chapter IV : Data Analysis and Interpretation The comprehensive interpretation of result in descriptive statistics and regression analysis are the body of this chapter.
Chapter V
: Conclusion
This closing chapter presents the research result in broad outline. It also discloses research constrains and future research suggestion.
THEORETICAL FRAMEWORK
A. Agency Theory
Perspective of an agency theory is the basis that has been used widely in understanding organization. Agency theory explains the relationship between the company’s executives as an agent with the shareholder or owners as a principal. Jensen and Meckling (1976) define agency relationship as a contract under which one or more persons (the principal) engage another person (the agent) to perform some service on their behalf which involves delegating some decision making authority to the agent. They also explain that agency relationship between ownership and control leads to a divergence between manager and owner interest.
A corporation's managers may have personal goals that compete with the owner's goal in company. Since the shareholders authorize managers to manage the firm's assets, a potential conflict of interest will exist between these two groups.
Agency theory is concerned with resolving two problems that can occur in agency relationship (Eisenhardt, 1989). The first problem is the principal cannot verify that the agent has behaved appropriately and the second problem is that principal and agent may prefer different actions because of different risks. Another negative impact which caused by an agency relationship could lead to information asymmetry problems. Information asymmetry occurs when some parties in business transactions have an information advantage over others (Scott, Agency theory is concerned with resolving two problems that can occur in agency relationship (Eisenhardt, 1989). The first problem is the principal cannot verify that the agent has behaved appropriately and the second problem is that principal and agent may prefer different actions because of different risks. Another negative impact which caused by an agency relationship could lead to information asymmetry problems. Information asymmetry occurs when some parties in business transactions have an information advantage over others (Scott,
B. Corporate Governance
Nowadays, corporate governance has already used by many entity in the bussiness world. Garcia et al. (2010) think that fact is caused due to two reasons which are change in the way of companies because of globalization, competition, new technologies and social and environmental concern and, secondly, as a result of financial scandals in several companies. Corporate scandals such as Enron, Global Crossings, Tyco, and WorldCom had a terrible effect on stakeholders. Most of the financial scandal has happened because of a lack of implementation of corporate governance by companies.
According to statement of World Bank (2005), corporate governance refers to the structures and processes for the direction and control of companies. Corporate governance concerns the relationships among the management, board of directors, controlling shareholders, minority shareholders and other stakeholders. The agency problems between owner and management can be handled by corporate governance mechanism. Corporate governance is one of the most efficient way in order to reduce occurrence of conflicts of interest and ensure achievement of company objectives required existence of regulations and control mechanisms that effectively directs the company operations and the ability to identify the parties who have different interests.
Effective monitoring from internal corporate governance is very important Effective monitoring from internal corporate governance is very important
a monitoring role in constraining the occurence of earnings management (Chen et al, 2006). The implementation of corporate gorvernance mechanism in company could protect investor and creditor from management opportunistic behavior.
C. Earnings Management
Scott (1997) defines earnings management as a management action by selecting the accounting policy of a certain standard for the purpose of maximizing their welfare and or the company's market value. He also defines four different pattern of earnings management, there are:
1. Taking a Bath This is the pattern of earnings management which done by increasing company profits become very high or very low.
2. Income Minimization This pattern is similar to taking a bath, but less extreme. Income minimization make company profit become lower.
3. Income Maximization This pattern is done by making company profit become higher.
4. Income Smoothing This pattern is done by raising or lowering company profits in financial statement so that the earnings fluctuation looks stable and normal.
aspects. First, earnings management interventions over financial reporting can be done with the use of judgment, for example judgment in estimating the number of economic events in the future to shown in financial statements, such as the estimated economic life and residual value of fixed assets, deferred taxes, receivables losses and the decline in asset values. Second, the purpose of earnings management is to mislead stakeholders about the economic performance of companies. This occurs when management has access to information that cannot
be accessed by outsiders. More specifically, Healy and Wahlen argue that earnings management is an activity where managers use their discretion to mislead stakeholders about economic performance of the company.
Ortega and Grant (2003) said that earnings management is possible because of the flexibility in financial reporting in order to transform the operations of a company's financial results. Earnings management will reduce the quality of reported earnings and also reducing investor confidence in the financial reports. In other words, earnings management is manipulating the earning to achieve a predetermined target set by the management. Earnings management can be measured by using discretionary accrual proxy inside the management agreement, where the management can interferee the process of making financial statements. The higher the value of discretionary accruals, the greater earnings is manipulated in company.
1. Chairman Characteristics
The role of the chairman is important to securing good corporate governance in company. Jensen (1993) defines the function of the chairman of the board as to run the board meetings, oversee the process of hiring, firing, evaluating and compensating the CEO. Chairman knowledge and experience are the significant elements in making sure the effectiveness of board monitoring function.
The tenure of the company chairman may have an impact on corporate fraud (Beasley, 1996). Firms that have chairman with shorter tenures are associated with higher incidences of fraud (Chen et al., 2006). They also explain that short tenure may imply the chairman lacks experience in the firm and so detecting fraud is more difficult. Hazarika et al. (2009) find that chairman tenure has negative influence related to earnings management. It means the longer chairman tenure in the company, the better the performance of the firm that could reduce earnings management.
The accounting and financial knowledge are beneficial for a chairman to understand better financial statements and financial reporting issues in company. Study recognized that chairman who has financial background are useful in monitoring management. Isidro and Goncalves (2011) found that earnings management is more likely to occur in firms that are run by a chairman and CEO who have a corporate and financial background.
monitoring over the board process (Fama and Jensen, 1983). The involvement of a chairman on board, either as director or chairman may create bias and inappropriately influence board decisions. Similarly, conflicts of interest may occur if a chairman is also an executive who is involved in the company management (Ismail et al., 2010). In such a firm, the executive chairman has more power over the board and firm without being supervised and evaluated. Jensen (1993) claimed that boards are less effective when the chief executive officer is also the chairman. Thus the following hypothesis is developed:
H 1a : Chairman tenure is significantly related to the earnings management.
H 1b : Chairman financial background is significantly related to the
earnings management.
H 1c : Executive chairman is significantly related to the earnings
management.
2. Board Structures
In general, the board of directors commissioned and given the responsibility for supervising the quality of the information contained in financial statements. Board of directors is the highest level of the control mechanisms in the organization since they possess the ultimate power to compensate the decisions that are made through the top management (Fama
directors reduce agency conflicts as they provide effective monitoring tool to the board (Fama and Jensen, 1983). The Malaysian Code of Corporate governance states that good corporate governance rests firmly with board of directors and the Code required one third of the board to comprise of independent directors in order to bring an independent judgment on the decision process. The outside directors are expert managers from other large organizations and with its expertise, independence, objectivity and legal power,outside directors become potentially powerful governance mechanisms to mitigate agency costs and protect shareholders wealth (Li, 1994). Empirical evidence from previous studies generally supports the expectation that board independence reduces earnings management and fraud accounting (Beasley, 1996 and Klein, 2002).
Board size is the number of directors on the board and an important factor in the effectiveness of the board in monitoring management. From agency perspective, larger board support effective monitoring management and protect shareholder’s interest. Previous studies that examine the monitoring effect between board size and earnings management found larger boards are more effective. Beasley (1996) shows an increasing relationship between fraudulent information on financial reports and board size. Further, Abdul Rahman and Ali (2006) find a significant positive relationship between board size and earnings management.
are more likely to discharge their duties in to monitoring issues such as earnings management, conflicts of interest and monitoring management. Conversely, boards that rarely meet may have no time to find out about such complex issues and may perhaps have time only to rubber- stamp management plans. Xie et al. (2003) claimed that a board that meets rarely may only have time for signing-off management plans and listening to presentations and they may not have time to focus on issues such as earnings management. They also find that earnings management is significantly negatively related to the number of board meetings. Thus the following hypothesis is developed:
H 2a : The proportion of independent board is significantly related to
the earnings management.
H 2b : The total number directors on the board is significantly related
to the earnings management.
H 2c : The total board meetings is significantly related to the earnings
management.
3. Independent Committees
Nominating committee (composed from inside the membership of the firm) suggests nominations and substitutions candidates for office in order to improve managers and administrator’s selection process and corporate Nominating committee (composed from inside the membership of the firm) suggests nominations and substitutions candidates for office in order to improve managers and administrator’s selection process and corporate
Vance (1983) claimed that the remuneration committee plays a significant role in the board composition. From agency theory perspective, the remuneration committee is a governance tool of control by the owners (principals) over top management (the agents) that is expected to set a compensation package that protects the interest of the shareholders, and to monitor management. Petra and Dorara (2008) argue that independent directors of remuneration committees are better able to accomplish their duties objectively. Furthermore, Dahya and McConnell (2007) also found that more outside directors sitting on committees leads to better performance as a result of independence.
The audit committee is charged with the responsibility of overseeing the firm’s financial reporting process (Klein, 2002). The purpose of the audit committee is to ensure the accuracy of the financial reports (Buchalter and Yokomoto, 2003). Audit committee is more effective if all of the members are independent. Study by Bedard et al. (2004) investigate the impact of audit committee characteristics including independent committee on earnings management and the result found that audit committee independence is The audit committee is charged with the responsibility of overseeing the firm’s financial reporting process (Klein, 2002). The purpose of the audit committee is to ensure the accuracy of the financial reports (Buchalter and Yokomoto, 2003). Audit committee is more effective if all of the members are independent. Study by Bedard et al. (2004) investigate the impact of audit committee characteristics including independent committee on earnings management and the result found that audit committee independence is
H 3a : Nomination committee independence is significantly related to the
earnings management.
H 3b : Remuneration committee independence is significantly related to
the earnings management.
H 3c : Audit committee independence is significantly related to the
earnings management.
4. Family Control
Unlike developed countries such as United Kingdom and United States of America with dispersed ownership structure. In developing countries partly large firms are controlled by family ownership. Asian firms have more concentrated ownership structure where family control is common in both small and established firms (Mak and Kusnadi, 2005). With most large corporations owned and controlled by families and with family members holding key managerial positions, however, the major agency problem exists not between the management and owners in general, but between the management (the controlling family) and minority shareholders (Ali shah et al., 2009).
Due to controlling power in company, the dominant family is able to influence appointments of top managers as well as board members. The
(2009) argues that controlling familes could monitor managerial behavior and actions effectively, which caused reducing managerial opportunities to engage in earnings management. They also gave opinion that there will be less pressure on management to meet short term earnings expectations because controlling families focus more on the long term. Based from previous study by Jiraporn and DaDalt (2007) reveal that family firms are signi ficantly less likely to manage earnings. Thus the following hypothesis is developed:
H 4a : The family involvement on the board is significantly related to the
earnings management.
H 4b : The proportion of family ownership is significantly related to the
earnings management.
RESEARCH METHODS
A. Research Design
This study is a hypothesis testing study and it aims to test independent variables that have an impact to dependent variables. This study was conducted to test and examine the effect of coporate governance mechanism to earnings management. This is a cross sectional study, which means that the data were only taken once (the end of 2010). Independent variables in this research consist of chairman tenure, chairman financial background, executive chairman, board size, proportion of independent board, board meeting, remuneration committee independence, nomination committee independence, audit committee independence, family involvement, and family ownership. Dependent variable is earnings management which represented by discretionary accruals.
B. Population and Sample
Population refers to the entire group of people, events, or things of interest that researcher wishes to investigate (Sekaran, 2000). Population of this research is all annual reports of manufacturing companies listed in Bursa Malaysia Berhad at the period of 2010. This country is chosen because the implementation of corporate governance mechanisms in Malaysia is better than in Asia countries.
population, means that by studying the samples and understanding of the characteristics of the samples subjects, it would be possible to generalize the characteristics of population elements (Sekaran, 2000). Sample methods for this research is purposive sampling which aims to obtain the representative samples along with researcher needs. For each company, the 2010 annual reports was obtained from Malaysia stock exchange website. The initial samples were chosen randomly for 200 annual reports. If the annual report does not meet those criteria then the firm is excluded from the sample. The criteria of sample are determined by:
1. The firm is manufacturing company which listed in Bursa Malaysia during the period 2010.
2. The firm publishes annual report and financial statements at the end of December 2010.
3. The firm has annual report in English or at least has the English version.
4. The firm has complete data on coporate governance and earnings management.
C. Source and Data Collecting Technique
This study uses secondary data which means data that refers to information that obtained from existing sources (Sekaran, 2000). The data comes from annual reports in Bursa Malaysia Berhard websites. Data used in this research are:
Berhard website.
2. Company’s corporate governance data is based on annual reports disclosures which published by the company.
3. Earnings management data is obtained from the financial statements of companies. The data includes: comprehensive income, net cash flow from operating activity, total assets, changes of revenues, property, plant, and equipment (PPE), and changes in receivables.
D. Operational Definition and Measurement of Variables
This study uses the independent variables, dependent variable, and control variables. The operational definition and measurement of the variables are described as follows:
1. Independent Variables
Independent variables in this study is good coporate governance which can be explained by chairman tenure, chairman financial background, executive chairman, board size, independent board, board meeting, remuneration committee independence, nomination committee independence, audit committee independence, family involvement, and family ownership.
a. Chairman tenure is measured by duration of chairman tenure until year t.
b. Chairman financial background is dummy variable. If chairman has financial education background = 1, otherwise = 0 b. Chairman financial background is dummy variable. If chairman has financial education background = 1, otherwise = 0
d. Board size is measured by the total number of board members on the board.
e. Propotion of independent board is measured by the proportion of independent directors on the board, expressed as a percentage.
f. Board meeting is measured by total number of board meeting which held annualy by the board of directors.
g. Remuneration committee independence is measured by the percentage of remuneration committee independence to total committee.
h. Nomination committee independence is measured by the percentage of nomination committee independence to total committee.
i. Audit committee independence is measured by the percentage of audit committee independence to total committee. j. Family involvement is measured using ratio family members on the board to total number of directors. k. Family ownership is measured by using percentage of direct shares owned by family members on the board.
2. Dependent Variable
Dependent variable in this study is earnings management. Earnings management is purposeful intervention in the external financial reporting Dependent variable in this study is earnings management. Earnings management is purposeful intervention in the external financial reporting
This is OLS regression equation to estimate Total Accrual:
Non Discretionary Accruals (NDA) can be calculated by the formula:
Discretionary Accrual (DA) can be calculated by the formula:
Explanation : DAit
= Firm’s value of discretionary accruals in year t
NDAit
= Firm’s value of non discretionary accruals in year t
TAit
= Firm’s total accruals in year t
Nit
= Firm’s comprehensive income in year t
CFOit = Firm’s net cash flow from operating activity in year t
TAC = Nit – CFOit
TAit/Ait-1 = β1 (1 / Ait-1) + β2 (ΔRevt / Ait-1) + β3 (PPEt/ Ait-1) + e
NDAit = β1 (1 / Ait-1) + β2 (ΔRevt / Ait-1 - ΔRect/ Ait-1) + β3 (PPEt / Ait-1)
DAit = TAit / Ait-1 – NDAit
PPEt
= Firm’s value of PPE in year t ΔRect = Firm’s change in receivables in year t-1 and t
e = error terms
3. Control Variables
Control variables in this study is explained by firm size, leverage and type of industry.
a. Firm size is control variable which measured by nantural logarithm of total assets.
b. Leverage is control variable which measured by ratio of total debt to total assets.
c. Type of indsutry is dummy variables which represented by give score (1,2,..,5) on each type of manufacturing companies.
E. Data Analysis Methods
In this study, OLS (Ordinary Least Squares) analysis regression is used to analyze the realationship between independent variables, dependent variable, and control variables. SPSS 17.00 for Windows is used as an analytical data tool to test the regression model. Theoretically, the model will give the valid value if classic assumption test are fulfilled.
Before testing the hypothesis, classic assumption test is important to ensure that study results are valid. Classic assumption test consist of several kinds of tests including normality test, multicollinearity test, autocorrelation test, and heteroscedasticity test.
a. Normality Test
Normality test is used to determine whether the residual value in regression model is well- modeled by a normal distribution (Ghozali, 2006). T-test and F-test is done with underlying assumption that residual value is normally distributed. Kolmogorov-Smirnov test is applied to test this assumption. Criteria that operate in this test are two tailed test, comparing p- value with significance level. This study use significance level 0.05. If p- value > 0.05 then the data is normally distributed.
b. Multicollinearity Test
Multicollinearity test is used to determine whether two or more independent variables in a multiple regression model are highly correlated (Ghozali, 2006). Tolerance value and variance inflation factors (VIF) could provide measurement to detect if multicollinearity exist. These measurements can show which independent variables are explained by other independent variables. If tolerance value < 0.05 and VIF > 5, then multicollinearity exist.
Autocorrelation test is used to determine whether there is a correlation between values of the process at different points in time, as a function of the two times or of the time difference. If there is no correlation between residual value, then the residual value is random (Ghozali, 2006). This study use run test to detect autocorrelation. Criteria that operate in this test are two tailed test, comparing p-value with significance level. This study use significance level 0.05. If p-value > 0.05 then the residual is random.
d. Heteroscedasticity Test
Heteroscedasticity test is used to determine whether the variance of the error terms differ across observations (Ghozali, 2006). Tests to detect existance of heteroscedasticity is look at the graph scatterplot between the predicted value of the dependent variable (ZPRED) and the residual (SRESID). When the dots result is spread and random, then there is no heteroscedasticity.
1. Descriptive Statistics and Univariate
Descriptive statistics used to find the average (mean), standard deviation, and maximum and minimum value from variables tested in the study. This analysis is intended to provide idea of distribution and behavior data samples (Ghozali, 2006).
From the hypothesis above, the research model can be explained by this formula:
DAC
= discretionary accruals
= parameters (i = 1,2,3,...11)
CTE
= chairman tenure
CFB
= chairman financial background
CEX
= executive chairman BDIND = board independent BDSZ
= board size
BDM
= board meeting
NOM
= nomination committe independence
REM
= remuneration committe independence
AUD
= audit committe independence
FAM
= family involvement
OWN
= family ownership
AST
= firm size
= type of industry
e = error terms
a. Significance Silmutaneous Test (F-Test)
F-Test is used to prove whether all independent variables have a simultaneously effect on dependent variables.
DAC =β 0 +β 1 CTE + β 2 CFB + β 3 CEX +β 4 BDIND +β 5 BDSZ + β 6 BDM +β 7 NOM +β 8 REM +β 9 AUD +β 10 FAM + β 11 OWN+
β 12 AST + β 13 LEV +β 14 IND +e
Coefficient of determination is used to explain how much of the variability of regression model can be caused or explained by its relationship to dependent variable. Each additional independent variable
will make R 2 increase.
c. Partial Regression Test (t-test)
This test is to determine whether the independent variables in the partial will affect the dependent variable, assuming the other independent variables constant. Criteria of test:
1. If significant value > alpha (5%, 1% , or 10%), it means an individual independent variable had no effect on the dependent variable.
2. If significant value < alpha (5%, 1% , or 10%), it means an individual independent variable had effct on the dependent variable.
DATA ANALYSIS
This chapter will describe about data description, data analysis, and research result that have been performed during the study. Analytical model used in this study is multiple linear regression using SPSS software version of 17.00
A. Total Data Collection
The population in this study is all listed manufacturing companies in Bursa Malaysia during period of 2010 taken from Bursa Malaysia Berhard. Based on the sample criteria discussed above, this study has obtained 200 final samples. The process of sample selection is described in Table IV.1.
Table IV.1 Results of Sample Selection
Explanation 2010
Total companies listed in Bursa Malaysia 828 Total non manufacturing companies
Total manufacturing companies
Manufactuting companies with incomplete data (98) Unpublished annual report of manufacturing companies until the
end 2010
(82) Total final samples
Source: Bursa Malaysia Berhard (2012)
B. Classic Assumption Analysis
The result of classic assumption test in this study can be found in appendix. The results explained that the residual data have been normally distributed and The result of classic assumption test in this study can be found in appendix. The results explained that the residual data have been normally distributed and
C. Descriptive Statistics and Univariate
Descriptive statistics used to find the average (mean), standard deviation, and maximum and minimum value from variables tested in the study. The operational definition of variable tested is described in Table IV.2.
Table IV.2 Variable Definition
Variables
Acronym Operational Definition
Earnings management
DAC
Discretionary accruals calculated by using modified Jones model
Chairman tenure
CTE
Duration of chairman tenure until year t Chairman financial background
CFB
If chairman has financial education background = 1, otherwise = 0
Executive chairman
CEX
Executive chairman = 1, chairman non-executive = 0 Proportion of independent board
BDIND
Percentage of independent directors on the board Board size
BDSZ
The size number of board on year t Board meeting
BDME
Total number of board meeting held annualy by the board of directors
Nomination committee independence
NOM
Percentage of nomination committe independent to total committee on year t
Remuneration committee independence
REM
Percentage of remuneration committe independence to total committee on year t
Audit committee independence
AUD
Percentage of audit committe independence to total committeeon year t
Family involvement
FMI
Percentage of family involvement on the board Family ownership
OWN
Percentage of direct shares owned by family on the board
Assets
AST
Natural logarithm of total assets
Leverage
LEV
Ratio of total debt to total assets Ratio of total debt to total assets
Table IV.3 Descriptive Statistics
Table IV.3 provides the descriptive statistics of discretionary accrual and corporate governance. Discretionary accrual has a minimum score -0.49 and maximum score 0.28 with an average score 0.0024. Negative value means the company made earnings management by lowering profits and positive value means the company made earnings management by raising profit. The average tenure of chairman is 6.935 and the average of chairman financial background is 30.5%, it means that most chairman did not have education background in finance. The average position of chairman is 39% as executive member, indicating the number of executive chairman less than number of non-executive chairman in
board is met with what Malaysian’s government requires. The rule states that proportion of board members should at least contain one third independent directors. The average size of board is 7.275 and the number of board meetings which were held has an average score 5.4. The average scores for proportion of nomination committee independence, remuneration committee independence, and audit committee independence are 79%, 65%, and 88%. The number of audit committee has met with the government rule which stated 1/3 of the members should be independent members.The family involvement in boards has a average score is 21.9% and the average score of family ownership is 6.87 %.
Control variables for this study are company size (AST), leverage (LEV), and type of industry (IND). The average score of company size is 19.5344 with a lowest score 17.16 and a highest score 23.36. Leverage has an average score 0.4204 with a lowest score 0.03 and a highest score 1.42. Type of industry (IND) is a dummy variables with minimum value 1, maximum value 5 and an average score 3.12.
Pearson correlation test results are desribed in Table IV.4. The table shows that coefficient between independent variables and dependent variable are relatively low so there is no multicollinearity issues. Independent variables such as chairman financial background (CFB), board size (BDSZ), and board meeting (BDME) are significantly correlated to earnings management. Otherwise, the
Table IV.4 Pearson Correlation
BDSZ BDME
BDIND ** 0.031 -0.122 0.187 -0.066
-0.371 BDSZ ** 1 BDME
0.295 ** -0.208 ** 0.091 0.610 ** 1 AUD
0.188 ** -0.146 * 0.177 * -0.201 FMI ** 0.161 * -0.162 * 0.006
-0.375 -0.167 -0.022