Documentos de Académico
Documentos de Profesional
Documentos de Cultura
com
Abstract
The purpose of this study is to investigate whether companies listed on the Jakarta Stock
Exchange (JSE) conduct efficient or opportunistic earnings management and to examine the effect of
ownership structure, firm size, and corporate-governance practices on it.
Using multiple regressions, we find evidence that the type of earnings management selected by
JSE listed firms tends toward efficient earnings management. This evidence is inconsistent with the
common view that earnings management in Indonesia is opportunistic. Family ownership has a
significant influence on the type of earnings management selected. Firms with a high proportion of
family ownership and non-business groups are more inclined to choose efficient earnings
management than other types of firms. We find inconsistent evidence with regard to the impact of
institutional ownership, firm size, and corporate-governance practices on type of earnings
management.
2008 Published by University of Illinois.
Keywords: Type of earnings management; Ownership structure; Firm size; Corporate governance
1. Introduction
Corresponding author.
E-mail address: sylvia.veronica@ui.edu (S.V. Siregar).
0020-7063/$30.00 2008 Published by University of Illinois.
doi:10.1016/j.intacc.2008.01.001
2 S.V. Siregar, S. Utama / The International Journal of Accounting 43 (2008) 127
controlling shareholders. In the former, there are fewer agency problems because the
conflict between principal and agent is less than that in the latter. However, as Claessens,
Djankov, Fan, and Lang (1999) find, family-controlled firms, through pyramid ownership
structure and their business group, expropriate minority shareholders (i.e., the public). In
this study, we suggest that in family-controlled firms with no business groups, the
motivation to expropriate minority shareholders is less and thus the earnings management
in these firms tend to be relatively more efficient.
Our sample consists of 144 firms for the years of 1995 to 1996 and 1999 to 2002. We
excluded the years 1997 and 1998 (the Asian financial crisis period) because Indonesia
experienced a heavy economic crisis in those years that resulted in financial statements for
most firms being highly distorted from the normal period.
Although our evidence regarding type of earnings management is mixed, it tends
to be more relatively efficient earnings management. This finding is inconsistent
with the usual view that earnings management (in Indonesia) is opportunistic. We
also find that family ownership has significant influence on type of earnings man-
agement; firms with a high proportion of family ownership and non-business groups
are more likely to adopt efficient earnings management efficient than other types of
firms. There is no consistent evidence that institutional ownership, firm size, and
corporate-governance practices have significant influence on earnings-management
type.
This paper contributes to the literature on earnings management in several ways. First,
the evidence in this paper suggests that firms largely owned by families and do not
belong to business groups are more likely to choose efficient earnings management
compared to firms with different ownership structures, thus, providing the first evidence
that family ownership and business group influence the type of earnings management
selected.
Second, we find no evidence that variables representing corporate-governance practices
(audit quality, the independence of the board of commissioners, and the existence of an
audit committee), influence on the type of earnings management. Our result is inconsistent
with the hypothesis that corporate-governance practices provide monitoring mechanisms
that constrain opportunistic earnings management. This finding may be due to the fact that
the regulation on corporate-governance practice in Indonesia is relatively recent, so its
effectiveness still remains to be seen.
2. Literature review
According to this rule, the number of independent board members must be 30% of the
board size, and the independent board members should be:
An audit committee should have at least three members, one of whom must be an
independent board member, who will act as chairman of the audit committee, and the other
members should be independent external parties, at least one of whom has accounting and/
or finance skills.
Several studies find evidence consistent with the opportunistic perspective. Burgstahler
and Dichev (1997) find that management engages in earnings management to avoid
reporting losses or earnings decline. Balsam et al. (2002) find a negative relationship
between unexpected discretionary accruals and stock returns around the earnings-
announcement date. This result indicates that the market views discretionary accruals as
opportunistic.
In contrast, other studies find evidence that is consistent with the efficient perspective.
Subramanyam (1996) concludes that discretionary accruals are efficient because they have
a positive, significant relationship with future profitability. This positive relationship
describes the ability that discretionary accruals have to communicate information about a
firm's future profitability to the public. Gul et al. (2000) and Krishnan (2003), following
Subramanyam (1996), also find consistent evidence.
and Reeb (2003) find that family-controlled firms are valued higher or perform better than
other firms. Anderson and Reeb (2003) show that minority shareholders in large U.S. firms
benefit from the presence of founding families.
Arifin (2003) finds that in his sample of publicly listed firms in Indonesia, family-
controlled firms, state-owned firms, or institutional-controlled firms have fewer agency
problems than publicly-controlled firms or firms without controlling shareholders.2 He
suggests that the agency problems in family-owned firms are fewer because there is less
conflict between the principal and agent. But, if there are minority interests in family-owned
firms, there is another agency problem, namely a conflict of interests between majority
(family) and minority ownership.
Claessens et al. (1999) find that higher cash-flow rights are associated with higher
market valuation, but higher control rights are associated with lower market valuation,
especially when cash-flow rights are low and control rights are high. This suggests
expropriation of minority shareholders by controlling shareholders. They conclude that
family control is an important factor behind the negative relation between control rights and
market valuation.
If family ownership represents an efficient organizational structure, then in family-
owned firms opportunistic earnings management will be limited. However, in firms with
business groups (in Indonesia most publicly listed firms have business groups), this pattern
may not hold. For firms belonging to business groups, most of the owners' capital is not
invested in a single company, but rather is spread over several companies. If any portion of
that capital is invested in public firms, then expropriation of minority shareholders and thus
opportunistic earnings management is likely to occur, even if the company is controlled by
one family. This happens because public firms are exploited by the owners who use them to
collect funds from the public which are in turn transferred to other firms in the business
group. Kim and Yi (2005) find evidence that opportunistic earnings management is higher
in firms with business groups compared to firms without them. Their results suggest that
firms with business groups give their controlling shareholders more incentive to engage in
earnings management.
2
There are agency problems in state-owned firms, because the principal is the public. But the public in its role
as a principal cannot monitor management directly. Instead they are represented by the government. Since
government is not the genuine principal, it is less motivated to monitor management (including monitoring on
earnings-management activity), which finally will harm the public.
S.V. Siregar, S. Utama / The International Journal of Accounting 43 (2008) 127 7
expectations. Jiambalvo et al. (2002) find evidence that is consistent with the view that
institutional investors also use non-earnings information to predict future earnings.
Balsam et al. (2002) find evidence that market reaction arising from the behavior of
sophisticated investors (institutional investors) occurs earlier than that of non-sophisticated
investors. They argue that sophisticated investors have access to more information from
other sources, more timely information, and are also more capable of decomposing earnings
into discretionary and non-discretionary components. Bushee (1998) suggests that
institutional ownership has a monitoring role that pushes managers to take actions that
will not harm the company in the long run.
While in Indonesia context, Mitra (2002), Koh (2003), and Midiastuty and Machfoedz
(2003) find evidence that high institutional ownership constrain earnings management in
those firms. However, Darmawati (2003) does not find significant relationship between
earnings management and institutional investors.
2.3.4.1. Audit quality. Several studies examine the association between audit quality and
earnings management. Becker, Defond, JiamBalvo, and Subramanyam (1998) and Francis,
Maydew, and Spark (1999) find evidence that discretionary accruals in firms audited by Big
6 auditors are less than that in firms audited by non-Big 6 auditors. Krishnan (2003) finds
that discretionary accruals in firms audited by Big 6 auditors have a higher positive
relationship with future profitability than that of firms audited by non-Big 6 auditors. He
says that auditing has a significant role in constraining opportunistic earnings management.
However, Sandra and Kusuma (2004) find no significant evidence that audit quality has a
moderating effect on the relationship between earnings management and stock returns in
Indonesia. This result indicates that auditor size may not be a good proxy for audit quality in
Indonesia.
2.3.4.2. Independent board. Indonesian corporate law stipulates that a corporation has to
follow a two-board system consisting of a board of commissioners and a board of directors.
The function of the board of commissioners is to oversee and supervise how the board of
directors conducts the company's operation. Members of the board of commissioners are
entirely different from the board of directors. However, being dominated by the majority
shareholders, the boards of publicly listed companies in Indonesia are controlled by these
majority shareholders in substance and these boards are not independent from each other.
8 S.V. Siregar, S. Utama / The International Journal of Accounting 43 (2008) 127
To alleviate the potential expropriation of minority shareholders rights (i.e., the public
shareholders), Badan Pengawas Pasar Modal (or Bapepam/the Capital Market Supervisory
Body) acquires that at least 30% of the members of the board of commissioners must be
independent from the company and from the majority shareholders. The existence and
function of the so-called independent commissioners are similar to the non-executive
members of the board under the one-board system, as the following studies show.
Dechow, Sloan, and Sweeney (1996) find that firms whose CEO also chairs the board of
directors1 are more likely to be subject to accounting enforcement actions by the SEC for
alleged GAAP violation. Peasnell, Pope, and Young (2000) also find that the probability of
income-increasing accruals decreases as the proportion of outside-directors1 increases for a
sample of U.K. firms. Chtourou, Bedard, and Courteau (2001) find that independent board1
is constraining earnings-management activity. These studies are conducted for the one-
board system. Indonesia uses a two-board system. There are also several studies related to
the two-board system used in Indonesia. For example, Wedari (2004), who examines public
firms in JSE from year 1994 to 2002, finds that an independent board constrains earnings-
management activity. In contrast, Parulian (2004) finds that independent boards for the
public firms in JSE have no significant influence on earnings management. Both these
studies define independent boards as those where members of the board of commissioners
are independent from the company and the majority shareholders.
2.3.4.3. Audit committee. Klein (2002a) finds that an independent audit committee and
active audit committee are associated with lower levels of discretionary accruals for U.S.
firms. Chtourou et al. (2001) find that income-increasing earnings management is
negatively associated with a committee composed only of independent directors1 that meet
more than twice a year.
In Indonesia, Wedari (2004) finds that discretionary accruals of firms with an audit
committee are significantly higher than that of firms with no audit committee. Parulian
(2004) shows that negative discretionary accruals of firms with an audit committee is
significantly lower than that of firms with no audit committee, but positive discretionary
accruals of firms with an audit committee is not significantly lower than that of firms with no
audit committee. But other studies find evidence that indicate the ineffectiveness of an audit
committee as part of corporate-governance practices in publicly listed firms in JSE.
Mayangsari (2003) finds the presence of an audit committee associated negatively with
financial-statement integrity (proxied by the conservatism index). Nuryanah (2004) also
shows that audit committee does not have a significant association with the value of the firm.
There are two types of earnings management: efficient and opportunistic. Earnings
management is efficient if managers use their discretion to communicate private information
about firm profitability, which is yet to be reflected in the historical cost-based earnings, while it
is opportunistic if managers use their discretion to maximize their utility, thereby garbling
earnings (Subramanyam, 1996). Therefore, we test whether earnings management is efficient
S.V. Siregar, S. Utama / The International Journal of Accounting 43 (2008) 127 9
Institutional investors are generally thought to be sophisticated investor who can be able
to use current information to predict future earnings better than non-institutional investors
(Jiambalvo et al., 2002). According to the Financial Economists Roundtable Statement on
Institutional Investors and Corporate Governance (1999), large institutional ownership in
an entity provides strong incentive for investors to actively monitor and influence
managements' policy for that entity.
Bushee (1998) finds that institutional investors create less incentive for management to cut
research and development expenditures to attain short-term targets, a finding which also
indicates that institutional investors play a role in monitoring management behavior. Jiambalvo
(1996) finds that absolute discretionary accruals have a negative association with institutional
ownership. Balsam et al. (2002) conclude that because institutional investors have
10 S.V. Siregar, S. Utama / The International Journal of Accounting 43 (2008) 127
access to more timely and relevant information, they could identify earnings man-
agement faster and easier than non-institutional investors. The results of these studies
suggest that institutional ownership leads to a monitoring role, which in turn constraints
opportunistic earnings management. Therefore, we formulate the following hypothesis.
Hypothesis 1c. The higher the proportion of institutional ownership, the higher the effect
of discretionary accruals on future profitability.
opportunistic earnings management. Klein (2002b) concludes that a less independent audit
committee will increase discretionary accruals.
Based on the above explanations, we expect that the higher the audit quality, the higher
the proportion of independent board members, and the existence of an audit committee will
restrain opportunistic-earnings management and, eventually, will increase the effect of
discretionary accruals on future profitability.
Hypothesis 1e. The effect of discretionary accruals on future profitability is higher on
firms audited by Big 4 auditors than on firms audited by non-Big 4 auditors.
Hypothesis 1f. The higher the proportion of independent board members, the higher the
effect of discretionary accruals on future profitability.
Hypothesis 1g. The effect of discretionary accruals on future profitability is higher on
firms with an audit committee than on firms with no audit committee.
Following Subramanyam (1996), to test Hypothesis 1a, we use the following research
model:
Xit1 b0 b1 CFOit b2 NDACit b3 DACit b4 DFAMit b5 INSTit
b6 DSIZEit b7 AUDITit b8 BODit b9 AUDCOMit b10 D99i
b11 D00i b12 D01i e 1a
where:
type of earnings management is efficient, the coefficient (b3) will be positive. Otherwise, it
will be either zero or negative. Other variables relate to firm size, ownership structure, and
governance practices and they are included as control variables.
Hypotheses 1b1g imply that the DAC coefficient (b3) is influenced by the
hypothesized variables (family ownership, proportion of institutional investors, etc.).
Therefore, to test Hypotheses 1b1g, we use the following research model, which allows
the DAC coefficient to vary:3
Table 1
Correlation between discretionary accruals in year t and year t + 1
DACt
DACt + 1 0.382
0.0000 a
Number in bold is the p value of the coefficient correlation.
t = years 1995, 1999, 2000, 2001.
t + 1 = years 1996, 2000, 2001, 2002.
a
Significant at 1%.
1. Jones (1991):
ACCRit a0 a1 DREVit a2 PPEit eit
where:
REC change in net accounts receivables from year t 1 to year t (RECt RECt 1).
CFO change in cash flows from operation from year t 1 to year t (CFOt CFOt 1).
Sample firms are further classified into belonging to business groups and not belonging
to business groups. For this purpose, we use information on Conglomeration Indonesia
(1997) and Top Companies and Big Groups in Indonesia (1995). These books provide a list
of business groups in Indonesia along with firms belonging to each group.
We hypothesize that firms in the category high family ownership and no business
groups are likely to engage in more efficient earnings management than the other three
categories (high family ownership and belonging to business groups, low family ownership
and not belonging to business groups, low family ownership and belonging to business
groups). To test the hypothesis, we make a dummy variable taking the value of one for firms
with high family ownership and no business groups and zero for otherwise.
3.3.6.1. Auditor's size5. Auditor's size is used to measure audit quality, where one for
firms audited by Big 4 auditors (high audit quality) and zero for firms audited by non-Big 4
auditors (low audit quality).
4. Sample selection
The sample for the study is comprised of all firms listed on the Jakarta Stock Exchange
(JSE), excluding firms in financial, real estate, and telecommunication industries. The
5
In our research period, 19952002, there was a change in the number of big accounting firms. From years
19951998, there were six big accounting firms (Big 6), in years 19982002 there were five (Big 5), and since
2002 there have been four (Big 4). Our definition follows the change in the number of big accounting firms;
however, for simplicity, in this study we use the term Big 4 for all big accounting firms during our research
period.
16 S.V. Siregar, S. Utama / The International Journal of Accounting 43 (2008) 127
Table 2
Sample selection procedure
Total number of firms listed in the JSE as of December 31, 1994 239
Firms in financial, real estate, and telecommunication industries (74)
Delisting during period 19962002 (15)
Preferred stock (3)
Firms with non-December 31 fiscal year (1)
Incomplete data (2)
Total sample firms 144
sample period is from 19951996, and 19992002. The following criteria are applied in
selecting firms for the sample:
Table 3
Evaluation of earnings-management-measurement models
Panel A: adjusted R2
Measurement model Adjusted R2
1995 1996 1999 2000 2001 2002 Mean
Jones (1991) 0.2005 0.0900 0.0300 0.0265 0.1520 0.0380 0.0895
Dechow et al. (1995) 0.1845 0.0625 0.0250 0.0250 0.1240 0.0345 0.0759
Kasznik (1999) 0.5220 0.5290 0.4145 0.1650 0.3790 0.1030 0.3521
Dechow et al. (2002) 0.2455 0.2000 0.0920 0.0480 0.3000 0.1771
Table 4
Descriptive statistics
Mean Median Maximum Minimum Standard deviation
CFOt + 1 0.0756 0.0662 0.4307 0.2905 0.1061
NDNIt + 1 0.0121 0.0114 0.3220 0.3312 0.1052
EARNt + 1 0.0120 0.0024 0.8395 0.9006 0.2565
CFO 0.0740 0.0644 0.5277 0.3210 0.1257
NDAC 0.0527 0.0583 0.2986 0.4116 0.1087
DAC 0.0001 0.0007 0.3968 0.3966 0.1158
INST 0.0659 0.0000 0.8423 0.0000 0.1420
BOD 0.0768 0.0000 0.7500 0.0000 0.1526
Proportion Proportion
Dummy = 1 Dummy = 0
DFAM 20.31% 79.69%
DSIZE 50.00% 50.00%
AUDIT 88.02% 11.98%
AUDCOM 11.46% 88.54%
CFOt + 1 = cash flows from operation one-year-ahead, NDNIt + 1 = non-discretionary net income one-year-ahead,
EARNt + 1 = change in earnings one-year-ahead, CFO = cash flows from operation, NDAC = non-discretionary
accruals, DAC = discretionary accruals, DFAM = one if firms have high family ownership and do not belong to
business groups and zero otherwise, INST = institutional ownership, DSIZE = one if firm is in the 50% highest
market capitalization and zero otherwise, AUDIT = one if firm is audited by Big 4 auditors and zero otherwise,
BOD = proportion of independent board, AUDCOM = one if firms have audit committee and zero otherwise.
The sample selection procedure is summarized in Table 2. After applying the above
criteria, there are 144 firms in our sample.
5. Results
To determine which model to use in our main analysis, we evaluate the explanatory
power (adjusted R2) of each model. The results for each model (Jones, 1991; Dechow et al.,
1995; Kasznik, 1999; Dechow et al., 2002) are presented in Table 3. Because Kasznik
(1999) shows the highest adjusted R2, we employ this model in our main analysis and the
others in sensitivity analysis.
Table 5
Family ownership and business groups
Business group
Part of business group Non-business group Total
Family N50% 48.96% 20.31% 69.27%
Ownership b50% 27.08% 3.65% 30.73%
Total 76.04% 23.96% 100.00%
18
Table 6
Correlation
CFOt + 1 NDNIt + 1 EARNt + 1 CFO NDAC DAC DFAM INST DSIZE AUDIT BOD AUDCOM
CFOt + 1 1.0000 0.6450 0.0380 0.3790 (0.0020) 0.1070 0.1510 (0.0610) 0.1270 0.1250 (0.0990) (0.1040)
In panel B of Table 3 we present the percentage of the coefficient for a predicted sign for
each model. The Kasznik model has a relatively greater proportion of coefficients that are of
a predicted sign.
Descriptive statistics and their correlation are shown in Tables 46. On average, the
sample firms have positive future cash flow from operation and positive future non-
discretionary net income (CFOt + 1 and NDNIt + 1). But from EARNt + 1, we can see that,
on average, the sample firms have declining earnings. The majority of our sample firms are
audited by big accounting firms (88.02%) but only 11.46% have an audit committee in
compliance with the JSE rule.
Only 20.31% of our sample is in the category high family ownership and not belonging
to business groups. Further examination of family ownership and business groups is
presented in Table 5. About 76% of our sample firms belong to business groups and 24%
are not members of any business groups. Consistent with Arifin (2003), the majority of our
sample is controlled by family (69%).
CFO has a negative and significant correlation with NDAC and DAC, which is
consistent with the smoothing nature of accruals. Future cash flows has a positive and
significant correlation with firm size, which means that large firms have high cash flows
from operation.
DFAM has a positive and significant correlation with CFOt + 1 and NDNIt + 1, which
indicates that firms with high family ownership that have no business groups have a higher
future profitability than other firms. A positive and significant correlation between AUDIT
and DSIZE shows that large firms tend to be audited by Big 4 auditors. A positive and
significant correlation between BOD and AUDCOM shows that firms with a high
proportion of independent board members tend to have audit committees. A majority of our
sample firms are non-DFAM firms and audited by Big 4 auditors.
The results from the regression of research model (1a) are presented in Table 7.
Hypothesis 1a is supported (significant at the 1% level). The DAC coefficient is positive if
we use cash flows from operation and non-discretionary net income and it is negative if we
use change in earnings as a dependent variable. This result indicates that the type of
earnings management tends to be efficient contracting because two out of three DAC
coefficients are positive. This is not consistent with the common view that earnings
management in Indonesia is opportunistic.
Subramanyam (1996), Gul et al. (2000), and Krishnan (2003) also find evidence that
earnings management of listed firms in the United States is also efficient. But Burgstahler
and Dichev (1997) and Balsam et al. (2002) find opposite evidence. They conclude that
earnings management is opportunistic.
Results from the regression of research model (1b) are shown in Table 8. The VIFs for all
independent variables are below 10, indicating that multicollinearity is not a problem.
Hypothesis 1b is accepted and this indicates that earnings management in firms with high
20 S.V. Siregar, S. Utama / The International Journal of Accounting 43 (2008) 127
family ownership that do not belong to business groups is more efficient than that in other
firms.
For panels A and B, Hypothesis 1c is not supported (5 is positive but insignificant).
This result suggests that institutional ownership does not significantly induce management
to adopt efficient earnings management. As shown in descriptive statistics in Table 3, the
average institutional ownership in our sample is relatively small and this could constrain the
ability of institutional investors to monitor management effectively. Hypothesis 1d is also
not supported (6 is positive but insignificant). This evidence could suggest that large firms
do not use efficient earnings management significantly more than small firms.
Hypothesis 1e is not supported, which show that firms audited by the Big 4 do not use
efficient earnings management more than firms audited by non-Big 4. This may suggest
that size of audit firms may not be a good proxy for audit quality.
Hypothesis 1f is also not supported. Two explanations for this result are: first,
independent boards have been shown to effectively monitor management in part because
Table 7
Regression of future profitability on discretionary accruals, other earnings component, and control variables
Variable Expected CFOt + 1 NDNIt + 1 EARNt + 1
sign
Coefficient p value Coefficient p value Coefficient p value
C 0.0224 0.1181 0.0212 0.0152 0.0571 0.1508
CFO + 0.4945 0.0000 0.7191 0.0000 0.0759 0.2563
NDAC + 0.4015 0.0000 0.3019 0.0000 0.1626 0.1754
DAC +/ 0.1365 0.0003 0.1373 0.0000 0.2536 0.0489
DFAM + 0.0218 0.0239 0.0023 0.6242 0.0516 0.0353
INST + 0.0374 0.8699 0.0299 0.9240 0.0713 0.1900
DSIZE + 0.0047 0.2937 0.0007 0.4460 0.0525 0.0094
AUDIT + 0.0227 0.0266 0.0084 0.1303 0.0220 0.2798
BOD + 0.0160 0.3563 0.0457 0.8944 0.0208 0.5630
AUDCOM + 0.0283 0.9651 0.0128 0.8540 0.0788 0.0454
D99 0.0047 0.7056 0.1495 0.0000 0.1157 0.0002
D00 0.0417 0.0145 0.0516 0.00004 0.1208 0.0034
D01 0.0150 0.4039 0.0076 0.5657 0.0817 0.1009
N 553 558 550
Adjusted R2 0.2497 0.6848 0.0966
F-statistic 16.3069 101.8418 5.8917
p value (F-statistic) 0.0000 0.0000 0.0000
Dependent variable: CFOt + 1 = cash flows from operation one-year-ahead, NDNIt + 1 = non-discretionary net
income one-year-ahead, EARNt + 1 = change in earnings one-year-ahead.
Independent variables: CFO = cash flows from operation, NDAC = non-discretionary accruals, DAC =
discretionary accruals, DFAM = one if firms have high family ownership and do not belong to business groups and
zero otherwise, INST = institutional ownership, DSIZE = one if firm is in the 50% highest market capitalization
and zero otherwise, AUDIT = one if firm is audited by Big 4 auditors and zero otherwise, BOD = proportion of
independent board, AUDCOM = one if firms have audit committee and zero otherwise.
N after excluding outliers with criteria 3 times standard deviation.
Significant at 1%, significant at 5%, significant at 10% (two-tail).
S.V. Siregar, S. Utama / The International Journal of Accounting 43 (2008) 127 21
they have only been operating for a short period (2 years, from 2001 until 2002). Second,
publicly listed firms appoint independent boards only to comply with regulations; therefore,
independent boards are not utilized as a monitoring mechanism.
Hypothesis 1g, which states that the effect of discretionary accruals on future
profitability is higher for firms with audit committees than for firms without audit
committees, is not supported in panels A and B of Table 8. The explanations for this result
Table 8
Regression of future profitability on discretionary accruals, discretionary accruals-ownership structure, firm size,
and corporate-governance practices interaction, other earnings component, and control variables
Variable Expected Panel A: CFOt + 1 Panel B: NDNIt + 1 Panel C: EARNt + 1
sign
Coefficient p value Coefficient p value Coefficient p value
C 0.0251 0.0817 0.0226 0.0234 0.0557 0.1625
CFO + 0.4839 0.0000 0.7125 0.0000 0.0668 0.2711
NDAC + 0.3970 0.0000 0.2997 0.0000 0.1893 0.1335
DAC +/ 0.1635 0.1190 0.1276 0.0660 0.3205 0.2653
DAC DFAM + 0.1556 0.0556 0.1071 0.0317 0.6365 0.0088
DAC INST + 0.1209 0.3256 0.0924 0.2547 0.3609 0.6990
DAC DSIZE + 0.0481 0.2620 0.0298 0.2661 0.0045 0.4920
DAC AUDIT + 0.0910 0.8119 0.0342 0.6915 0.1563 0.7220
DAC BOD + 0.0294 0.453 0.1025 0.2927 0.6298 0.2447
DAC AUDCOM + 0.1424 0.8437 0.1131 0.8541 0.7678 0.0475
DFAM + 0.0171 0.0622 0.0055 0.7741 0.0352 0.1179
INST + 0.0403 0.8878 0.0313 0.9511 0.0993 0.1084
DSIZE + 0.0058 0.2527 0.0014 0.4041 0.0572 0.0045
AUDIT + 0.0200 0.0424 0.0069 0.2102 0.0148 0.3466
BOD + 0.0282 0.2651 0.037 0.8343 0.0558 0.3336
AUDCOM + 0.0276 0.9632 0.0125 0.8594 0.0791 0.0396
D99 0.0047 0.7079 0.1493 0.0000 0.1172 0.0002
D00 0.0387 0.0215 0.0534 0.0000 0.1231 0.0027
D01 0.0111 0.5455 0.0050 0.7254 0.0721 0.1638
N 553 558 551
Adjusted R2 0.2492 0.6847 0.4473
F-statistic 11.1789 68.1855 25.7294
p value (F-statistic) 0.0000 0.0000 0.0000
Dependent variable: CFOt + 1 = cash flows from operation one-year-ahead, NDNIt + 1 = non-discretionary net
income one-year-ahead, EARNt + 1 = change in earnings one-year-ahead.
Independent variables: CFO = cash flows from operation, NDAC = non-discretionary accruals, DAC =
discretionary accruals, DFAM = one if firms have high family ownership and do not belong to business groups and
zero otherwise, INST = institutional ownership, DSIZE = one if firm is in the 50% highest market capitalization
and zero otherwise, AUDIT = one if firm is audited by Big 4 auditors and zero otherwise, BOD = proportion of
independent board, AUDCOM = one if firms have audit committee and zero otherwise.
N after excluding outliers with criteria 3 times standard deviation.
Significant at 1%, significant at 5%, significant at 10% (two-tail).
22 S.V. Siregar, S. Utama / The International Journal of Accounting 43 (2008) 127
are the same as for the independent boards. But in panel C, this hypothesis is supported and
significant. Control variables are not consistently significant over the three alternative tests.
To test the sensitivity of our main analysis results, we measure discretionary accruals
using the other three alternative models [Jones (1991), Dechow et al. (1995), and Dechow
et al. (2002)]. If we use change in earnings, discretionary accruals have a negative effect on
future profitability (although it is only significant if we use Dechow et al. (2002) to measure
discretionary accruals). Further, consistent with our main results, if we use cash flows from
operation and non-discretionary net income, we find that discretionary accruals have a
positive and significant effect. These results suggest that the evidence regarding earnings
management in the JSE tends to be efficient. Hypothesis 1b is also supported, which is
similar to our main analysis results. This indicates that earnings management in firms with
high family ownership and no business groups is more efficient than in other firm
ownership.
To obtain a better measure of discretionary accruals, as suggested in Bernard and
Skinner (1996), Collins and Hribar (2002), and used by Xie (2001), discretionary accruals
is estimated after controlling non-articulation events (such as merger, acquisition, or
divestitures). Thus, observations with merger, acquisition, or divestitures are deleted.6 This
sensitivity test also shows qualitatively similar results with our main results.
The effectiveness of institutional investors' role in the monitoring process depends on
the level of control they have over the company. These roles will be restricted if another
party holds a majority ownership (such as a founding family). We employ interacting
variables between institutional ownership and a dummy variable for majority family
ownership (one if the firm has a majority family ownership and zero otherwise) to test this
effect. This does not change the results in our main analysis.
We perform a sensitivity test using a dummy variable for firm size. We use a cutoff
40%:60%, where 40% of the sample firms with the highest market capitalization are large
firms and 60% of the sample firms with the lowest market capitalization are small firms.
These results also do not differ qualitatively from the results in our main analysis.
The research period for our main analysis is the non-crises period 1995 through 1996,
1999 through 2002. Years 19971998 are excluded because those are crises periods. To
examine the test results in a crisis period only, we repeat the test using observations in those
years. These results are similar to those from the non-crisis period, where the evidence
regarding earnings management tends to confirm the use of efficient earnings management.
Earnings management in firms with high family ownership and no business groups is more
efficient than that of other firms.
The JSE rule requiring publicly-owned companies to appoint independent boards and to
establish audit committees was released in June 2000 and effective as of December 31,
2001, at the latest. We repeat our test using 20012002 data only. BOD and AUDCOM are
6
Number of observations with merger, acquisition, and divestitures is 144 or 16.67% (144/864) of total
observations.
S.V. Siregar, S. Utama / The International Journal of Accounting 43 (2008) 127 23
consistently not significant. The results indicate that independent boards and audit
committees do not necessarily lead to more efficient earnings management.
In our research model, we use several dummy variables (DFAM, AUDIT, DSIZE, and
AUDCOM). There is an inherent problem in using several dummy variables in one model.
It increases the number of cells (the number of cells is n2, where n is the number of dummy
variables) and thus decreases the average number of observations in each cell. Accordingly,
the reliability of the results is questionable. To overcome this problem, we break down
research model (1b) into several sub-models, with only one dummy variable in each. So, we
have the following model:
Xit1 bk0 bk1 CFOit bk2 NDACit bk3 DACit bk4 DACit Dkit
bk5 Dkit bk6 D99i bk7 D00i bk8 D01i e 1c
Expectation: k4 N 0
where: Dk = DFAM for k = 1, DSIZE for k = 2, AUDIT for k = 3, AUDCOM for k = 4.
The results of the above research model are qualitatively similar to our main analysis
results.
6.1. Conclusion
Our study finds that the type of earnings management favored by publicly listed firms on
the JSE tends to be efficient contracting. This result is not consistent with public perception
that these firms engage in opportunistic earnings management. We also find evidence that
earnings management in firms with high family ownership that do not belong to business
groups is more efficient than in firms with a different ownership structure. In contrast, we
do not find significant evidence that larger firms, firms audited by the Big 4, firms with a
higher proportion of independent boards, and firms with audit committees engage in
efficient earnings management.
6.2. Implications
6.2.1. For regulatory bodies (Indonesian Capital Market Supervisory Agency and Jakarta
Stock Exchange)
We find sufficient evidence to suggest that earnings management in firms with high
family ownership that do not belong to business groups is efficient. This suggests that
control by a founding family seems not to harm minority shareholders, if those firms do not
belong to business groups. Given that a majority of publicly listed firms belong to business
groups, our finding could be interpreted by regulatory bodies as a need to place additional
monitoring on those companies.
We find that the effect of future profitability is lower (although insignificant) on firms
audited by Big 4 auditors on firms audited by non-Big 4 auditors. It means that big audit
firms do not necessarily restrict opportunistic earnings management. This finding could
24 S.V. Siregar, S. Utama / The International Journal of Accounting 43 (2008) 127
suggest that audit firm size is not a good proxy for audit quality in Indonesia. Another
proxy for audit quality is audit fee and audit hours. But these data are not available on
annual reports. The Indonesian Capital Market Supervisory Agency could issue
regulations that require publicly listed firms to disclose this information on their annual
report.
The existence of independent boards and audit committees do not significantly
affect a company's pursuit of more efficient earnings management. There are several
possible reasons for these results. First, public companies only appoint independent
boards and establish audit committees to comply with regulations. They do not use
those boards to monitor management. Regulators need to determine the best ways, not
only to enforce the rules, but also to disseminate information about the advantage of
having good corporate-governance practices. Second, the minimum requirement for
independent board membership is 30%. This proportion may not be high enough to
exert significant influence on board. If this is true, then regulators should consider
increasing the minimum proportion requirement (maybe N50%). Third, the regulations
about independent boards and audit committees were only started in 2001. Hence, the
short period for which data are available for our study may account for our negative
results.
1. The ability of the Jones model and modified Jones model to accurately decompose
accruals into non-discretionary and discretionary components is still questionable.
Accordingly, there is a possibility of misclassification of non-discretionary and
discretionary accruals. If some components of non-discretionary accruals are mistakenly
classified as discretionary accruals, then this may explain the positive relation between
discretionary accruals and some measures of future profitability.
2. Due to a lack of data on corporate-governance indexes, we employ only audit quality,
independent board, and audit committee to measure corporate-governance practices in
publicly listed firms. Nowadays, there is no institution in Indonesia that has developed a
corporate-governance index for all publicly listed firms in the JSE. The only index
available is the Corporate Governance Performance Index (CGPI), which was issued by
IICG. But, most listed firms refused to participate in the survey. Only the indexes for the
top-10 firms were published in SWA magazine while the indexes for the other
participating firms are kept confidential.
3. Public firms in Indonesia have been required to appoint independent boards and establish
audit committees only since 2001. Our research period only goes up to 2002. Therefore,
results on the influence of independent boards and audit committees on earnings-
S.V. Siregar, S. Utama / The International Journal of Accounting 43 (2008) 127 25
management type, may stem from this short period of data. In addition, the measures do
not indicate the activities of the independent boards and audit committees.
4. The size of an accounting firm may not be a good proxy for audit quality in Indonesia.
References
Albrecth, W. D., & Richardson, F. M. (1990, Winterr). Income smoothing by economy sector. Journal of Business
Finance and Accounting, 17(5), 713730.
Anderson, R. C., Mansi, S. A., & Reeb, D. M. (2003). Founding family ownership and the agency cost of debt.
Journal of Financial Economics, 68(2), 263285.
Anderson, R. C., & Reeb, D. M. (2003). Founding-family ownership and firm performance: Evidence from the
S&P 500. Journal of Finance, 58, 13011328.
Arifin, Z. (2003). Masalah Agensi dan Mekanisme Kontrol pada Perusahaan dengan Struktur Kepemilikan
Terkonsentrasi yang Dikontrol Keluarga: Bukti dari Perusahaan Publik di Indonesia. Unpublished Dissertation,
FEUI Graduate Program in Management.
Balsam, S., Bartov, E., & Marquardt, C. (2002). Accruals management, investor sophistication, and equity
valuation: Evidence from 10-Q filings. Journal of Accounting Research, 40(4), 9871012.
Becker, C. L., DeFond, M. L., Jiambalvo, J., & Subramanyam, K. R. (1998). The effect of audit quality on earnings
management. Contemporary Accounting Research,, 15, 124.
Bernard, V. L., & Skinner, D. J. (1996). What motivates managers' choice of discretionary accruals? Journal of
Accounting and Economics,, 22, 313325.
Bhattacharya, N. (2001). Investors' trade size and trading responses around earnings announcements: An empirical
investigations. The Accounting Review, 76(2), 221244.
Burgstahler, D., & Dichev, I. (1997). Earnings management to avoid earnings decreases and losses. Journal of
Accounting and Economics, 24, 99126.
Bushee, B. J. (1998). The influence of institutional investors on myopic R&D investment behavior. The
Accounting Review, 3, 305333.
26 S.V. Siregar, S. Utama / The International Journal of Accounting 43 (2008) 127
Bushee, B. J. (2000). Do institutional investors prefer near-term earnings over long-term value? Unpublished
Working Paper.
Chtourou, S. M., Bedard, J., & Courteau, L. (2001). Corporate governance and earnings management.
Unpublished Working Paper.
Claessens, S., Djankov, S., Fan, J. P. H., & Lang, L. H. P. (1999). Expropriation of minority shareholders: Evidence
from East Asia. Unpublished Working Paper.
Collins, D. W., & Hribar, P. (2002). Errors in estimating accruals: Implication for empirical research. Journal of
Accounting Research, 22, 105134.
Crijns, H., & De Clerck, D. (1997). Familiebedrijven in Vlandereen Hoe Anders Zijn Ze? A study on the
critical aspects of family firms in Flanders: Governance, ownership succession and human capital. Unpublished
Working Paper.
Dang, L. (2004). Assessing actual audit quality. Unpublished Working Paper.
Darmawati, D. (2003). Corporate governance dan Manajemen Laba: Suatu Studi Empiris. Jurnal Bisnis dan
Akuntansi, 5(1), 4768.
DeAngelo, L. (1981). Auditor size and audit quality. Journal of Accounting and Economics, 113127.
Dechow, P. M., Sloan, R. G., & Sweeney, A. P. (1995). Detecting earnings management. The Accounting Review,
70, 193225.
Dechow, P. M., Sloan, R. G., & Sweeney, A. P. (1996). Causes and consequences of earnings manipulation: An
analysis of firms subject to enforcement actions by SEC. Contemporary Accounting Research, 13(1), 136.
Dechow, P. M., Richardson, S., & Tuna, A. I. (2002). Earnings management and costs to investors from firms
meeting or slightly exceeding benchmarks. Unpublished Working Paper.
El-Gazzar, S. M. (1998). Predisclosure information and institutional ownership: A cross sectional examination of
market revaluations during earnings announcement period. The Accounting Review, 73(1), 119129.
Fama, E., & Jensen, M. (1983). Separation of ownership and control. Journal of Law and Economics, 26, 301325.
Francis, J. R., Maydew, E. L., & Spark, H. C. (1999). The role of Big 6 auditors in the credible reporting of
accruals. Auditing: A Journal of Practice and Theory, 18, 1734.
Gul, F. A., Lung, S., & Srinidhi, B. (2000). The effect of investment opportunity set and debt level on earnings
returns relationship and the pricing of discretionary accruals. Unpublished Working Paper.
Jiambalvo, J. (1996). Discussion of causes and consequences of earnings manipulation: An analysis of firms
subject to enforcement actions by SEC. Contemporary Accounting Research, 13, 3747.
Jiambalvo, J., Rajgopal, S., & Venkatachalam, M. (2002). Institutional ownership and the extent to which stock
prices reflect future earnings? Contemporary Accounting Research, 19(1), 117145.
Jones, J. J. (1991). Earnings management during import relief investigation. Journal of Accounting Research, 29,
193228.
Kasznik, R. (1999). On the association between voluntary disclosure and earnings management. Journal of
Accounting Research, 37, 5781.
Kim, J., & Yi, C. H. (2005). Ownership structure, business group affiliation, listing status, and earnings
management: Evidence from Korea. Unpublished Working Paper.
Klein, A. (2002a). Audit committee, board of directors characteristics and earnings management. Journal of
Accounting and Economics, 33, 375400.
Klein, A. (2002b). Economic determinants of audit committee independence. The Accounting Review, 77(2),
435452.
Koh, P. -S. (2003). On the association between institutional ownership and aggressive corporate earnings
management in Australia. The British Accounting Review, 35, 105.
Krishnan, G. (2003). Audit quality and the pricing of discretionary accrual. Auditing, 22, 109126.
Kurniawan, D. M., & Indriantoro, N. (2000). Corporate governance in Indonesia. Unpublished Working Paper.
La Porta, R., Lopez-de-Silanes, F., & Shleifer, A. (1999). Corporate ownership around the world. Journal of
Finance, 54, 471517.
Lee, B. B., & Choi, B. (2002). Company size, auditor type, and earnings management. Journal of Forensic
Accounting, III, 2750.
Mayangsari, S. (2003). Analisis Pengaruh Independensi, Kualitas Audit, serta Mekanisme Corporate Governance
terhadap Integritas Laporan Keuangan. Simposium Nasional Akuntansi VI Proceedings.
McConaughny, D. L., Matthews, C. H., & Fialko, A. S. (2001). Founding family controlled firms: Performance,
risk, and value. Journal of Small Business Management, 39(1), 3149.
S.V. Siregar, S. Utama / The International Journal of Accounting 43 (2008) 127 27
Michaelson, S. E., James, J. W., & Charles, W. (1995). A market based analysis of income smoothing. Journal of
Business Finance and Accounting, 8(4), 11791195.
Midiastuty, P. P., & Machfoedz, M. (2003). Analisis Hubungan Mekanisme Corporate Governance dan Indikasi
Manajemen Laba. Simposium Nasional Akuntansi VI proceedings.
Mitra, S. (2002). The impact of institutional stock ownership on a firm's earnings management practice: An
empirical investigation. Unpublished Dissertation, Louisiana State University.
Moses, D. O. (1987). Income smoothing and incentives: Empirical using accounting changes. The Accounting
Review, LXII(2), 259377.
Nuryanah, S. (2004). Analisis Hubungan Board Governance dengan Penciptaan Nilai Perusahaan: Studi Kasus
Perusahaan-perusahaan Tercatat di BEJ. Unpubllished Thesis, FEUI Graduate Program in Management.
Parulian, S. R. (2004). Analisis Hubungan antara Komite Audit dan Komisaris Independen dengan Praktek
Manajemen Laba: Studi Empiris Perusahaan di BEJ. Unpubllished Thesis, FEUI Graduate Program in
Management.
Peasnell, K. V., Pope, P. F., & Young, S. (2000). Accrual management to meet earnings targets: UK evidence pre-
and post-Cadbury. The British Accounting Review, 32, 415.
PricewaterhouseCoopers in collaboration with Singapore Exchange (1999). 1999 Survey of institutional investors.
Sandra, D., & Kusuma, I. W. (2004). Reaksi Pasar terhadap Tindakan Perataan Laba dengan Kualitas Auditor
dan Kepemilikan Manajerial sebagai Variabel Pemoderasi. Simposium Nasional Akuntansi VI proceedings.
Sarac, M. (2002). An empirical analysis of corporate ownership structure in Turkish manufacturing sector. 6th
European Business History Association Annual Congress in Helsinki.
Scott, R. W. (2000). Financial accounting theory, 2nd Ed. New Jersey: Prentice Hall.
Shahira, A. S. (2003). Does ownership structure affect firm value? Evidence from the Egyptian Stock Market.
Unpublished Working Paper.
Subramanyam, K. R. (1996). The pricing of discretionary accruals. Journal of Accounting and Economics, 22,
249281.
Suehiro, A. (2001). Family business gone wrong? Ownership patterns and corporate performance in Thailand.
Unpublished Working Paper.
Van den Berghe, L. A. A., & Carchon, S. (2001). Corporate Governance Practices in Flemish Family Businesses.
Unpublished Working Paper.
Wedari, L. K. (2004). Analisis Pengaruh Dewan Komisaris dan Keberadaan Komite Audit terhadap Aktivitas
Manajemen Laba. Simposium Nasional AkuntansiVII Proceedings.
Wiwattanakantang, Y. (2000). The equity ownership structure of Thai firms. Unpublished Working Paper.
Yammeesri, J., & Lodh, S. C. (2001). The effects of ownership structure on firm performance: Evidence from
Thailand. Unpublished Working Paper.
Xie, H. (2001). The mispricing of abnormal accruals. The Accounting Review, 76, 357373.